Featured Trade: (WHAT’S ON YOUR PLATE FOR THIS WEEK)

1) What’s on Your Plate for This Week

Economic analysts were sent reeling in the wake of the May nonfarm payroll report released Friday, which showed only a feeble 38,000 in job gains.

It appears that the Great American Job Creating Engine has suddenly ground to a halt.

You know that big Fed rate rise that was coming in 9 days because the economy was so strong? You can kiss that baby goodbye, write it off, and confine it to the dustbin of history.

Personally, I never believed that rates were going to rise. I have been in the December camp all along, if ever.

What really sent researchers scurrying for their pocket calculators was the fact that the headline unemployment rate fell to a decade low of 4.7%. This occurred because 458,000 dropped out of the labor force.

Is this the beginning of a revival of productivity, or the start of the next Great Recession?

Assets classes behaved as you would expect. Stocks cratered 150 points, with interest rate plays, like the banks taking, the biggest hit. So did oil. Gold and bonds soared. The US dollar collapsed.

The payroll numbers got uglier the closer you looked at them.

Temporary help fell by -21,000, manufacturing by -18,000, construction by -10,000, and mining by -10,000. The gains were in health care, -40,000, food services, +22,000, and professional services, +10,000.

The long term U-6 unemployment rate stabilized at 9.7%.

I have been saying for weeks now that buying stocks at the top of a two-year range would only bring tears. The tears have arrived by the bucket full.

As for the coming week, you really have the ask the question, “Other than that Mrs. Lincoln, how was the play?”

The impact of the disastrous Department of Labor report far overshadows anything that will come out over the next five days.

Janet Yellen will be speaking again on Monday afternoon in Philadelphia, and no doubt will say absolutely nothing.

The JOLTS report on job openings this Wednesday at 10:00 AM EST will get more scrutiny than usual, as it will shed more light on the jobs situation. However, this is a one-month lagging indicator, so it will probably still show strength.

The US Energy Information Administration oil inventory number at 10:30 will continue to be a subject of great interest, giving a hint as to the health of the global economy.

We will get weekly Jobless Claims at 8:30 EST on Thursday, as usual. The Baker Hughes Rig Count then comes on Friday at 1:00 PM EST. With oil now at $48, looks for hints of stabilization at the current 312 level (down from 1,600 in two years!).

Followers of the Mad Hedge Fund Trader trade alert service did alright this week. We took profits on our long Treasury position (TLT) and our short stock position (SPY).

I went into the May nonfarm payroll report with 90% cash because of the increasing randomness of the government report.

Unfortunately, the profit in the 10% weighting in the Japanese yen (FXY) vaporized overnight on the gap move down in the dollar.

However, I am going to hang on to my short position, as the beleaguered Japanese currency has risen 5% in four days. Moves like that in the currency market are as rare as hen’s teeth.

I assure you, the world hasn’t suddenly fallen in love with investment in Japan. If anything, economic conditions are worsening by the day, so the yen will fail again.

That said, if the (FXY) maintains a sustained close over the old high of $91.30, I am out of there. Iron discipline regarding stops is the only thing that will keep you alive in this kind of trading market.

This brought our final May return to an enviable 4.38%, and our average annualized return to 35.33%. The cream is still rising to the top.

What ever happens this week, don’t waste your time bothering. It’s still all about the June 14 Fed meeting.

You might as well hang out at the beach this week, save your powder for a better trading environment, and work on your tan.

In this environment, cash is king.

Until next time,

John Thomas
The Mad Hedge Fund Trader


The Market Cycle

High Probability Trading, in my opinion, is defined as those Trades that are Low Risk with a Very Good Chance of working out. In other words, making Trades with the Odds in your Favor.

For the most part, High Probability Trading is trading in the direction of the major Trend. There are numerous ways to define a Trend. For example, Moving Average crossovers, MACD, ADX/DMI, and other Indicators. One of the most simple ways to define a trend, yet often overlooked, is by using Price Action itself. The Market does not go straight up and/or straight down, it moves in a series of Waves, Higher Lows and Higher Highs or Lower Highs and Lower Lows. When a pattern of Higher Lows and Higher Highs or Lower Highs and Lower Lows changes, the Market may be providing a warning sign that a potential Trend Reversal is imminent.

A Technical Approach to define an Up Trend, Down Trend, and Sideways Trend by using Price Action itself is to apply the Market Cycle Model. The Market Cycle Model suggests that a Market has to be in one of four Market Stages.

The Four Stages of the Market Cycle, as illustrated in Figure 1, are a Basing Sideways Trend (Stage 1) with predominantly equal Lows and equal Highs, an Up Trend (Stage 2) with Higher Lows and Higher Highs, a Topping Sideways Trend (Stage 3) with predominantly equal Highs and equal Lows, and a Down Trend (Stage 4) with Lower Highs and Lower Lows.

Figure 1. The Four Stages of the Market Cycle.

Stage 1 (or Basing Sideways Trend) is where the Market is in a state of Equilibrium. During this stage, there will usually be several swings between Support at the bottom of the Sideways Trading Range and Resistance at the top of the Sideways Trading Range. This is the point where many Traders try to Enter LONG into the Market and catch the bottom price, however, it doesn’t do much good to initiate LONG positions yet until the beginning of Stage 2.

Stage 2 (or Up Trend) is where the Market is Advancing. This is the ideal time to initiate LONG positions, ideally on a Correction or when the Market pulls back to re-test the breakout from Stage 1. Initiating a LONG position here is a Low Risk, High Probability, and potentially High Return Trade. See Figure 2. This situation is Optimal for a LONG Entry as each successive High becomes Higher than the previous. The less the Market pulls back, the stronger the Market.

Stage 3 (or Topping Sideways Trend) is where the Market is in another state of Equilibrium. The Up Trend loses momentum and starts to Trend Sideways. During this stage, there will usually be several swings between Resistance at the top of the Sideways Trading Range and Support at the bottom of the Sideways Trading Range. This is the point where many Traders try to Enter SHORT into the Market and catch the top price, however, it doesn’t do much good to initiate SHORT positions yet until the beginning of Stage 4.

Stage 4 (or Down Trend) is where the Market is Declining. This is the ideal time to initiate SHORT positions, ideally on a Correction or when the Market rallies to re-test the breakout from Stage 3. Initiating a SHORT position here is a Low Risk, High Probability, and potentially High Return Trade. See Figure 2. This situation is Optimal for a SHORT Entry as each successive Low becomes Lower than the previous. The less the Market rallies, the weaker the Market.

Figure 2. Low Risk, High Probability, and potentially High Return Trade.

The key to successfully trading a Market is to:

  1. know how to Identify what Stage of the Market Cycle the Market is in,
  2. know what Direction you need to be Focusing your Trades on (determined by (1) above),
  3. know when a Favorable Opportunity presents itself to Enter the Market, and
  4. know how to Manage your Trades.


Figure 3.  A 15 Minute Chart of the E-Mini S&P500 Futures Contract clearly showing the Market Cycle.

Once grasp the concept of the Market Flow Analysis Method, it will change the way you analyze charts altogether and help eliminate any confusion that you may have about the Markets... making your analysis more objective and trading much easier for you… and more Profitable!

Have a profitable week!  

Craig Hill


Goodbye Machine, We’ll Miss You…or Maybe Not

One of the early pioneers in algorithmic trading, Larry Connors, announced that he was discontinuing his service, The Machine, to the public at the end 2015, and was returning to private money management.  The unfortunate traders using The Machine, were faced with the question, ‘What do I do now?’  

The answer is Algo-Trader (A-T)

For those who don’t know, The Machine was Larry’s program that allowed traders to mix and match trading algorithms in order to build a portfolio of trading strategies.  The Machine provided not only daily signals but also showed the back-tested results for the portfolio.   However, the cost of The Machine was significant and was always bundled with Larry’s other services, such as the Chairman’s Club or Swing Traders’ Summit, which gave members access to new strategies as they come available on a monthly basis.  If you didn’t subscribe to these additional services, the new strategies were not available in your Machine access.

The flexibility of being able to add and change strategies monthly was a double-edged sword for traders.  On one hand, having the newest strategies is great, you are able to expand your portfolio options with the latest research.  However, it can lead undisciplined traders to constantly change their portfolios as they chase the newest ‘fad’ trying to capture past returns.  As we have all learned, long-term trading success comes from identifying a trading edge and then applying that edge to the market in a systematic and consistent manner.  No matter how great the strategy, there will be times when market conditions are not favorable for that strategy.

Nothing hurts a trader’s psyche more than to abandon a strategy only to see it take off like a pilot being ejected from his cockpit. All while the new strategy (the one you’re in now) goes into a tailspin.

Taking some of the principles pioneered by Larry on mean-reversion and Connors RSI, AT developed some unique and truly effective strategies for both IRA and non-IRA portfolios.

Taking some of the principles pioneered by Larry on mean-reversion and Connors RSI, A-T developed some unique and truly effective strategies for both IRA (retirement) and non-IRA (margin) portfolios.  It then bundled them into a swing trading service. But we didn’t just stop at providing daily signals, it transformed the service into a full portfolio management tool; incorporating position sizing, money management, and an equity curve System Health Monitor (something that is lacking in The Machine and we will discuss below).

One key difference between A-T and The Machine is that while Larry’s group was continuously bombarding traders with new strategies, A-T focuses on a core group of strategies and then performs a rolling optimization monthly on key variables used in the algorithms keeping the strategies more reflective of current market conditions.  Trading strategies in The Machine allowed users to define some of the variables, such as the exit rules and the pull-back percentages required to enter a trade.  But users were unable to perform a true optimization on a particular strategy because many elements are hard-coded and cannot be changed by the user.

Another key difference in portfolio management is the System Health Monitor (SHM) feature provided in the Algo Trader service.  As algorithmic traders, one question that we must ask ourselves is when is a strategy broken vs. just going through a drawdown?  A-T answers that question through its SHM. When a portfolio drops below a dynamically changing threshold, you move to cash and take no new trades.  The service will continue to monitor signals and track results, but we will be in cash until such time that the portfolio returns above the threshold.  This feature alone helps prevent a catastrophic portfolio meltdown when a strategy no longer works in the market.

The Machine doesn’t have such a feature, leaving it up to the individual trader to make that determination.

As algorithmic traders, one question that we must ask ourselves is when is a strategy broken vs. just going through a drawdown?

If you are an algorithmic trader or considering this style of trading, you owe it to yourself to check out Algo Trader. It is a set-it-and-forget-it trading style vs. the emotional turmoil of being hit with a new strategy monthly and constantly questioning whether my portfolio strategies are up to date with the current market conditions. You sleep easier at night, and lo and behold, your returns will be better, much better.

The Machine is a trademark of Larry Connors and Trading Markets.

Yours in Trading Success,

Todd Mitchell


Case Study:  The Anatomy of a Collar:
An Options Strategy That Only The Wealthy
& Privileged Know About!

How Mark Cuban, a Billionaire, Saved a Billion Dollars By Utilizing This One Strategy

For years now, stockholders have “collared” shares to lock-in gains, especially when the stock represents a significant percentage of a person’s net worth or overall portfolio. The bursting of the dotcom bubble has brought prominence to some of these collars, including Mark Cuban’s of his Yahoo stock. The following article gives an example of the anatomy of a collar using the publicly available information about Cuban’s Yahoo collar. A collar is essentially a risk shifting agreement between parties allowing the current stockholder to lock-in gains at a certain level (frequently with an accompanying loan). Under a collar, the parties (the “Stockholder” and the “Bank”) agree to place both a floor and a cap (or ceiling) on the price of stock for a defined period of time, effectively creating a “collar” around the stock. If the price of the stock is below the floor at the end of the period of time, the Bank pays the Stockholder the difference between the current market price and the floor. If the stock price is above the cap, the Stockholder pays the Bank the difference between the stock price and the cap. If the Bank held the shares as collateral for the collar (and a loan), the Bank will return the shares to the Stockholder once all payments are made and any loan is repaid. The Stockholder may elect to sell some of the shares to pay any losses on the collar (in this case, any gain recognized on the sale of the stock may be offset by the loss on the collar).

Both the floor and the cap can be set at almost any point, but are generally priced so that the transaction is costless for the Stockholder through the setting of the floor with a corresponding cap. The cap is generally set at a price that would equal the cost of the floor. Accordingly, a higher floor price will result in a lower cap price, and vice-versa.

The actual pricing is based on the term of the collar and the volatility of the stock. The Stockholder could actually pay for a higher floor with additional funds, but most choose to have the floor at a level of approximately 80 – 90% of the current market price, and the ceiling set at a price of equal value.

A collar is frequently married to a loan. This allows the Stockholder to borrow money against the stock on better terms than he might otherwise (the Stockholder can usually borrow up to 90% of the floor price at desirable interest rates). In addition, as the Bank will require that it hold the shares as collateral, it is fully secured during the term. As a result, the Stockholder does not need to worry about margin calls during the term. In this manner, the stockholder may hold on to his stock (differing from a taxable sale), lock-in a certain minimum value, and obtain cash on reasonable terms.

In the Cuban example, Cuban held approximately 14.6 million shares of Yahoo, which were trading at $95 per share, for a total market value of almost $1.4 billion. Cuban had the option to: (i) sell his shares and recognize his gains, (ii) hold the shares in hopes of future gains but at the risk of a future loss, or (iii) engage in a collar or other hedging transaction to lock-in certain gains. Cuban chose to enter into a three-year “costless collar” for his Yahoo stock. In this case, it has been estimated that Cuban received a floor of $85 a share and a cap of $205 per share. Initially, when Yahoo soared to $237 per share in January of 2000, Cuban’s did not appear to be a wise move, but in light of Yahoo’s current price of roughly $13 a share, it may have saved Cuban over one billion dollars.

In more recent times, forward sales and other derivatives transactions have been used to replace some collar and loan arrangements resulting in improved tax and lending terms. Please contact a member of the Derivatives and Hedge Fund Practice Group for further information and assistance regarding collared and similar transactions.


The Peak Performance Revolution

Can you analyze the market really well…
but you struggle to capitalize on the analysis?

I call it the Performance Gap. You work hard… but with relatively little to show for it. In sports, combat and in trading there is a huge difference between understanding what you should do and being able to perform those tasks consistently in real time.

What’s the missing piece?

The money-making part of trading is essentially a performance sport. Which is why some of the best analysts can’t trade and some of the best traders can’t teach. 

Until recently, people believed that Peak Performance is based on innate talent… like a child prodigy. That means your performance limits are pre-determined. We now know this is not the case. (Anyone can learn to trade successfully.)

Malcolm Gladwell reviewed the scientific literature on performance and summarized his theory into a popular sound bite: 10,000 hours of practice is required for mastery. But that’s not really true.

It’s not about how much time you spend. … 10,000 hours of driving won’t make you a master driver and 10,000 hours of trading won’t make you a master trader: it’s how you practice that matters.

Top athletes and elite soldiers practice in a certain way. And in comparison to top traders, struggling traders spend very little time cultivating the specific skills that create Peak Performance. They simply don’t learn from their mistakes. 

Breakthroughs in performance are the predictable result of applying advanced principles and techniques for how to practice. These techniques are mostly applied in professional sports and the military, and until now, they have not been available to traders in a systematic way.

Here’s the secret: if you want real world results, train your brain like the top athletes and Navy Seals do. Then… and only then… will all your many hours of work truly make a difference in your bottomline.

To great trading!

Kenneth Reid, Ph.D.

AS SEEN ON:

U.S. Government Required Disclaimer - Forex, futures, stock, and options trading is not appropriate for everyone. There is a substantial risk of loss associated with trading these markets. Losses can and will occur. No system or methodology has ever been developed that can guarantee profits or ensure freedom from losses. No representation or implication is being made that using the Trading Concepts methodology or system or the information in this letter will generate profits or ensure freedom from losses.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.

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