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Guest Post: The Reasonable Ineffectiveness Of Mathematics In Trading

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The Reasonable Ineffectiveness of Mathematics in Trading

By JM

Mathematics affords virtually unlimited precision, but is limited in its scope.
        —paraphrase of Eugene Wigner,
         The Unreasonable Effectiveness of Mathematics in the Natural Sciences

Is mathematics a quantum leap forward compared to other methods of thinking?  Sure.  Its precision beats every other possible “system” and human intuition is limited by experience.  One cannot “see” curves without tangents, nor intuit an n- dimensional space.  But everyone lives and thinks with intuition in ordinary life.  Successful trading is about buying cheap and selling dear:  mathematical thinking is an indispensible means to that end.  But it can also obscure intuition that necessarily deals with the inexact definitions of everyday life.  Further, a mindset wholly engrossed in the mathematical development of an axiom base can take one far from practical relevance.  

Don’t Be a (Norbert) Wiener

Janos (Johnny) von Neumann reinvented himself multiple times before he died of cancer.  He was a key contributor to the foundations of mathematics, the pioneer of ergodic theory (Birkhoff tried to cheat von Neumann here), did some slick investigation on the invariant subspace problem, the expositor of the underappreciated subject of continuous geometry, the one who systematically investigated game theory, the human calculator behind components of the first nuclear weapon, and considered the father of machine computing.  This doesn’t even cover all his achievements, much less capture their depth.  He knew how to party too, but that comes further down. 

There was nothing superhuman about him:  he just had a solid, thoroughly normal personality with a tremendous work ethic.  If there was any genius in him, it was his instinctive drive to stay close to directly observed facts, and thus application.  This is not to say that he didn’t theorize.  In fact, his axiomatization of quantum theory is still one of the best reads on the subject because his axioms are stylized from observation, straightforward, and easy to relax and restrict depending on where you want to go.

This stands in stark contrast to Norbert Wiener’s approach to constructing a view of the world.  He was the first to rigorously characterize Brownian motion, but he exclusively used a (then) challenging and formal measure-theoretic construction.  Wiener avoided drawing connections to probabilistic methods because probability theory had a bad reputation among mathematical colleagues of the day.  Probabilistic intuition and measure theory reinforce each other:  many who could have benefitted most by the advance were left out of the discussion.

Perhaps these differences in approach are based on personality.  Von Neumann was reasonably courteous, somewhat intolerant of pretension and illusions of superiority, generally friendly, and a fun-loving people person.  Wiener was by accounts childish; overly-sensitive; a self-absorbed, difficult person to be around.  The divide between their personalities was diametric.

The current divide between mathematics and hard sciences couldn’t be much wider, either.  Mathematicians talk amongst themselves.  Engineers talk amongst themselves.  As the respective dialects grow mutually unintelligible, both tend to ignore natural problems that anyone can understand.  Instead, both delve into their own franchised abstractions.  For example, Lie group representations permit an abstraction of Fourier methods for solving differential equations, but the generalization is, with some exceptions, limited to equations amenable to separation of variables.  Lie groups do provide a vantage point where one can survey interesting mathematical vistas, but for close-up details, one often has to fall back on solution methods engineers routinely use.  These methods also fail to overcome current challenges.  Engineers busy themselves in altering one assumption after another to gain slightly more general solution methods (or accuracies) that persistently fail to adhere to demands of some real-life problems.           
     
Long gone are the days when Isaac Newton built the foundations of calculus by observing the effect of gravity on an apple, or a wave equation to measure the speed of sound.  Laplace corrected Newton’s work, not based on symbolic manipulation, but because of the values his experiments yielded.  Cauchy elaborated Newton’s theory of light dispersion using the same prism as a starting point.  Well into this century, Born, Heisenberg, and Schrodinger used harmonic analysis merely as a tool to substantiate quantum observations. 

Von Neumann stepped back and modeled experimental statements via a Hilbert space and deduced how the statements logically connect. Wiener refrained from deploying an expository method in common use and wide relevance because it was distasteful to colleagues of the day.  Everybody loses when experts write mutual admiration notes to each other, coded such that they either bore others to death or exclude them from grasping the point. 

This is just the tip of the iceberg.  If one thinks the difference between mathematics and engineering is huge, then consider the difference between them and softer subjects like economics (no offense meant).  Isolation leads to shallow thinking and research in applied settings, and mathematics needs relevant practical problems to renew itself.     

When the Emperor announced the Japanese surrender to the Allies after World War II, his subjects couldn’t understand what he was saying.  After centuries of distance from his subjects, the Imperial court no longer spoke Japanese.  The recording preserves a jumble of lilting tones and strange cadences that left everyone but a handful scratching their heads.

Action Precedes Data

Johnny von Neumann was terrible at poker.  This wasn’t because he got too drunk during the games:  Stefan Banach once got Neumann so drunk on vodka that he had to run to the toilet to puke.  After the purge, he reentered the Scottish Café and resumed the functional analysis discussion without missing a beat.

The point is that a human calculator with unrivalled skills of preparation like von Neumann could easily compute the highest probability opportunities of a poker hand, but if your hand sucks, it sucks.  Sometimes all options are bad, and the lesser evil is still disaster.  The only option:  action.  But sometimes nothing is a pretty cool hand. 

Poker involves human interaction and strategy, which means above all mind games.  Mind games, as their name implies, are designed precisely to throw reasonable thinking out of whack.  Must there be head games?  Well, basic reality is described by the observable arrangements of particles governed by replicable physical laws of motion (classical and quantum).  These laws are indeed imperfect, conditioned on a limited knowledge of the world.  But it is unconscious bits of brain matter that cause unobservable consciousness. 

Consciousness is subjective; conscious interaction with others shapes society.  Society in increasing complexity brings with it money, property, government, and standards of right and wrong.  But the foundation remains utterly subjective: they exist because enough people believe they exist in a reasonably concrete way.  The changing quantum of “enough people” determines the basic building block of value, what is desired.  Value presents itself when enough people who see it accept it.  Price presents itself as attractive when an individual accepts it.  The price is the price. 

People can anchor their perceptions of value based on the prices of things now.  Valuation becomes a part of the Gestalt, something given, not something for which to search.  Subjective consciousness and basic reality dissolve into a unity, because an unchangeable world-view is assumed.  Those who fail to “get it” simply do not understand.  There is little place for rational disagreement because it is arguing against the self-evident.  While the financial motivation for trading remains sure—the commitment to survive and thrive—there are opportunities within established parameters for anything and nothing. All action can be channeled into modes of “not missing out” and alternatively “not rushing in where fools tread”.  For a time, just about everyone thought equity tranche MBS was good enough and super-senior was bullet-proof.  Now only braver souls sniff non-agency securities. 

Action precedes data.  What drives price action is trading.  Without trading, or in an illiquid market, no one knows how an asset is valued.  Trading in a liquid market provides approximate knowledge of value up to an interval in which price fluctuates around the bid-ask spread needed to fund market-making.  Valuation is always dynamic.  Data that informs models comes after. 

By virtue of their beauty and elegance, mathematical methods can make even things with thoroughly unobservable foundations seem natural, realistic, and inevitable.  People manage voluminous information and complexity by sticking to a view of the world no matter how shaky that outlook is.  That illusion easily breaks down.   

Predictive mathematical models provide in a rigorous justification for behavior based on hindsight.  They reinforce belief that the world cannot materially change from the present (stationarity) and in so doing obscure the distinction between the subjective and objective.  Mathematics does have unparalleled precision, but unquantifiable events fall outside of its scope.  There is a place for thinking outside of data at hand and exploring if never-seen-before scenarios could make it fail. 
 
Using mathematics to model what is essentially subjective and intractable is like playing poker:  it can identify high-probability strategies to play, but one has to work the table.  This is why sell-side and forecasters exist.  The outcome of a bad hand is determined by how you play it as well as what’s in it to some cases.

Poker or Bingo

The current antidote to this endless cycle of falling blindly in love—not with an asset, but with a dubious axiomatization that shapes how the world is perceived—and the inevitable bitter disillusioning break-up is called risk management. 

Oversimplification alert:  the focus here is hedge fund risks that make money by taking residual risk, not on making money through the flow business.  Risk management is very different for the two.  Dealers need risk models that calibrate to daily markets, because tomorrow the position will be unloaded to another customer.  Risk management for those taking residual risk is managing liquidity (cash/near-cash provisioning), reducing return volatility (diversification), and hedging non-stationarity (cheap exposures to the other side of crowded trades). 

But at the end of the day what good does a reasonably self-funding but imperfect instrument like VIX call spreads really do in the face of a melt-down?  Risk management depends on the same world-view that leads to melt-downs in the first place.  Take VaR, for example.  VaR works like it should only when a book is liquid.  One is once more forced to concede that liquidity simply means you know what your book is worth.  Illiquidity means you can’t price it. 

In addition, one has to take into account the size of the players at the table and the types of trades they make.  Small investors are price takers and not price makers—they are able to enter the market, trade in the volume they choose, and leave, without disturbing the market price (however, any trade can shift the price to some degree under a microscope).  By contrast large investors are price makers because the size of trades they need to make inevitably shift market prices (thus they lack the anonymity of the small trader, and this can be seriously damaging, especially when a trader is forced to trade through visible weakness.  Considering that just about everything is a short-end borrow, the effect of illiquidity on everyone can be as extreme as a surfer swallowed by a tsunami.  It doesn’t matter how the hand is played.  You take what is given in this case. 

Illiquidity is non-stationarity.  Are there trades such that non-stationarity can be exploited?  These types of trades carry inherent risks still, but a floating component moves with non-stationary moves.  Meaningful diversification is a mix of receive float/receive fixed positions.

For fixed receiver example, consider CUSIP 38145X533, a 13 month reverse convertible note paying 6.5%.  You lose money only if the index drops ~80%.  Synthetics allow you to customize exposure with no float caps:  take a bond and buy protection on it, and then swap the cash-flow for a floating rate.  A simple concrete example:  buy a 10Y JGB with protection, pay fixed on a 10Y IR swap. Pocket the bond coupon and any floating rate (less funding, protection costs, and fixed swap payment).

Beware of the risks as well as classic paralysis by analysis.  Dangers grow as one broods on them.  In the concrete example, there is an implicit assumption that the CDS contract has a near-perfect inverse relationship to the underlying bond. Even if the trade is well within one’s risk tolerance, serious leverage has to be deployed to make money.  This leverage increases mark-to-market risk via funding pressure.  There can be upfront issues with a dealer.  There is counterparty risk on the float proceeds and the protection. Relatively inexpensive counterparty risk hedges like exposure to rising LIBOR-OIS spreads replicate the risk inefficiently.  CDS on the protection seller is costly (overkill?).  Even then, there is counterparty risk on that protection too.  There are currency risks:  cash serves as a reference point, but it certainly isn’t a risk-free one. 

Only trivial axiomatic worldviews are consistent: there will always be problems that cannot be resolved in a closed-form way.  The closer one looks, the more hedge needs come into view.  It can become like plugging holes in a Cantor set.  There are contingencies where hedging is futile.  There are times when precision is needed, and there are times when precision gets in the way. 

 


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Sat, 01/08/2011 - 10:02 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

If you could become rich trading, there would be billionnaire traders in the world. There isn't. And I'm not even sure there are multimillionnaire traders.

Day traders are very funny. They're always telling you how much they make, and how trading is so easy. The problem is:

1) Technical analysis is basically being able to identify geometrical figures. Everybody can do this as long as you learn it - including robots. Law of diminishing returns, value added, etc: everything proves technical analysis cannot work, as if it would work, it would be an economical absurdity.

2) The only ones making money trading are insiders. This is a fact. 99% of traders lose money. Are RobotTrader and HarryWanger in this 1%?

3) Day trading is like gambling in a casino. You can win $5,000, you can win $50,000, you can win an entire month, but as you reasonably bet more and more - you end up losing everything on a bad play.

Sat, 01/08/2011 - 10:49 | Link to Comment kato
kato's picture

how would you know? anything? stf up

Sat, 01/08/2011 - 12:23 | Link to Comment 4xaddict
4xaddict's picture

TGP I think you have to define "traders" because you start with a blanket comment about "traders" and then seem to shift your focus to "Day Traders".

I concur that the vast majority of those trading lose $ hand over fist. I am at my screen each day for 8 hrs. An hour either side of Asia close-Euro open and US open - Euro close and have been profitable for a number of years. My average trade duration can be from 10 mins to 2 months and I only trade spot FX and commodity futures. I do not claim to make billions of dollars per year but routinely return 35-65% p/a using very conservative money management and a couple of different methods depending on the shape of the market at the time.

Because I did not start with 50-100M I have not had the chance to be able to make M's of $ or B's of $ per annum yet and I dare say that becomes more unlikely as capital increases and brokers start reducing available margin but still there is a very good opportunity for a person to make sizeable sums (a term which changes in the eye of each beholder) and minimize risk to acceptable levels.

2008 was an outlier event even though I think Gladwell's writings are the intellectual equivalent of him wiping his ass with his hand and rubbing it under the readers nose. So let's say a Black Swan. The writing was on the wall though and the rumblings were occurring however long before the top hit. 2008 was one of my better years and while I certainly don't claim to have picked the top, however my technical analysis allowed me to take the Euro from 1.40's to the 1.19 area where I ran out of courage to stay in the game. In my experience TA can be very useful when combined with a lot of time watching price action, keeping abreast of and filtering news flow and maintaining an open mind to new ideas. You are right that if it was simple everyone would be billionaires however it isn't simple and the dynamic nature of the market is such that it never will be. Being able to learn and adjust is the only way to stay in the game.

I think what you are trying to say is that most people who call themselves traders aren't actually real traders. They may have bought themselves 10 screens to stare at and have learned enough trading terminology to talk shit however the proof is in the account balance, period.

My time in the markets only extends to the last 8 years though so you may be coming from a position based on a lot longer experience than me.

Can't say I agree with your wholesale slating of all traders but I too am willing to not be a literalist troll and therefore can see some of the valid arguments that you are putting fwd.

Sat, 01/08/2011 - 12:30 | Link to Comment Orly
Orly's picture

Thanks for that.

:D

I'm addicted, too!  Besides the money, isn't this a great kick-in-the-ass?  Having a ball!

Sat, 01/08/2011 - 12:58 | Link to Comment 4xaddict
4xaddict's picture

running your own hours and being able to say f%$£ it for a couple of weeks to do family stuff is the ultimate prize that this kind of trading affords us.

That and the challenge of it! Sure beats the hell out of having someone inevitably less intelligent that you but older so therefore in a position of seniority, breaking your balls in an office!

I don't use robots myself but have EAs running that alert me when things are satisfying my entry criteria. It took me a few years to find a rhythm and routine that keeps me focused and productive but once I did I found I made back my initial educational losses :) and now live quite comfortably from it. The hardest part I find to be honest is allowing myself to spend profits knowing what the return is that I could get on them :)

Sat, 01/08/2011 - 13:52 | Link to Comment Orly
Orly's picture

I love my robots and wouldn't want to trade without them, mainly because they do most of the trading while I am sleeping.  I have learned ("educational expenses," yes I have had plenty of those, too...) to keep the lot-size pillow friendly and build slowly over time.  Since they trade for me when I am unavailable or too busy, this greatly increases (maybe triples...) my time in the market with relatively little increased risk.

I will find what is going on in a weekly or daily trend, then sic my robots on it until the trend stops.  What is great is that I can tell the robots to trade long or short (or both...but I rarely do that.  If I don't have a good idea which way the market is movng, how can I expect my robot to guess?)and even to get my permission before opening a trade.  The way they work has also given me insight into trading ideas that I wouldn't have thought of myself.

Sat, 01/08/2011 - 12:59 | Link to Comment Orly
Orly's picture

P.S. I am wondering if your analysis is telling you the same thing I am seeing: that the coming five to eight weeks in 4X are going to be incredible.

I am reluctant to say anything or to offer a forecast because they seem so outlandish they may not be possible, yet the charts don't lie.

WW4XAD?

Sat, 01/08/2011 - 13:52 | Link to Comment 4xaddict
4xaddict's picture
Let's just say I think the €$ looks very similar to it's price action in the Jan '10 on the weekly. My play for this week is short €$ from 1.2945 (assuming there is a small retrace) with stops around 1.3085 and will look to add short on any bounce off the 1.26 handle. I'd ideally like to be entering @ 1.3020 area but an fearful it may not get there however the inverted hourly pinbar into close and the fact the weekly closed right on the lower boundary of the ichimoku cloud implies for me that there could be a small bid come in. But that is just me speculating and I'll end up taking whatever I'm given I think. If what the charts seem to be implying occurs then I could hopefully get my chance to build positions in GLD circa 1185, SLV circa $25 and AUD$ around 0.94 (possibly even 0.90). However, if the wheels start coming off in China in the near term then those low side targets become arbitrary in my opinion as not even my lowest projections in late 2008/early 2009 had me seeing things that low. I also think that people are still discounting the impact that the Australian floods are going to have both on Agricultural com output and coal prices. Things are really phucked at home. Probably the most surprising thing for me has been the £ strength lately. Sure a lot of it would appear to be the result of the € getting smacked but it's madness. Living in London, the economy here is completely over a barrel. My business is manufacturing and importing goods ex-East Asia for large retailers in Aus and Canada. Looking on the Sts here the number of people carrying shopping bags is miniscule and couple that with the reduction in the size of food packaging and all the retailers trying to put off the VAT increase till the end of January means margins are getting crushed. When the GST was introduced in Australia (VAT equivalent and only 10%), retailers across the country went into meltdown for almost 24 months. The flow on effects of the VAT increase here coupled with all the massive job cuts and everything else to me amount to the £ being poised for a genuine pummelling. I think we'll see 1.40 sooner than people think and possibly take out the '09 lows circa if things really escalate.

I've been trying to work out your acronym but I have come to realise that I must be retarded as I've no idea what it means lol

Sat, 01/08/2011 - 14:45 | Link to Comment Orly
Orly's picture

The acronym is taken from the southern Bible-belt here in the States.  The common is WWJD, What Would Jesus Do?, which would make you stop being a hypocrite and live along the straight and narrow.

In this case, it means, What Would 4X Addict Do?  Would you tell these crazy things on your chart?

Okay, I'll tell, because I can't believe what I am seeing and I need a good, old-fashioned grapefruit twisted in the face to make me see straight.

In regard to the Pound Sterling, it has been my belief that since the beginning of the crisis, all the 4X shenanigans have been devised to prop up the GBP, for in essence, the Bank of England failed along with the entire financial system.  I have been quite reluctant to trade the Pound, as none of it makes any sense, as you point out.  It may be allowed to find its natural footing one day but I cannot trust "some day."

The weekly charts here show a resumption of "risk-off," which will not include the USD as a safe-haven currency.  Action in the markets last week proved that, despite the fact that the USD rallied against most everything.  There was a sense of things breaking down and the dollar rally helped not one little bit.  The safe havens are going to be the Swiss Franc, the Japanese yen and the Ozzie dollar.

  • SPX has topped here and will see 950 lickety-split.  The downtrend move could begin possibly as early as the end of next week.  Or the week after..."earnings season," you know.
  • The EuroDollar will bounce off its lower Bolli to ~1.3096, then plummet, possibly to as low as 1.2340 but at least to 1.2494.
  • The USDJPY pair will also have a small bounce back to ~84.7, then plunge to at least 80, maybe even as low as 71.62.  (See?  Crazy...)
  • The USDCHF will see a bottom around 0.8413.
  • With the risk-off and the SPX plunging, the EURJPY can see lows to 86.65 and maybe to as low as 65.8 before a sharp rebound.  (Pure insanity...)
  • The AUDUSD may trade slightly lower but will actually recover from these levels quickly and top at 1.1111.
  • The EURAUD pair will bounce with the EURUSD pair to ~1.3587 before the plunge comes, possibly as low as 1.1.

I trade mostly support/resistance using long-term Fibolevels and there is nothing there to hold the line for the unbridled chaos we will see in the coming weeks.  The plunging SPX will be the catalyst for all these moves, along with a loss of faith in the USD.  The yield on the US 10-year note will revert to ~3%, giving even more impetus to USD and EUR selling and yen and CHieF buying.

The world will be seen as going to hell in a hand-basket and panic will ensue.  Euro longs will get fried like so much weiner schnitzel.

Please tell me where I am wrong so that I can take my meds, take a nap and not dream of these things!

Thanks so much,

Olexsandra

Sun, 01/09/2011 - 13:30 | Link to Comment ZeroPower
ZeroPower's picture

Nice discussion you two.

I dont trade 4X but enjoy looking at the daily swings, im definitely eyeing 1.22 straight away as 1.26 is too obvious of an area to take profits - if anything i feel most people will simply reload their shorts there after any failed break above. USDCAD is a mystery to me - strong oil is CADs biggest catalyst, but then again recent USD strength hasn't really been shown in the pair and current oil drops are a potential weakness for USDCAD. Will have to watch and see what happens i suppose.

 

Sun, 01/09/2011 - 16:11 | Link to Comment 4xaddict
4xaddict's picture

Aha, I will have to remember that one!

I can see where you are getting your levels however I am not sure the SPX at that level will translate into our extended targets straight away, it would need to be a bit lower I would have thought.

But there are a lot of familiar sounding rumblings coming from all different corners of the market that remind me of 2007.

My only real ? lies with the AUD becoming a safe haven. I am a little wary of things that everyone believes can do no wrong and while Aus escaped the worst of it the AUD value is not just correlated the Aus and Chinese economic prosperity. The AUD is so full of carry trade cash that it's back teeth ar floating. If things roll over in a ditch and everyone gets margin calls again etc the outflows will be immense because pre-crisis other currencies were also offering carry trade yield. Post crisis it's all AUD. As a native Aussie I can tell you that the economy is not as large as people are believing it to be given it's "last bastion of western strength" label everyone is buying into.

The AUD unlike the CHF is held by the masses voluntarily, the CHF is held in vast amounts of underwater mortgages is eastern Europe and even Poland and Austria have borrowed heavily. If things really start unwinding and masses of mortgage defaults ensue then the CHF buying will become a stampede so I can understand the case for USDCHF lower.

Wed, 03/16/2011 - 13:45 | Link to Comment Abiggs
Abiggs's picture

I just stumbled on this post and happened to read your overzealous "forecasts" from early Jan...

Congratulations - you managed to (horrendously) miss just about every signle one! Although your USJPY call was a success, it was obviously for the wrong reasons since your realm of analysis could not have seen the earthquake in Japan...

I bet you will tell me that you managed to change your hypothesis in the nick of time to acheive a 100% success rate... right, just another example of ego-driven donkeys chasing a pipe dream.

The only proven key to success in the financial markets is insider info; otherwise you stand no chance.

Sat, 01/08/2011 - 11:14 | Link to Comment Blindweb
Blindweb's picture

Yes.  The method of success is through intellectual synergy.  Focusing on one subject like day trading and mathematics leads to diminishing returns in learning that subject.  The human mind and body have best evolved to be adaptive to any situation.  By learning the broadest possible subjects not only are you learning those subjects, but you're learning the areas where the subjects cross over each other.  2+2=5.  You are maximizing your learning efficiency, and you are maximizing your ability to deal with an ever transient world. 

Buckminister Fuller, among others, talked a great deal about this.   Throughout history the technical specialists have been used by the power elite as tools for their gain.  The intellectual specialists' knowledge is so narrow that they are easily manipulated to use their knowledge to harm.

 

Insiders are people who know financial markets, but they also have social skills, and have fraud skills (not that i think that fraud is a subject to be learned unless to defend yourself).  Success through intellectual synergy. 

Sat, 01/08/2011 - 11:31 | Link to Comment jm
jm's picture

The "power elite" are as hopelessly incompentent as the rest of us when it comes to the future.

Something else.  If you track the richest and poorest across generations in a number of societies (England and Brazil, off the top of my head), guess what happens?  Invariably the grandsons of the richest become poor, and the poorest get richer.  Statistically speaking there is no power elite over time.  Try as parents might, they can't keep an undisciplined unworthy kid from downfall.  And thankfully, you can't keep a good man down.

 

Sat, 01/08/2011 - 12:31 | Link to Comment 4xaddict
4xaddict's picture

the further you remove a person from the "real world" the more unfair you become in expecting him to understand it.

Sun, 01/09/2011 - 10:19 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

Thinking, uh oh, danerous stuff ...

Ever read Alain Badiou? If not, worth a look. Not easy.

Sun, 01/09/2011 - 13:43 | Link to Comment jm
jm's picture

I thought for a minute I had.  Turns out it was Pierre Bourdieu instead.  This Christmas I was on a Ernest Junger trip.

Sun, 01/09/2011 - 14:20 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

Good for you!

Badiou is a French philosopher with a marxist / catholic past and a mixed set theoretic / ontological future. He has a stunning mind.

(Sounds like a bad movie trailer ...)

Sat, 01/08/2011 - 14:11 | Link to Comment Eternal Student
Eternal Student's picture

Here's an old Mathematician's joke:

What's the difference between a large pizza and a Mathematician?

A large pizza can feed a family of four.

 

Sat, 01/08/2011 - 11:16 | Link to Comment rsi1
rsi1's picture

Have a look at "Market Wizards" the book, and  you might want to rephrase your first sentence. And they are not alone. 99% loose? probably, but that doesnt mean 100% are doing it right.

if 100% of average people start doing brain surgery without extensive previous practice, study and the correct mindset, failure stats will probably be the same.

Sat, 01/08/2011 - 11:26 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

Can you name just one man who became billionnaire through trading? I'm not talking about investors or hedge fund managers, I'm talking about swing and day traders.

You also didn't answer the most important part of my post, i.e. the 1).

It's always the same with day traders, more training, more experience, more new techniques, and after all they go broke like anyone else before them. So much cadavers in the Forex forums on the Web... and most of these corpses were gurus. That's the funniest part.

Sat, 01/08/2011 - 11:47 | Link to Comment Orly
Orly's picture

George Soros.  Call him whatever "type" of muon you want to, he still made a killing shorting the British Pound.  That's a fact and it is irrefutable.

Sat, 01/08/2011 - 11:53 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

It is not day trading. I am talking about day trading and technical analysis.

Soros did a killing on a big short based on fundamentals and sufficient capital to be a market mover.

There is nothing wrong in that, and I acknowledge you can become rich through this. The Kennedy family started their wealth through a short.

Sat, 01/08/2011 - 11:59 | Link to Comment Orly
Orly's picture

Ponz, please.  At least try to get your facts straight.  The Kennedys made a load of money running booze in prohibition and translated that cash to Wall Street.

Ironically, the example you give supports RoboTrader's thesis exactly.  Only the insiders knew when to short RCA and those people, including the Kennedys and (presumably...) Bushes, made a lot of money on insider information.

Sat, 01/08/2011 - 12:03 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

Hum, sorry, no. You're wrong.

Sat, 01/08/2011 - 12:31 | Link to Comment Orly
Orly's picture

ok

Sat, 01/08/2011 - 20:08 | Link to Comment RexZeedog
RexZeedog's picture

John Bogle (Vanguard) and John Templeton (Templeton funds)

Both of these people were traders.

Your problem is that you insist that it must be short-term to count as trading.

Sat, 01/08/2011 - 11:30 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

Like I expected, all the day traders shitheads are coming to insult me. When you have confidence, your nerves don't broke at the slightest opposition.

Typical wishful thinking.

In fact they will be broke in 6 months, like every trader (approximately 500) I've seen in my life.

Sat, 01/08/2011 - 11:55 | Link to Comment kato
kato's picture

you are a fucking know-nothing idiot trying to express your big dumb ass opinions as if they were knowledge. shut up fucking moron. i know people who use math to make millions of dollars a year trading. millions year after year. shut up.

Sat, 01/08/2011 - 12:25 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

You seem pretty dumb and frustrated, poor ass. How are your shorts/longs going?

"i know people who use math to make millions of dollars a year trading. millions year after year."

And you're still commenting on Zerohedge like a no-life? Your golden goose did not manage to give you a few millions?

Can you name these people? If you can't, then you're a pathetic liar.

Sat, 01/08/2011 - 18:29 | Link to Comment kato
kato's picture

yes i can name the person. but he likes his life and does not want plebs like you coming around offering to lick his balls for insight. you are loser. go cry in your gutter.

Sun, 01/09/2011 - 01:14 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

You make millions - or at least have connections that make millions - but are still unable to write English correctly.

LMAO

Sat, 01/08/2011 - 11:25 | Link to Comment Diogenes
Diogenes's picture

"If you could become rich trading, there would be billionnaire traders in the world. There isn't. And I'm not even sure there are multimillionnaire traders."

What about George Soros?

Sat, 01/08/2011 - 11:28 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

George Soros is an investor, who occasionnally uses his capital to play the market mover.

Sat, 01/08/2011 - 11:52 | Link to Comment Orly
Orly's picture

Totally wrong.  George Soros, Jim Rodgers, all these guys...

Where do you think they got the money?  Did everyone say, as Sheep-Dog One says, "Here, take my wallet, please.  It's burning a hole in my ass"?

It seems that you're the one who is on the attack here, not us lowly and ignorant day-traders.  Sorry you got burned.  Learn risk management and appreciate the fact that there are some of us who can do it for a living.

Better luck next time, Ponz.

Sat, 01/08/2011 - 12:00 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

"all these guys"

In fact, I'm pretty sure you can only quote George Soros and Jim Rogers, because there is nobody else. And Soros and Roger never were day traders or even swing traders.

" Sorry you got burned.  Learn risk management"

LOL! The dumbest kid in the room knows that stops are important and how you should allocate your capital. Nothing to learn there.

"and appreciate the fact that there are some of us who can do it for a living."

Do you really do it for a living, or you're just hoping to do it for a living? That's two different things. Everybody who claimed trading for a living on some forums I frequented pathetically admitted 1 year later they were broke. In France, we have some websites which allow rankings and challenges between traders. The results are very funny. 90% of traders make very poor returns, and the other end up broke at one time or another.

It's funny: every financial firm is closing their desks (see the ZH article on the death of day trading), hedge funds are stopping all form of trading, and meanwhile, amateur day traders claim they're making loads of money.

Sat, 01/08/2011 - 12:17 | Link to Comment Orly
Orly's picture

ForexFactory fora should not count in your analysis.  Those guys are mostly get-rich-quick noobs who have no understanding that this market is not to be toyed with but taken quite seriously.  I don't consider myself a "day-trader" in 4X, though I do trade virtually every day.  That is, I have my robots do it for me at my direction and discretion.

As an aside:

I am not here to tell you that I am making rapacious sums in the 4X market. These days, I can't imagine anyone who is.  However, I was able to quit working for the man last year, thanks to family support and the results so far have been pretty good.

What is really, really surprising is that my family truly appreciates having someone at home, taking care of the house.  No more latch-key kids.  Everyone seems much, much happier even though my income has been cut to nearly nothing, as I build my account.

What I have come to realise is that the two-income paradigm initiated by our lovely banksta-gubmint in the late '50's has virtually ruined this nation.  Do an analysis of your own finances and see if it is possible for one of you to quit work (if you're married, of course, and especially if you have a house full of small kids...).  If it is at all possible, through down-sizing or even working for the man part-time, I would advise you to do it.  It is so worth it, I can't even begin to tell you.

You can't put a real-life value on these things, for, as jm says, most times life occurs outside of the mathematical models. Outside the mathematical models in this case involves love and a strong foundation for your children.  Can't put a price on that.

Sat, 01/08/2011 - 12:24 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

I already work as a freelancer and I totally agree with you on this.

But I have still important concerns on the viability of trading, notably in this free-money environment.

I know very famous French traders, and they have performed very poorly these last two years. So when I hear men on ZH saying they do millions on amateur day trading, this is hardly believable.

PS:My anger was mostly directed at kato who started insulting me, not at you.

Sat, 01/08/2011 - 12:51 | Link to Comment Orly
Orly's picture

Oh, no offense taken.  I am loving the discussion.  It was one of the things that held me back for so long- the damned statistics: 95% of 4X traders lose money!  Of the five percent remaining, four of those are basically breaking even and there leaves only one percent making any money at all.

Jeesch.  Talk about stacking the odds against you!  It was when I made it past the just breaking even set that I decided to take the plunge and try to make a go of it full-time.

Wish me luck!

Sat, 01/08/2011 - 16:54 | Link to Comment jeffgroove102
jeffgroove102's picture

Best of luck orly, I know someone from the east coast that does forex successfully, he is a swing trader. I myself have tried the daytrading futures and have gotten killed doing it, luckily for me, it was not that much money. From my brief time, it is my guess that really short time frame people are the ones whom lose. I even did an online trading room but found it to be really stressful, good post BTW.

Sat, 01/08/2011 - 14:24 | Link to Comment Diogenes
Diogenes's picture

He didn't say day traders, he said traders. Soros was a trader looking for trends, not an investor looking for bargains like Buffett. There is a difference.

Sat, 01/08/2011 - 12:37 | Link to Comment livestrong
livestrong's picture

Maybe no billionaire daytraders, but definitely multi-millionaires.  My closest friend started with $2,000 and turned it into $2 million in under 2 years...daytrading thousands of stocks.  He didn't get lucky with some big home run winners either--just thousands of small gains that add up.  And no, he didn't lose it all like so many do.  In fact, he has netted a total of about $5 million since starting 10 years ago.  And yes, he knows a few other traders just like him who are still around, even though he says trading has become much more difficult for everyone in the last couple of years due to HFT robots.

Sat, 01/08/2011 - 13:25 | Link to Comment Common_Cents22
Common_Cents22's picture

 

The challenge with daytraders is losing the forest while looking through the trees and the short term mindset causes them to be a profit looking for a trade, thus they force trades many times.

 

Secondly, this market is detached from fundamentals.  Good poker players dont even have to look at their cards (fundamentals if you will).  They just play off other players 'tells' and betting patterns (technical analsyis).

 

On Soros etc..they may have been savvy traders early in their careers but now their elite connections to insiders and government is where they generate their real value.  

 

Just remember, if you sit down at a poker table or negotiating table and don't see the obvious target mark, you are it.  Try sitting at a poker table as a stranger and play against a group of locals who know each other.  Their chips will ebb and flow but they as a group will suck all your chips in a short time.

Sat, 01/08/2011 - 14:28 | Link to Comment Diogenes
Diogenes's picture

This was a long time ago but Jesse Livermore was a day trader who made his first fortune in the bucket shops before moving to the big board. I have his book in which he lays out his method of trading. He was a pure trend following trader, he watched price changes like a hawk and that was always the basis of his method.

Sat, 01/08/2011 - 13:34 | Link to Comment scratch_and_sniff
scratch_and_sniff's picture

This BS about only 1% of traders making money is just infuriating, and to me, impossible to believe. Who makes these stats up? The institute of sore losers? That statistic is just an excuse to make the quitters feel better. Think of all the ways the statistic could be wrong…how many traders trade for a month and give up for example? If you believe that you are going to lose, then you are already there my friend, and by trading you are just going through the motions of clarifying your fatalistic assumptions. I offer no solutions, only because the problem needs to be addressed on an individual basis.

Its happened to me several times over the years, where I started to believe the market was against everything I did, where I swore blind that the market was being manipulated, every tick drove me nuts at the belief these fucks were stealing my money, and each thought was infested with nagging doubts that even bled into my normal everyday thought processes-I had been busted wide open… but if I was so utterly convinced of a rigged game, then why was I continuing to trade, more so than ever??? Why was I doubling up and inflicting more pain, throwing my money away on certified losers? Was it the case that subconsciously I wanted to lose quicker, to confirm my theories, just so I could get the nightmare over and done with for good?

The answer is nearly impossible to accept, and I still have to answer it every now an again, but the mental capitulation required to go from positive market participant to burnt-out fool with his asshole wide open, is all too possible for many. I’ve been there, and despised myself for it. It feels like being gang raped, dirty, squalid, compromised on such a fundamental level of masculinity…but you have to ask yourself, is there a part of you that wants to feel like this? Think hard about that the next time you toy with the idea of adjusting a stoploss or add to a position. Secretly, losers know why they have lost, but they wont face it, they don’t have it in them.

Trading is not a nice activity for the mind to be involved in, the mind will tell you time and again, but seriously, you wont pay any heed. The amount of stoical discipline and bodily regulation required is something the subconscious mind will balk at, but the slither of consciousness we occupy will stupidly embrace, fanatically.

I remember a few years back I was leveraging up and on a winning run, one of very few, and went to bed that night with all sorts of hormones and glucocorticoids pumping through my veins, physically I was tired, but in my bullshit state of mind I though I was a legend. I had a dream that night that I was totally naked, covered in faeces and being trampled on by angry horses…as one would expect, I woke up the next morning and thought, WTF!, I was properly stunned.

That morning I traded from the London open to the NY close only drinking tea and smoking cigarettes and I totally destroyed my account all bar a few hundred quid. I had utterly clusterfucked myself, again. Hero to zero, for no other reason than I couldn’t muster the mental strength to control my emotions…my mind had robbed me blind in a way, it had had enough of the pain, and couldn’t generate the hormones to make me my usual self; I had exceeded my limits, it didn’t want to meet mr market anymore and left me feeling like a dirty slut in the process. A fundamental part of me flipped the switch on my endeavours(hence the term “don’t over trade” is not a statistical warning, it’s a physiological one.)

People let the market take their money, they let a tooth ache turn into a brain tumour, sit back and suffer the agony, the excruciating pain of watching the market gorge on their funds, tick by tick, the more it takes, the more they feel the urge to give, until it just becomes second nature, and they can tap into that losing feeling in an instant, throwing they‘re money away just to fuck themselves up. They become addicted to that feeling of utter despair, emptiness, being covered is shit…rather than making the snap appointment with the dentist for an extraction, they lose all their teeth to gum disease. And rather than the delaying of pleasure, they take a few pips, think they are Bruce Kovner and re- mortgage the house for the next bout of martingale madness. (The urge to believe your own superiority is criminal) Know the nature of the beast, its not the market.

Sat, 01/08/2011 - 14:16 | Link to Comment Burnsy
Burnsy's picture

PONZ:

Evidently you equate trading with day trading. But plenty of hedge fund managers started out as shorter term traders (not necessarily intraday) / swing traders and evolved to longer term traders / investors as their lines increased. Here's one name that is relevant not only because he has had great success as a shorter term trader, but also because he credits technical analysis as a very important part of his success(has been quoted saying his success is owed half to TA and half to FA): Paul Tudor Jones. He is worth a few hundred mill at least.

Your claims are not wrong in that most traders lose money, but that does'nt make it impossible. I agree with you that most people stand to lose money short term trading. If this provokes people, too bad. It's the truth. However, some people are able to to it. It takes a lot of skill, and for most of the successful people, plenty of practice before getting above the breakeven point. One of my colleagues in my current job has basically been a swing trader (although he certainly does not shy saway from holding winners for long periods of time) for over 15 years, keeps an eye on technicals as one of his tools, and has never had a losing year (but plenty of near flats). He probably has a CAGR of about 14-15% over the entire period. This is what I aspire to achieve, 12-15% p.a, that is the shit that makes you rich over time. Very few are able to exceed this return over time.

Patient compounding is the road to success, whether long or short term. There are plenty of ways to skin a cat. fundamentals, technicals, discretionary, systematic, etc. Avoiding big losses is the key, that means tight risk management. And many daytraders blow up precisely because they cannot manage risk, often because of excess leverage.

Good luck trading,

Burnsy

Sat, 01/08/2011 - 19:58 | Link to Comment technovelist
technovelist's picture

One of my colleagues in my current job has basically been a swing trader (although he certainly does not shy saway from holding winners for long periods of time) for over 15 years, keeps an eye on technicals as one of his tools, and has never had a losing year (but plenty of near flats). He probably has a CAGR of about 14-15% over the entire period. This is what I aspire to achieve, 12-15% p.a, that is the shit that makes you rich over time. Very few are able to exceed this return over time.

I have a return of 11%+ CAGR for the last ten years in my retirement account, with no leverage and essentially no costs. What's my secret? Buy and hold... mostly gold.

Sat, 01/08/2011 - 15:04 | Link to Comment trx
trx's picture

Here in Scandinavia, the stock exchanges have something they call "Lotto Stocks". High volatility stocks, perfect for day traders to play around with on a day-to-day basis, and at the same time they're adding both volume and liquidity.

It's like those slot machines; programmed to give you a - not big, but substantial - payout at first. Just enough to get you hooked so they can drain you for everything you got.

Of course, most of the day traders lose money in the long run.

When a really big deal is going down, they're simply "run over" or "blocked" by the major brokers/banks, who provides most day traders with their leveraged funding.

It' a nice little dirty scheeme that's worked for years.

However, at the moment many of these major players are being stepped on by a few HFT geeks, and are screaming bloody murder....

 

"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed."

(Benjamin Franklin)

 

 

Oh, by the way, I've just started to use Mathematica and is having great fun with it. However, I still hasn't figured out what to use it for....it's almost like an advanced verion of PowerPoint.....

 

Sat, 01/08/2011 - 16:36 | Link to Comment jm
jm's picture

Mathematica:

It is terrific for figuring things out.  Great for symbolic computation; it has a "factor" function that clears through jungles in a flash.  For algebra and group representations, the graphing capabilities are the best out there.  Dynamics are great, too.

Numerical methods are terrific.  There are a lot of modules ready for use, but I coded some routines like cubic splines and root finder algos.  Some of the canned stuff has some limitations in applied usage.  For example, it has a good interpolating function method (in terms of agreement in testing), but it can be kinda black box:  I'm not sure which interpolation method it uses all the time.  The output is good, but it can make technical documentation a challenge.  Of course, you can specify "Legendre polynomials" and such as needed. 

There are a lot of notebooks you can download free.

Sun, 01/09/2011 - 12:50 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

Not to mention that the group on google has loads of information and examples :

http://groups.google.com/group/comp.soft-sys.math.mathematica?hl=en

Sat, 01/08/2011 - 10:09 | Link to Comment RobotTrader
RobotTrader's picture

The fallacies of mathematical models.

No better example than the endless numbers of sports handicappers who are "data hounds", guys who have the most exotic stat models to try and predict which team is going to be the best against the spread.

Just last week, there were 3 games where the stat guys got completely blown out where a team missed or beat the spread by over 25 points!!  Even the Vegas handicappers were destroyed on these games.

No different in trying to figure out where the market is going to go, or whether or not AAPL is overvalued or not.

The only thing that matters is what the big money is buying or selling.  If the big money believes in the v-shaped recovery hype and decide that stocks are much better than bonds, then there is no stopping the Dow from reaching 15,000, even if the unemployment rate stays at 9% for the next 5 years.

And if hundreds of mutual funds and hedge funds decide that AAPL's P/E ratio of 15 is too low and it deserves to be 30, then there is no stopping AAPL from going to $500/share.

Or let's say the economy starts recovering and the stats start improving each week.  If the big money thinks stocks are too expensive and they want to start distributing stocks to the retail investor, and then initiate a bear raid on the market so they can buy back stocks on sale after 9 months, then it is entirely possible to see the market go down 30% - 40% while the unemployment rate improves from 9% to 6%.

Lesson learned:

Follow the PigMen and follow the big money.

Any of you guys want to learn more, then Jim Puplava has an excellent interview with Quint Tatro on how this works:

http://www.netcastdaily.com/broadcast/fsn2010-1229-1.mp3

Sat, 01/08/2011 - 10:14 | Link to Comment TheGreatPonzi
TheGreatPonzi's picture

Interesting and I mostly agree, except on one thing: did the pigmen allowed or saw the 2008 events coming? Turns out they have been screwed like the rest, except very few insiders.

Sat, 01/08/2011 - 10:22 | Link to Comment RobotTrader
RobotTrader's picture

You are correct.  2008 was an outlier event.  However, tons of technical guys have gone back to review what happened, and everyone saw the retail and bank stocks breaking down before the overall tape collapsed.

I assure you, that everyone still has deep scars from that event, and nobody, I mean nobody, is going to miss out on catching the next bear market drop.

I know a lot of guys who have been playing on the long side, who are now starting to itch at the chance to make a quick killing by shorting the next big drop.

So it is possible that the next bear market phase is going to be a huge and fast drop, because everybody is going to try to profit from it.

Sat, 01/08/2011 - 11:08 | Link to Comment jm
jm's picture

Hey Robo.  Those outliers, while not common, certainly aren't rare.  You never know when they are coming.  Often they exhibit clustering effects.  There could be many.

But in general I agree with you.  Risk management models depends on the same assumptions needed to make relative trading systems work.  Both you trading and your risk management can melt down at the same time. 

BTFD?  Sure, I guess.  It depends on what you buy.

 

Sat, 01/08/2011 - 11:23 | Link to Comment sheep92
sheep92's picture

Do you really believe that nobody is going to miss out on the next bear market drop cause they are scarred from the last one?

All it really means is that if something 'happens' then the market is going to go no bid just like May.

My bet is that the next 'correction' looks  a lot like the flash crash except that it doesn't bounce intraday.

Another likelihood is that it starts outside the US so that the exits doors are firmly closed before anyone gets to pull the trigger.

There are strategies that have been working continuously over the last year or two that are well known, have fantastic historical sharps, and are probably overcrowded at the moment.

Two of my favorites to watch are short VXX and buy the friday close sell on monday.

With the huge contango in vix futures vxx bleeds a lot of money every day and has been a killer trade as both vols have come in and the roll yield is enormous (right now 10% a month!!)

If we do get a violent downturn it will come from the stuff that everyone is looking at.  We spent 2 years watching housing melt down and people denied it would have an effect because price hadn't comfirmed the the problem.  And then once it started to happen it was all over in a month or two.

We are watching the euro crisis unfold right before our eyes and everyone seems to think they will have time to get out just before the crisis point.  Even though last week we saw the SNB throw portugal and ireland under the bus.  Just like with Lehman and Bear the companies were screwed long before they were taken down.  Same goes for the weak sovereigns.

I do much what you do in terms of waiting for opportunity and last year was a good one for that. 

The opportunity here looks like its from the short side.  Its just going to be psychological difficult to trade cause you might be wrong for a long time before you get paid, just like any long vol strategy.  The trick is to get in late enough so you don't have to endure too much pain before the payoff. 

 

 

 

 

Sat, 01/08/2011 - 11:40 | Link to Comment Protonrick
Protonrick's picture

No, I respectfully disagree.

There are too many traders too anxious to leap headlong into the next bear trap.

And there will be one.

They will jump headfirst into the depths.  They will get overextended in their greed,  they will get squeezed when they do not see that the recovery bounce is a new wave up.

I will be there to thank them for the buy opp.

JMVHO. 

Sat, 01/08/2011 - 13:56 | Link to Comment Printfaster
Printfaster's picture

Robo:

So it is possible that the next bear market phase is going to be a huge and fast drop, because everybody is going to try to profit from it.

On the contrary, it seems to me with so many lined up on the backside, the drop will be fast, but the recovery will be even faster as the money in shorts gets killed by the bankers.

Talk about a throw-over.  The next drop will the mother of all throw overs and the bankers will be laughing all the way to the bank.

Sat, 01/08/2011 - 14:35 | Link to Comment Diogenes
Diogenes's picture

The big banks who caused the 2008 crash saw it coming. Not only did they see it coming, when they were selling morgage backed securities out the front door, they were shorting them out the back door, and buying insurance against them blowing up at the same time. I thought everyone knew this, at least regular readers of this board should know it by now.

Sat, 01/08/2011 - 14:16 | Link to Comment ExploitTheMarket
ExploitTheMarket's picture

Back when I worked in the casino the math geeks would come in on a regular basis and try to beat the house...sometimes (rarely) they did--back in the day when card counting used to work, but where it was real funny was on the dice tables (ever see anyone try to "count" dice?).... I think it was Jim Rogers who said that a degree in philosophy is far more valuable than a degree in finance or math when it comes to investing/trading (and I agree).... Yes, we do have robots/HFT making trading decisions in the short term, but human action/human decisionmaking relatively more important in my view (over the long term) and HFT provides opportunities that can be exploited. But he bottom line is, as RT says, "follow the money"

Sat, 01/08/2011 - 14:31 | Link to Comment jm
jm's picture

I still don't understand why math geeks have such a bad wrap other than some fiction.

The research desk always takes a backseat to the trading desk.  Those guys are the ones with the poker mentality.  They are encouraged to take risk and the lucky ones that don't blow up move up the ladder. The rest are wormfood.

The research desk plays chess.  There are some ego-centric bastards in there, but most of this is just insecurity and posturing to cover for it.  It takes a while for them to toughen up and get real confidence in themselves.

Sat, 01/08/2011 - 16:17 | Link to Comment ExploitTheMarket
ExploitTheMarket's picture

Math gets applied too much (or the wrong kind of mathematics--like the normal dist. to finance for example) to areas where it is inappropriate to do so, the results are often very negative.... The methods of the natural sciences and hard sciences do not always belong in the social sciences for instance, there are of course research methodologies that are appropriate for each context....

Sat, 01/08/2011 - 16:31 | Link to Comment trx
trx's picture

So, where is it?   The money?

Sat, 01/08/2011 - 10:13 | Link to Comment eigenvalue
eigenvalue's picture

Mathematics is in fact using complicated languages to state simple facts. For example the simple fact behind  the contraction mapping theorem is when you put a smaller map of London on a larger one, there must be one point that is fixed.

Sat, 01/08/2011 - 11:10 | Link to Comment jm
jm's picture

I would say that mathematics is not a complicated language, but rather a mercilessly logical language that requires some training to handle.

When you learn the lingo, it is more strong, vivid, and eloquent than any other form of human expression ever devised.

Sat, 01/08/2011 - 11:38 | Link to Comment Orly
Orly's picture

You must not admire Mozart at all...

Sat, 01/08/2011 - 11:57 | Link to Comment jm
jm's picture

Mozart didn't explore his demons like JS Bach did.

Sat, 01/08/2011 - 12:21 | Link to Comment Orly
Orly's picture

One would say that he was too busy expressing to waste time exploring.

:D

Sun, 01/09/2011 - 09:52 | Link to Comment jm
jm's picture

Bach's dialogue between angels and men:

http://www.youtube.com/watch?v=s5sRKe4WO8U&feature=related

Bach wrote this after his first wife died:

http://www.youtube.com/watch?v=H9V0Pr0aTi4&feature=related

 

And try this exploration:

http://www.youtube.com/watch?v=nvG0qKR6nG8&feature=related

 

Sun, 01/09/2011 - 12:52 | Link to Comment Dollar Bill Hiccup
Dollar Bill Hiccup's picture

Not during sex ...

Sat, 01/08/2011 - 10:19 | Link to Comment RobotTrader
RobotTrader's picture

Oh, by the way, very few daytraders make any money.

Intermediate term swing traders can easily make money, as long as they stay with the trend, up or down.

If fact, even in a choppy market, swing traders can make good money, but they key is to be out of the market most of the time, and only buy stocks when the market is severely oversold and due for a decent sized bounce.  You can make 15% - 20% about 3 or 4 times a year by patiently waiting for these setups.

But like sports bettors, very few stock traders have the discipline to stay out of the game most of the time and wait for the fat pitches.

I'm in 75% cash right now, since I already scored big on the huge run we had last year.  So I'm just sitting around waiting for the next "fat pitch".

The one sector I am eyeballing right now that has received no attention, has chronically underperformed, and often does well during corrective market phases are the drug and medical equipment stocks.  Names like ABT, MDT, etc., which have done nothing the last 10 years.

Sat, 01/08/2011 - 11:14 | Link to Comment jm
jm's picture

But like sports bettors, very few stock traders have the discipline to stay out of the game most of the time and wait for the fat pitches.

 

Bingo.  It is ultimately psychological.  Sell side and even dealers play mind games to get action going.

Sat, 01/08/2011 - 11:50 | Link to Comment topcallingtroll
topcallingtroll's picture

There are some sports betters who consistently make money.  The way to do it is make extreme bets with high odds and be patient.  Fat tail events are mispriced in sports gambling because the market makers in sports don't have the sophistication of financial market makers.  Now if sports market makers would only start buying and selling options the games would get really fun.  We could watch the options on the small screen while we watched the game on the big screen. 

Sat, 01/08/2011 - 10:45 | Link to Comment bugs_
bugs_'s picture

Math is hard.

Sat, 01/08/2011 - 10:52 | Link to Comment Misean
Misean's picture

Mathematics is a language with it's own internal formalities that make it precise, but like any language it can talk fantasies just as precisely as realities...perhaps more so.

Sat, 01/08/2011 - 10:53 | Link to Comment RobotTrader
RobotTrader's picture

Here are a couple of examples of how "math" is unecessary to understand what is happening.

Somebody big bought these stocks yesterday, based on the amount of buying volume and the large price spread.  Somebody knows something about these two.....

Sat, 01/08/2011 - 11:34 | Link to Comment sheep92
sheep92's picture

How would you determine if the first one was a 'technical' breakout which brought in the money from some 'inside' information.

And how would a forced short cover look for the second one relative to  'inside' information.

Have you ever done any sort of modeling on these patterns to determine if they have a forward return payoff or is this just off the cuff stuff?

Sat, 01/08/2011 - 11:10 | Link to Comment Mark Medinnus
Mark Medinnus's picture

Your meaning too often lies hidden within a hedgerow of words.  For example, take the last sentence in your first paragraph: 

Further, a mindset wholly engrossed in the mathematical development of an axiom base can take one far from practical relevance. 

True, but how tortured.  Reaching beyond the rhetorical barbs, your meaning is more easily expressed:

The use of mathematical models, then, by the successful trader, has limitations. 

In my opinion, JM, your post committed the worst of journalistic errors by requiring the reader to do the author's work of re-writing. 

    

Sat, 01/08/2011 - 11:20 | Link to Comment jm
jm's picture

I appreciate the criticism.  I can only offer in defense that the statement applies to far more than mathematics.  It applies to any "system" of thinking:  reasoning that depends on definitions and logical development of them is an axiom system.  Definitions in real life seldom have the exactness needed.  I was going for some readers to grasp Godel's ideas here.

This applies to technical analysis, Austrian economics, anything.  Some systems are more consistent than others.  IT doens't necessaryily makes them better than others.

 

 

Sat, 01/08/2011 - 12:16 | Link to Comment Mark Medinnus
Mark Medinnus's picture

Forgive me, JM, if my comments were harsh.  You had a Herculean task before you and, judging by the favorable responses, the ZH readership appreciated the depth of your insights. 

Having the flu today, I coughed through my criticism.  Like my mom always taught me, I should have covered my mouth. 

Humbly (and sniffly), Mark

Sat, 01/08/2011 - 12:40 | Link to Comment jm
jm's picture

I'm just trying like everyone else.  I have a head cold too.

Sat, 01/08/2011 - 11:32 | Link to Comment Diogenes
Diogenes's picture

"Further, a mindset wholly engrossed in the mathematical development of an axiom base can take one far from practical relevance. "

I thought it meant if you think about math too long you can go nuts. This whole article is a good example.

Sat, 01/08/2011 - 11:41 | Link to Comment Variance Doc
Variance Doc's picture

Exactly.  Another example is the use of technical terms such as "illiquidity" and "non-stationarity" without defining the terms, and how they relate to "trades".  These terms have a precise meaning in stochastic analysis (stationarity) and risk management/financial engineering (illiquidity), and it is not always logical to use them together.  Very poor article.

By the way, JvN was a "superstar" in mathematics.  Yes, he was THAT good.  JM claims "There was nothing superhuman about him..." and that is simply not true.  I trained under and worked with mathematicians of JnV's generation and every one of them agreed that his mind was NOT ordinary, but extraordinary!

An example, told to me by a famous mathematician, is one day George Dantzig (linear programming fame) met with JvN and preceded to talk about linear programming problems.  Dantzig, who was a bit of a hot shot at the time, proposed a problem to JvN, who proceeded to prove the hypothesis in about two minutes and tell Dantzig of all the new possible directions.  It took Dantzig years to prove the hypothesis.  Danzig was blown away by the prowess of JvN.

Sat, 01/08/2011 - 12:00 | Link to Comment topcallingtroll
topcallingtroll's picture

There might be a relationship between stationary and illiquidity.  Perhaps certain events are stationary only with a given amount of liquidity.  Housing might be one of those.  I don't see any hope of regression to the mean from five years ago until we return to the highly liquid, anything goes financing of five years ago.  It's highly likely that loan volume and ease of financing will never return to previous levels, in such case I would not expect regression to the mean in inflation adjusted housing prices to the previous high mean.  The new normal in housing may turn out to be the old normal of the seventies.  liquidity changes might have been the event that changed housing from it's high stationary mean of the early 200's to another lower stationary mean of the seventies, hopefully not thirties!

Sat, 01/08/2011 - 12:13 | Link to Comment jm
jm's picture

I gave you a working definition which we can spar over:

illiquidity = nonstationarity = you don't know what it is worth.

Von Neumann himself stated he didn't have the creative powers of some of his colleagues.  what he did have, as you mentioned, is a powerful capacity for calculation, and the instinct to stay close to application.  To his credit.  I'm told (as you were told things) he once stumbled into a theta function doing a sample problem in one of his classes.  instaed of erasing the board and starting over with a different example, he plowed on through.  A demon of perseverence.  

Was von Neumann terrific?  Of course.

You want true overwordly genius?  Ramanujan.

Sat, 01/08/2011 - 11:04 | Link to Comment AnAnonymous
AnAnonymous's picture

My, my, my... Some traders must be feeling the pressure of GAI on their jobs...

Sat, 01/08/2011 - 11:17 | Link to Comment max2205
max2205's picture

Every second the market changes. Try not to read too much. If your not a moron you usually have a good trade. Opinions of others dilute your own.

Sat, 01/08/2011 - 11:25 | Link to Comment jm
jm's picture

True you need a strong hand.  If the market always changes, shouldn't you be open and receptive to weight new ideas as they come?

This coming from a guy that admittedly thinks too much about everything.

Sat, 01/08/2011 - 13:31 | Link to Comment Al Huxley
Al Huxley's picture

I think what is needed is a working model, and then consider other input, but without breaking your adherence to the model.  In my experience, the best working models are relatively simple and roughly amount to doing what RobotTrader describes - ie staying onside with the trend as demonstrated  by the market.  The biggest challenge in this regard is ignoring all the noise that comes from 'experts' explaining why this or that is overbought, or oversold, or why the 'fundamentals' dictate a change in market direction.

So yes, weighing new ideas is a good idea, but maybe with a sceptical eye until you've proven that they work for you.

Sat, 01/08/2011 - 23:24 | Link to Comment jm
jm's picture

One question.  If you knew that anytime of the day on any day you could lose 25% of NAV would you trade differently than you are now (assuming that you dont' think that way know, which you may)?

That is the issue to me.

We all pretty much play for positive carry.  I propose that to really handle the issue is not to take long-short positions at somewhat high frequency.  Rather you need meaninful diversification. 

Some trades you structure to receive fixed and some you structure to receive float.  The float is risk-freeish and manages jumps in sample paths.  What I would call naive diversication smooths NAV relative to noise.  The kind of diversification I'm talking about smooths NAV relative to nonstationarity.

Sat, 01/08/2011 - 11:43 | Link to Comment topcallingtroll
topcallingtroll's picture

Most successful swing trading depends on volatility of events being stationary versus non stationary, otherwise regression to the mean would not occur.  Look at Robo's post earlier.  When one takes a position at the extreme one needs to be very careful to look for evidence disconfirming that this deviation is a stationary event, meaning that eventual regression will occur.  According to the scientific method one only looks for evidence against the event being stationary.  Confirmatory evidence is not real scientific evidence.  One must always look not for confirmation the event is stationary but disconfirmation.  Most people can't swing trade because they need reassurance and naturally tend to look for evidence they are right versus evidence that they are wrong.  A good trader spends most of his time looking for evidence that his hypothesis is wrong.  Contrary trading strategies do generate a small positive alpha over time, but it is very small on average and there is little evidence that people who generate large alphas in a given time period have done it in a non-random way according to Taleb.   Large alphas over time are generally luck.  There are very few people who generate large alphas over twenty years.  Out of the millions who trade chance alone dictates that perhaps one in a million can generate a huge twenty year alpha.  However a small alpha is better than no alpha plus it's just downright fun to swing trade.  One must be patient and not trade very much, but it is simple to follow bollinger bands, but then use your intuition for the non-linear stuff that can't be mathematically modeled.

Sat, 01/08/2011 - 12:04 | Link to Comment Jerry Maguire
Jerry Maguire's picture

Math is all over the market.  Especially "game theory".  This is largely the subject of this post:

http://strikelawyer.wordpress.com/2010/12/11/money-ii/

Sat, 01/08/2011 - 12:06 | Link to Comment myptofvu
myptofvu's picture

I just read this and now my head hurts

Sat, 01/08/2011 - 12:17 | Link to Comment Alex Kintner
Alex Kintner's picture

It Chaos bitchez. If your system ain't working, you're not applying enough chaos to your equations. Well, chaos plus brass chones. 

Sat, 01/08/2011 - 12:21 | Link to Comment Id fight Gandhi
Id fight Gandhi's picture

All the math. All the knowledge means nothing when the fed and its buddies can print, manipulate and fudge all the statistics whenever they desire.

I've poured over formulas, stats and trends fod years. These past 3 years have been a rigged casino. Nothing matters than the fantasy world of printed money and bailouts.

Sat, 01/08/2011 - 12:25 | Link to Comment jm
jm's picture

With insider information, anyone can beat the market.

Sat, 01/08/2011 - 12:24 | Link to Comment aleph0
aleph0's picture

There are no "traders" IMO, only Insiders and Outsiders.

As the late and great George Carlin once said : It's Club, and we ain't in it .

 

Sat, 01/08/2011 - 17:00 | Link to Comment jeffgroove102
jeffgroove102's picture

Gotta love carlin, I was watching one of his vids the other night.

Sat, 01/08/2011 - 12:40 | Link to Comment blindman
blindman's picture

all models must fail when they are based on rules that

are routinely bypassed.  a model that has fraud at its

basis might be useful but that would be impossible

to build on.  so, there ya go or   just get out as seems the

prevailing sentiment.  that or infinite hedging and execution

of fraud to capture influence , protection and spoils.

and there is no business like show business , no business

i know .... good morning 

.

Tom Waits - Blind Love

http://www.youtube.com/watch?v=UZGIK990m-A

.

" the streets turnin' blue, the dogs are barkin'

and the night has come."  t.w.

Sat, 01/08/2011 - 12:40 | Link to Comment M.B. Drapier
M.B. Drapier's picture

considered the father of machine computing

There's always been hostile muttering about how much von Neumann contributed to the EDVAC, beyond getting his name on the report. Even if you take Eckert's version with a pinch of salt, calling von Neumann the father of machine computing would be a huge stretch.

Johnny von Neumann was terrible at poker.

By contrast, Claude Shannon was very good at roulette, using a computer even. :)

Sat, 01/08/2011 - 12:45 | Link to Comment jm
jm's picture

Touche.  I didn't know of these grumbles.

 

Sat, 01/08/2011 - 14:23 | Link to Comment M.B. Drapier
M.B. Drapier's picture

No problem. I wasn't trying to carp at you, just to hold back the spread of the von Neumann story.

Sat, 01/08/2011 - 12:55 | Link to Comment Tense INDIAN
Tense INDIAN's picture

i thought that technical Analysis is useless.....but when i tool a closer look i found that its all in the technicals.....its not that precise ..but still playing the markets without technical analysis is suicide...i think for 70% of the time it can provide right entry and exit points ....if u r good at it........i have been learning Elliot wave as a Primary tool and see that the markets have been indeed following Fibonacci relations....

 

anyway i had been reading http://www.informedtrades.com/505742-50-things-you-should-know-about-elliott-wave.html........

 

i thought this was the easiest rule to apply.......check out 5.6 

 

5.6 the unextended fifth wave time rule

if wave 5 is not extended, timewise the start of wave 4 divides the whole impulse wave into 38 and 62 distance. 

 

now i know wave 3 in the INDIAN markets (NIFTY) was indeed extended and stretched out.....so wave 5 cannot be extended.......so according to that the wave 5 must END on 23-24 Jan.......i have also got confluence at that same point.....when applying the same rule to the 5 sub waves in the 5th wave ......the same end point was arrived..............if someone had been studying this ....a little help

.

 

 

Sat, 01/08/2011 - 12:56 | Link to Comment RobotTrader
RobotTrader's picture

Regarding high volume breakouts on RBN and LLL mentioned above:

After watching the tape for many years, moves like this have a 75% success rate.  I've seen these types of moves many times, and failed to act on it and missed out on huge runs on specific stocks.

Here is an example of one I saw right in front of my eyes, and failed to act:

CAT in July 2009.

 

That stock ran huge and remains pinned at $95 as we speak.

LLL is coming off an extended low base.  RBN is near the middle of its 3-year trading range, so neither are really "overextended".

Regarding overextensions:

The times I have seen these big volume breakout moves fail is near the end of a huge run, which resulted in an "exhaustion gap" that eventually fell apart.  Or often near the end of a bull market run where massive short covering events are occurring.  That's why there is a 30% chance of these setups failing.

Sat, 01/08/2011 - 13:27 | Link to Comment spekulatn
spekulatn's picture

Mr. Niederhoffer's website has a nice post on this subject.

"It's the Switches."

http://www.dailyspeculations.com/wordpress/?p=5727

Sat, 01/08/2011 - 14:13 | Link to Comment KickIce
KickIce's picture

Math deal with fixes values with no emotion involved.  (ok frustration is often involved)

Investing deals with ever changing asset values where people may make purchases based on emotion or hype, and values can even differ from country to country.  You would be hard pressed to write a formula for human emotion.

Sat, 01/08/2011 - 14:56 | Link to Comment Charles Wilson
Charles Wilson's picture

Propositions are lures for feeling

 

-  A N Whitehead

Sun, 01/09/2011 - 01:10 | Link to Comment nachtliche
nachtliche's picture

Everyone knows PI is the secret to the stock market! That was such a great movie, and I'm such an intellectual for understanding it. It's so smart it's like the key to everything.

Sun, 01/09/2011 - 10:06 | Link to Comment Natural
Natural's picture

Ken Griffin
John Arnold
I assume Blair Hull is close
Alan Harry supposedly has made 250 mil
Och ziff guys
The list goes on and on....

Sun, 01/09/2011 - 13:37 | Link to Comment jm
jm's picture

The question to me is whether or not these guys make the cash consistently through alpha or do they throw a knock-out punch once in a while and do snowplay the rest of the time.  And then their legend or reputation makes it easy for them to bring in more money => AUM growth.

Sun, 01/09/2011 - 10:05 | Link to Comment Natural
Natural's picture

Ken Griffin
John Arnold
I assume Blair Hull is close
Alan Harry supposedly has made 250 mil
Och ziff guys
The list goes on and on....

Do NOT follow this link or you will be banned from the site!