Ice hockey fighting markets

Ice hockey is one of those games, where even the casual observer can understand the basic gist of the game. You literally have to score goals to win, however difficult that might be. I don't claim to understand every rule of the game, but whenever I've watched it, it's been fast and fun to watch. The NHL is rarely on UK TV, and when ice hockey is on UK TV, it's usually from the Winter Olympics, which only comes around every four years.

A feature of ice hockey is the fighting. From my research (ok, a quick look at Wikipedia), in the NHL players are not sent off automatically for fighting, although you can be punished through a penalty, such as sitting out the game temporarily for 5 minute. I suppose the hope is that 5 minutes should be sufficient time for the player to calm down and at the same time to act as a suitable deterrent.

Fighting in hockey is also not an uncommon occurrence. According to HockeyFights.com (yes, there really is a website dedicated to hockey fights), in every hockey season several hundred fights occur. I'm not going to debate whether fighting should or should not be allowed, but regardless, of where you stand, you would have to acknowledge that in a fast moving game, such as ice hockey, a fight is going to slow down the action temporarily.

In a sense, markets are like this. There's calm and calm, till suddenly, volatility picks up and there's a break in the market, price action fights against the previous regime. If it's a sufficiently large vol spike, market participants can flip from seeking yield to capital preservation, and try to cut down their risk. If central banks see contagion risk they might seek to give markets a "5 minute penalty" to calm down, stimulating the economy through looser monetary policy. 

The financial crisis was obviously a classic example of this. I recently went to a public event, with Ben Bernanke, who is currently on a tour to promote his new book Courage To Act, a lot of which centres around the events of 2008. He robustly defended QE, noting that "there is no better thing for the middle class as job creation in the labour market, and that is what QE did". 

Revisiting our analogy, just as with penalties in an ice hockey game, after a while, there's a limit to how much monetary policy can do in isolation. If a player is seriously angry, a short 5 minute break won't calm him down. Bernanke made the point that central bankers have been expected to do too much of the heavily lifting around the crisis. Fiscal policy is also an important part of the dynamic and it is also up to politicians to act. Similarly, if consumers are in a state of severe risk aversion, looser monetary policy might not be enough of an incentive to get them to start spending again.

Sometimes, if a fight a severe enough, it'll take more than a penalty to stop it: monetary policy can only do so much...

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)

14 Nov - New York - Thalesians/IAQF - Andrey Itkin - Efficient solution of structural default models
25 Nov - London - Panel - Macro Markets Discussion
26 Nov - Zurich - Thomas Schmelzer - Portfolio Optimization, Regression and Conic Programming
14 Dec - London - Matthew Dixon - Machine Learning in Trading (Thalesians Xmas Dinner)

Read More

The Fed mandate for chocolate

For a moment, imagine you are in a chocolate shop or one which sells delightful cakes (as above). I suspect, your objective is to buy some chocolate or something similar. It is unlikely that you are visiting in order to lose weight. If you have a mandate to lose your weight, then visiting a chocolate shop somewhat conflicts with that. However, if your mandate, is occasionally enjoying some chocolate, you have probably come to the right place.

In this instance, it is easy to formulate a mandate for behaviour. More importantly, it is easy to see whether we have stuck to our mandate or we have broken it. For any job, you are essentially given a mandate, which governs how you behave. Often, the mandate can be more implicit, rather than explicit. Let's say you are a trader. Your mandate involves maximising P&L, whilst at the same time ensuring that risk is managed prudently. Other aspects of the mandate are also important, for example ensuring compliance with the rules of your institution and of the market. If you overshoot your risk limit repeatedly, you are breaking your mandate. If you repeatedly flout rules around market behaviour, you are not keeping your mandate.

The behaviour of central banks is also governed by mandates. If we think of the Federal Reserve, their mandate involves striving for: maximum employment, stable prices, and moderate long-term interest rates. Sometimes obviously, these multiple objectives can conflict with one another, and they need to temporarily emphasis certain elements of the mandate. There are some things that their mandate doesn't include:

• hiking, because the market is fed up with waiting for hikes
• hiking, because traders are finding it difficult to generate P&L
• hiking, to do the "right thing" and teach people a lesson who are on the wrong side of the trade
• cutting, because stocks aren't high enough
• cutting, to boost trader's P&L

Yes, central banks make mistakes and sometimes they can stick too rigidly to some of their mandates. Trichet's hikes in 2008 and 2011, were generally seen as policy mistakes at the time (and even more so afterwards). The Fed has also come in for criticism for the length of its asset purchase programme. Yes, maybe the impact of QE waned over time. But the initial Lehman shock was so severe that it called for unorthodox measures and the Fed could not simply walk away. In addition, the TARP program, which was sanctioned by Congress, also helped to stablise the market, by giving banks some breathing room and remove the very real possibility of a collapse in banks. Yes, it essentially was a bail out of the banks, but again think about what would have happened without TARP. Would Main Street really have been "better off" with a collapse of the banking system? Somewhat I think the Fed's mandate for maximum employment, would have been dented.

It's very easy to criticise central banks, and sometimes that criticism is warranted, they make mistakes too. At the same time, their mandate is very much different to that which governs the behaviour market participants, so what market participants might want, might not be best for broader economy. On a more focused look at when the Fed might actually hike, I'd also recommend reading Des Supple's latest note on the state of the US economy at present and what it means for when the Fed might hike.

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)

25 Nov - London - Panel - Macro Markets Discussion
26 Nov - Zurich - Thomas Schmelzer - Portfolio Optimization, Regression and Conic Programming
14 Dec - London - Matthew Dixon - TBA (Thalesians Xmas Dinner)

Read More

Burgers or macarons?

​
We all face choices, every day of our life. However, often the questions we might ask ourselves aren't really choices, because we are not always forced to choose. For example, in a restaurant, when we browse a menu, there is not really a choice between a main course or a dessert. The courses are specifically designed to be complementary, as opposed to replacements for one another.

Just because you might elect to have a burger as a main course does not prevent you from having a macaron for dessert, something sweet to end the meal. When it comes to main courses, it's not really customary to order several large dishes for yourself (unless you happen to be extremely hungry: I admit there have been occasions, when I might have had more than one burger!). So in effect, what might be framed as a choice, is not always a choice at all.

If we think of the way people talk about different trading styles, it's precisely the same! Often, they frame the question as a choice, when in fact, different styles are complementary. Take the choice between systematic and discretionary trading. On a personal level, you might be forced to choose between the two, simply because of a lack of time to do both and also because some people are better at discretionary, whilst others do a better job at systematic trading. On a higher level, if you are allocating to these strategies, there isn't necessarily a choice between either discretionary or systematic trading. If the strategies are in principal uncorrelated, you can choose to invest in both, being careful to manage the risk between them.

Back to burgers and macarons, now... there is also the question of knowing what you are eating. With a burger, it's fairly straightforward. Even to the least culinary of observers, it's clear that the burger is made up a bread bun, garnished with lettuce and tomato, separately by a patty, made of minced meat. Contrast that to a macaroon. Ok, it's clear it has sugar in it, but aside from that, if you have never made them and don't have a recipe book to hand, it is simply not clear how they are made or even the ingredients. In fact the most important ingredient of a macaron is ground almonds and the process includes making Italian meringue (which I never guessed until I tried to make some).

If we head back to our discussion about systematic and discretionary trading, we see another parallel. Systematic traders are often said to be running black box strategies. If anything, the strategies that systematic traders can run, can be far more transparent than those which discretionary traders do. Take for example CTA strategies, which are typically trend following. They literally buy assets which are trending higher in price and sell those trending lower in price - that is the whole idea, in a single sentence! In practice, when implementing it, there are many little details which complicate the matter, but the principal is pretty transparent - and hardly a black box. Let's instead ask, whether we can easily define what a successful discretionary trader does in a single sentence. It is extremely difficult to do so! If anything, I'd argue that discretionary trading is more "black box trading" than a lot of what goes under the name of systematic trading, because it is so difficult to define the process by which a discretionary trader makes a decision. With a well designed systematic model, you should be able to understand why it is putting on certain trades and the principal which the system follows.

So maybe, when you see a burger, in actual fact it's more like a macaron.... and vice versa, at least when it comes to classifying trading strategies? Maybe you can have both your burger, macaron and even cake and eat it, when it comes to allocating risk!

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)

21 Oct - London - Robert Carver (FULLY BOOKED!) - Lessons from systematic trading
25 Nov - London - Panel - Macro Markets Discussion
26 Nov - Zurich - Thomas Schmelzer - Portfolio Optimization, Regression and Conic Programming

Read More

Not always plane sailing

​
Travelling is rarely about the journey. People generally don't fly across the Atlantic to endure hours up in the sky cramped in a seat for the sake of it. It's all about getting to your destination and the time you spend there. Yet, the journey bit is the inevitable part of the whole travelling experience.

I've been travelling over the past two weeks for work. It's taken me to the Federal Reserve Board to present my research in Washington DC, Bloomberg TV in New York, as well as to a number of funds on the East Coast, a Thalesians talk in New York, Quantopian in Boston, an innovative startup helping retail traders create trading models with Python, as well as to the WBS Training Fixed Income conference in Paris. It's been challenging, at times questions I was asked about my research, I couldn't answer. However, it's definitely been a good learning experience and I definitely go away with loads of ideas for future research after meeting so many other market participants. During the downtime, I've also been lucky enough to meet a lot of friends and folks from finance Twitter along the way, via quite a few burger joints, which has been great!

It has got me thinking more broadly about the whole notion of travelling for work. I've been on planes, I've been trains, I've been in cars, during the last two weeks. At times the journeys have actually been fun, when trains have taken me through scenic landscapes. At other times, somewhat frustrating, being diverted to random airports in mid flight, when all I've wanted to do was get back home. Has it all been worth it? I think so. All the tweeting, emails and phone calls you can do, will never make up for a face to face meeting to present your work.

On a phone call, you'll never notice the sudden waning of interest from the audience as you mistakenly labour over a point which they find irrelevant. By contrast in real life, you can quickly shift focus to something your audience finds more interesting. Tweeting can be fraught with misunderstanding, in particular if you've never met in real life. True, it's easy to miscommunicate face to face, but there are so many more clues in body language versus 140 characters alone. As for emails, the more verbose they become, strangely the less meaning that can be deciphered from them, given the amount of emails we all have to deal with.

In real life, it also far easier for clients to tell you what they really think about what you present. Getting honest feedback is probably one of the most valuable things you can ever receive in your work. When you make mistakes, sometimes you'll only notice when other people point it out to you!
Yes, it can be tiring, it can be frustrating, it can be disorientating, but travelling for work really can be one of the best ways to get exposure for what your work and for learning about what you can improve. If you're organised you can pack as many meetings as you can on a trip, to get the most benefit for hopefully, the least amount of time spend on a journey. Travelling for hours on a plane, for just a single meeting, might not be the best use of your time, and might mean you have to make more return trips to meet other clients.

Social media and other forms of electronic communication are of course important and can help to reduce your travelling, but I do think they more compliment rather than replace meeting all clients in real life. Although, despite what I've written here, here's to hoping that the next time I travel it'll be for a holiday rather than for work!

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)

14 Oct - New York - Dan Pirjol - Can one price Eurodollar futures in Black-Derman-Toy? (Thalesians/IAQF)
21 Oct - London - Robert Carver - Lessons from systematic trading
25 Nov - London - Panel - Macro Markets Discussion
26 Nov - Zurich - Thomas Schmelzer - Portfolio Optimization, Regression and Conic Programming

Read More

Trading cookies

I've spent nearly a week in the USA, mostly to present my research at various funds, public talks and also at the Fed. I have admittedly, spent a rather large amount of my spare time sampling the most calorific parts of American cuisine: burgers, cheesecakes and cookies (including the one pictured above, which I'd describe as more like a quasi-cake, than a cookie). It has got to the stage, where I suspect I won't be having another burger for a very long time (too much of good thing I suppose).

I suspect, not everyone will agree with my taste, when it comes to food. The thought of a burger dripping in cheese and fat, is likely to make some seem less than hungry. However, as someone said (no amount of Googling will likely reveal the original quotation), you'll never make friends over salad. I would conjecture though, there's a distinct possibility of making friends over a burger. It might seem a bit irrelevant, talking about food on this blog and the matter of taste when it comes to food, given this blog essentially purports to be about "finance".

However, bear with me! When you invest, what are your main motivations? Do you prefer higher risk strategies, which offer more reward, but potentially more reward. Do you like more quantitative trading strategies, or would you prefer to use more in way of discretion when you trade? The questions are indeed endless. Just as with food, where tastes are not shared by all, when it comes to these investing questions, often there will be no answer which is suitable for everyone. One person's favourite trading strategy, might be totally inappropriate for another person.

It's something I can often encounter when I'm presenting my research on various systematic trading strategies. Often it is based upon some sort of basic premise, whether that is some of sort intuition based on economics or general market behaviour etc. However, if you don't agree with the general rationale, then it's difficult to see how you can believe in a general strategy. More unusual trading strategies, which use novel sorts of data, can often face an uphill battle to face acceptance, for this reason. In a sense, your doubts need to be disproved.

Without having an underlying rationale (or if you have difficulty believing in one), it can be troublesome to discern between a random trading strategy and one you have developed. That's why whatever rationale you have needs to be fairly well thought. Experience, is probably one thing which helps most of all when attempting to understanding the rationale behind a trading strategy (or indeed the converse, that it has no rationale and shouldn't be used!)

I'll be in Paris 6-9 Oct at the WBS Fixed Income conference, where I'll be hosting a systematic trading workshop and at some of the events below.

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)

05 Oct - Boston - Saeed Amen - Trading Thalesians Book Talk / PyThalesians Python Interactive Demo (Boston Algorithmic Trading Meetup Group)
09 Oct - Budapest - Taylor Spears - On the Sociology of CVA
14 Oct - New York - Dan Pirjol - Can one price Eurodollar futures in Black-Derman-Toy? (Thalesians/IAQF)
21 Oct - London - Robert Carver - Lessons from systematic trading

Read More

Predicting the past

I can predict the future. Although, if that were even remotely true, I probably wouldn't be sitting here writing a blog. Instead, I'd be lounging about on a beach somewhere. However, despite it being a totally inaccurate statement, I hope that it has encouraged you, the reader, to take a few moments to finish reading this article.

The problem with the future is that no one really knows what will happen. I remember when I was a kid. The notion of a phone having a computer in my pocket would have seemed laughable. The idea that computers would be so ubiquitous would simply be beyond my comprehension. Indeed, a similar point about the role of technology in trading was made by my good friend Pierre Lequeux speaking on a panel at the recent TradeTech FX. The difficulty with trying to predict the future doesn't prevent us from trying. Over the past weeks and months, the market has been musing about when the Fed could begin a hiking cycle, it's first in over several decades (ok, not quite, but it has been a long time since the Fed actually started a hiking cycle). What has complicated matters, is that even if the Fed does hike, what will that mean for markets?

A systematic trader does not attempt to predict the future (to an extent). I find it incredibly difficult to forecast when the systematic trading strategy that I've been running will make or lose money from day to day. This is despite the fact that the overall trajectory of returns has been upwards since I started trading my own cash just over 2 years ago. The objective is more about creating a strategy which is profitable over the long term on average.

Systematic traders rely upon patterns from the past persisting into the future, which on average have been profitable and have a good rational explanation. We can also look at the past to try to understand what happened to our trading strategy in similar situations, which might crop up in the future. The great thing about having a systematic trading strategy is that whilst we can't tell the future with certainty, we definitely know the past! I've been in the market for around a decade, and during that time I've run all manner of different systematic strategies. I can create a new trading system and then use historical data to understand how a strategy coped with the start of Fed hikes as an example, well before I even started working in currency markets.

Hence, even though I can't tell you precisely when a Fed hike will be, I can tell you how confident (or not) I would be with a trading strategy to cope with similar historical events. A discretionary trader can look back at their own P&L history to see how they coped with historical events, but unless they have been trading for a long time, they might be a bit stuck when trying to identify events before they started trading. I recently published a Thalesians paper, for example, discussing how CTA strategies have performed at the start of Fed hikes to test this idea.

Of course, there are caveats. The past is never precisely like the future. There will be unusual events that are not in our historical sample, which could impact our portfolio significantly. Indeed, this Fed hiking cycle could be very different to previous ones as an example (the Fed has never begun hikes from such a low level). At the same time, there are likely to be many historical events similar to future ones.

Whilst systematic trading isn't for everyone (just as discretionary trading isn't), the ability to look at historical data, gives us an ability to see how robust our portfolio has been to historical shocks and to check how our strategy has behaved. Even with all the mathematics that goes on behind creating a systematic trading strategy, perhaps the most important thing, is to have a modicum of common sense and understanding of risk!

If you're on the US East Coast, I'll be in Washington DC 27 Sep, NYC 29 Sep-3 Oct and Boston 5 Oct if you'd like to meet me and hear more about systematic trading! If you're in mainland Europe, I'll be in Paris 6-9 Oct at the WBS Fixed Income conference, where I'll be hosting a systematic trading workshop.

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)

21 Sep - New York - Agostino Capponi - Arbitrage-Free Pricing of XVA (Thalesians/IAQF)
23 Sep - London - Stephen Pulman - Multi-Dimensional Sentiment Analysis
01 Oct - New York - Saeed Amen - How to build a CTA? / interactive Python demo
05 Oct - Boston - Saeed Amen - Trading Thalesians Book Talk / PyThalesians Python Interactive Demo (Boston Algorithmic Trading Meetup Group)
09 Oct - Budapest - Taylor Spears - On the Sociology of CVA
14 Oct - New York - Dan Pirjol - Can one price Eurodollar futures in Black-Derman-Toy? (Thalesians/IAQF)
21 Oct - London - Robert Carver - Lessons from systematic trading

Read More

Burger parity

I recently visited Frankfurt and Zurich to help launch Thalesians quant finance talks there (a special thanks goes to Jochen Papenbrock, Adrian Zymolka and Swati Mittal for organising the events there). Travelling from Frankfurt to Zurich, I noticed several major differences.

One difference is the language. I can vaguely understand Hochdeutsch, as it is spoken in Frankfurt and the rest of Germany, owing to a few years studying German, during a period of my life when I could be called young (and importantly, my mind has not yet quite expunged all the German I learnt then). By contrast, my ears have some trouble understanding Schweizerdeutsch, the dialect of German spoken in Switzerland, simply because I am not used to it.

Another difference is the geography. Frankfurt to my untrained eye is relatively flat, making it pretty easy to get around on foot. In Zurich, the hilly terrain makes it somewhat more challenging to navigate to certain neighbourhood, such as the area around ETH, where I gave my Thalesians talk and where I had the opportunity to meet Nassim Taleb, through a combination of randomness and Twitter!

However, the difference I'd like to focus on is price. Perhaps, it is not an understatement, to note that Zurich and Switzerland in general feels expensive for visitors. One of the easiest ways to test this is to use the Big Mac index, maintained by the Economist, which gives you the relative cost of a Big Mac in a number of different countries. The idea is that you can work out how overvalued (or undervalued) a certain currency by assessing the price of similar goods in different countries. In practice, you would aim to choose a basket of goods, rather than a single item, like a Big Mac in such an index, which is referred to as a Purchasing Parity Power index,. As an aside, how much do this the burger costs at the top, which I had in Zurich (clue: it was rather more expensive than I would have liked...)? Using the Big Mac index, we note that in Switzerland, a Big Mac costs 6.82 USD. By contrast in the UK, it is 4.51 USD and in the Eurozone it is 4.05 USD.

We are now going to use this information to work on a little problem. Let's say, we had 5 USD and we wanted to share out Big Macs in Zurich, London and Frankfurt, as prizes. Whilst, in London and Frankfurt, we could give people a whole Big Mac and still have change. However, in Zurich, we would end up giving out less a full Big Mac. This would be kind of unfair, a prize in Zurich would be far less.

Yet, this is exactly what people can do when they invest, based on notional amounts of different assets. However, the "risk" that such an approach buys is unequal. A dollar worth of bonds is less risky than a dollar of equities. If you have a fund which runs a multi-asset strategy, trading all manner of different assets, if they scale purely by notional, rather than risk, the portfolio could have considerably different exposures to those intended.

There has been much in the press recently, talking about the recent performance of risk parity, which basically attempts to allocate in this fashion based on risk, rather than purely notional. Of course any strategy is not going to outperform all the time. What has been lost in the argument is why risk parity is used, namely that assets do not all have the same risk profiles. For example for trend following funds, if they had no method to adjust for the risk differences in their portfolios, they would end up being dominated by the highest volatility assets, like crude oil, whilst having little exposure to lower risk assets like bonds.

So yes, strategies might not always outperform all the time. But it is important to consider, what the alternatives are. In the meantime, parity is just as important for burgers as it is for risk...

If you're on the US East Coast, I'll be in Washington DC 27 Sep, NYC 29 Sep-3 Oct and Boston 5 Oct if you'd like to meet me and hear more about systematic trading! If you're in mainland Europe, I'll be in Paris 6-9 Oct at the WBS Fixed Income conference, where I'll be hosting a systematic trading workshop.

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)

21 Sep - New York - Agostino Capponi - Arbitrage-Free Pricing of XVA (Thalesians/IAQF)
23 Sep - London - Stephen Pulman - Multi-Dimensional Sentiment Analysis
01 Oct - New York - Saeed Amen - How to build a CTA? / interactive Python demo
05 Oct - Boston - Saeed Amen - Trading Thalesians Book Talk / PyThalesians Python Interactive Demo (Boston Algorithmic Trading Meetup Group)
09 Oct - Budapest - Taylor Spears - On the Sociology of CVA
14 Oct - New York - Dan Pirjol - Can one price Eurodollar futures in Black-Derman-Toy? (Thalesians/IAQF)
21 Oct - London - Robert Carver - Lessons from systematic trading

Read More