One of my goals on this site is to foster literate, respectful and informed discussion on trading. There’s a lot of reasons for this. First off, it’s somewhat draining providing info in a vacuum without learning new things myself. Second, in order to be a good trader you’re almost certainly going to need perspectives other than mine. Continue reading
Here’s a lesson that I’m consistently forced to re-learn: volatility and range matter. A lot. This is something which keeps coming up in my trading, and perhaps it represents a mental defect on my part that I can’t internalize it. Hopefully you can do better. Continue reading
Before continuing, you need to have a solid grasp of alpha and beta – otherwise the rest of this article will make no sense.
Back in part three, we developed a method for trading the S&P 500 for use in the long term speculative account. In other words, we’ve figured out how to trade beta. That’s good, but one of the goals of this speculation method is to limit beta exposure to +- 20% of the account value. The purpose of this limit is to mitigate account damage in unexpected crash situations (when long) or boom situations (when short). Since I’ve allocated 20% of the portfolio to beta trend following (which could thus produce betas between +-20%), ideally everything else in the portfolio should have a beta of zero. That’s a difficult requirement for stocks, however, because they essentially all have a positive beta, and in most cases that beta constitutes at least half of the stock’s movement. What we need is something that acts like a stock, but with no beta component. Continue reading
I want to convince you of something. It runs contrary to good old fashioned common sense, and yet I believe it’s true. Consider:
When you encounter an economic opportunity where it’s totally unclear if you have the best of it, frequently the best thing to do is risk some of your money and time and find out.
This could be though of as the anti-business-school method. Business grads spend plenty of hours figuring out how to analyze a business or opportunity, investigate the competition etc. That’s great. But it’s worth a little time to think about what happens if you give up on the B-school method entirely and instead learn about business by doing business.
Ideas like this are of course best illustrated by old gambling stories… Continue reading
An arbitrage is a trade that produces near risk-free and near guaranteed profits. In general, independent and retail traders are not successful as arbitrageurs. We’ll get into the reasons why in a bit. But it’s still important to understand how arbitrages work, because they’re a fundamental part of the structure of the market. Each arbitrage defines an equation, for lack of a better word, of how the prices of various instruments should be related to each other and to interest rates. Some of these relationships are trivial to understand, but others are far from obvious. Continue reading
Before we continue with the speculative alternatives to investment series, I need to introduce some mathematical concepts. Yeah, yeah. You’ve got a hangover and barely eked out a C- in calculus. But stick with me.
Two key tools of quantitative finance are:
- combining financial instruments together
- slicing a single financial instrument up into smaller pieces to understand how it behaves
It’s pretty easy to understand how you combine instruments – the easiest way is to make an index. You take a bunch of instruments (say, stocks) that are somehow similar and average their price. Typically you weight the average by a size metric like market cap. Voila – an index. This is a big data approach to understanding the movement of the market.
It’s a little less clear how you take one instrument and slice it up. Turns out there’s slightly beefier math involved – Pearson correlation, linear models and linear regression in this particular case. It’s OK if you skipped that class – there are plenty of tools to help us get through the math. Continue reading