FX Lingo: Positioning

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January 19, 2020

FX Lingo: Positioning

[Post Date]      Barbara Rockefeller

Positioning by professional bank and other institutional traders is the overlooked factor in FX determination. Who are these people? Not just big banks, although they are the key players. Insurance companies, hedge funds, sovereign wealth funds, government reserve managers and other fund managers need to be included, as well as those hedging corporate and fund flows. The important point is that big professional traders work with billions of dollars, more than the retail market to which you and I belong. And when they make a trade, each one is in amounts like $10 and $20 million, not the piddly $10,000-100,000 we may be trading.

It will happen to you: an overwhelming number of fundamentals point in one direction. On top of that, you have a chart on which 9 of 10 indicators point in the same direction. Suddenly and for no reason you can find, the price reverses. You never know whether it’s some short-term anomaly or if there is something behind it that hasn’t hit the news yet.

Sometimes it really is something that hasn’t hit the news yet—and never will. It’s not that professional traders have inside information from central banks or finance ministries, it’s that they have something equally valuable: orders from other big institutions. Example: an equity hedge fund decides the Tokyo stock market is peaking. It wants to cut its exposure by 50% and put the money into (say) Canada. It has to call its bank to sell those yen and buy the Canadian dollar to make the switch. The bank now literally has inside information about a price move that is going to occur. Whether it trades that information for its own account varies from bank to bank, but it’s not necessary to postulate insider trading for the effect to be the same—an unexplained dip in yen and an unexplained rise in the CAD.

That’s a one-time, stand-alone event. After that one trade, the existing trend may resume. Or others might see that switching out of yen in favor of CAD is a darn good idea and jump on the bandwagon. The starting point could be bar gossip (*) about Japanese equity valuations or a Reuters story, although chances are the event will be long over before it hits the newswires.

We also see longer-lasting, systematic re-positioning mostly as fresh news comes out or big institutional technical analysts perceive a currency overbought or oversold. These bigger, more widespread moves can be seen, with a lag, on the chart. The chances of guessing how big institutions will re-position are very small. You will almost never be in the first wave of an important price reversal.

There are a few exceptions to this, as in the case of Japanese managers generally preferring the yen as a safe-haven in times of geopolitical turmoil. Talk of a US-involved military conflict typically drives Japanese managers into their home currency instead of the safe-haven dollar. But this deduction is not 100% reliable and doesn’t work every time.

We have a big drawback in FX, too. Big institutions do not report their FX volumes or positions to anyone except periodically to government regulators and the Bank for International Settlements. The BIS reports volumes and currency market share only every two years. If you could see the yen volume suddenly rise but fall back in a day or two, you would be far better able to judge what is going on. In equities, volume is a critical factor and many useful indicators are built on it. Some equity managers trade using only volume indicators.

When you have really done your homework and can’t find a reason for a countertrend move in the fundamentals or technicals, the real reason is almost certainly big institutional positioning.

  • If you would like a glimpse into how professional big-bank traders behave, including decision-making on positioning, get a copy of Nick Leeson’s Rogue Trader, How I Brought Down Barings Bank and Shook the Financial World (1996). The book came out over 20 years ago, but don’t let that turn you off. Traders behave the same over time and over distance.
Barbara Rockefeller

President + Author