Part 28 Technical Analysis – Trade With The Big Players

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Economic Headwinds: Big Players, Regime Uncertainty and the Misery Index

Before we delve into the economic prospects for 2020, let’s take a look at the economies in the Americas, Asia, Europe and the Middle East/​Africa to see how they fared in the 2020–15 period. A clear metric for doing this is the misery index. For any country, a misery index score is simply the sum of the unemployment, inflation, and bank lending rates, minus the percentage change in real GDP per capita. A higher misery index score reflects higher levels of “misery.”

For purposes of consistency, I have used data from the Economist Intelligence Unit. Only countries with current data for 2020 are included in the accompanying tables.

A review of these tables indicates a clear rogue’s gallery. It includes the following countries with misery index scores of 40 or above: Venezuela, Brazil, Argentina, Ukraine, and South Africa. The only region not contributing to that gallery is Asia. But, that’s not the end of the story. All countries with scores over 20 are seriously deficient. These countries are ripe for reform.

Turning to 2020, it started with a bang. The world’s major stock markets are volatile and in negative territory. Commodity markets, led by oil, continue to plunge, and so has the value of most emerging market currencies against the U.S. dollar. Combined public and private debt levels relative to GDP have soared, and are well over the ratios that existed during the top of the last credit cycle in 2007. With this debt binge, the level of non-performing loans on banks’ books has soared, too. And if that’s not enough, the Institute of International Finance has just increased its estimate of net capital outflows from emerging markets in 2020 to $735 billion, with $676 billion of capital flight coming from China alone. Talk about a carry trade unwind.

The World Bank and the International Monetary Fund (IMF) have been revising downward their forecasts for global GDP growth. At present, the World Bank forecast for global GDP growth in 2020 is a paltry 2.9 percent, while the IMF’s 2020 forecast of 3.4 percent isn’t much better. It’s becoming clear that the global economy will face headwinds in 2020. It’s no surprise, therefore, that many are in a state of high anxiety and that a spiral of pessimism is developing.

One of the major sources of the storm is ironically what statists and interventionists around the world (read: “The Establishment”) think will save us — namely, big governments. More specifically, the academic literature has dubbed them “Big Players.” While there is a budding and serious academic literature on Big Players, or what could be termed Market Disrupters, there is virtually no mention in the financial press that the Big Players might just bury us. Perhaps this is because the valuable insights provided by the rigorous, and what is at times quite technical, analysis of Big Players is very contra-establishment. Indeed, instead of stabilizing markets, the Big Players disrupt them. They are the purveyors of instability. For those who wish to grapple with the technical literature, I recommend: Roger Koppl. Big Players and the Economic Theory of Expectations. New York: Palgrave Macmillan, 2002.

Big Players have three defining characteristics. Firstly, they are big — big enough to influence markets. Secondly, they are largely insensitive to the discipline of profits and losses — in short, immune from competitive pressures. Thirdly, they act with a large degree of discretion in the sense that their actions are not governed by a prescribed set of rules.

With these characteristics, Big Players are hard to predict. In consequence, they can disrupt. Among other things, they divert entrepreneurial attention away from the assessment of strictly economic market fundamentals — the present value of prospective cash flows and services generated — toward the actions of the Big Players. These are inherently political, and subject to unpredictable change. This reduces the reliability of expectations, with skill becoming devalued and luck counting for more.

The Big Players’ discretionary interventions render most market signals about fundamentals unreliable. They create environments that are ripe for herding and bandwagon effects, as well as noise trading, which is subject to fads and fashions. This explains, in part, why investment groups are spending big bucks to create a thinking, learning, and trading computer — a search for a super-algorithm. Never mind. Big Players increase volatility and create bubbles. They are the disrupters of the universe.

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Closely related to the Big Players problem is a strand of innovative analysis pioneered by Robert Higgs of the Independent Institute. It concerns what Higgs calls “regime uncertainty.” Regime uncertainty relates to the likelihood that investors’ private property in their capital and the flows of income and services it yields will be attenuated by government action (read: the discretionary action of Big Players, among other things). As regime uncertainty is elevated, private investment is notched down from where it would have been. This can result in a business-cycle bust and even economic stagnation. For Higgs’ most recent book, which contains evidence on the negative effects of regime uncertainty, I recommend: Robert Higgs. Taking a Stand: Reflections on Life Liberty, and the Economy. Oakland, CA: The Independent Institute, 2020.

The real question is: are Big Players ascending or descending? In gathering data to answer this question, I have become convinced that the Big Players problem is big and getting bigger. Indeed, the problem has become much more pronounced since the onset of the great recession of 2008-2009.

Most central banks possess all the characteristics of Big Players in spades. Since the advent and implementation of quantitative easing (QE), they have become bigger players, with the state money they produce making up a much greater portion of broad money (state, plus bank money) than before 2009. Not only have their balance sheets exploded, but the composition of some of their balance sheets has changed in surprising ways. It used to be that central bank assets were solely comprised of domestic and foreign government bonds. Well, now you can find corporate bonds on some central bank balance sheets. And that’s not all. Central banks use their discretion to purchase equities, too. Just take a look at the Swiss National Bank (SNB), one of the alleged paragons of conservative central banking. By late last year (Q3), the total value of stocks held by the SNB had risen to $38.95 billion. That’s the size of some of the largest hedge funds in the world, and amounts to over 5 percent of Switzerland’s GDP.

The Bank of Japan (BoJ) is also openly a big buyer of stocks — namely, Japanese ETFs. The BoJ is authorized to purchase roughly $25 billion of ETFs per year, and the government leans on the BoJ to use its fire power — especially when the Japanese stock markets are “weak.”

Less surprising is the stock-buying propensity of the People’s Bank of China (PBoC). It has thrown hundreds of billions of yuan into purchasing publically listed Chinese shares in a bid to stave off multiple stock market crashes. And, when it comes to Chinese markets, the PBoC is not alone. When Beijing cracks the whip, the “national team” — a group of state-owned banks, brokers, pension funds, government agencies, and you name it — either buy or sell. Much of the same goes on in Russia and elsewhere, but in those places the scope and scale of the Big Player phenomenon is no match for that of the Middle Kingdom.

Right behind central banks are sovereign-wealth funds (SWFs). With over $7 trillion in assets, they are huge. But, transparency (read: disclosure rules) with regard to size, holdings and strategies is limited. About all we know is that when the SWFs’ political masters command, the SWF technocrats march.

Then there are traditional state-owned enterprises (SOEs). While the wave of privatizations that started in the late 1970s put a dent in the SOEs, they remain Big Players in many countries. And, when compared to similar private enterprises, their actions are more unpredictable and their performance is dismal. Sales per employee are lower for SOEs. Adjusted profits per employee are lower. Per dollar of sales, operating expenses plus wages are higher. Sales per dollar investment are lower. Profits per dollar of total assets are lower. Profits per dollar sales are lower. Sales per employee grow at a slower rate. And, with the exception of state-owned oil companies, who often have considerable monopoly power, most traditional SOEs generate accounting losses.

But, traditional SOEs are only the tip of the iceberg. State capitalism — a model in which governments pick winners and use capitalist tools such as listing SOEs on stock markets — is on the rise. With state capitalism, the visible hand of the State replaces Adam Smith’s invisible hand of the markets. State capitalism runs the gamut from public-private partnerships to SOEs, and highlights the relevance of the Big Player problem. For a review of State Capitalism, I recommend the special report on that topic, which was published in the 21 January 2020 issue of The Economist. A review of that edifying report will convince the reader that the Big Player problem lurks everywhere.

Going forward, we will clearly face headwinds created by Big Players and regime uncertainty.

The Big Players In The Forex Market

By Nadav Snir | Submitted On May 25, 2008

The forex market is the biggest financial market in the world by trading volume. Every day currencies valued at approximately 3 trillion dollars are traded. This means that a trade of one million dollars is not even scratching the total daily volume of the forex market. A volume so big is created by many traders and institutions, each of them with a different intention.

Central banks are big players in the forex market. The purpose of central banks, like the Federal Bank of the United States, is to keep the economy and currency of their country stable. They do it with the interest rate decision and trading the currency market. Most central banks are active traders in the forex market, mainly to stabilize their currency and have a sufficient foreign currency reserve if the need for it ever arises.

Commercial banks are the main part of the forex market. These banks carry out the trades by other traders. This action requires them to exchange currencies with one another according to their clients’ needs. The commercial banks also trade currencies for their own profit and speculation. When banks believe that one currency will rise over the other, they perform the appropriate trade to make sure they profit from it. Since commercial banks control most of the money in the world, they are the one of the biggest parts of the forex market.

Importers and exporters are also a crucial part of the forex market. Since these companies work with countries other than their own, they also work in different currencies around the world. Their main activity in the forex market is to exchange money from their currency to their client’s currency and vice versa. They also use the currency market to “lock” an exchange rate and guarantee a certain profit. This is done to avoid the impact of fluctuations in exchange rates and guarantee a future profit.

Private speculators, including private citizens, hedge funds, and other non-regulated or little-regulated institutions also make up a big volume of the forex market. Usually they are not trading to do international business or stabilize an economy, but rather to make a profit for themselves or their clients. Their trades are being carried by commercial banks.

As you can see, there are many players in the forex market, and that number is just growing every day. You can also be a part of this market and profit from it. To do that, you need the best forex broker out there and a good forex trading system to help you, and you can start trading.

Only Take a Trade If It Passes This 5-Step Test

No matter which market you trade – stocks, forex or futures – each second the markets are open provides an opportunity to trade. Yet not every second provides a high-probability trade. In a sea of nearly infinite possibilities, put each trade you consider through a five-step test so you’ll only take trades that align with your trading plan and offer good profit potential for the risk being taken. Apply the test whether you’re a day trader, swing trader or investor. At first it will take some practice, but once you become familiar with the process, it takes only a few seconds to see if a trade passes the test, telling you whether you should trade or not.

Step 1: The Trade Setup

The setup is the basic conditions that need to be present in order to even consider a trade. For example, if you’re a trend-following trader, then a trend needs to be present. Your trading plan should define what a tradable trend is (for your strategy). This will help you avoid trading when a trend isn’t there. Think of the “setup” as your reason for trading. (For more, see: Essential Options Trading Guide.)

Figure 1 shows an example of this in action. The stock price is moving higher overall, as represented by the higher swing highs and lows, as well as the price being above a 200-day moving average. Your trade setup may be different, but you should make sure that conditions are favorable for the strategy being traded.

Figure 1. Stock in Uptrend, Providing Possible Trade Setups for Trend Traders

If your reason for trading isn’t present, don’t trade. If your reason for trading – the setup – is present, then proceed to the next step.

Step 2: The Trade Trigger

If your reason for trading is present, you still need a precise event that tells you now is the time to trade. In Figure 1, the stock was moving in an uptrend for a the entire time, but some moments within that uptrend provide better trade opportunities than others.

Some traders like to buy on new highs after the price has ranged or pulled back. In this case, a trade trigger could be when the price rallies above the $122 resistance area in August.

Other traders like to buy during a pullback. In this case, when the price pulls back to support near $115, wait for the price to form a bullish engulfing pattern or to consolidate for several price bars and then break above the consolidation. Both of these are precise events that separate trading opportunities from the all the other price movements (which you don’t have a strategy for).

Figure 2. Possible Trade Triggers in Uptrending Stock

Figure 2 shows three possible trade triggers that occur during this stock uptrend. What your exact trade trigger is depends on the trading strategy you are using. The first is a consolidation near support: The trade is triggered when the price moves above the high of the consolidation. Another possible trade trigger is a bullish engulfing pattern near support: A long is triggered when the bullish candle forms. The third trigger to buy is a rally to a new high price following a pullback or range.

Before a trade is taken though, check to make sure the trade is worth taking. With a trade trigger, you always know where your entry point is in advance. For example, throughout July, a trader would know that a possible trade trigger is a rally above the June high. That provides time to check the trade for validity, with steps three through five, before the trade is actually taken. (See also: Pinpoint Entry Points With Filters and Triggers.)

Step 3: The Stop Loss

Having the right conditions for entry and knowing your trade trigger isn’t enough to produce a good trade. The risk on that trade must also be managed with a stop-loss order. There are multiple ways to place a stop loss. For long trades, a stop loss is often placed just slightly below a recent swing low and for a short trade just slightly above a recent swing high. Another method is called the Average True Range (ATR) stop loss; it involves placing the stop-loss order a certain distance from the entry price, based on volatility. (See also: What Types of Investors Are Best-Suited for Stop-Loss Orders?)

Figure 3. Long Trade Example with Stop Loss Placement

Establish where your stop loss will be. Once you know the entry and stop loss price, you can calculate the position size for the trade.

Step 4: The Price Target

You now know that conditions are favorable for a trade, as well as where the entry point and stop loss will go. Next, consider the profit potential.

A profit target is based on something measurable and not just randomly chosen. Chart patterns, for example, provide targets based on the size of the pattern. Trend channels show where the price has had a tendency to reverse; if buying near the bottom of the channel, set a price target near the top of the channel.

In Figure 3, the EUR/USD triangle pattern is roughly 600 pips at its widest point. Added to the triangle breakout price, that provides a target of 1.1650. If trading a triangle breakout strategy, that is where the target to exit the trade (at a profit) is placed.

Establish where your profit target will be based on the tendencies of the market you’re trading. A trailing stop loss can also be used to exit profitable trades. If using a trailing stop loss, you won’t know your profit potential in advance. That is fine though, because the trailing stop loss allows you to extract profits from the market in a systematic (not random) manner. (For more, see: Trailing-Stop Techniques.)

Only Take A Trade If It Passes This 5-Step Test

Step 5: The Reward-to-Risk

Strive to take trades only where the profit potential is greater than 1.5 times the risk. For example, losing $100 if the price reaches your stop loss means you should be making $150 or more if the target price is reached.

In Figure 3, the the risk is 210 pips (difference between entry price and stop loss), but the profit potential is 600 pips. That’s a reward-to-risk ratio of 2.86:1 (or 600/210).

If using a trailing stop loss, you won’t be able to calculate the reward-to-risk on the trade. However, when taking a trade, you should still consider if the profit potential is likely to outweigh the risk.

If the profit potential is similar to or lower than the risk, avoid the trade. That may mean doing all this work only to realize you shouldn’t take the trade. Avoiding bad trades is just as important to success as participating in favorable ones. (See also: Calculating Risk and Reward.)

Other Considerations

The five-step test acts as a filter so that you’re only taking trades that align with your strategy, ensuring that these trades provide good profit potential relative to the risk. Add in other steps to suit your trading style. For example, day traders may wish to avoid taking positions right before major economic numbers or a company’s earnings are released. In this case, to take a trade, check the economic calendar and make sure no such events are scheduled for while you’re likely to be in the trade.

The Bottom Line

Make sure conditions are suitable for trading a particular strategy. Set a trigger that tells you now is the time to act. Set a stop loss and target, and then determine if the reward outweighs the risk. If it does, take the trade; if it doesn’t, look for a better opportunity. Consider other factors that may affect your trading, and implement additional steps if required. This may seem like a long process, yet once you know your strategy and get used to the steps, it should take only a few seconds to run through the entire list. Making sure each trade taken passes the five-step test is worth the effort. (For additional reading, check out: Create Your Own Trading Strategies.)

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