The Yin and Yang of Currency Pair

To understand the Taoist philosophy of Yin and Yang is to understand the natural dynamics resulting from the interaction of complementary forces. For examples, how may one define chaos, if not order is also defined? Direction must be defined in pairs; you cannot direct someone ‘to the right’ without pre defining a direction ‘to the left’. Sit back for a moment and try to take in the complementary environment around you.


Currency pairs are an excellent example of complementary dynamics and at the same time a special case for which these dynamics may be monetized. In particular, how may a trader use the Yin and Yang of currency pairs to anticipate direction? The first step would be to identify the extremes in terms of strengths and weaknesses. Fortunately for the trader, global central bank interactions have forced currencies into extreme relative positions. There are three possibilities in terms of strong and weak: strong/strong, strong/weak and weak/weak.


First, how do relatively strong currencies compare? Volatility studies are usefully applied here. Inserted on the left is a six month candlestick chart of USD/DDK. The envelope used is a standard Bollinger Band study. The sub chart is that of standard deviation. The pair has since retraced from that high, most likely due to a weakening of the USD, not as much because of a definitive strengthening of the US economy but more as a result of uncertainty in the direction which the US Federal Reserve Bank might take concerning its benchmark interest rate policy. On the other hand, Denmark’s Nationalbanken has suppressed its benchmark deposit to yield negative in order to defend its currency peg against the Euro. It’s not unreasonable to expect the Krone-Euro dynamic to remain stable, while US policy may tilt slightly, as has been stated by the Fed. The pair should be more affected by the Yin of US data, than by the complimentary Yang of the Krone. Hence the opportunity to employ Yin-Yang strategies on the pair, straddles, strangles or the like.


Conversely, what opportunities are presented by weak/weak pairs? The obvious pair that comes to mind is that of EUR/JPY. The chart on the left employees the same studies and demonstrates the catch phrase bantered about in the financial press: ‘the race to the bottom’. In this case note the definitiveness of the trend indicated by the spike in volatility, the breaking through the Bollinger Band’s simple moving average followed by breaking through the 2 standard deviation bands, above or below, as the case may be. The dynamics here are a little more involved. The most recent reporting of Japanese CPI seems to indicate that in spite of the extraordinary measures recently implemented by the BOJ, core CPI is at 0%. The 0% CPI measure may be attributed to the recent fall in oil prices. One may reasonably expect the BOJ to carry on for some time before a different course of action is taken. On the other hand, the ECB has expressed great confidence in its quantitative easing program . It’s beginning to show signs of success, but again, more time is needed to confirm the data. Lastly the trader needs to take into account the outcome of the Greek debt sustainability crisis. Hence it’s reasonable to conclude that the dynamic of the pair will be most affected by the Yin of Euro, and less so by its compliment, the Yang of Japanese Yen.


Lastly would be an example of a strong weak pair, for instance EUR/GBP. The BOE seems to be caught in the same quandary as is the US Fed. Recent economic data indicates both strengths and weaknesses in the economy, leaving the BOE to straddle the fence on upcoming policy actions. A recent statement by the BOE’s Financial Policy Committee labeled global markets as being ‘fragile’ and that the potential exists for instability and higher volatility. This would indicate that the BOE will not risk a potentially economic dampening rate hike until it was more certain of global stability. In particular, they have concerns over the outcome of Greece’s future in the EU and thus that of the Euro. The Yin-Yang dynamic here would be more so on the Yin of the Euro than the complimentary Yang of the Pound Sterling. Recent trading shows the EUR/GBP testing £0.70 and moving towards key resistance at about £0.75.


The point of the matter being that philosophies are taught as great universal abstractions, when in fact, they just might have a more practical application.