France has been at the center of attention due to the presidential elections, but it also has a data flow. The second-largest economy in the eurozone reported a growth rate of 0.3% q/q, under 0.4% expected. In addition, year over year growth posts a similar shortcoming: 0.8% instead of 0.9% predicted. And what about the elections? We [...]
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Although the RSI was featured in Wilder’s book „New Concepts in Technical Trading Systems“ in 1978, it is still widely used today. The RSI is, just like the MACD or Stochastics, a momentum oscillator, and requires therefore additional confirmation for opening buy and sell positions.
The relative strength index measures the size of recent gains and losses for a specified time period, and also includes the speed of these price movements in its calculation. Due to these characteristics, it is primarily used for identifying overbought and oversold situations in a financial instrument.
The standard setting used with RSI is a 14-day period. This is recommended by Wilder himself. If the average gains are larger than the average losses during a particular period, the RSI will have a higher value. And if average gains are smaller than average losses, RSI will move downwards. Like all trading topics, a chart is the best description. Let’s look at the USD/JPY chart with an RSI indicator included (red).
An Introduction to the RSI Indicator
It is also possible to use the RSI with time frames other than the daily, but in this case special attention is needed as the RSI can become more volatile on shorter timeframes, thus creating more false signals. The RSI indicator has a normalized value in the range from 0 to 100. This means, if over the periods indicated in the settings the price moved only up, the RSI would have a value of 100. It the price moved only down, the RSI would be 0. The RSI is a very effective indicator in creating trading signals, which only added to its popularity. The most popular use of RSI includes identifying overbought/oversold areas.
The RSI is widely recognized to have the ability of identifying overbought and oversold situations in a currency pair. Usually if the RSI is under 30, it indicates that the pair is oversold, while a value over 70 indicates an overbought area. With a strong upward move in the price, the RSI will get a higher value. If the price moved too quickly and the RSI is above 70, the presumption is that a correction move is ahead and traders should prepare for a fall in the price. This is considered an overbought situation.
Similarly, if the price moved quickly downwards and the RSI is below 30, traders should expect a possible upward move and prepare accordingly. This is an oversold situation. A popular trading strategy regarding overbought and oversold conditions, is letting the RSI move below 30 and waiting to break above 30 again, for opening a long position in oversold conditions. Letting the RSI move above 70 and waiting to break below 70 again would be used as a signal for entering a short position in overbought market conditions. The RSI can stay in oversold and overbought areas for a long time during strong down- and uptrends, and utilizing this strategy avoids entering counter positions in these situations.
Like all momentum indicators, the RSI can also produce false signals from time to time, especially during strong trends or on lower timeframes. Traders should therefore use other confirmation signals as well, and not solely rely on technical momentum indicators.
Trading the RSI Indicator on USDJPY
In the chart above, the first two red arrows show the RSI making false sell signals, while the price is still in an uptrend. The next three red arrows show that the RSI went above 70 and then moved back below 70, creating sell signals which resulted in nice drops of the price as the chart shows. The last green arrow follows the rule for opening a buy position in oversold conditions. The RSI went below 30 and came back above 30, which sends the signal of opening a buy position. As the chart shows, this would also result in a profitable position as the price moved up. Stop-loss orders should in both cases be placed just above/below previous swing highs/lows.
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The Canadian dollar remains under pressure. The pair reached a new high at 1.3670, reaching yet another 14-month high. The next level of resistance is only at 1.3850. The last time the pair saw these levels was in the wake of 2016. The crash in oil prices sent Dollar/CAD shooting all the way to 1.4690. Yet the fall [...]
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While markets focused on the Draghi show, and for good reasons, the US released a big bulk of data. And the data has not been that good. Durable goods orders came out at 0.7% for March, much lower than 1.5% expected. It came alongside an upwards revision from 1.7%, which did not compensate. Core orders slipped by 0.2%, [...]
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Taking a Behavioral Aspect on Technical Analysis for Better Trading Results
Financial markets are not only ruled by economic forces. Neoclassical finance has been the prevalent economic theory in the financial world for many years, and claimed that all financial practitioners are making rational decisions. However, empirical evidence and psychological studies have challenged the neoclassical finance in the last decades.
Behavioral finance explains how human psychology affects market prices, and raised as a strong alternative framework to neoclassical finance. Financial markets consist of humans and their psychological set-ups, and therefore the behavior of market participants systematically influence individual decision makers and market prices. According to Ricciardi (2008) “the different behavioral finance theories and concepts that influence an individual’s perception of risk for different types of financial services and investment products are heuristics, overconfidence, prospect theory, loss aversion, representativeness, framing, anchoring, familiarity bias, perceived control, expert knowledge, affect (feelings), and worry.” These concepts are reflected in market prices and charts, and therefore play an important role in technical analysis. By studying the historic prices of markets using charts, one is actually indirectly studying behavioral finance.
Technical analysis is another theory which challenges the neoclassical finance and efficient market hypothesis. Technical analysts believe that certain price patterns will repeat themselves in the future and thus provide profit opportunities. According to a leading technician, Martin J. Pring (1985), “technical approach to investment is essentially a reflection of the idea that the market moves in trends which are determined by the changing attitudes of investors to a variety of economic, monetary, political, and psychological forces. The art of technical analysis is to identify changes in such trends at an early stage and to maintain an investment posture until a reversal of that trend is indicated.” 25 to 30 percent of foreign exchange traders base most of their trades on technical trading signals (Cheung and Chinn, 1999), and technical analysis is used as either a primary or secondary source of trading information by more than 90 percent of foreign exchange market participants in London (Allen and Taylor, 1992). They report that traders base their long-term expectation on fundamentals, but use technical analysis for short-term investing and entry-exit signals. A survey made by Menkhoff and Schmidt (2005) report that 36% of German fund managers allocate their funds using alternative strategies including technical analysis.
According to Rolf Wetzer (2011), “academic interest in technical analysis started in the late 1950s. Ever since the first paper on this subject was written, researchers from universities and institutions, such as central banks, have tried to prove whether technical analysis is worthwhile or whether it is just pure nonsense. For decades, the prevalent regime was the “efficient market hypothesis”, i.e. the idea that market prices discount available information instantly and therefore, not only technical analysis but virtually every kind of analysis is useless. This quarrel has not yet been solved, but for over 20 years there has been a growing body of evidence that technical analysis can be profitable.”
Behavioral models suggest that technical trading strategies may be profitable because they presume that price adjusts sluggishly to new information due to noise, market power, humans’ irrational behavior, and chaos (D. Vasiliou et al., 2008).
Andrew Lo and J. Hasanhodzic (2010) explain that the efficacy of both technical and fundamental analysis is disputed by efficient-market hypothesis which states that stock market prices are essentially unpredictable. However, as long as anomalies in the market exist, technical analysis can be used to exploit inefficient prices.
According to psychologist Scot Heuttel, it takes only two similar particular events for the brain to expect they could occur also in the future. In behavioral finance this is called the “Heuttel bias”. “Financial professionals are a close group, sharing information in real and virtual space, thus becoming prone to emotional herding. The behavior of analysts for instance is closely observed by others and their opinions influence the investment public” (Raluca Qawi, 2010). This also explains the behavioral aspect of forming trends, bubbles or repeating technical patterns.
Technical analysis and behavioral finance can be efficiently combined to better understand the behavior of market prices, and thus provide investors with more relevant information in decision making. Exploring the behavioral aspect of technical analysis will give a practical framework for taking advantage of the human psychology in markets.
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After the ECB left the interest rates as well as the QE program unchanged, President Mario Draghi meets the press. The focus is on the tone: optimistic or pessimistic. There are reasons to be cheerful, leading us to favor the “glass half full” scenario over others. On the other hand, Draghi has proved his dovishness [...]
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The European Central Bank left the main lending rate unchanged at 0%, the deposit rate at -0.40% and the QE program at 60€ as widely expected. The April meeting does not consist of new staff forecasts. The focus shifts to the press conference by ECB President Mario Draghi. Will he see the glass half full? This is our [...]
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GBP/USD reached 1.2915, the highest level since October. This is above the previous high of 1.2905 seen after the announcement of the UK elections on June 8th. After reaching the new high, Sterling became shy once again. Is this a false break? Perhaps, but one that could preclude a second, more determined move. Momentum is [...]
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The French presidential elections will set the tone for EUR trades in the coming weeks. The 4 candidates – the far right Marine Le Pen, the independent Emmanuel Macron, the center-right Francois Fillon and the left-leaning Jean-Luc Melenchon – couldn’t be more different for the future of France. One thing is sure – an eventual victory of Le Pen would hit the euro hard. With Le Pen building her campaign on an anti-European tone, threatening that France would leave the EU and Eurozone in case she becomes the next French president, the euro is put under enormous pressure not seen since the sovereign debt crisis in Europe.
The first round is already over, with the independent Macron and Le Pen going to the second round of elections on May 7th. Last Sunday, Macron gained 23.7 percent of vote, while Le Pen got 21.7 percent. As the exit polls indicated a victory for centrist Macron, the euro hit a five month high against the dollar when the markets opened Sunday evening in Asia. The currency gained 2 percent on that day, hitting $1.0939 in early trading. EUR/GBP also rose 1.5% to .85 pence per euro. The market is confident that Macron will easily win against Le Pen on May 7th, with voices took over from Mr Melenchon as leftwing voters are committed to prevent Le Pen from gaining power.
Market Reaction to the First Round of French Presidential Elections
As Macron is known for his pro-European tone, the exit polls increased the confidence in the single currency, and increased flows in the European equity market could additionally support a stronger euro in the future.
With released market tensions and risk-on mode, French bonds are becoming increasingly popular among investors. The premium over German Bunds has narrowed to its lowest level since January 2017, at 44 basis points. The yield of a French 10-year bond is now 0.80 percent, compared to 0.36 percent of a German 10-year Bund. Gold also traded lower from a recent high of $1295, hitting $1265 as markets opened after the first round of French presidential elections.
Gold Selloff as the Market Reacts to the Macron 1st Round Win
The French stock-market benchmark index, CAC 40, also enjoyed increased market optimism. The index rose 4.1 percent, making the best trading day since 2015. European stocks also traded higher. The euro stoxx banks index, which trails the European financial stocks, gained 7.2 percent and touched a 16 months high.
“Now that the initial adjustment higher has taken place, we do not expect the French elections to have much further impact on the euro in the near-term,” said Lee Hardman, currency analyst at MUFG.
“The market’s focus will begin to shift away from political risk in Europe and more on to the improving economic fundamentals, which should begin to offer the euro more support.”
Jim Cramer, host of “Mad Money”, advised investors not to panic ahead of the French presidential elections. “Selling because of European politics has been a mistake endlessly,” Cramer insisted, stressing that recent Brexit sell-offs were largely caused by the trading of hedge funds. “No one ever made a dime panicking. But loads of money’s been made taking the other side of the panic”, he also added.
The market has already absorbed the expected win of Macron, but a definite victory in the final round would probably push the optimism even higher, continuing a risk-on investment environment. The impact of the final round, which takes place on May 7th, will also be determined by the percentage difference in exit polls. If Macron wins by a solid margin, we could potentially see the euro stabilizing at around 1.10 against the U.S. dollar.
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