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Understanding Basic Trading Relationships - 3 Systems for the Modern Trader
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Certain elements of day trading are not rocket science, although a good amount of research has been done to establish some basic trading relationships between a number of different assets. In fact this sort of grind-it-out statistical researching has been the basis of profitable stock picking for years. Lately though the markets have become much more correlated, making individual asset picking much more difficult. Successful traders have reacted to this change by focusing much more on market psychology and current events rather than corporate earnings data.

Three Types of Known Market Relationships

Macro Trading

Macro trading relies on making extremely short term investments in the marketplace in an effort to get ahead of changes in market psychology. The major theory behind macro trading is the extremely high correlation between risky assets today. Basically what this is saying is that the entire world of investment has begun to function like a "Risk On / Risk Off trading signal". Either all the markets for risky assets are up, or they are all down (with 'safe' assets like gold, the Swiss Franc and the US dollar performing opposite). The ultimate form of this kind of investment for retail traders comes in the form of 60 second options. These are a special subset of a type of contract known to traders as binary options.

Carry Trading

This has become one of the biggest global phenomena, and in part is a principal reason for the current financial meltdown in Europe. While forex trading is a relatively novel concept to US citizens, it's practically part of daily life virtually everywhere else in the world. Borrow money in a low interest rate asset (foreign currency or otherwise). These days the modern experts at this style of investing are the Japanese and the Chinese. Other countries have tried their hand at it (read: Iceland amongst others- see Michael Lewis' excellent works for more on that) - most often with disasterous results. As we spoke above psychology rules markets today and entire networks have been setup and designed specifically for the purposes of manipulating market psychology. This is one of the reasons so many people trying to hold margined carry trade positions get blown up. Pyschological changes in the marketplace creates volatility which blows up positions which require quiet, predictable and relatively stable activity.

Credit Default Swaps

On the theme of the aforementioned European sovereign credit meltdown a new type of instrument has been created: the Credit Default Swap, or CDS. These securities are particularly nasty for non-traders because they are fully designed to be abused in the marketplace. Credit Default Swaps are essentially insurance against the possibility of a debt issuer defaulting on their agreement to pay. Of course you may think that sort of asset would be prudent for a large investor or hedge fund to hold, and in a rose-colored world you would be right. On the other hand, imagine a case where a person (B) owns an insurance policy on someone other than themselves (person A for example). Imagine further that the policy only pays out to person B in the event of the death of the insured person A. Imagine further that person B has no economic interest in person A other than the insurance policy.

Given those circumstances... what exactly do you think would be the expected lifespan of person A? Very short: exactly. Now in the case of CDS securities, the above hypothetical situation is EXACTLY what we have in the real world - only the word person above is replaced by either corporation or government. It turns out that people with vast access to capital have the ability (and clear motive) to not only own CDS assets - but also to influence the likelihood of those CDS policies to pay off. It is seen frequently in central bank exchange rates in the market.

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