How To Trade Like Gordon Gekko

1. What is a world view?

Keeping everything under control – from multiple sources of information – requires a trader to have a very clear idea of how and why to use certain sources of information. There is very little left to interpretation; and there is basically zero tolerance for wasting time and/or energy (in pure Gordon Gekko fashion).

Forming a World View is quite a daunting task for any trader that hasn't been trading in the markets for at least a couple of years full time (so more, if it's part time) and has been consistent with the approach used. This means “rinse & repeat” with the sentiment identification method, the pre-trade analysis, the trade execution analysis.

It's not easy to get to this point, because in the markets you can apply a sturdy, logical plan and still lose money – twice or three times in a row – before starting to claw back. This causes newcomers and people with self-confidence issues to change approach without giving any particular strategy a decent run.

So in this article we will illustrate a World View for approaching Sentiment in FX. In order to do this, we must keep one main question in mind: why should XYZ currency pair move up (or down)? This question keeps us focused on the reasons behind possible moves and thus the aggregate sentiment in the marketplace. We do believe that technicals alone will get traders into trouble.

2. The starting poing: who have the thick sticks?

The first thing to do is metagame a little, and ask who is it that can step in and “force” the FX market in a certain direction. The answer of course: Central Banks and Treasury Heads. They hold the thick sticks. All it takes is the Bank of Japan to be “actively checking prices” at their agent banks for the word to spread along the grapevine and alert markets.

There is the SNB that has actively been defending the 1.20 level in EurChf for years on end. And if you are still in doubt as to the importance of what Central Banks have to say, go back to May 2014 and see what Mr.Draghi did to the Euro. At the time of writing this article, there is still no bottom in sight for this current trend.

EurUsd Daily – FXCM Marketscope

So now we know that we need to pay attention to what Central Banks say and do. Monetary policy divergence is a big driver in the FX markets and is relatively easy to keep track of.

So what are these policy makers focused on? Fundamentals! That's why “funny-mentals” are important to keep track of: they matter to the people that matter. The question to ask is: what do the policy makers base their policies on?

• interest rates (yields)
• inflation (growth)
• Employment/Housing/Mortgages
• Capital Inflows/Outflows (directly correlated with the various Equity Indexes)
• Imports/Exports

and we will cover in other articles how to understand/unravel dynamics in funny-mentals so we will directly convert this into effects in this article. Remember: the market is made up of humans and humans cannot popssibly keep track of all the variables at the same time. So what happens is that the market focuses on themes and stories. 

Themes generate the background conditions that pushes prices through the gears. We are currently witnessing a story of deflation in the Eurozone, with consumer prices subdued, producer prices subdued, interest rates at the lower boundary and hardly any economic growth if you exclude Germany. This is a general theme, an unresolved issue that the market always has in the back of it's mind.

Themes based on fundamentals are a little more difficult to corner in the FX market, relative to equities. After all, one could argue that equities are all about growth...whereas FX may be about a USD story; it might be about a local currency story like the Kiwi for example. Or there may be 2-3 themes playing out all at once. And that makes matters much more complicated because money flows in FX are not constantly focused on the same asset every day. And a true currency trader must be able to track the money flows each and every day, to stay on top of things.

3. Foreground Check: Headline Risk

It does not suffice, however, to concentrate only on background themes/sentiment. Almost every day, the market is loitered with emerging fundamental data in the form of event risk. An FX trader must always stay in touch with what is going to hit the market, what the market is expecting and if the events are important or not.

Economic Calendar example. Source: Investing.com

Many traders argue that following emerging fundamentals is only for the short term trader and not for the longer term traders. However, we respectfully disagree. When background conditions and foreground conditions comply, there can be room for some very “easy” opportunities to insert onesself into the flow of things.

GbpUsd Hourly Chart: on November 12^th 2014 the Bank of England released it's Quarterly Inflation Report. It was more dovish than the market expected. This downward surprize was in line with the background, Gbp-negative sentiment, and after the announcement there was scope for more downwards momentum.

Source: FXMC Marketscope

One last observation about headline risk: it's the deviation from the market's expectations that holds the key. Furthermore, expectations tend to grow in line with the trend. So the further the market pushed in one direction, the more “confident” strategists and analysts get with their predictions. This makes “surprizes” in the opposite direction quite powerful when they occur. Bottom line: especially during extended trends, try to stack the odds more firmly in your favour by getting background  and foreground  in alignment.

4. Don't forget your intermarket analysis

We're trying to become like Gordon Gekko right? So we need to understand what other markets are telling us. Is the USD rising but Gold is standing still? Are risk assets rising but the Jpy complex is not following suit?

It would be redundant to write more about how capital can flow through the various markets, so go and brush up on your intermarket correlations!

5. Behavioural traits of FX pairs

The final piece to the FX World View puzzle has to do with the history of each single currency. In the old days, currency dealing desks used to hire Italians to trade the Lira, Germans to trade the DM, British to trade the Pound, etc. because each currency had it's own “personality”. Things are slightly simpler nowadays with the Euro having absorbed so many local currencies. But there are still some worthwhile distinctions.

a) the USD is the king of currencies. In bad times, the USD gets bought as a safe haven because historically the US Government has been trustworthy and the economy is quite dynamic. Investors feel safe parking their hard earned money in US Bonds. The US economy is mainly service-oriented (so the health of businesses and consumers is of the utmost importance). The USD tends to be inversly correlated with Gold and Crude Oil.

b) the Euro is a melting pot of different currencies that reflect different cultures with different historical backgrounds. If there is something that history can teach us, it's that national identities are hard to eradicate. And the fact that a European, living in France, would prefer to be called a “French” rather than a “European” is one of the main challenges for the Euro as a whole. The Euro has thus always found difficulty attacting stable capital inflows, and it is nowhere near as good a reserve currency as the USD. The strength of the Euro is supposed to come through the numer of nations under the common umbrella. International trade is important, even though the service sector accounts for 70% of the economy.

c) the GBP is the EU's main trade partner and there is still a debate going on to this day on whether the UK was right to stay out of the Euro or not. As the Bank of England is the oldest central bank in the world, it may have been a case of national pride and wanting to mantain a certain independence, given it's history. In any case, the UK's economy is very much service-oriented with an evident slant towards financial services. Again, CPI, housing and the banking sectors are all worth keeping an eye on.

d) the Jpy is an exporter economy. As an example, we can recall Honda Motorcycles, Mazda, Toyota for the car industry. So the Japanese economy is very aware of their exchange rate. And the exchange rate happens to be very much time-sensitive. There are Jpy repatriation flows on March 31^st of each year; there are Jpy repatriation flows on behalf of insurance companies after any large natural disaster. And also keep in mind that the Bank of Japan is very much connected with the Ministry of Finance.

e) the CAD is something like the USD squared! The Canadian economy is very much linked to the US economy through trade (of primary goods first and foremost). It is also natural that commodity prices (Crude and Gold first) are directly correlated to the Loonie. However, keep in mind that the closer two countries are, the more the cross-rate of the two currencies will tend to range-trade and not trend. That's the main reason why UsdCad does not generally trend anywhere. A similar case is AudNzd.

f) the AUD is the main vehicle that traders use as a proxy for Asia/Pacific event risk. Since China and Australia do a lot of business with each other, traders trade the Aussie even on Chinese event risk. Above an beyond this, the Australian Dollar is very much linked to commodity prices being a prime producer of many prime materials including Iron Ore and Aluminium.

To sum up: in order to keep everything under control, and act as a real intermarket wizard, you need to have a firm understanding of what drives currencies, what the focus is on, and what the cross-effects on other markets (or from other markets) may be. FX is the most multifaceted asset to trade, which makes it the most fascinating but also the most difficult. The key is having a consistent map of things. What are the background drivers? What are the emerging fundamentals saying? How does this relate to the particular currencies' history and to the other markets (via intermarket relationships)? This is how you “trade the world”. And obviously, when in doubt, come into the Skype Trading Room to ask a question or two. 

Good Luck!