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Friday April 1, 2005 - 11:36:45 GMT
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The $ and April Fools Day


“The gold standard is a way of keeping God in control of the money supply.’”

Joe Sobran

FX Trading

It’s that special time of the month again—Payroll Friday—and how appropriate this month, falling on April Fools Day. For it’s a day that seems to fool many into believing they can forecast the future course of Federal Reserve policy based on this single event. But I shouldn’t disparage those pristine prognosticators. After all they apply a well proven research technique. A skill honed through years and years of diligent study of econometric analysis. Their secret analytical tool: Are payrolls over or under expectations?

I know this technique quite well. It’s a game I play within this report on a daily basis. Looking at fundamental economic data and trying to project future outcomes. But, that’s economics; what we do within our more narrow time frames is trading. They truly are two different animals.

One is performed by rational beings (in reality, there is no such creature) applying what they believe are “scientific” processes of evaluation. (We don’t have time to explode that myth here.) What we do is more akin to psychiatrics. At any given moment we never quite know how our patient is going to react despite what seems to be a similar set of circumstances and input. And because we can never forecast the outcome with any degree of certainty, we fool ourselves to suggest otherwise, what we do requires and entirely different skill and mind set than your average pristine prognosticator possesses, assuming we want to achieve any degree of “success” in this game (let’s define success as simply staying in the game for now).

After a recent re-reading of Mark Douglas’ excellent book Trading in the Zone I stumbled again upon some gems that seem especially appropriate here on April Fool’s Day.

Says Mr. Douglas: “To eliminate the emotional risk of trading, you have to neutralize your expectations about what the market will or will not do at any given moment or in any given situation. You can do this by being willing to think from the market’s perspective. Remember, the market is always communicating in probabilities.

“A probabilistic mind-set pertaining to trading consists of five fundamental truths:
1. Anything can happen.
2. You don’t need to know what is going to happen next in order to make money.
3. There is a random distribution between wins and losses for any given set of variables that define an edge.
4. An edge is nothing more than an indication of a higher probability of one thing happening over another.
5. Every moment in the market is unique.”

The point is we don’t have to forecast or even take a position in front of today’s report. In fact, if we do take positions in front of the report, we are assuming that we can forecast the market. That is a dangerous game that blocks us from interpreting price action. When we believe we can forecast, we tend to block out information telling us we are wrong and focus on the non-threatening stuff telling us we are right.

How many times have you been dead right on the over or under payroll data and dead wrong on the direction of the market? I’ve run out of fingers and toes trying to keep track of the number of times that’s happened to me. So let’s vow not to be fooled on this April Fool’s Day. Let’s just stay open and move with what the market gives us.

OK…back to economics. The last few days US long bonds have staged a nice little rally—coinciding nicely with a downward correction in the dollar. Again it seems traders are warming to the notion the Fed is a talking bull on interest rates, but it doesn’t have the wherewithal to be an acting bull. In other words, with global growth heading further south—highlighted by the dismal economic news out of Japan this week—and more evidence that leverage in the financial system is at nose bleed levels thanks to all the new hedge fund gurus playing exactly the same fixed income quant games, not to mention those home equity loans extended to Mr. Consumer, Mr. Greenspan and Co. are in a very tight box.

But I don’t buy that argument precisely because of the Japanese experience. The Bank of Japan has had a zero interest rate policy for many years and where has it taken them: right back into the deflationary soup. The argument is the Fed can’t afford to pop asset bubbles. The flip-side is the Fed can’t afford not to pop asset bubbles. Mr. Greenspan I think knows, despite his 24/7 bubble-ology efforts in the past, that the liquidity-com-speculation game carried to its logical conclusion leads to massive deflation in the end. (But let’s not get too uptight about the “D” word. For it is the economy’s way of washing out the inefficient users of limited capital.)

People and economies can exist on an artificial high for a while, but to maintain the same level of high it requires increasing amounts of artificial stimulus. Ultimately it ends badly; and the longer the high, the more painful the recovery—a la Japan. (Mr. Deflation has to work overtime to wash away the sins of the past.) I think Mr. Greenspan realizes the asset bubble economy he is responsible for creating—be it real estate, stocks, commodities, and fixed income—is in jeopardy of crossing the Rubicon into unmanageable if the Fed doesn’t take a stand now.

So as we listen to the interpretation of the jobs numbers today, let’s try not to be fooled in case jobs have nothing to do with the Fed’s ultimate agenda.

Jack Crooks


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