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.

The link between Fibonacci and financial markets comes through another school of thought for technical analysis, Elliott Wave Theory, named after Ralph Nelson Elliott (1871–1948). Elliott first made the connection between his Wave Theory and the Fibonacci sequence of numbers in his blog Nature’s Law — The Secret of the Universe (1946). Elliott Wave Theory suggests financial markets move in five waves of progression followed by three waves of regression. As such a 5–3 wave move completes a wave cycle. The five “up” waves are labelled 1–5, while the three “down” waves are labelled a–c. Of necessity, waves 1, 3 and 5 are seen as impulsive waves while waves 2 and 4 are seen as corrective.
Remembering the Fibonacci sequence, it should be immediately obvious that 1, 3 and 5 are Fibonacci numbers. Furthermore, if we break each wave down into sub-waves, we notice two things, firstly that each sub-wave conforms to the 5–3 wave pattern and secondly that when we add up these sub-waves we come to 21 impulsive and 13 corrective waves, making 34 in total. Once again, 13, 21 and 34 are all Fibonacci sequence numbers.
Fibonacci sequence numbers are also used in other technical indicators, such as in moving averages — e.g. 5, 13 and 21 moving averages, 21, 34 and 55 or 31, 55 and 144. Within the financial markets, the most widely used application of the Golden ratio is through the Fibonacci retracement, which relates to the fact that corrective waves have retraced the previous wave by 38.2%, 50% or 61.8%. Fibonacci fan lines provide key support or resistance corresponding to the Fibonacci retracement levels. Once such a Fibonacci fan line support or resistance has been broken, this tends to suggest the extension of a correction and thus a potential wave reversal. In sum, Fibonacci levels can provide crucial tops and bottoms in the market and are widely watched by both short- and medium-term currency market participants.
A final school of thought is Gann Theory, created by W.D. Gann (1878–1955), which seeks to predict future prices using specific geometric angles. Gann angles or Gann lines can be created by graphing price against time. The basic Gann angle or line is created by assuming an increase in one unit for both price and time, resulting in a line which is at a 45◦ angle to both axes. Because of the price and time increases involved, this is called a 1 × 1 angle. Gann lines are drawn off major price tops and bottoms. If the price is above the 1 × 1 line, this signals a bullish trend and conversely if it breaks below the line this signals a bearish reversal. Including the
1 × 1 angle, Gann identified nine significant angles or lines relating to price and time:
1 × 8 — 82.5 degrees
1 × 4 — 75 degrees
1 × 3 — 71.25 degrees
1 × 2 — 63.75 degrees
1 × 1 — 45 degrees
2 × 1 — 26.25 degrees
3 × 1 — 18.75 degrees
4 × 1 — 15 degrees
8 × 1 — 7.5 degrees
Each of the angles or lines can provide a support or resistance depending on the trend. Generally speaking, the 1 × 1 angle as reflected by a trend-line is not sustainable given the steepness of the angle involved. Prices cannot continue appreciating at a 45◦ angle forever. The 3 × 1 angle is generally viewed as more sustainable in terms of price trends over the long term.