Finding Abnormal Returns
Abnormal Returns is now a part of the StockTwits Network. You can read all about the change at Abnormal Returns and the StockTwits Blog.
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Monday links: uninformed traders
May was a banner month for hedge funds. (WSJ)
Natural gas is entering its best quarter of the year (historically). (Bespoke also ValuePlays)
With commodities on the mend, the frontier markets are back in favor. (WSJ)
“So is Claymore’s Gold IPO a signal for a top in gold?” (Trader’s Narrative)
Paulson & Co. owns a lot of gold. (market folly)
It will be hard for the market to rally until the financials and large-cap technology can move in unison. (VIX and More)
“Always make money when you are right.” (Andy Swan)
Some thoughts on forex trading. (Howard Lindzon)
What role do “uninformed traders” play in long-term price reversals? (Journal of Finance)
RIP, Peter Bernstein. If you haven’t read “Against the Gods: The Remarkable Story of Risk.” You should. (DealBook, Curious Capitalist, Capital Spectator)
“Airlines are unquestionably in bad shape.” (WSJ also FT Alphaville, Daily Finance)
The Baltic Dry Index is up, but there is no sign of recovery in truck and rail volumes. (Research Reloaded , Big Picture)
There is a big bulge of loans maturing a few years out. (Felix Salmon)
Let the TARP repayments begin! (WashingtonPost, Clusterstock)
Don’t believe bank propaganda that bank lending has held steady through the crisis. (Baseline Scenario)
Rick Bookstaber talks derivatives regulation in Senate testimony. (Rick Bookstaber)
Just how successful will caps on financial firm compensation be? (Megan McArdle)
Three scenarios on how the economy may play out. (WSJ, Free exchange)
What the late Fischer Black may have said about our current economic predicament. (SSRN)
An excerpt from “The Myth of the Rational Market” by Justin Fox. (The Big Money)
A neat find. A pdf of “Speculation as Fine Art and Thoughts on Life” by Dickson G. Watts from the 1880s. (StockVision via jdmarkman)
The top 10 websites of the economic downturn. (NYMag)
How to fix financial television. (Big Picture)
Journalists vs. bloggers. Separating fact from rumor. (BuzzMachine)
“What are employees inside Twitter working on to make the service better?” (Eric Jackson)
The Steve Jobs saga continues. (BusinessWeek, The Daily Beast)
What do the NBA and the English Premier League have in common? (SportsBiz)
You can now follow Abnormal Returns on Twitter at @abnormalreturns. Check it out.
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Sunday links: EMH breakdown
Can we still count on stocks for the long run? (Time)
How big a role did the ‘efficient markets hypothesis‘ play in how we got to into this economic mess? (NYTimes)
Amidst a junk-stock rally, is there still any value out there? (WSJ)
Don’t forget that the 200 day moving average is still pointed down. (StockCharts)
The market rally has pushed “dumb money” sentiment to enthusiastic levels. (Technical Take, Trader’s Narrative)
Is the high yield market no longer “distressed”? (MarketBeat)
Three steps to “save” the mutual fund model. (Morningstar)
Too much is made of the birth/death model. (Clusterstock)
The decline in housing is not yet over. (NYTimes, Clusterstock)
It is hard to describe the economic recovery as “robust.” (Econbrowser)
What was the economy doing when the yield curve was this steep? (Aleph Blog)
Personal bankruptcies are spiking. (Calculated Risk)
The many ways the business press let us down. (Big Picture)
Are CEOs rewarded for luck? (Rortybomb)
The private equity industry is awash in capital, but the risk of prior mega-LBOs looms. (The Deal also Deal Journal)
Ten books to help you understand the economic crisis. (Big Picture)
“In fact, never has an American union [the UAW] done so well at the expense of shareholders and creditors.” (Barron’s)
“..I think the Pre stands a much stronger chance of stealing customers away from RIM than from Apple.” (Daring Fireball also Silicon Alley Insider)
A map of the continuing shift of the center of US population westward. (strange maps)
Curious what other bloggers are saying about Abnormal Returns? So are we. Feel free to check out a compilation of reviews.
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Documenting the surge in “lottery ticket” trading. (Sentiment’s Edge also tangentially related A Dash of Insight)
Insider buying is virtually nonexistent. (Pragmatic Capitalist)
“Volatility is back in the Treasury market.” (WSJ)
“I don’t believe that there is Smart Money in stock markets. I do believe there is dumb money galore.” (Howard Lindzon)
“In sum, if enough people pay attention to the 200 day moving average, it becomes a self-fulfilling prophecy of sorts.” (VIX and More)
For traders, being right is overrated. (Abnormal Returns also Aleph Blog)
“(T)rying to extrapolate a big-picture global macroeconomic forecast from a relatively short-term movement in emerging-market stock indices is a fool’s game.” (Felix Salmon)
Can’t get enough emerging markets exposure? Don’t fret, a new Peru ETF is on the way. (greenfaucet)
Gold market timers are a tad too bullish. (Barron’s)
Is the rise in commodity prices in actuality a good sign for the global economy? (Economist, MarketBeat)
Carl Icahn is on a roll. (FT Alphaville)
In defense of the Coppock Guide. (Trader’s Narrative)
Hedging out the risk when your hedge fund investment is “gated.” (SSRN)
Examining momentum in the REIT market. (SSRN)
Thirty year mortgage rates are up some 50bp from the bottom. (Bespoke, Calculated Risk)
Surprise or not, another weak employment report. (Calculated Risk, Crossing Wall Street, Curious Capitalist)
Unemployment claims will come down at some point due in part to the “exhaustion effect.” (Kid Dynamite)
“(W)e are still not ready for hard economic conversations anywhere in the world. Wishful thinking prevails, in Europe as much as in the United States.” (Baseline Scenario)
“The markets resemble the Star Wars bar scene more than they do the economics faculty lounge at Princeton.” (Newsweek)
The motivations behind the war on naked shorting. (Clusterstock)
Citigroup (C) is beset by its regulators. (WSJ, Clusterstock, Felix Salmon)
More myths from the financial crisis debunked. (Hoover.org via Clusterstock)
Using “elementary social science” to debunk a widely publicized study on the role of medical bills on personal bankruptcy filings. (Megan McArdle, ibid)
An intriguing reverse takeover of Cowen (COWN) and the return of Peter Cohen. (Breakingviews)
Turmoil and turnover in venture capital. (WSJ also A VC)
Harvard grads are shunning Wall Street. (Real Time Economics)
A rave review of Nerds on Wall Street. (Infectious Greed also Freaknomics)
Steve Jobs is coming back to Apple (AAPL). Good thing, they need him. (WSJ, 24/7 Wall St.)
Navel gazing alert! On the value of full RSS feeds. (The Big Money, Felix Salmon, Baseline Scenario)
It’s National Doughnut Day! (IndyStar)
Have we overlooked an interesting post in the investment blogosphere? If so, feel free to drop Abnormal Returns a line.
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Being right is overrated
Joe Weisenthal at Clusterstock points out today an interesting (long) piece by Holman Jenkins at Hoover.org on the financial crisis. The gist of the article is that the financial crisis was by and large a massive financial accident that was unforeseeable.
Jenkins notes that even investors like John Paulson, who many claim to have foreseen the meltdown of the global financial system, did not in fact foresee the crisis. If they had they would have invested quite differently:
But those who bet successfully against subprime did so through elaborate, expensive, negotiated deals to purchase credit default swaps or buy “put contracts” on subprime indexes. Had they really seen what was coming, they would saved themselves a great deal of expense and bother by simply shorting Citigroup, Bank of America, Lehman, Bear Stearns, etc. Their profits would have been huger, their workload and hassle factor much less.
The point of the above quote is not whether the crisis was foreseeable, nor is it a criticism of Paulson. In today’s financial markets traders can express their viewpoints about the future through derivatives and structured products in a very precise manner. If Paulson had foreseen the collapse of the global financial system there were much easier ways to profit from (and express) that viewpoint. (Not that he is complaining.)
Much too much is made in the media about who is right, and who is wrong. (Not that these thing are well tracked.) On television, in print and on the Internet we are inundated with pundits who crow about their prescience, while omitting their missed forecasts. The funny thing is that for investors, being right is greatly overrated.
Investors and traders need only worry about one thing: profitability. Are you generating requisite profits from your portfolio for the risks assumed? Everything else is just noise.
The need to be right is a common error for beginning investors. Any one who has ridden a stock down for a large loss can attest to this. Behavioral finance experts have a term for this: the disposition effect. Investors tend to sell winners too soon, and losers too late. You could even think of this as ‘get-even-it is.’ Investors do not want to admit that they made a mistake.
The fact of the matter is that all investors make mistakes. It is simply a part of doing business. One way traders look at their profitability is expectancy. In a vintage post, Trader Mike does a nice job describing the components of expectancy. The take away is that the percentage of times you are right is only one component in your profitability. In theory, a trader could be wrong much more that 50% of the time and still be profitable, if the profits from their winning trades far exceed the losses on their losing trades. As he writes:
Expectancy, position-sizing and other aspects of money management are far more important than discovering the holy grail entry system or indicator(s).
Stated another way: For traders, being right is overrated. It is far more important knowing when you are right, and when you are wrong, and acting accordingly.
In summary, being right may be a necessary component of trader profitability, but it is not sufficient. Proper money management techniques are required to turn trading decisions into trading profits. While it is difficult some times to take, being wrong is a part of being a trader. Don’t let the need to be right prevent you from becoming a beter trader.
Update 6/5/09: Found in my bookmarks a piece over at CXO Advisory Group. Researchers find that traders are affected more by their win-loss ratio than their actual profitability. Stephen writes:
Individual traders may want to consider whether they are motivated more by being right than by making money.
Filed under: Behavioral Finance, Portfolio Management | 18 Comments
“Neither a 200-day simple moving average nor the exponential variation I’ll address below outperform enough to warrant consideration as independent indicators.” (Condor Options)
“The essence of the indicator [Coppock Curve] is that it assumes a bear market is of relatively short duration; so by definition, it will not be useful when a long-term bear market is under way.” (Economist)
“(Y)ou can’t get carried away with absolute numbers in the VIX. It’s a statistic, not a stock, I can’t emphasize that enough. Support and resistance are shaky constructs here.” (Daily Options Report)
“In other words, quality spreads in both the long and short ends of the maturity spectrum have returned to Earth.” (Barron’s)
Has the Value Line Timeliness Ranking System stopped working? (CXO Advisory Group)
“One characteristic I’ve found among successful traders is that they function effectively when they’re not trading.” (TraderFeed)
The Citigroup (C) arb-preferred conversion trade keep getting eaten away by carrying costs. (Zero Hedge)
Notes from The Big Picture Conference. (Big Picture)
Is nearly thirty year old investing advice for individual investors still relevant? (Street Capitalist)
Four examples of low-cost, index-focused ‘lazy portfolios.’ (Kiplinger’s)
Lee Ainslie and Maverick Capital are the next in a series of hedge fund biographies. (market folly)
Citadel is on the comeback trail. (Clusterstock)
“The influx of capital into what is a fundamentally capacity constrained strategy [high frequency stat arb] will compress returns and strip the alpha out in short order.” (Information Arbitrage)
Hedge fund managers want more than 2&20. They also want to be praised and loved. (Curious Capitalist)
United Airlines (UAUA) makes a big bet on the future. (24/7 Wall St., WSJ, MarketBeat)
What does the ISM Manufacturing report typically do during a recession? (Bespoke)
“June might as well become known as ‘the month the world discovered the deficit problem’.” (FT Alphaville also Clusterstock)
The steep slope of the yield curve implies better economic times ahead. (Carpe Diem)
Google Search data indicates consumers may be looking to Ford (F) in the wake of industry uncertainty. (Caveman Forecaster)
“Still, one day in 2010 or 2011, GM will declare itself profitable. The government’s bailout plan will be hailed. But it will be an illusion created by taxpayers’ black box of billions.” (WSJ)
Let’s call the whole thing off. The legacy loans program is dead. (Baseline Scenario)
The TARP worked. Is it time to give Hank Paulson a medal? (Deal Journal, Clusterstock)
Talk of monetization of the debt is premature. (macroblog)
On the geography of the economic crisis. (The Atlantic, Ryan Avent)
Executive compensation controversy, redux. Prepaid variable forward contract come to the fore. (WSJ)
We humans have difficulties seeing “large scale, long duration problems. We are not wired to see large systems, as being in motion.” (Gregor)
If “hindsight bias is virtually impossible to eradicate“, what can we do to combat it? (Psy-Fi Blog)
Strategy is overrated. “Reaction and execution are the ingredients of winners.” (Andy Swan)
Once invulnerable, the video game industry is hitting the wall. (The Big Money)
Is an “innovation deficit” the cause of the current economic downturn? (BusinessWeek)
“In short, the most fascinating thing about Twitter is not what it’s doing to us. It’s what we’re doing to it.” (Time)
You can now follow Abnormal Returns on Twitter at @abnormalreturns. Check it out.
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