Transformational Tools Intro

The late astronomer Carl Sagan was known for his gentle-spirited wit. One of his more amusing statements is as follows:

"If you wish to make an apple pie from scratch, you must first invent the universe."

It's funny because of the juxtaposition.

You begin with a common, comforting mental picture -- who hasn't had apple pie? -- and then sweep out to the impossibly abstract.

When one thinks about making a pie "from scratch," the natural tendency is to envision a kitchen counter with ingredients on it: The apples, the flour, the eggs and milk and sugar, and so on.

Technically, though, Sagan is correct. He has simply expanded the frame to maximum degree. To truly start from "scratch," i.e. nothing, you must manifest the atoms that make up the molecules of the pie ingredients... determine the physical laws that bind the atoms together... age the universe appropriately for billions of years, through all the various phase changes and evolutionary cycles to bring forth apples, sugar, homo sapiens, and so on.

It's a tongue in cheek meta-statement with useful purpose. It reminds you how the narrow view (which we often take for granted) can only exist in the context of the very (very) broad... and also how, for those who can see it, the magnificent secretly envelops the mundane.

So what does this have to do with trading, and more specifically with "Transformational Tools"?

The purpose of this installment, Transformational Tools, is to help "transform" you into a successful trader by offering a suite of mental tools, technologies and perspectives you can use to change and grow.

Let us zoom out a bit. How does one become a successful trader?

What must one "do," in the broadest sense of the word?

This takes us back to Sagan's apple pie. To wit:

If you wish to make a successful trader from scratch, you must first invent a successful trading life.

Ah-ha! See what we did there?

Before you can bake a pie, you must address the external layers of reality surrounding the possibility of baking.

And before you can focus on success in trading efforts, you must expand your consciousness to focus on the life that surrounds those efforts.

You must, in a quite literal sense, invent (and implement) a successful trading life.

Your destiny shall not be thrust upon you; you must boldly go forth and create it, by creating the life that enables it!

An apple pie is baked in an oven, which in turn resides in a kitchen... and not just any kitchen, but a particular and specific one.

Every apple pie ever baked has a single point of origin. No one has ever baked an apple pie in a generic void.

Similarly, a successful trading methodology is executed by a specific trader, in a specific intersection of time and space, in the context of that trader's "kitchen" i.e. his or her life. No one has ever traded purely in the abstract.

This matters because, just as one cannot bake a good pie in a bad kitchen, one cannot trade consistently well in an inconsistent life. And this is all very personal as far as the actual doing is concerned -- as personal as it gets.

So for you to become a successful trader, you have to work in your kitchen. There is no removing "you" from the equation... and this simple observation explains a lot.

So many failed traders were obsessively focused on the ingredients of the pie -- the parameters of the trading methodology deployed -- that they completely failed to address the state of the kitchen they were baking in (i.e. the state of their actual lives).

Many kitchens have problems. If your oven is under-powered and cannot get hot enough... or your cutting board is permanently onion and garlic stained... or you keep switching recipes mid-stream, or lack the self-discipline to follow a recipe all the way through and wait for results... then the ingredients you have literally do not matter.

You will never have the pie you want - until your kitchen problems are dealt with.

"If I could just find the perfect combination of oscillators and moving average crossovers... or the best fundamental screen for picking small cap winners... or the ideal juxtaposition of Elliott waves and Gann Wheels when the moon is in the seventh house..."

Nope. Nuh-uh. Not gonna work. All of that stuff is ingredient focused. Just like the ads you see on Stockcharts.com or in the back of Stocks and Commodities magazine. This system has a 92% win rate! Winning trades in five minutes a day! No kitchen clearance, no success. That which is zealously ingredient focused, is virtually guaranteed to be incomplete. (And much of the time pure bullshit.)

To bake well, even world class ingredients are not enough. You must have a clean kitchen, a powerful oven, and the right tools (mixing bowl, cutting board, knife, whisk etc) for the job.

Trading well, and consistently -- an accomplishment significantly more challenging, sorry pie enthusiasts -- similarly requires a successful trading life. One in which not just the state of the "kitchen" matters, but all the rooms of the house!

Again, most people do NOT take this approach.

Vetting the "state of their lives," if you will - which in turn cascades down into all sorts of things - never occurs to them as vital success / failure input.

The insight is not obvious. It is certainly not talked about much, especially in the trading world. The vast majority of market gurus, book peddlers, system hawkers et al will never address this stuff. It is too fuzzy, or too squishy, or too far afield from tapping into greed and making a quick sale.

But we address it here -- and address it first, in the context of the Field Guide -- because the cultivation of a healthy trading life is so important.

Those who ignore contextual life considerations, even if they succeed at trading for a time, are like young athletes living off junk food and cigarettes. Energy and enthusiasm can cover over sins... for a while. But the bad habits always catch up, and typically sooner rather than later.

You Must Become Extraordinary

Now let us face another unpopular truth. Of those who attempt trading, the majority will fail. There is no shame in this by the way -- the majority of small businesses fail too.

(As we have said before, if you have what it takes to run a small business, you probably have what it takes to be a trader. In addition to comparable success / failure rates, both favor traits such as determination, resourcefulness, work ethic, functional capacity with numbers, and so on.)

But here is the thing:

If failure is the "ordinary," or common, result...

And success is the extraordinary, or uncommon, result...

It follows you must become extraordinary yourself to best ensure success.

According to motivational business author John C. Maxwell, the successful entrepreneur fails an average of 3.8 times before they succeed.

We are generally skeptical of broad stats like that -- there are so many ways to misread or manipulate data -- but conceptually the gist feels right.

The entrepreneur who has shown willingness to fall down and get back up three-plus times, without throwing in the towel, has already demonstrated an exceptional level of determination and resilience relative to the general human population.

And if he has "failed forward" each time -- learning from his mistakes, remembering what not to do -- he (or she) has demonstrated an extraordinary level of adult learning capacity.

So, again: To best ensure the odds of extraordinary results, you must become extraordinary yourself.

But what does that mean? How can we better define "extraordinary" in this context?

Let us propose a definition:

The extraordinary individual embraces outlier standards of human excellence in multiple areas of life.

The ancient Greeks had a wonderful word, "arête," which, roughly translated, represents the qualities of all around excellence. Via Wikipedia:

Arête (/ˈærətiː/; Ancient Greek: ἀρετή), in its basic sense, means excellence of any kind.[1] In its earliest appearance in Greek, this notion of excellence was ultimately bound up with the notion of the fulfillment of purpose or function: the act of living up to one's full potential.

Sometimes translated as "virtue", the word actually means something closer to "being the best you can be", or "reaching your highest human potential".

Yep. It is no accident that top traders -- those with stellar track records spanning decades -- have a very strong arête quotient, not to mention spic-and-span kitchens (well-ordered and well-integrated trading lives).

There is Much You Must Do...

Switching tracks for a moment: To be successful as a trader, you must attain and manage capital. You must have cash flows, and be comfortable handling those cash flows.

To be blunt, it takes money to make money. The reason, say, a Warren Buffett or a Carl Icahn can make $300 million in profit on a single equity position is because they routinely put billions to work in the first place.

Fortunately you don't need billions or anything close to that. Heck, you don't even need thousands when just starting out. (As we will clarify in the next report, "How to Build a Trading Stake," you could start with ten bucks if need be).

But you will need to think about cash flow management, whether your account balance has seven zeroes or one zero in it, and the possible question of how to increase your cash flows, while managing your obligations, via money-making activities that exist alongside trading for a period of time.

And this, in turn, goes back to a successful trading life, and becoming extraordinary by embracing outliers of human excellence.

You cannot be average. You must become extraordinary to succeed. For instance:

The average individual is not disciplined enough to save money; as an extraordinary trader, saving money will be key in building your cash flows for trading.

The average individual is not on top of their finances; as an extraordinary trader, you will need to know your finances inside out, so as to know your resources and constraints.

The average individual is prone to rationalization and susceptible to fantasy; as an extraordinary trader, you will need to cultivate a hard-nosed objectivity, and maintain touch with reality at all times.

The average individual is bad at time and energy (T&E) management; as an extraordinary trader, you will need to become excellent at T&E management, so as to free up personal resources to do all that needs to be done.

Do you see, now, how so much of trading success comes back to a clean kitchen... a powerful enough oven... and the embrace of human excellence in the context of a well-integrated trading life?

All of this stuff is VITAL to true trading success... and we still haven't touched the ingredients yet!

The deep-dive methodology aspects - entry and exits, position sizing, pattern filters, portfolio management - WILL come soon enough, and over time will represent the main body of DM materials.

But first things first... who cares about ingredients if the kitchen ain't right!

For those of you to whom this thinking is new, there are two ways to respond to all this - the mad way and the glad way.

Door #1 (Mad Way): Are you kidding me! I just want to be told where to buy and sell so I can start trading and make some dough! You mean I have to go back and worry about figuring out my whole damn life and psycho analyzing myself and blah blah blah? This SUCKS!!!

Door #2 (Glad Way): Wow! I never thought of it like this... getting my "kitchen" in order, and approaching this whole thing from the perspective of inventing and implementing a successful trading life... this could be the puzzle piece I've been missing, which both 1) helps explain previous failures and 2) brings me a big step closer to success! That is AWESOME!!!

Those who choose Door #1, don't let it hit you...

Remember, hard problems are your friend in highly competitive environments.

When you identify a hard problem, you are closer to smashing the barrier that previously held you back.

And when you confirm your competitors have not solved this problem, you confirm the logic as to why an edge exists, and why that edge can persist.

And finally, when you solve that hard problem yourself - a feat your competition has not achieved -- a sustainable advantage is created, quite possibly a permanent one...

Inventing and implementing a successful trading life (the meta-context of "life" enveloping and sustaining the methodology you execute) is just such a hard problem.

Figuring out how to upgrade your personal arête quotient (embrace outlier standards of human excellence) is another hard problem. (One that takes knowledge and technique and study, not just willpower and determination, to solve.)

And the Transformational Tools - conceptual technologies, ways of framing and thinking - are designed to be your rocket fuel in that regard...

Now that you understand the magnitude of your goal - commensurate with the magnitude of rewards for success! - let's dive right in...

(to be continued...)

Feedback: jack@mercenarytrader.com

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FX Macro And Sentiment Analysis - Week 40 - 2013

https://docs.google.com/file/d/0B1lhI2t1ZNLZVndoS2o5RGxMczg/edit?usp=sharing

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A Monetarist Perspective On Current Equity Markets

Previous commentary suggested that equity market weakness in the late spring / early summer would prove temporary because the economic and liquidity environment remained benign. Three months on, historically-reliable indicators are still giving a positive message but are less favourable than earlier in 2013, consistent with a smaller fourth-quarter gain in markets – assuming no “shocks”.

The approach to forecasting the global economic cycle employed here relies on two key measures – real (i.e. inflation-adjusted) narrow money supply expansion and a longer leading indicator derived from OECD data. These measures lead global industrial output growth by about six months and both are currently at historically-respectable levels, although real money expansion has moderated slightly since the spring – see first chart.

The encouraging message is receiving confirmation from shorter leading indicators such as business and consumer surveys. The global manufacturing purchasing managers’ index, for example, reached its highest level since early 2011 in September, while consumer perceptions of labour market trends have improved, suggesting a faster fall in unemployment rates – second chart. This latter prospect is important because central bank policies are highly sensitive to labour market conditions.

The global economy, therefore, is on course to expand solidly at least through early 2014 – assuming no disruption from a US debt “crisis”. The liquidity environment, however, must remain favourable for economic progress to be reflected in equity market gains. A key global liquidity gauge is the gap between real money growth and industrial output expansion – a faster rise in real money than output may indicate that there is “excess” liquidity available to boost markets. This gap is still positive but has narrowed since early 2013 – first chart again.

The real money / output growth gap could close by early 2014 as industrial activity strengthens and / or real money expansion slows in lagged response to rises in market yields in 2013. The recent prolonged period of “excess” liquidity, in other words, may be approaching an end, cautioning against expecting equity markets to perform as well in 2014 as in 2013. The last liquidity “buy” signal occurred in September 2011, since when global equities have outperformed US dollar cash by 47%.

A change in the liquidity environment is more likely to be triggered in this way than by a shift in monetary policies. Falling unemployment is tilting central banks away from further easing but existing commitments imply a significant additional injection of cash into banking systems. Assuming that the Federal Reserve “tapers” to zero during the first half of 2014, the Bank of Japan (BoJ) adheres to its current plan and ECB actions are neutral, combined bank reserves in the big three developed economies will rise by about 40% by end-2014 – third chart.

The real money growth ranking across regions and countries can be used to inform investment allocation decisions. Previous commentaries questioned whether US equities would continue to outperform because US real money expansion had fallen back to around the global average; monetary trends in peripheral Eurozone markets and the UK, by contrast, had improved. The US underperformed international equities in the third quarter while peripheral markets rallied strongly. The UK beat the US and Japan, though lagged the rest of Europe – fourth chart.

Real money growth rates in the major economies are now bunched in a narrow range by recent historical standards, suggesting similar economic / liquidity environments and giving less reason to consider large active positions – fifth chart. UK real money expansion is modestly higher than the global average while Japan is lagging by a similar margin.

The relative weakness of Japanese monetary trends is, on the face of it, surprising given the current pace of BoJ securities purchases – twice as large, relative to the size of the economy, than those of the Fed. The increase in official buying, however, has been offset by stepped-up selling by banks, partly in response to the increase in their reserves, which has reduced the need to hold “safe” government securities – sixth chart. Inflation, meanwhile, has been boosted by yen weakness and is exerting a larger drag on real money expansion.

Bank bond sales may slow over coming months, allowing ongoing QE to have a larger impact on nominal monetary growth. A rise, however, is needed simply to offset the real money impact of a further inflation surge – albeit temporary – scheduled to arrive in spring 2014 when the sales tax is hiked from 5% to 8%. Caution on economic and market prospects, therefore, may be warranted, at least unless monetary trends improve significantly.

UK equities performed respectably in the third quarter but enjoyed less benefit than expected from robust monetary growth. This may partly reflect higher equity supply than in other markets, an influence that may persist near term. Domestic institutions, meanwhile, continue to direct the bulk of new inflows into bonds and overseas securities rather than UK equities. These drags argue against a large UK overweight.

Real money growth is almost the same in the core and peripheral Eurozone groupings but this conceals significant differences at the country level – the core / periphery distinction, in other words, has become less helpful. Greece and Ireland have moved to the top of the ranking, with the Netherlands bringing up the rear. France had been lagging but has improved sharply recently, with growth now on a par with Germany. Elsewhere in Europe, monetary trends remain favourable in Sweden but have weakened in Switzerland.

The last commentary noted that emerging E7 real money growth had recovered to match the G7 level, suggesting becoming less negative on emerging markets: the sign of the E7 / G7 gap has correlated with the relative performance of emerging equities in recent years – seventh chart. These markets kept pace with the US in the third quarter but underperformed international equities – fourth chart. The E7 / G7 real money growth gap is now positive, a condition that, if sustained, suggests adding to emerging equities. 

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How The Fed Creates Market Highs And Lows Whenever It Opens Its Mouth

Fascinating chart from Jerry Khachoyan at The Armo Trader blog. Below (click to embiggen), Jerry show's how almost every market top and bottom has coincided with an action or announcement from the Federal Reserve or its FOMC...

Read more: http://www.thereformedbroker.com/2013/10/02/fairly-obvious-manipulation-committee/#ixzz2ggLY1znE

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Analysts' Take On ECB Oct Meeting - HSBC, Morgan Stanley, RBS, BNPP, & Others

European Central Bank President Mario Draghi's press conference Wednesday offered little clarity for ECB watchers on the timing of another interest rate cut or long-term refinancing operation, although both remain likely options for the Governing Council.

Draghi was generally considered more dovish in his outlook on the economy by European analysts, but his failure to mention exchange rate risks in his opening statement was among the reasons for a spike in the euro-dollar rate to above USD 1.36. Some analysts emphasized that exchange rate appreciation could still tip the balance in favour of more easing in future.

While most analysts believe another LTRO is likely at some point in future, many felt Draghi signalled no immediate concern about the decline in excess liquidity.

The following is a collection of comments from ECB watchers following Draghi's monthly press conference:

HOWARD ARCHER, IHS Global Insight: "The ECB is keeping the door wide open to all policy measures including taking its key policy rate down from the current level of 0.50%. In particular, it looks ever more likely that the ECB will undertake another LTRO.

"We have little doubt that the ECB will undertake a new LTRO. The only question seems to be when exactly it will do this and what time span will it be for? We favour another three-year LTRO before the end of this year, perhaps just after the Fed starts to taper, which we currently suspect will happen in December. Meanwhile, we believe that it remains very possible that the ECB will eventually end up cutting interest rates from 0.50% to 0.25%."

CHRISTIAN REICHERTER, DZ Bank: "We are sticking to our expectation that guardians of our currency will become active again at a given time to provide support for the euro economy. Draghi did not repeat the possibility of another long-term tender for nothing. We also continue to see a further reduction in the main refinancing rate as a possibility."

RICHARD BARWELL, RBS: "President Draghi does not sound on high alert: As was the case last month, President Draghi's comments on the stock of excess reserves and repayment of LTROs did not sound like a central banker on the brink of action."

"President Draghi emphasised that current inflation was too low but he noted that these developments were not unexpected and pivoted attention to the medium term outlook. In short, there was no great sense of alarm on inflation that might signal an imminent move on rates."

PETER VANDEN HOUTE, ING Bank: "Surprisingly there was no mention of the euro exchange rate despite the fact that it is back around levels that prompted the ECB in February to qualify it as a downward inflation risk (no wonder the euro promptly climbed higher against the dollar today)."

"With the recovery at best shaky and inflation likely to hover a little longer at levels below the ECB's target, it is obvious that a tightening of monetary policy is still a long time away from now ... While the probability of a further rate cut has clearly diminished over the last few months, a new LTRO still looks a sure bet."

KEN WATTRETT, BNP Paribas: Draghi "was rather dovish in the context of the data flow that we're having, but as far as markets were concerned it was not dovish enough...My feeling is there's a circularity with this: The less dovish the market sees the ECB as being, the more likely the euro is to go higher, and ultimately that's likely to tip the balance in favour of the ECB doing something."

"My guess would be the ECB will end up taking action and LTRO seems a bit more prominent now than it was two or three months ago...a rate cut is still an option, particularly if the exchange rate appreciates. [The exchange rate] will probably enter the statement in early November as a downside risk to price stability."

ELGA BARTSCH, Morgan Stanley: "While the overall tone of the press conference was very similar to the September one, we would highlight an important change to the introductory statement. When talking about paying particular attention to money market developments and how they could potentially affect the ECB's policy stance, the ECB added that it stands ready to act using all available instruments. Clearly, one of these tools is the refi rate cut, we are forecasting ... an LTRO is another policy tool though that the ECB could use."

RAINER SARTORIS, HSBC Trinkaus: "It is clear that the ECB is not expecting a dynamic recovery...The bias of the ECB is still towards staying the same or even lowering interest rates. In my eyes little has changed here, and there were no indications whether it will happen sooner or later. We think that if something is going to happen, then the ECB will operate through the liquidity channel. We don't see a rate cut for the time being."

BEN MAY, Capital Economics: "As in September, Mr Draghi failed to repeat past warnings that interest rates could be reduced further. What's more, at the policy meeting, some Governing Council members once again indicated that they no longer considered a discussion of a further interest rate cut to be warranted. Given all this, we continue to think that the main refinancing and deposit rates have probably reached their floors."

"He again acknowledged that further LTROs were a possible tool to manage short-run market interest rates...However, there was little indication that the ECB is considering using such measures in the immediate future."

MICHAEL SCHUBERT, Commerzbank: "Ahead of today's ECB press conference, markets had eagerly awaited more concrete hints about a further LTRO, but in the end, such expectations were disappointed ... [Draghi] rather stressed that there were 'a vast array of instruments' at the ECB's disposal, without putting any particular emphasis on a new long-term tender operation."

"Draghi was eager to dampen fears that a further reduction of excess liquidity will lead to higher forward rates soon. The reduction of excess liquidity was no longer mentioned in the Introductory Statement of the press conference. Moreover, Draghi urged not to read too much into the relation between the excess liquidity and short-term money-market rates."

PHILIP SHAW, Investec: "This month's statement repeated the message that the ECB will remain 'particularly attentive' to developments which could have implications for the stance of policy, but added this time that it was 'ready to consider all available instruments'. This was a step closer than in September towards hinting that a new LTRO might be in the offing, and Mr Draghi reiterated this message several times in the press conference. Nonetheless currency markets had been of the view that the ECB was even further down the track on this and as a consequence, the euro moved temporarily above $1.36."

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