What is even going on? $SPX $VIX $VVIX


I tweeted this last night – SPX in blue, VIX in red and the VVIX in green.

Price velocity of the SPX has been rising while the VVIX and VIX have been falling over Q4 of 2016.

Here is one suggestion:

You’d have expected the VIX to rise due to an increase in the US base rate, which would cause volatility increases but this hasn’t happened. An introduction of the risk free rate should lead to a flight from higher risk assets to holding cash in an account (technically). This hasn’t happened.

What’s more is that the SKEW hit 6 year highs in January. This is the evaluative measure of tail end risk in out of the money options. Short term hedging ends up costing more, which prices a risk event short term. View the tweet from Chris Lemieux here:

I’m bored of saying that something is coming but it’s best to be aware of a few different events and when there is a feeling of complacency then there could be an issue.

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How do you trade Inside Bars?

I asked if anyone wanted to guest post for me and Miad (@ZFXtrading) responded with a great post on how he trades inside bars.

Take a look at his other content at www.this-is-forex.com. Some cracking stuff on volume spread analysis, a particular method that I incorporate in my trading.



Insidebar swing trading is a lot about doing nothing and sitting on your hands. Then when the setup comes it’s everything about execution and continued sitting on your hands again until markets treats you to a TP or slap you with your SL. Insidebars are born out of lacklustre and failure of market participants to break the previous seasons price range. Statistically insidebars and the inevitable breakout give a 50/50 chance of success. Where success is measured by yielding more or at least equally as much as you risked losing. But there are rare moments and in particular Certain environments where IBs are the calm before the storm, the build up before the momentum stretch and that’s where IBs get their reputation from. Catching that explosive move with a tight stop is everyone’s desire big or small players and IBs open up such provocative opportunities. 

Wicks are arrows

Now in order to separate poor setups from roulette once you want to understand the power of wicks. Every candle wick tells a story, mostly a boring one without any substance just like my old uncle. Nevertheless it has direction, and in a cluster of unbiased spikes these wicks become your beacon of light. If there are dozens of candles arrayed like sardines in a tin with obvious wicks pointing up the way then that’s because market participants are interested in higher prices. While everyone else is busy trying to figure out what’s going on, you can shape a bias based on price strength at the wicks. 


Collectively wicks are pointing lower and a sense of sentiment only from observing the wicks becomes clear while downside pressure persists.


It is incredible how in this chart example the lows got defended. Every dip got pushed back up leaving wicks pointing higher. In tight ranges like that it is impossible to figure out a breakout direction unless you look for your clues.

Realising that candle wicks are actually arrows and the bigger they are the more meaning they have opens up totally new horizons.

Swing high and low

Breaking down price behaviour into pivots gives us a better perspective. Now pivots with less noise and clusters around them have much more ease and room to flex. Hence when we observe a turnaround point in the middle of nowhere it tends to be a smoother sail as opposed to noisy conditions. So whenever you see price has broken free and leaves generous room to move be advised that it has an equal chance of returning to where it came from. All it needs is a spark, that spark could be an IB.

Bringing it together

When a mother bar and the subsequent insidebar both have wicks pointing lower then a breakout to the downside is likely to advance further. And when all of that happens at a swing high , well you got yourself a golden goose.


A recent example on CADJPY 4h IB setup at a swing high, upon breaching the lows price opened up. With open space to move into, price encountered little resistance to drop lower.


After a massive swing lower price consolidated briefly and broke out with the same momentum to the upside right after this lucrative IB setup that offered tight risk management.

IB trade management

Dropping a Fibonacci line from the bottom to the top of an IB range will plot 161,261 and 423 extension levels.


And here is the drool, I have forward tested IB setups as outlined above and 7/10 times 161 gets hit in the very first burst and 9/10 times 161 levels gets hit during the lifetime of a trade (mic drop). You’ll see 261 tested 7/10 times which accounts for a RR of 1.6 . Combined take profits will yield RR0.6+RR1.6= RR2.2 with an average strike rate of %70.

A question I was asked on Twitter

From @ijbarratt: what are the biggest changes you see coming in the following years and how do you plan to capitalise?

Pretty broad question. Cheers Izaac.

I think one of the biggest things we’ll start to see is decentralisation of processes. We’ve already seen the rise of the crypto-currencies and online marketplaces such as Silkroad which use Bitcoin to make transactions with since it is anonymous. Blockchain is a ledger process that is still heavily in its infancy, but I feel that there is definitely some place for it. Even investment banks are really starting to adopt the technology.

All transactions have an auditable trail and a traceable digital fingerprint. The data on the ledger is pervasive and persistent, creating a reliable “transaction cloud” where transaction data cannot be lost.

Another key difference between distributed ledger and traditional database technology is how they approach security. Distributed ledgers encrypt individual transactions or messages in the data stored on the blockchain, whereas traditional databases typically have a database-wide layer of security that, once breached, offers access to all of the data inside. In a world where the threats of hacking, data manipulation and compromised data are very real, the security and risk management implications of these two different approaches are important considerations.

The above is key for the future of keeping transaction, audit and costs from cyber crime low. In addition, because it isn’t centralised, if one ‘node’ is compromised then you can still gain access to the rest of the database with no issues.

I don’t know a huge amount about the technicalities, but it looks like it could be a major development. https://2030.io/ is a great community to learn more about it. How I’d capitalise? That is TBC.

The second change I see happening is a real push from ‘Internet of Things’ manufacturers. Someone only informed me that it was a real industry used phrase a few weeks ago. These are goods that are connected to the internet and which act intelligently i.e you can turn lights on or your heating with an iPhone app. Eventually I think that’s how our houses will be operating. You might have forgotten to turn a light off before you go to work, but you can then turn it off with your phone, saving a bit of cash. Or you won’t ever need a door key again, just your phone, a password and fingerprint.

The third change that may take a decade or so to proliferate is the US student loans crisis. I can foresee a load of defaults happening, since student loans and car loans are the only two markets post financial crisis where deleveraging hadn’t occurred. I’ve written about that here.

Lastly, I see a continued growth in app companies – Snapchat, Uber, Deliveroo etc. Massive valuations, no product at all, but provide a useful and needed service.

I don’t really like predictions because you live in dreamland with those, but that is what I could see happening.

Is Trump totally mental to dismantle Dodd-Frank?

Image result for dodd frank

Dodd Frank was introduced after the financial crisis to prevent excessive and dangerous banking practices that partly caused the 2008 meltdown and the requirement of taxpayers to bail out large investment banks and other institutions.

I think to answer the above question, the mechanism by which the 2008 crash occurred must be explained. Here is a very simple note on why it happened. 

I won’t go through all of the terms of the legislature because there are so many, and quite frankly, I don’t have the relevant experience to comment on some parts of it, but the parts that I do understand I will do my best to explain and evaluate.

In short, Dodd Frank is there to increase moral hazard on banks to protect the end consumer.

Moral Hazard – lack of incentive to guard against risk where one is protected from its consequences, e.g. by insurance.

Banks were deemed too big to fail. They knew that the taxpayer would have to bail them out. Dodd Frank’s introduction makes them more susceptible (in theory, but I’ll come onto this later) to accountability. The introduction of The Financial Stability Oversight Council and Orderly Liquidation Authority and Consumer Financial Protection Bureau 1) force banks to increase capital base (increase liquidity) if they are deemed to hold too much systematic risk and also break up banks for the same reason (ha, as if that would ever happen) and 2) the CFPB prevents mortgage brokers from earning high commissions via predatory practices (giving out subprime mortgages like they’re sweets) whereby they earn higher interest payments but the assets end up having a higher default risk.

What could Trump possibly benefit from by deregulating these areas? Well, he has quite a few ex Goldman executives around him. He has some of the biggest tech firms and conglomerates on his advisory team. These firms need access to capital and credit. Trump is a believer in trickle down economics (stupidly) whereby firms who provide jobs will eventually have their wealth trickle down to the workforce that they have created jobs for. This is absolute rubbish and has been proven not to work – look at the increasing disparity between executive pay and lowest paid workers in the majority of large firms.

The issue here is that repealing Dodd-Frank may mean rejecting the accountability measure that should be placed on banks when dealing with a product such as mortgage backed securities where everyone who owns a home or is renting from a landlord can be affected when they are traded – or when the system fails.

I think there has been too much emphasis placed on Dodd-Frank being the main development in banking regulation and process, however. Basel III has been a far greater and more far reaching introduction. Whether you want to attribute the following to Dodd-Frank or Basell III is negligible, because all that is really apparent about the following quote is that systematically, the risk is essentially the same if not subjectively worse:

Just how much has bank capital increased since the passage of Dodd-Frank?  It all depends on what you mean by capital.  According to the FDIC, at the end of 2015, commercial banks had “total equity capital” of $1.8 trillion.  This is certainly higher than the $1.5 trillion that existed at the time of Dodd-Frank’s passage.  But bank assets also increased.  What matters is the ratio of bank capital to total bank assets.  At the passage of Dodd-Frank that ratio was 11.1.  At year-end 2015, it was 11.2.

Some apparent increases in bank capital relative to risk-weighted assets are due to the fact that banks have massively shifted into low risk-weight assets.  Under a system of risk weighted capital, the required capital is a function of the target capital level times the risk weight of the volume of the asset.  For example whole mortgages have historically had a risk weight of 50%.  So if one holds $100 million in whole mortgages and the target capital is 8%, then actual capital is not $8 million but rather $4 million (8 x 0.5).  Needless to say the risk weights have come under considerable scrutiny, especially since assets like Greek government debt were given risk weights of zero.

Since Dodd-Frank, commercial banks have more than doubled their holdings of U.S. Treasuries, which require zero capital.  Banks have also increased their holdings of mortgage-backed securities and municipal debt, which also have low risk weights.  The point is that banks haven’t really raised lots of new capital as much as they’ve gamed the risk-weights to appear to have more capital.

https://www.alt-m.org/2016/03/18/did-dodd-frank-increase-bank-capital/

So the argument that repealing Dodd-Frank based on reducing systematic risk actually vanishes pretty quickly, since nothing has really changed when looking at the books. I would argue it has actually been made worse, except the introduction of Dodd Frank has simply allowed a veneer of respectability and accountability to be placed onto banks.

If this is the case, then Dodd Frank is merely protecting consumers via bureaucracy – which in this case isn’t necessarily bad. I would argue that the necessity to prevent practices such as being able to buy naked credit default swaps on failing assets while selling that failing asset to someone else (imagine being able to buy insurance on your neighbour’s house, setting fire to it, then collecting the insurance money – Goldman were doing that with collateralised debt obligations), which only Europe have done is necessary. Increasing pre and post trade transparency and reporting on bank risk is vital to be able to monitor systematic risk.

But let’s think of this. Has Dodd-Frank prevented Deutsche Bank or Santander from repeatedly failing stress tests in the US? Nope.

I think that repealing Dodd Frank won’t make much of a difference to systematic risk at all by looking at the last paragraph of the quote. So Trump is a madman, but this isn’t really a time which is going to absolutely wreck the world.

Oil, Gold, USD, GBP, Yen COT report breakdowns & interpretation #fx #oott

 

We are seeing a 5Y extreme net bullish positioning from non commercial speculators. I would want to see bids at $40-46 forced out first, however. This means that a drop of about $13 is available. We have a slight Wyckoff bottoming pattern. I remain bullish above $36 long term on oil (WTI).

Gold

Looking at PA and the reduction in longs over Q4 2016 indicates that we aren’t in for a bull run any time soon. Wyckoffian schematics indicate a move to $1,050. Currently hitting a rounded resistance retest of a key low volume break below support, I would continue shorting gold with a stop above $1,260, target of $1,050 for a 3:1 risk to reward trade.

USD

Dollar longs have remained stable over the past few months. Open interest had increased due to the Trump USD rally. Trump’s team has said the dollar is too high very recently. External to this, USD LIBOR rising could be causing investors to shy away from USD denominated assets over the next few months as dollar hedging costs become too great relative to potential yields. I’d expect the dollar to stay within current ranges of 96-104 for the foreseeable future, however longer term I still remain bearish. What could change this is a) NAFTA terms being reassessed b) changing geopolitical situations c) Trump does something even more mental that has longer term economic implications.

Sterling

Sterling shorts have been covered since November. This is most interesting to me due to the perceived general public fear over a GBP crash when Article 50 is triggered. This could suggest that in reality, sterling would be in for a rally if you want to look at recent sentiment regarding the pound. We’ve had a pretty large spike in bearish volume at lows back before Christmas. A spike in volume at relative lows or highs can sometimes indicate a reversal, but I wouldn’t put too much credence into that. The ‘fat finger’ low at 1.1945 has not been taken, however I am basing my stucture off of the lows at 1.21 and 1.20. A hold above 1.20 I will remain bullish, however I expect a ranging market where sellers will be absorbed over the next few months.

Yen

Similar PA to gold here (understandably). Non-comms are net short Yen. How long they’ll maintain this for is another question if we start experiencing risk offish behaviour in other assets. Yen on a longer term picture is more interesting –

Below 0.80 and we could see 0.70. If 0.80 holds, however, Yen bid is on, even if this is totally detrimental to the BoJ’s aims.

Trump and May Set to meet

Today’s “off the wall” (pun intended) trade idea? – buy avocado futures! (More on Mexico below)

Later today President Trump and U.K. Prime Minister Theresa May will meet in Washington.

There will be a press conference following the meeting at which Trump is sure to praise and encourage the U.K.’s efforts over Brexit. He is also likely to take the opportunity to bash the EU much to the chagrin of Merkel, Junker et al.

Yesterday saw the release of Q4 GDP data in the U.K which showed that the inflationary effect of the weaker pound and a perceived slowdown in consumer spending is yet to have any effect on growth.

Sterling continues its recovery. Its performance since the Brexit vote could be characterized as “taking the lift down and is taking the stairs back up!”

The pound has recovered 5% of the “flash crash” Brexit fall against the dollar and continues to be steady against the Euro.

Next week sees “Super Thursday in the U.K. when the Bank of England will issue its Quarterly Inflation Report and the MPC will make its decision on interest rates. Bank of England Governor Mark Carney has already stated that the Bank are watchful and will act pre-emptively should inflation start to increase “outside the normal cycle”.

Mar. Carney has already announced his intention to leave his position in June 2019. Whilst he hasn’t, as yet, taken on the almost mythical status of a Greenspan or Bernanke he was certainly the right man in the right place to steer than Bank of England into calmer waters following the debt crisis.

It is to be hoped that his successor is already being groomed with the departure coming at a critical juncture in Brexit. The U.K. will need to be careful not to become “Manchester United after the departure of Sir Alex Ferguson!”

Later today (1.30GMT) sees the release of Q4 GDP data in the U.S.

This is expected to see a healthy increase from 1.4% in Q3 to 2.1%. Economic activity continues to pick up in the U.S. Jobless figures are at the level which equate to “full employment” below 5%.  The dollar index has fallen (slightly) every week since the turn of the year and we could see the uptrend recommence should this data surprise at all to the upside.

President Trump has done pretty much all he can other than to “invoke the Spirit of the Alamo” upset Mexico over the past week or so. It seems the wall will be built but the question remains “who will pay for it?

80% of Mexico’s exports are to the United States. America has an eighty billion dollar trade deficit with Mexico. To a certain extent, they need each other but the onus is on Mexico as President Trump is well aware!

A 20% tax on Mexican imports is a double edged sword. It will pass the burden onto the U.S. consumer but could also drive importers of Mexican goods to look elsewhere to source product.

 

 

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Why Are Economists Wrong?

Andy Haldane has recently come out to apologise about the forecasts the Bank of England and experts had made in the wake of the EU Referendum. After having missed the occurrence of the 2008 financial crisis and totally misjudged the Brexit vote, is the Bank in disrepute?

Claims made by leading economic thinkers include statements of ‘fact’ (when it comes to experts providing opinion, the average Joe Public will take this as fact) such as:

“Britain’s shock vote to leave the EU has unleashed a wave of economic and political uncertainty that likely will drive the UK into recession,” Samuel Tombs, Pantheon Macroeconomics.

David Owen, the chief European economist at Jefferies International, said a technical recession – two consecutive quarters of contraction – may now be a given, followed by a period of very slow growth. He also said the UK’s long-term economic potential, known as trend growth, would be lower, “which has to impact the valuation of assets, particularly equities”.

(Guardian, 24th June 2016)

George Osbourne tweeted:

…as a result of Mark Carney’s presser which can be seen here, where they also expected a 20pc fall in the pound, which, by the way, was totally not unexpected – you can read about this in an article I wrote a month or two ago. In actuality, post referendum, we are experiencing very good economic conditions. Business confidence is up in Q4 2016 vs Q3 2016, inflation is at the highest level in 2 years (yet Andy Haldane is now arguing that inflation is going to hurt British consumers, after being a dove for a long time – talk about flip flopping), one of the biggest industries, construction, is seeing a boom, even in the face of higher material costs for builders, and finally, UK Q4 growth was better than expected.

This isn’t meant to be a total critique specifically of the post referendum expectations from the Bank and many expert economists, but a critique of forecasting of many events by economists, as well as their decision making along the line.

Consistently through history, economists have misjudged or mis-forecasted events, from the Great Depression, to Reagan’s ‘Trickle-down economics’, which many still feel holds weight today, to the predicting the financial crisis of 2008.

In 1999, The Economist wrote to the UK’s leading academic practitioners of the dismal science to find out whether it would be in our national economic interest to join the euro by 2004. Of the 165 who replied, 65 per cent said that it would. Even more depressingly, 73 per cent of those who actually specialised in the economics of the EU and of monetary union thought we should join – the experts among the experts were the most wrong.

(The Telegraph, August 2016)

I believe that it is because although economists use varying models, these models are consistently going to be outdated where human behaviours change according to environmental, technological, financial and resource bases advances and evolution. Models used 70/80 years ago are still being used today. A model that worked in a post war world doesn’t necessarily work today. It could lead you to ask why have interest rates consistently been on a decline for 30 years? Why are real wages decreasing long term? Evidently something is wrong with our economic system and I believe that a key reason for this is the lack of credible forecasting from our central banks and government economists, as well as other variables such as increasing inequality, which I think can also be attributed to certain post war mechanisms (hint, baby boomer created mechanisms).

In trading, you can argue that an analyst can have a totally different view of the market to a trader. The issue is that one is well, analysing, and one is actually putting their balls on the line and aiding price discovery – and everything is based on price discovery or supply and demand equilibrium. What is the punishment for Andy Haldane saying that there is the ‘potential’ for a post referendum recession apart from having to make an apology? Not much apart from a red face and an article critiquing him by an MT4 FX trader. A trader would lose or gain. There is something on the line but this leads me onto something that I feel economists totally forget about markets.

Pricing in is the notion that the market discounts everything. The price you view now is the price of all information known in the market. For example, one could look at the dollar rally we experienced from late summer to the December rate hike and consider the high of 118.5 as that being the market including all information based on the belief that a hike would have occurred, since we are now trading 200-250 ticks off of that price. The dollar tends to fall after US rate hikes anyway for about 6 months after. Slight tangent there, but the point is that economists tend to miss this a lot. Traders do not. A 15% fall in GBP was predicted by the IMF a year before Brexit. Traders knew this – they’d been shorting cable from $2.00 highs. They were just waiting for a catalyst to be able to capitalise on that fall – and in my opinion, it would have occurred anyway over time.

It’s the same with the Trump vote. There were heavy predictions of a stock market crash… we are hitting all time highs on Dow and SP500, and we can see the same phenomenon among economists working. In both cases, we saw economists over-estimate the effect of negative events and totally underestimate the effects of anything positive that could be taken from these two political decisions. To be honest, I was guilty of this on Trump. I thought he would win, but I did not expect there to be such strong risk on behaviour in bonds and equities. Conversely, we saw the opposite occur with the 2008 financial crisis. There were probably mutterings of ‘it’s housing, how can that go wrong’? Well in this case, the negatives were discounted totally. Part of this was due to ratings agencies providing smoke and mirrors to the actual situation, and part of this was due to the belief that if anything did go wrong, it would be so staggeringly bad that it just… couldn’t happen.

We also have the issue of data being provided sometimes 3 months too late (inflation forecasts for example). Economies are sensitive ecosystems. Supply and demand shocks can occur and change things very quickly during those periods. However, this is where I feel a more market analyst based approach has to be taken by economists rather than simply always adhering to macroeconomic models – humans aren’t rational beings all the time in relation to economics shocks, and the data lags don’t always reflect this. For example, I found it strange that the BoE cut rates by 25 BP back in August. You could say it was because they were trying to be accomodative, but then you have Andy Haldane coming out with statements that there are inflation risks, when we all know that monetary policy takes 12 months to take effect (however I think that just shows the Bank’s lack of forecasting ability and we go back in circles again).

One thing that I think that certain economists are really understating is the effect that China blowing up will have. Balls on the line, January 2018 that credit bubble will go boom (I can edit this if it happens in Feb).