Exchange Rates: Chart Technical Analysis

This strategy generates Buy & Sell signals using price action alone, depending only on information available at the time. It combines three elements - annual rates of change, moving averages and divergence. Buy & sell signals are represented by red arrows embedded in the price index.
 
The exchange rate is shown by the bold white line on the right hand axis. The moving average is represented by the thin white line alongside on the same axis. The explanatory variable, the momentum indicator, is the thin yellow line using the left hand axis. For comparability, exchange rate indices have been rebased to set year-end 1994 at 100.
 
The first element is based on the observation that the psychological effect of a shock takes about a year to wear off. Known as the Coppock Indicator, after the man who successfully applied the concept for forecasting the US exchange rate over many decades, this momentum indicator is designed to generate buy signals. In statistical terms momentum is defined here as a time-weighted moving average of monthly changes. Buy signals are generated when the rate of change turns up from a level below zero line, as shown by up arrows.
 
However, owing to the different character of market peaks, the Coppock Indicator has been supplemented by a second element, which uses moving averages to generate sell signals. These arise when the exchange rate index falls below its moving average, while above zero, as shown by down arrows.
 
The third element is necessary to offset the possibility of trend-based charting strategies generating buy and sell signals at the worst possible times. To reduce this risk, our strategy therefore also includes an overbought / oversold component. By combining three proven components in one strategy, overall performance can often be dramatic.
 
Owing to the conversion of legacy currencies into Euros, analysis is provided on the common currency, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.
 
Please note that signals may be late at times of crisis, because they are based on month-end prices, rather than automatically on reaching targets during the month.
 
Back-testing shows that this combination of three elements is much more effective than reliance on a single charting technique. It has continued to perform well and was only partially affected by the financial crisis of 2008.