This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com
In light of recent events, this is worth a read.
This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com
January 29th, 2008 at 12:32 pm
I immediately thought of Nassim’s latest book, The Black Swan, after reading a snippet from the Ehlers article: “If the prices are normalized to fall within the range from –1 to +1 and subjected to the Fisher Transform, the extreme price movements are relatively rare events. This means the turning points can be clearly and unambiguously identified.”
You already know how I feel about those who put too much faith in their conception of “normal” or “proper”.
January 29th, 2008 at 1:15 pm
what i do like about ehlers work (and he even admits that not all of his indicators are profitable) is that he is trying to come up with new ways of evaluating the information…i also believe that for day traders then those extreme price movements should be rare unless it is precipitated by some news event - in that case, all TA goes out the window
January 29th, 2008 at 1:16 pm
btw, i don’t mean to imply that i actually understand all of this…most of the math is way over my head, but i find it interesting…thankfully, many of the charting packages have programmers that can understand his work, and hopefully, code it
January 30th, 2008 at 9:19 am
The math isn’t as important as the fundamental idea you hit on. And it is soooo apropos for what is going on in the subprime-related derivatives markets. And in fact another very insightful article was just pixelled over at MarketWatch that expresses it much more coherently than I ever could…I’ve been bitching about this for months now, to a chorus of yawns. Everyone is so in love with their little abstractions these days that the elegance and the mystery and the spectacle of them have superceded what’s most important: the utility. It’s really just a big orgy of egos. The article is only slightly off-topic, but it’s interesting.
http://www.marketwatch.com/news/story/america-land-bubbles-next-pop/story.aspx?guid=60CE4669-6814-4A48-A555-BE998EC6FC58
January 30th, 2008 at 9:50 am
“Assuming normality means never having to say you don’t have enough data.”
The real truth of market return distributions is somewhere closer to Chebyshev than most people think. Take your “normal” estimate of a three-plus sigma event, times 3 or 4; take your “normal” estimate of a less-than-half sigma event, times 1.5.
http://www.billakanodoodahs.com/2006/11/on-golden-swans/
I think of Taleb as “Captain Obvious.” Unfortunately too much mathematical work is based on standardized distributions while ignoring the inconvenient non-robustness of the underlying assumptions.
January 30th, 2008 at 7:19 pm
Blah blah blah.
It’s obvious that Captain Obvious has made a lot more money than I have. A LOT more.
Also would any of these books teach me more about these golden swans.
http://www.amazon.com/Golden-Swan-Phylis-Warady/dp/141995069X/ref=sr_1_1?ie=UTF8&s=books&qid=1201738658&sr=8-1
http://www.amazon.com/The-Golden-Swan/dp/B000QMO1CA/ref=sr_1_2?ie=UTF8&s=dmusic&qid=1201738658&sr=8-2
January 31st, 2008 at 12:42 am
LP: i don’t know, but it might teach us the value of a pre-nup…here’s a quote from the review
However, marrying a penniless waif handpicked by his irate sire comes as an icy shock.
No SHIT! and her getting half came as a bigger shock!
January 31st, 2008 at 5:52 am
Bill: You’re monicker for Taleb may be obvious to you. It was also obvious for several *very large* hedge funds out there using their own proprietary mechanical models. Look at their returns over the last three years. Many of them are now insolvent. Their math was elegant, their theories compelling, but at the end of the day it was all just plain wrong. And yet the quants keep beating their little drums. I’m sure you’ll roll your eyes at this, but there it is.
If I could do a little armchair psychoanalysis, here is what I would say. These people are in love with how smart they think they are. They develop beautiful mathematical models which are really just metaphorical representations of borrowed theories — there is fierce debate even within the scientific community about whether some of these theories can truly explain market behavior. (We all know what these theories are.)
I also think that, on a grand scale, these theories are being modified to make the results more attractive. There is a certain curve-fitting of ideas, if you will, to conform to the desired outcome. Much, I would say, in the same way that the social sciences have borrowed their methodologies from the physical sciences over the last one hundred years and particularly in the last forty. And so what you end up with is a semi-empirical process that is inductive when it needs to be deductive and vice versa. So over longer time horizons, I really don’t think these quantitative trading and portfolio optimization models are any less immune to blow-ups than, say, a daytrader of the HPT variety!
Quantitative finance is a new and burgeoning field. Math and finance PhDs are now like MBAs — a dime a dozen. Even rocket scientists are getting into the business. There are still many problems to be solved. Some of them, perhaps many of them, will never find a workable solution, no matter what scientific paradigm or theory you throw at them. At the end of the day, an empirical approach is necessary, but the fetishisms that are emerging are simply no good for the markets and in fact may be contributing to this endless series of highly leveraged bubbles we seem to have gotten ourselves into.
That said, I have to say that there are opportunities for me to become very rich off of these bubbles. I’m working on it, but until then my moral side thinks this is not very good for the project of modernity. In fact, it could be a catalyst for its undoing. There, my doom-and-gloom scenario is out in the open. But before you laugh, read your history.
I digress. What I wanted to saw about three or four paragraphs ago was this:
Unfortunately, I have to say that your cynicism regarding Taleb is suspect.
January 31st, 2008 at 12:01 pm
jay: i’m not sure that many of these wizards are really trying to explain market behavior…however, i have a keen interest in many of these indicators…i’ve actually found a few that are far better than the traditional ones…in a few years, these may actually be the norm
in particular i read a book by william blau that opened my eyes…i’m looking into ehler’s stuff, and have found a few things that i think are useful…the idea is fairly simple…is there a way to reduce the lag in your normal canned indicators…ehler and blau are not presenting trading systems, but ideas to possibly change your thought process…if nothing else i find it interesting…a few ideas are actually making me a little money, but who knows how long that will last
January 31st, 2008 at 3:06 pm
Hey man, if you want more Ehlers, check this out if you haven’t already:
http://tadoc.org/
Ehlers is a rocket scientist who makes indicators that don’t work. I’m not saying his ideas aren’t valuable. Just that his indicators aren’t valuable. But Blau is a real trader. I personally like his ergodic oscillator. I also like the material Bill Williams has come up with. TADOC is a pretty good resource if you’re interested in browsing. It even has some limited stuff about Ehlers’ MESA material.
January 31st, 2008 at 3:30 pm
jay: thanks for the link…i’m a fan of bill williams too
i’ve used the MESA before, and think its valuable…i’m actually using it now in a different way, and i have my team of rocket scientists trying to determine my top secret indicator’s validity
its funny, but i currently use two of ehler’s indicators (plus one that is being tested)…the ones i’m using seem to do what i want
no more knocking rocket scientists or prospectus will photo shop u with a chicken!
January 31st, 2008 at 3:57 pm
Ah hell. My little secret’s out. Pro might as well. Just be sure you got a chicken that doesn’t mind a bunch of perverts watching so I don’t get pecked in my special place.
January 31st, 2008 at 5:06 pm
Unlike Bill I do believe in black swans. Not that not believing in it is bad either. (that’s the statesman in me). The problem is that I’m torn between two opposing philosophies. On one hand make money quickly and on the other hand make money slowly. Now the common misconception is that you can’t make money quickly without blowing up and if you make money slowly, you won’t blow up. And I not saying that either one is right or wrong. It’s how you design your risk, rules and the system.
Quant or no quant, I consider quantery as being similar charting. There is a right way and a wrong way to do it. Much like self proclaimed great chartists, the quants pop their collars too. We knock chartist for coming out with some very subject processes but yet we think that if we are presented with a bunch of number in excel, they will represent the truth. It’s human nature to find patterns. The mind is geared towards patterns. Maybe the best system is to look for the exception. They usually cost very little to bet on and pay out a lot even if it means that you may have to bet bunch of times more.
The bottom line is that we don’t know when catalytic events will take place. These events could be bad as well as good. Take Andrew Lahde for example, he took advantage of a prime opportunity that was skewed with extreme greed. So he made his money quickly. On the other hand we have heard countless stories of people making money slowly and giving it all back quickly.
The question is not how quickly or slowly we make the money, it more about how do we protect ourselves from the unknow. We shouldn’t seek to find out the unknow but rather just protect ourselves from the various possibilities. As Richard says “Trading is simple, you are complicated”. The smartest traders don’t mess around with chop but rather take appropriate bets at the most opportune times in the markets. Most of the great traders we know, tend to stay out of the markets until they have a clear edge, and even then they tend to risk appropriately and scale in as the position becomes more favorable. We dumbasses on the other hand tend to trade frequently and and scale out every time a position becomes favorable. This is all about fear and greed. It’s not about indicators, or trendlines or excel sheets.
So in a nut shell I am more interested in price, volume and extremes. The best part about the combination of those three is that you’ll know when you are right and when you are wrong fairly quickly.
January 31st, 2008 at 5:42 pm
You got me wrong, LP. I definitely believe that market returns are conditionally heteroskedastic, it’s just that I think it’s obvious to anyone who’s studied market history or distributions of returns - making Taleb’s premise (that bad things happen more often than one would expect if using a normal distribution) obvious, as well. Also, there are “golden swans” where the returns are much better than one would predict using a normal distribution, and they happen just as often as the black ones.
It’s hard to ratchet up the returns without ratcheting up the risk, too. Hard to control risk without dampening returns. It’s a tough problem.