FX Trading Opportunities in Current Markets

by Van K. Tharp, Ph.D. and Gabriel Grammatidis

The Current Debt Situation

I have been writing about the horrible US debt situation for years. How can the accumulated government debt (which is greater than $100 trillion) ever be paid back? In what time horizon and by whom? The level of debt is awful and unsustainable. And it’s not just the US.  Japan, Canada, Australia, the UK and other EU member states have helped support their economies by doing the same thing — government borrowing in an attempt to create liquidity and pull their economies out of recession.  Even China’s credit expansion is significant on a global scale though many people seem largely unaware of what their banking system has been doing.

Compare debt levels from pre-crisis 2007 to 2014.  Globally, debt levels have risen 40% – from $70 trillion to around $100 trillion (according to a recent BIS study). This $30 trillion increase accounts for around double the GDP of the United States1.
Did adding this debt help economies and equity markets? Yes. Will this continue forever? Definitely not. Despite a six-year recovery in the equity markets driven by low interest rates and an abundance in liquidity, global fundamentals look horrible.  While the first efforts of QE (Quantitative Easing) have helped the economy and the performance of the S&P 500 quite a bit, consecutive QE programs generated only diminishing returns (see below the S&P performance in relation to the QE1 to QE3 program).

source: SocGen

Now with the October 29 announcement that QE3 will be “tapering to zero”, liquidity surpluses from the US will no longer support the markets. In addition, the recent volatility in major stock markets has shifted the market picture and we could slip into a “Volatile Bear” market type much more easily and quickly now.
The recent volatility spike revealed the market’s vulnerability.  A lot of people got hurt in the mid-October dive and many more were uneasy about it. Since the May 2010 flash crash, many investors and traders have felt uncomfortable holding equity positions. This is a prime reason why retail market participation is at such low levels. On the other hand, the retail investors who have remained in the market have piled on margin. Look at the historical level of margin below (dollar volume of NYSE securities purchased on margin) which have reached all-time highs, surpassing even the overextended levels of 2001 and 2008.

source: Business Insider

FX Trading Opportunities and Alternatives

So with debt at unsustainable levels, what are the possible alternatives and FX trading opportunities?  Either —

• The economy will continue to be held up by another round of QE (in the US and anywhere else) supporting the system to go on for potentially many more years with central banks hoping to heal the debt situation through inflation.
  -or-
• Measures will have to be taken to reduce debt levels. There are some examples of various levels of austerity measures and financial “repression” (i.e. taking peoples’ money away) which seems to have worked well so far – with obvious amounts of pain. Countries such as Ireland, Portugal and Spain made progress and are showing some signs of economic recovery.

Either way, both scenarios involve some level of crisis.  But for those who are prepared, crisis means opportunity! Where can you find the opportunities in an environment of high daily volatility and a potential bear market type?
Consider trading equities short on a short-term basis only. Remember, bear market related volatility makes holding positions overnight (long or short) very difficult.
If we stay in the sideways mode that we’ve had in the S&P 500 for much of 2014, you will probably have a challenging time trading this market type as well.  The range change percent has been less than 5% for extended periods in the last year.
Thus, consider trading currencies.  Central banks have laid the groundwork for long term volatility and extended currency trends with their policies.  This factor alone makes Forex an attractive market to trade for years to come but currency trading has numerous advantages.  You can pick your preferred holding period – intraday, swing, or long term and you can utilize a variety of instruments – FX spot, currency ETFs, options, and futures.
Forex trading capitalizes on smooth, clean and consistent trends while mitigating risks. Currency price charts have many advantages in areas where you find drawbacks with stocks. FX has…

• virtually no price gaps (only minor ones over the weekend)
• virtually no slippage in price for small and large market orders
• no partials fills
• low transaction costs and efficient order management,
• the ability to go long or short anytime (no structural bias)
• as well as the ability to use position sizing™ strategies with different sized accounts.

All of these factors help reduce risks trading Forex compared with trading volatile equity markets.  These factors also help traders reduce the number of mistakes they make.  And for me a mistake is not following your rules – in a fast moving volatile market, mistakes are easier to make.
Apart from these advantages, FX markets are — in some sense, unique:

• The price development, reflecting the relative strength of two economies, is typically steady & smooth. Therefore, you can always find a good trend
• With the 24h-market market, you can choose a trading style, a timeframe and a time of the day that fits you best
• Tharp Think principles can be applied very easily
• It is the ideal asset class to start learning to trade — even with a small account

As Gabriel outlined in a recent article (Rich Man’s Panic), the market environment for currencies is very favorable now.  He demonstrated this in person trading his systems publicly at the last “Forex Live Trading” workshop.  In 18 trades over the two day workshop, he was able to make more than +20R and had a win rate of 89%.
If you are interested in learning more about trading Forex or investing in currencies, read Gabriel’s article  Top Ten Reasons to Trade Forex. You can also find a good list of resources and watch his videos at http://www.vantharp.com/workshops/forex.asp .

All the best,
Van K. Tharp and Gabriel Grammatidis

Debt Exceeds $100 Trillion as Governments Binge (Bloomberg)