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Sent: 15-06-2010 10:06:04
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Momentum TradesA How To Book Of Self Managed Super FundsEmail Marketing WorkshopsSMSFs power aheadEmail Marketing Business Opportunity - Helen Bairstow
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Momentum Trades

Click here to buy - A How To Book of SMSF's by Tony Negline
John Robertson

Momentum trades eventually create bubbles. Sometimes there is no inherent logic underpinning a momentum trade. It works simply because enough people think it will succeed. Eventually it breaks down.

Financial markets have become increasingly prone to market herding as technology has speeded up decision-making.

Information now flows faster between sources and its eventual recipients. Having been delivered, news can be processed in a matter of seconds, sometimes without any human intervention. Market orders are being placed and executed within another few seconds. With national boundaries being eliminated as constraints on trading, many more market participants are able to react to each piece of news than ever before, adding to the directional momentum.

Against this background, investors become fearful about being left behind. Rather than take time for analysis, many respond quickly by joining the existing market momentum rather than risk not participating in a subsequent market move.

We saw how these forces came together in the context of the 2008 financial crisis. More recently, a proliferation of shorter term momentum trades have been based on evolving views about the macroeconomic environment.

Each of these trades appeared to be taking advantage of sustainable medium term macroeconomic trends. However, in each case, the underlying analytical proposition was by no means certain. These trades tended to concentrate on the correlation between two single variables while forgetting about the hundreds of others that might have an impact on the net result.

In the end, whatever the analytical merits of the trade, the weight of funds validated the trade and kept it going as long as more investors were coming aboard to maintain the momentum.

Because these momentum trades do not take account of the full complexity of economic relationships, they can be quickly nullified by an outside event as the onset of the Greek fiscal crisis showed. Markets moved quickly from a consensus that the U.S. dollar would fall indefinitely to a consensus that the euro would be the currency to fall. The euro had already started to drop before the brunt of the Greek crisis hit markets but has now fallen 20% since a peak in November 2009. Forecasts of another 15-20% downside are becoming commonplace.

Gold has been another momentum investment. The chart at http://www.thebigpicture.com.au/atc/gold_euro.pdf shows movements in US dollar gold prices and the euro/US dollar exchange rate.

Between January 2007 and March 2008, gold prices rose 53% as the euro appreciated (the US dollar declined) 22%. The euro then gave up 18½% while gold lost 21½% between March 2008 and November 2008. Subsequently, gold prices again rose (by 48%) while the euro appreciated (by 17%).

All told, gold rose by 79% while the euro made a net gain of 16% over three years. Once the euro started to fall at the beginning of 2010 and after having moved in line with gold for three years, the initial response of the gold price was to fall also.

However, within two months the nexus had been broken. Gold continued to rise as the euro fell by 20% proving that there was no necessary reason for the gold price to be tied to one exchange rate in the way it had traded in the previous three years.

At face value, a new momentum trade might be underway. The choice for investors now is not whether economic conditions warrant a higher gold price as the euro falls further. Rather, the judgement for investors is whether the flow of funds into this trade will be sufficient to sustain the momentum beyond the relatively short span of four months that it has been underway.


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This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.

 
 
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