Saturday 3 December 2016

It has always been a 'Post-Truth' world


Tthe Oxford Dictionary has declared “Post-truth” as its 2016 word of the Year. "Post-truth" refers to circumstances where ‘objective facts’ are less influential in shaping public opinion than emotions and personal belief. As the big political 'shock' events have unfolded this year, commentators have come to increasingly apply the term ‘post-truth’, to make sense of the how the electorate have ignored facts and voted with their hearts. However, this ignores a crucial 'fact', people have always voted with their heart. In his 2004 book, 'Don’t Think of an Elephant!' George Lakoff, said that voters were motivated more by “moral identity and values”, than economic self-interest.

Politics and markets are two sides of the same coin. Anyone who has worked in markets long enough, has known that heart come before head. The lengendary investor Benjamin Graham called it right, when he saidIn the short run, the market is a voting machine but in the long run, it is a weighing machine. - Yes in the long-run, facts matters, the market will only stretch so far from value, however markets can stay irrational far longer than many can remain solvent, and in that sense it has always been a post-truth world.

Complexity and Uncertainty.

Thw one and only truth is that the world, as with markets, is inherently complex and uncertion. In  an interview back in the 1980s, when he was head of currency forecasting at the Federal Reserve, Kenneth Rogoff was asked 'What exactly did being head of currency forecasting mean?'. His response “It means that I know better than anyone else, exactly how much I do not know where markets are heading.

Markets rarely conform to what appear to be ‘the facts’. It is human emotions and feelings that tend to drive markets. This may seem illogical to many, but was perfectly understtod by John Maynard Keynes. Keynes used the term "animal spirits" to describe how human emotions drives crowd behaviour and the way people make decisions in markets.

Keynes' own experiences as an investor were a key factor in helping him come to these conclusions. Keynes had been responsible for managing the endowment fund of King's College at Cambridge. His early experiences were less than impressive. From 1924 to 1932 he only marginally outperformed the underpforming UK stock market. Yet it was during these times that Keynes, as the world’s leading economist, was as informed as anyone could. He had the ears of presidents, prime-ministers, finance ministers, heads of central banks, heads of mining companies, leading financiers, and anyone who was anyone in the financial and political world.

Post-1932 however Keynes's investment record was stunning. The table below, lifted from a 2012 Wall Street article, emphasises this. It was during this time that Keynes became the pioneer of what was to be known as Value Investing. Keynes’s method was to have a huge influence on the legendary Benjamin Graham, and one of his prodigys, Warren Buffett.


From 1932 onward, Keynes abandoned his practice of looking at the big macro factors to determine value, instead he took a bottom-up ‘micro’ approach. The truth based on objective data, was less important than trying to understand what 'moved' and ‘motivated’ people to value an asset. If he could understand and price that, then he could pick stocks which had a strong possibility of moving higher. To emphasise this, Keynes used as an example, what became known as the Keynesian beauty contest.

The Keynesian Beauty Contest.
Keynes compared selecting investments to the way people particpated in beauty contests common at the time in English newspapers. The newspapers would publish 100 photos of beautiful women, and asked readers to select the six faces they liked most. The winning reader would be the person whose selection most closely matched the six most popularly selected faces, or some variation of that. Keynes wrote that “It is not a case of choosing those (faces) which, to the best of one’s judgment, are really the prettiest, nor even those which average opinions genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be."

2016 - Brexit and Trump

2016 has been a huge challenge for many who are trying to rationalise events which challenge their view of the world. What they are seeing, what they believe they know, and what has happened seem completely at odds. It becomes far easier for them to explain this, by applying terms such as ‘post-truth’ or ‘post fact’. - In my formative trading years, I wish I could have explained losses I suffered as ‘post-truth’ or ‘post-fact’ events, it would have saved me a lot of anguish. Actually, as I recall, I may have done that: I once said ‘It wasn’t me that was wrong, it was the market’.

The problem is that our minds do not necessarily work in ways we think they do. All our experiences, knowledge and expectations accumulated over many years shape the way we see the world, often taking us away from reality. Optical illusions are often a great example of this. In this chessboard image below, squares A and B are exactly the same colour, yet even as I tell you that, with every sinew in your body you will believe this to be complete nonsense.

This is one of my favourite illusions. I often lead with this one on 'Behavioural Finance' seminars and workshops I give. No matter how much I try and tell people that square A and square B are identical colours, no one believes it. And even as I look at it now, knowing full well the truth, I cannot see it.

‘Markets and politics’, two sides of the same coin, do the same thing to us. Thus we rarely see matters as objectively as we think. We try to resolve these issues in a variety of ways. If I draw on this illusion as an example. We can either dismiss what we see, and trust the story, in this case the idea that square A and B are identical colours. Or we can dismiss what seems ridiculous and hold the opinion that Square A and B are different colours. Or if you have the time and energy you can do your own research (I have provided a link to assist you ). Or you may prefer to print it out and cut it up to prove (or disprove) me.

Returning to this year’s earth shattering political events:

In January you could have got great odds from bookmakers on both Brexit and Trump. You could have still got great odds in the first few minutes of both days of those events occurring. In January I was having breakfast with one of the markets leading, least known, yet most brilliant of economists, Martin Malone. Martin asked me what I thought would happen regarding Brexit and the US election. I said that the chances of a UK Brexit vote were incredibly low. Polling at the time had Brexit in the mid to low 30 percent. He looked at me, and laughed, ‘It’ll be a lot closer than that he said’. Adding, that he thought it would actually happen, and that he would fully expect the pound to drop to about 1.2500 to the dollar. As for the US election: I said, the idea of Trump getting elected was laughable. Again, the look on his face told me that once again his view differed.


What Martin does, as an economist, is he digs behind the numbers, he goes outside the ‘bubble’, he gets a truer understanding of the facts, and being privately employed he is not influenced by both conscious and unconscious agendas. More importantly, he builds a bottom-up case, and he certainly does not take anything at face-value.

Post-Truth = Inconvenient Truth.

I do not want to disseminate the various statements used along the way in the referendum/election processes, this is not a political piece, other than to state that politicians lying or grossly exaggerating is nothing new. What I will say however, is that the term ‘post-truth’ is being used to try and square the 'cognitive dissonance' and 'inconvenient truths' which has arisen for many people this year.

These days I no longer trade for a living, instead I work as a coach with traders and investment professionals. In doing this, I have come to appreciate many of the finer qualities and subtleties I see displayed by the finest exponents of making money and managing assets in financial markets. One of these is the ability to admit when one is wrong and to not be too dogmatic in one's views. Many of the best traders and investment professional I meet will readily admit that they know far less about where markets are headed than many people think. ‘Not knowing’ and ‘Being wrong’ are OK for them.

This attitude echoes the response Keynes once gave to an irate government minister who had accused him of reaching a conclusion which was contrary to that which he has previously reached. ‘When the facts change, I change my mind. What do you do, sir?’

The fact or the truth is, that we do not live in a ‘post-truth’ world, we live in a highly uncertain, highly complex world. We always have done and always will do. The big mistake is to confuse 'more knowledge', with 'better knowledge'.

Tuesday 15 November 2016

Risk Intelligence: The Dirty Little Secret of Successful Traders



Successful traders and investment professionals come in all shapes and sizes. They possess many, often vastly differing personalities and characteristics, have widely differing approaches to finding value, and adopt a broad array of different ways to monetise that value.

In my role as a 'Trader Performance Coach' I have been privileged to have access to many outstanding traders and investment professionals. This leads people to ask me the same question time and again. ‘What is it that differentiates the few extremely successful traders from those many capable individuals who are good, but do not quite make the grade?

In other words, 'What is their dirty little secret?'

This is not a question which can be answered with just one simple response. Successful individuals have multiple small edges that I believe compound to provide them with one huge edge. Something I call ‘the law of multiple small edges’.

It’s not IQ.

Whislt a moderately good level of IQ matters in trading, I do not believe it is a differtiating factor leading to success. If anything, a moderate level of intellectual intelligence is just a minimum requirement. Emotional intelligence is far more important, however the key delineator of trading success is something slightly different, though closely related to emotional intelligence.

The author Dylan Evans calls it ‘Risk Intelligence’,  he defines as "a special kind of intelligence for thinking about risk and uncertainty". Evans brought this concept into the open with his brilliant book 'Risk Intelligence: How to Live with Uncertainty'

At the root of Risk Intelligence is the ability to estimate probabilities more accurately. Taking this one step further, and applying it to an Investment and Trading context, I see Risk intelligence, as 'the ability to be able to determine, assess and evaluate risks with greater accuracy, and then crucially to monetise these risks effectively'. 



Risk Intelligence is generic across all types of trading styles.

Risk Intelligence works across all domains. From day traders to momentum and price action traders, from relative value traders, to longer-term macro fund-managers.

I meet highly risk averse traders and highly risk tolerant traders who equally display high levels of risk intelligence, and intuition-based traders and evidence-based traders, both of whom can display high levels of risk intelligence.

Likewise, the ability to build a successful system is not just reliant on technical, data or computer skills, the construction must also factor in risk intelligence, as must the running and management of the systems.

On the other hand, there are many examples of 'very smart or highly intellectual' people who lack ‘risk intelligence’. At the root of the ‘Long-Term Capital Management’ catastrophe of the late 1990’s were Nobel prize-winners who were flawed in their understanding of risk. The fatal flaw at Enron, a firm who supposedly hired the brightest and the best, was a complete vacuum of Risk Intelligence.

Risk Intelligence is the ability to ‘thrive in conditions of heightened uncertainty and complexity’.

The ‘Risk Intelligent’ individual is conscious that they will not always win. They are willing to suffer or sacrifice losses, albeit in a limited way. They make room for this in how they work. ‘Risk intelligent’ traders ‘lose well’. One of my favourite trading maxims is 'In trading, the best loser is often the long-term winner’.

This concept is challenging for many people who enter trading. Our Western philosophy grooms us all our lives to win, to come top of the class, to accumulate knowledge, to have answers, to get the best grades. In the Western discourse, failure is not accelerated or tolerated: ‘We must not lose’, ‘we must not fail’, ‘we must not accept defeat’, ‘we must not ‘not have the answer’.’

The ‘Risk Intelligent’  cultivate a mindset which gets past these attitudes. They usurp conventional thinking. This mindset, like Carol Dweck’s 'growth mindset', is a feature of the most successful traders. They are willing to accept defeat as a necessary evil on the way to victory. They are willing to admit they ‘don’t know the answers’. In a complex world, where you only ever have at best a tiny fraction of the relevant information in real time, how can any truly 'know the answer'?

A former trading client, who was also a successful poker player, told me that when he was at the poker table he didn’t believe he was any better at winning than the other players, but when it came to losing, he felt he was ‘far better than most’.

By accepting defeat as a necessary evil, and factoring it into the success equation, he was better able to accept the consequences of bad luck, and better prepared to ride out the negative outcomes of risky plays that didn’t work.

He took this same attitude into his work as an investment bank trader. This attitude contributed to him becoming the top trader in a firm which had several hundred traders and later led to a very successful career in the hedge fund world.

Conclusion

Risk Intelligence is not something we are born with. Like all forms of intelligence, we cultivate it throughout our lives. 
Some painful early life experiences may even make us more prepared for it. However, everyone can develop and improve their Risk Intelligence. I know as a trader I was lacking in Risk Intelligence in my early years, but my latter and most successful years were marked by far higher degrees of Risk Intelligence. 

Article by Steven Goldstein 

Steven Goldstein is a Performance, Team and Executive Coach who focuses on Risk and Financial Markets people and businesses.

Core to Steven's work is the belief that everyone has the potential, often latent or hidden within them, to surpass where they are now and to grow into what they want to be. His work as a coach helps people to rediscover that potential, to recognise it, to value it, and to leverage it to be better, happier, and more productive.

Prior to becoming a coach Steven worked for more than 20 years as a Rates and FX trader at some of the world’s leading investment banks. See Steven's Full Profile.

If you are curious about how Steven could help you or your business, please email him at info@alpharcubed.com. or call +44 (0)7753 446097. To know more about the work of AlphaRCubed and their broader performance and growth development services, please view their brochure at this link. .

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Thursday 20 October 2016

The Revenge Trade

Most traders at some time or another will have done ‘The Revenge Trade’. It’s one of the classic mistakes of trading. The Revenge Trade leads to immense frustration, deep anger, and a lot of soul-searching. More crucially, it is a major contributor to under-performance and to failure as a trader. – As with the image above, it is the metaphorical equivalent of punching yourself in the face, over and over again.

How might the Revenge trade look?
Let’s consider a simple example: You walk into the trading room, you do your early morning scan of the markets. – In your mind you start to formulate some trade ideas for the day. – Lets assume you are trading the SP500 futures.

You follow the opening price action and you quickly form a short-term bullish view. The market is trading around the 2130 and you think it is worth a buy. You like the price action, the momentum behind it, and the fact that its recently cleared and held a good resistance level. You have a sense that most short-term traders are not yet on the long-trade, giving it potential for further upside if they come on board. Your hunch is that in the next few days you could see a move up to 2150. 

Also emboldening your view is that your ‘Stop’ on this trade would not be far away, making it a great risk/reward trade. You believe it has a good possibility of holding above the 2127/28 area, and if it breaks there then you would have a stop at 2125. – So you are sitting there with a potential 4 to 1 payoff, a very favourable set-up. 
 
Day 1: You enter the market paying 2130 for 10 futures. That’s $2,500 a point. If you are wrong your risk is $12,500, if you are right you are looking at potentially a $50,000 profit, maybe more if you stay long beyond there. The market goes your way almost immediately, jumping to 2135. It then stalls and starts slowly ticking back down, it briefly tests the support but manages to  hold above 2128. Later that day it starts rallying again pushing up to 2137, before closing at 2135. You are off to a good start.

Day 2: The next day it opens with further gains, pushing up to 2140. The trade is going well, but then some news hits the wires which  sends the market lower, and an intraday sell-off starts to gather steam. Now you aren’t quite feeling so confident, people around you are selling and talking about a move far lower, the market drops sharply and soon it is testing 2128. Now you are starting to get nervous, instead of looking at the potential profit, you are on the defensive and fearing your stop at 2125 will be hit. The index ticks down to 2127, before stopping its decline and clawing its way back up slowly to just over 2130. Many day-traders around you are now short. 

In your mind the doubts start. As you watch the price action you start to question whether your view is right! You start wondering whether you would be best salvaging something from this trade whilst you can. Thus you make the decision to sell out at 2130. Now you are out flat, no loss  or no gain. The market again turns down to 2127, and for a short time you feel mightily relieved, giving yourself a metaphorical pat on the back. 

For most of the rest of the afternoon the index remains in a tight 2127-2130 range. Then in the last half hour it starts climbing, 2131, 2132, 2133, 2134, the intraday shorts have run out of patience and are now buying back. The market then puts in a surprisingly strong close, moving up sharply in the last few minutes to close at 2140, a gain of 6 points on the day. 

You are left feeling angry and foolish, the market has sucked you out of what was a good idea. Your original boundaries for your trade idea were respected, but you had let the noise and the uncertainty get the better of you. 

The Regret and the Pain. 

You ponder the day's events overnight. Outwardly you appear fine and calm, but inwardly things are turning over in your head. There is a circle you need to square; a cognitive dissonance is taking place in your mind. On the one hand you think, I’m a good trader who knows what I am doing’, on the other hand your thinkingI’m an idiot, I’ve been made to look and feel stupid’.  

The Next Day.

You go back in to work angry with yourself, angry with the situation, angry with the market. You are determined to right the wrong inflicted upon you.

Day3: The market immediately opens lower and drops back to 2135. Immediately you feel a little better, perhaps you were right to sell after all, perhaps you weren’t such an idiot!! - Yes, your timing wasn’t great, but your new view was possibly right after all. For a short time this helps you square that circle'; 'I am a good trader and not a fool'. – (Here comes the Ego: You have now justified your actions 'in your mind'. - The need ‘to be right/to be proved right’ (validation of your brilliance) has been achieved.)

Now you are going to show ‘The World’ and ‘The Market’ just how good you are.  (Here comes the 'Revenge Trade'; You are now personalizing ‘the World’ and ‘the Market’, as if they somehow care about you.). 
You sell 5 lots at 2135. 

In your mind your are right and this is going lower, a lot lower. (No one messes with you and gets away with it: In your mind you believe 'the market bends to your will'). You have convinced yourself of this, and now you are ready to take advantage of this. But the market has other ideas, it plays around a bit in the range in the mid-2130s, so you what do you do. You sell another 5 lots. (If you are right in 5, why not be right in 10 instead, maybe you can even help give it a slight nudge !!!!). You are now short 10 lots at 2135. But the market starts to rally, soon it is back to 2140. But so convinced are you in your ‘rightness’, that any objectivity, a characteristic you usually possess in spades, is no longer part of how you are working at this time. You convince yourself that this rally is just a blip, a re-test of last night’s close. Emboldened by your self-justifying rationalisation, you are staying with this, even considering adding some more. And duly you sell another 5 lots at 2140. You are now short 15 lots in total.

But the market doesn’t play to your tune, it keeps on rising. 

Now you are starting to get fidgety. An uneasy feeling starts to descend over you. You have no plan, no strategy, no prearranged stop, no levels, and if you pull the plug on the trade, you are an even bigger fool than yesterday. You are now relying on that most fickle of all allies, 'hope'; but hope is not a strategy. The market continues to climb:. 2145, 2146, 2147, you are glued to the screen, you cannot see or hear anyone else, all sense of perspective is gone, you have become increasingly animated and visibly angry. – A sign to all colleagues who may be long, that this move still has legs, until at least you cut out. – You however are fully invested in 'the pain trade'.  

Then the market hits 2150. – Enough is enough, you pull the plug, you square up. Where you should have been booking a $50,000 profit, you are now booking a $50,000 loss.  A total cost to you of $100,000. 


That is the Revenge Trade. 

But it is unlikely to end there: The new sense of self-doubt, the hit to your confidence, the damage to that most vital of assets 'self-belief', may potentially be more damaging in the long-term than the actual physical hit. Dennis Gartman's 3rd Golden rule of trading states that:

'Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital.'
 

There is a Chinese proverb, which it would do well to heed: 'He who seeks revenge should remember to dig two graves'. However in trading, this could be adapted, because in trading you only need dig one grave.


________

Steven Goldstein is a leading Performance and Executive Coach working with Traders, Banks, Energy Firms and Hedge funds: He is Managing Director of Alpha R Cubed, which works with banks and investment firms to improve their human capital within their financial risk businesses. To know more about Alpha R Cubed, visit their website www.alpharcubed.com or email Steven at steven.goldstein@alpharcubed.com.

Other recent articles:
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The Pre-Mortem: A De-Biasing Technique to Increase Trading and Investment Success.
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Dennis Gartman’s Timeless “Rules of Trading”, with added emphasis.
What is Trading 'Risk Type'? Why is it getting so much attention?
Still making the same old trading mistakes. What are you doing about it?



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