FX Weekly 08.22-29.08 Has Euro Formed a Bottom?

August 23, 2008

bkpicsmall FX Market Outlook
Dollar: Rally Done?
Euro: Data Dour But Support Holds
Yen: 110 Still Resistance
Pound: Crushed To A Pulp
Commdollars: Is 800 Support for Gold?

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

Will Cold Cash Prevent a Cold War?
Stealth Repudiation of US Debt?
All the Oil We Need
Will Roubini Be Proven Wrong?
A New Qualitative Capitalism

—————–Trading Thoughts- Getting Half the Juice—————
The longer you trade the markets the more you realize that the only absolute in the game exists on the downside. What I mean, is that the only factor that we can control with any degree of consistency is our losses. Most people of course believe they can control profits and that is perhaps the most naive belief of all. I’ll never forget one time sharing a cab downtown with well known colleague who opined in no uncertain terms that he never takes trades with less than 3 to 1 risk reward ratio. I remember feeling uncomfortable at the time with his utter conviction that this was the only way to trade and only much later realized that this man must have never put his own money on the line because his premise was laughably unrealistic.

————–FX Market Outlook————–

Looks like Russia’s foray into old style Soviet imperialism is coming to an end and so is the dollar’s rally. This whole past week the price action has been nothing but chop as EURUSD tried to carve out a sustainable bottom after losing nearly 1000 pips over the past month. Traders however paid scant attention to economic data and instead the FX market followed the oil market almost tick by tick. Oil in turn produced a schizophrenic performance of its jumping 5 dollars on Thursday and then dropping back nearly 6 dollars on Friday after the news that the Baku-Tibilisi pipeline reopened for business.

The wild action in the oil pits wreaked havoc for breakout traders as reversals were the order of the day. Nevertheless when the dust settled the euro held the lows and now appears to be in the midst of carving out a sustainable bottom. However, the unit saw very little help on the economic front last week with flash PMI readings and Industrial orders numbers decidedly dour still much of the decline has already been factored into the price so the impact was minimal.

Next week with Russian troops slowly pulling out of Georgia, attention should shift back to micro rather than macro concerns. German IFO, US Durable Goods and Q2 GDP will be the key event risks of the week. With market expectations already modest, any downside surprises are unlikely to generate much follow through. On the other hand any upside news could create enough fuel the test either side of the 1.4600-1.4900 range. With most of the primary dealers tanning themselves on the beaches of St. Tropez or the Hamptons the action may be remarkably quiet as everyone tries to enjoy the last bit of summer sunshine.

No sunshine for cable bulls however, as UK data turned from bad to worse. As we wrote on Friday “UK Q2 GDP was revised downward to 0.0% from 0.1% expected indicating that the economic growth has come to an absolute standstill amidst ravages of the credit crunch, the collapse of the housing sector and the skyrocketing costs of energy. The news sent pound plummeting by more than 2 cents in early London trade reversing all of yesterday’s gains.

Cable now finds itself perilously close to the 1.8500 level once again as traders continue to price in the increasing possibility of not one but two rate cuts by the BoE before the year end. This week’s MPC minutes revealed little new information regarding the BoE’s posture towards monetary policy, but as the drumbeat of dour UK economic news continues to hit the screens, the pressure on Mr. King and Company to ease will become immense.

The BoE next meeting is on September 4th and while most traders do not expected any change in policy quite so soon, it will be interesting to see if the UK central bank, which tends to be the most proactive and nimble policy making institution amongst the G10, preempts the speculation and cuts rates by 25bp right then.”

Next week the UK calendar is relatively quiet and the key question is whether the unit will be able to hold the 1.8500 level. With prices hovering near 1.8500 by end of trade Friday, the temptation to run the stops may be almost overwhelming. But once 1.8500 is cleared sterling may bounce simply to relieve its oversold condition.

Yen meanwhile continued to frustrate both bulls and bears as the unit broke for 200 points on Thursday only to erase all of its losses by Friday and end up at 110 once again. 110 appears to be a cement ceiling for the pair, but it could be penetrated next week if the slew of Japanese data from Retail sales to employment turn out to be bearish for the currency. l More than any other currency, however, the yen continues to trade of macro factors and it will be the value of the DJIA that will ultimately determine its direction. We continue to believe that in the next year the unit will outperform but in the near term 110 may be broken to the upside especially if oil and equities continue to prove friendly to the dollar.

Commdollars followed the action of the majors with both kiwi and Aussie finding strong support at 70 and 86 respectively. In fact, we argued last week that kiwi had already showed signs of bottoming last week suggesting that the euro would follow. The question going forward however is how much juice is left in the countertrend rally? Both countries have smattering of confidence surveys while Canada has GDP data on tap. Yet here too economics may take backstage to the macro factors, especially the price of gold. The yellow metal dipped below $800 last week before rebounding nicely but if it loses momentum and falls below that level, the commdollars are likely to follow to the downside.

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

Will Cold Cash Prevent a Cold War?
Stealth Repudiation of US Debt?
All the Oil We Need
Will Roubini Be Proven Wrong?
A New Qualitative Capitalism

In real trading there is no such thing as 2 to 1 trades or 3 to 1 trades because you never know ahead of time how much money the market will give you. It is an utter act of hubris to think that just because you want to make 100 points of reward for every 30 points of risk you will actually achieve it. The 2 to 1 or 3 to 1 risk/reward trades are what they teach you trading books, and of course as so often the case what looks great in theory is actually remarkably dumb in practice. As the greatest philosopher since Plato once noted “In theory there is no difference between theory and practice. In practice there is.”

Last week I spoke about the need to set minimum targets and stick to them. However when it comes to maximum gains - the game is always open ended. Sometimes you hit a home run, sometimes a double and sometimes you just have to satisfied with a dribbling bunt. (For all our non North American readers I apologize for the profusion of baseball metaphors) but I think everyone gets the general idea - YOU CANNOT CONTROL YOUR PROFITS, YOU CAN ONLY CONTROL YOUR POSITIONS.

Sometimes when you squeeze a lemon you only get half the juice, and trading can be very much the same way. In practice, most traders scale out of their trades, taking some profit as it comes. In fact when you read our Millionaire Traders book the one unifying theme amongst most of our interview subjects be they trend followers or trend faders, long term or short term traders was that they always scaled out of their winners. Certainty and arrogance is for amateurs. Professionals play the probabilities and always remain flexible and open to the markets.

Now on to this week’s video