ForexSpirit

This time last week I had a plan in place in the run up to the Fed interest rate announcement taking place on Tuesday. I was holding my positions in EUR-USD and AUD-USD looking for the US dollar to weaken slightly on Monday and Tuesday morning.

At the back of my mind I was contemplating just going all square on my trades if price was in positive territory (i.e. above my average entry point for the multiple trades I was holding) just ahead of the Fed rate announcement.

By noon on Tuesday price was indeed in positive territory, by about 50 pips in either pair. It was decision time. Should I just square everything and walk away, not even caring what the Fed decision turned out to be? This action would allow me to close out my trades for a slight profit and be able to take the rest of the month off, something I have been meaning to do, especially considering my lamentations on needing a break for a few weeks.

Maybe I could close out all my positions and just re-enter a small trade on EUR-USD to catch any further dollar weakness that might result?

The final option was to do nothing. The rationale for this non-action was to be able to profit handsomely from a surprise 50 basis point cut from the Fed which would send the dollar tumbling. Since I had such large positions on already this could mean a huge windfall.

The decision I went with was the last option, of doing nothing. Of going for the possibility of a 50bps cut. Of trying to make back up the losses that I had suffered in November in one fell swoop. Of being too greedy.

In retrospect, especially after the huge surge of the US dollar yesterday, the correct course of action would have been to go with my gut and close everything out and walk away for the rest of the year.

I made a Mistake. With a capital M. This mistake is most likely going to cost me a large chunk of my profits from the last three months.

Friday’s 300+ pip surge by the dollar on EUR-USD shows that there is definitely life left in the old dog yet. Price ended the week just above 1.44, more than 550 pips from the high in mid-November. I think we’re on a knife end here and the upcoming holidays are going to mean that the volatility and large moves are not done yet.

From here price could easily tumble down to 1.40 or climb back to 1.48.

The fundamentals point to the dollar weakness being still very much in play. The US PPI and CPI inflation data that fuelled the dollar move on Friday points to less likelihood of another Fed cut at the end of January. At the same time new Euro zone inflation figures point to inflation at over 3% which can only strengthen the case for a possible ECB rate hike, or at the very least, continued hawkish commentary from Trichet.

While the fundamentals point to further long-term dollar weakness (over the next couple of years) the technicals and my gut point to continued dollar strength for the medium term. I’m thinking the next three or four months here. The upward trendline on the euro surge ending in November has been broken to the downside. There is no chatter from the financial talking heads of the euro going to 1.55 or 1.60 any time soon. In fact, they are mainly talking about the euro declining slightly (the 1.4 handle is often mentioned as a 2008 year end price).

Price action on Monday and potential Tuesday this coming week is crucial to me ending out this year with anything worthwhile to show for it.

If price continues to drop then I’m pretty much screwed. I have two euro trades of far too high leverage 300 pips in the red right now. Similarly, on AUD-USD I also have two trades far too far underwater, one 300 pips the other 400. If this scenario unfolds then I’m going to have to realise those losses and just deal with a significant portion of trading capital being wiped out.

While a continued drop is a definite possibility I think it is slightly more likely that there will be a retrace of Friday’s move. The amount of retrace, if it does occur, will be key. If we retrace all the way back up to where price was on Thursday (at least above 1.46) then I think things will return to a slightly bullish if not rangebound nature. If this price action unfolds then I’ll probably hold on in to see if 1.47 is at least on the cards and I’ll hopefully be able to close at sometime close to breakeven. Such a steep move down followed by an equally abrupt move back up reminds me of the ‘railroad’ price pattern I came across in DiNapoli’s book. It’s often seen as a pretty bullish signal.

If price moves to above 1.45 but doesn’t break 1.46 then I think the downward price action is still very much in play. In this situation I’ll look to get out of my higher up entries. I’ll have to take on board the losses but at least they’ll be of a much more manageable size.

The last scenario is that price just meanders in the 1.44 handle all day. If that happens I’ll be in a sort of twilight zone waiting for one of the other above scenarios to unfold. My view is that the longer price stays down close to 1.44 the greater the chance of continued weakness. I won’t want to give it too much time to figure out where to go next. I’ll have to just cut my losses if no clear direction has emerged by Tuesday.

Of course I don’t have to close out all my underwater positions at once. This allows me some degree of flexibility to close out one or two trades at the first sign of continued trouble and then look to close the other trades at more favourable levels.

My options for entering new longs at these low levels are limited, especially given the thin margin of downside I have remaining with my currently open positions. I really need to see a solid base form here with pressure materialising to the upside before I can enter any substantial new longs. If I do get the chance to do that I can obviously bring down my average open position and extradite myself from this situation all the quicker.

I find myself back in damage control mode after having found myself a path out of my initial troubles from mid-November. I just didn’t follow through with my original plan and have found myself straight back in hot water.

I’ve definitely learnt about what works and what doesn’t work for me during this tumultuous period. Now all I have to do is survive this drawdown and make sure to follow through with my original intentions on how to go about that.