How To Spot A Bubble
Whenever traders speak about bubbles, they usually cite some anecdotal evidence that demonstrates just how irrational investors have become. By the late stages of the Nasdaq bubble, it was impossible to go anywhere in the U.S. – to a party, to the grocery store, to your dentist – without hearing about the booming U.S. stock market. Well, here is the latest symptom of investors gone wild – according to the Daily Yomiuri Online, a hit song in China contains the following lyrics:
Use intuition to buy stocks and make money
I won't be excited unless my investment goes up multiple times
I won't be excited unless my investment hits irrational highs
As stock investors, we must persist
From: "I'll Never Sell the Shares Even After My Death,"by Kaijie Gong
According to the article, the song is popular in karaoke bars, along with Gong's other hits, "Stock Investment is Like a Song of Sadness," "Investors Have No Time to Sleep," and "Stocks are Playing with our Hearts." As bad as the Nasdaq bubble was in the year 2000, I can't ever recall hearing Shania Twain or Metallica singing about the markets back then.
Letting the Air Out
The People's Bank of China struck a sour note this weekend when they raised the proportion of funds banks must hold in reserve by 0.5%, to 13.5%, effective November 26. It was the ninth such move this year. By forcing banks to hold a larger percentage of funds, the PBOC is trying to reduce the amount of money that can be loaned out – some of which undoubtedly would be used to purchase stocks, or perhaps even Kaijie Gong CDs.
Question of the Week #1
Q) I have a question regarding Fib Levels. What levels should you generally use? I can plot retracement levels based on yesterdays, high/low, this/last week's high/low this/last month's high/low, or even intra-day swing extremes, so I would really appreciate some insight into what levels are generally best to use.
Ed Ponsi) Thank you for your question. Instead of using daily, weekly, or monthly highs and lows, Forex traders use Fibonacci to measure a major move in the market. In other words, they measure from a major low point to a major high point, or from a major high point to a major low point, regardless of whether the high and low occur during the same day, week, or month. I prefer to use Fibonacci retracements on the daily or weekly chart, because I believe that Fibs are a self-fulfilling prophecy. If they are, then Fibs will work better if more people have time to locate them, and there is more time to locate the Fibs on the daily (or weekly) charts as opposed to intraday charts. Also, if Fibs are really self-fulfilling, then the most widely watched retracement levels - 38.2%, 50%, and 61.8% - will prove the most rewarding. Here's an example; the Australian Dollar/ U.S. Dollar currency pair recently bounced after a nearly perfect 38.2% pullback (see figure 1).
Figure 1: AUD/USD bounces nicely after a 38.2% retracement. Source: Saxo Bank
Question of the Week #2
Q) I am looking for information on arbitrage trading, but everything I have found only states that these opportunities last for just milliseconds. I have successfully completed three trades lasting no more than a day, but more than just seconds. I am just wondering if this is actually considered an arb, or is this just relative value over time?
Ed Ponsi) Arbitrage could be defined as buying in one market and selling in another, although the interpretation of the term has expanded over the years. It seems that you are trying to use one currency pair as an indicator to trade another currency pair. It's true that many of these opportunities have already been exploited to the point where they are no longer feasible for the individual trader. Here's what happens; someone identifies an arbitrage opportunity, meaning that when "A" happens, "B" usually occurs sometime afterward. Word eventually gets out. Every trader who takes advantage of that opportunity is in fact shortening the lead-time between the initial "signal" move and the "secondary" move. Eventually, traders begin to program computers to automatically exploit this relationship, and the lag time disappears entirely. At this point, "B" follows "A" so quickly that the individual trader can no longer gain an advantage. A trader would say that the advantage has been "arbed to death".
Does this mean that there are no arb opportunities left? No, old arbs die and new ones are born. If you find a real arb opportunity the best way to use it is to keep quiet about it, because once word gets out, the 'edge' will disappear. Let me put it this way, if you indeed have discovered something new, which is impossible to say from the sample given, then publishing it here will only speed its demise. Keep the nature of the arb hidden and it will last longer. Good luck!
Chuck Norris-ism of the Week
Chuck Norris doesn't mark to market. The market marks to Chuck Norris.
Curious about the term "mark to market"? Check out last week's article for a detailed explanation.
Bernanke on the Grill
On Thursday morning, Fed Chief Ben Bernanke appeared before the Joint Economic Committee of Congress. After reading his prepared remarks, Big Ben took questions from the committee. One of the highlights was Bernanke's grilling by Texas Rep. Ron Paul, who put the Fed Chairman's feet to the fire on the topic of the ever-falling U.S. Dollar. As usual, Dr. Paul's comments about the U.S. Dollar and the money supply were right on target.
"It is that not only have we had a subprime market in housing; the whole economic system is subprime. The real deception is when we distort the value of money, when we create money out of thin air. We have no savings. Yet there's so-called capital. There's money available. But it comes from what you have to do and the pressures put on you."
What does Dr. Paul mean when he says, "what you have to do"? According to Paul, what Bernanke and the Fed have to do in order to keep the economic ball rolling is print money. Lots of money. The problem is, when the Fed adds money to the overall supply without adding value, they are diluting the outstanding money – your money - thereby making every dollar worth a little bit less. Paul continued:
"There's a dollar crisis out there and people's money is being stolen; people who have saved, they're being robbed. I mean, if you have a devaluation of the dollar at 10 percent, people have been robbed at 10 percent. But how can you pursue this policy without addressing the subject that somebody's losing their wealth because of a weaker dollar? And it's going to lead to higher interest rates and a weaker economy."
M2, the broadest measure of the money supply that the Fed is currently willing to reveal (it stopped publishing the broader M3 in 2006), shows that the supply of money has increased by over ten percent since October of 2005, and has nearly doubled since 1990 (see figure 2).
Figure 2: The US money supply, as measured by M2, since 1990. Source: Saxo Bank
The impact of a weaker dollar will change the economic landscape of the U.S. It is not something that "just happens", it is a direct result of our economic policy. The high cost of a barrel of oil is not just due to strong demand; it is a side effect of a weak U.S. currency. As such, we Americans should demand that our elected officials be held accountable. Every Presidential candidate should be asked, "What do you plan to do about the weak U.S. Dollar?" Let's make this a campaign issue for 2008.
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