Suspension of FX weekly

I’ll be suspending the FX weekly posts indefinitely as I’ve been focusing on other asset classes and styles, and the commitment there is only going to increase.

The weekly opportunities haven’t been great of late as the EUR and GBP drifts without conviction, and so goes the AUD and NZD. The CHF is listless too. There may be some opportunities in the CAD. Bear in mind these are mid to long term opportunities I’m talking about – there’s still trades at the higher frequencies, but not suited for posts.

Finally, the USDJPY macro play is also called off, as the main reason for buying this pair (underpricing of expected and current rate differential) is now gone. The Fed is more willing than expected to lower an already low rate, just to keep the economy going the way it has been. If that is their stance, then the macro play is no longer worthwhile. It’s not completely bunk, but I am at least cutting most of my position.

When good is bad – Non-Farm Payrolls 2019-07

It's one of the stranger times when a better than expected report leads to an equity market sell off, and USD strength.

The logic is indirect (better economy = less chance of rare cut = bad for stocks) but it's interesting how market participants usually only focus on one narrative and ignore the others, such that price action is decisively in one direction instead of a mixed response.

For further study, it would be interesting to look through historical payroll reports and the corresponding price action.

FX Hedging

Main factors in deciding between whether to hedge or not: returns, volatility, and correlation. Very briefly:

  1. Cost of hedge: interest rate differential + any FX basis
  2. Volatility or underlying vs currency: check if a hedged position can give a better Sharpe; sometimes the currency is more volatile than the underlying
  3. Correlation between underlying and currency: some assets are better left unhedged i.e. JPY-denominated equities; denomination has a tendency to rise in times of equity stress

Typically, bonds are hedged while equities are left unhedged, but this 'typical' does not apply to everyone at every time - you have to see if it applies to your case.

Also, always do the analysis with your home currency in mind.

Insurance and Emotional-Monetary Basis Risk

There's no hedge against adverse circumstances in our lives.

Of course, no monetary amount can be exchanged for many of the things in life that are so critically important. But on a monetary exchange level, insurance transfers current money to possible future money at a time when we need it more, and when it could possibly make you feel a little better. For that, I am willing to pay.

When I buy insurance on cancer, it is almost like a 'basis risk' between my emotional/physiological state and my monetary state which is hedged.

What's my hedge ratio? I've never been through such a  state yet to be able to estimate it. The hedge ratio is related to the gain in monetary amount that would help buffer emotional loss (at least to some degree). I'm not sure if it does, but I would think that if I do get in to such a state, there is a possibility that some income would make me feel just a little bit better.

Predicting Limit Order Book Behaviour

I recently did an exercise on analyzing the limit order book for predictors of the first event that will occur in the next 1 second. There are 3 events: bid level retreating, ask level retreating, and no change in the top of the book price.

The result was that the log of (Bid/Ask) gave the strongest prediction. 

Below is a scatter plot for a small sample that shows the relationship between the bid and ask quantities, and the corresponding colours indicate the outcome (grey = no change, blue = bid retreated, red = ask retreated). Contours indicate the probability estimated by multinomial logistic regression.

Here's the full version using tick data of the entire day (about 127,000 data points). White = no change, for better visibility and truncated at size=300.

Below is the full version, without the ax truncation.