A$ continues to show strength

Since 28^th May the Australian dollar (AUD) has continued to strengthen, rising from 92 cents to 94 cents. These two price zones represent important support and resistance areas and provide an insight into where the AUD might be headed in the short to medium term.

There are many variables that drive the AUD and trying to remain up to date on all of them and what effect they may have on the AUD is exhausting and nigh on impossible. Which is why I go to the charts to determine the probability of the direction in the timeframe that might affect my off shore investments.

Why would a DIY SMSF investor want to know the direction of the AUD?

Prior to the early 2000’s most DIY Australian investors couldn’t really do anything about the movement of the AUD as it was difficult to get access to currency instruments in small enough lots with low enough costs to hedge or profit from such movements.

In recent times access to currency spot market instruments and other instruments such as currency futures, forward outright swaps, currency options and CFDs of futures contracts have become easily accessible at very low cost. What used to be only the domain of large financial institutions and large corporates has now moved all the way down the investing spectrum to DIY investors.

In my view the main reason that an SMSF investor would and should want to not only determine the direction of the AUD, but also take some action, would be to hedge any USD or other currency investments that they may have off shore. To achieve this, when the AUD strengthens against, say, the USD, an investor would buy the AUD and when it weakens, sell the AUD. The big question is: when might the AUD strengthen and when might it weaken?

The AUDUSD chart

The daily chart below shows two indicators, a five day swing chart overlaid on the AUDUSD price on the upper graph and a momentum indicator on the lower graph called the SIROC.

These two indicators are used to attempt to eliminate thee small up and down gyrations in the price, or what can be called the ‘noise’, by smoothing the price movement. The idea is to make the visual reading of the chart easier to interpret and ultimately less subjective and open to conjecture, opinion and emotion.

To do this I use some simple rules to determine whether there is a high probability whether the AUD will strengthen against the USD, my motivation being to insure my USD share holdings against falling in value due the AUD strengthening. Of course, the opposite is also true, when the AUD declines my USD share holdings appreciate in value.

Notice how the lower SIROC indicator (blue line) is closely aligned in a smooth manner to the AUDUSD price movement in the upper graph.

Source: Beyond Charts

On Thursday last week, 12^th June, the conditions of my simple rules were met so I opened a hedge to the value of my current USD share holdings. The conditions were:

1. The blue SIROC line is rising and placed above its green 13 period moving average line.
2. The AUDUSD must have broken above the previous 5 day swing high, shown by the red horizontal line. This occurred when the AUDUSD closed above 94.08 cents

The hedge will remain open until the blue SIROC line drops below its green moving average.

Such a set of rules will not hedge every pip of movement but it will insure against a large part of a large move in a strengthening AUD which is ultimately what one needs to insure against.

Where to for the AUDUSD?

The rise from below 87 cents in January 2014 to above 94 cents in early April has consolidated over the last 2 months in a sideways rectangle pattern which is a continuation pattern, having tested the support zone of 92 cents twice.

These technical conditions, amongst others, tell us that the odds are in favour of the AUD rising further against the USD. Which is why I opened the hedge position.

But hang on, many commentators, myself included (see Switzer Super Report 16^th December 2013), have longer term forecasts of a much lower AUD. That may still eventuate but in the meanwhile an objective analyst just has to objectively analyse the data before them believing that “anything can happen”. In the short to medium term the trend is up so I have to go with that.

The breakout above 94.08 cents could yet prove to be a false breakout or it could continue strengthening immediately, enforcing the breakout. A false breakout could see the AUDUSD move back to 92 cents again and even lower. But while the objective conditions that I have outlined above hold I am a buyer of AUD against the USD.

Gary Stone is the Founder and Managing Director of Share Wealth Systems.