How To Trade In Challenging Times

How To Trade In Challenging Times

By Ed Ponsi

Okay, so things are rough out there. Bear Stearns, Lehman Brothers, Washington Mutual, American International Group, B&B, Freddy and Fannie and the rest of the gang have all either gone to that Big Vault in the Sky, or are on life support. The proverbial "other shoe" has dropped so many times that we've all lost count – and the carnage isn't yet complete. But just because the world is facing financial Armageddon, and long-term investments are falling apart faster than the New York Mets in September, that doesn't mean your trading account has to suffer. In fact, some traders thrive in this rock 'em, sock 'em environment. Just take a look at the volatility in the Great Britain Pound – U.S. Dollar currency pair (symbol GBP/USD). Note how the candles on the left side of the chart are much bigger than on the right, indicating that the daily range has expanded dramatically. Also, take a look at the Average True Range indicator (ATR), which shows us that the average daily range of GBP/USD over the past 14 trading days now exceeds 300 pips! (See figure 1).


Figure 1: GBP/USD's average daily volatility has risen to over 300 pips. Source: Saxo Bank

This level of volatility hasn't been seen since the year 2000, and the type of wild action it creates will be welcomed by some traders and avoided by others. Here are three key thoughts to help you trade safely and securely during these challenging and historic times.

Nimble – Things are happening quickly out there, and the wide swings in volatility are causing markets to move faster and farther than before. In fact, volatility in the currency markets is at its highest point since the year 2000. What's a trader to do? Traders looking for quick intraday moves need to keep their finger on the trigger at all times – especially when they are already in a trade. The game changes quickly, so be ready for action at a moment's notice. Put your mouse cursor directly above the exit button, and keep your finger poised above the mouse. That way, you'll never be taken by surprise, and you'll always be ready to close your position.

Pip Slip – Prepare for slippage, as fast moving markets may cause some surprising fills. This is a common occurrence in the stock markets, but currency traders have been largely immune to slippage - that is, until the recent spike in volatility changed the game and turned the trading world upside down. How to deal with this problem? Plan ahead and don't be surprised when you get a bad fill; in fact, make it part of your game plan. When performing your calculations, assume that the price you receive for both buys and sells will be slightly worse than you would normally anticipate. Not only will you be prepared for a bad fill, but you may find yourself pleasantly surprised when you get a good one!

Park It - Trading in this fast-paced environment isn't meant for those with a nervous stomach. In fact, many of us would be better served by simply staying out of the trade and watching from the sidelines until the markets settle down. Always remember that part of our jobs as traders is to know when to avoid trading. The truth is you should never feel as if you absolutely have to place a trade, and you should only place trades when you feel that the odds are in your favor. Selectivity is the key; you will make more money from one good trade than you will from ten mediocre trades, so maintain your focus and only take the best trading opportunities.

Question of the Week

Q) Ed, I keep hearing about LIBOR in connection with the bailout but I'm not familiar with this term. Can you please explain what it means and why it is important to traders?

Ed Ponsi) Thank you for your question. LIBOR is short for London Interbank Offered Rate, and it represents the cost of borrowing dollars overnight in London. On September 30th, the last day of the third quarter and the day after the bailout plan first failed to pass through Congress, LIBOR spiked an incredible 431 basis points to 6.88%. Let's think about that for a minute; banks are charging each other an annual rate of 6.88% for overnight loans! They must be pretty frightened to charge such a high rate, perhaps because no bank wants to lend money, only to find out later that the borrower has evaporated.

In a way, you could say that LIBOR is a "fear gauge", and it is telling us right now that banks do not want to lend money to other banks except at ridiculous rates. This is despite the fact that the Fed and other central banks are constantly pumping liquidity into the system, jamming the banks full of cash so that they'll be more willing to lend. Many of the banks are just hoarding this added capital for their own needs instead of lending it out to others, defeating the purpose of the Fed's actions.

Right now we are seeing strength in the U.S. dollar, and that is because the USD tends to perform well when fear is high. But this will pass; fear is a temporary condition, and as bad as it may seem right now, things will eventually get better. When they do, watch out – the bill will come due for this mess, and when it does, it will weigh heavily on the greenback. Enjoy the USD rally while it lasts.

Have a question about Forex trading? Send an email to info@fxeducator.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.

Ed Ponsi

ATR and the TED Spread

Greetings from New York! This week, we have answers to your questions about Average True Range, the TED Spread, and more.

CLICK HERE to read the article

Ed Ponsi on CNN Today....

Hi Everybody,

I'm back on CNN International today between 7pm and 8pm London time (bet. 2pm and 3pm New York time). See you then!

Ed

Disaster Trading: Your Responses

Wow! Last week was the very first time I've asked for your responses to a question, and the feedback was overwhelming. If you missed last week's article, a philosophical question was posed; is it ok to place trades that are designed to profit from a natural disaster such as a hurricane? For the sake of clarity, I want to be clear that I am talking about trades that are specifically engineered to benefit from a disaster, not trades that just happened to be affected by one. I mentioned that I once traded for an outfit that had an "unwritten rule" against designing trades in this manner, and I continue to adhere to this attitude, but that doesn't mean that I don't respect those who disagree – I do, especially after reading your thoughtful responses.

I'd also like to point out that this is very different from the argument that blames speculators for all that is wrong with the markets. There are those who blamed speculators for driving the price of oil to $147 per barrel; now that the price has fallen more than $50 per barrel and is below $100, do we hear any praise for the speculators? I haven't heard a word of it, and I don't expect to. Speculators are always present in every market, whether that market is going up or down, and they are a necessary ingredient as they provide the liquidity that allows non-speculative market participants to have a counter party to their trades. Without the liquidity provided by speculators, markets would be thinner and consequently more volatile.

No matter whether you agreed or disagreed with me on this one, I'm very pleased not only with the quantity, but with the quality of your responses. It's clear to me now that not only am I reaching a fairly broad audience, but a thoughtful and intelligent audience as well, so I thank you one and all. My apologies, as only a small percentage of the responses could be accommodated - there were many good letters that you won't see here, due to limitations of time and space. Let's get to some of the highlights of your comments on this topic - plenty of you believe that it is wrong to place a trade specifically designed to benefit from a disaster:

"I completely disagree on trying to make profits on disasters. The market is full of opportunities, so if we cannot help those people, we might at least don't be a part of a bigger damage."

"I agree...I do not personally like the idea of trading off of other's misery. On a related subject, it seems that the "hot" new thing to do is buy "life settlements" also known as viaticals...that is, betting on when someone will die, and grabbing part of the life insurance. I think that is despicable, disgusting, and a reprehensible way to make a buck...but that's just me."

…But even more of you felt that it was ok – but usually with a few caveats. Here is a compelling argument in favor of disaster trading:

"Ed, There's nothing wrong with taking trades in anticipation of disasters. I cannot distinguish doing that from anyone who sells survival or emergency preparedness gear in their business. They profit from selling such gear because there's a good chance it's going to be used...and we've had plenty of disasters that show it's a good idea to have that stuff around. Should people not buy emergency gear? Of course, they should. And there's nothing wrong with selling it. By your logic, nobody should sell that gear, because they'd be likely to be making money off the misfortunes of others."

"I believe it is acceptable for a trader to take a position on this. Traders are in the business of making a profit with the least risk and if it means taking a position due to a disaster I do not see it being unethical. In my view any fundamental factor should be recognized and if a trader wants to trade the effect it could have it is acceptable. Now my closing thought is this - many people were adversely affected by these fundamental factors (losing jobs, losing homes, huge capital losses, etc.), but many traders profited. Was this unethical enrichment?"

"Do undertakers and funeral homes profit off disaster? Is that ‘wrong'? Profiting off disasters might be distasteful but it isn't immoral unless you are doing something that causes or worsens the disaster. If a store owner can raise prices on lanterns and candles in anticipation of, or because of, a hurricane, that will encourage more store owners to carry these items in the future. What's immoral about that?"

Several of you suggested that the profits from a disaster trade should be donated to the victims:

"The middle ground, and generous thing to do, would be to pay the profits from disasters into disaster funds to assist those badly affected."

"What's wrong is price gouging when disasters occur -- when people try to sell a $1 bottle of water for $5. I'll agree that's objectionable (and indeed, criminal). But if I see that a disaster will occur, and I make a trade based on a sound fundamental reason, I see nothing wrong with it. Perhaps, with my profit, I can donate more money to aid disaster victims."

"Take a percentage of whatever profits you make (what % is also your choice) and donate it to help the people you feel you made money off of. That way you are not only doing your job to the best of your ability, you are also helping those in need.... and if you choose to cheer out loud, do it because you were able to help someone else in need just by doing what you do best, TRADE!"

Some felt that we could extend this idea into other areas of trading:

"I found your discussion of trading during disasters very interesting. The picture you painted of traders cheering while others were suffering painted a very vivid picture. I have struggled with a similar idea. That is, trading against the economy of one's country. I cannot feel good about cheering a long EUR/USD position when that means that the NFP has plunged. If the NFP goes down it means friends, relatives and countrymen are losing their jobs, and the USA economy is tanking. Not much different than a disaster, really. Or am I not seeing things correctly?"

That brings up an interesting point. I did quite well shorting the U.S. Dollar earlier this year, as I'm sure many of you have over the past few years. I always told myself that it was ok because although various U.S. government officials claimed to support a "strong Dollar policy", I've felt very strongly that in reality they wanted the USD to weaken, in order to benefit big U.S. exporters. Because of this I never felt bad about shorting the buck – even as I've been calling for a change in this policy, because of its deleterious effects on the average American. It's not the traders, but the policies of our government that made the buck such a great short this decade.

Here is a great letter from a person who is both an investor and a relief worker:

"As a Disaster Worker I volunteer with agencies at the local, State and Federal level, and as an investor, I'd like to say that I find trading to profit from natural disasters to be fully acceptable. There are whole industries that depend on disasters for their livelihood, and no-one objects to them. Indeed, they are suppliers to governments, and necessary partners in the mitigation, preparedness, response and recovery process.

If they are not only allowed to profit from disasters, but encouraged to do so, shouldn't the investor, using only a computer or telephone be allowed the same ability? As long as none of us becomes "Lex Luthor", able to cause or control these disasters, then I see no problem with the ethics of the situation."

Here's a great thought on this topic:

"Is it morally right? I guess that depends on the individual and how driven they are by FEAR and GREED. And they should also ask themselves if they are sticking to their trading plan, I have not yet ever talked or met a trader that had developed a trade plan to trade natural disasters only."

And finally, let's end this on a high note!

"Thanks for regularly challenging your readership with excellent material on the currency market."

You're welcome, and thank you one and all for your participation – it's encouraging to have readers who are up to the task of dealing with these important issues, and who are able to express themselves their opinions while remaining civil. I'll see you again next week with a new topic.

Disaster Trading

Q) I'm just trying to figure out what you mean when you say it's wrong to make money off a natural disaster. If I trade for a living, then am I supposed to ignore a pending natural disaster? Am I supposed to take a few days off of trading (or a few weeks) until the threat of the natural disaster has passed? What if I was long the dollar when I heard about the hurricane, would it be would wrong and unethical to change my opinion and close my positions out due to that news? If I trade professionally, and I don't, then I would be a fool to ignore any information that could change my opinion or the markets opinion and help me make money.

Just for the record I never considered shorting or buying the dollar based on the hurricane because I don't see the correlation in this particular case. But I think your statements about whether people try and trade this news or not were insulting and ignorant. Nobody is making money off the misfortunes of others. They are making money off of other market participants. It's a shame that natural disasters, and human caused disasters happen in the first place...but they do. And to ignore the potential consequences those disasters may have on a market would be totally and undeniably idiotic...and a recipe for disaster.

Ed Ponsi) Thank you for your question and comments. Maybe I'm being old fashioned here, but I think it's wrong to bet on Death, Destruction, and Disease to win, place, and show. I'm sorry to hear that you find my stance "insulting and ignorant" as you put it, but I guess we'll just have to agree to disagree. In my years as a Wall Street trader, my employer frowned upon such "disaster trading". He didn't want to hear his traders cheering as the body count rose, so I guess he was old fashioned, too.

I certainly never said that anyone should stop trading due to a pending natural disaster, or that anyone should ignore the consequences of such a disaster. That would be foolish. But that is very different from trying to profit from an anticipated disaster. For example, if you are short the USD due to technical or fundamental reasons and an earthquake occurs in the US, you were not trying to game the disaster. In this example, it's possible that you may have benefitted from a natural disaster, but that wasn't the specific intent. That would be very different from placing trades that were specifically designed to profit from an earthquake. There is a huge difference between those two things; one is passive, and one is active.

I'd like you hear from our readers on this one; what do you think? Is it wrong to create trades that are specifically designed to profit from disasters, natural or otherwise? Or as traders, is it just our job to place the trades and ring the register, regardless of the circumstances? Let me hear your opinions at info@fxeducator.com

Read and Grow Rich

Read and Grow Rich

Greetings from Acapulco! It's cloudy, wet, and humid, not exactly great beach weather, but it's a perfect time to follow up on last week's article and answer a great question from a reader. Keep those questions coming!

In last week's article, titled "Deadly Hurricanes and Dangerous Assumptions", we discussed at length the reasoning behind shorting the Great Britain Pound and going long the Japanese Yen (GBP/JPY). The idea was to short the weakling of the group (GBP, which has been falling relentlessly) and go long the Japanese Yen, which is the only currency other than the U.S. Dollar that has been performing well recently. Please note that when that article was written on September 1 (published on September 2), the GBP/JPY pair was trading at a major support level, at about 195.50, as indicated on the Figure 3 chart from last week's article. Also indicated was a potential catalyst for a break of that support level, in the final sentence, "The Japanese Yen tends to perform well when equities markets perform poorly, so if recent stock market weakness persists, look out below."

Look out below, indeed. Now it is Friday, September 5. Take a look at the "Last" price on the weekly chart, and I guess it's safe to say that support has broken. The last price just under 188.00 indicates a gain of about 750 pips this week. The low price of 186.01 indicates that at one point, the weekly gain was about 950 pips. It's time to ring the register. Hey, it beats working for a living!

I've already heard from some of you who sold GBP/JPY short after reading last week's column, and while I appreciate all of your kind comments and praise, I want you to know that you deserve all of the credit – congratulations! Whenever we take a trade, the credit or the blame always goes to the person who hit the button or clicked the mouse. Trading is not a good business for those who do not take responsibility for their own actions, but it's a great business if you have the ability to stand up and admit when you're wrong – and there is nothing wrong with taking credit when you're right. If you hit the button, then you deserve the credit for those times when you win, just as you deserve the blame for those times when you lose.

More Ammo for GBP Bears

In the Forex market, there is a clear connection between technical and fundamental analysis that does not exist in the stock market. The technical weakness in GBP/JPY that was indicated on the charts is backed by fundamental information. At the same time that the chart was breaking down, the OECD released its predictions for growth in the third and fourth quarters of 2008. The OECD is the Organization for Economic Cooperation and Development, which describes itself as an "international organization helping governments tackle the economic, social and governance challenges of a globalised economy". Interestingly, they picked Japan to have the strongest growth of any G7 country, while predicting a recession for the United Kingdom. The U.K. was the only G7 country to receive that distinction.

Under these circumstances, it shouldn't be too surprising that the Yen has the British Pound on its heels, and one could say that the Yen is fundamentally - and technically - stronger than the Pound. Even if the OECD's predictions turn out to be inaccurate, they are a respected organization and their opinion carries some heavy weight. For more on the OECD, visit their website at http://www.oecd.org.

Deadly Hurricanes and Dangerous Assumptions

In this week's newsletter, we explore questions about the currency market's reactions to past disasters - the reactions may surprise you. Also, answers to more of your email questions.

CLICK HERE TO READ THE ARTICLE