Finance Floor

40 bits of trading wisdom

2012-01-28T18:41:00.000+02:00

Here is another post aimed at spreading practical wisdom about trading. Similarly to the 38 steps to becoming a trader one, I found this again in my remarks. After some google-ing the original source link seems to point to Traders-Talk forums at http://www.traders-talk.com/mb2/index.php?showtopic=17232

Most of the items below are really valuable. The point is they have to be followed in real to bring value. Any comments are welcomed.

Forty Bits of Trading Wisdom
Condensed from Capitulation's 40 posts.

If you want to stay in this business, leave "hope" at the door and stick to your stops.
When you get into a trade, start looking for signs right away that you are wrong. If you see them, then get out before your stop is hit.
Trading should be boring, like factory work. If there is one guarantee in trading, it is that "thrill seekers" get their accounts grinded into nothing.
It helps to just follow a handful of stocks on any given day. Don’t jump on the “next hot thing.” Develop your plan and stick to your plan.
You are trading other traders, not the actual stock. You have to be aware of the psychology and emotions behind trading.
Be very aware of your own emotions. Irrational behavior is every trader's downfall. If you are yelling at your computer screen, imploring your stocks to move in your direction, you have to ask yourself, "Is this rational?" Ease in. Ease out. Keep your stops. No yelling.
Watch yourself if you get too excited—excitement increases risk because it clouds judgment.
Don’t overtrade—be patient and wait for 3-5 good trades.
If you come into trading with the idea of making “big money,” you are doomed. This mindset is responsible for most accounts being blown out.
Don’t focus on the money. Focus on executing trades well. If you are getting in and out of trades rationally, the money will take care of itself.
If you focus on the money, you will start to impose your will upon the market in order to meet your financial needs. There is only one outcome to this scenario: you will hand over all of your money to traders who are focused on protecting their risk and letting their winners run.
The best way to minimize risk is to not trade. This is especially true during the low-volume “chop and slop” found during the afternoon trading session. If your stocks are not acting right, then don't trade them. Just sit and watch them and try to learn something. By doing this you are being pro-active in reducing your risk and protecting your capital.
There is no need to trade 5 days per week. Trade 4 days per week and you will be sharper during the actual time you are trading.
Refuse to damage your capital. This means sticking to your stops and sometimes staying out of the market.
Stay relaxed. Place a trade and set a stop. If you get stopped out, who really cares? You are doing your job. You are actively protecting your capital. Professional traders actively take small losses. Amateurs resort to hope and sometimes prayer to save their trade. In life, hope is a powerful and positive thing. In executing a trade, hope is a virus that can infect and destroy.
Be right on day one or get out. Don’t take a “red” position home overnight.
Keep winners as long as they are moving your way. Let the market take you out on a trailed stop.
Money management is the secret to success. Don’t overweight your trades. The more you overweight a trade, the more “hope” comes into play when it goes against you. Hope is to trading as acid is to skin. The longer you leave it in place, the more painful the outcome will be.
There is no logical reason to hesitate in taking a stop. Re-entry is only a commission away.
Professional traders take losses. Being wrong and not taking a loss does damage to your equity and your mind.
Once you take a loss you forget about the trade and move on anyway, especially if it is a small one. Do yourself a favor and take advantage of any opportunity to clear your head by taking a small loss.
Never let one position go against you by more than 2% of your account equity. The larger the position, the tighter the stop.
Use daily charts to get an idea of the 30-day trend, hourly charts to get an idea of the 1-day trend, and 5-minute charts to establish your entry points.
If you are hesitating to take a position, that indicates a lack of confidence that is not necessary. Just get into the position and place a stop. Traders lose money in positions everyday. Keep them small. The confidence you need is not in whether or not you are right, the confidence you need is in knowing you will stick to your stop no matter what. Therefore you can actually alleviate this hesitancy to “pull the trigger” by continually sticking to your stops and reinforcing this behavior.
Averaging down on a position is like a sinking ship deliberately taking on more water.
Build up to a full position as it goes your way.
Adrenaline is a sign that your ego and your emotions have reached a point where they are clouding your judgment. Realize this and immediately tighten your stop considerably to preserve profits or exit your position.
Look for opportunities not to trade.
Most of the time, you want to own the stock before it breaks out, then sell it to the momentum players after it breaks out. If you buy breakouts, realize that professional traders are handing off their positions to you in order to test the strength of the trend. They will typically buy it back below the breakout point—which is typically where you will set your stop when you buy a breakout. Greed comes into play when the stock breaks out again, and the momentum players are forced to chase it and “pay up” for the stock. Be aware of how trends are established and use that to your advantage to enter and exit positions.
Embracing your opinion leads to financial ruin. When you find yourself rationalizing or justifying a decline by saying things like, “They are just shaking out weak hands here,” or “The market makers are just dropping the bid here,” then you are embracing your opinion. Don’t hang onto a loser. Cut your losses. You can always get back in.
Unfortunately, discipline is typically not learned until you have wiped out a trading account. Until you have wiped out an account, you typically think it cannot happen to you. It is precisely that attitude that makes you hold onto losers and rationalize them all the way into the ground.
Siphoning out your trading profits each month and sticking them in a money market account is a good practice. This action helps to focus your attitude that this is a business, and your business should generate profits on a monthly basis.
"Professional traders only place a small portion of their assets into 1 position. Or if they take on a large position, then they strictly limit their risk to 1-2% of their current equity. Amateurs typically place a large portion of their assets into 1 position, and they give it "room to move" in case they are actually right. This type of situation creates emotions that ruin accounts, while professionals are able to make decisions and cut losses because they strictly define their risk."

Professional traders focus on limiting risk and protecting capital. Amateur traders focus on how much money they can make on each trade. Professionals always take money away from amateurs."
Don't be a hero…
In the stock market, heroes get crushed. Averaging down on a losing position is a “heroic move.” The stock market is not about blind courage. It is about finesse. Don't be a hero.
School of hard knocks in the only way...
Sadly, traders never learn the importance of “the rules” until they have blown their account out of the water. Until you “lose it all” it never seems that important to have to follow the basics of professional trading. (Cut your losses, let your profits run, etc).
The market reinforces bad habits…
The market reinforces bad habits. If early on you held onto a loser that went against you by 20%, and you were able to get out for breakeven, you are doomed. The market has reinforced a bad habit. The next time you let a stock go against you by 20%, you will hang on because you have been taught that you can get out for breakeven if you are just patient and hang on long enough. It doesn’t matter if the stock has just been upgraded or had a favorable write up in Forbes. You still need to protect your capital. In reality, today’s price is the true indication of the value of the stock, as it is the price people are willing to pay. Instead of rationalizing, control your risk by sticking to your stops.
Who is accountable for your trades?
The true mark of an amateur trader who is never going to make it in this business is one who continually blames everything but his or herself for the outcome of a bad trade. This includes, but is not limited to, saying things like:
- The analysts are crooks
- The market makers were fishing for stops.
- I was on the phone and it collapsed on me.
- My neighbor gave me a bad tip.
- The message boards caused this one to pump and dump.
- The specialists are playing games.
The mark of a professional, however, sounds like this:
- It is my fault because I traded this position too large for my account size.
- It is my fault because I didn’t stick to my own risk parameters.
- It is my fault because I really don’t know how to trade.
- It is my fault because I know the market makers can legally take some of my money, and I knew that going into this.
- It is my fault because I know there are risks in trading, and I didn’t fully comprehend them when I took this trade.
The obvious difference here is accountability. For amateurs, everything having to do with the market is “outside their control.” That is not reasonable thinking, and really just points to an individual who has, probably for the first time, had to confront their “real self” as opposed to the perfect self or idealized self they have constructed in their mind. This is also known as “living in a fog.” A person can drift around through life in their own private world, where they are pretty special and can do no wrong. Unfortunately, trading rips off this mask, because you cannot dispute what has happened to your account. This is also known as “confronting reality.” For many people, when they start trading they are suddenly confronting reality for the first time in their lives. Just to see the world as it really is requires a lifetime of training, and for many people trading the stock market is their first real step in this journey. Some people say that traders are born, not made. Not so. If you choose to see the world as it is, then you can start trading successfully tomorrow.
Pro vs. amateur trader difference…
Amateur traders always think, “How much money can I make on this trade!” Professional traders always think, “How much money can I lose on this trade?” The trader who controls his or her risk takes money from the trader whose head is in the clouds.
CONTROL YOUR RISK
Focus on controlling risk...
At some point traders realize that no one can tell you exactly what is going to happen next in the market, and that you can never know how much you are going to make on a trade. Thus the only thing left to do is to determine how much risk you are willing to take in order to find out if you are right or not. The key to trading success is to focus on how much money is at risk, not how much you can make.

And yes folks, that concludes the 40 bits of trading wisdom. I hope everyone enjoyed them and most importantly, I hope one person out there has taken these bits to heart and that they have made a difference with someone.
To summarize the important points:

Control your risk by setting your parameters BEFORE you get in the trade.
Have a plan with each and every trade and stick to your plan.
Stick to your stops.
Don't blame others when a trade goes bad, but rather learn from it so it hopefully won't happy again.
Don't bet the farm! Allocate only a small percentage of your capital to each trade.
Set a stop with each and every trade.
Leave hope at the door and stick to your stops.
Never add to a losing position....averaging down is like a sinking ship deliberately taking on more water.
Do not yell at your screen trying to "will" the markets in your direction. Be calm, ease in, ease out, no yelling.
Trading should be boring like factory work. If you are looking for excitement then trading is not for you because you will wipe out your trading account.
If you get stopped out, so what? Professional traders actively take small losses all the time...it's part of the game. Re-entry is only a commission away.
Once you are in a trade, immediately begin looking for signs that you are wrong. If something doesn't look right or the reasons that you entered the trade have changed GET OUT before your stop is hit.

Originally posted by Capitulation

38 steps to becoming a trader

2012-01-24T11:25:00.000+02:00

Following is a list of most of the steps every successful trader takes during their life. I recently found it in my remarks. I'm not sure of the author of the list so if any of my readers would know, please write me so respectful credits might be given. Happy reading, successful trading and don't forget that things always change! :)

38 steps to becoming a trader

They are as follows:

We accumulate information - buying books, going to seminars and researching.
We begin to trade with our 'new' knowledge.
We consistently 'donate' and then realize we may need more knowledge or information.
We accumulate more information.
We switch the commodities we are currently following.
We go back into the market and trade with our 'updated' knowledge.
We get 'beat up' again and begin to lose some of our confidence. Fear starts setting in.
We start to listen to 'outside news' and to other traders.
We go back into the market and continue to 'donate'.
We switch commodities again.
We search for more information.
We go back into the market and start to see a little progress.
We get 'over-confident' and the market humbles us.
We start to understand that trading successfully is going to take more time and more knowledge than we anticipated.

MOST PEOPLE WILL GIVE UP AT THIS POINT, AS THEY REALIZE WORK IS INVOLVED.
We get serious and start concentrating on learning a 'real' methodology.
We trade our methodology with some success, but realize that something is missing.
We begin to understand the need for having rules to apply our methodology.
We take a sabbatical from trading to develop and research our trading rules.
We start trading again, this time with rules and find some success, but over all we still hesitate when we execute.
We add, subtract and modify rules as we see a need to be more proficient with our rules.
We feel we are very close to crossing that threshold of successful trading.
We start to take responsibility for our trading results as we understand that our success is in us, not the methodology.
We continue to trade and become more proficient with our methodology and our rules.
As we trade we still have a tendency to violate our rules and our results are still erratic.
We know we are close.
We go back and research our rules.
We build the confidence in our rules and go back into the market and trade.
Our trading results are getting better, but we are still hesitating in executing our rules.
We now see the importance of following our rules as we see the results of our trades when we don't follow the rules.
We begin to see that our lack of success is within us (a lack of discipline in following the rules because of some kind of fear) and we begin to work on knowing ourselves better.
We continue to trade and the market teaches us more and more about ourselves.
We master our methodology and our trading rules.
We begin to consistently make money.
We get a little over-confident and the market humbles us.
We continue to learn our lessons.
We stop thinking and allow our rules to trade for us (trading becomes boring, but successful) and our trading account continues to grow as we increase our contract size.
We are making more money than we ever dreamed possible.
We go on with our lives and accomplish many of the goals we had always dreamed of.

ECB interest rate decision

2011-10-06T16:35:00.000+03:00

Updated with the current ECB decision and Mr. Trichet's statement

With the approaching of the ECB meeting on Thursday it seems the markets are getting more nervous and volatile. EUR lost more than a percent against USD on Monday and regained that percent back in Tuesday. US equities followed suit although their movements were far bigger and the changes were about 3% in both directions. The "fear index" VIX moved about 10% up and down for the first two days of the week.

The US equity markets finished strongly upward on Tuesday as FED's chairman Mr. Bernanke assured the markets "he’ll push forward with further expansion of monetary stimulus if needed ". After the strong selling during the last weeks and rebounding from the new low for the last two months made on Tuesday, the market seems hungry for good news. Mr. Bernanke's speech fitted well into such market expectations.

On the other side of the ocean Europe is still struggling with its sovereign debt problems. The Moody's Investor Service cut Italy's credit rating to A2 from Aa2 which at first made European equity markets to stay behind the increase of the US market from Tuesday. Later during the day the EU stocks advanced. Such an increase amidst credit rating downgrade (although possibly expected), an unexpected drop in EMU Retail Sales (YoY) of -1% and a decrease in Purchasing Manager Index Services in EMU could speaks of a strongly oversold sentiment. The same sentiment seems to be present in the US equity markets also.

So if everyone is focused on the ECB decision on the interest rate on Thursday, let's elaborate a bit on the possible outcomes.

Chart 1. Inflation in euro area, annual, non-seasonally adjusted; Source: ECB

The market consensus is that the ECB would leave its rate untouched at 1.5%. Any deviation from that consensus could sparkle market movements in both directions. Even if the ECB does not change the rate, the language it would use in the press release could signal the bank's further intentions.

In general ECB is strongly concerned with price stability. The last data on inflation in EMU showed an increase to 3% on annual basis after previously decreased a bit. Thus the market consensus that ECB would leave the rate unchanged seems reasonable enough as any further increase in the money supply by lowering the rate has the potential to increase the inflation pressure.

On the other hand data from October 5, 2011 show the growth in euro area slowed significantly to 1.6% (YoY) from the previous 2.5%. The combination of a high inflation and a slow growth does not seem to be in favor of any further increase in the ECB interest rate in the short-term. Such a combination however, does neither support a strong decrease in the rate which the currency markets seem to be hoping for as that would boost inflation. So basically that puts the two extreme options – an increase in the rate and a strong decrease out of the table for now.

We are then left with those two – rates unchanged as is the market consensus and a small decrease which would be a surprise given the consensus.

If the interest rate is left unchanged that would not have any significant direct effect on the markets as this outcome seems already priced in. The markets could continue to be moved mostly by oversold moods and short rallies. Not lifting the rate given the present weakness of the euro combined with the sovereign debt problems in EU however, could signal the ECB is not so strongly on the euro defensive position at the moment. That could increase the short-term confidence in the EU common currency or at least not hurt it further. All that however does not seem so strong to present a long-lasting and deeper change in the market sentiment if we account for the sovereign debt problems as well.

The second option which seems possible given the slowing growth, is a decrease of .25 basis points to 1.25%. Such an decrease would not hurt so much the interest rates differential between USD and EUR as to strongly send the Euro further down. Such a strongly weaker euro scenario does not seem a desirable outcome for the EU officials either.

A small decrease in the rate would be a surprise given the consensus and could give equity markets confidence the ECB is concerned with growth in EU at least as much as it is with price stability. That could more possibly result in EU markets increase than in US but in general both markets follow suit. The current negative sentiment resulted in a bit oversold market condition on both sides of the ocean and lead to a series of bullish divergences in EU stock markets on a short-term scale. In this light such a decision could lift up the world equity markets for a while as it would mark a possible shift in risk taking. In a longer perspective however, the commodities prices should be watched as they are able to present a big pressure on a macro level and limit growth while increasing inflation.

-----UPDATE-----

The ECB decided to leave its main refinancing rate unchanged at 1.5% so basically there were no surprises. Still the bank sees the situation as worsening concerning the EU growth prospects in the following months. ECB officials believe the inflation will continue to float above the 2% threshold but it will eventually calm down further on the line. Given the growth continues to be sluggish and inflation calms down, a coming decrease in the rate of at least .25 basis points could not be ruled out in the months till the end of the year.

You may also want to check the full text of Mr. Trichet's statement concerning the ECB decision on its rates.

EURUSD currency pair on the brink

2011-08-25T23:35:00.089+03:00

Despite some expectations EURUSD currency pair remained relatively stable during the recent market turmoils. As the equities and commodities were drown, one should expect the US Dollar to gain strength as it has almost always did in history. Instead the pair remained range bound.

Let's look at the graphs. You may click on them for a bigger version.

EURUSD Monthly Chart

EURUSD Weekly Chart

On the monthly graph we can see the long term trend hasn't changed. The Euro is still in an upward mode against USD. The bullish divergence seen between the MACD indicator and the currency value seems still valid. Usually the pair has to go above its previous high which hasn't happened till now. The Moving Averages are still pointing upward and MACD is on a positive side.

When will the pair break out of the range seems to be the question now.
Maybe tomorrow's speech of Bernanke would give us a key. Or maybe not. We'll wait and see.

Another factor which could trigger the movement is an improvement in the situation in Europe in the form of more political will to cooperate and occurrence of structural changes like common fiscal policies.

What is interesting is that on the weekly graph (graph below) is seen a clear triangle formation. This could signal a continuation of the previous trend and is in line with the bigger time-frame graph.

Anyway, given this breakout occurs in the next months we could see a value of at least 1.53 for EURUSD pair.

A movement in the pair would be a signal for commodities (mostly crude) to rise again on the hopes of improving economies as such a scenario most probably would be accompanied by stronger equities.

==Update Aug 26, 2011==

Some important events took place today.

Date	(GMT)	Country	Event	Actual	Cons.	Previous
Aug 26	08:00	EMU	M3 Money Supply (3m)	2.1%	2.3%	2.0%
Aug 26	08:00	EMU	M3 Money Supply (YoY)	2.0%	2.2%	2.1%
Aug 26	08:30	UK	Gross Domestic Product (QoQ)	0.2%		0.5%
Aug 26	08:30	UK	Gross Domestic Product (YoY)	0.7%		1.6%
Aug 26	08:30	UK	Index of Services (3M/3M)	0.5%	0.6%	1.2%
Aug 26	12:30	US	Gross Domestic Product Annualized	1.0%	1.1%	0.4%
Aug 26	12:30	US	Gross Domestic Purchases Price Index	3.3%	2.3%	3.9%
Aug 26	12:30	US	Real Personal Consumption Expenditures (QoQ)	2.2%	0.2%	2.1%
Aug 26	13:55	US	Reuters/Michigan Consumer Sentiment Index	55.7	56.3	63.7

M3 money supply in European Monetary Union (EMU) decreased a bit on annual basis which would mean the probability of higher inflation in EU is getting smaller. Hence the pressure on ECB to lift interest rates in order to fight any higher inflation decreases.

In the same time in US the Gross Domestic Purchase Price Index (GDPPI) is lower than previous reading although still far above the consensus. The inflationary pressure in US is getting weaker but not as fast as economists expected. Looking at that index the FED could rest assured its promise to keep the rates low does not induce higher inflation. For now.

Reuters/Michigan index value could signal a further decline in consumer spending. It however does not measure the real money spent. An expectations sometimes differ than reality.

On a quarterly basis the Real Consumer Expenditures grew and the current reading is far above the consensus.What this could signal is a widening gap between consumers' expectations and their real spending. Their spending might be more not because they are willing to spend more but just because prices got higher. Which gets us back to the GDPPI which does not fall as much as economists expect.

If inflation kicks in the consumers will have to spend more no matter if they are expecting it or no.

Bernanke's speech didn't reveal anything new in particular which itself is an interesting hint. FED's chairman continues to believe the markets impact economy and not that markets reflect economy in advance. Like he said they are actually on a stand-by.

FOREX markets reacted as sending down the Frank (CHF) both against US Dollar and the Euro (more than 2%). The one currency that has moved steadily up during the current crisis. Till a couple of weeks ago. At first after Bernanke's speech both currencies appreciated against the Frank. At the end of day only the Euro continued to advance. What is interesting is that it advances against the US Dollar also. Is the Euro breaking out of the triangle in line?...

US stocks indexes advance a bit for the day also. Do the market participants bet on higher inflation?

If markets continue in this direction Bernanke's waiting would come to be justified. Even if he'd did it for different reasons.

Cool Way to Follow World Debt in Real Time

2011-07-14T18:51:00.001+03:00

Impressive! :)

http://www.economist.com/content/global_debt_clock

At the moment, 18:50h, 14 July 2011 it goes to $39 845 906 800 408. Will check later in some days to see the change :)

Have a nice day!

Investment Thoughts

2011-03-31T22:29:00.000+03:00

"The most crucial out-of-sample test is future investment success. If the strategy becomes known to other investors, prices may adjust so that the strategy, however well tested, does not work in the future"
(Level I Volume 1 Ethical and Professional Standards and Quantitative Methods , 6th Edition. Pearson Learning Solutions p. 571)

But people always want a strategy that works best for everyone... The best strategies are kept secret not because of pure selfishness but simply because of common sense. Knowledge transforms reality and that knowledge may then become obsolete. Eventually everything slips away at some moment. That's why we live and work in a constantly developing environment.

EURUSD, GOLD, Crude Oil, Rates, Inflation

2011-03-23T18:04:00.000+02:00

As we happen to live in a global world and the financial markets are so much interconnected, it's nice to take a step back and try to observe the whole picture.

There were reports this month about FED and ECB taking different roads. At least on a first sight. The former seems more concerned with unemployment while the latter worries about the raising inflation. Hence the steps the market participants expect from both parties are different. There is a rate hike expected from ECB while the same seems not in line concerning FED. The ECB is expected to raise rates mostly because of higher Crude oil prices inducing higher inflation. That inflation is not a consumer based one (although there might be a consumer part in it). That expectancy of higher rates in Europe keeps driving the Euro higher against the US Dollar. At the same time the Crude (priced in Dollars), conquers new heights helped by the Libyan war and supply fears. And not to forget the hopes of improving economies. This improvement in turn happens to be at danger just because that same high Crude price. So what are the options?

There is no point for the Crude to rise if there won't be improving economies which to initiate the expected-to-grow demand for it. Provide there is a rate hike soon in Europe. My expectancy is for an increase for the year of .25. Higher ones could hamper further the still struggling economies of Europe resulting in even higher Euro and further difficulties for Europe exports. At the same time such a rate increase could happen to be already priced in the EURUSD rate and signal a decline in the Euro/USD pair. The expectations then could be shifted towards a needed US rate hike. Talks of such (as the one of Wharton professor Jeremy Siegel) already started to appear. Meanwhile the Oil resources of Libya could be available again. That combined with the higher Dollar and some profit taking in Crude trading would bring down or at least stop for considerable amount of time the increasing of Crude oil price. And yes, that way the higher prices of Oil would not present a big inflationary danger to the US economy (in line with the hopes expressed by the FED).

The lower crude price would ease to some extend the producer induced inflation in Europe which combined with lower Euro would help it boost its production and exports. At the same time the effect of lower Crude in US on the consumer spending could be zeroed because of decrease in prices and increase in quantities traded. Still that would leave more disposable money for any other types of spending.

All that (together with the increasing demand from Japan for recovering the country from the earthquake) would contribute to the nominal recovery of both Europe and US and bring back the risk appetite. With seemingly departing danger of another shrink of economies the need for hedging would decrease. That includes hedging through Gold. Which brings us to the next point.

GOLD now seems more and more a speculative trade as many more people of all types are getting into it. More volatility is expected and there could be turmoils at least in short to middle term. Generally it stands out nice on the face of every devaluating currency but since it was only a sideway traded metal once, now almost everyone from the big to the small is inviting you to enter Gold. Which itself creates a dangerous environment. This could prove to be a profitable but more risky situation and devaluates to a great extend the hedging characteristic of Gold.

Global YEN Intervention After the Earthquake

2011-03-18T12:26:00.001+02:00

The Japan earthquake took the YEN to its highest level against US Dollar in the post-war era. Today G7 group intervened on the FOREX market selling YENs. The selling was started by BOJ and is reported to be followed by other members of the group. The YEN lost about 2.9% for a day. This could be only the start of it. Let's get technical.

The monthly graph shows the YEN is on a strong support level (shown by the blue horizontal line). The level sustained for several months as seen on the graph. The more important thing seen on the graph are the bullish divergences between the price and MACD indicator. The same type of divergences are seen during 1993-1995 years. Divergences of such magnitude could result in a multiyear downtrend for the YEN against the US Dollar. That would have positive effect on the Japan export economy, could result in even greater Japan dominance on the world markets of goods and eventually get the country again on the rapid development road.

Is CAPE of above 23 extraordinary for a bullish stock market?

2011-02-16T20:32:00.000+02:00

In his article "Has the Nearly 2-Yr-Old Bull Market Topped Out?" the respected by me Mark Hulbert speaks about his concerns that the current bull market might be surpassing its sound valuation levels and it might be near its end.

The author uses a CAPE measure to prove his point. CAPE is a modified P/E ratio which was made popular by Robert Shiller, a Yale University professor who uses it in his book "Irrational Exuberance". CAPE stands for "Cyclically Adjusted Price Earnings" and it differs from the general P/E in that its denominator (the E) is average inflation-adjusted earnings over the trailing 10 years. The data the article cites could be found on the Mr. Shiller's website. It's a very complete data set in the Excel file format.

According to Mr. Hulbert's calculations the current CAPE of 23.7 (as of the date of his article) is considerably higher than the average CAPE of 18 for the bull markets of the last century which he examines. The conclusion is that it would be hard to argue that the market is undervalued or even fairly valued.

Now my remarks.

What Mr. Hulbert is missing is that as a rule of thumb a bull market could surpass a lot its sound valuation levels especially in its extreme points before it tops out and converts to a bear market. And such a conversion doesn't happen overnight. We know a bull market will stop but we usually don't know exactly what time will pass ebfore it really happens. Exiting too early could save your money but also would mean a lot of unrealized profits. Usually choosing one over the other is a matter of personal preferences and attitude.
Now as we stand on the understanding that a higher CAPE is a normal phenomenon for a bullish market, it would be nice if the article of Mr. Hulbert shows at what ratio the average CAPE the author calculated was overrun by the real CAPE for the years of the bull markets it discusses. But it doesn't. It just states the current CAPE is higher than the avegare one.

If we dig the data from Mr. Shiller's file we see that the current month CAPE is 23.69 and it's indeed higher than the average 18 Mr. Hulbert calculated. But during 2007 there was noticed a CAPE of above 27 (50% above the average value of 18), during 2004 - above 26-27 (again about 50%), during 1999-2001 - above 40 (122%)! In all the period between the late 1995 to 1999 CAPE values were above 24 with an average value of about 31.5 (75%).

So the current CAPE is 30% above the average of 18 but we've seen even higher differences during the past 15 years. Seen in that light a 23 CAPE doesn't seem so extraordinary.

If you are a strictly value oriented investor I understand that leaving your money in a market that you believe is overvalued is hard and against your logic. Not everyone in the market is such a type of investor though. That makes the market move and the imperfections present opportunities.

EURUSD possible trade on the sale side

2011-02-08T15:01:00.000+02:00

During the day the EURUSD pair has generally been up for the Euro with its value going twice to 1.3665. Still it was unable to break or even reach the barrier at 1.3680. But the more upward it goes the more favorable the risk/reward ratio seems measured toward that level. The longer time-frame graphs suggest there could be an upward movement of the US Dollar soon of roughly 100 pips or even more.

If entered on the sell side at the current level of 1.3645 with a stop at 1.3685 and a first target 1.3600, the risk/reward is slightly above 1 which is not very profitable. However the higher the pair goes toward 1.3670/80 area, the more profitable and less risky the R/R ratio gets.

VAR, Risk / Reward ratio and money management

2011-02-03T11:16:00.002+02:00

A positive risk/reward ratio is the heart of a successful trading.

Some thoughts derived from the yesterday possible trades.

The trades:

sell @ 1.3830, risk/reward (r/r) = 0.42 (losing 30 pips, gaining 70pips), closed @ 1.3780, 50 pips gain
sell @ 1.3805, r/r ratio = 0.28 (risking 10 pips, gaining 35), stopped out @ 1.3815, 10 pips loss

Total: 40 pips gain

Put that way the above figures mean almost nothing because they don't translate into real money. How they will translate depends greatly on the invested amount and its portion of your whole portfolio. So if you decide to put 5% of your portfolio in a deal and risk it, basically that's your Value at Risk (VAR). In general the greater the VAR, the faster the movement of your account (growing or vanishing). If you decide to have a VAR of 50% in a simple move you might double the account or zero it.

Let's say you are willing to risk 5% of your capital (your whole portfolio). The VAR is 5%. Simply this means that you might have 20 wrong trades in a row before you zero out your account. So if you want to have a greater number of tries, lower the risked amount. 1% VAR = 100 wrong trades in a row.

Where is the risk/reward ratio here? The risk/reward rule basically says that the amount of profit you expect from a deal should be greater than the amount you are willing to risk! As we deal with future events that ratio happens to be an imaginary variable strongly dependent on our own ability to successfully expect the correct future events! Thus the risk/reward ratio is often used to distinguish between possible bad and good deals.

Both the value of VAR and the risk/reward ratio have a direct impact on the level of stops you choose. Let's look again at the examples above. In the first trade the possible loss in pips was set to 30 by the stop being 30 pips away from the entry level. If the account was of $1000 and the player was willing to risk 5% of it that would translate to a possible loss of $50. $50 loss for 30 pips is achievable by trading almost $16500 which means the player had to open a position of $16500. The important point is that the player has chosen that deal because he or she is expecting the gain from the trade to be bigger than the possible loss.

The level of the stop could vary depending on the expectations of the player but if the value of VAR stays the same all other variables could be changed accordingly bearing the same risk (measured by the amount of possible loss) to the portfolio. It doesn't matter if you trade a position of $33000 and put a 15 pips stop-loss or a position of $16500 and 30 pips stop-loss. The VAR in both cases is $50. What changes is the probability of successfully striking your stop with the relation being that closer stops get hit more often. That probability could shorten the life-span of your account which means that in general the wider the stop, the better.

Combining winning and losing deals which have had a positive risk/reward ratio the player might successfully manage the growth of his or her account.

EURUSD on the hour

2011-02-02T19:11:00.000+02:00

The EURUSD pair ended the hour at 1.3778 - 50 pips below the possible entry level at 1.3830. Still there is some room for a fast drop to 1.3750 or even to 1.3730/20 (50% of the Fibo retracement). Depending on the client risk attitude the short USD trade could be closed now. Another strategy is to put a stop at 1.3780 in order to preserve the profits till now.

EURUSD Short-term possible trade

2011-02-02T13:48:00.000+02:00

The upward movement of the Euro shows some signs of exhaustion and a possible retreat to 1.3750/60 could be formed. The European currency failed twice for the last hour to break above the 1.3845 level and there is a bearish hidden divergence formed on both the 15m i 30m graphs. An entry at the moment (at 1.3830) has a positive risk/reward ratio of 0.42 which translates to a twice bigger gains than the possible losses. An even more favorable entry could be formed at the 1.3845 level if the pair gets there again before dropping down.

EURUSD Short-term Technical Analysis

2011-02-01T22:40:00.001+02:00

The technical EURUSD (Euro / USD) picture for the day and current situation (15min graph) is as follows:

main direction (daily) - Up (Euro rises as US Dollar falls)
current situation - on the edge, possible reversal in the way following a last upward movement.

The 15 min graph shows the EURUSD pair is in the middle of its upward movement. The danger presented by the negative MACD values could be temporarily offset by the oversold condition (shown by the lower values of Stochastic at the moment). This could lead the pair to new highs above the previous high at 1.3836. The negative MACD however could signal the end of such upward movement and a fail to probe strongly that level would prove such possibility. At that point the Stochastic might well be in overbought condition and further ease the going down.

The great danger to any continuation of the upward movement of the Euro are the negative MACD divergences seen on the 1h and 4h graphs. Still there is a space to go up and any down movement could be followed by a strong reversal.

Having in mind the above conditions a fall to at least 1.3790 is to be expected soon. Having that level broken, 1.3770 is the next target.

A Warning Sign for the Euro Bulls

2010-10-21T20:50:00.000+03:00

The rise up of the Euro against the Dollar has been in place for the last months. Now the time for a change may be near. Take a look at the daily EUR/USD graph (click on it to see it big):

Here we have a bit of a worring picture. The value of Euro has continued to rise despite the MACD recorded lower values. The Stochastic followed the MACD but still the MAs are on the positive side. That explains the volatile movements we are seeing these days. The Stochastic is pointing forward and the Euro rose again today. So far. The formation which is about to be formed is very worrisome for the Euro as there is a chance the power of the Euro Bulls that drives the increase of its value toward the Dollar to be vanishing.

The weekly graph still shows the Euro may has some time to go up but the Stochastic points it to be a bit overbought.

The more important warning sign is on the Monthly EURO/USD graph shown below:

Here the MAs are still not on a positive side but still the Euro has risen a lot for the past months. What lights the red lamp is the Stochastic value which show the Dollar might be oversold. If that proves to be true we might witness another major rise of the Dollar in the next months. The situations requires attention and the conclusions might vary depending on the real data.

Current expectations for September, 2010

2010-08-27T21:52:00.003+03:00

Expectations in short for September -
Dollar - down
Gold - down
Stock markets - up

Today the FED again has reassured the markets it will continue its monetary policy of easy money in order to stimulate consumer spending and get US out of the trap. This alone will give enough strength of the Euro to continue its advance as there will be expectations of increasing the amount of available Dollars on the market. The weaker Dollar will give more competitive strength to US companies and further improve their financial results. As a secondary effect the Crude oil value could increase.

On the other hand such stimulus money (or any other type of government support) would give markets the long awaited trigger to start trading positive expectations again.

As markets turn positive using Gold as a hedging vehicle would become less popular. Having a big enough drop in demand of Gold would pretty much turn the tide. A considerable drop in Gold price would scare most of the last crowd that entered the Gold market in hope to make some quick profits which would increase the selling pressure further.

All these are an expression of an analytic point of view. Will wait for the end of September to compare with the real data.

Euro/Dollar (EUR/USD) Technical Analysis - Daily, July 29, 2010

2010-07-29T02:47:00.000+03:00

The Euro/Dollar pair was in quite an uptrend for the last weeks. The graphs however show this could be close to an end. We examined the weekly graph in our weekly technical analisys and now the Daily one looks promising.

The Daily Euro/Dollar graph (click on it for a better view) shows the pair was making new highs for the last several weeks while the MACD continued to make lower highs. Now its even on the negative side. The Stochastic shows the Euro is now in the overbought area.
The bearish MACD divergence combined with the overbought condition could trigger pretty soon selling of the Euro after all the buying power gets too exhausted.

A possible trigger for such a movement could be any of the news expected today - the Unemployment change in Germany, the Economic confidence in EU, M4 Money supply in UK or the Jobless claims in USA. One may follow these news (and even more) in our Economic calendar .

Euro/Dollar (EUR/USD) Technical Analysis - Weekly, 31 week, 2010

2010-07-27T12:46:00.000+03:00

It's been a while since our last technical analysis of the Euro/Dollar currency pair. The Euro continued its upward movement supported by the strong oversold conditions of the previous months. Now it trades around 1.298/1.30 where the 61.8 Fibonacci retracement level lays. On the daily graph we see a continuing upward movement of the pair price for the last 2-3 weeks while the indicators continue to make lower highs.

The weekly graph of the Euro/Dollar pair (click on it for a better view) presents an interesting situation. MACD is on positive side while the MAs are still negative. The Stochastic is in overbought area. And the price of the Euro is at the 61.8 Fibonacci level. A fail to penetrate this level could result in another upward movement of the Dollar. The bearish divergence seen on the daily graph supports the idea that the current resistance level would sustain and another fall of the Euro could be on its way. For a clearer view we might look at the monthly graph below.

On the monthly graph we see the major trend is still up for the Dollar and down for the Euro. The Stochastic is signaling an increase of the Euro value which took place during the current month. Still the major trend is not changed and having in mind the weekly and daily graphs another fall of the Euro towards the 1.19/1.20 levels is possible soon.

Euro/Dollar (EUR/USD) Technical Analysis - Weekly, 27 week, 2010

2010-06-28T03:55:00.000+03:00

The expected upward movement for the Euro toward the US Dollar took place in previous weeks. While at first the Euro fell to about 1.19 then it advanced quickly to above 1.24 touching the 1.2460/70 area. After that the power of the Euro bulls started to vanish and it lost about 2 cents.
This week starts with an advance of the Euro again and now it trades near 1.24 level again. The weekly graph (click on it for a better view) however hardly supports a lasting increase of the Euro value against the US Dollar.

The Euro went to the MA level and the Stochastic is continuing to climb to the overbought areas. Still however, it is not there so we might witness a test or even a break of the previous high at 1.247 level. The next resistance lays at the 38.2 Fibonacci level which means it would trade around 1.256 Dollars. Still the MAs on the weekly graph are too far from each other and the possibility for another fall of the Euro to around the 1.2/1.19 level is valid.
The trading during the week could be a very volatile one because the Euro/Dollar pair is at marginal levels. Plus the end of the month is near which would form the view on the monthly graph.

The important news from the markets concerning the EUR/USD currency pair in the week ahead are the Consumer Price index in Germany (to be released on Monday), the Money supply levels in EMU zone and UK (due Monday and Tuesday), Personal income and Consumption in USA (to be released on Monday), Consumer confidence in EU and USA, Unemployment rate in Germany (Wednesday) and in EMU and USA (Friday), Gross Domestic Product of UK (Wednesday), Jobless claims in USA (Thursday).

US stock market short-term update - technical, S&P 500, 09062010

2010-06-09T11:46:00.000+03:00

The futures trading shows some of the strength of the bulls might be vanishing so one should beware.

What is formed on the 4 hour graph is a hidden divergence between the S&P 500 (SPX) index and the Stochastic indicator which could signal a retreat for the index at least in short term. There are several hours to pass before the opening of the market so these could be bears' hours.
On the smaller time-frame graphs the down direction is even more visible. On the 1 hour and 30 min there is still more time to pass before the down movement is finished.

US stock market technical analysis - S&P 500, daily, 09062010

2010-06-09T01:48:00.000+03:00

US stock market has fallen a lot. What started as a surprise to many of the players at the beginning of May continued during the whole month and now the S&P 500 index has reached one of its lowest levels for the period. The signs of the current fall were visible even in April when a series of bearish divergences were formed on the daily and weekly graphs and our expectations of a fall of the markets proved to be right. That downfall was striking to many people and now as they have fresh memories of the pains they might have taken during last 3 years, they are now more scared than ever. Suddenly almost everybody turned bearish which explains the striking volatility and sharp downfalls of the indices. But this means also one more thing - there could not be much more fuel to the inertia. And the rising of the markets could surprise at least as many people as did the sudden decrease of the indices. So much for the psychology. :)

What we see today on the daily graph might pretty much mean the bulls might take some control now.

The graph shows the index continues to make new lows but the indicators don't follow. For today the S&P 500 grew and the Stochastic shows it being in an oversold condition. Still the MAs show the index is in a negative area but those divergences could lead to an increase. Still for a long-term bullish view, this bullish divergence better be confirmed by the MAs crossing on the upside.
The weekly graph shows the index is in a downtrend but a warning sign for the bears (and a good news to the few bulls) is that on the monthly graph the index still hasn't crossed that line and is in an uptrend. There is also no MACD bearish divergence there.

Despite the uncertainty if the index will change its down trend now for the long term, the 4 hour graph shows that for tomorrow there's a big chance the increase to continue. What we see here is the bullish divergence is seen in two indicators which could definitely lead to a continuation of the increase. Around 1068-72 level could be some resistance and if that gets broken, the way up to 1100 seems open.

Euro/Dollar (EUR/USD) Analysis - Monthly, June, 2010

2010-06-03T13:17:00.000+03:00

Last month the Dollar made one of its biggest gains in a month against the Euro. The trading began at May, 1st at around 1.33 and closed the month at 1.2286 with 1.2140/30 being the lowest level reached. This made almost 7.6% gain for the Dollar.

As was supposed in the current weekly technical analysis, June started with a test of the lowest level around 1.214 which was penetrated a bit to 1.2110 and a bounce followed. Now the Euro trades below its previous support level around 1.23.

The monthly graphs shows we are in a Dollar area and the Euro is deeply oversold. A warning sign for any Euro bulls would be the MACD whose histogram continues to dig deeper on the negative side.

As the support level at 1.23 was broken last month the next one (which is a major strong support) lays around 1.17/1.19 area. If the inertia from the last month proves to be strong enough, this is a possible target to reach.

Looking on the Weekly and Daily graphs we could see some signs for an upward Euro movement but even if it appears during the month, the overall trend is still negative for the Euro.

One should keep in mind that there is a possibility for a strong bullish divergence for the Euro to be formed on the monthly graph and if that happens it could signal a long (possibly years) upward trend for the Euro against the US Dollar. Still as we are looking at a very big time-frame graph it could take 1-2 months before such a divergence to appear clearly.

Euro/Dollar (EUR/USD) Technical Analysis - Weekly, 23 week, 2010

2010-05-31T15:56:00.000+03:00

Hello. Let's take a look at the possible scenarios for the week ahead concerning the Euro/Dollar trading.

The weekly graph points to possible bullish divergences for the Euro which could signal the trend reversal is near. The main problem with these divergences however is that they are not finished yet. This could lead to many people getting hurt by expecting a strong upward Euro movement while it still hasn't found a strong enough momentum. A classical case for a bull's trap. This could trigger a wave of stops being hit which presents a big opportunity for a test of the previous lows of the Euro around 1.21.
The daily graph also raises some warning signs which basically consist of the fact that even with positive MACD histogram and being in a relatively oversold position, the Euro is still not able to advance high enough (above 1.25-1.26) and to sustain that level.

With all that said it would be good to keep in mind that the mentioned divergences could get formed in the near future (maybe even next week) and an explosive upward move of the Euro against the US Dollar is highly possible.

Gold fever. Will its price fall?

2010-05-27T11:09:00.000+03:00

For the last year Gold has attracted much of attention. There are numbers spoken in the range of 1500 to 5-7000 and rumors of bets in those areas. The notion is that if this is spoken of, it might happen. So everybody rushes in and tries to get a share in the profits. It's like people expect and believe the market is just and it is its duty to give them what they need. The sad truth is, to paraphrase what Mark Twain once said, that the market owes you nothing because it was here first.

Gold price might continue to rise. If the demand exceeds the supply this would be normal. Even if the trading never gets to deliver real bullion the price would still be a question of demand and supply. The only difference would be the leverage that is possible to be used when trading not in real bullion. The amount of that leverage however could vastly increase the available amount of money that could be poured into Gold and effectively to create a pump&dump structure similar to the credit bubble and the housing ones. These however, are only assumptions and possible future scenarios. Nothing is sure in markets.

Let's take a look at the historical movement of Gold compared to the movement of Euro/Dollar pair. As these are past numbers we could use them to make some notes or even conclusions.

Table 1. Changes in price of Gold and the value of US Dollar against the Euro

	1995-2001	2001-2008	2008-2008.10	2008.11-2009.11	2009.11-2010.05
Gold	- 39%	284%	- 41%	73%	5%
EUR/USD	- 39%	80%	- 29%	22%	- 20%

This comparison draws some interesting ideas.

The first one is that in general for the last 15 years Gold and Dollar were negatively correlated and the Euro and Gold were positively correlated. This means that whenever the Dollar rose in value against the Euro the price of Gold fell. This happens to be true till the last period which starts around the end of last year (November 2009) and continues till now. During this last period at first there is a slight fall of the Gold price in accordance with the rising value of the US Dollar but shortly after the Gold continues to rise and now Gold and Dollar seem to have broken its previous type of correlation as the value of Gold was increased by 5% for the period accompanied by a 20% rising of the Dollar.

In the light of the last market turmoil this could mean a lot more people could be using Gold as a hedge against a possible economic downturn. Or at least these people (or orders) entered the market in the last several months and were enough to break the previous type of negative correlation that was in place.

A second thing of note on the table above is the value of the correlation. Before 2001 the table shows the value was pure -1 which means there is a great possibility that the value of Gold was calculated in the "buying power" of the US Dollar. Thus every drop in the US Dollar drove the Gold price higher in the same proportion and vice versa. After year 2001 this doesn't seem to be the case.

During the later periods the negative correlation was still in place but it's power was changing. The proportion of movements (or say it Beta if you'd like) changed from pure -1 to more distorted values. For the next period the price of Gold rose 3.55 more that the value of the Dollar fell. With all other conditions equal this could mean there was a 3.55 times more demand for Gold than in the previous period. Such an increase in real demand looks a bit striking but having in mind the construction and debt bubbles all over the world in that period makes it not so impossible. The next periods just continue to distort the strong negative connection between the Dollar value and the Gold price. Thus we come to the last period in which the Gold price and the Dollar started to move in the same direction in contrast to all the previous periods in the table.

An interesting thing about the beginning of the century is that in the years of 1990-2001 the electronic means of trading became widely available. And then after year 2001 there came the CFDs to their fullest. This marked the era of the easy access to the market and eliminated the need to really own the shares (or commodities!) you trade in on leverage. With CFDs the leverage could go up to 1/100 or even 1/500. So a person with $1000 could have a buying power of $100000. This increased amount of available money could explain the bigger proportions between the movements of Gold and US Dollar during the period after year 2001. As the CFDs are not available to US investors this could mean that the world outside the US could be the reason for the changing the proportion.

Generally the price of Gold was affected by the value of the Dollar which happened to be lower in times of economic strength and growth and higher in troubled times. The higher value of Dollar when there are troubles in stock markets is possibly because the Dollar is perceived as a save-haven currency. I believe there is a chance the next recovery will be also accompanied by a weaker Dollar as this will help the US economy. So if the current newly found state of positive correlation between Gold and Dollar prices is preserved, this would mean the Gold could fall accordingly.

The last upside in the Gold price despite the rising Dollar and in the light of Europe's debt problems speaks that it could be mostly used as a hedge instrument now. Apart from the fact that using as a hedge something you own only on paper and not "holding in your hands" devalues the idea of hedge itself, using Gold as a hedging means that when there is no need to hedge a imminent danger, there would be no need to hold Gold.

All the above thoughts lead me to a conclusion that when times get calmer and the horizons look brighter the Gold price could fall. Even just in order to compensate the change in the correlation that appeared during the current crisis. There are technical signs that such a move could not be so much ahead in time but this would be a topic of another article.

Euro/Dollar (EUR/USD) Technical Analysis - Daily, May 26, 2010

2010-05-26T11:25:00.000+03:00

After yesterday's closing of the Euro/Dollar pair near to its open level, today's trade started lower. However the technical analysis shows the direction might change during the day.

The daily graph of EUR/USD (click on it for a better view) shows the Euro gets close to being oversold while the MACD histogram is positive. Still the Stochastic points down but the formation looks promising for an Euro advance. Let's check the lower time-frame graphs.

On the 1 hour graph of Euro/Dollar we see the pair is swinging around the Moving Averages. Still the MAs are positive and the Stochastic points strongly upward. This could lead to at least a short term advance of the Euro against the US Dollar with target placed at the previous high around 1.2380/90.

The overall risk of further decline of the Euro still stays on the bigger time-frame graphs.