Patterns & Correlations

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Patterns & Correlations

Postby bforex » Wed Apr 21, 2010 9:58 am

The CAD had explosive price action Tuesday, gaining nearly 1.7%. Look at the 1 hour chart below. We use a line chart in place of candles as a clear pattern sticks out. We also over-layed in red an 8 moving average to smooth price action out further. What we see develop is a Head & Shoulders pattern. Even more remarkable is the equal velocity with which price rose and fell. The CAD Resistance sits between .9960 and parity and once again looks to close within that range.

As we have mentioned numerous times, the CAD and Oil are highly positively correlated. The question is frequently asked which movement leads the other or do they share that role. More often than not they both serve as a price leader depending on what is pushing the markets higher or lower. In the chart below Oil fell from its recent high above $86 a barrel just as the CAD failed to sustain parity with the USD. Look at the 1 day jump in Oil prices a near $2.20 intra-day gain or a 2.0% (+/-) gain. Many traders use correlations to help formulate entries and exits. Very few correlations are 100% correlated and if they were it would remove the possibility for generating PNL as prices on the two assets would move in a near perfect parallel form.

Although there are many substantive reason to own the JPY, we need to first examine the JPY's role within currency markets. The JPY is thought of as a funding or financing currency due to the historically low interest rate in Japan. This is also beneficial for Japanese exports which is a major component of their GDP. As such, when risk aversion is in control traders will limit their financing cost and exposure which causes the JPY to appreciate. When traders jump back into their positions they seek to continue their positional financing and therefore sell the JPY in favor of higher yielding currencies. This causes the JPY to depreciate. Look at the chart below and you can see Friday and part of Monday's market risk aversion. On Monday the DJIA closes higher signaling risk aversion has subsided (vertical line) and the JPY looses ground, nearly retracing its gains completely. The correlation between risk and the JPY is very high and obviously effect the actual price at which the JPY trades.

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