MODIFIED COT STRATEGY

Students of my FXOptions classes know the power of Commitment of Traders, some even swearing by it, and laughing all the way to the bank! The returns on COT trades are staggering, as proven by real trading records from our students and even trading scenarios on PFX. But COT trading has its disadvantages in running large drawdowns in your account. This could be OK under normal circumstances but what if VIX is above 30 and is going up, like the current scenario? A high VIX is bad, and could lead to "abnormal" drawdowns which could cause YOU TO CAPITULATE INSTEAD! So how do we take advantage of the COT on the USDJPY when VIX is high?

Use a modified COT strategy which limits your losses on each lot. You can start buying USDJPY at the spot market, and keep on buying as it falls by 100pips. For each lot of USDJPY, you should buy 1 Protective Put Option (you can do this on ThinkorSwim or Saxobank) which expires this Friday (Options Expiration, although you can go longer on Saxobank). Even as the USDJPY goes against you, the effect of the Put Option is to limit your max loss to the cost of the Put. (This is a weird strategy because YOU WANT USDJPY to GO DOWN, DOWN, DOWN....). Once capitulation occurs, you should buy back the puts, which should have some time value left. This will allow you take advantage of the move up without suffering massive drawdowns. The drawing belows depicts this in graphical form.

For a more in depth tutorial on Protective Options, go to this link at PFX Global.

Happy Options Expiration!

Chief Shook

WAITING FOR VIX and VXO

The market just wants to go down it seems. Even a coordinated injection of over US$200billion has failed to calm nerves. Good CPI number? Yup, only to be torpedoed by the news of a bailout of Bear Sterns (by JP Morgan and the Fed, of all people). The VIX also closed at 31.16 which is the highest VIX close since March 2003. It's obvious that we're going into what will be a
volatile and roller coaster Options Expiration week. In addition, Put/Call ratio (CBOE) is at 1.16, the highest since, you guessed it, March 2004. So March seems to be a month of extremes! (and we thought it was October). It becomes clear that fortune favours the brave in March.

Looking at our "Triangle of Hell", the SPY is increasingly underpressure to test its support of 127.5 and its low of 125. If this breaks, we should see 122-122.5 and if that breaks....err, I don't want to talk about it since we'll have to seet the monthly fib retracements to get an idea of where we're going to (hell, that is).


It's possible that we have some ways down to go, which could result in"a bottom" (don't ask me whether it's "the bottom"). There are several reasons for this (aside from VIX and Put/Call extremes):
1. The market looks like it's extremely oversold (which is not a reason to buy the market anyway, since oversold leads to more selling) with pessimistic extremes. Notice how market turns happens when chicken little cries that it's the end of the world (for Bear Sterns investors, it probably is)
2. The Yen, which is a barometer for risk, is showing extremes with commercial traders at 0 (short yen) and specs at 100 (long yen). The recently released CFTC data shows specs reducing their long yen and long euro positions. This could be the recipe for a blowoff top (or bottom). I am encouraged by the Yen's movement which hit our 261.8% fib target at 99.15 which means a recovery rally is expected.
3. Historically, this could be "March madness" - when such extremes last happened in March 03 and March 04, the markets popped up.
4. Central Banks are in an intervention mode nowadays as can be seen from last week. The Bank of Japan could spring into action and stem the rise of the Yen, saving its manufacturers.

So how do we take advantage of this situation? First off, we shouldn't panic ourselves. Once we get this pyschological thing, then we have to lay the trap door for the frightening apex of VIX which could occur soon. In this case, we are waiting for extreme panic in the market, with VIX spiking to at least 37, with breach above 40 highly probable (in the late 1990s and early 2000s, the VIX spikes were at 45-50). Once capitulation occurs and is supported by VXO moving inside the Bollinger band, we have several choices:
1. SHORT the reverse proshares of the Dow (DXD), S&P500 (SDS). You get more bang for the buck as it moves twice as fast as the Indices themselves, i.e. DIA and SPY
2. BUY the ITM Options on the DIA to catch the fast and furious capitulation rally
3. BUY stocks which have held well during this rally, for example, those in the commodities complex, particularly agriculture and gold
4. Do a COT trade on the USDJPY (or AUDJPY) in 100 pip decrements. Note that your account must be able to sustain drawdowns. As the shorts clear their positions, the run-up will be fast and furious
5. Buy ITM April call options and increase your position as the USDJPY goes down
by 100pips. You can do this with Exchange Traded Options on ThinkOrSwim or with
Vanilla Options on Saxobank (you can even consider a similar strategy using OPTIONS on the USDCHF pair)
6. Once capitulation occurs, lock in the value of GBPJPY for one month. Buy the currency pair and sell a call option to give you around 1200-1500 pip protection. You should cruise earning the interest differentials in the next month, which works out to US$2.60-US$3.00 per mini lot a day. Why bother trading when you can earn interest,by allocating US$1,500 per mini lot? Scared of the volatility of GBPJPY? Then try out AUDUSD and buy yourself a 350 pip hedge.

These strategies should take into consideration your expertise. Pick something which you are most comfortable with.

The chart below shows how the markets behaved on the previous VXO and VIX peaks. The
markets turned promptly, rewarding strategic and patient investors many times over.
I rest my case.....Good luck and BOOYAH!


Note: These guidelines can be implemented by students who attend my FXOPTIONS classes. Don't try doing what you don't know, especially for new traders. Learn first lah!

Chief Shook

WAITING FOR CAPITULATION

The markets are in a doldrums, as the NFP (NonFarm Payroll) reports confirmed another minus
63K of job losses last month. The US looks like its in a recession, or is it? The S&P500 has
taken a hit and has broken down our so-called "triangle of hell." Fxoptions course students can
see the fake out to the upside of the triangle which was eventually stopped dead in its tracks.
(Fxoptions students would not have traded this fake out because they knew the market was going down due the commitment of traders on the VIX as well as the 10 Year Treasuries futures....How smart is that?). Look at the Triangle for yourself.

I am eager to see how the KLCI does on Monday (11/3) morning. What's the implication of the ruling National Front losing its 2/3 majority? Should make the local market a good buy once we get capitulation on the S&P.

So what is capitulation and how do we recognise it? Taking this definition from Investopedia, "In the stock market, capitulation is associated with "giving up" any previous gains in stock price as investors sell equities in an effort to get out of the market and into less risky investments. True capitulation involves extremely high volume and sharp declines. It usually is indicated by panic selling. After capitulation selling, it is thought that there are great bargains to be had. The belief is that everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom."

Here are some telltale signs of capitulation:
1. A VIX Spike - usually to above 37. Due to the volatile nature of the markets, don't be surprised
if $VIX spikes to 45-50, as was the case in the late-1990s and early 2000s.
2. $VXO spiking above the Bollinger Band. Be careful as VXO might (and will) climb up the Bollinger
Band without peaking. You need experience to tell.
3. A sudden reversal in stocks after a seemingly bottomless pit. The recovery is fast and furious.
We'd normally like to see multiple tests of the lows before committing. Also, recoveries can take
place much later in the day.
4. An extremely HIGH VOLUME day, giving credence to the turnaround (instead of it merely being a "dead cat" bounce.
(Note; Those who are more adventurous could also wait for the $TRIN to go above 3.5)

Here's what the most recent capitulation looked like (Source: Shadowtrader, Redoption)

Happy Capitulating and make it GREEN with PROFITS!

Chief Shook

MALAYSIAN TSUNAMI

As Forex traders,we know of two important issues - the Internet and Inflation. We use the Internet to trade Forex and we know inflation tends to push up values of currencies (through interest rate differentials). Somehow, Malaysia's ruling coalition forgot these rules.....Should come to my Fxoptions classes, eh? For the political tsunami that washed away the West Coast of Malaysia (Selangor,Perak,Penang, and Kedah, not to mention Federal Territory) is the result of a well-coordinated campaign in cyberspace. These feelings of uneasiness were furthered aggravated by inflation in daily goods and services - as can be seen by the rising DBC Commodity Index (wheat and fuel have risen dramatically in the past few weeks). This created a perfect storm for the Rakyat to voice their displeasure, which they gleefully accepted in full force. The outcome was something we never saw before as the Mainstream Media were at a loss of words to report what was going on after Penang, Kedah, Selangor and Perak all fell like dominoes (count in Wilayah too, except that there's no state called Wilayah). What's my hope? That the Government and new State Goverments (they're not "Pembangkang" anymore.....he he he) work together to keep prices in check. We are still in the middle of a commodities bull run that could take prices even higher. More than ever, we need a "welfare state", albeit temporarily, or run the risk of more of the rakyat falling below the "poverty line" (be it real or virtual). And even if commodities were to come down, it would probably be in response to a recession, which is also not good. Lets hope for the best. The brave people of Malaysia have chosen, so the Governments (federal and state) should give them what they want! POWER TO THE BLOGS AND PEOPLE!

Btw, could be use Kelantan's humungous gas reserves to subsidise our fuel and gas?

Chief Shook

"THE SECRET"

Students to my FXOptions classes know I'm on fire. The trades have working with uncanny accuracy. Case in point was the 3 trades I suggested for this week on EUR-JPY & USD-JPY Hedged Trade, the AUD-USD and EUR-AUD Hedged Trade, and Buy Call on GBPUSD. So what's the secret? Simple........BUY in the DIRECTION of the TREND. The Trend is indeed a forex trader's best friend since forex pairs do tend to trend very well (which by the way, makes them excellent candidates for Options Trades too). Here are the principles behind the trades:
1. Short EUR-JPY and Buy USD-JPY - This recommendation was made on Sunday, March 2nd. I was merely betting on the continuation of the downtrend on the DOW (it had fallen by 300+ points the preceding Friday). Since I was not sure of the market direction, I used USD-JPY as a hedge in case the market turned. The market did continue down, the trade was profitable by Monday night.
2. Buy AUD-USD and Buy EUR-AUD. The RBA was due to give its interest rate decision on Tuesday, March 4th, so trading the Aussie naked was a definite No-No. There was also a possibility that the overextended Aussie would retract after the Interest rate announcement (or it could fly, of course, like the venerable Euro). If the Aussie retraced, our gains on the EUR-AUD position would compensate for the loss on the Aussie. The RBA raised rates by 25bp to 7.25%, and the Aussie retreated, putting this position into profit by Tuesday morning.
3. Buy GBPUSD on a breakout. The 3rd trade required a bit of technical analysis. I had just completed teaching a module on Technical Analysis, so it would be fun to apply it to real trading. Enter the Triangle. I said to Buy GBPUSD on a break of a consolidation triangle. If GBP broke down, we would do nothing. The GBPUSD first broke down, and then coolly blasted over the triangle (the triangle top was 1.9917 on Thursday, March 6th) after the Interest Rate announcement, giving traders at least 100 pips!

3 Profitable Trades. Shows that it pays to know the fundamentals! This is why we need to read every day to understand the "pulse" of the market. Wanna learn more? Join the next FXOptions class!

Chief Shook

WHERE'S USDCAD GOING? WHO CARES!

I am doing a hedged trade using Options (exchange traded options on the ISE) on the USDCAD pair. I am also putting this on the ThinkorSwim "Paper Money" platform as the benefit to the students of FXOptions, so they can see how this trade is managed throughout the end of March Options Expiration. The USDCAD looks like its going to explode, either UP or DOWN. It could go up to the top of the channel and scale above 1.0350, or trace below and break the 0.9950 support all the way to 0.9755 (both PFXGlobal and DailyFX have contrasting views). So which will it be? The answer is that WE DON't CARE. We'll go short with our spot position, and long
with Call Options (CDD on thinkorswim). Note that I chose Short for our spot position, allowing us to do a COVERED PUT just in case we need to raise premiums (you can't do a Covered Call; need Saxobank for that). Upon Selling USDCAD at 1.0101, I also bought an ATM Call Option at the 101.00 strike for 1.44, giving us a "virtual stop" of 144pips. There will be adjustments to bring down the cost of the stop, but this will be described in detail in class. (In addition, Commitment of Traders data also support USDCAD losses. With Summer driving season expected to drive up Oil prices from April 08 onwards, this is logical). Would I do a similar trade on my Live TOS account? Sure, but it has to be 1.5 weeks prior to expiration. I hate paying for time premium.

See the chart below:

RETURN OF THE KING

Once the EURO was KING. A combination of strong fundamentals and a hawkish rhetoric by the ECB supported its ascent towards the "promised land" of 1.50 (vs. the US Dollar). But like most financial euphoria, this one fell short - it stalled at 1.4963, 1.4921, and 1.4953, leavings the bulls frustrated. When the Euro went down recently on concerns that the ECB would be forced to consider lowering rates in response to the Fed and BOE, the bulls literally threw in the towel. But herein lies the opportunity. For if the low of 1.4438 represented a "capitulation" of sorts, then the Euro could be on its way up. The rumours of Oil being priced in Euro's only adds fuel to the fire, and a struggling 10-year yield which cannot break out decisively of its downtrend line could lend fundamental support (A Swiss Franc swoon typically results in a uptrend for the Euro). So could it be that we're looking to hit the upper end of the triangle on the Daily Charts again (circa 1.4900)? You decide. BUY and average down.

ChiefShook

WANT EXCITEMENT? GBPCHF IS IT!

The GBPCHF remains as one of the most volatile pairs out there, rivaling the GBPJPY as the wildest pair in the wild,wild west of Forex. This makes it the perfect hedging vehicle for Covered carry trades on the GBPJPY (which can be protected to the tune of 1,500 pips). But we’ll talk on the GBPJPY on another day.

The GBPCHF is so far undergoing consolidation (see the triangle in the Charts below), presumably before breaking out again. But where to, you might ask? Although the 4 hour charts shows upside (for now), the longer term daily suspiciously points down. The short term direction might be down, as the Bank of England is expected to reduce interest rates to 5.25% while the ECB remains wary of inflation. But the Commitment of Traders show the GBPCHF breaking to the upside, with the big dogs long the Sterling and short on the Swiss Franc.

We’ll see. This pair remains a BUY on dips.

Chief Shook

RIDE ON THE AUSSIE CARRY TRADE

The Red-Hot Australian economy chugs along, oblivious to the implosion in the USA and signs of a rate reduction in the United Kingdom. Could Australia be an economy which has decoupled from the good ‘ol USA, with demand in commodities from China and India fuelling domestic growth? (Could there be hope indeed for similar commodity rich economies such as Malaysia?). As was reported by the news, “The Reserve Bank of Australia lifted official interest rates by 25 basis points to 7 percent to curb inflation in an economy which is running at full capacity: with unemployment at 30-year lows, strong consumer spending and booming house prices. Economists believe at least one more hike may be needed to cool demand and price pressures.”

This makes the Aussie an ideal candidate for the Carry Trade, ala ISOptions. The aussie has a lot of things going for it in addition to the robust domestic economy. Gold is expected to increase and breach the US$1,000 barrier, notwithstanding that it’s still some distance away from the inflation adjusted highs of US$2,000 (US$850) achieved in 1980. Will it make another bullish run (with consecutive limit-up days) in 2008, culminating in a blow-off top and island reversal like 1980? Whatever the case, gold stocks (Goldcorp, Barrick Gold, Cour de Alenes) look a good bet, as is the ETF GLD, and not to forget, the venerable Aussie dollar.

Allocating $1,000 to invest in one lot the Aussie, and the second $1,000 for a hedge (for example, the EURAUD), results in an annualized return of about 18%. That’s really cool! Call options would be used to protect your long Aussie positions as it churns out the money daily(about $0.86 per lot), and deep in the money options can provide coverage of up to 400 pips). I’ll drink to that! (The picture of the wine is of the brand Yellow Tail, featured in the best-selling business book BLUE OCEAN STRATEGY).

Chief Shook

WHERE TO NOW?

Gong Xi Fa Cai! The Year of the Rat should usher in element of water, which we really need now to temper the extreme volatility from the Year of the Pig. And what a roller coaster January has been! We’ve had our worst January since the 1960s (with the first 5 day declines matching the meltdown in the 1930s), and France’s Societe Generale suffering over US$7 billion (that’s about 3.5 billion pounds) in losses attributed to a single rogue trader. (who can blame him for taking long positions on the market? Weren’t we supposed to have January effect, by the way?). In contrast, Nick Leeson only cost Barings banks a “pittance” 800 million pounds. The Fed quickly came to the rescue, lowering interest rates by 1.25 percent in a week. But was the Fed a little bit to late to stem the tide of negativity pervading the markets? Will we have a crash this time round? (defined as a market going down by 37% and above……Amazingly, during the granddaddy of all crashes in 1932, the market went down by 86% and didn’t recover until 22 years later! I’m sure we won’t have that this time round).

The Dow has been struggling of late (not unexpected since we've rallied 1,000 pts off the lows) and hit resistance at its monthly uptrending line (which used to be support but which now functions as resistance). After being repelled at this level on Monday (4th February 2008), the Dow subsequently went down 370 points the following day the weak ISM service numbers. This number, which printed below 50, follows hot on the heels of a negative Non-Farm Payrolls number, and probably provides redemption for the analysts who have been saying that the USA is already in recession. A recession in the USA, will of course, slow down everyone else in the world and temper the demand for commodities. (I obviously don’t believe in decoupling, although the Australian economy is proving everyone wrong – this is in the next posting). The S&P meanwhile looks like its locked into a range from 1400 to 1265, with mild support at 131. If the range persists, using options for Credit Spreads look a good bet (Make sure you use PUTS on Calendars to be positive Vega and negative Gamma, should volatilities rise).
(Click in Picture to enlarge)

What’s the good news in all of this? The forex fundamentals are showing a probable near term turnaround. This means capitulation in the markets, and a quick (albeit short term) and sharp rebound to the upside. Either way, it’s time to have our guard up – because MONEY CAN AND WILL BE MADE!

P/S-I just read the Feng Shui analysis by Joey Yap during the weekend. He expects the market to go up early in the year, but to face headwinds in August. Seems like last year, doesn't it? I'm laying low, using interest to generate income, since the the Rat is not kind to Horses....

Chief Shook

THE JANUARY EFFECT IS IN KL, lah!

Well, well, well.....The elusive 2008 January Effect, which has avoided the U.S. markets this year, thus far, has finally been located! And surprise, surprise, it's all good 'ol Kuala Lumpur! Hard to believe, but that's the scenario now. For while the US stockmarkets have been swooning, Bursa Malaysia has been going gangbusters (perhaps they forgot it's not 1999, eh?). Plantation stocks seem to be in vogue, with the charge being led by the "4 Horsemen" (I couldn't help but mimick what they've been saying about the NASDAQ leaders) of Sime Darby, KLK, IOI, and Kulim. This is not surprising, since Palm Oil is Malaysia's main agricultural income earner. With Crude Palm oil hovering around all time highs of RM3100, we look forward to more good times for the seemingly defensive and laggard Malaysian economy. The Malaysian market is notorious for giving "false hopes" to retailers, so we'll hope for the best in 2008 and welcome the Chinese Year of the Rat. Bottoms Up!

Chief Shook

DUDE, WHO TOOK MY JANUARY EFFECT?

100 years....last week (the first week of Jan) was the worst week
for the DOW in 100 years. Are we going to have our January Effect or
is it going to the pattern of 2007, where hopes easily get busted?
The vicious first week of 2008 also brought the Weekly DIA charts at
the border of a Head and Shoulders formation, if violated, could bring
the DOW down by over 1,000 points (Note: It has been violated!).
The bogeyman called Volatility is very much alive and kicking in 2008.
We'll wait and see what happens.

If we go up, the Carry trade will rebound, if we go down, we'll start
buying Yen and shorting the high yielders. Either way, we'll probably have
a clear trend next week (instead of being frustrated and flabbergasted!).
On Tuesday (8th January), the downdraft continued, with the DOW succumbing
238 points despite being up earlier in the session on hopes of a rate cut.
It seems that such hope is instrumental in preventing us to fall further into the
abyss. This morning, futures are up, but who knows what will happen in the
actual session? Makes good trading for USDJPY though.

Chief Shook

OUTRAGEOUS PREDICTIONS FOR 2008 (and a dose of Feng Shui)

It's that time of the Year again when all the Experts line up and offer a gaze through their Crystal Ball of 2008. I don't bother to look at everything, and prefer instead to study proven predictions by people such as Bernie Schaeffer, Kathy Lien (DailyFX), and Peter Grandich. But two people who caught my eye last year, were Saxobank and Hong Kong Feng Shui Master Raymond Lo. I was impressed that they pretty much gave an accurate blueprint of what was to materialise later in 2007. So here are their predictions for 2008:

Saxobank (outrageous again.....) Click to access
I like their forecast on Grain Price doubling (it's not the Government's fault that we have high inflation, dammit! Go read Jim Roger's Hot Commodities). This should be a bumper year again for Commodities, and fertiliser and biotech foodstocks such as Monsanto and Mosaic.

Raymond Lo.....Click to access
I like his prediction that 2008 will be less volatile than 2007 due to the element of Water. Hey, dude, we all need a break from that thing called the VIX!

Enjoy the read.

Chief Shook

Dude, where's the rally?

So, while 2007 started with a "Bang", it's ended on a whimper. The Dow ended the last day of trading down 101 points at 13,264. Considering the Volatility we got in 2007, this was a rather commendable performance. We look forward to 2008, hopeful but ever more cautious. Whatever lies in front of us, the Volatility is back. This means traders in the future have to be experts at hedging. Options, ProShares, or Portfolio strategies come to mind. Trading without protection is just not worth it! The Chart below shows the Weekly chart of the DIA:

There's obviously a Head-n-Shoulders pattern developing, and coupled with a bearish crossing of the 10 and 18 EMA could spell trouble. MACD looks to be looking lower, having been bullish this year (What do you think it would be like if we were bearish?). Money is still flowing into the markets, though, which is good. On another thought, the end of they year selling could possibly give rise to a January Effect, as duds were thrown out the window! (and in a volatile year, there were many of that, which makes sense for tax purposes. After Pakistan, who could blame them?). This could fuel January 2008, especially with expectations on earnings lower, after the rout in November. Wishful thinking or Psychology?

Do we chicken out? NO. It's hard to pick bottoms, and by the time the panic comes, we'll probably be too panicky ourselves to trade. Rather, it's better to have a hedging strategy. This is why I'll be in Singapore on January 12th, to attend a Seminar by John Summa. I've had invitations to go to Indonesia, but we'll see. There's too much work back home, with FXOptions course going into full gear soon.

Happy Trading for 2008!

Chief Shook