BofA strategists Arjun Mehra and Cheryl Rowan have a warning more precisely aimed at the stockmarket. In a note to clients entitled Code Red, Mehra and Rowan claim there is "limited upside from here" and the "risk of a sell-off is high."
Peter from Ireland wrote in asking me to do a piece on liquidity on
the forex market. Although the market trades 5 trillion dollars per day
in volume, even forex traders face limitations in how much volume they
can push through in a short period of time.
A Zero Hedge article on the Reuters 3000 platform outage
cited some interesting statistics for the currency markets and where
the trading actually occurs. Although I was familiar with Reuters and
EBS previously, the Dow Jones article was the first place where I've
seen volume statistics published. Apparently Reuters, the biggest
platform, trades approximately $130 billion dollars in volume per day.
That's an astronomical amount of money. Intuition makes it feel like hitting
the ceiling on executing large transactions might be a problem for only
the biggest institutions. Let's take a look at where we might expect to
run into problems.
When I went through broker training at FXCM,
the team leader cited the EUR and USD as being involved with 60% of all
forex trading volume. That number does not imply how much volume occurs
in the specific EURUSD pair. Also, that that was seven years ago. I dug
around looking for more up to date numbers. Forex trading volume is
notoriously hard to track due to it being an over the counter market.
The best proxy that I know of is the FX futures market.
The CME publishes FX futures contracts volume
(page 16), which I used to estimate the proportion of the EURUSD pair
in relation to all traded volume. FX futures contracts, like their spot
counterparts, are all denominated in different currencies. Except for
the e-mini and e-micro contracts, which resemble the mini lots of retail
forex trading, the contract size is roughly $150,000. I'm counting
contracts rather than actual notional value to speed up the
calculations. You can double check my calculations by downloading this spreadsheet. The EURUSD pair represents 33% of all forex trading volume based on my rough estimates.
The
EURUSD value traded per day on Reuters is 33% of $130 billion, which is
43.33 billion. The average trading consists of 1,440 minutes per day.
43.33 billion trades per day / 1,440 minutes per day yields an average
traded amount of $30,092,592 traded per minute. Again, this is a huge
number.
Everyone in forex trades on margin. Institutions
traditionally keep their margin very low. Assume that 3:1 is the norm
for the big players. That means that the actual funding in the account
only needs to be $10 million dollars (30/3). That's a lot of money, but
that is chump change by institutional standards. That's more on par with
a wet behind the ears CTA that launched within the past few years. This
scenario is for the most liquid currency pair on the largest currency
trading platform in the world.
Dropping down to the retail scenario, the numbers involved get much, much smaller. The Financial Times cites FXCM's average trading volume
as $55 billion per day. This is tens of multiples higher than an
average broker's volume. I picked it because it's the highest that I
know of and I wanted to demonstrate a big scenario. 33% of $55 billion
is $18.15 billion traded on the EURUSD. $18.15 billion / 1,440 minutes
per day is $12.6 million traded per minute.
Retail traders
leverage far higher than institutions. Again, let's be kind and make the
assumption that the average retail trader employes 15:1 leverage on the
account (hint: it's much higher). $12.6 million / 15 implies that it
only takes an account balance of $840,277 to trade all of the expected
trading volume in an average minute. One trader is unlikely to have a
balance that large, but a segment of a broker's customers most certainly
do.
The fragmentation of the market combined with leverage makes
it strikingly easy for a group of traders to suck up all of the
liquidity available on a given platform. Even though trillions are
available across the broader market, the broker or platform where a
trader participates is substantially more limited. The scenarios modeled
use the EURUSD, the most liquid pair in the world. Liquidity gets
exponentially worse when examining exotics or cross currencies. The
volumes are far lower, but the available leverage and account balances
remain the same.
When too many traders buy the same EA, all orders
fire off at the same time. Blockbuster EAs easily reach the combined
account equity floor where demand overwhelms supply. Finer details like
all of the supply is being one sided make the situation all the worse.
Based on an overwhelming bearish negative bias on the euro (FXE) from multiple sources (individuals, banks,
analysts, and fund managers) we believe selling the euro on any run-up is a
viable strategy.
The euro climbed to a fresh seven-week high against the dollar on Thursday on news Spain is negotiating with the euro zone over conditions for international aid to bring down its borrowing costs though the country has not made a final decision to request a bailout.
Earlier, the single currency set a fresh seven-week high against the U.S. dollar after Federal Reserve minutes hinted at more monetary easing in the U.S., while French and German business activity surveys were not as bad as feared.
In today's volatile business environment, organisations must be ready to reconfigure their strategic priorities at speed, and with certainty.
Crucially, instead of basing major business decisions on intuition, they need to mine the data and information at their disposal to drive rapid decision making.
This is why analytics - the use of data, statistical and quantitative analysis, explanatory and predictive models - has moved centre-stage.
According to market research firm IDC, the market for business analytics software grew 14 percent in 2011 and will hit US$50.7bn by 2016.
Of course, analytics itself is nothing new.
Organisations such as Google, Tesco and Caesars Entertainment are well recognised for their ability to predict market trends, customer behaviours and workforce staffing requirements and turn these into top-line growth and/or bottom line savings.
But for the many other businesses now seeking to take advantage of analytics, there continues to be a lack of clarity around certain fundamental questions.
What is analytics? How can it propel and improve an organisation's competitive positioning or effectiveness?
What does it mean to truly become an analytical organisation? And how does an organisation set out on this critical journey?
Although the development of analytical capabilities and capacity is obviously important, a focus on data, methods and technology alone will not magically deliver the insights needed for competitive edge.
UBS AG (UBS) is starting a unit aimed at attracting clients among quantitative hedge funds, combining services from its prime brokerage and direct-execution trading businesses.
Scott Stickler in New York will be global head of the operation, called UBS Quant HQ. Strategies across equities, options and futures will be supported with fixed income and foreign exchange to be added later, he said. The business targets startups and established funds with long-short or hedged strategies and those focused on arbitrage.
Investment firms formed as a result of regulations to curb risk-taking within banks are looking for help with technology consulting services, trading and financing, according to Stickler, who was hired in July 2011. The unit began working with more than a dozen hedge-fund clients in the second quarter as it prepared for the Quant HQ introduction, he said.
“One of the trends we’re seeing is a number of startups, folks coming out of big banks because of the Volcker rule and starting their own hedge funds,” Stickler said in a phone interview. “Clients are coming to us who wanted us to be in this business and who want to be able to take advantage of our global presence and our counterparty safety, stock-loan and execution capabilities.”
Banks, companies and investors are preparing themselves for a collapse of the euro. Cross-border bank lending is falling, asset managers are shunning Europe and money is flowing into German real estate and bonds. The euro remains stable against the dollar because America has debt problems too. But unlike the euro, the dollar's structure isn't in doubt.
Otmar Issing is looking a bit tired. The former chief economist at the European Central Bank (ECB) is sitting on a barstool in a room adjoining the Frankfurt Stock Exchange. He resembles a father whose troubled teenager has fallen in with the wrong crowd. Issing is just about to explain again all the things that have gone wrong with the euro, and why the current, as yet unsuccessful efforts to save the European common currency are cause for grave concern.
He begins with an anecdote. "Dear Otmar, congratulations on an impossible job." That's what the late Nobel Prize-winning American economist Milton Friedman wrote to him when Issing became a member of the ECB Executive Board. Right from the start, Friedman didn't believe that the new currency would survive. Issing at the time saw the euro as an "experiment" that was nevertheless worth fighting for.
Fourteen years later, Issing is still fighting long after he's gone into retirement. But just next door on the stock exchange floor, and in other financial centers around the world, apparently a great many people believe that Friedman's prophecy will soon be fulfilled.
Banks, investors and companies are bracing themselves for the possibility that the euro will break up -- and are thus increasing the likelihood that precisely this will happen.
There is increasing anxiety, particularly because politicians have not managed to solve the problems. Despite all their efforts, the situation in Greece appears hopeless. Spain is in trouble and, to make matters worse, Germany's Constitutional Court will decide in September whether the European Stability Mechanism (ESM) is even compatible with the German constitution.
There's a growing sense of resentment in both lending and borrowing countries -- and in the nations that could soon join their ranks. German politicians such as Bavarian Finance Minister Markus Söder of the conservative Christian Social Union (CSU) are openly calling for Greece to be thrown out of the euro zone. Meanwhile the the leader of Germany's opposition center-left Social Democrats (SPD), Sigmar Gabriel, is urging the euro countries to share liability for the debts.
On the financial markets, the political wrangling over the right way to resolve the crisis has accomplished primarily one thing: it has fueled fears of a collapse of the euro.
AFTER a promising May and June, Steffen Knoop has seen his sales dip by 30%. His small Hamburg-based company, Wascut, sells cooling and cleaning oils for big machines, including those that make cars. “I have a pretty good window on the economy,” he says. Mr Knoop wonders whether the dip is caused by people taking extra long summer holidays or something more serious. Others with a broader and more long-term view of the economic landscape are asking the same question.
Building forex trading systems is the reason that this company
exists. Nearly every one of our clients aspires to be a fully automated
trader.
The percentage of clients that succeed over the long run,
however, is incredibly small. I don't think that is a big secret. If
that is news to you, allow me to be clear. The chances of developing a
successful expert advisor over the long term are minimal.
The
inevitable next question from new clients is an attempt to pick my brain
for some features common to successful systems traders. I decided to
outline the traits common to this rare breed and some of the challenges
that they encounter.
Traits of a successful EA developer
Expert
advisor developers that succeed are either incredibly bright
(engineers, Ph.D. holders, etc) or dumber than a sack of rocks. No
middle ground exists. A friend/client told me about an experiment that
struck me as telling. If you put a mouse in a cage where cheese appears
40% of the time on one side of the box and 60% of the time on the other,
all mice eventually pick the side that "wins" 60% of the time. The mice
stop guessing and go with what works more often than not.
That's
my theory for why the "intellectually challenged" crowd seems
disproportionately likely to profit from trading. They see right through
the noise to pick out a simple observation that wins more than it
loses. Holy grail systems certainly do not come from this group. That's
not honestly not the goal. It's about eating cheese more often than
going hungry.
The brainy crowd benefits from a heavy dependence on
analysis. Ideas usually stem from pet theories, many of which look like
the crackpot variety on first glance. The theory shifts and twists as
market tests reveal strengths and weaknesses. Logical conclusions
instill a robustness and variety into the system. Interestingly, the
approach to testing and verifying the systems follows the opposite path
of most developers. The ideas tend to get simpler with time rather than
more complex.
Emotion does not play a large role in the rationale
for developing an expert advisor. Again, the reasons are usually
logical. Examples like "I've been trading this system for 20 years and I
need to automate it" or "I came up with a way to accurately predict
market direction."
It may sound a bit zen, but the systems that
make money are the ones that do not set their primary goals as making
money. Making money is a totally open ended goal. The potential
variables know no limit. The lack of constraint encourages would be EA
traders to shoot off on tangents. Unless the wild ride accidentally
leads to the pot of gold at the end of the rainbow, they will fail. The
limitless bounds make it impossible to measure any progress.
In
that same vein, the journey is as important as the destination. Many
traders pay lip service to limiting drawdown. Few are able to
effectively rein in drawdown, especially within the context of an expert
advisor. To a certain extent, limiting drawdown is not possible. My
experience with money management makes it clear how much wandering a
return can make, even with a heavy advantage.
The easiest way to
limit drawdowns is to fight against severe losses. The goal is to obsess
over risk and reduce it to the lowest possible point. I want to
emphasize this point carefully. Risk always exists. The market
chaotically switches from deep slumber to extreme violence. No amount of
system engineering eliminates or alters the structure of the market.
The most effective way to handle risk that I see is not to prevent it
from happening (not possible), but rather how to react when risk
eventually flares up.
Approaching system design as a process
rather than a destination also encourages global thinking. My old boss
would describe it as the 40,000 foot perspective. When a forex trader,
for example, emphasizes a system's percent accuracy, it typically comes
at the expense of exiting at a better point in the market. A need to win
slightly more often actually drags the system away from its optimal
performance. A process oriented design watches how changes in the entry
method affects the exit efficiency. Clever money management removes the emphasis from entry and exit methods.
Designing
these systems takes hundreds of man hours or results from more than a
decade of experience. Emotion will certainly enter the equation at some
point. The real question is not how to remove it. It is how to
appropriately channel it.
Designing an expert advisor quickly
takes on the characteristic of an obsessive hobby. If the system's
success is measured in quantities of dollars, the emotional roller
coaster rises in tune with the account balance. A more appropriate use
for the emotion is to take heart in the system working correctly, not
profitably. Ideally, correctly also means profitably. They are not the
same thing, however. Drawdown and unlucky losing streaks are an inherent
part of trading. Gaining satisfaction from the trade behaving as
designed rather than as desired makes your emotional well being far less
dependent on market performance.
I have been running this company
for nearly five years and literally spoken with thousands of traders
over that time. In spite of that overwhelming number, I still have yet
to speak with anyone that traded a commercial EA successfully for more
than a few months.
The successful traders that I know personally
all developed their systems and strategies on their own. Maybe that
reflects on the abysmal quality of expert advisors for sale on the
internet. Maybe it reflects on not-so-expert trading coaches, or perhaps
genuine trading coaches and hapless traders unable to follow sound
advice. I suspect it's a little of everything. Regardless of the
problems, the take away point is that the person doing the succeeding is
also the person doing the developing. They take control of the
experience from the beginning and lead it into a successful outcome.
Systems trading is not a process where you buy your way to success or
follow like a sheep to green pasture. You must earn it.
Challenges of using a winning expert advisor
The
path to achieving a profitable strategy on paper is a long, hard road.
The switch from theoretical turns to live trading is a challenge in its
own right. Backtests spit out instantaneous results. Traders see
something like a 20% annual return, then mentally prepare themselves for
the steady accumulation of funds.
That kind of trajectory puts a
number in the trader's mind that is terribly misleading in real life.
Steady annual growth of 20% suggests a constant return of 1.67% (20/12).
That number 1.67% is a hiccup in a trading account. Many forex traders
risk more than that amount on a single transaction. Factoring in the
inevitable drawdown or periods of loss, the market makes it impossible
to distinguish whether or not the expert advisor is behaving correctly
or if it is falling apart.
Uncertainty in the face of risk makes
any normal person panic. At the very least, it instills a degree of
anxiety over the future. The moment that the machine stops churning out
profits is the moment where doubt enters the picture. Doubt feeds on
itself, which leads to changing the trading plan in midstream.
I
can tell you from experience that the transition from research to
execution is huge. A learning curve exists, like with everything. I
learn to cope by taking the confidence that I gain through the same debugging techniques
used in testing. The same techniques work for comparing live results to
backtested results. Does the backtest over the same time period as my
real trading match the actual performance? If so, then all is well. If
not, it at least gives me as the developer an opportunity to think about
specific problems. Execution or forex broker manipulation
can cause problems. More often that not, however, is some flaw in the
strategy design or code. Developing a methodical, reason based process
helps calm nerves and to stay focused. The alternative is a general,
undefined worry.
