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beHappy - Educational

Discussion in 'BeHappy by Tautvydas Marciulaitis' started by TMarciulaitis, Nov 23, 2012.

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  1. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Here I will post more or less educational stuff. Some general or deeper knowledge about markets. It will not be conventional educational info that most people give to you. I have my own way of educating people about the markets. By this I mean im trying not to give you some cheap bull**** about RSI or whatever. Ill try to give you fundamental framework. And answer questions why its so and not so.
     
  2. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    This one may not be an easy read, but it is useful to know some of the stuff discussed. So just try to read this. It is my own knowledge combined with some statistical research Ive done.

    One of the most common advices you can find in “how-to-trade“ books/lectures/articles for begginers is “do not copy others‘ actions“ and “only follow your own strategy“. I would like to challenge this point of view. In addition, I will try to show you how herding may help you to avoid losses and even gain profits.
    Lets get over some things from the beginning. Even though primarily dedicated to FX spot traders, information in this paper may be used by any traders, who trade any financial instrument. At no point of this paper I will intend to suggest that mimicking others blindly is rational and profitable in the long run. Nor I will try to challenge the idea that one must follow his own strategy. What I will try to do is to show that with sufficient knowledge and understanding, following others may be profitable.
    You may ask how does this work: follow your own strategy, but also follow other traders. It is not that hard to tackle. You have to have your own money and risk management rules (two most important nuances in trading). You have to have rules for entry and exit. You have to know how to manage your trades at any point in time. All of these are musts. However, there is no point for you to ignore what others are doing and not to use this information as an edge.
    Let me be clear: following others does not mean following retail traders. Given the scale of FX market, they are just noise. Nothing more. What you have to take into account is movements of large and institutional traders. I hope it is clear to everyone that they are the people who drive and move the market. Thus, knowing what they are up to and not going against them may at least help one to avoid losses. And this basically is why I find statements which tell you not to herd misleading. It depends on whom you herd on.
    Now lets move to the “so how do I make profits“ part.
    Obviously, one cannot call some hedge fund, Goldman or UBS and ask them for their live calls. But large money does not move unnoticed, there are ways to track it. I will not suggest that it is easy, as it is not. However, it is possible.
    The most straightforward way to do this is to monitor commitment of traders (COT) reports released weekly by Commodity Futures Trading Commission (CFTC). Yes, one may argue that CFTC reports represent only a fraction of futures markets, which by themselves do not have significant effect on spot prices. But like I said, we are following only large and institutional traders here. And as institutionals want to hedge their spot positions in futures markets, large traders are usually large not because they inherited loads of money, but because they are able to make good living from trading. These are only words. Lets check statistics.
    All the data used for further empirical analysis was sorted and checked for pitfalls such as autocorrelation, non-stationarity, skewness of residuals and etc.
    Using ten years of weekly data, lets try to find out if changes in large traders‘ long positions on euro futures denominated in US dollars are good at predicting future spot eur/usd prices. These two variables are highly correlated (correl=). Simple linear regression tests shows that at x% confidence level we may not reject the hypothesis that percentage changes in price are affected by percentage changes in large traders‘ positions. This is not the interesting part yet.
    Lets now test for Granger Causality. This test is most widely used to determine if we can predict changes in some variable by looking at lagged changes in another. In simple words, the logic is that if lagged values of some variable (variable A) are good at predicting future values of another variable (variable B), then it might be the case that variable A causes variable B.
    The results we get after running tests show that lagged percentage changes in large traders’ long positions is actually a good tool in forecasting percentage changes in prices. Simply said, large traders’ actions this week, may suggest to which direction prices will move over the next week.
    Of course, this is not highly accurate analysis, yielding undisputable results. But when logic and empirical analysis point to the same direction- I see no reason to ignore or discard it. This is additional information, which might give you an edge. And edge is all what enables any trader to make money.
    This was only part 1. There are some more ways to track the sharks.
    Another great tool is BBA LIBOR rates. Yes, I am aware of rigging scandals all over the place. Nevertheless, logic behind following these rates is simple: if largest banks in London start to value some currency less than others, why should I think otherwise ? LIBOR rates are trending and more often than not they change in a structural manner. It is so, as banks and other financial institutions usually do not change their view on hourly or daily basis. They act according to analysis conducted by their economists, which changes according to economic situation, not by some rumors or fads. So this one is more or less no-brainer for me.
    Following COT and LIBOR should give you a pretty good grasp of how money is moving around. But that is not all to it.
    Now comes the part which is hard to explain and learn. I believe most of you understand that large money does not simply stay in one currency or another. It is invested in different assets such as bonds, stocks and derivatives. Every time some fund or institution closes its position in one asset, it has to move to another. And it rarely changes positions couple times a day. It rarely changes position alone (if one fund or bank decides to accumulate something, wait for others to join). Usually money is being reallocated to a new asset within weeks or even months. To be able to profit, one has not only know what large money is selling, but also what it is buying. This part may be very tricky.
    It is not rocket science. But it is an art, which requires time and effort to master. At the end of the road, it is also rewarding. These skills and knowledge helps to identify mid to long term trends and avoid entering positions against them. Not only that, when you get good at it, following trends becomes way much easier. Sadly, nothing but hard work and patience may help you from here on.
    I know there are many day-traders out there, who will think this information is irrelevant to them. Do not fall for this. It does not matter if you scalp, day-trade or invest in long term positions. Not going against trend driven by large money is always the best idea. Does not matter what time frame you are in.
    As stated in the introduction, one of the aims of this paper was to challenge the view that traders should never herd. It should be self evident, when you think about it more thoroughly. More of your time was dedicated to another aim. Explaining, how to herd for profit. I thought it will be more useful to explain how to get and use the information, which may help you in trading, rather than to argue why someone is incorrect. And well.. It is quite clear: proof that you may make money from educated herding disproves the statement you should never do it.
     
  3. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Aight, I will add one PDF here. It is my BSc thesis. This is def not an easy read. Requires some technical knowledge and a is orientied to more advanced readers. Of course, everyone can understand it. But to make the most use of it, you simply have to have deeper knowledge about markets. While writing it, I have understood and learnt much. Hope you will find it useful :)

    ~51 pages long.

    Explore the determinants of herding (information cascades). Discuss whether herding behaviour is rational.

    Abstract
    With ever groing importance of financial markets, it is both interesting and important to look at how they work. As markets are made of people, to find out about markets, we need to look at agents‘ who participate in those markets behavior. Purpose of this paper is to find out how agents form their decissions under assymetric information and whether they herd when trading. This paper consists of theoretical discussion, which aims to answer why agents may herd. In addition, it is discussed if it is rational to do so in the context of financial markets. To see if herding behavior exist in real markets, large traders‘ and small traders‘ behavior was analysed. Despite different than usual approach and methods were used, our findings are consistent with theoretical and empirical work done so far. Results shown that even though herding exists, agents do not follow others blindly, but rather confirm their own signals by observing actions of those, who have more information.
     

    Attached Files:

  4. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Hey thought to write you something about supply/demand levels and just got tweeted this stuff:

    Supply and Demand by Mel

    Its not my words, nevertheless its pretty good. I may have said some things differently and may have not spoke about some of it. But well, like I said, its a pretty good piece of info. So if you are interested in basic suply/demand theory, its there.
    If you have some questions about it- please ask. :)
     
  5. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    An’ here I go again on my own
    Goin’ down the only road I’ve ever known
    Like a hobo I was born to walk alone
    An’ I’ve made up my mind
    I ain’t wasting no more time​

    Sings gold, while going south. So what did just happen with price of gold? (again) I mean, it is the real money, it’s price cannot go down.. is that not true ? Is Santa Claus not real ?!
    Well, let’s start with a chart:

    View attachment 7774

    This is not very impressive or spectacular. Just ~40USD in an hour. But well, it is not the first time, is it ? We have seen something similar. Just about a month ago. Let me quote myself:
    “Today’s (11-28-2012) range is something around average daily range over past few months. But it happened in less than a minute !
    Try to remember, if you have seen something similar happening. Well we all know about the flash crash, but lets concentrate on the gold market. On what instance did price crash quite heavily in a matter of seconds?
    You should remember at least one. Gold crash in April, 2012. Back then price of gold went down by ~100USD. That movement was not as quick as today’s, but well, it was 3 times larger.
    If you were in the markets back then (April 2012), you should know that huge recalls of physical gold were made, which lead to that price crash. You may ask how couple of recalls can make the price crash. It is, nevertheless, increase in gold demand. Pretty simple. Notional value of derivatives on gold exceeds the real value and reserves of gold by a number of times. So pieces of paper, which you call future contracts, are not fully covered. Or to say, they are next to worthless. However, clearing houses and exchanges have to have gold in their warehouses. In case someone wants to convert their paper into real asset. So when someone wants to exchange a paper into gold, which prices are pegged at 1:1 ratio while the ratio of real assets to paper is N:1, paper prices fly down obviously.“
    So after hearing about this new crash of gold and quickly seeing how it looks on charts, I was conviced- once again. But well I am not so sure now.
    Price did not drop rapidly enough. It just happened too slow for such a small movement. Yes it exceeds average daily range and etc. But well, it just does not seems as a proper recall. It is more something as simple sell-off.
    Gold is falling for a period of time now. Something like few weeks. Just after the last larger recall. Maybe coincidence, or maybe markets understood. Investment in an asset, which yields no fixed income but requires money to be held, relying only on price increase expectations, is not a good idea. Especially paper one. It just does not work that way.
    So I am thinking that some kind of sell-off continues, which started at 1900. Fears of Europe going bust held price of this metal high for last year, but there is no Armegedon, nothing is happening, so large boys got nervous. They would be better off in fixed income. Even in capital, with real dividends. Or VCing. Whatever, just not investing only on expectations about prices.
    I do not have any numbers on this one, but my educated guess is that if one buys enough physical, costs of holding it over the year are somewhat equal to it‘s price going by 5-10%. For those holding paper gold- price is self delusion. Guys, you are still holding paper dollar, against which collapse you are hedging. Get real.
    Another problem is that investors now understood: market is cornered badly. Any larger recall causes a larg drop in price. Thus, someone may manipulate the market. If they wish to do so. It increases the risk of being in the market very highly. It is like sitting in some small stock market, while knowing that Soros is also in it.
    It is hard to say how long this downwards movement will last. But the sole fact of gold not having high corr with USD is saying pretty much. Such things do not happen often. In my belief, real price should be somewhere around 800-1200 boundaries. Gold looks nice, it is sometimes useful, so people will buy it. But today‘s levels are too high. Price does not reflect real value. Why would you pay a hefty 1600-800 for 31 grams of more or less worthless (in practice) metal ? You could buy enough acres of land in Argentina or Brazil for that to have yourself a loaf of bread once in a while. So why would you buy 31 grams of metal ?
     
  6. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Everyone, especially new traders, sometimes find themselves in a position, where they have something like these thoughts “it will go up tomorrow, no sense to close it now with a loss”. Even more experienced traders may sometimes be caught thinking this. So is it true that it is really sometimes worth to hold loser for another day ?

    Obviously- no. If you have a take profit target, you must have a stop loss target. Money management 101. If you do not have stop loss, you have to know when you are fixing loss. Catching oneself thinking “it will go up eventually” is a sign to CLOSE THE POSITION. That’s all. It is plainly stupid to hold losers only on expectations and hopes that price will go up. Sorry for being harsh, but.

    First of all, market has no memory. It does not carry if you are in a position or not. So consider that you BOT AAPL @ 600. It is trading at 590. You hope that it will go up next day. However, you know that if it hits 580, you will definitely close this next day. As price is moving down and there are no reason for market to reverse, you know with all your guts that this trade is dead, but there is still a tiny hope inside you that on a miracle it may bounce back. Let’s leave it here.

    Now consider yourself without any trade. You are looking at AAPL trading @ 590. You know it was @ 600 yesterday. You want to sell it. However you stop yourself and say “I will not sell it today at 590, but rather sell it tomorrow at 580 !”. That looks a bit crazy. But that is effectively what you are doing when you hold on to your losers. It is exactly the same thing.

    People treat losses and profits very differently. I will not go into depth of that, but check Daniel Kahneman and Amos Tversky’s “Prospect Theory” for more detailed explanations. It is an academic, but very easy to read and comprehend paper.

    So that was a simple real life example why it is irrational to hold losers. Nevertheless, studies conducted show that people tend to hold losing trades for rather longer than winning trades. Fun thing is that at the end of holding period, losers go down even more, while winners go up more. Usually even couple of time more than winners.

    In plain English, if a trader has losing and winning positions, it is likely that he will hold losing position for 15 days, while winning for 10 days only. In addition, after he closes losing position, it will go down in next sessions for ~5%, while when winning position is closed, price of that asset will on average go up by ~10% over the few next trading sessions.

    I hear some of you spitting around curses on brokers, sharks and markets. They have more or less nothing to do with all this. It is all simple maths. Look at %returns on gold tick data:

    View attachment 7950

    They are more or less normally distributed around zero. Let’s take a look at daily %returns on EUR/USD pair:

    View attachment 7951

    Do not mind the dates, was too lazy to change them. It is actually 12 years from 2000 to 2012. These even though look a bit different, are also more or less normally distributed around zero. So what does it say to us ?

    Consider price of X is 100. At first session it goes down by 10%, so price now is 90. At second session it goes down by another 10%, so now it is 81. At 3rd session, price goes up by 10%, what makes X cost 81*1.1=89.1. After the end of 4th session it goes down by another 10, and now price of x is 89.1*1.1=98.01. So market moved up by 20% and down by 20% making %returns equal to zero (+20-20=0). While the price over the same time went from 100 to 98.01. This says one important thing: even if you were holding on to a loser and market did actually come back in percentage terms (what both charts above say it should do), you are still losing ! Add commissions to that and you will by down by ~3% on this trade.

    Thus to think that you can get back and win your loser denies statistics and math. Even thou %returns are normally distributed around zero, holding on to a loser, while market is acting normal, gives you a loss without anyone trying to kill your trade with bunch of money.

    What you have to take from this story is that holding on to a loser is pretty stupid. Of course, you may not expect to enter a trade and see it in profit in a few seconds. But you have to have a stop-loss. At least mental one. And the moment the idea of “it will bounce back” hits your head- close the damn trade. This is idea of last resort. It is your last hope. Basically it means that you have no more arguments to support your trade whatsoever and you are holding on to this straw “but it MAY bounce”. Doing this is plainly stupid. So please don’t.
     
  7. ada1976

    ada1976 Private, 1st Class

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    Hi TMarciulaitis,
    Thank you and welcome to FPA.Let me share my opinion



    No investors with economic background buying gold because of supply= demand factor. Only reasons are and facts;
    1)Massive imbalances in Economies, Financial Systems and its instruments
    2)None of the major currencies are creditable
    3)Inflation worries

    Hence till we have clear indication above 3 factors, I believe high Gold prices will remain with us for a long time. On a personal note if oil prices goes higher, because of imbalances in financial enstruments,eventually gold will go higher too.

    In relation to above,
    We have been led to believe by major players who entered S&P long at 1260 telling cu cu la la stories that things are getting better so that we can take same direction as they are. Only difference is small investor will enter from this prices and end up with huge losses. If anyone assumes that raising debt ceiling will solve problems and all markets will hit north, they may as well go to North Pole to see Santa.
    On the contrary, problems are beginning. Also problems in Europe, Japan or China far from over. Since 2009 Fed has been trapping his money in Financial System as excess reserve for the purpose of,hoping that this will increase productivity rather then inflation after math of any recession as previous Feds did . But this time around no one is sure what it will do . I heard a phrase once, for people like me(old school economics) and it goes like this “ it’s not that our Keynesian friends aren’t educated, it’s just that they know so much that just isn’t so”.
     
  8. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Thanks for your comment ! Appreciate it a lot !
    Anyways, as I agree with all 3 facts, I still do not see any good reason to buy gold. It costs to store it. Unless you buy paper gold. But paper gold is the same USD. So there is no point in doing that whatsover. Gold has no intristic value, it is useless peace of metal and was money only because everyone believed it to be money. I find no but historical sentimental reasons for gold. And I have never been given anything else by gold supporters. Supply of gold is increasing every year and demand is increasing only for financial usage of it. So yes, you can look at that as "investors believe in gold more than real money". But from my point of view "Goldman and friends have something to sell at historical highs".
    Lets compare 10 ounces of gold to piece of land. Both physical. Say you buy 10 ounces, which costs you 1669*10=16690 USD. Back where I am from, for that one could buy quite a lot of land. In fact, in rural areas, ~10 000 m^2 of land costs something around 2-3k USD. So you could buy 40 000 m^2 of good land and still have some money left. For whats left, you could buy people to work that land and have some wheat or whatever, which you could sell every year with profit. In addition, land would have some value. While buying 10 ounces of gold gives you no perspective cash flows. You would have to pay for storage, which would make value of your investment go down by couple % every year. Discounted cash flow is negative. To get positive RoI, gold price would need to be moving up every year or month. That may be possible. Nevertheless, that still would mean nothing up to the point, where you would cash out. Thus I see no reason to buy gold, when one could buy some asset giving cash flow and return on yearly basis. The only advantage of gold is liquidity. But well if you want to hedge against high inflation and currencies, you will have to hold your gold till the end. So liquidity does not play a role here. If apocalypse does not come, your investment would yield negative returns at the end of your life. And another very important reason against buying which is almost never mentioned is that for gold to be the next currency of the world: 1) everyone has to believe in gold 2) governments and corporations have to want gold to be the currency. That may happen, nevertheless I know a few things for sure:

    1) people will always need to eat
    2) people will always need to live somewhere
    3) people will always want education
    4) people will always want jobs

    Thus instead of buying useless peace of metal, I would definately go for one of those mentioned above. They generate cash flows, RoI is going up every year, investments are less market price dependant and all of them have a lot of intristic value. Up to this point no one has ever managed to explain me why I should choose gold instead of any of these.
     
  9. TMarciulaitis

    TMarciulaitis Macro Analyst at EFEForex

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    Most trading books, guides, websites and courses offer traders to find one’s favorite trading instrument and trade it without jumping to others. For currencies, it is usually some small-spread liquid pair like EURUSD or similar. However, I do not think that is very accurate.

    Of course, you have to have your favorite which you feel the most comfortable to trade. But that is not all to it. Like always, teachers somewhy forget to mention couple of nuances.

    Lets say your favorite currency pair is EURUSD. You are good at it and make enough money out of trading it. However, you can actually use your knowledge and EU analysis to trade some other currencies. Consider EU being at a strong level, which you think it will breach. Thus you put a limit somewhere around that level and wait. If trade goes well and target is hit, you get some profit. That is obviously good. Nevertheless, if you would have done the same trade on some other pair, you might have earned a bit more. Let me explain.

    Exotic and synthetic pairs usually have quite a low liquidity. Especially during current times, when interbank and credit markets are almost completely dry. Investors are risk averse and rarely go in for some exotic risky stuff. This implies that exotic currencies are heavily driven by the moves in major ones. Such pairs as EUR/exotic, USD/exotic (AUD, NZD) and EUR/illiquid, USD/illiquid (CHF, CAD) tend to be driven by moves in EUR or USD. This is not universal and does not happen always as there are times when investors go into one of those implying higher liquidity and less correlation. Nevertheless, you can always find some exotic/illiquid for time being.

    A clear example for the current situation: EUR/USD was at some resistance couple of days ago. As it broke up, EUR/NZD and EUR/AUD followed instantaneously. Also as those are less liquid, they tend to move much more. Thus, if you put pending buy on all of those, you would have gained more than from a single EUR trade. It does not happen always, but probability is high. As explained, there is low liquidity in interbank at the moment and so shallow exotics are reacting to their counterpart price action highly.

    Also remember one thing: exotics usually have greater interest rates than majors. Therefore, you have to pay quite much in swap form. So even if you go into a longer term position on major pair, try to close exotic trade as soon as possible. They are very volatile and expensive to hold. It is not worth it.

    There is also another way to use other pairs to improve ones trading. Once again, you trade EURUSD and you are heavy on the USD short side. Normally it is either SL or TP situation. Nevertheless, there are ways to make some other trades as a good hedge.

    It does not mean that you need to sell EURUSD on other platform as it will not work. But you can look for currency pairs on which USD still looks strong. Now one of those is JPY. Another is GBP. JPY is going south against everything. GBP was going down against USD for quite a while. Therefore, if you go long EURUSD heavily, it would make sense to also buy USD/JPY and USD/GBP. By doing this, you would insure yourself against sudden appreciation of dollar. In addition, those trades will most likely not generate loss even if EURUSD goes up, as both of the two currencies you are using as a hedge are depreciating.

    These are not the only tricks you can perform while trading. But given current market conditions, I use them the most as I find the highest chance of success in them. As both of those do not increase risk heavily, but gives you a lot of revenue potential. And it is not a rocket science to find out what is best for you in a given situation. Thus just think a bit more before conducting a trade and you might be both: safer and more profitable. Trade safe !
     
  10. deadant

    deadant Private

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    Very nice article! I've heard of COT somewhere else but forgotten about it until now, while when reading up on your posts I've seen it twice:)

    Thank you and keep up the good work!

    EDIT: Oops, this was a comment for the 11-23-2012 post, as I haven't read the later (or your thesis) yet.
     
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