FX Weekly 07.04-08.11.08 - Euro Rally Cut Short

July 5, 2008

bkpicsmall FX Market Outlook
Dollar: Dollar Turn For Real?
Euro: Rally Cut Short
Yen: More Downside To Come
Pound: On The Brink of Recession?
Commdollars: Relative Strength

Top 5 Stories in FX This Week

US Jobs Continue to Contract
Bear Stearns Assets Decline
Is Goldman Sachs Relying on Risky Prop Trading to Keep up This Pristine Facade?
Fed Ponders Private Equity In Banks
Crunch Still On

—————–Trading Thoughts-The Curse of Two—————-
Trading at its core is a game of sentiment not numbers. That’s why all the data driven strategies that employ second level derivate calculus equations and a cadre of computer engineers to run them eventually blow up. Numbers are nice, but feelings move prices. And feelings can be very capricious. Numbers may be saying one thing, but feelings often follow another path. In the long run numbers always win out, but in the short run traders frequently run out of money battling market’s feelings. That why the old saying that markets are not logical, they are psychological rings so true.

————–FX Market Outlook————–

“I have no bias”. The four little words uttered by ECB Chief Jean Claude Trichet killed the euro this week. In a market that was primed for further ECB rate hikes that one statement changed the market dynamic in a heartbeat as speculative longs bailed out and the pair lost more than 250 points within 24 hours. Is the turn for real? For time being we think so. Euro’s rise was predicated on an ever rising yield story and now that that story is in doubt any rally is likely to encounter a lot of resistance.

But as we noted in out commentary at the end of the week, “The data from US leaves little to cheer about, The NFP report was hardly encouraging showing a sixth consecutive monthly loss of jobs with the forward indicators suggesting that the economic data may only get worse. Under those conditions the Fed may have a very difficult time raising rates in September and once the market reaches that conclusion the EURUSD may resume its rally as interest rate differentials take center stage once again.”

Cable in the meantime hit a brick wall as the economic data destroyed any notion that UK economy continues to perform well. Construction, manufacturing and service sectors are all in a recession with PMI gauges missing their market forecasts by a mile. How long can the BoE keep rates steady in this clearly contractionary environment? The MPC meets this week to set rates and while no one expects a rate cut from Mr. King and Company, UK monetary authorities may not be able to hold out much longer if the data (most importantly the labor reports) shows further deterioration.

Last week we wrote, “If the news continues to drive stocks lower USDJPY could slice through 105 by the end of next week.” The low print last week? 105.14. Alas it occurred at the start rather than the end of the week, as stock rallied on the misguided notion that the NFPs “were not so bad”. Nevertheless, the central tenet of US equities is that they are in a bear market and that fact means generally lower USDJPY prices ahead.

Aussie was the center of attention in the commdollar universe last week as it reached all time highs after blow out Retail Sales numbers. This week the focus falls on the employment report. The market will want to see if last months horrendous miss was an aberration or the start of decidedly dour downward trend. That data therefore could determine if the Aussie makes the run for parity or slumps back below 9500.

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

US Jobs Continue to Contract
Bear Stearns Assets Decline
Is Goldman Sachs Relying on Risky Prop Trading to Keep up This Pristine Facade?
Fed Ponders Private Equity In Banks

Crunch Still On

Psychology, however will also impact not only what you trade but how you trade. One of the most difficult things about trading is the dynamic that I call the curse of two. Basically I believe most human beings can only tolerate two losses in a row, three at maximum. Our aversion to losing is so strong, so biologically programmed into every cell of our body that the moment we hit two or three consecutive losing trades we rebel and instantly begin to tinker with our trading set ups.

Tinkering is usually the death knell of the account, especially if the trading system you developed is a logical intelligent approach to the market. Examine the trading records of history’s greatest blows up and you will inevitably find the same pattern. Trader does well adhering to a clear cut, disciplined methodology. Trader hits a losing streak of several trades in a row. Trader begins to deviate from his methodology, changing his selection criteria, money management rules, leverage structure. Trading becomes erratic, random and ultimately disastrous ruining thr account. This script plays out a million times a year in a near universal fashion from Dubai to Denver.

Losing two or three times in a row is of course not only natural but almost assured in the markets. In my presentations I often like to show the trading recommendations of the second largest FX interbank dealer in the world. From 2001-2006 these recommendations produced a 50% return on your money on a cash on cash unleveraged basis. “How many people would like 1 Million dollars to be turned into 1.5 Million in just 5 years?” I often ask the room. Inevitably every hand goes up. Then I show them the real trading record of the account. These same interbank traders went through losing streaks of not one not two not three not four but 14 losing trades in a row!

Whenever I hit the curse of the two I often pull out that slide from my presentation and look at it carefully staring at all the consecutive red results on the page. The irony of trading is that in a job that requires near clinical dispassion and tremendous metal agility the most important value of all may simply be having the faith to trust your methodology.

Now on to this week’s trades.