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Crushing It!
Hello from New York! Vacation is over, so I'm back in the Big Apple making the rounds on the financial news networks. We have some great questions this week, so let's get right to it!
Q) Hello Ed, I'm subscriber of your newsletter provided by tradingacademy.com and I find it very informative. I have just started trading Forex live (January 2008) hence, I'm a newbie. I trade the daily charts and till date, I have executed four trades of which three were wins and the overall return is 12.46% (with appropriate Money & Risk Management criteria). However, my last trade (I shorted USDCHF) was a big winner (500% approx).
When I trade based on daily charts, trading opportunities appear much less often, maybe 4 or 5 good trades in a year. But if I keep this pace, I would be very old before I can see real good money. What do you suggest? Should I move down to smaller time frames, 4 hour or 2 hour, to get more opportunities?
Ed Ponsi) Wow! First of all, let me congratulate you on an awesome first quarter, you are crushing it! Traders who went with the trend (in other words, shorted USD) using daily or weekly charts made a killing over the past three months, especially if they shorted USD vs. the Euro (EUR) or the Swiss Franc (CHF). Here is my concern; you started trading at the perfect time, and because of this you may have acquired some misconceptions. It will not always be this easy, because while the currency markets are famous for long, strong trends, recent conditions have been ideal. I hope this recent trend continues but it has to end eventually. I want you to reinforce your positive behavior, so please reward yourself by taking some profit off of the table. Buy yourself something nice, like a watch or a condo – something physical to remind you of your recent success, and how you achieved it.
Also, don't assume that you'll make more money by switching to shorter time frames. Yes, you will get more trading opportunities in shorter time frames, but if experience is any guide, you will probably make less money. This is because currencies trend better on the daily/weekly time frames, and shorter frames create more false signals. The longer time frames are working for you, so why change?
I know this may sound crazy but try not to think about money when you trade, just think about the process of trading. When we think about the money, we tend to move away from things that are working well for us. Don't let this happen to you, you're doing great and I don't want you to be distracted from something that is obviously working well for you. If you keep repeating and refining the process, the money will follow. Who knows, you may end up managing money for others at some point in the future, if you can maintain and build on your success. Successful money managers rarely complain about their incomes, as they are too busy counting money. Be careful and good luck!
Q) Ed, it appears that a bank can now trade in a mortgage for a treasury note. They can then trade the treasuries anywhere they want to stay liquid, where before they were stuck with the mortgage. How does this pressure the dollar? Sure, we are in effect selling treasury notes but we are getting mortgages in return. So, the government is getting a loan for a loan, which is not unlike getting money for future payments. Later when the credit market returns, Big Ben can just sell them back to the investor market and take back the Treasuries, right?
Ed Ponsi) Thank you for your question. The Fed is doing a number of things to try to stabilize the credit and equity markets. What you are referring to – the fact that the Fed is now willing to accept mortgage-backed investments, and give back guaranteed U.S. Treasuries in return – is just one aspect of the Fed's plan. While not every mortgage or every investment connected to mortgages has gone sour, many mortgage-backed securities are now worthless; they will not regain their lost value in the future, and nobody is going to buy them on the open market for anything less than a fire-sale price. Here's why: the value of these securities is based on the assumption that the mortgage holders will repay the loans, and as we can see by the rapidly rising default rates, in many cases this just isn't going to happen. What the Fed is actually doing is giving a guaranteed investment in return for an investment that may have no value at all. This is great news if you're a bank or broker who invested in toxic subprime debt; it essentially lets them off of the hook for bad decisions that were made in the past. It also brings up the question of moral hazard; if banks and brokers are no longer allowed to fail, what is going to prevent them from making bad decisions in the future?
So where does the Fed get the money to create all of these Treasuries that they'll be exchanging for those worthless mortgage backed securities? Well, since the Fed controls the money supply they can simply create the money out of thin air. This may be convenient, but it has the unfortunate side effect of devaluing the currency that is already outstanding, for instance the money in your bank account or wallet. The U.S. Dollar responds by falling, something it has done steadily for most of this decade (see figure 1).
Figure 1: USD performance vs. a basket of currencies since 2002. Source: FXstreet.com
Q) Could you advise the best way to protect against currency risk? For example, if we sell a product – jewelry, for example - on day one and get the payments after 180 days, and the gold prices fluctuate in the meantime, this could have a big impact on our profits. And if for example we bought the raw material (gold) for $950, after six months it could go up to $1150 or come down to $800. How should we deal with this problem?
Ed Ponsi) Here's a really simple way to look at hedging - imagine the thing that you don't want to see happen, and then create a situation where you'll profit if it does happen. For instance, if you're Toyota, you don't want the Japanese Yen to appreciate, because it will make your product more expensive, and hurt sales. So what do Japanese automakers do? They buy JPY futures contracts and options that will make money if the Yen rises. That way, if sales are hurt by a strong Yen, they can make up the difference by cashing in their JPY bets. On the other hand, if the Yen weakens, the options and futures contracts will lose value, or become worthless. The only thing that is lost is the price of the contract or option; think of it as an 'insurance policy' against an adverse move in the exchange rate.
So if I had already purchased gold as a raw material, I'd be happy if the price went up; however, I would need to protect myself in the event that gold prices were to fall. So, I'd need to purchase contracts that would rise in value if gold prices fell. That way, I'd make money if gold prices went higher, but at the same time I'd have an insurance policy if gold prices fell. Good luck!
Quote of the Week
Recently, the New York Times asked former Secretary of the Treasury Paul O' Neill how the problems with subprime mortgages led to a financial meltdown of global proportions. O' Neill said, "If you have 10 bottles of water, and one bottle has poison in it, and you don't know which one, you probably won't drink out of any of the 10 bottles; that's basically what we've got here." That pretty much says it all!
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 