I have long believed that it is a fundamental law of the markets that trading strategies do not work. At least not in the long run. This is based on that fact that if they did, then eventually everyone would use the winning strategy which would make everyone trade the same way and cause the market to come to a standstill due to a lack of buyers or sellers.

In the short run, however they do work and this can of course be seen empirically. Generally, a trading strategy takes advantage of a little known or subtle anomaly in the market, that when discovered soon vanishes. (This is why all those amazing performance records of trading bots mean absolutely nothing)

Now if you get lucky you will find a strategy that lasts long enough for you to make a good amount of money and then leave the market while you are still on top, but I think we all know how often that happens. For long term profits a trading strategy isn’t helpful. They all take advantage of an aspect of the market that is only temporary.

However, a trading system is something that no trader should be without. What’s the difference? Well, a trading strategy tells you when to buy or sell what pair, while a system tells you how to act on a trade once you enter it. It’s the difference between what to do and how to do it.

There is no sure fire way of knowing what to do in the Forex market but, a good system will tell you how to trade the right way every time.

Last week I wrote that I expected a large drop in AUDUSD if the RBA signaled that they would be holding rates steady. Well they did, and boy did we get a drop. The pair has fallen down to the 0.8800 level. The 0.8600 level still stands as a strong support level, and I believe that the week’s trend of a falling AUDUSD will continue into tomorrow.

As far as tomorrow’s unemployment rate goes, Yohay Elam of ForexCrunch.com writes that “a drop up to 9.5% or a rise to 9.9% won’t make a difference”, and I agree with him. There is a good chance that this move will bring AUDUSD down to its support near 0.8600. This would be much sooner than I expected, but the market doesn’t really care what I think.

Whether USD will continue to gain strength into next week, is a hard call to make at this point. But, generally if we have a strong negative week, the next week opens to the upside, so I would not want to be in an AUDUSD short over the weekend. Of course I wouldn’t want to be long either.

Next week brings some very important news with it. On Tuesday we will see if the RBA will be hiking rates for the third consecutive time. There will be US unemployment data and a rate statement by the ECB. While the volume of data is not very high the importance of it is.

The market is slowly falling into risk aversion and it will have little reason to change course unless we get some new information.

Monday 5/3

No important news scheduled.

Tuesday 5/4

4:30 GMT Australian Interest Rate Decision

The expectation is for the RBA to hold, but this will be a close one. Don’t be surprised if they raise rates again. If they do it would be a short term gain for AUD, since there is a relatively high level of uncertainty about the decision. Watch the statement though for signs of the end of the rate hikes.

Wednesday 5/5

No important news scheduled.

Thursday 5/6

12:30 GMT ECB Interest Rate Statement

The ECB will continue to hold here, and for the foreseeable future as well. Trichet has little to no power over the Greece situation at this point, so his only option is to stand back and watch. Don’t expect much to come out of the statement.

Friday 5/7

12:30 GMT US Unemployment Rate

The unemployment rate in the US has stood at 9.7% for three months now. A lot of the employment strength has been due to seasonal adjustments by the BLS. The current down trend in unemployment could be tested here

AUDUSD remains constrained by its lower highs, a trend that began this month. There is still support just above the 0.9100 level; however the price action suggests that this support will be broken. The pair has been trading in a large range over the last six months. The lack of interest rate movement out of the Fed will likely contain the pair to this range.

The return to the bottom of the range around 0.8600 will most likely be triggered by a signal from the RBA that they will be holding rates steady. As long as they continue on their rate hiking cycle, the pair should be bolstered to the top of the range. There is strong profit potential for an AUDUSD sell, this would be a long term trade, with a larger stop loss above the recent highs around 0.9370 that would target a return to the 0.8600 level. This trade should be exited if either the Fed or RBA signal imminent rate hikes.

Down Trending Highs In AUDUSD

There is a tactic that every trader out there has tried, and it never works. Has this ever happened to you? You come up with a new trading strategy, only to find that it proves to be unprofitable. So you have the idea of reversing the signals to produce winning trades.  Surely this would yield a winning strategy, but it doesn’t. There are two main reasons why this does not work.

The first reason applies to those strategies that lose slowly. They have what I like to refer to as a leak. This leak is problem number one, the market is not a zero sum game; it is a negative sum game. In other words if you add up all of the winnings and losses in the market they would not completely equal each other, they would add up to a loss, since each transaction has some cost associated with it. For almost all retail traders this cost is the spread.  Most traders are capable of creating a system that takes advantage of anomalies in the market to squeeze out a few pips per trade on average. The problem is that the spread is greater than the average profit, so simply reversing the signal would yield not profit since the cost of trading is independent of the direction traded.

The second reason is from trades that lose most of their equity in a small portion of their trades, such as the death trade inherent in a martingale system. These signals cannot be reversed to produce a winning strategy because of the way that equity grows. Your rare large wins will not be equal in magnitude to your large losses of the original strategy, your equity has fallen and with it your ability to make profit. So, your rare but large wins will not be able to compensate for your consistent losses.

So, how can this help you be a better trader? By identifying these two major sources of losses, you can better avoid them. First, to reduce the impact of spread on your trading, find a broker with consistently low spreads. Second, protect your equity at all times with an emergency stop loss, remember you can close the trade before the stop loss it hit, but keep it there to protect your capacity for profit.

The market is not looking promising for risk appetite this week. Equities broke down below 1200 on Friday, and they remained under that mark in todays trading. The talk is that the SEC’s investigation into Goldman Sachs is what is causing this risk aversion, that may be the case but this type of news rarely has a lasting impact in the market, I believe that there is still hope for risk appetite this week.

Despite the poor showing in the equities market, AUDUSD made back half of its losses that it incurred since last Thursday. The pair still has a bit of strength left in it and looks to have set a course for 0.9285.  EURUSD has followed the same general movement as AUDUSD but a bit more subdued, although any short term gains in EURUSD would have a hard time breaking above 1.3515.

The one pair that remained intertwined in the equity price action was USDCAD. The pair has held on to its gains from last week. Partially to blame is its proximity to parity, which always seem to make USDCAD act outside of the normal correlations. The other, perhaps more important, reason for the relative strength of USD against CAD is the movement in oil which has fallen to just above 80 dollar a barrel in the last few trading days.

The long term trend is still in favor of risk appetite however, it looks like the most likely scenario is for the market to take a breather in the short run. This is only natural when you look at the price action since February.

Our friends at the Pragmatic Capitalist write:

As the can’t lose market continues to power higher I just can’t help but think about some of the catalysts that lie in our path over the next 24 hours.  Investors have been front running the current earnings season with very bullish expectations and the next 24 hours could prove them right as Intel and JP Morgan are set to report.  In addition,the commerce department is set to release their monthly retail sales report tomorrow and current low expectations could add fuel to the bullish fire.

full article

They are expecting a strong showing of risk appetite tomorrow, citing better than expected earnings and Bernanke’s zero interest stance as the catalysts. If this proves to be true, look for the S&P to break past 1200.
This would be an enormous boon for risk AUD, and would bring a nice rally in the carry trade. While today’s price action in US equities showed 1200 as a still unreachable target, it came right back up to that mark at the end of the day. This is quite promising for those looking to take a bite out of the risk apple.

Today, the committee in charge of declaring the beginning and end of recessions announced that it was too early to declare the current economic slump over.

In a statement on NBER.org, the Business Cycle Dating Committee said, “Although most indicators have turned up, the committee decided that the determination of the trough date on the basis of current data would be premature.”

This comes as no surprise to us here as IntegrityFX Plus’ Joshua Habben wrote in August of 2009 about the NBER’s lagging approach and the Fed’s subsequent action:

So under Greenspan, the Fed averaged a delay of 33 months between the recession ending and raising rates. There was even an average delay of 12 months between the NBER announcing the recession and the Fed raising rates. The Fed, despite its need to anticipate and act quickly, was unexpectedly behind the ball. One might wonder if the NBER would do a better job of monetary policy, but I’ll keep the focus on the timing, not the competence, of the Fed.

This data can be used to make a projection of when Bernanke will raise rates, specifically the earliest he would do so. The earliest the recession could reasonably be declared to have ended would be Q2 2009. So, under the assumption that the end of the recession occurred in June 2009, that yields the following projection:

1) The NBER will announce June 2009 was the end of the recession in February or March 2011.

2) The Federal Reserve will begin raising rates in March 2012.

Read the Entire Article From August Here

We’ll have to wait to find out if Joshua’s projections hold true, but judging from the lack of interest from NBER up to this point and the Fed’s staunch dovish stance, it seems right on track and can be used as a great indicator for interest rate expectations and the strength of the Dollar.

Even though the short term relationship between the US dollar and equities hasn’t been too strong as of late, it is still a powerful indicator to watch over the medium term. The S&P is facing some serious resistance at 1200 on both a technical and sentimental level. Remember that once the market fell below 1200 in 2008 it moved into the free fall that has taken the last year to recover from.

What we can say about this in reference to the dollar is that as long as the S&P stays below 1200 the dollar will continue to gain strength, especially against EUR. Above this mark however, the dollar will most weaken as investors become hungry for risk and seek out higher yields in their currency holdings.

Which brings us to AUDUSD. This pair has moved into the spot that EURUSD has in relation to equities. Australia is the highest yielding major currency, so look for new highs in the pair as the S&P breaks through resistance.

For more information about using equities to help trade Forex, read my article: A Guide to Intermarket Analysis Part 2: Equities.

After today’s announcement it is clear that Australia is continuing on its course to tighten monetary policy. The consensus is that they are targeting a 5.25% interest rate, according to a recent Bloomberg article. But, what about the rest of the world?

According to Bloomberg we will have to wait some time until we get rate hikes outside of Australia.

Policy makers have “gotten their eye off the immediate ball, which is deflation risk,” said Joseph Gagnon, a former Fed official who is now a senior fellow at the Peterson Institute for International Economics in Washington. “It’s misguided for anybody to be talking about exiting” from stimulus during the next year.

Trichet’s ECB Governing Council convenes April 8 as Mark Wall, Deutsche Bank AG’s chief euro-area economist, and Janet Henry, HSBC Holdings Plc’s chief European economist, scrap forecasts for the refinancing rate to be raised this year from a record-low 1 percent. Both now expect the first increase since July 2008 to come next March.

Major central banks “are going to stay on hold longer than otherwise, keeping zero rates or near-zero rates at least to the middle of next year,” Nouriel Roubini, a New York University professor and chairman of Roubini Global Economics LLC in New York, said in an interview.

According to the Fed, inflation will be kept at bay for quite some time now. In other words, there will be no interest rate hikes for quite some time. The Fed has stuck to the term “an extended period” so look for the exclusion of this term to signal the beginning of a move toward rate hikes.

It looks like AUDUSD has considerable fundamental strength behind it, possibly enough to return to its highs, if not break them.

The entire Bloomberg Article can be read here.