Posts tagged ‘efficient market theory’

Is the NASDAQ Now in Thin Air?

By , 23 October, 2009, 1 Comment

Of the three major indexes we track: DOW, NASDAQ and the S&P 500, only the NASDAQ is in thin air.

What do I mean by thin air? So far the NASDAQ is the only index to make it past the 50% Fibonacci retracement levels as measured from the highs seen in 2007 and the lows that were made in March of this year.

Both the Dow and the S&P 500 have rallied strongly from their March lows but have not made it over the 50% retracement level.

Click here to see the video “Is the Nasdaq Now in Thin Air”

Many professional traders – myself included – are looking at the NASDAQ’s Fibonacci retracement as it represents a potentially key turning point for this year’s market.

While not all the pieces are in place to go short or get out of long positions, one of the first clues is being put in place today by the Japanese candlestick charts.

In my new video, I share with you the NASDAQ retracement levels, as well as one of the key components that could lead to a potential reversal to the downside.

As always, our videos are free to watch and there is no need to register.

Click here to see the video “Is the Nasdaq Now in Thin Air”

Enjoy the video, all the best.

Can the Market Be Wrong?

By , 14 August, 2009, No Comment

This begs the question for the trader: Is the Market Wrong at Times?
Well, the answer is an easy one. The market is always right, and if you trade why you think is right versus what the market has deemed to be right you are in for an unprofitable ride.

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From the Baseline Scenario Blog…

By , 27 July, 2009, No Comment

After Peak Finance: Larry Summers’ Bubble

There are three kinds of “bubbles” -  a term often used loosely when asset prices rise a great deal and then fall sharply, without an obvious corresponding shift in “fundamentals“.

  1. A short-run bubble.  Think about 17th century Dutch Tulip Mania: spectacular, probably disruptive, but not a major reason for the decline of the Netherlands as a global power.
  2. A distorting bubble.  In this case, the increase in asset prices contributes to a reallocation of resources across sectors.  Think of the Dot-com Bubble: fortunes were made and lost, the collapse was scary to many, and – at the end of the day – you’ve built the Internet and some good companies.
  3. A political bubble.  Here rising asset prices generate resources that can be fed into the political process, through bribes, building politicians’ careers, and lobbying of all kinds.  Bubbles in Emerging Markets often generate resources that impact the political process, sometimes in good ways – but most often in bad ways, which eventually contribute to a collapse.

Larry Summers seems to think we are dealing with the consequences of bubble type #1.  In his speech last week, “the bubble” is a modern deus ex machina – it explains why we have a crisis, but there is no explanation of where this bubble came from, what exactly was bubbling, and what changes this bubble brought to the real economy or to our politics.

To the extent that Summers talks about the bubble at all, it seems to be in residential real estate.  It’s hard to argue that there was an unsustainable run-up in housing prices and that the fall has real consequences.  But what model – or even story – can explain the size of the global disruption we are facing without reference to what happened specifically in the financial sector?

The overall official consensus - which Summers continues to shape – seems to be that our problems are: housing bubble plus bad management in a few big financial firms and slightly too weak regulation.  So we’ll tweak regulation, ever so gently, and let the “good” big firms gobble up the people, market share, and perhaps even assets of those that fall by the wayside.

But what if we are looking at the effects of a distorting bubble?  In previous formulations – but not last week – Summers acknowledged that when financial sector profits hit 40 percent of total corporate profits, a few years ago, we should have seen that as a “warning sign”.  But was this a warning sign of something just about houses, or more broadly about the financial process in and around securitization that was both feeding the housing price increase and also reflecting a longer-run shift of resources into the financial sector?

Even James Surowiecki, a most articulate defender of our current financial sector, implicitly concedes that as a percent of GDP, finance is likely to fall from around 8 percent to GDP back towards 6 percent of GDP (its level of the mid-1990s; see slide 19 in my recent presentation; update, this link now fixed).  Of course, there is no way to know exactly where finance is heading – except that it is likely down as a share of the economy.

If the bubble (or metaboom with a series of bubbles) was in finance and pulled resources into that sector, we face an adjustment away from Peak Finance – and perhaps this will even more overshadow the next decade than Peak Oil.

The economic adjustment will not be easy for the U.S. but it will be much more painful for smaller countries that have specialized in finance.  The U.S., however, will likely struggle with the political adjustment – the financiers will not easily give up their licence to extract resources from citizens, either directly or through newly found rents channeled through the state (and coming ultimately out of your pocket, of course).

The political consequences of Peak Finance greatly complicate our economic recovery.

By Simon Johnson

Efficient Market Theory’s Demise: Where do we go from here?

By , 25 July, 2009, No Comment

Mendelbrot had the problem pegged long ago, chaos and randomness…there has been no real explanations because a degree of randomness exists in the market and it is difficult to account for irrational behavior, or market noise.

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Emini Trading: Do you have style?

By , 22 July, 2009, 1 Comment

I think before anyone embarks upon serious study of trading, then trying to make a living at trading, he/she ought consider the style of trading that best fits their personality.  Unfortunately, the term “trader” means a lot of things and encompasses a wide range of trading styles and methodologies.   My personal style of trading reflects my personality, I like immediate gratification and results, so I am a scalper.

So what is a scalper?

Most scalpers, especially the scalpers who trade the eminis, seek to exploit the natural rhythm of the market and carve out small gains on each trade.  My goal is often 12 ticks, though that can change depending upon the mood of the market and an indicator I used (and have written a post about) called the Average True Range.  My trades seldom last more than 10 or 15 minutes and I exit.  I never carry positions overnight.  My account is trade free at the end of the trading session, or at least, the period of time I am trading.

I scalp because it suits my personality.  I like the fast paced action and the lack of dependence on intermediate term prognostications on the direction of the market.  Some scalpers, seek to exploit the big/ask disparities in the market, though that is never my goal.  Scalpers need to implement strict money management guidelines in their trading, and never risk more than 5% of their capital on a given trade.  There are a host of traits scalpers use, and those traits even vary from scalp trader to scalp trader.  The important thing to remember in scalping is that I am looking for very short term moves in the market to exploit, and I do not attempt to predict any overall direction of the market as a whole.  I am interested in certain moves in very specific contracts.  The market as a whole does not interest me and, generally speaking, I don’t pay much attention to overall market conditions.  I trade the chart I am looking at, not the news, not the economy, just the chart before me.

Swing traders are a different matter, though.

Swing traders are really fundamental traders who hold their positions longer than a single day. Most fundamentalists are actually swing traders since changes in corporate fundamentals generally require several days or even weeks to produce a price movement sufficient enough for the trader to claim a reasonable profit.  The important difference between a swing trader and a scalper are basic: A swing trader has a notion or idea which way the market is going to move, or which way an individual stock is going to move, and invests based upon his belief.  Swing traders usually identify a specific characteristic or event in the market and trade based upon this theory.   I should point out that though many swing traders are interested in market and stock fundamentals, there is also a field of swing trading that invest based solely on technical trading.  Oscillators, Gann lines, Dow theory….there are scads of theories that swing trader may implement to ascertain the timing and direction of the trades they choose to execute.

Technical Traders, Fundamental Traders and Efficient Market Traders.

There is scant space in this post to cover the myriad of styles these three titles cover.  I should also point out that there is often very little agreement upon methodology by the three trading camps.  Each lays claim to correctness, though I incorporate parts of all three trading styles into my personal trading style.  I will devote some posts in the future to contrasting the mindset of each of these trading theories.

The point here is a basic one, a trader ought to decide who and what he is and what style he will implement in his trading activities.  This decision is usually gained through extensive reading and trading experience.  There are some great books written on each of these trading styles, and all traders out to consider spending some time reading about the great theorists of trading and the style and rationale they employed to reach the conclusions they write about.

Some suggested reading would include:

Dr. Burton Malkiel, “A Random Walk Down Wall Street”  (efficient market theory)

Benjamin Graham and David Dodd, “Security Analysis”  (value investing, fundamental investing)

Benjamin Graham, “The Intelligent Investor”  (value investing, fundamental investing)

John Murphy, “Technical Analysis of Financial Markets” (technical trading)

J. Welles Wilder, “New Strategies in Technical Analysis” (technical trading)

Martin Pring, “Introduction to Technical Analysis” (technical trading)

Dr. Bill Williams, “Trading Chaos” (chaos and fractal theory)

Benoit Mendalbrot “The Misbehavior of Markets”

All of these fine books will provide you with a great theoretical background to begin your journey as a trader.  I have dog eared copies of each of the books, and often refer back to them to refresh my own knowledge base.

So read, trade, experiment…then find the style of trading with which you can succeed.  As always, best of luck trading.

Efficient Market Theory in Practice: How do you account for Long Tails?

By , 12 June, 2009, 3 Comments

I was reading an interesting blog post yesterday on Falkenblog that seemed to defend, in part, efficient market theory. One of the most basic tenets of efficient market theory is the assumption of investors as rational individuals. Further, this rationality is a function of the dissemination of information in our society so that all is known about a certain stock or equity instrument. The conclusion, then, is that the market efficiently distills this information, via the rational persons buying and selling of certain stocks.

Twenty five years in the stock business long ago dispelled any notion I learned in college that investors are anything close to rational, though the law of large numbers would seem to apply in that the more individuals participating in an individual issue the more likely the issue is likely to be priced properly. But history has, again and again, made it apparent that rational investors are a scarce commodity. Whether it be tulips, dot.com IPOs or houses, we are NOT rational, we are irrational. Lemming-like.

Mendelbrot theorized in “The Misbehavior of Markets” that long tails exist along any dispersion curve. With that statement he infers that catastrophic or unique events cannot be nearly encapsulated in any market theory for the exact opposite reason efficient theory draws its premise: Investors are rational.

For example, the premise during the dot.com bubble was something like this: things besides information can be efficiently distributed over the internet. I can remember looking at the business model for a dry dog food distribution operation and wondering how in the world a rational man could believe such a business model could work. It didn’t, even though the initial IPO skyrocketed, irrationally, to dizzying heights in early weeks of trading. And no the dot.com IPOs are resting in peace, after relieving millions of rational investors of their money.

Is the housing bubble any different? Well, maybe a little, as there was an overriding greed component to this bubble. Which brings me to my point: Investors aren’t rational, they’re greedy. Now don’t think for a second I believe greed is a bad thing, for it is greed, or the desire to earn a higher rate of return, that fuels capitalism. But this greed component often leaves up out on Mendelbrot’s long tail, and we have to find our way out of the long tail wilderness and back to the cozy equilibrium that exists in the main Bell curve structure.

But if Efficient Market Theory and it’s CAPM component are bunk, why is it taught at the university level with the reverence afforded holy books? Well, it’s partially true, until it comes to Long Tails, and then it falls apart. Boy, economics is tough stuff

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