Thursday, May 29, 2014

Aussie dollar fails to oblige | Lessons learned

On Wednesday (May 28th) we took a number of positions in the Aussie dollar. We expected it to weaken. It was already in a downtrend against the counterparts we chose, the US dollar, the Canadian dollar and the New Zealand dollar. The price of Iron Ore, a major factor in the value of the Aussie, was and still is in major decline. The only report on the horizon was Private Capital Expenditure in Australia for Q1 2014, and we did not expect that to either be very good or a report that would have a major impact on the situation.

How wrong we were. Although Capex for the quarter under review, Q1 of 2014, came in at a level more than 4% worse than was expected, a survey of economists predicted that the figure for fiscal year 2014 – 15 would be a significant improvement. This crystal ball gazing alone, apparently, was enough to give the Aussie wings.

Lessons learned

The idea of taking three positions was to achieve a level of diversification in the trades. Two of these were under the control of the Mandelbrot algorithm and it decided to terminate one trade when the loss was around 1% and the other when it was somewhat less than that.

The one trade that was chosen in the classical manner was AUDNZD (chart above). It was a short trade (we expected price to go down). We chose our entry point and placed the stop loss order well above both the most recent highs and the 200 Day Simple Moving Average (SMA). As always the amount put at risk in a worst case scenario was 2%.

The worst case came to pass.

A review of the trade tells us that the stop was too tight. The chart below shows where it should have been. The price indicated is a much more fitting candidate for a resistance level than the one chosen for the trade. This is most apparent on the weekly chart.

True, abiding by the principle of putting 2% at risk would have meant a smaller position size, but that would not have been a bad thing in itself. The trade would still be alive and would have an excellent chance of coming back into profit. As it stands we must endure the full extent of the 2% loss on this trade.

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