Content

EDITOR'S NOTE
READERS' TESTIMONIALS
ABOUT THE AUTHOR
PREFACE TO THE WEB EDITION

INTRODUCTION TO THE PRINTED EDITION OF 1991

PART 1

Chapter One - BACKGROUND
Chapter Two - HISTORY OF FLOATING
Chapter Three - EXPERTS CONFOUNDED
Chapter Four - INTEREST YIELDS
Chapter Five - TURNING POINTS
Chapter Six - USING CHARTS

PART 2

Chapter Seven - BASIC TRADING
Chapter Eight - MASTER TRADERS
Chapter Nine - YOUR FIRST TRTADES
Chapter Ten - EXITS AND ENTRANCES
Chapter Eleven - WHO ARE YOU?

GLOSSARY
SHORTLIST OF HIGHLY RECOMMENDED BOOKS

EDITOR'S NOTE

Note:

This eBook is a guide - and serves as a first guide.

In addition, please get expert advice from this general inroduction to the futures markets:

The Futures Game, by Teweles and Jones.

Recommended overview of futures trading. McGraw-Hill, 1987; paperback ISBN 007063734 2.

Further recommended reading is listed in the last Chapter: SHORTLIST OF HIGHLY RECOMMENDED BOOKS

The Way of the Dollar was written in 1991, yet none of John PERCIVAL's principles of trading currencies for profit have changed! The D-Mark was replaced by the EURO in 1999/2000, the rest of the major currencies remained and are still quoted mainly against the Dollar.

Between 1989-1996, John Percival's currency portfolio at Chescor Capital (1987-2008) went from $1 million to $800 million. All his trades were explained in real time in his bi-weekly Currency Bulletin and Weekly Flash (1985-2017) part of which is still available in an online archive at currencybulletin.com.

The original illustrations provided by Datastream relate to market periods prior to 1991 and have purposely been kept mostly unchanged except for instances where the use of colours improved the legibility of the original black-and-white images (where dotted and solid lines were overlapping). The few re-designed charts had to rely on underlying historic data being readily available.

The original black-and-white charts convey the original impression of the 1991 rendering.

For example, the chart above has been replaced with the chart below:

This chart conveys the steady fall of the Dollar after Nixon abandoned the Gold Standard in 1971.

Since many pre-1991 economic data are not readily available – as they were then – only a few charts are re-designed and rendered in colour (a scope not available for the 1991 initial private printing).

Since 1991 the Dollar has moved in both directions, up and down, but the sentiment-based, contrarian thinking taught in The Way of the Dollar still applies:

Following a consistent contrarian sentiment-based approach works because it is founded on immutable human nature. The point about sentiment is that it's always there, always at work, and always offering an edge.

Highly acclaimed by readers and Currency Bulletin subscribers, this book has now become a classic and has been touted as the "Bible of Currency Trading".

The private print edition* was gobbled up fast. This e-book will now be welcome to all participants in the exciting world of currency markets.

* An extremely rare copy is on amazon, signed by the author – offered privately as collector's item.

THE WAY OF THE DOLLAR

Acknowledgements

To Datastream International and DynexCorp for the charts

To the University of British Columbia, Sauder School of Business, Pacific Exchange Rate Service provided by Prof. Werner Antweiler

To Leo Chapman for proof-reading

To Marlene Harrison-Panholzer for proof-reading this e-book edition

Peter Panholzer, Editor

31 August 2020

READERS' TESTIMONIALS

THE WAY OF THE DOLLAR

TRADING CURRENCIES FOR PROFIT

SYNOPSIS

As readers know, my approach to analysing the currencies – its method – is essentially anti-crowd. We look where the crowd is not looking for an underlying rationale for the direction of the main trend. And we use a series of contrarian* sentiment indicators designed to orient us in the opposite direction to the crowd. This method has worked well, and it is timeless so it should always work. The method is OK. If we can have confidence in it and can apply it, we shall win.

Readers' comments:

"The best advice on currencies you can hope to find" (Harry D Schultz, Harry Schultz International Letter, HSL)

"Has changed me from an on-balance loser to an on-balance winner" (Tony Begg, Los Alamos National Laboratory)

"Uncanny and awesome" (Ben Roberts Ltd, London)

"Has the courage of its convictions" (Alan Moore, Director of Lloyds Bank)

"Can demonstrably make money for me" (P Triffitt, Devon, UK)

"Very impressive" (Claremont Economics Institute, Berkeley, CA)

"An absolute must" (Paul Rumsey, Bank of America)

"Entertaining, witty . . . always useful" (Tony Hourmont, Vienna)

Jack Crooks wrote:

"My all-time favourite currency guy is John Percival (now retired and living comfortably in the French countryside I understand). My respect for his insights over the years is immense."

"I have been a reader of John's newsletter for over 20-years. I have learned a great deal from him, through his writings. There is a wealth of insights which I took from a very beaten up copy of his book, The Way of the Dollar, published back in 1991."

"Mr. Percival doesn't know this, but he was the only mentor I had in this market. I read his book from cover to cover to cover … pages are falling out … highlighted and notes everywhere. His book provides more insight every time you go back to it. And I go back to it often."

"John Percival made a key point in the book that struck me – my belief in what matters when it comes to markets has little to do with trading success. I believed I was well armed given my freshly-minted MBA in finance and economics. I had already worked as a financial analyst and even did a stint in the never-never land of corporate strategic planning. Anyway, Mr. Percival's book opened my eyes, but at the time I still didn't understand just how valuable his advice was."

"After years of trading and barking up all kinds of analytical trees, with major failure and moderate success in currencies, I went back to Mr. Percival's book. This time I appreciated what was right there in the introduction:"

Finally one had to see if there were other relationships which had any predictive value for currencies like inflation, trade, money supply, oil prices, economic growth, et al. So far, the conclusion is that few such relationships and none of the relationships that most observers seem to rely on are useful for predicting the dollar.

"Say what? I thought to myself. Heck, I have all these so-called analytical skills and education and now I'm effectively being told by John Percival if you want to trade currencies and make money, you better pack up that degree and see the market for what it is, not what you think it is with your left brain dominance. John Percival argues in his introduction to The Way of the Dollar:"

Because the systems constituent parts are mostly based on human behaviour which doesn't change, not on fashion, we can be confident it will continue to work.

The financial markets, as anyone familiar with them knows, are deeply paradoxical. They have a logic of their own which is why in a way the opposite of normal logic. Hence the market adage "sell on the news" applies to good news not bad news. Hence other bits of market lore like "a bull market climbs a wall of worry: a bear market flows down a river of hope." Markets do whatever they need to do to confound the greatest number of people.

This happens because prices reflect expectations. If everyone expects unemployment to rise, or a trade balance to fall, or inflation to remain steady, there is no intrinsic reason why they should be wrong: the expectation doesn't affect the outcome. But if everyone expects shares to fall, or the dollar to rise, there is every reason why they should be wrong: because current share price levels already reflect the expectations of lower prices, and the current level of the dollar already discounts a rise. In other words, the expectation vitiates the outcome.

"You can see why John Percival is an excellent mentor."

"When I first got started focusing on currencies, I did my best to think only about what John Percival talked about in his book and push out all the smart rational analytical skills I was confident I had already learned. I didn’t realize the quality of this little book I stumbled upon; it was a true gem in the world of investment book wasteland where most reside, or should. I went on to do extremely well with my first real trading account."

ABOUT THE AUTHOR

John Percival belongs to that envied species of well-bred, articulate Englishmen who travel the world, try their hand at a variety of professions and thrive in every one of them.

Born 1939 in Karachi – which was then British India – where his father worked for Shell Oil, Percival grew up in the family home in Gloucestershire in England. He attended public school (a British English for private boarding school) in Surrey and received a "Greats" degree in Latin, Greek, philosophy and ancient history at Oxford University.

After he spent a year "wasting" his time with a computer company, he started researching stocks for Eurofinance in Paris. Percival joined the Financial Times as a columnist for the Lex Column in 1967 for six years. After this he moved to an investment bank specializing in the Middle East. In 1975 he settled in Bahrain and became an entrepreneur himself, flying freight into the Gulf States and North Yemen.

This is where he came face-to-face with the foreign exchange markets at the hard end, when he contracted for his freight space in dollars and resold in local currencies. On one occasion, he had a Boeing 707 full of bits and pieces. A satisfactory profit margin on this might have been 5%, but unfortunately the currency fluctuation at the time went against him and cost him about 7%.

Intent on learning more about currency markets, Percival left the Middle East and moved to France in 1980. Travelling between rural France and London, he started publishing a bi-weekly eight-page newsletter. He also traded for his own account, specializing in the Deutsche mark, Japanese yen and Swiss franc.

Percival traded from his London-based firm, Chescor, running up the value of his currency portfolio close to $800 million.

John Percival retired from trading in 2017.

PREFACE to the web edition

It’s about thirty years since I started writing The Way of the Dollar (short "TWotD"), published by our advisory service Currency Bulletin (short "CB"), founded in 1982. Re-issuing it for the web has been a curiously time-consuming endeavour – for mainly technical reasons – even though I decided to reproduce it in its original form rather than in a revised edition. But of course times have changed.

Our methodology was settled in the mid-1980s and has remained fundamentally unchanged ever since. Up front, it has to be said that the currency markets have become highly ‘efficient’, by which we mean that the supposed price-sensitive information is effectively discounted in prices so that attempts to anticipate price movements in the major dollar parities on the basis of such information have, over time, tended to be no more successful than the throw of a pin. This concept sounds easy to grasp, but in practice people have great difficulty with it: even if they see it must apply in general, there often seem to be good reasons why it doesn’t apply in a particular case (where we think we have a special angle on the data; where we think it may not yet be discounted). We simply accept that it is a waste of time. The approach we adopted and set out in this book was to look elsewhere to an area of inefficiency in currency pricing which seemed to be consistently reliable.

The analysts out there are looking for the explanation for currency movement in future events – such as interest rate changes; or central bank actions; or shifts in economic growth. The degree to which any event is discounted in price and the scope for insight or inside knowledge in such areas is small, and not too susceptible to systematic study. In this, currencies differ from stocks, for example, where expertise can be acquired in the way of specialised knowledge of individual company affairs: ditto with certain commodities, I imagine.

The alternative is to concentrate on determining what it is that the crowd is expecting, which is what is already discounted in prices, and on evaluating the degree of the crowd’s commitment. Our theory is that this is where the most reliable inefficiencies in the currency markets are generated, when the crowd gets over-committed to a view of the future. And the degree of over-commitment can be gauged in various indicators of sentiment among currency observers and participants – the level of speculation and consensus, in particular.

Three basic assumptions were that 1) the crowd tended to lose money; 2) that it tended to be ‘right for the trends but wrong at both ends’; and 3) that therefore it would pay to go contrary to the crowd at the ‘ends’ or price extremes. None of the above was too contentious, but the assumptions take you nowhere unless you have a way of locating the price extremes. The formula we settled on was to define the extremes, not in terms of price but in terms of sentiment. The underlying equation was: a price extreme = an extreme of consensus + an extreme of speculation.

Naturally you can, at any moment, point to some other driving force like a divergence or convergence in growth rates; or a rising or falling stock market; or a shift in central bank policy, via intervention or interest rates. Recently, observers have put the finger on equity and direct investment flows. Any of these can be or seem to be the determinants of currency movements. Our contention was that this might be so, but that you were more likely to lose money following such episodic rationales than following a consistent contrarian, sentiment-based approach, which was founded on human nature. And it worked.

In two decades, there were a few periods when the ebb and flow of sentiment was distorted or overwhelmed by unpredictable forces. In the mid-1990s, the automated trading systems were disrupted by a series of ‘stop-loss-cascade’ moves that looked to have been triggered by other market participants. These movements were sufficiently violent to upset most methodical traders, but they nicely illustrated the critical weight of ‘set-up conditions’ – speculative positioning particularly – as an engine of price movement. The moment passed. Then in the second half of the 90's came the thundering horde of macro hedge funds, throwing many tens of billions at the yen carry trade (and dollar/DM). The disruption here was that the flows self-fed to an unprecedented degree as the size of the forex-active hedge money mushroomed – meaning that the extremes that we used to gauge got that much more extreme. That moment passed too. Hedge money has retired hurt from the currency markets, leaving them much slimmer.

The point about sentiment is that it’s always there, always at work, and always offering an edge to exponents who have been able to keep their finger on the pulse of sentiment (and this applies to all financial markets, and always has). The rationales that participants use to justify their expectations and positions are simply the raw material underlying the ebbs and flows in sentiment. We cannot use them, but keeping up with them is part of the business of keeping one’s finger on the pulse. In this respect, nothing has changed since TwotD was first published as a private edition in 1991.

I see our approach working a treat all round: in the broad sweep of the dollar and the euro, and in their minor mood changes; in the twists and turns in the commonwealth dollars; in the fluctuations in euro/SF; in the fashion shifts in sterling.

This leaves the adaptations we need to make for more widespread awareness of sentiment out there. Most investment banks now make some attempt at tracking clients’ positions. At least two banks, Deutsche Bank and Scotia Bank in Canada publicise their research in the area in the sense of allowing the media some access to it. As far as I know, Deutsche Bank does the most comprehensive work in this area – and very good it is too. When it comes to coverage of forex exposures, the danger is that the more comprehensive you aim to be, the greater the danger of producing a soup with no information. For every buyer there has to be a seller after all. Our aim has always been to concentrate on the speculative segment. To this day this is most purely represented in the IMM open interest ("OI").

We had never been able to make good use of the weekly figures produced by the CFTC for the Commitments of Traders – until Deutsche Bank and, later on, Scotia Bank came along and charted the series. That showed that the figures seemed to successfully separate out the speculators from the specialists and pros, thus giving a good picture of net speculative exposures. As noted this is only on a weekly basis, but it gives an interesting check on our subjective interpretation.

Amazingly, for the rest we’re back where we stood in before. The consensus gauges needed to be confirmed by anecdotal evidence from market gossip. The “perception of the trend” (Chapter 5 "The four Sentiment Gauges") has been refined into a price target gauge, in the light of the recurrent phenomenon, as the consensus hardens, on the direction of the trend – that price targets get extended further out: an intuitive indicator, this. The “reaction to news” gauge is as valid as ever – no more no less – being used as confirmatory indicator of a trend that is in the process of changing.

What about the introduction of the single currency to replace the nine currencies of EMU? Important as it is, it hasn’t changed any part of our methodology, which has always been based first and foremost on the main dollar parities. As far as they are concerned the euro has replaced the D-Mark, and that’s that. The weight of the euro, however, has created a new major parity in the shape of euro/yen – and some minor parities of more significance, like euro/sterling and euro/SF. The result has been to complicate the analysis of cable (nick name for GBP) and dollar/SF as well as dollar/yen, and we had better recognise the fact, by staying out when in doubt.

This brings us to a key conclusion about currency trading today as compared with two decades ago. We need to widen the area of operation by bringing in other currencies that we rarely traded previously – the ones that fit the bill being the CAD, NZD, AUD, MXN etc since we do have IMM data for these series.

As I reread THE WAY OF THE DOLLAR, it seems to me that very little of it needs to be changed. Still, some things just don’t apply any more, like the section on ‘loonie’ behaviour (see Chapter 8 "Loony behaviour"). It really did work once upon a time, but seemingly no longer. Trading via the internet has become the most popular option, but there are various prerequisites which are seldom all met. The counterparty must be personally known to you; should have least an AA credit rating; and an office that you have actually visited; and buy/sell spreads should never exceed 1 or 2 points. As far as I know, all these conditions are not often fulfilled. In most cases, it’s a context that suits the counterparty – because costs are low and personal contact minimised – but not necessarily the client. What the internet has done is to give everyone access to free or cheap price and news services. Beginners can get a running start by consulting the site of our associate, dynexcorp.com, with its valuable links (login required), in particular with regard to charting dollar sentiment.

INTRODUCTION to the private printing edition of 1991

Currencies were emerging during the 1990s as a ‘new asset class’, for investment in their own right, alongside stocks and bonds.

The breakdown of the Bretton Woods* system and the floating of the major currencies in 1971-3 transformed the foreign exchange markets. Instead of being concerned mainly with trade they came to be dominated by portfolio flows.

The effect was that a new global financial market was born, which rapidly grew to dwarf all the other financial markets. As usual, the perception of the transformation lagged behind the event. Participants only began to cotton on in the mid-1980s. And they still haven’t done much to change their thinking about this huge market.

What makes prices move? In the securities markets the answers to that question have been more or less known for decades. In the currency markets, very few participants have any idea, still.

Starting in 1981, we spent the next decade analysing, proposing, eliminating. Quite early on it became apparent that the main driving forces for the price of the dollar, which is the unit in which the prices of most currencies are measured, were the same as in the securities markets.

The fundamental driving force was the urge to maximise total return – in yield and price movement. What else could it be? Superimposed on this “underlying rationale” was the ebb and flow in sentiment among the participants. At times, sentiment could become the sole determinant of price movement.

The analysable element in total return in currencies is the yield, of course: the price is what we wish to forecast. So the first thing to do was to see whether there are any rules governing the relationship between yield and price – like the relationship between share prices and corporate dividends and earnings. The result is positive. There do seem to have been certain relationships that are more or less useful for prediction – perhaps more useful than the link between corporate earnings and share prices.

The next thing was to see what measures were available of bullish and bearish sentiment in the currencies and whether any could be used to anticipate changes in price trends. Again, the result is positive – though if you want objective measures, they only exist for the main dollar parities, not for cross-rates such as sterling in euros.

Finally one had to see if there were other relationships which had any predictive value for currencies – like inflation, trade, money supply, oil prices, economic growth, et al. So far, the conclusion is that few such relationships – and none of the relationships that most observers seem to rely on – are useful for predicting the dollar. The few exceptions are of course commensurately valuable. The advantage is that this greatly simplifies the task of analysis.

So much for the basic groundwork. It allowed us to evolve a systematic approach to forecasting the dollar which has worked well for several years. Because the system’s constituent parts are mostly based on human behaviour which doesn’t change, not on fashion, we can be confident it will continue to work.

The financial markets, as anyone familiar with them knows, are deeply paradoxical. They have a logic of their own which is in a way the opposite of normal logic: hence the market adage “sell on the news” applies to good news not to bad news. Hence other bits of market lore like “a bull market climbs a wall of worry: a bear market flows down a river of hope”. Markets do whatever they need to do to confound the greatest number of people.

This happens because prices reflect expectations. If everyone expects unemployment to rise, or a trade balance to fall, or inflation to remain steady, there is no intrinsic reason why they should be wrong: the expectation doesn’t affect the outcome. But if everyone expects share prices to fall, or the dollar to rise, there is every reason why they should be wrong: because current share price levels already reflect the expectation of lower prices, and the current level of the dollar already discounts a rise. In other words, the expectation vitiates the outcome.

Understanding this discounting mechanism of markets is a great help in forecasting them. Unfortunately it is no panacea for trading them profitably. In “efficient” and sophisticated markets, like the major stock and bond markets, enough people know about the discounting mechanism so that the market still manages to do what it needs to do to confound most traders.

This book is about both forecasting the currencies and trading them profitably. For relative newcomers, there is an alphabetic glossary of terms and concepts: normally there will be an asterisk * in the main text marking terms to be found in the Glossary, on the first couple of occasions they appear. Some readers may find it helpful to read through the Glossary before starting on Chapter One.

My chief message is this: when we understand the real driving forces behind currency movement, we will find again and again that they differ from those with which the consensus is preoccupied. This is not something we see so often or so clearly in the securities markets. It enables us trade against the consensus with consistent success. It makes not the slightest difference which way the currencies are trending: an uptrend in one means a downtrend in the other. So it's realistic to aim for systematic profits irrespective of trends, year after year. These profits won't come by themselves: we will win them by achieving the right state of mind – which is what Part 2 of this book is about.

Since trading the currencies ties up little of our capital (being done in the forward* or futures* markets), such systematic profits can be earned alongside of whatever returns we can achieve in the securities markets. Moreover the returns we achieve trading currencies are completely uncorrelated with returns in the securities markets. This diversification implies it is possible to run the two activities side by side to achieve higher returns at lower risk than can be achieved by either alone. Then we leave the miracle of compounding to do its own work.

CHAPTER ONE - Background

Those who know do not talk
Those who talk do not know

LAO TZU

And those who can, do; those who can’t, write? Well writing is some thing I do; and trading is also something I do. And I’m still learning how much I don’t know about both.

Here’s another confession. I see the currencies as the biggest, most fascinating, most profitable and most dangerous casino in existence. No, it’s not really a casino. In casinos you cannot win by skill. In currency markets you can. But it is a casino, in practice, for most of the people involved: only they don’t put on their own bets. For most participants, the currency gamble they find themselves involved in is an occupational hazard. The European investor who buys Japanese stocks or US bonds; the contractor who bids for a contract in the Middle East; the multinational corporation which borrows in dollars; exporters, importers, shippers, travel agents, economists, Chancellors of the Exchequer, bankers, oil companies, fund managers – all of the above find themselves involved with an international exchange which reportedly tots up a volume of over $600,000,000,000 a day. It isn’t their business; they can’t assess the risks and rewards, and yet the risk from currency movements may be the biggest risk they run.

The question is: can currency movements be forecast? As it happens, the currency markets can, I think, be forecast more reliably than any other major financial market. This is odd, if only because of the sheer size of the market. A big free market like that ought to be what academics call “efficient”. By this they mean that it works so well, that everything that can be foreseen is efficiently discounted in current prices: so no-one can forecast future prices except by luck. But what I am saying is that you can forecast the dollar, systematically, if you follow certain simple rules.

These rules follow from the character of the participants in currency markets. The way the great majority of them think and act dictates the rules. So it does in the other financial markets – stocks, bonds and money markets. But there is a crucial difference between the currency markets and other financial markets. The difference comes about partly because the currency markets, in their present “floating” form, are so young, dating back only to 1971. The difference is that compared with other major financial markets, the participants in currency markets are naive.

What do we mean by “naive”? The securities markets in the major financial centres have an immense wealth of wisdom behind them. Literally thousands of books have been written about the securities markets. Billions of man hours have been used up by seekers after the secret of what makes securities prices move and how to “beat the market”. This is hardly surprising since the securities markets are a major part of the store of wealth of developed nations, and it’s all quoted, so anyone who had a way of predicting price fluctuations could make a fortune. You can’t quite do this in real estate, which is the other major store of wealth. But you can invest your savings in shares or bonds or real property .You can accumulate wealth through capital growth and income, and the accumulation can, at least in theory, be greatly compounded by timely shifts between shares or property and bonds. And this is the way most investors think and act.

For every thousand stock traders

there is maybe only one currency trader

Traditionally, people have never looked at currencies as a major area for investment. Why should they? In the old days, the major currencies tended to be fixed in relation to gold. Even today, after two decades in which currency rates have been fluctuating freely in the same way as securities prices, most people – businessmen and investors alike tend to see currency fluctuations as something external and outside their control. In the securities markets there are millions of people involved whose sole aim is to make money out of price movements. In the currency markets,

Imprint

Publisher: BookRix GmbH & Co. KG

Publication Date: 08-25-2020
ISBN: 978-3-7487-5500-5

Dedication:
To Doina, Harry and Clea - - - and Bob

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