Tuesday, October 14, 2008

All Systems Go for Sustained Government Intervention

Today the US government added yet another weapon in their crash fighting arsenal: outright stock purchases. The US Treasury is prepared to deploy some 250 billion dollars to buy direct stakes in US financial firms. The results were predictable: with shorts running for the hills and investors seduced by avarice buying on the open, short term money dumped shares bought during yesterday's long orgy.

The government has remained ready and willing to do anything to prop up financial markets. They have temporarily guaranteed bank loans in response to similar actions in europe. With Treasury long bond prices still above par, the government still possesses an infinite supply of monetary bullets to fire at the evolving bear market.

Friday, October 10, 2008

The End of "The End"

This day marks the end of this current crisis. We might trade lower from here, or even sideways for the the short term. However, at some point in the next 6 months we will rally much higher.

The stage is set for a lot of unwinding and reshuffling of banks balance sheets. funds will fail and strong ones will consolidate. Just like after a forest fire, young saplings will take the place of large trees felled by the firestorm. All of this will happen in the market, but it will take time.

In the meantime the governments of the world have proven their resolve to act in unison to alleviate monetary pressure. There may be a meeting of the G8 (or G21) soon. Multilateral action will avert any currency crises that could arise from huge US government intervention in debt and equity markets.

Such willingness to rate cut out of trouble may set the stage for further longer term inflation, as the contemporary wave of inflation (that started in 1897 ) looks set to continue for at least a few more years hence.

As commercial paper rates come back into line with treasuries, investment firms will be able to conduct their primary business of financing and arranging transactions and the whole world economy can start anew the great ponzi scheme of growth that we currently rely on.

Thursday, October 9, 2008

It's Over

Ok, I'm willing to admit i was premature in thinking this market would bounce today. But losing a few percent isn't bad when the whole world is crumbling. Keeping the stop tights allowed me to survive this week; all the while betting on a bottom.

I'm going to continue trying to pick a bottom in this market, because one of my central market principles is that nothing can move in the same direction forever. On the microscopic intraday time level, stocks reverse themselves all the time. There will be a day when this market bounces 1000 points. It might not be tomorrow, but it will be soon. I will keep the stops tight until that day.

I will know it is time to buy when the cadence of the last few days abates itself. Sellers won every battle this week, so when they appear to back away I'll test if there are any buyers. If it is truly a reversal to the upside, a simple buy the dips and accumulate strategy will do just fine. Otherwise I will keep the stops tight, so I live to fight another day.

Keep the stops tight.

Wednesday, October 8, 2008

Forensic Examination of the Market

A view of the overall market might convince one that the end of the world is nigh. However, a closer examination of the market that composes this index tells a different story.

We can see that the oil services have gotten killed in the same pattern as the market (which is an AVERAGE of other stock prices, including oil service stocks)

Rio Tinto, one of the worlds largest mining firms, has lost 60% of its value. Arcelor-Mittal (MT) has lost 70%. US Steel is down 75%. This is all since the end of June.

What we are experiencing is a huge popping of a liquidity fueled commodity bubble. Remember the Chinese Liquidity Mechanism? Thats been happening in every asian country in to some degree. So since 2003 there has been a mechanism for creating a ton of money and reinvesting it both in the US and emerging markets. Since commodities are priced in dollars, they have represented an easy way to reinvest accumulated dollar reserves held in foreign banking systems. Now that the largest mechanism for financing this huge ponzi scheme -- the investment banks -- are rotting six feet under, the whole money flow system is under pressure. That has meant less money creation in emerging markets and falling demand for raw materials as Americans buy less shit.

All this has combined with our banking crisis and election cycle to make everyone jittery as fuck. Take a look at some banks. They have gone NO WHERE in the same time frame:

The MASSIVE (combined market cap of greater than $400 billion) domestic banks haven't done anything in the last 5 months except rattle about. Granted they have made huge moves, they just represent the uncertainty that has gripped the market in 2008.

Of course, if you were long some foreign bank ADR's, all bets are off:




Long story short: our banks our fine. They have huge net interest margin from rate cuts and tons of high yielding commercial paper to buy. They have a 700 billion dollar buyer for their toxic mortgage products.

A commodity bust led to a bust in emerging markets. In a country like China or India, natural resources make up a much larger portion of their economy. Their banks lend to raw material firms. Prices just collapsed. Loans will go bad. Banks will go bust.

The S&P's look bad because its made up of raw materials firms and banks. Don't panic, make money when the world returns to normal. Just don't lose it all now.

My Bailout

Having been shredded by the ~11am back and forth, I became bound and determined to be in NTRS when it began its inevitable rise back upward. If it were going to go down after I bought it, it would have just collapsed like on the moves that caught me earlier. But this one was different in that the buyers stayed pat on every down move, and the XLF's and regional banks were ticking up too.

Buying on the rebound happened fast, with a sub minute move from 62 to below 60. Within ten minutes the stock was up two points to its highs. Sold too soon on both trades.

Structural vs Fundamental Causation: A Look at Hedge Fund Redemptions

Depending on what sources you use, hedge funds face redemptions of 10-20% of their assets under management from disgruntled investors. When an investor redeems their capital from a hedge fund, unless the fund has excess cash it must sell some of its positions. If the market is depressed to begin with, and a herd of investors rush for redemptions all at once then we can see how the market could turn ugly quickly (e.g. the last 2 days).

This provides an excellent opportunity to contrast two different classes of causation in the market: structural vs fundamental. Everyone is familiar with a fundamental reason to make an investment decision. An investor could buy a company because their earnings look good. The return on investment might be higher with one company vs another. The economy could be expanding or contracting. These are all fundamental qualities.

Structural causation comes from things like the massive hedge fund redemptions: they are causes of a not necessarily fundamental basis. They may be caused by fundamentals; a rash of redemptions was caused by a fundamentally crappy market. But structural causes often appear disconnected from fundamental reality. The government has intervened in unprecedented scale and scope; net interest margins will be improved by coordinated worldwide rate cuts. But there are some firms that still need to sell things to raise cash. Until they are able to get the cash they need in loans or by selling inventory, the crash will continue.

Mid-day Report: Don't Feel So Bad, Traders are Getting Annihilated Too

I make my living exploiting statistical linkages between stocks on a microscopic level. Because I am so short term and exploit spreads, I make money on 85% of the days that I trade. That being said, these last two days have been complete garbage. Correlations that I have used profitably for months were demolished today. Any semblance of order was replaced by an inexorable pressure to the downside.

The moral of this story is to stay on the sidelines or if you do trade stay as small as possible. That is not to say that there isn't any opportunity in this market. Buy and hold investors are getting amazing prices. But if your strategy is X and the market wants Y then you've got to take a chill pill for awhile and relax. Either get some new strategies or sit back and watch until yours work again. IT IS EXTREMELY EASY TO LOSE EVERYTHING IN A MARKET LIKE THIS. Be careful, and live to buy another day.

Justice in the World?

Looks like they finally got around to busting those crazy trades I was blogging about on the 19th of september. Is this all really designed to protect the investor? How did the SEC/FINRA decide that 9:37 (where the chart really starts) was the proper cutoff time to bust trades? Do the people who bought at 57 feel protected when they just saw it trade for >100?

It all seems rather arbitrary, because it is...


Tuesday, October 7, 2008

The Ineffectiveness of a Short Sale Ban: Russell 2000 Anecdotal Evidence

This chart is the IWM exchange traded fund (ETF) which tracks the Russell 2000 stock index. Note the large spike up to ~$78. That was September 19th, which some of you might remember as the day the SEC out lawed short selling a list of mostly financial services stocks. It doesn't take a computer program to see the nearly 30% decline that has occurred since the ban.

Like I have said before: no short sellers leaders to less buyers on the downside and less sellers on the upside. What we have experienced here is the market in the absence of shorting, and it is the stupidest wild whipsaw ride I have ever experienced as a trader. The SEC should seriously consider letting the ban expire this Thursday; perhaps then markets will start to behave again and prices will actually mean something for a change.


There's Lots of Blood Everywhere

If you have ever waited for one of those dare to be great moments, the next few days will be it. If a 20% decline in the sp500's constitutes "blood in the streets," then this is a good time to buy. There might be some despondent selling off the open, but if we don't bounce HARD tomorrow we're in for some serious trouble.

The VIX is at 53.68. Here is a disclaimer. I think the spyders have to bounce some time tomorrow or we're doomed. That being said, I have never been trading when the VIX is >50.

Stay alive to fight another day. This market is for long term buyers and traders.

Sunday, October 5, 2008

The Binary Volatility Regime

There is a lot of empirical evidence that suggests there exists two different states of the market: high volatility and low volatility. A corollary of this binary model is that volatility "shocks," defined as sudden large changes in volatility, are persistent; when a shock occurs that increases volatility quickly, it will stay elevated for a macroscopic (multiday) period of time. 

I agree with this model; but it is made more perceptive by adding on a level of complexity. What if there are four states to the market: high volatility & bull market; high volatility & bear market; low volatility & bull market; low volatility & bear market. This assumes that the market is either bull or bear at any point in time. Under this model, we use august 2007 as the transition from a bull to a bear market.

Right now we are in a high volatility & bear market model. This means huge moves up or down; but the market will maintain a proclivity to crash and reverse. It will be hard to make money long or short, but not impossible. Remember my previous post and buy on huge declines for a short but sure return.

The question reduces to where do we go from here? 


Saturday, October 4, 2008

Sector Trading: A Primer

One of my favorite setups is to watch an entire group of competing stocks. If there is a leader, you can watch the leader and trade the laggers to make a quick scalp. This makes money because of the existence of statistical arbitrageurs who keep a sector in line. 

Take the agricultural chemicals, for example: POT, MOS, AGU, TRA, CF, MON. Using a statistical technique known as a minimum spanning tree, we can establish POT as the "leader." AGU is the closest lagger behind POT. 

So in the beginning of the day, if POT is ripping you can buy a little AGU and have a positive expected value of your return; as long as POT keeps going you can book profit in AGU. The same works on the downside.

Do your own research; look at some good charts to verify what i'm saying. use some stats packages to establish a theoretical price for POT given AGU. the best approach is a combination of the two. 


Friday, October 3, 2008

Staring Into the Abyss

I know its getting pretty hard to be forced to be a long only trader during a huge market decline, but there is still hope in buying low and selling high. As I've come to find out over many years of trading, when a stock goes down a lot it almost always overshoots. By that I mean that the stock will always go down more in the short term than it ends at the end of the day. Take the case of State Street (STT) as pictured below:
After the bill passed, the market took a huge shit. STT and all the other financials got sold like there was no tomorrow. While I still have no idea why we sold off, it is a fundamental property of the market that when a stock experiences a huge decline it will inevitably overshoot and correct itself to some degree.

Here we see STT doing just that. This killing allowed for 4 possible quick buy points. The first came after the initial 4 point decline from 52 that occurred in five minutes. Any time a stock moves down with such velocity the chances are good for at least some reversal. Buying on the bid meant you could have flipped your stock for a point profit several minutes later. The second buying opportunity occurred when down velocity picked up on the drop from 50 to 47. Within twenty minutes the stock had made the rebound back to 50. The third chance occurred after STT broke though its old lows at 47 and crashed to 42. This was the hardest to catch, because how would you know when it would stop? You will notice, however, that the decline was an almost unbroken string of red bars downwards. If you had bought after the stock stopped falling and began a rally, you could have caught several points from 42-44. The final buy occurred when the stock dipped back below 44 in one minute. Ten minutes later you have a point profit.

While it can be very difficult to make money buying dips in a bear market, hopefully this example can show you where to find short term buying opportunities even in bad markets.

Thursday, October 2, 2008

The Dollar Remains Strong

The Euro is 1.38. Pound is 1.76. The Dollar is as strong as it has been in a long time. The rest of the world is still keeping shortest t-bill rates low (at <1%). All this reflects a confidence in our government as the truly risk free products that make us the reserve currency of the world.

You see, to understand how powerful the US government money creation can be, consider the following series of statements. Our government debt is currency that can be traded for dollars. When we issue debt and someone buys it, this has the same benefits as printing money. Actually its even better than printing money because there is a complex multiplier effect.

Lets take a look at the transaction taking place: US government sells bond; investor buys bond and marks as an asset on its balance sheet; government gets dollars from investor and marks liability on its balance sheet. Since federal government debt is regarded as "risk free", that means the government's balance sheet is effectively infinite. So now the government has cash to spend and the investor has assets to hold or use as collateral for loans (which would increase the money supply even further).

Our government debt is regarded as a cash equivalent because they can be sold so easily after purchase or used to get a cash loan with which to buy other dollar denominated products. So when our government sells debt, the money borrowed becomes multiplied several times over because our debt is so liquid. if the government takes the borrowed cash and then loans it as a bailout to dying banks, then the money becomes levered even further.

Some people have wondered how the hell inflation wouldn't go crazy with all this money creation, but that is where our highly liquid capital markets come in. Foreigners face a choice of what to do with all the dollars we give them: invest them in our markets or sell them, ruin your cheap currencies, reverse the trade balance that gave u the dollars, and fuck yourself royally. which would you choose? They all invest in our markets and as long as we sell enough shit into them to mop up liquidity we're all good. sometimes they lead to asset price bubbles, and everyone loves them on the way up. Such is the economy.

Senate Passes Bailout Bill: Sends It Back to House

I see a couple of scenarios playing out here which are combinations of some simple random variables.

List of Var's

+Market's Move In Between Votes

Possible Outcomes:

- We rip up into the new vote
- We trade sideways into new vote
- We die into new vote

*Note Vix has hovered ~40 in last three days, hence the expectation of volatility.

+House Re-vote on Bailout

Possible Outcomes:
sub outcomes of Failure:
=>Eventual Passage
=>Bouncing Back and Forth

+Market Response to ANY US Legislature Event (vote, significant comments, etc)

Possible Outcomes:

-Knee Jerk Up
-Knee Jerk Down

Secondary Outcomes (endemic to knee jerk event reactions):

-Reversal of reaction
-Continuation or maintenance of reaction

-Scenario 1: Rip Into New Vote + House Package Passes => Knee Jerk Up + 50% Reversal
-Scenario 2: Rip Into New Vote + House Package Doesn't Pass => Knee Jerk Down + Continuation
+Sub Scenario 2a: Bailout Eventually Passes: Bottoming or Crashing into Passing Vote => final bottom and upward after
+Sub Scenario 2b: Bailout Bounces: Severe market decline, fed printing money, lowering rates doing everything it can to avoid depression
-Scenario 3: Sideways into New Vote + House Package Passes => Knee Jerk Up + Continuation
-Scenario 4: Sideways into New Vote + House Package Doesn't Pass => Knee Jerk Down + Continuation
+Sub Scenario 4a: Bailout Eventually Passes: Bottoming or Crashing into Passing Vote => final bottom and upward after
+Sub Scenario 4b: Bailout Bounces: Severe market decline, closed markets, fed printing money, loweringrates doing everything it can to avoid depression
-Scenario 5: Crash Into Vote + House Package Passes => Knee Jerk Up + Monster Continuation
-Scenario 6: Crash Into Vote + + House Package Doesn't Pass => End of Time, Interest rates cut to zero

Wednesday, October 1, 2008

Not Out of the Woods Yet, but Certainly Near Town

The VIX has retreated from historic highs back into the "less jittery": <40's. Pretty frightening stuff for everyone I assume.

Some of us enjoy good times when the volatility spikes and the markets jerk from up 300 to down, and so try not to be levered to one side more than the other. I have become a structural bull since bernanke showed his willingness to support credit markets, but we may go down more or at least not go up much while the fed pumps several more injections into money markets. After a lot of liquidity is forced in, the banks will return slowly to their chief pursuit of borrowing short/lending long. This is when the bulls will eat good again

In the mean time don't be greedy and try to be a trader if you are a trader. no one ever went poor taking profits. buy on fast dips, sell on fast rips if its not illegal (short selling ban extended!).

Ron Paul: Buying bad debt is the wrong solution

Two days after the House rejected the $700 billion bailout bill, the Senate is set to vote on the rescue plan for financial institutions.Ron Paul continues to be stuck in the gold standard. He attacks the patient for taking its medicine and then offers no substitute relief of market suffering.

read more | digg story

The Market Is Beautiful

The market has completely reversed the bounce we experienced last week, overshooting on both the upside and the downside. Ending just about right where it started, showing the futility of such short sighted government manipulation of markets.

We're actually lower than before the ban... if we don't start holding some levels on the upside tomorrow, could start getting uglier before it gets better. Keep them stops tight.