(A) S&P 500
Thoreau was wrong. What you look at and what you see matters. How often are you blindsided? You are blindsided if you go long when you should go short or short when you should go long. The 11-day linear regression channel (LRC) Chart (A) above shows SPY, an S&P 500 exchange-traded fund or ETF. Chart (A) was captured on March 26, 2010. Each price bar is 180 minutes long.
On March 26, going long the S&P seemed like a good idea. Chart (B) below shows SPY on May 7, 2010. Going long the S&P on March 26 was a bad idea. Between March 26 and May 6, bullish S&P investors and traders were blindsided.
(B) S&P 500
Media outlets in the United States often headline each day's U.S. stock market action by looking at the Dow Jones Industrial Average, an index of 30 stocks. United States-based stock mutual funds often compare their results against the S&P, an index of 500 stocks.
Most U.S. stocks track directly with the S&P.
Before you go long or short a particular stock, look at a chart of the S&P. If you think your stock should go up, but the S&P is going down, be careful about going long that stock. If you think your stock should go down, but the S&P is going up, be careful about going short that stock.
Know what to look at. Welcome to the world of correlated indicators.
Ouch!
On May 6, 2010, U.S. stocks collapsed. The Dow recorded the biggest intraday point drop in its history. The Dow and S&P subsequently rallied that same day. Still, you can see on Chart (B) (above) that, from a long-side viewpoint, May 6 was a shocker. Investigators in the various U.S. financial exchanges and federal government asked, "Who caused the drop?"Who? Sellers. They were more aggressive than buyers. Why? The May 6 drop was a delayed reaction to what was already happening worldwide. Look at Chart (C) shown below. This is an 11-day LRC chart for the June 2010 Eurodollar futures contract covering the same time period as (B) above. See a similarity?
(C) Eurodollars
Chart (C) is the work of bearish Eurodollar investors and traders. These bearish market participants offered more aggressively than their counterparties bid. With Eurodollars, as price falls, short-term interest rates rise.
On April 28, 2010, the Federal Open Market Committee (FOMC) of the Federal Reserve ended a regularly scheduled two-day meeting with these words: "The Committee will maintain the target range for the federal funds rate at 0 to ¼ percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."
The Fed is powerful. It is not all-powerful. Listen to what the Fed says. Look at what the Fed does. And, see how the markets react.
On April 28, the Fed (I paraphrase) said, "It's OK, folks; short-term rates will stay low." Low, short-term interest rates were one of the pillars supporting the February / March / April 2010 U.S. stock market rally. Equity buyers believed the FOMC. Eurodollar sellers disbelieved the FOMC.
Look at the next two charts -- (D) and (E). Both are 3-month charts. Each price bar is a single day.
(D) Eurodollars
(E) S&P 500
Chart (D) shows the June 2010 Eurodollar futures contract. The chart below that (E) shows SPY. Eurodollars presented a leading indicator: They began breaking in mid-April. SPY did not begin breaking until late April and early May.
Media reports on May 7 included a comment by a writer who concluded: "No one saw Thursday's (May 6) (S&P) collapse coming." No one? It takes a buyer and a seller to execute a trade: Two counterparties. Eurodollar sellers and S&P sellers were active before May 6. Those sellers were not blindsided. Buyers were blindsided. That writer must have been a buyer or clueless about how a trade works.
Study Charts (D) and (E). You are blindsided when you do not know what to look at and see. Consistently successful investors and traders know what to look at and see. Consistent success depends on sharply limiting how many times you are blindsided.
Coming into May 6, I knew Eurodollars were weak (short-term interest rates were rising). I also knew that Hong Kong equities were weak. But, U.S. equities were generally ignoring those rising rates and were ignoring Hong Kong. I was puzzled.
The problem (which I realized later) was that, although I knew to look at Eurodollars and Hong Kong, I was not looking at them in a consistent way. I could not see because I was not looking correctly.
Study Charts (F) and (G) shown below. Chart (F) is a repeat of the Eurodollar Chart (D) shown above. (G) shows EWH, an ETF representing Hong Kong (Hang Seng) equities.
(F) Eurodollars
(G) Hong Kong
EWH is a surrogate for Chinese equities as a whole. EWH sellers turned aggressive before Eurodollar sellers turned aggressive. EWH sellers knew to sell going into May 6. Eurodollar sellers knew to sell going into May 6. S&P sellers knew to sell going into May 6. Who saw May 6 coming? A lot of people. What you look at and how you see matters.
As a result of May 6, I changed my trading screen to improve how I look and see. I learned a lesson. I now look at 47 eSignal LRC charts to improve my situational awareness.
I See; You See
Many people are the same. Many are different. There are many ways of looking at and seeing market behavior. You cannot trade unless you are matched with a counterparty who looks / sees / acts differently from the way you do. When you see a "buy opportunity", your counterparty necessarily sees a "sell opportunity" or vice versa.If market participants do not look / see / act differently, there are no markets. No counterparties. No trade. In my first article in this 19-part series, I list multiple forms of trading analysis (ways of looking / seeing). Several forms center on correlation indicators. These are used to understand contextually how markets might move next.
Even if you use none of these forms, be aware of them. Many traders use these forms to gain advantage over their counterparties, including, possibly, over you.
- Alpha Model (see Alpha Generation Platform)
- Alpha Generation Platform (see Derivative Pricing Model)
- Beta Model ("Correlation" Indicator)
- Delayed Reaction ("Correlation" Indicator)
- Derivative Pricing Model ("Correlation" Indicator)
- Dow Theory ("Correlation" Indicator)
- Efficient-Market Hypothesis (see Inefficiency)
- Enhanced Indexing ("Correlation" Indicator)
- Fair Value (see S&P 500 Index Arbitrage)
- Inefficiency ("Friction" Indicator)
- Intermarket ("Correlation" Indicator)
- Leading / Lagging Indicator ("Correlation" Indicator)
- Net-Flow Value ("Correlation" Indicator)
- Quantitative (see Derivative Pricing Model)
- Relative-Value (Risk) Arbitrage (see Inefficiency)
- S&P 500 Index Arbitrage ("Correlation" Indicator)
- Statistical (Risk) Arbitrage (see Inefficiency)
- Trading Intelligence Template ("Correlation" Indicator)
- Volatility ("Price-Risk" Indicator) (see Beta Model)
- Volatility (Risk) Arbitrage (see Statistical Arbitrage)
"Alpha" is slang for "return on capital". Algo programs are non-human: they are tireless, and their capacity for detail is theoretically limitless. Algo programs take advantage of correlations / anomalies in markets worldwide. If you can act on a correlation / anomaly before the next guy, you can profit more. Human / non-human traders who / that took advantage of the EWH / Eurodollar / S&P April / May 2010 anomaly enjoyed a high alpha.
"Beta" is slang for "volatility". It is a measure of one thing's price volatility correlated to another thing's price volatility. If, using a beta model, I can identify an anomaly and take advantage of the thing that is more volatile (has a higher beta) then I will earn a higher alpha.
Delayed Reaction, Efficient-Market Hypothesis and Inefficiency form a trio. Efficiency (Efficient-Market Hypothesis, Efficient-Market Theory) holds that no human can consistently beat the annual return of the S&P 500. How so? Because all public information on the stocks in the S&P is known and will be acted on instantly by all traders involved with the S&P. Really?
Trading is based on mutually exclusive motivations. Remember: When you enter a trade, it is because you are motivated to buy, and your counterparty is motivated to sell or vice versa. No counterparties. No trade.
If all participants given the same information reach the same conclusion to buy or to sell at the same time, there is no market (price surges or collapses or evaporates) until someone (or some algo program) steps in to act as a counterparty. Trading exists on friction, on inefficiency.
Inefficiency recognizes that different participants in a market can have different motivations and use the same information to arrive at different conclusions at different speeds. Inefficiency is a study of how participants look at, see and act on information.
Delayed Reaction is a study of how leading indicators form and affect correlated markets (think EWH and Eurodollars).
Dow Theory is based on the ideas of Charles H. Dow, founder of the Wall Street Journal. William Peter Hamilton, Robert Rhea and E. George Schaefer formalized Dow's ideas into Dow theory (see www.wikipedia.org).
There are multiple parts to Dow theory, one of which supports efficient-market theory. Another part of Dow theory divides the 30-stock Dow into sectors and appreciates that different sectors can move differently, a nod to inefficiency.
Charles H. Dow recognized the value of waiting for confirmation of a move among key sectors. He understood the links among differentiation, leading indicators, correlation and confirmation.
Enhanced indexing is an "obvious" idea. Five hundred stocks make up the S&P 500 index. The price of the S&P is basically an aggregate price of those 500 stocks. U.S.-based stock mutual funds often compare their results against the S&P. Many stock mutual funds make their money off fees and a percentage of assets under management.
The game, from a stock mutual fund manager's viewpoint, is not performance (that's not where the incentive is). The game is to increase your assets under management. How? By "simply" outdoing the stock-picking performance of most of your rivals by a slight percentage relative to the S&P.
You do not need to risk shooting for the moon. Beat the S&P 500 index by a little with sharply limited risk, and you could become an asset magnet.
This is the process: You ignore the laggards in the S&P and invest in the rest. Or, you single out just the leaders. The thinking here is that the leaders should strengthen while the laggards weaken. When a leader becomes exhausted, rotate into a fresh leader. If you invest in an "enhanced" S&P, you should consistently beat the "basic" S&P.
Fair Value involves ego. Who is smarter: Equity index futures traders or equity index cash traders? Before the 9:30 a.m. open of the New York Stock Exchange regular (cash) session, S&P futures traders bid and offer according to where they think the S&P will move next.
If they collectively rally the price above the last cash price, this theoretically indicates that cash traders will follow suit to the up side at the 9:30 bell. If S&P futures traders collectively break the price below the last cash price, this theoretically indicates that cash traders will follow suit to the down side.
Fair value assumes that futures traders are smarter than cash traders. But, have you ever seen the S&P abruptly reverse at the 9:30 bell? When that happens, cash traders are smarter. Sometimes, fair value works as an indicator. Sometimes, not. The bell introduces a new mix of participants. The dynamic of a trading day can change when the participant mix changes.
Relative Value is an arbitrage idea. I am using a "loose" definition of arbitrage -- taking advantage of price anomalies (discrepancies) wherever they occur. Look for an anomaly between any two things that are correlated.
For example, in late April 2010, Chinese stocks and Eurodollars began breaking while the S&P was still strong. Assuming that Chinese stocks and Eurodollars were leading indicators relative to the S&P, you might have decided that the relative value of the S&P was too high. You might have decided that the spread between Chinese stocks and the S&P and the spread between Eurodollars and the S&P were "out of balance" and would be forced to narrow and that the S&P would be the one to break.
Instead of buying China and Eurodollars, you might have simply shorted the S&P on the assumption that its beta would surge. You would have been right. Your alpha on the short side of the S&P would have surged correspondingly. Arbitrage is a rich study in its own right.
S&P 500 Index Arbitrage is "dark horse" thinking (short the leaders; long the laggards). Imagine going to a race track. If you bet on the horse favored to win, and it does win, you make something. The odds (return on capital) on a favorite (a leader) are low, and favorites do not always win.
If you bet on a dark horse, and it wins, you make a lot. The odds on a dark horse (an unknown, a laggard) are high and dark horses sometimes surprise. That is what makes a horse race a horse race.
Imagine if you could consistently bet on dark horses that win. Most U.S. stocks track directly with the S&P. During a broad rally, leaders in the S&P sometimes play out. There is a rationale for the spread between a laggard and leader to narrow and reverse (rotation). If the S&P is rallying, even laggards can overtake leaders. The question is: Which laggards?
Intermarket analysis is a catch-all. It basically means looking at a lot of correlated things (markets, sectors, stocks, and so forth) to try to see patterns. Intermarket analysis combines alpha, beta, delayed reaction, inefficiency, Dow theory, enhanced indexing, fair value, relative value and S&P 500 index arbitrage, plus other forms of trading analysis, some of which you can only guess about and some of which you cannot even imagine (the stuff used by very deep-pocket dominant traders).
Statistical (Risk) Arbitrage is a mean-reversion catch-all. The slang term is "stat arb". The basic idea is to look for (or sometimes create) a short-term inefficiency in a thing that "should" subsequently revert to a mean.
Think in terms of all the markets in the world. Think of all the exchanges in the world. Think of everything in the world involving a buyer and a seller that is liquid enough to flip in a few seconds, minutes, hours or days.
Imagine extraordinary computing power. Imagine a 24 / 7 software brain with an all-seeing eye, a master counterparty raking in money day after day from lesser counterparties / competitors. I am being dramatic to make the point that markets are ecosystems filled with predators and prey.
In a command market, those who make the rules make the money. In a free market, those who understand the rules better make the money. Your task is to understand the rules better.
When command-market thinking and free-market thinking clash, markets can turn exceptionally volatile; beta can surge. In a way, markets search constantly for a mean. The history of the markets is a history of a search for a mean. On your trader's bookshelf, alongside a section on the history of markets, include a section on stat arb.
Leading / Lagging Indicators are a time-sequencing (if-then) study of "motion". How can I predict (and profit from) the future movement of many things by looking at the current movement of one or a few things? Include a section on your trader's bookshelf on tradable leading / lagging indicators.
When I was younger, it seemed logical to me that everyone should be able to decide at a single point in time on a Monday what the price of everything should be until the following Monday. I thought prices should be stable, not fluid.
I could not understand why people kept changing their mind about prices. I could not understand why money flowed so rapidly between markets. A command market was intuitive to me. A free market was counterintuitive.
Net-Flow Value is a study of how money flows between two or more correlated markets. At its most basic, net-flow value is a study of how money flows between equity and debt (for example, between the S&P 500 and 30-year U.S. Treasury bonds).
Sometimes, money flows into both or out of both. More often, money flows from one to the other. Whether you are an S&P trader or a bond trader, you can give yourself an edge by appreciating the current net flow between the S&P and bonds. (Note: Do not become complacent about net flow. Relationships can persist or suddenly change.)
The concept of an Intelligence Template largely originated in World War I. That war saw a rapid expansion of the intelligence-gathering capabilities of armies, including the first large-scale use of aerial photo intelligence. Planes went up, took lots of pictures and deposited those images into the hands of human analysts.
Starting with a lot to look at, these analysts had to figure out what they were seeing. Each image was a piece in a puzzle. These bird's-eye views flooding back from the planes showed a bit of this and a bit of that but rarely showed a comprehensive image of where the enemy was or what he might do next.
Gradually, intelligence analysts appreciated that armies are large nervous systems that necessarily organize and train to do things in repetitive ways. If, for example, you receive an image of the location of a particular artillery piece, you can estimate the relative location of the artillery pieces habitually collocated with that original artillery piece.
You can infer a larger picture from a detail. You can then estimate the relative location of enemy forces habitually collocated with the artillery pieces that you inferred. And, so on.
From the location of a single piece of enemy equipment and a handful of troops, you can infer the location of thousands of enemy troops, at least in theory. While your enemy hides his forces and intentions, you can use your enemy's predictability to uncover (infer) his forces and intentions.
Of course, an enemy can use that against you. The enemy can place false clues to lead you to false inferences.
A Trading Intelligence Template appreciates that markets are less devious than armies. In day trading especially, markets track according to finite patterns (the big picture). The more familiar you become with the patterns, the better.
If you can identify a day's key details in time (the day's small pictures), you may be able to infer how the markets you are observing may close (see Leading / Lagging Indicators). You can work top-down (from big picture to small) and bottom-up (from small pictures to big).
For example, working top-down, you might appreciate that the S&P 500 has been moving directly with Eurodollars. As a new trading day starts, you might see a sharp rally in Eurodollars (small picture) even as the S&P is sluggish (small picture). You can infer (big picture) that the S&P may rally to catch up with Eurodollars.
Traders are creatures of preference. Each has his / her preferred way of looking at and seeing the world (see Inefficiency). Some traders like filtered watch lists. Using numbers (watch lists are numeric-based), these intelligence templates can cover a mass of correlated markets, sectors, stocks, and so forth.
Some traders like heat maps. Using color-coded shapes depicting (for example, current volume, movement [up or down] and intensity [rate of change in volume or percentage change in movement -- heat maps are graphic-based]), these intelligence templates can cover an array of correlated markets, sectors, stocks, and so forth.
The purpose of a watch list and a heat map is to help a trader work top-down and bottom-up. These templates take the flood of each day's information and help the trader make improved sense of what may happen next.
I, myself, do not use watch lists or, strictly speaking, a heat map. Instead, I cover my trading screen with 47 charts displaying equities, debt, currencies (Euro FX EUR / USD), metals (gold and copper) and energy (crude oil WTI).
I also use an acetate overlay covering most of my screen that reminds me (using symbols and plain English) how my markets can correlate. That acetate is, strictly speaking, my intelligence template. The template improves my situational awareness. (I discuss my screen later in this 19-part series.)
Volatility is a bugbear, an evil thing that eats bad traders. Volatility can wipe you out if you fight it (buy low / sell lower). Volatility is good if you learn to flow with it (buy low / sell higher).
Beta and Volatility (Risk) Arbitrage are studies of volatility. Intuitively, I am frightened by volatility. I began my trading life as a position (trend) trader. Volatility ended that phase. I evolved into a day trader.
Look at a chart with the telltale saw-tooth pattern of volatile trading. Now, draw a line dividing each run up and each run down. You will likely see discrete days and parts of days. Position (trend) trading tries to flow with macro reversals.
Day trading tries to flow with micro reversals. Volatility risk arbitrage gauges a reversal, focuses on the more extreme member(s) (markets, sectors, stocks, and so forth) of a move, then, plays the spread(s).
Fear of volatility must be unlearned. Flowing is an acquired intuition. I now find that day trading is safer. Start each day market / mind neutral. Trade each day's "best, cleanest" trade(s). End in cash. Repeat.
Derivative Pricing Model analysis is the Rosetta Stone -- the philosopher's stone. Imagine if there were a key that let you use the price of one thing to decipher the relative value of all things (see stat arb). You could use arbitrage to take advantage of mean reversion as each thing moved toward its "proper" relative value.
Imagine an algorithmic model(s), a mathematical equation(s) that allowed you to generate eternal profits. Far-fetched?
I am writing these words in May 2010. In front of me, I am looking at an article titled "4 Big Banks Score Perfect 61-Day Run". The article goes on to report that the trading divisions of four major U.S. banks showed a marked-to-market profit on a proxy "eternal" basis.
The article does not say in which markets or positions these trading divisions made their money. The article tantalizingly omits that information although I doubt the writer knows. All the writer knows is the surface fact based on the banks' reports: "Perfect 61-Day Run". When is the last time you experienced 61 days of consecutive gains in your trading account(s)?
During this same month (May 2010), the U.S. Congress is busy outlawing a repeat of this kind of performance. In the United States and around the world, we are at a curious place in terms of trading. Governments hold the rule book. They can change the rules at will.
Market participants, however, hold the energy that propels markets. As I write these words, the forces of command markets, free markets and hybrid markets are swirling. Hmmm. Has this happened before?
Which brings me to Quantitative Analysis, a master catch-all. I recommend a book, The Quants, by Scott Patterson (2010, published by Crown Business). Scott lays out the history and soul of the financial engineers (quants) who currently infuse Wall Street. Quantitative analysis drives the lion's share of trading on today's markets. Read this book.
Scott makes a point that "alpha" (in the mindset of financial engineers) is the "truth". Alpha is the unifying theory of return on trading capital. Alpha is the grail. Contemporary financial engineers believe, or act as if they believe, that all markets can be reduced (elevated?) to equations that can be leveraged, by the cognoscenti, to produce eternal profits. 62 days, 63…
"There's a sucker born every minute." -- P.T. Barnum
In a free market, counterparties who don't "get it" (who are disorganized and undisciplined and who lose consistently) are suckers. Counterparties who "get it" (who are organized and disciplined and who win consistently) are P.T. Barnums.
Free markets distribute wealth toward the top. Skill theoretically wins. Command markets, theoretically, distribute wealth toward the bottom. Dictate wins.
I appreciate both camps.
The United States is extending the throes of the industrial revolution in an ongoing clash between free markets and command markets. This is a messy business.
You wish you could be as "good" as those four banks ("4 Big Banks Score Perfect 61-Day Run"). You just don't know how they do what they do. They're just so much bigger than you are. They just have so much more money than you do. They just have so many more resources than you do. They probably cheat.
Or, maybe there is no secret beyond hard work and focus. You do not need to be excessively tuned into the markets worldwide. You need to be sufficiently tuned in. The promise of a free market is that you, too, can aspire.
You have the resources (available free on the Internet) to know what the Chinese markets are doing. In April 2010, the Chinese began to dampen their economy. You can see what Eurodollars are doing (see www.cme.com). And, you can follow business news; turn on your computer; turn on your TV. You need to better organize what you look at and how you see. Get better organized. Get disciplined.
The last charts I showed above covered the S&P 500 plus Eurodollars plus Chinese stocks (via Hong Kong and the Hang Seng) through May 7, 2010. U.S. retail equity traders are mainly long-side traders. They are oriented toward a rising U.S. stock market.
Following the May 6, 2010 S&P collapse, the S&P rallied. Happy thoughts returned to the minds of long-side equity traders.
Inversely, U.S. 30-year Treasury bonds broke. Money flowed out of debt. Money flowed back into equity. How was your money allocated?
Heads You Win; Tails You Win
One allocation strategy is to put 50 percent of your money in an S&P 500 index exchange-traded fund (ETF) and 50 percent in U.S. 30-year Treasury bonds. Then, according to a regular interval (say, every calendar quarter), rebalance your holdings.If the S&P goes up, sell the excess above 50 percent of your net and put that money in bonds. If bonds go up, sell the excess and put that money in the S&P. Maintain a 50 / 50 balance. In the meantime, enjoy the dividends off the S&P and the interest off the bonds.
A conservative investor may say, "I like this." An aggressive trader may say, "Are you kidding?" Look at Charts (H) and (I) shown below.
(H) S&P 500
(I) Bonds
I have colored the charts for dramatic effect. The top chart shows the E-mini S&P 500 June 2010 futures contract. The bottom chart shows the Globex 30-year bond June 2010 futures contract. The action spans from 12:10 a.m. to 10:00 p.m. Eastern Time on March 23, 2010.
See how the S&P and bonds moved inversely? Gains in the S&P were offset by losses in bonds. The rally in the S&P was confirmed, inversely, by the break in bonds. The two charts are inversely correlated.
As a trader, I ambidextrously use futures and ETFs. I find that each has its strengths. I have found that following both presents a more complete picture of what each may do next. Look at the two 3-month charts -- (J) and (K) -- below. These charts include the day of and the day after the May 6 S&P collapse.
(J) S&P 500
(K) Bonds
The top chart shows SPY, the S&P 500 index ETF. The bottom chart shows TLT, a 30-year bond ETF. See how the S&P and bonds moved inversely. The two charts are inversely correlated. In Charts (H) and (I), the S&P rallied while bonds broke.
In Charts (J) and (K), the S&P broke while bonds rallied. Charts (H) and (I) are 1-day charts. Charts (J) and (K) are 3-month charts. Even so, despite the difference in the time period covered in each pair of charts, the S&P and bonds showed the same relationship. Namely, the S&P and bonds moved inversely.
If you had been trading when these charts were captured, you could have used the S&P to inversely trade bonds and vice versa. Don't want to split your money between the S&P and bonds (invest conservatively)? Then, shift your money between the S&P and bonds (trade aggressively).
The Spdyer and the Mirror
Imagine a spider. The spider walks on to a mirror.The spider pauses. Then, it bends its spidery legs. Down goes the spider. Up goes its reflection in the mirror. Next, the spider straightens its spidery legs. Up goes the spider. Down goes its reflection.
SPY, the S&P 500 index ETF is nicknamed the "Spyder". Spyder goes down in price; bonds go up in price. Spyder goes up in price; bonds go down in price. Bonds are the Spyder's reflection. Bonds do the opposite of what the Spyder does. The Spyder does the opposite of what its reflection does. Sometimes, the S&P leads. Sometimes, bonds lead.
Position (trend) traders, swing traders and day traders alike can take advantage of this Spyder-bond relationship. Watch the S&P. Watch bonds. When the S&P moves, see what bonds do. When bonds move, see what the S&P does. Look for each to confirm a move in the other.
Sometimes, the Spyder and bonds move in unison. You need to keep on your toes.
"Houston, we have a problem."
Immediately following the May 6, 2010 S&P collapse, as the S&P rallied, there was a sense among equity bulls that stocks had somehow managed to "whistle past the graveyard". The May 6 collapse was judged to be a mistake, an aberration that could be corrected with new regulations.Talk of a rise in short-term U.S. interest rates (an effective tightening by the U.S. Federal Reserve) and a continuing dampening of the Chinese economy by the Chinese government was muted. The focus among U.S. media outlets was on how the U.S. Congress could prevent a future collapse and how the European Union could handle the debt crisis spreading across Portugal, Ireland, Greece and Spain. There was hope in the air.
By this time, I was more in tune with the world. On my improved 47-chart trading screen, I could see that Eurodollars remained in a down trend. I could see that crude oil, an on-again, off-again proxy for the global economy, remained in a down trend. I could see that copper, another global economic proxy, remained in a down trend. I could see that EWH, the ETF representing Hong Kong equities (the Hang Seng), EWJ, an ETF representing Japanese equities, EWG, an ETF representing German equities, EWA, an ETF representing Australian equities, and Euro FX EUR / USD remained in a down trend.
So what happened next? Think Spyder on a mirror.
The world at large was pointing down. The S&P reversed its post-May 6 bounce and followed the world at large. Spyder went down in price. Bonds went up in price. The S&P re-tested its May 6, 2010 lows. Bonds re-tested their May 6, 2010 highs.
On May 6, 2010, the S&P seemed, to some observers, to crash "spontaneously". After May 6, 2010, the S&P re-tested those same May 6 lows deliberately. The May 6 S&P collapse was not a mistake: It was the work of buyers and sellers reassessing the value of the S&P.
Charts (L) and (M) below show 6-month views of the S&P and bonds as of May 21, 2010. I understand why a long-side S&P trader might have felt victimized during both May collapses. I also understand why a proactive trader, deciding not to be victimized, rode the long side of bonds. Think Spyder on a mirror.
(L) S&P 500
(M) Bonds
This is part 2 of my 19-part series of articles on intermarket day trading using eSignal LRCs. For now, all I intend to highlight is the value of intermarket relationships in making trading decisions.
For a position trader, making decisions is a relatively slow affair: Position trading decompresses time. For a day trader, making decisions is a relatively fast affair: Day trading compresses time. Even so, the decision-making process is generally the same. Each trader must understand what to look at and see. Position traders can learn from day traders and vice versa.
In the parts to come in this series, I will explain why I use futures and ETFs, why I use linear regression channels and moving averages, and which 47 charts I follow. For now, remember: Markets are correlated; markets are connected; money flows; markets are inefficient.
If you trade stocks, watch the S&P. If you trade the S&P, watch bonds. If you trade bonds, watch the S&P. Look for relationships. Trade what you see.
*Reprinted (and modified) with permission from Richard L. Muehlberg, the author of 17 articles published in Futures magazine. www.DayTradingWithLinesInTheSky.com. richardmue@yahoo.com.
| ARTICLES IN THIS 19-PART SERIES: |
| Intermarket Day Trading with eSignal LRCs |
| (Part 1 of 19: How Price Moves) |
| (Part 2 of 19: Spyder on a Mirror…The S&P 500 versus Bonds) |
| (Part 3 of 19: What "Poker Tells" Can Teach Traders) |
| (Part 4 of 19: What "Helmet Kill" Can Teach Traders) |
| (Part 5 of 19: Good Day Trading Is Good Trend Trading) |
| (Part 6 of 19: Fractal Charting and Multiple Levels of Observation) |
| (Part 7 of 19: Hot-Money Tactics and LRC 1-Day Charts) |
| (Part 8 of 19: Hot-Money Tactics and LRC 3-Day Charts) |
| (Part 9 of 19: Hot-Money Tactics and LRC 11-Day Charts) |
| (Part 10 of 19: Hot-Money Tactics and LRC 6-Month Charts) |
| (Part 11 of 19: The Swing Trader's Mantra and "The Rule of 5") |
| (Part 12 of 19: Timing...Timing…Wait 'til 3:45 p.m. to Buy a Down Day) |
| (Part 13 of 19: Not-So-Secrets of Catching a Falling Knife) |
| (Part 14 of 19: Bull and Bear Traps...Seeing What Isn't There) |
| (Part 15 of 19: The Extraordinary Power of Simple Moving Averages) |
| (Part 16 of 19: Consensual Limits and Standard Increments) |
| (Part 17 of 19: Restricted Trading for Impulsive Traders) |
| (Part 18 of 19: Beta Booster...Trend-Swing-Day Trader!) |
| (Part 19 of 19: Rich Traders Are Reality Tested) |
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