What with all the bailing-out and near-zero interest rate policy going on, and the hope that the American or Asian consumer will spend enough to keep the economy from grinding to a halt, it reminds me a lot of the “anchoring effect” that’s been talked about in behavioural economics. That is, the tendency for people to get accustomed to a certain level, whether it be the price of the stocks in their portfolio or the level of their consumption (cars, big screen televisions, houses) and feeling a stronger emotional hit on the way down. Admittedly, it is depressing when the economy suffers and people get laid off en masse, but the need to sustain constant growth has always struck me as bizarre and doomed to failure. Why do we assume cyclicality is overlaid on an upward bias? Didn’t Shiller point out that house prices in Holland in the 15th century sank downwards for at least a hundred years? Why is it so difficult for people to envision long periods of decay or stagnation? Perhaps things will rebound quicker than the doomsayers expect, too. But it seems like a major blind spot with a lot of people, to always quest for growth — as Ozymandias points out, there has been many a civilization that has disappeared in desert sands.
When one is born, one begins to die.
December 27, 2008
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Posted by Nelson Yee
Wool-pullers
December 26, 2008Another Madoff victim speaks about skepticism in financial affairs. I find it kind of funny how l’affaire Madoff has given birth to a class of “I was snowed by Madoff” articles. Here’s another one that’s really self-absorbed and not particularly interesting except that it’s almost an unintentional troll of people who aren’t nearly as well off as this woman was. Personally, in my opinion, people who get scammed this way should probably just stay quiet but I guess they figure if they can make a bit of money off their story it’ll go some small way to compensate their losses (plus it’s probably cathartic).
On a side note, you’d think that first article could get Robert Shiller’s name right; it’s wrong even in the academic-style reference at the end. Do people ever copy-edit anymore? I’m pretty sure there’s been a serious decline in proofreading and fact-checking, perhaps due to the “must publish immediately” ethos that’s infected the media. I don’t remember newspapers having so many typos and clear errors as I’ve seen in the past few years.
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Posted by Nelson Yee
Egg nog, crude oil and market meteorology
December 25, 2008Although there have been some profitable opportunities in the commodities lately, especially in oil, I’m mostly on vacation and plumbing new depths of unhealthy holiday eating. BC’s a messy winter wonderland (hope everyone made it home to their families for Christmas Day) and I’ve been getting some nice skiing in.
From Econbrowser, I found this pretty interesting article on the price of crude oil which links to an NPR story on oil traders. Nothing particularly new but I still find it fascinating how predictions really aren’t worth the paper they’re printed on, in my opinion. That’s why I’ve really transitioned to tactics over strategy in my own financial career and put it above any attempt to scry or prognosticate, which are usually based on the contemplation of a static model that has to constantly be revised, usually after someone’s lost money. I think this is ultimately why the Turtle traders were so successful — they had some arbitrary method of picking appropriate entry and exits but they were emotionally tough and never deviated from their plan (which was really more tactical than strategic).
The other thing that I find funny about the first article is how it comes to what is essentially, at least in my mind, a really obvious conclusion: price is driven by emotion and sentiment, with a dash of supply-demand factors and other macro-economic/fundamental variables, a tincture of soothsaying, and heated to full boil. It’s not just one thing, plus factors like self-reflexivity and feedback loops come into play. All the old traders knew that at heart; it’s really only in this century that the economists and modellers have become the majority — perhaps it’s something to do with the primacy of science in our time, the exemplar of our modernism. It reminds me a little of how much emphasis was placed on developing a Grand Unified Theory in physics. Traditional scientific practice, generally, wants to try to explain everything, in an elegant and pared down manner, something which doesn’t apply very well here. Perhaps those who look in probabilistic areas are more on the right track but in the end it won’t make you more money. Mandelbrot is the most interesting to me in this area, but even he admits that his models aren’t useful for trading as much as having a stronger sense of the risk involved.
Trying to predict markets is exactly like predicting weather, in that you can have some sense of general trends, but you have no real idea how it’s going to shake out and you can only employ tactics (nail boards over your windows, get snow tires, have rock-solid stops, etc) to deal with the situation. If you were to trade the weather, you’d have some idea of general trends (forecasters are fairly good at predicting short and medium term weather), but occasionally you’d get bonked on the head by a storm you didn’t see coming, and you’d have a hell of a time predicting weather in the long-term. If it was sunny for the past month, you wouldn’t necessarily assume that it would be sunny for the next month. And there’s an element of cyclicality in weather, that exists in markets — you have the cyclicality of seasons, but also larger cycles in weather that occur over years and decades. Perhaps it’s not surprising that Mandelbrot’s fractal mathematics has been so effective in modelling both natural weather patterns, geography and financial markets.
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Posted by Nelson Yee
He’s macher, you’re minor.
December 15, 2008Sacha makes a really good point about the Madoff scandal and Ponzi schemes:
The irony is that banks functionally perform as a ponzi scheme - if everybody decided to withdraw money from a bank at once, that bank would collapse. Typically banks have equity of about 1/10th of their liability portfolio (liabilities in this case being customer deposits) so if every customer of the Bank of Nova Scotia started to pull their cash out, you would see a bank collapse in Canada in short order. It’s the confidence that people have that their money will be there tomorrow that keep these institutions afloat.
Later: A first-hand account of getting screwed by the longest con. One of the interesting things about that article is that according to the the author, they sold their house at the “peak of the market”, and then promptly ploughed it all into a single fund — I mean, I’m not a huge fan of total diversification, in the sense of investing in a basket of everything, but jeez. It’s also a good reminder that you have to be on guard constantly when money’s involved, unless you don’t really like having the use of it. I mean, you can’t kill yourself over the occasional bad or stupid trade, but when you’re risking your entire bankroll, you might pause a little longer before you go all-in. (How did that turn into a poker analogy?) I wonder if they thought they were being clever by selling at the peak, only to go and do that?
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Posted by Nelson Yee
Pin the butterfly
December 10, 2008As time goes on, this blog has really become a personal clearinghouse of articles that mirror or enhance my own philosophy about financial markets — strangely enough, I’ve found my old writing quite informative when I go back, and I like being able to see the evolution of my opinions and beliefs about the markets. It’s a little like a collection of maxims that I’m writing to myself, but hopefully helpful to others who happen by here.
That’s all to say, here’s another article about being leery of “science” with regard to trying to determine laws that govern markets, by Emanuel Derman. It’s interesting to me that he got into finance from a scientific background but has, over time, realized the inability science has to be applicable to market behaviour. It still strikes me as a bit weird to spend a great deal of effort back-testing and discussing probabilities in the context of markets; at the heart of it, good trading or investing is still incredibly subjective and depends more on horse sense than anything else.
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Posted by Nelson Yee
The skeptical inquirer
December 8, 2008Here’s a good article by Michael James about the need to be skeptical of experts. My own natural deep skepticism means I tend to be wary of experts anyhow, but it’s never bad to reiterate it. There’s always a side of every human, however small, that is a herd animal and wants to have it easier or to depend on someone else’s thinking — we take shortcuts, which has helped us but can also hinder us, especially in areas like investing and trading. (And in politics: the hype wave of Obama’s campaign was a lot like a bubble, with all that entails.)
On a related note to that article, I haven’t found a mechanic I totally trust, but that might just be because I hate upkeep on a car; I can’t stand certain ski shops for a similar reason — I’m still a tightwad, no matter what I’m doing. I did find a terrific dentist, though, after going through a slew of mediocre ones that insisted on various procedures or dental accoutrements that I was pretty sure I didn’t need. By cross-referencing the recommendations between various dentists, I found zero agreement on the work I needed done; I later found out from a dentist couple that this was not uncommon, the overzeal in recommendations for work. The difficulty here in all these industries is that it’s both more profitable and better from a safety standpoint to keep recommending “preventative work”.
The Michael James article seemed to coincide with thinking I had done after reading Noreen Rasbach’s latest column in the Saturday Globe where she wrote: “…it’s always smart to hear what the experts have to say.” Say what? I actually feel the exact opposite — there’s been too much hearing-out of “experts” that have gotten us into trouble. Soon after, I saw an advertisement for CBC Television’s business news program called “The Bottom Line”, which purported to give you advice and tips on how to protect your bottom line. And it struck me how strange it was that we rely on news and talking heads to give us direction. It’s incredibly hard to not be swayed by media, whether mainstream or independent, and there are too many hidden agendas for expertise to be taken at face value. Every day, perusing tens or hundreds of articles, I see experts making predictions, forecasts and basically flapping their lips because that’s what they do — they are people that create filler for the news media, for the most part, so that the terse newswire snippets can be customized into “journalism” (i.e. a story). The average journalist (at least in business news) is often a poor filter, and is looking for nice quotes to pad out the word count. That sounds harsh, but I think ultimately that’s the truth. I don’t know if there really is a way to avoid hearing the words of experts, but my sense is that you have to keep reading, and let the various voices, some dissenting, percolate through your mind until you’re getting the essence of the news, the factual portion that can be acted on. It’s avoiding short-termism, opinion and the herding instinct and seeing the bigger picture. I attribute my ability to act earlier than most on the slide in various markets to this wider view, but ensuring that I keep that perspective constantly is definitely the hardest part of the job. Even now I wonder if I’ll succumb to listening to the pleasant stories of analysts, pundits… “experts”.
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Posted by Nelson Yee
Fail to compose
December 27, 2008I really like this bit from Steve Randy Waldman: