BKT Special Report 09.26-10.03.08 - Hero or Zero? - The Long Dollar Trade

September 27, 2008

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

Pandora’s Bailout
How Main Street Will Profit
How the U.S. Could Make Money off the Bailout
Bailout Is About Saving Credit Flow, Not Banks
Where’s the Bottom? Still Anybody’s Guess

———–Trading Thoughts-A Gambling Account Part 2—————
Last week I talked about the need for a separate gambling account to let off steam and allow our worst impulses run wild in a controlled and contained environment. This week I’d like to suggest that a gambling account is not merely a diversion for Vegas like entertainment but could in fact be a very useful tool in our arsenal as FX traders.

————–FX Market Outlook————–

There is an old saying on Wall Street. You eat your losses or your losses eat you. The Paulson Plan, the AIG rescue, the Fannie/Freddie bailout are all signs of US government officials refusing to eat their losses. It is the oldest and most pathetic tool of trading - the Hail Mary prayer for time. Oh Lord if I just wait long enough maybe the environment will improve and my position will rally to profit.

Of course that strategy almost always fails for anyone who follows it. Few players are big enough and well capitalized enough to ride out the market storm and cash out on the cyclical rebound. Ironically enough throughout its history Goldman Sachs has been the one exception to that rule. If you read Lisa Enlich’s “Goldman Sachs : The Culture of Success” what comes between the lines, isn’t how brilliant GS has been throughout its existence, but rather how lucky. Over and over, Goldman Sachs traders (including Robert Rubin at one time) assume massive positions, sometimes well in excess of the company’s net worth. These risks frequently go against them initially, but GS traders wait out the turbulence and come out profitable at the other end.

Unbelievable as it may seem, the basic strategy of the GS trading comes down to nothing more than “hold ‘em til the come back” and because if its size and marker presence that strategy has worked so far helping the firm to become the dominant player in capital markets in the 21st century. Any wonder then why Hank Paulson, the current US Treasury Secretary and the former CEO of GS proposed his $700 Billion plan? At its core the Paulson plan is nothing more than the old GS Hail Mary trade. Get enough capital to maintain the position and hope the market turns and takes you out at a profit in the end.

If the Hail Mary works once more, Paulson will be proven right and the long dollar trade will probably succeed. But what if doesn’t? What if this strategy finally fails? What is the Chinese, the Japanese, the Arabs and the Russians stop buying US debt? What if the world places a massive margin call on United States of America?

Despite this ominous possibility there are reasons to be optimistic. US debt to GDP ratio remains at approximately 60% - well below those of Italy or even Japan. In short hard as its to believe US still has capacity to assume further debt. But given the slowing economy, the disturbingly rising unemployment claims and the sharp drop off in retail demand, its difficult to see how the events of the past month could turn out well for the greenback.

Still trading the EUR/USD over the past week has been akin to walking blind in the middle of Broadway on a red light- you never know from which side you’ll be clipped from next. The euro, riddled with problems of its own has has hardly been a attractive alternative to the buck. In fact the trade in the EUR/USD has been nothing but a race to the bottom and the pair will likely remain range bound in a Mexican standoff for the time being. USDJPY on the other hand continues to offer the clearest ant-dollar bet. If you believe as we do that irrespective of final outcome in Washington DC the pressure on equities will drag the Dow below 10,000 by year end then 100 USD/JPY is a likely outcome in the FX market.

So, hero or zero? Too soon to say, but for now the anti dollar bet remains with the yen, even if there are some euphoric Dow rallies in the near term.

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

—————–Trading Thoughts-A Gambling Account Part 2—————
Last week I talked about the need for a separate gambling account to let off steam and allow our worst impulses run wild in a controlled and contained environment. This week I’d like to suggest that a gambling account is not merely a diversion for Vegas like entertainment but could in fact be a very useful tool in our arsenal as FX traders.

Perhaps the greatest problem facing many traders is the fear of losing. It is the primary reason so many trade without stops, postponing the day of reckoning in order to avoid the immediate pain of capital loss. In fact when trading a gambling account many traders do just that - they lay on a trade, leave no stop and hope for the best. But the “have a hunch bet a bunch” strategy inevitably ends in tears and a margin call.

On the other hand, if you actually practice safe trading by always using stops, a gambling account can be an incredibly liberating, educational experience. A gambling account when used with stops can be a source of experimentation and learning. You can experiment with a variety of strategies and money management approaches that you might never consider in your regular account.

Granted you could do all of these things on a demo, but your experience and sense of commitment would be completely different. Do you really think you would be checking quotes every 5 minutes on your Blackberry on your USDJPY position if it was done on e demo account? Hardly. Even if your are trading for just a $1 per point real money makes a difference and makes your trading much more meaningful.

For me one of the most useful lessons from trading a gambling account is the realization that just staying the course can often mean the difference between victory and defeat. Woody Allen one said that, “90% of life is just showing up.” In trading this can often be true. Trading in these wildly volatile markets this week, I often would find myself in a deep hole by the middle of the day, but by sticking to my plan and continuing to take trades that were part of my setup I was able to end up positive by the end of the day. Would I have had the courage to continue if this wasn’t my gambling account? I doubt it - that’s why the lessons I learned were worth far more than the pips that I earned.

Now on to this week video.