How to Out-Trade the Mighty Goldman Sachs

Want to know the secret to trading better than the mighty "Government Sachs"?

That's easy - don't do as they say, do as they do!

Tyler Durden of ZeroHedge fame hits the nail on the head when he points out that you should take Goldman's investment advice to their clients with "the usual airplane carrier full of salt, and dodecatuple reverse psychology" - ha!

Thanks to Tyler for posting this presentation, which is a real yawner to anyone with the slightest contrarian bend to their investment outlook:

Goldman Where to Invest

"Invest in the BRIC's...S&P rally to continue for now...yawn"

Want to make some real money? Then think about shorting the BRIC's - that's probably what Goldman is doing right now!

Hat tip to good friend Jonathan Lederer for passing this along - I trust Jon's S&P fair value estimate a lot more than these Goldman jokers!

The Amount of Managed Money Currently Invested in Gold

Now that gold is rangebound, how do you make money trading it? That's easy - treat it like a wooden pony and straddle that thing.

For the details on this trade, in more professional terms as well, check out Brad Zigler's article for Hard Assets Investor:

So what's an investor to do? Well, you can certainly sit tight and wait. But if you do, you'd be passing up an opportunity the market doesn't hand out every day—cheap volatility premiums.

Option traders know all about volatility: It's one of the primary drivers of option costs. When volatility contracts, as tends to happen in range-bound markets, option prices soften. So much so, in fact, that the purchase of option straddles and strangles becomes attractive.

A straddle is a combination of a put and a call on the same asset, each sharing the same expiration date and exercise price. A strangle is similar, but the options' strike prices are different.

You can read Brad's full piece here.

The potential risk here, at least IMHO, is if the next potential wave of deflation finally comes to fruition, taking down everything, gold included.

But if you believe that gold will be rangebound for a bit here, straddles are definitely an interesting potential play.

And here's a VERY interesting chart that Brad posted in his piece - it shows another reason some smart money is wary of gold at these prices - because managed money is heavily in gold right now, which often indicates a shorter term top in price:

Chart courtesy of Hard Assets Investor.

Gold has had a heckuva run, it could easily trade sideways, or even pull back sharply, and still be within the confines of a larger bull market. Nothing goes straight up or down - trade accordingly!

The Top Three Investment Themes to Watch in 2010

Happy New Year...and New Decade! Let's dive into some of the top investment themes to keep an eye on in 2010...but first, a haiku:

09 Reflation

Can it continue for long?

Dollar may foil!

1. The US Dollar: The Linchpin

The dollar, which topped out in early March roughly around the time the stock market bottomed, has been looking frisky of late. It's not above it's 200-day moving average yet, so there is some potential resistance in the short-term, but it's looking stronger by the day.

Can the re-flation trade continue to motor along if the dollar mounts a sustained rally? If the first wave of the global meltdown was any indication, then probably not. We haven't yet seen any evidence to invalidate the "all the same markets" hypothesis.

Is the dollar's recent upturn tipping off an impending markets downturn? In my opinion, this is THE theme to keep an eye on in the first quarter of 2010.

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View the full NYSE:UUP chart at Wikinvest

I do get a kick out of the financial media's explanations for the dollar's recent strength - leave it to them to justify the charts with "news"!

2. China: The Global Economic Savior

China has been billed as the posterchild of the global economic bounceback. Which seems appropriate, as it was also the star of the 2003-2007 credit fueled equity liftoff globally.

"China is fine," pundits say. Well, perhaps. But rather than rely on various analysis and opinions on China, I'll stick with the lazy man's approach - watching the stock market itself.

In late November, we pointed to a potential downturn in Chinese equities as some dark clouds on the financial horizon.

How's China done since then? While still perched above it's 200-day SMA, the Shanghai Composite appears to be embarking upon a third attempt to take out its early August highs.

China's rally stalls.

(Source: Yahoo Finance)

A third failure would increase the likelihood of a Chinese breakdown, and a breach of the 200-day SMA (red line above) definitely would. And if that happens, look out! I'm not sure the re-flation trade could withstand this.

3. The Banks: Still Not Lending, and Breaking Down Too

I was tempted to stop the list at #2, because we know that all the markets are still correlated...but then I pulled up this foreboding chart of the bank stocks:

Bank stocks breaking down.

(Source: Yahoo Finance)

The bank stocks are trading right around their 200-day moving average, since making their rally highs in October. So while the blue chip indices have continued to rally and make new highs, many secondary indices have failed to confirm, especially "crap" like the banks.

Summing It Up: Deflation Likely to Return (Again)

To sum it up, it looks like the re-flation trade may be running out of gas...in which case, it would be time for the dollar to rally, and for deflation to once again take the upper hand.

A couple of months ago, I reviewed my favorite inflation and deflation arguments. Since then, I don't think anything has changed. We remain at a key inflection point in the inflation/deflation battle, at least as far as 2010 is concerned.

I personally think the odds favor the scales tipping once again in the favor of deflation. Then it will get really interesting, as we'll see our heroes at the Fed again swing into action. I'm skeptical they'll be able to do much of anything useful, as I don't think they "saved" us from anything the first time around either. The markets were oversold, and set for a huge rally - and rally they did. Where they go from here will be the true litmus test.

My 2009 Trading Review: Ouch, I Suck

Usually at the end of each year, I pat myself on the back for a year well done. Well this year, unfortunately, I got rocked. So rather than dwell on it too much, I'd rather focus on learning something from my mistakes - and hopefully you can too!

In no particular order, I made a few key ones:

1. Taking position sizes that are too large. You really shouldn't risk more than 2% of your overall capital on any given trade. Because, if the trade goes against you, the most important thing is to live to see another day.

This is the top way that traders go "bust" and lose all of their capital. Something I'll try to (finally) accept in 2010!

2. Not catching market turns properly. Since 2007 or 2008 I've predominantly traded with the trend, which I believe is the right thing to do. BUT, I've gotten burned on trends switching on me. My solution? Use a more robust system for catching turns, including investor sentiment that may indicate when a move is close to bottoming, or topping.

3. Lacking a set plan for exiting a trade - whether a winner, or a loser. Stops are life savers - it's important to honor them, and again, live to see another trade!

Overall no complaints, investing and trading is often an expensive tuition, and the only way to learn it is to do it. So I'm grateful to still have a fair amount of capital intact (off of a small initial stake), and look forward to continuing to improve in 2010!

Thanks for reading!

Trader Vic: The Best Trading Book You've Never Heard Of

A few months back a friend mentioned an obscure trading book to me, citing it as one of the best trading books he's ever read, despite the fact that very few people have ever heard of it. Since this guy is a top notch trader in his own right, I made a mental note to add this book to my reading list.

This weekend I read Trader Vic: Methods of a Wall Street Master cover to cover, and have to agree it's a fantastic read - one that I think our regular readers will definitely enjoy. It's authored by legendary trader Victor Sperandeo, who tells all for 260 pages. Think of the insight contained in each interview in Market Wizards: Interviews with Top Traders, but in even more detail.

Sperandeo categorizes market participants into three basic types:

1. Traders, who focus their activity on the intraday and/or short term trend
2. Speculators, who focus on the intermediate trend, taking market positions and holding them for weeks to months
3. Investors, who deal mainly with the long term trend, and hold their positions from months to years

He identifies himself as primarily a speculator, but one who plays all three trends, which he jokes might make him a "speculative trader who also invests."

What I found so great about this book is that Vic does not hold up any one theory or technique as holding the secret to investment success. On the contrary, he cites this as the flaw of most investment books - so, he set out to write one that would combine technical and fundamental analysis, with a healthy sprinkling of probabilities and risk management.

The key takeaway is that investing/trading is a game of probabilities. Your goal, as a market participant, is to maximize your probability of success on each trade, while simultaneously optimizing your risk/reward on that trade.

For much of the book, Sperandeo shares, chapter by chapter, the considerations he uses when placing his positions. He holds Dow Theory in very high regards, using it as a strong guide (but never an absolute indicator). He also uses basic technical analysis, saying its greatest value is that it "provides a method of measuring the tendency of the market to react in a particular way under similar conditions throughout history."

He does not rely on complex technical analysis though, and instead pokes fun at the die hard practitioners. Fellow fans of Elliott Wave Analysis may be a little disappointed that Vic does not regard it as particularly useful.

However Vic has no shortage of additional insights to share that compliment his use of basic technical analysis. He discusses how he identifies a change of trend, which he believes is "the fastest and most risk-free way to make money in the markets." He shows you how to draw and trendline and make use of moving averages and oscillators - again for framing your trading decisions, and not as an absolute guarantee of success.

As most astute traders seem to be, Sperandeo has deep rooted libertarian views. He is not a fan of Keynesian Economics (to put it lightly), and properly lambastes this school of thought for the fraud that it is...ending by basically saying that this is all going to end very badly.

Last but certainly not least, the second portion of the book is dedicated to helping you get your mental and emotional house in order. Vic says that out of 38 people he trained in the 1980s, only 5 made money and went on to pursue their own careers as traders?

Why such a low success rate? He cites the difference between success and failure in trading as "neither intelligence or knowledge to trade, but the will to execute knowledge."

In other words, the unsuccessful traders were not so because they lacked knowledge - it was because they couldn't keep their heads about them and stay disciplined in the heat of the moment!

This discussion of personal discipline and beliefs is very valuable, and similar in flavor as what Van Tharp advises and schools traders on.

In summary, whether you are primarily a trader, specular, or investor, Trader Vic: Methods of a Wall Street Master is a fun and enlightening read. I'd highly recommend you add it to your reading list.

What Does Trader Vic See Ahead for 2010?

The one thought that kept floating through my head while reading Trader Vic was: "Man, I'd love to hear what this guy is thinking today!"

Well, as luck would have it, our friends over at Hard Assets Investor just caught up with Trader Vic last week!

Lara Crigger, associate editor, HardAssetsInvestor.com (Crigger): Which commodities do you think are going to do well next year?

Victor Sperandeo, "Trader Vic" (Sperandeo): Well, I'm on record across the world as saying that gold is the best investment in the world for the next two to three years. It's fundamentally obvious, but when you're printing huge amounts of paper vs. something that is considered money, the paper will depreciate and the hard assets will go up. So gold and silver will do well—silver a little less so—but gold certainly.

Even when it was about $830-$850/oz, I basically said, "I don't see any scenario where it can come down." But I wouldn't say that it can't correct at any given moment. When the Fed decides to raise interest rates, at that point, gold will sell off. It will be a steep correction.

But it's also a buying opportunity, because if they raise rates, it would only be to try to stabilize the dollar. But it wouldn't affect the kinds of huge deficits and the printing of money that's going on for the next 10 years. It's unsustainable. So gold, that's my most favorite, if you will.

Read the rest of HAI's interview with Trader Vic here.

The Latest At-Home Party Craze: Gold Selling

So is the gold market getting overheated, or not? The opinions on both sides sure are polarized.

Some, like our pal Trader Vic, insist this isn't a gold bubble. I was listening to the Financial Sense Newshour yesterday, and they agreed, saying we're not even close to the mania stage yet.

On the other hand, our local rag, the Sacramento Bee, reports that "the latest at-home party craze is gold selling."

Move over, Tupperware, candles and kitchenware.

The latest at-home party craze is gold selling.

Whether spurred by cash-strapped consumers or the alluring jump in gold prices, the concept is enticingly simple: Bring your tangled chains, broken bracelets, outdated earrings or a hoop that's lost its mate. Even dental fillings or an ex-boyfriend's heart-shaped pendant. Your stash of unwanted gold is tested, weighed and traded on the spot. For cash.

And with gold briefly sweeping past the $1,200-an-ounce mark in recent weeks, it's becoming an even more tantalizing invitation. Here and across the country, it seems, old gold is turning into green.

If not a bubble, then we're at least overdue for the current correction, which we're about $100 into so far. And surprise, surprise - look at the gold bull that predicted this correction a few weeks back...our hero, Jim Rogers...

Correction: We're Not Trading Against Jim Rogers After All

On Sunday, I mused that one of my deepest concerns about being bullish on the US Dollar is that I'm on the opposite side of the trade from Jim Rogers, who thinks the buck is doomed.

Not so, pointed out astute reader Sibbie via email, citing a recent Rogers interview in BusinessWeek:

Q: How much of the runup is being driven by U.S. deficits and the weakening dollar?

Jim Rogers: A huge amount is about not just U.S. deficits, but all deficits. Deficits are going berserk nearly everywhere. Throughout history, printing money has led to weaker currencies and higher prices for real assets. And there are many, many pessimists about the dollar, including me. So many pessimists that I suspect there's a rally coming. I have no idea why there should be, but things do usually rally when you have this many bears at the same time. I've actually accumulated a few more dollars. I mean, it's not a significant position, but I do own more dollars than I did a month ago. And we'll probably also have a gold correction because there's so many bulls on gold.

Nice find, Sibbie, thank you!

You can read the rest of Jim Rogers' interview with Maria "Money Honey 1.0" Bartiromo here.

Positions Update - Still Really Short the S&P, Had to Roll the Dollar Contract

On Friday I had to roll my dollar contract, and then realized I didn't have enough margin to buy back in...oops! So I'm still holding the S&P shorts and puts, and am waiting for a re-entry point on the long dollar side.

We had a nice week of gains on the dollar, and we may be due for a short-term pullback, so I'll wait patiently, and hope for the S&P breakdown that we've been waiting for.

What's reassuring is that nobody seems to be a believer that this is the start of a dollar rally. That's just the way we like it.

A strong week for the dollar - looks like the bottom may finally be in place.

(Source: Barchart.com)

The S&P continues to defy gravity - but its time may be limited, if the dollar has indeed put a bottom in.

(Source: Barchart.com)

Open positions:

Thanks for reading!

Current Account Value: $18,304.68

Cashed out: $20,000.00
Total value: $38,304.68
2009 Returns: Ugh, too depressing to calculate right now...

Prior yearly returns:
2008: -8%
2007: 175%
2006: 60%
2005: 805%

Initial trading stake: $2,000

Why Trend Following is Your Only Hope for Investment Survival

Buy and hold. Stocks for the long run. Diversify. These investment mantras were gospel during the great bull market of the 80s and 90s.

Drinking this Kool-Aid will get you slaughtered today.

There is no freaking way I would "buy and hold" anything right now. Too dangerous. Buy and hold hasn't worked over the past ten years, and it's unlikely to work for the next ten. We're in a secular bear market, and these things take time...usually 15 to 20 years...to run their course.

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View the full INDEX:.SPX-E chart at Wikinvest

Buying and holding the S&P was a crappy trade over the last 10 years.

No doubt, we are in uncharted financial waters right now. Anyone who says they 100% know what's going to happen next is lying, or dilusional.

We've got historic deleveraging taking place, as unprecedented debt levels are slowly paid down. In the meantime, we've got the US government, among others, running the printing presses at full steam, and tossing boatloads of money down rat holes like Government Motors and socialized medicine.

The foundation of the system has been permanently rocked, and stability, or even just the illusion of it, won't be back anytime soon.

With the Fed's printing press (an irresitable force of hyperinflation) battling massive deleveraging (an immovable deflationary object), the crux of any investment thesis today starts with "inflation, or deflation?"

There's no shortage of arguments on both sides, many made by folks much smarter than I. For awhile, I was reading them until my head spun...first I'd read a very well thought out argument on why hyperinflation will win out...then I'd read a perfect counterargument for the deflation case.

So I thought - what the heck can a guy like me do, if these smart dudes can't reach the same conclusion themselves?

Then it hit me - trend following.

If gold and commodities go up - get in those vehicles, because the market is screaming "inflation"! Gold at $1100 could go much, much higher...real, real fast.

On the other hand, gold still has not decisively broken through $1000. It could very well retest it's lows below $700. So if it breaks down below, say, $900 - that's the market telling us that inflation is not in the cards...at least not yet.

Early this week, gold stocks hit a 3-week low...so I sold all of them. And I'll stay out until they once again "break out" to the upside. That's the only way I can see to play these insane markets - buy the breakouts, and follow your stops. It's OK to have a hypothesis, but don't wed yourself to it. If the market says you're wrong...then you probably are!

My friend Brian Hunt (editor-in-chief of The Daily Crux, an excellent investment website) made a great point to me on Friday about investing in China. Nobody knows what's going to happen in China. Some think it's a trainwreck waiting to happen. Others think China will be just fine, still the growth story of the 21st century.

So what's an investor to do? Watch the price of copper, he says. As long as copper's doing fine, that means China's doing fine. Let Dr. Copper show you the way.

To facilitate my trend following strategy, I've pared my investment assets down significantly. I used to own 40-50+ different stocks, a few currencies, a few commodities...if something looked good in one of my many newsletters, I bought it!

Then I learned during the Great Deleveraging of '08 that diversification does not prevent bad things from happening. Overnight, the correlation of almost all assets went to 1, and everything dropped 40% in a matter of 6 months!

Because I believe the inflation/deflation question is the only important one, I only need a few asset classes to play it. That makes trend following much, much easier for an armchair investor like myself - get into positions and back out quickly - no problem.

Remember the market is the judge and jury combined, the final arbiter of your investment decisions. So let's listen to what it's telling us in the turbulent years ahead...after all, the trend is our friend! And this friend may be our only lifeline to investment survival right now.

In Case You Missed It...This Week's 5 Most Popular Posts...

1. How Herbert Hoover Put the "Great" in Great Depression
2. Richard Russell: We're Nearing Gold's Mania Stage
3. Marc Faber on American Economic Policy
4. Jim Rogers' favorite country (surprise: not China!)
5. Chinese students laugh Tim Geithner out of town

Positions Update

Last week in this spot, I mused:

"Nice week but I have to admit – I’m starting to get quite cautious that some of these trends have played out"

It looks like the caution I expressed last week was warranted...commodities got hit hard across the board this week.

I exited all positions on Monday morning, after seeing the rough start to the week - that was enough to chase me out of all positions. On Thursday, I did reinitiate an Australian dollar position, after reading how the Reserve Bank of Australia was working very hard to keep their currency down in the month of May.

Current Account Value: $31,483.93

Cashed out: $20,000.00

Total value: $51,483.93

Weekly return: -6.8%

2009 YTD return: -38.0%

Prior year's results:

2008: -8%

2007: 175%

2006: 60%

2005: 805%

Initial stake: $2,000.00

How to Determine a Market's Trend

A guest article and video by Adam Hewison, President, INO.com.

One of the easiest ways to determine the trend in any market is simply to connect the dot's. In this five minute video, I explain how you can connect the dots in any market to determine its trend. I will show you three examples of connecting the dots...

1. How to determine a downtrend.
2. How to determine an uptrend.
3. How to determine when a market is making a change of direction.

One of the key components I look for is how a market closes on a Friday or the last trading day of the week. This is when traders have to decide what they want to do with their positions. It also tells you with a high degree of probability which way the market is headed for the upcoming week. I learned this trading secret on the floor of the exchange in Chicago and it is one I would like to share with you today. I feel that this technique has a lot of validity, particularly in light of today's volatile markets.

Enjoy the Video
http://www.ino.com/info/266/CD3396/&dp=0&l=0&campaignid=3

Editor's Note: A simple yet enlightening video, and I wish I would have connected the dots on Cotton before jumping into this trade too early. I am going to try to start incorporating this technique into my entry criteria for a new trade. This would have saved me at least some of the losses I encountered this summer, by trying to go long markets that were setting lower highs and lower lows.

New "Cash Out" Strategy

Yesterday I started reading The New Market Wizards: Conversations with America's Top Traders by Jack D. Schwager. I'm just over 200 pages in - a very good read so far.

Something I've been thinking about is how I can continue to grow my account at a rapid pace while managing the risk of total obliteration. Awesome gains are possible in the futures market thanks to the amount of leverage you can use - but leverage works both ways. A bad trade can totally sink you if you are overleveraged.

One trader in the book started his first account with $12K and grew it to $250K over a four year period - only to then lose the entire balance in 4 days. This was a common theme in the book - great traders learning their lesson about leverage the hard way.

So my new strategy is to put away a set percentage of gains. For the near future, for every $15K in gains, I plan to put $5K away. This will leave me with $10K in gains to leave in the account and leverage as I like - while still having $5K in the bank to pay taxes with and save for a rainy day.

I am a strong believer in the commodity bull market, and I think it has at least another 10 solid years to run. So I want to make sure that I'm in the game for the next decade! As tempting as it is to leverage up as much as I can to make millions, I need to control this so that I am not wiped out by a sharp decline.