Why wait until January for the first premium lesson? Why not now I said?
Here is the first one.
Assorted Thoughts – December 15, 2012
I don’t know what portion of the mastery course you are up to. Whatever part you are on, I would urge you to at least read it once in the proper order, then afterwards you can skip around to the lessons that you feel are the most important to your situation.
There are some people that have asked me about forums or chat rooms, etc. I really don’t believe in those things. I don’t want you searching mountains of forum posts or chat logs to find the information and training you are looking for.
My vision is to help you learn how to interpret the information flow and market action so you can be the wizard yourself. In that spirit, I will give you the direct lessons myself in this format.
Here is some volatility training.
Where is the money? Where was The Big Money on Friday December 14, 2012?
Was it in the Gold Market?
Was it in USD/CAD?
Or was the big money in EUR/USD?
If you said EUR/USD, then ding, ding, ding you are correct!
The big money was in the EUR/USD. Why? Because it posted a volatility explosion.
There were people trading Gold or the USD/CAD, but they didn’t make the big money. There will always be some scalpers trading the markets. I am sure there were plenty of traders that scalped a few ticks off the gold market. There are plenty of trading courses out being sold claiming that they will teach you a strategy to scalp your way to cashflow in the markets.
When in reality, the big money isn’t in the scalping. The big money isn’t in the choppy markets.
The big money is in the volatility. If anyone allocated part of their money to the gold or USD/CAD on that specific day, then it was a poor allocation of money as the market didn’t move.
You want to always prefer the big money (volatility moves) to the small money(scalping for a few ticks). This is a big mindset differences between the top traders and the retail speculators.
The retail speculators are desperately looking to generate any cashflow they can from the market so they try to scalp their way for a few ticks. The top traders realize that the big money is in the big swings.
There is another nugget of wisdom. Namely that the big money (volatility moves) are also the easy money. Remember the easy money vs difficult money lesson?
Big Money (volatility) = Easy (or easier) Money
Small Moves (lack of volatility, choppiness) = Difficult (or harder) Money
Always prefer the volatility to the choppy moves and always prefer the easy money to the difficult money.
George Soros wrote in The Alchemy of Finance:
If the authorities handle the situation well, the rewards for speculating in currencies will become commensurate with the risks. Eventually, speculation will be discouraged by the lack of rewards, the authorities will have attained their goal, and it will be time for me to stop speculating.
Soros is a smart man, but he says things very cryptically at times. He uses very complicated language so it can be hard to understand him. But since you have me, let me explain to you in easy language.
When Soros says “rewards for speculating in currencies will become commensurate with the risks”, what he is saying is that when you speculate in the market, you take risks. If you take a currency position and you have a 200 pip stop loss, you are taking risk in the market. Any time you have on a position you are taking some risk. So therefore, if you are taking risk, you need to be rewarded. Rewarded with what? Well, rewarded with volatility!
If you have on a trade with a 200 pip stop loss lets say, well you better have a reason for expecting the market to move at least 200 pips in your favor, or 400 pips, or 500 pips, etc. The rewards for speculating need to be greater than the risks you are taking in the market.
When Soros said that quote, it was in 1985 and he was short a lot of U.S. dollars and the market was forming a global macro move and making him a fortune. Eventually he realized that the trend would end, and the “authorities” may discourage speculation by attempting to create policies that lowered the volatility. If the market goes from making a global macro move to making only a few ODVE moves, or very choppy range, then there are lack of rewards, and if there is lack of volatility, or lack of future volatility, you don’t want to have on a big position on, for you are not being compensated for taking the risk.
Therefore, when you are trading, you need to be compensated for taking risk. You should be compensated by having the volatility in your favor.
Now you may ask, well DUH Grk, how do you know when the market is poised for a big move? This is where you need to perform some news release impact analysis and sensitivity analysis to determine if the market is “acting right.”
As Jesse Livermore said:
After all, the game of speculation isn’t all mathematics or set rules, however rigid the main laws may be. Even in my tape reading something enters that is more than mere arithmetic. There is what I call the behavior of a stock, actions that enable you to judge whether or not it is going to proceed in accordance with the precedents that your observation has noted.
If a stock doesn’t act right don’t touch it; because, being unable to tell precisely what is wrong, you cannot tell which way it is going.
You can just insert the word “financial instrument” in for “stock.” If a “financial instrument” doesn’t act right, you shouldn’t touch it, unless you really, really know something about it the market does not.
Now you may ask, well how can you tell if the market is acting right?
Let’s see what my currency master files had to say about how the markets responded after the release of the U.S. FOMC Statement on Wednesday, December 12, 2012:
EUR/USD: +15 pips FM, then ret full, then +20 pips over next hour
Gold: +$6 FM, then ret full, then +$4 over next hour, then NS
Now let me get a few charts to show you the market action:
And a look at the gold chart:
As you can see, for bullish purposes, the EUR/USD was acting a lot better than Gold. The EUR/USD surged higher on more FED QE, then some natural profit taking kicked in. But the market didn’t sell off that much.
With gold however, the market rose on more FED QE, tripped light intraday topside stops, then sold off. It crashed through support and formed a one day volatility explosion to the downside. It seems the gold market reached the “macro exhaustion point.” Everyone was all loaded up betting on more QE, then after the news came out, there was big profit taking in gold. There were some market participants that were very disappointed and those disappointed longs in gold caused the down move.
This is very important information. If EUR/USD was able to stay relatively steady, while Gold collapsed, then that tells you a lot about the market. It tells you that the gold market isn’t acting right and that you probably shouldn’t play it to the bullish side. If gold cannot rally on more FED QE, then what is going to happen to cause gold to rally? I am not saying it can’t rally. If you expect it to rally, then you just need to find a good enough reason for it to do so.
The gold market right now is sandwiched between macro sell orders from people who want to get out if they believe the Fed has maxed out on their QE path. But the market is also being propped up by macro limit buy orders due to the fact that the FED did QE, and is going to be buying tens of billions more per month for the next few months. So there are still definitely macro buy orders in gold, they just aren’t strong enough to push the price higher yet.
After that, for the EUR/USD, it was just a matter of grinding higher until the market got within striking distance of the 1.3120/30 stop losses. They were some juicy stops above the market and they were triggered and it causes a small sentiment/psychological shift as the market rallied all the way up to 1.3170 or so.
You may ask, well why hasn’t the USD sold off more? Well there are various theories out there. One theory is that the FED is having diminishing returns from their QE programs. So some people say this time around, the USD won’t fall in value as much as the previous times.
The other reason is the lack of a fiscal deal. The lack of a fiscal deal is causing the USD to not lose as much value as there is a small safe haven bid element. If there is a successful resolution to the fiscal deal, that should cause a surge in the S&P and Crude Oil, and cause the USD to go down on the higher risk appetite.
But I have another theory as well. It is the action in USD/JPY. You have a situation where USD/JPY has been rising a lot over the past few weeks. Since it has been rising so much, it is capping the EUR/USD, and other xxx/USD pairs topside. The USD has been very strong versus the JPY and that is feeding its way into EUR/USD, etc by the EUR/USD topside being capped. At least that is my theory.
Because normally, when the FED does another round of QE, that causes USD/JPY to go down. But now, USD/JPY somehow doesn’t care about more FED QE. USD/JPY barely went down when the FOMC statement came out. That shows a sensitivity shift. Normally USD/JPY should go down 50-200 pips on more FED QE. But when the past FOMC came out, USD/JPY only went down 15 pips and then it was bought up very fast.
Why has USD/JPY been going up? There are the obvious reasons about expectations that the Bank of Japan will embark on a massive QE program. About how Shinzo Abe is talking tough and people believe he will politicize the BoJ and put pressure on them. Those would be the global macro reasons.
But there is another potential order flow generator. This one comes in the form of a market positioning scenario.
I need to talk a little bit about hedge fund trading here.
USD/JPY has been a tight range for a very, very long time. It was suffered from a lack of volatility. When hedge funds and banks see this, some of them still want to extract profit from it. So what they do is they start to sell options in the market. Some of them sell call options in USD/JPY and pocket the premium if they expect those options to expire worthless. Others may sell exotic options to other people. For example, a bank may sell a hedge fund a 85.00 OT option. The bank pockets the premium and expects the market to stay in a tight range so they don’t have to payout. While the hedge fund is hoping the price rises to hit 85.00 so they can make their payout.
So you had this situation going on for months and months. When this happens in a liquid currency pair with a lot of exporter/importer activity like USD/JPY, then what happens is that the market can be caught “short vol.” There can be an imbalance in option activity. A disequilibrium environment in the option activity. This imbalance can reach billions and tens of billions of dollars worth of option activity.
“Short vol”, meaning that the market is caught short volatility. You have a situation where a lot of market participants are hoping that the price continues to stay stuck in a tight range.
Once USD/JPY broke above 80.65, a lot of the people who sold call options and sold various exotic options started getting scared. They pocketed some option premium, but they have a liability. The more USD/JPY rises, the higher their liability grows.
Obviously, some people choose to hedge their option activity. But not everyone.
There are some market participants that do not hedge, or only hedge partially.
So you had a situation where the more USD/JPY goes up, the more these option players get scared and have to start buying up USD/JPY in order to hedge their growing liabilities. Add to that some option hunters are opportunistically taking out some topside option barriers and you have the market bias be higher, so long as there isn’t any disappointing news out of Japan.
In the Hedge Fund Mindset Mastery, you will see this almost exact situation happen to George Soros in the USD/JPY in the 1990’s. He got caught on the wrong side of such an imbalance in option activity and lost hundreds of millions of dollars.
GBP/USD News Trade Example:
Here is an example of the News Spike and stops tripped, market overextended, and reverses.
It happened in the GBP on December 13, 2012.
Here is the zoomed out chart to see which stops got triggered:
As you can see S&P cut Britain’s credit rating outlook. The GBP dropped 33 pips in a one minute news spike. In the process it took out stops below 1.6095 and you could have faded those for a long trade.
Did I place it?
No I didn’t, since I was already long EUR/USD from the previous day, I didn’t want the correlation risk of adding another GBP/USD long position. My stop price alerts were firing off as the GBP dropped below 1.6110, so I was aware the GBP was selling off, but I wasn’t looking for any more short dollar exposure so I passed on it. Although, if I was flat for currency positions, I would have probably gone long.
Changes In The Rules Of The Game
George Soros said in his book Soros on Soros:
Question: How would you describe your particular style of investing?
Soros: I would put it this way: I do not play according to a given set of rules; I look for changes in the rules of the game.
The key words are “looking for changes in the rules of the game.”
Now a rookie trader may read that statement and assume that Soros is talking about manipulating the markets, or insider trading, or some other shenanigans. But that is nonsense.
Again Soros is talking in cryptic terms. Luckily I can explain it to you.
What Soros is talking about is that he is looking for changes in the macro rules of the game. He is searching for changing in the global macro rules of the game. Global macro shifts. He wants to identify a situation where something has happened that has caused the “rules of the game” to change and thus cause a trend to develop or volatility move to develop.
For if there is a global macro shift, then that can cause MDMM moves, or GM moves, big trends, etc that you can capture. In other words, identifying the changes in the rules of the game allows you to make the Big Money and the easy money.
What are some examples of changes in the rules of the game from this year 2012?
Here are two examples from the summer of 2012.
The first is when the ECB President Mario Draghi said that the ECB:
is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.
The EUR was selling off in early and mid July due to fears that Spain was going towards the path of Greece. Then Draghi came out with this statement and changed the rules of the game. He put a floor underneath the EUR crisis. All of a sudden, any macro sellers that wanted to get aggressive and continue selling EUROS would have to go up against the prospect that The ECB may enact policies that could cause short covering in the EUR and alleviate the crisis. Thus, a whole bunch of macro funds started to cover their EUR shorts.
The rules of the game had changed and it caused big movements in the subsequent weeks in many different markets, not just the EUR. The stock market rallied big time.
The second example is from the Federal Reserve in August 2012.
The market was operating under the assumption that the Federal Reserve would not engage in more QE unless the economy slowed down from its current level.
On August 7, the Fed official Rosengren said that QE should focus on MBS (mortgage-backed-securities)
On August 22, the FOMC Minutes came out and it said that many officials saw further easing as warranted fairly soon “unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.”
The rules of the game had changed. The Fed changed its stance from only being willing to engage in QE if the economy slowed down, to being willing to engage in QE, if the economy did not increase as fast as they expected or create jobs as fast as they expected.
They changed the rules of the game and USD sold off heavily and the stock market surged higher yet again armed with fresh macro buyers from more perceived Fed QE. Gold surged higher $150 per ounce.
That is why it pays to understand when the rules of the game are changing. It pays big time.
I think that’s enough for today. That’s it for today!