Recouping My Losses

Today has helped me more than recoup my losses from the last big blow up. I closed out an overnight trade in NQ like 20 points ago so my IB account isn't yet back to its all time high, but my Ameritrade accounts, which hold the core position of each trade that I hold for several days are more than making up for it. Ostensibly the cause is the 9% drop on the Chinese exchanges over night and more signs of impending recession. The ten year bonds are up 19.5 ticks at the moment. It's the only green thing on my screen apart from put options :) From a technicians perspective the bottom line is the markets were ready to fall and just waiting for the shock which is why I was net short. The rise in bonds will help balance some of my loss on long stock positions elsewhere in my investment portfolio. It's looking like being a good month unless I do something incredibly dumb tomorrow.

Suze Orman is Extremely Risk Averse

Suze Orman was interviewed today in the New York Times Magazine. I've read before about her extreme risk aversion. In the article she comments that her net worth is about $32 million allocated $7 million to owner occupied real estate, 24 million to municipal bonds (tax free), and $1 million in stocks. She says about the stocks that she put $1 million in them because if she loses it all it doesn't matter. There is no reason to be aggressive when you are as wealthy as she is. But her attitude that "you could lose it all" by putting money in stocks (you could lose 20% of it in a day based on historic precedent) is interesting and also that only 3% of her net worth is in that asset. This would make me less likely to take her advice.

But many people seem to be interpreting this comment in an exactly opposite fashion. This is also interesting. It might be related to what economists call "money illusion". Maybe talking about a million dollars not mattering is alienating to potential followers. I wouldn't like to lose $12000. But I've certainly lost more than that in a month. I even lost 3% of my net worth on a dumb trade in one day. The latter was not a pleasant experience to say the least. But in the larger scheme of things it didn't really matter. So losing a million dollars doesn't matter to Suze.

By investing in stocks to the degree I am I am setting myself up to potentially lose a very significant chunk of net worth. And that is what happened in 2002 for example. But I think it is worth taking on some risk for return.

P.S. For economics afficionados - if I feel the same way about losing 3% of my net worth as Suze does then I am assuming we must both have logarithmic utility functions. Which can't be true if she is more risk averse than I am.

Snork Maiden's Taxes

Looks like I will be doing Snork Maiden's taxes. The software she used last year won't let her file as a non-resident alien this year, even though that is clearly what she is. All foreign students count as non-resident aliens irrespective of how long they've been in the US. On the other hand I don't yet have a green card but count as a resident for tax purposes.

Back when I was a grad student I used to file a 1040-EZ even though I was a non-resident alien. For most people you pay less taxes that way. Yes, it is cheating on taxes. So we are going to file properly. The only software I use for taxes is Excel and the IRS's forms and instructions. My taxes take several hours to figure out when I get down to it. I reckon Snork Maiden's federal return will take less than half an hour. The Vermont return will be a novelty for me. I've completed Massachusetts and New York tax forms for myself before and also a California return (not my own).

Trading went pretty well today. Of my two new indicators for overbought conditions, one said to go short today and one formally said not to, but was pretty close to short. So I was short and the market went down. My overnight trade (short 2 NQ) was profitable and then I initiated another trade (short 3 NQ) in the afternoon which I held for about breakeven at the close. I also have 4 QQQQ puts and short 1200 QQQQ shares as my core trading position. So now I am effectively short the equivalent of one big NDX contract or 4000 QQQQ shares. At midday I was only short the equivalent of 1600 QQQQ shares. I'm down this month in trading but despite the big blow out my net worth performance has not been affected at all. I only have about 6-7% of my net worth allocated to trading. Good investment performance and the rise in the Australian Dollar have easily offset losing 15% of my trading capital in one day. That is the benefit of true diversification.

New Trading Rule

The big problem with my trading model has been that when the stochastic in the chart below is over 80 as it is today or under 20, I can't predict ahead of time when the market will turn and we should sell or buy. All I could do was wait for the stochastic to cross over.



So the model gave me no advantage over anyone who can read a free chart when the index was overbought or oversold. And that is a lot of the time. The model did give me a big edge when the stochastic turned around in the range between 20 and 80. I could predict that. I tended to get very jittery in these overbought and oversold zones and ended up losing most of the profits I made the rest of the time.

Today, I came up with a rule which uses one of the forecasts I was already generating from the model to give predictions for turning points in these overbought and oversold zones. I would say it works about 1/2 the time. Its performance is halfway between a trading algorithm that reverses from long to short or vice versa at the end of days when the stochastic crossed its moving average during that day and a model which shows perfect foresight and reverses position at the beginning of days that see stochastic crossovers. Let's see if it adds to my performance.

For what it's worth the model is not formally predicting that the stochastics will cross on Friday using the rule I found to be optimal. But unless there is another strong rally it's going to be hard for them not too and there are clear sell signals in palce on the S&P 500 and Dow indices, so I'm skeptical about that strong rally. The market has, however, continued to be stronger than I expected.

Credit for Federal Telephone Excise Tax Paid

Now I know why I kept all my old telephone bills :) The standard credit for a single filer for the Federal Telephone Excise Tax Refund is $30.00. I just computed my credit using my old bills and Excel (where I set up a spreadsheet to replicate Form 8913 and do all the summations and multiplications needed). My credit comes to $111.13. $81 is not bad for half an hour's work :) Most of the credit is due to tax I paid on bundled service. So if you have those old bills give them a quick check to see if you might exceed the standard credit and if it's looking good, do the computations.

Wealth Cycle Investing

Since Millionaire Artist wrote that Loral Langemeier's "Wealth Cycle Investing" was a very foreign in approach to her, I was intrigued to take a look for myself. I got a copy and have started reading it. Basically it seems to be about levering up your balance sheet and taking more risks and for people with zero or negative net worth starting a side business to generate some cash to invest. This isn't very unusual to me. I feel Langemeier is overexaggerating how different her approach is. But it is radically different to the advice given by the usual personal finance gurus like Suze Orman.

Like many such business investment oriented "gurus" she favors direct investment in income-producing assets rather than financial assets like stocks. But she does like origination of loans to other people. I don't see any neccessary inherent advantage in direct purchase of productive assets. Take for example Warren Buffett. He does get involved directly in the insurance business - this is where Berkshire's real business knowledge is. Otherwise they are investing insurance profits and float is other people's businesses. Even when Berkshire buys whole companies as subsidiaries they retain existing management in place. In fact that is a key Berkshire principle - investing in good managers. But Loral only seems to think that investing in stocks as a way to learn about businesses (which it is too). Why not invest with good managers?

In fact, good managers could be seen as part of the investor's "team". Langemeier emphasizes continually the importance of a team to investment and business success. And it is true that networking and extensive use of specialized professionals is going to be crucial to the kind of investing she favors. Investors like me network too - but mainly online. I don't yet use any professionals for the kind of investing I do. I rely on books written by professionals. I figure out my own taxes and figure out that at this stage I don't need an "entity" (guru self-help books often overemphasize the need for "entities" - filing Schedule C as a self-proprietor has many of the same advantages - but again they are going to be much more useful for direct investors than financial traders). Well in fact Langemeier does recommend investment in private equity. Her rationale seems to be that she is more likely to have direct access to management as a private equity investor. Given the minimum usual required investment in private equity and the need to diversify over a few deals, even if you could get in on a deal as a non-accredited investor it might not be a good idea. On the other hand if you are really an active participant then it is like investing in your own business and maybe is a risk worth taking?

Otherwise, her advice seems generally solid to me and she does discuss risk, but like Kiyosaki, and others I think overstates how appropriate this path is for most people. There is no inherent advantage in my opinion in investing in any particular class of asset or starting any type of business unless you have some aptitude or edge in that investment or business. If you lack the aptitude things can instead go very wrong. If you have no edges you want to be maximally diversified (actually, to her credit, Loral likes diversification). Her best client story, is based on Jed who was managing a small chain of bike stores but had a net worth below zero. Following his first investment of just $3000, Jed quickly manages to put together complicated real estate deals. I think his management experience helped him to do this. Understanding what your edge is is I think very important to business and investment success but rather under-discussed.

Should You Rely on Trading Test Statistics?

Henry Karstens recently posted a primer on testing strategies. A key indicator is what he calls "optimal f" which is related to the Kelly Criterion. Optimal f is supposed to tell you how much you should have in your account per standard sized trade. I computed this statistic for all of my trading of NASDAQ 100 futures since I opened my IB account - a total of 98 closing trades. I standardized the gains and losses for each trade by dividing the amounts by the number of contracts bought or sold. The criterion shows that I need $4906 per contract traded in my account. It would mean I could trade up to 79 contracts with my current net worth, or $2.85 million of underlying stock.

Another statistic that Karstens presents is the z-score which is a test of whether the average gain per trade is statistically significantly greater than zero. My z-score is only 1.04. Which means there is around a 15% probability that my system, the way I am trading it, doesn't make any money at all.

The bottom line, I think, is to take all trading test statistics with a big pinch of salt. The same data that says that there is a good probability that my results are random also could be construed as saying I should be trading with 7.3 times leverage.

Uh-oh Another Blow-Up

Things were going very well this year until today. My trading was awful today and I've probably lost the profits I made this month so far and a little more. I need to use stops more and be prepared to get out of a losing position fast. Bernanke's testimony to Congress caused the market to melt-up when I was very short. The model was, in fact, pretty ambiguous on the direction today. Some signals pointing one way and some the other. I need to learn to take a small position or a hedged position in those circumstances and then really get out fast if the market is determined to go against me. If each "blow-up" gets less than the last one then I guess I am making progress.

Trading Performance Update

My results since I made this post about money management strategy have largely confirmed what I wrote there. My system mainly produces winning trades but winning and losing trades are both making or losing similar amounts of dollars. Since December 1st - when I closed the disastrous Australian Dollar trade - I have made 66 winning trades and 19 losing trades. The average win is $153 and the average loss $190 for a total of $10,156 of winning trades and $3,618 of losing trades. When I read about most trading systems and the usual advice to cut losses quickly and let winners run and that "it's more important how much you win when you win than how often you are right" I get the distinct impression that those trading signals are not much better than random and it's all in the money management.

I've almost doubled the account since then as I was down to just over $7,000 (I invested $10,000 in the account) and I have done it pretty smoothly:



Based on weekly returns the annual Sharpe Ratio is 9.7 which is just way off the scale. But based on daily data "the model" tends to have a Sharpe Ratio around 7 and extreme levels of alpha. Up till now I have only intermittently been able to trade the model correctly. I'm not convinced that I won't see erratic performance again in the future that will significantly reverse the good performance I am currently seeing. There isn't a single down week among those ten weeks since December 1st. But last July and August also looked very good too and then some sharp reversals appeared and my trading was just awful.

Penny Options Trading Gets Underway

Today was the first day on which U.S. exchange traded options (ETOs) in QQQQ the NASDAQ 100 ETF can be traded in penny increments. Up till now option bid and ask prices had to be in 5 cent increments for options priced below $3 and 10 cent increments for options priced above $3. You couldn't place a bid to buy an option for $3.03. Only $3.00 or $3.10 were acceptable prices. Market orders in options though could actually trade at any price when two orders were crossed. There are a few other stock tickers involved in this pilot program. If it is successful I suppose it will spread to trade in all ETOs.

I've been watching today and the bid-ask spread for the $47 March QQQQ put is averaging 3 cents rather than the previous 10 cents (I have two of these contracts in my Roth IRA account). The spread on QQQQ stock is typically a single penny.

I predict that the volume of options trading will accelerate as a result of this innovation. Relative to buying stock, buying options has meant immediately losing a pile of money due to the spread. The narrowing of spreads should make trading ETOs more attractive. I know I am going to be more likely to trade them in my Roth account now. Trading QQQQ stock requires more capital but still has the advantage of being able to trade pre-open and after hours if neccessary. Futures contracts require little capital, trade almost 24/5 and have narrow spreads during the main trading hours. On top of that they are taxed lower in the US. I still do some QQQQ stock trading in my regular trading account. But over time I am doing more and more of my trades in the futures market.

My First "Carnival"

Believe it or not, this is the first "carnival" I've ever participated in:

The first edition of 30s and 40s Personal Finances: Wealth Accumulation Carnival

And it's the very first edition of this carnival too!

January Report

Income and Expenditure

Expenditure was $US2,515 - 76% of take home pay ($3,299). Expenditure is up this month because of paying for flights and hotels in Florida for our upcoming trip. 403b contributions now total $1,795 and Roth contributions $333.33. Non-retirement investment returns were very strong this month ($8,989) and were the most significant factor in increasing net worth by $10,941. Retirement investment returns were negative.



Net Worth Performance

Net worth rose by $US10,941 to $US377,402 and in Australian Dollars gained $A21,262 to $A485,842. This is $US3000 more than needed to be on track for my 2007 goal of a net worth of $470k. The Australian Dollar fell this month resulting in a relatively large gap between performance in the two currencies. Non-retirement accounts reached $US205,646 or $A264,735. The growth of non-retirement accounts has been very strong relative to retirement accounts recently:



The brown line shows non-retirement accounts and the green line retirement accounts. The emerging rapid acceleration in the non-retirement accounts is the reason I started maxing out my 403b. Hopefully, the strong investment and trading performance will continue but I also need to think about how to increase returns on the retirement accounts.

Investment Performance
Investment return in US Dollars was 2.28% vs. a 1.02% gain in the MSCI World Index, which I use as my overall benchmark and a 1.51% gain in the S&P 500. Non-retirement accounts gained 4.58%. Returns in Australian Dollars terms were 3.86% and 6.19%. U.S. Dollar returns also beat the indices over the last 12 months:



The contributions of the different investments and trades is as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency losses appears at the bottom of the table together with the sum of all other investment income and expenses - mainly margin interest. Finally QQQQ/NQ trading yielded very strong returns. The Everest Brown and Babcock entry covers returns on a listed fund of hedge funds and the management company itself which are both listed on the Australian Stock Exchange. The management company saw a large increase in share price this month. Merger candidates Powertel and Symbion also performed strongly. I also made $1170 trading Apple on the day of the evening of the earnings release. I still hold the short IYR position which is performing very badly for me.

Progress on Trading Goal
Trading in my US accounts netted $4525 a 19.7% return on trading capital. The model gained 9.1% while the NDX rose 2.0%. My goal for the year is to end up with at least as much in my three accounts - regular trading, Roth IRA, and IB - as I've put into them. The accounts in total gained $4578 which is about a quarter of the annual goal of adding $19,000. So here too, I am well ahead of my goals for this point in the year.

Asset Allocation
At the end of the month the portfolio had a beta of 0.76 56% of the portfolio was in stocks, 44% in bonds, 8% in cash, and loans totalled -18%. The remainder was in hedge fund type and real estate investments, futures value etc.

Floridian Frugality?

Posts by Cliff and Nirav about frugality and buying luxury on the cheap got me inspired to write something about "frugality" myself. Usually I don't write about this topic. I feel very comfortable with my level of spending and it isn't an area where I feel I need to improve - unlike my trading or investing - and most of the time I don't think it would be very interesting to anyone. I grew up in a pretty frugal family and the habits were instilled in me from birth. There never seemed like there was another way of living apart from being frugal, saving, and investing. My father thought me to be very spendthrift in fact. Most of my friends would say I was frugal. I rarely though buy the cheapest option, I try to get good quality stuff at a low price.

So here is an example. Moom and Snork-Maiden, Moomin's significant other, are going for a trip to Florida. There are four alternatives:

1. Don't go to Florida - invest the thousand dollars plus that the trip will cost.

2. Go to Florida and do all the cheapest things. Like buying $160 airline tickets - that arrive at 11pm in Florida and staying in a low price motel ($80 per night) on the mainland.

3. Buy tickets @ $250 that get us to Florida at 4pm. Still spend a while online finding this good deal. Moom and Snork-Maiden discussed this one quite a bit. Moom was insistent on spending the extra money, while Snork Maiden thought the cheaper ticket was better. Moom just thought that $80 extra each was a good price to pay for not arriving late at night especially if something goes wrong (flight delayed, hotel booking screwed up etc.). And if everything goes to plan we spend an extra evening in Florida visiting Snork-Maiden's friend. We also booked a hotel for the second two days of our trip on one of the barrier islands. It costs $120 per night. There are lots of much more expensive hotels surrounding it.

4. Just buy the first tickets we see that have good times and splash out on expensive hotels etc. with the best amenities right on the beach. You can spend more than $400 on a ticket and up to that a night at a hotel.

As you can see we ended up with 3. I think the extra money is worth it. But I am still doing option 3 instead of option 4.

What would you do? I am curious how frugal other PF Bloggers would really be in this situation? Would it make a difference if you had the same net worth and income as me (you could be better or worse off actually)?

Looks Like January was a Great Month

In order to keep on track for my 2007 goal of reaching a net worth of $470,000 I needed to reach $374,000 this month. It looks like I am north of $376,000 at this point. Other major milestones are exceeding a net worth in non-retirement accounts of $200,000. In Australian Dollar terms I added more than $A20,000 to net worth and sailed past $A 1/4 million in the non-retirement accounts. I made $4525 in short-term trading in the US - a rate of return for the month on capital employed of 19.69%. Yup that's more than 800% on an annual basis, so don't expect me to sustain that :) Overall investment returns were far above market indices. January is usually a month where I do very well.

Full details will be coming in a few days.

Paying for Grad School

A good article about whether to pay for a graduate degree. My usual advice is if you aren't going to do a degree in a lucrative and/or high demand professional area (business, law, medicine, physical therapy etc.) don't pay to go to grad school. Even if you are rich, if the school or some other sponsor doesn't want to pay for you then that should be a warning sign that maybe this isn't a good idea. Of course, if you really just want to do it for fun and you have the money, go ahead...

Even some of the students whose PhDs we pay for (I am director of graduate studies for my department) turn out to have been bad investments. Perhaps a quarter of them really shouldn't have done a PhD. If you count those who ended with a masters (while they planned on getting a PhD) maybe up to half of admits are a bad investment. Now maybe some people we refused funding to would have been good investments. But I like to think we do know a little when we make these decisions and that most of the people we don't fund shouldn't go to grad school.