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Chapter 8 - Exchange rate forecasting, technical analysis and trading rules. The objectives of this chapter are: To explain why exchange rate forecasting is needed, to illustrate forecasting techniques, to explain how to evaluate the performance of forecasters,...
Chapter Exchange Rate Forecasting, Technical Analysis and Trading Rules Objectives • To explain why exchange rate forecasting is needed • To illustrate forecasting techniques • To explain how to evaluate the performance of forecasters (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-2 Objectives (cont.) • To demonstrate how technical analysis is used to generate buy and sell signals • To explain how filter rules and moving average rules work Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-3 Definition • Forecasting is a formal process of generating expectation • Expectations are implicit forecasts Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-4 Why we need exchange rate forecasting? • • • • • • Spot speculation Uncovered interest arbitrage Spot-forward speculation Option speculation Hedging Investment and capital budgeting (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-5 Why we need exchange rate forecasting? (cont.) • • • • • Financing decisions Pricing decisions Strategic planning Macroeconomic conditions Central bank intervention Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-6 Econometric forecasting models • These are models that are specified on the basis of economic theory and estimated by an econometric method • They are classified into single-equation and multiequation models Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-7 Single-equation models • The exchange rate (or its rate of change) depends on one or more variables: St f ( X 1,t , X 2,t X n,t ) St a0 a1 X 1,t a2 X 2,t an X n,t Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-8 Examples of single-equation models S t a0 a1 ( P P )t S t a0 a1 (i i )t St a0 a1Ft 1 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-9 Problems of single-equation models • • • • • • The ‘black box’ problem Forecasting the explanatory variables Data frequency Structural changes Measurement errors Qualitative variables Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-10 Trendlines and trend channels S (a) Upward trend (bull market) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa Time (cont.) 8-34 Trendlines and trend channels (cont.) S (b) Downward trend (bear market) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa Time (cont.) 8-35 Trendlines and trend channels (cont.) S Time (c) Sideways trend (trading range) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-36 Support and resistance levels • A support level is the bottom of a market swing • A resistance level is a point where the market peaks and the exchange rate reverses an upward move Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-37 Creation of resistance and support levels S S2 S1 t1 t2 t3 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa Time 8-38 Flags • A flag is a continuation pattern • A flag occurs when a major trend is interrupted Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-39 Triangles • An ascending triangle appears when buyers come to the market at progressively higher levels Otherwise it will be a descending triangle • A symmetrical triangle is difficult to interpret Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-40 Head and shoulders • This formation indicates the reversal of an upward trend • A reverse head and shoulders formation implies the opposite (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-41 Head and shoulders (cont.) S Head Shoulder Shoulder Neckline Time Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-42 Reverse head and shoulders S Neckline Shoulder Shoulder Head Time Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-43 Market efficiency and trading rules • Market efficiency implies that it is not possible to make profit by adopting a mechanical trading rule or by following buy-sell signals extracted from charts Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-44 Filter rules • An x% filter rule means that a currency is bought when it appreciates by x% from the most recent trough and is sold when it depreciates by x% from the most recent peak Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-45 A single moving average rule • A single moving average rule means that a currency is bought when the moving average cuts the exchange rate series from above and is sold otherwise (cont.) Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-46 A single moving average rule (cont.) 2.00 1.90 Exchange rate 1.80 1.70 Moving average 1.60 10 11 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 12 13 14 8-47 Double moving average rule • A double moving average rule says that a buy signal is indicated when the long moving average crosses the short moving average from above, and vice versa Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8-48 ... 2,t an X n,t Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8- 8 Examples of single-equation... McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8- 12 Time series models (cont.) • Exchange rates move predominantly... with significant random variation Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A Moosa Slides prepared by Afaf Moosa 8- 13 Cycles