Tharp's Thoughts Weekly Newsletter (View On-Line)

• Article Preliminary Thoughts and Positioning on Japan's Current Situation by D.R. Barton, Jr.
• Trading Education Peak Performance Home Study
• Trading Tip The Grail Seeker and the Master Craftsman by Ken Long
• Workshops May 2011 Brings in Van's Two Essential Workshops for Traders
• Mailbag Calculating Position Sizing™ Levels

by D.R. Barton, Jr.

In a natural disaster that dwarfs most others in recent memory, our thoughts and prayers go out to the courageous people of Japan. In the face of dire conditions, we see a brave nation coming together to begin what will certainly be a long road to recovery. Amazingly, with power, food, water and services in short supply or even non-existent, there has been essentially no looting. What a credit to the character of a nation.

Before we look at the financial side of the event, we have to be aware of how fluid the nuclear plant situation remains. Despite the many designed-in redundant defense systems at the Fukushima Daiichi nuclear power facility, the reactors are far from under control. This lack of control will continue to add to the uncertainty of the markets until the plant has been stabilized. Even as I was proofreading this article on Wednesday before lunch, the Dow plunged 155 points in about twenty minutes on what was thought to be new information from a European nuclear official. That new information, however, turned out to be an opinion based on old information. Any snippet of news over the next days and weeks could send the market into a tail spin or rocketing higher. Be on high volatility alert until the situation (especially on the highly emotional nuclear front) stabilizes.

Let’s turn our attention now to the economic aftermath of the tragedy; we have a number of factors to consider.

A Few Economic Thoughts

Morgan Stanley’s Steven Roach, a well-regarded thinker, points out that this earthquake/tsunami disaster comes on the tail of an economy in Japan that has been suffering for years. The population of Japan has been aging AND declining for some time now. The effects of that demographic profile have been compounded by a very strict immigration policy that has put extreme pressure on economic productivity in the country. After the short-term stimulus and aid package effects wear off, these background circumstances do not bode well for a speedy recovery in Japan.

Let’s look at a few other issues:

• Japan’s overall economy could be devastated. Power loss and disaster recovery have caused many industries essentially to shut down for the near term. In addition, a more valuable yen will continue to depress the Japanese export trade. Early indications are that the effect on Global economic growth will be at least 30 basis points, just in the short term.
  
• Repatriation of the yen to assist in the disaster recovery process has significantly strengthened the currency—too much so for the central bank. In the period of an hour on Monday, The Bank of Japan bought 186 BILLION dollars (selling the yen) to keep the yen from strengthening further. A hedge fund manager that I know calculated that without this intervention the yen could have jumped to 70 yen per dollar (instead of 81 or where it stopped on Monday). If the aftermath of the Kobe earthquake in 1995 is any indication, the yen has more appreciating to come.
  
• The Bank of Japan has very few bullets left to help the economy. A $500 billion stimulus package is already underway. This amount basically equals the US’s QE2 expenditures, but it enters an economy that is only one-third as large.
  
• The effects of the earthquake are actually quite bearish for crude oil. A global slowdown should depress oil prices. Current political tensions in the Arab League nations will continue to keep oil prices elevated and may offset any global slowdown. This tug-of-war between fundamental and geopolitical pressures will result in a very volatile energy market into the intermediate time frame.
  
• As an interesting aside, the Japan Exchange Traded Fund (Symbol: EWJ) had its highest volume trading day ever on Tuesday. SPY is the highest volume stock in the world, trading an average of 150 million shares a day. EWJ is a very active stock, trading 30 million shares a day on average. On Tuesday, EWJ traded more shares than SPY, with 396 million shares traded vs. 359 million, respectively. This is just another indication of the market’s news sensitivity.
  
• In the face of all the market negativity, we must remember that the Japanese people have shown themselves time and again to be an extremely resourceful, resilient and industrious group. A national tragedy like this will only strengthen their resolve and very likely mitigate many of these negative factors in the long run.

Short Term Actions to Consider

In the face of expanding volatility across almost all markets and with the market’s news sensitivity level at a 10+, swing traders would be wise to curtail activity, widen stops and reduce position size. Swing trading systems tend to get chopped up in extremely uncertain markets.

Long term traders and investors need to mind their stops and more sophisticated players may want to consider adjusting position size to take into account the extra market volatility.

Intraday traders can enjoy the ride! Be nimble to change directional expectations at a moment’s notice, with huge swings possible on news or even rumored news.

As a final note, you may want to check out the stunning before and after satellite images that show the devastating effect of the tsunami and give at least a modicum of appreciation for what the Japanese people are going through. The images can be found here. Moving your cursor across the pictures shows the scale of the devastation.

I’d love to hear your thoughts and feedback on this article or about trading and investing in general at drbarton “at” iitm.com. Until next week…

Great Trading,
D. R.

About the Author: A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena. He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at "drbarton" at "iitm.com".

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Trading Tip

by Ken Long

Your beliefs about your trading activity influence the way you plan, prepare and execute your trading plan.   How you mentally frame your approach to trading has major implications for your success in trading—even how you define success. 

Grail Seeker

If you think of trading as a quest for the Holy Grail, you probably use the language of mysticism, spirituality, and intuition and find yourself in search of the magic keys to the kingdom or purifying yourself in order to be worthy of receiving divine inspiration.

You might spend your time in search of magical moments where the true knowledge of the world is revealed to you in strange and mysterious ways.

Your success or failure in the markets would be tied deeply and directly to your soul and would be a reflection of God’s judgment on your true worth as a human being.  

Robert Pirsig describes the mind set of Grail seekers as a “romantic approach” in his book Zen and the Art of Motorcycle Maintenance. He associates this mind set with the hippie movement, bohemians, and “dabblers in art.”

He describes them as people in search of a spiritual connection to intuitively satisfy their desires. They dream of connecting to the world as it should be on its highest plane of existence. 

I honor and value the search for meaning through the pursuit of excellence in life-long journeys. However, quest seekers can never be satisfied truly until the moment of ultimate satisfaction when they receive the Grail. Everything short of that is filled with yearning and emotional cycles that possibly bounce from ecstasy to despair based on the interpretation of the moment.

Surveying Western literature reveals very few that have actually achieved the Grail.   I therefore cannot recommend this as a strategy for those intending to make money in the markets in fulfillment of their financial objectives within personal parameters for risk. Think of the psychological pressure that such a quest would place on every trade you make and every decision to act or not act.

Let’s contrast this nearly unachievable, idyllic, super spiritual, almost narcissistic pursuit of the Holy Grail with the craftsman’s pursuit of perfection.

Master Craftsman

I admire and aspire to the master craftsman’s appreciation of the art, wisdom, knowledge and goodness that lives in his hands, heart and mind.  He seeks to manifest these values in the world through right thought and right action. He comes from his center to speak his truth to the world in a quiet, humble, human voice. The voice acknowledges both the possibilities of the human spirit as well as the shortcomings of those who dream big. 

The master craftsman values attention to detail in all things, however, the master craftsman knows better than anyone that he is imperfect. His appreciation and pursuit of perfection, his perfection, is perfection.  He is aware of the mistakes he makes along the way. He has a sensible and routine approach to managing risk, doing no harm, caring for tools and his workplace. He also cultivates calm and patience, and acts appropriately when the preparations have been made and right action must be called forth to be in harmony with his craft. 

The craftsman who aspires to be a master craftsman respects his art, acquires knowledge of that which is knowable, appreciates that which cannot be known, and seeks to live with grace while taking care of business in the usual way. 

He accumulates perfection in small daily contributions of virtue and he puts that tiny little piece of the Grail in his spiritual bank. He values the journey, appreciates the way and has earned his rest and just rewards whenever he gets there in his own good time. 

Choose your metaphors wisely.

About the Author: Ken Long is a retired Lieutenant Colonel in the U.S. Army with a Master's Degree in Systems Management. He is a  doctoral candidate researching the management of uncertainty and an active trader.   He is a proud father of 3,  a husband, teacher, student and martial artist. The above article was reprinted from Ken's blog. Read more of Ken's essays at http://kansasreflections.wordpress.com.

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Mailbag

Q: How would I get my trading system, as simulated in the Definitive Guide to Position Sizing, to find optimal position sizing levels given my level of ruin?

A: Good news: you do not need a simulator to find good position sizing levels to meet your objectives.  You need to calculate your system’s SQN calculation and then reference the tables in Chapter 14 of the book or use the maximum portfolio heat table in Chapter 9.  You would take the appropriate heat figure and divide it by the number of positions that you typically hold.  There is enough information in the book to help you figure out an effective position sizing strategy in order to meet your objectives if you can calculate your system’s SQN result.

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