FX Market Outlook
* Dollar: Suddenly Supreme
* Euro: Hawk No More
* Yen: 110???
* Pound: Just A Matter of Time
* Commdollars: Complete Collapse of CRB
Top 5 Stories in FX This Week
* A Tale of Two Monetary Policies
* The Knife's-Edge Economy
* Has the Dollar Fallen Far Enough?
* Spotlight on Euro
* Baby Boomers We Have A Problem
FX Market Outlook
Last week we went on Squawk and said that if 1.5500 gives way 1.5200 could soon follow. Frankly, however, even we were surprised by the ferocity and the magnitude of the decline. Once again currencies demonstrated that speculative markets will always move far more that you expect once the cascade of stops kicks in.
The rally in the dollar was of course not due to any improvement in US economic prospects but rather the result of bursting of the euro bubble. After Trichet's press conference on Thursday not only did the markets stop thinking about any additional rate hikes, but they started to price in rate cuts by early 2009 as all evidence pointed to the start of a recession in the 15 member union.
The key question next week - will 1.50 hold? There is little on the economic calendar to suggest direction either way as both US and EZ data is likely to disappoint. At this point trading is all a matter of flow. If 1.5000 does not find bargain hunters the fall in the EURUSD could continue all the way to 1.4800. Still, with the pair having fallen so far so fast, and with US data unlikely to offer any upside surprises, a short covering rally could be due, so sell at your own risk.
Cable followed euro to the downside albeit at a slower pace as 1.9500 gave way all the way down to 1.9200 and traders became convinced that it is only a matter of time before BoE caves and starts to cut rates. Last week the BoE left rates unchanged, but this week the labor data may hold the key to future policy decisions. If traders see another month of poor unemployment numbers, the pressure on Mr. King and company to cut will become immense.
USDJPY meantime came within a whisker of the 110 handle and really appears to be grossly overbought at this level. The dollar rally has been predicated on the assumption of US rate hikes by early 2009, but we are highly skeptical of Fed doing any tightening for all of next year. As matter of fact US monetary policy is very likely to follow the Japanese model as the economy sinks deeper into deflation and authorities continue to socialize losses on financial assets. When markets finally realize that no rate hike is coming USDJPY rally will stop dead in its tracks.
Finally the collapse of the CRB index has really hurt the commdollars and instead of parity the Aussie now trades below 90 cents. A bet on comm dollars is a bet on global growth and global growth is clearly slowing. The Chinese market is already discounting the post Olympic hangover and if the equity investors are right the commdollar may have more pain to go but kiwi may see a dead cat bounce if retail sales print better than forecast.
Trading Thoughts-Running Money
K and I often receive offers to manage money and so far we've refused everyone of them because we are simply too busy with research and our advisory services to devote the proper energy to the task. However the idea of running money has made me think about the criteria I would use to evaluate a money manager. Following are simply my thoughts and are by no means the final word on the subject, but I thought they may be useful points of reference for everyone to consider.
1. Be Sceptical
I never believe triple digit returns. Even if the trader can show me an audited trail of his results (and most never can), I know that 100%+ gains can only be achieved in two ways - through massive leverage or unbelievable luck. In either case, disaster is just around the corner. Leverage will turn on you like a rabid dog and luck will always run out. Have I seen traders take $100 to $10,000? $10,000 to $1,000,000? Yes and yes. But inevitably I've seen those same accounts give the money back as $10,000 suddenly shriveled to $2,000 and $1,000,000 dropped to $100,000.
The problem with investing with a hot hand is that you never jump on board during the initial $10,000 to $1,000,000 run because the trader has no “record”. Once the trader has a “record” and you climb fro the ride the losses inevitably start. In fact the longer I am in finance the more I believe that allocating your capital based upon the best return “record” is a near guarantee of losing money.
2. Acceptable Drawdown
Paul Tudor Jones, one the greatest traders of all time, has a very simple and I believe very effective formula for properly analyzing trading success. No sharp ratio, no risk-adjusted returns, no complicated math at all. Instead the Tudor Jones rule is quite straight forward. Your drawdown should not be greater than 1/3rd of your gains. That means that for every $1 run up in profits you should not give back more than 33 cents to the market. That is a very difficult task to achieve. Even, if the trader only gives back 50 cents of every dollar won consider him a good prospect for your money.
3. Evaluate By Months, Not Trades
Consistency is the last refuge of the unimaginative according to Oscar Wilde, but when it comes to financial returns it is the true measure of success, because money compounds and grows much faster in the long run with small but predictable returns rather than with huge hits or misses. At the same time worrying about every trade is a sure path to an early grave. Most professionals evaluate trading records on a monthly basis which seems to be a period long enough to smooth out the day to day bumps but short enough to warn the investor of any possible problems. Steve Cohen and Paul Tudor Jones have only had two or three losing months out of more than 200 and in the losing months they never gave back more than 2% of the equity. That's the gold standard to beat.
4. The 1% Solution
What's a reasonable rate of return? 1% per month. Achieve that and you are making 12% a year - almost double the long term average of the equity markets. Make 2% per month and you are on the way to hedge fund immortality as less than 1% of all investors worldwide produce such returns on a consistent basis. These expectations may seem remarkably modest but they are realistic. You make millions one slow dollar at a time.
Let me know if you have any other thoughts on the subject and I will be happy to publish them in future columns.
Boris Schlossberg
BKTraderFX
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