1/ Hedge Fund Market Wizards (Jack Schwager)
Thread with quotes from the book
"This volume is part of my continuing effort to meet with exceptional traders to better understand the elements underlying their success."
amazon.com/Hedge-Fund-Mar…
Thread with quotes from the book
"This volume is part of my continuing effort to meet with exceptional traders to better understand the elements underlying their success."
amazon.com/Hedge-Fund-Mar…
2/ "How you package your work > what you have actually done. There is massive herding in economic forecasting. By staying near the benchmark / prevailing range, you get all the upside of being right without the downside. Once I understood the rules, I became quite cynical." (p.5)
3/ "In order to make problems tractable, you need assumptions, which then become axiomatic for the entire subject—not because they are true, but because they are necessary for a solution.... The problem is that markets aren't efficient, but that is conveniently ignored." (p. 9)
4/ "Markets matter more than policy: real fundamentals, not what policy makers want to happen. The willing disbelief of people can carry on for a long time, but eventually, it is overwhelmed by the market.
"The genius of Soros was recognizing the turning point." (p. 12)
"The genius of Soros was recognizing the turning point." (p. 12)
5/ "As long as no one cares, there is no trend. Would you be short Nasdaq in 1999? You can't be short just because you think something is fundamentally overpriced....
"Even though something might be a good idea, you need to wait for and recognize the right time." (p. 12)
"Even though something might be a good idea, you need to wait for and recognize the right time." (p. 12)
6/ "Risk premium was too low in everything (2006-7). Credit was trading at ludicrous spreads, and no one cared about quality.
"But you can't be short because you lose carry, and at the same time, the spreads get lower.... You just have to make money going the other way." (p. 13)
"But you can't be short because you lose carry, and at the same time, the spreads get lower.... You just have to make money going the other way." (p. 13)
7/ "We were happy to be part of the bubble but in positions that were highly liquid so we could exit quickly.
"Markets look liquid during a bubble; it's the liquidity afterward that matters. We did a lot of trades through options where positive carry paid for the option." (p.14)
"Markets look liquid during a bubble; it's the liquidity afterward that matters. We did a lot of trades through options where positive carry paid for the option." (p.14)
8/ "By being long options... you are never short that horrible tail.
"One of the aspects of risk premiums being very low was that option prices were generally too cheap. It was a low-volatility bubble, which meant that options worked. That's not always the case." (p. 15)
"One of the aspects of risk premiums being very low was that option prices were generally too cheap. It was a low-volatility bubble, which meant that options worked. That's not always the case." (p. 15)
9/ "During the entire Fed hiking cycle of 2005-6, the futures market kept being priced on the premise that it was about to stop... so you had a great risk/reward that in six months, they would still be hiking. As the months rolled on, you could keep repeating the trade." (p. 15)
10/ "There are very few market forces to make macro markets priced efficiently. For tech stocks, then sure, hedge funds are huge. But for FX or Treasuries, hedge funds are tiny compared to PIMCO or the Chinese. I am a small fish swimming in a sea of real money." (p. 16)
11/ On LTCM: "T-bond futures were going up limit every day. That told me there was something going on. I didn't need to know why. Once you realize something is happening, you can trade accordingly.
"If you wait until you can find out the reason, it can be too late." (p. 17)
"If you wait until you can find out the reason, it can be too late." (p. 17)
12/ "After a bull market goes on for years, who is managing most of the money? The bears are all unemployed; you have a few very flexible people, but they run relatively small amounts of money.
"You shouldn't expect a big bull market to end in any rational fashion." (p. 19)
"You shouldn't expect a big bull market to end in any rational fashion." (p. 19)
13/ "Because the bulls control most of the money, expect the transition to a bear market to be quite slow, but then for the move to be enormous when the turn does happen. Then the bulls will say, 'This makes no sense. [The housing bubble] was unforeseeable.' " (p. 19)
14/ "In a world where everyone assumes that everything goes up forever, big price changes occur when market participants are forced to reevaluate their prejudices. The world didn't change that much in 2008; it was just that people finally noticed there was a problem." (p. 20)
15/ "You can notice when things have changed. Most people, though, don't. When Nasdaq is at 4,000 after having been at 5,000, there are a lot of people buying it because it is 'cheap.' People are poorly attuned to making decisions when there is uncertainty." (p. 21)
16/ "Implementation is the key in everything: more important than the trade idea behind it. Having a beautiful idea doesn't get you very far if you don't do it the right way.
"I tried to do the trade in such a way that my timing didn't have to be perfect." (p. 23)
"I tried to do the trade in such a way that my timing didn't have to be perfect." (p. 23)
17/ "People were acting on the premise that Bear Stearns and the banking system were solvent.
"You can't fix a solvency problem by adding more liquidity. If you have a house worth $100K with a $200K mortgage, I can lend you another $100K, but it won't solve the problem." (p. 25)
"You can't fix a solvency problem by adding more liquidity. If you have a house worth $100K with a $200K mortgage, I can lend you another $100K, but it won't solve the problem." (p. 25)
18/ "To make sure our business was as safe as possible, we avoided counterparty exposure to Lehman. We simplified the book. We reduced leverage a lot during 2008. We restricted our trading to highly liquid positions, avoiding OTC trades with lots of counterparties." (p. 26)
19/ "Storytelling is only 10% of what is important in macro. The rest is implementation and flexibility: implement a trade in a way that limits your losses when you are wrong, and be able to recognize when you are wrong." (p. 28)
20/ "Even though Soros will sometimes play up to his public image as a guru who knows what is going on, it is in no sense what he does as a manager. He has no emotional attachment to an idea. When a trade is wrong, he will just cut it, move on, and do something else." (p. 28)
21/ "I've only done one single-stock trade: buying Berkshire in 1999. The price had halved because Buffett refused to be involved in the dot-com bubble. I thought that was the stupidest reason I had ever heard for a stock price to halve." (p. 31)
22/ "Trading books are designed for people who have excess optimism and are in emotional denial of their losses. The rules are designed to protect traders who are gamblers. For them, the books could be greatly shortened: 'Don't trade. You are really bad at this.' " (p. 32)
23/ "The main thing about bubbles is that you need to be early. The worst thing you can do is to be stubborn and then late to convert. I am trying to learn to be an earlier convert to things that make no sense [Pets dot com].
"When it starts to go down, sell it." (p. 33)
"When it starts to go down, sell it." (p. 33)
24/ "Irrationality doesn't matter: if you try to point it out, believers will just give you an even more ridiculous justification why the market should go up. Bubble markets have legs because it takes such enormous evidence to make people change their minds." (p. 35)
25/ "Be long the exponential up-move of a bubble without taking on the gap risk of a collapse. Options are a good way to do this.
"Tops are messy, and reversals in bear markets are horrendous. It is very rare to find comfortable shorts in bear markets." (p. 36)
"Tops are messy, and reversals in bear markets are horrendous. It is very rare to find comfortable shorts in bear markets." (p. 36)
26/ "A CTA has a systematic way of defining when a trend has changed. Another way you can tell is if a market displays price action that is characteristic of the late stages of a bubble, such as an exponential price rise, like silver in 2011." (p. 36)
https://twitter.com/ReformedTrader/status/1189676012990124032
37/ "The repercussions of the top were a lot easier to play than being short the Nasdaq itself....
"The economic downturn led to a big move in fixed income that provided a much calmer way to play that idea than a direct trade in equities." (p. 37)
"The economic downturn led to a big move in fixed income that provided a much calmer way to play that idea than a direct trade in equities." (p. 37)
38/ "I can't tell you what your trading style should be.
"If I try to teach you what I do, you will fail because you are not me. If you observe what I do, you may pick up some good habits. But there are a lot of things you will want to do differently." (p. 39)
"If I try to teach you what I do, you will fail because you are not me. If you observe what I do, you may pick up some good habits. But there are a lot of things you will want to do differently." (p. 39)
39/ "Perseverance and the emotional resilience to keep coming back are critical because, as a trader, you get beaten up horribly. Frankly, if you don't love it, there are much better things to do with your life. No one who trades for the money is going to be any good." (p. 39)
40/ "People run lots of money with relatively unsophisticated risk management. Throughout 2008, I spoke to managers who said they had halved their risk. I would answer, 'Do you realize volatility has gone up five times?' Their risk exposure had actually gone up." (p. 40)
41/ Ray Dalio: "Recognize that you will certainly make mistakes and have weaknesses: what matters is how you deal with them. If you treat mistakes as learning opportunities that can yield rapid improvement if handled well, you will be excited by them." (p. 51)
42/ "The type of thinking necessary to succeed in the markets is entirely different from what is required for school.
"You have to be assertive and open-minded at the same time. Any time you are an independent thinker, there is a reasonable chance you will be wrong." (p. 53)
"You have to be assertive and open-minded at the same time. Any time you are an independent thinker, there is a reasonable chance you will be wrong." (p. 53)
43/ "The Fed and other central banks have tremendous power. In both the abandonment of the gold standard in 1971 and in the Mexico default in 1982, I learned that a crisis development that leads to central banks easing can swamp the impact of the crisis itself." (p. 55)
44/ "Being long pork bellies when they were limit down every day taught me the importance of risk controls. I never wanted to experience that pain again. It enhanced my fear of being wrong and taught me to make sure no bet could cause me to lose an unacceptable amount." (p. 56)
45/ "Diversifying to a thousand stocks will only reduce the risk by about 15%, since the average stock has about a 0.60 correlation to another stock.
"With zero correlation, by the time you reach only 15 assets, you can cut volatility by 80%, a factor of five." (p. 57)
"With zero correlation, by the time you reach only 15 assets, you can cut volatility by 80%, a factor of five." (p. 57)
46/ "There are ways to structure trades to produce a bunch of uncorrelated bets.
"I strive for approximately 100 different return streams that are roughly uncorrelated. There are cross-correlations, so the number works out to be less than 100, but it is well over 15." (p. 57)
"I strive for approximately 100 different return streams that are roughly uncorrelated. There are cross-correlations, so the number works out to be less than 100, but it is well over 15." (p. 57)
47/ (Note: From time to time, I get questions about whether to buy/sell a stock. Diversification into assets with low correlations matters much more than adding or cutting a single position. The AQR paper below reaches the same conclusion as Dalio does.)
https://twitter.com/ReformedTrader/status/1200558223180230656
48/ "Each market behaves logically based on its own determinants, and as the nature of those determinants changes, what we call correlation changes. When inflation expectations are volatile, stocks and bonds will be positively correlated (interest rates)." (p. 57)
49/ "I am looking at whether the drivers are different: 15 or more assets that behave differently for logical reasons. I may talk about return streams being uncorrelated, but I'm not using the term the way most people do. I am talking about causation, not the measure." (p. 58)
50/ "To the extent that there is strong disagreement about an issue, a lot of people are wrong. Yet most are totally confident they are right.
"Imagine how much better almost all decision making would be if we were less confident and more open to thoughtful discourse." (p. 58)
"Imagine how much better almost all decision making would be if we were less confident and more open to thoughtful discourse." (p. 58)
51/ "We reach resolutions by questioning each other, which leads to better understanding. You say that. Why do you say that? What is the evidence? How can we resolve the difference? Whom do we need to bring in to facilitate the conversation and help us move forward?" (p. 58)
52/ "Many people experience drawdowns that are larger than expected because they never really understood how a strategy would have worked under different environments.
"Strategies that are based on a manager's recent experience will work until they inevitably don't." (p. 60)
"Strategies that are based on a manager's recent experience will work until they inevitably don't." (p. 60)
53/ "Timeless and universal: there is no reason why a strategy's effectiveness should change in different time periods or when you go from country to country. This broad analysis through time and geography gives us a unique perspective relative to other managers." (p. 60)
54/ "We realized that if we took bond systems and traded them on a spread basis rather than an absolute basis, we could produce much better return/risk. That change took advantage of the universal truth that you can enhance the return/risk ratio by reducing correlation." (p. 61)
55/ "We know our transaction costs very well, and we know how long it takes for us to get in and out of positions. We will limit our position size to assure that we can get out reasonably quickly and to keep our transaction costs small relative to the expected alpha." (p. 65)
56/ "We didn't have the same vulnerability to a year like 2008 as most hedge funds did: the inherent nature of our Pure Alpha strategy avoids embedded betas.
"The truth about hedge funds is that much of what is packaged as alpha is really beta sold at alpha prices." (p. 66)
"The truth about hedge funds is that much of what is packaged as alpha is really beta sold at alpha prices." (p. 66)
57/ "The average hedge fund is about 70% correlated with stocks. Why are most hedge funds skewed toward strategies that do well in good times? I think it is human nature for people to choose strategies that worked well during the recent past, which implies a long bias." (p. 66)
58/ "The biggest mistake investors make is to believe what happened in the recent past is likely to persist.
"The tendency of investors to buy after a price increase for no reasons other than the price increase itself causes prices to overshoot." (p. 70)
"The tendency of investors to buy after a price increase for no reasons other than the price increase itself causes prices to overshoot." (p. 70)
59/ Larry Benedict:
Having family and friends invest "would just add another layer of distraction. I would rather write my parents a check if they needed the money than ever have them in my fund." (p. 80)
Having family and friends invest "would just add another layer of distraction. I would rather write my parents a check if they needed the money than ever have them in my fund." (p. 80)
60/ "I came in short straddles on the day of the 1987 crash. Not only did the puts skyrocket as the market crashed, but the calls also went up because volatility exploded. The account went from somewhere around $25,000 to a deficit in a matter of hours." (p. 84)
61/ "Seeing that day taught me that anything can happen. The puts went up so much by the end of the day that I probably would have been down several hundred thousand dollars if I had stayed with the position. The puts I covered at 20 probably went as high as 200." (p. 85)
62/ "I never gave up.... I had no strategy and no discipline. All the mistakes I was making along the way—and there were many—were providing experience, which was critical. The lessons I learned from those early failures helped me become successful." (p. 86)
63/ "Electronic trading (which also made high-frequency trading possible) has been great for me. The phones don't ring. I can buy and sell anonymously. Before, when my orders were placed through the pit, the brokers would steal from me, and I still made money." (p. 90)
64/ "One big mistake is averaging losing trades. Trading is very hard, but it is also easy if you maintain discipline. People blow up because they lose their discipline." (p. 95)
65/ "A number of traders ended up committing suicide or being homeless. They all shared a gambler's mentality. When they were losing, they were always looking for that one trade that would make it all back.
"You can't do that. This is a business where you have to work." (p. 99)
"You can't do that. This is a business where you have to work." (p. 99)
66/ Scott Ramsey: "I couldn't believe how easy it was to make money. You just bought something, and it went up. This was in 1979 when commodities were going ballistic.
"I really had no idea what I was doing. I was making money because I was buying in a rising market." (p. 106)
"I really had no idea what I was doing. I was making money because I was buying in a rising market." (p. 106)
67/ "I bought silver at $50, which is right near the all-time high.
"Shortly afterward, silver collapsed. The market went into a string of limit down days. It was a gut-wrenching experience.
"I lost all the money I had made plus some of the money I started with." (p. 107)
"Shortly afterward, silver collapsed. The market went into a string of limit down days. It was a gut-wrenching experience.
"I lost all the money I had made plus some of the money I started with." (p. 107)
68/ "I spent days watching every tick in certain markets and doing point and figure charts. The results weren't good. I made every rookie mistake: rather than trading with the trend, I was trying to pick tops and bottoms, and I sat with losers and took small profits." (p. 108)
69/ "By observing retail clients, I learned a lot about what not to do, like taking small profits and letting losses run. Certain traders were surprisingly accurate at picking tops and bottoms—the wrong way—based on emotional decisions and market activity." (p. 112)
70/ "The brokerage firms who directed business to CTAs would set the commission rates. In my own account, I was trading at a $12 commission rate, which by today's standards is insanely expensive. My customers were trading at a $50 commission rate or even higher." (p. 113)
71/ "If everyone thinks this way, and it seems so logical, then if the market goes the other way, everyone is going to be wrong, and they will have to cover their shorts. That's your trade." (p. 114)
72/ "Rigorous risk control is not only important in keeping losses small, but it also impacts profit potential. If you have trades that are not working and your mental energy is going toward damage control, you can't think clearly about opportunities." (p. 118)
73/ "When 2008 hit, the dealers wouldn't make a market on these things [over-the-counter fixed income]. I would have been up 26% for the year instead of 19% if it weren't for those trades. I will never again trade a market where liquidity is at the whim of a dealer." (p. 120)
74/ The biggest mistake is "looking to outside sources for guidance. The belief that you can watch CNBC and get useful advice is very misguided. You have to formulate your own opinion and not rely on so-called experts." (p.122)
[Evidence to back this up:]
[Evidence to back this up:]
https://twitter.com/ReformedTrader/status/1163209969577017344
75/ "You have to get past the idea that just because you lost money on a trade, it means you failed. Every trading decision you make is subject to some randomness. It doesn't matter whether you win or lose on any individual trade as long as you get the process correct." (p. 122)
76/ "Although I had a directional bias, I didn't take the trade until the lira broke out of its trading range. The market had to prove itself before the trade was entered. If there had not been a breakout, there would not have been a trade." (p. 123)
77/ "Novice speculators would buy platinum as a proxy for gold because 'it hasn't made the move.' Buying a laggard as a proxy for a leader is a bad idea, and as a trader, I am keen to take the other side of such a trade when I see a potential setup." (p. 124)
78/ Jaffray Woodriff:
"When he was in high school, Woodriff thought it was sad that most people loved Fridays and hated Mondays. 'I was going to make sure that wasn't me. I realy wanted to find a way to make Mondays as exciting as Fridays.' " (p. 130)
"When he was in high school, Woodriff thought it was sad that most people loved Fridays and hated Mondays. 'I was going to make sure that wasn't me. I realy wanted to find a way to make Mondays as exciting as Fridays.' " (p. 130)
79/ Woodriff: "My starting $2,500 had more than quadrupled. Then, on my 11th put trade, I lost more money than I had made on the first 10 put trades combined. I'd increased my trade size as I made money."
Schwager: "So you blew it all on one trade?"
Woodriff: "Yeah." (p. 139)
Schwager: "So you blew it all on one trade?"
Woodriff: "Yeah." (p. 139)
80/ Schwager: "There was another reason why you wouldn't have pursued a trend-following approach. A trading approach that, by definition, requires staying with the herd would have been exactly opposite your natural instincts. You would have had trouble following it." (p. 142)
81/ "I had the realization that I could build a whole third class of models that were trend neutral on average: that is, trading models that were neither trend following nor countertrend.
"It was much better to use multiple models than a single best model." (p. 143)
"It was much better to use multiple models than a single best model." (p. 143)
82/ "Market-specific models were far more vulnerable to breaking down in actual trading (prone to being overfitted).
"Using the same models across multiple markets provided a far more robust approach. I added substantially more markets; the diversification also helped." (p. 146)
"Using the same models across multiple markets provided a far more robust approach. I added substantially more markets; the diversification also helped." (p. 146)
83/ "Any models that score well training on randomly generated data are 100% curve-fitted; the best model provides a baseline. You need models that do much better training on real data. It is only the performance _difference_ that is indicative of expected performance." (p. 152)
84/ "Software is more focused on handling large quantities of data than on providing users with very strict protocols to make sure they don't curve-fit.... It leads users in the wrong direction because it allows them to generate bogus evidence to support pet theories." (p. 153)
85/ "It is amazing how valuable older [pre-1990] data still is. The stationarity of the patterns we have uncovered is amazing to me, as I would have expected predictive patterns in markets to change more over the longer term." (p. 153)
86/ "It takes a tremendous amount of deterioration to drop a model. We don't react to short-term results b/c the current year performance of any single model is not predictive of next year's performance. What is predictive is how it performed over the entire 31 years." (p. 154)
87/ "Although this change has reduced our diversification, there is a strong pattern for our edge to be greater in more liquid markets. Besides increasing capacity, the shift to allocating a greater percentage to more liquid markets has also improved performance." (p. 154)
88/ "The core of the risk management is evaluating the risk of each market based on an exponentially weighted moving average of the daily dollar range per contract.
"Through the chaos of 2008 and 2009, our volatility remained very near our target level of 12%." (p. 155)
"Through the chaos of 2008 and 2009, our volatility remained very near our target level of 12%." (p. 155)
89/ "Allowing the OTC markets to be unregulated and opaque makes as much sense as leaving 50 eight-year-olds unsupervised for a month. The OTC markets are very often used to take advantage of clients who are 'sophisticated' in the legal definition but naive in practice." (p. 156)
90/ "The OTC markets have been built to maximize asymmetries of information and are an example of how markets should not operate. Markets should be fair and transparent, as the futures and equities markets have mostly evolved to be." (p. 156)
91/ "Periods of poor performance are difficult. I generally handle it by focusing very hard on improving the trading system.
"Look where others don't. Adjust position sizes to overall risk to target a particular volatility. Pay careful attention to transaction costs." (p. 157)
"Look where others don't. Adjust position sizes to overall risk to target a particular volatility. Pay careful attention to transaction costs." (p. 157)
92/ Ed Thorp:
Assuming winning and losing months are coin tosses, "the odds of getting at least one track record ≥ Thorp's would still be less than 1 out of 10^62. The odds of randomly selecting a specific atom in the earth would be about a trillion times better." (p. 162)
Assuming winning and losing months are coin tosses, "the odds of getting at least one track record ≥ Thorp's would still be less than 1 out of 10^62. The odds of randomly selecting a specific atom in the earth would be about a trillion times better." (p. 162)
93/ "Track records such as Thorp's prove conclusively that it is possible to beat the market and that the large group of economists who insist otherwise are choosing to believe theory over evidence. (Thorp's track record is only one of many refutations of EMH.)" (p. 163)
94/ "This is a very conservative assumption since, in fact, the size of Thorp's average win was significantly higher than his average loss, which implies that the probability of Thorp achieving his win percentage by chance will be even lower than the estimate we derive." (p. 162)
95/ "Physicists would discuss models but wouldn't explain the assumptions carefully. Once I learned the logic of math, I could come back to physics and see quite clearly the assumptions they were making and why they were making them." (p. 170)
96/ "Life published an article, 'The Professor Who Breaks the Bank," which created a lot of publicity for blackjack betting systems.
"They discussed various alternatives, including getting rid of me and breaking knees. Fortunately, they settled on changing the rules." (p. 180)
"They discussed various alternatives, including getting rid of me and breaking knees. Fortunately, they settled on changing the rules." (p. 180)
97/ "The abstract committee reviewed my [blackjack paper/talk] proposal, and unbeknownst to me, they were going to reject it as the work of another crank.
"Fortunately, one of the members on the abstract committee was a number theorist whom I had worked with." (p. 181)
"Fortunately, one of the members on the abstract committee was a number theorist whom I had worked with." (p. 181)
98/ "There was a much larger number of players who heard you could beat blackjack but were poor players. The casinos had a good thing, but they thought it was a bad thing. They started a war with the card counters. They tried to ban them. They beat up some of them." (p. 183)
99/ "The next day, on the drive home, the accelerator locked in the down position on a mountain road, and the car couldn't be stopped. The car sped up to 80 on this curvy mountain road.
"Something had fallen off to make the accelerator rod lock down." (p. 188)
"Something had fallen off to make the accelerator rod lock down." (p. 188)
100/ Schwager: "Don't you think you might be have been better off exploiting the warrant trading on your own instead of publishing?"
Thorp: "I don't think so, because historically, ideas don't just appear in one place; they tend to appear in several at the same time." (p. 190)
Thorp: "I don't think so, because historically, ideas don't just appear in one place; they tend to appear in several at the same time." (p. 190)
101/ "Warrants with less than two years to run typically traded at premiums that were too high. The typical trade we did was to short the warrant and hedge it by buying the stock. We started out with a static hedge and then decided that dynamic delta hedging was better." (p. 191)
102/ "The embedded optionality in convertible bonds tended to be underpriced, and funds could earn considerable profits by buying underpriced bonds and hedging the risk with short stock. Increased competition made the sophistication of the model more important." (p. 193)
103/ "The innovation vis-a-vis stat arb was that he grouped the stocks by industry and set up long/short portfolios. By adding industry neutrality, he significantly reduced the risk." (p. 201)
A paper was published about this in 2011 (26 years later):
A paper was published about this in 2011 (26 years later):
https://twitter.com/ReformedTrader/status/1137800301740564491
104/ "I decided there was a better way (1986): make the strategy factor neutral. We did a principal components analysis of the portfolio and tried to neutralize the principal factors.
"The biggest PC is the stock market. The returns went up, and the risk went way down." (p. 203)
"The biggest PC is the stock market. The returns went up, and the risk went way down." (p. 203)
105/ "Over the years, hedge funds began to shift from having edges to being asset gatherers. At the same time, the fees increased. There was a time when a flat 20% profit incentive fee would do it. Then it became 20% incentive plus 1% management, then 2% management." (p. 209)
106/ "This tanker had a scrap value of $4 million, and Bruce Kovner bought it for $6 million. We just sat on it. It was sort of like an option on the oil market. When activity picked up, there was a huge demand for tankers, so our tanker got used over and over." (p. 210)
107/ "There are some versions of futures trend following that have a Sharpe ratio of about 1.0 or more, but that is low enough that there is still a significant risk of getting shaken out.
"It worked but was risky enough that it was hard to stay with it." (p. 211)
"It worked but was risky enough that it was hard to stay with it." (p. 211)
108/ "[Our strategy] combined technical and fundamental information. In metal/agricultural markets, backwardation/contango can be important, as can the amount of storage relative to storage capacity." (p. 212)
2007 for Thorp; this came out 12 years later:
2007 for Thorp; this came out 12 years later:
https://twitter.com/ReformedTrader/status/1193247530898739200
109/ "We tracked a correlation matrix that was used to reduce exposure in correlated markets. If two markets were highly correlated, and the technical system went long one and short the other, that was great. But if it wanted to go long both or short both, we would take a smaller
110/ "position in each.
"A 60-day lookback was best. Too short of a window, and you get a lot of noise; too long, and you get old information that isn't relevant.
"We also had a risk management process that worked a bit like the old portfolio insurance strategy." (p. 213)
"A 60-day lookback was best. Too short of a window, and you get a lot of noise; too long, and you get old information that isn't relevant.
"We also had a risk management process that worked a bit like the old portfolio insurance strategy." (p. 213)
111/ "We didn't use the Kelly criterion at all in trend following because the bet size was such a small fraction of Kelly that it didn't make any difference. I would guess that we were probably using something equivalent to 1/10 or 1/20 of Kelly." (p. 214)
112/ "When I looked at Madoff's record, I noticed that miraculous trades (in S&P futures) would be put on periodically that would get rid of the potential losing months and make them winners and get rid of the big winning months and make them moderate winners." (p, 215)
113/ "Half of the option trades were for options that didn't even trade on the transaction date (zero volume). A quarter of the rest couldn't have traded at the prices quoted.
"His organization didn't appear as counterparty on any of [the 10 trades that were checked]." (p. 216)
"His organization didn't appear as counterparty on any of [the 10 trades that were checked]." (p. 216)
114/ "I had previously found some small frauds and was told by a lawyer friend of mine who sent eight years working for the SEC that it would be a waste of time reporting it... because they didn't care about stuff like that." (p. 217)
115/ "Try to figure out what your skill set is and apply that to the markets. If you are really good at accounting, you might be good as a value investor. If you are strong in computers and math, you might do best with a quantitative approach." (p. 218)
116/ Jamie Mai
Schwager: Due to enormous contango, "it was possible to store oil on a tanker, hedge it by selling much higher-priced futures, and deliver it against the contract at expiration. The price difference far exceeded the costs of operating the tanker." (p. 224)
Schwager: Due to enormous contango, "it was possible to store oil on a tanker, hedge it by selling much higher-priced futures, and deliver it against the contract at expiration. The price difference far exceeded the costs of operating the tanker." (p. 224)
117/ Because the fund was too small for opportunities like the one above, "Mai decided to open it to a handful of like-minded, sophisticated investors with whom he could be reasonably transparent and share ideas rather than seeking to maximize assets under management." (p. 225)
118/ "My father nudged me toward accounting as a backdoor way to get into private equity (better than the traditional career path of investment banking or management consulting). There is some truth to the adage that accounting is the language of business." (p. 229)
119/ "Markets are generally good at estimating the magnitude of a contingent liability, but they are often poor at evaluating outcomes probabilistically. Examples include litigations, regulatory actions, and other events that create the perception of going concern risk." (p. 231)
120/ "Markets tend to overdiscount the uncertainty related to identified risks and underdiscount risks that have not yet been expressly identified. Whenever the market is pointing at something as a risk, most of the time, the risk ends up being not as bad as anticipated." (p.232)
121/ "We had already seen cases where the option market assigned normal probability distributions to situations that had clearly bimodal outcomes. Altria option prices still implied a normal distribution, which meant the out-of-the-money options were way too cheap." (p. 232)
122/ "Options are priced lowest when recent volatility has been very low. In my experience, however, the single best predictor of future increases of volatility is low HV. When volatility gets very low in a market, we look for ways to get long volatility." (p. 234)
123/ "Often, the longer the duration of an option, the lower the IV, which makes absolutely no sense. We recently bought OTM 10-year calls on the Dow as an inflation hedge. IV on the index is very low. If rates go up, the value of the options can go up dramatically." (p. 235)
124/ "Option models generally assue that forward prices are predictive of future movements in the spot price. Academic research and common sense suggests that this relationship is often invalid. Forward option-pricing models can break down, particularly in interest rate markets
125/ "with steep term structures and low volatility levels." (p. 235)
AQR generalizes this idea (carry) and applies it to a broad set of futures. They find that futures are worse forecasters than spot prices: in other words, carry works everywhere.
AQR generalizes this idea (carry) and applies it to a broad set of futures. They find that futures are worse forecasters than spot prices: in other words, carry works everywhere.
https://twitter.com/ReformedTrader/status/1188911052253040640
126/ "In 2010, the current Brazilian interest rate was ≈8%; the 6-month forward rate was >12%. 6-month forward option prices were distributed around the forward rate.
"IV was 100 bps normalized... the market was assigning the odds of rates staying ≈8% as >4 SD event." (p. 235)
"IV was 100 bps normalized... the market was assigning the odds of rates staying ≈8% as >4 SD event." (p. 235)
127/ "We structured a trade that had a strike price ≈10%, which was cheap because it was well OTM based on the forward interest rate but was actually well ITM based on the current rate. Rates could have gone up by half the difference, and we would still have made money." (p.236)
128/ "Despite XLP's low beta, net percentage changes in XLP and the S&P 500 were almost identical.
"We went to an exotic option dealer and asked them to price an outperformance option. XLP had to outperform the S&P,and the S&P had to be unchanged to higher." (p. 240)
"We went to an exotic option dealer and asked them to price an outperformance option. XLP had to outperform the S&P,and the S&P had to be unchanged to higher." (p. 240)
129/ "By making the option conditional on XLP outperforming the S&P, we were able to get beta exposure to the market extremely cheaply. Figuring out how to make the premium cheaper is one way of mitigating time decay." (p. 240)
Betting Against Beta (AQR):
papers.ssrn.com/sol3/papers.cf…
Betting Against Beta (AQR):
papers.ssrn.com/sol3/papers.cf…
130/ "Volatility is a terrible proxy for measuring potential price change over longer intervals of time. One of our strategies, 'cheap sigma,' is predicated on the idea that markets sometimes trend and that volatility will dramatically understate the potential move." (p. 241)
131/ "In 2007, the Canadian dollar was trending very smoothly as it broke the dollar mark for the first time in decades. Spot went from about 1.10 to 0.92—a very large move. Based on the very low market volatility, a nonsensically improbable event had just happened." (p. 241)
132/ "Vol ∝ √t may provide reasonable approximations for shorter time intervals, say ≤1 year, but if you have a very low SD and extend it for a very long time, it doesn't scale properly. If one-year SD is 5%, assuming that 9-year SD = 15% is probably an underestimate." (p.242)
133/ "We achieve our margin of safety by having a high expected value. We are comfortable losing 100 percent of our premium four times in a row as long as we believe that a 25x payout is likely to occur if we make the bet 10 times consecutively." (p. 243)
134/ "We got to the subprime trade late, which is typical for us because we like situations where there is a compelling reason why a trade should be working, and the only counterargument is that everyone says it should work, but it hasn't." (p. 243)
135/ "Due to the zero correlation assumption implicit in the CDO construction, we were able to buy protection on the AA tranche, which consisted entirely of the worst quality subprime MBS, for only LIBOR + 50 bps. It was, without a doubt, complete and utter insanity." (p. 249)
136/ "The dealers had bought massive amounts of MBS to hold in inventory in anticipation of turning them into CDOs. So they were stuck with a huge amount of inventory of the crappiest MBS at the time when the ABX index based on those securities was falling sharply....
137/ "If proper mark-to-market prices were allowed on the existing CDOs, it would have killed the CDO market, and dealers would have been stuck with huge inventories of MBS."
Schwager: So the dealers were deliberately mispricing the CDOs?
Mai: "Oh, yes. The buyers of CDOs...
Schwager: So the dealers were deliberately mispricing the CDOs?
Mai: "Oh, yes. The buyers of CDOs...
138/ "were not the most sophisticated investors.
"We asked, 'How could you issue a CDO at 70 bps that you are unwilling to assume the risk on at 300?' They said they would get back to us. Of course, they never did....
"We asked, 'How could you issue a CDO at 70 bps that you are unwilling to assume the risk on at 300?' They said they would get back to us. Of course, they never did....
139/ "The ABX fell 30%, and our CDOs were still being marked at cost [by Bear Stearns].
"We were concerned about the integrity of the financial system. We bought a ton of puts and CDS on Bear Stearns because we though they would go bankrupt." (p. 250)
"We were concerned about the integrity of the financial system. We bought a ton of puts and CDS on Bear Stearns because we though they would go bankrupt." (p. 250)
140/ "The ratings agencies rated thousands of securities with the same grade as U.S. Treasuries when they weren't worth more than the paper they were printed on. And yet, despite this horrific record, the market still jumps when the rating agencies opine." (p, 251)
141/ "It is difficult to come up with a more extreme case of failure to do a job. Until recently, ratings agencies have shielded themselves from responsibility, not on the substance of their argument, but rather by deflecting any claims under the shield of free speech." (p. 251)
142/ In early 2007, the newly launched TABX index "provided the first observable data indicating that the mezzanine tranches, up to the 'A' tranches, and perhaps even the 'AA' tranches of an index replicating CDOs had already lost total value. Yet the banks, who were desperately
143/ "trying to get their MBS inventory off their books, were still issuing similar CDOs at par. The TABX made it impossible for the banks to continue this charade.
"We love trades that are so close to their absolute limit tht they have tremendous asymmetry." (p. 252)
"We love trades that are so close to their absolute limit tht they have tremendous asymmetry." (p. 252)
144/ "For several years, Korean companies that generated steady and impressive cash flows kept getting cheaper. Investors who had bought Korea earlier as a value trade had gotten burned. By the time we arrived, there were lots of companies trading at substantial negative
145/ "enterprise values. There were companies with market caps of $300 million, no debt, and $550M cash on the balance sheet, which was expected to increase to $650M the following year. There was tremendous asymmetry because these companies had nowhere to go but up." (p. 253)
146/ "One U.K. bank (Aug 2007) was 60x leveraged. Its balanced sheet was 7% of world GDP and >150% of U.K. GDP. Banks wouldn't lend to each other b/c they had too much exposure.
"We shut the [market-neutral equity] strategy down.... I was afraid of a lack of liquidity." (p. 271)
"We shut the [market-neutral equity] strategy down.... I was afraid of a lack of liquidity." (p. 271)
272/ "There was huge excess leverage in the system everywhere you looked, and when LIBOR jumped by 10 bps, it was like seeing the first crack. [LIBOR liquidity after that point] went straight down. The LIBOR-OIS spread started to widen." (p. 272)
148/ "In 2008, BlueCrest made the most money for investors in its history up to that point. Even so, many of our investors redeemed simply b/c they couldn't get their cash from anyone else. We were making $500 million a month and in numerous months paying out $1 billion." (p.273)
149/ "We faded a lot of the very big call and put skews in the market in 2009. The OTM strikes were insanely expensive, so we shorted a lot of OTM options and protected ourselves with offsetting long ITM options. The tails were enormously fat because of what had happened in 2008.
150/ "The breakeven points on the shorts in the OTM strikes were so crazy that you needed to have another major crisis to come anywhere near losing money on the position. And I didn't think we were going to have another crisis six months after the 2008 crisis." (p. 274)
151/ "The most dangerous risks [if correlations drop] is spread risks. If I assume that IBM and Dell have a 0.95 correlation, I can put on a large spread position with relatively small risk. But if the correlation drops to 0.50, I could be wiped out in 10 minutes." (p. 276)
152/ "Being long volatility is great protection against all scenarios. Typically, we are neutral to long volatility, and I hate shorting OTM strikes. We made an exception in 2009 because the OTM options were very overpriced, and we hedged them with long ITM positions." (p. 276)
153/ "I want guys who when they put on a good trade immediately start thinking about what they could put on against it. They have paranoia.
"Analysts and economists have big egos, which gets in the way of making money because they can never admit that they are wrong." (p. 278)
"Analysts and economists have big egos, which gets in the way of making money because they can never admit that they are wrong." (p. 278)
154/ "How you implement a trade is critical.... there are 20 different ways I can play it. Which way gives me the best risk/return ratio? My final trade is rarely going to be a straight long or short position." (p. 279)
155/ "Losing money kills you. It is not the actual loss... it messes up your psychology. You feel like an idiot, and you're not in the mood to put on anything else. Then the elephant walks past you while your gun's not loaded.
"80% of profits come from 20% of ideas." (p. 279)
"80% of profits come from 20% of ideas." (p. 279)
156/ "You need a decent fundamental story, a good trend that looks like it will carry on, and the market handling news the way you think it should. Bull markets ignore any bad news, and any good news is a reason for a further rally." (p. 280)
157/ "The minute you ask people for their opinion, they feel important. If I ask a hedge fund manager for his opinion on where the 30-year bond will be trading in three months' time and he starts talking about factors that will push rates up, I know he is short bonds." (p. 281)
158/ "You have the option to keep 20% of your P&L this year, but you also want to own the serial option of being able to do that every year. You can't blow up.
"The two biggest mistakes traders make is that they don't do enough homework and are too casual about risk." (p. 282)
"The two biggest mistakes traders make is that they don't do enough homework and are too casual about risk." (p. 282)
159/ Steve Clark: "Fear cripples people who have been in the business too long. Very few people maintain their ability to take risk throughout their careers. Most don't. Most can't. They have had too many bad things happen to them, too many fat tails; it damages people." (p. 293)
160/ "I've seen this happen to many traders, and I have gone through it several times myself. When you find that you can't make any money, smaller and smaller losses take on greater and greater emotional significance, and you lose all perspective." (p. 295)
161/ "Price is irrelevant; it is size that kills you. If you are too big in an illiquid stock, there is no way out. I wanted to cut the position, but I couldn't." (p. 298)
162/ "I had terrible experiences with people—company politics, people lying. In my view, all I had ever done for any of my employers was make money. Yet I didn't have much money. Either I didn't get paid properly, or even when I had a contract, I got screwed on that." (p. 304)
163/ "Running a fund doesn't make me happy. I enjoy it, but I used to enjoy it a lot more. It was less complicated: just trading. Now it's running a business.
"When you have a business, you can't walk away. It becomes a prison, whereas being a trader was very free." (p. 307)
"When you have a business, you can't walk away. It becomes a prison, whereas being a trader was very free." (p. 307)
164/ "I constantly think I am about to be found out, which is another personal driver. A number of times in my career, I have thought that maybe I have just been lucky. Maybe I don't really know what I'm doing, and I have just bluffed my way through." (p. 308)
165/ "If you are the type of person who doesn't handle volatility well, you will end up cutting and losing money, even if the trade was ultimately a big winner. It is the size of the position rather than the price that determines your ability to keep the position." (p. 309)
166/ "Liquidity is very important. When a merger deal breaks, we cut it straight away because you get a pocket of liquidity. It may be at a much lower level, but if you wait you will be left with an outsized position in what has become a directional trade." (p. 310)
167/ "Traders come from an information-rich environment, such as a big investment bank, and find that the information flow is all gone. It is like trading in a vacuum. They find they can't make money and maybe even lose a little bit. It becomes a downward spiral." (p. 310)
168/ "It is a very good thing to be busy.
"You don't want to be sitting in front of your screen and staring at market prices for 12 hours a day; that won't tell you much. You will overprocess and overtrade.
"You will feel physical pain with every tick against you." (p. 311)
"You don't want to be sitting in front of your screen and staring at market prices for 12 hours a day; that won't tell you much. You will overprocess and overtrade.
"You will feel physical pain with every tick against you." (p. 311)
169/ "Watch for signs that the stock is resilient on down days in the market, suggesting that there is underlying buying support, and nibble away at establishing a position." (p. 312)
This sounds like a discretionary version of risk-adjusted momentum:
This sounds like a discretionary version of risk-adjusted momentum:
https://twitter.com/ReformedTrader/status/1190418423081132032
170/ "I kept asking a question I knew he couldn't answer. I asked the same question 10 different ways. There were so many things that would have been perfectly reasonable for him to say, but all he said was, 'I can't answer that question.' "
"I said, 'Sell it now.' " (p. 313)
"I said, 'Sell it now.' " (p. 313)
171/ "Because Deutsche Bank was a large seller of rights and the stock was difficult to borrow, the rights [embedded options] were trading below intrinsic value." (p. 314)
Impracticality of actual arbitrage made options available at arbitrage-like prices.
Impracticality of actual arbitrage made options available at arbitrage-like prices.
https://twitter.com/ReformedTrader/status/1207829228114206721
172/ "Nearly all successful traders I know are one-trick ponies. When they stray from that single focus, it often ends in disaster.
"A number of great macro traders decided to branch into multistrategy funds. It didn't work too well in 2008 when they were all exposed." (p. 315)
"A number of great macro traders decided to branch into multistrategy funds. It didn't work too well in 2008 when they were all exposed." (p. 315)
173/ "You need to be a bit obsessive to do the same thing 10 hours a day. People who are obsessive can become very good traders.
"Really good traders are also capable of changing their minds in an instant. If you can't, you will get caught in a position and wiped out." (p. 316)
"Really good traders are also capable of changing their minds in an instant. If you can't, you will get caught in a position and wiped out." (p. 316)
174/ "In an instant, I completely switched my orders and started selling whatever I could.
"I recognized in a moment of clarity that if I had reached a fever pitch in trying to buy at any price, the moment the market turned, it would just head straight down." (p. 316)
"I recognized in a moment of clarity that if I had reached a fever pitch in trying to buy at any price, the moment the market turned, it would just head straight down." (p. 316)
175/ "OTM puts would provide protection against a change in margin requirements."
"In 2008, volatility quadrupled. I decided we should trade a fraction of what we used to. Most people didn't do that and got blown up." (p. 318)
Volatility targeting:
"In 2008, volatility quadrupled. I decided we should trade a fraction of what we used to. Most people didn't do that and got blown up." (p. 318)
Volatility targeting:
https://twitter.com/ReformedTrader/status/1080273477926436864
176/ "If you wake up thinking about a position, it's too big.
"Never stop asking questions. Speak to as many people as you can. Research every opposing opinion.
"When everything lines up, swing for it because even if you're wrong, you probably won't be by much." (p. 318)
"Never stop asking questions. Speak to as many people as you can. Research every opposing opinion.
"When everything lines up, swing for it because even if you're wrong, you probably won't be by much." (p. 318)
177/ "If the position starts behaving in a way you don't understand, cut it because you clearly don't know what is going on.
"The market is not about facts; it's about people's opinions and positions. Anything can be any price at any time. You need to have stops." (p. 318)
"The market is not about facts; it's about people's opinions and positions. Anything can be any price at any time. You need to have stops." (p. 318)
178/ Martin Taylor: "High-level accounting is about opinion. You don't necessarily want someone who just looks at nuts and bolts because they're not going to get the big picture. That is why I think the London accounting firms recruit from across disciplines." (p. 326)
179/ "I expected to meet smart people; my list of companies included a lot of highly regarded firms. What both fascinated and appalled me was that all these [investment bankers, stockbrokers, asset managers] were just out of university, making hundreds of thousands of pounds...
180/ "while I'm making £12,000, and I thought 99% of them were just plain stupid. They were thick and arrogant, and yet they were earning these staggering sums of money.
"If you interview a trader for an audit, they try to blind you with jargon: alphas, deltas, gammas...
"If you interview a trader for an audit, they try to blind you with jargon: alphas, deltas, gammas...
181/ "in the hope that you'll run away in 10 minutes because you can't understand.
"I hate failure, so I would make them take me through it. By doing that, I became fascinated by how markets work. Also, the 1% of traders who were smart were *really* smart." (p. 327)
"I hate failure, so I would make them take me through it. By doing that, I became fascinated by how markets work. Also, the 1% of traders who were smart were *really* smart." (p. 327)
182/ "I started with £2,000, and after six months, my account was up to £10,000. I thought I was a bit of a genius.
"As I made more money, I got more and more confident, and I increased my position each time. Ultimately, I put on a position where I was completely wrong." (p.328)
"As I made more money, I got more and more confident, and I increased my position each time. Ultimately, I put on a position where I was completely wrong." (p.328)
183/ "I sold it when my account was back to £2,000. Over a five-day period, I lost everything that I had made over the prior six months.
"Because I had lost money that I never had in my hand, it didn't feel as bad.... In another two days, I would have lost it all." (p. 329)
"Because I had lost money that I never had in my hand, it didn't feel as bad.... In another two days, I would have lost it all." (p. 329)
184/ "The Russian market had more than tripled during the Asian crisis as investors fleeing Asia shoveled money into a country that was being touted by brokers as a post-Communist 'miracle.'
"Although I was disgusted by Russia at the time, I had been willing to stay in it...
"Although I was disgusted by Russia at the time, I had been willing to stay in it...
185/ "as long as it kept going up. I wasn't going to argue with all the idiots who were buying. If I had gotten out, and it kept going up, it could have been the end of my career. Remember, Russia was 40% of my benchmark.
"What I did was to be a bit underweight in Russia...
"What I did was to be a bit underweight in Russia...
186/ "relative to the benchmark. So if it suddenly collapsed, I would still do better. The day the market collapsed, I felt physically sick because I was only underweight by 3%, and this was a situation [fraud in Russia] of which I had developed enormous conviction." (p. 334)
187/ "People who had missed out on the Russian bull market saw the previous day's sharp correction as an amazing buying opportunity.
"I was right to start selling that day because the spell created by the senseless bull market had been broken by the previous day's collapse....
"I was right to start selling that day because the spell created by the senseless bull market had been broken by the previous day's collapse....
188/ "When markets are trending up strongly and there is bad news, it counts for nothing. But if there is a break that reminds people what it is like to lose, suddenly the buying is not mindless any more. They start looking at fundamentals, which I knew were ugly indeed." (p.335)
189/ "No one in Russia wanted to buy ruble-denominated T-bills [at a 30% real rate of return]. The Russians knew perfectly well what was going on, and they put all their money in Switzerland. In an emerging market, the smart money is domestic, not international." (p. 336)
190/ "Having $2 billion to invest in a tiny market, as East European equities were at the time, was insane. I would have a good idea, put on about 25% of the position, and then the stock would run away because other people would hear what I was doing. I felt trapped." (p. 339)
191/ "If you're investing in assets with an annualized volatility of 20% to 40%, you're inevitably going to take two or three decent hits to your NAV each year. If you can't live with those hits because your clients are telling you that they can't live with monthly drawdowns...
192/ "as soon as a position starts going against you a bit, you will sell it in a panic near the lows. You will then be psychologically impaired in regard to that position, which means you will never buy it back and will miss out on any subsequent upside." (p. 340)
193/ "The people who annoy me the most are the market strategists that work for brokers. They will recommend being aggressively overweight or being net short, and then they are wrong for two or three years. They are total bears or total bulls. If they worked for a hedge fund...
194/ "they would been wiped out many times over. Running people's money, I can't take extreme positions and maintain my mental equilibrium.
"Being dogmatic is why a lot of hedge funds who did brilliantly in 2008 because they were short then blew up in 2009." (p. 341)
"Being dogmatic is why a lot of hedge funds who did brilliantly in 2008 because they were short then blew up in 2009." (p. 341)
195/ "We didn't have a single redemption until October 2008. From that point on, our fund was used as a cash machine: given my golden rule of investing only in liquid securities, we remained open for monthly dealing. Most of our peers resorted to gating their funds." (p. 344)
196/ "Managing long-only money is easy because if you are up more than the index, everyone loves you, since a huge majority of the managers (85%) underperform the index. Even when you lose, as long as you are losing less in relative terms, people still love you....
197/ "Whereas if you are a hedge fund manager, when the market is up, investors want you to perform like the market or better. When the market is down, they want you to perform like cash." (p.345)
People don't diversify; they can't handle being different:
People don't diversify; they can't handle being different:
https://twitter.com/GestaltU/status/1201217517903110145
198/ "Management fees in emerging markets are relatively high: typically, 1% to 2%.
"The high volatility leads to managers making poor investment decisions, such as panicking out of positions near the bottom and jumping in near the top.
"The composition of the emerging market
"The high volatility leads to managers making poor investment decisions, such as panicking out of positions near the bottom and jumping in near the top.
"The composition of the emerging market
199/ "index changes frequently, leading to a negative bias when managers sell a stock that has been dropped (widespread selling pressure).
"Emerging markets behave more irrationally than any other because a large proportion of participants are retail investors." (p. 345)
"Emerging markets behave more irrationally than any other because a large proportion of participants are retail investors." (p. 345)
200/ "There are several reasons why emerging market long-only funds have persisted despite their appalling performance. One key reason is marketing. Look at the Templeton funds, for example, managed by Mark Mobius....
201/ "Contrary to his media image as an emerging markets investment guru, he has massively underperformed the index over the past 20 years. This fact hasn't stopped them raising tens of billions of dollars because he is always in the papers visiting and opining on emerging market
202/ "The world of investment advisors is heavily influenced by media image, so they suck their clients into this stuff.
"Clients are not looking at relative performance. If the index is up 10%/year and the advisor is up 6%/year, they are just looking at being up." (p. 346)
"Clients are not looking at relative performance. If the index is up 10%/year and the advisor is up 6%/year, they are just looking at being up." (p. 346)
203/ "Previously, a large percentage of my clients were funds of funds who were driven by monthly data because a large percentage of their clients were as well. You end up obsessed with monthly returns, which can influence poor long-term investment decisions." (p. 348)
204/ "Bad companies have the greatest risk of being takeover targets. Emerging markets are full of sectors where multinationals want exposure, and the only companies they can generally take over are bad companies.
"It is much more difficult for a foreign firm to get government
"It is much more difficult for a foreign firm to get government
205/ "approval for a takeover of a local company that is doing well or about to do well; the authorities will fear being seen as 'selling out' to foreigners. Whereas for a bad company, regulators are much more likely to approve the acquisition because it will be seen as saving
206/ "the company and saving jobs. You can be long a good stock at 7x earnings and short a bad stock at 15x , and some stupid foreign company comes along and pays a 50% premium for the bad company.
207/ "Most of our net exposure adjustment is done through shorting stock index futures rather than individual companies."
Robeco looked at the long and short legs of factors and found that the short leg has no alpha after controlling for the long leg:
Robeco looked at the long and short legs of factors and found that the short leg has no alpha after controlling for the long leg:
https://twitter.com/ReformedTrader/status/1200183194718371840
208/ "We only short bad companies that can't be taken over because they are owned by the government or their own pension fund. If owned by the pension fund, it will never be sold because the workers are afraid that the acquiring company will sack 20% of the labor force." (p. 351)
209/ "In controlling risk, it is very important to have people in your team whose opinions you respect who can push back at your ideas in a way that will make you stop, listen, and test your own views." (p. 352)
210/ "Normally, I let winners run and cut losers. I consider taking quick profits in 2009 a dreadful error that came about because I had lost confidence due to experiencing my first down year in 2008. I was constantly worried markets were going to go down again." (p. 355)
211/ Tom Claugus: "My father was a product of the Depression and was scared to death of being poor again. I knew I wanted to be financially independent.
"I calculated that by saving 2/3 of my income and investing at 10%/yr, I could be a millionaire by the time I was 53." (p.362)
"I calculated that by saving 2/3 of my income and investing at 10%/yr, I could be a millionaire by the time I was 53." (p.362)
212/ "I never wanted to depend on my job for money, so I started investing from day one. I tried to give myself motivation to save money. My plan was to live on one-third of my income plus 3% of my net worth (based on the assumption that I could earn at least 10%/year)." (p. 363)
213/ "I started shorting. A lot of times, before the market cracks, lower-quality stocks zoom. I remember being on the tennis courts with my friends the summer of 1987, and I was losing so much money that I had to call my mother to get a loan to meet the margin call." (p. 363)
214/ This is consistent with the idea that factors' short legs are more vulnerable to tail risk (more negative skewness and higher kurtosis) than their long legs are.
https://twitter.com/ReformedTrader/status/1200192568228630528
215/ "I was short fly-by-night companies, some of which were prob. manipulated. I think there were two stocks that were up on 10/19/87; I was short one of them. It eventually cratered.
"The fundamental underpinnings were completely different from the way it was priced." (p. 364)
"The fundamental underpinnings were completely different from the way it was priced." (p. 364)
216/ "The responsibility of having other people's money really weighed on me. If you have a 10-year time horizon, you can make good decisions and make a lot of money.
"But if you have only a three-month horizon, anything can happen." (p. 366)
"But if you have only a three-month horizon, anything can happen." (p. 366)
217/ "I didn't have the guts [to replace my shorts]. I have people tell me all the time that I should short stocks after they break. All I can tell you is that if you didn't short the stock when it was 80, psychologically, it is very difficult to sell it when it's 50." (p. 373)
218/ "Being short in a rising market is very difficult from an investor relations standpoint. In 2008, we were losing money, but so was everyone else. It's a lot easier to keep your capital base in that scenario." (p. 374)
219/ "Companies that are trying to jump the Grand Canyon and prob. won't make it: first, the company is trading at >5x book; second, the company is losing money.
Regardless of 1999, "I would short these types of stocks again because 99x/100, I am going to make money." (p. 375)
Regardless of 1999, "I would short these types of stocks again because 99x/100, I am going to make money." (p. 375)
220/ "Just b/c you made money doesn't mean you were right; just b/c you lost money doesn't mean you were wrong. It is all a matter of probabilities." (p. 375)
Schwager: "It's not a matter of whether you won or lost, but whether you would make the same decision again." (p. 375)
Schwager: "It's not a matter of whether you won or lost, but whether you would make the same decision again." (p. 375)
221/ Joe Vidich:
As a stockbroker, "I didn't know anything. I was probably dangerous to my customers. I was literally following the firm's research, but if you work for a firm that has bad ideas, you don't have a chance." (p. 388)
As a stockbroker, "I didn't know anything. I was probably dangerous to my customers. I was literally following the firm's research, but if you work for a firm that has bad ideas, you don't have a chance." (p. 388)
222/ "It is always better to do your own work and get your own information because then you will have confidence. If you listen to someone else to get into a trade and things go bad, then you have to listen to that person again to get you out....
223/ "I have real antipathy to outside research analysts calling us with trading ideas because if you follow their advice to get into a trade, then you have to wait for their advice to get out, and things can change. The price could be down 10-15% before they call again." (p.390)
224/ On Citigroup in 2008: "I didn't understand anything that was said about CDOs or mortgage-backed securitizations. But the key thing I realized from the call was that not a single analyst understood it, either.... Confusion is opportunity, so I went short the stock." (p. 391)
225/ "It is really important to manage your emotional attachment to losses and gains. Limit your size in any position so that fear does not become the prevailing instinct guiding your judgment." (p. 398)
226/ "To be successful, you have to be willing to change your opinion. Most people are not willing to. You have to be humble about your ideas.
"Most people are more afraid of making money than losing money. There is no real reason to sell a stock just b/c it's up 20%." (p. 398)
"Most people are more afraid of making money than losing money. There is no real reason to sell a stock just b/c it's up 20%." (p. 398)
227/ "They are afraid of losing gains. If a stock is down 20%, they are not going to sell it. What they are really afraid of is not being right. That is why they won't sell it when it's down 20% - because that would confirm they were wrong." (p. 399)
228/ Schwager: "I had a degree in economics, but they taught you nothing about markets. The interview was for a job as a commodity research analyst. The research director asked me if I knew anything about commodities. 'Not really,' I said, 'something about gold.' " (p. 408)
229/ Kevin Daly:
"We used to call EV to EBIT a 'cap rate', similar to a cap rate used to value real estate. Why buy a piece of commercial real estate with a 6% cap rate or a bond with a 7% yield if you could buy a business like Macy's with a 20% cap rate?" (p. 412)
"We used to call EV to EBIT a 'cap rate', similar to a cap rate used to value real estate. Why buy a piece of commercial real estate with a 6% cap rate or a bond with a 7% yield if you could buy a business like Macy's with a 20% cap rate?" (p. 412)
230/ Joel Greenblatt:
"The fact that our value approach doesn't work over periods of time is precisely the reason why it continues to work over the long term. Our formula forces you to buy out-of-favor companies, stocks no one who reads a newspaper would think of buying...
"The fact that our value approach doesn't work over periods of time is precisely the reason why it continues to work over the long term. Our formula forces you to buy out-of-favor companies, stocks no one who reads a newspaper would think of buying...
231/ "and hold a portfolio consisting of these stocks that, at times, may underperform the market for as long as two or three years.Most people can't stick with a strategy like that. After one or two years of underperformance, and usually less, they will abandon it."
232/ "I spend time trying to get people to understand that, in aggregate, we are buying above-avg companies at below-avg prices. If that approach makes sense to you, you will have the confidence to stick with the strategy over the long term, even when it's not working." (p. 466)
233/ "The most popular indexes, such as the S&P 500 and the Russell, are inefficient because they are cap-weighted: the higher the price of the stock, the larger a percentage it represents. By definition, the index automatically owns too much of the overpriced stocks." (p. 469)
234/ Schwager: "The fundamentally-based index does about as well as an equal-weighted index, but it can handle more money."
Greenblatt: "This is exactly right. We thought we could provide additional improvement by creating an index that allocated more to cheaper stocks." (p.470)
Greenblatt: "This is exactly right. We thought we could provide additional improvement by creating an index that allocated more to cheaper stocks." (p.470)
235/ "No one was really picking stocks. If we can be #1 out of 1,300 funds by outperforming by only 5% and the last place fund out of 400 in another category by under-performing by only 5%, it means that almost everyone must be index hugging." (p. 470)
236/ On the Magic Formula site, "self-managed accounts underperformed [systematically] managed accounts by >25% in the first 2 years.
"Both had the same principles and same list of stocks, but letting investors make their own decisions destroyed all the outperformance." (p. 474)
"Both had the same principles and same list of stocks, but letting investors make their own decisions destroyed all the outperformance." (p. 474)
237/ "I sit on several multibillion-dollar investment boards. I know from direct experience that after four or five quarters of performance, the natural response is, 'One guy knows what he's doing, and the other doesn't.'
"Most allocators chase who did well recently. It is hard
"Most allocators chase who did well recently. It is hard
238/ "to resist this temptation because you are getting all this data, and you have a fiduciary responsibility. The world has become much more institutionalized over the last 25 years, and time horizons have continually shortened."
239/ "The advantage of taking a longer-term investment horizon has increased.
"Most managers can't wait two years for an investment to work. Even if a manager knows that he should be looking longer term, his investors pressure him for performance over the near term." (p. 478)
"Most managers can't wait two years for an investment to work. Even if a manager knows that he should be looking longer term, his investors pressure him for performance over the near term." (p. 478)
240/ "Past results are very misleading.
"2000-09, 97% of the top quartile managers for the decade spent at least three years in the bottom half, 79% spent at least three years in the bottom quartile, and nearly half spent at least three years in the bottom decile.
"2000-09, 97% of the top quartile managers for the decade spent at least three years in the bottom half, 79% spent at least three years in the bottom quartile, and nearly half spent at least three years in the bottom decile.
241/ "You know investors didn't stick with the managers in the bottom quartile, let alone the bottom decile. Yet those were the managers that ended up with the best record for the entire period.
242/ "The single best-performing mutual fund for the decade was up 18%/year, on average, during a period when the market was flat, yet the average investor in that fund lost 8%. Every time the fund did well, people piled in, and every time it underperfomed, people redeemed.
243/ "Institutions make the same mistakes as smaller investors.
"Allocators should be looking at the process - how the manager goes about picking stocks and managing the portfolio - not returns, which have no predictive value." (p. 479)
"Allocators should be looking at the process - how the manager goes about picking stocks and managing the portfolio - not returns, which have no predictive value." (p. 479)
244/ "To beat the market, you have to do something different from the market. If you are going to be different, sometimes you will underperform significantly.
"If you are a value investor, there will be times when the market will be responding to emotion and momentum." (p. 480)
"If you are a value investor, there will be times when the market will be responding to emotion and momentum." (p. 480)
245/ "Because returns are mean-reverting, managers that pension plans fire go on to outperform the ones they hire."
"Institutions fire managers that do poorly, then allocate to ones who have done well, who then go on to do poorly."
"Institutions fire managers that do poorly, then allocate to ones who have done well, who then go on to do poorly."
https://twitter.com/ReformedTrader/status/1069459004491845633
https://twitter.com/ReformedTrader/status/1215080727714226178
246/ "You are setting yourself up for failure if you invest differently than you want to in order to please investors.
"Manage your own account if you can. There is nothing like actually doing it and learning what your emotions are when you are doing well or not well." (p. 484)
"Manage your own account if you can. There is nothing like actually doing it and learning what your emotions are when you are doing well or not well." (p. 484)
247/ Stuff I learned from reading this book:
* Strategies with the strongest support in academic papers have also worked with real money: value, short-term reversal, quality, sentiment, trend/momentum, betting-against-volatility, and volatility targeting, among others.
* Strategies with the strongest support in academic papers have also worked with real money: value, short-term reversal, quality, sentiment, trend/momentum, betting-against-volatility, and volatility targeting, among others.
248/ * Successful traders were using strategies (Black-Scholes, delta-hedging, stat arb, deep value, CMA, volatility-adjusted carry, enterprise multiples) before academics decided to write about them.
* Some is high-turnover stuff most of us shouldn't try (short-term reversal)
* Some is high-turnover stuff most of us shouldn't try (short-term reversal)
249/ * Even the best managers have blind spots and sub-optimal portfolios. (Value managers ignoring momentum = underdiversification, rules-of-thumb risk management instead of systematic vol targeting)
* Successful traders survive fat tails (long volatility, stops, vol targeting)
* Successful traders survive fat tails (long volatility, stops, vol targeting)
250/ * Super-star managers have survived long enough to get monster returns because they make concessions to investors, especially in being long more market beta than they would otherwise like to
* They learn from mistakes and have figured out how to control their emotions.
* They learn from mistakes and have figured out how to control their emotions.
251/ AQR looks at the factor exposures of superstar managers and verifies that their strategies have historically had exposures to factors (sets of systematic rules).
https://twitter.com/ReformedTrader/status/1217884016797310976
252/ Hedge funds as a group have historically provided only moderate factor exposures. With the passage of time, their market beta exposures have increased, and alphas have declined to about zero.
Long/short systematic factors could be a viable choice.
Long/short systematic factors could be a viable choice.
https://twitter.com/ReformedTrader/status/1233573232881438720
253/ There are more hedge fund trader interviews in Steven Drobny's book Inside the House of Money:
https://twitter.com/ReformedTrader/status/1284680960357720064
254/ Gain to Pain ratios, net of fees (as of 2012)
O'Shea: 1.76 (p. 6)
Benedict: 3.4 (Sharpe 1.5; p. 79)
Ramsey: 2.2 (p. 105)
Woodriff: 1.43 (p. 134)
Mai: 4.2 (Sharpe 1.12; p. 225)
Platt: 5.6 (p. 262)
Clark: 4.1 (Sharpe 1.50; p. 288)
Vidich: 2.4 (p. 386)
Daly: 3.2 (p. 406)
O'Shea: 1.76 (p. 6)
Benedict: 3.4 (Sharpe 1.5; p. 79)
Ramsey: 2.2 (p. 105)
Woodriff: 1.43 (p. 134)
Mai: 4.2 (Sharpe 1.12; p. 225)
Platt: 5.6 (p. 262)
Clark: 4.1 (Sharpe 1.50; p. 288)
Vidich: 2.4 (p. 386)
Daly: 3.2 (p. 406)
255/ Jack Schwager's preferred performance statistics
Gain to Pain Ratio
(Sum of all returns divided by absolute value of the sum of all negative returns)
Sortino Ratio/√2
(This adjustment allows for direct comparisons of Sharpe and Sortino ratios.)
jackschwager.com/market-wizards…
Gain to Pain Ratio
(Sum of all returns divided by absolute value of the sum of all negative returns)
Sortino Ratio/√2
(This adjustment allows for direct comparisons of Sharpe and Sortino ratios.)
jackschwager.com/market-wizards…
257/ Jack Schwager's most recent book:
The Unknown Market Wizards
The Unknown Market Wizards
https://twitter.com/ReformedTrader/status/1324077836907421696
258/ Jack Schwager interview on Michael Covel's Trend Following podcast
* Hedge Fund Market Wizards
* Chapter-by-chapter Q&A
* Low volatility can be a sign of high risk if it increases the likelihood of a crash
* Comparison of performance metrics
trendfollowing.com/2021/04/01/ep-…
* Hedge Fund Market Wizards
* Chapter-by-chapter Q&A
* Low volatility can be a sign of high risk if it increases the likelihood of a crash
* Comparison of performance metrics
trendfollowing.com/2021/04/01/ep-…
260/ "It's not easy to stand apart from mass hysteria - to believe that most of what's in the financial news is wrong, to believe that the most important financial people are either lying or deluded - without being insane."
https://twitter.com/ReformedTrader/status/1393652576206299139
261/ Boomerang: Travels in the New Third World (Michael Lewis)
https://twitter.com/ReformedTrader/status/1394856866161643525
262/ "the spreads widened out. You’re seeing some of that right now again in the marketplace [in November 2007].
"That was a mistake. I thought the liquidity would be there, would always be there, and I was not careful about my position size at the time."
"That was a mistake. I thought the liquidity would be there, would always be there, and I was not careful about my position size at the time."
https://twitter.com/NeckarValue/status/1578044789588639744
264/ "My Evel Knievel screen to short stocks: companies trying to jump the Grand Canyon and probably won't make it.
"There are two conditions. First, the company is trading at more than five times book value. Second, the company is losing money." (p. 374)
"There are two conditions. First, the company is trading at more than five times book value. Second, the company is losing money." (p. 374)
265/ Joel Greenblatt: "Value forces you to buy out-of-favor companies and hold a portfolio consisting that, at times, may underperform the market for as long as two or three years. Most people can't stick with a strategy like that." (p. 466)
You mean like 2018-2020? Exactly.
You mean like 2018-2020? Exactly.
266/ "After one or two years of underperformance - usually less - they will abandon the strategy, probably switching to one that has done well in recent years.
"The only way you will stick with something that is not working is by understanding what you are doing." (p. 466)
"The only way you will stick with something that is not working is by understanding what you are doing." (p. 466)
267/ "When you have six to eight positions in a special situations portfolio and one doesn't work out, you're not happy.
"Using a systematic value approach, we put together L/S portfolios with hundreds of names on each side, compounding nicely w/ much less volatility." (p. 467)
"Using a systematic value approach, we put together L/S portfolios with hundreds of names on each side, compounding nicely w/ much less volatility." (p. 467)
268/ "If you lose 50%, you have to make 100% to recover the loss. Volatility can result in large losses that are difficult to make up.
"A more diversified L/S portfolio has a smoother ride & the opportunity to compound very well." (p. 468)
More on this:
"A more diversified L/S portfolio has a smoother ride & the opportunity to compound very well." (p. 468)
https://twitter.com/ReformedTrader/status/1457797335430225922
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