Aussie Heaven or Hell?

Posted October 28th, 2010 by Sam Evans in Education

Aussie Heaven or Hell?

When writing these weekly articles for Online Trading Academy, I like to not only offer practical and hopefully useful trading advice, but I also endeavor to keep my material as "real" and interesting as possible. In my own experience of trading, I have found that too many sources of trading education and information often suffer from the same issues of being rather stale or too heavy in their nature. Ever since I started to make consistent progress in my trading career, I have found that many of the day-to-day experiences I am faced with in life itself often have very similar parallels with the behavior and characteristics of the market, too. It is almost as if the same lessons and observations we make in life are there right before our eyes in all aspects of price and trading as well.

With this unique dynamic in mind, the event which actually inspired my article this week was the news of the Australian Dollar reaching the parity level of $1.00 apiece with the US Dollar, a significant event to say the least in the general world of Forex trading and the market itself. I happened to be taking a day off from trading when price reached this level, so I had to hear about it on the news channel when watching the nightly bulletins on the BBC late one evening here in the UK, but I really can't say I was surprised by the report, as only a few days before I had been working with my ongoing Extended Learning Track (XLT) students in the virtual Forex room when we were looking at and anticipating this very move ourselves. At the time of the news, I happened to be sitting with my fiancÈ (who is not a trader, I would like to add) and it was her reaction, which was most interesting of all. We will get to that a little later on in this article, but before we do, I would like to tell you all about an interesting little event I witnessed a few weeks ago with my colleague and good friend, Sam Seiden, which itself relates directly to my fiancÈ's reaction.

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As I mentioned a few weeks ago, Sam Seiden and I embarked on a small tour of the UK and Ireland for a number of All Star Events. After finishing up a day's teaching and presenting, we caught a cab to Dublin Airport, checked in, grabbed some food and had a drink while we waited for the call to board our plane back to London. With around 45 minutes to go before the flight took off, we noticed that all of the passengers waiting for the flight were sitting down in the departure lounge ahead of the call, with absolutely nobody standing in line. Considering that we both were a little bored with waiting, we decided to conduct a little "experiment" to kill some time. We got up out of our seats and headed to the front of the empty queue, so as to be the first in line to board our flight. What happened next was very interesting. Within literally 5 minutes of us getting in line, around 90% of the passengers in the departure areas then got up from their seats and joined the line as well. Now, you may be thinking "so what?" but to Sam and I, the interesting thing was that not a single announcement had been made over the loud speakers to advise any passengers to get in the queue or that boarding of the plane was about to commence. It was almost as if not a person in the line even cared about the fact that they had not been asked to join the queue for boarding the plane, but simply because they saw a few others doing so, then they thought that they should do the very same themselves. This example I have presented to you may well seem very trivial in nature, but as traders, Sam and I found this mild event so very similar to things we observe each and everyday in the money markets: The phenomenon of herd mentality.

Herd mentality is and has been ever present in the human genome since man and woman first walked the earth. Let's face it, without herd mentality, it would be hard to imagine our race of mammals ever achieving even half of the wonders we have so far. Herd mentality is a positive aspect of human evolution and progression, but we should also recognize that there are times when we also have to make choices in our lives, which call for us to also follow a path of singular individuality, and nowhere is this requirement more intrinsically fundamental than in trading the markets.

Without question, it is common knowledge that the greater percentage of traders actively speculating in the markets have and continue to lose money, forcing them to have to call quits on their careers. This basic fact alone is evidence to suggest that ergo, adopting an approach of herd mentality in trading is never going to be a catalyst for consistency and profits in the arena of Forex trading or any other asset class for that matter, which brings me back to that night of watching the news of the Australian Dollar's parity achievement on TV with my partner. What struck me initially about this report was how excited the news team was about the fact that the Aussie was at the same parity level as the US Dollar. As the story expanded, the reporters talked about the various fundamental reasons why the Australian Dollar had shown such strength in recent months and just how this strength in the currency would affect the Australian economy moving forward. Literally, as the piece finished, my partner turned to me and made the simple statement, "I guess you will be buying the Australian Dollar tomorrow then will you?" Now, as I stated at the start of this article, my fiancÈ is not a trader and we try to keep our work away from our relationship, so to me her reaction and questioning statement was exactly what I would have expected.

Considering she is totally removed from the world of trading, it made complete sense to me for her to assume that I would be buying the Aussie Dollar the very next day ñ and why not? Had we not just both seen a news report on the biggest TV network in the country that had been telling all of the viewers about how strong the Australian currency had become? To her, it seemed obvious to jump on-board as soon as possible. She was just following her human nature to follow the actions and events that had been presented to her, much like the individuals at the airport in the departure lounge who jumped into the line not because they had heard an announcement, but rather because they saw some others doing it. I explained to her there and then that actually, I had been advising my students to do the opposite and sell the Aussie Dollar when it reached this level because the sensible thing to do would be to sell something that had already risen in price, not buy it. I went on to explain that as a trader, it is my job to only enter the market when I see an opportunity which offers the lowest risk and potentially high rewards, and that by buying an asset that had already risen in price gave me little room for a profit margin at these current levels. Sure, I would be interested in buying the Aussie at some point in the future, but only when it went on sale at a reasonable price. The news of the Australian Dollar's rise meant very little to me because it was nothing more than news of an event that had happened in the past, and gives us little clue to the events of the immediate future. This necessary detachment from news can be hard for a trader to understand, but as we can see from the chart below, will often help us to stay on the right side of the market and keep our risk low:

Figure 1

When we also look at the technical chart of AUDUSD and witness the dominant uptrend, which has been in place for the last few weeks, it does not help us in the difficult choice to shy away from buying either, especially when this price action is coupled with the news at the same time. However, I will say, again, that objectivity needs to prevail in these circumstances, and as the market goes on to illustrate, buying this currency pair would have been the wrong thing to do:

Figure 2

Literally, within hours of reaching the $1.00 parity price, the AUDUSD managed to fall almost 350 pips to the levels of around 0.9650, costing the high buyer plenty of cash in the process. Now some of you may be looking at this chart and be saying to yourself that considering the dominance of this prevailing upward trend, the short position at $1.00 would not be the best thing to do, and to an extent, I can agree with this point of view. However, we should also take into account that after a sustained period of buying, any potential reward at this exact moment in time is heavily reduced. Therefore, if one feels uncomfortable shorting price action of this manner, they can always choose to sit on their hands and wait for a drop in price on AUDUSD before buying in an attempt to join the upwards trend at a later stage along the line.

In essence, and no matter what the outcome of any position or trade, nobody can really know what is going to happen next. All we have to work with is objective analysis of price action and the ability to apply consistency in looking for low risk and high potential reward trades. The sooner a trader decides to walk their own path of judgment and rely upon their logic as opposed to what they hear from others, see in the newspapers and watch on TV, the better. Any kind of news item is always going to be reported after it has happened, thus unhinging our timing at nearly every opportunity presented to us. Remain calm, disciplined and objective at all times. Thinking like the herd is not always a bad thing, but in the case of the markets, it can cost us dearly if we are not cautious at all times. Planning a trade in a disciplined fashion is always more logical than reacting to an event which has already passed.

Have a good week,
Sam Evans

PLEASE NOTE: In last week's article I stated that US based citizens could open up overseas Forex trading accounts if they wished to avoid the new Leverage rules, which were recently introduced by the CFTC. This was an incorrect statement at the time of printing and I apologize for the error. As it stands, US-based citizens are required to open accounts only within the US. Thank you for your understanding on this matter.

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