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Risk, Money & Timing

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In the last week I have done an enormous amount of reading and thinking about what is going on in the markets. My home library is eclectic with a heavy dose of doomsday material. During the last financial crisis in 2008-2009 I bought a lot of literary works on the Great Depression. My primary reason was to try and understand what times were like in those days, that is during the buildup and the aftermath. 


It is Monday morning and instead of providing you with doomsday insights, let me dive straight into some market insights from a traders perspective. Before I get there I want to provide a quick update on the Copy Trading Initiative and AxiSelect program.  


We are in the final stages of getting our legals in place to kick off our alpha program for a limited audience. Yes this has taken a long time and I am doing my best to move this along. On the AxiSelect capital allocation program, we remain open for business and are keener than ever to identify and develop trading talent. We haven’t been immune we have suffered a drawdown of roughly 5% across our program which given the volatile conditions has been pretty satisfying. 


Market Risk


People who have known me for a long time know I like to trade extreme markets. My reason is simple. I don’t believe I have much edge trading within the typical ebb and flow of the markets, especially ones controlled by central banks. However when markets get stretched out of their comfort zone, something interesting happens. We get what academics call cascade effects. It is during these times that I believe the classically accepted efficient market hypothesis comes under pressure and is hard to defend. Of course identifying these periods of market disequilibrium is the Trillion Dollar question.


The 1929 market crash lasted until 1933, not before a massive 89% of value was wiped from the Wall Street stock exchange. The 1987 Crash was one which saw a massive selloff of 22% in one Black Monday which proved to be relatively short lived and turned out to be a great buying opportunity. During the Dotcom bubble from 2000 to 2002 the Nasdaq lost nearly 80% and the S&P500 50%. The the Global Financial Crisis lasted from 2007 to 2009 with the Dow losing 54%.


Last week as the market bounced off the current lows people have started saying their is some great value in the markets it is a good buying opportunity. I just want to say categorically I think this is your classic suckers rally. I am not arguing against wealth managers who are advising clients to stick some cash they have waiting to invest on a regular basis into the market, kka “Dollar Cost Averaging”. I am saying that you are likely practicing wishful thinking if you believe the central banks and government fiscal stimulus can avoid a serious hit to the economy which will quickly see the markets current valuations re-rate to more realistic values significantly lower than the lows we recently witnessed. 


In my case I have been short the US markets since October last year and of course copped my fair share of abuse that I am fighting the Fed which is a losing game and valuations are fair with interest rates this low. Being early to a crash is something I have become quite well accustomed to. It takes research, strong fundamental insights and ability to withstand the abuse of the crowd. 


Here are the famous Bob Farrell’s 10 Rules for Investing which are worth reviewing before we dig deeper:


1. Markets tend to return to the mean over time. 

2. Excesses in one direction will lead to an opposite excess in the other direction. 

3. There are no new eras — excesses are never permanent. 

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. 

5. The public buys the most at the top and the least at the bottom. 

6. Fear and greed are stronger than long-term resolve. 

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. 

8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend. 

9. When all the experts and forecasts agree — something else is going to happen. 

10. Bull markets are more fun than bear markets.


As the markets continued to sell off in big moves I was locking in profits and got to a market neutral position by Tuesday last week. On Friday I personally went net short and realize that the market may have more to bounce but I believe this is a selling opportunity for traders like myself. 


Just a couple of personal observations before we learn some deeper insights into the market.


In my case I have hardly put a foot wrong since the sell off started on the 24th February 2020. What I have noticed is that I have suddenly started thinking that I can call each market squiggle, and this is a bad mistake on my part. I know better than most that the markets are largely random so thinking I can fine tune each market call is a mistake. Especially because my main trading theme is an extreme bearish view which I am predicting will take years to manifest in full. If this is the case then trying to trade each squiggle is potentially harmful as it is creating a lot of noise around my main thesis which can wear me down for the inevitable tough times that lie ahead when trading a wild market. I could feel it was draining me as each little move that moved against me and resulted in giving back a few dollars of gain was causing me pain.


With this said I spoke to myself and said stop letting your ego get in the way trying to sound like a “know all”. So with that said I have loaded up a fair size position and just like I was prepared to wait 5 months for my thesis to start to play out, I am preparing to wait a good few months for my main thesis to play out and try and ignore the short term movements to my account PNL and leave that for the day traders to enjoy.  


Black Swans


One of the great things I have discovered from my studies is the randomness and lack of normality I have witnessed manifest in the distributions of our lives. 


I probably have a psychological disorder because I love everything Nassim Taleb writes about randomness and the fragility of our lives. What I truly enjoy beneath the brilliant scientific proofs is the F..k You attitude he brings to the party. Yes he is obnoxious. However, for someone to take on the establishment there is no point trying to argue within the rules made by the “club”. You need to come with a street fighter mentality.  Moving on …..


In Taleb’s original blockbuster – Fooled by Randomness, he introduces us to the Thanksgiving Turkey. The turkey believes that they have an awesome life for 1000 days. They are being hand fed, food is always around, they are getting fat, life is good – until ….. 


The turkey doesn’t realize that the hand that has been feeding it for 1000 days has something else in mind. They are planning on eating this fat gorgeous bird on Thanksgiving. The 1001 day.





The chart above is very similar to many trading strategies, for example Martingale strategies which produce regular small winning days making the trader/investor happy with life only to eventually blow up, as in the Turkey Surprise.


This brings me to a very important point worth considering. With the current Corona Virus we are being told by business and politicians that this is a one in a one hundred year event, a Black Swan. I call B.S.


You see I grew up I living near my grandparents, people who survived the Great Depression having being expelled from eastern Europe due to pogroms and antisemitism. The older generation would speak about saving for a rainy day. Before I make myself out to be Mr Sensible with regards money I can say that while I have not always practiced what I learned, the lessons were always learned. 


The world today believed and probably still believes that you should borrow as much as you can when interest rates are low and easily available. The horrible lessons of excessive debt are still to be learned. People don’t understand the lag effect, that plugging holes with stimulus are not long lasting and paying a mortgage without a job eventually doesn’t add up. We are currently watching a horror movie that has been put on pause, or in some cases slow motion. People are simply ignoring the information around them much like the Thanksgiving Turkey. 


Let me come back to why I believe blaming this on a Black Swan event is not an excuse. 


Firstly, our current models that run most of society and business hopelessly under estimate risk. They naively or ignorantly assume normal distributions of events to make for easy modelling. Yet when we look at history over a reasonable period of time and measure the events that in fact took place we learn that distributions of uncertain events are more likely to have fat tails. I am not naively saying that no distributions are normal. Such modelling works well when predicting the likelihood of seeing a 6 foot person in China. 


Secondly and most importantly, I believe many people do in fact realize they are working with flawed models but choose to proceed anyway. With this knowledge in mind I ask a question that is applicable to the PsyQuation world of trading. 


Is a trader really worth investing in because they have demonstrated incredible past returns? My answer is, if you can see that the returns are very short in duration, i.e. a couple of months, then you cannot know enough to make any strong predictions. If you see that their returns are produced with small increments of profit with large amounts of risk then you need to be extremely cautious. 


I think we will soon start to once again admire those traders who have proven their robustness by surviving for years with maybe not as impressive returns as traders who come and go with flash results and then disappear in a flash. It is my hope especially now that we will soon be launching a copy trading platform that our community look beyond the flashing lights. Our PsyQuation Score will help you along the way, but it remains up to you the investor/trader to choose wisely.  

Velocity of Thought Watching the Year in Review