Futures Sept Magazine

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TAPER WORM
HOW FED ACTION
WILL AFFECT FOREX
LOOK MA!
BUILDING BETTER
MOVING AVERAGES
RATIO MATTERS
BEST TOOLS FOR
MEASURING PORTFOLIO
PERFORMANCE
Midas
SEPTEMBER 2013
FUTURESMAG.COM
Shrugged
BEN DAVIES
TALKS GOLD, CURRENCIES AND
CENTRAL BANK-FREE MARKETS
41
years
E
D
U
C
A
T
IN
G TRAD
E
R
S

F
O
R
F
U
T
U
R
ES MAG
A
Z
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CONTENTS
6 Ad Index
8 Editors Note
Metamorphosis
10 Forex Trader
Fed tapering and U.S.
dollar potential
12 Options Strategy
Deriving income from cash on
hand by selling premium.
46 Trader Profile
Vallen: Second times
the charm
DEPARTMENTS
SEPTEMBER 2013 // VOLUME XLII NUMBER 7
Ben Davies:
Turning adversity into gold
By Michael McFarlin
After a back injury forced him to re-evaluate his Olympic dreams,
Ben Davies found a new thrill in the competition of trading. Now
managing a long-only gold fund, he strives to protect investors
wealth while advocating for free market reforms around the globe.
COVER STORY
14
4 FUTURES September 2013
For reprints and e-prints of FUTURES articles, please contact
PARS International at reprints@parsintl.com or (212) 221-9595.
FEATURES
MARKETS
20 Dollar days coming
as Fed prepares exit
By Daniel P. Collins
How will forex markets react to the
Fed signaling a stimulus exit as other
central banks are hitting the gas?
TRADING TECHNIQUES
26 The 48-hour movement strategy
By Azeez Mustapha
Swing-trade yourself to success with
this strategy for forex markets.
28 Leveraging futures vs.
ETN differentials
By Paul Cretien
As metal market relationships have
shifted this year, the different trading
contracts have had to evolve.
30 A closer look at price
chart choices
By Jean Folger
Price charts are a traders portal
to the markets. Its important to
choose the style that works for you.
EQUITY TRADING TECHNIQUES
34 Stocks, moving averages and
how to leverage them
By Bramesh Bhandari
How to select the best moving
average to identify opportunities.
TRADING 101
36 Quick and easy guide to
livestock trading
By Rich Nelson
Cattle and hogs offer opportunities
that are unique from other markets.
MANAGED FUNDS
40 Measurement matters
By Mark Anson, Donald Chambers,
Keith Black and Hossein Kazemi
There are a number of ways to see
inside rates of return. Here we look into
some of the most popular methods.
For additional information,
visit futuresmag.com
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SEE CLASSIFIED ADVERTISING ON PAGE 45
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Associate Editor
Michael McFarlin
Editors At Large
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Steve Zwick
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Murray A. Ruggiero, Jr.
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FLOORED
Watch for
the official
web pre-
miere of
Floored
in early
September.
Released
for the first
time on the
Internet,
this directors cut version of the
film follows floor traders as they
were forced to adapt to the new
world of electronic trading and
how some tried to fight against
that current of change.
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BOOK REVIEWS
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reviews Trading
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Investors by Van
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AD INDEX
09-IB13-659CH628
Interactive Brokers LLC is a member of NYSE, FINRA, SIPC. Lower investment costs will increase your
overall return on investment, but lower costs do not guarantee that your investment will be profitable.
Supporting documentation for any claims and statistical information will be provided upon request.
Margin Rate as of July 1, 2013. *For additional information regarding margin loan rates, see
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Metamorphosis
EDITOR'S NOTE
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O
nce on a flight from
Chicago to San Francisco,
I (miraculously) was
upgraded to business class and
was seated next to a very tall man
who was on the phone from the
time we entered the plane to take-
off. Overhearing the conversation, I picked up some puts and
calls recommendations, which obviously piqued my interest.
When we were in the air, I asked him if he was an options trader.
He said he used options only to protect his portfolio, which he
managed for a large East Coast firm.
As we spoke, he said he had gone to the University of Illinois,
where he had played football. It turned out he was the quar-
terback and a stand out until sustaining a debilitating injury.
He said during those dark days when he was reevaluating his
life goals, he had a real gut check. He eventually went on to
become a doctor and then an asset manager, where he focused
on health/medical stock funds.
Although Illinois friends were excited I met one of their
former football stars, I was most impressed with his ability to
reinvent himself successfully. Moving from athlete to doctor to
asset manager is quite a curvy path, but he seemed to do it easily.
I remembered this when reading our cover interview with
Ben Davies (see Ben Davies: Turning adversity into gold,
by Associate Editor Michael McFarlin, page 14). Davies had
been on deck to go to the Atlanta summer Olympics to play
field hockey when he was sidetracked with a back injury, which
basically ended that career. However, a chance meeting led to
a stint at Man Financial, which was at that time a private com-
modity group. Eventually he came to work for one of the top
primary dealers, Greenwich Capital, where he really cut his teeth
both in trading and devising his worldview of free markets and
the importance of hard assets.
Today Davies manages a multimillion dollar long-only gold
fund for his firm, Hinde Capital. Granted, its been a tough year
for gold, and yes, for Davies fund, but he says his fund has done
better than gold. He also reminded us that the gold fund is only
one part of a clients overall portfolio.
Change is inevitable and often not easy. Moving from an old
to new media platform has been long, tedious and sometimes
exhilarating for us at Futures. However, seeing how the above
traders/managers used their competitive skills and smarts to
change is a testimony to being agile and opportunistic in mar-
kets and in careers.
One of the sea changes for the futures industry was its move
off the floor into electronic trading. It was long in coming
and then seemed to happen overnight. In early September,
FuturesMag.com will host the web premier of the movie
Floored. Originally released in theaters in late 2009, the
directors cut will be available for the first time on the Internet,
and, for now, only at FuturesMag.com.
The documentary shows how the waning days of the floor
affected many traders; some of them had made their money
and left, while others planned to be the last man standing. Its
poignant, troubling and funny, but captures the trading indus-
try and some of its players well and, of course, solidifies the
incredible legend of the trading floor.
Director James Allen Smith, like many successful traders, also
learned to adapt to his environment. He started off as a painter
but became a web designer, which landed him a job with a for-
mer trader who ran an upstairs business. Smith then became a
filmmaker, something that never was in his original game plan,
when he saw how life on the floor was changing and how many
traders werent adapting.
No doubt the skills of the floor are different than the skills
needed upstairs. But perhaps only the best traders are able to
adapt to adversity, both in life and in trading. That shouldnt be
surprising as volatility is the lifeblood of this business.
E-mail me at gszala@futuresmag.com
1.800.264.8516 | TradeStation.com
No oer or so||c|tat|on to buy or se|| secur|t|es, secur|t|es der|vat|ves, utures products or o-exchange ore|gn currency (orex) transact|ons o any k|nd, or any type o
trad|ng or |nvestment adv|ce, recommendat|on or strategy, |s made, g|ven or |n any manner endorsed by any TradeStat|on af||ate. Trad|ng commod|t|es utures, opt|ons
and o-exchange ore|gn currenc|es carr|es a h|gh |eve| o r|sk and may not be su|tab|e or a|| |nvestors. There |s a poss|b|||ty that you may susta|n a |oss equa| to or
greater than your ent|re |nvestment, thereore you shou|d not |nvest or r|sk money you cannot aord to |ose. P|ease v|s|t our webs|te www.TradeStat|on.com or re|evant
r|sk d|sc|osures. Equ|t|es, equ|t|es opt|ons, and commod|ty utures products and serv|ces are oered by TradeStat|on Secur|t|es, lnc. (Member NYSE, FlNPA, NFA and
SlPC). Forex products and serv|ces are oered by TradeStat|on Forex, a d|v|s|on o lBFX, lnc. (Member NFA). TradeStat|on Secur|t|es, lnc. and lBFX, lnc. are separate but
af||ated compan|es. 2013 TradeStat|on. A|| r|ghts reserved.
TradeStations tools help you spot opportunities
before other traders do. See for yourself. Go to
TradeStation.com and take the TradeStation Tour.
The Proof is in the Platform.
C
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W
hen the U.S. Federal Reserve embarked
upon the policy of asset purchases (known
as Quantitative Easing) in the wake of the
2008 credit freeze, the goal was to stimulate the econ-
omy by keeping longer term interest rates low. This is
accomplished by creating new money that increases the
supply available.
If a strong economic recovery takes hold, this new
money looks for a home and immediately can be sold
into other assets or investments. This would weaken the
purchasing power of the U.S. dollar (USD). Therefore,
for the past five years, traders have grown accustomed
to translating quantitative easing into representing a
weaker USD.
Beginning in May 2013, the Fed communicated more
purposefully to the markets the potential for tapering
its purchases. The exact amount of the taper, along
with when the initial taper might happen, hasnt been
announced yet, but economists are forecasting it will
occur in September 2013.
If the Fed follows through with this plan, there are several
reasons for future strength in the greenback. Some of the rea-
sons are exclusive of one another, so dont look for all of them
to occur. Rather, look for at least one of these reasons to fuel
a USD rally:
t If USD weakens on increased money printing, then it makes
sense for the opposite to occur, and we would see strength of
the USD on reduced quantities of new money.
t If tapering releases the headwinds and interest rates rise with-
in the context of a stable U.S. economy, then capital may be
attracted toward the U.S. currency.
t If tapering increases rates, the higher rates may act like a tax
on income and upset capital markets. Money then looks for
safety that is found in the USD.
U.S. dollar bottom
We will use the Dow Jones-FXCM Dollar Index (ticker:
USDOLLAR) in our forecast, which reflects the change in value
of the U.S dollar measured against a basket of the most liquid
currencies in the world. The index is built by equally weighting
of the following currency pairs: EUR/USD, GBP/USD, USD/
JPY and AUD/USD. Together, this basket typically accounts for
80% of world-wide currency spot market activity and reflects a
diverse economic and geopolitical make-up.
Using technical analysis, we can see USDOLLAR has been
hitting a series of higher highs and higher lows. The U.S. dollar
already met the definition of an uptrend before the formalized
taper plan was announced.
In fact, the USDOLLAR carved out its bottom in August
2011, nearly two years ago (see Taper talks, above). So not
only did the USDOLLAR uptrend begin before the taper
plan was formalized, the
uptrend began before the
announcements of QE3
and QE4. [Note: The U.S. Dollar Index bottomed in 2009.]
This is what we find most compelling because the
USDOLLAR was showing relative strength when it had every
reason to be weak. Think of it like pressing down on a spring.
Once you remove your thumb, the spring explodes higher. In
this example, the USDOLLAR is the spring and the Feds asset
purchases are the thumb. If the asset purchases get smaller, it
would be like taking your thumb off a compressed spring.
How do you trade this?
Naturally, we want to look for technical opportunities to buy
the greenback. In forex, trades are made in pairs, so if we buy
the USD, then we need to look for a weak currency to match it
against simultaneously.
If the taper results in increased interest rates in the United
States and a stable environment, then look for other low yield-
ing currencies to match it against. This way, you can earn a daily
dividend by holding the trade open at 5 p.m. each business day.
At of the time of this writing, the euro (EUR), Swiss franc
(CHF) and Japanese yen (JPY) are the major currencies that you
can buy the USD against and earn a daily dividend.
Therefore, enter trades toward USD strength by selling the
EUR/USD pair or buying the USD/CHF and USD/JPY pairs.
If the Fed taper results in increased interest rates but in a risk-off
environment, then consider the USD against other higher yielding
currencies like the British pound (GBP) or Australian dollar (AUD).
That would mean selling the GBP/USD or AUD/USD pairs.
Jeremy is an active trader and head of DailyFX education of FXCM.
He currently specializes in FX and writes education/analysis articles.
Fed tapering and U.S. dollar potential
BY JEREMY WAGNER
FOREX TRADER
For daily forex updates:
futuresmag.com/Forex
TAPER TALKS
Source: FXTrader
06/18 09/19 12/23 07/01 10/02 04/12 07/14 10/15 04/25 07/25 10/26 05/01 08/02 11/05 08/15
12/11/2007 03/30/2009 01/07/2010 01/18/2011 01/27/2012 02/08/2013
2009 2011 2013
11,750
11,500
11,250
11,000
10,750
10,500
10,250
10,000
9,750
9,500
9,250
QE
QE2
QE3
QE4
USDOLLAR Bottom August 1, 2011
10,745
04/19/2013
The USDOLLAR uptrend began in August 2011.
BREAKING BREAKING NNEW EWS
EEE CLUSIVE XCLUSIVE RREPORTS & EPORTS & AANALYSIS NALYSIS
E CATION DUCATION
TRADING RADING SS ATEGIES TRATEG
L VE MARKE IVE MARKET UPDATES P
THEE 24/7 RESSOU 24/ RESOURRCE FO CE FORR TODAYS TODAYS TRRADE ADERSS
Watch for the official web
premiere of Floored in early
September. Released for the
first time on the Internet, this
directors cut version of the
film follows floor traders as
they were forced to adapt to
the new world of electronic
trading and how some tried
to fight against that current
of change.
W
ould you like to collect income regardless of the see-
saws in the market? Heres how to use two comple-
mentary strategies for collecting short-term income.
The first thing thats needed is a low-dollar stock with options
that have high implied volatility. The higher implied volatility
means theres more premium to collect. For this example, take
a look at the Yahoo (YHOO) price chart below. At the bottom of
this chart you can see that the implied volatility is trading in the
middle of its one-year historical range. My rule on this is that if
the volatility clearly isnt low, then its high. Thats the case here.
The first strategy is selling a short-term ATM (at-the-money)
put spread. With the stock trading at $27.25, and 10 days remain-
ing until expiration, selling the 27 strike put for $0.33 provides
the credit. But well also buy to open the 24 strike put for three
cents as protection in case the stock drops. The net credit for the
spread is now $0.30 and has a maximum risk of $2.70. In this
instance the net credit represents a potential 11% ROI in 10 days.
If the stock remains
steady, or moves high-
er, the put spread will
drop in value. By expiration, if the stock is higher than $27, then
both puts should expire worthless and you would keep the full
credit as the income.
I said should expire worthless because even though the 27
strike put option is out-of-the-money, the option holder still has
the right to exercise it and might do so in certain circumstances.
So best practices would dictate buying to close the option when
it drops to one to two cents. Some brokers offer no, or lower,
commission costs to close short options below five cents.
After buying the short option to close, its time to sell the
ATM put spread again for the next expiration. Depending on
the stock or ETF youve chosen, the next expiration could be
anywhere from one week to one month away. Sell the ATM put
option to open, and buy a lower strike put, as a short vertical
put spread. Which strike should you buy? Look for something
cheap, five cents or less, just to hedge the downside risk.
Repeat this trade every expiration until the day comes when
you get assigned the stock. Its going to happen, so you need
to be prepared to buy the stock. What do you do now? This is
where the second strategy comes in: A collar.
In a previous issue the use of a cashless collar was discussed,
but the implementation of this collar differs. Instead of sell-
ing an OTM (out-of-the-money) call as a way of paying for the
protective put, this strategy sells a call with the same strike as
the put on which you were just assigned. Lets assume the 27
strike again for this example.
For those who understand synthetics, youll see that owning
the stock from the assignment and selling the 27 strike call
acts just like a short 27 strike put. By buying the OTM put for
protection, this position resembles the same short put spread.
At expiration, if the stock remains below $27, you keep the
credit income from the call, and your long put protects the stock
if the price continues to drop. If the stock moves above $27 at
expiration, then you sell the stock back at the same price you
bought it, and you still keep the credit.
As long as the implied volatility remains high, keep this trade
going. When the implied volatility reverts back to the low end of
the range, then its time to find another suitable candidate and
start the process again. Over time, taking in these short-term cred-
its will start to add up regardless of which way the market moves.
Greg Loehr is a former CBOE market maker trained by Susquehanna
Intl. Group, and founder of education firm OptionsBuzz.com. He has
written and presented extensively on options globally.
IMPLIED VOLATILITY
Feb Mar Apr May Jun July Aug
Question: How can I derive income from cash on hand?
Answer: Sell premium.
BY GREG LOEHR
OPTIONS STRATEGY
For more options strategies:
futuresmag.com/Options
YAHOO CHAIN
Exp Strike Bid Ask
$27.25
Aug 13 23 0.01 0.02
Aug 13 24 0.02 0.03
Aug 13 25 0.03 0.05
Aug 13 26 0.10 0.12
Aug 13 27 0.33 0.34
Aug 13 28 0.89 0.91
Aug 13 29 1.73 1.76
30
29
28
27
26
25
24
23
22
21
20
0.4
0.35
0.3
0.25
0.2949
27.2
Source: Need source...
WHY YOU SHOULD
TRADE FUTURES WITH A
COMPANY YOU THOUGHT
WAS JUST AN
OPTIONS SPECIALIST.
Our innovative, easy-to-use platform was also designed for futures traders.
After all, we specialize in more than just options.
Options and futures involve substantial risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options and
Risk Disclosure Statement for Futures and Options, available by calling 1-888-280-8020, prior to opening an account. Multi-leg option strategies may also be
subject to multiple commissions. Prots may be eroded by the commission expended to open and close the positions, and other risks apply. Online trading has
inherent risk due to system response and access times that may vary due to market conditions, system performance, volume and other factors. Website content
and tools are provided for educational and informational purposes only. Supporting documentation for any claims, comparisons, recommendations, statistics,
or other technical data will be supplied upon request. optionsXpress, Inc. (Member SIPC) and Charles Schwab & Co., Inc. (Member SIPC) are separate but afliated
companies and subsidiaries of The Charles Schwab Corporation. 2013 optionsXpress, Inc. All rights reserved. Member FINRA, SIPC, NFA.
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DIGITAL EXCLUSIVE 14 FUTURES September 2013
G O L D
FUTURES MAGAZINE: Ben, you went to school
to be an athlete and came very close to com-
peting in the Olympics. Can you tell us how you
went from athlete to trader?
BEN DAVIES: I was born in Cambridge and went to
first school in Cambridge. That was a very academic
school. I think it is fair to say that I enjoyed the aca-
demic rigor but my real passions [were] sports and
psychology. I came to appreciate academia years later
because of trading as I wanted to learn for learnings
sake, not because of the enforced nature of exams.
So, I made the decision when I was 18 that I
wanted to follow my true passion, which at the
time was sports science. I focused on exercise
physiology, sports psychology and biomechan-
ics. I became a sports science and finance student
at Loughborough University, which is very well
known for its sporting programs. Early on, it was
really psychology and sports that attracted me to
competition and developing winning strategies
that comes with that, which is very pertinent to
trading today.
At that time I was a field hockey player, and
being a sports psychologist and going to college
there, I was able to devote a lot of my time play-
ing for Loughborough, Wales and Great Britain.
As you said, I was on the Atlanta Olympics squad,
but I had to pull out because of a serious back
injury early on. I will say that my passion had
probably since passed, and if you are going to do
anything well, then you need to be authentic and
have integrity, otherwise youre not going to give
your best for it. It made me rethink my career,
and I made that move from athlete to trader.
It was a chance discussion that lead me to a few
days work at Man Financial, which at the time
was a private commodity group, and Ive been bit-
ten by the bug ever since. I think it was a manifes-
tation of Could I do it? How would I have coped
with some of the famous crashes? I wasnt trading
in 1987, but how would I have adapted to it? That
led me to make that shift. It was part forced, but
part that desire to pit myself against the market.
FM: Where did you get your break into trading?
BD: Its interesting having come from the back-
I
t was a chance encounter after a back injury that turned Ben Davies attention from
sports to the markets, but the same competitive spirit still drives him in advocating for
monetary reforms. Cutting his trading teeth at Greenwich Capital, he saw firsthand
the events and conditions that led to the 2008 financial crisis.
Now having started his own firm, Hinde Capital, Davies is a champion for free markets
and allowing them to [function] independent of central bank intervention, all while oper-
ating a long-bias gold fund to protect investor purchasing power. We caught up with him
to get his view on the gold market and the role of central banks.
BEN DAVIES:
Turning adversity
into gold
I NTERVI EWED BY MI CHAEL MCFARLI N
PHOTOGRAPHY BY JORDAN HOLLENDER
Q & A
DIGITAL EXCLUSIVE
Competi ti on al ways has been
a way of life for Ben Davies, only
his opponents have changed. Now
hes facing his biggest foe: Central
banks and their fight for survival.
futuresmag.com 15
DIGITAL EXCLUSIVE
ground I had as an athlete just how many people wanted to hire
me more for my sporting prowess than perhaps my academic
capabilities. Ultimately it was Greenwich Capital. That was my
breakthrough into trading markets at the macro fixed-income
level. I also was very fortunate to meet my now work partner,
Mark Mahaffey, who co-founded the London office of Greenwich
Capital. For people who dont know, Greenwich Capital was the
No. 1 primary dealer in U.S. government bonds, agencies and
to some extent mortgages. [Mahaffey] was the chap who really
instilled in me the inquisitive nature you need to pursue the truth
in developing your rigor and understanding of the markets.
FM: What were some of the important trading lessons you
learned throughout your time at Greenwich?
BD: I started off as a market maker, and I think thats a great
place for any young trader to start because you get an appre-
ciation of risk. Often youre put into positions that are not
conducive [to] a positive outcome, the risk/reward isnt nec-
essarily conducive to a successful trade there and then. It was
very much about mitigating loss rather than turning it into
profit. The time horizons for a market maker are very differ-
ent from [those of] a macro proprietary sort of longer-term
investor where you can determine the timing of your trades,
but nonetheless it gave me a huge appreciation for risk-taking.
Trading for me ultimately is about having conviction and
flexibility, which in many ways are at odds with each other. If
you allow your conviction to boil over too much, it can border
on hubris, but if your flexibility is too much that you cant risk
at the first sign of trouble, then thats not successful either. A lot
of the subjective and discretionary risk-taking that I first learned
at Greenwich Capital, and [from] my partner since, has been
codified in [the] systems, we use as our parameters to ensure we
have very good risk and dynamic money management.
FM: You just mentioned Greenwichs position in the global
securities market What did your time at
Greenwich teach you about the global
economy?
BD: It gave us a very unique, inside track as
to what one of the largest players in capital
and trade flows was doing, and that was
China. In regard to the U.S., being the No.
1 dealer in bonds, agencies and mortgages,
I was able to see firsthand this buildup of
FX currency reserves, and see how they
were impacting and driving down long-
end rates. By driving down long-end rates,
the U.S. was supporting mortgages and
consumer credit, while at the same time
creating a dearth view for pension and
endowment funds, the symptom of which
was financial engineering.
The sub-prime crisis really was a prod-
uct of Bretton Woods II, which I refer to
as a semi-fixed exchange rate where the
U.S. is centric . In essence the Asian coun-
tries are more or less pegging their currencies to the dollar with-
out the backing of gold to maintain their relative competitive
ability to sell things cheaply to the U.S. The defining nature
of this whole international monetary system is financing the
United States huge deficits, both fiscal and trade, and has done
those at low interest while allowing them to finance the export
boom of China. Really, its helped build up a huge amount of
credit in the system. If we had been under a gold conversion or
standard, there would have been restraint on that build-up of
reserve currency, that would have been the natural equilibrating
mechanism of the trade balance, but we havent had that. So,
weve had this egregious proliferation of credit as a consequence.
In many ways, this is what led us to setting up Hinde Gold
Fund. It was our macro insight that led us to believe there is
going to be an unraveling of the financial system or this credit
bubble, and that the re-balancing of this vendor financing
relationship ultimately would lead to the collapse of the credit
bubble and the recapitalization or monetization by the private
sector of gold. Thats what we are witnessing.
FM: Was this view pervasive among other traders at Greenwich?
BD: No, definitely not. Dont get me wrong, I do think there
was an inordinate [number] of people that understood there
was something wrong with the financial system. All asset prices
were rising, and they hadnt necessarily put the macro picture
together, which I felt that we had. And, certainly we had the con-
viction to set up a business. We created a unique long-only man-
aged gold fund that was backed primarily by allocated gold held
outside the jurisdiction of the banking system, and it garnered a
lot of interest at the time. You have to remember that for CNBC
and Bloomberg at the time, gold wasnt even a ticker on the TV
screen when we started, despite it being in a stealth bull market
probably for about five years. Certainly the reaction from others
suggested that this was a rather unique and insightful thought
process, but I would say there were many who understood that
Q & A continued
DIGITAL EXCLUSIVE futuresmag.com 17
Go to futuresmag.com/davies
for an unabridged version of this interview.
something was fundamentally wrong.
FM: Youve already mentioned that government securities
are some of the largest and most-traded assets available;
what made you go from trading bonds and securities to the
comparatively much smaller gold market?
BD: We perhaps were intellectually correct but commercially
nave. We thought that the boom of the gold market would
create sponsorships of very big gold funds, and we wanted to
be part of that. But primarily, we wanted to protect investors
assets from what we saw as potential fallout from the finan-
cial crisis, either from default risk or policy responses of cen-
tral banks and governments, which would be to increase the
money supply to such a significant extent that they would try
and underpin the credit system. Thats what were continuing to
see today. That policy prescription probably is the definition of
insanity; well keep repeating the same state over and over again.
But it wasnt about moving from a big market to a small mar-
ket. In fact, I would argue that we are in the process of witnessing
the great bond bubble, which is at the center of our financial
system. You have to think about how fractional reserve banking
ultimately is collateralized with sovereign debt. When you under-
mine the credibility of sovereign debt by getting to a level where
the country doesnt have the income to service its debt repay-
ments, then you have to look to the growth of a new monetary
system. I certainly think that gold is part of that new mechanism.
FM: Obviously these views led to your forming Hinde Capital.
Can you tell us a little about your fund?
BD: We started Hinde Capital in 2007 and we set up a long-only
managed fund. It garnered enormous attention both from the
media and from investors in our first few years, but ironically
the 2008 crisis and forced deleveraging all the reasons why
people should have gone into our fund suddenly meant that
it wasnt available to them because they were putting out fires.
It was a very difficult couple of years.
As people came to understand that gold is growing as an asset
class, we started getting a lot of interest from pension funds and
sovereign wealth funds, and the firm grew in accordance. Despite
the recent correction in the gold market, the fund has returned more
than 40% [since inception] and weve outperformed our benchmark
gold price, perhaps not by as much as we had hoped because we
had an allocation to mining. Thankfully 18 months ago we had the
foresight to reduce that almost to a zero holding because we saw a
cost issue where, lets just say, the banking and mining industries
were being disingenuous about what the true costs were. Our big-
gest macro expression is a belief that the crisis is ongoing, and the
distortion in market rates is creating all sorts of opportunities and
hence why a lot of our investors asked us to set up a global macro
fund, which is what we are in the process of doing.
FM: So your gold fund only trades in the gold markets?
BD: We trade allocated precious metals gold and silver pri-
marily and we can choose to have up to 20% in the mining
sector as well.
FM: You recently made some astute calls in the silver market,
predicting both the markets takeoff and subsequent decline.
Whats your trading methodology?
BD: Its interesting you should mention those; when youre able
to make those sort of accurate calls, it does tend to put you on
the map. It was more important for us actually to create a return
out of both of those situations, rather than just be a mouthpiece
for what was happening. Thankfully we were able to achieve that
with a very good risk vs. reward setup.
We center everything around macro analysis, all in conjunc-
tion with understanding the market dynamics. It doesnt matter
what our macro conclusions are on a potential trajectory of an
economy or marketplace, we have to wait for a signal genera-
tion of whether to deploy risk in that asset class. As you know, if
the marketplace isnt in a dynamic state to facilitate your view,
you end up losing a huge amount of capital in terms of time
premium, opportunity costs and mental capital associated with
that. We always feel we need to know what phase the market is
in is it trend ready, exhausted or in homeostasis?
All of this is assessed within the bigger picture of Breton
Woods II, which is a highly imbalanced currency system.
It drives imbalances right across the global economy, and it
impacts right down to the micro level, like the silver market.
Take the vendor financing relationship under Breton Woods
II, which financed the U.S. housing boom, and because that
arbitrage of interest rates was the same across Europe, it was
why we had a housing boom there. So we like to look at and
examine supply and demand imbalances both at the macro
and micro level. That can be a trade in capital accounts or all
the way down to these inconsistencies that we refer to in silver
where there seems to be a huge imbalance, and definitely in
my mind proves the efficiency of markets under [the efficient
market hypothesis] (EMH) is a complete fallacy. Its fair to say
that is a disproven theory. We tend as a firm to observe more
heterodox economic theories, highly polarizing doctrines that
are in development of each other. In many ways its distasteful
and perhaps born out of egotistical posturing, but we can learn
a lot [from] other economic theories.
When we go through the macro observations, there are prem-
ises that business cycles are propagated by excessive growth in
banking credits, vis--vis fractional reserve banking. This obvi-
ously is being encouraged by central bank interest rates remaining
below the natural rate of interest, i.e., this is where individuals
would truly lend or borrow based on consumer or temporal pref-
erences. It is this monetary intervention in the market that has
created a distorted signal of demand, and has led to the misalloca-
tion of capital in various sectors like precious metals. The facts
dont support or match consumer preferences. What people see
as a rising price and think is rising demand in fact is an inflation
dynamic of that business cycle or that industry.
FM: So how do you model this in your trading?
BD: When it comes to modeling, we look at the macro side, as
Ive alluded to, from the concept that the business cycle is the
credit cycle. In terms of the market dynamics, Albert Einstein
used to say a theory is more impressive the simpler its premises,
DIGITAL EXCLUSIVE 18 FUTURES September 2013
Q & A continued
so my mantra is keep it simple, stupid or KISS. So, we distill every
complex notion down into its component parts, ask the obvious
questions and build a hypothesis from there. For me, markets are
like nature they definitely are a complex system, which exhibits
complex organizational behavior and similar dynamics to nature.
You end up with ruptures brought about by plate tectonic shifts
and earthquakes; its the same principle when you see volatile
cracks appearing in markets before a crash. Yet, systems are very
holistic. You have these observations where you can see stresses
as the precursors for a rupture or movement in the market.
The way theory is today and the way people model today
is based on trying to find order and equilibrium, which is an
innate desire within people. One area that we use particularly
is fractal analysis and market behavior, i.e., that which has dis-
credited EMH and the random walk concept. All these partici-
pants are solving for the wrong question. Trying to understand
why we are here why were on this planet or why the market
is where it is is an insolvable question. Markets for me are
just a function of life. It comprises decision-making by myriad
people; its a combination of interactions and reflects as either
rational or irrational in the eye of the beholder. So any crowd
maintaining order is extremely difficult.
So, what we do is look to the market to tell us the state, rather
than comprehend all the reasons it is in that state. We dont
try and assign cause; we ignore our innate desire for order. We
tend to look at the market in a more three-dimensional way. For
us, markets look the same on every time or scale. Most people
look just at price and time; we tend to look at four-dimensional
components. We want to look at the phase changes that occur
before a change in the state of the market.
FM: Speaking of market states, the bear market in gold that
began after the 1980 peak lasted for about 20 years. Where
do you see us in the lifespan of the current gold bull market?
BD: Were more interested in what the present state and dynamic
of the market is. Certainly the four-dimensional components of
the market that led to the down trade showed a scaled invari-
ance to different time scales. The market
was exhibiting some stress. Looking at par-
ticipants in the market, there were some
that had been in the market for a long
time, and ultimately the market was trend-
ing and was ready to make a move in one
way or another. In this case, stale longs or
whatever the trigger we can debate, but the
market had to release lower. I personally
believe markets move from fair value, and
that isnt a mathematical value based on
intrinsic values of cash flow, but is based
on supply and demand of participants in
the market having satisfied the conditions
for exchange until such time as the market
becomes out of balance with one or more
of those economic agents perceiving that
economic value needs to be higher or lower.
Then the market will start to trend. Now,
when I talk about the market trending
here, it was in regard to a short-term trend that was corrective
in nature to the primary trend, which is still higher. This is a
very healthy correction, and the market on our models has now
reached trend exhaustion, it has exhibited all of those signs.
When we talk about the gold market, its actually two markets
a physical market and a paper market. There is no doubt that
there is a fractional reserve banking-esque element to the gold
market whereby for every ounce that is traded, many multiples
of that are leased out or traded in some OTC construct. That
leads to an unfair amount of potential supply at some points
on the marketplace that is not reflective necessarily of funda-
mentals. Right now, weve satisfied the conditions of the short
sellers, and if anything the long-term holders in the market are
extracting new value. As you can see, the market has started to
rebound and probably will find itself at a new trading range
in the next six months at around $1,400 to $1,600 [an ounce].
FM: Youve already talked about some of the factors that
are really affecting gold, but do you see traditional supply
and demand factors at play or is gold being moved by larger
geopolitical concerns?
BD: Ben Bernanke pays very little lip-service to gold, he almost
doesnt mention the word at any point in any of his directives
or speeches. Its almost as if [it would] give some acknowledge-
ment to an alternative currency, which lets face it, it potentially
is. [Gold] was once money, and it could be again. It could be a
way of recollatoralizing the system either through a government
gold standard or through the private sector creating some kind
of payment system that uses gold as a backing for transactions,
and perhaps in some countries, like the East, using it to exchange
their U.S. dollar holdings. That definitely is the dynamic in play.
China and the rest of the BRICS probably couldnt believe their
luck when they were able to purchase gold at these levels for some
of the U.S. Treasuries and agencies that they already owned. So,
yes, its part of a bigger dynamic indeed.
Q & A: Ben Davies continued on page 45
F O R E I G N E X C H A N G E
S
ince Federal Reserve Board
Chairman Ben Bernanke first
hinted back in May that the Fed
at some point would reduce the amount
of monthly bond purchases (QE3), talk
of a taper and its effect has dominated
all market sectors. Currencies are no dif-
ferent. But the one constant in financial
markets over recent years is a gnawing
uncertainty. The economy has experi-
enced slow, tepid growth and, just as the
recovery looks to gain steam, there is a
downturn. All Fed action is data-depen-
dent and the data is screaming, ugh!
Things are better but we arent out of the
woods yet.
A consensus was building that the Fed
would begin tapering at this Septembers
FOMC meeting, which would be U.S. dol-
lar positive, but weaker jobs growth in the
July employment report may have pushed
it back to the 50/50 range.
The entire tapering debate is the
biggest catalyst for the dollar at the
moment, says Andrew Wilkinson, chief
economic strategist for Miller Tabak &
Co. LLC.
George Dowd, head of Chicago for-
eign exchange for Newedge, sees tapering
occurring earlier than consensus based on
better employment numbers (we spoke
before the July report came out; one more
employment report will come out before
the Fed meets next). Dowd expects a taper
in September and thinks it may be more
substantial than expectations.
You have to look at where they are going
to go with the purchases as well, he says.
Currently they are purchasing $45 billion
in Treasuries and $40 billion in [mortgage-
backed securities]. The market consensus
for the September meeting is they go 35
and 30; I think they can go 30 and 30.
While the taper is generally bullish
the dollar, Wilkinson believes like the
initial reaction to taper talk the dollar
rally may have gotten ahead of itself.
What changed in [July] is that the
market has dealt with the distinction
between tapering and raising interest
rates. It shouldnt be confusing. Price
action tends to mislead investors and
that is exactly what happened. Rising
bond yields immediately impacted the
stock market and the logical conclusion
was that the Fed is tightening, and that
wasnt the case, Wilkinson says. What
has transpired over the early part of the
summer is that the dollar is not set to
benefit any time soon from rising yield
differentials on account of official inter-
est rate rises, so as the market discounts
that, investors appetite for dollars
become less.
Sharpe + Signa Managing Director
Garen Ovsepyan agrees. Fed tapering is
dollar-positive in terms of market senti-
ment; however, as far as money markets
are concerned, tapering is not necessarily
a hike in rates, he says
Ovsepyan points out that the dollar
consistently has failed to take out signifi-
cant technical resistance at 83.50. If the
Dollar Index trades convincingly above
83.50 at least on a weekly basis, we adjust
our view from bearish to neutral or pos-
sibly mildly bullish.
Dowd, however, sees the dollars slide in
July as an opportunity. It has had a nice
little retracement down from where it had
been; you cleaned out a lot of weak longs,
he says. The fundamental focus going
into year end is going to be dollar-bullish; I
am expecting new highs in the dollar index
going into year end. You will see the dollar
trading up around 85.50-86.00.
For forex updates,
go to futuresmag.com/Forex
p g j
recovery looks to gain steam, there is a
downturn. All Fed action is data-depen-
dent and the data is screaming, ugh!
Things are better but we arent out of the
woods yet.
A consensus was building that the Fed
would begin tapering at this Septembers
FOMC meeting, which would be U.S. dol-
lar positive, but weaker jobs growth in the
July employment report may have pushed
g
Currently the
in Treasuries a
backed securi
for the Septem
and 30; I think
While the
the dollar, W
initial reactio
rally may hav
What cha
market has d
between tap
rates. It shou
action tends
The taper debate
Carry trade divergence
The U.S. Federal Reserve appears ready to begin tapering just as other central
banks may be adding to their balance sheets. What will this mean for the global
forex market? And remember, this is all data-dependent.
MARKETS
Dollar days coming
as Fed prepares exit
BY DANI EL P. COLLI NS
futuresmag.com 21
Jason Rotman, president of Lido Isle
Advisors, says the data needs to justify dol-
lar confidence. A lot of people are looking
for the U.S. dollar to start to go up again
and break this years high of about 85,
but it is not doing that, it is not coming
close, Rotman says. For the U.S. dollar
to continue its 2013 bull trend, it will need
several months of phenomenal nonfarm
payroll growth and even start to see the
core [Consumer Price Index] numbers
[come in] consistently above expectations
because the Fed does not want to crash
this market with a premature statement
of stimulus reduction.
FXCM Chief Currency Strategist John
Kicklighter sums up the divergence of
opinion on the dollar: For the remainder
of the year, one of the takeaways is that it
is going to be extremely volatile.
He adds, It is a game of competitive
stimulus. It is going to have an impact
on the dollar. If we see the taper occur
in September, it is the thing that could
cause the dollar to continue higher.
One reason why Kicklighter is expect-
ing greater volatility is the divergence
between the S&Ps and the carry trade.
You have a strong correlation between
the S&P 500 and the carry trade index
(see Volatility watch, right). Just over
the past three or four months you have
seen a very substantial divergence in their
performance, Kicklighter says. This is
one of those early warning signs that you
get when the markets [dont assume] that
there is going to be very low volatility. I
dont think there has been a carry trade
because of these concerns. The carry
trade has a lot more room to unwind,
especially if things get dicey.
Another divergence Kicklighter points
out is the dollar is a safe haven. While
that always will be the case, he points
out that its correlation with the S&P has
built in 2013 despite a strong equity rally
with low volatility (see Safe haven or risk
asset? right).
He says the dollar will get to 90 by year
end but not go beyond it. To make the
transition, you have to have extreme risk
aversion and the dollar is already essen-
tially at a three-year high so a lot of the
taper concern has been priced in. but I
dont think you will get beyond 90 until
you have the conversation that you are
moving beyond stimulus.
And therein lies the rub because as
the U.S. central bank is debating when
to take money out, others are looking to
add more stimulus.
You are talking about the Fed at the
crest of its stimulus program while the
Bank of Japan just recently hit the accel-
The S&P 500 usually is highly correlated to the carry trade. You can see the divergence
between the Deutche Bank Carry Trade Harvest index vs. the S&P 500. Each represents
a buy and hold philosophy, and they tend to be highly correlated.
VOLATILITY WATCH
Source: FXCM
1800
1600
1400
1200
1000
800
600
330
310
290
270
250
230
210
190
Carry trade market and yield value
S&P 500
DB Carry Trade Index
7
/
1
/
2
0
0
3
7
/
1
/
2
0
0
4
7
/
1
/
2
0
0
5
7
/
1
/
2
0
0
6
7
/
1
/
2
0
0
7
7
/
1
/
2
0
0
8
7
/
1
/
2
0
0
9
7
/
1
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2
0
1
0
7
/
1
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0
1
1
7
/
1
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7
/
1
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1
3
Kicklighter says the risk-on/risk-off trade pattern has changed because historically we
expect the safe haven to be on the opposite side of the spectrum of the investment
benchmark. Here we see (in 2013) a high correlation despite subdued volatility as
measured by the VIX.
SAFE HAVEN OR RISK ASSET?
Source: FXCM
90.0
80.0
70.0
60.0
50.0
40.0
30.0
20.0
10.0
0.0
-1.0
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
Correlation - Safe haven dollar and high return S&P 500
VIX
SPX -USD Correlation (60-Day, Inverse)
1
/
2
/
2
0
0
3
1
/
2
/
2
0
0
4
1
/
2
/
2
0
0
5
1
/
2
/
2
0
0
6
1
/
2
/
2
0
0
7
1
/
2
/
2
0
0
8
1
/
2
/
2
0
0
9
1
/
2
/
2
0
1
0
1
/
2
/
2
0
1
1
1
/
2
/
2
0
1
2
1
/
2
/
2
0
1
3
S
&
P

5
0
0
V
I
X
D
B

C
a
r
r
y

T
r
a
d
e

I
n
d
e
x
S
P
X
-
U
S
D

C
o
r
r
e
l
a
t
i
o
n
erator, so they are at different phases of
their programs, Kicklighter says.
And it is not just the yen. New Bank of
England Governor Mark Carney is making
noise that the BOE will add stimulus soon,
as is likely with the European Central Bank
(ECB) and the Reserve Bank of Australia.
Euro conundrum
The euro is in a curious place because
on the one hand monetary policy looks
set to ease in the Eurozone even as the
economy improves, and as the economy
continues its improvement more people
appear to be buying the euro, which in
effect is creating tighter monetary con-
ditions, Wilkinson says. That in itself
argues for further easing from the ECB.
Dowd says, I dont think the ECB is
opposed to having the euro weaker. So if
the dollar gets strong, the first step on the
downside [for the euro] after you get past
the 1.2740 [2013 low] is 1.25. Germany
is the big question. It is really how much
Germany wants to continue to carry some
of these peripheral countries.
But the euro has shown resilience in
2013 and may be in in a good spot where
growth is beginning to pick up, but not
so much as to prevent further stimulus.
The euro is really the weakest link,
though one of those things that has
helped it is the fact that it is always in
trouble: Greece, Ireland and rest of the
[peripherals], Kicklighter says. The euro
is going to be interesting because it really
depends on how robust risk trends are
going to get. You probably will be down
to 1.25 by end of year. The [British]
pound will drop back to 1.48.
The euro has been extremely strong,
Rotman says. It has been in a range
from 1.27-1.34 throughout the summer.
Now we are getting pretty positive eco-
nomic confidence data coming out of the
Eurozone and Germany. Even though the
European officials have said that the job
growth is horrendous, you really could
not tell that by looking at the euro. It is
at 1.33 and approaching the range high
of 1.34. Any time it has gotten to the bot-
tom part of the range we have found sig-
nificant buying. I could see 1.36.
Wilkinson sees this, but says, My out-
look for the euro is to fight the trend. The
trend is very clearly upward and that is
tripping a lot of people up. Most people
are not looking for monetary tightening,
with many looking for easing. I dont
think improving growth prospects is a
sufficient factor to drive the currency
higher at this point.
Dowd also is skeptical of euro strength.
The euro has some structural issues; we can
get down to 1.2450-1.2500 before year end.
Ovsepyan splits the difference, expecting
the euro to settle near 1.3000 by year end.
So there you have it analysts are split
between the euro making either a yearly
low or yearly high as 2013 comes to a close.
Manipulation
In our April currency outlook, we men-
tioned there was some fear of a currency
war based on a statement from the Group
of 20 at its Moscow Summit expressing
concern over the level of central bank
machinations and a chance some coun-
tries might be labeled currency manipu-
lators. That seems to have calmed down
and most view the various central banks as
simply doing what they can on the mon-
etary side to support their economies.
Japan has been the [closest] example
of manipulation that you are going to
get, Kicklighter says. They dont label
them a currency manipulator because if
you label Japan a manipulator, then you
would have to label China a currency
manipulator and then you would have
to say the U.S. is a currency manipulator
because we moved our stimulus program
to exceptional levels.
He adds, The appropriate term is
competitive stimulus gain. You have
to measure what their objectives are,
they have to prove that you are trying to
manipulate the exchange rate simply for
the exchange rate sake rather than pro-
moting domestic growth.
Rotman says active central banks are a
part of life today. That issue is so wide-
spread and commonplace in todays
central-bank-dominated currency mar-
ketplace. Central banks overtly affect the
currency markets on a daily basis. That is
the reason the Aussie dollar went below
the 90 level [at the end of July].
Dowd sees the move down in July in
the yen as more corrective. [The yen] is
going to move up to 105. By year end the
yen will be around 105-110.
Dowd has the consensus opinion but
the yen has improved against the dollar
despite the interventions of Abenomics
to weaken the currency based on Japanese
Prime Minister Shinzo Abes policies.
We are going to have a pullback in
MARKETS continued
Whether you blame China or the Aussie central bank, correlation among commodity
currencies has split.
NO LONGER BEST BUDDIES
Source: eSignal
1.07000
1.06500
1.06000
1.05500
1.05000
1.04500
1.04000
1.03500
1.03000
1.02500
1.02000
1.01500
1.01000
1.00500
1.00000
0.99500
0.99000
0.98500
0.98000
2013 16 Feb Mar Apr 16 May 16 Jun Jul 16 Aug
1.08000
1.07000
1.06000
1.05000
1.04000
1.03000
1.02000
1.01000
1.00000
0.99000
0.98000
0.97000
0.96000
0.95000
0.94000
0.93000
0.92000
0.91000
0.90000
0.89000
0.88000
AUD/USD Spot Forex (Daily)
CAD/USD Spot Forex (Daily)
0.90060
1.04110
futuresmag.com 23
the yen for the next month and a half
but eventually end the year at 105,
Kicklighter says.
The pace of yen weakening has
stalled with the yen trading below 100,
Wilkinson adds. I believe it is a cor-
rection; ultimately the yen will trade
between 104 and 110, whether that is
before the end of the year I am not sure.
Rotman pegs 105 in the yen by year
end. Ovsepyan is the outlier, pegging 98
in the yen.
Aussie
A permanent concern in all markets and
market sectors is China, and slow growth
in China has been blamed for the extreme
weakness in the Aussie dollar.
I have been of the opinion that the
Chinese economy is slowing because of
what happened in the Eurozone. Yes, there
is some domestic slowdown in China but
it appears the Chinese authorities will step
in to support growth even if it is slipping
to a historically low level, Wilkinson says.
Dowd says, Australia is going to be
dependent on how things go in China but
when you look at that chart it looks a little
oversold right here. If we can trade above
95, the market gets back on a flat position.
Wilkinson points out that China has
emerged and may see lower GDP num-
bers as a result. As the Eurozone news
becomes less bad, you will definitely see a
pick-up in Chinese activity. Whether that
is sufficiently strong to drive a rally in the
Aussie dollar is [debatable].
Also debatable is whether weakness in
the Aussie dollar can be blamed on China
or if the reason is closer to home.
Rotman says central bank statements,
not Chinese weakness, is the reason for
the fall. It is because Australian central
bank chief Glenn Stevens blatantly said
we still think our currency is too high.
You cant get much more obvious than
that. As soon as he said that the Aussie
went from 91 to 89.
Whether you blame it on China or
Stevens, it has caused a split in the once
dependable correlation in the commod-
ity currencies (see No longer best bud-
dies, left).
Wildcards
Opinions are varied, and of course data-
dependent. The one wildcard mentioned
by most analysts is a significant change in
the expectations of a tapering, but more
importantly the fundamental reasons for
such a change. Dowd sums it up, The real
wildcard would be if the [United States]
turns down again. If we saw a real dete-
rioration in the employment numbers or
the housing market in the [United States],
that would be a game changer.
The U.S. dollar appears strong because
the U.S. economy is preparing to begin
weaning itself from extraordinary accom-
modation while the rest of the world is at
the trough. If the numbers dont justify
it, things could change.
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M
arkets often experience long,
smooth upward pushes
punctuated by violent pull-
backs, brought about by some fun-
damental event. This isnt surprising,
especially when we delve deeper into
market dynamics.
Market studies have shown that the
seriousness of market metamorpho-
sis could be decided by the buying and
selling pressure. During a serious price
movement, pressure gains momentum.
Intensifying moves in an equilibrium ter-
ritory may portend an exponential rise
in price pressure. Moves that become less
intensified may forecast a counter-trend
rise in pressure.
Expanding pressure brings with it a
more colossal directional move, but you
should not overlook the seemingly refrac-
tory nature of the financial markets. The
most crucial issue is that it is not just the
pressure itself. With any given market
move, dont assume there is a bear for
every bull; therefore, market pressure is
ineffectual. If this were true, the markets
would be caught in never-ending consoli-
dation. Fear and greed of bulls and bears
propels the markets.
Transaction pressure and market
movements reveal price dynamics.
Consider buying/selling pressure as
a lopsided attempt, while the market
action is the aftermath. If bears are
inclined to close orders at all costs, there
might be a propensity to do so at the bid
rather than the offer. If purchasing need
is scantily situated beneath the price,
then the markets would be propelled
toward the downside until bears get sat-
isfied. Alternatively, if bulls are inclined
to act, they may purchase the offer and
not sit on the bid. If there is not much
resistance, the market may move higher
until the bulls are satisfied.
We can capture the tendency of the
market to swing from one short-term
extreme to the other with a technical-
based trading strategy that brings with
it the added benefit of simplicity.
Swing strategy
The 48-hour movement system uses a
simple moving average (SMA) and the
relative strength index (RSI), both on
a 20-period basis. It is most effective
trading currency pairs and crossrates
(for example, EUR/JPY, AUD/JPY, EUR/
USD, AUD/USD, EUR/NZD, EUR/
CAD, GBP/USD, GBP,CHF). It trades on
hourly charts. The rules are simple: Go
long when the price is above the SMA
and the RSI is above 60. Go short when
price is below the SMA and the RSI is
below 40.
The trade triggers are just part of the
plan, however. Just as important are posi-
tion sizing and risk-control guidelines.
Maintain a stop loss 90 pips from the
entry price. Take profits 180 pips from
the entry price. Move the stop loss to
breakeven once prices moves 50 pips in
your favor. As for size, smaller positions
are auspicious. Trade $2,000 lots.
Finally, if the stop loss or the profit
target arent hit within 48 hourly bars,
exit the position.
Trade examples
In the charts showing the trade exam-
ples, the vertical red line on the right
shows where a position was opened. The
vertical red line on the left shows where
it was exited.
On June 8, the major trend on the
EUR/NZD was bearish (see Swinging
Trading success is rooted in the consistent application of proven techniques.
For most traders, that starts with the right strategy. Heres one swing-trading
method that works.
The 48-hour movement strategy
BY AZEEZ MUSTAPHA
F O R E X
A short-term swing trading strategy
Using technical tools for swing trades
Finding opportunities in forex markets
For more from Azeez, go to
futuresmag.com/Mustapha
low, top right). The entry criteria were
met, and a short position was opened.
There were minor pullbacks and a gap
during the course of this trade (which
could test our emotions), but sticking
to our exit rules paid off. We entered
the trade at 1.6280, with a stop loss at
1.6370 and a profit target at 1.610. On
June 12, our profit target was hit for 180
pips of profit.
On March 13, a bullish signal was
generated in the GBP/CHF (see Swiss
opportunity, center right). This cross
experienced some prior consolidation,
especially a few days before this par-
ticular signal. This trading method can
be used to avoid a range-bound market
in that the RSI would neither be above
the level 60, nor be below the level 40
when there is consolidation. This trade
also worked well. We entered the trade
at 1.4400, with a stop loss at 1.4310 and
a profit target of 1.4580. The target was
hit the following trading day for the
maximum profit.
In Breaking even (below right), we
can see our risk control at work. The
short trade in the AUD/USD initially
went our way but then it failed to reach
its target. Luckily, it has moved far
enough into profitable territory (50 pips)
that we had moved our stop to breakev-
en. Analytically speaking, the price hit
a major demand zone and shot higher.
Our entry price was 0.9682 on June 1
with an initial stop loss of 0.9772 and a
profit target of 0.9502. The stop, which
we later moved to breakeven, was hit
the same day.
Over time, this trading strategy works.
As with all systems, though, its impera-
tive to follow the rules and to always
trade small so you can stay in the game.
If the system doesnt work for you, either
because of your risk tolerance or your
time frame, then move on, but dont
modify the system or ignore trades. The
trade you skip may be the one that puts
you in the black. Above all, however, dont
stop learning. Commit yourself to ongo-
ing education and explore new opportu-
nities with discipline and restraint.
Azeez Mustapha is a professional forex trad-
er, forex signal strategist, fund manager,
researcher and coach.
futuresmag.com 27
During this short trade, there were some market developments that tested our
discipline. As we can see, sticking with the rules paid off.
Following an extended period of consolidation, this trade shot higher shortly after our
criteria were met, making for quick profits and a great trade.
Not all trades make money, of course. Thankfully, though, this one at least didnt lose
money. Before the market moved against us, we had followed our rules and adjusted
our stop loss to breakeven.
SWINGING LOW
SWISS OPPORTUNITY
BREAKING EVEN
Source: MetaQuotes Software Corp.
1.6530
1.6485
1.6440
1.6395
1.6350
1.6305
1.6260
1.6215
1.6170
1.6125
1.6080
1.6035
1.4635
1.4605
1.4575
1.4545
1.4515
1.4485
1.4455
1.4425
1.4395
1.4365
1.4335
1.4305
0.9905
0.9875
0.9845
0.9815
0.9785
0.9755
0.9725
0.9695
0.9665
0.9635
0.9605
0.9575
100
0
100
0
100
0
Downtrend: A bearish signal
A bullish signal
An aborted trade
2012
2012
2012
6 Jun 7 Jun 8 Jun 11 Jun 12 Jun 13 Jun
8 Mar 9 Mar 12 Mar 13 Mar 14 Mar 15 Mar
29 May 30 May 31 May
06:00 14:00 22:00 06:00 14:00 22:00 06:00 14:00 22:00 07:00 15:00 23:00 07:00 15:00 23:00 07:00 15:00 23:00
02:00 10:00 18:00 02:00 10:00 18:00 03:00 11:00 19:00 03:00 11:00 19:00 03:00 11:00 19:00 03:00 11:00 19:00
07:00 15:00 23:00 07:00 15:00 23:00 07:00 15:00 23:00 00:00 08:00 16:00 00:00 08:00 16:00 00:00
1.6145
2012.06.08 16:00
2012.03.13 12:00
2012.06.01 03:00
2012.06.12 16:00
2012.03.14 16:00
2012.06.01 15:00
60
60
60
40
40
40
4 Jun 5 Jun 6 Jun
T
he relatively smooth price trends
for gold, silver and copper
futures that were in place when
2013 began were interrupted by rough
waters in mid-February. As you can see
in Futures price changes (right), values
fell abruptly in the middle of April. The
metals showed signs of modest recovery
by the end of the month, but that process
has been slow to develop.
Metals exchange-traded notes (ETN)
followed much the same course as the
futures contracts through the first four
months of 2013. Metals ETNs veer from
futures (far right) shows that although
the overall patterns of price changes are
similar, there are significant differences
between the ETN and futures markets.
For example, the cumulative percentage
price change for the silver ETN (USLV) fell
to negative 95% on April 16 as opposed to
the cumulative change of 30% for May
2013 silver futures. This difference is not
surprising for an ETN that has the objec-
tive of providing three times the daily per-
formance of the S&P GSCI silver index,
plus a daily accrual of three-month U.S.
Treasury rates (less the daily investor fee).
In other words, leverage may be sought for
price gains or losses, and it is obvious that
the leverage is working as intended.
The gold ETN (UGOLD) also is lev-
eraged, and has the goal of producing
three times the S&P GSCI gold index.
At the end of trading on April 16, 2013,
the cumulative percentage price change
for June 2013 gold futures was down
by 19% compared to 68% for the gold
ETN, again demonstrating the power of
leverage.
Copper futures and the contracts
comparable ETN do not show the same
results as gold and silver. The operative
copper ETN is iPath DJ-UBS Copper
TR Sub-Idx. The note has the objective
of reflecting the performance of copper
The metals markets have experienced a big trend shift this year. Heres how the
relationships among different contracts are evolving.
Leveraging futures vs. ETN
differentials
BY PAUL D. CRETI EN
TRADING TECHNIQUES
G O L D & S I L V E R
The metals market underwent a major shift this spring, when prices fell off the
proverbial cliff.
FUTURES PRICE CHANGES
Source: Barchart.com
Precious vs. industrial
Breaking down the metals markets
How metals relate in the new economy
For more from Paul, go to
futuresmag.com/Cretien
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
-30%
-35%
J
a
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3
J
a
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8
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1
1
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1
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2
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3
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4
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1
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6
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1
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1
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2
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2
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2
6
Cumulative percentage price changes
(Gold, May silver and copper futures)
Gold Silver Copper
futures contracts traded on the CMEs
Comex and is not leveraged. While the
May 2013 copper futures fell to a 14.30%
cumulative change on April 16, the cop-
per ETN had declined by 14.96%.
For a trader interested in gaining from
leverage and willing to accept the risk,
silver futures and silver ETNs are prime
alternatives.
Leveraged opportunities
Metals call options (right) shows June
and December delivery dates for silver,
gold and copper futures on April 16, 2013.
The three higher price curves for December
(square symbol) have silver above copper
and gold because of silvers acceptance by
the options market as the most volatile
and, thus, the most valuable option of
the three calls having the same expiration
date. For June calls (triangle symbol), silver
is still the highest curve, reflecting its supe-
rior volatility. While copper has given up
its position relative to gold, the two price
curves are almost equal.
Heights of options price curves, as
measured by the ratio of the call value at
the point where the futures price is equal
to the strike price, indicate the options
markets assessment of relative (implied)
volatility for each futures contract. For
the calls on silver, gold and copper, the
curve heights for the December expira-
tion are 8.77%, 6.34% and 7.18%. For June
futures, they are 5.19%, 3.76% and 3.12%.
The call price curve heights are deter-
mined by the spread between upper
and lower breakeven prices (at which a
neutral delta spread will return neither
profit nor loss at expiration). According
to the options markets forecast on April
16, 2013, December breakeven prices for
silver, gold and copper are $29.64-$20.61,
$1,657.28-$1,257.62, and $3.88-$2.91,
respectively. These price ranges compare
with the December futures prices on
April 16: silver, $23.665; gold, $1,378.40;
and copper, $3.34. As always, the options
market does not forecast a direction of
price change. It only cares about volatil-
ity and time to expiration in determining
call and put prices.
Descriptions of the gold and silver
ETNs indicate that they are an easily trad-
ed pair, priced as exchange-traded securi-
ties not too far apart in dollars and cents.
After slowly gaining with respect to
silver over the first three months of
2013, UGLD plunged by $13.03 from
April 9 to April 16, while USLV fell
$8.64. Gold has led the recovery from
that short-term trough, rising by $4.78
vs. $1.23 for the silver ETN through
April 30. Based on past experience, sil-
ver eventually should narrow its price
spread with gold; however, at the end of
April 2013 this had not occurred.
The copper ETN DJ-USB is not lever-
aged but is based on an index of copper
futures contracts. On April 30, 2013, the
index consists of one futures contract on
copper, currently the high-grade copper
futures contract traded on the Comex.
The ETN is balanced with copper futures
by dollar weighting. This creates the pos-
sibility of a shadow price in the same
way that the COW agricultural ETN was
shadowed by a combination of agricul-
tural futures contracts (see Trading
cattle, hogs and ETNs, November 2012).
A chart of cumulative percentage
price changes for May copper futures
and the copper ETN would illustrate
how closely their prices move togeth-
er, with apparently little chance for a
profitable spread trade between the
two. However, we will look at the daily
differences in percentage price changes
between the futures contract and ETN
to investigate trading potential.
As shown on Differences in per-
centage price changes (page 33), there
are many one-day shifts between plus
futuresmag.com 29
The price drop as measured by ETNs is similar to the futures, although there are some
differences due to the leveraged nature of the gold and silver products.
METALS ETNS VEER FROM FUTURES
20%
0%
-20%
-40%
-60%
-80%
-100%
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2
6
Metals ETNs
(Cumulative percentage changes)
Gold Silver Copper
All else equal, silver options are priced higher due to that markets higher volatility.
METALS CALL OPTIONS
0.09
0.08
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0.00
0.75 0.80 0.85 0.90 0.95 1.00
Futures price/Strike price
C
a
l
l

p
r
i
c
e
/
S
t
r
i
k
e

p
r
i
c
e
Silver June Silver Dec Gold June Gold Dec Copper June Copper Dec
Trading Techniques: Cretien continued on page 33
P
rice charts are a technical traders
portal to the markets and a pri-
mary means of making trading
decisions. Todays market analysis plat-
forms offer traders a variety of options
for viewing price data on a chart, from
chart style to interval. The style of the
chart determines how price is displayed;
for example, bar and candlestick charts.
The chart interval dictates which data are
used to construct the display. Here, we
take a look at popular chart styles and
intervals, including time, tick, volume
and range bar charts.
Chart styles
While there are many different chart
styles, the two most common ways to
display prices are bar and candlestick
charts. These two styles show the same
information: The open, high, low and
closing prices for a specified chart inter-
val. Visually, however, bar and candlestick
charts are quite different. On a bar chart
(also called an OHLC chart), the high
and low prices for each specified interval
appear as a vertical line, and two, small
horizontal lines that represent the bars
opening and closing prices appear on
either side, as shown in the left chart of
Two styles (above).
Candlestick charts show the same
open, high, low and closing prices with a
different display. Here, the opening and
closing prices form the body of the can-
dlestick, and the high and low prices for
the interval are represented by the wicks
thin lines that appear above and below
the body, as shown in the right chart in
Two styles. The body of the candlestick
appears black if the close is lower than the
open and white if the close is higher than
the open. Its common for traders to sub-
stitute colors for black and white. A green
Understanding how prices are represented on your computer screen is critical to
seeing market moves clearly.
A closer look at price
chart choices
BY JEAN FOLGER
TRADING TECHNIQUES
C H A R T I N G
Bars and candlesticks
Visualizing market moves
Putting prices in perspective
For more from Jean Folger,
go to futuresmag.com/Folger
Two common chart styles are OHLC bars and candlesticks. Both convey the same
information: The open, high, low and closing prices for a specified interval.
TWO STYLES
Source: NinjaTrader
15500
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14600
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14000
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Mar Apr May Jun Jul Mar Apr May Jun Jul
Candlestick Chart
OHLC Bar Chart
up bar up bar
high high
low low
close close
open open
down bar down bar
high high
low low
open
open
close
close
14895
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14895
body, for example, means that price closed
above its open (showing strength), while a
red body often indicates that price closed
below the open (showing weakness).
Some traders use candlestick charts
to spot price patterns that may indicate
a reversal or a weakening of the trend.
Patterns can be formed within the same
candlestick by comparing the size of the
body to the wick, or across several adja-
cent candlesticks. A bullish engulfing
pattern, for example, is a reversal pattern
that occurs when the body of an up-can-
dle bar completely covers, or engulfs, the
body of the prior bar, signaling the end of
a downtrend, as shown in Time to turn
(above). Candlestick charting often works
best when combined with other technical
tools or indicators for confirmation.
Time-based charts
Most investors and traders are accus-
tomed to viewing price charts that are
based on time, such as daily, 60-minute
or five-minute intraday intervals. With a
time-based chart, one bar be it a can-
dlestick or OHLC bar prints at the end
of each specified time interval, regardless
of the amount of trading activity that
has occurred. On a five-minute chart,
for example, a bar will print at 9:35, 9:40,
9:45, 9:50 and so forth until the end of
the trading session.
There always will be an equal number
of bars per trading session when the same
time interval is applied. Time-based charts
can be as small as a few seconds to as large
as weekly, monthly or yearly intervals.
A traders style often determines the
size of the chart interval. Longer-term
traders, such as swing and position trad-
ers, might use hourly, daily or even week-
ly charts. In contrast, short-term traders
may prefer 30-second or one-minute
charts to see the details of price action.
Activity intervals
While time-based charts are perhaps the
most widely used, activity-based price
charts offer traders a different view of the
markets, and as more bars print within a
set amount of time, these charts can indi-
cate an increase in volatility. Tick, volume
and range-bar charts are examples of
activity-based charts.
These charts print a new bar at the
close of a specified activity interval,
regardless of how much time has elapsed.
Activity driven (above) shows a 15-min-
ute chart of the E-mini S&P 500 (ES). The
overlays in the chart show one 15-min-
ute bar exploded to illustrate the tick
(on the left) and range bar (on the right)
activity that took place during the same
time. Activity-based charts can paint a
more accurate picture of market action
by showing the effect that the number
of transactions or volume has on price.
Heres a closer look at various types of
activity-based charts.
Tick charts
With a tick chart, each bar represents
the price activity that took place dur-
ing a specified number of transactions.
A 100-tick chart, for example, prints a
new bar each time 100 transactions have
filled. Each transaction is counted just
once, regardless of the size.
Because tick charts are based on a cer-
tain number of transactions per bar, they
help traders identify current market infor-
mation. Acting much like the display on
a gas pump that allows you to judge the
flow of gas into your car by the speed at
which price scrolls by, tick charts give trad-
ers instantaneous information about the
speed of the market. The more time that a
trader spends in a particular market using
tick charts, the more the trader will be
used to that markets tendencies. Periods
of increased activity and potential trad-
ing opportunities then instantly can be
recognized and acted upon.
The interval of tick charts often is
derived from Fibonacci numbers, a
numerical series discovered by Leonardo
Fibonacci in which each number is the
sum of the previous two numbers. While
traders can specify any number of trans-
actions, popular Fibonacci-based inter-
vals include 144-, 233-, 610- and 987-tick
charts. It is common for traders to use
different tick intervals across multiple
charts of the same trading symbol. For
example, a trader might make trades off
of a 144-tick chart after finding confir-
mation on a 987-tick chart.
futuresmag.com 31
This chart of the E-mini S&P 500 shows a close-up view of the tick and range bar
activity that takes place during one 15-minute candlestick.
ACTIVITY DRIVEN
Source: NinjaTrader
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05.00 05.30 06.00 06.30 07.00 07.30 08.00 08.30 09.00 09.30 10.00 10.30 11.00 11.30 12.00 12.30 13.00 13.30 14.00 14.30
15-minute
price bar
Tick interval activity
inside 15-minute
price bar
Range bar activity
inside 15-minute
price bar
1611.50
Candlestick charts can be used to identify
price patterns, such as this bullish engulf-
ing pattern example.
TIME TO TURN
Source: NinjaTrader
Bullish Engulfing Pattern
The body of the up candle
bar completely covers, or
engulfs, the body of the
prior bar.
D
o
w
n

t
r
e
n
d
Volume charts
Volume charts record the prices for a
specified number of contracts or shares
traded. In a 1,000-volume chart, for
example, a new bar prints every time
1,000 contracts (for futures/commodities
markets) or shares (stocks and exchange-
traded funds) have traded, regardless of
the time that has elapsed. One bar might
represent a single large transaction or
numerous small trades and, similar to
tick charts, traders can get an idea of
how rapidly a market is moving simply
by noting how many (and how quickly)
bars are printing.
Volume view (above) shows a
5,000-volume chart of the E-mini S&P
500 contract. To illustrate how volume
and activity can differ throughout the
trading session, the first hour and lunch
hour are highlighted in yellow. Note how
there is significantly more trading activity
during the open.
Volume intervals are typically scaled to an
individual symbol to reflect normal market
activity for that symbol. A symbol that trades
under large volume, such as the E-mini S&P
500, would require a larger interval to pro-
vide relevant charting analysis.
Popular intervals include 500, 1,000,
2,000 and 5,000 volume charts (again,
depending on the symbol), though vir-
tually any number could be assigned. As
with tick-based charts, Fibonacci inter-
vals, such as 987, 1597 and 2584, are
popular choices for volume charts.
Range bar charts
Range bar charts are the relative newcomers
to the charting world, and are composed of
bars that are based only on price activity,
thereby eliminating time, number of trans-
actions and volume from the equation.
Each bar represents a specified price move-
ment, such as 10 cents or 50 cents, and once
price has moved the specified amount, one
bar will close and a new will open. The three
governing rules of range bars are:
t Each range bar has a high/low range
that equals the specified range;
t Each range bar opens outside the high/
low range of the previous bar; and
t Each range bar closes at either its high
or low.
Unlike time-based intervals where an
equal number of bars print each trading
session, any number of range bars can
appear during a session depending on the
volatility of the given market.
Range bars can help traders view price
in a consolidated manner. A lot of the
noise that occurs when prices bounce
back and forth in a narrow range can be
reduced to one or two bars, helping trad-
ers distinguish what is happening to price.
Because much of the noise is eliminated,
range-bar charts make especially ideal
charts on which to draw trendlines to
point out areas of support and resistance,
as shown in Home on the range (left).
Chart views
Determining the best chart interval
requires practice and screen time. The
chart should match the trading style
and the time frame in which the trader
operates. It is important to remember
that time and activity chart settings are
relative to the market being traded, so
no single setting is appropriate across
all markets or trading styles.
Jean Folger is the co-founder of, and system
researcher with, PowerZone Trading, LLC. Jean
can be reached at www.powerzonetrading.com.
TRADING TECHNIQUES continued
Volume bars can help traders identify periods of increased activity and better trad-
ing opportunities.
This chart of the Nasdaq 100 illustrates the effectiveness of applying trendlines to range
bar charts.
VOLUME VIEW
HOME ON THE RANGE
Source: NinjaTrader
Source: NinjaTrader
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09:30 09:37 09:50 10:01 10:15 10:37 11:03 11:38 12:18 13:02 13:50 14:20 14:52 15:26 15:43 15:59
09:09 09:28 09:30 09:32 09:34 09:36 09:40 09:43 09:47 09:50 09:54 09:57 10:00 10:01 10:02
One hour One hour
Horizontal trendlines indicate
areas of support & resistance.
Once price breaks out, a nice
upward move follows.
1607.75
2945.75
5000-volume chart
Range bar chart
and minus differences from Jan. 3
through April 30. Because the bar chart
shows changes in the futures price less
changes in the ETN, a positive differ-
ence means that neither a negative nor
positive change in the futures price
could overcome a larger negative shift
in the ETN. Counting on the possibil-
ity of a one-day reversal, this suggests
buying the ETN and selling the futures
contract to hedge and to help provide
funds for the ETN purchase.
On the other hand, a negative differ-
ence means that a change in the ETN
price could not overcome the negative
change in the futures price. Thus, the
indication would be to buy the futures
and sell the ETN to cover the trade.
From Jan. 3 to April 30, 2013, there are
11 dates on which the difference in per-
centage changes exceeds 40 basis points
(0.40%). In eight of these, the difference
is positive (buy ETN, sell futures), with
three dates showing a negative difference
(sell ETN, buy futures).
Results for the 11 spread trades are
summarized on Spread profit: Copper
futures vs. ETN (left). In each trade,
2,500 ETNs are spread against one
futures contract of 25,000 pounds of
high-grade copper. This ratio generally
produces a net one-day investment of
approximately $20,000.
Of the 11 spread trades, eight are prof-
itable, with the highest return being April
16-17 at $1,325. Two trades show losses
($150 April 25 and $200 April 30). One
trade, resulting in no gain and no loss,
occurs on the weekend of the big shake-
out in metals prices, April 12-15. Because
of the large dollar amounts swinging
both ways on this date, it appears that the
market was able to counteract possible
losses in either direction. Futures and
ETN price charts described earlier indi-
cated that huge gains and losses were at
stake at this mid-April event, from which
the metals are still recovering.
Are the profits on these trades realis-
tic? To a certain extent, the results are
hypothetical and depend on actual mar-
ket prices reflected in end-of-day num-
bers. Actual trading results could vary
significantly from those shown here. It
also is surprising that a positive dollar
amount could remain for retail trading
following arbitrage between ETNs and
futures.
Paul Creti en i s an investment anal yst
and financial case writer. His e- mail is
PaulDCretien@aol.com.
futuresmag.com 33
As we can see here, copper futures often diverge from the ETN. The goal is to take
advantage of those differences as the two instruments converge.
DIFFERENCES IN PERCENTAGE PRICE CHANGES
0.80%
0.60%
0.40%
0.20%
0.00%
-0.20%
-0.40%
-0.60%
-0.80%
J
a
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4
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a
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9
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a
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e
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e
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0
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8
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p
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p
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1
6
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p
r

1
9
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2
4
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p
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2
9
May Copper futures less DJ-UBS Copper ETN
Of the 11 trades based on a basic futures vs. ETN arbitrage strategy, eight of those
trades made money.
SPREAD PROFIT: COPPER FUTURES VS. ETN
Date ETN Futures ETN
change
Futures
change
Gain
(Loss)
plus Jan 3 46.55 3.7200
Jan 4 46.69 3.7035 350.00 (412.50) 762.50
plus Feb 20 45.31 3.6250
Feb 21 44.83 3.5695 (1,200.00) (1,387.50) 187.50
plus Feb 25 44.52 3.5610
Feb 26 44.99 3.5830 1,175.00 550.00 625.00
plus Mar 7 44.03 3.5205
Mar 8 44.02 3.5090 (25.00) (287.50) 262.50
minus Apr 4 41.97 3.3515
Apr 5 41.72 3.3440 (625.00) (187.50) 437.50
plus Apr 12 41.61 3.3500
Apr 15 40.84 3.2730 (1,925.00) (1,925.00) 0.00
minus Apr 16 41.23 3.3055
Apr 17 39.52 3.1875 (4,275.00) (2,950.00) 1,325.00
plus Apr 17 39.52 3.1875
Apr 18 39.87 3.2045 875.00 425.00 450.00
minus Apr 24 39.37 3.1570
Apr 25 40.23 3.2370 2,150.00 2,000.00 (150.00)
plus Apr 26 39.41 3.1845
Apr 29 39.73 3.2255 800.00 1,025.00 225.00
plus Apr 29 39.73 3.2255
Apr 30 39.43 3.1875 (750.00) (950.00) (200.00)
Cretien continued from page 29
T
he moving average is one of the
classic and most-reliable tools for
technical analysis. A moving aver-
age simply shows the average value of a
securitys price over a defined period of
time. The direction of the average reflects
the general trend of the security.
Although the moving average is one of
the simplest technical indicators, there are
variations in its calculation. For example, the
moving average calculation can be based on
a securitys open, high, low, close, volume or
even another indicator. In addition, it can
be calculated over different time periods.
The longer the time period, the smoother
the average. The shorter the time period, the
more reactive the average.
There also are variations in the process
used to calculate the average. Two of the
most popular methods are the simple
moving average (SMA) and the exponen-
tial moving average (EMA).
The only signif icant difference
between the EMA and SMA is the weight
assigned to the most recent data. The
SMA applies equal weight to all prices
in the range; the EMA applies more
weight to recent prices. Two averages
(above) shows a 20-day SMA in red and
the equivalent of a 50-day EMA in blue
applied to daily data of the Market
Vectors Gold Miner (GDX) exchange-
traded fund (ETF).
An SMA is calculated by adding the
securitys price for the desired lookback
period (say, five days) and dividing by the
same number (in this case, five). Each day,
we add the new day and drop the oldest.
For example, assume these seven
daily closing prices: 101, 102, 103, 104,
Trends can make you money in the stock market, and one of the best tools to identify
opportunities during trend moves is the moving average.
Stocks, moving averages and
how to leverage them
BY BRAMESH BHANDARI
T E C H N I C A L A N A L Y S I S
Exponential moving averages apply more weight to more recent prices. Simple
moving averages weight all prices within the lookback period equally. Here, we also
can see how longer-term moving averages are smoother and less reactive than
shorter-term ones.
TWO AVERAGES
Source: www.chartnexus.com
Finding trends in stocks
SMA vs. EMA
How moving averages work
For more from Bramesh, go to
futuresmag.com/Bhandari
56
55
54
53
52
51
50
49
48
47
46
45
44
43
42
41
40
39
38
37
36
35
34
33
32
31
30
29
28
27
26
25
24
23
22
70.0M
64.6M
59.2M
53.8M
48.4M
43.1M
37.7M
32.3M
26.9M
21.5M
16.1M
10.8M
5.38M
Aug Sep Oct Nov Dec 2013 Feb Mar Apr May Jun Jul
50-day
exponential
moving
average
20-day simple
moving average
EMA (50d)
Market Vectors Gold Miner (GDX)
Moving average (20d)
105, 106, 107. On the fifth day of this
sequence, the average would be (101 +
102 + 103 + 104 + 105) / 5 = 103. On the
second day of this sequence, the aver-
age would be (102 + 103 + 104 + 105 +
106) / 5 = 104. On the third day of this
sequence, the average would be (103 +
104 + 105 + 106 + 107) / 5 = 105. Such
an average is probably too sensitive to
price changes because small changes in
price quickly are reflected in changes in
the average.
This is where EMAs are helpful.
Because EMAs emphasize more recent
prices in their calculation, we can achieve
a smoother average line with nearly the
same level of reactivity.
EMAs are based on the most recent
value of the average, the most recent raw
price and a weighting multiplier. The
weighting multiplier can be changed to
mimic a comparable length SMA. For
the initial EMA calculation, an SMA of
the target length is substituted for the
previous-period EMA.
First, we calculate the value of the mul-
tiplier.
Multiplier = (2 / (Time periods + 1) ) =
(2 / (5 + 1) ) = 0.33
Then, we insert the multiplier value
into the following EMA formula:
EMA = [Close EMA(previous day)] x
multiplier + EMA(previous day)
Average comparison (right) shows
the values of a five-day SMA and EMA
for Apple. The exponential moving
average starts with the simple moving
average value of 449.61 in the first cal-
culation. After the first calculation, the
EMA formula takes over. The chart of
the EMA is shown in Apple smoothie
(below right).
Because the EMA gives more weight to
recent price action, whipsaws are less fre-
quent. As seen in the chart, Apple closing
prices stay above the stocks five-period
EMA throughout most of the uptrend
that started in January 2012.
Reading averages
The most popular method of interpret-
ing a moving average is to compare the
relationship between a moving average
of the securitys price with the securitys
price itself. A buy signal is generated
when the securitys price rises above its
moving average and a sell signal is gener-
ated when the securitys price falls below
its moving average.
While such basic trading rules may be
appealing, moving averages may be bet-
ter used in a less-rigid sense. For exam-
ple, they can be used to find support and
resistance and trend identification.
Look at me, MA (page 45) shows an
example of the S&P 500 bouncing off
its 50-day SMA. The green arrows iden-
tify points of bullish reaction. The red
arrows identify periods when the average
provided resistance.
Trend identification generally is done
with long-term averages. Perhaps the
most popular application is the 200-
day moving average. In general, the
market is considered bullish when it is
above the 200-day moving average, and
bearish when it is below the 200-day
moving average.
As seen in Look at me, MA,
Microsoft broke its 200-day moving
average on Sept. 29, 2012, at $30. It cor-
futuresmag.com 35
Trading Techniques: Bhandari continued on page 44
This table shows a side-by-side comparison of SMA and EMA values for Apple.
AVERAGE COMPARISON
Date Closing price SMA Multiplier EMA
25-01-2012 446.66
26-01-2012 444.63
27-01-2012 447.28
30-01-2012 453.01
31-01-2012 456.48 449.61 449.61
01-02-2012 456.19 451.52 0.33 451.80
02-02-2012 455.12 453.62 0.33 452.91
03-02-2012 459.68 456.10 0.33 455.17
06-02-2012 463.97 458.29 0.33 458.10
07-02-2012 468.83 460.76 0.33 461.68
08-02-2012 476.68 464.86 0.33 466.68
09-02-2012 493.17 472.47 0.33 475.51
10-02-2012 493.42 479.21 0.33 481.48
13-02-2012 502.60 486.94 0.33 488.52
A five-period-equivalent EMA applied to Apple (AAPL) is just as reactionary as the SMA
during quick price changes but is smoother during times of less volatility.
APPLE SMOOTHIE
649
638
627
616
605
594
583
572
561
550
539
528
517
506
495
484
473
462
451
440
429
418
407
396
385
374
49.9M
46.1M
42.3M
38.4M
34.6M
30.7M
26.9M
23.1M
19.2M
15.4M
11.5M
7.68M
3.84M
Apple Inc (AAPL)
EMA (5d)
5 12 5 12 2 9 3 9 6 13 19 27 19 26 16 22 17 23 21 27 30
2012 Feb Mar Dec Apr
W
e previously covered general
grain fundamentals to moni-
tor during the summer, key
reports to follow and the 2013 picture
(Quick and easy guide to summer grain
trading, June 2013). Here, we tackle
the less-understood, but opportunity-
rich, livestock markets, namely cattle
and hogs. Well provide a breakdown of
the complex and offer a general taste of
fundamental analysis. A framework for
finding true value in pricing will be given.
The value picture is drawn mostly by
livestock balance sheets similar to those
prevalent in the grain complex. However,
instead of trying to estimate the amount
left over, called ending stocks, the meat
industry is priced off the amount left
for the U.S. consumer in a given period.
It is that measure, the supply left in the
United States, that is the basis for price
determination.
The implications of this discussion
should be clear. Production decisions are
made months in advance, without a per-
fect knowledge of demand for that peri-
od, and the market must find the right
price to make that supply move through
the system. This gives many opportuni-
ties for both sharp rallies and declines.
In Balance sheet (above), we see an
example of the pork balance sheet for
the coming fourth quarter. Separate
numbers are used for cattle. We are not
comparing these numbers against the
first, second or third quarters because
demand changes from season to season.
Only a comparison against other fourth
quarters is made.
In the meat world, analysts monitor
pricing for the live animal, wholesale
processed meat and retail levels using
slightly different tools. The table shown
here works well for finding true value at
Cattle and hogs offer opportunities for traders that are unique from those available
in other markets. Heres a breakdown of supply and demand factors that drive
livestock prices.
Quick and easy guide to
livestock trading
BY RI CH NELSON
TRADING 101
C AT T L E & H O G S
The balance sheet gives an overview of the current fundamentals. Heres the balance
sheet for pork for fourth quarter 2013.
BALANCE SHEET
Source: Allendale Inc.
Supply and demand
What moves livestock markets
Cattle and hog price drivers
For livestock updates, go to
futuresmag.com/Meats
100
90
80
70
60
50
40
30
20
10
0
14.5 15.0 15.5 16.0 16.5 17.0 17.5 18.0 18.5
Fourth quarter pork pricing (1993-2012)
P
r
i
c
e

(
A
v
e
r
a
g
e

L
e
a
n

H
o
g

P
r
i
c
e
)
Supply (Per capita consumption, carcass)
2011 - 15.8, $88.86
Q4 Pork Balance Sheet
2012 - 16.35, $82.07
R
2
= 0.7471
ALDL
2012 2013
Beg Stocks (from Q3) 712 706
Production 6,249 6,255
Imports 205 209
Total Supply 7,166 7,170
Exports 1,386 1,328
End Stocks 625 617
Disappearance 5,155 5,226
Population 315.2 317.5
Per Capita (lbs.) 16.35 16.46
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CAN YOU DIVE INTO THE FUTURES MARKET
WITHOUT BEING SHARK BAIT ?
TRADING 101 continued
the live animal level for the general trad-
er. Background tables of these per capita
disappearance numbers can be found
on the website for the U.S. Department
of Agriculture (www.ers.usda.gov/data-
products/livestock-meat-domestic-data.
aspx#.UdcvwZys_Qh).
Traders also can get a feel for the
USDAs own viewpoint on future pro-
duction and trade figures in the back
tables of the monthly Livestock, Dairy
& Poultry Report (available at www.ers.
usda.gov/publications/ldpm-livestock,-
dairy,-and-poultry-outlook/ldpm228.
aspx#.UdrshZys_Qh).
For cash-settled lean hogs, you need to
estimate the lean hog index on the expira-
tion dates for futures. You either can com-
pute where those dates typically fit into the
quarterly average or move to a monthly
format. Focusing on the current 2013
December contract, last years December
2012 price for the lean hog index was
$82.59. Research suggests that we will see
a slightly higher supply offered to the U.S.
consumer this year. Excluding estimates of
U.S. consumer financial health and com-
peting meats, this would imply a slightly
lower price for the 2013 contract.
Exports have a role
After supply estimates, the next real issue
on the balance sheet is the trade picture.
The economic health, food needs, cur-
rency values and trade relations with
other countries all play a part. There are
tremendous hopes for the long-term
meat demand picture for the world (see
Purchasing power, above).
As incomes improve, diets improve.
Usage of vegetable oils, dairy products
and eventually meats increases. The rela-
tive purchasing power of the two most
populous nations has doubled over the
past 10 years. Gains in many develop-
ing countries also have been impres-
sive. At the start of this 10-year period,
Japan, Canada and Mexico took 77% of
our pork exports and 87% of our beef
exports. Due to new markets for our
product, those same figures are 52% and
58%, respectively.
This year has seen a number of export-
related developments. Russia and China
have discussed problems with our use of
a popular animal feed additive in hogs
and cattle. Canada and Mexico have
raised concerns with a U.S. meat labeling
law. They may eventually retaliate against
our meat exports. A good example of the
importance of these numbers was the
recent announcement of the intended
purchase of the largest U.S. pork proces-
sor by a Chinese firm.
Throughout the summer, we heard
wildly inflated estimates of U.S. pork
export growth from traders not familiar
with actual numbers. Last year, China
accounted for only 14% of our total
exports. Before we even discuss increases
over last year, we first have to fix our cur-
rent sales problem. Exports to China in
May (the latest data available at this time)
were 14% lower than last year. While we
dont fight the initial move made from
irrational hopes or fears, a fact-based
approach to fundamental analysis can
signal clear mispricing opportunities.
U.S. demand conundrum
Most discussions in the meat complex
revolve around supply. There is a great
deal of quality information for sup-
ply through daily, weekly and monthly
slaughter reports. Future production
levels can be computed from the various
government surveys of producers.
The industry calls the last line of the
balance sheet we have shown either per-
capita disappearance or per-capita con-
sumption. That is incorrect terminology.
A much better term would be product
supplied. Essentially, we put the meat
on their plate whether they asked for it
or not. Their method of telling us accep-
tance is through price.
In the example above, lets say we proj-
ect a 16.46 lbs. per-capita consumption
(product supplied). Depending on con-
sumer demand for it, that could trigger
a price from $62 to $102. Though the
majority of price changes in livestock
come from supply, we cannot forget
about the year-to-year changes in con-
sumer demand. Consumer income/
employment and the economy/asset
appreciation are all factors to consider.
For 2013, specifically, consumer spend-
ing on meats is up slightly over last year.
Lean hog futures
The CME Group lean hog futures con-
tract, symbol HE, calls for 40,000 lbs. of
hogs on a lean (carcass) basis. Today, a
270 lb. live hog produces a 203 lb. car-
cass. Pricing is quoted on a dollar-per-
hundred-weight (cwt.) basis. Therefore,
a quote on the screen of 85000 is called
$85 per cwt. The minimum tick size is
2.5 cents per cwt. A minimum tick move
from 85000 to 85025 would represent
a change in value of $10 per contract.
As the purchasing power of consumers in other countries grows, so will the demand
for U.S. pork and livestock exports.
PURCHASING POWER
$10,000
$7,500
$5,000
$2,500
$0
GDP per capita (Purchasing power parity in current $)
India
China
2
0
0
4
2
0
0
5
2
0
0
6
2
0
0
7
2
0
0
8
2
0
0
9
2
0
1
0
2
0
1
1
2
0
1
2
2
0
1
3
(Take note that some quote systems do
not quote the last digit.) The contract is
cash-settled against a two-day weighted
average of the cash market called the
Lean Hog Index, symbol IHX. Contract
expiration is generally around the 12th
of each contract month.
Supply projections are pretty straight-
forward for lean hogs. It takes just six
months from birth (farrowing) to
slaughter. When you add in a 114-day
pregnancy period, you have a relatively
modest 10-month delay from a decision
to expand or contract to when those
numbers hit the packing plant and
affect prices.
The main long-term supply pic-
ture comes from the USDAs quarterly
survey of producers called the Hogs
& Pigs Report (which can be down-
loaded at http://usda.mannlib.cornell.
edu/MannUsda/viewDocumentInfo.
do?documentID=1086). The general
trader can get a quick idea of supply for
the next six months out by looking at
the weight breakdowns in the kept for
marketing numbers. With slightly more
effort, the farrowing intention numbers
can help provide a map of supply for the
next full year out. For 2013, with sharply
lower grain prices, the question in the
industry is not if producers will expand,
but when and by how much.
Live cattle
The CME Group live cattle futures
contract, symbol LE, also is traded in a
40,000 lb. allotment. Though packers
buy on a carcass- and live-animal basis,
this contract is based off the live animal
pricing. It also is different from hogs in
that it can be physically delivered. Keep
that in mind as first notice day approach-
es. Pricing is quoted as dollars per cwt. A
price of 127000 on your screen is there-
fore $127 per cwt.
Supply projections are a little different
for cattle because there is a two-stage pro-
duction process. The base producer in the
industry carries a herd of mothers (cows)
and sells the offspring in the form of
400-500 lb. calves or later as 600-900 lb.
feeder cattle. Those offspring are fed out
in feedlots from three to eight months,
depending on various factors, until they
are 1,100 to 1,400 lbs. Profitability in the
feedlot phase is dependent on the pur-
chase price of feeder cattle, feed costs and
selling price of live cattle.
Important for us for the long term is
that the base producer has a separate
concern as well: Quality pastures. With
drought a lingering concern in the Plains,
the breeding herd has been in liquidation
for eight years. As there is a three-year lag
between a decision to expand and when
that expansion hits the packing plant,
the long-term supply picture is clear here.
The report that the industry gauges
to determine monthly supply is the
USDAs Cattle on Feed Report. It can be
accessed at http://usda.mannlib.cornell.
edu/MannUsda/viewDocumentInfo.
do?documentID=1020. A supply pic-
ture for the coming months can be made
by following the number of new calves
and feeders starting their feeding peri-
od, called placements. We can gauge
whether feedlots are actively selling mar-
ket-ready animals on time by monitoring
the marketing numbers.
Chicken rising
Though there is no longer an active U.S.
futures contract for chicken, this is the
industry powerhouse. Although most
traders will not need to have a full work-
ing knowledge of chicken fundamen-
tals, it is important to know the general
trends of both production and prices and
how they can affect cattle and hogs. The
story into 2014 is increased production
because of lower feed costs (see Meat
breakdown, above). This will help tem-
per some of the shortfall in beef produc-
tion expected next year.
Spreads
Almost as popular as outright trades in
individual contracts are spreads. Spread
trades involve two opposing positions in
related contracts or different months of
the same contract.
Popular spreads play off seasonal sup-
ply changes. For hogs, we are heading
into the period with heavy supplies, so
many traders sell the winter contracts
and buy the spring. Cattle traders often
buy the period with tight supplies, such
as December and February, and sell the
June against it. Another trade to consider,
as cattle and hogs are entering opposite
supply periods into winter, is simply to
buy the cattle and sell the hogs.
Rich Nelson is the chief strategist for
Allendale Inc. He has more than 15 years of
experience as an analyst and broker covering
agricultural futures. His daily analysis can be
accessed at www.allendale-inc.com.
futuresmag.com 39
Although there is no active futures market in chicken, it remains the most popular
meat in the United States, and that popularity is growing.
MEAT BREAKDOWN
2012 ALDL 2013
100
90
80
70
60
50
40
30
20
10
0
U.S. meat production
B
i
l
l
i
o
n

L
b
s
.
Turkey Chicken Pork Beef
+2.5%
+0.8%
-2.1%
P E R F O R MA N C E
F
inancial theory tells us that inves-
tors should expect a positive
relationship between risk and
return: Those who assume greater lev-
els of market risk are expected to earn
higher returns, while lower risk portfo-
lios should earn lower returns. However,
investors should not expect to earn
higher returns by accepting higher levels
of risk from single stocks or a concen-
trated portfolio, because the markets do
not compensate investors for risks that
easily can be diversified away.
Key to determining an investment is a
measurement to estimate the magnitude
of the risk-return tradeoff that can differ
across investments and investment man-
agers. Performance measures may show
that a high return is not attractive given
the extraordinarily high level of risk that
is needed to earn that return, while lower
levels of return may be quite attractive if
they come with minimal risk.
There are two major types of perfor-
mance measures. First, there are ratios of
return to risk. Return can be expressed in
several ways in the numerator, and risk
can be expressed in numerous ways in the
denominator. The denominator of the
ratio can be any risk measure, although
the most popular performance measures
employ the most widely used risk mea-
sures, such as volatility (standard devia-
tion) or beta. The risk measure may be
an observed estimate of risk or the inves-
tors belief regarding expected risk. These
ratios include those developed by William
Sharpe, Jack Treynor and Frank Sortino.
A second method to measure perfor-
mance is to generate the risk-adjusted
return of an asset and compare that return
to a standard. The alpha measure, devel-
oped by Michael Jensen, compares the
return on an investment to the expected
return on an investment of similar risk.
Sharpe Ratio
The most popular measure of risk-
adjusted performance for investments
is the Sharpe ratio (see Measuring
sticks, right).
When using annual returns and an
annual standard deviation of returns,
the Sharpe ratio may be interpreted as
the annual risk premium that the invest-
ment earned per percentage point in
annual standard deviation. In this case,
the investments return exceeded the risk-
less rate by 35 basis points for each per-
centage point in standard deviation. In
an analysis of past data, the mean return
of the portfolio is used as an estimate of
its expected return, and the historical
standard deviation of the sample is used
as an estimate of the assets true risk.
Throughout the remainder of this analysis of
performance measures, the analysis may be
viewed as interchangeable between using his-
torical estimates and expectations.
Obviously, both the numerator and
denominator of the Sharpe ratio should
be measured in the same unit of time,
such as quarterly or annual values. But
the resulting Sharpe ratio is sensitive to
the length of the time period used to com-
pute the numerator and the denominator.
Note that the numerator is proportional
to the unit of time, ignoring compound-
ing. Thus the excess return expressed as an
annual rate will be two times larger than
a semiannual rate and four times larger
than a quarterly rate, ignoring compound-
ing. However, the denominator is linearly
related to the square root of time, assum-
ing that returns are statistically indepen-
dent through time:
T = 1 T where T is the standard
For more on CTAs, go to
futuresmag.com/Managed-Funds
investors should not expect to earn
higher returns by accepting higher levels
of risk from single stocks or a concen-
trated portfolio, because the markets do
not compensate investors for risks that
easily can be diversified away.
Key to determining an investment is a
measurement to estimate the magnitude
of the risk-return tradeoff that can differ
across investments and investment man-
agers. Performance measures may show
th t hi h t i t tt ti i
tor s belief reg
ratios include
Sharpe, Jack T
A second m
mance is to
return of an as
to a standard
oped by Mic
return on an
return on an i
Sh Sharpe e RRat
The most p
adjusted per
i th Sh
Return-to-risk ratios
Risk-adjusted returns
Trading performance can be measured in many ways. Here we review what tools
asset allocators use to see inside rates of return.
MANAGED FUNDS
Measurement matters
BY MARK ANSON, DONALD CHAMBERS, KEI TH BLACK AND HOSSEI N KAZEMI
deviation over T periods, 1 is the standard
deviation over one time period, such as one
year, and T is the number of time periods.
This formula assumes that the returns
through time are statistically indepen-
dent. Thus, a one-year standard devia-
tion is only 2 times a semiannual stan-
dard deviation, and a one-year standard
deviation is only twice (4) the quarterly
standard deviation. Thus switching
from quarterly returns to annualized
returns roughly increases the numerator
fourfold but increases the denomina-
tor only twofold, resulting in a twofold
higher ratio.
For example, ignoring compounding
for simplicity, and assuming statisti-
cally independent returns through time,
the Sharpe ratios based on semiannual
returns and quarterly returns are shown,
using the same annual values as illus-
trated earlier:
Annual: (10% 3%)/20% = 0.350
Semiannual: [(10% 3%)/2]/ 20%
0.5= 0.247
Quarterly: [(10% 3%) /4] / 20%
0.25= 0.175
Note that the Sharpe ratio declines from
0.350 to 0.175, which is a 50% decrease,
as the time interval for measurement is
reduced by 75% from annual to quarterly.
If returns were correlated perfectly
through time, the Sharpe ratio would
not be sensitive to the time unit of mea-
surement; it would be dimensionless.
However, in a perfect financial mar-
ket, returns are expected to be statisti-
cally independent through time and,
in practice, returns usually are found to
be somewhat statistically independent
through time. The point is that Sharpe
ratio comparisons must be performed
using the same return intervals.
Sharpe ratios should be computed
and compared consistently with the
same unit of time, such as with annual-
ized data. They then can be easily intui-
tively interpreted and compared across
investments.
However, Sharpe ratios ignore diversi-
fication effects and are primarily useful
in comparing returns only on a stand-
alone basis. This means that they typi-
cally should be used when examining
total portfolios rather than evaluating
components that will be used to diversify
a portfolio. Of course, if the investments
being compared are well-diversified port-
folios, then the Sharpe ratio is appropri-
ate because systematic risk and total risk
are equal in well-diversified portfolios.
It should be noted that a well-diversified
portfolio is traditionally defined as con-
taining only trivial amounts of diversifi-
able risk.
Finally, a Sharpe ratio is only as useful
as volatility is useful in measuring risk. In
the case of normally distributed returns,
the volatility fully describes the disper-
sion in outcomes. But in many alterna-
tive investments with levels of skew and
kurtosis that deviate from the normal
distribution, volatility provides only a
partial measure of dispersion. Thus, the
Sharpe ratio is a less valuable measure
of risk-adjusted performance for asset
returns with non-normal distributions.
The Sharpe ratio should be used with
caution when measuring the performance
of particular investments, such as options
and option-like strategies, which have
return distributions that are skewed or con-
tain the potential for non-linear payoffs.
The Treynor ratio
Another popular measure of risk-adjusted
futuresmag.com 41
MEASURING STICKS
Ratio Use Formula Defnitions Example
Sharpe Ratio Measure of risk-adjusted perfor-
mance for investments; annual
risk premium that the investment
earned per percentage point in
annual standard deviation
SR=[E(R
p
)-R
f
]/
p
rSR is the Sharpe ratio for portfolio p
rE(R
p
) is the expected return for portfolio p
rR
f
is the riskless rate
r
p
is the standard deviation of the returns
of portfolio p
A portfolio that earns 10% per year and
has an annual standard deviation of 20%
when the risk-free rate is 3%. The Sharpe
ratio is (10% 3%)/20 %, or 0.35
Treynor Ratio Measure of risk-adjusted
performance for investments;
risk premium that the investment
earns per unit of beta
TR = [E(R
p
) R
f
]/
p
rTR is the Treynor ratio for portfolio p
rE(R
p
) is the expected return, or mean
return, for portfolio p
rR
f
r
p
is the beta of the returns of portfolio p
A portfolio that earns 10% per year and
has a beta with respect to the market
portfolio of 1.5 when the risk-free rate is
3%. The Treynor ratio is (10% 3%)/1.5 or
0.0467 (4.67%)
Sortino Ratio A measure of risk-adjusted
performance; uses the concept
of a target rate of return both
in expressing the return in the
numerator and the risk in the
denominator.
Sortino Ratio =
[E(R
p
) R
Target
]/TSSD
rE(R
p
) is the expected return, or mean
rReturn in practice, for portfolio p
rR
Target
is the users target rate of return
rTSSD is the target semistandard deviation
(or downside deviation)
A portfolio that earns 10% per year when
the investors target rate of return is 8% per
year. The semistandard deviation based
on returns relative to the target is 16% an-
nualized. The Sortino ratio would be (10%
8%)/16% or 0.125
Jensens Alpha Direct measure of the absolute
amount by which an asset is es-
timated to outperform, if positive,
the return on effciently priced
assets of equal systematic risk in
a single-factor market model
p
= E(R
p
) R
f

p
[E(R
m
) R
f
]
rE(R
p
) is the expected return of the portfolio
rR
f
r
p
[E(R
m
) R
f
] is the required risk premium
r
p
is the alpha of the returns of portfolio p
If a portfolio is expected to earn 7% an-
nualized return when the riskless rate is 4%
and the expected return of the market is
8%, then if the beta of the portfolio is 0.5,
the alpha of the portfolio is 1%:
p
= 7%
4% [0.5(8% 4%)] = 1%
Source: CAIA Association
performance is the Treynor ratio. Unlike
the Sharpe ratio, this ratio uses beta as the
measure of risk in the denominator rather
than standard deviation.
The Treynor ratio may be interpreted
as the risk premium that the investment
earns per unit of beta.
The Treynor ratio depends on the unit of
time used to express returns. Generally, the
beta of an asset, the denominator of the
ratio, would be expected to be quite simi-
lar, regardless of the unit of time used to
express returns. However, ignoring com-
pounding, the quarterly returns would be
expected to be one-quarter the magnitude
of annual returns, and monthly expected
returns to be one-twelfth the magnitude
of annual returns. Thus the numerator
is proportional to the time unit, and the
denominator is roughly independent of
the time unit, meaning that the ratio is
proportional to the unit of time.
The Treynor ratio is easily intuitive-
ly interpreted as excess return earned
by bearing systematic risk. Unlike the
Sharpe ratio, the Treynor ratio should
not be used on a stand-alone basis. Beta
is a measure of only one type of risk,
systematic risk. Therefore, selecting a
stand-alone investment on the basis of
the Treynor ratio might tend to maxi-
mize excess return per unit of systematic
risk but not maximize excess return per
unit of total risk unless each investment
were well-diversified.
Beta does serve as an appropriate mea-
sure of the marginal risk of adding an
investment to a well-diversified portfolio.
Therefore, the Treynor ratio is designed
to compare well-diversified investments
and to compare investments that are to
be added to a well-diversified portfolio.
But the Treynor ratio should not be used
to compare poorly diversified invest-
ments on a stand-alone basis. It is less
frequently applied in alternative invest-
ments, because beta is not an appropriate
risk measure for many alternative invest-
ment strategies.
The Sortino ratio
A measure of risk-adjusted performance
that tends to be used more in alterna-
tive investments than in traditional
investments is the Sortino ratio. Unlike
the Sharpe ratio, the Sortino ratio sub-
tracts a benchmark return, rather than
the riskless rate, from the assets return
in the numerator. Also, it uses downside
standard deviation, rather than standard
deviation, as the measure of risk in the
denominator. Therefore, the Sortino
ratio can be used for investments with
skewed returns, especially those where
the downside risk seems larger than the
upside potential.
As a semistandard deviation, the target
semistandard deviation (TSSD) focuses
on the downside deviations. As a target
semistandard deviation, TSSD defines a
downside deviation as the negative devia-
tions relative to the target return rather
than a mean return or zero. Thus, the
Sortino ratio uses the concept of a tar-
get rate of return both in expressing the
return in the numerator and the risk in
the denominator.
Even if the target return is set equal to
the riskless rate, the Sortino ratio is not
equal to the Sharpe ratio. Although they
would share the same numerator, the
denominator would be the same only
for perfectly symmetrical distributions
and where the mean return of the asset
equaled the riskless rate.
The point is that the emphasis of the
Sortino ratio is the use of downside risk
rather than the use of a target rate of
return. To the extent that a return distri-
bution is nonsymmetrical and that the
investor is focused on downside risk, the
Sortino ratio can be useful as a perfor-
mance indicator.
Jensens Alpha
Jensens alpha follows directly from the
single- factor market model, which links
the expected return of an investment to
the amount of beta risk incurred.
Jensens alpha is a direct measure of
the absolute amount by which an asset is
estimated to outperform, if positive, the
return on efficiently priced assets of equal
systematic risk in a single-factor market
model. It is tempting to describe the
return in the context of the capital asset
pricing model (CAPM), but strictly speak-
ing, no asset offers a nonzero alpha in a
CAPM world, because all assets are priced
efficiently. In practice, expected returns
on the asset and the market, as well as the
true beta of the asset, are unobservable. So
Jensens alpha is typically estimated using
historical data as the intercept (a) of the
following regression equation:
Rt- Rf = a + b(Rm,t- Rf)+t
where Rt is the return of the portfolio
or asset in period t, Rm,t is the return of
the market portfolio in time t, a is the
estimated intercept of the regression, b
is the estimated slope coefficient of the
regression and t is the residual of the
regression in time t.
The error term t estimates the idio-
syncratic return of the portfolio in time
t, b is an estimate of the portfolios
beta and a is an estimate of the portfo-
lios average abnormal or idiosyncratic
return. Because the intercept, a, is esti-
mated, it should be interpreted subject
to levels of confidence. Positive levels of
alpha show outperformance, meaning
that the manager has earned a greater
amount of return than justified by the
amount of risk undertaken. Conversely,
negative alpha measures underperfor-
mance, where the return on the invest-
ment was lower than expected for the
amount of risk incurred.
Other popular performance measures
exist, and some firms use those unique
to the firm. In practice, a variety of per-
formance measures should be explored,
each of which is selected to view perfor-
mance from a relevant perspective.
Mark J.P. Anson, Ph.D., CFA, has head-
ed up several asset management firms,
including Nuveen Investments, Hermes
Pension Mgmt. and British Telecom Pension
Scheme, as well as was CIO of the California
Public Employees Retirement System.
He also is on the board of the Chartered
Al ternati ve I nvestment Anal yst (CAI A)
Association. Donald R. Chambers, Ph.D.,
is the associate director of programs at
CAIA and a professor of finance at Lafayette
College. Keith H. Black, Ph.D., CFA, is the
director of curriculum for CAIA. Hossein B.
Kazemi, Ph.D., CFA, is a professor of finance
at the Isenberg School of Management at
the University of Massachusetts, Amherst.
He also is a CAIA managing director.
This piece is an exerpt from CAIA
Level I: An Introduction to Core
Topics in Alternative Investments,
Second Edition, Wiley, 2012.
MANAGED FUNDS continued
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Hyatt Regency McCormick Place
rected until it reached $26, and then
consolidated and started forming its
base. On April 9, 2013, eight months
later, Microsoft was able to close above
its 200-day moving average at $29.60,
initiating a big rally that hit $36 by June
5, a 20% rally in just two months.
Crossovers
Two moving averages can be used
together to generate crossover signals.
Crossovers involve one relatively short
moving average and one relatively
long one.
As with all moving averages, the gen-
eral length of the lookback period deter-
mines the indicators sensitivity. A system
using a five-day EMA and a 20-day EMA
would be deemed short-term. A system
using a 50-day SMA and a 200-day SMA
would be long-term.
A bullish crossover occurs when the
shorter moving average crosses above
the longer moving average. A bearish
crossover occurs when the shorter
moving average crosses below the lon-
ger moving average. As seen in Look
at me, MA, when the five-period EMA
(red) of Caterpillar (CAT) crossed
below the 20-period EMA (blue), the
stock began a downtrend correction
from $95 to $83.
Moving average crossovers produce
relatively late signals. After all, the
strategy depends on two lagging indi-
cators. The longer the moving average
periods, the greater the lag in the sig-
nals. These signals work great when a
good trend takes hold. However, a mov-
ing average crossover system will pro-
duce lots of false signals in the absence
of a strong trend.
As lagging indicators, all moving-
average-based strategies are not intend-
ed to get you in at the exact bottom nor
out at the exact top. Rather, they keep
you in line with the securitys price
trend by being on the right side of the
bulk of the move.
Br amesh Bhandar i wr i t es at www.
bramesh- techanalysis.com and provides
online tutoring on technical analysis. He
can be reached via email at bhandari -
brahmesh@gmail.com.
Bhandari continued from page 35
1) Often, markets will react when they intersect with moving averages, resuming the
dominant trend. Heres a 50-day SMA vs. the S&P 500.
LOOK AT ME, MA
Moving Average (50d)
1695
1680
1665
1650
1635
1620
1605
1590
1575
1560
1545
1530
1515
1500
1485
1470
1455
1440
1425
1410
1395
1380
1365
1350
1335
1320
1305
1290
1275
1260
May Jun Jul Aug Nov Feb Sep Oct Mar Apr May Jun Dec 2013
2) Microsoft established a generally bullish tone above the 200-day moving average
and a bearish or sideways tone below it.
3) Caterpillar corrected following a bearish cross of its EMAs.
Moving Average (200d)
36.0
35.6
35.2
34.8
34.4
34.0
33.6
33.2
32.8
32.4
32.0
31.6
31.2
30.8
30.4
30.0
29.6
29.2
28.8
28.4
28.0
27.6
27.2
26.8
26.4
100
99
98
97
96
95
94
93
92
91
90
89
88
87
86
85
84
83
82
81
80
79
Oct Nov Dec Sep Mar Apr May Jun Jul Aug 2013 Feb
EMA (20d)
EMA (5d)
4 11 4 11 1 8 3 10 6 13 19 25 18 25 15 22 17 24 20 28 22 28 29 1
Feb13 Mar Apr Jun Jul May
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FM: And how have all of these dynam-
ics affected your funds performance
recently?
BD: Weve continued to outperform
the gold price. Fortunately, because we
had the foresight to sell out our mining
exposure, which is a leveraged play on the
gold price, we have maintained outper-
formance to the gold price. We certainly
had a difficult run. Models are based on
human input, and theres always in long-
only funds an innate bias when you see
value to be over-allocated. The way our
system works is that when the market is
trend ready, we have to get under-invest-
ed. We did that, but not to the allocation
that we would have liked.
One dynamic of the gold market that
is very difficult to explain to investors is
that because of this dichotomy between
the paper market and the physical mar-
ket, it sometimes is hard to read the real
cues as to what is going on. Typically,
when local London is trading at a pre-
mium, it means that theres normally a
dearth of metal in the system and that
normally leads to a significant price
reversal. Now in this case, we saw that
come much earlier, and the price of gold
probably dropped another 20%. So, there
are not any absolute levels that neces-
sarily could have given us a warning of
that. You can see that its perhaps not as
simple as other markets. Suffice [it] to
say we are the leading gold fund over the
last five years, and although Im pleased
with that, we have higher performance
aspirations and perhaps have not been
good as we had hoped considering the
skill sets and modeling we have.
FM: Being a long-only fund in the gold
market, do you primarily express your
views on the physical markets, or do
you use futures to hedge also?
BD: We have a construct where ultimately
the bedrock of the fund is 75% physical
allocated gold stored in Switzerland out-
side the traditional banking system, but
we have futures and OTC forward hedges
that we lift through the futures market to
give us exposure to the upside or we sell
more futures to get under-invested. We
look at all the dynamics within the COT
data; you have to as a gold fund manager.
FM: Your fund is down about 20% year-
to-date; what are some of the things
you could have done differently to
improve that performance?
BD: You have to remember that it is a
long-only managed fund. Were advo-
cating it within asset allocation. We
subscribe to the theory that you have X
amount in equity, X amount in real assets,
X amount in fixed income and maybe X
amount in cash or property. What were
trying to achieve by you allocating to us
is to outperform our index, which is what
we achieved. So if the market goes down,
we will lose a certain percent of the gold
price. If it went straight down, we typi-
cally would lose 75% of the gold price. But
by capturing the waves in the market over
the course of a year or two, we start to cre-
ate outperformance and, until the recent
six months, we have outperformed the
gold price 8% annualized. That is what
were trying to achieve for our investors.
FM: You mentioned that you store all of
your funds gold outside of the banking
system in allocated form. Can you talk
a little about why you decided that was
necessary?
BD: We felt that the credit bubble and
the bursting of it would expose finan-
cial institutions to default, which we
witnessed, and its often very difficult
to determine what the systemic fallout
from that would be. So, its essential that
we mitigate all the risks associated with
that default. Also, its just cleaner to have
that gold held outside that default risk.
Its that simple. When Man Financial
went down, there was all the rehypoth-
ecation that occurred in the banking
system through repos of bonds, and to
some extent weve even seen that in the
gold market, which is why the bedrock is
almost entirely physical bullion in allo-
cated form. That means it is in our name
and no one else has rights to it.
FM: Switching gears a little, youve writ-
ten a fair amount about what money
actually is. Can you talk a little as to
what constitutes money?
BD: Money is in the eye of the holder. It was
Nelson Mandela who said Money wont
create excess, but the freedom to make it
Q & A: Ben Davies continued on page 50
Davies continued from page 18
R
obert Lavin has spent 30 years trading for institutions,
customers, government agencies and himself, but may
have found his niche with the recent relaunch of com-
modity trading advisor Vallen Advisors. Lavin initially launched
Vallen in 2009 but shut it down after two years to pursue more
lucrative opportunities in consulting.
The program came about by accident in the first place as
Lavin launched it after leaving Fort L.P. He was hired by Fort
to help build short-term trading models to complement their
successful and growing longer-term programs, but redemptions
because of the fallout of the credit crisis (not in Forts programs,
which weathered the crisis well) forced them to cut back.
The goal was to build new products for those guys,
Lavin says. Unfortunately when the crisis hit they had about
$900 million in assets and favorable liquidity provisions led to
redemptions and a lot of assets went out the door.
Lavin liked what he built and decided to offer it as a separate
program. It wasnt his first rodeo; he ran a successful short-term
CTA, Sage Capital, in the early 1990s. He left there to take a job
with Sallie Mae, where he traded a $10 billion bond portfolio for
the government-sponsored entity managing student loans.
Lavin has had many stops at significant firms over the past
three decades, but found a home in the Washington, D.C. area,
where he operates out of Leesburg, Va.
He was head swap trader for Security Pacific Bank in the mid-
1980s when no one knew what a swap was and went on to build
hedging strategies for Citicorp.
He also had stints as managing director for GMAC and the
Blackstone Group before being named director of market risk
for Fannie Mae, where he was when he was tapped by Fort to
develop their programs.
I always was in trading. Most of the time I was managing
positions for corporations or trading for customers, he says.
In all those stops he specialized in quantitative short-term
trading with a bit of a discretionary overlay. In fact, Lavin points
out that he was one of the very few people trading off of intraday
data back in the 1980s when it wasnt so easy to get.
He took those skills to Fort and when he decided to launch
Vallen it was based on intraday data trading with a one-day time
horizon. The program earned 9.5% in the last nine months of
2009 but dropped 4.5% in 2010. He decided to shut it down
and take on a consulting offer, but he continued to trade and
optimize the program with proprietary money.
He really liked the improvements to the program and decided
to offer it to customers again earlier this year. I hadnt really
thought of coming back and trading for institutional money
until late 2012 after I did all the stress testing and was pretty
certain this thing was for real, Lavin says. First I thought it
was too good to be true.
The changes included lengthening the time horizon from one
to three days, eliminating intraday data from his models, changing
the entry time from the open to late in the day and, perhaps most
importantly, adding an intermarket overlay to his entry model.
Vallen 1 had some good ideas but then I took everything and
reworked it; changed some of the time horizons, changed some
of the ways I calculated formulas, changed the time of execu-
tion, Lavin says. One thing that I found that was very favor-
able was using more than one market to [trigger] a trade. I call
it a combination; we take markets that are positively correlated
and trade the more volatile one. For example, in metals the most
liquid markets are silver and gold; silver is more volatile. The
only instrument I trade is silver but [run my] analytics on both.
He uses five predictors that together create a score that indi-
cates whether to go long, short or stay neutral. A neutral posi-
tion can be pushed to a long if the companion market has a buy
signal based on his analytics.
Lavin calls this his most significant upgrade and has a com-
panion market for all of the eight markets he trades. In the
stock indexes he will run his analytics on the Dax, which can
trigger a signal in the S&P 500. For the Nasdaq 100, he looks
at the FTSE and for the 30-year bond he will look at the TLT
exchange-traded-fund (iShares Barlcay 20-year+ bond).
It was kind of a big breakthrough. I also look at index ETFs. I
use them as analysis instruments and then trade the comparable
futures contract, Lavin says.
His strategy is a combination of momentum, countertrend
and pattern recognition with a volume overlay. The risk is
equally divided into four asset classes: Equities, fixed income,
commodities and forex. Each sector has one quarter of the risk.
The changes seem to be working well. His proprietary trading
since the initial 2009 launch has produced a compound annual
return of 14.32% with a worst drawdown of 6.34%. And the pro-
gram is up (based on proprietary and customer returns) 15%
through July. Seems like the second time is the charm for Lavin.
Vallen: Second times the charm
BY DANI EL P. COLLI NS
TRADER PROFILE
P
H
O
T
O

B
Y

D
A
N

C
H
U
N
G
ROBERT LAVIN
2013 Daniels Trading 100 South Wacker DDrive, SSui u tee11225 Chicago, o, IIllin inoi ois s 60 6060 606.
Past performance is not necessarily indicati tive ve of fuutu ure r performance. Th The risk of lo loss ss iin n tr trad a ing future res s co co cont nt ntra ra ract ct cts ss or or o
commodity options can be substantial, and ther eref e ore in inve vestors should uund nder e stand the risks invo volv lved ed iin n ta taki k ng lev e er erag aged ed ed
positions and must assume responsibility for the rris isks ass ssocciated with such h in investments s an and d fo for r th thei eir r reesu sult lts. s YYou ou sho h uld
corefully consider wheIher such Iroding is suiIoble for r yo y u in in ligh ghI of your circummsI sIonces ond dn nonciol resou ourcces es.
ELEVATE YOUR EXPECTATIONS.
Visit danielstrading.com or call 800.800.3840 today.
CREDIBILITY
CREDIBILTY IS DRIVEN BY
CHARACTER & COMPETENCE.
THESE PRINCIPLES ARE AT
THE CORE OF WHO WE ARE.
WE BELIEVE EVERY
INTERACTION IS AN
OPPORTUNITY FOR US
TO DEMONSTRATE
OUR CREDIBILITY TO
OUR CLIENTS.
Trading Beyond the Matrix:
The Red Pill for Traders
and Investors
By Van K. Tharp, Ph.D.
John Wiley & Sons, Inc.
$40.00; 397 pages
BY LESLIE N. MASONSON
This book is about psychological
transformations and a journey of self-
discovery. Thus, it portrays a very dif-
ferent trading and investing approach
than most books in this field. Tharp
puts forth the premise that a trader
does not trade the market, but instead
trades his beliefs about the market. And
if the beliefs about the market are not
useful, then they must be eliminated
to not sabotage trading.
Examples of the latter
include: Not developing
and following written
trading rules, not using
stops, not using a trad-
ing log, fear of trading,
not being able to pull the
trigger, cutting profits
short and not willing to
take small losses, among
many others.
Thar p i s t he pro-
lific and well-respected
author of f i ve trad-
i ng books i ncl udi ng
Super Trader and Trade Your Way to
Financial Freedom. He is a trading
coach, consultant and trader with 30
years of experience helping many trad-
ers better understand themselves and
achieve better trading performance
through a three-level approach, which
he covers in detail. Chapters focus on
each of these three levels, and a small
group of his students have written per-
sonalized chapters illustrating the ben-
efit of learning his trading approach
to understand themselves and achieve
greater success in their trading and per-
sonal lives. These chapters demonstrate
that traders with different psychologi-
cal profiles and trading approaches all
benefited from Tharps coaching.
One of the most useful chapters cov-
ers the importance of adding Tharp
Think to your trading. Here Tharp
provides 40 key principles about trad-
ing that need to be understood and
applied. Other material from his Super
Trader book is scattered through-
out this book. In addition, there are
many useful resources included for
individuals to analyze their trading,
including a checklist for trading busi-
ness handbook, checklist for prepara-
tion and commitment and a scoring
sheet. Moreover, by going to Tharps
website, readers can obtain a free evalu-
ation of their level of consciousness,
play a position sizing game, obtain
Super Trader lesson five and receive a
free weekly e-newsletter with Tharps
market views, commentary and current
course offerings.
Key concepts that top-notch trad-
ers must master include
proper position sizing
(often not addressed),
trading efficiency (elimi-
nating trading mistakes),
managing the risk-reward
ratio, creating your own
trading business plan,
confronting and get-
ting rid of your trading
demons, understand-
ing why exits are more
important than entries,
keeping a trading log and
getting rid of all non-use-
ful trading beliefs. These
concepts are hammered home many
times throughout the book.
Tharp believes that if a trader reads
this book, takes the red pill (referencing
the Matrix movie where Neo selects the
red pill to see the world as it truly is), and
follows its methodology, it will forever
change his life by reprogramming him to
operate at a higher level. I suggest that
traders not familiar with Tharps books
consider reading the two mentioned
earlier in addition to this one to better
understand the authors total approach
and the reasons for his success in train-
ing and coaching hundreds of traders to
excel on all levels.
Leslie N. Masonson is a day trader and the
author of Buy DONT Hold and All About
Market Timing, (Second Edition). Reach
him at lesmasonson@yahoo.com.
BOOK REVIEWS
48 FUTURES September 2013 DIGITAL EXCLUSIVE
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MARKET
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IS GOLD NO LONGER
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TREND SCALING
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VOLUME IN ACTION
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HOW THE
JOHN BRYNJOLFSSON:
The Art and Science of
Technical Analysis:
Market Structure,
Price Action & Trading
By Adam Grimes
John Wiley & Sons, Inc.
$95.00; 480 pages
BY BI LLY WI LLI AMS
Go into any bookstore, and youll find
countless books stacked flush in the
Investment section on the subject of
technical analysis, but most add very
little beyond using it to trade the mar-
ket for consistent gains. This is such a
common experience, its almost a rite of
passage for the aspiring trader and even
joked about among veteran traders who
have experienced it firsthand.
However, The Art and Science of
Technical Analysis, by Adam Grimes,
is something of an anomaly in a sea of
mediocrity on the subject. Possibly the
most impressive aspect of Grimes work
is the opening where it is stressed that
having a traders edge is fundamen-
tal to successful trading. It goes on to
explain that without the existence of a
defined edge in your trading, success just
isnt possible, and Grimes deserves deep
praise for stressing that aspect of trading
upfront to the reader.
The rest of the book expands on that
subject while moving into key factors
that are essential to long-term success as
a trader, such as expectancy, price action,
price swings, the use of indicators, a break-
down on the use of moving averages, stud-
ied use of technical analysis
in the pursuit of successful
trading and more. Using
these key factors, Grimes
helps you understand how
to approach the market
with a clearly defined set
of criteria to locate points
of imbalance in the market
where you gain a signifi-
cant edge to exploit profit-
ably, while identifying the
periods of price action you
should avoid.
He goes on to make the
case that there are two
competing forces in the market mean
reversion and range expansion. These
forces express themselves through alter-
nating trends and trading ranges while
giving you the tools to formulate strate-
gies to trade each market type.
Armed with these tools, Grimes con-
veys to the reader that success is possible
because smaller traders are not playing
the same game as the big institutional
traders or mutual funds. Grimes lays out
the case that most professionally man-
aged funds are so large that they often
are the market, and lack the agility of
a skilled trader who understands price
action and market structure.
The subject of price action is a complex
and imperfectly defined
subject in and of itself,
and Grimes work is a big
contribution. His stated
goal is to help the trader
identify the markets own
structure and movement
so that he can use those
dynamics to profit over
and over again.
This is a massive work in
scope and breadth on the
subject, which depending
on your own point of view
is not necessarily good or
bad, but it will take you
some time to get through it to apply it. In
total, the book succeeds in adding some-
thing meaningful to a difficult subject
while helping traders gain the understand-
ing and skill-set to profit in the market.
Billy Williams is a 20-year veteran trader
and publisher of www.StockOptionSystem.
com, where you can read his commentary
and a report on the fundamental keys for
the aspiring trader.
Watch for the official web premiere of Floored in
early September. Released for the first time on the
Internet, this directors cut version of the film fol-
lows floor traders as they were forced to adapt to
the new world of electronic trading and how some
tried to fight against that current of change.
THE 24/7 RESOU HE 24/7 RES RR O CE FOR TODAYS TODAYS TRRADDDERRS
DIGITAL EXCLUSIVE
will. So, my premise for how I look at money is based on my views
being a classical, liberal economist. Not to sound too pompous, but
thats the order that I bring to my own personal life.
Talking about chaos and order earlier on, Im definitely an
advocate that the pursuit of society [should be] property rights
are observed, the rule of democratic law is observed, the role of
government is limited and you have institutions that are sup-
portive of freedoms such as speech, religion, thinking and politi-
cal persuasion. All of those are parts in my mind of a free market
enterprise. If money is a statement of the day through central-
ization, taxation and de jure money, then we have fiat currency
and debt creation that ultimately only helps fund political votes.
Its not a democratic process; its not conducive to a free market
enterprise. For me, pursuits of democracy, political or social
freedoms are totally inseparable from economic freedom, and
economic freedom comes from having money that is chosen
by the free market.
History has told us over the last 6,000 years that gold and silver
were commodities that had intrinsic value. The reason why it
works so well is because it isnt corruptible, and you cant print
it like you can on the printing press. It is limited in its annual
supply to 1.5%-2.5%, which incidentally is what the population
growth is each year. So it meets that supply/demand dynamic of
population growth, which is helpful, but maybe that will change
50 years down the line as we see a tapering off of demographics.
A pure gold standard provides a constraint on governments to
fund welfare and largesse and to build up a credit system. It just
provides more stable prices. Its not ideal, but at the moment
its probably better than the system that is highly volatile based
on credit proliferation that we have right now. You just have to
observe that wealth creation from credit is not permanent in any
stretch of the imagination. You just have to ask a Spanish house-
holder what the value of his house is next to zero right now.
FM: So is gold a commodity, a currency or both?
BD: Its not money in legal terms right now, but it has all the [ele-
ments] that make it attractive as a means of exchange. Certainly
it can be a store of value. The excessive volatility that weve seen of
late is more representative of a leveraged futures market, which
I dont think is necessary for gold. It gives potential for govern-
mental bullion banks to be coercive of the gold price. You might
say, Well, why would they want to act in such a fashion? At the
end of the day, gold is the proverbial canary in the coal mine and
a rising gold price signifies there is stress or a lack of faith in the
currency of a country or certainly in the faith of that govern-
ment. Any distrust of fiat currency takes away the engine that
drives those economies and drives the government machine. I
certainly think that in that regard gold fits the remits that you
need to be money. It is a commodity-money at this point, but
its not in fact legal tender.
FM: Does the same hold true for silver?
BD: Thats a very good question. Gold has a more representative
supply/demand dynamic relative to population growth than
potentially silver, but let the free market decide. Ultimately, you
can have competitive currencies. I dont have to assign all my
value to gold being the alternative currency. Im sure we might
have a debate later, but [Im for] alternative currencies, limiting
of fractional reserve banking or free banking itself, anything
that allows the free market to express what it thinks holds value.
The market is very efficient at doing that. It might be that by
a metallic standard, silver at times holds a certain amount of
value. Its when you see excessive price movements that you tend
to see hoarding, and then that causes deflationary escapades.
That is definitely a drawback that if it becomes more speculative
in nature rather than a currency, then you have problems. The
reason you get hoarding at the moment is because people are
fearing the fiat currency system. If we allow a competing system
to take place, which government is not interested in doing for
the obvious reasons that I just mentioned, then we probably
would see less of that hoarding because
we would spend it, or spend electronic
payments backed by gold or silver.
FM: Youve been quite a champion for
monetary reform around the globe. Can
you explain your platform briefly?
BD: Im a classical, liberal economist. I
believe that credit proliferation due to
state manufactured money has allowed us
to view most commodities as too specula-
tive. For example, our houses are no longer
our homes. [Theyre] no longer a store of
value. Housing globally has started to col-
lateralize the financial system. It misdirects
production and savings away from more
innovative and productive areas. I find that
such misallocations like weve seen into
housing ultimately are very disruptive to
the social and material wealth of a nation.
Thats why I feel rather strongly about
Q & A continued
Davies continued from page 45
being an advocate for sound finance. It also allows a level playing
field in terms of wealth equality. There is no doubt that perhaps the
next bubble, the bubble were exhibiting now based on this credit
proliferation, the rich or those closest to government through plu-
tocracy have enriched themselves at the expense of those who have
not had access to that. So you end up with a potential bubble for
the ruptures in the fabric of society. Social cohesion is going to
unravel, and were already witnessing that. Clearly that instability
is more egregious the greater the credit system is. It seems to me
that when we had a sound monetary system, namely gold, we had
far less wars under a 200-year period, or certainly not as significant
an inflationary bias so people could afford to live with less and their
disposable income actually bought them more of the amenities
they required. But when those are stretched, as were seeing in the
Middle East, and food, shelter and water come at a premium, that
leads to a revolt, which is an inevitability.
FM: So what sorts of reforms are you advocating?
BD: First and foremost, [we] need to limit the availability of credit.
There needs to be a check on that. Unfortunately the system is
built up so much, and policy makers are very fearful that a collapse
of the credit bubble would lead to a more permanent retraction
of prices and growth. [Conversely], I see a reduction in prices and
growth as part and parcel of any correction that leads to healthy
growth. For example, fire suppression in California: They real-
ized that allowing a certain amount of controlled bush fires actu-
ally regenerated green growth. Ultimately, there was more green
growth around, less tinder and fewer bush fires.
Its exactly the same if you suppress the marketplace and sup-
press money. If you do it in a wholly constrictive manner, then
you are just sowing the seeds for a greater calamity, which is
what I believe we are in the midst of doing now. We need to dial
back the credit in the system. If we are going to have central-
ized banking and money, then we need appropriate regulatory
reform, but that does not mean coercive constriction of capital
and forcing these banks to have far too much government debt,
which probably isnt worth the paper it is on because they are all
so in debt. We need tax reform, and to provide education both
vocationally and intellectually to the masses so they understand
the purpose of a sound economic system. The list is endless, but
that for me is the core; that will drive everything else.
[We need] institutions that foster this, the rule of law and
most importantly property rights, which protect individuals
when governments are desperate to pay for services and are
highly indebted. That is when they are desperate to take capital
from the private sector, and they will pursue any means to do it.
The financial transaction tax and off-shore tax havens werent
the issues that caused the banking crisis, but nonetheless these
are the regulatory outcomes as governments go seeking private
savings to pay for their own largess.
FM: What do you see as the role of central banks under your
proposed reforms?
BD: My belief is that the free market ultimately will move toward
a money born out of a crisis situation. Technology is allowing
people to understand the importance of money through the
World Wide Web, I call this the Internet Reformation. Payment
systems are going mobile and borderless. They are allowing peo-
ple to almost circumvent the current fiat currency system. With
bail-ins and perhaps bail-outs on the horizon in Europe, people
are going to look for ways to protect their money as a store of
wealth and circumvent the traditional system.
Although I see all those things happening, in a crisis situation,
which I still see as highly likely globally, central banks will have
to consider and already are considering backing their systems
with something stable. The BRICS, and particularly China, have a
great affinity to gold, and have the potential to back their systems
with gold. In the death throes of a monetary collapse, which I
dont rule out, this is when a new system perhaps would occur,
and likely would be some kind of commodity standard or gold
standard, or a change to the banking system itself, which prob-
ably would maintain a central bank but in reality would be gold
as the constraint on the system. It would constrain trade flow
through the balance of payments process, and it would constrain
the ability of banks to create credit by having a certain amount of
currency backed by gold say 40% as it was traditionally.
FM: So then related to the things youve been talking about,
lately there has been a lot of talk about currency wars devel-
oping. Do you see this as a real possibility?
BD: Its happening, isnt it? What is a currency war? Ultimately,
its where you have beggar thy neighbor tactics to try and
improve your export market to steal growth from other coun-
tries. The question right now is if it is more coordinated? Its
almost like countries are going around one after another the
United States does quantitative easing, followed by the European
Unions [Outright Monetary Transactions] and now weve had
Japan beginning a huge QE process, which wasnt unexpected
because theres no one left in the world to purchase their debt.
I wonder if at some point it will be of more pertinence and
value for someone to break away from that coordinated attempt
to reflate the banking system. All these central bankers and gov-
ernment officials realize that a coordinated effort is better than a
single effort because it spreads risk. It would impact demand too
much across the world if one, two or three countries go down.
So, were seeing a subtle currency war starting to develop, and
certainly Japan has upped the ante because it has to. Whats real-
ly interesting is that there have been 500 interest rate cuts [glob-
ally] since the crisis. That really has a huge impact on trade and
capital flows. Its only going to lead to more financial repression
as people realize that as other nations manage to steal some of
their growth, [those nations] have to find capital from some-
where, so they have to conscript capital from the private sector
in any shape or form they can. That can lead to capital controls,
currency controls; all of those are at risk.
FM: What will the man on the street see as a result of these
subtle currency wars?
BD: This is where there is huge debate, and it is binary and there
wont be a muddle through. I certainly feel that central banks
have tried to maintain the balance of credit in the system as
it is, and what they do is adjust the money supply and volatil-
DIGITAL EXCLUSIVE
ity, but they do so by circumventing the necessary adjustments
that you need within the monetary system. You need market
failures, but they are not allowing this market failure to take
place. They pump up the monetary side, which you think would
lead to inflation, but credit matters more than money. It is this
overhang of credit, and ostensibly the system hasnt delevered
to the extent that people think it has.
There has been a redistribution perhaps in the way debt is
organized, maybe from private to public sectors. All of that
has gone to underpin nominal GDP. You can argue that there
should be an inflationary impact, and perhaps in some ways
there has been because without that money supply increase,
prices would be a lot lower. Right now, because of the unravel-
ing of imbalances between China and the United States, China
is beginning to finally break down from its own credit largess.
This imperils the world to a very deflationary outcome and it
will be interesting to see how central banks ratchet up.
For me, it is very binary. There is the deflationary outcome of
full credit retraction, which would lead to a resetting of the system,
or there is a hyper-inflationary phenomenon that might occur in
places like Japan where if all the reserves that have been created to
buy their bonds end up in the economic system, that will cause
prices to rise dramatically. If I was arguing any country might see
hyper-inflation, that would be it. Its not an easy dynamic to com-
prehend, but its basically pumping up the system with money and
the overhang of credit, which if you notice has continued to rise or
stayed at the same pace it has and is phenomenal. As a consequence,
for every bit of credit that is pumped into the system, the margin
utility, or the bang for your buck, is less and less. Thats not good
for growth; thats not good for taxes, so we wont be able to repay
the system. I feel the system has to reset its just which way Im
not sure as of yet, but it will manifest itself.
FM: If you see those as the two possible outcomes, how would
you suggest people prepare themselves?
BD: If I was to think from a wealth allocation perspective, I
would say there is no holding of fixed-income debt at the levels
weve seen. Under an inflationary or insipid economy, you are
looking at guaranteed real losses. Under a deflationary spiral, or
even just the rate of inflation goes up, that will be significantly
negative for long-end interest rates. Either way, the bonds sector
is just not a sector that will yield compensate you in any way. Its
a guaranteed capital loss of a significant amount were talking
20%, 30% even 40% depending on the credit spectrum.
Equities have definitely benefited from this portfolio chan-
neling effect. Because of the environment created by central
banks, yields have been driven so low that capital is forced to
circulate by looking for yields. In equity, its almost like it is driv-
ing up all asset prices so that the return on your investments will
by $0 at the wrong price. So, equities in large parts, particularly
in the U.S. and emerging markets, have come back. Again, they
are very risky, and you have to reduce your holdings.
At these levels, would I be advocating shifting into the pre-
cious metals sector? Absolutely. It provides a base here for a
default or deflationary fallout, and if you want to earn equity,
then it provides a significant diversifier that mitigates that
downside risk over a long tenure of 10 years not necessarily
a couple of years because any year can have increased volatility.
FM: It sounds like you really believe you need to have the
physical asset to protect your wealth then.
BD: You cannot be participating in paper constructs because
you leave yourself open to counterparty risks. However much
some of these providers say they are backed by allocated gold,
why take the risk? The ultimate cost is so much cheaper to store
gold with an allocated provider, and if you have the economies
of scale, then it becomes much cheaper than an ETF, which to
me is a more speculative vehicle.
FM: With the macro perspective that youve already dis-
cussed, how realistic do you see a return to the gold standard
at this point?
BD: First off, it is not in the interest of governments to want to
do that. Obviously there is a growing groundswell in the United
States, but it has not happened, which isnt to say it wont hap-
pen. More importantly, the development of technology and the
awareness that has been created by the Internet is creating prob-
lems for governments around the world in how people perceive
the intentions of that government, whether it has their best inter-
ests [at heart] or not. I always encourage my step-children that
they should hold their politicians accountable. That largely has
been forgotten today they are representatives of ours. They
are seen as too powerful and important to talk to, but in reality
they are elected officials. We seem to have lost that point of view.
We would have to go to an extreme crisis scenario, which I
assign a much higher probability. Im one of those people that
doesnt believe in absolutes. The exponential rate of growth in the
monetary system has been so manifest even to energy creation
and population that I think the stresses are very manifest. Weve
had one major shock in 2008, and I dont believe the solution
to the problem will be a prescription of more of the same. This
system needs to readjust lower, and that could be very volatil-
ity. Thats typically when the system is questioned, and the pro-
pensity for a new alternative currency could come into play. It is
incumbent on the free market to make it felt that there is an alter-
native. Im a big proponent that we create online, mobile payment
systems that potentially are backed by gold. The private sector can
start to create that, but obviously that runs into the regulatory
and legal nightmare the state will throw at you, but it needs to be
addressed through [government] by asking for banking reform.
FM: You alluded to Fed Chairman Ben Bernanke earlier; in
his most recent testimony to Congress, he mentioned at one
point that No one understands gold prices. Do you?
BD: Yeah, his statement barely mentions gold. He almost was
forced into a comment on it, and by being dismissive of it, hes
not providing any validity to gold being a potential alternative to
what he sees as the best system or mechanism for running a com-
plex monetary system. I dont know him personally, but through
degrees of separation I have some insights into his psyche and
beliefs, and I believe he is far too dogmatic in his doctrine and
he should, as I am, be open to all sorts of ways to prevent the
Q & A continued
catastrophes we have witnessed over the
last few years. I dont think I can be more
fair than that.
FM: Youve talked about alternative cur-
rencies throughout this interview. Can
you talk a little about some of the differ-
ent ones that have been proposed such
as Bitcoin?
BD: Oh Bitcoin. Absolutely fascinat-
ing, that is a great example of what were
talking about. I notice it is referred to as
a virtual currency, almost as if to invali-
date it. I believe in the principle of Bitcoin;
it meets many of the requirements of an
alternative currency.
Just to say what Bitcoin is, its a decen-
tralized, censorship-resistance, digital,
peer-to-peer currency that was created by
someone with the pseudonym Satoshi
Nakamoto about four years ago. You can
use that currency to buy goods and services over the Internet
without having to pay bank fees or government tax. In many
ways, its theoretical roots do come from the Austrian school. The
inception of it was the fear of the current fiat monetary system
and all the interventions that have taken place by the government.
So, it follows up from the belief you should have competitive
currencies, and certainly this is a competitive currency, although
its not one with any intrinsic value like gold. But, its very clever
because it has this data-mining principle that creates supply just
like gold is produced, but it limits it each year. It has something
called a block chain that creates a public record of all the transac-
tions in the system, so it has that ledger that prevents you from
spending it twice. In that regard, it absolutely is fantastic.
More importantly, whether or not it becomes a real challenge
to the fiat currency system, which I suspect it wont, it is techno-
logically too complicated unless you are programmer, you dont
understand the open source code that is part of its credibility in
theory because everyone can look at it. Im not convinced that
the cryptology used to secure it is not perhaps open in some way
to the issuer or issuers of the limited number of Bitcoins a year,
which could be inflationary. Theres no constraint on currency
proliferation like you would have if you were backing the system
with gold, which is why I still believe gold is the best fit for an
alternative currency. It has created good debate, though.
The other issue with it at the moment is Bitcoin is more a
speculative instrument. Im not sure how many people really
see it as an alternative currency. Obviously, it doesnt have a
store of value yet. Security and integrity of its system, there
has been embezzlement, but thats more at the exchange end.
There are exchanges where you can convert Bitcoins into fiat
currency, and interestingly this is where regulators have really
gotten ahold of them. Again, its not in governments interests
to have potential alternative currencies vying with the official
state currency that ultimately people have to pay taxes in. They
want people to pay taxes to pay for the welfare system with that.
Ultimately, its a natural progression that payment systems
that historically have been arcane and very slow are now moving
to new methods of payment. Were going to have a cashless soci-
ety. I really think biometric identification is going to come in and
remove all this password nonsense that you can never remember.
This is a really helpful evolution in both currency usage and the
debate about who should determine what currency should be and
where the counterparty risk is. At the end of the day, the bearer
is the U.S. government at the moment, but why shouldnt it be a
free market concept? Why shouldnt we decide what we choose
as long as the supply of it is constrained by something that is
naturally in constraint of its own supply, i.e., gold? Where I differ
is gold could be the bedrock to that electronic payment system. It
is fascinating and Im learning more about it all the time.
FM: Looking specifically at Bitcoin, do you see it has a viable
alternative that will have staying power and will still be around
in 10 years?
BD: Sometimes you think First-mover advantage, but as an
alternative, borderless currency, I plead the Fifth Amendment.
Im not sure how its going to pan out. I suspect there will be
systems that are better maybe in some way will work within the
current system. Once that happens, that changes the dynamics
of it. I really watch its base. If Bitcoin can convince people this is
not just a speculative investment, and its more about facilitating
free trade, then its a real possibility.
FM: Going back to gold, Jim Sinclair recently was quoted as
saying he could see it going as high as $50,000 an ounce.
Do you have any projections?
BD: If Im consistent in what weve been talking about, I certainly
can envision outcomes based on macro analysis, but we always
wait for a signal generation. I dont believe in absolutes; I believe
the Gaussian curve descriptive is not representative of complex
systems. Why it would get to $50,000 an ounce is in my mind
DIGITAL EXCLUSIVE
because these fiat currencies have completely collapsed. At that
point its not about value anymore but complete distrust of the
system, although I would question at what point supply would
come on and lead to dishoarding at a level where there would be an
arbitrage opportunity whereby you could divest yourself of physical
gold assets to buy other assets at lower prices. I dont know if he
was saying all prices will be at that level, or whether just gold will
be at that level.
I would say for gold to be at that level, everything else will
be much higher in price. With the technological advances in
energy, barring a complete collapse of the monetary system,
I find that difficult to see. Ive been very consistent in saying,
all things equal, $6,000 based on the backing of the monetary
system as it stands and all the credit. If you look at the $220
trillion market capitalization of all assets, clearly that has been
way in excess of the growth of gold. I suspect that credit will
rescind and gold value will go up to somewhere in between,
which for me is around $5,000-$6,000 an ounce. As a visionary
of monetary changes, Im not sure I can bring myself to envi-
sion $50,000 yet.
FM: Weve talked about a lot of different topics here. Finally,
what are the next steps for you professionally and for your
firm, Hinde Capital?
BD: The most exciting development for us is we have received
huge recognition; even being in this magazine is fantastic. Were
not one of the big boys and to have recognition more and more
over the last five years from lots of major publications means that
our message is getting across. We have a unique fund; we have a
unique message. In terms of staying within the bounds of tradi-
tional investment management, were setting up a global macro
fund. The distortions that have been created by central banks
and governments at this point will lead to far more ruptures and
trends within the marketplace that we will look to exploit because
we want to create a capital return, hopefully adjusted for inflation
a real return, that protects their purchasing power. Thats our
aim. Its very exciting that I feel I can complement my promotion
of monetary reform while focusing more clearly on my first love
trading and investing. Developing a new fund is very exciting.
From my own personal perspective, Ive wanted to create a busi-
ness that aligns itself heavily with investors. I do think the hedge
fund model is likely over for the institutional players. The days of
upfront fees after a period of poor performance and not having
to return them are over. Theres a disproportionate payout, and
in conversations with friends who reminded me of my integrity,
fund businesses will have less of a short life and can be more about
building investor value if they align themselves with long-term
investors, private equity firms or family offices that take a stake
in thier businesses. They help with the operating capital, because
it is very difficult for a mid-size firm to survive beyond five years.
The average shelf-life of a hedge fund is very short, probably under
four years, and weve been going seven years, which is a testament
to our investors and how we structure our funds. Its about being
aligned with our investors, changing the fee structure for longer-
term performance. Thats a much more authentic approach, and
is one you either embrace or be forced upon anyway.
Additionally, Im in the process of putting all these thoughts
we discussed today into a more succinct format in a book ,
which will depict how we got here and where we may be going,
and have a proper debate about alternative and virtual curren-
cies and solutions rather than just knocking how we got here.
Maybe thats for my own edification, but it is also about the
education process, because a lot of people dont understand
whats happening with money and why its so important for
our belief systems and generational sustainable wealth. People
need to understand sound money.
continued
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