Wednesday, November 27, 2013

Our trades in Kiwi, Aussie and Yen | “Broad framing” and thinking in probabilities

 Our call on the AUDNZD was a prescient one and the pair is now more than half way to our first profit objective. It has broken through the well established support line at around 1.12.

Why did the AUDNZD pair break through this support (and go below it for the first time in five years), after attempting and failing to do so on four previous occasions since August of this year (see chart above)? The reason is the swap differential, a measure of the gap between the interest rates set by the relevant Central Banks, and its relationship to the exchange rate. It now transpires that the swap differential and the currency exchange rate between Australia and New Zealand has had a correlation of 97% over the last 12 months (National Australia Bank calculation). That means they are, to all intents and purposes, moving in lockstep.

Given the above and knowing the potential for further interest rate divergence, which we discussed when we first signalled the trade, it is reasonable to believe that the AUDNZD pair should fall.

The Japanese Yen

The USDJPY pair continues to advance after breaking out of the pennant that completed formation on October 30th. The rise seemed to stall yesterday but the upward trend is intact. Apart from anything else, this is the last week of the month, and the Japanese Yen is a real merchant currency. It has functions way beyond those contemplated by us currency traders, whose only object is to anticipate directional movement in order to make a profit.

Japan has a massive export economy. Every month, Toyota and all the other mega corporations that sell overseas find it necessary to pay their suppliers. This often means buying Yen. Of course they have their own treasury departments which attempt to hedge their exposure to the currencies of the countries into which they export but there is, inevitably, some balancing to be done from time to time.

Nevertheless, the upward trend, as mentioned, continues. The breakout from the pennant is well under way and has cleared the first potential resistance (point 1 on the chart). It is now negotiating the second one, at around the 101.50 level.

“Broad framing”, or thinking in probabilities

It must always be borne in mind that descriptions of individual trades, such as those above, are only for the purposes of what we call “studying the anatomy of a trade”. The calls above were made, not because we can see the future, but because the circumstances were recognised as representing High Probability (HP) trades.

Success in trading is dependent upon the trader being able to structure activities so that each individual transaction has the potential only to cause a loss that is small relative to equity amount, should it go wrong. Risk control and money management are central to this. There will be losses and these must be borne, both from the monetary and psychological point of view. This is what Mark Douglas (“The Disciplined Trader”) calls thinking in probabilities, and what Daniel Kahneman (“Thinking, Fast and Slow”) classifies as “broad framing”.

Knowing, or being told these facts, of course, is only part of the story. Implementation requires discipline and the correct mind set. The OmiCronFX algorithmic routines, and all the other aspects of what we teach, are designed to allow this to happen, so that consistent profits are the result.

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