It seems that the financial news lately has been full of stories like this (via the FT):

Oil producers shun dollar – Oil producing countries have reduced their exposure to the dollar to the lowest level in two years and shifted oil income into euros, yen and sterling, according to new data from the Bank for International Settlements.

The cover of The Economist last week even taunted a falling dollar: (more…)

So the conspiracy nut inside of me wants to talk about Amaranth, and how they are the first domino in a long line of dominos…

Maybe pension funds and other less aggressive investors will realize that they don’t really want the added risk that comes from investing in hedge funds, and start to pull their money out of hedge funds, broadly and without any distinction… With decreasing assets in hedge funds, many have to start liquidating their positions and de-leveraging… Prices start to fall since most hedge funds have a long-only bias (a side effect of the Bernanke/Greenspan Put?), and their selling causes prices to fall despite the lock-up periods they have forced their investors into… and prices begin falling across the board with stocks and commodities (remember, pricing happens at the margin)… we see liquidity disappear more convincingly than a David Copperfield magic trick… spreads widen, and a sharp downturn begins…? The markets panic, and the bottom falls out… (The sky turns to fire, the sea turn to blood…)

But then I snap myself out of it, and realize, Amaranth was a HUGE fuck-up, but they still met their margin calls. Sure, they lost $6 billion or 65% of their assets, but their brokers cut them off before they presented a risk to the entire financial system… unlike LTCM where the brokers were blindsided by how much exposure they had, and had to have the Federal Reserve twist their arms until they dealt with the situation.

The risk of failure was born by those that could bear it. The failure wasn’t paid off by the public at large in the form of higher taxes like the Savings & Loan crisis back in the early 80s… The burden wasn’t hoisted on unsuspecting employees who had all their 401(k)s invested in the company stock (Enron)…

So, have we progressed to the point where we can survive the failure of a significant player in the markets? Can we rest easy knowing that we’ve learned a lot since 1998 when LTCM imploded?

Or maybe, just maybe, those who are currently bearing the risk will realize that it might be more risk than they originally anticipated… and then they start to pull their money out of hedge funds…

You can see the last 20 years of the Nikkei on Yahoo.com.

I also found this chart in Financial Reckoning Day, where the authors try to draw parallels between the Japanese situation 15 years ago with the one in the US now (or was in 2003 when the book was written). (more…)

The subject of stop-losses is such an intensely difficult topic to discuss.? I’ve had many latenight debates in trading forums and chatrooms and I’ve been through every camp in my experience as a trader.? The best answer I’ve ever been able to come up with is that answer famous and frustrating for its truth: it depends. (more…)

We have talked in the past about having larger stop-loss threshholds than the actual expected reward, and the backlash on forums when this type of trade is even mentioned. The logic of the backlashers is that you have to have reward larger than your potential loss to win in the game of trading.

I wanted to explore the concept a little bit further and just think through the implications of what it means to put on a trade where your potential reward is smaller than your potential risk.

Let’s start with an example… If a stop is 2x the size of reward (e.g., a stop loss would be triggered at a loss of 10% but we’ve set a price target of 5%) then we have to get at least 70% of our trades correct to make money. (66.7% plus slippage and commissions, I’m guessing ~70% if not higher.) To me, this seems like a fairly high hurdle to start with, though it is certainly possible. (more…)

Of?all techniques used to analyze markets, the one that I find underappreciated is market profiling and auction market value theory.? This style was first codified?by CBOT as Market Profile.? But the basic principal is finding areas of price that generate more ticks of trading than others.? I’ve talked of this before as “density” areas. (more…)

I feel like most people don’t give weekly charts their proper respect. Take a look at the daily and the weekly charts for the NDX. While many people will look for various moving averages or other technical indicators to show trend and direction of price, sometimes it just pays to simply zoom out to the weekly chart.

In the case of the NDX’s daily and weekly charts, it seems like the weekly chart smoothes out a lot of the daily noise, but it still captures the entire range for the week in its high and low marks. It also shows nicely that the trading ranges each week are fairly wide, and only in a few specific weeks did we really have strong movement significantly beyond the previous week’s trading range. (more…)

Despite the fact that my last discussion was received with a deafening silence, I’m going to make another go at it. If you feel the writing juices, post via a trackback your answer to the following query, what is your favorite underappreciated analysis technique? What makes it good, and why don’t others realize it? (more…)

On the topic of Black Swans, I can think of one experience that would qualify. At the very least, it was an event that I never thought was even possible.

Picture a scene… it’s early 2002 and Jason is learning about options and has been trading options for about three months now. He’s made many of the rookie mistakes, but learned a lot along the way. One morning while at work, he logs into his brokerage account to dump an option that wasn’t performing (he’s an option buyer and was long 1 out of the money call). The day before the option was trading at a bid/ask spread of $0.50/$0.60, yet this morning when he logs in, he sees the price on his screen is at $3.50/$3.60.

Ma-neh-wah?!?! (more…)

You’ve at least heard of the book Fooled by Randomness by Nassim Nicholas Taleb if not read it. The main point of the book is that many people trade in the markets based only on the experiences that are probably, ignoring the possibility of the existence of a black swan.

The definition from Investopedia of a black swan is “An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict.” Most people would consider the crash of ’87 to be a “black swan event”. (more…)

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