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Reaction to the “worst analysis” post

My post from yesterday, Some of the worst market analysis ever!, generated a bit of a response (I’ve also noted that another blog picked up the post to which I was reacting). While my main focus was on showing readers of this blog the sort of analytic pitfalls one can fall into, I’ll admit that picking a bit of a fight with Zero Hedge was on my mind as well. I didn’t really expect a reaction, as I’ve written about the posts there before without any, but this time someone actually made note of what I said in the comment section of a ZH follow-up post on the same subject. That generated a few reactions there.

Actually, one reaction was left as a comment on my post. It was left by someone who apparently is very shy because he/she left no name and a bogus email address. The comment was

“um you trade them in a ratio, the author assumed you would get this.”

I can perhaps understand the commentor’s reluctance to attach their name to this brilliant bit of insight which has absolutely nothing to do with the problem I have with the analysis in question. It speaks not at all to the whole “risk free” question, nor does it address the viewing of converging lines on a dual-scale chart as representing a spread going to zero.

On the ZH site the author left his own reaction to someone named sumo posting my assertion “There is absolutely no mathematical or other direct linkage between the S&P and EUR/JPY.” At least I think it’s the author. As I understand it, several people actually author on ZH under the same nom de plume (that’s pen name), so it could have been someone else on the staff. In any case, the response was:

“I assume the gentleman has never heard of the carry trade and its implications.”

Hah! We’ll leave out a discussion of the fact that I was in the forex market long before “carry trade” became common parlance and focus on the mechanics.

The assumption implied by the above statement is that all carry trading is done through stocks. It most definitely is not. In fact, the simplest and easiest carry trade is to just borrow the low interest rate currency and invest the proceeds in a debt instrument of the higher interest rate one. The carry trade need not have anything at all to do with stocks. That means, as I indicated, there is no direct linkage between the S&P 500 and EUR/JPY, meaning carry trade related movement in the likes of EUR/JPY need have nothing at all to do with the stock market. It can move independently. The current market environment is such that the risk tolerance of traders/investors creates a common driver of action in the forex and equity markets. Were something to happen like a Bank of Japan rate hike, however, there could be a very serious sell-off in EUR/JPY on yen appreciation which probably would have a very minimal impact on US stocks.

I’m not sure whether this comment by aldousd was directed at me:

“it’s ridiculous to say that it isn’t related. it’s been going on all day. I keep reading people saying that it’s a coincidence… a second by second coincidence.”

In case it is, though, I certainly never said anything about “coincidence”. In fact I noted that the drivers for the comparable moves are similar.

There’s another reaction offered up by BeerGoggles to the first comment posted:

He’s going on about zero prices as well and clearly has never looked at the ATRs of EJ and S&P.

I have no idea what this person is going on about. I definitely didn’t say anything about zero prices. Maybe he’s referring to the author, but aside from talking about a zero spread (which I contend is incorrect) I don’t recall him saying anything about zero prices either. For the record, though, as of June 7 the normalized 14-day ATR (meaning ATR expressed as a % of the 14-day average) was about 2.8% for the ES and a touch under 2.5% for EUR/JPY.

Here’s a comedian:

Does he use charts for his trading, or some secret method of essentials we haven’t yet heard of?

Whitty, but the incorrect application of the charts is exactly the problem I have with the analysis. For the record, I use charts all day, every day.

Here’s someone who gets it:

I’m not a trader or an FX expert, but I do know maths and you guys are missing the point.

What the “non-fan” is saying, is that a graph of two variables NOT on drawn on the same scale, is going to lead the observer to false conclusions about trading opportunities when they see a gap. It’s perfectly possible (and in this case highly likely), that you’d loose money by trading ONLY based on the existence of a large gap.

By all means do all the carry trades you wish, but not based solely on this gap information. You need more information to guarantee an easy trade.

Thank you virgule (commentor’s handle)! In case you were wondering, “non-fan” is me. 🙂

As I said in my post yesterday, it’s not about whether doing this kind of pair trade is the right thing. It’s about not employing faulty analytic methods to get there, and not thinking that this is a zero risk arbitrage trade.

By John

Author of The Essentials of Trading