Trading Lessons Learned by the DailyFX Team in 2009

One of the most important keys to successful trading is proper money management. Indeed, it’s essential to make a conservative use of leverage and always use stops to protect your account from sudden losses. For instance, in the first half of 2009, some of my analysts had a series of losing trades, mostly because we were holding long positions in the dollar. In hindsight, I think we should not be buying dollars while the US Federal Reserve was implementing quantitative easing and the US Treasury was printing money to pay for the massive stimulus plan. However, we can’t go back and change that and more importantly this is not the point that I’m trying to make. Instead, I’m trying to say that no one is 100% profitable, not even those gurus that sell their services for thousands of dollars. So, if you want to trade long enough to learn with your mistakes it’s essential to keep your position size according to you account equity and risk taking profile. In my case, despite the many months of losses, I managed to keep enough equity in my account to make a strong comeback in the second half of the 2009. In fact, what could have been a very bad year, ended up being my most profitable year so far. Happy Holidays and good luck with your trading for 2010!

Without question, my biggest mistake(s) this year was being too early (and wrong) in calling for a US dollar reversal-both in my analysis and my own trading.  I was ‘sure’ that the EURUSD had topped in June, then August, September, October, and November.  I was wrong, losing money and not sleeping well. The EURUSD market environment of June through November, and especially August through November, was a difficult one to analyze (at least for me).  From June 1st to the November high, the EURUSD rallied 7%, a decent 6 month rally but not impressive in the context of that time’s recent history.  In the six months before June, the EURUSD had experienced rallies of 17% and 14% with a 15% decline in between.  I expected that the high volatility environment would continue and assumed that each medium term reversal would lead to a larger decline (as had been the case for the last 11 months).  A larger decline did begin in late November but I was wrong for the better part of 6 months, which is a long time to be wrong in a highly leveraged market such as FX.  There are several lessons that I take from this experience: being early can be just as bad as being late; if you are sure you are right, you are probably wrong; do not ignore trend indicators.  Use a filter such as a 1 or 3 month moving average in order to keep yourself on the right side of the trend for a longer period of time.  For example, the EURUSD was above its 3 month (63 day) moving average for all of June through November.  It closed below the average on December 7th, at 1.4756.  Waiting until then before ‘turning bearish’ the EURUSD would have saved me a lot of money and stress; and finally simple is usually better. This sounds simple, but it is difficult in practice.

Looking back, 2009 was an interesting year. It was perhaps more straightforward and consistent than what I had expected. While it is my general rule of thumb that I do not fight larger trends, I spent the second half of the year looking for risk appetite to collapse and the US dollar to subsequently rally. However, as John Maynard Keynes said, “the markets can remain irrational far longer than you or I can remain solvent.” In fact, heading into the close of the year, I have maintained my bias on the greenback and risk trends. And, while the currency has started to show some signs of life, the more prominent trend in sentiment has yet to reverse course. Looking to the source of my counter-trend convictions, it is my fundamental half fighting my technical side. At the beginning of the year, the global economy was mired in the worst recession and just coming off the worst financial crisis since the Great Depression. Naturally a recovery from extremely oversold levels was warranted (a quick reversal was attempted and rejected in December) as things settled; but fear developed into a return to the market and then to outright speculation far more aggressively than the expectations for returns and lingering risk would suggest. Yet, this is an incredibly value evaluation: risk appetite is overblown. This is where you turn to technicals. Wait until there is a confirmed reversal in underlying price action (and not in just one security; but across the board) before jumping in on a fundamental position. This is a lesson I will be putting into practice in 2010 and beyond.

For the latter half of the year I was convinced that financial markets would once again falter, sending the US Dollar substantially higher against all currencies except the Japanese Yen. I was so sure in my conviction that I allowed it to color all of my analysis and made bad trades—buying dollars despite the clear strength of the trend in the other direction. This perhaps wouldn’t have been so bad, but when the turn finally came, I had lost so much faith in my analysis that I didn’t fully take advantage of the move.
The lesson learned was surely that, no matter how much evidence there was of a strong dollar reversal, I shouldn’t have pigeon-holed myself into a single bias. My trading account and certainly the strength of my forecasts suffered as a result, and I should have been disciplined enough to truly wait for signs of a turn. This would have allowed me to take full advantage of the year-end Dollar turnaround when the EUR/USD finally broke below my “line in the sand” at 1.4630.

As cliché as it sounds, 2009 proved to be a year that reinforced John Maynard Keynes’ infamous pronouncement “the market can stay irrational longer than you can stay solvent.” While thankfully my solvency was protected by a religious adherence to conservative money management techniques, the market certainly remained irrational far longer than I would have expected. Risky assets raced higher and the US dollar tumbled, seemingly going beyond the scope of any reasonable correction (which would have been quite reasonable after the sharp moves in 2008) despite this year seeing the first contraction in global economic growth in the postwar period. Indeed, global stock markets rose to the highest levels relative to earnings in nearly seven years. My commitment to the belief that risk-taking had gone too far, too fast while the greenback had become grotesquely oversold led to much frustration as trying to capture a turn from the bottom on the US currency continuously failed to yield positive results.

In retrospect, this experience brought with it a valuable lesson and an amendment to my trading strategy. Previously, I would develop a fundamentally-based world view and directional bias on major currencies and then use technical analysis to identify entry and exit points. Most often, this meant that my attention to the technical picture was most intense when entering a position and tended to become much less so if the trade moved into profit. Looking back over the charts, the signs of an emerging US Dollar downturn were evident, but I overlooked them as my focus centered on what I believed (and continue to believe) to have been the correct fundamental world view. However, as aptly noted by Bruce Kovner, “Fundamentalists who say they are not going to pay any attention to the charts are like a doctor who says he’s not going to take a patient’s temperature.” To extend this metaphor, I head into 2010 intent to check my patient’s temperature regularly throughout treatment rather than just for the initial diagnosis.

The biggest trading mistake I made during 2009 was getting out of positions too early. After identifying solid targets, I would allow brief periods of volatility to shake my conviction and take me prematurely out of profitable trades. It can be difficult to leave profits on the table when price action goes against you, but in the long run you will most likely have more losing trades then winners and if you don’t capture the full profit potential of your winners then you will ultimately come out on the losing end. Failing to determine whether you are a long-term or short-term trader could be a costly mistake. If you are taking a longer view, then you shouldn’t at times trade like a short-term trader. For instance, if your target is 500 pips away then you must be willing to except proportionate draw downs in order to reach your objective.  It is unlikely that you will see one way price action from the onset of the trade until the target is met. I typically do better with a longer-term perspective and therefore will take bigger positions when I see desirable set-ups. However, I often see opportunities based on event risk and short-term changes in sentiment that will provide potential for profits. On those occasions I will make smaller bets which cure my impulsive nature but doesn’t risk erasing all of my winnings from my longer-term positions.

The spillover effects of the financial crisis sparked extreme market conditions paired with increased volatility in 2009, and there are many lessons to be learned from the market reactions that developed throughout the year. There were some profitable trades that I failed to realize when implementing my usual trading practices which have worked well during normal market conditions, and I found myself increasing the flexibility of my strategies and tailoring them to adapt to shifts in the trading environment. While attempting to catch short-term tops and bottoms or adding to winning positions, increasing the leverage on the trade in expectations for a favorable move had become a habitual discipline given the large movements across the currency market, and in some cases led to substantial losses which could have been minimized.  Rather than keeping a fairly tight stop for leveraged trades, placing wider bands with lower leverage helped to avoid getting stopped out on sharp spikes in the exchange rate as well as the risk for loss, and has certainly helped to improve my turnover of profitable trades compared to the number of losing positions.

My trading methodology is contrarian based and as such, I will look to take advantage of extreme overbought and oversold situations in anticipation of a near-term necessary corrective bounce. While the methodology works quite well most of the time, there are those rare situations in which the irrationality of market price action takes things to a whole new level, with the market going hyper-parabolic and accelerating even further in the same direction despite already being severely overextended. This is what happened to me in late September 2009.

I had been watching the GBP/AUD cross closely and noticed that the market was approaching oversold levels. The market had already dropped quite sharply below key psychological barriers by the 2 handle and we were now trading in the 1.8800 area when the daily RSI crossed below 30. Everything was aligned properly and I then established a long position and was very excited with the prospect for an immediate bounce. However, this was not the case, the market continued to drop another 13 big figures down into the 1.7500 are before finally finding a bottom. While I was fortunate enough to place some stops, I made the fatal error of adjusting my initial stop-loss and provisioning for a bigger loss, which eventually occurred.

Here are some takeaways from this experience that I think are invaluable.  1) I would never put myself in a position in which I would be compromising so much equity in such a short time. At the time, I was up a good deal on the year and gave up a substantial amount of profit on this trade. 2) A trader should always be prepared for the worst case scenario and be able to price this in ahead of establishing the position, so that he/she is able to properly and confidently proceed. It is of critical importance to have a game plan when entering a trade and to never change your exit strategy once you have committed to this plan. Otherwise, you will be at risk to making a poor decision under pressure that more often than not will produce unfavorable results. 

The DailyFX Research Team Wishes You Happy Holidays!