OlsenBlog

The biggest danger for any trader is excessive exposure. An unexpected price spike can then trigger a margin call that wipes out all the profits generated over months of hard effort. This is the most frequent reason why traders lose money. How can we prevent this from happening? What do we have to know?

Diversification

As there is no such thing as perfect foresight and an unexpected price spike can occur at any time, a trader should always diversify his risk and trade not just one, but two or three ideas at the same time. It is through diversification that he can improve his risk profile – when one trading idea is in the profit, the other runs a loss and vice versa. (more…)

The sovereign debt crisis that started with Iceland last year has now spread to Greece, Spain and Portugal. Other countries with large deficits are on the firing line as well, the US is one of them with a deficit of 12 percent of GDP, the same as Greece. Treasury Secretary Timothy F. Geithner tried to shore up confidence in an ABC News interview by claiming that the US would never lose its Aaa rating. A number of commentators have picked up on this news and have ridiculed Geithner saying no way; the US will lose its Aaa rating.

It is no trifle matter, if a country has a government budget deficit of 12 percent; this is even more perilous when interest rates are at an absolute low as they are today and there is the danger that interest rates snap up dramatically increasing the cost of servicing debt and the size of the public deficit. There are also the private house holds, which make up for 70% of GDP with their consumption, who are heavily indebted. (more…)

USD_JPY collapsed from 90.60 to a low of 88.65 in 30 minutes taking down AUD_USD from 88.00 to 86.15. The Scale of Market Quakes for AUD_JPY recorded a strong quake of 4.4. Three trades triggered the move: margin calls on long AUD positions, liquidations of short JPY and short USD positions. The market was building up to such a move because there was a bifurcation in the market, where one group of traders believing in the long-term collapse of the USD turned a blind eye to their increasing losses due to the gradual rise of the USD, while on the other hand there were the traders with the growing confidence in the continued strengthening of the USD. Similar to children that rock a rowing boat the combination of margin calls and aggressive trend following trades triggered the sell off. (more…)

In the first blog on how to trade I have tried to explain why traders should not rush to open positions and that there was always another profitable trading opportunity in the waiting. The second blog is devoted to the phenomenon of the butterfly effect of cascading margin calls, which in my view is one of the most important forces driving market prices that few people talk about. Cascading margin calls come about because a butterfly; be it  a random news event or large market order, triggers a price spike, which leads to a margin call with one trader somewhere in the world who then has to liquidate a largish position enough to fuel a continuation of the price move triggering further margin calls. Cascading margin calls may last only for a few minutes or hours, but can also take days, weeks or even months. They can be so strong that they turn fundamentals upside down. To become a successful trader it is important to understand the phenomenon. (more…)

Today, there is a divide between the optimism of the public and the concerns of practitioners with in-depth market knowledge. Who will be right?

What does the theory of high frequency finance tell us?

Central banks and governments have the clout to skew market prices for extended periods of time. They are successfully doing this in response to the economic crisis by providing liquidity to lower short-term interest rates and by buying long dated debt to lower long-term interest rates. They succeeded in stopping the meltdown of the financial markets, but they cannot continue their skewing strategy indefinitely. They need to be aware that their actions will give rise to a rebound, which has the effect that interest rates will be higher than normal. Financial markets tend towards a dynamic equilibrium, where overshoots in one direction will ultimately be balanced out by overshoots in the other direction. (more…)

The pressure is increasing in the currency markets as the USD approaches new lows. The central banks with strong currencies, such as Australia, Canada and Europe, will have to decide whether or not to adopt the policy of the SNB and intervene to weaken the EURO.

The SNB has intervened for the past 6 months and has temporarily blocked the Swiss Franc from appreciating. The cost of doing so is, however, higher than most people appreciate. There are more and more traders, who are shorting the CHF and rely on the SNB to intervene in the market. The SNB interventions have the effect of subsidizing these speculators and are becoming increasingly costly. (more…)

Price displacement in the fx market is an artifact of market mechanics that have nothing to do with determining fundamental value. The inefficiency of over-shooting is disruptive, increases risk, and drives uncertainty.
Olsen’s investment methodology counters this uncertainty by anticipating imbalances between buyers and sellers and providing liquidity that can restore prices to more reasonable levels…

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By: Richard B. Olsen, Founder and CEO of Olsen Ltd

2008 was a watershed for the financial markets: equity markets experienced a massive sell off and credit markets stopped functioning with bank lending coming to a standstill. Central banks had to intervene on an unprecedented scale.
Will the government and central bank interventions reverse the tide? Based on our analysis worse is to come: our biggest fear is that one of the governments of the G6 will default on its debts and that confidence in the financial system will plummet.
Olsen measures tick by tick market volatility: today, the short-term market volatility in currency markets is approximately 10 times higher than in previous years. This indicates that liquidity has declined by roughly 80 percent. At the same time, global capital flows have continued at the original pace or worse are actually increasing, because companies and investors have to rebalance their international exposure. In previous years, it was safe to assume that currency moves would be contained within a range of plus minus 20 percent. Based on our quantitative analysis, we expect price moves of 50% and more for G6 currencies in 2009. We expect that AUD, CAD, CHF and JPY will be beneficiaries and USD, GBP and EUR will be the losers…

Clicking here will retrieve an Acrobat version.