Q&A

Q: What drew you to foreign currencies?

A: It really began as a passion for the financial markets in general, when I was in high school. I grew up in a border town (Detroit/Windsor) and my father, an engineer and a numbers guy, was in manufacturing at Ford in Dearborn, MI, while we lived in Windsor, Canada. He’d come home from work each night to dinner at a small table of eight kids
occupying its entire perimeter and arguing about something inconsequential. When my dad pulled out the days Wall Street Journal everyone knew to shut up. He would highlight feature global events starting with the front page, the third column from the left, and his favorite reporters, while explaining the importance of the issue from a macro global perspective. From there, he would proceed to the markets and begin explaining the major events impacting price movements on indices, oil, gold, interest rates, USD/CAD volatility and correlations between asset classes. I recall when I was about fifteen, following a divergence between DJ Transports vs. Industrials and its potential impact for DJIA movements into the future. Of course, it didn’t really mean anything to me at the time.

Bear with me here, because I’m going to make a point with this information. Most importantly, my dad taught us financial responsibility across the board. We had no hand-outs, no allowance and no contingencies, as such, and we were directed to where we could derive income to support our little kid and teenager lifestyle. I do not recall ever receiving $1 for a personal need. We were taught to earn it and that is a lesson I truly appreciate to this day. These life lessons were valuable, because it taught me the necessary skills to set goals, develop discipline, focus and understand the essentials of winning, a prerequisite to success in the financial markets.

In the 1970’s I came home from delivering papers one day and explained to my dad that I just made 10% off a customer on a USD/CAD FX transaction when the pair was volatile and CAD was strong. Joy filled his heart that someone was listening to him out of interest rather than obedience and from that point he’d stuff me with every financial periodical imaginable through my teenage and college years. I loved the information and began to connect global macro with what I was experiencing in my European travels on Canada’s Olympic Bobsled Team, but my passion for sport overrode my interest in settling down to work for a living until I retired from sport. In the meantime, I maintained a keen interest and study in the financial markets and in what was going on in FX, as I traveled. I knew the financial business was for me and I was always guiding my teammates on financial matters.

Initially, I wanted to become a financial advisor, but arrived at the conclusion that I am horrible at “selling” and was also discouraged by risk in equities, which I consider to be a bit of a fool’s game for reasons we won’t discuss here. When I retired from sport after my last Olympic games in 1998, I decided to further intensify my study in FX. The life and financial lessons I learned from my dad growing up combined with the personal and psychological skills I developed in sport offered a critical foundation and a rapid learning curve to connect with FX as an asset class. Moreover, I found FX to be less risky (volatility vs. equities, commodities) in an open and efficient marketplace, friendly for “non-institutionalized” participants. Once I realized the passion I had for FX, I started reading everything I could get my hands on to understand the industry both from a trading and research perspective. Currencies are effectively a direct proxy of the financial health and state of the economy. It is the most liquid asset class and all other asset classes
are priced in a currency. If one chooses to invest in a view about a specific country, the capital must flow through the currency, before a position in the asset class.

Currencies are liquid, efficient and less vulnerable to hidden or undisclosed risk events. Contrary to popular myth promoted by the uninformed, FX is a least risky asset class.

Q: I know you trade currencies in various time frames—day-trading to long-term investing and even asset protection using the currency markets. Can you tell our readers what are the most important factors for you when you make a decision to put on a long-term currency trade?

A: Risk is the number one factor when considering any financial transaction. When putting on a long term currency position it is important to determine the objective of the position in relation to ones current portfolio diversification including all asset classes. Further, determine the currency on which you are measuring your marked to market performance. If you are keeping it simple and using USD’s are your performance gauge, then for every currency position you take on, you are going short USD. Keep in mind that if you have $1, or equivalent, you have FX exposure in your portfolio.

The risk parameters must be customized to the investor profile and portfolio. Since the question was asked specifically what “I” would consider, we will look at factors that will apply to both our professional applications as well as for individual investor benefit.

Naturally, risk management and diversification are the priority in the trading model since one will not know for certain from which region the next major price trend will emerge.

The objective for the risk management system is to expose the portfolio to multiple potential market moves while limiting overall quantified risk. New position risk is limited to less than 1% of the overall portfolio value. We do not take on leverage in diversified cash positions unless there is a material positive carry with a view that the spread will
remain favorable to our exposed long position.

In general, the following core factors should be considered along with some ideas.

1. We seek regions that will offer greatest potential for capital growth and yield, while maintaining a stiff risk profile? Our long term model reviews regional growth prospects and potential for interest rate movements. We remain mindful of FX correlation with various asset classes or indices, in general. Risk and opportunity can be diversified in several ways, to name a few;

i) reallocate cash/fixed income into a foreign currency,
ii) Use a cash base as collateral to take a cross rate position with the risk being no greater than the collateral, which will diversify away from solely USD short risk, 3) Overlay strategies using a choice of options strategies or other derivatives.

2. Are we currently overweight our base currency and what are the risks in carrying that position? If your cash, equities, bonds, loans and real estate are all held in USD’s, consider diversifying.

3. Determine the maximum potential risk (loss) of the position considered within the generally determined window of the investment period.

4. What is the percentage weight the position holds within the portfolio?

5. What will you do if a market risk factor (commonly unforeseen) causes a shift in fundamental drivers against the view on which you originally took on the position? Will you overlay the position, reallocate risk or liquidate the position?

6. Assuming a risk position is a non-USD position; quantify a worse case scenario if USD should rally against the crosses.

In summary, we need regional growth/recovery prospects, yield and suitable risk profile.

Q: When you look at the world today, what are you most concerned about in the global macro-economic environment? (Situations, events, particular currencies, etc. however you choose to answer, but thinking 6-12 month at least view here)

A: In the current global macro-economic environment I have the same concerns as I did leading into the summer of 2007 when we saw the first sign risk aversion through funds of funds redemptions in week three of Aug 07. My concerns are also my secret desires. I would like to see a natural re-pricing of assets to reasonably fair valuation, if such a thing exists. Although necessary at the time, the global Central Banks band aid solution will only mask the problem and there will be consequences at an undetermined time.

However, as traders we cannot become mired in what does or does not make sense, rather remain objective while adapting a sense of the psychology and sentiment driving the market and weighing the potential risks of the current environment while seekingopportunities.

We currently hold the view that equities will either drift lower, or fall aggressively from current levels in H1 2010 on the same concerns that pushed equities lower in 08. With this view, we have scaled out of, or protected 90%+ of our risk positions, long AUD, NZD and some EUR. We remain long AUD against non USD and JPY crosses, with the view that AUD has the strongest fundamentals in the risk group of currencies and will see gains against its peers in a risk-averse event. We would like to see a pullback in risk to build new positions in AUD.

Concerning equity and FX correlations, should equities only drift lower, we are looking for FX/Equity correlations to dissolve and capital flows begin yield seeking. In this scenario, currencies at the bottom of the rate cycle will become attractive. If global equity markets begin to deteriorate rapidly, then the FX/Equity correlation is likely to tighten
driving USD and JPY higher, which will also present opportunities.


Q: What are you most optimistic about?

The first potential opportunity we are most optimistic about is a substantial USD rally in approximately H2 2010, or whenever the market offers. We may see some mini rallies beforehand. Fed Funds Futures prices are now indicating FED may signal exit strategies soon. The second possibility, a JPY sell off subsequent to any risk-averse move that
peaks JPY. As always, the question is if, when and how it will emerge and what will be the primary drivers. I suggest you continue to follow Jack for guidance on this one; he is one of the best in the industry. It is a wait and see game.

We will be on watch for several scenarios. A risk-averse move in equities will likely strengthen both USD and JPY and weaken risk currencies for the short to medium term.
This is not the substantial USD rally we will be looking for, yet. In this (risk -averse) scenario, we will look to build positions in the well supported AUD against both USD and JPY should our criteria be met. In this environment, the JPY should strengthen on risk aversion against weak JPY fundamentals, which will set up a short for JPY against USD and AUD (set up long USDJPY and AUDJPY), in particular. We look to sell into JPY strength primarily against AUD, NZD and USD in the coming year, but not yet. We are being patient on this one and hope not to miss it.

The marketplace is convincingly USD bearish, at present (as of week 2 November interview date), but not yet overwhelming. At the point when the market becomes overwhelmingly USD bearish as witnessed in Dec 04/Jan 05, we may see hints of rates coming off their bottom or some other self fulfilling market justified USD strength (get used to that). Possibly at the Christmas/New year peak)

Now the following concept may sound elementary, but it is a less popular tool I use in my trading, called “common sense.” Much like the dog who senses the flood and runs to the hills for safety. When I sense a market is exceedingly strong or weak, I will let it run a little further and look for the first sign of breakdown. Naturally, the fundamental and
technical aspects are put into the filter. The final surge in market psychology becomes parabolic as the masses convert, which pulls support from the trend, regardless of fundamentals. An emotional concept I also apply to my intraday volatility model, the more fearful the market, the more comfortable I become in taking on positions.

It is important for your investors to understand that the information flow can change our outlook dramatically. Almost certainly, the market will not develop in the exact manner proposed above. Keep in mind that the market absolutely will not move in the exact manner we envision, rather we filter the fundamental and technical information flow and remain sensitive to the psychology of the market that is driving sentiment and make decisions within clearly defined risk parameters as events unfold within the general framework outlined above.

Folks, this is unsolicited, but I recommend you follow Jack closely. Jack’s diligent research helps our team stay in connection with certain market events. I recall in 2008 we wanted to sell GBP/USD, but were not clear on all the facts. After reading Jacks summary in June or July, we sold it above 2.000 for a substantial gain.

Q: Your considered one the top teachers of trading, besides doing it every day yourself, can you tell our readers what is the single biggest mistake people making when it comes to trading currencies and what key things should they do to help them profit over the long run in this market?

A: Well, give me a minute while I try to decide which of the five single biggest mistakes is the single biggest mistake. There is a list on my website, which includes; market knowledge, independent thinking, trading model, risk model and discipline, to name a few. I also recommend they download an ebook titled “Face the Trader Within,” available in the free members area.

Perhaps sounding like every other list of “biggest trader mistakes,” I’d have to say success demands a clearly defined risk model. This subject fascinates me. If the major constituent parts of trading are fundamentals, technical’s, psychology and risk management, I am convinced that risk management is the easiest component of trading to understand. Risk is common sense, fairly simple numbers with an array of options to employ definitive risk parameters. However, the human persona has an inherent tendency to avoid risk activity and will avoid taking on the responsibility to thoroughly work through and engage risk provisions. So implementing a risk model is easy to understand, but most difficult to employ the discipline required. This same shortfall in discipline will also expresses itself in position selection, which is another subject matter.

The nature of risk avoidance in human beings draws a defensive response that denies its very element. So rather than dealing with its authentic and potentially very harmful presence of risk, the trader will aggressively seek the opportunity trading offers, which further increases risk and inevitably, failure.

Allow me to summarize with the following recommendations.

Learn as much as you can about the market you are engaged in. I will tell you thatreading Jacks materials, I continue to learn from his perspectives.

Think independently and use a filter while making investment decisions, understanding that no single view will be full in its accuracy. You are ultimately in control of defining your risk parameters and managing your positions.

Every participant has a unique understanding and view of the market. Every participant has a unique psychological profile. Use your strengths to find your niche in the market to draw out money. Your niche will be unlike any other in the market. Don’t try to duplicate someone’s thought process or decision making parameters. Have confidence in your own
decisions and position management. This is why I am able to lead so many traders to become financially independent, because I teach them about the market and all the micro details of price and order flow, give them specific strategies, and guide them in their development. Those who are I have trained well now feel eternally grateful to me, as I am
with my mentor, the greatest trader I’ve ever seen.

Try this little experiment… if you are long a position and the market is rallying, rallying and rallying some more, and just when you are so excited you start dreaming of how high it is going to go and start to calculate how much you will make when it moves higher. SELL IT! Then watch what happens. And the next time, repeat that experiment.

Over time, use your experiences to develop your trader self and your trading model.

Your decisions are a portrait of yourself. Trade with discipline.