Posted by: Bevan | April 5, 2012

March 2012 Trading Commentary

March was a quiet month in the markets.  The inexorable upward climb of the US stock market continued, buoyed by Fed money flushing through the economy and a few positive economic reports.  The Yen weakened further, consolidating towards the end of the month.  Corn finally broke out of consolidation to the downside, however this turned out to be a bear trap as it quickly returned to its range.  Lean Hogs also headed south later in the month.

The Yen move produced a trend allowing a 0.6 R profit for my system.  The sideways consolidation carried on a bit too long after a strong upmove, however we will rejoin the trade should the move show continuation.  After a 1 R loss at the beginning of the month Lean Hogs produced a solid move at the end of the month.  Although this trade hasn’t closed yet it should produce a solid profit.  A brief  ‘fake-out’ down-move in the Euro led to a 1 R loss, while unfortunately a 1.14 R loss resulted from bad slippage on a T Notes up move which didn’t continue, and which saw an exit in a very fast market after economic news.

My long trade in early March was followed within a couple of days by a strong reversal. Although I suffered bad slippage in my exit on the 9th 'cutting my losses short' proved to be the right thing to do once again - look at the ensuing price action!

Overall the month saw a 7% loss.  This is the longest losing streak and biggest drawdown since I began trading systematically in late 2009.  It certainly is frustrating although still within historic norms.  We just simply haven’t had the number of bigger trends that are necessary to produce profits.  All that can be done is to stick at it through the months until they arrive.  Arrive they will though – history shows us that fundamental factors eventually prevail and often very strongly after being suppressed by lack of market participation or intervention.  The past decade has seen a few bad years for trend following methods generally.  2005 to 2007 were tough for many, and although I wasn’t trading it then this system performed pretty poorly in 2009.  It exploits trends nicely, has a good profit to drawdown ratio and will latch on when the moves are there to take advantage of.

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Posted by: Bevan | March 31, 2012

The Next Plateau

Rereading the excellent fourth section of Ed Ponsi’s book Forex Patterns & Probabilities has reminded me that its probably worth revisiting my goals as a trader. Anyone who has been successful in any endeavour will know that setting a goal firmly held in the mind is the beginning, and the cornerstone of success. I’ve been sitting on a plateau for quite a while now, and the time has come to look higher and more clearly define what the next step should be.
In reflecting on how far I’ve come in almost five years of trading, I have not achieved what I expected at the beginning. I’m not worried about that though, as those expectations were set by educators and are possible only for a tiny elite, either through pure luck or shear genius. Indeed it is difficult to distinguish the two! The expectations I had then were to try and achieve small but deceptively simple goals like 15 to 20 pips a day trading the Forex market. The incredible power of compounding would result in millions within a few years.
That hasn’t happened, and I don’t know many (well any really apart from some of those in the Market Wizards series of books) real traders for which it has. Producing those kinds of results on such a consistent basis has proved beyond me thus far. So what have I achieved, and why am I still in the game?
The most important lesson I have learned is that money can be made in the trading game. This might seem trivial, but in fact a huge volume of traders drop out after a year or two because of failures and losses. They fail to persist and work on the reasons for their lack of success, blaming the markets or others and abandoning trading as either impossible or too hard. This is why the brokerage and spreadbetting industry has to spend a fortune encouraging new clients into the markets each year, and why trading education is such a massive industry.
With that knowledge in mind secondly was finding the ability to identify and exorcise my trading demons. It is no great insight that the main reason people wash out of this industry isn’t through picking the incorrect entry and exit points, risking too much or whatever else. Those superficial causes are almost always due to psychological flaws. The market seems to draw these out in the same way that too much alcohol often reveals people’s less pleasant side! For me my sins were a desire for excitement, the thrill of quick and easy money. Secondarily I had a short attention span, flitting from idea to idea and failing to show any consistency in my approach. Once I had identified these I was able to tackle them head on. I decided that mechanical trading would enforce the discipline of making decisions based on price action and risk management principles. Secondly trading on a longer term basis meant that not only would my chances of survival be much higher, but that I would avoid the temptations of excitement seeking that short term trading produces.
I spent a year trading Alexander Elder’s Triple Screen approach, then at the end of 2009 moved to trading a trendfollowing system which I discovered through Futures Truth magazine’s Top Ten lists. I’ve been able to stick at this system, enlarging my portfolio of instruments in the UK but unfortunately having to reduce them somewhat in moving back to New Zealand and trading CFDs.
I have achieved very satisfying returns from my trading. It has enabled me to buy a few tangible items like a car and permitted my account to grow healthily. Although the last few months has been challenging (I am now in a 28% drawdown) I am confident that a trend or two will materialise and make back my losses and achieve new equity highs. I made a conscious decision to push my risk factor when I began trading again in late 2011 so that I could trade a wider variety of instruments, and accept that my returns will be more volatile as a result. My portfolio is tested and I have an idea of what kind of variability to expect.
Instead of being defensive in this situation, I need to look at the next plateau – how will I take this business forward to the next level? I have decided to add two new instruments for every 15% gain on my account (into new equity highs) until I have made a 50% gain. It will be interesting to see how long this takes! The system I trade can potentially make those returns in a year or less based on my previous experience, if the market allows it. Trading the additional instruments will add potential returns and soften the variability in performance both through diversification and also because I will maintain my risk per trade at the same dollar value. By the time I have made the 50% gain I will have gone from risking 4% per trade to 2%.
At this point I want to add a longer term system to my portfolio. I have my eye on several options here – ATS3200, Trend Harmony, Dollar Trader, Ready-Set-Go, WaveRider and The Aberration Strategy. I’ll continue to watch how they react to changing market conditions in making my selection. I would love to add a short term system as well however my lifestyle and work commitments makes this difficult.
Hopefully by this time next year I will have implemented some of the new instruments, and might be closer to adding a new system – we’ll see what the markets give or take from me this year!

Posted by: Bevan | March 2, 2012

February 2012 Trading Commentary

The drought for trendfollowers (well me specifically) continued in February.  It was a fairly quiet month, with three trades closed and two new positions opened.  All three closed trades were losers, comprising -0.8, -0.72 and -0.94 R losses.  This measure is a gauge of the size of a loss in terms of the initial risk taken.  Unfortunately in this case we did not have the opportunity to reduce risk much as the trades did not move significantly in our favour before reversing.

The lack of persistent trends is frustrating but a reflection of a zero interest rate environment with mediocre growth and economies on the cusp of inflation/deflation.  The move up in oil during the month was interesting although it seems a bit overdone against the fundamentals.  The signs of ‘green shoots’ in the US are pretty positive but Europe is still a disaster and its hard to make a good demand story.  On the supply side the Iranian situation seems full of bluster but without much real supply impact at the moment.  I don’t have a lot of faith in the continuation of the trend to 2008 levels.

The Yen has been an interesting trade this month.  I commented on the Japanese macro situation back in January, and the blogosphere has seen increasing commentary on how the ‘widowmaker’ short Yen trade looks more and more viable. The macroeconomic situation there in terms of demography and government debt looks challenging, but you’ve always got to bear in mind that people have been calling for a Yen decline/collapse for a long time without fulfillment.  I’m sure the Japanese Central Bank has been contributing to the Yen decline and all too happy with commentators helping out.  I am short the Yen (due to the compression last year it didn’t take much for my trades to change direction) and would love to see it roll on but any new risk (aside from a Japanese debt crisis) will surely see the currency trading back to the 2011 highs.

Posted by: Bevan | January 31, 2012

January 2012 Trading Performance

After a gloomy December, and a round of negative outlooks for 2012 the markets proceeded to confound the experts in January as they often do.  For me the turnaround happened after Friday the 13th, when the long awaited credit downgrade for France by S&P was announced, along with similar changes for a range of other European nations.  The following Monday was a narrow range day in the EUR/USD matching Friday’s low, however on Tuesday suddenly the Euro took off to the upside, absent of any obvious news.  It has proceeded to put in over two weeks of very stable upward action.  The stability of the uptrend is probably due to the fact that big numbers of participants have not really bought into it one way or another yet, reflecting similar low volume gravity defying moves in the equity indices.  The moves have the hallmarks of being buoyed by central bank money distribution, in the European context the LTRO policy finally lowering yields on Italian bonds.

We exited our long standing Euro short  on the 20th, as the evidence was that the clear downtrend was over.  The exit was determined by price action confirmation rather than second guessing due to ‘oversold’ and ‘overcrowded’ trades, beliefs that would have resulted in us exiting far earlier.  The one disappointment was that the Euro position was not ‘loaded up’ in terms of contracts all that much due to the amount of volatility when we entered in early November.

Other positions exited as the markets engaged in their first decisive trends for some time, with the absense of the risk on/risk off cycle we have come to know and dislike!  Many of the positions were fledgling and closed at losses, the worst being a 0.8R loss in Crude which after buoyancy due to threats from Iran flagged on the 20th.  Oil has remained rangebound through the month.

Market sentiment has improved with the feeling that the worst Euro crisis outcome for Greece was priced in, and that China appears to be engineering a soft landing.  It is a fact however that the Greek debt talks with private sector bondholders have still not concluded.  Tension remains with revelations of plans for the EU to oversee, approve and veto Greek spending decisions, and the Greek government must walk a fine line with many Greeks rejecting what they perceive as an internationally led campaign of imposed austerity.  Talk in Europe has turned noticeably towards discussing growth with even Merkel softening the ‘austerity only’ line.  Interestingly this is exactly in response to the criticisms in the S&P downgrade report (maligned by the European politicians) which commented that budget discipline alone would not resolve the crisis, and in fact might be self defeating.

Late in the month we were flat for around a week before continued tests of resistance in 10 Year T-Notes triggered a long trade, while a significant upthrust and reversal in the USD/JPY resulted in another short trade.

Both of these markets have failed to perform recently, and short Yen trades are difficult in particular because of continuing intervention threats.  Just today Japanese finance minister Jun Azumi warned of “firm action” if necessary.

Although the month ended with a small loss, all trades were taken according to the trade plan and risk management guidelines.  There is a feeling of a change in the wind as we enter another period of monetary expansion (Ben Bernanke discussed QE possibilities at the last FOMC meeting, Europe is engaging in LTRO) and we may see decent trends begin to form.

Posted by: Bevan | January 21, 2012

The Reason For Trends & Reversals

Although I use a trend following trading methodology, all traders depend on trends in some timeframe and duration in order to generate profits.  In the past few days the downtrend in the EUR/USD MAY have reversed.  As mentioned in a previous post the record levels of short positions in the pair (as reflected on the futures market by the weekly Commitments of Traders Report) have generated a few weeks of speculation that the pair was ‘oversold’ and an ‘overcrowded’ trade.  The pair continued grinding down despite these comments.

Last Friday (ironically the 13th) S&P finally confirmed the anticipated credit rating downgrade for France, along with a bevvy of other European countries including Austria (also losing its AAA rating), Italy, Spain, Portugal, Cyprus, Malta, Slovakia and Slovenia.  On the same day it was announced that a meeting to agree a haircut on Greek bonds (i.e. private bondholders agreeing to lose perhaps 50% on the value of Greek bonds they had bought) had been unsuccessful.  All this was happening in an atmosphere of disappointing earnings reports in the US.

Despite all this negative news, suddenly on Tuesday the Euro started climbing.  Stocktwits and Twitter went crazy with short term traders either jumping on or selling the rally, and the financial media pushed the button on a bevvy of stories about buying the news selling the fact, short squeezes etc.  My system closed out the short Euro trade (dating back to early November) on Friday, however many traders are debating whether the downtrend is over or not.  Some point to their broken trendline, others to the broken 50 day moving average.  The bears still say there are grave risks and the Euro is fundamentally over-valued, or that it is still under the 200 day moving average for those of a more technical bent.

Identifying the beginning and ending of a trend is subjective, and difficult.  I believe that it is not even necessary.  In fact top and bottom picking strategies, which are usually countertrend and try and grab on right at the turning point don’t seem to test very well in my observation.  The trait of trends that I have found most profitable is that trends tend to continue, all that object in motion stuff from physics seems to apply just enough that it can be used to grab a profitable bite.  I’m wrong more often than I’m right, in the sense that a lot of trends are simply movements within ranges.  A lot are destroyed by unexpected fundamental reversals due to supply or demand factors or, commonly these days, central bank intervention.  Enough do continue though to provide those rare ‘outlier’ trades that produce more than 3 times the risk taken and account for the lion’s share of profits.

Alex Elder provides an interesting section in Trading for a Living where he discusses the psychology of trends.  The reality is that although news and events are always occurring in the background, like this week with the Euro, it is the actions, feelings and decisions of traders which actually propel price action.  The following section describes it well (from page 63):

Winners feel rewarded when price moves in their favor, and losers feel punished when price moves against them.  Crowd members remain blissfully unaware that when they focus on price they create their own leader.  Traders who feel mezmerized by price swings create their own idols.

When the trend is up, bulls feel rewarded by a bountiful parent.  The longer an uptrend lasts, the more confident they feel.  When a child’s behavior is rewarded, he continues to do what he did.  When bulls make money, they add to long positions and new bulls enter the market.  Bears feel they are being punished for selling short.  Many of them cover shorts, go long, and join the bulls.

Buying by happy bulls and covering by fearful bears pushes uptrends higher.  Buyers feel rewarded while sellers feel punished.  Both feel emotionally involved, but few traders realise that they are creating the uptrend, creating their own leader.

Eventually a price shock occurs – a major sale hits the market, and there are not enough buyers to absorb it.  The uptrend takes a dive.  Bulls feel mistreated, like children whose father hit them with a strap during a meal, but bears feel encouraged.

A price shock plants the seeds of an uptrend’s reversal.  Even if the market recovers and reaches a new high, bulls feel more skittish and bears become bolder.  This lack of cohesion in the dominant group and optimism among its opponents makes the uptrend ready to reverse.

Posted by: Bevan | January 20, 2012

What Do We Replace Capitalism With?

The Telegraph (UK) really has a strong financial section – I’m pleased I recently discovered it.  Today they published a thought provoking article entitled Capitalism: The Sequel which argues that capitalism has failed with the global financial crisis, and looks at whether there are any viable alternatives.

I don’t think the events of the past few years show that liberal capitalism has failed.  What has failed is when debt rather than productivity and innovation is used to drive growth, when a non-productive financial sector is left to grow unfettered and unregulated.  The moral hazard caused by the bailouts, both to banks and countries means that the risk of worse problems still exist.  Banks and countries like Greece will not transform themselves if they are given a big wad of cash and a wag of the finger any more than an alcoholic in the same situation.  The other issue is one of political economy – the most powerful economy and nation in history, the US, is crippled by crony capitalism where democracy has been severely damaged by excessive influence from the financial sector.

A return to liberal capitalism will be painful, but will allow rebalancing of the distortions and debt addiction that has led to these problems.  Zombie banks run by the same individuals that caused our problems need to be replaced by smaller institutions that go back to playing their commercial function in the economy of providing credit to producers. Currency unions where wealthy nations benefit from low exchange rates while uncompetitive nations avoid reality by basking in cheap money aren’t viable, especially with the cultural and historical differences between them.  The Euro has to be split up (perhaps into factions rather than nation states) to allow the Mediterranean states to regain competitiveness and solvency under their own steam.  Solutions dictated by others will always lose legitimacy and lead to political instability in the long run.
Posted by: Bevan | January 19, 2012

Marketland – A Fairytale

Thanks to TraderFoxxx for introducing me to this lovely, and educational fairytale:

“Once upon a time there was an enchanted land called Marketland where a fascinating game called ‘The Market was played most days. And the thing about this game was that it would go up or down every day and the players would make bets about the outcome — very simple game.

But there were complications, which had to do with the fact that all the players in Marketland had opinions about which way the market would go.

And not only opinions: The players had systems, methods, evidence and analysis to back up their opinions. They had Dactyl numbers and Pdontiff waves, Xandom lines and Zigdar harmonics. They had the legacies of the old masters, Oerbot and Caljen. They had inventories and earnings, money-flow studies, astrology charts and the benefits of 4th-order spectrum analysis, all of which was extremely fascinating. Yes indeed, the players had many marvelous things.

The problem, though, was that sometimes the methods called for the markets to go one way and it would go the other way. This never failed to astonish everyone concerned, and there were many long discussions about how or why the market could be so perverse. However, it was usually agreed that this had just been a temporary aberration by the market and that the methods and analyses were as good as ever.

But one afternoon something happened to one of the players, a man named Mr. Beright. And he was never the same again. Mr. Beright had made a detailed study of Azerhof numbers, becoming one of Marketland’s recognized experts on the subject. And the Azerhof numbers were now quite plainly stating that the market needed to go up, so Mr. Beright had taken a solid long position.

Unfortunately, quite soon after Mr. Beright had gone massively long, the market started down. This did not worry Mr. Beright excessively, since he realized the market had to go up. But the market (strange creature that it is) wouldn’t pay any attention. It kept going down. And down. And down. And Mr. Beright (understandably, since we’ve all lived through these moments) got quite anxious and depressed. But he knew it would all get better very soon, just as soon as the market turned around and went the way it was supposed to go.

Now all good fairy tales have children in them and this one is no exception. Mr. Beright, it turns out, had a beautiful five year-old-daughter named Herenow, and just as he was contemplating his sad fate, Herenow walked into the room. Sensing that something was wrong, she asked, “what is the matter daddy?”

“Oh nothing, darling, you wouldn’t understand. It’s just that the market is supposed to go up and it hasn’t yet.”

“Is this the market daddy? This line on the screen here?”

“Yes.” Little Herenow went over and peered intently at the jagged line on the screen. And the she said:

“Well daddy, I don’t know anything about the market. But it certainly seems to be going down.”

Is it going up, or down?

Well dear, that’s why you don’t understand. You see, the Azerhof numbers say that absolutely, positively the market has to go up here.”

“I know, daddy, but right now it seems to be going down.”

“Not only that Herenow, but the Melinxar frequencies state unequivocally that the market has got to go up here.”

“I know, daddy, but right now it seems to be going down.”

“You don’t understand, darling. When the Azerhof numbers and the Melinxar frequencies agree, the market has got to go in that direction.”

Little Herenow looked puzzled. She went over and peered at the screen once more.

“I don’t understand all those things you’re talking about, daddy, and I don’t understand the market, but right now it seems to be going down. Doesn’t it?

Mr. Beright paused and looked carefully at his five year-old daughter. “Would you say that again, Herenow?”

“Just that right now, daddy, the market seems to be going down. That’s all. Did I say something wrong?”

“No dear…not at all.”

And at that precise moment something snapped in Mr. Beright. All those years of studying Azerhof numbers and Melinxar frequencies and everything else swam in front of his eyes. Then he looked at his little daughter again, picked up the phone and sold out his long position. And what’s more, he went very, very short.

Now Mr. Beright is a changed man. Because all that time that he used to spend studying Azerhof numbers and so on he now spends playing golf and enjoying his family. And his friends think he has become very strange, because he has no interest in all those fascinating systems and methods and indicators and statistics about the markets anymore.

But Mr. Beright doesn’t care because he’s making money. Lots and lots of it.”

by Jim Sloman, from The Adam theory of markets—What matters is profit by J. Welles Wilder

Posted by: Bevan | January 17, 2012

Trouble In The East

China and Japan are often, rightly compared for their remarkable growth stories. Following World War II Japan rebuilt and developed highly advanced manufacturing sectors that expanded and eventually outclassed the US. Their economy was the envy of the West in the eighties, with massive trade and current account surpluses, ever increasing stock valuations and a vertical real estate market. The massive debt expansion which occurred later in the piece fell apart when asset valuations plummeted in the early 90s. Years of easy monetary policy and fiscally loose government have failed to reinvigorate the nation. Now we see frightening signs that another Sovereign debt crisis is looming.

Whenever we see a “risk off” move at the moment the Yen gains value, as it has done for several years when money moves to the Nippon safe haven. The Bank of Japan (BOJ) has spent (wasted) unknown billions of Yen repeatedly intervening in the foreign exchange markets in response to political pressure from the export sector. And yet the so-called speculatively driven increase in the Yen has rolled on year after year, still according to the BOJ in defiance of the fundamentals.  Additionally a major factor is that other ‘reserve currencies’ have engaged in more aggressive monetary loosening than Japan, with relative interest rates making Japan’s meager returns more competitive.

Soon economic reality will finally come to the BOJ’s rescue and reverse the trend, weakening the Yen. The fiscally loose policies have been supported over the years by the extraordinary wealth of the private sector and their high level of savings.  This has been reflected in a high current account surplus, however this is now under threat.  Reuters recently reported that the current account surplus fell by 85.5% in November 2010 from a year earlier.  Savers support for the government is likely to deteriorate with a lack of direction and persistence of policies that have failed to generate a meaningful recovery and have left Japan with frightening amounts of debt – 233% gross debt to GDP.

The inexorable rise in 10 Year Government bond CDS's shows the increasing concern at Japan's debt burden and economic outlook (Source: Bloomberg)

The fundamentals are not attractive for Japan.  Exports are weak, the current account surplus is vapourising, CDS’s on Japanese Government Bonds are rising significantly (the cost of insuring against Japanese default, a reflection of risk in the government’s debt) – all we need is a catalyst for the trend in the Yen to turn.

Posted by: Bevan | January 16, 2012

Contrarianism and Its Limitations

We frequently hear reports of how bearish market positions on Euro currency are at record highs, and that this is an ‘overcrowded trade’.  Certainly by traditional measures the Euro is extremely oversold – it is some way from the 50MA, and as is regularly reported Futures short interest is at a four year high (http://online.wsj.com/article/BT-CO-20120113-712186.html) with much media attention.  Twitter and the blogs have lots of talk of short squeezes.  I’ll admit that I expect a strong rally to test the short sellers at some point.  However I’ve been expecting that rally for weeks.  Looking at price with a trendline, in fact this is an extremely orderly downtrend, and as long as the fundamentals are in place these can continue for some time.

Looking at the trendline we’re not terribly oversold and many commentators actually believe that the Euro is still considerably overvalued, with market participants not sufficiently factoring in the likelihood of default, the serious contagious interlinks with Sovereign bond and CDS exposure throughout the financial system and the probability of a significant recession exacerbating problems.  To put it all in perspective, do a search for articles on overcrowded or oversold Euro.  You’ll find ones like this one on the excellent site Seeking Alpha written in early 2010 – we seem to have found ourselves in the same old situation again.

I look at it from a trend following perspective – there is no such thing as speculating that the price is too high or too low.  It is what it is, an orderly downtrend which certainly appears to be in line with the dismal fundamentals.

Posted by: Bevan | January 8, 2012

Hear Hear

Some great words from John Hussman:

“Happy New Year. We enter 2012 with a great deal of hope, but our hopes are not for more bailouts, or money printing, or any of the myriad policies that investors seem to hope will save bad investments and sustain elevated valuations. Instead, our hope is that in 2012, the market will finally “clear,” in the sense that bad debt around the world will be recognized as bad and restructured; that overleveraged financials will be taken into receivership instead of forcing austerity on every corner of the global economy in order to make them flush again; that rates of return will rise enough to compensate and encourage saving – and high enough to encourage borrowers and other users of capital to allocate the funds productively. Of course, in order to restructure bad debt, someone has to accept a loss. In order for rates of return to rise, valuations must decline. In short, our hope is for events that will unchain the global economy from an irresponsible past and open the gates toward a prosperous future. Maybe that is too hopeful, but we are not entirely convinced that bailouts and ‘big bazooka’ will be as easily procured in the year ahead as a confused public has allowed in recent years.”

 

– John P. Hussman, Ph.D. (hussmanfunds.com)

Quoted in an excellent article by John Mauldin on the Big Picture Blog.

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