The Way of the Dollar

positions was “the appropriate action” (CB 10 Sep ), and to hell with ‘being right’ or ‘being wrong’, in terms of whether the dollar would gain a few more pfennigs against the DM or a few more pence against sterling.

I talk of “forecasting” as being one of CB’s main functions. But it isn’t forecasting. We can’t see into the future, and we know it. The key job of analysis is diagnosing the set-up conditions for the next turning-point. At minor turning points – the fluctuations within the main trends – the relevant set-up conditions seem always to be to do with sentiment. At major turning points in the main trends, there is usually a new underlying rationale around, as well as a polarisation in sentiment. Conditions at such junctures often lead to chaos.

At major turning points, the basic certainties of the mass of punters comes under attack. The equation that worked until then creates its own destruction when everyone comes to believe in it, and you often have chaotic volatility. Looking tack on CB’s commentaries at the time, it’s clear that the only rationales for the dollar bull market were 1) that the US currency was “cheap”, and 2) that the US trade account was improving. But we know from the experience of all the 1980s that these are unreliable dynamics. A more sure dynamic had crept up on the currency market, i.e. the aforementioned narrowing in the dollar’s yield premium. The trouble was that the old illusory dynamics still appeared to be driving the currencies in mid– September. To call a turn at that point demanded courage of an almost obtuse kind.

In the event, chaos manifested itself in an almost identical repeat of Thursday June 14, on “loony Friday” September 15, when sterling gyrated 5% in one day –”shouting reversal as in mid-June”. But still CB of 22 Sep

was only looking for a 6-week correction in the dollar, not necessarily for a major reversal: “we don’t know whether we are faced with a multi-week move or maybe a multi-month move,” it said. We never do. However in terms of trading action, one just has to take a deep breath at such moments… and make a simple bet – a fifty-fifty affair. Either the dollar would be higher in some months time, or lower. Which would it be? You just have to bet. There’s nothing else for it. Like when you’re on the green, you just have to go up and putt – for better or for worse. Just putt.

Windfalls and whammies

Talking of chaotic 5% gyrations in currencies raises another point. When a currency drops 5% in one session, what are you supposed to do if you’re exposed? Are there any rules –a) if you’re short and b) if you’re long?

Jesse Livermore advocated always taking advantage of a windfall profit. For sure he was 100% right: when the market hands you in a few hours, more than you could have hoped for in days or weeks, you accept graciously and “clean up” as Livermore put it. Always. Rationalising and failing to do so costs plenty over time. That takes care of a).

But what if b) the position goes violently against you? In the currencies, and using a method like CB’s which is designed to detect extremes, I believe the odds easily favour a course of action which is anathema to trend-followers and inflexible adherents of firm stops. If the price movement is prompted by news, don’t fight or fly: freeze . More specifically, if you have a stop that has not already been hit, take it off and take the day off too. Things will be back in proportion the next day – when 9 times out of 10

you will find your position is better, usually much better, than it was at the moment when you would have been stopped or panicked out.

As with most rules, there are exceptions, one in particular. If you find yourself positioned in line with a strong consensus, amid high speculation; and something happens which challenges the rationale behind the consensus, then get out quick, no matter what.

With a time-frame measured in weeks, most of us are much better off never making decisions intra-day, but always waiting to review things calmly after markets close, and plan ahead accordingly. When asked by Jack Schwager* why he had no screens on his desk, Ed Seykota replied: “Having a quote machine is like having a slot machine on your desk – you end up feeding it all day long. I get my price data after the close each day. “

You may not have known that not having a screen was such an advantage! If you want to know the shape of the day’s price action, to gauge how the market reacted to a news item, for example, you may be able to get an account – or an intra-day chart – from your broker .

Position Size, Choice of Currency

Early September was the ideal moment for call options: when you have no way of gauging the downside but see clear upside on a multi-week view, the value of call options lies in the way you can precisely define your stake, for the initial punt. After the “shout” of reversal on September 15, outright forwards or futures made more sense. Once again, the stake was defined by mental stops placed just below the freak lows reached on loony Friday. With hindsight, one knows that moments like these, when the turning point has been located, must be exploited with maximum stakes.

The currency of choice here was clearly the D-Mark –the “pack* leader” at the time. (The reason I keep on referring to what was written in CB at the time is that it helps me avoid the trap of being wise after the event). The rationale for the ensuing bear market in the dollar lay in the drop in the interest rate differential between the dollar and the DM to “1.4% from over 4% in March” (Sep 22). The rise in German interest rates had been prompted by “domestic, not currency considerations”, so it was “likely to lead the DM (up) not follow as a result of DM weakness.”

Staying In.

In the weeks ahead, punters were to blow hot and cold over the D-Mark because of the developments in central Europe, German reunification, money union and the rest. But that had nothing to do with the rationale for the OM’s bull market. So this was a case where long-termers had to stand pat, and traders had to refuse to play the game of political speculation. At least, this is clear with hindsight.

The dollar slid from a high of DM 2.00 in September to below DM 1.70 in early January, while the Yen flopped out after a terrific rally, from early October. Sterling and the SF lagged behind and then took over the running in the new year. The dollar got desperately oversold in December. Yet the fundamentals (yield) continued to run so strongly against it that there was no great temptation to cut and run. With a whole year’s hindsight it’s not clear that one should have got out at all. But it is clear that a trending market gave way to a ranging market in the currencies in first half 1990. And when such a change becomes apparent, new tactics are appropriate, for sure.

Trading the Range.

During the move, you need to stay in. During the range, traders had better stay out. But first they have to get out. As we’ve seen in Chapter 8, the danger once you’ve ridden a good move is