Rhody Trader

Here’s what worries me.

No one seems to be talking about what kind of impact things like Cash for Clunkers programs can have. They create market distortions. Any time the government comes through and incentivizes something it does that. In this particular case I worry about what can be thought of like an ocean wave.

What I mean is that before a wave comes in the water ahead of it actually drains back into the ocean. Think about the tsunami witnesses who talked about how far back the ocean had receeded prior to the surge coming in. When people can anticipate something like this Cash for Clunkers program they will naturally hold off on their purchases until the incentive is available, if they have a choice to do so. That dries up demand prior to the program just like the ocean receeding.

Then the wave comes through when the incentive kicks in. By all accounts it’s a big wave going on right now given how the government is running out of money already. With a tsunami one can see the ocean receeding to get an idea of how big the incoming wave is going to be (or at least that it’s going to be a doozie). It’s a bit harder to do that with car sales in the full economy, but the size of the wave we’re seeing now does tip us off that there was a lot of car buying that was held in check prior to the program kicking in. Some of that is new demand incentivized by the pay-out, and some is demand that was just holding off on a purchase they were poised to make anyway.

And that brings us to the back-end of the wave. Where are we going to settle out after it passes? If the demand caused by the Cash for Clunkers program was mainly folks who just put off a purchase until they could take advantage of the pay-out, then we could expect the demand level to settle back in to whatever the normal replacement cycle level is in relatively short order.

If, however, a large part of the demand created by Cash for Clunkers is from people who would not otherwise have been in the market for a new car at this point – as I think is probably going to end up being the case – then we could see the repurcussions for a while. It will throw off the replacement cycle in much the same way all the technology upgrading in the run up to Y2K did during the early part of this decade (which I have always said was the biggest reason tech stocks got crushed).

Oh, and where do all these clunkers go? If they aren’t getting scrapped then we’ve actually got a net auto supply increase.

Yeah, right!

What we have in common is that we are both Wiley authors. I’m quite sure, however, that he’s a top tier guy that Wiley is willing to put some weight behind in terms of marketing and promotions. I, on the other hand, am basically left to plug my book entirely on my own.

But I have been invited to David’s book signing:

Come hear “And Then the Roof Caved In” author David Faber of CNBC speak on July 30 at the 5th Avenue Barnes and Noble. Stick around for a book signing following the talk.

The event begins at 6:30pm at:

Barnes & Noble 5th Avenue
555 Fifth Avenue, New York, NY 10017, 212-697-3048

Find out more at http://store-locator.barnesandnoble.com/event/61998

About the Book:
And Then the Roof Caved In skillfully explores the causes and consequences of the recent financial collapse. Written by David Faber—the award-winning CNBC correspondent—this compelling account is filled with the candid reflections of the people who brought the crisis to life. Expanded from the CNBC documentary that the New York Times called “broad, comprehensive, and compelling,” and that Frank Rich noted as “superbly done,” this book is a must-read.

I haven’t read the book myself – at least not yet. Maybe Wiley will send a free copy to one of their authors. I’m not holding my breath, though. Interestingly, the reviews on Amazon are barbelled – meaning there are a lot of 5s and a lot of 1s. I’m sure part of that is the usual celebrity bashing, but I’ll leave you to your own judgements.

Over the weekend (I think), someone uploaded a copy of the Trader video, the documentary from circa 1987 featuring the now legendary money manager and original Market Wizard Paul Tudor Jones, to YouTube. No, it wasn’t me, and I don’t know who did. Although I do own the video, I would never post it on YouTube or any of those sharing sites (so don’t bother asking). Obviously, others have no problem doing so.

Boy, did that create a storm!

I don’t frequent a lot of the apparently really popular market-related sites (as I’m finding out), so I probably don’t even know the full extent of how far things spread. I do know, however, that several very prominent sites, including at least one well known traders’ forum, had articles or posts which embedded the YouTube video. It made rapid progress from site to site – at least until the video got yanked from YouTube for copyright infringement at some point on Tuesday.

Still, the video was out long enough for a lot of people to give it a look, and the comments I’ve seen so far have been very positive, though there are of course the to-be-expected jokes about 80’s technology and fashions. I have always thought the video offered quite a bit of educational value for developing traders, and once upon a time used it in my college classroom teaching, but PTJ clearly has a problem with it being available.

The blast of interest in the video splashed on this website and my trading education one as well. Both sites had BIG jumps in traffic. Part of it was search based, which brought a lot of people to this post I wrote about 15 months ago, which shows up very high in Google’s search results. I got even more traffic to this post on my Essentials site. Part of that was search too, but that one was also directly linked to by several prominent websites because it includes the text from the back cover of the original video tape case. As far as I can tell, that turned Tuesday into the single biggest traffic day either site has had so far. That was certainly totally unexpected.

With the video no longer up on YouTube, the attention will no doubt back down to its normal underground levels, though I’m sure those who missed out seeing it will be eager to try to find a copy somewhere.

There’s been quite a bit of talk in the markets of late about a big drop off in trading volume in the forex market (Bloomberg, Kathy Lien). What’s interesting is that while global volume is down, trading volume in the retail forex arena seems to be on the rise.

Now, I’m not surprised that the broad measures of volume as reported by the central banks, etc. are showing a decrease. Currency market flows are predicated mainly on international trade and capital flows. With trade slowing, naturally the volumes are expected to come down as well. I had questions about whether the capital flow part was dropping too, though, so I looked to the only real volume proxy there is for the forex market – futures.

The chart below shows the weekly front month continuous Yen contract.

You’ll notice two things above. Firstly, volume in 2009 is definitely running well below where it was in 2008. Last year was probably close to 2007, though with much less variance from week to week. This year too is showing fairly consistent volume week to week, but the baseline level seems to be 30% or better below where it was last year.

The even more dramatic and telling thing is the clear downward slope in the Open Interest line. It’s been dropping for basically two years running now, giving us a pretty good indication of what’s been happening in the Yen carry trade. Right now we’re looking at OI running about a third of what it was this time in 2007. That’s a clear sign of less market participation.

I received a trading career email over the weekend.

Hi John,

I have recently began reading your book and this posed questions within myself. What makes a trader truly successful? Reading charts? partly so. Economics? I believe so. But more importantly the knowledge required to interpret the raw data &/or mews on a macro & microeconomics level.

Without this skill would be akin to a pilot flying without instruments? So I began looking for companies requirements of employing traders. They all seem to require a minimum of Bachelor in Business or Finance at university level.

My question is. To become part of the successful few would it be advisable to complete a Bachelor of Business or Finance?

Regards,

Darren D.

PS This book of yours has started me on a path.

I don’t claim to know how the programs of every university are structured, but as far as I understand it, most of them don’t specifically differentiate between a Business degree and a Finance degree. The latter is merely a subset concentration of the former. For example, I have a BSBA – a BS in Business Administration. My major (we still called them that back then) was Finance. I also have an MBA with a concentration in Finance. Again, Business is the degree, Finance is the concentration. So basically a Finance degree is the same thing as a Business degree (though not necessarily the other way around).

Of course traders don’t just have business degrees. Some of them have economics as not all universities offer business programs. Still others find their way into trading jobs from entirely different disciplines. It is probably that much easier going for a job in the markets coming out of a Finance/Economics program than something like English, though, for the simple reason that the programs in question are generally more geered to placing students within their field.

Having said all that, it could very well be what you do outside of your college classes which help you get your foot into the trading door. In my case, my understanding of technical analysis and membership in the Market Technicians Association went a long, long way toward landing me my first job out of college.

Be aware, however, that institutional trading is very different from individual trading. Recruiters probably are going to be less interested in your trading performance (unless you’re going to work in a position where you will specifically be running money yourself) than in your overall knowledge of the markets. This is even more the case with the first line of corporate recruiters who are HR people, not traders themselves.

I received an email overnight asking about some action in the options market.

Another blogger’s post today says that through 12:45 this morning the volume traded on SPY December $95 puts was 122,018 contracts, i.e. a $1.1 billion worth of underlying.

It has been commented before that a large number of institutional players would enter long positions in stocks once the S&P 500 closed above 950.

Could these large purchases of “portfolio insurance” be signalling such a move?

To answer the question, the sale of the options could certainly have been a type of portfolio insurance play. It was commented on CNBC this morning that this kind of sized put buying is something generally done by fund managers who want to protect against a sizeable move down. They wouldn’t buy puts to hedge against a smallish contrary move because of the cost involved. Those calls closed Thursday out at about $5.70, so they aren’t cheap. Futures may be a preferred way to go there in that circumstance, though there are different implications going with that alternative.

It’s worth noting that there’s a lot of open interest at a number of points in the September puts. Specifically, there’s more than 100k at each 5 multiple strike point from 75 to 90, with 135k at the 85 strike. Only the 100 stirke calls have 100k+ in open interest as of yesterday’s close.

The subject of Bollinger Bands was discussed recently on the VIX and More blog. I’ve employed the Bands for many years now, but not in what a lot of folks would call the classic way. I did research on volatility back in college with Bollinger Bands as the focal point and later published my first ever magazine article in Technical Analysis of Stocks & Commodities. I’ve done my fair share of testing with different ways of employing the Bands, but in the end I settled into using it to help me identify markets readying to make a move into a new trend.

One of the things mentioned by the Vix and More post is the idea of the Bollinger Bands supposedly containing 95% of the price action based on using a 2 standard deviation setting. John Bollinger himself has apparently indicated it’s more like 89% from is own research. My thinking is that a lack of understanding of the statistics of price action keeps people caught up in these figures.

Academics will generally tell you that it’s returns rather than prices which approximate a normal distribution (but as noted by V&M and others do not match it because of the fat tails). Regardless, the look-back period of the Bands don’t really include enough data to really draw much in the way of conclusions in any case. That’s why I’ve never really put much weight on where prices are relative to the Bands. I just use their width as a visual look at historical volatility.

A member of the forex analyst team I’m part of was injured in rather serious fashion last week. It’s bad enough that my employer – the IFR Markets group of Thomson Reuters – is looking to fill his position on at least a temporary basis. The proposal has been put forth to hire someone on a three month contract basis, though there is a chance that it could become something permanent, depending on how things fall out.

Basically, we need someone who can step right in without much ramp up time. The following are some of the credentials involved:

• Good writing skills
• Several years market experience
• Understanding of how short-term events impact price action
• Market contacts to pick up flow information
• Ability to work on a real-time basis
• Located in either the NYC or Boston area

While we don’t expect to be able to find a person with decades of experience as we’re losing, we definitely want someone with experience who understands the forex market well and can communicate what’s happening and what the future may bring to our primarily institutional readership.

If you or someone you know might fit the bill, please contact me at john.forman at thomsonreuters.com.

I just found out from an old friend that Emma Watson, AKA Hermomine from Harry Potter, will be attending Brown University in the Fall. In case you weren’t aware, I was a coach for the women’s volleyball team at Brown for six years. I can think of a few of my former players who would no doubt have found a way to befriend Emma had they been classmates with her.

I’m sure Emma will enjoy her time at Brown. The alumni I’ve spoken with have basically nothing but good things to say about the school. I, of course, had a somewhat different view of things. Not that I’m dissing the university in terms of its academics, which I would really have enjoyed as an undergrad. I did, however, have some serious issues with the way the administration – from the top on down – treated the volleyball team during my time there. I almost quit a few weeks before my final season there because of yet another thing they did. Maybe I should have given how that final season went, but it would have left the team in a tight spot.

Emma certainly won’t be the only high profile student on the Brown campus. There have been many and no doubt are several there now. I met Danny DeVito, his wife Rhea Pearlman, and their youngest daughter on a visit. They came to the volleyball office to talk about the team. The girl was never going to be a prospect for us, and she knew it, but Danny really got into the video we showed them of the team in action.

I’ve been involved in what you could rightly call a long-running project. It involves a neural net based trading system which a professor friend of mine has been very slowly bringing up to being something useful. Needless to say, if I were running the show things would have moved much more quickly. It being under the control of an academic, however, snail’s pace doesn’t even do the progress justice.

Anyway, he finally got something producing visible trading indications a bit over a year ago. The results were fantastic. It focused on stocks and was generating monthly portfolio gains in the 10% area and better. That didn’t account for what would be meaningful transaction fees given the trade frequency, but even factoring that in the gains were quite exciting.

Now, my big issue with all this was that we needed to produce a much longer and deeper back test to see how the system would do in alternate volatility environments. Meanwhile, the professor was fixated on reducing the loss %, which ran about 20%. I keep trying to tell him that in trading 80% is a good win rate, especially if your winners generally exceed your losers. He’s kept tweaking, though, eventually to the point where he broke something – not surprisingly, as far as I’m concerned.

Aside from the researcher’s need to keep improving things - which I understand – he’s got a metric that he wants to meet or exceed. To provide a quote:

Back to AT, the 5-6 papers / symposiums we attended were reporting error rates under 5%.  I can believe that because their models were superior to what we have created.  No surprise there becasue we just didn’t get back to the model building stage.  What they lack (and what we have to my surprise) is extreme creativity on how we (and other American firms) have built a self-managed AT system – in our case using basic micro parts.

AT means “auto trader”, in case you’re wondering. When he says “they” he’s referring mainly to European researchers, who apparently have an edge on us Yanks in the more quantitative aspects of finance. Error rates means incorrect directional calls – losing trades. What I don’t know is how the winning trades compare to the losing ones.

I keep trying to explain that it’s a question of expectancy and frequency (with transaction costs accounte for), not win %, that determines trading success. The effort to increase win % almost invariably reduces the ratio of size of winning trades to losing ones. At some point it usually means tipping over the edge into declining performance.

Hopefully one day we’ll actually have something we can put into productive use. In the meantime he wants to help a student do some parallel work on the forex side.

At least I’m not dealing with one of the professors who believes his knowledge of financial theory guarantees him of trading success. Those kind of arrogant academics often fine themselves getting bitch slapped by the markets.