Outlook

28 November 2017

Global economic data has taken a positive turn leading to optimistic demand projections for oil. The Eurozone is on-board with the global trend, lifting the Euro up from major lows earlier this year. Even the Greek economy is reporting healthy growth levels. The chief laggard in EU is now the UK which is on the way out, more good news for The Euro.

On the plus side for The UK, the pound has retraced half of the post-Brexit-vote dip. The full re-tracement can only happen once Brexit is complete, a good argument for a cliff-edge solution. The improving global economic climate is softening the blows and heralding a return to investment in The UK. More details here.

 

Disclaimer

Cable Flash

There will be a lot of speculation about what happened to the pound overnight, even after the analysts have given their answers. The difficulty of doing a conclusive analysis is that Forex transactions are not channelled through exchanges like stocks and shares, it is a dispersed market.

Nevertheless, there are a finite number of possibilities, including these:

1. Fat Fingers. Someone put too many zeroes in their order.

2. Algo Frenzy. The machines doing rapid fire selling, because the other machines are doing rapid fire selling.

3. Stop Hunt. People speculating on the pound rising, “the longs”, would have protective stops below the current price to defend against a sudden shock. If all those stops are tripped you get a cascade down.

4. Traders and/or hedge funds running “night raids” on the pound while the Bank of England is literally in bed.  This is similar to the George Soros attack in 1992.  If this is the case it is a perilous time to be in any GBP trading.

Certainly long speculators have had their stops taken out and suffered serious losses. It is possible that someone did this deliberately to clean out the speculators and get a clearer picture of what business thinks of Brexit. Only someone with a lot of money, like a Central Bank, would be capable.

The truth is likely a combination of the above. In the dead of night, a sleepy fat fingers trade or a hedge fund raider launched the Algos into a frenzy and tripped the stops of all the Brexit speculators. A perfect storm, or rather a sort of strange noise in the night that we’ll never really understand.

If that isn’t exiting enough, here are some charts:

Fig 1. on a typical day the pound moves 0.011 in dollar terms. During The Flash, it moved 0.098. In trader terms, we usually move 110 pips per day, here we had 980 pips in 5 minutes. Each bar in the chart shows 15 minutes of trading. This is a very ugly chart.

gbpusd_20161007_flashm15

Fig 2. Compare it with the worst move in recent memory, on Brexit night, 1790 pips over 5 hours, this is how human traders deal with a shock. The Flash is a much sharper move, it looks machine made.

gbpusd_20160624_brexitm15

Fig 3. Just to emphasise the extreme nature of The Flash, this chart shows each individual price move, “tick”, as it happened. In the first 26 seconds there are lots of ticks and a 250 pip move. It’s already scary. Between 01:07:16 and 01:08:41 it looks like one huge trade moved 600 pips. That would cost around $6 billion. That goes beyond scary, open mouthed staring happens here. To get another perspective on the size of this Flash, look at the “aftershock” at 01:13:04, that vertical jump is slightly bigger than a normal trading day.

gbpusd_20161007_flashtick

Fig 4. Contrast that with typical price moves at that time of day/night, 24 hours earlier. Look carefully at the price scale, it moved 4 pips during the same period on 6 Oct.

I don’t have enough detail to work out exactly what happened and no information on who did it. Until someone confesses it is unlikely anyone will have concrete answers.

The wider analysis points to a combination of a government happy to let the currency suffer the fallout of their conference posturing and currency traders who persist in trading best case scenarios. To the second group I can recommend Nassim Taleb’s article  explaining how a government with a thin majority can only deliver a hard Brexit and why it will be worse than the worst forecasts.

Day Trader

A defining trait of the Day Trader is he starts each day with a clean slate, there are no trades running overnight.  This is because short term trades follow daily borrowing rate fluctuations.  It follows that a position entered on this basis can not be held overnight.

Many institutional traders are using the same trading and risk management tools as each other, this leads them to take similar day-to-day positions.  When this happens the price charts show consistent moves at certain times of the day.  The Retail Trader can benefit by spotting these moves as they develop.  There is no need to attempt predictions using technical analysis tools.

It is sufficient to be aware of the opening price of the day and the trading direction, which will be set during the opening session.  Entries and exits can be taken when momentum fades and prices form highs and lows.  14 day ATR levels and monthly highs and lows provide additional exit points.  Economic data releases can be disruptive, trading those periods is a matter of experience.

Multicollinearity

A horrible unreadable chart
Too Many Indicators, an unreadable chart

The most important thing to know about technical indicators is that what you are seeing is in the past.  So, it doesn’t matter if you use a Moving Average or MACD, it’s all in the past.  Also, MACD is a calculation based on Moving Averages so if you have both, you are cluttering your charts with two views of the same thing.  This is Multicollinearity, if your indicators are based on closing prices, you only need one of them.

Mean Regression is the justification for trading Moving Averages, the price reverts to the mean (average).  However, you just have to try it, or look at a chart to see that just as often the Average will catch up to the price.

Unlike natural phenomena, say an athletes performance, price is not bound to revert to the mean because the underlying factors that determine performance aren’t limited. If the ECB launches a new QE program then today’s Euro won’t be worth as much as yesterday’s Euro, there is no point sitting there waiting for it to revert to the mean. Price Discovery kicks in, and that’s one very important element that does not have a Technical Indicator.  In such a scenario, Technical Analysis will have to be suspended until the price settles into a new Trading Range.

Athletes performance? Yes, the Sports Illustrated effect. When an athlete in a rich vein of form makes it to the cover of Sports Illustrated, his performance drops. Aka, the Curse of Sports Illustrated. In this scenario, the athlete is actually performing above his mean for a period and gets noticed. So they put his picture on the front cover. Then, his performance reverts to the mean, and Sports Illustrated gets the blame. The reality is nothing happened, performance is variable in any sport. Each athlete has certain average or mean where he performs most of the time, occasionally raising his game, sometimes dipping below.

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