Monday, September 03, 2012


I want everyone to look at this very closely. This is a standard bell curve and it plots normal distributions of data within measureable ranges. Just basic statistics 101 here for a few minutes. What this graph does is plot distributions of numbers in a fashion that shows that most of the action occurs in a bell shape type of form. This tells us that when we trade, most of the action will be ho hum, in normal type ranges. We see this every day in the see saw action of most markets. Occasionally, we get a really extreme move that takes us out to the edges of this graph. Gold on Friday would be an example of that. There was a really interesting approach to trading this curve that was developed many years ago called Market Profile. What that theory did was print X's when prices traded at certain levels on a left axis, kind of turning this bell curve and rotating it 90 degrees.

The basic theory was then when price traded at an extreme just a time or two then came back into the middle, you were to fade the next move it made to the extreme. Whereas when you were trading in the middle of the Bell, price was very comfortable trading in that range, and you did not need to be in a  hurry to make a trade since the probabilities were it would stay there. This is why I called this post trading on the margin. In this theory you are trading for the most part, at the margin where price rarely went, and likely would not stay there.

I think too many people are trying to craft approaches to trading or to life, trying to pick those magic rare points at the margin. For example trying to pick highs and lows is trading at the margin. When the Gold and Silver markets made there highs earlier this year, I would wager that for every person who shorted those highs and made a killing, there were thousands who got smoked trying to pick them. I do constantly research ideas for doing this type of thing and without any exception, when I find one that seems to work pretty well, the draw downs in it are massive, and beyond the risk level I want to trade with. It is so easy to visually see in the graph above, that what we are doing when we attempt this, is trying to pick the occasions that happen so rarely. We are much better off working with larger data sets, and trying to find ways of maneuvering in the middle of things. The majority of money is made in the middle of moves, not at the beginning or the end of them.

It is a rare person who can buy for example a V bottom, time it just right, then hold that position for months or years. There are those who can do it, but it is really tough to do. Most often you enter a period where you are initially right, then get a big profit, then inevitably, the first test comes along of the low point, and you see your open profit getting eaten away. The mind set becomes you don't want to let this big win become a loss, a mind set I agree with in this case, so then you start messing around with stop loss orders in the wrong places. Often they get picked off just to see the market take off again without you. This has happened to me and also many other traders I know. My solution is either I take the money quicker when I chase trades like that, or I just don't do them in the first place.

I do talk about turning points a lot here, but rarely do I try and catch a high or low tick.

I had a really nice chat on the phone over the weekend with someone new to reading my blog here, who lives in Europe. He is very concerned about the safety of money in banks and brokerage accounts, a concern I share. I am about as sure about something as I can be when I say that more customer thefts of Segregated money are going to happen, and are probably happening now and have not yet been discovered. Here is why I am so sure of this.

If you look at the system as a whole, you see that in the equities firms, co-mingling of funds is legal and goes on every day. The firms are allowed to use your money. I think some people do not realize this. That is why the segregation requirement in futures was supposed to make them more safe. However, there is one big reason why this does not make it so. FCM's are responsible for making sure margin calls are met with individual accounts. We know there are so many people that do dumb things with money, and the commodities industry has more than it's share. They take insane leverage and risk, and blow up their accounts. In the instances where they can not meet a margin call, the FCM has to make up the difference, with their own money. As a result, there already is some FCM money in the Segregated accounts, and they adjust that amount over time. In other words they are already taking money out or putting money into the Seg account right now as a common practice.

The most shocking part about this to me is the clause that states that in a circumstance where someone blows up and the FCM cannot cover the loss, that loss is shared equally amongst all the other segregated account holders who had nothing to do with it. As a result you can see that even as things stand right now, and an FCM is behaving them selves with regard to segregated money, there still is risk for us. If they happen to let some rogue operator do a trade that should not be done, we could all get clobbered. When you see these huge moves in markets like the Grains, this is where something like this could happen. I think there is only one example in history of this happening, and I  think the damage per account was very small, but that risk is there. When you couple that with knowing that already funds are co-mingled on some level as I just described, you get a different picture than what many people think is a very safe place for money. There are some real issues that need to be addressed in this industry. I am fairly sure the regulators will do nothing about this other than BS us and run the clock for a couple of years until another PFG happens. One will happen.

What we can do is be more diligent. Generally speaking companies that are doing fine do not collapse overnight. Study the ratings services where your money is and make sure the company is not in any financial difficulty. I took my money out of Knight the second that story hit about them. My wire request hit their office within 15 minutes of reading the story on the web. I recently took my money out of Tradestation and moved it to TDAmeritrade. I did that based on a very low financial rating from Rapid Ratings on their parent company. For all I know they will be fine, but the rating on them was lower than PFG's was when they went down, and about where MF Globals was. TDAmeritrade has a pretty good rating in these same services as does Straits Financial, where I have my other account. If these ratings drop, I will move the money instantly. Had I been doing this with PFG I would have saved myself. I am having some learning curve issues with TOS platform, but I like the safety so I am trying to get comfortable with it. I think the Platform is good, but it is so different from what I am used to.

The other thing you can do is try and stay clear of places where large firms or hedgers have their accounts. It is those places where the risk of one large loss that trickles down via a Obama share the wealth skit comes into play. You can find this out by asking IB's if the FCM's they are using have large hedgers there, these guys know that answer. We are trading at the margin if we have our money at places that either have bad ratings or large hedgers trading there. 

If you have a bigger fear of widespread financial collapse, that is another matter. However, it is the ultimate at the margin thought. I do agree this fear is based on some reality, but I cannot live my life in fear of something like this. I have a fair amount of cash stashed in a place nobody knows about, and I have four 180 lb dogs and a bunch of guns and martial arts abilities, to defend against someone trying to take it away. That is enough for me to feel like I have some back stop. I live my life now without any fear of that. The one thing I always try and do when these extreme scenarios get put forth by very bright people with sound reasoning, is to try and visualize what would happen if the predictions they are making prove correct.

If we have massive bank failures and runaway hyperinflation, here is what the doomsayers are missing. This would result in some percentage lets say 20% of the world's population dying. Why? If the governments are all insolvent, the states and banks are as well, how would anyone be able to eat? People would starve to death, or kill each other trying to survive. This is just not a scenario that I can visualize in my mind as having any chance of happening. As a result, I just do not worry about it or pay attention to those who are predicting it. They have a good front end marketing story, but the whole scenario to me just falls apart. Also, who would want gold in that situation? People would want food and water.

In the midst of all this blind fear, there is a very simple solution to all of this. Let those who have bad businesses fail. If this is a bank, a government, a country, so be it. Watching Germany get into trouble now because they have to bail out all of the bankrupt on paper countries in the EU is just stupid. If I were them I would say no yesterday to any more money going out the door. If Spain and Greece are insolvent, let them go bankrupt. There are good and bad cycles in life, we are in a bad one now, there is a good one around the corner again even though it may not seem like it. It never does at the depth of down cycles.

In summary today, don't trade at the margin and don't trust brokerages at the margin. Times are tough now but they will not be this way forever. Take it upon yourself to look responsibly after your money and take the steps I recommended above to do so. Once you have done this, focus on trading and making money and tune out the noise. I am flat right now and don't see any trades at the moment for Tuesday.

WEB SITE UPDATE: I am working on the web site and I am close to the content aspect of it being done. However, having to register the new business and all that stuff takes a little time. If you wish to subscribe to the Bond Service and are waiting for Pay Pal, you can send money to me in Pay Pal now. I have someone who already has done that. I know there a few people who have been waiting for this option and it is available now. I will have it directly in the site once it goes up but that could be a couple of weeks the way it looks now. Pay Pal won't let me have a link to a business account without seeing business license stuff etc, and when I do it as an individual, they won't allow a link in a web site to me.


Enrico said...

It would be the time now to sell a good strangle over the "world".. Just to trade it on margin!

Michael Tredr said...

i want to say alot more but i'll keep it short. this is a great explanation per livermore's saying about "the highest and the lowest 1/8ths being the most expensive" hope the week is going well for you so far chris!

Anonymous said...

Hi, I have a large account at TradeStation and would really appreciate reading the Rapid Ratings report you reference in this post. Would you either share it with me or let me know how you obtained it? If you prefer to communicate offline, my email address is j.elfenbein@yahoo.com.

Many thanks,
Jason Elfenbein

Chris Johnston said...

go the the CCC website, you can get free access to rapid ratings for a period of time there that is where I saw the report. Just scroll through the recent posts or do a search. It was intended for the victims of MF and PFG but I think you can get a look at it. I did not save a copy. The parent company is Monex out of I think Japan, and the low rating was on them not the TS subsidiary. I am just not taking any chances of any kind ever again, so I may have been over cautious. I had accounts at TS for a very long time with no problems except a few bad fills.

Anonymous said...

Thanks, Chris. I just requested the report through the RapidRatings, hopefully they'll send it along tomorrow. Yes, the parent is Monex. I was annoyed when TS was taken private, because my access to public information on the firm's performance was eliminated. I'd really prefer not to switch.


Chris Johnston said...

Switching is a pain I have done it twice now away from Knight and away from TS. Ultimately it is a judgement call on our part as individuals. It really is impossible for us to detect fraud when even employees who work at these places can't.

The problem I see with TS is that it appears to me they are holding the seg money and it is not at the FCM. They do some clearing and also use RJO. Usually this dual situation means they are holding the money. They certainly seem to be very strict about things which should be good, but the parent company being non US bothered me in terms of recourse should anything go wrong. I have no reason on the surface to suspect anything is going on there at all, but I have a quick trigger finger now due to PFG.