Today's Guest Blogger is frequent TV contributor, Bob Iaccino from TraderOutlook.com. Iaccino will try to take a stab at teaching us about the importance of risk management in the Forex markets.You can also see Bob's recently released video series, charting his trading methods and successes. Make sure you comment below with any questions you have for Bob.
Position traders are suffering a little bit, both short and long term in the Forex market right now. Even scalpers are feeling the sort of chop they haven’t felt recently because of the lack of “trend/congestion, trend/congestion” that has been the consistent general nature of the Forex markets. When the economy is in a particular phase such as recession, growth, or even depression, we’ll see the Forex markets trending. However, the direction of the trend doesn’t ultimately matter. They’ll trend for a period of time, and then they’ll pause and move sideways.
Right now the sideways motion is filled with mini-trends. Let me give you an example. When looking at a 4 hour chart, you’ll see one, maybe two periods of consolidation followed by a massive emotional candle. Then you’ll see two or three periods of consolidation and a massive emotional candle to negate the previous emotional candle’s move. Normally, Forex markets have a steady pace of “trend then congest..trend then congest.” Right now it’s more a cycle of “trend, congest, trend, congest.” There’s a departure from the signature trending cycle.
The reason behind this is fundamental in nature, because the market is in a switch between recession and growth and its undecided if that switch is actually going to take place. What do I mean by that? Growth cycles last somewhere in the range of 5 years on average dating back to the Great Depression. More recently, we’ve seen spiked up growth during the Clinton and George W. Bush years. Those cycles of growth are fairly long compared to historical levels. Recessions generally last somewhere around 2 years, but more generally in the range of 14 months on average. During those periods, the 14 month recessions or 5 years of growth, the Forex markets will trend. By virtue of being the largest traded market in the world and the largest transactional entity, meaning that money changes hands more than with interest rates or commodities, the greatest need for hedging is in Forex.
Large hedgers, ones that do billions and billions in transactions at a time, hedge for general economic conditions. An example would be a large insurance company. They’ve got sizeable holdings of gilts* (Risk-free bonds issued by the British government, equivalent of U.S. Treasury securities) and the interest rates on gilts are heading lower. They will hedge their currency exposure, based on a large exposure to the guilt, for a period of time. Say the economy then switches. Growth can cause higher inflation, causing higher interest rates. If higher interest rates occur, those large holders of gilts, in the multi billions of dollars worth, now need to hedge for higher interest rates as opposed to lower. So they will then switch their hedges from one side to the other. The timing of that is the current question Are we actually switching to growth?
If not, they would need to switch their hedges back. The reason we’re seeing these large moves, is that hedgers will come in on large news and reverse the hedge the other way. They’re not sensitive about the moment to moment movement. They may reverse the hedge half a dozen times. If they have the hedge on the right way and the economy is heading in the proper direction, that hedge will stay on for a long time, sometimes years. They’re not in and out traders. This is what’s causing the strange trading in the market right now that’s affecting position traders and scalpers alike. It’s not a time to question your strategy. It is a time to pull back risk in your trading and sit and wait for the economy to stabilize in one direction or the other. What direction is unimportant. Refer to our motto, Never increase risk, always reduce it when in doubt and this is one of those times.
Thanks again to Adam for the ability to write for you today, and if you're able, please check out my series of videos showing how I work here.