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Forex Q&A with Ed Ponsi
Greetings from Mexico! I'm getting a lot of great questions from readers, so we're going to continue with Forex Q&A. This week, we'll talk about protective stops, inter-market relationships and how to defend against loss. Here we go!
Q) Hello Ed! I am one of your students from last Sept/Oct. Thanks so much for your class. You are a very special teacher and have great patience. You and the academy have already made a great change in my life. I have been trading with (Forex broker X), they do not promise that your stops will be honored over the weekend. I checked my trades this morning and my take profit order was indeed not executed. Is this common for most Forex platforms?
Ed Ponsi) Great question! First I'd like to explain the concept of honoring stops to all of my stock trader friends out there. You see, stock traders live in a world where their stops are constantly skipped over, partially filled, or completely ignored. When stock traders learn that many Forex brokers honor stops - even during market gaps over a weekend – their eyes become glazed, and the room begins to spin. The honoring of stops is one of the huge advantages of trading currencies. If it's any consolation, I didn't believe it at first either. Because gaps are rare in the Forex market, brokers are often willing to honor stops on those rare occasions when the market does gap, as it did here on January 27, 2008 (see figure 1).
Figure 1: Visible weekend gap on the 5-minute EUR/USD chart. Source: Saxo Bank
Different brokers have differing policies on the honoring of stops. Some brokers are willing to honor stops up to a certain size (50 lots, for example), and other brokers even claim to offer "guaranteed stops". You really have to check with your individual broker to clarify their policy, but you should be aware that in certain cases, a perk like the honoring of stops during gaps can be negotiable; it depends upon the size of the account and the amount of business you bring to the table. Good luck!
Q) Dear Ed, I have noticed a very strong direct relationship in the movement of the USD/JPY pair to that of the US stock markets. The pair usually gains when the US markets are up and falls when the US markets are down. Have you identified any currency pair relationships with the movements of the Asian and European markets? Please share with me your thoughts.
Ed Ponsi) Thank you for your question. Off to a strong start already in 2008, the Japanese Yen may have more upside potential than any other major currency. Last year we saw a strong correlation between world equity markets and movements in Yen currency pairs, especially EURJPY and GBPJPY. Sharp drops in the S&P 500 and other major stock indices often coincided with major rallies in the Japanese currency. This so-called risk aversion trade, which consisted of selling stocks and buying the Yen, is on again in 2008 as the subprime mess and related issues continue to damage investor confidence and threaten global growth (see figure 2).
Figure 2: GBP falls hard vs. the Yen, and then bounces as market turmoil subsides. Source: Saxo Bank
The Japanese Yen has been moving in the opposite direction of world stock markets in general, not just the US stock markets. Movements in the Asian and European bourses are creating an impact on the Yen that is similar to that of the US markets. I think the relationship between USD/JPY and the equities markets is a bit less pronounced than the EUR/JPY and GBP/JPY relationships because the US Dollar, like the Yen, is in some ways a beneficiary of recent equity market selloffs.
Keen market observers may have noted that recent seizures in the credit markets have been accompanied by U.S. Dollar rallies. In fact, in August of last year, when the extent of the credit crisis first became apparent and equities markets began to suffer, EUR/USD plunged from 1.3900 to 1.3300 as the greenback sprung to life. This dollar rally lasted until Ben Bernanke and the U.S. Federal Reserve unexpectedly cut the discount rate by 50 basis points on August 17, simultaneously restoring confidence in credit markets and sending the buck into a tailspin. Between mid-August and mid- December, the EUR/USD currency pair climbed all the way from 1.3300 to just below the huge psychological resistance level of 1.5000. This demolition of the dollar continued until – you guessed it – overnight lending rates between banks climbed through the roof in December, indicating that banks had once again become uneasy about lending to one another. This tightening of credit was accompanied by another USD rally, with EUR/USD falling back from 1.4900 to the 1.4300 area (see figure 3).
Figure 3: USD shows pockets of strength vs. Euro during credit crisis. Source: Saxo Bank
Most recently, the Fed's recent inter-meeting rate cut of 75 basis points then caused the buck to resume its slide vs. Euro. Inter-market relationships between currencies and stocks come and go, but as long as these various crises linger, expect the strong correlation between the Yen and world stock markets to continue.
Free Special Event in Washington! Chris Koomey, Scott Trello, and everybody at the brand new Online Trading Academy Washington, DC office would like to invite you to a special Forex seminar and book signing event on February 29. I'll be speaking about the Forex market and answering your questions, and my new book "Forex Patterns and Probabilities" will be available at a special discount price. Who knows, maybe Mitt, Hillary, Rudy, and Barack will show up! I hope to see you there.
Q) Dear Ed, I live in Dubai, UAE, I've been reading your newsletters and your Q&A sessions are like gold to me. Last year, I shorted gold and then shorted Euro, huge contracts; as a result, we collectively lost. To try my luck again, this time around, I did a few trades here and there and also lost due to the mania on "Maniac Monday". Ed, without any formal education in this line, I ventured, thinking will make some money. Since I'm a CPA and understand economics, I thought I would be moderately successful there. Please give me your advice.
Ed Ponsi) Thank you for your question. Trading is a skill set that is completely separate from other areas of finance. I'm sure there are successful traders out there who don't know how to balance a checkbook; what makes them successful is not a deep knowledge of economics or the ability to understand esoteric mathematical concepts (although that certainly doesn't hurt). They are successful because they have the discipline to get out of a trade that has gone awry.
Your situation sounds very similar to my early days as a stock trader. There was a time when I exhibited similar behavior; I used to place big bets and I had no idea where or when I was going to get out of the trade. I was very lucky to have started trading stocks during the bull market run of the 1990's, which was a very forgiving environment for new traders. Essentially, the market would bail traders out, no matter how bad the entry or the execution of the trade, provided that the trader was "long". I was lucky to have survived those early years.
Over time, I learned that the difference between success and failure in trading was wrapped up in a concept called "risk management". This is a concept that is shared by all successful traders, the idea that losses must be limited. Eventually, I learned to stop worrying about profit and to focus my attention on losses. It is acceptable to lose money on a trade, but what is unacceptable is to lose a large amount of money on a trade. Every major trading loss, from Nick Leeson to Long Term Capital Management and even the current fiasco at Societe Generale, can be traced to poor risk management. If there is a secret to trading, it is this: cut your losses short. If you take care of the losses, and you are using good strategies and techniques, the gains should take care of themselves. Thank you and good luck.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through 