A couple of the largest banks on the Unofficial Problem Bank List – in terms of assets – are in Puerto Rico. We haven’t seen any bank failures in Puerto Rico yet this cycle, but according to the following report that is about to change …
From José Carmona and John Marino at caribbeanbusinesspr.com: Feds expected to take action against island banks next month
Federal regulators are likely to begin taking action against troubled island banks sometime next month, government and industry sources told CARIBBEAN BUSINESS.
Since the beginning of the year, the Federal Deposit Insurance Corp. (FDIC) has been beefing up its local ranks, recruiting accountants and auditors, leading to speculation about imminent action during this year’s first quarter.
…
There are three local banks operating under FDIC cease & desist orders—R-G Premier Bank, Eurobank and Westernbank.
…
According to reliable industry sources, one of the three local institutions under cease & desist orders will most likely fall into receivership status under the FDIC due to its inability to raise capital, while the other two will probably survive through consolidation.
As of Q3 2009, Westernbank had $13.4 billion in assets, R-G Premier Bank had $6.4 billion and Eurobank had $2.8 billion in assets.
And from David Johnson at Contrarian Pundit: Tamalpais Bank Update
The bad news has continued for Tamalpais Bank since I broke the story last December that the institution had lent the equivalent of almost all its capital to the highly leveraged, publicly excoriated, and increasingly broke Lembi Group in the middle of the 2008 real estate crash. In January, the Federal Reserve took enforcement action against the parent company, following up on the bank’s cease and desist order from the FDIC last September. And on February 16, the bank announced total losses of $26.2 million for the last quarter and $37.6 million for 2009.
As grim as the news has been, the bank may be in even worse shape than acknowledged in media reports.
… the bank is currently in violation of the terms of the FDIC’s cease and desist order.
And in an update, David points out the bank has just received a “Prompt Corrective Action” giving the bank a March 21st deadline. Tamalpais had about $700 million in assets as of Q3.
Courtesy of The Pragmatic Capitalist
The market’s love affair with Ben Bernanke continued today as stocks rallied on the release of Bernanke’s written testimony. This was in the face of some pretty bearish news. New home sales data was very weak this morning coming in at 309K vs the expected 360K. This was a new low for home sales. It is a notoriously weak time of year for the housing market and I fully expect to see some stability in housing this Spring – particularly as procrastinating home buyers jump in before the tax credit expires. This data, however, shows what the market looks like underneath its calm surface. This is a market that is reeling and still at risk of substantial downside.
Stocks are rallying almost 1% this morning, however, as Bernanke reiterates the need for accommodative measures. Bernanke has essentially become a broken record. He is a one trick money printing pony and will reflate this economy regardless of the long-term destruction it causes. In his testimony he repeated the comments we have heard all too often. The economy is modestly recovering, inflation is benign and low rates are warranted for an extended period:
“The improvement in financial markets that began last spring continues. Conditions in short-term funding markets have returned to near pre-crisis levels. Many (mostly larger) firms have been able to issue corporate bonds or new equity and do not seem to be hampered by a lack of credit. In contrast, bank lending continues to contract, reflecting both tightened lending standards and weak demand for credit amid uncertain economic prospects.”
Source: Econoday
Note: See previous post for video and discussion of Bernanke’s testimony.
The Census Bureau reports New Home Sales in January were at a seasonally adjusted annual rate (SAAR) of 309 thousand. This is a record low and a sharp decrease from the revised rate of 348 thousand in December.
Click on graph for larger image in new window.
The first graph shows monthly new home sales (NSA – Not Seasonally Adjusted).
Note the Red column for 2010. In January 2010, 21 thousand new homes were sold (NSA).
This is below the previous record low of 24 thousand in January 2009.
The second graph shows New Home Sales vs. recessions for the last 45 years. New Home sales fell off a cliff, but after increasing slightly, are now 6% below the previous record low in January 2009.
Sales of new single-family houses in January 2010 were at a seasonally adjusted annual rate of 309,000 … This is 11.2 percent (±14.0%)* below the revised December rate of 348,000 and is 6.1 percent (±15.1%)* below the January 2009 estimate of 329,000.
And another long term graph – this one for New Home Months of Supply.
There were 9.1 months of supply in January. Rising, but still significantly below the all time record of 12.4 months of supply set in January 2009.
The seasonally adjusted estimate of new houses for sale at the end of January was 234,000. This represents a supply of 9.1 months at the current sales rate.
The final graph shows new home inventory.
Note that new home inventory does not include many condos (especially high rise condos), and areas with significant condo construction will have much higher inventory levels.
Months-of-supply and inventory have both peaked for this cycle, but sales have set a new record low. New home sales are far more important for the economy than existing home sales, and new home sales will remain under pressure until the overhang of excess housing inventory declines much further.
Obviously this is another extremely weak report.
Courtney Comstock of Business Insider
According to the Wall Street Journal’s sources, SkyBridge Capital is talking with Citi about buying Citi’s fund of funds business.
Citi plans to offload their $4 billion hedge fund investment business as part of a plan designed to unwind $715 billion in non-core assets, said the WSJ. The pool is currently down to $547 billion.
Apparently the current plan is to keep Citi’s employees in place. Citi’s core fund of funds earned 21% last year.
As you can see from our chart set, our major indices are trading very much in synch, more likely than not propelled by trade-bots that already have the next 25 trading days already mapped out to take us through the end of the quarter. Of course you can argue that it’s perfectly natural for 8 of 9 different indexes to follow virtually identical patterns as a result of the random trading of millions of individuals trading Trillions of Dollars worldwide and that’s your perogative. I prefer to think of it as one giant scam and then figure out ways to make a little money off it for ourselves…
Several times last week I said to members I thought “THEY” were running the market higher so they could sell calls to suckers at high prices but, in general, the move was “fake, Fake, FAKE.” What do we do in the face of flagrant market manipulation? What do you think we do – we play along! We don’t complain about good manipulation when we see it – we join in! Don’t be confused by the fact that I complain about it in my morning post – once the bell rings we move right to the other side of the table and happily run with the wolf pack. We’ve tried to fight the power – it’s not fun, nor is it profitable…
We remained fairly conservative last week and, as I discussed in our “Weekend Trend Spotting” post, we are more inclined to believe we are in a range that centers around 10,400 than about to break back over 10,700. The bounce zones we predicted when we first began to sell off in January are finally being tested (red lines on above charts) but the 5% line (blue lines) are still exerting a pull and we NEED some healthy consolidation in between those blue and red lines if we are ever going to get serious about making a real move higher.
Speaking of healthy consolidation – Congrats to our own David Ristau of the Oxen Group and all the members who played along with yesterday’s specially featured selection of SAH. David nailed it in his 1pm post (also sending out a 1:06 Alert to our Members) and put us into the stock right in his target range at $9.45 and it looks like we’re getting a nice 3-cent beat this morning (20%) and this should be a very nice 5% day-trade gain. We also played the longer-term March $10 puts, sold at .95 and those are looking like strong candidates for 100% gains. If you want to get these trade ideas when they are published along with Alerts that come right to your inbox while the trade is hot -Subscribe HERE.
Evan Lazarus of T3Live.com
What had been one of the market’s leaders during the run-up from the March lows now looks weaker than the broader market. In today’s Trade for Thought, I took a look at a longer-term chart of Apple (AAPL) in order to gauge which way it will break next.
Much has been said lately about the record cash balance on the books of S&P 500 companies (ex. financials- those are a different story altogether). Bullish pundits claim that this money will be used for all sorts of M&A, stock buybacks, expansions, etc., to make the point that companies can’t wait to go out spending, so we should all front run them and buy whatever public companies may one day be on the auction block. We decided to take the inverse approach – by looking at the balance sheet and the cash flow statement of the S&P 500 companies (again, ex fins), we have attempted to understand just what the source of all this excess cash is. Listening to any of the permabulls on CNBC, one could easily get the impression that all this newly record cash comes simply from excess revenue which, courtesy of massive layoffs and a collapsing SG&A line, feeds an ever increasing retained earnings line, which in turn goes straight to cash. While this is certainly possible, our analysis indicates that the primary source of cash over the past year has really been a very generous cash “rotating” adjustment in some critical CapEx and Net Working Capital items. Our findings demonstrate that of the nearly $130 billion in additional cash on the books of S&P 500 companies from June 2008, through September 2009, two key sources, net working capital and a reduced capex spend, have generated over $150 billion, meaning organic operations have accounted for a whopping -$20 billion (yes, negative) of incremental cash.
We have used CapitalIQ data to analyze quarterly periods beginning in December 31, 2005 through September 30, 2009 (the data for the most recent quarter has not been fully compiled yet, with about 100 companies having yet to file a 10-Q. Once all the required data has been deposited into Edgar, we will update this analysis for data including the Q4 2009 period).
First, we present the cash holdings for all companies, ex. fins, that make up the S&P 500. It should come as no surprise to anyone that companies have been hoarding cash: whether this is due to uncertainties about the future, or some other reason, is irrelevant. Again, our focus here is whether this cash was accumulated fair and square, or whether it was some simple accounting fudge of balance sheet/cash flow items.
So once we know that S&P500 balance sheets are replete with cash, the next question is not where it is going, but where did it come from. In other words, is this merely a transfer from one asset/liability to another?
We analyzed the Capital Expenditures and Depreciation and Amortization data of the universe under observation. What we noticed was a dramatic reduction in cash outflow patterns, coupled with a substantial increase in the depreciation and amortization, beginning with the Q1 2009 quarter, or just after the economy went to hell in H2 2008. As the chart below demonstrates, CapEx which has historically trended not only higher, but represented an average $26 billion differential to Depreciation and Amortization over the past 4 years, took a sudden and dramatic leg down beginning in Q1 2009. At precisely the same time companies, no doubt in order to get the benefit of a D&A tax shield, ramped up their asset depreciation activities. The net result: for the first time in many years, the differential between CapEx and D&A turned negative: companies were depreciating more than they were adding to their PP&E, in Q1, Q2 and Q3 (although in Q3 the number turned just slightly positive). This is the definition of asset stagnation, as normal asset-intensive businesses (remember, this exercise excludes financial companies), need to add to their PP&E by more than they traditionally depreciate due to the unequal GAAP amortization schedules. In other words, in the first three quarters of 2009, the S&P 500 asset base depreciated by much more than it was repleted, thus substantially impairing its cash-generative powers. This can be seen on the chart below.
It is no wonder then that companies managed to “generate” substantial cash – instead of investing in their asset base, they simply let PP&E (unadjusted for various GAAP gimmicks) decline, while building the cash and cash equivalents portion of the balance sheet.
What will be the impact of this going forward as the PP&E has to be renormalized? In the LTM period CapEx – D&A was negative $42 billion, while the average LTM differential over the past 4 years has been positive $13 billion. This means that companies will have to spend an incremental $55 billion over time just to catch up to the PP&E trendline, let alone to add incremental cash generating assets. And since the immediate IRR for organic capex is traditionally much higher than for external acquisitions (with some notable exceptions), it is only after this catch-up has been accomplished, that the S&P500 companies will be truly seeking M&A opportunities, as opposed to what the mainstream media will have you believe. The topic of how much less in taxes S&P 500 companies paid in 2009 due to the tax shield nature of the incremental D&A boost is a topic for another day.
In addition to cash retention through asset deterioration, another favorite trick of company CFOs is to boost cash at the expense of Net Working Capital (ex. cash), i.e. the difference between current assets (Accounts Receivable and Inventory) and current liabilities (Accounts Payable). Therefore, the next analysis we did was to analyze the Net Working Capital status of S&P 500 members. The results were as expected: from a peak of $520 billion in June of 2008, NWC (ex. cash) has declined to the current almost three year low of $430 billion. In other words, as companies have accelerated their cash collections via declining AR balances, they have also pursued inventory liquidations, coupled with flat or expanding Accounts Payables. The chart below shows this accounting gimmick in vivid color:
Following the cash generated by this decline in NWC, leads to the following chart: as pointed out above, roughly $90 billion has been generated simply as a function of squeezing cash out of other current net working capital, and simply rotating this into the cash & cash equivalents balance sheet item.
So what does combining all this data conclude? As was pointed out initially, the non-financial S&P500 companies boosted their cash holdings by roughly $130 billion from June 30, 2008 through September 30, 2009. This would have been great if this was cash attained in the traditional way, whereby sales get converted into retained earnings, and cash, all else equal. However, a dig through several hundred balance sheets and cash flow statements, indicates that of this $130 billion cash increase, about $90 billion was due to Net Working Capital Changes, and another $55 billion was due simply to underfunding capex by an amount required to preserve maintenance cash generation from existing asset bases. Which means that of the cash boost, operations generated a whopping…($15) billion in cash! Had companies not been using accounting gimmicks to boost cash on a one time basis, current cash would likely have been about $15 billion lower than June 30, 2008, or $688 billion. The adjusted cash balance, normalizing for Net Working Capital shifts and normalizing CapEx spending since June 30, 2008 is shown below:
The conclusion is that one should be very wary of generalizations such as those by JP Morgan which claim that companies, sitting on huge cash war chests, are now ready to go out and spend, spend, spend. The truth is that had companies not been using various accounting fudge factors, their real cash position would have been much more precarious. Should companies revert to their mean Net Working Capital and CapEx exposure over the past 4 years, we will see $155 billion of cash disappear merely to plug the hole that was dug over the past 3 quarters merely to make S&P 500 balance sheets more palatable.
We will update this analysis with Q4 data as soon as it is available in its entirety.
The WSJ carried an interesting (and misleading) opinion piece today:
Regulatory reform that can improve competition and consumer choice in financial services is long overdue. But no new federal bureaucracy such as the Obama administration’s proposed Consumer Financial Protection Agency (CFPA) is needed to bring that about.
More importantly, the administration is incorrect in claiming that such an agency would have prevented the present financial crisis and is necessary to prevent the next crisis. On the contrary, such an agency might be the first step toward more problems.
How does forcing lenders to reduce a credit card or mortgage agreement to language that can fit on both sides of an 8-1/2 x 11″ page in 10 point courier type constitute “a first step toward more problems?”
During the housing boom bankers made a raft of extraordinarily foolish loans. Some were the result of lenders defrauding borrowers; probably at least as many were the product of borrowers defrauding lenders. But there is no evidence, as Elizabeth Warren (a champion of CFPA and chair of the TARP Congressional Oversight Panel) recently asserted on these pages, that lender fraud was the overriding cause of the crisis.
The bank loans were not foolish because borrowers didn’t realize what they were doing. They were foolish because of the incentives they created for borrowers, especially when housing prices turned south.
No, the bank loans were foolish because the banks lied about what they were selling, to some degree to consumers but to a much larger degree to investors.
My own research confirms the analysis provided by University of Texas economist Stan Leibowitz on these pages last July: The initial onset of the foreclosure crisis was a problem of adjustable-rate mortgages, whether prime or subprime. It was not initially a subprime problem.
Who wrote loans without qualifying the borrower on the fully-indexed (that is, the highest rate the loan could reach) rather than (as they did) qualifying them on teaser rates that were known to have a short expiration date, sometimes as short as two years post-initiation?
That would be the banks, who created not a mortgage product but instead a product for asset-stripping the consumer, in that they wrote paper that they knew the consumer could not “pay as agreed” through the entire term.
The intent was to force the consumer to come back and get a new loan in a couple of years. This was insanely productive for the banks for two reasons: it gave them another set of fees they could strip off from the consumer, and in addition virtually the entire payment stream during those first two years on an amortized note is interest, with almost none of it principal.
That is, the intent of such a note was not a “mortgage” – an amortizing loan contemplated to be retired at maturity. The essence of these “loans” was in fact more akin to a typical commercial real-estate loan where amortization is not the prime purpose; these are typically written as interest-only balloons and refinanced, with the interest payments made from tenant leases. In this case the interest payment is made from the “home tenant’s” employment cashflow. A Consumer Financial Protection Agency could and should bar the marketing of such loans as “mortgages” and instead demand they be called what they are – a complex financial transaction that effectively amounts to a lease!
The error of course in the bank’s thinking was that home prices could never go down. In fact, their bet was that home prices would always appreciate fast enough to accommodate both the paid interest and the fee to refinance after two years.
In the second phase, falling home prices provided incentives for owners whose mortgages were under water to walk away from their houses. And in the third phase, which we are now experiencing, traditional macroeconomic factors like unemployment led to more foreclosures—especially where homeowners’ mortgages are already underwater. Reflecting this situation, the Mortgage Bankers Association reports that the fastest-rising segment of foreclosures in recent months has been traditional prime, fixed-rate mortgages.
Again, we get down to my favorite graph:
It doesn’t matter how you slice the pie here. House prices cannot expand faster than wages forever, just as debt cannot expand faster than GDP forever. The compound function of exponents makes all such claims and expectations false and dangerous.
The proliferation of mortgages with minimal downpayments, interest-only or even negative amoritzation terms, and cash-out refinances meant that many consumers fell into negative equity territory much more rapidly than they would have otherwise.
Those mortgages were made available only because the banks willfully and intentionally ignored warnings by The FBI, HUD and private credit analytical firms that these loans were not as represented. They packaged them up and sold them to investors either knowing (or willfully blind) that the credit quality of the paper inside those MBS (and the more-complex securities structured upon them, including the partially and fully-synthetic versions) were not as represented.
This was not an accident it was a scam.
Regulators may want to limit mortgages that provide so many borrowers with such strong incentives to walk away when housing prices fall. They may want to prohibit lenders from making loans with minimal downpayments or interest-only loans that result in consumers having minimal equity in their homes. But that’s an issue of safety and soundness, not protection against fraud.
If regulators prosecuted and jailed those executives who misrepresented the credit quality contained in these securities then the loans could not have been made. Without the ability to obtain funds you can’t loan funds.
The bank that has $100 million to loan out must sell its loans to be able to make more loans. If it cannot sell them at a price representing the risk and make money (because it allowed people to take out loans on “prime” terms when they were poor credit risks, and upon disclosing this honestly to buyers nobody will pay anything close to “par” for that paper) then they are immediately restrained from continuing this conduct and the fuel for the bubble is immediately removed.
Without that free-flowing and fraudulently-granted credit there is no price appreciation spiral that drives the bubble. The bubble does not inflate. The price appreciation does not happen. The mania is quelled before it begins and the damage to the economy does not happen.
The financial crisis resulted primarily from the rational behavior of borrowers and lenders responding to misaligned incentives, not fraud or borrower stupidity. Policies that fail to appreciate the difference will not protect, and may hurt, the very consumers they are intended to protect.
Bah. The financial crisis resulted primarily from promises by lenders (on both the funding and lending side) that were knowingly false and in some cases maliciously so. Borrowers were flatly told they could come back and refinance before any “payment shocks” happened – not that they might be able to, but that they would be able to. They were led to believe by the statements of what amounted to con men that they were getting not only a great deal but that they could come back at any time and continue to get a new great deal.
At the same time buyers of the paper emitted by these lenders and their cronies on Wall Street failed to disclose that as early as 2004 The FBI was warning of an epidemic of falsehoods in mortgage applications – that is, that the paper contained in those securities was trash. Despite having authorization to verify the statements of borrowers (via 1003s and 4506-Ts) the lenders willfully did not do so and issued paper with reps and warranties that were issued as statements but which they intentionally failed to verify. Ratings agencies accepted data submitted without verification and filled in “blank” data with unsubstantiated guesses, along with running computer models that presumed there would never be a home price decline (a mathematical impossibility given the flat income curve for the median citizen since 2000.) All of these assumptions were made by “wise people” who either factually knew or, had they actually exercised their claimed wisdom and knowledge, should have known.
Synthetics were then created at the behest of hedge funds and others through the purchase of a naked credit-default swap – a bet that the reference securities would default – while not owning the reference security. Those synthetic CDOs were then sold to investors, rated on the underlying (bogus) credit of the reference instruments. The outrageously-overrated credit quality claimed for these reference instruments came to light almost immediately, in many cases mere months after these synthetics were created, with the buyers taking heavy and in some cases total losses. Was it disclosed to the buyers of these synthetics that they came into existence only because someone bet that the purchaser would lose all their money? Would you buy a security that came into existence only because the person at who’s behest it was created believed that it was in fact worthless, if that fact was disclosed to you up front?
The essence of the crisis was, as Mr. Zywicki notes, the three-cycle collapse of the housing market first by adjustable-rate loans, second by price declines and now by unemployment.
Mr. Zywicki acknowledges (in a phone call I just completed with him) that but for the price increases caused by these fraudulent misrepresentations the bubble would not have happened – and thus neither would the collapse.
BUT what he refuses to recognize is that the essence of the Consumer Financial Protection Agency is to prohibit practices that amount to fraudulent and misleading conduct on the part of lenders in their dealing with consumers. That is, promising that you “will be able to refinance” before that teaser expires, qualifying borrowers on other than fully-amortized and fully-indexed rates and other abusive practices that lead consumers to believe that the fundamental mathematical laws that govern all exponential functions have somehow been repealed, even if temporarily.
Fraud in all it’s forms was the essence of this crisis. It could not and would not have occurred but for that fraud, as the home price increases seen in the 2000 decade could not have occurred without the money flow necessary to fund the spiral, and that money flow could not have happened without misrepresentations by both omission and commission up and down the line.
Each and every part of the flow of funds was involved – lenders, borrowers and investors.
Even those who were not involved in the fraud in any way – who took out traditional, fixed-rate 30 year mortgages during these years – were harmed by this fraud. They were induced to pay a price that was fraudulently inflated for the property they purchased – a price that was not supported by the fundamentals of the market – that is, free action by informed buyers and sellers - but rather a price that was inflated by the fraudulent loan originated, made and securitized to the person who bought a house down the street. That fraudulent loan presented itself in the marketplace as false demand in that the “buyer” was incapable of affording the home he allegedly “purchased.” Each and every buyer of a home from 2003 to 2007 was thus harmed by these practices, irrespective of whether their loan was honestly represented to them or not.
Resolving the crisis demands prosecution for all those involved in the myriad frauds, starting from the top down. We have done exactly none of what has to happen to clear the system of this fraud, nor have we punished the perpetrators, even though intentional misrepresentation by omission or commission is, in nearly all cases where financial injury results, already illegal.
Preventing this from happening again requires not only that the financial industry be subject to true oversight and enforcement to keep it from defrauding investors, but that consumers be protected from the misrepresentations perpetrated upon them by the financial industry in the lending products offered and that it be made clear that consumer misrepresentations and frauds perpetrated upon lenders will not be tolerated either.
Mr. Zywicki is a law professor at George Mason University and a senior scholar at the Mercatus Center. This op-ed is based in part on a Mercatus working paper, “The Housing Market Crash.”
Mr. Zywicki claims in his areas of expertise consumer credit and consumer lending. It is clear from his piece (and my phone call) that in point of fact his position is that anything a consumer gets themselves into is a function not of deception and defective understanding (due to omissions or commissions by the lending industry) but rather simply a matter of “efficient markets.”
I strenuously disagree, and submit that if you’re attending George Mason University to become versed in how to claim that it’s all the consumer’s fault (even when actively misled) or perhaps even to defend against allegations of these misrepresentations and omissions while working for a financial institution, you’ll do well to attend his classes. He’ll fill your head with everything you need to recite in a puerile attempt to defend the indefensible.
I’ll take a pass as that’s the sort of lawyering that leads me to recall my Shakespeare - Henry VI, of course.
Reuters filed this report about the latest mortgage delinquency and foreclosure data from the fourth quarter, a time when things clearly didn’t improve for homeowners with mortgages.
The Mortgage Bankers Association said on Friday the combination of loans in foreclosure and one payment in arrears was 15.02 percent on a non-seasonally adjusted basis, the highest ever in the survey.
…
A sizable number of the loans in the 90-plus day delinquent bucket are in loan modification programs. They are carried as delinquent until borrowers demonstrate they will make the payments agreed to in the plans.The pattern of mortgage delinquencies now very much follows the pattern of unemployment, which was at 9.7 percent in January, according to the Labor Department.
“Therefore, until the issue of this large segment of long-term unemployed is resolved, many of the longer-term mortgage delinquencies will remain a problem with a strong likelihood of turning into foreclosures down the road,” said Jay Brinkmann, MBA chief economist.
Do you think we’ll still be talking about this in 2011, 2012, and 2013?
It seems as though we’ve been talking about the foreclosure crisis for years now. But, then again, maybe that’s because we have been talking about it for that long.
The following article is an excerpt from Elliott Wave International’s Trader’s Classroom Collection.
Every trader, every analyst and every technician has favorite techniques to use when trading. But where traditional technical studies fall short, the Wave Principle kicks in to show high probability price targets and, just as importantly, how to distinguish high probability trade setups from the ones that traders should ignore.
Where Technical Studies Fall Short
There are three categories of technical studies: trend-following indicators, oscillators and sentiment indicators. Trend-following indicators include moving averages, Moving Average Convergence-Divergence (MACD) and Directional Movement Index (ADX). A few of the more popular oscillators many traders use today are Stochastics, Rate-of-Change and the Commodity Channel Index (CCI). Sentiment indicators include Put-Call ratios and Commitment of Traders report data.
Technical studies like these do a good job of illuminating the way for traders, yet they each fall short for one major reason: they limit the scope of a trader’s understanding of current price action and how it relates to the overall picture of a market. For example, let’s say the MACD reading in XYZ stock is positive, indicating the trend is up. That’s useful information, but wouldn’t it be more useful if it could also help to answer these questions: Is this a new trend or an old trend? If the trend is up, how far will it go? Most technical studies simply don’t reveal pertinent information such as the maturity of a trend and a definable price target — but the Wave Principle does.
How Does the Wave Principle Improve Trading?
Here are five ways the Wave Principle improves trading:
1. Identifies Trend – The Wave Principle identifies the direction of the dominant trend. A five-wave advance identifies the overall trend as up. Conversely, a five-wave decline determines that the larger trend is down. Why is this information important? Because it is easier to trade in the direction of the overriding trend, since it is the path of least resistance and undoubtedly explains the saying, “the trend is your friend.” Simply put, the probability of a successful commodity trade is much greater if a trader is long Soybeans when the other grains are rallying.
2. Identifies Countertrend – The Wave Principle also identifies countertrend moves. The three-wave pattern is a corrective response to the preceding impulse wave. Knowing that a recent move in price is merely a correction within a larger trending market is especially important for traders, because corrections are opportunities for traders to position themselves in the direction of the larger trend of a market.
3. Determines Maturity of a Trend – As Elliott observed, wave patterns form larger and smaller versions of themselves. This repetition in form means that price activity is fractal, as illustrated in Figure 1. Wave (1) subdivides into five small waves, yet is part of a larger five-wave pattern. How is this information useful? It helps traders recognize the maturity of a trend. If prices are advancing in wave 5 of a five-wave advance for example, and wave 5 has already completed three or four smaller waves, a trader knows this is not the time to add long positions. Instead, it may be time to take profits or at least to raise protective stops.
Since the Wave Principle identifies trend, countertrend, and the maturity of a trend, it’s no surprise that the Wave Principle also signals the return of the dominant trend. Once a countertrend move unfolds in three waves (A-B-C), this structure can signal the point where the dominant trend has resumed, namely, once price action exceeds the extreme of wave B. Knowing precisely when a trend has resumed brings an added benefit: It increases the probability of a successful trade, which is further enhanced when accompanied by traditional technical studies.
- How the Wave Principle provides you with price targets
- How it gives you specific “points of ruin”: At what point does a trade fail?
- What specific trading opportunities the Wave Principle offers you
- How to use the Wave Principle to set protective stops
- Keep reading this free lesson now.
