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Jean-Philippe Bouchaud: Tail Risk Premia vs. Pure Alpha

Jean-Philippe Bouchaud, Chairman of Capital Fund Management, passed along a new paper Tail Risk Premia vs. Pure Alpha.


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Murray Gell-Mann: Beauty and Truth in Physics


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Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

Ep. 279: Mark Broadie Interview with Michael Covel on Trend Following Radio

Mark Broadie
Mark Broadie

My guest today is Mark Broadie, the Carson Family Professor of Business and Vice Dean at the Columbia Business School. His research focuses on quantitative finance and sports analytics. His golf research has appeared in academic journals and many golf publications. He developed the new strokes gained approach to analyze the performance of amateur and professional golfers and worked with the PGA Tour on their implementation of the strokes gained putting stat.

The topic is his book Every Shot Counts: Using the Revolutionary Strokes Gained Approach to Improve Your Golf Performance and Strategy.

In this episode of Trend Following Radio we discuss:

  • How he became, in Covel’s words, the “Bill James of golf”
  • How Broadie connected his finance work to the sport of golf
  • Why certain golfers win
  • Why approach shots are the most important
  • “Drive for show, putt for dough”
  • How Broadie started, the software he used, and how he got better data
  • Whether Broadie had any sense of where the data might go when he first collected it
  • Power as a separator
  • The connection between sports anaylitics, business analytics, and investing
  • The psychology of golf
  • First putts vs. second putts
  • The world golf rankings, and how these can be fixed

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The Scientific Method: An Explanation For Explanations

Nathan Myhrvold, CEO and Managing Director, Intellectual Ventures; Co-Author (with Bill Gates), The Road Ahead; Author, Modernist Cuisine, writes:

Humans are a story telling species. Throughout history we have told stories to each other and ourselves as one of the ways to understand the world around us. Every culture has its creation myth for how the universe came to be, but the stories do not stop at the big picture view; other stories discuss every aspect of the world around us. We humans are chatterboxes and we just can’t resist telling a story about just about everything.

However compelling and entertaining these stories may be, they fall short of being explanations because in the end all they are is stories. For every story you can tell a different variation, or a different ending, without giving reason to choose between them. If you are skeptical or try to test the veracity of these stories you’ll typically find most such stories wanting. One approach to this is forbid skeptical inquiry, branding it as heresy. This meme is so compelling that it was independently developed by cultures around the globes; it is the origin of religion—a set of stories about the world that must be accepted on faith, and never questioned.

Somewhere along the line a very different meme got started. Instead of forbidding inquiry into stories about the world people tried the other extreme of encouraging continual questioning. Stories about aspect of the world can be questioned skeptically, and tested with observations and experiments. If the story survives the tests then provisionally at least one can accept it as something more than a mere story; it is a theory that has real explanatory power. It will never be more than a provisional explanation—we can never let down our skeptical guard—but these provisional explanations can be very useful. We call this process of making and vetting stories the scientific method.

For me, the scientific method is the ultimate elegant explanation. Indeed it is the ultimate foundation for anything worthy of the name “explanation”. It makes no sense to talk about explanations without having a process for deciding which are right and which are wrong, and in a broad sense that is what the scientific method is about. All of the other wonderful explanations celebrated here owe their origin and credibility to the process by which they are verified—the scientific method.

This seems quite obvious to us now, but it took many thousands of years for people to develop the scientific method to a point where they could use it to build useful theories about the world. It was not, a priori, obvious that such a method would work. At one extreme, creation myths discuss the origin of the universe, and for thousands of years one could take the position that this will never be more than a story—how can humans ever figure out something that complicated and distant in space and time? It would be a bold bet to say that people reasoning with the scientific method could solve that puzzle.

Well, it has taken us a while but by now enormous amounts are known about the composition of stars and galaxies and how the universe came to be. There are still gaps in our knowledge (and our skepticism will never stop), but we’ve made a lot of progress on cosmology and many other problems. Indeed we know more about the composition of distant stars than many questions about things here on earth. The scientific method has not conquered all great questions – other issues remain illusive, but the spirit of the scientific method is that one does shrink from the unknown. It is OK to say that we have no useful story for everything we are curious about, and we comfort ourselves that at some point in the future new explanations will fill the gaps in our current knowledge, as often raise new questions that highlight new gaps.

It’s hard to overestimate the importance of the scientific method. Human culture contains much more than science—but science is the part that actually works—the rest is just stories. The rationally based inquiry the scientific method enables is what has given us science and technology and vastly different lifestyles than those of our hunter-gatherers ancestors. In some sense it is analogous to evolution. The sum of millions of small mutations separate us from single celled like blue-green algae. Each had to survive the test of selection and work better than the previous state in the sense of biological fitness. Human knowledge is the accumulation of millions of stories-that-work, each of which had to survive the test of the scientific method, matching observation and experiment more than the predecessors. Both evolution and science have taken us a long way, but looking forward it is clear that science will take us much farther.

Foundational to trend following success.


How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

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Trend Following Podcast Guests
Frequently Asked Questions
Performance
Research
Markets to Trade
Crisis Times
Trading Technology
About Us

Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

Hit The !@#$ Home Run!

Some companies, and individuals, stress [focus on] the short-term performance of trend followers. They look at one month’s performance, see a down month, and panic. They have complete ignorance of the long-term objective–big money. How bad can it get? I have seen trend following traders make 100 percent in a year followed by a year where they lost 5 percent. That 5 percent loss causes some critics to not see the 100 percent number. That is insane thinking. Just like a baseball player’s batting average can have short-term up or down streaks over the course of a season, trend followers have streaks. Trend following performance will deviate from averages, but over time there is remarkable consistency when it comes to putting up big returns—as long as unpredictable home runs are allowed to happen naturally and unforced. The leading thinkers across varied fields, including insurance, casino gambling, and investing, all emphasize the same point. It’s the Babe Ruth effect: Even though Ruth struck out a lot, he was one of baseball’s greatest hitters. The home runs made up for his strikeouts. A trend follower coaching a baseball team would approach it like the former manager of the Baltimore Orioles. Earl Weaver designed his offenses to maximize the chance of a three-run homer. Weaver did not bunt or want guys who slapped singles. He wanted guys who hit big home runs. Trading is a waiting game. You sit, you wait, and you make a lot of money all at once. Profits come in bunches. The trick when going sideways between home runs is not to lose too much in between.

Note: From my book Trend Commandments. Shout to Michael Mauboussin.

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How can you move forward immediately to Trend Following profits? My books and my Flagship Course and Systems are trusted options by clients in 70+ countries.

Also jump in:

Trend Following Podcast Guests
Frequently Asked Questions
Performance
Research
Markets to Trade
Crisis Times
Trading Technology
About Us

Trend Following is for beginners, students and pros in all countries. This is not day trading 5-minute bars, prediction or analyzing fundamentals–it’s Trend Following.

Ep. 253: Perry Kaufman Interview with Michael Covel on Trend Following Radio

Perry Kaufman
Perry Kaufman

My guest today is Perry Kaufman, an American systematic trader, index developer, and quantitative financial theorist. He is considered a leading expert in the development of fully algorithmic trading programs.

The topic is systematic trading.

In this episode of Trend Following Radio we discuss:

  • How Kaufman came to the idea of 100% algorithmic trading systems
  • The difference between being systematic and being automated
  • Optimization vs. validation
  • The biggest advantages of testing
  • Why discretion is not part of Kaufman’s toolbox
  • The problem of tail events
  • Why discipline is the most important characteristic of a systematic trader
  • The “loose pants fit everyone” philosophy
  • Preparing yourself for uncertainty
  • Comparisons between risk management and risk measurement
  • The Sharpe ratio
  • High volatility trades vs. low volatility
  • Why Kaufman places equal weight on both risk management and the underlying system
  • Systematic trading in established mature markets vs. emerging markets

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Ep. 242: Jean-Philippe Bouchaud Interview with Michael Covel on Trend Following Radio

Jean-Philippe Bouchaud
Jean-Philippe Bouchaud

My guest today is Jean-Philippe Bouchaud, the Chairman of the multi-strategy quantitative hedge fund Capital Fund Management (5B+ AUM) and co-supervisor of the research team. He is a well known authority in the field of Econophysics, co-author of “Theory of Financial Risks and Derivative Pricing”, a Professor of École Polytechnique where he teaches Complex Systems and has his Ph.D in theoretical physics from École Normale Supérieure.

The topic is Trend Following.

In this episode of Trend Following Radio we discuss:

  • Bouchaud’s physics background and how it collided with the world of classical economics
  • The Black-Scholes model, and its still use; experimenting with simulation
  • Bouchaud and his colleague’s paper, “Two Centuries of Trend Following“
  • The efficient market hypothesis
  • Why the existence of trends is one of the most statistically significant anomalies in financial markets
  • How trends predate trend following
  • Why classical economics has no framework through which to understand “wild markets”
  • Benign randomness vs. wild randomness
  • Accepting uncertainty
  • Differences between physicists and economists

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