Wednesday, October 29, 2014

Oil, Growth, Sustainability - How the world cannot continue as it has for much longer.

Oil, Growth, Sustainability - How the world cannot continue as it has, for much longer.

Not a blog today, just a fascinating, though older video showing the mathematics behind growth, and how we fool ourselves into thinking the world can sustain 7% growth forecasts - semiindefinately.

Well worth the hour long watch if you have the time.

Exponential and logarithmic thinking at work.

Friday, October 24, 2014

The Four F’s of Investing Behavior.

The Four F’s of Investing Behavior.

One of the first things I learnt in Psychology 1011 a lifetime ago, was the basic framework of the “Four F’s” to explain most basic human and animal behavior.

Otherwise known in part as the “Fight or Flight response.”

The Four F’s:
Feeding and:
“Fornication.” (Resisting using the other term!)

Since I’m sure that most wont forget to eat while trading ….. or do the other thing, I was thinking how easy it is that we go from the fight to flight response under stress.

Having just gone through the correction, our rational behavior, or at least mine was tested by the flight response (fear), despite having a rational belief that “everything would be alright.”  No one is immune to emotional behavior sometimes, or certainly instinctual programming.  But there is hope.

Fear is often treated in people with phobias (arachnophobia etc) through exposure therapy.   I.e. Exposing someone to his or her fear in a safe environment, leading to extinction or reduction of the response to it.  Whilst I wouldn’t classify what I felt as fear, there was a little stress and avoidance going on perhaps.

So what makes someone less susceptible to this reaction?  Clearly experience, through seeing the events unfold, a skill increase through surviving such events and learning, and a solid foundation/training to rely on.

I bet US Navy SEAL Team 6 would score far less on fear scales under relevant stressors than the typical population does due to intense exposure to those factors above.  I also bet they NEVER stray far from their training or procedures!

These days I’m thinking far less about the profit I want to make in the markets, and far more in the learning & conditioning this year should provide.  It’s a good thing!

Wednesday, October 22, 2014

Fooled By Randomness, Ancient vs Modern World.

Fooled By Randomness, Ancient vs Modern World.

(WARNING: This is a bit off topic - a bit of history and then a modern Investing parallel).

Taleb makes an interesting point on history, and Homer’s Iliad, “…the epic poet did not judge his heroes by the result: Heroes won and lost battles in a manner that was totally independent of their own valour; their fate depended upon totally external forces, generally the explicit agency of the scheming gods.” (Taleb, Fooled by Randomness , p39).

“Heroes are heroes because they were heroic in behavior, not because they won or lost.”  Of course to prove your heroic behavior, you had to at least survive long enough to do something…heroic!  (Luck?/Survivor Bias?).

Take Julius Caesar as an example however.  Clearly one of history’s most skilled Generals.  But he was also very lucky (…until he wasn’t)!  (Hail Imperator!)

His Battle of Alesia was a masterful example of tactics.  In a nutshell he besieged Vercingetorix’s Gaulish town by surrounding it with trenches and fortifications to starve them out.  But, while waiting on that, he anticipated reinforcements would arrive, and built a second defensive wall around his army (Skill).   An enormous army of reinforcements did indeed arrive and attack.  Caesar took desperate great risks to win that battle, personally riding through the perimeter to spur on the legionnaires, and leading a cavalry detachment to attack the enemy in the open field, which forced his cavalry general to double his efforts after “seeing their leader undergoing such risk,” (  Of course it was lucky he didn’t get killed, as that usually ended such battles immediately, and world history would be very different.  Paul K. Davis writes that "Caesar’s victory over the combined Gallic forces established Roman dominance in Gaul for the next 500 years.”

Caesar accepted the role of fate in his outcomes; “the die is cast” being one of his quotes.  The goddess of luck Fortuna was also consulted prior to battles and appeased.  But as Brad would say, he positioned himself to get lucky.  He also was the first expert general/politician in writing his own history and contemporary propaganda, which only discussed his skill, of course.

Caesar was skillful – and Caesar won (as did Wellington, Eisenhower, Nelson).  But there are undoubtedly foolish generals that have won a war (most of the British Generals in France WW1 for instance, who were there mostly due to peerage over inate ability); and there are skillful generals that lost (Mark Antony, Rommel, Napoleon).

The ancient world was one where the gods interfered in life, where disease, famine and war uncontrollably altered lives and outcomes randomly caused reversals of fortune.  They understood that randomness would have the final say in the outcome, as probability couldn’t be assessed, despite skills or individual choices. 

Taleb argues that “we are left only with dignity as a solution – dignity defined as the execution of a protocol of behavior that does not depend on immediate circumstance, p227).  This sounds a lot like having a PROCESS to me, in our situation here, and something I’m certainly still working on developing.

Marc Antony lost to Octavian (Emperor Augustus – and Caesar’s adopted son) in battle, and returned to Cleopatra and committed suicide.  The Romans’ would have understood that he had been skillful in command his whole life, lucky often, but that in defeat he was stoic.  His Heroism would never have been questioned, and in fact suicide was heroic and expected of him.

Before getting onto a modern equivalent, one last point on history’s view.

Chivalry evolved throughout the middle ages and was a set of behaviors that gentlemen and knights would follow strictly.  It was a formalized continuation of the following of a dignified process that you would be judged by.  Skill was important and displayed by battle and jousts, but only in the context of being chivalrous.  So it allowed for a bad outcome and acceptance; if you followed the process you remained heroic and admired, even when you were unlucky and lost.

But I believe we have lost that distinction now.  Skill and Luck are not considered in those we follow anymore.

Babe Ruth would have been forgotten if he hadn’t been successful – yet in baseball, luck is fairly important in deciding outcomes.  In fact, in professional sports where every player is highly skilled, luck plays a larger and often hidden component to the outcomes.  Yet they are idolized as heroes.

In the investment world - even more so.  No talking head investment manager would have been on CNBC if they had been unable to make big money at some point, a task where skill matters, but luck plays a huge part too.

Partly perhaps, is this because the narrative has changed?  One - it is fed to us daily by compelling sources that have biases.  Two - is that instead of being a narrative about the process of actions (skillful behavior + luck = any outcome), it is often a narrative about the outcome of actions (high skill = successful outcome).  The latter often backed up with inaccurate or misleading statistics.

This plays into our brains difficulty in understanding probability, especially in the face of a good narrative.

“Such tendency to make and unmake prophets based on the fate of the roulette wheel is symptomatic of our ingrained inability to cope with the complex structure of the randomness prevailing in the modern world.”  (Taleb, Fooled by Randomness , p40).

I’m off to make my offering to the goddess Fortuna.  “Fortune favors the bold,” afterall, and it can’t hurt.

Saturday, October 18, 2014

The Market Got to Me This Week.

The Market Got to Me This Week.

Now I’m kind of embarrassed to admit this.  But the market got to me this week.  Yes at first the portfolios were down a bit, but then I made two mistakes.

1. From my early trading days, I had held onto two CFD positions that I should have dumped long ago. As the market fell this week that account that holds only options otherwise, was put under increasing pressure from the stupid CFD’s, that I admit, I was/am too attached to.

2. As that happened, guess what?  I started watching CNBC more than I ever would.  That led to the inevitable blood pressure rise, and micro monitoring.  And here I was thinking I was more immune to all that now.  That information is just too toxic, and Taleb argues that, “its also statistically insignificant for the derivation of any meaningful conclusion.”

They were both long term positions that I had bought, based on some fundamental and technical analysis, but were pressured by the randomness of the market in the shorter term due to the leverage effect.  Dammit!

Long story short - I finally cut one of the CFD positions for a loss (and I know it will bounce now – but that leveraged volatility is also the problem).  The other, well I'm still too attached to it to cut it yet, but as soon as I can on my terms - its gone. 

In my long-term option only portfolio, it was down a lot, but so what – I didn’t feel the emotional buzz like I did in the first account.   I don’t know for certain that it will perform well in the future, but I do know that the outcome will be a result of the correct signal over time, and not pressured by short-term volatility, journalists or market noise.  I like the comfort in that, and the lack of needing to make rash decisions when pressured.

How can you make the right decision when forced into the only action that you can possibly choose?

How can you not burnout when you allow yourself to be put under that pressure?

Friday, October 17, 2014

The Greatest Con on Earth.

The Greatest Con on Earth.

“The trick is as follows.  The con operator pulls 10,000 names out of the phonebook.  He mails a bullish letter to one half of the sample, and a bearish letter to the other half.  The following month he selects names of the persons to whom he mailed the letter whose prediction turned out to be right, that is 5,000 names.  The next month he does the same with the remaining 2,500 names, until the list narrows down to 500 people.  Of these there will be 200 victims (who think this guy can predict the market brilliantly by now).  An investment in a few thousand dollars worth of postage stamps will turn into several million dollars (unwitting fools deposits who bought the story). Then the Con Artist elopes with the money obviously. 
Fooled by Randomness, Taleb, p146.

So what are the real two greatest cons as I see it?
(Feel free to rip me apart if you disagree – I can take it).

1. Ever seen “Boiler Room”, or “Wolf of Wall Street,” where cold calling stockbrokers target large numbers of marks with their HOT pick?  If they are correct, they then re-call and re-call until they grab the whale’s investment and commissions.  If they are wrong they simply disappear (sounds familiar to the above story right!?)

2. And I think this is even worse.  Mutual funds have great fact sheets showing their performance against some benchmark, with confusing YTD numbers and tables that fool most people into believing some amazing fund manager is in place charging 1.5%, consistently beating the market, whilst also beating, or ignoring randomness.  (You are sold the story that the picks matter – but remember Russian Roulette?).

But due to survivorship bias, the bad funds are never even seen, as they are gone.  But the news is rarely shown, as are the size of the failures, or that if you invest now, whether that fund will exist in five years due to underperformance or not, as fund management companies don’t like to talk about those closures.

“Closed for subscription” is something I have seen several times (and owned)…. until the fund quietly fades into the night, or is rolled into another.  The Fund Management Company might not mail or call you, as they are subtler.  They simply advertise and promote the winning survivor funds – then net even larger numbers of people to join it.

In 2001-2012 – 7% of all funds failed every single year!  That’s not just lost money, that’s FAILED.

ETF’s have also failed at a high rate, even in market growth conditions.  And, fair enough, some of the ETF failures have been specific obscure ones, but at least the major trackers of a whole index or industry should be somewhat immune.

The following article I think gets it wrong though a little.  While some of the deaths are simply due to bad timing, closures help weed out weaker players and lead to higher-quality products.”  Perhaps, but more importantly: NO, it just leaves the survivors to date, some of which will be the next to fail, whilst allowing a batch of new “great” ETF investments to lure the next whale, at their recent publicised success.

Tuesday, October 14, 2014

To a Journalist, “it’s a small world,” afterall.

To a Journalist, “it’s a small world,” after all.

You are walking through Kmart (or Country Road if you are a snob), when you run into your cousin from across town….

“A … misconception of probabilities arises from the random encounters one may have with relatives or friends in highly unexpected places.  “It’s a small world!” is often uttered with surprise.

But these are not improbable encounters….

It is just that we are not truly testing for the odds of having an encounter with one specific person, in a specific location, at a specific time.  Rather, we are testing for ANY encounter, with ANY person we have ever met in the past, and in ANY place we will visit during the period concerned.

The probability of the latter is considerably higher, perhaps several thousand times of magnitude of the former.

When a statistician looks at data to test a given relationship, say to ferret out the correlation between the occurrence of a given event, like a political announcement, and stock market volatility, odds are that the results will be taken seriously.”
(Fooled by Randomness – Taleb p 148).

Journalists DAILY provide us with reasons that the market moved up 2%, or crashed 3%.  All noise of course on a short-term basis.  But they are just reacting to the any relationship, small world sample, and making any connection.

In fact, “Causality can be very complex.  It is difficult to isolate a single cause when there are plenty around.  This is called Multivariate Analysis.”  (Fooled by Randomness, p197).   To imply causality, ALL possible reasons for the stock move must be looked at, both in isolation and jointly, with calculated confidence levels to arrive at the conclusion.

I studied Statistics a bit at University, and whilst I forget WAY more than I remember, I DO remember that those Multivariate Analysis calculations were pretty damn complex.  I’m also sure the media is not running those before they make their claims!!!  (Remember what I said about statistician’s results, and being taken seriously – I am no statistician!)


…the three major indices rebounded on Friday thanks to a solid GDP report…

The bond markets, meanwhile, struggled in Friday trading on the news that “Bond King” Bill Gross is leaving PIMCO, the firm he founded, for Janus Capital.

When you look for any relationship to explain data, it will often amaze people.
Couple that with the human need for a “story or narrative” (Nick and Jarrod did a webinar on this which I thought was great) and you have modern media defined to perfection.

I was in NY recently, and saw the block-long lines for tickets to the upcoming “Star Trek Convention” getting airtime on the Midday News.  The Dow was down that day a little….

I can see the headlines now….


(Hype – Noise – Noun – Verb – Random Event = Headline).

Finally, do you remember those drawings as a kid where you connected the numbered dots to reveal a picture?  1 to 2 to 3 to ….. 45.  And you had a BEAR drawn!!!  (Picture included for illustrative purposes only – below).

You only had a bear because someone led you to it. Without the numbers, there was any combination of other pictures, or simply a messy ball of string and randomness.  (Which is YOUR narrative?)

Sunday, October 12, 2014

Fooled by Randomness, Russian Roulette, and CFD’s.

Having recently finished reading “Markets Never Forget, But People Do” by Ken Fisher, I just started “Fooled By Randomness” by Nassim Taleb.

I was intrigued by the discussion on Russian Roulette: 
(and wrote this to mainly attempt to clarify my thoughts).

“Imagine an eccentric tycoon (we’ll call him Brad) offered you $10million to play Russian Roulette….Five-out-of-Six of these histories would lead to enrichment; One would lead to a (catastrophic) statistic.”

“If the roulette-betting fool continues to play the game, the bad histories will tend to catch up with him – but if there are enough players, say thousands, we can expect to see (a handful) of extremely rich survivors (and a very large cemetery).”

Finally, …. “Consider the possibility that the roulette winner would be used as a role model…,”  and “the winner of the $10million (multiples) would elicit the admiration and praise of some fatuous journalist.”
Fooled by Randomness, Taleb.

Statistically (if I have calculated this right)…. using a 6-shooter:

83.33% chance of a Reprieve (Win)
16.66% chance of a Boom

But what if you played more than once? (0.833 X 0.833 etc)

2. 69.44% chance of Reprieve / 30.56% Boom
3  57.87% chance of Reprieve / 56.87% Boom
4  48.22% chance of Reprieve / 52.78% Boom
5  40.19% chance of Reprieve / 59.81% Boom
6  33.48% chance of Reprieve / 66.52% Boom
7  27.91% chance of Reprieve / 72.09% Boom
10 16.15% chance of Reprieve / 83.85% Boom
13 9.34%   chance of Reprieve / 90.66% Boom

Despite the book’s argument about the mathematics not being necessary, I was compelled to calculate the numbers.  What Blew-Me-Away (ha-ha), was that after 4 plays - you had effectively just flipped a coin, … at still existing.

Someone that had played Brad’s game successfully 4 times, might be starting to think that they are really good at Russian Roulette (perhaps they say that they spin the chamber differently to everyone else, or it could be, they say that they handle pressure better – whatever), but where is the skill in a 50-50 chance?  

This is where the CNBC journalist and public attention comes in, which only reinforces the winner’s belief in their (mistaken) view of skill over randomness.  Or, at least in the winners underestimation of their exposure to the hidden risk of randomness.

Here’s my point – finally:

I feel like I have played this game. I used CFD’s. I’m still alive, in that I have not blown up completely but I certainly haven’t made millions.  However, I think I started to hear the coming BOOM more and more, each time I heard my CLICK.

Perhaps if I had hit that massive winner first up on Tesla like I almost did, I’d be a victim of my own success by now, but Damn, I was getting more and more gun-shy each time I pressed the trigger.

For a time I thought I was actually smart enough to out-wit the market, and read the charts well enough!!  But sure, you can be right once or twice (skill/luck/randomness –whatever), but after 4 tries, if the randomness becomes a 50-50 bet, and the loss result is blowing up your account – I realize I REALLY don’t want to play anymore.

Taleb goes on to discuss the real world differences to Russian Roulette, which manifests as the “black swan” event, the infrequency of the fatal bullet and increased difficulty in anyone even assessing risk in the market.  All interesting stuff.

There’s a another flipside to this discussion I think, that involves Pavlov’s Dog, and Classical Conditioning of the Salivation Reflex.

A Bell rung, will occasionally also deliver food to the dog, but not always.  The dog learns to salivate each time in anticipation of this random event.  (The promise of a financial reward with each buy CLICK – even when infrequent - leads to the gambling trader).  

A dog can’t count to 5 or 6.  Can the trader?  Maybe I need a 7-shooter.

But that’s a whole new issue I need to work on.