This is something that happens sometimes in trading and it’s a difficult thing to deal with; right now, I can’t see why or how currencies will move. The reason?  What exists now in the market is a serious lack of strong fundamental drivers, which tend to get market participants thinking in a herd mentality and price moving in a trend.

What I do see is that many of the familiar correlations are breaking down.  For example, when investors are buying higher-yielding assets (i.e. buying risk), what happens is that lower yielding currencies like the yen are borrowed and traded (sold) for higher yielding assets like the Australian dollar. This is what’s known as the carry trade and something that’s been a major factor in currency movement for years. The reverse is also true; when the market wants to get out of riskier positions, carry trades unwind and the yen tends to gain while higher-yielders fall.

The dollar became the funding currency du jour last March after Bernanke announced on television that the Fed was electronically printing dollars. The resultant flood of excessively cheap liquidity sparked an enormous rally in stocks (over 60% from then until the end of 2009) and a plunge in the dollar against basically everything as its interbank borrowing costs (LIBOR) fell below everything, including the yen.

Let’s look at a Bloomberg headline from today:

“Yen, Dollar Gain as China-Slowdown Concern Spurs Safety Demand”

Huh? The Nikkei and Topix were up 0.68% and 0.77% respectively, while the FTSE was gaining 0.22%. And while that may be nothing to write home about in terms of appreciation, it’s hardly what I would call a “risk-averse” move.   True, there’s a bit of panic over Greece, but that’s been in the news for days now. Why didn’t the euro fall yesterday or the day before that? How can you make a guess that the euro would fall on Friday when the news was basically three days old?

In any event, Bloomberg was also reporting that “corporate credit quality is improving at the fastest pace in almost three years, underpinning the surge in bond sales as economies rebound.” So the question is where’s the risk aversion?

If you’re really going to be a trader it’s important to come to the realization that there are going to be times when NOT trading is about the best trade you can make (meaning that the decision not to trade is a trade itself). I know that isn’t easy because we’re all here to make trades, but you really should be here to do is to make winning trades. For me, that means not trading when I come to the conclusion that I think I’m confused.

I personally can’t trade when I don’t feel extremely confidant in what I’m doing, and that usually happens when a strong fundamental driver is in play. Here’s an example:

I was desperately hoping that the recent NFP report was going to be good. It that had happened, investors would have been speculating like mad about the Fed raising interest rates sooner rather than later, which would of sparked a very nice rally in the dollar that may have lasted for weeks. What happened was that the report was somewhat mixed in that it showed a worse than expected loss for December while the November numbers were revised to a small gain (the first in 20 months). Speculation came off regarding a Fed rate increase, but for the most part currencies suffered the kind of back-and-forth movement that generally is deadly to most traders’ accounts throughout most of the week.

Truth be told, I really don’t feel like I have a handle on things right now and I’m not embarrassed to say so. What I really think is that I’m confused and when I that happens, I try to resist all temptation to push the button. Look at it this way:

Let’s say that trading is basically a coin flip or a 50-50 shot; your trade can only be a winner or a loser (leaving break-even out of the equation for a moment). Fifty percent of the time you’ll lose, and 50% of the time you’ll win. Let’s also say that in 50% of your winning trades, at some point you will be losing. What that means is that in 75% of the trades you get into, there’s a chance that at some point you’re going to be in a negative position.

So my question is, how can you get into a trade when there’s a 75% chance that you’re going to be losing money at some point unless you feel very confident in what you’re doing? I certainly can’t, because there’s nearly a 100% chance of two things happening.

  1. I’m going to decide to cut my losses much faster than usual
  2. I’m going to close the trade with only a small profit, which means that my reward to risk ratio was probably very low or maybe even negative (which means that I could be winning 60% to 70% of my trades and still be a loser)!

So, don’t be afraid to not have a trade. It’s sometimes the best decision you can make. Keep your powder dry until there’s a good strong fundamental driver present because they happen frequently enough and they can last for weeks or months.