Thursday, October 2, 2014

Are US dollar positions being unwound? | The effects on account equity

A few days ago we pointed to the fact that US dollar strength might just be about to turn (US dollar strength constrained by historic trend line) and, sure enough, yesterday and the day before gave us evidence that such a development might be in train. All the major pairs that contain the greenback went into reverse. The start of both a new month and a new quarter, as occurred on Wednesday of this week, is just the occasion for such a development if it was going to take place at all.

Any reversal in US dollar sentiment is yet to be confirmed, however. At the very least, the Non-Farm Payrolls report, due later in the global day, will have to be taken into account before any sure view can be taken. Given that the market now seems to have an appetite for a US dollar correction, any outcome that does not comfortably exceed 200k new jobs could result in a dollar selloff.

The effects on account equity

Open orders, which contain profits on paper, are part of the calculation of trading account equity. And the total equity is the amount that traders are most aware of. They naturally like to see it increase all the time.

This creates a problem when there is a reversal in trade sentiment, as might be happening now in regard to the US dollar, discussed above. In this case it is important to terminate trades. Unfortunately there will, inevitably, be a reduction in the account equity when this happens. All trades must go into reverse in order to signal that a change is taking place to which the system, in this case the Mandelbrot routine, can respond, and this reverse will impact the total equity amount. Both the EURUSD chart at the top and the USDJPY trade above show examples of how this works. And the effect will be multiplied by the number of open trades that are in existence. Some of these will be there is an effort to gain a degree of diversification but in a case like the reversal of US dollar strength, there will be little diversification – correlation will be the order of the day.

But the drawdowns must be taken and endured. The alternative could be a lot worse.

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