There is now a vicious circle where a weakening US economy is making the financial markets’ crunch more severe and where the worsening financial markets and tightening of credit conditions will further weaken the economy via further falls of residential investment and further slowdowns of private consumption and of capital spending by the corporate sector.

A housing recession alone cannot lead to an economy-wide recession as housing is only 5% of GDP. But now the housing slump is spreading to other parts of the economy: the auto sector is in a recession; the manufacturing sector is sharply slowing down; demand for housing related durable goods (furniture, home appliances) is falling. Moreover, US private consumption – that represents over 70% of aggregate demand – is now under pressure. The US consumer is now saving-less, debt-burdened and buffeted by many negative forces. As long as home prices were rising it made sense for US households to use their homes as their ATM machines, borrow against their rising home equity and spend more than their income (negative savings). But now that home prices are falling there is the beginning of a retrenchment of consumption whose growth rate slowed down from a 4% average until the first quarter of 2007 to a weak 1.3% in the second quarter, even before the summer financial market turmoil.

There are now many negative factors squeezing US consumers and forcing them to retrench spending: falling home values leading to a negative wealth effect; sharply falling home equity withdrawal preventing households from overspending; a credit crunch in mortgages and consumer debt markets rising debt servicing costs for consumers; still high oil and gasoline prices; the beginning of a serious weakening of the labor market – as signaled by today’s employment report and other data - that will significantly reduce income generation in the months ahead. As long as income generation and job generation was robust, one could dismiss the risks of a hard landing; but the signal from today’s employment report is that the only force that was preventing a hard landing (jobs and income generation) is now starting to falter.

Thus, in the next few months you can expect a further slowdown of consumption growth from its already mediocre growth rate of 1.3% in the second quarter. Indeed, after an ok July, retail sales were weak in August: based on the Redbook Johnson and the UBS Securities/ICSC data same store retail sales in August actually fell relative to July; and in real terms such retail sales in August were lower than in August 2006. Thus, the deceleration in consumption in Q3 is already clear in the data.

It turns out that a the retail data came with a big fat *asterisk, which (as happens all too often) presented a very misleading view of the data.

Why? Well, we track these numbers so as to have a good read on the strength of the consumer, and how sustainable their present spending pattens are. Given that the US consumer is 70% of the economy, their actions are quite significant.

That's what makes today's asterisks so significant: Much of the volume gains came via one offs, unusual factors, and huge discounting, with retailers sacrificing margin in exchange for volume:

What other asterisks are out there for retailers?

* Florida and Texas pushed back the start of their school openings by several weeks this year, inflating the August sales of teenage-oriented retailers (Abercrombie & Fitch, Aeropostale)

* Tax-free shopping days — formerly a single day or week, have been extended through much of August. Abercrombie (ANF) admitted that without the delay of tax-free shopping days in Florida and Texas, its sales would have risen just 1% rather than 5%.

* The International Council of Shopping Centers (ICSC) noted that August 2007 saw a 2.9% increase -- relatively weak compared with August 2006's 3.8% sales gains.

* Marketwatch reported that "the hottest August weather in 113 years also sent shoppers buying air conditioners and other hot-weather items as retailers cleared out their summer merchandise in a transition to fall goods, said weather consulting firm Weather Trends International

* Retail slumming is in full effect: Discounters, rather than full-price chains, reported the strongest performance in August '07. At stores open at least one year, sales rose 6.1% at Target (TGT) and 3.1% at Wal-Mart (WMT).

* Gasoline prices below $3 a gallon made consumers feel more comfortable about shopping. However, since then, Oil has ticked back up towards its highs, with gasoline prices sure to follow

* The NYT reported that Wal-Mart said "Consumers flocked to its stores for bedding, apparel and towels, categories that the chain had struggled with for much of the year." Why the sudden reversal of fortune? Big discounts.

* Who else was the big winner? Luxury chains. Sales rose 6.6% at Nordstrom and 18.2% at Saks.

* Whose struggling? Full priced department stores. Sales fell 4% at J. C. Penney, 5% at Dillard’s and 0.6% at Kohl’s.

The question on everyone's mind is, when will the market hit bottom? Analysts who dissect market movements have many theories about how to pick the bottom. One that has been effective is to look for days of exceptionally heavy selling, followed by days of exceptionally heavy buying. The logic: When stocks are approaching the end of a decline, investors tend to be in a panic, and their sell orders dominate trading. Then, once the selling runs its course, bullish investors step in with heavy buy orders that dominate trading and, in turn, signal the beginning of a rally.

Lately, that combination of heavy selling followed by heavy buying is exactly what the market has seen -- on steroids.

"We have been getting these days at the rate of one every 3½ days, and that's just crazy," says Paul Desmond, president of research service Lowry's Reports in North Palm Beach, Fla., who has done extensive research on the subject. "We don't have anything like that anywhere in our history" of data, going back to 1933, he says.

Heavy volatility can excite investors when markets are rising, but it is scary when markets are disturbed, as they have been lately. The trick is to figure out when the down volatility is running its course, and that is what seems to be getting harder to do.

To identify one-way days, Mr. Desmond looks at total trading volume for all stocks that finished up and for all stocks that finished down. He also looks at the total price moves, in dollars, for those two groups. The days to watch are those on which 90% of volume was in the same direction, and 90% of price moves were as well.

On the Friday before the 1987 crash, 90% of volume and 90% of price movement were accounted for by declining stocks, according to Mr. Desmond's data. On Monday, Oct. 19, 1987, the crash day, trading was even more heavily centered on decliners. But that was the low point of the selling. On Oct. 21, 90% of stock volume and price movement was up, indicating the worst was over.

Similar days occurred at the bottom of the 1990 bear market. There was only one such day at the 2002 bottom, but several such days hit a few months later, in 2003, when the U.S. invaded Iraq and stocks fell almost to the 2002 low. After that 2003 decline, stocks entered the bull market that has continued until now.

The article has a great chart showing the phenomena

Leverage is a wonderful thing when spreads are moving in your direction. It's now payback time for those who borrowed short and lent long. Short term borrowing costs are rising while the value of long term assets, especially mortgage debt is sinking.

See Duration Mismatch to Bankruptcy (in one week flat) for the saga that caused Sentinel to go bankrupt in short order once their mismatch mattered.

The issue is not whether it's absurd for Lehman or Bear Stearns debt to be trading at a discount to Columbia, the issue is how much leverage Lehman (LEH), Bear Stearns (BSC), Merril Lynch (MER), Goldman Sach (GS), Citigroup (C), Morgan Stanley (MS) are using as well as the timing and size of needed debt rollovers.

It was a huge mistake for corporations to assume they could perpetually roll over short term debt at good prices. If you stop and think about it, many homeowners over leveraged in homes have a similar mismatch problem. Incomes have not risen as expected but short term financing costs have gone through the roof with no way to roll over the debt.

http://www.reuters.com/article/bankingfinancial-SP/idUSN1030940720070910

Washington Mutual Inc said on Monday that most U.S. housing markets are weakening, creating a "near perfect storm" that may force the largest U.S. savings and loan to set aside more money for bad loans.

Chief Executive Kerry Killinger said the thrift may set aside $500 million more for loan losses than the $1.5 billion to $1.7 billion it had forecast in July. Any increase would be Washington Mutual's fourth this year.

Speaking at a Lehman Brothers Inc financial services conference, Killinger said the housing market faces rising delinquencies and foreclosures, higher borrowing costs, tighter underwriting standards and tough capital markets, "creating what we call a near-perfect storm for housing.

"Most housing markets appear to be weakening, to us," Killinger said. "We would not be surprised to see declines in housing prices in many regions of the country ... for the next few quarters." He said corrections in the housing and credit markets will last longer than the thrift expected.

6. The next shoe to drop? LBO financing. Remember investment banks hold more than $400 Billion worth of loans that they guaranteed to private equity shops. The stuff is not moving and today comes news that KKR which has been playing hardball with Wall Street up to now, finally blinked.

The truce private-equity giant Kolhberg Kravis Roberts & Co. has reached with its bankers on the financing of First Data Corp. could provide the model for other deals coming to market over the next few weeks.

KKR, known for vowing to hold the line against banks seeking better terms, agreed to make several concessions to bankers, according to people familiar with the matter. But the firm changed the terms largely at the margins. That assured that market attention will remain focused on the $26.4 billion First Data leveraged buyout as the first and most important in a string of coming deals valued at about $400 billion.

First Data "is the canary in the coal mine. If it gets done, then another $350 billion is doable," says the co-head of private equity at one major Wall Street firm. "But if not, then the whole market may plunge, and the rest of the capital markets will react badly."

Sunday night, KKR reached an agreement with its bankers to introduce one covenant, or performance standard, on First Data debt, said the people familiar with the matter. Under the covenant, First Data, a processor of electronic payments, must maintain a certain ratio of earnings before interest payments, depreciation, tax and amortization to its amount of senior debt, these people said. The covenant somewhat reduces risk for investors who buy the debt, though people familiar with the matter say the ratio is modest.

Still, KKR declined to agree to increase fees to the banks to enable them to cut their losses on financing the $24 billion in debt. And more importantly for investors, KKR declined to agree to an increased interest rate on the loans. The concessions were sufficiently toothless, said one banker, to describe them as offering the banks "sleeves on the vest."

Reclusive billionaire Joseph C. Lewis, who made his fortune trading currencies, has taken a 7 percent stake in Bear Stearns Cos Inc (BSC.N: Quote, Profile , Research), snapping up the investment bank's sagging stock to become one of its largest shareholders in less than a month.

Bear Stearns' shares were up 1.5 percent at $107 in early trading on the New York Stock Exchange. Lewis was not available for comment.

Lewis disclosed the stake on Monday in a filing with the U.S. Securities and Exchange Commission. His stock purchases - between August 6 and September 4 -- make him one of Bear Stearns' biggest shareholders, if not the largest.

Lewis owns 8.1 million shares of Bear Stearns, according to the SEC filing. That's more than what any other shareholder reported at the end of June. At that time, Putnam Investment Management was Bear's largest institutional shareholder with 7.03 million, or 6 percent, of Bear's outstanding shares.

Bear Stearns Chairman and Chief Executive Jimmy Cayne owns about 5.8 percent of the company's stock, including restricted stock and incentive-related shares, according to the company's latest proxy statement.

The company was not available for comment.

Bear Stearns' shares are down about 35 percent this year, hammered by the collapse of two hedge funds and its heavy reliance on mortgage-related revenue amid a meltdown in the subprime lending industry.

Born in London, Lewis operates from the Bahamas and Florida. His investments include English Premier League soccer club Tottenham Hotspur, golf course developments in Florida, Alcatraz Brewing Co. and life sciences companies. His investment vehicle, Tavistock Group, holds interests in more than 170 companies in 15 countries.

A New York Times profile of Lewis in 1998 said he was born in 1937 in London's rough-and-tumble East End, the son of a pub owner. The newspaper said he dropped out of school when he was 15, but built his fortune on theme restaurants, currency trading and real estate speculation.

Lewis-controlled entities named Aquarian, Cambria, Darcin, Mandarin and Nivon bought large blocks of Bear Stearns shares in August and September, the SEC filing shows. The last reported purchase was a block of 400,000 shares on September 4.

Treasury investors basking in the biggest rally in four years have reason to fear for their profits: The largest owners of U.S. government debt are heading for the exit.

Two-year Treasuries returned 1.09 percent in August, the best monthly performance since 2003, according to indexes compiled by Merrill Lynch & Co. At the same time, holdings of U.S. bonds by governments and central banks at the Federal Reserve fell 3.8 percent, the steepest decline since 1992.

The dollar's slump to a 15-year low against six of its most actively traded peers is turning the gains into losses for international bondholders, prompting China, Japan and Taiwan to sell. Overseas investors own more than half of the $4.4 trillion in marketable U.S. government debt outstanding, up from a third in 2001, according to data compiled by the Treasury Department.

``The support that Asia has shown in buying U.S. Treasuries has been a major supporter of keeping long-term interest rates lower than where they probably would be,'' said Gary Pollack, who oversees $12 billion as head of fixed-income trading in New York at the private wealth management unit of Deutsche Bank AG, Germany's biggest bank. ``This could put some upward pressure on yields in the United States.''

U.S. long-term interest rates would be about 90 basis points, or 0.90 percentage point, higher without foreign government and central bank buyers, according to a 2006 study for the Fed by Professors Francis and Veronica Warnock at the University of Virginia in Charlottesville.

9. But Brad Setser thinks that is much ado about nothing, arguing that China basically shifted from Treasuries to Agencies.

Over the course of 2007, three things have been happening.

First, some central banks with large existing holdings of Treasuries have been slowly reducing their Treasury holdings – whether by selling into the market or by not rolling over maturing bonds – and adding to their Agency holdings (and perhaps otherwise diversifying as well). Korea and Japan are the obvious examples. If nothing else was going on, that would tend to lower Treasury holdings.

Second, those central banks that are adding to their reserves rapidly have been buying more Agencies and fewer Treasuries – China is the most obvious example (Russia is, strangely enough, buying more Treasuries than in the past … but that isn’t saying much, since it previously held an “all Agency” portfolio)

And third, the overall pace of global reserve growth picked up sharply. In the first two quarters of the year, I suspect it will be about $300b a quarter – a $1.2 trillion pace – though that estimate hinges on the q2 IMF data and some expected revisions to the q1 data.

The result – central banks were buying a lot more of everything, including Treasuries. So their Treasury holdings were going up, just not as fast as their holdings of other assets. In some parts of the Treasury market, there actually aren’t many outstanding bonds left for the central banks to buy.

August though was a bit different. Global reserve growth slowed, particularly in places where global reserve growth reflected large capital inflows. International investors took profits and took money off the table. Money even flowed out of a few markets – Russia most notably.

Absent those inflows, the trend move out of Treasuries and into Agencies looked a bit more prominent. And I suspect that central banks needing liquidity sold their most liquid asset – Treasuries. That is a good thing. Right now the private market wants Treasuries.

But the fall in the Fed’s custodial holdings exceeds Russia’s need for liquidity – and even if you add in a few other countries, my guess is that the fall is a bit bigger than can easily be explained by a slowdown in global reserve growth.

So a few central banks that previously held long-term Treasuries sold – and either bought Agencies or moved into bank deposits.

That could include Japan and Korea. This would be a great time for both to accelerate their long-standing plan to diversify away from Treasuries.

And it also might include various European central banks. Remember, a lot of European banks right now have an enormous need for dollar liquidity (all their conduits) ….

I hadn’t thought of the European angle, but Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co in New York, did. Reuters:

"half of the decrease (in Treasury holdings) relates to the purchases of agency securities. The rest of it may be that central banks are looking to hold dollars, rather than investments because there has been a shortage of dollars in the European banking system."

It makes sense to me.

This is a case where the easy conclusion (central bank Treasury holdings are falling, China must be selling) is not likely to be the right conclusion.

I have long argued that there is a risk that central banks are a potential source of financial instability should they stop adding to their dollar holdings at points in time when the market doesn’t want dollars. That still strikes me as a risk – though not a high probability one. There are a set of countries that hold far more dollars than makes economic or financial sense, and at some point they might decide that they don't want to continue to buy even more.

But all indications suggest that emerging market central bank have been a stabilizing, not a destabilizing, force in the markets over the past month.

10. Finally best trade in Great Depression? Gold. Check out the rise of Homestake Mining while everything else was liquidated for pennies.

http://www.gold-eagle.com/editorials/great_crash.html

posted by BKTrader  # 9/11/2007 02:38:00 AM 0 comments

The Prettiest Girl on the Floor

If markets are always right how come they are always changing?

Ben Stein

Ben Stein’s snarky observation in this Sunday’s New York Times, put a smile on my face and got me thinking about John Maynard Keynes. I’ve written about Keynes before noting that while he is recognized as the most influential economist of the 20^th century, few people realize that he was also one the greatest traders of all time. Unlike most pointy headed academicians, Keynes understood that markets - and for that matter all business activity - were controlled more by emotion rather than reason.

Rather than trying to construct complex mathematical solutions, Keynes produced a psychological model to explain the dynamics of the market. It is quite bittersweet to see the accuracy of his approach in light of the fact that so many “brilliant” quantitative hedge funds chuck full of “the smartest people on earth” relying on some of the most complex financial algorithms ever created, experienced double digit losses this month. One of the more famous of those funds, Goldman Sachs’ Alpha fund is located in the same building on Wall Street as our company and as I came in to work this week, looking at the signatures of Goldman traders on the building’s sign-in ledger I often wondered what they must be thinking now.

Perhaps they would have been better off reading a bit of Keynes who had a decidedly non-academic view on how the markets worked. Keynes likened the markets to a beauty contest. It was the traders job to find and identify the contestant that the majority of the audience would find the most beautiful. Setting the anachronistic sexism of the metaphor aside, let’s focus on what Keynes actually meant by this idea. Note that Keynes specifically emphasized that the trader should not judge contestants by the trader’s personal standards of beauty, but rather try to figure out how the crowd would make its choice. This was Keynes’ great insight into trading, teaching us that our view does not matter. Only the market’s opinion matters. As speculators it is our job to figure out how the majority will feel on any given day and then construct a trade based upon that hypothesis.

In the currency market, there was only one question to answer this week. Risk or no risk? Depending on how well you handicapped that question on any given day resulted in whether you won or lost. It was almost immaterial what currency pair you chose to trade. During moments of risk aversion yen rose and all other majors declined against the dollar and during periods of risk assumption the reverse dynamic ruled true. Fortunately we were correct in our assessment two out of three times catching EURCHF for 57 points and EURUSD for 52 points.

Indeed reduced to their Keynesian terms, the markets are actually quite easy to comprehend. “Understand the story, understand the trade,” is the catchy little phrase we often use in our trading seminars, It is, of course easier said than done. Stories can turn on a dime as unexpected news changes the crowd’s opinion. Still as traders this approach offers us the best chance for success. It also helps us to properly deal with losing trades. Instead of viewing those trades as some signs of our personal inadequacy we should accept them for what they really are – occasional mistakes in our ability to gauge crowd behavior. Looked from that perspective stops are then not some sort of moral transgressions but rather proper expressions of mature decisions making. After all, the key to being a well developed, grown up individual is our ability to accept mistakes graciously. Is there anything more pathetic and infantile than an adult man or woman who refuse to see the error of their ways throwing an emotional temper tantrum in the process?

If nothing else, Keynes “beauty pageant” model teaches us to not take the markets too seriously which in turn provides us the proper distance to make mature, adult like decisions with respect to each trade.

Have a great weekend.

We’ll be back next week with more trade ideas.

B & K

posted by BKTrader  # 8/26/2007 05:24:00 AM 0 comments

Direction and Amplitude

Novice traders often think that finding proper direction is the most difficult aspect of trading. No doubt getting direction right is a challenge, but with experience that task can be mastered. After some time in the markets many traders can accurately forecast direction as much 60% to 70% of the time. However in order to succeed, a trader must no only predict direction but also the amplitude of the move. Put simply we need to accurately forecast not only if the instrument will go up or down but by how much it will do so. And amplitude can be maddeningly hard to estimate. Every time we see a moving average crossover, a Ballinger band breakout or an event risk reaction we can never be sure if the move will last for 10 pips or for 100.

This week was a good case in point. We had two long term trades that initially moved our way but ultimately reversed and hit the stops. Our short EURGBP stayed very quiet while the rest of the market was caught in a whirlwind of activity. The trade even slowly moved 10 pips our way as our forecast of stronger UK Retail Sales and therefore more bullish cable posture proved accurate. Bu the move was short lived. The market this week wasn’t paying attention to economic news – it was strictly trading off risk aversion theme as carry trades were liquidated wholesale. The EURGBP got caught in the cross fire of volatility as the 1000 point declines in GBPJPY ultimately pushed the pound lower.

In the GBPUSD trade we had a different dynamic but similar results. We bet on the fact that after Thursday’s massive sell off the high yielders would be due for a bounce. Going long GBPUSD into the Asian open we were right from the start and the trade moved 40 points our way. But when the Nikkei opened for Friday trade, panicked Japanese investors sold stocks at a frantic pace pushing the index –800 points. The pressure was just too much for the currency market and the pound buckled hitting our stop and falling for another 100 points lower before finding some support.

Some of you took us to task for letting a winner turn into a loser and rightly so. Generally we trade with two units so that when 1 unit moves into profit we take a small profit and move the rest of the position to break even. This, in fact, is the only practical solution to the direction/amplitude problem. Since you never know whether the move is good for 10 or 100 points you take some money off the table and look to ride the second unit to a much larger profit. However, we decided that using two units on our long term trades exposes subs to too much risk. A typical 100 point stop could generate a 200 point loss on two units of trade. Therefore we prefer using only one unit. The trade off for assuming less risk is that we will sometimes miss banking small profits. Of course some of you chose to use 2 units even on long term trade recommendations and wrote to us that you’ve been able to bank profits that way. You are more than welcome to do so. In fact the most successful BK subs are those that use our ideas but adapt them to their own trading style. For our part we will try to manage these trades tighter and will trail our stops to or near breakeven once they move in the money in order to minimize risk.

Overall the market continues to be dominated by themes rather than event risk and therefore we will maintain more of our focus on longer term trades rather than news ideas. We expect volatility to continue for at least another week as investors try to assess the magnitude of last weeks damage, We also have Category 5 hurricane Dean barreling into the Gulf of Mexico which may wreck havoc with oil markets and impact financial markets as well. All in all it promises to be another exciting week in the markets and we will be back to you with fresh trading ideas.

posted by BKTrader  # 8/18/2007 10:53:00 AM 0 comments

Variation on the Theme Part II

This week we introduced our first long term trade and were able to bank 31 points out of the USDCAD short. At one point we had a 60 point profit and were hoping to milk it for more but the release of Ivey PMI which printed much weaker than expected forced us to change plans and cover sooner which proved prudent as the pair traded higher for the rest of the day. Overall, we’ve received overwhelmingly positive responses from subscribers on the long term ideas. They clearly allow for a more leisurely approach to trade entry and management and we will definitely continue to produce more of them as part of our repertoire as BKForexAdvisor.

On the short term trade front, we saw lots of heat, but little light this week as some of our better trade ideas were negated by offsetting news factors. For example we were dead right in calling for weaker Japanese Overall Household spending, but the trade was sabotaged by better labor figures that came out at the same time. Similarly US ISM Manufacturing was weaker just as we forecast, but US Pending Homes Sales (a notoriously manipulated figure by the NAHB) printed far better than expectations and took the string out of the dollar bearish ISM news. Alas, these are the vagaries of the market. These certainly weren’t the first obstacles to trading event risk, nor will they be the last, but as you saw we stayed very disciplined in our approach keeping our drawdown on the short term trades to a very manageable –40 points in what were very challenging conditions. One positive trade should erase most of those losses and two will put us square in the black. This is the essence of our trade approach – which is to keep our losses very contained so that they may be made up with only one or two good trades.

This week, I wanted to continue our discussion of various ways to trade event risk by sharing with you an exert from an article I wrote for the upcoming November issue of SFO magazine (www.sfomag.com). It deals with variety of approaches to trading event risk and I share it with you in the spirit of offering you some alternative methods to trading the news. Note that we do not follow this particular methodology with BKForexadvisor because collectively the logistics of pre- and post positioning are just too difficult to accomplish due to fast markets, but on an individual basis this may be an interesting idea to consider.

“If proactive trading is too volatile and reactive trading is too limited is there a better way to trade event risk? There is. The solution is really a fusion of the two techniques along with an assist from Jesse Livermore. Jesse Livermore, one of the greatest speculators of all time was well known for his probative approach to trading. Instead of committing to a position all at once Livermore would test out the waters by sending small orders into the market to see if his directional analysis was proven right. If the initial trade made money he would add to the position trying to pyramid his gains.

By adding to winners rather than adding to losers, the Livermore approach stands in stark contrast with the typical way most traders trade. Scaling up rather than scaling down into position is clearly the better money management technique as it minimizes losses while amplifying gains. However, the Livermore methodology is extremely difficult to implement because it requires the trader to forsake near term profits for the potential of much larger albeit more infrequent long term gains. There is perhaps nothing more frustrating to the average retail trader than watching profits turn into losses which happens quite often under the Livermore technique as prices retrace their initial gains. That is why most people do the exact opposite of what most trading professionals recommend – they allow their losses to run wild but cut their profits short.

However, the retrace risk which sabotages so many scale up trades can be generally avoided during news trades if the surprise is significantly large. Let’s use the EURUSD pair and the US Durable Goods report as an example. For purposes of illustration let’s assume that the EURUSD is presently trading at 1.3700 and the Durable Goods Number is expected to print at 1%. We are bullish the US Durable Good number and will therefore sell the EURUSD (a dollar bullish position since we are getting short euros and long dollars by selling EURUSD) a few minutes before the release. Just as we expected the Durables Goods number prints at 2% - much better than forecast and EURUSD immediately trades down to 1.3670. Our position is now 30 points in the money. We short another unit of EURUSD for the reactive part of our trade, move the stop on the whole position to breakeven and target 1.3655 as our profit target on the trade. A few minutes later as the news disseminates through the market, the EURUSD is pushed lower and our target is hit. Total profit on the trade is 60 points (45 points on our proactive position plus an additional 15 points on the reactive part). Why so little profit on the reactive part? Remember that most of the price adjustment had already taken place and we are looking only for a limited follow through. Nevertheless by making even a small amount of additional profit on the second unit we’ve been able to increase our gain from 45 to 60 points or nearly 33%!

What happens if the analysis is wrong? This is perhaps the best feature of the strategy. Often you are able to exit the position with only a 5 or 10 point loss before market prices fully react to the news. But suppose that the price adjustment is abrupt and the stop of –20 is hit. No problem. The loss is still minimized because you are only using 1 unit for your initial entry and are not adding to a losing position. Therefore, in the best case scenario the trade yields 60 points of profit when you are right. When you are wrong you are able to exit with 5 or 10 point loss most of the time and occasionally you get hit with –20 point stop. Overall that is a very favorable risk reward spectrum. You only need to be right 3 out 10 times to be net profitable. That’s the kind of margin of error that most traders could accept. However, very few traders can trade this way because most human beings cannot accept multiple losses in a row even they are very small. And make no doubt about it, news trading is a volatile strategy. Yet when practiced properly it can also be quite profitable. There are only three rules that the trader must follow in order to achieve success.

1. Exit trades immediately if there is no surprise in your direction

2. Add a second unit to your trade on those rare occasions when you are correct in your analysis and price has moved at least 30 points in the money.

3. Don’t be greedy and take quick profits as price continuation is often limited. “

I hope you’ve found this variation on the theme of interest. One final note. We are now in the dog days of summer and both K and I will be traveling next week, so there will be no weekly issue. But fear not we will have both short and long term trade ideas this week and will be back in touch in two weeks.

Wishing you best

B & K

posted by BKTrader  # 8/05/2007 07:30:00 AM 0 comments

Ever since we started Bkforexadvisor we’ve had requests for longer term trade ideas. That’s very understandable given our intense, short term orientation towards the FX market. Many subscribers found it difficult to follow all our trade ideas since they are issued round the clock 5 days per week. Despite the fact that our trading style probably has the shortest exposure to market risk of any FX newsletter (since the majority of our trades last no more than 30 minutes), the need to be in front of the computer to trade each specific event risk can be difficult for subscribers situated across the globe.

Over the past few weeks we’ve made several improvements in terms of delivery of signals by initiating positions only 15 minutes before the event (thus minimizing the impact of negative drift) and posting everything in the chat room first allowing for much better reaction time to the news. For those of you still not familiar with the chat room please note that its is the black button on the front of the www.bkforexadvisor.com that says Instant Trade Alerts. The direct link is http://www.bkforexadvisor.com/members/tradealerts.aspx and we highly recommend that you check it out if you haven’t done so already.

In any event we’ve received overwhelmingly positive response from those of you who’ve adopted the new features, but these improvements all revolve around our short term event risk model and didn’t address your requests for more longer term, less intense trade ideas. Well you will be happy to know that we took your suggestions seriously and over the past several months Kathy and I have been busy beta testing a longer term trade model that we believe to satisfy these requests. The model is a proprietary combination of technical and fundamental variables that tries to exploit reversals as well continuations of trend.

As always we will try to be as transparent as possible in providing reasons for various trades. In fact the single greatest compliment we’ve recently received on our service came from a gentleman at Dallas expo who told us that unlike all the other investment advisory services he has ever tried, we were the only one who provided clear well thought and easy to understand arguments for our positions. This is our greatest strength. Instead of just telling you buy X here, sell X there we always provide context and reason for why we are doing something. Win, lose or draw you always know WHY we are trading. Our most ardent subscribers truly appreciate that fact as they can evaluate each trade on its merits rather than just being forced to blindly follow every signal.

As you can imagine the long term trades ideas will very different from short term signals and its very important for you to understand the difference.

1. Leverage.

We do not recommend any specific amount of leverage for our trades since each person’s risk tolerance is unique. However, it is important to note that the long term trade ideas will have much wider stops because we will looking for very different risk and reward parameters. In our present short term model we generally do not allow more than 40 points of risk, In the long term signals the stops will be between 100-200 points so please lower your leverage accordingly to make sure you are not assuming a disproportionate level of risk for you profile.

2. Size

In our short term model we trade with two units initially and exit the first half of our position at 1 times risk, then go to breakeven on the rest of the position and try to make 2-3 times risk on the second half. The long term model will use a very different money management approach. We will always enter the trade with 1 unit and may occasionally ADD to the position if our initial entry moves deep into profit territory. We will never scale down into a trade by adding to a loser, but may at times scale up by adding to a winner.

3. Timing

The alerts will be issued at 5 PM EST (22:00 GMT) after the close of the New York session and the trades will generally last between 2-10 days depending on the price action of the market

4. Frequency

The model typically generates 1 or 2 trade idea per week, but there are some weeks when price action may be so quiet that we may not do any long term trades at all. Our goal is to select the best possible ideas and sometimes that simply means that we will be sidelined

5. Demarcation

We will clearly label the long term trade ideas in our emails, so that you will be properly informed on the type of trade you are receiving and can make your own judgments as to the recommendation. We will also mark the long term trade ideas with an LT prefix in the all trades page and will keep a separate tabulation since this is a different model with different trading goals.

Finally for those of you preferring the short term approach with much tighter risk parameters rest assured that we will continue to send out event risk trading ideas. In fact we have a full slate for next week. However, by offering the longer time frame signals we hope to address the overwhelming demand for this type of trading and provide an even richer array of services for our subscribers.

Have a great week-end

B&K

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posted by BKTrader  # 7/28/2007 10:16:00 AM 0 comments

This week, to an overwhelmingly positive response we changed our entry procedures to eliminate as much of the negative drift as possible. As many of you know we used to take positions as early as two hours ahead of event risk, in large part to accommodate the inevitable delays in email that plague communication on the Internet. During that time we enjoyed periods of positive drift (when prices would go our way before the event) as well as occasional negative drift (when they went against us). However when negative drift began taking us out of positions before news even printed the costs clearly started to outweighed the benefits and we changed our procedures.

Therein lies the first trading lesson of the day – adjust, adapt, evolve or die. Those of you who have been with us from the beginning know that we always show trading as it really is with all of its travails and challenges rather than as some imagined make believe get rich quick scheme. You have seen us adapt and refine ideas as market environment have changed because truly successful trading always requires creativity, and adaptability in order to survive and thrive in the game.

BK Advisor trades event risk. The operative word here is risk. We believe that you cannot achieve excess profits in the market unless you assume risk. This strategy is therefore highly speculative and should only be used with risk capital – money that you can easily afford to lose. In fact we always recommend that new subscribers follow the recommendations on a demo account. That why we offer a 30-day money back guarantee. During this time you can paper trade our signals to get an idea of how they operate and even more importantly to see how you yourself can best fine tune and adjust them to your own trading style.

Some of our longest running subscribers incorporate our ideas into their own trading strategy rather then use them robotically like a machine. As we’ve always stated trading is an art, not a science. Those looking for the “magic” formula will be always disappointed. It doesn’t exist and never will. Trading will never be mastered by engineering and profitable trades will never be erected with the speed and efficiency of skyscrapers in Shanghai. If that were possible. Goldman Sachs, Merrill Lynch and all the other major players in global finance would have long ago eliminated all the risk out of their trading operations and would have minted profits the way that McDonalds manufactures hamburgers. But as we’ve seen this week in the case of Bear Stearns whose CDO hedge funds lost all of their capital such is not the case.

In fact McDonalds and Merrill Lynch serve as good examples to better understand the difference between trading and all other business activities. There is almost no reasonable scenario (short of nuclear Armageddon) under which we can imagine McDonalds losing 10 Billion dollars in one day. Their model is the essence of precision, efficiency and repeatability that is constructed on natural laws of physics. On the other hand it is quite easy to imagine ML losing $10 Billion dollars in a day if the Dow dives 2,000 points in a matter of few hours. Furthermore it is not at all inconceivable that such an event could occur once every decade or so. That’s because trading is not based on a rock solid laws of nature, but rather on the ever shifting whims of man.

Those subscribers who understand the fluid nature of the markets and are creative with our trading ideas tend to enjoy the BK service more as they add their variations to theme. As one sub recently wrote us, “I view my subscription to your service as my long-term commitment to educating my self. Thanks for your great service.” Adding in another email, “The MOST valuable is your service is anticipating the news. I am a technical/system day trader and my net average between 300 to 500 pips monthly. I used to avoid trading around the time of economic news. Now with your service, I can trade around economic news with confidence.”

So in the spirit of stimulating more creative possibilities for our model here is an idea that comes from another subscriber. He writes, “The new way you work is nice because we can prepare and anticipate the trades If we enter just before the new release do you think that we can put a SL closer from the entry point (10-15 pips) because usually the direction doesn’t hesitate just after the new and we can benefit of the first spike. Thanks for your help and best rgds.”

This is an interesting idea. Let me discuss its merits and drawbacks. As you know our trading model depends on cutting loses quickly and letting a portion of our profits run. Anything that can minimize risk is therefore a positive factor. We put our stop at –20 as a fair compromise between mitigating risk and giving room for some pre-event volatility. After the news comes out we often exit way before the stop if the news is contrary to our position, posting the reaction in the chart room first . http://www.bkforexadvisor.com/members/tradealerts.aspx

Therefore, moving the stop to –10 or –15 one or two minutes before the event may not be a bad idea for some of you to consider. By doing so you have a tighter control on your risk without the trouble of manual exit. One caveat however. Occasionally the news release can create post-event volatility where price may initially spike against your position only to move in your direction after a few seconds. Thus if you lower your stops you must accept the fact that you may get taken out of what may ultimately prove to be a profitable trade and you must judge if the trade-off of smaller stops is worth the cost of the premature exit.

Trading is full of such trade-off. In fact trading is nothing more than a series of trade-offs and we can never know ahead of time if we make the right or the wrong decision. All we can do is control our risk and make adjustments as the market demands. Being flexible and creative is of the essence and we will try our hardest to be both as I will share with you more variations on our trading style in upcoming weekly emails.

Wishing you the best week-end.

Watch for a trade idea Sunday night!

B&K

posted by BKTrader  # 7/21/2007 11:44:00 AM 0 comments

The subject this week is power laws. For those you not familiar with this notion it can be best expressed in the well know example that in business 80% of profits come from only 20% of transactions. Many entrepreneurs or salespeople are probably shaking their head in agreement as they read this having seen this dynamic repeat itself over and over.

Yet while many people accept this fact in regular business, most novices somehow refuse to believe that power laws apply to trading. Everyone who starts out trading wants to achieve 80% profits and only 20% losses. As pleasant as that idea may be it’s utterly unrealistic. One can of course achieve such favorable ratios but only at the expense of suffering ruinous losses. In fact one can even record 99% accuracy in trading, by simply never taking any stops but the one wrong trade will wipe out all of your profits and all of your equity. History is littered with such examples and most recently investors into the subprime hedge funds of Bear Stearns learned that fact the hard way.

If traders could truly achieve 80% accuracy with minimal risk in their trades they would within a decade become trillionaires as such a powerful skew in odds would almost assure that they would be able to capture all of the profits in all of the financials markets of the world. In fact Jamie Saettele my technical analyst and I always smile at the naïve desires of most investors to look for a consistent track record. There isn’t a more dangerous investment to be made than one into a hedge fund that has had three winning years in a row. Inevitably those investments will experience losses rather than wins , because typically such steady returns are achieved through massive risk taking which is hidden from view.

Why do I bring up the idea of power laws this week? Because our trading approach very much follows those rules. We try to do the opposite of what is physiologically pleasing in order to achieve that which is financially prudent. In our journey for profits we will often take many small losers, but these losses will be overcome with only one or two winners. Instead of trying to please the psyche we try to adhere to the universal rules of power laws as we try to show you what reality based trading is really like.

That having been said our model this week, performed poorly, partly because the data simply did not go our way – something that is very much to be expected from time to time but also because of sub-optimal execution – something that can be definitely corrected. So let’s tackle the issues that we can correct and see what we can do better.

One of out vexing problems with trading event risk has been the lags in communication. Email is notoriously inconsistent in delivering messages on time. That was one of the reasons we used to issue our alerts an hour or two ahead of the event – in order to make sure that you received the message. Unfortunately, taking a trade so far ahead of the event subjects the position to negative drift and slippage. Prices can hit our stop before the news is even released, something that happened twice this week. Most of the time the stop out actually foretells that our direction was wrong as the news misses our expectations, but occasionally negative drift takes us out of what turns out to be a very profitable trade. Furthermore, our model is based on the idea of quickly cutting our losses and negative drift has the insidious effect of generating maximum rather than minimum losses.

So starting next week we are going to alter our message and entry delivery protocol to minimize the problem of negative drift. We will still issue our trade recommendations about 2 hours before the event, and we will still provide you with our 24 hour trading plans, but we will now actually enter trades 10-20 minutes before the event, minimizing the pre-event noise. We will post our entries in both chat room and on the website, which have a timestamp and provide as near an instantaneous information flow as possible –eliminating some of the slippage and communication problems we saw this week. We will continue to send out all exit and trade update alerts via email and SMS as before. In short this is a rather minor change. We will continue to offer you as much information as possible through email, SMS, web site and chat room, but by making this adjustment we will be able to provide you with better entry signals and hopefully offer you a more robust model to trade.

There will be no trade alerts on Monday but the rest of next week promises to be busy so stay tuned for our updates.

Boris and Kathy

posted by BKTrader  # 7/16/2007 02:39:00 PM 0 comments