At My Signal, Unleash Hell
From sea to shining, sea, U.S. politicians continue to bash traders and blame them for high energy prices. A variety of bills have been introduced that are designed to limit the amount of money that hedge funds can invest in energy, reduce foreign trading and even put an end to energy speculation altogether. Do these politicians have even a basic understanding of how the futures market operates? "No, they're clueless - at least most of them," said former U.S. Commodities Futures Trade Commission chief economist Gerald Gay in a recent Fortune magazine article about oil speculators.
Here's a thought - instead of discouraging speculation, which is a necessary ingredient to provide liquidity in any market, why not instead encourage those speculators to sell and drive prices lower? If you give traders a good enough reason or reasons to sell, they'll do it. Instead of trying to eliminate speculation, why not use it as a weapon to drive prices lower?
Here's what I mean. Remember the movie "Gladiator"? In it, Russell Crowe plays the general Maximus, who gives the order, "At my signal, unleash hell," thus initiating a series of actions that drive the enemy into disarray, retreat, and defeat. Imagine a day in the not too distant future, when the following series of synchronized events are unleashed on unsuspecting commodity traders:
11:00 am: Ben Bernanke and the Federal Open Market Committee shock the markets with a surprise 50-basis point rate hike, sending the U.S. Dollar rocketing higher, and causing oil prices to plunge.
11:01 am: The U.S. Department of Energy announces that it is suspending its policy of adding supply to the Strategic Petroleum Reserve, and will in fact release some of the oil from the SPR into the open market. The drop in the price of oil accelerates as panicked traders begin to cover long positions.
11:02 am: Saudi Arabia announces that it will add 800,000 barrels per day of supply to the market in addition to the 200,000 bpd increase that was announced last week. Sensing a rout, traders sell short energy contracts by the fistful, driving the price of oil to its worst one-day loss in history.
Can you imagine the market reaction that would ensue from this orchestrated series of events? Within three minutes, traders would panic and bail out of their positions, creating an avalanche of selling that would collapse oil prices. While it certainly wouldn't be easy to choreograph these specific events, I'm sure that with a little creativity and a lot of motivation and cooperation, a similar series of surprises can be arranged. If speculators truly are driving energy prices higher – and it's debatable whether they are - then they have the ability to drive them lower as well. Let's give them a reason to do so.
Questions of the Week
I've got three great questions this week, two of them from recent students. Here we go!
Q) Ed, I just read your latest email. I understand almost everything you stated. But I'm wondering if you could shed some additional light on the "U.S. easy-money policy". What exactly is this and how does it work? I'm guessing it is linked to low interest rates, but does it also include the Fed purchasing U.S. Treasuries and pumping more money into the system?
Ed Ponsi) Thank you for your question. You're right, it's been the Fed's policy to cut interest rates to stimulate growth, and there's nothing wrong with that. The problem occurs when the Fed cuts rates so deeply that the Fed Funds rate falls below the rate of inflation, and that policy has helped to create bubbles in housing and commodities.
The other side of easy money policy is the injection of liquidity. As you mentioned, the Fed buys securities from the banks in the open market and gives them money in return. This is referred to as "open market operations". Now those banks have additional funds, some of which may be loaned to other banks. Because the overall supply of available money is now higher, the cost of borrowing money begins to fall. In a sense, you could say that the Fed is lowering interest rates (though not in the traditional sense) when they perform these open market operations. That may be a good thing in the short term, but the long term effect of constantly adding to the overall supply of money is to erode the value of the currency; in other words, by adding to the overall supply without adding anything of real value, the value of each individual unit of currency is lessened. That is a big reason why the U.S. is in the mess it's in right now. Let's hope for a change in direction and philosophy soon.
Q) Hey, hope you're getting some good sun in Mexico! I want to ask you about the existing home sales report on June 26 at 10am. The sales were better than expected but in every currency pair it was bad for the dollar. I read in the information on the economic calendar that it would be good for the currency, so I was just wondering what I missed?
Ed Ponsi) Thanks, the weather's been great in Mexico! Ok, Thursday's Existing Home Sales figure was better than expected, but only slightly – the result was 4.99 million, vs. expectations of 4.96 million. Even though this rate was a tiny bit better than expected, it also represents a drop of almost 16% from last year's pace; it's also below the psychologically significant level of 5 million. There were a couple of unsettling data points; first, the inventory of unsold homes remains historically high, down slightly to 10.8 months in May. That means if no new sellers enter the market, it would take nearly 11 months to sell the homes that are now available at the current pace of sales. Here's the really scary part - nearly one-third of all existing homes sold last month were reportedly either foreclosure sales or short-sales. That doesn't bode well for future economic activity, and that little piece of information might have spooked USD longs. Thanks, it was great having you in the class!
Q) I just wanted to say thanks for a great class. I really think I jumped up a level. I have one question for you. Do you sometimes sit on the sidelines for a few days when it seems like there is nothing to trade? It just seems this week that I cannot find any really good setups.
Ed Ponsi) Hi, thanks for your kind comments, it's always good to hear from the students! Trading is funny, sometimes it seems as if one day you have more opportunities than you can handle, and the next day you can't find any good trades. There are going to be times when you're looking for a good setup but just can't find one. What is the best way to react in this situation? Just walk away. I always try to take whatever the market is willing to give me, and if the market isn't willing to give anything, the worst thing to do is to try and "force" a trade. Sometimes staying out of the game is the hardest thing to do, but chasing after "phantom" trades that aren't really there is a recipe for trouble. Good luck!
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through