The Way Of The Dollar Part 5

The model currency trader might make a dozen significant trades in a year a"by significant I mean not backing hunches but trades in which he/she backs conditions where aall the pieces fita, Two or three of these trades will account for most of the yearas net trading profit: of the remainder , perhaps 4 will make money and 5 will lose money and they may more or less cancel out. And this he will do year in year out a" shooting 69/71/70; very rarely 64, and when he shoots 64 it will probably be because he wasnat stretching himself and didnat feel he was running much risk a" like the Zen archer* who hits the target with actually taking aim.

CHAPTER NINE.

The most remarkable performances in the investment world in recent years have been achieved by people, or .funds, operating in the .futures markets a"and increasingly in financial. futures. George Soros* was a pioneer in what me might call aThe New Investment Way. a The currencies markets have been central to the investment approach of Sorosa Quantum* Fund, in which James Rogers was a partner for a time, and which grew from a few million to over $2bn. Currencies are the most important market for Bruce Kovneras Caxton Corporation, which has overtaken the Mint group in size. The success of these .funds should have changed the way people think about currencies. But the change is coming about very slowly.

A freight agent in the Persian Gulf was chartering planes to bring in electrical equipment. The agent paid his charter cost in dollars but agreed to accept payment for the freight in Belgian francs. On one occasion, a sharp rise in the dollar cost him all of his profit margin plus about the same amount again. He resolved never to expose himself to a comparable currency risk again. Moreover as he pondered the way a move in the dollar had amounted to twice the profit margin on the freight, he further resolved to study the currency markets in depth; and in due course, perceiving that there could be no half measures with currency risks, he left the freight agency business to devote all his time to the a.n.a.lysis and trading of currencies.

The first thing we have to decide in currencies is once and for all to separate occupational risk from performance aims. Occupational risk is exposure incurred as a by-product of your situation a"whether it be the commercialas problem of currency receivables and payables or the investoras risk in holding foreign a.s.sets or liabilities. Performance is to do with making money .Bankers usually blur the difference. But you and I should have no truck with fuzzy thinking which encourages one to muddle riska" perception and performance: you end up muddling fear and greed.

Itas up to you to decide what occupational risk you can stand: what you canat stand you should eliminate by hedging, taking into account the costs involved. Having done that, you are free to pursue performance any way you like. This book is about the pursuit of performance in the currency markets; and this chapter is about how to set about it in practice. Itas addressed to investors, to fund managers including treasurers, to other speculators, and to commercials concerned with the timing of currency purchases and sales. Youare already on your way to being knowledgeable a.n.a.lyst and a keen forecaster .

Trading forward, trading future

You can deal in the currency markets in 3 ways a" cash*, forward* or futures*. The cash (or aspota, as in cash-on-the-spot) and forward markets are made by banks: they decide the rates at which they will deal. They have no currency aexchangea, in the way you have a stock exchange, or a futures exchange. The equivalent of a quotations board is the video screen where the buying and selling rates of specific banks in specific financial centres are purveyed through the agency of Reuters, Knight-Ridder and others. This is the so-called ainter-banka market.

Interbank Market.

The banks provide a very compet.i.tive service to large clients who are able to pick and choose between their quotations, as multinationals are and as brokers are; and they provide the only service for the aspota market, and for all currencies other than the main areserve*a currencies. But for centuries, people have wanted to settle their commercial dealings at a future date a"to pay for the goods a after the s.h.i.+p comes ina, for example. However they often wished to settle the rate for conversion between two currencies now. This is just the kind of thing bankers are happy to do if they are handsomely remunerated.

So for centuries bankers have been quoting rates for forward dates. This is the forward* currency market, in which rates are quoted for almost any date in the future. The way forward rates differ from spot rates has been described in Chapter IV .It is determined mathematically by the difference in interest yields on the currencies in question: if 6-month interest rates on the two currencies happened to be exactly the same, the 6-month forward rate would be the same as the spot rate.

In the early 1970s, after currencies had begun to float, some luminaries in the futures markets of Chicago said aHey! Why donat we start up a futures markets in these currencies, just like in corn and hogs.a There was no reason why not. To Chicagoans, and Texans and Californians et al, foreign currencies were not that different from corn and hogs and copper and gold, and few Americans knew much about the interbank market in currencies. So they went ahead and the first financial futures were born a" to be followed by futures in T-Bonds and stock indices and Eurodollars and the rest.

IMM Futures Market.

The currency futures markets in Chicago thrived, partly because of the thinness of the interbank currency markets in North America. Of course they quoted the foreign currencies in dollars and cents, just as they quoted hogs and corn in dollars and cents. So their method was to quote the D-Mark as, say , l DM = 29.5c or $0.2950, rather than the European way of $1 = DM 3.390. And the future settlement dates were fixed at specific quarterly dates in March, June, September and December. But in other respects, the afuturea was much the same as the forward. And if the price of mid-June D-Marks got too high in relation to the forward interbank rate, someone would arbitrage* the difference by selling the future in the IMM* (International Money Market) exchange and buying the forward in the interbank market.

Contrary to the conventional wisdom prevailing in Europe, I suggest you donat deal in the forward interbank market, unless you deal in very large size, through a broker or through a fair selection of banks, who will accommodate you through most of your normal waking day (see Chapter One). If you deal in the futures market, one broker should suffice. The one essential you seek in your broker is immaculate execution. Thatas all. But it does include always answering the telephone instantly; being available from 7.30 am a" 8.30 p.m. London time; offering 24 hour execution of stops; and complete honesty in all things, notably in the matter of the price at which your trades are executed.

In addition to the big US brokers, such as Merrill Lynch, Prudential Securities, Shearson-Lehman, there are many smaller outfits which can offer a more personal service at compet.i.tive commission rates. See abroker*a in the Glossary. Some of these advertise from time to time in the financial papers.

The 24-hour day covers Singaporeas Simex* futures market as well as Chicagoas IMM: the currency contracts at Simex are interchangeable (afungiblea is the technical term) with the IMMas. But in addition, the so-called EFP* market offers IMM quotations at most times when an active interbank market exists somewhere in the world. EFP stands for aexchange for physicala: the EFP market consists of a number of specialist market-makers, who are in the business of arbitraging between futures contracts and the aphysicala interbank forward markets. Like the banks, they make their turn on the aspreada between offer and bid prices: the spread is usually 3 to 5 points (as opposed to 1 point in the IMM) a" i.e. $37.50 to $62.50, on contracts of $70,000-$120,000 a"which is very compet.i.tive with the spreads quoted by banks for such amounts.

The amount of currency exposure a bank will allow you to run is a matter for negotiation. The IMM operates a amargin*a system, as do all futures markets a" margin being money you have to ante up to cover the risk in a futures position. The margin for the currency contracts a" DM, SF, , Yen, Can $ and Aus $ a" varies around $2,000, which is a mere 2 or 3% of the contract value. If you have any sense, you will never care a" or even know a" what this margin is. It bears no relations.h.i.+p to the kind of gearing or leverage with which you can expect to trade profitably. Not being in the business of blind gambling, our inflexible rule must be: never , ever, risk a margin call*. Itas difficult enough to win without such an extraneous constraint which abolishes the use of judgement.

We know the currencies can fluctuate up to 5% in a day, and we know we may well wish to hold our position in the event of such a fluctuation against us. Itas a good idea to hold a balance in your brokerage account of 10% of exposures ($10,000 per contract on average in round figures), in US dollars; and to limit overall exposures to a maximum of 3 times oneas overall liquid capital. In other words, keep 30% of your liquid capital in the brokerage account, if your exposures are likely to run up to the recommended limit. You should earn proper interest on funds in excess of margin requirements with your broker.

Position Size*.

Experience shows that to trade the multi-week swings successfully, you have to be prepared for drawdowns* (paper losses) in double figures if youare running to 3 to 1 gearing (leverage), just as a result of the natural fluctuations in currency holdings a"that is without even making mistakes. Getting reconciled to that is a major step on the road to winning, I think. If we cannot accept it, we cut back our gearing.

Achieving currency exposures of up to three times oneas liquid funds with a deposit of 300/0 of those funds with a broker is a reasonably conservative approach. At the other extreme is the investor who has a lump sum in cash and has settled for depositing it in one or more foreign currencies, aiming thus to secure diversification and protection from a decline in his own currency.

You can also do your sums by long division on paper, and go to work on a horse. If you chose to proceed in this way knowing about the capabilities of calculators and motor cars, thatas fine. But there are many people out there who think futures are just intrinsically dangerous a" as people once thought about motor cars. And the fact is that not everyone knows that you can get all the currency exposures you want in the forward and futures markets without tying up all your cash. And once you know, you see that you can do much more in the futures and forward markets than you can do with cash. In fact, you can get all the exposure you want in the futures markets to most bond markets and most stock markets. And I personally can see many advantages and no disadvantages to going about it this way.

The New Way to Invest

Consider an investor in Britain a" call him Altman a" with 250,000 (say $420,000). He holds 100,000 in gilts, 50,000 in US bonds, 50,000 in D-marks and 50,000 in cash. His investment income (early 1991) is 25,000. He has cashed in his stock market holdings, and believes most stock markets are too risky. He also believes the dollar and sterling are both vulnerable against DM and Yen. So he thinks he may lose out on his US bond holdings.

Now consider another British investor with 250,000, called Newman. This is end-March 1991 and UK interest rates are still around 14%. He has 200,000 on deposit with Swiss Bank Corporation (an AAA-rated credit risk). The other 50,000 is held in a dollar account with a futures broker. His investment income is 32,000.

His investment views are much the same as Altmanas. In his brokerage account he is short a couple of Long Gilt futures (90,000 a"$175,000); long two US T-Bond contracts ($190,000) and a German Bund contract (DM 210,000 or $120,00). He also has 8 IMM Yen futures ($720,000) and 2 DM futures ($145,000) and is short 2 pound contracts ($240,000). He is planning a put option in the S & P US stock market future.

Altman is no fool. He knows that the kind of returns stock markets a"and the property market a" offered in the 1980s are non-recurrent. His target is a 15% total return on his money, and perhaps heall make it.

Newman is no fool either. In the past5 years, he has parlayed 100,000 into 250,000. He reads all the good books on investment as they appear a"particularly those on trading futures. His target for the next 5 years is to turn his 250,000 into lm and for the next 10 years into 5m. He knows something about risk, having lost a bundle in high-tech stocks in the 1980s. I think maybe heall make it.

Using Currency Options

As a matter of course, currency options* are not a solution to the problem of currency risk, or of normal adverse fluctuation (drawdown) a"though useful to traders who place a high value on having maximum loss defined. Ideally, options should be used as a tactical weapon, particularly when bottoma" fis.h.i.+ng. There is little to be lost and something to be gained by using more distant option maturity months a"the most distant consistent with market liquidity. Beginners are drawn to the nearer option months, because the outlay is smaller. This tends to be a false economy.

Numerate readers may be drawn to the idea of selling options rather than buying them a" feeling that this way you tip the odds in your favour.

From experience, I donat recommend it, for two reasons. 1) The price of currency options doesnat justify it. 2) It distorts your trading judgement: and we have too good a forecasting system for the dollar to want to jeopardise it for the sake of a couple of percentage points!

The best way to get a feeling for the valuation of options is to consult the pages of the Wall Street Journal regularly. The IMM options on futures are much more liquid than the Philadelphia variety, which are convertible into the cash currency: stick to the IMM. Three-month options aat-the-money*a cost a little under 2.5% of contract price in normal times. My rule of thumb for valuing options is to take the 2 calls and 2 puts at strike* prices nearest to the current market price and divide by 4: then divide by the market price to get a percentage figure.

The tactical use of options? We want to use options when they are economical, relative to using outright futures or forward positions. The acid test is that they should reduce our stake, for a similar reward. Our stake is the amount we are prepared to lose if a trade goes wrong, and it can be defined by our stop-loss limit on outright futures. In cases where we see fit to place our stops rather deep, the use of options may prove more economical. You can calculate on the basis of 2 at-the-money 3-month options per futures contract or the equivalent in the forward market. Itas not a bad idea to calculate the sum in actual dollars. An IMM option standing at 100 costs $1,250.

The other aspect of options is psychological. Our system of a.n.a.lysing the currencies is designed to aget us in at the starta of a new move. That means we are often abottom-fishersa whether we like it or not; and we know we canat catch absolute bottoms. So we have to cope with the kind of volatility you get at bottoms (or tops: thereas no distinction in currencies) a"which can be a stomach-churning exercise. With this, options can help greatly, because they lose value increasingly gradually in the event of adverse price movement. Conversely, when the script is right and the gamble pays off, options gain value at an increasing pace. Thus our dollar exposures increase and that can help to remind us a" when weare in danger of thinking weare smart a" that our risk has risen geometrically. So weare positively encouraged to take partial profits, which is alright as a percentage play.

CHAPTER TEN.

aThe perfect speculator must know when to go in; more important he must know when to stay out; and most important he must know when to get out once heas in. a Attributed to JAY GOULD

Getting In.

Perhaps we should considera staying outa before considering agoing ina , for as Jay Could said, knowing when to stay out is more important. But the rule for staying out is simply ado so unless all the pieces fita. So there we have it. Unfortunately itas a rule that almost everya" body has to learn again and again and again.

The apiecesa have been described in earlier chapters: they are our friends A) the main trend and its underlying rationale and B) the 4 sentiment indicators, that tell us how near to an extreme turning point we are.

In the summer of 1989, as we know with hindsight, the 18-month-old slide in the European currencies was coming to an end. At the time, the signs were tentative: what we saw at the end of May 1989 was 1) that the interest rate differential between the dollar and the rest had narrowed significantly (from 4.5% to about 2% in the case of the D-Mark); and 2) high bullish sentiment in the dollar, as reflected in CBas sentiment gauges.

Well, there are no such things as certainties in financial markets (when the dust has settled, the train has left the station). But all the pieces suggested at that point that some kind of extreme in the dollar was close: high bullishness of the dollar was accompanied by substantial short positions in the Chicago currency contracts. That called for immediate action to liquidate all long dollar trading positions: that means that treasurers and other speculators go aflata, while investors cut back to acorea positions, which are those positions which they are happy to hold through a multi-week correction of maybe 10%. We canat see into the future: we do not know whether the main trend is threatened. Stage I, getting out of the old position, is the first step in agetting ina to a new one. It helps you to look both ways a" up and down a" rather than just the way you were facing before. Having got out, there is a good case for staying out longer than you may be inclined to. This is a hundred times easier to say than to do.

If we use sentiment gauges to get out, weare likely to be early. At this stage, we have to be unconcerned with whether we are right or wrong: the only issue is whether we follow our rules faithfully. If wea re early, the crowd will still be amaking moneya following the old trend. Thatas OK: the crowd is going to be arighta before itas wrong-footed, which it always is at turning points. This is where we have to think about time-frames. Inevitably, our time-frame has to collapse as we get closer to the turning point: we look for the day and the hour for getting out a"and indeed for getting in. The trouble is that this reduces us to the lowest common level. Everyone is shooting for the exact turning point; but no-one has any way of locating this point except with hindsight. The solution is to keep on saying to ourselves: alet that be someone elseas problema. Having no way of picking the exact turning point in advance, we will not worry about doing so.

To return to the dollar in mid-1989, the sentiment gauges told us to flatten our positions in May .The dollaras peak came in June with a violent blow-off on what CB called aloony Thursdaya 14 June. And for once we had as clear a signal as you can hope to get in financial markets that an important peak in the dollar had actually been made on that day. The only hindsight we needed was a few hours. That Thursday was full moon (hence aloonya); IMM speculation in Yen and DM was at record levels; and to cap it all, we had akey reversals*a (one of the few reliable chart patterns a" see Chapter 6) in all the major Chicago currency contracts. Thus It was possible to conclude at the time that aThursday saw a multi-month high in the dollara (CB of June 17). This was the signal to move to stage II and get in.

We canat expect a bell to ring at the exact top or bottom. But the lesson is that if a bell is going to ring, we cannot know it before the event. So we must give the market a chance to tip its hand. We must give it time to make a little tinkle if itas going to. We get out when the sentiment gauges tell us it is time to do so a"but we donat get back in until all the pieces fit. We donat have to be right. We donat have to worry about catching the exact extreme. What we have to do is get as little exposure as possible to doubt. Which means staying out, until we can go in with confidence. Doubt equals losses.

If we are fortunate enough to have as clear a signal as we had on June 14 of an extreme in the dollar, there is no doubt that traders should play for the reversal with as big a position as they are comfortable with a"for such opportunities are not common. The size of the position is determined by the maximum loss you are prepared to sustain in the event youare wrong or your timing turns out to be wrong. This was a possible moment to use call options* , though not ideal, because our script had clearly located the dollaras extreme already, making a better case for a straight bet in the forward or futures market. (A better moment was to come soon for call options).

On futures or forward purchases, the maximum exposure can be determined by a stop-loss, which could be placed, on the D-Mark for example, at a close at just beyond the previous dollar intra-day high of DM 2.05, i.e. at a closing price of DM 2.06, say. You determine what you are prepared to lose as a percentage of available funds and in dollar terms (that helps to concentrate the mind); and the drawdown to the stop-loss tells you how big a position to take on. If youare risking a 2.5% drawdown (price decline), and wish to limit your loss to 5% of funds, your exposure must not exceed 200% of available capital.

The currencies rallied a respectable 12-15% from their June lows. The central banks had won an expensive battle a" the Fed alone having spent $12bn in support of the greenback. But the next three months were to be a difficult and instructive period, during which it was by no means clear that the banks had won the war. Initially the currencies were driven up by heavy short-closing. Then the speculative interest began expanding in line with price as can be seen from the IMM charts. But this was a trap, and down came the currencies, up went the dollar from the start of August a" so that by early September the dollar looked as if it might retest its June peaks and maybe continue its bull trend.

Yet once again, as in June, there were warning signs of an extreme approaching. There was atoo much dollar bullishnessa a" with a big speculative short interest; and the greenbackas yield premium had been whittled back as low as 1.5% against the DM in August. Once again, it looked as if aprudential profit-takinga on long dollar positions was athe appropriate actiona (CB 10 Sep ), and to h.e.l.l with abeing righta or abeing wronga, in terms of whether the dollar would gain a few more pfennigs against the DM or a few more pence against sterling.

I talk of aforecastinga as being one of CBas main functions. But it isnat forecasting. We canat see into the future, and we know it. The key job of a.n.a.lysis is diagnosing the set-up conditions for the next turning-point. At minor turning points a" the fluctuations within the main trends a" the relevant set-up conditions seem always to be to do with sentiment. At major turning points in the main trends, there is usually a new underlying rationale around, as well as a polarisation in sentiment. Conditions at such junctures often lead to chaos.

At major turning points, the basic certainties of the ma.s.s of punters comes under attack. The equation that worked until then creates its own destruction when everyone comes to believe in it, and you often have chaotic volatility. Looking tack on CBas commentaries at the time, itas clear that the only rationales for the dollar bull market were 1) that the US currency was acheapa, and 2) that the US trade account was improving. But we know from the experience of all the 1980s that these are unreliable dynamics. A more sure dynamic had crept up on the currency market, i.e. the aforementioned narrowing in the dollaras yield premium. The trouble was that the old illusory dynamics still appeared to be driving the currencies in mida" September. To call a turn at that point demanded courage of an almost obtuse kind.

In the event, chaos manifested itself in an almost identical repeat of Thursday June 14, on aloony Fridaya September 15, when sterling gyrated 5% in one day a"ashouting reversal as in mid-Junea. But still CB of 22 Sep was only looking for a 6-week correction in the dollar, not necessarily for a major reversal: awe donat know whether we are faced with a multi-week move or maybe a multi-month move,a it said. We never do. However in terms of trading action, one just has to take a deep breath at such momentsa and make a simple bet a" a fifty-fifty affair. Either the dollar would be higher in some months time, or lower. Which would it be? You just have to bet. Thereas nothing else for it. Like when youare on the green, you just have to go up and putt a" for better or for worse. Just putt.

Windfalls and whammies

Talking of chaotic 5% gyrations in currencies raises another point. When a currency drops 5% in one session, what are you supposed to do if youare exposed? Are there any rules a"a) if youare short and b) if youare long?

Jesse Livermore advocated always taking advantage of a windfall profit. For sure he was 100% right: when the market hands you in a few hours, more than you could have hoped for in days or weeks, you accept graciously and aclean upa as Livermore put it. Always. Rationalising and failing to do so costs plenty over time. That takes care of a).

But what if b) the position goes violently against you? In the currencies, and using a method like CBas which is designed to detect extremes, I believe the odds easily favour a course of action which is anathema to trend-followers and inflexible adherents of firm stops. If the price movement is prompted by news, donat fight or fly: freeze . More specifically, if you have a stop that has not already been hit, take it off and take the day off too. Things will be back in proportion the next day a" when 9 times out of 10 you will find your position is better, usually much better, than it was at the moment when you would have been stopped or panicked out.

As with most rules, there are exceptions, one in particular. If you find yourself positioned in line with a strong consensus, amid high speculation; and something happens which challenges the rationale behind the consensus, then get out quick, no matter what.

With a time-frame measured in weeks, most of us are much better off never making decisions intra-day, but always waiting to review things calmly after markets close, and plan ahead accordingly. When asked by Jack Schwager* why he had no screens on his desk, Ed Seykota replied: aHaving a quote machine is like having a slot machine on your desk a" you end up feeding it all day long. I get my price data after the close each day. a You may not have known that not having a screen was such an advantage! If you want to know the shape of the dayas price action, to gauge how the market reacted to a news item, for example, you may be able to get an account a" or an intra-day chart a" from your broker .

Position Size, Choice of Currency

Early September was the ideal moment for call options: when you have no way of gauging the downside but see clear upside on a multi-week view, the value of call options lies in the way you can precisely define your stake, for the initial punt. After the ashouta of reversal on September 15, outright forwards or futures made more sense. Once again, the stake was defined by mental stops placed just below the freak lows reached on loony Friday. With hindsight, one knows that moments like these, when the turning point has been located, must be exploited with maximum stakes.

The currency of choice here was clearly the D-Mark a"the apack* leadera at the time. (The reason I keep on referring to what was written in CB at the time is that it helps me avoid the trap of being wise after the event). The rationale for the ensuing bear market in the dollar lay in the drop in the interest rate differential between the dollar and the DM to a1.4% from over 4% in Marcha (Sep 22). The rise in German interest rates had been prompted by adomestic, not currency considerationsa, so it was alikely to lead the DM (up) not follow as a result of DM weakness.a

Staying In.

In the weeks ahead, punters were to blow hot and cold over the D-Mark because of the developments in central Europe, German reunification, money union and the rest. But that had nothing to do with the rationale for the OMas bull market. So this was a case where long-termers had to stand pat, and traders had to refuse to play the game of political speculation. At least, this is clear with hindsight.

The dollar slid from a high of DM 2.00 in September to below DM 1.70 in early January, while the Yen flopped out after a terrific rally, from early October. Sterling and the SF lagged behind and then took over the running in the new year. The dollar got desperately oversold in December. Yet the fundamentals (yield) continued to run so strongly against it that there was no great temptation to cut and run. With a whole yearas hindsight itas not clear that one should have got out at all. But it is clear that a trending market gave way to a ranging market in the currencies in first half 1990. And when such a change becomes apparent, new tactics are appropriate, for sure.

Trading the Range.

During the move, you need to stay in. During the range, traders had better stay out. But first they have to get out. As weave seen in Chapter 8, the danger once youave ridden a good move is arrogance. You get to think youare smart, and all you need to do is trade to make money. The old clich has it that itas much easier to make money than to keep it. And the clich is dead right for this phase in the trading cycle. There is nothing easier than to give back in a consolidation all that youave made in a good move. Youare thinking in terms of bigger stakes. Youare careless. Youare on a roller. You get reckless; and you fall to pieces. Very disciplined traders may be able to handle this phase, but for lesser mortals, the best discipline is to get out and wait for the market to tip its hand again, the way it did when you made your original play for the move.

We must have a formula for getting out As all good traders are agreed, you have to have a formula for getting out a" a system which is prepared in advance (see agetting outa, below). The basic formula has already been spelt out: you get out as soon as your reason for holding is no longer valid. This formula is good for all players a"traders, investors, commercials, all of us. It is valid for trend-following chartists as much as for more fundamentally oriented punters. The latter, having decided that they have overstayed their fundamental rationale, can give themselves pricea" based rules for exiting, if they wish. We can use the atrailing stop*aa" a retracement of 2 or 3%, for example. Or we can use a time-limit. We can get out when a move has completed 12 weeks for example. Or we can use a price target, if we have any basis for placing faith in a price target; or a combination of price and time limits, whichever comes first. Iam not sure that the precise formula matters too much a"so long as we have a formula which we have decided upon thoughtfully beforehand. The objective, in any case, is to pre-empt the emotions.

For the investor who is not interested in playing corrections and feels he can live with the drawdown involved, there are ways of being prepared for the drawdown, since itas so easy to be shaken out of good positions when they start going against you. The first step is to decide that a correction is quite likely: the second is to cut back to a level of exposure which leaves you feeling serene in the event of a reaction. If youave prepared yourself, itas easier to view adverse action with equanimity. aThe object of investmenta, someone said, ais serenity .a The danger when currencies are ranging is athe dither-trapa. When we are dealing with a move from an extreme, weare pretty clear in our minds that the object is to buy low and sell high. When a move has been made, we know we have left the extreme well-behind, but we are apt to be concerned with not missing the last of the move. Therefore we are tempted to buy on strength. Equally, since we are aware that a correction is due at any moment, weare tempted to sell on weakness. So we dither. Having bought on strength we often cover when the strength fades; and having sold on weakness, we cover on strength. And we lose money every time.

The best way out of the dither trap is to decide that we donat have to play. We donat have to predict the market: we simply stay out a" and say to the market a show mea. Instead of having preconceived ideas, we watch for the evidence. In this way we can regain the initiative. If we spot an oversold condition after a correction (with punters beginning to short the currency they were recently all bullish of) we can reinstate modest long positions a"

not for the rally to the top of the range, but for the next move to decisively higher ground, whenever that may be.

The Wolf Pack*