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# Geometry and the major pairs

Discussion in 'General Forex Talk' started by cowmadagan, Jan 25, 2010.

1. ### cowmadagan Sergeant

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I've seen lots of articles in forex, but they don't seem to say much about the influence each currency has on seemingly independent pairs.
Because of this, I've decided to write something to explain ALL of the majors as far as what I've learned so far. First I need to introduce a math term that has helped me get the impression I have, which is linear dependence.
No major pair is independent of the other currencies.

If you don't want to read the explanation of the geometrical component of my findings, then scroll down now to where I write 'CHEAT SHEET'

Any two lines going in any number of dimensions will appear to be moving on a plane from any perspective if the image is flattened like in a photo. If there are any angles where the two lines intersect that aren't 90 degrees then they are 'linearly dependent' because one can directly affect the other in a 'slowing' sense when adding the lines together. If they are separated by 90 degrees then they can't slow (or mute if that's more descriptive) each other.

An example of this is if a person is crossing a river that flows from north to south, it doesn't matter how fast he attempts to cross, he can't go directly east to west unless he simultaneously rows slightly northward. That's because north and south lines are 'linearally independent' of the east and west directions. They are separated by 90 degrees, and geometrically and in practice we see that no amount of east-west on its own can cancel the north-south movement of the water.

Since forex has no 'linearly independent' currencies, the only way to hedge now that you can't directly hedge any more is to find the comparatively dependent cross pairs.

As a side note, if you want to get super rich, figure out a matrix including a separate coefficient for each currency value that will give a good idea of what news will do to the price of all pairs. What I mean by that is just like the formula for switching between Celsius and Fahrenheit is C = [(F-32)/9]*5, you'd have to figure out the magic number (the 32) you should add or subtract, and then the percent change that will happen for every '1' that the other makes.
I'll pull a formula out of the air to make an example, so I'll use EUR/GBP vs USD/JPY. If I want to know how a change from 90 JPY/USD to 91 JPY/USD would affect EUR/GBP, it might be: Change in USD/JPY = {[(EUR/USD-1.41)*-0.004]+[(GBP/USD-1.60)*-0.003]}*(EUR/GBP-0.87)

(I put this post on here so that I wouldn't have to make up a function like the one above, but I'm guessing it would look something like that.) End side note.

Even though this formula was pulled out of thin air, there's something I want to demonstrate by it. Let's say you expect the Euro to increase in value, and the GBP to decrease in value. It would seem logical that if you go long on EUR/USD and GBP/USD, that if you are up 20 pips on the first pair and 10 pips on the second that you'd also be profiting from a long EUR/GBP position, because you would also have a complete set of dependent lines...but that's not true. Even if EUR/USD increases faster than GBP/USD, EUR/GBP might go down....Why?

The JPY is traded against both the EUR and the GBP, and so if the price of EUR/JPY goes down faster than GBP/JPY, it will skew the USD pairs further from EUR/GBP.

CHEAT SHEET

Since Switzerland is surrounded by the Eurozone, yet has a smaller economy that it, anything the Euro does against the USD will happen in the CHF, but it will be amplified. That means each time the Euro goes up or down, CHF tends to do the same thing but change by an extra 10% of the pips or so. The range of the 10% or so eventually leads to slips in the EUR/CHF value. The smaller economy also means that it will deteriorate in times of crisis. Lastly, they have the most 'intervention happy' central bank of all, and that means the market knows how much they love to give out free money. Recently, and it's ultimately because of the low value of the CNY and its peg to the USD, the Swiss central bank has stopped caring how much strength the CHF has against the USD, but rather strength against the EUR. *01/29/10 Note: That last intervention shows that the last movement down in the EUR changed the Swiss central bank back to being more concerned about the USD than the EUR.

The JPY is the closest to an independent currency as I've seen, and that means whatever USD/JPY does, EUR/JPY does too. What took me a year, and the Dubai problem, to figure out is that it's more independent as it works as a wedge in the European currencies. *Read the last two paragraphs before CHEAT SHEET to understand this better. The size of Japan's economy, and its surplus in trade balance, also means that JPY will appreciate in times of crisis.

The GBP and EUR tend to benefit off of each other's misfortune, but EUR/GBP doesn't tend to have outrageous ranges and I feel that's because all of the other less valuable major currencies act as buffers. For example if EUR/GBP went way up then the EUR would have to cost way too much in USD, JPY, or others as the GBP is such a valuable currency itself.

The CAD and AUD are usually grouped together by the term 'commodity currencies' but I personally feel the two couldn't be more different from each other. There similarities are that if gold goes up, they go up, and if crisis happens they lose a ton of value. They're dissimilar because AUD is a gold and interest (carry trade) currency that is tied closely to China and less to the US, and CAD is an oil currency that is tied to the USD without any slack. Sure, the world needs gold for reserves so it can control the economies via value of the currencies, but the world needs oil every second of every day. That's why I find the CAD to be a very resilient currency outside times of crisis. The way CAD and AUD affects other currencies is by making investors regret not getting involved in them when they make these massive moves in value. If you catch a year like 09 then you could make 12%, interest aside, by letting your cash sit in them.

Gold is a dynamo that is sometimes carried around in value by the value of EUR/USD, but other times gold will just carry the other currencies around for the ride. In this sense, now that I think about it, gold is also quite similar to the JPY as a relatively independent variable.

What you should take away from this is how to mix about five positions, and using various numbers of lots and smaller stops than take profit levels you can make a hedged and diversified position.
That doesn't mean you'll be right, and the only thing I can guarantee is that this info does explain most of what happens when a newsbreak happens.

#1
Last edited: Feb 12, 2010
2. ### cowmadagan Sergeant

Joined:
Dec 23, 2009
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There's one other thing I didn't mention, and that's the influence of the stock markets. There's always a correlation, but I find that correlation can switch from time to time. High stockmarkets are back to where they were last year, being that they raise the price of the EUR, and gold.
The EUR/JPY pair is commonly known as the risk pair, and I don't really agree, but one thing that is true is that if the stockmarkets start sliding, the EUR/JPY pair will slip down faster than the USD/JPY pair.

#2
Last edited: Jan 29, 2010
3. ### cowmadagan Sergeant

Joined:
Dec 23, 2009
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Another vector is the one of intervention which I just got my head around thanks to S&P's threat of downgrading the Japanese national credit rating.
It seemed to me that since the Japanese government is currently worried about deflation and the drop in exports due to the appreciation of the yen that it's easily solved (compared to strengthening a currency, which requires reserves to buy back the local currency) because they could just print more money and pass it around.
That causes three problems:
1) Just like if someone always throws a party at their house and then the neighbors call the cops every time, eventually no one's going to come to the party. That means that eventually people (I imagine principally exporters to your country) will lose interest in trading, because of the extra risk of you playing with the money supply all of the time.
2) If your local economy isn't borrowing enough from the central bank then the ability to buy back the newly printed cash is diminished.
3) Because money printing can have reactions that go horribly awry, you have to take your risk exposure into account based on the amount of assets in your reserves.
Again, if anyone has something to add, please do.

4. ### Pharaoh Colonel

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Cowmadigan - fx genius or babbling insanely??? Either way, this is intriguing.

5. ### clem699 Sergeant

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Cowmadagan,i appreciate you for the time you set aside to develop these educating threads.If i get you right on this topic,are you referring to correlation currencies vis a vis currency correlation/relationship with other markets or commodities.If that is what you are talking about i think it will do more good if you select simple words(plain English) rather than making it look abstract and scientific.

If the thread is about correlation which to me is a simple and interesting topic,i think it would be more interesting and appreciated,even with your formula,if it is simplified.

People love to read write-ups that are written in very simple language even if the topic is abstract it will be very much appreciated.

#5
Last edited: Jan 29, 2010
6. ### Stony Sergeant

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I agree. Too many words for simple facts.

7. ### cowmadagan Sergeant

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Dec 23, 2009
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I know what you mean, and I appreciate your criticism.
That's why I put the cheat sheet at the end, but I went into detail in the explanation to prove I'm not just selling snake oil.
I'll try and trim in this weekend, but just like Pharaoh, I write these things knowing that there's a very good chance that the post is like a 'final draft' rather than final.

8. ### clem699 Sergeant

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Correlation Currencies

It is no criticism but an advice/contribution so that a pain staking job would be more appreciated.

#8
Last edited: Jan 29, 2010

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