Thursday, September 15, 2011

Trading and washing toilets

The constant evolution of a trader comes from the attempt to minimize the distance between what one should do (strategy) and what one actually does (execution). The endeavor to close the gap between these two is a career-long challenge. After multiple years of trading your tool-box of strategies should be brimming, your risk-management skills solid, but what constantly differntiates the mediocre traders and the great traders is this distance between what they know they should do, and what they actually do. Ideas are a dime a dozen, but it’s the execution that will make or break you.

Treat trading as a job. Imagine washing toilets for 8 hours straight and then your boss coming to you and saying, well actually I’m going to take back the last 5 hours of your pay and will only pay you for 3 hours. Losing in trading is inevitable, but it has to hurt you — if you’re going to lose money it has to be on a trade that set up great but just didn’t work. Those are the losses that we like — they don’t put us in a bad mood. A loss from a trade that you would not hesitate in taking again. Most traders like trading, for them it’s a great job, much better than for example, washing toilets. And the money can come in fast — the normal correlation between time spent working and income occurs at a much different rate than in other jobs (at least from an hourly/daily point of view for daytraders). And maybe because of this they act fast and loose.

This is the reason we like having a pre-defined plan from the night before — it helps us execute well. A pre-defined plan gives us conviction and conviction and good execution (trading tight and disciplined) go hand in hand. Every single trade should count — and you should take the money earned from the job as seriously as the guy counting the hours washing the toilets at the city park.

The Game Plan

This morning the market reversed at 121 $SPY resistance (and $ES_F 1200). Day is still young and we could base intraday and take out 121 before the close –even though we’d prefer a close under 121, a few days basing, and then a breakout of 121 and into next resistance of 123.5 which would be top of channel/50SMA.

Of course in this market you have to be open to all options — and reversing back down is also one of them. However, this scenario is looking less likely in light of recent market action.

Tech, retail and trannies are acting well, but basic materials and financials have to start pulling their own weight soon if this rally is going to have any standing power. The daily chart is technically still in the bear camp until we break out of this range but short-term the price action is with the bulls. Our focus into the next few days will be the catch-up sectors (especially basic materials) as tech takes a rest.

Wednesday, September 14, 2011

Rip or Die

We’ve written before that this range-bound market seems to only know how to rip up or die down. There’s very little chilling in between. If we do want to finally leave this range then the market needs to digest the moves and start to build bases — something that has been missing since the correction started in August.

Note how we keep bouncing off the lower range and reversing off the higher range (and today no exception as market screeched to a halt and reversed down as we hit the higher range in the $ES_F, and the 50SMA in the $SMH).

Who do you believe?

Listening to the CEO of Societe Generale one can’t help but to feel re-assured that all will be well:

And just when you’re lulled into complacency this report by Jeffries’ market strategist  David Zervos smashes any sense of calm:
In most ways the excess borrowing by, and lending to, European sovereign nations was no different than it was to US sub prime households. In both cases loans were made to folks that never had the means to pay them back. And these loans were made in the first place because regulatory arbitrage allowed stealth leverage of the lending on the balance sheets of financial institutions for many years. This levered lending generated short term spikes in both bank profits and most importantly executive compensation – however, the days of excess spread collection and big commercial bank bonuses are now long gone. We are only left with the long term social costs associated with this malevolent behavior. While there are obvious similarities in the two debtors, there is one VERY important difference – that is concentration. What do I mean by that? Well specifically, there are only a handful of insolvent sovereign European borrowers, while there are millions of bankrupt subprime households. This has been THE key factor in understanding how the differing policy responses to the two debt crisis have evolved.
In the case of US mortgage borrowers, there was no easy way to construct a government bailout for millions of individual households – there was too much dispersion and heterogeneity. Instead the defaults ran quickly through the system in 2008 – forcing insolvency, deleveraging and eventually a systemic shutdown of the financial system. As the regulators FINALLY woke up to the gravity of the situation in October, they reacted with a wholesale socialization of the commercial banking system – TLGP wrapped bank debt and TARP injected equity capital. From then on it has been a long hard road to recovery, and the scars from this excessive lending are still firmly entrenched in both household and banking sector balance sheets. Even three years later, we are trying to construct some form of household debt service burden relief (ie in order to find a way to put the economy on a sustainable track to recovery. And of course Dodd-Frank and the FHFA are trying to make sure the money center commercial banks both pay for their past sins and are never allowed to sin this way again! More on that below, but first let’s contrast this with the European debt crisis evolution.
In Europe, the subprime borrowers were sovereign nations. As the markets came to grips with this reality, countries were continuously shut out from the private sector capital markets. The regulators and politicians of course never fully understood the gravity of the situation and continuously fought market repricing through liquidity adds and then piecemeal bailouts. In many ways the US regulators dragged their feet as well, but they were forced into “getting it” when the uncontrolled default ripped the banks apart. Thus far the Europeans have been able to stave off default because there were only 3 borrowers to prop up – Portugal, Ireland and Greece. The Europeans were able to do something the Americans were not – that is “buy time” for their banking system. And why could they do this – because of the concentrated nature of the lending. In Europe, there were only 3 large subprime borrowers (at least so far), so it was easy to front them their unsustainable payments – for a while. But time is running out. Of couse, the lenders (ie the banks) have always been dead men walking!
At the moment, the European policy makers – after much market prodding – have finally come to grips with the gravity of their situation. And having seen the US bailout movie, they know all too well what happens when a default of this caliber rips through the financial system. The reason the EFSF was created in the first place was so that there could be some form of a European TARP when the piper finally had to be paid and the defaults were let loose. Certainly many had hoped the EFSF could be set up as a US style TARPing mechanism (like our friend Chrissy Lagarde suggests). The problem of course is that there are 17 Nancy Pelosis and 17 Hank Paulsons in the negotiation process. And while the Germans are likely to approve an expanded TARP like structure on 29-Sep, it increasingly looks like it may be too little too late. The departure of Stark, the German court ruling on future bailouts/Eurobonds, the statements by the German economy minister and the latest German political polls all suggest that Germany is NOT interested a full scale TARPing and TLPGing process across Europe. They somehow think they will be better off with each country going at it alone.
The bottom line is that it looks like a Lehman like event is about to be unleashed on Europe WITHOUT an effective TARP like structure fully in place. Now maybe, just maybe, they can do what the US did and build one on the fly – wiping out a few institutions and then using an expanded EFSF/Eurobond structure to prevent systemic collapse. But politically that is increasingly feeling like a long shot. Rather it looks like we will get 17 TARPs – one for each country. That is going to require a US style socialization of each banking system – with many WAMUs, Wachovias, AIGs and IndyMacs along the way. The road map for Europe is still 2008 in the US, with the end game a country by country socialization of their commercial banks. The fact is that the Germans are NOT going to pay for pan European structure to recap French and Italian banks – even though it is probably a more cost effective solution for both the German banks and taxpayers.
Where the losses WILL occur is at the ECB, where the Germans are on the hook for the largest percentage of the damage. And these will not just be SMP losses and portfolio losses. It will also be repo losses associated with failed NON-GERMAN banks. Of course in the PIG nations, the ability to create a TARP is a non-starter – they cannot raise any euro funding. The most likely scenario for these countries is full bank nationalization followed by exit and currency reintroduction. Bring on the Drachma TARP!! The losses to the remaining union members from repo and sovereign debt write downs at the ECB will be massive (this is likely the primary reason why Stark left). It will require significant increases in public sector debt and tax collection for remaining members. And for the Germans this will probably be a more costly path. Nonetheless, politics are the driver not economics. There is a reason why German CDS is 90bps and USA CDS is 50bps – Bunds are not a safe haven in this world – and there is no place in Europe that will be immune from this dislocation. Expect a massive policy response in Europe and a move towards financial market nationlaization that will make the US experience look like a walk in the park. Picking winners and losers will be VERY HARD but let’s look at a few weak spots –SocGen 12b in market cap (-70% this year) with assets of 1.13 trillion BNP 31b in market cap (-55% this year) with assets of 2 trillion Unicredito 13b in market cap (-70% this year) with assets of 1 trillion Intesa 14b in market cap (-70% this year) with assets of 700b Compare this with the USA where we have – JPM 125b in market cap with assets of 2.1 trillion BAC 70b in market cap with assets of 2.2 trillion
Importantly, France GDP is only 2 trillion and in bank balance sheets are some 400% of that number. The banks are dead men walking with massive leverage to both home country income as well as assets. The governments are about to take charge and Europe as a whole is about to embark on a sloppy financial market socialization process that has been held back for nearly 2 years by 3 bailouts. The weak links will not be able to raise enough Euros/wipe out enough private sector equity to get this done, so there will be EMU members that need to exit and use a reintroduced currency for this process. We put a Greek drachma on the front cover of our Global Fixed Income Monthly 20 months ago for a reason.

Who do you believe?

Source/ h/t: Reformed Broker via BloomBerg, ZeroHedge

Tuesday, September 13, 2011

SPY US downgrade range

The blue rectangle represents the price range for $SPY  between Friday August 05 (downgrade didn’t come until that evening but rumors were already flying) and the Monday/Tuesday reaction.   Three days carved out the range for the next 6 weeks (+).

Monday, September 12, 2011

Cry Wolf Market

A fantastic squeeze into the close to end the day with a gorgeous green candle.      It’s hard not to get excited by such action, especially considering we gapped down below the trend-line.   But we’ve heard this story now multiple times in the last month.  Take a look at the following chart of the $SPY and the blue circles and note how many close at high candles there have been in this period:
Note that there was even follow through on some of these green candles, only to get it whacked down again and again.  We have no idea whether this is IT, and for day-traders it doesn’t really matter (we’re long $ES_F overnight ourselves), but if we were swing traders we’d put out a few tester longs, have a lot of dry ammunition (cash), and accept that we would pay up in price in exchange for more evidence/confirmation.

For you Fib lovers out there

We bounced in August on the important 61.8% retracement, next support is at the 50% retracement which also happens to be major daily support near $SPY 102.    We have no idea whether we’ll actually pull back to that area but we’re open to the idea and believe the possibility is definitely on the table.   However, it doesn’t really affect our type of trading as our time-frame is too short (i.e. even if we get there it won’t be a straight line and will give lots of opportunity short and long).   But for you longer time-frame position traders — keep an open mind.

Backing Off

In the conclusion of the newsletter this weekend we wrote, “We have been pretty active since this whole correction started but we are stepping back now for the first time and seeing how Monday shapes up”. We basically couldn’t think of any plan coming into today: we weren’t interested in buying the bottom trend-line test this time (too many tests in short period of time) and we felt like we were too oversold to initiate shorts. Basically, we had no conviction in either direction coming into today.

We broke the flag today — next support is 112 on the $SPY. Breaking that bottom trend-line removes a lot of our edge as we were trading against that for the last month. We mentioned in our post The Big Road Map the possibility of creating a new range and it’s quite possible we’re in the process of carving out new pivots for that scenario.

August was a good month for us as range-bound strategies ruled supreme. However we feel now (and hope that we’re wrong) that we are entering a more difficult stage of “slim pickings” and are backing off and going into more defense mode. Basically, we are protecting recent profits and refuse to give them back in what very well could be an edge-less trading time. To be continued….