Technicals and fundamentals

The persistence of trendedness is because of traders grabbing hold of one or two key ideas and hanging on like a terrier with a bone until a bigger idea comes along. The big themes don’t change much over the years, either, so the longer you trade the FX market, the easier it is to understand why traders respond the way they do to certain types of news and economic developments. If you can forecast the news and economic data, you can get a head start on what the majority of traders are going to do. Anticipating trader reaction to news allows you to forecast the direction of a trend and bet on it early –– when the juiciest profits are to be made.

It might sound silly to say “forecast the news” when obviously no one has a crystal ball, but in practice we usually know the probable range of any particular piece of news and can guess how traders will act along the spectrum of possible outcomes. For example, after the Federal Reserve raised a warning flag about foreigners potentially losing their appetite for U.S. securities because of the huge current account deficit, the monthly capital flow report became the most important piece of data in the world. Ahead of the October data release on Dec. 15, the previous month saw an inflow of $65 billion and the monthly average for the year-to-date was $72 billion. Also, the November trade deficit had just come in at $55.5 billion.

Never mind the trade report was for a different month than the capital flow report.

In the rough arithmetic of trading, it didn’t take a rocket scientist to figure out the capital inflow had to be higher than the trade deficit to avoid being hugely dollar-negative.

Then the news came out incoming foreign investment fell to only $48.1 billion. The dollar tumbled vs. the euro by 36 points in 15 minutes and by 56 points over the next three hours, in a straight line. If you had known the number was going to be bad, the trade would have been a no-brainer.

Actually, many people had guessed the number was going to be bad. One clever analysis noted that inflows into corporate bonds the month before (the $67 billion month) was abnormally high.

Corporate issuance (selling of corporate bonds) in the relevant reporting month had been abnormally low. Therefore, it was likely the net inflow would fall short by the amount of reduced corporate bonds sold to foreigners, which is pretty much what occurred.

But even if you do not have access to fancy analysis like this, you could have made the same guess. Numerous Federal Reserve officials, including Chairman Alan Greenspan, had been harping on the issue for more than two months, practically inviting traders to sell the dollar –– a big-picture environmental factor that had set the tone for an anti-dollar bias. Also, the sheer size of the number was frightening. The trade deficit was a record $55.5 billion, higher than expected and the fifth consecutive month over $50 billion.

Worse, the deficit with China –– the sorest of sore spots — was $16.8 billion, up 27 percent over theyear before and more than 30 percent of the total deficit. Because there is nothing the U.S. can do (at least nothing that would provide an instant fix), these bad numbers have risen to the top of the list of important factors.