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Is The Market Always Right?

George Soros likes to joke that market has predicted seven of the past two recessions. And he is right. Since the market is forward looking, it will sometimes discount fundamentals that will never become a reality.

Prices reflect people’s expectations about the future, mostly about the near-term future. To say that the market is always right means to assume that people’s expectations about the future always come true. We all know that this is not the case. No one has a crystal ball. People are often wrong.

Is the market always right?

No, but this does not stop people who follow price trends to make a lot of money. The market could remain “wrong” (irrational) for a very long period of time and even become “wronger”. (more…)

External and Internal rules for Traders

Assuming you use rules in your trading, here’s an exercise that can bring new insight into analyzing your trade metrics. The next time you review your trade history (you do review it, right?) focus on the rules of the trade. Specifically, ask yourself how you responded to the rules.

For this exercise we will use two types of rules—external and internal. An example of an external rule would be one generated from your trading system. Let’s use a simple moving average cross as a buy order. An example of an internal rule would be discretionary in nature. Usually we can find these in statements like “I told myself that I’d trade smaller ahead of my vacation so I wouldn’t have to worry about positions and truly relax.”

Take a piece of paper and divide it into two columns; one for external and one for internal. Now process your prior trades to see which types of rule you followed and didn’t follow. Take it a step further to see which type of rule had larger profits or losses over time. See if there’s a correlation between length of trade and type of rule. Perhaps there’s a common thread between losing trades and not following your internal rules. If so, this would suggest a lack of discipline on your part which can be fixed by creating an external rule to avoid or lessen losses in the future. Have fun with the exercise but approach it with the intent to improve your trading. (more…)

What is a ‘Zero-Sum Game’?

Zero-sum games are the total opposite of win-win situations – such as an agreement that creates value between two counter-parties – or lose-lose situations, like war and mutually destructive relationships for instance. In real life, however, things are not always so clear-cut, and winners and losers are often difficult to quantify. New traders get confused and do not understand that in trading, profits come from the people on the other side of your trade that are making the wrong decision. The reason that trading is difficult is because you have to out smart someone to get their money, how you do this is what gives you your edge if you are profitable. In all financial markets buyers and sellers are always equal and the time frame in which they are trading determines if their decision was the right or wrong one at the time of their trade. Your entry is someone else’s exit and your losses are in some one else’s account as profits.

A zero-sum game is a situation where one person’s gain is always equivalent to another person’s loss, so the total wealth for the players and participants in the game is always a net change of  zero as a whole.  The financial contract markets of futures and options are a zero-sum game with several million players. Zero-sum games are found in game theory, but are less common than non-zero sum games. Poker and gambling are popular examples of what a zero-sum game is since the sum of the amounts won by some players equals the combined losses of the others. The money at a poker table at the start of the game does not grow it is just redistributed to the winners from the losers by the end of the game. All of the casino’s profits come from the gambler’s losses and all the gamblers profits are taken from the casino. Games like chess and tennis also fit this model becasue there is one winner and one loser they are always equal. In the financial markets, option contracts and future contracts are examples of zero-sum games, excluding transaction costs, for every long contract their is someone short the same contract. Some one has to sell a contract to create open interest and someone has to buy it, there has to be a winner and a loser at all times, one long and one short. Brokers and market makers disrupt the perfect balance of winners and losers by taking commissions or profiting from the bid/ask spreads. But, for every person who profits on a contract’s value going in their direction, there is a counter-party who loses who is on the other side. (more…)

A Review: “Two Centuries of Trend Following”

The paper “Two Centuries of Trend Following” by Lemperiere, Derenble, Seager, et al of Capital Fund Management purports to show that trend following has been profitable, over a wide range of markets, consistently over 200 years. It deserves to be reviewed as it represents a case study of the statistical practices, and armchair explanations that are sometimes used to justify a system that in the most recent five year period has lost its mojo. Rocky has asked me to review it.

The amazing thing is that the authors seem to know how to compute hyperbolic tangent regressions, and compute the duration of a drawdown given a sharpe ratio, yet they seem completely unaware of the problem of multicollinearity, overlapping observations, and lack of independent observations.

In a nutshell, they compute hundreds of thousands of means, and they combine them and measure how far away from randomness they are. Recall that the average of two random observations is about 0.7 times as variable as one observations. The average of 100,000 observations is about 1/320 as variable as 1 observation. (more…)

12 Market Wisdoms From Gerald Loeb

1. The most important single factor in shaping security markets is public psychology.

2. To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.

3. Accepting losses is the most important single investment device to insure safety of capital.

4. The difference between the investor who year in and year out procures for himself a final net profit, and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.

5. One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages. (more…)

The PROPER Use Of Hope and Fear

If you’ve been involved in the markets for any length of time you will no doubt have heard of the twin pillars of market psychology, Hope and Fear (or sometimes Greed and Fear).

In fact, if you’ve ever been involved in an endeavour where you have something on the line – a business, a wager, a job, or even a date – you will have experienced Hope and Fear in some form and the devastation it can play on your psychology.

Experiencing Hope

For most traders, Hope looks like this:

They’ve just bought a stock or commodity, and they hope that it goes up.  Of course, this is the name of the game, we all hope it goes up if we are buying!  But then the stock starts to fall, and instead of selling out, the trader holds on with the hope that it will rise again.  The more the stock falls, the more they hope and pray that it will rise.

But they don’t realise – Hope does not equal Action.  And only our Actions make money in the stock market.

Experiencing Fear (more…)

Christine Lagarde: "China's Slowdown Was Predictable, Predicted"… Yes, By Everyone Except The IMF

In what may be the funniest bit of economic humor uttered today, funnier even than the deep pontifications at Jackson Hole (where moments ago Stanley Fischer admitted that “research is needed for a better inflation indicator” which means that just months after double seasonally adjusted GDP, here comes double seasonally adjusted inflation), in an interview with Swiss newspaper Le Temps (in which among other things the fake-bronzed IMF head finally folded and said a mere debt maturity extension for Greece should suffice, ending its calls for a major debt haircut), took some time to discuss China.

This is what she said. 

Turning to China, Lagarde said she expected the country’s economic growth rate to remain close to previous estimates even if some sort of slowdown was inevitable after its rapid expansion.
China devalued its yuan currency this month after exports tumbled in July, spooking global markets worried that a main driver of growth was running out of steam.
“We expect that China will have a growth rate of 6.8 percent. It may be a little less.” The IMF did not believe growth would fall to 4 or 4.5 percent, as some foresaw.

Actually, some – such as Evercore ISI – currently foresee China’s GDP to be negative, at about -1.1%. (more…)

$25 Billion Hedge Fund Manager Explains 'How To Be A Great Trader'

Some perspective on ‘efficient markets’ from Elliott Management’s Paul Singer,

The fact that the vast majority of investors and traders cannot (with rare exceptions) beat the markets over long periods of time is not an argument for efficiency.Rather, the reason is that they are mostly doing the same thing sharing the same set of assumptions, and following the same impulses.

The fact that a basic assumption about the world is widely held does not make it true, nor does it make trading and pricing decisions based on that assumption efficient regardless of how liquid markets pricing in that assumption appear to be!

Certainly there are periods of time when some markets and submarkets appear to be efficient, but those who have vision, creativity and an understanding of the broader context of markets will make greater returns and/or attain a superior risk profile (assuming they do not get run over by standing rigidly against the sometimes-deeply false passions of the day expressed by the consensus).

How do the select few more or less continuously make money when the “efficient” markets are moving all over the place? Why do most investors fail, over long periods of time, to keep up with their desired index? And why do some people blow up? (more…)

5 Market Insights from Paul Tudor Jones

Paul Tudor Jones is one of the most emblematic figures in the hedge fund industry. His best percentage returns happened during severe market corrections: 126% after fees in 1987 when U.S. markets lost a quarter of their market cap in one day. 87% in 1990 when the Japanese stock market plunged. 48% during the tech crash of 2000-2001. He returned 5% in 2008. His funds have underperformed in the past 8 years. He charges 2.75% management fee and 27% performance fee, which significantly above the industry average of 2 and 20.

Outside of financial markets. PTJ founded the Robin Hood foundation, which attempts to alleviate problems caused by poverty in NYC.

The biggest conundrum when studying successful money managers is do you pay attention to what they are doing today or do you focus on what they were doing before they became widely popular, were managing a lot less money and had a lot higher returns?

Here PTJ talks about how new powerful trends often start – basically, a big price expansion from a long base.

The basic premise of the system is that markets move sharply when they move. If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try to fade that price move. When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion.

PTJ on risk management

If I have positions going against me, I get right out; if they are going for me, I keep them… Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in.

(more…)

China greasing economy with $55bn in tax breaks

China’s State Council on Wednesday approved 380 billion yuan ($55.1 billion) in tax relief that will mainly favor farmers and small businesses in a move that is seen as both economic and political.

The second large-scale tax cut to follow last year’s comes as China’s economy is forecast to slow down in the latter half of 2017, during which the Communist Party will convene its 19th National Congress and reshuffle top leadership.

China will modify its value-added tax this July by removing the 13% bracket while retaining the 6%, 11% and 17% tiers. The 13% rate currently applies to farm products and natural gas, but they will move to the 11% category. Farmers as well as households that purchase rice and vegetables will likely benefit from this change.

For smaller companies, those that pay 300,000 yuan or less in annual taxable revenue qualify for preferential tax treatment. The ceiling will be lifted to 500,000 yuan. Furthermore, small businesses and startups will be allowed to deduct 75% of research and development costs, up from 50%. These tax breaks will remain in effect until the end of 2019.

The Chinese government enacted about 500 billion yuan worth of corporate tax cuts in 2016. Helped also by a surge in infrastructure spending, the real economy grew 6.9% during the January-March period this year, marking the second quarter of economic acceleration. However, the People’s Bank of China, the country’s central bank, has been gradually raising market interest rates in order to rein in the real estate bubble. (more…)