25 ledna 2010

How to get more Bang for your Buck trading FX

Good afternoon,

Apologies for the absolute cliché that is the subject line of this email but at the heart of what I’m going to be writing below is the very simple principle that all of us apply to our everyday lives and in most instances do it as naturally and unconsciously as drawing breath. I’m talking, of course, about the natural human instinct to seek value in anything and everything we do and especially buy or sell.
Ultimately no one wants to give anything away for less than they believe it’s worth and equally so you’ll be hard pressed to find anyone (perhaps the occasional billionaire) that is prepared to pay more for something than they intrinsically think it should cost.

So the obvious question is why is the same principle not fundamentally utilized when it comes to trading financial markets and more specifically FX?

Don’t get me wrong of course there are those out there that do, but for the most part it seems many traders particularly those in the retail sector fail to look for good value trades and just follow the herd when it comes to the major (or even in some instances minor) pairs.

In a nutshell what I’m talking about is the “Relative Value Trade”, simply put the concept here is to look to trade pairs that for fundamental reasons are either over or undervalued against one another. I know this sounds painfully obvious, but sitting where I do and have done now for the better part of 16 years, you would be shocked to see how little this is actually (literally and effectively) put into practice.

Starting at the beginning, let’s consider the characteristics of what an average RV trade looks like;

• An average (min) 3-4 trade horizon
• Have significantly less volatility than other pairs
• Technical indicators need to confirm in a clearly recognizable (textbook manner) the correctness of the trade
• Entry and exit will be within a predefined region/zone thereby giving an average entry and exit level, but only one stop loss for the whole position
• One currency will be overbought/sold against another in spite of genuine economic fundamentals proving otherwise

It is actually the last of these points that is perhaps the most relevant because you are evaluating a trade based on the fact that everything is pointing to another outcome yet the market finds itself in this position. I illustrate all this rhetoric with the simple example below.

Recently I sent out 2 strategic trade recommendations within days of one another, in which on the first I was a seller of the CHF/JPY while on the other I was a seller of GBP/CHF. So if we look at these individually;

Short CHF/JPY In this case I am a seller of the CHF and buy the JPY
Short GBP/CHF In this case I am a seller of the GBP and buy the CHF

Logically most would look at that and say that I’m either confused or have something wrong, because first I sell the CHF and within days I buy the CHF, but obviously it’s against different crosses and in both instances I look for the relative value in that I think the GBP on fundamentals has been overbought and while I still believe the CHF has room to go lower I think that the GBP will depreciate much faster than the CHF. For those of you that have been following my daily comments you’ll remember that while I sold the CHF/JPY I was happy to be long of the USD/JPY, which again intuitively sounds counterproductive, but in relative value terms makes perfect sense.

So what to take form all of this as a client looking to increase your overall returns while mitigating as much risk as possible;
Simple really, spend a bit more time examining macroeconomic fundamentals and put them in a comparative light to look for opportunities (discrepancies) whereby despite all other measure a currency is either overbought or oversold against another and as always use technical indicators (the fewer the better) to confirm the timing of entry, exit, stop loss and limit levels.

I hope this in some way helps, because in markets and conditions such as the current one simply trading intraday for the sake of 30/40 pips is not only seldom rewarding but more often than not quite risky and costly especially in the major crosses.

Best regards,

Ken Veksler.

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