Struggles of a real time experiment: Reflecting on a losing trade

Yesterday, I was short AUDUSD ahead of the Lowe’s speech. Yet did I expect that the Fed’s non-meeting FOMC created large shift in positioning in TYU7 and therefore the real rates TIPS or inflation expectation expressed from the YTM curve. Along with those who are shorting US bonds given “relatively soon” QT and higher YTM expectations, a shock came when inflation expectations was revised downwards (Yes, if you are ahead of the curve, last 4 months inflation was below expectations, despite Fed’s own part of thinking that Philip’s Curve rule will stand true and strong, going ahead of the curve to hike. While large “block trades” on TYU7 are signs of reversal, not correction, will it persist? It well may i.e. USD may continue falling pass it’s weekly 200ema, given current positioning is light i.e. positioning differentiates if a view is conventional or unthought of. But will this pan out, given that expectations of USD weakness due to weak inflation has been agreed by the Fed when the market has all along not been believing that inflation is picking up? Sadly, a profitable trade turned sour and bad. A lesson to be learnt.

Yes, Yellen is like Cercei Lannister who secretly bombed all her rivals with wildfire. DFvk_hhUMAEGG9y2017-07-30 15_07_33-Clipboard.png

I admit my mistake above and I’m reflecting here. I short AUDUSD at 0.7930 and I close my position at 0.8050. Now as I write, it has fell back to 0.7960. Eh???? FYI, DXY fell to its lowest at 200ema weekly, at a very strong support “yet to be tested” since end Nov 2015. So will trade weighted US dollar bounce off support? Or will DXY persist its downtrend as it did in from start of the year 2002? Or worst still, if the market doesn’t have a consensus expectations of DXY, will someone challenge to test the level to call out defenders?

My thoughts: I believe there should be some defenders at current near prices, given we are hiking unlike Jan 2002 when FFTR was cut from 175bp to 100bp. Given that the Fed accepts the fact that low inflation is here to stay and that the market has priced them now, it would be easier to beat expectations in months to come, and that’s bullish for DXY. However, that said, things could be worse if inflation did not improve given being shorfall of expectations the last 4 times. Market followed reality accordingly and long TIPs each time. What’s more, QT is coming.

What’s the positioning now? 

DXY shorts are picking up fast, AUD is at its position high. Was I wrong in shorting AUDUSD? No for AUD, Yes for USD as my base currency. I should have chosen another base currency such as CAD where both are related to commodities influence on its price i.e. oil, steel. Furthermore, a carry against lower yield base such as CHF, JPY makes better choices given their unchanging OIS curve.

DXY speculative positiondxy position.pngAUD net speculative positionaud investing net speculative position.pngsaxo audusd position cot.pngCAD net speculative positioncad investing net speculative position

Yes, CAD has been net short since 2013 reflecting the persistant uptrend in USDCAD. Despite a sharp devaluation in USD against CAD, it merely closed its shorts and flip to a small net long. Shorting AUDCAD bodes well if AUD positioning scales down to neutral as Lowe talks down AUD later and CAD net long increases on US political division. Of course, besides policy rate as transmission to all dependent rates, rates on housing in particular has been rising ahead of policy rate. This relaxes the pressure on Lowe to affect all transmission with the help of a targeted rate, advantages of a small, manageable economy.

Yes, there is a tendency for human minds to catch a falling knife by knee-jerk reaction out of protecting your foot. Should we catch the falling knife or move aside? Hm… best answer? Catch it only when you can reach it, otherwise, wait for it. Be patient for the right price. Price is that one step closest that matters all the world to your bottom line.

This relates to: why is discipline all important for anyone trading? Get a right price to reduce drawdown, a good price means small drawdowns, and most importantly, stay in the game. If its nowhere near any support or resistance, i.e. parallel only or with drift S-R, should we hit one side on the order ticket and be exposed immediately or wait? That depends on the speed of the trade flow, you need a second nature pulse for such flows. If you don’t have such ability, its better to wait and follow for the market to tell you so.

However, identify the environment first before playing your tactics. Are we in a risk on or risk off environment? Is the market trending (sticking to the momentum, not their ideas) or ranging (waiting to confirm their vision, carry earning term premium from rolling forwards)? The market won’t be confused. A common misconception here is the difference between “Tactics” and “Strategy”. [Comment below if you have a better way of phrasing them]strategic-tactical.jpg

  • Strategically, QT would cause the yield curve to reflect a bear steeperner, but tactically, reality is showing deflation is here to stay and the Fed’s target is way off, so the market leverages on the present to test boundaries until the Fed faces reality.
  • Every strategist expects their expected endgame to materialise in reality, but without tactics, the strategist will not live through to see the endgame. The strategist has to be flexible to update its plan to accommodate short term needs such as other players reactions.
  • Every strategist always see a turning point somewhere in the near future, but to survive, he needs to find comfort going against his vision and follow the herd so that he lives to see his vision.
  • Strategically, the market is overvalued, but tactically, the positioning says otherwise.
  • Strategically, there is ample of opportunities in new markets, but tactically, we don’t have enough talent to capture those opportunities.
  • Strategically, we seek to unravel the cause and relationships, but tactically, we trade technically.
  • Strategist loves to think of “what-if” scenarios that may or may not happen, but a tactful person simply wants to improve the present.
  • To sum up, doing the right things will not thrive if you’re not doing things right!strategy vs tactics.png

A side digression here, is related to my frequent reliance on Twitter for market news. I realise that there are many doomsayers and permabears who stick to their views for a period feeling like centuries. Its a sticky expectations that don’t know the limits of when they are wrong. Ask yourself a checklist each time you believe something they push forward: Are they jumping into some conclusions based on some unfounded assumptions? What are their thought process and the flow of their arguments leading to their conclusions? Is it sound?

Aristotle once said, “It is the mark of an educated mind to be able to entertain a thought without accepting it.” So next time someone pushes an idea to you, WAIT AND THINK! 

wait and think.gifwait and think 2

If we already have a position expressing a tactical (near term, present) view and someone proposes an against argument, how should we know whether to stick to our tactical view? On one hand, it takes time for the position to turn profitable, but on the other hand, there’s no virtue in sticking to a plan merely because it’s “the plan”. So here is a five-step plan to figure out when to pivot and when to stand your ground and hold your positions tight.

  1. Start with concrete specifics you can track. An old saying points out that, “The difference between a goal and a dream is a date.” Specific, finite and measurable goals you can easily track make your progress easy to see, so don’t hesitate to “drill down” when you need to. Big concepts are great, but they work better when they’re reduced to solid numbers. You can’t track a concept, but you can track pluses and minuses. For example, you should know your stop loss before entering into a position so you know beforehand the amount you have allocated to loss.
  2. Keep existing assumptions in mind, but keep them up to date. For example, you are long pound in expectations that the MPC will hike interest rates in the coming meeting, and that expectations is build on assumptions that MPC is 1) data driven and 2) hiking to prevent a weak domestic currency from exporting hyper-inflationary pressures abroad that diminishes their purchasing power relative to their sticky income 3) and you are expecting inflationary pressure to pick up down the road, so MPC will hike. So as time pass, keep updated to these 1,2,3 assumptions and be the first to know if any are violated.
  3. Track and review your progress and your results. Set a regular review schedule and keep to it. Work with plan-versus-actual-reviews. A review meeting should start with a review of assumptions, move to the plan versus the actual numbers, then examine: the results of recent events, the milestones met and the milestones coming up. The more measurable the specifics, the more visible the good or bad performance will be. Of course, plans are often wrong and things are not as expected, so the key decision for most meetings will be to what extent to revise and correct the plan. Those decisions have a lot to do with what makes a business successful.
  4. Identify any changes in assumptions. When assumptions have changed, there is no virtue whatsoever in sticking to the plan you built on top of them. Use your common sense. Were you wrong about the whole thing, or just about the timing? Has something else happened, like market problems or disruptive technology or competition, to change your assumptions?
  5. Evaluate execution. At this point, you know what’s been working and what hasn’t; and you have a good guess about how your original assumptions have changed. Use your judgment to look at the most important differences between the plan and the actual results, to highlight the execution. Did things not work because the assumptions were wrong, or because the plan wasn’t executed? Did sales fall behind because of poor tactics or unexpected turn of events?

So. . . stick to the plan, or change It? Do not revise your plan glibly. Remember that some of the best strategies take longer to implement. Remember also that you’re living with the plan every day; it is naturally going to seem old to you, even boring, long before the target audience gets it. There are no best practices or easy formulas to apply. You make these decisions based on the specifics. But do it well, and your performance will see improvement.

While fundamental, macroeconomic theories are the basis backing huge leverage bets, market are far from perfect. Technicalities such as ‘relative’ positioning, expectations on short end, expectations on long end, varying correlation between short vs. long rate depending on which part of the curve the currency is pegging to i.e. policy or expectations, depends on the many nuances like the reality of life. Trading is as much an art as science. Reconciling theories with realities is the best a trader can be. reality vs dream.gifTheories dictates the asset classes you wish to be exposed or avoid i.e. asset allocation. However, in trading, price is of utmost priority before fundamentals. The best entries and exits levels are higher highs, higher lows, resistance turned support, vice versa, and its an art of picking off the charts which are tested most. When “a buy on dip mantra” is so ingrained into traders, whether they hold bullish or bearish views, it doesn’t pay to fight the trend. If it doesn’t break, its not the end which many doomsayers out there likes to argue it is near. The endgame, which means a reversal of trend, takes a long time to pan out, it could just be a start of a bubble when doomsayers blow the whistle that a bubble is about to burst. A bubble doesn’t burst just because many people says the bubble is bursting. If that’s been the case, all whistle blowers would be rich now! So does this mean you should always be contrarian to crowd views? It really depends on whether all the participants in the game believe in that thought, or are sticking to an alternative view of reality. When it comes to actual trading, I doubt there’s any time to refer to charts. So stick to the key levels which you should prepare the day before.

If you simply refuse to use TA and solely use fundamental analysis, a conditional statement such as a wait-and-see stance like “until debt ceiling issue have been settled or GOP healthcare have been passed..” or a trigger like “unless inflation expectations in US rise…” provide some reference dates and perspectives on the time horizon of the position you are holding. So, in summary, you need to know when your “theory” are out of the sync with “reality”, in dimensions of time or price, or both. Having both, an expectations of volatility and price range within the holding horizon is recommended.

A summary of rules I need to follow:

  • Know your tactics and your strategy
  • Know your key levels before the day – look further into history when levels are near being broken
  • Know your environment i.e. would you want to fade into or follow through at key levels? Look at positioning ( Saxo COT report, spec pos) and other measurable specific that allows you to identify your current environment i.e. base scenario based on seasonality, historical outcomes of similar events, or is it a totally new environment with no similar history? If so, what are the new dependents in this new environment that every big players in the market is following closely?
  • Create a system with measurable specifics, follow it. Use limit orders to establish stop loss levels or partial profit targets, if you are away studying or sleeping. Here, Fibonacci expansions and projections confluence can help if price is in no man’s land. Other references as you like and trust.
  • For fundamentals, as much as I like seeking supporting views, there is no harm seeking out opposing views too. Your assumptions become clearer as you questions theirs. So why not?
  • Use the 5 step plan to know whether to stick to your positions or pivot
  • Either study or trade. No multi tasking.

Yes, winter is coming… Fiscal policies have started taking place (updated: failed miserably w/o supports), Fed has wise up to reality, the road back to political stability could well be happening (you know what I mean). Large changes in allocation might be coming. Note the block trades. Its time for high alert. Image result for trump game of thrones

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