BKT FX Weekly Review - Is This The End of The World? 10.24-30.08

October 24, 2008

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————–Top 5 Stories in FX This Week—————-

This Bailout Doesn’t Pay Dividends
The Quest to Cut Social Security
Will Your Recession Be Tall, Grande, or Venti?
The Coming Pink Slip Epidemic
Velocity And The V-Shaped Recovery

—————–How To Trust Your Setup—————

One of the great ironies of life is that as traders we often trust ourselves least of all. Most traders (myself included) approach the whole enterprise with deadly combination of overweening sense of arrogance in our ability and underwhelming sense of confidence in our trade setups. When it comes trading no one can second guess or sabotage us better than ourselves.

All it takes is one or two stop outs in a row and suddenly the setup that we worked on for months, goes out the window. Impulsive trading takes over as we “try to get it back from the market” and the account soon plunges into a deep drawdown.

————–FX Market Outlook————–

Is this the end of the world? The fact that I ask this question probably means that it’s not. However sometime around 2 AM EST on Friday night it certainly felt that way. The Nikkei which had been plummeting all night on a bad Sony warning, collapsed completely dropping well below the 8000 level and ending the session -10%. The yen then stated a swan dive that culminated in stomach churning drop of 150 points in about 15 seconds.

At first I was amused at the price action, then thrilled at being able to capture some of the move then suddenly I became very, very afraid as the full implications of a total global financial meltdown began to dawn on me. A few days earlier I had opened a direct account with the US Treasury, but the documentation would take a few weeks to process and in the meantime my money was scattered in three separate bank accounts vulnerable to failure at any time. No one knew better than I that bank deposits were simply a figment of your imagination. Once you gave the money to the bank it became theirs not yours. To them it was simply nothing more than an electronic ledger transaction and if they got in trouble good luck standing in an FDIC line behind millions of other suckers desperately waiting to retrieve your savings.

As these dark thoughts ran through my mind, the markets became completely unhinged. EURJPY which only a few hours ago traded at 123.00 was down to 114.00. US stock index futures were shut limit down and my friends on Squawkbox looked frightened. But then I noticed something. The carry pairs had lifted off the lows and were actually running up pre-market despite the fact that the index futures were still locked limit down. I called the guys at CNBC and told them that the open was not going to be as bad as everyone feared. Sure enough after a -500 point open, the Dow stabilized and traded up off the lows for the rest of the day. Panic selling did not materialize and while no one was celebrating any rallies, for one day at least it appeared that the worst had been averted.

Was last Friday just a taste of things to come? Hard to say. I certainly hope not. Every commentator on TV bravely announces that this is NOT the start of the second Great Depression. I tend to agree, if for no other reason than I can’t imagine such wanton suffering thrust upon our society. One thing is clear however. We do need radical change in how we govern ourselves and our markets. Last week I was accused my some readers of being a socialist. First of all let me say that “socialist” is not an insult. Most Scandinavian societies with much better standard of living and far higher life expectancy than ours are democratic socialist societies. So is Canada. Onatario, by the way, has been named the best place on earth live by a United Nations survey that weighed such variables as wealth, health and social justice. So maybe we should all have a more open mind to the idea of social democracy.

The irony however, is that I myself come from Soviet Russia. No one knows the horrors of collectivist thought and the ineptitude of the communist system better than I. I am actually a big believer in free markets which through competition produce creative wonderful products and services we all enjoy.. What I despise, are rigged markets. I hate Vegas for that very same reason, because it provides the illusion of success while in fact creating the reality of theft. Unfortunately, over the past decade Wall Street has adopted the Las Vegas model of business and we have all been grifted on a scale far greater than any con job ever done. Rigged markets in my opinion are just as evil as collectivist governments because they concentrate the power in the hands of small group of elite leaders that do not reward merit but promote corruption and graft.

As I argued two weeks ago we need free, but fair markets if we are to survive this mess. That means no more side bets in the over the counter world. No more shadowy off -shore hedge funds. You want to play? Play by the rules. Disclose your positions and trade only on a centralized exchange where everyone has a fair shot at success and counter party risk is eliminated. Until these changes are made, I am afraid the nightmares of Friday will contineu to repeat themselves.

————–Top 5 Stories in FX This Week—————-

—————–How To Trust Your Setup—————

The most maddening thing about trading is that even if you are doing everything right you will be wrong continuously. In no other profession (except perhaps meteorology) does such a high rate of failure seem acceptable. Take dentistry. Once you know how to fill a cavity, you can repeat the process hundreds, thousands of times without ever making an error. In trading, especially in rapid day trading you will likely make an error at least once or twice each day.

So how we learn to trust our setups? Practice, practice, practice. Trading is contact sport and can only be mastered through endless repetition. One of the biggest mistakes that many traders make is to learn on a demo account. Demo trading in my opinion is less that useless. It creates a false sense of control and overblown sense of importance especially if you trade with “millions’ of demo dollars. Demo trading is good for only one thing - getting to know the trading software. Once that’s done you need to trade with real money. Why? Because you can never replicate the psychological pressures of real trading unless you have skin the game.

The great benefit of many retail FX trading platforms is that you can configure your size down to a 10 cent pip so you can still trade with real money but not have to pay much for your education. The more you trade your setup, the more you will learn its intricacies under real market conditions. The more patient you will become. The more you will start to trust your setup and the more you will start to trust yourself.

Now to this week’s video