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FX Trading – What do we know and what do we think we know?

JR and I are always amazed at the hubris of so-called “market gurus.” You know them when you see them. They use terms such as “it will go to xyz” as they discuss future prices of an asset. Or they pontificate with these three words, “I am sure” abc will happen. And they couch stuff in probabilities, e.g., “I have an 80% probability,” on that.

If you have played this game for a while you can only marvel at the confidence expressed by people who pretend to know. If you dig a bit further into these gurus backgrounds and paychecks, you will likely learn said person has no stake or, very little, in the outcome of where XYZ actually goes. The paycheck flows from building the pontification story itself. I think if these seers were forced to take a significant stake in their own brand of “certainty,” they would be a lot more circumspect about what it is they do. Just think how different the advice would be on CNBC or Bloomberg or Fox if that happened. The world would be a better place. The birds would sing again, and …

Now of course, everyone seems to think they know exactly where the US dollar is going because they “know” the Fed is about to embark on quantitative easing in a “big” way.

May the ubiquitous “they” be right? Absolutely! May they be right for the right reasons? Absolutely! May they be right for the wrong reasons? Absolutely! May they be completely wrong? Absolutely!

The point of this missive is to show there are lots of potential outcomes from here given all the so-called certainty and high confidence expressed by the gurus.

I keep a whole list of trading rules in my trading notebook (hundreds of them), along with a host of articles and chart pattern setups and other things accumulated over the years I felt was important at the time. Last weekend I was looking through my notebook and came across my huge list of trading rules. [Of course some contradict others as rules tend to do, but I think many are helpful.]

Thinking about our current situation I chose a few for example. First there is this one:

#67 – A known fundamental is a useless fundamental.

Of course we know why this is and has to be. Markets look forward, not backward, and news is discounting quickly into the price.

Then there is this one:

# 138 – Disregard all prognostications. In the world of money, which is a world shaped by human behavior; nobody has the foggiest notion of what will happen in the future. Mark that word—nobody! Thus the successful trader bases no moves on what supposedly will happen but reacts instead to what does happen.

Markets in essence represent participants’ best guesses about the future with the information and data available to them today. These collective best guesses are referred to as “consensus” to make them sound more authoritative. This is why surprises move market prices the most. Thus, knowing the consensus view and watching how reality plays out against that view, and the market’s reaction to that, is the best we can do.

And then this one:

#91 – If it appears that lots of bulls are long—be nervous!

In other words, when there is no one left to buy, and everyone has made a one-way bet long, i.e. every player who wants to be long is long, and there is the slightest surprise by the news, many rush to exits at the same time (fear is a bigger motivator for humans than greed; in this case fear by those fortunate enough to get into the trend early fear their profits will evaporate, and the Johnny Come Lately additions to the trend fear they have made a big mistake by finally capitulating near the end of a trend).

Thus, what might appear to be a minor disappointment to the consensus view, when everyone is one-way, often leads to a seemingly inordinate change in price, and even a change in trend.

We think we know the Fed will do some type of quantitative easing; the Fed Minutes released yesterday provided some clarity there, we think. We just don’t know how much QE they will do — $500 million, $1 trillion, $20 gazillion. But if we believe markets are discounting mechanisms, we should expect that much of this expectation is already embedded in the price of the dollar.

Once again, we don’t want to get in the game of top picking. And we don’t want to fight the trend or fade the Fed. But, we are getting nervous when we look at the positioning of euro bulls/dollar bears and the rising certainty the dollar has to fall in order to solve the world’s problems.