Central Banks and Mass Quantitative Easing: Is Global QE Good or Bad for the World Economy?
Holy Grail of Trading: What Is It, Really?
Unravelling the Quant Model Enigma
A Closer Look at the Oil Industry of Venezuela
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Trading Street The World’s Premier Investment Online Magazine Volume 1 Issue 3
January 17, 2015
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Table of Contents
Trading Street Magazine Is published FREE each month
Evaluating the Performance of Your Strategy............6 By Tad Slaff, CEO/Co-founder Inovance
Bang Moments: How to Protect Against SNB Type Events............................................................................11 By Sam Eder, FxRenew
Technical Signals Anyone Can Use.............................15 By Thierry Laduguie
Publisher Trading Street, LLC Editor Timothy LuCarelli Business Development Bil Hoerter Marketing Ric Chappetto
Crude Oil – Trade It without So Much Drama.........20 By The Nadex Team
Contributing Writers Benjamin Lee Darrell Martin
A Handful of Dynamic ETF’s for the US Equity Markets.................................................................................24 By Jean-François Owczarczak, Director at FinGraphs.com
A Closer Look at the Oil Industry of Venezuela........29 By Shayne Heffernan Ph.D - CEO at Heffx
Holy Grail of Trading: What Is It, Really?...............39 By Darrell Martin, CEO www.ApexInvesting.com
The 7 Killer Trading Mistakes That Doom Traders From Ever Becoming Consistently Profitable...........42 By Benjamin Lee - CEO Think Trade Think
Unravelling the Quant Model Enigma.......................45
Sam Barry Shayne Heffernan Jean-François Owczarczak Thierry Laduguie Sam Eder Tad Slaff For Subscription Information Please visit the website www.tradingstreet.co Contact Information 646-396-8108 info@tradingstreet.co
By Sam Barry, CEO Littlefish FX
The End of an Era – As Open Outcry Trading Pits Are Set to Close Forever.....................................................48 By Bill Hoerter of TradingStreet.co
Central Banks and Mass Quantitative Easing: Is Global QE Good or Bad for the World Economy?...........53 By Tim LuCarelli, Trading Street
Trading Street Magazine
March 7, 2015
Advertisements in Trading Street Magazine are the sole responsibility of the advertiser. Consumer questions should be directed to the individual advertiser. ALL RIGHTS RESERVED ON ENTIRE CONTENT Trading Street Magazine is published monthly by Trading Street, LLC and is free of charge by viewing online. Reproduction of content, articles or advertisements, is strictly prohibited without the express written consent of the Publisher. All information is provided as is and has been checked for validity to the best the writers’ abilities. Any third party information has been reprinted with permission of the content owner and may not be reproduced from this publication without the owner’s consent.
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Letter From the Editor
This month’s issue of Trading Street Magazine has some very good and well researched articles. As our stable of experts grows so does the depth of knowledge for all types of investment from simple strategies to some of the most complicated quantitative analysis. In this issue we say goodbye to the first formalized trading institution in the world as it too has been succeeded by advances in technology, causing a morphing of what was known by over 12 generations as the markets. We are fortunate enough to have on our staff several people that worked on the trading floors in Chicago and our very own Bill Hoerter took the lead recalling his exploits as well as insights. I too worked on the floor of the Chicago Board of Trade for a short period and I will never forget the first time I walked onto the floor, it was like mainlining pure adrenalin. The sights and sounds were intoxicating, the smell horrid and the people unbelievably fascinating. After a while it became obvious that very little of what was going on was about the money but the action; everyone on that floor was a Type A action junkie. I hope you find this month’s articles full of interesting information and of value. There is certainly enough variety to appeal to all type of traders from stocks to any type of futures. If there is something you have questions on or want to find out more information about please feel free to contact the author of the article, they are all approachable. And, if you have any questions or suggestions for our next issue please feel free to contact me. Thank you
Timothy LuCarelli tlucarelli@tradingstreet.co
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Evaluating the Performance of Your Strategy By Tad Slaff, CEO/Co-founder Inovance
C
reating a trading strategy is only the first step to trading successfully. You must then evaluate its performance and decide if you can trust it on a live account. While so much attention gets paid to coming up with a strategy, there is surprisingly little on how to tell if the strategy is any good. Most traders take a look at the net profit, some risk-adjusted metric like the Sharpe ratio, the max drawdown, overall accuracy and, if the equity curve looks fairly smooth, it’s good to go!
Exactly how risky is this strategy? Are these results statistically significant? Under what market conditions did my strategy perform poorly? If I do trade it on a demo account, how long should I wait before going live? These are just a few of the questions you need to be asking yourself with every strategy you are considering trading live.We’ll break down the strategy’s performance into 5 categories; Profitability, Risk, Statistical Significance, Stability, and Live Performance.
This article will cover the first 3 categories, ProfitHowever, this can be a naive approach that ignores ability, Risk, and Statistical Significance, as it pertains to many important aspects: Am I just overfitting the data? an fx-based strategy. Page 6
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Profitability
Especially when trading on lower timeframes, it doesn’t matter how profitable a strategy is if you cannot at least make up the cost of entering a trade.
The easy answer is looking at the Return Per Trade • RPT = Net Profit /Total Number of Trades • You need to have a good idea of what your trading costs actually are. While your broker’s “average” spread might be 2 pips, a closer inspection shows it can vary wildly. If your strategy trades during high volatility, your “average” spread is going to be much higher. You need to know what the commissions and slipProfitability is the first thing most traders look page will be like when you are actually at but answering the question “how profitable was my trading. strategy?” is a surprisingly difficult question to answer. Saying it returned 20% does not tell you much.
Effects of position sizing
Was it 20% before or after trading costs? What Whether you are using fixed lot or fixed percenttype of drawdowns did you have to go through to get age position sizing is going to have a huge impact on that 20% return? Over how long of a period did it take? your returns. If it was annualized, did you make 120% 6 years ago and nothing since? • Fixed lot, or using the same position size on eveWhen measuring profitability, there are a couple of important things to remember:
Risk-adjusted return is what matters
Earning a 100% return is great as long as you did not have a 500% drawdown to get there. Here are a couple metrics to consider when measuring your riskadjusted return: • Profit - to - Drawdown Ratio = Average Net Profit / Max Drawdown • Amount of realized profits compared to the max drawdown. • Ideally you would have a ratio of over 2 with any strategy you are trading live.
ry trade, will lead to a more linear growth rate while fixed percentage, for example risking 2% of your capital on every trade, will exacerbate both your growth and drawdowns. • As Einstein said, “Compounded interest is the 8th wonder of the world”, meaning a strategy that compounds on its returns by using fixed percentage will have a much steeper equity curve than a fixed lot sizing strategy, at the expense of potentially larger drawdowns.
Risk
Measuring your risk is a well documented but much more difficult and misunderstood topic than profitability. Especially in light of the recent Swiss National Bank’s (SNB) actions and “Francogeddon”(or the “SNBomb” depending on your sources), the importance of understanding market risk, liquidity risk, and counterparty (broker) risk becomes all the more apparent.
• RINA Index = Net Profit/(Average drawdown * percentage of time in market) • The RINA Index rewards strategies that spend less time in the market, decreasing Market Risk the inherent market risk. Market risk, or the risk of losses coming from • You would like ratios over 100, with over movements in market prices, is the most obvious one 200 being ideal. to traders. While the easy answer is to “always use stop losses” that is only part of the solution.
You must at least cover trading costs Trading Street Magazine
March 7, 2015
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One area that is often overlooked by more active traders is the benefits of trading a diversified portfolio of strategies. Trading uncorrelated strategies is a great way to decrease your market risk.
If you had been long the EUR/CHF and short
broker reimbursing negative accounts, what is not deposited in your brokerage account is very difficult for the broker to collect. Unless you have a very large account and huge losses, it is unlikely the broker will come after you personally.
the USD/CHF you would have felt a lot better Counterparty Risk
The importance of understanding counterparty risk, or the risk that your broker will no longer be in business when you go to withdraw your money, once again become abundantly clear with the trouble of Liquidity Risk many fx brokers during the SNBomb, including Alpari Liquidity risk is much trickier and isn’t something going bankrupt and FXCM’s much publicized troubles. you usually have to worry about in the most liquid market in the world but once again the recent SNB move One benefit of this most recent crisis is it gave us a showed why this is important as many traders were not good look into which brokers have a solid financial base able to exit their positions. There isn’t a sure-fire way to and were able to withstand heavy losses. guarantee you’ll be able to get out of a trade but there are a couple things you can do to decrease your risk. Statistical Significance
waking up to the news of the 2,000 pip move.
• Use a true no-dealing desk STP/ECN broker • While most brokers are switching to a no-dealing desk straight through processing (STP) or ECN model, there are still brokers that are operating as the counterparty to their traders. With an ECN broker you have access to much deeper pools of liquidity, better prices and the advantage of analyzing the depth of market (DOM) to get a better idea of when liquidity could be drying up; however, this is not much help with sudden market events like major bank announcements. • Minimize your account size • While you cannot always count on your Page 8
After running your backtest one of the first questions you need to be asking yourself is “are these results statistically significant?” or, in other words, “what are the chances that these results occurred solely by random chance?” While diving into the world of statistical analysis can be daunting, there are some fairly straightforward techniques to get a better idea of whether you were actually able to find a real exploitable pattern in the market.
Confidence Intervals
One benefit of turning to statistical analysis is you Trading Street Magazine
March 7, 2015
can get concrete confidence intervals on your results.
Monte Carlo Simulation
Taken from the CFA study guide, we can use the t-distribution to calculate the confidence intervals around our return per trade (RPT). The t-distribution gives us a conservative estimation of how likely an average is to fall within a given range. This technique lends itself very well to working with financial data and can easily be implemented in Excel with the “TDIST” function.
What the Monte Carlo simulation tells you is “had I run a huge amount of strategies that randomly went long or short for each bar, what percentage of times would have I achieved the same returns as my strategy?”
RPT ±(t-distribution) *((Standard Deviation of Returns)/√(Sample Size))
This is another popular one that you hear a lot about but still is not employed by the average trader.
For example, if your “proprietary” strategy had returned 20%, but you find that a random strategy had a 40% chance of returning at least that amount, you aren’t going to be very confident with that strategy moving forward. Here is one good resource on how to apply a Monte Carlo Simulation in Excel. Understanding the profitability, risk, and statistical significance of your results is only the first part of trusting your strategy to trade live. In the next article we will go over how to measure the stability of your strategy and to know when it has fallen out of sync with the market during live trading.
What this calculation will tell us is: “With 95% confidence, my return per trade will be above ___ and below ___”. To decrease the range of the confidence interval, you can either increase your sample size or decrease your confidence interval to 90%. This is a very handy trick to know when evaluating your strategy. Trading Street Magazine
March 7, 2015
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Bang Moments: How to Protect Against SNB Type Events By Sam Eder, FxRenew
“You are a risk manager first, and a trader second” A “bang moment” is a statistically improbable event whose monumental effects are felt in a split second. If you’re not prepared, it istoo late to do anything about itwhen it happens. For example, we experienced a “bang moment” recently when the SNB announced it was removing their currency peg against the Euro. “Bang moments” are a lot more common than you might think. Markets have what are termed “fat tails” when it comes to probability distribution. That Swiss National Bank is, things that statistically “should not happen” occur With the proliferation of poorly regulated and much more often than you would expect. undercapitalised Forex brokers, this is a big risk for FoExamples of long-tail events include the “black rex traders. Counter-party risk is perhaps the more Monday” stock market crash of 1987, the events lead- difficult of the two risks to guard against. ing tothe failure of Long Term Capital Management, the Japanese Tsunami, and in January the re-valuation of Guarding against market long-tail risk with deep out of the money options. the Swiss Franc. Assuming you use stop-losses to protect yourself Preparing for “bang moments” in Forex, can help if the market goes against you, but how do you guard you avoid risks that have the potential to knock you out against the risk of the price significantly gapping though of the game, or with a bit of luck even allow you to profit. your stop-loss, like it did when the SNB removed the peg? Two types of risk Deep out of the money options allow you to benWhen a bang moment happens you face two types efit if the price moves a long way against you. For examof risk. ple the EUR/USD is currently trading at around 1.1000. 1. Market risk If you brought a call option at say 1.1800 (which would 2. Counter-party risk be deep out of the money), that would give you proMarket risk is what it sounds like. If the price goes tection from any move back above 1.1800. You might against you, then you will suffer massive losses quickly, pay 10-15 pips or so for this protection for a couple of if you are heavily leveraged. It is perhaps the easier of months. the two risks to protect against. If you were to buy options that have a strike price Counter-party risk is the risk of your broker get- close to the market, they can cost quite a bit. It’s beting into financial trouble, and therefore not being able cause they are a long way from the current price that to access or withdraw your funds. In the worst-case you can get them for cheap. Whether you are in and scenario; you may lose your money altogether. A recent out, or holding positions for long-term moves, 15 or so high profile example of counter-party risk was the col- pips should not break the bank. lapse of MF Global. Trading Street Magazine
March 7, 2015
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Maximum position sizes When you are developing your risk management plan, it’s important to define how large a position you will have in any currency pair, or correlated pairs. You should also set the maximum amount of leverage you will use on your account. For example, you might allow yourself to have positions two times the size of your account value, with a maximum total leverage on the account of ten times your account value. You can add these considerations into how you build your option positions. Structuring your accounts with a broker How you structure your capital in your trading accounts serves two purposes. Firstly, it can protect against market risk, which I will explain below. Secondly, it can protect against counter-party risk (the risk of your broker going bust).
Exactly how many put options to buy will depend on your risk management objectives. The more There are a number of considerations to be aware “perfectly” you hedge your risk, the more expensive of: your hedge will be. If you want all your positions to be hedged, then it will cost more to buy the options, so Market Maker vs. ECN perhaps you will hedge any position that is greater than The first thing to understand about structuring the size of your account. It will depend on what you are your accounts is the difference between a market maker trying to achieve in the long run. and an ECN broker. It is during the bang moments that a “good” market maker can shine. As a market maker Scale-in to reduce costs on long-term trades has the ability to create the price, they can fill your orThis strategy suits a scale-in approach der even when it does not trade there in the if you are long-term trading. If your first pointer-bank market. sition is small, then you may not hedge it, Imagine if ... but as the trade moves in your favour and ... the price And some will do it. youadd to your position, you can start to During 9/11, the Japanese Tsunami gapped build a hedge. As the market has moved in and the recent SNB intervention, some maryour favour, the out of the money options against your ket makers filled stop orders without slipwill be cheaper meaning the cost of your position for page. Meanwhile, those trading with ECN’s protection is less. would have had to acceptthe prices from the 2000 pips. pool of liquidity providers in the ECN. GenBeware of the cost of hedging on shorterally, the market maker is a better choice in term trades. this scenario (though no guarantees!). As short-term traders tend to trade with greater leverage, the tail risk can be greater. Imagine if you had How brokers handle negative balances a large day trade on the USDCHF, and the price gapped Some brokerswill tend to wipe any negative acagainst your position for 2000 pips. You will need to count balances that their clients experience (generally do some testing of worst-case scenarios, and consider the larger market makers will be best at this). how much risk you are willing to take when you structure your protection. It’s important to note that you can Why do this? buy and sell an option pretty easily, but the cost of the spread is higher than on currency pairs themselves. Page 12
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Brokers are scared of the regulatory risk from negative balances. Did the client properly understand the risk that their account could go into negative balances when they opened the account? A broker never wants to be seen as shady, so it pays in the end just to eat the negative balance. It is this type of complaint that can threaten their long-term business. Even if the regulators will generally find in the favour of the broker, they would prefer not to have to deal with that risk. So, if possible, they will simply wipe negative balances. Again, no guarantees, but it is worth considering. I hope this is not seen as too sceptical about brokers’ motivations. They do this out of a positive desire to help and protect their clients, too. Brokers are large trading organizations… but some are not very sophisticated risk managers. The third consideration to think about with brokers is that they themselves can end up holding large positions in currency pairs. This happens either through prop trading, or due to customers’ orders. Sometimes this is hedged, but other times it is not.
funds you keep with your broker. The broker should be a market maker with a track record of filling orders in adverse situations, as well as clearing negative balances.
This does not mean you need to reduce your position size when you trade; it simply means you can use “notional funding”.The idea behind this concept is that you could have $5000 in your account,but still trade as This means that some brokers, as we have seen, though it were $50,000. You can be prepared to risk can find themselves in strife if their positions go south. your capital, without having all of it in your trading acDo not put too much faith in your broker being staffed count at any one time. by good traders or risk managers. A good approach is to keep just enough money Keep your account balances at a minimum in your account to maintain your trades, and make sure Taking into consideration these three factors, one you do not get stopped out or margin called! Any excess strategy to minimise tail risk is to limit the amount of funds can be kept in a more secure (preferably government guaranteed) financial institution. You then transfer funds into your account as you need them. In the event of a move against you, like we had with the SNB announcement, your risk could be limited in three ways. 1. Your order could be filled even if the price does not trade at your stop-loss 2. If your account does go into a negative balance, there is a chance it will be wiped 3. If you broker goes under Trading Street Magazine
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while you are using “notional trading”, you will have lost a small amount of trading capital, rather than your entire account. If you combine with this with a deep out of the money option strategy, you could experience a situation where any losses in your account are limited, yet your potential gain on the options is unlimited. This is, of course, if you have the options in a separate account – with a different broker (which you should!).
Be a risk manager first “Bang moments” can happen at any time, and it is only the prepared trader that will be saved (or prosper!). Take the steps that you need to build a risk management plan that protects your trading account from tail risk before it is too late. It will take discipline to apply your risk management rules consistently – to guard against risks that very rarely occur. But, I can guarantee you one thing. When the next bang moment comes, you’ll be glad you did.
This is the type of trade you want; one where downside risk is constrained, and upside potential is unlimited.
About the Author: Sam Eder Sam has been trading since 2007. Sam is an ex-army officer and he holds a masters in Leadership. In 2008 Sam joined one of the top 10 Global Forex brokerages, where he worked in both Australia and Singapore. Since then he started a share investing business, SpoonFed Investor. Ever the entrepreneur, in 2014 the opportunity arose to take over FX Renew, an already successful Forex signals business, along with Michael Collins. Sam is the author of The Advanced Forex Course for Smart Traders, which he spent close to 500 hours developing. He is also author of The Definitive Guide to Building a Winning Forex Trading System.
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Technical Signals Anyone Can Use By Thierry Laduguie, CEO Better Trader
Trading Street Magazine
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I
use a variety of indicators depending on what I am trading. If I am trading stocks I go for standard technical indicators like the relative strength, moving averages, directional movement index and MACD. If I trade the index I go for more advance techniques like Elliott wave analysis and sentiment indicators. Stocks One of my favourite technical signals combines the relative strength and the 55-day moving average in a daily chart. Relative strength compares two securities to show how they are performing relative to each other. Or, the stock’s price change is compared to the index price change (the base security) and is calculated by dividing the stock’s price by the index price.
Elliott Wave MACD
than the index). When the relative strength moves sideways both the stock and the index perform the same. What does the relative strength tell us? At first glance a rising relative strength over a six-month period or more tells us that the stock has strong fundamentals, it could be one reason why the stock outperforms the index. In the case of Prudential, the relative strength has been rising for more than three years. Even during periods when the FTSE 100 was going sideways the stock continued to advance. This characterizes On the above chart of Prudential (LON:PRU – strength and when a stock is strong it will seldom drop black line on chart above) the stock is compared to the to the 200-day moving average. Instead when it pulls FTSE 100 index and the relative strength is the blue back, the decline often ends on the 55-day moving avertrendline at the bottom of the chart. When the relative age. Each time the stock drops below its 55-day moving strength moves up the stock outperforms the index (per- average (red trendline) it is a buy. This occurred many forms better than the index). When the relative strength times in the last three years. moves down the stock underperforms (performs worse Page 16
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A divergence occurs when prices make a new high but the MACD makes a lower high (or when prices make a new low but the MACD makes a higher low). The divergence occurs between the 3rd and 5th wave and there should be 40 to 80 bars in the five-wave sequence under observation. If there are less than 40 bars or more than 80 bars the divergence might not be visible. These divergences confirm the end of the move and can be seen in any time period (intraday, daily, weekly‌). On the chart the S&P 500 is higher at the Indices end of wave (v) but the MACD is lower (bearish diverOne of my favourite signals on indices is a fivegence). This means the S&P 500 will pullback. wave move (Elliott Wave) accompanied by a divergence on the MACD (moving average convergence diverInvestor sentiment gence) between the third and the fifth wave. Here is an By far the most important piece of information is example:
Trading Street Magazine
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investor sentiment. A major advance starts when sentiment becomes extremely bearish as indicated by the 34-day BTI (chart below). I created this indicator to measure extremes in sentiment. For example after the stock market correction in October 2014, the 34-day BTI dropped below -400 on 20th October (extreme in bearish sentiment). When the indicator is below -400 sentiment it is extremely bearish and in this case the odds of a rally in the short/medium term are high. This meant the S&P 500 was near a bottom. In fact the bottom was recorded a few days earlier. The S&P 500 then rallied from 1900 to 2090 in a few months.
where we are now. The indicator does not tell us when the decline will start but the message is clear. Sometime in the next few months the S&P 500 will be trading significantly lower. This example illustrates the power of investor sentiment. The stock market rises and falls in line with sentiment but when sentiment reaches an extreme it is often a turning point. An extreme in sentiment at the end of a five-wave sequence has even greater forecasting value.
The opposite situation is when the 34-day BTI is above 400, in this situation sentiment is extremely bullish and the odds of a decline are high. This is precisely
About the Author: Thierry Laduguie
Thierry joins Trading Street as an investment advisor, analyst, guest speaker and writer who is widely published in the UK and Europe for his mastery of Elliot Wave analysis and the predictive powers of his proprietary indicators in a number of markets. A member of the UK Society of Technical Analysts and an active advisor to various private clients, Mr. Laduguie has been published by such well known publications as Fleet Street Publications and as editor of Spread Trader, as well as many industry websites on the subject of trade theory, technical analysis, and the fundamentals of trading equities. He currently is chief trading strategist at BetterTrader.co.uk and is soon to be unleashed as a contributor to Trading Street, your premier (global) investment website.
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You know futures trading. But do you know Nadex? There’s a fast, innovative way to gain exposure to the futures markets. Nadex binary options offer: • Access to fast-moving, heavily traded commodities markets • Short-term contracts ranging from intraday to weekly expirations • Protection from getting stopped out
Get on board or get left behind.
Join the Nadex movement.
The North American Derivatives Exchange
www.nadex.com Futures, options and swaps trading involves risk and may not be appropriate for all investors.
Trading Street Magazine
March 7, 2015
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Crude Oil – Trade It without So Much Drama By The Nadex Team
W
hatever your opinion ofwhere crude oil is headed next, few would disagree that the $52-54 level in crude oil is technically significant. It was one of the few areasof support on the way down in mid-December and the market consolidated in that area again at the end of December before plunging in January.
ing market is above the strike price. That’s called “in the money” and it’s what you want as a buyer. If it is at or below the strike price, the binary is worth $0 and you lose whatever you paid up front. When you sell a binary, you want the opposite: you want the underlying to beat or below the binary’s strike price at expiration. When the binary settles at $0, you receive the settlement payout of $100.
If you are contemplating taking a position in crude oil futures, you may also be wary of the big price With Nadex binary options, you decide your maxswings the market has seen lately. At $10 per tick, a imum risk and profit. And even if the market swings futures position can go seriously wrong quickly causing wildly, you cannot get stopped out. No margin calls, no losses to mount in the blink of an eye. surprises, just the risk you chose up front. Instead, you could take a crude oil position with limited risk on theNadex exchange, the largest CFTCregulated USbinary options exchange. On Nadex you can trade binary options and spreads based on many of the most popular markets. The Nadex Crude Oil Binary is basedon the NYMEX® Crude Oil Futures.
Let’s look closer at a hypothetical crude oil trade.
A binary option is a simple yes or no question: Will crude oil be above or below a certain price at a certain time?That price is called the strike price. The time is called the expiration. When you buy a binary, you expect the underlying market to finish above the strike price at expiration. The binary’s price will trade between 0 and 100, based on where the underlying market is, relative to the strike price, the time till expiration and market volatility. At expiration, the binary will be worth $100 if the underlyPage 20
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Assume you see the52.50 levelas resistance and expect April Crude Oil futures to go down. One way to trade it would be a short position on an April Crude Oil futures contract. You would likely want to protect yourself with a stop loss, with an acceptable risk to profit ratio. On February 20th, 2015 at8:45am ET the Crude Oil futures are trading at 52.27 and you decide to use a buy stop controlling your risk at 52.52 equivalent to $250(assuming no slippage). You are comfortable with that risk, but if the markets are choppy you could get stopped out once you get filled, only to see the market then move back down without you. You were right, but all you have to show for it is a $250 loss. Even worse, you could get filled on your stop loss even higher and lose more than $250. There is no cap on losses in futures.
Maximum trade risk =initial cost That is a risk every futures trader deals with, how- $246.00($250/$20.50= 12.19 contracts) ever using binary options to initiate a short position on April Crude Oilcouldlimit one’srisk. For the same $250, When you sell a binary, your initial cost is the difyou can sell multiplebinary contracts at various strike ference between $100 (the settlementpayout) and the levels. trade price. Your net profit would be the trade price itself (not including trade fees). For $250, you could Here is how the process could work. At 8:45am afford any of the above trades using in-the-money or ET, you sell any of the following binary options expiring out-of-the-money strike prices. at 2:30pm ET. In this case, the stop level on your crude oil fuCrude Oil (Apr) > 52.50 (2:30pm) @ 36.25 - Initial cost tures position was close at 6 ticks away but never got $63.75/contract – Short 3 binary contracts hit before the price of crude oil dropped over a dollar. Maximum trade risk =initial cost Even if the price had gone up, using a binary option you $191.25($250/$63.75= 3.92 contracts) wouldn’t have been stopped out. Crude Oil (Apr) > 52.00 (2:30pm) @ 52.75 - Initial cost $47.25/contract – Short 5 binary contracts Maximum trade risk =initial cost $236.25($250/$47.25=5.29 contracts) Crude Oil (Apr) > 51.00 (2:30pm) @ 79.50 - Initial cost $20.50/contract – short 12 binary contracts Trading Street Magazine
March 7, 2015
At the 2:30pm expiration the futures were trading at 50.88. If you were still short a futures position you would have been up $1390.00 (not including trading fees). Of course to trade futures you have to have a certain account balance and available margin. To trade Nadex binary options you only need to Page 21
binary options you only need to risk the cost of the trade risk the cost of the trade. In this example all the binary strikes finished in the money, meaning you as the seller received the $100 per contract settlement payout.
Crude Oil (Apr) > 51.00 (2:30pm) profit $79.50 *12 contracts = $954.00–ROI= 387.8% Initial Cost= $246.00 (fees not included) In this example, both trades would have profited, but Nadex binary options offer you limited risk with the ability to stay in a trade even if it moves against you. Sure, you do not get as much drama as you might with a futures contract, but adding something a little less dramatic to your trading toolbox may also be less stressful.
Crude Oil (Apr) > 52.50 (2:30pm) profit $36.25 *3 contracts = $108.75–ROI= 56.9% Initial Cost= $191.25 (fees not included) Crude Oil (Apr) > 52.00 (2:30pm) profit $52.75 * 5 contracts = $263.75–ROI= 111.6% Initial Cost= $236.25 (fees not included) Futures, options and swaps trading involves risk and may not be appropriate for all investors. Past performance is not necessarily indicative of future results.
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A Handful of Dynamic ETF’s for the US Equity Markets By Jean-François Owczarczak, Director at FinGraphs.com
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• Chart 2: Consumer Discretionary (the XLY select sector SPDR ETF), a typical early cycle mover, has started to resume its uptrend vs. SPY (the S&P500 SPDR ETF) following a correction down during 2014. It is on the brink of turning positive again. • Chart 3: Technology (the XLK select sector SPDR ETF), another early cycle mover, is approaching the upper boundary of our corrective targets up vs. SPY (“C up” or the grey target oval). It could soon turn impulsive up, opening the way to much greater out-performance. • Chart 4: in the 4th Quarter of 2014, mid caps (MDY, the SPDR Midcap Trust Series I) have started to catch up vs. SPY following a very negative 2014. They are now only slightly bearish to neutral (Bear Trend, but Betting on a cyclical upturn: 2014 was mostly a defensive year: stocks were no targets). We have not considered the IWM iShares modestly up and the US economy improved, yet de- Russell 2000 ETF (not shown) as it is still in an Impulfensive sectors such as Staples, Healthcare and Utilities sive downtrend vs. SPY (i.e. too early to consider in widely out-performed the broader market, especially in terms of trend positioning). the second half of the year. If you have followed FinSo, growth should outperform value, cyclicals graphs latest analysis, you may be aware that we are still widely positive on US equities. Hence, despite an un- could accelerate and mid caps are making a come-back. convincing January, we believe that the cyclical upturn As mentioned above, we also believe that the SPY (the has started to gather momentum in February’s strong S&P500 SPDR ETF) should continue up over the next few months. One strategy could be to use SPY as the move higher. core ETF in a US Equity portfolio and complement it with MDY (the SPDR Midcap Trust Series I) to achieve The charts below tend to confirm this view: more dynamic returns. That said, our selection pro• Chart1 : Growth should continue to accelerate cess is to concentrate on ETFs that offer the best overall vs. value (the IWM iShares S&P500 Growth ETF vs. the positioning, for now MDY is only neutral, at best, vs. IVE iShares S&P500 Value ETF is in an Impulsive up SPY. An alternative would be to replace SPY, which is based on the capitalization weighted S&P500, by one of move with more upside potential), its equal weighted surrogates. We suggest RSP (the Guggenheim Equal Weight ETF). It offers in one instrument a balanced exposure between large and mid caps. It is also well positioned on sing equity ETF’s picked from the Fingraph.com platform of 150 available ETF’s, we will attempt to create a diversified investment portfolio. The investment horizon targeted is the next 3 to 6 months, or until mid 2015. Accordingly, to illustrate our selection process we will use mosaics of our weekly charts offering a perspective over the next two quarters. Although to some degree we have considered size, liquidity and management fees, our main selection criteria will be market positioning (relative trends and price potential) as well as composition (e.g. concentrated ETF or broader based ETF).
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Sector focus: looking for vectors of growth We have benchmarked the major US sectors vs. SPY (most sector ETFs are cap weighted; SPY is thereRSP vs. SPY – Investor’s View (a combination of a fore better suited for a like comparison than RSP). As Weekly, Daily and Hourly chart): we are betting on a cyclical upturn, we will generally avoid Defensive Sectors such Consumer Staples (the XLP select sector SPDR ETF) and Utilities (the XLU select sector SPDR ETF). These corrected up in 2014, but are now resuming their downtrend vs. SPY. We will also exclude Financials (the XLF select sector SPDR ETF) which has been slightly down vs. SPY over the last 2 years, a downtrend which lately appears to be accelerating. Finally, we will also stay away from sectors which typiThe Weekly (left hand chart) and Daily (middle cally start to outperform later on in the cycle, namely chart) continue to show strength respectively over the Industrials (the XLI select sector SPDR ETF), Materials next few Quarters and Months (our investment hori- (the XLB select sector SPDR ETF) and Energy (the XLE zon). Shorter term, the hourly (right hand chart), which select sector SPDR ETF). These are still in downtrends is meant to analyse market perspectives over the next on our Weekly charts vs. SPY. few weeks, is in a mere consolidation for now. It has reached its corrective targets down (“C Down done”) his process by elimination leaves us and could now be ready to resume its uptrend. Ideally, with three sectors, which we will fowe would not want it to move below this corrective tarcus on: Consumer Discretionary (the get range as it would imply more short term downside XLY select sector SPDR ETF), Techpotential over the coming weeks. nology (the XLK select sector SPDR ETF), both early cycle movers, and Healthcare (the XLV select sector Hence, we will choose RSP as the first element of SPDR ETF) which although considered as defensive, is our ETF portfolio (the Guggenheim S&P Equal Weight showing strong resilience in its outperformance (outETF). It is an important one as it will serve as the core performed in all of the last 4 years). XLV benefits for of our US Equity exposure. a strong underlying secular trend, i.e. an ageing population, and is also widely exposed to the very dynamic bio-technology sector. a relative basis vs. SPY as we can see in the following relative strength Investor’s View chart combination.
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haustion down vs. IYC (our Impulsive price target zone has been reached, labelled “I down done�), its trend is still negative. Hence, in the early stages of this cyclical recovery, IYC still seems to be the better choice. We will use it as the second element of our ETF portfolio. It will serve as the main Consumer discretionary: proxy for the cyclical upturn. In this sector, we have chosen IYC, the iShares U.S. Consumer Service ETF. It focuses on cyclical consumer The last two charts above review two segments related stocks, mostly, but not only, in the Consumer of the Consumer Discretionary space, benchmarking Discretionary sector (also includes stocks from the Staples, Industrials, Healthcare and Technology sectors). them vs. IYC to assess if they could add additional value It is a very broad based ETF which includes circa 190 to the portfolio. While Homebuilders (the XHB Homecompanies, offering more diversification than its pure builders SPDR ETF) are still in an impulsive downtrend Consumer Discretionary peers which over the last cou- vs. IYC, Retail (the RTH Market Vectors Retail ETF) is ple of years has shown better returns with less volatility. aggressively outperforming and should continue to do so. We will include it as the third element of our ETF portfolio as it provides an additional kick in the cyclical weighting of our portfolio.
In the first chart below, we first benchmark IYC vs. XLY (the Consumer Discretionary select sector SPDR ETF) and confirm that IYC should continue to outperform over the next few Quarters (still some potential in terms of targets; in addition the Risk Index of this relative chart is not Overbought yet). In the second chart, we benchmark the more broad based growth ETF IVW (iShares S&P500 Growth ETF) vs. IYC. On this relative chart, although IVW has reached a certain level of ex-
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Technology: As we mentioned above, XLK (the Technology select sector SPDR ETF) is on the verge of breaking out above corrective targets into impulsive territory vs. SPY (above the grey oval in our first chart below). That said, in our second chart, it is still widely underperforming vs. the tech heavy Invesco Powershares QQQ which includes the largest 100 non-financial companies listed on the NASDAQ Stock Exchange. We will favour QQQ over XLK as the fourth element of our ETF portfolio to gain exposure to the technology sector. In the last two charts above, we also single out the semi-conductor segment using SMH (the Market Vectors Semiconductor ETF). It should continue to outperform XLK over the next few quarters and is in a corrective up phase vs. QQQ with a Risk Index Trading Street Magazine
March 7, 2015
which is not yet overbought. We will include it as the fifth element of our ETF portfolio believing it brings exposure to a highly innovative segment of the hardware side of the technology sector. Healthcare: We believe the healthcare sector is a hybrid and as such brings great value. It is traditionally considered as being defensive and will provide a hedge to our cyclical bias if that bias is proven wrong. It also capitalises on the aging of the population, a strong secular trend. The sector is widely exposed to the very innovative bio-technology sector, which in a few words mirror growth and innovation with a defensive tilt.
The seventh element of our ETF portfolio would be IBB (the iShares NASDAQ biotechnology ETF) further skewing the portfolio towards this innovative Healthcare segment.
Our US Equity ETFs portfolio on an absolute basis: The mosaic above presents the 7 ETFs we have The first chart below highlights the remaining selected as building blocks for our US Equity ETF portpotential of XLV (the Healthcare select sector SPDR folio. On an absolute basis, they all show positive upETF) vs. SPY. The second would however lead us to trends. favour a more broad-based Healthcare ETF: VHT (the As for the weighting of these different building Vanguard Healthcare ETF). It has outperformed XLV over the last couple of years and should continue (upper blocks, it will depend on how confident you believe targets not fulfilled yet, Risk Index not yet overbought). each part of our argumentation is in terms of adding As it happens, it is also outperforming QQQ (our third positive value and diversification to the US Equity mix. chart). We will include VHT as the sixth element of our It will also depend on your propensity to engage in proETF portfolio allowing us to gain a broad exposure to cyclical risk. the “hybrid” Healthcare sector.
About the Author: Jean-François Owczarczak, Director at FinGraph.com In 2003, after 5 years in Investment Banking at Paribas and Deutsche Bank in London, Jean-François joined Management Joint Trust. Today, he acts as Chief Investment Officer and Head of Business Development for the company. He holds a Master in Business from the University of St Gallen (lic. Oec. HSG 1997) as well as the CFTe certification (Certified Financial Technician). Jean-François was awarded the Bronwen Wood Memorial Award 2012 by the International Federation of Technical Analysts. This distinction is given out to the best CFTe exam paper written in the world each year. Jean-François is also a member of the Swiss and UK societies of technical analysts. Trading Street Magazine
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Global Investment Perspective
A Closer Look at the Oil Industry of Venezuela By Shayne Heffernan Ph.D - CEO at Heffx
Overview
Venezuela contains some of the largest proven oil and natural gas reserves in the world. In 2013, it was the third-largest exporter of crude oil to the United States. It consistently ranks as one of the top suppliers of crude oil to the US. Venezuela is one of the world’s largest producers and exporters of crude oil and has consistently been one of the largest exporters of crude oil in the Americas. As a founding member of the Organization of the Petroleum Exporting Countries (OPEC), Venezuela is an important player in the global oil market. In recent years, through significant upfront investment, an increasing share of Venezuela’s exports have been delivered to China and India. In 2012, Venezuela consumed 3.3 quadrillion British thermal units (Btu) of total energy. Oil continues to represent the majority of total energy consumed, while use of natural gas has increased in the past five years. Hydroelectric the country’s state-run oil and natural gas company. power represents less than 25% of total consumption, Along with being Venezuela’s largest employer, PDVSA and coal represents less than 1%. accounts for a significant share of the country’s gross domestic product (GDP), government revenue, and exPetroleum and other liquids port earnings. During the 1990s, Venezuela took steps Venezuela was the world’s 9th largest exporter to liberalize the petroleum sector. However, since the and 12th largest producer of petroleum and other liq- election of Hugo Chavez in 1999, Venezuela has inuids in 2013. creased public participation in the oil industry. The Chavez government initially raised tax and royalty rates According to the Oil & Gas Journal (OGJ), in the on new and existing projects and mandated majority beginning of 2014 Venezuela had nearly 298 billion bar- PDVSA ownership of all oil projects. rels of proved oil reserves, the largest in the world. The next largest proved oil reserves are in Saudi Arabia (266 In 2002, nearly half of PDVSA’s employees walked billion barrels) and Canada (173 billion barrels). The off the job in protest against the rule of then-President vast majority of Venezuela’s proved oil reserves are lo- Chavez, largely bringing the company’s operations to cated in its Orinoco heavy oil belt. a halt. In the wake of the strike, PDVSA fired 18,000 workers and overhauled the internal organization to Sector organization solidify government control. The loss in human capital Venezuela nationalized its oil industry in the has never been entirely recovered, resulting in a loss of 1970s, creating Petroleos de Venezuela S.A. (PDVSA), technical capabilities affecting PDVSA’s overall producTrading Street Magazine
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tion levels. In 2006, Chavez implemented the nationalization of oil exploration and production in Venezuela, mandating a renegotiation of a 60% minimum PDVSA share in projects. Sixteen firms, including Chevron, ExxonMobil, and Royal Dutch Shell, complied with new agreements, while Total and Eni were forcibly taken over. After Chavez’s death in 2013, President Maduro continued Chavez’s policies. Venezuela is also increasing pressure on foreign operators that remain in the country to increase investment to offset recent production declines.
being reinvested into petroleum production. Despite its declines and lack of reinvestment, Venezuela is still one of the largest producers of petroleum in the world. In 2013, Venezuela was the fifth largest producer in the Americas, behind the United States, Canada, Mexico, and Brazil.
Estimates of Venezuelan production vary from source to source, partly because of the measurement methodology. For instance, some analysts directly count the extra-heavy oil produced in Venezuela’s OriExploration and production noco Belt as part of Venezuela’s crude oil production. The U.S. Energy Information Administration Others (including EIA) count it as upgraded syncrude, (EIA) estimates that Venezuela produced 2.49 million whose volume is about 10% lower than that of the origibarrels per day (bbl/d) of petroleum and other liquids nal extra-heavy feedstock. in 2013 which represents the 12th largest producer in the world and the 5th largest producer in the Americas. enezuela’s conventional crude oil is Crude oil and condensates represented 2.2 million bbl/d heavy and sour by international standof the total, with condensates, natural gas liquids, and ards. As a result, much of Venezuela’s refinery processing gains accounting for the remaining oil production must go to specialized production. This production level marks a significant domestic and international refineries. The country’s decrease from production peaks in the late 1990s to most prolific production area is the Maracaibo basin, early 2000s, largely owing to human capital losses from which contains slightly less than half of Venezuela’s oil the 2002-03 strike and the diversion of revenues to so- production. Many of Venezuela’s fields are mature, recial programs to bolster the administration rather than quiring large investments to maintain current capacity.
V
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Orinoco heavy oil belt Venezuela’s Orinoco Belt, located in the central part of the country, may contain upwards of 513 billion barrels of crude oil; according to the US Geological Survey. However, much of the resource is extra-heavy crude oil and bitumen deposits which requires additional capital to bring it to market. PDVSA began the Magna Reserva project in 2005, which involved dividing the Orinoco region into four major areas that are further divided into 28 blocks, and then quantifying the reserves in place. This initiative resulted in the upgrading of Venezuelan proven reserve estimates by more than 100 billion barrels. In the 1990s, Venezuela’s PDVSA established four strategic associations with international oil companies to exploit these resources. After the implementation of the nationalization policy in 2006, these strategic associations led by ConocoPhillips, ExxonMobil, and Total became newly formed mixed companies with PDVSA holding the majority shares. The nationalization resulted in the exit of ConocoPhillips and ExxonMobil, as they were unable to accept PDVSA taking majority shares. Trading Street Magazine
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sues.
The Magna Reserva projects involve converting the extra heavy crude and bitumen to lighter, sweeter crude, known as syncrude. The upgrading facilities themselves introduce another element of risk into Venezuela’s petroleum supply chain. While the country’s four companies tasked with the upgrading have managed to install production capacity of about 600,000 bbl/d of syncrude, production levels for these facilities remain at less than 500,000 bbl/d as a result of maintenance and safety is-
Venezuela plans to further develop the Orinoco Belt oil resources in the coming years. In 2009, Venezuela signed bilateral agreements for the development of four major blocks in the Junin area. In 2011, the country awarded two more major development licenses in the Carabobo region. They expect these projects to add more than 2 million bbl/d of heavy oil production capacity by the end of the decade. However, given recent financial, regulatory, and operational issues, considerable uncertainty surrounds the future of Orinoco production. Trade Venezuela was the fourth-largest supplier of imported crude oil and petroleum products to the United States in 2013. However, Venezuela’s exports to the
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United States have been declining while U.S. exports of petroleum products to Venezuela have been increasing. EIA estimates that in 2013 net exports from Venezuela totaled nearly 1.7 million bbl/d of crude oil and petroleum products, a significant decrease since the peak of 3.1 million bbl/d in 1997. Venezuela sends a large share of its oil exports to the United States because of the proximity and the operation of sophisticated U.S. Gulf Coast refineries specifically designed to handle heavy Venezuelan crude.
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Although the United States receives the bulk of Venezuela’s exports, other important destinations of Venezuelan petroleum exports include the Caribbean, Asia, and Europe. Two of the fastest growing destinations of Venezuelan crude oil exports have been China and India. EIA estimates that Venezuela sent more than 260,000 bbl/d of crude oil to China and more than 400,000 bbl/d to India in 2013.
n 2013, Venezuela was the fourth-largest supplier of imported crude oil and petroleum products to the United States behind Canada, Saudi Arabia, and Mexico. U.S. imports from Venezuela have been on an overall decline in recent years. In 2013, the United States imported 797,000 bbl/d of crude oil and petroleum products from Venezuela, a decline of 49% from a decade ago. In prior years, U.S. imports from the U.S. Virgin Islands were calculated as imported volumes from Venezuela because the petroleum US imports of products produced were almost exclusively Venezuelan oil refined from Venezuelan crude. However, since the U.S. Virgin Island’s Hovensa re- have decreased finery was shutdown in 2012, the U.S. Vir- 49% in the last gin Islands no longer exports refined Vendecade ezuelan petroleum.
Venezuela provides a sizable amount of crude oil and refined products to its regional neighbors. Under the Petrocaribe initiative, Venezuela provides crude oil and refined products to many countries in the Caribbean and Central America, offering favorable financing and long repayment terms that often feature barter arrangements instead of cash transactions. In addition, Venezuela has a separate supply agreement with Cuba. According to industry reports, these preferential supply agreements amount to more than 400,000 bbl/d of Venezuelan exports. Although Venezuela publicly maintains that Petrocaribe will not dissolve, many analysts believe, given the financial circumstances of PDVSA, shrinking foreign exchange reserves, and exports guaranteed to other countries, that Venezuela will have to redefine the terms offered under Petrocaribe.
While U.S. imports of primarily crude oil from Venezuela have been on the decline, U.S. exports of petroleum products to Venezuela have increased largely because of Venezuela’s tight finances that leave it unable to invest and maintain its own domestic refineries. A decade ago, the United States exported 7,000 bbl/d to Venezuela; in 2013, the United States sent Venezuela 84,000 bbl/d of petroleum products, primarily methyl tertiary butyl ether (MTBE), intended for blending in gasoline, motor gasoline, and distillate fuel Refining oil. Venezuela maintained 2.8 million bbl/d of total Page 32
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capacity of 755,400 bbl/d. CITGO’s gulf coast refineries source most of their crude oil with PDVSA under longterm supply contracts. PDVSA also owns a 50% stake in the 189,000-bbl/d Chalmette facility in Louisiana. In 2009, Conoco Phillips exercised the option to purchase PDVSA’s share of their refinery in Sweeny, Texas. This move, coupled with Venezuela’s sale of its equity stake in Germany’s Ruhr Oel GmbH to Rosneft, constituted a substantial contraction of Venezuela’s net global capacity. In addition, PDVSA announced a desire to sell its stake in its European assets, but the country has yet to do so. Minor equity acquisitions in the Caribbean have partially offset this change. Domestically, Venezuela plans to add new capacity of more than 400,000 bbl/d by 2020. Notable planned global refinery builds include a 400,000 bbl/d joint venture with PetroChina global refining capacity in assets throughout the United in Guandong province, China; a 300,000 bbl/d joint States, the Caribbean, Europe, and domestically in Ven- venture with Petroecuador in Manabi, Ecuador; and a 230,000 bbl/d joint venture with Petrobras in northeastezuela in 2013. According to OGJ, Venezuela had 1.3 million ern Brazil. In light of the ongoing currency and liquidbbl/d of domestic crude oil refining capacity in 2013, ity issues, many of these and other announced projects all operated by PDVSA. The major facilities include have been delayed or are on hold. the Paraguana Refining Center (955,000 bbl/d), Puerto de la Cruz (195,000 bbl/d), El Palito (126,900 bbl/d), Natural gas Venezuela has the second-largest natural gas reand San Roque (5,200 bbl/d). While capacity remains serves in the Americas, behind the United States. Much largely unchanged, the throughput from these refineries has suffered because of the lack of investment to main- of the natural gas is used to bolster production in its tain the facilities. This problem was highlighted by the mature oil fields. Amuay refinery fire in August 2012 that left more than According to OGJ, Venezuela had 196 trillion 40 people dead, and disabled some of Venezuela’s refincubic feet (Tcf) of proved natural gas reserves at the ing throughput at the Paraguana Refining Center. beginning of 2014, the second largest in the Americas Through PDVSA and its subsidiary CITGO, Venezuela also controls significant refining capacity outside the country, giving it a total global refining capacity of 2.8 million bbl/d. The largest share of Venezuela’s global downstream operations is in the United States, followed by significant operations in the Caribbean and stakes in Europe. CITGO, a wholly-owned subsidiary of PDVSA, operates three refineries (Lake Charles, Louisiana; Corpus Christi, Texas; Lemont, Illinois), with a combined crude oil distillation Page 34
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behind the United States. In 2012, Venezuela produced 803 billion cubic feet (Bcf) of dry natural gas and consumed 869 Bcf.
About 90% of Venezuela’s natural gas is found associated with oil
Since 2003, the petroleum industry has consumed about 40% of Venezuela’s gross natural gas production, primarily for gas reinjection to bolster crude oil extraction. Because of the declining output of mature oil fields, natural gas use for enhanced oil recovery has increased by 42% since 2005. To meet the growing industrial demand for natural gas, Venezuela imports gas from Colombia and the United States. The government has prioritized developing domestic natural gas production for industrial uses as well as residential and commercial markets, and is developing its gas infrastructure in support of this effort.
Sector organization In 1999, Venezuela adopted the Gas Hydrocarbons Law, which was intended to diversify the economy through facilitating non-associated natural gas development and expanding the role of natural gas in Venezuela’s energy sector. This legislation allows private operators to own 100% of non-associated projects, in contrast to the ownership rules in the oil sector. It also mandates lower royalty and income tax rates on nonassociated natural gas projects than on oil projects. The law gives PDVSA the right to purchase a 35% stake in any project that moves into commercial status. In 2007, Chavez announced a public referendum on proposed constitutional amendments, one of which would entitle the state to a controlling stake in new gas projects, similar to that of the oil sector. However, the Venezuelan people defeated the referendum in December 2007. Since then, the state has yet to repurpose amendments to the gas law.
Following Chavez’s announcement of the Socialist Gas Revolution in 2009, the Energy and Petroleum Ministry announced plans to increase natural gas production to roughly 14 billion cubic feet per day (Bcf/d) and to begin exporting natural gas by 2015. Currently, Venezuela is working to increase the production of non associated gas, largely through the development of its offshore reserves. Onshore, PDVSA is working toward raising production and capacity at existing sites, including the Anaco field, the Barrancas field, and Yucal Placer. Offshore, PDVSA has awarded exploration blocks to international oil companies, including Total, Statoil, and Chevron, in the PlataformaDeltana, Marsical Sucre, and Blanquilla-Tortuga areas off Venezuela’s northeast coast. Venezuela has also awarded exploratory blocks to Gazprom and Chevron to develop the potential 26 Tcf gas blocks in the Gulf of Venezuela in the northwestern part of the country. Offshore exploration has yielded many successful finds, including Repsol-YPF and ENI’s discovery of 6-8 Tcf of recoverable natural gas in the Cardon IV block in the Gulf of Venezuela, one of the largest natural gas discoveries in the history of the country. In early 2014, ENI announced gas production would begin in 2015 at their Perla field project with estimated reserves of 15 Tcf of natural gas.
PDVSA had also found a field with a potential 7.7 Tcf gas reserve at Tia Juana Lago in the Sur area. For PDVSA produces the largest amount of natural Venezuela’s offshore gas development to move forward, gas in Venezuela, and it is also the largest natural gas international partners will need to play a central role in distributor. A number of private companies also cur- production. PDVSA does not have experience in prorently operate in Venezuela’s gas sector. Participants ducing non associated gas—the company’s most recent with significant assets include Repsol-YPF, Chevron, attempt at operating an offshore natural gas project reand Statoil. sulted in the sinking of the Aban Pearl semi-submersible drilling rig in May 2010. Exploration and production About 90% of Venezuela’s natural gas is found as- Pipelines and liquefied natural gas (LNG) sociated with oil but the country is looking to locate and In recent years, Venezuela has improved its 2,750produce more natural gas from non-associated fields. mile domestic natural gas pipeline transport network to Trading Street Magazine
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Venezuela depends on hydroelectricity for the bulk of its electricity needs, accounting for 60% or more in the past decade. In 2011, Venezuela had nearly 25 gigawatts of installed generation capacity. The country generated roughly 119 billion kilowatt-hours of electricity in 2011, 70% from hydroelectric power and the remainder from fossil fuels. Preliminary estimates indicate that 2012 levels remained the same, with hydroelectric power accounting for 69% and the remaining from fossil fuels. allow greater domestic movement and use of natural gas with the roughly 190-mile Interconnection Centro Occidente (ICO) system. The ICO connects the eastern and western parts of the country, making natural gas more easily available for domestic consumers and for reinjection into western oil fields. Expansion efforts to the ICO will increase capacity to 520 million cubic feet per day (MMcf/d). In addition, the 300-mile SinorGas pipeline project will transport gas produced offshore to the domestic pipeline network via Sucre and Anzoategui. In 2008, the Antonio Ricaurte pipeline came online, connecting Venezuela with Colombia. Currently, the pipeline allows Colombia to export natural gas to Venezuela, with contracted volumes ranging between 80 and 150 MMcf/d. While Venezuela planned to eventually export 140 MMcf/d of natural gas to Colombia, difficulties surrounding the development of its resources required Venezuela to continue to import natural gas from Colombia. In September 2008, Venezuela signed initial agreements to create three joint venture companies to pursue liquefied natural gas (LNG) projects along the northern coast of the country. Although PDVSA signed contracts with a number of international investors for these projects, continued negotiations, difficulties, and feedstock concerns are likely to delay its planned start date. Electricity Page 36
In the past decade, available data show Venezuela’s electricity consumption increased 48% while installed capacity expanded by only 20%, leaving the Venezuelan power grid stretched by the end of that period. A major drought in 2009-10 led President Chavez to declare an “electricity emergency” and led the government to implement painful demandreduction policies. Sector organization Large, state-owned companies dominate the electricity sector in Venezuela. The government controls the electricity sector through the National Electricity Corporation (CORPOELEC), a state-owned holding company created in 2007 to consolidate the power sector. CORPOELEC is responsible for the entire electricity supply chain, controlling all major electricity companies in Venezuela including Electrificaciondel Caroni (EDELCA), which supplies more than 70% of the country’s electricity. Hydroelectricity Hydroelectricity provides the bulk of Venezuela’s electricity supply. Most of the country’s hydro production facilities are located on the Caroni River in the Guavanaregion. The 10,200-megawatt Guri hydroelectric power plant on the Caroni is one of the largest hydroelectric dams in the world and provides the majority of Venezuela’s electric power. Water levels at the Guri Dam dropped to record-low levels during the 200910 drought, forcing the country to implement rolling blackouts, to reduce industrial production, and to fine Trading Street Magazine
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large users for excessive consumption. Venezuela plans electricity generation from fuel oil and diesel could furto expand hydroelectric production in the future. ther reduce Venezuela’s oil exports. Fossil fuels About half of the electricity generation from fossil fuels in Venezuela is from natural gas, and the rest is from fuel oil and diesel. There has been increasing investment in conventional fossil fuel generation capacity to reduce reliance on hydropower and use domestic hydrocarbon resources. PDVSA began generating power for its own consumption in 2010 to manage powersupply risks in the oil production sector. Expansion of
Notes • Data presented in the text are the most recent available. • Data are EIA estimates unless otherwise noted.
About Shayne Heffernan Shayne Heffernan holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reached a peak market cap of $15b. He has managed and overseen start ups in Mining, Shipping, Technology and Financials. Shayne Heffernan founded the Heffernan Group of Companies and you can interact with him in his own Live Trading Lab here on Trading Street. Click the picture to the right to find out more.
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Holy Grail of Trading: What Is It, Really? By Darrell Martin, CEO www.ApexInvesting.com
When the words “Holy Grail� are mentioned, you may have many things come to mind. You may think of a movie like Monty Python and the Holy Grail (1975) or Indiana Jones and the last Crusade (1989) where they are searching for the Holy Grail. For centuries, there have been people searching for the Holy Grail, but what is it exactly? In history, it is a reference to the cup or grail used by Christ at the Last Supper. Of course, those that search for it would love to be able to find this rare artifact with a tag affixed clearly stating that the object in their hands was indeed the Holy Grail. But since such a simple thing is not possible, people continue their quest and make movies as well as write stories.
Risk Management Diagnostic M36 rule
drawdown. It must have an acceptable win rate that is balanced out by the reward to risk ratio. Reward must be higher than risk and be enough to cover a lower winning rate or the win rate must be significantly higher if the reward to risk ratio is not favorable. One of the two must be high enough to cover the other one. This system would have easily available stats that show how well its trades have played out. It would be easy to back How does this apply to trading? Is there a Holy test so that you could see for yourself potential profGrail of Trading? There are people that search for a its and losses. This Holy Grail of Trading would have trading system that never loses as they believe this is the good, defined stops and exits. Whether it is trend or Holy Grail of trading. The real Holy Grail counter trend it would need to be able to let of Trading doesn’t come with a tag attached run. The max drawdown from peaks As a trader profits or a magical indicator that makes it imposto valleys must be manageable. You must sible to lose! Seekers of the Holy Grail of you must ask know how it has performed historically Trading search in vain and at great expense in order to determine the proper account for a system which wins 100 percent of the yourself where size needed to trade it and by knowing its time. Many never accept that there is no you want to be history; you would know when to be consuch thing. They change settings, adding cerned versus letting profits run. To round indicator upon indicator upon indicator. in 12 months, out the requirements for the perfect trading Some over optimize, while others buy $50 not 12 days. system, it needs to be something that will systems wondering why they do not work. fit your schedule and personality whether it Then there are those that attend webinars is trend, counter trend or scalp trading. If or read every book they can find and basically jump on this Holy Grail of Trading system does not perform as the bandwagon of every new thing that comes along. expected, you cannot or will not be able to trade it consistently and follow the rules. So what is the Holy Grail of Trading if it is not a system that never loses? The Holy Grail of Trading In your search for the personal Holy Grail of comes down to one primary component; good risk Trading, have you ever felt that you have risked too management in a consistently executable system that much? Has there been a time when you have felt conworks on a variety of markets and in a variety of market fident that you have a comfortable account size just to conditions over time. That is often said but how is it ac- blow through it quickly? A major component in your tually achieved? personal Holy Grail, that perfect trading system has to
be risk management. As a trader you must ask yourself A Holy Grail of Trading would be a system that where you want to be in 12 months, not 12 days. If you provides risk/reward ratios, win/loss ratios, number of do not, you will risk too much, jump in too fast, all to get trades to calculate in commissions and fees, and max rid of that boss or pay those bills only to result in blowTrading Street Magazine
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ing through your account too quickly. In addition, you must consider the amount risked per trade. This will help you know the size you should trade. A good rule to follow for risk management that many traders enjoy using is the Diagnostic M36 rule. This is where you take five percent of your account size and divide by six. That is the amount you can risk per trade. You do not exceed a five percent drawdown. If you encounter six net losses, then you stop trading for that day. You may profit from three trades, lose in nine and that would be six net losses, if they were all 1:1. If you made more that 1:1 on your profits, then you would not be down six net losses or five percent and you could continue trading. Even a bad trader has a hard time losing six net losses in a row. Using this rule and keeping the risk size in check allows you to keep trading after a few losses so you do notend up stopping right before the big trades that make the whole day worth the effort. In addition, using this rule, you recalculate the five percent of your account size only once a month. You are not compounding up or down. This helps keep your account size under control
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and helps in the psychological aspects of trading as well. The quest continues: Could there possibly be a system that would do all that you need it to do? Although there is no perfect trading system, there is one that meets many of the requirements listed above and more. It is known as the Trend Catcher System. The beauty of this system is it limitsrisk on stocks, futures and Forex. It is easily customizable allowing you to find what works with your risk tolerance, trading style, account size and schedule. You can see instant stats with the click of a button, as shown in the image below. It has defined entries and exits with audio and visual alerts making it easy to place your trades. There is a trade simulator that can be used. By using Trend Catcher, not only do you have limited low risk on futures, Forex and stocks, but you have defined risk on Nadex binaries. You can use this system on all as it is a very versatile application. It is price action based instead of time based. Why have a line form just because
Trading Street Magazine
March 7, 2015
As you continue on your quest to find your personal trading Holy Grail, do notbe fooled by the Holy Grails that are out there claiming to never lose and make you a millionaire in one week! Make sure you get a good system that works for you. Whether you use Trend Catcher or any other system, always keep risk management in mind. It is important to maintain good risk management in order to protect your account and your sanity. the earth moved? The line on the chart should form because something happened in the market, not because a minute passed! The image below shows the simplicity of the Trend Catcher System.
For more info on Trend Catcher see Apex Investing ad on page 38.
You can know the immediate direction of the market and know which way to place your trades. With Trend Catcher you can have tight stops but it allows profits to run in big moves.
About the Author: Darrell Martin
Darrell Martin coined the phrase “diagnostic trading.” He defines “diagnostic trading” as looking at how fundamental investors, technical investors, statistical investors, and seasonal investors look at the market and then using that knowledge to be one step ahead of the markets. His Elite Trend Catcher System simplifies trading entries, stop losses, and take profits to the tick/pip/cent and works on the one thing that moves the markets. Attend the webinar to find out the truth behind how markets work and how to get one step ahead.
Trading Street Magazine
March 7, 2015
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The 7 Killer Trading Mistakes That Doom Traders From Ever Becoming Consistently Profitable By Benjamin Lee - CEO Think Trade Think
This is part three is a seven part series.
realize that they are the final contingency plan when anything goes wrong. In other words, they will have to work longer and harder than anyone else in their business because no one else will have as much invested as they have invested. Most new traders think that they can learn a trading system and just show up in the morning and be successful. This could not be farther from the truth. I am certain of this because that’s what I originally thought when I first started trading. In the beginning, you will need to spend hours and hours learning your trading system. As your level of understanding increases, you will need to spend time watching and trading the markets. This will help you get a feel for the markets. Then you will have to work on your daily preparation and trading psychology. Until you log several thousand hours of work, you will need to focus a majority of your time learning as much as you can about trading and about yourself.
When traders ask me what they need to do to become a consistently profitable trader I respond with a simple, yet profound statement. You must be willing to do what 90% of traders aren’t willing to do. When you’re following the crowd you can’t expect the results of the few. In other words, you can only become consistently profitable once you make the decision to do the things that a majority of the people may judge you on. For example, some of the proprietary strategies I teach to my clients may be considered new age or airy fairy. We practice visualization, mediation, awareness, staying in the present moment, and managing your emotional states. Some of these processes may seem weird to the masses and some people would never be caught doing them; yet the results speak for themselves. All of my clients see a significant improvement in their trading because they are willing to do what a large majority of traders are not. Which leads us into the third killer In addition to the time and effort you must spend, mistake; most traders do not treat their trading like a it takes a sound business plan and execution to create a business to their own detriment. successful business and to become consistently profitable in trading. A business plan creates a direction and Killer Mistake #3: Traders do not treat their trading framework for your business and your trading. An eflike a business. fective business plan will detail your goals on paper, how you are going to achieve them, and what your budget Did you know that over 65% of businesses fail will be. One of the main reasons you want to create within the first four years? There are a multitude of a business plan is to give yourself the opportunity to reasons why businesses fail, such as poor location, in- think exactly what you want to do when you’re trading. sufficient capital, lack of experience, competition and If you try to decide on a course of action in the heat of personal use of corporate funds. Does that sound really battle, chances are you will mix some of your emotions familiar to what you are experiencing with your trad- with your decisions. Also, if you ever get off track, you ing? A lot of those reasons are the same reasons why can always refer to your business plan. But even if you traders fail as well, except that the failure rate is much have the best business plan in the world, if you do not higher – usually at 90%. It’s even harder for traders to execute it well, you still risk blowing out your account. become successful compared to normal businesses. So You need to have the discipline required to execute that how do you start and maintain a successful business plan to perfection. Developing your self-discipline is and/or trading career? a very important part of becoming consistently profitable. There is no one looking over your shoulder to When most people begin thinking of starting a make you keep to your plan. So you can be your own business, they believe that having their own business best friend or worst enemy if you don’t work on your will afford them more time and freedom. They do not self-discipline. Page 42
Trading Street Magazine
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Key to Success
“If you have more than 120 or 130 I.Q. points, you can afford to give the rest away. You don’t need extraordinary intelligence to succeed as an investor.” Warren Buffett
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Trading Street Magazine
March 7, 2015
Unravelling the Quant Model Enigma By Sam Barry, CEO Littlefish FX
The first in a series of articles about quantitative modelling. Here at Littlefish FX, our primary business is in quant models and building trading systems. Over the past few years, quants have received a lot of attention and primarily, in my opinion, bad press. I have no intention of setting the record straight (it’s honestly the only time in my life I could consider myself anything close to a bad boy so I’m taking it...). However, what I thought I would do is give you a bit of insight into the mystery that surrounds quants and their “evil” algorithms...
Quants Generate Alpha
Likely quants will become even more prevalent and so will the algorithms used to trade the markets. It is inevitable really. Why would I hire 100 traders to do what I can get a server and a computer to do just as well? As technology increases, this will ever more be the case. What is a quant? Let’s start with what the difference is between a quant (quantitative analyst) and a discretionary trader. In the most part, algorithmic trading isn’t quite as evil as some people would make you believe. TypiA quant uses consistent mathematical models in cally all an algorithm does is model human behaviour and trading rules set by humans and does it with greater order to set rules for placing trades, while a discretionconsistency. After all, the computer never sleeps. How- ary trader uses discretion to determine the best trades ever, like everything in this world, there are exceptions. to place. Some of the Dark Pool* algorithms trading on insider Quants have a hard set of rules that could be information have been considered inappropriate behaviour in the financial markets and trading world, but like coded by a computer to set all trading decisions. These them or not these sorts of strategies and other algorith- could be rather complex, or more likely really simple mic trading is here to stay, meaning it’s better to under- but there are clearly defined rules. stand them to see how they will impact your trading Additionally, for a quant, the rules will have to be than to remain in the dark. proven. This takes one of two forms typically. A theory * A Dark Pool is an order book run with very specific is formulated and then proved, and the theory becomes conditions so you are unable to view the orders inside them. the rules. Or, the rules are defined by data mining of These became extremely popular with large traders who want- historic data. Many times these two overlap a lot in the ed to hide the size of their order so as not to move the market, quant world as models advance. however they became famous for corruption within order types that allowed people, and more specifically High Frequency Trading Firms, to game the order books with specialist order types (i.e. they were allowed to front run large trades) Trading Street Magazine
March 7, 2015
The roles of quants are straight forward in description, and challenging in execution. The whole point of a quant is to generate what we call ‘alpha’. More Page 45
than likely you have heard of alpha. It is a return in excess of a risk-free rate (think of this as the return you get on your savings account in a bank). On top of that, quants must also ensure they are uncorrelated to the equities markets (FTSE100/S&P500) and all systems must fit into strict risk management models.
In general though, quants will take a few different approaches. They either look at really long timeframes of test data to ensure consistency through the widest range of possible scenarios, or they look at really short timeframes and accept curve fitting - ensuring the model can adapt to changing conditions.
Essentially, a quant needs to design and build The problem most people see when trying this is trading strategies by coming up with a theory, then back they find something that works amazingly well for two testing it over 10 to 20 years worth of data for consist- or three years and then it blows up as the market condiency. Finally set rules for inclusion within a portfolio. tions change. For the most part, most of those ‘scam’ robots you see in FX may well have been well-intentioned; Working out a broad range of parameters could be they were just naive to how they were curve-fitting to used with the system; like guarding against the dreaded specific conditions. curve fitting, which means each trading strategy has to work regardless of the parameters supplied. So once the quant has his theory, has proved it and has a solid set of parameters, we then run it on Typically to do this a quant will supply the trading cost models and risk models to ensure it performs well system every possible parameter option and then plot enough to actually work as intended. If it does which by the returns on a distribution curve. Think of it as using this point is a very small subset of what we started with, a simple two moving average strategies, where you buy it then goes into testing. on a line cross above or below. So there’s your initial intro into quantitative modIn this case using every possible parameter for els, stay tuned for the next issue when I will take a look a period of two moving averages and plot the total re- at the different types of models we use: the strategy, the turns. This helps ensure the model is not curve fitting to cost and the risk models. specific situations. So, if market conditions do change, the chances are that we will still make money. About the Author:
Sam Barry is the CEO of Littlefish FX, who are seeking to democratise the foreign exchange market by providing educational materials, analytical tools, trading systems and alternative investments based on order flow concepts and strategies (traditionally the preserve of large financial institutions). Get all of the indicators mentioned above, and learn more about order flow trading techniques, at LittlefishFX.com.
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Trading Street Magazine
March 7, 2015
The End of an Era – As Open Outcry Trading Pits Are Set to Close Forever By Bill Hoerter of TradingStreet.co
On February 4th of this year, the Chicago Mercantile Exchange announced that it will be closing most of its Open Outcry Futures Trading Pits by midyear: “As open outcry futures trading has fallen to just one percent of the company’s total futures volume, CME Group today announced it will close most of its futures trading pits in Chicago and New York by July 2, 2015.” The Open Outcry pits – where people used complicated hand signals, and loudly shouted orders – and which provided speculative liquidity to a vibrant marketplace for futures of all types is being relegated unceremoniously to the history books now that anonymous electronic trading has taken over the world of modern trading.
Background of the Pits – A Personal View As a veteran of these wondrous trading venues, I would like to share some of my thoughts. Let’s look at how this historical trading actually built a foundation upon which modern financial markets have been forged, what they represented, and what mankind is capable of building when a need is recognized. The Pit Traders provided commodities that were physically traded around the world a primary source of liquidity. They did so by offering to buy and sell nearly any viable commodity during a set number of hours throughout the trading day in the classic, loud, physical “outcry” mode; where apparent chaos actually competed in a highly organized mode for cheaper buy-prices and dearer sell-rates. The pits themselves were in various Midwest cities and on each coast of the US, but the beating heart of these markets was in downtown Chicago and for decades represented the center of basic commodity shipping countrywide. At the heart of this kind of trading were people willing and able to showcase their bids and offers either to one another, producers or growers of product, end-users of various commodities, or institutions who had a financial interest in the underlying product. Traders were Middle Men in the classic sense of the word – the kinds of folks who would routinely place their or their firm’s (small or large) fortunes on the line every day. These were true “Type-A” personalities, men and women alike, who took control over their lives with each gesture or spoken word in the course of their trading.
recently into modern high speed fiber optics and instantaneous digital satellite feeds. The prices upon which the pit-speculators traded could either be benchmark daily pricing in many cases, or merely part of the 24 hours a day continuum of prices in which financial instruments, such as foreign currencies or treasury instruments would trade in money center institutions around the world. In either case, anyone in the business of free trade knew, and understood the role trading floors played in day-to-day modern commerce. Many cities created institutions that mimicked the trading done on these exchanges; just as nowadays they are everywhere recreating electronic access to “allday” markets; much of which was created right here as offshoots of our local wide-open, loud and spacious trading floors. As modern electronics have radically changed the way commerce is done in these markets, these exchanges are closing their doors to the human capital that drove the original marketplaces. Let’s look closer at what those floors really offered on a human scale.
People speak often of the education Trading available in the School of Hard Knocks. When asked about our personal curricuSchool lum vitae, and what exactly is it that allows of Hard us to comment on financial markets in the first place, we humorously cite these lifeKnocks ... experiences. It’s obviously less of a title for better than a resume, and more for anecdotal use, but nonetheless this schooling is as important an MBA as anything obtained by degree or certification. Upon learning that the walls containing our personal Academy of Open Outcry floors at the Chicago Mercantile Exchange will be “coming down” for good this year, I thought it might be worthThe difference between the negatively connota- while to reflect for a moment. tive classic “middleman”, who would simply add a fee to a commodity for resale and the kind of trader in the Listen, Learn, Scream and Shout pits were that “floor guys” provided pricing and liquidThe decades of the 1970s & 1980s were a superb ity to the end-user regardless of whether the price was time for picking up a financial education “on the fly” higher or lower at the end of the day. Many made a even for someone who’s college liberal arts education great deal of money providing this liquidity, and were was 180 degrees removed from anything financial. never ashamed of that fact, as every single trader out Mention “internship” to anyone who grew up on the exthere knew failure in trading far more often than profit. changes: opinions will vary greatly depending on one’s associations – but many will agree that there really was The opening and closing prices provided in these nothing like the life experience obtained by working on pits were broadcast around the world, beginning with the trading floors. newspapers and the old ticker-tapes, morphing more Trading Street Magazine
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Recalling walking in that first time and seeing the frenzy of activity and utter chaos that made no sense at all to the untrained eye was an experience I will never forget. People have characterized it as either utterly repellent or as intoxicating as a first kiss when you were a kid. If you were lucky it grabbed you by the throat and heart, and likely never quite let you go. If the floor reached into your psyche that first day, you likely went home that afternoon and opened a book to see just what had transpired so you could understand what it was you had just witnessed. Nowhere else could you stand in an elevated “pit”, literally, and learn the elaborate hand signals that allowed your boss (often a pit broker) to communicate to the many companies who were competing for his attention constantly throughout the trading day. Orders were transmitted this way, and deals were done or “filled”, or sent back as “unable”. The language and signage of the pit clerk was unique to the trade. Other trainees began their trading life as “runners” literally sprinting orders from company phone clerks to those pit workers who also had the hand-signal responsibilities. So the world of the trading floors had phone clerks, pit reporters, assistant managers, compliance officers, screen-reader data collectors, technical analysts, guards, and, of course, the badged and vetted Traders or Brokers themselves. It was literally a world all its own, and a semi-secret society upon which global commerce was conducted and fortunes were won and lost each and every business day; wide-open yet completely hidden from the average consumer. If you worked there, beginning your career in “floor finance”, your story might go something like this: You are on the floor in some entry-level capacity. You likely know little, and simply take it all in. At some point early on, you’re asked by a Boss or a friend of theirs if you know what “arbitrage” is. You say “yes” of course – not wanting to appear clueless. Then, you go home and look up the word in your dictionary. The next day you start to learn the hand signals, and before you know it you’re paired with a pit broker (member of the exchange) and you begin something called “class-B arbitrage” and bingo (!) … you have a job for a year or Page 50
so learning how to buy and sell currency for spot settlement to a bank, while simultaneously buying or selling the corresponding futures contract in the trading pit. Every day you learn something new about the futures market and how it relates to the “real” world of interbank trade. Plus, you get paid to do it; albeit not very much! Depending on your drive and abilities, you work your way onto various institution desks and if lucky enough, at some point down the road you’ll find yourself before a membership committee, on your way to becoming a member of the exchange. You either are financed personally, or you are working on a corporate membership for a Futures Clearing Merchant but either way, you land on the “inside” of the trading pits. It then becomes your personal “outcry” that is out there making deals being posted around the world. It is a heady, intoxicating brew of personal triumph and one hell of a way to earn a living.
Saying Goodbye There will always be those who will harbor thoughts we “floor rats” were merely crazy ADHD personalities who couldn’t find another job while perhaps living at home with the parents. Perhaps you’ve heard horror stories about drugs and the frenetic buzz at the local bars and clubs surrounding these exchange floors. Or stories about aberrant behavior at the offices of the thousands of firms associated with the industry. Some Trading Street Magazine
March 7, 2015
might point to the Wolf of Wall Street types who ran the scams and bucket shops around the country. However, ask yourself if this kind of behavior does not exist anywhere else there are the “Young and the Beautiful” of the world. Ever heard of Hollywood? Anywhere you have many thousands of people working in close quarters, their downtime is often a bit over-the-top. Ask anyone who has ever served in the armed forces if you doubt it. The people who worked the trading floors were always smart, adventurous and driven to succeed. That seems more a trait to aspire to rather than to condemn.
anyone’s personal history, but as this article is written let it be said that this author’s past in the great trading pits of the Chicago financial district is one that is as intrinsic within the development of modern finance as the contributions of an MBA from any of the elite universities around the world.
How many occupations offer an introduction to so many associated opportunities in financial services worldwide? In life as in business, nothing is more important than team-building and self-awareness, something that Chicago’s great exchange floors had coursing On another day we may reflect how the entire through its veins, and deep into its DNA. trading floor infrastructure fits into the world of finance, or perhaps share some of the many wonderful How damn sad it is to see those wild and crazy stories that those days birthed. For now, it will serve to days gone forever. Oh, how I will miss those ghosts that merely note that after those days on the floor almost any made me the man I am today. other activity in this wonderful business seems rather tame by comparison. There is so much to be said of
About Bill Hoerter
Beginning on the Mid-American trading floor back in the late 70’s when prices were still recorded on chalkboards, Mr. Hoerter found himself on the trading floor of the CME in the 1980’s in roles varying from B-arbitrage currency pit clerk/trader, to Broker-Member of the exchange. Trading Street Magazine
March 7, 2015
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“It amazes me how people are often more willing to act based on little or no data than to use data that is a challenge to assemble.� Robert J. Shiller
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Trading Street Magazine
March 7, 2015
Central Banks and Mass Quantitative Easing: Is Global QE Good or Bad for the World Economy? By Tim LuCarelli, Trading Street
Starting in the early 2000’s the Bank of Japan initiated the purchase of government debt with an electronic balance sheet entry beginning what was to become an on again off again program designed to stimulate a decade’s long deflation. Once the recession hit in 2008 and interest rates were lowered to zero in many countries the central banks of the US and England embarked on their own version of balance sheet entries to purchase securities. It worked so well for both countries that now many other central banks are embarking on the process. What is QE? Central banks, depending on the country, usually have complete autonomy from political influence or at least they are supposed to be separated. While many people think that central banks print money most of them actually have nothing to do with the actual printing of cash bills. However, in a round-about way they can electronically create money or destroy money through the use of interest rate instrument purchases or sales. When they purchase interest instruments they are creating money and when they sell interest rate instruments they are destroying money. Some economists refer to the process as adding liquidity or removing liquidity from the “system” and the “system” reference is the banking system. Many central banks adjust system liquidity on a daily basis providing banking liquidity when needed and taking it away when there is a surplus; this is what keeps the banking system monetarily stable. In times of high inflation, people and businesses seek hard assets anticipating that they will sell those assets for a profit quickly, thus increasing the velocity of money and causing more inflation. In order to control inflation central banks remove cash from the system by selling securities, causing banks to purchase the guaranteed return of those securities as opposed to making loans ultimately reducing money in the system. When times are bad central banks will buy securities and the money they use to buy the securities flows into the banking system ultimately forcing banks to make more loans, or so goes the thought process. Page 54
Central banks do these purchases and sales in the short term interest rate markets; overnight paper, repurchase agreements, 30 day, 60 day and 90 day securities. Most of the time the purchase and sale of securities in these time frames are enough to force the banking system to change interest rates. Quantitative easing comes about when central banks have forced short term interest rates to zero, the economy is stagnant and long term rates have not dropped as much as short term rates. By forcing long term rates lower businesses can refinance their debt thus increasing their profit margins which in turn allows them to spend more and pay their people more increasing spending by people which starts the economic cycle moving once again. In order to force long term rates lower the central bank has to purchase longer term interest rate instruments in the open market; most central banks are not allowed to purchase directly from the government as that would mean the central bank is electronically creating money to buy government debt allowing the government to spend endlessly. So, by “back dooring”, purchasing in the open market, they can say they are not financing the government debt with fiat funds. In order to make these longer term purchases the central bank has to hold the securities on their books which from an accounting standpoint is an increase in their overall balance sheet value. Of course someday the seTrading Street Magazine
March 7, 2015
One of the biggest opposition arguments to quantitative easing by politicians is that is causes inflation. Does QE Create Inflation? The simple answer is no! Many people are under the false impression that having excess money in the banking system will cause inflation. While having excess money in the system is necessary for inflation it has never been the cause. Inflation is pure demand, without demand there can be no inflation curities will either mature or the central bank will find it no matter how much excess funds there are in the sysnecessary to raise interest rates and sell those securities. tem. This has been proven over and over again in Japan as well as in the US and UK. All three central banks A Political Hot Potato have been pumping excess liquidity into the banking Politically this is great fodder for those that are system and the general economy for over five years, anti-central bank, especially if they do not understand through quantitative easing, and inflation is still nonaccounting principles. We have heard politicians in existent; inflation needs demand. the US, UK, Japan and more recently Germany actively campaign against any type of quantitative easing. Some Who are the Winners and Losers? of the arguments include that QE will fund the excess After more than five years of QE by the US Fedspending of the government. That is possible, but of eral Reserve and the Bank of England the clear winners course the politicians are the ones that would have to have been companies and the people that invested in appropriate the spending. them. The main reason for this is that the decrease in longer term yields increased company profits pushing Another argument against QE is that it will be company valuations higher and thus increasing the impossible for the central bank to reduce their balance wealth of anyone who owns those companies. sheet. Central banks have swelled their balance sheets many times in the past and it always turned out just fine Losers may be categorized as the vast majority – what goes in must come out. Many politicians wrongof people that had no investment in any company with ly look at only one side of the balance sheet during QE, debt or could make money from lower interest rates. the asset side, thinking that the bank is lopsided. This is where the lack of accounting understanding creates a So now that many other countries’ central banks misnomer. It is a balance sheet which means it has to are embarking on QE programs what will this do for the balance, there has to be an opposite entry to the increase whole global economy? More than likely it will provide in assets; in this case on the liabilities side. Eventually wealth for those that are invested in companies that do the interest rate instruments the central bank bought or business internationally and some of that wealth may sold will mature and come off the balance sheet thus retrickle down to everyone else. Overall, most countries, ducing both assets and liabilities equally. Additionally, including the ones it is intended to help, will see very the central bank could sell some of its holdings in times little effect on the broader economy. of inflation or buy some of its short positions in times of deflation. Either way the bank can do it whenever they want, there is no hurry. Having a swelled balance sheet by the central has no impact until it is unwound. Trading Street Magazine
March 7, 2015
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