Historical Chart: RBA and Turning Points in AUD

aud/usd Australian Dollar australian dollar forecast Kathy Lien Reserve Bank of Australia

The last 3 times the RBA made a monetary policy announcement, a small to large reversal was triggered in the Australian dollar. RBA rate decisions can frequently mark a top or bottom in a currency -- this does not happen 100 percent of the time, but given the number of considerations that go into an interest rate decision as well as the impact that high interest rates have on the attractiveness of a currency, we can understand why it is such a big market mover. In fact, the main reason why the Australian dollar has had such a nice run in recent is because of its high interest rate. As a result, A$ traders need to be particularly wary of the possibility of the RBA decision triggering a top in the AUD/USD.

RBA Rate Decision: What to Expect for the AUD

aud/usd Australian Dollar Kathy Lien Reserve Bank of Australia

The Reserve Bank of Australia has a monetary policy announcement this evening and even though interest rates are not expected to be changed, the tone of the statement could seal the fate of the Aussie by determining whether it makes a run for 1.05 or falls back towards parity. The key with the RBA is to look for comments related to the terms of trade and the Aussie.

If the RBA emphasizes the negative impact of a strong currency over the positive implications of higher commodity prices to the terms of trade, the AUD/USD could give up its gains. If they emphasize the terms of trade and doesn’t even mention the currency (which would be unlikely), then it could be clear sailing to 1.05. The most likely scenario however is that they attempt to temper their positive outlook by discussing the risks posed by a strong currency which should help the A$ in the medium term but probably hurt it in the short term.

Here are the levels to watch in the AUD/USD:

The Australian dollar has come a very long way over a very short period of time. Since the middle of March, the AUD/USD has appreciated more than 7 percent to a record high of 1.04168. The big question for the central bank this evening is whether the recent gains in the Aussie sufficiently mitigated inflationary pressures and how it has affected export demand. Like the Australian dollar, commodity prices have performed very well in recent weeks, which helps to support the metal and mining industry and there is a good chance that this will have a bigger impact on the Australian economy than the strong Aussie. If the gains in the A$ have not deterred other countries from buying Australian commodities, the RBA will probably acknowledge that the outlook for investment and terms of trade has improved. Consumer spending has been a big concern for the RBA, but retail sales have slowly creeped higher which could build the case for a rate hike. The labor market has also remained strong but with the Australian dollar trading at a record high, the RBA may want to be very careful about saying anything that could push the currency even higher. No export centric economy wants a strong currency.

How Much Further Can the EUR Rise?

2010 eurusd forecast 2010 eurusd forecasts 2011 euro forecast ECB ecb rate hike Kathy Lien

Sorry for the radio silence -- have been on vacation then corporate craziness

The euro staged a remarkable rally today after dipping as low as 1.4060 following the U.S. non-farm payrolls release. The resilience of the single currency is incredibly impressive considering that Standard & Poor’s downgraded Ireland’s sovereign debt rating and Fitch warned about the possibility of their own downgrade in the near future. Both rating agencies currently have Ireland at the same level but a downgrade by Fitch would move Irish debt one step closer to junk.

However none of these rating actions have deterred forex traders from buying euros in anticipation of the first rate change in nearly two years. At the last monetary policy meeting in March, ECB President Trichet said interest rates could be increased as early as April. Since then, the central bank’s message has been very consistent with a number of ECB officials reiterating the need for tighter monetary policy. In contrast, the Federal Reserve is still debating whether QE2 should be cut short. Although many members of the Federal Reserve have grown more optimistic, there are also a number of Fed officials who believe that caution is warranted.

As a result, the best that we can expect from the Fed won’t nearly be as hawkish as the least that we can expect from the ECB. The better than expected U.S. non-farm payrolls report on Friday helped to lift the dollar against the euro but we believe that the EUR/USD could make a run for fresh year to date highs ahead of the ECB’s rate announcement on Thursday. The direction of interest rates is one of the most important drivers of currencies and investors usually prefer to invest in currencies where the interest rate is high and growing and the euro certainly fits the bill. Aside from the ECB rate decision, Eurozone retail sales, German factory orders, industrial production and the trade balance are also scheduled for release. Baring any major downside surprises, the euro should be on its way to a new year to date high. After the rate decision however, the euro could weaken if a classic buy the rumor, sell the news dynamic takes hold.

This chart shows how rate hike expectations have changed in recent weeks:

In terms of how high the EUR/USD can rise, there is a VERY good chance that the currency pair will make a run for its Nov high of 1.4282. If this level is broken, then it could be clear sailing to 1.45

How To Successfully Second Guess Yourself

Boris Schlossberg

This week on my Twitter account (if you are not yet following me @fxflow please do) I posted a chart called, “Why waiting for that last pip can be very costly.” It showed a long EUR/USD trade that didn’t quite make it to my 4150 target. After a few minutes of failure to move higher, I bailed at 4148 just before it plunged 40 points on some fresh piece of news.

Those of you who follow me closely know that I often exit my trades early especially if I see price losing momentum. After all -- 99.44% of a loaf is better than none. Of course I rarely get 99% of my target and frequently have to be satisfied with only 60% or 70% of my intended profits, but in the end, I believe selling out too early is better than selling out too late. When Baron Rothschild was asked for the secret to his family’s wealth he calmly replied, “We always sell out too early.”

I don’t mean to imply that selling out early is always a good idea. Clearly you need to keep you risk and reward ratios somewhat it check otherwise it doesn’t matter if you win 9 out of 10 times -- you’ll still lose money in your account. Ideally, I try to keep my risk and reward ratios as close to 1:1 as possible, but that doesn’t mean I stick to my targets with robotic stubbornness on every trade. In fact, flexibility is the key difference between discretionary and algorithmic trading and the primary reason why I think all computerized Expert Advisors fail in the end.

Computers lack the ability to second guess themselves. Many algo traders will often laud that attribute as one of the best characteristics of the machine. I however, believe that this is actually the machines’ greatest weakness. The machine will do the same thing over and over again regardless of context. But the markets are nothing but context. Markets after all are driven by messy, emotional, hyperactive human beings that can change their minds more often than my teenage daughter changes her clothes. Just a few days ago we were trading 76.00 on USD/JPY and now we are challenging the 84.00 figure. Has anything really changed? No. Only the story. Not the facts. Machines however are only good at processing facts rather than understanding the story.

That’s our strength as human beings. Just as winning at poker is more a function of reading your opponent rather than knowing the odds of each hand to fifth decimal point, so too in trading it is more important to understand the immediate drivers behind the price action rather than blindly follow your rules. Second guessing is often denigrated as the domain of the weak and indecisive, but when used properly it is the key to critical thinking and in my opinion the one factor that still gives humans the edge in the market.