Spiked Deployment
[21/10/26]
A book has had a big impact on my trading recently. The book I referenced in the Homework#1 article. Specifically, one chapter is about trying to trade more efficiently and not ‘wasting shots’. When you’re a market-making trader, it’s your prerogative to be actively involved and intentionally overtrade. You need to ascertain a feel for the market at all times, to see which side of the orderbook is more fickle, hence have your finger on the pulse of which side of the market is the weaker side and thus requires protection when quoting a two-way price. You’ll also be managing a constantly evolving franchise position in your core CCY book, so will be actively trading around your core position from which you will be quoting around, if you’re lucky enough to have an active franchise! You also have the luxury of a brokerage bill being centralised and deducted at top-line-level as a desk expense, as well as your ‘cost of turning over your positions’ being concealed within your P/L. As you move from the active franchise seat, through the HF PM seats, prop trading seats and towards retail trading, three things become apparent.
1: Execution/brokerage costs become more visible as a direct cost of doing business. Siloed strategy with own-account cost centre makes you brokerage-aware and more spread-sensitive than you had been prior. The % payout mechanics also make it impossible to ignore how running a tight ship maps to your personal compensation.
2: Spreads widen. Whilst Tier1 HF PMs have the luxury of choice option pricing and quasi-choice G10 FX spot streaming, Tier2/3 fund PMs will notice FX swap pricing become punitive in places and for fair reason. Unwinds on option trades or barriers can sting, too, vs the pre-trade POA. Trying to reduce spread paid, when turning water into wine, becomes part of the job and feels particularly important in tougher times.
3: Prop or retail traders realise the cost of leverage. It’s not free. For prop traders at established firms, although trading spreads remain institutionally tight, PB costs in the 5-10x levered Tier 1 FX PB account are significant, as well as minimum monthly volume hurdles that need hitting on execution platforms (BidFX), if you don’t have to pay or the platform access itself (TT, BBG). These costs related to brokerage and leverage may be absorbed at firm rather than trader level, but you’ll effectively be paying for the platform via your P/L split of 50-70% to the prop firm. For the retail trader, spreads are half-decent in the liquid products, but swaps are likely punitive, and financing and commission on FX and liquid futures are of course based upon the market traded notional (NOP) and not the margin account size. The saving grace is of course that whilst over-trading can negatively compound, your profit split is 100%.
All said, being a more efficient risk-taker in any iteration of buyside seat is a way to maximise Sharpe and build an impressive track, whilst also preserving emotional capital for the right moments. Good grace and trust with risk departments is built by demonstrating proactive, risk conscious trading, i.e. not driving full speed all year round. Being able to trade into serious market dislocations can be where the year is made. The domino of stop-losses as pods close consensus and over-levered positions is where years are lost.
You will often hear variations of the statement “there are only 2-3 real macro trades per year”.
What I have realised this year, being the first year I have truly traded in a vacuum, is that I have had 2-3 months that have moved the needle in P/L terms, whilst the others have been noisy and largely netted-out.
I’ll provide my current market screening, as an example of my point, because right now I don’t think there are a huge number of attractive FX trades to enter. To provide a real-time example, my trading account’s margin-usage or buying-power has transmutated from 55% during the global bond rout in the second half of September to just 22% as I write this piece. Opportunities feel scarce, so powder is dry and I am also trading more defensively as I slowly exit a drawdown phase. I am hoping that others share this sentiment and that it is not me that is suffering from a mental block, but I am fairly comfortable that it’s the case, having traded many mini-cycles.
The only 4/5* trade I see right now is long some form of US duration. If I catastrophise and predict the AI bubble bursting, then recent correlation suggests US FI receives a safe haven bid, whilst VaR-reduction sees momentum players and CTAs short bonds trim the risk. A Fed hike next week spurs this and curve flattening insulates the long-end. If the Fed hold and risk assets rocket higher, the duration trade can work slowly and carry insulates your downside; only the fiscal question mark bludgeons the long-end, and I don’t think we are there yet. This trade still feels high EV to me, with a regime-dependent payoff chart similar to the USD smile theory. It makes even more sense when paired with a short US equity view. My personal expression of this at present is long ZB26 vs short ESZ6 in 30% of the former notional.
Examples of trades that are only 2 or 3 star at present:
Long JPY on a cross basis. Monday’s 20Y JGB auction is receiving increasing coverage (thanks, PK, for bringing this to my attention as it happened). Bid-to-cover ratio was almost 6x. Domestic or local take-up dominated, with this year’s Apr-Sep purchases confirmed at the highest rate since 2009. The supertanker is turning, with yields finally high enough to lure repatriation, but there is no near-term catalyst. I keep reading that the 20Y is the lesser-loved sibling of the 5 and 10Y, thus not to be read into. Long JPY feels like an investment, rather than a trade, if you will. If anything, a Dec hold would be a meaningful spanner in the works. I am short a little bit of USDJPY, but no trigger to add; trade on ice for now. I still like CHFJPY lower as a VERY long term trade and with a reduced carry bill, but levels don’t suit. North of 194-196 looks better with a stop through the YTD highs.
Short USD. USDCAD has left many behind on the local hiking story. AUDUSD is rallying but it is unclear if this is shorts getting squeezed or AU payers rebuying the ccy on Hauser. USDJPY is sharply unchanged and the market already feels ‘too short’ of EURUSD. GBPUSD shorts are cutting as gilts take a breather and Burnham’s posse feel surprisingly responsible. Therefore, I don’t think there’s a clear theme/index move, or a good enough story to bet against the USD and be happy paying for your bet in most places. All roads have led to USD strength for a while now, but that doesn’t have to unravel quickly. Especially with oil still at the highs and potential for a hawkish Fed surprise to kick US 2Y yields higher.
Short EURXXX. Owned, added and extended. OATs flashing red and the energy cliff into winter accompanying the fiscal one as markets draw parallels to the 2012 debt crisis. As with the long USD trade, short EUR isn’t wrong, but you can’t be the last one into the trade. Waiting to sell a rally in EURUSD, EURJPY or EURAUD specifically.
Long AUD. I don’t love how bullish the market still is on AUDNZD. Waiting for this position to be clearer. This alone is stopping me getting long AUDUSD, after being burned in NZDUSD. Watching brief, but Hauser’s payer-inducing rhetoric was powerful overnight.
Long metals. Debasement building blocks are in place, but have been for a few months. CB’s combatively hiking and ‘doing the right thing’, combined with contagion from French/EZ yields, is seeing nominal and real yields put a pin in the safe haven and debasement thesis, for now. Expecting take-off to resume but not until fed-up longs have reduced.
Short NQ. This is for the doomsayers regarding both AI and the US fiscal spiral I wrote about recently, with an explainer of fiscal dominance. Fortunes can be lost betting against the Nasdaq. My own thinking is that if and when it starts to gap lower, missing the first 2-5% of the move will be OK.