pips

There are  times when deciding not to trade is the best trade you can make and right now appears to be one of those times. I know, I know, there are a certain number of you guys out there who claim to be very nimble when the market is moving sideways (as it has been over the past 6 weeks or so) but for the vast majority of traders (me included), sideways movement is just too hard to deal with. The problem is that staying on the sidelines is difficult for many to do because they develop a syndrome I call ‘trader’s finger,’ which means your finger gets itchy to push the buy or sell button.

It’s very important to resist the urge to trade just for trading’s sake or because you feel you have to “do something” like earn a certain amount of pips each week.  I haven’t taken a trade since I saw the markets moving sideways weeks ago and I’m feeling better about my decision every day.

I can’t feel comfortable in a trade if I don’t have a clear idea of where the market will be in a few weeks or months and what’s even more important is that I’ve avoided putting myself through the mental anguish of making bad trading decisions and losing money, which I hate to do and which I know is inevitable when markets get choppy.

Basically, I have the same goal in trading that I have when I get in my car, which is to not get into an accident. The way I look at it, as long as I avoid crashing, the odds are a lot higher that I’ll eventually get to my destination.

What’s interesting is that over the past few weeks I’ve seen so many “professional” opinions on Bloomberg or wherever turn out to be totally wrong. Even good ‘ole Marc Faber, one of my favorite people, appears to have gotten things incorrect when he said 2 weeks again that the dollar was set to gain over the next two months or so. Since then, he might be ahead a little bit but what’s more likely is that all the back and forth movement has caused him a lot of aggravation.

Now, Marc Faber is probably one of the world’s great traders but even he looked to be suffering from trader’s finger during his last Bloomberg interview. Back in March when markets were really crashing, he seemed to go out of his way to say that stocks were set to rally-and that turned out to be one of the year’s great calls. He didn’t have quite the same confidence 2 weeks ago however-in fact, it looked more like he was saying something in order to justify being interviewed. After all, it’s hard to get in front of the cameras and advise people to stay on the sidelines!

But when you think about it, why should that be so? I know that I put just as much effort into making a judgment not to trade as I did when I called a 1000 pip short trade on the pound last summer (my “Four Figure Trade” article), or when I went long on GBP/JPY and AUD/JPY in May (see twitter) and made about 900 pips over 4 days, or when I made about 400% on some A$ options (twitter again) between April and May.

Now, what am I looking for that could start a trend? Simple really if you use some logic. Let me ask you a question.

Is it not true that all of the fiscal and monetary policies have been put in place because the economy is in an emergency situation? Of course it is. So then doesn’t it follow that if and when the signs are given that these extraordinary policies can begin to be withdrawn it indicates that conditions are improving and will continue to do so? I would think so. In fact, I was hoping against hope that the G8 might signal just that last week but unfortunately, they did just the opposite when they said that now is not the time to begin withdrawing liquidity. Apparently, they weren’t in a “green shoots’ mood in Italy (although we did learn that Obama has a preference for satin-clad booty…lol).

Likewise, when economists like Paul Krugman are talking about the need for a second stimulus, that doesn’t exactly instill much confidence in me that the economy is set to improve in a meaningful way any time soon. And when I hear Nouriel Roubini talking about unemployment going to 11%, an anemic recovery and the chance of a double dip recession along with housing prices falling another 20%, somehow it just doesn’t put me in the mood to buy and hold for the long term.

In fact, I think that professor Roubini helped put the kibosh on the spring rally, so what we need to see is some data proving his opinions on the economy are wrong (a tall order, I know). So, it would be great to see new unemployment claims fall below 500K per week and for the number of continuing claims to stop making fresh records with each report. Stabilization of housing prices as measured by the S&P/Case-Schiller Home Price Index would be helpful. The ISM’s above 50 would be very significant.

Obviously it’s going to take some time to see these data points materialize but what I’m also going to be looking for are any surprises like Bernanke announcing the Fed was “electronically” printing dollars. Listening to what’s being said at Jackson Hole next month could prove to be valuable.

Also, check the Fed’s H.4.1 report each week, specifically the line regarding the amount of deposits commercial banks are holding at the Fed banks under liabilities. In normal times there’s about $14B or so on deposit being kept there because of reserve requirements but at the height of the crisis banks were hoarding nearly $1T .

All that money sitting at the Fed means  the banks aren’t lending (or doing very little lending). We need to see that trend towards normalization because as the amount on deposit decreases, the velocity of money increases as banks make more and more loans.  The amount kept on deposit decreased to about $625B just before stocks took in March but increased to about $900B during the stress tests, so I would like to see it get at least to that level (and decrease further) again.

Range Bound Markets

In case you haven’t noticed, things have been kind of range bound over the past month or so for the major currency pairs as well as the S&P 500. Understanding why that’s happening  will lead you into the next trend when conditions change, setting up a good trade.

For many traders, this kind of back and forth movement is much harder to trade than when prices are moving in a trend. I posted a long trade on GBP/JPY and AUD/JPY May 26 on twitter that returned about 1000 pips by June 1 but on June 8 I said “it isn’t a good time to trade currencies due to the lack of a strong fundamental driver.”

This is exactly where trend-following trading systems fail, because there’s no indicator to tell you that markets will go range bound. You have to rely on fundamentals (and your instinct) in order to make a judgment call like that.

While there are a number of arguments that can be made regarding why this is occurring now, for my money it’s the fundamental state of the economy which is dictating the action here at the end of the second quarter. Simply put, it appears that a depression has been avoided and that the recession is slowly coming to an end.  But what also appears to be the case is that the economy will remain sluggish for a period far beyond the end of the recession as the unemployment rate edges inexorably towards 10% (or higher).

This is the view of none other than Nouriel Roubini, who believes that 2010 will “fell like a recession” even if the economy is technically out of one. Meanwhile, San Francisco Federal Reserve Bank President Janet Yellen believes that although the recession is likely to end later in 2009, a “frustratingly slow” recovery marked by continued high unemployment is likely to follow.

“I am not optimistic that the economy will spring back to normal anytime soon,” she said on Tuesday during a scheduled speech. “I’m more concerned that we will be tempted to tighten policy too soon, thereby aborting recovery.”

Unemployment will “remain painfully high for several more years,” she said, which obviously points to more troubled loans for the banks in both residential and commercial mortgages.

She also implied that policy makers will leave the Fed Funds Rate near zero for the next several years, saying that such a policy is “not outside the realm of possibility,” in the press conference which followed her remarks.

Here’s something interesting I found on Bloomberg regarding a Goldman Sachs currency trade:

“Goldman Sachs exited a bet that the Canadian dollar would strengthen versus the Mexican peso,” the article said. “Goldman entered the trade on June 8 and stands to lose about 5% including the cost of carry after being “stopped out” when the peso traded beyond 11.40 per Canadian dollar yesterday.”

This just goes to show that even the best of the best can lose when the fundamentals are too unclear or when they fail to provide a strong impetus.

On To The NFP

The much smaller loss of jobs last month (-345K vs. -504K previous) was accompanied by an increase to 9.4% (from 8.9%) in the unemployment rate. Stocks fell a bit on the news and the dollar gained that day.  Stocks gained for a few days afterwards on the realization that the increase was due in part to greater labor force participation (people who had given up looking for jobs started to look again, a good sign). The rest of the month was basically flat.

Now, if we put the NFP together with what we believe to be the prevailing view of the economy, what we (as traders) want to see is some data that indicates the prevailing view is wrong. So what I would suggest is to come back to this article after the NFP is released; not for an immediate short-term reaction but to see if a reason exists for a trend to be established which will be where the best potential for a good trade will exist.

For example, if by some miracle the unemployment rate were to fall, there would be a good chance to see stocks get a boost over the next few weeks. That would put some pressure on the dollar vs. the euro, pound and A$, and it probably would be positive for those currencies against the yen as well.

A Great Trader

In any discussion of great traders, Marc Faber (the original Dr. Doom) surely comes to mind as being right at the top of the list. He correctly called the commodity rally and dollar bear market early in the decade and more recently said back in March that stocks had probably bottomed.

I always look for his interviews on Bloomberg and CNBC because they’re both entertaining and informative. And I just love the way he concluded his monthly bulletin back in June 2008:

“The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer/software it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US. I’ve been doing my part.”

Faber was on Bloomberg the other day saying that the dollar was likely to gain over the next 4 to 6 weeks. If we get a big jump in the unemployment rate he could turn out to be right, especially if riskier assets like stocks and commodities are sold (we did get a jump of 0.5 last month and we didn’t see a strong sell off). But if the data goes the other way (meaning the unemployment rate falls), he’ll likely wind up with egg on his face.