usion. For instance, the normal spread inspot Euro–dollar may be one pip – i.e. 0.8910/11 – but try transacting USD500 million in thatspread when the spot exchange rate is moving two or three “big figures” – 0.89 to 0.90 – a day!Readers should note that when I say interbank dealers, I mean currency forward and optionsdealers as well as spot dealers. These also take positions as well as provide liquidity for thebank’s clients. Here too, like any market where competition has increased over time, spreadshave narrowed and the emphasis to position taking has shifted proportionally. In addition, asthe needs of clients have changed and become significantly more specific and sophisticated,so there has also been a move by forward and options interbank dealing desks to meet theseneeds with more exotic forward and options structures. The advantage for the bank concernedis that the spreads on these products are usually larger than those for plain vanilla forwardsor options. However, markets work in real time. Here too, competition has quickly moved tonarrow those spreads.9.4.2 Proprietary DealersThe second group of currency speculators is that of the “proprietary dealer”. This individualis usually among the most experienced currency dealers in the dealing room. He or she playsno part in providing liquidity for client orders, but instead uses a designated amount of thebank’s balance sheet for the specific purpose of position taking in the currency markets. A“prop” dealer may take these positions based on any combination of fundamental, technical,flow or quantitative considerations. He or she has the luxury of not having to quote or makemarkets for others. On the other hand, their value to a bank comes in the form of one numberalone, their P&L at the end of the year. They get all the kudos and all the blame depending onwhat that number is. They are a bit like racing drivers – and many would be happy with thatanalogy. There are old prop dealers and bold prop dealers, but no old, bold prop dealers! Theanalogy is meant in light-hearted fashion. Good prop dealers are extremely hard to find. Mostthat I have met are in complete contrast to the image of a financial market dealer as loud andbrash. On the contrary, many are relatively quiet, analytical and extremely bright.
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9.4.3 “Hedge” FundsThe very term may for some conjure up the devil incarnate. There is little question that theimage of the hedge fund has changed over time. Before we get onto that image, let us first dealwith what they do. The first thing to say is that there are hundreds, if not thousands, of differenttypes of hedge fund. The term “hedge fund” is in fact an extremely vague one, encompassingthe activity of a very wide variety of funds that trade in currency and asset markets. Certainspecific hedge funds may seem particularly synonymous with the term, but while their fundsare some of the largest they are in fact the tip of the proverbial iceberg in terms of reflectingthis section of the financial community.For a start, most of them unlike their name do not hedge. Indeed, their aim is to take assetmarket or currency views, to increase risk albeit selectively rather than to hedge risk. Ratherthan tie up balance sheet capital through spot positions, they frequently use derivatives toexpress a view, using leverage. The amount of leverage that hedge funds are allowed to use hasdecreased significantly since the failure of LTCM in 1998. Hedge funds are still active participants in the currency markets, though their involvement has in fact diminished substantiallyfor a number of reasons. Firstly, the LTCM failure caused the counterparties of hedge funds –the banks they dealt with – to take a broadly more conservative approach with regard to creditand leverage given to the hedge funds. This in turn reduced the ability of hedge funds to takeon the large, leveraged positions they had in the past. Secondly, the global equity rally (i.e.bubble) in 1999–2000 represented a competitive threat to this sector of the financial community. Hedge funds achieve popularity with investors precisely because of their outperformanceto “the market”, that is to the traditional equity and fixed income markets. Thus, when equitymarkets were exploding higher in 1999, it became extremely difficult for some to achieve thatoutperformance, particularly when this took place at a time of deterioration in the relationshipbetween hedge funds and the rest of the financial markets in the wake of LTCM. Thirdly, thelarger a fund becomes the more unwieldy it can become in terms of its market positioning.Benchmarks have to be outperformed and that can be achieved only with size when traditionalmarkets are performing well. Yet, to do that may lead to market disruption, both on the wayin and on the way out, reducing the attractiveness of taking the original position. In the endmany hedge funds became trend followers in 1999, buying the NASDAQ and running with thecrowd, more with the aim of defending returns than generating greater returns. Currency speculation is generally less attractive during times when traditional asset markets are trending soclearly, given that a fundamental part of currency speculation is to find economic imbalances –positive or negative – that the markets are not pricing in and trade on those in the expectationthat the markets will eventually realize such imbalances and trade their way. Several hedgefunds reduced their currency speculating operations in 1999.This decision may have been somewhat premature. The bursting of the equity bubble in 2000has brought hedge funds the opportunity to add value once more, including doing so by meansof currency speculation. Indeed, it would not have been difficult to beat the NASDAQ’s returnin 2000 and the first half of 2001! Equally, while there may have been a reassessment of hedgefunds in the US, both from within and without, the hedge fund community has blossomedand flourished in Europe subsequently, particularly in several countries in continental Europe.The umbrella term of “hedge funds”, even those that focus on the same asset or currency orhave the same trading style, can reflect a variety of different types of organization. Recently, anumber of total return or leveraged funds have been created. These may have not have a strictmutual fund structure, which helps at least to give some definition to the traditional hedge
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funds one thinks of, but they do have a very similar trading approach. In addition, banks canhave internal hedge funds for specific client products. In sum, there are a very large numberof hedge funds that “speculate” in a large number of assets and currencies. The performanceof speculative currency funds is measured by a number of organizations, including the MAR(Manager Accounts Report) Trading Adviser data (available at: www.marhedge.com), ParkerGlobal (www.parkerglobal.com) and the Ferrell FX Manager Universe. The irony with regardsto their critics is that most base their trades either on inconsistencies in market pricing, whichcan instantly be arbitraged, or on sound macroeconomic principles. This latter group, knownas the “macro” hedge funds, make up by far the largest group of funds that are publicly known.They are speculating according to fundamental principles. Thus, one could argue they are notspeculating at all.While many may seek to make a clear distinction between speculative and non-speculativeactivity, any such line of distinction is frequently uncomfortably blurred. At its most basic level,there is the idea that corporations take currency positions purely for transactional or hedgingpurposes, while hedge funds or prop dealers take currency positions for directional gain, withno underlying asset. The idea that there is such a clear distinction between the two sides is afiction. Over the last decade, several major corporations have experienced painful losses andsome have even collapsed as a result of taking on financial market positions that subsequentlywent sour. In this regard, problems tend to start when financial speculation overtakes theunderlying business in importance.Whatever the case, there are therefore other currency market participants we need to examine,which can at times be considered as currency speculators. Though many would no doubt bristleat the term, that is what they are if the individual transaction they are conducting has no related,underlying asset.
9.4.4 Corporate TreasurersI realize fully the reaction that may be caused by labeling some corporate Treasurers as speculators, but frankly that is what some of them are according to my definition of currencyspeculation. This is in no way whatsoever a criticism. It is however a reflection of the realization that while most corporate Treasuries see their main goal as management and reduction ofrisk, a (not small) minority sees the Treasury as a profit centre in addition to the underlyingbusiness. These deliberately take asset and currency market positions for the specific purpose ofadding to the company’s bottom line. There is no definitive answer as to whether this is “right”or “wrong” in very simplistic terms. It goes without saying that one had better know whatone is doing if conducting such speculative activity. While adding to the company’s bottomline is clearly a good thing – both for the company and for the Treasurer – financial marketscharge a risk premium for P&L or balance sheet volatility. This should be a considerationwhen deciding whether or not to allow active speculative activity within the Treasury, usingthat balance sheet.The other and decidedly more frequent kind of speculation that corporate Treasurers go in foris in not hedging out currency risk. We looked at this in Chapter 7 in substantially more detail.However, within the overall topic of this chapter, it is important to reiterate and make clear thepoint that not hedging currency speculation equates to taking a currency view, and that in turnequates to currency speculation. Granted, it is a stretch to fit this type of currency “speculation”within the narrow definition chosen for this book. There is after all an underlying asset. That
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said, not hedging means leaving that underlying asset exposed to financial market volatility.Such a decision would seem to be speculative under most broad definitions of speculation. Thisis in no way to suggest corporate treasuries should hedge currency risk each and every timethey have an underlying exposure. The aim here is not to counter one extreme with another.Rather, it is to seek to challenge an idea, an ideology almost.The idea and the ideology is that currency hedging represents a cost, while losses due to nothedging are simply the result of unpredictable market volatility. To me, the latter representsan abandoning, a shirking of responsibility. It is part and parcel of the job of a Treasurer orfinance director to predict their business needs. Should it not be also to predict the context withinwhich those business needs exist, the context being of course the global financial markets thatspecifically affect the risk profile of their business? A corporate Treasurer may say that they haveto explain the cost of a currency hedge to the company’s board, particularly if it had a notableimpact on the company’s figures. They should equally have to explain when they do not hedge,and subsequently the company’s unhedged currency exposure leads to extraordinary losses andbalance sheet pain. It is sloppy thinking to just leave it to the market to blame. If markets werecompletely unpredictable, strategists or analysts would not exist. Granted, some are better thanothers, but the very existence of the profession suggests that at least some are getting it rightpart of the time. That in turn suggests that a corporate Treasurer or finance director, who isfar more senior in both experience and rank to a bank’s strategist, should be at least as wellinformed as the latter. Companies exist within the market context their businesses operate in.The two cannot be separated. Some need to do a better job of understanding that context.
9.4.5 Currency OverlayAgain, it is probable that most currency overlay managers might not appreciate being labelledas speculators. Here however, the definition we have used in this book for currency speculationappears to work well. After all, the very job of a currency overlay manager is to differentiatecurrency risk from underlying asset risk within the overall risk profile. Active currency overlayrequires that currency risk be managed separately and independently from the underlying.Therefore de facto, it falls within our definition of currency speculation. This does not meanthat a currency overlay manager is of necessity anything like a prop dealer or a hedge fund.The job of a currency overlay manager may be either to ensure the total return of the portfolioby reducing risk as much as possible, or alternatively it may be to add alpha.Either way, currency overlay managers use currency hedging benchmarks, as we saw inChapter 8. They can manage the currency risk passively by maintaining the currency riskaccording to the benchmark. Alternatively, they can manage the currency risk actively bytrading around the currency benchmark to add to the total return of the portfolio. The former areclearly not currency speculators in that they are hedging currency risk related to an underlyingasset and moreover they are doing so passively. They are not “taking a view”. The latter group,who trade actively around the currency benchmark, are indeed currency speculators in thatthey are taking positions not specifically related to the underlying asset.Corporate Treasurers and currency overlay managers may think their world is as far awayas one can get from those of the prop dealer or hedge funds, but there are times when thedistinction between the two sides becomes decidedly less clear than many might like to think.In turn, this should mean one takes a more balanced and measured view of the very topic ofcurrency speculation.
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9.5 THE SPECULATORS – WHY THEY DO ITThe obvious answer is of course simply to make money. At a slightly more sophisticated level,market participants undertake currency speculation for the reason that they think they can earnexcess returns by doing so. In turn, the reason they think that is because they or others havedone so in the past.Just as fashions and retail trends change over time, so does the idea of “conventional wisdom”within financial markets. In the 1970s, despite the break-up of the Bretton Woods financial system, the conventional wisdom was to have pegged currency regimes and maintain a significantdegree of government control over the economy. In the 1980s, the US and the UK underwentsubstantial financial reform, opening up their economies and capital markets to the idea offree trade of goods, services and capital. With regards to currency or exchange rate regimes,the conventional wisdom has gone from governments trying to maintain control to allowingfreely floating exchange rates. A slight fine tuning of this in the wake of the currency crisesof the 1990s is the idea of the “bi-polar” world so eruditely explained by Stanley, former FirstDeputy Managing Director of the IMF, in speeches and written research notes. This arguesthat in a world of open capital accounts and free trade, exchange rates have to be managedaccording to either the hardest of pegs or the freest of free-floating principles, that anythingin between these two poles will eventually prove unsustainable. Whatever the merits of thisargument, there is little doubt that it has become the conventional exchange rate wisdom ofthe day, notwithstanding the protests of a few dissident voices.The conventional exchange rate wisdom of the time of necessity affects the way marketsoperate, and thus how markets speculate for or against currencies. For instance, market participants who have been used to making good profits by speculating against pegged exchange ratesmay try to do so again, against a currency peg in a completely different part of the world. To avery large extent this is self-fulfilling. For this reason, a currency board regime that gets attackedin one part of the world can lead to markets attacking other currency boards on the other sideof the world. For this very reason, the currency boards of Argentina and Hong Kong are oftenlinked, although that link has been gradually reduced in the market’s mind as the Hong Kongauthorities have proved time and again their determination to maintain the currency board.Currency speculators trade currencies to make money, pure and simple. They have a varietyof methods, which we will look at subsequently, but the incentive is always the same. The factthat they can do so in the reasonable expectation of achieving their aim causes a problem withstandard economic theory, not least because the theory suggests it is impossible over time.According to the theory, currency speculation is zero sum gain, which of necessity cannotresult in consistent excess returns given the unpredictability of currency markets. The fact thatexcess returns can and have been achieved suggests this theory needs to be amended!
9.6 THE SPECULATORS – WHAT THEY DOAs noted previously, there are a wide variety of currency speculators and therefore it is noeasy task to explain their methods or techniques since they too vary widely. The techniques ofcurrency speculation vary widely, just as with stock market speculation. Indeed, the analogyis a good one. Just as in equity investment where you have “top down”, “bottom up”, “valueinvesting”, “growth or income” investing, so in currency markets you have speculators orinvestors – however one likes to term them – who focus on the macroeconomic “big picture”,long-term currency valuation, microeconomic factors affecting currencies, money flow and
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technical analysis. The titles are perhaps different but the guiding principle is the same; whatseparates and differentiates the framework within which they analyse the market. Below, weattempt to summarize the types of techniques and strategies with which currency speculatorsapproach the currency markets.9.6.1 MacroThis approach is for the most part identified with the so-called “macro hedge funds”. Broadlyspeaking, “macro” or macroeconomic-based currency speculators look for market pricinginconsistencies between the prevailing economic fundamentals and the long-term currencyvaluation, with the current market pricing. Their raison d’être and their incentive is that currentmarket pricing is “wrong” relative to those fundamentals and valuation, and they can earnexcess returns by trading against that market pricing.Here again, the line between the currency speculator and the “fundamental” market participant is blurred. After all, where is the difference in terms of incentive and action between theasset manager who invests in a country’s equity or fixed income markets and the macro-basedcurrency speculator who invests in a currency because they think it is undervalued relative tofundamentals and valuation?It is widely assumed that currency speculators only trade against currencies rather than intheir favour, but this is very far from the case. Indeed, during the Asian crisis itself, a numberof macro hedge funds bought Asian currencies such as the Indonesian rupiah on the viewthat they had overshot their fundamental value – unwisely and prematurely as it turned out. Ithas frequently been easier to make excess returns by trading against currencies rather than intheir favour during the 1990s, not for any malign reason but simply because it was discoveredthat semi-pegged exchange rate regimes were incompatible with free and open capital markets.Keeping on the Asian example, to focus on currency speculation for or against Asian currenciesis to ignore the fact that the Asian boom became a speculative bubble that was in any casewaiting to burst, a bubble, which the authorities were seemingly unwilling or unable to stop.Macro currency speculators are a stabilizing force against economic imbalance, an arbiter ofgovernment economic policies. The disruption that currency markets might experience is notcaused by their activity. Whether they were capable of doing so in the past due to much greaterleverage that is certainly not the case now. They can merely accelerate the process, but theycannot cause it. The real cause is the government policy in the first place, which triggered theeconomic imbalance.9.6.2 Momentum (and Fellow Travellers)Momentum funds have a different trading approach as regards currency speculation. Ratherthan focusing on apparent disparities between the economics and the price, they use so-calledmomentum models to trigger buy or sell signals in currency pairs irrespective of the economics.Granted, one could argue that since economics affects the price of the currency, so it also affectstheir models and therefore their trading approach. However, it is fair to say that economicsis not their primary focus. Their aim is to be disciplined to the extent that they rigorouslyfollow the trading signals of their momentum models. As one might expect, the nature of thesemodels varies. For instance, one such momentum model relies on technical analysis indicatorsto provide short-term moving averages. When a 5-day moving average crosses up through the15-day moving average they buy and when the opposite happens they sell. Granted, this is a vast
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oversimplification and there are many significantly more sophisticated momentum models thanthis. That said, the principle is surely the correct one. Momentum models, however complexand whatever indicators they rely on, focus on changes in market prices as their key determinantfor providing signals rather than economic fundamentals. Therefore, it is probably a reasonablegeneralization to say that they are more short term in their trading approach than macro-basedcurrency speculators might be, depending of course on how long the momentum signal lasts.9.6.3 FlowIt is debatable whether or not momentum traders are trend-followers. There is no debate whenit comes to flow-based currency speculators. The very act of using order flow information forthe purpose of trading in the currency markets requires that the user is following the trendsuggested by that flow data. Currency speculators, who focus on flow, use that informationto anticipate the continuation or end of a trend. Clearly, with flow products, both the qualityand the relevance of the flow data are crucial elements in deciding whether or not to use suchproducts as one’s primary information source for trading. There is no point in using a flowproduct where the order flow is neither reflective of the currency market as a whole nor hasany impact on it. Flow-based currency speculators can certainly earn excess returns, but aswith other trading approaches discipline is needed. Unlike in the case of the momentum traderwhere the model creates the signal irrespective of all other factors and therefore the trader’sonly job is to execute according to that signal, there is still a significant degree of discretionand interpretation in flow-based currency speculation. For instance, temporary seasonal factorscan distort flow. If the flows model were passive, this would mean that a trading signal wouldbe triggered irrespective of this important consideration. That said, the aspect of discretionautomatically increases the possibility of misinterpretation and making mistakes. As withmost types of trading or currency speculation, experience counts.9.6.4 TechnicalLastly, we focus on currency speculators who use technical analysis, either primarily or solelyin order to determine their trading in the currency markets. Again, I have found that it surprisessome economists that such people exist, not least because it flies in the face of the view thatmarkets are efficient and that pricing is therefore irrelevant. My answer and more importantlythe answer of the technically-based currency speculators themselves is that markets are notperfectly efficient, though they are predictable to an extent and technical analysis helps withthat. As discussed in Chapter 4, there are a number of schools of thought within technicalanalysis, such as Elliott Wave, Gann and Fibonacci. A good technically-based currency speculator would use a number of types of technical analysis, not least to test their core view beforeexecuting the position. As with other types of currency trading, technical traders can be short orlong term in their approach. More generally however, all are looking for trading opportunitiesusing existing market pricing, either for or against the existing trend.
9.7 CURRENCY SPECULATION – A GUIDEReaders who are familiar with most serious works on currency markets, which deal with theissue of currency speculation, will be familiar with the fact that most do so from the perspectiveof economic theory. That is to say, most look at the act of currency speculation in terms of its
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role relative to the specific types of exchange rate regimes, within the context of the overalleconomy. For instance, there have been several works that look at currency speculation relativeto “target exchange zones”. Optimal currency areas are, in this particular sense, those whichare sufficiently strong and balanced to be able to deter most currency speculation and withstandthat which is foolish enough to try.There is nothing out there – and I have searched – on how to be a better currency speculator.Again, I realize this may cause a reaction within some. I must only reiterate that I see currencyspeculation neither as a benign nor as a malign force. Currency speculation does provide neededliquidity to those areas seen as productive within the economy. It also acts as a necessary arbiterof economic policy. Governments are answerable to the voters, but they are also answerableto financial markets, just as a board is answerable to its shareholders. Equally, governmentsmust ensure against excess within those markets. The balance between the two is a delicateone, a dynamic one that changes over time. Both sides are cause and effect. There must beregulation and there must also be free markets, not least because all alternatives have been triedand have proved miserable failures. Completely unfettered, unregulated markets may provechaotic and damaging. Equally, overly regulated markets may stagnate. Currency speculationplays a useful role as regards the overall health and vitality of the financial markets. Granted,this has been a role that has been little understood. Hopefully, this chapter has helped to achieveat least some clarity in this regard.So, how to be a better currency speculator? As we have seen above, there are many techniquesfor currency speculation, depending on the framework one uses to analyse the market. I wouldsuggest however that there are some guiding principles in the art of currency speculation,which should help speculators generate consistent excess returns. My perspective is that of anadviser rather than a trader. Having watched the currency markets for over a decade and inthe process benefited from the knowledge and experience of the hundreds of currency marketcontacts that I have made or come into contact with, as an emerging market currency strategistI advise a bank’s traders, sales and clients on what are the best trading and hedging strategieswithin emerging market currencies. The recommendations that I have made are compiled inan EMFX leveraged model portfolio1 which produced annual cumulative simple returns of46.3%, 25.9% and 47.1% in 1999, 2000 and 2001, respectively. As a result, I feel reasonablyqualified to make some suggestions, which though they may undoubtedly not prove definitiveat the very least add to the debate.(1) An integrated approach – The most powerful, consistent form of currency analysisand therefore of currency speculation is that which brings together all the main analyticaldisciplines to create a combined trading signal. Fundamentals may or may not be enough ontheir own. However, currency speculators who want to create consistent outperformance andhigh excess returns do not deal with “maybes”. Fundamental, technical, flow and valuationanalysis need to be coordinated and integrated to provide the clearest picture of what is goingon in the market and how one can profit from it. This is the heart of currency economics that Ihave tried to impart. A very simple and effective discipline is to create a signal grid for thesefour types of analysis and stick to it rigorously (see Table 9.1). Only when at least 3 of 4readings are showing “green” or “red” should one put on a major new position. The advantageof this is that it should greatly reduce the bias created by relying only on one analyticaltype.1[See an integrated approach] These figures are based on the simple cumulative returns resulting from recommendations and havenot been officially audited.
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Table 9.1 A currency strategy signal grid
Exchange rate
Currency economics
Flow analysis
Technical analysis
Long-term valuation
Buy/sell
Buy/sell
Buy/sell
Buy/sell
(2) Risk appetite – Use a risk appetite indicator as a gauge of overall market sentiment andas a benchmark against which to measure your positions. The one I mentioned in Chapter 2 isan excellent one, the Instability Index, but there are others. When your signal grid is showingno clear signal, but the risk appetite indicator is in risk-neutral or risk-seeking mode, go longa basket of higher carry currencies, albeit selectively chosen, in order to boost the total return.When the risk appetite indicator moves from risk-seeking to risk-neutral, take half your profit.When it moves from risk-neutral to risk-averse, cut your position entirely and go short thecarry basket of currencies you have used. This strategy, used in a disciplined way, can addsignificantly and consistently to your total return, particularly during periods when the signalgrid is showing mixed signals (which will be most of the time).(3) Trading discipline is at least as important as having the right view – A currencyspeculator can have the right view but bad trading discipline can reduce or even reverse tradingprofits. The view should be the unequivocal result of the combined trading signal from thefour analytical disciplines, or as a result of the risk appetite indicator. There is nothing elseto consider. “Gut feel” can earn excess returns for a period of time if you are a good andexperienced currency speculator, but it is not enough on its own. Eventually it will result inyou getting burned. The more overconfident you are, the more badly you are likely to getburned. As regards positions, the entry, exit and stop levels should be decided by flow andtechnical considerations. Run profits, depending on technical and flow developments. Alwayscut losses. The field of behavioural finance teaches us what we know intuitively, that it is muchharder to cut a position, whether it is running a profit or a loss, than to initiate it. Hoping orwishing a position to come back in your favour is a beginner’s mistake. Be disciplined and thatmeans at times being ruthless. Not cutting losses is the easiest and the most efficient way ofdestroying your total return.(4) Emotion comes before a fall – Currency speculation is about making money pure andsimple. There should be no emotional aspect to it. It is neither moral nor immoral. Furthermore,try to remain detached from your P&L to the extent that it does not affect your trading approach.Great danger lies in the making of both profit and loss. The more profit you make, the more yourview of financial markets appears to be confirmed and the more overconfident you become.Many have produced incredible results speculating against market inconsistencies to the pointwhere they appeared to believe they were the market. That is usually the signal that the goodtimes are about to end. Losses can also be dangerous because they make you loss averse andthus reduce the amount of potentially profitable opportunities you can take advantage of.(5) Less is more – Take fewer trading positions rather than more for two reasons. Firstly, asmall number of trading positions is more easily managed than a larger number of positions,and that takes us back to point 3. Secondly, currency speculation is the pursuit of inconsistencyin currency market pricing. There are rarely a very large number of inconsistencies at any onetime, not least because if it were that easy we would all be doing it. The aim of creating thesignal grid and using the discipline of the risk appetite indicator is to trade on sure-fire winnersand nothing else. A portfolio that has a very large number of positions suggests a portfoliothat is trading on more than sure-fire winners, a portfolio that is increasingly relying on such
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vague concepts as luck, hope, belief and emotion. Currency speculation is not a game, it is notbetting and there should be no luck involved. If there is, you have the wrong position. Cut it.(6) Speculators make predictable mistakes – Everyone makes mistakes and currencymarket practitioners are no different. However some mistakes are more predictable than others.In this regard, there are three key themes of behavioural finance that should be considered asa guide to the usual mistakes made, and therefore how to avoid making them in the future.Readers who have well understood the points above will of course note that the mistakes belowreflect straying from the signal grid and the risk appetite indicator:
r Heuristic-driven mistakes2 – Currency speculators frequently rely on “heuristics” or rulesof thumb in relation to their approach to trading. For instance, one such heuristic or rule ofthumb can be that previous trends will continue. If something has gone up for six weeks itwill go up for a seventh and an eighth. Heuristic-driven trading is biased in that the veryact of establishing a rule of thumb approach to one’s trading reflects one’s past experience.Because of their reliance on heuristics, or rules of thumb, currency speculators can holdbiased beliefs that make them vulnerable to committing errors, errors that result in painfullosses.r Frame dependence – This idea deals with the distinction between form and substance.Framing is about form. Frame dependence means that the results of one’s currency view aredependent on the frame or framework within which one focuses one’s view and thoughts.Frame dependence can deal not only with one’s fundamental view but also one’s approachto trading generally. One can be loss averse, meaning that one is far more reluctant to makea certain-sized loss rather than put on the risk necessary to make that level of profit. Lossesresult in emotion, which results in regret, which in turn alters the frame one uses to look