Bill Lipschutz was a highly successful forex trader who was interviewed for the “New Market Wizards” book. He was nicknamed “The Sultan of Currencies.”
If you don’t have the book yet, don’t worry as the interview from the book has been posted on Bill Lipschutz’s website. He currently runs Hathersage Capital Management.
You can find the interview here:
I will now analyse the interview for you and provide the golden nuggets of value.
Bill Lipschutz has quote screens and monitors in every room in the house, even the bathroom. Good move by him as he knows that the fundamental value and sentiment can shift rapidly at any point in the day and when you are running multi billion dollar positions you may need to adjust your positions at any point within the day.
Bill had a large TV screen with a Reuters news feed running across the bottom. It helps him stay plugged into the information flow. He is definitely not suffering from information overload.
Bill, while doing the interview decided to place a trade in the Australian dollar while the market was falling after some bearish comments from the Australian finance minister. He placed a limit order to buy $20 million Australian dollars. The currency started to move higher for the next few hours, but Lipschutz’s limit order was not filled.
Why would Lipschutz try to buy Australian dollars after negative comments? Perhaps he knew that the small change in fundamental value from the finance ministers comments was going to be met with some bargain hunters stepping in to buy Australian dollars. If he day trades the market heavily, then he can get a feel for how the good and bad news affects the markets. In this case he was hoping that the people taking profit on Australian dollars or going short due to the finance ministers comments would provide him liquidity.
He thought the market was overextending to the downside. Now it is also possible for some stops to have gotten tripped to the downside and for the market to be even more overextended because of those stops.
Also, he was probably keeping a mental note of what the fundamental value of each currency pair that he trades in is. He keeps that number in his head as he takes into account all the various information and determines how various market participants respond to this information. Many of the great traders have a certain feel for the market and know when it is out of sync and stretched too far.
He then states that “Missing an opportunity is as bad as being on the wrong side of a trade.”
I generally disagree with him. Missing an opportunity can feel bad at first. But once you realize that huge market moves will occur at various points indefinitely into the future, then it doesn’t really matter if you miss a big move. So long as you have an order flow edge in the markets, and know you have developed the skills to be able to find and place those good trades.
Bill Lipschutz seems to like to trade using limit orders. He hates using market orders. He feels strongly about this as he says “What! And pay the bid/ask spread?”
I personally have no problem using a market order and paying the spread. If I have been waiting patiently for a big move to occur in the forex markets, and have the market timing down, then I will pay the spread no problem. If the market is going to make a 100 pip move, I am not going to be trying to get an extra pip or two better price. I will pay the spread.
Then the interview goes into his background. Bill Lipschutz started off studying architecture, but wounded up a trader. A lot of highly successful traders have stories like this. Bill Lipschutz started off studying architecture. Bruce Kovner used to be a taxi cab driver.
Lipschutz spent a lot of time studying annual company reports when he started off trading stock options. He read a lot of financial periodicals. Sounds like he was increasing his conscious and subconscious market understanding.
He points out that he never remembered making a conscious decision to be a trader. Bill states that it was a gradual process.
And that is how trading is, especially order flow trading. It is a gradual order flow transformation.
Eventually Bill Lipschutz talks about how Salomon Brothers just decided to start a foreign exchange department. Bill says that they just got a whole bunch of bright people together, traded the product and see if they can make some money. They have no written business plan. They just did it on the fly. They just got a few traders together with RAW trading talent. That was how the gunslinger traders did it back in the days. Go in guns blazing, take a few positions, get a feel for the market, the order flow and information flow and figure out how to trade it.
Lipschutz states that they went to dinner with different international bankers a few times per week. Looks like he was trying to get plugged into the information flow. To get a feel for what was going on in the world, and what could affect the different economies and currencies of nations.
Then Bill Lipschutz gives us a little bit of old trader wisdom, which still stands fairly true today:
“Foreign exchange is all about relationships. Your ability to find good liquidity, your ability to be plugged into the information flow-it all depends on relationships. If you call up a bank and say, “I need a price on ten dollar ($10 million) mark,” they don’t have to do anything. They can tell you, “The mark dealer is in the bathroom; call back later.” If I call up at 5 P.M. and say, “Hey, Joe, it’s Bill, and I need a price on the mark,” the response is going to be entirely different: “I was just on my way out the door, but for you I’ll see what I can do.”
Bill then talks about how he was the first person to have a trading screen at his house. His friends thought he was nuts, but Lipschutz told them the forex market is 24 hours. It is there all night and it can move.
Bill Lipschutz was a true trader who understood that news could breakout, the fundamental value of a currency can change at any point throughout the day, whether it is London open, New York open, at the 5pm rollover.
Bill would talk with bankers throughout the day and night in Tokyo, London, Frankfurt and New York. Bill Lipschutz wants to be plugged into the information flow. He wants to know what is going on in the world. He wants to know what the global macro environment looks like. He wants to hear rumors of big players entering and exiting the market. He wants to get a feel for how the market is positioned. Is everyone starting the day fully long or short? Or is there a mixture of positions?
Bill Lipschutz then gives us some more trading wisdom: that foreign exchange trading is all about trading off information flow. I would add in order flow into that mix as well. So forex trading is all about trading off order flow and information flow. This is the formula for all financial markets.
Bill then gives an example of information flow, sentiment and market expectations. He talks about the Berlin Wall coming down and how the market believed that they would want to pump money into East Germany. The market thought that these large capital inflows to rebuild East Germany and get it up to par with the rest of the world would result in the Deutsche Mark appreciating in value. That was the market sentiment, that was the market expectation and there were probably billions of dollars riding on that scenario playing out.
Once market starts to figure out that the large capital inflows into East Germany won’t happen and that the rebuilding effort would take longer than expected, the market had to unwound those billions of dollars betting on Deutsche Mark appreciation. The sentiment starts to shift as new data releases, and new speeches start to cause market participants to come to the realization that the rebuilding and integration of East Germany would be difficult.
Eventually people start unwinding those bets being long Deutsche Marks. That causes bearish order flow for the Deutsche Mark. There may also be some speculators not just reducing their exposure to zero, but also going short the Deutsche Mark as well. That results in more bearish order flow. If you combine two economies together lets say West Germany and East Germany, with the west portion being strong economically, but the east being weak economically coupled with a difficult rebuilding and integration process, then that can hurt the currency because the German Central Bank – the Bundesbank, now needs to take into consideration this weaker economy that just entered Germany and may hold off raising interest rates.
Then Bill Lipschutz gives us some more trading wisdom:
What is important is to assess what the market is focusing on at the given moment.
Not everyone is going to interpret things in the same way, at the same time, as you do, and it’s important to understand that.
You need to be plugged into the news and to know what the market is looking at.
Never, ever forget those above quotes for as long as you are trading. They are truly golden.
Lipschutz then talks about stop hunting. He then gives an interesting trade example about where the floor traders hunting stops which were 200 ticks below the market, even though the closest stops were only 50 ticks above the market. The floor traders knew that everyone was long in anticipation for the market running the stops higher. Everyone had gotten their orders filled to go long and were looking for the stops above the market to get tripped to liquidate into them. They had certain expectations attached to this order flow. The floor brokers knew it and decided to pound the market lower. They knew those traders who were positioned long had pain tolerance points which the floor brokers were exploiting. The floor brokers made a calculated decision to go for the stops 200 ticks below the market instead of 50 ticks above the market. They calculated that pushing the market lower would cause much more order flow to be generating because of all the people stuck long already. A very calculated decision.
Bill was on vacation at the time and he talked about how one of his traders Andy, shorted $60 million worth of dollars during the New Zealand session on Sunday. Now the early Sunday session is very illiquid, with high spreads. Add in that this huge news release and the market was was trading with a 200 pip spread!
Andy executed trades for shorted $20 million dollars at 280, another 20 mil at 279, and another 20 mil at 278. He pushed the market lower 300 pips just by selling 60 million dollars in the illiquid Sunday New Zealand session.
Why was Andy willing to place trades with 200 pip spreads? Because he knew the fundamental value had changed so much with the Plaza Accord that the dollar had potential to depreciate thousands of pips, therefore if you know the U.S. dollar is going to depreciate by 2,000 pips lets say you don’t mind paying a 300 pip spread on the entry. Because when you go to cover the position in a few weeks, you can cover the position during a liquid session where the spread goes back to normal below 10 pips. So yes, there are certain situations where you can place trades and absorb 300 pip spreads, but such moves only tend to happen a few times in a lifetime.
But that is the hallmark of an order flow trader – flexibility.
Bill Lipschutz made $6 million on that one day.
Lipschutz then eventually starts talking about a trade that went wrong in 1988. The Deutsche Mark was trading in a tight range, and in order to make some decent money during low volatility periods Bill traded ever larger position sizes in order to capture smaller and smaller fluctuations. Bill was long about $3 billion Deutsche Marks against the dollar. He was holding through the event risk of the Gorbachev speech. The market interpreted the news to be bullish towards the dollar and the dollar started rallying against the Deutsche Mark. Bill was down 1% or $30 million dollars.
Judging by the trade description, Bill Lipschutz was talking about Gorbachev’s speech to the UN on December 7, 1988.
Lipshutz then talks about how he couldn’t find liquidity to get out of his position during the late NY session and had to wait for the Tokyo session. His strategy was to sell a few hundred million more dollars increasing his position size, in order to try to stop the market from moving against him. This is a very calculated risk, that some large traders do make from time to time. They average down on their losers, if they believe that the additional order flow they generate can change the market psychology, or allow them to survive to access a better liquidity time center. But they do average down their losers.
So Bill sold another $300 million dollars in the afternoon New York session bringing his position size to being short $3.3 billion dollars. Bill did this because sometimes during the afternoon New York session if someone comes in to buy a few hundred million that could move the price a few hundred pips. Remember from the Billion Dollar Day documentary where Brad Westerfield said the afternoon market was all about who would buy or sell the next $100 million and move the price 100 pips?
Well, Bill Lipschutz was hoping that by selling $300 million dollars he could absorb that order flow and cause the price to stay put and not move against him. But that wasn’t enough as the news seemed to change the fundamental value of the U.S. dollar to being more bullish and Lipschutz averaged down into a trade that was clearly moving against him for fundamental and sentiment reasons.
Bill was down almost 70-90 million dollars paper loss.
The dollar though did start depreciating again going into the Tokyo open and again into the European open so Lipschutz held off covering the position and did cover it in Europe, for only a 18 million dollar loss.
Lipschutz knew that if he tried to exit a $3 billion position during the afternoon New York session or the Sydney session that he could push the market against him by hundreds of pips. Instead he waited for the liquidity in Europe to exit the position. And yes you can get out of a $ 3 billion position in the European session some of the time over the course of a few hours without moving the market too much against you if you do it strategically. Bill Lipschutz has a very strong grasp of the liquidity situation in the forex markets.
So what looked like a 70-90 million dollar loss turned into only a $18 million loss. That is the hallmark of a great trader cutting his losses. The order flow and liquidity moving in your favor always helps. Remember the only two things that can save your trades – order flow and liquidity.
Bill Lipschutz drastically misjudged the liquidity situation but the market spared him most of the cataclysmic losses.
Bill Lipschutz then proceeds to give us some more market wisdom:
“Always understand the risk/reward of the trade as it now stands, not as it existed when you put the position on.”
Very important information. The risk to reward ratio of a trade doesn’t stay the same – it changes as the market takes into account information that doesn’t exist on a chart.
Lipschutz continues with some more golden nuggets of value and talks about size being an advantage:
“If a big buyer comes in and pushes the market 4 percent, that’s an advantage.”
Bill talks about how the big players can change the psychology and sentiment of the market with their huge size and ability to generate huge amounts of order flow. He is correct. There are times when a huge 500 pip move in one direction can change the market psychology for the next several days.
Some more trading wisdom:
“If my perception that the fundamentals have changed is not the market’s perception, then there’s something going on that I don’t understand. You don’t want to hold a position when you don’t understand what’s going on. That doesn’t make any sense.”
Bill Lipschutz talks about how the big banks front run in the interbank market. They do it every day to make a tidy profit. And Lipschutz rationalizes it this way, which is reasonable from the bank’s perspective:
“When I allow you to come in and sell $2 billion in the foreign exchange market, I’m accepting the credit risk and providing the liquidity and facility to make that trade. In exchange, you’re providing me with the information that you’re about to sell $2 billion. That is not a totally unreasonable rationalization.”
Lipschutz then talks about how many traders at the big banks don’t know how to be real traders. They don’t know how to take real calculated risks.
Bill continues with some more words of wisdom about counterparty risk and why some people are willing to accept it:
“At a certain interest rate level, you would lend any bank money.”
Bill Lipschutz then talks about scenario analysis:
“You can even argue further that playing out scenarios is something that I do all the time. That is a process a fundamental trader goes through constantly. What if this happens? What if this doesn’t happen? How will the market respond? What levels will the market move to?”
More words of wisdom from Lipschutz regarding market feel and understand:
“In this sense, what people describe as gut feel is probably better described as subconscious market experience.”
Hope you enjoyed the analysis.
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