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Understanding Theta II
Brian Overby
June 26, 2006
In my previous post on theta, we explained how time premium is calculated and graphed the rate at which an At-The-Money (ATM) option typically decays. Now let’s dissect the actual Theta number.
To begin with a straight definition, theta is the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract. Keep in mind that Theta measures time decay only; it does not account for stock price movement or the myriad of other variables affecting options pricing.
The last post discussed how time decay accelerates as an option nears expiration; accordingly, then, theta is a larger number for near-term options than it is for longer-term options. For example, consider XYZ trading at 100 and the 100 call, trading at 1.15, with an implied volatility of 20% and 7 days remaining to expiration. The one-day theta for this option would be -.085 or a negative 8 1/2 cents. This means if nothing else in the marketplace changes except one day of time passing, this contact will trade for around 1.15 - .085 or $1.065 in absolute terms.
Now let’s consider the same option contact, but with 180 days remaining to expiration. The call option would be worth $7 and the theta would be -.025 or negative 2 ½ cents - a much slower rate of decay than the 7-day option.
While Theta represents the consensus of the marketplace as to the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract there is no guarantee that this forecast will be correct.
Understanding Theta I
Brian Overby
June 20, 2006
Theta is enemy number one for the option buyer. It is defined as the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract. To the option buyer, the passage of time is similar to the effects of the hot Florida sun’s rays on a block of ice. Each hour that passes causes some of the long option’s value to “melt away.” Not only does the premium “melt away,” but it does so at an accelerated rate as expiration approaches.
If we focus on At-The-Money (ATM) call options and don’t worry about the affects of interest rates and dividends, there’s a quick and dirty way to calculate how fast an option's time premium will decay. ATM options move at the square root of time. We are using ATM options for this example because they are only made up of time value and it makes the calculation simple. This means if a one-month ATM option is trading for $1, then a two-month option would be trading for 1 x sqrt of 2 or 1.41 and a three-month option would be trading for 1 x sqrt of 3 or 1.73 (see below)
If we work back and say the underlying does not move at all and none of the other variables change, the three-month option’s time value will lose 32 cents as soon as it drops to two months; it loses another 41 cents in month 2, and in the final month the option would lose the entire dollar. It’s pretty obvious from this example that not only do options decay, but they decay at an accelerated rate as expiration approaches.
If we plot these points graphically you call see the accelerated curvature of the graph.
Note: this large rate of decay is mainly true with ATM options. If the option is way deep in-the-money or way out-of-the-money, the options will decay in a more linear fashion, largely because these options will have a much lower time value.
Now that we’ve set the stage, the next blog will dig deeper into theta itself and how to use it to factor in your time decay risk in trading.
While Theta represents the consensus of the marketplace as to the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract there is no guarantee that this forecast will be correct.
Understanding Gamma
Brian Overby
June 13, 2006
In the last post I noted that delta is dynamic: it moves not only as the underlying stock moves, but as expiration approaches. Gamma is the Greek that determines the amount of that movement. Officially speaking, Gamma is defined as the amount a theoretical option's delta will change for a corresponding one-unit (point) change in the price of the underlying security. But here’s a more intuitive definition I like: If you look at delta as the "speed" of your option position, Gamma is the "acceleration".
When you are buying options, just like when you are buying a car, Gamma/acceleration is a good feature to have. If your forcast is correct and your option has a large Gamma, its delta will approach 1 quickly, in other words giving it 1-to-1 movement with the stock quickly.
Gamma is highest for the near-term ATM strike, and slopes off toward the ITM and OTM strikes. This is the main reason why the near-term ATM strike usually is the series that has the largest number of contacts that trade each day. Buyers of options like these options because they have high Gamma values. The graph below shows a near-term option (15 days to expiration) on a stock now trading around 85; Gamma is largest on the ATM strike. You can also see as the underlying stock moves up or down the Gamma becomes smaller, this is because Delta is either approaching one or approaching zero which means Gamma has to become smaller because Delta can not go beyond these levels.
To explain this further, let’s use the same example we examined in the previous delta posting.
Say we have an ATM call at 50 strike, the stock is at 50, and there’s one day remaining to expiration. Delta in this case will be exactly 50. Why? If the stock goes up, the call will be in-the-money; if it goes down the option will be out-of-the-money. In other words, you have a 50/50 chance of the option finishing in-the-money on expiration; hence, delta is 50.
Now consider a 50 strike call option that is already in-the-money with one day remaining; the stock is at 51. What’s the delta now? Think about the second definition. Being one point in-the-money with only one day remaining means the stock has a very high likelihood of staying in-the-money. That likelihood translates into a much larger delta, close to 90.
What’s Gamma then? Remember the definition. With that one-point movement in the stock’s price, Gamma measures the acceleration factor on delta, from 50 to 90. This means the Gamma was 40 or .40 when the stock was still at 50.
If we lengthen the time to expiration in the last example, it vastly changes the way the option will act. Let’s now say the option has 60 days remaining until expiration, the stock is still at 51 and the call strike is still 50. Now, what’s the probability of the option being in-the-money at expiration? It’s much lower because the stock has more time to move. Delta on this option will be around 60. That makes Gamma 10 or .10 on this option contract when the stock was still at 50.
If we wanted to know the acceleration at which the option will move all we would have had to do is look at the Gamma before we placed the trade.
Of course, there’s a tradeoff to keep in mind. If you seek out high Gamma for more acceleration, you’re also likely to get high theta (rate of time decay). In the next posting we will define theta and discuss how that relationship affects the dynamics of your trade.
Understanding Delta III
Brian Overby
May 22, 2006
From the previous posting, you should have a feel for how Delta can help you gauge an option’s likely movement for a one point movement in the underlying security. Delta is dynamic, so that, if the option becomes deeper and deeper in-the-money (ITM) the Delta will approach one, or if the option gets further and further out-of-the-money (OTM) Delta will approach zero.
This is only part one of a two-part story, though. Delta not only moves as the underlying security moves; it also moves as expiration approaches.
To better explain this concept I need to introduce to another definition of Delta, one used often by market markers: Delta is the probability of the option contract being in-the-money at expiration. You won’t see this definition in text books. Rightly so, it is not the exact math formula used to calculate Delta. For learing about Delta it is good enough. I use this “non-standard” version to explain how and why Delta changes as expiration approaches.
Say we have an ATM call at 50 strike, the stock is at 50, and there’s one day remaining to expiration. Delta in this case will be exactly 50. Why? If the stock goes up, the call will be in-the-money; if it goes down the option will be out-of-the-money. In other words, you have a 50/50 chance of the option finishing in-the-money on expiration; hence, Delta is 50.
Now consider a 50 strike call option that is already in-the-money with one day remaining; the stock is at 52. What’s the Delta now? Think about the second definition. Being two points in-the-money with only one day remaining means the stock has a very high likelihood of staying in-the-money. That likelihood translates into a much larger Delta, close to 95.
If we lengthen the time to expiration in the last example, it vastly changes the way the option will act. Let’s now say the option has 60 days remaining until expiration, the stock is still at 52 and the call strike is still 50. Now, what’s the probability of the option being in-the-money at expiration? It’s much lower because the stock has time to move. Delta on this option will be between 65 and 70. Here’s another way to put it: more time to move means less likelihood of the option still being in-the-money at expiration; this translates into a smaller Delta.
Below is a table of actual Deltas from the marketplace. These Deltas are from options based on the S&P 500 Exchange Traded Fund (ETF), called the Spiders.
In this example, the April options had 11 days remaining until expiration and the July options had 158 days remaining. The 127 strike call has a much larger Delta, 80, compared to the July option, 65. With only 11 days remaining the April option had a much high likelihood of still being ITM at expiration, hence the higher Delta.
Now, let’s talk about how the delta is affected by time on out-of-the-money options. Look at the 133 strikes in the chart; the July option’s Delta is much higher than that of the April option. That’s because, for a July option, time is now your friend: if you’re buying OTM options, you need time for the stock to move up to the strike price. In other words, there’s a much higher probability of the underlying finishing ITM for the July option than for the April; Delta reflects that probability.
The moral of the story is that Deltas are dynamic. Not only do they change as the underlying stock moves up and down, but they also change as expiration approaches.
Understanding Delta II
Brian Overby
April 17, 2006
In the last post I talked about the importance of delta and gave a basic example. I also posed a question: a stock at 50 moved to 51, and its 2-month 50 strike call moved from $3 to $3.50. At the time, the delta was $0.50, explaining the move in the options price from $3 to $3.50.
Now based to the cliffhanger question, the option is trading at $3.50 and the stock is at 51, what do you think the option will be trading for if the option goes from 51 to 52? Will it move 50 cents again, or more or less than that?
The answer is more than 50 cents. The option should be trading for about $4.10, which means it moved about 60 cents. Delta is dynamic, so how close or how far away the stock is from the strike price determines how the option will react to the stock price movement. When we started out the option had a delta of .50, which meant if the stock went up one the option should go up about 50 cents - 50% of the stock’s movement. When the stock was trading at 51, the option’s delta was .60, so when the stock made the next point move, the option moved about 60% of the stock price movement.
This illustrates a useful rule-of-thumb about delta. At-the-money (ATM) options usually have a delta of around 50 cents, or traders will often remove the cents and just say the delta is 50 (which is the convention I will use). In-the-Money (ITM) options have deltas between 50 and 1, never larger than 1; and out-of-the-money (OTM) options have deltas between 50 and 0, obviously never going below 0.
ATM – Delta close to 50
ITM – Deltas between 50 and 1
OTM – Deltas between 50 and 0
Below is a chart of actual deltas derived from the TradeKing option chains.
In the next post, let’s move on to another question: how can we use delta to predict option’s price movements as they approach expiration?
Why Do We Care About Volatility? part 3: Calculating implied volatility
Brian Overby
February 7, 2006
Welcome back to my series on “Why Do We Care About Volatility?” Last week I walked through some math to explain standard deviation, a crucial statistics term that helps you estimate the likelihood and size of a security’s price swings in a one-year period. Today you’ll find out how to apply that information to any time period.
All volatility figures are quoted on an annualized basis unless stated otherwise. Since we did not state otherwise in last weeks example, the marketplace thinks that “most likely” the underlying stock will not be below 80 or above 120 at the end of one year. “Most likely” is defined as in 68% of all occurrences.
Our next move is to break down the one standard deviation move so that it fits any time period – that way you can apply it to any expirations you’re interested in trading. The formula in the simplest form is the following:
OSDM = Price x Implied Volatility (ann.) x (sqrt) Calendar Days to Exp.
(sqrt) 365
(A more accurate formula is to use trading days to expiration instead of calendar days, and then divide the entire equation by (sqrt) 252, which is the total number of trading days in a year.)
Now let’s assume we are dealing with a 30 trading day option contract. The one standard deviation move then becomes:
OSDM = 100 x .20 x (sqrt) 30
(sqrt)365
OSDM = + 5.73
This means over a 30 calendar day period the underlying is expected to finish between 94.27 and 105.73. If we perform the calculations for a 60 and 90 calendar day period and then graphed the results the graph would look like the following:
This shows us that the longer the time period, the larger the potential for wider swings in the underlying stock. Keep in mind that even if you are looking at a 30, 60, or 90 day options the implied volatility will always be quoted as an annualized number.
Why Do We Care About Volatility? Part 2: Calculating implied volatility.
Brian Overby
January 30, 2006
Welcome back to my series on “Why Do We Care About Volatility?”. Now that we’ve defined terms, it’s time for some math that will show you how volatility really works – and why it’s important in both stocks and options trading.
To calculate implied volatility, the first step is seeing where At-The-Money (ATM) options are trading. (Since the most option trading volume usually occurs on the ATM options, the industry standard is to use the ATM options to calculate the implied volatility.) Once we know the price of the ATM options we can use a pricing model and a little algebra to solve for the implied volatility.
As a figure, implied volatility tells you how much the marketplace as whole thinks the potential movement will be for the underlying security that the option is based on. Keep in mind: volatility has no regard for direction. If the implied volatility is a “large” number, the market place thinks the security will make larger price swings in either direction. Similarly, a “small” number implies the underling’s price will not move as much.
Now’s the time to dust off the old college stats book. Don’t get too scared, though – we’re not going to derive the Black/Scholes pricing model or anything too wildly complicated. Once you have the implied volatility for an option, you can actually calculate an expected high side number and an expected low side number for the underlying over the life of the option contract. In other words, you can use implied volatility to see if the marketplace agrees with our outlook for a stock or index. It can be used as both a measure of risk and potential reward. Best of all, volatility is based on statistics, so it’s an objective way to test your hunches and manage exit points.
The math starts here. First off, we have to address the biggest assumption made by people who build pricing models - the log normal distribution of stock and index prices. Check out the bell-shaped curve below, which is the basic normal distribution. A normal distribution of data means that most of the examples in a set of data are close to the "average or mean price," while relatively few examples tend to one extreme or the other. Again in laymen’s terms, most of the time stocks and indexes do nothing and stay close to their current price and only every once and awhile they make an extreme move.
(The difference between a normal and a log normal distribution is the fact that a stock or index can theoretically go to infinity on the upside and only zero on the downside. A log normal distribution accounts for this fact and because of this has a slight upside bias in the distribution.)
Say we have a stock trading at 100 with an implied volatility of 20%. First we’ll start with defining standard deviation and how it relates to implied volatility; then we’ll reverse the process and show you how standard deviation can give high and low price points for a stock. In subsequent posts we’ll evaluate how to use these numbers as you make trading decisions.
Key words for this discussion are standard deviation and annualized. Statistically speaking, implied volatility is a proxy for standard deviation. If we assume a normal price distribution, we can calculate what a one standard deviation move (OSDM) of the stock will be. To do that we first multiply the stock price with the Implied Volatility:
100 x .20 = 20
OSDM = 20 points
The number of points it sums to is a one standard deviation move. This refers to either a move up or down in the stock. So the next step is to add and subtract the OSDM from the current stock price.
100 + 20 = 120
100 – 20 = 80
This gives us the normal expected range of the underlying stock. Standard statistical formulas imply the underlying stock will stay within this range (80 to 120) 68% percent of the time. When discussing a normal distribution most math text books refer to a one, two and three standard deviation move. That means the one standard deviation move will occur at a confidence interval of 68% of all occurrences, a two standard deviation move will occur with a confidence interval of 95% and a three standard deviation move will occur with a confidence interval of 99%.
Now you know how to gauge the underlying’s swings over a one-year period. Check back next week to find out how to adjust this annualized figure for options contracts of any length.
The Golden Parabolic Spike Pattern
by Kristen Lush
June 13, 2006
One of the first things traders learn about the financial markets is that history has a way of repeating it self. And from that one piece of information most technical oriented traders focus on price patterns which repeat time and time again. Below are a few charts of gold that show a parabolic spike price pattern which has occurred twice in the last 10 months and could very much happen again soon.
What is a parabolic spike?
A parabolic spike is a rapid increase is price which is not sustainable. Thus a sharp sell off usually occurs after the rising price ends.
The Parabolic Spike
You will notice that there are two parabolic spikes in this 10 month chart. But what else is similar?
The Consolidation
Before the parabolic spike, gold made a 3 wave consolidation patter twice. What else is similar?
The Gold Rush
This phase is either the final step in this three step pattern or the first step depending on how you look at it.
Putting It Together
Final Note:
The recent parabolic correction has provided us with a great short trade from the $682 level and prices are still sliding lower. A close above our trend line will be our exit signal. But until then, we are taking full advantage of this Parabolic Pull Back.
The nicest feature I find when trading gold and gold funds is that we have a very accurate leading indicator. The HUI, this one tool makes trading gold very accurate as it under and out performs gold generally before a pending reversal some times up to 7 days in advance providing more than enough time to tighten trend lines and stops. Our complete trading model is available at http://www.TheGoldSector.com.
http://www.financialsense.com/fsu/editorials/2006/0613.html
The Greatest Scam On Earth
by Douglas V. Gnazzo
May 31, 2006
Caveat Emptor
"To seek power by servility to the people is a disgrace,
but to maintain it by terror, violence, and oppression is not
a disgrace only, but an injustice." [1]
Abstract
The word mortgage is derived from morgage, mort gage: dead pledge; mort, dead, and gage a pledge. It represents a pledge of property as security for payment of a debt.
The most common use is in the buying, selling, and borrowing for a home where the mortgage refers to the debt secured by the mortgage. It can also refer to the legal document used in securing property.
Let's take a close up look as how this process works.
"The creditor has legal rights to the debt secured by the mortgage and often make a loan to the debtor of the purchase money for the property."
"The debtor or debtors must meet the requirements of the mortgage conditions (and often the loan conditions) imposed by the creditor in order to avoid the creditor enacting provisions of the mortgage to recover the debt." [2]
There are two main types of mortgages: mortgage by demise and mortgage by legal charge.
"In a mortgage by demise, the creditor becomes the owner of the mortgaged property until the loan is repaid in full (known as "redemption"). This kind of mortgage takes the form of a conveyance of the property to the creditor, with a condition that the property will be returned on redemption."
"In a mortgage by legal charge, the debtor remains the legal owner of the property, but the creditor gains sufficient rights over it to enable them to enforce their security, such as a right to take possession of the property or sell it.
To protect the lender, a mortgage by legal charge is usually recorded in a public register. Since mortgage debt is often the largest debt owed by the debtor, banks and other mortgage lenders run title searches of the real property to make certain that there are no mortgages already registered on the debtor's property which might have higher priority." [3]
The Tax Man
"Tax liens, in some cases, will come ahead of mortgages. For this reason, if a borrower has delinquent property taxes, the bank will often pay them to prevent the lienholder from foreclosing and wiping out the mortgage." [4]
Notice how in all of these definitions that instead of becoming simpler with each explanation it is instead becoming more complicated with increasing legal terms and ramifications.
"A tax lien is a lien imposed on property by law to secure payment of taxes. Tax liens may be imposed for delinquent taxes owed on real property or personal property, or as a result of failure to pay income taxes or other taxes." [5]
Internal Revenue Code section 6321 provides :
"Sec. 6321. LIEN FOR TAXES.
If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount (including any interest, additional amount, addition to tax, or assessable penalty, together with any costs that may accrue in addition thereto) shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belong to such person." [6]
Are you getting a quesy feeling down in the pit of your stomach yet? If not just wait, there is much more user friendly legalese to come. First we will delve into foreclosure.
Foreclosure
"Foreclosure is the legal proceeding in which a bank or other secured creditor sells or repossesses a parcel of real property (immovable property) due to the owner's failure to comply with an agreement between the lender and borrower called a "mortgage" or "deed of trust". Commonly, the violation of the mortgage is a default in payment of a promissory note, secured by a lien on the property. When the process is complete, it is typically said that "the lender has foreclosed its mortgage or lien." [7]
The further we progress into the issue the more complicated it becomes. This is why a lawyer is needed in the conveyance of property.
"Conveyancing is the act of transferring the ownership of a property from one person to another. The buyer needs to ensure that he or she gets good 'title' to the land; i.e., that the person selling the house actually has the right to sell it." [8]
A Deed
A deed is a legal instrument used for transferring title to real estate from one person to another although it can be used in other proceedings. Now we are getting closer to the bone as it is said.
We are all familiar with the terms deed and title, as such legal instruments are used in the conveyance of all real estate. Anyone that owns property such as their home and land have heard these terms before. Let's take a little closer look, as these legal instruments are very important and carry specific encumbrances and ramifications.
"Fee simple, also known as fee simple absolute, is an estate in land in common law. It is the most common way real estate is owned in common law countries, and is ordinarily the most complete ownership interest that can be had in real property short of allodial title, which is often reserved for governments.
Fee simple ownership represents absolute ownership of real property but it is limited by the four basic government powers of taxation, eminent domain, police power, and escheat.
How ownership is limited by these government powers often involves the shift from allodial title to fee simple such as when uniting with other property owners acceding to property restrictions or municipal regulation."
Although a bit complicated, it sounds like once you wade through all the legelease and you pay off your mortgage, that you own your property and are in possession of the title for it.
Property Titles
But how many people ever pay their mortgage off in full to begin with? If the mortgage doesn't get paid off, then we do not have the title to the property in our possession. The title remains with the lender. So the lendor actually owns the land until the mortgage is paid off.
"Ownership is the state or fact of exclusive possession or control of property, which may be an object, land/real estate, intellectual property or some other kind of property."
"At common law, an estate is the totality of the legal rights, interests, entitlements and obligations attaching to property. In the context of wills and probate, it refers to the totality of the property which the deceased owned or in which some interest was held. It may also refer to an estate in land." [9]
Well that doesn't sound too bad, if once again the mortgage has been paid off in full. I wonder if there is a difference between possession and exclusive possession in the above definition of ownership.
"At common law, a mortgage was a conveyance of land that on its face was absolute and conveyed a fee simple estate, but which was in fact conditional, and would be of no effect if certain conditions were not met --- usually, but not necessarily, the repayment of a debt to the original landowner." [10]
Hmm, now it's gone from complicated to very conditional, as in the difference between exclusive ownership and ownership.
Conditions
Now we find that a conveyance of land that on its face was absolute (kind of like exclusive) was in fact conditional and could be of NO EFFECT.
Bankruptcy
It almost sounds like none of us really owns anything outright, as in allodial title, which is reserved for governments or the Royal Family, which are the same. Complicating matters even more is the law of bankruptcy:
"Under the law of bankruptcy in the United States, the "estate" is defined by the Bankruptcy Code as all assets or property of any kind belonging to the debtor which is available for distribution to creditors. The bankruptcy estate is defined at 11 U.S.C.§541. In some cases, the person with legal responsibility for the estate is the trustee." [11]
Rights
The creditors have more rights to the property than the individual who "bought" the property and is paying off the mortgage. In fact, the debtor does not retain the title to the property until the mortgage is paid in full. In the mean time, the creditor owns and has possession of the title.
The poor borrower is at the back of the line regarding ownership of any property; as before him, in the eyes of the court, is the lender; and ahead of the lender is the State. The buyer is last in line. Yes - I know, it is hard to believe. So here is a bit of evidence:
Senate Document No. 43
"The ultimate ownership of all property is in the state; individual so-called ownership' is only by virtue of government, i.e., law, amounting to a mere user; and use must be in accordance with law and subordinate to the necessities of the State." [12]
One could reasonably argue that it makes perfect sense that the creditor or lender owns the title and the property; until such time when the borrower (buyer) pays off his loan from the creditor, especially if the lender can show proof that he paid in full for the property and holds a legal title. Now the fun part begins, as we are going to look a bit closer at this thing called lending.
Lending
When one decides they want to buy a house or property, they go to their friendly banker to take out a loan to purchase the real estate. Just for the sake of an example, let us say we are going to buy a $1,000,000.00 house. We have to come up with a deposit and the required proof that we can reasonably be expected to pay off the loan, which runs for a period of 30 years.
The "proof" usually includes having a good job with an income large enough to not only service the debt for the house, but to also supply adequate resources to pay all the other necessary bills to survive in today's modern world. Any other existing debt is of consequence, as well as our history regarding paying off debt.
Credit by Mortgage
If we pass inspection, our friendly banker says that if we put down a 10% deposit of $100,000.00 dollars, then he will loan us the balance of the money needed to purchase the house. The banker offers to extend us credit via a mortgage.
This on the surface sounds straightforward and innocuous. Millions of people have done it, and millions more do it each day. Nevertheless, let us dig beneath the surface a bit to see what we can discover.
The price of the house is $1 million dollars. We are going to put down a 10% deposit of $100,000.00. The difference of $900,000.00 the banker is going to loan to us. Of course, he will charge us interest on the loan, as that is what bankers do - they collect their hard earned vig, as do all good collectivists.
So, we sign the mortgage and take out the loan. We also get a schedule of monthly payments for the next 30 YEARS. These are our mortgage payments, which include not only the $900,000.00 but the monthly charge of interest on it as well.
Debt Servitude
Note: when we sign on the dotted line of a 30 year mortgage, we obligate ourselves to work for the next 30 years, to earn enough income to service our newly acquired debt: the mortgage loan.
To get possession of the title we must pay off the loan; in consequence, we have accepted a large obligation that lasts for most of our adult life. Faust must be smiling.
If a borrower takes the full 30 years to pay off the mortgage loan, by the time all is said and done, they will have paid the banker almost 3 times the original purchase price of $1,000,000.00 - a total of almost $3,000,000.00. Oh yes, we get to pay property taxes as well.
Needless to say, the banker makes out quite well. Come to think of it, he must be very rich to be able to lend so many people so much money. I wonder where the banker got all the money to loan out to everyone.
Where's The Money
The truth of the matter is that the banker does not lend any of "his" money. In fact, the banker does not lend any money, as the money does not really exist. All the banker does is extend credit. He simply marks in his ledger (computer screen) that he is loaning you $900,000.00 dollars.
"Mr. Patman warns us to remember that: "The cash, in truth, does not exist and never has existed. What we call 'cash reserves' are simply bookkeeping credits entered upon the ledgers of the Federal Reserve Banks. These credits are created by the Federal Reserve Banks and then passed along through the banking system." [13]
Does the banker or the bank have this money on deposit in reserves at the bank? No, they do not. The money did not exist until the banker created it by the very act of lending it to you, and marking it in his ledger.
The extension of credit, whereby money is created - is nothing more than a bunch of double-entry bookkeeping figures. Tough work if you can get it.
"Modern Money Mechanics publication from Chicago, once again: "Deposits are merely book entries...demand deposits are liabilities of commercial banks. The banks stand ready to convert such deposits into currency or transfer their ownership at the request of depositors." [14]
That is all our monetary system is under the thumb of paper fiat debt-money: empty, hollow promises to pay - promises that can never be kept. How could they be - there is no money. It is all just a scam, a fraud - an illusion of delusion.
Debt Equals Money
How can this possibly be true, the reader must be asking. Our government would not allow this - would they? Yes, they would, and yes, they have.
"And, from further testimony from the Federal Reserve itself: In a publication from the Federal Reserve Bank of Chicago, entitled "Two Faces of Debt," -- "Currency is so widely accepted as a medium of exchange that most people do not think of it as debt." [15]
On June 5, 1933, Congress passed the House Joint Resolution 192 to suspend the gold standard and the redeemability in gold of paper money. Since that time, it has been impossible to lawfully pay off a debt. The resolution stated:
"... Whereas the holding or dealing in gold affect the PUBLIC INTEREST, [STATE-Corporate Interest] and are therefore subject to proper regulation and restriction: and whereas the existing emergency has disclosed that provisions of obligations which purport to give the obligee a RIGHT TO REQUIRE PAYMENT in gold or a particular kind of coin or currency . . . ARE INCONSISTENT WITH THE DECLARED POLICY OF CONGRESS IN THE PAYMENT OF DEBTS . . . PAYMENT in gold or a particular kind of coin or currency, or in an amount in money of the united States measured thereby, IS DECLARED TO BE AGAINST PUBLIC POLICY: . . . AND . . . EVERY OBLIGATION, HERETOFORE OR HEREAFTER INCURRED, SHALL BE DISCHARGED upon payment, dollar for dollar, in any coin or currency which, at the time of payment, is legal tender for public and private debts . . ." [16]
This statute accomplishes four unbelievably corrupt acts. The first two are: it dismisses what was left of the hard currency monetary system of the Constitution (gold & silver coin), for being inconsistent with the declared policy of Congress; and it declares the constitutional mandate to accept gold as legal tender to be against public policy.
Constitution & Law
These acts are not in keeping with the Constitution, and can only be changed by a constitutional amendment - which has not occurred. We are hereby reminded, why any law, if not in pursuance of the Constitution, is null and void, as if it never occurred; and consequently, is not part of The Supreme Law of the Land.
It also allows for debts to be discharged WITHOUT the use of the hard money currency of gold and silver coin of the Constitution, thereby allowing for the use of paper fiat debt-money in the discharge of debt - or what the Federal Reserve refers to as: monetizing the debt.
Credit Equals Money Equals Debt
Lastly, by instituting a paper fiat debt-money system, whereby credit and debt and money are one and the same - it is issuing debt obligations that are backed by the credit extended by the acceptance of all mortgages on our homes, and other private property.
"The Federal Reserve Notes, therefore, in form have some of the qualities of government paper money, but, in substance, are almost purely asset currency possessing a government guaranty against which contingency the government has made no provision whatever." [17]
Essentially, it comes down to the fact that we borrow money that does not really exist as it did when gold and silver coin was money. Back then the hard currency existed. Today, most of what is called the money supply, as well as the supply of credit, is nothing more than numbers on the ledger of the lender's books.
Perpetual Interest
In addition, the lender gets to create more money or credit - by simply offering it to us. When we accept the offer, money and debt are created by the act of accepting credit.
Money, debt, and credit are one in the same in a paper fiat land, as opposed to a hard currency monetary system of Honest Weights and Measures, as stated in the Constitution and the Coinage Act of 1792. Then silver and gold coin circulated as the currency.
"Mariner Eccles, former chairman of the Federal Reserve Board, held the following exchange with Congressman Patman before the House Banking and Currency Committee on September 30, 1941:
Congressman Patman: "Mr. Eccles, how did you get the money to buy those two billions of government securities?"
Mr. Eccles: "We created it."
Patman: "Out of what?"
Mr. Eccles: "Out of the right to issue credit money." [18]
Bond-age
A paper fiat monetary system of debt-money also insures that there is a perpetual national debt, which insures a perpetual service of interest payments to the elite collectivist.
"They should not have foisted that kind of currency, namely an asset currency, on the United States Government. They should not have made the government liable on the private debts of individuals and corporations and, least of all on the private debts of foreigners." [19]
It is nothing more than monetary prostitution of our freedom and liberty, as well as our children's and their children's.
Payment or Discharge
This is why Joint Resolution 192 switches from payment of debt to the discharge of debt. With real money of gold and silver coin, one can pay debts - hell that is the purpose for having money. However, when you do away with real money, you no longer have any real way to pay off debts - so now they are simply discharged by, or transferred to, others.
Perhaps this is why Congressman Long stated the following:
"That is the equity of what we are about to do. Yes, you are going to close us down. Yes; you have already closed us down, and have been doing it long before this year. Our President says that for 3 years we have been on the way to bankruptcy. We have been on the way to bankruptcy longer than 3 years. We have been on the way to bankruptcy ever since we began to allow the financial mastery of this country gradually to get into the hands of a little clique that has held it right up until they would send us to the grave." [20]
It appears that Congressman Patman understood it all too well when he said:
"I want to show you where the people are being imposed upon by reason of the delegation of this tremendous power. I invite your attention to the fact that section 16 of the Federal Reserve Act provides that whenever the Government of the United States issues and delivers money, Federal Reserve notes, which are based on the credit of the Nation--they represent a mortgage upon your home and my home, and upon all the property of all the people of the Nation--to the Federal Reserve agent, an interest charge shall be collected for the Government." [21]
There is much more to say on this, however, this is a good start. More will follow in due course, especially by what ways and means land was originally obtained, and just what is this thing called Common Law.
If the above is true, which I believe to be the case, we all must take a stand on the issue of Honest Money by using our power to vote. We need to vote the right people into position to make the overhaul of a pernicious system happen.
It cannot be done all at one time - but a journey of 1000 miles begins with one step, and is further advanced, one step at a time. If man can build the Great Pyramid, thousands of years ago - we can at least institute the mandates of the Constitution, including Honest Money.
There is a saying that if all good men doing nothing, then evil can endure. If all good men cast their Light as beacons of truth - evil dissipates, as all it is - is the absence of Light.
Babaji speaks to devotees: Blessings, Change is difficult. The Lower Self cannot accept change. It will create division to avoid change. Division is destructive. Division causes misery and despair. Be Alert to this. Be Aware of this. Change is inevitable
"Simplicity without a name
Is free from all external aim.
With no desire, at rest and still,
All things go right as of their will." [22]
[1] Plutarch
[2] Wikipedia
[3] Wikipedia
[4] Wikipedia
[5] Wikipedia
[6] Internal Revenue Code Section 6231
[7] Wikipedia
[8] Wikipedia
[9] Wikipedia
[10] Wikipedia
[11] Wikipedia
[12] Senate Document No. 43, "Contracts payable in Gold" written in 1933.
[13] Congressional Record
[14] Modern Money Mechanics
[15] Federal Reserves "Two Faces of Debt"
[16] House Join Resolution 1933
[17] Congressional Record
[18] House Banking & Currency Meeting Records - 1941
[19] Senator Packman
[20] Congressman Long - Congressional Records
[21] Congressional Record, Congressman Patman, March 13, 1933
[22] Tao Teh King by Lao-Tzu
Talk BackTalk Back
Douglas V. Gnazzo
Honest Money Gold & Silver Report
Market reversal or just a bounce? This tool can tell you
By Deron Wagner
TradingMarkets.com
May 30, 2006 9:00 AM ET
Stocks bounced higher for the third consecutive session last Friday, as trading activity slowed ahead of the holiday weekend. The S&P 500 (SPX), Nasdaq Composite (COMP), Dow Jones Industrial Average (DJX), S&P Midcap 400, and small-cap Russell 2000 indices each gained 0.6%. Each of the major indices also finished near their intraday highs, although the Nasdaq was relatively choppy. Overall, last week's one percent bounce in the S&P 500 was a welcome relief for the bulls, but the index still remains 2.3% lower for the month. With two days remaining in May, the Nasdaq is down 4.8% in the same time period.
As anticipated, turnover declined significantly in last Friday's session. Traders cutting out early for the Memorial Day holiday contributed to total volume in both the NYSE and Nasdaq coming in 23% below their respective levels of the prior day. It was the lightest volume day for both exchanges in more than five weeks. The broad market registered solid price gains between last Thursday and Friday's sessions, but the problem is that total volume levels fell off substantially both days. Preceding Friday's 23% decline in volume was 24% lighter volume in both exchanges the previous day. As such, the stock market's gains of the past two days certainly have not been confirmed by higher volume. While higher volume is not always necessary in order to signify a market bottom, there generally needs to be an overall pattern of accumulation either when the rally starts or immediately preceding it. So far, the only accumulation we have seen was the higher volume gains of the May 24 reversal day. Conversely, a vast majority of the market's down days in recent weeks have been on higher volume, which signifies institutional distribution.
Did last week's retracement in the broad market represent a bottom or was it merely a technical bounce within the context of the downtrend that began earlier this month? One tool that is useful for answering this question in situations such as this is the use of Fibonacci retracements. Simply put, the three major Fibonacci retracement levels we follow are 38.2%, 50%, and 61.8%. In a downtrend, the less an index or stock retraces, the more likely it is to head back down and continue its downtrend (the opposite is true in uptrends). A market that is steadily trending lower will commonly retrace up to 38.2% or even 50% of its last downward move before resuming the current trend and setting new lows. However, if a downtrending market retraces more than 61.8% of the last move, that is often a warning sign that a bottom may have formed and the trend is about to reverse. Conversely, markets that are VERY weak may not even bounce up to the 38.2% retracement level. Since stocks have rallied off their lows for the past several days, let's take a look at where both the S&P 500 and Nasdaq-100 indices stand in relation to their Fibonacci retracement levels. We'll begin by looking at the S&P 500 SPDR (SPY), which mirrors the benchmark S&P 500 Index:
The most notable technical event in SPY is that it tested and bounced off support of its 200-day moving average last week. However, despite three straight days of gains, SPY has only recovered a little more than 38.2% of the slide from its May 5 high down to its May 24 low. The 61.8% retracement level, often a reversal point in short-term trends, lies between resistance of the 20 and 50-day moving averages. Not only is the 61.8% retracement level a major area of resistance, but both the 20 and 50-day MAs have now become major resistance levels as well. Given the lack of power behind the broad market's rally over the past few days, it seems unlikely that SPY will rally up to its 61.8% retracement level on this move before the bears step back in. Even if it does, there is now additional overhead supply created by the break of the 20 and 50-day MAs. Therefore, the daily chart points to decent odds that SPY will at least re-test last week's low before it sees its 50-day moving average again. Next, take a look at the daily chart of the Nasdaq-100 Tracking Stock (QQQQ):
As you probably noticed very quickly, last week's retracement in QQQQ lagged the recovery in SPY. When measured from its most recent peak on May 8 down to its May 24 low, QQQQ has not yet even rallied up to its 38.2% retracement level and remains well below its 20, 50, and even 200-day moving averages. While this is obviously bearish, it is not surprising considering that QQQQ also showed more relative weakness than SPY by losing a greater percentage on the way down. In fact, notice that QQQQ formed its top a full month before SPY. When SPY broke out to a new high on May 5, QQQQ merely formed a "lower high." You may recall our analysis at that time in which we suggested that the relative weakness in the Nasdaq would eventually drag down the S&P and Dow as well.
When the broad market is choppy and stuck in a trading range for a lengthy period of time, we tend to focus our analysis on specific industry sector ETFs that are showing the most relative strength or weakness to the broad-based indices. Such is the reason why a vast majority of our daily technical analysis focused on individual sectors, rather than the broad market, throughout March and April of this year. However, when the major indices are trending steadily in either direction, we find it makes sense to trade the broad-based ETFs such as SPY or QQQQ instead. In a steady uptrend, relatively easy profits can be realized through buying each price retracement down to a major Fibonacci support level and subsequently selling into strength a week or two later. Conversely, we have had an equal amount of success over the years through selling short the broad-based ETFs on rallies into Fibonacci resistance levels. Presently, we remain short the Dow Jones DIAMONDS (DIA) and regular subscribers will see our specific trigger price for adding shares to that position in the event of a resumption of the downtrend.
On a different concluding note, we want to make you aware of a new ETF that was launched on the American Stock Exchange last week -- the Market Vectors Gold Miners ETF, which trades under the ticker symbol GDX. Unlike the GLD or IAU exchange traded funds, both of which mirror the price of the spot gold commodity, GDX follows the price of the Amex Gold Mining Index, a composite of 43 individual gold mining stocks. Because the price of the commodity itself is often out of sync with the performance of the mining stocks, the new Gold Miners ETF provides a way to easily participate in the mining index without the need to determine which are the best performing stocks in such a volatile sector. GDX has been added to the Morpheus ETF Roundup report and will be included in the next revision that is automatically e-mailed to subscribers.
http://www.tradingmarkets.com/.site/Swingtrading/Commentary/todaysetfo/-52048.cfm
Speaking of 1987...
Commitments of Traders Report: The 1987 Crash
by James West
May 6, 2006
I would highly recommend that you first listen to the Financial Sense interview with Larry Williams, a real guru when it comes to the COT (Commitments of Traders) report, before reading my post.
I also recommend reading the book mentioned in the interview: Trade Stocks & Commodities with the Insiders by Larry Williams. You can find the interview at this link:
So what is this report all about?
The COT report is published every Friday by the Commodity Futures Trading Commission (CFTC) that seeks to provide investors with up-to-date information on futures market operations and increase the transparency of these complex exchanges. (Investopedia.com)
This report provides valuable information about changes in the position commitments of various types of investors. These reports are used to help determine the likelihood of a trend continuing or coming to an end. (Investopedia.com)
Who are these ‘various types of investors’?
Small traders: These are the small traders, who control a very small portion of open interest. Their actions in the market (buying & selling) are to be ignored.
Large traders: These are the large speculators who are often characterized as trend followers in the market. The large traders are typically funds, who like to jump into an existing trend but often end up having their largest net-long positions at market tops and largest net-short positions at market bottoms. Control roughly 30-40% of open interest.
Net Long/Short positions: This is a simple calculation that gives us a better idea if – overall – a group of investors are buying or selling the market. The calculation is derived by subtracting the total number of contracts purchased minus the total number of contracts sold in a set time frame. If the number is positive, investors in this group are bullish on the market, and if the number is negative investors in this group are bearish on the market.
Commercials: An entity involved in the production, processing, or merchandising of a commodity. (According to the Commodity Futures Trading Commission). Also known as commercial hedgers; these players are users of the commodity. For example, if Nestle (a commercial) buys sugar, they actually plan on taking delivery of the product and using it to make some chocolate bars. These players know the markets better than anybody because it is their business, they are seldom wrong, and their actions (buying or selling) are often responsible for starting new trends in the market place.
Control roughly 50-60% of open interest.
KNOWLEDGE = POWER
If you are confused, do not worry, I was too when I started studying the COT report. It takes a little bit of time before you start making sense of it all. Still, the best way to learn - in my personal experience - is to chart COT data from various time frames and to compare them to market price charts in the same time frame.
If you are still totally confused about the COT report, just keep this in mind:
Yellow line rising (commercial buying) = GOOD* for market
Yellow line declining (commercial selling) = BAD* for market
*GOOD means market is setup to go up; BAD means market is setup to go down. But just because the market is setup to rise or decline does not necessarily mean it will do so the next day, it may take a month or two or more until the move begins!
Here we go! The much awaited crash of 1987
January to February of 1987
Commercial players (yellow line) are buyers of this market (S&P 500). In the month of January their net long position stood at approximately 17 000 contracts. In late February the yellow line dips to roughly 10 000 contracts. So while the market is rallying from January to late February, and commercials are still buyers of this market, they are less-bullish on the market in February relative to January. In other words, selling pressure amongst commercials has been increasing. This should raise a caution flag to anyone reading the COT report in early 1987. While the market is still rallying, and the overall trend is up, it would be advisable to commit a little less money to the market than usual and tighten up on your stops; oh and of course, look for the next month’s COT report release for more clues.
March of 1987
From 10,000 contracts in February, the commercial net long position rises to 20,000 contracts by mid-March. Okay, this is interesting. From January through March, the S&P 500 index has been in a steady uptrend. However, it is very unusual for commercials to be buyers in an uptrend. Commercials like to buy – relatively speaking – at low prices, and sell – again, relatively speaking – at high prices. So here we are in an uptrend and commercials are buyers. This unusual behavior is considered very positive (bullish) for the market. The large traders or trend followers (blue line) are, until now, neutral on the market. (A bullish sign as well)
April of 1987
From 20,000 contracts, the commercials drop to a new low in April of 5,000 contracts net long, and then drop even further by the April’s end to 2,000 contracts net long. For whatever reason, the commercials were buyers in March relative to February, but are now sellers in April relative to March. This indecisiveness on the commercial’s part is a good reason for investors to stay in cash and for traders to make small bets with very tight stops. If there is one silver lining to all of this, it is that large traders are still neutral on the market. Could the market be topping here? We will have to wait for more COT data to find out!
May to June of 1987
Commercial net long position rebounds from a low of 2,000 in April to a high of 11,000 in mid-May. And in June it is still much of the same, commercials are net long 11,000 contracts in early part of that month, but then drop to 4,000 contracts by June’s end. In fact, if you look at the commercial net longs (yellow line) thus far from January to May, it is slowly but surely declining, meaning that in the big picture commercials are getting out of this market. While at the same time, the price action on the S&P 500 is going no where. It is stuck in a slightly bearish trading range. (2 light-blue parallel lines). And finally we see some commitment on the part of large traders, notice the spike in the blue line at the very end of June. This means that the trend followers are finally waking to the rising prices in the S&P 500 and they want a piece of the action. This probably means anymore upside in the S&P 500 is limited. So is the top finally here? We will need more COT data to find out, but so far it’s looking rather bearish.
July of 1987
Hallelujah! Commercials net long position rises from 4,000 contracts in June to 15,000 contracts in mid-July. Wow, wail till you see what happens next, by the end of July commercials are net long 23,500 contracts in the S&P 500; their largest net long position thus far in all of 1987. And look at the large traders; they are selling out of this market! Not only that, but commercials are buying in an uptrend. Again, this is unusual action, but is considered very bullish. For whatever reason, commercials are heavy buyers in the market. The green check mark represents the pivot point, from a potential top to a renewed buying interest in the S&P 500. Make note of the green vertical arrow as well. This is a good example of what I mean when I say the markets get setup by the commercials ahead of the move itself. Even though commercials were buyers in July, it took another month until you saw in a significant rally in August. (Yellow arrow) As soon as a savvy investor saw that spike in commercial buying interest in the month of July, there is only one thing to do, and nobody screams it out like Cramer; ‘BUY BUY BUY!’
August of 1987
Is this market for real? A new high in commercial net long positions followed just as quickly by a new low in commercial net long positions?! As commercials are selling like no tomorrow, the S&P 500 is hitting all time highs. Also notice the red down trend-line; if you ignore the July spike in commercial buying for just a second, the yellow line is trending down once again confirming that commercials are getting out of this market and that the spike in buying interest was nothing but a one night stand. This is critical to understand: if commercials are net long in July, but then they turn net sellers in August, this is a BIG RED FLAG. It tells investors to move onto the sidelines and for traders to get ready to short. But what if commercials became aggressive buyers in September? What if they went net long 30,000 contracts?? That would be an even BIGGER GREEN FLAG, telling investors to get back into the market until the COT report tells you otherwise. (This was not the case, however, only a hypothetical scenario).
Is this finally the top? So far, it sure looks like one.
September of 1987
In this month commercials are net long -5,000 from a previous net long position of -4,000 in the month of August. (Negative net long simply means that there are more commercial sellers relative to commercial buyers). Meanwhile, the large traders or trend followers are, for the first time in 1987, have a positive net long position in the market of 500 contracts in late-September. (This is bearish) Any sane investor or trader analyzing the COT report should NOT have been initiating any new long positions in the market from August to September. Looking to short the market would be advisable.
October of 1987
The S&P 500 declines over 29% in 4 short days. The extent of the decline was unexpected, but the decline itself was foretold by the COT report. Is there anyway to foretell a market crash like this one? There is actually; click below to find out more about the Hindenburg Omen. http://www.financialsense.com/fsu/editorials/mchugh/2006/0410.html
November to December of 1987
The market crashed, RUN!!! Or, look at the COT data instead: hmm, will you look at those commercials! They are quietly buying into the market when the media is shouting ‘Armageddon!’
What happened after 1987?
After the 1987 crash, which marked a long term bottom in the stock markets, large traders were sellers (in anticipation of lower price), small traders were sellers (also anticipating lower prices), and - you guessed it - commercials were buyers (anticipating higher prices). In the next year or so (from the start of 1988) the S&P 500 index went up to retrace all of its losses from the 1987 crash and went on even higher, much higher.
This happens time and time again, and will continue to occur simply because of the characteristics and fundamental nature of these players and their views of the markets.
Next Week. . .
We will look at the COT reports for the broad indexes TODAY, and see if we can find any clues as to where the market is headed next. What is even more interesting is that we got a confirmed Hindenburg Omen in April. ( http://www.financialsense.com/fsu/editorials/mchugh/2006/0410.html ) In short, the Hindenburg Omen has pretty much, signaled –ahead of time - all the big market crashes and significant declines in history.
http://www.financialsense.com/fsu/editorials/west/2006/0506.html
1) Investopedia.com. "Commitments of Traders Report - COT." http://www.investopedia.com/terms/c/cot.asp. Investopedia Inc (May 04, 2006).
The April 2006 Hindenburg Omen Has Now Been Confirmed
by Robert McHugh
April 23, 2006
There have only been 24 confirmed Hindenburg Omen events over the past 21 years, and it could be argued there were only 21 as there have been three declines tied to a pair of Omens a few months apart.In each instance, a sharp decline followed within 1 to 4 months; some were crashes. While April 2004's decline was mild if measuring the post 30 days, the actual decline lasted half a year, albeit choppy, and led to an 820 point, 7.8 percent decline from April to October 2004. Call it a kickoff to a mini Bear market. The point is, these are rare, and usually reliable forecasters of meaningful declines. We show them pictorially this weekend with red arrows designating when the H.O. cluster began. Yellow arrows show the subsequent damage. In all instances when the confirmed Hindenburg Omen occurred, at the very least we got a sideways interruption to the prior rally trend. In no instances did a rally ignore the Omen and keep going without at least a small sideways pause.
Further, there was not one major decline (over 10 percent) that did not first have a Hindenburg Omen present to give an early warning. We were warned every time there was a crash, or multi-month plunge, of the higher-than-normal probability of one coming, through the presence of a Hindenburg Omen.
Well, once again we have one on the clock, right now, April 2005. Since April 7th, when we observed the first one, there have been three official confirming Omens, so we now sit with four. There actually have been two more that met the old definition that many analysts followed, but just missed under our stricter requirements that we established to improve the correlation with declines (see issue 305 in our archives for that definition). Of the five criteria, these last two missed only because New Highs were more than twice New Lows. Sometimes that situation leads to false positives, so we eliminate them. But, we still have four, so this Hindenburg Omen is now confirmed.
You can go to www.technicalindicatorindex.com and click on the Guest Articles button to get a more in-depth discussion of the criteria for a Hindenburg Omen and the theory on why it works. Let's recap what this means as far as probabilities of decline:
If we define a crash as a 15% decline, of the 23 previous confirmed Hindenburg Omen signals, six (26.1 percent ) were followed by financial system threatening, life-as-we-know-it threatening stock market crashes. Three (13.0 percent) more were followed by stock market selling panics (10% to 14.9% declines). Three more (13.0 percent) resulted in sharp declines (8% to 9.9% drops). Five (21.7 percent) were followed by meaningful declines (5% to 7.9%), four (17.4 percent) saw mild declines (2.0%to 4.9%), and two (8.6 percent) were failures, with subsequent declines of 2.0% or less. Put another way, there is a greater than 25 percent probability that a stock market crash -- the big one -- will occur after we get a confirmed (more than one in a cluster) Hindenburg Omen. There is a 39 percent probability that at least a panic or crash sell-off will occur. There is a 52 percent probability that a sharp decline greater than 8.0 % will occur, and there is a 73.8 percent probability that a stock market decline of at least 5 percent will occur. Only one out of roughly 11.5 times will this signal fail. All the biggies over the past 21 years were identified by this signal (as defined with our five conditions). It was present and accounted for a few weeks before the stock market crash of 1987, was there three trading days before the mini crash panic of October 1989, showed up at the start of the 1990 recession, warned about trouble a few weeks prior to the L.T.C.M and Asian crises of 1998, announced that all was not right with the world after Y2K, telling us early 2000 was going to see a precipitous decline. The Hindenburg Omen gave us a three month heads-up on 9/11, and told us we would see panic selling into an October 2002 low.
Here's the data:
Date of first
Hindenburg
Omen Signal # of Signals
In Cluster DJIA
Subsequent
% Decline Time Until
Decline
Bottomed
4/7/2006 4 ? ?
9/21/2005 (1) 5 2.2% 22 days
4/13/2004 (2) 5 5.4% 30 days
6/20/2002 5 15.8% 30 days
23.9% 112 days
6/20/2001 2 25.5% 93 days
3/12/2001 4 11.4% 11 days
9/15/2000 9 12.4% 33 days
7/26/2000 3 9.0% 83 days
1/24/2000 6 16.4% 44 days
6/15/1999 2 6.7% 122 days
12/22/1998 (3) 2 0.2% 1 day
7/21/1998 (4) 1 19.7% 41 days
12/11/1997 11 5.8% 32 days
6/12/1996 3 8.8% 34 days
10/09/1995 6 1.7% 1 day
9/19/1994 7 8.2% 65 days
1/25/1994 14 9.6% 69 days
11/03/1993 3 2.1% 2 days
12/02/1991 9 3.5% 7 days
6/27/1990 17 16.3% 91 days
11/01/1989 36 5.0% 91 days
10/11/1989 2 10.0% 5 days
9/14/1987 5 38.2% 36 days
7/14/1986 9 3.6% 21 days
(1) In September 2005, the Fed pumped $148 billion in liquidity from the first week in September, just before the Hindenburg Omens were generated - to the third week of October, an 11 percent annual rate of growth in M-3 (2.5 times the rate of GDP growth and 5 times the reported inflation rate), to stave off a crash. The liquidity held the market to a 2.2 percent decline from the initiation of the signal.
(2) In April 2004, the Fed pumped $155 billion in liquidity from the last week in April - right after the Hindenburg Omens were generated - to the third week of May, a 22 percent annual rate of growth in M-3, to stave off a crash. Even with the liquidity, the market still fell 5.0 percent.
(3) The 12/23/1998 signal barely qualified, as the McClellan Oscillator was barely negative at -9, and New Highs were nearly double New Lows. Had this weak signal not occurred, condition # 5 would not have been met. This skin-of-the-teeth confirmation may be why it failed. It says something for having multiple, strong confirming signals.
(4) This signal came close to having two confirming signals, which may be why as a non-cluster signal, it produced a strong sell-off.
Another point to make here is that the actual stock market declines are often greater than the measures in the prior data chart. That's because oftentimes the decline from a top has already occurred before the Hindenburg Omens have been generated. These percent declines are only measuring the declines from the first Omen in a cluster. If we measured declines from the tops, it would be worse in many cases. For example, the September 2005 signals came after the September 12th high of 10,701. The autumn decline of 2005 into October 13th, 2005 bottom ended up being 545 points (5 percent) even with all the liquidity pumping by the Fed.
Here's something interesting: Oftentimes equities will rally after a Hindenburg Omen occurs, faking folks out, then the plunge comes on the other side of the hilltop. 1987 is a perfect example of that. We are also seeing that now.
As of April 21st, 2006, here are the details for the cluster of confirmed signals (4 so far) that meet all five of the conditions required for a potential stock market crash warning:
April 7th, 2006: The figures were 3,435 total issues traded on the NYSE Wednesday, with 167 New 52 Week Highs and 103 New 52 Week Lows. The common number of new highs and lows is 103, which is 3.00 percent of total issues traded, above the minimum threshold of 2.2 percent. The McClellan Oscillator came in at negative -120.43, and the 10 week NYSE was rising. New highs were not more than double new lows.
April 10th, 2006: The figures were 3,463 total issues traded on the NYSE Wednesday, with 86 New 52 Week Highs and 104 New 52 Week Lows. The common number of new highs and lows is 86, which is 2.48 percent of total issues traded, above the minimum threshold of 2.2 percent. The McClellan Oscillator came in at negative -135.71, and the 10 week NYSE was rising. New highs were not more than double new lows.
April 17th, 2006: There were 3,440 issues traded on the NYSE Monday, with 113 New 52 Week Highs and a rising 190 New 52 Week Lows. The common number of new highs and lows is 113, which is 3.28 percent of total issues traded. The McClellan Oscillator came in at negative -163.12, and the 10 week NYSE Moving Average is rising. New Highs were not more than double new lows.
April 18th, 2006 (Occurred during a mega 200 point rally, believe it or not): While The Wall Street Journal, our preferred data source, showed New Highs slightly more than twice New Lows, other services we follow count NYSE New Highs as not being more than twice New Lows. The McClellan Oscillator was negative, at minus -47.65, WSJ NYSE New Highs were 278 and New Lows were 131, the lowest common amount being 131, which is more than the 2.2 percent of total issues minimum requirement, at 3.8 percent of 3,446 issues. And, the 10 week moving average for the NYSE is rising.
Warning: Do not go short the farm! We now have to factor in that the Fed is pumping liquidity to prevent crashes once these signals occur. And now that they have hidden M-3, we cannot even monitor how much liquidity they are supplying to the Plunge Protection Team. So you do not want to go short the farm. You may want to think about taking prudent precautionary action according to your investment advisor given the much higher-than-normal odds of a crash. That may not mean shorting. It may mean increasing cash positions or hitting the sidelines for a while. Or it may mean a carefully constructed shorting strategy developed with your advisor, that limits losses, and invests only the amount which you can fully afford to lose.
* * *
http://www.safehaven.com/article-5019.htm
Global Contagion
by Joseph Russo
April 16, 2006
TECHNICAL ANALYSIS
All of the charts presented are in nominal terms using classic tenets of Elliott Wave Theory. The analysis reflects both the nature and maturity of wave structures as interpreted by the author.
Our technical contribution and comprehensive subscription service is designed to assist traders, investors, and portfolio managers in navigating many of the unique technical conditions surrounding current market patterns around the globe.
The one tenet of Elliott Wave Theory that surfaces time and again in our “contagion” analysis is that of the fifth wave extension at intermediate degree or higher.
The propensity for fifth waves to extend has been quite rare in recent decades. Back in the late 1800’s through the late 1930’s, there appears to be sufficient evidence that stocks tended to stretch their final runs.
It also seems to have been Elliott’s general preference to anticipate that the fifth wave of an impulsive advance would often pack the biggest punch by way of “stretching” or “extending.”
From the ‘40’s through the 80’s this has not generally been the case. Today, it is more common to anticipate that it will be the “third” wave and not the fifth that holds the higher probability of extending the stock indices.
Given the price action across a broad array of global equity indices, it is difficult for us NOT to consider the probability that extended fifth waves are currently under way.
Just how far along they are in development remains somewhat elusive. In some markets, the extensions appear ripe for termination at any moment, while others display clear evidence of more room to run.
Monitoring the unfolding of such extensions is quite challenging due to the perplexity and multitude of sub-divisions required to complete the sequence.
As always, the larger periods are dominant, and what may count out as a satisfactory sequence of completion on a daily chart may well end up disappearing into the larger time frames subsuming rendition of the pattern in force.
The probable cause of its development may reside under the auspices and repetition of exponentially larger and larger injections of global liquidity at numerous junctures of crisis spanning 10-20 years or more.
Below is an idealized extended Intermediate Degree (5) terminal:
The following pattern example is a more realistic representation of how an extended (5) of Intermediate Degree may unfold in real time:
Now it is time to explore some of the recent Global Contagion in real time.
AUSTRALIA
A Glimpse of the Top from Down Under
Since the 2004 wave (4) print low in 2003, the ASX has gracefully ascended with fewer and fewer pullbacks in five waves of Minor Degree; marching straight toward the top of its trend channel.
BRAZIL
Perpetual Carnival since late 2002
Of interest regarding the Bovespa, is the prospect for the currently topping Intermediate (5) to be terminating only that of Primary “3”.
INDIA
Forever Rising in the East
India continues to display a relentless advance- virtually absent of any meaningful corrections since 2005. The fifth wave extending in the BSE appears to be one of Minor Degree. The completion of Minor x5 will mark an extended Intermediate (3) terminal. Note the smaller narrow trend channels drawn from the 2005 lows. Price has climbed near the top of this trend channel and has already begun to descend.
MEXICO
That GIANT SUCKING SOUND seems to have bred one heck of a Bull Market for Mexico
After kicking and clawing its way through Intermediate (4) and Minor 4, the Bolsa has done nothing but ascend in stellar fashion since the 2002 low marking Minute ‘2’. Of immediate concern are the two divergences occurring against the ’06 all time highs in both the RSI and ROC. Note the two key power up trend lines in light gray and blue. Should they both hold- the top of the trend channel remains very much in play.
RUSSIA
RED BULL …. A bull like no other!
We will let the chart of the RTSI speak for itself.
Commntary in Full
http://www.financialsense.com/fsu/editorials/russo/2006/0416.html
The Phantom Cartel Part I
by Mark Taylor
February 26, 2006
The suppression of gold prices began when? I read one story that it began in August 1993 with an anomalous occurrence in prices. Another article claims the price suppression began in early 1996 in response to prices rising above $400. To advance this theory there must be an identified perpetrator. Central Banks, Bullion Banks, and various Commercial Traders operating out of the COMEX gold market are accused of this alleged manipulation and suppression. I say operating out of COMEX because every time gold suffers an intraday loss of $5-10, the conspiracy theorists yell "the Commercials are at it again". I don't know how many times I've read how blatant their operations have been in the COMEX market over the past few years.
Fortunately the CFTC keeps a very in-depth record of all traders in the futures markets and categorizes them. The categories are as follows; Non-Commercial, Commercial, and Non-Reportable. The two that most heavily influence the market are the Non- Commercial and Commercial participants. However as this study moves forward, we will see that the Non-Reportable Traders play a significant role in price movements as well. The CTFC has documented the positions held by all market participants since the beginning of 1986. The complete record can be found at the following website Historical Commitments of Traders Reports by Year and can be easily downloaded. These records, and a long term gold chart (this type of chart works best because of the price scrolling feature) Barchart.com - Charts - GCY0 GOLD Cash COMEX will be needed to verify many of the comments I make in this study.
We will begin with the claim that the price suppression began in 1993. The particular study that I refer to proposes that price anomalies occurred on 5/1-5/3 in 2004. Simply stated, the selling occurred at the same time each day and that was the reason to suspect manipulation. It was then proposed (by using a given set of intraday prices) that the price suppression could be pin pointed to an exact day of commencement, August 5, 1993. It was also concluded that the price suppression was, and continues to be concentrated in the COMEX market.
As mentioned earlier, it is without question (among all conspiracy theorists) that this manipulation of prices is being conducted from within the group of market participants known as the Commercials. With this in mind, we will go back in time ourselves and see what really happened in 1993 and what group or groups of traders caused it.
We will need to look at the COT data from 3/19/93- 10/19/93 and a long term chart of gold. Before beginning, I would suggest that the historical COT data be viewed in Excel as it is easier to read. It is important that the data we look at is separated properly so I will lead you to the statistics in question. In Excel format, vertical line H = Total Open Interest, I=Non-Commercial long positions, J=Non-Commercial short positions, K=Non- Commercial spreading, L=Commercial long positions, M=Commercial short positions, N=Total Reportable (Non-Commercial and Commercial combined) Short positions, O=Total Reportable long positions, P=Non-Reportable (Small traders) long positions, and finally, Q=Non-Reportable short positions.
The reason we want to look at data from March 1993-October 1993 is because that is when the rise in prices from a trough low began, a peak in prices occurred, and another trough low was found. Before we look at the data in question, let's see what was going on prior to this time. Looking at the Non-Commercial positions, it is clear during the 27 weeks leading up to the March '93 low, Non-Commercial traders were net short sellers of gold. On the other hand, the Commercials were net long buyers of gold. Suddenly during the COT reporting period of 3/16/93 (which coincides with the rise in prices) the Non- Commercials began to go long and buy gold, by the end of the next week they were net long buyers. They continued to be buyers until the 8/3/93 reporting period when they had added an astounding 77,066 long contracts their previous low of just 5,010 long contracts in March. The Small Traders were doing the same thing; they had added an incredible 50,171 long contracts. That is the anomaly, two separate groups in a market adding 127,237 long contracts to what was a net short position just 21 weeks earlier. It was this move from being net short to becoming record breaking long buyers that drove the price up from $326 to $409. The peak in prices did occur at the same time the Non- Commercial and Small traders had stopped buying. All the while, the Commercials were simply accommodating the buying by offering to sell physical gold. They moved from being net long purchasers of gold to being massive sellers. The old buy low and sell high trick? How dare they?
Now we have reached the pinnacle in buying and the coinciding price appreciation of the reporting period 8/3/93. During the next COT reporting period (8/10/93) prices began to fall sharply and it is in this reporting period, which the supposed suppression of prices began. The Commercials were to have caused this price decline, but how could they have? In order for them to change the trend, they would have had to do just the opposite of what they had been doing. Since they were massive sellers of gold for 21 weeks, the opposite play would to become massive buyers. This however would have driven prices even higher. With their massive short positions, the only thing they could have possibly done was to begin covering those positions, but this move results in what is called a short squeeze, which also causes prices to rise. The Commercials are running out of options here but there is a couple left. One is to continue adding to their short positions and sell more gold; the other is to convince the small segment of Commercial longs to sell out of their positions. The COT data from 8/10/93 argues conclusively that neither was the case. The fact is, in less than 5 days, the Commercials decreased their short positions by 34,132 contracts and increased their long positions by 14,554 contracts. Hey wait a minute; they increased their long positions by 14,554 contracts? We'll get back to this a little later. Ok, we'll have to look elsewhere to find the culprits behind the price decrease that occurred. Since there are only two other groups in the market this won't take long at all. The COT data is incontrovertible; the reversal of price trend was caused by a massive move to sell out of long positions held by both the Non-Commercial and Small traders. During the reporting period of 8/10/93 the Non-Commercial traders dumped 26,351 long contracts while the Small Traders ran from 18,915 of their long contracts. That is 45,266 long positions liquidated in less than five days. The COT data from 8/10/93-10/5/93 also reveals that it was the same two groups of traders that continued to liquidate long positions. By the time these traders were finished selling, (nine weeks later) they had liquidated 88, 322 long positions.
It can only be concluded that the entire price move from $326 to $409 was a direct result of massive speculative buying on the part two groups of traders. The quick fall in prices from $409 to $341 was just as well, a result of these traders' actions in that they reversed their operations to the sell side in a historically rapid manner.
We are not quite finished here; remember when the Commercials were supposed to make their move in an effort to crash the price of gold? If that were their intent, why did they start buying into long positions the very week that the price began to fall. As a matter of record, they did a lot of buying when they should have been selling if they wanted lower prices. While the price of gold fell for six weeks, the Commercials added 43,016 long contracts while trimming 52,157 short contracts. I don't know about you, but if it were my intent to cause gold prices to fall, I sure wouldn't go into the market and buy 4,301,600 ounces of gold while the price is falling. I also would not have accumulated such a large short position in the first place knowing that a short squeeze would cause the price to rise even higher.
So why do the Commercials take on such massive short positions knowing that an exit from those positions will either cause higher prices or help to put a floor under a falling price? The answer will be found in part 2 of The Phantom Cartel.
Mark Taylor aka Zorro
dowtheoryproject.com
http://www.safehaven.com/showarticle.cfm?id=4679
Is the US following Japan's Path?
by Steve Saville
April 04, 2006
Below is an extract from a commentary originally posted at www.speculative-investor.com on 30th March 2006.
Those who argue that the US cannot avoid a deflationary outcome will often support their case by pointing to the experience of Japan during the 1990s. The Japanese monetary authorities, so the story goes, were unable to prevent the slide into deflation despite their concerted efforts to promote inflation.
The first thing we'll note is that Japan didn't actually experience deflation during the 1990s. The following chart shows that although Japan's year-over-year M2 growth rate plummeted following the bursting of the stock market bubble, apart from a slight dip below zero during the second half of 1992 the money supply continued to expand (albeit at a very slow rate). Since deflation is a contraction in the total supply of money it therefore doesn't make sense to cite the Japanese experience of the 1990s as an example of how deflation cannot be voided once a credit-induced asset price bubble bursts. It is true, however, that over the past 50 years Japan has come closer to genuine deflation than any other major economy.
Japan is actually a good example of how deflation CAN be avoided under the current monetary system even in the face of collapsing stock and real estate bubbles. However, it's one thing to avoid outright deflation and another thing entirely to keep inflation going at the rate desired by the authorities. Using the above chart it could be argued, for instance, that the Bank of Japan (BOJ) might have avoided deflation but it proved to be incapable of generating any significant inflation after the boom turned into a bust.
Our view is that the BOJ and Japan's Ministry of Finance had the power to do a lot more to promote inflation than they actually did. For example, throughout the 1990s the Japanese banking system laboured under the weight of massive non-performing loans. Had this non-performing loan crisis been 'handled' in the same way that the "Savings and Loan Crisis" of the 1980s was handled in the US, that is, had there been some form of government bail-out of the banks using newly-printed Yen, Japan's inflation rate would have been considerably higher.
The Japanese monetary authorities were, we think, hamstrung by the incredibly high savings rate of the voting public. To be specific, when a large chunk of the public's savings are held in the form of cash and income-producing securities a monetary policy that significantly lowers the value of the currency will probably not be popular, especially when it is clear that the currency is being devalued as part of a plan to 'paper over' the lending mistakes of large banks.
The US Federal Reserve obviously isn't operating under the same political constraints as the BOJ because the average member of the US voting public has very little savings and is up to his/her eyeballs in debt. Also, there might have been a better chance of the US following Japan's path if Japan had never followed this path in the first place. That is, the Fed has fewer restrictions on its ability to inflate as well as the luxury of being able to learn from the BOJ's post-bubble experiences.
At this point it's important to note two things. First, although people with lots of debt and no savings will generally prefer inflation, keeping the voting public happy between now and the next election is not the only, or even the main, reason why more inflation is in store for the US over the next several years. The main reason is simply that the current system could not survive a period of deflation. It's a giant Ponzi Scheme, which means that the supply of money MUST continue to expand or the system will collapse. Second, inflation doesn't make anything better. It can create the illusion of prosperity for a while, but the misdirection of investment that it causes always leads to slower real growth (which, ironically, provides the excuse for the central bank to facilitate more inflation).
Lastly, we find it both interesting and strange that the "Fed won't be able to stop deflation in the US for the same reasons that the BOJ couldn't stop it in Japan" argument continues to pop up even though there is now a lot of empirical evidence that the US is following a very different path to the one followed by Japan during the 1990s. In particular, whereas the money-supply growth rate in Japan 'fell off a cliff' shortly after the bursting of the stock market bubble, in the US the year-over-year M2 growth rate rocketed to a 20-year high during the first two post-bubble years and averaged around 7%/year during the first four post-bubble years (refer to the following chart for details). The rate of monetary growth has subsequently slowed, but only because the Fed has taken its foot off the monetary gas pedal in response to the resounding success of its preceding efforts to inflate.
Steve Saville
Hong Kong
Regular financial market forecasts and analyses are provided at our web site: http://www.speculative-investor.com/new/index.html.
http://www.safehaven.com/article-4908.htm
Weekly Wrap-up: Risk and the 4-Year Cycle
by Adam Oliensis
April 03, 2006
The following article was originally posted at The Agile Trader on Sunday, April 2, 2006.
Dear Speculators,
The Dynamic Trading System did not close any trades this past week so it has no realized gains or losses to report. The System has two open positions, which we will continue to update in our daily Morning Call and Afternoon Note.
In this space we have recently been discussing the 4-Year Cycle on the SPX. And this week I'd like to go into some detail on that cycle and why, for now, we remain bearish, though not aggressively so, for the period between now and October.
Let's start with a logarithmically scaled chart of the SPX that dates back to 1962.
* The dashed blue verticals represent the start of each 4-Year Cycle.
* The yellow highlights represent points at which the SPX had not corrected by more than -3.1% off its 3-month high for a period of 90 trading days or more.
As you can see, such periods are rare (less than 5% of the time), though we are in one such period now. In general such periods augur near-term bearish for the SPX, though there are some exceptions. Those exceptions, though, (in the early '60s and in 1995) exist historically primarily in the 1st year of the 4-Yr Cycle and exclusively in the 1st half of the cycle.
During the past 44 years there is no precedent for the market's refusing to retrench during the 4th year of the cycle, and the latest prior onset of such a retrenchment was in February of the 4th year, where we are now all the way into April of the 4th year of this cycle without having suffered one.
Note: in 1994 the SPX was able to move up +5% after going uncorrected for 90 trading days. However that 5% was subsequently sharply corrected (and then some) before the SPX launched into the great bull market of the latter '90s.
Conclusion? Though there is a low-probability "exception" scenario (ala 1994), we are likely overdue for a sell-off.
So, why doesn't it feel like it? For our long-time readers, I'd like to remind you of our discussion of the human tendency toward complacency at the statistically least opportune times, and for those of you who are new to our work...
Here's an example that illustrates the general point:
Let's say there's a statistically unlikely event that takes place 1% of the time, which is to say on 1% of the opportunities for it to happen. So, suppose, just for argument's sake, that if you go for a walk in New York City, 1% of the time you will get hit by a bus. (Obviously this is a greater chance of disaster than there is in reality, but we're just trying to understand something about how risk works, statistically speaking, over time.)
So, if you go out for a walk 1 time, you have a 99% chance of not getting hit and a 1% chance of getting squashed. But suppose you go out for 1 walk every day for 10 days. The chance that you will get hit on 1 of those occasions rises. And the way it's calculated is by figuring the odds that the LIKELY event will obtain at every single iteration and then subtracting that from 100%. The equation is:
D = 1-(1-P)^N
Where
D=cumulative percentage chance of disaster
P= Percentage Chance of disaster on each opportunity (iteration)
N=number of iterations
So, if you go out for 10 walks, your chance of getting turned into chopped meat is
1-(1-.01)^10 = 9.6%.
And if you go out for a walk every day for, say, 90 days, your chance of getting obliterated is
1-(1-.01)^90 = 59.5%.
Here's what the series looks like.
And in this scenario, if you go out for a walk every trading day of the year (about 252 times) the odds are about 92% that you will meet your demise.
But the funny thing about our human nature is that if, say, you went out for 252 walks in New York City and came back 252 times, without having had any violent encounters with city vehicles, you would assume that experience was teaching you that there was very little danger. (And indeed it might be, if you didn't already know the likelihood of getting run over.)
As human beings we are especially primed to generalize from experience (that's science) but most especially to generalize from our most recent experiences (which is less reliable science--or anecdotal evidence). So, the more walks we go on without getting pulverized the less likely we FEEL it to be that we will ever get pulverized, irrespective of what statistics might tell us. As our risk increases, statistically speaking, we feel safer and safer.
We are all familiar with the expression "tempting fate." One has to wonder if our savings-short, consumer-spending-driven, mortgaged-to-the-gills, trade-deficit-heavy, job-exporting economy isn't doing just that. That is, it's worth considering that we might be somewhere fairly far along on the curve charted above, feeling safer and safer carrying all these economic loads, but with an ever greater and greater chance developing of the incidence of one or another severe, "dislocating," and "unlikely" events.
**** **** ****
OK, now that our shoulders are up around our earlobes and we're all terrified of getting run over by a bus...or by the stock market... let's look at the range of likely magnitudes for what we anticipate will be a corrective period in the SPX.
For a variety of reasons we continue to expect a relatively benign 4-year low to be made in 2H06. (Our definition of benign in this context is a retrenchment of less than 20%.) And here is a weekly chart showing one set of our reasons for holding this view...there's a lot going on here, so let's dig in:
* Top Pane: SPX on a log scale.
* 2 nd Pane: PE on Forward 52-Week EPS. Prior to 1994 we use the PE on actual Forward EPS. From 1994 forward we use PE on the F52W EPS Consensus.
* 3 rd Pane: Forward 52-Week Performance of the SPX.
* Red highlights: Points at which both 1) the PE was below 15.1 (now 15.0) and 2) the lowest weekly close during the subsequent year was down 20% or more from the then-current SPX weekly close.
Let's repeat that last one just to get it straight. The red highlights appear when 2 conditions obtain simultaneously: 1) the PE is below 15.1 and 2) the SPX will suffer a weekly closing low, down 20% or more during the subsequent year.
Of the 4,134 weeks studied here 185 show red highlights. And 119 of those came by 1946. So, all told, red highlights have shown up about 4.5% of the time, and since 1946 red highlights have appeared just 2.2% of the time. (New red highlight is unlikely.)
So, unless we have a Great Depression, a World War, or Runaway Inflation (as per the fat red stripe in the middle of the chart in the mid '70s) the odds of a drop of more than 20% from current levels look pretty darn slim.
Here are some other fun facts that we discovered using this study:
* The F52W PE has been < 15.1 at 52% of weekly closes.
* When the PE is < 15.1, the market has closed higher a year later 76% of the time.
* When the PE is >=15.1 the market has closed higher a year later only 56% of the time. (PE does matter.)
As for why the correction is likely to be relatively modest by 4-Yr Cycle Low standards, let's look at some macroeconomic data.
This chart plots Q/Q Annualized Nominal Gross Domestic Product Growth (dashed purple line), the 4-Yr Average GDP Growth Rate (thick purple line), and 1 Standard Deviation from the 4-Yr Average (blue line). (The blue line represents the value of 1SD, it's not measuring 1SD from the purple line.)
What we see on this chart is that Nominal GDP is growing at a solid rate and that, after the dip in 2001 the non-volatile trend has been resumed. What's remarkable is that GDP continues to grow, that inflation remains low by recent historical standards, and that the volatility of growth remains so low as well.
The 4-year average for Nominal GDP is above 5% with 1 Standard Deviation at 1.8% (meaning that about 68% of the time GDP has come in between 6.8% and 3.2%). Strong growth, low volatility of growth, and low inflation are what make up the "Goldilocks" economy. But the question is, what has allowed for this improvement. And one answer, (over and above New Technology, Increased Productivity, REFI Cashouts, and Fiscal Stimulus) is Money Supply.
This chart shows the 13-Week Annualized Growth of M3 , the broadest measure of Money Supply (blue line), and the 50-Wk Average of that 13-Wk Growth (black line).
What stands out to me is how volatility in M3 rose sharply in the '90s, stayed high through the bear market and may now be declining. So, as the volatility of GDP has stayed low the Money Supply has been tinkered with, counter-cyclically, like "shock absorbers," increasing the volatility of M3 in order to "smooth the ride" in the GDP numbers.
At this point the trend in M3 growth is very close to its long-term median, despite the alarmist writings of perma bears. And the Fed is ceasing to publish this data (which is a damn shame)...but one can well imagine that the extreme volatility on this chart is both a) embarrassing to monetary authorities and b) very difficult to interpret in real time. So, while speculation is rampant as to why this data will now disappear from public view, its volatility suggests that the Fed has been extra-active in managing the supply of money, and perhaps susceptible to the charge of being too aggressively interventionist.
**** **** ****
EARNINGS AND VALUATION
We continue to be concerned with the deteriorating trend in EPS estimates. The growth rate of the F52W EPS (blue line below) has shrunk to +13.3%. And while that's still fairly robust, the 3-month annualized rate of growth of the Consensus (red line below) is down at +5.6% and leading the blue line lower.
Once that blue line drops below +10% the market is likely to struggle, as per the yellow highlighted areas on this chart.
Our Risk Adjusted Fair Value target is below the SPX price for the first time since mid '04.
We derive this target using this equation:
F52W EPS / (TNX + Med ERP)
Where
F52W EPS = Forward 52-Week EPS ($86.47)
TNX = 10-Yr Treasury Yield (4.853%)
ERP = SPX Earnings Yield - TNX (6.68% - 4.8535% = 1.83%%)
Med ERP = Median Post-9/11 ERP (1.95%)
$86.47 / (0.04853+ 0.0195) = 1271
**** **** ****
Summing all this up...the odds favor a correction on the SPX of more than 5% but less than 20% between now and October. Beyond that, it would appear likely that the index will make a higher high by the spring of '07, if not before.
In our daily issue of the Morning Call we'll examine the technical charts on the leading and lagging indices this coming week, as we seek confirmations and divergences on the major market indices. If you'd like a free, no risk 1-month trial to our daily work, please join us at The Agile Trader. And if you're interested in auto-trading futures based on our Dynamic Trading System (model portfolio has netted +393% in realized position gains since July '05), click on The Agile Trader Index Futures Service to read more about our service and to subscribe.
Best regards and good trading!
Adam Oliensis,
Editor The Agile Trader
http://www.safehaven.com/article-4903.htm
Experience
by Joe Ross - Jan 16, 2006
Throughout our course on futures trading, we have tried to point out to you that there is a great difference between having an investor attitude and being a trader. There are also many similarities. In one sense, a trader is someone who invests in his own trading ability. Therefore, in that sense trading is investing. Trading and investing are interrelated. You come to realize this through experience.
For the most part, the trading approach comes from a much shorter- term mindset than the mindset of an investor. It can also be much more based on technical information than on fundamental information. But here again we find a dilemma. What exactly is technical information? What exactly is fundamental information? Where do the two overlap, or do they? Are they interrelated? Sure they are. But again, it is through experience that you learn about and develop an appreciation for these concepts.
Technical vs. Fundamental??
As futures traders, we get to hear some pretty weird things, and also as writers, and teachers in the business of educating people about futures trading . One of the strangest things we get to hear is when people try to separate trading into either technical or fundamental. Why, oh why, does everything have to be put into a box? Would someone please explain how to separate one from the other? Is it possible, or is there some middle ground that cannot be classified as either technical or fundamental?
For example, how do you classify trading from news stories? Surely you would not call news stories fundamental information, would you? A friend of ours tells about a time in January when he heard a commentator on CNBC explain that the price of coffee had gone up because of a freeze in Brazil. The only thing wrong with the story was that January is the middle of summer in that country. Was the news worthy of the name fundamentals?
What about seasonal trades? Are they technical or fundamental? Certainly they are not based upon hard facts. Who knows if tomorrow will bring a season like the last? Who knows that the weather will be the same this summer as it was the last?
They say enter on rumor, exit on fact. Is that technical or fundamental? Or is it just plain good old common sense?
This article is about experience, but here’s the catch: You must survive as a trader long enough to gain experience. Experience will show you that trading cannot be placed into a box. Experience will bring you to the realization that some of the best trades you will ever make come from experience, gut feelings, and good old common sense. Experience will demonstrate to you that many great trades are derived by paying attention and learning to be an opportunist. Experience will bring you to the point where you will take a smattering of what others may call “fundamentals” along with a pinch of what some call “technical analysis,” and combine them with a spoonful of know-how to succeed in making your living in the markets.
Fundamentals
Our understanding is that fundamentals deal with known facts and published or unpublished information about the underlying commodity or instrument you wish to trade. Because statistics lie, governments knowingly lie with statistics, or at times do so unwittingly, those who can afford it and also have a need, spend tons of money doing their own research in order to come up with their own body of fundamental knowledge. This includes gathering information and statistics on anything imaginable that might affect the underlying. They research production, marketing, crop conditions, financial conditions, etc.; everything they can find out about the underlying. They may even make in-person visits to farms, mines, or financial institutions for discussions about the underlying. They then combine this knowledge with what they find believable as handed down by various reporting agencies.
Even with live data, it is not economic to compete with these behemoths with regard to the amount of fundamental knowledge they can afford and are able to gather.
Technicals
Technical analysis in its purest form assumes that everything known about the markets that affect the markets can be seen on a price chart. We believe that to be true. But that’s where reality and the kind of technical analysis we see today part company. What we mean is, in general what do technical indicators show you that you can't normally see with your two eyes via pure chart reading and analysis? Admittedly there are a few things. We have never denied that an indicator like Bollinger Bands can show you the location of 2 standard deviations. We cannot visually know where that amount of deviation from price would be without the bands. But most technical indicators wipe away the very things we do want to see. They take your focus away from what is truly happening to price.
By smoothing, they purport to remove “noise.” But it is the noise that we, as traders, and especially as day traders, most want to see. The noise is what tells us the reality of what is going on.
Realities
Fundamentals, in the purest sense, are beyond what the individual trader can deal with. Most individual traders simply don’t have the time to conduct the required research. But that doesn’t mean they cannot use this information should the happen to stumble across it. Technicals in the purest sense are fine, but the way they have been bastardized into virtually meaningless indicators makes no sense. The ultimate foolishness of technical indicators is that of rendering them as mechanical trading systems. Employing mechanical systems represents the height of the undisciplined mind. It is tantamount to conceding that because you do not have the discipline to exercise self-control, you will undergo the harsh discipline enforced on you by an uncaring, unfeeling machine. While you try to escape from self-disciplined trading, mechanical systems force an even more horrible discipline upon you in that you now have to sit and grit your teeth due to the pain brought on yourself because of the mechanical aspect of the system. Mechanical trading is not without discipline, rather it places the discipline onto the wrong part of the trade. Instead of placing the emphasis on planning, organizing, directing, and controlling the trade, it gets the trader in via a mechanical signal and then forces him to suffer through the trade in order to exercise discipline — quite often a discipline he does not understand based upon a system he does not understand, and that may have been derived entirely outside the realm of reality.
The realities of the market are many. Markets are affected by a lot of things that are not measurable by either fundamental or technical analysis. In addition to seasonality, news, rumor, weather, and common sense observation, one has to take into account the market conditions at the time at which a trade is to be entered. Is the market fast? Is the market thin? Is the tick size abnormal? Are market makers moving the market? Is it options expiration day? Is it the day before a holiday? Is an important dignitary going to make a speech? Has the market gone into a state of hysteria, or even euphoria? Are you going to buy or are you going to sell? It is the summation, organization, and perception of these and even other criteria that constitute the realities of trading.
Reality Trading
We are convinced that the best way to trade should be termed “Reality Trading™.” In fact, we are so convinced that we have trade marked the name for future use. Reality Trading views the market as an entire entity, a living, throbbing reality that includes fundamentals, technicals, and realities such as news, rumors, seasonal tendencies, common sense observations, and market conditions.
Let’s look at a possible trade that is based upon realities. Let’s say that this is a trade that has been good most years in the last 15 years. Let’s say that the trade is to buy March wheat between September and December of the current year.
First we look to see if March wheat futures are behaving normally. What does the March wheat futures chart need to look like if this trade is going to work?
We begin watching March wheat futures in the first week of September, for possible entry between that time and the last week in November. We’re not particularly interested in what the March wheat futures look like prior to September, but according to past seasonal patterns, they should not end September in a down trend. The normal pattern for wheat futures at that time of year is that wheat prices begin to rise or at the very least remain flat. Falling prices would indicate an over supply of wheat. The rising or flatness may have begun earlier, or it may begin later, but not by the end of September. The main thing we don’t want to see is wheat prices falling after September. If wheat prices are falling in the time period mentioned above, then we do not have a normal year for these futures and we want to avoid this trade. No one knows for sure what weather conditions will be between the first week in September and the time the that wheat inventory figures are known. No one knows if exports will be up, down, or flat compared with the previous year. It is the seasonal anticipation that should prop up the price of the wheat futures.
Obviously, this same sort of technique could be applied to any purchasable commodity that can be expected to experience increased activity seasonally.
So, lets look at a wheat chart. We want to select the best the best possible time to enter. Experience has shown that the two best times are as follows:
* An announcement by the government between September and October that it export sales of wheat have increased materially – a buying situation
* A report showing a greater than expected inventory of wheat in September through November – a selling short situation.
At “A” we see announcements coming from government reports that demand for wheat for export is great. It is the middle of September. People rush in to purchase wheat futures. However, from the look of this chart, overall demand for wheat was not very good. Actually, the year shown was poor for wheat most of the time.
Later, beyond the time frame in which we are interested, at “B” we see that the government crop report for January was really bad for wheat. There was simply too much of it. Wheat prices began to plunge. What stopped the plunge? Anticipation of planting problems due to unusually cold weather.
http://www.trade2win.com/knowledge/articles/general_articles/experience/page1
Has trading got tougher lately? Let's find out...
By Brett Steenbarger
TradingMarkets.com
March 13, 2006 10:30 AM ET
Before I present some eye-opening findings, allow me to propose a thesis:
Every market has its personality, and that personality is defined by two traits: Volatility and Trendiness. A volatile market is one that moves a great deal from time period to time period. A trendy market is one that tends to move in the same direction from one period to the next. Over time, markets change their personalities, which is to say they change their volatility and trending. This is part of what makes markets so difficult to trade: just as traders adapt to one market personality, another is likely to take its place.
What we've seen in recent years in the S&P 500, however, is a personality change worthy of Jekyll and Hyde. I believe this accounts for the common perception among retail and professional traders alike that the recent period has been one of the most difficult on record to trade.
In fact, I can prove it.
For my investigation, I went back to January, 1934. I looked at two time periods in the Dow Jones Industrial Average: hourly (the first hour of the day) and daily and measured their volatility and trendiness. Both of these were measured as a 500 day moving average, which covers roughly two years of trading. Hourly volatility was measured as the absolute values of the price changes from the close of the previous day to the close of the first hour of the current day. I used first hour data only, since this is commonly the most volatile intraday period. Daily volatility also looked at the absolute value of price changes from the close of the prior day to the close of the current day.
To assess trendiness, I followed the methodology of my recent article. I examined the number of occasions in a moving 500 day period in which rising first hours (days) were preceded by rising last hours (days) or falling first hours (days) were preceded by falling last hours (days). Recall that, if we assume that the odds of a rise or decline are 50/50, we should average about 250 occasions out of 500 where a rise or decline continues into the next period.
First we'll start with volatility. Here is the chart for hourly volatility:
Now here is the chart for daily volatility:
As you can see, for all practical purposes they are identical. They show us three things:
1) current volatility has dropped considerably from the 2003 peak;
2) by historical standards today's volatility is below average, but not historically unusual; and
3) periods of low volatility can persist for considerable periods of time. Indeed, volatility could drop further and we still would not be at historic lows.
Now let's look at trendiness at an hourly level:
This absolutely floored me when I saw it. Notice that we were above the 250 level consistently from 1934 to 1976. Since 1976, however, the trending quality of the first hour has gone steadily downhill, to the point where we're now well below 250 at historic lows. For the first time in market history, this suggests, we are now *more* likely to fall in the first hour if the last hour of the prior day is up and vice versa.
This hourly pattern fits with the intraday studies on my research site. http://www.traderfeed.blogspot.com/
How about trendiness on a daily basis?
Once again, we see a very similar pattern. In the mid-1930s we saw some values below 250, but after that, up days were more likely to be followed by up days and down days by down days. This changed starting after 1976, and now we have been below 250 rather consistently. Instead of trending, markets are tending to reverse the direction of their prior period.
So let's put these findings together: We are seeing reduced volatility *and* we are seeing reduced trendiness. That means that traders are able to take less movement out of trades *and* they are less likely to see movement carry over from one period to the next. Is it any wonder that traders are experiencing such difficulty? We have never seen a market personality quite like this one, in which low volatility has also been accompanied by low trending.
But now the bad news. I've also performed historical studies of trendiness on a five-minute basis (reported on my research site). The proportion of trending occasions is nowhere near even the one-half level; it's more like one-third. That is because of the low volatility: a third of the time the market doesn't move at all (price stays constant) and another third of the time the market reverses. The short-term momentum trader is thus in the worst of all possible worlds, as low volatility produces a lack of movement and low trending produces a lack of follow-through on moves.
I believe traders--especially short-term traders of the stock indices--need to take these findings very seriously. To the extent that the loss of trending is created by increased arbitrage and program trading, there is no assurance that it will reverse. Moreover, we've seen that the loss of volatility in the market can also persist--and even get worse. To blindly hope that the market will "get better" is not a trading plan, much less the plan for a trading career.
The good news is that there are trading instruments with far higher levels of volatility and trendiness, and those include many individual stocks. (One look at this is on the Trader Performance page of my personal site). Note that this makes stock picking and portfolio selection more important than ever. There aren't any universal laws in trading, but this one might come close: Make sure the personality of what you trade fits with how you trade.
Brett N. Steenbarger, Ph.D. is Associate Clinical Professor of Psychiatry and Behavioral Sciences at SUNY Upstate Medical University in Syracuse, NY and author of The Psychology of Trading (Wiley, 2003). As Director of Trader Development for Kingstree Trading, LLC in Chicago, he has mentored numerous professional traders and coordinated a training program for traders. An active trader of the stock indexes, Brett utilizes statistically-based pattern recognition for intraday trading. Brett does not offer commercial services to traders, but maintains an archive of articles and a trading blog at www.brettsteenbarger.com and a blog of market analytics at www.traderfeed.blogspot.com. He is currently writing a book on the topics of trader development and the enhancement of trader performance due for publication this fall (Wiley).
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