Markets are complex. Many interconnected variables influence their behaviour. Yet quite often even the best analysts or neural networks find themselves on the wrong side of the market. The steady decline in oil and commodities is a good example of how commodities companies trading companies and hedge funds have totally failed in understanding the deep routed weakness in the oil complex.
For many the collapse of the oil price has been a no brainer for years. The recession, shale oil, fuel efficiency, increased production by OPEC, and new technology are only a few of the many reasons why oil had reached a multi decade top. Yet traders and pundits have been calling a bottom to the slide for a year and even putting their money where their mouth is. This contrarian play is deeply routed in the nature of human psychology and trading or is it.
Behind every single tick move in any instrument is a notion of interconnectedness. Statistically a price can go either way in each single tick. It is not possible to connect one tick to another based on complex mathematical algorithms or formulae. So humans invent complex or simple reasons why 2 prices may be connected. This starts with simple moving averages and continues with complex algorithms. We inherently go from phase shift, where no connection exists to chaos theory where every event could influence that particular tick.
This paralysis of analysts in itself causes panics in the market when black swan events happen and leads to extreme volatility. In effect markets are self fulfilling prophesies of themselves. High frequency traders are very successful in this environment and fund managers and many hedge funds are totally useless. Conventional technical analyses or fundamental analysis have no place here. This is the work of the turbo charged trading algorithm trading differentials of price in seconds and milliseconds. In chaos theory there is order. It has to be found and is often microscopic.
The reality of price differentials are a mix of both phase shift and chaos theory. Apart from perception nothing connects 2 ticks in any market, yet humans have developed complex theories to explain movements in any 2 variables. These theories are universally used and accepted and therefore have become norms for traders globally. Yet the most successful traders are the ones that have absolutely no bias on any timeframe and treat each tick or candle or price as new unconnected event. The steady observation of these unconnected events creates a momentum that magnifies during high volatility black swan events creating immense moves in the direction of the trade.
Wednesday 30 September 2015
Monday 17 November 2014
Iran's nuclear non-armament
With hard-line politicians in the US and Iran dismissing any possibility of a meaningful nuclear agreement between Iran and the West, the negotiators press on in the hope of saving face for the Obama and Rouhani detente.
The reality is that whatever solution they come up with is already history. Until recently Iran's only deterrent against a US attack was its semblance of control of the straits of Hormuz, export route for much of the oil from the Middle East. This particular deterrent has been nullified by the copious amounts of oil in the global market and futility of closing its main trade route.
The second major deterrent is, of course its potential nuclear arsenal. No one really knows how advanced Iran's nuclear weapons programme really is. The layer upon layer of deceit and misinformation has surely ensured that only a small fraction of the immense nuclear and weapons programme will ever come to light.
So despite the waving of agreements the managers of Iran's security know the only thing that separates them from events in Syria or Iraq is a nuclear arsenal. Historically, the dilapidated nuclear power of North Korea can still threaten the US and its allies and remain unscathed yet 2 of the largest armies in the Middle East, Syria and Iraq imploded leading to the disintegrated of those countries. Ironically, Syria was regarded as a safe haven for many Iranian leaders, who kept residences and safe houses there.
Building an advanced nuclear programme with intense sanctions is costly and dangerous. However, the loosening of sanctions and the possibility of a closer relationship with European and US companies can facilitate the import of just the right components to add on to the substandard ones provided by Russia, and North Korea. Iran may curtail its legitimate nuclear programme but it needs advanced rocket capabilities and nuclear warheads for its survival. No Iranian regime would disassemble a programme that it claims, does not exist
The reality is that whatever solution they come up with is already history. Until recently Iran's only deterrent against a US attack was its semblance of control of the straits of Hormuz, export route for much of the oil from the Middle East. This particular deterrent has been nullified by the copious amounts of oil in the global market and futility of closing its main trade route.
The second major deterrent is, of course its potential nuclear arsenal. No one really knows how advanced Iran's nuclear weapons programme really is. The layer upon layer of deceit and misinformation has surely ensured that only a small fraction of the immense nuclear and weapons programme will ever come to light.
So despite the waving of agreements the managers of Iran's security know the only thing that separates them from events in Syria or Iraq is a nuclear arsenal. Historically, the dilapidated nuclear power of North Korea can still threaten the US and its allies and remain unscathed yet 2 of the largest armies in the Middle East, Syria and Iraq imploded leading to the disintegrated of those countries. Ironically, Syria was regarded as a safe haven for many Iranian leaders, who kept residences and safe houses there.
Building an advanced nuclear programme with intense sanctions is costly and dangerous. However, the loosening of sanctions and the possibility of a closer relationship with European and US companies can facilitate the import of just the right components to add on to the substandard ones provided by Russia, and North Korea. Iran may curtail its legitimate nuclear programme but it needs advanced rocket capabilities and nuclear warheads for its survival. No Iranian regime would disassemble a programme that it claims, does not exist
Friday 14 November 2014
Saudi Arabia: the new OPEC
OPEC's rearguard seems to have momentarily stopped the exponential slide in oil prices. It seems there is a level where all interests converge to stabilizing the price.
The unilateral actions by Saudi Arabia has damaged the relationships within OPEC beyond repair. It is virtually impossible to differentiate between the sectarian battles on the ground and the groupings within OPEC.
The growing mistrust between Iran and Saudi Arabia and the collection of failed states and minnows that make up the rest of OPEC have only self interest as their priority and currently Saudi Arabia either funds or subsidies many of the regimes.
The United States and Saudi Arabia will now want to see a period of stability for oil prices. It seems the ever chaotic region can now tolerate continued sectarian violence, as long as the Saudi oil fields are out of bounds.
- Saudi Arabia has clearly warned of the negative implication of continued US production.
- Iran and Russia have been painfully reminded not to meddle too much in their neighbors affairs, or suffer the consequences.
- OPEC has been thoroughly tamed.
- The US consumers can happily drive to their Thanksgiving dinner without being bankrupted.
The unilateral actions by Saudi Arabia has damaged the relationships within OPEC beyond repair. It is virtually impossible to differentiate between the sectarian battles on the ground and the groupings within OPEC.
The growing mistrust between Iran and Saudi Arabia and the collection of failed states and minnows that make up the rest of OPEC have only self interest as their priority and currently Saudi Arabia either funds or subsidies many of the regimes.
The United States and Saudi Arabia will now want to see a period of stability for oil prices. It seems the ever chaotic region can now tolerate continued sectarian violence, as long as the Saudi oil fields are out of bounds.
Thursday 13 November 2014
OPEC conundrum and the Middle Eastern endgame
It is impossible to believe that a few years ago peak oil was the main paradigm in the oil complex. Shorting oil was unheard of and Middle Eastern leaders were throwing their money around like confetti. The oil complex has gone full circle.
OPEC is powerless and the grand traders and politicians dictate the oil markets and the politics behind it. This is the endgame for many Middle Eastern regimes. A painful war of attrition on the battlefield and the oil field. The nuclear talks with Iran are now irrelevant as the country is hemorrhaging capital and a normalization of ties with the West will even reduce the price of oil further. With the price of oil so low, the larger powers can afford to have a multitude of proxy wars across the region, without worrying about the disruption of supplies. The only issues is how deep are the pockets of the oil producing nations.
It is difficult to fathom how long the Iranian regime can sustain itself with 70 dollars a barrel oil. The rear guard of OPEC desperately push for higher prices, unaware that they will have to pump more to sustain their market share. The dual threat of alternative energy sources and shale oil has thrown the traditional oil complex into turmoil and destroyed the old order.
The revolutions started in the streets but ended in the boardrooms of the great trading houses and oil producers. As economists in the Middle East and the US count the costs of this war of attrition consumers reap the reward of cheaper energy prices. Yet this is a short term phenomenon. The low prices of oil can only lead to trouble in the Middle East. A few points to consider.
OPEC is powerless and the grand traders and politicians dictate the oil markets and the politics behind it. This is the endgame for many Middle Eastern regimes. A painful war of attrition on the battlefield and the oil field. The nuclear talks with Iran are now irrelevant as the country is hemorrhaging capital and a normalization of ties with the West will even reduce the price of oil further. With the price of oil so low, the larger powers can afford to have a multitude of proxy wars across the region, without worrying about the disruption of supplies. The only issues is how deep are the pockets of the oil producing nations.
It is difficult to fathom how long the Iranian regime can sustain itself with 70 dollars a barrel oil. The rear guard of OPEC desperately push for higher prices, unaware that they will have to pump more to sustain their market share. The dual threat of alternative energy sources and shale oil has thrown the traditional oil complex into turmoil and destroyed the old order.
The revolutions started in the streets but ended in the boardrooms of the great trading houses and oil producers. As economists in the Middle East and the US count the costs of this war of attrition consumers reap the reward of cheaper energy prices. Yet this is a short term phenomenon. The low prices of oil can only lead to trouble in the Middle East. A few points to consider.
- How long can Iran sustain its embargo ridden economy with massively declining revenues ?
- When will the increasingly sectarian Sunni-Shia war in the Middle East spillover ?
- How will the new emerging oil states like the Kurds change the oil-state dynamics ?
- How long will Russia remain on the sidelines of this oil war ?
Tuesday 24 June 2014
Trader Dynnamics Toolkit: Riding the wave
These are times of big changes. Volatility is at an all time low in many global markets. Trader apathy is at an all time high and the no economy cocktail of low growth and low inflation has created an economic cycle where Central Banks have cut their hands off.
They have deliberately or foolishly left themselves with very little power to manage the economy. Interests rates are so low that ECB had to bring in negative interest rates to force banks to lend their money. In the US, on Wednesday, Jannet Yellen acted more like a CNBC commentator telling everyone proudly that stocks were not overvalued. The market blindly jumped on the bandwagon.
For many traders it has been a quiet year and, if it wasn't for the special situations that have arisen from political turmoil in the Ukraine or in Iraq many funds would be well under break-eve. Every day more and more forex traders disappear as the Euro/USD regularly trades in tight ranges.
All this is not earth shattering news to any seasoned trader. In fact it is these moments that test the market knowledge of most traders. As robots, computers and automatic algorithms take over much of the trading the possibility of arbitrage, whereby taking advantage of the slight variations in different markets evaporates.
In the past this has led banks and trading houses to come up with novel and exotic ways of making money. We had junk bonds, we had a biotech bubble and a Dot Com bubble. We had a sub-prime bubble. As traders and market followers this is like sitting and waiting for the encore or the next wave in the ocean. The market continues and traders are dusting off strategies for low volatility none existent economic conditions until the next wave appears.
In 2007 Paulson became a billionaire by short-selling subprime mortgages and made $3.7 billion that year. It is hard to believe that in 2011, he made losing trades in Bank of America, Citigroup and, Sino-Forest Corporation.
His flagship fund, Paulson Advantage Fund, was down over 40% as of September 2011. So, how is it possible that with all the resources and a deep understanding of the market the same person can get things fundamentally wrong.
Trading is a combination of 2 activities, one mechanical and one emotional or psychological. The mechanical side of trading is very much like chess. You know all your moves and you can pretty much foresee the other sides moves and counter them. It eventually becomes a war of attrition. Whoever has the most knowledge, patience and willpower will gain the advantage. When things go as planned the mechanical side of trading is beautiful.
Then there is backgammon. The players know all the moves, yet the dice is the king. The game can change quite rapidly if you throw some bad numbers. The reality about trading is that despite all the theory you can not predict what can happen one tick from now.
But the best explanation for me, a mathematician, is Schrödinger’s cat. In the Copenhagen interpretation, a system stops being a superposition of states and becomes either one or the other when an observation takes place. The market can be dead or alive at any particular moment and it is only its observation at any particular moment that makes it relevant.
Financial markets have the same mathematical basis as natural laws. Why else would a Fibonacci number that measures spirals on shells, and spiral galaxies be relevant. There are financial models based on fluid dynamics, wave patterns, crowd dynamics and mass mood psychology. In fact there are very few purely economic models to trade, apart from following fundamental news. However, that can be extremely distorted at times too.
So what is it that makes the trader successful in this dynamic ? It is the persistent and powerful motion of the financial market. Any surfer who sits in the ocean will get a massive wave eventually and maybe it will be a Tsunami. The second he observes the wave he is doomed to act. He will either ride it to the shore or die.
The observation is part of the equation and being observed as an actor is the other. Your system observes the market waiting for the next best move but is all the decisions made by you that ensures the trade is successful.
Many traders sit through wave after wave waiting for the big one and nothing happens. Look in the right places and really observe the market and you will see trading opportunities in every candle. Sometimes you will get it wildly wrong and be on the wrong side of a Tsunami. But that is trading. Sensible money management ensures that you will not get blown out and you keep on trading.
They have deliberately or foolishly left themselves with very little power to manage the economy. Interests rates are so low that ECB had to bring in negative interest rates to force banks to lend their money. In the US, on Wednesday, Jannet Yellen acted more like a CNBC commentator telling everyone proudly that stocks were not overvalued. The market blindly jumped on the bandwagon.
For many traders it has been a quiet year and, if it wasn't for the special situations that have arisen from political turmoil in the Ukraine or in Iraq many funds would be well under break-eve. Every day more and more forex traders disappear as the Euro/USD regularly trades in tight ranges.
All this is not earth shattering news to any seasoned trader. In fact it is these moments that test the market knowledge of most traders. As robots, computers and automatic algorithms take over much of the trading the possibility of arbitrage, whereby taking advantage of the slight variations in different markets evaporates.
In the past this has led banks and trading houses to come up with novel and exotic ways of making money. We had junk bonds, we had a biotech bubble and a Dot Com bubble. We had a sub-prime bubble. As traders and market followers this is like sitting and waiting for the encore or the next wave in the ocean. The market continues and traders are dusting off strategies for low volatility none existent economic conditions until the next wave appears.
In 2007 Paulson became a billionaire by short-selling subprime mortgages and made $3.7 billion that year. It is hard to believe that in 2011, he made losing trades in Bank of America, Citigroup and, Sino-Forest Corporation.
His flagship fund, Paulson Advantage Fund, was down over 40% as of September 2011. So, how is it possible that with all the resources and a deep understanding of the market the same person can get things fundamentally wrong.
Trading is a combination of 2 activities, one mechanical and one emotional or psychological. The mechanical side of trading is very much like chess. You know all your moves and you can pretty much foresee the other sides moves and counter them. It eventually becomes a war of attrition. Whoever has the most knowledge, patience and willpower will gain the advantage. When things go as planned the mechanical side of trading is beautiful.
Then there is backgammon. The players know all the moves, yet the dice is the king. The game can change quite rapidly if you throw some bad numbers. The reality about trading is that despite all the theory you can not predict what can happen one tick from now.
But the best explanation for me, a mathematician, is Schrödinger’s cat. In the Copenhagen interpretation, a system stops being a superposition of states and becomes either one or the other when an observation takes place. The market can be dead or alive at any particular moment and it is only its observation at any particular moment that makes it relevant.
Financial markets have the same mathematical basis as natural laws. Why else would a Fibonacci number that measures spirals on shells, and spiral galaxies be relevant. There are financial models based on fluid dynamics, wave patterns, crowd dynamics and mass mood psychology. In fact there are very few purely economic models to trade, apart from following fundamental news. However, that can be extremely distorted at times too.
So what is it that makes the trader successful in this dynamic ? It is the persistent and powerful motion of the financial market. Any surfer who sits in the ocean will get a massive wave eventually and maybe it will be a Tsunami. The second he observes the wave he is doomed to act. He will either ride it to the shore or die.
The observation is part of the equation and being observed as an actor is the other. Your system observes the market waiting for the next best move but is all the decisions made by you that ensures the trade is successful.
Many traders sit through wave after wave waiting for the big one and nothing happens. Look in the right places and really observe the market and you will see trading opportunities in every candle. Sometimes you will get it wildly wrong and be on the wrong side of a Tsunami. But that is trading. Sensible money management ensures that you will not get blown out and you keep on trading.
Sunday 22 June 2014
Trader Dynamics Toolkit: Evolving on the Edge of Chaos
Markets are inherently chaotic. To an external observer and newbie trader the counter intuitive movements of markets creates a vacuum that makes rational decisions difficult. This is the sole reason why many traders fail and blow out their accounts. They believe all the false moves as changes in the direction of trend and get caught out in a counter move.
Furthermore at lot of the market gurus advocate an over dependence on lagging indicators and short-term trading. Anyone that has followed short-term movements in prices knows how chaotic that is. Throw in the behaviour of banks and market makers in taking out stops and creating false breakouts and we have a very volatile cocktail.
So how does one manage expectations in this turmoil. Firstly even chaos theory recognises that at some level, even micro, there is inherent order in a system. An airport might look like a manic place to most observers but it is a highly organised complex place with every person following a definite route and timeline. One has to acknowledge that within chaos there is a point where perfection exists.
In markets this point is difficult to find as so much of market movements are based on psychology and sentiment. If you break down the movements you see a tug of war between the traders going up and the traders going down. In a micro and short-term time-frame it seems like it goes both ways all the time but on a longer and medium time-frame the charts look quite ordered.
The challenge for most traders is to follow the long-term sentiment yet trade regularly in the short-term. The rapid and chaotic movements in the short-term stops out many people if the entry points are not chosen correctly. If we revisit the airport analogy the people who arrive early have a long wait and the people who arrive late often rush and miss their plane but there is a point right before it gets too busy about 1 and half hours before departure when the momentum gains and most people arrive at the check in counters.
This is when the lines can be longest, but the system is working at maximum efficiency to get the people on that plane. The deadline starts to loom and the authorities want to ensure that everything runs smoothly. This is the moment any accomplished trader should be getting into the market.
Early signs of a buildup of momentum. Most traders get there too early, get nervous and sell out or get there too late and miss the plane. There is a case for getting there early but this is wasted time as the plane may be delayed and the move may not happen for hours, days, or weeks.
The problem with most systems is that they bring you to the extremes. They are either lagging or get there too early. How many times have people made a trade based on the RSI only to realise it has floated up in the extremes for weeks. And how many times have people made a decision based on a moving average, just to see it swing back.
So the only indicator you really need are the key points and blockages. These are normally the pivot points where congestion starts to happen and markets get choppy and some indication that prices are moving and momentum is happening in a particular direction. If you use candlesticks this is when the small candles become long and solid in a particular direction. If you look at numbers you will see numbers start moving fast but predominantly in the same direction 4 forward 2 back 6 forward 3 back, that kind of thing. This is the moment to trade.
Be mindful of the longer term trend and realise you are on the edge of chaos. Things will start moving rapidly but the momentum has started the lines are building up and the people are moving. Just like in the airport. Go with the flow, don’t fight it. You will get there in the end.
Furthermore at lot of the market gurus advocate an over dependence on lagging indicators and short-term trading. Anyone that has followed short-term movements in prices knows how chaotic that is. Throw in the behaviour of banks and market makers in taking out stops and creating false breakouts and we have a very volatile cocktail.
So how does one manage expectations in this turmoil. Firstly even chaos theory recognises that at some level, even micro, there is inherent order in a system. An airport might look like a manic place to most observers but it is a highly organised complex place with every person following a definite route and timeline. One has to acknowledge that within chaos there is a point where perfection exists.
In markets this point is difficult to find as so much of market movements are based on psychology and sentiment. If you break down the movements you see a tug of war between the traders going up and the traders going down. In a micro and short-term time-frame it seems like it goes both ways all the time but on a longer and medium time-frame the charts look quite ordered.
The challenge for most traders is to follow the long-term sentiment yet trade regularly in the short-term. The rapid and chaotic movements in the short-term stops out many people if the entry points are not chosen correctly. If we revisit the airport analogy the people who arrive early have a long wait and the people who arrive late often rush and miss their plane but there is a point right before it gets too busy about 1 and half hours before departure when the momentum gains and most people arrive at the check in counters.
This is when the lines can be longest, but the system is working at maximum efficiency to get the people on that plane. The deadline starts to loom and the authorities want to ensure that everything runs smoothly. This is the moment any accomplished trader should be getting into the market.
Early signs of a buildup of momentum. Most traders get there too early, get nervous and sell out or get there too late and miss the plane. There is a case for getting there early but this is wasted time as the plane may be delayed and the move may not happen for hours, days, or weeks.
The problem with most systems is that they bring you to the extremes. They are either lagging or get there too early. How many times have people made a trade based on the RSI only to realise it has floated up in the extremes for weeks. And how many times have people made a decision based on a moving average, just to see it swing back.
So the only indicator you really need are the key points and blockages. These are normally the pivot points where congestion starts to happen and markets get choppy and some indication that prices are moving and momentum is happening in a particular direction. If you use candlesticks this is when the small candles become long and solid in a particular direction. If you look at numbers you will see numbers start moving fast but predominantly in the same direction 4 forward 2 back 6 forward 3 back, that kind of thing. This is the moment to trade.
Be mindful of the longer term trend and realise you are on the edge of chaos. Things will start moving rapidly but the momentum has started the lines are building up and the people are moving. Just like in the airport. Go with the flow, don’t fight it. You will get there in the end.
Thursday 19 June 2014
Profiting from the fog of war
By now the whole world knows about ISIS. This seemingly invincible army of several 1000 marauding across Iraq tweeting and preparing glossy annual reports. They have been linked to every world power and have now replaced their brand new Toyotas with even newer Humvees. My first impression would be if they are tweeting and communicating and using brand new Toyotas, then surely we should know a lot more about them, then we let on.
The Middle East has always been the toughest region for analysts and journalists. Middle Easterners love drama and exaggeration. They will blame everything on some power or another and conspiracy theories are part of regular day to day reporting. Furthermore, to a Middle Easterner everything happens for a reason. The great powers have meddled in the region for so long most people see some grand imperialist plan behind every event.
I don't find it surprising that even the seasoned journalists are buying into these wild conspiracy theories. They sound good, sell papers and are great copy and paste material from regional websites. As a trader you can't trade on irrationality but you can profit from it, if you look through the fog of war you will see trading opportunities in every market.
The oil companies, aid agencies, and anyone that has to take rational decisions seem to be playing things down a bit. I am glad that the markets did not go into full panic mode. Ironically it is in times of crisis that the markets revert to looking at true fundamentals of the economy.
Iraq is clearly a failed state. It has been for decades. Iraq is currently Baghdad and the few well guarded oil facilities in the South. The much talked about refinery in Baghdad was predominantly for domestic use and a pretty inefficient plant, at that. Iraqi oil has been plagued by so many mishaps and has been on and off the market for so long that the Kurds seem to think they own most of it anyway.
The predominantly Shia Iraqi government and army pretty much allowed the Sunnis and Kurds to manage their own domains. They did not fight ISIS, because there was nothing to fight for. This a feudal, tribal failed state. As far as the Shia are concerned that is Sunni land anyway. If the Sunnis attack Najaf or Kerbala, things will change.
The questions that should be asked are, not so much who is behind ISIS but who will attempt to gain from this bizarre phenomenon and the latest twist in another failed Middle Eastern project. For the list is long and getting longer by the day, but I am sure the journos are already copy and pasting the latest conspiracy theory.
From a trading perspective the noise and trading opportunities are widely amplified by geopolitical activity like this. We saw that in Ukraine, as well. The initial movement tends to be quite rapid, particularly with the algos going bananas looking at ISIS Twitter feeds about world domination.
However hedge funds and regulators are far smarter then they used to be and a nod here and a few encouraging words normally sends the market in the direction it was going anyway or stabilises it.
It is hard to believe, just last week everyone was complaining about a lack of volatility.
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