Know When to Fold ‘Em
By Van K. Tharp, Ph.D.

One of my hobbies is playing poker and I can do it for free online.  When I visit a casino and play poker, I usually make money.  However, when I started to play online with play money, I had tremendous difficulty making money.   And that didn’t make sense to me because I knew that most of the people I was playing against were terrible.  Why couldn’t I make money?

However, one day I read a poker book by a professional who said that he had the same experience in low-limit games in Las Vegas.   He said that when he had a good hand, he typically had five or six bad players staying with him.  One of them would typically make a very lucky draw and he would be beaten. 

Once he figured out what was happening, however, he rarely lost again.   And his secret was knowing when to fold ‘em.   In Texas Hold’em, every player is dealt two cards face down.   These are your unique cards that you must use, although with five common cards that are dealt face up, to make the best five card poker hand.   You typically bet your hand after you see your two “pocket cards;” after the fist three common cards (called the flop); and after the fourth and fifth cards respectively.

Bad players typically play most starting hands they are dealt, but if there are enough bad players, then one of them will get a good draw that will beat most people.   So the solution to beating them is to only play the outstanding starting hands – the hands that will typically win the pot 30% of the time or better.   That means that you must FOLD 80% of the hands you are dealt.   You never play them and in most cases, it doesn’t cost you anything not to play a bad hand.

One of the advantages we have as traders is that we do not have to trade.   And it costs nothing to not trade.   So the common solution is to only take a position in outstanding trades.   And these are usually either trades that are moving strongly in your favor before you enter or trades that are so highly undervalued that you are getting an investment at a small fraction of what it is worth.

One of the highest starting hands in poker is an Ace-King of the same suit.  In a ten person game, this starting hand will typically win 68.6% of the time.  But it usually does require some help to win.    Suppose you are dealt an Ace-King of hearts which you bet so you can see some more cards.   However, the next three cards are a 3 of clubs, a jack of diamonds, and a 7 of spades.    Those three cards didn’t help you at all.  You don’t even have a pair in your hand and you only have two more cards to see.   Now the odds don’t look good that this will be one of the 68.6% of the hands that an Ace King of the same suit will win.   You should fold that hand, especially if other people are betting heavily.   And again, it won’t cost you much money at this stage to fold – just the amount of your initial bet.

The same occurs when you invest in a stock.   You buy the stock because it is going up.   However, once you buy it, it starts to slowly go down.    After several weeks, it’s down about 5%.   At this point it’s like the bad poker hand – you should walk away from it.  The odds, right now, don’t seem to be in your favor.

Bad players will typically play bad hands to begin with and they’ll stay with good hands that don’t get supported as more cards are revealed.   If you become more conservative with the odds, only playing the best hands, you’ll probably win most of them and lose very little money.

One of the golden rules of trading is to cut your losses short and this means get out of trades that don’t seem to be working in your favor.  Next, week we’ll talk about the opposite situation, when the poker hand or the trade starts to look really good.

Placing An Order
By Mark DiMaggio

Today’s discussion will focus on getting your investment in position, or as some call it placing an order or trade. Let us address the issue of getting an order “filled.” Most traders will look at a quote source of some kind and then place their order either on an electronic platform or at an order desk. There are many options to placing an order, no pun intended, from the electronic platform where a trader keys in their own trades to a discount order desk where a “clerk” or broker takes your order, and then calls a central order desk on the floor to place your trade, or goes to a floor individual who gives attention to your order, then places it with either a “runner” or a floor broker who then holds the “paper” until the price is attained via the bid and ask, and endorses or fills the ticket.

The electronic platform is potentially risky for some investors, as there are horror stories about traders that “fat-fingered” their trade entry or exit order touching the keys one too many times and ended up placing a “100” lot instead of the “10” lot order that they intended to place. One error of this magnitude could literally wipe out days or weeks worth of gains. The discount desk is appropriately named, as you get just what you pay for, discount service, no expertise, phone calls transferred often, slow execution if at all with clerks and newly licensed brokers lacking the experience to handle the hard earned capital in your investment account.

The broker that is experienced and knows how to work hard for their clients when getting an order placed, by calling their own floor broker to request a “bid and ask” in an effort to get their investor the best possible fill is worth the full commission charged. Consider opening the bigger account so as to have access to the floor and options pit, thereby allowing one to enter an order with the source.  Using outright options or using options spread strategies, an inexperienced trader or broker may place the outright option or option spread order at the market.

This “market” order is basically like throwing $50 dollar bills out the window of 10 story building since the fills on the order will likely be no where near the theoretical value of the option.  According to floor rules of the various exchanges, only “one” side of a spread order must be filled within the trading range, which means that the market-maker or floor broker can fill the other side outside of the range. This is almost never to the client’s advantage, as the floor broker does not have a vested interest to you the investor, to give you an “or better” fill price.  Do your homework and know what the option should be worth, consider the volatility of the day with respect to world events or economic data released that day and place limit orders that give a few ticks away, but not the farm.

Swing Trading: Making $$$ in a Sideways Market
By Jim Wyckoff

Commodity Markets Review
By Kevin Klombies

The euro appears to be ‘channel top’ just under 1.22. We were looking for a turn lower from the 1.22 to 1.23 range but, with a bit of adjustment, the chart shows that as long as the euro holds below the low 1.22’s the trend remains nicely lower. Below we show corn futures and the ratio between the U.S. Dollar Index (DXY) and copper futures. Through 1994 the combination of a weaker dollar and rising copper prices went with a falling trend for corn futures prices. As corn prices finally swung higher into the powerfully rising trend that stretched into mid-1996 the DXY/copper ratio flattened out before turning upwards once again. The argument here is that a stronger dollar and some sort of price peak for copper should go with a recovery in grains prices. After years of underperforming soybeans the corn/soybeans ratio has now broken higher.

Brazil makes ethanol (alcohol) out of sugar as opposed to corn. Gasoline in Brazil has to include at least 25% alcohol although a new generation of vehicles can now run on gasoline, alcohol, or any combination of the two. We mention this because there is a general relationship between sugar and unleaded gasoline prices. The chart at right shows unleaded gasoline futures and the ratio between sugar and corn futures. The charts have been offset or shifted by about 4 months. The idea is that the ratio between sugar and corn trends higher and lower- with a 4-month lag- with unleaded gasoline futures. From this perspective the marked rally in sugar prices can be explained through the 2005 price rise in energy prices. A long corn/short sugar position would be another way of positioning for lower energy prices.

 

Have a wonderful day!

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Weekly Currency Wrap-up
By Darrell Jobman

There was no definitive interest rate comments from US Federal Reserve, but Fed Governor Moskow stated that there was a good case for further interest rate increases to stem inflationary pressure. US interest rate futures and expectations strengthened very slightly over the week as a whole and this helped stabilise dollar sentiment.

The economic evidence continued to point to a recovery in the Euro-zone economy. There was a further significant increase in the German ZEW index to the highest level since June 2004 while there was also a significant increase in French industrial production. In its post-meeting statement, the ECB expressed unease over inflation trends and also stated that policy was still accommodative, but it also pointed to near-term downside risks.

Global trade accounts were an important focus during the week. The US deficit for November received most attention and narrowed to US$64.2bn from US$68.1bn the previous month, but the 11-month deficit was US$661.8bn and the US will still have recorded a record deficit for 2005 as a whole. The November deficit was narrowed by a drop in oil imports and by a 1.8% increase in exports with the export data boosted by a further rebound in aircraft shipments following the Boeing strike settlement.

The UK reported a record GBP5.97bn deficit for November after a GBP5.05bn deficit for October, while the Australian trade account reported an AUD2.47bn deficit for November.  Elsewhere in Asia, China reported a US$101.9bn trade surplus for 2005, an increase of over 200% from the 2004 level. There are doubts over the accuracy of the data, but there was still a substantial trade surplus and the data overall probably understates the surplus. There are also substantial trade surpluses being run by Asian economies such as Japan and Taiwan. The pattern of significant and sustained trade deficits in the US, UK and Australia, coupled with surpluses in China and much of Asia, will remain an important market focus.

Political events simmered below the surface and, although they did not have a major impact, it would be dangerous to ignore them and developments will need to be watched closely in the short term. There were further US casualties in Iraq while the Israeli political situation and future of Middle East peace negotiations remained unclear. Attention tended to switch more to Iran as the Iranian authorities restarted the nuclear development programme. This issue and the potential for US/Iran tensions are likely to be a long-term background market issue. The US dollar will be vulnerable if there is any significant increase in the political risk premium.

Have a great day and a wonderful weekend.

Two Important Charts from Larry Pesavento

The stock market remains in a very overbought condition as we approach the 3 day holiday weekend.  This sets up a potential reversal week coming into Tuesday.  The VIX index of volatility is near historic lows and lower than the top of March 2000.  This is a bearish event that may take several weeks to complete or it could climax this week.  As you can see from the VIX chart it has an inverse relationship to stocks.  This is suggesting a turn down in the stock market is imminent. 

Much of the rally was fueled by the so called “JANUARY EFFECT” which means if stocks rise in January the whole year will be bullish. History shows that this effect is a very poor indicator of future trend for the next 11 months.