Tuesday, October 31, 2006

First Futures Trade

By this afternoon I felt comfortable enough with the IB software and with the market to do my first real futures trade - selling a NASDAQ 100 E-Mini contract (@1743). This is equivalent to shorting 800 QQQQ shares. At the market close (NYSE - the Globex futures market trades almost 24 hours a day) I was up $112 on the trade. So that is nice that my first futures trade at least starts off profitably. Commission is just $2.40. Still puzzled by some quirks of the IB interface - like why I am not seeing the current profit and loss on my account window. I am also short 1500 QQQQ in my Ameritrade trading account and have 3 QQQQ puts in my Roth IRA account.

First Impressions of IB and Futures Trading

I spent some time last night getting used to the IB system and making paper trades in NASDAQ 100, 10 year bond, and Australian Dollar futures. Someone posted recently in response to one of my blogposts that trading all three would be like having three full time jobs, if trading QQQQ was like a full time job. I don't think so but it is hard to execute a paper trading strategy and a real trading strategy at the same time if they are not identical and you also have another real full time job... This morning I was feeling rather nervous, not because I would lose "money" on the paper trading but that it was taking my attention away from the real trading and some time today I need to get a lot of other work done. Being a professor gives me a lot of flexibility about when I do a large portion of my work, but it still has to get done... So I closed out the paper trades and either later today or tomorrow I will take a look at the daily statement generated to get familiar with that. IB also update your account value on the fly and I found some quirks in that, some of which may just be bugs in the paper trading simulation. One is that the standalone Trader Workstation (TWS) gives you the current profit and loss and realized and unrealized portions on each position. But when I opened a chart (which is initially disabled on new accounts) all that disappeared! The browser based version of TWS didn't seem to give me that at all. I will have to check my real account. Also I didn't really understand how they compute various of the figures regarding margin - there doesn't seem to be much rationale. I asked an experienced futures trader and he said he didn't understand it either. I would have expected that the initial required margin would be moved into my "commodities account" and then that value would fluctuate with the profit and loss. But the amount is somewhere between the initial and maintenance margin. I should probably do some deliberately "money" losing trades and see what happens when the maintenance margin is hit. The charts are pretty flexible though as slightly less user friendly (not surprising) than those in Ameritrade. They don't look as dynamic as Ameritrade's charts - but if you look closely they show exactly the same information.

Monday, October 30, 2006

My First Paper Trade

Bought 13 Australian Dollar contracts @ 0.7675. IB gives you $1M in imaginary play money and the underlying value of an Australian Dollar futures contract is $A100,000. So hedging $US1M into AUD requires 13 contracts. Now I am looking through all the reports generated to try to understand what happened. A bonus of IB is all the contextual help menus are very useful.

Paying Money Overseas

Paying money overseas gets easier and easier as credit card payments get more widespread internationally. But sometimes you need to pay in foreign currency. It isn't hard to do this if you know how. You go to your bank and either buy an international money order and mail it or wire the money to an account directly. But you need to know. I was just talking to my mother today. We are still trying to get money from the German government in compensation for property that was seized by the Nazi regime. As an aside, this is one reason I'm not a big fan of real estate as an investment. It is a long story - the property is in Eastern Germany and until 1989 there was no way to get anything from the Communist government of the Deutsche Demokratische Republik. Some time after 1989 (1995) we were contacted by a lawyer that we could make a claim and since then we have been in process. We have received some money. My mother decided to split our share of the value between my brother and I. So far I've received about $7000. This was my share of one of our properties. Now we are trying to get the money for the second property and several months ago the German government required us to pay a small number of Euros as a fee to get to the next stage. Finally, today I understood that the reason this is still held up is instead of paying in Euros my mother sent a personal check in Sterling drawn on her bank in London. Obviously the check hasn't been cashed. It would probably cost the government agency there about as much to cash a personal check in foreign currency as the fee is worth... Her reason why she didn't send payment in Euros is that the bank where she lives gave her a hard time about paying in Euro. I can't really get a straight answer why. I think they just told her it would cost a lot and discouraged her so she took the "easy" way out and sent a personal check in the wrong currency. I told her to phone the lawyer and tell him what she did and what can she or he do next.... Hopefully soon this story will finally be over

Saturday, October 28, 2006

And Today Wasn't

a good trading day. I closed out the MSFT trade for a profit which was the only good thing that happened. HCBK was downgraded by Merrill Lynch. The model predicted a turning point at last night's close, but if the stochastic rose above 80 that turning point would be negated. So the stochastic was above 80 until around midday when the market suddenly fell. I was still convinced the uptrend was continuing though so I tried to go long part way into the fall after getting stopped out. Bad move.... Oh well, I didn't lose as much as I made yesterday. It now does seem that we are back in a downtrend.

Friday, October 27, 2006

Market Update

In my existing accounts I bought some Microsoft shares this morning in anticipation of this evening's earnings release. I remain long QQQQ. The model is long but tomorrow could be a turning point unless the stochastic rises above 80. If today's close is strong that is possible. At the moment the market is down a bit due to the fall in new home prices announced at 10am of 9.7% since September 2005. This was the biggest fall year on year since that index started keeping records. Sales of new homes though increased and the housing sector ETF, XHB is up.

4:49pm Update

Turned out to be a very good trading day. Berkshire Hathaway B (BRK/B) shares rose $98! Unfortunately I only own one share :( I did some day-trading of Redhat (RHAT) which fell more than 25% and then rebounded a little. I also bought Microsoft (MSFT) shares in anticipation of this evening's earnings. Though Microsoft beat analysts' expectations by more than 10%, some traders initially thought they were guiding to a much lower earnings number for next quarter. Turns out they expect to earn roughly in line with analysts' estimates but are deferring a third of the income to the following quarter due to Vista related issues. Also bought shares in Hudson City Bank Corp (HCBK) - a New Jersey based thrift. Not sure if this is a position trade or an investment. Will have to see what happens. There is a chance that it will be added to the S&P 500 soon. Also it has a large amount of excess cash for a bank and is buying back shares. However, the P/E is very high for a bank and so these expectations may already be built into the price. On the other hand with all that cash it should do fine if the housing market really implodes and maybe be in a position to acquire other banks down the road?

Thursday, October 26, 2006

Interactive Brokers Account Operational

After faxing a copy of my driver's license to IB yesterday my IB account is finally operational. All I've done so far is log in, look at some quotes, and put in a request for a paper trading account. Expect more reports as I figure out how to use the different tools and make some paper trades.

Nationwide Retirement Score

I just did the online retirement preparedness quiz. Like most such questionaires it didn't ask the big question about inheritance. Do people think that that is inappropriate, or too uncertain, or make people feel put off by feelings of envy for those with large inheritances, or the providers just want to minimize people's assets so that they save more with the provider in question?

I don't think it asked about assets such as businesses either. Very much designed for the middle-class employee...

I scored 125. What is your score?

Wednesday, October 25, 2006

New NetWorthIQ Release

NetWorthIQ have a new release. The new version splits out non-owner occupied real estate. I think that is a great improvement. They also have some notes attached to each net worth category on the net worth updating page explaining what should go in each entry. Good start on both. Splitting out the value of businesses is another thing I would like to see. Mentioning where more exotic investments and loans like margin loans and short positions should go would also be useful. I lump the latter into "other debt". I could just put the net worth of my brokerage account under "stocks" but that would be a bit misleading. Once I break out the cash and include that in cash the short positions would result in a negative stock value. At the moment I include options under "other assets". Therefore those have to go in other debt. Don't know yet how I will treat futures positions. Actually, as they now list REITs and other real estate funds under "other real estate" I am going to have to go back and recompute all my entries!

Reality Check

At this point there doesn't look like any way I am going to meet my original goal of getting to $370,000 by the end of this year. So I am lowering the goal to $350,000. That would still be a 30% gain in net worth and more than my minimal goal of a $50,000 gain. The same growth rate implies goals of $450k for 2007, $575k for 2008, $775k for 2009, and $1M for the end of 2010. These are still very steep goals. But they are something to aim for that is not totally unrealistic.

Monday, October 23, 2006

Risk and Return in a World Where Only Relative Wealth Matters

Eric Falkenstein, a hedge fund manager in Minneapolis with a PhD in economics, has written a fascinating paper (warning: grad-level economics stuff :)) about risk and return on investments in a world where investors only care about their wealth relative to others and their returns on investment relative to others returns on investment. The rationale for investigating this idea is that:

1. The traditional CAPM (Capital Asset Pricing Model) doesn't have much empirical support - the average rate of return on high beta stocks isn't higher than on low beta stocks.

2. Much research on happiness in economics has shown that beyond a basic subsistence level relative wealth matters more than absolute levels of wealth.

3. The prevalence of index investing and relative return investing. This may have been accompanied by a trend to lower risk premia for stocks, corporate bonds, and other traditionally risky assets over time.

He argues that if all you care about is relative wealth then holding the average market portfolio has zero risk. Deviating from the market portfolio is risky. If this is true then the rate of return on all assets in the market portfolio is equal. There is no extra reward for investing in assets with higher variances of returns compared to the market portfolio whether those risks are correlated with the market portfolio (high beta) or not (idiosyncratic risk). I have yet to work through the implications (except that there is no extra reward for buying and holding stocks in such a world over buying 90 day T-Bills) but if the guy is right he could be on the path to a Nobel Prize in Economics... I understand the paper, but I as I am not a specialist in financial economics I don't know if there are any flaws in his argument which aren't immediately obvious.

Friday, October 20, 2006

Rentometer

A Zillow for renters: Rentometer. Very cool. Oh and both my apartment and my girlfriend's are very good deals, not surprisingly :)

Sunday, October 15, 2006

Marriage, non-Marriage, and Economics

An interesting article in the NY Times today discusses the implications that now a minority of US households consist of married couples with or without children. A quote: “we have an anachronistic view as to what extent you can use marriage to organize the distribution and redistribution of benefits” expresses how I feel about the way taxation, benefit, and other systems are set up in the US. In my opinion the state should only play a role in helping (or not) raising children who are not able to fend for themselves and are society's future members. I don't see why the state should be at all involved per se in partnerships with or without children involved. The reason they are involved is because historically women had very limited economic opportunities so it was natural to provide benefits to women who were married and not working through their husbands (for example by inheriting social security payments). Rather than extend such an anachronistic system to further people through gay marriage (though the numbers are small as this article points out and so practically don't make a big difference) I would favor making the system more gender neutral and individual based and allow people to develop partnerships as they see fit without worrying about the financial implications. Many countries have systems that are much closer to my ideal. Australia, one of the two countries I am a citizen of (and the other one is not the United States) is closer to this ideal in many ways. Changing a small country, populationwise, is probably easier than changing institutions in a country as large as the US.

Friday, October 13, 2006

Stopped Out Again

Again the model was stopped out today. I lost a lot of money. The majority of my profits from this experimental trading period have been lost. In fact I am back to the return the market has given over this period. From that perspective I guess it hasn't been too much of a disaster? :) If one stuck exactly to the model a day like today wouldn't be disastrous. But if you don't trade the system properly days like today are very bad news. Over this period I have improved the model and decision rules a lot. It is a much better system than at the beginning of the period. So it hasn't been a waste. I am not giving up. I still have some profits left and a tool that in theory can produce tremendous profits. I'm not sure what the problem has been. Too much leverage does make me nervous and do dumb things. I plan to use less leverage going forward and try to stick more closely to the model signals. Doing what are really two full time jobs at the same time is hard. I end up doing neither very well. On the other hand trading more than one thing simultaneously in smaller amounts in each instrument would be psychologically easier. Soon I will be able to start paper trading at IB (I initiated the transfer of $5000 today). I am thinking to experiment with trading two or three instruments simultaneously. As it won't be real money I won't be worried about losing money. Probably trading NDX, bonds, and Australian Dollars would be a good combination as the three assets have little correlation with each other. I won't have time to model bonds and dollars so I will trade these purely on the basis of charts. Right now I'd be long the AUD and short bonds probably.

Wednesday, October 11, 2006

The Old Model Won

The old model won today as NDX ended up a couple of points and even the new "averaged stochastic" rose. But really the market didn't go anywhere much. Tomorrow these various stochastics almost absolutely have to fall due to the way they are computed. Will it be a down day finally? One potential trigger is the beginning of earnings season. Alcoa reported after the close and did not meet expectations.

I won't be updating the old model unless the new doesn't prove to be better in actual trading. In simulated trading since January 1st and June 30th this year it strongly outperforms the old model, even if today, the first day of using it was not one of those outperforming days.

I remember Teresa Lo from years back when she posted on Silicon Investor. Now she also has a blog and my impression is she has a similar attitude to me somewhere between academic finance and technical analysis and trying to work out objectively what works and what doesn't. She also emphasizes the very important role of psychology in trading success.

Tuesday, October 10, 2006

Major Model Improvement?

I noticed today that the standard slow(5,3) stochastic began to decline today while my preferred full(5,5,3) stochastic increased steeply. The existing model forecast predicts a decline in the market starting on Wednesday. But with the slow stoch already declining I would feel uncomfortable about being long. I did some trading simulations on a spreadsheet and found that the slow(5,3) stoch is often too early in determining changes in trend while the full(5,5,3) stoch is too late. Is this why I find it hard to stick to trading the model? Averaging the two stochastics outperforms either of the two stochastics. So now I have applied the forecasting models to this averaged stochastic. All three indicators estimated using the new model say the averaged stoch will fall on Tuesday. To do that the NDX must fall at least 10 points. Therefore, the model's decision is to get short at today's close.

Monday, October 09, 2006

Getting Started with Technical Analysis

Million Dollar Countdown asked for some advice on introductory books on technical analysis. There are only two technical analysis books I have ever read. One is the classic guide to interpreting charts by Edwards and Magee. This book provides the fundamental rationale for technical analysis. Once you read this, hopefully, you will be convinced that movement in the financial markets is not totally random. They explain the basics of price and volume action in the markets. This kind of understanding is even more important in intraday trading than in interpreting large scale chart patterns. This edition has been much updated from the 1960s edition I borrowed from our university library in Australia. The other book is Frost and Prechter's "The Elliott Wave Principle". Elliott wave theory systematizes a lot of the formations and ideas found in traditional technical analysis as presented by Edward and Magee. Everything else I know I picked up on the web or developed myself. Stockcharts.com has an excellent "chart school" for example.

I am very skeptical about a lot of the other technical analysis out there. Some of it makes no sense to me coming from a background in time series analysis and much of the rest is not very predictive. Those latter methods may be good for working out which waves the market has gone through and maybe E-Wave could then help in predicting what might come next but the indicator itself doesn't predict anything. One such indicator IMO is the much used MACD. However, I have found that stochastic oscillators are much more useful and can be used to predict the market to some degree. Then there are methods, which are hard to comprehend but seem to produce excellent results.

As a beginner a reasonable goal is to understand technical analysis well enough to avoid making stupid and expensive mistakes.

Interactive Brokers Application

I finally got around to submitting an application for an account with Interactive Brokers. Security checks are now running before I can actually fund the account. My plan is to initially deposit $5000 from my HSBC Online Savings account which I have been saving up. That's the minimum amount required to open an account. At this stage I signed up for all US stock, options, and futures markets. You can also trade a number of foreign markets, but I don't have any need for that at the moment and one can always add additional permissions as required. IB has a paper trading facility and I plan to use it initially to get used to futures trades which is what I plan to use the account for initially. Once I get used to trading I will initially trade one E-Mini NASDAQ contract which is equivalent to 800 QQQQ shares. I also will look at trading Australian Dollar contracts to hedge my Australian Dollar and US Dollar exposures. The reason I want to trade stock futures is because under the 60/40 rule they are taxed at lower rates than short-term stock trades. Being able to modify my currency exposure without wiring money between the US and Australia is also attractive. The Australian Dollar ETF (FXA) is not a viable alternative. To sell short $A100,000 requires margin of about $US37,500. Using futures the required margin is only about $US1,500 for the same transaction (and the taxes on gains are lower). My new short-term goal is to reach a total of $65,000 in my three U.S. trading accounts.

Sunday, October 08, 2006

Zillow?

Has anyone else noticed that Zillow hasn't updated any house prices for the last three weeks (since 9/15/06)? What's up over there? Frustrating for financial markets junkies like me! Zillow is a great easy to use service though it has its quirks like not updating past estimates when new information becomes available which can lead the trends in prices to be very unreliable. Hope this lack of updating doesn't signal some trouble with this enterprise.

Thursday, October 05, 2006

Labels!

I upgraded to the new Beta Blogger, so that I could get faster publishing and add labels to my posts. I have long wanted to be able to categorize posts so that I could find those posts about long-term planning, personal finance, or economics, amongst all the posts about trading. Hopefully, my readers will find it useful too! I've added a categories menu to the sidebar. In goals posts I set out my goals, in planning posts develop my plans to achieve them, and then report on achievement of goals in performance posts. Monthly reports are highlighted separately from other performance posts. The largest number of posts are updates on market direction and my trading with a few of these posts mentioning the trading model highlighted as well. Posts on retirement cover both my own plans and more general thoughts. Thoughts on other aspects of personal finance are listed separately. There is a similar approach to tax issues - my own tax issues and more general thoughts about tax. There are also links to commentary by other commentators and my own comments on both macro- and micro- economics. Posts on the housing market have their own category. Finally, there are just some links to useful websites that don't fit in any other category.

Elliott-Wave Count for NDX



If this count is correct then there could be some more upside left. But the Full(5,5,3) stoch can only rise at most to 64 tomorrow. If the index ends much below the high of the day then the stoch will fall. A continued strong rally therefore seems unlikely on that basis.

Final Report for September

Investment Performance
Investment return in US Dollars was -0.77% vs. a 1.19% gain in the MSCI World Index, which I use as my overall benchmark and a 4.71% gain in the NDX which I use as a trading benchmark. The trading accounts lost 4.2%. Investing like a hedge fund should result in more stable returns than if I was a pure investor or pure trader. Total returns in terms of Australian Dollars were a gain of 1.14%. The best performer of the month was Mayne Pharma, which was subject to a takeover offer resulting in a gain of $A2330. The second best performer was the CFS Conservative Fund, my biggest single investment, with a gain of $A2186. The worst performer was QQQQ trading with a loss of $US1833.

Asset Allocation
At the end of the month the portfolio had a beta of -0.51 (a 1% rise in the market would result in a 0.51% decline in the portfolio). Assets were allocated as follows:

Asset Class:
Stocks Long 39.37%
Stocks Short -35.72% (QQQQ)
Put Options 1.39% (QQQQ)
Bonds 45.79%
Real Estate 4.94%
Hedge Funds 3.15%
Cash 50.04%
Loans -9.15%
Asset Loans 0.18%

Much of the cash is used as margin for the short position. Bonds are held via the CREF Bond Market Fund and the CFS Conservative Fund. 64% of net assets are deemed to be AUD related and 25% USD related with the remainder in global funds.

Net Worth Performance
Net worth declined by $US207 to $US330131 but in Australian Dollars gained $A9529 to $A442,421.

Income and Expenditure



As you can see total investment income was $US3197 before taking into account foreign currency fluctuations which resulted in a net investment loss of -$US2553. Expenditure was $US2054 - as usual living well within my means.

Stopped Out

The model stopped out. If this level holds then the model will reverse to the long stance again. The fluctuations in the last couple of weeks or so have been too rapid to trade and have whipsawed the model around to lose money or go sideways... From an E-Wave perspective the NASDAQ 100 index could be forming an ending diagonal formation. That would be the bearish case as that is the end of a move... But a new post July high would be coming in the next days... Bottom line is things are now as unclear as they have ever been.

Wednesday, October 04, 2006

New ATH on the Dow

Yes there was a new intraday all time high (ATH) and a new closing ATH on the Dow. NDX was up a bit on the day but totally within model expectations. So the model, which officially went short at Monday's open, remains short.

Update on model performance to date. Based on 63 real time trading days so far the model has a beta of 0.09 and alpha of 153%, Sharpe Ratio of 6.26. These values haven't changed much each day as new data comes in.... My account for only the 4 monthly data points has a beta of -0.77 and alpha of 128% (Sharpe ratio of 2.50). So that means if the market makes 10% p.a. trading like this makes 130% p.a. Still very few datapoints for that analysis. If one could trade the model perfectly with no leverage one would get 159% p.a. on that basis. For comparison, typical hedge funds have Sharpe Ratios (return/standard deviation) of 2 or so. Market indices are always lower than that. Some hedge funds have recorded 100% plus years but never for more than a year or so. The very best hedge funds would record runs of 30-40% returns. Though those are after fees so they were doing better before that.

Monthly data so far:

July

NDX: -4.18%
Model: 10.44%
Account: 13.06%

August

NDX: 4.66%
Model: 8.36%
Account: 13.19%

September

NDX: 4.71%
Model: 6.23%
Account: -4.20%

October (first two days)

NDX: -0.84%
Model: 0.84%
Account: 3.83%

So far to date:

NDX: 4.13%
Model: 28.20%
Account: 27.28%

Sunday, October 01, 2006

Provisional Report for September

Not a good month, but not a terrible one either. The model gained 6.23% compared to an NDX gain of 4.71% but my trading accounts lost 3.94%. Overall my portfolio looks like it lost 1.5% while the MSCI is up 1% and net worth is down about $1000. But this is partly due to the fall in the Australian Dollar. Preliminary net worth seems to be up around $A8000. More detailed results will come in a few days time.

For Monday, even if prices are level with Friday's close the stochastic will fall below its three day moving average and below the critical 80 level. So unless some very good news can give the market a boost, expect prices to fall. In simulations I have run with my older "autoregressive model" there is pretty much limitless downside with no support if a major downmove gets underway. This doesn't mean it will but technical indications from E-Wave to the McClellan Oscillator are weak and mean that the probability of a downmove is much higher than that of a continued rally.