The recent collapse of brokerage firm Sonray Capital Markets raises a number of issues and questions that are important to all investors – not only those trading Australian shares and CFDs, but traders in all markets and all instruments. Reports from the appointed administrators suggest that SONRAY has lost around $46 million of client’s funds out of a total of around $76 million through a combination of illegal and inappropriate trading activities and poor business management. Apparently, client’s funds were being used to fund the illegal trading activities being carried out by SONRAY. It is suggested that a trader or traders within the SONRAY organisation had access to client funds and used this money to fund the illegal trading activities and prop up the business. These trades have gone horribly wrong leaving clients facing losses of their trading capital and perhaps even shares they believed they owned, through no fault or action of their doing. These clients may well be asking how was this allowed to happen and what are the regulators intending to do to prevent this occurring again?

Cash at risk

Many of the Sonray clients may well have believed that their Funds were held safely in ‘a client segregated account’ that was separate from the brokers ‘house’ account. This appears to not be the case. This may well raise a number of questions, including:-

1. Why and how was access gained to this pool of client’s funds?
2. Who has access to this pool of client’s funds?
3. Are client’s funds really as ‘safe’ as we would like to think?

I’m sure you can think of many more.

After researching the security of cash injected into accounts for trading we found that there is no alternative more secure than having your capital deposited in an Australian bank account, whether linked to your online broker or not. Many Australian brokers provide their clients with CMA (Cash Management Account) or CMT (Cash Management Trust) accounts which are typically linked to client online trading accounts or are the linked account to the online broker. Accounts under $1 million are also secured under the Australian Government’s Financial Claims Scheme (FSC).

In the case of Sonray, it has been reported that client cash, that is the deposited monies in their online trading accounts that were not invested in shares, is allegedly not secured and therefore is at risk of being used by the appointed liquidators to pay outstanding creditors. This remains to be confirmed by the currently ongoing Sonray liquidation process. I’d urge investors to familiarise themselves with the Sonray situation, and to thoroughly research your current broker to determine if they deposits monies in a similar way to the method that Sonray did or in a more secure manner that cannot be used to pay creditors in the event of a broker default.

If an ASX broker provides an online linked CMA or CMT account with an Australian Bank in the client’s name, the clients’ funds are protected in the event of a default by the broking arm of the business. This means that your funds are held at the bank in your name and not within the brokerage firm. In the event that the broker was to default, your cash would be secure within the banking structure. The risk is significantly reduced but it is not eliminated.

If a broker deposits their client’s funds into any other account other than an account with a recognised Australian bank in the client’s name then the client’s cash that is not invested in the market may be at risk of being used by the broker in the event that the broker defaults or a client of the broker defaults with a large loss. This is a general statement as the level of risk varies depending on the details provided in the broker’s PDS and any back-to-back contractual agreements that the broker may have in place with third parties.

I urge you to thoroughly research and understand the way your broker holds your funds so that you are fully aware of any extra layer of risk that you may be exposed to in the markets. This starts with your brokers Product Discloser Statements. You should start by reading your brokers Product Discloser Statement in detail and assess what are the potential risks you are exposed to. Don’t treat your broker Product Discloser Statements or your broker client agreement forms the same as you would treat your general banking or general insurance Product Discloser Statements. Be diligent and ask your broker specific questions that concern you and your money.

As traders and active investors we CHOOSE to participate in the financial markets. We know and understand individual trade risk, we understand market risk, and we also need to understand the potential for broker default risk as the Sonray example shows. This is a layer of risk over which we have little if any control when things go wrong. We can take steps to limit this risk but we must still be aware that it can occur.

We also need to be aware of the fact that ‘cheap’ brokerage is not always the ‘best’. Whilst at first blush it may appear that a brokerage rate of $10 per trade is cheaper than $25 per trade, this is of little consequence if our trading capital disappears into a black hole if our cheap broker defaults and collapses, and leaves us thousands of dollars worse off. As always, do your research, know your risks, and understand fully the whole environment in which you are trading.

Next week I will discuss how shares are ‘held’ and what happens when trading other instruments such as futures and FX.

A better way to think about bear markets

The beauty of long bear and sideways market periods is that they are almost always followed by long rising market periods. The majority of the time, the longer and stronger the bear market, the longer and stronger the bull market that follows. This is how consistently successful traders think. Winning, whether it be in the markets or elsewhere, is a state of mind, as is losing. Winners see down market periods as impending opportunity. Losers put a significant amount of focus on the monetary drawdown that they suffer during down market periods and are blinded to the imminent opportunity. Often they withdraw their funds and miss the complete upturn performance when the market takes off again.

So, look upon a bear market as an opportunity—the opportunity for the market to catch its breath and to set up for the next rising market. See the lead up period to the next rising market as the period in which trades will be signalled that will take your portfolio out of drawdown and recapture what may have been lost during the drawdown period.

The mechanical methodologies that I have traded and continue to research show that every drawdown period has been followed by a new equity peak, thereby making a new equity peak a high probability outcome. By thinking from the market’s perspective, you think in probabilities, which means that you think in terms of your edge and the drawdown trading statistics will revert to the mean of the long term researched statistics of the edge. Then you should be able to consistently execute the processes of your edge without reservation or hesitation, believing that anything can happen and that you do not need to know when the next bear market will be or how long it will last.

Summary

Is this the only way to train yourself to become a successful trader?

Probably not.

But it is a high percentage approach that, if completed, will result in a high success rate of people who complete it because people change who they are. You become a trader rather than a market observer, a chart reader or just an analyst. Broking firms employ chart readers and analysts who are very good at their job, but they are not traders—there is a massive difference between the two.

If you want to join the discretionary ranks from the very beginning, in an attempt to become a successful trader without using a mechanical system to assist with retraining your mind, you may come out the other end as a successful trader but the probabilities are much lower and the failure rate is much higher.

Those who embark on the discretionary pathway do so mostly because they are ignorant of another way and don’t understand how their mind works or they have a large ego that urges them to take the most difficult pathway. Their big ego will take care of the outcome all on its own.

Life is a percentage game as are all sports and games that human beings play. Follow the high percentage route and resist the high ego route. Play the par five like a par five and you will, over a large sample, have a better average score than the big ego hitter that tries to play the par five like a par four and birdie it every time.

But at the end of the day, your subconscious is not tested until you play the game with your money.

Thinking about the markets from the market's perspective can remove fear from the equation by creating a belief that down markets are a necessary part of market behaviour in the future and just as tradable as low market risk periods.

If you think from the paradigm of your business, your job objectives or from your societal perspectives, you will have a core belief that all down markets are bad. Imagine if employers were paid an inconsistent amount of salary every month and some months you even had to pay some in! People in that situation would not be motivated employees—but they might be better traders, as they would be trained to endure drawdown. “Winners are grinners”, the saying goes. Have you met a winner who has not been a loser at some stage—even though they rarely talk about losses? Losing teaches you how to win. Losing puts winning into context, just as pain puts pleasure in to context; hate puts love into context and hot puts cold into context.

Imagine if people went to the football looking forward to their team losing!!! Reading this statement will seem foreign because people have a core belief that the reason they go to the football is to enjoy the feeling of being there for a win. Of course, this sets people up for feeling the total opposite if their team loses. Win and you feel happy. Lose and you feel unhappy ! What did you do? Nothing. The team did it all!! The outcome of an event over which you have absolutely no control has defined how you feel. If you changed your paradigm to that of being at the football to appreciate the high level of skill by both teams, witnessing a close contest, soaking up the atmosphere and being amongst the buzz, then perhaps you could be happy, regardless of the outcome. This is a simple example showing that how we think can define how we feel. The same event takes place; the only change is how we perceive the event.

Remember what we said about thinking from the market’s perspective? You think in terms of probabilities by thinking in terms of the probabilities of your edge. This becomes the focus, not how much money you have in your account. That is, you detach from the money and attach to the process to execute your edge. Achieve your edge and the money will flow. Focus on execution to achieve your edge and your account will take care of itself. Knowing that you have an edge researched in the market environment with a positive mathematical expectation means that you are thinking in probabilities. Then, you can simply focus on the process of execution.

Thinking this way can define away and eliminate:
• The fear of losing
• Feeling despair, frustration and anger during drawdown periods
• Living with ongoing fear of the prolonged bear market

It is our responsibility to ensure that we are in the best frame of mind to execute the next trade.

Research shows that the average down market lasts three to four months. However, it is not the short-lived down market periods that active investors should worry about, but the occasional longer and sustained down market periods, such as the one we are now experiencing. All ‘long’ strategies, whether they are Buy & Hold or more active, will go into drawdown during sustained bear market periods. The perennial active and passive investment dilemma is that nobody really knows when the prolonged bear period will occur or how long it will last. However most investors live in fear of such a situation and it is this fear that causes investors to become inconsistent in their actions during the down period and the ensuing positive market periods.

Why is there fear of such market periods? Because people fear losing. Is it a comfortable feeling living in fear of such market periods? Probably not. Would investment life be more liberating if such fears could be overcome? Probably so.

So how can we overcome the fear of losing? If this fear can be mastered, active investment will become much simpler and more enjoyable.

Most try to handle it by looking for a reason for their loss, hence analysing charts and indicators. However there will always be loss trades. So fear is impossible to analyse away unless a perfect solution can be found in which there is never any loss or drawdown. Such analysis is an infinite task that has a limitless path. If it is impossible to achieve a lossless environment through analysis in order to overcome the fear of loss, then another way has to be found to overcome the fear.

You can achieve this by changing the way you think about the market, by learning to think from the market’s perspective as we have said before. Why do we need to think from the market’s perspective? Because understanding why and how the market moves makes us empathetic with the market, we become one with the market’s movements, we become an insider looking out rather than being an outsider looking in. Markets do move up and down, not just up. An obvious statement we could assume. So why do people have an eternal expectation of upward movement only and become despondent when downward price movement prevails?

Another way to think about the market is to accept that down periods are good for the market because they allow the market to catch its breath. Down periods provide the setup for new upward moves. Up periods, which bring profits, follow down periods. This is the law of polarity—everything has an equal but opposite polarity: there are ups and there are downs, there is hot and there is cold, there is good and there is bad, there is outside and there is inside, there is long and there is short, hate and love, pain and pleasure, win and loss, bitter and sweet, good shots and bad shots, etc. As an imperfect growing human being, in every endeavour we will experience positive and negative outcomes. This is the law of polarity.

In the context of the market down periods causes drawdown in portfolios and generate loss trades. All of these movements are a necessary part of the anatomy of the market. We must encourage ourselves to accept down markets rather than feel fear, despair, frustration and anger. We must learn to accept drawdown in our portfolios as a necessary occurrence of active investment. Whilst still tough, this is easier when using a proven system with a positive expectancy.

This week I have moved away from psychology training as I feel that it is important to add my commentary on the current market conditions.

I’m not one to normally predict the direction of the market. To be honest I don’t get caught up in the economic noise or the negative press articles on the economy or market factors but I must say I can see this current market moving even lower, purely using technical analysis. Actually, I think we need to condition ourselves to this fact and that the bear market may be around for a while yet. This may help many traders and investors align their expectations to their trading plan.

Recently I reflected my thoughts in the Share Wealth Systems Active Investor eNewsletter and clearly stated that, “if the Friday 25 June low does not hold this week then the ALL-ORDS must find support around the 4325 level or it could fall to 4200 (there is weak support around 4275 where the trend line is drawn). If 4200 does not hold then the next target is around the 3954 – 3961 level which is some way below where the ALL-ORDS is now”.

With the All Ords closing at 4324, I beleive this market does not have to move much further for it to go much, much lower. If the price action at 4200 does not hold this market could move a further 200 plus points down in the blink of an eye.

Whilst I am sharing my thoughts and technical analysis experiences, most of you would know that I am a pure advocate for mechanical trading. I would always much rather react to the market than attempt to predict it. Attempting to predict what the market will do next is a sure fire way to lose both money and face! That being said, a disciplined application of technical analysis can provide some valuable insights into market trends and internal market structure.

The SPA3 system I designed and released 12 years ago triggered a short or hedge signal only yesterday. Whilst the last hedge trade our customers made back in May was a profit trade, the previous three previous trades before this were loss trades. Rather than questioning our rules and making changes based on a small sample we follow our predetermined trading plan. It now remains to be seen where the market goes. Perhaps it can hold support around these current levels, but if it doesn’t, then the technical indicators appear to be pointing to further price falls. As always, now is the time to be disciplined and consistent in the application of our trading plans and trading rules so we are able to once again take advantage of suitable market conditions when they do re-appear.