The Unlikely is Not Impossible

And sometimes it's even likely. This is a paradox I often find myself wrestling with as a trader, particularly since I like to think I approach the forex market with a statistical mindset. Why do you think I go on about Bollinger Bands so much? They're one of the more statistical indicators out there, based on a measurement of 2 standard deviations from a specified moving average. But if you trade long enough, you discover that your statistical ideas about market behavior often run headlong into the painful realities of how the market actually behaves.

What set me off on this particular tangent was a recent article in The Economist. (Seems I reference them in every other post. Such is intellectual laziness.) It was commenting on the recent volatility in world financial markets, seen in the meltdown of the Chinese stock market, the serious decline in US markets, and similar turbulence in all the other markets I don't really follow. What really got my attention were these remarks about the statistical likeliness (or rather, unlikeliness) of all this marketplace drama:

"According to Goldman Sachs, the latest jump in the Vix (a measure of stockmarket volatility) took it eight standard deviations from its average. If conventional models are correct, such an event should not have happened in the history of the known universe. Then again, the move in energy prices that caused the collapse last year of Amaranth, the hedge fund, was a nine standard-deviation event. [I wrote about the Amaranth collapse a while back, follow that link to learn more about how they screwed up.] Perhaps modellers do not know the universe as well as they would like to think."

Eight standard deviations. Nine standard deviations. These make the 2 deviations of my Bollinger Bands look painfully inadequate to accurately gauge possible market fluctuations. The key of course is that these types of events are extremely unlikely. Just like the global financial implosion triggered by Russia's loan defaults and the devaluation of the Thai baht back in 1997. Extremely unlikely events, and yet they brought Long-Term Capital Management crashing down. [Wrote about them too. Follow the link for more hedge fund meltdown fun. So, got any assets in hedge funds?]

Extremely unlikely, and yet they happened. In fact, if you look at historiy it seems inevitable that extremely unlikely events like these will happen again. So what does that make them - likely? Depending on your timeframe, yes and no (century: likely, month: unlikely). And they're definitely severe enough to include in whatever rosy model you have for trading and investment success. If you live in an earthquake zone (which I do) you don't expect one every day. But you do prepare yourself for the day when the floor starts moving. So how strong is your trading floor?

Related article:
The Economist: Grey Tuesday - An overdue sell-off flusters exchanges and sobers investors

Currency News Page

Quick update on a new site feature - I've just added this news page featuring headline feeds from various news services including DailyFX, FXStreet and MarketWatch: The Latest Forex News

It was fun to put together because it's the first time I've tried to integrate RSS feeds directly into my content. They'll be updated dynamically as each service publishes new articles, so the content of this page will be changing pretty frequently. Seems to be working OK so far. One disappointment was discovering Bloomberg's not publishing RSS yet, but once they get their act together and start pushing out some feeds I'll add those too.

If there's an essential forex news provider that I've missed (and that offers RSS) please let me know and I'll make sure to include them.

Related topics:
The Latest Forex News
Forex News Services

In case you're wondering about that Thanksgiving dollar meltdown...

If, like me, you'd just publicly stated you were looking forward to a nice, quiet carry trade through the holiday and then discovered on Wednesday that your stops were gone, and then discovered on Friday that the dollar had been pounded down even further, you might be excused for wondering what the hell just happened. Since I certainly don't have the answers (just scroll down a bit to my previous post for proof of this) I'll hand you over to Kathy Lien and Boris Schlossberg at Daily FX for an excellent analysis of the holiday craziness:

Carry Trade Liquidation Hits the US Dollar

[Note to self: next year consider liquidating your trade before the holiday rather than blogging about it.]

Euro and Pound Reach Multi Month Highs

Looking for more forex news? Check out these Forex News Services.

FX Engines News Calendar & Trading Alerts

One of the niftier recent features added to FX Engines is a calendar providing alerts of upcoming news events that are likely to move the forex market. Each event is listed with a rating of 1 to 5 stars, with more stars indicating a higher likelihood the event will produce a major price movement. If you're a news-oriented trader but find it confusing and a little tedious to keep track of the whole cycle of economic events, as well as gauge their likely impact on the market, you'll probably find the calendars and alerts come in very handy.

If you have an account with FX Engines you can access the calendar on their Upcoming Events page. Here's a typical news alert:


To trade on a particular news event in FX Engines you can either (1) sign up for their news trading services, (2) trade the event manually by placing a standard order through their interface as you would with any other broker (trades are placed via FXCM), or (3) design your own customized news engine. Just remember that trading the news is a volatile business, and there's absolutely no guarantee you'll make consistent profits - but with a news calendar and automated tools you may be able to improve your odds.

Related links:
FX Engines
FX Engines Launches News Trading Tools

Disclosure: Forex Forays has a business relationship with FX Engines, but I wouldn't write about their services if I didn't find them worthwhile.

Interpreting Market Reactions to Non-Farm Payroll (NFP) Numbers

As I've noted before, I don't trade news events like the Non-Farm Payroll. One of the main reasons is that I prefer to be asleep when most of them happen. Another big reason is that I find it difficult to interpret what they mean in the 10 seconds or so you have to make that decision and place a trade. So if I ever do trade the news in a serious way it'll be on an entirely automated basis with FX Engines.

But that's doesn't mean I ignore these events entirely, and a recent email from a reader got me thinking even more than usual about the NFP report. The reader was curious about why the dollar strengthened after weaker-than-expected employment numbers, which I thought was an excellent question, and tried to answer as best I could. Here's our Q & A exchange about what it all means:

Q: "I am very confused with Friday's dollar action. The NFP report seems negative to me, no matter how you look at it. If the consensus was 120k and the actual figure is 50k... well that's a huge decrease to the negative side. Then, it was explained to me that the previous month's numbers were inaccurate and the two months averaged together equates to 120k. Again, this to me is negative for two reasons.: 1, last month's report was wrong = negative 2. if last month's number was actually much higher than 120k than the drop from last month to this month at 50k would be even worse!

Yet the dollar strengthened. I am confused. If you could share your thoughts on the event, if would be greatly appreciated."

A: "Frankly, I usually find market reactions to the NFP and other events pretty confusing too, which is why I generally stick to statistical and technical analysis of price movements (if X and Y happened today, Z will happen tomorrow 60% of the time, etc.)

However, in this case I think I know why the dollar strengthened: higher employment tends to be correlated with higher inflation, and inflation has been a big worry in the markets lately. The closer the economy is to full employment, the higher the upward pressure on prices as consumers have more in their pockets to spend. This relationship is known as the Phillips Curve.

On the flip side, slowing employment growth actually helps reassure traders that inflation is under control, which leads to greater confidence in the dollar. This also leads traders to conclude that the Fed is less likely to raise interest rates to control inflation, and might even start lowering them again - another big reason to buy the dollar.

However, this doesn't mean the market will have the same reaction down the road. If a future NFP report showed continued weak employment and inflation had ceased to be much of a concern, I wouldn't be surprised if traders began to have more serious concerns about the fundamentals of the US economy and the dollar weakened as a result. Market reactions to news events are highly dependent on the context within which the events occur, so the same news could produce wildly different reactions in different contexts."

That's my amateur interpretation, at least...what's yours? I'd be very interested to hear how other traders interpret the NFP, so feel free to post your analysis in the comments below!

Related topics:
Why I don't trade on economic news
FX Engines launches news trading tools

Related links:
Non-Farm Payroll Report
Phillips Curve
FX Engines

Fed Leaves Rates Unchanged - But Not My Charts

So the Fed Open Market Committee just announced they're leaving the federal funds rate unchanged at 5.25%. Here's what my charts look like for the past couple hours - volatility, anyone? Interestly, aside from those crazy whipsaws up and down, the price has returned to a point not terribly far from where it was before the announcement. This is a case where trading on the Fed news could've left you with painful losses as the whipsaws triggered your stops.

Let's say you'd been brave enough to trade on this news and had set both short and long limit orders with tight stop losses, say 15 or 20 pips in each direction. Unless you were wise enough to take profits fairly quickly and contented yourself with modest gains, those upward and downward spikes could've earned you losses on both the long and short trades as the market swung back and forth, setting off both of your limit buy and sell orders but never resolving into a clear trend that would actually make you money.

This is one of the reasons I'm very leery of trading the news these days. For the record, I've been short the EUR/USD since the weekend for technical reasons: on the daily charts, the price moved inside the upper Bollinger Band on Sunday, and that's what I've been trading on since then. After all this Fed fuss I'm still showing a 36 pip profit on that trade, and I'm glad I've got my stops set way up over 1.29, otherwise this could've been an ugly day. Now I'm hoping that original downtrend will continue when all the dust settles from this Fed announcement.

Related topics:

The Bernanke Bounce: Markets Rally on Fed Chairman's Inflation Comments

In case you're wondering why the currency markets went crazy today...the Fed raised rates

Fed Chairman Ben Bernanke's Speech at the International Monetary Conference

Fed Chairman Ben Bernanke on Energy Prices and the US Economy

FX Engines Launches News Trading Tools

One of my favorite forex trading platforms, FX Engines, has just rolled out a new set of signals and tools enabling you to trade on market-moving news events, such as the release of data on Non-Farm Payrolls, Building Permits, the Consumer Price Index (CPI), Consumer Confidence, Housing Starts, Personal Spending, and Retail Sales - to name just a few.

I've always had a hard time trading on economic news, a problem I ranted about in this post a while back. Having a set of automated tools that will let me place trades at the moment news hits the market, even if I'm fast asleep at the time, should make it a lot easier to start adding this data to my trading system. I'm planning to test out these new features at FX Engines on a demo basis, and if they bring in consistent profits, I'll start trading the news with real funds.

You can read more about these new trading tools on the FX Engines "Trade the News" page. News events to watch in the coming week are ISM Services, Initial Claims, and Wholesale Inventories.

Related topics:
Comparing Forex Platforms: FX Engines
FX Engines Update
My Best EUR/USD FX Engine
My Best GBP/USD FX Engine
Divergence FX Engine

Why I don't trade on economic news

1) Most of it seems to come out while I'm asleep. It's very hard to trade while you're asleep, and there's no way in hell I'm changing my sleep schedule to wait for a US Treasury or Commerce Dept press release.

2) Half the time it seems like everyone knows what the news is going to be already, so it's already factored into the price. In short, sometimes the news isn't even news.

3) The only thing more boring than reading economic reports is reading the phone book, and I don't have to get up at 4:00 AM to read the phone book.

4) I'm no good at figuring out exactly how much a currency price is likely to move after a particular type of report. So if I ever tried to trade on economic data I'd go crazy trying to guess when the trend had maxed out.

5) Major news ends up being reflected in the technical data anyway, so by analyzing the technical data you're in effect analyzing the impact of the news. And I find it much easier to do technical analysis than gauging the effect of a particular report or press release.

6) I'm lazy and hate having to keep track of exactly when this, that or the other government agency is issuing what report and how it compares to the last report and whether it's above or below expectations and What It All Means For The Market. Man, I tired myself out just writing that sentence.

7) I am not a trained economist and am not even remotely qualified to understand half of what's being said in these reports.

8) I'm an ignoramus and have no idea what I'm missing out on by not trading on economic news.

I think that pretty much covers it. Now, back to my nice big comfy spreadsheet of price data.