What To Do …And Not Do… In A Confused Market

What Is A Confused Market?

A confused market has several symptoms.  A confused market is more than just observed volatility.  It also ranges, has no clear trend, or no clear price action.  In a confused market, price may also get stuck between our traditional exponential moving averages (EMAs).  Think of someone spilling rum on your best nautical chart while you are preparing to get underway  …you can squint at it all day long but still won’t be able to make out the channels from the currents.

Observed volatility leads to expected volatility.  This is the thing investors may not like, financial salesmen do not like, but what the calm, patient trader needs to pay the bills. A  confused market has none of that.

In a confused market, patience is key.  Be patient, Stay up-to-date on fundamentals, update your risk model, calculate your probabilities, reconcile your accounts, wait for price action to cross the proverbial line in the sand, but do not make any hasty trades and gamble client accounts.

Remember, capital is one of the three key factors to economic prosperity and capital preservation is number one rule.

That all leads up to my recent trades –which have all been purely technical with a short holding period (and less than 2.5% gains).  I am currently holding a PLN and CHF long which will probably play out before Sydney opens.

The greatest challenge I face in a confused market is holding a trade for too long.  I use many off-chart market indicators that guide me on when to close a trade.  Those indicators are just not very accurate in a confused market.  Again  …p a t i e n c e.

A little bit goes a long way in times like these.

If you want to make sense of a confusing market, go visit the fine folks who taught me how to read a chart:  Infinite Prosperity, a Corp. Authorised Representative of Alpha Equities & Futures Ltd ABN 76131376415

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↓€/PLN

Weekly eur/pln market structure looks good, so I put in a foundation trade at 4.23 with a wide stop. After the weekly candle finished, I checked for CCI divergence & positioning on the COT report.

Today, CCI divergence is confirmed on the weekly & daily.  The CFTC reports that dealers increased their euro shorts & non-commercials are taking profit on euro long positions this week.

Initial foundation trade (4.23) is a 1/3 bell, but looking at the DXY, not sure when I will add to it.  So keeping a weather-eye on the DXY for now.

Update:  added a bit of outside leverage to the trade, held for a couple weeks and eventually scaled out on the 4-hour chart; closed at a total of +18% of margin.  this is an extremely volatile pair and my risk management model was definitely put to the test.

Risk Off Event Volatility

Looks like the market has now been prepped for incoming volatility.  To profit in times like this, it is important to remember your risk threshold and your market correlations

With a 2-year wedge breakout on the VIX, equity markets declining, and risk-sensitive currencies finding temporary highs; we have to be ready for extreme volatility.

The market has followed through to the downside with the DOW sliding over 900 points, risk currencies declining, and the JPY powering up reflecting a true risk-off sentiment.  Risk off means movement in JPY and CHF.

Additionally it’s important to note that crypto-currencies did not receive a bid during the latest, big risk-off event; confirming that these speculative assets are sold in times of uncertainty to raise cash out of fear or greed.

The winners of the day will be those who don’t get emotional about the big market swings and stick to their money management model….always.

To be successful, think dynamically and understand the correlations among financial markets.  Tunnel vision on one specific asset class no matter the market cycle is not true objective analysis.

For me, this month I am closely watching correlations, commodities and balancing my portfolio out with metals while I search for an auditor to update the gains to my track record for 2017.

The Federal Open Market Committee

FOMC Interest Rate Announcements

What Is The Federal Open Market Committee (FOMC)

The FOMC is the policy-making arm of the U.S. Federal Reserve. The FOMC determines short-term interest rates in the U.S. by manipulating the overnight interest rate that banks pay each other for borrowing reserves.  Banks borrow reserves when a bank has a shortfall in required reserves. This overnight rate is the fed funds rate.

The Federal Open Market Committee also determines whether the Fed should manipulate liquidity in credit markets by other means. The Fed announces its policy decision (whether to change the fed funds target rate or not) at the end of each FOMC meeting. This is the FOMC announcement.  It also includes brief comments on the FOMC’s views on the economy and how many FOMC members voted for and against the policy decision.

Since the last recession, the statement also includes information on Fed purchases of assets, aka “quantitative easing”, which affects long-term interest rates.

Why Is The FOMC announcement important?

The Fed determines interest rate policy at FOMC meetings.  A FOMC meeting happens approximately every six weeks.  The FOMC meetings are the single most influential event in the markets.  For weeks in advance, market participants speculate about the outcome of each meeting. If the outcome is different from expectations, the impact on the markets can be significant.

FOMC The Fed Funds Rate
Effects Of FOMC Announcements Reach Far And Wide.

Why Is The Federal Funds Rate Important?

The interest rate set by the Fed, the federal funds rate, serves as a benchmark for all other rates….All. Other. Rates.

A change in the fed funds rate (the lending rate banks charge each other for the use of overnight funds) affects all other interest rates from Treasury bonds to mortgage loans. It also changes the flow of  investment dollars. When bonds yield 5 percent, they will take more investment away from equities than when they only yield 3 percent.

Interest rates impact the economy in various ways. Higher interest rates tend to slow economic activity; lower interest rates tend to stimulate economic activity while at the same time erode pension fund returns and consumer savings. Either way, interest rates influence consumer sales. In the consumer sector, fewer homes or cars will be purchased when interest rates rise.

Furthermore, interest expense is a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits.  When interest expenses increase, net profit decreases which lowers corporate profit. The bottom line is that higher interest rates are bearish for equities.  While a low interest rate environment is bullish for equities AND juices up government tax revenue.  Get the picture?

 

Alternative Investments -Measuring Performance

How to measure performance between accounts.

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Dealing in Alternative Investments requires a bit of statistical knowledge (the more the better).  So I picked out one component that would benefit someone who handles their investments personally and, at the same time, benefit someone who pays an advisor because it never hurts to ask the right questions.

The following is not investment advice, but one way to assess the advice you were given…

High Frequency Trading or Unconventional Return Periods

When returns are realized at higher frequencies (many times per year), Sharpe Ratios and the corresponding t-statistics can be calculated in a straightforward way.

Assuming there are N return occurrences per year, and the mean (μ) and standard deviation (σ) of the returns are μ and σ, the annualized Sharpe Ratio can be calculated as (μ×N)/(σ×√N) …or (μ/σ)×√N.

The corresponding t-statistic is (μ/σ)×√(N × number of years).

For monthly returns, the annualized Sharpe Ratio and the corresponding t-statistic are (μ/σ)×√12 and (μ/σ)×√(12 × number of years), respectively.  Here, μ and σ are the monthly mean and standard deviation of returns.

Similarly, assuming μ and σ are the daily mean and standard deviation for returns (you traded every day the market was open…please don’t do that:) and there are 252 trading days in a year, the annualized Sharpe Ratio is (μ/σ)×√252 …the corresponding t-stat is (μ/σ)×√(252 × number of years).

The calculators I use to find these metrics are listed in the right-hand column on “my trading desk.” They both have statistical functions.

The Test Statistic

Test Statistics (t-stat,t-statistic) are tricky creatures.  Essentially when evaluating performance, I require a t-stat of 4 or more (the higher the better) before considering a stake.  In the future, I will explain a simple model I use to allocate cash among accounts and strategies according to their t-stat.

Now, here is a simple formula to estimate a t-statistic for unusual return periods:

Test statistic= (μ/σ)×√(N return occurrences × number of years).

Note that “N return occurrences×Number of years” is just the total number of return occurrences resulting from the investment or strategy (either positive or negative).  So, if you closed out 3 trades (at 1%, -2.3% and 3%), that counts as N=3.

Or, if your investment reconciles every 6 weeks, for the past 1.5 years then N=13, (78 weeks / 6).

Remember, it is important to convert your daily/weekly/monthly returns to an annual (yearly) number.  This makes it very easy to compare performance against conventional, low-return investments pushed by financial salesmen.

And since the volatility adjustment is built-in, it is an apples-to-apples comparison.

 

Sails Up

Long The Japanese Yen.

↓ CAD/¥

The global macro picture looks squared away: swap dealers are short CAD and long Yen; institutional managers are actively buying Yen contracts.  Bond activity indicates risk-off verifying ¥ long positioning.  Retail positioning is not optimal and BoJ numbers are due out this week so a wide stop.

The charts show good CCI Divergence on the daily and weekly.  Stop is set north of ¥92.  Position size is a full bell.

Update:  10/01, order triggered; 10/18, closed at +2.4% of margin;

 

↓ €/¥

Similar global macro factors with institutional managers  actively closing their euro shorts.  CCI divergence on the weekly; stop-loss is set above the weekly high.  A correlated trade so I will be trailing the stop on this pair if it triggers. Risk taken is a 2/3 bell.

Update: 10/01, order triggered;  10/18, stopped out, -1.94% loss on equity

Trader Error:  this trade was held too long, I was away from my laptop and missed the profit target on the morning of 10/16.

European Monetary Union: Flash PMI

Emerging Markets: Flash PMI

EMU: Purchasing Manger’s Index

This week the Flash PMI for the EMU will be released.  The flash Composite Purchasing Managers’ Index (PMI) provides an early estimate of current private sector output.

The flash data are released around ten days ahead of the final report and are typically based upon 75-85 percent of the survey sample. Results are synthesized into a single index which can range between zero and 100. A reading above (below) 50 signals rising (falling) output versus the previous month and the closer to 100 (zero) the faster is output growing (contracting).

The report contains flash estimates of the manufacturing and services PMIs. The survey is produced by IHS Markit and uses a sample of around 5,000 manufacturing & services firms.

Manufacturing firms located in:

  1. Germany
  2. France
  3. Italy
  4. Spain
  5. Netherlands
  6. Austria
  7. Ireland
  8. Greece.

Services firms located in:

  1. Germany
  2. France
  3. Italy
  4. Spain
  5. Ireland.

The report is significant because other investors/traders value it –economic data such as the PMIs  indicate what the economic backdrop is for the various markets:

  • Equity investors like to see rapid economic growth because that usually translates to higher corporate profits.  However, increased corporate profits may occur without any growth whatsoever.
  • Forex traders like rapid growth as well because that is one indicator of demand for a country’s currency.
  • The fixed income (bond) market prefers slow to no growth and is extremely sensitive to whether the economy is growing too quickly due to inflationary pressure.

So which market do you think the central pirates banks cater to?

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