“USD/JPY” CURRENCY PAIR TREND ANALYSIS

 By Tom Cleveland

Stocks are down 38% as Housing Bubble bursts.  Housing prices fall 90% in some cities as consumers and businesses alike are underwater on mortgage debt.  Bank balance sheets balloon with toxic assets awaiting write-downs.  Consumer confidence is eroding.  Sound familiar?  But these are not our news headlines from a few years back.  These were the news headlines in Japan in 1990, some twenty years ago.

Japan Incorporated, the model for super successful business strategies, was in full economic breakdown.  The stereotype of the “Salaryman” working five and a half days a week for one company for a lifetime was in jeopardy.  Newer generations wanted no part of this work ethic, nor did they procreate enough to support future social security and tax liabilities.  The resulting recession lasted fifteen years, ending in 2007 when the rest of the world found itself hanging on a precipice similar to Japan’s 1990 version.

To many, the “Great Recession” has replayed many of the same scenarios as in Japan some twenty years back, but on a global basis this time around.  Advanced economies of developed nations have been mired in tepid recovery plans, trying every monetary and fiscal trick in the playbook to turn their respective economies around.  As Japan sat on the sidelines, most analysts expected the U.S economy to pull out of its ditch and speed past Japan.  However, the “USD JPY” currency chart depicted below does not bear out these sentiments for the past year:

The Dollar actually peaked back in 2007 at 123 Yen, but has been on a decline ever since the Lehman Brothers failure.  For eighteen months from 2009 into early 2010, the Yen tested the “90” level, finally falling to new record lows and forming the descending triangle illustrated in the above chart.  The anticipated breakout from that pattern materialized in November, but a new channel quickly formed, only to witness another brief upward breakout as shown. Enthusiasts of forex trading hat have gone long on the Yen have profited handsomely from that strategy for the past several years.  The question now is where will this currency pair head next?

Japan recovered from its prolonged recession without major structural reforms and was only recently passed by China as the number two economy in the world.  The country still imports basically all of its energy and commodities.  Japan’s land mass is smaller than California, and only 15% of that is inhabitable, which must also be shared with agriculture.  Effeciency and effective use of all resources, though emblimatic of the culture, are more a necessity than a way of like. 

Although officials were slow to respond to the latest global recession, Japanese businessmen have been quick to adopt Western ways.  Personnel budgets have been slashed at unprecedented rates, including summer bonuses.  Supply chains and distribution channels have been restructured.  Corporate Japan is leaner and meaner these days, and more than ready to face new competitive challenges around the planet

Although most believe the strong Yen has bottomed, it is never wise to underestimate the prowess of the Japanese to adjust to new economic situations.  The experience gained during their prolonged “balance sheet recession” is immeasurable.  The fact remains that the “79” level was never tested during recent pricing behavior, and the market’s inability to gain ground is worrisome.  Sideways market action is too reminiscient of last year’s long-playing record.

While the United States wallows in high unemployment and ever-increasing budget deficits, one has to wonder why this pair would ever move north.  Another round of quantitative easing will not help either.  Be cautious if lows are tested again.

FX BACKTESTING

By Jennifer Gorton

Successful traders swear by it.  In fact, many claim it to be the most important habit that they have developed over time to ensure their success.  What is deemed to be a habit that you cannot do without?  Backtesting is the consistent reply by those in the know.

A straightforward definition of the word from an Internet dictionary is as follows:

“Backtesting is a process, usually performed with aid of computers, by which traders try to estimate how financial instruments would have performed in the past had a particular mechanical trading system been employed to trade them.”

Ever since commodity traders observed pricing patterns tied to the seasons centuries ago, the art of technical analysis has evolved to a level of sophistication that has produced thousands of signal indicators for the purpose of prudently guiding a trader’s entry and exit in any market.  Everyone, including those involved in  currency trading,, seems or wants to believe that there is a Holy Grail out there that will produce instant wealth, if only it could be found.

Forex price behavior never moves in a straight line, but in zigzag patterns that resemble waves.  These waves, like all waves that occur in the natural world, are produced by the ebb and flow of buying and selling forces in the market, searching for a balance point.  Technical analysts have studied these waves and can predict with a high degree of probability the future direction of such prices when certain conditions exist.  The objective then becomes finding the right “system” or combination of signal generators that give accurate guidance more times than not.

Traders could obviously test out their theories using broker demo accounts and real time trade data, but that process could take years to perfect.  If going forward takes too long, then going backward must be the answer.  By testing a “trading system” with historical data, a trader can fine tune his parameters, measure his success rate, and prepare for a real time test using real money.  Sounds like a logical plan of attack, but does it work?

To begin with, it would help if you had a programming background.  The first task is to assemble a database of historical forex trading data.  This task is not as easy as it sounds.  The forex market is not centralized.  Various data reporting services “buy” their data from a variety of banking participants in the interbank market.  There are no reliable sources for accurate data.  The data you get is reflective of the point of access, nothing more, nothing less, and variations are to be expected.  In fact, there may be gaping holes in the acquired data, and depending on the timeframe, you will have millions of items to deal with, thereby requiring something a lot more sophisticated than an Excel spreadsheet.

Some traders accept the historical data that their forex broker can provide, usually two years worth, but only for a few trading pairs.  The highest volume pair is the “EUR/USD”, but traders tend to prefer the “GBP/USD” pair since there is more volatility and opportunity for profitable trades.  Assuming that you get past the historical data requirement, there are three basic methods for backtesting:

·         Manual Testing:  Yes, the old tried and true manual approach is one way to go.  It does take time, as you have to bring up the data elements one at a time, allow your system to generate signals as you scroll through data, and then record your results.  It is time consuming, but you are building valuable trading experience as you slog through the data;

·         Software Testing:  The preferred method is to use software designed for the process.  It produces results as if you were in a real trading environment.  The product mentioned most in review articles is “Forextester”;

·         Programmed Approach:  OK, if you are not a programmer, this is not an option.  But if you are, then you can design something that appeals to your personal needs.  However, the automation of trades does not always replicate how you might react in a trading environment, so there are more variables to consider.

The primary issue with backtesting is that the past is no guarantee of how the future will unfold.  For example, if you had chosen to use data over the May/June period of this year, the European debt crisis would have skewed the test data enormously and given mixed results for backtesting. 

The fact is that situations are always changing and shaping price behavior accordingly in our markets.  However, the general experience and confidence that can be gained in a trading system by backtesting are benefits that most likely make the process worthwhile.  Confidence leads to consistency, the primary goal in every trader’s plan of attack.