Why go to a restaurant, if you can cook?

It's a simple question, if you can cook why go to a restaurant? First, being able to cook something to ward off hunger is not the same as being able to cook a Michelin star meal. The latter takes years of training and is somewhat of an art. How deep is your repertoire of dishes and would it compare to a restaurant? For example I like to bake and often make cookies. I have made them so many times, that I know the various tips and tricks, to make them relatively well. This of course doesn't mean that I can miraculously move on to making cheesecakes to the same standard. I also can't somehow easily transfer my cookie making skills to burgers, which I would truly love to do.

The food is also not the only part of the restaurant experience. It is also about the environment of the restaurant and most of all, the company of your fellow diners. Also when we say a "restaurant", what do we mean. The standards of restaurants can vary significantly, as does the cost of them. Hence, treating restaurants as one homogeneous group seems wrong.

We ask parallel questions when it comes to investing. If we can invest in simple strategies such as long only index trackers, why go to a hedge fund, which charges higher management fees? As an example, my expertise is largely in the realm of systematic trading, primarily in liquid markets such as currencies. This does not mean that all of sudden, I can start trading some other unrelated asset class from a discretionary perspective, without a lot of training or effort. Baking cookies doesn't automatically mean we can bake cheesecake. Hedge funds give you this ability to make the leap.

Just as with restaurants, hedge funds are not all the same. The question suggests we are trying to group them together. This ends up missing the point. For one, the strategies that hedge funds employ vary significantly. Some might be long/short equity funds, others will be trend followers and so on. There can also be a large amount of dispersion in the returns of various hedge funds in a certain sector. Furthermore, even if we might be possible to replicate a modicum of a hedge fund's strategies, the details will always be more difficult to implement and time consuming to do yourself. A hedge fun is being paid to do this in a more efficient fashion. The flipside is that you need to do your homework when it comes to selecting a hedge fund.

There's a lot more to restaurants than just the cooking. There's also a lot more to investing in hedge funds, than an initial glance might suggest.

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 interesting 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 and Budapest - join our Meetup.com group for more details here (Thalesians calendar below)

29 Apr - London  - Global macro & UK election panel - Eric Burroughs / Reuters, Mark Cudmore / Bloomberg, Jordan Rochester / Nomura, Jeremy Wilkinson-Smith / Independent & Saeed Amen / Thalesians

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IRL - In real life

IRL is the internet abbreviation for "in real life". Think about how much of your communication is outside this sphere of "real life". How many e-mails you send and receive a day? How often do you text your friends? Do you tweet or use Facebook? The list is of course endless. I've mainly gone through these questions to illustrate how so much of our communication consists of reading and writing messages electronically. The speed and ease with which we can do this, means our brains are saturated with information throughout everyday. There are few places in the world where we can be truly cut off from the beep-beep sound of a phone receiving a text message. Perhaps, with this information overload, "real life" communication is no longer as important?

To ask this question, seems to ignore the fact that real life communication is so much richer than electronic messages. The spontaneity of a real life chat, is difficult to replicate, by reading and writing. We of course have telephones and Skype, which help bridge the gap, but both somehow still fails to capture meeting all the nuances of real life conversation.

After all, despite all the advances of communication, business people travel the world more than ever before to strike deals and meet counterparts. Conferences are just as much as an opportunity to meet your counterparts in your industry as they are a time to hear presentations. Finance is of course no different. I would say that finance is probably a place where real life communication is even more important. Trading is the business of acting on news and judging how the market reacts to events. If you don't know anyone else in the market, how can you tell how they will react to events? I have got many ideas from chatting to traders. The exchange of ideas just happens so much quicker when you're there in the same place!

It's one of the main reasons we started running Thalesians' finance seminars all those years ago, to try to bring together members of the finance community "in real life" and hopefully shed some light on markets at the same time, starting in London, but also now in New York and Budapest (where we just had a bitcoin panel, yesteday). We're very excited about our next panel event in London on Wed 29th Apr, which brings together experts, which include Eric Burroughs (Editor of FX Buzz, Reuters) and Mark Cudmore (EM strategist, Bloomberg), to discuss global macro markets and the UK election. The panel will also be taking questions from the audience, given everyone a chance to take part in the discussion.

So if you want to learn about markets in a snapshot more than 140 characters at a time, in that most "old school" of ways "in real life".. register here to attend our next LDN panel event on Wed 29th Apr. Tickets are selling out quick and I hope to see many of my blog readers there!

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 interesting 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 and Budapest - join our Meetup.com group for more details here (Thalesians calendar below)

22 Apr - New York - How Smart Money Invests and Market Prices Are Determined - Lasse Pedersen
29 Apr - London  - Global macro & UK election panel - Eric Burroughs / Reuters, Mark Cudmore / Bloomberg, Jordan Rochester / Nomura, Jeremy Wilkinson-Smith / Independent & Saeed Amen / Thalesians

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The mystery of patterns

I love patterns. As a mathematician, it seems natural that I seek to find patterns. Does this make me unique? Not really, it's a human trait to want to find a modicum of order in anything. In the book The (Mis)Behaviour of Markets: A Fractal View of Risk, Ruin and Reward by the late mathematician Benoit Mandelbrot, he illustrates this point through the use of a simple example. He plots a number of graphs. Some are of real market prices and some are random paths. I've repeated the exercise below. Which of the following examples are random and which are real?

It's somewhat difficult to guess, although I'm sure some of you might recognise some of these. At the bottom of the article, I've given the identify of the random plots, but I'll let the real ones remain a mystery (e-mail me if you really want to know their identities!). 

So is it futile to try to find patterns in markets? Well, no (I'm hardly going to say yes, when I've spent the past decade doing exactly that!). The question is not necessarily whether we can find patterns in price action, but understanding whether there is a logical rationale for patterns you find. There are numerous examples of patterns I can cite. Whilst some might be sceptical of technical analysis, there is an obvious reason why it works, the element of self-fulfilment. If enough market participants think a certain type of price action could result in a trend, and they jump on that trade, it becomes like a virtuous circle.

More broadly, there can be relatively intuitive reasons why we see certain patterns in price action, related to more behaviour aspects of trading. One interesting example can be seen in intraday volatility in FX markets. We could of course also make the case that volatility as a quantity is easier to forecast than market prices, because it has many "nice" properties. Volatility for example tends to be mean-reverting and also (relatively) bounded. In the plot below, we calculate the intraday volatility by time of day in EUR/USD over the past decade. There are several obvious patterns. Volatility tends to be lower during Asian hours, when there are generally fewer market participants. During London hours, volatility picks up and starts to tail off when London traders go home. We also notice spikes such as 1.30pm and 3pm LDN time, which tend to be the time of US data releases. Of course, attempting to monetise this pattern is tricky! However, it does illustrate that the idea that markets can have fairly distinct patterns.

So just because patterns might be difficult to separate from randomness, we can't simply say they don't exist in markets! There is of course the crucial caveat, that on many occasions there really is no pattern to be found. It is experience, which helps separate the data mining from the pattern finding in markets. Best of luck finding patterns in markets!

If you'd like to know more about vol patterns in FX, I wrote an article in the Financial Times explaining the volatility chart in a bit more detail (FT: Unpicking higher currency volatility: a guest chart - 10 Apr 2015) and also a comprehensive Thalesians quant paper discussing various patterns in both intraday currency volatility and also liquidity, which is very topical at this time (Thalesians: Once upon an intraday - 09 Apr 2015). If you'd like a copy of that research paper, let me know!

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 interesting 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 and Budapest - join our Meetup.com group for more details here (Thalesians calendar below)

17 Apr - Budapest - Impact of bitcoin - Tamas Blummer & Panel featuring Izabella Kaminska / FT)
22 Apr - New York - How Smart Money Invests and Market Prices Are Determined - Lasse Pedersen
29 Apr - London  - Global macro & UK election panel - Eric Burroughs / Reuters, Mark Cudmore / Bloomberg, Jordan Rochester / Nomura, Jeremy Wilkinson-Smith / Independent & Saeed Amen / Thalesians

The random plot is graph 4. All the others are of real markets.

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Words & numbers in trading

There are words and numbers. It seems drummed into us from an early age that we're either a "words" or a "numbers" person. Perhaps, it is an over generalisation, to say that there's a certain pride at not being good at maths if you're "words" person, or having poor spelling if you're a "numbers" person. Of course, we could complement our list with "art" and many other skills. Whilst, I enjoy writing a lot, I have to confess I'm probably more of a "numbers" person than a "words" person if I was forced to make a clear decision.

However, it wasn't always like this. Going back in history to the ancient world, there were many famous polymaths, such as Thales. His expertise spread across many disciplines, philosophy, mathematics and astronomy, naming just a few. Indeed, one of the chapters of my book Trading Thalesians discusses the idea that having a wide array of interests like Thales can be very positive for modern day trading. As for "art" and "numbers", figures such as Da Vinci, remind us that these subjects need not live in totally different spheres.

Markets are becoming ever more complicated. Information is flowing from many different sources. Simply relying on one sort of data or approach to understand markets can end up missing out a big part of what's going on. Numbers are of course the crux of any sort of algorithmic trading strategy, we cannot get away from that. Even if we are a discretionary trader, who uses human judgement to make trading decisions, a modicum of quantitative analysis can help us. 

One of the biggest events of the coming weeks is the UK General Election. Much has been written about who could win. Strategists have outlined the potential outcomes. Of course, a lot of the commentary could be biased! As with art, there are many ways to see the same situations, zoom in and see something, zoom out and get a totally different interpretation!

What about trying a quantitative approach for analysing the UK elections, using numbers to compliment a more fundamental "words" take? I recently wrote a paper for the Thalesians (Thalesians: My kingdom for a vote), which attempted to do this. The idea was simply to understand how markets had behaved in historical elections, depending on the winner. I also analysed how well polls predicted the results. Interestingly, since 1974, on most occasions, the largest party was in line with polls prediction. The election of 1992 was a major exception. It surprised pollsters, although in that instance, the polls were very close beforehand. However, even more surprising is the way GBP/USD has behaved historically following UK general elections. In most cases, whether there was a Conservative or Labour victory historically, GBP/USD depreciated. We can see this in the chart below (the "art" bit!), which I have taken from my paper.

(If you like coding up Python, I've written a blog post at Plot.ly, which contains the Python code for the analysis I did for the chart below, as well as how to make it interactive using Plot.ly! You can view the below plot interactively here too.)

Of course, I am not advocating that we should always forget about words when analysis markets... indeed, we can convert words into numbers too, so "numbers" people can understand "words"! Over the past year, I have done a significant amount of work looking at news data, which is converted into a machine readable format together with a sentiment score and other metrics that attempt to quantify news. I have found news data to be very useful for a systematic approach to trading, doing projects for RavenPack, a news data vendor, showing how it can be used to reduce drawdowns of FX carry and improve upon long only bond futures (those papers are available on request). The key of course though is to have a well thought out framework for how you wish to use news data in your trading, before undertaking the analysis.

If what I've talked about sounds interesting and you want to learn more about how to be a "numbers" and a "words" person when it comes to systematic trading, come to one of my talks. I'll be speaking about both news based trading and also volatility markets during scheduled events at Global Derivatives in May in Amsterdam. I hope to see you there!

Why be either a "numbers" or a "words" person when you can be both!

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 interesting 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 and Budapest - join our Meetup.com group for more details here (Thalesians calendar below)

17 Apr - Budapest - Impact of bitcoin - Tamas Blummer & Panel featuring Izabella Kaminska / FT)
22 Apr - New York - How Smart Money Invests and Market Prices Are Determined - Lasse Pedersen
29 Apr - London  - Global macro & UK election panel - Eric Burroughs / Reuters, Mark Cudmore / Bloomberg, Jordan Rochester / Nomura, Jeremy Wilkinson-Smith / Independent & Saeed Amen / Thalesians

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