Sunday, 31 January 2016

Breaking the trading routine

19:11 Posted by The Thalesians (@thalesians) No comments

Routine. The drudgery. The predictability. The sheer monotony. In all my years, I can't recall reading the words, "I dream of routine". No one enjoys the sense that everything they do is routine. However, a modicum of routine helps to give life at least some structure.

Those occasions when we break from our routine, are in a sense what makes it all manageable. A stroll through a new environment, the sight of a painting you've never seen, the sound of song being played on the radio for the first time: the freshness of novelty is intensified when it is a comparatively rare experience. If we are repeatedly surprised by the novel, far from enriching our viewpoint, it suddenly becomes commonplace and routine, a dull and underwhelming experience. Bertrand Russell describes this idea very well, in his book the Conquest of Happiness.

Markets are both routine and novel. At times price action seems boring, range bound and directionless. News seems to do little to move prices. Of course, these periods are never permanent, and are often preludes to a shift in sentiment. I remember, when I quit my job in 2013, FX markets seemed to be on inescapable path to lowering volatility, accompanied by declining lack of interest. The dollar rally started in earnest as Autumn came in 2014. Volatility spiked and currencies actually started to move.

Is a routine or a novel market better? It depends on our strategy! If we are a carry investor, lashings of volatility accompanied by risk sentiment that swings around like a yo-yo are unlikely to be a joy to behold. By constant a trend follower much prefers markets where volatility is picking up, which are often accompanied by the development of trends.

We can complain all we want that the market environment is unsuitable for our specific trading strategy. We unfortunately don't get to choose the market which faces us. It is like complaining that you feel cold whilst strolling through the park during a particularly brutal winter day, when you haven't bothered to wear a coat. Rather than saying the market is unsuitable for our strategy, maybe we should instead think about it the other way round: whatever trading style we are adopting isn't suitable for the current market.

If our time horizon is very long, and we are not massively leveraged, we may well be able to stick it out in an "unsuitable" market. If we have developed a systematic trading strategy we might find that historically that periods of under performance occurs at times, but as a whole, the strategy is still profitable over reasonable time periods. However, with high levels of leverage and very concentrated risk, we don't have this luxury, and need to to think about what we can do to alleviate the situation.

So which is better, the novel or the routine? Sometimes we can't choose between the two, and simply have to deal with it.

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our Meetup.com group for more details here (Thalesians calendar below)

08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
16 Feb - New York - Thalesians/IAQF - Harry Mamaysky - Does Unusual News Forecast Market Stress?
29 Feb - London - Jessica James - FX option trading
21 Mar - London - Robin Hanson - Robin Hanson, Economics when robots rule the Earth
13 May - Budapest - Saeed Amen/Paul Bilokon - Thalesians workshop on algo trading at Global Derivatives

Saturday, 16 January 2016

Mitigating Risk, Managing Uncertainty

16:21 Posted by The Thalesians (@thalesians) No comments

Happy new year! If you're in markets, the new year has been anything but happy. The markets have greeted the new year with more than a modicum of scepticism. Crude oil has continued to trade very poorly. Equities have sold off significantly since the start of the year, mirroring the behaviour of August's sell off. Elsewhere, in FX, risk aversion has gripped the market. The high beta currencies in G10 FX have got trashed. EM has also been hit hard. The market has also been thinking about "one off" events such as Brexit and also to a lesser extent the breaking of the Saudi peg.

In a sense, this whole period has brought to the fore, the fact that a trader's job is literally to manage risk, trying to minimise downside risks and at the same time being able to capture the upside. The difficulty is that whilst in ordinary times "risk" might seem benign, this job can be much easier, during risk aversion, traders are faced with an explosion in volatility. This can make it difficult for traders to stick to their goals, even if they happen to be on the right side of the trade. Short term volatility can force traders out of positions which are fundamentally sound, but still come under stress, when the markets switch from seeking yield to wealth preservation in periods of risk aversion. When it comes to "one off" events, such as Brexit, we cannot simply use probability tools to understand the risks, we also need to use our judgement and an element of qualitative analysis.

So what should we do? Luckily, on Wednesday at the Thalesians in London, Nick Firoozye, a Managing Director at Nomura International and heads of a global team in cross-product derivatives research, will be doing a presentation on exactly this subject of uncertainty and risk. I must admit it's more a product of coincidence that the talk will be happening at this time of market turbulence, rather than some element of foresight on my part! Nick will be talking about his new book "Managing Uncertainty, Mitigating Risk - Tackling the Unknown in Financial Risk Assessment and Decision Making" and also signing copies. In his book, he stresses that we cannot simply use conventional probability to understand uncertainty in finance, and instead we need to seek understand the mathematics of uncertainty. He introduces concepts such as uncertain value-at-risk (UVaR) in the book, which helps to incorporate expert's insights into a risk framework.

I am looking forward to Nick's talk and hopefully see you there on Wednesday, if you can make it!

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our Meetup.com group for more details here (Thalesians calendar below)

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - Robin Hanson, Economics when robots rule the Earth
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
29 Feb - London - Jessica James - FX option performance (TBC)
21 Mar - London - Robin Hanson - Robin Hanson, Economics when robots rule the Earth

Saturday, 9 January 2016

I haven't got the foggiest data

16:46 Posted by The Thalesians (@thalesians) 2 comments

The first full week of the year has passed. Christmas decorations have come down. Lazy morning starts are fading from memory. In their place, has come the hectic tempo of early morning commutes to work, the flip of 2015 to 2016 in the calendar, that feeling of starting all over again.

In markets, the volatility which had been absent over the holiday period, has returned. The first week has seen stocks sell off, in particular in China. Whether the Shanghai composite is of key importance for world markets is another question (after all, international markets mostly ignored their bubbly rise last year and Chinese stock market is dominated mostly by local retail investors). Geopolitical tension has increased in the MidEast, which only failed to stop crude oil's continuing decline for a couple of an hours.

Does the first week of the year in markets have any significance on the rest of the year? I recently ran a simple test, plotting the returns from S&P500 during the first week against the rest of the year. Whilst in the past decade there was at least a passable relationship, in the decades before that, it's very difficult to spot any relationship. The difficulty is that we have a comparatively small number of points to test this idea upon, given a trading rule would involve only one trade a year.

We can come up with other examples of this limited data problem in markets. For example, if we are trying to create a model to estimate when (or if) a managed currency might experience a sudden regime change. Rather than attempting to precisely time such a difficult binary event (which is near impossible!), we can instead try to build a probability distribution for that event. In our managed currency instance, we could look at central bank reserves data and other critical economic variables. We can then compare the market pricing for such an eventuality and compare to our model. Indeed, this approach looking at market pricing and also modelling other market variables is the approach I took in recent research on the peg of USD/SAR (see my interview here on the subject).

Should we never do analysis when we have very small amounts of data, given the problems? I would argue not. Once we have a probability assessment of our model, we can then overlay our own judgement on top of that and compare to market expectations. Analysing very small datasets might help us see a bit further into the fog of the future: after all it is likely better than doing nothing! At the same time we need to cast a critical eye on the output of our analysis.

Like my writing? Have a look at my book Trading Thalesians - What the ancient world can teach us about trading today is on Palgrave Macmillan. You can order the book on Amazon. Drop me a message if you're interested in me writing something for you or creating a systematic trading strategy for you! Please also come to our regular finance talks in London, New York, Budapest, Prague, Frankfurt, Zurich & San Francisco - join our Meetup.com group for more details here (Thalesians calendar below)

20 Jan - London - Nick Firoozye - Managing Uncertainty, Mitigating Risk
29 Jan - Budapest - Robin Hanson - The Age of Em: Robots
08 Feb - London - Saeed Amen/Delaney Granizo-Mackenzie - CTA/Pairs trading (joint Thalesians/Quantopian event)
29 Feb - London - Jessica James - FX option performance (TBC)
21 Mar - London - Robin Hanson - The Age of Em: Robots