Trading Thalesians (eBook)

Saeed Amen is Managing Director and co-founder of The Thalesians, a think tank of dedicated professionals with an interest in quantitative finance, economics, mathematics, physics and computer science. In this role Saeed publishes FX and gold quant strategy, drawing upon nearly a decade of experience creating and running FX trading models. Independently, he is also a systematic FX prop trader. Prior to this Saeed was an Executive Director and FX Quant Strategist at Nomura, London, where he built up a number of systematic FX spot and volatility trading models both for clients and the trading desk which were run profitably with prop capital. He also prepared a large body of quant FX strategy notes in areas such as high frequency, macro, technical analysis, positioning, liquidity, hedging and options. Saeed began his career at Lehman Brothers, London, as an Analyst and Quant Strategist in Foreign Exchange following completion of a Master's degree (MSci) in Mathematics and Computer Science at Imperial College, University of London. Saeed is quoted regularly by the FT, WSJ and ZeroHedge.

Cover 1
Contents 8
List of Figures 12
Foreword 14
Prologue 16
1 Introduction 17
2 The Basis of Everything Is Water: Understanding Risk in Markets 24
Water as risk 24
The motivation to measure risk 25
Understanding risk in games 27
Oracles rather than probabilities 29
Quantifying financial risk through volatility 31
Structural breaks in volatility regimes 34
Risk sentiment and the impact on market volatility 36
Can we predict shifts in market risk sentiment? We can try . . . 38
RORO your investment boat 39
Understanding implied versus realized volatility 41
Trading risk directly through options 45
Classifying groups of investors by their attitude to risk 47
Does the time horizon of a trading strategy correlate with how risky it might be? 48
Understanding risk through the use of scenarios 49
How can we estimate our maximum possible loss? Using stop losses and take profits is one way 51
Should we even bother to quantify risk if it’s difficult? Yes! 53
3 Harvesting Olives: Alpha and Beta Strategies 55
Olives, presses and Ancient Greece 55
The ancient Olympic Games, the unusual olive trade of Thales, and following your strengths 57
An example of differences between supposedly simple cash markets 59
The ideas of alpha and beta in the present day 62
What if there’s no obvious market beta? 64
Allocating between different market betas 67
Ancient Greek maritime traders, grain, timber, olives, and alternative beta 68
A practitioner’s thoughts on alternative beta, alpha, and beta 71
Alpha is not always better than beta 72
Do retail investors beat the market beta? Not in our examples 74
Should investors trade alpha or beta? 76
4 The Code of Hammurabi: Reducing Risk 77
The origins of insurance and Hammurabi 77
The concept of diversification when investing 81
The mathematical way to diversify: The good, the bad and the super-leveraged portfolio 83
Alliances amongst Ancient Greek poleis: Hedging specific risks 86
Hedging specific risks in a portfolio: A financial viewpoint 87
Illustrating hedging with an example 88
For times illiquid: A proxy hedge 90
Is diversification always a good thing? Is concentration always a bad thing? 92
Diversification in a hedged world 97
5 Not What They Care About: Having Targets Other than Returns 99
How did Thales’ motivation to trade differ from the investors of today? 99
The problem with only targeting returns 100
What about purely targeting risk within a limit? 103
A tale of two traders 104
Ancient incentives to change trader behavior 105
Using the Sharpe ratio as a target 108
What does the Sharpe ratio fail to capture? 109
Understanding drawdowns in investments 111
Is all volatility bad? Enter the Sortino ratio for targeting investment performance 113
Why should portfolio targets differ between investors? 115
Is reaching an investment target fate? 116
Deviating from our investment mandate can impact our targets 118
A view on targets and risk from an investor 120
Summarizing our journey through investment targets 124
6 Predicting the Eclipse: Searching for a Black Swan and Windows of Doom 125
The solar eclipse foretold by Thales, and Black Swans 125
Black and white swans, and proof by contradiction 126
Defining a Black Swan with examples 127
Black Swans and probabilities 129
Are there varying shades of Black Swans? Can we decipher the relative Black Swan-ness of events? 130
The extent of Black Swan-ness depends on proximity to historic events 132
Can we profitably trade Black Swans as a single strategy? Enter the window of doom 134
Using Black Swan strategies as tail-risk hedges within a portfolio 138
Other ways to lessen the impact from Black Swans in the market: Leverage 139
Extended market positioning and Black Swans 141
A final word on Black Swan events 143
7 In the Stars: Lateral Thinking to Understand Markets 146
Thales: A polymath of the ancient world 146
What is lateral thinking, and how does it differ from vertical thinking? 147
The risks from blinkered trading, the opposite of lateral trading! 148
Lateral thinking to the path of an investment idea 151
Noise and signal and time: The battle in making decisions 152
Lateral thinking to a different data angle 154
Foreground versus background versus processed background public information 155
A spurious warning 157
It’s all so obvious (with hindsight) 159
Lateral thinking to a conclusion 160
8 The Silk Road and Its Secrets: Is There Really a “Secret Sauce” in Trading? 162
Images from the Silk Road 162
Blurring the origins 163
The secret of silk 165
Different route, same destination, and the “secret sauce” 166
So what could be the “secret sauce?” The details, rather than the grand idea 168
The mystique of a “secret sauce” 169
Adaptation and diversification is another element of the “secret sauce” 171
Further thoughts on the “secret sauce” 172
Concluding our discussion about the Silk Road 175
9 The Father of History: This Time Is Sometimes Different in Markets 176
Herodotus, the “father of history” 176
Markets change, even if people don’t 178
Why backtest a trading strategy? 178
Backtesting versus real track record 180
When the data-mining gets too much 182
Historical robustness of a strategy in different market regimes 183
How far back should we look to test a trading idea? 184
The trading style depends on the trader, not on the style 188
Why should history matter for trading? 190
And then it was history! 193
10 A Last Word to Conclude 195
A yard to end 196
Acknowledgments 198
Further Reading 200
Bibliography 201
Index 205