How many technical indicators you need in making a trading decision? Many traders fall victim to analysis paralysis and use too many indicators. What you need to do is master only these two indicators; The Stochastics and the MACD (Moving Average Convergence Divergence). Both are called oscillators as their values oscillates between two extremes!

Trending conditions in the market exist not more than 30-40% of the time. Rest of the time, the market is range bound or what you call consolidating. After a nice trending move, the market will move in a consolidation phase.

In choppy range bound market conditions, Stochastics is your best friend. And in a trending market conditions Moving Average Convergence Divergence (MACD) will give you solid trading signals.

Now, the myth that MACD is the best indicator out there may not be true. The reason being market conditions change and the people’s perception on an indicator’s given value. There is no holy grail in trading. Under certain market conditions, Stochastics maybe more useful as compared to MACD.

Stochastics is also known as a Momentum Indicator. This is a popular trading tool used to determine whether the market is in an overbought or an oversold condition.

Overbought means that the prices have advanced too far too soon and are due for a downside correction. On the other hand, oversold means that the prices have declined too far too soon and are due for an upside correction.

Stochastics used a mathematical formula that sows the location of the current close as compared to the high/low of the range over a certain period of time. Closing prices near the top of the range show that buying pressure and closing price near the bottom of the range show selling pressure.

Now Stochastics uses two line known as the %K and %D. These two lines are plotted on the chart for a given time period. The %D is the 3 period moving average of the %K line. Now %K is a ratio or percentage and fluctuates between 0 and 100. It is calculated with the formula that used the recent close, highest high and the lowest low.

Now the %K line is the faster line and will change direction as the %D line is just the moving average of the %K line. The general rule is the if the reading is over 80%, the market is overbought and ripe for a downside correction. And if the reading is below 20% on the chart, the market is oversold and ripe for bouncing down.

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Face the fact that in currency market all is possible and there is no golden rule to follow. There are so many aspects to consider that you will need at least another head to set this puzzle together.

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On the eco front German Retail sales surprised to the downside printing at -2.4% versus 0.0% eyed, but the figure was not as bad as the headline would suggest. The numbers is subject to seasonal adjustments and further revisions and did not contain the auto figure within it. On annual basis Retails Sales increased by 2.7% from March of last year – the strongest gain since September 2008. We continue to believe that the underlying fundamentals in Germany are improving, but for now the sovereign debt concerns remain the primary driver of trade with bears in full control and 1.3100 likely to be given before the day’s end.

In Australia, the RBA hiked rates to 4.5% but the slightly dovish tone to the post announcement statement sent the pair below .9200 in Asian and early European trade. Governor Stevens noted that, “As a result of today’s decision, rates for most borrowers will be around average levels,” lading most traders to conclude that RBA will pause for the foreseeable future. We noted yesterday that PBOC’s tightening may have a negative impact on Aussie going forward and along with today’s RBA policy stance that appears to be the case with pair remaining tapped in a broad .9000-.9400 range.

The pound meanwhile was weak as well despite strong PMI data as election news preoccupied the market. Manufacturing PMI hit its best reading in more than a decade printing at 58.0 versus 57.5 eyed, but traders focused on Thursday’s Parliamentary election where conservatives appear to be falling short of a majority win. The Guardian newspaper ran with a story that suggested the market may make a run on the pound once the election results are in.

In North America the calendar is light with only Pending Homes and Factory orders on the docket. The dollar has been strong across the board rallying not only on risk aversion flows but on growth differential assumptions as well, as currency traders continue to be impressed by strong US economic data. Tomorrow’s ISM Services and the ADP report will be the final dress rehearsal ahead of Friday’s NFP report which could prove pivotal to the near term direction of the greenback. For the time being trading will likely continue to be dominated by the newsflow from the other side of the pond with EUR/USD 1.3100 the key battleground for the rest of the day.

Price Action

• USD/JPY 95.00 rebuffed for now as option defense holds
• AUD/USD below .9200 after dovish RBA
• GBP/USD drops below 1.5200 on broad dollar strength
• EUR/USD contagion risk still weigh as 1.3150 gives way

FX Upcoming

Economy Continues to Improve, RBA Remains Weary of Asset Bubbles

The reason why the RBA remains so aggressive is because despite 125bp of tightening, the Australian economy continues to outperform. Any indications of cooling have only been temporary with the economy quickly regaining steam. Last night’s manufacturing sector PMI report was the perfect example. Yet inflation will continue to be the primary reason why the RBA wants to raise rates. In the first quarter, Consumer Prices neared the 3% mark on an annualized basis, coming close to the top-end of the RBA’s inflation target, and is almost double from last quarter. Since the bank has held true to keeping inflation in check, there is definitely an argument in that the RBA may want to act as quickly as possible to prevent the development of another asset bubble. The labor market has also been particularly strong. Last month, Australia’s employment Change indicator rocketed from 0.4K to 19.6K. As the main aid to the hiring frenzy, manufacturing activity has also increased rapidly, with the AiG PMI index increasing at the fastest rate in nearly eight years. Services, on the other hand has been a bit slower to stage a definitive comeback, with the PMI report still below the 50 expansionary/contractionary thresholds. However, perhaps the most concerning release since the RBA’s last decision is Consumer Confidence, which, despite strong momentum in the labor market, sunk fell 1.0%. Nonetheless, it is safe to say that the economy has improved since the last meeting, which will encourage the RBA to raise rates to 4.50%.

The reason why the Reserve Bank of Australia’s interest rate decision excites so many traders is because they are the only major central bank tampering with interest rates. For the most part, central bank watchers in other regions have been relegated to focusing on incremental changes in statements and commentary. For the RBA, actions speak louder than words. As evidence of that, the central bank has taken rates higher for an unprecedented five times out of the last six meetings. The RBA has been the outlier because the Australian economy emerged from the ‘Great Recession’ almost untouched; completely skirting recession while others faced one of the harshest financial storms in history. For that reason, recovery took hold early on, prompting the RBA to move before anyone else.

A few weeks before the release of Australia’s inflation report, it looked doubtful that the bank would hike for the sixth time in seven months. After all, the speed in which they withdrew monetary support gave them a fair amount of flexibility to sit back and watch the implications of their actions. RBA Governor Glenn Stevens almost sealed the deal when he said that “rates are pretty close to average.” Assistant Governor Debelle also said recently that “we’re moving back to something around about average levels, which is not far away from where we are at the moment.” Add the sovereign debt crisis in Europe to an equation that includes toned down central bank comments and there was a good chance the RBA could pause. However, with the release of the inflation numbers, which showed prices were challenging the bank’s preferred inflation band, a completely sentiment emerged. In addition, the RBA’s latest Minutes sharply contradicted comments from Stevens and Debelle, saying that “it might be prudent not to delay adjustments.” Adding to matters was a decision by lawmakers to increase mining taxes to 40% starting in 2012. This step in the form of fiscal tightening reflects some concern that the economy has become overheated. As a result, 75% of economists polled by Bloomberg now expect yet another hike at tomorrow’s meeting.

How to Trade the RBA

Scenario # 1 – If the Reserve Bank raises interest rates by 25bp and does not comment on further rate hikes, the Aussie should rally.

Scenario # 2 – If the Reserve Bank raises interest rates by 25bp and suggests that they are nearing the end of their tightening cycle, the Aussie could weaken.

Scenario # 3 – If the Reserve Bank leaves interest rates unchanged, regardless of what they say, the initial impact should be a sharp sell-off in the Aussie.

Potential Strategy: Sell if prices rally to 89.64 risking 90.24 targeting 88.04.

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1. Greece – The biggest story is of course Greece.  Even though Eurozone finance ministers have approved a EUR110 billion bailout package, there still needs to be Parliamentary approval from individual nations that will affect the speed and size of the final bailout.  Eventually Germany will come through because underneath all of the political backtracking, the government knows that in order to avoid a more damaging and embarrassing bailout of German banks, they need to bailout Greece first. There will be strikes and protests, but at the end of the day, the aid is needed to stabilize the region’s economy, support investor sentiment and prevent the euro from falling further. There is even talk that the Germans could be fast tracking their vote. However even if Greece is successfully bailout out, investors could turn on countries like Spain, Portugal, Italy and Ireland at anytime especially if there are additional downgrades by rating agencies. As a result of these developments, the European Central Bank has already amended their collateral rules to include Greece regardless of their rating which suggests they will refrain from saying anything hawkish on Thursday to support the fiscal austerity measures.
2. China – The second top story in the markets today is China’s decision to raise their reserve requirement ratio for the third time.  Although raising the RRR is less hawkish than an all out rate hike, it reflects the Chinese central bank’s commitment to gradually tighten monetary and fiscal policy.  Their attempt to cool the economy has contributed to the risk aversion in the markets because almost every major nation will be affected by slower Chinese growth.
3. Australia – This week the Reserve Bank of Australia is expected to raise interest rates and their announcement higher taxes on the profits for commodity producers reflects their commitment to taming inflation and preventing asset bubbles.   The tax hike suggests that prices and growth have not cooled enough to satisfy the RBA.
4. Gulf Oil Spill – Aside from tighter fiscal and monetary policies in Asia, the worsening oil spill in the Gulf has boosted oil prices and raised concerns about the impact on the U.S. economy, the environment and cleanup costs.
5. Goldman – The possibility of a criminal investigation into Goldman Sachs remains a risk for the equity markets.
6. U.K. Elections – Elections in the U.K. on May 6 remains a risk for the British pound since a hung Parliament where there is no majority becomes increasingly likely.

The only hope for risk appetite this week would be a round of positive U.S. economic data.  We have already seen some healthy reports this morning and if the leading indicators for non-farm payrolls support a strong number, this prospect keep help to support risk.

Dollar Gains Accelerate on Stronger Data

The acceleration of personal income and consumption in the month of March indicates that the U.S. economy is improving, giving consumers the confidence to spend.  Personal spending rose 0.6 percent, the strongest in 5 months while incomes rose 0.3 percent.  The PCE deflator rose from 1.8 to 2.0 percent, which reflects growing inflation pressures.  If the labor market continues to improve, we could see a further pickup in incomes and spending.  Manufacturing Sector ISM also rose from 59.6 to 60.4, which was the fastest pace of growth since 2004.  The manufacturing sector continues to fuel the U.S. recovery while the pickup in prices paid signals growing inflationary pressures. The Federal Reserve can’t be cautious forever.  With activity in the manufacturing sector accelerating, payrolls growth in excess of 200k on Friday could push the Fed to drop their “extended period” language in June.