Tuesday January 25, 2005 - 11:41:22 GMT
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Black Swan Capital - www.blackswantrading.com
Disequilibrium and the dollar
“First, price changes are not independent of each other. Research over the past few decades, by me and then by others, shows that may financial price series have a ‘memory’ of sorts.”
“Economics is not physics. Financial markets are not always governed by the strict and ironclad laws of science. But a system in disequilibrium -- and an ever-expanding disequilibrium to boot -- is ripe for adjustment,” says Morgan’s Stephen Roach. Let’s not kid ourselves. Equilibrium is a theoretical construct, plain and simple. If it were not, prices would not fluctuate. Stagnation would be the norm. The system will always be in “disequilibrium.” And we should be thankful for that. It means there are speculative opportunities and our economy has a dynamic pricing system.
As we watch the constant feedback loop operating in the currency markets each day, it should be clear that equilibrium is a fantasy. Prices are a function of future expectations of thinking participants who have various biases and act on those biases. This effectively means that all market prices are theoretically flawed.
As Soros says, “When a situation has thinking participants, the sequence of events does not lead directly from one set of facts to the next; rather it connects facts to perceptions and perceptions to facts in shoelace pattern.” And he goes on to say, “People are groping to anticipate the future with whatever guideposts they can establish.” Bingo!
Consider the potential guideposts that confront us each day in our currency decisions:
• Chinese revaluation
• Global imbalances
• Central bank reserves
• Interest rates
• Retail sales
• Industrial production
• Housing prices
• Oil prices
• On and on into infinitum
Is there a point to this, I imagine you are thinking (something I say to myself each morning as I scribble at the key board). Well the point is: we will never be able to forecast any of the events above with any degree of certainty we would consider significant. And even if we were able to forecast that stuff, there is NEVER any guarantee that currency prices will react as we “expect.” There’s ebb and flow of what is considered important at different points in time throughout the business cycle. Why? Because of the biases of the thinking and acting participants—disequilibrium becomes the norm, not the exception.
So, what is reliable? I would say the only thing that is consistently reliable as an indicator is market sentiment. I think the best we can do is measure current expectations—as we do with our quantitative analysis (technical) and our qualitative analysis i.e. How is the market acting? Are prices confirming the consensus? Is the background rationale being confirmed by price action?
It is the qualitative stuff of price action and the quantitative measure of open interest that leads me to the belief that the current account is no longer a viable rationale impacting trader sentiment. And the evidence comes in the form of one chart this morning…
Euro futures daily…
I hope some of this ramble this morning made some sense. Keep in mind, if we see a rally in the euro, it may be simply a rally to shake out some of those warming to the new rationales. It may be a whole new set of rationales reacted to by the crowd. But it doesn’t necessarily mean the old one is back in vogue.
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