Many traders start this process backwards and choose a stock to trade and then hope the market cooperates or just have no idea how much the market influences the movement of individual stocks.
Then I started to understand what things like a "Carry Trade" were and why spotting the formation of a new one or the decline of an existing one was important information, although it wasn't stocks/equities, but currencies. For example, a fund has something called "AUM" or "Assets Under Management", essentially the dollar amount invested with the fund. However if a fund sees a big opportunity in the market, they want to leverage up their AUM as a 10% return on an AUM of $100 million is much smaller than a 10% return on leveraged AUM of say $500 million, but for the clients who still have a total of $100 million invested, the performance or outperformance is stellar and that's the key to a fund manager keeping their multi-million dollar job and clients. Consider this, the top 25 hedge fund managers make more money than the top 500 CEOs altogether! In fact, about 4 times more than all of the CEOs of the S&P 500 companies combined! The average has moved around over the last 10 years, but the average for these top 25 managers is $500 million to $1 Bn a YEAR, depending on the year. That's a job they want to keep!
The point is, knowing when they are leveraging up with currency carry trades tells you something about their expectations, those carry trades can increase their leverage from 10x to 100x, some even more. Conversely, when things aren't looking too bright, a 1 pip move against an open carry trade can mean millions of dollars lost and you tend to see them closed.
Take a look at one of the larger Carry Trades...
It's pretty obvious where funds were leveraging up and where they are trying to get out without taking a loss or trying to keep gains.
The next extension of that is to understand the individual currencies in the pair to understand where it's likely to go and how managers will react being leverage cuts both ways and can destroy a fund faster than anything we've seen, read about Long Term Capital Management, the smartest guys in the room created a super fund, this included two Nobel Prize winners for economics. The fund returned (on an annualized basis) 21%, 41% and 43% the first 3 years and then in 1998 lost $4.6 BILLION Dollars in 4 months! The F_E_D had to step in as the failure of LTCM jeopardized the entire US economy.
Back to the "Leverage cuts both ways"... LTCM was known for their excessive use of leverage to generate these returns, but as I said, it cuts both ways... In the first three weeks of September, LTCM's equity tumbled from $2.3 billion at the start of the month to just $400 million by September 25. With liabilities still over $100 billion, this translated to an effective leverage ratio of more than 250-to-1 !!!!
Here's how bad things got...
Goldman Sachs, AIG and Berkshire Hathaway offered to buy out the fund's partners for $250 million, to inject $3.75 billion and to operate LTCM within Goldman's own trading division. The offer was stunningly low to LTCM's partners because at the start of the year their firm had been worth $4.7 billion. Warren Buffett gave LTCM less than one hour to accept the deal; the time period lapsed before a deal could be worked out.
So obviously there's a few lessons there about leverage and about how the Carry Trade works and what you can learn from it.
I realized Bonds/Treasuries meant a lot, even though they weremn't equities, money was either flowing in to bonds from equities as the "Flight to Safety" or from bonds to equities as the "Risk On" trade. What bonds/Treasuries are doing give us a lot of data, this is why Yields are one of my favorite leading indicators.
Credit traders are some of the smartest guys in the room and I'm not talking about anything to do with credit cards, but typically corporate offerings, junk credit, High Yield, Investment grade, the flow of credit from HY to IG tells you a lot about the market, in fact so much so, the Wall St. maxim is "CREDIT LEADS, EQUITIES FOLLOW".
IN ANY CASE, THE POINT IS, THERE'S SO MUCH MORE INFORMATION OUT THERE BEYOND STOCKS AND MARKET AVERAGES, I could go on and on about $USD correlations, what it means to commodities, gold, silver, and stocks and how that has changed because of QE and how it's changing again now. NOTHING IS STATIC IN THE MARKET, IT'S LIKE A LIVING , BREATHING ANIMAL OR PARASITE (depending on your perspective) FED BY HUMAN EMOTION (no wonder it's so extreme).
So lets take a look at what some of the Futures charts are telling us...
The easiest feel for the market is right here in Index future 3C charts.
When you think about a $1 bn salary for a hedge fund manager, you can just imagine how large their positions are, things don't move as quickly as we'd expect until there's real trouble and then we can see several months of gains taken out in 1 morning (look at the 2008 market or the 2000).
Treasuries...For now I have to assume these are still being treated as a flight to safety trade, we saw TLT accumulating yesterday suggesting a move out of equities on this week's move and in to the safety of Treasuries, this is why I closed the TBT position yesterday, Closing TBT (long) For now
TBT is down -.86% today so thus far it was the right call, it's the continued movement in Treasuries that would be interesting to us.
10-year benchmark Treasury Futures (these set interest rates from car loans to credit cards to mortgage rates...
USD/JPY and loitering...
Yen indications, a rising Yen means downward pressure on the USD/JPY and thus the market as well as the carry trade which means market positions have to be closed to close out the carry trade.
As I said yesterday, just about all of the market ramping levers have been exhausted, the last was the USD/JPY and it failed overnight to ramp Index futures, moreover, it looks like the pair itself is ready to fail based on Yen building positives in strong timeframes.
The $USD, the other half of the pair...A rising $USD usually is bad for the market, for oil, precious metals, commodities in general, but because of the Carry Trade, it is actually good for now, so a falling $USD puts downward pressure on the USD/JPY and thus the Index Futures.
To make money you have to see what the crowd missed.
VIX Futures...
YG... Gold futures... While they don't have the same level of market correlation/inverse correlation, they often move opposite the market on smaller swing type moves.
We'll also take a look at gold and silver themselves, but becareful not to have too much exposure to any one highly correlated group.
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