It’s Friday (last time we checked, although it’s possible we were all wiped out in a nuclear attack on Thursday evening and today is a dream we’re all having as we transition to the afterlife), and that means former trader Richard Breslow has got one more series of anecdotes for you.
Unfortunately for those of us who enjoy listening to Richard vent his frustrations with how completely incompetent everyone who isn’t named Richard Breslow is, he’s closing the week on a pensive note.
So while there will be no telling you how stupid you are (at least not until Monday rolls around), Breslow did manage to pen a great note on the return of risk and volatility to markets.
Of particular note is the discussion of how risk and volatility are not the same thing, and how by removing the former (well, they removed both, but let’s focus on risk) central banks have created a scenario where it no longer makes sense to seek out asymmetries between actual risk and how the market is pricing it.
Read below for some good perspective on where things stand as we head warily into a weekend that’s sure to bring more “fire” from Trump’s increasingly “furious” twitter feed…
Via Bloomberg
- Given that investors are being forced to actually ask fundamental trading questions and are debating central bank reaction functions, to boot, I couldn’t help but think back to the Market Wizard Lessons lists derived from the books of Jack Schwager. If you need some expert advice, why not go to the source?
- The most important one is well-known and has been knocked out of our heads by continuous examples since the days of Chairman Greenspan: volatility is not a synonym for risk. For the last decade we’ve had neither. In its most basic form think of it as trading technique and prowess versus understanding what can go wrong. One’s an opportunity, the other something you were supposed to be demanding compensation for and have suddenly chosen this week to realize it’s been underpriced
- By removing risk from the equation, the central banks have negated the requirement to seek out asymmetric return versus risk opportunities. This, of course, has led to a miscalculation of sensible position sizes. Getting that metric right is key to much of the advice that pervades these works. Instead, we’re left, once again, with hopelessly over-leveraged, and therefore inherently unsafe, portfolios
- A common theme that runs through all of the books is the need to find a trading methodology that suits your personality. That’s a tough one, because we’ve become inured to closing our eyes and front-running the intentions of our central banks. Not a lot of skill nor fun in that. But it indeed worked. However, clones have a difficult time distinguishing themselves
- Which brings us to another lesson that has been utterly forgotten: avoid convincing yourself that winning and losing trades are the same as good and bad ones. They aren’t. The answer to “why do you have that position” shouldn’t be, “what else am I supposed to do?”
- In a market that featured price-makers providing liquidity to price-takers, it was good counsel to warn that if you are out of sync with what’s going on, it’s fine, as well as smart, to do nothing. Market structure being what it is, we run the risk of someone just turning the boxes off to avoid the next flash crash. Strange that this is all happening just a few days removed from the anniversary of October 15, 2014. You have to look that one up yourself. There may no longer be an adequate work around on this one
- There are a ton more examples and well worth a re-read while contemplating what’s going on. When I was on the desk, the one that seemed my boss wanted us to follow was, “Do more of what works and stop doing what doesn’t.” That was a good piece of advice that I never welcomed
Does backtesting identify what works or what worked?