As trading psychologists, we once conducted an experiment with a fund company in which three investors each gave $100,000 to the same fund manager, willing to make a high profit at a high risk.
The money manager sticks to a carefully tested trend-following approach.
It sets up separate accounts for each customer and manages each account the same way.
In no trading market has risk exceeded 3.5 per cent of capital, and the average loss on every loss-making trade historically has been below 2 per cent.
The basic purpose of individual foreign exchange trading should first be to preserve value.
First, there is the problem of preserving foreign currency assets.
If you have a large proportion of dollars in your foreign currency assets, you can sell some dollars and buy other currencies such as Japanese yen and mark to diversify your foreign exchange risk.
For example, if you are going to study in the UK and you have a lot of dollars, you can take advantage of the fall in the pound to buy sterling to protect against future losses if the pound rises in foreign exchange.
Secondly, there is the problem of maintaining the value of foreign currency against RMB.
For example, if you have 1,000,000 yen, and on April 28, the dollar bought 108 yen in the international market, the Bank of China bought 100 yen to 7.7780 yuan, or 77,780 yuan for 1,000,000 yen.
If the Yen-dollar exchange rate falls in the international foreign exchange market, the Yen-yuan exchange rate at the Bank of China’s listing price will also fall, reducing the amount of RMB worth 1,000,000 yen and causing a loss of yen deposits.
So it’s a good time to convert yen into dollars.
Since the dollar is relatively stable against the yuan, renminbi-denominated dollar deposits will also remain stable, thus preserving value.
If you are holding 1,000,000 yen and want to deposit it in the bank for a year, don’t do it!
The current one-year yen deposit rate is just 0.0215%, which means that after a year, you’ll earn only 215 yen, or $2 at best, or less than 20 yuan!
But if you exchange yen for higher interest rates in sterling or dollars through your personal foreign exchange business, it’s a different story!
Let’s take the dollar as an example.
Suppose you buy 1,000,000 yen at the exchange rate of 108 yen for 9260 dollars, and the one-year dollar deposit rate is 4.4375%. After one year, you can earn interest of 410.9125 dollars, and the total principal amount is 9670.9125 dollars. Assuming the exchange rate is unchanged, this is equivalent to 1,044,458.55 yen.
That’s 44,243.55 yen more than a year ago, equivalent to about $410, or more than 3,000 yuan.
Three, the basic principle of hedging is to buy low and sell high.
If you hold $10,000 and buy 19,000 marks when USD/DM rises to 1.90, then sell the proceeds and buy back $10,440 when USD/DM falls to 1.82, you will earn a difference of $440.
And recently, the foreign exchange market ups and downs, up and down frequently, to arbitrage to earn the exchange difference provides a very favorable opportunity.
Since May 20, 1999, the yen has risen from 124 yen to 108 yen per dollar. If you held $10,000 and bought 1,240,000 yen at 124 yen then and sold it at 108 yen today, you would get $11,481, a net gain of $1,481.
4. What is foreign exchange trading for?
The first client was retired and full of desire to travel.
So, he decided to take off and travel around the world.
He didn’t come home for 14 months.
When he got home, he found 14 broker statements in a pile of mail.
He leafed through it carefully, opened the most recent one and was pleasantly surprised to find that the initial investment had grown from $100,000 to $227,000.
The second client was also hoping for an above-average return on her $100,000 investment.
As soon as she receives her monthly brokerage statement, she opens it to see how her account is doing.
For four months, she watched her account balance grow from $100,000 to $170,000.
Needless to say, she was overjoyed.
Then, however, things seemed to change.
Over the next two months, she watched her account balance drop from $170,000 to $161,500 and then to $133,000.
The $37,000 drop in two months scared her.
She fears that if the situation continues, she could be back to square one or even lose money.
So she picked up the phone, called the fund manager, closed her account, took $137,000 and walked out.
The third client was even more different from the first two.
He has a lot of free time and is computer savvy.
He likes to use all kinds of investment strategies, and he can check his account online at any time, 24 hours a day.
Because he’s home most of the time.
In the first month, he only checked his account once or twice.
At the end of the month, he was delighted to see his account grow by more than $20,000.
So the following month, he decided to take a closer look at how the manager made such a handsome return.
He logged into his account at least once a day to try to understand the operations of the fund managers on his account.
However, as he looked at his accounts day after day, he became nervous.
On some days, he would see his balance grow by as much as $15,000, then see it drop by another $5,000.
He didn’t know what was going on.
So he decided to check his account at least two or three times a day.
Sometimes he sees no change, and sometimes he sees a significant change in the balance.
Although he added $20,000 to his account at the end of the month, he found the daily changes unbearable.
He called the manager, closed the account, took $140,000 and left.
Overall, the same fund manager handles three identical accounts in the same way.
After the first two months, each account had increased by $40,000, but the third client had left.
Four months later, at least $37,000 was added to the remaining two accounts, but the second customer also withdrew.
After 14 months, the account of the first customer who didn’t quit had grown from $100,000 to $227,000.
What is the reason for the different results of the three accounts?
The investments of the three-dimensional investors were formed over a time frame, but the investments managed by two of the clients were made over a shorter time frame.
We see the same dynamic among traders, who are swayed by good trading ideas when they replace profit targets with point-by-point market reviews.
Take the usual Friday trading.
S&p futures surged hundreds of points shortly after the jobs report, then retreated, but the index failed to break through key levels as interest rates surged.
Stocks then rebounded at the open, but the weakness was already evident.
I posted on my research blog that only two of the representative basket of stocks I track made new highs for the week, even though the S&P looks stronger.
A return to the previous day’s midpoint is statistically possible, offering quite a bit of profit potential.
However, every two rises of more than 1 per cent was enough to scare many traders away from profiting from the trade.
Anxiety stems from the perception of uncertainty.
Once we make a profit on the trade, we also “lose” the opportunity to continue to make a profit.
Uncertainty is now seen as a threat.
This leads us to respond by asserting (excessive) control, managing the transaction in a different time frame than the one that led to the transaction in the first place.
At that point, we’re not really managing the transaction anymore.
Instead, we are managing our own anxiety.
This is the definition of emotional disruption in trading: when the things we do to avoid losing prevent us from making a profit.
The ability to tolerate uncertainty separates traders from those who trade for profit and those who trade not to lose money.
We can only benefit from the strengths that are on display in the marketplace if we allow them to unfold.
