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The worst performer today was the Canadian dollar, which lost value against all of the major currencies. The loonie started the North American trading session strong thanks to a larger than expected increase in manufacturing sales but dovish comments from Bank of Canada Governor Carney caused the CAD to tumble quickly and aggressively. Due to slower than expected first quarter GDP growth and low inflation, Poloz said he may have to reconsider the central bank’s neutral monetary policy stance. More specifically he said they can’t rule out further rate cuts if the downside risks to inflation increases. The BoC’s fresh concerns about the economy and consideration of additional easing sets them far apart from other central banks who are tightening monetary policy or beginning to remove stimulus. The CAD has reacted accordingly and we believe there could be further losses. However CAD/JPY is trading at a very important juncture that can either turn into a triple bottom or a sell-off that drives the pair to fresh 1 month lows. Given that USD/JPY is hovering right above support going into the FOMC meeting, we caution traders against selling CAD/JPY into the lows ahead of such an important event risk. The sustainability of any move in CAD/JPY hinges on USD/JPY’s reaction to FOMC. If USD/JPY drops below 101, then CAD/JPY is bound to fall to fresh lows but if it rises back above 102, then we have a potential triple bottom near 91.
From a technical perspective, CAD/JPY is obviously weak. The previous 1 year low of 90.78 was set in February and tested in early March. If this level is broken in a meaningful way, there is no major support until 90. Should CAD/JPY recover, the first level of resistance will be around 92.25 with a more significant resistance level at 94.
GBP/CAD is in play over the next 24 hours because both countries have retail sales reports scheduled for release and there is a very good chance that one will be strong and the other weak, leading to a big directional move in the currency. Starting with the U.K., we have a number of reasons to believe that the retail sales report could surprise to the upside. Earlier this month, the British Retail Consortium reported the strongest increase in consumer demand in more than 2.5 years. The BRC retail sales monitor rose a whopping 3.9% in January, which compares to a 0.4% increase the previous month. Despite the rise in the unemployment rate, jobless claims dropped more than expected while average weekly earnings increased at a faster pace – both of which have positive implications for consumer demand. Confidence also improved significantly, rounding out our reasons for expecting an upside surprise in retail sales on Friday. In contrast, there’s a significant risk of a downside surprise in Canadian retail sales. Wholesale sales fell a whopping 1.4% in the month of December and unfortunately in our experience, this report has a strong correlation with the broader retail sales release. Economists are looking for a soft number and expect retail sales to fall by 0.4%. With job growth and manufacturing activity slowing in December, would not be surprised if retail sales dropped more than 0.4%, which would trigger a sharp sell-off in the CAD. Stronger spending in the U.K. and weaker spending in Canada could drive GBP/CAD to fresh 4-year highs.
The recent rally in GBP/CAD has taken the currency pair within a whisker of its year to date high at 1.8560. This level capped gains in the pair for the past 2 month and if GBP/CAD finally musters the strength to break above this rate, there is some near term resistance at 1.8600 but beyond this level there is no major resistance until 1.90. If the currency pair fails at current levels, there is a very good chance it could drop back down to 1.82.
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Trade on longer time frames
As a retail trader you have two massive barriers which are the bane to your existence -- spread and volatility. If you trade a short term time frame you are vulnerable to adverse movements in both.
Spreads at most brokers are variable and can go to 15 wide on daily basis even when nothing is happening. (Ever see EUR/JPY at 5PM NY Time?). If you are trading with 15 point stop there goes your trade. Volatility is similar. One big exporter order on the fix could flip your trade from a winner to a loser as prices scurry 20 points in 20 seconds and then come tumbling back.
Its all a matter of math. 2 point spread on a 10 point stop is 20% cost of business. Same spread on 100 point stop is 2% cost of business. The higher your costs, the better you have to be to make money and I am not that good -- are you?
Focus on avoiding risk rather the chasing reward
Here is a simple exercise to consider. Take a strategy with 15 point target and 15 point risk. Now subdivide the equity into two halves. Trade one half on 15/15 basis and the second with 15 stop and 8 target. You have three scenario you lose on both halves you are -30. You lose on one half and make 1 take profit you are -7 (-15, +8) you will on both halves you are +23 (15+8). In the original scenario you are either -30 or +30.
So let’s compare and contrast. In worst case scenario you lose -30 both way. In best case scenario you win +23 on the 15 and 8 strategy and +30 on pure +15 strategy. So you are -7 on combo. However in the intermediate case you are only -7 on the combo but -30 on the pure +15 strategy. You are actually +21 on the combo. (You only lost 7 points on the combo and -30 on +15 -- you would need to make up 21 points just to get equal to combo)
When you look at risk this way you realize that you have some very asymmetric payoffs. In the best case scenario the “bet it all on one target” strategy only gets you 7 more points, but the murky middle (where almost all of life and trading takes place) it loses 21 points. Effectively the combo strategy is a better because its a compromise between cutting risk and chasing reward.
(This is a very simple example to illustrate a point. Spare your emails on expectancy ratios, etc. I am well familiar with statistics. I also know stats often don’t mean jack in a non-static environment like the market)
Mix and Match
We all know that diversification is good because it creates non-correlated returns which are supposed to be less volatile. But here is something to consider. You don’t need two separate strategies to create a diversified portfolio. The same strategy using different stops and take profits can produce wildly different results that are not very correlated and can therefore provide the portfolio effect you seek. So when you mix and match don’t just look at different system look at same systems trading differently.