GBPUSD: A Drunken Sailor

The cable, as the GBPUSD is called, looks like drunken sailor.

The chart is all over the map, with massive daily swings lined up one after the other all over the place.

There are some pips to be made in there!

I'm not generally trading the GBPUSD, but I'm going to put a few moments into figuring out whether my AUDJPY chart set up seems applicable.

It's hard to resist all that volatility.

Seeing Beyond The Bailout

Now that the US bailout package has been passed the question on everyone's mind is what happens next?

Nobody knows. Conversely, everyone knows!

Once the question of government action has been answered we know that the currency markets will move either up or down. Basically, the only time they are in near stasis is when speculators and investors need the next piece of information in order to properly develop their expectations.

Okay, I know, you'd like some ideas to consider so that you can gather ammunition and make up your own mind.

My take is that the GBPJPY and AUDJPY are setting up for a possible double bottom on their 1d charts. The bailout package represents a reason for currency traders to accept a bit more risk. As I'm sure you know carry trade positions are liquidated during periods of risk aversion. Somebody, somewhere, is going to look at the exchange rates and decide that there are some deals.

I'm unsure which currency is more appealing. Both the UK and Australia appear to be in the process of relaxing fears with respect to inflation. When they drop interest rates their currencies won't react by appreciating in price.

However, the GBPJPY is extremely low in historic terms. Perhaps there is some inertia or general distrust of the cable that needs to be worked out, but you have to wonder how much further it can fall. Isn't somebody out there going to start considering goods and services from the UK competitively priced?

With respect to the AUDJPY, I can't imagine that Australia won't be able to sell commodities into Asia. Sure, currency prices may be falling, but the fall in the Australian dollar will leave exporters in a profitable position regardless. With this being the case -- how can Australia consider inflationary pressures to be abating?

Of course, I should note, speculation on macroeconomic fundamentals such as above is not a short term play.

So, what's my strategy?

I plan to accumulate carry trades during upswings. Sure, what upswings you might be wondering. If there aren't any, then I'll continue to wait. However, I expect to see them soon. Once these trades are profitable I'll place in-profit stop losses on them and open up new positions at opportune moments.

Looking at the long term as I am I see thousands of pips on the table. If I can accumulate more and more positions, under the protection of profitable stop losses, I could end up riding some serious profit. Of course, the hard part is not letting all my trades be shaken off when the market is bucking.

Daily Market Action

Every morning, upon waking, I open up my Forex trading platform and look for any major changes in the world of finance.

This morning, for example, I see that carry trades have had a bounce overnight.

So what, right?

Well, wait a minute here. Bounces represent opportunity. If you look at the 1hr GBPJPY or AUDJPY you'll notice some serious signals. Sure, the CCI, Williams %R and stochastics all moved north in the late evening, but just as importantly the price of these pairs started to show a bottom.

This would have been an excellent place to think about sticking your toe in. I use that phrase to make clear that there is every risk the market will continue to collapse after a false lull. However, those that don't freak out when the talking heads on the tube are mooing up a storm, have the opportunity to pull in some cash.

However, there is a bigger issue that I want to make you aware of. It is very common that the US and Asia will go in one direction while Europe goes in another. It's a natural turnaround point.

Just as Europe may wake up and find a sea change in the markets, so too can we. The end of the day, after Asia has had time to react, before the European markets open, if often a good time to act.

So, to be clear, if you live in Australia or Asia, the close of your markets represents a potential turning point. If you live in the US, you need to stay up until around midnight or so EST to see if the Forex markets will send you some smoke signals about a possible retracement.

Carry Trade Panic Selling?

Did anyone notice the panic selling out there?

All kinds of carry trades unwound several hundred points in a very short period of time. Speculation in the Forex news rags suggests that losses due to the falling stock exchanges forced people to unwind their carry trades to cover their margins.

In any case, after days of regimented downward movement, the sudden fallout represented a panic moment -- for someone. In the short term, at the very least, this should represent opportunity. I've stuck my toe in.

I certainly don't know if it represents a bottom, but if everyone that wanted out got out, then it won't have much pressure to fall further.

Personally, I'm looking at the Yen based carry trades. Things like the EURJPY, GBPJPY, and the AUDJPY. While the US may eventually recover and raise interest rates, I don't see the Japanese being able to raise interest rates while their currency is appreciating.

How in the world would they compete internationally, exporting products, if they drove their prices up now when everyone else looks to be faltering already?

Have I mentioned lately how important it is to have money on the sidelines so that you can take a poke at raging opportunities? Whether or not you are a fan of his, Jim Cramer also is a proponent of not being fully invested -- which he states is a common joe public trader type of mistake.

Big opportunities offer big profits, but only if the opportunity didn't break you as it was developing.

Carry Trading Thoughts

Today's post is basically a bit of mental exercise concerning accumulating carry trades. If you are looking for serious advice, this post probably isn't it.

Anyway, for the two or three people that do follow along, you know that I like carry trading. For today's exercise, let's consider the GBPJPY. Looking at the five year chart on Google finance we can see an absolute range of approximately 7000 pips. The GBPJPY price went from somewhere near 180.00 all the way up to 250.00 at it's high.

That's a lot of pips!

Looking closer, we can see that from the highs last summer we have retraced almost 5000 pips.

Now, I know that there is a lot of turmoil in US, UK and world markets, but I don't forsee the GBP being wiped out any time soon. I'd like to accumulate GBP but I don't want to simply buy it on the way down as I have no idea how far down the currency might travel before finally deciding to fight back.

Let's think. How can I take advantage of another future uptrend without risking a lot of capital before it happens? How can I take serious advantage of such a future uptrend if I don't currently have much capital myself? Obviously, I need to find a way to minimize my risk and take advantage of a future trend with house money.

What if I execute some type of sneaky manual gridding strategy. I'm going to design this so that I never have much actual capital at risk while not have to sit on the sidelines if things go my way. Curious? So am I, as I haven't worked through the details yet myself.

Since I trade with Oanda let's consider some very low capital trading. We'll create limit orders above the current market value. These can only be tripped if the market moves up. Given the current bid price of about 198.20 let's consider the following order list...

- buy 10 at 198.30
- buy 10 at 198.35
- buy 10 at 198.40
- buy 10 at 198.45
- buy 10 at 198.50
- buy 10 at 198.55
- buy 10 at 198.60
- buy 10 at 198.65
- buy 10 at 198.70
- buy 10 at 198.75

There, that's ten trades. We'll have a total of 100 units of GBPJPY if the pair moves up to 198.75 at some point. I know this isn't very impressive. I also know that the price is likely to drop too -- it never moves in a straight line. So how do we handle these issues?

First, let's realize that you'd have to have a tiny account to worry about any size of price move while holding onto a mere 100 or 200 units of currency. So, having this level of capital at risk is not a problem. Hey, don't laugh, we aren't done yet!

To keep our risk limited, let's set a stop loss on our lowest priced trades. We'll set it 11 pips above our purchase price and leave only 100 units of currency at risk at any point in time. At 11 pips we'll grab a penny per stop loss tripped potentially see 9 positions left underwater. Keep in mind that over time we could leave multiple sets of 9 positions underwater whenever the price rises for a while prior to the GBPJPY hitting what will become a regional low.

Thinking out loud some more, if we leave 10 underwater sets above us on the way down we'll be sitting on approximately 1000 units. Let's say they average 5000 pips underwater -- which leaves a LOT of room for continued deterioration. We'd be looking at a capital drawdown of less than 500 dollars. At the same time, this is a carry pair, so we would be earning some offsetting interest during this period of being underwater.

Okay, so I am probably looking at a fairly safe idea. I don't expect another 5000 pips of descent, but it's also possible that I can leave more than 1000 units underwater if prices start to whipsaw. I'm comfortable. Now, am I interested? Let's take a look at the behavior on the way up.

Here's an aggregate accumulation of positions during an uptrend...

198.30 - 199.25 ... 200 units
199.30 - 200.25 ... 200 units
200.30 - 201.25 ... 200 units
201.30 - 202.25 ... 200 units
202.30 - 203.25 ... 200 units

Hmm, this doesn't seem to be a large enough accumulation to really sink my teeth into an uptrend. Can I fix it? Maybe. What if we execute trades with larger and larger sizes? Is this somewhat reminiscent of a Martingale strategy?

buy 10 at 198.30
buy 11 at 198.35
buy 12 at 198.40
buy 13 at 198.45
buy 14 at 198.50
buy 15 at 198.55
buy 16 at 198.60
buy 17 at 198.65
buy 18 at 198.70
buy 19 at 198.75
buy 20 at 198.80
buy 22 at 198.85
buy 24 at 198.90
buy 26 at 198.95
buy 28 at 199.00
buy 30 at 199.05
buy 33 at 199.10
buy 36 at 199.15
buy 39 at 199.20
buy 42 at 199.25

Well, this certainly grows a lot faster. We would have 435 units open after about 100 pips of movement. This is going to increase our risk quite a bit. There is always a tradeoff. You simply cannot increase rewards without increasing risks. While I'm not going to do a lengthy detailed analysis of varying rates of growing trade sizes, you can certainly see that our larger riskier trades happen at higher and higher prices. That doesn't feel right.

Another way to look at this is that the probability of making a losing trade increases as the price rises. Eventually the price of the currency pair will hit a regional top and any trades made near that point must be losers. Let's look for a strategy that doesn't require increasing risk with increasing prices. I still want to make a future GBPJPY recovery work for me!

What if I'm willing to add additional funds to my account? I generally have no problem putting about 10% of my net asset value into active carry trades. It would take a tremendous move to cause a margin call if you only use a small amount at any point in time. With a $450 capital infusion I'd be willing to use $45 of margin. Let's see a grid based on getting this money into the market.

- buy 125 at 198.30
- buy 125 at 198.40
- buy 125 at 198.50
- buy 125 at 198.60
- buy 125 at 198.70
- buy 125 at 198.80
- buy 125 at 198.90
- buy 125 at 199.00
- buy 125 at 199.10
- buy 125 at 199.20

Okay, we get 1250 pips out of a 100 point move. If the market doesn't go up then our grid will adjust and move downward. If the grid is activated but then the market immediately drops we have sunk our cash infusion into a reasonable carry trade. Assuming another cash infusion in the following month we can continue to lay out upward grids above the current price.

By putting in fresh capital, and expecting further fresh capital, we can get comfortable pushing our capital into positions at a relatively rapid pace. What happens if the market starts to follow an overall upward trend? Following along from where the grid above left off we get...

- buy 125 at 199.30; place stop loss at 198.40 for our trade at 198.30
- buy 125 at 199.40; place stop loss at 198.50 for our trade at 198.40
- buy 125 at 199.50; place stop loss at 198.60 for our trade at 198.50

Okay, our overall risk isn't increasing. Each time we open a new trade we protect the capital behind the trade which is currently most profitable. We are accumulating more and more open positions without increasing trade size.

However, there is every possibility that it may takes months of capital infusions and a fairly sizable carry trade position before the market turns around to any degree. What if it takes years before the GBPJPY makes any attempt at serious recovery?

Anyway, as I said at the beginning, this is just a mental exercise. I don't think that very many people trade with a carry accumulation mindset. I suspect that many traders are looking at the swings in price and trying to get in on them... as they are huge in magnitude compared to shaving some interest from the market over larger time periods.

I've had some luck trading price movements myself... but I like the lure of building up some type of income stream over time.

Forex Turmoil: Still On The Sidelines

During the last few weeks of topsy-turvy price movements I've been playing it safe. I like to buy carry trade pairs, but they've been heading down a lot.

Now, the big question, when will things start to turn around? A few of the pairs are getting into historically low valuations. For example, take a look at the GBPJPY pair on google finance -- click the 5yr option when it loads.

Sure, we could set new lows, perhaps for a months or years, but the odds of the UK having lower interests rates than Japan seems rather extreme. At some point, when things do finally settle down in another year or more, the GBPJPY will start to get attractive.

Other pairs, such as GBPUSD or EURUSD, which represent a bet against the US dollar make me nervous. While there is a possibility that some parts of the world, notably Australia, New Zealand and Asia, can avoid a recessionary period it's also very possible that the sinking US dollar will create a large enough trade advantage to shift the slowdown from the US to other countries as their own companies find it harder to compete internationally.

Anyway, I don't know how it will play out and from what I've learned buying a currency without having a clear notion of what you expect to happen is akin to gambling. Sure, you can be wrong when you believe something, but at least then you aren't throwing your money at the toss of the dice... and often it is possible to figure out what is going on to some degree.

So, for now, I'm keeping an eye on the JPY crosses. Perhaps the AUDJPY, EURJPY, GBPJPY and CADJPY will find themselves showing up in my account?