Boris and Kathy's FX Blog www.bktraderfx.com

What's a Good Trade?
Feb 11, 2007

This Friday over outcries of protest from K and the American shift crew, who were stuck in the office doing work, I took the European shift crew for a daytime outing to the Museum of Natural History. For those of you not familiar with this institution it is truly one of the great treasures of New York city – a museum so massive it occupies four very large city blocks on the Upper West Side of Manhattan and contains some of the most interesting exhibits on earth. To be frank, the trip was not my idea, but rather that of Jaime Saettele our technical analyst at dailyfx who like all great technicians has a highly inquisitive, scientific mind and wanted to see the new exhibit on the pre-historic roots of mankind.

So off we went enjoying the sunny but very cold and icy Friday afternoon in the city. Once in the museum we came across the meteorite exhibit which was fascinating in and of itself showing that the moon was the result of a colossal collision between the earth and a large meteor and contained many of the basic elements that we find on earth. This of course led to a conversation of what would it be like if the moon was fully colonized and perhaps even nationalized in the future. Would it issue its own currency? What would be its name? Jaimie instantly replied that it should be called “the lunar”. I of course unable to resist the notion, immediately speculated on the possibility of the lunar/loonie cross .as future currency traders would make markets on the economic potential and costs of mining commodities from the Moon versus that of Canada. Yes, you can take the boys away from the FX market but you can’t take FX market out of the boys.
Highly amused at our own construct we wandered aimlessly through the halls of the museum until we came across the main exhibit that Jamie wanted to see and here is where things became quite interesting. The Hall of Human Origins at the Museum is one of the greatest exhibits we’ve ever been to, and if you find yourself in New York we highly recommend that you make time to see it. Finding ourselves amidst the German tourists and the neighborhood mommies slowly pushing their strollers around the myriad of very interesting displays on paleontology, archeology, DNA analysis etc. we stumbled across the answer to a very fascinating question – what makes humans smarter that all other species on earth? Is it the size of our brains? No. In fact, whales, dolphins and several other species posses brains larger than our own. Is the size of our brains in relation to our bodies? No again. It turns out that bird’s brains are 8% of their body weight while ours are only about 4%. So what is it that makes us so unique as a species? Apparently, the part of our brain called the frontal cortex – the part is responsible for rational thought is what differentiates us from all the other mammals on the planet. We are not the only ones that have it – dogs for example have it as well - but we are the only species that have fully developed the frontal cortex.

So, how does any of this relate to trading? We think quite directly. We believe that traders who use their frontal cortex –that is the rational part of their faculties - are far more successful in the long run than those who rely on the more primitive, emotional and instinctive parts of our brains called the limbic and the reptilian systems that we happen to share with many other lower species.

Plan your trade and trade your plan may be a well worn adage in trading, but it encapsulates perfectly this very notion of the need for rational thought. The idea in trading is to use you reasoning abilities to analyze, assess and prepare your trades, so that at the moment of action you have a rational, logical game plan for managing both risk and reward. How many times have we reacted instinctively, much like caged animals, when trapped in bad trades only to have caused further damage to our trading positions and our accounts? The trip to museum clearly showed the key distinction that makes us human. It’s time that we as traders begin to use it to improve our performance

And now let’s review our trades for the week.

Short EURJPY +47

This was the best trade of the week. In last week’s update we talked about the theme of carry trade liquidation and therefore watched EURJPY like hawks to find the optimal time to express that idea in a trade. On Monday night at the start of Asia session we began to see this theme play out and jumped on the bandwagon. The trade went our way from the get go and we banked 47 points in less that 3 hours on a nearly flawless execution.

Long EURUSD +0

In many way this was the most interesting trade of the week because we did so many things right and wrong at the same time. The trade was triggered off Chairman Bernanke’s dovish testimony to Congress. Acting on a purely Pavlovian impulse we remembered that the last time Bernanke sent a dovish message to the market, the EURUSD veriticalized nearly 300 points higher for two days afterward. However, had we been more patient and thought the idea through we would have realized that this time a much better way to take advantage of this news would have been through a short USDJPY trade rather than long EURUSD. We were after all confident of the carry liquidation theme and JPY GDP which was expected to be strong was coming up that night. Alas we let our instincts rather than our reason rule and took the EURUSD long trade instead. However, at this point we did implement our trading plan and controlled the trade quite well. As you remember from our AUDJPY trade last week, we often enter on fundamentals but ALWAYS manage the trade on technicals once we are in position. In the case of EURUSD we were looking for continuation and indeed we got a little bit of follow through Thursday morning in early European trade. We immediately moved the stop to breakeven, reasoning that if price was unable to take out the prior high of 1.3152 we did not want to be in the trade beyond our entry point. Indeed prices failed and dropped after that and we were taken out at breakeven. No harm no foul. This was certainly not the best entry of the week, but it was one of the better exists because it adhered to our long held strategy of always protecting trading capital first and foremost.

Long EURGBP +20

On the surface this appeared to be a very good trade. It was after all profitable from the moment we entered it and it made 20 EURGBP pips which are equivalent to 40 pips in any other pair. In reality however, this was only the second best trade we could have made that night. The trade was triggered off absolutely horrid UK Retail numbers, but here again we were too monolithic in out thinking. The night prior to this trade EURGBP had collapsed on hawkish commentary from Mervyn King about the potential dangers of inflation still extant in UK economy. We thought the speech total BS and believed that the EURGBP reaction was completely wrong given the clear slowdown in UK economic data. So we were obsessed with the long EURGBP trade and pounced on it the moment economic news offered us an opportunity. However, the far more intelligent trade to have made at that time was short GBPJPY. Why? Because Japanese GDP which had just printed that night was much better than expected while UK retail sales as we’ve already noted were horrid. As an FX trader you always want to pair the best currency against the worst to give yourself the optimal chance at a profit. Thus, while EURGBP trade was winner, the GBPJPY short would have been a grand slam.
Short CADJPY +12 A good trade which again was triggered off the idea of yen strength coupled with the lackluster price action of CAD the along with a powerful technical break of 480 hourly SMA. This trade however was a perfect example of why trading will always remain an art rather than pure science. The pair dropped 30 points in the money only to retrace all of its gains. After it moved lower the second time we decided to cover for small profit. Should we have stayed in the trade longer and tried to milk it? Perhaps. But this was truly a judgment call as price action was far from definitive and so we banked a small gain and moved on.


Short AUDUSD –24

No doubt the worst trade of the week, based on spurious logic. The trade was triggered by the idea that dollar weakness was done. But this is nothing more than a top/bottom picking trade that so many traders get suckered into. In trading there is not such thing as overbought or oversold price action until we have concrete evidence of exhaustion. In the case of AUDUSD trade the evidence was so negligible as to be non-existent. It was based on the doji the day prior – but a doji is a neutral signal indicating indecision rather than an actual turn in the price action. The only saving grace to that trade was that we tightened the stop and contained the risk somewhat.

Since last Friday with the USD/CAD trade we’ve had had six trades with 4 winners for 115 point, one scratch and one loser for –24, so we’ve become more disciplined at trade selection, but we intend be better yet. Clearly, we cannot control profits or losses, but as trades we can control our selections and we will continue to refine that process.

Next week only two key event to keep you eye on - BOJ Rate hike and German IFO Key Event Risk BOJ Rate Decision Wednesday Feb 21 5:00 GMT The decision will not be easy as Japanese data continues t be lackluster at best. The Tertiary index, a measure if the country’s service sector, continued to disappoint printing at -0.4% vs. -0.1% expected. This was the second consecutive month of negative readings lead by a massive 13% drop in demand for postal services which include savings and insurance as Japanese retail investors favored deposits in high yield currencies such as the Australian and New Zealand dollars. In short as Governor Fukui described it, the economic news was “mixed”, making next Tuesday’s announcement a 50/50 proposition. Some analysts even suggested that the bank may opt for a Solomonic solution of raising rates by only 12bp thus reaffirming their commitment to price stability without affecting consumer demand too harshly. This may indeed be the case but whether will considered such a move good enough to spur further yen buying remains to be seen

Key Event Risk German IFO Friday Feb 23 9:00 GMT The German IFO survey is due to be released on Friday night and is likely to be the marquee event of the week, The market is looking for a small drop to 107.5 from 107.9 which should not dent the unit much, IFO has hovered near record reading for most of the past year and has been one of the primary foundation for euro’s strength. If it does not change much the unit is likely to remain well supported. However, if the survey registers a massive drop due to the concerns over VAT, the EURUSD could tumble hard given the pair relatively overbought status.

Have a Great Weekend B&K