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Trading Book Reviews

Book Review: A Trader’s First Book on Commodities

[easyazon-link asin=”0137015453″][/easyazon-link]I was recently given the opportunity to read Carley Gardner’s new book, [easyazon-link asin=”0137015453″]A Trader’s First Book on Commodities[/easyazon-link]. I think Gardner, whose bio lists her as Senior Market Analyst and Broker with DeCarley Trading, as well as a columnist for Stocks & Commodities (you may have also seen her articles on Trade2Win), has put together a pretty solid introduction to futures trading. Notice I use the term “futures” there rather than “commodities”, though. The book title tends to reinforce the view that commodities and futures are the same thing. The markets were effectively the same thing for many years, but the advent of financial futures a couple decades back means commodities are in reality just one facet of the futures markets at this point. Gardner’s writing doesn’t restrict itself just to commodities in her discussion of futures trading, though.

That little terminology nitpick aside, like I said, it’s a solid introductory book. One of its strengths is that Gardner spends more time than most authors do talking about the brokerage side of trading. It’s something a lot of users are likely to benefit from as they make their own trading plan decisions.

In standard introductory trading book fashion, the book also covers the usual material on market history, market structure, margin, terminology, instruments, order types, and quotes. She’s also got solid discussions on the subject of trading as a business and the emotional side of playing the markets.

One of my little gripes about the book are that Gardner has a tendency at times to go off on streams of consciousness which take her away from the main point she’s trying to make. At a couple of points she also mentions a more complex subject, suggesting that it need not be addressed at that point, but then proceeds to talk further about it anyway. Those two items aside, though, I found the book to be well put together and a useful starting point for anyone looking at commodities/futures trading.

Check out my full list of trading book reviews.

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Reader Questions Answered The Basics

The Cost of Forex Trading

I was asked by frequent emailer Rod to address something he came across regarding the cost of forex trading as compared to trading other markets, like futures. He is referring to this blog post in which the author compares retail forex to emini S&P 500 futures. In particular, the following statements are made:

“…unlike a stock, option or futures trade where one pays to enter and again to exit (but not to hold) a FX position is inherently a short-term trade, as you will be charged simply for the privilege of holding your position open over a period of time.”

“If you short the Euro/USD cross, for example, and expect a 100 pip (one cent) move on your trade, you might pay three pips of spread to enter and another three to exit, for a total “vig” of six pips.  That’s a 6% commission!

There’s plenty for me to address here.

Spreads and Commissions
I’m going to start with the second quote first because there is one blatant error, and other less obvious ones.

First of all, you don’t pay two spreads. In fact, you don’t really “pay” a spread at all, though certainly it is a cost. The only time the spread impacts you is when you first open a trade. Let’s say the market is at 1.4500-1.4503. If you go long, you will enter at 1.4503 ask/offer price. Now in order to exit your long you would sell at the bid price of 1.4500. As a result, you have a 3 pip loss from the outset. That’s the only time the spread comes out. If the market moves to 1.4600-1.4603 – the 100 pip gain noted in the quote – you would exit at 1.4600 for a net gain of 97 pips, not 94 as suggested.

Second of all, the 6% calculation is based on being leveraged at 100:1. I’ve already shown that the spread loss is not 6 pips, but rather only 3, so that cuts the cost to 3% on a fully leveraged position. Most traders, however, don’t go anywhere near 100:1 leverage. Experienced folks often limit themselves to 10:1-20:1. At 20:1 the spread cost is 0.6%, while at 10:1 it’s only 0.3%.

But wait! The 6% calculation is also based on erroneous figures. It assumes that a full contract is worth $100,000 and a pip is $10. The value of a full EUR/USD lot priced at 1.4500 is $145,000, for which $1450 would have to be posted as margin at 100:1 leverage. A 3 pip spread value of $30 on that full contract would thus only be about 2%.Going with the lower 20:1 and 10:1 leverages noted above, the more realistic cost for the trader is 0.4% and 0.2% respectively.

Thirdly, the blogger fails to account for the fact that futures have spreads too. I see this happening all the time – people claiming that other markets don’t have spreads, or simply being ignorant of the fact. The usual spread in the e-mini S&Ps is a quarter point, or $12.50. The round-turn commission the blogger mentioned in his post was $6, so when you factor in the spread cost you get $18.50. That’s about 0.4% when the blogger’s $4050 initial margin requirement is applied. Looks pretty comparable to me.

Carrying/Holding Costs
Now back to the subject of the first quote. The blogger is correct that there isn’t a carrying cost for trading stocks (unless you’re doing so on margin, in which case you have interest expenses). There is carry for all the other markets, though.

In options time decay is a cost of carry for those long the option, but a benefit for those who are short. In futures there is a spread between the contract price and the spot market price, which moves to zero as the contract nears delivery. In some cases the spread is positive, while in others it’s negative. Obviously, the forex market has daily roll-over/carry which can either go for or against the trader depending on which way the interest rate spread is going.

In other words, unless you’re a short-term trader, there is a carry involved in all the markets except stocks. To claim otherwise is to be misinformed.

Cost Competition
Keep in mind too that it behooves forex brokers to be price competitive when compared to futures. If not they stand to lose especially their bigger customers (and thus their bigger volume) to the futures market.

The bottom line is that retail forex trading is pretty comparable in terms of its costs to other markets available to individual traders. If you have any doubt about that, do the math for yourself based on your own trading.

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Reader Questions Answered

Stock Trading is Not Zero Sum

I recently got a zero sum question in regards to the stock market.

The one question I cannot seem to find the definitive answer to is this:

Is the Stock Market a “zero sum” entity?

I have done a lot of online research the last week or so trying to answer this question. Unfortunately, there are too many differing views on this subject and I have not yet found confirmation.

I’ve addressed the general zero sum question previously in the post The Zero Sum Game. Let me tackle stocks specifically here, however.

First, a zero some game is one in which there must be an equal loser for each winner. Basically, it’s a matched pair where there can never be any net gain or loss in value in the aggregate because increases in value for one side are offset by decrease in value on the other side.

Think of it like this. Billy and Bobby each have 5 balls for a total of 10. They are in an enclosed space, so no new balls can be introduced and no balls removed. In order for Billy to have 6 balls, one must be taken away from Bobby, who will be left with 4.

In trading terms, zero sum mean that there is a short for every long. The futures market is a perfect example of this. Futures are contracts for an exchange to take place at a later date. There are two sides to each contract – a long and a short. The long benefits from an increase in the value of the contract, and suffers from a decrease. It’s vice versa for the short, on a dollar for dollar basis. What the long gains comes from the losses of the short.

In asset markets, however, there isn’t necessarily a short on the other side of a long position. In fact, in most cases there isn’t. That means generally speaking, someone who owns the stock will be the sole winner or loser should the value of the stock change. No one else is mirroring that performance on the other side. It’s like owning a house. There’s no short on the other side of a home purchase, so the home owner is the only one impacted by changing values in the property.

I have heard some contend that the seller of the stock (or house) is in fact like a short because of the forgone gains or losses. That’s an opportunity cost argument, though, and one which really cannot be pursued in any reasonable fashion for the simple reason that we don’t know what the seller is doing with the funds, nor do we know if the buyer is actually making the best investment with her/his money.

Others might contend that if you only look at “trading” then stocks are zero sum. Again, since there doesn’t have to be a short on the other side of a stock long then it’s not really zero sum. Besides, traders buy stocks from investors and investors buy stocks from traders, so you cannot look at the groups in isolation.

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Trader Resources Trading Tips

Watching Positioning Figures for Biases and Changes

As you may have gathered from some of my prior posts (like
Using COT data to spot potential big moves), I keep an eye on the weekly Commitment of Traders data to see if there have been any big shifts in trader positioning. A big part of that is tracking how  the small speculators are positioned in the mini S&P 500 futures. There it’s about looking to play against the herd when they are strongly positioned. As of last Tuesday they were 68% short the market, which keeps me suspecting that more upside is probably coming in stocks.

I also watch the COT data for currencies to see what the big players are doing. Now, this isn’t the same as seeing positioning data in the spot market, but it does at least hint at things. In particular, it’s worth noting when the are very strongly biased positions on, and when they change. We’ve seen both recently in a couple currencies.

Take a look at the tables on the left. Notice what has happened in the last few weeks with the way the Large Speculators have been positioned and how that’s changed over time. In most cases that means reducing previous large long positions.

For example, in the euro they were about 60% long and now are nearly 60% short. There wasn’t a switch in the pound, but traders have certainly gotten much more short than they were. This is from the dumping of longs, though, not the increase in shorts.

Things get really interesting when looking at the yen. The large players were 83% long just a few weeks ago. Now they are much closer to being neutral, though remain a bit long thanks to a combination of long reductions and short expansions.

Things are even more dramatic in the Swiss franc. There the large players reached almost 90% long about a month ago. Now they are almost right on the flat line thanks to a combination of both a major cut in long and a 3-fold or so increase in shorts.

If you compare these changes in COT positioning data to the price action of the last few weeks you can clearly see how things have been playing out. GBP/USD has traded down from near 1.69. EUR/USD has given up about 800 pips since the early-December highs. USD/JPY is up nearly 600 pips from its lows (meaning yen losses). USD/CHF has risen more than 500 pip from it’s lows (again, swissy losses).

Now, much of the action these last few weeks has put the market more toward a neutral position. The one exception is in the pound, where traders have been getting more short. That is going to be worth watching.

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Reader Questions Answered

VectorVest and Trading Forex in IRAs

Back in action after nearly a week off leading up to my 40th birthday!

It’s nice to see that the markets didn’t really do very much while I was away, which actually makes what I wrote about in my last post, Watching for a Market Explosion or Implosion, even more so. Now I’m stressing about getting my holiday shopping taken care of ASAP (don’t for get the The Trader’s Wish List). 🙁

I got a couple of quick questions while I was on break (along with several happy birthdays). The first was this:

Are you familiar with the market timing and analysis “system” used in/by VectorVest? If so, what are your thoughts about it as a research source?

I personally haven’t ever looked at VectorVest (coincidentally, one of the commercials was just running on CNBC). I encourage any reader of this post to share their views if they are or have used the service, however.

The other quick question was this:

Can you trade currency with a Roth IRA acct?

While you can certainly trade currency ETFs in an Individual Retirement Account (Roth or otherwise), actually trading spot forex, or even futures, is a harder thing because of their highly speculative nature. If you have your IRA account set up with a traditional broker or other financial institution then the answer is very likely to be negative. There are ways, however, to open IRA accounts which are less constrained (can invest in real estate, etc.). I forget the exact term for those accounts (self-directed IRA, or something like that).

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Trader Resources Trading Tips

Using COT data to spot potential big moves

I’ve mentioned the Commitment of Traders data on a few occasions previously in terms of its usefulness for tracking the positions market participants are carrying in the futures market (see Commitment of Traders: A Weekly Report Worth Viewing). The action in the British Pound of late provides a pretty impressive example of how you could have seen ahead of time the prospects for a big reversal were you tracking the COT figures

Take a look at how short the big traders had gotten in BP futures.

BPCOT101909

Notice in particular the Bullish column under Large Speculators. See how as of October 13th that group was 88% short (100%-12%). That’s a massively lopsided market.  When a market is so imbalanced like that it sets up for some real volatility when things start going in the other direction. We’ve seen that this week in GBP/USD.

GBPUSD102209

GBP/USD rallied from about 1.5850 to almost 1.6650 in 7 trading days. That’s nearly 800 pips and a great deal of the action, especial the October 15th rocket ride, was the result of short stops being tripped. Basically, we saw a short squeeze in sterling. Had you been watching how short the big players were getting as per the COT figures you could have at least been alerted to the potential for something like this happening and strategized for it.

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Trading Tips

Fighting the Ignorance of Traders Who Claim They Know

It’s ranting time!

There’s a certain blogger out there who’s only purpose for posting (seemingly) is to sell his trading guide, or whatever he calls it. I’m not even sure why I bother to look at his posts. It must be to occassionally get me pissed me off at his hubris and ignorance enough to turn his foolish blathering into an educational post here.

The latest entry (I’m not going to do him the favor of linking to it and helping his page rank) is full of nonsense like this bit here:

There are certain types of trading instruments that I feel should not be peddled. One is the futures market. I’ve never traded the futures but this is a highly leveraged form of trading and it’s just stupid because 99% of all traders who delve into this arena will fail.

There is no market in which 99% fail, so right there he’s killed his credibility with anyone who knows anything – if he hadn’t already done so by saying he’s never traded futures. Yes, the failure rate is high. But it’s also high for his preferred market, which is individual stocks (and it a whole lot of other activities one could get started in).

Read this and remember it well:

Leverage is not the reason people fail in trading. It just punishes more severely those who fail to manage risk.

After relating the story of a trader who ran a small amount up to a large one and right back down, this blogger even makes my point:

It was lack of risk management and money management that made him $4 million very quickly and also the lack of risk management and money management that caused the demise of his account.

That’s the brightest point he made in his whole post bashing all but his favored market.

After he got done with futures he trashed penny stocks and options (for some reason he starts calling people involved in these “mouth breathers”), claiming he particularly hates the latter because buying them is a big scam. Here’s why:

In order to win, you have to get EVERYTHING right – the timing, the magnitude and the direction. The time decay is always eating at your money every single day. Similar to penny stocks, you cannot put too much of your money into one trade or you risk immediate ruin. Putting 1-2% into each options trade means you will need 50-100 great trades (of 100% gain each trade) to double your initial principle. That’s almost an impossible task!

I’m not going to deny that if you want to make directional plays in options that timing is a critical factor. I would contend, though, that magnitude and direction are something which any straight out stock trader has to get right as well. And it’s absolutely true that you cannot put too much money in any one option, just like you can’t put too much in any one stock. We just had the risk management discussion.

As for needing tons of winners to double your portfolio, apparently someone doesn’t really grasp the upside potential for options. It’s nothing for one to double. If you catch the right moves you could be looking at 5- or 10-baggers, and up. Oh, and not everyone is necessarily out to double their money each year.

So what does this braggart trade?

The best way still is trading mid to large cap stocks. They are alot safer than those trading instruments mentioned above. And you can still make huge gains, like I did last year being mostly on the long side in a terrible bear market.

Anyone who’s followed my writings for any time now will no doubt anticipate what I’m about to say.

Safety is not about what you trade. It’s about how you trade.

and…

There is no best market – only the best market for you.

I don’t know this guy’s methodology, and don’t really care. If it works for him, that’s fine. It might work for others as well. I’m going to guess that some options folks would have ideas for ways they could use take that approach and apply it successfully in that market. I know that for the way I trade stocks, options work very well for providing great risk management and expanding opportunities. Again, that may or may not work for others. I do not, however, make any suggestion that my way of doing things is the only or best way. There are a lot of perfectly workable trading methods, and money can be made in any market, though some are clearly better for some traders than for others for any number of reasons.

I hate it when these types of people claim that their market is the only one that makes sense to trade. It makes me want to slap someone upside the head. I don’t care a whit how good their performance is.