What Lies Behind the Price Chart

A trend is a tendency that emerges during a long period of time in economy or any other area marked by a stable situation.

Historically, most traders perceive the trend literally, only as a line in a price chart, overlooking the essence of processes that stand behind the graphical picture. It is balance sheets. Major market players, primarily legal entities (banks, transnational corporations, hedge funds), have to prepare a balance sheet for transactions they made on the trading floor during a certain period of time. Therefore, the time structure used to prepare balance sheets is a key to understanding trends on any trading floor as this structure is present in any market... (see more details in the beginning of the article in the last but one issue of ML).

Unlike the stock market, the inter-bank forex market and the currency futures market have no official earning seasons.

Unlike in the commodities market, reports in the interbank market are not based on periods of the year because currency movements do not depend on weather conditions. Nevertheless, the interbank also has certain periods for which balance sheets are made by major financial institutions. As a commercial, for-profit entity, the bank makes different conversion operations such as setting the value for transactions, brings contracting parties together, speculates on its own behalf and on behalf of its clients. To control all these transactions, banks maintain balance sheets for conversion operations for a certain period of time, for example, the financial quarter. This is mainly the pattern followed by the entire banking system. It cannot operate without data provided in balance sheets.

A reasonable question arises - why does a usual trader need to know all this? How can this information be applied in trading and what is actually the connection with the trend...? The first part of the article (see ML # 25) asked a question: what lies behind the price chart? We got the answer: financial flows and balance sheets. To answer the questions above, I will ask a counter-question: what logic lies behind actions of a major player of a certain exchange? In particular, at the interbank market and the market of currency futures?

 We have closely approached the understanding of how financial flows move: the less time remains before a certain time period closes and balance sheets are prepared, the more likely it is that major players will start closing their positions. An institutional player reasons this way: to make statements for the current period, it got to strike the balance for actual operations. This is why banks and hedge funds fix part of their trades. Since market operators trade huge volumes, their actions put pressure on the price. This helps us understand the phenomenon called 'correction' in technical analysis. Essentially, any more or less meaningful correction that has taken and will take place in financial markets is related, in many respects, with positions covered before expiry of an investment period and preparation of balance sheets.

Sometimes correction is referred to as 'cutoff' in stock exchange slang because positions are cut off, profits are cut off for the previous period. EUR/USD 2009, close of the financial year. Please note a sudden change in the Euro's trend in September/October 2009. This is the time in the Eurozone when balance sheets are prepared for the previous financial year and a new financial year opens. The market corrected itself by 400 pips during the cutoff. In early October priorities changed dramatically, and we see smart money starting to aggressively buy the market. This is the period when a new trend starts.

After the cutoff takes place and balance sheets are reported, a new time interval opens: month, quarter, half a year etc. There is a high likelihood at the start of the new period that new trends are born or change. This is why it is the time when smart money makes a decision to buy or sell a certain currency, futures, stock. It is during this period that graphical and wave patters will perform best, indicators' signals will work out. It is the time when the market is filled with fresh money. It is crucial at this time to follow volumes invested by institutional players in a new investment interval.

The tendency born in a new period has a huge potential of evolving into a medium-term or long-term trend. EUR/USD, targets reached for the first 2010 financial quarter in the Eurozone. The cutoff in September brought about a medium-term trend of 800 pips.

Currencies are traded in different time intervals of different significance in the interbank market. For example, the Eurozone closes its financial year in September/October. Great Britain and Asian currencies do the same in March/April. In addition, currency futures close their contracts each quarter, and these periods also have a strong impact on the dynamics of trend formation. There are shorter periods such as the month and the banking week. Balance sheet reports can be followed during the current session for some currencies within the day. One should understand that the time structure offers us a starting point where a trend begins forming and which does not depend on a certain timeframe. This is why the trader can identify the trend at an early stage of its development rather than post factum as is usually don in classical technical analysis.

Materials provided by the Volumes Department of the