Guest post by NewstraderFX
As I look back on my trading experiences, one thing always seems to hold true:
When I get the feeling that I have to “rush” into a trade because I feel so positive, it frequently ends up being a loser. What also happens is that even with the ones that ultimately turn out profitable, I very often have to sit with a sizable loss at first. On the other hand, when getting into a trade which basically scares the hell out of me (because I’m going against the sentiment), those trades frequently turn out well because aside from being profitable, any losses at the beginning are usually small.
Two Examples Of This
Back on August 27, when Bernanke first talked about QE2 at Jackson Hole, the growing sentiment among a number of observers was that a double dip recession was becoming more likely- hardly the time when you would feel like rushing in to get long on stocks (and short the dollar) and probably the time you would feel most nervous about doing so. Buying when many are talking about a double dip certainly seems like the dumb thing to do on the face of it.
Let’s look at what happened when QE2 was officially announced on Nov 3. Just a few days later, the Chinese, other foreign countries (like Germany, whose finance minister called it “clueless”), many U.S. politicians and even a good number of important economists (like John Taylor), where quite vocal in their opposition, saying-among other things-that the fed was attempting to debase the dollar. Trades like buying the dollar against the euro, aussie and pound would have seemed like the dumb thing to do when everyone is talking about dollar debasement and you surely would have felt very nervous about doing so. Yet, the dollar gained quite a bit.
In the second example, you could make a case for saying the official announcement of QE2 was an instance of buying the rumor and selling the fact since it certainly looks that way (“buying the rumor” in this case meaning to buy stocks and go short the dollar).
What these two examples do have in common is that a strong fundamental which ran counter to the prevalent sentiment had come into play. Bernanke’s hinting at additional QE overcame the idea of a double dip (along with acting as a negative on the dollar) and the Nov. 3rd announcement of QE2 coincided with Irish debt problems coming to a head.
With that being said, I’m not implying there never comes a time to rush into a trade. For example, if Greece or Ireland were to suddenly announce they are insolvent (which technically, they are) and were seeking to restructure their debts, or if (God forbid) a war between N. Korea and S. Korea breaks out, I definitely will rush into long dollar trades because an overwhelmingly negative fundamental would exist which would cause the market to become massively risk-averse.
By no means, neither am I implying that it’s always wise to trade against market sentiment. Indeed, there has to be a very strong fundamental reason to do so and in both these instances, there certainly was.
We can only guess about what would have happened starting in late August if Bernanke had not hinted about QE2 at Jackson Hole (and afterwards). But given that corporate profits and economic data improved over the intervening weeks, it’s reasonable to say there could have been a slow grind to the upside in stocks (while the dollar declined) as the fears of another recession faded (just as they have).
How about the scenario where Bernanke does hint at QE2 in August (and afterwards), announces it on Nov 3, but then no Irish crisis comes to a head? We very possibly could have seen some selling of the news, but what I also think would have happened is that the dollar’s rebound would not have been as strong and that currencies like the euro and aussie would be higher by now then where they were on the day QE2 became a reality.