2/ "How you package your work > what you have actually done. There is massive herding in economic forecasting. By staying near the benchmark / prevailing range, you get all the upside of being right without the downside. Once I understood the rules, I became quite cynical." (p.5)
3/ "In order to make problems tractable, you need assumptions, which then become axiomatic for the entire subject—not because they are true, but because they are necessary for a solution.... The problem is that markets aren't efficient, but that is conveniently ignored." (p. 9)
4/ "Markets matter more than policy: real fundamentals, not what policy makers want to happen. The willing disbelief of people can carry on for a long time, but eventually, it is overwhelmed by the market.
"The genius of Soros was recognizing the turning point." (p. 12)
5/ "As long as no one cares, there is no trend. Would you be short Nasdaq in 1999? You can't be short just because you think something is fundamentally overpriced....
"Even though something might be a good idea, you need to wait for and recognize the right time." (p. 12)
6/ "Risk premium was too low in everything (2006-7). Credit was trading at ludicrous spreads, and no one cared about quality.
"But you can't be short because you lose carry, and at the same time, the spreads get lower.... You just have to make money going the other way." (p. 13)
7/ "We were happy to be part of the bubble but in positions that were highly liquid so we could exit quickly.
"Markets look liquid during a bubble; it's the liquidity afterward that matters. We did a lot of trades through options where positive carry paid for the option." (p.14)
8/ "By being long options... you are never short that horrible tail.
"One of the aspects of risk premiums being very low was that option prices were generally too cheap. It was a low-volatility bubble, which meant that options worked. That's not always the case." (p. 15)
9/ "During the entire Fed hiking cycle of 2005-6, the futures market kept being priced on the premise that it was about to stop... so you had a great risk/reward that in six months, they would still be hiking. As the months rolled on, you could keep repeating the trade." (p. 15)
10/ "There are very few market forces to make macro markets priced efficiently. For tech stocks, then sure, hedge funds are huge. But for FX or Treasuries, hedge funds are tiny compared to PIMCO or the Chinese. I am a small fish swimming in a sea of real money." (p. 16)
11/ On LTCM: "T-bond futures were going up limit every day. That told me there was something going on. I didn't need to know why. Once you realize something is happening, you can trade accordingly.
"If you wait until you can find out the reason, it can be too late." (p. 17)
12/ "After a bull market goes on for years, who is managing most of the money? The bears are all unemployed; you have a few very flexible people, but they run relatively small amounts of money.
"You shouldn't expect a big bull market to end in any rational fashion." (p. 19)
13/ "Because the bulls control most of the money, expect the transition to a bear market to be quite slow, but then for the move to be enormous when the turn does happen. Then the bulls will say, 'This makes no sense. [The housing bubble] was unforeseeable.' " (p. 19)
14/ "In a world where everyone assumes that everything goes up forever, big price changes occur when market participants are forced to reevaluate their prejudices. The world didn't change that much in 2008; it was just that people finally noticed there was a problem." (p. 20)
15/ "You can notice when things have changed. Most people, though, don't. When Nasdaq is at 4,000 after having been at 5,000, there are a lot of people buying it because it is 'cheap.' People are poorly attuned to making decisions when there is uncertainty." (p. 21)
16/ "Implementation is the key in everything: more important than the trade idea behind it. Having a beautiful idea doesn't get you very far if you don't do it the right way.
"I tried to do the trade in such a way that my timing didn't have to be perfect." (p. 23)
17/ "People were acting on the premise that Bear Stearns and the banking system were solvent.
"You can't fix a solvency problem by adding more liquidity. If you have a house worth $100K with a $200K mortgage, I can lend you another $100K, but it won't solve the problem." (p. 25)
18/ "To make sure our business was as safe as possible, we avoided counterparty exposure to Lehman. We simplified the book. We reduced leverage a lot during 2008. We restricted our trading to highly liquid positions, avoiding OTC trades with lots of counterparties." (p. 26)
19/ "Storytelling is only 10% of what is important in macro. The rest is implementation and flexibility: implement a trade in a way that limits your losses when you are wrong, and be able to recognize when you are wrong." (p. 28)
20/ "Even though Soros will sometimes play up to his public image as a guru who knows what is going on, it is in no sense what he does as a manager. He has no emotional attachment to an idea. When a trade is wrong, he will just cut it, move on, and do something else." (p. 28)
21/ "I've only done one single-stock trade: buying Berkshire in 1999. The price had halved because Buffett refused to be involved in the dot-com bubble. I thought that was the stupidest reason I had ever heard for a stock price to halve." (p. 31)
22/ "Trading books are designed for people who have excess optimism and are in emotional denial of their losses. The rules are designed to protect traders who are gamblers. For them, the books could be greatly shortened: 'Don't trade. You are really bad at this.' " (p. 32)
23/ "The main thing about bubbles is that you need to be early. The worst thing you can do is to be stubborn and then late to convert. I am trying to learn to be an earlier convert to things that make no sense [Pets dot com].
"When it starts to go down, sell it." (p. 33)
24/ "Irrationality doesn't matter: if you try to point it out, believers will just give you an even more ridiculous justification why the market should go up. Bubble markets have legs because it takes such enormous evidence to make people change their minds." (p. 35)
25/ "Be long the exponential up-move of a bubble without taking on the gap risk of a collapse. Options are a good way to do this.
"Tops are messy, and reversals in bear markets are horrendous. It is very rare to find comfortable shorts in bear markets." (p. 36)
26/ "A CTA has a systematic way of defining when a trend has changed. Another way you can tell is if a market displays price action that is characteristic of the late stages of a bubble, such as an exponential price rise, like silver in 2011." (p. 36)
37/ "The repercussions of the top were a lot easier to play than being short the Nasdaq itself....
"The economic downturn led to a big move in fixed income that provided a much calmer way to play that idea than a direct trade in equities." (p. 37)
38/ "I can't tell you what your trading style should be.
"If I try to teach you what I do, you will fail because you are not me. If you observe what I do, you may pick up some good habits. But there are a lot of things you will want to do differently." (p. 39)
39/ "Perseverance and the emotional resilience to keep coming back are critical because, as a trader, you get beaten up horribly. Frankly, if you don't love it, there are much better things to do with your life. No one who trades for the money is going to be any good." (p. 39)
40/ "People run lots of money with relatively unsophisticated risk management. Throughout 2008, I spoke to managers who said they had halved their risk. I would answer, 'Do you realize volatility has gone up five times?' Their risk exposure had actually gone up." (p. 40)
41/ Ray Dalio: "Recognize that you will certainly make mistakes and have weaknesses: what matters is how you deal with them. If you treat mistakes as learning opportunities that can yield rapid improvement if handled well, you will be excited by them." (p. 51)
42/ "The type of thinking necessary to succeed in the markets is entirely different from what is required for school.
"You have to be assertive and open-minded at the same time. Any time you are an independent thinker, there is a reasonable chance you will be wrong." (p. 53)
43/ "The Fed and other central banks have tremendous power. In both the abandonment of the gold standard in 1971 and in the Mexico default in 1982, I learned that a crisis development that leads to central banks easing can swamp the impact of the crisis itself." (p. 55)
44/ "Being long pork bellies when they were limit down every day taught me the importance of risk controls. I never wanted to experience that pain again. It enhanced my fear of being wrong and taught me to make sure no bet could cause me to lose an unacceptable amount." (p. 56)
45/ "Diversifying to a thousand stocks will only reduce the risk by about 15%, since the average stock has about a 0.60 correlation to another stock.
"With zero correlation, by the time you reach only 15 assets, you can cut volatility by 80%, a factor of five." (p. 57)
46/ "There are ways to structure trades to produce a bunch of uncorrelated bets.
"I strive for approximately 100 different return streams that are roughly uncorrelated. There are cross-correlations, so the number works out to be less than 100, but it is well over 15." (p. 57)
47/ (Note: From time to time, I get questions about whether to buy/sell a stock. Diversification into assets with low correlations matters much more than adding or cutting a single position. The AQR paper below reaches the same conclusion as Dalio does.)
48/ "Each market behaves logically based on its own determinants, and as the nature of those determinants changes, what we call correlation changes. When inflation expectations are volatile, stocks and bonds will be positively correlated (interest rates)." (p. 57)
49/ "I am looking at whether the drivers are different: 15 or more assets that behave differently for logical reasons. I may talk about return streams being uncorrelated, but I'm not using the term the way most people do. I am talking about causation, not the measure." (p. 58)
50/ "To the extent that there is strong disagreement about an issue, a lot of people are wrong. Yet most are totally confident they are right.
"Imagine how much better almost all decision making would be if we were less confident and more open to thoughtful discourse." (p. 58)
51/ "We reach resolutions by questioning each other, which leads to better understanding. You say that. Why do you say that? What is the evidence? How can we resolve the difference? Whom do we need to bring in to facilitate the conversation and help us move forward?" (p. 58)
52/ "Many people experience drawdowns that are larger than expected because they never really understood how a strategy would have worked under different environments.
"Strategies that are based on a manager's recent experience will work until they inevitably don't." (p. 60)
53/ "Timeless and universal: there is no reason why a strategy's effectiveness should change in different time periods or when you go from country to country. This broad analysis through time and geography gives us a unique perspective relative to other managers." (p. 60)
54/ "We realized that if we took bond systems and traded them on a spread basis rather than an absolute basis, we could produce much better return/risk. That change took advantage of the universal truth that you can enhance the return/risk ratio by reducing correlation." (p. 61)
55/ "We know our transaction costs very well, and we know how long it takes for us to get in and out of positions. We will limit our position size to assure that we can get out reasonably quickly and to keep our transaction costs small relative to the expected alpha." (p. 65)
56/ "We didn't have the same vulnerability to a year like 2008 as most hedge funds did: the inherent nature of our Pure Alpha strategy avoids embedded betas.
"The truth about hedge funds is that much of what is packaged as alpha is really beta sold at alpha prices." (p. 66)
57/ "The average hedge fund is about 70% correlated with stocks. Why are most hedge funds skewed toward strategies that do well in good times? I think it is human nature for people to choose strategies that worked well during the recent past, which implies a long bias." (p. 66)
58/ "The biggest mistake investors make is to believe what happened in the recent past is likely to persist.
"The tendency of investors to buy after a price increase for no reasons other than the price increase itself causes prices to overshoot." (p. 70)
There are multiple ways to embed @ReformedTrader's unrolled
1. Direct link
2. Use iframe
Sharing is caring 😍
Like this thread of @ReformedTrader?
it with your friends & followers.
Love Thread Readers? Upgrade to premium to unlock all features
A whole new way to explore your interests. Convert your Thread to PDF,
save and print. Subscribe to interesting authors and be notified when new unroll is
available. Auto publish your threads on Medium and WordPress websites.