Items Tagged With risk

Since China famously revalued the Yuan last summer, trade lobbyists and protectionists have continued to urge the Bush administration to pressure China on its exchange rate policy. In a sign that it may be bowing to popular demand, the US Treasury Department recently announced it may officially label China a ‘currency manipulator,’ in its biannual report to be released in April. The label would provide a basis for trade and economic sanctions. Chinese officials have considered the possibility of such an accusation, but continue to maintain that the Yuan will be adjusted at China’s pace. This is not surprising, as China’s exchange rate policy is determined at the highest level of political decision-making. The Wall Street Journal reports:

Chinese exchange-rate policy will be guided not by politics but by calculations on how any changes will affect domestic growth. “Nobody thinks” the U.S. will label it a currency manipulator, which would require formal talks with China on the issue.

For the better part of a year, the Australian Dollar (AUD) has remained relatively constant in value, hovering around .75 USD. Economists and analysts have identified several factors that are preventing the AUD from moving by pulling the currency in opposite directions. On one hand, commodity prices and Australian economic fundamentals continue to perform strongly, which would seem to drive the AUD upward. On the other hand, the interest rate differential between the US and Australia has narrowed to only 100 basis points, which may not be enough to bring the capital of risk-averse foreigners to Australia. By the same token, many investors are moving funds to New Zealand, where interest rates exceed 7%. The Sydney Morning Herald reports:

All told, last year saw the lowest degree of variability in the Aussie's value in any year since the float in December 1983.

In all likelihood, the next couple of years will witness a narrowing of interest rate differentials between the US and Europe. Accordingly, many analysts are predicting risk-averse investors to begin migrating their capital from the US to Europe, which would cause the Euro to appreciate. Leaders of Central Banks have begun to make their own preparations in response to this expected trend. The United Arab Emirates has already announced its intention to increase the portion of its forex reserves held in Euro-denominated assets from 2% to 10%. Other Arab nations, including Iran and Syria, are mulling similar propositions. If these nations ultimately decide to diversify, it could feed back into forex market psychology and hasten the dollar’s decline. Dow Jones News reports:

U.A.E. officials have repeatedly said that if they move out of dollars, it will be because of market dynamics rather than because of politics. Such a move would reduce the risk that the central bank would incur heavy losses should the dollar weaken sharply.

I took my first trade in months this past Thursday.  I have been slowly trying to get back into the forex market by cautiously watching the GBP/USD.  It's been a while since I followed any currency pair so I wanted to be sure that I watched the GBP/USD for a couple of days before taking any trade.  I've decided to start referring to my profits/losses in terms of expectancy.  Expectancy is "simply the mean or average R-multiple generated."  (Source:http://www.iitm.com/sm-Expectancy.htm)

The "R" in R-multiple is short for risk.  The best way to understand it is to either read the source above or continue reading.  Let's take my first trade as an example.  I knew my total dollar risk before entering the trade, that amount being $650.94.  (yes, that exact)  I exited half of my position when I had profited $329.  I moved my stop to breakeven on the remaining position.  Unfortunately I was stopped out on the rest giving me a total profit of $329.  To figure out the R-multiple, you would take (profit / amount risked) which in this case was $329/$650.94 = .5R.  Ideally, the higher the R in a profit situation, the better.  For instance, a 2R multiple would be obtained in a 2:1 reward/risk trade and a 3R multiple in a 3:1 reward/risk trade.   In a loss situation, a higher R is actually worse.  Ideally, if you lose on a trade, the R-multiple should be 1R or less.  If it's 1R, it simply means that you lost the amount you were expecting to risk.  So in my above example, if I lost $650.94 on the entire trade, my R-multiple would have been 1R.  Let's just say that I got stupid and decided to stay in the position and not honor my stop loss setting.  Because of this stupidity, let's also say that I wound up losing $1301.88, twice as much as my initial risk.  Calculating using (loss / amount risked) I would have an R-multiple of $1301.88/$650.94 = 2R.  

So what does all of this mean? Well, I only have 1 trade to calculate my expectancy which would currently be .5R.  I'll get more into calculating mean expectancy once I've compiled more trades.  But having .5R isn't desirable because it basically means that I risked twice as much as the reward I obtained.  This is exactly why I want to try to use R-multiple when I talk about my trades because even though I had a $329 profit on my first trade, it isn't as rosy as it may seem.  The R-multiple was only a .5R and although it was profitable, if I trade this way in the long haul, I'll surely lose.  

Another good source that also mentions the critics of R-multiple can be found at http://tradermike.net/2006/09/r_r-multiples_defined/

I've been emulating my real account trades with my demo account for the January forex trading contest.  I'm currently in first place with a return of 11.16%.  After today though, my return will drop 2 percentage points to about 9% since I lost 2% on a trade.  I don't know if this will be enough to hold on to the lead.  

This is an overview of how I've been trading so far in January 2008: 

1. I have been risking exactly 2% on every trade.  No more, no less.  
2. I've been using my forex position size calculator everyday when figuring out my trade size and find it very handy.  Some of you have commented the same.  
3. My R-multiple on every trade has been 2R.  For those of you that haven't heard of R-multiple, it's really just an abbreviation for reward-to-risk.  2R means my reward-to-risk is 2:1.  
4. I'm not watching my positions so there isn't any fancy money management going on.  I haven't once set my stops to breakeven. I'm just letting them ride.  If they hit my target, they hit it.  If they don't and stop out, so be it.  This is quite different from what I've done in the past.  In the past, I've been quick to set my stops to breakeven when they move a little in my favor.  The consequence of doing this was typically a gain/loss of zero.  I can't tell you how many times I've moved my stop to breakeven only to see it get stopped out.  Then I have to watch as the price goes back in the direction I was trading where it hits my initial target price.  This to me was more frustrating than losing.  I'd rather stick to my guns on a trade instead of playing it scared.