Tuesday, July 31, 2012

Does it sting a little to be right, and not involved?

In my prior post, i described the probable outcome as dictated by Market Profile is ES (buying the bottom of the bell curve @ 1375.5, and then getting flat when the mkt trades up to 1380...the new center of value).  I also said that this was more of a gut call than a model generated trade (because the model had conflicting signals), and thus, I would not participate in the trade.  So, does it sting a bit when you have a gut call, and you don't do anything about it?  I'll say "Yeah, it stings little, but that is the price of discipline."

Stocks should have sold off by now...so i covered

To start, I just bought back my 1 unit of ES contracts at 1377 (short originated at 1382).

If there was going to be a major reversal of Fridays move in ES, it should have happened by now.  Comments came out of Germany that put a damper on the new ECB rescue attempt.  While the market shows no signs of strength...it isn't falling apart either.  Its unlikely for new significant positions to be initiated in front of tomorrow's FOMC statement.

Market profile would suggest that we are hanging at the bottom of the bell curve in a non-trending market amid very low volume...and so would suggest buying the market here, with an intention of getting flat back at the center of value, which seems to be around 1381.  However, this is a very tight bell curve (only 11 S&P points from top to bottom).  If I had to have a position, I would buy the bottom of the bell curve here (1375.5 in ES) with the expectation that I could sell that position out at 1380.  However, I don't have to have a position, so I'll stay flat for now.

Ona longer 2-week term view, i'm bearish on ES in general.  However, trading is a business, and its not my job to trade what my gut feels.  Its my job to trade when the probability is greater than 80%.  Does it sting sometimes when my gut is right and I don't participate? Of course it does.  Have I tried trading my gut in the past and gotten burned?  Of course I have.  This is why I attempt to be disciplined now.  Experience is a bitch...but at least we don't forget those lessons.

Finally, the German rebuke we've been waiting for

 9:11 AM NY time Bloomberg headlines

So finally German bankers have spoken to say "NO" to Mario Draghi, and his idea of the ECB printing more money and buying Spanish and Italian sovereign debt.  This means that, NO, the ECB cannot finance Spanish and Italian spending by priming up the printing press.  I watched a movie the other night, where a group of Spaniards and Italians were criticizing Americans for always working so hard and not enjoying life.  What these Italians forgot to mention was that they enjoy life so much  by spending money they don't have, and then criticize Americans for being so "stingy" with life.   While I agree that the Americans that I know tend to work too hard (wall street tends to do that to a person), I think the Spaniards, Italians, Greeks and French could take a lesson from those who don't spend what they don't have.  Just Say'n.   So anyway, this should be negative for stocks (ES), and bullish for US bonds (ZN).  The bond market didn't dip enough overnight for me to buy it, so my only position is that small short position in ES.  The only hope for ES now is for the FOMC to announce QE3 at tomorrows 2:15 PM FOMC statement.  Personally, I doubt that will happen, but who knows.

So, lets take a step back and return to market profile.

In treasuries (ZN), a mode has not been established yet (we haven't spent enough time and volume at any single price area). We wanted to buy a dip, but the market did not dip, it has just been floating up up up.  In stocks (ES), the overnight market was remarkably stable, but the cash session hasn't opened yet, so we still need to wait and see what will happen between 9:30 and 10:00.  I'm hanging onto my short position for now, hoping for something in the neighborhood of 1360.  Normally, after a buying day (Friday), when the market stabilizes for 2 days in a row (Monday and today), the buying day gets "undone" as the fresh buyers dump their stocks after not getting "satisfaction."  However, that is not an 80% probability type of trade...its more like 55%...which is not good enough to trade on in large size.  While I "expect and hope" for stocks (ES) to selloff...market profile is neutral on this trade, which is why my position is so small.

more later....good luck trading

Monday, July 30, 2012

Trading stocks and bonds with Market Profile

I don't advise any trader to limit themselves to any one idea or method.  However, Market Profile seems to be one of those tools that enables traders to best filter out the noise, and is perhaps the best tool to view the long end of the US Govt bond market (for our purpose here, ZN 10-year futures), as well as the S&P Index eMini contract (ES).  For this reason, I will mostly be talking about the US Govt Bond Market and Stocks (hereafter referred to as "the market" or just "the mkt") in terms of Market Profile as I attempt to blog about my trading in real time.

In order to effectively use Market Profile, and hence, the concept of Bell Curves, we first must agree on a few concepts.  The Mode (like from statistics) is just another term for the current center of value.  When the market is not trending, the mode will suck in the market with "gravity."  High amounts of both trading Time and Volume will occur at this center of value.  The farther away from the center of value during non-trending activity, the stronger should be the force of gravity, and hence the bigger should be our positions with an expectation of a return to the center of Value.  There are different models that use Market Profile to determine the center of value, as well as the extended value zones, in order to determine the best times to initiate / exit a trade. 

The million dollar question is, "how do we determine when the market has transitioned from non-trending to trending, and how do we know when the center of value has shifted?"  The answer to these 2 questions are the most difficult in trading, and correspondingly, the most profitable opportunities.  We will attempt to answer these questions thru observation and example as we post our interpretation of the market, as well as our trades so the audience can follow along.

So, lets dive right in and look at what the market has done over the past couple days.

Friday and today (Monday July 30), the bond market is in what we call "value seeking" mode.  This means that, while surely there is a center of value somewhere, the market has not been kind enough to inform we observers what that level is in the market...not yet anyway  For this reason, there is only minimal edge in having a position from a Market Profile point of view.  Below is a screenshot of the Sept 10-year US Treasury Future, Market Profile chart (5 days, 30 minute periods) with volume at price overlapping time at price.  Below the market profile image is the corresponding 5 day intraday price graph, just so we have a common frame of reference.

ZN Market Profile

ZN Tick

While we can (and will) talk about what happened on Friday July 27, and Today, Monday July 30, you should know the story as it would be told by any participant.  Namely, on Friday morning around 9:00 AM in NY, several large macro hedge funds sold the bond market in size, while simultaneously buying stock index futures, also in large size.  This was in reaction to a Medley Global Advisors report, stating that the political landscape within European Central Banks had shifted in favor of using the ECB to purchase peripheral govt debt to reduce interest costs for struggling nations.  Then, just after 1:00 PM NY time, the head of the ECB publicly announced that he and the ECB  would "do anything necessary to save the EUR."  Thus, the Medley report was proved "true"and the market went haywire for about another hour (1pm -2pm).  While the stock market held onto its 1pm announcement gains, the bond market returned to pre-1pm levels after about an hour.  This is all that happened on Friday.  There were no new announcements over the weekend, and Monday proved to be a slow grind higher, back to the level where the "Medley sellers" initiated their position.  This is where the market now sits as i write this blog post Monday afternoon.

All this movement around political announcements extends the time frame for which Market Profile must be expanded, in order to properly observe what is taking place in the market.  Or, in other words, these announcements, and the markets reaction to the announcements, do not change the dynamics of the market as viewed thru the lens of market profile.  Yes, stocks rose sharply, and bonds sold off sharply because of these announcements.  However, in the long run (lets talk 1 week here for the long run, which is an eternity in the capital markets), market profile will still enable us to talk about the auction process of the market, and come up with a clear prism thru which to view the market.

So, lets see what Market Profile would say about what happened on Friday.  The bond market started off with an initial center of value around 135-00 (134-29+ during the overnight session) with the most recent volatility being 7 ticks both above and below this center of value (we are talking about Thursday afternoon, moving into Friday morning).  (That takes us to about 6:00 AM Friday)  The next event to attempt to move price was the Medley report.  An attempt to sell the market moved price away from the most recent center of value.  Important to note that this selling attempt was initiated BELOW the center of value (134-17 is where the large selling volume occurred, and you could have seen this in real-time if you were watching the futures market).  The selling volume was larger than 10% of the ADV, which tends to be enough to move the bond market for a while.

Note, the ADV of the US Govt bond market is about 450bln 10-Year duration equivalents.  This means that 25 bln 10-year equivalents is usually enough to cause the market to escape the gravity of the center of value, at least for the day.

So our market profile tells us that a large seller has attempted to sell the market at 134-17 from below the center of value. We are still just watching at this point.  We then observe the head of the ECB concur with the Medley report (no surprise here..Medley is almost never wrong in the short term).  The bond market goes home Friday in the low half of the range at 134-07 (again, not surprising given the way the selling worked out.   The market has not spent enough time at any one price area to determine a new center of value.  Also, the selling was initiated from below the center of value (previous days value was 135-00...and the overnight value was 134-29+).  So, we are left wondering, did the sellers create enough of an oversupply condition to transition the market from non-trending to trending?  We would need to see the market spend a significant amount of time in the lower 3rd of the selling days distribution.  So, now lets go over the numbers.  The ZN seller sold most of the product at 134-17.  The local low with any volume was 133-28.  This is approx 21 ticks. So, 1/3 of 21 ticks is 7 ticks.  If this seller was going to successfully create a trending market, we would expect to see the market stay below 134-03 (133-28 plus 7 ticks = 134-03) for the next 8 trading hours.  We count trading hours starting at 2:00 AM NY time (about 7am London time) thru 5pm NY time.  Tokyo trading is generally irrelevant for this determination as very little volume trades there.  Unfortunately for the sellers, the market ends up settling around 134-07, which is already 4 ticks above our determination of where the market would need to stay below in order to create an oversupply condition.  8 hours later (10am in NY) the market is still trading at 134-07 (after dipping briefly to 134-02).  This is not looking so good for the sellers.  While their position is still "in the money," we would have expected the market to stay in the lower 1/3 of the trading distribution after their selling.  This would indicate the beginning of a new trend.  This has not happened.  This indicates that the probability that the sellers will ultimately (within a week) be unsuccessful is greater than 60%.  Fast forward another 6 hours to the end of the NY trading session at 5pm NY time, and indeed, the market has traded all the back up to where the large sellers initiated their position, and will go out at 134-18.  This leaves us with a very interesting question...have these 10year bond sellers closed out their position, will they attempt to sell the market again, or do they still need to cover their short?  If they closed out their position, then we can expect the market to settle in to a new center of value relatively soon.  If they have not closed out their position, then that means they still need to.  That would create a massive short covering rally, as todays buyers are currently in control (having initiated their long positions around 134-08). 

So, lets see what our options are.
a)  Friday Sellers holding and Monday buyers holding (buyers in control with mkt around 134-18)
b)  Friday Sellers have already short covered and mkt has not been bought by new buyers

Under scenario a, the most likely outcome is a massive short covering rally
Under scenario b,  the market will gravitate to some new center of value

Given the price action of the past 2 days, both scenarios seem to indicate the bond market moving to higher prices.  However, we do not like the concept of buying high without an under supply condition.  The market moving to higher prices in these scenarios results from short covering, and short covering is difficult to predict.  That said, short covering is exactly what we are predicting.

So, as I transition from teacher to trader, I will look to buy a dip in the ZN bond market overnight, but I will be small.  I will also look for an opportunity to sell ES stock futures overnight.  The reasons are not identical but similar.  Stocks (ES) traded up 30 points on Friday, but only went sideways today, while bonds rallied.  As stocks tend to be the last bastion of hope, and the potential for Fridays buyers of stocks to have been the offer into today's strength while they bought back their bonds (hypothetically), the net pressure in stocks is now towards lower prices.  Just to have a position, I sold 1 unit of ES contracts at 1382 today.  I was looking for a chance to buy a dip in bonds, but a dip did not materialize.  Perhaps overnight.

I'll update overnight if i make any trades.

Good luck trading

Will "Medley Global Advisors" become the next "Expert Networks" scandal for global macro hedge fund insider trading?

As a participant in the capital markets, along with many of my peers, I often wonder how the markets (stocks, bonds, futures, Forex) can move with such large volumes in such short spans of time, shortly before public government officials make public statements.  This statement i just made was facetious...because I know exactly how these market movements occur, and I've grown fed up.  Allow me to explain.

Statements by public government officials regarding economic policy are classified as "material non-public information" before they are made public.  For this reason, wouldn't prior knowledge of these statements not only preclude persons from trading on the information, but also preclude persons from disseminating the information to others?  Wouldn't the government officials who "leak" this "material non-public information" be accountable to some legal ramifications for their actions?  Would selling this information to 3rd parties who then trade on this information be considered "insider trading?"

In 2001, Goldman Sachs got caught participating in just this type of scandal.  The short of the story was that a Goldman employee gained "material non-public information" that the US Treasury was about to stop issuing new 30 year US Treasury bonds, shortly before the information was made public.  The Goldman US Govt Bond trading desk proceeded to buy 30 year US Treasury bonds in the open market, before this information was made public.  Then, after the announcement was made public, the value of this trading position skyrocketed, Goldman sold the position for a quick profit, and then proceeded to business as usual.  For any doubters out there, this activity is illegal.  Possession of the "material non-public information" precludes any person from acting on the information "in any way."  This causes us to beg the question, "does the same standard hold up to general statements to be made by government officials with decision making power over their domain?"

So last week, the head of the ECB, Mario Draghi, made some very aggressive but vague comments about how the ECB will do anything to save the EUR and the EU.

from Bloomberg July 26 headlines

Interestingly, just before these official comments came out, a Medley report was published to a small but expensive subscriber list, indicating the political climate in the Euro area had changed regarding central bank purchases of peripheral government debt.   For those who are unaware of how this system works, the firm "Medley Global Advisors" has unparalleled access via their "relationships" to central bankers and their staff, along with a plethora of other government employees.  Many of the employees and analysts at Medley Advisors are former employees of these central banks, and thus have an inside track on the thinking, and just perhaps, on the public speeches that central bank officials will make, before they are made available to the general public.  Now, i'm not a lawyer or a specialist on the definition of insider trading, but something about this smells fishy to me. This is a firm with 2 main products.  One product is an economic analysis of varying countries and economic sectors.  Fair enough, they have a great deal of experience in analyzing and predicting trends on these topics.  The other service is an "insiders view" into the thinking, thought process, and content of future statements to be made public, by government officials, ranging from FED and ECB central bankers to Treasury officials and other government employees.  This "other service" is the real service. Hedge funds and investment banks pay big money (hundreds of thousands of dollars) for this inside information.  I'm just wondering, what makes this "inside information" different from "SEC classified inside information" about a company before it too is made public knowledge.  I may not be a legal scholar, but something just feels illegal here, with a similar feel to the "Expert Networks" that Raj Gupta has been convicted of using to obtain inside information about companies before trading in their securities, and very similar to the incident where Goldman Sachs got caught up in back to 2001.

From my prior experience on a sell side US Treasury trading desk, I know that a number of large Global Macro hedge funds trade in large size almost immediately after a Medley report is issued, when the said report indicates a change of attitude or warns of future speech forthcoming from central bank and other governmental figures.  My question dear readers is thus:  Is this service from Medley Global Advisers legal?  Should the government officials who "leak" this "material non-public information" go to jail?  Should Medley Global Advisors be prosecuted for disseminating information they know to be "material non-public information?"  I don't know the legal answers to these questions, but I somehow doubt that the well connected owners and employees of Medley Global Advisors would appreciate even the appearance of impropriety.  Isn't that the standard government officials are supposed to be held to?  I personally do not have the financial or legal ability to pursue this line of questioning.  However, perhaps some interested journalist might take the torch and pursue this apparent case of insider trading in the global capital markets?  If this behavior is not illegal, well shouldn't it be?  Could this be the next hedge fund scandal?