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What Predictions Say About Us

  
Education, Video
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An excerpt:

…predictions are a way of demonstrating knowledge. Of course, in most things, a successful demonstration involves being right. In golf, a good argument will suffice. Most compellingly, human beings are wired to predict. In ancient times predictions served as psychological counterweight to the extreme uncertainty of life. As we’ve gained more control over daily existence, predictions help encourage the illusion that we are in charge of our own destiny. The more that is unknown, the greater the urge to predict. As the recently departed futurist author Ray Bradbury once said, “Mysteries abound where most we seek for answers.”

If you can find yourself comfortable not trying to predict daily life (and trading) there is a nice reward for you.

Trading Lessons

  
  Education
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Trading lessonsThe market is always right–except at significant tops and significant bottoms.

Keep and open and flexible mind. When in doubt, get out.

If you must have a guru, take him or her with many grains of salt

Do not add to losing positions.

Try every day to make yourself stronger, better and more integrated as a person.

Stay true to yourself. Lying to yourself and others, and trading on hope and prayer do not work

Most importantly, accept and recognize that you are not perfect. You are human and are going to make mistakes. Trading is the only profession where losing is actually winning. BUT— unless you accept mistakes as mistakes and learn from them, you will not progress and be upside down. Unless you are able to get your trading brain out of the cave you will not accumulate regret. It is only through the true acceptance of a mistake as a mistake that we accumulate regret. This is how we learn and grow as traders and human beings.

7 Characteristics of Great Traders

  
  Education
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1. Education, education, education.

The old cliche touted by politicians when they can’t think of anything clever to say to their audience. The importance of education to success in trading cannot be placed on a high enough pedestal. You have to learn to earn, the best traders work obsessively to refine their edge further to stay ahead of the curve.

2. Adapt or Die.

Market conditions change and technology advances, thus the conditions for trading are always evolving, the rise in mechanical trading is testament to that. The very best traders through a process of education and adaptation are constantly staying ahead of the curve and creating ever new and ingenious methods to profit from the markets evolution.

3. Fail to plan, you plan to fail.

The best traders have a well documented plan; they know exactly what they are looking for and follow that plan to the letter. Their preparation for a trade starts long before the market open, it is this meticulous planning and importantly adherence to that plan that helps them avoid the biggest demons for any trader, over trading and revenge trading.

4. “Be like Machine”

As human beings emotions pay a key role in our existence, for a trader emotions can be a source of great pain. Trading psychology and the management of your emotions in a trade play a key role in overall success. Fear and greed can cut your winners short and let your losers run. Dealing with emotions follows on from your plan; the more robust your plan the less likely you are to fall into the emotional mine field. (more…)

Money solves all of your problems.

  
  Education
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What that phrase means is that who ever you are that day will show up in your trading.  This of course comes in varying degrees.

In many professions your emotional state may not effect your earnings or employment.  In trading, a “bad” day can  create a cascading effect. You lost when you should have made money.  You created a bad habit.  Losing doesn’t trigger the right response, etc.

A trader views the market through themselves.  Now, most of the time it is little things that can be easily passed over.  Human beings are always going to have to deal with things they rather would not have to.  Every person has a bad day.

Money solves all of your problems, till it doesn’t.  The difficult part about trading is the problems start and the money (win or loss) CAN come at different times.  Think about this concept another way, a headline comes out and the market reacts to it (or it is reasonable to think it is a catalyst).  Well it turns out the headline is old and everyone already knew about it.  The story/money and what it bears can often come at the “wrong” or different times.  You are rewarded or punished just not always easy to connect the actions in real time.

Money does not necessarily mean your actions are correct.  Yes over time it evens out but some run out of money, patience, emotional currency before it corrects.  They weren’t honest about who they were that day.  It is prudent to always look a gift horse in the mouth.

Trading ‘Tilt’

  
  Education
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A few of the many lessons to be learned from this story:

The market is always right–except at significant tops and significant bottoms.

Keep and open and flexible mind. When in doubt, get out.

If you must have a guru, take him or her with many grains of salt

Do not add to losing positions.

Try every day to make yourself stronger, better and more integrated as a person.

Stay true to yourself. Lying to yourself and others, and trading on hope and prayer do not work

Most importantly, accept and recognize that you are not perfect. You are human and are going to make mistakes. Trading is the only profession where losing is actually winning. BUT— unless you accept mistakes as mistakes and learn from them, you will not progress and be upside down. Unless you are able to get your trading brain out of the cave you will not accumulate regret. It is only through the true acceptance of a mistake as a mistake that we accumulate regret. This is how we learn and grow as traders and human beings.

Some Money Launderers are “More Equal” than Others

  
Analysis, Education
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“All animals are equal, but some animals are more equal than others.”
– George Orwell’s Animal Farm

It’s been many, many years since I read George Orwell’s Animal Farm, but the message conveyed in it will remain with me forever.  The book is many things, but more than anything else, it is a portrayal and critique of human nature and the political systems that we create. For those that need a refresher, or have not read the book, here’s the basic plot.

There’s a farm headed by a Mr. Jones, who drinks so much he becomes unable to take care of the farm and feed the animals.  Over time, the animals (in particular the pigs), decide human beings are parasites and the pigs lead a revolt and run Mr. Jones off the property.  They change the farm’s name from Manor Farm to Animal Farm and create a list of 7 commandments.  They are:

  1. Whatever goes upon two legs is an enemy.
  2. Whatever goes upon four legs, or has wings, is a friend.
  3. No animal shall wear clothes.
  4. No animal shall sleep in a bed.
  5. No animal shall drink alcohol.
  6. No animal shall kill any other animal.
  7. All animals are equal. (more…)

3 Characteristics of Great Traders

  
  Education
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 Adapt or Die

Market conditions change and technology advances, thus the conditions for trading are always evolving, the rise in mechanical trading is testament to that. The very best traders through a process of education and adaptation are constantly staying ahead of the curve and creating ever new and ingenious methods to profit from the markets evolution.

 Fail to plan, you plan to fail.

The best traders have a well documented plan; they know exactly what they are looking for and follow that plan to the letter. Their preparation for a trade starts long before the market open, it is this meticulous planning and importantly adherence to that plan that helps them avoid the biggest demons for any trader, over trading and revenge trading.

 “Be like Machine”

As human beings emotions pay a key role in our existence, for a trader emotions can be a source of great pain. Trading psychology and the management of your emotions in a trade play a key role in overall success. Fear and greed can cut your winners short and let your losers run. Dealing with emotions follows on from your plan; the more robust your plan the less likely you are to fall into the emotional mine field.

15 Points for Trading System & Money Management

  
  Education
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1. Capital comes in two varieties: Mental and that which is in your pocket or account.
Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.

2. “Markets can remain illogical longer than you or I can remain solvent”, according to our good friend, Dr. A. Gary Shilling.
Illogic often reigns and markets are enormously inefficient despite what the academics believe.

3. An understanding of mass psychology is often more important than an understanding of economics.
Markets are driven by human beings making human errors and also making super-human insights.

4. The market is the sum total of the wisdom … and the ignorance…of all of those who deal in it; and we dare not argue with the market’s wisdom.
If we learn nothing more than this we’ve learned much indeed.

5. The hard trade is the right trade: If it is easy to sell, don’t; and if it is easy to buy, don’t.
Do the trade that is hard to do and that which the crowd finds objectionable.
Peter Steidelmeyer taught us this twenty five years ago and it holds truer now than then.

6. There is never one cockroach: Bad news begets bad news, which begets even worse news. (more…)

Black Swans

  
  Education
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Black swan is regarded as a rare, unexpected event that could bring disastrous consequences for those that don’t have a contingency plan. Can you be prepared for something that by definition is unexpected? It depends on how do you look at the world. There is a difference between the impossible and the highly improbable. The latter is possible.  The  black swan is not the same for everyone. What looks like unexpected to one, could be totally predictable for another. For the turkey Thanksgiving day is a black swan, but this is not so for the butcher.

There is a natural tendency for human beings to underestimate the odds of seemingly unlikely events. Few realize that once in a 100 years event is equally likely to happen tomorrow as it is to happen after 95 years. And if there are insufficient data to calculate the probability of a very bad outcome, as is often the case, that doesn’t mean we should assume the probability is zero and look at contingency plans as a waste of time and efforts.

There is an Irish proverb, which I have always thought that relates very well to capital markets – The obvious rarely happens, the unexpected constantly occurs. The “unthinkable”, the “unimaginable” takes place much more often than most people are willing to accept. The stock market crash of 1987 was described at the time as a 27-standard-deviation event. That implies that the odds of such an event not happening were 99.99% with 159 more 9s after it. It was unheard of kind of event, but it happened. Those who weren’t prepared, those who were over-leveraged, didn’t survive.

When it comes to objectively assessing the real risk of any investment, there is one important question to ask: What is the worst thing that could happen and how it may impact your solvency. Human beings are naturally biased and tend to look for information that only confirms an already established thesis. Not much thinking is devoted to figuring out what could go wrong and to preparation of a contingency plan of action. People are often not prepared and when something unpleasantly surprising happens they don’t know how to react. They panick and let their emotions to rule decision making, which invariably leads to losses.

A good way to minimize the impact of emotions is to go long gamma. What are some of the characteristics of getting long premium:

– more precise risk control

When long or short equity, you don’t have full control of your potential losses. Stops are not very helpful when your position gaps against you or during sudden evaporation of liquidity. If you are long gamma, you know the exact amount of the potential maximum loss – the whole premium. Armed with that knowledge, position sizing becomes easy.

– more precise time management

You know exactly how much time you have  in order to be right. If your thesis happens to remain wrong until options expiration, your position is automatically wiped and you start clean all over again. Many investors realize in hindsight that they were right on their analysis, but wrong in their timing as the market was not ready to accept their  thesis. Being long premium takes away the whole aspect of having to worry about precise risk management. It is like paying for someone else to be your risk manager. You have an investment thesis and you want to go long GLD for the next 12 months. Going long gamma is the perfect way to do it. You pay a small amount to see if your thesis is right. Even if the option goes down a lot in the beginning to the point that it is worthless, you will still own it and you never know what might happen. Adverse market moves and emotions won’t shake you out of your position, because you already have a plan for the worst possible outcome – you will lose the paid premium.

– overpaying for premium, but still able to make money

You have to realize that in most of the time you will overpay for options. If you did proper due diligence that should not bother you as the move in the underlying asset will more than compensate the wasting effect of time and volatility. Especially when you move past one month options. There is a tendency to believe that people overpay for options because the research shows that IV is higher than realized volatility. That has to be the case for the seller to be willing to take the risk and to write you an option – he’s got to make some money. The difference is, he’s going to delta hedge and you’re not, so you are going to have to pay a little bit extra so that he gets compensated. You have to realize in advance, that yes you are overpaying. The seller is making his money of the delta hedge, and you are paying him a little bit by paying him more than what realized volatility is, but no one really knows in advance how big the realized volatility and the move of the underlying asset are going to be. Both the seller of the option and the buyer could make money. The profit for the seller comes from extracting the risk premia in the daily volatility and for the buyer it comes from the fact that most underlying assets tend to exhibit trending behavior. (more…)

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