Trade Team Update

Today's update is going to be a little different than the typical... we'll talk about the market and the euro of course but I'm also going to talk about risk and money management and I'm asking you to kindly to pay close attention to what I say... if you have to read it 10 times then read it 10 times...

Today:

The big questions in everyone's mind is: "why is the euro dropping and when is it going to stop?"

First of all there are several factors all working in unison to give the dollar a boost and to push the euro down. This sharp correction from the 1.5840 level is rooted in the underlying fundamentals of the market, specifically the interest rate fundamentals of the Fed and ECB.

Trichet and Bernanke are firmly entrenched in a battle of wills and a battle of words, with each of those market-manipulators trying to support their respective currencies while trying to scare the markets, specifically to cool the continued strength of commodities which is causing stifling inflation pressures.

Contrary to what I thought would happen last night, Bernanke came out with guns blazing again. Not only did this serve to push the euro down but it also caused Fed Funds to start pricing in a September rate hike. Yes, you did read this correctly... Fed Funds is now pricing in a 25bps rate hike just three months time. This is crap. It's ridiculous really.

Yes, I told you weeks ago the Fed was done cutting but I see absolutely no way the FOMC is going to vote on a rate hike in September. With unemployment rocketing up to 5.5%, with the Current Account and Trade Balance at their worst levels ever, and with the country loosing thousands of jobs each month, and with GDP barely showing any gains there is absolutely, positively no way the Fed is hiking rates in the fall unless we have a massive and almost instantaneous fundamental turnaround over the summer.

So, we've got Fed Funds giving the dollar a boost... what else? Well really all market correlated variables are working in favor of the dollar... gold got its butt kicked today, oil struggled to push higher, the 10-year yield ticked up and over 4.00%, and the Dow managed to hold on for dear life in today's trading.

Take today's Trade Balance for example -- it's the lowest print in 13-years. Even with a worthless dollar we're not seeing any easing of the tremendously USD- Trade Balance. This is very telling of the current situation.

And let's not overlook today's euro fundamentals -- French and Italian Industrial Production all printed to the upside and the German wholesale situation remains very inflationary. These are all very EUR+ factors.

Now I'm not trying to make a case for a strong euro but I am making the case against a strong dollar.

Tomorrow:

Be advised now: tomorrow does hold the risk of more dollar strength. Reason being, tomorrow is all about the Fed. Kohn and Kroszner are speaking and then we get the Beige Book. Neither Kohn or Kroszner is specifically scheduled to speak on monetary policy but you never know what they may throw in.

The biggest risk tomorrow for the euro lies within the Beige Book. I do expect the Beige book to have a bleak outlook on the overall economic and growth situation. The wild card will be how strong the rhetoric on inflation is. Should the Fed talk tough on inflation again through the Beige Book you can expect the dollar to make more gains on the euro. It's really that simple...

EUR/USD:

The market correlated variables are all working in favor of the dollar. The Fed is working in favor of the dollar and the banks are taking profits on long positions while running stops.

Can this persist? Absolutely. Do I think it's never going up again? Nope. But the euro is going to need some help and is going to need a boost from commodities and is going to need some big bank movers to step in and help reverse the current momentum push to the downside.

As far as trading goes, I'm still holding all euro longs. Last night I shorted the rise above the 1.5600 level which was according to my game plan to short the rises. I also addrd two more shorts this morning before we dropped to the 1.5440 level.

I suppose this is a good point to get into the risk management commentary I feel I must share with you...

Risk management:

Part of my personal risk and money management rules requires me to maintain a usable margin level of no less than 90% at all times and under all market conditions.

Because of my euro longs from 1.5702 down to 1.5640 were going into a higher degree of drawdown this put my usable margin in jeapordy of falling below my established 90% level.

Price action told me my margin was going to fall out of my comfort zone. Seeing this was going to happen, it was time to hedge -- to hedge against my dwindling usable margin.

Now, there were two ways I could have hedged/solved the margin issue. The first option was closing out all of my negative euro longs and covering those losses by closing out some of my really great euro swing longs. The losses on those negative entries could have been covered by me closing out one of my great euro longs from the 1.5100 level.

Based on current market conditions, this solution was not one I wanted to use. Now if I was convinced the market had zero chance of returning to at least the 1.5650 level I would have used this option.

Here's the lesson in this form of hedging option -- one of the reasons I hold on to trades that go hundreds and hundreds of pips into profit is so that I can use them to cover losses should I get caught going the wrong way and should my margin fall to uncomfortable levels.

Many ask, "how can you hold onto a trade that is up 400 pips and not take profits on it?" Well, some of those trades are used as "damage control" and not necessarily used as sources of big profits. This is a key aspect to my trading style.

This doesn't make sense to most people in the retail FX market but I do take trades not for the purpose of making big profits but for the purpose of covering losses should I need to. If I get myself into a margin mess and I find myself caught going the wrong way I know I have an out that is not going to hurt me too bad.

This is my own personal form of hedging that is unlike how most others hedge. I'm happy to take a loss knowing that I have the ability to make that loss a wash... so, if I'm in 400 pips worth of negative entries and I've got an open trade(s) that's 400 pips to the positive, I can wash out and breakeven on my losses.

As I said, I did not use this form of hedging to protect my margin in this particular case. I used the other form, which was adding short positions to feed my equity and usable margin against my negative entries that are sucking up equity and usable margin.

Because I am net euro long from 1.4595 all the way up to 1.5702, I can take shorts for free -- shorts that do not take any usable margin at all. Until last night I only had two open shorts, one at 1.6011 and one at 1.5810, so I have plenty of free margin to work with.

What I did was add enough shorts to stop my usable margin from bleeding. I didn't get it perfect but right now my margin is at 89% and it will not drop below there because of my short entries that are feeding me positive equity.

Now, are those equity-feeding shorts going to make me money? I sincerely hope not. That was not the purpose of taking them. They are not on my account to make me money they are on my account to prevent my usable margin from falling any further.

Should the market move back up, those equity-feeders will be closed at breakeven and then my negative entries will turn into positive entries and will cease from sucking up my equity and usable margin.

This is risk management 101 and this is how I manage and control risk. This is just how I do it and how it works best for me. The point is this: I have a risk plan and I follow it.

I've talked to a good number of panicked traders the past 24-hours who have not taken any risk management steps at all whatsoever. This is unacceptable and inexcusable behavior in my opinion.

I'll never tell a trader to manage risk the way I do but I will tell every trader to establish a risk management plan and follow it with military-style precision and discipline.

I have no sympathy for a trader that gets an MC. It's not me, it's not this blog, and it's certainly not the market that causes traders to margin call. Let me repeat: the currency market does not cause a trader to margin call! Is this clear? Do you understand this? If you get margin called you are the reason why. It's your fault and it's your problem because you didn't manage risk and you didn't have a gameplan and an exit plan.

Be smart.