22 November 2010

Forex and Equities: Deep Market Structure

What are the necessary conditions for QE to actually do something constructive ? It is the contention of this blog that stimulus in a financial market must fade, no matter how large the inputs. Stimulus can be useful for a number of reasons:

a) It can rescue, stop a market from finding devastatingly accurate valuations, for example in the aftermath of the crisis.

b) It can re-float assets revalued this way, but only up to a point. At this point, stimulus simply fades, and one sees that slid the blog has spoken of. QE2 should have lifted the market up on a money flow surge, but it did not.

c) The problem is stimulus needs real growth to back it up. Real growth is a fractal phenomenon, it comes and goes in complex formations. This has been seen in the way companies have grown in the past year. There is a real economic recovery, but it has very little if anything to do with stimulus.

But it may be it cannot. They are very different processes. One sees this in the equity market, where a company grows fractally, expressed in that trademark mirror of the Dow. But at some stage it becomes a creature of money flow (where most investors and funds are, where the big money is, where it can push around shares).

So let's look at the economy like this. Maybe Europe is like that company (with the possible exception of Germany as always and maybe now the UK). But the US is not. Perhaps uniquely is can re-generate itself economically and grow fractally again. Hence the fact the Dow keeps on growing.

But it maybe that a limit has been reached, computationally. However this may be true, but I do think the US can move through this, because it has the promise of the Internet bubble to fulfill.

The Dow seems to make a kind of marker for future growth, which the economy fulfills. In fact the Dow seems fractally to model the future economy. But of course it is, it is a device for expressing future expectations of growth and it does seem accurate over time.

So what is the role of stimulus in all this, well it seems to be something by which a new growth cycle can begin.

Thus the Fed is doing something very clever indeed with QE2 ? Maybe. It is not so far getting a re-run of that stimulus climb. Those technical issues, like the gravity well of 10,000 express something real, that the economy needs to find a new way to grow.

But I do believe it has it. On a log scale as this blog has argued, the Dow is trying to find a path up from the tech bubble, it is not tracing out a head and shoulders pattern.

Let's face it the only real growth since 1999 has been from tech companies, but this is only the beginning (the rest of it was asset inflation, taken from the housing bubble). It maybe that extreme stimulus is necessary to kick-start an economy which is trying to grow fractally.

So what does all this mean for forex. What does this market seem to do. It seems to be part of the process by which fractal growth coheres with stimulus. That is is the computational mechanism by which an economy re-starts. This suggests that forex should be volatile. It suggests as well that the growth of EUR/USD from 01-07 was incorrect.

This kind of process should not be in forex, it was imposed by rate differentials and caused a huge volatile correction, from a market that was doing what it is supposed to do.

As always this blog believes USD re-valuations upwards = real growth. Thus it is maybe that roads are converging to make dollar re-value upwards no matter what the intention or expectation is. I agree this is a contrarian view, but indeed that is what makes the market flow. It is the nature of market computation, it cannot flow with the money, it has to flow against the money, but at its own time, for its own computational purposes.

Anybody who tries to trade against the computational nature of a market, will tend to lose money. This suggests that those who trade forex are mostly trading against the computational nature of forex. They (we) do so because its nature is hidden, there isn't the safe shore of company growth to protect you.

That, btw, is the intensely high risk of this market. If one does not see how a market works, then you are in the grip of the antagonistic nature of market makers, big money and other traders.

It is the contention of this blog that to see how forex works need the capacity to see a multi-dimensional optimization surface that one cannot see in a visual sense. But the structural capacities of the mind can certainly feel it in some sense. If one wanted to back up this, one could perhaps look at some of the more blue-sky research that looks at the way the mind may compute.

It seem to be the basis in all events for such capacities as creative reasoning and intuition, including intuitive trading.

But one can support this process, that is what makes the mind more effective, to bring out more explicitly the deep computational logics in the brain. In forex this translates as using indicators in terms of what do they tell you about the markets. Indicators can in some circumstances help answer the question for you, what do the markets say.

PFE tells you if there is chaos in the market, RSI tells you if there is an inflexion point for money flow. The market content itself will tell you if the market will do what it is supposed to do and optimize over that.

What does that mean. It means you will see movements that will kill your stop-loss because they are not linear. In this state the market is highly variable in its range of motions, except it is really following a path, but a very complex hidden one, but with support maybe your mind can feel it.

Basically a fractal path is deterministic but an optimization path is not because it is a search. That is ultimately why one can more easily make money as a long term trader (and indeed can make long term trades, which is highly problematic in forex even with the deepest pockets).

By long term trader I mean investing as Phil Town describes it for example, traveling with a company up its growth path and exiting when money flow comes into it.

Remember the way the Dow grows, it find a plateau, like from 01-07 before it takes off again. And it needs money flow to take off, and will fall to its plateau as money flow moves out. The fractal nature of the Dow means this is seen in companies as well, that is the basis for those investing approaches.

Is there another way to invest ? Is there a symmetry back into equity from forex. Well, yes, that is the basis for hedge funds. It is like riding the flow of money, but can you do it on a small scale. I would expect you would need to look for that moment of coherence. As the blog has said, the mechanics of investing are simple, you buy and sell currency pairs and buy and sell stocks, trying to ride a value differential.

That makes riding hard, except it is easy in forex. Now what is the first time I have used the word easy with forex. What I am suggesting is that forex and stocks can make a compliment that takes the edge out of both. The edge is ruinous losses. In the methods I outline I am looking for chaos from the equity market to structure a forex trade. I am looking for money flow to give a possible direction. This gives a logic for a path.

Forex content gives the capacity to ride, but companies are really giving the direction. This gives another view of the way the forex market is a funding source for equities, and why it does not behave as one might expect. It is not so much a funding source it is more like a structure source.

That is the symmetry back into equities. The mirror of the Dow, the mirror of its fractal components reflected back as an optimization process into a deterministic market. That is perhaps why one should view equities and forex as an investing pair, that is deep market structure.

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