Category: Black Swan Thinking

I am not promising this example will make you a better trader, but it will get your probabilistic juices flowing.

More.

I had the opportunity to meet Mark Shore last spring in New York City at a presentation. His paper on ‘Skew’ (PDF) will be of interest to many readers:

Skewness relates to the symmetrical characteristics of the return distribution. Returns shifted towards the right (left), create positive (negative) skewness causing asymmetrical returns. When considering components of a portfolio, one must consider the co-skewness of each component. What is the result of the portfolio’s skewness when a new asset is introduced into the portfolio?

Shore also appears on my podcast.

I was forwarded this excerpt, which apparently first appeared on Victor Niederhoffer’s site from a contributor. It is Sabermetrician Bill James speaking, from his 1981 Baseball Abstract, on the difference between sports writing and sabermetrics:

1. Sports writing draws on the available evidence, and forces conclusions by selecting and arranging that evidence so that it points in the direction desired. Sabermetrics introduces new evidence, previously unknown data derived from original source material.

3. Sportswriters characteristically begin their analysis with a position on an issue; sabermetrics begins with the issue itself. The most over-used form in journalism is the diatribe, the endless impassioned and quasi-logical pitches for the cause of the day–Mike Norris for the Cy Young Award, Rickey Henderson for MVP, Gil Hodges for the Hall of Fame, everybody for lower salaries and let’s all line up against the DH. Sports writing “analysis” is largely an adversary process, with the most successful sportswriter being the one who is the most effective advocate of his position. I personally, of course, have positions which I advocate occasionally, but sabermetrics by its nature is unemotional, non-committal. The sportswriter attempts to be a good lawyer; the sabermetrician, a fair judge.

James objective decision making process dovetails nicely with the objective decision making of his current boss trend following trader John W. Henry.

From the NY Times, an interesting read (PDF). An excerpt:

Models have other advantages beyond their accuracy and consistency. They allow an organization to codify and centralize its hard-won knowledge in a concrete and easily transferable form, so it stays put when the experts move on. Models also can teach newcomers, in part by explaining the individual steps that lead to a given choice. They are also faster than people, are immune to fatigue and give the human experts more time to work on other tasks beyond the current scope of machines.

A good reminder (PDF) worth reading. An excerpt:

“Imagine an unbiased coin is flipped three times, and each time the coin lands on heads. If you had to bet $1000 on the next toss, what side would you choose? Heads, tails or no preference? Anyone calling tails is suffering from the gambler’s fallacy – a belief randomness mean reverts. Of course, it doesn’t. The coin has no memory, on each flip it is just as likely to come up heads or tails. How does this relate to the equity market? Well, year on year returns in equities are essentially a random process, just like the coin toss. So saying markets can’t go down four years in a row is just like calling tails in the coin tossing example…”

I do know the article was written in 2003, but does that make a difference to the author’s overall lesson?

In doing some research on the concept of ‘uncertainty’, this paragraph caught my eye:

“If there is one thing that defines and limits our efforts to better understand extreme and rare events it is uncertainty. Uncertainty arises from both an imperfect understanding of the rare events and processes we wish to study (e.g., terrorism, natural hazards), and the imperfect, out-of-date, and incomplete data we must work with in order to try and understand these events and processes.”
Mark Harrower
University of Wisconsin-Madison

Along these lines consider the following white paper “Confronting Uncertainty: Intelligent Risk Management with Futures” from trader Robert M. Tamiso: View PDF.

How should one look at trend following performance? Winton Capital, David Harding’s successful trend following shop, offers insights from their recent white paper PDF.