arrogance. You get to think you’re smart, and all you need to do is trade to make money. The old clichй has it that it’s much easier to make money than to keep it. And the clichй is dead right for this phase in the trading cycle. There is nothing easier than to give back in a consolidation all that you’ve made in a good move. You’re thinking in terms of bigger stakes. You’re careless. You’re on a roller. You get reckless; and you fall to pieces. Very disciplined traders may be able to handle this phase, but for lesser mortals, the best discipline is to get out and wait for the market to tip its hand again, the way it did when you made your original play for the move.
We must have a formula for getting out
As all good traders are agreed, you have to have a formula for getting out – a system which is prepared in advance (see “getting out”, below). The basic formula has already been spelt out: you get out as soon as your reason for holding is no longer valid. This formula is good for all players –traders, investors, commercials, all of us. It is valid for trend-following chartists as much as for more fundamentally oriented punters. The latter, having decided that they have overstayed their fundamental rationale, can give themselves price– based rules for exiting, if they wish. We can use the ‘trailing stop*’– a retracement of 2 or 3%, for example. Or we can use a time-limit. We can get out when a move has completed 12 weeks for example. Or we can use a price target, if we have any basis for placing faith in a price target; or a combination of price and time limits, whichever comes first. I’m not sure that the precise formula matters too much –so long as we have a formula which we have decided upon thoughtfully beforehand. The objective, in any case, is to pre-empt the emotions.
For the investor who is not interested in playing corrections and feels he can live with the drawdown involved, there are ways of being prepared
for the drawdown, since it’s so easy to be shaken out of good positions when they start going against you. The first step is to decide that a correction is quite likely: the second is to cut back to a level of exposure which leaves you feeling serene in the event of a reaction. If you’ve prepared yourself, it’s easier to view adverse action with equanimity. “The object of investment”, someone said, “is serenity .”
The danger when currencies are ranging is ‘the dither-trap’. When we are dealing with a move from an extreme, we’re pretty clear in our minds that the object is to buy low and sell high. When a move has been made, we know we have left the extreme well-behind, but we are apt to be concerned with not missing the last of the move. Therefore we are tempted to buy on strength. Equally, since we are aware that a correction is due at any moment, we’re tempted to sell on weakness. So we dither. Having bought on strength we often cover when the strength fades; and having sold on weakness, we cover on strength. And we lose money every time.
The best way out of the dither trap is to decide that we don’t have to play. We don’t have to predict the market: we simply stay out – and say to the market “ show me”. Instead of having preconceived ideas, we watch for the evidence. In this way we can regain the initiative. If we spot an oversold condition after a correction (with punters beginning to short the currency they were recently all bullish of) we can reinstate modest long positions –
not for the rally to the top of the range, but for the next move to decisively higher ground, whenever that may be.
While the D-Mark was consolidating along with sterling in Hl1990, the Yen was still heading down sharply (into May, anyway), and the Swiss franc took over the leadership of the pack, followed in May by sterling.
The rationale in the case of the SF lay in the perception that the Swiss National Bank’s governor Lusser really was determined to reverse the weak franc policy of his predecessors and raise Swiss interest rates to whatever level might be necessary to support the currency –despite the resentment against high mortgage rates and the price in terms of raised cost of living. Then, come Iraq’s invasion of Kuwait, the SF, being already seen as the strongest of the hard currencies, got an added shine as a ‘haven’ currency for funk money from Arabia. The resultant rise in the Swiss unit drove the DM down to quite near 80c by September.
The rationale for the pound’s surge from May onward was of course the idea of sterling joining the ERM* , the exchange rate mechanism of the EMS* – plus the perception, clearly endorsed by Margaret Thatcher herself, that if the pound did enter the ERM it should do so at a higher level, rather than a lower one.
In both cases, there was no shortage of detractors who ridiculed both the rise in the currencies and the rationales for them. In instances of this sort, it usually pays to let price action be our guide. We have to distinguish two sorts of players – the crowd and the heavy money. When price moves with
the crowd, we can sit out the hand and look to go contrary. But when the media and the crowd sing one song and the price moves another way – the consensus which is not confirmed by price – it makes sense to follow price.
However, you had to see these rationales early on – before the crowd saw them. If you don’t see the rationale early ,don’t play. Just don’t play – like Jim Rogers.
The rationale followed classic lines in the case of the Yen, which had attracted heavy speculative sales against the D-Mark and other currencies. In the course of 1989, the DM had risen from around Y73 to peak at Y95. In the process, sentiment against the Yen had gone about as far as it could go – to the point of ‘revulsion*’ , as CB called it. The stage was thus set for a major comeback in the currency. The clincher was a further rise in Japanese interest yields during the summer, reducing the differential with American yields to zero by August.
What we are always looking for is the “set-up conditions” for major currency moves. And in August, we finally had all the set-up conditions for a major “catch-up” in the Yen. Sentiment had passed from revulsion to uncertainty; and at this point, the least show of strength was liable to challenge the perception of the trend, and change it at a stroke from down to up. Moreover the Yen was acting remarkably well in the face of a soaring oil price. With the shift to a zero-yield differential with the dollar, all the pieces fitted.
DOLLAR FN YEN 1989 TO 1990 (Source: DalastreainJ
Such moments call for commitment. There are no certainties in financial markets: but there is conviction. More exactly, there is a scale of confidence, with conviction at one end and something more like hope or wishful
thinking at the other. When we have conviction – when all the pieces seem to fit –then we have to go for it. We have to commit ourselves, for this act of commitment is as much an essential ingredient of success in trading as risk-control. What we say when we commit ourselves is: “this position can lose, like any position. We must have a contingency plan for getting out economically. But it’s an exceptionally good position and it’s not going to lose.” And when all the pieces fit, we should bet our final stake straight off, in my view .That way we bet most when the odds are best, i.e. when the risk is lowest.
You may find that difficult to swallow – and it’s not a course of action that is recommended by most pundits, though it was in the end the one recommended by Jesse Livermore. Most futures traders recommend
