FOMC Day

Apparently the markets think the Fed's statement is bullish. I was short and suffered a big loss. Mainly due to being short individual stocks. If I had traded strictly according to the model I would have lost only about 25% of what I did. If you reversed to long when the stop was hit you would be flat for the day. The stop is at a 1.25% loss and the market rose another 1.25% after that. It makes sense I think to reverse at the stop when the next day's forecast is for a change of trend.

I closed all positions and went long... too late in the day though. The model is now forecasting up (like that's hard to do LOL).

From now on I am trading only QQQQ in position trades and now and then in day trades to improve my position. I may also do trades in individual stocks if there is a good reason to do so. But I won't use them to capture the market direction. I may use other ETFs like HHH too. Of course I also invest but I follow strict risk control there too in terms of position sizes.

Let's see if this improves my net worth. This month will be very bad. If I am lucky I will stay just over the $300k mark.

The Market Went up Today... Better News from Australia

The market went up today, but my model is still on short heading into the FOMC announcement tomorrow. We are getting close to a turning point in the market though. Better financial news out of Australia for me today. There was an update about a very complicated real estate security (IYS) I invested in which is going to be wound up and the capital distributed. The final distribution will be 21 Australian cents a share more than previously offered ($A1.91 vs $A1.70). Should wind up in September. I am tempted to buy more but the risk control side of me says: "who knows what might happen?". The spread is enormous. The bid is $A1.24 and the offer $A1.72. It almost never trades. Maybe put in a bid at $A1.25 and see what happens? I can't see why anyone would sell at that price though. But why sell at the offer price either?

Croesus Mining Declares Bankruptcy

I wrote in an earlier post about the trading halt in the shares of Australian gold miner Croesus Mining. In the last couple of days the firm went into "administration" the Australian equivalent of Chapter 11 after the Japanese Mitsui Bank refused to reschedule the gold hedging contracts between it and Croesus. Macquarie Bank in Australia had agreed to reschedule the hedging commitments. This means the value of the shares is likely totally wiped out. I won't write down the loss to my net worth (about 2.5%) until this is finally confirmed. At least some of it can be used as a short-term capital loss reducing the hit somewhat. The basic problem was that Croesus was not producing enough gold to meet its commitments to sell gold to the banks at the prices of the hedging contracts. Therefore, they would be forced to buy gold on the open market at a much higher price fill the contract. Macquarie was happy to reduce the monthly commitment. I suppose they thought that the price of gold will continue to rise so it doesn't matter if they have to wait a while for their cheap gold. And, additionally, they let a borrowing client survive to borrow another day.

Kiyosaki Wrong on Mutual Funds

I like a lot of what Robert Kiyosaki says usually and there are serious problems with a lot of mutual funds, but the basic point in his column on Yahoo's website is plain wrong. He says that if a mutual fund earned 8% a year and charged 2.5% in fees (the first number is plausible as an after inflation return on a long stock mutual fund, the second number is high but not totally implausible) then your after fees return is 5.5% which means that over a 65 year period $1000 would grow to $140,000 if there were no fees but only $30,000 after fees. So far so good. But then he says that this implies that the fund manager makes 80% of the return and you only make 20%. Not true. You make 21% of the potential before fees return but the fund company only makes 10% of the potential return ((2.5*30,000/5.5)/140,000). 69% of the potential return just disappears. So it is just as bad as he said but the mutual fund company isn't benefiting from this. The idea that if you lose someone else must be gaining is a common myth among investors - many people think that if the stock market goes down and investors who own stocks lose someone must have gained. Not true - a few short-sellers do gain, but most of the value just evaporates.

The truth about mutual funds is that actually fees don't matter. Fund companies like Vanguard who have low fees would like you to think this. All that matters is your net return after fees. If the return after fees is better than you can do on your own after taking into account the value of your time you would rather spend on something else then the mutual fund is worth buying and otherwise not. You could just buy an ETF invested in a stock index. If an actively managed mutual or hedge fund returns after fees more than this investment then it is worth buying. I find that in very strong trending markets, passive investing beats active investing. In weaker markets active investment seems to win out even after fees. Last year in the US active funds beat passive funds. But in Australia the opposite was true. In the 1990s, active investing won in Australia and passive investing in the US.

Market Forecast

Despite the market being up today all my newly developed indicators are pointing the same way - down. Some other indicators and the chart pattern too are ambiguous. The NDX (NASDAQ 100 index) would need to rise around 14 points I think to reverse this. Something unexpected can always happen. I'm thinking now when I do reverse position I will set up main position using stock after all. This is so I can do an after hours trade if neccessary - you can't trade options outside regular market hours. But the position in my Roth IRA will remain in options. Will be interesting to see how the two approaches work out.

Technical Analysis Modeling

Been spending a lot of time recently on developing new technical analysis methods (commonly known also as "charting" - but the stuff I am developing barely involves a chart). In my academic career most of my research has involved applying time series models (statistical modeling methods related to regression analysis applied to data that is available as observations over time like historical temperatures, GDP, stock prices, population etc.). I have also done some work to apply these methods in the stock market.

I have found that, not surprisingly, it is pretty much impossible to forecast daily changes in stock prices using any standard time series model. This is why academic economists who work in finance say that technical analysis is rubbish and can't work. It is also why technical analysts use indicators which rather than forecasting changes in stock prices try generally to pick out turning points in the trend. I have created one indicator myself that is fairly useful by using an unusual combination of time series methods. My new approach is to try to forecast an indicator.

Recently, I have found that if you could predict the direction of the %K(5,5) full stochastic oscillator correctly (see this chart) you would beat the market by maybe 100% in bull market years and by hundreds of percent in bear market years. So being able to predict it is definitely a worthwhile thing. And it is far more predictable than stock prices themselves. Of course, no forecast can be 100% accurate and so these kinds of returns are not possible.

The time series model I have developed so far (in the last couple of days) can predict it well enough to increase the value of the account in bear markets. But in bull markets, following it blindly could lose money big time. Interestingly, we are now in a bear market by that definition. I tested each year from 1997-2006 and see how the model does over each year separately. This is called backtesting and is standard in developing technical analysis methods.

So I think my focus should be on improving those forecasts. Next step is to try some things that aren't in the time series textbook.

Anyway at the moment we have a very high probability forecast that the oscillator will be lower on Monday - i.e. stay short. This is backed up by the McClellan Oscillator and my E-Wave discussed in previous posts.

Plutonomy

Plutonomy is a term invented by some analysts at Citigroup. Download their articles here. The central thesis goes against everything you probably thought about people's saving behavior and what is taught in macroeconomics and development economics. They provide evidence that today in the more unequal developed economies - the plutonomies - the rich save less than the poor or the middle class. In order to understand this idea you need to remember that in the national accounts capital gains are not included as part of personal income. Most capital gains go to the highest income and wealthiest segment of a society. If you are a CEO with big options grants it is easy to spend your salary and save the profits from your option exercises and have a zero savings rate. This turns the popular notion that the decline in the US personal savings rate is due to poor and middle income consumers spending beyond their means (by cashing out housing equity in the middle class or running up credit card and other consumer debt in the working class) on its head. Another thing they don't mention is that people who save successfully for retirement are going to end up in the wealthier segment of society and they are dissaving. This phenomenon does not apply to developing economies apparently even though many are far more unequal than the United States. It is certainly an intriguing idea and the evidence looks strong but something is still nagging in my mind that makes it hard to 100% believe in it.

The Correction Continues - Technical Analysis

We are still in what I believe is a correction of the 14 June rally in US stock markets. Even though yesterday's rally exceeded the previous highs it took place on weak volume. Volume only really picked up when the selling off started. Today was mostly down and then sideways. This type of correction is called a "flat" in the terminology of Elliott Wave Theory.

Check out this chart of the NASDAQ 100 index. The stochastic oscillator maps out the waves pretty clearly. And the last wave of the oscillator is clearly pointing down and has some ways to go before it bottoms out. So market timing doesn't work and technical analysis is rubbish? It is still hard to determine a turning point as it happens. Once the move is underway though the momentum is pretty clear. But a rally like yesterday's is just noise as far as the oscillator on a daily chart is concerned. You need to go down to the hourly chart to detect it... and then keep the daily one in mind too. And this is part of the reason why I am thinking of using multiple trades simultaneously some longer term (based on the daily chart) and some shorter term (based on intraday charts). My mutual fund investments would be traded on the basis of a montly chart perhaps.

Trading Diary Part II

9:33am

I won't post hour by hour detail today. Have a big meeting from 12-2 anyway. Market is showing early strength. For the moment I will hold my positions until I am clear a bottom has been reached and then reverse course to the long side. Will report positions at the end of the day. Right now I am short 50 GOOG, 500 QQQQ, and 100 AAPL as at the close yesterday.

4:03pm

A mixed day - not much to report - ended down $50 overall in my Ameritrade accounts and with more short positions than I started. So the new plan still isn't implemented but my trading positions are not bigger than my risk management allows: 1000 QQQQ, 50 GOOG, 100 HANS, 100 AAPL all short (and 4 QQQQ puts and 150 GLD long in my Roth account). The GOOG and HANS positions are in the 5-6% of net worth range. QQQQ positions can be much bigger as this is a market index. My current position is conservative.

Trading Diary

Today I am trying to exit from my previous strategy and initiate the new one.

9:54am

I went into today short 100 GOOG and 500 QQQQ in my trading account (I also have 1 BRKB in this account. I added 500 QQQQ and 100 HANS to the short position in pre-market or the first few minutes of trade. Let's see how it goes. Barrons had a negative article on GOOG (as did the Economist) over the weekend. In Friday trading GOOG's share price got pinned down to the $390 strike at the option expiration. Maybe it can fall a little now that the options expiry is over. I see the market as a whole as needing to consolidate a little after last week's rally. HANS is very volatile and so sometimes is good for daytrading though often spreads are big and often it can't be shorted and because of the relatively low liquidity spikes in either direction can easily appear from nowhere. So not the ideal daytrading stock. But I don't have any other real ideas.

I have the market running on my laptop while working on other stuff on my desktop. Using the F9 key on my Mac I can get all the windows to be visible nicely spreadout across the screen and monitor various stocks for anything unusual out of the corner of my eye....

10:10am

Perfect reason not to trade individual stocks in large amounts - $5 spike up in GOOG came out of nowhere in 5 minutes. $2 of the spike happened in 1 minute. As I write the stock is falling back. No news out, nothing. I don't need this kind of stress. If I had half the number of shares I wouldn't worry.

10:23am

GOOG's back in the red for the day LOL

12:53pm

I am tracking the SP500 index. Tech stocks are showing relative strength today and it is hard to tell which way the market will go by just looking at the NASDAQ indices alone. The SP500 index though is much easier to read and if it goes down it is hardly likely the NASDAQ will go up. Looking at correlations across multiple indices and securities is one of the ways I try to work out what will happen next. Most individual traders and market commentators seem only able to focus on one thing in isolation.

1:40pm

With AAPL showing relative strength today and everything else near or at session lows. I add 100 AAPL to the bundle of shorts. Maybe this is getting too clever for my own good. But I figure the downside can't be too bad. Now I am using my full daytrade buying power.

2:47pm

With indices at session lows I bought to cover half my QQQQ and GOOG positions. The remaining positions are around 6% of net worth each and so much closer to my comfort zone. I am also well within the overnight margin requirements. So from now on if the market goes down more good, if it goes up a bit no big deal.

3:31pm

I covered the HANS position for about $500 profit. Actually I accidentally pressed the button :) I had the order set up and was looking for the price to fall back a bit and then accidentally leant on my laptop.... anyway the probability of more gain is too low now to make reshorting it worthwhile.

7:24pm

Well it was a good trading day, but we will need to wait till tomorrow to complete the transition plan. But at least I no longer have an outsized position in an individual stock.

Mid-Month Update

As of 16 June net worth has declined to $304k (down $14k) with an investment return for June so far of -4.56%. The MSCI global index (in USD terms and including dividends on a pre-tax basis) is down -3.41% for the month so far. So I am lagging the index. YTD my return is only 3.20% against the MSCI at 2.80%.

New Short-Term Trading Plan

After my experiences over the last couple of months I have developed a new trading plan to try to implement a bit more discipline. This doesn't cover very long-term trades using mutual funds and changing currency exposure.

1. Only do short-term trades in my US accounts. This gives me a break rather than thinking I need to trade in both the US and Australia. Australia is only for long-term investment and long-term trades. The rationale is that it is more expensive and difficult to trade in Australia in every way (executing trades and getting real time information) and the market is less liquid.

2. Set up a position trade (i.e. for period of week, weeks, months) using options on QQQQ based on my own market timing model, E-Wave, and other technical analysis of daily and weekly data. The rationale for this is that options give some up and downside protection in the event of an unexpected market move (and stops won't really help outside the regular market day) and that option spreads (difference between bid and ask prices) are wider than individual stock spreads so that daytrading options can be difficult.

3. Set up a few position trades of small size in individual stocks. These should be less than 5% of net worth and probably smaller.

4. Do day and multi-day trades using stock in QQQQ and individual firms where appropriate. Use stops on these trades to weed out the losing trades fast. I don't have to day trade as I will have a position trade in place. Hopefully in a situation like yesterday I would have shorted the stock but kept a call options position. This would have mitigated the damage. Even better would have been not to go short at all till the end of the day :)

Comfortable Being Bearish

Went into today with my Ameritrade account short and added to the shorts and bought puts in my Roth IRA. So far it is working out. And I feel much more comfortable being bearish than trying to be bullish. It suits me much better :)

Trading and Emotions

I am now at the point where I know good money-making trades but the problem is actually executing them. Seems that all the recent volatility in the market has shaken me up and I am making bad decisions. Starting today I had good positions and ideas for good trades. I executed those trades and then midday reversed course and blew up most of the profits I had made. Don't really know why I did it. I guess there is the fear of losing the profits I had made. But why go short? Anyway the market kept rising through the day and I ended up giving back most of my profits by the end of the day. My trading account and Roth IRA ended up about $500 on the day but it could have been at least $2000 if I had played things right. Only consolation is that this is only 10% of my money. Another 10% is in my 403(b) and 80% in Australia in retirement and non-retirement accounts which I am not actively short-term trading.

Net Worth Update

After last week's "trauma" I did a thorough update of the results so far this month. Investment return is -2.67% but the MSCI World gross index is down 2.82%. So still beating the benchmark :P I guess reversion to mean. Lot of luck in this business. I just hope that each debacle I suffer in the markets makes me a better investor and trader. The data so far say yes. But it is a very slow process. I updated my net worth profile and it is down almost $8000 or 2.5%.

Stressful Trading Day

Today is a day when everything went wrong. Here are just some of the things

1. I went into the day long even though I didn't really have any good case for it and vaguely thought I already should have sold.

2. I didn't manage to sleep last night. Not good for cool headed decisions.

3. I still didn't sell when the futures showed the market would open down or whent he market started falling - I was like a deer in the headlights.

4. Cramer said to sell HANS the night before.

5. I finally sold half my position after QQQQ had bounced 20 cents above the bottom. That was enough for me to stop panicking.

6. The market then rallied to end the day not far from where it started. I had to be in a meeting for part of that, but don't think I would have added to my position anyway at this stage.

The realised loss after tax is about 1/2 % of net worth. So in the big scheme of things not really such a big deal I guess. B ut I was feeling very scared while it was happening.

One of my problems is that when my trading starts going well I get cocky and arrogant and start breaking my rules. Then I blow up. Mostly I am upset at the time I wasted making those profits in the first place and why I was so dumb.

To make money trading you need emotions, but too much fear and panic will end up losing you money.

One good move: I sold my TLT call options just when bond prices were at the peak of the day.

Today's Report

I think there is still more downward movement coming in the stockmarkets in the next week or two, but today I sold most of my put options (kept Starbucks as it didn't seem worth trying to trade it) and covered my short positions and went long (QQQQ and HANS) for this bounce. The bounce might end tomorrow already but hard to tell at this point of course. I now have a small margin loan in my US account.

Net Worth in Australia

An interesting article about net worth levels in Australia. In the US median net worth is around $US93000. Recently I read in the New York Times that US mean net worth was just above $US400k. The mean net worth in Aus according to this article is similar ($US351k), while the median is more than twice as much ($US225k). However, the Australian study includes the value of cars and household contents in net worth which the US data does not - a comparable median figure is probably around $US175k. Official statistics typically place Australia with income per capita of around 80% US levels and around the same level of inequality in terms of income. These data indicate less inequality of wealth in Australia than in the US. I have seen median net worth statistics for Sweden and the UK which were much lower than the US median. Is the typical Australian the wealthiest citizen in the World? A comprehensive international comparison would be very interesting.

Kondratieff Waves and Deflation

Michael Alexander has begun a new series of articles on SafeHaven. His analysis can look a little weird to mainstream economists like me but reading his articles in the past was the first time I really began to understand the Kondratieff Cycle. Of course I was familiar with this long cycle of more than 50 years in economic activity, but none of the previous discussions I had read seemed to be particularly well-informed and it was rather confusing to me. If the theory is valid then the current cycle is longer than previous ones. We are currently supposedly in the deflationary depression part of the cycle in the US - though Japan went through that in the previous decade. Yes, both Alexander and Mike Shedlock think that deflation, not inflation is the threat. I think they are probably right. My big bet on bonds in my portfolio (and my Mom's) wouldn't make sense if I thought we were facing inflation. In inflation interest rates rise and bond values fall. This is what happened from 1966 to 1982 in the US. Since then the reverse has been happening. We believe that the disinflationary cycle is not yet complete. Both these commentators have been marshalling the evidence in favor of this thesis. Everything I see reinforces the suspicion I already had that this is what will happen. Of course this is a hyper-contrarian belief. Most so-called contrarians believe that inflation is greater than government agencies state and that it will rise further. Wall Street orthdoxy is that the economy is strong, the Fed will stop both inflation and deflation etc. Actually, I don't think we will see any significant deflation in the prices of goods or services but little inflation either.

BTW, I finally got the second part of my Federal Tax Refund in my HSBC Online Savings Account. I now have over $11k piled up there exactly balancing my credit card debt. In July I will pay off all those debts before the zero percent offers terminate. I may get balance transfers in the future but will use a lower balance ratio so as not to affect my credit score.

Levels of Frugality and Wealth Creation

There is a lot of personal finance advice out there on the web and a lot of it is quite good, but of course little or none of it is tailored for people's specific financial situations. The things that are going to be important to focus on are going to change not only with people's life stages but also with their wealth and income relative to expenses. I've seen quite a few discussions in the blogosphere about whether paying attention to the latte factor makes a difference or whether PF bloggers are saving too much for retirement. And then there are people with negative net worth giving advice to supposed multimillionaires.

So here are some random thoughts:

1. If you are a student or on a low income the key is not to get into a level of debt which will be hard to stablize or pay down once you start working or get into a higher income job. Being very frugal is going to help. But it doesn't make sense to make undue sacrifices if you know your future income is likely to be much higher. My Dad told me I should be saving when I was a grad student rather than borrowing. I ignored his advice, to my mind that made no sense.

2. If you are earning roughly the average income for your city, country etc and can't make ends meet, then serious frugality intervention is required to get back into balance. This is where the stop buying crap, latte factor etc. are going to be important. Otherwise, I think even if you expand your income, your expenses probably will expand at the same rate. This has never been a problem for me or some others. We are just lucky to have had the frugalness meme instilled in us I guess. So I don't discuss this at all in my blog.

3. Once you have that under control then I think income expansion becomes the next focus whether increasing salary, or business and investment income. My focus in the blog is on the latter and how to manage the money. The key I think is to expand expenditures slowly and smoothly over time so that they always remain far behind income.

4. Once you have money to save then the natural focus is where to put it. When your monthly savings are still relatively large compared to your total wealth, managing the money is probably less important. For example, if the stock market goes down, the dollars you lose will not be very many and your new savings will buy more shares through dollar cost averaging. At this stage all the usual PF advice about building up emergency funds, index fund investing, different types of retirement accounts etc. is most relevant.

5. Soon enough you have more wealth than annual income or several times more wealth than annual income. The absolute dollar impact of each investment decision becomes greater. At this stage, searching for superior investment managers, seeking true diversification, thinking about market timing strategies etc. becomes much more relevant. That is the stage where I am at with financial wealth equal to more than four times annual income. So it's what I am mostly going to blog about. Buying real estate (or not) I think should come in at this stage. Most middle class people are house rich and financial asset poor. No surprise that I'm not a big believer in the usual advice about buying a house. To my mind it would usually be a good idea to get beyond stage 4 at least first, but this will differ with local conditions and personal preferences.

There are stages beyond here of course - when true wealth is reached and you can live off of business income, investment income, or retire. Or take an increasingly proactive role as an investor.

Monthly Report for May

I am happy with my financial performance this month and this year so far. Net worth increassed $6413 to $318482. It would have been stronger if there hadn't been a bit of a fall in the Australian Dollar. The gain in Australian Dollars was $A12740. I am almost halfway to my goal of adding $100,000 in net worth this year. At the beginning of this blog I said I would be happy with adding only $50,000 for the year, so I should be really happy now :) Investment performance for May was 0.59%. Doesn't seem much but the MSCI world index fell 3.33% and many stock indices and mutual funds fell by much more. I've noticed quite a few bloggers out there commenting on the decline in their portfolios in May. I am up 8.14% year to date (MSCI 6.35%) and 18.97% for the last 12 months (18.55%). Over the last three years I have gained more than twice the gain in the index. Beating the index is possible. But it takes both effort and skill and maybe luck :)



Other income is particularly high this month because my employer always pays June's salary on the last day of May. Spending was high this month because of the vacation trip and associated expenses. As you can see investment income on non-retirement accounts was halved by the change in exchange rate (I don't bother computing this for the retirement accounts). In order to increase net worth in June I am going to need to have a higher investment income than my spending (the retirement contributions for June will still occur in June though). That might be hard!

Follow-Up on US Retirement Accounts

I've done a bit more research since posting on the retirement account puzzle. I now see that there are more options to get the money out of US retirement accounts without penalty before age 59 1/2 than I thought. The main one is if you convert the account into a lifetime annuity you can withdraw the money anytime without the 10% penalty (see comments for a better option suggested by Stealthbucks - coincidentally one of my local fiannce radio shows is talking about it right now...). For 401(k)s and 403(b)s it will be taxed at your marginal income tax rate rather than the lower investment (long-term CGT, qualified dividends) rates. You can get a variable annuity which varies with an underlying investment or a fixed annuity. A key issue here will be your tax rate when making contributions vs. withdrawing them. If you are happy with the annuity option and the tax rates work out in your favor then this could make sense. However, for a Roth IRA the distributions are taxable before age 59 1/2. So 401(k)s, 403(b)s, and traditional IRAs are clearly superior for this purpose and I think taxable accounts are too.

The other way money can be withdrawn before age 59 1/2 without penalty is if you are over 55 and leave your job or make a hardship withdrawal etc. (Roth's also allow a withdrawal for the first time purchase of a residence after the account has been open 5 years).

Australian retirement accounts are not as flexible in terms of withdrawing the money before age 60 (for those of us born in 1964 and later). It's not even a question of paying penalties.

Please only use my blog as a starting point to do your own research as I am not a qualified financial adviser of any sort.