Since May 28, 2014 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 Aussie dollar might be headed in the short to medium term.
There are many variables that drive the Aussie dollar and trying to remain up to date on all of them and what effect they may have 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 offshore 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 Aussie dollar 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 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 Australian dollar, but also take some action, would be to hedge any US dollar or other currency investments that they may have offshore. To achieve this, when the Australian dollar strengthens against, say, the US dollar, an investor would buy the Australian dollar and when it weakens, sell the Aussie dollar. The big question is: when might the Aussie dollar 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 the 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 the Aussie will strengthen against the US dollar, my motivation being to insure my US dollar share holdings against falling in value due to the Aussie strengthening. Of course, the opposite is also true, when the Australian dollar declines my US dollar 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, June 12, 2014, the conditions of my simple rules were met so I opened a hedge to the value of my current US dollar share holdings. The conditions were:
- The blue SIROC line is rising and placed above its green 13-period moving average line.
- 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 Aussie dollar which is ultimately what one needs to insure against.
Where to for the Aussie?
The rise from below US87 cents in January 2014 to above US94 cents in early April has consolidated over the last two months in a sideways rectangle pattern which is a continuation pattern, having tested the support zone of US92 cents twice.
These technical conditions, amongst others, tell us that the odds are in favour of the Aussie rising further against the US dollar. Which is why I opened the hedge position.
But hang on, many commentators, myself included (see Switzer Super Report 16th December 2013) [1], have longer-term forecasts of a much lower Aussie dollar. 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 US94.08 cents could yet prove to be a false breakout or it could continue strengthening immediately, enforcing the breakout. A false breakout could see the Aussie dollar move back to US92 cents again and even lower. But while the objective conditions that I have outlined above hold, I am a buyer of Aussie dollar against the US dollar.
Gary Stone is the Founder and Managing Director of Share Wealth Systems.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.