Dec

5

 What the statistician traders miss is that the human brain is programmed to observe and create geometrical patterns. Since the observers admit to looking at price charts then they know that they might influence results.

Homo erectus was making patterns on shells long before today's speculators were trying to use patterns to turn a profit.

Apr

22

 12 insights about markets and life from reading Ken Roman's The King of Madison Avenue and The Unpublished David Ogilvy.

1. Be unorthodox and imaginative in your hiring. Ready to hire people with unusual backgrounds. Would you hire this man for an advertising executive? "He is 38 and unemployed. He dropped out of college. Has been a cook, a salesman, a diplomat and a farmer. Knows nothing about marketing. And has never written any copy. Is interested in advertising as a career at the age of 38, and is ready to go to work cheap." It was Ogilvy himself who 3 years later became the most famous copywriter in the world and built the eighth biggest ad agency.

2. Treat women as if they are as knowledgeable as your wife when you advertise to them. They don't like to be talked down to or treated as robots. Peter Lynch and Jim Cramer are not the only investors who got 10 baggers from their wives.

3. The purpose of advertising is to sell a product. Make sure you go for the sale. Forget about aesthetics. Learn from the mail order ads where everything is tested, and no ad continues unless it pays it way. Forget about the 3rd and 4th moments in your quantitative measures and concentrate on making a profit on your trades.

4. Don't show off or try to be funny. It doesn't go well in print. It demeans the readers' intelligence. If you show off in a trade or competition, it will defuse your energy, and take you away from the bottom line.

5. Always hire a secretary of the same sex as you to make appointments. It will show you're interested in business and not in romance. And it will prevent you from being too expansive if the romance doesn't work out, or too soporific if it does. You have to be alert to be successful in markets.

 6. You never know someone's character until the chips are down. Everyone's a good winner. Choose side men of unquestioned integrity, preferably eagle scouts, or those who follow the code of the west. Roman himself was not gifted by an excess of loyalty from his mentor when the chips are down. Don't expect your clearing firm to give you the benefit of the doubt in a tight situation. They have to worry about their stockholders and when you are down, there is ample opportunity for them to make a profit against you, the same way a poker player can when he knows you can't withstand a big bet.

7. Always be reading good biographies. Ogilvy was an incessant bio reader and used the lives of the greats as examplars for building his international operation. The best bio of a market person I have read is MFM Osborne's biography by Melitta Osborne and Tom Wiswell's proverbs. Both are available on the DailySpec.

8. Write 100 headlines and read everything about your competitors and your product before you write your ad. Be ready to test 100 systems until you find one that really works and is not subject to ever changing cycles.

9. Surround yourself with people that have talents that are different from yours. Ogilvy knew nothing about finance or tv or computers, and hired good people to fill in the gaps. If you're a macro guy, hire a micro guy to get you on the right track. The palindrome hired me because I could get him a tick or two, and that was enough to start the steam roller going.

10. Work hard. Oglivy supposedly worked 120 hour weeks, and drove his wives crazy by working all through the night. The little bit extra is the difference between success and failure. I won countless matches in squash by diving for shots while my opponents were apologizing for hitting it off the wood.

11. Be prepared with a good defense. Ogilvy wrote what Fortune described as the best sales manual ever for the aga cooker. In it he enumerates 10 common reasons for not buying the product and shows how to turn each objection into a sale. Are you ready on your trades to turn your losses into profits, to survive if it goes against? Prepare a manual of defense and stick to it.

12. Be ready to learn from and compliment your competitors. Ogilvy often walked out of a meeting and told the prospect to go with his competitor because the other side was better. Practical investment people can learn much from the academics, and the fundamentalists and the technicians should be friends.

Andrew Goodwin writes: 

I was thinking about what you said about how you shouldn't expect your clearing firm to give you the benefit of the doubt in a tight situation.

That doesn't make sense unless one gets preferable margin callings or the like due to status as a .01% large player. There is a mathematical sweep or a reg T margin from most brokers one can find who run a tight ship.

For my part, I'd like to see how the clearing firm traders use the customer position data. If you know someone is levered up the gills and has to post more money at certain levels, then of course they will take the other side if there are no Chinese Walls.

Long ago, I saw an indicator in print which showed the margin purchases versus the cash purchases of Merrill Lynch customers. When optimized it had reversion results that were nearly perfect for the many years preceding the printout.

If you know the margin call levels for the largest number of the public customers on Reg-T, then one should fade the mandatory liquidation levels once crossed with little caution. That's why you buy stock in brokers and hope they don't pay themselves all the trading profits in bonuses.

Feb

10

 If one hasn't noticed, the Olympic judging of figure skating has changed. One no longer gets to see how the judge of each country has voted on skaters' performances on TV. This change from a disclosed 6.0 scoring system by judge with country affiliation revealed to the new ISU scoring system creates the prospect of great unmonitored injustice.

No longer can we see the scoring by judge of each country for each performance. If one can't measure a scoring bias by seeing the country by country judge data, then how can one register a complaint as an athlete? This creates a de facto measurement method on par with that of a Court of the Star Chamber in use famously during the 15th until mid 17th Centuries.

Far from taking a step forward, the new scoring system, in reducing accountability of judges, increases their omniscience. One might argue that hiding the identity of the judges through the random selection of judges' scores might allow a judge from a non-totalitarian state to make a fair call. That would make the assumption that the judges aren't under some other type of surveillance or control.

Feb

7

 The latest contestant on the popular game show "Jeopardy" has found an unorthodox way to beat the game. Using game theory, Arthur Chu has managed to win 4 times in a row. His unorthodox methods have traditional Jeopardy fans upset as he follows the rules, but goes non traditional, and hits the big money first, then searches for the daily double. In fact, in one daily double, he found it in the category of sports (which he has little knowledge), and bet only $5. His style of play is to deny his opponents the big money, just like we try in the markets.

Anyways, Chu has upset the apple cart and won over $100K. Fans, along with the host Alex Trebec are visibly upset, but Chu is playing to win, not appease viewers or the host. This reminds me of speculators who get upset and blame HFT, flexions, the other side, etc. when they lose. They were mad at old man Rothschild when he had news of Wellington first and scooped the market. I'm sure that in the future, there will be many boogeymen to blame things on.

I applaud Mr. Chu for his out of the box thinking, and wonder why nobody has done this before, considering Jeopardy has had a 30+ year run. Mr Chu can teach us many valuable trading lessons.

Andrew Goodwin writes: 

This guy is a close friend of my gf. He has garnered much anger from the crowd. He has won four times in a row and is now being called the "Jeopardy Villain" by the press and fans of the show.

This is a take from the net describing his methods:

"What is Chu's game theory, exactly? While most players opt to stick with a single category and work through it from lowest to highest prize amounts, crossword-puzzle style, Chu begins with the most difficult clues in an effort to solve the Daily Doubles and doesn't hesitate to lay down the big bucks when he finds them in a topic he's familiar with. If the question belongs to one of his less-practiced knowledge categories, like sports, he'll only wager $5 and throw it away, knowing that it's off the board for his competitors. He also spat in the face of the $1-over wager tradition in Final Jeopardy, in which the extra dollar prevents a tie; instead, Chu intentionally bet to tie twice, though only once did he and his competitor (Carolyn Collins) both answer correctly and move on. This is not a humanitarian move, by the way, but it is a clever one (Keith Williams, former Jeopardy! winner and obvious math person, breaks it down for you in detail here.

Playing to tie increases your chances of advancing both because of game theory and mind-fu—- your opponent ("if your opponent knows you're going to wager for the tie, he might disregard a rational wager and go for broke in an attempt to tie you"). Chu is also quick to buzz in, which is perhaps the most useful Jeopardy! skill of all."

Chu has already won four games in a row and gets to compete again on Feb 24th. He is using game theory and statistics to beat the other opponents and has mastered them all so far using his unexpected system.

I suggest we watch to see if his play changes the behavior of the next opponents so that they match his tactics and alter the game show for good. This is the live popular culture version of the theory of ever changing cycles at work for all to see.

Far from a game of mere trivia knowledge, Jeopardy now is a game of greater complexity than thought previously due to the skilled tactics of Arthur Chu. Granted, I understand that Chu was considered a genius back in college, but he is not winning like Jennings in knowing all the trivia.

Adam Robinson would really enjoy this story.

Best regards, Andy

Jul

30

 If you are the trader getting squeezed and know it then you don't have to liquidate the threatened positions. What you do is rank the most liquid correlated positions and especially the liquid OTM options of correlated and liquid items and let the predator activity enrich you.

I'd like to see your answer on this plan about cutting the slippage and hopefully doing it near the point where they think they've got you and you can exercise options to hit back.

It's a military type tactic that suckers the predators into a trap. If one can slice and dice orders anonymously without a bank holding all the cards, one might make it work.

The trader getting squeezed has perfect information on the vulnerable positions and goes to the electronic and somewhat anonymous options markets to buy cheap OTM volatility explosion options in all liquid and related assets to soften the blow. Let's see the predators game the algo slicing and dicing of hedges while inflicting what they think is pain. They should pay off the victim of such a squeeze 2:1 at a minimum.

Victor Niederhoffer writes:

What do you people think of this? For reasons of loathing, and avoidance of squeezes, I have avoided any study or consideration of options for many years. 

Russ Sears writes: 

It seems much of the hedge cost is tied up in matching an exact date and risk of sudden jumps across the strike as that date approaches. From my experience hedging variety of equity indexed annuities (S&P indexed call options embedded in an deferred annuity). I believe the secret to not getting squeezed is to manage the gamma position under "normal" conditions by writing shorter dated options an buying slightly longer time positions. And manage the delta exposure by the different strikes. If you are long gamma you maybe shorter delta than you want after a big drop, this can be carefully reversed (sell long dated, buy shorter options) as volatility spikes.

While not endorsing the derivative expert's new book "antifragiles" (he is too long winded), I would recommend only reading the prologue. It is like exercising, if you practice hard the first order effect is to tear down. The second order is to recover. So you go long the healing process under healthy times to prepare for age and diseases. People dread the first order pain too much so they don't exercise and buy out of the money expensive puts.

What the expert misses is not only do you stress yourself to increase your ability to recover, you indulge your self after the stress, sleep, food and ice baths etc. if inflammation is too much. In the book he says he is on a fast of some kind almost always. But he also lifts weights walks and exercises. This is not healthy. It is as much about the recovery as it is accepting some first order pain.

Jul

8

TaurusThere have been a number of absurd studies over the transom lately. VIX has to go above 29% for a market bottom because that's what it's done at the bottom of other market declines. Equally ridiculous is that the average market decline when it's gone down at least 20% is 27%. What these studies fail to note is the expectation from a given level as of a closing price. They are flawed because of retrospection and perfect knowledge as well.

Lawrence Schulman writes:

I don't think those studies are absurd at all. The four big selloffs we had last August, November, January, and March had VIX going above 29. Right now the market has taken out the previous lows. So I think it is wise for anyone to have some cash on the sidelines since the probablity would favor another large VIX spike. As far as the average bear market's being down 27% from the top, I would have told an investor: when the market is down 20% from its bull market high — which happened this week — the likelihood is the market would not stop going down once it hit the 20% pullback. And on Friday the market was down 22% from its bull market high.

Andrew Goodwin remarks:

Seems absurb that a bell will ring at a market low, which was to be announced, according to multiple pundits, by a VIX move above 30. The markets normally confound attempts at bottom fishing by the masses. Those looking to the contrarian idea that an indicator so scrutinized by the public could not possibly work, and even citing the Heisenberg principle, were taken aback when the tool worked this time. This time was different because the smart money contrarians outsmarted themselves by looking for deception. The VIX lady really did sing at the end and it didn't convince all.

Dec

14

Esteem. What are the reasons that business people act as they do? One reason is the desire for profits. The second most studied reason is the sanction and guide of regulation and the law. A third reason, which is not considered enough, is the desire for esteem and the avoidance of disesteem. This topic is covered very well in The Economics of Esteem by Geoffrey Brennan and Philip Pettit. They consider how esteem is allocated and how it can be improved in the economy. Chapters include why we want esteem, the demand and supply of esteem, the economics of equilibrium of esteem, publicity, the intangible hand, and voluntary associations. It's mainly a diagrammatic and psychological framework within which the principles and non-mathematical tools of economics are applied. It should have great application to the endeavor of finding good companies and good managers.

VIX. With VIX at 9.7, its lowest level in 12 years, the jury is out. Will the new year, or the new expirations to be traded, lead to a change in regime? Usually decision-makers are not apt to change horses near the holiday season, especially in view of the bonuses gravitating down to the middle classes.

Torts. It's hard to do anything these days without thinking that fear of litigation is a driver of the customs and procedures. In hospitals, people in critical care are subjected to an endless barrage of red tape while in shock so that doctors can protect themselves from subsequent claims, including giving X-rays while life hangs by a thread. And of course autopsies are a thing of the past because they often are not paid for, and because of what they might reveal.

Happiness. The happiness that people forego to protect themselves from liability is often not accounted for in the cost benefit-analysis of third party payment schemes. For example, in squash, certainly the rule that one must wear goggles causes more accidents than it saves. And people can't remember the time when you could actually enjoy a game of squash and see the whole court. And many people have not taken the game up because of the wearing of goggles. Of course, the invisible hand explanation for such rules is the fees associations get from the manufacturers. More importantly, many have had their happiness quotient decreased. The same is true of car seat laws for babies. How much wasted time, how many cancelled trips? There are hundreds of other examples.

Antipodes. I spoke at Yale yesterday, a week after Professor Taleb had been there. And we have both adopted George Zachar's device of "your own man says it's so" to discuss the merits of what the other does, even though it is more than 99% likely that on any given trade in the pit we are on opposite sides.

Anthropology. The customs of various trading pits, and the movement from simple to complex rules, a subject anthropologists study, would also be good for speculators to consider. I am reading the Encyclopedia of Anthropological Theory and find in every chapter insights into the way people perform tasks in different cultures and times, and the way that markets work. The anthropology of markets should be studied in detail and not just in terms of the customs and norms that develop on the floor and how they affect the public.

George Zachar replies:

One of the peculiarities of the big dealer shops I frequented was their intensely tribal nature. The sales/trader types loathed the slick investment bankers, who in turn treated "the floor" with contempt. The bond guys thought the stock guys were idiots, and the stock guys thought the bond guys were dweebs. The salesmen thought the traders were calculating lying thieves, and the traders thought the salesmen were glib lying thieves.

Many of the failures I observed at these firms could be traced directly to these tensions, and management's inability to get all the horses to pull the twin carts of customer satisfaction and firm profitability.

I've always assumed the key to 85 Broad Street's stupendous success lay in creating and sustaining a culture/management/incentive structure that solved the tribalism problem.

Vance Falco adds:

I'll reinforce George's observations. In the late 1990s I ran a research desk on the trading floor of a small boutique investment bank. Our primary responsibility was to very quickly make assessments about news flow regarding the companies under the firm's coverage, synergize that with the industry analysts' existing research stance and get the perspective out to block traders and the institutional salesforce. It was very amusing to see the quickly shifting manner in which we were treated. When queried about the meaning of something, we were treated (generally) respectfully. The moment we weren't on stage providing the value added insight (we hoped), we slid back to being treated as simply consumers of others' potential compensation upside and our part in the larger process was lost. To the traders, we weren't rough and tumble enough. To the salesforce, we knew the research well but weren't glam enough to put out the firm's sales call. Second class citizens from every angle.

Yishen Kuik comments:

I just wanted to add that I've long shared the same observations.

My experience is that some institutions can be very balkanized and surprisingly ineffective at coordinating efforts. Additionally, not especially well organized to move talent within the organization, allowing it to find its best fit.

Having said that, the Grand Sichuan Bank does seem to have created a good structure/culture to deal with these issues.

Vincent Andres contributes:

This reminds me of a very very good book called The Naked Ape by Desmond Morris.

Considering we're just apes with costumes has often helped me to put things into perspective. I believe it's also useful to understand crowd behavior, because most new types of behavior emerge at common denominator points, and thus many such behaviors are of a very primitive sort.

Andrew Godwin extends:

Having played squash for over 25 years, I give the thumbs up to Victor's analysis of goggles. Rather than point out profitable liability management portfolio ideas to the public, shouldn't you instead go long the athletic cup manufacturers? The sport authorities don't make you wear those yet. The loss of family jewels in a squash match would count much more significant than injury to goggle-protected portions to males without children. Indeed, parents and grandparents would support such an initiative. Only current spouses or kids in divorce situations would object. The descriptive terminology of "family jewels" makes the point to savvy marketers. Self-evident points need expression in your form, apparently.

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