Betting on more to come… 2 Mar 07

Key News

• Japan's consumer prices were flat for the first time in eight months in January. (Reuters)

Key Reports Due (WSJ):
• 10:00am. End-Feb Reuters/U Of Mich Consumer Sentiment Index. Expected: 93.3. Previous: 93.3.

“In physics you are playing against God, who does not change his mind very often.  In finance, you are playing against God’s creatures, whose feelings are ephemeral, at best unstable, and the news on which they are based keeps streaming in.”

E. Derman

FX Trading –  Betting on more to come…

A quick rant to start the morning:

With all due respect to CNBC, I know they have to fill space (I’ve been on the program), but my reasons for not watching it much were validated this week as one airhead “analyst” after another trotted out to tell us that it’s time to buy stocks again.  And even if now isn’t the time to buy, it’s close because this “correction” is almost over one after another blathered.  It’s painful watching that pabulum. (That being said, my bows to Rick Santelli—he is a truly brilliant guy who never disappoints and understands this game in real gut-level depth and can explain it in plain English.  He alone is worth the price of admission.)

Many of the CNBC talkers, blindsided by the Black Swan event this week, tell us that “economic fundamentals are solid, so I’d be a buyer on any dips.”  Dips is right! 

A Fooled by Randomness Constant from Nassim Taleb:

“An overestimation of the accuracy of their beliefs in some measure, either economic or statistical. 

They never considered that the fact that trading on economic variables that has worked in the past may have been merely coincidental, or, perhaps even worse, the economic analysis was fit to past events to mask the random element in it.  Carlos entered the market at a time when it worked, but he never tested for periods when markets did the opposite of sound economic analysis.  There were periods when economics failed traders, and others when it helped them.

The U.S. dollar was overpriced (i.e. foreign currencies were undervalued) in the early 1980s.  Traders who used their economic intuitions and bought foreign currencies were wiped out.  But later those who did so got rich (members of the first crop were bust).  It is random!  Likewise, those who ‘shorted’ Japanese stocks in the late 1980s suffered the same fate—few survived to recoup their losses during the collapse of the 1990s.  At the time of writing, there is a group of operators called ‘macro’ traders who are dropping like flies, with ‘legendary’ (rather, lucky) investor Julian Robertson closing shop in 2000 after having been a star until then.  Our discussion of survivorship bias will enlighten us further, but, clearly, there is nothing less rigorous than their seemingly rigorous use of economic analysis to trade.”

Bingo!  Thank you Mr. Taleb!

Doubtful this thing is over.  Though economic theory, and the bell curve would tell us otherwise, bad days tend to come in bunches—consider these “bursts of dependence.”

Dow Jones Industrial Average Weekly:

USDJPY Weekly chart:

And now we look at them together....

Dow Jones Industrial Average vs. USDJPY:

Maybe we will learn just how much the U.S. stock market was funded by the yen carry trade or something like that. 

Jack Crooks

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