Sunday, February 18, 2007

Marlyn Does FOREX

Tyro trader has a story about a really bright guy who lost a bundle trading FOREX. Wow another newbie got scalped in the FOREX world - now that's an original story.

I think those stupid "Trade FOREX" TV infomercials should be made illegal. They won't be, of course, because "investing" is "moral" and gambling is not - yet I believe that with far less effort you would have better odds at a black jack table and certainly a better chance at a poker table. Yet those are "games" and are "gambling" and are thus "immoral". I’m a fairly good poker and black jack player – not professional class – but talented enough to win most of the time when I sit down to play.

Several years ago the “Trade FOREX” bug bit me. I approached it differently from the newbie in Tyro trader’s article however. I actually did it the way you are supposed to – make a small account and trade. Why? Because paper trading isn’t worth the paper it’s printed on. In the very first day I knew that different instruments traded at different spreads and the other thing I knew was that all instruments traded exactly alike.

What? Well it’s this way – pick three instruments on the spot market, they can be any three instruments but I like to use Euro, USD, and Cable (UK Pound) for the example. If you put the three together on a spread sheet what you will see is when one makes a move against another that move is reflected in the remaining instrument in the exact same proportion to the move between the original two. The relationship remains the same between the USD and EURO as it does between the USD and the Cable as it does between the EURO and the Cable. It has to - all money is based on the same "trust me" principle - it's the reason no one uses gold any longer - no arguments over valuation. All money then follows the risk free interest rate of the country of issue and the amount of money in circulation at any one time determines its value on the open market. Computers - you gotta love 'em.

In other words the Internet has brought perfect balance to the spot market in FOREX and the old days when arbitration was the way to make money there are long gone. Consequently in order to play FOREX you simply find one instrument of one of the major pairs that you like and play that one instrument exclusively both long and short. I specialized in the Australian Dollar – USD pair.

My broker only took a 1.5 pip spread on that pair most of the time. “Most of the time” means except when a major announcement was expected from either side regarding interest rates or other economic factors that affect interest rates such as GDP. Your bet had to be in place several minutes to tens of minutes ahead of these announcements – and my choice of words here is perfect – bet. That’s because what was normally a 1.5 pip (pip = hundredth of a cent) spread could expand to a 10, 20 or more pips spread depending on the numbers of bets on the books long and short just before the announcement.

When the announcement time came the market went crazy with this currency going up, that one going down and sometimes the moves were intense – up to several cents - especially when the announcements dealt with interest rate changes. I became adept at scalping. I’d wait for about 5 minutes for the excitement to subside and then take the counter trade of the move that just occurred. If the AUD went down I bought it, if it went up, I sold it. It took a lot of practice and observation to be able to tell when the major move was over and the counter move was about to begin. Thus I could game the market a couple of times a week, secure my account, and go on with my daily business. And when I say “secure” I mean go to all cash.

Long story short – in the first couple of months I doubled my account. Yes kiddies I doubled my small (couple of thousand) trading account in a few months. Doubled it by scalping. Then hubris took over.

I had noticed that the Japanese Yen was moving overnight about 20 – 30 pips or so in a downward direction (it was becoming more expensive relative to the dollar on a daily basis). I reasoned that I was wasting an opportunity to make a couple of extra quid by not parking my money in the Yen-USD pair overnight – short yen. So I started doing that. Of course I kept a tight stop on the transaction – and what was the worse that could happen? Lose a couple of pips on a stop.

Japan, or course, trades while Marlyn is asleep so I did this for a number of nights and my account continued to go up, up, up. Then one morning I got up, looked at my trading window and saw a huge green line stretching forever into the top of the chart. Overnight the Japanese bankers growing tired of this continued strengthening of their currency to the detriment of their international trade balance just dumped a huge amount of Yen on the market (bought dollars). In a supply and demand world when the supply increases the price decreases and that is what happened on the spot market. Except that the Yen trades long to the dollar when it is getting weaker and I was short. The stop was ignored until the carnage ended and given the huge amount of leverage involved when the wind stopped blowing Marlyn had about 63 dollars and a few cents left in his account.

I reloaded once more but my heart had been ripped out. All I did was worry about the next Central Bank beating I was going to take and sure as hell several months later the UK did the same thing and I took another heavy hit. I ended my FOREX career at that time. It was too expensive, and much too nasty. I’ll take the specialists of the NYSE any day over those Central Bankers. The specialists can only dream of the kind of power those guys wield.

Do I think people can make money in FOREX – sure – lucky people and people like Warren Buffet who can put billions into a single transaction and hold it for years and years. Oh, and the other class who make money in FOREX – the folks who sell the “Get Rich Quick in FOREX” products on the TV infomercials.

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