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…)