Mike’s note: Mike Merson here, managing editor of Trading Icons.

Before we get to today’s essay, I wanted to remind you about Andy Krieger’s legendary trading event occurring tomorrow night at 8 p.m.

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Now, on to today’s essay…

For something as technical as trading, the actual process is almost never black and white. Over time, traders develop an intuition… Something that helps them identify imminent, market-rocking events when no one else can.

Andy, with his over 33-year career trading the markets, carries this same intuition. After learning to accept your losers, developing a trader’s intuition with repeated practice and a skeptical mindset is the next most essential part of trading.

In today’s essay, Andy demonstrates how his trader’s intuition signaled a big trade back in 1988… and resulted in a massive profit only he saw coming…

The Value of a Trader’s Intuition

The Value of a Trader’s intuition

By Andy Krieger, editor, Andy Krieger Trading 

Yesterday, I wrote to you about a strange aspect of trading that’s lost on most people – you have to accept your losses if you’ll ever succeed in the long run.

This dynamic has brought about massive profit opportunity cycles for me over the years.

One of these positive cycles came into full force in early 1988.

I had just finished a year in which I had made hundreds of millions of profits for the bank I traded for, with my profits coming from plays in most major currencies and gold – one of my favorite markets to trade.

My play in the New Zealand dollar got a lot of attention… but my views on other currencies were great for most of 1987, and I was quite profitable in many currency pairs. The kiwi trade was a special situation, since I was convinced that the New Zealand dollar was a dramatically overbought and overvalued currency that was going to go down – hard.

I just decided to give it a little encouragement to head lower – by selling short New Zealand dollars – so I wouldn’t have to wait too long for the down move to take place.

(Ok… I gave it more than a little encouragement. My net exposure in the kiwi was at one point greater than the money supply in the country.)

I’m sure it would’ve gone down even if I hadn’t sold one New Zealand dollar, but not as fast. It just would’ve taken weeks rather than days.

Early in 1988, I was trying to form my big-picture views for the year. In 1987, I’d ridden the dollar’s downtrend very profitably against the yen, Deutsche mark, British pound, and Swiss franc… but I had closed all the positions at year-end. I took a week off and tried not to think about the markets.

Suddenly, a strange feeling hit me.

I was thinking about the Intifada, the Arab uprising in the Middle East. The story had been in the press a bit, but I didn’t usually watch TV. My source of news was typically just Reuters and Bloomberg, along with a quick glance at the Wall Street Journal.

I started to think about a kind of “dollar uprising,” similar to what was happening in the Middle East…

After being beaten down for the whole previous year, I felt that the dollar would soon start its own “violent protests” – against the other currencies. Almost as if the dollar was oppressed and beaten down… and wanted to have more freedom and independence.

Plus, numbers were about to come in for U.S. trade deficit. And every trader I knew was staying short the dollar.  If the dollar were to take off and rally, it would be a horrible start to the year.  Too often, the market does exactly what will cause the maximum pain, so I figured that the people who were short dollars were about to be punished.  It was just too popular a trade.

With this in mind, I became more and more convinced that the dollar’s bear market was over. It was time to play for a major dollar recovery.

Still, at some core level the idea seemed idiotic.  I had made a fortune selling dollars over the prior years, and habits built on successful feedback don’t die easily.  I was torn internally.  I knew at some intuitive level that I was right, but my logic fought me tooth and nail.   Finally I concluded the dollar’s down move was overdone, and a major dollar recovery was coming.

This was a classic example of how one can start to develop a kind of intuition that only comes with practice. You learn to become skeptical of overly popular trades; you learn to sense when overdone situations are due to reverse – and you learn to trust that little intuitive voice.

So, I positioned myself almost immediately, buying a few billion dollars’ worth of one-year dollar calls against the mark and yen. I was sure it was the right trade, but I also knew it would be a difficult one. The market had been selling dollars profitably for years, and it would fight the upside move. These one-year dollar call options were part of a structural, long-term bet. But I was also looking to put on a short-term play on the British pound that could potentially have a big, quick payout if my hunches proved right.

For my short-term play, I bought 3 billion pounds’ worth of short-dated, out-of-the-money 1.8450 puts on the pound versus the dollar. I felt that the British currency would be particularly vulnerable to the expected short-term dollar strength. The face value of the options was equivalent to $5.5 billion, and they only cost .1%, or $5.5 million. I thought the implied leverage was incredible, as I would be able to control $5.5 billion worth of currency for a total downside risk of $5.5 million.

The pound was trading around the 1.8900 level and I knew it needed to have a dramatic move over a short period of time, but I thought this was possible if everything played out perfectly. In fact, I expected the pound to drop sharply over the next week towards the 1.8400 level – an extremely sharp move in such a short time.

We’ll get back to that in just a second. But let’s first return to the dollar.

I figured that the market would need a jolt, a major shock, in order to really start a major dollar reversal.

The U.S. trade numbers were going to be announced in several days, and I had a strong feeling that this would be the catalyst for the dollar’s “uprising” to really get going.

The market’s expectation for the trade number was a deficit of $18 billion, a huge number at the time… but I thought the number would come in much lower – around $14 billion. At that time, the market was heavily focused on trade data, and the dollar’s fortune rode on those releases. A smaller deficit would be very bullish for the dollar. So, if my hunch was right, then I would make a lot of money.

If things played out perfectly, then speculators around the world would be scrambling to cover their short dollar exposures, and my dollar calls would shoot up in value if the trade number came in much better than expected.

There was a huge amount of anticipation about the trade data before the release of the number. There was even a pool on the trading floor as people were betting on where the number would come in.

The night before the data released, for some strange reason, the number $13.8 billion popped into my mind. I figured this was just my desire driving my subconscious mind to create a favorable outcome on the U.S. trade deficit number.

The next day, the number came out to exactly $13.8 billion.

The trading room was eerily silent for a moment and then there was total bedlam on the floor. The dollar started gapping higher and traders around the world started panicking. The market was caught short and the dollar was exploding higher. My core long-dollar bets were doing great and I had no interest in touching those positions at all.

My short-term play against the British pound, however, was a different story.

I’ll finish that story in tomorrow’s essay. Stay tuned…


Andy Krieger

Editor, Andy Krieger Trading

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