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.
Showing posts with label volatility. Show all posts
Showing posts with label volatility. Show all posts
Tuesday, 24 June 2014
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.
Wednesday, 4 June 2014
Volatility conundrum
The key ingredient that moves prices is volatility. Demand and supply, creates a market but price volatility moves it. In the past few weeks volatility has been scarce in the commodities and index markets. Volatility in forex has fallen significantly in the past few years. This development does not bode well for hedge funds which thrive on volatility. However, they are partly responsible for pulling the plug on volatility.
Many of the complex algorithms used by hedge funds depend on a number of interlocking variables that provide regular winning trades again and again. The success of the algorithm is the consistency and the fractal nature of markets. Whether they bet for 5 minutes or 5 months they will ensure a steady return.
The drawback of algorithmic trading is the inevitability that markets change over time. In the past hedge funds have been burned in moments of market change. This time they have learnt from the failed lessons of the past and have pulled the plug on the algos. Most traders are sitting on their hands. Maybe they are waiting for the World Cup to finish. Maybe there is some significant news around the corner that we are not aware of. The only real movement seems to be in treasuries. Who does that benefit ?
Many of the complex algorithms used by hedge funds depend on a number of interlocking variables that provide regular winning trades again and again. The success of the algorithm is the consistency and the fractal nature of markets. Whether they bet for 5 minutes or 5 months they will ensure a steady return.
The drawback of algorithmic trading is the inevitability that markets change over time. In the past hedge funds have been burned in moments of market change. This time they have learnt from the failed lessons of the past and have pulled the plug on the algos. Most traders are sitting on their hands. Maybe they are waiting for the World Cup to finish. Maybe there is some significant news around the corner that we are not aware of. The only real movement seems to be in treasuries. Who does that benefit ?
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