Trading GBP/JPY

Some time ago I wrote about GBP/JPY. Today I received the following eMail:

i really like the way you descibe gbp/jpy in the blog globetrader and i really want to learn more about gbp/jpy market as the way u seen it or trade it...do u have any system,e book,or whatever that can enrich my knowledge on this gbp/jpy market.. i only trade on gbp/jpy but only a small trader and plan to increase lot by few months.

The system, the things I look at in trading can be found in my blog. Sometimes I rearrange them, put things together in a different way, but they are all there. I’m trading for some time now and the longer you trade the more you will find that there is nothing new. Just ways to look at things this or that way.

Sure not every market is the same. Some markets move slowly like a big river, others move fast, but still predictable and then there are markets which are just too fast to trade, which have swings you can’t survive in the long run.

GBP/JPY is called the widow maker…and for a reason

I hope you have learned already that there are major pairs in Forex trading and then there is the rest. Some pairs of this rest are still traded very active, but with the exception of a few days and weeks they are at the mercy of the majors. The 6 (eventually 7) majors are all traded against the US-Dollar and they are EUR/USD, JPY/USD, GBP/USD followed by USD/CHF, USD/CAD, AUD/USD and the last NZD/USD. You might add the Renminbi, but as the Chinese currency is not free floating, it’s not(yet) in the list.

EUR/JPY is the major cross-currency followed by a big gap and then the GBP/JPY and the EUR/GBP, followed by the other former carry-trade currencies (AUD/JPY CAD/JPY and NZD/JPY). Other cross-currencies I would just not look at, as they are not actively traded.

What is the difference between a cross-currency and one of the majors? Why do I have to concern myself with the GBP/USD market if I want to trade the GBP/JPY market (or the USD/JPY market)

Unlike other markets the FX market is interconnected. There are no imbalances. Every cross-rate can be expressed by looking at each of the two against a third currency. And guess, what that third currency is? The US-Dollar as the most liquid currency in the world.

Assume you are a big player being in need of Japanese Yen and what you have is British Pound. You go ahead and trade British Pound against the Yen? I wouldn’t guess so! You would crush the market, actually you wouldn’t but only because all other big players would compensate for your folly and let you pay for it. You not being dumb will avoid that folly and you will first trade your GBP against the USD, which might move the market by a few ticks but nothing major and then you will trade the USD against the Yen, which will result in nearly no movement at all as the USD/JPY market is extremely liquid and as big as your trade might seem, it’s just a small one compared to the daily total trade volume in the USD/JPY market.

But your trade will still influence the GBP/JPY market as the GBP/JPY exchange rate will not be found by market forces of Buyers looking for Sellers or vice versa. The GBP/JPY exchange rate is found by doing the following calculation: GBP/JPY = GBP/USD * USD/JPY

And if there is any deviation at all from that mathematical result (maybe caused by market orders which bring the GBP/JPY market out of line) then arbitrage programs will make sure, that the GBP/JPY exchange rate will be back at the mathematical correct value in no time at all. Any deviation from that value is riskfree money. A deviation from the correct value of 0.0001 times 10.000.000.000 is a huge amount of money, which arbitrage can give you absolutely riskfree. So if you want to trade GBP/JPY you actually are trading 2 markets: The GBP/USD market and the USD/JPY market.

If you can do that and if you can read both of these markets without a problem, then go ahead and give yourself the new challenge of trading the GBP/JPY market. But if you are new or just not as experienced, then I would suggest you first master the USD/JPY and the GBP/USD markets before you take a look at the GBP/JPY market. Yes you can make fantastic profits in that market, but can you survive 50 to 100 pip moves against you, which are just a wiggle in the longer trend? Will you be able to use adequate Stops in that market? Are you prepared for the spike in GBP/JPY if GBP/USD trades up to 1.4710 while USD/JPY trades at 90.60 and can you tell me without a second thought what direction the spike in GBP/JPY will have, when GBP/USD and USD/JPY both retrace, when GBP/USD retraces back to support at 1.4660 while USD/JPY remains in the 90.50 to 90.70 range. Do you know what Stop to use, when you are long GBP/JPY at 133.25 in that scenario?

Do your account a favor and master the major pairs first. GBP/JPY will still be there, when you are ready to trade it.

EUR/GBP parity

Any chance at all for P A R I T Y. Not within a day. Expiration games carry only so far and December 19th went without a spike for parity, instead we saw a pull-back. But there is renewed talk in the media calling for parity and the pound joining the ECU. It will take some time, but parity is sure in the cards now.

Take a look at this parabolic move:

Is the Euro really that strong? Isn't the EU in as big a mess as the US. Obviously not, at least if you look at the exchange rate. My article on November 25th  was prophetic. But I did not expect such stellar returns. I'm just glad I followed my own advice at least that much, that I converted my account to Euro, when the Euro broke 1.31. I did not hold additional futures, but at least I did not lose on the US-Dollar depreciation.

But when will it stop?

Markets can remain irrational a lot longer than your account can survive. Still there is strong resistance 200 pips ahead from that top made in the down move. And I expect the Euro to stop and retrace from there down to at least 1.40, which would form a very clear inverse Head and Shoulder pattern on the daily and the weekly chart, something not seen very often.

At the same time the Euro/GBP exchange rate is on the move. London isn't at all unhappy about the weak pound to help it's ailing economy. Add to that, that it might economically be in the interest of the UK to join the ECU and a move to parity wouldn't be such a bad thing to convince our British neighbors to join the ECU.

Just 570 pips to go.

1x1 of ETF trading

ETF is not ETF.

There are regular ETF's. These move in value comparable to the underlying index. A prominent example are the Spiders (SPI) or the Diamonds (DIA) which mirror movements in the S&P500 and Dow Jones index. So 1 point up in the S&P is a 0.1 point up in the spiders. No problems here. You may stop reading, if you trade just these. This article does not apply to these regular ETF's. Just make sure you have just these regular ETF's in your portfolio.

But there is a new kind of ETF's. These ETF's move the same percentage as the underlying index. Meaning if the underlying index moves 5% up, then the ETF also moves 5% up. If it's 5% down in the index, then these ETF's move 5% down as well. There is also a very hip breed of these percentage based ETF's, which give you double or triple the percentage move of the underlying index.

These percentage based ETF's show certain characteristics, which makes them great trading vehicles for short term swing trading, but make them very dangerous for investment strategies.

Let's look at a few examples to show my point:

You are long 200 DDM (Dow30 Ultra 2x long) ETF at 30.00.

Now consider two alternate scenarios:

1. Monday the Dow rises 5%, Tuesday up another 3%, Wednesday up 0.35%, Thursday up 2%, Friday up another 2%

or

2. Monday the Dow rises 2%, Tuesday up another 5%, Wednesday down 3%, Thursday up 5%, Friday up another 3.35%

Can you tell me which scenario your account likes better?

Lets look at another example:

1. Monday the Dow rises 10%, Tuesday up 0.5%, Wednesday up 0.5%, Thursday up 0.5%, Friday up 0.5%

or

2. Monday the Dow rises 2.4%, Tuesday up 2.4%, Wednesday up 2.4%, Thursday up 2.4%, Friday up another 2.4%

Or can you tell me how it is possible that a Long ETF and a Short ETF both starting at 50 when they start public trading, today trade both below 50, even if they both move the same percentage points?

EG: Long +10% is mirrored by the Short -10% and it is every day the same, still you can have both ETF's trading below 50. Is it all a sinister fraud a conspiracy to get your money? Or is it something different?

(First you have to remember, that a Ultra 2x ETF will move twice the percentage points the market made

Long DDM	30.00	1. Alt	Price	2.Alt	Price
Monday		10%	33.00	4%	31.20
Tuesday		6%	34.98	10%	34.32
Wednesday		0.7%	35.22	-6%	32.26
Thursday		4%	36.63	10%	35.49
Friday		4%	38.10	6.7%	37.86
200 Long			7620.00		7572.90
Paid			6000.00		6000.00
Profit			1620.00		1572.00

Interesting what that one down day made to your total profits, even if the percentages in both scenarios added up to 24.7% up.

Let's look at the second example:

Long DDM	30.00	1. Alt	Price	2.Alt	Price
Monday		20%	36.00	4.8%	31.44
Tuesday		1%	36.36	4.8%	32.95
Wednesday		1%	36.72	4.8%	34.53
Thursday		1%	37.09	4.8%	36.19
Friday		1%	37.46	4.8%	37.93
200 Long			7492.00		7586.00
Paid			6000.00		6000.00
Profit			1492.00		1586.00

 

Both percentages add up to 24% upmove, but in the first scenario we had a big upswing and then consolidation with an upward bias, while the second scenario was a typical rising market, nothing spectacular just relentless upward. The percentages add up to the same amount, still the results are different.

As far as I can see at the moment, ETF's are great for trading, but you don't hold them and forget them. Especially when you do some calculations to find the answer to my third question.

Why can 2 ETF's, which are supposed to mirror each other starting from the same price at 50.00 both trade below 50 after a while?

Meaning, if you invest 100 in the ETF long and 100 in the ETF short, your net should remain 0 after 1 or 2 or 10 years. But that is not the case and I hope you have an explanation as the answer might result in the decision to go short the Short ETF, when you intend to go actually long or Short the Long ETF, when you want to short.

That way you would trade the fund side of the ETF investment game and no longer the investor side. Investors buy either long or short ETF's, the Fund sells them and is therefore always Short.

Let's look at an example I just made up to show my point:

Assume you have a long and a short ETF and both started trading on 1.1.08 at 50.00.

We had a bit of a buying spree at the beginning of the year, reality setting in after 3 days and the market retracing over the next trading days, then just regular market madness, nothing spectacular, nothing you wouldn't expect from today's trading ranges. My example shows a regular and an Ultra 2x ETF. As you see, the Ultra results are just more pronounced.

Now within just 17 trading days an investment in 100 shares (10,000$) each of the Long and Short ETF is down 231$, in case of the Ultra you are down 902$. If you have 2 accounts and in one account you go long 100 shares of the Diamonds and in the other you go short the Diamonds. What is your net after 17 days, assuming an initial investment of 10,000$. Sure it's 10,000$, any gains in one account will cover the losses in the other account.

With ETF's it's different. Sure you get the expected result, if you go long 100 Long ETF in one account and short 100 Long ETF in another, but that's not how it is sold to the public.

The public goes long the Long ETF, if they think the market will go up and it goes long the Short ETF if they assume the market will go down ultimately.

Btw: The results are nothing sinister, no conspiracy, just the way ETF's are setup to trade. They mirror percentage moves and that means ETF's will always fall faster than they go up. And the higher the leverage, the more extreme the results.

50 -10% = 45.00
45 +10% = 49.50

Who is gaining? Well the Fund companies selling these ETF's of course. They are short the ETF's you go long and if you are down 1000$, they are up these 1000$.

But can't they lose? Sure they can. But in the long run statistics make sure, that any ETF will be likely to fall below the price the fund opened trading.

DUG is the Ultra Short 2x Oil & Gas ETF and you would assume that contract should be trading above it's highs

DUG started trading at 69 in February 2007.

Despite the huge downward move in the Crude Oil price reflected in the Long Ultra Oil & Gas ETF (DIG) The corresponding Short ETF (DUG) is down. An investment of 100 shares in both the long and short ETF at the start of trading in February 2007:

100 DIG at 60 = 6000$

100 DUG at 68 = 6800$

Total 12800$

Today's value:

100 DIG at 27.35 = 2735$ Down 3265$

100 DUG at 32.99 = 3299$ Down 2701$

In other words, Going Short 100 DIG in February 2007 and going Short 100 DUG in February by selling you your position in the Proshares Fund has made the ProFunds Distributors, Inc. 6834$ (excluding commissions).

6834$ on an 12800$ investment in 1 and 1/2 years.
That's a 53.4% return on investment. Not bad, really not bad at all.

So shall you go Short the Short ETF, when you think the market is going up and Short the Long ETF, when you think the market is going down? The results point in that direction, especially if you intend to hold your ETF's for the long run.

ETF's favor the Fund company, if the market moves against the ETF (meaning the market is going down and you hold a Long ETF. Just look at these beaten down ETF's I have told you in recent articles about: DXO, UYG or URE). But they have great leverage and they will bring you good profits if you swingtrade them. Actually if you trade futures and you want to expand your trading into swingtrading, ETF's are a great way to do it. You are used to watching your positions like a hawk. You are used to fast adverse movements, which require instant action and you are not likely to panic in case the market is not doing what you expect the market to do.

Just know that the odd's in ETF trading favor the short side, that any long gains are most likely temporary, and even when an ETF trades 100% above it's initial open price, don't expect these gains to hold. Adverse percentage moves will make sure, that these ETF's can fall extremely fast and hard. A lot faster than stocks will fall.

DXO - a 2 x Ultra Crude Oil ETF

I received this question regarding my last article:

Looking at the daily chart it looks like that price you bought at is near to a 1.272 extension at 2.57 the 1618 is at 2.18. Buy more ?

First the answer: Yes I intend to buy more DXO. As written all ETF positions have a target of 1000 shares initially. I just decided to scale into these positions as otherwise the daily movement will affect my daytrading as long as I have no segregate account for these swing holdings. In addition I don't see an up- and away type of market, but further consolidation in huge ranges before the market will be able to take off again. Too much damage has been inflicted in too short a time.
While the UYG position has options available so I get paid for my willingness to build a position, the DXO has a different rationale.

Looking at the above chart, short is the only way to go and where DXO a regular share I would go short and stay short until the company filed for chapter 11.

But DXO is no regular company, it mirrors the development in the Crude Oil market. And it is supposed to make a daily percentage move twice as big as the crude oil market is doing.

Will Crude Oil go to zero? A limited resource the whole world depends on. You really believe that then go ahead and short DXO.

Crude Oil is a limited resource and the moment the economy starts going again, we will see new highs in oil. It's just inevitable. I don't care if it's in 6 months or 3 years or 10 years, oil will go up again unless someone discovers a way to make oil from saltwater. But why would someone do that? With oil below 40$ in the short term? It makes no economic sense whatsoever!

Right now there is no reason at all to invest in oil or the oil industry. And the moment we need oil again, the world will find, that -what a surprise- there is not enough oil to bolster the economic upturn.
As I said, I don't know when it will happen, but I'm quite sure it will happen.

Friday the first call was made for oil below 25$...you remember what happened, when the oil 200$ calls were made? It wasn't long after these, that the market started to break down.
Surprise.. it were the big investment houses, who made these calls. And who was on the other side, if you believed that oil 200$ call and went long?
Who is on the other side, if you go short oil now? I won't bother you with the answer, but I bet you that even if Goldman is now a regular bank, they still have an inhouse department going against the mainstream. And that department might save the day in one or two years when their oil profits will pay for all the losses made in other departments.

DXO at 2.50 has a very limited downside. Sure it takes a while to go up again, sure Ultra ETF's fall faster than they rise as a 25% move down from 5$ brings it to 3.75$, while a 25% move up again from that level brings you to 4.68$ and not 5$.

So what! If oil goes really down to 25$, then I will have added to DXO at 2.25$, 2.00$, 1.75$, 1.50$, 1.25$ and 1.00$.

	Shares DXO	Price	Total
	200	2.59	518.00$
	200	2.25	450.00$
	200	2.00	400.00$
	200	1.75	350.00$
	200	1.50	300.00$
	200	1.25	250.00$
	200	1.00	200.00$
Total	1400	1.76	2468.00$

When oil is down to 25$ I will be down about 1500$ in my position as it will be worth about 900$ total. Should this happen I will still sleep sound as the size of the position will not affect my trading. My risk is really limited and to tell the truth I actually would like to see oil at 25$ to build that position. I have a bigger problem, if oil starts to rally now and I add to my position in a rising market only to see it come back down in spring and retest the lows made now.

Investment Plan

Today I decided how to handle this investment idea in the future.
(Part I, part II, part III, part IV)

1. I won't trade 10 cars (as I did last month, when I sold a great UYG long for a meager 30% gain instead of holding it for possible 120%, just because the position was affecting my daytrading).

I start with 2 cars and add to them. That way, my positions initially will be just take and forget positions, which is exactly what I want them to be in the start.

2. I will open a second account with IB, where i will park these position trades, so I'm not always tempted to daytrade them, something I just can't stop myself to do.

3. I will look for these extreme beaten down Ultra ETF's and start long positions in them. As I said I will start with 200 shares of the selected ETF and sell 2 in the money puts into the next expiration.

4. I will add to my position every 5.00, 2.50, 1.00, 0.50 or 0.25 USD down depending on the initial price I got for my position.

5. I plan for a maximum holding of 1000 shares in any selected ETF and will plan my add-on strategy accordingly. Regularly add-on's shall be made monthly by being assigned the shares against the in the money put's I sold. But I'm not prohibited to add to my position if an opportunity arises.

6. If prices go up, I will buy back my put and sell the next in the money strike to the upside, to make sure I get my add-on at expiration.

7. I will never add twice within a day.

 

I started this plan today with

200 DXO at 2.59, the 2 x Ultra long Crude Oil ETF (no options available on that one) and

200 UYG at 5.53, the 2 x Ultra long Financial ETF and

I sold 2 UYG Puts Strike 6 at 0.90

 

My homework over the weekend will be to identify other likely candidates for my investment plan. A list of available ETF's was recently published by Leavitt Brothers and can be found here.