Loans and money issues

The various techniques of technical analysis, which we have only briefly touched on here, have been widely practiced by traders for a very long time — centuries rather than years. The first futures market was created in Japan in the early 1800s and the Japanese candlestick charting theory is seen as having emerged on the back of this. The very fact that we can chart US Treasuries back to the American Civil War confirms that the art of charting is also hardly a new phenomenon in the US either. While currency, equity and fixed income traders have long followed technical signals, corporations and asset managers have on the whole been somewhat more reticent to do so, either because of scepticism as to the merits of technical analysis or a lack of knowledge of how it works — or both. The best advance of any type of analytical discipline is that it actually works in practice; that it is capable of predicting exchange rates in this case and therefore using it one can generate excess returns. As Osler shows in her piece “Support for resistance: technical analysis and intraday exchange rates”,3 empirical evidence demonstrates that technical analysis can help in exchange rate prediction over and above the results available by simply using a random walk theory. Simply put, there is something to this. Looking at a slightly longer time frame, can a corporate Treasurer or an investor use technical analysis as part of their currency risk decision? The answer in this case is also, yes they can. While the primary focus of technical analysis is short term, it is fully capable of predicting multi-month of even multi-year moves. As an example, at the end of 1999, when the dollar–rand exchange rate was trading at around 6, the CitiFX Technicals team put out a buy signal, based on a combination of Elliott Wave Theory and the “golden cross” between the 55- and 200-day moving averages, with a multi-year target of 9.4 The exchange rate hit 9.00 on September 27, 2001. Again, the sceptical may see this as coincidence. However the fact is that skilful application of technical analysis principles correctly forecasts a move in the exchange rate that no interpretation of the “fundamentals” would have provided. At the very least, technical analysis should be a consideration for all types of currency market practitioner. Short-term traders are likely to use it as their primary analytical tool ahead of fundamental analysis because it is better suited to predicting short-term exchange rate moves than the traditional fundamental exchange rate models. Corporations and asset managers can use it as a cross-check of their fundamental views and also in terms of timing their hedging activity. The fact that traders watch technical levels and that traders make up the majority of currency market participants automatically makes those levels important.
What we have attempted in these few posts is to look at the basic principles and schools of thought within technical analysis, along with how and why it works. Having looked at pricing patterns, it is also important to look at the structural dynamics that determine that price. That is to say, one can look at a chart of an exchange rate, but it is also important to know how that price has been created and under what circumstances. Indeed, the type of exchange rate regime can render virtually worthless for periods of time most types of analysis, distorting both the fundamental and the technical signals that might otherwise be read. Thus, in the series of posts we take a look at the types of exchange rate regime and how each type might impact the exchange rate itself.

Having gone through the basic building blocks of technical analysis and the technical indicators that are used, we will now look at the major technical schools of thought that have dominated the way technical analysts and traders look at price patterns. The first one to focus on is the Fibonacci school of thought, named after Leonardo Fibonacci, an Italian mathematician born in 1170. Fibonacci discovered a series of numbers such that each number is the sum of the two previous numbers:
1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233 and so on . . . To some, these numbers may seem more or less random. In fact, they are actually far from random, containing important interrelationships, and they are found in a surprising number of real-life examples. Indeed, it is not too much of an exaggeration to suggest that these numbers represent the mathematical building blocks of life. For a start, note that any given number is roughly 1.618 times the previous one. Equally, any number is 0.618 times the following number. As it stands, this does not answer the question of how Fibonacci happened to found, albeit inadvertently, a type of technical analysis. For this, we have to look first at Fibonacci’s so-called “rabbit problem”, which relates to his attempt to demonstrate the application of Hindu–Arabic numerals through the example of rabbits. The mathematical problem that Fibonacci posed is that if two rabbits were put in an isolated place, how many pairs of rabbits could be produced from that pair in a year if every month each pair produces a new pair, which itself from the second month also becomes reproductive? At the start of the first month, there would only be the first pair. By the start of the second month, there would be the original pair plus one new pair, resulting in two pairs of rabbits. However, during that second month, the original pair will again produce another pair while the second pair is maturing. Thus, at the start of the third month, there should be three pairs, which brings us back to the Fibonacci number series. In terms of a mathematical formula, this can be expressed as: X n +1 = X n + X n−1 where X n is the number of pairs of rabbits after n months.
This became known as the Fibonacci sequence, as coined by the French mathematician Edouard Lucas (1842–1891). As the Fibonacci sequence progresses, a clear relationship between the numbers becomes apparent, as reflected by the 0.618 and 1.618 ratios mentioned above. The very fact that there can be a consistent ratio between numbers is itself “statistically significant”, confirming that there is more in this than just a random series of numbers. Note also that if you take any number and divide it by the number two higher in the sequence the ratio comes to 0.382. Not coincidentally, 38.2% and 61.8% are major Fibonacci retracement levels within the Fibonacci school of technical analysis.
While we look to Fibonacci and Lucas as the founders of modern-day Fibonacci analysis, it appears that long before them the importance of this sequence of numbers and ratios was well known and appreciated. Indeed, these ratios appear to have been used in the construction of both the Great Pyramid of Giza in Egypt and the Parthenon in Greece. The 0.618 or 1.618 ratio, also known as the Golden ratio, is commonly viewed in mathematics as one of the building blocks of natural growth patterns — in geometry as in life. Even the human body can be shown to contain elements of the Golden ratio, measuring the distance from the feet to the navel and in turn from the navel to the top of the head as a ratio. The basic building blocks of human beings, the DNA double helix, also contains the Golden ratio.