Monday, 15 December 2008

A lesson in trading discipline

The latest missive for paddypowertrader:

In my first blog I wrote that one key indicator of risk appetite would be a reversal of fortune for the yen. That’s exactly what’s happened last Wednesday. Take a look at the Euroyen cross – it jumped out of a key downward trendline. Short Euroyen is a deflationary trade – it’s a sign that risk appetite is on the decline and that Japanese investors are selling their assets held overseas and bringing their cash home; it’s also a sign that the carry trade is breaking down. A reversal is very significant, especially when combined with the other bullish indicators as the indices push up above their 50-day moving averages. So I bought some EUR/JPY at 11942 and by Thursday evening it was comfortably trading above 12200. Nice trade. So I thought to myself that I’d need to watch it carefully but if it holds above the 12000 level that’s a further sign that we could have seen a bottom in equities, for now.

So I went to bed on Thursday night smugly looking at a growing three figure profit on the euroyen cross, thinking about all the nice Christmas presents I could buy with the proceeds, which in turn would keep the high street humming and my retail longs winning. But then the Senate voted down the auto bailout and EUR/JPY plummeted an hour to two to 200 points below where I went in, taking out the position. I’d put a stop at 11972 above where I went in so I made just £30 on that trade. And because my position size was so small (just £1/pt) I couldn’t do what Mr FT usually does on the currencies and take some profits when the trade was firmly in the black, just leaving a small long running. It was all or nothing. In my case, I got next to nothing.

Now here’s the really daft part. I was almost speechless when I found my P/L figure so unexpectedly reduced on Friday morning, even though most of the loss was down to the loss of that single EUR/JPY trade. So at 8am set about selling off half of my winning equity trades, in a panic about potentially losing even more profit. My retailers and other equities had fallen back a bit, but a lot of them were well off my stops, and as the news filtered through that some sort of TARP-inspired rescue would transpire, the markets recovered sharply during the day. So I compounded my panic by cutting back the risk, even going short on FTSE and the Dow momentarily before the indices bounced back.

All this is a tricky call. It’s easy to add risk – building up positions - when the market is moving in the direction you’d like, and the profits just appear to multiply. But the more risk you take on, the more pain and shock you feel when the inevitable reversal happens. But that’s exactly what stops are for and the trick is to be disciplined – if you’ve built up a position over time you can trail some stops near high points but leave others with wide margins so that the whole trade isn’t chucked out by the volatility. It’s also a lesson in the risks involved in leaving trades running overnight – and a warning about being too smug about having called a move correctly.

And having been stung I didn’t have the guts to buy back in to the EUR/JPY – look how quickly it bounced back! A sign that there’s still some desire out there to buy equities, I think. I might have another go at it later in the week.

Trading Update

This week I’m still running that long gold position from $777, and I’ve added to it a bit with additional longs from $789 and $803, all protected with stops; I’ve moved the stop on the main gold trade to $790. As far as I can tell, it’s dollar weakness that is pushing up gold, together with a bit of a revival in other precious and industrial metal prices on the back of that theme about infrastructure and automobile production. I still have a basket of equities that I’m long of, although my long positions in Barclays and Man Group hit their stops (above the entry point) in Friday’s volatility and I’m disinclined to buy back in. I’m also looking to see if the long EUR/GBP trade is going to get squeezed, particularly if the various bits of eurozone data due out are weak (I expect they will be). So I’ve set a small sell order in EUR/GBP below the current trading range at 8930, with a tight-ish stop just 40 points away at 8970. And I’ve got a long FTSE position from 4266 and a long Dow position from 8430, both with stops set just above their entry point.