Friday, May 23, 2008
This chart shows the Dow rally over the past 45 minutes. It is beginning to lose momentum. On the 3-minute chart, prices have shown signs of stalling at the Upper Bollinger Band. I won't short it until I see a lower low and a lower high -- signs of a renewed downtrend in the market.
Yesterday's closing price is shown as the red line at the top. Until America deals with its energy shortage and accepts responsibility for creating its own energy supplies, stocks will have a difficult time sustaining a long-term rally.
Thursday, May 22, 2008
Exception - Energy-Related Commodities
Generally speaking, only the energy-related commodities are near record high prices. Energy-related commodities (including corn and soybeans -- biofuels) are the only exception to my argument that there is no bubble. Even biofuel grains, it could be argued, aren't in bubble territory. While they are near all-time highs, prices for corn and soybeans have been flat for weeks! The biofuel bubble is solely the fault of Congress because of their idiotic ethanol mandates and the consequential impact on food prices. Let's hold them responsible for food inflation. It is at their feet that the blame justly lies. Most other commodities are well off their record-setting prices from the early part of this year.
The Price of Sugar is Sweet -- for Consumers!
Wheat is also trading 41% lower than its record high from just a few months ago (below). A huge 41% drop! That is also a confirmed downtrend. It is also trading below both its 50-day and 200-day moving averages, and closed today at the lowest price in six months. As recently as last week, volume indicators suggested a possible bottom for wheat. It hovered around its 200-day moving average for a couple of weeks, but in the past few days, it has dropped below the 200-day moving average. One can only wonder how far the price of wheat will fall!
Before the soft commodities began to trade electronically slightly more than one year ago, the charts were much more erratic and looked like radio static. Now that electronic trading has brought much-needed liquidity to the soft commodity markets, the charts trade much more like smooth sine waves. Many of these soft commodities have now become a joy to trade compared with how they used to be. The beginning of electronic trading has brought much-needed liquidity to the markets. But there is one thing it hasn't brought -- higher prices!
There is no commodity bubble!
Treasuries are one of my favorite instruments to trade because they are among the most liquid of all futures and the margin requirements are modest. Treasury futures have margin requirements that are roughly 1/4 those of stock index futures. I can therefore take a larger position in treasury futures than I would ever dream of doing with stock futures.
Execution, Execution, Execution
I am told that the three rules of real estate are location, location, and location. In futures trading, execution is the first law of success. This requires deep, constant liquidity for a trading instrument.
The combined open interest for treasury futures outnumbers the open interest for even the stock index futures. Prices for treasuries also tend to move more gradually than other futures. While I might take 10-20 trades each day for soybeans, I might make only 5-10 trades for treasuries, even though treasury futures trade 3-4 hours longer each day than grains. These factors make treasuries easy to get excellent executions, superb and accurate fills, and to enter and exit easily and quickly. Treasuries are also a good way for new traders to cut their teeth because the charts tend to move more slowly and gradually. They are good for practicing their trading skills.
In contrast, I haven't traded energy futures over the past year (despite the obviously good returns for energy traders who are long) because while crude oil futures are very liquid, they tend to print so rapidly across the screen that I am unable to get good executions at the proper prices for my methodology. Just watching the crude oil futures print across the screen can often be a dizzying exercise. Thus, I stay away from crude oil and other energy futures.
I also tend to stay away from grain futures in the first 5-10 minutes of the day trading session because they move too quickly for me to get accurate executions. I will usually wait for a slightly more subdued market in which trading conditions are more sedate and I can get good executions under more stable conditions.
Tick Bar Adjustments
Likewise, I have found that the Russell 2000 futures, which I used to trade exclusively at one time, tend to print too rapidly for me to be able to get good executions. Even adjusting the number of ticks in a bar for the Russell 2000, I haven't been able to find one that looks clean on the charts. I prefer to trade the Dow mini because the charts tend to trade more cleanly with less market noise. Market noise is, in my humble opinion, deadly for small traders like me. It will drive prices through stops and convince traders to exit prematurely with losses, often just before the market makes a spasm back in the other direction that would have resulted in a profit. I always look for clean charts, and will occasionally adjust my tick bars until they look clean. Only then will I trade them. Anything else has too much market noise. And as I said, market noise is deadly.
Wednesday, May 21, 2008
The Fed has indicated in its last FOMC minutes that even if economic activity turns negative, inflation fears may keep the Fed from cutting rates any more. Wow! Stocks are selling off as a result! Interestingly, interest rates are dropping on treasury futures!
Fractals Entries Minimize Risk
This involves less risk because if the reversal of direction fails at these points, it is immediately evident and a trader can exit quickly with only a small loss. One prominent trading book suggests adding only at the point where the previous high was surpassed (the red-arrow fractals in this chart), but I don't agree. By taking a new trade only as the most recent high is surpassed, a trader must accept that the trade very likely will go negative for at least a short time in the future. If, on the other hand, a trader buys at the green arrows just as prices confirm above the Exponential Moving Average, most likely the trade will be in the profit within a minute or two (and usually less), and will never go negative at any point. To me, this minimizes risk and maximizes profits.
Fractals and Phantom's Rules
This concept of using fractals at these inflection points is also harmonious with Phantom's Rules because it disciplines a trader to react quickly to remove or reduce a position unless it proves correct almost immediately under Rule #1. Fractals also provide a very clear point to add onto an existing position under Phantom's Rule #2, providing that all conditions are met for the add-on.
Definitions of "Fractal"
fractal (frac tl)
n. A geometric pattern that is repeated at ever smaller scales to produce irregular shapes and surfaces that cannot be represented by classical geometry. Fractals are used especially in computer modeling of irregular patterns and structures in nature.
n. Mathematics, Physics. a geometrical or physical structure having an irregular or fragmented shape at all scales of measurement between a greatest and smallest scale such that certain mathematical or physical properties of the structure, as the perimeter of a curve or the flow rate in a porous medium, behave as if the dimensions of the structure (fractal dimensions) are greater than the spatial dimensions.
Chaos Theory Explained
(Mathematics ) A dynamical system that has a sensitive dependence on its initial conditions.
(Physics) a dynamical system that is extremely sensitive to its initial conditions.
(definitions from Dictionary.com)
Stochastic behavior is probabilistic behavior. (Stewart, Does God Play Dice?)
By placing both stochastic and deterministic in the same definition, the mathematicians have formed a bridge between the two sciences - two sciences that were regarded as mutually exclusive until then. Chaos is the study of deterministic systems that are so sensitive to measurement that their output appears random.
(excerpts from Introduction to Chaos Theory, by Mike Andrews)
Chaos Theory can be generally defined as the study of forever-changing complex systems. Discovered by a meteorologist in 1960, chaos theory contends that complex and unpredictable results will occur in systems that are sensitive to small changes in their initial conditions...
Although chaotic systems appear to be random, they are not. Beneath the random behavior patterns emerge, suggesting, if not always revealing, order. Recognizing that the stock market is a non-linear, dynamic, chaotic system /one stock market mathematician/ applies the principles of Chaos Theory in order to determine the pattern behind apparent random nature of market prices.
(from a website called, "Pi, The Movie")
Following are some images of fractal patterns as they occur in nature. They are often beautiful to behold. Fractals are the beauty and order of nature's chaos!
Fractals in the meanderings of a river
Fractals in brassicas
I noticed that prices found support at the 50-day moving average. Is this a factor?
Tuesday, May 20, 2008
This is very bad news for the American consumer, because if this downward trend for the Dollar continues, it is almost certain to reignite inflation. Further, if Congress allows populist sentiment to lead it to interfere in the futures markets, prices may back off temporarily, but will ultimately head much higher. One reason for this is that, according to CME records, market participants who take only long positions tend to be well capitalized (pension funds, PIMCO are examples) and take long-term positions, whereas people who take short positions in the market (like me and other traders) tend to be small, short-term traders, because we don't have huge sums to take long-term positions in the market. Small traders like me are a check on unbridled buying by larger market participants, because we will short the markets quickly when they are overbought, taking advantage of counter-trends and market inefficiencies. When this happens enough, prices fall. Therefore, by restricting trading or banning futures trading, Congress would hamper those of us who tend to short the markets, thus causing prices to move even higher. Large funds would only be affected marginally. What a way to shoot ourselves in the foot!
With a day this bad (the Dow is down over 200 points thus far with no end in sight), the Fed is going to think it must step in and interfere in the markets again. The trouble is that inflation is heating up even faster, with today's PPI showing inflation rising year over year. With crude oil at $129.50 and climbing, what is a central banker to do? Needless to say, I'm short the market today! Surprisingly, I was long yesterday! What a difference a day makes!
In the first hour of trading today, stocks have erased the gains made during all of last week. What a difference a day makes! The daily chart on the left shows the erasure of last week's gains, and the right chart show today's losses thus far. Still, I wouldn't be at all surprised if the stock index futures reversed at some point today, and recovered at least some of the losses. It could be exciting!
Winter wheat crops are showing signs of being at risk, and emergence figures are well below average for the last half of May, suggesting that this year's crop could come up short. Australia is also beginning to show signs of more drought. This may also be bullish for prices.
PPI this morning has reached 6.5% year over year, and stock index futures are plunging as a result. Gold and crude oil are consequently rising modestly, as this stocks the fears of greater inflation ahead.
Monday, May 19, 2008
Here's a Bloomberg article on the fundamentals of more buying:
Wheat Rises Most in a Week As Cheap Supply Boosts U.S. Exports
Soybean prices moved lower, but grains are largely stagnant today.
On days like this, I will immediately look for another trading vehicle that shows clean trading with sufficient volatility to trade well. Stock indexes and some of the currency majors fall into this category today. I use some software triggers to help me find these opportunities as they occur.
A story I read earlier this morning. This sounds like good news not only for energy production, but for lower food prices as well:
The U.S. Department of Energy recently awarded SunEthanol a $100,000 research grant to helpHere is the website of SunEthanol Inc:
develop clean transportation fuels from a variety of non-food feedstocks, including corn stover, bagasse, switchgrass, sorghum, softwood (pine), and high lignin poplar. This is the third DOE grant that SunEthanol has been awarded in the past year. America
Both corn and soybeans have moved modestly lower overnight, mostly due to favorable weather conditions this past weekend that have improved the outlook for good crop yields this fall.
Wheat is trading slightly higher, but on weak volume.
Executives of the Chicago Mercantile Exchange recently testified before Congress that there could be terrible consequences to trying to force speculators out of the futures markets. Here are a few facts that were pointed out:
- The Nymex increased margins 140% during 2007, and the price of oil doubled. Clearly, increasing margins won't bring down the price of oil
- Speculators are already required to put up 33% larger margins than exchange members who take delivery
- Restraining capital in this country will only cause capital flight to other places in the world where there is capital freedom. If this country doesn't accept or attempts to restrict capital, there are numerous other global futures exchanges where speculators can send their capital -- and they will.
- Research indicates that long traders tend to be much better capitalized than short traders. Therefore, increasing margins will only restrict those who short the markets, thus sending prices higher, not lower.
- Speculators only come into the market because the fundamentals are supportive of higher prices. Speculators don't drive prices higher; they follow the market.