Been thinking about implications of AI disruption on investing. When incumbents fall and new upstarts emerge, stocks usually don’t go from 100 to 0 or vice versa overnight - they get there over time, forming strong trends. Momentum investors who win on trends caused by real fundamentals take their profits to chase fake trends too. Dumb money that got lucky can’t tell the difference but now they have enough capital to really move things.

Yet another Shannon's Demon musings thread. Imagine a stock that has a 50/50 chance to gain 100% or fall 60% every day. Long term buy and hold will almost guarantee a total loss. But buying for one day is an incredibly good trade: (100-60)/2 = 20% expected return. 1/ This is an asset with very positive arithmetic avg return but very negative geometric avg return. You can make money as a long (and lose money as a short) if you get close to the arithmetic return. And this is done by effectively making one-day trades, i.e. daily rebalancing. 2/

Seems like a good time to revisit this old thread discussing different types of trends.

There are trends where price goes up because of price going up, but there are also trends where price goes up *despite skepticism* and trend-following is actually contrarian.

https://twitter.com/walt373/status/947171512355885056

I think it's the same idea behind +/- gamma. Options are like strategies embedded in an instrument. Long calls = long stock and trading pro-trend, buying more as price goes up. Short put = long stock/trading counter-trend. If everyone's selling covered calls, calls will be cheap.

Domination of passive remains one of the most important trends. $ flowing out of active into passive means $ flowing from active overweights into underweights/shorts. And thus relying on reversion to efficiency is treacherous in this market. Short thread: Market efficiency is created by active managers all trying to fairly value securities. Passive assumes the market is highly efficient and attempts to free-ride on it. But obviously this assumption will not hold if passive drives out the very agents enforcing it.

The counterintuitive idea behind the Kelly Criterion that's striking to me is that you can improve returns by taking less risk. Seems like many use Kelly to justify more risk, but I believe the opposite, especially after accounting for uncertainty and correlation. Thread: Kelly tells you the mathematically optimal bet size given the risk/reward of a bet. When you bet too big, your returns fall. Not risk-adjusted returns, actual returns. Overbet enough and your returns go negative. But when you underbet, you still get most of the returns.

A lesson for me over the last couple years is that flows drives price and fundamentals only matter to the extent they drive flows. I know it's become a meme at this point but that's saying something - I think the market as a whole came to understand this and changed. Thread: Ex: severe recessions always coincided with bear markets. But recessions didn't cause bear markets directly, they caused market outflows by corps and households, which then caused bear markets. But this relationship breaks down if outflows are more than offset by govt actions.

$MSFT is an interesting case study. Tech bubble, crash, wandered in the desert for years, got cheap and made it into the Magic Formula, mgmt change, pivot biz model and caught a secular trend, then quality/growth and momentum winner for years on end. Something for everyone. 1/n

https://twitter.com/vitaliyk/status/1268869824106520576

The original tweet pointed out how long it took for MSFT to regain its tech bubble high. What I find more remarkable is its performance since it stopped going sideways. Almost a straight line up and to the right.

Highly recommend The Second Leg Down. Tons to think about from this book. Some excerpts that I liked: Hope is not an investment strategy

Sometimes traders say "confidence" is important. I didn't get it, but starting to now. When you believe in your own abilities, you don't latch onto one stock/strategy/style. Cutting a loss or taking a profit is easy if you know there's always another good trade around the corner. As opposed to when a trade is "the opportunity of a lifetime" or if it's "make or break." If everything comes down to this, you're emotionally invested and can't think clearly. Experience brings the perspective that new opportunities will appear and you'll be able to find them.

The philosophical difference between investors and traders is that traders value humility. The name of the book The Intelligent Investor implies other approaches are unintelligent. The allegory of Mr. Market as a manic basket case teaches investors to regard it with contempt. 1/ Investors value intelligence, conviction, and pain tolerance. A success story is Michael Burry in The Big Short. He was years early, held to his conviction, took the pain, and was rewarded for it in the end. The formula works if you're right, but is catastrophic if you're wrong.