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Evening Standard
Examiners Report
Candidates faced a tougher examination than previously. Higher
marks were needed for both pass and distinction and a more
rigorous approach was taken to the framing of questions. Indeed in
the opening section the choice was reduced to two questions as
opposed to three in order to avoid an easy option. Once again
assistance was given in preparing questions on a specialist topic by
the Diploma course lecturer concerned.
There were 23 candidates of whom 3 gained distinctions, a further
12 passed and 8 failed. The average mark was 61.3% (compared to
61.3 last year, 60.8% in 1998 and 60.9% in 1997).
The percentage of candidates failing rose to 34.8%, which is
marginally worse than the 33% students are warned to expect and is
in line with other courses at academic establishments.
There was, however, an improvement in the general quality of work
presented and this may well stem from another change in this years
exam: time allowed has been extended from two and a half hours to
three. An omission from a full complement of answers is much rarer
and fuller answers are common.
Point and Figure is an option that most candidates choose and it is
an obvious strength of the South Bank Diploma course since most
are well conversant, if not yet expert, in the technique.
Candidates seemed well prepared and the quality of communication
has improved. Revision day was held nearly three weeks ahead of
the exam permitting more time for its influence to help guide
candidates.
Despite the increased failure percentage, the average mark remains
the same. It does mean that the general standard has improved.
Students have manifestly worked hard; the lecturers on the Diploma
course are to be congratulated; the examination author and
administrative team also deserve much credit.
Book Review
4
MARKET TECHNICIAN Issue 38 July 2000
Trading in the FX market has changed dramatically over the last few
years. While this is still a $1.3 trillion per day market, as outlined in
the article All change in the FX market published in the IFTA
magazine last year, the market has gone through a period of change.
The consolidation of the FX industry is partially due to the
introduction of the euro and the headline-making bank mergers,
both of which have led to margins being squeezed in traditional FX
markets. This makes banks more eager to deal in exotic markets
that they would have avoided in the past, as the margins in less
liquid currencies are still wider, hence making them more profitable
for dealers to work in. On the other side of the trade, the Asian
crisis of 1997/1998 highlighted the need for corporate and
institutional customers to be pro-active in their FX risk management
as the sharp swings can affect returns in a quite a large way. Charts
are very useful for spotting opportunities and helping to determine
the risk / reward ratio that is critical to any trade or investment,
especially in regional markets where strict adherence to the
underlying fundamentals or listening to the locals can be very,
very wrong! For example, it was inconceivable to many in Asia in
early 1998 that by cutting interest rates the local currency would
strengthen. The charts however identified potential reversal patterns
which showed that the market was re-evaluating the trend and that
cutting interest rates, despite what the local experts were saying, was
being well received by the market.
Some key things to keep in mind are: Charts and common sense
can help...
Basic charting techniques are best (patterns, moving averages)
Know the local market conventions and legalities
Yield enhancement versus real risk must be considered at all times
Dance like a butterfly, sting like a bee (the exit doors can get
rather small!)
CARRY TRADES AND YIELD ENHANCEMENT
Many investors and funds trade in regional currencies in order to
enhance the yield that is available to them. This is usually done on
a leveraged basis by borrowing funds in a low yielding currency and
investing the funds in a high yielding currency. The potential
carry gains are easy to calculate and the potential positive
movement in the FX rates can be very attractive. Keep in mind
though that the high yield on the currency is probably there for a
reason, and that can make the potential losses on adverse
movement in the FX rates extremely high. The question that must
be asked on every trade is Does the potential reward outweigh the
potential risk?.
Indicative yields for market amounts of $1 million USD or more on
deposit for 92 days are: EUR 3.00% US 5.69 % GBP 5.68% Yen
0.2% CHF 1.75% South African Rand 10.50% Turkish Lira 25%
Greek Drachma 8.25% Czech Koruna 5.13% Slovak 7.50% Polish
Zloty 17 % Norwegian Krone 5.25% Icelandic Krona 10%
Mexican Peso 16%
Carry trade = Lending yield borrowing yield or
Carry trade = high yield low yield which hopefully will outweigh
depreciation /devaluation risk!
Example
1 million USD worth of EUR/ISK for 30 days = $6,250
(yield spread x amount x number of days)/360
on a $20 million portfolio = funding at 2.5% lending at 10 % FX
stable = $125,000 profit per month with no gearing. If this was
done every month for 1 year there would be a $1,500,000 profit!
Given the market norm of 10 times gearing, the $20 million USD
portfolio would gear up to $200 million and the profit would be
$15,000,000 per year. To repeat the main point, the question is
whether or not the FX relationship is stable. If the spot rate moves in
an adverse manner the gearing can create a situation where the $20
million portfolio becomes a $5 million portfolio at the end of the
year.
The Yen is the funding currency of choice for many carry trades.
With interest rates near zero the yen is attractive but as the chart
below shows, it is a very whippy currency. The move from the
Y147.60 yen lows (USD high) of 1998 down to below 110 wiped out
many of the carry trades that were funded with the yen as the
adverse spot rate move really hit the market. Looking at the chart
shows that a head and shoulders pattern (the first of many) could be
in place with targets near Y80. This serves to keep Yen carry traders
on their toes.
The chart below shows the THB/USD a weekly chart with 13 and
50 week moving averages. The THB was until summer 1997 a
wonderful currency to trade. The central bank (Bank of Thailand)
ran the THB as a basket currency, with the basket made up mostly of
Yen and Deutschemarks. Given that THB deposits paid a lot more
than Yen and DEM deposits, borrowing the last two and lending in
THB was an easy way to put a carry trade on, with the stability
of the FX relationship more or less ensured as long as the basket was
intact. The summer of 1997 basically shattered that relationship as
the THB was attacked by speculators, the BoT smashed the
speculators by using the forward market and spot, driving spot
sharply higher against the USD before giving up, letting the THB
float (no more basket) and the Asian crisis was underway. The
lessons from the early part of the crisis are clear, always be aware
that the exit door in illiquid FX markets is smaller than the entry door.
When there is a panic big/offer spreads will widen out, options will
be expensive (if available) and the disappearance of market liquidity
means that you really need to have a good relationship with your
bank to trade these currencies for any hedging purposes. From a
charting perspective the blowout in 1997 was basically a series of
bull flags on the daily charts, with market sentiment following the
traditional fear / greed / fear / greed cycle. The USD peak was
marked by the market being in full panic mode, while the firming of
the THB against the USD in 1998 was marked by continued disbelief
in many that the worst was over. Charts showed a pretty V top
with a potentially massive head and shoulders pattern dominating
activity. Current activity is showing a potential crossover in the 13
and 50 week moving averages but for choice any USD upmove will
Charting the regional FX markets
By Gerry Celaya
This article is a summary of a talk given to the Society on 12th April, 2000
JPY=. Bid [Hi/Lo/Cl Bar] [(MA 50] Weekly
Issue 38 July 2000 MARKET TECHNICIAN
5
be limited to the 40.000 zone with the next major move still
expected to be in line with the major top pattern, towards 36/35.60
again and lower for the USD (25.000 in a few years?). As a side
note, even though the USD rally in 1997 suggests that the
speculators won the battle, George Soros is on the record as saying
that the BoT squeezed them and many others out of their positions
before the THB really devalued, suggesting that the major USD
buying through the 3rd and 4th quarters of 1997 was done by
corporates and hedgers.
The chart below shows the THB/YEN relationship. As seen, the pre-
summer 1997 relationship was relatively stable. Since then the cross
plummeted (weak THB, strong YEN, hurting any carry trade) and
has yet to show any convincing long term basing signals. For choice,
a flat trading range should continue to dominate.
The USD/SGD chart shows the Asia crisis effect pretty well with
Singapore in the middle of it all . The breakout of the flat channel in
1997 was followed by a solid panic of buying USD. The SGD
chart is different from the other Southeast Asian FX charts because
the fact that the Malaysian Ringitt, its cross straits neighbour, is
pegged,has served as a dampener on activity over the last 18
months. Technically, current activity shows pressure on USD
resistance and the risk of a break through 1.7360/7400 is high. For
choice, even though the turn above the declining trendline in early
2000 suggests that the USD will fly higher, the horizontal resistance
line at the 1.7360/1.7400 area should hold up. A break would be
bad for the SGD and leave 1.76/1.78 open.
The SGD/JPY chart shows the effect of the strong Yen since
September 1998 and while it could be basing at the 60 zone, this is
by no means confirmed. In fact, moving averages are still bearish
for the cross rate; watch 66 as a turning point for a reversal, 60 as
the zone to break in order to continue the trend lower.
The USD/HKD chart below shows the extremes that the Hong
Kong fx rate went to during the crisis. The spike in the HKD from
the 7.74 area to the 7.62 zone really happened, as the Hong Kong
Monetary Authority took on the speculative players. The real
action from then on was in the forward market, when rates
(normally close to USD rates) skyrocketed to 80% and even higher
at one stage. The spot rate, given the peg that the HKMA held to,
did not move that much, and has only moved to a weaker HKD
rate. This chart highlights our forecast for 7.800 in the coming 12
months.
The Indonesian Rupiah chart (overleaf) shows the large breakdown
in 1997 in the IDR, with a run from 2500 to 17000 seen in a little
over a year. Not only did the Asian crisis hit the IDR but local
events deteriorated further which gave the IDR the second spike
against the USD in the summer of 1998. Current activity supports
the USD with the 13 and 50 week moving averages pushing
higher for the USD with 9200 open and spikes to 10,000 possible
on the charts.
THB=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
SGDJPY=R. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
AKD=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
THBJPY=R. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
SGD=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
6
MARKET TECHNICIAN Issue 38 July 2000
The JPY/IDR cross (number of IDR per Yen) weekly chart below
shows a relatively flat trend over the last 16 months, with the cross in
the 13/50 week moving averages suggesting that the Yen could be
set to gain against the IDR over the coming weeks towards 8000.
The chart of the USD/KRW below shows how the Korean Won was
sold off from 850 towards 1920 /1980 over a few months. While
the 1997 crisis was seen as a Southeast Asia problem to begin
with, the exposure to Thai debt and short term USD exposure really
hit the KRW at the tail end of 1997. Technically the KRW formed a
large reversal in the 1st quarter of 1998 and has been slowly firming
since then. The 13/50 week moving averages show the KRW trying
to put together a move through 1100 for 1000; this should take
some time. When seen, though, 1060/20 will be open.
The YEN/KRW (Korean Won per Yen) chart shows a very flat trend
which is expected to continue to dominate trading over the coming
months. The 13/50 week moving averages are flat while the charts
show a sidways channel dominating. This does present a decent
carry trade given the KRW yields near USD levels (or above) and
the very low Yen rates.
The USD/MYR (Malaysian Ringitt) chart is a favourite for chartists
these days. The MYR had the same breakout pattern as the rest of
the SE Asian currencies in 1997 but the fixing at 3.8000 and the
introduction of controls prevented the MYR from firming with the
rest over the last 18 months. Market rumours continue to roil about
the fixed FX regime ending but as usual the market will need some
clear signals from the central bank to really get excited.
Looking at regional currencies closer to home, some key points need
to be made. The first and probably most important one is that many
of the eastern European countries will be joining the EU in the
coming 10 years and hence their currencies will be euro candidates.
While this is a significant amount of time, the FX market is notorious
for trading ahead of itself (or is it very efficient at discounting
information?). The second is that liquidity in the FX market is not
high in these currencies, especially outside of London hours. And
thirdly, while derivatives are available in some of these markets, the
liquidity issue is a key one and bid/offer spreads can take much of
the incentive out of dealing here.
The EUR/CZK chart below shows a head and shoulders top pattern
IDR=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly JPYKRW=R. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
MYR=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
EURCZK=. Bid [Hi/Lo/Cl Bar] [MA 20][MA60] Daily
JPYIDR=R. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
KRW=. Bid [Hi/Lo/Cl Bar] [MA 13][MA 50] Weekly
Issue 38 July 2000 MARKET TECHNICIAN
that dominated trading in early 1999. While the central bank was
not happy with the CZK firming and many economists and local
market players were convinced that the CZK had to weaken, the
chart told a different story. The current push through trendline
resistance is central bank inspired (heavy intervention) but with the
risk zone at 37.20 and expected to be difficult to break, this
should be another CZK buying opportunity. Technically flat
trading in a large band is expected to dominate activity here for
the coming months with the risk being that the downtrend has
been broken.
The Slovakian koruna has rallied strongly over the last year against
the euro but is now losing some ground. For choice the 42.00 area
will be able to hold off the euro gains, but, if broken, then the turn
above the 60 day moving average would suggest that the SKK could
back up further. Looking out though and given the decent carry
over the euro, the SKK would be seen to be a buy for further flat
trading as the top of the range should be the old head and shoulders
neckline near 44.30/50 while 41.60 supports. A bout of SKK
strength through the latter would put 40.80/40.60 into the sights,
continuing the firming trend seen over the last year.
The chart below is of the Polish Zloty, now one of the most liquid
Eastern European FX rates. The last two years have seen this market
mature from where one would have to trade the Tbills to gain PLN
exposure, to a free floater as of yesterday! On the chart one can see
that the PLN took the flotation news pretty well and firmed back to
the 4.06 area against the USD. There is a floor at 4.000 though and
further choppy trading seems likely. The local market tends to focus
on the Nasdaq as a barometer of sentiment (foreign direct
investment into Poland is seen as one of the big reasons for any PLN
strength) which makes it worthwhile keeping an eye on that market.
The risk would be that this is a bull flag and sustained gains through
4.20/25 would worry for 4.40/4.50 and worse.
The South African Rand has been in a breakout since the early part
of the year, and even though I kept looking for a turning point or a
top, there has been little joy here yet. Hit by very negative sentiment
this one could be on course for 6.85 to break with technical targets
pointing to 7.00 and 7.50. The key has been the fact that the ZAR is
not paying for risk, interest rates have only edged higher since the
6.20 level broke and the market seems very reluctant to take the risk
on board without getting paid for it!
The Icelandic Krona is a basket currency which is tied mostly to the
euro and euro-linked currencies as well as to the GBP and USD
and other currencies*. This FX rate offers one of the more
interesting regional or exotic FX plays as Iceland, population
250,000 on a good day it seems, pays over 10% on the Krona
compared with rates below 4.0% on the euro. The chart below is
of the ISK/USD and for those who wish to bottom fish for a long
term EUR/USD recovery, the ISK is a different way to play this as
the positive yield differential over the USD gives one some cover.
Technically this is a broad range in play but 73.80/74 needs to
hold as resistance, since a turn in the trend will be signalled by a
breakthrough 73.00. The warning on liquidity definitely applies to
the ISK as the market is usually for 5 million USD or less, and
options are very difficult as the bid/offer spreads can reach truck
driving levels.
The chart overleaf shows EUR/ISK which is pretty much locked in a
bear trend. The key here is the 70 zone which is likely to be a
struggle, and I could see flat trading dominate in a 73/70 range,
yield differential makes playing the range from the buy ISK above
72.30, sell below 70.80 angle attractive.
7
EURCZK=. Close(Bid) [Line] [MA 60][MA20] Daily
PLN=. Bid [Hi/Lo/Cl Bar] [MA 20][MA60] Daily
ZAR=. Bid [Hi/Lo/Cl] [MA 13][MA50] Weekly
ISK=. Close(Bid) [Line] [MA 60][MA20] Daily
*The ISK (Icelandic Krona) trades as a currency basket with the majority of the
weighting placed on the European rates. The major short term risk on the currency is
still an overheating economy with rising inflation and inflation expectations, which
suggests that interest rates should remain on the high side. One month money is
near 10.00% and three month money is near 10.00% as well. The breakdown of the
basket is:
EUR 32.14% GBP 13.39% DKK 9.16% NOK 8.26% JPY 5.39%
USD 24.09% SEK 3.85% CAD 1.37% CHF 2.35%
MARKET TECHNICIAN Issue 38 July 2000
The Greek Drachma is now trading with eyes on the 340.70 entry
rate (March 2001) and is a trading buy for the yield. Basically,
most of the rate cuts are expected to take place closer to the EMU
entry date (like the Irish did in 1998) which should leave the
EUR/GRD to give carry opportunities up until then.
The Turkish Lira chart is a pretty easy one for trend followers to
predict! The controlled devaluation with 80% and much higher yields
did provide decent returns for some time, but those days are over.
With the new IMF backed inflation fighting regime, yields have
dropped to the 25%/40% zone in the 3 month money area and the
FX is expected to devalue nearly 20% on the year, breakeven if you
are lucky! Given our criteria of risk vs. reward (need to be paid for
the risk) the TRL is now a much more selective play (wait for yields
to back up on any political concerns and then jump in).
And finally, Latin America. The Mexican Peso is the most liquid of the
LATAM currencies and even trades as a reasonably deep contract on
the IMM. The close ties with the US makes this one attractive as a
hedging or speculative currency and the high rates often entice hot
money into it as well. The 1994/1995 Tequila crisis is seen pretty
clearly below as traders went home for the holidays in 1994 only to
find out that the MXN had taken a swan dive in their absence! The
general trend was for a weak MXN over the last few years with carry
trades mostly working out depending on the entry point (yields well
over 20% compensating for the risk). While the Asia crisis of
1997/1998 ran its course with little in the way of sustained pressure
on the MXN, the Russian/Brazil effect of August 1998 really hit the
MXN. Given the liquidity of the MXN compared to the Brazilean Real,
the USD shifted higher in a very aggressive manner and even touched
the 11.10/20 zone after Brazil devalued in early 1999. Since then the
market has seen the MXN firm sharply and a case for 9.20/9.85 as a
range trade can be made. While the recent push towards 9.20/9.15
could have threatened to see 8.70 and lower for the USD, the fact
that yields in the short term instruments dipped to 13% and lower
took away the risk premium. Holding to the view for the range
trading , then buying MXN below 9.20 is not that favoured and in
fact a turn back to 9.60/9.65 is needed before the MXN becomes a
buy again. A sustained USD rally through 9.85 would shift the risk
here and put 10.20/10.50 into the light, not really favoured.
The chart of the Brazilean Real below shows the devaluation, as once
again a market went from We will never devalue to Whoops!.
The toppy pattern after the devaluation could be a head and
shoulders in the USD/BRL with subsequent activity being very flat.
While moving averages are convergeing and there is a risk of a shift
back to 1.90, this one seems more likely to trade in a flat manner
between 1.86/1.76 for the coming months. The 17%+ yields help on
the carry trade for the BRL but keep in mind that activity is mostly
done through the non-deliverable forward market (NDF, with no
exchange of the local currency taking place, only USDs going back
and forth for the difference in FX between entry and exit levels).
Thus, in a crisis, the exit door in the BRL gets very, very small.
SUMMARY
In summary while the potential carry gains are easy to calculate
and the potential positive movement in the regional FX market can
be very attractive the critical factor to keep in mind is that the high
yield on the currency is probably there for a reason. This will
usually make the potential losses on adverse movement in the FX
rates extremely high as the exit door in these markets is invariably
much narrower than the entry door. The question that must be
asked on every trade is Does the potential reward outweigh the
potential risk?. Charts give a very useful indication as to what the
market is doing and can give valuable insights for forecasting
purposes. While data is at times not that clean, this is improving and
the charting of regional FX markets will continue to grow in
importance for hedging and speculative purposes.
8
EURGRO=. Bid [Hi/Lo/Cl Bar] [MA 60][MA20] Daily
TRL=. Bid [Hi/Lo/Cl Bar] [MA 60][MA20] Daily
MXN=. Bid [Hi/Lo/Cl Bar] Weekly
BRL=. Bid [Hi/Lo/Cl Bar][MA 60][MA20] Daily
EURISK=. Bid [Hi/Lo/Cl Bar] [MA 60][MA20] Daily
Issue 38 July 2000 MARKET TECHNICIAN
9
CONCLUSIONS:
1. The new economy TMT group of stocks has recently rallied
from deeply oversold positions. These initial reflex rebounds are
likely to be followed by some back testing. That should lead to
more extensive base-building, which, in turn, should lead into a
new and more sustainable advance later this year.
2. Undervalued old economy groups rallied during the March / May
TMT sell-off. But progress is likely to slow for a while as these
sectors do battle with significant overhead resistance levels.
3. Ultimately, its possible that the two sides manage a degree of
reconciliation. The higher quality TMT build new bases (although
they may well not surpass Q1 peaks for some considerable time)
whilst a number of cyclical / value plays regain their share of the
limelight. The issue is probably not so much new economy versus
old economy as, quite simply, a changing, evolving, economy.
4. Uncertainty and market volatility could remain a feature a little
longer. But, looking ahead to later this year, markets could be
preparing for their next advances. Medium and long term rate-of-
change momentum measures look in place for this, at least for
the U.S. and the UK. These cycle indicators seem to be buying
the soft landing scenario for the Anglo Saxon economies.
CHART 1:
The NASDAQs March May decline broadly speaking found
support in the 50% retracement region of the October 1998 /
March 2000 advance. Medium term momentum (e.g. 13 week
RoC) reached oversold extremes not even seen in October 1998, and
is starting to turn up.
Chart 1: NASDAQ, Fibonacci Retracements, 13 Week RoC
CHART 2:
But a number of technical positives are still missing, e.g. sentiment is
not yet really bombed out. And long term momentum, shown in
chart 2, suggests that at this stage rallies largely still provide trading
buys. A more secure base can be seen in the 2800 area, where a
61.8% retracement of an 18-month trend (see chart 1) more or less
coincides with the 50% level in relation to the entire 1995 2000
bull market. Chart support in this region is a bonus.
Chart 2: NASDAQ, Long Term Chart; Long Term Momentum
CHART 3:
Dow Industrials. The medium term momentum buy signal should
reinforce support levels. At the very least, it should limit downside,
particularly since the long term version has now fallen back to
below the zero line its first visit to that area since Q3 1998. That
kind of combination is not saying that the index starts to trend up
from this point forward, but it is likely to be setting the stage for a
major upturn a little later in the year. Price activity over the last 12
months looks to be shaping up into a diamond: this may be a
continuation pattern. Some people see a head and shoulders:
volume would argue against that.
Chart 3: Dow Industrials, Weekly Data Momentum; Volume
CHART 4:
FTSE looks broadly similar. Medium term momentum is bottoming;
the long term version is already giving a buy i.e. it is a little
ahead of the Dow. The 6400 / 6000 area has recently re-established
itself as support.
Chart 4: FTSE 100
CHART 5:
A founder member of the TMT group, the Software & Computer
Services sector. Sharp falls between March and May have found
support in the 50% retracement region (in relation to the Q3 1999
Q1 2000 relative uptrend). But base-building, leading to a sustainable
new uptrend, is still going to take some time.
Chart 5: Software & Computer Services Relative to the All Share
Equity Markets: Outlook for Wall Street and
FTSE, TMT and Old Economy
By Luise Kliem, MSTA
This article is a brief summary of the talk given to the Society on 10th May 2000
Source: Bridge Information Systems
Source: Bridge Information Systems
Source: Bridge Information Systems
Source: Bridge Information Systems
Source: Datastream
continues on page 11
10
MARKET TECHNICIAN Issue 38 July 2000
INTRODUCTION
Under the normal course of events an analyst examining the
historical record of the behaviour of an exchange traded futures
contract for any particular delivery month would reasonably assume
that the numerical data on prices, volume and open interest
represented the outcome of the trading activity for that contract.
Similarly, it would be assumed that the transformation of these data
into a graphical form would provide a meaningful visual
representation of that behaviour from which various relationships
might be deduced using different analytical techniques. However, it is
likely that this no longer is the case with certain futures contracts.
ENTER MOS
The reason is the existence of the Mutual Offset System or MOS
which is provided by the Chicago Mercantile Exchange (CME) in
conjunction with the Singapore International Monetary Exchange
(SIMEX) for clearing members on both exchanges. What is MOS? It
is a facility to allow new or liquidating trades to be executed on
SIMEX by CME members and then be transferred back to the CME.
The opposite is also catered for e.g. SIMEX firms can have trades
executed on the CME and then be transferred back to SIMEX. The
facility is currently available for three interest rate futures contracts
i.e. 3 month Eurodollar, Euroyen, Euroyen Libor, together with the
Japanese Government Bond. There is also a MOS arrangement ,
termed a Link , between SIMEX and the International Petroleum
Exchange (IPE), London for Brent Crude Oil futures. The
implications of such MOS for technical analysis is discussed here in
the context of the CME-SIMEX system.
MOS allows a participant to effectively borrow the liquidity in
SIMEX when the CME is closed and vice versa, and have the
convenience of only having to post margin for one exchange
i.e. their own local one. In addition, a participant whose local
exchange was, say, the CME, could establish a position in SIMEX
then have two choices open to them:
(1) have the position brought back to the CME at the price their
order got filled on SIMEX, to be processed through the CME
clearing house [as if the order had been filled in the CME pit],
thus being marked to the market against the CME market
settlement price.
(2) leaving the trade with SIMEX and having it processed through
the clearing house system there, thus being marked to the
market against the SIMEX settlement price.
Given such convenience, MOS must undoubtedly be a welcome
development from a hedgers viewpoint. However, a personal view is
that what is generally good news for the hedging community usually
spells bad news for the speculating community. MOS appears to be
no exception.
SOME INFERRED DYNAMICS
However, before spelling out the nature of the bad news it is
necessary to explore the consequences of participants taking
advantage of the MOS facility, in terms of the impact on the internal
dynamics of the auctions at the Chicago and Singapore ends of the
system. If, say, a Chicago based participant has an order executed on
SIMEX, which represents the initiation of a new position, then the
arrival of that order in the Singapore pit will impact on the ongoing
auction, by influencing a shift in the price, in some way depending
on the liquidity conditions prevailing at the time of its arrival in
relation to the size of the order. For the order to be filled, some other
participant, be it a floor broker or a local will have to take the other
side of the trade. Consequently the creation of the transaction will be
recorded in the exchanges time and sales register for that market.
Thus the price level and number of contracts involved will have been
captured and be available to be fed into the clearing house system
should the Chicago based participant decide to leave the position
in Singapore.
What happens if (s)he so elects? The answer is that a footprint of
that trade, in the form of a data point, will subsequently appear in
the tick price data record for that day. If the exchange is in the habit
of issuing volume at tick price then the volume associated with the
trade will also appear there. Secondly, if the position is held after the
Close it will be recognised as new commitment and factored into the
clearing house calculation of the open interest figure for that day. If it
was a relatively large order in relation to the typical orders of the day,
it could well end up helping to generate an increase in the open
interest figure, as it reflects the initiation of a new position(s). So far
what has been described is the normal i.e. non-MOS process,
which would occur irrespective of the geographical location of the
participant.
However, what if our Chicago participant elects to have the position
transferred back to Chicago? It will be marked to the market using
the CME settlement price. As such it will end up being factored into
the clearing house calculations that produce the open interest figure
for that day. The interesting question then arises. What happens to
the transactional volume figure associated with the trade? This has
already been captured by the SIMEX time and sales computers as
was the price tick(s) involved. As such they are a unique constituent
element(s) of the historical record of the auction microstructure at
SIMEX during that trading session in which our Chicago participant
took part. As such these data can hardly be transferred to CME
alongside the fill price(s) of the local trade(s) it would make a
mockery of the time and sales data for that days auction on the
CME, because the trade(s) never took place there! The answer is that
the transactional volume and price ticks remain with SIMEX, but the
trade makes no contribution to its clearing house calculations of the
new open interest figure for the day in question, for that SIMEX
contract.
THE BAD NEWS
How these data, relating to the trades transferred from the
exchange where the position was initiated to the exchange where
the participant wishes to have the trade marked to the market and
thus carried until it is either offset or delivery is made/taken, are
handled, is a key issue. This is because under the normal course of
events the price tick record, which goes to make up the summary
or short-hand statement of the familiar Open, High, Low, Close
price bar, together with the days transactional volume and the
change in open interest represents the outcome of the how of the
way that the various orders were processed in the pit, in terms of
their size and sequence of execution.
As such the record encapsulates the cause and effect relationship
between the three variables of price, volume and open interest.
Knowing this, it is normally quite realistic to undertake an analysis of
these data and have a legitimate expectation that whatever cause-
effect relationship might be discovered for that day [possibly in
conjunction with a number of previous days data] it is valid, and can
thus legitimately be allowed to influence an analyst or traders
subsequent view of the likely future behaviour of the market of
interest.
If, however, as appears to be the case with a market having a MOS
facility, where it seems impossible to maintain the integrity of the
legitimate tick price/volume/open interest relationship that reflects
MUTUAL OFFSETTING SYSTEMS
A PROBLEM FOR TECHNICAL ANALYSIS?
By Dr Michael Wignall MSTA
Issue 38 July 2000 MARKET TECHNICIAN
11
the auction process, the results of any analysis will likely be faulty.
This is because the cause-effect relationship between the three
variables will have been corrupted by the MOS trades which their
owners decided to transfer back to their local exchange.
IS WHAT YOU SEE THE WAY IT WAS?
Before the advent of MOS the answer to this question for the price
chart of any market of interest would simply have been Yes.
However, with the existence of MOS, the answer must now be
Maybe. It will depend on whether the contract under scrutiny
trades on more than one exchange and whether it has been blessed
[cursed?] with a MOS facility or some equivalent. If it has, then the
answer is Unlikely and the analyst and trading system developer
will be inviting trouble if they ignore the implications. Ultimately it
will come down to the volume of MOS transactions involving
inter-exchange transfers in relation to the volume of MOS
transactions not involving inter-exchange transfers and the volume
of non-MOS transactions for the contract of interest. The greater
the proportion of MOS transferred transactions in any one contract,
over time, the greater the likely distortion of the historical record of
the dynamic relationship between intra-day price changes,
transactional volume and inter-day open interest changes for the
contract in question.
SOME CONSEQUENCES
As pressures for 24 hour hedging facilities grow to recognise existing
24 hour global trade flows, it is likely that mutual offsetting will
become an increasingly common feature of contracts as commodity
exchanges around the world set up partnerships based on joint
interest. Why accept the costs of fighting for market share for a new
financial product, or retain a share for an existing product, when the
revenue from its usage in the form of exchange fees can literally be
shared between exchanges co-operating, rather than competing,
across time zones?
Assuming the interpretation of the implications of the mutual offset
process is correct, then the likely consequence is that conventional
technical indicators which factor volume and open interest into
price changes can be expected to demonstrate erratic behaviour in
some markets, but not so in others. Whereas in the MOS-free world
of the past such indicators would have been expected to give
relatively uniform results across any selection of markets, this
comfortable simplicity has likely passed away. In the case of futures,
for example, erratic behaviour can be expected from the operation
of the Herrick Payoff Index, and were MOS to be eventually
extended to cater for options on futures, then the Hines Index
would be so affected. Thus charts, whether they be hard copy or
screen-based might one day, when MOS markets become more
prevalent, display a disclaimer by the more perceptive and risk
conscious data vendors:
This market has a mutual offset facility with another exchange
which may consequently render unreliable any analytical methods
which factor volume and open interest into the price history.
Analysts making recommendations or traders basing decisions on
such methods do so entirely at their own risk.
CONCLUSIONS
In other words no assurance can any longer be implied that what is
being offered via a chart is how it actually was. Unfortunately a MOS
such as the CME-SIMEX, has the ability to destroy the hitherto
inseparable linkage between tick price, volume at tick price, daily
volume and changes in open interest. Perhaps the most prudent
approach would be for analysts and traders with a speculators
mindset to avoid futures markets which have MOS assuming they
take the trouble to discover which do.
Computer based trading system developers who typically view
markets simply as collections of time series data needing to be
manipulated, and who lack any real understanding, or even interest in
the how or the why the numbers came into existence in the form they
did, are particularly vulnerable to the trap offered by such markets.
Of course speculator participants who remain ignorant of the
problem will continue to unwittingly provide the liquidity that the
hedging community needs. As ever, hedgers bliss can be defined in
terms of speculators ignorance, and MOS represents just one more
potential facet of the latter attribute. Speculators wondering why the
actual future, being experienced through the constantly unfolding
present, does not materialize in the form that their definition of the
future would have them believe it should, may unknowingly be
trading a market with a Mutual Offset System. One in which
significant inter-exchange transfers are taking place.
REFERENCES
Chicago Mercantile Exchange, CME/SIMEX Mutual Offset System;
The Worlds Most Successful Trading Link, CME, n.d., Chicago, IL.,
http://www.cme.com/market/interest/ mos.html
Chicago Mercantile Exchange, Euroyen Futures At The CME, CME,
n.d., Chicago, IL., http://www.cme.com/ market/euroyen.html
Chicago Mercantile Exchange, CME Contract Specifications For
Interest Rate Futures And Options, CME, Jan. 06, 2000, Chicago,
IL., http://www.cme.com/clearing/spex/ csinterestrate.html
Chicago Mercantile Exchange, Interest Rate Marketing Dept. to
Wignall, Jan. 24, 2000, (e-mail)
Hines, Ray, Hines Index, Technical Analysis Of Stocks &
Commodities, Vol. 7, No. 4, (April) 1989.
Neil, Trevor, The Herrick Payoff Index: making use of futures
contracts open interest, Market Technician, Issue No. 25, (March)
1996.
Wignall to CME Currency & Interest Rate Marketing Dept., Jan. 24,
2000, (e-mail)
Authors postscript: SIMEX has since merged with the Singapore
Stock Exchange to form what is known simply as the Singapore
Exchange, or SAX. The MOS facility remains in being.
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ChronoGraphics
BAR
ChronoGraphics
BAR
Issue 38 July 2000 MARKET TECHNICIAN
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Fig 2
By adding in this information we are now also able to define each
ChronoGraphics Bar in terms of its behavioural characteristics: This is
because the Close may be either above or below the Open.
If a Close is above the Open in a positive sloping ChronoGraphics bar
(Fig. 2.1 and Fig. 2.2), or if the Close is below the Open in a
negative sloping ChronoGraphics bar (Fig. 2.5 and Fig. 2.6), then
that bar is deemed to be normal.
If, however, the Close falls back below the Open in a positive sloping
bar (Fig.2.3 and Fig. 2.4), or if the Close rises back above the Open
in a negative sloping bar (Fig.2.7 and Fig. 2.8), then that bar is
deemed to be abnormal.
Note that for an abnormal bar, the colours of the ChronoGraphic bar
invert.
The importance of an abnormal ChronoGraphics bar (whether
positive or negative sloped) is that it is an item of additional
information, which has trading implications. Evidence suggests that
only about 10% of ChronoGraphics bars are abnormal.
ChronoGraphics bars can therefore be defined by their directional
and behavioural characteristics.
Applications of ChronoGraphics
The extra information that is supplied by ChronoGraphics bars can be
used in a number of different areas of Technical Analysis. Chapters of
a book could be devoted to some of these areas. However, here is a
very brief overview:
Multiple time frames
Multiple time frames have been difficult to incorporate on one chart
using traditional bars. Quite simply, they become too difficult to
read. ChronoGraphics allows the overlay of a number of periods,
with no confusion, and with clear and easy to read trend lines.
Trend lines
When using traditional bars, trend lines drawn using different time
frames tend to give different results. ChronoGraphics integrates
different time frames on one chart, and thereby gives consistency
of trend line signals. Also ChronoGraphics enables trend lines to be
drawn that, although relevant to trading decisions, would not have
been apparent using traditional methodology.
Chart patterns
With each bar now being defined in more detail, classic chart
patterns can be seen and analysed in more detail. Also
ChronoGraphics has its own unique patterns given by the various
angles, colours and lengths of the bars.
System testing
One of the drawbacks of traditional system testing is that the
algorithms in software assume that the price extreme closest to the
Open was the one that traded first. This is not always necessarily
true and can give false system performance results. ChronoGraphics
shows the chronology of High, Low, Open and Close.
Formulae
Generally speaking, current formulae used in TA are restricted in
their ability to adapt to market conditions due to the one-
dimensional time element. However with the added information
from the slope of the bar (in terms of direction and angle), as well
as the time element of the extremes, the potential for deriving
new and better formulae has increased significantly.
Strategy
ChronoGraphics can be used to focus attention on opportunities in
the market such as highlighting abnormal market conditions. This
can be combined with other forms of analysis to formulate a
strategy for trading.
CONCLUSION
ChronoGraphics bars are a new way of presenting price information.
They provide much more information per bar than was traditionally
the case. The slope of the bar provides information about the
direction and speed of the market movement, and the colours of the
bars provide information about the chronology in between the open
and the close. In principle ChronoGraphics integrates the information
from traditional bars and candlestick bars, and goes beyond both.
Probably the most exciting aspect of using ChronoGraphics is that
they provide new building blocks for research to be carried out.
ChronoGraphics will be available from Bridge Information Systems on
BridgeStation as part of their charting software packages of Athena
and AthenaExpert as from the middle of July. Chronographics will
also be available on Aspen Graphics for BridgeFeed. Bridge has a
Patent pending on ChronoGraphics.
Nick Burnton is the European Director of Technical Analysis at Bridge
Information Systems.