December 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 continuing decline in global stock markets this month. Both these trends were milder than last month. Net worth also decreased in Australian Dollars terms. Trading results were bad and I stopped active trading to focus on improving my trading performance using simulated trading.

Income and Expenditure



Expenditure was $3,547 - there were no exceptional expenses. There were $315 of implicit car expenses - depreciation and interest - so actual cash expenditure was $3,212.

Non-investment earnings ($5,924) included another refund of 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 from her employer were $559.

Non-retirement accounts lost $6,052 with $1,414 of the loss resulting from the fall in the Australian Dollar. Retirement accounts lost $1,731 but would have lost only $405 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. Trading contributed around half the loss in the non-retirement accounts, but actually came out slightly positive in my Roth IRA.

Net Worth Performance
Net worth fell by $US4,759 to $US448,556 and in Australian Dollars fell $A1,161 to $A511,233. Non-retirement accounts were at $US237k. Retirement accounts were at $US211k.

Investment Performance



Investment return in US Dollars was -1.72% vs. a 1.08% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 0.69% loss in the S&P 500 total return index. Non-retirement accounts lost 2.51%. Returns in Australian Dollars terms were -0.88% and -1.70% respectively. In currency neutral terms the portfolio lost 1.11%,. Summing up the year, we gained 18.35% (USD) vs the MSCI with 12.18% and the SPX with 5.5%. Our non-retirement accounts are up 21.68%. Australian Dollar returns were competitive with the SPX. In currency neutral terms we gain 9.8% for the year.



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. Trading resulted in some of the biggest losses - QQQQ/NQ and ES. Otherwise, no clear story emerges this month except that EBB.AX and EBI.AX continue to perform poorly.

Progress on Trading Goal

I lost $2,003 in trading . The loss is 6.92% of trading capital. The NDX was down 0.2% for the month. For the year, trading generated $9,749 or a gain of 35% vs. an NDX gain of 18.4%. So in the end I beat the market, but with a lot more risk and volatility.

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 0.47. Using a regression on the last 36 months of returns gives a beta of 0.81 to the MSCI or 0.60 to the SPX. Alphas are 0.55% and 6.44% respectively. A more sophisticated time series method yields a beta of 0.97 and alpha of 7.6% for the MSCI index. The extra beta generated by these methods is due to the correlation between equity returns and the Australian Dollar in recent times as a result of the "carry trade".

Allocation was 29% in "passive alpha", 66% in "beta", 6% allocated to trading, 3% to industrial stocks, 7% to liquidity, 3% to other assets (including our car which is equal to 2.8% of net worth) and we were borrowing 14%. Our currency exposures were roughly 60% Australian Dollar, 30% US Dollar, and 10% Other (mainly global equity funds).

Stops: The Key to Success in Day Trading

I wanted to give this post a positive title. All experienced traders know that the key to being profitable is to set stop losses and use them. Even a system which generates random entries to the market could be profitable if the exit strategy is systematic. If you set and use appropriate stops you can be profitable. Beyond that it is all about increasing profitability and/or reducing variance. I emphasized day-trading here because my model that uses daily data can be profitable without stops. In intraday discretionary trading you can't apply such sophisticated strategies. At least I can't. A black box systematic program maybe could trade without stops intraday.

Anyway, the point is that I know all this stuff but still make the mistake of not honoring my stop-loss even when I'm now trading with imaginary money. Here is my equity curve trading the Australian Stock Price Index Futures with virtual money:



The blue line is the actual equity curve and the red line what would have been if I had stuck with my planned stop. This looks a lot like my real money trading in recent months. A slow consistent climb followed by a fall off the cliff.

So why did I screw up? This chart shows the SPI futures:



They open at 9:50am Sydney time. Ten minutes before the stockmarket. The first five minute bar was red and my NDX and Nikkei models were short so I went short. Very quickly the market reversed and my plan was to exit if the market traded above the opening price, which would show that my idea that the market would trend down from the open was wrong. We can also see here that my stochastic oscillator crossed over and moved up, showing me that I am wrong on this idea that the market is going to go straight down. This should be a slam dunk to get out. So why didn't I?

When the actual stockmarket opened, the first five minute bar was up, but the second one was red:



I "hoped" that the market was actually going down here. This was just noise though as shown by the stochastics - and the first ten minutes of trading in the Australian market is pretty meaningless as each stock is opened in alphabetical order over the first ten minutes (the Dow Jones index is similarly meaningless in early trading in the US). So I should have just ignored this. But hope got me into a completely wrong train of thought that the market would turn down despite all the evidence to the contrary. 20 minutes in I even shorted a second contract at 6352 (the first was at 6341). Eventually, I capitulated above 6370.

I'm disappointed that I'm trading this bad even with virtual money. OTOH I can't wait till Friday when the Japanese market next trades to get practicing again on Nikkei futures.

U.S. Restaurant Stocks

Take a look at the charts of these U.S. restaurant stocks:

Starbucks
Cheesecake Factory
Darden
Ruth's Chris
Ruby Tuesday
Buffalo Wild Wings
Jack in the Box
IHOP
Brinker
Wendy's
Morton's
Benihanna
P. F. Chang
Texas Roadhouse
Peet's
Domino's Pizza
California Pizza Kitchen
Papa John's
CKE
J. Alexander
Cosi
Cracker Barrel
Krispy Kreme Donuts
Rubio's
Bob Evans
Denny's
Grill Concepts
Steak n Shake
Chuck E. Cheese
Panera Bread
Jamba Juice

This one was doing well till recently:

Einstein/Noah Bagels

There are plenty more once you start digging...

Mostly they look as bad as homebuilders or financials. I got the idea of checking this out after reading in some article about what a bad stock Ruby Tuesday is. There are some exceptions:

Yum Brands
McDonald's
Burger King
Chipotle

The first three are all low price fast food chains. These are doing well, but mid- and high-range restaurant stocks are doing terribly. Sign of recession?

Any Australian restaurant stocks?

P.S.

I found an Australian one - Domino's Pizza:



Not too hot either.

Goals for 2008

Yesterday, I reported on performance relative to my goals for 2007. I've discussed why I think my earlier goals for 2008 were unrealistic. So here are some thoughts on more achievable goals:

1. Increase Net Worth I'm not going to specify whether in Australian Dollars, US Dollars, or in currency neutral terms. Increasing net worth in all three would be nice but large fluctuations in exchange rates may make one of the goals hard to achieve. We can compute the change in currency neutral net worth by taking away the gains or losses for the month or year due to exchange rate fluctuation from actual net worth in either currency. Probably a gain in currency neutral terms should be the minimum goal here. We get a head start from Snork Maiden's employer's superannuation (retirement) contributions of around $A8.600 for the year. Failing to meet this goal means either that investment returns were -2% or worse roughly and we spent all of Snork Maiden's salary or that we are spending more than her salary and our after tax investment returns or some combination of overspending and/or poor investment returns.

2. Positive Alpha This goal says that our investment returns should on a risk-adjusted basis beat the MSCI World Index on a before tax basis. Beating the index (in a risk-adjusted sense) could be the only justification for trying to manage your money yourself (rather than buying a bunch of index funds) apart from educating yourself about finance through the process of managing your portfolio.

3. Increasing Non-Retirement Net Worth by More than the Index This is a much tougher goal to achieve. It requires substantially beating the index on a before tax basis and/or spending less than Snork Maiden's income. Again we can measure this in Australian Dollars, US Dollars, or in currency neutral terms.

4. Achieving Break-Even on Ameritrade and IB Accounts This was a goal for 2007. Though I made progress on it, I didn't achieve it. Things will have to be bad on the trading front in the coming year if I'm not to achieve this goal.

5. Making More Money from Trading I made more money from trading in 2007 than 2006, though not as much as I'd have liked. The goal for 2008 is just to make more again. I have two measures of trading income - the net non-investment gain on my Ameritrade and IB accounts (trading and net interest) and short-term capital gains reported on my tax return (which includes short-term gains or losses in Australia but excludes margin interest). Both numbers were about $US9,500 for 2007.

Trading Consistency

A very interesting blogpost about trading consistency. The bottom line is that you need to take as many trades as possible within your system guidelines to be consistently profitable as long as your expected profit per trade (expectancy) is positive. Which makes perfect sense statistically. Even my simulated trading of the Australian futures has a "profit factor" (total dollars of winning trades/total dollars of losing trades) of only 1.84 currently. I can find an average of 1-3 trades per day probably. But still around 95% of months would be expected to be profitable based on the somewhat simplified analysis in the article. But my real money NASDAQ/SPX trading is now only at a "profit factor" of 1.11. Not much more than half of months would be expected to be profitable. Which is what I saw this year roughly (7/12).

By contrast, Dinosaur Trader has a profit factor based on his daily results of 3.01. But still he had two losing months out of nine (78% consistency). That is a very negative outlier. According to the article, with 20 trading days per month consistency should be in the 97-98% range. I notice that the win percent in their simulations is very high compared to DT's or my own.

BTW DT's win percent is similar to mine: 64% but his win/loss ratio (how much his typical win makes relative to his typical loss) is 1.70. His trade by trade data might be quite different. On average he made $604 per day with a standard deviation of $2708. The t-statistic to test whether this mean is greater than zero is 2.81 which is highly statistically significant. In other words, it's not luck.

2007 Goals Review

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

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).

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.

Trading Update

This month's trading result is again negative due to a few big losses. But this week (so far) is the best individual week since May, which is encouraging (a couple of other weeks since May came pretty close to this one). The loss for the month is now less than the single biggest losing trade. What am I doing - pretty much pure day-trading with minimal use of "the model".

P.S. 1 December

Trading loss for the month was $1,004. I was down around $2,500 only three days ago so have done very well since then. I'd like to think that that is the beginning of the turnaround. Time will tell. I'm holding one trading position over the weekend - 300 shares of QID the double short NASADQ 100 ETF. Up $279 on that trade.

Update on Goals

I've kept the 2007 goals on the sidebar but I've taken down the goals for 2008 and beyond as they are looking increasingly unrealistic. Exchange rate fluctuations mean that a goal in any particular currency is hard to hit as do stock market fluctuations for buy and hold investors. Perhaps I could come up with a currency neutral measure of net worth gain. But probably I am going to go for aspirational goals going forward: Increase net worth (increase non-retirement net worth - which is harder), increase trading income, etc. It's easier also to set goals for investment and trading performance relative to a benchmark (Increase non-retirement net worth faster than the MSCI index?). As for the goal of a net worth of $1 million, I now project that that could occur by the end of 2012 rather than 2010. It remains an interim goal but setting any date on achievement of the goal is too hard. I'll do a revised set of goals later in December.

Is that the Bottom?

Howard Lindzon is calling a bottom in the stock market here. Is this the bottom? My model appears to be exiting the noisy conditions that made using it almost impossible and is now giving a much clearer signal. Expect some downside starting most likely on Monday. It is also signalling that we remain oversold not overbought. Conditions look very similar to early August where a consolidation in the market was followed by a plummet to the final lows on August 16th. This could happen and looks like the likeliest scenario to me and is supported by a lot of other stuff I am seeing. But this could be the bottom. We'll only really know when the next low occurs next week - will it be a higher low or a lower low? In the meantime enjoy the rally :) The fundamentals behind this rally are supposed to be the investment by Abu Dhabi in Citigroup and the possibility of rate cuts. Both facts show that things are very bad but help is on the way to stop them getting even worse. The fact that Citigroup needs this capital injection on such bad terms is very bad news. But I guess the market thought that things could be worse and noone might come to Citigroup's rescue.

Australian Election

I voted yesterday in the Australian Federal Election. Snork Maiden came along, even though she can't vote here, and I was surprised to find we had to stand in line to vote, like (now former) prime minister John Howard in the picture. I didn't encounter that in previous years here (or in England). I voted Labor for the first time here in Australia. Labor seem to have finally moved much closer to the centre than in any time in their eleven years out of power. The Hawke-Keating Labor government before 1996 was a very reformist administration, but after they lost power the party swung left and stayed out of power till now. The Liberal Party didn't seem to have much of an election pitch except to warn of the dangers of electing Labor claiming them to be inexperienced and extremist. Many people seemed to have also decided to give the other guys a chance. Labor's main difference with the Liberals was on their plan to roll back some of the Liberals labour market reforms - this would have put me off voting Labor. What swung me to Labor was their more convincing approach to climate policy. In fact I voted Green with my second preferences to Labor. In Australia we get to order candidates according to how much we prefer them rather than just choosing one candidate. If your first choice candidate doesn't get enough votes to win a seat your votes are transferred to your second choice candidate and so forth. Another unusual feature of Australian elections is that voting is compulsory.

Here in the ACT it is pretty much guaranteed that Labor will win both lower house seats and that the Senate will split one Liberal and one Labor senator. So voting for a minor party can indicate a policy preference while your vote in the end goes to one of the major parties. I've long thought it would be nice if we could de-bundle political parties - choosing different parties to represent us in different policy areas.

Searching NetWorthIQ by Country

Networth IQ has finally added the ability to search by country. Not surprisingly, Australia seems to be the best represented country outside the US. I wonder though how many profiles are in Australian Dollars in fact and how many in US Dollars. Not that it makes a huge difference for Australia at the moment. I know for example that Enoughwealth's profile is in Australian Dollars, while mine is in US Dollars. A nice feature for the site would be allowing people to enter data in their native currency and then for users to read profiles either in the original currency or in US Dollars.

Monday Night Trading

I lost money today, but not too badly which was partly the result of a little skill and a lot of luck. Again I got too caught up in thinking about what the model said rather than what the streaming charts were telling me. The NDX model was stopped out again. So it isn't exactly much use at the moment. I went long per the model after the market had declined before the official open - a gap down was likely and this happened. Then shortly after the market (US) opened there was a good opportunity to close my trade profitably. But I stupidly hung on for more gain and ended with a loss instead. Letting your winners run is one of the most common pieces of advice given to traders but it can be very dangerous. I managed to close the trade with only a small total loss by doubling down (a big no-no in the standard advice for traders). Then as I was feeling good at not suffering a huge loss I entered another trade assuming the market was going to continue rising. The market immediately started falling towards the close instead. I closed that trade for a larger but still reasonable loss after the market close and Hewlett Packard's earnings announcement. I did some other every quick trades that won a few bucks here and there. But that second trade was a totally arrogant trade - again believing that the market would rise as the model dictated irrespective of the evidence. I'll slowly hammer this behavior out of my mind - at least until the model begins performing better again. Anyway, I lost half the profits I made since the big loss a few days ago. Am still down badly for the month, but feel I am learning something despite all these errors, or rather because of them.

Petrol Consumption

Amazing that Australia uses more petrol than France that has three times the number of people. Price of filling up a Honda Ciivc here is currently $US60. It would have been lower last November probably when this table was created.

Big Picture Update

A good article about where we currently seem to be in somewhat longer term market cycles. I am also looking for the market to go down after a Thanksgiving rally to a bottom at a similar level to the August 2007 low. In fact I am looking for the final leg of this big triangle to play out:



Support for this idea is provided also by the McClellan Summation:



The stochastic on this chart has plenty of space to fall yet... There are likely several weeks till the bottom is reached. The NYSE McClellan Summation presents an identical picture.

At that point I am thinking to make a major change in strategy and significantly increasing the beta of my portfolio as well as buying financial stock funds like FF and XLF. If the market gets back to the August lows the atmosphere is likely to get very bearish - when everyone agrees on something in the investment world it is probably wrong. Everyone currently thinks the US Dollar will fall and the Australian Dollar Rise. Until very recently they've been right. I've been taking the contrarian bet to a minor degree. 61% of my assets are in Australian Dollars and I aim to reduce that to 50% over time - so I'm not making any big bets on the US Dollar rising - on the other hand we've tried to avoid spending our US Dollars and I haven't converted any of them into Australian Dollars since March 2006. In fact I bought US Dollars in April and May 2007.

Change of Trading Tactics

Since the big loss on Tuesday I've swtiched trading tactics. I now plan to do pure day-trading in the near term - only betting on the direction of the market for the next few minutes or hour - though I have an opinion based on the model about what will happen in the course of the day I'm not explicitly betting on that outcome. However, I am using the model to decide on the predominant direction to place trades. So for example, on Friday the model was long and so I looked for long trades. If the model was correct these trades would get some extra lift from the overall trend for the day. I've seen some good short trades in the last couple of days but not taken them. As I get more confident I may add these too. I'm spending some time in the evening here after the European market opens to trade and in the morning in the last couple of hours of US trade. The speed and momentum feels very different in these two periods. During the Asian session momentum (volume) is so low it is hard to trade the US futures at all. I've made $550 in these two days. At this pace I could get back to my peak profit level in one and a half months. But there are no guarantees that my success rate - win percent 83% and win-loss ratio of 16.3 - will continue. The win loss ratio (average win per contract in winning trades divided by average loss per contract in losing trades) certainly won't remain so elevated!

Day Trading Environment

Current market conditions are only suitable for day trading in my opinion. The SPX model has been stopped out (1.25% or greater market move against it intraday) 5 out of the last 7 sessions and only one of the model's trades - short on 12th November was a winner (a 1% gain). The model is back where it was on 29th August - ignoring any slippage, commissions etc that would have been incurred in trading it. The NDX model has been stopped out 4 of the last 5 trades with a winning 2.5% trade on the 12th November (and winning trades on the 7th and 8th November, six and seven days ago). I had another small winning trade this morning and then a losing trade where all I lost was the commission (entered and exited at the same price). Still, so far I only made back 10% of my big loss earlier in the week. It is so much easier to lose money than make it (though at least I am more likely to make money on any given trade - 2/3 of my trades win). The models are still long despite the decline of the last two days. It doesn't look that corrective though - a corrective move here would imply that another rally similar to Tuesday's was coming up.

Globex Glitch Trade

Some glitch took down Globex (the Chicago Mercantile Exchange's electronic futures trading platform). I was actually watching the open of the Australian stock exchange and Australian futures at the time. Then I noticed that the NASDAQ futures were down 12 points or so from the close of futures trading. I couldn't see any fundamental news and the S&P 500 wasn't down as badly. I switched out of my simulation account at Interactive Brokers and into my real trading account. The technicals also looked like a very short term bottom was being made. The Australian market was flat roughly after an initial small sell off (only the Australias and New Zealand markets were trading at this point globally). The model is long though a gap down overnight is possible. So I decided to go long the NASDAQ futures on the assumption that the steep decline was caused by the glitch. I'm also tracking the S&P (ES) market as the trade progresses. The latter market is the most liquid after hours futures market and it is easier to see what is happening in it. The NASDAQ futures can have a spread of a point or more during the Asian trading session and so it can be hard to see what the price action really is by looking at a chart.

11:15 Eastern Australian Summer Time

Japan opened up after the US sold off. This supports my trade idea. Let's see how this goes.

11:25 Eastern Australian Summer Time

The trade finally moves into profitability.

11:40 Eastern Australian Summer Time

I got out of the trade with only a 1.5 point gain. On second thoughts the current price is close to where the stock market closed at 4:00pm US time. There was a big rise in price in the futures after 4:00pm. Maybe the sell-off in NASDAQ futures was justified? Anyway the 5 min stochastic was showing signs of topping out. Is this a case of selling a winner too soon?

Starting Over

All my stuff that I shipped from the US was delivered this morning. I haven't done any unpacking yet apart from removing and throwing away the packaging that the shippers wrapped the furniture items in. Now my part of the move is over - Snork Maiden's stuff is still to arrive - and it's time to start rebuilding in a sense as I've mentioned before. Hopefully, the same can apply to my trading. It's been a crazy 5 months - moving internationally, quitting my job, dealing with US immigration issues (and Australian ones for Snork Maiden), setting up home in Australia, and losing money trading pretty much continuously. The investment side of the equation hasn't been too good either, though the soaring Australian Dollar has made USD returns look good. Somehow I don't feel so bad about last night's loss. It's so bad I'm almost not afraid of losses anymore. Not sure if that is good or bad. It is good if it means I have gotten over my loss aversion - unwillingness to take small losses which then turn into large losses.

The Problem is Me

It's not the market nor the model, the problem is me. I just suffered my second worst loss per contract since I started trading futures. The model started the day short but predicted there could be a bounce. I got long the bounce for a while - this first trade was good. Then I switched to short. I knew there was a potential for the model to reverse if there was a strong enough rally. But a rally of that size seemed unlikely. Looks like we got it. I stayed short. Missed the opportunities to get out with reduced losses and then finally gave up. No stop and no discipline. I haven't destroyed all the profits I made earlier in my Interactive Brokers account, but I am getting there. Three bad undisciplined losses this month and this is the worst by far. The model is making money this month. There is no reason why I should be losing. I'm not sure what to do. Do I keep trading and try to stick to the discipline? Stop trading? Paper trade? I really don't know.

Effect of Exchange Rate Fluctuations on Returns

My recent net worth reports have shown huge fluctuations due to the volatility in the Australian Dollar-US Dollar exchange rate. Returns are strong in US Dollar terms when the Australian Dollar is rising - even though this is making us poorer in Australian Dollar terms. Each month I calculate the contribution to investment returns from the change in exchange rates under the heading "Forex" in my income and expenditure table and my table of returns on individual investments. In the last few days the Aussie has plummeted resulting in strongly negative investment returns for the month to date. This table shows just how much difference changes in the exchange rate make:



Stripping out the exchange rate results in lower average returns for the year so far (12.8% vs. 20.7%) but greatly lowered volatility and hence a higher Sharpe Ratio, which is a measure of the excess return (above a 5% hurdle in this case) divided by the standard deviation of returns. Both Sharpe Ratios exceed those for the MSCI and SPX total return indices. The SPX has risen less than the 5% hurdle so far this year (3.1%) and thus has a negative Sharpe Ratio. The MSCI has returned 12.8% at this point. A large part of that return is due to the fall in the US dollar. This is a global index measured in US Dollar terms. So really I'm doing neither as good, nor as bad as it might seem. I'm probably really beating the MSCI but not by as much as the crude numbers suggest. I've had two negative months - but both have come in the second half of the year, which has made me feel a bit despondent but the two indices have had four or five negative months.

Here is the same data for the more visually oriented:



BTW I haven't seen any comments in the personal finance blogosphere (obviously there's plenty on trading blogs) so far about this month's so far sharp fall in the indices. I guess it will come soon.

Following up from yesterday's blog. Actually, the model has been doing fine this month so far with only one stop-out so far (Friday). But I've been scared to get back on board due to its poor performance from the beginning of September to 2/3 the way through October. There were heaps of stop outs in late July and early August too. I wish there were a futures contract smaller even than the NQ (NASDAQ E-Mini) and I would be trading it overnight my time (US day time).

Stuff Arrives

Just got a call from the shipper this morning. They will deliver my stuff tomorrow. They could have done today but I need to accompany Snork Maiden to an appointment this afternoon (I'm the navigator). Pick up date was 3rd August, so it's taken a little over 3 months, which is roughly what is expected. Maybe this will help me feel a little more stable once everything is organized. By the way there was a fee of roughly $700 at this end for government fees etc. in passing through quarantine and customs. Snork Maiden is heading for the Melbourne area this evening - her first trip out of Canberra. Unfortunately she won't be in the city and instead in about the most boring bit of countryside one could find (just north of the airport). She gets to go to Perth in December and will be near the city centre but that trip will be extremely rushed. The election campaign is heading towards the final two weeks now and both parties are making more and more ridiculous promises. We need a Libertarian Party here :) Well a real liberal party would be good. I don't agree with many libertarian positions.

P.S.

The Australian Dollar is down 3 cents today alone and now around 7 cents from it's high. This is the classic "unwinding of the carry trade" - the Yen is up against the US Dollar and all the high yielding currencies are down. I would like the Aussie to go down (so that our US investments are worth more in Australian Dollars), but a slower decline would be prettier for the net worth figures! (as expressed in US Dollars).

Model Facing a Crisis

My trading model has been performing poorly in recent months - the model is frequently stopped out - the market moves more than 1.25% in the opposite direction - far more than in other periods in recent years. As a result I have low confidence in placing trades according to the model. I've been in a desperate search to find a way to improve the model, but haven't found anything better than what I already have. The question is whether this is a temporary phenomenon or are the markets changing in some fundamental way? In the meantime, the best I can do is use the model as a guide to doing some intraday (or intranight) trades. I haven't done many of those recently either. I'm going to experiment a bit with some nonlinear model ideas, but I don't think they are likely to yield anything either.

Need to Focus on Trades with an Edge

This morning I fell victim to over-trading/over-confidence. I had been doing pretty well this month so far and then decided to make a trade in the Australian Share Price Index futures. Partly to get over my fear of the size of the contract (about twice the size of an E-Mini S&P contract, four times the size of an E-Mini NASDAQ contract). The results were two losing trades in a row more than wiping out my profit for the month so far. This is the equivalent of my GOOG and AMZN trades last month which turned what would be a winning month trading US index futures into a losing month. I need to focus on the trades where I have a documented statistical edge and not experiment with other sorts of trades where I am just guessing. I haven't succeeded yet in modelling the Australian index. It tends to follow the US market but not sufficiently so for the US models to be reliable indicators. And the contract size is much bigger than what I am trading in the US, so any mistakes can easily wipe out my US-based profits.

Price Dispersion

This is purely anecdotal, but it seems to me that there is more "price dispersion" in Australia than in the US. Price dispersion is the variation in prices charged by different sellers for the same item. It's closely related to price discrimination but the latter is intentional charging of different prices by the same firm while price dispersion is charging of different prices by different firms, though it would also include charging of different prices in different outlets by the same firm which is possibly price discrimination (it's not price discrimination to the extent that costs differ across locations).

Prices certainly do vary in the US from luxury outlets to discount stores and from poor to rich neighborhoods but I don't remember seeing as big a variation between stores that are more or less side by side. For example, you can buy an Oral-B or Colgate toothbrush for anywhere from $1 to $7 within a few store fronts in the Canberra Centre (the big mall in Canberra City). The $1 toothbrushes were apparently intended for the Vietnam or Thai market but are being sold in Australia. Large ranges also exist for food items (particulary fruit and vegetables) at side by side stores. Also for items like bed sheets the range can be very wide for a given quality level. Are Australians less willing to shop around the stores to find bargains than Americans? ("Shopping around" would result in competition and convergence to the same price), or do I have the wrong impression of the US? Or is this just a Canberra (the wealthiest metropolitan area in Australia) phenomenon?

P.S. Just one price I noticed today - haircut at a franchised chain - $A22, U.S. price $US14. Another example of where the exchange rate ought to be - though 63 U.S. Cents is a bit at the low end (it's currently at 92 U.S. Cents).

Writing Off Croesus Mining

I finally decided to write down Croesus Mining's value in my accounts to zero. The stock was suspended from trading ont he Australian Stock Exchange in March 2006. There has been an ongoing story of the restructuring of the company and stock and the company wants to be relisted on the ASX - though the valuation would be miniscule compared to the last quoted price. So I decided that I will write the price down to zero and if the stock is ever traded again, put that increase in value down as a profit for that month. I am taking the whole loss in March 2006, which now saw a -3.05% return for the month or a loss of $US8,939. I've updated all net worth figures back to March 2006 on NetWorthIQ.

October 2007 Report

All figures are in US Dollars (USD) unless otherwise stated. This month saw a record gain in net worth in US Dollar terms, mainly due to the continuing rise in the Australian Dollar. Net worth also increased in Australian Dollars terms. Underlying investment performance was also strong - strong enough to result in investment gains in Australian Dollar terms despite the drag exerted by the appreciating currency. Trading results were negative but getting better.

Income and Expenditure



Expenditure was $5,940. We paid a year's car insurance and also depreciated the car immediately by $A1250. Dividing the insurance by twelve and using a typical month's implicit car costs (depreciation plus interest) we would have spent $US3,944. This calculation is useful for forecasting future expenses.

Non-investment earnings ($13,280) included a refund of relocation expenses from Snork Maiden's employer. She also 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 ($784) also started kicking in (in theory - we only got the application forms for her superannuation today!).

Non-retirement accounts gained $15,951 with $8317 coming from the continuing rise in the Australian Dollar. Retirement accounts gained $7,964 but would have gained only $948 if exchange rates had remained constant. In AUD terms non-retirement accounts gained and retirement accounts lost for the month.

Net Worth Performance
Net worth rose by $US31,322 to $US490,433 and in Australian Dollars rose $A10,517 to $A529,111. Non-retirement accounts were at $US271k. Retirement accounts were at $US219k.

Investment Performance
Investment return in US Dollars was 5.21% vs. a 3.92% gain in the MSCI (Gross) World Index, which I use as my overall benchmark and a 1.59% gain in the S&P 500 total return index. Non-retirement accounts gained 6.41%. Returns in Australian Dollars terms were 0.49% and 1.67% respectively. YTD we're up 27.3% (USD) vs the MSCI with 18.6% and the SPX with 11.0%. Our non-retirement accounts are up 34.3%.

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. The Google and Amazon trades were two of the negative contributors. Symbion also fell in the wake of ongoing shenanigans orchestrated by Primary Health, which is attempting to block the merger with Healthscope. Nice gains were seen in listed and unlisted funds and some individual stocks (e.g. Rick's Cabaret). Index trading only saw small gains.

Progress on Trading Goal

See the trading report.

Asset Allocation
At the end of the month the portfolio had an estimated beta of 0.51. Allocation was 31% in "passive alpha", 65% in "beta", 4% allocated to trading, 6% to industrial stocks, 5% to liquidity, 4% to other assets (including our car which is equal to 2.93% of net worth) and we were borrowing 15%. Our Australian Dollar exposure rose to 62% partly due to the rise in the Aussie.