What's the best way to trade?

Boston is to America what Cambridge and Oxford are to Britain. Indeed, the neighbouring town to Boston, Cambridge is named after its English predecessor and has within it both Harvard and MIT. Boston also served as one of the hot beds of the American revolution, being the home of the Boston Tea Party. However, I must confess that my knowledge of American history, is somewhat sketchy, although I'm endeavouring to improve. Indeed, if you have any suggestions on history books to read about America, I would love to hear from you!

Walking along the streets of Boston, it seems easier to become immersed in history than perhaps in other large American cities. Whilst skyscrapers occasionally dot the landscape in Boston, there are regular reminders of the past, such as the historic houses of Beacon Hill or Quincy Market, which today is thronged by tourists eager for lobster roll.

I took many photos on my recent visit to Boston, which was perhaps too short, including the graffiti at the top of this article. The graffiti suggests it is "not art". Whilst the point is somewhat simple, it made me think. What precisely qualifies as art and what doesn't? I am sure that artists have grappled over the ages with this question. Personal taste clearly plays a role, as well as so many other metrics, such as originality. For someone who is versed in mathematics, a well written proof can in itself seems artistic (although perhaps artists amongst you might disagree?)

When it comes to trading, we might attempt to ask a similar question: what precisely makes a trading good strategy? Is there a best way to trade? Moreover, what makes a trading strategy good enough for me to run? There might be commonalities which govern "good trading" such as not leveraging up more than you can afford. Yet, as soon as we get to specifics, here again, the answer to the question is related to the person making it.

Each investor has their own criteria for what would make a successful investment and the capital available to them differs hugely. Some investors have a long time horizon and are less leveraged. Hence, investments in more illiquid assets are more feasible for them. Some might prefer a more discretionary style, whilst others could be more comfortable with systematic strategies. When I'm trading my own capital, I am much more sensitive to drawdowns, in particular because I employ a modicum of leverage. As a result, I prefer high frequency strategies in liquid instruments, which typically have higher risk adjusted returns. They can of course have drawdowns, when a strategy becomes crowded out, and part of my job is to identify where these points could occur (somewhat difficult, but I am willing to give it a try).

I am also running fairly small amounts of capital on my personal account compared to when I was in bank. Everything is relative, when it comes to risk taking. Thus, the fact that these types of higher frequency strategies have lower market capacity are less of a concern. For a hedge fund running billions of dollars, there would be capacity issues. Indeed, in that scenario, the solution would be to come up with a large array of different high frequency strategies. The cost here is not so much purely the cost of capital, but also the cost of time. Even once we have identified the frequency or the assets we would like to trade, there are a massive number of other choices which we have. By the time, we have actually chosen a trading strategy which we believe is suitable for our investment style, we have discounted countless other ones.

What seems clear is that other investors faced with the same question, could have chosen totally different strategies, once they have jumped through all the hoops necessary to come up with a trade. Hence, whatever we have chosen to trade has been tailored for us. Whatever constitutes the best way to trade is merely the best for you, rather than for everyone else.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can order the book on Amazon.

Read More

New York Style of Trading

Martin Amis is a master of the English language. I remember reading one of his books (or maybe it was Hitchens quoting Amis, somehow after reading so many books, they all seem to coalesce into one another). The whole discussion in the book was an attempt to describe Las Vegas using a single word. I'll leave you in suspense to guess that word, although I'm sure you can think of some obvious suggestions! Whilst I've never been to Las Vegas, I have been to another beacon of very different version of Americanness, New York. Indeed, I am currently writing these words ensconced in Starbucks in this wonderful city, with the sound of country music whispering past, sung by someone is distinctively not Taylor Swift.

When it comes to New York, an attempt to classify this great city in one word will always fail. Simply walking down the street invites try brain to pick out a multitude of words: skyscrapers, street carts, surprise. Every neighbourhood has a different character. Contrast the low rise buildings of Greenwich to the high rise millionaire towers of midtown snooping a peek at the stars. Burger joints sit amongst Michelin starred restaurants, each delivering their take on what is New York cuisine.

Each word is somewhat unique in its ability to describe a certain facet of the New York experience.

The same is true of a good trader. It is very difficult to find single factor in isolation which can explain why the approach of a trader should be successful. Instead, it is an amalgamation of many factors which can at some level explain the profitability of successful traders. There are several obvious points, such as the ability to risk manage these views effectively, being able to cut losses, and allow profitable trades grow and accrue larger returns.

However, perhaps the most important attribute of a successful trader is what they don't do. This might seem contradictory. The ability to recognise when not to trade is perhaps just as important as knowing when to trade. Sometimes markets are simply not amenable to your style of trading. Despite this market participants might feel that they nevertheless need to trade despite the lack of opportunities. The result is overtrading.

The FX market has been a prime example of this. For much of the past year, markets were simply not producing sufficient trading opportunities because of a lack of trends. Obviously in recent months, the USD rally has spurred many trading opportunities. This has been reflected in the recent pick up in returns from trend followers (in particular in September). It feels as though the good times of strong returns are slowly returning to FX investors, although this has somewhat been tempered by the controversy around 4pm FX.

In hindsight, things are clearer, in terms of knowing when it was right to get involved in the market and when it wasn't. However if something really isn't working with your strategy or trade, perhaps blaming the market is unhelpful. Simply trading for the sake of it, might seem to fulfil your role as a trader (as in person who trades). Yet, from a returns perspective it is suboptimal.

Instead, patience is one facet of trading and waiting for the right opportunity. Trade when you want to, not when you need to.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can order the book on Amazon.

Read More

Learning Rhapsody

I see a little silhouetto of a man
Scaramouch, scaramouch will you do the fandango
Thunderbolt and lightning - very very frightening me
Gallileo, Gallileo,
Gallileo, Gallileo,
Gallileo Figaro – magnifico

Song lyrics, they always seem faintly odd, when written down on a page. In a sense, it’s akin to watching a lion in a zoo, wondering around his cage, aimlessly thinking of better days in the wild. Indeed, take a look at the lyrics above. Recognising their origin is far easier with a melody, which is after all, the way we usually interpret lyrics. The melody itself acts as a memory aid for the lyrics themselves. Melody somehow seems simpler to remember, forming a base on which to build the words. Whilst I love music, I am incapable of producing it. I managed to screech my way to playing the violin as a child, but I suspect for anyone listening, the sound I produced in this manner, was perhaps more noise than music. Yet, despite being a repeatedly failed musician, music is still one of things that I enjoy.

For me at least, the lesson of music, is that music is an interaction of so many things. Clearly, there’s the melody, the rhythm, the lyrics. There’s the infectiousness of live music, singing along to your favourite band or singer (such as Souad Massi, pictured above), in a crowd of others doing the same,

In finance, we don’t really sing along to price action in the same way. However, like music, markets are an interaction of many factors. Is there a secret to trading and a way to understand the markets? Sorry, to dampen your joy, but there is unfortunately no secret sauce to trading!

Perhaps the one “secret”, is not even a market based trading strategy. It is simply that you learn from others more than you learn from yourself or a book (although, I would hope my book is somewhat informative). Whilst hard work and reading are of course important to understand markets, they cannot replace real life communication with others. I have been particularly lucky in my career to learn from many market practitioners such as traders in banks. Had I not had this luck, I suspect my knowledge of markets would be far narrower.

Now working in the Thalesians, I'm now away from a massive trading desk in a bank. I no longer have continual interaction with traders. Hence, I've found it even more important to meet market practitioners and hear their thoughts in person. One result has been that I have started to attend and also speak at more financial market conferences. Whilst I do enjoy presenting my research, chatting to market practitioners at events has been incredibly useful.

Indeed, there's always something I should have added to a presentation, which someone in the audience has spotted. At the same time, I would hope that in every presentation I make, there's at least one very usable theme for the audience to take away. In the past, I've found that hearing just a single point has given me enough ideas to go away and build or improve a trading strategy. It even be one sentence, which someone says, which is sufficient to spark an idea.

However, sometimes perhaps a single talk isn't quite enough to articulate a subject. I'm also going to start doing workshops, to provide a bit more of an interactive way to present my research work. The first Thalesians led workshop will be held at the new AlphaScope conference in Geneva in February 2015. I shall be leading the workshop alongside Paul Bilokon, Director in MET (Market Electronic Trading) at DB and my fellow founder of the Thalesians. The idea will be to cover a large amount of my research work on systematic trading, in cash and vol markets, in particular in the subject of Big Data. Paul, will be covering his area of expertise which is electronic trading. I will also be attending the rest of the conference, to hear ideas from the world of systematic trading from other practitioners. So watch this space, if you're interested in systematic trading…

In the meantime, I'll stop reading lyrics and start listening to them.

For further details of the AlphaScope conference can be found here. To learn more about the Thalesians workshop at AlphaScope click here.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can order the book on Amazon.

Read More

Write once, read many

Youth vanishes from the stage first, supposedly to reappear in a later act, as wisdom. As each generation drifts into the past, its wisdom and experience seeps into the fabric of collective memory, weaving what will be called history. Just as the present is debated vigorously among its many actors, so is the past. The interpretation of the past changes over its immediate aftermath and over the ages. History is not so much a chronological list of events. It is more the understanding of how these events relate and why they occurred, which forms the basis of history. Indeed, Herodotus, the father of history, emphasises these points in the introduction of his epic work, the Histories:

This is the Showing forth of the Inquiry of Herodotus of Halicarnassus, to the end that neither the deeds of men may be forgotten by lapse of time, nor the works great and marvelous, which have been produced some by Hellenes and some by Barbarians, may lose their renown; and especially that the causes may be remembered for which these waged war with one another. (Herodotus & Macaulay/trans, The History of Herodotus, 1890)

No matter how hard we might try, events still obey the rule of write once, read many. We cannot undo an event, once it has been "written", despite our continual reinterpretation and "reading" of it. We can of course conjecture about whether a different path, would have altered history.

Finance is of course no different, when it comes to mapping the present with the past. There is a constant need for reflection of the past, perhaps even more so in finance, where traders profit from seeking the future. For specific cases, we have masses of data, which can aid us in the process of interpreting the past. For example when it comes to systematic trading strategies, backtesting can enable us to understand how a model would have performed in the past. Of course, it can be fraught with difficulty, notably the scourge of data-mining, which involves traders "fitting" a model excessively on historical data. The result is often an over-fitted model, which fails to capture the dynamics in the future.

There are more complex scenarios, where alternative paths for the path are somewhat more difficult to model. We recently saw the end of quantitative easing by the Fed, which fits under this category. The policy has had both its detractors and supporters. For supporters, we know how QE has played out in the short term. Would policymakers have liked more growth? Of course, we all would have liked that. However, for detractors, we shall never know quite the world would have turned out without the Fed's policy of QE. Yes, Fed QE has not been perfect. Markets may have been indulged for too long on this fix of morphine. Indeed, will the main memory of QE be S&P500 at 2,000?

Yet, reaching back to the days of the Lehman crisis, those were not normal days, neither for policymakers nor for markets. Policymakers responded with the experiment of quantitative easing, which seemed to stabilize the complete and utter confusion over the most severe part of the crisis. Perhaps, we have been made complacent these days, by comparatively stable markets. Indeed, in recent weeks, when VIX, Wall Street's fear gauge, jumped a few points, or S&P500 dropped a hundred points, it was as though pandemonium had spread through markets. By Lehman standards, it literally nothing and by the end of October this year, it seemed as though markets had recovered.

The past is not an exercise in perfection, after all it is humans who write it. Writing a different past, does not always mean a better present. If only we could write many....?

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can order the book on Amazon.

Read More

The Brevity of Modernity

Coffee whispers to my sense of smell, whirring through my consciousness, as I sit here in an American coffee shop. Above me, sitting aloft are skyscrapers their crests emblazoned with the names of American banks, a corner of London more Empire State than Wren. My fingers tap on my keyboard has slowed, no longer are words magically appearing on the screen seeking my eyes’ attention. Whilst headphones are perched in my ears, music pulsating through them, I hear little. I ignore the continual beeping of new Twitter messages, the flickering of pop ups signalling new e-mails, the stream of customers entering the coffee shop.

I am thinking, seeking to find a path through my thoughts to a cohesive narrative to write here. The wonder of thinking is that clear separation between you and the rest of the world, a time to indulge in the unknown. Thinking occurs when you allow the stimulation of the outside to dull, for a time, to allow the wonder of ideas to develop from within you. It is what I love about reading, seemingly abstract shapes on a page, creating words to catalyse my thoughts over time, rather than the gratification of images instantly flooding into my mind, a stream so rich, it can sometimes smother my thoughts. What spurs thought is not so much a flow of information, but the time spent digesting that information flow later.

Yet, how often do we think at length today? The modern world seems to favour brevity. Information seems to grow exponentially, each year that passes in this, the Internet Age, hastening the attraction of brevity. The length of this article is governed by how much time, you, the reader will give me, the writer. Our attention span can seem little more than one hundred and forty characters at a time. The notion of spending time investigating anything at length seems to have lost out. It seems passé, a relic of days past. Books are to be absorbed upon the screens of a device which needs batteries, but only in small chunks, rather than on the wonders of paper, a medium which lasts for a lifetime.

I might seem like a Luddite, expressing these sentiments, indeed perhaps somewhat hypocritical, since new technology is something I embrace. I love using Twitter and have for nearly a decade worked in financial markets, my eyes for hours each day, continually seeking out the words emerging from my news feed and price flashing up or down, analysing this vast trove of data systematically. Decades ago, I would have been staring at a solitary ticker tape of prices, rather than multiple screens, using programming languages with exotic names like Java and Python. My point is not so much that we should abandon modern technology, which has spurred this move to brevity.

Instead, I ask why can't the one hundred and forty characters of the tweet and brevity of news wire headlines, sit alongside books: the novels of Fitzgerald and Dickens, the non-fiction of Hitchens and Taleb, in our society. We need not choose between brevity and length. From tweets, we learn from the thoughts of many people, in brief snapshots, which coalesce to provide a sample of the world at a single point in time. By contrast books give us an opportunity to delve into the thoughts of others at length. However, this opportunity is only afforded to us if we are willing to exchange our time.

The same is true of markets, the incessant media coverage of high frequency trading seems to neglect the fact that it is possible to profit from longer term trading, where we might take a significant length of time to come to a trading decision. If anything, for some investors sticking to longer term trading can be a better approach, than being sucked into intraday trading and potentially the spectre of over-trading. Often with higher frequency trading, more care needs to be taken to ensure the noise of short term price action is not confused with a signal that market dynamics are changing. It can be done, but needs focus.

It's not a question of modernity or a Luddite appetite for the past. It's simply an acknowledgement that modernity should not usurp the idea that sometimes, we simply need to spend time thinking, wondering and reading, to allow us to escape (as the photo above implores us), as well as browsing. The question is this: what will you read next, a tweet or a book or perhaps both?

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can pre-order the book on Amazon.

Read More

The small in Big Data

Waltzing along the Thames from the Tower Bridge to Westminster, in amongst the plethora of skyscrapers struggling to reach the gods and tourists snapping photos, there lies the White Tower, its stone weathered by a thousand years of rain and wind, battering the British landscape in all seasons. The history of a nation lies there carved into the stone of Caen.

Generations have passed. Ages have passed since its construction. This island nation fell at Hastings, a nation forced to kneel at the sword of William the Conqueror from across the Channel, the man who built the White Tower. In the royal court, the foreign sound of French replaced that of English, the language of the Anglo-Saxons. As this green and pleasant land beckoned before him, the question for William was simple. What was this land which I have conquered?

William sent out his men throughout the land, to seek answers (and taxes), by conducting a survey of the nation’s wealth, recording the holdings of landowners, in nearly 13,500 places across the kingdom. The result was the Domesday Book which was completed in 1086, a truly epic work for its time. Indeed, for medieval times, the amount of data collected was truly astonished. Perhaps this was an example of medieval Big Data?

Leaping across a millennium to today, the term Big Data is as ubiquitous as it appears to be misunderstood. The term has seemingly captured an almost ethereal quality. Despite, the regularity with which the term appears, it seems to be rarely defined in the popular press. Essentially, Big Data refers to massive data sets.

The sheer quantity of data makes it computationally very difficult to analyse. Yet, beneath this veneer of complexity, the supposed promise of Big Data is that we can find simple and wonderfully intuitive results and relationship between the data, which can be visualised in novel ways. Big Data is only useful if we can make it “small” data that we can interpret. The web has given rise to masses of Big Data. Simply think of Google and Facebook and the reams of data which their servers trawl through every second. As oil was the way to profit from the twentieth century, is data the basis of alchemy in the twenty-first century?

Clearly, for the aforementioned institutions, data has proved to be valuable (we, the consumers, have freely given it to them in our droves). However, does simply throwing more data at a problem help create solutions? The difficulty is that more data can often mean more noise.

A model with more variables does not mean a better model, in the same way that having more lights on a motorcycle might not improve it (see photograph above). Financial markets are plagued by noise. Every minute newswires buzz with more stories, some crucial for markets, whilst others can be discarded as noise. Human traders have (always) used news to trade markets and have continually needed to make these decisions. We can apply a similar approach to trade markets by examining large amounts of news data (maybe we should call this Big News).

Whilst Big Data is not a panacea, through diligence it can improve our understanding of financial markets. In a sense it is like baking a cookie. We can see Big Data as a set of complicated ingredients, which only taste good once baked. Indeed, I have written about this topic in an earlier blog article, where I demonstrated how Big Data can be used directly for trading. I showed how RavenPack news data can be used to create trading filters for reducing the drawdowns associated with carry trades in the currency markets. The method I employed relied upon relatively straightforward concepts, notably understanding how news volume is related to market volatility and also the impact of the labour market on risk sentiment. Whatever approach we choose to Big Data, a modicum of old fashioned trading intuition needs to be there to start us on our way.

The key is to filter the signal from the noise, as Nate Silver might say, so we can find the small in Big Data.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, also has some colour on lateral thinking to a trading idea and much more (mixed in with a bit of ancient history). You can pre-order the book on Amazon.

Read More

When an idea gets currency

Anguish had ensued for months, with declining volatility seeming to compound the misery of the market, killing any potential trend. Traders in currency markets were being rebuffed by a currency that did not wish to rise. It had been the consensus year ahead trade at the beginning of 2014. The moves for much of the year seemed to “prove” that the consensus was wrong. Finally, over the summer, the dollar showed the market some love, rallying over 7% against the euro and against nearly every other currency in recent weeks. Perhaps consensus was actually right about the elements (see above) being here for a dollar rally?

The narrative which has been at the heart of the market’s desire to see a stronger dollar is fairly clear. I recently went to a talk by Mark Cudmore at a currency conference, TradeTech FX, in London. He has been in the currency markets for a decade. I have known him for nearly that whole period and I am always keen to here his thoughts on the market. His presentation was based on the premise that the market follows narratives, which can often overshadow other factors. In my experience, this becomes more evident, each year you follow the markets! Trying to point to fundamentals, whilst another set of narratives is in play and a dominant trend is sweeping markets, can be a painful experience even if the narrative eventually pivots to your viewpoint. There are countless examples not purely confined to currency markets. In the dotcom crash, investors who went short, hoping to profit from a fall in overvalued tech stocks, were eventually proved right. However, any investors who went short too early, would have been forced to close out their trades before they became profitable.

In currency markets at present, the market narrative is of a central bank considering when to hike, the Fed, whilst another is in easing mode, the ECB. Indeed, this has been prominent in most market research that I've read and in the media. This is the classic divergence play, which has so often been central to currency markets and has helped to trigger the rally in the dollar. It is the type of trade, which has been lost in the muddied waters of the past few years, where central banks seemed to be engaged in a race between one another for the bottom in yields. Much of the post-crisis period has seen markets driven more by shifts in risk sentiment than anything else. This contrasts to monetary policy expectations which are linked to expectations around growth and inflation. If we look at unemployment rates in the US and the Eurozone, we can see an illustration of why there should be some monetary policy divergence, in particular once the buffer of Fed QE has been eroded. I could show you numerous other plots to illustrate the same point. (Of course, there has been this divergence for years, but the market narrative was somewhat different!)

Figure – US vs. Eurozone unemployment

Indeed, the ECB has been easing policy, cutting deposit rates to negative territory and committing to purchase ABS. The potential for further moves, notably through the purchase of sovereign bonds remains a possibility. The Fed are still conducting asset purchases, admittedly in smaller sizes, and this will finally end in October. Of course the market is pricing in higher short end Fed rates and the Fed “dots” are also pointing to hikes. The “dots” are representative of individual Fed governors’ forecasts of future rate policy at various Fed meetings.

Figure – Fed dots and market pricing – In case you didn’t know markets expects the Fed to hike soon

UST 2Y yields have also risen, as we approach the end of Fed QE, which are traditionally the most important part of the curve for developed currency markets (by contrast to UST 10Y yields, which are markedly lower on the year). However, despite all these moves in the UST yield curve, the answer to whether the Fed have hiked is clearly “no”. Hence, the dollar is rallying partially on an expectation that hikes will happen soon. Whilst, I find it difficult to disagree with the view and I am (like the rest of the rest of the market) forever enamoured with a trend, we need to consider several factors.

Positioning in short EUR/USD trades is at an extreme, if we look at public sources such as the CFTC’s speculative net positioning data. Hence, this suggests that many market participants are already in heavily long USD. I know some of you will bemoan that I use this data, given that it is largely dominated by CTAs (those funds which predominately trade trend following strategies) and it is also quite lagged. However, in my analysis, I have found that it is generally best to go with the “flow” in CFTC positioning data. Hence, at extremes, it is generally profitable to follow it, but to be weary once it starts to pull back and traders begin the process of liquidating their positions. In particular, there is crossover point, where existing shorts can feel enough pain from a liquidation to force a squeeze which can be self-perpetuating. It also does begin to concern me when forecasts are rapidly being cut by many banks in succession, something that is happening to EUR/USD.

Figure – EUR/USD CFTC speculative positioning – is very short

On a broader point, price action often gets ahead of itself. One example, cited during Mark’s talk, was the rally in USD/JPY which began when in November 2012 and accelerated following the election of Abe in that December. In a Draghi-esque “whatever it takes” manner, Abe pledged to restart the Japanese economy with "three arrows" of fiscal stimulus, monetary easing and structural reforms (via FT/Wikipedia). The market’s love of Abenomics was perhaps even deeper than what we are currently witnessing for the dollar. USD/JPY rapidly rallied from around 80 to 95 from November to April, just before the BoJ’s historic meeting when they announced a massive program of QE. I have fairly vivid memories of that time, which felt somewhat electric from my viewpoint, working at the time of the currency desk of Nomura, a Japanese investment bank.

Figure – USD/JPY rally since 2012 and mentions of Abenomics in Bloomberg News

Since that historic BoJ meeting in April 2013, USD/JPY has managed to rally to 110. However, this second part of the journey higher has been fairly disjointed. In other words, the yen was weakening during a period where there were expectations of significant monetary policy easing by the BoJ, rather than actual easing. Does this sound familiar, a currency moving ahead of a central bank actually changing their policy? Furthermore, the most recent rally since August has come at a time of broad based dollar. Perhaps more of a dollar narrative playing out than a yen one at present?

As Mark remarked (I give no excuse for that pun) and what is so often said in the market, don’t fight the narrative. At the same time, we need to consider whether the market is getting ahead of itself. When will the motivation to take profits for market participants be stronger than following the narrative on the dollar? When the Fed does actually hike, will the market have already been exhausted by a rallying dollar? A great story only translates into profitable trades when the rest of the market also listens.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, also has some colour on this generalised topic (mixed in with a bit of ancient history). You can pre-order the book on Amazon.

Read More