Growing Forex Diary
Trading Trend Or Range?
Thursday, February 21, 2008 - - 2 Comments
Whether trading stocks, futures, options or FX, traders confront the single most important question: to trade trend or range? And they answer this question by assessing the price environment; doing so accurately greatly enhances a trader's chance of success. Trend or range are two distinct price properties requiring almost diametrically opposed mindsets and money-management techniques. Fortunately, the FX market is uniquely suited to accommodate both styles, providing trend and range traders with opportunities for profit. Since trend trading is far more popular, let's first examine how trend traders can benefit from FX.
Trend
What is trend? The simplest identifiers of trend direction are higher lows in an uptrend and lower highs in a downtrend. Some define trend as a deviation from a range as indicated by Bollinger Band "bands" (see Using Bollinger Band "Bands" to Trade Trend in FX). For others, a trend occurs when prices are contained by an upward or downward sloping 20-period simple moving average (SMA).
Regardless of how one defines it, the goal of trend trading is the same - join the move early and hold the position until the trend reverses. The basic mindset of trend trader is "I am right or I am out?" The implied bet all trend traders make is that price will continue in its present direction. If it doesn't there is little reason to hold onto the trade. Therefore, trend traders typically trade with tight stops and often make many probative forays into the market in order to make the right entry.
By nature, trend trading generates far more losing trades than winning trades and requires rigorous risk control. The usual rule of thumb is that trend traders should never risk more than 1.5-2.5% of their capital on any given trade. On a 10,000-unit (10K) account trading 100K standard lots, that means stops as small as 15-25 pips behind the entry price. Clearly, in order to practice such a method, a trader must have confidence that the market traded will be highly liquid.
Of course the FX market is the most liquid market in the world. With US$1.6 trillion of average daily turnover, the currency market dwarfs the stock and bond markets in size. Furthermore, the FX market trades 24 hours a day five days a week, eliminating much of the gap risk found in exchange-based markets. Certainly gaps sometimes happen in FX, but not nearly as frequently as they occur in stock or bond markets, so slippage is far less of a problem.
High Leverage - Large Profits
When trend traders are correct about the trade, the profits can be enormous. This dynamic is especially true in FX where high leverage greatly magnifies the gains. Typical leverage in FX is 100:1, meaning that a trader needs to put down only $1 of margin to control $100 of the currency. Compare that with the stock market where leverage is usually set at 2:1, or even the futures market where even the most liberal leverage does not exceed 20:1.
It's not unusual to see FX trend traders double their money in a short period if they catch a strong move. Suppose a trader starts out with $10,000 in his or her account, and uses a strict stop-loss rule of 20 pips. The trader may get stopped out five or six times, but if he or she is properly positioned for a large move - like the one in EUR/USD between Sept and Dec 2004 when the pair rose more than 12 cents, or 1,200 pips - that one-lot purchase could generate something like a $12,000 profit, doubling the trader's account in a matter of months.
Of course few traders have the discipline to take stop losses continuously. Most traders, dejected by a series of bad trades tend to become stubborn and fight the market, often placing no stops at all. This is when FX leverage can be most dangerous. The same process that quickly produces profits can also generate massive losses. The end result is that many undisciplined traders suffer a margin call and lose most of their speculative capital.
Trading trend with discipline can be extremely difficult. If the trader uses high leverage he or she leaves very little room to be wrong. Trading with very tight stops can often result in 10 or even 20 consecutive stop outs before the trader can find a trade with strong momentum and directionality.
For this reason many traders prefer to trade range-bound strategies. Please note that when I speak of ‘range-bound trading' I am not referring to the classic definition of the word 'range'. Trading in such a price environment involves isolating currencies that are trading in channels, and then selling at the top of the channel and buying at the bottom of the channel. This can be a very worthwhile strategy, but, in essence, it is still a trend-based idea - albeit one that anticipates an imminent countertrend. (What is a countertrend after all, except a trend going the other way?)
Range
True range traders don't care about direction. The underlying assumption of range trading is that no matter which way the currency travels, it will most likely return back to its point of origin. In fact, range traders bet on the possibility that prices will trade through the same levels many times, and the traders' goal is to harvest those oscillations for profit over and over again.
Clearly range trading requires a completely different money-management technique. Instead of looking for just the right entry, range traders prefer to be wrong at the outset so that they can build a trading position.
For example, imagine that EUR/USD is trading at 1.3000. A range trader may decide to short the pair at that price and every 50 pips higher, and then buy it back as it moves every 25 pips down. His or her assumption is that eventually the pair will return to that 1.3000 level again. If EUR/USD rises to 1.3500 and then turns back down hitting 1.3000, the range trader would harvest a handsome profit, especially if the currency moves back and forth in its climb to 1.3500 and its fall to 1.3000.
However, as we can see from this example a range-bound trader will need to have very deep pockets in order to implement this strategy. In this case employing large leverage can be devastating since positions can often go against the trader for many points in a row and, if he or she is not careful, trigger a margin call before the currency eventually turns around.
Solutions for Range Traders
Fortunately, the FX market provides a flexible solution for range trading. Most retail FX dealers offer mini lots of 10,000 units rather than 100K lots. In a 10K lot each individual pip is worth only $1 instead of $10, so the same hypothetical trader with a $10,000 account can have a stop-loss budget of 200 pips instead of only 20 pips. Even better, many dealers allow customers to trade in units of 1K or even 100-unit increments. Under that scenario, our range trader trading 1K units could withstand a 2,000-pip drawdown (with each pip now worth only 10 cents) before triggering a stop loss. This flexibility allows range traders plenty of room to run their strategies.
In FX, almost no dealer charges commission. Customers simply pay the bid-ask spread. Furthermore, regardless of whether a customer wants to deal for 100 units or 100,000 units, most dealers will quote the same price. Therefore, unlike the stock or futures markets where retail customers often have to pay prohibitive commissions on very small size trades, retail speculators in FX suffer no such disadvantage. In fact a range-trading strategy can be implanted on even a small account of $1,000, as long as the trader properly sizes his or her trades.
Conclusion
Whether a trader wants to swing for homeruns by trying to catch strong trends with very large leverage or simply hit singles and bunts by trading a range strategy with very small lot sizes, the FX market is extraordinarily well suited for both approaches. As long as the trader remains disciplined about the inevitable losses and understands the different money-management schemes involved in each strategy, he or she will have a good chance of success in this market. Next month, we'll examine the various currency pairs to determine which ones are best suited for trend strategy and which are best suited for range.
by Boris Schlossberg
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
Trend
What is trend? The simplest identifiers of trend direction are higher lows in an uptrend and lower highs in a downtrend. Some define trend as a deviation from a range as indicated by Bollinger Band "bands" (see Using Bollinger Band "Bands" to Trade Trend in FX). For others, a trend occurs when prices are contained by an upward or downward sloping 20-period simple moving average (SMA).
Regardless of how one defines it, the goal of trend trading is the same - join the move early and hold the position until the trend reverses. The basic mindset of trend trader is "I am right or I am out?" The implied bet all trend traders make is that price will continue in its present direction. If it doesn't there is little reason to hold onto the trade. Therefore, trend traders typically trade with tight stops and often make many probative forays into the market in order to make the right entry.
By nature, trend trading generates far more losing trades than winning trades and requires rigorous risk control. The usual rule of thumb is that trend traders should never risk more than 1.5-2.5% of their capital on any given trade. On a 10,000-unit (10K) account trading 100K standard lots, that means stops as small as 15-25 pips behind the entry price. Clearly, in order to practice such a method, a trader must have confidence that the market traded will be highly liquid.
Of course the FX market is the most liquid market in the world. With US$1.6 trillion of average daily turnover, the currency market dwarfs the stock and bond markets in size. Furthermore, the FX market trades 24 hours a day five days a week, eliminating much of the gap risk found in exchange-based markets. Certainly gaps sometimes happen in FX, but not nearly as frequently as they occur in stock or bond markets, so slippage is far less of a problem.
High Leverage - Large Profits
When trend traders are correct about the trade, the profits can be enormous. This dynamic is especially true in FX where high leverage greatly magnifies the gains. Typical leverage in FX is 100:1, meaning that a trader needs to put down only $1 of margin to control $100 of the currency. Compare that with the stock market where leverage is usually set at 2:1, or even the futures market where even the most liberal leverage does not exceed 20:1.
It's not unusual to see FX trend traders double their money in a short period if they catch a strong move. Suppose a trader starts out with $10,000 in his or her account, and uses a strict stop-loss rule of 20 pips. The trader may get stopped out five or six times, but if he or she is properly positioned for a large move - like the one in EUR/USD between Sept and Dec 2004 when the pair rose more than 12 cents, or 1,200 pips - that one-lot purchase could generate something like a $12,000 profit, doubling the trader's account in a matter of months.
Of course few traders have the discipline to take stop losses continuously. Most traders, dejected by a series of bad trades tend to become stubborn and fight the market, often placing no stops at all. This is when FX leverage can be most dangerous. The same process that quickly produces profits can also generate massive losses. The end result is that many undisciplined traders suffer a margin call and lose most of their speculative capital.
Trading trend with discipline can be extremely difficult. If the trader uses high leverage he or she leaves very little room to be wrong. Trading with very tight stops can often result in 10 or even 20 consecutive stop outs before the trader can find a trade with strong momentum and directionality.
For this reason many traders prefer to trade range-bound strategies. Please note that when I speak of ‘range-bound trading' I am not referring to the classic definition of the word 'range'. Trading in such a price environment involves isolating currencies that are trading in channels, and then selling at the top of the channel and buying at the bottom of the channel. This can be a very worthwhile strategy, but, in essence, it is still a trend-based idea - albeit one that anticipates an imminent countertrend. (What is a countertrend after all, except a trend going the other way?)
Range
True range traders don't care about direction. The underlying assumption of range trading is that no matter which way the currency travels, it will most likely return back to its point of origin. In fact, range traders bet on the possibility that prices will trade through the same levels many times, and the traders' goal is to harvest those oscillations for profit over and over again.
Clearly range trading requires a completely different money-management technique. Instead of looking for just the right entry, range traders prefer to be wrong at the outset so that they can build a trading position.
For example, imagine that EUR/USD is trading at 1.3000. A range trader may decide to short the pair at that price and every 50 pips higher, and then buy it back as it moves every 25 pips down. His or her assumption is that eventually the pair will return to that 1.3000 level again. If EUR/USD rises to 1.3500 and then turns back down hitting 1.3000, the range trader would harvest a handsome profit, especially if the currency moves back and forth in its climb to 1.3500 and its fall to 1.3000.
However, as we can see from this example a range-bound trader will need to have very deep pockets in order to implement this strategy. In this case employing large leverage can be devastating since positions can often go against the trader for many points in a row and, if he or she is not careful, trigger a margin call before the currency eventually turns around.
Solutions for Range Traders
Fortunately, the FX market provides a flexible solution for range trading. Most retail FX dealers offer mini lots of 10,000 units rather than 100K lots. In a 10K lot each individual pip is worth only $1 instead of $10, so the same hypothetical trader with a $10,000 account can have a stop-loss budget of 200 pips instead of only 20 pips. Even better, many dealers allow customers to trade in units of 1K or even 100-unit increments. Under that scenario, our range trader trading 1K units could withstand a 2,000-pip drawdown (with each pip now worth only 10 cents) before triggering a stop loss. This flexibility allows range traders plenty of room to run their strategies.
In FX, almost no dealer charges commission. Customers simply pay the bid-ask spread. Furthermore, regardless of whether a customer wants to deal for 100 units or 100,000 units, most dealers will quote the same price. Therefore, unlike the stock or futures markets where retail customers often have to pay prohibitive commissions on very small size trades, retail speculators in FX suffer no such disadvantage. In fact a range-trading strategy can be implanted on even a small account of $1,000, as long as the trader properly sizes his or her trades.
Conclusion
Whether a trader wants to swing for homeruns by trying to catch strong trends with very large leverage or simply hit singles and bunts by trading a range strategy with very small lot sizes, the FX market is extraordinarily well suited for both approaches. As long as the trader remains disciplined about the inevitable losses and understands the different money-management schemes involved in each strategy, he or she will have a good chance of success in this market. Next month, we'll examine the various currency pairs to determine which ones are best suited for trend strategy and which are best suited for range.
by Boris Schlossberg
Boris Schlossberg runs BKTraderFX, a forex advisory service and is the senior currency strategist at Forex Capital Markets in New York, one of the largest retail forex market makers in the world. He is a frequent commentator for Bloomberg, Reuters, CNBC and Dow Jones CBS Marketwatch. His book, "Millionaire Traders" (John Wiley and Sons) is available on Amazon.com, where he also hosts a blog on all things trading.
British Pound Rises Versus Euro as BOE Lifts Inflation Forecast
Thursday, February 14, 2008 - - 0 Comments
By Kim-Mai Cutler
Feb. 13 (Bloomberg) -- The pound climbed to a two-week high against the euro after the Bank of England raised its inflation forecast, prompting traders to pare bets on interest-rate cuts.
Britain's currency also traded near the highest level in a week versus the dollar after the central bank forecast in its quarterly inflation report today that price growth will overshoot its 2 percent goal in two years even as ``downside'' risks to the economy remain. The pound also gained as a government report showed unemployment fell to a three-decade low in January.
``Sterling rallied because the market is going to focus on slightly higher rate expectations,'' said Adrian Schmidt, a London-based senior foreign-exchange strategist at Royal Bank of Scotland Group Plc, the fourth-largest currency trader. ``But they've also talked about downside risks for growth.''
The pound climbed to 74.15 pence per euro, the strongest since Jan. 30, and was at 74.28 pence by 4:39 p.m. in London, from 74.41 pence yesterday. It rose to $1.9655, the highest level since Feb. 6, before trading little changed at $1.9611.
It's ``odds on'' inflation will exceed 3 percent, Bank of England Governor Mervyn King said at a press conference in London today after publishing the report. Still, he said he expects a ``marked slowing'' in growth.
The central bank based the forecasts on expectations the benchmark interest rate will fall three quarters of a percentage point to 4.5 percent by year-end.
U.K. Inflation
Inflation expectations climbed to a five-month high today. The yield difference, or breakeven rate, between two-year U.K. nominal bonds and inflation-protected notes of the same maturity rose 8 basis points to 3.45 percentage points, the widest spread since September. The difference represents the inflation rate that's expected over the life of the securities.
Inflation accelerated to a seven-month high last month, the Office for National Statistics said yesterday. Still, the rate was lower than economists forecast as discounting by fashion stores blunted the impact of rising gasoline and food costs.
Claims for jobless benefits in Britain dropped 10,800 from December to 794,600, the lowest since June 1975, a government report showed today. The decline was more than double the 5,000 median forecast in a Bloomberg News survey of 28 economists. The jobless rate stayed at 2.5 percent.
Britain's currency pared gains against the dollar, and gilts dropped, after a U.S. government report showed retail sales in the world's largest economy unexpectedly rose in January.
The 0.3 percent increase followed a 0.4 percent decline the month before, the Commerce Department said in Washington. It was a sign consumer buying, which accounts for the biggest part of the economy, is holding up even as a housing slump deepens.
Gilts Decline
Two-year U.K. government note yields rose 2 basis points to 4.27 percent. The price on the 5.75 percent security due December 2009 lost 0.03, or 30 pence per 1,000-pound ($1,962) face amount, to 102.56. Ten-year gilt yields climbed 2 basis points to 4.62 percent. Yields move inversely to bond prices.
Government bonds will advance for the next six months in the world's biggest debt markets, including the U.K., as the U.S. economic slowdown spreads to Europe and Asia, a survey of Bloomberg users showed.
Bonds will rally in the U.S., Germany, U.K., Italy, France, Japan and Hong Kong, according to the monthly Bloomberg Professional Global Confidence Index, which canvassed more than 6,800 users from New York to Paris to Tokyo.
Policy makers lowered the U.K.'s main rate a half-percentage point to 5.25 percent since December and are weighing the need for a third cut to boost Europe's second-biggest economy. The Federal Reserve reduced its benchmark rate by 1.25 percentage points this year, the fastest pace since 1990.
Rate Expectations
Britain's central bank will lower the rate to 4.75 percent by midyear and to 4.5 percent by the first quarter of 2009, according to the weighted average of 20 forecasts in a Bloomberg survey of analysts.
The chances of a 25 basis-point cut at the March 7 policy meeting have halved this week, to 14 percent, according to a Credit Suisse Group index of probability based on overnight indexed swap rates.
The implied yield on the December sterling futures contract has risen 11 basis points this week to 4.65 percent, the highest level for two weeks, as traders reduced wagers on lower U.K. borrowing costs.
Feb. 13 (Bloomberg) -- The pound climbed to a two-week high against the euro after the Bank of England raised its inflation forecast, prompting traders to pare bets on interest-rate cuts.
Britain's currency also traded near the highest level in a week versus the dollar after the central bank forecast in its quarterly inflation report today that price growth will overshoot its 2 percent goal in two years even as ``downside'' risks to the economy remain. The pound also gained as a government report showed unemployment fell to a three-decade low in January.
``Sterling rallied because the market is going to focus on slightly higher rate expectations,'' said Adrian Schmidt, a London-based senior foreign-exchange strategist at Royal Bank of Scotland Group Plc, the fourth-largest currency trader. ``But they've also talked about downside risks for growth.''
The pound climbed to 74.15 pence per euro, the strongest since Jan. 30, and was at 74.28 pence by 4:39 p.m. in London, from 74.41 pence yesterday. It rose to $1.9655, the highest level since Feb. 6, before trading little changed at $1.9611.
It's ``odds on'' inflation will exceed 3 percent, Bank of England Governor Mervyn King said at a press conference in London today after publishing the report. Still, he said he expects a ``marked slowing'' in growth.
The central bank based the forecasts on expectations the benchmark interest rate will fall three quarters of a percentage point to 4.5 percent by year-end.
U.K. Inflation
Inflation expectations climbed to a five-month high today. The yield difference, or breakeven rate, between two-year U.K. nominal bonds and inflation-protected notes of the same maturity rose 8 basis points to 3.45 percentage points, the widest spread since September. The difference represents the inflation rate that's expected over the life of the securities.
Inflation accelerated to a seven-month high last month, the Office for National Statistics said yesterday. Still, the rate was lower than economists forecast as discounting by fashion stores blunted the impact of rising gasoline and food costs.
Claims for jobless benefits in Britain dropped 10,800 from December to 794,600, the lowest since June 1975, a government report showed today. The decline was more than double the 5,000 median forecast in a Bloomberg News survey of 28 economists. The jobless rate stayed at 2.5 percent.
Britain's currency pared gains against the dollar, and gilts dropped, after a U.S. government report showed retail sales in the world's largest economy unexpectedly rose in January.
The 0.3 percent increase followed a 0.4 percent decline the month before, the Commerce Department said in Washington. It was a sign consumer buying, which accounts for the biggest part of the economy, is holding up even as a housing slump deepens.
Gilts Decline
Two-year U.K. government note yields rose 2 basis points to 4.27 percent. The price on the 5.75 percent security due December 2009 lost 0.03, or 30 pence per 1,000-pound ($1,962) face amount, to 102.56. Ten-year gilt yields climbed 2 basis points to 4.62 percent. Yields move inversely to bond prices.
Government bonds will advance for the next six months in the world's biggest debt markets, including the U.K., as the U.S. economic slowdown spreads to Europe and Asia, a survey of Bloomberg users showed.
Bonds will rally in the U.S., Germany, U.K., Italy, France, Japan and Hong Kong, according to the monthly Bloomberg Professional Global Confidence Index, which canvassed more than 6,800 users from New York to Paris to Tokyo.
Policy makers lowered the U.K.'s main rate a half-percentage point to 5.25 percent since December and are weighing the need for a third cut to boost Europe's second-biggest economy. The Federal Reserve reduced its benchmark rate by 1.25 percentage points this year, the fastest pace since 1990.
Rate Expectations
Britain's central bank will lower the rate to 4.75 percent by midyear and to 4.5 percent by the first quarter of 2009, according to the weighted average of 20 forecasts in a Bloomberg survey of analysts.
The chances of a 25 basis-point cut at the March 7 policy meeting have halved this week, to 14 percent, according to a Credit Suisse Group index of probability based on overnight indexed swap rates.
The implied yield on the December sterling futures contract has risen 11 basis points this week to 4.65 percent, the highest level for two weeks, as traders reduced wagers on lower U.K. borrowing costs.
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