Boris and Kathy's FX Blog www.bktraderfx.com

Volatility is baaaack! And we have been particularly active with our trading recommendations because of it. We sent out 8 recommendations, every single one of which was right in direction, but we missed additional profits because we focused on trading defensively. We banked 123 pips this week, 6 out of 8 of our recommendations were winners, 1 broke even and 1 lost us 4 pips. Year to date, we are up 229 pips. Despite the fact that one of us is in Dubai giving presentations, it has been a good week. We focused on trading only our setup and we enjoyed decent profits with low risk because of that. There is certainly room for improvement - we focused too much on preserving our hard earned profits and because of that, we bailed out way too early on some of the trades. However, the famous J.P. Morgan himself once said, “No one ever went broke taking a profit.” Our motto has always been to preserve capital AND to generate return.

So what happened this week? Believe it or not, liquidation in the currency market triggered liquidation in many of the other financial markets around the world. Over the past few years, the participants in the market have become very speculative and highly leveraged. Not only did international speculators borrow the low yielding Japanese Yen to buy high yielding currencies like the New Zealand dollar, US dollar, British pound, and Australian dollars, in what is known as the “carry trade,” but they also borrowed against the Yen to buy stocks and commodities. In such leveraged environments, losses become exacerbated on a percentage basis, which will force many of these speculators to bail at the first sign of trouble. On Tuesday, we saw the consequences of this aggressive risk appetite . On an intraday basis, the Dow hit a low of 12,086 which represents a drop of over 500 pips. Even gold did not escape the liquidation. It still remains to be seen whether February 27, 2007 will either go down in history as a major turning point for the financial markets or an unparalleled buying opportunity. To read more about this, see our special report “Dow Down 400 Points, Dollar Falls to 12M Low against Yen - Is This a Major Pivot Point into a Recession?”

Before the big turn in the Yen this past week, we already wrote about the potential of 2007 being the breakout year for USD/JPY from a statistical standpoint. Not many people know that in 2006, the Japanese Yen had the tightest range against the US dollar in 35 years. Last year, volatility in the currency market contracted significantly, causing USD/JPY to remain restricted to a 10 big figure (each big figure is 100 pips) trading range. Over the past 35 years, the average high to low range of USD/JPY was approximately 30 big figures or 3000 pips. In 2006, the yearly range was one third of that. Sharp contraction in ranges tends to lead to sharp breakouts and 2007 could be the year in which we see just that. To read more, see our special report “US Dollar / Japanese Yen (USDJPY): Will 2007 Be the Breakout Year”

Finally, China has also been blamed to be the force behind the sell-off on Tuesday because when China sneezed, the world did too. Since then the ebb and tides of the US financial markets has been determined by the overnight fluctuations in the Chinese market, which is a dramatic shift away from the way things normally operate. When the Chinese government denied any plans to take the steam out of the stock market by increasing corporate taxes, the sell-off abruptly stopped. So is the Chinese government the puppet master behind these moves? Have they become the new linchpin for the global markets and can US traders now use the Chinese stock market as a leading indicator for what will happen to the Dow? To find out, read our article “Is China, the New Puppet Master of the Global Markets.”

Here is another interesting fact, as pointed out to us by our technical analyst Jamie Saettele at DailyFX. According to Elliott Wave International, every double digit stock market collapse that we have had in the past 10 decades has been in the sixth or seventh year. Remember 1997 was the Asian Financial Crisis. 1987 was Black Monday. Between 1976 and 1978, the stock market fell 28 percent and in 1966, the market fell 27 percent. Does this mean that 2007 will be a crash year? So far it seems that way.

Now onto this week’s trades:

Short USDJPY +15

On Monday, our technical setup gave us the signal to go short USD/JPY before the major collapse on Tuesday. We nursed the trade for a good few hours but it gave us little more than 15 pips. The CADJPY short signal was screaming at the time, so we switched out of the USDJPY short for the CADJPY short. Some of you asked us why we didn’t keep both. Of course everything looks great in hindsight, but USDJPY and CADJPY are very correlated, shorting both means that you are doubling the risk on basically the same trade. If it turned against us, both would have been stopped out.

Short CADJPY +71

Shortly after closing the USDJPY short, we switched into the CADJPY short. As our setup suggested, CADJPY had a far bigger move (530 pips) than USDJPY (440 pips) between Tuesday and Friday. We closed our trade a few pips shy of our target as we took part in the beginning of the major yen rally.

Short NZDUSD -4

NZDUSD was our only loser this week and we only closed out of it because we saw a better opportunity in USDCAD. In retrospect, we should have stuck with the NZDUSD trade. Our technical reason was the fact that NZDUSD broke the below 100-hour SMA on the hourly charts and had been holding below it for the past 4 hours. We felt that the pair would remain below the moving average, which was where we placed our stop. Since then, the pair has yet to break back above the 100-hour SMA and has instead fallen 163 pips in our direction. The SMA was golden.
Long USDCAD 0

We went long USDCAD on the break of February 22 high of 1.1639. We felt that this represented a very significant technical break to the upside and that there would be room for an extension. Unfortunately we hate it when news screws up our technical setups. Refinery outages triggered a reversal in oil prices, which would have been bearish for USDCAD and we opted to get out of the trade at breakeven.

Short AUDUSD +12

Throughout the week, we were very bearish on the high yielders with a particular emphasis on the commodity currencies. On a fundamental level, we felt that there would be more liquidation of carry trades. On a technical level, the AUDUSD provided a very good risk/reward opportunity. We went short the currency pair 0.7887. When the Australian markets opened, Australia reported the strongest level of manufacturing in 4 years. With such positive fundamentals, we did not want to be short the AUDUSD on the potential for a sharp rebound. Therefore we opted to bank 12 pips on the trade.

Short NZDUSD +6

On Thursday, we once again went back into the short commodity/high yielding currency trade (when you have something that works, stick with it!), but this time in the NZDUSD. The break of the past 2 day’s low signaled the potential for more losses in the NZDUSD, so we went short at 6936. The currency pair then proceeded to stay confined within a 20 pip trading range for the next 13 hours. Having watched this painstakingly for the entire time, the smallest rebound from +20 to +6 at 10:40pm EST tested our patience and we decide to close the trade and put an end to the pain. Four hours after that, the NZDUSD broke down, which means the pair consolidated for a total of 17 hours before actually moving in our direction. This was one of the trades that where we should not have questioned our technical setup and simply stuck with it.

Short EURUSD +12

On Thursday night, our technical signal triggered a short on the EURUSD. The risk was small enough that we were able to hold both a NZDUSD and EURUSD short at the same time. US data was strong and German retail sales were exceptionally weak. The pair came within 7 pips of our target, it was 4am in the morning EST and no one was around to catch the profits. So we moved our stop to breakeven but we banked 12 pips on a dip before it eventually rallied beyond our breakeven point.

Short AUDUSD +11

Our last trade of the week was the AUDUSD. Gold prices were selling off and our technical setup triggered a short trade with low risk. 0.7855 was also a clear resistance level from multiple time frames indicating its significance. If the pair broke that level, we knew that we were clearly wrong. Once again, we were right on the direction, but since we do not hold trades over the weekend, we opted to bank 11 pips before the market close.

Looking ahead, the economic calendar next week is lighter than the past week’s, but the upcoming reports are just as market moving. We are expecting service sector ISM, the Beige Book report, Factory orders, Non-farm Payrolls and the Trade balance. There should be more volatility in the currency market as expectations for stronger service sector activity and a smaller trade deficit is met with forecasts for weak factory orders and non-farm payrolls. The ECB is scheduled to raise interest rates, the press conference by Trichet will be particularly market moving. For more on our outlook for the week, read “US Dollar – More Volatility Ahead”