SFO Feb11

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The Big Picture:
Big Green Should
Widen Its View
38
By Phil Flynn
CONTENTS
INTERVIEW
MARKETS
OF THE WORLD
21 THEU.S.ANDCHINA:A
LOVE-HATERELATIONSHIP
ByHeatherLarson-Blakestad
26 AROUNDTHEWORLD
WITHETFS
ByDavidFry
36 TIMEFORTHEEUROZONE
TOFACEREALITY
ByHowardL.Simons
46 AUSSIE&KIWIATTRACT
INVESTMENTFLOWS
ByAngiePointer
56 NEWINVESTINGHORIZONS
ByCharmaineBuskas
DEPARTMENTS
6 EDITORSNOTE
8 ONSFOMAG.COM
11 ASKDR.DUKE
12 BOOKREVIEW
14 EYEONFUTURES
16 TECHNICALSTRATEGY
18 TRADEOFTHEMONTH
96 THELASTWORD
FEATURES
73 THEFORGOTTEN
PRECIOUSMETAL:
COPPER
ByMikeDaly
79 WORDSOFWISDOM
FROMWORLDCUP
WINNERS
ByHeatherLarson-Blakestad,
KiraMcCaffreyBrecht&
MeghanPedersen
87 DAYTRADING
INDICATORS,PART2
ByMarkusHeitkoetter
&MarkHodge
NEW!
TAKETHE
BULL
ByRobDavenport&KevinHeller
BYTHEHORNS
67
SPOTLIGHT
PFGBESTs Futures Training Division invites you to Introduction to Futures Trading - Spring Semester 2011
Week 7 >> Trading & Platforms
Week 8 >> Options, Foreign Exchange & Alternative Investments
Week 9 >> Building Your Trading Game Plan/Blue Print
Week 10 >> Brokerage, Back Offce & Behind the Scenes
Week 11 >> Review & Final Exam
Week 12 >> Exit Interviews & Next Steps
Week 1 >> Introduction & Class Overview
Week 2 >> The Basics of the Futures Markets
Week 3 >> Contracts, Orders & Specifcations
Week 4 >> Fundamental Analysis
Week 5 >> Technical Analysis
Week 6 >> Review & Mid Term Exam
Class is in Session!
FREE
12-WEEK
ONLINE
COURSE!
For more information about the online course and to be put on the spring waiting list,
please complete the following form:
FIRST NAME
LAST NAME
EMAIL
SUBMIT
There is a substantial risk of loss in trading commodity futures, options and of f-exchange foreign currency products. Past performance is not indicative of future results.
PUBLISHER
Wasendorf & Associates Inc.
Russell R. Wasendorf Sr., Chairman and CEO
P.O. Box 849 Cedar Falls, IA 50613
EDITORIAL
EXECUTIVE EDITOR: Heather Larson-Blakestad
MANAGING EDITOR: Kira McCaffrey Brecht
ASSOCIATE EDITOR: Meghan Pedersen
CONTRIBUTING WRITERS
PRODUCTION
CREATIVE DIRECTOR: Sara Kies
DESIGNER: Sarah Judisch
DESIGNER: Samantha Schmiesing
WEB DEVELOPER: Jeff Kennedy
CONTACT SFO
Customer Service: 800.590.0919

SUBSCRIBE TO SFO
ADVERTISE WITH SFO
Stephanie Rottinghaus: 319.553.2100
Copyright 2011 by Wasendorf & Associates Inc. All rights reserved.
No part of this publication may be reproduced or transmitted in any
form by any means, electronic or mechanical including photocopying,
recording or by any informative storage and retrieval system without the
written permission of Wasendorf & Associates Inc.s president.

This publication is strictly the opinion and conjecture of its writers
and is intended solely for informative and educational purposes and
is not to be construed, under any circumstances, by implication or
otherwise, as an offer to sell or a solicitation to buy or trade in any
commodities or securities herein named. This publication is not meant
to recommend, promote or in any way imply the effectiveness of any
trading system, strategy or approach. Information is obtained from
sources believed to be reliable, but is in no way guaranteed. Further,
there is no guarantee of any kind that is implied or possible
where projections of future conditions are attempted.
The publisher is not liable for typographical errors.
Commodity futures, securities, options and forex trading involve risk
and are not suitable investments for everyone. Any investment should
be carefully considered in light of an investors personal financial
objectives and risk tolerance.
Articles and/or advertisements contained herein may provide
hypothetical or simulated performance results. Hypothetical or
simulated performance results have certain inherent limitations. Unlike
an actual performance record, simulated results do not represent
actual trading. Also, because the trades have not actually been executed,
the results may have over- or undercompensated for the impact, if any,
of certain market factors such as the lack of liquidity. Simulated trading
programs are also subject to the fact that they are designed with the benefit
of hindsight. No representation is being made that any account
will or is likely to achieve profits or losses similar to those shown.
Further, past performance does not guarantee future results.
FEBRUARY 2011
EDITORS NOTE
6
Heather Larson-Blakestad,
executive editor
MONEY TRAVELS

Ill be honest, I am a bit envious of
my brother- and sister-in-law. They
have traveled internationally on a
regular basis for the past several
years, including a trip around the
world, whereas my husband and
I have only managed to take two
short vacations within the U.S.
Before having children, I
traveled considerably more. I
fnd myself fondly remembering
trips to Spain, Germany, Mexico
and the Czech Republic. And I
daydream about where I want
to go next. I fuctuate between
standards, such as Italy and
the United Kingdom, and more
adventurous locations, such as
Thailand and Costa Rica.
But while I long to travel,
my money is on an interna-
tional journey.
A PERSONALIZED ITINERARY
Two great aspects of global
investing is that people can fnd
choices that ft their risk toler-
ances and can take advantage
of a variety of economic trends.
These include steady growth in
developed countries, such as Aus-
tralia and Canada, and riskier but
potentially more proftable oppor-
tunities in emerging economies,
such as Brazil and Indonesia.
And exchange-traded funds
have made it possible for individu-
als to access companies, curren-
cies and countries that had been
off-limits to them in the past.
Because of the boost global
investing can give individuals,
this month SFO presents ar-
ticles about international ETFs,
the economies Down Under, the
CIVETS and more.
So while I wait for my chil-
dren to graduate and my
personal travel itinerary to
catch up with my in-laws, I will
continue to send my money to
far-fung regions of the world.
T r a de r s s houl d uT i l i z e only T he
v e r y B e s T i n T e c hnol ogy.
I built PFGBEST to be a different type of trading company. Traders should utilize only the very
best in technology. We have invested heavily over the years to assure the technology weve built is
comprehensive, intuitive and at the forefront for peak performance. In a world where microseconds
count, we cant afford to put out anything less than the BEST.
The BEST thing about our technology is our people.
800.333.5673 > www.pfgbest.com
T her e i s a s ubs t ant i al r i s k of l os s i n t r adi ng commodi t y f ut ur es , opt i ons and of f - ex change
f or ei gn cur r ency pr oduct s . Pas t per f or mance i s not i ndi cat i v e of f ut ur e r es ul t s .
ON SFOMAG.COM
8
FEBRUARY 2011
NEW!
TUNE IN TO
TERRY & TODD
IN THE NEWS TODAY
With SFOmag.com, keep up on news specifcally chosen for
individual traders and investors. Sign up for the News RSS feed
to have daily stories sent directly to you, or you can check the
website for updates throughout the day.
Here is a sample of the Top Stories from the past several weeks:
U.S. Clients Will Not Be Able to Invest in Facebook
Crude Oil Drops as Pipeline in Alaska Resumes Operations
Italy, Spain, Portugal to Sell Bonds as Gold Rises
Monsoons, Flooding Take Toll on Australian Meat Exports
In addition to the webinar pre-
sented by David Fry related to
his article, SFO is offering three
more in the coming weeks.
FREE
WEBINARS!
TOP PLAYS OF THE WEEK
Mike Bellafore, co-founder and
managing partner of SMB Capital,
shares his favorite trades and setups
from recent market conditions.
FEB. 3 AT 3:30 P.M. CT
TECHNICAL STRATEGY:
FIND WINNERS WITH LESS RISK
Amber Hestla, an independent
research analyst, gives more tips
about using last months Technical
Strategy, based on using moving
averages and rate of change.
FEB. 16 AT 10:30 A.M. CT
HEAR SFO NEWS FIRST!
Each Saturday tune in to Terry
and Todd Talkin Money, a free
podcast, for a chat about the
previous weeks market action, a
look at the coming weeks likely
moves and an interview focus-
ing on a current fnancial issue.
And you can take the podcast
wherever you go. Simply stream
the audio on your mobile Inter-
net device or download the fle
to an MP3 player.
In the past, Terry, Todd and
their guests have covered
central bank action, trends for
2011, the changing face of the
consumer, the European debt
crisis and more. They stay on top
of the action so you can, too.
It is easy to know when a
new episode is available. You
can sign up for the RSS feed or
receive notices by following SFO
on Twitter or Facebook.
And SFO wants to know
what you think of the show,
who you think Terry and Todd
should interview and topics
you want them to cover, so
send us your ideas.
THROW AWAY YOUR CRYSTAL
BALL: TRADE WHAT THE MARKET
GIVES YOU
Kerry Given, Ph.D. (a.k.a. Dr.
Duke), discusses how delta-
neutral options strategies can
reduce trading stress.
MARCH 8 AT 3:30 P.M. CT
REGISTER NOW!
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The information provided herein is taken from sources believed to be reliable. However, it is intended for purposes of information and education only and is not guaranteed by CME Group, Inc. or
any of its subsidiaries as to accuracy, completeness, nor any trading result and does not constitute trading advice or constitute a solicitation of the purchase or sale of any futures or options. The
Rulebook of the applicable exchange should be consulted as the authoritative source on all current contract specifcations.

CME Group is a trademark of CME Group Inc. The Globe logo, CME, Chicago Mercantile Exchange, E-mini and Globex are trademarks of Chicago Mercantile Exchange Inc. CBOT and Chicago
Board of Trade are trademarks of the Board of Trade of the City of Chicago. NYMEX, New York Mercantile Exchange and ClearPort are trademarks of New York Mercantile Exchange Inc. COMEX is
a trademark of Commodity Exchange Inc. All other trademarks are the property of their respective owners.
Get your kit at www.pfgbest.com/CMEtoolkit
FREE PFGBEST financial calendar
FREE CME Group educational videos
Stock options frst traded on an exchange a mere
35 years ago and have exploded in popularity in
recent years. Today more than two billion options
trade every year in the United States alone.
Many people dabble in options without really
understanding howthey work and howthey can
be used most efectively. The Rookies Guide to
Options: The Beginners Handbook of Trading Equity
Options will give you the basic trading tools you
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Options were created as tools to allow risk takers
to hedge part of that risk. This book will help you
learn to use options the way they were originally
intendedto manage risk and increase profts.
Youll follow step-by-step as the author guides
you through the decision-making process in
terms of puts, calls, strike prices, expiration dates
and strategic equivalents.
This book, aimed at the beginning option
investor, will help you gain a clear understanding
of how youve been using options for years, even
if unaware of doing so. If you have bought car
insurance, accepted a rain check at a discount
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understand the concept of using options.
If you thought options were too complicated,
Wolfngers clear and detailed explanations put
that myth to rest. Youll see how to adopt basic
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minimize risk and maximize profts.
About the Author
Mark D. Wolfnger has beeninthe options business
since 1977, whenhe beganhis career as a foor trader
at the Chicago BoardOptions Exchange (CBOE). Over
the next 23 years, he workedprimarily as a market
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industry, includingrisk manager, of-foor trader and
coachfor newtraders.
Wolfnger is still anactive options trader who fnds
it more funandless stressful to trade fromhis home
computer thanto trade inpersononthe exchange
foor. After leavingthe CBOE he beganeducating
investors onhowto use options proftably andsafely.
He gives tradingseminars as well as provides individual
mentoringvia telephone or email. Over the past seven
years, he has publishedthree books andwrittenmore
than20 articles.
BornandraisedinBrooklyn, Wolfnger currently lives in
Evanston, Illinois, withhis life partner, Penny. He holds
a BS fromBrooklynCollege anda PhDinchemistry
fromNorthwesternUniversity. Prior to his trading
career, Wolfnger was a researchchemist for Monsanto
Company. His website is mdwoptions.comandhe
welcomes comments at rookies@mdwoptions.com.
If you are a seasoned stock trader or a casual
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Unlike many option guides, this book features
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that outline the costs and benefts of each choice
along the wayeverything you need to plan and
execute trades on your own. Wolfnger shows you
howto analyze alternatives and explains why each
may be appropriate for a particular investor with
certain investment objectives. Youll develop a
basis for deciding what is suitable for you and your
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Wolfngers strategies will help ensure that your
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The Rookies Guide to Options:
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Sell your stock above market value.
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Q&A
ASK DR. DUKE
Kerry W. Given,
Ph.D. (a.k.a. Dr.
Duke), is the
founder and
managing direc-
tor of Parkwood Capital LLC and the
author of No Hype Options Trading.
age of the implied volatility
of selected at-the-money call
and put options.
When you computed the
value of one standard devia-
tion for RUT using the ATM IV
from your brokers website or
other data source, you effec-
tively calculated an average
risk and applied it to both
sides of the condor.
If you were to calculate one
standard deviation for the call
option side of the condor us-
ing the IV of the short call of
the call spread and similarly
for the put spreads, you would
see much different results.
For example, with RUT at
743 with an ATM IV of 27.7%
and 50 days to expiration,
the standard deviation equals
76, so plus or minus one
standard deviation yields
667 and 819. You might sell
the 660/670 put spreads for
$1.35 and the 820/830 call
spreads at 80 cents (both
at the midpoint price). This
results in an iron condor with
about an 84% probability
of success for either side of
the spread.
DEAR DR. DUKE,
I position the spreads of my
iron condor a little more than
one standard deviation away
from the index price. Recently,
I sold the Russell 2000 Index
(RUT) 660/670 put spreads for
$1.10 and the 780/790 call
spreads for 50 cents when RUT
was trading at 725.
In this situation, the market
values the put spread higher
than the call spread, but the risk
associated with these spreads is
about the same; the strikes are
both about one standard devia-
tion from the current index level.
Would I ever want to sell a
call spread if there is a put
spread that would give me
signifcantly more premium for
the same risk?
Caroline, Atlanta

DEAR CAROLINE,
That is an excellent ques-
tion. Remember that implied
volatility (IV) is only applicable
for an individual option. We
often see a statement like,
the implied volatility of IBM is
20.5%. That value of 20.5%
represents a weighted aver-
However, if you calculate the
standard deviation with the
implied volatility for the short
strikes of those spreads, you
would see a different picture
of risk. The IV is 32.4% for the
670 put and 19.4% for the
820 call. This yields a prob-
ability of success on the call
side of 92% but only 81%
on the put side. Of course,
this is more consistent with
the credits received for the
spreadshigher returns are
accompanied by higher risk.
An alternate approach is to
look at the deltas of the short
options of the spreads as your
shorthand for the probabili-
ties. Deltas of about nine to
10 will correspond to prob-
abilities of success of approxi-
mately 85% to 90%.
11 The Official Advocate for Personal Investing
WELL-ENDOWED
By Suzanne Cosgrove

Large university endowments
traditionally achieve better long-
term investment results than in-
dividual investors. John Baschab
and Jon Piot set out to discover
why in their book Outperform.
For the 10 years ended in
June 2009, large endowments
returned an average of 6.1%,
compared with the S&P 500
Index average of -2.22%, ac-
cording to a National Associa-
tion of College and University
Business Offcers-Commonfund
endowments study.
Baschab and Piot interview
chief investment offcers of both
public and private universities,
including Ohio State University,
University of Texas, Cornell Univer-
sity and Emory University, which
have a combined total of more
than $125 billion in assets under
management. The No.1-ranked
endowment, Harvard Manage-
ment Co., a wholly owned
subsidiary of Harvard University, is
mentioned but not dissected.
The book details how a dis-
ciplined approach to investing
allows for stronger-than-average
long-term returns. But while Out-
perform thoroughly documents
how the CIOs approach their du-
ties, most of the advice for small
investors is standard fare.
For example, the authors
interview Ohio State Universitys
CIO, Jonathan Hook, who warns
against the idea that diversifca-
tion means scattering invest-
ments across a variety of U.S.
public equity subclasses. Instead,
Hook says, investors need to
understand what asset classes
are available, what is owned and
how the pieces ft together.
Read more ...
Suzanne Cosgrove is a freelance
writer and a journalism professor.
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BOOK REVIEW
STRANGER THAN FICTION
In Zero-Sum Game, Erika S. Ol-
son shares her insiders take on
the historic merger of the Chi-
cago Mercantile Exchange with
the Chicago Board of Trade.
The book reads like a novel with memora-
ble and often quirky characters, an action-
flled plot fueled by the crosstown rivalry,
and the chaotic setting of an exchange.
Olsons writing mirrors the sentiment of the
time with its high energy, colorful dialogue
and smart humor.
Hired as a managing director at the CBOT
just months before the merger announce-
ment, Olson takes the reader along on her
whirlwind introduction to the world of trad-
ing, seamlessly weaving industry history
and explanations into her tale in a manner
quite the opposite of the cut-and-dried
material one often encounters.
Olson has delivered a frank and enjoy-
able account of a dramatic event.
By Meghan Pedersen
888.726.8864
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MANAGED
Futures Options
PREMIUM STOCK INDEX PROGRAM (PSIP) The general strategy
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the premium. Trades are usually made 30-45 days before
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BALANCED VOLATILITY PROGRAM (BVP) The objective of the BVP
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EYE ON FUTURES
want to trade, take heed of tick
size and tick value. The conse-
quences might go from bad to
worseand quicklydepend-
ing on the tick value. It might
seem like common sense, but
every tick counts when you are
talking about the bottom line.
For instance, if CBOT wheat
prices drop 50 cents, that rep-
resents 200 ticks for a value of
$2,500 per contract ($12.50 x
200). If you are trading several
contracts, that can add up fast.
THE MORAL OF THE STORY
Although each contract is stan-
dardized, standardization does
not apply across the board. A
tick is a tick, but it ticks differ-
ently in different markets.
Be sure to research your
market and know the contract
specifcations before trading be-
cause, obviously, not all futures
contracts are created equal.
Curt Wagaman is an instructor
and professional trading mentor
for the Futures Training Division
of PFGBEST.
14
FEBRUARY 2011
A TICK IS A
TICK IS A TICK?
By Curt Wagaman
Each futures contract is built
from a unique set of blocks
known as contract specifca-
tions. These ensure standard-
ization, which in turn enhances
liquidity and price discovery.
Some of the items stan-
dardized include the contract
symbol, size, pricing unit,
tick size and value, trading
months, trading hours, daily
price limits, last trading date,
and settlement procedure.
Physically settled contracts
have additional specifications
such as acceptable quality
and delivery stipulations.
TICK SIZE AND VALUE
Most of the specifcations
are self-explanatory, but what
exactly is a tick? Simply, it is the
minimum price movement in
any particular futures contract.
This sounds easy enough;
however, tick size and tick value
come in an assortment of com-
binations based on the contract
at hand. Even contracts of the
same general category can
trade completely differently.
Is the tick size in the market
you want to trade equivalent to
a point, a half point, a quarter
point, a tenth of a point, a thirty-
second of a point, a sixty-fourth
of a point, a hundredth of a point,
a thousandth of a point or even a
ten-thousandth of a point? Does
your market even trade in points?
Maybe it trades in cents per
bushel, cents per gallon, cents
per barrel or cents per pound.
You can fnd this information on
the listing exchanges website or
from your broker.
Once you know the tick size,
you can move on to understand-
ing tick value. Each time the
market moves one tick in your
particular contract, how much
is it worth? $1, $5, $10, $12.50,
$18.75, $31.25 or even $62.50?
To determine tick value, take the
contract size multiplied by the tick
size. For example, a CBOT wheat
contract (worth 5,000 bushels)
has a tick size of a quarter cent
($0.0025), so its tick value is
$12.50 (5,000 x $0.0025).
Along with all the other
particulars of a contract you
something
Big is coming.
can you guess?
there is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products.Past performance
is not indicative of future results.
heres a few hints:
1. this new trade expresses simple
yes/no propositions.
2. the contract size is always $100.
3. your maximum risk on a trade is always
known in advance.
4. you can never be called upon for extra
funds or margin.
think you know? tell us.
TECHNICAL STRATEGY
PLAYING THE
RETEST
By S. Wade Hansen
Frustration is watching an asset
you trade break above a major
resistance level or below a ma-
jor support level and not being
in the trade. You do not want to
chase the trade, but you do not
want to miss it either. What to
do? Wait for the retest.
This is a technical pattern that
forms as the price of a currency
pair moves back to test a former
support or resistance level
before resuming the new trend
that began with the breakout.
Often, a former support level
will reverse its role and act as
a new resistance level after
the price has broken down and
through the initial support level.
The opposite is also true.
A former resistance level will
frequently reverse its role and
act as a new support level
after the price has moved up
and through the initial resis-
tance level.
Source: MetaStock
FIGURE 1: Retest on the Euro/U.S. Dollar
July 2010 August September October November
Retest
Breakout
1.20
1.25
1.30
1.35
16
FEBRUARY 2011
THE PSYCHOLOGY
Retests occur when traders
want to confrm that a breakout
is indeed the beginning of a
new trend and not just a fake-
out. This is how it plays out:
1. After the initial breakout oc-
curs and the stop losses that
were placed above resistance
(below support) have all
been cleared out, some trad-
ers look to take profts just in
case the move is not going
to last.
2. This starts pulling the price
back toward the support
(resistance) level that was
just broken.
3. As the price gets closer and
closer to that level, traders
who did not get into the
trade on the initial breakout
and have vowed to get in if
the price ever came back
to that levelor traders
who were in the trade at
the initial breakout but want
to add to their positions
place new entry orders just
below the former support
level (above the former
resistance).
4. This buying (selling) pressure
will cause the price to turn
back around and resume the
trend that started with the
initial breakout.
RETEST IN ACTION
Recently, the euro/dollar
currency pair broke below
a support level at 1.38. This
uptrending level had been
serving as support for EUR/
USD for about five or six
weeksfrom the beginning
of October 2010 through the
first week of November 2010.
During that time, EUR/USD
dropped to and bounced off
of that level two times.
On the third time down, EUR/
USD broke down and through
the support level. Naturally, this
would have been a great time
to be short the pair.
Unfortunately, if you were not
already short the euro/dollar,
you were left asking yourself, do
I get in now or am I just chas-
ing the trade at this point?
Luckily, as is often the case,
the price of EUR/USD turned
around and moved higher to
retest its former support level.
Sure enough, the former
support level turned into new
resistance, and the EUR/USD
moved downward and resumed
its new downtrend.
WRAP UP
Will a currency pair always
retest a level it has broken
through? No. Sometimes playing
the retest will cause you to miss
some moves, but doing so def-
nitely puts the odds in your favor.
S. Wade Hansen is a founder
and managing partner at
Learning Markets.
Often, a former support level will reverse its role and act
as a new resistance level after the price has broken
down and through the initial support level.
TRADE OF THE MONTH
Source: Waverly Advisors
FIGURE 1: Daily U.S. Dollar Index

75
77
79
81
83
85
87
89
Jun-10 Jul-10 Sep-10 Oct-10 Dec-10 Jan-11
Stop level 81.55
Entry is a close
under 78.75
Cover part of position at first target 75.75
www.waverlyadvisors.com Daily increments with 20XMA +/- Keltner Channels
Cover part of position at rst target 75.75
Entry is a close
under 78.75
Stop level 81.55
87
85
83
81
79
77
Jul-10 Sep-10 Oct-10 Dec-10 Jan-11
18
FEBRUARY 2011
SHORT THE
DOLLAR
By Adam Grimes & Andrew Barber
Soft economic growth, bulging
debt levels and negative de-
mographic trends have cast a
long shadow over the U.S. dollar.
Although it remains the global re-
serve currency, the intermediate-
term macro view is mixed at best.
The U.S. Dollar Index has been
trading between 81.50 and
78.75 (basis cash, see Figure 1).
A preponderance of momentum
shifts on multiple timeframes
suggests the potential for a
signifcant break below this level.
THE TRADE
Open a short position in the in-
dex on a close below 78.70 on
the cash index. (The easiest way
to execute this will be via dollar
index futures, so levels will have
to be adjusted for the correct
futures-to-cash premium.) Once
flled, establish a stop-loss order
for the trade on a close above
81.55 (basis the cash index).
Take partial profts for up to
50% of the position near 75.75,
using a good-til-canceled order
in all sessions.
If flled on these proft-taking
orders, aggressive traders may
want to sell into any bounce,
holding below the initial entry
price up to and not exceeding
the original position size.
Once you take partial profts,
hold the trade for a possible
extension and signifcant selloff
below 75.75.
THE OVERVIEW
For this trade, our primary
concern from a risk perspective
is increased debt problems in
Europe. The U.S. Dollar Index
is a relative measure of the
dollar, and the euro accounts
for almost 60% of the currency
basket. In the near-term, con-
cerns about weaker EU states
could cause the Dollar Index to
snap back into our face.
Adam Grimes is director of tactical
investments at Waverly Advisors
LLC, and Andrew Barber is director
of strategic investments there.
The POWER to stay on top of your
Futures, Forex and Options trades.

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There is a substantial risk of loss in trading commodity futures, options and off-exchange foreign currency products.
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By Heather Larson-Blakestad
The mid-January state visit of Chinas
president Hu Jintao to the U.S. could be
described as an early Valentine for U.S.
companies. While in the States, he met
with several business executives, en-
couraging further economic ties between
the two countries.
However, such dates have a dark side.
U.S. offcials have accused China of arti-
fcially keeping the yuans value low. And
the Peoples Bank of China had to in-
crease interest rates late last year to curb
domestic infation, which some think has
been caused by the U.S. Federal Re-
serves quantitative easing.
In addition, conficts on broader politi-
cal issues such as human rights simmer
between the countries.
Regardless, China is undeniably a key
to the global fnancial recovery, and the
THE U.S. AND CHINA:
A LOVE-HATE RELATIONSHIP
Feature Interview with New York Global Groups Benjamin Wey
5. Do you believe that the undervalued
yuan is the main cause of the U.S.-China
trade imbalance? Why or why not?
6. Increasing interest rates in China may
help curb infation there, but what are the
root causes of Chinas rising prices and
what would be the best ways to address
them for China and the global economy?
7. Is the infation currently developing in
China a result of the Feds QE2 policy? How
are the Feds actions affecting the Chinese
economy?
8. The Chinese and American economies
are tightly intertwined. So, what is your
view on the balance of power over the next
decade between these two countries, in
light of the current lender-debtor relation-
ship status? Is the U.S. losing its edge on the
global scene because of its debtor status?
1. All eyes are on China to gauge how the
global economy will progress. What are the
big issues facing Chinas economy now?
2. What developments do you predict for
U.S. and China trade relations this year
and in the next fve?
3. Recently, U.S. government offcials
have speculated that President Hu may
be one of the weakest leaders of the
Communist era in China. How do Hus
perceived leadership challenges within
China complicate trade negotiations with
U.S. offcials?
4. U.S. offcials have accused China of
manipulating the value of its currency to
keep the prices of its goods low in relation
to Americas. How will these accusations
affect U.S.-China trade and political rela-
tions? Does this kind of talk have any ef-
fect on Chinese monetary policymakers?
U.S. remains the worlds largest economy. So, these powers
making eyes at each other may be good for everyone.
For an insiders understanding of the U.S. and Chinas relation-
ship, SFO turns to Benjamin Wey, president of New York Global
Group, one of Americas largest middle market advisory frms
specializing in China-related transactions. He is an expert on
China and U.S.-China trade relations, and has been a consultant
to Chinas central bank.
Benjamin Wey, president
of New York Global Group
Copyright 2010 Traders Press Inc. All rights reserved.
One Peregrine Way, Cedar Falls, IA 50613
CUSTOMER PICK
The Brainwashing of the Ameri-
can Investor
By: Steven R. Selengut
This book is da bomb. It was an
easy read but very beneficial to my
trading practices. I would recom-
mend this to anyone who takes
pride in a nicely designed publica-
tion
- Steve Smith, Cedar Falls, IA
ADP: December Private Jobs
Rise 40,000
US Consumer Bankruptcy
Filings Soar
Pimco: Fed Funds May
At first glance, you might pass over 8 Ways to Great.
It's a small book -- only 128 pages. The title doesn't zero in on its
possible usefulness as a trading tool. The cover doesn't scream, "This
book will improve your trading."
That is, perhaps, by design: The book transcends a particular focus
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to Great can be applied to anything to which you'd devote brain-
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In 8 Ways to Great, traders will indeed find valuable, untapped
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Where others promise to "teach" you, he gives you the tools to teach
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The "ways to great" seem easy enough. You may even read them
and say to yourself, "There's nothing there I don't know." You don't
even have to buy the book to get the list:
1. Let your true passion be your core motivation
2. Develop self-awareness and use what you know about both your
strengths and weaknesses
Wednesday, April 7, 2010
weekly
Review of 8 Ways to Great: Peak
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Reviewed by Karris Golden,
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TRADER NEWS
STOCK INDEX FUTURES: Not Even S&Ps Can
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9. 2011 is the frst year in Chinas 12th Five
Year plan. What is the focus of this plan,
and how will resulting policies affect in-
ternational commerce with China?
10. The SEC is cracking down on reverse
mergers, especially those involving com-
panies based in China. As a result, these
mergers are getting a bad reputation in the
U.S. What is your experience with reverse
mergers, and are they benefcial to the
companies and investors?
11. As the U.S. continues with an eased
monetary policy, talk is emerging of us-
ing something other than the U.S. dol-
lar as the worlds currency for trade and
central bank reserves. The euro does not
look good as an alternative due to Europes
struggles with managing its sovereign
debt. Where do you see the Chinese yuan
ftting into this discussion?
12. Should the Chinese yuan be included
in the basket of currencies that makes up
the International Monetary Funds special
drawing rights? Why?
13. As someone who works with U.S. and
Chinese companies, where can corpora-
tions take advantage of Chinas growth po-
tential and American wealth and stability?
SubScribe
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Around the World with ETFs
Around the World with ETFs
By David Fry
seas to faster-growing
economies and linked
exchange-traded funds.
U.S. LAGS
Economic growth in vari-
ous countries and re-
gions has outpaced that
of the U.S. Growth in the
20th century belonged
to America, and this was
capped by the dynamic
expansion in the 1990s
after the end of the Cold
War and a revolution in
technology. It was led by
the Internet and so-called
dot-com companies.
In the aftermath of
the U.S. tech bubble and
9/11, a change in over-
seas economic growth
became more apparent.
To many, this growth
appeared abruptly, but it
had been building over
the years, especially in
emerging markets.
In China, the economy
expanded at a double-digit
pace through the 1980s
and 1990s. But this growth
was obscured once again
by the boom in U.S. stocks,
driven by the tech revolu-
tion. Furthermore, invest-
rent global growth rate
differentials and their
obvious implications for
investment returns, espe-
cially from equities.
Income-oriented inves-
tors should know that
higher economic growth
rates generally, but not
always, mean bond yields
from these countries
will also be higher, not-
withstanding currency
differentials. Therefore,
investors may beneft by
expanding their invest-
ment allocations over-
With the end of the Cold
War, many countries did
not need to be aligned
with the Soviet or Western
bloc. A major result of this
geopolitical restructur-
ing has been that many
nations have been free to
pursue independent paths
toward prosperity without
fear of retribution from
one side or the other.
Many investors have not
grasped the macro impli-
cations of this.
First, investors must un-
derstand and accept cur-
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28
FEBRUARY 2011
Western Europe, Japan
and others qualify in
this regard. Further,
regional ETF investment
vehicles offer interna-
tional exposure, such
as the popular iShares
MSCI EAFE ETF (EFA).
Emerging markets are
becoming more diffcult
to identify as ongoing eco-
nomic growth has taken
some out of this category
unoffcially. Many indexes
created for these so-called
emerging markets are old
and may be out of date.
MSCI is the clear leader
in creating popular in-
dexes to which popular
growth? In other words,
if you are investing for
growth, why choose any
of the developed coun-
tries where gross domes-
tic product growth is low
and/or declining?
History has shown that
equity returns are much
higher within countries
demonstrating signifcant-
ly superior GDP growth.
THE DEVELOPED AND
EMERGING NATIONS
Developed markets are
easy to understand and
more comfortable for
most experienced inves-
tors. The U.S., Canada,
ing in markets such as
China was diffcult due to
regulatory restrictions for
retail investors, and a lack
of investment structures
and products beyond mu-
tual funds.
In particular, retail in-
vestors found their only
direct way to invest in
China was via Hong Kong
markets. This was dissatis-
fying when better returns
were available at home.
But things change.
THE MACRO VIEW
Figure 1 could answer
the question, where
should I invest for
FIGURE 1: GDP Growth in Developed Countries vs. China
16%
14%
12%
10%
8%
6%
4%
-4%
2%
-2%
USA Japan Germany China UK France
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
0%
Source: World Bank
The U.S.-listed SPDR
S&P 500 ETFs 10-year
return is an unimpres-
sive -0.08%.
OTHER AVENUES
Of course, there are the
popular BRIC (Brazil,
Russia, India and China)
themes. They can be bought
or sold in a group such as
with the Guggenheim BRIC
ETF (EEB) or as single-
country ETFs from a variety
of sponsors, such as iShares
and Van Eck.
Recent trends are for
ETF companies to issue a
variety of sector ETFs to
include infrastructure or
consumer issues, for ex-
ample, where perhaps even
greater opportunities arise.
Further, China-oriented
ETFs have blossomed,
whether in Hong Kong,
Shenzen or Shanghai.
Recently, Van Eck has
issued Market Vectors
China ETF (PEK) which
seeks to replicate the
Shanghai CSI 300 Index,
a popular benchmark
previously the exclusive
domain of institutions and
Chinese citizens. PEK
would be quite trouble-
some to existing ETFs.
iShares MSCI Emerging
Market ETF (EEM) is one
of the largest ETFs by
assets. If the index were
changed to add new coun-
try markets and remove
older issues, it would cause
a massive reallocation
of the index. This would
signifcantly disrupt the
performance and owner-
ship of EEM for retail and
institutional holders.
Do not get me wrong;
EEM, Vanguards Emerg-
ing Markets ETF (VWO)
and Schwabs Interna-
tional Equity ETF (SCHE)
or even similarly linked
SPDR S&P Emerging
Markets ETF (GMM) are
great ETFs with excellent
equity market exposure
that have provided above
average returns.
THE NUMBERS
Performance compari-
sons are startling:
MSCI Emerging Market
Index has provided an-
nual returns of roughly
13.44% through Decem-
ber 2010.
emerging-market ETFs
are linked. However,
some countries within
this index have grown to
the point of ftting more
appropriately in the de-
veloped category.
For example, South Ko-
rea currently constitutes
nearly 13% of the MSCI
Emerging Markets In-
dex. Clearly, the countrys
GDP and economic con-
ditions overall have out-
lived this classifcation.
Other heavy index
weights include China
at 18%, Brazil at 16% and
Taiwan with 10%.
Taken together, these
country weightings
amount to nearly 60% of
this index.
MSCI would like to keep
this allocation for now
because redistributing it
Join David Fry for
a free SFO webinar
Feb. 22 at 10:30 a.m.
CT to learn more tips
on using ETFs for in-
ternational exposure
in your portfolio.
REGISTER NOW.
30
FEBRUARY 2011
TOP PLAYS OF THE WEEK
Presented by Mike Bellafore
Feb. 3 at 3:30 p.m. CT
TECHNICAL STRATEGY: FIND WINNERS WITH LESS RISK
Presented by Amber Hestla
Feb. 16 at 10:30 a.m. CT

AROUND THE WORLD WITH ETFS
Presented by David Fry
Feb. 22 at 10:30 a.m. CT
WEBINARS
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SFOmag.com/webinars
smaller countries in East-
ern Europe, Africa, the
Middle East and Latin
America. They may be
off-putting to some, but
one should not ignore the
benefts of positive demo-
graphics.
Many BRIC and frontier
markets offer much better
demographics for growth,
given their younger popu-
lations compared to devel-
oped countries. This may
mean more opportunities
in consumer goods and
infrastructure.
Currently, many of these
markets are dominated
by fnancial sectors. How-
ever, this is beginning to
change, especially within
the BRICs.
The growing Islam-
ic world is becoming
wealthier and interested
in ETF issues listed in
their own markets. Some
of the ETFs are compli-
ant with religious tenets
while others are not.
The populations of
these countries feature
an estimated regional
population with 65% be-
low the age of 30.
demonstrates the depth of
issues now available for
overseas investors within
the second-largest econo-
my in the world.
NEW FRONTIERS
As emerging markets
become upgraded, fron-
tier markets will take
their place. These include
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B
r
a
n
d
N
e
w

U
p
d
a
te
d
2
n
d
E
d
itio
n

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itio
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32
FEBRUARY 2011
Many broad commod-
ity-tracking ETFs are
available, and more indi-
vidual commodity funds
exist for precious metals,
With economic growth,
consumer opportunities
seem apparent. These
demographics are similar
to previous Asian Tiger
markets (South Korea,
Taiwan, Malaysia, Thai-
land, Hong Kong, etc.),
which have shown great
growth. However, cultural
issues, education and civil
strife have held the region
back. That could change.
ALTERNATIVE
INVESTMENTS
Alternative investments
generally mean currency
and commodity investing.
The expanding ETF
market has delivered more
accessible products with
less leverage, lower costs
and greater liquidity than
previous products for all
investors. Many of these
have lowered risks to in-
vestors interested as well.
Commodities and cur-
rencies are important
because generally speak-
ing, they are uncorrelated
to conventional invest-
ments and, therefore, of-
fer greater diversifcation
opportunities.
[sidebar: try to place it earlier in the
layout if possible.]
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GLD/DGZ
10%
DBC/DDP
10%
RSP/SH
10%
QQQQ/PSQ 10%
EEM/EUM 10%
EFA/EFZ 10%
FXI/FXP 10%
EPI 10%
EWZ/BZQ 10%
UUP/UDN 10%
FIGURE 2: ETF Digest Aggressive Growth Portfolio
GLD/DGZ (SPDR Gold Shares/PowerShares DB Gold Short ETN)
UUP/UDN (PowerShares DB US Dollar Index Bullish/PowerShares DB US Dollar
Index Bearish)
EWZ/BZQ (iShares MSCI Brazil Index/UltraShort MSCI Brazil ProShares)
FXI/FXP (iShares FTSE/Xinhua China 25 Index/UltraShort MSCI Brazil ProShares)
EPI (WisdomTree India Earnings)
EFA/EFZ (iShares MSCI EAFE Index/Short MSCI EAFE ProShares)
EEM/EUM (iShares MSCI Emerging Markets Index/Short MSCI Emerging Mkts
ProShares)
QQQQ/PSQ (PoswerShares QQQ/Short ProShares QQQ)
RSP/SH (Rydex S&P Equal Weight/Short S&P 500 ProShares)
DBC/DDP (PowerShares DB Commodity Index/PowerShares DB Commodity
Short ETN)
base metals, grains, softs
(sugar, cotton, cocoa, cof-
fee), meats and so forth.
All of these give investors
the opportunity to invest
Source: ETF Digest
At ETF Digest, we use
these products tactically.
Doing so has protected
our portfolios and led
to profts for our hedge
fund-like structures.
SORTING THE CHOICES
More than 1,000 ETFs are
available. Cobbling to-
gether so many funds into
a portfolio is a challenge
for many individuals.
We have assembled 10
portfolios that meet a va-
riety of investor styles and
objectives at ETF Digest.
Figure 2 shows our Ag-
gressive Growth Portfo-
lio that follows a global
macro long/short style. A
combination of different
ETFs and inverse issues
are used for both hedging
and growth. The macro
view is to gain exposure to
markets where economic
growth is most apparent.
For added diversifcation,
alternative investments
are added. Once all the
ETFs are assembled, we
in markets that previous-
ly were highly leveraged
and complex, which made
most individuals uneasy
about the process.
Single-currency ETFs
allow investors to specu-
late or hedge their cur-
rency exposure.
INVERSE AND
LEVERAGED ETFS
Controversy has swirled
over these products, but
if used properly for short
periods, they allow for
quick profts by turbo-
charging positionsmak-
ing up ground quickly for
investors left behind in a
big moveand allow even
conservative investors to
hedge their long market
exposure easily.
The incorrect use of
inverse and leveraged
funds is to use them as
buy-and-hold investments
because of tracking inef-
fciencies due to volatility,
daily tracking and com-
pounding issues.
proceed to manage them
using technical analysis.
DO YOUR HOMEWORK
Most investors are under-
weight on overseas mar-
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in their overall portfolios.
ETFs make it relatively
easy for investors to gain
exposure to both sectors.
Many investors abhor
higher-risk leveraged
and inverse ETF sectors.
Again the tools and is-
sues are available to those
willing to use these issues
properly for speculation
and hedging.
Assembling portfolios is a
challenge given the tsuna-
mi of ETFs that often ap-
pear seductive but perhaps
do not integrate well with
other issues or, when taken
together, do not achieve the
investors objectives and
goals. Most investors, and
even fnancial advisers,
need help in this regard.
David Fry is founder and pub-
lisher of ETF Digest.
History has shown that equity returns are
much higher within countries demonstrating
signifcantly superior GDP growth.
34
FEBRUARY 2011
R
E
S
E
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R
C
H
OUTLOOK 2011
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Those of a certain age will recall the 1970s-era com-
mercial for margarine regarding the fooling of Mother
Nature; that along with the kindred-spirit you cant
cheat an honest man form the basis for one of the
great struggles in fnancial markets of our daythe
battle between reality and government attempts to
postpone reckoning with that reality.
FACE REALITY
Time for the Eurozone to
By Howard L. Simons
merce since the frst loan
was made: The govern-
ments involved had bor-
rowed too much money
in an attempt to maintain
their citizens lifestyles
after the 2008 fnancial
panic had depleted fnan-
cial institutions capital.
Then, mirabile dictu,
they could not repay those
debts and, unlike in the
merry old days prior to
the adoption of the euro,
they could not depreciate
their currency as a form
of debt repudiation.
ger and worse. Your frst
loss is your best loss.
Consider a case in
point: the sovereign debt
problems of various Eu-
ropean Monetary Union
members, including
Greece, Spain and Por-
tugal, that frst bubbled
to the surface in Octo-
ber 2009 and then re-
emerged with predictable
vengeance in May 2010.
On the surface, the
problem was simple and
had been understood by
all parties in human com-
Put your money on real-
ity. If governments man-
age to push the inevitable
back in time somewhat
as they have been trying
to do since at least the
December 1994 Mexican
peso devaluation and on
through all of the re-
sponses to the 2007-09 f-
nancial panicput a little
more money on reality.
Each time you sweep a
problem under the rug and,
as everyone reading this
can attest, trade by hope,
you make the problem big-
Visit our full catalog at
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With the exclusive, Traders Press Inc. Econoday Weekly Investors Journal, critical market events and the coming week,
month and year are always in view. You can anticipate potential times of market volatility to prepare accordingly; jot
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ONE OR THE OTHER
What to do, what to do?
Governments may like to
have their cake and eat it
too, but reality asserts itself
early and irrefutably on
occasion. A government or
central bank can fx an ex-
change rate or a short-term
interest rate, but it cannot
fx both simultaneously.
As the fundamental
equation for currencies
has the forward currency
level as a function of the
spot rate and the short-
term interest rates of the
two countries involved,
one is left with a single
equation and three un-
knowns. Even the people
who had to go to law
school because they were
poor algebra students
have to grasp this.
As an aside, this is why
currencies can move
around so much; there is
no one single price that
clears the system but
rather a large number
of spot rate and interest
rate combinations.
If a government pegs
the exchange rate in
a currency board sys-
tem as Argentina and
Bulgaria tried to do for
much of the 1990s, it
will have to increase or
decrease its short-term
interest rates fairly ac-
tively to maintain that
peg. This becomes an-
noying for both borrow-
ers and lenders, to say
the least.
If a country fxes a
short-term interest rate,
as the U.S. did in De-
cember 2008 or as Japan
frst did in March 2001,
the currency will have
to swing about as exter-
nal interest rates change.
This also becomes irk-
some, in this case for
importers and exporters.
As everyone in the
economy is either a
borrower or lender and
is involved in inter-
national trade via the
purchase of imported
goods if nothing else,
it is easy to see how
schemes to manage
currencies become ev-
eryones business rath-
er quickly.
THE EUROZONE CASE
The euro can be thought
of as a fxed exchange
rate among the Euro-
pean Monetary Unions
member countries.
It follows that each
member countrys short-
term interest rates, yield
curves and fxed-income
volatilities have to swing
about to absorb the
stresses resulting from
perceived changes in
credit quality.
The normal response for a
country faced with a capital
outflow and a weakening
currency would be a rise in
short-term interest rates relative
to long-term interest rates.
Visit our full catalog at
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With the exclusive, Traders Press Inc. Econoday Weekly Investors Journal, critical market events and the coming week,
month and year are always in view. You can anticipate potential times of market volatility to prepare accordingly; jot
reactions; track key indices or your golf score; and so much moreall in one convenient place!
Retail $45.00
TRADERS PRESS INC.
Order yOur 2011 ecOnOday Weekly InvestOrs JOurnal!
Pre-Order tOday & save 15%
Access FREE Webinars at WWW.PFGBEST.COM
LIVE WEBINARS!
There is a substantial risk of loss in trading commodity futures, options and off-ex-
change foreign currency products. Past performance is not indicative of future results.
Dates and times are subject to changePlease visit www.pfgbest.com/webseminar for
further details and up-to-date information!
USE VOlUME TO TradE in HarMOny WiTH inSTiTUTiOnal MOnEy
WednesdAy, FebruAry 2, 2011 3:30 PM CsT
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Western Europe has been
a longing for the single
political entity lost with
the collapse of the Roman
Empire in the west in 476
A.D. Get over it, already.
Returning to the short-
term interest rate dif-
ferentials, I have found
that prior to the Euro-
pean Central Banks May
2010 extension of a credit
backstop to Greece and
others (really to the pri-
vate commercial banks
different credit ratings
and different cultural
attitudes toward debt,
offcial corruption, tax
collection, etc.
This is not meant to
disparage anyone or any
country; it is almost the
defnition of a national
culture and why the geo-
graphic expression of
Europe includes many
small countries instead
of one large one. Much
of the cultural history of
One of the eurozones
central battles with reality,
alluded to in the found-
ing Maastricht Treaty of
1992 but then ignored in
practice, is the fction that
all of its members could
be forced into having the
same credit quality if only
they adhered to some arbi-
trary standards of budget
defcits, debt-to-GDP ratios
and the like.
In reality, of course,
different countries have
Source: Bloomberg data; calculations Simons Research
FIGURE 1: Only Greek Yield Curve Inverted
G
r
e
e
c
e
P
o
r
t
u
g
a
l
S
p
a
i
n
G
e
r
m
a
n
y
F
r
a
n
c
e
F
i
n
l
a
n
d
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a
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J
a
n
-
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o
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e
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c
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-
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e
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-
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O
c
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-
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1.225
1.200
1.175
1.150
1.125
1.100
1.075
1.050
1.025
1.000
0.975
0.950
0.925
0.900
0.875
0.850
F
o
r
w
a
r
d

R
a
t
e

R
a
t
i
o
,

2
-
1
0

Y
e
a
r
s
I
r
e
l
a
n
d
I
t
a
l
y
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e
l
g
i
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m
A
u
s
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r
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N
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t
h
e
r
l
a
n
d
s
that would have been
rendered functionally
insolvent had Greece and
others defaulted, but
that is a different story),
short-term rates and yield
curves between nations
varied quite widely.
Figure 1 is of the for-
ward rate ratios (FRR2,10,
the rate at which one can
lock in borrowing for
eight years starting two
years from now, divided
by the 10-year rate itself)
between two and 10 years
for 11 eurozone members
going back to the recog-
nized beginnings of the
problem in October 2009.
It shows how a fairly
uniform set of yield curve
shapes splits apart as the
situation developed.
What should one expect
to see here? The normal
response for a country
faced with a capital out-
fow and a weakening
currency would be an
increase in short-term
interest rates relative
to long-term interest
rates; the yield curve
does not actually have to
invert, but it should fat-
ten considerably.
What did happen? At
the risk of sounding as
if there were a moral-
ity play involved, one
can split the eurozones
members into the virtu-
ous and the, um, not-so-
virtuous credits.
FIGURE 2: 2-year Volatility Shot Higher in Weaker Credits
I
m
p
l
i
e
d

V
o
l
a
t
i
l
i
t
y
130%
125%
120%
115%
110%
105%
100%
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
35%
G
r
e
e
c
e
P
o
r
t
u
g
a
l
I
r
e
l
a
n
d
S
p
a
i
n
G
e
r
m
a
n
y
B
e
l
g
i
u
m
I
t
a
l
y
N
e
t
h
e
r
l
a
n
d
s
F
r
a
n
c
e
F
i
n
l
a
n
d
A
u
s
t
r
i
a
D
e
c
-
0
9
J
a
n
-
1
0
F
e
b
-
1
0
M
a
r
-
1
0 J
u
n
-
1
0
A
p
r
-
1
0
M
a
y
-
1
0
J
u
l
-
1
0
A
u
g
-
1
0
S
e
p
-
1
0
O
c
t
-
1
0
Source: Bloomberg data; calculations Simons Research
42
FEBRUARY 2011
www.sfomag.com
V
O
L
U
M
E

9
,
N
O
.
1
2

|

D
E
C
E
M
B
E
R

2
0
1
0
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steeper yield curves with
higher long-term inter-
est rates than they would
have faced otherwise. The
burden of adjustment for
the eurozone has been
shifted from a weaker cur-
rency and higher short-
term interest rates in its
weaker members to higher
long-term interest rates for
its stronger members.
This would hardly be the
frst time in history the
innocent were punished to
save the guilty, but none
of it was necessary. The
original sin herethe
attempt to fool Mother
Naturecame about with
the willingness to look the
other way after the Maas-
tricht Treaty was signed.
Traders and investors
will be coping with the
consequences of this un-
willingness to face reality
for years to come.
Howard L. Simons is president of
Simons Research, which provides
economic and fnancial analyses
and commodity trading advisories
for frms, traders and exchanges.
steepens because both
situations are seen as un-
stable by bond traders.
However, when dete-
riorating credit quality
overwhelms normal inter-
est rate considerations,
implied volatility can in-
crease. This occurs in cor-
porate bonds during times
of credit stress as well.
Three implications are
clear for the eurozone and
the integrity of the euro
going forward.
The frst is non-European
investors are going to have
to be plied with higher
short-term interest rates for
them to accept the curren-
cy risk of holding the euro.
Second, higher volatility
raises hedging costs and,
therefore, the costs of do-
ing business. This is never
bullish for risky assets.
The third and fnal im-
plication is that the more
virtuous members of the
eurozone are going to face
On the virtuous side,
FRR2,10s for Finland, the
Netherlands and Ger-
many actually steepened
as money fowed into their
short-term notes.
At the non-virtuous end,
the Greek yield curve
inverted, and the Portu-
guese, Irish, Spanish and
Italian yield curves fat-
tened as their short-term
interest rates had to rise to
compensate investors for
the increased credit risk. I
will return to the implica-
tions of this point shortly.
THE VOLATILITY
DIMENSION
I can illustrate this in an-
other way through two-year
zero-coupon volatility (see
Figure 2). As the credit cri-
sis unfolded, implied vola-
tility levels shot higher for
the lower-quality credits.
Normally, fxed-income
volatility jumps when rates
fall and the yield curve
Higher volatility raises hedging
costs and, therefore, the costs
of doing business.
The land Down Under has quietly
been shaping up as a land of invest-
ment opportunity.
While much of the world continues to
feel the ripple effects from the global
fnancial crisis, both Australia and New
Zealand have been growing steadily,
and analysts expect continued positive
economic activity in 2011.
WEATHERING THE STORM
Australia and New Zealand are poised
for further growth because of how they
weathered the global fnancial downturn
and the basic nature of their economies.
According to Srinivas Thiruvadanthai,
director of research at the Jerome Levy
Forecasting Center, a macroeconomic
research and consulting frm, Australia,
compared to other nations, was relatively
unscathed by the crisis in part because
the government contained the problem
before it spiraled out of control with a
massive stimulus package. It included a
steep cut in interest rates and a doubling
of the frst-time homebuyers grant.
&
Attract Investment Flows
Aussie
Kiwi
Attract Investment Flows
By Angie Pointer
The housing market, which was look-
ing to keel over, got a second wind of
life, he says.
Additionally, the swift stimulus kept the
Australian banking system from feeling
the same pressures that were seen in the
U.S. when the housing bubble burst.
There was never really any banking
crisis, so there was no reason to use pub-
lic money to bail out banks, says Mark
Dougan, managing director for Australia
and New Zealand at Frost & Sullivan, a
business research and consulting frm.
ABOVE WATER
Australia never went into a technical
recession. Since 2008, the country has
only experienced one quarter of negative
growth in gross domestic product.
Perhaps one of the most signifcant
and overlooked reasons Australia and
New Zealand have continued to grow is
their economic base in commodities.
[Australia has] an abundance of
pretty much any mineral that we would
fnd useful, says William Buechler,
president and chief investment offcer at
Buechler Capital Asset Management, an
investment advisory frm.
In addition to gold, iron ore, zinc, nick-
el, coal, uranium and bauxite, Australia
has enormous deposits of natural gas.
AGRICULTURAL PRODUCERS
And agriculture is important. Australia
is a major wheat producer, while New
Zealands top exports include dairy
products, meat and fruit.
This commodity foundation was impor-
tant because despite the fnancial turmoil
elsewhere in the world, Chinas voracious
appetite for raw materials did not slow.
During the downturn, the Chinese
economy didnt retract and, in fact, con-
tinued to grow. A large part of Australias
economic success has been around sell-
ing resources to China, particularly coal
and iron ore, Dougan says.
As the global situation began to im-
prove and commodity prices rose, both
New Zealand and Australia have ben-
eftted. For instance, the soaring price
of gold boosted Australias exports of it
36% in October, which widened the trade
surplus to A$2.63 billion from A$1.81 bil-
lion the previous month, according to the
Australian Bureau of Statistics.
OUTLOOK FOR 2011
The strength of coal and iron ore exports
to China, as well as high gold prices,
have ignited capital investment in Aus-
tralias mining industry that in turn has
increased employment. The boom in the
mining sector was cited by the Organi-
sation for Economic Co-Operation and
Development as the primary reason the
Australian economy is forecast to grow
robustly in 2011 and 2012.
The OECD predicts Australian GDP
will grow 3.6% in 2011 and 4% in 2012.
Strong growth, driven by terms of trade
48
FEBRUARY 2011
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tock
s, F
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an
cial m
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ets, as th
at is a
passin
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t. W
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at w
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g th
e political system
. W
ill th
is im
pact
th
e m
ark
ets?
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ese action
s by th
e govern
m
en
t w
ill create in
efficien
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at w
ill h
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to w
ork
th
em
selves ou
t over a few
years. B
u
t th
e n
et ou
tcom
e is goin
g to be on
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th
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an
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capitalism
. R
em
em
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begin
s w
ith
th
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ited
stock
com
pan
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h
is is a political in
ven
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, n
ot an
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om
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s
you
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person
al from
corporate w
ealth
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. T
h
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efin
ition
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an
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h
ow
it is d
istribu
ted
h
as alw
ays been
political.
W
e
e
k
l
y
gains and dynamic investment, will re-
duce unemployment, the group said.
In the quarter ended Sept. 30, GDP
grew 0.2% on a seasonally adjusted ba-
sis from the previous quarter. GDP has
grown 2.7% on an annual basis as of
Sept. 30, according to ABS data.
GROWTH AREA
Australia has growth potential in en-
ergy as well. Several enormous natural
gas projects are currently in develop-
ment, Buechler says. One of the largest
is Chevron Corp.s A$43 billion Gorgon
Project off Australias western coast.
The Gorgon Project, which includes
construction of a liquefed natural gas
plant, will be an important pillar of the
Australian economy for more than 40
years, said Chevron (CVX).
Analysts point out that several massive
projects like Gorgon are underway and are
expected to add billions to the nations GDP
and employ tens of thousands of workers.
Most analysts and economists agree
that Australia will see growth in com-
ing years, but the magnitude will depend
upon a lengthy list of variables.
GLOBAL GROWTH
Global economic conditions are also
critical to the level of Australias success.
The threat of a double-dip recession in
the U.S. or Europe could dampen Aus-
tralias growth.
Theres a remaining vulnerability to a
second downturn, or a fattening out, in
the global economy, Dougan says, who
expects to see the nations 2011 growth
around 2% or 2.5%.
[Australia has] an abundance of
pretty much any mineral that we
would find useful.
THE CHINA CONNECTION
If Chinas economic juggernaut slows
substantially, that could put the brakes
on demand for natural resources,
crimping Australias potential. Many
of Chinas commodity imports are pro-
cessed and then quickly turned around
for export. One example is cotton. China
is the top importer of U.S. cotton, which
is then processed and exported as tex-
tile products.
Australias top exports to Chinacoal
and iron oreare different, Thiruvadan-
thai points out. China uses most of the
iron ore and coal in the manufacture of
steel and electricity, fueling an expan-
sion of its infrastructure. If the Chinese
economy slows, then such infrastructure
development will wane as well.
The longer Chinas economy continues
to grow at break-neck speed, the more
the risk of a problem increases, Thiruva-
danthai says.
Its very diffcult to maintain this kind
of thing without having some kind of
accident, he cautions. However, ana-
lysts say predicting what will happen in
Chinaor whenis diffcult, especially
given the governments opacity when it
comes to economic information.
RISKS
Vulnerabilities within Australias own
economy are also variables in the growth
equation. While the resources and ag-
riculture sectors have performed well,
the Australian dollar has strengthened
considerably. That, in turn, has squeezed
other more traditional sectors such as
manufacturing, education and tourism.
The longer the currency, which has
recently been above or near parity with
the U.S. dollar, remains strong, the more
pain it inficts on sectors, such as manu-
facturing, that are dependant on price
competitiveness, Dougan says.
KIWI FORECAST
Looking to New Zealand, higher com-
modity prices and returning export
demand will fuel modest growth in 2011,
analysts and economists predict.
The OECD estimates New Zealand
GDP will grow by 2.7% in 2011 and 2.5%
in 2012, noting that the economic recov-
ery will become self-sustaining as busi-
nesses hire and invest to meet reviving
export and consumer demand.
In the quarter ended June 30, GDP grew
0.2% from the previous quarter on a sea-
sonally adjusted basis, and marked the
ffth consecutive quarter of increased eco-
nomic activity, Statistics New Zealand re-
ported. GDP for the year ended September
2010 was up 1.4% from the previous year.
Recovery is cautious and slow, but it is
happening, notes Andre Clarke, coun-
try manager for New Zealand at Frost &
Sullivan. If commodity prices continue
to go up, that fows through into higher
rural incomes, which benefts the rest of
the economy.
52
FEBRUARY 2011
Clarke also points to two important
events coming in 2011 that could beneft
New Zealands economy.
First is the huge reconstruction effort
needed in Canterbury province following
a massive earthquake in September 2010.
Damage estimates from the quake range
from NZ$4 billion to NZ$4.9 billion.
The rebuilding effort is likely to take
years, and that will have a huge boost to
the [provincial] economy and the wider
New Zealand economy in terms of con-
struction that needs to be done there,
Clarke says.
Second is the 2011 Rugby World Cup,
which will be held across New Zealand
from Sept. 9 through Oct. 23. Clarke says
the event is expected to bring in 80,000
to 85,000 visitors and revive a stagnant
tourism industry.
CLOUDS ON THE HORIZON
As is the case with Australia, New Zea-
land is vulnerable to a shock if global
economic conditions worsen or if com-
modity prices weaken considerably.
For both nations, the strong curren-
cies represent opportunity and potential
trouble. Many investors have focked to
the Australian dollar in recent months as
the nations economy grows and its inter-
est rates are attractive compared to other
investments, analysts say.
However, such a currency surge is not
without danger. If recession rears its
head again in the U.S. or Europe, the
The OECD
estimates New
Zealand GDP
will grow by
2.7% in 2011 and
2.5% in 2012, and
the recovery
will become
self-sustaining.
resulting fight-from-risk assets would
have negative consequences for the Aus-
sie dollar, Thiruvadanthai wrote in the
November edition of The Levy Forecast.
This is due to the fact that most of the
foreign investment in Australia is in risk
assets such as real estate, unlike in the
U.S., where most foreign investment is in
Treasury vehicles such as bonds, which
are viewed as safe havens for investors
in times of uncertainty, he explains.
COMMODITY DEMAND IS KEY
Nonetheless, Buechler concludes the
long-term growth potential for Australia
and New Zealand outweighs any risk
because demand for basic commodities
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including food, fuel and raw materials is
unlikely to dry up.
Large mining or energy projects such
as Gorgon that often come with multi-
decade contracts, are not vulnerable to
economic or currency fuctuations in the
next quarter or the next year.
The immensity of these projects prob-
ably means that economic growth will
tend to be positive for several decades to
come, he says.
Angie Pointer is a freelance writer based in the
Chicago area.
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56
FEBRUARY 2011
The term BRICs, which describes the
economies of Brazil, Russia, India and
China, is now nearly a decade old. This
collection of economies has had an im-
pressive expansion and weathered the
global downturn in a remarkable way.
However, with their success and grow-
ing role globally, these economies are
no longer viewed as new frontiers.
The new up-and-comers are coun-
tries with some common and attractive
features that make them an interesting
collection of economies to watch. The
New
INVESTING
HORIZONS
BY CHARMAINE BUSKAS
CIVETS include Colombia, Indonesia,
Vietnam, Egypt, Turkey and South Af-
rica, and take their name from a cat-like
animal found in many of these areas.
This is one of many new monikers
for emerging markets. There is a larger
group called the N-11 (or next-11), which
is comprised of 11 countries poised for
robust growth. But here I focus on a few
of the CIVETS.
TURKEY REFORMS
Several features make the Turkish
economy stand out. First, its population
dynamics are attractive. At 77 million
people, Turkey is largely comprised of
working age citizens (those between 15
and 64 years old). That bodes well for
domestic demand going forward.
Not only does a large, young population
provide a long-term source of demand,
but Turkeys location as a bridge be-
tween central Asia and Europe makes it
an important trade route.
Because of its location and economic
progress, Turkey has been exploring
free trade agreements with the Europe-
an Union. This could leverage the deep
relationship between Turkey and the EU,
which is Turkeys No. 1 import and ex-
port market, while Turkey ranks as the
EUs ffth largest export market.
Moreover, like a number of Asian econ-
omies that weathered the Asian fnancial
crisis in 1997 and subsequently went
about implementing structural reform to
repair their damaged economies, so did
Turkey after its crisis in 2001.
In the aftermath, Turkey implemented
comprehensive structural reforms. These
included important changes to the bank-
ing system and its regulatory framework.
Also, Turkey implemented tighter fscal
and monetary policies, and privatization
of some key industries. These measures
were instrumental in buffering Turkey
against external shocks and provided a
strong macro backdrop to help it weather
the global recession.
With such circumstances, the growth out-
look appears favorable. The combination of
solid consumer demand and healthy bank
balance sheets may have paved the way for
the economy to have grown by nearly 8% in
2010, according to International Monetary
Fund forecasts in early December.
For 2011, the IMFs forecast is a little
softer at 3.6% gross domestic product, but
it is still quite respectable, considering
the expected performance of Turkeys
largest trading partners in the eurozone.
The expected robust performance of this
country sets it apart from its peers in
central and eastern Europe.
In conjunction with strong growth
fundamentals, Turkey has seen massive
foreign direct investment fows, and the
liras strong appreciation has created dif-
fculties for exporters.
But data suggest that some degree of
cooling is already taking place. Infation
slipped to 7.3% year-over-year in Novem-
58
FEBRUARY 2011
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ber from 8.6% y/y in October. The gover-
nor of the Central Bank of Turkey noted
recently that increases to offcial rates are
unlikely to occur until late in 2011 be-
cause of softening infation trends.
Aside from the expected lack of yield pick-
up this year, the outlook has other risks.
These are largely exogenous factors such as
growth in the eurozone, as that region con-
tinues to struggle to keep its footing amid
lingering debt problems in its periphery.
Related to this is how global risk appe-
tite unfolds in the coming year, as well as
how Turkish domestic political stability
is maintained to keep consumer conf-
dence buoyed.
DOMESTIC DEMAND DRIVES INDONESIA
On the whole, Asia rebounded quickly fol-
lowing the global fnancial meltdown in
2008, with an impressive recovery in 2009
and early in 2010.
Throughout 2011, as the global recov-
ery continues, Asia will remain a global
leader. More specifcally, growth in coun-
tries driven by domestic demand, such as
in Indonesia, appears more lasting than
in other smaller Asian countries.
NEW FRONTIERS
Common ground for the
CIVETS countries is that they
all feature similar attractive
structural features, such as
large and young popula-
tions, diversifed economies,
generally controlled infa-
tion, relative political sta-
bility and some degree of
fnancial stability.
These new frontiers in emerg-
ing markets are going to
become increasingly important
to watch as the global recov-
ery becomes more entrenched
and risk appetite comes back
(see Figure A).
Investors will become pro-
gressively choosy about
where they invest their money,
R
e
a
l

G
D
P
,
Q
u
a
r
t
e
r
l
y

%

C
h
a
n
g
e

f
r
o
m

a

Y
e
a
r

A
g
o
World
Advanced Economies
Emerging Economies
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
2
0
0
7

Q
1
2
0
0
7

Q
2
2
0
0
7

Q
3
2
0
0
7

Q
4
2
0
0
8

Q
1
2
0
0
8

Q
2
2
0
0
8

Q
3
2
0
0
8

Q
4
2
0
0
9

Q
1
2
0
0
9

Q
2
2
0
0
9

Q
3
2
0
0
9

Q
4
2
0
1
0

Q
1
2
0
1
0

Q
2
2
0
1
0

Q
3
2
0
1
0

Q
4
2
0
1
1

Q
1
2
0
1
1

Q
2
2
0
1
1

Q
3
2
0
1
1

Q
4
FIGURE A: Emerging Markets Are Poised to Outperform
particularly given the les-
sons of the recent fnancial
turmoil. As such, with a strong
fundamental backdrop and
Source: IMF
positive cyclical drivers, these
economies may be poised to
reap the rewards of the return
of risk appetite.
60
FEBRUARY 2011
One characteristic that puts Indonesia
into this unique class is positive demo-
graphic trends that underpin a healthy
long-term outlook. As the fourth most
populous country in the world, more
than half of its population is under 30
years old. That bodes well for consump-
tion prospects for quite some time.
Moreover, the composition of the
economy as well as the physical location
of the country suggest that it will easily
be able to leverage its position as a top
natural resource exporter.
It also has a solid manufacturing base
with one of the lowest unit labor costs
in Asia, so it can sell goods to expand-
ing economies such as China and India,
which are geographically close.
The IMF estimates that Indonesian
GDP will have expanded by 6% in 2010
and will grow by 6.2% this year, thanks
in large part to robust consumption and
investment, plus the additional support
from planned infrastructure spending.
This is slightly lower than its projection
for Asian GDP growth of about 8% in
2010 and 7% in 2011.
Keep in mind that the forecast for all of
Asia is skewed higher by China and India.
On the currency front, however, like
a number of strong global perform-
ers, Indonesia has had to deal with the
rampant appreciation of its currency,
the rupiah, much to the chagrin of its
central bank. Its decision to keep offcial
rates steady at 6.5% through most of 2010
Investors & Traders
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comes as little surprise as the lack of
yield pick-up deters hot money fows.
The central bank has repeatedly aired
concerns about strong foreign infows
and their potentially destabilizing ef-
fects. This ultimately may give way to
the central bank pursuing measures to
contain volatile capital infows, such as
forcing investors into longer-term in-
struments, if low offcial central bank
rates are unable to contain the fows.
Recently, the central bank imposed a
one-month holding period for all (foreign
and domestic) holders of central bank bills.
However, despite infation complicating
matters for the central bank as it has re-
cently proven to be hotter than expected
at 6.3% y/y in November due in part to
weather-related increases in food prices
(which comprise a larger share in the
Consumer Price Index than elsewhere),
the bank still can pull other policy levers
to deter hot money fows.
But the outlook does have risks; most
have to do with the external environment.
The primary risk is that the global
recovery will stall or disappoint expec-
tations. Indonesia is somewhat insulated
from the negative effects of a slowdown
in the U.S. or the eurozone because of its
strong intra-Asian trade linkages.
Nevertheless, a disappointment in
growth in the developed world could
lead to a retrenchment of risk appetite.
This in turn would affect frontier coun-
tries such as Indonesia, because Asian
debt and equity markets tend to be high-
ly correlated to global market trends.
Lastly, what the global crisis has high-
lighted is the importance of ensuring
that private domestic demand becomes a
more prominent engine of growth. This is
already true for Indonesia, but it remains
an important theme not to be ignored.
COMMODITY RICH SOUTH AFRICA
South Africa is the largest economy on
the African continent, but in compari-
son with the stellar growth prospects in
other newly emerging economies, South
Africas outlook may appear as a rela-
tive laggard. Regardless, it exhibits some
positive attributes.
First, the bulk of its large population is
of working agea positive and common
feature of all the economies discussed
in this piece. However, its chronically
high unemployment rate prevents this
age cohort from fully contributing to the
economy. The countrys population of 49
million is the worlds 25th largest, but it
is the second smallest of the CIVETS.
South Africas large wealth of natural
resources has long been an important fea-
ture of the economy. Besides large mining
and mineral operations, the country has
a substantial agricultural sector, which
means that South Africa can participate in
a commodity-led global expansion.
Indeed, robust commodity demand was
the key feature of the 2004 to 2008 ex-
pansion there.
62
FEBRUARY 2011

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FIGURE 1: Countries with Strong Fundamentals Will Do Comparatively Better
Gold is among South Africas top ex-
ports, as is platinum and other minerals.
The fact that its top two export markets
are China and the U.S., where 10% and
9% respectively of exports fnd their
home, means the economy should have
a strong lever to global expansionpar-
ticularly because of its linkage to China.
However, it was exactly those connec-
tions that created an undertow for South
Africa in the past two years. Its strong
linkages to the global economy at a time
of extreme pressure exacted a heavy toll.
As such, South Africa slipped into reces-
sion in 2009.
G
D
P
,

A
n
n
u
a
l

%

C
h
a
n
g
e
10%
8%
6%
4%
2%
0%
-2%
-4%
-6%
2007 2008 2009 2010 2011
Turkey Indonesia South Africa World U.S.
But now that there is some momentum
developing in the economy, the IMF es-
timates that its GDP may grow between
3% and 3.5% in 2010-2011.
To kick-start growth once again, Presi-
dent Jacob Zuma recently reshuffed the
cabinet and released a new economic
strategy. It is aimed at reducing the unem-
ployment rate from 25% to 15% by 2020.
Even with positive plans for the future
in place, the central bank has still had
to acknowledge that the economy re-
mains fragile.
Adverse global developments make the
outlook more uncertain, and moderating
Source: IMF
64
FEBRUARY 2011
price pressures will keep infation well
within the central banks 3% to 6% infa-
tion target. These factors underpinned
the 50 basis point rate cut to 5.5% in No-
vember and add to the already 600 basis
points of rate cuts delivered during the
past two years.
TOP PICKS
Clearly, the growth stories differ among
the CIVETS, but within this group are
positive underpinnings. Investors can
take advantage of these countries rela-
tively better performances compared to
developed markets (see Figure 1).
As the global recovery continues to
unfold and risk appetite returns to the
market, investors will be incredibly dis-
cerning. Therefore, the expected rally
in emerging markets in 2011 will be
marked by those countries with the best
fundamentals, and investors will be less
focused on the search for pure yield.
In this regard, the Turkish lira and
Indonesian rupiah look better positioned
compared to the South African rand.
They offer the yield play and have solid
fundamentals to back it up.
Charmaine Buskas is an independent global mar-
kets strategist with 12 years of experience.
To request the latest copy of our Weekly
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In a world of equity market neutrality,
funds of funds and global macro-eco-
nomic models, the idea of trading like a
hedge fund is more of a concept than a
specifc strategy. In fact, at the end of the
day trading like a hedge fund has less to
do with complex methodologies or high-
frequency trading and far more to do
with trading and investing like a pro-
fessional: consistently, confdently and
successfully.
Even more to the point, trading like a
professional means, above all else, be-
ing successful whether the market is
moving up, down or sideways. It is about
balance, balancing your portfolio with
strategies designed for different condi-
tions.
The best and most successful hedge
funds consistently make money in all
market environments. And most often
they use multiple strategies to accom-
plish this goal.
Now, we at The Connors Group do not
claim to know all the different strategies
that these elite hedge funds use. But our
researchculminating in the develop-
ment of a new software resource called
The Machine
has uncovered what we believe are three key combina-

tions of strategies that every trader can use to begin trading with the same
reliability as the savviest hedge fund professional.
The three combinations are:
1. Trade stocks and exchange-traded
funds.
In a world of equity market neutral-
ity, funds of funds and global macro-
economic models, the idea of trading
like a hedge fund is more of a concept
than a specifc strategy.
In fact, at the end of the day trad-
ing like a hedge fund has less to do
with complex methodologies or high-
frequency trading and far more to
do with trading and investing like a
By Rob Davenport and Kevin Heller
professional: consistently, confdently
and successfully.
Even more to the point, trading like a
professional means, above all else, be-
ing successful whether the market is
moving up, down or sideways. It is about
balancing your portfolio with strategies
designed for different conditions.
The best and most successful hedge
funds consistently make money in all mar-
ket environments. And most often they use
multiple strategies to accomplish this goal.
Now, we at The Connors Group do not
claim to know all the different strate-
gies that these elite hedge funds use.
But our researchculminating in the
development of a new software re-
source called The Machinehas un-
covered what we believe are three key
combinations of strategies that every
trader can use to begin trading with the
same reliability as the savviest hedge
fund professional.
The three combinations are:
1. Trade shares of stocks and exchange-
traded funds.
2. Trade mean-reversion (i.e., pullbacks)
and trend-following strategies.
3. Trade both the long and the short side
of the market.
These combinations are critical for
building a balanced portfolio that can
participate in bull markets, take advan-
tage of strategic opportunities in bear
markets and earn money when markets
are rangebound.
Importantly, even traders and inves-
tors who cannot incorporate all of these
combinations into their methodology can
beneft from creating more balance.
TRADE STOCKS AND EXCHANGE-
TRADED FUNDS
Equities are at the core of our trading
and investing strategy. No other asset
class provides the same level of potential
reward as stocks do.
When traders have historical edges on
their side, it is possible to buy and sell
stocks proftably and consistently with
high win rates and low drawdowns. Our
research has found that using mean-
reversion strategies for short-term hold
periods of two to 10 days when trading
stocks produces this edge.
More than a decade's worth of research
has led us to this simple conclusion:
Over short hold periods, it is generally
best to buy weakness above the 200-day
moving average and sell strength below
the 200-day moving average. Most of our
short-term trading strategies are based
on this simple premise.
The growth of exchange-traded funds
during the late 1990s and the explosion
of these products in the frst decade of
the 21st century created enormous po-
tential for short-term traders. And we
wondered if short-term edges could be
defned and quantifed in ETFs the same
way they have been in stocks. Could
buying weakness and selling strength
68
FEBRUARY 2011
work as a high-probability strategy for
trading ETFs?
The book High Probability ETF Trad-
ing by Larry Connors and Cesar Alvarez
published research in 2009, which proves
that mean-reversion strategies work for
exchange-traded funds. Additionally, the
returns from ETFs are less volatile and
in many instances have even higher win
rates than stock strategies.
More important, high-probability ETF
strategies can be combined with those
for stocks in portfolios that represent the
best of both worlds: the diversifcation
of ETFs with the potential for outperfor-
mance of individual stocks.
Combining short-term ETF trading
strategies with short-term stock strategies
will generally reduce the overall volatility
of a portfolio, smoothing the equity curve
and minimizing drawdowns.
TRADE MEAN-REVERSION AND TREND-
FOLLOWING STRATEGIES
For many years, short-term mean-
reversion trading strategies have been
the core of our research. They have per-
formed well through a variety of market
conditions. Nevertheless, they tend to
provide traders with less exposure to the
market than desired during extended,
low volatility bull markets, such as the
last two-thirds of 2009.
This means that traders have a poten-
tial opportunity when they expand their
trading beyond mean reversion.
In 2010, The Connors Group was able,
for the frst time, to quantify edges in
longer-term trend-following strategies.
By adding trend following to a portfolio
otherwise built on quantifed mean-
reversion strategies, traders can achieve
several critical goals:
1. Create an even smoother equity
curve. This is no doubt due to the
portfolio's ability to ride high-quality
stocks or ETFs higher for months at
a time.
2. Decrease the volatility of the portfolio
while key variables such as the Sharpe
Ratioa risk metric developed by No-
bel laureate William Sharpecan be
improved signifcantly.
3. Help meet the most fundamental
goal of making money in any market
environment. This is because mean-
reversion strategies often begin to
buy selectively just as trend-following
strategies are cashing out.
TRADE LONG AND SHORT STRATEGIES
Whether the beginning point is 17th
century Amsterdam (the frst stock
exchange), the U.S. crash of 1929 or the
Reagan era, there is no denying that
stocks have had a strongly upward bias
over the long term. The investing phi-
losophy of buy and hold is built almost
exclusively on this historical fact.
But it is also true that during specifc,
signifcant stretches stocks have not
moved higher. In fact, for many peri-
ods1962 to 1978, 2000 to 2010stocks
have made no gains at all. During these
timeframes, stocks have essentially
moved sideways.
And this is to say nothing of those
times when markets have had a strong
bias downward, such as in 1969, 1973,
2002 and late 2007 to spring 2009. Even
those stocks that were not decimated
during these vicious bear markets
brought signifcant losses of 20%, 30%
or more to the portfolios of those who
invested in them.
Active investing in the 21st cen-
tury means building portfolios that
are equipped to deal with the reality
that markets shift among periods of
growth, decline and stagnation. Be-
cause of this, it is advantageous to use
both long and short equity and ETF
trading strategies.
Much has been written about the
fallacies of trying to time the market.
Attempting to predict which way the
market will move is a game that simply
cannot be won consistently. Instead,
sophisticated money managers build
portfolios that include strategies that
allow them to have an edge in all
market conditions. That includes
trading short.
It is worth pointing out that despite
the significant advantages of trading
both long and short, our mean-rever-
sion approach has been successful
even when trading only on the long
side. Traders who simply prefer to
remain on the buy sideor who are
prohibited from trading on the short
side due to individual retirement ac-
count restrictions, for examplehave
nonetheless been able to profit from
trading only long positions. They
trade on the "buy weakness" side of
the buy weakness, sell strength trad-
ing formula.
FIGURE 1: Backtested Performance of Portfolios in The Connors Group Study
PORTFOLIO NUMBER OF
STRATEGIES
STRATEGY
TYPES
ANNUAL
RETURN
WIN % SHARPE
RATIO
MAXIMUM
DRAWDOWN
1 1 ETF Pullback 16.80% 75% 1.34 -11.36%
2 2
Stock Pullback, ETF
Pullback
19.21% 73% 1.79 -11.46%
3 3
Stock Pullback, ETF
Pullback, Trend Following
17.25% 72% 1.84 -9.52%
4 5
Stock Pullback, ETF
Pullback, Trend Following,
Stock Short, ETF Short
17.70% 72% 2.94 -4.73%
Source: The Connors Group
70
FEBRUARY 2011
PUT IT ALL TOGETHER
Combining these concepts in one port-
folio results in improved performance.
Figure 1 shows the backtested perfor-
mance of a portfolio as diversifed strat-
egies are added. The allocation remains
equally split among the strategies in all
four cases.
Portfolio 1 is 100% allocated to a single
ETF mean-reversion strategy.
Portfolio 2 splits the allocation be-
tween two strategies: a stock and an
ETF mean-reversion strategy.
Portfolio 3 adds trend following.
Portfolio 4 adds two short strategies
(one stock and one ETF).
The addition of different strategy
types to the portfolio has minimal
impact on the returns (compound an-
nual growth rate); however, the added
strategies signifcantly improve the
risk-management capability of the
portfolios. The Sharpe Ratio more than
doubles, and the worst-case drawdown
is reduced to less than -5% by adding
the diversifed strategies.
Each of the three combinations dis-
cussed here is valuable in and of itself
and will improve the consistency of a
portfolios performance. If an individual
trades stocks, he or she should consider
adding ETF strategies. If one is a short-
term trader, one should consider includ-
ing trend following.
And if a trader already plays stocks
and ETFs but focuses mostly on the buy
side, then he or she should consider
adding short strategiesin stocks and
ETFsto balance the portfolio and im-
prove the bottom line.
At the end of the day, whether some-
one trades stocks or ETFs, the long or
short side, pullbacks or trendsor, of
course, all of themthe goal is always
the same. As Paul Sabo, the head trader
for a large hedge fund, puts it: What
is your goal as a trader? Your goal is to
make money. How do you make money?
You make money by having an edge.
To trade like a hedge fund, one needs
an edge, ideally, a quantifed edge. And
one needs diversifed strategies with
quantifed edgesstocks and ETFs,
mean reversion and trend following,
and long and short strategies.
This is the secret of the top-tier pro-
fessionals. They create portfolios that
are balanced and can perform well
in any market environment. With the
information available and with todays
technology, this goal is now within the
reach of the individual trader and ac-
tive investor.
Rob Davenport is the chief marketing offcer for The
Connors Group. Kevin Heller is the lead technical
writer for The Machine.
319.553.2100 800.553.1711
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T HERE I S A SUBSTANT I AL RI SK OF LOSS I N T RADI NG COMMODI T Y FUT URES, OPT I ONS AND OFF- E XCHANGE FOREI GN CURRENCY PRODUCT S.
China has been driving the price of
copper for years. In 2009 alone,
the country imported a record 3.2
million metric tonnes of it, up 119%
from 2008. China is the worlds
leading consumer, and its economic
infuence on the metal should con-
tinue to escalate.
strength. Recently, high
unemployment coupled
with foreclosures and a
sluggish housing sector
have strained the Ameri-
can economy.
In many respects, cop-
per has become the for-
gotten precious metal,
despite its status as the
material that runs the
economy. For instance,
65% of copper produced
is used for electrical ap-
plications, such as in
transformers, motors and
generators to provide
electricity. And here are
more examples of how it
is used:
50 to 80 pounds of copper
go into one automobile.
A 22,000 square-foot
house requires about
450 pounds of copper.
A Boeing 727 airplane
uses 9,000 pounds of
the metal.
COPPER AS AN
INDICATOR
The construction and
housing sectors are key
indicators of the U.S. econ-
omys health.
As noted, the construc-
tion industry requires
a massive amount of
copper; for this reason,
many economists use
the metal as a gauge for
measuring economic
ing economy that has an
insatiable thirst for both
precious and base metals.
China and India will need
signifcant amounts of
copper to modernize their
electricity and plumb-
ing infrastructures. This
demand story is a trend I
feel will continue to grow
by leaps and bounds.
KNOW THE MARKET
When trading copper via
a futures contract, it is ex-
tremely important to un-
derstand the marketplace.
Copper typically follows
gold and silver, but these
are not normal times.
Volatility in the precious
metals sector has caused
these metals to shrug off
their usual indicators and
trends. In addition, the
trading volume in copper
is substantially less than
that of gold and silver,
which adds to its volatility.
It is imperative that
copper traders use stop-
loss orders as well as exit
initiatives every time they
open trades. As in all mar-
kets, there will be many
opportunities to enter a
Despite a U.S. slow-
down, demand for copper
has continued to increase,
and in the past few years
its price (like that of sil-
ver and gold) has esca-
lated. This is largely due
to heavy demand from
China, which is estimated
to represent 38% of the
copper market.
The Chinese are pres-
ently enjoying a thriv-
74
FEBRUARY 2011
winning trade; however,
high volatility and volume
issues have created huge
swings and choppy trad-
ing conditions.
In other words, there is
great opportunity along
with substantial risk
when trading copper. And
with the current state of
the global economy and
day-to-day uncertainty, I
predict traders will con-
tinue to see huge price
fuctuations in precious
and base metals.
Technically, gold, silver
and copper are all in over-
FIGURE 1: Top 10 Copper Producers
0 1,000,000 2,000,000 3,000,000 4,000,000 5,000,000 6,000,000
5,320,000
1,310,000
1,260,000
960,000
950,000
900,000
750,000
655,000
580,000
440,000
2009 Copper Production (Metric Tonnes)
United States
Peru
China
Indonesia
Australia
Russia
Zambia
Chile
Canada
Poland
Source: Copper Investing News

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5
experiencing historically
high prices in its basket of
commoditiesthat is, in-
fation. Economic experts
believe the Peoples Bank
of China will continue to
increase interest rates to
compensate for the coun-
trys rising prices.
Under normal economic
conditions, when a central
bank raises rates, pre-
cious metals prices are
usually sent tumbling.
However, savvy investors
and traders have been
anticipating rate hikes
and thereby lessened the
recent increases effect.
More rate hikes are
projected, so traders must
guard their precious met-
als positions with either
hedged positions or stop-
loss orders.
MORE OF THE SAME
The forecast for precious
metals appears to be a
continuation of the cur-
rent trend.
In 2010, gold hit new all-
time highs, silver reached
30-year highs and copper
traded at unprecedented
levels. These prices are
bought territory. In fact,
they have been techni-
cally overbought for years,
and they continue to trend
higher despite this status.
Fundamentally, tremen-
dous global demand to
own precious metals and
coppers versatility are
keeping its prices lofty.
Because we are in un-
chartered water and in
the midst of high de-
mand for all metals, trad-
ers should create a game
plan to provide the best
opportunity for success.
They must adapt and do
their homework.
For example, a copper
trader should monitor
key producing regions
(see Top 10 Copper
Producers), watching
for possible shut downs,
work strikes or war out-
breaks. In addition, they
should choose strategies
that ft their personalities
and their pocketbooks.
I have been a fan of using
option spread strategies
that are inexpensive and
limit risk for trading copper
in such uncertain condi-
tions. For instance, a bull
call spread is a hedged po-
sition with full liability al-
ready factored in, meaning
a trader can only lose his or
her initial investment.
MONITORING INFLATION
Traders must also keep an
eye on the Peoples Bank
of China. Because Chinas
economy is growing at
a phenomenal rate, it is
76
FEBRUARY 2011
YOU KNOW?
The American penny was made of 100% copper until
1982, when the actual price of copper became so high
it was more than the value of the penny itself. Since
then, the United States Mint has made pennies using
97.5% zinc covered with a thin copper layer.
DID
with a second round of
quantitative easing tak-
ing place through June
2011, there are hopes of
a brighter U.S. housing
and employment pic-
ture ahead. If the global
economy continues as
it is, I expect copper to
follow gold and silver to
higher levels.
Mike Daly is senior precious met-
als analyst at PFGBEST Research.
will continue to buy gold
as a safe-haven invest-
ment to protect wealth.
Higher gold prices will
in turn boost the price
of copper.
Supply and demand
are factors in any mar-
ket, and as noted, there
is signifcant underlying
fundamental support for
coppernamely over-
whelming demand from
China and India.
However, this mar-
ket experiences volatile
price fluctuations. And
not without merit. If the
global economy continues
in this manner, I expect
precious metals to contin-
ue their moves higher.
Silver and copper have
many more industrial
uses than gold, but both
track its movements.
Because investors glob-
ally have lost confdence
in fat currencies and
savvier investors have
chosen gold as their cur-
rency of choice, I believe
that until the world econ-
omy stabilizes, people
HOW WELL ARE YOU SLEEPING?
In these uncertain fnancial times,
Economies may rise and fall, currencies may
come and go, but precious metals endure.
Diversifcation helps protect your portfolio against
fuctuations in the value of any one-asset class.
Precious metals are an ideal diversifer because
the economic forces that determine the price of
precious metals can be different from, and in many
cases opposed to, the forces that infuence most
fnancial assets. These advantages are currently
attracting considerable attention from fnancial
professionals and sophisticated investors worldwide.
WELL HELP YOU DIVERSIFY.
PreciousMetals
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Precious metals markets are highly volatile and have wide swings on a daily basis and should be considered a high risk investment.
WORDS OF
WISDOM
from World Cup Winners
WORLD CUP TRADI NG CHAMPI ONSHI PS
With actual money on the line, the World
Cup Trading Championships have earned
the reputation of being the true proving
ground for traders. As such, it makes sense
By Heather Larson-Blakestad
80
FEBRUARY 2011
to turn to the winners for their stories and
hard-won advice.
For 2010, the contest included two divi-
sions: stock trading and futures and forex
trading. From Jan. 2 through Dec. 31,
2010, individuals fought against the mar-
kets and each other to turn an opening
account of $15,000 into much more. This
time, competitors with past World Cup
experience had the edge:
Stock division winner Kurt Sakaeda
had a 21.5% return. This is his fourth
top fnish in the championship.
Stock division runner-up Chuck
Hughes earned a return of 7.9%. He is a
three-time past winner.
Futures and forex division frst-place
fnisher Andrea Unger had returns of
239.6%. He has won the division three
years running, a frst for the competition.
Futures and forex division second-place
fnisher Brady Preston brought in a
return of 193.2%. He placed third in the
2009 contest, his frst year competing.
Read on for valuable insights from
Sakaeda, Unger and Preston.
GET IN ON THE ACTION
If you think you have what it takes to beat
the worlds top traders and earn the 2011
World Cup Trading Championship trophy,
now is the time to enter. Be sure to check
out the complete list of prizes for both
competitors and winners.
Kurt Sakaeda, 2010 World Cup Trading Champion,
stock division
Leaving class at Chicagos
DePaul University in late
May 1979, Kurt Sakaeda
saw a giant plume of black
smoke in the sky. It was the
remnants from an aviation
accident where an engine
fell from a DC-10 jet, killing
all aboard.
The aircraft was manu-
factured by McDonnell
Douglas, which was high-
lighted in national news.
Sakaeda, a computer and
mathematics major in
college, noticed that the
companys stock price
plummeted in the wake of
the accident.
He told his father, I bet
the stock recovers. His
father replied, Dont bet
with me, go fnd a bro-
ker, which Sakaeda did.
Using part of his tu-
ition money, he bought
100 shares of McDonnell
Sakaeda Succeeds
WITH SEASONALS
By Kira McCaffrey Brecht
Douglas stock, his frst
trade. He remembers see-
ing a news story that fo-
cused on the fact that Mc-
Donnell Douglas was 75%
McDonnell aviation fghter
jets and 25% Douglas com-
mercial jets, which added
fuel to Sakaedas underly-
ing premise for the trade.
He placed a bid for the
stock at $21 per share and
held it for about a month
selling at $27 per share.
Profting about $600 on the
trade, Sakaeda remembers
feeling like he knew ev-
erything there ever was to
know about trading.
THE WORKFORCE
After graduation, Sakaeda
continued to dabble in
stock trading, while work-
ing as a computer pro-
grammer for a variety of
frms. It turns out, he says,
that the McDonnell Doug-
las trade was bad luck for
me, because I thought I was
very clever. I dont think I
had another winning trade
for about three years.
For 20 years, Sakaeda
continued working as a pro-
grammer, but traded pro-
gressively more on the side.
COMPUTER SKILLS
He directly applied the
skills from his profes-
sional career to trading.
He explains, I worked on
servers; I could run mil-
lions of tests.
In 1992, after a friend
mentioned the concept of
seasonal price variances
in commodity futures,
Sakaeda purchased his-
torical data on soybeans.
After running his own
tests, he found out his
friend was right.
82
FEBRUARY 2011
At harvest time, price
goes down, while during
planting season prices go
up, he says.
The following year, he
opened a trade based on
this seasonal factor. I
shorted beans in June,
picked them back up in
October and made a couple
thousand dollars, he says.
FULL-TIME TRADING
Over the years, Sakaeda
began to play a game with
himself regarding his
tax withholding from his
paycheck. As his profts
from trading increased,
he instructed his person-
nel offcer to deduct larg-
er and larger amounts of
withholding for taxes.
Since 2001, Sakaeda has
been a full-time trader.
Today, he trades a bit of ev-
erything, including stocks,
stock options and futures.
I had long said when I
get to 100% withholding,
Id quit. I was trying to get
it [paycheck] down to 1
cent, so I could keep my last
paycheck as a souvenir,
Sakaeda says.Computer
programmers make
$60,000-$70,000 a year, but
all my paycheck was be-
ing withheld for taxes on
my futures trading. My last
paychecks were 5 cents and
38 cents, he remembers.
He is primarily a systems
trader, though he does enjoy
entering contrarian trades,
based on the popular maga-
zine cover trade idea.
In September and Oc-
tober 2010, Sakaeda
noticed that magazine
covers were highlighting
the continuing collapse
of the housing market.
Playing the contrarian
angle, Sakaeda bought
housing-related stocks,
SAKAEDAS BOTTOM LINE
Kurt Sakaeda tells new traders: People with very good inten-
tions will give you good advice that will be 100% wrong. If you
have a theory about something, you need to test it. I am a
quant. Its not about what I feel in my heart. Ive tested, and
this stock eight times out of 10 will rise at this time of the year.
such as Whirlpool and
Mohawk carpets.
How is he doing on that
trade? I havent lost any-
thing yet, he says as of
early January.
MOSTLY SYSTEMS
However, 90% of his
trading is based on two
systems: the seasonal
commodity system and a
seasonal stock system.
Although he wrote both
of the systems years ago,
each year he tweaks and
adds extensions. Through
research and testing, he
fnds that like commodities,
certain individual stocks
boast seasonal factors:
Anheuser-Busch and
Coke peak in the summer
because people dont drink
as much beer and soda in
the winter, he says.
Retail stocks fnd their
peak Dec. 1 due to the
holiday shopping season.
The Hershey Company
tops on Valentines Day.
He explains, A lot of
companies are tied to
these cycles as well.
The ability to adapt is crucial for suc-
cessful trading as both the 2010 World
Cup Trading Championships futures
and forex division winner and runner-
up know.
Andrea Unger competed with three
accounts in 2010a normal account
trading the E-mini S&P 500, FDAX
futures, EuroFX futures and crude oil
futures; a highly aggressive account
open to any electronic market showing
opportunity; and a WorldCupAdvisor
account for people to follow that fo-
cused on four forex pairs. These ac-
counts fnished in frst, fourth and ffth
place, respectively.
Unger explains that despite his win in
the 2009 competition, he was not fully
satisfed with his systems: I needed
some diversifcation, and thats why I
added crude oil to cover energy in ad-
dition to index futures and currency
futures. By adding a new market, I
thought I would be able to cover some
periods where the indexes were not
moving enough.
Brady Preston, who fnished in sec-
ond place, also diversifed more in 2010,
adding a few systems that traded across
many markets.
Another adjustment that helped Pres-
ton was the automation of his systems
with Trade Navigator (the year prior
he used the electronic platform Rob-
bins Trading Company provided). This
helped smooth errors caused by manual
execution, he says.

2011 GAME PLAN
Both traders intend to compete again this
year. Preston will use an aggressive mon-
ey management style focusing more on
return versus reward to risk. He will use
his E-mini system again, but he plans to
apply more systems to the E-mini.
In 2011, Unger will compete with only
one account in hopes of fulflling his
goal of winning the competition with
the account that allows followers. To do
so, he will modify his position sizing to
dampen the equity swings in the com-
petition account.
SYSTEM DEVELOPMENT
So how do these competent developers go
about designing their winning systems?
Preston takes a broad approach: I
design many different types of systems
because most systems have value and a
place. Some ideas and systems do work
better than others, but it is in the combi-
nation of ideas that I am interested.
From the Futures
& Forex Finishers
By Meghan Pedersen
For the World Cup, he frst considers
his goals. Then he reviews the sys-
tems cycle and makes a decision about
which systems are most likely to per-
form to meet his goals.
Unger looks for intraday trends and
flters out days with statistically high-
er probabilities for adverse moves.
He studies patterns on daily bars,
searching for the best ones and ex-
amining them to see how they work
and behave.
Indicators are not one of Ungers
preferred tools, but he does emphasize
the importance of position sizing. He
explains, common sense is most im-
portant, especially in a competition be-
cause of the higher degree of risk that
is necessary to get as much as possible
out of every trade.
Unger typically develops strategies
that focus on average trade perfor-
mance and limit the number of trades.
But for the competition, he alters
his approach to maximize the perfor-
mance of his position sizing model,
because it normally acts on the next
trade. And the higher the number
of trades, the higher the number
of times your model changes size
hopefully increasing it.
OUTSIDE OF TRADING
Thankfully, these competitors are not
tight lipped about the secrets to their
success; they graciously share advice
Andrea Unger shares his secrets for
developing sound trading systems:
1. Keep the concepts simple. Even though
genetic algorithms or neural networks
may lead to excellent systems, old, simple
concepts can also give you good results.
2. Be careful and avoid overoptimization of
the models. The border between a good
filter and a data-mining approach is never
clear enough, and if some conditions are
not showing a valid reason to exist, it is
better to leave them out.
3. Avoid spending too much time playing
around with the tricks offered by the
development tool, which may lead
to losing sight of the target. It is very
important to establish, first, what has to
be developed and to evaluate step-by-
step the results that are obtained.
Unger remembers more than one
case when he made modifcations to
a strategy that already showed good
results, found that the modifcations
led to a less-proftable system, but was
unable to revert to the former version.
The only way to avoid this is to be very
precise in every single
step, he says.
Read more ...
UNGERS TIPS
Andrea Unger, 2010 World Cup
Trading Champion, futures and
forex division
84
FEBRUARY 2011
learned from experience with developers
and traders (see the sidebars for more).
For Preston, the most important point
to remember is to always keep your
head on your shoulders, [remember]
that you did not achieve success on
your own.
Preston says he has been blessed in
many wayswith a supportive fam-
ily and wife, a mentee relationship
with Larry Williams and God-given
abilitiesbut without any one of these
items, I would not be where I am today.
Unger also emphasizes life outside of
the trading realm. He advises people
to leave space in their lives for things
other than trading.
For Unger, this meant once more
making time for running and training.
A competitor and goal setter, he com-
mitted to running his frst marathon
in September. And this goal helped his
trading. He explains that running re-
laxes the mind and promotes discipline.
Losses in the market were sometimes
soothed by a good run.
Though the path was challenging, his
satisfaction was enormous when he
completed the Berlin Marathon in just
over three hours.
He says, It made me feel that I could
achieve any goal with serious planning,
training and discipline. The same ap-
plies to trading; a plan is needed, dis-
cipline is a must, but the satisfaction of
success can be really great!
Brady Preston offers these pointers for
improving readers trading:
1. Find a great mentor. Prestons is
Larry Williams, and he says Williams
has taught him most of what he
knows about the markets.
2. Write a trading model,
describing every aspect of it
how to control your emotions,
allocate your money, manage
the unexpected and so on.
PRESTON PROVIDES POINTERS
Brady Preston, 2010 World Cup Trading Champi-
onship, futures and forex division runner-up
3. Test the model. See if it holds
up in live markets.
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USING INDICATORS
At Rockwell Trading, we use
indicators for three reasons:
1. To determine if a market
is trending or moving
sideways.
2. To decide the appropriate
trading strategy to use
based on market conditions.
3. To identify entry and exit
points in the market.
difference between two exponential
moving averages.
The settings we use at Rockwell Trad-
ing are standard: 12 for the fast mov-
ing average and 26 for the slow moving
average. These moving averages are not
shown on the chart but instead are used
to plot the MACD line itself.
As an indicator, MACD fuctuates
above and below a center line (also
known as the zero line). When MACD
is above the zero line, the faster mov-
ing average is above the slower moving
average, indicating that the market is
moving up. If MACD is below the zero
line, the faster moving average is below
In part 1 (published in January 2011),
we discussed the pros and cons of indi-
cators and how to use Bollinger bands
to determine market direction and spot
trading opportunities. Although these
bands are a powerful indicator, traders
should consider using an alternate indi-
cator to confrm trends.
In addition to Bollinger bands, the
moving average convergence di-
vergence (MACD) and the Relative
Strength Index (RSI) can be used to
identify opportunities in the mar-
ket and to determine whether trend-
following or trend-fading strategies
should be applied.
USING MACD
Known as a momentum indicator and
used to identify market trends, MACD is
usually charted with four components:
MACD, a zero line, a signal line and a
histogram. MACD is derived from the
When all three indicators
are confirming the
direction of the market,
traders have a perfect
opportunity to enter
short and participate
in a trend.
the slower moving average, suggesting
that the market is moving down.
The next line of importance is the
signal line. The signal line is actually an
exponential moving average of MACD.
The standard setting for the signal line
is usually nine periods, which is the set-
ting we use. Because the signal line will
88
FEBRUARY 2011
FIGURE 1Source: Trade Navigator, Rockwell Trading
FIGURE 1: Identifying Trends Using MACD
trail MACD, many traders use MACD
and the signal line together, looking for
crossovers to identify new trends. In
trending markets, this works reasonably
well, but in sideways markets, cross-
overs can be misleading.
The MACD histogram fuctuates above
and below the zero line. It is positive
when MACD is above the signal line
and negative when MACD is below the
signal line.
The size of the histogram represents
the distance between the signal line
and MACD, and can be interpreted as
the strength of the trend. When the his-
togram is increasing in size, the trend is
strengthening. When the histogram is
decreasing, especially following larger
bars, the trend is weakening.
IDENTIFY STRONG TRENDS
Although many traders look for MACD
and signal line crossovers to enter new
trends, numerous crossovers can appear
in sideways markets, making this ap-
proach slightly aggressive and diffcult
to trade. Instead, traders should consider
looking for a MACD/signal line cross-
over and then wait until MACD is above
the zero line for an uptrend or below the
zero line for a downtrend.
Simply put, traders should look for
the following conditions to fnd strong
trends using MACD:
1,190
1,188
1,186
1,184
1,182
1,180
1,178
1,176
1,174
1,172
3
2
1
0
-1
-2
-3
UPTREND
DOWNTREND
DOWNTREND
Signal Line Zero Line
MACD
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UPDATI NG LI NK
THE RSI
The Relative Strength Index was created by J. Welles Wilder and was
introduced in his book New Concepts in Technical Trading Systems.
RSI is a rate of change indicator and should not be confused with a
markets relative strength, which often compares a stock against a
sector or index.
?
Uptrend: MACD is greater than the
signal line and MACD is greater than
the zero line
Downtrend: MACD is less than the
signal line and MACD is less than the
zero line
In Figure 1, you can see the bars are
colored red for a downtrend and green
for an uptrend based on these rules.
Black bars are shown when there is a
MACD/signal line crossover, but the
conditions that we wait for are not pres-
ent. Using these settings, traders can
easily identify trends in a market, and
more importantly, determine when a
market is moving sideways.
If you recall how traders can use Bol-
linger bands to determine the direction
of the market, you will fnd that Bol-
linger bands and MACD complement
each other well.
ADD RSI
The Relative Strength Index is an
oscillator that was initially created to
identify overbought and oversold con-
ditions in the market. Unlike MACD
that oscillates above and below a zero
line without upper and lower limits,
RSI oscillates between the values of
zero and 100.
Most traders consider RSI readings
above 70 to be overbought and read-
ings below 30 to be oversold. However,
a curious thing happens when intraday
moves are identifed as overbought or
oversold using these values; the market
continues to trend!
Indicators are not
magic, but they can
be extremely effective
when used to interpret
market moves.
Instead of using RSI as it was original-
ly intended, we have discovered that it
can actually confrm trends. Take a look
at Figure 2.
RSI dips below 30 when the market is
in a nice downtrend and moves above
70 in a nice uptrend. To make these RSI
readings easy to see on the chart, we
have used red shading to identify over-
sold conditions and green shading to
identify overbought conditions (bars are
Source: Trade Navigator, Rockwell Trading
FIGURE 2: Confirming Trends with RSI
UPTREND
DOWNTREND
30 Level
70 Level
1,190
1,188
1,186
1,184
1,182
1,180
1,178
1,176
1,174
1,172
100
75
50
25
0
Source: Trade Navigator, Rockwell Trading
FIGURE 3: Combining Bollinger Bands, MACD and RSI
TREND
TREND
1,190
1,188
1,186
1,184
1,182
1,180
1,178
1,176
1,174
1,172
2
0
-2
100
50
0
92
FEBRUARY 2011
still colored red or green based on the
MACD settings previously discussed).
Using RSI and MACD together you will
discover that these two indicators can
help pinpoint the strongest market trends
and provide a warning when trends are
weakening or coming to an end.
The standard RSI setting with many
charting packages is often 14 periods.
When day trading, you should con-
sider using a setting of seven to en-
sure that the indicator is responsive to
intraday moves.
DOWNTREND RULES
Now lets see how we can combine
Bollinger bands, MACD and RSI to
spot trading opportunities. In Figure
3, you will notice that a strong down-
trend occurs when the following con-
ditions are present:
Price is tagging the lower Bollinger
band, and the lower Bollinger band is
clearly pointing down.
MACD is below the signal line and be-
low the zero line.
RSI is oversold with a reading of less
than 30.
ENTRY SPOT
When all three indicators are confirm-
ing the direction of the market, you
have a perfect opportunity to enter
short and participate in a trend. Once
in a trade, you can exit with a set tar-
get or use these three indicators to
ensure that the trend continues to
remain strong.
If a set target has not been reached, it
is time to take profts and close a trade
when RSI eventually pushes back above
30 and the lower Bollinger band begins
to fatten.
UPTREND RULES
The opposite is true for a nice uptrend:
Price is tagging the upper Bollinger
band, and the upper band is clearly
pointing up.
MACD is above the signal line and
above the zero line.
RSI is overbought with a reading of
more than 70.
Looking for an uptrend, the combina-
tion of these three indicators should
V
ID
EO
LIB
R
A
RY
THE BEST INDICATORS FOR DAY TRADING, PART 3: In this video, learn
tips on using M
ACD.
THE BEST INDICATORS FOR DAY TRADING, PART 4: Check out this
video for m
ore exam
ples of how to
use RSI.
make the nice trend at the right of
Figure 3 obvious. However, recognizing
the difference between a sideways and
trending market is just as important be-
cause traders cannot make money with
a trend-following strategy if the market
is no longer trending.
It should be easy to see that between
these two trends, the market is clearly
moving sideways. In these situations it is
good to stay out of the market, or bet-
ter yet, consider applying trend-fading
strategies to proft from price changes
when there is no trend.
THE RIGHT STRATEGY AT
THE RIGHT TIME
Indicators are not magic, but they can
be extremely effective when used to
interpret market moves. Now that you
know how to combine three comple-
mentary indicators for day trading,
try them.
Understanding how to identify the di-
rection of the market and knowing when
to trade the proper strategy will likely
have a major impact on your trading,
regardless of the strategies and time-
frames you trade.
Markus Heitkoetter is founder and CEO of Rock-
well Trading. Mark Hodge is head coach at
Rockwell Trading.
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94
FEBRUARY 2011
C
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Y
CM
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CY
CMY
K
BestDirect AD-7.875x10.pdf 5/5/09 11:57:28 AM
INTERNATIONALLY SPEAKING
Tell us what you think about global markets. Then check The Last Word
page on SFOs website for updated results throughout the month.
1. My preferred method for gaining global exposure in
my portfolio is through (choose one):
2. Where do you have international exposure for your
investments (choose all that apply)?
3. Do you think Chinas interest rate hike will adversely
affect Australias economy?
4. Are you interested in investments/trades related to
the CIVETS countries?
5. I think the euro will emerge from the sovereign
debt crises:
AHEAD FOR
MARCH
In the next issue, SFO de-
votes signifcant space
to options trading.
Learn strategies for
trading options on forex
futures, playing break-
outs with options, using
option pricing theory to
predict changes in the
market, and adjusting
the Harvey butterfly.
In addition, we present
articles covering gold
and other commodities
priced in U.S. dollars,
technical analysis versus
modern portfolio theory,
and stock picking tactics.
For excerpts of all
March 2011 articles, visit
the Sneak Peek page
after Feb. 22.
LAST WORD ...
T
H
E

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