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.

• 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 ?

Contrarian Trading: Where perception meets reality

The moves in the market, now, reflect an interesting market dynamics. The Euro-zone continues under performing and the US economy is sputtering to life. The hype surrounding economic recovery  is  based on a market perception that has been fed with European and Japanese financial stimulus and US Quantitative Easing.  As the US starts to  taper the Euro-zone picks up the baton and runs the  printing presses at maximum speed.  Things are not right economically , but we follow the traders not the economists.  Economists and politicians love a nice bull run.  Traders don't  care as long as something, somewhere  is moving.  

Markets  are about perception, much of it is not real or connected to reality. The futures market is exactly that, a perception of the future. There are many perceptions of the future. Which is why people bet against each-other. You cannot compete with someone else’s perception of the future, you have to create your own. Furthermore, even though individually people tend to be rational we have seen, in history, as a group they become completely whimsical. The psychological make-up of the market is more akin to a panicky impulsive 4-year-old then a grown up.

If you follow the US market all you have to do is look at the S & P or Dow. The Dow regularly falls over 100 points and regains it based on the flimsiest pieces of news and conjecture. In the modern era where 60 % of trades tend to be through computers and neural networks trading has become much easier.  People may pretend that these algorithms are super complex but the reality is that most of them just look at the prices of a few different instruments and some key Twitter accounts. They look at correlations between certain markets and also filter out key keywords from news sources and then place trades automatically. 

They react. They are not really neural and clearly cannot predict much. In fact their power of prediction is far worse then human traders. However, they trade better because all the emotions associated with human traders have been taken out of the equation. 

It is true, there are the High Frequency Traders and some people who are privy to inside information, but that is nothing new. If anything,  inside information is pretty useless as one cannot predict how the market will react to it. Good news can be bad market and so forth. So how does one trade against these mechanical monsters ?

It is pretty clear if you are a regular market follower. The old adage about trends being your friend is great if you are trading on the daily, weekly and monthly charts.  A yearly chart of the US/Yen looks very tradeable but on the smaller time frames this is madness.

High Frequency algorithms, neural networks are inherently linked to the human psyche but magnify our emotional problems. They panic buy and panic sell based on a few keywords. They muddle up correlations between currencies because the people who design them hide behind formulas and equations not the truth about markets. It is for this reason that, after the sub prime crisis, the human traders in hedge funds have a habit of turning them off and trading manually when things heat up.

Do your research, and use your system but when the market goes crazy don’t blame it on the computers, dust off one of your nice contrarian strategies and make money. There are many effective strategies based on divergence. Once you start using them you will see divergence everywhere.

Trading divergence is the modern betting against the panic. It is a tough call and not for the faint hearted but as Hyman Roth said in the Godfather II when his associate Moe Greene got a bullet in the eyeball: And I said to myself, this is the business we've chosen.

The Grey Zone

This has been  a month of  great moves. All month the financial media has been talking up a massive fall in the US markets yet the SP and Dow have been racking up record after record. How do we reconcile the vast ocean that separates perception and reality ? We have been told  every day that traders  are shorting the market, yet 100s of points later the market is still rising and will most likely continue to climb.

This is a  phenomenal  learning curve to experience for any trader that sincerely believes the rubbish that comes from analysts and financial  journals.  The market will eventually  fall but in the interim it will  wipe out every short contract in iits way. Believing in the hype and calling tops or bottoms and preempting changes  in market  direction is a brokers wet dream. No sane person attempts that unless they have vast amounts of margin capital or  inside information.

In the age of computers, algorithms  and vast  permutations the simple  trader that trades accounts under 10 million dollar is safer  following the market. He gives up a few  pips at the top  and a  few pips  at the bottom but  he makes  that up in not getting snowballed for weeks on end my  market makers that are happy raking in massive amounts  of margin calls on short positions.

The Noise trader approach where you  piggy back on the larger market moves and stay in as long as you can until there is a turn in sentiment has been the preferred trading method for many of the most succcessful traders.  In fact it was so effective the famous Mr Summers wrote a paper about it.  Check out the paper below on Noise trading. And see if it works for you.


The Noise Trader approach to Finance
How Noise Trading Affects Markets: An Experimental Analysis