QE2

From Richard Russell:

“Right now, we’re seeing the results of a bubble in Fed-created liquidity. When the water continues to pour into a bath-tub, everything — the rubber ducks, the plastic boats, the soap bars — float up with the water line. This goes on until either the water flows over the tub and onto the floor — or mom comes in and pulls the plug. I think that’s what we’re experiencing now in the markets. Everything tradeable, stocks, bonds, gold, silver, commodities in general are rising. I call it an all-around mega-bubble. It will continue until someone, purposely, or by mistake, pulls the plug. There are only two items which seem immune to the surging liquidity. The two items are home prices and unemployment. But there’s another possibility. Build a tower out of children’s blocks. You can build that tower just so high, and at some point the last block is too much. The tower shudders, it tilts and falls over.”

Boeckh Investment Letter, Volume 2.14: US Government Debt 092110

Setiment Cycle

Definition of Deflation, Inflation and Hyperinflation

Deflation: A decrease in the prices of goods and services, usually tied to a contraction of money in circulation. Formal deflation is measured in terms of year-to-year change.

Inflation: An increase in the prices of goods and services, usually tied to an increase of money in circulation.

Hyperinflation: Extreme inflation, minimally in excess of four-digit annual percent change, where the involved currency becomes worthless. A fairly crude definition of hyperinflation is a circumstance, where, due to extremely rapid price increases, the largest pre-hyperinflation bank note ($100 bill in the United States) becomes worth more as functional toilet paper/tissue than as currency.

Gross Debt in G7 Ecomomies

Practice Deep Learning to Master Trading Skills

Deep Practice gives an overview of what kind of practice seems to build myelin and gives examples from sources as diverse as skateboarders, the Bronte sisters, and Renaissance artists. Coyle’s term Deep Practice is in most ways similar to Ericsson’s Deliberate Practice and my own notion of Intentional Practice. He culls three rules of Deep Practice:

1. Chunk it up: Basically this consists of breaking things into pieces that are more easily done or thought about. It also includes listening to and/or absorbing the whole before breaking the skill down and includes changing the material to make it easier, for example, slowing down a difficult musical passage.

2. Repeat it. This is pretty self-explanatory, but also not as simple as it sounds.

3. Learn to Feel it. This includes sensing (and remembering!) how something feels when it is done right, but also developing awareness of how it feels to struggle.

Secular US Market Cycle

Four Formulas A Trader Must Master

1) Risk of Ruin

Risk of ruin = [ {1-(W-L)}/{1+(W-L)}] Power of U
W = Probability of winning, L= Probability of losing and U= # of units of money on the account.
E.g W is 56%, L is 44%, U is 5 .
Risk of ruin = [ {1-(0.56-0.44)}/{1+(0.56-0.44)}] power of 5 = 30%

You must avoiding risk of ruin, achieve ZERO% risk of ruin. E.g Using 20 U and min 63% W, and min 1.5 win to loss trade.

2) Expectancy

Expected return $$ = [ P of winning x Ave win/Ave loss ]-[P of loasing x Ave win/Ave loss ]
High Expectancy can be achieve with low accuracy e.g 30% but high Ave Win vs Ave Loss
Trend Trading min Positive expectancy with P of winning 34% with 3 to 1 Win/Loss ratio.

3) Holy Grail = Positive Expectancy x Opportunities

4) Kelly Formula Kelly Formula F= (R+1)*P-1)/R

P= % accuracy of the system winning

R= Ratio of winning trade to losing trade

E.g Accuracy P 65% and win R 1.3 size of loss F= (1.3+1)*0.65-1)/1.3= 85%

How to adjust a long stock position

To create a trade that profits if stays in a range, and if Vol stays the same or drops.

Here’s the trade example.

• I own 100 shares of PCP, currently trading at $107.79. (My price is $121.40)
• +1 Sep $105 put.
• +4 Sep $120 call.
• -5 Sep $110 call.

The P&L looks like this after I added the options, below: Notice that this trade is ‘profitable’ in the range that I anticipate. If the underlying stays in the range as I predict, my trade that is currently around -$1,400 will be -$300. Then in Sep, I can put on a similar trade again as long as my predictions have not changed. I now have a limited risk trade that I can manage or stop out if PCP should rally hard. Synthetically, you’ve created a broken wing butterfly (long stock and long put is long call +1 $105call / –5 $110 call / +4 $120 call).

Count Test