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“The market is akin to a person with OCD in that the behavior is patterned but not sensible.”
Robert Prechter

Commentary & Analysis
True confessions! Being “smart” doesn’t mean you will make money in FX

I was on the radio last Saturday to discuss currencies. Unfortunately I had some phone troubles and couldn’t finish the interview. One of the things I was going to talk about before my phone went dead was the fact that the gentleman on before me (a smart and nice man whom I respect) was absolutely gushing over the Canadian dollar’s huge rally. Is it time to start looking in the other direction?

This man on the program said how wonderful it was to vacation in the US because things are so cheap there. He was downright excited and proud everyone around the world seemingly wanted to put money to work in his fair country-Canada. It seemed to him, by what I gathered, it was a foregone conclusion the Canadian dollar was on a perpetual glide path higher (USDCAD lower).

What he said about existing conditions was all true. All the numbers will validate. But often when an intelligent guy who has been around the investment field a long time gets that excited and can find little to question about Goldilocks it is usually a sign we are getting close to a top!

When I hear that kind of overt gushing for any asset class or currency, I right away think of Mr. Yin-Yang. [As far as I know Mr. Yin-Yang is still free; the Chinese haven’t made him disappear yet, though they have been trying very hard.]

So, to steal a famous movie line, “say hello to my little friend:”

Hope versus disappear. Optimism versus pessimism…the wheel turns. We know it does. It has to; it is the way it is. The only question is when does the wheel turn? It usually turns before it is generally recognized by our analytical and logical cause versus effect Newtonian-based mindset would validate evidence it is time to turn. [I apologize for that sentence, but couldn’t resist.]

This was the reading of bullish versus bearish consensus for speculators from the latest Commitment of Traders report on the Canadian dollar:

Bullish 96%                 Bearish 4%

This bull/bear positioning number suggests there are a whole lot of people gushing over the Canadian dollar. What is more interesting is this whopping COT number was produced before the recent new high in CAD against the buck. Starting this week, it is likely approaching 100%…hmmm.

There are never ever, ever, any guarantees in this game. There are never ever, ever, any perfect indicators–it is the nature of the beast of human rational and irrational behavior that this be so–but I think if we could be handed one single indicator out of all we use–fundamentals and technical–sentiment would be the best. It must be, because sentiment captures all of the fundamental and technical analysis of all the players to reach a yes or no conclusion–trade or not.

The problem for us and our analytical Western mindset is we want “real” proof, hard facts, and statistics. This mindset has evolved for very good reason and served us very well in our everyday lives. But it’s the type of mindset that gets us in trouble in the investment world; that’s a world in which the most important information may come in the “soft” stuff, where few people are focusing upon.

Let me give you an example of what I am trying to say. Assume you are a hotshot analyst and asked to be on CNBC with Becky Buffet Quick, Joe Kernan and Carl (can’t spell his last name)–guest hosting. So, Mr. Hotshot analyst, why do you think the Canadian dollar is close to a top? Well Becky, everyone loves the Canadian dollar. There is a sentiment extreme. That’s why.

Nope. That won’t do it. Becky, Joe, and Carl will press you for facts and figures. Economic growth comparisons, yield differentials, central bank monetary policy, impact of QE2, why the Canadians decided to get involved in Libya, the latest hockey scores, and powder depth in Whistler versus Aspen. Of course, not wanting to embarrass yourself, stick to your principles, and walk off the set and lose those “hotshot” credentials, you spout statistics that blur the brains of most listeners.

That’s how the “hotshot” analyst game is played. Wow! That guy is really smart, did you hear that Martha? There is a 72.567498% correlation between Whistler snow depth and 14.5786 week trend duration in the USDCAD.

I call that the “statistical confidence” game.

When launching rockets into space, or building bridges, or doing something in the real world that is important, you better be able to play this game well–otherwise people die. But in the investment world, this game seems to me extremely overrated and often kills trading accounts.

In the currency world especially, thanks to all the potential reasonable sounding rationales ranging from crude oil prices to what Bernanke had for breakfast, I am finding increasingly that less is more.

If you sound too smart, and try to “be” too smart, you are likely filling your head with tons of analysis which leads to the dreaded “paralysis of analysis.” The first sign of infection is that you can’t pull the trigger on a trade. And when you do pull the trigger, an anxiety attack follows.

As I get older, I am finding that less is definitely more when it comes to winning in currency trading. I continue to learn the same darn lesson. I learned it again recently. This is true and a real life example using me as the subject and unfortunately my clients paid the price of me learning this again.

I decided to subscribe to Reuters 3000 (now the Eikon platform) a while back so I would have news and analysis on virtually every living and dead asset anywhere around the globe 24/7. I can even get the Sumo wrestling scores when I want them. The day I got that system, so I could do more analysis and become “smarter,” is the day I started trading badly. And the day I stopped using the system, and went back to my old simpler ways of chart analysis and evaluation of the markets basic thematic views is the day my trading started to improve. That is my confession. And no, I am not going on to the Oprah show with that!

Does this mean my trading will continue to be good? No. Does it mean using Reuters is a bad idea for traders? No. But it does tell me that less is really more for me, and I bet it’s the same for many of you.

The think the more we ignore the soft stuff, fill our minds with statistics–the hard stuff, keep trying to sound “smart” and stop taking some free time to just sit and think, the worse our trading gets and yet we don’t know why because we are doing “everything” right.

So thinking about what my little friend is telling me about the gushing for the Canadian dollar, just maybe it is time to start looking in the other direction. Stay tuned.