We didn't meet any of the goals we set for the year but we did go a considerable way in the right direction:
1. Increasing net worth from $365k to $470k. We are ending the year around $450k which is around 80% of the way to the goal. The merger with Snork Maiden, quitting my job, and the move to Australia were unexpected events (a positive and two negatives for net worth). I also expected to inherit a small amount of money, which didn't happen yet - as it is still tangled in the German legal system. The Australian Dollar was extremely strong which helped raise net worth a lot. Given all this, it is pretty amazing we ended up anywhere near the goal.
2. Returning the combined value of my US brokerage (and Roth IRA) accounts to the value invested in them. At the start of the year I had $41k in these accounts but had invested $60k. In other words, I had accumulated losses of $19k. Now I have around $50.5k with $58k invested. Around 60% of the goal was achieved.
3. A vague goal was to achieve the $19k in goal 2 through trading. Later, I stated $18k as a 2007 trading goal. I made around $9,800 from trading in the end or about 54% of the goal. I was much closer to the $18k goal at the end of June.
Tomorrow, I will post on my 2008 goals, which will look very different.
Monday, December 31, 2007
Sunday, December 30, 2007
Trading in the Zone: Review
I've now read Trading in the Zone by Mark Douglas. There are lots of reviews that give the book high praise. My review sounds very critical, but probably this is because I am already aware of a lot of a lot of the issues covered in the book through reading trading blogs such as Brett Steenbarger's.
The author is a trading coach but not a psychologist. He is right on the mark in describing the emotions and thoughts traders have which damage their performance but one of the weak points of the book is any of his discussion of how the brain works or any other science for that matter. We read of beliefs being conscious of themselves, the law of conservation of energy applying to such beliefs etc. Other weak points is that the first ten or so chapters could be much condensed. He only really gets to the point in the final chapter: "Thinking Like a Trader". It would also be helpful to have far more examples of actual traders that Douglas has encountered who illustrate his points. There are very few such examples. I can only think of two off the top of my head. Instead there are pages and pages of the single example discussion about a hypothetical boy who is afraid of dogs.
One of the key parts of Douglas' prescriptions for successful trading is to have total confidence in your ability as a consistent trader. What he doesn't address is the real possibility that your trading system stops working in terms of giving you an edge due to temporary or permanent changes in market conditions. What do you do then? How do you know that the edge is gone?
On the plus side he is right about the nature of the markets and the problems traders face and what is necessary to trade in a consistently profitable fashion. There is really only one exercise in the final chapter aimed at changing the trader's thinking. This is of course a very important exercise. One insight I did get was into the nature of "self-sabotage". Douglas says that our belief that other activities are more important or valuable than trading causes us to get distracted and not pay attention to the market and then make mistakes and lose money. This might be especially true once you had made some money - you might think - "OK now I can get back to more important stuff that society values more highly" - and then your profits are lost.
Though my comments here are mostly critical, I'd still give this book 4 stars if I was doing an Amazon.com review. It would be especially valuable for people who have gotten started trading and are experiencing their first round of frustration with not being able to hold onto profits.
The author is a trading coach but not a psychologist. He is right on the mark in describing the emotions and thoughts traders have which damage their performance but one of the weak points of the book is any of his discussion of how the brain works or any other science for that matter. We read of beliefs being conscious of themselves, the law of conservation of energy applying to such beliefs etc. Other weak points is that the first ten or so chapters could be much condensed. He only really gets to the point in the final chapter: "Thinking Like a Trader". It would also be helpful to have far more examples of actual traders that Douglas has encountered who illustrate his points. There are very few such examples. I can only think of two off the top of my head. Instead there are pages and pages of the single example discussion about a hypothetical boy who is afraid of dogs.
One of the key parts of Douglas' prescriptions for successful trading is to have total confidence in your ability as a consistent trader. What he doesn't address is the real possibility that your trading system stops working in terms of giving you an edge due to temporary or permanent changes in market conditions. What do you do then? How do you know that the edge is gone?
On the plus side he is right about the nature of the markets and the problems traders face and what is necessary to trade in a consistently profitable fashion. There is really only one exercise in the final chapter aimed at changing the trader's thinking. This is of course a very important exercise. One insight I did get was into the nature of "self-sabotage". Douglas says that our belief that other activities are more important or valuable than trading causes us to get distracted and not pay attention to the market and then make mistakes and lose money. This might be especially true once you had made some money - you might think - "OK now I can get back to more important stuff that society values more highly" - and then your profits are lost.
Though my comments here are mostly critical, I'd still give this book 4 stars if I was doing an Amazon.com review. It would be especially valuable for people who have gotten started trading and are experiencing their first round of frustration with not being able to hold onto profits.
Saturday, December 29, 2007
Phoenix Market Neutral Fund Changes Managers
A follow up to the story I reported earlier this year about TFS Capital's approach to the directors of the Phoenix Market Neutral Fund, offering to take over management of the fund. It turns out that though Phoenix did not respond to TFS they did decide to change the manager of the fund. I can't find any more information on this event even on Phoenix's website.
Friday, December 28, 2007
Capitulation on Symbion
Primary Health Care (PRY.AX) extended their takeover offer for Symbion Health (SYB.AX). The takeover is for $4.10 in cash but Symbion is trading at $A3.98. Primary currently holds around 35% of the company. Healthscope (HSP.AX) whose previous takeover bids collapsed holds over 10%. I've been waiting for something new to happen in this ongoing saga while paying margin interest to fund my position. Symbion's board says to reject the offer but hasn't come up with any alternative. Maybe I could get more by hanging on, but that's not what the share price says so I prefer to take the certain $A4.10. I'll have to record a $A90 short-term gain as I bought 2000 shares at $A4.04 after the original takeover emerged and a long-term capital gain of $A3,578. I first bought into Symbion (as Mayne Nickless) on 17 February 2000 and that block is still on my books.
Thursday, December 27, 2007
Trading vs. Investing
Snork Maiden commented on Tuesday's post "If we earned so much more from passive investments and long-term capital gains than from trading, maybe we should put more into those kind of investments and less into active trading?".
Well it's not so simple to make that judgment. We only have 6% of net worth allocated to trading vs. 61% allocated to other non-retirement assets. So the $31,691 we earned from longer term investments and cash represents a lower rate of return than the $9,294 we earned from trading. In fact the non-trading rate of return on assets (not equity) was just 11.5% while the trading rate of return was 34.9%. On the other hand, much more risk was experienced in earning the trading income. The Sharpe Ratio in trading for the twelve months of 2007 was about 0.49 while for all non-retirement accounts (including trading) it was 0.90 - in other words relative to volatility excess returns were around twice as high. Based on this, if unlimited leverage at reasonable interest rates was available it would be optimal to lever up the non-trading return instead of trading. On the other hand, the correlation between trading and total non-retirement investment returns is just 0.34. Therefore, it would make sense to have a diversified portfolio that included long-term investments and trading. Depending on preferences, probably the optimal allocation to trading would quite small and some leverage should be used in investing. And that is exactly what we are doing.
This argument is pretty obvious I think if you are familiar with "modern portfolio theory". This graphic illustrates this argument:
The y-axis is the rate of return - 34% for trading and 11% for investing. The x-axis gives the standard deviation of returns, 13% and 70% respectively. The curved black line is the "efficient frontier" - portfolios that allocate varying amounts to trading and investing. The shape of the frontier here is purely illustrative. If the investor has to put all their money into a mixture of investments and trading and can't allocate any to cash and also can't borrow any money then they are going to be at some point on this frontier. With 100% in trading they will be at the point marked trading and with 100% in investing at the point marked investing. Points to the left of investing or right of trading involve shorting one of the two asset classes. The points in between are more interesting for practical cases. Because of the low correlation between investing and trading allocating some money to trading at first raises returns by relatively more than it increases risk - in other words the efficient frontier is convex (up). As we allocate more and more to trading risk increases relatively fast compared to return. Where the optimal point is depends on the investor's preferences. More risk-averse investors will choose more investment and less trading.
If we can also allocate money to cash, the picture is different. Now, it is optimal for all investors to choose the portfolio marked with the green spot for their risky investments and combine this portfolio with cash investments along the green line. If they allocate 100% to cash they receive the risk-free rate (RF) but have zero risk - they are at the point marked RF on the y-axis. Again, where on the green line you invest depends on your level of risk-aversion. By the way, this simple investment theory says that the typical advice to invest more in bonds as you age or have greater risk intolerance makes no sense, unless we are talking about 90 day government bonds which are cash equivalents. All investors should have the same percentage portfolio allocations for their risky investments but different amounts of cash.
If we can borrow money - margin loans, mortgages etc - the picture changes again. Usually the rate we can borrow at is higher than the rate we can lend at and the optimal portfolio is marked by the red point where the red line is tangent to the efficient frontier. The red line starts out at the borrowing rate (BR) which is higher than the risk free rate. This means that if we are thinking about borrowing to invest it is optimal to choose a riskier portfolio to invest in. There is a quantum leap in thinking about risk between leveraged and non-leveraged investors. By borrowing money we have access to return-risk combinations along the solid red line. The more we borrow the higher the return, but the higher the risk. Still borrowing allows us to get higher returns for less risk than if we simply allocated more money to the riskier asset - trading. Again, which point on the line is optimal depends on preferences. We aren't borrowing a lot so we are still relatively risk-averse compared to a more leveraged investor.
There are three counterintuitive results here - examples of what makes economic theory interesting - everyone should have the same allocations to different asset classes once they decide how much to invest in risky assets - but if we borrow to invest we should go for a riskier underlying portfolio - and borrowing to invest is safer than trying to maximize returns by allocating more to high risk investments. All of these go against what most people would think is common sense on investing.
Well it's not so simple to make that judgment. We only have 6% of net worth allocated to trading vs. 61% allocated to other non-retirement assets. So the $31,691 we earned from longer term investments and cash represents a lower rate of return than the $9,294 we earned from trading. In fact the non-trading rate of return on assets (not equity) was just 11.5% while the trading rate of return was 34.9%. On the other hand, much more risk was experienced in earning the trading income. The Sharpe Ratio in trading for the twelve months of 2007 was about 0.49 while for all non-retirement accounts (including trading) it was 0.90 - in other words relative to volatility excess returns were around twice as high. Based on this, if unlimited leverage at reasonable interest rates was available it would be optimal to lever up the non-trading return instead of trading. On the other hand, the correlation between trading and total non-retirement investment returns is just 0.34. Therefore, it would make sense to have a diversified portfolio that included long-term investments and trading. Depending on preferences, probably the optimal allocation to trading would quite small and some leverage should be used in investing. And that is exactly what we are doing.
This argument is pretty obvious I think if you are familiar with "modern portfolio theory". This graphic illustrates this argument:
The y-axis is the rate of return - 34% for trading and 11% for investing. The x-axis gives the standard deviation of returns, 13% and 70% respectively. The curved black line is the "efficient frontier" - portfolios that allocate varying amounts to trading and investing. The shape of the frontier here is purely illustrative. If the investor has to put all their money into a mixture of investments and trading and can't allocate any to cash and also can't borrow any money then they are going to be at some point on this frontier. With 100% in trading they will be at the point marked trading and with 100% in investing at the point marked investing. Points to the left of investing or right of trading involve shorting one of the two asset classes. The points in between are more interesting for practical cases. Because of the low correlation between investing and trading allocating some money to trading at first raises returns by relatively more than it increases risk - in other words the efficient frontier is convex (up). As we allocate more and more to trading risk increases relatively fast compared to return. Where the optimal point is depends on the investor's preferences. More risk-averse investors will choose more investment and less trading.
If we can also allocate money to cash, the picture is different. Now, it is optimal for all investors to choose the portfolio marked with the green spot for their risky investments and combine this portfolio with cash investments along the green line. If they allocate 100% to cash they receive the risk-free rate (RF) but have zero risk - they are at the point marked RF on the y-axis. Again, where on the green line you invest depends on your level of risk-aversion. By the way, this simple investment theory says that the typical advice to invest more in bonds as you age or have greater risk intolerance makes no sense, unless we are talking about 90 day government bonds which are cash equivalents. All investors should have the same percentage portfolio allocations for their risky investments but different amounts of cash.
If we can borrow money - margin loans, mortgages etc - the picture changes again. Usually the rate we can borrow at is higher than the rate we can lend at and the optimal portfolio is marked by the red point where the red line is tangent to the efficient frontier. The red line starts out at the borrowing rate (BR) which is higher than the risk free rate. This means that if we are thinking about borrowing to invest it is optimal to choose a riskier portfolio to invest in. There is a quantum leap in thinking about risk between leveraged and non-leveraged investors. By borrowing money we have access to return-risk combinations along the solid red line. The more we borrow the higher the return, but the higher the risk. Still borrowing allows us to get higher returns for less risk than if we simply allocated more money to the riskier asset - trading. Again, which point on the line is optimal depends on preferences. We aren't borrowing a lot so we are still relatively risk-averse compared to a more leveraged investor.
There are three counterintuitive results here - examples of what makes economic theory interesting - everyone should have the same allocations to different asset classes once they decide how much to invest in risky assets - but if we borrow to invest we should go for a riskier underlying portfolio - and borrowing to invest is safer than trying to maximize returns by allocating more to high risk investments. All of these go against what most people would think is common sense on investing.
Tuesday, December 25, 2007
Trading and Investing Cash Flows for 2008
I'll be doing comprehensive reporting on the year's activity and performance later in January but as the mutual fund distributions are in for the year and I don't plan on doing any more trades with real money till the new year I can report on passive and active investing and trading income in terms of cash payments for 2007:
These numbers are for non-retirement accounts only and also do not include unrealised investment gains nor tax credits received. On the other hand, I don't deduct margin interest costs which were capitalised onto the loan principal. So these are the actual cash payments received that we could have had paid out to a bank account (and in many cases did). For long-term gains and takeovers I'm only counting the profits from the transaction though, not the entire cash received this year. At first glance the numbers look good with a 34.4% gain in investing and trading cash flows in USD terms and a 23% gain in Australian Dollar terms (all numbers to the left of the total column are in US Dollars). If you count the takeover of Powertel as a regular long-term gain, long-term gains realised also increased this year by 60%. Despite all my recent gloom trading income rose 56%. The problem is that I was in a much better position at the end of June regarding trading and unrealised investment gains have also fallen substantially since then. Total income is 24.1% of non-retirement net worth at the beginning of the year, which is similar to 2006's 22.8% rate. Again, this isn't our investment rate of return, which I estimate at 19.5% in USD terms including unrealized gains, tax credits, and margin interest, or only 8.3% in AUD terms (19.1% and 10.2% in 2006).
Looking forward to 2008, I am obviously hoping to do better on the trading front, though even repeating this years 56% improvement in trading income would still not give me very good results in absolute dollar terms. I expect mutual fund distributions to be flat or lower as it seems that the rate of payout has been unsustainable due to the funds selling a lot of their longer term holdings this year and I don't expect as large a gain in dividends in 2008 either. In short, I'm not expecting another 23% increase in cash flow and if it comes it will probably have to be from trading.
These numbers are for non-retirement accounts only and also do not include unrealised investment gains nor tax credits received. On the other hand, I don't deduct margin interest costs which were capitalised onto the loan principal. So these are the actual cash payments received that we could have had paid out to a bank account (and in many cases did). For long-term gains and takeovers I'm only counting the profits from the transaction though, not the entire cash received this year. At first glance the numbers look good with a 34.4% gain in investing and trading cash flows in USD terms and a 23% gain in Australian Dollar terms (all numbers to the left of the total column are in US Dollars). If you count the takeover of Powertel as a regular long-term gain, long-term gains realised also increased this year by 60%. Despite all my recent gloom trading income rose 56%. The problem is that I was in a much better position at the end of June regarding trading and unrealised investment gains have also fallen substantially since then. Total income is 24.1% of non-retirement net worth at the beginning of the year, which is similar to 2006's 22.8% rate. Again, this isn't our investment rate of return, which I estimate at 19.5% in USD terms including unrealized gains, tax credits, and margin interest, or only 8.3% in AUD terms (19.1% and 10.2% in 2006).
Looking forward to 2008, I am obviously hoping to do better on the trading front, though even repeating this years 56% improvement in trading income would still not give me very good results in absolute dollar terms. I expect mutual fund distributions to be flat or lower as it seems that the rate of payout has been unsustainable due to the funds selling a lot of their longer term holdings this year and I don't expect as large a gain in dividends in 2008 either. In short, I'm not expecting another 23% increase in cash flow and if it comes it will probably have to be from trading.
Saturday, December 22, 2007
Neural Networks
Necessity is the mother of invention. In the last couple of days I've taught myself how to use neural networks to forecast time-series. Very helpfully, the econometrics package I am using - RATS - has a built in neural networks module, which is pretty easy to use. Reading some online papers by econometricans got me to see through the rather esoteric language used to understand that these are basically a specific type of non-linear regression model that isn't too far from some of things I've used in my academic research. I experimented with trying to forecast the stochastic oscillator but couldn't get anything better than I could with simple time series models. Now I am "training" a network to forecast changes in the NASDAQ 100 index using all the indicators that my existing model produces. The problem with the existing model is that there are several different indicators (there are three actual time series models for each index). Sometimes the direction is clear but a lot of the time, different indicators point in different directions. I've gradually developed ad-hoc rules for how to interpret the indicators in different situations but it is then very easy to second-guess and make mistakes. The neural network finds the best rules it can given the structure of neural net (explanatory variables, number of neurons etc.) and provides a simple long, short decision. So far the results are extremely good, but this is early days. Using this approach would add another layer of models to run every day but reduce the amount of time needed observing the market etc wondering what to do and whether the right decision was made.
In my simulated trading this week I did really well trading the Australian stock index futures (SPI) but not well trading the Nikkei. I think though I am beginning to get the hang of how to day trade the Nikkei.
Overall, it feels like I made progress this week, which is good.
Thursday, December 20, 2007
Imaginary Money Almost Feels Like Real Money
In the past I found it hard to take simulated trading seriously. There was no real money at stake so it was hard to take seriously the need to use a precious resource time to monitor the market closely on those trades. I didn't feel any pain of losing money, it was just an experiment to see how things worked. But now simulated money feels almost like real money. The pain and anxiety of losing money is real the euphoria of winning is real too. To a lesser degree of course than when I win or lose real money. The reason I think is that now I feel my "trading career" is on the line and I really need to improve my skills and discipline. Each bad trade I do even under simulation is taking me away from that goal and that is the emotion I am feeling. Some emotion I think is necessary to make us care about the outcomes of trading. Too much of the wrong emotions are of course very detrimental. It's a delicate balance.
Wedding
Yesterday evening we met with a "marriage celebrant" and started the ball rolling for real on our wedding. It's going to be a very small and frugal wedding as these things go but things to plan or pay for begin to add up fast. So far we have the celebrant lined up and a dress for Snork Maiden that she got from China a little while ago. We've been thinking through some ideas and so far tried to check out two possible restaurants where we'd plan on having a lunch (we're planning at the moment to hold the ceremony in ate morning). The first restaurant turned out to have closed down and as we were already out we decided to go to another, somewhat disappointing, place. Last night we went to another which was better but still suboptimal. I guess these are "research costs" of the wedding :) We'll have plenty to do over the Christmas-New Year break in "purpose-driven sight-seeing". We are planning to have the wedding early in the new year so that Snork Maiden can then ASAP file for an Australian permanent residence visa.
Wednesday, December 19, 2007
Trading School
I'm not going to do any real trades for a while until I am satisfied that I've got my act together. In the meantime I'm in "trading school". Did 4 simulated trades so far this morning - two on the SPI (Australian Index) and two on the Nikkei. All have made money. For the Nikkei trades I am using a version of the rule of three - entering the trade with three contracts and then scaling out. The exits are all pretty random though, though I am trying to exit the last contract at my actual target based on the stochastics and/or using a stop. But it's helping - my second contract is being sold at a higher price than the third. This approach ensures that winning trades don't become losers, which is what often happens to me. Nikkei mini contracts are small enough for me to actually do this with real money. SPI contracts are so big it would be way too scary to enter with three contracts - I don't even have enough money in my account for that amount of margin at the moment!
Still, I am left a lot of money on the table in my SPI trades. Being able to scale out would have increased the rate of return.
Still, I am left a lot of money on the table in my SPI trades. Being able to scale out would have increased the rate of return.
Tuesday, December 18, 2007
Trading in the Zone
I walked into town this afternoon and bought a copy of this book at Borders (yes we have them here too). Luckily there was a copy available. The book is in twelve libraries in Australia including one of the public libraries here in the ACT, checked out till 20th January. But I want to read it before then and at my leisure so I thought it was worth the investment. I'll report on what, if anything I learn. Most people seem to say it is one of the best books on trading.
New Low
I traded the NQ futures this morning and lost more money. Again, going long when the model is short and the market already down a lot, hoping to catch a falling knife and then doubling up to two contracts from one when I was already down. All the mistakes I could make, I made. Now reached a new low in trading profit and loss for the last six months.
On the other hand, yesterday morning I made simulated trades in the Australian (SPI) and Nikkei futures. I made three SPI trades which were all winners for a total of an imaginary $A800 or so. In the Nikkei I made ¥5,500. That's more than I lost for real this morning. Why do I trade better with imaginary money than real money? It seems a lot of people have exactly this problem. I'm going to do more simulated trading later today. I think this is the best thing to do at the moment.
Yesterday lunchtime I met a guy who works with Snork Maiden. He does stuff with neural networks but hasn't applied it to time series. He is also interested in trading and has read quite a bit but hasn't actually even opened a brokerage account yet. I guess it was mostly me telling him how tough it is and what does or doesn't work. Later I met a PhD student at ANU who wanted to quiz me on one of my research areas and I also worked a bit on a paper I am revising with a former student in the US. More people here are finding out that I've returned to Canberra. I bumped into one guy who was riding his bike on campus. He used to work as a non-faculty staff member in my department. In the meantime he did a PhD and is now a lecturer (assistant professor) at ANU. We haven't met in five years but he recognized me stopped his bike and we had a chat. Another guy sent me some stuff about jobs here. I'm not willing to give up on the trading dream yet as I have barely gotten started on trying to trade Australian and Japanese markets during the day here. If that doesn't work for me either then maybe I'll have to admit defeat.
My emotions now are different than they were after other recent losses. Then typical I couldn't bear to trade for a while and felt very upset and despairing. Now I fee angry with myself and frustrated. It would have been good not to go right back in and trade today. I guess "revenge trading" is what screwed me up today.
On the other hand, yesterday morning I made simulated trades in the Australian (SPI) and Nikkei futures. I made three SPI trades which were all winners for a total of an imaginary $A800 or so. In the Nikkei I made ¥5,500. That's more than I lost for real this morning. Why do I trade better with imaginary money than real money? It seems a lot of people have exactly this problem. I'm going to do more simulated trading later today. I think this is the best thing to do at the moment.
Yesterday lunchtime I met a guy who works with Snork Maiden. He does stuff with neural networks but hasn't applied it to time series. He is also interested in trading and has read quite a bit but hasn't actually even opened a brokerage account yet. I guess it was mostly me telling him how tough it is and what does or doesn't work. Later I met a PhD student at ANU who wanted to quiz me on one of my research areas and I also worked a bit on a paper I am revising with a former student in the US. More people here are finding out that I've returned to Canberra. I bumped into one guy who was riding his bike on campus. He used to work as a non-faculty staff member in my department. In the meantime he did a PhD and is now a lecturer (assistant professor) at ANU. We haven't met in five years but he recognized me stopped his bike and we had a chat. Another guy sent me some stuff about jobs here. I'm not willing to give up on the trading dream yet as I have barely gotten started on trying to trade Australian and Japanese markets during the day here. If that doesn't work for me either then maybe I'll have to admit defeat.
My emotions now are different than they were after other recent losses. Then typical I couldn't bear to trade for a while and felt very upset and despairing. Now I fee angry with myself and frustrated. It would have been good not to go right back in and trade today. I guess "revenge trading" is what screwed me up today.
Sunday, December 16, 2007
Short the Nikkei
I've now estimated my model for the Nikkei and it is pretty successful in backtests. The model says to look for short-trades in the Nikkei on Monday. I probably won't start trading it though till Tuesday due to a couple of meetings I have during the day on Monday. Perhaps more on one of those meetings with someone interested in trading and modeling after we meet. A lot is happening this week actually. Should be interesting. I'll keep you informed.
P.S. The US models would suggest to switch to long Monday except that even if the indices were unchanged they would fall deeply into the oversold zone, which says to stay short. So only a very strong rally on Monday would actually show to get long. There is a reasonable likelihood of a positive gap up at the open Monday, that might be what you need to get long.
P.S. The US models would suggest to switch to long Monday except that even if the indices were unchanged they would fall deeply into the oversold zone, which says to stay short. So only a very strong rally on Monday would actually show to get long. There is a reasonable likelihood of a positive gap up at the open Monday, that might be what you need to get long.
Saturday, December 15, 2007
Back to Square One Again
I shouldn't boast on this blog about making money, because I tend to go ahead and lose it immediately. The chart above shows the profit and loss on my Interactive Brokers account from 14th November till today. On 13th November I suffered a major loss (of $1750) and since then I have been struggling to rebuild my account. I've now been through three cycles of consistently making money only to blow it all up again. The positive aspect is I'm only blowing up profits I made since that day and so in some sense the situation is stabilizing. Three losing trades contributed to last night's blow-up - the first was excusable though silly, the next two were just plain dumb - going long on a down day in the market and holding on hoping for a turnaround. I could have gotten out of these two trades with a decent profit, but let them turn into losers. One lesson I think is not to daytrade overnight. Most of these losses recently have occurred late into the night. One of my rules is not to trade in the middle of the US trading day as I find the direction of the market very unclear. I need to stick to that and currently focus on trading the last two hours of US trade and then Australia and probably Japan. In the winter here (northern summer) I'd trade the US open and Australia/Japan. Some day I'd get around to trading my model with trades over a few days. But right now, just getting any kind of profitability is the focus.
Friday, December 14, 2007
Japanese Futures
During the 24 hour global trading day stock indices appear to be most influenced by the largest market currently open as well as catching up on what the US markets did the previous day. The day starts in New Zealand, a tiny market, followed by Australia - either the second or third largest Asian market depending on who you believe and an hour later Japan comes online with Korea, followed later by Shanghai, Hong Kong etc. At 7pm Eastern Australian time (3am on the US East Coast) the major European markets including London, the largest, open. US stock index futures tend to track what is happening in the largest open stock market. This is particularly clear once the London market opens. Volume on US future usually increases substantially and often volatility does too as the futures begin to track what is happening in London. The same is also true of the Australian stock index futures to some degree - once Japan opens the Japanese market has a strong influence on Australia. At the moment I am trading US futures during the time that the London stock market is open in our evening here in Australia. I can get up to date data on the FTSE index from Yahoo's website. Unfortunately though Nikkei data is delayed by 20 minutes and this is one more factor making trading Australian futures difficult (other reasons are the large size of the contract, the often think market, the staggered index open etc.). Interactive Brokers can provide data from the Osaka Futures exchange for 1200 Yen a month (USD 10.70).
You can then also trade the Japanese futures. So I am thinking of trying this out, maybe next week. It could help me trade the Australian futures but also I might actually trade in Japan. I will have to see what the market there looks like before committing to the idea, with some paper trades first. There are two contract sizes available:
Full size contract:
Value = ¥1000*Nikkei (i.e. USD135k per contract)
Initial margin = ¥750k (i.e. USD6,700)
Tick size = 10 points
Commission = ¥500
Mini contract:
Value = ¥100*Nikkei (i.e. USD13,500 per contract)
Initial margin = ¥75k (i.e. USD670)
Tick size = 5 points
Commission = ¥150
The large contract is about the same size as an Australian futures contract and the minimum tick size is equivalent to one S&P futures (ES) point. That means that you are down the equivalent of 1 point immediately (plus commission) when placing a trade. Neither of those are good for me. The small contract though is about the third of the size of a NASDAQ futures (NQ) contract and the tick is equivalent to half an ES point. ES and NQ futures tick size is 1/4 point, Australian futures tick size is one point which is the equivalent to the ES 1/4 point. The mini contract might be an attractive day trading instrument. And I could really "day-trade" as opposed to "night-trade", which is what I am doing at the moment.
BTW, the CME-Globex exchange offers Nikkei futures, but they only trade when the Japanese stock market is closed!
P.S. After a bad start to the month I am now about back to breakeven on my Interactive Brokers account. Though right this minute I'm in an ES trade that is not going well :(
P.P.S. I signed up for the data and trading permissions and already have it! Very cool. There are plenty of contracts being traded and the discrepancy between the mini and full-size spread is real - how weird.
Wednesday, December 12, 2007
Volatility
I'm now turning to looking at volatility of stock prices and seeing if it could be a useful addition to my trading model. More sophisticated investors and traders and familiar with measures of stock price volatility derived from the implicit volatility expressed in options prices according to the Black-Scholes options pricing model. The VIX and VXN are the best known of these and measure the volatility implied by options on the S&P 500 and NASDAQ 100 indices. But one can also measure volatility directly from stock prices. The most straightforward would be a standard deviation of changes in the index. The problem with this and the reason why the options based indicators are popular is there will be a different result depending on how many observations are used to compute the standard deviation. This indicator also doesn't address intraday volatility. A measure of intraday volatility is Average True Range. True range measures the range of prices from previous close to close (and therefore includes any gaps in the range). ATR is simply an exponential moving average of this. A problem with this indicator is it is dependent on the level of prices. Of course we can simply divide true range by average price over the day to get a unit free measure of the daily range as a percent of price. The chart tracks a five day exponential moving average of this latter indicator.
The late 1990s and early 2000s were far more volatile than today with volatility peaking with an average of a 9% daily price range over the a five day period. As the post 2002 bull market took off volatility declined to very low levels and has now begun to re-emerge but not to the extent seen several years ago.
Why might volatility be interesting?
1. While mainstream finance theory claims that it is not possible to forecast stock prices (this is true though direction of stock prices may be forecastable) it is believed to be possible to forecast volatility in the short term. Typically ARCH (autoregressive conditional heteroskedasticity) time series econometric models are used. Being able to forecast volatility is a big advantage obviously in option trading and a reason I mostly avoid option trading except using deep in the money options as proxies for margined stock or futures. Volatility is not a component of futures prices which makes trading them a lot easier.
2. Stock prices are far more volatile when declining than rising. Market tops are more commonly characterised by narrow trading ranges that finally fail than by volatile "blow-offs". Market bottoms typically show violent intra- and inter-day fluctuations. If one forecast rising volatility - declining prices might also be associated with that forecast. Of course it makes sense that volatility is higher with declining prices -a rise in volatility implies a rise in risk and higher risk implies that lower prices are optimal - investors should pay less for a given amount of earnings with higher volatility assuming risk aversion.
At least volatility might explain some things about stock price behavior that my current completely price based model does not. So I'm going to do a bit of research on this. My first problem though is deciding on an appropriate indicator of volatility.
Monday, December 03, 2007
November 2007 Report
All figures are in US Dollars (USD) unless otherwise stated. This month saw a fall in net worth in US Dollar terms partly due to the fall in the Australian Dollar and partly to poor investment performance due to the decline in global stock markets this month. Net worth also decreased in Australian Dollars terms. Trading results were negative but I managed a significant turn around in the last few days of the month.
Income and Expenditure
I've introduced a breakdown of investment and trading income for the first time in this month's report. The two sum to "core investment income" which together with "forex" sums to "investment income". I've used different size fonts to try to express this relationship. Not sure that it works :) I've also broken out "core expenditure" which excludes work-related and moving-related expenses.
Expenditure was $6,680 but this includes a large work-related expense for Snork Maiden (which resulted in us effectively buying two thousand or so Australian Dollars (expense in US Dollars, reimbursement in Aussie) and port-handling charges in Sydney for both of us. Core expenditure was well under control at $3,280. This included $A59.07 of implicit interest costs of owning a car.
Non-investment earnings ($7,119) included the refund of the work-related expenses from Snork Maiden's employer. She also again got paid by her previous employer. We've told them to stop paying and we may need to pay this money back, but for the moment I am counting it as income. Snork Maiden's retirement contributions were $1180.
Non-retirement accounts lost $19,364 with $8,315 of the loss resulting from the fall in the Australian Dollar. Retirement accounts lost $6,917 but would have gained only $249 if exchange rates had remained constant. This gain is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. In AUD terms non-retirement accounts lost and retirement accounts gained for the month.
Net Worth Performance
Net worth fell by $US24,563 to $US453,326 and in Australian Dollars fell $A3,171 to $A512,406. Non-retirement accounts were at $US241k. Retirement accounts were at $US212k.
Investment Performance
Investment return in US Dollars was -5.50% vs. a 4.38% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 4.18% loss in the S&P 500 total return index. Non-retirement accounts lost 7.46%. Returns in Australian Dollars terms were -0.96% and -3.01% respectively. In currency neutral terms the portfolio lost 2.26%, which is relatively good compared to the performance of the indices. YTD we're up 20.4% (USD) vs the MSCI with 13.4% and the SPX with 6.4%. Our non-retirement accounts are up 24.8%.
The contributions of the different investments and trades are as follows:
The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. My Australian funds all did horribly with Platinum Capital being the worst of all. I also suffered net losses trading SPI (Australian Share Price Index) and ES (S&P 500) futures but gained in NASDAQ trading. PSS(AP) is Snork Maiden's superannuation fund, where we are starting off with a loss...
Progress on Trading Goal
I lost $1,035 in trading following losses of $1,123 in September and $681 in October. The losing streak is depressing even though relative to net worth the numbers are small. The loss is 3.97% of trading capital vs a 6.69% loss in the NDX. My IB account lost exactly 6.69% for the month, though I gained 7.8% or $1,310 in the last week in this account. As far as my goal of achieving breakeven in my 3 US trading accounts, I have currently invested a net amount of $60k and the accounts are currently worth $54,230. At the end of 2006 the value stood at $41,042 so I have made progress even if it is slower than I would have liked.
Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.42. Recent performance shows, though, that actual beta of my USD denominated returns is a lot higher than this. My time series estimate using the Kalman filter estimates beta to the S&P 500 at 0.90 and to the MSCI at 1.00. The reason for this is that the Australian Dollar is becoming increasingly correlated with global stock market returns due to the carry trade where traders borrow in low interest currencies like the Yen and buy high yielding currencies like the AUD and stocks. When their "aversion to risk" increases they sell both Aussie Dollars and stocks and buy Yen and US bonds.
Allocation was 29% in "passive alpha", 67% in "beta", 6% allocated to trading, 4% to industrial stocks, 6% to liquidity, 3% to other assets (including our car which is equal to 2.8% of net worth) and we were borrowing 15%. The biggest losses this month were in the funds that I have designated as "passive alpha". Those funds really contain a lot of beta of course too. I include all hedge-fund like and alternative investments under the "passive alpha" label and all long-only equity mutual funds under "beta". Our currency exposures were roughly 60% Australian Dollar, 30% US Dollar, and 10% Other (mainly global equity funds).
Income and Expenditure
I've introduced a breakdown of investment and trading income for the first time in this month's report. The two sum to "core investment income" which together with "forex" sums to "investment income". I've used different size fonts to try to express this relationship. Not sure that it works :) I've also broken out "core expenditure" which excludes work-related and moving-related expenses.
Expenditure was $6,680 but this includes a large work-related expense for Snork Maiden (which resulted in us effectively buying two thousand or so Australian Dollars (expense in US Dollars, reimbursement in Aussie) and port-handling charges in Sydney for both of us. Core expenditure was well under control at $3,280. This included $A59.07 of implicit interest costs of owning a car.
Non-investment earnings ($7,119) included the refund of the work-related expenses from Snork Maiden's employer. She also again got paid by her previous employer. We've told them to stop paying and we may need to pay this money back, but for the moment I am counting it as income. Snork Maiden's retirement contributions were $1180.
Non-retirement accounts lost $19,364 with $8,315 of the loss resulting from the fall in the Australian Dollar. Retirement accounts lost $6,917 but would have gained only $249 if exchange rates had remained constant. This gain is due to the strong exposure to bonds in our retirement accounts and the stronger exposure to equities in our non-retirement accounts. In AUD terms non-retirement accounts lost and retirement accounts gained for the month.
Net Worth Performance
Net worth fell by $US24,563 to $US453,326 and in Australian Dollars fell $A3,171 to $A512,406. Non-retirement accounts were at $US241k. Retirement accounts were at $US212k.
Investment Performance
Investment return in US Dollars was -5.50% vs. a 4.38% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 4.18% loss in the S&P 500 total return index. Non-retirement accounts lost 7.46%. Returns in Australian Dollars terms were -0.96% and -3.01% respectively. In currency neutral terms the portfolio lost 2.26%, which is relatively good compared to the performance of the indices. YTD we're up 20.4% (USD) vs the MSCI with 13.4% and the SPX with 6.4%. Our non-retirement accounts are up 24.8%.
The contributions of the different investments and trades are as follows:
The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. My Australian funds all did horribly with Platinum Capital being the worst of all. I also suffered net losses trading SPI (Australian Share Price Index) and ES (S&P 500) futures but gained in NASDAQ trading. PSS(AP) is Snork Maiden's superannuation fund, where we are starting off with a loss...
Progress on Trading Goal
I lost $1,035 in trading following losses of $1,123 in September and $681 in October. The losing streak is depressing even though relative to net worth the numbers are small. The loss is 3.97% of trading capital vs a 6.69% loss in the NDX. My IB account lost exactly 6.69% for the month, though I gained 7.8% or $1,310 in the last week in this account. As far as my goal of achieving breakeven in my 3 US trading accounts, I have currently invested a net amount of $60k and the accounts are currently worth $54,230. At the end of 2006 the value stood at $41,042 so I have made progress even if it is slower than I would have liked.
Asset Allocation
Using the simple method of adding up the betas of each individual investment weighted by their portfolio allocation, at the end of the month the portfolio had an estimated beta of 0.42. Recent performance shows, though, that actual beta of my USD denominated returns is a lot higher than this. My time series estimate using the Kalman filter estimates beta to the S&P 500 at 0.90 and to the MSCI at 1.00. The reason for this is that the Australian Dollar is becoming increasingly correlated with global stock market returns due to the carry trade where traders borrow in low interest currencies like the Yen and buy high yielding currencies like the AUD and stocks. When their "aversion to risk" increases they sell both Aussie Dollars and stocks and buy Yen and US bonds.
Allocation was 29% in "passive alpha", 67% in "beta", 6% allocated to trading, 4% to industrial stocks, 6% to liquidity, 3% to other assets (including our car which is equal to 2.8% of net worth) and we were borrowing 15%. The biggest losses this month were in the funds that I have designated as "passive alpha". Those funds really contain a lot of beta of course too. I include all hedge-fund like and alternative investments under the "passive alpha" label and all long-only equity mutual funds under "beta". Our currency exposures were roughly 60% Australian Dollar, 30% US Dollar, and 10% Other (mainly global equity funds).
House Price Update
Thanks to financial reality for the graph. House prices continue to fall in the US. However a renewed decline in house prices is yet to get underway in Australia. There was a decline in prices in Sydney and a slowdown in other cities earlier in the decade and since then prices rebounded. The following are year on year changes for September 2007:
Data are reported on a quarterly basis by the Australian Bureau of Statistics. Only Perth is now showing the beginning of a slowdown though price actually rose in the last three months there.
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