There have been a number of post on finance and trading on LW recently. gilch and I realized that we don’t have a great sense of how much people on LW know already and what they would find helpful.
[Question] What posts on finance would your find helpful or interesting?
People often don’t know what they don’t know. ;-) Were there specific concepts you and gilch were wondering whether people already know?
There is a number of fundamental topics: shorting, different asset classes, leverage, volatility, futures/derivatives, liquidity, market making, arbitrage, hedge fund investment structure, momentum / mean reversion. It’s true that for all of these you can go and read about them on Investopedia or something. But I know I personally read LW a lot and if someone explained the basics of some field I don’t know much about here there’s just a higher chance I’d read and trust them.
On the more advanced side: constructing trades based on your beliefs, public funds (e.g. SPY), options, finance history, most theory, macroeconomics. There are a lot more topics here for sure; it’s hard to generate them on the spot.
I guess I’m also thinking that many people *do know* because they have heard some concepts being brought up a few times (not necessarily on LW) and it piqued their interest.
Would it help to include / link to definitions for financial terms?
Yes, this would be very helpful!! I am just a layperson and get lost very easily in discussions of finance.
I am not sure if this would come under the umbrella of financial terms but a discussion of different ways companies can be valued would be interesting. My understanding is that in addition (or instead of the traditional PE ratio) some people use free cash flow. Also other people look at EBITD, and other metrics.
Technical analysis, momentum, trend following, and the like, from an EMH-informed perspective.
I’ve been dismissive of anything that looks at past price information, but given that markets are clearly sometimes inefficient due to short selling being constrained by availability and cost of borrowing stock (which causes prices to be too high which can cause short squeezes), this can “infect” the market with inefficiency during other times as well (because potential short sellers are afraid of being short squeezed), which means there’s no (obvious) theoretical reason to dismiss technical analysis and the like anymore.
Oh nice, I can definitely write about this. This is basically what I do all day.
Hmm, so I’m realizing I can’t write much about this without revealing / implying certain key information about how we view things at my hedge fund. :/
But I found this document, which is pretty sane and goes into some details on this and other basic topics: https://bigquant.com/community/uploads/default/original/3X/7/d/7d3a0a5a4f0f2fbfd87b2c6e70037dd3c8f48e2c.pdf
Honestly the very basics. How does short selling actually work? How does leverage actually work? As someone who has never really gone into finance I’d love a LW sequence explaining what all the numbers actually mean.
One thing I’d really recommend to get started is to open a demo (or “paper”) account with a stockbroker. Get familiar with the mechanics of actually ordering trades with their software. Then you can experiment with what you’re learning. Don’t worry about blowing up your account, because it’s not real money. You can just reset it.
Hmm, is there an app for that?
There are lots of apps for that. Search for “demo account” or something. The ones with a real stockbroker are going to be the most realistic, and will probably use real market data delayed by 15 minutes. My favorite trading application so far is the desktop version of thinkorswim (TD Ameritrade owns it at the moment, but Schwab might be buying them.) It’s scriptable and has some nice analysis tools.
Leverage is the ratio of the amount of the investment you control to the amount of money you need to control it. Buying the investment outright is 1x leverage.
Wise use of leverage is probably required for a good return. I talked about this a bit in How to Lose a Fair Game.
Leveraging up means you are increasing the ratio, which usually means you are borrowing money to buy investments.
The common way to do it is a margin account. You buy stock, and use the stock as collateral for a loan from your broker, which you use to buy more stock (not necessarily the same one). You can profit twice as much from a favorable move, but you also lose twice as much from an unfavorable one. That’s 2x leverage, you can use less. The broker also charges interest. The loan is fully collateralized, so if the shares you’re putting up lose value, you have to pay back the excess loan. This situation is called a “margin call”. You can also get leverage using options or buying shares in a fund that is itself leveraged in some way.
Leveraging down means the opposite, usually you keep some cash in reserve, and keep the ratio of cash to investment value balanced. For example, a portfolio of 50% cash and 50% stock has 0.5x leverage, assuming you keep it balanced as the value of the stock changes.
Short selling means that you borrow shares of stock to sell to someone else. You probably can’t do this in a basic account or a retirement account (with some minor exceptions). Your broker will find someone on your behalf. Some stocks are hard to borrow. Your broker might not be able to find enough of them.
You’re still on the hook for any dividends and have to compensate the original owner for any dividends they miss. Again, the broker should handle this automatically. If the market price falls, you can then cover your short position for less than you sold it for, which is a profit. The opposite case would be a loss. If you do have a margin account, your broker may also loan your shares to someone else to sell. Some brokers compensate you for this. If your shares are loaned out you still get the dividends, but they don’t count as dividends for tax purposes.
What do you mean by “numbers”?
I see people throwing around words with numbers attached like “I shorted the stock at $x” or “I bought at 5x leverage, and I only vaguely know what the words mean and how they’re related to the numbers being thrown about.
A curriculum for getting started, as well as some guidelines for when it’s worthwhile to begin doing so. Personally, the flow into my savings in on the order of $4k/month, plus a pool currently of $20k cash, and about $90k invested in mostly stock ETFs. I have appetite for risk and tolerance of volatility, but don’t yet know if the sums of money I have to play with make sense for strategies beyond ‘hold the market’. If so, I don’t know how to begin bootstrapping—gilch’s recent posts have been interesting, but are a still a bit light on details and model-building.
Yeah. I’m in index funds because someone told the London group “here’s what it means to get into index funds, here’s why it’s a good idea, here’s how you do it, here’s a list of places you can sign up with to get one”. I kind of want to dabble a little in stocks and other investments, but I don’t know who offers that ability and I haven’t looked closely yet.
(My impression is if I was in the US a decent answer would be “Robinhood”. And authors here might not know anything UK specific, which is fair enough. But that’s the sort of thing I’d find helpful.)
Yes, this also raises a couple other good points:
How to begin localizing knowledge if you’re *not* in the US. My sense is this is particularly gnarly bec most info assumes you are and quickly gets into weeds related to the US tax system. It seems to me that as a first approximation of understanding investing you should tend to ignore tax structure, but maybe that’s wrong?
Tools and pipelines for programmatic trade bootstrapping. Looks like Robinhood does have an API. Not sure what other packages/api/tools specifically for finance are relevant.
Some brokers are available internationally. I have heard of people using Interactive Brokers outside the US. CFDs are illegal in the US, but an important investment class elsewhere.
I’ve been using Alpha Vantage and Yahoo finance for historical data. I have heard Stooq is good for UK market data.
I’ve started using Oanda and Zorro on an EC2 VM to autotrade Forex. Zorro is also supposed to work with Interactive Brokers (among others). You can try Zorro for free if your account size is small enough.
I have heard there are other options. Lots of brokers have an API. It’s probably not worth your time to write your own backtester/robotrader when you can use one off-the-shelf. You still have to code your strategy though.
I’ve been wondering what are the caveats with relying on Sharpe ratio to measure how much risk was taken to get an investment’s returns.
For example, Titan touts a high Sharpe ratio, and frames its marketing like it’s better than the S&P in every way with no downside: see https://www.lesswrong.com/posts/59oPYfFJjYn3BBBwi/titan-the-wealthfront-of-active-stock-picking-what-s-the
But doesn’t EMH imply that all Sharpe ratios long term will tend to the same average value, i.e. no one can have a sufficiently replicable strategy that gives more returns without more risk?
And in the case of Titan, is the “catch” to their Sharpe ratio that they have higher downside exposure to momentum reversal and multiple contraction?
An incomplete list of caveats to Sharpe off the top of my head:
We can never measure the true Sharpe of a strategy (how it would theoretically perform on average over all time), only the observed Sharpe ratio, which can be radically different, especially for strategies with significant tail risk. There are a wide variety of strategies that might have a very high observed sharpe over a few years, but much lower true Sharpe
Sharpe typically doesn’t measure costs like infrastructure or salaries, just losses to the direct fund. So e.g. you could view working at a company and earning a salary as a financial strategy with a nearly infinite sharpe, but that’s not necessarily appealing. There are actually a fair number of hedge funds whose function is more similar to providing services in exchange for relatively guaranteed pay
High-sharpe strategies are often constrained by capacity. For example, my friend once offered to pay me $51 on Venmo if I gave her $50 in cash, which is a very high return on investment given that the transaction took just a few minutes, but I doubt she would have been willing to do the same thing at a million times the scale. Similarly, there are occasionally investment strategies with very high sharpes that can only handle a relatively small amount of money
Nice ones. The first is probably the one that most accounts for funds like Titan marketing themselves misleadingly (IMO), but the others are still important caveats of the definition and good to know.
Great question! I think a lot about this too, although I don’t have an answer. Regarding EMH though see my other recent posts though.
I don’t understand Titan’s strategy well enough to know if it would work, but a Sharpe of .77 is totally achievable though various means. It’s really not that hard to beat the index in terms of Sharpe ratio. Diversification really is a free lunch. The S&P 500 is American large caps. You can diversify a lot more than that. That doesn’t seem to be what Titan is doing though.
I don’t buy the EMH, because alpha exists, but yes, that is what the EMH would imply: you can only outperform due to luck.
If you model an asset price as a random walk with drift, and then try to compute the Sharpe ratios, you will get different answers at different times due to luck. Same process. Could it vary between .77 and .51? Yes. Easily.
It might be out of the scope of what you’re asking but personnaly I’m very interested in the philosophical constraints of the models used in economics.
Specifically, I found that I can learn on pretty much any theoretical model of finance quite easily if I spend enough time on the internet.
But, in the process of reading about it, it’s actually very hard to know if it takes for granted a specific philosophical model with specific restraints.
I lack a global understanding of the philosophy of economics and it worries me given the supposed hegemony of the US-born humans in financial science as well as the usual cultural disdain towards “left” ideas, socialist and communist offshoots etc. Be it conscious or not.
I’d be interested in reading a review / summary of PIMCO’s An Asset Allocation Primer: Connecting Markowitz, Kelly and Risk Parity (or a post that otherwise covers the same material).
I have a rough idea about what M1 and M2 and how banks create M2 money but at the same time I uncertain that I understand the subject well. Especially, when it comes about reasoning about what that means for society. The fact that there are a lot of conspiracy theories around the topic makes it harder to trust sources on the internet to give a good explanation of the topic.
Why are people willing to hold so much government debts at zero percent interest rates? Why don’t the institutions that hold so much debt instead buy index funds?
One part of the puzzle is that most institutions are limited in what kind of assets they can buy. They are further limited by what kind of risk/return profile their investors are looking for. If you’re holding government debt, it’s considered pretty safe and has very low volatility. You’re not going to lose that much money in any given year (but you also won’t make much). For an index fund you could lose or make +/- 20% in any given year. Some institutions just can’t tolerate that risk in the sense that it’s not their job to take on that much risk.
What kind of organizations have trillions laying around while they can’t tolerate risk? If I would run the Chinese division that currently owns treasury bills, why would I have a problem with the risk?
The fact that you can just raise a trillion of additional debt in a crisis also suggest that simply the decision to raise more money brings owners of a trillion dollar to decide to suddenly want to hold the bonds.
Losing money with bonds seems very doable. Accordigng to bad internet searching because I don’t know the best terms, between October of 1993 and October of 1994, the 30-year on-the-run Treasury bond lost about 30% of its value.
Hmm, then can you be more specific what “people” and “institutions” you’re referring to in “Why are people willing to hold so much government debts at zero percent interest rates? Why don’t the institutions that hold so much debt instead buy index funds?” Are you talking about governments? Because almost all people and institutions don’t have trillions lying around.
In total there are 26 trillion dollars in US government debt. That’s 3 trillion more then at the beginning of this year. That money has to come from somewhere and it’s hard for me to understand where that kind of money comes from.
My sanity check reflexes tell me that it’s strange that this money is easily available but I might not have a good grasp to ask the right question ;)
I don’t know who owns the majority of US treasury bills. In total the US government seems to owe $26 trillion in July 2020. 6 trillion seem to be held intragovernmentally by the FED and other sources which is more understandable but it’s unclear why so much other institutions are willing to hold them.
The best way to get leverage
[I’m not your financial advisor. I don’t know your financial situation, and this is not financial advice. Leverage is a double-edged sword. Don’t Bet the Farm.]
Depends on what you need it for. 3x ETFs are probably plenty for a basic risk premium portfolio. LEAPS might have more variety, but you have to buy 100 share increments (which makes it harder to balance in a small account), and you have to deal with vega risk and occasional rolling hassle and costs.
Portfolio margin is probably the best way overall. But I haven’t seen it available for less than a $100,000 account. You can get almost 2x on an ordinary Reg-T margin account though. Brokers may charge outrageous amounts of interest for margin loans. You can sort of work around this by financing with box spreads.
Outside the US, you can probably get 5x on CFDs. I can’t trade them, so I haven’t looked into them too much.
Leverage up to 20x is easy to get for Forex (and maybe 50x for the major pairs), because Forex volatility is so low, you need a lot of leverage to bother with it. But the market is mature and efficient enough that I don’t recommend trading it without some automation. Grinding out an edge that small is really tedious if you have to do it manually.
A post on the absolute basics of how stocks work, written for an intelligent, open-minded, yet totally uninformed audience.
It could cover info on how and why stock gets created in the first place, regulatory agencies and what they do, what benefits and risks are attached to stock ownership, the different ways it can earn money for its owners, and then get into the more theoretical stuff and weird behavior that tends to get talked about more.
The reason I’d like to read this is that I’ve picked up all my (limited) financial knowledge from conversations, news articles, and podcasts. I’ve never tried to understand finance from the ground up, so my knowledge feels very patchy.
Caveat: Articles like this do already exist. It’s just that I never thought to seek one out until about yesterday. It’s probably better for someone with your experience to write new content rather than to do a new spin on old content, unless you are familiar enough with the “for beginners” content that’s out there to have a sense of how it could be improved.
For anybody who’s like me, here’s a place to start.
How to convert simple predictions/probability distributions (e.g. $stock will go down with x% probability at a date distributed around day Y an amount normally distributed around Z) into positions.
How much should the average person worry about tail risk? the average EA?
Less naive portfolio construction.
What tools from quantitative finance might be useful outside of finance: Econometrics & probabilistic modeling as used in finance (or as used 8 years ago or whatever)? Risk modeling?
If that offer is still active, I, as an abstract thinker, formalism lover, and mathematical symbols worshipper, would very much enjoy a palatable door of entry into the world of finance. I’ve read so much, but grew so little, feeling like reading reflections of shadows in muddle puddles in a cave (Allegory of the cave).
What exactly do you mean by door of entry? Like a way to get into the industry? Or start trading yourself?
I should have been more precise, I fancy a knowledge door of entry to understand finance; not a practical door, nor a career door.
1) Meta-level post listing interesting sources to learn different aspects: assets pricing, relevant parts of macro (for example, it seems that in academia, there’s a number of different, conflicting, business cycle theories—but as financial institutions actually have skin in the game, it’d seem reasonable that they came up with a “correct” version of it), HFT, general info.
2) Examples of (obviously, already-dead) strategies that made significant profit before—if such descriptions are available anywhere.
2) Books reviews—having recently read Flash Boys and When Genius Failed, I’d be really interested in an expert evaluation of those. Also, other books recommendations (as in 1), but with a more documentary(or even fiction?)-focus.
I think there are a lot of good sources out there on finance, and a LW author wouldn’t necessarily have any particular credibility or special knowledge on the subject.
I’ve been running one of the world’s largest crypto quant hedge funds for the past 3 years. We’re still pretty small when you compare us to hedge funds outside of crypto, sure, but it’s become less true every month.
There’s a number of other authors on LW who have decent qualifications.
After https://www.lesswrong.com/posts/rPe6b7MCxaK8ZzYdC/you-need-more-money?commentId=qESxHMdp7dKjbbEYq this seems to be a second comment by you asserting that specific people have no special knowledge.
LessWrong brings together a bunch of smart nerds and some of those happen to be Quants who do have special knowledge on finance.
I see how quants or other people who run hedge funds would have some special knowledge. But most LWers do not run hedge funds, and I don’t think smart nerdy LWers are more qualified to write about money than smart nerdy non-LWers. I like to hear from analytical nonconformist types, but they’re already out there writing about money! Don’t assume rationality is only to be found here.
And most LWers are not writing financial posts.
I think many people here go outside of LW to source ideas and bring them back here to share. I agree that there are plenty of high level discussions happening outside of LW. But I don’t understand why those same discussions shouldn’t also happen here.
When writing posts, people usually write posts when they think they have some knowledge to share that the average person in the audience doesn’t have.
Taking all your information about a significant topic from one source is generally a bad idea. To me that in no way implies that LessWrong shouldn’t be one of the sources to inform oneselves about a given topic.