Weekend at Bernanke’s 2

A pair of losers try to pretend that their murdered employer is really alive, but the murderer is out to "finish him off”. No, the losers are not Andrew McCarthy and Jonathon Silverman; they are Ben Bernanke and Barak Obama. And it’s not a corpse they are propping up, but a lifeless and morbid economy that is about to finish off the markets and what’s left of America’s wealth.

The original “Bernie “ film, although premised on a  ludicrous story line, was actually funny and a box office success. As with Bernie 1,  QE1 was "successful". It created artificially low interest rates and along with the fiscal stimulus, it enabled and forced capital to flow toward riskier assets. With risk mitigated by an acknowledged Fed put and a low yield environment that offered minimal returns on safer assets, the market responded with a 83% rally in the SPX off the March 2009 lows.

However, QE2 the sequel, appears destined for box office failure. While the original “solution” may have propped up the market the first time around, investors don’t seem to be buying into the story this time around. In spite of record low yields in the bond market, investors are staying away from risky assets, and are hunkered down in the perceived safety of treasuries, commodities, and gold. 

Investors realize the current “recovery” is unsustainable. While the U.S. and the rest of the world markets have experienced a bounce, industrial countries remain below pre-crisis levels of GDP, wealth, and employment. The bounce has not translated into the type of job creation and corporate investment, we would normally see during an economic recovery.

The U.S. economy is still experiencing low to medium growth, and deteriorated public finances, and is now going to be facing greater government regulation and higher taxes. Consumer confidence is abysmal along with the the housing market, and the money supply continues to shrink, leaving both the domestic and global economies  vulnerable to more  financial instability.

It is under this context that the market rallied Friday, following Dr. Bernanke’s speech in Jackson Hole. However, there are a confluence of technical indicators that suggest this rally may be as short lived as all the other rally attempts of late.

There is a downside gap overhead in the SPX that is filled at 1067.08, along with the 9MA at that same level, which provides the closest level of resistance, and a multitude of other factors that  lead to a high probability  of  the market trading lower, which Rennie Yang discusses on his “ Market Tells” site. I am planning on coverings my longs from Friday afternoon at 1073.25 against the R1 pivot on Sunday evening, and waiting to reassess the market tomorrow morning.

MIDDAY MARKET MEAT - THURSDAY - 08/26/2010

Market is setting up for it's 2:00 PM move , after a FBO of the H&S neckline. E-minis never broke above the 500MA which was needed for confirmation and subsequently sold off, but held the high of value and the pivot, and is  now trading below the opening range, 200 MA, 100 MA  and. VWAP.

Support is the pivot at 1050 .75 and primary resistance is  at 1055.25. Cumulative tick and cumulative adjusted tick just made new lows which indicates willing sellers and a break down to 1044.

HEAD & SHOULDERS BOTTOM

There is a potential break-out above the neckline of an inverted head and shoulders, with a minimum measuring implication of app. 20 points. However, the market needs to clear the 500MA at 1064.00 for confirmation.* CLICK ON CHART TO ENLARGE

The Path To Success

Along with filling my tires with air and my tank with gas, I always wash my car before embarking on a road trip. Not only is a clean machine more pleasing to the eyes, but a clean windshield is more transparent to the eyes. This pristine condition however, is about as ephemeral as the freshly filled tank of gas. Between the smoke and dirt, to pollution and oil, it is amazing how quickly, dirt and gunk can collect on a clear windshield and morph it into an opaque sheet of glass. Even after, I generously apply my spritzers, I cannot attain the level of transparency I had achieved at the car wash.

Just like car windows, we go through life, and as we progress, we all collect some level of gunk on our souls and subconscious minds. This gunk consists of misinformation, prejudices, conflict, trauma, and myriad other experiences, that form negative layers on our psyches. These layers form an opaque film, that prevents us from seeing the world in the way it truly exists. And being unable to see reality clearly,  will severely limit  one from fulfilling their true potential. 

Enveloping us, this obscuration and its destructive effects, are often exposed and magnified when trading. Negative habits and emotions cause more trading losses, than misreading a chart or misinterpreting market fundamentals. It is often said that the eyes are the window to the soul, but anyone who has ever traded,  knows that trading can expose one's weaknesses, and open up a Pandora's box of vulnerabilities, that are there for all to see and quantify.

The only way traders are able to shed this fabric of filth is through self-discovery. You can read as many books on trading  as you desire, and create new indicators and ways of looking at, and analyzing the market, but if you don’t look at, and analyze yourself first, it will be difficult to find success.

The road to self-discovery inevitably leads to the path to success, but you must first be able to chip away at the layer that obscures your vision and clouds your view of the road. By determining and eliminating your weaknesses, negative habits, and negative emotions, you will then be able to trade with a clear head and clear vision.

One of the reasons I enjoy writing, is that allows me to express my feelings and emotions, and vent my frustrations in a positive way. It not only also forces me to think about what is happening around me, but also what’s happening within me. It is my path to self-improvement, and it helps provide me with guidance and direction throughout my life, and my trading.

In his book The Daily Trading Coach, Dr. Brett Steenbarger writes about the importance of keeping a cognitive or psychological journal, along with an educational and trading journal. He place equal importance on all three categories, but recommends beginning with the educational, following with the trading, and progressing to the psychological.

The idea is to use the cognitive journal to keep a real time record of what you're thinking and feeling while you are trading, so that you can become a better self-observer. This helps you to identify problems as the occur, so that you can keep them from affecting your trading.

His suggested progression is logical because perfecting the psychological skill is the most difficult one to achieve. Traders not only have to learn what do correctly, but have to unlearn bad habits, and deeply embedded negative emotions. 

My best practice calls for writing in your journal first thing in the morning, describing exactly what’s on your mind, and what is troubling you. This initiates the process of purging your negative emotions and clearing your mind,  allowing you to be focused  for the remainder of the day and the trading session.

Acquiring the knowledge of trading mechanics, tactics, strategies, and risk management is relatively easy and a finite process. Developing the mental skills of focus, discipline, objectivity, and self- confidence is much more demanding. In fact, it’s the one area of trading performance that is a continuous learning experience, and for some a continuous struggle.
 

For the most part,  electronic traders are all participating on a level playing field. They all have access to powerful computers, large band-with, the same front ends and pipes, and resources. The traders that rise to the top, however, are the ones that have achieved mental mastery along with trading expertise. They have found a way to clean that gunk off the window, and obtain a clear view of life, the markets, and themselves.

BEFORE THE BELL- MARKET MEANING 08/20/10

ES 09 10 is currently trading pre-market below yesterday's low of 1068.50, below the VWAP, well below the 200MA, and below value, developing value, and below the S1 pivot. Bonds traded higher last, and the euro sold off (dollar rallied). Resistance is at 1068.50 and 1071.00, and the S2 target is 1063.58. There are no major economic reports today, and the path of least resistance is still to the downside.

MARKET MATTERS - MIDDAY MARKET MEAT - THURSDAY 08/19/2010

E-minis sold off from their overnight highs at 1095.00 on the Initial Claims report, and then pulled back to the 100MA - 200 MA cross just after the opening, and out the bottom of the opening range for a 20+ handle free fall down to 1068.50.
Today's range is already 1.75X today's Initial Balance. If the market were to extend it's range 4 pts.to the downside, the range would be 2X the IB. On any given day there is a 37% chance of that occurring. But considering today is shaping up to be a trend day down, it is highly likely we extend the range lower, and close near the lows.

MEMOIRS OF A FLOOR TRADER

Growing up in Chicago and getting a job as a teenager at the one of the futures or options exchanges, was like growing up in L.A. and getting a job at one of the movie studios in Hollywood, or perhaps like a kid coming of age in Brooklyn and finding work on Wall Street. When I started my trading career in 1971 at the Chicago Mercantile Exchange, working at the exchanges wasn’t quite as in vogue, as it would be a decade later. Of course now, the floors of the CME and CBOT are one in the same, and ironically, trading is primarily done electronically.


One would think that having spent my entire adult life either working at the world’s largest futures exchanges, or being an independent trader in the world’s largest futures pit, that I would have been adequately prepared for screen based electronic trading when I retired from the floor. In part, my previous experience was beneficial, and in part it, my years at the exchanges inhibited my transition to screen based trading and prohibited my potential future success.


A popular misconception is that floor traders, were exactly that...traders. In fact, the majority of us were not. Some of the guys in the bond pit didn’t even know what treasuries were, or didn’t know a head-and-shoulders, from a double bottom. Most of the locals on the floor, were market makers. Our job was to make a two sided market for the brokers, taking the other side of both retail and institutional orders. Without the local independent trader, there would not be sufficient liquidity to facilitate the customer order flow.


For taking the risk of providing liquidity, and aiding in the process of price discovery and risk transference, the local was afforded privileges, that non members of the exchanges were not so lucky to enjoy. Of course, this created an extreme advantage for the local trader and created a very unlevel playing field for outside customers..


There were certain perks that were shared universally by all members, such as a very favorable commission structure, with a yearly cap that was usually reached within the first few months of the year. For those who “demanded the edge” and didn’t step out on trades, they got to buy on the bid, and sell on the offer, and to varying degrees everyone had a “look” at the order flow. In essence we were making the market and the market information flowed out from the exchange; not the other way around.


Where you stood, whom you stood next to, and which pit you traded in, in most instances had more to do, with how much much money you made, than how good of trader or market maker you were. I stood next to a couple large “order fillers” with retail decks, but I also knew who the brokers were that were filling Goldman’s, PIMCO’s, and other institutional orders.


Obviously, you didn’t want to be on the other side of one of those big institutional orders, you wanted to be in front of them. Conversely, you did want to be on the other side of the retail orders, as they were more likely to be wrong, and more likely to place their stops at bad levels. The advantages and edges that were intrinsic to being a member of the exchange and a floor trader did lead to some questionable practices, at times. Ironically, most of the toxic algorithmic techniques you see today, were first manually practiced by local traders in the pits.



Standing next to a broker meant you had “something to lean on”. If the broker was bidding for size at a certain price, and you could buy it elsewhere in the pit, you could then lean on his bid. If the market started to trade heavily on the bid, you could hit the broker’s bid and scratch your trade, and if the market turned you could easily flip.


Irrespective of all these advantages and various other edges, if you were not disciplined and practiced good money and trade management, you would still get your ass handed to you, just like anyone else. It still boiled down to limiting your losses, and milking and adding to your winners. If you traded a large enough sample, let’s say a 100 a side and you scratched half of them, lost a tic on 15 of them and made 1-3 tics on the remaining 35, you could easily make $1500.00 after commissions and exchange fees. If you were disciplined you could do this 5 days a week 50 weeks a year, and if you wanted to take more risk, you could increase your size to scale, and make multiples of this amount.



So naturally, one would think that after having been a pretty successful trader for all those years, the transition to electronic trading would be easy and natural. Well it was and it wasn’t. Luckily, I had always been a student of the markets and technical analysis, and not only made a market in the bond pit, but position traded, and traded options. I understood the markets, I knew how to interpret charts, and I was even one of the first locals to try Pete’s funny looking Market Profile. Nevertheless, the transition was very difficult, and when I first left the floor I spent the first year trading Steve Schonfeld’s money and not mine.



Discipline, trade management, and money management were not the issues affecting my progression to a successful screen based trader. However, over trading and interpreting the price action, sans all the feedback I had taken for granted over the years, were 2 of the biggest problems.



While trading on the floor, commissions and execution slippage were not issues, so you could trade as much as you liked. In addition, you could “feel” and see what was happening. I could easily tell if the pit was long or short, and I could clearly determine what the commission houses were doing, and if there was any institutional buying or selling. It was all there for me to see. With electronic trading, it was all gone.



After quite a period of “ deliberate practice” I am starting to feel that I have reached the level of expertise I enjoyed on the floor, albeit not the consistency. I had so many edges on the floor that I think it is virtually impossible to achieve that kind of consistency trading electronically. That’s not to say that I don’t make as much or more money, than I used to make while trading on the floor. But, I am taking more risk and experiencing much bigger swings now.


In the final analysis, electronic trading has made me a smarter and better trader. No longer playing with the "house edge", it has forced me to relearn my craft, adapt, and re-invent myself. And, it is in the ways, in which we adapt to change, that ultimately defines our success.

PRICE BENCHMARKS   

• OPENING RANGE   
• VWAP                                                               1090.5
• OVERNIGHT TRADING RANGE               1085-1093.50
• PREVIOUS DAY'S TRADING RANGE       1083.25-1098.75
• VALUE                                                             1085.00 -1095
• DEVELOPING VALUE                                   1086.75-1091
•  200 MA 15M                                                    1089.25
•  PIVOTS                                                            1091 P                                                                           1094.25 R1  

MARKET MATTERS - WEDNESDAY, AUGUST 18, 2010

E- minis opened slightly better this morning, just above the VWAP and within yesterday's value area, with the low of the opening range, testing and holding the 200MA. The market then rallied 14 points to 1098.50 forming  a double top against yesterday's high. The last 2 hours of the day the market traded lower finishing even on the day, and right back at the 200 MA shortly after the close of pit trading. Interesting to note, the bonds also sold off in the afternoon, and gold closed higher. 

The range trade continued as the e-minis appeared to be headed for a double distribution trend day up, only to fail just above the high of yesterday's value, and almost close lower on the day. While that kind of action is not constructive, all price probes lower have been met with buying, as of late. In my opinion, the market is still very much on the defensive, although the bears show no clear control.

For now, trading from a responsive versus initiative mind frame is advised, until either the bulls or bears gain control.

VWAP 1090.5 OVERNIGHT  RANGE 1084.50 - 1093 PREVIOUS DAY'S  RANGE 1083.25 -1098.75 VALUE 1085 -1095 DEVELOPING VALUE 1087.25 -1088.50 200 MA 15M 1086.25 PIVOTS 1087.5 Pivot .

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MARKET MATTERS - MIDDAY MARKET MEAT- TUESDAY 08/17/2010

Hope everyone was wearing their rally hats this morning as the market opened above all my benchmarks, and went out the top of the opening range  right through Friday's high,  rallying 8 handles. While the potential exists for a trend day up, I am seeing some divergences at 1095, so a rotation lower is highly possible.

MARKET MATTERS - ALERT

I am seeing  Cumulative Delta divergence and Cumulative ES Volume ROC divergence at the 1095 level, indicating possible price exhaustion.

MARKET MATTERS - PRE-MARKET MEANING- TUESDAY 08/17/2010

1. Monday's Range                    1066.25 - 1080.75
2. Monday Night's Range          1074.50 - 1085.75
3. VWAP                                      1082.50 RISING
4. Value Area                              1073.50 - 1080.00
5. Developing Value                   1076.75 - 1082.75
6. 200 MA 15m                           1078.00
7. Pivot                                        1077.00
8. 6E                                           +0.14%
9. FESX                                      +0.89%                                     
10. ZN                                           -0.07%                                         -
11. ZB                                          +0.02

Housing Starts and PPI @ 8:30AM-ET and Industrial Production @ 9:15AM-ET

E-minis traded higher last night, along with the Euro and Stoxx 50, finding resistance at 1085.75,  the low of last Wednesday's value area.  Major resistance is at 1089.25 Fridays high, and the 20MA on the daily.

RISK ON...RISK OFF

The SPX  was down 3.8% for the week, the DJIA -3.3% and NASDAQ -5% with Wednesday’s "gap down" testament to risk aversion,  accounting for the majority of the weeks range and damage. Call it what you may - implied easing, QE Lite, or just plain old monetizing the debt, the market and investors  were neither pleased with the Fed’s actions, nor reassured with Dr. Benanke’s downgraded assessment of the U.S. economy. 

Only the dollar, gold and treasuries, traded higher as investors seeked  safety, with the 10 YR  bond closing out the week yielding 2.67%, and the yield curve widening to almost 120 basis points. With earnings out of the way, option’s expiration, and little in the way of major economic releases next week,  we could be in store for more low volume days like today’s, as we close out the summer months.

After a  3% plus rally in the SPX the last 3 weeks of July,  and a fresh influx of capital  the first week of August, that led to a minor rally from 1088 to 1130, the “pundits” on CNBC were all calling for the next leg of the summer rally. Meanwhile, the “smart money” seized this opportunity  to unload their long positions and did not wait until Wednesday to begin. The hedge funds and institutions started  moving out of equities and into treasuries, July 27. 

While the market rallied, and  bullish sentiment swelled, institutional money was flowing out of equities. The rate-of change (ROC), and the money flow index (MFI) both fell as the market traded higher, indicating institutional selling and what may have been a “prescient” move from "risk on" to "risk off."

For now uncertainity pervades the the market. Fewer reliable investment strategies are available to investors, and asset classes with quantifiable returns-on-investment are scarce. Current market behavior and volatile movements of capital should perpetuate as money chases fewer “safe” assets, and investors capriciously switch back and forth, between risk aversion and risk taking. 

The SPX has the potential to break down to 875. However, if there were to be another "black swan" event, i.e., a significant geo-political crisis (like Israel attacking Iran) the SPX  could conceivably take out the 666 low.

Catching these moves are critical. As a result of structural changes to the global economy and global markets, mean reversion strategies are far less effective as returns now cluster around what have become fatter, larger tails.

For the last 25 years we were in an investment environment, where perceived risk was small, and actual risk was great. There was a predictable, almost "laissez faire" government policy, controlled inflation, and predictable business cycles. In order to generate alpha returns in this low volatility environment, investors used great amounts of leverage to achieve returns that were bunched around the mean.

In the current investment environment, perceived risk is great, and due to central bank accommodation, actual risk may not be as great. Increased government regulation is now de rigeuer, there is great economic uncertainty, and the potential transition to an inflationary economic cycle looms close behind. Lenders and investors will have to account for the greater uncertainty and risk, and the cost of investment financing will rise, and valuations on securities will be adjusted lower.

All these factors will serve to discourage the use of leverage and magnify the importance of "getting the tails right." Investors who don't understand the implications of these changes and adapt accordingly, will not be successful.  

INFLATION, OH INFLATION! WHERE ART THOU, INFLATION?

While the economies of emerging nations are breaking out and almost constitute half of the global economy, they are not demanding “a similar lifestyle afforded to Americans.” In fact, the economies of emerging nations are geared to produce for export, not internal consumption. Western style consumption is actually antithetical to emerging countries’ cultures. Conversely, developed nation consumers are maxed out because of too much debt. It is this lack of global aggregate demand, resulting from too much debt in parts of the global economy and not enough in others, that is the essence of the problem and the reason treasuries continue to rally.

While Germany’s economy may be experiencing an uptick, it shouldn’t be a surprise. Germany has the least amount of debt, and historically, the strongest economy in the eurozone. Unfortunately, the rest of Europe is still in the midst of a deflationary drag, and there are serious questions about the very makeup of the eurozone, and the financial stability of its banking system. Therefore, in Europe we’re unlikely to see any signs of inflation over the next few years.

Japan faces similar problems as the U.S., however their problems pre-date ours, and their susceptibility to inflationary concerns lags behind ours.

Will the bond rally last forever? Of course not. Is it ending anytime soon...doubtful. Inflation is a lagging indicator of the economic cycle; it takes a while for inflation to turn in either direction, either up or down. It’s not uncommon for inflation to ramp up a year or so after the economy recovers, and I don’t think you will see that happening till the latter part of 2011.

When the bond rally does come to an end, will it be because of one of the reasons you enumerated? (“ inflation do to external pressures, an improving domestic economy or investors demanding higher yields for greater risk” ) Most likely it will be a combination of factors that first brings about inflationary concerns, and the first reason you mentioned may be part of the problem. Higher prices for the goods that the developed economies import from emerging countries could either cause in part or exacerbate existing inflation. Higher wage demands from emerging country workers, combined with devalued currencies of developed countries would lead to higher commodity prices. In fact, we are experiencing higher commodity and crude oil prices, and a weakened dollar currently.

Demand based inflation due to economic growth may be exacerbated by capacity constraints as economies start to recover, leading to the possibility of higher inflation. However, the “new normal” appears to be a reality. Slow growth in the developed world, insufficiently high levels of consumption in the emerging world, and seemingly inexplicable low total returns on investment portfolios, bonds and stocks. For now, there is plenty of excess capacity and the money supply is still shrinking. Even if money supply were to begin to grow, it would take a year or two until it’s inflationary effects were felt on the economy, so I don’t think you will see demand based inflation, from an improving economy for a while.

In a risk adverse environment, yield loses importance, and safety and liquidity become a paramount priority. We are seeing that currently. Historically low yields, yet they are still buying treasuries, (and corporate debt for the yield) because of their perceived safety. Investors are content to buy short dated maturities, and are not venturing out the curve in search of higher yields.Demanding a higher a yield for investments does not cause inflation, inflation cause investors to seek higher yields, in search of real returns. ,

More likely, the cause of the next bout of inflation will be caused by the actions of central banks or governments and then exacerbated by higher commodity prices, and supply demand imbalance due to capacity destruction. Central banks may be too late in reigning in extraordinary accommodation or may even feel that another QE is necessary. Finally, some governments will be tempted to use inflation as a solution to fiscal deficits during an era of low real growth. If a country doesn't see an easy way to grow out of its budget deficit, it could adopt inflationary policies such as debt monetization or currency devaluation as ways to solve its budgetary problems.