Risk, Probability and Psychology
Means, Medians and Mistakes
This is part II in our series of how to understand and manage risk in trading.
“Risk depends on the skills of a specific trader and is all of the things outside our control. So traders with different sources of edge will have different remaining risk factors. If I have an edge in volatility prediction and you don't, volatility is my edge and your risk. This is true in most of life. For a heart surgeon, doing a bypass is a low risk operation. For me, it would be murder.”
Perspectives on Risk
The difference between mean and median is known by anyone with a high school education. But a lot of traders, particularly option traders, seem to misunderstand what it means in practice. Any trade with edge needs to have a positive expected value, which is the mean return. Unfortunately, if your trade has highly skewed returns you are much more likely to observe a median value than a mean value.
Seasonality and The Variance Premium
This is part I in our series of how to understand and manage risk in trading.
“It is the focus on risk that separates good investors from poor ones. No matter how good your edge is, if you go bankrupt through poor risk control you won't be able to capture the money. Successful trading is a long term game. “
The Carry Trade: Benefits and Risks
The idea of “sell in May and go away” isn’t new. It is pretty much the opposite of new. It is an anomaly that has persisted for 322 years .
Volatility and Drivers: Q&A with Elana Margulies-Snyderman of EisnerAmper
I've gone from thinking that categorizing strategies was useful to thinking it is essential. Dividing trades into inefficiencies or risk premia helps when deciding how aggressive to be in sizing and also how suspicious to be about its decay in effectiveness. I've found the model based or situational dichotomy helpful with sizing decisions.
Options & Dividends: When to Optimally Exercise
Our CIO, Euan Sinclair, was featured in EisnerAmper’s “Trends Watch” last week discussing volatility and its drivers in today’s market.
Advertising & Volume
There are two ways for a trading idea to be big enough to make it worthwhile. It can have depth or breadth. Index options have depth but there aren't many indices to trade. Equity options have more breadth. There are currently over 3000 companies with listed options and, although liquidity drops off fast after the top few hundred, equity options are worth trading.
It is well known that investors have limited attention. Every day they have to consider an enormous number of potential investments and it is just too much to take in. But there hasn't been much research showing how traders and investors react when they are reminded of particular firms (reactions to earnings announcements have been very well studied but that is a situation where people are watching the news on their own and don't need an external reminder). But now a recent study has shown that even a very quick attention grabbing prod can produce a surprisingly large effect.