Black Swan Trading Systems
Posted by Mark on February 27, 2020 at 07:02 | Last modified: May 8, 2020 11:03I have been going through my “drafts” folder this year trying to get more organized by finishing partially-written blog posts. Discussion in this post led to my thoughts on this from Sep 2018.
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For me personally, I think the small sample size is still a
problem and it may be the reason why I’d be skeptical
that any statistically valid Black Swan system could
really be developed.
Ultimately, how could such a system ever be said to be
better than luck? Even if it hits the next one, two, or
three market crashes (over how many years or decades
would that take?), the sample size is still very small.
I think this is why I personally have never endeavored
to pursue development of such a system. This would also
be the root of my skepticism if I ever saw one.
I would offer up the caveat that from a practical
standpoint, hitting big on even one market crash could
make a boatload of money regardless of whether lucky
or not. I’m definitely not saying it’s a wasteful
pursuit: only one incapable of statistical validation.
Rather than developing such a directional system, I
wonder about having some long put insurance on
at all times. The insurance will lose a small amount
most of the time. Rarely, the insurance will pay
off big. Even if the total return is negative, lowering
the max drawdown of bullish strategies may still make
it a worthwhile addition (demonstrating this through
backtesting would probably face the same challenges
that I mentioned above, though). In addition, I could
always advertise “if the market goes to zero, the
system will profit handsomely.”
Musings on Naked Puts in Retirement Accounts (Part 5)
Posted by Mark on February 24, 2020 at 06:20 | Last modified: May 8, 2020 09:15I’ve been going through my “drafts” folder this year trying to finish partially-written blog posts and get more organized. The four-part mini-series ending with this post was an excellent discussion about naked puts (NP) versus vertical spreads with regard to leverage and volatility of returns. As I have said before [and I especially mean it this time], in the longshot case that someone out there could possibly benefit, what follows is Part 5 from August 4, 2017.
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If I were paying someone to manage my money, then I would rather less of my capital be traded with a high degree of leverage. This is synthetically equivalent to more capital being traded with much of it in cash except I would not be paying a management fee on idle cash. [1]
One future direction for research is how standard deviation of returns and max drawdown compare to NPs from a gross dollar perspective if I lever up with vertical spreads. Given that employment of leverage will significantly decrease notional risk, what would be the comparable position size?
I suspect research cannot answer the question of proper position size to use because we never know when/if that large market crash will occur and the number of historical occurrences of said “large market crashes” is too small (see third paragraph here) for future indication.
Spreads are also harder to trade than single options so I might lose something additional to transaction fees. If I were just counting on the long option to protect from catastrophic loss, though, then that really doesn’t matter and the only question would be when to close it, which I briefly discussed in the fifth paragraph here.
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I no longer agree with [1] for a couple reasons.
Most investment advisors (IA) would not trade retail accounts with a high degree of leverage. First, it is risky and not suitable for most investors. Second, for this reason most IAs probably know very little about trading with a high degree of leverage especially with regard to futures and options. Sticking with more conventional, existing products, leveraged ETFs exist but are only recommended in narrow circumstances. Again, I’m guessing it would be difficult to find IAs with expertise in this area.
Finally, trading in a leveraged manner may require cash to be left in the brokerage account unless one plans to actually take out a margin loan and pay margin interest. The one thing I know for certain in this scenario is that headwinds are against me. For this reason, I cannot recommend it.
Categories: Financial Literacy | Comments (0) | PermalinkOption Fanatic, RIA (Appendix C)
Posted by Mark on February 10, 2020 at 13:41 | Last modified: May 6, 2020 07:10Today I will finish tying up the loose ends from this blog mini-series.
I left off discussing compliance for investment advisers (IA).
What limited information I have been able to obtain about standard guidelines implemented by compliance firms has left me somewhat dazed and confused. The red tape certainly does hinder/prevent action. I don’t think it’s all for naught though. With all the chicanery that has run rampant throughout the financial industry (see fourth paragraph here), prospective investors need to be protected.
Should I go forward with my own IA, I will probably hire a lawyer and/or compliance firm that specializes in these matters. I want to trade and study trading-related matters rather than getting stuck in all the red tape.
Should I go forward with my own IA, I may consider pursuit of a relevant credential. My doctorate is in pharmacy, which is not relevant. I don’t have a CFP, a CFA, or even an MBA. I don’t believe the credentials mean much with regard to character (honesty). Nevertheless, they are a symbol of expertise and they may be good for marketing. I would have to get licensed through the Financial Industry Regulatory Authority (FINRA), however, by passing the Series 7 and/or Series 65 exams.
Why would people want me to manage their money?
Don’t pick me because I’m good; I don’t believe picking the right stocks or making the right trades is even a thing. All I can do is put the odds in my favor, which is what what I do. From that point onward, if we lose then we lose and the possibility always exists that we will. This is a different mindset but it’s what I believe is really going on.
A better reason to pick me might have to do with my pharmacy experience. What about this:
> As a pharmacist, you trusted me with your life;
> you can certainly trust me with your money.
I truly believe this even though it may sound somewhat cheezy. I gave recommendations on medication, taught people how to use medication, and evaluated medication from time to time. If people could trust me with tasks like these—and they most certainly could—then they should also be willing to trust me with their investments.
Categories: Money Management | Comments (0) | PermalinkOption Fanatic, RIA (Appendix B)
Posted by Mark on February 7, 2020 at 11:01 | Last modified: May 5, 2020 14:14Today I will pick up with excerpt [1] from my last post.
The Investment Advisers Act of 1940 is a thing. Most people probably don’t know it, which would warrant a dedicated post.
The ’40 Act defines an investment adviser (IA) as any person or firm who is engaged in the business of providing advice to others or issuing reports or analyses regarding securities for compensation. The definition includes three parts with each as detailed as you might imagine any legal statute to be.
I disagree with the claim in [1] that “there is no need to be regulated.” If you are acting as an IA then you better be properly registered. Period. If you try to go “off the record” and get paid “under the table” then you’re engaged in tax evasion as well.
The same contributor wrote the following:
> One of the most important things to consider when you start
> managing other people’s money is how to deal with potential
> losses. Most guys who’ve been profitable jump into this business
> but when the first big loss arrives they have problems coping.
> What are you going to tell investors? How would they react to
> losses? Would they flee? How would this affect you financially?
> Everyone has different psychology. In my career as money
> manager, I’ve tried to select clients who are psychologically
> stable and predictable. I had once a client who liked to call
> he saw an article… about markets going down. He asked… am
> I sure every time nothing will happen to his money? In three
> months I decided to return his money and part ways for good.
Probably as much as anything else, this has been a good deterrent over the years against my entry to the IA business. For my own IA, I would be very cautious accepting money from strangers—especially people with little understanding about how the markets work. If working for someone else, though, I may not have much choice what clients I take.
I mentioned “red tape” in the fifth paragraph of Appendix A. Wikipedia describes red tape as follows:
> …an idiom that refers to excessive regulation… that is
> considered redundant or… hinders or prevents action or
> decision-making…
> …generally includes filling out paperwork, obtaining
> licenses, having multiple people or committees approve a
> decision… can also include “filing and certification
> requirements, reporting, investigation… and procedures.
I have studied most of the individual laws, but organizing everything into a manageable whole would be a herculean task. Compliance firms make it their business to handle these challenges for IAs. Compliance firms distill the various components of related laws (e.g. ’40 Act mentioned above, Uniform Securities Act, etc.) into generalized guidelines that will fit as many of their [prospective] clients as possible to maximize compliance firm efficiency.
I will continue tying up loose ends next time.
Categories: Money Management | Comments (0) | PermalinkOption Fanatic, RIA (Appendix A)
Posted by Mark on February 4, 2020 at 03:29 | Last modified: May 5, 2020 11:36In my quest to complete unfinished drafts, what follows are thoughts composed in July 2014 pursuant to this blog mini-series.
In these three posts, I talked about taking custody of client assets with regard to trade opacity and liability. Custody is where a brokerage or other financial institution holds securities on behalf of the client.
Another consideration with regard to custody is trading efficiency. Custody would easily allow me to place all trades at once.
I really have no need to take time shortcuts in executing trades because I would only be looking to trade as many separately managed accounts (SMA) as I could reasonably handle on any given day.
Perhaps more important than opacity or efficiency are the rolls of red tape I would need in order to maintain compliance with the “Custody Rule.” The Custody Rule, part of the Investment Advisers Act of 1940, clarifies and builds upon the above [and Part 6] mention of “liability.” Its purpose is to provide protection for client funds or securities against the possibility of loss. I should do a complete blog post on the this since most people probably don’t know it exists.
For multiple reasons, my preference would be to avoid custody altogether. By maintaining control of their own accounts, clients will be able to see how much money they have and how the account is performing in real-time. I am not running a Ponzi scheme or Madoff fraud whereby I take client funds and provide only my trusted word about investment performance. Clients will still get monthly statements from their brokerage rather than only me [or my company].
Trading in SMA is probably in the best interests of the client and myself as adviser when starting out an RIA.
The next issue is whether to incorporate an investment advisory or to stay “off the record.” One internet source volunteered:
> There is quite a lot of incorrect advice on this thread… if you are
> carrying out investment business then that is a regulated activity
> and if you are not regulated then if it all goes wrong then you are…
> personally liable for all the losses. However it is not as clear cut as
> all that… although it is a grey area if you are only managing a few
> peoples money, (it comes under the broad umbrella of friends and
> family) and it isn’t some [elderly woman] whose life savings you are
> about to spunk up a wall, then there is no need to be regulated… I
> would also say this isn’t just my opinion, I have spent a fair few
> pennies getting legal advice on this very matter in the past. [1]
I will address this next time.
Categories: Money Management | Comments (0) | Permalink