Monday, October 25, 2010

Augen, Trading Realities

In Trading Realities: The Truth, the Lies, and the Hype In-Between (FT Press, 2011) Jeff Augen ventures beyond his safe haven of option trading to take on a world filled with bogeymen. There is Ben Bernanke whose appointment “hammered the final nail in the dollar’s coffin.” There are the government number crunchers who offer data that “have been adjusted to mislead the market,” that are “fake.” And there is the “mystery buyer” who “seems to step in at key times to stop potential meltdowns.” These bogeymen, to Augen’s mind, are only too real.

As if these alleged government manipulations were not enough, the retail investor is faced with some stark realities in the markets themselves. Long-term investing is a relic, and with the advent of high-frequency trading the markets are increasingly efficient. Technical analysis as a standalone approach is no longer viable for the retail investor. The gap between the power of the large institutional investors and all other market participants is widening. The tools that individual investors use “operate in time frames that are thousands of times too slow to compete with the large systems that drive the market. More important, private investors looking at patterns on stock charts are competing with the very systems that create and exploit those patterns.” (p. 156)

All is not lost. Augen claims that “smart private investors who do their homework and follow the financial markets can run with the best institutional investors over long periods of time. The simplest and best approach combines two important sources of information that everyone has access to—the daily stock chart and readily available financial news. Separately, they’re not all that useful, but the combination is much more valuable than the sum of the individual parts.” (pp. 70-71) Augen illustrates his claim with a marked-up eight-month chart of U.S. Steel. It includes analyst upgrades and downgrades, earnings reports, and macro news. Armed with this kind of information, the investor will be able to make profitable decisions, especially with regard to trend failures.

In addition to his chart/news combination, Augen offers another indicator for predicting market corrections, the ratio of the VIX to true volatility.

As might be expected, Augen considers stocks to be a dangerous way to invest and diversification an “overly simplistic and ineffective way to hedge. Most effective solutions,” he argues, “involve structured positions that use both options and stock, or just options alone.” (p. 191) He provides an overview of some basic option strategies.

I fear that in this sweep through his book I have made Augen’s arguments appear a bit simple-minded. They are not. As he fleshes them out, they become more intriguing and more compelling. (I’m excluding the anti-Washington vent, since I find little that happens in Washington, for good or ill, either intriguing or compelling.) Most reflective readers will disagree with some of what Augen has written. That is only natural. But this brief book will most likely force them to hone their arguments—and that’s a tribute to Augen’s insights.

Trading Realities provides a foundation, and rationale, for anyone who aspires to become a macro informed, volatility driven options (or hybrid) trader. And it stands as a challenge to those who don’t.

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