A long standing client flew in to our office last August. He wanted to build a scalping system that would churn through as many trades as possible. I tried explaining that gauging risk from only 6 months of data is not enough time and that the markets can be far wilder than imagined.
The Swiss central bank intervened the very next day, sending the EUR/CHF up 1,400 pips to 1.20. The USD/CHF climbed even more in terms of pips. It was a shocking, jaw dropping display of market insanity.
Many traders almost certainly got caught in the wave of destruction. Low leverage positions received almost unthinkable margin calls in the course of several hours. It seems insane to think that an institution would come in and buy 20 billion euros in the span of several hours. Yet, that’s exactly what happened.
Staring at historical data does not tell you anything about future risk. The only thing that historical data tells you is the past sense of normal. That may continue into the future for a time, but eventually, things change.
My personal opinion is that the best you can do is to characterize the personalities of different instruments. The GBP/JPY is notoriously wild due to its speculative nature. The UK and Japan have no real trade relations to speak of. The currency pair is something of a market accident. They are two liquid currencies that happen to be exchangeable, but very few people in normal business need to exchange them directly.
The Swiss franc, on the other hand, is a bastion of conservatism. The currency was historically backed by physical gold. It used to be fully backed. Then it declined to a 40% backing. I don’t remember what the backing is today, but it’s a fraction of what it used to be.
Not incidentally, the conservative behavior of the franc changed in line with the reserves behind the paper. The franc gets more wild as the gold supply securing its value diminishes. Volatility grows increasingly wild with the passage of time.
I encourage traders to look at the rate of change for an instrument when they attempt any kind of profiling. Rather than saying that the CHF is quiet, I tend to say that it’s historically conservative with an increasing tendency to undergo wild episodes. It’s basically the 30,000 foot view. Rather than asking what it’s like today, we rephrase the question to ask what it’s likely to do tomorrow.
Watching the EUR/CHF explode before he had a chance to trade likely saved my client from blowing up. It was a learning experience, but most traders are not lucky enough to learn from the sidelines.
If you have any kind of hyperactive trading idea that depends on range bound markets, I would encourage you to stick it into the “save for later” bin. This summer and fall are ramping up to be quite a wild ride. If anything, now is probably a great time to bring out strategies that only do well when it looks Armageddon is near.