How AIG Fell ?

When you hear that the collapse of AIG or Lehman Bros. or Bear Stearns might lead to a systemic collapse of the global financial system, the feared culprit is, largely, that once-obscure (OK, still obscure) instrument known as a credit default swap. So, what is a CDS, and why is it so dangerous? At first glance, a credit default swap seems like a perfectly sensible financial tool. It is, basically, insurance on bonds. Imagine a large bank buys some bonds issued by General Electric. The bank expects to receive a steady stream of payments from GE over the years. That's how bonds work: The issuer pays the bondholder some money every six months. But the bank figures there's a chance that GE might go bankrupt. It's a small chance, but not zero, and if it happens, the bank doesn't get any more of those payments. The bank might decide to buy a CDS, a sort of insurance policy. If GE never goes bankrupt, the bank is out whatever premium it paid for the CDS. If GE goes bankrupt and stops paying its bondholders, the bank gets money from whoever sold the CDS. Who sells these CDSs? Banks, hedge funds, and AIG. It's easy to see the attraction. Historically, bond issuers almost never go bankrupt. So, many banks and hedge funds figured they could make a fortune by selling CDSs, keeping the premium, and almost never having to pay out anything. In fact, beginning in the late '90s, CDSs became a great way to make a lot more money than was possible through traditional investment methods. Let's say you think GE is rock solid, that it will never default on a bond, since it hasn't in recent memory. You could buy a GE bond and make, say, a meager 6 percent interest. Or you could just sell GE credit default swaps. You get money from other banks, and all you have to give is the promise to pay if something bad happens. That's zero money down and a profit limited only by how many you can sell. Over the past few years, CDSs helped transform bond trading into a highly leveraged, high-velocity business. Banks and hedge funds found that it was much easier and quicker to just buy and sell CDS contracts rather than buy and sell actual bonds. As of the end of 2007, they had grown to roughly $60 trillion in global business So, what went wrong? Many CDSs were sold as insurance to cover those exotic financial instruments that created and spread the subprime housing crisis, details of which are covered here 1. As those mortgage-backed securities and collateralized debt obligations became nearly worthless, suddenly that seemingly low-risk event-an actual bond default-was happening daily. The banks and hedge funds selling CDSs were no longer taking in free cash; they were having to pay out big money. Most banks, though, were not all that bad off, because they were simultaneously on both sides of the CDS trade. Most banks and hedge funds would buy CDS protection on the one hand and then sell CDS protection to someone else at the same time. When a bond defaulted, the banks might have to pay some money out, but they'd also be getting money back in. They netted out. Everyone, that is, except for AIG. AIG was on one side of these trades only: They sold CDS. They never bought. Once bonds started defaulting, they had to pay out and nobody was paying them. AIG seems to have thought CDS were just an extension of the insurance business. But they're not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends. If you sell enough and price things right, you know that you'll always have more premiums coming in than payments going out. That's because there is low correlation between insurance triggering events. My death doesn't, generally, hasten your death. My house burning down doesn't increase the likelihood of your house burning down. Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially. Credit default swaps written by AIG cover more than $440 billion in bonds 2. We learned this week that AIG has nowhere near enough money to cover all of those. Their customers-those banks and hedge funds buying CDSs-started getting nervous. So did government regulators. They started to wonder if AIG has enough money to pay out all the CDS claims it will likely owe. This week, Moody's Investors Service, the credit-rating agency, announced that it was less confident in AIG's ability to pay all its debts and would lower its credit rating. That has formal implications: It means AIG has to put up more collateral to guarantee its ability to pay. Just when AIG is in trouble for being on the hook for all those CDS debts, along comes this credit-rating problem that will force it to pay even more money. AIG didn't have more money. The company started selling things it owned-like its aircraft-leasing division 3. All of this has pushed AIG's stock price down dramatically. That makes it even harder for AIG to convince companies to give it money to pitch in. So, it's asking the government to help out. AIG might be in trouble. But what do I care? Because the global economy could, possibly, come to a halt. Banks all over the world bought CDS protection from AIG. If AIG is not able to make good on that promise of payment, then every one of those banks has lost that protection. Overnight, the banks have to buy replacement coverage at much higher rates, because the risks now are much worse than they were when AIG sold most of these CDS contracts. In short, banks all over the world are instantly worth less money. The numbers seem to be quite huge-possibly in the hundreds of billions. To cover that instantaneous loss, banks will lend out less money. That means other banks can't borrow to pay this new cost, and weaker banks might not have enough; they'll collapse. That will further shrink the global pool of money. This will likely spur a whole new round of CDS payouts-all those collapsed banks issue bonds that someone, somewhere sold CDS protection for. That new round of CDS payouts could cause another round of bank failures. Generally, with enough time, financial markets can adjust to just about anything. This, though, would be an instantaneous transformation of the global financial system. Surely, the worst part will be the confusion. CDS are largely over-the-counter instruments. That means they're not traded on an exchange. One bank just agrees with another bank to do a CDS deal. There's no reliable central repository of information. There's no way to know how exposed a bank is. Banks would have no way of knowing how badly other banks have been affected. Without any clarity, banks will likely simply stop lending to each other. Since we're only just now getting a handle on how widespread and intertwined they have become, it seems possible that AIG, alone, could bring the global economy to something of a standstill. It's also possible that it wouldn't.

The Essentials Of Cash Flow

If a company reports earnings of $1 billion, does this mean it has this amount of cash in the bank? Not necessarily. Financial statements are based on accrual accounting, which takes into account non-cash items. It does this in an effort to best reflect the financial health of a company. However, accrual accounting may create accounting noise, which sometimes needs to be tuned out so that it's clear how much actual cash a company is generating. The statement of cash flow provides this information, and here we look at what cash flow is and how to read the cash flow statement.

What Is Cash Flow?
Business is all about trade, the exchange of value between two or more parties, and cash is the asset needed for participation in the economic system (see What Is Money?). For this reason - while some industries are more cash intensive than others - no business can survive in the long run without generating positive cash flow per share for its shareholders. To have a positive cash flow, the company's long-term cash inflows need to exceed its long-term cash outflows.

An outflow of cash occurs when a company transfers funds to another party (either physically or electronically). Such a transfer could be made to pay for employees, suppliers and creditors, or to purchase long-term assets and investments, or even pay for legal expenses and lawsuit settlements. It is important to note that legal transfers of value through debt - a purchase made on credit - is not recorded as a cash outflow until the money actually leaves the company's hands.

A cash inflow is of course the exact opposite; it is any transfer of money that comes into the company's possession. Typically, the majority of a company's cash inflows are from customers, lenders (such as banks or bondholders) and investors who purchase company equity from the company. Occasionally cash flows come from sources like legal settlements or the sale of company real estate or equipment.

Cash Flow vs Income
It is important to note the distinction between being profitable and having positive cash flow transactions: just because a company is bringing in cash does not mean it is making a profit (and vice versa).

For example, say a manufacturing company is experiencing low product demand and therefore decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer for the used equipment, but the manufacturing company is definitely losing money on the sale: it would prefer to use the equipment to manufacture products and earn an operating profit. But since it cannot, the next best option is to sell off the equipment at prices much lower than the company paid for it. In the year that it sold the equipment, the company would end up with a strong positive cash flow, but its current and future earnings potential would be fairly bleak. Because cash flow can be positive while profitability is negative, investors should analyze income statements as well as cash flow statements, not just one or the other.

What Is the Cash Flow Statement?
There are three important parts of a company's financial statements: the balance sheet, the income statement and the cash flow statement. The balance sheet gives a one-time snapshot of a company's assets and liabilities (see Reading the Balance Sheet). And the income statement indicates the business's profitability during a certain period (see Understanding The Income Statement).

The cash flow statement differs from these other financial statements because it acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period. It shows whether all those lovely revenues booked on the income statement have actually been collected. At the same time, however, remember that the cash flow does not necessarily show all the company's expenses: not all expenses the company accrues have to be paid right away. So even though the company may have incurred liabilities it must eventually pay, expenses are not recorded as a cash outflow until they are paid (see the section "What Cash Flow Doesn't Tell Us" below).

The following is a list of the various areas of the cash flow statement and what they mean:

• Cash flow from operating activities - This section measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company. For example, Microsoft's normal operating activity is selling software. 
• Cash flows from investing activities - This area lists all the cash used or provided by the purchase and sale of income-producing assets. If Microsoft, again our example, bought or sold companies for a profit or loss, the resulting figures would be included in this section of the cash flow statement. 
• Cash flows from financing activities - This section measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases, which investors might be glad to see. 

When you look at a cash flow statement, the first thing you should look at is the bottom line item that says something like "net increase/decrease in cash and cash equivalents", since this line reports the overall change in the company's cash and its equivalents (the assets that can be immediately converted into cash) over the last period. If you check under current assets on the balance sheet, you will find cash and cash equivalents (CCE or CC&E). If you take the difference between the current CCE and last year's or last quarter's, you'll get this same number found at the bottom of the statement of cash flows.

In the sample Microsoft annual cash flow statement (from June 2004) shown below, we can see that the company ended up with about $9.5 billion more cash at the end of its 2003/04 fiscal year than it had at the beginning of that fiscal year (see "Net Change in Cash and Equivalents"). Digging a little deeper, we see that the company had a negative cash outflow of $2.7 billion from investment activities during the year (see "Net Cash from Investing Activities"); this is likely from the purchase of long-term investments, which have the potential to generate a profit in the future.Generally, a negative cash flow from investing activities are difficult to judge as either good or bad - these cash outflows are investments in future operations of the company (or another company); the outcome plays out over the long term.

The "Net Cash from Operating Activities" reveals that Microsoft generated $14.6 billion in positive cash flow from its usual business operations - a good sign. Notice the company has had similar levels of positive operating cash flow for several years. If this number were to increase or decrease significantly in the upcoming year, it would be a signal of some underlying change in the company's ability to generate cash.

Digging Deeper into Cash Flow
All companies provide cash flow statements as part of their financial statements, but cash flow (net change in cash and equivalents) can also be calculated as net income plus depreciation and other non-cash items.

Generally, a company's principal industry of operation determine what is considered proper cash flow levels; comparing a company's cash flow against its industry peers is a good way to gauge the health of its cash flow situation. A company not generating the same amount of cash as competitors is bound to lose out when times get rough.

Even a company that is shown to be profitable according to accounting standards can go under if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to outstanding debt, known as the operating cash flow ratio, illustrates the company's ability to service its loans and interest payments. If a slight drop in a company's quarterly cash flow would jeopardize its loan payments, that company carries more risk than a company with stronger cash flow levels.

Unlike reported earnings, cash flow allows little room for manipulation. Every company filing reports with the Securities and Exchange Commission (SEC) is required to include a cash flow statement with its quarterly and annual reports. Unless tainted by outright fraud, this statement tells the whole story of cash flow: either the company has cash or it doesn't.

What Cash Flow Doesn't Tell Us
Cash is one of the major lubricants of business activity, but there are certain things that cash flow doesn't shed light on. For example, as we explained above, it doesn't tell us the profit earned or lost during a particular period: profitability is composed also of things that are not cash based. This is true even for numbers on the cash flow statement like "cash increase from sales minus expenses", which may sound like they are indication of profit but are not.

As it doesn't tell the whole profitability story, cash flow doesn't do a very good job of indicating the overall financial well-being of the company. Sure, the statement of cash flow indicates what the company is doing with its cash and where cash is being generated, but these do not reflect the company's entire financial condition. The cash flow statement does not account for liabilities and assets, which are recorded on the balance sheet. Furthermore accounts receivable and accounts payable, each of which can be very large for a company, are also not reflected in the cash flow statement.

In other words, the cash flow statement is a compressed version of the company's checkbook that includes a few other items that affect cash, like the financing section, which shows how much the company spent or collected from the repurchase or sale of stock, the amount of issuance or retirement of debt and the amount the company paid out in dividends.

Conclusion
Like so much in the world of finance, the cash flow statement is not straightforward. You must understand the extent to which a company relies on the capital markets and the extent to which it relies on the cash it has itself generated. No matter how profitable a company may be, if it doesn't have the cash to pay its bills, it will be in serious trouble.

At the same time, while investing in a company that shows positive cash flow is desirable, there are also opportunities in companies that aren't yet cash-flow positive. The cash flow statement is simply a piece of the puzzle. So, analyzing it together with the other statements can give you a more overall look at a company' financial health. Remain diligent in your analysis of a company's cash flow statement and you will be well on your way to removing the risk of one of your stocks falling victim to a cash flow crunch. by Investopedia Staff, (Contact Author | Biography) Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including more than 1,200 original and objective articles and tutorials on a wide variety of financial topics.

Find Investment Quality In The Income Statement

I find this article simple and striaght to the point. Love it. To a large degree, it is the quality and growth of a company's earnings that drive its stock price. Therefore, it is imperative that investors understand the various indicators used to measure profitability. The income statement is the principal source of data to accomplish a profitability analysis, which should cover at least a five-year period in order to reveal trends and changes in a company's earnings profile. (To learn more basics on the income statement, see Understanding The Income Statement.) Accounting Policies With regard to the income statement, investors need to be aware of two things related to a company's accounting practices. First, the degree of conservatism, which indicates the degree of investment quality. The presentation of earnings depends, basically, on three accounting policies: revenue recognition, inventory valuation and the depreciation method. Briefly stated, a completed sale, last in, first out liquidation (LIFO) rather than first in, first out liquidation (FIFO) valuation, and shorter-term depreciation periods, respectively, would produce higher quality reported earnings. (For related reading, see Inventory Valuation For Investors: FIFO And LIFO.) Investors will be alerted to any changes and their impact on performance figures in a company's accounting policies in the notes to financial statements. Investors need to read these qualifying remarks carefully. Sales While the so-called "bottom line" (net income) gets most of the attention from financial analysts and investors in any discussion of profit, the whole earnings process starts with a company's revenue, or net sales. The growth of this "top line" figure is a key component in producing the dollars needed to run a company profitably. A healthy sales growth rate generally defines a growing company and is a positive investment indicator. For investors, all sales increases are good and can occur as a result of sales grow through more unit volume from existing products/services, the introduction of new products/services, price increases, acquisitions and, for international sales, the impact of favorable exchange rates. However, some increases should be viewed more favorably than others. There's no question that greater unit volume is the best growth factor, followed by product-line expansion and new services. Price increases, especially those above the inflation rate, have their limits, as does sales growth through acquisitions. As applied to companies with foreign operations, the currency translation effect into U.S. dollars, either positive or negative, will even out over time. Positive investment quality in the sales account comes from growth in better unit volume and the maintenance of reasonable pricing. Margin and Cost Analysis In the income statement, the absolute numbers don't tell us very much. A simple vertical analysis (common size income statement) - dividing all the individual income and expense amounts by the sales amount - provides profit margin and expense percentages (ratios) for the whole income statement. Looked at over a period of five years, an investor will have a clear idea of the consistency and/or positive/negative trends in a company's management of its income and expenses. The success, or lack thereof, of this important managerial endeavor is what determines, to a large extent, a company's quality of earnings. A large growth in sales will do little for a company's profitability if costs grow out of proportion to revenues. The term margin is used to express the comparison of four important levels of profit in the income statement - gross, operating, pretax and net - to sales. Aside from monitoring a company's historical profit performance, these profit margins (ratios) also can be used to compare a company's profitability metrics to those of its direct competitors, industry figures and the general market. Unusual Items Also known as special, extraordinary or non-recurring, these items, generally charge-offs, are supposed to be one-time events. When they are, investors must take these unusual items, which can distort evaluations, into account, particularly when making inter-annual profit comparisons. Unfortunately, in recent years, companies have been taking so-called "big-bath" write-offs with such regularity that they are becoming commonplace rather than unusual. Large multi-year charges on the income statement are increasingly distorting corporate earnings. Needless to say, evidence of undue use of major charge-offs is not indicative of investment quality. This practice is another reason why some financial analysts prefer to work with operating and pretax income numbers to evaluate a company's earnings, thereby eliminating the distortions of unusual items to net income. (To continue reading manipulating the books, see Cooking The Books 101.) Traditional Profit Ratios In addition to profit margin ratios, the return on equity (ROE) and return on capital employed (ROCE) ratios are widely used to measure a company's profitability. ROE measures the profits being generated on the shareholders' investment. Expressed as a percentage, the ROE ratio is calculated by dividing net income (income statement) by the average of shareholders' equity (balance sheet). As a rule of thumb, ROE ratios of 15% or more are considered favorable. The ROCE ratio expands on the ROE ratio by adding borrowed funds to equity for a figure showing the total amount of capital being used by a company. In this way, a company's use of debt capital is factored into the equation. For this reason, conservative analysts prefer to use the ROCE ratio as a more comprehensive evaluation of how well management is using its debt and equity capital. This percentage ratio will vary among companies, but suffice it to say, that investment quality is represented by a higher rather than a lower figure. (To read more, see Spotting Profitability With ROCE, Measuring Company Efficiency and Keep Your Eyes On The ROE.) The impact of leverage is picked up in the return on capital (return on invested capital or ROIC) ratio. (To read more, check out Spot Quality With ROIC.) Earnings Per Share While an absolute increase in net income is a welcome sight, investors need to focus on what each share of their investments are producing. If increased net income comes as a result of profits from increased share capital, then earnings per share (EPS) is not going to look so great, and could fall below the previous year's level. An increase in a company's capital base dilutes the company's earnings among a greater number of shareholders. (To learn more, read Types Of EPSand How To Evaluate The Quality Of EPS.) Because of this circumstance, a company's net income, or earnings per share, is expressed as basic and diluted. The former represents EPS as of the balance sheet date as per the number of actual shares outstanding and net income as of a certain date, which is generally the company's fiscal year-end. Diluted EPS captures the potential amount of shares that could be outstanding if all convertible bonds, stock options and warrants were exercised. While such a consequence is highly unlikely, it is possible. In terms of the investment quality of the income statement, a significant spread between basic and diluted EPS should be seen as a negative sign. Conclusion Logic tells us that growing, profitable companies are generally attractive investment opportunities. However, how that growth is achieved is more important than the absolute sales and income numbers. In addition, conservative accounting policies, substantive sales growth, consistent and/or improving profit margins, the absence of outsized write-offs, above average returns on equity and capital employed, and solid earnings per share performance are the hallmarks of top-level investment quality. It is this set of attributes that investors should attempt to find in the income statement before they invest. By Richard Loth Richard Loth has more than 38 years of professional experience in the financial services sector, including banking, investment consulting and capital markets development, both internationally and in the U.S. He has worked with Citibank, Fleet National Bank and the Bank of Montreal. Mr. Loth is currently the managing principal of Mentor Investing, an independent Registered Investment Adviser based in Eagle, Colorado. Over the years, he has authored several investment education articles, publications, and books. His most recent book (self-published), "Finding Investment Quality in a Mutual Fund," is available from Mentor Investing (email mentor@centurytel.net or call (970)328-5591).

Trading Systems - A Complex World With Simple Answers

Advances in technology have been the driving force behind the change and growth in the world of market speculation. One of the many recipients of faster and stronger technology is system trading as high speed computers now help retail and institutional traders develop systems, crunch numbers, and back test hypothetical results in seconds. In the world of professional money management, I have seen plenty of trading systems. Ironically, most don't seem to work and of the ones that do, they typically work for a bit and then fail. Being on the education side of the industry as well, I have seen hundreds of automated systems yet, I can only say that I have seen less than a handful actually produce a consistent profit year after year. I often get emails from people who have read an article I wrote that want to share an automated strategy with me. They are sending it so I will help them review it and perhaps improve it. Traders will send me back tested hypothetical performance reports from these strategies that suggest they have the holy grail of trading systems. Most of these will show 80% winning trades or better and huge profits. Most of the time however, when they take the next step and trade the system with real money, they lose and lose fast. With explosive advances in technology and market information, why is system trading so difficult for most who give it a try? There is a very simple reason I will discuss later. In this piece, I will focus on the foundation of a profitable trading system, offer specific tools and rules of a profitable system, and expose the dangerous traps that lead to system trading failure.

The Most Important Aspect of a System
As much change and growth has occurred due to technology, there is one component to trading that has not changed one bit and that is how the consistently profitable trader derives consistent low risk / high reward profits. The key to a proper trading strategy all comes down to the foundation of that strategy. To have the proper foundation, you must have a solid understanding of how markets work and why price moves as it does. If you have one flaw in your thought process, you can be sure it will lead to poor trading results. The reality is that markets are nothing more than pure supply and demand at work, human beings reacting to the ongoing supply/demand relationship within a given market. This alone, ultimately determines price. Opportunity emerges when this simple and straightforward relationship is "out of balance." When we treat the markets for what they really are, and look at them from the perspective of an ongoing supply/demand relationship, identifying sound trading opportunities is not that difficult a task. Market speculators who understand this simple concept and what this opportunity looks like on a price chart typically derive their income from market speculators who don't. In other words, those who "know" get paid from those who "don't know".

Who Is On The Other Side Of Your Trade?
If we want a consistently profitable trading system, we had better make sure that the person on the other side of our trades is a consistent losing trader. Our system had better be an expert at finding a novice trader or we are in trouble. We don't need to know the exact person on the other side of our trade, we just need to know if they are a consistently profitable trader or a consistently losing trader, and the chart will give us most of this information.
Let's face it, when it comes to charting and technical analysis, most active traders use indicators. While many people including myself have often beat up the indicators, they are actually a great tool when used properly for automated or semi-automated trading systems. The problem is that people tend to take every buy and sell signal an indicators produces and this is the last thing you want to be doing. Those who take each buy and sell signal an indicator offers are likely to lose their trading capital fast. It is not that the indicators are doing anything wrong. They will always do what they are programmed to do. The key for the trader is to use them in conjunction with proper trend analysis. One of the great benefits to using indicators and oscillators the right way is that they allow you to trade based on a mechanical set of rules. Let's use a single moving average and stochastics in our attempt to use indicators in our system to find the consistent losing trader to trade with.
     Figure 1

Above is a chart of the QQQQ. On the chart is a 50 period moving average and a slow stochastic oscillator. To begin with, we must assess the trend of prices in this market. For this task, I use a 50 period moving average. Notice that the slope of the moving average is up suggesting we are in an uptrend. Once we know this, we only want to buy pullbacks in price. The mechanical signal to buy comes when the stochastic produces a buy signal in over sold territory (moving average cross, circled above). While this turned into a nice low risk buying opportunity, notice the price action just prior to this buying opportunity in the QQQQ. During the uptrend, the stochastic was very overbought, producing sell signals during much of the uptrend which would have led to many losses had you sold short at those times. This is a trap new traders can fall into when using these tools without reality based logical rules

Buy Rule: When the moving average is sloping upwards, take the stochastic moving average cross in oversold territory as a buy signal. When the moving average is sloping upwards, IGNORE EVERY sell signal the stochastic moving average cross in overbought territory produces.

The Reality Based Logic: When prices are moving higher, we want to find a buying opportunity when things are on sale. Most importantly, our buy signal told us objectively that someone was selling after a decline in price and selling in the context of an uptrend. This can only be the action of a novice seller. A consistently profitable trader would never sell after a decline in price and in the context of an uptrend.

     Figure 2

On this chart, we also have a 50 period moving average and a slow stochastic oscillator. Here, the slope of the 50 period moving average tells us the trend is down. Once we know this, we only want to sell to a novice trader who is buying after a move higher in price in the context of a down trend. The mechanical signal to sell comes when the stochastic produces a sell signal in over bought territory (moving average crosses, circled above).

Sell Short Rule: When the moving average is sloping downwards, take the stochastic moving average cross in overbought territory as a sell signal. When the moving average is sloping downwards, IGNORE EVERY buy signal the stochastic moving average cross in oversold territory produces.

The Reality Based Logic: When prices are trending down, we want to find a shorting opportunity when prices are high. Furthermore, we want to sell short to the buyer who is buying after a rally in price and in the context of a downtrend (a novice buyer).

Is this or any trading system perfect? Certainly not, there is no perfect trading system and there doesn't need to be. If there was, that person would have all the world's money. However, wrapping some simple rules and logic around your trading is the key to stacking the odds in your favor. Even Las Vegas does not win all the time. They do well over time because they realize they don't have to always win. They just need to stick to their rules that allow them to keep the edge which means betting against people who don't have the edge.

Any Market and Indicator Will Do When You Think About the Markets Correctly

    Figure 3

This is an intra-day chart of the NASDAQ Futures with the same 50 period moving average. In this example, I simply switched the Stochastic for the Commodity Channel index, better known as CCI, we will get almost the same signals.

Technical Reason for Shorting:

1. The down sloping 50 - period moving average suggests this market is in a downtrend.
2. A CCI Overbought reading (circled are on the chart).

Logical Reason for Shorting: Sell short to a buyer who buys AFTER a rally in price and in the context of a downtrend. The only type of mindset that would take this action is someone who makes decisions to buy and sell anything based on EMOTION, not simple and proper logic. This is the pedigree of the trader we want on the other side of our trades.
Trading strategies that work don't change with time, markets, or changing market conditions. Quite frankly, to think market conditions ever change at all is a strong illusion that can only be removed when one focuses on the foundation of price movement, pure supply and demand. The systems I see working are very simple. The example below is an intra-day chart of the Dollar/Yen. Let's apply our same basic principles.
    Figure 4

Technical Reason for Buying:
1) The up sloping 50 - period moving average suggests this market is in an uptrend.2) A CCI Oversold reading (circled are on the chart).

Logical Reason for Buying: Buy from a novice seller who sells AFTER a decline in price and in the context of an uptrend.

Summary
Uptrend/Oscillator Overbought: Ignore       Downtrend/Oscillator Oversold: Ignore
Uptrend/Oscillator Oversold: Buy Signal    Downtrend/Oscillator Overbought: Sell Short Signal

Turning Failure Into Success
I see the vast majority of traders that go down the system path spend years form-fitting indicators and oscillators based on back tested hypothetical results (numbers). I see very few people develop strategies based on the simple logic of how and why price moves as it does in any market. From my reality based market experience, trading is a simple transfer of accounts from those who don't understand simple market logic into the accounts of those who do. Trading systems just expedite the process.

As I mentioned earlier, most traders who develop trading systems don't take this approach or think in the simple terms I am suggesting. Why? It is because of how most people learn about markets and trading. Most will not begin their learning path as I did by handling institutional order flow on the floor of an exchange. The vast majority of market players will start with a trading book or seminar written or delivered by someone who writes books and delivers seminars, NOT a real market speculator. These books are filled with conventional use of indicators and chart patterns that simply don't work. If they did, the author would certainly not be selling the book to you. This leads to a novice trader thinking they can take a trading system short cut and add a few indicators and oscillators to a price chart and let the computer find the parameters for each of those indicators that would have produced the best results in the past (back testing). Typically, when the novice system trader begins trading with real money based on those quality hypothetical results and begins losing money, they take the next wrong step - they begin adjusting indicator settings and worse yet, they add more indicators. This is a path that leads to trading disaster yet the novice system trader does not even know it. They say, "How can a system with such great back tested numbers not work"? It doesn't work because the system is based on number crunching and curve fitted back testing results. The reality of how markets work is ignored. When designing your trading system, make sure you bring your foundation back to the basics of how and why price moves in any and all markets.

Have a great day.
- Sam Seiden

Dynamic Yield Curve

Link This chart shows the relationship between interest rates and stocks over time. The black line is the Yield Curve. The fading "trails" behind the black line show how the yield curve developed over the preceding days.Click anywhere on the S&P 500 chart to see what the yield curve looked like at that point in time.Click and drag your mouse across the S&P 500 chart to see the yield curve change over time.Alternately, click the Animate button to automatically move through time.

BODMAS - BracketsOrdersDivisionMultiplicationAdditionSubtraction

Go back to Basic... 3 men go into a motel. The man behind the desk said the room is $30, each man paid $10 and went to the room. A while later, the man behind the desk realised the room was only $25, so he sent the bellboy to the 3 guys's room with $5. On the way the bellboy couldn't figure out how to split $5 evenly btw 3 men, so he gave each man a $1 and kept the other $2 for himself. This meant that the 3 men each paid $9 for the room, which is a total of $27, add the $2 that the bellboy kept = $29, WHERE is the other dollar?

Soros: Market Will Retest Its Lows

Quote from Wall Streets Journal... May 7, 2008, 3:58 pm Soros: Market Will Retest Its Lows Stocks are currently in a “a bear market rally,” and will probably retest their lows of earlier this year, George Soros says. Soros “I think we’ll retest the lows, depending on what measures the authorities take,” Mr. Soros said in an interview with The Wall Street Journal Wednesday. He made similar comments later that day in a discussion at the Council on Foreign Relations in Washington. “We may go beyond” those lows, he said. But he also said the worst has now passed for the credit markets and spreads between yields and risky bonds and Treasurys will not return to their highs of a month ago. “The acute phase of the credit crisis, or financial crisis, is abating,” said Mr. Soros. Mr. Soros, chairman of Soros Fund Management which advises the Quantum funds, is one of the world’s most famous and successful hedge fund investors. “The markets are breathing a sigh of relief but the fallout in the real economy is only now beginning.” In his latest book, “The New Paradigm for Financial Markets,” Mr. Soros argues that the current credit crisis conforms to his longstanding view that markets drive fundamentals, instead of the other way around, producing bubbles and crashes– a dynamic he has dubbed “reflexivity.” The book argues the subprime crisis has triggered the bursting of a “super-bubble” that has been building for 25 years. Prior crises, from the 1987 stock market crash to the emerging markets crisis of 1997 were merely “testing events,” he writes. Because the authorities successfully averted catastrophe in those events, they encouraged consumers and investors to believe markets were fundamentally self-stabilizing and built up even more leverage, he wrote. Mr. Soros’ latest book is his third to predict disaster; prior books did so in 1987 and 1998. In the interview Mr. Soros acknowledged he sounds like the “boy who cried wolf,” but noted, “The third time, the wolf really came.” Mr. Soros said how the U.S. comes out of the current period is highly uncertain because it depends a great deal on how investors and policy makers respond to the depth of the threat. He called it “inconceivable” that the U.S. would avoid a recession that lasts at least into next year. He noted house price declines are accelerating, and said nothing policy makers can do can slow that down much. It’s quite possible the U.S. could “muddle through” after next year, he said, with 1% to 2% growth for the decade and rising unemployment. But “there are many ways for it to work out.” Mr. Soros withdrew from active investing in 2001 with the departure of his partner, Stanley Druckenmiller and his hedge funds were converted to an endowment fund run by outside managers, mostly tasked with managing the assets of his philanthropic foundations. But he returned in August, 2007 by establishing a macro account of his own. He said that while he has been mostly bearish on U.S. stocks and Treasuries, he moved to a neutral position earlier this year when he sensed a bear market rally might be in the offing. He returned to a short position on both, but too soon, he said. He has also been long stocks in China and India, but has been hurt by the dramatic selloffs in both this year. “We are not making money this year. We are slightly in negative territory.” On the dollar, “we are moving towards neutral. We have greatly reduced our short position. It’s not clear which way it’s going.” He said its depreciation to date is in effect exporting the U.S. slowdown to other countries. In his remarks to the Council on Foreign Relations, Mr. Soros said, “I personally think we have the acute phase of the financial crisis largely behind us. The authorities have as their mission to stop the system from falling apart and providing liquidity at all costs. They’ve done it and have passed several thresholds. That is a source of reassurance that the system is not going to fall apart. But the damage that has been done to the financial system has to affect the real economy, and that is only starting to be felt.” A repeat of Japan’s 1990s experience is “the pessimistic extreme” he told the audience. Japan had “a real estate bubble and a financial system loaded down with bad debt. The big difference between Japan and us is here, the losses are being recognized, written off. Some of the writeoffs may turn out to be excessive.” –Greg Ip

Steve Jobs Stanford Commencement Speech 2005

Stay HUNGRY, stay FOOLISH

50 years of market swings

Interesting link from CNN Money.com. Show you the market swing over the last 50years... http://money.cnn.com/magazines/fortune/storysupplement/investor_special/2008/index.html

Economic 'misery' more widespread

Quoted from CNN Money... Some experts argue that true inflation and unemployment - the components of the economy's 'Misery Index' - are higher than the government's official figures. By Chris Isidore, CNNMoney.com senior writer Last Updated: May 14, 2008: 10:36 AM EDT NEW YORK (CNNMoney.com) -- Americans are feeling a lot more economic pain than the government's official statistics would lead you to believe, according to a growing number of experts. They argue that figures for unemployment and inflation are being understated by the government. Unemployment and inflation are typically added together to come up with a so-called "Misery Index." The "Misery Index" was often cited during periods of high unemployment and inflation, such as the mid 1970s and late 1970s to early 1980s. And some fear the economy may be approaching those levels again. The official numbers produce a current Misery Index of only 8.9 - inflation of 3.9% plus unemployment of 5%. That's not far from the Misery Index's low of 6.1 seen in 1998. But using the estimates on CPI and unemployment from economists skeptical of the government numbers, the Misery Index is actually in the teens. Some worry it could even approach the post-World War II record of 20.6 in 1980. "We're looking at government numbers that are really out of whack," said Kevin Phillips, author of the book "Bad Money." No inflation if you don't eat or drive According to the government's most recent Consumer Price Index, a key inflation reading, consumer prices rose 3.9% in the 12 months ending in April, down slightly from the 4% annual inflation rate in March despite record gasoline prices. But Phillips argues that consumer prices are probably up at least 5% and perhaps more than 10%. Part of the disconnect may be due to the fact that nondurable goods, such as food and gasoline, makes up only 12% of CPI. In addition, food and energy prices are eliminated from the so-called core CPI, which many economists tend to focus more closely on because they claim food and gas prices are volatile. But food and energy costs are a very important part of household budgets. And those prices have been skyrocketing: Gas prices were up about 21% over the 12 months ending in April. However, due to seasonal adjustments in the CPI, the government reported that gas prices were down 2% in April, even though on a non-adjusted basis, gas prices rose 5.6% from March. And even that number may be too low. Measures of gasoline prices by AAA and the Department of Energy suggested prices rose as much as 10% in April. Meanwhile, food prices rose 5.1% over the last 12 months, according to the report. The nearly 1% one-month jump in food prices in April was the biggest spike in 18 years. To that end, nearly half of the respondents of a recent CNN/Opinion Research Corp. poll said inflation was the biggest problem they face. CPI missed the housing bubble...and bust Another problem with the CPI figures, according to skeptics, is that it doesn't accurately reflect what's going on in the housing market. That's significant because the cost of buying a home has twice the impact on CPI as does the prices of all nondurable goods combined. The CPI showed only an 11% rise in home ownership costs from 2002 through 2006, a time that the National Association of Realtors reported that existing home prices soared 34%. The reason for the low CPI reading is because the CPI looks at equivalent rents, rather than home prices. So inflation was understated during this period, according to Phillips. He argues this may have helped feed the housing boom since it kept mortgage rates lower than they should have been. Now that the housing boom has gone bust, the CPI appears to be missing the declines in home prices as well; it estimates that the cost of owning a home posted a 12-month increase of 2.6% in April. But because the CPI figure was so far behind tracking the increase in home values, the housing component of CPI still is leading to a lower inflation reading than what it should be, Phillips said. The inflation 'con job' The unusual way that housing prices are estimated isn't the only peculiarity of the CPI report. Over the past ten years, there have been other changes in the calculations, particularly for big ticket items. Cuts to estimated prices for items like electronics and cars that are thought to have improvements in quality year-after-year have lowered the overall CPI. In addition, changes in the way certain products, such as food, are tracked by the government, have also contributed to lower readings than otherwise expected. Bill Gross, the manager of Pimco Total Return, the nation's largest bond fund, refers to the CPI as a "con job" that deliberately understates the price pressures faced by Americans in order to keep Social Security payments and other government costs pegged to the index unduly low. In a report about the CPI, he noted that some of the adjustments don't accurately reflect how much consumers pay for goods. Pimco estimates that the changes have shaved more than a percentage point off the CPI. "Did your new model computer come with a 25% discount from last year's price?" Gross wrote. "Probably not. What is likely is that you paid about the same price for memory improvements you'll never use." Another flaw with the CPI numbers is that the government now assumes that higher prices for one item will lead consumers to buy more of a substitution item. That may be true. But if people buy fewer steaks and more hamburgers, for example, it's unrealistic to say that inflation isn't a problem, skeptics maintain. "The government can claim there's no inflation but all they're measuring is a reduced standard of living," argues Peter Schiff, president of Euro Pacific Capital, an investment firm specializing in overseas investments. With all this in mind, California economist John Williams argues that CPI is understating inflation by at least 3 percentage points and perhaps as much as 7 percentage points. So instead of an annual inflation rate of 4%, the true number could be between 7% and 11%. Unemployed, but not counted Finally, there's the unemployment rate. It was at a relatively low 5% in April. But according to Williams' Web site, ShadowStats.com, the actual rate may be between 8% and 12% if you use a more accurate reading of those out of work. Even the government's own numbers show there are many unemployed people not showing up in the unemployment rate. The official reading does not include 4.8 million people who want to work but haven't found a job, for example. Many of these people are dropped from the official calculation because they have become so discouraged from looking without success that they haven't looked in the previous four weeks. Simply adding those people to the number of unemployed takes the current unemployment rate to 7.8%. The Bureau of Labor Statistics, which produces both the CPI and unemployment readings, says changes in both measures were made to more accurately reflect the real world. The BLS also says the changes have resulted in changes of less than 1% for each measure. Still, the Labor Department's own broadest measure of unemployment, which includes as jobless those working part-time jobs because they can't find full-time positions as well as some discouraged job seekers, puts the unemployment rate at 9.2% in April, the highest level for that reading in more than three years. So if you take that number and add that to the 7% that Williams thinks is a more likely annual inflation rate, you're looking at a "Misery Index" of 16.2, much worse than the 8.9 you get from the official numbers. And while that may seem a bit high, it's probably a more accurate gauge of how bad the economy is for many Americans. First Published: May 13, 2008: 4:32 PM EDT

Japanese Supermonk

Wow, I thought running a marathon, completing a Hawaii Ironman is tough... but there is always someone else out there who can beats all odds and did the real impossible. When the desire to complete something is a MUST, it can be done with all odds stacks against human being and the eventual winner is still the one who make it a MUST.