Interview with Mike Kulej of FXMadness: “Trading the News is Akin to Gambling”

Today, we bring you an interview with Mike Kulej of FXMadness. Mike has been trading securities since 1989. From 2001 to present, the vast majority of his activity has been concentrated on Forex markets. Currently he is a Chief Forex Strategist for Spectrum Forex LLC, a currency consulting and advisory company. He resides in Seattle, Washington. Below, Mike shares his thoughts about the effectiveness of technical analysis, volatility, leverage, and more!

Forex Blog: I am intrigued by the fact that your blog is deliberately focused on “the exciting world of Forex outside the dollar.” Is there a strategic reason for this choice?

At the time when I started the blog, everybody was talking about the Euro, the Pound, the Yen, so there was a lot of information available regarding the so-called “majors”. In principle, those are all of the main Dollar pairs. However, there were far fewer sources covering the crosses and exotic pairs. For example, everybody has an opinion about the EUR-USD, but not the NZD-CHF or the GBP-AUD. I wanted to offer information not easily found elsewhere and increase awareness that there are opportunities outside the US Dollar. Besides, that is what I trade…

Forex Blog: What’s the most undervalued/under-appreciated currency?

Among the most popular currencies, I feel that the British Pound is the most undervalued, followed by the New Zealand Dollar. The Canadian Dollar also has plenty of appreciation left. Within exotics the Indian Rupee, the Russian Ruble and the Polish Zloty come to mind.

Forex Blog: Could you briefly explain your approach to analyzing and trading in the forex markets. Do you prefer technical or fundamental analysis, or a combination of both?

My analyses include both fundamental and technical views. After all, it is the fundamentals that drive the markets, forcing big money to flow in and out of given currency. Unfortunately, they are very imprecise, and not suitable for active trading. Acting on fundamentals alone is more like investing. Trading demands specific conditions to be met, for both entries and exits and that is offered by technical analysis. My buy and sell decisions are made based on technical factors, with awareness of fundamental conditions.

Forex Blog: It is always refreshing to read another trader/blogger discourage the use of extreme leverage, especially given that it remains one of the main selling points that brokers use to attract potential customers. Can you elaborate on your philosophy of leverage, and perhaps offer some advice in this regard to novice traders?

Yes, brokers overplay the availability of leverage. They manage to point out advantages, but not the risks. Leverage itself will not make anybody better trader, it will only magnify losses and gains. In addition, trading with high leverage adds to the already highly emotional nature of this activity. It is natural that a trader wants to make as much money as possible, but before using leverage, one should prove it to him/herself that the account is actually growing. I would suggest trading without leverage, at 1:1 for some time, at least 50 or more trades. If at this point the account shows gains, some form of leverage might be employed. Somewhere along the line a trader will discover the “right” leverage for own personality, one that will allow to take advantage of this tool at a correct emotional level.

With me, leverage changes depending on the time frame employed for any given trade. If I use daily/weekly charts and expect the trade to last weeks, than no leverage is employed. For trades based on 4h and 1h charts, the leverage is either 2:1 or 4:1. Vast majority of my trades are done on at these levels. For very short-term transactions, using 5m charts, for example, my leverage can go as high as 10:1, but this is rare.

People often overlook that using low leverage per trade allows opening many different trades at the same time in one account. This diminishes dependence on any one trade. As long as the trades are not too correlated (like shorting all Yen pairs at the same time), using low leverage allows for diversification within an account.

Forex Blog: What do you think about the recent report by the Saint Louis Fed that concluded that the power/profitability of technical analysis in the forex markets is steadily declining? Do you think that this should serve as a warning to retail traders that they need to consider alternative strategies, or that they simply need to work harder?

This report focuses primarily on trend identification analysis, with moving averages in focus. For the longest time currencies had a reputation of instruments that trend very well, meaning the main trends last a long time and are relatively gradual. Under these circumstances, moving averages can be simple, yet effective, trading tools and this is what the report covers. It is just a matter of finding “correct” MA, which is always easier said than done.

Forex Blog: You revealed that some of your biggest trading profits were netted around the peak of the credit crisis. Were these trades based on fundamental factors, technical factors, or simply instinct?

Trend following strategies are typically used by the biggest trading entities, because their size forces them to trade that way. That was obviously very difficult during the last few years, as currency trends changed from relatively steady to very choppy. The Japanese Yen, for example, had been getting steadily weaker for years. In summer of 2007, this trend became shakier, but prevailed. Many trend following programs were stopped out, so they had to adjust to a little more volatile conditions, by making stops wider. However, that was not enough for what came next year, during the 2008 crisis. Bigger price swings, losses and positions in opposite direction had to have even larger stops to account for prevailing volatility. Then the sharp corrections in early 2009 likely triggered even those extended stops. Comparing to those times, current environment is relatively quiet, so trend following systems are doing probably better and, who knows, might work just fine for years to come. It will be interesting to see similar report in, say, 10 years.
Incidentally, all types of technical analysis will have good and bad times. Does not matter what indicator, pattern or charting method is used, nothing is 100% correct. The trick is to not to get discouraged during losing periods, which are sure to happen.

At that time fundamental analysis were just about worthless and amounted to not much more than guessing. When reading opinions and predictions by some of the biggest names in the business at that time, we can see just how diverse and contradicting they were. Those trades were technical, using large magnitude charts, mostly weekly. The strategies were common, only that they do not happen often on large time scales. Of course, there was an element of “luck”, in a sense that I cannot replicate these results at will – right set of market conditions must be present, including extreme volatility. After all, how often does GBP-JPY move 2000 pips in one day?

Forex Blog: On a related note, you seem to enjoy volatility. Does volatility make trading more profitable, or simply more exciting? Do you have to adjust your trading strategy when the markets are especially choppy?

It depends on what type of volatility we are experiencing. When markets are changing direction without a rhyme or reason, I try to stay away. On the other hand, volatility expressed by an increased size in price swings after a period of consolidation is my friend. Most of my strategies depend on this type of volatility and yes, that is what makes my trading profitable. More exciting? To a degree, yes, although I try to keep emotions to minimum. But realistically, whom are we kidding? Every time real money is on the line, emotions are involved to some degree. The key is to control them.

Forex Blog: You’ve alluded to the possibility that a Tobin tax (on all forex transactions) could one day be implemented. As a trader, you are clearly against this. Still, do you think that this could serve any positive economic function? Do you think Central Banks and policymakers ought to pay any attention (and react accordingly) to exchange rates?

The Tobin tax is supposed to fund global environmental issues. Great idea but why single out this particular segment of population? Who would have a say in how and where to spend the funds? Can we envision the level of cooperation between countries, which would be necessary to implement any changes? Besides, a concept of a worldwide tax for any reason is simply too radical.

As far as central banks go, it is their function to pay attention to general financial conditions, which includes exchange rates of domestic currency. All of their decisions effect exchange rates intended or not. Central banks should be treated as another player in the market. If the currency is floating, the central bank has every right to “react accordingly.” Their success rate is not much better than any other group of market participants. At least they are a “known quantity,” unlike central banks of countries, which do not allow floating rates.

Forex Blog: After rising dramatically in the wake of the natural disasters, the Japanese Yen appears to have fallen back. Even though you are not currently trading the USD/JPY, would you care to offer a short-term forecast?

Funny you should mention the USD-JPY. I had not traded it in a long time, other Yen crosses simply offer better opportunities – they move more. Recently, though, I covered a trade in this pair on the blog. It created a very clear, easy to spot, high probability trading set up, and so I took it. In my opinion, the USD-JPY has made a major bottom and I expect to see 90.00 within the next 1-2 months and 100.00 maybe before the end of the year. Anything beyond that will have to be decided as the price unfolds and new important fundamentals emerge.

Forex Blog: How does the possibility of interest rate hikes bear on your current trading strategy? Will you deliberately exit any relevant positions you on days that interest rate decisions are scheduled?

When trading short-term time frames, I avoid taking positions before major announcements. And yes, if in a trade, I often exit before these events, regardless of profit or loss. Currently the news releases, which have the biggest impact, are rate decisions by FED, RBA, RBNZ and BoC (Bank of Canada), as well as monthly employment data from these countries. These are the most volatile and unpredictable. This list changes from time to time. As a rule, I do not trade news releases with the intention to capitalize on them, for example getting in a position before the NFP data and trying to exploit what happens after. I find it too akin to gambling.

Forex Blog: Finally, what advice do you have for forex traders that want to beat the market in these uncertain times?

This may sound old and worn out, but always use stops. You will not get mega rich in a day, yet can go broke in one if, a stop is not in place… Preserve your capital.