Forex Follies

FX Market Outlook

It was the best of times, it was the worst of times to be a euro bull this week. It simply depended on which time of the day you traded. As I noted in Friday's commentary,”As we approach the holidays the currency market has taken on all the characteristics of Florida weather - just wait a minute and it changes."After rising by a staggering 10% in 2 days the EUR/USD fell just as quickly stopping out both longs and shorts in its wake.

The spike in volatility this week have been nothing short of breathtaking with the hunger for yield creating one of the most ferocious speculative moves ever recorded in the history of the currency market. Yet when the dust settled the winner was far from clear. Although the euro was up on the week, its strength was driven strictly by ECB's reluctance to join everyone else in a race to ZIRP.

On the economic front the situation in the EZ was anything but positive as IFO survey hit an all time low suggesting that manufactures in the region are in world of pain. With one out of seven jobs in Germany dependent on the car industry it is impossible to imagine that German unemployment will not rise materially in 2009 which will inevitably force the ECB to relent and ease. The car industry is in such a mess that even storied Toyota will report its first loss ever in the company's 70 year history.

The hard truth therefore, is that there is no place to run. The dollar is yielding zero and the EZ is a cauldron of nationalistic tensions ready to ignite at the first hint of rising unemployment. Perhaps this week's insane volatility was just a function of holiday illiquidity, but somehow we don't think so. The wild moves suggest extreme uncertainty and concern about the future and we believe there will be more turbulence in 2009.

For the time being however, the holidays are almost upon us and hopefully the markets will calm down to give everyone much needed rest. We will not be publishing next week as the FX market tends to slow down materially during the Christmas to New Years week. Perhaps the best thing that can be said about 2008 is that we survived it.

K and I wish you and your families the very best of health, love and wealth in 2009 as together we try to navigate the always challenging currents markets next year. Happy Holidays!

Evidence Based Trading

In this past Friday's day trading session in our chat room many subscribers asked me to explain in detail my approach to short term trading. So I could think of nothing better for an end of the year column then sharing with you my evidence based approach to the markets. Before I begin let me preface by saying that I am the first to admit that this trading technique is far from bulletproof. Markets at their core are simply pools of sentiment and can therefore be wildly irrational and unpredictable. Nevertheless, over the long run trading is a game of probabilities and I try to put the odds in my favor every time I trade. As Daymon Runyan once said, "The race is not always to the swift, nor the battle to the strong, but that's the way to bet."

My philosophy of trading is relatively simple.

1. Have a bias
2. Let price confirm your bias
3. Manage the risk

For me, my evidence based approach starts with Kathy's Economic Calendar. Every week she combs through all the upcoming economic data isolating the most probable economic surprises using a host of proprietary analytic techniques to beat Wall Street at its own game. Over the course of the year she has been accurate approximately 65% of the time - an edge that I will take any time.

More importantly Kathy's calendar calls provide me with an intelligent, logical, well researched foundation for my fundamental view. Often currency markets will start moving in the direction of her call hours in advance of the economic event, bringing me to my second point. The fundamental bias is worthless if price action does not confirm the thesis. In trading your opinion does not matter. The only opinion that counts is the opinion of the majority of market participants. Ultimately our job as traders is to figure out the opinion of the majority and join the move before it runs out of steam.

There are a hundred different ways to generate a signal for technical entry using my approach, but my most favorite one is simply to let the price fall (if my bias is short) or rise (if my bias is long) through the 20 period simple moving average on the 5 minute chart. The key point for me is that I never sell on a green candle and I never buy in a red candle. Guessing tops or bottoms is a mugs game and I need evidence of strength or weakness before I put on a trade.

Of course price can lie. Sometimes breakdowns are instantly reversed and break outs fade faster than Vanilla Ice's career. That's when risk control becomes paramount. Again there are a hundred variations on proper stop and take profit placements but I prefer two basic approaches.

Approach One - trade with 2 units. Make the take profit target on half the position 1 times risk (usually 20-30 points). Once T1 is hit trail the rest by 10-15 points back.

This is generally the better risk control model because it allows you to capitalize on occasional large break out moves. Alas I have no patience and frequently opt for approach two.

Approach Two - trade with 1 unit and make your Take Profit target 75% of your risk stop (15 points TP on a 20 point stop) This is negative risk reward ratio, but it works if you have a high probability set up with 70% accuracy rate or better. When I adhere to my evidence based rules I often achieve better than 70% rate of success. When I deviate - I pay the price.

Trading is one of the few human enterprises where you can do everything right and still fail. That's why evidence based trading does not always work. But as Churchill once said about democracy -it is the worst type of government except for all others. Evidence based trading forces you to be aware of and utilize every aspect of the currency market - fundamentals, technicals and money management and I hope it provides you with the same edge that it has given me.

Boris Schlossberg
BKTraderFX