The Weight of Our Convictions

Warren Buffet once said that “In the short run, the market is a voting machine. In the long run, it’s a weighing machine.” What he meant is that ultimately, in the financial markets just as in real life, action talks and baloney walks. No matter how ridiculous, how illogical, how utterly insane prices become, they always correct to their intrinsic value. Witness the Nikkei in 1980’s, Internet stocks in the 1990’s, US housing market in 2000’s.

Mr. Buffet’s maxim holds true for investors, but it can be a cold comfort for speculators like us who trade the most fickle market in the world. Ostensibly, the currency market exists for corporations to hedge their foreign exchange exposure, but fully 97% of the volume (last measured at $4 Trillion per day) is driven by speculators such as banks, hedge funds and retail traders like ourselves. The dirty little secret of FX is that everyone speculates -- even the corporates and the central banks.

The history of the market is littered with ghost stories of Fortune 1000 corporations whose Treasury departments lost millions and sometimes even billions of their shareholders capital in badly managed FX trades that had nothing to do with their core business. Even Mr. Buffet dropped a cool billion at the start of this century when his bet on the collapse of the dollar turned woefully wrong.

So how do you think about value in a market where sentiment reigns supreme? After all equities at least had some semblance of net worth because they represent hard assets of the corporations that issue them. Currencies on the other hand are a completely abstract concept backed only by the full faith and credit of their respective sovereign entities. In our world, money is just a blur of electronic bits on a computer screen.

Therefore as speculators we must operate differently. In order for us to heed Mr. Buffets advice we must make sure that the market is operating as both a voting and a weighing machine at the same time. What that means in plain English is that in order to succeed we must make sure that fundamentals and price action are in alignment. Those of you who follow me on twitter know that my ideal flow trades are always driven by a combination of price momentum off some fundamental trigger. In trading flow it is not enough to be on the right side of the news -- price action must confirm your analysis. Only then do you have a high probability trade.

The longer I trade flow, the more I am convinced of the efficacy of this approach. Whenever I deviate from my method, by trying to fight either the price action or the newsflow, I inevitably lose. In short, Mr. Buffet is right the market is both a voting and a weighing machine and it is our duty as traders to make sure we respect both factors before entering the fray.

Boris Schlossberg

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