Correlation between the Usdjpy and the

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This leads us to the correlation between the USD/JPY and the Dow. Since the Nikkei and the Dow are correlated like the Nikkei and USD/JPY, one would automatically assume that the Dow and USD/JPY are correlated as well. Although this is true, the correlation is weaker than the two

Japanese Nlkkel 225 Index vs. USD/JPY 2000-2008

Japanese Nlkkel 225 Index vs. USD/JPY 2000-2008

2000 2002 2004 2006

figure 10.28 The Nikkei 22 5 and the USD/JPY

2000 2002 2004 2006

figure 10.28 The Nikkei 22 5 and the USD/JPY

correlations that we have already seen, which illustrates why it is particularly important to not base your trade ideas primarily on the correlations. It is nice to see that on a day-to-day basis, the asset classes may move in lockstep, but that should be only a component of your trading decision and not the primary basis for the strategy.

With this in mind, there are two different ways that I like to use equities to trade currencies, and both incorporate either fundamental or technical analysis.

TRADING THE CORRELATION WITH FUNDAMENTALS

My favorite strategy is to use the correlation with fundamentals. Here is an example of an actual trade that I recommended to subscribers of BKTraderFX (see Figure 10.29).

On May 7, 2008, we recommended going short the New Zealand dollar against the U.S. dollar for two reasons. The first was that the Dow had plummeted over 200 points and we believed that carry trade selling would

Short NZD/USD 05.07.Ü8+107

May 07,2008 3:36pm

Short NZDUSD market tnow 7S12) Stop 7S&0 T1 7782 T2 7688

New Zealand employment is com»ng up and we think the number will be weak. The pair has been tradino heavily a It day a rid we are going to get front of this number to see if we rake advantage of the downward momentum that has be* building up.

May 07,2008 6:45pm

Short NZDUSD Ti hit +30; we are breakeven 7812 on the rest Hoy 07,2008 7:OOpm|

Trade movino cur way; we are moving stop on 2nd unit to 7792 to lock in +50 Hay 07,2008 8:25pm

Move stop to 7735 to lock in 1D7 pips May tJ/,2008 8:32 pm

Out of the trade for 107 pip*

figure 10.29 Sample Trade, BKForex Advisor (Source: BKTraderFX.com)

continue into the Asian trading session. With an interest rate spread of 625 basis points at the time (New Zealand's rate was 8.25 percent and the U.S. rate was 2.00 percent), the NZD/USD was one of the few carry trades left in the market. However, that was not the only reason we took the trade. The primary reason was the upcoming New Zealand employment report, which we expected to be weak. The market was looking for employment to drop by only 0.1 percent in the first quarter, but given the big drop in the Manpower Index and the employment component of the Purchasing Managers Index, we were looking for an even bigger decline. The combination of a bearish carry trade environment and the possibility of weak New Zealand data gave us the confidence to short the New Zealand dollar at 0.7812. As indicated by the progression of our trade, we managed to bank 107 pips.

Figure 10.30 shows how the NZD/USD was trading. Trading was heavy all day due to the weakness in the Dow and then broke down following the New Zealand employment numbers.

TRADING THE CORRELATION WITH TECHNICALS

Another way to trade the correlation between equities and currencies is with technicals. Here is a simple example. On May 1, 2008, the Dow Jones

www.eSignal.com)"/>
figure 10.31 USD/JPY Hourly Chart (Source: www.eSignal.com)

Industrial Average opened strongly and rallied over 100 points in a matter of three hours. USD/JPY, interestingly enough, did not follow higher. One of the reasons for this lack of follow-through may have been the strong resistance provided by the 100-day simple moving average, as indicated by Figure 10.31. Given the strength of the equity market, a possible strategy would have been to buy on the break of the moving average in the expectation that stocks would take USD/JPY higher in the U.S. session and the move would continue into the Asian trading session. The entry point would have to be above the attempted break four hours before at 104.21. As indicated in Figure 10.27, such a strong move in the Dow should lead to a similar rally in the Nikkei when the markets opened for trading. The Dow proceeded to rise another 100 points by the time the market closed, and even though USD/JPY did not race higher immediately, it did quietly grind higher throughout the Asian and European trading sessions. The key to using technicals with equities is to have flow on your side.

CHAPTER 11

How

to Trade

Like

a Hedge

Fund

Manager

This chapter on how to trade like a hedge fund manager is really about the steps to developing a successful trading strategy. Having worked with many money managers and being involved in the process of launching managed fund products, I have realized that all money managers work in a similar way. Their strategies may be different, but the way they come about developing these strategies is not. The reason there are common threads is because professional fund managers need to have accountability. In other words, they need to understand their own methodology inside and out.

The difference between a professional and an unprofessional trader is that a professional never goes into a trade blindly. This is important because in order for professional money managers to be confident enough to solicit investments into their funds, not only do they need to have a battle-tested strategy, but they also need to know when the fund succeeds, when it fails, and how bad things can get.

As retail or individual traders, our $20,000 accounts are just as important as any $20 million hedge fund. In fact, our accounts may be even more important, because we are trading with our own money whereas the $20 million hedge fund manager is most likely trading with other people's money. Therefore, if all hedge fund managers follow a five-step process in developing their trading strategies, there is no reason why individual traders should not to do so as well.

The best way to develop a trading strategy is to follow a five-step top-down approach:

1. Properly defining the trading strategy.

2. The art of entering and exiting.

3. Test drive.

4. Getting intimate.

5. Self-reflection.

PROPERLY DEFINING THE TRADING STRATEGY

Every hedge fund manager, like every trader, follows a different methodology. Some will only use fundamental analysis, while others will only use technical analysis. The first thing to do is to figure out what type of trader you are and what type of style you want to trade in. This chapter will not tell you which style of trading (fundamental versus technical or short-term versus long-term) will be the most profitable, because there isn't one style that is best. In Millionaire Traders: How Everyday People Beat Wall Street at Its Own Game (John Wiley & Sons, 2007), we interviewed 12 successful traders from all walks of life and learned that there isn't just one way to trading success. Every trader is different; some would hold positions for weeks and months, while others would hold them for mere seconds.

There are four key things that you need to think about when defining a strategy, and these need to be done before you start trading. Trade with a plan and do not develop that plan on the fly.

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