Jamaica's investment club debate

Professional economists are supposed to love empirical evidence. I admit that as a professional economist I have shied away from certain things, one of which is regression analysis and econometric forecasting. The main reason for that is a belief in a maxim I learnt at graduate school: the one thing you can be sure about with a forecast is that it will be wrong. If that is the case, I figured, then why spend laborious hours modelling and refining data sets to get something wrong? If my instincts tell me something I perhaps stand as good a chance as a modeller in getting a right answer.

I had a teaching assignment in Tortola, British Virgin Islands in September (see blog); my teaching was in the evenings and my hillside hideaway where I was living gave superb views to the sea and other islands and I had time to think. I kept on getting notions about OLINT and whether the numbers made sense. High returns often lead to immediate suspicion that something is not right. It can happen for short periods of time with speculative ventures and when you are the innovator of some idea and get huge benefits from being first. You see this easily with investments in IPOs where the price on opening is often multiples higher and those who were in the IPO make a whopping profit--hence the suspicion about who investment agencies allow into IPOs (friends, family, etc).

Most financial institutions pay meagre nominal returns, except in situations where inflation is high. You may often find that in real terms (adjusted for price increases) it is hard to get positive returns. The institution where I do most of my banking in the US pays 0.15% a year on my current account. Several years ago I looked at US market interest rates and saw that money markets were paying substantially more than that (say 4+%), and giving similar liquidity, so I took my deposits and placed them in a money market account (MMA). I found the MMA was not as easy to use for regular banking (bill paying, transfers etc.) so I looked for another option and found Internet banks but they too were a little like bricks and mortar banks (a bit bureaucratic and sluggish) but on the Internet. So I looked for another option. I discovered PayPal through selling on eBay. PayPal allows money to be placed into an Internet account and for transfers in and out to be made by e-mail; most transfers are free; and it pays rates close to money market rates. It also links to real bank accounts so permits transfers across them in a way that the actual banks still find difficult. So for the past five years or so most of my banking is done through PayPal. I can make transactions where ever I can find an Internet connection and my only minor problem is that transfer take about 3 business days. I have been earning closer to 4-5% a year on current account instead of 0.15%--a big difference over several years.

OLINT is paying something near 10% a month. How is that possible? I decided to do some research. The "investment club " is supposedly able to do that because it is based on foreign exchange (forex) trading. I say supposedly because one of the issues about such clubs is that details of their actual activities have not been disclosed; that's not a crime but it makes it hard to prove what is going on. So I started online forex trading (see earlier blogs) and wanted to see if I could replicate OLINT's results. Now I admit that I made horrible mistakes at the beginning: these are especially common to new traders, though seasoned traders are also guilty of them occasionally. I started trading with real money much too soon, but I found that I enjoyed the risk taking, and it was important to deal with the real environment--as vices go it seemed not so harmful and playing just with play money seemed like a waste of time. The real environment means nerves: when losses or gains start to show, the heart races, the palms start to sweat and calculations are being made about how far this will go.

Experienced professional traders set up deals in quite precise ways: they set the all important point of entry, which gives the maximum risk/reward potential, and set their risk ("stop-loss" point) and reward ("limit"), then make the deal and sit back. (Actually, they watch what is going on, getting new information that may change outcomes today or later, but tend not to tamper with their deals). They take the gain or loss as set up. If things dont work out they go back and analyze their assessments and try to come up with revised trading strategies.

Professional traders have a particular way of dealing with potential gains: taking half the profit when the reward is two-thirds satisfied, and setting the stop-loss to the entry point, so ensuring a decent profit and no possible further loss. They also use "trailing stops", which follow the price by a pre-set margin, say 10 points: when the deal moves in your favour the limit keeps moving to safeguard the pre-set margin, when the price moves against you the margin reduces but no more than the pre-set amount. So the most you lose is say 10 points from where the price is. If you have already set a limit for your deal but are not content to see that be met the trailing stop says take me out at my limit but don't let me lose gains because of price reversals, so you get out at the deal limit of the trailing stop limit, whichever is met first. (I have started using these more; my first experience was bad and I misunderstood how it worked; it's very important to ensure that the trail is set the right way, such as buy--not sell--when that's what you need to close . Sounds simple but believe me misstakes happen.)

I am learning all the time. I found from trading the live and practice accounts that volume is very important. US$50,000 in the practice account is huge and with the margin trading possibilities of lots of $100,000 you can see gains that make you blink but also losses that make you wince. You can also take risk with trades and not care. With live money you wince a lot whatever, but as a I said your nerves start to play on the deal and that is a major barrier. I use smaller margin trading lots there (US$10,000, meaning I put up say $100 of my money to play with the bigger amount and a 1 point movement represents US$ 1 on my actual money, so 15 point gain/loss is $15 profit/loss). I have learned over the last two months to let my nerves play less. I try not to watch deals as much and let them run. I even set deals and then go on trips, which sounds risky but is no different from keepinga position overnight and seeing how its done in the morning.

Why volume matters is that if the balance is small then deal sizes must be small and also the margins for losing are very finer. If there is an intention to make a decent amount of money one needs a balance of at least $1000: that allows deals bigger than just one lot that don't risk too much capital and can handle a few losses. Amounts such as $250-500 are really too small. about $2000 is nearer ideal for starting as a small trader. By having larger lots and letting deals run longer individual deals can net $50-100 more easily (say 2 lots gaining 25 points); of course you can lose more on each deal. (Onlinefxtrading is an interesting blog about one Jamaican's experience with online trading and highlights perfectly why small amounts wont work and are likely to end up losing.)

I also found that intervention tends to lead to worse results. I found that tampering with a deal tended to mean that actual gains were less than potential gains. A major novice mistake is to close deals too fast either to minimize a loss or because you fear losing a gain. But in doing that you miss the nature of price movements in financial markets, which have wave tendencies (ebb and flow) and reversals are normal. The experts have sophisticated ways of calculating the possible reversals and set deals up so that reversals do not damage the risk/reward set up. So, with a stop-loss of 45 points a 38 point reversal towards loss is interesting but not critical; without the analysis a 38 point reversal often leads to a panicky feeling, especially if the trading position is large. This pull-back as it is called is part of the trend and so should be left alone. So, armed with their charts, and price movement details and experience, professional traders make money more than they lose and they can make large profits. [Yesterday showed me that well: I had sold at 1.4610 and set my stop-loss for Euro:US dollar at 1.4660, the price rose to about 1.4590, then reversed and the Euro ended the day closer to 1.4430. (I did not get all of that gain as I did not believe the fall would be so dramatic--very unlike Euro/US dollar in recent weeks--and took my profit earlier.)]

I, on the other hand, am armed with few of these tools, including lots of sources and market contacts alongside that can tell me about developments in related markets (especially futures, equities and commodity prices); this is a big handicap because the markets are linked. Nevertheless, how have I done? Well, David Smith and OLINT can sleep safely for the moment. Since September I have not managed to make 10% a month; I am down overall. But since September my performance has been improving, and at mid-December I am up 25%, so if I made no more trades that would be a good point of satisfaction. On any given day, it is possible to make money whether prices rise or fall, and I have played with several "emotional" strategies, including looking for cheap deals (say 5-15 point gains, especially on a single lot), which satisfy the need to see the cash balance rise but tend to give less overall if one looks back on how a deal could have played out. So, I have tried not to be greedy and if I see that I have made between 1-5% on the day I tend to say "I'm out". Now deal making is such that new opportunities always present themselves so to avoid that temptation I often have to close my account and walk away from my "dealing room" (my basement office). Another lesson is that the return visit tends to mean losing some of the initial gain.

Experience matters. When I lose $200-500 in a day I am not fazed anymore because I now know I have the potential to gain the same amount. The tendency to think the market is against you when you lose is normal. (Believe me, you do feel this way when a lot of deals go sour.) You also need to live through volatile experiences and know your history. I was in the market during the past two weeks when the major countries (Canada, UK, European Economic Commission, and US) made interest rate decisions and also when very important data were published. Many traders take a side line ahead of such situations knowing that the price movements afterwards are hectic and conditions can be unclear; they prefer to see how things settle and then re-enter. I gained despite the increased volatility; it is hard to say where I would have been if I had been on the sidelines but I am in the middle of my own research and it's important to know the feeling of seeing your position move 60-100 points for or against you in a flash. I also learned important lessons about disorderly about trading conditions: my stop was set at 30 points but my deal was not filled until the loss had gone to 60 points--there was a market gap when it is almost impossible to fill orders because of the speed of price moments,which usually lasts no more than 30 seconds, and deals then get filled at the nearest point. Expensive lesson in that case, but it also helped me with a large gain in another deal. I also learned that it is better to stay with a group of currency pairs, and get to know their market characteristics better. It's good to know where the US dollar sits in terms of decade lows and have a notion of to which point it will initially rebound, and so on.

Bottom line? My question was whether forex trading made of over 10% a month returns possible . I have enough information to tell me that the answer is yes, though I don't know how sustasinable it is. Judicious trading can easily net 1% a day, and over 20 trading days a month even 20% is not amazing. So, I have no in principle problem with the gains that OLINT is paying out; there is no guaranteed amount and in recent months the monthly pay out has been around 7-10%. Now, David Smith is an experienced trader and reputedly very good so my next question would be how much is OLINT really making? I am not going to pursue that here except to say that if the gains are closer to 20% a month then with a lower pay out that allows space for covering other costs and a tidy profit for Mr. Smith and his corporation. I won't begrudge him that. Trading is stressful and though it may be different to play with other people's money I imagine the stress is still very high especially with sums in millions of US dollars. Big corporations give large pay outs to their CEOs if they can make the business very profitable so Mr. Smith is entitled to his slice of the cake.

Jamaica's "small man" has been thrown a welcome life belt with schemes such as OLINT and a lot of deposits have flown from banks into such schemes. I do not think all the schemes are the same so I will make no judgements about them. The government and financial regulators in Jamaica are now pursing various legal cases against such schemes and their outcomes will be very important (see article). Financial system regulation is important to give investors confidence in the institutions with which they deal, and also to determine if there is a need for insurance or some other cover to protect investors from losses. If something is not illegal then it can't be stopped on legal grounds. If it is risky and legal then investors need to know the risks they are taking on; so trading stocks or forex means living with price rises and falls and losses and gains.

If the legal cases go against the "unregulated investment schemes" and mean that some of them have to close the financial fall out could be devastating. Common talk in Jamaica is that the banks won't see many of the depositors flocking back because the widespread belief is that they are grossly underpaying depositors. The recent action of some banks (see article) to try to close the accounts of OLINT and Cash Plus, not honour their checks, and to demand that their employees disclose if they have accounts with such "clubs" or risk being firedhas angered many people unions. Again there is now a court case over this and injunctions have been issued to stop closures for the moment. It may also lead to a run on the clubs as depositors clamour for their money, which could threaten what was a viable operation (not Northern Rock, but the example is very vivid and current). A senator has asked that the issue of the investment clubs be>

The general feeling is that if you are able to invest with OLINT and Cash Plus you have been able to get a very handsome return. OLINT has been running for several years and I have seen no reports of dissatisfied customers. That is not to say that either club can continue to do as well. As far as OLINT is concerned, if its principal activity is forex dealing then this is not illegal. If it has been giving investment advice (which it denies) then in Jamaica that is an activity reserved for licensed and regulated institutions. If complying with relevant legal requirements is a problem then that will signal another problem. Forex trading seems to be a growing activity for small investors, and online companies are sprouting up like mushrooms; not surprisingly Jamaicans are apparently jumping on them (see Silicon Caribe blogs and also recent Gleaner article). They make money on the spreads (difference between buy-sell prices). David Smith is now offering such opportunities with the sweetener of a $100 bonus for Jamaicans who open with a stake of the same size (see I-trade FX website).

Sensible investors have not put at risk money they cannot lose. Some people might have taken on risk they cannot handle, but the recent sub prime mortgage crisis and other past financial crises show us vividly that this is always the case. They also show us that regulation does not prevent financial crises. Simple precautions help prevent certain kinds of losses which individuals can avoid, one of these is to test how easy it is to withdraw funds: my feeling is that if that is a problem then better not to go there. I tried an online trading company recommended by one of my commentators and doubled my initial stake and more. I then tried to withdraw the full balance. The company asked for several pieces of documentation to prove who I was and confirm my credit accounts, part of normal "know your customer" rules. My money has been returned to my credit card account so I feel that I am dealing with an institution I can trust, even though the process was cumbersome.

A bitter pill in the recent dealings with the investment clubs is the vigour with which they are being pursued and that has made the "small man" very angry as he has done well out of it. So, he is asking, "Why the government can't go catch all o' de thief and murderers who a mek we suffer?" Good question.