Author Bio

A reader of my trading education blog recently left a comment questioning the concept of so-called “off-exchange” forex trading. The reader in question had some concerns about the way the regulators in the U.S. have defined retail forex trading in this fashion. Those concerns, however, are unwarranted.

The term “off-exchange” is merely an indication that a market (or subset of one – in this case retail forex) does not function through an exchange like the New York Stock Exchange (NYSE) or Chicago Mercantile Exchange (CME). Exchange-traded markets, most notably the global stock markets, get considerable space in the press. They do not, however, represent the bulk of world financial market volume (though regulators have certainly been moving toward getting more trading done on-exchange for the sake of improved transparency).

Two very notable and very significant markets operate primarily off-exchange in the over-the-counter (OTC) market. One is the market for debt – long and short maturity paper issued by governments, municipalities, and companies. While there are significant exchange-traded markets for these money market and fixed income securities (Eurodollar and T-Bond futures are notable examples), the bulk of the volume is in the inter-bank/dealer OTC market.

The other major OTC market is, of course, foreign exchange. There is some on-exchange forex trading in the futures market, but that is just a sliver of the overall global volume transacted each day. The vast majority occurs between inter-bank dealers and their customers (or each other) without passing through any exchange. Retail forex trading is simply an extension of the inter-bank OTC market. As such, one need not get caught up in the “off-exchange” legal designation used by the regulators. It is simply clarifying language.

Would retail forex be better served to become exchange-traded? Perhaps. It would certainly make it easier for those who research it (like yours truly) to get useful information.

My suspicion, though, is that the nature of retail forex makes it hard to adapt to an exchange-based model. The whole daily rollover mechanism in particular is problematic. This is not something which can be done in the futures market with the fixed contract maturity dates. Otherwise, though, retail forex functions a lot like the futures market, at least the ones with cash settlement rather than delivery. This is no doubt why it is overseen by the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) in the U.S., rather than the likes of the Securities Exchange Commission (SEC).

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Toward the end of 2012 I authored a post that discussed a phenomenon academics in the area of behavioral finance term the Disposition Effect. This is a bias theorized and observed in which traders are prone to hold on to losers too long and close out winners too quickly. Anyone who has been involved in the markets for a decent amount of time while have likely heard the equivalent of cut your losses short and let your winners run, which is advice essentially meant to counter the psychological impact of the Disposition Effect without actually naming it.

In that prior post I talked about how this bias can be just as problematic for those taking part in social trading as trading on their own. The inclination to take sure profits can be very strong.

Of course there are ways one can work to overcome the desire to cut winners short and let losers run. Some traders opt for totally automated trading to take emotion completely out of the picture. Those who don’t go that route face significant challenges.

A recent paper looks at the impact on the inclination toward Disposition Effect influences on trading from the perspective of experience and sophistication. The authors find that higher levels of either measure can reduce the impact considerably, but neither can eliminate it on its own. Even when combined, high experience and sophistication will only eliminate the “hold the losers” side of the equation. It does not completely rid one of the inclination to close winning trades.

To restate the above, you can largely overcome the impact of the Disposition Effect on your trading through education and practice. That will make taking losses tolerable, but there will likely still be some compulsion to want to close out winning trades early. Knowing this, though, should help you overcome that bias.

Following on this subject, there’s another paper which looks at the Disposition Effect somewhat differently than most have to date. It firstly supports the case of the paper I just talked about in that it indicates the larger accounts (suggestive of more sophisticated and/or experienced traders) tend to show less inclination toward exiting winners and holding losers. This, however, is only the case when looking at individual trades. When looking at things from a portfolio perspective (they use forex accounts, so think multiple trades being on at once) the Disposition Effect influences continue.

Basically, the second paper says more experienced and sophisticated traders may be able to overcome the Disposition Effect on any given trade, but they still fall victim to it when managing a group of active positions. This is another thing for you to keep in mind, whether you’re doing your own trading or engaging in social trading. The easy solution is to have a specific plan to stick to it.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Broadly speaking, the more someone trades, the worse they do. Did you know that?

A pair of academics named Barber and Odean published a paper in the Journal of Finance back in 2000 with the blunt title Trading is Hazardous to your Wealth.  The focus was on individual stock traders. The authors concluded that the most active traders demonstrated the worst performance on a relative basis. Basically, these stock trades couldn’t overcome their transaction costs.

As part of my on-going PhD research I replicated the Barber & Odean study looking at retail forex traders. I’ve written previously about how retail forex is a negative sum game. As a result, one must anticipate mathematically that higher levels of trading will result in lower returns, on average. Still, it’s interesting to look at what the data has to say.

The study I’ve done breaks the traders each month into quintiles based on their trading activity. I used number of trades, total dollar volume, and turnover (total dollar volume divided by account size) as the metrics of trading activity. In the chart below you will see how each metric relates to performance in each quintile.

The performance shown above (left scale %) is return relative to the monthly average. So when you see positive readings that means for that quintile of traders the monthly return for those in that 20% of the population is greater than the monthly return of all traders (though it’s still negative overall, as the negative sum game expectations dictate). Likewise, a negative reading means returns worse than average.

The pattern is pretty clear. No matter how you look at it, returns are worse the higher one’s relative trading activity. The one little wrinkle is Quintile 5 for volume, which shows an uptick. My suspicion is that relates to the size of trades being done by more professional traders (presumably with larger accounts), but I need to dig into that further to be sure.

As I noted, however, these are aggregate numbers and not specific to any one trader or common group of traders. Thus, they cannot speak to the trading of any one individual. It does, however, demonstrate how destructive it can be to trade very actively (either in terms of frequency of trading or in the amount of leverage applied, which the turnover figures capture) when one does not have a clearly defined statistical edge. This is something you need to think about not only for your own trading, but also when analysing the performance of prospective social trading providers/platforms and other type of alternative investment vehicles.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Stocks are trending higher and the dollar is doing the same. That’s not something we’ve seen much of over the years. We can see from the chart below comparing the S&P 500 to the USD Index how unusual it is for the two to move in the same direction. No doubt the recent positive correlation has thrown a number of algos for a loop.

Of course the whole risk-on, risk-off pattern of the markets holding forth during long periods since the Financial Crisis played a major part in defining a negative correlation between stocks and the US dollar. Traders and investors would either flee from “risky” assets into the safety of the greenback (and US Treasuries), or do the reverse. Obviously, that’s not what’s happening at the moment.

So what’s happening now?

I’d argue we’re back to more “normal” markets which are less psychological and more fundamental. By that I mean exchange rates are moving on market participants’ perceptions of the differences between economies, rather than just reacting to fear.

That said, it is often the case that the USD falls in periods of economic strength. This is driven by American demand for imports. These days the US seems to be the strongest among the major Western economies, so we would expect to see a similar pattern. The markets, however, are reflecting other dynamics at work. Monetary policy is a big factor.

Better economic figures in the US lead investors to start to look at when the Fed will start taking a less accommodative stance. In and of itself, that tends to be positive for the greenback (less or no asset purchases means reduced increase in dollar supply). At the same time, though, Europe continues to have significant issues, and the same can be said of Japan. No one is talking about tighter monetary there, so those currencies are suffering by comparison.

The question is how long that will continue.

As we can see from the chart below, which includes the German DAX index as the lower plot, European stocks too have broken the 2011 highs and are close to the ones from 2007 (the FTSE is showing comparable performance).

The implication of rising stocks on a global basis is the anticipation of better times ahead. Stock market investors may have it wrong (wouldn’t be the first time), but if they don’t, then we should look for improvement in the European situation in the months ahead. That would very likely then mean the dollar losing its strength as more traditional patterns are seen (dollar weak in good economic times). That will be worth watching, as it we don’t see the USD rolling over before too long it may be a sign the stock rally will have trouble continuing.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The big news of the weekend, not just in the markets, was the Moody’s downgrade of the UK credit rating. As some readers will know, I currently live in England. The news coverage here – national, not just business – has been all over it. Naturally, it has become a political discussion at least as much as a financial markets one. We saw much the same when the US went through this a while back.

Of course the markets have anticipated this sort of thing for some time now. As the chart below shows, GBP/USD has been steadily losing ground since the end of 2012.

We can see that another new low was put in at the start of the new week’s trading in reaction to the news. As of this writing, though, that has been reversed in what looks to be a case of “sell the news”.

We can similarly see that UK yields have been anticipating a development like the ratings downgrade for some time now. The 10yr Gilt chart below tells a similar story as that of GBP/USD in terms of a market which has been generally trending one way this year. Interestingly there, though, UK yields have backed off their highs of late even has the currency made new lows, indicating there’s been some kind of shift in the markets of late.

Of course the trend higher in rates and lower in GBP/USD in 2013 is contrary to what many folks expect to see, namely higher rates equating to a stronger currency. The falling pound coming with rising yields in this case points to a declining interest in UK assets and investments rather than some kind of anticipation of tighter monetary policy by the central bank to combat increased inflation. If we think about the relatively poor performance of the UK economy in the last year, this should come as no real surprise.

Just goes to show that one cannot make pat assumptions about cross-market relationships. There is a causality to the way markets correlate which comes from the fundamental underpinning of the markets.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Each quarter the US forex brokers who fall under the regulation of the Commodity Futures Trading Commission (CFTC) – which is most of them – report profitability figures (see the most recent tallies posted by Forex Magnates here). This has been going on since 2010, with reported figures back to 2009. On average, these reports have shown that just about 30% of active accounts (those doing at least 1 trade) make money in any given quarter. The CFTC put this reporting requirement in to provide a bit of transparency as to the reality of performance among traders, but in some ways they have actually muddled things a bit. Let me explain.

First of all, the broker-reported figures are for accounts, not traders. Granted, for most people that is the same thing. As I discussed in a recent post, however, some traders have multiple accounts and the evidence suggests that these are among the better performers. If that is indeed the case, then the broker-reported figures actually overstate how many traders make money each quarter. It’s not likely by a huge factor (probably just a couple percentage points at most), but it is one way these figures belie reality.

The second, and to my mind more significant, problem with these quarterly figures is they provide no indication of whether there is any consistency of profitability. As I documented in Starting to detail forex profitability data, this is something very important to keep in mind because the reality is that most traders don’t get the job done consistently.

According to my research, only about half of all accounts (keeping to the comment measurement of the broker-reported figures) had at least 1 winning quarter during the 3+ year period of my study. Of those who had at least 1 profitable quarter, only about 43% were able to follow that up with another winning quarter in the next three month period. That means we need to take the 30% figure mentioned above and cut it in half (and then some) to get at some sense of reality where consistent profitability is concerned.

Taking it a step further, less than half of those who were able to generate multiple winning quarters were able to produce back-to-back winners more than 50% of the time. That means even among those who are part of the about 15% able showing back-to-back winning performance there is very little consistency of performance.

If we were to continue extending the consistency question to include higher levels of repeat performance we would see lower and lower percentages. In other words, it’s only a small fraction of active forex traders who consistently make money. It’s a hard game to win. Keep that in mind as you decide on how you will approach it.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In academic terms, the Disposition Effect is a psychological bias in traders and investors to take profits quickly and let losses run. This is something which has been talked about in the markets for many years. It comes from a combination of risk aversion effects and a bias toward certainty over uncertainty. In other words, we humans generally prefer a sure gain, even when there is the prospect for a bigger one, while at the same time we prefer having the prospect for a smaller (or no) loss, rather than a sure one.

It’s pretty easy to see how these biases can turn into being quick to book a gain, but giving the market a chance to turn around rather than taking a sure loss.

It is to avoid the potential negative outcomes from this bias – not making as much as we should on winning trades, and taking losses which are much bigger than they should be on the bad trades – that we introduce systems and processes in our trading. For some it goes as far as strictly mechanical trading. For others it includes rules about where to place stops and how to move them up with the market. They attempt to enforce a discipline on us to avoid allowing psychological biases like the Disposition Effect to negatively impact our performance.

Keep in mind, however, that this needs to apply to social trading as well.

In most cases, when using an auto-trading or mirror trading system like Trade Leaders you have the ability to make changes to trades that are done in your account. As a result, there may be the temptation to close out or cut-back a winning trade before it is done by the trader you are following. This is not something that is good idea.

Consider the math of trading performance. Expected returns follow this formula:

R = (win% x avg. winner) – (loss% x avg. loser)

If you close out winning trades early you are impacting the size of the avg. winner. That lowers R – the expected return. This could go so far as to produce a negative expectancy in the most sensitive systems.

In other words, as a social investor you need to ensure you abide by very similar discipline as you would if you are trading in your own right. Don’t let the Disposition Effect drag down your performance.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

In June of 2012, a proposal by the National Futures Association requiring stricter regulation of PAMM accounts went into effect, sending many money managers and CTAs scrambling for PAMM account alternatives.

A PAMM account, or Percentage Allocation Management Module, is simply a way for investment management firms and CTAs to manage individual investor accounts more efficiently. Multiple individual accounts are aggregated into one “Master Account,” which is traded by the money manager or CTA. It is operated as one pooled account and the P&L is divided equally among the investors based on their equity in in it.

In April of 2012, James Bibbings, a former NFA supervising auditor, wrote a very informative post discussing the implications of the pending proposal. Appearing on SeekingAlpha.com, the post explained how the NFA felt PAMM accounts too closely resembled Commodity Pools, without being registered as such.

The points they brought up described multiple instances of structural problems. Issues with liquidity and margin were posing risks to investors and contributing to questions about the fairness of the division of P&L among sub-accounts. In the proposal, the NFA recommended the restructuring of PAMM accounts as a means of eradicating any dangers they could cause participating investors.
Bibbings also notes that PAMM scrutiny has reached the state level. Pennsylvania state security regulators saw the PAMM allocation system as a mechanism that was generating a “synthetic securities product.” This view made PAMM accounts subject to many additional securities laws and regulations in Pennsylvania, and could do so in other states, too.

At the time of Bibbings post, things weren’t looking good for PAMM accounts as they fell under intense regulatory scrutiny. Two months later, after the proposal took effect, “traditional” PAMM accounts began disappearing to make their necessary compliance changes. Some companies have seized the opportunity to create PAMM alternatives and others offer consulting services to help existing PAMMs comply with the new rules.   These instruments play an integral role in providing CTA’s and Money Managers with the key benefit of PAMM accounts: centralized management.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Labour Day has come and gone, which means the US summer season is officially over.  Wall Street brokers have made their way back from the Hamptons, and returned to their desks to prepare for the final stretch of 2012, a year that has been kind to the owners of common stocks so far, with the Dow Jones Industrial Average delivering solid, double-digit percentage-point gains during the first eight months of the year, while the S&P 500 has returned to the levels that prevailed just before stock prices descended into free-fall in the autumn of 2008.

It is often said that bull markets climb a wall of worry, and the old, nineteenth-century adage has certainly proved true in the year-to-date.  Indeed, investors’ asset allocations appear to have been swayed more by the potential for further unconventional central bank action, rather than the myriad threats – from the persistent turbulence in the euro-zone to a rapid slowdown in Chinese economic activity – that would have been expected to keep risk appetites in check.

Long-term investors are undoubtedly cheerful, but they would be wrong to take comfort from the stock market’s relatively tranquil price action in recent months, as the latest upward move has been accompanied by a marked deterioration in technical indicators, and a growing air of complacency among the professional investment community.

The major market averages’ risk/reward profile is decidedly asymmetric at this juncture, with the potential downside far outweighing any possible upside.  As a result, a nasty surprise could well lie in wait for the increasing army of bulls, who display uncritical satisfaction with their current allocation to risk assets.

The ‘Dow Theory’ is a useful place to start given its long and rich history as a staple for wannabe technical analysts, and it reveals some discomforting divergences that question the true health of the stock market’s present condition.  Far from confirming the optimism of the diehard bulls, the study of recent price action and trading volume, suggests that the upturn in the major stock market averages has become increasingly fragile, and when some of the financial world’s savviest short-term traders hint that are they are positioning for an impending downside shock, perhaps it would be wise to take notice.

For those unfamiliar with Dow Theory, it was derived from a series of Wall Street Journal articles penned by the newspaper’s founding editor, Charles Henry Dow, from 1900 until his untimely death, aged just 51 years, in 1902.  The journalist assembled the Industrial Average in 1896 and the Railroad Average one year later, which meant that he had only a limited sample of historical data from which to develop a cohesive theory.

Dow’s failing health meant that he had little time to put all his thoughts on paper, but William Peter Hamilton, his successor at the financial newspaper, used his predecessor’s theory as the basis for the market predictions he made in more than 250 articles from 1903 until his own death in 1929.

Hamilton clarified the basic outlines of the theory in the 1922 classic, “The Stock Market Barometer,” and the study of stock price movements was further refined by Robert Rhea, who reduced the analysis to a set of theorems that an ordinary investor could understand, in 1932’s timeless, “The Dow Theory.”

Dow believed that both stock averages must confirm a trend, and Rhea noted in his text that, “The movement of both the railroad and industrial averages should be considered together…Conclusions based upon the movement of one average, unconfirmed by the other, are almost certain to prove misleading.”

In this regard, it is interesting to note that the recent cyclical high in the Industrials has not been confirmed by the Transports.  Indeed, the Transportation Average reached a cyclical peak during the summer of 2011, and registered a lower high earlier this year.  Rhea warned that, “A wise man lets the market alone when the averages disagree.”

Dow argued that trading volume should confirm price trends, and Rhea believed that investing in a market that had become “dull on rallies and active on declines” was foolhardy.  The entire advance off the crisis-induced lows during the spring of 2009 stands out in this regard, as trading volume has been consistently higher on weakness.  Indeed, the coefficient of correlation between the ninety-day average of trading volume and stock prices has been a disturbing –0.84 since the cyclical bull market began, as compared with a positive correlation of 0.88 during the early years of the great 1980s bull market.

Not only has trading activity collapsed, with volume at the recent cyclical high in stock prices almost sixty per cent below the figure recorded at the 2009 bottom, but daily price changes have also declined into insignificance.  Since the crisis-induced low, stock prices have registered a percentage point move of more than two per cent once every nine trading sessions, and a more than three per cent change once every 28 sessions.  Recently however, the daily fluctuations have been miniscule; there has been just a single two per cent change in almost fifty trading sessions, and the market has not registered a daily move of more than three per cent in nine months.

Dick Arms, a respected figure in the world of technical analysis, observes that, “There are times when the market gives the impression it is fading into nothingness.  Volume becomes very low, trading ranges become very small, volatility becomes very low.  Also, there is very little change in market levels, and day-to-day fluctuations are minimal.  Looking back at history, when that happens, it is almost always a sign of a market high point.”

Investors have been warned.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

It’s always reassuring when an industry leader releases information shedding positive light on the future of an alternative investment. Today, it was derivatives marketplace Chicago Mercantile Exchange, or CME Group, discussing the promising outlook of foreign currency futures.

Since the CME is arguably the biggest futures exchange out there, is it any surprise they’re touting FX futures contracts? No, not really, but the whole concept of currency futures is still pretty interesting nonetheless. I decided this fit as a nice follow-up to a post I wrote the other day on managed futures and risk mitigation in general, since these particular investments can get a little complex.

For anyone who’s unfamiliar with them, currency futures allow investors to exchange one currency for another on a future date at a specified price that is set at the time of the agreement.  This allows investors the ability to make a purchase that will be executed sometime in the future for the price it would cost them today. In turn, they’re granted protection against exchange rate fluctuations, which could end up working for or against them depending on where the currency pair moves.

Derek Sammann, global head of foreign exchange and interest rates at CME Group, explains how, due to rapid economic globalization, cross-boarder asset flows show no sign of slowing down anytime soon. This provides both a growing opportunity for potential prosperity, as well as risk, for investors interested in tapping the $4 trillion a day foreign currency market.

As Forex continues to become a more mainstream alternative investment option, the need for a supplementary vehicle for hedging risk will inevitably rise. Currency futures are just one avenue investors can take to fill that need. Others come in the form of continuously developing advanced software controls within the realm of spot Forex trading. As various up and coming forms of alternative investments popularize, it is interesting to note what types of risk controls they will inspire and bring with them.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.