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Plato’s Cave and How I Lost $127,562.06

Last housekeeping note: Fall enrollment for our Collective closes tonight at midnight. We won’t be opening our doors again until sometime early next year most likely. So if you’re interested in joining the team, make sure to click the link and sign up. Shoot me an email if you’ve got any Qs. Looking forward to seeing you in the Comm Center!

Are you familiar with Plato’s allegory of the man in the cave?

It’s about a man deep in a cave who’s been chained to a wall his entire life. He’s never seen the light of day and doesn’t know there’s an outside world.

In this cave, out of the man’s purview, there’s a fire with people moving statues in front of it, casting shadows on the wall which the man sees.

The man believes these shadows are real things. He sees shadows of lions and thinks they’re real lions, he sees shadows of people and thinks they’re real people… you get the idea. The shadows are his reality.

This story is meant to show the natural state of ignorance man is born into and in which most live — where they spend their days looking at shadows thinking they’re real…

This is exactly how my trading career started out. I was that ignorant bastard chained to a wall ogling shadows. I didn’t know jack. But because of my professional background and my previous successes, I thought I was pretty smart. I was even a bit arrogant.

This arrogance, mixed with my ignorance, cost me a LOT of money. $127,562.06 to be exact.

Here’s the quick story of how it happened. This is how I hit rock bottom, plunging to the darkest depths of the cave of ignorance… and how this painful failure pushed me to discover the key to beating markets going forward.

Let’s go back in time to two years before I lost the $127,562.06 gambling in markets.

I had been trading for a number of years by that point. I worked a full-time job in an unrelated field but spent nearly every minute outside of work on markets. I was hooked. I read all the classic trading books you’re supposed to and scoured the farthest reaches of the internet for anything that would give me an edge.

Through all this work and study, I became decent… or at least I thought so. I only lost a little bit of money while occasionally hitting winners when I got lucky. But like I said, I was arrogant. Every win, no matter how small and infrequent, sparked grand visions of me soon being praised as the next George Soros… but with Ed Thorpe’s quantitative know-how and Dan Loeb’s jawline.

I’m not joking. I really believed Market Wizard status was right around the corner, even though I had barely made a penny trading and was by no means consistent.

I figured the only thing holding me back from becoming a trading legend was the size of my stake. I needed a real bankroll. I mean who can be expected to do anything amazing when they’re piking around with $15K. That’s play money. If I could get a six-figure line, then I would really buckle down and make a killing.

So I went to the Middle East. A war zone in the Middle East to be exact. Not a normal place to build a trading stake, but with my background, it made sense.

To quote Liam Neeson, I have “a very particular set of skills. Skills I have acquired over a very long career. Skills that make me a nightmare…” You get the point.

Certain companies are willing to pay people with my skill sets buku bucks to operate in a warzone (all perfectly legal, above board, and in support of the US of course).

So I packed my backpack along with a 120-pound trunk full of trading books (Kindles weren’t really a thing yet) and set off to the other side of the world.

I spent a year working 12+ hours a day, 7 days a week, in a hot and shitty desert, only to go back to my trailer and study/trade markets for another 4-6 hours. I was dead set on becoming the next PTJ.

After the year was finally up, I came back with the six-figure trading line I always wanted. I was 100% ready to fulfill my “destiny”. It was finally time to become the next Market Wizard

And then the absolutely worst f*cking thing happened to me.

I started winning. And I mean A LOT.

I was minting money on nearly every trade.

It was ridiculous. I made more than my previous annual salary in just a few months. And in less than six months, I had more than tripled my money. I was like the guy from that old E-Trade commercial getting wheeled into the ER with money coming outta my wazoo!

It was the worst…

Now you’re probably wondering why the hell this is a bad thing.

Well… remember those visions of grandeur I had before? They multiplied 100 fold.

I began believing I was the love child of Livermore and Buffett… the living, breathing trading Jesus born to bless markets with his divine mouse click and great hair. Every time the phone rang I fully expected it to be Jack Schwager asking for an interview.

Maybe you can see where this is headed…

Anyway, after all that winning, the tide eventually began to turn (as it always does in markets) and I started losing.

At first, it was just a little bit. But then it became alotta bit.

It just didn’t make sense. Trading Jesus didn’t lose… how was this possible? So, of course, like a jackass I upped my risk and started trading more. I NEEDED to make back the money I lost and do it fast.

This is when I began my journey to traders’ hell, where I visited all of Dante’s eight circles, enjoying each as much as the original protagonist. Every day I woke up to my P&L bleeding red. And as the losses kept piling up, I felt more and more physically sick.

After my legendary year, it took me just THREE MONTHS to give back $127,562.06 in profits.

This was no small beans for me. I was a 20-something at the time and this was by far the most money I’d ever had.

The fact that I felt like a market god after my astounding year made this fall all the more painful. That’s why I said winning like I did was the worst thing that could’ve happened to me.

At some point, I finally hit rock bottom — total utter despair. I realized my Market Wizard year was just a lucky streak and that I was still a shoddy trader. I can’t remember exactly what did it, but I eventually called my broker and had him send my remaining balance back to my bank account. I was done.

This experience was more than humbling, it was downright brutalI mean it was knees-to-the-mat-delusion-busting-4am-wakeup-call kind of brutal. The emotional rollercoaster rocked me. And I don’t get rocked easily. I’ve been in some pretty sticky situations overseas and have been trained to handle my emotions. But this was something completely different. I was honestly shocked by the effect it had on me.

And that’s when it hit me.

Markets are nothing more than a bunch of people like me, trying to manage their emotions. And these emotions are really just a result of their beliefs. Together, these beliefs and subsequent emotions make up the pricing mechanism we call the “market”.

So really, if I wanted to succeed in markets, I didn’t need to worry about finding the “correct” price of an asset. I just needed to understand the other emotional sons of bitches I was trading against!

It was so damn obvious once I realized it.

The majority of my professional training, whether as a spec ops sniper, military interrogator, or government counterintelligence specialist, all focused on psychology over everything else. It wasn’t just about managing my own psychology, but understanding the psychology of my opponent as well. The goal was always playing the player.

Hell, even outside my military experience, anything I ever strived for, whether it be a new job, a lovely lady, or even a discount at the car dealership… it was all about playing the player. And if the market is just a giant version of these one-on-one interactions, with beliefs and emotions all mixed in, then what was the difference?

It was this realization that helped me finally break the chains keeping me inside Plato’s cave of ignorance.

I finally learned what it meant to be a contrarian. And not a twittering holier than thou trend fighting finger missing knife catching “contrarian”… But an actual Keynes’ ‘Beauty Contest’ fourth-degree playing patient salmon type contrarian — you know, the kind that actually makes money.

I had to earn this realization, with plenty of blood, sweat, and tears — on top of a pile of lost money.

But it was necessary. Necessary because that is part of the Trader’s Journey. The trader’s journey is a lot like Joseph Campbell’s Hero’s Journey. We go out into the world and venture into the unknown, accept challenges and stare into the abyss, make discoveries, learn from our mistakes and return a better person with newfound knowledge and skills.

That’s what the Macro Ops Collective is all about, facilitating this Trader’s Journey.

If you choose to embark on this journey and do it well. You have to step off knowing there is no there there. It’s an endless spiral of growth and evolution. There are always new challenges to tackle, problems to solve, mistakes to be made, and goals to strive for.

This is why the MO Collective is not just another newsletter giving stock picks. Yeah, sure, we provide regular research from Brandon (value investing focused), ChrisD (systems+technicals), and myself (a bit of everything). But that’s just a small bit of our value proposition, to be honest.

I mean, show me one person who’s become rich after signing up to a newsletter? Exactly… Do you want to know why that is? It’s not just that most newsletters are really disguised investo-tainment. Services that spin good yarns but are only as valuable as monkeys throwing darts when it comes to  your P&L.

The bigger reason is that newsletters are all — and I mean all — focused on the wrong thing. Wanna know what that is?

Stock picks and market predictions — the same damn thing that every other trader and investor focuses on.

The funny thing is if you talk to any pro – and I mean a real pro, not some guy who wears a necktie and regularly appears on CNBC but somebody who actually consistently carves out profits from the market for a living. They all say the same thing: “trade picks are maybe 10% of the game, predictions are detrimental to your bottom line, and trade management is EVERYTHING”.

Trade management is about having a watertight process. One that you follow day in and day out. It’s position sizing, risk management, and entries/exits — and more position sizing. That’s it. Nothing flashy or glamorous. The truth is successful trading and investing is fairly mundane. At least it is if you’re doing it right.

And that’s why we not only give you fish but teach you how to do so yourself.

If you want to join us on the journey, learn to fish, and hopefully catch a few whoppers along the way. Then go ahead and click this link and sign up. You can come in and try us out for 60-days risk-free. If you realize it’s not for you, no hard feelings, we’ll give you a refund in full and hope you continue to enjoy our publicly available work. Simple as that. No downside, life-changing upside potential = a very asymmetric trade.

I hope you enjoy the rest of your Sunday.


If you’re interested in joining our group of macro traders and investors then sign up for
The Macro Ops Collective before this Sunday, October 13th at 11:59PM!

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Question EVERYTHING: A Recent Thing I From One of the Better Traders I Know

Quick housekeeping note: Fall enrollment for our Collective closes this Sunday at midnight. If you’re interested in joining our group, then make sure to get in there sign up before the close. Looking forward to seeing you in there.

There’s been a few things that have been rattling around in my brain-housing group that I wanted to get down on paper and share with everybody.

What sparked this flywheel of thought is something my buddy and resident systems trader here at MO, ChrisD (@ChrisDMacro) tweeted a few weeks ago. Here it is.

Chris joined our team late last year. I am unbelievably lucky to have him as a partner. Let me tell you why and then we’re going to get to the above tweet and talk about a number of “aha!” moments I’ve had lately.

ChrisD. is no sh*t probably in the top 0.1% of traders in the world. That’s not an exaggeration. It’s not hyperbole. And he’s going to hate this email if he sees it because he’s a modest low-pro type of guy. But it’s absolutely true.

Chris regularly puts up annual returns in the triple digits. He does this not by leveraging to the gills and swinging for the fences. Quite the opposite, actually. He accomplishes it through a maniacal devotion to trading his systems.

You see, Chris has been at this for a while. He’s been trading for two decades. He’s built and managed hedge funds, consulted for quant firms on building systems, and now mostly manages his family office and works with us here at MO while he and his wife fly around the world living out of fancy Airbnbs. He’s an interesting dude, but I digress…

The thing that Chris does better than almost anybody I know, and which I think is a key reason behind his incredible trading success, is the fact that he questions everything. Literally everything… He takes nothing at face value no matter who’s saying it, how many people accept it as true, or how long it’s been touted as wisdom.

He rigorously tests all assumptions. As in, he’ll spend days manually — and I can’t stress the importance of this point enough, the guy spends days living in excel going through charts bar by bar —  backtesting ideas, systems, beliefs about the market etcetera…

Now think about most market participants. They tend to be high on opinions and low on supporting evidence, right? There’s not a lack of false confidence out there. You can choke on it if you expose yourself to the Wall st. noise long enough.

Here’s the thing. These people — as in the vast majority of people — never truly try to figure things out. I mean, really truly look into something, interrogate the hell out of it, and chisel down to the core of the matter.

Nah… The modus operandi of the masses is to start with a belief. One that is almost always given to them, not independently formed. And then subconsciously or consciously seek out confirming evidence.

How does one get rich playing in markets they ask themselves?

Well, you do exactly what Warren Buffett did and what all the other 50 million Buffett fanboys around the world try and do every day.

If Buffett’s style of long-term investing isn’t for you then go and try and be George Soros. You know, try and outsmart central bankers by making big leveraged bets against their currencies. Really learn economics so you can talk the language, sound smart amongst your macro peers, and discuss complex things such as the inner-workings of the repo market. That’s how you do it, right?

Over the last couple of month’s I’ve fallen down the Rene Girard rabbit hole — if you’ve been reading my work lately, then you’ve heard me talk Rene and his theories more than a few times.

Rene was a French philosopher who taught at Stanford. His big idea was “mimetic desire”. Mimetic desire states that people only desire things because other people desire them. Basically, we’re hard-wired to imitate others. There’s little true free will or original thinking involved in our decision making. Rather, most if not all of our decisions are driven by our desire to be like someone else and that someone else’s decisions are driven by their desire to be like someone else, ad Infinium.

We want things because others want them. We want to do things because others do them. And then we provide ourselves with post-rationalizations to trick ourselves into believing they were our own desires all along!

This theory has largely been confirmed by brain scan studies, such as this study that was titled “Memetics Does Provide a Useful Way of Understanding Cultural Evolution.” Here’s an excerpt from the report (emphasis by me).

“A common objection to memetics is that it undermines human autonomy and the creative power of consciousness, and treats the human self as a complex of memes without free will. These ideas follow naturally from the universal Darwinism on which memetics is based. That is, the idea that all design in the universe comes about through the evolutionary algorithm and is driven by replicator power. This means that human creativity emerges from the human capacity to store, vary and select memes, rather than from some special creative spark, or power of consciousness (Blackmore 2007).”

Here’s an interesting thought.

This idea that “human creativity emerges from the human capacity to store, vary, and select memes…” aligns with much of the work that is coming out on what top performers from various fields hold in common.

The book Range by David Epstein (one of my fav reads of the year) gives a number of examples that support the idea. Here’s one of my highlights from the book (emphasis by me).

“Scientists and members of the general public are about equally likely to have artistic hobbies, but scientists inducted into the highest national academies are much more likely to have avocations outside of their vocation. And those who have won the Nobel Prize are more likely still. Compared to other scientists, Nobel laureates are at least twenty-two times more likely to partake as an amateur actor, dancer, magician, or other type of performer. Nationally recognized scientists are much more likely than other scientists to be musicians, sculptors, painters, printmakers, woodworkers, mechanics, electronics tinkerers, glassblowers, poets, or writers, of both fiction and nonfiction. And, again, Nobel laureates are far more likely still. The most successful experts also belong to the wider world. “To him who observes them from afar,” said Spanish Nobel laureate Santiago Ramón y Cajal, the father of modern neuroscience, “it appears as though they are scattering and dissipating their energies, while in reality they are channeling and strengthening them.”

The main conclusion of work that took years of studying scientists and engineers, all of whom were regarded by peers as true technical experts, was that those who did not make a creative contribution to their field lacked aesthetic interests outside their narrow area. As psychologist and prominent creativity researcher Dean Keith Simonton observed, “rather than obsessively focus[ing] on a narrow topic,” creative achievers tend to have broad interests. “This breadth often supports insights that cannot be attributed to domain-specific expertise alone.”

I don’t think Epstein, or anybody else I’ve read, has made the connection. But don’t these two ideas fit nicely together.

If the evolutionary algorithm underlies all of the universe and is driven by replicator power. And human creativity is born not from original thought pulled from the ether but rather emerges from the combining of knowledge teased from the collective consciousness. Then wouldn’t it make perfect sense that one of the most statistically attributable commonalities amongst all top performers be that they’ve dabbled in a wide range of fields; often disciplines that have no apparent connection to their own.

Isn’t the combining of memes really just reasoning by analogy? Johannes Kepler, the father of planetary motion, wrote in his personal journal “I especially love analogies… my most faithful masters, acquainted with all the secrets of nature… One should make great use of them.”

When Kepler was working on his grand scientific breakthrough of “action at a distance”, the theory which spawned astrophysics. He routinely turned to analogistic reasoning (aka relational thinking) to help him stitch together his theory; using available ideas around odor, heat, and light to magnets and the current a boatman draws while steering through a canal to help him dream up a theory about how the planets revolve around the sun.

Okay, now let me bring this wide arcing circle back to our original topic; trading and investing.

Suppose that mimetic desire is real, which I believe it is — and the 40,000+ “contrarians” who travel every year to Omaha to worship at the feet of their Guru pretty much confirms that it is so. Shouldn’t we take a serious step back and ask ourselves what we’re chasing. I mean, really think about what exactly it is we desire?

If our desire is to be a successful investor like Buffett then I have a counterintuitive thought for you.

Don’t follow the herd and try to be like Buffett.

You know why? Because Warren Buffett didn’t start out trying to be like Warren Buffett. He became successful because he learned what he could from Graham and then paved his own path, no doubt utilizing relational thinking from his wide-ranging studies to help him arrive at truth.

He wasn’t trying to imitate anybody, that’s the point. This liberated him to focus on being someone who makes a lot of money from the market precisely by doing what no one else was.

Do you catch my drift? Are you picking up what I’m putting down?

If you try to imitate, you’ll end up average. Like everybody else, because that’s exactly what they’re doing. The market is literally made up of averages. If you’re reading this, I’m guessing you don’t want that to be you. Because why spend your Saturday’s reading my ramblings if you’re just going to make the return of the S&P?

Now back to Chris and his habit of questioning everything.

You can think of the commitment to not taking anything at face value, of examining everything for its utility or lack thereof to your goals, as a kind of way to channel and leverage your mimetic desiring cognition.

Instead of trying to be like someone else and blindly following what you think they do. You can instead, state a goal and then work backward. Think of it as a kind of reverse engineering to get you to where you want to go — which in the markets, should be making high risk-adjusted returns.

Trading great, Ed Seykota once said: “Win or lose, everybody gets what they want out of the market.” That quote baffled me for the longest time. I just didn’t get it, who the hell wants to lose? But now it makes perfect sense.

For most people, being like somebody else, trading or investing like how they think their idol trades and invests, is more important to them than making money — plus it’s a LOT easier to not have to think for themselves

Would they ever admit that to themselves? Not likely. It’s a painful truth to have to accept. But an absolutely necessary one if you want to break the chains of mediocrity, climb out of the cave of ignorance, and burst free from the confines of the muddling masses.

And that’s been my big “AHA!” from working alongside ChrisD over the last six months. At times I’ve felt like Neo after having taken the red pill. I’ve been forced to reinspect and subsequently tear down many of the false idols I once clung to.

I’ve refocused my effort on eschewing conventional wisdom, spending more time on thinking exactly what it is I’m trying to accomplish, and then creatively (using relational thinking) testing out various ways and means to get there.

The late Bertrand Russell once said “In all affairs, it’s a healthy thing now and then to hang a question mark on the things you have long taken for granted.”

I’m curious, what things do you think you’ve “long taken for granted” and should perhaps “hang a question mark on”?

You’ll be surprised by the results once you start seriously exploring this path of inquiry. It’s a deep-deep rabbit hole, my friend. But one that is certainly worth falling down.

If you’re interested in joining our group of macro traders and investors then sign up for The Macro Ops Collective before this Sunday, October 13th at 11:59PM!


Side note:
If you find any of this stuff interesting and want to pop the MO red pill — a decision that will open your eyes to a new way of thinking about investing and markets, then sign up and take our Collective for a spin.

The Collective is made up of a wide range of members; from HF managers who swing lines in the billions to college students trying to learn the game. We have macro traders, value investors, and short-term systems traders and everything in-between. The one common denominator amongst all of us is that we’re crazy about this game. That’s it. We all love the game of speculation. Our community is bar-none the best out there. No question.

That’s my favorite part about this whole MO gig. I get to wake up every morning and interact with some of the most interesting and passionate people around the world. And we all get to channel and feed off each-others energies while chasing the same objective — unwinding the riddle of the market for fun and profit.

It’s the reason I decided to turn down a high paying job at a large HF (a place that was once my dream job) to start this website. A website that I wanted but didn’t exist. That was nearly 4-years ago to this very day. It’s been a hell of a ride but the future is even more exciting. There’s a lot more we want to do, to create, so as to better provide value to the group. It’s a long and endless journey but one that’s absolutely worth walking.

One of the things that gives me the most pleasure is when members write us saying that we’ve given them “a super-charged MBA in actual investing for a fraction of the price” or like a recent email we received from a mid-sized quantitative fixed income shop that said the work our team is doing has “completely shattered their previous illusions of how to think about markets” and “has led to them totally reevaluating their approach.”

After all, we live for these “aha!” moments. The more like-minded people we can share them with, the better.

If you’re interested in joining an elite group of macro traders then sign up for The Macro Ops Collective before this Sunday, October 13th at 11:59PM!

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Ditch the Predictions and Play the Odds

We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes. ~ Ned Davis

When I became a winner, I said, “I figured it out, but if I’m wrong, I’m getting the hell out, because I want to save my money and go on to the next trade.” ~ Marty Schwartz

When I see or hear of someone pushing a gigantic market call, talking as if they know exactly what’s going to happen in some well-extended time frame, my inner skeptic has a field day.

There is a HUGE difference between odds-based scenarios and needlessly gaudy predictions… and I tend to trust gaudy predictions about as far as I can throw them.

I mention this in light of three “big calls” that, though not exactly new, have garnered fresh media attention in recent weeks.

I’ll avoid naming names here, as specifics aren’t so important.

Let’s just say one of these guys is a well known perma-bear who’s been screaming about a recession over the last 10-years and now sees — can you guess? — a catastrophic recession around the corner. Another is a popular perma-bull who hasn’t seen a dip that shouldn’t be bought since he first opened his etrade account in 2000… the third is a media-hungry academic who thinks now is a “great time” to be a buy and hold investor.

Useless. All of ‘em.

It’s Not About Being “Right”

As a general rule of thumb, I could care less what media-hungry attention seekers think. The manufactured certainty is more than a bit off-putting, as is the cozying up to quote-hungry news outlets. In the swirling sea of uncertainty, here are a few things the MO trader knows to be true:

    • The vast majority of “big calls” are an annoying waste of time.
    • Being “right” or “getting a big call right” has little to do with real trading.
    • Great traders have balls, but they sure as hell ain’t crystal.
    • Being right and making money are two completely different things.

Why are table-pounding market calls – especially ones spoon-fed to the media for the sake of garnering attention – more often than not a waste of time?

Aside from rampant cherry picking – step right up and pick an opinion! – one big reason is because successful trading is NOT about prediction (i.e. being “right”). Instead, it’s about seeing the markets as an odds game, and understanding the full implications of what that means.

First and foremost, seeing the markets as an odds game means constantly putting the odds in your favor.

Always acting pragmatically… always in concert with the dictates of observation and experience… always aligned with the twin goals of maximizing profits and minimizing risk (as applied over the full spectrum of trades).

In actual, real world, day to day execution – something far too many pundits have far too little knowledge of! – this means cultivating a ruthless focus on making money, with being “right” so far down on the trading priority list it’s practically an afterthought.

Because, think about it – if you’re emotionally and intellectually focused on being “right,” then you aren’t truly focused on making money, are you?

Or, if you’re captivated by all the dough you’re going to make by being “right,” then you are probably hopelessly enmeshed in confirmation bias and grossly neglecting the downside risk.

P&L First!

On the other hand, let’s say your primary trading focus is indeed on making money (as it should be). Let’s further say a handful of new trades are not acting right (or that the market script is otherwise going off-kilter).

Well, if P&L (i.e. making money) is the ruthless focus, what are you going to tell yourself when things get iffy? That you should stick to your guns and keep those funky-smelling positions on because, dammit, you are “right” and the market is wrong?

No way José. A truly good trader will act in the best interests of P&L first… even if that means admitting being “wrong” in one’s initial assessment of a trade. For discretionary traders, i.e. those forced to make a steady stream of decisions as part of their discipline, this kind of thing happens all the time.

In other words, being “right” takes a backseat to making or preserving $$$ every time a market shift behooves a change of mind. (And yet, the table-pounding types NEVER seem to change their minds. Notice that?)

There is simply no way around it: Being right and making money are competing priorities… and a focus on one greatly diminishes the other.

Prediction versus Conviction

Something else: It’s important to distinguish between flashy calls and high-conviction probabilistic assessments based on accumulated evidence and a clear read of market conditions. The first is an ego trip; the second is betting with the odds in your favor.

A damn good trade is like a damn good poker hand. You rarely if ever have 100% certainty (and you certainly don’t pretend that you do)… but you can most definitely know, based on the situational dynamics of the hand, when it’s time to bet big.

John Hussman explains the conditional probability concept well (I know, Hussman? The irony doesn’t escape me but that doesn’t detract from this explanation it just means he can’t follow his own advice):

From a Bayesian standpoint, if you always observe a certain combination of information when X occurs, and never observe that same data when X is not present, then even if X is hidden under a hat, you would conclude that X is most likely there. If I see clowns walking around the grocery store buying peanuts, and there’s a big top tent with two unicycles in front of it in the middle of what is usually an open field, I’m sorry, I’m going to conclude that the circus is in town.

Cutting Through the Crap

One final thing. Let’s say there are two opposing scenarios, both of them plausible (a fairly regular phenomenon in markets). Plausible scenario A says market “Up.” Plausible scenario B says market “Down.” Which do you choose?

Easy – you don’t worry about it. You watch and wait… and let price action be your guide.

One of the great things about price action is the way it cleaves through “analysis paralysis” like a hot knife through butter.

Simply put, price action cuts through the bullshit. It’s a lamp unto our feet (or rather, our P&L).

We can make the most of price action signals, you see, because as MO Traders we are nimble and liquid. We are speedboats, not aircraft carriers. Not for us the problems of the hidebound pension fund, the mammoth Fidelity manager who has to buy $200 million worth of stock just to move the needle, or the glacier-slow advisory board that takes three months to make a decision. Being small and fast, we can turn on a dime in real-time… and thus bypass the lumbering constraints that plague the big and slow.

So, forget prediction – and tune out anyone who tries hard to get your attention by making one. Focus on odds and gaming out the various scenarios instead, and be wary of anyone who “knows” what’s going to happen.

If you want to be consistently successful as a trader – to carve out large chunks of profit in the MO style – here is how it’s done:

You invest time and energy developing a flexible forecast – be it for an industry, a commodity, a currency, or even the broad market itself.

You digest info from high-quality sources, but with the intent of getting in tune with the market, not embracing some iron-clad far-off prediction that can’t possibly account for the dynamic nature of markets in the first place.

You do your fundamental homework and your due diligence legwork, gathering useful data to give you a sense of conditional probabilities and odds-based assessments. You work with probabilities, not certainties, in mapping out your potential trade setups.

You make it your primary focus to get a handle on the scenarios – to synch up with the ‘market script’ – as opposed to consulting a crystal ball. You regularly consult the charts and maintain a general awareness of how other market participants are positioned. You overlay all such activities with a ruthless focus on MAKING MONEY as opposed to being “right.”

And then, when your trading vehicle of choice approaches an actionable juncture, you watch and you wait… and you let the price action tell you what to do.

A favorite trading quote of mine comes from Bruce Kovner of Market Wizards fame. He put the job of a trader as this.

One of the jobs of a good trader is to imagine alternative scenarios. I try to form many different mental pictures of what the world should be like and wait for one of them to be confirmed. You keep trying them on one at a time. Inevitably, most of these pictures will turn out to be wrong — that is, only a few elements of the picture may prove correct. But then, all of a sudden, you will find that in one picture, nine out of ten elements click. That scenario then becomes your image of the world reality.

Another Wizard profiled in Schwagger’s iconic series is Stan Weinstein (he authored an excellent trading book titled “Secrets for Profiting in Bull and Bear Makrets”). Anyways, Stan who’s motto was “The tape tells all” was an incredible market timer — he made a LOT of money playing the big swings in the market.

He didn’t do this by being an ideologue, having an opinion on the market’s direction and then seeking out confirming data. He looked at what he called the “weight of the evidence”, which for him was a dashboard of 48 technical market indicators that looked at everything from margin debt levels to credit spreads, call-put ratios, odd-lot short sales, and more.

These indicators never gave him a “sure bet”. They were just data points that added up to odds in a constantly evolving continuum where the tape was the final arbiter.

Quite a different process than the one practiced by those who’ve been confidently predicting a recession since the last one, isn’t it?

In the following series of posts, we’re going to imagine alternate scenarios and evaluate the weight of the evidence by going through our process for pulling signal out from all the noise.

Stay tuned…

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The Evolution of Political Regimes

Plato, using Socrates as his mouthpiece, wrote the following condemnation of Athenian democracy in his Republic:

[The citizens] contemptuously rejected temperance as unmanliness… Insolence they term breeding, and anarchy liberty, and waste magnificence, and impudence courage… The father gets accustomed to descend to the level of his sons and to fear them, and the son to be on a level with his father, having no shame or fear of his parents… The teacher fears and flatters his scholars, and the scholars despise their masters and tutors… The old do not like to be thought morose and authoritative, and therefore they imitate the young… Nor must I forget to tell of the liberty and equality of the two sexes in relation to each other… The citizens chafe impatiently at the least touch of authority, and at length…. They cease to care even for the laws, written or unwritten… And this is the fair and glorious beginning out of which springs dictatorship… The excessive increase of anything causes a reaction in the opposite direction;… dictatorship naturally arises out of democracy, and the most aggravated form of tyranny and slavery out of the most extreme form of liberty.

Plato reduced the evolution of political regimes to a sequence of monarchy, aristocracy, democracy, and dictatorship. In the excerpt above he’s commenting on the fraying democracy in Athens that was driven by a widening gap between the rich and poor… sound familiar?

The wealth disparity drove the poor to try and enlarge their cut of the pie through legislation, taxation, and revolution. The rich banded together to protect themselves and their money. This division fractured Athenian society and opened the door for Philip of Macedon to invade and conquer Greece.

Greeks had grown so despondent with their political system that many actually welcomed his conquest. Greek democracy transitioned to dictatorship.

Nearly 300 years later we saw a similar sequence play out in Rome. The Roman Republic created enormous amounts of wealth through its vast control and exploitation of foreign lands. The new aristocrats curried favor with the leaders on Palatine Hill through bribes and political support. Over time, the government began to work for the special interest of the few.

In response, the commoners supported Julius Caesar who seized power and established a popular dictatorship. He was then stabbed in the back (literally) by the aristocrats and replaced by another dictator, Gaius Octavius. Democracy became a dictatorship which then became a monarchy.

Political regimes like much of nature seem to oscillate between extremes (democracy and autocracy), where each extreme sets the conditions for the inevitable transition towards the other. How a nation’s wealth is divided amongst its people is one of the biggest drivers of this constant pendulum.

In Will and Ariel Durant’s The Lessons of History they write that “inequality is not only natural and inborn, it grows with the complexity of civilization. Hereditary inequalities breed social and artificial inequalities: every invention or discovery is made or seized by the exceptional individual, and makes the strong stronger, the weak relatively weaker.”

This fact keeps the political system in oscillation between extremes. Where — again quoting both Durants—  “…freedom and equality are sworn and everlasting enemies, and when one prevails the other dies. Leave men free, and their natural inequalities will multiply almost geometrically, as in England and America in the nineteenth century under laissez-faire. To check the growth of inequality, liberty must be sacrificed, as in Russia after 1917. Even when repressed, inequality grows; only the man who is below the average in economic ability desires equality; those who are conscious of superior ability desire freedom; and in the end superior ability has its way.”

When economic prosperity is relegated to a few, society’s desire for political freedom becomes merely a conciliatory afterthought. This arises not so much through the wealthy’s direct exploitation of the poor but rather due to the increasing complexity of the economy and government. This complexity puts an additional premium upon one’s superior ability to navigate it, which further amplifies the concentration of wealth and political power.

Running under all of this is the Bridgewater style long-term debt cycle. The wealthy are the creditors that hold the assets, the poor the debtors who suffer under the liabilities. The larger the balance sheet grows, the more complex the economy and the more enriched the wealthy and the more financially strangled the masses become. Until of course, a natural limit is hit… equality pushes back at freedom… and democracy inches towards autocracy.

The Durant’s note that when “our economy of freedom fails to distribute wealth as ably as it has created it, the road to dictatorship will be open to any man who can persuasively promise security to all; and a martial government, under whatever charming phrases, will engulf the democratic world.”

The interesting political events of late (ie, Brexit, Trump, the rise of nationalist parties in Europe etc) are not causes but rather effects of the debt cycle and the natural evolution of the political sequence as described by Plato some 2,400 years ago.

That is not to say we are going to see a shift to dictatorship or anything of the kind in the near future (we aren’t)… nor am I saying that is what Trump in any way represents (he doesn’t). Rather, I’m talking about the large tidal forces at work; the historical cogs that are turning and driving the current rise in populist sentiment and which will play out for many years to come.

We are witnessing the battle between two opposing forces of political and economic nature unfold. Neither is good or bad, they both simply are. Each is embedded in the evolution of our natural system where equilibrium is merely a concept and constant change a reality.

It is with that understanding that we must judge and assess things to come. Taken in this context, the current insanity of the world begins to make a lot more sense.

The course we are on now is not a sustainable one.

I fear the rise in populist politics is only just beginning. Let’s hope we don’t swing too far back in the other direction…

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Adaptability Versus Optimization: The Cockroach Approach

As we trudge onward in the longest bull market in US history, I thought it wise to share with you a section from an old article, written by Richard Bookstaber, titled “Risk Management in Complex Organizations”.

The article talks about risk. Particularly, that most pernicious kind of risk… The kind we can’t foresee.

Volatility selling, FAANG hodling, growth at any price investing… any strategy that’s become over-optimized for the current market regime faces a high susceptibility of risk of ruin in the next. For those of you heavily involved in such activities, it may be time to learn some lessons from the lowly cockroach. Here’s Bookstaber:

“We can manage risks only when we can identify them and ponder their possible outcomes. We can manage market risk because we know security prices are uncertain; credit risk because we know companies can default; operational risk because we know missteps are possible in settlement and clearing. But despite all the risks we can control, the greatest risks remain beyond our control. These are the risks we do not see, things beyond the veil. The challenge in risk management is how to deal with these unidentified risks. It is more than a challenge; it is a paradox: How can we manage a risk we do not know exists? The answer is that we cannot manage these risks directly, but we can identify characteristics of risk management that will increase our ability to react to the risks. These characteristics are easiest to grasp in the biological setting, where we are willing to concede that nature has surprises that are wholly unanticipated by life forms that lack total foresight. A disease that destroys a once-abundant food source, the introduction of chemicals in a pristine environment, the eruption of a volcano in a formerly stable geological setting are examples of events that could not be anticipated, even in probabilistic terms, and therefore, could not be explicitly considered in rules of behavior. They are nature’s equivalent to the unforeseeable risks for the corporation.

The best measure of adaptation to unanticipated risks in the biological setting is the length of time a species has survived. A species that has survived for hundreds of millions of years can be considered, de facto, to have a better strategy for dealing with unanticipated risks than one that has survived for a short time. In contrast, a species that is prolific and successful during a short time period but then dies out after an unanticipated event may be thought of as having a good mechanism for coping with the known risks of one environment but not for dealing with unforeseeable changes.

By this measure, the lowly cockroach is a prime case through which to study risk management. Because the cockroach has survived through many unforeseeable changes — jungles turning to deserts, flatland giving way to urban habitat, predators of all types coming and going over the course of the millennia — the cockroach can provide us with a clue for how to approach unanticipated risks in our world of financial markets. What is remarkable about the cockroach is not simply that it has survived so long but that it has done so with a singularly simple and seemingly suboptimal mechanism: It moves in the opposite direction of gusts of wind that might signal an approaching predator. This “risk management structure” is extremely coarse; it ignores a wide set of information about the environment — visual and olfactory cues, for example — which one would think an optimal risk-management system would take into account.

This same pattern of behavior — using coarse decision rules that ignore valuable information — appears in other species with good track records of survivability. For example, the great tit does not forage solely on the small set of plants that maximize its nutritional intake. The salamander does not fully differentiate between small and large flies in its diet. This behavior, although not totally responsive to the current environment, allows survivability if the nature of the food source unexpectedly changes. We also see animals increase the coarseness of their response when the environment does change in unforeseeable ways. For example, animals placed for the first time in a laboratory setting often show a less fine-tuned response to stimuli and follow a less discriminating diet than they do in the wild.

The coarse response, although suboptimal for any one environment, is more than satisfactory for a wide range of unforeseeable environments. In contrast, an animal that has found a well-defined and unvarying niche may follow a specialized rule that depends critically on that animal’s perception of its world. If the world continues on as the animal perceives it — with the same predators, food sources, and landscape — the animal will survive. If the world changes in ways beyond the animal’s experience, however, the animal will die off. Precision and focus in addressing the known comes at the cost of reduced ability to address the unknown.”

Investors who pile into trendy strategies simply because they’ve worked so well in the recent past run afoul of mistaking the unknown for the nonexistent as Nassim Taleb puts it.

Strategies predicated on simple “coarse decision rules” on the other hand, may not be the best performing approach in any single environment but they lend themselves to being more robust and adaptable, which in the long-run means greater odds of survivability and in investing that means staying in the game.

Choose adaptability over optimization. Be more like the cockroach.

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Why The 90% Trader Failure Rate Is Good News

Tyler here.

It seems intimidating to tackle an endeavor where 90% of participants fail. The little voice whispers:

 Wow, nine out of ten people fail at this? What makes me so special then?

And yet, consider:

  • Nine out of ten small businesses fail.
  • Nine out of ten Americans can’t stay on a diet.
  • Nine out of ten Americans can’t get in the gym on a regular basis.
  • The vast majority of Americans don’t have the discipline to work from a home office.
  • That same majority lacks the basic business skills to run a corner grocery store…

Then too, consider the following in weeding out “the ninety percent:”

  • Those who trade for entertainment.
  • Those who trade because they like to gamble.
  • Those who trade because they hate their jobs.
  • Those who indulge in trading fantasies.
  • Those who trade without willingness to learn.
  • Those who refuse to admit their mistakes.
  • Those who are just plain stupid (dumb as a box of hammers).


WHY THE 90% IS GOOD NEWS

Once we move past the initial fear of the 90% barrier – the notion that “9 out of 10” is daunting – we can see that a 90% failure rate is very good news.

Why? Because of the zero-sum nature of the trading game:

  • If bad traders did not reliably lose money…
  • Then good traders could not reliably win it.
  • If the supply of bad traders dried up…
  • Then winning traders would be in trouble.
  • But the supply of bad traders is endless…

In Breaking Down A Market Edge, we explain how the mechanics of excess returns work. There’s only a set amount of alpha out there. Which means winning traders need must feast off of the errors of their inferiors in order to generate excess returns.

If this seems confusing, try thinking about it from the perspective of “who can make the fewest mistakes.” There is a collective pool of capital. The proper actions you take generate a positive expectation, which causes capital from that pool to flow towards your trading account. Meanwhile the mistakes you make generate a negative expectation, which causes capital to flow out of your trading account, back into the pool, and ultimately toward someone else. The picture is still one of a minus sum game, in which all participants compete and the house takes a vigorish — but you win by focusing deeply on the quality, clarity and consistency of your own actions. Your profits come from the 90%, but your focus is not on them… it is internal.

Good traders make money from bad traders (and bad investors)… and the supply of bad traders is endless. Human nature makes it so. For the past 100 years, the game has not fundamentally changed. The suckers will always hand over their money to the sharps.

 Livermore has been saying this since his day (via Reminiscences)

At first, when I listened to the accounts of old-time deals and devices I used to think that people were more gullible in the 1860’s and 70’s than in the 1900’s. But I was sure to read in the newspapers that very day or the next something about the latest Ponzi or the bust-up of some bucketing broker and about the millions of sucker money gone to join the silent majority of vanished savings…


It will not change for the next 100 either…

As a winning trader, your profits do NOT depend on:

  • a booming economy
  • a hot new technology
  • inside information
  • super powerful computing software
  • a secret “holy grail” trading recipe
  • a magical “genius” level talent
  • or anything of the above nature

Instead, your profits depend on the continuing presence of bad traders (the 90%) making mistakes that allow you, the 10% minority, to profit over time… and that supply will NEVER END.

So rejoice the 90% failure rate! That’s where the pile of money comes from for the sharps to harvest. As long as you don’t become part of the 90% trading will prove fruitful.

Going forward, how do you ensure that you stay in the 10% and don’t fall into the 90%?

  • Test your process! Before committing hard earned dollars to a trading program make sure properly vet your strategy. Does it make logical sense? Has it made money in the past? Do you have reason to believe it will continue making money in the future? Can you identify the sucker or group of suckers that will provide you with excess returns?
  • Continuously improve. The ‘vetting” process in trading never ends. Record your trading results, track the performance, and adjust fire.
  • Maintain emotional control. Play to win not to feel good. Emotions are a traders worst enemy, do whatever possible to control them and separate them from the trading process.
  • Never assume what you read in on a blog, textbook, of white paper is true! The trading advice might actually be helpful, but the 10%’ers will verify the claims through their own research. The 90% shortcut the process and immediately implement what they read on Fintwit or a random financial blog.
  • Join a community of like minded 10%’ers who will help you grow. Putting yourself in the company of an elite crew, will help keep your edge sharp.

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Breaking Down A Market Edge

To be an active investor, you must believe in inefficiency and efficiency. You need inefficiency to get opportunities and efficiency for those opportunities to turn into returns. ~ Michael Mauboussin

A limited amount of alpha exists out there in the trading universe. And these excess returns come from errors, missteps, and knee-jerk reactions from the market collective.

I like to think of active trading as a large poker game. Each day before the bell, traders from all over the globe take their chip stack to the exchange and bet on the returns for the day. The ones who were correct on that given day receive money from those who weren’t.

Just like in poker, luck determines performance over the short-term, but over the long-haul after many iterations and trades, those with skill over the others — those with an edge —  come out ahead. These winners earn alpha at the expense of other less skilled market participants. Succeeding in trading requires a clear understanding of edge.

In order for one trader to have an edge over the market, a market inefficiency must exist. Trading Great Ed Thorp said:

There is a market inefficiency if there is a participant who can generate excess risk-adjusted returns that can be logically explained in a way that is difficult to rebut.

Generally the more liquid the market, the less inefficient. If you’re into macro trading like us, you’re playing one of the hardest games out there. Full dedication to the craft is merely table stakes for macro traders.

Now here comes the million dollar question, how do we create a trading edge?

In his latest research paper “Who Is On The Other Side?” Michael Mauboussin, one of the world’s leading thinkers on market game theory, organizes available market edges into 4 different categories using the acronym BAIT. I’ll break them down one by one from here.

The B in Mauboussin’s acronym stands for Behavioral.

Behavioral edges come from a trader exercising superior emotional control over the market collective. These edges are extremely robust since from the dawn of markets, the herd’s emotional response to price movements has largely remained the same.

How can a macro trader effectively take advantage of behavioral inefficiencies?

This requires a careful examination of market sentiment.

This is because once the crowd has fully committed to one side — there is only one way to go, the opposite way. Mauboussin explains this concept in further detail (emphasis mine):

For a crowd to be wise, the members need to have heterogeneous views. To be more formal, consider the diversity prediction theorem, which says that given a crowd of predictive models, the collective error equals the average individual error minus the prediction diversity. You can think of “collective error” as the wisdom of the crowd, “average individual error” as smarts, and “prediction diversity” as the difference among predictive models. In markets, price veers from value when investors come to believe the same thing, or act as if they do. In other words, when investors lose diversity markets lose efficiency.

Once the market collective all agrees on a single outcome price has nowhere left to trend. “Greater fools” have all run out and there is literally no one else available to buy (or sell). To correct this market inefficiency, the price will snap back in the opposite direction. The graph below shows just how well expectations of the crowd line up with future returns. The higher the expectations the lower the future returns of equities.

We saw this play out recently in the S&P last 2018. Take a look at the graph below which shows AAII Bull-Bear Sentiment plotted alongside the SPX index.

Bullish sentiment peaked at the beginning of 2018 right before the volatility blow up. Later that same year, the market sold so hard into Christmas that bearish sentiment reached extreme (read: consensus) levels. Alex wrote about that at the time here and here.

When there was “no one left to buy” in Jan 2018, the market reversed and fell sharply. When there was “no one left to sell” in December 2018 the market turned around and embarked on an enormous rally.

Sentiment drives a significant amount of macro price action. Some traders can make money focusing on sentiment alone. It’s that powerful.

Sentiment indicators are not a panacea though. A bubble can continue growing in size and the sentiment indicator can go off the charts with it. That’s why it’s best practice to always pair price action with every type of trading edge. It keeps you from buying falling knives or selling into face ripping rallies too early.

The A in Mauboussin’s acronym stands for Analytical.

Analytical edges are created by processing publicly available information more effectively than other market participants.

Weighting information differently, updating your views more effectively or anticipating a change in the market’s narrative quicker than the majority are all examples of how one can create an analytical edge.

People incorrectly weight information due to confirmation bias and recency bias. It’s natural for traders to look for confirming evidence to back up a trade of their interest. Do the opposite to gain an analytical edge. Read the other side’s argument to red team your own trade idea.

Also, it’s easy to fall down the trap of looking at the most recent information and assuming it holds more weight going forward than other conflicting information. Just because an asset has been going up recently doesn’t mean that trend will continue. Analytical edges are created by looking at the entire picture without overweighting information from a particular time window.

Maintaining an analytical edge doesn’t end at trade entry. New information is constantly flowing in, and incorporating that into a trading view is important. Updating beliefs based on new information is called Bayesian analysis. When new data is released, price action evolves, sentiment changes, and the narrative morphs. Take these things into account.

It’s good practice to have predetermined time intervals where you check in to see if your trade thesis has strengthened or weakened. If things have changed its possible to increase your analytical edge by tweaking position size.

Finally, to stretch an analytical edge as far as possible, take a step back from the hard data and look at the market narrative.

Machines can analyze simple data sets extremely well, but they aren’t so great at evaluating market narratives. And at the end of the day, it’s the stories we tell ourselves that drive price.

The I in Mauboussin’s acronym stands for Informational.

Informational edge is one of the more obvious edges. If you knew what Apple earnings were before the market it wouldn’t be that hard to place bets the day of the earnings announcement and instantly pocket a nice chunk of change.

But technology and regulation, in particular, have mainly zeroed out this edge.

Jesse Livermore made a killing by reading the tape because price action data wasn’t widely available and not many people knew how to get it. These days everyone has that data and knows how to read a chart. Fundamental information has undergone a similar transformation. Everyone is a simple google search away from finding the key metrics to gauge a company’s health.

Government has made sure that all of this data is released in a fair and orderly manner to all market participants. Gone are the days where connected and high powered individuals could access company news before the public.

Now the new rage is alternative data. Things like satellite imagery of retail parking lots and oil tankers. Soon this information will lose its efficacy as well.

Information edge is a STRONG edge but it does not last and you need a large technical infrastructure in place to capitalize on it. Any individual or small trader is best served working on the other acronyms in BAIT. Leave the informational edges to the quant firms packed with Ph.D. data scientists.

The T in Mauboussin’s acronym stands for Technical.

Technical inefficiencies describe instances where other market participants are forced to transact in direct contradiction to their own forecast. For example, a trader sells a crashing stock even though he believes it will end up higher from the market price in 3 months time.

Common reasons for these forced transactions include laws, margin calls, fund redemptions, fund inflows, and other regulations. Technical edges often coincide with extreme market stress and they don’t last long.

In A Man For All Markets, trading wizard Ed Thorp describes how he exploited a technical edge during the 1987 stock market crash.

After thinking hard about it overnight I concluded that massive feedback selling by the portfolio insurers was the likely cause of Monday’s price collapse. The next morning S&P futures were trading at 185 to 190 and the corresponding price to buy the S&P itself was 220. This price difference of 30 to 35 was previously unheard of since arbitrageurs like us generally kept the two prices within a point or two of each other. But the institutions had sold massive amounts of futures, and the index itself didn’t fall nearly as far because the terrified arbitrageurs wouldn’t exploit the spread. Normally when futures were trading far enough below the index itself, the arbitrageurs sold short a basket of stocks that closely tracked the index and bought an offsetting position in the cheaper index futures. When the price of the futures and that of the basket of underlying stocks converged, as they do later when the futures contracts settle, the arbitrageur closes out the hedge and captures the original spread as a profit. But on Tuesday, October 20, 1987, many stocks were difficult or impossible to sell short. That was because of the uptick rule.

It specified that, with certain exceptions, short-sale transactions are allowed only at a price higher than the last previous different price (an “uptick”). This rule was supposed to prevent short sellers from deliberately driving down the price of a stock. Seeing an enormous profit potential from capturing the unprecedented spread between the futures and the index, I wanted to sell stocks short and buy index futures to capture the excess spread. The index was selling at 15 percent, or 30 points, over the futures. The potential profit in an arbitrage was 15 percent in a few days. But with prices collapsing, upticks were scarce. What to do?

I figured out a solution. I called our head trader, who as a minor general partner was highly compensated from his share of our fees, and gave him this order: Buy $5 million worth of index futures at whatever the current market price happened to be (about 190), and place orders to sell short at the market, with the index then trading at about 220, not $5 million worth of assorted stocks—which was the optimal amount to best hedge the futures—but $10 million. I chose twice as much stock as I wanted, guessing only about half would actually be shorted because of the scarcity of the required upticks, thus giving me the proper hedge. If substantially more or less stock was sold short, the hedge would not be as good but the 15 percent profit cushion gave us a wide band of protection against loss.

In the end, we did get roughly half our shorts off for a near-optimal hedge. We had about $9 million worth of futures long and $10 million worth of stock short, locking in $1 million profit. If my trader hadn’t wasted so much of the market day refusing to act, we could have done several more rounds and reaped additional millions.

Technical edges can be extremely lucrative but they don’t happen often, so you can’t rely on them for your entire trading process. They should be the icing on the cake.

There you have it Behavioral, Analytical, Informational, and Technical edges. Those are all the possible ways you can make money in the market.

Another thing to keep in mind while searching for edge is that generally the harder you worked for the edge the more robust it will be. Humans have a default mode to seek out the lowest hanging fruit. No one wants to put in extra hours at the office if they can avoid it.

That’s why, as Mauboussin notes in his paper, inefficiency is found in places where few are willing to venture and the information flow is complex.

Finally, before placing a trade think deeply about the question “Who is on the other side?”

If you can’t answer that question in a compelling and concise way, it may mean that you’re playing without an edge and engaged in a game of randomness.

If you want even more market wisdom check out our Lessons From The Trading Greats guide for free by clicking here!

2020 US Presidential Election
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Using Political Prediction Markets For Fun And Profit

Elections are interesting to us as macro traders. High-profile political election results can move the markets in a big way, Just look at how crazy the E-mini S&P’s traded during the US’s 2016 presidential election…

They had a 5.5% crash and rally when the cash markets were closed!

The magnitude of a macro market move after a political event depends on how much the results surprise traders. It works just like a stock’s earnings announcement. If results come in way above expectations the stock will rip hard. If results come in way below everyone’s expectations the stock tanks.

Up until recently, we’ve had to rely on sub-par polling models created by people who have no real money backing their predictions. These models did not give us a good indication of the true positioning of traders in the market.

Now, prediction markets like PredicIt allow us to get a glimpse of how people around the world are judging the odds of global political events (and backing those judgments with real money).

PredicIt operates based off a simple contract priced between $0.00 and $1.00. Traders have the option to either purchase “yes” or “no” shares on any given question or event. The market operates exactly like a futures market where for every “yes” contract there exists another trader holding “no.”

At the end of the event, the winners are each paid out $1.00 a share and the losers receive $0.00 a share. Leading up to the event the prices for “yes” and “no” fluctuate depending on supply and demand of the market. This floating opinion allows us to use PredicIt to assess how various political outcomes will impact markets.

Let’s look at a quick example.

PredicIt already has a market for the 2020 US Presidential Election.

If a trader thinks Trump will win again he can purchase “yes” shares on Donald for $0.30.

  • If Trump wins the trader will receive $1.00 for a net profit of $0.70
  • If Trump loses the trader will receive $0.00 for a net loss of $0.30

Now if the trader wanted to bet against Trump he could buy “no” shares for $0.71.

  • If Trump wins the trader will receive $0.00 for a net loss of $0.71
  • If Trump loses the trader will receive $1.00 for a net gain of $0.29

How does this help us handicap the actual event? It’s easy, simply take the price of the “yes” shares and use that as the implied probability of Trump getting elected. Do the opposite if you want to calculate the implied probability that Trump will not get elected.

In the Trump example, since “yes” shares cost $0.30 there’s a 30% chance that Trump goes on for a second term. There’s also a 71% chance that he will not get elected because “no” shares cost $0.71.

Here is a rule of thumb for quickly gauging the likelihood of an event using PredicIt:

  • If the “yes” shares are expensive (close to $1.00) you know that the probability of the outcome happening is high
  • If the “no” shares are expensive (close to $1.00) you know that the probability of the outcome happening is low

As the 2020 US election nears, the price of these contracts will fluctuate based on new information that materializes similar to how stock prices fluctuate based on the most recent earnings announcement.  

Once election time comes we’ll have a more clear indication of how markets will react to another Trump victory. If Trump “yes” shares come into the event cheap, then we know another Trump victory will rattle the markets since it was priced in as a low probability event.

We prefer using prediction markets over polling or bank forecasts. Why? Because in the prediction markets participants have skin in the game, while the modelers and pundits typically don’t. Without financial downside forecasts tend to suck. You need that potential for pain to get a real price on what will likely play out in the future.

Besides using PredicIt as a trading indicator it can actually be a fun way to separate the annoying political loudmouths in your life from their money. We all know a handful of people at work, on Facebook, or at the dinner table who babble on non-stop about their favorite candidate. And no matter what you say in response they won’t waver from their conviction because they are emotionally attached.

The trick here is finding someone who’s obsessed with a polarizing candidate even though that candidate is a cheap “yes” on PredicIt.

For example, let’s say this coworker, friend, or family member is adamant about Trump winning reelection and Predict it has Trump “yes” shares offered for $0.30 (30% chance of winning).

Here’s what you need to do.

  • Buy “yes” shares for Trump on PredictIt for 30 bucks.
  • Now go to the political loudmouth and bet 50 bucks against Trump. (Most people unfamiliar with betting will always accept 1:1 odds because it’s mentally simple and intuitive.)
  • Once both bets are locked in you have guaranteed yourself a $20 (minus PredictIt fees) no matter what happens with Trump
  • If Trump wins, you lose 50 bucks to your political loudmouth, but gain 70 bucks on PredicIt
  • If Trump loses, you win 50 bucks from your political loudmouth, but lose 30 bucks on PredicIt.

You can pull this arbitrage off again and again by finding more passionate Trump supporters in your circle to wager against (assuming they have no knowledge of PredicIt).

Or if you have a whale/ultra passionate person in your circle you can 10x your bet,  $500 against him, $300 on PredicIt and lock in a nice $200 for yourself — an entire free night out for a fancy steak dinner and a show with your significant other!

I’m always on the hunt for this type of stuff, it’s fun, and it helps train your mind for trading.

Just make sure before you wager your friend at 50 you can buy for cheaper than 50 on PredicIt. The lower the number on PredicIt the better the trade!

 

 

,

How To Earn $1 Billion Dollars

The father of modern physics, Albert Einstein was unquestionably a brilliant mind. Not only did he change the world with his work in physics, but he was also an avid sailor, played the violin and shared this gem with the world:

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.

In investment circles, Warren Buffett is most credited with exploiting the benefit of compounding and, at 88 years old, has obviously figured out how to do just that!

It isn’t too challenging to understand and agree with what Einstein and Buffet have taught us: anyone in the markets understands that compounding is a powerful force. But, for fun, indulge me for just a second while I run through some good ol’ fashioned numbers to illustrate the point.

A couple of assumptions before we begin. For simplicity, I am not factoring in inflation, down years, depressions, unusual returns, time away from the markets, commissions and fees, and/or anything that would make this a more robust system than it needs to be for purposes of this exercise. The goal is to not get bogged down with details, but to take a step back and see what compounding interest can build over the long term.

I started the test out at age 30 with $10,000. Maybe you started earlier and already have $10,000 saved at age 21, or over $100,000 by age 50. If you’re one of these magic unicorns, kudos! You are already well ahead of the game and on the road to billionaire status. For the rest of us, here is what my model revealed.

The math is simple: if compounding can put 10% per year back into our accounts, then in theory, all we have to do is live longer to cross that $1 Billion threshold.

In my model, starting at age 30 with $10,000 means by 151 years of age you’ll be a billionaire.  

If you want just half a billion, then you only need to live to about 144 years old! Maybe $100 Million is more your sweet spot…that’s only to 126 years old.

Interestingly you don’t actually break the million dollar mark until your 79th year.

I’m not going to lie, it is slow going in the beginning, so it’ll be hard to keep your eyes on the prize until later in life, where the numbers really start to shoot up dramatically.

If you are 44 years old with $500,000 in assets, you reach the $100m mark on your 100th birthday! And a billion by the potentially attainable age of 124 years old.

Yes, I recognize that this simplified “all you have to do” theory may sound ridiculous, but we can all agree that if you have more time to earn, then your overall assets will grow much larger. So, it isn’t a question of whether or not the math works out (it does), but instead, how long you can live while still maintaining a high quality of life?

We need a lot of time to get to the billion dollar mark, but we also need to get there in as good as shape as possible, otherwise what’s the point? Our bodies and minds must be healthy enough to enjoy that large nest egg.

In 1955 the average life expectancy in North America was 69 years of age. In 2015, 50 years later, it was 79 years old. A nearly 15% increase. Using this metric, 50 years from now, our average life expectancy may be close to 90 years old. And it’s not crazy to think that life expectancy will exponentially increase over the next 50 years as we see rapid advances in tech and healthcare.

So there is a potential to earn a billion dollars like Charlie Munger says:

Sit on your ass. You’re paying less to brokers, you’re listening to less nonsense, and if it works, the tax system gives you an extra one, two, or three percentage points per annum.

And he’d know, at age 95 he’s made a lot of money just sitting on his ass and compounding.

If we want a chance to hit the $1 Billion mark we need to stay laser focused on increasing our own life expectancy.

Here are the leading causes of death in the United States from the Center for Disease Control.

And internationally it’s fairly similar according to the World Health Organization.

Generally speaking these are common worldwide:

  • Heart Disease
  • Cancer
  • Accidents
  • Stroke
  • Alzheimer and Dementia
  • Diabetes
  • Road Injury
  • Lower Respiratory Infections
  • Influenza
  • Suicide

Knowing that we don’t have cures for most of these just yet, it is a bit hard to optimize against them; however, we have lots of information regarding known causes of heart disease, cancer, diabetes, alzheimer’s and the flu. If you are living in a world where chronic disease is inevitable, we should chat more. It isn’t.

We know that diet, negative environmental factors, sleep, exercise, and sense of purpose have been directly linked to the most common causes of death.

To achieve a $1 Billion net worth we have to pour our energy into making sure our body and mind stay healthy for as long as possible.

Dr. Peter Attia is the foremost expert on the front lines of longevity. If you are interested in learning all about his work in the field of longevity, I highly recommend you go down this rabbit hole – it is well worth the read, watch the video, and then get to Googling.

If you’d rather just read an abbreviated version, here are a few of Dr. Attia’s suggestions:

  • Fast – 12-16 hours per day is good for metabolic health and weight management and something that can be practiced everyday. I’ve been doing this for about 15 years now, off and on.
  • Fast – A more challenging fast that lasts 2-3 days. It isn’t a complete fast, it is a fast mimicking diet called Prolon which increases autophagy or simply a cleaning of the bad stuff by your cells. And finally a 4-5 day Prolon fast really increases stem cell based rejuvenation. Research this before you undertake it.
  • Eat whole foods, the stuff our grandparents would recognize.
  • Drop the sugar and keep insulin low.
  • Sleep more and sleep better.
  • Drink more water.
  • Don’t Smoke.
  • Exercise, and focus on strength/resistance training above all other forms of exercise.
  • Live for something, have a mission!
  • And if you live in the United States, stay off the Opiates.

What’s the payoff?  Well, you’ll feel better almost immediately, but you also may have a shot at compounding your face off to a $1 Billion net worth!  

In summary, start purchasing cash flow producing assets, let them compound, don’t fiddle with them, eat less, exercise more, sleep more, drive safely, and live for something! Write to me when you turn 150 and cross the $1 Billion line so we can celebrate!

Age Assets

30 $10,000.00

31 $11,000.00

32 $12,100.00

33 $13,310.00

34 $14,641.00

35 $16,105.10

36 $17,715.61

37 $19,487.17

38 $21,435.89

39 $23,579.48

40 $25,937.42

41 $28,531.17

42 $31,384.28

43 $34,522.71

44 $37,974.98

45 $41,772.48

46 $45,949.73

47 $50,544.70

48 $55,599.17

49 $61,159.09

50 $67,275.00

51 $74,002.50

52 $81,402.75

53 $89,543.02

54 $98,497.33

55 $108,347.06

56 $119,181.77

57 $131,099.94

58 $144,209.94

59 $158,630.93

60 $174,494.02

61 $191,943.42

62 $211,137.77

63 $232,251.54

64 $255,476.70

65 $281,024.37

66 $309,126.81

67 $340,039.49

68 $374,043.43

69 $411,447.78

70 $452,592.56

71 $497,851.81

72 $547,636.99

73 $602,400.69

74 $662,640.76

75 $728,904.84

76 $801,795.32

77 $881,974.85

78 $970,172.34

79 $1,067,189.57

80 $1,173,908.53

81 $1,291,299.38

82 $1,420,429.32

83 $1,562,472.25

84 $1,718,719.48

85 $1,890,591.42

86 $2,079,650.57

87 $2,287,615.62

88 $2,516,377.19

89 $2,768,014.90

90 $3,044,816.40

91 $3,349,298.03

92 $3,684,227.84

93 $4,052,650.62

94 $4,457,915.68

95 $4,903,707.25

96 $5,394,077.98

97 $5,933,485.78

98 $6,526,834.35

99 $7,179,517.79

100 $7,897,469.57

101 $8,687,216.52

102 $9,555,938.18

103 $10,511,532.00

104 $11,562,685.19

105 $12,718,953.71

106 $13,990,849.09

107 $15,389,933.99

108 $16,928,927.39

109 $18,621,820.13

110 $20,484,002.15

111 $22,532,402.36

112 $24,785,642.60

113 $27,264,206.86

114 $29,990,627.54

115 $32,989,690.30

116 $36,288,659.33

117 $39,917,525.26

118 $43,909,277.78

119 $48,300,205.56

120 $53,130,226.12

121 $58,443,248.73

122 $64,287,573.60

123 $70,716,330.96

124 $77,787,964.06

125 $85,566,760.47

126 $94,123,436.51

127 $103,535,780.16

128 $113,889,358.18

129 $125,278,294.00

130 $137,806,123.40

131 $151,586,735.74

132 $166,745,409.31

133 $183,419,950.24

134 $201,761,945.27

135 $221,938,139.79

136 $244,131,953.77

137 $268,545,149.15

138 $295,399,664.07

139 $324,939,630.47

140 $357,433,593.52

141 $393,176,952.87

142 $432,494,648.16

143 $475,744,112.97

144 $523,318,524.27

145 $575,650,376.70

146 $633,215,414.37

147 $696,536,955.81

148 $766,190,651.39

149 $842,809,716.53

150 $927,090,688.18

151 $1,019,799,757.00

 

,

Emergent Properties of the Market Collective

One of the coolest things to watch in nature is a Starling murmuration.

If you’ve never seen one before then give this video a watch.

Starlings — which are small and not particularly intelligent birds — are somehow able to form these amazingly complex and beautiful airborne systems that are capable of extremely intricate flight patterns which shift and shape with near instantaneous coordination.

They do this apparently in response to threats; to thwart off and confuse predators.

I’m fascinated by systems that display emergent properties such as murmurations. Where a network operating off simple behavioral rules can emerge complex, seemingly intelligent, behavior.

Scientists have long been awed by the same and using the latest technology they’ve been able to gain a fuller understanding of exactly how Starlings accomplish this.

The following excerpt is from a paper on murmurations by Italian researchers. You can find the whole thing here (emphasis by me).

From bird flocks to fish schools, animal groups often seem to react to environmental perturbations as if of one mindHere we suggest that collective response in animal groups may be achieved through scale-free behavioral correlations… This result indicates that behavioral correlations are scale-free: The change in the behavioral state of one animal affects and is affected by that of all other animals in the group, no matter how large the group is. Scale-free correlations provide each animal with an effective perception range much larger than the direct interindividual interaction range, thus enhancing global response to perturbations.

Scale-free correlations mean that the noise-to-signal ratio in a Starling murmuration does not increase with the size of the flock.

It doesn’t matter what the size of the group is, or if two birds are on complete opposite ends. It’s as if every individual is linked-up to the same network.

The Starlings accomplish this feat by following very simple behavioral rules. Wired magazine notes the following:

At the individual level, the rules guiding this are relatively simple. When a neighbor moves, so do you. Depending on the flock’s size and speed and its members’ flight physiologies, the large-scale pattern changes.

It’s easy for a starling to turn when its neighbor turns – but what physiological mechanisms allow it to happen almost simultaneously in two birds separated by hundreds of feet and hundreds of other birds? That remains to be discovered, and the implications extend beyond birds. Starlings may simply be the most visible and beautiful example of a biological criticality that also seems to operate in proteins and neurons, hinting at universal principles yet to be understood.

A Starling murmuration is a system that is said to always be on the “edge”. These are systems that exist in what’s called a “critical state” and are always, at any time, susceptible to complete total change.

Wired writes that Starling murmurations are “systems that are poised to tip, to be almost instantly and completely transformed, like metals becoming magnetized or liquid turning to gas. Each starling in a flock is connected to every other. When a flock turns in unison, it’s a phase transition.”

What are the benefits of this emergent behavior?

The broader effective perception range combined with their existing in a constant state of criticality, provide Starlings with a strong competitive advantage for survival. The Italian researchers conclude that:

Being critical is a way for the system to be always ready to optimally respond to an external perturbation, such as a predator attack as in the case of flocks.

Individual Starlings operating off their own simple self-interested rules in aggregate create a vastly superior “collective mind” that broadens their perception range — and thus information intake — which enables them to operate in a continuously critical state. A state that’s optimal for responding to threats which helps raise their odds of survival.

You might be asking at this point, “Interesting stuff Alex, but what does this have to do with markets?”

Fair question…

Well, isn’t the market just one big collective mind?

Similar to a murmuration, the market is just the aggregation of individual actors operating off simple inputs (prices, data, narratives) in order to try and avert danger (ie, lose money on the way down or miss out on the way up).

Like Starlings, market participants instinctively key off one another. Robert Prechter, the popularizer of Elliott Wave Theory, writes in his book “The Socionomic Theory Of Finance” that:

Aggregate investor thought is not conscious reason but unconscious impulsion. The herding impulse is an instrument designed, however improperly for some settings, to reduce risk.

Human herding behavior results from impulsive mental activity in individuals responding to signals from the behavior of others. Impulsive thought originates in the basal ganglia and limbic system. In emotionally charged situations, the limbic system’s impulses are typically faster than the rational reflection performed by the neocortex… The interaction of many minds in a collective setting produces super-organic behavior that is patterned according to the survival-related functions of the primitive portions of the brain. As long as the human mind comprises the triune construction and its functions, patterns of herding behavior will remain immutable.

These simple inputs create a market that is collectively smarter than its individual constituents. It has a much broader perception range and exists in a critical state (always ready to phase shift from bull to bear regime) which allows it to more ably respond to changes in the environment.

When Stanley Druckenmiller first got into the game, his first mentor Speros Drelles — the person he credits with teaching him the art of investing — would always say to him that, “60 million Frenchmen can’t be wrong.”

What he meant by that is that the market is smarter than you. It knows more than you thus its message should be heeded because 60 million Frenchmen can’t be wrong…

Druckenmiller often says that “The best economist I know is the inside of the stock market. I’m not that smart, the market is much smarter than me. I look to the market for signals.”

We’ve known about the wisdom of crowds and the power of collective intelligence ever since Francis Galton — a British statistician and Charles Darwin’s cousin — discovered the phenomena while observing groups of people guess the weight of an ox at a county fair (the individual guesses were far off but the average of all guesses were spot on). There’s since been a significant amount of work done on the topic; The Wisdom of Crowds by James Surowiecki is a good summation of it.

But, there are a few key differences between markets and murmurations and the unique impact and limitations of crowd intelligence in financial markets, specifically.

The first is —  and this is a big one —  that markets are reflexive.

George Soros was the first to discover this truth. He wrote that “Reflexivity sets up a feedback loop between market valuations and the so-called fundamentals which are being valued.” This means that the act of valuing a stock, bond, or currency, actually affects the underlying fundamentals on which they are valued, thus changing participants perceptions of what their prices should be. A process that plays out in a never-ending loop…

This is why Soros says that “Financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality.” And that the level of distortion is “sometimes quite insignificant, and at other times quite pronounced.”

This means that markets are efficient most of the time except for some of the times when they become wildly not so.

The key driver between low and high distortion regimes are the combined effect of (narrative adoption + price trends + time). These three inputs all work in unison. So when there’s a narrative that becomes broadly adopted, it drives steady price trends, and when these price trends last for a significant amount of time, they then drive more extreme narrative adoption. And so on and so forth…

This positive feedback loop hits at the unconscious impulsion herding tendencies of investors and drives them to focus on trending prices in the act of valuation at the near exclusion of all other factors (ie, earnings, cash flows, valuation multiples etc…).

Most of the time, there are enough competing narratives which drive price volatility and keep the market fairly balanced.

Another major difference is that Starlings aren’t aware of the broader complex system they are an integral part of. It’s all instincts… evolutionary programming… they turn when the bird next to them does.

Whereas in markets, we can be aware of the system of which we form. We can consciously separate ourselves from the herd and view the whole objectively (at least to the best of our abilities).

This is important. Because as traders, we’re in competition for alpha with the rest of the flock. We don’t just want to turn when and where the others turn. We want to get to where they’re going before them. And to do this, we need to be able to develop a sense for where they’re headed…

Which brings us to the lesson I”m trying to impart.

The reason I’ve been chatting so much about birds, collective intelligence, and reality distortion and all that jazz… is because if we understand the signaling power of certain areas of the market, whether in a low or high distortion regime, we can eschew the need to try and predict all together and instead let the market tell us where things are headed.

I was reminded of this while listening to this Knowledge Project podcast interview with Adam Robinson. Here’s Part 1 and Part 2.

For those of you who don’t know him, Adam is a prodigy who “cracked the SAT” and created The Princeton Review. He now spends his time thinking, writing, and advising hedge funds on strategy. He’s the penultimate first principles thinker. He shared some of these principles in the above interview which we’ll cover now.

To begin with here’s Adam summarizing the lens in which he views markets (emphasis by me):

The fundamental view of investing is that you can figure out something about the world that no one else has figured out. It’s a bit like prospecting, right, gold prospecting. You can go out with your pan and find something that no one else has found. Well, the difference between investing and gold prospecting is that gold prospecting, you actually find gold that you can actually go sell, right? If you find a value that no one else has found, what makes you think… If people are irrational enough to believe that the price of gold is different from what you think it is or should be, what makes you think they’re going to become rational tomorrow? There’s that great quote by John Maynard Keynes, “Markets can stay irrational longer than you can stay solvent.” Good luck with that.

So, there’s a third way, and John Maynard Keynes said, “Successful investing is anticipating the anticipation of others.”

My approach to markets is simply this, to wait for different groups of investors to express different views of the future, and to figure out which group is right. I look for differences of opinion strongly expressed, and decide which one is right.

Whatever else you may think about the world, the world is the product of our thinking. So is the economy. So are our investments. If you think about it, an investment is nothing more than the expression of a view of the future. So when you buy Facebook, or you short the dollar-yen, or you buy gold or short US Treasuries, you are expressing a view of the future. Your view of the future can be right or wrong, and your means of expression can be right or wrong, but that’s what you’re attempting to do, right?

So, if you and I were to go to Columbia Business School or Harvard Business School right now and ask the assembled MBA students, “What is a trend?” They wouldn’t be able to define it at all. In fact, I don’t know that any investor in the world can define a trend. They can define it simplistically like this: “A trend is the continuation of a price series.” Yeah, well that’s great. What’s causing the continuation? Right? And I’ll tell you what a trend is—this is an investment trend—actually it’s true for all trends. A trend is the spread of an idea. That’s all a trend is. It’s the spread of an idea.

Adam doesn’t believe in the existence of intrinsic value but rather views markets as an evolutionary narrative continuum; where stories spawn, develop, spread, only to eventually get outcompeted and then wither and die.

This is similar to what The Philosopher said in Drobny’s The Invisible Hands which I discussed in my piece on How To Be a Smart Contrarian. Here’s the Philosopher in his own words (emphasis by me):

Market prices reflect the probability of potential future outcomes at that moment, not the outcomes themselves.

One way to think about my process is to view markets in terms of the range of reasonable opinions. The opinion that we are going to have declining and low inflation for the next decade is entirely reasonable. The opinion that we are going to have inflation because central banks have printed trillions of dollars if also reasonable. While most pundits and many market participants try to decide which potential outcome will be the right one, I am much more interested in finding out where the market is mispricing the skew of probabilities. If the market is pricing that inflation will go to the moon, then I will start talking about unemployment rates, wages going down, and how we are going to have disinflation. If you tell me the markets are pricing in deflation forever, I will start talking about the quantity theory of money, explaining how this skews outcomes the other way… People tell stories to rationalize historical price action more frequently than they use potential future hypotheses to work out where prices could be.

Adam references the work done by Everett Rogers in the study of the Diffusion of Innovations (Rogers has a book by the same title which is well worth a read). This line of study is about how the adoption of technology spreads but the work really can be applied to how everything spreads: narratives, ideas, social norms etc…

Rogers breaks down the categories of adopters as: innovators, early adopters, early majority, late majority, and laggards. Well in markets there is a similar breakdown of participants who are consistently early or late to the adoption of narratives and thus trends.

Knowing which groups are which and what their signaling means has been a critical part of Druckenmiller’s process over the years. Here’s Druck in his own words:

One of my strengths over the years was having deep respect for the markets and using the markets to predict the economy, and particularly using internal groups within the market to make predictions. And I think I was always open-minded enough and had enough humility that if those signals challenged my opinion, I went back to the drawing board and made sure things weren’t changing.

Adam breaks down these groups as follows, from earliest trend spotters to later adopters:

  1. Metal traders
  2. Bond traders
  3. Equity Traders
  4. Oil Traders
  5. Currency Traders
  6. Economists
  7. Central Bankers

What does this mean in practical terms?

Well, metal traders tend to be the most farsighted of the group. They are usually right and early about changing trends in the economy.

Why is this?

Adam gives three reasons, “The first is, they [metal traders] are the Forrest Gumps of the investing world. Their view of the world is very simplistic. Are people buying copper? And if they are, thumbs up. All is good in the world’s economy. Great. I guess interest rates are going higher. That’s the way metal traders view the world. And if people are buying less copper, they go, ‘Oh, that’s bad. Economic slowdown’.”

Secondly, “People buy and sell copper. It’s used — it’s a thing. It’s not just a number on a screen, which is all currency traders look at. Right?” And third is time frame, “Commercial metal traders look months to years ahead. Because if you want to take copper out of the earth, it’s going to take years to open that mine, right? So, metal traders are the most farsighted. They have the simplest model of the world, and they are actually in touch with the world economy.”

In our November MIR, China is a Teacup, we pitched the case for buying US treasuries. One of the reasons why was because metal traders were signaling slowing economic growth ahead and slower growth means lower rates (bonds get bought). The trade was an easy layup…