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Mar Hedge Magazine

Running Profits

Article by Elise Coroneos, June 2002

Mario Kelly and Daryl Swain began working together at CMC, a london-based brokerage firm, in 1992. Kelly's experience included front and back office operations at Morgan Guaranty Trust Co of New York, Girozentrale Vienna London and a further 10 years experience at various margin foreign exchange companies.

For his part, Swain had traded a foreign exchange book with many differing currency exposures, and implemented several account controls for various institutions.

Upon leaving CMC in 1997, the pair decided to form Wallwood Consultants Ltd to fill a demand for specialist foreign exchange training and education. Before long, they sought to extend their brief by applying to get the company regulated to give investment advice. The go-ahead came in August 1999.

"So the company was then effectively having seminars and teaching people, and also giving buy-and-sell recommendations on currencies," says Kelly.

From these beginnings, Kelly and Swain sought to extend their vision by managing assets on behalf of clients, which they have done since January 2001. They now manage $1.2 million in assets on behalf of various high-net individuals and one institution.

Wallwood trades three currency pairs: US Dollar/yen, euro/US dollar, and a synthetic euro/yen crossposition, which is achieved by going long on US dollar/yen and euro/US dollar. The firm restricts its exposure to this limited number of position combinations, says Kelly, because of its ability to capture the movements of the two main liquid currency groupings covering the three geopolitical time-zones around the world.

"We often get asked why we don't trade sterling, but generally we find that it tends to follow the euro nine out of ten times," says Kelly.

"Because we trade the most liquid currency pairs, it doesn't matter what size position one has. One is able to trade out of them without too much slippage. It is a liquidity thing.

Swinging Systems

The trading system employed by Wallwood, which is the result of three years of development, consists of a form of "swing" trading. Thus, the program follows the market wherever it is trending and simply reverses, or 'swings', that move when the market changes direction.

This method stems from Kelly and Swains' experience with clients trading through brokers who acted in a converse manner, that is, taking profits and running losses. "When we were working for the brokers, one of the main mistakes we consistently saw was clients who run their losses but take their profits," says Kelly.

"So we look to do the opposite. We never have a profit target; we run our positions as far as we can, but on any position we know our potential maximum loss."

The system aims to maximize profits by using trailing stops and to limit losses when there is no clear market direction. All positions have a stop in place of between 30 and 70 basis points; thus the maximum loss on any position is defined. This type of trading system seeks to close out losing positions quickly and to hold portions of profitable positions for as long as the trading system determines that a particular market trend is continuing.

Wallwood had only one position on at the time of writing, according to Kelly. It was a US dollar/yen combination, which was in profit by about 10 basis points. "If the market goes down from here we would lose this profit on the position. But then we would forecast the market to carry on going lower. So if the dollar goes lower, we will go short. If the dollar goes higher, we will look to move our stop higher, maybe up to a break-even situation."

Between them, Kelly and Swain monitor the markets 24 hours a day because of their shared philosophy that any firm wanting to trade the Interbank market must effectively act as a bank. "So, even though we have only one office in London, we act as if we have offices all around the world by monitoring the markets from the one place," says Kelly.

Support and Resistance

Although the Wallwood program is systematic, Kelly believes that most technical indicators on currencies create too much of a time lag, thereby trading behind the actual market. Therefore, instead of traditional technical indicators directing decisions to enter a position, Wallwood's method is characterized by "support and resistance," according to Kelly.

"For example, on the euro at the moment, we have an order on the upside, a buy-stop entry. In such cases, we use our own experience and judgment in determining where the line of resistance is in the euro. This is the only place where we use discretion."

Kelly says that if the system does not detect a price trend, a neutral trading signal will be generated. "This neutral signal is designed to filter out high-risk markets when markets are range bound within narrow bands, as there as less opportunities. However, when any breaks occur, the trading system has orders in place to take advantage."

The Wallwood program achieved a return of 41.8% in 2001, and has a compounded annualized return of 29.1%, which compares very favourably with the median return of the Zurich currency subindex of 6.4% for the same period. Kelly attributes last year's good performance to the euro's trending lower and the volatility that came about in September and October particularly.

The program has had a harder time turning a profit so far this year, says Kelly, owing to the lack of volatility. Despite this, however, it is up 10.9% through May. "Recent months have been very good in that there has been more movement with the euro moving up from 90 to 94 and the US dollar/yen getting out of its box."

The program's timeframe orientation is short to medium term, with one week being the longest time a position has been held. Stops tend to occur at between 30 to 70 basis points away from where the current market is trading when a position is entered into.

Leverage is used at 6:1, or 15% margins. However, says Kelly, because some clients simply pay for advice and do not invest through Wallwood, they may be trading with a small amount of capital with their leverage being far higher than that of the program; hence, their returns would be greater.

In April this year, the firm added trading in the Dow futures to its repertoire, It currently has two clients with $30,000 apiece in the vehicle, which is up 7% for the year.

"We began to perceive that the momentum plays in currencies were diminishing and we were looking at the volatility that tends to be present in the stock market and realized that that suits our method of trading," says Kelly.