I have been studying currency strength and the movement of the prices of currencies and currency pairs for almost a decade now, mostly from a price-centric perspective. I have learned to view the price of anything that is bought by human beings as moving in cycles. The movement of such assets is fascinating – and once you understand it, your job is done. You’ve made it, and for the rest of your life you will be paid for your understanding. I have some insights and I have developed tools and utilities focusing on supply and demand and currency strength, which represent my understanding thus far, as I continue to study the financial markets from a quantitative perspective.
Why cycles happen
Cycles in finance occur due to human behaviour. Today, because we have so much data on how behaviour has historically affected cycles, we can now go about it differently and look at cycles first and use them to make predictions about human behaviour. This is very powerful and enables us to see how wars, pandemics, extreme weather, elections, times of the year/month/week/day and political shifts, to name just a few, have historically affected our behaviour, and how this has had a direct or indirect impact on the global economy, starting at the micro economic level and going all the way up to macro economic level. And while some of the data available is tough to apply to financial markets, some of it can be rather useful, especially when we have a way to visualize relevant cycles in a way that enables us to make investment decisions.
What do cycles look like on a price chart?
If you look at how the price of a currency pair, such as the EURUSD for example, moves over the course of several hours, days months or years, one thing that is obvious is that it isn’t moving in one direction all of the time. Price moves higher to attract sellers and lower to attract buyers. This balancing act between supply and demand goes on and on, on all time-frames, constantly. Focusing on a single currency pair will prevent you from seeing most of the bit picture, as what we are actually seeing on a currency pair chart, is the fluctuation of strength between the two currencies, relative to one another. Sometimes the Euro is attracting more flows relative to the Dollar, and other times the Dollar will be attracting more flows than the Euro. This constant shift in flows is happening all the time, even when we are not aware of it. The following EURUSD chart clearly shows this shift in flows, from the Euro to the Dollar, resulting in downward movement, and from the Dollar to the Euro, resulting in upward movement.
In the chart above it’s clear that the price of the asset increases and decreases in cycles. What drives these increases and decreases is how the liquidity of the asset is distributed, which translates to volume. If there are big players looking to buy or sell this asset, depending on the liquidity distribution engines and algorithms, the filling of orders either efficiently or not. The process is fascinating and constant.
What tools can be used to view cycles?
Many traditional technical analysis tools and utilities such as oscillators, moving averages and the likes, attempt to identify market turning points, which most often proves to be difficult, as the task becomes a subjective interpretation of a secondary representation of price, via lines and other visual indicators. The result is often tough to know what to do with, as persons A and B can look at the same data yet have conflicting interpretations. I think the challenges with this approach are clear despite the fact that some are able to apply such mechanisms with success.
Currency strength and price cycles
Another way to view cycles is to observe currency strength and how currencies are performing as a whole, relative to each other. This provides tremendous insight, as it enables us to consider the general performance of individual currencies (economies) relative to others, as economic data in the form of jobless claims and unemployment, interest rates, inflationary data and so on, is often priced into the value of a currency and thus visible in the form of strength or weakness when compared to other currencies. Here is an example of such a comparison of 9 currencies, each represented using a different colour:
In the above example we can clearly see how each currency is performing relative to others, which enables us to draw simple conclusions about the future performance based on different factors. Typically, when trends are in place, we are being told something about how liquidity is distributed; up-trends tell a story of buying, which translates to higher liquidity below price and lower liquidity above, as higher prices tell us that people are happy to continue to pay increasing prices and are looking to buy 1) if price pulls back to a more attractive price or 2) if price breaks new highs then this may be confirmation that price will continue to rise. If only it was that simple. While the above is indeed true, there is a flip side to this story. What happened when the Australian Dollar (the orange line) reached the top of the chart? What happened to the Japanese Yen (the purple line) when if reached the bottom of the chart? Did they continue to move higher and lower, respectively? No, they did not.
Macroeconomics and monetary policy
Macroeconomics studies how an overall economy behaves, and focuses on phenomena such as growth (or lack thereof), prices, employment as well as the other areas mentioned earlier. Monetary policy refers to the actions undertaken by central banks to control money supply and to achieve macroeconomic goals that promote sustainable economic growth and maintain a general healthy economy. It is the central bank’s job to take action when macroeconomic data is out of alignment with their goals. Changes in monetary policy via any of the tools central banks have at their disposal to maintain a healthy economy, have a gradual yet relatively predicable affect on the flows of money, which correlate nicely with cycles and thus currency strength.
Currency strength and cycles in the Foreign Exchange
Looking at a price chart of a singe currency pair won’t tell you much about the health of the two economies, it will only tell you a little about how the two currencies are performing relative to each other, here and now. Focusing on how each currency is performing relative to a basket of currencies representing trade partners however, tells us much more.
Forex is well know to be highly affected by the economic data releases published on a regular basis, which tell us how good of a job the central banks are at reaching their goals. If they’re not reaching their goals, then they will often tell us what they are prepared to do in order to ensure that they reach their goals. Much of this data is already priced into the value of a currency – and only when major discrepancies between actual and expected data occur, do we experience short-term volatility. What I’m trying to say is that if you are able to look at how each currency (economy) is performing relative to other currencies (economies) then you are able to make some decent estimations regarding what could happen in the future, which is when currency strength becomes a valuable tool.
Timing trades with currency strength and buy and sell zones
Essentially, currency strength is affected when the value of a currency is in expansion and high then there is a very high likelihood that it will soon contract and move lower while in alignment with the macro view of that currency and associated economy. When married with liquidity distribution patterns where we look for the ends of cycles that occur at the beginning of buy and sell zones, then there is a very high likelihood that price will react. I will leave you with the following video.
Currency strength, weakness and momentum trading
Price action, liquidity, the economy and cycles
Market cycle, put the odds in your favour