"Bonds, a smart pre indicator ..."

There are many ways that traders try to pre-empt a market move, many of which are based on indicators that are based on the same underlying information, so confirmation is often quite difficult. In addition indicators like moving averages, oscillators and so forth are really lagging indicators and by the time these techniques kick in your trade is often under water.

So are there any leading indicators worth their salt ?

Both the indicators I like to use are drawn from the futures markets. The first one that I like to use is the DOW Futures (/YM) and the second are the30 year Bond Futures (/ZB)

Example :

On December 1st, in the pre market the DOW futures were up 145 points going into the open whilst the Bond futures were showing a significant drop. Over the subsequent trading day the DOW rocketed up 249 points and the Bonds dropped significantly.

DOW Furture 1st December 2010:

Bond Futures - 1st December 2010 :

The subsequent trade action on the 2nd of December was that the DOW went up 249 points :

Clearly the message here is that the futures markets lead the equity and options markets and that each of these products are an excellent leading indicator.

Cheers

"The truth about global warming ...."

"I woke up this morning around 10am,

and by lunch time, it was noticeably warmer ...."

Arj Barker, November 2010

Cheers

".... more thoughts on how much Capital ..."

As we are now beginning to understand, Capital measurement is not an easy matter to resolve. I would like to make some further observations or comments to add into the debate.

In my previous life I was a banker, & if you came to me and asked for money or capital to start your business, I would have charged you interest on all you borrowed from me, not just the amount you used to buy your initial stock or trades.

When you trade for a living, your trading account is your capital, and in order to manage the financial health of the firm, we need to look at two core elements:

1. The first is how much should I buy my raw supplies for, and in turn sell my product for . This equates to the net difference between the opening and closing of a trade. In this instance we need to look at the cumulative P&L from all the individual sales (trades), and make sure we are net positive dollars. Now the important thing to realise here is that when you come back to me as your banker, I am going to ask "...  how did you do this month ? ...".
   
   Now do not be fooled by my nice smile and the pleasant enquiry about the family, what I really want to know is, how is the business going, did you get an adequate return on the capital I lent you, can you pay me my interest and will you be able to pay me back my money?.
   
   Whilst I might be interested in your marginal return on each trade, I am really more interested in the bigger picture. If things are not rosy in your garden, I might start thinking about handing your account over to the Credit management team, and these guys are like Pit Bulls. They will take a big interest in your sales margin and in how you run your business, because they will want the banks money back and will not think twice about restructuring it from the ground up by each sale (trade) and the margin on each sale or trade and in many cases you may find yourself restructured out of a job.
    
2. The second, is at the end of the month, how did you do financially ?, Were you up on sales or down ?, What was your ROA.

The above harsh reality of meeting your banker now raises a split in how to measure Return. Clearly all of the capital is at risk, even if we are not using 100% of it. Remember the banker ? Capital is not free and he will want a return, so all sales (trades) need to generate sufficient return to show a healthy business growth.

So we now know we have some decisions to make on how to measure our firms success. Investment theory, and in particular, Discounted Cash Value analysis,(DCF), Net Present Value, (NPV), & Portfolio replication theory, (PRT), are areas that we will find helpful here.

In large companies there are always more projects demanding funding than management can squeeze out of the Board. So how do we decide one project over another. In this instance, we can look at a Discounted Cash Value (DCF) for each project and rank them in order of the best to the worst return.

Now I know this might be new to some people, but hang in there it is not quantum physics, and it is reasonably easy to understand. What happens, is all the project incomes are entered into a spreadsheet for each month going out over the life of the project ( say 36 months) next you subtract all the costs generated by the project on a monthly basis for the same period. This leaves you with the net cash position in future dollars for your project cash flow over the life of the project. This is the hard bit - each monthly number is now multiplied by a number that effectively takes the future dollars and discount them to today's dollar value. These discount factors are mathematically worked out and usually found at the back of any good stats book.

Right now we have each of the future cash flow values now converted to their current dollar value or the Present Value of all the future cash flows from this project over the future life of the project. Each of these numbers is now aggregated into a single number called the Net Present Value (NPV), that can be compared between competing projects. Companies rank all these projects from the best return to the worst return and spend their capital on each project in the list until the allocation of funds runs out. Using this method you know you are optimising the potential returns on capital by choosing the most productive projects that offer the highest returns for the capital invested.

All interesting stuff - but how does this help my trading business - well the point I am attempting to make is that there are two measure we need every month to help us run our business - a monthly optimised trade target and the overall return of the business activity on the Capital lent to you by the bank to start your business up. We now have TWO measures not One.

One thing to keep in mind with Capital when grappling with the issue of :

"... but I only used $5,000 of the $10,000 you lent me, why should I pay interest on the full amount ...?"

Going back to the DCF analysis above - a core assumption of this methodology is that Capital is not free and if it was not used in this project it would have been allocated elsewhere or invested in stocks, bond, futures etc. A bank will not leave funds idle - so if the bank does not lend to you - we will lend to your neighbour - we will get our return on our capital with or without your deal. So here is a fact :

Capital is not free you have to pay.

Lets now look at some ways to calculate a monthly target for each trade and see how this target would combine up into a suitable Return on Equity sufficient to please me as a banker.

In finance there is a rule of thumb called the "rule of 72" - in simple terms if you borrow money at 6% per annum, by dividing the interest into 72 you get a rough rule of thumb as to how long it will take you to pay back the loan. In our example 12 years. Lets re-engineer our thinking and use the rule as an investment guideline. In this instance if I aim to get 6% from each trade I should double my money in 12 months.

OK so far - but wait there is more ..... What about my poor risk to reward ratio of 50/50 - well we can scale up our target of 6% by our 50/50 R/R to now give us 12% target for each trade.


But hold on - what about the tax man - I am on 30% tax, so by dividing the 12% by the amount of money I get to keep after tax, 70% ( 100-30% = 70%), we now have a target rate of 17% for each trade.

As you can see, we can keep refining our target rate to reflect the complexities of our business. However the main point is that if each trade gets 17% we will double our money over 12 months and for some trades like Calendars - 17% is not an extraordinary target, but might be for an Iron Condor.

Now we need to do the same at the portfolio level and at this level we need to take into account how all our trades have impacted our total available capital because we need to make a salary and cover all our bills - including the friendly smiling bank manager ( & OK we can include the tax man but we ware stretching the bonds of friendship here). So how can we attempt to create a sensible target - using the same method as above will give us a similar number to the 17% and this is potentially unachievable on a consistent basis for most businesses.

Well, one of the ways we can move ahead is to look at the minimum rate that we need to cover our costs - Firstly lets say that the bank interest on our capital is 6% per annum and that we need say $2,000 a year to live on ( assume this is one of Dan's blind squirrels that made all that money back in the 90's doing their budget). Essentially the principle would be to convert each of the numbers into a monthly rate. The 6% becomes 0.5% and the $2,000 equates to around 4% (Our capital, remember from above was $10,000) is around 2%. Also lets say we had accumulated business costs of another $1,500, which equates to 1.5 %. If these were the only requirements impacting the business we can start to get a feel that a portfolio target of 4% will cover our Cost of Capital, ( interest payments to the bank), all our bills and income needs.

The beauty of this measure is that it is risk adjusted because the monthly returns have already taken risk reward and tax into account.

An alternative to this aggregative rate method to calculate a portfolio return might be to look at another financial method called Internal Rate of Return (IRR). Under this method we could look at how much income we need each month and use similar discount factors to those used to calculate the NPV. However under the IRR method, the cumulative forward monthly cash flow requirements are reduced to a single rate of return that would generate the amount of income we would need for the year.

Whilst there is a lot here to read, the concepts are still very much of the Keep it simple stupid (KISS) principle. Even Dan's blind squirrel can use these concepts to calculate how much capital he needs without losing his nuts!

Cheers

"Das Kapital, back up the truck ...".

If we have a trade that initially uses $10,000 in margin, and through various adjustments over the month, we added say another $5,000 into the the trade, giving a total requirement of $15,000.

Now, lets say the trade is closed out making $1,000 profit.

Here is the question - what is the return - do we calculate the ROI on the original capital in the trade or the capital utilised over the life of the trade?

Did we make 10% ( $1,000/$10,000) or, did we make 6.67% ($1,000/$15,000). ?

Cheers

".... the poetry of mathematics ..."

"Poetry, really good poetry, is the music of mathematics,
and
Philosophy, is the path we turn to when mathematics has lost it's way"

 

Cheers

"rational expectations with a large fries please..".

In February 1936, Keynes published his seminal work, The General Theory of Employment, Interest and Money, in which he postulated that :

"... markets can remain irrational much longer than an investor can remain solvent ..."

John Maynard Keynes - Economist

In the chapters on interest rates and financial markets, Keynes makes the point that if we all had perfect knowledge of how the markets operate, then this impact on interest rates would create a yield curve that looked like a step function. However, because we all have different financial, economic and political opinions that influence our decision making processes, it is our rational expectations that drive us to have a different rate expectation to the next person. Thus with a multitude of different rate expectations, influenced by a myriad of different economic and business views, the yield curve is a curve or slope rather than a sharp step function that changes at the point of perfect knowledge. Because of the multitude of different expectations about rates, the step function is "smoothed" out to give a curve.

Taking stock prices as an example, if we all had perfect knowledge, stock prices would stay at the same price until there was a change in some exogenous and influential variable that then lead to the change in the stock price. If we graphed these changes in the stock price over time we would see that it looks very much like a step function and if we all had perfect knowledge of the markets we would all buy or sell that stock at the same time as the change took place. This would reflect perfect knowledge and an arbitrage free market.

If we take a look at National Australia Bank, (NAB), over the past five months we can see that back on the 21st May 2010, NAB completed a Wave 3 decline and began to retrace into a rising Wave 4. As we have discussed in many posts over the past five months the Wave 4 failed on numerous occasions.

NAB 15th October 2010
(click chart to expand)

Keynes idea of rational expectations has a lot to answer for here. If the market, or in this case NAB, were arbitrage free and market makers and investors alike had perfect knowledge, then under Elliott Wave theory, once the wave three was over, wave four would begin and retrace back up by 38% and then a declining Wave 5 would begin.

But is this what happened. Did the stock move to the theoretical point where the rational trader expected the price to go then turn in the opposite direction ?, No. This is not what is happening, and it is because every market participant trading NAB has a different view of what is going on as well as what key impacts are likely to effect NAB's stock price on a daily basis. Primarily we have seen in the USA in particular, that the market at present is very news driven. In fact over the months of August, September and October, bad economic results for employment, retail sales and GDP were announced and the volatility soared as prices plummeted. Whilst a day later,there was some good news announced on the market, such as a company listed on the DOW posting a favourably revised profit outlook, and markets claimed back all the points they lost the previous day. Where is the rationale in these radical and highly volatile market moves. At this stage of the economic cycle, these moves are unpredictable and often irrational.

In NAB's case the Elliott wave begins the expected retracement, then unexpected news out of Europe, China or the USA changes the whole ball game. At first blush the news may seem important enough to shift the market but on deeper analysis the logic just does not stack up and you are left with an inexplicable market move that will very likely reverse heavily on the coming days to reclaim the original market position.

There is often very little rhyme or reason in these market movements. Certainly not prefect knowledge and certainly not rational expectations. This is why Keynes made the comment that markets can stay irrational longer than investors can remain solvent.

As far as NAB goes the battle for the endless Wave 4 retracement, five months in the making so far, goes on and we continue to live in the hope of a rational expectation.

Cheers

"... asymptotically yours ..."

 "... old option traders never die,
their Gamma just converges asymptotically to zero ..."

 

 Cheers

"NAB, wave 4 - let's take the scenic route ..."

Back on our last NAB post for Friday June 25th, it looked as if we had some excellent confirming signals that NAB had peaked and was ready to retrace into a Wave 4 downward.

"... Not a failed Wave 5 but an extended Wave 4 ..."

Comparing the chart on the left to the earlier chart we can see that NAB hit the ellipse target on the 22nd of July and began to retrace back up.

By shifting from the normal Elliott 5,35 oscillator to a 5,17 we can see the inner wave structure and although the 5,35 oscillator did not exceed 90%-140%, the retracement of the intermediate wave 4 count did not pull back to less than 90% and as such was an early warning that the downward trend was most likely not going to continue.

In fact NAB did retrace back up into the $25.50 region and because this was a new high the Elliott Wave 4 recounted and shifted from the previous high in the 24th June to the new Wave 4 high on the 3rd August.
At this point we waited for the new Wave 4 to break out of the regression channel and cross the 6,4 displaced moving average to give us the signal to enter the short protective puts for the Collar position. Note also that the 5,17 Oscillator has pulled back to the zero line and is trending in the right direction.

As of close on Friday 13th August, we had Nab trending sideways for the day as it hit a support line at $23.41. However our downside inotial target projection is at $23.26 where we will tih=ghten our stops and wait to see if this support level is broken. If this is the case I would expect Nab to trend lower to around $22.50 in order to reach a low below the previous wave 3 and in doing so, finally manage to get the bearish Wave 5 completed.

"trading a failed wave 5 is a snap"

Cheers

" last man standing & fiscal rotation ....."

The US Federal Reserve has left the federal funds target between zero and 0.25 per cent but it has elected to further support a slowing economy. The Fed will reinvest "principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve's holdings of Treasury securities as they mature." The Fed voted 9-1 in favour of the decision with Thomas Hoenig opposing the decision to keep the federal funds low "for an extended period."

For some time now Hoenig has been the sole dissenter in lowering rates and providing further stimulus, and at a vote of 9:1 yesterday I wonder if Hoenig has begun to lock himself into a situation where he feels it is too late to reverse his stance without losing "face"
The interesting thing about the Fed's proposed stimulus round #2 is that it is not creating new money which leads to inflation but rather is recycling the Treasury instruments which are also a key lever for the Government to manage Fiscal & Monetary policy.

The other thought that occurs to me is that what we all want is a more active economy and indeed an activity level that further stimulates other sectors to become self sustaining. Too this end I seem to remember from my Macro Economics lectures that the formula around the money supply and economic activity is MV=PT which essentially means that taking the same money and reinvesting it has the effect of speeding up the economic activity a little faster each time the money supply is rotated through the economy.

Now given that the Fed is rotating the money via reinvestment of the maturing Treasuries etc this seems a reasonable plan to me and I am at a loss as to why Hoenig may have objected. In addition the funding is also targeted into the weakest sectors of the economy and not a blanket reinvestment.

Cheers

"When Worlds Collide ...."

Politicians have two objectives in life.

• The first is to get elected, and 
• the second is to stay in power. - at all costs.

If we reflect on these goals, you and I do not figure very prominently in the equation at all, and when the worlds of democracy and politics collide, there can only be one winner. One would like to think that it would be democracy, but sadly as we saw this week, it is the world of politics that soundly beat democracy.

On 24th June, the Australian Labour Party, dumped its leader, Kevin Rudd, who was also the Prime Minister of Australia, and replaced him with Julia Gillard as the new Australian Prime Minister. Now what is a little alarming about all this manoeuvring by the Labour Party, is that the position of Prime Minister is a democratically elected position by the people of Australia. And since voting is compulsory in Australia, one would think that whomever gets elected, has done so on the basis that the majority of the Australian people want them to lead the country and set the political agenda.

What I find disconcerting over the events of June 24th is that, whilst it is fair and reasonable for the Labour Party to want to change its leader, I cannot see that it is fair, reasonable or even democratic, that a few factional power brokers within the party, can engineer the dumping of a Prime Minister and the installation of another politician in the top job, who has not been voted in by a mandate from the Australian people.

What has become evident over the last week, was that a few of the key factions in the Labour Party were not happy that the Prime Minister was making decisions without reference to them as key labour unions and members of the political machine. Well that's what Leaders do - they make decisions and after all he was placed into the job to make decisions and lead the country. The end result was that a few quick phone calls, pressure was brought to bear on other key members, and the Labour Party voted Kevin Rudd out of the leadership role.

To me, it does not follow that a few disenfranchised power brokers on the left can remove a Prime Minister without a democratic election.
Although Julia Gillard is a sensible and probably palatable politician, She did not get voted into the role by every Australian - quite the contrary - She was placed into the top job by about half a dozen or so key political players in her own party. If this now sets a precedent, what happens in the future if a Labour Prime Minister does not tow the labour union line ?. Will that factions members simply huddle together, get the numbers and move to toss him out, then replace him with their own puppet leader and push their own agenda through Parliament, irrespective of what the wider community want?.

Although I did not vote for Kevin Rudd, I do agree that he was elected by a democratic process to lead the Australian people for a term of four years, and should have been allowed to do that job. If the Labour Party feel he no longer represents their ideals, then they can vote him out as their leader. But then, if they do not want him as the Prime Minister, the party should place a motion of  "no confidence" and if passed, the Prime Minister should approach the Governor General for permission to hold a general election, so the people can decide on a new Prime Minister.

Not a few back room boys, - that is not the way a democracy works.

Truly a sad day for democracy in Australia.

Cheers

"NAB, ...there's a bear in there... "

As NAB begins to retrace from its earlier Wave 4 high of $25, it would seem that the potential Wave 5 target low might be between $22 to$23.

In addition when we use the Ellipse tool to pick up the most probable position for the downward trend to continue, it has been incredibly accurate over the past few weeks. Refer to the price chart below as an example.

his is a price cart for NAB dated 24th June 2010, and as can be seen the ellipse tool has accurately picked :.

1. the false bottom to the projected Wave 5 and relabelled it as B in an ABC correction. 
2. The peak of the ABC correction as the Wave 4 high.
3. The end point of the first gap down which coincided with the Australian "Coup' where Prime Minister Rudd was deposed in favour of Julia Gillard as the new Prime Minister of Australia.
4. The last estimated ellipse point shows that NAB is at a significant support area

The plan, come Monday, is that if NAB breaks below the ellipse point of $23.83 and goes lower, then the hedge will be left in place. Otherwise the existing hedge will be closed and the profit taken to account and a new series of Puts will be put in place to hedge the stock position. If the existing hedge is closed out, the new hedge may be based on August Puts rather than July contracts as we are getting into the final 30 days and Theta decay and Gamma will escalate at a non linear rate to our detriment.

Cheers

"... a frequent path for us all...".

When I was young,
It seemed that life was so wonderful,
A miracle, it was beautiful, magical.
And all the birds in the trees,
they´d be singing so happily,
joyfully, playfully, watching me.

But then they sent me away,
To teach me how to be sensible,
Logical, responsible, practical.
And they showed me a world,
Where I could be so dependable,
Clinical, intellectual, cynical.

At night, when all the worlds asleep,
The questions run too deep,
For such a simple man.
Won't you please, please tell me what we've learned,
I know it sounds absurd,
But please tell me who I am.

Now watch what you say,
Or they'll be calling you a radical,
A liberal, fanatical, criminal.
won't you sign up your name,
We'd like to feel you're
Acceptable, respectable, presentable, a vegetable.

There are times when all the worlds asleep,
The questions run too deep,
For such a simple man.
Won't you please, please tell me what we've learned,
I know it sounds absurd,
But please tell me who I am.
Logical by Roger Hodgson,an excerpt from "Breakfast in America".

This is a "story of innocence and idealism lost", with Hodgson condemning an education system not focused on knowledge and sensitivity but focusing on the endgame. It tells of a man who:

• is taken away from the unspoiled immediacy of childhood, (When I was young, it seemed that life was so wonderful, a miracle, it was beautiful, magical).
• He undergoes a predetermined education, (but then they sent me away to teach me how to be sensible, logical, responsible, practical).
• He sees a future prepared for him lacking any spontaneity of reaction, (And they showed me a world where I could be so dependable, clinical, intellectual, cynical).
• He feels constricted in his freedom of speech, (Now watch what you say or they'll be calling you a radical, illiberal, fanatical, criminal).
• He is put under pressure to conform, (Won't you sign up your name, we'd like to feel you're acceptable, respectable, presentable, a vegetable).
• and he ends up confused, without a coherent self-image, (please tell me who I am).

Image : Roy Lichtenstein, "Hopeless".

Do any of us really know who we are or how we fit in ? It can take a lifetime to find out just what our destiny is to be.

But it is part of human endeavour to search, - it is this tenaciousness that makes us what we are, - An Individual.

Cheers

"NAB, Wave 4 in the making ..."

On April 30th we began to look for the formation of a Wave 4 with NAB retracing off its lows to a previous high in the order to $25.

The big change between April 30th and now, is that we had a number of significant market announcements that impacted financial institutions. There was the sovereign debt crisis of Greece, Spain and Hungary, leading to the "Flash Crash". Then, the was the BP oil spill, the elections in Germany, and the UK. There was the threatened demise of the Euro, and finally for NAB, there was the rejection of the AXA deal by the ACCC, and then NAB pulling out of the Royal Bank of Scotland retail branch M&A deal in the UK, which drew NAB's UK operations into question. The impacts of these market announcements is highlighted in yellow.

Chart 1.

As we can see from the the price chart above, the potential for a Wave 4 low was lost when the various falls in NAB's price were so material that we got an Elliott recount and a new Wave 3 low down to $22.25.

So, what can we expect over the next week for NAB's price? The price chart #2 below is for June 22nd and shows that NAB exceeded the traditional 38% target of $24.64 and has headed up to the next Fibonacci level for the 50% retracement level of $25.38. Interestingly, as of today the price is beginning to weaken and may reflect the beginning of the new Wave 5 down. However if we look at the recent high, the price stopped right on the 50% Fibonacci level of $25.38.

Chart2.

Elliott theory suggests that if Wave two is a simple structure, then we should expect Wave 4 to be a complex structure.

This is called the "Rule of Alternation".

So how has NAB gone since April 30th ? We can see from the price chart #2 above, that the Wave 4 has in deed had a few false starts at attempting to reach our potential target of around $25 which is consistent with the "Rule of Alternation".

It would seem that at this stage there is an early indication that Wave 4 has now completed at the 50% Fibonacci level of $25.30 and will now head back down to a Wave 5 low target of around $22.25.

 Cheers

"NAB: where is my Wave 4 retracement ?"

Back on the 20th April, National Australia Bank reached its wave 3 high, and since then we have been waiting for the confirmation of the Wave 4 retracement.

In the chart below for 29th April, we can see that driven by the Greek sovereign downgrading to Junk Bond status, the 230 point drop in the DOW, the US Fed keeping rates on hold, a plunge in the EURO and Athens activating the country line of credit sooner than expected, you would have expected the Wave 4 to kick in with a vengeance.

But alas no - it seems that the 25% retracement level of $27.88 is a real stumbling block and NAB seems very resistant to dropping below this point.

However price has dropped out of the regression channel and we have strong drops in the stochastic & MACD with sell signals in the CCI.

We wait in hope for a confirmation soon - at least before our May PUT options degrade too far !

Cheers

"... NAB - is this the fun park : 198% profit, what a ride"

Back on the 5th March 2010, I posted my analysis of NAB which looked as if it was completing the final legs of a Wave 5 down. Here is the link.. : NAB-is-this-fun-park-are-we-having-fun .

The analysis indicated that NAB should begin to rise within a week, so I began to watch the stock more closely for indications of an early wave 3.

Here is a quick update of how thew trade unfolded.

On the15th February we saw NAB bottoming with a Doji indicating confusion in the market.

This Doji was also around the Fibonacci target for the end of a wave 5, so this added some weight to the idea that the current wave 5 was running out of steam.

In addition, the daily volume was also low and below average.

One of the early signs I was looking for, was signs of gaping in the price as Wave 3 began and as we can see from the chart I posted back on March 5th, we have evidence of gaping at the end of Wave 2.The entry signal is when NAB rises above the Wave 1 high.

This was the signal to get ready to buy a long Call. The next issue was which Call to buy. By selecting an OTM long Call, we can minimise our upfront cost, and by looking for a Delta as close to ATM as we can afford, this will improve our speed into profitability. I purchased an April $26.50 Call.



When looking at the Deltas, ideally you should select a delta between 25-35. These options are cheaper because they are OTM, but are on the cusp of moving into the steepest part of the Delta curve, and as such, move much faster into the money and improve our profit leverage and eventual ROI.

By the 4th April we had a high Doji, indicating indecision in the market. There was no real news pending, and NAB was very close to the Wave 3 Fibonacci targets, so I decided to take the trade off after 46 days, for a 198% profit.

The next step is to watch the price make a new low off the recent Doji high and break below the current support line to indicate a wave 4 is beginning. At this point I will look to reinstate my Collar to protect my shares by buying some $27.50 or $27 May Puts as well as selling a $28.50 Call to offset the cost of the PUT insurance. The PUT selection will be guided by the delta. My objective is to get a delta around 35, as I have noticed that with the shorter Wave 4 you need a bit of speed to get into profit as quickly as possible.

Now all I need to do is wait and watch.

Cheers

"... take two VIX & call me in the morning ....

"... Can't seem to face up to the facts,"

"I'm tense and nervous, I can't relax,"

"Can't sleep, the beds on fire,"

"don't touch me I'm a real live wire ...."

excerpt from Psycho Killer, 1977, Talking Heads, by David Byrne

Cheers

"...scratching the surface ...".

"... beneath everything ordinary and common place, 
  lies the extraordinary and unique ...".

Cheers 

"... NAB, is this the fun park: are we having fun ?."

Pummeled by the associated risks of the Greek and other sovereign debts defaults possibilities and the presentation of a lackluster profit update compared to CBA & ANZ recently, one could be forgiven for thinking that NAB was down for the count and not one of the preferred pillars in Australian banking.

So has NAB dropped the ball, and what do the market makers think about its performance?


Recently I read a number of broker reviews on NAB, they were jam packed with balance sheets, P&L statements, provisioning estimates, bad debt exposures, and reports I found hard to decipher, much less their relevance as to whether NAB was a buy or sell.

As a lapsed Economist, I believe that price is the ultimate piece of knowledge and reflects all the market knows about a company. In short, the market will go where it wants to go. We just tag along for the ride.

Look at the longer term weekly chart dated 26th February 2010 above. What we see here is that NAB looks to be completing a Wave 4 low and getting ready for a rise back up towards $34.45, which is the 62.% Fibonacci price target. However there are a few issues with this chart, mainly that Wave 4 has violated it's statistical targets, and so the expectation is that the Wave 5 high that is due to follow, will not likely to be a new Wave high, but rather equal to the height of the previous wave 3. This would give a price target of around $32.40.

By comparison, lets drop down a degree, and look at the daily chart to see what insight we can glean from it's price projections. In this chart, dated 26th February, we can see that NAB has recently completed a Wave 5 low, has almost completed both Waves 1 & 2 and may be in the early stages of a Wave 3 rise.

As we know from Elliott Wave theory, Wave 3 is the longest wave, so this early identification offers a great opportunity to make greater than average profits, - but only if the wave count is correct. In this instance the price target is the Fibonacci extension of 1.618, yielding a price of $28.07, which is in the ball park of the conservative price from the weekly chart. Interestingly both the MOB tool target and the 1.618 Fibonacci targets line up on the daily charts as well.

So since we cannot control the markets and it will wander where it wants too, is $28 a place that NAB will wander too over the next month or so?

If so why not tag along for the ride?.

Cheers

"... Rene's Cartesian Pluralism ...".

"... to do is to be", - Jean Paul Sartre."
"... to be is to do", - Rene Descartes."
"... do be do be do be", - Frank Sinatra."

Cheers

"... how full is your glass ?".

Remaining focussed and positive in turbulent markets is hard.

What do you see :.

"OPPORTUNITY IS NO WHERE".
"OPPORTUNITY IS NOW HERE".

In his book, "Trading Dimensions: How to profit from chaos in stocks, bonds and commodities", Bill Williams, (1998), indicates that if we saw the first statement, we are more likely to be taking a negative view of where the markets are heading. Whilst if we saw the second statement we are more likely to be more positively focussed about the future.

Williams points out that this moment in time is unique, it has never been before, and will never come again, and that our attitude towards how we will trade it from this point onwards, is greatly influenced by our current perceptions and the environmental factors that have shaped our intellect to date.

How full is your glass ?

Cheers

"... trading your shirt for your conviction ...

With the markets moving two and three standard deviations every other day, some times the damage to your account, your ego and your mental state takes it's toll and you want to give up.

Ask yourself, "... where is my conviction, has it deserted me in this time of need ...?.

"A man who can keep his childhood dreams in all their purity,
Preserve them in his naked and defenceless breast ,
Who, despite the laughter of this world, dares to live as he had dreamed in his childhood,
Down to his last days: yes that is a man, a man in all he is".

On July 21st 1944, Major General Henning Von Tresckow's wrote these words in a farewell letter to his wife, Erica, a few days before his execution as the leader of Operation Valkyrie , the plot to assassinate Adolf Hitler.

Now, reflect on this and again and ask yourself, how strong is your will, your conviction, your focus to seek out what you need to do to survive in these times?.

Try harder.

Cheers

"The deviousness of Black Swans ...".

Although we are in a new trading year, and the recent statistics such as GDP look good, I am far from sure that we are in a stable and upwardly mobile market. In addition I wonder if the past wisdom of "Das Uber President" is still intact, or more lately if it has deserted him in our time of economic need?

As recently as January 20th through to 22nd we had three consecutive days of around one to one and a half standard deviation moves in the DOW. This started me thinking about the probability of such a move. For example if one standard deviation is 68% then the probability of price moving outside this range is 32%. Not to bad, but what is the probability of three days in a row?

Market prices of the DOW as at 28th January 2010.

Under the Central Limit Theorem, price moves should be normally distributed, and as an adjunct to this, the law of large numbers would see the appearance of a greater than one standard deviation is just 32% chance in a year. However as Taleb points out in his various books, we are all being fooled by what constitutes randomness within the normal distribution and the inability of market price to converge to the mean.

Referring to the price movement in the chart above, lets look at calculating the probability of a single standard deviation move and then the combined probability for the three days, 20th, 21st and 22nd of January.

Probability of event.

First lets look at the theory. and set out the proof for a one standard deviation move. 

Proof of methodology.

We know that a 1 standard deviation = 0.68 or 68%, therefore a move greater than 1 standard deviation = 0.32 or 32%. To convert this to find out how many days we take the reciprocal and divide it by the number of trading days in the year, 220, as follows:.

.32/220 = 0.00145 x reciprocal = 687.5 x .32 /220 = 1 year.

Probability of a Black Swan.

Now the daily price moves during January were actually around 1.5 to 2 standard deviations, so lets settle on a 1.5 move for convenience and use the above method to calculate the January Black Swan. 

A 1.5 standard deviation move is calculated as follows: 1-((0.68 + 0.95)/2) = 0.185 or 18.5% chance of happening.

Next we calculate the probability of moving beyond a one Standard deviation move in one day as :

Probability of 1.5 standard deviation in a day 0.185/220= 0.0008409.

Next we need to get a little fancy and multiply the probability of a move for the first, second and third days together to calculate the combined probability of occurrence.

Thus the probability of 3 x 1.5 standard deviation in a row is 0.185/220 x 0.185/219 x 0.185/218. Notice how the number of trading days drops from 220 down by one day for each calculation to account for the remaining trading days in the year. 

Next we take the reciprocal to convert the probability of happening to the range in days that this event might occur.

So we Multiply out the 1.5 standard deviation moves to get combined probability of 3 back to back moves as above and then we divide by the number of trading days remaining , to get trading years :.

In our case the probability of getting three days in a row of greater than a 1.5 standard deviation move is equal to once every 1,394,945 years. 

Release the Swans to do their worst.

But wait, there is more than one swan. If you refer to the chart above you can see from the highlighted sections that over November and January we had a number of instances and that this three day event was not an isolated case. Lets now add the November plunge in as well to see how our probabilities work out.

The earlier moves in previous months can be included by multiplying out the event probability of 18.5% by the remaining number of days in the trading year.

Thus the probability of 5 greater than 1.5 standard deviation moves in a month is now :
0.185/220 x 0.185/219 x 0.185/218 X 0.185/217 x 0.185/216 x 0.185/215. Again notice how we drop the trading days from 220 down to 215 as each trading event happens.

When we convert this very small probability number to years, we get the probability of once every 222,020,900,000,000 years which is longer than the life of the known universe. And remember, this calculation is only taking into account the last two Swans in November and January. What about July, August, September and October ?.  I thought about looking at these, but my eyesight is too dim and my calculator too old to handle the pace.

So forget your endothermic or exothermic reactions, Hell just keeps freezing over and it is only January - It would appear that game theory is no longer a game!.

Trading in reasonable times - Alice are you sure ?.
 

Cheers

"... NAB, a whole lot of bull ...".

NAB 15th January 2010

When we last looked at NAB on 30th December 2009, we projected a retracement of price to a target of  $27.85 and in fact we achieved a price of $27.75 on the 5th January. Not bad. In fact we also thought that the retracement back up to this level would be short lved and that NAB would come back down to around $26.72 which in fact it has also done. Each of these moves can be seen in the chart above and the predictions can be verified in the earlier blogs for NAB.

Looking at the chart above the price action seems to have stalled and is channelling between the previous upper target of $27.81 and the lower target of $26.72.

My strategy for this situation is to be patient and see whether the wave three continues by price breaking to the down side or if price breaks the $27.81 level to the upside to also continue in a wave 3.

The weekly and monthly charts would seem to give the weighting to an upside breakout and with this in mind the upper price targets would be $30.09 as a first conservative target with a more aggressive target as $32.14.

The first target lines up with the 1.6 Fibonacci level whilst the second target lines up with both the MOB target taken from the previous wave 4 high as well as the 1.618 Fibonacci level.

Time will tell, but here's hoping NAB will be serving up a whole lot of bull.

Cheers

"The DOW at 400 as an extreme sport ...".

For almost as long as I can remember, Robert Prechter at Elliot Wave International, (EWI),  has been saying that the market is in for another crash and one that will be significantly more devastating than the last one in 2008. 

In a recent post, 18th January 2010, EWI published their forecast ,that the DOW will hit 400 by 2015. Yes that is right 400.  

The EWI chart looks to be a monthly projection and my reading of the chart seems a little different to EWI. However when I had a look at my own chart I could not get the same pattern. My analysis saw the DOW getting down to around 5500. Here are some of the thoughts that occur to me when I went over the chart:.

1. The Wave 4 that is in progress now has violated the upper Wave 4 channels and as Prechter points out in his book, if this happens then it is unlikely you will get a full wave 5 retracement.
2. The Profit Taking Index in GET is only 28, which less than the targeted 35. This would also indicate that there is a reasonable probability that there will not be a correct Wave 5 retracement along the lines in the EWI post.
3. Using the Ellipse study, it would indicate that the Wave 4 is still not over as the two ellipse have not converged. If this is the case we could see the current upward trend move higher for awhile yet. The implication is that any retracement from this higher end point would be also higher than the lows currently being projected
4. If we assume that the points above are correct, Prechter points out in his book that the retracement would be to the previous wave 3 low of 6440 rather than his projected 400.
5. Using the Ellipse tool on the previous Wave 4, this would seem to indicate that the end of a projected Wave 5 down would be somewhere between the current high of 10609 and the low of the previous wave 3 at 6440. 
6. If we assume that the above analysis is wrong and the current wave 4 dynamics hold true to the rules in prechter's book, then the targeted wave 3 low is around 5357 by November 2010 and not 400.
7. Again, if we assume that the current analysis is still wrong and we take a wider view and project a low from the previous wave 4 low back in October 2002, the projection only gets us around 5752 by November 2010 and nowhere near the 400 posted in the blog.
   

The interesting thing about this analysis is that many of the tests back each other up and give targets that seem to be close. Then again I could be wrong, but for all our sakes I hope not.

One other observation on the EWI chart is that they place the greatest reliance on the shape of the chart and inform us that price is approximate and the timescale for the chart is not reliable.

Cheers

"...I SPY ...".

SPY 15th January 2010.

Since August 2009, the SPY has been demonstrating some very interesting patterns. In summary here are some observations from the above chart :.

1. The SPY has stayed well within a two standard deviation regression channel, which has a correlation co-efficient of 98.2%.
2. Similarly, the SPY has ridden the Bollinger bands in almost a classic pattern of comming off the lower band and making a rapid rise to the upper band and riding this until the price hits the upper regression channel.
3. Note that at this point, the price, upper Bollinger and the upper regression line all coincide. Then within days, the SPY gaps quite dramatically down to the mid line in the regression channel.
4. Once the SPY has reached the mid line of the regression channel, it is a make or break situation. Either the price rises again to retest the upper regression line and Bollinger band, or the price breaks through the mid regression line and gaps quite suddenly to the lower regression line and lower Bollinger Band.
5. In all the time since August 2009, the SPY has only once broken through the mid regression line support to reach the lower Bollinger and lower regression line. Mostly the mid regression line holds firm as a support line and the SPY begins to rise within a day or two back up to retest the upper regression line.
6. Finally, in an obtuse sort of way, the 50 day moving avarege also acts as a loose support level for the SPY as well.

The SPY pattern in the chart above is almost an oscillation. One impressive feature of the charting package, Advanced GET,  is the uncanny accuracy of the ellipse study. Notice how each of the supports also coincide with the ellipse projections.

Interestingly, every ellipse for the upper resistance points misses the target. The upper ellipse studies are not plotted on the chart. In this instance, the ellipse is very accurate in projecting the support and turning points, but totally inaccurate in projecting the upper turning points and resistance levels.

So how can we use this information. Well depending on implied volatility, (which is another problem all together), we could do a slightly out of the money, Calendar or Butterfly around the 1155 level, and allow the SPY to creep up into our trade zone. This strategy assumes that the oscillating pattern of the SPY continues, attempts to optimise the theta decay. In addition, we are also assuming that the mid line of the regression channel will continue to have a reasonable probability of acting as a firm support to keep the price above the 1100 lower level of a trade.


Cheers

".... are we there yet ?"

 

Over the last few months it seems that even the unemployment numbers are having less of an impact on the market.

If you look at the chart, this is the worst situation that the US has experienced since the war, and employment still looks like it is on a downward slope. In addition the closest point to the level of unemployment now was way back in 1948. Everything in between 1948 and now was a mere trifle compared to what we are experiencing now.

However, it is a pity that the figures for the Great Depression are not included, as I think they would show around a 7% unemployment rate, and with the post war numbers, you have to factor in that many of the men did not come back from the war. So full employment would have been somewhat easier to achieve as there were less people to fill massive demand for war reparation and the restocking of goods and services in very depleted economies.

So, "... are we there yet ?". Is the market becoming complacent and running the risk of looking the other way when the freight train comes out of that tunnel that they have been seeing the light at the end ?.

There is a great line in the Lamb Lies Down On Broadway by Genesis:.

.... and I feel like a fly hovering, waiting for a windshield on a freeway ...".

Undeniably, the chart above clearly shows how devastating the global financial crisis has been in it's impact on employment. So are we now waiting for a large "smack" as we hit Wall Streets windshield, or does the chart above tell us we are near the turning point ?.

Cheers

"National Australia Bank - the new year rise ?"

Back on November 16th we looked at National Australia Bank, and asked, "where is NAB heading ...?". The price at the time was around $30.50, and our analysis showed that a Wave 4 had been completed and confirmed, and that the price was beginning to retrace down and had broken out of the regression channel. In fact we noted in the posting for November 16th that :.

 "... it would seem that the stronger weekly chart indicates that NAB is trending lower but only for the moment and that we should expect a near term low around $27.85 and then for the stock to resume it's upward trend early in the new year ...". 
 

As we can see from the above chart, NAB did in fact get to our target of $27.85 and then dropped substantially lower, when NAB announced a counter offer to AMP, to take over AXA Life Insurance, back on December 17th 2009. As a result of this announcement, NAB dropped over $3.

One short term opportunity for all the Bulls out there might be to look for a short term rise in NAB to fill the gap back up to the earlier target of $27.85.

But wait there's more ....

Note that we seem to have just completed a Wave 5 low and that any retracement back up to the earlier target may be short lived as the market pulls back to complete a wave 2 low which would be back down around $26.50. The good news is that if this pattern holds, then we would see the early beginnings of a new Wave 3 high, with a potential target back up around $31.50 by mid January 2009.

So where is NAB heading next ?.

Cheers.