The Thalesians

Sunday, 31 January 2016

Breaking the trading routine

19:11 Posted by The Thalesians (@thalesians) No comments

Routine. The drudgery. The predictability. The sheer monotony. In all my years, I can't recall reading the words, "I dream of routine". No one enjoys the sense that everything they do is routine. However, a modicum of routine helps to give life at least some structure.

Those occasions when we break from our routine, are in a sense what makes it all manageable. A stroll through a new environment, the sight of a painting you've never seen, the sound of song being played on the radio for the first time: the freshness of novelty is intensified when it is a comparatively rare experience. If we are repeatedly surprised by the novel, far from enriching our viewpoint, it suddenly becomes commonplace and routine, a dull and underwhelming experience. Bertrand Russell describes this idea very well, in his book the Conquest of Happiness.

Markets are both routine and novel. At times price action seems boring, range bound and directionless. News seems to do little to move prices. Of course, these periods are never permanent, and are often preludes to a shift in sentiment. I remember, when I quit my job in 2013, FX markets seemed to be on inescapable path to lowering volatility, accompanied by declining lack of interest. The dollar rally started in earnest as Autumn came in 2014. Volatility spiked and currencies actually started to move.

Is a routine or a novel market better? It depends on our strategy! If we are a carry investor, lashings of volatility accompanied by risk sentiment that swings around like a yo-yo are unlikely to be a joy to behold. By constant a trend follower much prefers markets where volatility is picking up, which are often accompanied by the development of trends.

We can complain all we want that the market environment is unsuitable for our specific trading strategy. We unfortunately don't get to choose the market which faces us. It is like complaining that you feel cold whilst strolling through the park during a particularly brutal winter day, when you haven't bothered to wear a coat. Rather than saying the market is unsuitable for our strategy, maybe we should instead think about it the other way round: whatever trading style we are adopting isn't suitable for the current market.

If our time horizon is very long, and we are not massively leveraged, we may well be able to stick it out in an "unsuitable" market. If we have developed a systematic trading strategy we might find that historically that periods of under performance occurs at times, but as a whole, the strategy is still profitable over reasonable time periods. However, with high levels of leverage and very concentrated risk, we don't have this luxury, and need to to think about what we can do to alleviate the situation.

So which is better, the novel or the routine? Sometimes we can't choose between the two, and simply have to deal with it.

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our Meetup.com group for more details here (Thalesians calendar below)

08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
16 Feb - New York - Thalesians/IAQF - Harry Mamaysky - Does Unusual News Forecast Market Stress?
29 Feb - London - Jessica James - FX option trading
21 Mar - London - Robin Hanson - Robin Hanson, Economics when robots rule the Earth
13 May - Budapest - Saeed Amen/Paul Bilokon - Thalesians workshop on algo trading at Global Derivatives

Mitigating Risk, Managing Uncertainty

16:21 Posted by The Thalesians (@thalesians) No comments

Happy new year! If you're in markets, the new year has been anything but happy. The markets have greeted the new year with more than a modicum of scepticism. Crude oil has continued to trade very poorly. Equities have sold off significantly since the start of the year, mirroring the behaviour of August's sell off. Elsewhere, in FX, risk aversion has gripped the market. The high beta currencies in G10 FX have got trashed. EM has also been hit hard. The market has also been thinking about "one off" events such as Brexit and also to a lesser extent the breaking of the Saudi peg.

In a sense, this whole period has brought to the fore, the fact that a trader's job is literally to manage risk, trying to minimise downside risks and at the same time being able to capture the upside. The difficulty is that whilst in ordinary times "risk" might seem benign, this job can be much easier, during risk aversion, traders are faced with an explosion in volatility. This can make it difficult for traders to stick to their goals, even if they happen to be on the right side of the trade. Short term volatility can force traders out of positions which are fundamentally sound, but still come under stress, when the markets switch from seeking yield to wealth preservation in periods of risk aversion. When it comes to "one off" events, such as Brexit, we cannot simply use probability tools to understand the risks, we also need to use our judgement and an element of qualitative analysis.

So what should we do? Luckily, on Wednesday at the Thalesians in London, Nick Firoozye, a Managing Director at Nomura International and heads of a global team in cross-product derivatives research, will be doing a presentation on exactly this subject of uncertainty and risk. I must admit it's more a product of coincidence that the talk will be happening at this time of market turbulence, rather than some element of foresight on my part! Nick will be talking about his new book "Managing Uncertainty, Mitigating Risk - Tackling the Unknown in Financial Risk Assessment and Decision Making" and also signing copies. In his book, he stresses that we cannot simply use conventional probability to understand uncertainty in finance, and instead we need to seek understand the mathematics of uncertainty. He introduces concepts such as uncertain value-at-risk (UVaR) in the book, which helps to incorporate expert's insights into a risk framework.

I am looking forward to Nick's talk and hopefully see you there on Wednesday, if you can make it!

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - Robin Hanson, Economics when robots rule the Earth
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
29 Feb - London - Jessica James - FX option performance (TBC)
21 Mar - London - Robin Hanson - Robin Hanson, Economics when robots rule the Earth

I haven't got the foggiest data

16:46 Posted by The Thalesians (@thalesians) 5 comments

The first full week of the year has passed. Christmas decorations have come down. Lazy morning starts are fading from memory. In their place, has come the hectic tempo of early morning commutes to work, the flip of 2015 to 2016 in the calendar, that feeling of starting all over again.

In markets, the volatility which had been absent over the holiday period, has returned. The first week has seen stocks sell off, in particular in China. Whether the Shanghai composite is of key importance for world markets is another question (after all, international markets mostly ignored their bubbly rise last year and Chinese stock market is dominated mostly by local retail investors). Geopolitical tension has increased in the MidEast, which only failed to stop crude oil's continuing decline for a couple of an hours.

Does the first week of the year in markets have any significance on the rest of the year? I recently ran a simple test, plotting the returns from S&P500 during the first week against the rest of the year. Whilst in the past decade there was at least a passable relationship, in the decades before that, it's very difficult to spot any relationship. The difficulty is that we have a comparatively small number of points to test this idea upon, given a trading rule would involve only one trade a year.

We can come up with other examples of this limited data problem in markets. For example, if we are trying to create a model to estimate when (or if) a managed currency might experience a sudden regime change. Rather than attempting to precisely time such a difficult binary event (which is near impossible!), we can instead try to build a probability distribution for that event. In our managed currency instance, we could look at central bank reserves data and other critical economic variables. We can then compare the market pricing for such an eventuality and compare to our model. Indeed, this approach looking at market pricing and also modelling other market variables is the approach I took in recent research on the peg of USD/SAR (see my interview here on the subject).

Should we never do analysis when we have very small amounts of data, given the problems? I would argue not. Once we have a probability assessment of our model, we can then overlay our own judgement on top of that and compare to market expectations. Analysing very small datasets might help us see a bit further into the fog of the future: after all it is likely better than doing nothing! At the same time we need to cast a critical eye on the output of our analysis.

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - The Age of Em: Robots
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
29 Feb - London - Jessica James - FX option performance (TBC)
21 Mar - London - Robin Hanson - The Age of Em: Robots

If it wasn't for me, I'd do brilliantly

15:33 Posted by The Thalesians (@thalesians) 1 comment

Christmas has come. Christmas has gone. The tree remains. The wrapping has gone. The decorations still sparkle. Christmas markets are still around (as above), but quieter. The days between Christmas and New Year are here, that odd period of limbo, where the last year, 2015, lingers, hanging on to time as an outstretched hand seeks that embrace of the familiar, whilst, the new year, 2016, awaits the chimes of Big Ben, an unknown artist ready to grab its 15 minutes of fame. It's a time to recollect what we have done, and indeed, what we have failed to do, which we had planned for in the past year. One of my favourite quotations about explaining success and failure, is from Chamfort, the eighteen century French writer (which is incidentally the opening quotation in my book, Trading Thalesians and the title of this post):

'If it wasn't for me, I'd do brilliantly.'

When it comes to plans, we know the saying that the best laid plans of mice and men, often go awry! What is a plan, but an ill suited straitjacket for the future? It is somewhat disconcerting to accept that randomness plays such a deep role in our lives, given that the more randomness an event seems to exhibit, the less power we have to influence it. It feels so much more satisfying to believe that we have a casting vote over our lives. My earlier comment on planning might have been somewhat facetious, given a modicum of planning does have its place. Having no plan whatsoever, surrenders all your control to randomness. At the same time, a plan which assumes little or no space for randomness is doomed from the start.

So much of modern life is random. Who we meet for example is so often a product of randomness. In particular if we think of the modern day, both cheap travel and the advent of social networks have suddenly increased the number of connections we can make exponentially. If we seek to eliminate all randomness from our life, yes, we might eliminate the potential downsides, yet, we simultaneously remove any opportunities for upside from randomness.

A good trader recognises that randomness is an intrinsic part of what he/she does, trading is the monetisation of managing risk. Yet, a good trader also understands, that it is sufficient to skew the odds in their favour to be successful, rather than to be right all the time. This want to coax value from randomness, need not be confined to trading. The same approach can transcend so many other parts of our life too: making the most of randomness, rather than attempting to master it (which is impossible).

So maybe this time of limbo in the calendar, isn't so much a time for planning, maybe it's simply a time to accept, that randomness will happen. Rather than being fooled by randomness, embrace it. Best of luck for 2016!

Margin is too small

11:07 Posted by The Thalesians (@thalesians) No comments

Saturday mornings are perhaps not the times at which we associate that the brain is most awake. It is more time for slumber, than the gathering of thoughts. Unable to come up with anything remotely useful to say on an early Saturday morning, I tweeted the following:

trying to think of something truly inspirational to say on a Saturday morning, I think I have it, but it's too long to fit in 140 chars

It is perhaps somewhat facetious to compare myself to the great French mathematician (in retrospect, that sentence sounds more accurate without the word "somewhat"). However, the tweet alluded to something Fermat wrote in the 17th century and well done, to @ewankirk for recognising the Fermat reference in my tweet too. To quote that fountain of all knowledge, Wikipedia, with some help from Google, Fermat claimed that he discovered a proof to the following, Fermat's Last Theorem, which states that:

no three positive integers a, b, and c satisfy the equation aⁿ + bⁿ = cⁿ for any integer value of n greater than two. The cases n = 1 and n = 2 were known to have infinitely many solutions.

However, Fermat wrote that the proof was too small to fit in the margin of the notebook he was working on. Alas, he never thought to buy another notepad to write it down... either that, or he didn't really have a proof. The theorem remained unsolved till the mid-1990s, when Andrew Wiles solved it. He was subsequently knighted recognising this great achievement. His proof amounted to around 150 pages. So Fermat was right in some respects, the proof was indeed far too big to fit into his notepad's margin.

Mathematics is often about the proof, not so much purely the statement of fact. There are many ideas which are very easy to understand in mathematics (and might seem intuitively true), but their proof is so much more difficult to articulate. Indeed, if we consider Fermat's Last Theorem, it isn't that difficult to understand what it says.

Unlike in mathematics, in markets, there is very little that we can actually "prove". We can have theories about how markets behave, we can use historical data to illustrate them. I can use statistics to show a trading strategy would have made money. We can use our intuition to judge that the conditions necessary for the strategy to make money, are likely to be there in the future (or indeed that they won't be there). But can I "prove" that you will definitely make money in the future. No.

In a sense, trading and in particular, quantitative trading (or least successful variants of it) requires a modicum of skills from many different areas. The first one is common sense. Sorry, no amount of mathematics can erase the necessity for common sense when it comes to trading.

Instead mathematics and statistics, needs common sense to guide its correct usage when trading. You may have found the best ever strategy in the world (ever, ever, really!), but a bit of common sense, might tell you that it's impossible to execute in practice or that transaction costs you've assumed are totally unreasonable. As well as common sense and a good knowledge of statistics, an ability to code is important for systmatic trading, after all, the more data you have to play with, the less likely it is that Excel will be sufficient to crunch it. Oh, and a bit of luck can help too! We might live by our median result (which we hope is above zero), but a good start is always a bit of a luck.

I can't prove any of this obviously. But if we could prove everything easily, wouldn't everything suddenly become very boring? With that, I wish you a very merry Christmas!

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - The Age of Em
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)

Fed up of hikes?

19:06 Posted by The Thalesians (@thalesians) No comments

In recent years, Christmas in London has been accompanied by the sparkling lights and loud sounds of Winter Wonderland in Hyde Park. I've never been to real German Christmas market, so for me this "faux" version is still a bit of a novelty and never fails to cheer me, even if it is somewhat hectic and busy. For markets, in the run up to Christmas, it hardly seems like a time of cheer and no amount of visiting Winter Wonderland is likely to change that. With the FOMC, likely to hike rates at their meeting this week, markets have already begun to feel jitters (although it could be argued that this is not all related to the potential Fed hike).

The question is, of course, should these jitters derail what seems like a done deal (at least if we consider markets pricing of the likelihood of hike)? I have no clue whatsoever, and do not for a moment claim any better reading of this than anyone else in the market! What I do know however, is that whenever the Fed would choose to hike, it will signal a sea change in monetary policy. For years the market has become accustomed to rates being on a downward trajectory, so whilst 25bps is hardly a massive move, it is more the signalling effect that the first hike will herald. To that end, the Fed have telegraphed the likelihood of a hike for an extended period, clearly attempting to prepare the ground. No one in the market should be "shocked" if the Fed does indeed end up hiking in December! This is in sharp contrast, to the taper tantrum of May 2013, when Bernanke mused about the likelihood of tapering QE: it caught the market totally unaware. The risk is of course, if the Fed fail to hike this time, after preparing the market so long, will the market really take it on board beforehand? Beware of the boy who cried Fed hike.. one too many times.

For systematic traders, the focus on the Fed hiking might well prove interesting, but by definition, they do not make discretionary decisions. They stick to what their model is telling them, and don't simply override it unless they have an extremely good reason for doing so. If you keep on making alterations to your model, you end up running a discretionary strategy! For systematic traders, perhaps a better question is asking, do events like FOMC on average favour their strategy or end up disadvantaging them, and is it dependant on whether the Fed hike or cut rates? Obviously, every FOMC meeting is different and to some extent you could argue this event is fairly unique, hiking from ZIRP, but if you have enough data, it should cover multiple hiking cycles. For instance, if you're strategy is skewed towards being long equities, you can show on average, that long equities positions perhaps well on FOMC days. However, this might not follow for all other types of models.

Good luck for the week, whichever way you choose to trade markets, whether it is from more of a discretionary perspective or using a systematic model. Most importantly have a very merry Christmas and a happy new year!

14 Dec - New York - Yakov Amihud - The Pricing of the Illiquidity Factor's Systematic Risk (Thalesians/IAQF)

14 Dec - London - Matthew Dixon - Machine Learning in Trading (Thalesians Xmas Dinner)
20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk

Writing about nothing

19:24 Posted by The Thalesians (@thalesians) No comments

There's a certain deliciousness in writing reams of prose which in effect say nothing, using words merely to enhance the reader's vision of the scene. This sentiment might seem ridiculous but bear with me for a moment. Just as the richness of light envelopes the human eye to enable it to see, it is through the sheer adaptability of words that a writer can render a scene in a reader's mind. To what end you might ask, is the writer's intention to labour so patiently to fashion an image from words? Surely what is important is for the writer to describe what happens, rather than to write about what is there?

My point is best illustrated by describing the difference between a photograph and a film. A photograph captures that single moment, a slither of time never to be repeated, available to us to replay again and again in a photograph whenever we want. A film does something similar, but with moments of time strung together before eyes. Suddenly, those single moments lose their significance in a film, washed up in a sea of time, sweeping away time in its path.

To truly treasure a moment, we need to recall it. If we fail to recall it, it loses its significance. To enable us to understand what could happen in the future, we need to be able to describe what we observe in the present.

The same is true of markets. A market view is not manifested from a void. It comes about through a careful observation of the present and what it could mean for the future. An inability to describe the present situation in markets in detail and indeed to be aware of the past, makes predicting the future so much more difficult. You could argue that the market did this before the last ECB meeting, somehow misreading the current situation, and thus adjusting expectations to such very stretched levels it would be difficult for Draghi to placate the market, when the ECB meeting actually arrived.

Of course, that ruthless punisher of errors, hindsight can never be beaten: we can but do our best beforehand with the information we have at that point, not after the fact. Yet to do our best, we need to sit back and take a snapshot of situation. We only have ourselves to blame if we misread the situation because we have missed something.

14 Dec - New York - Yakov Amihud - The Pricing of the Illiquidity Factor's Systematic Risk (Thalesians/IAQF)

14 Dec - London - Matthew Dixon - Machine Learning in Trading (Thalesians Xmas Dinner)

Sunday, 31 January 2016

Breaking the trading routine

Saturday, 16 January 2016

Mitigating Risk, Managing Uncertainty

Saturday, 9 January 2016

I haven't got the foggiest data

Saturday, 26 December 2015

If it wasn't for me, I'd do brilliantly

Monday, 21 December 2015

Margin is too small

Sunday, 13 December 2015

Fed up of hikes?

Saturday, 5 December 2015

Writing about nothing