Archives of “hypothesis” tag

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Do Stocks Fall Faster than They Rise?

  
  Education
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Think about it1) Markets fall faster than they rise — and options traders know this. Otherwise, arbitraging this difference would be a meal for a lifetime.

2) Market participants perhaps anticipate that the realized volatility during a bear market is greater than a bull market. However, the problem with this analysis is one might expect to see an upward sloping volatility yield curve in out-of-the-money puts (during bull markets), and yet that does not usually occur based on my tests. Conversely, right now have a downward sloping yield curve in out of the money calls — which confirms the hypothesis that market participants anticipate slower price rises in the future. [Note to quants: I am not confusing delta, gamma and vega. I’m using options to predict terminal price at expiration.]

3) For most humans, fear of loss is a stronger emotion/motivator than the pleasure of gain (greed). This is well documented in the psychology and behavioral finance literature. Hence, ceterus paribus, capital market participants (who have a net long position) will, as a group, pull their rip cord faster — to flee from risk — than they will embrace the possibility of profit.

Hypothesis of the day

  
Analysis, Education
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Hypothesis I thought of the other day daydreaming:

A test of lows or highs is similar to how when you break up with a lover you always go back for a second try to probe to see if you made the right decision. Both parties are usually willing (bulls/bears and man/woman or etc/etc. If test falls short, low/high rejection a new trend is formed or new high/low is formed and trend is resumed. If two partners give it a second try either their relationship moves to new deeper levels of intimacy or they split up and look for new partners.

Of course break out failures and failed failures happen, but at least the scenarios can be confined to a limited set of outcomes.

THE GUESSING OF TRADING

  
  Education
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Trading is based on our hypothesis. In other words trading amounts to our educated guesses, which means the more you invest in your education, the more likely you are to find yourself on the right side of the trade. One of the most widely overlooked parts of trading education by traders is the study of past charts. I make personal videos, so that like a football team I can review my plays and create better strategies.

Your chart will tell you almost every thing you need to know to get on the right side of the trade. The one thing it doesn’t tell you is what is going on behind the scenes and it will even give you a hint to that most of the time. Your bullish/bearish ENGULFING patterns are evidence that there are some secrets that the market keeps to itself.

Mastering your candlestick psychology, your support/resistance, and your trendlines are things that you want to major on and learn well. You may not win every trade, but having a firm foundation on these simple techniques can greatly increase your odds of a successful trade. I think the more simple your charts, the better and easier it is for you to enter a good trade.

Sometimes you will have the perfect trade set up and all of your analysis will be right and you will find yourself on the wrong side of the trade. No big deal, it happens to all of us, review that trade and see if you can identify the error. When you have reviewed it, look for the next trading opportunity. There is NO PERFECT TRADING STRATEGY!!!!!!! This is only a guessing game for those of us who like to play the odds. The better your education, the better your odds will be against the house.

The strategy of one of the best-performing hedge fund

  
Analysis, Education
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Norway is not what you would call a hotbed for hedge funds. Due to restrictive regulatory requirements and an almost uniformly long-only focused investor-community, there are only a handful of hedge funds managed out of Norway.

Despite this, Norwegian Warren Short Term Trading (WST) is one of the best performing hedge funds in the world. Since the fund’s inception in November 2011, its return has been 46.7% with a net 2012-return of 29.1% after fees (pdf).

WST hedge fund manager Peter Chester Warren explains how this works:

Our hypothesis is that most of what happens in the markets during a single day is noise created by orders, rumors and other temporary influences and that there is no informational value in this. Unlike our other funds, we do not try to separate the signal from the noise in WST but accept it for being just noise. … Time is instead spent on creating mathematical and statistical models meant to uncover short-term human behavior.

This is a significantly different strategy than that of most other hedge funds, which typically own assets over a period of time. WST rarely owns assets longer than a few minutes or sometimes even a few seconds.

And every day when the asset manager goes to sleep, he holds zero assets. Then, when he gets back in to the office the next day, he starts from scratch again, looking for tiny opportunities in the markets using a combination of correlations, math and experience. (more…)

Girls can’t trade

  
Analysis, Education
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GIRL-Day traderCoates, John M., Mark Gurnell and Aldo Rustichini (2009) Second-to-fourth digit ratio predicts success among high-frequency financial traders. Proceedings of the National Academy of Science, 106/2: 623-8.

Introduction

What does traders’ success on the market floor depend on? Earlier studies have shown that one’s level of testosterone did affect one’s daily results. Since “prenatal androgens have organizing effects on the developing brain, increasing its later sensitivity to […] testosterone”, it would make sense that prenatal androgens also have a structural effect on a trader’s results on the long term.A surrogate marker is commonly used to define one’s exposure to prenatal androgens: the second-to-fourth digit length ratio, noted 2D:4D. Such market has been found to predict professional athletes’ performance. In this paper, the autors test the hypothesis that a high exposure to prenatal androgens as indicated by 2D:4D would also predict traders’ long-term profit.

Click here to read more

One of the best Trading Psychology books I've ever read!

  
  Education
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“Psychology of Intelligence Analysis” by Richards J Heuer, Jr., published by the CIA’s Center for the Study of Intelligence, 1999.

woman-reading
 

Available as a pdf download from this webpage
 

Ok, so it’s a CIA book written for Intelligence Analysts, not a trading book written for traders. However, the information available in this book is superb. Well written and easy to follow. This is an excellent source of information on how we think, and the cognitive biases which undermine our ability to process information and conduct market analysis.
 

VERY APPLICABLE TO TRADING. HIGHLY RECOMMENDED.
 

Here’s what’s it covers:

 

Part 1 – Our Mental Machinery

  • Chapter 1: Thinking About Thinking

  • Chapter 2: Perception: Why Can’t We See What Is There to Be Seen?

  • Chapter 3: Memory: How Do We Remember What We Know?

Part 2 – Tools for Thinking

  • Chapter 4: Strategies for Analytical Judgment: Transcending the Limits of Incomplete Information

  • Chapter 5: Do You Really Need More Information?

  • Chapter 6: Keeping an Open Mind

  • Chapter 7: Structuring Analytical Problems

  • Chapter 8: Analysis of Competing Hypothesis

Part 3 – Cognitive Biases

  • Chapter 9 – What Are Cognitive Biases?

  • Chapter 10 – Biases in Evaluation of Evidence

  • Chapter 11 – Biases in Perception of Cause and Effect

  • Chapter 12 – Biases in Estimating Probabilities

  • Chapter 13 – Hindsight Biases in Evaluation of Intelligence Reporting

Part 4 – Conclusions

  • Chapter 14 – Improving Intelligence Analysis

 

Available as a pdf download from this webpage

Six steps for Traders

  
  Education
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  • Define the question
  • gather information and resources
  • form hypothesis
  • perform experiment and collect data
  • analyze data
  • interpret data and draw conclusions that serve as a starting point for a new hypothesis.

1. Define the question: What is it exactly that you are trying to achieve? Are you shooting for high returns with high risk, long term gains with minimal risk, day trading, swing trading, position trading? Are you trying to make enough money to buy a new car or enough to buy a yacht? First define what it is that you want out of your trading!

2. Gather information and resources: What will be the best route to achieve your trading goals? Are you going to be a stock trader, a futures trader, a forex trader? Maybe everything? Doing the necessary research and taking the time to really get to know your market/markets is absolutely key to successful trading. Some people make great futures traders but horrible stock traders and vice-versa, while others are able to dabble in a little bit of everything and be successful. One way to see what fits you best is to try trading a little bit of everything and see where you feel the most comfortable. Start with small accounts and see what fit is a good one for you.

3. Form hypothesis: This is the fun part and where you get to design your “system” or “rules” by which to trade. Does your trading hypothesis revolve around chart patterns, trendlines, support and resistance, or are you more of a numbers kind of person that trades strictly off price? Do you use indicators? Maybe you are a programmer that has developed an algorithm. Whatever it is I believe it is important to form a hypothesis and then… (more…)

Positive words carry less information than negative words

  
Analysis, Education
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Intriguing new paper showing the higher signal in negative words.

Positive words carry less information than negative words

We show that the frequency of word use is not only determined by the word length [1] and the average information content [2], but also by its emotional content.We have analysed three established lexica of affective word usage in English, German, and Spanish, to verify that these lexica have a neutral, unbiased, emotional content. Taking into account the frequency of word usage, we find that words with a positive emotional content are more frequently used. This lends support to Pollyanna hypothesis [3] that there should be a positive bias in human expression. We also find that negative words contain more information than positive words, as the informativeness of a word increases uniformly with its valence decrease. Our findings support earlier conjectures about (i) the relation between word frequency and information content, and (ii) the impact of positive emotions on communication and social links.

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