Apparently people are struggling to make money in foreign exchange markets this year - as I heard for the thousandth time earlier this week! Mean reversion is playing a role, without doubt, but there is something, more basic, at the heart of participants' struggles and one person's experience from Brexit night is illustrative. How can it be that people have missed out on making money on a well-signalled, prolonged move in FX markets? Here is one possible answer - and it goes back to the roots of trading methodology
Once upon a time, a very, very, very long time ago, a generation of traders (of which I was one) was introduced to the concepts of crosses. This introduction was not without some mishaps of course, but it was an invaluable outcome of our elders and betters teaching us how to read markets, more specifically how to identify drivers of moves in the main currency pairs. It is hard to escape the conclusion that in the modern FX market, such skills are thin on the ground.
Welcome to 2017 – I hope it is successful for all.
We enter the new year with another buzz phrase doing the rounds – so-called “fake news” – something that apparently allows Joe Public to make things up and get a reaction (always a lure to some in society) and for politicians to use as a feint to avoid answering difficult questions.
Putting aside the oxymoron that is “fake news” (clue: it’s not “news”, it’s fiction or blatant lies) the foreign exchange market has not escaped its clutches.
The starting point for this column has to be the observation that, by and large, foreign exchange dealers do like a moan. Let’s face it, we’re a bunch of whingers and the events of the past week – thanks to flip-flopping central bankers – have only reinforced this trait. Are we, however, looking at things the wrong way? Markets undoubtedly adjust quicker to events than they used to, but is there an opportunity for traders in this? I happen to think there is.
Markets are busy but there’s not much happening market structure wise so let me take this opportunity to offer some consumer advice/life coaching to readers. If you work in foreign exchange, you are bound, at some stage, to be asked, “what do you think of the (fill in currency)?” You have two choices – either mumble something about it not going far (without defining “far”), or make a big, bold prediction (with no time horizon). In both cases, be prepared to blag it.
We often think 'big is better', but some hedge funds over the years have undergone the type of experience to make them question that adage. The scale of their success ultimately put too much pressure on the business and they had to scale back, or bifurcate their funds into internal and external investment pools. There is another advantage of not being institutionalised, as well, because thanks to the changing market structure, style drift may not be as taboo as it once was.
This is a pretty horrible time for CTAs, not only because of the sector's very visible performance issues, but because it's even worse than the numbers suggest. After all, the big selling point for CTAs has always been they are a good hedge in falling equity markets - but they clearly have not been this year. It may not be all doom and gloom, however, for using new technologies and techniques they have the opportunity to re-engineer their models to meet the challenges of the modern market structure.