FOLLOWING THE AUCTION – WE ALL WANT AN EDGE

This week in Following the Auction we’re talking about what everyone wants… an edge. The current hysterical discussion that’s all over TV and the internet is about balls. The NFL and literally everyone is being questioned… were the footballs intentionally deflated to less than what actual game balls are, by rule, supposed to be? Regulation standards say balls should be inflated to 12.5 to 13.5 pounds of air per square inch and weigh 14 to 15 ounces. Deflate gate is really an argument about Team A having an advantage, an edge… over Team B.  Clearly having an edge over your competitors is big business… ask the 1994 Cleveland Indians about their corked bat, ask the HFT traders (if you can find them), or… just ask Lance Armstrong. 

As traders we want an edge over our competitors. Part of our edge is preparation. And part of that preparation is knowing our competitors and what they’re doing. Jim Dalton, market profile master, looks at market trends and divides the market participants into 5 different categories.

• Innovators – These are the traders that have have insight into possible game-changing news.
• Early Adopters – These are the traders that see the balance and get in before the breakout.
• Early Majority – These are the traders that see the breakout and create the herd.
• Late Majority – These are the traders that see the developed trend and join the herd.
• Laggards – These are the retail traders that finally got the word… 

What happens next in the above cycle is usually profit taking by the innovators… the trend has run it’s course and there’s no one left to buy. So the auction develops excess and goes into balance as profit is taken and then trades lower in search of prices that will bring in new buyers to start the cycle again. So why talk about innovators and laggards? Let’s take a look at the Bund. Bunds are the German equivalent of U.S. Treasury bonds. Click on chart to enlarge.

The next chart is the same as above but a closer look at the most recent trend that started the day Draghi said… QE. 

The question for Bund traders is clear, where do we go from here? All this activity has brought a lot of attention on products that may be new to you. A traders’ edge is knowing the products he trades, a great place to learn about the Bund, the EuroStoxx 50 and the Dax is the Eurex Exchange website.

The question coming into this week is what’s going to happen with our own market? Monday, no news, Tuesday, Durable Goods, Consumer Confidence and New Home Sales, leading into Wednesdays FOMC at 1:00 pm CT. With Thursday’s rally on the European QE news, and Friday’s fizzle back to the safety of Thursdays value area… what do we expect for the week? Will you prepare – be an Innovator – take profits? Or will you join those Laggards – and pay the price?

Register for Free! on our website! Then you can access Pat Tabet’s morning updates with the ever popular Bull/Bear line and support and resistance plus lots of other information, including current rotations for the different time-frames. Join Lewis Borsellino first thing in the morning to get his colorful youtube video’s showcasing his preparation and Pat Tabet’s specially designed proprietary indicators. Then during the day Lewis will update on the twitter feed @ManOverMarket. Get with the MOM team! Lewis and Pat have been knocking it out of the park! And their bats aren’t corked!!! But their calls have an EDGE! 

Have a great week! As always trader smarter, not more often!

FOLLOWING THE AUCTION – BLACK SWAN EVENT and MARGIN

This week in our series Following the Auction, thanks to the Swiss National Bank, we have the opportunity to cover two terms, Black Swan Event and Margin. 

On January 15th the Swiss National Bank removed a 3 year-old cap on the Swiss Franc. Initially enacted to protect the swiss economy from the European debt crisis, by removing the cap, they allowed the Swiss Franc to strengthen. This has created havoc with the currency and financial markets. Poland and Hungary have huge exposure to mortgages in Swiss Francs, yet Swiss citizens “stormed” neighbouring Germany to go shopping on Saturday.

Goldman Sachs Chief Financial Officer Harvey Schwartz said on this morning’s earnings call that this was something like a 20-standard-deviation event, and while the exact number of standard deviations is of course a subjective matter, that’s the right ballpark. Over the 12 months ended on Wednesday, the annual volatility — that is, the annualized standard deviation of daily returns — of the euro/franc relationship was a bit over 1.7 percent; over the last three months of that period the volatility was less than 1 percent.  That converts to a daily standard deviation of something like 0.1 percent.  On Thursday, the euro ended down almost 19 percent, or call it 180 standard deviations, depending on what period you use.

The Black Swan Theory, developed by Nassim Nicholas Taleb as defined in Investopedia, is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. And so, the SNB created the goose that laid the golden egg for some but definitely qualifies as a Black Swan Event and has reeked havoc with many currency brokers. And this is where our next term comes into play, Margin.

Margin defined by Investopedia is simply borrowed money used to purchase securities. Of course all brokerages have margin requirements that vary with the product. The popular FX brokerage, FXCM, felt the impact of the Black Swan related to it’s margin requirements when the SNB removed it’s cap on the swiss franc. Daily moves in the swissy were typically less than 0.1%, so that meant that 95% of the time customers positions would move by less than 0.2% in a day. So if FXCM required 2% margin — that is, they demand $2 of cash from a customer for every $100 worth of Swiss francs that they trade — FXCM felt pretty safe knowing 95% of the time, it’s customers couldn’t lose more than one-tenth of their equity in a day, and the customer’s position could be liquidated if necessary before a loss was incurred by FXMC. Sounds great! This article, No One Was Supposed to Lose This Much Money on Swiss Francs, does some math for us and shows an approximate notional trade size of 1.3 billion requiring margin at 2% is 26 million. Enter Black Swan and with it for FXCM a negative equity balance of $225 million! Imagine the calls that broker had to make to his clients. OUCH!

As an aside, I ran across this broker Oanda that did something surprising.. they forgave all negative balances! That’s something you don’t see.. ever. Good for them.

Trust Me, I’m a Swiss Central Banker is a very good article that goes into much more depth about the Swiss Franc, and the situation.

Have a great trade week! Remember always use STOPS, protect yourself (as much as possible) from being one of those people receiving a margin call!

Tune in Tuesday morning on the website (registration is FREE) for Pat Tabet’s morning updates and Lewis Borsellino will fill in the day with market commentary on youtube and twitter.

Remember, trade smarter! Not more often!