A Love Affair with Trends: Why It Will Burn You in the End

Posted 06/05/2009, 9:00 am EST by Chuck Butler from worldcurrencywatch.com

I'm going to let you in on a little secret.

As a currency investor, it's almost too easy to fall in love with trends. After all, long-term currency trends can last for years.

Take the dollar for instance. We've had five major dollar trends since Nixon took us off the gold standard in 1971, and each one lasted an average of seven to 10 years. So as you can imagine, when the dollar has fallen or risen for years, it's pretty easy to fall into the trap of expecting the dollar to behave in a certain way.

As we've seen the last seven months, the dollar definitely has the potential to shock us out of that complacency - even during a bear market.

Now I truly believe that this type of dollar rally has more to do with the rest of the world's poor fundamentals (which look even worse in relation to the U.S. dollar), the fallout from the credit crunch, and the Obama-bounce that I've been talking about recently.

I don't think this is the beginning of a multi-year bull market for the dollar. But I think it's a good example of how a currency can pull a fast one and surprise investors even in the middle of a long-term trend.

This is just one more reason why you can't just blindly follow currency trends. You still need to do your research.

As you're researching, it's helpful to think of a currency as a "stock" of a particular country. Just as when you're buying a stock, you should examine a country's "balance sheet." You look at the country's earnings, its "dividends" (aka its yield), the country's ability to attract investment, its leadership and its stability.

Right now, I would say one of the most important factors to watch is how a particular country is responding to this global recession. It's the same advice I would give when evaluating a particular company - what company's look like they will pull out of this recession with actual earnings?

When One Currency Goes Up, Another Goes Down?

It's Just a Question of Which

In the case of currencies, what countries actually appear worse off than the U.S. now that we're all facing the same struggles? (Remember, if one currency is falling, another currency by definition has to be rising in relation to it. So all you need to do is find the currency that appears worse off by comparison.)

Once you've done your research, you will find that a handful of countries have the kind of fundamentals that you are looking for - even during a recession. And you'll have a better handle on when even the dollar will respond going forward.

About the Author: Chuck Butler is a senior editor for Currency Capitalist and a daily writer for FX University. He's also the President of EverBank World Markets and long-time editor of his own daily E-Letter, A Pfennig for Your Thoughts. A regular speaker at financial events, Chuck focuses on the factors that affect a currency's value over the long run ? from trade and fiscal balances to interest-rate policy and credit expansion. Because of his concentration on the fundamentals, he has correctly called the dollar's demise and the euro's rise since 2001, as well as many other important long-term moves.