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Gaining a Trading Edge by Thinking a Few Steps Ahead

Alexander P Morris — Sat, 07 Apr 2012 00:55:48 +0000

In late 2011, once the market bounced off its early October lows, there was increasing chatter over how it’s probably too early for a real full-blown European debt crisis at that point in time, and how the “powers that be” would likely run the market higher into the new year. But, the real “tell” would be how the markets behaved come the new year, and that’s when all hell would likely break loose all over again. I too began to think that while the rest of 2011 may lead to a good bounce in the markets, early 2012 could bring back some real turmoil.

Then a thought struck me. Between all the blog posts, newspapers, and television media pundits calling for a “let’s see how January goes” moment – hey, even I myself was thinking the same thing… What if, with all of us worrying over that same possibility, January turned out just fine – a perfect “non-event”? And heck, even Ben Bernanke was probably worried about the new year, and we all know what that leads to: more cheap money and credit would likely be dumped right back into the markets at the first hint of trouble.

So as 2011 came to a close, while I did sell a few positions just in case, I decided to leave most of my longer-term positions as is. And, while hindsight is always 20/20, that did turn out to be a great decision. Of course, we never know for sure, and that’s why traders and investors must consistently practice sound risk management. One must always protect against the times we miss. And it not only serves to protect and preserve your bankroll, but it also helps provide the clarity and peace of mind necessary – an edge in itself – to properly consider and evaluate the information available to you. Worrying if your over-leveraged position might blow up in your face is not going to help you make a smart decision.

Traders and investors alike must always be open to taking every piece of relevant information into consideration, including our own preconceived notions and biases. As Ray Dalio of Bridgewater Associates once said “I constantly want to know what I don’t know. I want to know when I am wrong. And it helps when someone points it out.” While it certainly helps if someone else points it out, we can also objectively look at our own thought process, feelings, and emotions and consider how they too may be wrong or dangerously biased. This in itself becomes part of a valid trading edge. Everything counts, and we are often our own worst enemy in most endeavors we pursue. As in playing chess or poker, those players who patiently take a step back in order to “see the bigger picture” and contemplate the best moves will, in the long-run, always triumph over those less savvy players just itching to make a move.

We should always ask ourselves what do other traders think they know. What are they worried about or afraid of and to what extent? Am I starting to feel worried or nervous myself, and are these thoughts rational and based on sound reasoning? There was a great line in the movie Margin Call when CEO Tuld (played by Jeremy Irons) says “It’s not panicking if you’re the first one out the door.” Granted, no one (and no firm) should ever be leveraged to that extent in the first place, but from his “clear” perspective the mortgage game was up. And you certainly don’t want to be the one panicking out at the bottom of a move, with or without margin calls over your head.

Am I afraid that if don’t buy some stock tanking like a “falling knife” right now, I’ll miss the huge bounce coming right around the corner? Is it possible many other traders are thinking the same way? The reality is that it’s rarely “too late” to get a better price when buying into a crashing stock. When the price action settles down, stabilizes, and starts to rebound, the stock will probably still be priced below your initial entry. Sometimes our own feelings can give us strong clues as to what the “crowd” is thinking as well. There was no need to predict ahead of time that October 4^th, 2011 would be the low of the last crisis and panic. However, through awareness of our own feelings, astute observation into the collective thoughts of others, and by watching the price action in relation to the current headlines, we are continually provided with clues as to what is more likely to happen next. For example, each time new headlines appeared about Greece and its debt problems, the chatter they generated seemed to lead to increasingly complacent market action and behavior. There would be short-lived dips that would quickly recover, as if no one really cared any more.

And more recently, how has the market reacted as we’re hitting new multi-year highs? Ironically, the VIX (fear) index (and even more so, the publicly traded VXX index based on the VIX futures) has been acting more fearful of a potential coming crash the higher the market goes. Markets don’t generally crash right after making new highs, unless they’ve just gone through a high-volume blow-off top. I recently read a study analyzing future market behavior when there are strong upward moves in both the VIX/VXX and the overall market in the same day. The study showed that it has lead to even stronger upward price action in the near future. And so far in 2012, that’s exactly how things have played out in the market. But human behavior is not rational, and memory of the recent volatile past is still imprinted in traders’ minds. So with each new high in the market, traders buy the VIX products expecting a crash that never materializes, and are then hit over the head with some of the highest levels of contango (the huge cost of rolling over current futures and options contracts to the next month) the VIX market has ever experienced. And of course, traders are also greeted with another leg up in the market as well. Never has it been easier for me to explain or visualize the term “climbing a wall of worry”.

In reality, it is the unexpected shocks that lead to the most “real” fear. Especially where credit and leverage is concerned, it is these quick shocks that are most likely to catch firms (such as MF Global) unprepared and caught with their pants down. But the more time that goes by with an event in the forefront, the longer the world has to deal with it, adjust by preparing for the worst, and “get used to” the new norm. Just remember back to the Japanese nuclear crisis, the BP oil spill, or even more recently, the fears over a massively understated Greek CDS credit event once the ISDA declared the Greek bond “re-pricing” a credit event. Banks, governments, and central banks have now had upwards of eight months to deal with the possibility of messy CDS defaults. While there were some pundits calling for the possibility of three trillion dollars worth of losses versus the three or so billion claimed, it was likely that “the powers that be” had all the time they needed to deal with these issues. And, believe it or not, the ISDA CDS auction also came to pass without incident. That’s not to say there aren’t plenty of roaches crawling around everywhere. But just as Countrywide Financial and Morgan Stanley were rolled into Bank of America to perhaps conceal a much worst debacle in the sub-prime mortgage market, the “powers that be” have likely had enough time to take similar measures to deal with any more potential blow-ups in the Greek bond market (well, at least for the time being).

In conclusion, always consider all the information available to you, be aware of what you don’t know, and consider where you might be flat-out wrong. Seek to develop the focus and patience to position yourself in the best possible way, as opposed to merely trying to capture the next small wiggle. Instead of missing out or being incorrectly positioned, you may provide yourself a much better chance to capture a nice chunk of the real move about to appear just around the bend.

On Being Contrarian, don’t fight the crowd just for the sake of it

Alexander P Morris — Thu, 20 Oct 2011 22:43:33 +0000

(RobertSinn) Being a “contrarian” in the markets has become quite popular recently. Many market participants seem to think that they must be smarter than any group of other market participants who share the same view. The logic goes something like “if everyone agrees and thinks the same thing then they cannot possibly be correct”- I believe this notion of contrarianism is very dangerous.

Full Story: On Being Contrarian (RobertSinn)

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.” — Benjamin Graham

Martin Armstrong on Market Predictions and Objective vs Subjective Analysis

Alexander P Morris — Wed, 11 Nov 2009 08:01:52 +0000

Martin Armstrong is the author of the Economic Confidence Model based on an 8.6 year business cycle theory inspired by the work of Nikolai Kondratieff. Two years ago, the cycle once again accurately predicted the peak of the last economic cycle years in advance. February 26, 2007 yielded some of the tightest credit spreads ever (easy access to credit), and the housing market had already begun its sharp decline.

He is currently in prison, indicted in 1999 on charges of defrauding Japanese investors. His trial would have made more sense had it taken place in “Alice in Wonderland”. Without getting into all the details here, just the fact that he was in jail for seven years for contempt of court should be enough to make any American cringe and wonder how that’s possible in the great ‘ole USA. He finally caved in and plead guilty in 2007 to the fraud charge. In return, he was given an additional five year prison term in addition to the seven he had already served! Now, if this were any ordinary American schmo, perhaps he could be written off for one reason or another as just another guy with a crazy “they’re out to get me” sob story. However, when you look deeper into the facts, and then consider that Mr. Armstrong was also one of the most respected financial research advisers to scores of powerful figures from central bank executives to heads of multinational corporations to heads of state, it really makes you wonder what’s going on with the “Rule of Law” — the real glue that holds our country together. Armstrong even authored the most insightful and thorough analysis of the 1929 crash ever assembled on behalf of the Reagan administration in the ’80s.

From his jail cell, Martin Armstrong continues to write some of the most insightful and interesting essays I’ve come across on a variety of topics from market cycles, to rule of law, to the history and cycles of politics and war. Since he has access to little more than an old typewriter (and no whiteout), you must understandably have a bit of patience with his “what I’m thinking about now” writing style. Would I be showing my age if I can still recall the nightmare of using a typewriter for school papers? It’s horrible.

Regardless, I’ve learned more useful knowledge about world history (and our own history) from Armstrong’s essays than I ever learned in school. And it’s more fascinating than you can even imagine. Everything’s been done and tried before. And here’s some food for thought… in the six thousand or so years of civilized history, can anyone find one example where socialism actually succeeded with a happy ending? But I guess that’s why most politicians don’t bother to learn any of history’s lessons. It would just interfere with their agendas and other questionable motives.

The following text is an excerpt from Martin Armstrong’s latest essay entitled “Objective vs Subjective Analysis” (pages 10-12). I’ve also taken the liberty of making some small corrections here and there to make the text more readable while still hopefully maintaining Mr. Armstrong’s full meaning and intent.

(read more...)

Manchester Inc. – trading the amazing stock that doesn’t go down – and what Amaranth should have known

Alexander P Morris — Thu, 05 Oct 2006 22:00:00 +0000

Manchester Inc. (OTCBB:MNCS)… Manipulated? Controlled? The price action is unbelievable and such perfectly steady moves are nearly unheard of. What can we all learn from not only this freak-of-nature opportunity, but from the Amaranth hedge fund blow-up as well.

Be sure to check out the Notes/Transcript section for updates on MNCS… It doesn’t go down… until it finally does… then watch out! Remember Jesse Livermore’s old adage, when the markup’s over, it’s reeeealllly over.

Inflation and Excess Taxes: The True Hidden Enemy of Savings

Alexander P Morris — Sat, 03 Jun 2006 22:00:00 +0000

Taxes Taxes Everywhere and how our wallets did shrink… Even our Savings are Taxed, and in time it won’t even amount to a drink.

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admin — Mon, 27 Mar 2006 03:43:37 +0000