Ranking the majors

First, let’s take a look at the summary rankings in it. The Canadian dollar (see “Remember the forgotten currency,” February 2006) has spent the most time in a trending state since the Jan. 4, 1999 advent of the Euro. The Australian dollar (see “What’s down with the Australian dollar?” March 2008) has the lowest average excess volatility. Both are considered to be commodity- linked currencies (see “Of commodities and currencies,” July 2006).

The AUD had two rather lengthy up trends, one between summer 2001 and spring 2004 and another from fall 2006 through July 2008, at which point it broke sharply.

What is surprising is how often during its rather pronounced uptrend the oscillator not only turned negative but several times fell into oversold conditions. Visual inspection turns up nothing unusual in any of these downdrafts; in each and every case they were sharp and shortlived sell-offs within a broad uptrend. While some could (and indeed will) argue these represent buying opportunities, they also represent real loss of equity for those with long positions.

The excess volatility chart (bottom) is more interesting in many ways. During the first broad uptrend, excess volatility remained high as the AUD had been under severe downward pressure in the late 1990s. The situation reversed during the second uptrend — the currency market was very comfortable with a long AUD position. Excess volatility collapsed during the sell-off in September-October 2008, which indicated the actual severity of the AUD’s move was left uninsured by options traders.

The Canadian dollar ( is the market most currency traders would assume was the trendiest. The CAD had a long and powerful uptrend between the beginning of 2003 and the end of 2007, but as was the case with the AUD, it had a large number of short-lived bona fide downturns. A trend following trader could — and by evidence did — get knocked out of long positions numerous times during this trend. The CAD, like the AUD, broke sharply during the September - October 2008 credit crunch. Its break was swift and severe enough to be done without any trend reversals.

The excess volatility chart tells the real story, though. It remained quite high for the CAD during the tail end of its long bear market (extending through 2001), but once its bull run began, excess volatility dropped during nearly all periods of positive trend. Also like the AUD, its excess volatility fell sharply in the September-October 2008 sell-off.

There must be something about speaking English that is related to currency trends, as the third trendiest currency amongst the majors is the British pound. This is a little surprising given the GBP’s primary trade is not against the USD but rather against the Euro. And visually the price chart is far noisier than that of either the AUD or the CAD. But let’s remember that point about hikers and their compasses and accept the data for what it is.

The most interesting aspect of the British pound here is, like the Canadian dollar, how high the excess volatility was in 1999-2002 and then how it switched to a pattern where volatility spikes tended to mark tops in price. A data-mining trading system designer (which may be a redundancy) could back-fit a trading system to sell the GBP on these volatility spikes. In addition, the GBP’s excess volatility is both highly asymmetric — it tends to surge much higher over 0.00 than it falls below it — and has the highest average level of any of the major currencies by far.

Few of us would expect the Japanese yen to rank very high on any measure of trendiness, and we are not disappointed in that regard. The JPY has remained in a fairly narrow trading range since 1999, but within that range we have seen several substantial trending moves tied to global financial crises and developments in the yen carry trade (see “A closer look at the carry trade,” July 2007). Moves in the trend oscillator outside of ±0.40 tend to produce mean-reverting responses, and as befits a long-term trading range, these moves have been fairly symmetric.

The excess volatility measure for the JPY was quite high in 2000-2001 as the Bank of Japan contemplated quantitative easing, which at the time was regarded as improbable. Once they went to the policy, excess volatility fell and remained in a narrow range until the credit crunch emerged in mid 2007. When traders unwound yen carry trades in response, excess volatility fell and remained low except for a brief period in early September 2008. The market knew what it wanted to do with the yen, which was to repurchase what it had borrowed, and proceeded to do so without further ado.

The Swiss franc (see “The Swiss franc’s commodity connection,” October 2008) used to, along with the old Deutsche mark, have a reputation for long running, pronounced trends. This changed after the advent of the Euro and the realignment of global currency trading into two broad currency blocs — the dollar bloc and the Euro bloc (see “The dollar index and ‘firm’ exchange rates,” December 2005).

Even so, the CHF remained in a broad uptrend against the USD from mid-2001 until the September-October 2008 credit crunch. This is evidenced by a very large number of overbought spikes on the trend oscillator against but one oversold spike in mid-2005. Also, the CHF appeared to be very comfortable within its uptrend judging by its low excess volatility measure after the Swiss National Bank ceased cutting its LIBOR target rate in mid-2003. And like other currencies, its excess volatility broke after September 2008 as the USD strengthened.

We finally come to the least trendy currency amongst the majors: the Euro. Even though it spent the first two-and-ahalf years of its history declining against the dollar and the next six years rallying — before breaking severely during the September-October 2008 credit crunch — it has had sufficient backing and filling to spend almost 40 percent of its life outside of a trending state. As the deepest and most liquid currency market in the world, the Euro tends to get very crowded at the end of a trend and reverses suddenly. This explains why trend-followers in currencies have such a poor track record.

The excess volatility spikes since 2003 have provided clear signs as to when these reversals are coming. The market senses it has moved to an extreme, but instead of reducing trend positions, it seems content to buy option protection. We can revisit the one article on trading psychology that’s ever been written as to why this is: Greed overtakes fear when a trend gets strong.