The Onion of Truth

Ugh...the trends moves on. Looks like there won't be an opportunity for a pullback buy. NVDA's basically at such a sharp ascending triangle that there's very little room for the trend ping-pong to continue. It can't break $14. It can't drop below the EMA20. I'm about to use 12.5% of my "money" to pick up some more UVACN (Mar 10 NVDA Calls).


Recall that when I made the trade, I had a lot of reasons for making the trade that would seem moot if my call was right. For instance, if the EMA20 is a trading signal, why does the MA50, which will be below the EMA20, even matter?

The answer is that no trade is 100% certain, but trades with lots of layers of certainty tend to take care of the trader. If you're not right about this contention point, maybe there's a larger contention point brewing that will build momentum if the first pattern fails. And so on and so forth.

On the other hand, NVDA just needs to stably break $14 to go into a little bit of a pop. It just needs to break $14. Not today, not four weeks from now. When it happens, the stock will have a tendancy to "fill the gap." The gap ends at $17, at which point UVACN will have $3 of intrinsic value and at least some time value left.

So here goes. The total is 12.5% of my cash on some options that were trading at $2.10 at the beginning of this post. The other 12.5% will probably follow shortly, but you'll get an update on it. I'll do the math regarding how many contracts I actually would have sought to obtain later.

Stay tuned.

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"That Guy Stole My Market Manipulation Software!"

Today's Leeroy is more refreshing in ways. Sergey Aleynikov, former Goldman Sachs employee was arrested on suspicion of stealing software used for millisecond trading.

At a bail hearing three days later, a federal prosecutor asked that Mr. Aleynikov be held without bond because the code could be used to “unfairly manipulate” stock prices. ~ New York Times

As opposed to arresting Goldman Sachs for probably using the software to make billions of dollars? I sincerely hope that someone makes the connection between the theft and who it was stolen from. We might be seeing a test case so to speak since this is likley the first time any prosecutor has had their hands on such software.

Until the late 1990s, big investors bought and sold large blocks of shares through securities firms like Morgan Stanley. But in the last decade, the profits from making big trades have vanished, so investment banks have become reluctant to take such risks. ~ New York Times

Recall what I wrote in an earlier post regarding the large spike in volume after 2000 and the formation of a down megatrend for most of this decade:

Computer trading started in the 80's and was driven simply by the emergence of the technology. What could have lead to the need for so much more trading activity? Let's say you're a major fund manager and you realize that the megatrend has meat in it and that investing long isn't going to pay well. What do you do? Play volume, derivatives, arbitrage, and market smoke and mirrors to take advantage of every move that occurs in the relative market stagnation.

Notice that the volume was about a billion shares per day and was fairly consistent over the last decade. Notice how it started directly coincident with the tech crunch. No, this isn't a conspiracy theory. Don't read into this line of thought too much, but I will go ahead and suggest that there was a recognized need for large trading establishments and hedge funds to generate profit from trading in the relative shortage of investable stocks.

What makes this line of thinking consistent is that the trading activity didn't continue to grow, suggesting that market fees and other limitations put a hard cap on how much profit could be squeezed out of this type of trading. Or perhaps there is an overlay of two conflicting trends. Either way, the volume spike and subsequent stagnation starting in 2000 is a little curious and I'll get back to this before the end of summer. ~ from Falling Off the Blade

Looks like I'm not the only one who suspects that the down megatrend was widely recognized by a lot of large trading firms, driving a huge spike in adoption of electronic trading systems for price manipulation and market-making at ludicrous speed.

I'll keep watching, but I suspect that the derivitives bubble was a lot more well known than a lot of people want to admit. If I dig back far enough into my own posts on a trading forum a few years ago, theres a post regarding the slow down in home sales likely cascading into increased mortgage defaults. At the time it was rather clear to see the lack of real health in the housing market. After a few years of near zero interest rates, home lenders had litterally sprouted like kudzu, and people were buying into the market because the market was strong.

Be it known, home buyers are not nearly as smart as equity market investors. They will not recognize that what goes up can also come down. I had never seen a real-estate bubble, and it really didn't factor into my projections that the housing bubble and derivitives bubble could actually fuel an equity bubble taking the Dow to 14k. Thus here we are with tons of defaulted mortgages and a Dow 9k. I remember a commercial with a computer generated bull and bear. The bear gave his stereotypically gloomy estimates. They actually came true.

Update: After thinking about this a little more, I see the potential for something larger. The prosecuter looks at the code and finds evidence of techniques that are clearly designed to manipulate trading feedback. The code is used to press charges against Aleynikov and subpoena more code from Sachs. The code that is obtained from Sachs leads to charges and more subpoenas against Sachs. In a plea bargain, Aleynikov testifies against Sachs as the lead witness. Aleynikov took the code knowing that Sachs would have to chase him out of the alley and into the open.

By chasing him, Sachs might end up costing themselves more than having let him go. The interesting part is if Sachs thinks that protecting their code was more valuable than anything they will lose by chasing Aleynikov. Depending on how this unfolds, it could draw enough scrutiny onto big trading firms and hedge funds to get serious investigation into the practices as a whole, and given how unpopular the bailout was, congress will be ready to throw a lot of ink at the SEC and markets in general. Right now Wall Street is the Afghanistan of 2001.

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UVACN.X

.X is the ticker suffix on yahoo for derivatives. UVACN is the March 2010 call for NVDA with a strike price of $14. Going to play a blog game on paper. Recall that I consider 50% cash to be sufficiently diversified. This is probably only true if you want to trade options. The biggest advantage of cash diversification is that you don't have to watch it at all. It's safe and keeps you from experiencing catastrophic losses, which is the point of diversification.

If you're not into options, just take this opportunity to watch me try to make the best of what's ahead. This will be the first trade that I'll make to build up a small pile of case studies in various types of trading regimes.

I've been waiting on NVDA to perform a gap fill for some time. The reason is that I'm long NVDA. In other words, I beleive that inevitably the value will hit $14, and when it does, there will be a gap fill. Leeroy has continued to relinquish market fears about larger economic recession. The right numbers with the right amount of sunshine keep trickling in.



Ideally I would wait for support, but we're reaching a critical level of contention. The gap is at $14 and 20day EMA support is over $13. Without some type of market pullback, we're going to hit the gap, and that's a sensitive trading region -- too sensitive to wait for the support.

Ideally you always buy options when the stock is trading down because the option orders are very finicky and whenever you trade them with the grain they tend to run away. Trade them against the grain and they will sell you all you want. To make a bar room analogy out of it, you're headed towards one side of the room when most people are moving away in search of greener tables.

However, it's still possible to trade a larve volume of options very quickly. Buy all at once, so that your crashing through existing orders before they can move, and buy into the market depth. I have seen numerous occasions where 2k or 3k contracts for large cap stocks are just twiddling around $0.05 across the spread. That's equivalent to 200k or 300k shares under contract.

In this theoretical trade, because I want to go ahead and open a position before the gap starts to fill, I will hypothetically trade 1k contracts at $2.15, which is a little over the current ask price. This would cost about $215k In reality I would try to work with 25% of my capital, which is 50% of the money I'm willing to commit. This is to hold a little bit of cash in case we do get a pullback. So I'm assuming a working capital of $860k. These numbers are just to keep the calculations simple.

Now, here's what I see in my crystal trading ball at this point:

• Over the EMA20 - check
• Over the MDA50 - check
• Below a gap - check
• Stock is long - check
• Market has no imminent contention points to resolve - check
• No pending (known) Leeroy events - check
• Stock is far away from plausible valuation limits - check
• No immediate additional product competition - check
• Potential to enter additional markets - check

Each one of these factors tells me some very important things. There are support points below, so even if there is a decent sized disruption, the stock will likely recover. In fact, with 25% cash in waiting, I'm willing to sit through a 50MDA check. Without large, unresolved questions whose answers will have material impact on the fundamentals, I'm essentially saying that the existing pattern, not fundamentals will drive this trade to profitability.

Here goes 1k UVACN.X @ $2.15

After following up with another 25% of my paper capital, I will continue to monitor and look for the right time to sell, at which time I will be accepting the bid price on these options. Right now that's at $2.00, so just by making the trade, I've lost a little bit of ground. This what options are. You have to be able to trade with a very high degree of certainty. The moment you commit to a trade, you've already stepped backwards across the spread. After that, the time value will continue to decay until the expiration date. You don't break even on options hardly ever. Even if your predictions about the stock market are mostly right, you can still lose money. At around the one-year interval, I'm not too concerned about the time premium I'll be losing, but if things drag out, it's usually best to pull your cash out once your predictions are getting stale.

Oh, and if I were actually doing this, I would be using an IB account. Whatever you do, get real time quotes and market depth when you start getting this serious about trading. Delayed quotes will destroy you on options. Interactive Brokers has a decent UI, very serious minded trading fees, and access to lots of markets.

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Dragon Bones

Faux-fact: Way back in the pre-Zhou dynasty in cHiNR (pronounced, "China") there was a practice of carving runic messages into turtle shells and heating them over a fire until they cracked from thermal stresses. Then an old man with one eye open much wider than the other and likewise off-center behavior would analyze the way that the shell fractured in order to determine the answer to whatever cryptic message was scrawled onto the shell. Then the emporer or whatever (China has not nearly as continuous history as Chinese historians, PRC, and other Sinophiles would have you believe) would make his interpretation of the old man's word and choose the path to righteous destiny!

These bones were burried for future generations to dig them up and hawk as a miracle ingredient in traditional Chinese medacine. And they were called:

Dragon Bones!

Well, thousands of years later, and perhaps not yet too much brighter, here we are divining buy and sell signals from the stock market. There are websites hawking advice, possibly mafia gimmicks, and maybe tried and traitorous buy-and-hold tonic.

If you've been keeping up with my posts, you should have a decent feel by now for the concept of limited determinism. The rugby pile at the knife edge on the beach head in the bar room full of singles who want to be first, but don't want to be desperate. The chaotic cow that has absolute authority to vanquish the magician back into the realm of his game. The magician and Leeroy Jenkens battling it out unceasingly inside the circus tent that flows withing the chaotic probability zone.

What I'm really getting at is that there are places where the stock market's movements are absolutely limited by the price elasticity --- as well as places where bar room politics and magicians tricks and cameo appearences by Leeroy take over.

I have tried numerous times and many ways to figure out the correct analogy for how to make use of the serendiptitious patterns that emerge from the chaos whenever the stock market is trading well within the realm of price-elasticity, the places where limited determinism is more like conditional determinism, which is a paradox in itself.

The technical patterns, Leeroy effects, and magic shows are fun to watch. Inevitably there is a contention point, and that contention point will lead to the development of a new pattern, a new trend, a new wave to ride on. The capability of the wave to sustain itself is many times, by virtue of being well within the chaotic trading range, purely up to the surrounding chaos, which was itself decided in a nearly arbitrary fashion and wholly lacking of discernable sense to the average Vulcan.

In the end, the chaotic movements of the stock market are in so many ways just like the dragon bones. The charts almost even look like the cracks as they split through the dragon bones. How can this completely unreliable process provide any opportunities to make rational trading decisions at all? I give you my final answer:

The shape of each crack is arbitrary
The existence of cracks is absolute

What I mean by this is that you don't have to find meaning in the cracks, but never for a second think that just because there is no higher order that you can afford to ignore them.

And this is how the emporer rolls. Yes, the months and weeks leading up to a contention point should theoretically have no impact on the prices traders are willing to buy and sell shares at. At the contention point, the fact that the knife can fall either way would seem to suggest that there is no significance to the result. The cracks could have gone North and South or East and West and the old man still would have given his answer to the emporer just as if there was some greater meaning to it. The emporer's word is final. The follow-through of his beauracracy is like wise absolute. The follow through of the stock-market is no different.

When trading in the chaotic regions, try to spot the serendipity. Say not, "the stock will trade this way," but "if the stock trades this way, it would be likely to follow through this way." Then once the knife falls, if it falls in such a way that you think it has momentum and the blessing of the chaotic cow (it's well towards the middle of its price-elasticity curve) ride the storm until the next contention point. Better yet, if the pattern is stable, wait for the pattern's reinforcing signal, whether it's a linear uptrend or a moving daily average, and then make your move.

When dealing with a pattern that has room to run, it tends to do just that. That tendancy is strong enough to overcome the times that you will be wrong or a Leeroy event will pop up. No trade is ever 100% certain, but even with pitiful diversification (keeping a 50% cash position is diversification in my book), if the trades you're going after are the ones that you're 90% certain on, and you've tested and matured your ability to know when you can be right and when you can't, the mathematics will take over and you'll be sitting pretty at the end regardless of a few Leeroys throughout your trading career.

I'm almost absolutely certain that I'll get one of these tests soon enough a la NVDA. I'm waiting for it to fall back to its strength. When it gets there, I'll show a prediciton and we can watch it play out.

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