Forex Q&A with Ed Ponsi

Forex Q&A with Ed Ponsi

By Ed Ponsi, President, FXEducator.com

Greetings from New York! I'd like to thank everyone for all of your great questions. Let's get started!

Q) Hi Ed, I really enjoy your column. Could you please explain the rally in the Euro after the recent FOMC meeting?

Ed Ponsi) Thank you for your email. The Federal Open Market Committee (FOMC) created quite a stir when they announced they would begin purchasing massive amounts of U.S. Treasuries. This is not very different from recent announcements made by Great Britain (please see "It's Not That Complicated") and Switzerland (please see last week's article, "Swiss Franc Goes Ballistic"). EUR/USD shot higher in response to this announcement, gaining nearly 400 pips in just a few hours (see figure 1).

Figure 1: Euro crushes the U.S. Dollar after the FOMC announcement on March 18. Source: TradeStation

Since the Fed plans to print the money used to buy the bonds, the USD fell due to the anticipated dilution of the greenback. After a recent announcement by the Bank of England, the British Pound slid by about 600 pips vs. the U.S. Dollar. Also prior to the Fed announcement, the Swiss Franc (CHF) lost nearly 400 pips vs. USD in just one hour on a similar announcement from the Swiss National Bank.

It seems that whenever a central bank announces they are about to fire up the printing presses, that currency falls. So which shoe will be the next to drop? So far, Europe has resisted the rush to print money, and the Euro has looked pretty stout recently, especially against the Yen and the British Pound. But on March 24, European Central Bank (ECB) Vice President Lucas Papademos said the bank could consider quantitative easing if all other options to revive the economy have been exhausted. Traders will be watching the news closely to see if the ECB joins the printing press parade, a move that could create a sudden down draft in the EUR.

Q) Hey Ed, maybe you can help me out with this question/comment. You and everyone else keep mentioning this enormous national debt that keeps on growing and growing. Is it really that big? It seems like if you take the total value of all the assets in this country, it would be well into the hundreds of trillions of dollars. Why are we so concerned having a debt level that is equal to probably 1% or 2% or less of total assets? I guess I'm on an island all by myself here but I don't see this debt being a serious problem down the line based on the ratio of the debt to total assets of all citizens in the country. What am I missing? If the U.S. were a corporation we would be talking about their phenomenal debt to asset ratio. Why is it so different - because it's a nation and not a corporation? I guess what I'm asking is why is a debt/asset ratio of 1-2% considered such a serious problem for a nation...yet considered great business practice for corporations? Thanks for the help. Keep up the great work.

Ed Ponsi) Thank you for your email, it's a great question. The first point I'd like to make is that generally speaking, companies borrow money to make more money; for example, if you borrow money to build a factory, you certainly intend to make enough money to pay back that loan many times over. I'd call that a good debt. But how would you feel about a company if it had to constantly borrow money just to meet its payroll and pay for employee pensions and healthcare? What if that company needed to borrow more money just to pay the interest on its outstanding debts? You probably wouldn't want to own stock in that company.

Also, while companies are expected to adhere to strict accounting rules, the financial statements the Federal government releases are held to a much lower standard. Government debt statistics do not include the amounts it expects to pay in the future for the Social Security, health care programs, and various other obligations, like publicly held debt, military and civilian pensions, Federal insurance, loan guarantees and leases.

So how big is the real U.S. debt? It depends who you ask. The National Debt Clock currently shows a liability of over $11 Trillion USD, a number that is compiled from figures given by the U.S. Treasury Department. But remember, some of the biggest liabilities are left unmentioned in official government statistics. According to David M. Walker, the former Comptroller General of the United States, the actual number is much higher – about $52.7 Trillion USD. This represents the equivalent of $175,000 per person living in the United States, or $410,000 per full-time worker. The really bad news is, Walker's $52.7 Trillion figure is as of 2007 – in other words, it was calculated prior to the massive spending orgy we are about to undertake. For the very first time, a single-year Federal budget will increase the overall debt by trillions of dollars. We are already in deep, and we are digging the hole much faster now.
Chuck Is Back!

Sorry to bum you out with all that talk about debt. Here are a few Chuck-isms to brighten your day:

Chuck Norris' options expire from sheer terror.

When your platform goes down, it's because Chuck Norris punched it in the face.

Chuck Norris' calendar goes straight from March 31st to April 2nd; no one fools Chuck Norris.

Ed Ponsi on Forex TV

Here is the link to today's ForexTV appearance. We covered EVERYTHING!

This link should work for about a week.

It's Not That Complicated

It's Not That Complicated
By Ed Ponsi, FXEducator.com

Why does the British Pound continue to slide? The continuous downward trend is pretty obvious, but why? The British Pound has been falling hard vs. the U.S. Dollar for months, and bargain hunters trying to "buy low" have been slammed repeatedly. Note that since late 2007, the GBP/USD exchange rate has fallen by more than 7000 pips. The pair has remained trapped beneath its 10-week Exponential Moving Average since August (see figure 1).

Figure 1: GBP/USD has been in a downward spiral since late 2007. Source: Trade Station

Even after this crushing move, sentiment toward the British Pound remains negative. Sure, the U.K. economy is in trouble, but that is not a unique problem. Now, the British government is preparing to unleash a flood of cash in a bid to restart the economy. The Bank of England has announced that they are about to embark on quantitative easing, a strategy designed to relieve stress on the credit markets and fire up the economy. The Bank of England (BoE) has just committed to a 75 billion Pound asset buying spree designed to do just that.

Quantitative easing may sound complicated, but it's really very simple. The BoE will "print money" and use it to buy "gilts," a slang term for U.K. government bonds. Although quantitative easing is often described as "printing money," no new notes and coins are actually created. Instead, a central bank "creates" more money on its balance sheet, and then uses that money to buy the assets of commercial banks, such as home loans and government bonds, thereby pumping extra cash into the system. The commercial banks have accounts with the central bank, and the money will simply be credited to those accounts. One could say that the new funds are created electronically, rather than physically.

When a central bank floods the banking system with masses of money to shore up financial systems and promote lending, it is known as quantitative easing. The hope is that when the banks are flush with cash, they will lend some of that money out to businesses and consumers, who will continue to circulate the money, thus boosting the economy. The problem is, such a tactic can dilute the currency, and the perception that such dilution is about to occur is dragging the Pound down right now.
Question of the Week

Q) I recall you saying on one occasion that during the non farm labor report, stops are not guaranteed. So I phoned my broker and posed the question to him. He said that stops are never guaranteed. Do any Forex companies guarantee their customers' stops? I know there are companies that guarantee no negative account balance.

Ed Ponsi) Thank you for your questions. I'm not surprised that an employee of a specific broker has not heard of guaranteed stop losses, because many companies do not offer them, but they do indeed exist. These orders are referred to as GSLO's (Guaranteed Stop Loss Orders), although entries and exits can also be guaranteed under some circumstances. A common GSLO might guarantee your protective stop up to a certain size of trade, such as 20 standard lots. These orders provide an extra layer of security for traders who are concerned about gaps. For example, assume that a EUR/USD trader places a stop on a Friday afternoon at 1.2600. If EUR/USD closes on Friday at 1.2620, and opens on Sunday evening at 1.2580, a person who placed a GSLO at 1.2600 will have his or her order filled at exactly 1.2600. Not all brokers offer this feature, and some actually charge the client to use a GSLO, so check with your individual broker for details.

How can brokers afford to offer this type of protective stop? Compared to the equity markets, gaps are relatively rare and benign in the Forex market (although recent high volatility has caused an increase in the size of these gaps). There are two main reasons for this; first, the tremendous liquidity of the Forex markets (estimated at about $3.2 Trillion USD per day) means that there are available buyers and sellers at virtually every price point. The other reason is the lack of opening gaps, which only occur on the weekends due to the 24-hour, round-the-clock nature of the currency markets. In conclusion, gaps do occur in the Forex market, but traders can avoid them by using a GSLO or by closing all positions entirely prior to the weekend.

Regarding a guarantee that your account balance will not turn negative, this is pretty much standard operating procedure in the Forex world. Stock brokerages tend to close positions manually, whereas Forex brokers execute them automatically. Unlike the stock brokerage model, where a trader who fails to use good risk management could possibly lose a sum greater than the amount invested, most Forex accounts will automatically close out positions before the account equity turns negative. This is reflective of a superior use of technology by currency brokers; since they are newer than most stock brokerages, they did not suffer from antiquated procedures (such as literally calling a client who has received a margin call).

Also, the international nature of the Forex market would make it difficult and time consuming for creditors to chase debtors. For example, suppose a broker is located in Switzerland, and a client of the broker lives in Costa Rica. If the trader in Costa Rica fails to send funds owed to the broker in Switzerland, the broker may find it difficult to collect that money. In fact, that Swiss broker may have clients in 100 different countries, and the time and effort involved in chasing them around the world to collect funds would be too great. This is why many Forex brokers will automatically close trades before all of the funds are drained from an account.

Yen Suddenly Not So Tough

Yen Suddenly Not So Tough
By Ed Ponsi, President of FXEducator.com

In last week's article, we took a close look at the Japanese Yen currency pairs, specifically at two setups; a double-bottom pattern on USD/JPY's daily chart, and an inverted head and shoulders pattern on GBP/JPY. Well, one week later, USD/JPY has soared by 400 pips in a relentless move higher, as the greenback finally gained the upper hand over the Yen (see figure 1).

Figure 1 USD/JPY blasts higher after forming a double-bottom pattern. Source: Trade Station

The greenback continues to be the currency that is perceived to be the safest in this maelstrom, which is really not saying much. In a country like Mexico where the Peso has collapsed, the buck is an obvious choice for storing wealth, and residents are fleeing the local currency. On March 4, Vladimir Putin felt the need to reassure the world that Russia's Ruble is not about to collapse. Considering the damage to the Ruble, the Peso, and other troubled currencies, it's easy to see why the USD seems like a good place to stash your cash. But while USD/JPY is reaching its highest point since November, GBP/JPY has struggled mightily as it attempts to break out of a bullish inverted head and shoulders pattern (see figure 2).

Figure 2: GBP/JPY is tries to break out of an inverted head and shoulders pattern. Source: Trade Station

As you can see, GBP is locked into a life and death struggle with JPY in the area near 140.00. Why would the GBP have so much difficulty working its way higher vs. JPY while the greenback cruises into the stratosphere? In a word, the answer is sentiment. Over the past six months or so, the British Pound has been the currency market's version of the 0-16 Detroit Lions, a currency unable to get out of its own way. However, unlike the stock of Citigroup or AIG, there is no threat of the GBP going to zero. GBP is probably undervalued on a fundamental basis here, but until this currency can show some sustained strength, there is no good reason to buy the Pound.
Question of the Week

Q) Hello Ed, first of all, your articles are very good, I may say even illuminating and I enjoy reading them. I intend to enter the Forex market and I am interested in your opinion on extremely long-term Forex pair trading. I am referring to the major pair combinations of EUR/GBP/USD/CAD/CHF/AUD/NZD. Long term for me is in monthly charts and entering trades with periods of month or even years (where the weekly and daily charts are used for fine tuning the entries/exits).

From back testing all these pairs I observed that during the last 10 years, I got between 4 to 8 trades per pair using a relative simple technique. The testing also showed that I have no need to be glued to the computer and I can pursue other activities as well. The profits also seem to be solid, my only issue is the relative large stop-loss needed and here I will appreciate your input - what stop-loss size would you recommend?

Ed Ponsi) Thank you for your email and your kind comments. It's refreshing to hear from someone who is looking at the market from a different perspective, in this case a very long-term one. And I thought I was a long-term trader! Although I've never traded off of the monthly chart, I do use the daily and weekly time frames frequently. I agree that using longer time frames allows a trader to have the freedom to pursue all kinds of worthwhile activities, and though we sometimes may lose sight of this, didn't we all get involved with trading so that we could enjoy more freedom? I think that most traders would list freedom as the number one reason for pursing this career in the first place.

Now to the specifics of your strategy; it's true that as a long-term trader, you'll need to use wide stops and targets. Fortunately, this doesn't necessarily mean that you'll have to risk large sums of money on every trade; instead, you have the option of trading fewer lots, mini lots, or even micro lots if necessary. For example, in a mini account, a one-lot EUR/USD trade using a 500 pip stop equates to a maximum potential loss of $500; in a micro account, a one-lot trade on EUR/USD with a stop that is 500 pips away from your entry point creates a risk of only $50! With this kind of flexibility, you can certainly use longer time frames without incurring the risk of a major blowout.

We really can't say that the strategy is complete or profitable until you've determined a method for placing the stop; after all, risk management is the most important part of any strategy. Without understanding the strategy's specifics, I can't really tell you how far away to place the stop as I have no real understanding of your methodology, or other important information such as the profit objective. You'll need to add specific rules for stop placement to complete the strategy, and then test it, before you can know if it really is a profitable strategy. Good luck!


Ed Ponsi

A Ray of Hope for Stocks?

A Ray of Hope for Stocks?
By Ed Ponsi, FXEducator.com

Since the middle of last summer, one of the most reliable currency trades has been to short GBP/JPY, EUR/JPY, and/or USD/JPY on rallies. These currency pairs have had a strong correlation to the equity markets since the early part of what we used to call the "subprime mess," so as stocks fell, these pairs fell along with them. But now we are seeing this correlation fall apart, at least temporarily. As the stock market continues to plunge, reaching depths not seen since the 1990's, several currencies pairs that feature the Japanese Yen appear to be staging reversals. In fact, GBP/JPY appears to be forming an inverted head and shoulders, a bullish formation, despite the recent setbacks in the stock market (see figure 1).

Figure 1: GBP/JPY forms a bullish inverted head and shoulders formation. Source: Saxo Bank

At the same time, USD/JPY also appears to be forming a bullish reversal pattern; in this case, the pattern takes the form of a double-bottom. In fact, USD/JPY has passed beyond the breakout point and has climbed above 95.00, a level not seen since November of last year (see figure 2).

Figure 2: USD/JPY breaks out of a bullish double bottom pattern. Source: Saxo Bank

Undoubtedly, this scenario will lead to the following question: since the equity markets fell along with the GBP/JPY and USD/JPY currency pairs, does a reversal in those pairs foretell a similar reversal of fortune for U.S. and world stock markets? I wish that I could tell you for certain that this is the case. On the one hand, one can't deny that a strong relationship exists between the JPY and equities. This has been a bread and butter trade for a long time, and something I've written about frequently in this column (see last week's article, "Using Inter-Market Analysis to Trade Forex" and last October's "Using Stocks to Trade Forex"). But that doesn't give me the right to ignore the possibility that the market may be changing, as constant change is a hallmark of all trading markets (and the anathema of back testers everywhere).

On the other hand, correlation is not causality; in other words, just because the JPY pairs and stocks fell together, this doesn't mean that they have to rise together. If I scratch my nose and it begins to rain, those two events are a coincidence; yet a child or a primitive man might believe that he caused it to rain by scratching his nose, leading to elaborate nose-scratching rituals in an attempt to duplicate the earlier result. In other words, two things can happen at the same time despite the lack of any relationship between the two. Correlations come and go, new ones are born and old ones fade away all the time. If the same correlations remained intact on a constant basis, our jobs as traders would be much easier. Constant change keeps traders on their toes, and the ones who can adapt quickly tend to do well.

One thing that is disturbing to me about the recent push to new depths in the stock markets is that there seems to be a complete lack of panic. Major lows are often accompanied by panic selling, but there has been no hint of indiscriminate dumping of stocks as of this writing. We have not seen a spike in the Volatility Index or VIX, which would indicate a high level of emotion in the markets. If there are buyers lurking, they might be waiting for just such a sign. It's likely that many long-term traders are "keeping their powder dry," waiting for panic selling as their indicator to initiate long positions.
Question of the Week

It seems that our discussion of mini and micro lots created a big response, so I'd like to handle a question on that topic.

Q) Hi Ed, how many lots can I trade in the Forex with $5000? There are so many factors to consider. Would you be kind enough as to give me some pointers as what to look for or avoid? A little advice would go a long way right now. Thank you in advance, Cindy.

Ed Ponsi) Thank you for your question, the number of lots you can trade with $5000 depends on the account type. In a standard account, you must put up margin collateral of $1000 to enter a one-lot trade; this would be highly unadvisable because just a one-lot trade would use up 20% of your buying power. This means that your flexibility would be severely limited, especially when faced with multi-lot scenarios. Many traders prefer multiple lots because it allows them to exit a portion of their trade at a profit while allowing another portion of the trade to run.

However, the requirement to enter a trade in a mini account is only $100, and in a micro account the requirement is only $10. The temptation is to worry about the fact that it will be difficult to make a large sum of money under these circumstances, but that is putting the cart before the horse. Instead of thinking about money, consider opening a mini or micro account with the intention of mastering the skill of trading. In a smaller account, this can be done with a minimum of risk, if good techniques are applied. Once you have learned proper technique and risk management, you can always scale your trades to a larger size. The mistake some people make is that they are too blinded by greed and are in too big of a hurry to make money, so they skip training and dive right in to large sized trades, with negative results. Meanwhile, traders who study hard and risk little while they learn are giving themselves a chance for success.


Ed Ponsi