Expect the posts to get sparse and short, or possibly even non existent for the next 10-20 days, as I will be travelling.

Thanks

This post, marks the official beginning of the series, where we will try to move forward first slowly, trying to build basics into simple probability theory, to more advanced concepts.

Now, lets get started like this. Consider the term, variable. What does it mean? Something which can vary. Lets try to finetune it a bit more, can it vary within bounds? We can’t necessarily say that.

What about, can we impose some limits on its behaviour? Depends on what kind of limit we are talking about.

Okay, so if we consider the equation , where are constants, then, will be a simple deterministic variable. Given we do know how will vary. Nice and good. We in our daily lives used to seeing and working with deterministic variables.
Now this set of variables have got more snobby cousins, called random variables. What are random variables?

Practically just think of an experiment, where there are n outcomes possible. And we assign a value to those outcomes, say 1,2,3….n. It doesnt mean a weight or something like,it just is a marker of the outcome which has come out. You can even call it, by the names of your kids, or your girlfriends. Now, if I ask, what is the outcome of the experiment, we dont know about it, accurately. Because, each time we repeat the experiment any one of them can pop up randomly. Hence we assign the result of the outcome as X and say, X is a random variable and can take values from 1,2,3…n

So here the values which it can take, is called sample space.So the outcome of the experiment of tossing a coin, or throwing a dice will have a sample space as {H,T} or {1,2,3…6}.

Plain and simple eh?

Now lets try to crank the quotient a bit.

Lets consider we have a signal source, an information source. Randomly it switches itself on, transmits something for some time period 0 to T, the information is not known before hand*, and switches itself off.

So because what is being transmitted is unknown,  and each time it switches itself on, is considered a process. Now the signal which is being transmitted, its contents (or information content we dont know and can’t predict).

In these cases, to model the situation  at hand, we deduce something, we assume a few things, and then try to forward our journey. As a sidenote, most of my education, I have tried, (not necessarily succeeded) to connect the dots which are coming towards me with the path I have traversed till now. So for example you know linear algebra, you will try to work with say equations, then slowly move to quadratic equations, all the while trying to form relationships between what you have studied, and trying to solve the challenge at hand by what you already know. Nothing hi-fi, simple plain things.

So now, we want to come back to our signal source, and want to study its characteristics. We notice a few things, in the signal source, the signal source, can generate anything, and can take any of the probable ways. Not all are equiprobable, not necessarily. So such kind of a setup, a system, a non deterministic situation we call as a stochastic process.

What is stochastic process?

Lets add some rigour to it, we dont know how it will evolve into future, it will have multiple paths of evolution, not all equiprobable, yet given the initial state, we still wont be able to deduce where it will go. (it reminds me as I write, of chaotic systems)

Now, consider Anna is talking with her best friend, Bethany. They are discussing some very juicy details of gossips, which the other counterparty doesnt know. And as happens, Anna doesnt know what Bethany is going to talk about, or how will the conversation evolve. So if you just consider that Anna doesnt talk at all (or rather, Anna’s talks doesnt disturb Bethany’s rantings and ravings) then Bethany will be transmitting an effectively stochastic signal. Now if I assume the same thing, being repeated multiple number of times, ad infinitum we have a stochastic process. Mighty boring for Anna, and Beth as well, but its interesting to note, that information transmission is considered a blue blood stochastic process. Had Anne and Beth both would have talked, and responded to each other they would have been a process with its information content dependent on each other.

So mathematically, given a probability space(“experiment”) , a stochastic process if sampled at any time period which lies between 0 and T,then we will have a randomvariable whose sample space is  each individual value in .

So that means,you sample a stochastic process over its numerous trials at time ‘t’, what we get is a random variable with its sample space as those value of sampled stochastic process.

Sampling a stochastic process yields a random variable

Now, I have in this figure, tried showing visually “driftless”(non trending) signals.Consider for example I have some finite drift involved, in the process. Just for kicks.

That just means, we have at some point of time, a series which keeps on growing large. Now, though we don’t have anything against trends, but consider if I then sample a time unit in neighbourhood of those instances where it goes arbitrarily large, what I will get is a random variable with some possible outcomes as very large. i.e I have some considerable chances of getting “fat tails” whhoops!!!

Take care,

Soham

* Information is defined as the randomness or entropy in a signal. The less we  know, about a particular signal, the more is the information content.

I have much pleasure of being quoted by Prof Dhananjay, regarding the volatility.

Thy author in his limited wisdom, decided to enlighten his readers in his own small ways, the potential challenges and rewards one might get in this approach.

Considereth, O Thine Readership,thou hast a price series named and you want to analyse this. So the idea is, to first make it stationary.

A question might arise, why stationary and what is stationary?

Lets start our quest with the second question, what in the god’s name  is stationary? But before I broach that subject, I want, to hold your precious patience, and let me go about this in a holistic manner,

Do you remember, how easy is to solve an equation like this?

Its easy, simple and we can easily do it by transposing ; But what if you are asked to solve a system of equation like this:

So if we dont know how to solve a simultaneous equation, and what we know instead is how to solve a simple linear equation in one variable. Hence lets leverage that knowledge to solve our work. Lets decompose this equation into a simple linear equation and try to solve it like that.

Now, coming back to price series and return series etc, its very easy and we know how to deal with finite mean, finite standard deviations, nice looking bell curves, not so nice looking kurtic distributions etc. We know how to deal with it. But what we dont know, is how to deal with arbitrarily large variances etc,which is present highly in the day to day observation series we have.

Dont get me wrong, we do have finite variance, finite mean distributions as well. But when a series tends to trend(pun unintended) our work simply becomes unweildly. So we decided lets reduce it to something we know, we have worked with. Lets reduce it to those general characteristics? Why? Because its not stationary!

What? What is not stationary? The price series, if you try to investigate, it has time varying characteristics i.e the price can be thought as

Here the mean is not a constant but a time varying metric. Similarly And of ten in a trend the variance becomes arbitrarily large. That it means it will take an arbitrarily large observations for us to notice a reversion to the average.

So to cut these things off, lets detrend it. That is ,take away the time dependent components off and form a return series instead , where is the return of the price series from t-1st day to t th day.

It serves essentially two purpose: a. we essentially make the mean as finite from an unknown number(potentially large).  And secondly, if we assume that the variance is finite, then we have something we can work with.Of course how we treat the unknowns in our hand, underpins the challenge of the system.From here onwards our paths diverge into various forays, and I will try to bring forward some more development in the next few posts. I would be glad, to know if I have got your appetite whetted.

P.S: I will be trying to touch up more on these subjects, with some simulations and real life charts. At the very outset, it might not give that great a “feel” of things to come or how to use it, but trust me

Although I dont agree everything written here, but nevertheless there are some good nuggets of information here.

“Five Ways to take smart risks in uncertain markets” is titled by Minyanville and is a synopsis of Dr. Doug Hirschhorn latest video blog on CNBC. He  is one of the premier trading coaches is the author of “8 Ways to Great: Peak Performance On The Job and In Your Life” and “The Trading Athlete”

If I could I would have titled it as, “Four Ways to train yourself before you make your first trade” [okay a popquiz: I said four ways, while there are five written, so which one I disagree with?]

The Link is here

Thanks goes to TheKirkReport

Readers of this blog, might in subconscious ways stereotype this place as a “trading” blog or a financial market blog. But the fact of the matter is that it remains in its roots connected with strategizing.  Of course, heavily involving what I do, how I do, and how good I do what I do, but a bit of variety is good for you as well.

Now cutting the chase, let me come square at the point. I have been hearing a lot of talk on why, the government cannot and should not let education be turned into a “profit” game and too much of deregulation will effectively destroy the fine tree called learning. But this type of thinking is wonderfully naive and devoid of any practical consideration.

For decades, India have talked how profits in industries is okay, but in education a taboo. Well, socialism’s cobwebs is indeed addictive yet, strangely unfruitful. We have created just failures over the ages in educational system while living in denial. Think of it, we have got only 2 universities  in the list of world class insitutions, while China has 30. And US has 159.

There is remarkable lacuna and hesitation when it comes to reforming education. But socialism’s children don’t understand that public sector might look altruistic on paper but is parasitic when it comes to real life. Zero accountability, thicket of red tape, inertia and everything else stands for a failed policy making.

For some more sophisticated thinking, have a look at this: here. Andre Beteille has talked well, about why are our hesitations regarding education reforms are unfounded. And for a better comparison and problems afflicting our education system,here is a dated article from WSJ.

This quarter had been another spectacular quarter, and I must say, right now, until unless something too drastic too happens, my goal of posting 100% in this calendar year looks within reach. So, since inception in March, we are up 81%. Its interesting to note, that the bulk of this quarter’s growth came in August and September. July was a pretty bad month and the bulk of the drawdown was during those times.

In the following figure, I have attached how your fund(initial amount of ~1lakh rupees) would have grown(only profits, doesnt include the base capital) had you invested in March 2009 with me, in my flagship fund “Falcon Pride”. Note, the graph is a trade based equity curve.

Profit Growth Curve of Falcon Pride

And some  numbers for those who like to read the fineprint.

Some Performance Metrics

To be noted, is my average capital is not 1 lakh and has gone fund infusions since March. (once in August, once in September). Hence the ROE is on average capital. If I dont use average capital but the initial funding capital, then I have already given more than 100%, but of course that just cosmetic feel good statistic. What matters  is growth on average capital. And thats what I have included here.

Thank You for the commercial break

Soham Das

Here is a (short)profile of Steven Cohen, the mystical multi-billionaire hedge fund king of SAC Capital Advisors.

Steven Cohen on NYMAG

And here is a considerably longer profile on George Soros, the palindrome, the hedge fund speculator who as he described is guided by “primal animal instincts”.

George Soros on NYTIMES

Also a longer version here

I was wrong and I apologise.
I apologise for breaking my own rules.
I was wrong for not seeing or rather ignoring the signals completely.

A few days back, I reiterated my position. My opinion that the global markets seeing a huge bubble type scenario, the last boom, bust and crash.

When I initially posted, my bearishness, I was fully prepared to pay the opportunity cost. Opportunity Cost which comes when you lose a very euphoric part of the rally. When everything you touch is a winning trade and you start planning of an early retirement. It can be a beautiful time to live. But like all good things, it comes to an end badly. And I was ready to stay out of it, and miss it.But many things have changed in between.

What has changed since?

A lot of things. A lot of important things. I initially guessed Chinese markets rallying from here a making a lower high. Well, yes it has rallied to make a lower high, but is it the top?

No, I wont believe it. My system which I had been successfully using in the past on Indian Equity Markets have thrown a buy signal on Shanghai. And being a pure price action guy, had I had the resources I would have taken the trade. So the bottom line, Shanghai will rally and we are not yet there. Am I bearish on the global situation. Hell yes! Does it mean top is here? Hell no!

I have often told, and reiterating it once again, economics and trading are two different things. Lets bother about important stuff like money and investing and trading first. We can safely theoretize about econ later.

What about SPX?What about it? Its testing the downward trending channel made by this bear run and with what it looks like, its going to break out of it, and rally subsequently. See this link for more(thanks to @Woodshedder )

So the question is, are we really doing justice to what the market is showing us. Fundamentally, again, I would defend my views. Somebody has to service the debt, the Fed debt, The Shanghai Debt, The Medicaid yada yada . But who will and when will they, I dont know. Doesnt look like anytime sooner.

Swimming Upstream, today, tomorrow, forever

My effective concern is not that, this is a bubble or not. My effective concern is, too many idiots are very afraid and very cautious about it.I see NIFTY rallying to 5000, and analysts jumping in and saying NIFTY is gonna top out at 5000.(Idiot, Idiot, Idiot!!!) I see and hear  suddenly too much of caution in voices of people who have made an entire career out of throwing the same caution to the winds.
Suddenly everybody has become a crash expert, a financial doom expert, an Indianised version of Mr. GloomBoomandDoom And thats where, I apologise to you for not seeing the right signals when everywhere it was on plain view.

Just recently, I chanced upon a blog which was selling , surprise surprise, tips!!!! Well, he was a shade better than his peers, he was actually actively tracking them. And what I saw, told me the magnousity of how wrong I was, of how wrong I could have been.  In his portfolio he had, around 7-8 well known shares, well known, darling of retail shares like BHARTI AIRTEL, POWERGRID yada yada yada. He posted a snapshot of his portfolio maintained on Excel,on his blog. All had “investment” horizons of 2-3 years. Poor guy is diligent. Has given out four targets for most of his stocks. Some of them showing returns upto 400% in 5 years. Interesting, very interesting. But what caught my attention was one singularly striking thing. He held in his portfolio 4500 puts of NIFTY bought at 165. He plans to hold it for the next three months. But what threw me off guard were his targets. Target 1 was 500, Target 2 was 800 and hold your breath, Target 3 was 1100. Do I remember Black Scholes equation or have I lost my mind. For PE to go above 500, the index has to be in 3900 around with extremely high volatility. 800 is what? 3500 around?

My point is this: If the aam junta, the retail, the dumb money is this cautious, fearful, and anticipating a crash this badly, it really doesnt make any sense for me to stay in their side and expect a crash. Literally everybody in the nation wants the market to go down, that too fast. Why? I reckon they want to buy!!!

Contrarianism Explained

But markets are not gonna give them a second chance. At least not the way they want. I am a contrarian and in some ways, I misread the signals. And this will be a good way to show, how contrarian bias is formed. Being contrarian is not a method of investing, for meI try to make it  a philosophy in life. I have applied it to as diverse as trading, relationships, dating, romance and even future strategizing.  But knowing how to apply it in the right way, takes a bit of insight. The underlying philosophy is the crowd is never right. Copper ‘em. Whenever you can, Wherever you can, Whichever way you can. So when the entire crowd thinks and is fearful be aggressive in the same measure. When its greedy, be cautious even more. Market extremes usually give an ample opportunity to read the signals, thwack your head and go the opposite way.

In this business, if an opinion is widely held, then it surely will be proved wrong. Think of it, it makes sense. If money is distributed the way it is today, highly unsymmetric with huge fat tails(take 10 usual persons from your neighbourhood and measure mean wealth. Now add one Rakesh Jhunjhunwala to the group and now calculate average. The 10 of the 11 people will be below the mean. Its called fat tail distribution and can be solved by using Quantile-Quantile plots, but those things later on), then for every million people to lose money, one guy will become a millionaire. How will that guy be  a millionaire. Do just the opposite of what those million people did. Now extend it to every aspect of trading. This is why I believe simplicity can prove to be an advantage. Usually people engage in paralysis by analysis and kill themselves. Also, this is one reason I strongly believe systematic trading can be a harnessed well. So can be quant. The more off-fringe the method is, the better will be its profitability. So the bottom line is copper them.

The End Game

Now how to go about fixing your bias. Once I do get my bias okayed, I just manage my risk exposure of my systems. I dont ignore or liquidate my holdings, I just reduce the exposure. Like, I cut down my slow trades a bit faster. I put a tighter stop loss(again decided by the system). I am a bit more cautious, put the stops as AMO, small things like that.

So how do I get to fix my bias. My usual, indicators, very subjective though and mostly fantastic in market extremes. The name is Hemline Indicator. I blogged about it, long time back, do give it a look. (here) also search for it online, you will getter better idea about it.

The other part, I almost regularly scour through is Common Investing Magazines.

For example notice the recent issue of Outlook Profit. Do look at it, because this is gonna give you a fantastic exercise of first hand contrarianism

Outlook has increasingly cut down on its bullishness and cultivating a cautiousness unseen

The yellowed out part is mine. Notice the pessimism in the tone. Notice a sense of bearishness in the headline which is blaring out. Its dark, filled with an understated sadness, and an ominous feeling. You can click to enlarge but not really quite sure, how clear it will be, since I took a printscreen and posting here. Also note on the sidelines, the column of sophisticated sounding international “experts”(it gives the word a completely different meaning, ain’t it ?) The first one is cautious and asks a question- “is it sustainable?” He is unsure and almost asks a question to his logical self.

A more detailed report of their cautiousness bearishness

This image is the continuation of the same article. With the column on the left is supposed to be a positive upbeat comment, but if you read the green lined section, it makes you wonder if this is the “experts” optimism then what is going to be called pessimism. I havent’ even bothered about highlighting the pessimistic experts opinion.

Notice the very bearish to mild bearish comments made out in the left hand side column. Comments like “canary in the mine”, “potential to signal a deeper correction” “sluggish mid term growth in US” etc. So my dear readers, I lay infront of you, all the nuggets of information which I have gleaned and found to hold some semblence of truth.

Conclusion

I would recommend, myself first, you second to come out of this bearishness. Yes I know we would love to see a correction, and prove all those talking heads right, and make those puts in the money(see above), yet, market is going to carve out a trajectory of maximum pain. And this is gonna continue till the last bear, (this bear cartel was formed in this bear run) is hurt, chopped, killed and his skin flayed. This bear cartel has found a psychologically easy way to be right, be pessimistic. Though they have been rewarded in the previous bear run, but this time they wont be. I would highly recommend ourselves to get hold of things, and be highly aggressive in entering market, on the long side. When I mean aggression, I dont mean ignoring risk management, I mean, with an aggressive bullish bias. Inching your portfolio exposure to market above the normal times, while managing the individual position risk deftly and cleverly.

What is not Prologue, is Epilogue

Some current media reports on present day Fashion:

• Hemlines heading way up in Spring 2010
• The latest hemlines from two ace hotties, walking down the ramp for Nishka Lulla in the latest Lakme Fashion Week, just concluded in Kolkata :

Upbeat not exuberant

No Hemlines- Sobriety, Pessmism

Public definitely wants more of them with shorter hemlines. Personally I love them both. But when they come with such dresses, it just sounds all the more sweeter.

Update[12.30 pm 22nd Sept 2009]:

Its official now, Rediff posts an update and summary of recently concluded Lakme Fashion Week in Kolkata, titled “Raised Hemlines for rising temperatures”

Some links to discuss:  Astute readers of this blog would have noticed that from a macroeconomic basis I tend to keep a contrarian approach. But how exactly is this methodology is something I would have liked to discuss, yet could not exactly bring myself to quantify it enough, to share it well.

So I give in to you, a good article ,albeit very simplistic on Contrarianism or rather to beware of naive contrarianism. [Link here ]

While we are at it, do browse through other links given at the bottom of the same page

And by the way, some nice eye candy, thanks to Paul Kedrosky, the evolution of debt across the globe, a screencast. (Link here )