Australian Dollar under Severe Pressure

Aug 21, 2007: 6:53 PM CST

The relative value of the Australian Dollar has plunged over the last few weeks, underscoring the point that global markets are suffering along with the United States.

The visual chart of the decline shows a market under intense selling pressure, and is an educational example of how price can run away from you as a trader if you don’t utilize some sort of stop-loss strategy. Let’s look at the charts:

Daily Swing Chart of the Australian Dollar Futures Contract:

While the 14% decline took us from a high of $0.8871 to a low of $0.7673, price only erased gains and returned to the pre-breakout levels seen in April, 2007.

The decline was due to fundamental reasons, and not strict technical analysis, but we do see technical warning signs in the form of a momentum divergence and new momentum lows before the ‘shock’ decline from $0.86 to $0.76.

Traders who were long the stock – which would not have been a bad trading idea due to the strongly rising uptrend – should have placed stops below the 50 period moving average, which should have taken them out and also helped prevent the large majority of the decline. Traders also could have gotten short at this level, taking a risky bet against the trend.

Traders who refused to use stops would have gotten squeezed in the downtrend, at times unable to exit the tumultuous decline.

Let’s look at a different view.

The Australian Dollar Index – Daily

The prices are a bit more ‘choppy,’ not because the index experiences strange and unforseen gaps, but because market hours are different in Australia and the caluclations in StockCharts do not reflect this properly.

Still, prices may be a bit more clear to see through the decline than in the swing chart above. We still saw the new momentum lows following the ‘gaps’ from the highs serving as the initial warning. Stops should have been placed beneath the 50 period moving average and exercised – hopefully automatically – when price fell definitively below this important support level.

Why did this happen?

According to Yahoo Asia News, large Japanese security houses (firms) and investment banks contributed significantly to the decline. Furthermore, the price decline was “the worst in a decade” and “may remain hostage to changes in global risk appetite.”

Despite the decline in the dollor, Australia’s benchmark S&P/ASX 200 Index of stocks closed up 4.6 percent Friday, representing its biggest one-day percentage rise in more than a decade.

The largest reason stated for the decline is the fears from fallout from the subprime ‘crisis’ in the American economy spilling over into global economies.

Strategists forecast that the Australian dollar would recover within the next six months, provided this overreaction was due to over-intensity of fears of the global economic situation due to the relative ‘lending crisis’ worldwide.

Remember that the US Dollar has been under pressure for an extended period of time, but moves like this in any major currency are relatively rare, but it is important to study the ramifications and lessons when these situations occur.

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