Tuesday, April 20, 2010

Macro Economic Top Down Approach

This is the last of the trading/investing styles I am going to cover in my review series. First, a couple of notes.

1) Anyone who read the few comments by one poster about Arbitrage needs to be aware that he/she is a complete fraud. I did some searching on the internet and discovered that this person if they even exist, just cuts and pastes that same little excerpt everywhere they go. There is never anything more or anything less, just those exact words. Just be careful when you run into claims like what was represented there. I will be blocking all future attempts by this jerkoff to get things in here. Always trust but verify, but also do not automatically trust. Anyone representing there is no risk in any investment strategy is just simply lying. This person has developed no such thing and is trying to scam money out of people. Also, arbitrage strategies do not make those kinds of returns.

2) I entered and exited 4 shorts yesterday in individual stocks shown below. One actually entered Friday ( AIZ ). I decided that even though patterns in these stocks were there for shorts, there was not one for the indexes as a whole, and it was just not quite time to be short. Two of those trades won and two lost, and I came out about 1k ahead net. You can see the 2 losses were exited very close to where I entered them. This is not bad considering I was against one of the great up trends we have seen in recent years. I do think we are close to a sell signal in the indexes, and it could happen this week. If that develops I will load the boat with individual stocks as well. Patience Grasshopper.

You will see the great exit I had in JWN, this was actually a gut call, something I do not do very often. I got short early yesterday and this stock just fell out of bed, a very large move for a stock like this one. When I looked at how large the range of the bar was and the fact that the indexes were stabilizing, I reasoned that I should take the money. Obviously, as you can see that was a great decision.

I did also in the spirit of the great ole' american rally, go long one stock yesterday which I have held, ABT.

I do not have any futures trades on at the moment, but do have buy orders in for Natural Gas above where we are currently trading.


This is probably the single most difficult way to trade/invest, and make consistent money. With this approach, you develop a big picture economic view of what you think will happen, then try and position your money in accordance with what you think the financial market ramifications of your economic theories will be. A prime example would be the Elliott Wavers. They have been spreading the doom and gloom view as we have moved up 1100 points in the Dow average. Since their structure has told them financial armageddon is coming, they are positioning themselves on the short side of basically everything. They are currently being clobberred but hold things very long term, so it could eventually work out for them. They sit on huge drawdowns often.

They may well be right, I have no idea. The trick though with these approaches is both one of having to be right about the big picture, right about how that big picture will move markets, and right about the timing of such moves. This basically requires a hat trick to do well. An example of where people have done this and it has paid off, is in the metals markets several years ago. I know several people that got very bearish on everything and concluded that would result in a rise in GOLD prices. They then positioned themselves accrodingly, and did very well.

This was no small feat. History would have shown that this macro-economic view has not typically resulted in rising gold prices, this was an exception and not the norm. In this case they developed a big picture view that was actually historically incorrect, but correct by the way it played out. This accurate analysis paid big dividends. Had I been investing that way I would have lost money because I study history, and never bet on the once in a lifetime scenario coming true. I always bet on the odds on favorites, so I would likely be a losing trader in this approach. This leads me to the main challenge with this approach.

You can be right about your view, no small task. You could also use correct historical market movements in reactions to prior such conditions. Next you could lose all of your money. Look at the people that are bearish on stocks and have been for months. Some of these people have taken tremendous losses. They probably have the macro view right, yet what they have wrong is that there is not the relationship between short term stocks prices, and big picture economics that they have factored into their model. They have part of the equation right and part wrong. There are so many moving parts in this type of approach that if any one of them goes wrong, you lose money and potentially quite a bit.

You can do everything right, and then have the outlier event happen that kills you. In the GOLD example, the outlier event was what they bet on and it came in, a home run. Like putting all your money on one number in a roulette wheel. Longshots do happen at times, but it is not the way you want to bet over a large sample size. Life is full of random activity, and the older I get the more I think there is.

This is an approach that also requires tremendous patience as well as confidence that you "have it right." It will often take quite awhile for all these things to come in line for you to find out if you are right or wrong. You have opportunity cost that your money is tied up for a very long time, you better be right or you have foregone alot of other possible things you could have done to make money.

Some people do this well, it is not for me.


jg said...

This third approach is the one that I used to make my money over '05-'08. I came to the conclusion that we were moving into a depression, as household debt-to-GDP levels were way above what they were in '29 (and the behavioral analogs between then and now -- which I gleaned from reading 'Only Yesterday' and 'Since Yesterday' were shocking). Over the '29-'33 depression, there were two approaches that made money: long gold mining stocks and short the broad market.

So, that is what I did: I was long gold mining stocks (via UNWPX and VGPMX) over '05-'06, then moved to shorting the S&P 500 over '07-'08 (via shorting SSO). Over the four year period, I quadrupled my money.

Yes, I had some ugly drawdowns -- 20-25% -- but through ongoing analysis, I remained supremely confident of my read of the economy and where it, and the stock market, was headed.

My long-term money, once again, is invested using this third approach: 2/3 gold and 1/3 silver bullion. I feel comfortable that there will be a return to gold and silver-backed currencies, and I want to own gold and silver (held in a private bank in Switzerland; the Swiss stood up to Nazi attempts at forced repatriation, and I feel comfortable that they will stand up to U.S. attempts at forced repatriation) when central governments come hat in hand to buy.

Trying to make money in the short-term with my short-term timing/trading portfolio has been much, much harder for me (I essentially failed, losing 80% of my short-term portfolio last year). Standing fast, confident in my read of the economy, waiting for the market to catch up, served me poorly when trying to make short-term money.

So, that is why I read your blog, Chris, to attempt to learn risk management and entry/exit timing. I am slowly learning, and thank you for your generous instruction.

Chris Johnston said...

Good analysis on your part. The error I would have made had that been my approach would have been looking back at times of stock market strife, metals have not always risen. They have at times fallen sharply. As a result lacking that consistent relationship, I would have not made that play.

I congratulate you for having connected the dots correctly. I think the metals will fall sharply if stocks fall again, but again there is no consistent relationship over time between stocks and metals, so I will not base any long term decisions on it.

Like I said at the end. Some people can do it well.