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 CB’s 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 than their DM cross rates had, like euro/sterling and euro/ SF. The result has been to complicate the analysis of cable and dollar/SF as well as dollar/Yen, and we had better recognise the fact, by staying out when in doubt.

Which brings us to a key conclusion about currency trading today as compared with 1991. The pulse of sentiment is not always as clear and strong as it was in those old days: therefore we need to stay out more often and trade less often, by cherry-picking more carefully; and/or widen the area of operation by bringing in other currencies that we rarely traded in the old days – the ones that fit the bill being the CAD and AUD, since we do have IMM data for these series. But most important now is to cultivate the James Rogers mindset. Remember? “I don’t play. I just don’t play. . . It happens all the time. I don’t do anything until all the pieces fit” (see page 86).

As I reread TWotD 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 (page 73). It really did work once upon a time, but now, forget it. Trading via the internet may seem a tempting 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 3 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.

The currencies are 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, Currency Bulletin 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 –perhapsmore 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 like sterling in D-Marks.

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 Currency Bulletin 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.

The book is intended to help you better understand Currency Bulletin as you follow it over the months and years. 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 II of this book is about.