Sunday, March 03, 2019

Contrarian Forex Trading Against the Dumb Money

I used to do a lot of technical and fundamental analysis in my Forex trading. I've largely tossed all of that.

Now I focus on one massive fundamental assumption, one fundamental data point, and one technical aspect of the market

The massive fundamental assumption is that whatever the retail trading crowd thinks is right, is wrong, and the really big pools of money (financial institutions, including central banks) will be along shortly to wipe out all of the "Dumb Money."

The fundamental data point I pay attention to is open interest in the various currency pairs, which many Forex brokers publicly report. I check it at the start of each week to see what the Dumb Money thinks is the way to go. This week they like the Australian Dollar (AUD) by a long shot, so I'm shorting it:

Generally I'm interested in going long or short opposite of anything that the Dumb Money is more than 60% committed to (I'm skipping the EUR/CHF trade this time because of other trades I already have open, I don't want to be spread too thin, and the metals trades on the chart I don't have access to thanks to Dodd-Frank; may they both burn in Hell).

Beyond that, I just look at the weekly chart for each pair and pick a take-profit level, somewhere that it looks like support or resistance might exist for the current range the pair is in (if any).

As trades progress, I check back on the open interest. If something shifts closer to 50/50 against my open trade, then I'll either trim it down or close it out. As it so happens, to make room for these three shorts this week I closed out a USD/JPY long since the Dumb Money brought that one back to about even between open long and short positions.

Basically, this is a very simplified trading method that operates on the idea that a relatively small pool of traders, retail traders, will collectively decide that a currency pair is going to perform in some particular way. They will tend to exhibit a crowd effect and pile into a currency pair in one direction.

Then the big money will notice the imbalance and get in on the other side of the trade. Their sheer size enables them to move the currency the opposite way, wipe out the Dumb Money trades, and pocket the profits.

This is probably why retail Forex traders lose money in the vast majority of cases: they simply do not have the weight to push back against institutions in the market, and their reliance on technical analysis will tend to cause them to all reach the same conclusions about what price will do next. Then they're set up to be bowled over by the 800 pound gorillas in this market, which is exactly what happens. Rinse, repeat.

So, instead of mucking around with all kinds of technical indicators and hocus pocus bullshit, I just try to hop a ride on the gorillas' backs now. It's a lot less work to do, and the results seem to make a hell of a lot more sense than watching "perfect" technical setups simply, suddenly, and "inexplicably" fail over and over again. It's all about whose got the biggest balance sheet in this market (and many/most others, for that matter) and trying to stay on their side of the action.

If you can't beat 'em, join 'em.

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