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.

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. 

The new paradigm of trading and politics: Follow the noise

There was a time when to succeed in the developing world you needed a flag, a carefully marked out border, an airline, and a despotic leader with lots of foreign bank accounts. Before that time the world  was pretty much a feudal realm with lots of self appointed leaders.

The recent events in the Middle East show us a new acceptable form of global politics. Random territories, controlled by different groups with conflicting sectarian and tribal links. Borders that are nonexistent or highly porous. Armies often number in the hundreds and drive around in Toyotas, pillaging, and massacring.  The so called authorities hide in massive fortified citadels protecting their oil.  Has anyone ever seen Mad Max, or Game of  Thrones.  This  is a mix of the two.  Ironically, Iran is  now seen as saviors in this mess. The pariah state condemned by most of the world has gone full  circle.  How bad are the baddies, when Iran is a goodie ? 

In a world of high tech gadgetry, can a couple  of 1000 lightly armed men with no air-support really take the world hostage and cause a panic in the oil complex. Then there are the Kurds.  A nation that spans four geographic countries, that has  no real  state but now has the capacity to negotiate and sell its oil in the open market and pretty much do anything it wants. In the middle of this, real nation states like  Iran and Turkey struggle to cope with the enfolding crises and somehow get condemned for not following global political and human rights norms. The ultimate questions are being asked and not answered.  Were we safer in a world with the likes of Saddam Hossein ??? Who knows.

This is the brave new world  of the high frequency traders, super speed news. A world where we can lose an airplane but can locate our Ipad at the touch of a mouse. Its a new  world for politics, but also  for trading.  Most independent traders still look at systems and use indicators. 90 % fail. At any particular moment 10% are succeeding and a few percent are doing rather well.  What do the 10%  do that is so  successful. They wait,  they don't trade. Not trading is your best  trade. They play Poker. Hang out with the kids  and keep  a very close eye on things.

They know what moves the market. A  market is never over bought or over sold.  It is at exactly the right price in that moment. Indicators on most  instruments have been over-something for days or months with no reversal.

They just wait. The most difficult thing for a human being in the age of action. Waiting  And when the small band of pirates run towards the oil, or when the Bank of  England dude talks up the pound or when some random correlation signals a black Swan in a market. they move. With all their available resources. Intensity that you can not believe and an unsurpassed conviction in the trade. You cant  really get that conviction with a lagging moving average. The 90% lag and fail, like their indicators.  Like the hooded guy on the Iraqi border. They go as fast as they can wiping out all the stops along the way and clearing the table. Then its back to the drawing board.

Now,  don't get me wrong, all this requires a ton of preparation. Sure you look at the charts checking out  Fibonacci,  Ichimoku and other exciting, colorful names from the last  millenia , but do they actually trade on it, unlikely. Its funny how oil  really  did not go  up  that much after the ISIS  business,  but it went up quite a lot in the weeks  before. There were no secrets, all the info about the impending madness  was a Google  search away. The eagle eyed algo or the able trader pieced it all  together. Everyone else was saying oil was overbought 2 weeks  ago. The 90%.  That is the new paradigm of politics and of trading. By all means, follow the noise, it is louder than ever, but enjoy the quiet, while  you wait.  

For more on poker and patience check out the aptly named Mercenary Trader link



      

The ISIS axis. Middle East's new power brokers

With the militant war raging in Northern Iraq  it seems  like the crazy plan  of containing the Syrian civil war has finally failed. The total inaction in Syria for the past 2 years has led to the training and arming of a large army of  battle hardened over zealous militants that now threaten to spillover into the rest of the region.

With Syria largely  forgotten and with no great prize  apart from a desolate wasteland the militants are moving to plan B. Even the name ISIS could have been apt for any James Bond nemesis.  Like any great movie the sequel has to have far more action, bigger explosions and involve the whole world.

ISIS is heading directly for the Iraqi  capital  and the oil fields of  Southern Iraq. ISIS's  timing is bizarrely perfect. With an America that doesn't seem to have an appetite for war and an Iran that is bending over backwards to seem nice, the vacuum in the region leads nicely to the doorstep of  Saudi Arabia.  Of course, you do not bite the hand that feeds you, so Saudi  is clearly the final  frontier for ISIS.

The only  questions that remain is will  Iran still  pretend to be nice or will ISIS wind them up enough for them to unleash their full insurgency in Iraq.  You can just imagine the fuming IRGC generals sitting  on their hands and gritting their teeth. It wasn't  a long time ago that Hezbollah and the IRGC were the most  feared insurgency in the Middle East.  Those days  have long gone.

Oh yes, there is  one more question.  The Kurds are remarkably quiet in this little war. Could there be a tacit  agreement between the Kurds  and ISIS to carve up the area.  That would  be a  formidable  force.  The Kurds are historically some of the most accomplished  and battle hardened fighters in the region. They also sit on a nice patch of oil rich land.  This is one hell of  a sequel  waiting to  happen.  And by the way , if you were thinking of  shorting oil and a nice quiet summer forget it.

OPEC: Counter hegemon or lame duck

How  many of  you  remember the imperious personality of Sheikh Yamani ? The suave Saudi Minister of Oil and powerful OPEC delegate for 25 years. There was a time  when the whole world held their breath every time OPEC met. The meetings in Vienna became such a global media spectacle that the infamous Carlos the Jackal took the OPEC ministers hostage in 1975 to  further his dubious cause.

The world has indeed changed. Even though Saudi Arabia is still  an oil powerhouse and the Straits of Hormuz still have strategic value, the emergence  of powerful  non-OPEC oil  producers and the collapse of the OPEC administered pricing system in 1986 ushered in a new era in oil pricing. The nail in the coffin for OPEC was the United States's Strategic Petroleum Reserve and the US energy self sufficiency doctrine that has emerged. This led the US to invest  heavily  in the technology to produce shale oil and alternative energy sources. The notion of Peak Oil, so  popular just a few years ago  has been banished to the scrap heap.

The  real  challenge for  OPEC is not setting oil ceilings and controlling prices. That power shifted from multinational oil companies in 1950s and 1960s and OPEC from 1973 to 1986 to the so called market. However, the international market for trading oil is a fragmented beast that involves many diverse private and public entities. This includes investment banks, hedge funds and retail investors, including private investors and high net worth individuals.

The futures markets attracts a wide range of financial players (pension funds, hedge funds, index investors, technical traders, & retail investors). Concerns that these financial players & their trading strategies could move the oil price away from the true underlying fundamentals has alarmed many governments and regulatory authorities.

With large private  oil companies and national oil companies virtually powerless to control oil prices and a world that can function with relatively high prices the OPEC countries have been happy to sit on the massive windfall and the enormous budget surpluses  that have resulted in Middle Eastern sovereign funds buying whole neighborhoods in London and Paris.

In short OPEC fell from its lofty position, as the only developing world entity that could  stand up  to  the hegemonic power of globalization, to an embarrassing quango  with very little  teeth  and firmly in the pocket of what we loosely term the market.

Even within the elite club the grand vision of the Shah of Iran in the 70s  and the war mongering Saddam in the 80s have been replaced with dithering leaders and a dilapidated and fragmented oil complex that is in need of new technology and fully  dependent on Western companies to function. Iran is the only country that has tried to run its oil industry without too  much outside influence.  But this has led it to halve its export capacity and practically eliminate any influence it had in OPEC.

Will this scenario change ?  The simple answer is no. Running a Middle Eastern country is a difficult  job, with very little job security. Qadaffi, Assad, the Shah of Iran,  and Saddam Hussein can vouch for this. Middle Eastern leaders know  the oil price will not stay this high forever. One day there will  be too many Teslas to  warrant a 110 dollar oil  price. At that stage the status quo will  remain in perpetuity and the Middle East will again become the forgotten route between East and West, the Silk Road.