THE HOLY GRAIL OF TRADING

We all love to hear a too-good-to-be-true story and quite often we are hooked by offers for unrealistic returns and results. For instance, recently I came across a spam-site which promises 165% returns in 40 days on deposits – how would that be even remotely realistic. Or, reading an advertisement for a jump-rope, which you can even use while sitting for incredible results – I just cannot help but laugh. Such is also the story for the holy grail of trading. We are constantly looking for a method which would provide us with the ultimate edge, telling us exactly when and where we should enter the market with no risk, making a fortune in no time. And finally, making all that work obsolete, so that we can lie on a beach somewhere drinking cocktails from coconuts until the rest of our lives.

Though there does not seem to be a holy grail in trading, it has wisely been said that a trading edge must consist of three M’s – and that is the closest we get to it. These three M’s are

Method,

Money-Management &

Mind.

They refer to the way that a trader is generating signals, protecting his account and reacting to changes in the market place.

Quite often it has been said that the least important of these is the method, while the mind-element takes up to 80% of the importance here. This might be just slightly different from what your broker was telling you when you were signing up for your account. Though I would suggest that any successful strategy must have a strong component of all of these, different people put a different value on the distribution and specialize in different fields.

For instance, most people believe that it is necessary to be able to forecast the market in order to make money and so they look for some way to do this – whether through fundamental analysis or technical analysis, they try to find some kind of what they consider to be a cause-effect relationship and dedicate themselves to staying alert to the causes, betting on the effects. Here, the almost mythological W. D. Gann comes to mind, who has been said to have been able to forecast dates and prices years in advance. If we could only do that, too, we reason, than we would have no issues with our trading. However, since few people seem to have been able to reproduce even parts of his work, we have to assume that we have to deal with the uncertainty and operate in an environment of risk. Even though W. D. Gann has made the impression to be right in the majority of cases, his trading books, some of them over 100 years old, still give plenty of practical money-management strategies and psychological tips to the layman.

On the other hand, in economic theory and academic circles it has always been assumed that the market is unforecastable and the stochastic element has to be taken into account. And since no one has an accuracy of 100%, we have to ration our capital the same way a poker player does, with a system of percentages of our capital for all of our bets. But the problem goes deeper: not only do we believe that the market is a random-walk process, but, as Nassim Taleb shows us in his Black Swan, even this assertion is wrong. Making such a statement already generates a probabilistic outlook on the markets, while he explains that we have a totally wrong understanding of those processes. We tend to underestimate extremely unlikely events and live in a world which we believe to be normally distributed – until it isn’t and we go broke. Coping with his understanding of the world he looks to create a risk-management strategy which is anti-fragile, i.e. gains from shocks, instead of breaking down. Ultimately, assuming that we have absolutely no clue about the market, we just have to make sure to make profits. Bingo.

Lastly, other people think that the previous two components are useless, if the mind is not stable and strong. Trading is a mindset and it requires discipline, dedication, consistency and hard work. In one such extreme we could look at tape-readers, who say that the pulse of the market can be felt and anticipated through constant monitoring of the market and the right mindset about trading. For instance, in an interview Tom Hougaard from WhichWayToday has said that he does not even have a system, instead he just assumes that he is watching another group of people who exhibit their regular behavioural patterns. Other people just watch 1minute charts and go with the flow, while others set up statistical trading robots and just repeat to themselves that in the long run the system will make money.

Whatever it is, a combination and knowledge of all three of the above seems to be absolutely necessary for making speculation a profitable profession. Whichever you specialize in, though, the markets are a fascinating guiding light and challenge – however, the ultimate goal is solely to make money. Do not forget that.

EURO TWO WEEK LOW

Update: Though the Euro has continued its agressive decline into the 1,24 area into its next time period, I still expect the same type of retracement move.

Just a short notice: The Euro has been following our projections quite closely and should have reached a sentiment extreme for the next two weeks. The newsflow has been a disaster over the last weeks and price has tumbled quite closely to the cycle low from January. How exactly the Greece issue will play out is unclear, however we will have to follow the market in between its resistance points. There is still time to come before the ultimate long trade arrives, but eager traders might want to jump on board for an hesitant 200+ pip rally to 1,2910.

Similarly, a low in the SP500 should have been reached for now and we might be going sideways for the next month.

HOW LONG WILL IT LAST?

A couple of weeks ago, in the article A PROPHECY: 2012-2015 we proposed that in the SP500, based on a repeating cycle, the current bottom should come approximately 20 days after the top. Indeed, price has hit the proposed bottom and accelerated into the direction of 1530 with a gap. It definitely looks strong for now!

But how long will it last?

Our timecount coincides with the apex of the triangle and right now this gives us an approximate date around the 10^th of June. Let’s see how far we get!
(This is just one of various dates which all coincide over the summer for a major high. Looking back at the tops in 2000 and 2007 it looks likely that we will see a repeated attempt to break overhead resistance before the real turn occurs.)

But in order to get a more clear picture of the internals of this rally, let us consider the significant changes that we can already see ahead of us for the foreseeable future. First of all, we are in an election year and every economic indicator is being fine-tuned to create short-term “confidence” in the general public. However, elections bring uncertainty with them and we cannot know for certain how the market will react to any changes. Analysts are already following closely the elections in France and we can expect them to do the same regarding the US elections on the 6^th of November, 2012. As always, markets are forward-looking, so any expectations about the outcome will be priced in far earlier.

Additionally, Operation Twist is coming to an end this summer and so far we have no clear indications if there will be QE3;  Though, I am certain, policy-makers are itching to run the printing presses again, it can be felt that anti-government sentiment is on the rise and their so called “perception-management”-operation becomes an even more impossible task to accomplish. On the other hand, indications of further easing have the potential to permanently erode the confidence in the dollar and further complicate the global world view. Decisions, decisions, decisions!

With so much uncertainty around the landscape, the market is vulnerable to cascades, as liquidity has dried up and the retail investor seems to have permanently left the building. Apparantly, the "weak hands" will not be fooled this time!

Not only the public seems to have lost confidence in the market, insiders seem to have just as little faith in the economic outlook. This, combined with self-reinforcing movements through HFT-trading, gives us a hint that there will be no one to stem the tide, if it just happen to turn against us. 

Unfortunately, the cycles indeed indicate that the tide will indeed most likely turn against us very soon. Until then, enjoy the calm before the storm.

Charts: ZeroHedge, Barclays Capital, Bloomberg

BLACKSMITH CAMP 2012

Last year I was at Sovereignman.com's BlackSmith Liberty & Entrepreneurship Camp and had a truly mindblowing time there, which has expanded my understanding of the world. This year, I created this video to encourage other young people to do their best and meet some amazing people during the 2012 camp, held July 26 - 30, 2012 in Trakai, Lithuania.

 Please apply HERE, deadline is the 15th of May, 2012!

Watch @ Dailymotion

A PROPHECY: 2012-2015

In our previous article NOTHING IS OLDER THAN OUR HABIT OF CALLING EVERYTHING NEW we presented the outlook for a 20-30 year sideways market in equities. Let us have a closer look today at the structure of these moves, pinpoint where we are today and more importantly, where we are going. Let us start out with Neowave structure:

Since 2000 a three-year decline has cut the SP500 to a price level of half of its price peak. This decline has consisted of many different waves, with price hesitating up and down continuously. Additionally, in 2001 the September WTC terrorist attacks are included in this chart, with price dropping vertically for several days and afterwards just as quickly recovering into the X wave. Price action can best be explained as an ABCDE-x-ABCDE formation, with the last part taking half the time of the previous two parts combined and ending at an approximate 61% extension of the first ABCDE formation.

From there on a 5 year slow rally began, with price ultimately reaching a slightly new high. This formation can best be described as two ABCDEFG-diametrics with an x-wave in between. Again, the ending of this pattern could be perfectly timed through half of the time of the initial two formations and a 61% extension. 

At the end of 2007 price was peaking out, initiating what we would call today “The Great Recession”. As always, price action was forward-looking, dropping way ahead of the upcoming fundamental problems. An ABCDE-cascade was initiated, which led to the failure of Lehman Brothers and raised awareness and panic of the economic problems and issues. Price ultimately bottomed out at on the suspiciously precise 666 “Mark of the Beast” level in May 2009.

As time has moved on, today we are again in a slow and painful upward drift, which has brought price almost back into the upper 1/8^th of price and 2/3 of the time range. Looking back in time, it seemed impossible to expect or predict price regain of so much of its price territory over the last two years; yet, here we are. Whether the constant injection of liquidity by central banks into the market has been the cause of this move or cyclical factors is irrelevant. All we know is that we are again approaching a sensitive point in price and time where the odds favour a new three-year bear market.

Zooming in further into this 8-year segment, which should last until 2015, we can see that when the cascade came to its end, a move started, which has so far lasted more than four times the time of the initiating ABCDE-formation. Such a time duration is unusual and gives us a hint for an unfolding FLAT correction. Looking closer at the structure, we see three triangles (in blue) currently repeating their behaviour. Most striking are the rapid B-wave declines, which were the causes for the so-called “Flash-Crashes”, which raised awareness of the problems with High-Frequency-Trading, market instability and evaporating liquidity.

Comparing those three segments gives us a striking resemblance. The initial two have taking 275 and 263 days respectively, separated by a similar 73 and 80 day correction. If this structure continues, then we should still have another 70 trading days and at least 100 points ahead of us, before we enter the next phase of this market.

So let us see where we are going: Comparing the three analogous D-waves, we should still have another 20 SP500 points to drop until the end of the month of April, before we start a rally towards 1500. From there on we start approaching major time resistance, with an important astronomical date on the 15^th of May. Price should consolidate for a while, preparing for the next stage of a three-year bear market during this summer. Rapid declines should commence, which should last for a couple of months. Investors will believe that this is simply another repetition of the Flash Crash and will buy into the ensuing consolidation into the end of the year. Few people will have noticed the change in outlook and will be surprised by what the new year 2013 will bring us: a return to a new crisis. It will remind us that we cannot cover up structural problems and that the market is stronger than policy makers and politicians. Mass selling pressure will culminate in unstemmable declines and a new liquidity crisis, which will bring down the fundamentals and all risk assets. Capital will be scrambling for “riskless” assets, but if there is one thing that we have learned in the last couple of years it is that there is no such product. Risk has simply been shifted from the finance industry to the government (and they are not exactly risk management professionals). When we reach this inflection point all the added dangers will come crashing down again. Social unrest, anti-government and anti-central bank protests will become the norm in the Western World, as more people wake up to the fact that they are again poorer, thanks to other people’s decisions. If our Euro Analysis (NO MORE EASING?, THE EURO DEBATE) is correct, then the major game changer will be a loss of confidence in the US dollar – this time, the flight to safety will not be to towards the United States. Since no asset will hold its value only speculation will be able to produce positive returns.

Rahm Emanuel has said “You never let a serious crisis go to waste. And what I mean by that it's an opportunity to do things you think you could not do before.” Whether this prophecy will turn out to be correct, time will tell. But an awareness of the underlying fundamental problems and cyclical forces will help us weigh this possibility into our decision making framework. In this train of thought the next year should turn out to be a major game changer and the people who are prepared to seize the opportunity will do so. You can choose to ignore the lessons and dangers of history or, alternatively, you can profit from them – the choice is yours.

CONTINUATION

A week without any significant news has almost passed by and it seems that EUR/USD price action is ripe for major declines again. Though I suspected a stronger rally into the 1,3300 area, the down trend appears to be too strong for this advance to last all too long.

A seven-wave diametric formation appears to be coming to its end until the end of this week. Friday we will also witness March US CPI and University of Michigan Confidence indicators, which should turn out to be good triggers for initial declines. As we have already passed more time than the initial downmove, we have green light for shorts. A critical level to the upside is 1,3160, where the previous high resides, the 38% fibonacci retracement, as well as resistance from the low from mid-March. Since the pattern is in its contracting stage it will be very easy to sell aggressively the rally back into the range with a tight stop. Under this condition, currently calculations indicate a stop at 1,3190. Alternatively, if you want to be more conservative you can wait for a break below old lows on Monday - the last one is currently around 1,3070. As a reminder, prices below 1,2800 should be possible - Let's not miss this trend again.

Update: Price has broken through the contraction-condition, briefly touching 1,3200 but from there dropped 125 pips!

NOTHING IS OLDER THAN OUR HABIT OF CALLING EVERYTHING NEW

When things are going well, we tend to forget the lessons from history and our success-habits get sidestepped in the name of leisure and comfort. Hard work is no longer the norm and society turns back to socialist principles and big government taking all the decisions. “This time it’s different”, we quite often hear; “Our modern society will never allow the same mistakes of the past to happen again”. Well, thanks to the recent crises, today there are again people, who remind us that this time it is never different and our linear, self-imposed view of the world is most likely wrong. We have to discount our modern knowledge and stick to what has been working over the ages.

So what can the history of the market tell us about where we are going? What are the lessons from history that we can draw from 100 years of Dow Jones Industrial data? Where are we today and where are we going? In order to give a likely answer to this, we will have to shatter some myths.

The first one concerns the structure of time by itself. For instance, in “The Fourth Turning” Strauss & Howe identify three different views on the reality of our time-space continuum, i.e. chaotic, cyclic and linear. Though cyclical time has been at the core of all ancient civilisations and calendars, today, while still using the same natural time-keeping mechanisms, we disregard this view and consider time to be linear.

“The great achievement of linear time has been to endow mankind with a purposeful confidence in its own self-improvement. A linear society defines explicit moral goals (justice, equality) or material goals (comfort, abundance) and then sets out deliberately to attain them. When those goals are reached, people feel triumphant; when they aren’t, new tactics are applied.  Either way, the journey never repeats. Each act is original, granting a sense of authentic creativity unknown to those who re-enact the past. […] When we deem our social destiny entirely self-directed and our personal lives self-made, we lose any sense of participating in a collective myth larger than ourselves.” – Strauss & Howe – TheFourth Turning

This social meme is one of the reasons why today technical analysis is quite often disregarded as a pseudoscience and the lessons of history are not given its proper attention both in our education, as in our economic life in general. And it still boggles my mind how blindly hypotheses about the markets are stated without any historic confirmation. So what has history to tell us about the stock market?

First of all, the stock market runs in cycles of exponential growth, followed by long periods of inactivity and depression. For instance, having a look at a chart of the Dow Jones Industrial Average from 1920 to 1953 teaches us several key lessons:

a)      Prices had entered a logarithmic growth phase before the start of the Great Depression and rose from a value of 60 to 380;

b)      Prices collapsed much quicker all the way back to 40 in the span of three years, effectively losing 90% of its value (similar to other markets, as discussed in SOFIX = PORSCHE?);

c)       Prices needed another 20+ years to regain the territory of the old highs;

d)      Momentum was slowly accelerating and the logarithmic growth became again visible.

That was it! We were out of the woods, optimism reigned supreme, it was time for the hippies to run their course and life was great again! Technological advancements were going well, the future looked better than ever and the stock market was climbing to new highs every day. Well, it wasn’t long until we were again in for a harsh surprise in 1966: A 20 year sideways market followed. This market must have been devastating for the psychology of investors, as prices were cut in half, doubled again, only to be cut in half again during the course of this timespan. As can be seen, the myth of buy & hold "for the long run" strategies works only during specific time periods and must be synchronized with the economic cycle. Market timing is the most important factor for successful investing.

But, as all good things come to an end, so did the sideways market and we continued our exponential growth, rallying from a value of 800 in 1980 into the “Dot Com Bubble” in 2000, with prices reaching 12,000 on the DJIA. 

So where are we today?

If you listen to the world’s politicians and the mainstream media, we are in the Great Recovery. But can anyone really testify to this with a straight face? Does anyone really believe this? And more importantly, does anyone have the confidence to invest into long-term prosperity? Chances are you see where I am going. We are in the midst of a long period of sideways movements and are only halfway through. This thesis can be expanded on the back of several theories.  

For one, basic market behaviour tells us, that a corrective move must take more time than an upward impulse. This by itself gives us a minimum end date of this sideways move not until 2020 and it could even last until 2030. Looking at the core of the fundamental problems today, this is a reasonable hypotheses, as it will take a long time to unwind the mountain of debt in the world today, while simultaneously trying to preserve the social fabric and international peace. Those in power will do everything to stay in power and it will take some significant effort to clean the system from our old way of thinking. However, once this is done, it is quite likely that we will continue our journey of progress and exciting times will be due!

This same hypotheses can also be expected by a Kondratieff cycle, which indicates that we are still in a Winter period, as demonstrated by the following wheel:

We are also aware of the popular doom & gloom scenario, connected with the ancient Mayan Calendar in 2012. According to some authors, this is a time when the world ends; however, the Maya’s way of thinking was rather that an ending is the start of a new cycle and of something miraculous. Ex-NASA scientist Maurice Chatelain in his book “Our Ancestors Came From Outer Space” devotes a reasonable amount of time to calculate the Ninevah constant and its relationship to the Mayan calendar. In fact, under his calculations this calendar was started 49,611 BC and ends in 2020, in line with our market analysis. What exactly this will bring to us is still unclear, however David Wilcock argues that our species will enter a higher level of consciousness.

As we all know, all of our human timekeeping has been done through the astronomical wheel. Using this knowledge for an understanding of market cycles, we can explore the activity of “Market master” Uranus to give us matching historical sections, for cyclic modelling until 2016:

All in all, we have unified several different ideas which all prove to us that will have the pleasure of living through exciting times, though we can only hope that they will not escalate in international conflicts. For a roadmap of the events that should unravel, let us again quote the two historians Strauss & Howe from their book “The Fourth Turning” (1997):

“The next Fourth Turning is due to begin shortly after the new millennium, midway through the Oh-Oh decade. Around the year 2005, a sudden spark will catalyze a Crisis mood. Remnants of the old social order will disintegrate. Political and economic trust will implode. Real hardship will beset the land, with severe distress that could involve questions of class, race, nation and empire. The very survival of the nation will feel at stake. Sometime before the year 2025, America will pass through a great gate in history, commensurate with the American Revolution, Civil War, and twin emergencies of the Great Depression and World War II.” – Strauss & Howe - The Fourth Turning

In future articles I will show the current market structure and explain why the period around the 15th of May and especially the start of Q3 2012 are critical for a three year change in market sentiment – stay tuned!