The Lawrence Chan Blog

The Pursuit Of More Timely Trend Identification

I started my chart reading education with the swing trend definition because that was the one that my mentors use. It works great back then and works even better nowadays. I have tested many trend definition methods in historical data and none of them really doing better than the plain old simple swing trend method.

It can be puzzling why this simple concept works so well yet people keep looking for better trend identification method.

So why do people keep trying to better the swing trend method?

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I wrote about social trading several weeks ago and some readers would like to know my objective take on this trading style. I do not expect that there are so many people interested in the subject. I am posting my first impression here since I have already tried out several brokerages offering the service.

Bottom Line

All the social trading brokerages offer some kind of tracking facilities for their clients to see who are the best performers. All kinds of statistics are computed so that the clients can browse through the top ranking accounts easily. For example, you get to see the top performers based on total percentage gain for their trades, total percentage gain for the accounts, best percentage winners, etc.

The goal, of course, is to have the clients to get excited and read about these top performers. In the process of socializing, the opportunities of the interested crowd to follow the top performers increase. After all, the brokerages can only make more money when the clients all trade more.

Difficulties With Picking Winner

The bad news – it is extremely difficult to identify the good accounts to follow.

The statistical methods used to identify the top performing accounts can tell you only what happened before, but they are not projection tools that can tell you what will happen in the future. Without knowing exactly how those trades happened with the top performing accounts, it will be quite difficult to figure out if one can follow the future trades with confidence that the performance will be close to what happened.

Even long term tracking of an account may not be able to tell you if the performance is stable because it could be a stable environment that fit the strategy used by the account contributing to the success. Adding this to the already difficult task of separating the good traders, the not so good ones but having a lucky streak, and those who trade with a gambling mindset in exchange for the payout from the brokerages (for having followers copy their trades), it is easy to see why it is not a trivial task to pick a winner to follow at all.

The Land Where Contrarian Play May Not Work

I have looked into the bullish / bearish ratio reported by several social trading brokerages on the major pairs in forex and the S&P 500 CFDs. I found that there is no real consistencies in the data they reported against the turning points in the underlying markets.

There is no consistent confirmation bias with the ratios. There is also no consistent contrarian bias with the ratios. In another words, the trading activities within these social trading brokerages do not resemble the behaviour of normal markets.

My guess is that the bullish / bearish ratio reported are affected by the massive number of followers in those markets I analyzed thus you cannot obtain real market sentiment off the reported data. My study of these sentiment data is still in the beginning stage. If I find a way to utilize the information, I will change my opinion in the future.

The Risk Behind Following Bot Traders

Some of the social trading brokerages offer accounts allowing trading bots to drive the trading.

Following bot traders has similar pros and cons like following the human traders. With bot traders, however, it has the advantage of pulling trigger without emotion thus their performance should be more consistent than the human traders. The effect should be more profound in the scalping arena comparing to the swing trading environment. Human traders can become fatigue after trading intensively during hectic market environment. Hence leading to slippage in performance as judgement can be more error-prone than usual.

For long term swing trades, a good trader can often outperform bots by making the proper exception when the environment has changed. Thus an account you track that gains slowly and steadily through long term trades may not be a bad idea at all if the trader behind the account has a lot of experience. That, you have to talk to the person to get to know the trading principles behind and see if that is something you are willing to accept before copying the trades.

Attractive Alternatives For Potential Good Traders

There are definitely talented traders out there. Not everyone talented have seed capital to trade with in the beginning. Those who have the potential in becoming great traders will find social trading a very attractive alternative comparing to trading for a prop firm or raising capital the traditional way. Social trading enables a trader to start with small amount of capital. When the trader gets better over time, a loyal following from the crowd will supplement the trading profit nicely. Think of it as an alternative way to run a fund where you have extreme transparencies into every trade you take.

The catch, however, is that exposing yourselves to public comments on specific trades and strategies can be detrimental to the development of your trading psyche. Once a position is openly discussed, majority of people will find it difficult to not defending their position in place. The act of defending your open position in public can affect your thinking process and reduce your willingness to cut your losses even when the situation no long warrants the trade. This is bad for your trading.

The goal of a trader is to make money. Flipping your opinion is not only allowed, it is actually encouraged when you see signs of danger that can affect your bottom line. Unlike social networking, the interactions with other people in this situation can hurt a trader from developing the proper attitude towards trading.

Interesting Future

I can see social trading becoming something big in the near future as traditional brokerages no longer offer real values to their clients. Brokerage fees are really execution fees nowadays. Many brokerages are too generic and lack the uniqueness to hold onto their clients. Social trading can change all that. Since retail investors have no clues in trading will be happy to find someone they believe in to copy their trades, those brokerages without the social trading service or the talented traders will have a very hard time to survive.

The new competition among the brokerages in social trading will be very interesting.

Would that turn into something similar to TV stations trying to find the next blockbuster TV show?

Or, using the internet metaphor – finding the next youtube sensation?

Just think of the fiasco we heard of about the rock stars or famous writers switching publishers. You probably get the picture.

The star traders among the people will rise to the top as their trading abilities will be real value and driver behind the revenue of the brokerages. Since these traders can command the followers, it will be difficult for the brokerages to keep them if the deals given to these star traders are not good enough. A brokerage cannot force these star traders, after all, being their clients, into contractual obligation to stay with them.

If the brokerages make their deals harsh and unfair in the first place, it will be very difficult for them to recruit future star traders. Their competitors will make sure of that with better deals and perks.

Interesting future indeed.

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Taken off preferred list?

http://news.yahoo.com/goldman-takes-apple-stock-off-preferred-list-190919393.html

As we all know GS market calls are almost always oppose to what their prop desk does. And their prop desk has been contributing significantly to the firm’s earnings all these years. So, if it is not a stealth buy signal, I don’t know what it is.

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I have decided to speed up the schedule and give this new chat room software a try.

The main problem is that we cannot tell when will the next burst of users using the chat room will be. We also do not know what it will do to the website. We were lucky the last few times that the database damage were minimal. It may not be the case, however, on next overload.

So here it is – a new look for the chat room.

In coming weeks I will find ways to incorporate the extra stuff we used to have with the old commentary system.

One good thing with this new chat room software is that it is scalable. My guy will monitor the performance and let me know if we need to offload more work to the chat room service.

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It is actually very simple to fix the current financial crisis if the major economic powers in the world can agree to do all of the following things.

Create a form of basic banking services that is non-profit and guaranteed by the governments

What this requirement means is that normal people who are seeking a place to park their money should have a choice to do so. It is part of the law in almost all the western countries that the personal assets are supposedly to be protected. This change essentially make sure these countries enforce the law that is already in place.

People who seek for return on their savings can choose to park their money with the so-called banks as we know them nowadays.  This separation of the banking classes give the people a choice – they can choose to park whatever amount of money they have with the non-profit service knowing that their money is 100% safe. Or, they can choose to put their money in various financial institutions with 100% wipe out risk.

The idea is to give the power back to the people. They will tell the world exactly how much money they are willing to risk with the financial institutions. To lure the people to put money into these banks so that they can conduct their speculative activities, the banks will be forced to offer much more attractive terms. This means the risk capital from the normal people and business finally being recognized properly, as oppose to being disguised or labelled as deposit when the banks can rip all the profits from the utilization of the funds.

With the technology we have nowadays, it is easier than ever to implement this simple protection for the citizens of the advanced countries. A free / affordable basic banking service with no risk to the money put into the accounts can be a reality any time. From this new foundation, people will have the power to limit the banks from growing too big. Real check and balance against the banking sector.

Enforce personal liabilities on bank management

One of the ways bank management (well, any major corporations) loots the system is by engaging in activities that are high risk with no consideration of the consequence. If things work out, they pay themselves with huge bonuses. If things do not workout, they walk away with money in their pockets already.

To stop this kind of reckless behaviours, whatever bonus they setup for themselves, should be deposited into government monitored accounts for decades before the funds are released. Reducing their outright pay cheques to significantly smaller amounts so that they would feel the pain.

This is real skin in the game. Not the bullshit some of these bankers said that shift the blame to normal people.

This will make sure people doing their jobs at these banks do not do it with the mentality of committing a robbery (i.e. take the money and run) as oppose to the proper thinking of building a sustainable business.

Write down of sovereign debts among the countries and invalidate all the related bets together

There is no point to argue from one country to the next to hammer out special deals to bail out their banks. The banks should not be bailed out in the first place anyway. The focus should always be protecting the saving of normal people and liquid assets of the normal businesses. In another words, the priority of all countries should have been protecting their productive economic activities, not the frictional cost (banking sector) of their economies.

By structuring a complete removal (or permanent reduction) of the sovereign debt together with the related speculative derivatives, it will stop the stupid bail out game all together and buy the world time to recover from the destructive path it has been taking over the past 5 years.

Structuring bail outs without the removal of the related derivatives is simply an act of looting money from the poor people into the hands of the banks. It will never stop the problem from spreading. Considering all the facts, isn’t it better to contain the damage now as oppose to letting the system bleed to death at this point?

Just think about it from a detached point of view. An overall reduction of the outstanding debt from the unstable countries at 20% to 40% with related derivatives removed from the system is not that much different from the bail out deals we have seen so far. But it has the added benefit of visible stability for all involved parties. It is something the piecewise solution EU seeking so far cannot offer.

Just Like Any Policy Change, There Are Always Declared Winners and Losers

If the changes I talked about are implemented. The world financial system will recover slowly over a decade or so as the majority of money from the normal people and businesses are already looted by the bankers. It will take a long time for normal people to regenerate their wealth as the amount of money looted from them is a significant portion of what they used to have. To speed up the process, governments can choose to prosecute and confiscate the assets from the top executives of the banks which may not be viable under the legal system of most countries.

In short, once the changes are implemented, the banking section worldwide will suffer a heavy blow like the dot com era where the excessive internet businesses at the time are destroyed. And it happens to be the best thing happening to the internet sector. As all the non-productive workers in the sector has left the industry and that many dot bomb companies closed their doors, the current state of the internet companies are much more stronger and functional comparing to the dot com era.

Unlike the dot com era where the bubble burst on its own, this time if the policy makers around the world can implement the changes I mentioned here, the burst of the financial industry will be a controlled one with manageable impact into the other parts of the worldwide economy. It is way better than the alternative of letting the financial industry running wild and leading the world into total economic collapse.

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