BKT FX Weekly Review - The End of Fear? 10.17-25.08

October 18, 2008

bkpicsmall

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

A Short History of Modern Finance
How the Credit Crisis Could Forge a New Financial Order
Destructive Creation not Creative Destruction
Turning Japanese
Baltic Dry Shipping Collapses

—————–How To Win After Losing—————

One of the hardest things to do in trading is to win after losing. A losing streak can be triggered by a number of factors. Bad trade selection. Bad luck. Bad market environment. Unfortunately in their eagerness to “make it back” most traders usually make it worse. Typically after two or three losing trades the urge to win overtakes the ability to think calmly and collectively and a wild orgy of stop losses follows.

Despite trading for twenty years I still fall victim to these problems, especially when I experiment with new setups. Lately however, I learned to curb my worst instincts and correct my behavior before doing real damage to the trading account. In short, I learned how to win after losing.

————–FX Market Outlook————–

“Never underestimate Americans ability to do the right thing ….eventually” Winston Churchill.

What do Hank Paulson and Joe the Plumber have in common? They were both completely wrong. By the end of this week Paulson had to apologize for his original misguided idea of TARP as he adopted the much more sensible direct capital injection plan of UK PM Gordon Brown. Meanwhile Joe the Plumber had to admit that the Obama policies would actually lower his taxes instead of raising them since he never stood to make than $250K net from his would be “plumbing business.”

To some, the two men on the opposite ends of the socio-economic spectrum, represent everything that is wrong with America today. An infantile nation of intellectually incompetent, hypocritical, self-absorbed citizens that have neither the educational foundation nor the moral fortitude to face the problems that are about to challenge them. The litany of woes is well known.

1. We teeter on the verge of bankruptcy having run chronic current account deficits for more than a quarter century.
2. The demographics of our country are such that greater and greater amounts of our resources will have to be allocated to the least productive part of our population - the elderly, who through the advances of modern medicine are now living longer but have less assets to pay for their nursing care. The young, therefore, already burdened with stratospheric debts from their college education will be forced to pay more of their income to support the bulging elderly population resulting in a massive generational conflict.
3. The latest orgy of credit has resulted in nothing more than endless rows of useless and now worthless McMansions without expanding the economy’s productive capacity one bit.

No doubt, the picture is bleak and the problems are real but Americans ability to adjust and adapt, is unsurpassed in the history of mankind. When given lemons, Americans always try to turn them into lemonade. The pragmatism of Americans has always been stronger than their “fundamentalism”. Despite utter cultural primitivism, Americans have always embraced invention and innovation with open arms and that’s been our saving grace. Thus, robotics may solve the nursing problem. Bio-engineering the food and energy shortages. Stem cell research a hots of medical problems. And the productivity waves that these industries trigger should be able to pay for all excesses of the past. That’s the long view and I hope it comes true.

Meanwhile, in the short term we are likely to see more economic pain. The news this week, was nothing if not bleak. Industrial production saw the biggest drop since 1974. U of M consumer sentiment survey sank like a stone in the wake of troubles in the financial sector and Retail Sales were twice as bad as forecast. Yet the markets stabilized with most traders betting that the worst was behind us.

Does this new calm mean the return of risk? I doubt it. As I wrote on Friday, “The docile pace of trade is unsurprising given the fact that volatility is far more mean-reverting in the markets than price. Indeed, if the credit crisis conditions ease, the next few weeks may bring on a frustratingly rangebound environment as traders begin to assess the impact of the financial meltdown on the real economy. There is little doubt that some sort of contraction will occur and the only question facing the market is will the recession be shallow or deep.”

Perhaps, as turbulence passes, the new environment will usher the return of the micro trade. As we well know, during the past month economic data has not mattered at all. Traders only cared about one question - risk or no risk. As markets return to normal, micro economic events may start to exert a greater influence on the FX market with focus shifting from carry vs. safe haven bets to relative strength/relative weakness trades. I’ll be watching carefully if the end of fear brings micro economics back to the markets.

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

—————–How To Win After Losing—————

Marty Scwartz, the famed trader who wrote Pit Bull had a great saying. “You have to pass through neutral before you can go forward from reverse.” Marty always believed that the first thing you must do after losing is go to cash and just stop trading. He was a great believer in pulling yourself away form the screen. Stopping to him meant physical separation from the market. In trading, winners never quit but they frequently stop and pause.

The single most toxic thing you can do after 3 or 4 losers in a row is to keep on trading. At that point your chances of winning are better in Vegas than on Wall Street. Much better to walk away from the screen, go for a walk, have an espresso, read a book and come back next day rested and relaxed.

Why not just fight through it? Trade until you get your groove back? Because inevitably turn to impulsive trading and move away from the well thought out, well tested disciplined approach of our trading plan. In pursuit of “getting it back” we quickly abandon our rules. That’s exactly what I did two weeks ago with my Levels setup. I got sloppy, then angry, then obsessed and before I knew it I dropped 10% of my account in one day. Fortunately, I stopped, left to have lunch with friends in Brooklyn and completely took my mind off the disastrous trading spree.

After some thought and relaxation I reassessed the setup, made a key adjustment and with few minor exceptions traded with sniper like precision taking the account to new equity highs. To learn more about how I did it, please watch the video.