Archive for November, 2007

by Charles Edgar
The financial investment system known as the stock trading robot has been taking the investment world by storm, and it is quite fascinating how it all came to be. The system was created by two men named Michael and Carl who named the trading robot “Marl” which is actually a software system. Marl was the most recent work of these guys who had previously developed an investment software program while employed with Goldman Sachs. Amazingly, the success of this software resulted in over $4,000,000,000 in annual trading profit for the firm. Obviously, these gentlemen seem to know what they are doing.

The ability to unveil this type of system to the public was restricted by a non competitive agreement that they had signed while at Goldman Sachs. Such an agreement is pretty standard in the corporate world. But after weeks of living a life of wealth and very relaxed unemployment, it was decided that they start a new project. They realized that they had to think differently and alter their approach to honor the agreement with Goldman Sachs. Thus, they decided to create a system designed for small investors so that Goldman Sachs would have no objections. This was when they created the stock trading robot, which is tailored to handle funds between $100 and $500,000.

One of the biggest benefits of this software is that it utilizes the only two advantages that small investors have over big investors. The first is the ability of small stock traders to get in and out of trades very quickly without disturbing the current stock price. Big funds simply cannot do this as their positions are so big that whenever they buy and sell, it will drive the price up and down. The second advantage is that small stock investors can buy and sell stocks of small companies. Large funds must invest in huge companies because of all the capital they have to invest.

So with the small stock trader in mind, Michael and Carl created a trading robot called Marl, which operates by using technical analysis. Technical analysis simply means it examines past movements of stocks and then calculates probabilities and statistics to predict the future movement of each stock. Few people realize that many stocks create patterns on charts that tend to happen again and again right before they take off and make a big move.

There are two benefits from employing the stock trading robot system to assist you in finding winning stocks. The first is that Marl has the ability to easily watch and monitor hundreds and hundreds of stock simultaneously. The second benefit is that Marl is set up on an evolutionary framework which means that it will actually learn from each stock it examines which makes it able to predict its next move under thousands of possible situations. So there is no doubt that anyone who invests in the stock market would greatly benefit from using the stock trading robot system.

Stock Trading Robot System - Revolutionary new investment software is knocking the stock market on its head. See how small stock investors are profiting from this fresh new approach to investing.

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by Walter Thatcher
Do you remember the Seinfeld episode, “The Boyfriend,” when Elaine starts dating former Mets great Keith Hernandez. Jerry gets to meet him and beforehand is fretting about his shirt. Jerry worries that it was too early in the relationship to help Keith move. As with many Seinfeld episodes, it was a very funny rendering of a true life situation. Investors get mancrushes as well, especially value investors. Perhaps you don’t have it bad for Buffett, but what about Ben Graham? Do you think that David Dreman is dreamy? Joel Greenblatt? Marty Whitman? Seth Klarman? Eddie Lampert? It goes without saying that you’ve read the books. Do you religiously read GuruFocus in order to see what these guys are buying? Do you feverishly Google them searching for articles or blog posts for information about their latest moves or philosophical treatises? Have you been to the Berkshire annual meeting in Omaha?

It’s good to have heroes or people that you emulate. Reconstructing the rationale behind past investments of the masters of capital allocation can be very instructive. Just don’t forget that you are you. Coke or the Washington Post are not selling at a fraction of their intrinsic worth. You can’t snatch up KMart bonds right after its bankruptcy. This is not to say that you can’t match or exceed their long term records. As Buffett has pointed out many times, he has more money than ideas and he could get better returns if he weren’t so big. Take a cue from the latest Nike basketball commercial featuring Buffett pal LeBron James, “you don’t want to be LeBron James, you wanna be better than me.” So learn what you can from these masters, but don’t be hedged in by their thinking. Just like they did, you’ll have to find the style that works best for you.

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by Kristien Wilkinson
Don’t all investors wish they have one. While a few may get lucky in choosing their stockbrokers with minimal effort, the general rule is to flesh out your investment needs and do adequate research before hiring a broker. Picking a stockbroker is just as important as choosing your stocks. If you’re going to entrust your money to these people, then you have to be certain that they have the intelligence, ability, and resources to do their job properly. Most importantly, make sure that they’re not filthy felons who would run off with your money the first chance they get.

Stockbrokers can be classified into two types: the regular brokers and the broker-resellers. Regular brokers work for a brokerage firm and deal directly with investors while broker-resellers act as an intermediary between the investor and a larger broker or firm. The general opinion is that regular brokers are more reputable than broker-resellers since the latter may not have taken or passed all the necessary licensing examinations in order to qualify as a standard broker. This doesn’t mean you should avoid all broker-resellers at all costs; you just have to be more careful in choosing resellers you’ll be dealing with.

Regular brokers are further divided into two kinds: the full-service brokers and the discount brokers. If you want a more extensive array of services which includes financial advice, research and analysis, retirement planning, and investment tips, then a full-service broker is the one for you. These services will cost you a lot though; full-service firms charge higher commissions and fees than discount brokers. If you have the time and resources to do your own research on the stock market and you feel that you are fully capable of making intelligent investment decisions, then a discount broker should be enough to work for you. They simply execute your trades with no added frills and charge less than a full service brokerage.

In choosing a broker, it’s better not to be content with any random person a brokerage firm assigns to you. Personally review his credentials. Choose someone with four to five years of experience and ask for a list of clients that you can contact for references. Check with regulation authorities if there have been complaints against him.

You also want a broker who doesn’t have too many clients particularly if you decide to be an active trader. If your broker is too busy handling 300 other clients, you may often end up talking to a call center representative. There are instances, of course, when your concern can just as adequately be handled by a call center so don’t abruptly close your account just because your broker wasn’t able to answer all your calls. The point is, your broker should have sufficient time and focus to take care of your portfolio. However, if you’re perfectly comfortable executing trades on your computer without having to talk to a human being, then you can pick out an online discount broker and execute your trading on the internet. Just make sure that the online broker has a competent customer service department to address your problems and concerns.

Finally, read the brokerage contract carefully and pay attention to the fine print. If the advertised fees seem to good to be true, look out for hidden costs or interests. Don’t be afraid to ask questions especially if there’s any part of the contract that’s not clear to you. Remember, you’re already taking on a considerable amount of risk by investing in stocks. You at least deserve to have a decent level of security in doing business with your broker.

Kristien Wilkinson is an online writer and contributor to http://www.tradingstocks.com

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by Kristien Wilkinson
Putting your money on companies with big market capitalizations is often touted as one of the safer ways to invest in stocks. After all, these blue chips and mega cap companies are generally stable, secure, and are well-known industry leaders. They are traded on major exchanges such as Dow Jones and Nasdaq and are widely covered by the media. Thus, investors can easily get their hands on a wealth of corporate information about these companies. Clearly, playing with the big boys in the stock investment arena has its perks.

For the stout-hearted and adventurous investor though who can handle much higher risks, micro cap companies are worth looking into. Micro caps, also known as penny stocks, have market capitalizations of $50 million to $300 million although some companies can have as low as $6 million in tangible assets. They often trade for less than $5 per share but this range fluctuates depending on market performance. Penny stocks could outperform large and small cap stocks by as much as three percent. Because of their low stock prices, these stocks are quite attractive to retail and novice investors.

Micro cap stocks are traded on the Over-the-Counter Bulletin Board. While companies listed in the major exchanges need to meet minimum requirements such as net assets and number of shareholders, penny stocks are not subjected to any listing standards. The Securities and Exchange Commission requires micro cap companies to file financial reports except for those with less than $10 million in assets. These are helpful sources of information for investors although the accuracy and timeliness of the reports could at times be disputed.

Micro cap stocks are generally not covered by mainstream media and analysts which makes it difficult to obtain information about these companies. Investors must then do their own research. Relevant factors to look into are the 52-week high/low trading range, the price/earnings multiple, and the net profit and cash flow. Note also if the company files its financial statements on time and on a regular basis.

Most companies in the micro cap range aren’t raking in major earnings yet and may take a long while to do so. The key is to study a company’s business model and to be aware of any potentially marketable product or technological innovation that it plans to launch into the market.

Investing in micro caps requires a lot of effort in research and patience in waiting for the company to develop. Penny stocks have relatively low liquidity and as such, cannot be sold quickly to minimize losses should things go wrong. A lot of micro cap companies also tend to have short life spans and could fold up anytime.

The market of penny stocks is also teeming with fraudsters who illegally profit from unsuspecting investors. Unscrupulous brokers would buy stocks from a micro cap company at very low prices and re-sell them with an outrageous mark-up. Some micro cap promoters also create hype about a certain company to start a buying frenzy and increase the stock price. The overvalued stocks would eventually plunge back to its penny price once the hype is over and consequently wipe out the investors’ money.

Kristien Wilkinson is an online writer and contributor to http://www.tradingstocks.com

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by Mike Estrey
One of the great themes of investment, whether it is stockmarket, commodity, foreign exchange or indeed any financial instrument, is whether or not what you are trading is in a clear trend. The reason this is so important is that trading a trend creates much bigger opportunities than trying to second guess moves within a trading range.

The problem is that for certain instruments, trends do not occur very often. Indeed for some shares, a clear trend is in place perhaps for less than 30% of the time.

Looking for the extra returns

Depending on what you read and your own observation of charts or other analysis, there are times when it is hard to decide if what you want to trade is in a trend or trading a range.

As a starting point for CFD trading, this distinction is absolutely crucial because many popular indicators that are used throughout all market conditions simply don’t work all the time. These indicators are of course used as predictive tools, so it is essential to know when they are useful and when they are not.

As with fundamental analysis, you have to look deeper under the surface if you want the extra returns. It is plainly dangerous to rely on dividend yields, p/e ratios, sales to market capitalisation ratios etc., as stand alone reasons to buy a share on a valuation view.

Likewise it is foolhardy to simply use RSI crossovers, MACDs or stochastics and so on without a thorough assessment of the merits of each within a certain type of market.

This paper is not designed to tell you which indicator works and when, because the answer is ‘some of them do’ and ‘some of the time’. The aim here is to impress on you the need to look for trading opportunities in a detached manner with the information that is in front of you, and then make a trade using a defined set of rules. One of which is simply: “go with the trend”.

Relying on one indicator

Many newer investors tend to find one technical indicator that they feel comfortable with, and stick with it during all market conditions. From a very long term point of view, this approach may have some validity, but in the short term, indicators tend to ebb and flow in their edge over other approaches.

You can of course use indicators to highlight certain set ups, but bear in mind there are millions of people around the world who can tap into any number of free financial websites giving every conceivable indicator.

You may be part of a big crowd with the same information but it is the ability to sift that information that gives the best opportunities. A computer can do this very fast and you actually do not need indicators, although they of course have their uses (see our various other papers).

The reason is that chaos theory tends to negate the benefits of an initial edge — the more people that know about something that works, the more influence that has on pricing to the point where it negates the original benefit. This is standard human nature, even though the cycle no doubt returns in due course.

What is more, there is a school of thought that believes that if you gave a trader a proven system that worked over time, together with the suggested entry points and trading methodology, they would never do as well as the system. Why? Because humans recoil from events outside the norm, and you can be guaranteed that at some stage they will not take all the signals. So we return to going with the trend, and this will focus the mind.

Benefits of finding a trend

The best 90% of market returns are made only 10% of the time, and those usually happen when there is a clear and major trend in place. It is therefore essential to isolate markets, currencies, commodities or whatever is ‘hot’ and ensure that you are participating where you can as a trader only in these issues.

If a share price oscillates but ends up the same price as when you first started watching it, it’s not easy to win consistently, and win a lot. But if you are focussing your trades on stocks or markets with a clear and strong trend, it is possible to ride any number of profitable trends, and win consistently over time.

How many times have you looked at something that appears ludicrously expensive and looked for a short trade when the trend was clearly up? Not only are you missing the big, big uptrend, but you will be emotionally worn out when the downtrend returns.

So, stand back and look at your charts from a distance — does it look as though it’s going up or down? — if you’re not sure, it’s not in a trend.

About the Author:
Mike Estrey is the Head of Research for Blue Index, the Online CFD Trading Specialists. A free 15 day trial of their CFD Research is available, along with CFD Trading Seminars and Workshops.

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by Mike Estrey
CFD traders will often hear the phrase ‘yield curve’ used in long and short term evaluation of investment trends, and it is seen as important as one barometer for the outlook for the economy, and thus the stockmarket. The curve itself shows the structure of interest rates plotted over different maturities as measured by government bond prices, from the shortest dated bonds, which usually are related to short term interest rates, to long-dated i.e. 30 year plus maturities.

This enables investors firstly to be able to compare the yields offered by short-term, medium-term and long-term bonds. As there is usually a higher risk involved in choosing a longer dated maturity, typically the yield curve should slop upward, but it is the actual slope that is of interest. This also has relevance for forex investors as it reflects one part of longer term currency risk evaluation.

The three shapes of the curve

The yield curve usually takes one of three shapes. If short-term yields are lower than long-term yields, the line of interest rates will slope upwards, and this is seen as normal.

If short-term yields are higher than long-term yields, the line then slopes down (at least at the beginning), and this is referred to as an inverted or negative yield curve.

Occasionally, a flat yield curve reflects hardly any disparity between short-dated and long-dated yields.

What bonds are plotted?

It is very important that only bonds of similar risk are plotted on the curve, as the gap between low and high risk bonds itself is another factor for longer term investors to examine when choosing investments. In the US, the most common type of yield curve plots Treasury securities because they are considered risk-free and are used as a benchmark for determining the yield on other types of higher risk debt. The yield curves are calculated and published by The Wall Street Journal, the Federal Reserve, and a variety of other financial institutions.

In the UK, gilt stocks are used in the same way and it is simple to compile current yield curves from the Financial Times.

The importance of the yield curve

As mentioned above, when the yield curve is positive or sloping upwards, this indicates that investors require a higher rate of return for the added risk of lending money for longer periods of time, which is normal.

If the yield curve shows a steep upwards slope, this indicates to some commentators that investors are looking at strong future economic growth and potentially higher future inflation, which might lead to higher interest rates.

Changes in the shape of the yield curve can also have an impact on portfolio returns by making differently dated bonds more or less valuable relative to other bonds, so analysts and investors need to study yield curves carefully.

If there is a flat curve this generally indicates that investors are unsure about future economic growth and inflation.

The inverted yield curve

This has been quite topical in recent months as inverted yield curves have been seen in many economies after the period of steadily tightening monetary policy up until this summer.

Where there is an inverted yield curve this suggests that investors expect slowing economic growth and potentially lower inflation. The inference here is lower interest rates to stave off possible recession, and this is what we have seen in the US earlier this month when the Federal Reserve lowered rates by 50 basis points.

There have been many studies that have found that inverted yield curves tend to precede recessions, but this may be subject to revision given the prevailing fiat monetary policies in much of the developed world currently.

Yield curve theory

There are three main theories that attempt to explain why yield curves are shaped the way they are, and it is for the long term investor to decide whether these are relevant or superfluous to the prevailing shape of the curve.

The expectations theory states that expectations of rising short-term interest rates are what create a positive yield curve and vice versa.

The liquidity preference hypothesis states that investors always prefer the higher liquidity of short-term debt and therefore any deviance from a positive yield curve will only prove to be a temporary phenomenon.

The segmented market hypothesis states that different investors confine themselves to certain maturity segments, making the yield curve a reflection of prevailing investment policies.

About the Author:
Mike Estrey is the Head of Research for Blue Index, the Day Trading specialists in Contracts for Difference. Foreign Exchange Trading also forms part of their extensive services.

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by shell56
The title may sound strange to some investors or traders, especially to those that are new to the subject. Some people are convinced that this is the single most important thing for success in the stock market. But the truth is; when it comes to being a successful investor, how much money you make when you’re right really isn’t all that counts. The simple fact is you won’t always be right. Oops. Bad news, right. It’s not something you like to hear, but it’s true. Isn’t it? Even though it’s possible that some of you may have met someone, at one time or another, that claimed to be right almost 100% of the time. And if you haven’t met that person yet, you might run into him or her somewhere in the future. When you do, be careful. When someone tells you he or she is always right, in general, three scenario’s are possible:

- You’re talking to the world’s best investor / trader
- You’re talking to a textbook example of beginners luck
- You’re talking to a liar

Let’s take a quick look at all these possibilities. The first scenario is of course highly unlikely. Fortunately it’s easy to find out if this is the case. Just take a look at the person’s track record. People that like to brag about being right all the time, usually enjoy making their point. So they would love to prove their track record to you. If they fail to cough one up, they’re probably not telling you the truth.

The second scenario is a lot more likely. Only a couple of years ago, when every idiot could make a profit because share prices were continuously on the rise, it seemed like these people grew on trees. In today’s market you won’t find a lot of those people hanging around. Most of them got more than they could handle when the bubble burst. And many of them never had the courage, or the financial means, to return to the game of investing.

Then of course we have the third and most likely scenario. In this case, you would take the same approach as you did with the super investor. You ask them to show you their track record. The liar of course will never give you this. Instead they will try to convince you with wonderful stories. All of which are probably fascinating. Some would be interesting enough to serve as a plot for a Hollywood blockbuster on Wall street. However, none of these stories will do you any good when it comes to making it in the stock market.

The plain and simple truth is that nobody can invest for any period of time and be right each and every time. It simply is not possible. Now that doesn’t mean that anyone telling you they never lose is lying. It depends on what they’re really saying. They are not saying that they never lose on a trade or on a specific investment. What they may be saying is that they never close out a year with a loss at the end. So how come they can make money every year even when they lose on some trades just like everybody else? The answer is simple; they are right more often then they are wrong. And more importantly, when they are wrong they limit their losses.

To illustrate this, let’s compare the stock market to a game of roulette. Some people could easily substitute one for the other. They live under the assumption that both are simply games of chance. Others may find this comparison ridiculous because the two are so vastly different. The two camps would probably never agree, so let’s not go into that discussion here. However there is something very important we can learn from roulette.

In a game of roulette the odds are actually divided in a reasonably fair way. If you were to continue playing by constantly just betting a small amount, say $10.00. And you would consistently play the same colour, say black. You would be right 18 out of 37 times on average. Of course you would also be wrong 18 times. If you would consistently play the game this way, you would probably never win much, but you couldn’t lose much either. As a matter of fact if you would just continue playing long enough, you would eventually lose on 1/37th of all your bets.

nfortunately the same cannot be said for the stock market. The odds are quite different there. Yes, the market can go up and down, and there is no zero, but there are many more factors to be taken into account than in a game of roulette. The same strategy that was described in the roulette example could work quite well in the stock market, but it could also cost you everything you’ve got. One part about being a successful trader is to be right as often as possible. And even though you cannot predict the market, at least not perfectly. You can do your homework by studying the technical analysis charts and doing some fundamental analysis into the company. If you know what to look for, this will greatly increase your chances of being right.

However, you still will not be right all the time. And that is where both the lesson from the roulette example and the title of this article come in. First of all, you have to place your ‘bets’ evenly. Stick to the $10.00 example. Don’t be persuaded to invest a significantly large part of your investment capital into any one trade just because you’re so sure this time. This may work out fine many times, but sooner or later it will hurt you, and it will hurt bad. You see it is not how much you make when you’re right that counts. It is what you keep yourself from losing when you’re wrong that really matters in the long run. You can be right 90% of the time and make some pretty good money. But it won’t do you any good if you lose it all on the 10% of your trades when you’re wrong. Of course diversification and proper asset allocation can help protect you, but that simply isn’t enough. You have to know when to get out.

So next time when you’re about to make a trade, ask yourself: “What if I’m wrong”. And then determine a price level at which you will take your loss and get out. Once you’ve determined this simple rule, just stick to it. It may cause you to lose a little money every once and a while. Even on trades that may bounce back just one day later. But in the long run that will hurt far less than the losing trade you so desperately hang on to, hoping it will recover. Only to find out that it won’t.

www.moneymadeeasy.co.nzIan Shellian@moneymadeeasy.co.nzwww.moneymadeeasy.co.nz

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by Mike Estrey
It is fair to say that some modes of technical analysis of the stockmarkets move beyond the purely mathematical and one of these is Gann analysis which has many devotees around the world despite its more esoteric appeal.

The body of work that has built up around WD Gann began with his own series of predictions in the early part of the 20th century which were uncannily accurate, and he soon built up a big following as one of the first real technical analysts. His analysis combined price and time studies to make what he described as the market time factor, and he believed that all market movements could be defined by a series of mathematical laws and the workings of the natural world.

The basics of Gann analysis

There were three starting rules:

1 Price, time and range are the only three factors to consider.

2 The markets are cyclical in nature.

3 The markets are geometric in design and in function.

Gann had three areas of prediction: His price studies included support and resistance lines, pivot points and angles, many of which are standard analytical techniques in modern day technical analysis. His time studies sought out historically reoccurring dates, and these were derived by natural and social means, which was more subjective. He also studied patterns to seek about potential market swings using trendlines and reversal patterns.

Price, time and the construction of Gann Angles

What Gann sought to do was to set out a series of geometric angles that could be used as rising support and resistance levels based on natural laws, and these are now known to analysts as speed lines.

Much of his work was empirical, which meant he developed the analysis based on experimentation and observation, but he was committed to the central 1*1 price against time line measured as a 45 degree line on a chart.

The second point was where to start the lines, and Gann discovered that major highs or lows made excellent starting points. He also then moved onto horizontal support and resistance levels using what he called “vibrations” or “price swings”, and again his evidence was empirical in nature using mathematical theories such as Fibonacci retracements (which we have discussed elsewhere).

Once the relevant price and time points were observed on a chart, Gann then drew in (modern software systems do this automatically) several important lines, of which the two most common patterns were the 1X1 line, the 1X2 line (which is a more gentle rate of ascent, and the 2X1 line (a steeper rate of ascent).

The idea would be that if the price of a stock broke through the ascending 1X1 line, the odds favoured a move down to the 1X2 line, and vice versa.

Aswell as these lines, he worked out a series of subdivisions that could be plotted on a chart as follows:

1 x 8 = 82.5 degrees
1 x 4 = 75 degrees
1 x 3 = 71.25 degrees
1 x 2 = 63.75 degrees
1 x 1 = 45 degrees
2 x 1 = 26.25 degrees
3 x 1 = 18.75 degrees
4 x 1 = 15 degrees
8 x 1 = 7.5 degrees

The patterns could be drawn in an ascending manner from major lows or descending lines from peaks, and in both cases they could be used as support and resistance points at any time.

Because all markets were seen to be cyclical in nature, the longer the line could be drawn connecting points along the way, the more important its overall influence would be (some commentators still point out a Gann speed line rising from the major 1982 low in US equity markets that is still in place for instance).

Benefits of Using Gann Angles

The main benefit to stockmarket investors is that the important speed lines act as support and resistance levels that are different to other trendlines connecting a series of lows or highs. It is a very straightforward method of observing rates of change when various speed lines are inserted into the chart of a share price.

Some investors use pullbacks to a rising speed line as an opportunity to add to already profitable positions.

Where a speed line interacts with a horizontal line of importance, the combination of time and price becomes more important and Gann showed that these points often forecast major turning points in the future.

Drawbacks

As with any empirically based technique, Gann analysis works differently for each investor and each stock as it depends on what is observed. Drawing the speedlines is clearly different in each market due to the inherent variable pricing of stocks.

There is some scepticism that ideas based on natural laws are more astrological than mathematical, and many analysts have dismissed the theory as mumbo jumbo, along with fibonacci and Elliott wave theory for instance.

As with all technical analysis, though, there are no fixed right or wrong answers. It is not possible to predict the future, but it helps if one can add some element of probability theory to the analysis based on patterns of human behaviour, and Gann analysis does that.

A final point is that at the time, WD Gann had the edge until his theories became widely known, and of course was able to show stellar returns on his trades. Chaos theory and the speed of computer systems these days suggest any new edge is much harder to find and sustain in terms of absolute buying or selling points. CFD traders and other investors would always do better to adopt an overall disciplined approach to the investment process to succeed.

About the Author:
Mike Estrey is the Head of Research for Blue Index, specialists in Online CFD Trading, Contracts for Difference and Online Forex Trading.

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by Mike Estrey
Long before CFDs became commonplace, we lived in a land of early programme trading, extended settlement and mainly phone based dealing, and almost twenty years to the day occurred what is now known as ‘Black Monday’

This was the session on Monday, October 19th 1987, when the benchmark Dow Jones Index fell by a 508 points, which was then 23% and the biggest one day percentage decline in stock market history, with huge drops also seen right across the world’s equity markets.

The falls actually cascaded from the Far East, through Europe to the US and back again, and it felt to some like the end of the financial world was upon us, but of course the situation resolved itself after a few weeks of turbulence. Nevertheless, it was a momentous day in stockmarket history and worth looking back on for traders and investors alike.

It is interesting to note that the terms ‘Black Monday’ and ‘Black Tuesday’ were first coined after the days October 28th and 29th 1929, some fifty years earlier. These occurred after ‘Black Thursday’ on October 24th, which began the market crash of that year, but the falls on the Monday twenty years ago were much larger and quicker. So what happened exactly?

The background up to that weekend

There is some confusion associated with the 1987 crash, and it has often been seen as a one-of-a-kind event, but in truth the series of events that provided the background could just as easily conspire again, allowing for each market’s current trading limits before any suspension.

The actual cause of the crash has never been truly agreed upon, but what did happen differently to the falls in 1927 was how quickly the Federal Reserve and other central banks acted to put liquidity into the system to prevent further problems. Indeed, this process has continued ever since, and some have argued it has placed an artificial floor on stockmarkets, which might rebound on the bulls at some stage. Either way, the worst was over quickly, and the Dow Jones actually bottomed on day two, October 20th. Although it was volatile, that time could be seen in retrospect as an excellent long term buying opportunity.

In 1986, the growth in the US economy had began to slow down, resulting in a soft landing, and then corporate earnings began to pick up again, leading to a resumption of the bull market in 1987. During that year the Dow rose 44% by August, and then on October 14th it dropped 95 points to 2412.70, a record fall at the time, and fell another 58 points the next day, so it was already down over 12% from the August high. On the Friday, October 16th, it fell another 108.35 points to close at 2246.74 on record volume.

Over the weekend, Treasury Secretary James Baker had stated his concerns about the falling prices, and the crash began in earnest in Far Eastern markets during the morning of October 19th. Later that morning, two US warships shelled an Iranian oil platform in the Persian Gulf, but this simply added to the sense of panic, despite turning out to be of no consequence.

The main causes of the rapid decline

There were several main areas that were seen as significant towards causing the huge declines seen on the Monday, but many factors have often been quoted.

The first and most serious aspect was the effect of programme trading, which was blamed for exacerbating the declines.

US Congressman Edward J. Markey had been warning about the possibility of a crash, and stated afterwards that programme trading was the principal cause. What happened on the day was that computers performed rapid stock executions based on external inputs, such as the price of related securities.

There were several strategies that were used in programme trading including arbitrage, where for instance the index futures might be trading lower than the cash market, so the computers gave stock selling orders until the disparity was resolved. On the day, the futures market in Chicago was consistently lower than the stock market, and instead of buying in Chicago and selling in the New York cash market, which would be a normal response, instructions were given to sell into the falling market.

Portfolio insurance was another aspect of these strategies, whereby sell signals were given to reduce asset, sector and stock allocation as the value of these fell, in effect to act as insurance against further falls, which clearly did not happen. There were several accounts suggesting that almost half the trading on October 19th was a small number of institutions with portfolio insurance, and all that happened was that they continued to sell as the value of their equity dropped.

Other reasons

It has since been argued that although programme trading strategies were used primarily in the US, other markets fell just as hard, so there must have been other reasons. The crash actually began in Hong Kong, then spread to Europe, and hit the US only after many markets had already declined by a significant margin.

So other reasons have been put forward, and another possible cue for the crash was the simple overvaluation of equity markets which had put them at p/e ratios not seen since 1929. (It might be worth noting that p/e ratios in the last ten years have often been higher still). The view here was that value investors had already begun to bail out of the market during the late summer, and the crash was simply the end of the decline.

There were also some macroeconomic concerns at the time, which included international disputes about foreign exchange and interest rates, and fears about inflation, but these in themselves would have been unlikely to trigger such a derating so quickly.

Another common theory states that the crash was a result of a dispute in monetary policy between the G-7 industrialized nations, whereby the US, which desired to keep the dollar high to restrict inflation, tightened policy faster than European central banks.

An opposing argument stated that the crash happened because of the breakup of the Louvre Accord, which was a monetary pact between the US, Japan, and West Germany to keep currencies stable. Just prior to the crash, Alan Greenspan had said that the dollar would be devalued. You can take your pick from both of these somewhat contradictory arguments.

A final factor which affected the UK market was the Great Storm of 1987 in England, which occurred on the Friday before the crash. At that time, most dealing was done by phone, and brokers had to physically get to work in London to carry out deals. That morning, many routes into London were closed and consequently many traders were unable to reach their offices in order to close positions by the end of the week. This added to the panic selling which occurred on the following Monday on the FTSE 100 index, which fell around 250 points that day, and another 250 points on the Tuesday before a massive rally retraced some of the losses.

Conclusion

As can be seen, the classic market crash was in retrospect the result of various inputs, and it is hard to pin down one trigger. Indeed, despite efficient market theory suggesting that falls of the magnitude seen on Black Monday are a once in a lifetime (possibly a millennium) occurrence, we have since seen some hefty falls on a daily basis in the last twenty years.

One point should be mentioned in particular, and that is that markets were already in short term downtrends before the crash started, so the drops did not occur without warning. This is food for thought for CFD traders in these uncertain and somewhat faster moving times, and provided stops are used, these happenings can present major opportunities for profit for the astute trader.

About the Author:
Mike Estrey is the Head of Research for Blue Index, specialists CFD Brokers, providing seminars on how to trade CFDs and offering a Live Trading Simulator.

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by Mike Estrey
In our daily reports, we comment on the background and outlook for the gold price, but from time to time we refer to other precious metals. One of these that can be traded using CFDs is platinum, and various contracts are available, as well of course as companies with interests such as Johnson Matthey and Aquarius Platinum, which have long appealed to stock market investors.

The metal itself

As gold is rare than silver, so platinum is around 35 times rarer than gold and is less widely found. Its main exploration areas are South Africa and Russia, and then Zimbabwe, Canada and South America.

Less than 90 tonnes of platinum are turned into jewellery, compared with 2,700 tonnes of gold, and it takes eight weeks and ten tonnes of ore to produce an ounce of platinum, against three tonnes mined to produce the same amount of gold. The current price (as shown by the January 2008 CFD) is $1401 per ounce, which is very close to an all time high.

Uses of platinum

Platinum has several unique properties which have led to its increasing industrial use, aswell as for jewellery. It is found in the automotive, aerospace, electronics and chemical industries, most notably in catalytic converters, where Johnson Matthey is a world leader.

It also has major uses in medicine, as it is not affected by the oxidisation reaction with blood. It has excellent conductivity, and is compatible with living tissue, making it ideal for use in pacemakers.

Its density makes it more durable than many other metals, and is extremely inert, being resistant to heat and acids with a melting point of 1,768ºC.

From a jewellery standpoint, the metal does not wear away, and although it can scratch, this is simply a displacement of the metal with no volume lost, which is not the case for gold.

Despite its super strength and density, platinum is highly pliable, and one gram can be drawn to produce a fine wire over a mile in length.

The outlook

Platinum is enjoying a major bull market in line with the rest of the precious metals sector. The usual supply demand arguments apply, with the long lag in developing new mine capacity being one of the main reasons why the sector is expected to continue to be rerated, aswell of course of the simple rarity value in a world of expanding demand.

From that demand point of view the outlook remains extremely positive, and the three biggest markets are now China, Japan and North America.

The bridal sector is an important market for jewellery, as in Japan platinum is still used in almost all engagement rings and over 80% of wedding rings. In the USA, platinum’s share of the bridal market was non-existent twenty years ago, but is approaching 50% now.

Fuel cell technology

There has been a dramatic interest in fuel cell technology mainly as a result of increasing concerns about environmental degradation. Fuel cells do not burn fuel, which eliminates the air pollution associated with fossil fuels.

Almost all prototype fuel cell vehicles are powered by the proton exchange membrane fuel cell, which uses platinum as the primary catalyst, and all major automobile companies have expanding fuel cell programmes.

Demand is so far quite small, but the expectation is for gradual medium to long term growth, first in stationary fuel cells and later with the commercialisation of fuel cell vehicles.

About the Author:
Mike Estrey is the Head of Research for Blue Index, specialists in Online CFD Trading, Contracts for Difference and Online Forex Trading.

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