Category: Trading 101

"F---wits"

May 05, 2008

A question and answer from a recent Trader Monthly interview with David Harding:

Q: Do you have strong opinions about the differences between money managers educated in mathematics versus those with liberal-arts degrees?

David Harding: Investment management has been, for years, run by arts graduates. That has been the tradition. We’re on the cusp now of it being run by science graduates. For a long time in the investment-banking business in England, you needed to go to one of the top WASPy, blue-chip institutions to find your way into the money world. This was equivalent to your Ivy League in the U.S. But George Soros went to England after the war, looked around after getting a job in banking and asked, “Who are these f---wits?” before heading to America. In America, he found a small number of clever people in finance, and that’s why he started a hedge fund there. I don’t know if America is better overall than England, necessarily, but it certainly is more meritocratic.

Prenuptial Agreement with the Market

April 24, 2008

At the panel I moderated today in Paris Peter Borish put the concept of a stop loss into terms everyone can grasp. He called it a "prenup" with the market. You have to know your downside, his simple but crucial point.

Point Blindness

April 21, 2008

A recent academic study (PDF) on point blindness:

Millions of Americans pay attention to US stock market news. They get this news from many sources. Print outlets, 24-hour news networks, and thousands of websites provide scores of financial reports. Many of these reports focus on the rises and falls of major stock indices. As Robert Shiller puts it, “Nothing beats the stock market for sheer frequency of interesting news items.” One reason for increased attention to the stock market is a dramatic shift in responsibility for the post-work well being of American workers. Part of the shift is from employers to workers. Participation in defined benefit plans (e.g., pensions) has dropped significantly over the past two decades while participation in defined contribution plans (e.g., IRAs, 401(k)s and 403(b)s) has skyrocketed. A parallel shift from government to workers is also occurring due to growing doubts about the extent to which Americans can count on Social Security for retirement income. As the 2007 Annual Report of the Social Security Administration states: “The financial condition of the Social Security and Medicare programs remains problematic; we believe their currently projected long run growth rates are not sustainable under current financing arrangements. Social Security's current annual surpluses of tax income over expenditures will soon begin to decline and then turn into rapidly growing deficits as the baby boom generation retires.... The longer we wait to address these challenges, the more limited will be the options available, the greater will be the required adjustments, and the more severe the potential detrimental economic impact on our nation.” Where recent generations looked to employers or government for post-work guarantees of income, younger and middle-age workers have a different future ahead. Their future financial security is more likely to depend on their own and others’ investment decisions. As a result, what Americans believe about the stock market is important – not just to their own financial futures but also to governments and others whose assistance will be sought if scores of people make bad investment choices simultaneously. For these and other reasons, the conclusions Americans draw from stock market news have important implications.

A complicated way of saying to turn off Cramer.

Jesse Livermore

April 19, 2008

A reader forwarded a PDF copy of a very old Jesse Livermore title. Worth checking out to see relevance for today.

Google Black Box

Barry Ritholtz brings up the notion of Google's black box and how it might affect the firm's fundamentals. For me it is further confirmation as to why the only real thing you can know is the traded price each and every day.

Decipher?

April 11, 2008

Can anyone decipher this for me? I can't tell where he is trying to go exactly. My (2) books, as but an example, don't cover traders with "uncertainty of exit schemes".

One reader writes:

Hi Michael, I read the article you linked to and was thinking it was another mathematician over-optimizing everything in sight, then I read the date it was published - 1st April 2008! So I guess it's a case of take your pick really....Matt

Wisdom from 1974

April 06, 2008

Barbara Dixon, a student of master trend follower Richard Donchian, writes in 1974:

Technical Analysis is based on market action, or price. The theory derives from basic economics. The price of a commodity at a given time is determined by the supply, the demand, the general economic outlook, the weather, the political climate, the optimism or pessimism of the population, and other factors. The technician looks only at the price, since by itself it represents one side of the equation and thus encompasses all the other inputs. The technician mentally substitutes the words “buy” for demand and “sell” for supply. Thus, when corn increases in price, the technician says that buying – demand – is increasing and that the price is going up. The trend follower makes no attempt to forecast the extent of a price move. His basic tenet is that once a trend begins, it has a tendency to persist in the same direction for some time. He devises precise rules to determine what, to his mind, constitutes a trend and identifies the situation when a trend has finished or reversed. He then further disciplines his thoughts into a strict set of conditions for entering and exiting the market. He acts on these rules (his “system”) to the exclusion of all other market factors. In so doing, a trend follower removes, hopefully, emotional judgmental influences from his individual market decisions.

Not exactly dated wisdom!

How Goldman Sachs Secretly Destroyed Bear Stearns

April 03, 2008

The piper comes calling if you play with fire.

TD Ameritrade Webcast

March 20, 2008

I did a TD Ameritrade Webcast yesterday with 300+ people. Will post shortly.

Lost On Me

March 17, 2008

If Bear Stearns can go to zero, a stock anyone could buy with no restrictions, tell me again the point of government regulation that limits who can buy a particular hedge fund or not? It seems like the current market situation is proof positive that people should be able to diversify into assets that the government otherwise has prevented them from owning.

Bear Sterns: The Price Didn't Lie About Direction

March 14, 2008

The chart shows that the "price" was indicating a problem long before we got to today.

Everyone Gets What They Want

March 12, 2008

An article of mine published on TradingMarkets.com yesterday.

-42% Down in No Time

March 06, 2008

Ouch.

401K & the Courts

February 21, 2008

I was forwarded this article with this comment:

"Sue because you lost money in your 401k?"

Is that what the article says? I don't read it that way. The suit issue revolves around negligence, not losses.

Buying Opportunity or Short Opportunity?

February 10, 2008

A chart to consider from China. I am not saying it will end like this or this, but it could.

Michael Martin on MSFT + YHOO

February 03, 2008

A take on the proposed mega merger. The YHOO trend was definitely not up!

On $11 an Hour, Jersey Man Made Millions

January 27, 2008

An excerpt:

Paul Navone is one of those quiet millionaires next door. His friends had no idea he had money until he started giving it away -- $1 million to a college and another $1 million to a prep school. The 78-year-old retiree never made more than $11 an hour while working in the New Jersey mills, according to a story by Joe Logan in the Philadelphia Inquirer, and to this day Navone buys his clothing at thrift stores, and doesn't have a TV or a phone.

More.

What Does Goldman Know That We Don't?

January 17, 2008

From Michael Lewis an interesting take on Goldman Sachs.

How To Meet People?

January 11, 2008

An email in:

Hi Michael, I am looking for some help and to be absolutely honest with you I really don‚t know where to start. I will give you a little background about myself... I started trading 10 years ago and on the whole it has been a disastrous experience. I learned the hard way that I wasn't designed for short term trading or fundamental analysis and so when I stumbled across your website I immediately recognized I had the answer. I completed my system in November 2005 and to date the return is in excess of 50%. I am lucky to have a father with a gift for programming and so we were able to back-test 25 markets over 30 years which gave me the confidence to trade what I believed would be a winning system. What is certain is that without your website the system may not have been possible or would have taken considerably longer, so thank you. I currently have a small capital base and while I'm delighted with the returns they are in no way life changing. I am assuming you come into contact with a lot of people like me and I want to know whether the best route is to build one's own client base or cold call every Hedge Fund and CTA to see if they would be interested in backing a system, or something else. I will no doubt employ all possible strategies but would very much like to hear any advice you may have. Thanks in advance for your time.

Regards,
Stuart

You bring up tough issues. Many of these issues hit at explaining why some Turtles were not able to make it after the program ended in 1988 (See chapters 11-13 of "The Complete TurtleTrader"). That something extra, that entrepreneurial ability that Jerry Parker and Salem Abraham possessed (as an example) speak to what it takes to really build - no matter what your business is. Specifically, in terms of meeting top people and learning from them, the Managed Funds Association is a great direction. There is no short answer though. Building a Rolodex takes time. In terms of capital, it sure seems that the traders I have met who don't have to close down if all of their clients take their money and go home are in a much better position. Simple statement yes, but a lot behind it.

One Great Bet? Or Repeatable Skill?

December 01, 2007

"In that giant casino known as the U.S. economy, there is always someone who can count the cards, work the odds and beat the house." Read full article.

One great bet? Or repeatable skill?

Does it matter?!

Demystifying Managed Futures

November 27, 2007

A brief paper (PDF) aimed at demystifying managed futures from Man Investments.

Jim Rogers on No Prediction

November 25, 2007

I caught an interview excerpt the other day:

Dave Goodboy: Do you use technical analysis at all?

Jim Rogers: No, its pretty simple just figuring out what is going on in the world. I try to find things that are cheap and invest in them if I see some positive change coming. I don’t understand the charts. Don’t misunderstand me, I do look at the charts, but I only look at a simple long-term chart to see what has happened over the last 15 years or so, not to tell me what is going to happen in the future. For example, if I am looking at sugar, I want to know the high, the low, when, why, and things like that. I look at the charts to educate me, rather than a predicting tool.

Rogers, who has said that he is not a trend follower to me, sure sounds very similar with his non-prediction stance.

Michael Lewis Article About Wall Street's Irrelevancy

November 23, 2007

The December 2007 issue of Portfolio magazine has an article titled "The Evolution of an Investor" by Michael Lewis. An excerpt that caught my eye:

Nobody knows what the market as a whole is going to do, not even Warren Buffett. A handful of people with amazing track records isn’t evidence that people can game the market. Nobody knows which company will prove a good long-term investment. Even Buffett’s genius lies more in running businesses than in picking stocks. But in the investing world, that is ignored. Wall Street, with its army of brokers, analysts, and advisers funneling trillions of dollars into mutual funds, hedge funds, and private equity funds, is an elaborate fraud. The problem was the entire edifice of modern Wall Street, in which some people—brokers, analysts, mutual fund managers, hedge fund managers—presented themselves as experts and were paid fantastic sums of money for their expertise. But essentially, Ellis argued, there was no such thing as financial expertise. "I read this book," Blaine says, "and I thought, My whole life is a lie, and everyone around me is facilitating this lie."

The Buffett System

November 17, 2007

One system? Buy after Buffett buys!

Pied Piper Feedback

October 17, 2007

Below is fedback from an "Old Pro" trader who has written me great stuff before:

Hi Michael,

I am happy to see the overwhelming positive response to your new book on Dennis and his turtles. I just think it's a great read and it touches on the commitment one must make to be successful in the trading business. A recent post on Paul Tudor Jones, who I knew from my old days at Commodities Corporation, prompted me to send you the following comments:

Everyone remembers the story of the Pied Piper of Hamelin, Germany. In 1284 the town was suffering from a great rat infestation. One day a man claiming to be a rat-catcher approached the villagers with a solution.The town promised to pay him to remove the rats and thus he proceeded to do so. The man played a musical pipe that lured the rats into a nearby river in which all the rats drowned. The town refused to pay the rat-catcher and later he returned and lured all of the town's children into a nearby cave never to be seen or heard from again. The story has many endings and I prefer the one where the town paid the piper in Gold for the return of the children.

What does the rat-catching pied piper have to do with trading? My belief is our industry is full of modern day "rat-catchers". They come in many forms but mostly they write newsletters on trading and what markets are going to do and how "rats" aka novice traders can simply follow their advice and achieve great wealth literally overnight. These letters range in cost from $20 per month to $3000 per month. They are constantly dwelling on the most recent "good call" on XYZ market. So what's a good call. Let's see? A recent newsletter I was provided by a close friend states The US stock market is at or very near an important high. Okay-great! How do I get in and where? How much do I bet? How much do I risk on this bet aka where is my stop loss protection? Where do I get out if the bet works? This particular newsletter advocates avoiding the use of stops. That's a sure way to get to the poorhouse in trading. I believe it is very simple why 95% of new traders lose money. Many of them follow the "pied pipers" aka gurus that are alive and well in our industry.

I attended a manged money conference a few years ago. There were probably 100 booths promoting the latest "get rich quick" trading system and then of course there was the "guru section". Out of curiosity I approached a very well known guru and introduced myself. We had a nice conversation about his service. I then asked him why he didn't just take his own advice and start a hedge fund. His answer was probably sincere but from my perspective it was laughable. He stated that so many people subscribed to his service there would be a conflict of interest for him to ACTUALLY follow his own advice. Boy is that a vote of confidence!

If a new trader wants to he or she can wave with Bob, season with Jake or Ring with Glen. At the end of the day trading success comes from hard work and dedication. Most important is the mental discipline required to follow one's own rules. For those who want to follow the gurus just be prepared to "pay the piper" in more ways than one at the end of the day!

Keep up the good work!

Paul Tudor Jones

October 13, 2007

A fun article on Paul Tudor Jones. I have this video documentary on him. It is a great film.

Hedging Your Hedge-Fund Bet

October 05, 2007

An article sent in by a reader:

Hedging Your Hedge-Fund Bet
By JONATHAN REISS

HEDGE FUNDS ARE SUSPICIOUSLY popular these days among financial cognoscenti. The Institute for Private Investors' survey of extremely wealthy investors indicated that about 80% have some investment in hedge funds and nearly a third have more than 25% of their assets in them. Private and public pension funds are increasing their stakes in hedge funds in the hopes of scoring double-digit returns on investments. This raises public policy concerns as poor performance will not affect just rich investors but also put employee pensions and taxpayers at risk.

Undoubtedly, some of the 8,219 hedge funds will produce excellent returns for the $1.2 trillion in assets entrusted. Yet it is almost certain that in aggregate, hedge fund returns will be disappointing. It just isn't possible for every manager -- like Lake Wobegon's children -- to be above average. Indeed, their proliferation suggests a much more interesting investment opportunity: selling hedge funds short.

Think like a hedge fund manager for a moment. Is it possible that large classes of these funds with similar strategies will actually beat the market, especially net of their hefty fees? If all the funds "exploit market inefficiencies," as they claim to, will there be enough inefficiencies to go around? Or will the enormous growth of the industry cannibalize those fleeting opportunities? Because of their size, number, leverage and active strategies, hedge funds now represent more than half of the trading in many markets. If they all make the same market bets, can anyone make money? And if they take opposing sides of the same trade, half are assured of losing. Either way, it will be very hard to add value and cover fees, commissions and other costs.

While this critique can also be applied to mutual funds and other active managers, the scale of fees and expenses incurred by hedge funds puts them in a category of their own. Because of their leverage and turnover, hedge funds' costs per unit of capital are many times those of mutual funds -- and so are their fees. Their performance fee structure is a "heads we win, tails we don't lose" proposition for the managers (at the investor's cost).

So, why do people still throw money at them? Largely because of wishful thinking and behavioral quirks. Most people recognize that stocks and bonds will not continue to produce the double-digit returns they have in the past three decades. However, some don't want to accept that those returns are unavailable anywhere. So, these people irrationally wish for a new type of investment - hedge funds - that can produce these kinds of gains. This is paradoxical, considering that the funds invest primarily in the very same securities that they are expected to outperform-namely stocks and bonds. Any individual investor may be right to think that his hedge funds -- like his children -- are exceptional. But, if everyone believes it, that's collective folly.

This folly persists because hedge funds benefit from several well-documented anomalies (more formally called cognitive biases) in the way people make decisions.

The first is the "winner's curse," named for the tendency of people to overbid in auctions (therefore the winner ultimately feels cursed). The hiring of hedge funds is like an auction. Investors are guessing at the future performance of these enterprises. Some guesses will be high, others low. Those most bullish about a fund's prospects will invest. The result is that each fund is valued by those who are most optimistic about its prospects.
[drawing]

Overconfidence, the second peculiarity, aggravates this problem. In Nobel laureate Daniel Kahneman's words, decision-making involves a combination of "high confidence and low accuracy." Kahneman notes that "hindsight bias" worsens overconfidence. We do not learn from experience. Even when we get feedback such as investment returns, we tend to attribute the bad outcomes to luck or other people's failings and the good outcomes to skill.

A behavioral aberration called "base rate neglect" also contributes. The Lake Wobegon effect is real. Studies have found that almost all of us believe we are safer-than-average drivers. Similarly, all hedge-fund investors believe their fund is above average. When we make assessments, we tend to focus on the particulars of the situation and ignore the larger context. In assessing hedge funds, that means we put too much weight on the fund itself and not enough on the fact that these vehicles collectively fail to achieve returns that compensate for their very high fees.

Of course, there's another reason people overvalue hedge funds that is not a behavioral quirk. Millions (perhaps billions) of dollars are being spent convincing us that they are good investments. Much, much less is spent arguing the contrary. It would be unusual if this marketing did not affect our judgment.

What's a rational person to do? Not investing in hedge funds is a good start. But, ideally, you would like to invest less than zero -- in other words, to sell them short. While logical, this is difficult to do. But nothing is out of the reach of Wall Street financial engineers. One of their tools is called a "swap" -- a basic financial agreement between two parties. Jane, for example, could agree to pay Fred the return on a hedge fund in exchange for a payment from Fred of a short-term interest rate. Fred benefits if the hedge fund's returns are good while Jane benefits if returns are poor. Effectively, Jane has sold the hedge fund short.

Swaps could be an effective way for investors hankering to be part of hedge funds closed to new investors. In effect, they could bet on continued good returns from the fund while bearish investors would be happy to bet on faltering returns. Now, it must be mentioned that swaps entail significant risk and require very substantial capital. They should be engaged in only by very sophisticated investors. Of course, that is supposed to be true of hedge funds, too.

What would happen if investors could short hedge funds? Very likely, sellers would zero in on funds of hedge funds to sell short. They have two layers of fees, which reduces their performance. In addition, they diversify, which reduces the risk -- for both investing and shorting. Making this short interest visible would provide a valuable signal to investors currently funneling billions of dollars into these outfits.

Last month the European Central Bank cited hedge funds as a "major risk" to financial stability and further noted that the industry "warrants close monitoring despite the essential lack of any possible remedies." The Securities and Exchange Commission's effort to monitor them has been frustrated by a court ruling. While such monitoring is desirable, the ability to short hedge funds would also help maintain rationality. There have also been a number of frauds exposed recently. Short sellers have been effective in sniffing out fraud in other venues and could play a useful role here too.

The creation of a short interest in hedge funds would also offer a new opportunity: The funds could short each other, and new entrants could spring up to short all the existing players. It's just the sort of game hedge funds love to play.

JONATHAN REISS, former head trader in international bonds for Sanford C. Bernstein & Co., is founder of Analytical Synthesis, a research firm focused on financial innovations in the public interest. He says he is both a safer-than-average driver and a better-than-average investor.

Studying the August "Crisis"

September 28, 2007

The New York Times weighs in.

A Losing Month Means What?

September 17, 2007

If you lose 50% in a month you have a problem. Big problem. But what if you lose 2%? Or 5%? Or 10%? Or 20%? Well, those numbers are not so easy to pin down. Read this article. What does that tell you? Was it a tough month for many? Of course. But telling you that hedge funds on average experienced losses for one particular month tells you zilch. What are you supposed to do with the information if you don't know that particular trader's strategy to begin with?

Tough Chart

September 05, 2007

Even if you were the best fundamental analyst in the world, how do you explain (and trade) this chart.

Open-Outcry Cries

August 29, 2007

A question in today:

What are the differences and similarities of the open-outcry and computer based trading? What do you think are the pros and cons of both systems?

A timely question. Read.

The Other Side of the Zero Sum Game?

August 20, 2007

August has been carnage in the hedge fund space. It seems to have smacked all types of funds and all types of strategies including trend following. While it is difficult to assess the situation on a real time basis, one question keeps coming to mind for me: who are the big winners in the zero sum game for this particular event?

Alan Sloan on the Handouts

August 19, 2007

As usual, good logic from Alan Sloan.

Picking Winners Is Not the Fed's Job

August 17, 2007

The worst part about being a trend follower? The Fed. When the Fed intervenes, like they did today, market trends often flip on a dime. Now this of course is nothing new as the Fed has always been prone to not let the market run its course, but it sure would be nice one day if the Fed just stood back.

James O. Rohrbach on Timing

August 16, 2007

Jim Rohrbach is a big believer in trend trading. His most recent sell signal for the NYSE was on 7-24-07 and his most recent sell signal for the NASDAQ was on 6-7-07. That said, Jim doesn't put signals out there trying to call tops and bottoms as that is impossible. Some of his recent commentary:

Is it too late to get out? I get this question quite often, or I am asked if it is too late to get in, when the market is going up. Both of these questions assume that I can predict the future course of the stock market. I can't. But my answer will always be the same. If the RIX is on a Buy Signal, get in. If it is on a Sell Signal, get out. Any other response gets into the game of guessing. I leave guessing up to others.

Jim's site.

The Hedge Fund Implode-O-Meter

August 12, 2007

The Hedge Fund Implode-O-Meter tracks the hedge fund implosion.

Hedge Fund Toasted

August 01, 2007

From the New York Times:

At the beginning of the summer, Sowood Capital was a $3 billion hedge fund run by a money manager who hailed from the team that built Harvard’s endowment into the $30 billion giant that it is today. Yesterday, Sowood sent out a letter to investors indicating that heavy losses in the credit market had caused the fund to lose more than half its value, prompting it to sell its portfolio to another hedge fund and return the remaining $1.5 billion to investors. With that, Sowood becomes the latest hedge fund hit by a tightening of the credit markets that started in subprime mortgages and has expanded into the broader market, including the loans and bonds used to finance leveraged buyouts. At one time, using leverage, or borrowed money, the fund had $12 to $15 billion worth of positions.

A protégé of the famed Harvard endowment, someone with all of the track record, someone with all of the experience, and now responsible for toasting billions down the drain. He should have just rolled dice instead.

Some background:

Sowood Capital Management is [was] a 59 person investment management firm with approximately $3 billion under management based in Boston. Sowood was formed in early 2004 by Jeffrey Larson of Harvard Management Company, the investment arm in charge of Harvard University’s endowment. Larson specialized in foreign equities while at Harvard. Harvard’s chief investment office, Jack Meyer, had this to say about Larson when he left: “He’s consistently outperformed his benchmark, and he will be missed,” Meyer said.” Of the $2bb that Sowood started with, $500mm was from Harvard.

Keep your eye on the benchmark! Must beat the benchmark! Benchmark, benchmark, benchmark! So what did Sowood do differently than other Meyer trainees to have such a meltdown? That's the real question to answer.

Market Value v. Fair Value

July 14, 2007

Some feedback in from Germany:

Good article on why market value is more important than fair value, [and] why arbitrage is a lot more risky than many assume.

A Matter of Perception

July 11, 2007

I thought this excerpt was well stated, but still ends going the direction of "fundamentals" for an answer:

May 17th 2007
From The Economist print edition
Averages need to be treated with caution

CONSIDER these two statements: the American stockmarket was overvalued in 2000; company profits are high relative to economic output. Many people would agree with both propositions, but implicit in each is that there is a correct, or normal, value for shares or profits. The corollary is that when share price or profits are too high or too low, they will eventually revert to the mean. But what do people mean by mean? Efficient-market theory, which states that prices already reflect all available information, presents an immediate problem for the idea of a reversion to the mean. If share prices were obviously too high, investors would sell their holdings until prices fell to the correct level. There would be no extremes to revert from. However, in the light of the dotcom bubble, it seems inherently unsatisfying to argue that markets are always fairly valued. Such a position also gives a green light to those who argue that “it's different this time”, and who use any old valuation measure (price per eyeball for internet stocks) to justify share prices. Pinning down the right mean, however, is difficult. American profits look high by the standards of the past 20 to 30 years. But they do not look unreasonable relative to 1950s and 1960s levels. Perhaps the 1970s and 1980s (which saw high inflation and double-digit interest rates) were the aberration and the immediate post-war era was the norm. Things get even more complicated when investors start to talk about stockmarket valuations. Most analysts tend to use the prospective price-earnings ratio as their chosen measure, rather than the historic figure. They justify this by saying that investors look forward, not back. But banks are in the business of selling shares. Since analysts nearly always forecast rising profits, the prospective p/e ratio is usually lower than the historic one; that makes the market sound cheaper.

Finding "cheaper" is not the objective. Buying and selling to a profit is the objective.

Hedge Clipping

June 26, 2007

Is there a way to get above-market returns on the cheap? John Cassidy writes. The New York Times adds to this with Building a Hedge Fund, With No Manager Required.

Mark Cuban on Hedge Funds

June 22, 2007

Mark Cuban has a nice fundamental piece on hedge fund/private equity IPOs here. Fundamentally, he makes sense. Good sense. But what if the Blackstone IPO goes from its current $35 a share to $200 over the next 2 months even though Cuban may be right? Would you skip that hypothetical trend just because you could not justify it?

More fundamental analysis here.

Hedgies

June 18, 2007

Food for thought about hedge funds - the basics.

Long Ago Wisdom

June 17, 2007

From the introduction to Wall Street Speculation, Its Tricks and Its Tragedies (published 1902):

Wall Street speculation is the most stupendous game known to the world of chance; as compared with it, the game of Monte Carlo pales in utter significance; in no other game are the stakes so high, is success so transitory and failure so overwhelming. It is a game in which the wealth of Croesus changes hands in a single hour, a game in which a few manipulators behind the scenes pile up millions on top of millions year after year; but in which the vast majority of the outside public, who tamper with it, go to financial and often to physical and moral ruin.

Bubbles on the Brain

June 12, 2007

Marc Andreessen writes on his blog about perma-bears. An excerpt:

But as with other habits ingrained into us by evolution, the habit of predicting doom and gloom when it isn't in fact right around the corner might no longer make sense. On Wall Street, investors who have this habit are known as "perma-bears" and generally are predicting the imminent collapse of the stock market. This habit keeps them from being fully invested. Sure, they're well protected during the occasional crash of 1929 or 2000, but by and large they massively underperform their peers who take advantage of the fact that most years, the economy grows, and the market goes up. They have disappointing careers and die unhappy and bitter. In reality it seems very difficult to predict either a bubble or a crash. Lots of people predicted a stock market crash... in 1995, 1996, 1997, 1998, and 1999. They were correct in 2000. But as soon as the stock market recovered in 2003 and 2004, they were back at it, and there have been similar predictions from noted pundits ever since -- incorrectly.

U.S. Stocks Roar; Why?

May 31, 2007

U.S. stock markets are roaring. What does it mean? You should be long. Why? They are going up. How long will they keep going up? No one knows. "That's not a good enough answer for me! Why not? What is the alternative?

Churn

May 18, 2007

Question: What do you think of Moving [Average] 2 and Moving [Average] 5? From my research, these indicators look reliable.

Ed Seykota Answer: I think the two-day moving average and the 5-day moving average are fairly reliable as ways to churn accounts and generate commissions.

Taking a Loss

May 15, 2007

From Trader Daily:

The most common reason traders are reluctant to take a loss is their fear that once they do, the trade will rebound. Sound familiar? If this is how you think about taking losses, try to recognize that this kind of thinking might well prevent you from reaching your potential. It might even destroy your career. So stop trying to be right all the time - trading is a game of probabilities, which means winning and losing are necessary components. No one gives a bonus check to the trader who was 'right' the most over the course of the year. To coin a phrase, wrong happens. Great traders know how to implement damage control and are willing to take a loss. Are they scared and hesitant? Of course, but that doesn't prevent them from doing what they need to do to stay in the game. If George Washington hadn't decided to abort the Battle of Brooklyn and cede Manhattan to the British at the start of the Revolutionary War, for example, we'd all be eating 'crisps' and watching the 'telly' right now. He took a loss - but lived to fight on. That's what true champions must sometimes do. A client of mine - I'll call him Aaron - is a bond trader at a major bank. He was earning seven figures annually but envisioned taking his game to another level. During our first meeting, Aaron showed me his numbers, proudly pointing out that he was winning a healthy 81 percent of his trades. He rambled on, saying that his number was the highest in his group and telling me his managers had asked him to train other traders to be as 'consistent as I am.' I looked Aaron straight in the eye. 'Was your performance bonus based on your winning percentage?' I asked him. He paused. 'No,' he replied. 'Exactly my point,' I told him. Put simply, Aaron needed to stop obsessing about being right and start focusing on making money. Several follow-up meetings made it clear that he was taking his winners quickly and holding his losers way too long, even adding to them in some cases. I challenged him to think about what might be triggering this tendency. 'The trade can always come back,' he told me. 'Maybe I'm just not giving it enough time.' That's not an answer; it's a rationalization. 'Come on,' I told him. 'You're either a control freak or a perfectionist, but you always seem to have to be right. And this is limiting your ability to reach your potential.' Aaron, I was discovering, was afraid to admit when he was wrong. So I presented him with a simple formula to help him get out of his own way: H + W + P = E. Hoping + Wishing + Praying = Exit the trade now!

Doug Hirschhorn, a former Division I baseball player and commodities trader, has a Ph.D. in sport psychology. He is the coauthor of The Trading Athlete and has served as trading coach for Deutsche Bank, Schonfeld Securities and Balyasny Asset Management. He is currently a consultant for financial institutions, trading firms and hedge funds. E-mail him at headcoach@tradermonthly.com.

Are We Really Capitalists in America?

May 12, 2007

From the AP comes "Congress on the loose":

Hedge Fund Managers Step Up Activism
Saturday May 12, 1:41 pm ET
By Marcy Gordon, AP Business Writer
Wealthy Hedge Fund Managers Step Up Activism in Washington As Tax Rumblings Grow Louder

WASHINGTON (AP) -- With Congress always looking for new ways to boost tax receipts and protect individual investors, it's natural for hedge fund managers to worry that they have a bull's-eye on their chests -- especially now that word is out that some of them made more than $1 billion apiece last year.

Continue reading Are We Really Capitalists in America? »

Seasonality

May 09, 2007

Lindsay at Wallstrip tackles seasonality.

What Makes a Pro Trader?

Brett Steenbarger writes on what makes a professional trader. Nice piece. However, the word "professional" can be replaced with the word "great" to possibly make an even better point.

Hedge Fund Fraud Risk

May 05, 2007

http://www.youtube.com/watch?v=orFrvK9Vfko

Cramer On Games Hedge Funds Play

Watch on YouTube. This is from a while back, but worth keeping in mind if you are heading down the path of trying to be a day trader.

How Do You Define Risky?

April 27, 2007

A while back I was interviewed by reporter Kambiz Foroohar for an article he was working on. I will go back and check my notes for more detail, but I remember telling him that if Christopher Cox and the SEC were ok with mutual funds selling NASDAQ index funds, which we all remember dropping -77% during the last market bubble pop, then the idea that average investors should be turned away from hedge fund opportunities (with track records that don't come close to -77%) by the GOVERNMENT was contradictory and frankly bogus. I also implored this reporter to address the word "risky" - what in the world does it mean in the government's eyes? I still don't know.

The government can't on one hand sanction mutual fund strategies that we already know can go down to zero, but then turn around and keep people away from hedge fund opportunities that have actually assembled track records of note and make money. That doesn't even address the issue of the average Joe having his pension monies put into hedge funds anyway - just without his knowledge by the institutional manager who controls his retirement future.

Here is the article in question where my comments did not make the final cut. The article features Christian Baha of Superfund.

The Jock Exchange

April 22, 2007

The Jock Exchange article (PDF) by Michael Lewis is a good view of the future of "markets".

Financial Disasters Will Keep Coming

April 14, 2007

Richard Bookstaber has a new book called A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation. Bookstaber also recently wrote this article for TheStreet.com titled Financial Disasters Will Keep Coming. The article:

While I didn't cause the two great financial crises of the late 20th century -- the 1987 stock market crash and the Long Term Capital Management hedge fund debacle 11 years later -- let's just say I was in the vicinity. My actions, which seemed insignificant at the time and their consequences unintended, did help get the ball rolling.

Continue reading Financial Disasters Will Keep Coming »

Hedge Fund Overview

April 13, 2007

An interesting hedge fund overview (PDF) sent in by a reader.

John Arnold of Centaurus

April 12, 2007

The Globe and Mail ran an article today. The end of the article:

Michael Covel, author of a book about trading called Trend Following, said some skeptics believe successful trading is in the end all about luck, but he added, "To some degree, I think that's somewhat disingenuous, specifically when you have some traders in business for 20 years." In terms of how it's done, it's all about volatility, and there are few markets as wild as natural gas, which gyrates daily, often because of the weather. Among Mr. Arnold's employees is a full-time meteorologist. "The good traders don't really care if it's natural gas or corn or some obscure Chinese stock. All they care about is if there's enough movement and enough liquidity," Mr. Covel said. "I'm sure Mr. Arnold is agnostic to the market. He just wants to find the opportunity. And if Mr. Arnold has the golden touch, all props to him."

As a quick clarification, I was not referring to Arnold being in business for 20 years. He is after all only in his early thirties.

Boone Pickens Slams It Home

April 11, 2007

Last fall I met with Boone Pickens in his Dallas office and posted this. This feedback came into me last fall after my post:

Perhaps a good question would be to ask how much Mr. Pickens is down year to date some say over forty percent.

I responded last fall:

I was told numbers that differ greatly than yours. All positive.

My happy friend responded:

If he is actually doing well this year, I'm glad for him, but I feel holding him up as as example is misleading....there's no proof he's not just a black swan event in and of himself. I notice you don't spend much time talking about the thousands of managers / CTAs who perished....you are making the mistake of being fooled by the survivorship bias...and anyone who knows statistics knows Boone Pickens is likely an example...

Well, to update the situation, Boone's 2006 earnings are in:

From Trader Daily this week:

T. Boone Pickens
City: Dallas
Firm: BP Capital
Age: 78

The world’s biggest oil bull may have gotten gored in late 2006 and early 2007 as crude prices slipped, but that slide didn’t last long. Besides, his prudent bearish play on natural gas in the fall of ’06 was more than enough to fuel his energy-futures and derivatives fund to a startling 98 percent return.

“Most of our money came from shorting natural-gas futures,” says Dick Grant, BP’s CFO. The firm’s total assets, across two main funds, are around $3.6 billion, 45 percent of it Pickens’s own money. Grant wouldn’t confirm Pickens’s take, but if our estimate isn’t pretty close, we’ll build Oklahoma State a new football stadium.

Estimated Income: $1 billion–$1.5 billion

Nice Paychecks

April 09, 2007

From Trader Daily (full article):

NEW YORK (Reuters) -- The wealthiest U.S. hedge fund managers and traders became a lot richer last year when five of them took home $1 billion or more each.

John Arnold, a newcomer to the exclusive club of top industry earners, banked an estimated $1.5 billion to $2 billion in 2006 for having coolly and correctly called the direction of natural gas prices, according to a study compiled by magazine Trader Monthly and released Monday.

Arnold, a 33-year old former Enron trader, delivered an eye-popping 317 percent before fees to investors in his hedge fund Centaurus by taking the other side of a bet that felled Amaranth Advisors last September, the magazine said.

Arnold's returns helped him muscle past mathematician-turned-investor James Simons of Renaissance Technologies Corp., ESL's Edward Lampert, veteran oil trader T. Boone Pickens and SAC Capital Advisors' Steve Cohen, who each made at least $1 billion.

Simons, Lampert and Pickens have ranked among the top three earners since magazines such as Alpha and others started tracking their paychecks.

Kenneth Griffin Profile

A fun read.

Buy and Hold Issues

April 05, 2007

Mark Hulbert, at MarketWatch, writes:

Here's a depressing realization...Consider two hypothetical individuals who started investing on the same day: Nov. 30, 1999. The first put everything in the stock market, while the second put everything into 90-day Treasury bills. Guess what: Both investors' portfolios are today worth almost precisely the same amount. Since then, each has produced a 3.1% annualized return. (To calculate the stock market's return I used the Dow Jones Wilshire 5000 index. This means that a stock investor has nothing to show for the agony and sleepless nights he has incurred over the past seven years. The investor in T-Bills has slept like a baby and has just as much money in his portfolio.

Mark makes a good point. There is not enough emphasis on how much the Dot-Com 2000-2002 crash still affects the millions of people who bought into buy and hold.

More Beta and Alpha

April 03, 2007

Two articles regarding beta and alpha in the context of hedge funds: "Hedge Funds Selling Beta as Alpha" (PDF) and "Hedge Funds Levering Betas" (PDF).

Bob Pardo on System Testing

April 02, 2007

Bob Pardo, an expert in trading systems and someone whose work I respect, let me know about a workshop he will be giving titled "Building Trading Systems: Laws and Flaws".

Check it out.

Bio: Bob Pardo, president, Pardo Capital Limited and Pardo Group Limited , which have provided money management and consulting services in all aspects of trading strategy design, application and of computerized trading tools to the trading community since 1988. He has been designing and creating trading software and trading systems since 1983.

Beta & Alpha

March 24, 2007

From 'Professional Adviser' comes an article titled 'Taking a Bet?'. An excerpt:

"A traditional investor invests on the basis of expectation and hope. The expectation is that they will enjoy the market return (Beta) and the hope is that their manager will produce something on top of that (Alpha). The problem is that Beta is now commoditised, and can be accessed for as little as 0.2% annually. Consider this in the context of a typical active long only manager where 90% of returns are derived from market exposure (Beta). That means the client is paying 1% annual management fees yet receives only 10% potential Alpha. That translates into an overpayment of Beta of somewhere in the order of four and half times."

Without the jargon this means what? Billions are being paid in fees to mutual funds to deliver something that is basically free now. Article (PDF).

2007 State Street Hedge Fund Research Study

March 22, 2007

A study (PDF) from State Street about hedge funds.

What's In a Name?

March 21, 2007

Heather Flick writes at Trader Daily:

Hated by many and understood by few, most hedge funds today are not even, literally, hedged. This is an industry in need of an extreme makeover...The name “hedged fund” was coined by A.W. Jones, a late-blooming Australian immigrant who in his 40s developed a strategy for eliminating market risk by taking complementary positions. Selling some stocks short while buying others long, he built his portfolio to have equal total value, rendering market-wide moves in either direction a wash. He hedged his bets based on stock picking rather than market direction, thereby creating a win/win situation. Today’s hedge funds are private-investment pools open to a limited number of accredited (savvy, rich) participants. These pools can invest in almost anything, which encourages creative management strategies unavailable to other, more regulated funds. That’s basically it. Although governed by the rules of private offerings, partnerships and LLCs, the term “hedge fund” actually has no legal definition.

That is a nice primer. It adds to a comment of mine from before.

A Comment on George Soros

March 14, 2007

I offered some comment (PDF) recently to a reporter who openly admitted she was new to the subject of George Soros. I think she did a good job of "getting it" for a newbie.

Money Still Learning to Lobby

March 13, 2007

From today's New York Times:

Big Money Still Learning to Lobby By JENNY ANDERSON: The hedge fund industry seems resigned to no longer be a wallflower in Washington as it joins the lobbying dance with Congress.

Modern Markets Scorecard

March 10, 2007

This Modern Markets Scorecard (PDF) from Rydex paints a case for diversification. Mebane Faber is thanked for bringing this to my attention.

1938 Wisdom Part 2

March 08, 2007

Last night I posted an excerpt from The 1938 book "Commonsense Speculation". Another very relevant excerpt:

Never forget that all market profits are "paper" until collected. A $1000 or $100,000 paper profit can soon turn into a loss from mental lethargy or indecision.

Continuing:

Inasmuch as 99% of speculators trade on the bull side, get out somewhere while the going is good. For most people a bull market is like a trip in a elevator. Floor after floor is called out by the starter, but few emerge. Finally, to continue the metaphor, the elevator reaches the roof as the bull market is culminating. Then the machinery breaks, the car plunges to the bottom of the shaft, and the passengers - most of them badly injured - struggle to climb out of the wreckage that a bear market has brought.

Of course, it goes without saying that getting into a market, or getting out, requires a preset plan before you ever take the first step to speculate.

1938 Wisdom Part 1

March 07, 2007

The 1938 book "Commonsense Speculation" offers:

One of the most commonest of speculative sins is to be unduly influenced by the previous high of a stock. If the price has declined a good many points, a universal feeling is to assume that it cannot go much lower. The stock market can do anything and an individual stock can go almost anywhere - up or down - in the course of a dynamic move.

Further the book quotes the head of Chase National Bank from 1937 regarding speculation:

I know the whole system of speculation in securities is questioned by some; that speculation, as a whole, in any market is condemned by some; I know that there are those who identify all speculation with gambling, and would not rule out all speculators as social parasites who have no useful function. But the verdict of impartial economists on this point is clear and very nearly unanimous. The difference between speculation and gambling is that in gambling artificial and unnecessary risks are created; whereas in speculation the risks already exist and the question is simply who shall bear them.

James O. Rohrbach on Recent Stock Market Action

March 06, 2007

James O. Rohrbach forwarded me some of his recent commentary:

If you listen to the to the Wall Street Experts, you know exactly what caused the big drop and you know where the market is heading from here. It's amazing how these people can get on the tube and tell us exactly what is going to happen. I am listing a few Expert comments that I heard. They really clarify the current situation:

1. The drop is over and the market will resume it's up move.
2. We need to have another drop that will take us down 10 to 11%.
3. This is not a great buying opportunity. This is a great buying opportunity.
5. The market reached perfection levels and needed to correct.
6. Greenspan caused it.
7. China caused it. Volatility caused it.
8. Sub-prime mortgages caused it. The trade balance caused it. The dollar caused it.
9. The market will be much higher by the end of the year.
10. The market will be much lower by the end of the year.
11. Traders will not like to be long the market over the weekend.
12. Don't worry about the glitch in the NYSE central market system on Tuesday. It worked fine.
13. Interest rates are going to be reduced. Interest rates are going to be increased.
14. The economy is strong. The economy is getting week.
15. Hillary says we have to do something about the growing debt.

There, now you know exactly what caused the drop on Tuesday and you know exactly how to proceed with your investments.

The Aftermath

February 28, 2007

A day after an equity market mini-correction, "news" fills the air at Yahoo! Finance:

"It's typical that you get a bounceback the next day," said Joseph V. Battipaglia, chief investment officer at Ryan Beck & Co. "Now we're essentially flat on the year. Can we go up from here or down? That sorting-out process will continue now."

I don't know what anyone could do with those comments. They probably sound great to some, but in terms of usefulness, they serve scant purpose. That said, some players were more careful:

Bernanke let the lawmakers know he wouldn't be led into publicly contemplating what role Greenspan's remarks or any other developments had played in setting off the worst one-day point drop since Sept. 17, 2001, after the terrorist attacks. "I don't think it would be useful for me to try to parse the movement into the components associated with different pieces of news or pieces of information," he said.

That is a refreshing piece of candor. No attempt to give an immediately circumspect "why" answer.

Down Day for Stocks

February 27, 2007

From the Street.com today:

"The market has been stretched for the last three months, and there's been lots of speculation," said Phillip Roth, chief technical market analyst with Miller Tabak. "It's been destined to crack, but no one knew which trigger would do it."

1. A market is stretched? A market is a market. There is a price every day. They don't stretch either up or down. They do go up and down.
2. There is always speculation in markets. Same as it was a 100 years ago, 10 years ago, 1 year ago and today. Nothing new.
3. "Destined to crack" will always be a subjective statement.
4. When a market goes up or down, fast or slow, there is never a way to truly know the "trigger".

What to make out of today? What's the big lesson? Stocks went down. You don't like that answer? You want a story? You want to feel better by attempting to "understand"? There are lot's of folks who can make you feel better with endless "why" theories. I am not one of them.

Hedge Fund Resources at Harvard

February 25, 2007

A hedge fund resource site at Harvard.

A Quantitative Approach to Tactical Asset Allocation

February 23, 2007

Feedback in tonight from Mebane T. Faber:

You linked to my white paper awhile back. A newer version was recently published in the Journal of Wealth Management. The Journal of Wealth Management link is here, and the free SSRN version is here.

A View on Trend Following

February 05, 2007

An interesting exchange about trend following trading just forwarded to me.

Ed Thorp: Beat the Dealer

A quick note on Ed Thorp from Time (PDF).

A View on the Government Regulating Opportunity

Here is a comment from a reader, Eric Rupert, placed on the SEC website concerning S7-25-06. This stems from my prior post:

I am offering comment on the portion of File No. S7-25-06 that proposes redefining what constitutes an 'accredited investor'. I would like to begin by reviewing what 'investment' choices that are currently available to non-accredited investors. As a non-accredited investor I currently am able to enjoy the safety of the following investment options:

-I can buy or sell short individual stocks. Earlier this decade I had the opportunity to buy any number of dot-com stocks that eventually and quickly evaporated. I enjoyed this luxury without any oversight from federal regulators.

-I can invest in mutual funds run by kids right out of college that will underperform any index.

-I can (and have) watched as the company match portion of my wife's 401(k) nose dived to zero because it was invested in company stock (Kmart). The underlying corporation sought government protection. This happened in a government regulated plan, strange!

-I can get 100:1 leverage in Forex trades for a minimum $2000 investment. This is about a ludicrous as it gets.

-I can buy (or sell) futures or future options on any number of agricultural, energy, metal or financial contracts. I am certain to have little expertise in the fundamental aspects of these!

-I can buy or sell put or call options on just about anything. Additionally, because I have a little experience with these I can apply more complex strategies like Butterfly Spreads, Iron Condors, etc.

-I can (as an aside) play any number of poker games for money from my home computer.

I think that you get the picture. There are numerous options for me to go financial cliff diving. Uniquely, I can do all of this with all of the equity that I have built up in my home. Even better yet, I can get an interest only loan in order to put more of my income in these instruments.

Clearly, investing involves risk. Investing also involves a degree of responsibility on the investor, brokerage and government to assess, provide and regulate risk appropriate investment choices for EVERYONE. A threshold of net worth may have been an appropriate metric at one time. Today, I believe, not only does a net worth test fall short but it is also discriminatory.

An acceptable solution would be to continue with the change to the 'accredited investor' status. Make this indexed to inflation at a prescribed interval. Additionally, there is a need to provide the means for an investor that is not a high net worth investor to have access to managed vehicles that provide a higher level of risk and return.

I would propose a plan under which a non-accredited investor could access pools that are currently private. The first step would be to create a class of fund that would be regulated as 'high-risk' under suitable guidelines. The second step would be to provide a qualification test whereby a financial institution or accredited financial advisor could serve as gate-keepers and allow (or deny) access to these pools. This test could be set up to be based upon experience, income and the percent of assets under management that was to be placed in any high-risk pool.

There is truly no way to protect every investor from themselves. As you can tell, the average investor can blindly 'invest' in just about anything that a hedge fund can. I believe that it makes much more sense to open the access to hedge funds (professionally managed) in a regulated fashion than it does to allow relatively inexperienced investors access to the futures and forex markets with their high degree of leverage.

Thank you for your consideration.

John Mauldin on New Hedge Fund Regulations

February 03, 2007

'A New Definition of Rich' by John Mauldin offers some sobering analysis. An excerpt worth reading:

I am in South Africa as this week's letter is being sent out; so it is with some irony that the letter is focused on a topic that generally concerns only US-based investors, although what the SEC does has an effect on regulatory bodies abroad. This is a letter you may want to forward to your friends and associates. The Securities and Exchange Commission (SEC) has posted a new proposed rule that would raise the minimum net-worth requirement needed to invest in private funds from $1,000,000 total net worth to $2.5 million liquid net worth. This is a major change, and it means that some 7% of American households will no longer be able to invest in private offerings. In my opinion, it is likely to become law in the not too distant future unless there is significant public comment. This week we look at the proposed rule and some of its consequences, as well as a very interesting proposal by SEC commissioner Roel Campos.

Continue reading John Mauldin on New Hedge Fund Regulations »

Play for Position, Not Performance, in Your Portfolio

February 02, 2007

Jonathan Hoenig makes some interesting points here. An excerpt:

"...most of the artistic world is subjective. One person's trash is another's treasure. But trading is just the opposite - it's unabashedly objective. Numbers don't lie. You're either in the black or not. We've often pointed out that the only reason to invest in anything is to make money. Talk is cheap and performance is the only thing that really matters. So it might surprise you that, on a daily basis, I don't keep precise tabs on my fund's monthly or year-to-date performance. At any given moment, I'll have a general estimate of where I stand, but as a rule I try and tune out the exact score. Why? If performance is all that matters, why would I avoid following the exact return? The answer is because trading is like chess, not weightlifting. It's not an endeavor that's won or lost in one day depending how hard you flex your financial muscles. It's a finesse game; it's strategy. So you think and play for position, looking to set up exposures that are likely to unfold slowly over the next six months...not 60 seconds."

Hedge Funds and Politics

January 26, 2007

From the New York Times (link):

"Money from Wall Street has long been a factor in Washington and has tended to flow, with a policy agenda, to the ascendant political party. Giving by people in hedge funds, on the other hand, tends to be more personal and ideological. Some of the most aggressive donors have been Democratic supporters like George Soros, David E. Shaw of D. E. Shaw and James H. Simons at Renaissance Technologies, as well as younger executives like Thomas F. Steyer at Farallon and Marc Lasry at Avenue Capital, all of whom gave generously during the 2006 election cycle. While hedge fund money appears to be tilting toward Democrats of late, Republican donors like Julian H. Robertson Jr., the founder of Tiger Management, who has given more than $700,000 over the last three cycles, and Bruce Kovner at Caxton Associates have backed their party’s candidates and causes. Still, compared with the billions of dollars that hedge fund magnates have spent on art, mansions and other extravagances, these political donations are a pittance, held in check by federal finance laws that limit personal contributions to $2,100 and by a general reluctance to step into the public limelight. But with the rapid growth of their money and stature, an increasing number of the hedge fund wealthy are not just putting their money to work, they are forging personal and professional ties with a generation of politicians who have come to spend as much time raising money as they do drafting legislation.

Michael Mauboussin on Diverse Thinking

January 24, 2007

Michael Mauboussin, Chief Investment Strategist of Legg Mason Capital Management (LMCM), is just an interesting thinker. His latest effort (PDF).

Are You "Short" Energy?

January 18, 2007

There are literally millions of plausible reasons why energy has been dropping in price. Does it really matter why? When you look at the charts of Crude Oil, Natural Gas and Heating Oil - why would it matter why these markets have gone straight down as long as you were short and able to profit?

Real Life System Test

January 13, 2007

At Ed Seykota's web site he was recently asked a question by a reader who was risking 40-50% of his equity on each trade. Ed responded:

Hmmm ... you are risking 40-50% of your Equity on one trade. Professional trend traders typically risk around one percent as much as you risk. You can test your system a couple ways.

1. You can back-test it on a computer and notice it goes broke on small whipsaws.
2. You can run it in real-time, as you are doing. When you go broke, your test is complete.

Seykota, in an earlier response to another reader, offered wisdom to those looking for the 'end' of trend following:

Unwavering commitment to following a system is essential to making it work. Those who do not keep their commitments seem to generate justifying beliefs, such as the idea that the market's job is to derail systems. Such beliefs are consistent with the experience of abandoning a system - right before it becomes profitable.

Jesse Livermore: Reminiscences of a Stock Operator

December 27, 2006

Jesse Livermore's bio 'Reminiscences of a Stock Operator' is always good reading (PDF).

For Beginners by New York Board of Trade

December 23, 2006

A good multimedia link from the New York Board of Trade sent in by a reader. It is about futures trading basics.

Silver Drops 7%

December 15, 2006

Today silver dropped 7%:

NEW YORK/LONDON (Reuters) - Silver plunged about 7 percent, while gold fell to its lowest in more than five weeks late Friday, as a rallying dollar, weaker base metals and the bullish stock market triggered heavy selling by funds ahead of the weekend. Spot silver fell to $12.82/12.89 at 4:30 p.m. (2130 GMT), down from $13.76/13.83 late Thursday. It hit a low of $12.77, lowest in about four weeks. New York Mercantile Exchange March silver accelerated its loss in late trading, plummeted to a four-week low, down 97 cents, or 7 percent, to finish at $12.980, Leonard Kaplan, president of Prospector Asset Management, called precious metals "way too high," and said fund selling was behind the markets' decline. "When the dollar started to turn around, all the funds got out at the same time, creating enormous volatility," said Kaplan. "You see the funds liquidating everything. They are selling grain. They are selling copper, everything," Kaplan said. Kaplan also said that when the stock market could not maintain its new highs, it was the signal for investors to sell, including commodities. "The sell-off certainly began with the dollar-friendly economic data," said James Steel, analyst at HSBC. "It's not just precious metals, the base metals were down quite a bit too." he said.

It was an exit. Pure and simple. You don't see this type of decline from the assessment of fundamental factors or new economic views. This was technical. I see the comment that silver was "way too high." What's high? High to what? I wonder if AP would ever give me the opportunity to offer a less BS view on price movement. I am betting that unless I could tell them "why" something happened they would not hire me!

Return on Equity

December 14, 2006

Perusing the chat sites and news sites offers me great food for thought. I caught this excerpt tonight from Yahoo Finance about 'return on equity':

We begin the series with a discussion of return on equity. ROE is one of the most crucial and elemental gauges of a company's profit potential. There's more than one way to determine ROE. IBD's method is to divide annual operating income by an average of the last two fiscal years' stockholders' equity. IBD also blends ROE in its SMR Rating, a gauge that also includes sales growth and profit margins. Stockholders' equity, in turn, is a balance sheet item that shows the difference between assets and liabilities. That result, expressed as a percentage, shows how efficient a company's management is with its equity funding. This allows shareholders to ask, "How good are these guys doing with my money?"

So do you think if you become an expert on a company's ROE that you will also become an expert on when to buy that company's stock, sell it and know how much to buy or sell of it at any given time?

Jim Cramer on Hedge Funds

November 16, 2006

Jim Cramer offers some good and bad comments about hedge funds here. His conclusion:

In the end, the lesson to be learned from Amaranth isn't about a sole runaway manager who made bad bets on the weather. It's about broad institutional problems: how hedge funds are run and monitored, and who's investing in them. Hedge-fund strategies have become so obtuse, their sales pitches so aggressive, and their monitoring so lax that one could question whether anyone should be in these funds, let alone pension-plan managers who have no ability to judge what these funds are doing and are supposed to invest regular folks-money in relatively safe places. Sure, pension funds that opt out won't generate the huge returns that hedge funds do in good times, but more important, they won't get crushed in the bad ones. The simple truth is that only the rich, who can take the hit, belong in these funds. And even they should proceed with extreme caution.

As I commented recently on Christopher Cox's similar views, what about mutual funds? They can't go down? To keep lumping all hedge fund strategies into the same camp is not an accurate portrayal of reality. Cramer is dead wrong when he implies the average guy should have no access to something beyond buy and hold long only. Of course, you need to be careful and do your homework, but that's the case for just about everything in life these days.

Why Fundamentals?

October 26, 2006

Feedback:

"Michael, I have been a trend follower for a couple of years now. Your book slapped me upside the head sufficiently to get me out of my fundamental analysis ways and see the light. There are a couple of things I still don't understand though. Why haven't more people abandoned traditional fundamental analysis, which has no consistency at all, in favor of trend following? I'm actually glad this hasn't happened because then all us trend followers might be screwed because all the money would be moving together, but how is it that the old fundamental money still dominates the financial market industry? Is it just that firms like Goldman have so much riding on the fundamental investment fallacy that they don't want people to change their investment strategies, because they have essentially figured out the way people react to stock fundamentals and can score big profits off of it with big money bets? Not only that, but how do fundamental analysis firms still exist in today's market?"

Isn't Goldman the exception? With that kind of access and money, are they different? Many think they are. Many think they are invincible. Others say exactly what you say, not as much because of fundamentals, but rather because of extensive leverage in an assorted collection of mean reversion strategies. Time will tell.

One Man's Ten Commandments

October 25, 2006

One man's Ten Commandments (PDF). An excerpt:

"Discipline trumps conviction. No matter how strongly you feel on a given position, you must defer to the principles of discipline when trading. Always try to define your risk and, above all, never believe that you're smarter than the market."

Dorsey, Wright & Associates, Inc. on Enron

October 13, 2006

A good white paper (PDF) from Dorsey, Wright & Associates, Inc. about Enron - price counts...

Who Won Amaranth's Losses?

October 08, 2006

An article forwarded in to me:

Arnold's hedge fund thrives as Amaranth falls
Centaurus gains approach 200% in '06, but manager has an enemy in Houston
By Alistair Barr, MarketWatch
Oct 5, 2006

SAN FRANCISCO (MarketWatch) - One man's trash is another man's treasure. When Amaranth Advisors LLC was losing $6 billion at the hands of its top natural gas trader Brian Hunter last month, rival energy hedge fund manager John Arnold was busy making millions.

Continue reading Who Won Amaranth's Losses? »

More on Boone Pickens

October 05, 2006

Boone Pickens uses fundamentals to make his decisions. He did tell me though, and I paraphrase, "It was hard to buy gas at $2 a gallon, but much easier to buy twice as much when it reached $3 a gallon."

I am envious of the 50 years of experience that Pickens has in the energy markets to make his decisions. He does, however, make that big money off of big trends. And 2005 saw energy trends out of this world.

Continue reading More on Boone Pickens »

Good Advice About Big Banks

October 02, 2006

Comments from Edward Talisse describing the inner workings of the large investment banks:

"There is massive confusion and misunderstanding between the concepts of skill and luck. Traders which collected bid-offer spreads for years discovered the painful truth once dealing spreads collapsed. They are left with no skill and no luck. Make sure you always study and keep ahead of the pack. Don't count on luck."

"There are very few real risk takers at the big Banks. The real emphasis is on collecting fees, collecting bid-offer spread where available and front running large client transactions. The real risk takers are purged at the first sign of trouble. The best ones go to Hedge Funds. Get out if you really believe you are a great risk taker. There are fewer constraints and bigger rewards outside the big Banks."

Who Are the Winners?

September 28, 2006

Amaranth loses...so who wins? This blowout has the smell of a few big winners - maybe one big winner. It reminds me of Barings Bank. One dumb bet (Nick Leeson is now played by Brian Hunter) with some smart winners on the other side. Think the winners will be on the front of Time Magazine?

Mean Reversion Lesson

A reader, Chris Dugan, forwarded me this comment on Amaranth from Bernie Schaeffer:

"It's amazing to me that Amaranth seems to have relied on the same "principle" as did the disgraced managers of Long-Term Capital, "stewards" of what was (until Amaranth) the biggest blow-up in hedge-fund history. Simply put, this "principle" holds that various historical relationships between various markets will "mean revert" once they begin to diverge significantly from the norm. The mean reversion principle has become an article of faith among many of the major hedge funds. Given the alleged sophistication of these supposedly risk-savvy players, it is shocking that a principle that thumbs its nose at the "fat tail" events that are far, far more common than any modeling ever suggests continues to have holy-grail status. And then, when funds like Long-Term Capital and Amaranth blow up, the ready excuse is "who would have thought such a 'highly remote' event would ever occur?"

He added:

"The lesson here is that these models that are so avidly followed by those who should know better have been dead wrong and continue to be dead wrong about the odds of so-called rare events. The equity markets have been in a derivatives-induced coma for several years now, and my sense is that the upcoming fourth quarter is about as ripe a period as I can imagine for this coma to come to an abrupt end. Regardless of which way the break goes, we will likely have derivatives pain, which almost certainly means more hedge fund pain. An upside breakout can blow away those who've been heavily overwriting calls; a downside break creates potentially huge liability for those who have sold a massive quantity of very low delta puts that have thus far been "free money," month after month. In other words, market moves may begin to feed on themselves rather than mean revert, and some players will pay - big time - for this."

Now that is a great view from Bernie Schaeffer.

Short Now

September 25, 2006

From the Associated Press today:

"Oil prices have dropped 23 percent since the middle of July, attributed to ample global inventories, eased worries about supply threats from Iran and Nigeria, receding fears about this year's Atlantic hurricane season and as signs of economic weakness in the U.S. point to a possible softening in demand for energy. "The hedge funds and investors have been bailing out because geopolitical tensions have eased and they also realize that inventories are high during this period of seasonably weak demand at the end of summer," Shum said."

The funds I know have not "bailed." They are just short energy now - making money on the down trend.

A Chart That Buried a Hedge Fund

September 20, 2006

Natural Gas Down Move.

Amaranth Spin

September 18, 2006

David Faber in reporting about the Amaranth hedge fund losses said today (they went from +23% YTD to -35% YTD), "It will have no impact on other funds." Oh really? It is a zero sum game! Those losses of $3 to $4 billion at Amaranth went to winners on the other side of the coin in Natural Gas.

From MarketWatch:

"Hedge fund Amaranth Advisors LLC said Monday that it has suffered heavy losses related to in its investments in natural gas and it could report a year-to-date decline in the fund of more than 35% when it finishes unwinding its positions. The firm said it has met every margin call to date on the positions, and has nearly completed disposing of its natural gas exposure. "We are in discussions with our prime brokers and other counterparties and are working to protect our investors while meeting the obligations of our creditors," the company said in a prepared statement issued Monday."

From Dealbreaker.com:

So who is this Brian Hunter we mentioned in the previous item about the huge losses at Amaranth Advisers? We haven’t been able to track down a picture of him yet but we’ve collected some details on young man who came to head his fund’s energy trading desk at the age of thirty-two. Earlier this year, Trader Magazine ranked him at 29 in its list of top one hundred traders. He’s said to have made $800 million for the fund in 2005—much of it from the skyrocketing price of natural gas in the wake of hurricane Katrina—and was paid somewhere between $75 and $100 million. When he decided he wanted to leave New York for his native Calgary, Amaranth set up an office there for his team. Hunter’s role in the losses his fund expects to suffer as it unwinds its natural gas position is not yet known. One source familiar with the market for energy trades told DealBreaker he believed Hunter had made trades this year similar to his winning 2005 bets and got caught out when 2006 produced a much calmer hurricane season and new oil discoveries in the Gulf of Mexico.

From TheStreet.com:

"Based in Greenwich, Conn., Amaranth employs more than 360 people, including 115 traders. The fund's Web site tabs its assets at $7.5 billion, and the firm has offices in Houston, Toronto, London and Singapore. Sources say assets under management may have been more than $9 billion going into September. "We have met every margin call to date," the letter continues. "We are in discussions with our prime brokers and other counterparties and are working to protect our investors while meeting the obligations of our creditors." A person familiar with Amaranth says the fund was up a little more than 20% for the year as recently as mid-August. Using that figure, a back-of-an-envelope calculation means Amaranth at one point was up $1.5 billion for the year. But in recent weeks it may have lost as much as $4 billion. The fund, assuming it is down 35% for the year, now has about $5 billion in assets under management. A trader with another hedge fund says the news of the big loss at Amaranth may explain some unusual trading in certain stocks last week. The trader speculated that Amaranth may have been liquidating positions in some of its equity holdings to satifisy the margin calls from its prime broker. Amaranth wouldn't comment beyond its letter to investors. The hedge fund reported having $2.3 billion invested in U.S. stocks as of the end of June. Several of Amaranth's big investments were Humana , Goldcorp and Sprint. A broker gives a margin call when an investor or trader does not have adequate collateral to support the amount of money it has borrowed."

No Secrets

September 09, 2006

Someone asked Ed Seykota about 'market secrets' that will be revealed at a conference that Ed is speaking at in Singapore. He responded:

I do not know what secrets the other speakers intend to reveal as these are, well, secret. I can tell you a couple "secrets" about purveyors of secrets:

1. There are no secrets.
2. They don't want you to know that.

Setting Up a Fund

September 06, 2006

I thought this document (PDF) on setting up a fund, which arrived unsolicited in my 'in' box, may be useful for some readers.

More Old Pro Wisdom

August 29, 2006

I have developed a friendship with an old pro trader who sends me regular insight. A recent email in:

Hello again everyone-due to other commitments today will be my last "morning market comments". As most of you know several months ago I was invited to be a ghost analyst for a well-respected daily newsletter writer in the futures industry. For a number of reasons I decided not to get involved but in my trial period I found a number of things about myself I had never recognized before. Some things I learned are not necessarily about me per se but more about trading and I learned a few things about some of you. My readers included two successful commodity trading advisors, a surgeon, a real estate developer, a successful businessman, a successful salesman, and a federal law enforcement agent. The point here is that people from all walks of life have an interest in trading on some level.

A few of the things I learned are as follows:

#1 there is a huge gap between market analysis and trading markets to make money.

#2 There is no relationship between being "right" and making money.

#3 While markets are not predictable people are.

#4 Anything can happen in the markets so how worthwhile is a market opinion?

#5 Having a definable game plan and following it will overcome poor analysis.

#6 I know some very rich traders but I have yet to meet a rich analyst.

#7 You should never give out market advice because readers don't need your bad advice and they will ignore your good advice so don't give them any advice.

#8 A correct market opinion does not answer the questions of how and when do I place a bet, when do I know I am wrong, how big is my bet in terms of dollar or percent risk, and most important how do I manage my trades when they are working.

#9 Some very smart people think the stock market is going up. Some other very smart people think the stock market is going down. Since I don't have a clue what the stock market is going to do I totally agree with both opinions.

#10 Managing the money and more importantly managing the trade is more important than being "right".

#11 A good trade is a trade which was entered and exited following one's rules regardless of the dollar outcome be it a gain or a loss.

#12 Most newsletters offer both sides regarding market direction. Whichever way the market goes will then be highlighted in subsequent newsletters as if the writer new what was coming.

#13 The more negative email you receive regarding a market opinion the more you should bet.

#14 If you receive emails endorsing your view you might want to re-think your opinion.

#15 You learn very little "watching" someone else trade and you might very well harm yourself as a trader by following the advice of others. Be your own man or in one case lady!

#16 Keeping a trading diary on a daily basis will teach you how you think. Be honest and don't edit your diary in hindsight. Again trading is not about right and wrong but it is about doing and not doing.

Good trading to everyone!

How Change Happens

A reader sent me this excerpt from John Mauldin. He touches on analysts' propensity to offer explanations for every market move:

"To trace something unknown back to something known is alleviating, soothing, gratifying, and gives moreover a feeling of power. Danger, disquiet, anxiety attend the unknown - the first instinct is to eliminate these distressing states. First principle: any explanation is better than none... The cause-creating drive is thus conditioned and excited by the feeling of fear ...." Friedrich Nietzsche

"Any explanation is better than none." And the simpler, it seems in the investment game, the better. "The markets went up because oil went down," we are told. Then the next day the opposite relationship occurs. Then there is another reason for the movement of the markets. But we all intuitively know that things are far more complicated than that. As Nietzsche noted, dealing with the unknown can be disturbing, so we look for the simple explanation. "Ah," we tell ourselves. "I know why that happened." With an explanation firmly in hand, we now feel we know something. And the behavioral psychologists note that this state actually releases chemicals in our brain which make us feel good. We become literally addicted to the simple explanation. The fact that what we "know" (the explanation for the unknowable) is irrelevant or even wrong is not important to the chemical release. And thus we look for reasons. And that is why some people get so angry when you challenge their beliefs. You are literally taking away the source of their good feeling, like drugs from a junkie, or a boyfriend from a teenage girl. Thus we reason the NASDAQ bubble happened because of Greenspan. Or a collective mania. Or any number of things. Just like the proverbial butterfly flapping its wings in the Amazon that triggers a storm in Europe, maybe an investor in St. Louis triggered the NASDAQ crash....

Top 10 Ways To Lose All The Money In Your Trading Account In 30 Days Or Less

August 20, 2006

I came across the list below from 'Craig' here. It is a great list:

Top 10 Ways To Lose All The Money In Your Trading Account In 30 Days Or Less - Guaranteed!

#10 - Put all of your efforts into finding the perfect technical indicator. Once you find this magical indicator, it will be like turning on a water faucet. Go all in. The money will just flow into your account!

#9 - When your technical indicator says that the stock is oversold, BUY IT RIGHT THEN. Always do what your technical indicator says to do. It takes precedence over price action.

#8 - Make sure to visit a lot of stock trading forums and ask them for hot stock tips. Also, ask all your friends and family for stock tips. They are usually right, and acting on these tips can make you very rich.

#7 - Watch what other traders do and be sure to follow the crowd. After all, they have been trading a lot longer than you so naturally they are smarter.

#6 - Pay very close attention to the fundamentals of a company. You MUST know the P/E ratio, book value, profit margins, etc. Once you find a "good company", consider going on margin to pay for shares in their stock.

#5 - Forget about developing a trading plan. If you see a good stock just buy it. Don't worry about when your going to sell. No need to get caught up in the details. Besides, you'll probably get rich the first year of trading anyway.

#4 - Buy expensive computers and trading software. While your at it, buy a couple more TV's so that you can watch CNBC on multiple screens! You NEED all of these gadgets in order to trade stocks successfully. Then watch the money roll in!

#3 - Always follow your emotions. They are there for a reason. If you feel nervous, sell the stock! If you are excited, buy more shares. This is the best way to trade stocks and fatten up your trading account.

#2 - Don't worry about using stop loss orders. When the time comes, you will be able to sell your shares and take a loss. Your emotions won't even come into play. Besides, stop loss orders are for sissies!

#1 - Absolutely, without a doubt, FORGET about managing your money. Don't worry about how much you can lose on a trade. Only think about how much loot your gonna make. Then start planning that trip to Fiji!

Independent Traders v. Goldman Traders

August 10, 2006

I was talking the other day with an old pro trader about the comparison of independent minded traders, like the trend followers mentioned in my book, to in-house traders at the likes of a Goldman Sachs. His comment:

"The lack of accountability for the in-house traders [is hard]. Their mess-ups are hidden in the rest of the pile. My track record was there for everyone to see...the institutional guys make a lot of noise when they hit but their mini crashes never make the news. I have always felt on some level the big guys let you know what they are doing or actually have done when it supports their market position. CTA's [trend followers] are really under the microscope every day performance wise and I am sure in house traders have supervisors that watch them but psychologically I think they are world's apart."

Returns Down on Purpose?

August 06, 2006

I posted a quote from Paul Tudor Jones the other day. But after thinking about it, I wanted to add some more comment to it.

I often hear the cry, "trend following returns have decreased!" In many instances they have, but for a simple reason: the client wanted it that way. To make more money you apply more juice (see leverage). Great trading, any great trading, will always require more risk and result in greater drawdown if you want to make big money. Many clients today, many of the institutional investors are plain happy with 10-15%. That's all they want for an assortment of reasons, i.e. peer pressure (no incentive due to competing with benchmarks), or even just not that smart about the benefits of absolute returns. Paul Tudor Jones, while not technically a trend follower, has traded futures from a macro perspective for decades. He says it clearly:

"Our returns have definitely flattened out since the '80's. But if you look at my risk adjusted returns, they're very similar and I'm probably the same exact trader as I was 15 years ago. What's different has been my own personal appetite for risk and volatility. I think that probably happens with a lot of people as they get older. Everything is a function of leverage, how much of a draw down are you willing to tolerate, how much leverage do you want to put on. When I was younger, I had much greater draw downs, much greater draw down frequency, much greater leverage. So again, I'm probably the exact same trader as I was 15 years ago, it's just less risk, less return."

A Trader's Train to Wall Street, Conn.

August 05, 2006

From the NY Times today:

"Thousands of young financial workers stream into Grand Central Terminal every weekday morning. But many are not on their way to offices on Wall Street or in Midtown. Instead, they are crowded into trains for Greenwich, Conn., which has emerged as the home of the ballooning hedge fund industry. The center of power in finance has shifted in recent years, and in one sense that shift is geographical. Some of the most powerful traders in the market can be found miles away from Wall Street, in Greenwich, Stamford, and Westport, Conn. 'If you look up and down the train line in Connecticut you will see all the hedge funds concentrated right along the line,' said Thomas Torelli, a corporate real estate agent in Greenwich. Those funds are there because their founders and top managers live nearby. But thousands of their employees do not and as result do what to the rest of Wall Street is a reverse commute. The trains leaving Grand Central between 7 and 8:30 a.m. are packed. Most seats are taken and conversation is sparse. Unlike Wall Street commuters, many are not wearing suits. Yet like the Wall Street crowd, some are working furiously on their BlackBerrys and laptops. A little less than an hour later, when the train rolls into Greenwich, workers stream out of the train and walk to their nearby offices. 'Greenwich is quiet, peaceful and clean,' said a young hedge fund employee on the train who lives in Manhattan. 'But I am 24 and single - I couldn't imagine living in Greenwich.' He spoke on the condition that he and his firm not be named because he was not authorized by the hedge fund to speak to reporters. Many other commuters declined to comment for the same reason. Hedge funds are notoriously secretive organizations. They will not disclose who their employees or investors are, much less their strategies. Now, apparently, how their employees commute is off limits, as well."

Au contraire, strategies are only so unknowable. The performance data of whatever hedge fund always offers a big clue...

Pure Talent is Not Enough

If talent is THE key to success, then explain, for example, Enron:

“Enron was the ultimate “talent” company bringing in a steady stream of the very best college and MBA graduates to stock the company with talent. During the nineties, Enron was bringing in two hundred and fifty newly minted MBAs a year. Once at Enron, the top performers were rewarded inordinately, and promoted without regard for seniority or experience. Enron was a star system. “The only thing that differentiates Enron from our competitors is our people, our talent,” said Ken Lay, Enron’s former chairman and C.E.O. As another senior Enron executive put it, “Creative Destruction - We hire very smart people and we pay them