FOMC Rate Decision

There are two services I subscribe to that I find invaluable for the assessment of fundamental data:

  • Shadow Stats: www.shadowstats.com
  • ECRI Light: www.businesscycle.com

Shadow Stats provides an alternative data source to official US statistics and ECRI Light provides reliable leading indicators on the state of the US economic growth and inflation. The two together provide data on whether or not my ideas about ‘long-term’ perspective are being reflected in the economy.

I tend to rely more on the ECRI report than Shadow Stats and will lean to the former if there is a conflict. But right now they both agree: the US economy sucks. Despite the rosy picture provided by Non-Farm payrolls, the latest Shadow Stats demonstrates why the official figures are an illusion.

The ECRI published Friday Dec 7 2007 for the week ending Nov 30, shows US economic growth at a 5-year low and inflation down a tad. The ECRI indicators have about a 3-months lead time. So, I’ll know if my idea – that the massive increase in the money supply in August through to November 2007 will lead to a rise in inflation despite the weak economy – will be correct about 3-months before there is pressure on the FEDS to raise rates. But that’s for the future.

For today, the true state of the economy is the focus. Tuesday 2:00 PM EST, the FEDS will announce their decision. The worry for me is I am in the majority camp – I think there is little chance there will not be a .25 cut in the Fed Fund Rate and in the Discount Rate. But given the state of the economy, the sub-prime liquidity crunch, and Bernanke’s ideas of the causes of the 1929 Depression, I rate the probability of a hike above .25 around 67%.

If it were just the matter of the economy, I’d rate the probability much higher. However in the near term, the FEDS have the US$ to worry about. I would hesitate a guess that despite the jaw-boning, they would not be averse to a sliding US$ as a measure against recession. However, what they don’t want to see is a US$ rout. And that is what they are likely to get if they decreased rates in the Fed Fund Rate and the Discount rate by 0.50. In addition, the decrease in rates in the Fed Fund Rate has done little to assuage the liquidity problem.

So, for all these reasons, I rate the probability of about 67% for a decrease of .50 in the Discount Rate and a .25 cut in the Fed Fund Rate. Such a move at least provides some chance the US$ decline will not turn into a bearish stampede.

What do I see happening if such an eventuality occurs? Well, I’d expect the ES to rally strongly and take out the current highs before year-end. We’re only 70 points or so away, so that’s not hard to imagine.

I’d expect the US$ to drop strongly over the next week but do expect to see some buying come in. December is seasonally a strong month for the US$ and so far it has held up well.

As always, whatever your position (long or short), in whatever instrument (Gold, Interest Rates, Stocks and Stock Indices etc), I recommend you create some worse case scenarios in case the FEDS do something unexpected and/or the market reacts in a way contrary to your expectations. Preparation is my key to preventing the ‘rat brain’ seizing control and thus turning a well-planned loss into a catastrophic one.

The Anatomy of a Bubble

I have just completed reading a good book by James Montier, “Behavioural Investing, a practitioner’s guide to applying behavioural finance”

One of the more interest chapters was ‘The Anatomy of a Bubble’. James postulates that bubbles tend to move through 5 stages:

  1. displacement
  2. credit creation
  3. euphoria
  4. financial distress
  5. revulsion

The author suggests that displacement is usually an external event that creates opportunities in one sector that are greater than the opportunities lost by the event. In the US, the most recent bubble was caused by the internet.

The boom thus produced is given a mighty boost by monetary expansion. This idea is in line with the Austrian economic theory of what causes the business cycle – but more on that another day. James argues that in 1998 because of the LTCM and Y2K crises, the Feds cut the Fed Fund rates to protect the financial system. But the Feds overdid it and as a resultant liquidity surge moved into financial assets.

James defines ‘euphoria’ as the stage when speculation for price increases is added to investment and sales. He takes the view that between 1991 and 2002, the US experience fitted this description.

Financial distress follows an environment he calls the ‘critical stage’; he says the two – critical stage and financial distress tend to move hand in glove. The critical stage is marked by insider selling as was the case in2000/1. James believes that the US passed such a stage between 2000 to 2002.

The final stage of the bubble cycle is the ‘capitulation stage’ – a stage where people are so badly scarred by their experience that they no longer wish to participate in the markets. The US still has to see this stage. Certainly it was not present in 2002 – if two measures that James uses are any guide. Firstly, the strategists remained bullish. Secondly volume remained high. James takes the same view as many technical analysts that market bottoms are usually marked with collapse in volume. This has yet to happen.

What sort of valuation decreases need to occur to mark a possible bottom? The author suggests at the very least a 30% decline from the highs.

Next week the market will be down to what I have been calling the minimum buy zone. If the 13-w (quarterly trend) uptrend is to hold, then the low at 1370.60 basis cash S&P needs to hold. Breach of that low will mean that whatever we have in the 13-w, we no longer have an uptrend (the sequence of higher highs and higher lows will be broken). I have argued that the massive injection of funds by the Feds since August 2007 will keep the bears away until the Feds are forced to raise rates in 2008 – when the liquidity finds its way into the inflation numbers. For this reason I believe that the probabilities favour the 13-w low holding. That is the low risk idea.

But an idea needs to measured against present tense information and so far there has been little sign of slowing downside momentum as the market approaches the buy zone. This is a tell-tale sign that the zone will hold. If momentum continues to build into the core zone, 1393 to 1370, this will be a warning that the zone will give way.

If that occurs, then, we may be seeing the start of the down leg that will culminate in James’ revulsion stage. By the way, a point James makes and one that accords with my experience: in the revulsion stage, the negative correlation between stocks and interest rates will no longer apply.

That’s not the way I would describe it but the result is the same. In my jargon, we are in a phase of the business cycle where once a bear market starts, the Feds will be unable to limit the damage to the economy by lowering rates.

I am looking forward to next week; it should provide interesting opportunities.

Thanksgiving

It’s Thanksgiving in the US. This means I have a holiday and time to reflect. As a trader, I get caught up with the markets (especially with the volatility of late) as well as the other hurley burley events in my life. It’s good to take time out to smell the flowers; to take time out to pause and be grateful for the wonderful people and things in my life.

I have a lot to be grateful for. The markets have been good to me. Oh sure, there have been down years; but overall I have not only achieved my goals but also more than I even dared to dream. It was not always that way: if you had asked me 7 years into my trading career: “Hey Ray! Are you going to make it?”

I’d have answered: “Sure! But you wouldn’t know it from my present results!”

It took me a long time (over 7 years to have the first winning year) and a lot of losses (about A$750,000.00). I succeeded because my wife, Chrisy, stood by me and provided the financial resources to keep going after I had lost our savings. During those tough years, her support was on occasions, the only thing that kept me going.

Chrisy bought me time; Pete Steidlmayer delivered the content that proved the turning point for my trading. He showed me that trading is a probability game and the lessons I learnt in 1980 are still beneficial today.

Those are yesteryear events; events for which I am grateful. Venturing closer to today, I now have friends who provide the bedrock social support and warmth so necessary for life – friends like Stuart Leslie, Anna Wang, Mic Lim and Jeff Tie. Stuart and Ana started off as mentor students and have become close friends. Mic is one of the best traders in Singapore (sorry Mic I know how much you dislike me saying that in public – but mate you are!). Jeff is my first friend in Singapore.

Trading is a tough game. There is no established educational process and the industry is full of hype and empty promises. On the other side of the equation are the newbies whose attitudes are best summarised by the words of an event participant: ” I want a system that is easy, costs no money and time to learn and one that will quickly make me a large fortune from a small starting base” (!!).

For those that know that trading success will take time, effort and money, take heart. Unlike when I first started, today you have access to genuine (and sometimes free) assistance. There are coaches like Brett Steenbarger, Denise Schull, Jim Kane & others…who each in their own ways provide an excellent service to the struggling newbie. So, no matter how you are trading and no matter what challenges you face, take a moment to enjoy the view that life is providing.

Happy Thanksgiving!

The Role of Intuition

As a discretionary, technical trader, I find my intuition plays a strong role in my trading. Today’s price action in the ES was a great example of what I mean.

I subscribe to a few Sentiment Indicators, Floyd Upperman, Whisper Numbers, and Sentiment Trader. All were bearish to some degree, and one was bearish even though the COT figures used in the approach showed a bullish bias. Even though this view was consistent with the system’s rules, it struck me that there was just too much bearishness in the market.

Add to this the fact that many of the technicians I respect were looking for the market to head towards the spike low – the one formed on the S&P on Aug 16, and you’ll appreciate the reason for my discomfort. I prefer to be a lone voice; company, especially company I respect makes me uncomfortable. In short, my intuition was screaming ‘long tonight’. In my view the 18-d (monthly) trend is still up and there is no change in trend pattern in sight. So my strategy is to find spots to go long for this timeframe.

I had my strategy (long); I also had my zone – well sort of. The market was near the upper band of my entry zone (about 25 points away) but it was close enough for me. I had my setup to go long when I found that the market was going to gap up sharply.

Figure 1 shows what Peter Steidlmayer called ‘trapped money’, a form of Negative Development. The Trapped Money Zone is the zone between yesterday’s close and today’s open. Trapped Money needs a spike low and strong open leaving shorts trapped by last night’s price action. If the market holds above that zone tonight, then the probabilities favour a move back to 1532 and probably the 1576 to 1550 zone (basis cash).

Trapped Money

Trapped Money

FIGURE 1 Trapped Money S&P 80 Mins

In addition, on a seasonal basis, Nov 14 is favoured to be a down day. So if the market shows strength today, this is a plus for the bulls. And, after the 14th, seasonal strength kicks in. Figures 2 and 3 show the seasonal charts for November and December. The only seasonal danger is the period December 8 to December 12.

Season Strength November 2007

Season Strength November 2007

FIGURE 2 November Seasonal

Season Strength December 2007Season Strength December 2007

FIGURE 3 December Seasonal

The difficulty with the trade was the large stop: below1438. For this reason I decided to take a half the normal size. Entry was relatively painless. After the initial run up, I bought the third half hour weakness, entering at 1459.25 (basis Dec), stops below 1438.

To stay in the trade, I’d need to see market close in the top 33% of today’s True Range: High of today – Close of yesterday (or low of today whichever is the lower). If the market can extend its current range 1466 to 1454.5 and close in the top 33% of its True Range, so much the better.

If the market fails to close above 50% of its true range, I’ll exit the position. The reason is ‘trapped money’ suggests strength. A failure to close above the 50% mark is a sign of weakness. My initial target will be 1532 basis cash and I will be adding to my longs once I see confirmed signs of strength.

Nature of Trends Wiley Edition – A Review

Today I have posted a review by a student and friend on my book Nature of Trends, Wiley Edition. By the way, my self-published edition has been withdrawn from sale. The Wiley edition is available from Amazon.

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REVIEW by ANNA WANG

As an STCer of Ray Barros, I could finish reading the new book within 24 hours and comprehend well what was written initially for his mentor students in 2004.
THE NATURE OF TRENDS – Trading Success 1- Ramon Barros 2004, has 6 chapters and a smaller book volume.

THE NATURE OF TRENDS –Strategies and Concepts for successful investing and trading – Ray Barros (Wiley 2008), has 7 chapters, of which two new chapters on Entry & Trade Management and Effective Money Management & Winning Psychology were added while Formulas for Constructing chapter was omitted.

I have found the new book revised to cater to easier reading and comprehension for the general traders as well as newbies who are not familiar with BarroMetrics or some understanding of Ray Wave. Still, it is not easy reading as it is full of traders jargon and technical analysis. However, for those who aspire to trade well, reading widely and attending trading courses will eventually help in understanding most of what was written.

Ray has been studying since the day he started trading , but he found an edge in his trading seven years later on under the pupilage of Pete Steidlmayer (the father of Market Profile) who has a great influence in his trading analysis . To this day, after almost 3 decades of trading, Ray is still learning, reading widely all the trading books he can find/buy. For your information, he is the only person I know who has to rent a place to store and catalogue his books as in a library, in HK.

However, to trade with an edge and to adopt all the tools of analysis used by Ray would require an in-depth study over a course/courses of study under him.

As his students are aware, it is not just for any one who can afford his mentorship fees who will be accepted. He selects 5 mentor students per annum after a careful screening of the students’ attitudes and sense of commitments to succeed.

It is no wonder there are potential students queuing up to be accepted as his mentor students in spite of his high fees to mentor and hand-hold for 2/3 years each mentor student.

Under the chapter on Effective Money Management & Winning Psychology, I was pleasantly surprised to see in print the results of a joint competition that I persuaded Ray to be my partner when I came across the Daniels Forex Futures competition in June/July 2007 which allowed two joint contestants for entry.

We were placed in top positions many times but on the final day, placed second, losing out by just over 1%. It was not so much about winning the competition as participating to test his methodologies in the real-world of trading. The results shown in the attachment prove that the tools in Ray’s book do produce good results if and when applied properly and free from the ‘rat brain ‘ syndrome.

I would recommend this new book to all traders, especially to students of BarroMetrics and Ray Wave, to buy this book and study it as your bible of trading well.

The first edition by Ray is harder to comprehend and by reading the second edition by Wiley press, I personally find the reading and comprehension go hand in hand after reading both.

Daniels FXFutures Trading Results

Daniels Trading Results

Anna Wang

STC Student

November 11, 2007