special report trading basics: two building blocks every trader … · 4 • trading basics: two...

ANDY KRIEGERT R A D I N G

Trading Basics: Two Building Blocks Every Trader MUST Know

Special Report

2 • Trading Basics: Two Building Blocks Every Trader MUST Know

Imre Gams: Hi, Imre and Andy here. In this guide, we’ll talk about assessing market sentiment. We’ll also discuss some fundamental analysis. This is foundational stuff for traders – and especially currency traders, which is our main focus here at Money Trends.

When you’re analyzing the markets, you want to start with the fundamentals and the overall market sentiment. And, Andy, I think this is how you first learned how to trade. Is that right?

Andy Krieger: Honestly, I’m not sure how I first learned to trade, because I didn’t have charts. My knowledge was very academic in terms of what I’d studied in my MBA program. I knew options theory very well. But I had no idea how to trade spot or futures or other markets.

[Spot and futures are two ways to trade in the currency markets. A “spot” trade means the commodity is delivered almost immediately. When trading “futures,” on the other hand, the delivery date is in the distant future.]

I was trying to put my finger on the pulse of the market to determine what was coming next. It was very short-term, initially. Later, it evolved into much more of a fundamental top-down approach.

Imre: That’s definitely a lot of what we’re going to cover in this guide. And I liked how Andy put it. We’re going to examine how we can put our own fingers on the pulse of the market and get a sense for what people around the world are thinking.

When it comes to the global markets – and currency markets in particular – we’re really plugging into the information flow of the entire world. By contrast, when you trade American stocks, for example – shares of Apple, Google, and so on – you compete against mostly players in North America.

But with currency markets, the field opens up considerably. Now we have to contend with different cultures, different ways of thinking, different world views, different politics.

TRADING BASICS: TWO BUILDING BLOCKS EVERY TRADER MUST KNOW

BY ANDY KRIEGER AND IMRE GAMS | EDITORS, MONEY TRENDS


And that makes trading foreign exchange – or “forex” – so much more interesting. It also makes it potentially more challenging. But, of course, the other side of challenge is reward.

To make sense of it all, in currency trading, we use sentiment analysis. And when I think of sentiment analysis and how to assess what the market is feeling, I look at two broad spheres. I look at “risk-on” and “risk-off.” In other words, is the market feeling bullish or bearish?

That’s a very simple binary assessment to make. And depending on which side of the fence the market is largely positioned on – bulls or bears – we’re going to see certain assets outperform and certain assets underperform. Andy, do you have a slightly different take on this?

Andy: Well, not so much different, but just a little more expansive. When I’m trying to analyze a currency pair and where it’s going next, I look at everything – from the political situation in the country, to the monetary policy of the central bank, to the growth rates in the economy, to the demographics, and so on. I look at all these things in both countries of the currency pair.

[Currency trades always happen in pairs. Some pairs you may see in Money Trends are the U.S. dollar and Japanese yen (or USD/JPY), Australian dollar and Japanese yen (AUD/JPY), and British pound and Swiss franc (GBP/CHF).]

I don’t think I’ve ever taken a trade in a currency without first looking at everything from stock markets to bond markets to relative interest rates. All these things go into my equation.

Then I try to figure out what’s priced into the market. In other words, what does the market expect? Does the market expect certain types of data? Does the market expect certain growth rates? Does it expect certain outcomes in elections?

All of these things go into a kind of amorphous kitchen sink, where everything is mixed in and tossed around. But if I know what’s expected, I get important information… because when economic or political data is released, I can watch the market’s reaction. That reaction tells me a lot about how the market is positioned.

Once I have that information, I can study the technical factors, which give me still more information. So it’s a multi-tiered, complex process. As you said, Imre, it’s challenging but very rewarding when you get it right.

Imre: That sounds intimidating at first glance. But what I really like about our process is that, when we look at the markets, we fall into a rhythm. That leads to a discussion…


And that eventually leads to either consensus-building, or we might disagree with each other. If we disagree, we can examine where that disagreement lies.

One of the other things I look at to assess the overall risk environment is this: What are the current themes driving the market? Which themes are playing in the media? What are the hosts on CNBC talking about today? What’s in the papers?

Of course, what the media talks about is not necessarily a shock to the market. But it is what a lot of people pay attention to, so it can help drive some of the trends. One of the biggest examples – and it’s been going on for a long time now – is the trade tensions between the U.S. and China.

Whenever those trade tensions come to the forefront, we see market volatility. If negotiations seem to be going poorly, we see a sell-off, and the market shifts to “risk-off” mode. If the negotiations seem to be going well, the market shifts to “risk-on.”

But that’s a small piece of it. We also look, as Andy already mentioned, at the general stock market. How are people feeling about stocks? And we also look at bonds. When it comes to bond yields specifically, we like to look at the 10-year bond yield. The 10-year tells us a lot about how investors are positioned in the bond market.

We also look at certain commodities that tend to diverge from one another depending on whether the environment is risk on or risk off. So, for example, we look at the price of gold and crude oil.

A lot of people know that gold is a safe-haven asset. So when the market is in a risk off mood, the price of gold tends to go up. On the flip side of that, investors tend to sell crude oil when the market is in a risk-off mood.

The same thinking applies to the currency markets. In a risk-off environment, the yen tends to go up – as do the Swiss franc and the dollar.

In short, there are certain assets that perform very differently depending on the risk environment. And we take that into consideration in our analysis as well.

Andy: This type of analysis is so important. If you sit back and analyze why certain outcomes have certain effects, you can learn so much.

For example, think about a scenario where the president says, “Trade talks aren’t going so well. We might have to impose a tariff in a week or so.” Is money really going to turn around and pour into Swiss assets… just because they know tariffs are about to be imposed, and the Swiss franc is traditionally a safe-haven currency? Don’t think so.


Why? I could make an argument that putting money into a place where they have negative 70 basis points in the short-term interest rate is not necessarily a very safe thing to do… particularly when the Swiss economy is dealing with other issues.

But that’s looking into it a little too deeply sometimes. The truth is, the market is a little bit like Pavlov’s dog. In other words, it’s been trained to expect that certain types of triggers will have certain types of reactions.

Imre: That’s right. So when we conduct our own sentiment analysis, we pay attention to a lot of the stuff in the background – for example, as Andy mentioned, interest rates and the strength of a country’s economy. But then we also focus on what’s at the forefront. What are people paying attention to now?

It’s really interesting when you see how money starts flowing into certain things and out of certain things. And part of our job as traders is to stay ahead of that curve. It’s to anticipate what happens next, after the current movement is done and the dust settles.

Andy: In a way, the job of the trader is to be pragmatic. I would say it’s not to be rigid and orthodox, but to be relaxed and flexible. For example, I may stop and think: “Do I really believe that a trade deficit from month to month is so critical to the value of a currency in the giant picture? No. But if the market does, OK, I’ll pay close attention to it.” And that’s the pragmatism.

I mean, it used to be that the trade numbers were the main number people paid attention to. I saw this firsthand on the trading floor at Bankers Trust, for example, back in the ’80s. Traders would take huge positions based either on their expectations of the numbers, or based on the data that actually came out.

Today, if you ask most traders for details about the trade imbalance, for example – the surplus or deficit we’re running with various countries – they wouldn’t have any idea. They would probably know what the deficit is with China because that’s been in the news. But that’s about it.

However, if you look at the collective economies of the United States and China, we’re looking at around $35 trillion in GDP and a $600 billion deficit. Is that really enough to cause all this turmoil and commotion? Maybe. I don’t think so. But it’s all right – the market thinks so. Therefore, it’s relevant, and I’ll pay attention.

Imre: Exactly. So one of the questions we try to answer most often when it seems like the market is making a knee jerk reaction is this: Has the world fundamentally changed?


Has something really shifted in a structural sense? If it hasn’t, our initial positions are probably OK. We might experience some short-term volatility. But after the dust settles, we’ll see things pick back up and go in the direction we originally predicted.

What’s important to keep in mind is that a lot of this news has short-term bursts of energy in the market. And what we’ve seen more recently is a complete lack of follow-through from investors, especially in the currency markets. It’s almost like we need one piece of knee-jerk reaction news after another just to keep moves going.

That certainly makes for a challenging environment. So what do you do? You either zoom in so close to the action that you’re like a soldier on the frontlines of war. And that’s where you might be day trading. In other words, you might be taking very short-term positions. Or you do the opposite, and you take a much longer structural view. Then, you wait for things to really start taking off.

The bottom line is that, as a trader, you have flexibility. And this is a theme we are constantly coming back to. One of our biggest advantages as traders is how much flexibility and freedom we have. We don’t always have to be positioned in the markets.

Andy: The other thing to note is that, for example, we talk about economic policy. For example, let’s talk about interest rates. Relative interest rates are very important. But is a difference of 10 basis point between one country and another really so important? Is 10 basis points really going to affect major decisions from global investors? Probably not. 20 basis points? Probably not.

So, again, it comes down to understanding what the market expects. If the market expects that the central bank won’t do anything, but then the central banks does something, OK – that will cause a reaction.

And so, in a way, our goal as traders when it comes to understanding market sentiment is this: to put our finger on the pulse of the collective “everyman” who’s out there buying and selling currencies based on a variety of factors. (Although, usually, there are a few big players that really drive the market.)

As I mentioned, what’s critical when we have a position open is to watch the market’s reaction to data releases. And again, it’s important to be pragmatic about it.

Imre: Indeed. You need to have contingency plans. In other words, you should plan out as many scenarios as you can, and then know ahead of time how you will react to each scenario.


Now, obviously, nothing goes according to plan every single time. It would make our lives a lot easier if it did. But one of the keys to being a successful trader is that, when something happens contrary to your expectations, your game plan must change. You must shift.

Andy: That’s not to say we expect Money Trends readers to start poring through reams of economic data and statistics and so on. But we do think that everyone owes it to themselves to at least understand the big picture.

What do I mean by that? Know relative growth rates, have a good sense of interest rates – short-term and maybe 10-year rates – and start getting a feel for this kind of data.

Imre: I love what Andy said. You don’t need to go and memorize 10 years’ worth of inflation data. That’s not going to help you. But being generally aware of data like that is very, very good.

A lot of the forex traders I’ve worked with, what happens is they trade news report to news reports. So they say, for example, “What are these employment numbers going to mean? Is that going to move the market?”

What they’re missing is the bigger picture. In other words, what’s the trend? If we have very strong employment for a couple of years now, and then all of a sudden we have a “miss” on one report, the market might sell off for a few hours. But does that mean we’re on the precipice of some huge unemployment issue? Not necessarily.

Andy: Although we rarely react to economic data, we do react to the market’s reaction to the data. There are times when our own forecasts are very different from what people are expecting, and that complicates the decision process. There are also times when the market’s reaction to shocking news is very different from what we expected. That tells us a lot about how people are positioned.

During those times when our own forecasts deviate sharply from market expectations, we pay a tremendous amount of attention to the market’s reaction once the data is released.

Imre: The bottom line, when it comes to understanding the fundamentals and market senti-ment, is this: Be aware of what’s happening both in the background and in the foreground. Know the major themes that are driving the market – where they’re coming from, how they might change, and how you will shift your trading behavior if something doesn’t go accord-ing to plan. And always, always be thinking about your downside and how to protect it.

We’ll have more to say on these themes in our e-letter, Money Trends. So keep an eye on your inbox every week for new issues.


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special report trading basics: two building blocks every trader … · 4 • trading basics: two...

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