By Michael Weissman
Since the US Congress returned to work, and I use the term
"work" very loosely, on Monday the markets have experienced some
serious whipsaws as predictably one after another politician offers their
particular take on how confident or not they feel about reaching a deal to
avoid going over the US fiscal cliff.
They all "understand the devastating effects of not reaching an
agreement" or so they say. Personally, I think the only thing our
irresponsible representatives are concerned about is which party gets blamed
for letting it happen.
Tuesday saw the US
dollar strengthen and the equity markets decline as soon as Senate Majority
Leader Harry Reid said there has been “little progress” made in
talks about resolving the fiscal cliff of tax increases and spending cuts. That
sentiment carried over into Wednesday trading until House Majority Leader John
Boehner said he was “optimistic that we can continue to work together to avert
this crisis, and sooner rather than later". Then President Obama followed
later saying “Our ultimate goal is an agreement that gets our long-term deficit
under control in a way that is fair and balanced, and I believe that both
parties can agree on a framework that does that in the coming weeks.” Right after Boehner's comments market
sentiment reversed again and coupled with Obama's comments that followed lasted
throughout the US session and then
accelerated into early European sessions on Thursday.
For reasons I will explain shortly I do not believe our
leaders are close to a deal and remain pessimistic that anything meaningful can
be achieved over the next few weeks so I expect to see many more instances of
high volatility and quick market swings as emotions and sentiment swing back
and forth as political posturing continues while the clock ticks and the days
left to resolve the issues dwindle away.
The issue at this time is really very simple. The US spends
too much money and current commitments to entitlement programs are
unsustainable. The democrats are fixated on 1 thing only and that's raising tax
rates on individuals who earn over $200,000 per year or families who earn more
than $250,000 despite the fact that the additional money doesn't come close to
addressing our budget deficit and have shown no serious interest in tackling
the real problems that threaten the longer term future of our country.
With Obama in the white house and Democrats controlling the
Senate the Republicans who control the House have 1 and only 1 piece of
leverage and it would be irresponsible and a slap in the face to their constituency
to give it away and my take on Obama's comments yesterday that helped fuel a
risk on rally suggest to me that the sides are as far apart as ever. The ace in
the hole for the Republicans is that all of the so called "Bush Tax
Cuts" will expire at the end of this year.
Boehner's comments turned the market around because he made it clear
that the Republicans were willing to put higher taxes on the table. What has
been under reported and extremely relevant is the fact that tax increases were
on the table but only as long as they were accompanied by spending cuts. That's
relevant because Obama was also clear later in the day that he wants to only
address the tax cuts now and leave the spending cuts to be worked out next
year. By agreeing to tax increases now for the promise of spending cuts next
year the Republicans give away their only bargaining chip. In my opinion It's
NOT going to happen.
Raising taxes in this
environment on anyone is foolish. It would wreck the economy. I see no possibility of the Democrats
seriously discussing spending and entitlements in the next few weeks. The Republicans
will not agree to extend the Bush tax cuts unless they either include all
taxpayers or the democrats come to the table with entitlement reform. The best
we can hope for, which is also the responsible and prudent way to resolve the
fiscal cliff issue IMO is to extend the Bush tax cuts for everyone for 1 more
year and give the new Congress and the President time to come up with a
comprehensive plan to reform the entitlement programs and the tax code in a
truly bipartisan basis. What worries me is that the terms responsible and
prudent have been absent from our political system for far too long.
So how do you trade in a market environment that is so
unpredictable in the short term? First and foremost recognize that we are in a
very skittish market environment and understand sentiment can and will change
quickly. Keep your leverage low and use smaller position sizes. You need either
very tight stop losses to avoid whiplash or believe it or not larger than
normal stop losses so sudden swings don't stop you out of your trade. Remember
it's not the amount of pips you risk that's important-it's the amount of your
trading capital you risk that counts. I
never risk more than 2% of my trading account on any 1 trade so when I decide
to use large stop losses which I am currently doing, I just use smaller
positions than normal. As an example, suppose you have $10,000 in your trading
account. I would risk no more than 2% or $200 on a trade. Now depending on the
setup I might use a 20 pip stop on a eurusd trade. This means I can lose $10
per pip. A eurusd pip is worth 1$ for every $10,000 of the currency pair held
so this means I can put on a $100,000 position. So if my $100,000 position goes
down 20 pips and each pip is $10 then my max loss is $200. Now suppose I choose
to use a 100 pip stop loss. I still want to risk a maximum of $200 which means I
can now risk only $2 per pip. So now instead of a $100,000 position I reduce
the size to $20,000. So now if the position goes against me and I lose 100 pips
I lose the same $200. So please remember
the golden rule. It's not pips risked in a trade it is capital risked. As I
expect a very volatile market throughout the fiscal cliff negotiations I have
adjusted my stop losses to allow for this volatility and have reduced my
position sizes accordingly.
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