Tuesday, October 19, 2010

Forex for Investing: Deep Trading

How does one invest in a forex pair ? One can lower the leverage and buy a currency pair you think will grow and take the profits from that growth. One would need a lot of money to do this. One could increase the leverage but then one exposes oneself to volatility.

One could treat the instrument like some treat equities and sell on local highs and buy back on dips, but that is a dangerous proposition in forex. The forex market is designed to punish that kind of activity (assumptions of regularities).

The presupposition is one is investing on 1 month over the long term, a matter of years. Firstly one needs a currency which will grow like this. EUR/USD did so from 01 - 08 and that fact is what has been pulling EUR up from the depths of its valuations in the wake of the crisis. EUR/USD was itself inflated, deflated and then reflated though.

Each time it looks like a new asset inflation measure is coming, which is what keeping Fed funds rates near zero is, EUR rises. It is like a memory in that system, but not really a memory, more like a computational sensitivity to money flow of a certain kind.

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Now the nature of money flow phenomenon is they are not self supporting (fractal chaos growth structures are). Thus they actually need stimulus to get them up. Keeping them up is another matter and indeed the capacity of such boosts to work over time seems to decay, interestingly a feature of stimulus in natural systems as well.

The way the market has behaved in the past year is evidence of this. This blog has argued that EUR is itself a phenomenon of this. This blog has also questioned the economic plausibility of upward valuation of EUR and downward valuation of USD.

But the question is, is $ a good investment choice, whether one can actually do this or is simply interested in it as a paper trade.  It is a hugely important question, the value of $ has the most profound affects throughout the world economy. $ is the reference currency for the world still.

In investing one asks is an instrument undervalued or overvalued relative to other similar instruments and to something intrinsic to it. That is generally expressed as the structure of its financial data over time, is its equity valuation in coherence with what the data is saying.

The complication is that this is often a future potential the astute analyst is seeing in a company. One assumes though that the Dow will bring it up to this potential over time. But the forex market does not do this. It seems to value now, based on a number of things this blog has a called a matrix of valuation computations within an overall optimization.

What is the equivalent of a growing balance sheet in forex ? The nearest equivalent would seem to be technical indicators. Their signals are part of that matrix of computation. But more properly something like RSI catches the money flow element of forex and Polarized Fractal Efficiency the chaos element.

The forex market is money flow structured by chaos towards an optimization. To grow an instrument needs chaos in the mix. But to direct that growth needs optimization. In equities the balance sheet itself directs that growth, the optimization is up to the company itself. In forex that optimization is a result of such things as Fed Funds rates and economic performance.

But that optimization in forex takes place on technical indicators, because leverage makes it necessary to pinpoint entry and exit points. But use of Fed Funds or Fed Funds and ECB rate differentials (a differential means you do not need to raise interest rates at all, because you can direct money flow with a differential) has the same issue as money flow in assets in the equity market, they sharply correct or slide back.

Money flow is much stronger in forex than equity, hence the way the market apparently cycles back and forth in ranges. The exception seems to be those currencies mostly tied to the US equity market, $ and EUR. But those currencies are also part of that interest rate differential. Without growth they move up and down in ranges.

Very simply this blog believes that real economic growth is good for $, money flow asset inflation growth is good for EUR.  This blog has tracked the effect of this phenomenon, otherwise called risk on/risk off. But the reason why seems to be that the forex market does not compute that much on the kind of structure real economic growth provides and this itself is why asset inflation has been so attractive.

The great promise of Obama is that he will focus on real economic growth rather than the money flow related asset inflation. Real economic growth may bring recessions but it does not bring about depressions.

Asset inflation always does and arguably this is a deep depression we are in right now. But in deep depressions great things are born. Real economic growth would be expected to bring about recessions, look at how fractal phenomenon grow.

But the nature of Elliott Waves suggest that money flow is always a factor in markets, that is at some stage the fractal growth decays and money flow takes over resulting in something from a correction to a valuation slump. Then the computers surge up the instrument after a basing pattern and in this process chaos begins again.

Thus I am suggesting again that chaos in markets is not exactly like chaos in nature, it is highly linked to algorithmic processes rather than self growth from a program. The difference is one is dynamic one is static. Into this mix are human minds which seem to have an advance on algorithmic computation.

That may be a source of optimizations in forex as well. Money flow may be a super smart thing tied up with human minds.

Thus is $ undervalued ? The US economy is itself a victim of the money flow surge decay effect it has been happening for decades. Real growth will add that essential structure of chaos growth and superstructure for the alchemy of money flow valuations to work again.

It is the most liquid country, thus in a restored economy it is undervalued. In business as usual it is probably overvalued (technically it is undervalued, that is important for short term action). Thus the medium-long valuation of $ is highly dependent on the coming election in the US.

The point is that apparent growth in forex (e.g. EUR/USD) is a function of a kind of economy which may be disappearing. The suggestion is that the kind of economy that Obama wants to engender may produce forex pair behavior that is not conducive to investing even of the long term kind.

In theory those policies would be good for $, once Fed funds can be raised. But the problem is, its valuation is relative and ECB rates will be raised as well. A truly growing US economy will surge chaos into all markets, the source of Dow chaos is the US economy itself, that immensely complex powerful system.

The effect of that on EUR, which effectively has only Germany as a power source remains to be seen. The point is ranging as an expression of an optimization search may be more probable. A growing US economy will change the chaos structure within which that optimization seems to happen. Instead of Fed and ECB optimizing it, or setting optimization ranges, the economy itself will be doing this.

That means that the way to investing in forex is to link it with the hopefully resurgent Dow. That effectively turns the ranges into a growth trend.

UPDATE COMMENTARY 03/05/11: The performance of the equity market since this post does lend some support to these ideas. It did indeed resurrect itself after a time, perhaps enough for the market to compute on the effects of QE2. One notes the temporal delay in such processes even in forex.

However the market has since de-structured, with those vast drops one remembers from the crisis. But there is significant support there as well, from company growth, I suggest, because it acts like a support framework when the money flow cascades away.

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