Where is the Exit?

My dad, used to always tell me – don’t let the perfect be the enemy of the good. As an unreconstructed perfectionist, I’ve always had a hard time following that advice, but this week really showed the price of ignoring those words.

Trading as we all know is hardly a precise discipline. As the ultimate barometer of human emotion it is inevitably messy, frequently frustrating and often an exasperating activity. The best that we can all hope for is to make three steps forward and only two steps backward, thus keeping us ahead of the game in the long run. This week, I passed on many good opportunities that could have resulted in profits. I could lay the blame for making so few trades on the fact that I am alone at the desk as K continues her trip of the Far East, but that would be an unadulterated lie. And as many you know, that while we cannot guarantee success, we try to be as honest The plain truth of the matter is that I simply chocked this week, passing on perfectly reasonable trades is search of the “sure thing”.

No more.

I know that you look at BK advisor as not only a source of good trades but a source of multiple trades ideas. So starting next week I promise to deliver them all to you, lose win or draw, and furthermore I will also try to point out the danger of each trade along with our usual entry, stop and target parameters.

Meanwhile let’s just look the following graphic to show you the themes I sketched out at the start of last week and some of the trade setups that we could have taken had I been less conservative in my approach.

http://docs.google.com/Doc?id=dn8z7zs_7754xbbw

I will have the our Google calendar for next week prepared by Sunday as always sketching out the main themes on the Sunday panel and the event risk on the rest of the calendar.

As many of you know my setups are primarily fundamental in nature while K’s are driven mostly by technical factors, I trade in the direction of the newsflow but I do use technicals to manage my exits. Several of you asked about the reasoning for our exits so I thought we could use this weeks trades to examine some of our exit strategies.

Short EURCHF +20

This trade was based on the idea that Swiss eco data continues to post blowout results while the EZ indicators are showing some danger of slowdown. However, as has been the case over the past few weeks, the market really only cares about two themes right now – carry trade and risk aversion. Therefore despite great numbers from Switzerland, as the week went by, EURCHF actually rose as risk appetite returned and stoked demand for the carry trade. We were fortunate to make money out of this trade by keeping a careful eye on the technicals. Note the first spike bottom on the chart at 1.6115. Once the pair failed to break that key level, we quickly covered for +20 which turned out to be the right decision as EURCHF eventually went on to rally above the 1.6200 level.

http://docs.google.com/Doc?id=dn8z7zs_79d85xz4

Short EURGBP –8

This trade was triggered by the very strong UK Retail numbers which we thought would push EURGBP lower still on interest rate hike expectations by the BoE. Typically the signature of my trades is that they resolve themselves within 3-6 hours of entry as the fundamental newsflow pushes the pair in the direction of the trade. However, in this case the pound had already rallied sharply throughout the week, so the impact of the positive news was considerably weaker. Instead of trading lower EURGBP stalled and tormented me for more than 24 hours flirting several times with the stop. Out of sheer frustration I exited trade at –8 and of course to add insult to injury the pair dropped almost instantaneously after my exit. In a follow up note I wrote, “No one can make you feel stupider than Mr. Market, no sooner did we get our of the EURGBP short the trade moved our way. For those fortunate enough to ignore our advice please feel free to take profits now. Most importantly place your stops at breakeven or tighten them to no more than -10 to protect your capital. ” The proper action in that trade would have been to lower the stop to 6790. Since I wasn’t as confident in the trade 24 hours later as when I first put it on, the lower stop would have curtailed some of the risk, but allowed us to stay in the trade in case it finally moved in our direction.

http://docs.google.com/Doc?id=dn8z7zs_81gcmf9s

Short USDJPY –22

Sometimes its is absolutely incredible at how stupid the markets can be. Iranians seized 15 UK sailors in Iraqi territorial waters in what was essentially an act of war and the markets simply shrugged it off as another day at the office. Sure enough news over the week-end is that Iranian President Mahmoud Ahmadinejad’s has cancelled his trip and planned speech at the United Nations Security Council in New York and Iranians now claim that the Brits have “confessed” to broaching their territorial borders. In short the crisis escalates and it would be interesting to see if this flare up will finally bring some risk aversion to the market. In the meantime we followed the long held dictum of Lord Maynard Keynes who stated that markets will remain irrational far longer than we can stay solvent, and quickly cut our losses once we saw the price refusing to cooperate with our point of view.

We wish you great trading next week and look forward to sharing many more trade ideas with you.

B & K

In his seminal book on trading Market Wizards, Jack Schwager interviews one mysterious currency trader with penchant for meditation and Sanskirt who is uncannily successful in making profits for his employer. The start of the chapter contains the following exchange:

Schwager:

How do you recognize when (your trading power) goes away?

Trader:

When I am wrong three times in a row. I call time out. Then I paper trade for while.

Schwager:

For how long do you paper trade?

Trader

Until I think I’m in sync with the market again. Every market has a rhythm, and our job as traders is to get in sync with that rhythm.

The trader’s identity has never been revealed for certain, but I believe that it was Andy Krieger who said those words. He was so phenomenally successful in the heyday of interbank currency dealing that he managed to earn 300 Million dollars for Manufactures Hanover ( which has since merged with Chemical, which in turn became Chase, which is now JP Morgan Chase) in just one year.

This small snippet from 300+ page book is almost a throw away paragraph. Few people ever recall it. But ever since I’ve read it many years ago I’ve always thought those words held special meaning. Now, I am even more convinced that this little exchange is perhaps the wisest advice ever given to traders.

Losing streaks are universal in trading. Anyone who has day traded for longer than six months will recognize that fact. George Soros lost $1 Billion dollars in the Russian ruble fiasco, but everyone remembers him as the man who broke the bank of England. Michael Steinhardt was decimated in the emerging debt market meltdown of 1994, but he is revered as the one the greatest hedge fund managers of all time. The reason most novice investors and traders never appreciate the true risk of the game is because they rarely see it. Typically, most traders simply look at their end of the year statements and only see the end result. Rarely do they realize that their money may have suffered a 20% loss sometime during that year.

One of the great aspects the BKForexAdvisor is the fly on the wall view to trading that it affords the subscriber. Real trading, like real life, is a three steps forward, two steps backwards affair.

While I was away in Dubai, K was blazing hot for the first week hitting 6 winners in a row, but then she hit a wall in the second chalking up 4 losses. What happened? Markets got funky, her setups – the same setups she used the week prior – simply stopped working as she got out of “sync” with the market. One of the key differences in the currency market over the past two weeks has been the strong correlation with the equity market. In fact CNBC could not resist putting up side by side charts every half hour on the hour of the USDJPY and the Dow Jones industrial average showing the near tick by tick matching movement of the two instruments. This unusual sequence of events rendered many of the typical triggers of FX movement practically moot and introduced huge unpredictability into the market. Therefore, when I returned to the desk this week, as K left for her trip to the Far East I decided to tread cautiously and traded very little. Although this may have been frustrating to some of you, I remain convinced that this was the right course of action.

We are up 117 points or 11.7% on a 10:1 lever factor year to date – hardly a stellar performance – but a positive one nevertheless. The reason why we have been positive is because we remain vigilant about not giving our profits back. Every story of failure in trading is the same. It always revolves around the desire to “get the losses back quickly”. Instead of stepping back and “paper trading” when they hit a rough patch most novice traders press on and force the issue. The results of such stubbornness are predictably dismal. That’s why that little exchange in Jack Schwagers book has always stayed in my mind. It is remarkable how that simple piece of advice is ignored by most novices, who do not understand that the key to trading is the ability to manage your losses, not your wins.

Turning to our trades this week, we got clipped on the USDCAD short (-45) which again was the part of the setups that were simply not responding to the current market action, as the pair looked like it was ready to come down to 1. 1600 only to be caught up in the US equity market collapse . As we wrote at the time, “The breakdown in the US stock market seems to be hitting USDCAD as people fear that Canada will be particularly hurt by the downturn in the US economy”.

We did better with the second trade our EURUSD long (+17) but not before that trade tortured us by coming to within 5 points of the stop. Of course nn retrospect, we took our profits too early, but at the time it was impossible to predict the breakout in the pair, especially given the very weak price action that occurring at the moment.

With the markets now revolving around the key theme of US housing problems, we think next week will be a much better environment to trade and we expect to generate many more ideas for you. Furthermore, we received requests from some of you to trade specific setups from our e-book, so I have decided to modify the RSI Rollercoaster setup for the risk parameters of the newsletter and will add it to our arsenal next week as the opportunity affords.

The RSI Rollercoaster setup will be modified as follows.

1.We will trade 15 minute charts

2. Looking for Currency pair to leave the RSI overbought (+70) or oversold (+30) zone before initiating a trade.

3. We will use the swing high/low as our stop points, risking no more than 30 pips per trade and will target 20-50 points of profit.

4. We will trade this only on the currency crosses, to eliminate as much as possible the fakeouts due to event risk on the dollar denominated pairs.

This is a short term reversal setup that looks bank 20-50 pips with during intra-day pints of price exhaustion. It’s strictly technical in nature, but if we can we will also look for fundamental triggers to increase of our chances of success.

For more info on this setup please refer to our e-book.

Finally, tomorrow, before the start of the week I will post on our public google calendar the key themes and possible trades ideas that we are looking to exploit this week.

Wishing you the best of trading,

B & K

Last week, we said that volatility was back, but this week, it seems to have gone into hiding once again. The only volatility that we saw was on intraday price action which was kind enough to spike us out on multiple occasions. Most of the currency pairs licked their wounds this week and recovered some of the past week’s major losses. The question on the forefront of everyone’s minds must be whether the carry trade liquidation is over.

To answer that question, we must look at what happened this past week:

1) Reserve Bank of New Zealand raised interest rates by 25bp to 7.50% and signaled that more rate hikes are in store
2) European Central Bank raised rates by 25bp to 3.75% but signaled that they will hold rates steady in April
3) Bank of England left interest rates unchanged > Lots of strong data
4) Stronger US Non-Farm Payrolls reduces chances for an August rate hike, but US Sub-Prime lending sector is really in trouble
5) Canada and Australia both reported solid economic data

And what we are expecting next week…

1) The Swiss National Bank to raise rates
2) And the US to report a number of key releases including retail sales, PPI, and CPI

Oil prices increased 15% in Feb, which indicates that both PPI and CPI could be strong.

Where does that leave us?

The high yielding currencies (New Zealand, Australia, Canada and US Dollar) have the data to put an end to the carry trade liquidation, at least for the time being. US retail sales are the only problem since Wal-Mart reported a drop in sales due to the wintry weather (remember, February was one of the coldest months on record). If we get a strong number on Tuesday, then we have the all clear to jump back into carry trades. However it is the Yen that will be sold rather than the Swiss Franc given the Swiss central bank’s plans to raise interest rates.

Even though a lot of high brow economists have compared the latest liquidation to 1998, where we saw a 20 percent collapse in USD/JPY, we think that conditions now are very different. In 1998, the sell-off and risk aversion was driven by Russia’s default on its international debt and the collapse of Long Term Capital. This time, the liquidation was driven by overvalued stock markets. What we have is more of an orderly correction, of which the average move has been 8.6 percent. To read more about this, see our special report, “Is the Carry Trade Liquidation Over?”

We also want to point out that the Dow / USD/JPY relationship that we talked about in our last report is still very much in place (“Dow Down 400 Points, Dollar Falls to 12M Low against Yen - Is This a Major Pivot Point into a Recession?”)

That is, the movements in USD/JPY have foreshadowed movements in the Dow.

Now onto our trading:

Last week, trading was easy. The trends were clear and the moves were big, giving us over 120 pips in gains. This week, the range trading environment and the intraday spikes have made trading far more difficult, leaving us down 83 pips.

Short USD/JPY +31

When the markets opened on Sunday night, the liquidation from the prior week continued. Strong capital expenditures data and nonchalant comments from the Japanese government sent USD/JPY tumbling from 116.60 to a low of 115.13 in a matter of hours. After the data, we caught a part of that move and banked 31 pips relatively quickly.

Short EUR/CAD -44

This trade was one of the most painful trades that we have had. On Monday, we went short EURCAD at 1.5441 with a stop at 1.5485. On 2 occasions there were quick spikes, once to 80 and once to 86. Some of our traders got stopped out on the first spike, we didn’t, but on the second spike, we were stopped out while others weren’t. What happened? EURCAD is a less traded currency pair which means that brokers have different spreads and vary on pricing. The tighter spread brokers kept the traders in, the wider spread ones, stopped them out. After hitting a high of 1.5486 (one pip above our stop), EURCAD sold off to 1.5368. If it wasn’t for the spike, we probably would have lowered our stop and banked some part of the 70 pip profit. In retrospect, EURCAD is indeed a hard pair to trade given the sharp divergence in spreads between brokers – next time, unless we a super attractive opportunity in the pair, we may just avoid it.

Short EUR/USD -29

We sold the Euro on the expectation that the ECB would tone their comments and move to neutral at their policy meeting. Although this was the case on Thursday, we were early to the trade by selling the Euro on Monday. The rebound in EUR/JPY was so strong that it sent Euro soaring, stopping us out for a loss of 29 pips.


Long USD/CHF + 5

We went long USD/CHF because Swiss GDP came out strongly while US unit labor costs was weak. Although we liked the trade, we ended up closing it out at breakeven.

Short USD/CAD -37 pips

On Wednesday we went short USD/CAD on the back of stronger Canadian data and weaker US data. Once again, the movements in the Japanese Yen sent CAD/JPY tumbling, dragging USD/CAD up with it. The fundamentals that we were looking for did not convince the market until Friday, when the break in USD/CAD finally happened. We were stopped out of the trade for 37 pips.

Short EUR/USD -9 pips

Our final trade of the week was short EUR/USD. We had difficulty getting into our trading station after the NFP number, causing us to get a much worse fill than we wanted. We went short EURUSD because the strong NFP would delay any plan for the Fed to cut rates while the comments from European Central Bank President Trichet signaled that they would not be raising rates again in April. We still like the EUR/USD short, but as per our general rules, we do not hold positions over the weekend, which is why we closed the trade for a minor loss of 9 pips and will revisit it on Sunday evening.

We have kept our losses relatively small, which is why we are still quite positive year to date. Limiting drawdowns will make it easier to recover from a series of losing trades. Looking ahead, after this past week’s rather boring economic data, next week we are expecting a ton of data that could bring back market volatility. Check out our Calendar for all of the potentially market moving events.

Volatility is baaaack! And we have been particularly active with our trading recommendations because of it. We sent out 8 recommendations, every single one of which was right in direction, but we missed additional profits because we focused on trading defensively. We banked 123 pips this week, 6 out of 8 of our recommendations were winners, 1 broke even and 1 lost us 4 pips. Year to date, we are up 229 pips. Despite the fact that one of us is in Dubai giving presentations, it has been a good week. We focused on trading only our setup and we enjoyed decent profits with low risk because of that. There is certainly room for improvement - we focused too much on preserving our hard earned profits and because of that, we bailed out way too early on some of the trades. However, the famous J.P. Morgan himself once said, “No one ever went broke taking a profit.” Our motto has always been to preserve capital AND to generate return.

So what happened this week? Believe it or not, liquidation in the currency market triggered liquidation in many of the other financial markets around the world. Over the past few years, the participants in the market have become very speculative and highly leveraged. Not only did international speculators borrow the low yielding Japanese Yen to buy high yielding currencies like the New Zealand dollar, US dollar, British pound, and Australian dollars, in what is known as the “carry trade,” but they also borrowed against the Yen to buy stocks and commodities. In such leveraged environments, losses become exacerbated on a percentage basis, which will force many of these speculators to bail at the first sign of trouble. On Tuesday, we saw the consequences of this aggressive risk appetite . On an intraday basis, the Dow hit a low of 12,086 which represents a drop of over 500 pips. Even gold did not escape the liquidation. It still remains to be seen whether February 27, 2007 will either go down in history as a major turning point for the financial markets or an unparalleled buying opportunity. To read more about this, see our special report “Dow Down 400 Points, Dollar Falls to 12M Low against Yen - Is This a Major Pivot Point into a Recession?”

Before the big turn in the Yen this past week, we already wrote about the potential of 2007 being the breakout year for USD/JPY from a statistical standpoint. Not many people know that in 2006, the Japanese Yen had the tightest range against the US dollar in 35 years. Last year, volatility in the currency market contracted significantly, causing USD/JPY to remain restricted to a 10 big figure (each big figure is 100 pips) trading range. Over the past 35 years, the average high to low range of USD/JPY was approximately 30 big figures or 3000 pips. In 2006, the yearly range was one third of that. Sharp contraction in ranges tends to lead to sharp breakouts and 2007 could be the year in which we see just that. To read more, see our special report “US Dollar / Japanese Yen (USDJPY): Will 2007 Be the Breakout Year”

Finally, China has also been blamed to be the force behind the sell-off on Tuesday because when China sneezed, the world did too. Since then the ebb and tides of the US financial markets has been determined by the overnight fluctuations in the Chinese market, which is a dramatic shift away from the way things normally operate. When the Chinese government denied any plans to take the steam out of the stock market by increasing corporate taxes, the sell-off abruptly stopped. So is the Chinese government the puppet master behind these moves? Have they become the new linchpin for the global markets and can US traders now use the Chinese stock market as a leading indicator for what will happen to the Dow? To find out, read our article “Is China, the New Puppet Master of the Global Markets.”

Here is another interesting fact, as pointed out to us by our technical analyst Jamie Saettele at DailyFX. According to Elliott Wave International, every double digit stock market collapse that we have had in the past 10 decades has been in the sixth or seventh year. Remember 1997 was the Asian Financial Crisis. 1987 was Black Monday. Between 1976 and 1978, the stock market fell 28 percent and in 1966, the market fell 27 percent. Does this mean that 2007 will be a crash year? So far it seems that way.

Now onto this week’s trades:

Short USDJPY +15

On Monday, our technical setup gave us the signal to go short USD/JPY before the major collapse on Tuesday. We nursed the trade for a good few hours but it gave us little more than 15 pips. The CADJPY short signal was screaming at the time, so we switched out of the USDJPY short for the CADJPY short. Some of you asked us why we didn’t keep both. Of course everything looks great in hindsight, but USDJPY and CADJPY are very correlated, shorting both means that you are doubling the risk on basically the same trade. If it turned against us, both would have been stopped out.

Short CADJPY +71

Shortly after closing the USDJPY short, we switched into the CADJPY short. As our setup suggested, CADJPY had a far bigger move (530 pips) than USDJPY (440 pips) between Tuesday and Friday. We closed our trade a few pips shy of our target as we took part in the beginning of the major yen rally.

Short NZDUSD -4

NZDUSD was our only loser this week and we only closed out of it because we saw a better opportunity in USDCAD. In retrospect, we should have stuck with the NZDUSD trade. Our technical reason was the fact that NZDUSD broke the below 100-hour SMA on the hourly charts and had been holding below it for the past 4 hours. We felt that the pair would remain below the moving average, which was where we placed our stop. Since then, the pair has yet to break back above the 100-hour SMA and has instead fallen 163 pips in our direction. The SMA was golden.
Long USDCAD 0

We went long USDCAD on the break of February 22 high of 1.1639. We felt that this represented a very significant technical break to the upside and that there would be room for an extension. Unfortunately we hate it when news screws up our technical setups. Refinery outages triggered a reversal in oil prices, which would have been bearish for USDCAD and we opted to get out of the trade at breakeven.

Short AUDUSD +12

Throughout the week, we were very bearish on the high yielders with a particular emphasis on the commodity currencies. On a fundamental level, we felt that there would be more liquidation of carry trades. On a technical level, the AUDUSD provided a very good risk/reward opportunity. We went short the currency pair 0.7887. When the Australian markets opened, Australia reported the strongest level of manufacturing in 4 years. With such positive fundamentals, we did not want to be short the AUDUSD on the potential for a sharp rebound. Therefore we opted to bank 12 pips on the trade.

Short NZDUSD +6

On Thursday, we once again went back into the short commodity/high yielding currency trade (when you have something that works, stick with it!), but this time in the NZDUSD. The break of the past 2 day’s low signaled the potential for more losses in the NZDUSD, so we went short at 6936. The currency pair then proceeded to stay confined within a 20 pip trading range for the next 13 hours. Having watched this painstakingly for the entire time, the smallest rebound from +20 to +6 at 10:40pm EST tested our patience and we decide to close the trade and put an end to the pain. Four hours after that, the NZDUSD broke down, which means the pair consolidated for a total of 17 hours before actually moving in our direction. This was one of the trades that where we should not have questioned our technical setup and simply stuck with it.

Short EURUSD +12

On Thursday night, our technical signal triggered a short on the EURUSD. The risk was small enough that we were able to hold both a NZDUSD and EURUSD short at the same time. US data was strong and German retail sales were exceptionally weak. The pair came within 7 pips of our target, it was 4am in the morning EST and no one was around to catch the profits. So we moved our stop to breakeven but we banked 12 pips on a dip before it eventually rallied beyond our breakeven point.

Short AUDUSD +11

Our last trade of the week was the AUDUSD. Gold prices were selling off and our technical setup triggered a short trade with low risk. 0.7855 was also a clear resistance level from multiple time frames indicating its significance. If the pair broke that level, we knew that we were clearly wrong. Once again, we were right on the direction, but since we do not hold trades over the weekend, we opted to bank 11 pips before the market close.

Looking ahead, the economic calendar next week is lighter than the past week’s, but the upcoming reports are just as market moving. We are expecting service sector ISM, the Beige Book report, Factory orders, Non-farm Payrolls and the Trade balance. There should be more volatility in the currency market as expectations for stronger service sector activity and a smaller trade deficit is met with forecasts for weak factory orders and non-farm payrolls. The ECB is scheduled to raise interest rates, the press conference by Trichet will be particularly market moving. For more on our outlook for the week, read “US Dollar – More Volatility Ahead”