EURGBP : Swinging in the rain

I'm swiiiinging in the rain... just swiiiinging in the rain... Actually to be more precise I've been swing trading on the EURGBP for a couple of months. The final outcome, whether it will end up with a gain or a loss, is still not certain and my execution is being far from perfect with some good stuffs, some bad stuffs (and maybe some ugly ones to come...), nothing to be proud about but assessing my trades on the EURGBP will allow me to tell more here about my techniques and my system, not sure anyone is interested...

The reason why I chose to trade EURGBP that is not a commonly traded pair as it's mainly driven by both ultra popular EURUSD and Cable (USDGBP), is not that I'm a European guy working in London who hedges the GBP he happens to earn. No need, all along the way of the depreciation of the GBP from 0.65 to 0.90, I've had the best possible hedge against the depreciation of the GBP (with the help from my beloved wife): I've just spent all the GBP I've earned! More seriously, I'd say the main reason I'm looking at EURGBP is that we have on the two sides of the pair on the one hand the Bank of England that looks happy with a weak pound (to boost the exports, the growth, etc) and on the other hand, the ECB that tends to be keen to live with a strong EUR and to focus on the fight against the inflation. 2 central banks, 2 different interests that have in common that they tend to push fundamentally the EURGBP up.

This said, I believe that EURGBP is strongly mean reverting. It looks like there's an equilibrium somewhere between 0.66 (GBPEUR @1.5) and parity and that the EURGBP prices tend to revert to this value when they extend too much on one side, upper or lower. In the discussions I had and in the articles I read about this, I've been often been told about the Purchasing Power Parity (PPP) theory. An economist would explain that much better than me but roughly (as far as I understand) in the case of the EURGBP, goods made cheaper in the UK to the Europeans due to the depreciation of the sterling are massively purchased by them and ultimately it drives the GBP up: to some extent, the zillions of European guys on Oxford street on the weekends act as arbitrageurs.

This latter point affects the way I trade EURGBP. While generally I try to catch the big swing and to ride a trend as much as I can, trading only on one side of a given pair: buy or sell, I tend to swing the EURGBP, taking early my gains as soon as I can see that a resistance is likely to hold, reverting my positions from buy to sell when the EURGBP looks expensive playing the mean reversion I talked about.

One last point before I enter in the core of the topic: I'll measure here my performance as a function of the average maximum amount I risk on a trade: let's call it R to match for instance Van Tharp's notation. For the sake of simplicity, I'd say that R is a percentage of my equity (say 0.50-1%) and the position I put on EURGBP is such as R corresponds to 2 or 3 ATR (the Average True Range, which is roughly the exponential average of the difference between the top and the lows of a trading day, corrected to take into account the opening gaps). I'll detail all these stuffs one day in a later post.

Here is the action! In the chart below, the green circles are my purchases of EURGBP, the orange ones are my sales.

- On the 6th of August : the Bank of England extended its Quantitative Easing (QE) program and announced it will expand its purchase of bonds to GBP 175 MM, beyond its initial limit. Roughly speaking, they intend to purchase bonds with freshly printed (in an electronic way) GBP. The news surprised the market and the EURGBP jumped that morning. I didn't bet on any direction before the announcement and had no position but I noticed that I often profit more trading AFTER the news than speculating on a news release and trading the surprise before. Of course I won't mention the numerous wrong bets on news I did in the past and all the lost money, but this year, I managed to have the good bets on QE for Switzerland and for the US (when the FED surprised the market with an unexpected program of Treasuries purchase too). In both cases, as the prices jump in my direction, I took the profits way too early on my position only because I was excited to have made the right call and to see my profits grow in minutes while I could spend days or weeks to make otherwise. The only situation you want to avoid in such a case is to see the profits vanish while you made the right bet and you just forget about the "Let the profit run" stuff... Back to that day, I thought "Don't fight a central bank" and decided to catch that train after it started. I went long 1.5R of EURGBP @ 0.8525 (first green circle on the left). It appears now it was a good call as it has not been below that level since (as I write 3 months later) and went all its way up to 0.94. Of course, as I will describe below, I took profits too early and too late. One can notice that the 6th of August printed a white marubozu candle on the chartist landscape, a growing candle with no shadow indicating strength. It is one of the bull signal I use, simple but efficient!

- As the other white marubozu that showed up on the 10th of August seemed to indicate that I was right on my position, I added on my position the next day (second green circle) 1R @ 0.8571 on the 20-SMA bringing my total position to 2.5 R @ 0.8544. Simple Moving Averages (SMA) particularly when they flatten tend to act as support/resistance, for instance here the 50-SMA (the purple one) was momentarily breached on the 18th but the EURGBP came back in the next day and it looks like it was then boosted with a sequence of white candles, the breach of the 100-SMA and I’ve enjoyed a nice ride all the way up to 0.89…

- On the 3rd of September, after the EURGBP found a resistance at 0.89 and pulled back to the 100-SMA, I added 1R more 0.8756 (3rd green circle) bringing up my position to 3.5R @ 0.8604. This deal was a bit hard because at that stage the only thing you want to do is sell and take the profit, driven by the fear to see all your profits vanish… But it looked like I was right as the next day another white candled push the EURGBP back to the 0.89 resistance. At that stage, all the things were unfolding perfectly and my trading was decent.

- My first mistake came on the 11th of September (mmmh bad day). As the 0.89 resistance hold for the second time (it is what I call a First Test First Failure (FTFF) pattern, the resistances often break at the second test, don’t ask me why), further to discussions with some fellow traders (about the PPP, the EURGBP is too expensive etc) and mainly because I was scared to let run the profits... I decided to scale out and take some profits here : I sold 2.5R @ 0.8739 (first orange circle), banking a profit of 2.52R and let 1R long @ 0.8756 run. Bad call! The day after I reduced my position, the EURGBP jumped, breached the important level of the 200-SMA (remember one thing : bulls live above the 200-SMA, bears below) and reached the 0.94-mark… Arggghhh, the cost of opportunity is around 3R (just look on the chart what I missed…)

- After a few bearish black (blue on the chart) candles appeared indicating strength on the downside, on the 21st of October, BoE Governor King said Britons should start preparing for interest-rate increases. That was too much for my long position and I just got out of the remaining 1R @ 0.9039 banking a 1.89 R profit. It was again a “Don’t fight a central banker” play. My full EURGBP position unwound with a profit of 4.41 R (roughly +4% of my equity in 2 months on this pair only), that’s not bad… if only I stopped here…

- Surprise the very next day as UK GDP figures unexpectedly showed negative, showing the UK still in recession (for the longest period ever). Hahaaaa King screwed the market (including myself)! At that stage, I reminded my readings about 1992 when Soros broke the Bank of England shorting the pound: “the Central Bankers systematically announce they won’t depreciate a currency the day before they do it”, I even didn’t think and went back straight long 1.5R EURGBP @ 0.9128. It jumped to 0.92 before my stop loss was hit 4 days later @ 0.8944 for a -1R loss so my total gain decreased to 3.41 R. When I’m thrown out of a position with that speed and strength I usually reverse the position. Here the 3 black quasi-marubozu (the famous 3 black soldiers pattern) were a powerful signal on the downside to me and despite fundamentals that said that the BoE will probably extend their QE program (actually they extended of 25MM) pushing the GBP down, this technical argument prevailed and I went short 1R of EURGBP @ 0.8935 (the last orange circle represents both my stop loss and my new reverted deal) that very same day. As I write, this short 1R position is still open and the EURGBP is below 0.89 fighting at the 200-SMA which is a consequent obstacle.
So far, on the closed deals, I have an average profit of 0.85 R per deal on the EURGBP. It’s pretty high as if I trade 100 deals a year on that average of 0.85R and with a R of 1% of my equity, my annual performance would be of 0.85*100*1% = +85% per year … The trick here is the average is computed using only 4 deals with 75% of winning trades… Normally I target more an average of 0.2-0.3 and trust me, it's not easy to reach...

Anyway, I may keep on swiiinging in the rain, just swiiinging in the rain…