ETF Securities is now providing levered 2X ETFs on four popular European indexes (see Financial Times article, Citywire article). The eight ETFs being offered include both long and short exposure on the FTSE 100, Dow Jones Euro STOXX, CAC 40, and DAX. The four 2X short ETFs will carry annual management charges (AMC) of 60 bps. The 2X leveraged long ETFs will carry charges between 40 and 50 bps. The company is offering the ETFs to allow fund managers the ability to hedge portfolios in place of borrowing stock or using derivatives.
According to the recent TIM (Trade Ideas Monitor) report and the TIM Sentiment Index (TSI), institutional brokers became more bullish over the last five trading days as the TSI increased 12.7% from 51.96 to 58.54 (see previous post or youDevise website for additional information on the TIM report). For the five trading days ending June 25, the number of new long ideas as a percentage of new ideas sent to investment managers increased to 72.55% from 70.92% one week earlier (see last week's post). The intra-week trend was positive. Longs now represent 66.50% of all ideas in June.
As for individual securities in the U.S. and North America, Ashland Inc. (ASH), Bank of America (BAC), and Black & Decker (BDK) were the stocks most recommended as longs by institutional brokers, while Boeing (BA), Century Aluminum (CENX), and Microsoft (MSFT) were recommended as shorts. The information technology, industrial, and energy sectors had increased broker sentiment for the week, while health care had decreased sentiment.
Below is a video by Peter Navarro which explains how he uses a select group of international exchange traded funds to better help him time trades in the domestic market, in particular, the S&P 500 (SPY). The three international indexes he follows include the FXI (following 25 large and liquid Chinese companies, sometimes called the Dow of China - betting that as China goes, so goes Asia), the IEV (following the S&P Europe 350 Index), and the ILF (following the S&P Latin America 40 Index).
While I have not back-tested these specific indexes for providing leading signals, the video does remind us of the benefits of looking at other data for helping one to spot trends and even forecast movements in domestic indexes. A number of years ago I was engaged in some research that was looking to see if the S&P 500 could be used to help predict trends in various international indexes. After all, the feeling was that as the U.S. goes, so goes the rest of the world - or so we assumed. As our research progressed, and we began doing correlation studies, principle component analysis, information-based data mining, and everything else we could throw at the problem, it became clear that in many instances we had it backwards. The international indexes were more predictive in helping forecast the U.S. market. While some of these correlations broke down over time, it nonetheless helped send the message that we could not assume that the U.S. markets were always driving the world markets, or that the influence was always consistent, in either size or direction. While this is more clear today, and less of a surprise, it still seems as though few traders and investors use such information. The three international ETFs mentioned above are a good place to start your own studies.
In an interview with the WSJ, Gary Gensler, Chairman of the Commodity Futures Trading Commission, said he believes the most critical change needed in the oversight of derivatives is the regulation of dealers involved in derivatives (see article). He goes on to say that "only through the dealer can we get the whole panoply" of information regarding derivative contracts. Such a move would require customized contracts traded over-the-counter (OTC) to go through a central repository, similar to an exchange clearing house.
Gensler believes that "central clearing will further lower risk," but will it? While this is probably true initially, the long-run benefits could disappear. How so? Given that dealers will need to abide by stricter capital and margin requirements, the capital requirements will no doubt continue to grow as the added liquidity risk of less actively traded contracts is accounted for. While again this seems sensible, the extra cost will force even more contracts to move on to the exchanges. This will in turn reduce the amount of OTC contracts that are likely to be offered. Once again, all good, right? Not necessarily. One of the benefits of OTC contracts is that you can develop a specialized contract that better matches the risk you are trying to hedge. Standardized contracts do not offer the same flexibility, causing a company to enter into less than perfect hedges, thereby making the company more risky over the long-run. This has the effect of causing risk management to be more expensive and less efficient for companies, just at the time when additional risk management is being encouraged.
Once again, raising capital requirements on risky assets has some obvious benefits, but hopefully the added burden is not so much as to eliminate the efficient use of the OTC market. If this happens, regulators may find themselves dealing with yet another problem. In the mean time, I guess at least the exchanges (NYX, NDAQ, CME) will be happy as the potential for increased order flow continues to rise.
That great American philosopher Mike Tyson was once asked about whether it worried him that his opponent was training hard and seem to have developed a fight plan against him. Tyson respond with something to the effect of "Everybody has a plan until they get punched in the face". So true. Once you get knocked back on your heals, everything changes, with your plans often getting scrapped in the process. Traders and investors know the feeling all too well. Even the best made trading plans and analysis can be ignored after the market throws you a curve ball and administers the equivalent of a punch to the face.
All of this came to mind today as I was watching what seemed to be a muted reaction to the Fed decision, and more importantly, a reaction that did not fit well with the plans or expectations of many of the traders I was following on Twitter. When this happens, it is easy to start improvising, but of course, this is were new traders, and even those with experience, start to get into trouble. On such days I always find it useful to remind myself of some common mistakes to avoid, three of which are nicely presented in a new wallstcheatsheet.com article based on interviews with traders Joe Donahue and Joey Fundora (see article). While most mistakes fall into the category of common sense, it is still good to remind ourselves of them from time to time. The three mistake given by Donahue and Fundora, along with some added comments, include the following:
1) Not Selling Fast When You Are Wrong: Here it is important to remember that one of the most important metrics is knowing what you can lose on a given trade or investment. Of course, having an idea what you can make is also important, along with knowing what the risk-reward of the trade or investment is, but knowing when to cut your losses will keep you in the game. The old adage of "let your winners run, but cut your losses quickly" applies here. If you let the winners run, but have tight 8-10% stops on your losses, it is possible to be right less than half the time and still make money since you have kept yourself in the game for those times when your due diligence pays off, and the market finally realizes how smart you are.
2) Using Multiple Approaches or Strategies: This ties in somewhat with the Mike Tyson quote. While it is important to have a trading/investing plan and strategy in mind, you need to remember that every once in a while the market is going to punch you in face. During these times it is important to remember why to got into the trade and try not to stray or trade aimlessly or recklessly, simply chasing. Sometimes the best contingency plan is to simply walk away from the computer and shut your engines down for the day, giving yourself time to evaluate your strategy.
3) Trading Too Large: Trading small, or even paper trading, is always good advice for new traders. Stepping back on the amount of capital at risk is also good for experienced traders who have hit the wall and are not seeing trades and investment opportunities quite as they should. Even baseball players that consistently hit over .300 will lay down a bunt just to help them get out of a slump. Trading is no different - except you often don't get paid when in a slump, making it all the more tempting to swing for the fences. Discipline is key.
A few other common mistakes worth repeating include the following (adapted from here and here):
- Mistake 4.) Committing too much capital per trade
- Mistake 5.) Not effectively using different time frames
- Mistake 6.) Not using technical analysis (using only fundamentals, especially for short-term trading)
- Mistake 7.) Not paying attention to what the market indexes are doing
- Mistake 8.) Not being selective enough, and taking the time to screen for the best opportunities
- Mistake 9.) Not paying attention to volume
- Mistake 10.) Not paying attention to sectors (and industry trends)
- Mistake 11.) Not knowing what to expect from the trade (risk versus reward)
- Mistake 12.) Being greedy and not leaving the party soon enough
- Mistake 13.) Following the crowd too long, or too late in the move (chasing the market)
- Mistake 14.) Immediately reversing the trade once it goes against you
- Mistake 15.) Trying to pick tops and bottoms
- Mistake 16.) Losing your cool and letting your emotions cloud your thinking
- Mistake 17.) Waiting too long to pull the trigger after the analysis is done
- Mistake 18.) Trading too many markets at once
- Mistake 19.) Assuming the news you just read has not already been discounted by the market
- Mistake 20.) Relying on tips or talking heads without doing your own analysis.
Traders who are clients of StreamBase are using software developed by the company to scan Twitter for information that can be utilized by their algorithm-based automated trading platforms (see Telegraph article). While the company is not specific about who is using the software to follow Twitter feeds, current clients of the company include the Royal Bank of Canada and hedge fund BlueCrest Capital Management. Those using the software to monitor the Twitter feeds hope their automated trading platforms can utilize breaking news that has not yet been filtered by providers such as Reuters Thomson or Bloomberg. One trader mentioned how using a broadcast tool such as Twitter would allow them to further take advantage of the ability to "buy on the rumour and sell on the facts." Given the volume and variety of the content you find on Twitter, or for the matter, any message board or social networking site, the term "rumor" is probably a little generous in many cases. For their sake, let us hope that those firms following any social networking site have a good AI system for separating the wheat from the chaff. This tasks is hard enough when all you are following are those slow "filtered" news sites.
The Institute for Financial Analysts polled its members and found that they no longer believe in efficient markets, or at least that prices reflect all information (see hedged.biz article). So, is stock investing based on fundamentals a waste of time? After all, information is more prevalent now than every before, and new information (for the most part) is suppose to be shared equally. If prices are not reflecting fundamentals, then surely, efficient market theory is lacking. As a kind of compromise, some will argue that while the markets are efficient, the participants are not, each analyzing the news, information, and data differently. It is felt that this is where some of academia has gone wrong - assuming that all participants interpret new news in the same way (although those in behavior finance might beg-to-differ).
Unfortunately, this view usually creates more confusion given that for many the participants are the market, such that as long as there are human traders, there will be fear, greed, and pricing anomalies. This is why it is often felt that being a fund manager is as much about understanding historical patterns and psychology, as it is about knowing the fundamentals. The irony is that as the flow of information has become more efficient, given the Internet and the 24-hour new cycle, one could speculate that the market may have actually become less efficient. Now freshly armed with new information, you have even more traders and investors trying to figure it all out, each with their own biases, over-reactions, and in some cases, somewhat predictable herd behavior. Such inconsistencies will no doubt keep market participants looking for alpha, all the while allowing fund managers and technical analysts to continue to thumb their noses at those in the ivory tower.
Over at the Clusterstock blog (poster John Carney), there is an interesting discussion/insight from Michael Lewis into the new regulatory reforms being introduced by the Obama Administration (see article here, original video link here, and embedded video below). A few days old, but worth a look. Interesting, and a little depressing.