Talking Points:
- A drain on liquidity exposes a trader to faster moving currents and trouble positioning should conditions run astray
- Over the weekend, traders are essentially stuck with their trades until markets come back online
- Aside from developments that may arise, we have the French election this weekend that can impact more than EUR/USD
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Liquidity is vital to navigating the markets. When markets are too thin we run the risk of running aground. During full drains - as occurs during the weekends - there is no room to maneuver. Should anything catastrophic happen during that downtime, those holding exposure through the lull have little recourse but to hope that they can beat a hasty exit when trading resumes the following Monday. Liquidity also doesn't always exist at the extremes - fully topped off or completely cut off. This past week showed us a backdrop where holiday conditions had lowered the water level significantly but not enough to cause serious problems with event risk. Then there is the systemic rise and fall whereby we find ourselves in a historic drought where complacency has pushed risk exposure and lowered market participants' inhibitions.
Given the complete void during the weekend, traders should take additional caution with their exposure. For those with longer trade horizons (multiple weeks or higher), the natural scale of the trade with stops, targets and accommodation for drawdown imparts a natural tolerance for weekend uncertainty. However, for those with a shorter duration, it is often wise to exit a trade and reestablish it at the open Monday in Tokyo's session when it is clear that circumstances have not fundamentally changed. The cost of the spread and perhaps a few pips between Friday close and Monday open is worth the peace of mind. For risks, there are two general types: those that we can anticipate ahead of time and those that are complete surprises. When there is a high profile event due over the weekend, it would be more than cavalier to brave the storm.
Heading into this coming weekend drain, there is both known event risk and a considerable chance of unscheduled squalls. For scheduled threats, we have the first round French election. There is a consensus that moderate parties will be able to form a coalition and keep France on a 'tolerable' status quo track. That said, the polls are remarkably close between Macron and Le Pen with two other party candidates close on their heels. For the Euro, the implications are clear. If the election offers the same surprise outcome that the US election and Brexit have before it, the shared currency will be throttled. The impact will not stop there however. As the world's second most liquid currency; the Dollar, Pound and Yen will fill the repercussions. If the result is one that furthers the populism agenda, it could further collapse 'risk trends'. The implications are clearly profound. For unscheduled event risk - the threat is the leverage that a lack of preparation adds. Tension between the US and North Korea, Syria, Russia is just one possible node of trouble. We discuss the many times it is best to remove risk before the the weekend and the few times it is okay to hold in today's Strategy Video.
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