go ahead and be willing to sell within 5 pips ofthe line. This seemed perfectly reasonable. Now I added another trade onthe piece of paper in front of me: November 16, 2003: Profit/122.
Next I looked back to October 24. Price rose up to a high of 1.1856, andthen  fell  backward  immediately.  It  didn’t  even  stay  in  the  1.1850  area  formore than two 15-minute candles. Then it fell all the way down to 1.1720, or130 pips, within two days. Another good trade. I wrote: October 24, 2003:Profit/130.
On October 23, price reached as high as 1.1843 but not any higher. Al-though it would have created an excellent trade, I stayed with my rule of a5-pip-buffer zone. Staying with the rule meant that I couldn’t take this su-perprofitable trade. But I realized that if I started changing the rules now, Iwouldn’t have a very good set of results (see Figure 17.1).
On October 10, price reached 1.1845, never went higher, and droppedall the way down to 1.1547 in just seven days, before making its next climball the way back up to 1.1843 on October 23. This was nearly 300 pips ofgain and hardly any risk. I wrote: October 10, 2003: Profit/297.
The next example was October 9, which netted at least 150 pips. I hadtaken a short trade at 1.1845 to 1.1850. It only went as high as 1.1857. Obvi-ously, this level was important. Maybe as important as the 1.2200 mark.
I then found six more occasions on which the pair had hit that level andreversed.  Three  times  it  stretched  over  the  1.1900  mark  before  it  fell  backlower. Once it went as high as 1.1931, not quite 100 pips. Two trades only took30 pips of profit, if I adhered to the rule of finding the lowest point the pairreached before starting back up to hit the 1.1850 region. All I wanted to knowat this point was the maximum number of pips available on each trade.
The total number of trades I found—11:1 loss and 10 profitable trades.If I kept my stop loss at 100 pips, then my average loss would be 100. Myaverage profit across all trades was 171. I realized that this time I had onlylooked at selling the EUR/USD, never buying it at the 1.1850 level.
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FIGURE 17.1 Harry’s 5-pip-buffer zone rule.
I pulled out a Post-it note and wrote:
Short EUR/USD 1.1850 (if rises from underneath)
Stop: 1.1950
Profit: 1.1700
That seemed completely reasonable. But how far did the pair have tofall  below  the  1.1850  mark,  and  then  rise  back  up,  to  create  the  trade?Maybe I should consider a buy trade at that level. I’d have to talk to Roddyor George, or Craig, if he was interested, to find out if I could reverse thesystem.
In the meantime, I knew that it would be unsafe to simply plan a buytrade. No Post-it note for this one. I’d have to wait. If I missed it, who caredanyway? I was trading on paper and I was doing this to build up some ex-perience and confidence, without putting money on the line.
Well, not my money at least. Perhaps some of Ernest Wellington’s.This work had taken me over three hours and it seemed like only 15minutes had passed. This analysis work appealed to me as much or morethan trading. I experienced the wonder of discovering new stuff, and noneof the pain or emotion of having to commit to a trade or live through it. Allmy trading up to this point had been impulse driven. But now analysis andstudy were driving the trade planning.
And I had only scratched the surface. I had a zillion questions:
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Could I apply this to any currency pair?
Could I apply this to shorter time frames, if not for trading, then at leastto prove the concept of horizontal support and resistance trading?
What about interest rates? George Sisler had wanted me to study up oninterest rates. What’s more, I’d already seen how an interest rate deci-sion could send the market into a frenzy. How did rates fit into all ofthis?
I called my wife and told her that I wasn’t coming home. I was on a roll.
A WILD WEEKEND
By Saturday morning, I had hit the mother lode of information. At 7:00 A.M.,I  went  home  and  had  breakfast  with  my  family,  kissed  them  all,  and  re-turned to Ernest Wellington. My wife was completely supportive, and al-though she didn’t understand what I was talking about, she was happy thatI was putting extra time in to figure it all out. We both had a feeling that Iwas finally taking a rational, methodical approach to trading, so much sothat it began to seem more like investing. We liked that.
During the next two days, not only did I research the so-called crosscurrency pairs, but I had found information on the Internet about interestrates—a  lot  of  information.  I  was  now  convinced  that  George  Sisler  hadgiven me a huge gift in directing my focus to studying interest rates. I hadsome ideas about how I could combine what I had learned about horizon-tal support and resistance with interest rates, but I would have to talk tohim first.
Late Sunday afternoon, Roddy and George were the first ones into theoffice. They came in on Sunday because they worked the Asian hours, andit was already Monday in Asia. They were in good moods and immediatelyapproached me: “Banes, are you makin’ bloody trades for the entire officehere again?” That was Roddy.
“No, Roddy. Just on your account. You are short a hundred million Pol-
ish Zlotys.”
He laughed. “Good one!” He slapped me on the back. “Want to start off
the week with some paychecks?”
George cut in: “Harry, don’t listen to him. We had a bit of a wild
weekend.”
Who knew what trouble they’d been in. What bars they’d been to, howmuch  they’d  drank,  what  parties  they’d  gone  to.  It  couldn’t  hurt  to  ask.“What kind of a wild weekend?”
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“Testing!” Roddy exclaimed.Testing? Drug testing? Testing for sexually transmitted diseases?George nodded. They were nearly giddy with excitement. “We’ve beenbacktesting  a  new  short-term  strategy  and  we  had  a  breakthrough.  Wehaven’t slept for 48 hours.”
I nodded. “Neither have I.”“Banes!” Roddy yelled. He actually picked me up and bear-hugged me
and screamed: “You’ve been testing, you bugger! Haven’t you!”
I couldn’t help but laugh. He was twice my size and had 50 times theenergy of a normal human. I admitted to them that I’d been testing and hadsome breakthroughs of my own, but I needed to talk to people who knewmore than I did to confirm what I’d found.
“You  can  talk  to  us,”  George  offered,  and  then  pulled  two  chairs  upnext to me. Roddy was too excited to sit down and couldn’t wait to hearwhat I’d found.
I decided to share with them my testing of the horizontal support and
resistance. They ate it up.
THE LESSON IN BACKTESTING
RODDY: So how many pairs did you look at?ME: Only five. The EUR/USD first, then the GBP/USD, the GBP/JPY, the
EUR/JPY, the USD/CAD, and the EUR/CAD.
WINNIPEG GEORGE: What time frames? Mostly long-term?ME: Right. All long term. But I did drill down to the shorter time frames to
verify stops and profit targets.
WINNIPEG GEORGE: This  is  really  similar  to  what  Roddy  and  I’ve  beenlooking at. We call it “short-term trading from the longer term charts.”ME: That’s a good name. I kind of feel the same way. I’m just jumping onfor some pips on a reversal. Most of the trades aren’t open for more thana couple of days. I liked planning them from the four-hour and the dailycharts the most, but I have a feeling that this would work on the one-hour charts, too.
RODDY: You’ve got a good feelin’, Banes! It shorely does work on the one-
hour! That’s me favorite chart!
ME: Why is the one-hour your favorite?WINNIPEG GEORGE: It’s his favorite because he doesn’t have the attention
span to look at anything longer term than that.
RODDY: Not true! I can look at the fifteen-minute chart all day long!WINNIPEG GEORGE: That’s shorter term.
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RODDY: Oh. Right you are!ME: I did a lot of work to analyze this stuff. I looked at twenty trades on
each of the pairs, and kept notes on all of them.
WINNIPEG GEORGE: Your notes are all over the place. You wrote all of this
down by hand?
ME: Yep. I guess there is an easier or better way, but I started rolling along
and couldn’t stop myself.
WINNIPEG GEORGE: You need to start keeping this information in spread-
sheets.
ME: I don’t know how to use spreadsheets.WINNIPEG GEORGE: Well, you can worry about that later, but let me showyou an example of why it’s so important. I’m opening one of our testingspreadsheets  right  here.  We  just  type  in  the  entry  price,  the  closingprice, and the spreadsheet tallies up the wins and losses. It gives us afinal pip count for wins and losses. It tells us how big the average win-ner is, the average loser. It tells us our win percentage—which is howoften we can expect to have a winning trade, based on the informationwe’ve already provided.
ME: And you do this for all of your testing?RODDY: Don’t leave home without it! We never test without it. We spread-sheet everything. We have spreadsheets on top of bloody spreadsheets.I can hardly keep track of all of ’em. Banes, did you say that you’ve onlytested twenty trades so far?
ME: Yes! Twenty per currency pair. So I actually finished testing one hun-
dred, in total.
RODDY: One hundred’s not enough, boy! You gotta do better than that!ME: How much better?WINNIPEG GEORGE: Well,  we  spent  the  entire  weekend  testing.  We  got
through about a thousand trades.
ME: [silence]RODDY: Yeah, Harry. Did you do a thousand trades? I think not!ME: How did you get that many done?WINNIPEG GEORGE: We sat on the couch with our laptops—one of us withcharts and the other one with spreadsheets. We had food brought in, andwe watched basketball, baseball, and cartoons, and only took breaks togo to the bathroom. We didn’t shower, answer the phone, or interact withhumankind in any way. It was complete focus.
ME: And you tested the same system, over and over again?WINNIPEG GEORGE: We actually did five hundred trades each on two vari-ations of the same system. The main system we tested was a combina-tion  of  the  CCI  [Commodity  Channel  Index]  oscillator  with  long-termsupport and resistance. The second variation, that we tested simultane-
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ously, was to look at Fibonacci retracements for exits, instead of usingset profit targets.
ME: How did you do that?GEORGE: It would take too long to describe here, but let’s just say that wefound  a  few  fib  retracement  levels  that  we  really  liked.  Using  the  fibexits, we increased our average profit by 20 percent.
ME: Are you ready to start trading it?RODDY: I am! I’m divin’ in this afternoon.GEORGE: That’s a bit of an ongoing discussion. I’d like to actually watch itfor a week without opening any trades. We’ve been putting the pieces ofthis together for a long, long time. We have been testing every weekendfor about seven months now. We’ve changed strategies and rules a mil-lion  times  but  now  we  think  we’ve  found  something  that  we  can  livewith for the long term.
ME: And what are you trading in the meantime? I mean, you still have to
make trades.
GEORGE: Oh, we do a lot of price making for clients. Remember, that’s ac-tually  our  first  job,  to  quote  prices  for  clients.  You  already  know  howthat works, I’m sure.
ME: Yes.  A  manufacturer  or  a  hedge  fund  might  call  the  bank  and  say that they want to buy some British Pounds. And you’ve got to give thema price.
GEORGE: Right. That’s what we do all day. We generate profit for the bankby  the  difference  between  pricing.  Sometimes  we  offset  the  trade  byselling or buying on the spot market. Sometimes we keep the trade if wethink it will be profitable for us.
ME: So how does this new system fit in?RODDY: Don’t say a word, Winnie!ME: Winnie?RODDY: That’s the name I’ve got for George. Winnie! He’s from Winnie-peg,
Canada. So that’s his nickname.
ME: I think I’ve got a lot of work ahead of me. One hundred trades isn’t
going to be enough.
GEORGE: But don’t feel like you can’t start paper trading, like you’vebeen doing. You make a lot of sense with the levels you’ve chosen fortrades so far. The 1.1850 level is something that we’re looking at, too.
ME: For a buy or a sell?GEORGE: For  a  buy.  The  pair  has  stayed  above  that  level  for  some time now, and we think the tables are turned. What used to be resist-ance is now support. We’re going to happily buy Euros at that price.All we can. What are you going to do next? Which pair are you goingto test?
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ME: All of them. But first I need to talk to George Sisler again.GEORGE: Sisler? The hedge fund guy? You’re going to talk to him?ME: Yes. If I can. I met him last week and he wanted me to do some re-search into interest rates—which I’ve done. But now I have more ques-tions than answers.
GEORGE: Mind if I come with you?ME: I don’t mind at all. I’m not sure he’ll actually meet with me. But I am
going to try.
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Homework
Idoubted that George Sisler would talk to me without Harvey. Anyone
running a zillion-dollar hedge fund wasn’t going to just waste his timeon someone like me. Perhaps Harvey had told George that I had takenharebrained  trades  and  lost  my  account,  in  which  case  a  meeting  withGeorge would even be less likely.
So I was surprised when George took my call the next day. I called himas soon as I arrived at Wakeman at 7:00 A.M., and he picked up the phone.
“George Sisler.”I had anticipated a secretary or a receptionist. I paused to collect mythoughts, and in that small amount of time, George hung up the phone. Ob-viously,  he  was  very  busy.  I  called  and  this  time  he  answered  again:“George Sisler. Who is this?”
“It’s Harry Banes. The guy that—”“Harry! Did you do your interest rate homework?”“I did. I did a lot of work. But I have some questions before I can
continue.”
“I’ll see you at lunch,” he told me, and then he hung up.I worked my brains out that morning so that I could spare a couple ofhours for lunch. It had been a personal goal of mine to not leave for lunchat all in the next few weeks, so that I could pay back time lost at the firm.But  a  meeting  with  George  Sisler  took  precedence  over  that  for  now.  Atlunchtime, I hopped in a cab and hoped that I wasn’t making a mistake byshowing up without Harvey.
175
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It didn’t seem to matter. George saw me right away. The office wasn’tany different from the last time I’d seen it. Just as dumpy as before. Thistime  I  had  a  new  appreciation  for  it.  I  started  to  wonder  what  George’shouse looked like. Did he live in his car, or under a bridge?
I would soon find out. But first he had questions for me. Lots of
questions.
“What did you find?” he asked.“You specifically asked me to find out if I could figure out a way to takethe  carry  trade  on  a  retail  platform,”  I  answered.  “That  was  my  focus.  Istayed up all night on Friday and did a ton of research on it.”
“And?  You  found  that  it’s  impossible.”  This  was  a  statement  of  fact,meant  to  encourage  me  to  move  on  to  the  next  point.  So  he  was  not  somildly shocked when I announced: “Oh, it’s very possible. Just not in theexact same way that you do it.”
His eyes brightened. “Really? Now I want to hear more.”I pulled out my notebook and flipped open to the tab I’d marked “Inter-est Rates—Retail Carry Trade.” Then I began: “You talked about borrowingcheap money and then investing in high-interest currencies. I sat down forat least two hours and learned why that works. It 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  you
learn?”
“I 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. I am sure I amnot telling you anything that you don’t already know.”
He  nodded.  “Probably  true.  But  I  have  thirty  minutes  and  I  want  to
hear it all again.”
I looked 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 P.M. eastern time.”
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“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(cid:2)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 I 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, I’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’sa lot of money. Way more than I would be earning from the interest.”
“It’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
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a low-interest-bearing currency. This way, I’m basically paying myself extrafor holding onto a trade.”
“I 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 exit
the buy trades. That would limit the downside risk.”
He nodded. “That is a start. But is there a way you can use options or
futures contracts to hedge yourself, in case of a big, sudden decline?”“I’m 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.”
“If there is, I am 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 ploton a graph how interest rates have affected currency rates over time. I know
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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 same
time.”
“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  more
trades, 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  four-hour  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
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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