Archive for June, 2009
Shift from “Green Shoots” perception of economic recovery: look at USD, CAD
![Daily chart of WTI Crude Oil [source: Dukascopy]](http://thegestaltshift.com/wordpress/wp-content/uploads/2009/06/crude-300x225.jpg "crude oil daily chart")
Daily chart of WTI Crude Oil [source: Dukascopy
Last week marked a turning point in perceptions of a global economic recovery emerging (a.k.a. “Green Shoots”) especially with this week’s FOMC meeting on the horizon. The new sentiment in the markets is captured well by today’s headline in the Financial Times: “Recession Worries Rattle Markets.” Let’s take a look at what going on across multiple markets to get a clue for currency trades: Oil tried to rally upon the increasing instability in Iran but couldn’t hold above the $70/bbl figure. Stocks went down upon several weak figures, including industrial production, empire state manufacturing, and others. The remarks by the IMF that China could recover soon and pick up global demand was also not well received.
The Euro has been trading in a declining range against the dollar (see my previous post about factors weighing Euro outcomes for more information) and particularly hasn’t been able to respond positively to good news supporting the “green shoots” perception such as last week’s larger than expected and increasing ZEW survey outcome. The pound has been ranging at high levels due to a perception that the UK may still turn around fast and the political situation is now under control, however the sentiment shift is affecting its upside as well. Traders who got in in the 1. 40s and 1.50s when I originally started speaking about the imbalances should start reducing their longs and move toward a more neutral bias or take their big 1000 pip profits altogether.
In short the shift in perception away from economic recovery has led to Dollar strength if it is looked at as an individual currency (this can be done with a mathematical algorithm and I will start posting my plots of this, especially if I get reminders). Currencies are starting to show signs of weakening but have not yet given way to Dollar strength yet. A trigger that could reverse currencies would be a remark from the Fed that although there have been signs of recovery, they will not tighten for a long time or that housing has shown no clear signs of bottoming. Traders are focused now on the Fed’s exit strategy and the housing market. If the housing market doesn’t show convincing signs of a recovery, other sectors such as jobs and retail won’t be able to recover either. These are just possibilities, but traders should consider any catalysts that could start driving currencies down and supporting the dollar. Remember our formula: imbalance + sentiment shift = price movement. In this case, I believe a medium term imbalance is the behavior of traders: they started bidding up currencies dramatically over the last couple of months due to a framing bias (focusing solely on the notion that the economy was recovering). It is not a strong imbalance, although there needs to be a newer, stronger belief to emerge in the market before the dollar weakens further. Meanwhile, the Canadian dollar (CAD) has weakened rapidly, no doubt due to weakening crude prices. Because of greater risks to the downside in crude oil after its rapid increase on the recovery story and the BOC’s concern of Canada’s ability to export with a stronger currency during this time, the CAD is particularly vulnerable.
Update on GBP/USD position: Gordon Brown, the Bank of England and more
![Gordon Brown [source: telegraph.co.uk]](http://thegestaltshift.com/wordpress/wp-content/uploads/2009/06/gordon-brown-telegraph-co-uk.jpg "Gordon Brown Telegraph")
Gordon Brown [source: telegraph.co.uk
![Bank of England [source: BBC World]](http://thegestaltshift.com/wordpress/wp-content/uploads/2009/06/bank-of-england-bbc.jpg "bank-of-england-bbc")
Bank of England [source: BBC World
Review of “Inside the House of Money” by Steven Drobny and how it relates to the Gestalt Shift
In this post I review “Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets” by Steven Drobny. The book is a modern version of Jack Schwager’s Market Wizards in that it contains techniques that don’t rely on some kind of outright mispricing in the markets that were once prevalent in the 80s. Furthermore, this book contains only interviews with “global macro” style fund traders. This is arena of finance that is about big changes in monetary policy and geopolitics that trickle from currencies and bonds all the way down to individual companies and commodities. I believe Inside the House of Money is a must have for currency traders who are looking to profit from position trades on fundamental and behavioral trading.
Jim Rogers, the Pioneer
The book contains interviews from a wide variety of institutional traders and specialties. Drobny speaks with a prop trader (Christian Siva-Jothy), a Chicago floor trader and manager (Yra Harris, Praxis Trading), Jim Rogers of commodity and currency fame, fixed income traders from London Diversified Fund Management, an emerging market trader, and an anonymous currency trader among others. What’s interesting is that even though the instruments they traded were different, they all looked at instruments in other markets to find imbalances and they all looked at how policies (fiscal, monetary, and geopolitical) were changing. Although few expressly admitted it, nearly all utilized their own framework of behavioral analysis to determine an imbalance to profit from those few macro themes that appear each year.
Drobny essentially asked the interviewees the following questions: Where do you source your information? What constitutes a good opportunity? How do you size your positions? What is the time frame of your trades? How have markets changed over time and how have you adapted? If the market is a zero-sum game, where does your edge come from? Are you long or short gamma? Of course there are examples of their best trades and worst trades. I was surprised by the level of detail with which the traders elaborated on their strategies. The only disappointment was when the trader assumed that the reader knew about some esoteric concept or left out some information that would’ve been useful. For example, the currency trader explained how there are usually only 3-4 macro themes a year at most, yet it’s hard to stay out of the market so he always has positions on. He doesn’t really explain how he decides on a directional bias or generally how he makes entries. That said, each trader in this book have enough comments to spur ideas for developing a trading framework.
Particularly of interest in “Inside the House of Money” to many readers in this community would be the interview with the Currency Specialist. His view of trading and the markets was very influential in my philosophy regarding the current style of trading I do. He emphasizes that news is coming out every few seconds but no new information over all this noise really occurs for a long time. The trader asserts that the real information really comes and identifies opportunity, it is usually in the form of a perceptual, or Gestalt shift among the market participants. What I found most useful in his interview was his explanation of reading central banks. If you flip on Bloomberg most analysts are blasting numbers from every single economic indicator imaginable and speculating on how X event can cause Y price movement, but they often forget that central banks (with few exceptions) set currency rates in the long run. The central banks where many of the imbalances are found that allow one to change their trading bias.
In summary, I recommend getting the book if you are interested in the style that I trade with (global macro). Don’t just read the currency interview. Markets are interrelated and the things each of the traders look at are similar. I believe you might find some useful strategies and ideas from each of them.
Where will the Pound go? GBP/USD trading strategy using Gold/Oil ratio
Where will the Pound go? The single unit climbed above 1.60 and now there are fears that it has gone too far too fast. If there’s one thing that ever remains the same it’s market pundits and analysts who have to ascribe an overbought or oversold rating on something simply because it has moved. This will not get you far in trading.
As successful macro traders we have to keep asking ourselves, “what has brought price to where it is now?” If an imbalance exists then we have to look for a catalyst (read, Gestalt Shift) to start entering trades in the other direction. The market had been fleeing to the safety of the dollar since before march, but then a Gestalt Shift developed as the market developed a perception of economic recovery. This was signaled long before currencies made their move by the Gold/Oil ratio. The Gold/Oil ratio is a good way to look at the value of the two commodities because the US dollar factor is ommitted. Gold is usually a good unit of measure for other assets due to the fact that it has true value (unlike currencies), whereas oil usually tracks global growth and demand. The plot of the Gold/Oil ratio over the last year shows that it reached a turning point toward an indication of global recovery long before equities and currencies caught on. This should have been another clue in addition to my article on the Pound imbalance.
![Gold/Oil ratio 2008-2009 [source: Bloomberg]](http://thegestaltshift.com/wordpress/wp-content/uploads/2009/06/slide1.jpg "slide1")
Gold/Oil ratio 2008-2009 [source: Bloomberg
Traders should look for this ratio to increase again before establishing a short bias on the GBP/USD pair. I’ve created a table/graphic below to explain what factors are limiting the Pound’s and the Euro’s upside as well as supporting their strength right now. One must not be swayed by the ebb and flow of news releases, but rather keep an eye out for major imbalances. Although the Pound could retrace quite a bit (nobody knows), the bias should be long considering there is no striking imbalance that would suggest money should start flowing into the dollar like before. The media is talking about the Fed hiking rates sooner rather than later, but the truth is they have their hands tied (especially with China holding the bulk of US Treasuries) and it’s too early to tell whether we have really have a turnaround in the US. From a probabilistic standpoint, the pound has a better chance of getting more upside while the Euro is more likely to range. As always– These are likelihoods, and do not need to be correct to make money.
Pound and Euro driving forces
