Friday, 1 October 2010

$EURUSD loss this month.

Its always cathartic to analyse a trading loss, and hopefully consign it to the box of expensive lessons rather than repeating it. With this being a rookie mistake and knowing what he did wrong before the event its not going to add much to knowledge box, but certainley requires some public self flagellation because he has clearly forgotten some basics.

The Raven shorted $EURUSD quite agressively on the 21st Sep, then got stopped out pretty quickly, then bought some downside puts, lost that premium and repeated it again. All in a loss of 10% of trading capital, even for a high return and volatility account definitely needs some serious thought.

The first short was at 1.3128 stopped out at 1.3160 on the same day, 21st Sep.

The put buys were on the 23rd Sep when spot was ~ 1.3333, where the Raven bought a lot of 1 week 1.32 puts, and the second lot 28th Sep spot ~ 1.3450 buying the 1.33 put, and on the 30th Sep spot ~ 1.36.

The first thing to do is rather similar to what one would imagine an AA meeting is like, admit your errors and sins, owned up to the actual errorS. Now time to understand the flaws personally.

There are several rods with which to beat his own back;
1) The cardinal sin; The first trade was very wrong on one level and right on another. Trading before the market has started moving in your direction is a mugs game, really that is unforgiveable, bad discipline and senseless. The small redeaming feature is that a moment of rationality dawned and the trade was cut because of sensible risk management.
2) The compounding error; Looking at the actual bond auction data and what was being reported was obviously too good a bait for the Raven's ego and it enticed him to make a classic error. He believed that the market was reacting to headlines, when he knew the headlines were wrong, which is the incorrect assumption to make. Similarly if you know an idiot is buying a stock and its going up, it doesn't mean that the stock should go down, however its very tempting to use this data point to falsely bolster one's confidence in the trade idea.
3) repeat step 1. correct to buy options to limit risk, bloody stupid to ignore your own first principles and trade against the market.
4) repeat step 2. further headlines, except now one has to be honest and admit that a degree of loss aversion and ego were kicking in, as well as a sense of frustration for making the error of step 1.

Its only now after getting a bloody nose and having portfolio level hard risk limits kick in that its really possible to step back properly and analyse the mistakes made. Additionally one can analyse the initial premise for the trade with less baggage.

Its not automatic that we should repeat the $EURUSD meltdown at the beggining of the year if we see a further melt up in European sovereign spreads. Perhaps we could see what we saw with the dollar in late 2008, a squeeze in the currency due to large losses being taken in that currency? similar to the squeeze in the Yen that Hugh Hendry thinks may happen.
On a similar thought to the Yen, HH points out that politicians and central banks need the political capital to act. Although he was talking about a different central bank and set of politicians one could apply the same logic to the EUR. Trichet is not going to trash the currency unless there is some real economic hardship, reaching as far as Germany, and for that to happen we'd have to actually see the $EURUSD a lot higher to slaughter their exports. Trichet is very arrogant (the irony isn't lost in this comment), so the pain level will have to be enormous.

The other side that really has to be mentioned is the sell dollar buy anything for the end of year trade, (which fits really well with long term trend following alpha patterns, ie. its about this time in 2004 they swung around after being down a similar amount).
Anyway just a thought, which is rather pleasant to have without the burden of the idiotic mistakes of September. At least trading stocks has been profitable.

1. I will not trade against the trend
2. I will not trade against the trend
3. I will not trade against the trend..........

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