Friday, May 31, 2013

A little bit of magic on the hourly chart

The AUDUSD pair has continued its downward trend, as expected. As in all these cases a currency pair will never move to its price target in a straight line. There will always be deviations and retracements, and one of the challenges of writing trade management Algorithmic software is to be able to determine what is a retracement of this nature, and what is the start of a trend change from one direction to the other.

As regular readers will know, we set quite a bit of store by the 200 period Simple Moving Average, or 200 SMA.

Earlier this week, on Thursday (30th May 2013), the hourly chart of AUDUSD observed the 200 period SMA on the hourly chart with the precision of a Swiss watch. One of those really expensive ones, of the type we see advertised when we visit our brokers in Geneva, Dukascopy Swiss Bank. A glance at the chart above will illustrate the case.

We have to ask why this should be. The original idea of using moving averages, or any other technical indicator, was that it would provide a statistical indication of where price might go in the general case. Statisticians talk about margins of error and confidence levels, which mean in reality that their determinations are the very opposite of being precise. The kind of precision shown here has no statistical basis whatsoever.

So we have to postulate some other reason for this happening (for which we are very grateful, by the way, and long may it last).

We have mentioned before that the 200 SMA has a characteristic that other indicators, such as MACD and Stochastics, do not. It requires only one parameter, the integer 200, and this is common to all users. Where you have many parameters, and where different traders have their own favourites for these values, then the results will be all over the shop. On the other hand the 200 period SMA will look the same on each and every chart on the planet for a particular currency pair and time scale, and is therefore more likely to be... a self-fulfilling prophecy.

Could there be more to it than that? Could it be that some of the bigger players use the 200 hourly SMA as a programmed backstop in those cases where they are required to make large, countertrend transactions, for example when putting on a hedge? In this case the computers they use would always stop buying or selling, as the case may be, when they come to the backstop. They would then let another head of steam build up in the market, in the trend direction, before entering again. If the positions were large enough, this would give us what we see. And then the price action would have the very significant number of individual traders who watch the 200 period SMA on all time scale charts to reinforce the tendency. The computer placed hedge would also be more likely to be put into play at month end, which we have right now.

No matter what the reasoning behind it, it is an interesting, and significant, not to mention profitable phenomenon for us.

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