Judging by the number of threads on this topic here and elsewhere, many novice traders (and probably quite a few of the relatively tenured) were taken to the woodshed last week. I don’t presume to know exactly why; but still the question begs an answer: why?
Was it because oil was still going up? No. Oil had lost over 10% off of it’s high before the dollar began it’s descent on July 22: $WTIC - SharpCharts from StockCharts.com
Was it because gold was still going up? No. Gold had lost almost 10% off of it’s recent high @ ~980/oz. before July 22: $GOLD - SharpCharts from StockCharts.com
Was it because of the magnificient economic expansion currently unfolding in the UK, Japan, Switzerland, the Euro Zone?
Was it the FOMC, the MPC, the ECB? Did Tricky Trichet’s jawbone wear out?
Or was it because the notion of shorting the USD based on a shoddy patchwork of generic, reactive fundamental assumptions had so insinuated itself into the mass consciousness shared by many private retail traders that the idea of actually going long USD was virtually unthinkable?
Maybe some of each. But I’ll focus on the last point.
This isn’t witchcraft: the market doesn’t play tricks. Did “the charts” foreshadow this move? That’s in the eye of the beholder, perhaps: it may depend on what one were looking at and what one looked past. Certainly no trader can say oil or gold didn’t tip them off. Any trader who uncritically ascribes to the prevailing directional bias for a currency that has been adopted as the apparent consensus of “the market” will be astounded again and again as the instrument they trade behaves “irrationally”.
Reasons? There are quite a few, many deriving from theory about the psychology of crowds, for which there are good books out there on the subject and a fine laboratory (your brokerage account) for observation at your disposal. It all boils down to a couple discrete items, though:
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Market manias, big or small, are engendered and perpetuated by lack of historical reflectivity and limited analytical scope. Put another way, crowds induce a compulsion toward conformity among their members through a variety of pressures or perceived benefits. As an example, where USD-negative sentiment seems almost unanimous among others, hopping aboard the bandwagon provides reassurance and seems to be the only rational perspective - even when maintaining this perspective can have adverse consequences. The advantage of the small trader as a nimble and autonomous agent in the market is at least partly nullified. Analytical rigor goes out the window in favor of varying degrees of passive assent to the “analysis” of others. Not a bad argument for the conscious practice of selective market-related ignorance. Just ask all those guys who remained glued to CNBC 6-7 years ago as their retirement assets vanished during the dot-com bust, deriving comfort from all those bottom-calling commentators.
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Fair value v. perceived value: what is the fair value of USD v. the EUR, the GBP, the YEN, the CAD, etc.? Disagreement over this point makes the market in which we trade. What better resource to gauge perceived value than the market itself? But, traders - for various reasons - are often deluded, insisting on asserting their own perception of fair value vis-a-vis naked market behavior. This is often where bottom (or top) picking comes into play. Combined with a scenario similar to that depicted in #1, this can end up quite ugly. Expressions put forth by any trader such as “It surely can’t go down any further than [I]this[/I]” and such practices as buying at support with a very liberal or no stop loss because you’re “all but certain” price will bounce are examples of the delusional superimposition of opinion onto the wider market as objective fact.
Underlying both of these, not surprisingly, is a certain brand of hubris: false confidence in and reliance upon the market crowd (highly notorious for proving itself as truly pitiful at forecasting or behaving rationally), as well as one’s own privileged ability to surmise (usually from a very small to nonexistent body of data) where a currency [I]ought[/I] to go based off of it’s fair value relative to some other currency. There are other reasons, but these are always present in any market in any context where the “impossible” or “highly improbable” suddenly happens. Humility before the market, on the other hand, brings with it adaptability to changing conditions and the opportunity to exploit and follow emerging trends wherever they lead rather than anticipating continuations or reversals where they aren’t likely to occur.
