Friday, 26 September 2014

If you start(up) me up

11:25 Posted by The Thalesians (@thalesians) No comments



Music began with the heartbeat. Every one of us has rhythm, every moment of our lives, that heart beating, whilst time cascades on, a visitor whose sojourn among us is briefer than any of us would like. And so, as our heart beats on, through the music, we hear our heart whispering thoughts and dreams of change.

Our mind seeks to ignore. Our mind seeks to keep our life on track, along some journey it believes is pre-defined. Keep going, keep going and that goal will be reached, it mutters. Yet, what if that goal is illusory, simply some manifestation of what others desire? It is so easy to fall in love with time, simply watching it drift away. So obsessed we become, that the notion of change falls away out of view, some strange distraction from watching the seconds hand of our life's clock, tick, tick, tick away. But sometimes life needs change, it needs risk, it needs the cajoling comfort of certainties to dissolve away.

Change as a concept can feel hostile. It is the force, which seeks to break apart. The force which alters the course of our present journey. I have always had an odd relationship with change. When it comes, I adapt and seek to make it work. Yet before it arrives, it is sometimes fear which envelopes me and I seek to avoid it. The most difficult part of change I find is to embrace it, when my journey has been relatively comfortable. Why alter the path, when everything seems to be going well?

I faced this quandary just over a year ago. My life seemed comfortable. I had a job which I enjoyed, working at a large investment bank in the currency markets. I wrote for clients deciphering the quantitative side of market. I also had exposure to the bank's P&L developing systematic trading models traded by the desk, a crucial link to understanding markets. The process of learning in financial markets is so much clearer, when you feel some feedback of P&L. You cannot backtest pain, you can only feel it. I still loved (and do love) markets, as I am sure do many of you reading this. I felt and still feel that I am too young to throw away the thrill of the markets. However, I felt that after a decade in banking, I could apply my knowledge in a more independent capacity. That required that crazy little thing called "change", that concept which I had failed to grapple with before.

I had co-founded the Thalesians several years before, with several friends, primarily to do finance seminars alongside my full time job in banking. In essence, it was much more of an educational venture than a company. However, could I develop it into a fully-fledged start-up, specialising in research and consulting in systematic trading, if I went full time? Usually, I would shy away from change, unless it greeted me first. This would be one of rare occasions, when I would seek out change from its place resting in the future.

A year ago, I did it. I resigned. The first time I had willingly left a job. My sojourn at Lehman Brothers has ended rather more abruptly after the bankruptcy. Once I started working full time at the Thalesians, suddenly, I had to decide what to do, it was no longer a question of . I researched. I sold. I wrote (a book).

In this past year, I have realised that “change” can actually be good, although the journey can be an arduous affair. The experience also highlighted what I was successful and somewhat less successful at in my previous jobs. Sometimes, the environment of the trading floor can be intoxicating. It is the ideal environment to absorb markets. However, such absorption can be too successful in a somewhat blinding way. After a year, though I feel that the fruits of my work have slowly begun to show, most notably through a partnership between the Thalesians and RavenPack, a news data vendor.

Furthermore, the past year has made me realise that being able to “change” as a concept is central to financial markets. The most difficult aspect of trading is not so much having a view. Rather, it is having the ability to see that the view is now wrong and needs change. There is a subtle line between being right and being stubborn. It is when these two concepts are able to balance one another that a trader becomes successful. This applies both to systematic and discretionary traders, who become too wedded to an approach of trading the market or to a particular position. Being the doom-sayer forever in markets, might well bring fame, yet it is unlikely to bring profitable trades in the long run (I admit that phrase is the most loaded of terms in the financial lexicon).  Moreover, it is perhaps one of the most difficult decisions to make in markets deciding when the time is right to abandon a strategy.

Change can be good. Fear can be good. Yet, always siding with fear against change, is a mistake. I’m glad for once, I gave change a chance. Change doesn’t mean having to do a start-up, although for me it has. It simply means an ability to change the unknown to the known. I leave with you a few words from the Rolling Stones, who seemingly have a knack of enveloping a somewhat complex sentiment in relatively simple lyrics. Somewhat paraphrasing them, if you start and you’ll never stop, but first you must start.

If you start me up
If you start me up I'll never stop
If you start me up
If you start me up I'll never stop
I've been running hot

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 topic (mixed in with a bit of ancient history). You can pre-order the book on Amazon.

Friday, 19 September 2014

Lehman Brother can you spare a yard?

23:39 Posted by The Thalesians (@thalesians) No comments

It has been six years ago this week, when I could say that green was our colour. It wasn’t a bright green, but a dark, somewhat dignified green, like the shade which adorned British racing cars for much of the twentieth century. It was the green of the leaves of Californian redwoods, standing in the way of the winds for thousands of years. It was the green of the grass, rising up from the rich soils of the prairies of the Midwest and the cotton fields of the Deep South. It permeated all around, carefully threading its way through the carpets, upon the upholstery of the chairs, up the walls of marble meticulously veined with streaks of white, on the booklet covering my business cards.  Maybe green was our colour, because our competitors were envious that we were so good or at least that’s the impression you would have listening to our management.

I never found out for certain, but most likely I suspect green was our colour as a nod to the fabled greenback, the American dollar. Those crisp green banknotes were partially composed of cotton, that commodity we traded over one hundred and fifty years ago. Each one of them emanated from a printing press in Washington DC, telling a story of the American Dream, of great Presidents, from Washington to Lincoln, who built the American nation, through independence and the pain of Civil War, freeing the nation of slavery. They were Uncle Sam's gift to the world: the object of our desire, our raison d'etre and our purpose was to accumulate as much of them as possible. Lose a million of them in a day, then luck could be the only blame for us, but gain fifty million of them in a year, then genius beckoned, along with adulation. You were the rock star whose audience was the trading desk. Together, we could make millions, no billions or as we called billions in the financial market slang: yards. Whilst billions and millions sounded similar, saying yard was unambiguously different and made the amount of money somehow more real. Supposedly the term yard was derived from the French for billion, milliard. Throughout the boom years, like our competitors, we ran through “yards” and “yards” of profits, the alchemists of the early twenty-first century, but we had seemingly found a way to make gold, unlike our predecessors.

Our leader was the man, the man with millions to his name, who signed his e-mails to us with simply, Dick, scrawled in his own hand, his signature forgoing the use of his surname Fuld. He didn't need two names: he was like a rock star, needing simply his first name to make him recognizable, like Elvis. But he was our Elvis, the man who'd been with us since the time when Elvis himself was the cream of Las Vegas and man had first walked on the moon, in 1969. When he eventually left the building, so had we. He was the man who clearly told my graduate class, that one of his proudest moments was overriding his whole board, to bring back smart dress, after a brief experiment with business causal. For him, appearance was paramount: the fine silk ties on our necks, the slick suits carefully tailored, the polished black leather Italian shoes. This carefully crafted image was perhaps designed to set us apart from the rest of Wall Street. We were Goldman's number one rival, or at least that was the notion which was cultivated by management. We were supposedly as good as them, but with a green tint, although our undoing ultimately proved this not to be the case.

As well as explaining his sartorial preferences for us, he also told us that we survived the crisis of 1998, the Russian default, which nearly destroyed us. We overcame the tragedy of 9/11, clocking up one hundred and fifty years of service. We strove to regain our independence from American Express, gaining it in 1994, when we were spun off back into an independent company. In amongst all this, there was always chatter on Wall Street, even in the bull years, that we were too small, that we would ultimately lose our independence once again.

I started working there, my first real job out of university, in the summer of 2005. In less than a month: I had received news that I had attained a first class honours degree from Imperial College whilst on holiday in Boston; heard that my hometown London had been awarded the Olympics on return; been in London during the terror of the bomb attacks, before finally starting on July 14th, which was coincidentally Iraqi Independence Day (and also coincidentally Bastille Day for the French). I’m British and of Iraqi origin, the birth country of my father and mother. Maybe it was a sign that my life was changing on such an auspicious day, in the same way that Iraq had changed that same day in 1958. So the rigours of work began, that July 14th, sweeping away the academic freedom and dreams of university. There were first a couple of weeks of training, a time also for posturing amongst the graduates, to secure a role on the most popular trading desk and also to get to know our fellow graduates, some of whom became good friends.

In our graduate intake, the Holy Grail, the place where we all wanted to work, was the collaterised debt obligations desk or as it was known more succinctly the CDO desk, which had apparently discovered a mystical way of printing greenbacks. I even bought a book all about these new-fangled credit derivatives, hoping it would help me gain the edge. I never ended up reading that rather expensive book. I never even managed to get past the first stage of the interview process: I was never destined to be a hotshot CDO trader. I was disappointed. I continued my rotations around other such fashionable desks, such as the equity derivatives desk. It was always the derivatives desks, which were of interest to our class, for they were the ones making the most money. In the end, I secured a job at the comparatively staid foreign exchange desk, doing research. It was not the most fashionable of areas, dealing mostly with one of the most vanilla of products, foreign exchange spot, simply buying one currency and selling another. In the process, I had turned down a role as a trader on the fund derivatives desk, a role which sounded attractive, having the fabled derivatives postfix. 

However, I had little inkling of what it precisely involved, which looking back on it, explains my reticence in joining that desk. By contrast foreign exchange was more tangible, it was something familiar, at least to anyone who has traveled abroad at some point. After all, even I knew what dollars, pounds and euros were and I had even handled them in my hands. The currency markets had been trading as they do today since the early 1970s, when the dollar was allowed to float by Nixon. The role of currency changers had been around in some form, for many years, as long as man has traveled. So maybe if a market had been around for that long, it served as sufficient proof that it would last throughout my career.

In return for the early 6.30am starts every weekday, waking up in dark in the winter and leaving similarly shrouded in darkness, I was rewarded with those greenbacks. Once a year, I would be called to Jim's office, for a chat, where I would be handed a paper. On it would be my salary, which I already knew, and next to it my discretionary bonus, the figure I had been waiting for, all in dollars, but kindly converted into sterling at some aforementioned exchange rate. I always preferred to read the figure in dollars, because numerically it was always bigger, somehow making me feel I had been paid more. As Jim, my boss, would read the number, in his relatively soft American accent, he would ask what I thought of the figure. I usually didn’t say much, but as the years passed, I would voice more of an opinion during these chats with Jim, which was widely nicknamed the “comp discussion”. Contrary to popular believe, not everyone was paid millions there, although internal documents made available to the public later by the Los Angeles Times, showed that more people than I expected were paid such amounts. Obviously, as a junior I never was one of this group.

The (somewhat less than serious) plan was for my career to evolve towards an apex which was meant to occur around the time of my thirtieth birthday, a time by which I would be able to retire and enjoy my life, swimming in a cascading waterfall of riches, a life that was a fairy tale of joy, enveloped in the love of a beautiful woman, preferably with long deep satin hair, a face like that of Shakira, a smile able wipe anyway any woes, who presumably would not be with me purely for my planned riches, whilst in the background the sounds of laughter would seem omnipresent. 

Today, a few years later, my hairline has receded considerably, somewhat prematurely I feel necessary to add, through a myriad of stress and genetics, although it’s impossible to decipher which of them is more responsible. I’m often told that the lack of hair is a result of an excess of testosterone (ladies, surely that’s an attractive trait, if you can ignore the shiny glow of my balding head beneath lights?). At times, I’ve shaved my hair to create an even feel to my head, which some (overestimate) have deemed as attractive, although admittedly it does give me the look of the famous EastEnders character Phil Mitchell, giving my usual smiley face an edge of seriousness. Grey hairs have also begun to seize their moment to shine in amongst the sea of those black hairs, which have successfully battled against baldness. 

In this state, with my status still very much un-retired, if such a word exists, I have started working full time at the Thalesians, a company I co-founded, still largely doing foreign exchange research, without a terrifyingly seductive woman at my side with a ring encrusted with diamonds grasping her finger, it is difficult to say that my tongue in cheek plan ever succeeded. But maybe that’s not the point, whether or not my plan came to fruition. The point is simply to have a plan or an idea, whether or not it succeeds. Without a plan or some hazy image of a destination in your mind, you are a traveler without a map and accordingly your progress is hampered. In any case, even if my plan did not succeed and years have toiled to whisk away my twenties, I’m still broadly happy, a result most likely to my close-knit family, I’m more knowledgeable than I was those years ago, I’m still yearning to learn, I can call upon close friends both in the good and more importantly in the bad times, so surely these are all things that I should be thankful for?

As the years passed working there, my interest in foreign exchange markets grew, learning mostly from my senior colleagues at Lehman in my team, such as Jim and Alexei, who as the name might suggest, was Russian, and also colleagues on the trading desk. True, reading books can give you insights into the markets, but are a poor second compared to working with willing mentors, whose years of experience are so evident. No one needs to teach you at work. No one needs to share his or her time. But some do and I was lucky to have somehow found myself working with people who did (and also did at Nomura, where I worked for several years after Lehman). For that I shall always be grateful. 

Our research team grew under the thoughtful leadership of Jim and the foreign exchange desk increased its profits in the years that I was there, ironically reaching record levels at the time of our demise in 2008, moving from a peripheral player to one of the major currency dealers. In spite of the success of our desk, in the summer of 2007, we could see problems within the company as a whole. I remember distinctly during that time, we had a meeting, more commonly known as a town hall. Town halls were essentially large-scale presentations, where traditionally, we were told how successful our company was by someone senior, roughly once a month. He (for the speaker was nearly always male) would stand in front of a screen of illuminated PowerPoint, with charts peppered with our trademark green colour, relating to profits, which always seemed to be composed of rising lines.

This town hall was different. The specter of the subprime crash had reared its head and the markets had begun to take note. There was chatter that we would suffer, given we were the ones with massive exposure to the US property market. We were reassured, that we could survive a year, without tapping markets for funding. That proved correct, although not in the way we would like it to be. The company declared bankruptcy just over a year later in the middle of September 2008, so in a way our presenter was right.

In the end, our company collapsed, when we failed to persuade the US Treasury to spare us a couple of “yards”, to bail us out. I do not wish to enter into the debate of whether this decision not to bail us out was right or wrong, even though many other institutions were bailed out during the financial crisis. It has now happened. It is far more important to acknowledge, that our institution failed because of the actions of some of those people who worked there, rather than complaining that we were not bailed out.

The cause of our failure was excessive leverage, a deliberately fancy way, of saying our company borrowed too much to gain exposure to a US property market which collapsed.  Strangely, the experience of our failure, although shocking, didn’t seem to hurt me, most likely, because of other issues at home, which illustrated what really is important in life: the loss of a job, a salary, a few company stocks weren't those important facets of life. I also managed to find a job relatively quickly afterwards, another important reason for me to avoid complaining. 

I remember my last day there at the end of September 2008. On the address system, a loud message was delivered to the members of the fixed income division, which included the foreign exchange desk, to assemble in the auditorium. We knew what was coming, given the company had already filed for bankruptcy two weeks earlier and there hadn’t been any agreement for the purchase of our division by another company. Upon arrival, in the auditorium, the bankruptcy receivers announced that we were fired and we should vacate the building by the end of the working day. I wondered how many times the team of receivers had delivered this news to employees of a bankrupt institution. For them, it was a regular occurrence I presumed, a necessary consequence of working in the field of bankruptcy. For us, that was it, a clear change in our lives, rather than some purely administrative process. We all left the building, carrying white plastic bags or boxes, filled with the detritus of years of employment there, including peculiarly, in my case, an emergency evacuation kit, emblazoned in that green colour. I still have it somewhere, some place; a memory stored in a dusty box, in a cupboard, its contents decaying with the passing of time. It was as though taking it was somehow compensating me for what had happened.

One strange side effect of the bankruptcy was that I started to go to the gym regularly, rather than halfheartedly. This seems to suggest that if you want to lose weight, work for a company, which will want to go bankrupt, although as mentioned earlier, you might also lose your hair at the same time.
The bankruptcy did also have another effect, apart from conditioning my weight and what can be optimistically termed as toning my muscles via a sojourn at the gym. I remember whilst working there, people outside the banking industry never knew the name of my company. But after the bankruptcy they did. After all, we were the biggest bankruptcy of all time, which tipped the world into financial crisis, which has lurched ever since, becoming superseded by the Eurozone crisis. But clearly, whatever, weird positives I draw from the bankruptcy, they were massively outweighed by the negative impact of the whole episode on the market and more importantly the subsequent follow through into the wider economy, on people who had nothing to do with Wall Street.

On a personal level, I made many friends there, who to this day are some of my best friends and as such I don’t regret choosing to work there. I shall always look back fondly on my time working there, as a Brother, one of the Lehman Brothers, even if it ended in a way I had never wanted. 
A mistake is only a mistake, if you regret making it, otherwise it’s called an experience. Has my plan changed now? Yes, now the plan is to create the perfect burger, they taste better than greenbacks.

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 topic (mixed in with a bit of ancient history).

Friday, 12 September 2014

Great Scot! Vol over the Scotland vote

14:33 Posted by The Thalesians (@thalesians) 1 comment

For much of the summer the market had largely been looking at the Scotland referendum as a relatively low risk event. Common wisdom was that the vote would likely be "no". What binds is more than what separates? Perhaps another factor was simply that it was just too far away for the market, as evidenced by the relative lack of media coverage outside of Scotland until recently.


However, market expectations clearly changed with the YouGov poll in last week's Sunday Times (7th Sep), which showed the "yes" vote in the lead. The immediate market reaction was to dump GBP and buy GBP vol as soon as markets open on the Sunday evening (see chart which illustrates the different reaction of GBP/USD implied to Scotland news to EUR/USD implied). Since then GBP has managed to recover to some extent, helped by some new polls which suggested "no" was in the lead. This leads us to the question of how precisely can we quantify the market risks of such a scheduled event? One way we can do this is by looking at implied volatility as a measure of the market's expectations around the future risk of any asset. Implied volatility is after all a function of not just the general volatility environment but also the expectations of realised volatility around future scheduled events.

Typically, before scheduled events, vol market makers will mark add-on weights for these events. For the US employment report this amounts to around 3-4 vol points on an overnight EUR/USD. The precise figure obviously depends on the market demand around dates and the general importance attached to the event by the market. Generally speaking, if say the US employment report has been a non-event the last few times, the market might not be as keen to bid up vol around an event. The converse can also occur. Given the impact of the scheduled event will be unknown, the market's event implied vol add-on associated it will obviously be an estimate.

As a result, implied volatility over such events generally tend to exhibit a large risk premium. In other words, implied vol tends to be higher over these events then realised volatility.More broadly, implied vol tends to be higher than realised volatility, but the presence of scheduled events can widen this difference (see Thalesians - What's in an event - Understanding FX implied vol event add-ons - 03 Nov 2013). We could argue that because the scheduling is known, market participants might overemphasis hedging its risk over these dates. (You won't get fired for paying up vol over payrolls, but you might be fired that one time realised explodes!)

We can attempt to monetise risk premium via gamma trading (see What's gamma trading - 22 Jul) from the short side (see Thalesians - Gamma, gamma, gamma - Explaining gamma trading in FX markets - 14 Apr 2014). We must be very careful how we do this, given that the returns from such a strategy can be skewed. We also need to consider all sorts of trading issues, such as delta hedging, when we run such a strategy. A failure to do could result in much deeper drawdowns on those occasions when realised volatility really does outperform implied.

In the case of Scottish referendum, unlike the US employment report, there are very few comparable precedents. We can for example look to UK general elections. However, the nature of this referendum and general elections. One of the closest similar events is the Quebec referendum in 1995. Admittedly, even the Quebec vote was very different and clearly a sample of 1 is not enough to make a proper statistical comparison.


The difficulty in pricing the event means that traders will demand a much higher event vol add-on than for an "ordinary" event. Even if the probability might appear "low" of a "yes" vote, the tail risk is clearly something that traders needs to be compensated for. Complicating matters is also the way that poll results have become "vol" events, which traders should mark in their vol calendars (if you're a vol trader and you don't do this, someone else will and you'll be left holding the bag!). To some extent, this can also help us, giving us more "similar" events to extrapolate from. We could also examine realised volatility over the release of various polls, to give us a hint about how price action could behave (with the caveat that a poll is not as important as the actual referendum).

Whichever way you look at it, pricing vol over the referendum date and even leading up to it, is extremely challenging, given the lack of past comparisons, but we can at least try!

To read more about this topic please see the below work I've done on systematic gamma trading and quantifying the value of events in vol terms. My book Trading Thalesians also has some colour on this topic (mixed in with a bit of ancient history).

Thalesians - Gamma, gamma, gamma - Explaining gamma trading in FX markets - 14 Apr 2014 (available for Thalesians clients only)
Thalesians - What's in an event - Understanding FX implied vol event add-ons - 03 Nov 2013 (available for Thalesians clients only)

Friday, 5 September 2014

I heard the news (analytics data) today

11:09 Posted by The Thalesians (@thalesians) No comments

It's perhaps a clich├ęd question to ask what is your favourite Beatles song? Ask most people and they'll reel off one of the well known tracks. Surely, "Yesterday" is one of these. Perhaps "Ticket To Ride" with that infectious guitar riff. Perhaps "Hey Jude", the piano chords waltzing in the background underneath Paul McCartney's vocals. However, one of my favourites is "In my life". It's a wonderfully simple track, only 2 minutes 27 seconds long, a track which most of you are unlikely to have heard.

I'm listening to it, whilst my fingers pulse the various keys on this keyboard, John Lennon's voice coming from the right of me, harmonies from Paul McCartney and George Harrison, punctuated by Ringo Starr drumming through my left speaker.Another Beatles track also seems to linger in my memory, namely "A day in the life", which has several contrasting sections. It begins with the line:

I read the news today, oh boy

It's perhaps a line which can resonate with everyone who follows markets. We hear news, we react. That's what we do in markets, we read the news and sometimes our reaction is simply "oh boy". The problem is that these days there is so much information from markets. Not only do we observe market data in its droves, but news data seems to multiply endlessly.

Before, maybe it was just newswires. Now the web is awash with blogs and other market moving commentary. Then we have Twitter too. It is impossible for a human to look at every bit of news and interpret it. The news gathering process becomes a matter of prioritizing what is "important" and what is "irrelevant" news. Sometimes however, news can slip beneath the your radar, only to suddenly tip the price action later. At other times, price action reacts almost immediately such as after payrolls data. The signal seems subsumed by masses of noise and can often be interpreted in so many different ways. Take for example the picture above, which I took a few months ago in a Budapest gallery. What I see in it, could be very different to what you observe. The same is true of markets. However, there is also a crucial difference in markets, there is only one "correct" interpretation, that of the price action!

So what can we do in this challenge to interpret news to extract that signal from in amongst so much noise? One solution is increasingly to look at news analytics. Data vendors essentially parse the news and then output summaries of news articles/blog posts in an easier to process format that can be read in a systematic fashion. One of the most well known is RavenPack, who have recently sponsored some of my Thalesians research, specifically to investigate how news analytics data can be used to trade markets. I found that news data could be used as a filter for FX carry (see results below - and ask me for a copy of the paper if you are interested, I am also offering a free subscription for shortened versions of Thalesians quant notes). Obviously, there are many other uses, but this is just a single example.


Compared with other data sources, news analytics is a relatively new area. Even amongst those who are aware of the idea, a lot of people can be dismissive. To some extent, this is good news if you want to trade off it! If a data source is relatively underutilised, strategies based on it, are unlikely to be as crowded. Furthermore, if it takes time to develop an algorithm to extract alpha from a data source, it also reduces the likelihood of crowding around a signal. Having spent a considerable amount of time analysing news analytics for trading purposes, it also seems apparent that there are numerous ways of trading on the data. Again a good point for reducing crowding around a specific strategy.

So next time you think you haven't got enough time to read the news, consider using news analytics. The last thing you want to be doing is reading the news, only to realise you've missed something and mutter "oh boy!".

To read more about ideas about using RavenPack news analytics data see my Thalesians quant paper listed below. My book Trading Thalesians also has some colour on reading through the noise when trading (mixed in with a bit of ancient history). Pre-order on Amazon UK here and Amazon US here.

Thalesians - Carry the news trade - Filtering FX carry using RavenPack news analytics - 2 Sep 2014 (Ask me for subscriber details! Shortened versions of my papers are available for free. Given this is a sponsored paper the full version is available free on request!)