An Inauspicious Start

2010 has certainly gotten off to an inauspicious start with the markets behaving in ways not seen since the summer of 2008! Market characteristics have changed, in particular the correlation factor between the two most dominant currency pairs; GBPUSD and EURUSD.

Correlation is the statistical measure of the relationship between two securities (currency pairs). The correlation coefficient ranges between -1 and +1. A correlation of +1 implies that the two currency pairs will move in the same direction 100% of the time. A correlation of -1 implies that the currency pairs will move in the opposite direction 100% of the time. A correlation of zero implies that the relationship between the currency pairs is completely random.

The EURUSD currency pair has been severely impacted by the negative news from Greece and the inability of the EU to commit to a plan that will restore confidence and bring some financial stability to the entire situation. The issue is extremely sensitive because throughout the financial crisis that commenced in 2008, the EURO was seen as a strong alternative to the US dollar. It’s amazing that all of that has changed overnight because of one country – GREECE. Others may follow with Spain and Portugal having crises of their own. Not to mention Italy. This is the greatest threat to the Stability of the European Union since its formation. This is the first real test...

How has this affected trading? For the entire year 2009, the GBPUSD and the EURUSD enjoyed a correlation factor of 0.88. In simple terms this means that 88% of the times these currencies move together. Just last week this correlation factor was at 0.01!

As a momentum breakout trader, one of the factors that ensure a high probability trade (breakout) is the movement of currency pairs in the same direction. i.e. the majors strengthening or weakening against the US dollar which is in most cases the base currency. The correlation factor is a great tool that quantifies and qualifies the relationship between these pairs as they trend. The EURUSD is the most liquid currency pair. However, the GBPUSD is more volatile and usually leads. Since the EURUSD commenced its dive last month, the GBPUSD which usually leads has been lagging and has oftentimes remained in an unusual range completely offsetting the normal breakout profile. This has certainly presented some unique challenges to say the least!

Each challenge provides an opportunity for growth and development. No two trading days are the same and there is always something new to learn. That’s what makes this endeavour so thrilling! Yes, the year had gotten off to a slow start. However, I remain focused and committed to the task at hand and will meet the targets mentioned in my previous posting.

In the next posting, I will be discussing the issue of Leverage. The CFTC is seeking to impose a maximum leverage of 10:1. There seems to be a deliberate attempt to eliminate Retail Traders. It commenced last year with the “No Hedging Rule.” Now this… The question is... what next?