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Tag: statistical thinking

The Trend Following Dice Roll

Posted on by Michael Covel

More.

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Revisiting Kat’s Managed Futures and Hedge Funds: A Match Made in Heaven from Sunrise Capital

Posted on by Michael Covel

Why Tactical Macro Investing Still Makes Sense — Further Revisiting Kat’s “Managed Futures and Hedge Funds: A Match Made in Heaven” (PDF):

In November 2002, Cass Business School Professor Harry M. Kat, Ph.D. began to circulate a Working Paper entitled Managed Futures and Hedge Funds: A Match Made in Heaven. The Journal of Investment Management subsequently published the paper in the First Quarter of 2004. In the paper, Kat noted that while adding hedge fund exposure to traditional portfolios of stocks and bonds increased returns and reduced volatility, it also produced an undesired side effect — increased tail risk (lower skew and higher kurtosis). He went on to analyze the effects of adding a macro investment approach known as “managed futures” to the traditional portfolios, and then of combining hedge funds and managed futures, and finally the effect of adding both hedge funds and managed futures to the traditional portfolios. He found that managed futures were better diversifiers than hedge funds; that they reduced the portfolio’s volatility to a greater degree and more quickly than did hedge funds, and without the undesirable side effects. He concluded that the most desirable results were obtained by combining both managed futures and hedge funds with the traditional portfolios. Kat’s original period of study was June 1994–May 2001. In this paper, we revisit and update Kat’s original work. Using similar data for the period Jan 2001–December 2015, we find that his observations generally hold true about 15 years later. During the subsequent 141⁄2 years, a highly volatile period that included separate stock market drawdowns of 36% and 56%, managed futures have continued to provide more effective and more valuable diversification for portfolios of stocks and bonds than have hedge funds.

More from Sunrise Capital:

Jason Gerlach appears on my podcast.

The Little Book of Trading (first chapter features Sunrise Capital).

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 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. 59: Don’t Let Them Fuck You Around with Michael Covel on Trend Following Radio

Posted on by Michael Covel
Don’t Let Them Fuck You Around with Michael Covel on Trend Following Radio
Don’t Let Them Fuck You Around with Michael Covel on Trend Following Radio

Please enjoy my monologue Don’t Let Them F*** You Around with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive.

Listen to this episode:

Want to learn more Trend Following? Watch my video here.

The Illusion of Control: Dancing with Chance

Posted on by Michael Covel

From INSEAD:

First you accept that there are things you can’t control. Then you try to assess the uncertainty and finally augment your plan to make sure you manage risk more effectively.

That means using models, independent opinions, internal and external advice and any other means to assess the unknown risks and to make your business nimble and open to change when the unexpected happens.

“You are better off focusing your energy on planning for the range of possibilities that could actually happen.”

For example, he says it’s very difficult to tell which start-up businesses will be successful in the early stages. If you accept that, a better strategy is to try to diversify over a number of projects just as venture capitalists do. Not all the projects will pay off but you diversify your risk so that you have a better chance of nurturing one that will succeed.

Chance and randomness play a significant role in business and in our lives. “The point is not that the world is hopeless and you shouldn’t do anything, it’s just that we should do a more careful assessment of what we can predict and what we can’t predict. And where we can’t predict then the effort and the resources are better spent on planning,” Gaba told INSEAD Knowledge.

“Instead of trying to predict this, which you actually cannot, you are better off spending your resources and effort on planning for various contingencies.”

And when it comes to managing risk in investing, the authors have pillars of wisdom: “Be average. Be patient. Be risk aware. Be balanced.”

Another vantage to consider? “What can we learn from expert gamblers?”

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Rapid shifts are the hallmark of climate change, epileptic seizures, financial crises, and fishery collapses…

Posted on by Michael Covel

From SEED:

Nonlinear systems, however, are not so well behaved. They can appear stationary for a long while, then without anything changing, they exhibit jumps in variability—so-called “heteroscedasticity.” For example, if one looks at the range of economic variables over the past decade (daily market movements, GDP changes, etc.), one might guess that variability and the universe of possibilities are very modest. This was the modus operandi of normal risk management. As a consequence, the likelihood of some of the large moves we saw in 2008, which happened over so many consecutive days, should have been less than once in the age of the universe.

Our problem is that the scientific desire to simplify has taken over, something that Einstein warned against when he paraphrased Occam: “Everything should be made as simple as possible, but not simpler.” Thinking of natural and economic systems as essentially stable and decomposable into parts is a good initial hypothesis, current observations and measurements do not support that hypothesis—hence our continual surprise. Just as we like the idea of constancy, we are stubborn to change. The 19th century American humorist Josh Billings, perhaps, put it best: “It ain’t what we don’t know that gives us trouble, it’s what we know that just ain’t so.”

Wisdom.

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 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.

Understanding Your Relationship to Risk: Rolling the Dice and Loss Aversion

Posted on by Michael Covel

Stephen Horan writes:

Everywhere we turn, psychological tests are available to help us better understand ourselves and our own behavior. But often these tests fail to shed light on a person’s relationship to risk, particularly the risk of losing money.

That’s why I like to do my own thought experiment. When I speak to groups, I often ask the participants to consider the following scenario:

Suppose you are sitting in a captivating presentation and someone comes in and locks the door. Then the person announces that everyone in the room is free to leave under two circumstances. You can leave if you pay a $1,000 fee (à la Hotel California) or you can leave after flipping a coin and going double or nothing. If the coin turns up heads, you exit for free; if it’s tails, you pay $2,000.

On a consistent basis, some 80 to 85% of the people in the room choose to flip the coin. The results are always very biased toward flipping, and that says something about the human tendency toward loss aversion.

The classical theory of the rational, economic man would have him avoid risk and thereby avoid the coin flip. The difference in this case, however, is the negative expected returns (a loss of $1,000 in each case since with option B you have a 50% chance of paying $2,000).

Since negative returns are at play, a loss aversion mechanism kicks in, and people will actually go double or nothing in order to keep from losing—thereby taking more risk.

The first reaction I get is surprise from people who otherwise think they make “rational” decisions regarding money. They realize for the first time the innate nature of loss aversion. That’s why I put the term “rational” in quotes. People are not necessarily “irrational” or stupid on this point; they are simply being human.

That thinking is foundational to becoming a successful trend following trader.

Note: Shout to Alistair Evans for the hat tip.

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 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.

Trigger Your Thinking: Jim Simons

Posted on by Michael Covel

An excerpt from: The Secret World of Jim Simons by Hal Lux:

Like all quantitative money managers, Renaissance aims to find small market anomalies and inefficiencies that can support profitable trading on billions of dollars of capital. Though all quant shops are alike in their dedication to models Let the best algorithm win! Renaissance’s approach differs from the “convergence trading” popularized by John Meriwether’s Long-Term Capital Management and similar arbitrage shops. Convergence traders price financial instruments based on complex mathematical models, find two different instruments that are cheap and expensive on a relative basis and then buy one and sell the other, betting that the prices will, at some point, have to return to their proper level. The Renaissance approach requires that trades pay off in a limited, specified time frame. And Renaissance traders never override the models. Back in action, Medallion made its mark through rapid, short-term trading across futures markets. “I have one guy who has a Ph.D. in finance. We don’t hire people from business schools. We don’t hire people from Wall Street,” says Simons. “We hire people who have done good science.” “We have three criteria,” says Simons. “If it’s publicly traded, liquid and amenable to modeling, we trade it.” Unusual for a hedge fund, the heart of Renaissance is not its trading room an uncluttered room where a score of traders buy and sell around the clock but rather an auditorium with exposed beams that seats 100 and features biweekly science lectures. Last month a molecular biologist presented research on colon cancer. “When you hear someone talk about an interesting use of statistics it helps trigger your thinking,” says one Renaissance employee.

I remember a few years ago, sitting in the private office of one of the best trend following traders around (performance and assets), talking about this very issue with him: how does Simons really trade?

He was not buying the ‘short term’ public facade.

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
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• 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.