makes perfect sense tome. A high-rated borrower has, in effect, a huge pool of capital to drawfrom. I realized that a wise investor should always look to borrow at thelowest rates and invest for the highest rates possible, combined with a rea-sonable expectation of return. I hadn’t ever considered that, not because itdoesn’t make sense, but rather because it’s just not something I would havethought about.”
George smiled. “And now that you thought about it, what did youlearn?”
“T learned that carry traders don’t just invest in currencies. They alsoinvest in U.S. stocks, bonds from around the world, real estate, they evenpurchase entire companies with the borrowed money. There is a whole lotof borrowed Yen out there. But I will get to that point later. Iam sure I amnot telling you anything that you don’t already know.”
He nodded. “Probably true. But I have thirty minutes and I want tohear it all again.”
Ilooked down over my notes. There was no possible way for me to getthrough everything in half an hour. But I plodded onward: “Once I had anunderstanding of why it worked, and believe me, it took me a while to fig-ure it out, I realized that I could try to apply the same principles in my cur-rency trading. I called my currency dealer and asked about interest rates. Itturns out that retail currency platforms charge and pay out interest in thesame way that a bank would charge or pay interest. Only retail platformscall it a swap rate, and the interest is calculated at the end of every cur-rency trading day—in other words, at five pM. eastern time.”
 
Homework 177
“How much are they charging or paying out?”
“Well, for my research here, I used the British Pound versus the Japa-nese Yen, the GBP/JPY. Because interest rates in Japan are at zero, andrates in the United Kingdom are at 4 percent—and, I might add, expectedto keep rising—when I buy one standard lot of the GBP/JPY cross pair inmy trading account, which is $100,000 worth of currency, I get paid about$20 every day in interest.”
“What kind of leverage do they give you?”
“That's my next point. I have 400:1 leverage with my dealer, which Iknow sounds ridiculous. It’s a ton of leverage. But the leverage is almost ir-relevant,” I told him, “and this is where it gets exciting. I hope I haven’tgone totally wrong with this research, because I think I stumbled ontosomething really amazing.
“Let’s say that I open an account with Universal Currency Brokers. Iput $100,000 in the account. I don’t have that much money, but let’s just sayI do. I put up only $10,000 of that money for margin. And because of lever-age, they let me buy $4,000,000 worth of GBP/JPY, or forty standard lots.Every day that I hold that currency, I get paid $20 for every standard lot, or$800. Just for holding onto the currency pair in a buy position. This soundstoo good to be true, but I called around that night to at least 20 currencydealers. I found that almost all of them are paying interest in thoseamounts. Almost all of them. I hope I’m okay so far.”
George nodded. He looked at his watch. I could tell that [had capturedhis interest. He said: “I ordered in some sandwiches but I’m losing my ap-petite while you talk to me about money.”
“Me, too. I can eat later.”
“Good. So far, this is fine research you've done. This is slightly differ-ent than the way it works for us, but it’s perfect so far.”
“I’m happy to hear that. If the research was faulty up to this point, ’'dhave nothing left to say. But here’s what comes next: I thought, it soundstoo easy to just buy the GBP/JPY each day and try to earn $800. Why? Be-cause the currency pair might fall, instead of rise. You know, if some newscomes out, or if there is a terrorist act, the currency pair is going to bouncearound. And for each standard lot traded, a pip is worth about nine dollars.Say it drops 100 pips, and I’ve traded 40 standard. If the pair falls 100 pipsin one day, I would lose 100 times nine dollars times forty—that’s 100 pips,times nine dollars per standard lot, times forty standard lots traded. That’salot of money. Way more than I would be earning from the interest.”
“Tt’s just not worth the risk then,” he added.
“Right. It would be ridiculous. But, if I could find good levels at whichto buy the currency pair, and hold on, then I would be in good shape. Reallygood shape. Not only could I earn interest, but I would be earning pipgains, too. This would be far better than taking the same type of trade with
 
  
 
178 ADVENTURES OF A CURRENCY TRADER
a low-interest-bearing currency. This way, I’m basically paying myself extrafor holding onto a trade.”
“T like what I’m hearing. But how would you be hedged?” he asked.
“Hedged?”
“Yes. How would you balance out the risk?”
“Well, for one, I would come up with a series of stop loss rules to exitthe buy trades. That would limit the downside risk.”
He nodded. “That is a start. But is there a way you can use options orfutures contracts to hedge yourself, in case of a big, sudden decline?”
“Tm not sure I understand. I’ve never traded options or futures.”
“Well, Harry, you’ve made a good start here. But if you want to be aworld-class trader, you are going to have to go one step further. You haveto nearly eliminate your risk. As low as you can get it. Meaning, you wantto have the least amount of exposure to losses as possible. And I bet thatyou can find a way to hedge the trade so that you can hold onto it for a longtime, without worrying about having to open and close the trades.”
“That sounds good to me. I am not sure that would be possible.”
He laughed. “It’s definitely possible. We do it here all the time. We do itwith options and futures. I’m not sure those financial instruments will beavailable on your retail trading platforms. But there has got to be a way tomake it work.”
“Tf there is, Iam dedicated to finding it.”
“Very good. Here is what I want you to do. It’s not going to be easy, butit will be worth it. I want you to do some very, very deep research into in-terest rates now. I want you to go way down. Do you know how to usespreadsheets?”
I was embarrassed to explain to him that I didn’t.
“All right, then. Find yourself someone who does.”
Roddy and George! “I know just the people.”
“Good. Now I am going to start you off by giving you some data on aCD,” and then he called over to a trader across the room. “Bobby! Bringover the spot rates CD.”
“Which one, Mr. Sisler?”
“Sterling, Swiss, and Yen.”
“You got it.”
Bobby walked over and handed me a compact disc. George nodded toit. “Now, please don’t give out that data. It took us a long time to compile.It’s got spot rates for more than 20 years back on two cross currency pairs:the GBP/CHF, and the GBP/JPY.”
“All right.”
“I want you to look up interest rates for the United Kingdom, forSwitzerland, and for Japan, going back that far. And then I want you to plotona graph how interest rates have affected currency rates over time. I know
 
Homework 179
you've already told me that you know that interest rates drive currency val-ues, but now I want you to show me exactly how that is true. Understood?”
“Yes. I understand. When do you want this?”
“A week from today. Monday, April 19. I will see you here at the sametime.”
“If I get some help on this, can I bring a couple of other people?”
“Of course. Now I gotta run. See you in a week.”
POUNDING THE YEN
 
Winnipeg George and Roddy were excited, to say the very least. After I fin-ished work at 7:00 p.M., I visited with them and explained everything. Ap-parently, they believed the interest rate information was going to be easy tofind. “We can stay here tonight and we'll have all of it by tomorrow morn-ing,” Roddy told me.
Up all night? During the week? I was missing a lot of family time, and Iwas also not going to be in great shape for work the next day, if I didn’t getany rest at all. “I don’t know. Can we do this on the weekend?” I asked. “Ifit’s really this easy?”
“Sure,” answered Winnipeg George. “Meanwhile, we can plan moretrades, and you can learn how to use spreadsheets.”
“Deal,” I said, and with that I decided that for the rest of the week Iwould split my time between planning more trades and learning to use aspreadsheet.
And over the next few days, both endeavors worked out very well.Learning the spreadsheets was easy. And overall, the trades worked outvery, very well. Some of them stayed open for over a month. Some wereover nearly as soon as they were opened.
The first trade expressed my desire to benefit from the interest ratesdifferential between the United Kingdom and Japan. So I looked at theGBP/JPY, starting as usual with the fourhour chart. I wanted to find aplace to buy. The first thing that I noticed was that this pair tended to moveup and down a lot—it seemed to trade inside a range all the time. The nextthing that I noticed was that recently, the 193.00 level offered a reasonableamount of support to the pair. In the last part of March, the pair had notbeen able to rise through the level and stay above it; then a week later itwas able to burst through the level, but not fall back down below it. Thiswas a perfect example of resistance becoming support.
Roddy and Winnipeg George had their own views of why the 193.00level was a good support or resistance zone, and it had something to dowith the fact that their CCI oscillator was overbought or oversold every
 
  
 
180 ADVENTURES OF A CURRENCY TRADER
  
 
GBPJPY - 240 minMarch 30
ne
  
    
April2
2
all
    
April 7
 
2s
[e000 "3n0 4300 at ‘01 1300 402 4d (13:00 406 407 43:00 408 108
 
FIGURE 18.1 Stops and profit targets.
time the line was hit. Although I was happy that their tested system wasalso confirming the trade, I was ready to write it down and paper-trade itno matter what. We did agree that although the currency pair had stoppedstone-cold on the 193.27 mark previously, we would wait for it to hit 193.00even because, according to my new trading partners, this was a currencypair that tended to obey the round numbers. At this point, I was ready totalk about stops and profit targets (see Figure 18.1).
Winnipeg George believed that 195.00 represented a perfect exit forthe pair; it would give us a 200 pip target, and it was also the same placewhere the currency pair had stalled on three different occasions: first, onMarch 18, when the currency pair had fallen to the 195.00 figure andstopped dead in its tracks before heading lower. Second, on April 6, whenit had finally risen above the 193.00 level. And third on April 8. On each ofthese collisions with 195.00, the currency pair had only managed to breakthrough by 50 pips or so. What I liked the most was that 195.00 had alreadyplayed the dual role of support and resistance.
I wrote down:
Long GBP/JPY 193.00, Stop: 192.00, Profit target: 195.00
Roddy and Winnipeg George took the trade for the firm (Figure 18.2).It was enough for me to watch them with the trade.
This trade opened and closed while George and Roddy were workingthe overnight shift—it opened on April 13 at 3:00 in the morning and closedalmost exactly 48 hours later.
 
Homework 181
        
 
GBPJPY - 60 min
Trade closes
 
+1920
—_— Trade opens — mss
[ane ‘00 ” "aia M00 Tana “S00 1300" ‘ais 10.00 “Yen '
FIGURE 18.2 George and Roddy’s trade.
I still didn’t have any desire to do any trading of my own. The lossesfrom the week before were still fresh in my mind. Maybe I would be readyin a month when Wakeman gave me my first check. Maybe sooner. Thiswas a decision better made with Harvey Winklestein’s help, and I hoped tosee him again soon.
Harvey’s absence certainly didn’t keep me from planning more trades,however. Together with Winnipeg George and Roddy, I analyzed andplanned for four more trades. Two of them were based on the GBP/USDone-hour chart and each of them netted 40 pips. I was not present to seeeither of those trades open. Another trade was based on the EUR/USD 15-minute chart and gave us 50 pips. I didn’t like the short-term chart as much,but Roddy and Winnipeg George convinced me that I needed to know if thesystem I was using would work on the short-term charts. It did, and thatwas enough proof for me. I was still determined not to base my tradingplan on the short-term charts.
During this time, we also began to call this trading system the “Win-nipeg Special,” mostly because Roddy forced us to do so, in honor of Win-nipeg George’s home province and also because it confused people whoasked what we were doing. Roddy thrived on that. Most traders, includingCraig, had generally left us alone for the entire week and my trade ideaswere no longer the popular flavor. I realized that most traders at EW wereinterested in the hottest ideas, wherever they could be found. But theydidn’t focus for very long on any idea in particular. Also, they were engagedin a lot of other stuff, like quoting prices for customers, trading options,
 
  
 
182 ADVENTURES OF A CURRENCY TRADER
futures, and other instruments. My Post-it notes were simply not sexyenough to hold their attention for long.
My focus on learning to trade for myself made up for the lack of inter-est other EW traders showed in my ideas. With each trade, I grew moreconfident in my abilities. I had a goal to test 1,000 trades by the weekendand record the results in my spreadsheets, and I was making excellentprogress.
Winnipeg George showed me how to build a spreadsheet that wouldlog the entry price, the original stop, the profit target, the largest draw-down during the trade, and the final result in pips. It also showed myoverall win percentage and the size of the average win and loss. He saidthat this information was absolutely critical to my success. I would learnwhy later.
By Friday I had done over a thousand practice trades and logged theminto the spreadsheet. I had been operating all week long on very littlesleep and had essentially avoided my family entirely. It was then I realizedthat I owed George Sisler a ton of research on interest rates, and I hadhardly started.
 
 
TeamBanesBegins Anew
 
search was easy to do, and invited me to spend all of Saturday
night into Sunday with them, to gather the results. But Ihad prom-ised my wife that I would attend Sunday morning Mass with her and thekids—something that I rarely did—and I was determined not to let themdown. I’m glad that I didn’t.
Sunday morning was bright and cheerful and I was happy to spendtime with my family. Over breakfast, Gini was excited to hear about theprogress I'd made at the law firm, where I had been able to interview sev-eral promising candidates for my replacement. I hadn’t told her muchabout Winnipeg George and Roddy, so I explained that they were helpingme compile a lot of research. I told her about the trades from that weekand what I might be looking for in the weeks to come. She was more inter-ested in hearing that I was finally figuring out how to do my own analysisand less about how much money I was helping George and Roddy make.
“It would only seem fair that Anderson or even George or Roddywould pay you something for the work you’ve done. You’ve made them alot of money.”
“Over 300 pips in the last week alone. It’s hard for me to believe that Icould help plan those trades at all. And they really are paying me back bydoing a bunch of research for me today while I spend time with you.”
“Maybe. But I still think that if you’re helping them make money thenyou ought to be paid for it. I'm not surprised that you're doing well at it. Iknew you could.”
\ N Jinnipeg George and Roddy were positive that the interest rate re-
183
 
  
 
184 ADVENTURES OF A CURRENCY TRADER
Hearing this made the week’s hard work worthwhile, and I smiled forthe entire walk down to our church, where the priest was standing at thedoor, greeting the faithful one by one. Father Gonzales pulled me asidewhen I approached him, and I was sure that he would suggest that I couldgain great blessings by attending more regularly with my family. I couldn’tdisagree with that, but it wasn’t what he wanted to say.
“There is a gentleman inside who would like to see you. We had a nicechat about you this morning, Harry,” and then he patted me on the backand handed me back to my family.
Inside, I knew exactly who to look for.
Harvey Winklestein was sitting in the last pew and grinned broadlywhen he saw me. He rose to introduce himself to my wife and children. Hehad a large paper bag beside him, which, he explained, contained treatsand surprises for whoever behaved themselves the best during the ser-vices. My wife invited him to our home for dinner and he agreed.
He then told us that he would take a walk around Brooklyn, say helloto an old friend, and then meet us again after our services were over.
I hardly listened to Mass that day. I lost track of where to stand up, sitdown, and kneel. Instead I thought of Harvey's wide smile and happy face.Just over a week ago I had decided that I was the worst trader in the world.Harvey had agreed with me, or at least agreed that I was bound to lose all mymoney if I continued to trade. What a difference a week could make! I hadn’ttraded at all, but I had proven that I knew how to do my own analysis and test-ing. Ihad spreadsheet upon spreadsheet that I wanted to show to Harvey later.
Harvey Winklestein also turned out to be the best dinner guest we hadever known. He read to the children while Gini and I prepared the meal andhe finished two helpings of my wife’s meatloaf, and then demanded therecipe. When the kids finished and left the table to go play in their bed-room, Harvey was ready to talk about trading.
THE BANES TEAM IS FORMED
 
Harvey: I wanted to talk to both of you today. From this point on, you area team in this, and you both need to be involved. This includes you, Gini,even though you will probably not be doing any of the trading.
Gint: I want to be involved. I think I have been included in most of it up tothis point. Even if I heard about trades or whatever a few days late, atleast I’ve heard about them.
Me: I do want her to be a part of all of this. I can see how thatwill help.
Harvey: How?
 
Team Banes Begins Anew 185
ME: She needs to be aware of the amount of money we have in the ac-count, the amount of money we have at risk at any given time. This isher money, too, and I am hoping to be ready to trade again soon. But noton my own completely.
Harvey: This is good to hear. Gini, this means that you are going to haveto meet with Harry at least once every day. Preferably before any newtrades are open, to talk about what trades are being planned, whattrades are already profitable or not, and how much is at risk. Theremight be times that you both agree to scale down the risk, or scale it upand make a bigger trade. You will know how to do those things as youwork together.
Me: I want to show her my spreadsheets, too.
Harvey: I want to see those as well. Tell me what you learned about test-ing.
Me: I learned, first of all, that the money management principle you taughtme—the 75/25 rule—made so much more sense after I did hugeamounts of testing.
Harvey: Why is that?
Me: Because I had an appreciation for the benefits of a winning system.You taught me never to let my account go below 25 percent. Testingshowed me that I could develop a system, test it, and give myself a posi-tive expectancy of gains. By filling up a thousand rows in a spreadsheet,I found that I didn’t have to trade on emotion. And that trading on emo-tion didn’t have a positive expectancy.
Harvey: No, it doesn't. It has a negative expectancy, in fact.
Me: And while I did the testing, I realized that I wanted to only take tradesthat I could feel confident about. And I couldn't feel confident abouttrades unless I understood how those trades fit into a larger picture, abigger overall system. It wouldn’t bother me now to lose 100 pips on atrade because I know that first of all, I won't ever risk very much on thetrade in the first place, and second of all, that over time I am going tohave more winners than losers. And the winners are going to be biggerthan the losers, on average.
Harvey: How much bigger?
Me: It depends. When I tested the daily charts, I tested at least three hun-dred trades across the GBP/USD, the GBP/JPY, and the EUR/USD. Myaverage winner was 212 pips, and the average loser was 88. So for thattime frame, I had a win-to-loss ratio of 2.5.
Gini: What exactly does that mean?
Me: It’s good news, because it means that on average, my winning tradesare going to be two and a half times larger than my losing trades.
Gini: But what if you lose more than half the time?
 
  
 
186 ADVENTURES OF A CURRENCY TRADER
Harvey: Great question! Harry, in those three hundred trades, did youtally the wins and the losses?
Me: Sure did. Two hundred thirty-two winners and seventy-eight losers.That means that over the course of a few hundred trades, I am likely tohave 77 percent winning trades.
Gint: So this is a good system. A really good one.
Me: Right. But it wasn’t the best. I did better on the four-hour chart thanany other. I tested over six hundred trades across the same currencypairs. I ended up with an average winner of 267 pips and an averageloser of 94. I had a 74 percent win percentage as well.
Harvey: Impressive. Is that the chart you are going to focus on now withlive trading?
Me: Yes, as soon as I’m ready. Until then I am going to keep paper trading.
Harvey: Good. We'll talk about that in a moment. For now, I have morequestions for the two of you.
Me: Okay.
Gint: All right.
Harvey: Gini, what if Harvey starts trading, let’s say, this week, and for therest of April he only has losses. He has ten trades and all are losers.What should he do?
Gint: I’m not sure what you want me to say. I think I would tell him tokeep trading.
Harvey: Why?
Gini: Because over time he is going to make money with the system thathe tested.
Harvey: That’s right. That’s a brilliant answer. But, Harry, what’s the otherside of that answer? What are we assuming about your trades?
Me: We're assuming that I am only risking very small amounts on eachtrade, so ten losses really does not damage the account.
Harvey: Perfect! That’s the next point to make. If you open another accountwith five thousand dollars, then I suggest that you trade for just one dollarto three dollars per pip. If you have an average loss of 100 pips, then eachtime you're only risking a few percentage points of the account. Thesmaller the trades, the better. That way you can last much longer.
Gint: It’s going to be hard to earn a lot of money from trades that small,don’t you think? Why not put in more money and take the same percent-age risk, but at least have the chance to earn more money?
Harvey: That’s not a bad question, but it takes the focus off where itshould be. For the next month, Harry should concentrate on takinggood trades, checking them with you, continuing his testing, and prov-ing the validity of his system. He is working at Wakeman again so it’s nota question of how much money he can make from trading now. It’s a
 
Team Banes Begins Anew 187
question of how much he can make from trading down the road, if hecan prove that he can do it now.
Gini: That makes sense. Trade with as little money as possible now, whilehe is still learning to trade.
Me: And learning to be responsible with the money. If I lose five thou-sand dollars more, at least we know that I can stay at Wakeman for awhile longer. In a way, it’s money that we can afford to lose.
Harvey: There is no such thing as money that you can afford to lose.
Gini: [silence]
Me: [silence]
Harvey: Do you move into an apartment, and say to each other, well, it’sokay if the apartment burns down? We're only going to move into apart-ments that we can afford to burn down?
Me: No.
Harvey: Your trading account is your next apartment. It’s the Park Slopebrownstone you want to buy. Do you want to trade to earn the money tobuy the brownstone, and then lose that money? Would that be moneythat you can afford to lose?
Gini: No way. Harry?
Me: Whoa, I’m sorry! I didn’t ever think of it that way. But it’s true. If I lost25 percent of my account now, it would be like losing 25 percent of ourfuture home. That’s right. That is exactly why I didn’t treat the first ac-count with a lot of respect. I didn’t think about what it took me to earnthe money in the first place, or what future goals I was throwing awayby not being responsible.
Harvey: I could not agree more. If you can learn to show respect for aone-hundred-dollar account for these reasons, then you can take care ofa million-dollar account. The amount of money won’t make a differencebecause you will agree that you will never do anything to damage yourdreams.
Me: Agreed. I promise. And Gini will oversee it.
Harvey: Harry, where do you stand on the emotional scale? How have youfelt the past week or so, not trading?
Me: I haven’t cared much about it until now. I don’t feel compelled totrade on emotion anymore. If I had any desire at all to start makingtrades this week, it came in just the last day or so because I now have atested system and I had seen so many examples from that system that Ican’t really know much more about how it works until I trade it withreal money.
Harvey: All of this is exactly what I wanted to hear. Now we'll get down tothe last law of trading: I will hold myself accountable. Harry, your wife isgoing to hold you accountable, and she is going to make sure that you
 
  
 
188 ADVENTURES OF A CURRENCY TRADER
follow everything that we've said so far. You will need to keep a note-book of your trades. In that notebook, you’ll write down your tradeplans, including the size of the trade, the entry, the stop, and the limit.You'll write down your thoughts about the trade, and how it compareswith other trades you've already taken. You'll include thoughts and a re-view once the trade is closed. If you can, you should print off a screenshot of the chart from the trade and include that in the notebook as well.Gini will sign off on every closed trade, which means she will have seenexactly what you planned and if you followed through on the plan.
Gini: I like this. I like the idea of being included in the trading.
Me: | like it too. This is going to definitely help me maintain some disci-pline.
Harvey: Gini, how do you feel about Harry doing some trading, startingthis week?
Gint: As long as we abide by the rules you've laid out, then I am excited togive it another try.
Harvey: Then let’s see what Harry Banes can do. For real this time.
 
 
PresentingOur Findings
 
of George Sisler. The fact was that the only thing that could impressGeorge Sisler would be a ton of interest rate data.
And we had it.
Winnipeg George and Roddy had hardly slept on Saturday or Sundayand had produced an astounding amount of information. On that Mondaymorning I had done some of my own research, finding the time by taking ahalf day off work. I hadn’t seen Roddy or Winnipeg George that morning,so they didn’t know what I was going to say. But it would dramatically in-crease the profits in the system that we were following.
At lunchtime we met in the dark lobby of Sisler & Company, and wewere buzzed onto George Sisler’s trading floor right on time. I could tellthat Roddy and Winnipeg George were unimpressed, to say the least, withthe offices. They had heard more about Sisler than I had, and so they’d ex-pected to see a sparsely decorated office, but not a downright ugly one.Later Roddy would tell me that he was going to sign Sisler up for a sub-scription to Martha Stewart Living magazine.
George Sisler had set aside an hour for us, and some of his tradersgathered around as well. He explained that they were curious to see whatwe'd discovered about interest rates, since they had been doing their ownresearch. And then we let Winnipeg George launch into our presentation:“Mr. Sisley, our basic conclusion is that interest rate differentials lead crosscurrency values by several months if not more. I want to start off by tellingyou how we approached the project and then, in a roundabout way, let youknow how we can use this information in our trading.”
Re« wore his oldest suit the next day. This was to show off in front
189
 
  
 
190 ADVENTURES OF A CURRENCY TRADER
GBP/JPY Spot Rate vs. IR Differential
 
Interest Rate Differentialayey yods Adf/dad
 
Feb 1986 - Jan 2004
FIGURE 20.1 The interest rate differential is 3.75 percent.
“Sounds fine to me, boys. Let’s dig right in.”
Winnipeg George opened his laptop and produced a chart. “You cansee on the graph here that between February 1986 and January of this year,there have been some wide fluct