On "stationarity"...

When we talk about something being "stationary" we mean that the observations look like they could be drawn from the same "bag of observations" (distribution), regardless of what time we choose to look at.

You can observe this by eyeballing charts.

VIX (blue) stays within a range the whole time. If it gets to extreme values, it's likely to revert back to moderate values.

By contrast, the SPX price (orange) just seems to drift away. It doesn't appear anchored to any range.

We can also see this by sampling from the distributions at different times.

Let's divide our sample roughly in half (2004-2012 vs 2013-2021).

From the histogram, it's clear that SPX prices are not drawn from the same distribution in the first and second periods

Compare this with the same plot for VIX...

It's much less clear that the VIX index marks are picked from a different distribution in the first and second halves...

To complete the discussion, let's look at the distribution of SPX log returns in a similar way...

After transforming the prices to log returns, it is now much less clear that they are picked from different distributions.

This is why we did it in the initial analysis.


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More from @therobotjames

9 Mar
Let me try to be helpful.

If you have some kind of factor that you think predicts future stock returns (or similar) and you are making charts like below, then here are some tips...

We'll go through an example of trying to "time" SPX with the level of VIX.

A thread 👇👇👇👇
You get daily SPX index prices and daily VIX close data

You align them by date and plot them on dual axes, in true RealVision style.

"SPX tends to go down when VIX is high. I can therefore time an SPX allocation based on VIX. Let me share this on twitter" you say.

No. Very no.
There are two main problems with what you did:

1. The SPX price drifts. We can't directly compare the price of SPX in 2004 with its price in 2021

2. As traders, we are more interested in whether high VIX is *followed by* decreasing SPX prices, not *coincident with* them.
Read 23 tweets
28 Feb
This is a fantastic initiative from @KrisAbdelmessih.

It is hard for a beginner to know what effective trading "looks like", and where to concentrate efforts.

This will help bring the best of pro trading training programs to the masses.

Some thoughts on trader training... 1/n
The path to profitable trading is straight and narrow.

Having a theory on inflation, or memetics, or an in-depth knowledge of the VIX expiration, is a waste of time if I'm quoting corn options.

So good training concentrates the trader on things that matter.

You need to concentrate on micro things (information, motivations, constraints, game theory) when you're playing micro games.

And you need to concentrate on macro things (stats, broad behavioural tendencies) when you're playing macro games.

Read 12 tweets
10 Feb
Broadly, there are 3 types of systematic trading strategy that can "work".

In order of increasing turnover:
1. Risk premia harvesting
2. Economically-sensible, statistically-quantifiable slow-converging inefficiencies
3. Trading fast-converging supply/demand imbalances

1. Risk Premia Harvesting - is typically the domain of wealth management, but it's important to any trader who likes money.

A "risk premium" is the excess return you might expect over and above risk-free cashflows for taking on certain unattractive risks
"Equity Risk Premium", for example, is how you say "Stonks, they go up" if you work for Blackrock

(Though, they're really referring to the extent to which they "go up" more than an equivalent less risky thing)
Read 20 tweets
3 Dec 20
Trading is a game of repeatedly asking:

1. What exposures do I want?
2. What exposures do I have?
3. How do I get closer to 1 from 2, given that:
a) it costs to switch positions
b) my estimates are noisy
c) co-movements of assets are somewhat predictable

Concepts like "open trades" and "unrealized p&l" tend to be unhelpful in this paradigm.

If you don't like the exposures you have, then move them closer to the ones you want.

It makes no difference if you're underwater or in profit in your "position accounting"

There is no difference between a position that you have kept on the book for a while and one you just opened. It's exactly the same exposure either way.

Let's run through these 3 questions using a simple toy trading approach...

Read 21 tweets
2 Dec 20
In this brilliant article, Kris talks about the importance of trying to "shorten the feedback loop"?

How does a fundamental manager "shorten the feedback loop"?

I don't do anything that looks like "fundamental investing" but I couldn't stop thinking about the problem...

I think of the returns from "fundamental investing" coming from two sources...

1. Risk Premium - The tendency of risky assets to be relatively cheap vs their expected cashflows. This leads them to "carry" more than they would if their real cashflows were riskless

2. Mispricing - For behavioural/structural reasons, some assets are under/over-priced vs a reasonable estimate of their ex-ante "fair value".

On average, we expect them to converge towards fair value over some long time horizon.

This is "alpha" in fundamental investing

Read 10 tweets
2 Dec 20
Traders often implicitly assume recent conditions will persist - without checking whether that's likely to be true.

You need to understand the assumptions you are making, and whether they are reasonable.

Here are some examples and a simple analytical approach 👇👇👇

"I want to find an asset with characteristics X

"So I'm going to look for stuff which showed these characteristics in the recent past - and I'll hope it carries on having them for a while."

Sometimes this is reasonable. Sometimes it is wishful thinking.

How do we tell?

Here's an example of something we know is persistent - volatility.

"I want to find a low volatility stock - so I'm going to look for stocks which have been low vol this year"

Is this reasonable, or wishful thinking? Let's see...

3/n Image
Read 17 tweets

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