Education of a Speculator

Cover of The Education of a Speculator

A word on Victor Neiderhoffer –

Education of a Speculator was the first real investment memoir I had the pleasure of reading. It wasn’t the first book written by a former fund manager I had read, that credit goes to Peter Lynch and his One up on Wall St. Upon completing that book I felt that I could trade stocks successfully. However at the time my interest in the market was developing, being a long-term investor just didn’t make sense, nor did it fit in with my goals of creating mountains of cash over the next couple of months. That’s where Education of a Speculator comes in. To think that I came across it unintentionally, and wouldn’t have read (and re-read) it had I not been intrigued by the title.

Backtesting

Prior to any investment or speculation you should challenge your rationale for putting that money at risk. This was a radical concept to me. It didn’t matter that I didn’t have a MonteCarlo simulator or access to the CRSP (Center for Research into Stock Price  at Graduate school of Business University of  Chicago) I started to sit and contemplate possible scenarios that would present pricing anomalies and then go and look for the data to prove my theory. As a scientist first comes up with a hypothesis and then tests that hypothesis to find truth, a trader no matter what he’s trading must if they want to survive, backtest their basis for investing.

Understanding Market Dynamics

The best way to understand how the market works is to go to your local zoo and go to the big cat exhibit at feeding time, ou will see that the lil kitty who looked so warm and cuddly just 2 minutes earlier is now ready to battle to the death for his piece of the pie. Same is true of fund managers.
There are a million reasons for a seller to sell and a buyer to buy, most of these reasons fail to take into consideration that the involved is supposed to be maximizing his expected utility, and as a result the product being bought or sold has its true value distorted just a little while longer.But there exist in every market no matter how liquid or illiquid extremely rational and ruthless participants who are there to take your savings and your soul while leaving you thinking that they did you a favor. It’s evolution on a micro-scale. The strong survive and the weak well the weak continue to give their earnings to the real players in the form of 401K contributions.

Understanding that the  person on the other side of the trade is there to basically take your money should motivate you to make sure that your trade is as close to a sure things as possible.

Random or Non-Random

So if the market is indeed random and the Efficient Market Hypothesis (E.M.T.) is accepted as if it came down from on high, how can one profit, state with any certainty that something is highly probable or improbable. That’s always been my problem, it would make it easier as a trader if we had the answer to these questions. But this is a debate for academics. As a trader it is your duty to come up with a road map that will lead you to profitability. At the end of the day what really matters is how much money you have in the bank not whether you were on the right side of an academic debate. The only way to increase your time in the market and the amount of money you have in the bank is to trade high probability events. The only way to do guarantee that outside of inside information is to  back test your theories. Do not try to make the data fit to your hypothesis unless you want to be stuck listening to Cramer instead of trading against Cramer.

Depth

I didn’t go as in-depth into some of these topics as I really wanted to. I really wanted to touch on Brownian Motion, Fractals, and Hemline analysis (it’s based on a theory that you can gauge the market based on the length of a woman’s skirt). I will in future posts my goal here is to ease you in to understanding the intricacies of the market and the debates among participants.

http://www.dailyspeculations.com/wordpress/,

http://www.wiley.com/WileyCDA/WileyTitle/productCd-0471249483.html,

http://en.wikipedia.org/wiki/,

http://blogs.wsj.com/financial-adviser/2010/02/25/ten-things-i-learned-while-trading-for-victor-niederhoffer/

 

The Business Press

We cannot avoid the onslaught of financial advice and entertainment
in today’s society.  Some good comes of
it, we get to experience Schadenfreude when the latest corporate executive is haled
of in hand cuffs. But much of what is on CNBC, FOX Business, and their  ilk is of no real value to you as a trader.
Every once in awhile you will see, read or hear something that you feel will
benefit your trading day, but once we hear it has about, the likelihood that
you will be able to realize a return on investment that can be specifically
attributable to that piece of news is highly improbable.

I don’t advocate that you disregard everything that you hear
outside of a boardroom or trading floor, just don’t use it as justification to
put your capital at risk. If you have a disregard for money there are millions
of other ways for you to show that disregard that will bring both you and the receiving
party more satisfaction than following another one of Cramer’s trades.

I have had the fortune (some would say misfortune) to read a large
number of memoirs by current and former traders. While I felt that I was able
to take something from each book I read, I can honestly say that the memoirs of
Victor Niederhoffer http://en.wikipedia.org/wiki/Victor_Niederhoffer  and Nicholas Nassim Taleb http://en.wikipedia.org/wiki/Nassim_Nicholas_Taleb had by and far the most
qualitative and quantitative affect. If you choose to read my blog with any
regularity you will become as familiar with their personal philosophies and
professional trading styles as I have.

I won’t delve too deep into who they are, what they have
accomplished and why they matter. I have included a couple of links in case you
are the inquisitive type like myself and must know now. I can safely say that
their trading styles are as different as night and day. However they do agree
on the fact that you will gain absolutely nothing, and will in fact increase
the probability that you will have a losing trade,  if you base your trade off of something in
the financial press.

One thing you must remember whether you are trading or investing
is that financial journalists do not have their jobs because of their ability
to analyze the market. (Then again the same can be said of some fund managers!)
If you must rely on someone else for trading ideas and you don’t have the
ability to have your money manager at an address in Greenwich CT. you’re better
off asking someone who has absolutely no exposure to the markets, than someone
with superficial knowledge.