ForexSpirit

We’re well into the second half of the month of August and I’ve made a grand total of two trades to date.

It’s plain from looking at any of the main currency pair charts that it’s been a great month for US dollar bulls. During that time I’ve been sitting on my hands, studiously practicing my patience. It was a trading skill that I had to relearn earlier this year and it’s certainly come in mightily useful this summer.

Patience now ranks alongside consistency as a fundamental pillar needed in the mindset of a successful trader (or in my case aspiring trader).

I stood aside and watched as the markets interpreted Trichet’s words at the ECB rate meeting on 7 August to be incredibly bearish for the European market. EUR/USD got pummeled and broke to the downside out of the 1.53-1.60 range it had been stuck in since March.

My first trade of the month occurred on August 10th when price spiked down just after the Sunday opening after having dropping 500 pips on the Thursday and Friday of the week before. I doubted that the downtrend would be over that quickly but I did think there was a high probability of a least a slight pullback as the pros took advantage of all the Johnny Come Latelys who would enter shorts at the start of the week as a result of the big drop that had just occurred.

There was indeed a nice pullback that lasted into Monday’s London session before the downward momentum resumed. I extracted 75 pips from that trade.

The rest of last week saw a lot of consolidation between 1.4850 and 1.4950. This area represents the top of the range that EUR/USD was trapped in from the end of October last year until February 2008. It represented a significant support level and I entered a trade at 1.4850 on Thursday, as the low of the week had been at 1.4814 on Tuesday. While I obviously felt the probabilities were high of a bounce back up, price didn’t see it my way and I was stopped out at 1.4800.

I’ve stuck to having fixed 50 pip stop losses in place which forces me to be extra critical in deciding when to enter the market. I have contemplated having a slightly more elastic stop loss level, potentially related to the current ATR (Average True Range) but I’ve yet to decide if the benefits of this extra complexity (however minor it may be) is worth distilling the straight forward simplicity of what I’m currently using. Once I have a few more months of real trades under my belt I think I’ll be able to go back and examine what would have happened if I had used an ATR-based stop loss level instead of a fixed pip amount. Only then will I know if it is truly worth changing things.

Last Friday the Euro continued to break down and found itself at the 1.47 handle. It seems as if we’ve broken through the 1.48-1.49 support level, although the price drop over the past ten days has been so steep that it is hard to see it continuing with such ferocity for much longer.

There are understandably compelling arguments on both sides. The US economy seemingly has all the bad stuff out in the open. Everyone is well aware of the credit crunch and the problems it is causing, even if all of its consequences and writedowns have yet to become reality. The Eurozone is now beginning to experience its own slowdown in earnest. The US dollar bulls see the US economy bottoming out and beginning a slow rise while the European economies are about to go down the toilet, ergo the Euro gets sold.

The US dollar bears wonder what the bulls are smoking. None of the fundamental reasons that have been the main factors in the US dollar’s decline over the past seven years have been addressed or fixed. Issues such as the trade and current account deficits are still two sleeping elephants in a china shop. The US housing market is still a mess and US consumer saving abysmal. The official strong dollar policy is seen as a mirage and the seemingly miraculous resurrection of the US dollar in recent weeks is due more to the correlation with oil and central bank intervention. Neither of which is considered to be viable in the long term for providing a solid base for continued dollar strength.

I think the US dollar bulls have the momentum for now but I don’t see how the they’re going to overcome all the reasons that have seen the dollar weaken for years now. I still believe that the dollar bear trend is in place and this is a strong correction.

I can’t really see myself going actively long again until one of two things happens:
1/ We reach the support level at 1.4250.
2/ One or more pieces of US fundamental data come out so bad that all the wind is taken out of the dollar bulls sails.

I think there’s probably a very good chance that we’ll just end up range trading in the same price range from the start of this year: 1.43 to 1.49. If that range trading does materialise then I’ll be looking to position myself for breakouts to the upside again, for another retest of the 1.6 all-time high.

Now I have just one other decision to wrestle with: 1.4250 is almost 500 pips below where we currently are. Do I take short only positions to take advantage of the remaining vestiges of this dollar bull train, or continue to sit on my hands until it’s time to place a high probability long position?

I’m inclined to the later option. I’ve waited the move out this far and waiting a bit more only gives me extra time to practice on my patience! I’m also trying to take very seriously these days the Sage of Omaha’s number one rule: don’t lose any money!

I’m going to wait until tomorrow’s US housing data to make a definitive decision. In a sense I really am trading the medium term trend, so if the dollar is going to be strong for the weeks and months ahead then I need to trading in the direction of that trend. While I foresee that the long term trend of dollar weakness will resume that doesn’t mean that there aren’t tradeable corrections that I can take advantage of. The dollar bull move in 2005 is a prime example of this, although it is yet to be seen if this dollar move has the legs of the one from three years ago.