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  • Momentum overpowers value investing in Aussie market

    This piece in the AFR is currently doing the rounds with various people trumpeting that this is what they do so they are a genius. To be fair without actually seeing the original Morgan Stanley report or understanding what they did any comparison between different methodologies is profoundly limited in its utility.  

    Momentum overpowers value investing in Aussie market
  • Where Is The Money?

    One of the frustrating things about being a trend follower is that it takes time to overcome the inertia of a new system, particularly if that system is based upon slightly longer time periods such as weekly data. Part of the frustration that traders encounter is based upon the simple mechanics of how systems work.… Read more…

    Where Is The Money?
  • GBP Flash Crash Investigation Report

    On October 7th 2016 the GBP suffered a minor aneurysm and dropped like a stone for a short period of time as seen below. The Bank of International Settlements had just released a report into possible reasons for the crash. You can download the full report here.  The executive summary  outlines a constellation of  reasons… Read more…

    GBP Flash Crash Investigation Report
  • Another Day At The Office

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Recent Articles

Momentum overpowers value investing in Aussie market

This piece in the AFR is currently doing the rounds with various people trumpeting that this is what they do so they are a genius. To be fair without actually seeing the original Morgan Stanley report or understanding what they did any comparison between different methodologies is profoundly limited in its utility.

 

Where Is The Money?

One of the frustrating things about being a trend follower is that it takes time to overcome the inertia of a new system, particularly if that system is based upon slightly longer time periods such as weekly data. Part of the frustration that traders encounter is based upon the simple mechanics of how systems work. A system that is correctly designed takes its losses quickly and allows its profitable trades to simply roll along. This results in the system instantly going into drawdown and it is this drawdown that causes traders to develop friction with their system. This friction often leads to tinkering as they attempt to force the system to give them something it cannot give. This is exacerbated in times of a flat market – you cannot force returns from a market. The All Ords of late has not really been a stand out performer as can be seen from the chart below the market has been slowly grinding its way up in a broad channel.

Ords

With this in mind I thought I would look at the yearly returns for the various stocks within the All Ords – so I found some data on their percentage returns and stuck it into a frequency histogram to see what the performance of individual stocks looked like.

Frequency

I have a arranged the data into a serious of blocks and did a count of the number that fell into that category. I also calculated the average performance of the group which for this period stood at 17.09%. However, if I drop out the 200% and above outliers this average value falls to 13.04%. As you might have guessed the majority of values cluster around the mean with a long right handed tail. This sort of distribution is common with stocks since we have unlimited upside but limited downside – a stock cannot decline more than 100%. Our psychology dictates that we are instantly drawn to the right hand side of the chart and the extreme outliers that occurred over the past year. And as traders these are the sort of trades that we hope ours might evolve into. However, in doing so we ignore that left hand side of the chart. The majority of stocks (60%) have below average performance. You may assume as a trend follower that this is not an issue since you would avoid these large losses and poor performance by the use of stops but that ignores the reality of the actual trading process. As a mechanical trader you will not incur these losses but you will burn time wading through these non performing stocks before you hit the ones that do perform. You waste time, a little bit of money and a lot of patience dealing with this mediocre performance.

My anecdotal experience has been that trading returns are made up of a lot of modest returns and a tiny handful of trades that do very well but to get to the ones that do very well you have to crank through a reasonable number of trades and you have to keep going. This is where the notion of emotional resilience comes into its own in trading and the ability not to tinker with the system hoping that it will generate these sorts of trades. Systems dont actually generate these sorts of trades – the market does so you cannot actually build a system with the preconceived notion that it will find you trades that generate a 500% return. What the system does do is generate a population of trades, most of which will be duds and hopefully a few large winners. But in the beginning all trades look the same.

 

GBP Flash Crash Investigation Report

On October 7th 2016 the GBP suffered a minor aneurysm and dropped like a stone for a short period of time as seen below.

GBP_USD 5 Min

The Bank of International Settlements had just released a report into possible reasons for the crash. You can download the full report here.  The executive summary  outlines a constellation of  reasons for the crash –

A number of factors are likely to have contributed to and amplified this market dysfunction. In particular, significant demand to sell sterling to hedge options positions as the currency depreciated appears to have played an important role. The execution of stop-loss orders and the closing-out of positions as the currency traded through key levels may also have had an impact. A media report released shortly after the move began, which would have been interpreted as somewhat sterling-negative, is only likely to have added marginal weight to the move as it did not contain new information. These factors appear to have contributed to the mechanical cessation of trading on the futures exchange and the exhaustion of the limited liquidity on the
primary spot FX trading platform, which encouraged further withdrawal of liquidity by providers reliant on data from those venues.

The presence, outside the currency’s core time zone, of staff less experienced in trading sterling, with lower risk limits and risk appetite, and with less expertise in the suitability of particular algorithms for the prevailing market conditions, appears to have further amplified the movement. Other factors such as ‘fat finger’ errors and potential market abuse cannot be ruled out, but there are little, if any, hard data to substantiate them.

The report is actually an interesting read if only from the perspective of educating traders as to how liquidity can slip even in a market as large as FX due to changing time zones.. The data below gives an interesting insight into how you can have a period of high trading activity combined with relatively low liquidity as markets shift time zones.gbp liquidity

Another Day At The Office


 

More On Being Wrong

There’s an academic I know — very well respected — who especially values one of his collaborators. This particular colleague isn’t invaluable because of his creativity or intellect, says my professor friend, but because “he is willing to tell me when I’m wrong, and that’s rare”. It is indeed rare. Perhaps even rarer is the practice of seeking out colleagues because they give frank criticism.

I certainly don’t enjoy being told that I’m wrong. And it seems that I’m not alone. A recently published working paper from Paul Green and Francesca Gino of Harvard, and Bradley Staats of the University of North Carolina, caught people in the act of avoiding criticism. The particular kind of criticism that interested the researchers was where I think I’m doing a good job, and then you tell me that I’m not. (In the jargon, this is “disconfirmatory feedback”.)

Green, Gino and Staats looked at data from an internal peer feedback process in a medium-sized company over several years. They were able to show that when disconfirmatory feedback arrived, workers would then avoid contact with the people who had given them the unwelcome comments. This is the exact opposite of my professor friend’s behaviour — but, I think, a much more typical response. We don’t like it when people tell us that we’re failing.

More here – Tim Harford

Gold Vs S&P500

I am still intrigued by the US markets reaction to the results of the US election when viewed in tandem with an instrument such as gold which is generally seen as a hedge against uncertainty (in this instance read outright dickheadedry) As such I though I would look at the relative returns of both instruments over a series of times frames if that told me anything about the market currently being uncertain about its own uncertainty. In looking at these two instruments I have cheated a little bit in that I am using a proxy for gold. I am using GLD which is an ETF that tracks the physical price of gold. I accept that this is a broad brush approach given the nature of the construction of GLD. However, I am looking for at a battleaxe approach not a rapier so the small inconsistencies dont bother me. I am more interested in looking at the broad pattern. If you have to look too hard then there is no pattern at all. If the relationship is not then when being as subtle as a sledgehammer then it is not there at all.

The firts thing I wanted to do was to look at the relative performance of the two since the US election and this can be seen in the chart below.

gld 1

My reading of this from left to right is that Trump wins the election and the long term rally that has been in place since 2009 reasserts itself with equities taking off and GLD drifting. A few weeks later the ramifications of electing a buffoon become apparent and the market stalls and GLD rallies slightly. We now have the situation where the market is rallying in the short term as is GLD. A cynic might suggest that trades are hedging their bets a little.

However, it is important to note that these sorts of performance comparisons are dependent upon the starting date. If I roll the starting date back a year a different picture emerges.The big picture alters every time you change the starting date.

gld2

We can see that GLD actually begins to drop off in the second half of 2016 as physical gold runs into a wall and begins to fall back. The out performance of the S&P500 over this time becomes even more apparent but the bounce in GLD is still there but the performance of the S&P500 is so much more apparent. This raises the question as to whether this sort of analysis whilst mildly interesting on an academic basis actually provides any insight that is worthwhile. Such a question also highlights a simple fact of analysis and of system design in general. Everything you do needs to add some form of value to the system. Unfortunately academic interest does not add value to a system so on this basis my feeling is that this sort of thing doesn’t add any value outside of curiosity and the vague conclusion that traders are uncertain about being uncertain. To be blunt you have to ask the question does it help make money since that is the aim of trading. For some it might but for me it just kept me occupied for half an hour.

 

 

 

Why Not To Listen To The Media And Brokers

A comment appeared in relating to this piece I wrote the other day and it deserves a fuller explanation. I will state at the outside that it is my contention that if you listen to the financial media and the sell side of the finance industry you will never get anywhere. And as a first step I recommend that everyone read Where Are The Customers Yachts by Fred Schwed. Now approaching its sixth decade it is still profoundly relevant.  In terms of broker advice as a source of recommendations upon which to build your wealth I thought I would look at an extreme example – Enron the US energy trading company that was in essence one giant scam. The trajectory of Enron’s share price can be seen in the chart below.

Enron chart

As befitting a company of Enron’s size it was covered by numerous brokers and you can see in the chart above I have highlighted the decline in Enron’s share price – this decline coincides as you would expect with it becoming known that Enron was a scam of massive proportion. The table below looks at the recommendations offered by brokers at this time. This table has a few components, on the left are the names of the brokers offering the recommendations, in the centre are the recommendations themselves. These are colour coded as to the type of recommendation and along the bottom is the price at which these recommendations were made. When viewing this table keep in mind the chart above.Enron

As you can see for the majority of the decline Enron was either a strong buy or a buy for the majority of brokers. Even after it became common knowledge that Enron was a fraud and was under investigation by the SEC brokers still continued to recommend it. In fact as it disappeared it was still considered to be a hold. So let me state that again – even after it was known that Enron was a giant con job and was headed down the toilet brokers still continued to recommend it. The most perceptive observation on this situation was actually offered by the humourist Dave Barry –

Wall Street relies on “stock analysts.” These are people who do research on companies and then, no matter what they find, even if the company has burned to the ground, enthusiastically recommend that investors buy the stock.

Dave Barry
February 3, 2002

This quite naturally raises the question as to why this sort of thing occurs and the answer can be found in the structure of the finance industry. In very broad terms  what people generally refer to as stockbroking has traditionally been split into two very broad camps – corporate advice and retail advice. Corporate advice covers high end activities such as capital raising, mergers, and company listings. Retail advice covers telling people who used to ring in to buy BHP because its a good company. Each of these arms generates a very different revenue stream for the firm, corporate advice generates fees in the millions whereas retail advice might involve an order that generates $6 in brokerage. You can see where the massive imbalance in revenue comes from and therefore you can see which side of the firm is more important. Consider a simple example, I head off to my local merchant bank/broker and I want to list my company to liberate some of the value in it and this listing will generate for the firm $5 million in fees. Naturally, if I want to list my company I need shareholders so it is the job of the retail arm to go a get them for me via selling the prospectus to them and after that via selling it to new punters via the secondary market. In terms of importance I am immensely important and my needs come first because I have given the firm $5 million, a retail investor doesn’t even give them enough for a slab of beer.

Underlying all of this is the simple need of stockbrokers to eat – stockbroking at its heart is a sales profession. If I dont sell you a second hand good in the form of a share then I dont eat. Even better if I can get you to sell one stock you own for another because then I get two lots of commission. You might think that with the advent of online trading that this situation might have evolved and changed because technology has removed the need to actually talk to someone. In some ways it has but it has also shown a new flaw in the advice model and that is in the recommendations that are generated by broking firms. If we think logically about markets then you would assume that markets are comprised of a mass of differing stocks, some doing well and going up, some doing poorly and going down and others doing nothing in particular. This is not how the industry sees markets – to them every single stock is a buy. Consider the table below which I generated a few years ago.

by

This chart looks at the ratio of buy to sell recommendations being offered by brokers. The lowest the ratio got was in 1983 when the industry were net sellers – this coincided with the beginning of the 1980’s bull market. Since then the industry has always been net buyers and the latest figures I could find indicate that the buy to sell ratio sits at around 100 to 1.  It doesn’t seem logical that for every stock that is a buy there could only be one that is a sell. The industry is overwhelmingly biased towards the buy side.

In looking into the industry over the years the best explanation for the behaviour of its members can be found in the following quote –

“An investor might expect advice that is free of both psychological bias and self interest. Instead they discover belatedly that the advice is a mixture of wishful thinking and self- serving hype.”

Brian Bruce Journal of Psychology and Financial Markets (2002 Vol 3, No4, 198-201)

As the question as to how to navigate all of this the answer is really quite simple – do your own thinking. If you want to be subject to the whims of others then that is fine but just remember this is an industry that had to be dragged kicking and screaming into acting in the best interests of their clients.

 

 

 

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The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.