It's been one of the best weeks for us this year. Don't be mistaken, what the markets experienced over the last 5 days will go down in the history books as one hell of a ride. But as traders, we live for this type of events.
We've been too busy managing our books to pen a piece for our readers, and it's only until today (3 September) that the first interlude of respite allowed us to lay down our thoughts. The previous Wednesday and Thursday have seen the largest 2-day rally since 2008, after markets posted one of their largest daily losses following the previous Friday's bearish signal.
We wanted to share with readers how we approached and traded this week's vicious correction, including what went through our minds and how we managed to profit while most others failed to.
In the last 2 weeks, most retail traders have lost money, or even completely blown their leveraged trading accounts. If you're reading this and are one of them, this piece is for you. In such markets, you need to know what you're doing. Most retail traders were utterly clueless and were gambling. It's hence no surprise that so many lost.
Some Context: China China China
For 2 weeks now, dating back to the previous Wednesday's release of the July FOMC minutes, traders and investors all across the world have had shock therapy to their brains. That includes us, and we're not denying that. Market moves that only occur once every quinquennium were seen on multiple occasions over this period. We are quite frankly, astounded.
As we've been warning, when China sneezes, the world eventually catches a cold. Our latest post, just before things got really ugly, talked about a deluge of matters which bore tangents to the current situation. It all started with China.
The seeds of what is now known as "25 August Black Monday" were sown way back ago in China (and the EM sphere in general). Remember that cataclysmic collapse in China's stock markets forcing both the CCP and PBoC to intervene on an unprecedented scale? That in hindsight, was the first signs of cracks.
2 Friday ago, China posted its worst manufacturing data (Caixin manufacturing PMI) since the 2008 Great Recession (this was confirmed by this Tuesday's final revision). The 47ish figure came well below expectations and severely rattled markets all across. U.S. equity futures accelerated in their respective declines coming over from Thursday, and saw almost no respite until the markets closed for the weekends.
It was a bloodbath waiting to happen. Screens were filled with red and even redder pixels once the first markets begun trading late Sunday evening. As more liquidity came online, the selling only intensified. It became terminal once Japan and Asia (including China) started their sessions. By late Sunday night in New York, S&P 500 futures were already down well over 2% from Friday's close.
Across the spectrum of markets we monitor, there was almost nothing isolated from that mass exodus out of risk. Anything and everything that could be sold was sold. Carry trades in FX, HY and IG corporate bonds, commodities were liquidated; stocks and credit were sold hard; safe government bond yields tanked; and safe haven currencies (JPY, CHF, EUR) were bid to the moon.
But the panic button wasn't actually pushed until the European session began. At around 230am EDT Monday, everything started to really crash. EM currencies, equities and debt were absolutely battered. Industrial commodities smashed through previous support levels like hot knife through butter. Just about all stock markets were trading deep in various shades of reds. U.S. treasuries and German bunds yields posted their largest declines in almost a year.
As we approached the U.S. open on Monday, we reached the point of no return. The markets literally went down in a straight line. A parabolic curve extending to the sky for safe havens, and the opposite for risk assets. But something extremely rare happened at around 910am EDT Monday. Nasdaq futures were limit down and were entirely halted. We suspect that as a direct result, the selling in other assets intensified by the minute.
In the currency markets, extraordinary things also happened. Within the span of 2 minutes, many widely traded currency pairs including USDJPY, AUDUSD, AUDJPY, NZDUSD, NZDJPY, GBPNZD spiked in the direction of their prevailing trends by upwards of 5% (currencies hardly move more than 0.5% a day). In technical parlance, we saw extremely abrupt and massive moves to the tune of thousands of pips within 2 minutes.
Even crazier was the fact that those ludicrous moves were almost completely reversed in the course of the ensuing minutes; they registered as long tails on OHLC charts on any timeframe over 15 minutes. Totally surreal! There were platitudes of other insane events that earned 25 August 2015 its "Black Monday" title.
Just know that risk continued to be sold throughout the day and carried over into Tuesday. We'll now give readers an idea as to what we wee doing and how we not only stayed safe during much of the episode but also managed to have one of our best trading weeks of 2015 in the process.
Starting Off On The Wrong Foot
Immediately post the 19 August July FOMC minutes, we had long exposures to risk, namely the S&P 500 (SPX). We were long at several price points but didn't manage to figure out that there was something severely amiss before the floor gave way the following day.
A few of the traders that we were in touch with managed to spot anomalies in the SPX and were either hedging their exposures or stayed in cash altogether. We didn't, unfortunately.
So when the market opened Thursday, hell started to break loose and the SPX began breaking out of its weeks long squeeze (put on a daily chart with just the close and you'll see what we mean) and never really looked back.
What was honestly going through our heads at that point? Well, we (like many others) took the initial selloff like those in the not too distant past, treating it as corollary noise and that the 2050 level would hold firm as support. As it turned out, what was on past occasions potent support, was instantly demolished on Friday.
Before the markets closed for the weekends, we squared our longs and took the bitter pill of being wrong. Those losses were difficult to stomach, but we did so anyways.
Learning To Be Wrong, And Admitting It
The weekends were a good time to reevaluate our strategy to tackle (what was then) a potentially different market environment. It also gave us time to come to terms with the facts of the drawdown our portfolio had suffered that week.
Being able to quickly admit a mistake and accept that we as traders will frequently get it wrong, is paramount to long term success. No one, and we repeat no one, knows if a level is going to hold. Being wrong is part of the business, and being able to quickly accept that fact is a step up.
We knew that being long risk into a free falling market, a market that had lost all semblance of sanity after a terrible Chinese print, was not going to turn out well. So we cut our losses and stayed flat into the weekend. You can be wrong on more occasions than right and still make money in the markets. It's no secret.
We see so many retails traders and self-proclaimed money managers or even better, 'hedge fund managers', unable to admit their mistakes; they all eventually get slaughtered by an impartial market.
The market doesn't care where you think it should trade at, and it also doesn't care if you're a PhD in Quantitative Finance. It just does its thing and you'd better learn to play along.
There's a fine line between sitting through drawdown while a trade is still fundamentally valid, and holding on to losing positions that get larger by the hour. We were lucky enough to realize by mid Friday, that there was more to the selloff than a casual dip.
Staying Objective And Taming Emotions
To say that we can be emotionless whilst managing a trading portfolio is an outright lie. It's highly likely that even the most season of traders experience some sort of emotion while trading. The ability to control those emotions and manage expectations is the distinction between a strong and weak mental state.
The weekends gave us time to reevaluate our biases. The market's slant was clearly towards risk aversion. Sentiment (mostly, in our opinion) from China seemed to have spilled over to almost all asset classes. Bonds were bid, but not to the extent we anticipated. Safe haven currencies were the top gainers in terms of volatility (standard deviations).
Our stance became clear. We formulated a simple no-frills attack plan once liquidity filled the markets on Monday. It was to simply go short risk (not as a hedge) by favoring shorts on currencies that historically had the strongest positive correlation to equity returns (AUD and NZD); and to go long safe haven currencies (JPY and CHF).
We didn't trade the USD because we felt it was a gamble threading both high lines - that of the market selloff, and that of the Fed's rate liftoff timing debate.
Traders who didn't exit long risk positions on Friday would have seen their accounts go deeper into drawdown on Monday. It's too easy for traders to get emotionally attached to trades, loosing or winning.
Greed and fear. The former pulls you to stay in a trade and over leverage when it no longer is objective to do so. The latter often paralyzes traders, limiting their ability to make or reevaluate decisions, and most often leading to mounting losses.
The reason why the entire selloff ended with a bang rather than a whisper was due to (we think) this predictable trait of market psychology. Most of the selling was backloaded, that was why the market went down in a vertical line at its climax. The inability of traders to manage their overwhelming emotions is the classic death knell when such dramatic moves happen.
Were we part of this group in the past? You bet. But we've grown out of it. Get out when you know you're wrong. Period. Unfortunately, most don't.
Knowing When To Load Up The Boat
Fast and volatile markets like the one we've just saw, and still continue to see, are mega opportunities for a properly trained trader to make a killing. An entire quarter or even an entire year's P/L goal can be achieved in an extremely brief span of time.
Knowing when and how much to leverage is more art than science to us. An experienced trader understands that riding off the back of extreme momentum can be the immensely gratifying. To be honest, it's hard to fully express the importance to be properly prepared for such events that happen only once in a blue moon.
Right from last Monday's getgo, we layered trade after trade where our books were positioned to take advantage of downward momentum in risk. Sentiment was atrophying with financial media blathering incessantly about "Black Monday" and how everything was doomed. Right. We knew better, honestly.
AUDNZD long was the first trade we booked a profit on. If memory serves well, that winner was in excess of 300 pips. In the intensity of the liquidations and covering, it was interesting to us that NZD was the weakest currency (more so than AUD) while JPY was the strongest. We levered the heck out of that, which thankfully turned out nicely.
Our next winner was a short AUDJPY trade which netted around 150 pips over a span of less than a day. We were actually short USDJPY (Monday morning) before AUDJPY but that one was closed at its entry point after the markets staged one of the most epic intraday reversal we've seen during Monday's U.S. open.
Remember that it wasn't just currencies but commodities which were getting their bottoms kicked. We wanted to play the short side of oil but didn't want to be directly exposed to the commodity.
Instead, we picked a USDMXN long trade which served two objectives: Riding the wave of acute risk aversion, and betting on lower crude prices. We ended up closing our long for more than 3000 pips, or a little over +1.9% percentage wise (of spot price).
A couple of other trades which went well in the money also panned out, but not without putting up a fight.
Flipping Pancakes And Constantly Adjusting
Did we know where the markets were going to next? Nope. Did we know if a certain level on the SPX was going to hold? Nope. So how the hell did we trade?
Simple. We reacted to prices movements when they happened. We digested the news flow. We were constantly analyzing and interpreting sentiment in the markets. All serving to help us make our judgement call. And on that constantly changing judgement, we made decisions.
After decisions to enter trades were made, they need to be reevaluated whenever called for. Tumultuous markets like this require diligent supervision, because markets can turn on a dime, and they actually did! No kidding.
Monday's low in most risk assets was carved before the U.S. open. For the SPX itself, the lows of 1820s have not yet been tested even after almost 8 trading days since its nadir. Whatever prompted that incredible reversal (yes, we don't know what did), was not to be reckoned with. We understood that.
We were still very bearish risk on Monday. We didn't change our stance on Tuesday either - we opened our AUDJPY short then. However, towards Tuesday's close, we revised our bias on risk to be short term neutral. We felt that selling had been temporarily exhausted and that we could see a bounce higher in stocks, and the other relevant proxies.
Our revised stance led us to cover our AUDJPY short as well as tapering down gross exposure. By Tuesday night, we were no longer short risk, and decided to stay flat to await further developments.
The price action that ensued rewarded this decision. The SPX began marching higher, tugging the carry trades behind it. If we had held on to our JPY longs, we would have given back a lot of our unrealized gains to the markets.
Being able to turn on a dime is the hallmark of a good trader. Traders, by definition, constantly make decisions and make adjustments to those decisions. They never stay firmly planted to one particular camp, especially when confronting a wall of unknowns.
We were bearish on Monday and the first half of Tuesday. But we'd already flipped to neutral by late Tuesday, and actually turned bullish by the end of last week.
Were we emotionally attached to our trades? No. Over the following days, the markets would start flip flopping before rallying to retrace more than 50% of its decline.
We cannot count the number of times we flipped from being short term bullish, bearish, and neural on the markets. Our trades reflected those views. Once those views changed, we made sure our books were reflective of those views.
Amateurs to this business always demand hard and fast answers where there aren't any. They want the fastest route to 'success'. They want to be told what to do, where to buy at and where to sell at. What to trade, and not how to trade. Ask the wrong questions, and you'll get equally wrong answers.
So In Hindsight...
It was a good week. There's no denying that. We learned more from the past 2 weeks than the last 6 months collectively. It wasn't the monetary reward that satisfied us, but the invaluable experience that such events bring. Money doesn't buy happiness, but it did buy us some confidence. It's like a positive feedback loop once you get it right. Absolutely rewarding.
But one week doesn't mean anything in the grand scheme of things. Performance must always be evaluated over time. It just so happened that August was a month where most were concerned about the return of capital, and not the return on capital.
The first rule of trading is to not loose money. Once that's settled, the second is to make money. God speed to our continued success. Let's win together!