Archive for September, 2008

An Ugly Day on Wall Street

By trader7757, 30 September, 2008, No Comment

Yesterday was one of those days you could throw out all that you knew about trading and just watch in amazement as 900 billion dollars evaporated into thin air. As you are all probably aware of by now, the market reacted violently to the house repudiation of the bailout bill and dropped an unprecedented amount. As you can see on these charts, some of the bars were 50 pts long, so I had to switch over to 1 min bars from 3 minute bars just to stay in the game. It was like riding a bucking bronco and I stayed very conservative and only took a few trades, and then only traded one contract, yesterday was a good day to lose a bundle or make a bundle if you were in an aggressive mood. Myself, I stayed conservative. I am sure there are others that would have done differently. As you can see, the market started down as the votes were being tabulated on the bailout bill, but I worried that a large block of yes votes may surface and the market would gap up, through my stops and cause a catastrophic loss. So I settled for a few scraps here and there and ended up +18 at 1 contract. Which isn’t all bad, but looking all that was on the table, it was not what could have been done, just the same, I was happy with my trading.

In a panic market like this, support and resistance were not reliable, nor were any oscillators, at least not with any consistency. It was trading off the cuff, which is not really my style. It was a day that the market romped out of control. I would look for more of this in the coming days as the bailout bill works it’s way to the Senate and then probably back to the House. It should provide some interesting financial pyrotechnics.

Wow! Check out the length on some of these 3-minute bars

By trader7757, 26 September, 2008, No Comment

ESZ8

As you may have been reading throughout the course of this blog, we try to enter trades at the +100 and -100 points on the CCI, depending upon whether or not you are going long or short. We try to exit when the slow stochastic diverges from the direction of our trade. Of course, these are just general rules of thumb, as we also take into consideration the available pivot points, support and resistance and price action.

Of course, the best laid plans can be made useless when volatility reaches a point where the three minute bars may stretch from 5-11 bars, making almost impossible to stay in a trade, no matter which direction you think the market is moving. And that was the case today….it was like trying to surf in a hurricane….the waves were just too big to ride. So you are reduced to guessing which way the market may take off, which is a situation that I will participate in…proper investing goes from being a systematic artform to a binary outcome guess.

The reasons for today’s, and most of the past weeks, volatility is rooted in the continuing financial shake out in the banking system, with Washington Mutual the casualty of the day. I would expect more bank failures in the coming weeks, as we are just now going through the deleveraging process caused by the securitization of mass quantities of these subprime and Alt-A mortgages. As you might expect, Congress has dithered away valuable time in a hotly contested bail out plan….a plan that has been replete with all sorts of pageantry and theatrics as members of congress grandstand for popular acclimation by the masses. In the whole, it has been a pathetic demonstration of our democratic deficiencies. We will overcome it all, though.

More of the same in the futures markets….

By trader7757, 25 September, 2008, No Comment

ESZ8 09-23-08

As has been the case the last couple of weeks, the market yesterday was searching for some direction. Once again, I had to widen my stops to stay in a trader as the volatily was substancial.
Looking at the chart, it appears to be any easy one to trade, but the was not the case for me yesterday. The morning session took maximum concentration to be profitable.

I would expect the markets to remain volatile until the bailout bill is hashed out and presented for a vote. Of course there is not shortage of opinions on how the crisis might be handled, but nothing definitive has emerged from the talks yet….although I don’t think anyone n Congress misunderstands the dire situation we are in.

A technical explanation on Hold to Maturity pricing from Calculated Risk.

By trader7757, 23 September, 2008, No Comment

reprinted with permission from CalculatedRisk

Hold-to-Maturity Pricing

by CalculatedRisk

An interesting question is why do Bernanke and Paulson believe the Hold-to-Maturity price is higher than the current market price for MBS?

One possible explanation is market failure based on information asymmetry. Mark Thoma explores this question: “Hold to Maturity” versus “Fire Sale” Prices

Let me try to give a defense of paying above current market prices (in a devil’s advocate sense). For markets to function according to competitive ideals, full information must be available to all market participants. When information is lacking, or when it is asymmetric, the outcome is inefficient relative to the full information outcome.

The nature of these assets – their opacity as it has come to be called – makes full information unavailable. I’m not sure how asymmetric information is, people holding the assets don’t know themselves whether a particular asset might blow up and lose it’s value or not, but there is some degree of asymmetric information in these markets (a standard lemons problem).

This is market failure due to lack of full information, and asymmetric information to the extent it does exist, is depressing prices.

In this case, I don’t think the information is asymmetric because both buyer and seller are aware of the characteristics of the MBS. There is uncertainty regarding future house prices (and MBS performance is related to house prices), but that isn’t a market failure.

Professor Thoma also links to Professor Kling: Hold-to-Maturity Pricing

Suppose that you owe $110,000 on your mortgage, due in one payment a year from now. The “hold to maturity price” is that $110,000, discounted back to the present. At an interest rate of 10 percent, the price is $100,000…..NOT!

The fair price depends on the probability that you will default. If there is a 50 percent chance that you will default, the fair price is more like $50,000.

The probability that you will default depends on the distribution of possible paths of future home prices. Along paths of falling home prices, defaults are much more likely than along paths of stable or rising prices.

It’s hard to know how home prices will behave, but right now if I were pricing the risk (something I used to do for a living, unlike the key decision-makers in this bailout), I would include a lot of paths where prices go down. That would make the “hold-to-maturity” prices of the mortgage securities, properly calculated, pretty low in many cases.

First, this analysis assumes 100% loss severity in the event of default. If there is a 50% chance of default, half the time the mortgage will be worth $110K discounted back to the present. But if the borrower defaults, the value will not be zero since there is a recovery value on most mortgages. Kling apparently assumes a loss severity of 100% in the event of default (perhaps he was thinking of a 2nd mortgage), but a more normal severity would be around 50% or $55K discounted back to the present. So in this example, and using a 10% discount rate, the mortgage would be worth $100K * 0.5 + $50K * 0.5 or $75K at present.

But I think this might provide a clue to the pricing disparity: because of the uncertainty in future house prices (and MBS performance) potential buyers are probably using a higher discount rate than Bernanke / Paulson. Typically the higher the standard deviation of the potential outcomes (higher risk), the higher the discount rate. So even if investors view the future price the same as Bernanke/Paulson, they might view the NPV as much lower. In addition, the cost of capital is higher for private investors – also impacting their discount rate.

Perhaps Bernanke / Paulson believe that aggregating assets will lower the risk. Usually when you aggregate assets, the overall volatility decreases. This is almost always true for holding a group of stock (the beta on the S&P 500 is lower than the beta on most stocks in the S&P 500). But if the assets are all impacted by one parameter – in this case future house prices – aggregating assets does not lower the risk.

This would make a great question for Bernanke tomorrow. Why does he believe the Hold-to-Maturity price is higher than the current market price? Is this because of some market failure? Or because of different discount rates? Or some other reason?

a quick post

By trader7757, 19 September, 2008, 1 Comment

I have been having some minor health issues and have finally decided to have them addressed by a surgeon over the weekend. As you may have noticed my posts have to been as frequent as normal as I go through the battery of tests required to have this surgery. It isn’t life threatening surgery, but it’s definately going to slow me down for a week or two….I promise to come back stronger than ever.

the last two futures trading days

By trader7757, 17 September, 2008, No Comment

From the onset I have to apologize for not posting for two days, but we a serious illness in the family and that event, along with the time I had to devote to trading, kept me from posting. But here are the charts.

The first thing you will probably notice is that on very volatile sessions I switch from trading the ESZ8 to the YMZ8…while this may be some psychological disorder brought on by years of trading, I have always switch to the YM because there is less black box and technical trading on the YM. Okay, that is what I think and I cannot for one second substantiate the fact. But psychological I always seem to trade the dow futures contract than the S&P contract on chaotic days.

I will not rehash the troubling events that have led to the unprecedented turbulence we have endured this week and in the past weeks,,,,,,Fannie Mae, Freddy Mac, Lehman Brothers, AIG, Bear Sterns….and a host of potential corporations that are bound to join this list before this unprecedented event comes to a close. In my opinion, the derivative issues are now just coming to light and the full extent of the pervasiveness of them is yet to be determined, let alone the level of leverage each individual contract assumed. It not going to be an easy or painless task and it is going to take a very deft touch to see us through this mess.

It should be an interesting Monday

By trader7757, 14 September, 2008, No Comment

I’ve taken some time today and read most of the financial blogs and financial websites I generally use, and have decided that tomorrow ought to be an interesting day, to put it mildly.

1. It appears that Lehman Brothers has found itself at the end of the road, as no suitors have come forward to save the beleaguered firm. This is the fourth largest investment in the US and the implications for the potential implosion of the firm has far reaching consequences. Most articles are stating the negotiations are ongoing, so there may be some new developments later in the day to calm the markets, but as of this minutes it appears Lehman Brothers is going the way of the Titanic.

2. Crude oil may spike some as the damage for Hurricane Ike is assessed and it’s implication on refining are revealed.

3. Washington Mutual appears to be in desperate straights, too. The implications for this bank failure are absolutely enormous. I can’t imagine the effects it may have on the market.

It is my opinion that all the meddling the government has engaged in to prop up the beleaguered banking industry are actually putting of the inevitable, which is a dramatic correction in the markets. We need to find a market bottom somewhere in this mess and though it would be a painful measure, we might actually be able to sort out just where we are. As it stands, the Fed and others are plugging holes in the financial dike to stave off this correction. In doing this, I believe that many financial institutions have hidden much of their suspect Alt-A and sub-prime exposure….which really isn’t doing anything but buying time, for the time being.

Of course, some economist believe we could “inflate” our way out of this mess, that is, get interest rates to rise and, in effect, stave off market worries by increasing prices and values in several troubled banking areas. Needless to say, this approach would be less than desirable for the average consumer as inflation is a hardship for the middle class. And there is much more inflation out there than our government would have you believe. There is an excellent discussion on how the government currently calculates inflation number they disseminate, as oppose to the way they used to, and the way other countries calculate inflation number. You can find excellent discussions on the topic in past posts on the Calculated Risk and Financial Armageddon blogs, which are listed on the sidebar of this blog.

As a trader, I am not affected by wild swings in the market. To the contrary, volatility is an important factor in how we trade. But as a consumer, many of the implications of the Feds policy of late are far from consumer friendly.

Where is this Market headed?

By trader7757, 13 September, 2008, No Comment

The market has once again shrugged off all sorts of negative news and continued along is merry path of indifference to the real world problems we are experiencing. I can honestly say that I have never seen our economy in such perilous straights, though you could scarcely ascertain that fact by looking at the charts for the last few months.

Of course, the market has been skittish, as of late…and very difficult to trade as it chops along with very wide intra bar (three minute) swings. I have been very conservative in my trading and had only marginal success in keeping myself from being stopped on trades. Note: Look at the length of some of the bars on today’s charts and assuming a 12 tick stop, notice the difficulty one has in staying in a trade. While the direction of the market hasn’t been necessarily difficult to ascertain, the volatility has it very hard to stay in some trades without expanding your personal risk tolerance by widening your stops a few points. I won’t do it, and have been very quiet in my trading as a result of this.

Up? Down? All Around? Trading in Extreme Volitility

By trader7757, 11 September, 2008, No Comment

As has been the case for the last few days, the market was once again focused on the financials and the futures trading was frantic…..from -132 pts early on to +162 and higher after I stopped
trading for the day. Lehman Brothers and it’s attendant problems, along with oil, sub prime mortgages and every imaginable malady ran the market at a manic pace. I stayed fairly conservative all day, more out of fear than anything. Entries and exits were difficult to pinpoint, so I stayed at a 12 tick and stop limit and made out okay…though I did not trade more than 3 contracts at any point during the day. I was up 4 pts by the time it was over, but felt like I’d been on an out of control roller futures trading coaster. Support and Resistance levels, along with pivots were honored now and then, but by and large the market staggered around like a drunken sailor….searching for leadership and direction.

Choppy Markets

By trader7757, 10 September, 2008, No Comment

Today was an especially difficult day to trade. As a matter of fact, I traded for about 1 hour and stopped as the choppiness in the market made it very difficult to stay in a trade. Some of the candlestick formations stretched 3-7 points which is a higher risk tolerance than I can endure. Not that the direction identification was wrong, but surviving the turbulence to stay in the trend became very costly. The only option is expand your risk tolerance past 12tick stops, which for me is too much risk to take. So my trading was curbed today.

The announcements of Lehman Brothers has been scapegoat quoted by most analysts, and I feel like the revelations unnerved a good number of traders. On days like this I stop, as I feel as if I am “guessing” at the market direction. The market did settle down some later in the day, and resumed a more normal trading pattern.

The important lesson is knowing the market conditions that lend themselves to profitable trading and market patterns that are difficult to trade, at least trade systematically. Very early in my career I would hang in there and battle the market, usually losing money, and as I have gotten more experienced there are days that are simply hard to trade. Today was a day like that for me, as I was stopped out of my first three trades….and I stopped. and saved myself some money and frustration. -9 pts on 3 contracts. A very disappointing day.

The Fractal Futures Trader