Thursday, December 31, 2009
Happy new year and decade
Unfortunately I can't send each of you a card from my favorite e-card site, but here's the unpersonalized view. I wish everyone a peaceful, healthy, and prosperous year--geez, even decade!
Wednesday, December 30, 2009
Losing to win, investment in loss, not repeating mistakes
At the age of eight Josh Waitzkin was defeated in his first bid for a national chess championship. He had been the favorite, but ultimately he fell short. He took the summer off to go fishing with his parents. It was during this time that he “questioned everything and decided to come back strong, [that he] arrived at a commitment to chess that was about much more than fun and glory. It was about love and pain and passion and pushing [himself] to overcome.” He had confronted his chess mortality and “responded to heartbreak with hard work.” (p. 23)
Years later came a new challenge—Push Hands from Tai Chi that seeks “to defeat a thousand pounds with four ounces.” The only way that Push Hands students can progress “is to release the ego enough to allow themselves to be tossed around while they learn how not to resist.” (p. 107) It’s what his instructor calls investment in loss—giving yourself to the learning process. Waitzkin also describes it as humility training. The less successful students were “frozen in place, repeating their errors over and over, unable to improve because of a fear of releasing old habits. . . They were locked up by the need to be correct.”
Waitzkin suggests that “if a student of virtually any discipline could avoid ever repeating the same mistake twice—both technical and psychological—he or she would skyrocket to the top of their field. Of course such a feat is impossible—we are bound to repeat thematic errors, if only because many themes are elusive and difficult to pinpoint.” In his own chess career, for instance, he didn’t realize that he was “faltering in transitional moments until many months of study brought the pattern to light.” (pp. 107-108) And let me quote the passage that describes this faltering in full because it should resonate with traders. “For a period of time, almost all my chess errors came in a moment immediately following or preceding a big change. For example, if I was playing a positional chess game, with complex maneuvering, long-term strategical planning, and building tension, and suddenly the struggle exploded into concrete tactics, I would sometimes be slow to accommodate the new scenario. Or, if I was playing a very tactical position that suddenly transformed into an abstract endgame, I would keep on calculating instead of taking a deep breath and making long-term plans.” (p. 75) With awareness and action, he reports, his weakness was transformed into a strength.
My follow-up post, on using adversity, will continue this general theme. As a sidenote, I just finished reading T. J. Stiles’s biography of Vanderbilt, The First Tycoon, winner of the National Book Award for non-fiction, a prize apparently worth the non-Vanderbiltian sum of $10,000. The commodore had horrific losses, adversities that beset him like clockwork, but he was always revitalized to push on harder and smarter than ever. He’s not nearly so endearing as Josh Waitzkin (he certainly wasn’t a Push Hands kind of competitor), but he’s a model of the power of relentless perseverance.
Years later came a new challenge—Push Hands from Tai Chi that seeks “to defeat a thousand pounds with four ounces.” The only way that Push Hands students can progress “is to release the ego enough to allow themselves to be tossed around while they learn how not to resist.” (p. 107) It’s what his instructor calls investment in loss—giving yourself to the learning process. Waitzkin also describes it as humility training. The less successful students were “frozen in place, repeating their errors over and over, unable to improve because of a fear of releasing old habits. . . They were locked up by the need to be correct.”
Waitzkin suggests that “if a student of virtually any discipline could avoid ever repeating the same mistake twice—both technical and psychological—he or she would skyrocket to the top of their field. Of course such a feat is impossible—we are bound to repeat thematic errors, if only because many themes are elusive and difficult to pinpoint.” In his own chess career, for instance, he didn’t realize that he was “faltering in transitional moments until many months of study brought the pattern to light.” (pp. 107-108) And let me quote the passage that describes this faltering in full because it should resonate with traders. “For a period of time, almost all my chess errors came in a moment immediately following or preceding a big change. For example, if I was playing a positional chess game, with complex maneuvering, long-term strategical planning, and building tension, and suddenly the struggle exploded into concrete tactics, I would sometimes be slow to accommodate the new scenario. Or, if I was playing a very tactical position that suddenly transformed into an abstract endgame, I would keep on calculating instead of taking a deep breath and making long-term plans.” (p. 75) With awareness and action, he reports, his weakness was transformed into a strength.
My follow-up post, on using adversity, will continue this general theme. As a sidenote, I just finished reading T. J. Stiles’s biography of Vanderbilt, The First Tycoon, winner of the National Book Award for non-fiction, a prize apparently worth the non-Vanderbiltian sum of $10,000. The commodore had horrific losses, adversities that beset him like clockwork, but he was always revitalized to push on harder and smarter than ever. He’s not nearly so endearing as Josh Waitzkin (he certainly wasn’t a Push Hands kind of competitor), but he’s a model of the power of relentless perseverance.
Tuesday, December 29, 2009
Aldridge, High-Frequency Trading
First, what Irene Aldridge’s High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems (Wiley, 2010) is not. It’s not an idiot’s guide to high-frequency trading, and it’s not a do-it-yourself manual for the small fry self-directed trader who wants to transform himself into the next Renaissance Technologies. (At least not unless he gets a pretty hefty infusion of cash into his trading business and has highly developed quant skills.) Instead, this book is a description of some of the key elements of high-frequency trading—order execution, ways to find trading opportunities, backtesting, portfolio optimization, and risk management. It draws on academic research (some 20 pages of bibliography) and explicates many ideas with mathematical and statistical formulas.
Aldridge’s book is, I think, particularly valuable for the intraday trader who will often have a high-frequency trading system on the other side of his trade. It’s imperative to know how these systems operate and how they can sometimes in what seems a blink of the eye exploit a market inefficiency and, presto, return the market to efficiency. The book also offers useful pointers for those seeking to develop, automate, and monitor their lower-frequency trading strategies.
There’s a lot of meat on the bones of this book. To profit from it directly you have to be quantitatively savvy. To profit indirectly, you need only be intellectually curious and not mathematically challenged.
For the latter group (yes, I include myself) let me share two of Aldridge’s broad-based hypotheses. I suspect that if a trader truly understands and acts on the issues involved in these two hypotheses, whatever his reasoned conclusion as to their validity, he will leapfrog ahead of his competition, high frequency or snail-paced.
First, Aldridge claims that “in the long term, none of the markets is a zero-sum game. The diverse nature of market participants ensures that all players are able to extract value according to their own metrics.” (p. 47)
Second, all traders seek to differentiate predictable price moves from random moves. Aldridge describes some of the tests that can be performed to determine market efficiency—for instance, non-parametric runs tests, autoregression-based tests, tests based on the martingale hypothesis, and cointegration-based tests. She concludes that “the same security may be predictable at one frequency and fully random at another frequency. Various combinations of securities may have different levels of efficiency. While price changes of two or more securities may be random when securities are considered individually, the price changes of a combination of these securities may be predictable, and vice versa.” (p. 89)
I will never be a high-frequency trader, but even for the “slower and duller” Aldridge’s book has a lot to offer. What works at warp speed is sometimes, slightly modified, a winner for those who are entering their trades (even manually) via a cable modem far from the exchange.
Aldridge’s book is, I think, particularly valuable for the intraday trader who will often have a high-frequency trading system on the other side of his trade. It’s imperative to know how these systems operate and how they can sometimes in what seems a blink of the eye exploit a market inefficiency and, presto, return the market to efficiency. The book also offers useful pointers for those seeking to develop, automate, and monitor their lower-frequency trading strategies.
There’s a lot of meat on the bones of this book. To profit from it directly you have to be quantitatively savvy. To profit indirectly, you need only be intellectually curious and not mathematically challenged.
For the latter group (yes, I include myself) let me share two of Aldridge’s broad-based hypotheses. I suspect that if a trader truly understands and acts on the issues involved in these two hypotheses, whatever his reasoned conclusion as to their validity, he will leapfrog ahead of his competition, high frequency or snail-paced.
First, Aldridge claims that “in the long term, none of the markets is a zero-sum game. The diverse nature of market participants ensures that all players are able to extract value according to their own metrics.” (p. 47)
Second, all traders seek to differentiate predictable price moves from random moves. Aldridge describes some of the tests that can be performed to determine market efficiency—for instance, non-parametric runs tests, autoregression-based tests, tests based on the martingale hypothesis, and cointegration-based tests. She concludes that “the same security may be predictable at one frequency and fully random at another frequency. Various combinations of securities may have different levels of efficiency. While price changes of two or more securities may be random when securities are considered individually, the price changes of a combination of these securities may be predictable, and vice versa.” (p. 89)
I will never be a high-frequency trader, but even for the “slower and duller” Aldridge’s book has a lot to offer. What works at warp speed is sometimes, slightly modified, a winner for those who are entering their trades (even manually) via a cable modem far from the exchange.
Monday, December 28, 2009
Two approaches to learning
Sometime back in August, in a comment on one of my posts, Jorge suggested that I read Josh Waitzkin’s The Art of Learning (Free Press, 2007). I got as far as obtaining a copy of the book and then somehow got distracted—too many books, too little time. When Linda Raschke referenced it in a recent webinar I refocused. I curled up with The Art of Learning, a truly marvelous book for anyone seeking to improve her performance.
Josh Waitzkin, in case his name doesn’t resonate, was an eight-time national chess champion in his youth. He was the subject of Searching for Bobby Fischer, a book written by his father and subsequently made into a movie. He then went on to become a martial arts champion with 21 national championship titles and several world championship titles. He also helped to develop Chessmaster, the best-selling chess-playing computer game series, now owned by UbiSoft. You might describe him as an overachiever.
I’m going to mine his book for insights over a series of posts, but there’s no way my desiccated summaries can begin to capture the passion of the book. You get what you pay for. Today’s theme is essentially the difference between statis and process.
There is little room at the top in competitive worlds. Most people who try will be disappointed. So, Waitzkin asks, what separates out the winners from the also-rans and the outright losers? And, “if ambition spells probable disappointment, why pursue excellence?” He suggests that “the answer to both questions lies in a well-thought-out approach that inspires resilience, the ability to make connections between diverse pursuits, and day-to-day enjoyment of the process. The vast majority of motivated people, young and old, make terrible mistakes in their approach to learning.” (pp. 29-30)
Drawing on the work of developmental psychologists Waitzkin describes two differing views of intelligence—entity and incremental. The first view looks upon overall intelligence or skill at a certain task or set of tasks as fixed; the kid is inherently smart or dumb, is good at math but is a bad speller. The second view might adopt the old Avis slogan “we try harder” as its mantra; with hard work, incrementally, the bad speller can improve and perhaps even become a crack speller.
When challenged, those who have an entity view of intelligence are “brittle and prone to quit” because they have a “learned helplessness orientation”; the incrementalists keep plugging away. It is easy to destroy the self-confidence of the first group because “they feel the need to live up to and maintain a perfectionist image that is easily and inevitably shattered.” They find it difficult to come back from defeat.
Fortunately it seems that we can reprogram ourselves to view particular tasks/challenges as part of an overall learning process in which we are trying to achieve mastery rather than as stand-alone exercises that will be judged or graded. This reprogramming is not only good for the soul; it also improves performance on these tasks. Kids who received “mastery-oriented” instructions outperformed those who received “helplessness-producing” instructions.
Josh Waitzkin, in case his name doesn’t resonate, was an eight-time national chess champion in his youth. He was the subject of Searching for Bobby Fischer, a book written by his father and subsequently made into a movie. He then went on to become a martial arts champion with 21 national championship titles and several world championship titles. He also helped to develop Chessmaster, the best-selling chess-playing computer game series, now owned by UbiSoft. You might describe him as an overachiever.
I’m going to mine his book for insights over a series of posts, but there’s no way my desiccated summaries can begin to capture the passion of the book. You get what you pay for. Today’s theme is essentially the difference between statis and process.
There is little room at the top in competitive worlds. Most people who try will be disappointed. So, Waitzkin asks, what separates out the winners from the also-rans and the outright losers? And, “if ambition spells probable disappointment, why pursue excellence?” He suggests that “the answer to both questions lies in a well-thought-out approach that inspires resilience, the ability to make connections between diverse pursuits, and day-to-day enjoyment of the process. The vast majority of motivated people, young and old, make terrible mistakes in their approach to learning.” (pp. 29-30)
Drawing on the work of developmental psychologists Waitzkin describes two differing views of intelligence—entity and incremental. The first view looks upon overall intelligence or skill at a certain task or set of tasks as fixed; the kid is inherently smart or dumb, is good at math but is a bad speller. The second view might adopt the old Avis slogan “we try harder” as its mantra; with hard work, incrementally, the bad speller can improve and perhaps even become a crack speller.
When challenged, those who have an entity view of intelligence are “brittle and prone to quit” because they have a “learned helplessness orientation”; the incrementalists keep plugging away. It is easy to destroy the self-confidence of the first group because “they feel the need to live up to and maintain a perfectionist image that is easily and inevitably shattered.” They find it difficult to come back from defeat.
Fortunately it seems that we can reprogram ourselves to view particular tasks/challenges as part of an overall learning process in which we are trying to achieve mastery rather than as stand-alone exercises that will be judged or graded. This reprogramming is not only good for the soul; it also improves performance on these tasks. Kids who received “mastery-oriented” instructions outperformed those who received “helplessness-producing” instructions.
Sunday, December 27, 2009
Goldman Sachs VIP stocks
Toward the end of August Goldman Sachs published a hedge fund trend monitor.
Among the data collected were the fifty stocks that “matter most” to hedge funds—that is, the fifty stocks that most frequently appear among the largest ten holdings of hedge funds. Here are the top ten as of June 30, 2009. I calculated (first column) the rate of return between June 30 and December 10 and (second column) the rate of return between June 30 and the highest close after June 30 and before December 10.
As you can see, as of December 10 the top stocks on average underperformed the SPY. By contrast, at their height they outperformed the SPY by about 9%. So hedge funds had to be nimble to get outsized returns from this basket of stocks. (Not that any one fund owned the whole basket.) Looking at the ten stocks individually, six were outperforming the S&P 500 as of December 10 and eight outperformed at their height, some dramatically so. As is so often the case, timing made the difference.
AlphaClone also slices and dices hedge fund holdings and publishes leaderboard. This clone fund is made up of the largest equity holding for each hedge fund in their database, 50% hedged and rebalanced quarterly.
Among the data collected were the fifty stocks that “matter most” to hedge funds—that is, the fifty stocks that most frequently appear among the largest ten holdings of hedge funds. Here are the top ten as of June 30, 2009. I calculated (first column) the rate of return between June 30 and December 10 and (second column) the rate of return between June 30 and the highest close after June 30 and before December 10.
| BAC | 15.23% | 40.83% | MSFT | 25.66% | 25.56% | AAPL | 37.91% | 45.33% | GOOG | 40.30% | 40.30% | JPM | 20.99% | 38.26% | PFE | 22.13% | 25.67% | QCOM | 0.80% | 7.19% | RIG | 8.63% | 24.78% | CVS | -1.16% | 19.26% | V | 32.22% | 33.26% | Average | 20.27% | 30.04% |
| SPY | 20.33% | 21.13% |
As you can see, as of December 10 the top stocks on average underperformed the SPY. By contrast, at their height they outperformed the SPY by about 9%. So hedge funds had to be nimble to get outsized returns from this basket of stocks. (Not that any one fund owned the whole basket.) Looking at the ten stocks individually, six were outperforming the S&P 500 as of December 10 and eight outperformed at their height, some dramatically so. As is so often the case, timing made the difference.
AlphaClone also slices and dices hedge fund holdings and publishes leaderboard. This clone fund is made up of the largest equity holding for each hedge fund in their database, 50% hedged and rebalanced quarterly.
Wednesday, December 23, 2009
World’s most unusual Christmas trees
As Charlie Munger said, “Invert, always invert.” Why the upside-down tree? So specialty stores could display ornaments while using as little floor space as possible.
If you have a soft spot for the pathetic, Charlie Brown’s Christmas tree should really resonate.
And what do you do with all those trading books and magazines? Make a bookshelf tree.
From a Singapore jeweler comes this tree with 21,798 diamonds totaling 913 carats and 3,762 crystal beads. Worth a million bucks!
These images are among the ten featured on the Neatorama site (admittedly two years old, but fun anyway).
Is trading self-poisoning?
I’ve started reading Peter Ward’s The Medea Hypothesis: Is Life on Earth Ultimately Self-Destructive? (Princeton University Press, 2009). I doubt that I’ll read it cover to cover, but its premise is intriguing in a Malthusian, doomsday sort of way.
Contrary to Gaia hypotheses that envisioned “Mother Nature” as a kindly, nurturing force, Ward offers us Medea. She, of course, was the quintessential bad mother who murdered all her children after she found out that husband Jason, who could cast a spell over any woman (and bewitched her), was a cad—and an unlikable one at that. Ward’s Medea hypothesis is that “the overall effect of life has been and will be to reduce the longevity of the Earth as a habitable planet. Life itself, because it is inherently Darwinian, is biocidal, suicidal, and creates a series of positive feedbacks to Earth systems . . . that harm later generations. Thus it is life that will cause the end of itself, on this or any planet inhabited by Darwinian life. . . .” (p. 35) Only human intelligence and engineering, Ward suggests, can delay this fate.
Okay, you ask, what does this have to do with trading and investing? Let’s look at two characteristics of Medean life.
First, species keep increasing in population, ultimately outstripping resources vital to their continuance. Take the classic example of putting a breeding pair of insects in a closed jar with some food. The insects multiply, the food disappears, and the bugs die off from starvation, “usually with some last phase of cannibalism preceding the complete extinction.” I couldn’t help thinking of competing hedge funds when picturing the insects in the jar. Fortunately for some funds “angels” often add food to the jar. “But the point here,” says Ward, “is that . . . there are always too many bugs for the amount of food, and some are always dying of starvation or being killed by other bugs as they fight for food.” (p. 36) Simple Darwinism at work. Just ask the presumably dwindling number of real estate agents in Greenwich, CT.
Second, life is self-poisoning in closed systems. We need not linger over the image of increasing amounts of carbon dioxide in the air and liquid and solid waste in the ground. Instead let’s jump directly to the analogous question: is trading self-poisoning? We know that it can be. Just think of Frank Norris’s 1903 novel The Pit. (If you haven’t read this tale of the Chicago wheat pit, it’s available for free download online via the Gutenberg Project.) Perhaps Jesse Livermore’s suicide is another testament to the self-poisoning character of trading.
But there’s no reason a trader has to encapsulate himself in a world that excludes everything that isn’t market related. Moreover, isn’t trading, virtually by definition, an open system—that is, a system that continuously interacts with its environment and that has supplies of energy, however metaphorically defined, that cannot be depleted? Well, in some sense yes, but unfortunately we can’t extend the notion of energy supplies, no matter how hard we try, to include financial resources. They certainly can be depleted through trading.
I suspect that trading, at least for those who are successful at it, is both self-sustaining and self-poisoning. I also suspect that most trading systems start to degrade not only because markets change but also because they change markets; that is, they themselves have “self-poisoning” qualities. I have no proof of any of this, but it’s something to think about. And, oh yes, happy holidays! Ho-ho-ho.
Contrary to Gaia hypotheses that envisioned “Mother Nature” as a kindly, nurturing force, Ward offers us Medea. She, of course, was the quintessential bad mother who murdered all her children after she found out that husband Jason, who could cast a spell over any woman (and bewitched her), was a cad—and an unlikable one at that. Ward’s Medea hypothesis is that “the overall effect of life has been and will be to reduce the longevity of the Earth as a habitable planet. Life itself, because it is inherently Darwinian, is biocidal, suicidal, and creates a series of positive feedbacks to Earth systems . . . that harm later generations. Thus it is life that will cause the end of itself, on this or any planet inhabited by Darwinian life. . . .” (p. 35) Only human intelligence and engineering, Ward suggests, can delay this fate.
Okay, you ask, what does this have to do with trading and investing? Let’s look at two characteristics of Medean life.
First, species keep increasing in population, ultimately outstripping resources vital to their continuance. Take the classic example of putting a breeding pair of insects in a closed jar with some food. The insects multiply, the food disappears, and the bugs die off from starvation, “usually with some last phase of cannibalism preceding the complete extinction.” I couldn’t help thinking of competing hedge funds when picturing the insects in the jar. Fortunately for some funds “angels” often add food to the jar. “But the point here,” says Ward, “is that . . . there are always too many bugs for the amount of food, and some are always dying of starvation or being killed by other bugs as they fight for food.” (p. 36) Simple Darwinism at work. Just ask the presumably dwindling number of real estate agents in Greenwich, CT.
Second, life is self-poisoning in closed systems. We need not linger over the image of increasing amounts of carbon dioxide in the air and liquid and solid waste in the ground. Instead let’s jump directly to the analogous question: is trading self-poisoning? We know that it can be. Just think of Frank Norris’s 1903 novel The Pit. (If you haven’t read this tale of the Chicago wheat pit, it’s available for free download online via the Gutenberg Project.) Perhaps Jesse Livermore’s suicide is another testament to the self-poisoning character of trading.
But there’s no reason a trader has to encapsulate himself in a world that excludes everything that isn’t market related. Moreover, isn’t trading, virtually by definition, an open system—that is, a system that continuously interacts with its environment and that has supplies of energy, however metaphorically defined, that cannot be depleted? Well, in some sense yes, but unfortunately we can’t extend the notion of energy supplies, no matter how hard we try, to include financial resources. They certainly can be depleted through trading.
I suspect that trading, at least for those who are successful at it, is both self-sustaining and self-poisoning. I also suspect that most trading systems start to degrade not only because markets change but also because they change markets; that is, they themselves have “self-poisoning” qualities. I have no proof of any of this, but it’s something to think about. And, oh yes, happy holidays! Ho-ho-ho.
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