The Final Reckoning

Issue .10
The Final
Reckoning
alan Greenspan
in The dock
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Editor’s Letter
I
Original cover image by Larry
Downing / Reuters
M
E
D
I
A
Published by
Square Up Media
4 Tun Yard
Peardon Street
London SW8 3HT
Tel: +44 (0)20 7819 9999
Fax: +44 (0)20 7819 9840
Editor
Martin Deeson
deputy Editor
Mark Hedley
Art Editor
Matt Hasteley
Associate Editor
Eugene Costello
Junior Designer
Matt Gregory
Editorial assistant
Emma Taylor
Contributing Editors
Monty Agarwal, Mike Baghdady, Lou
Cooper, Bernadette Costello, Fiona
Duncan, Gareth Groves, James Gurney,
Jon Hawkins, Margaret Kemp, Jennifer
McCormick, Simon Mills, Johan
van Overtveldt, Sam Taylor, Wayne
Weddington III
Advertising
Michael Berrett, Mark Edwards,
Vicky Miller, Christian Morrow,
Kevin Rudge, Alex Watson
Accounts
Steve Cole, Natalie Jackson
managing Director
Tim Slee
Printing
Broglia Press
Certified distribution 5,900 jan-jun 09
t’s been an interesting year for anyone
who lays wagers on popularity stakes.
If there was a market in public
opprobrium it would have been a clever
punt indeed to have successfully predicted
the movements of the tabloid hatred index.
Ever since Diana’s death in the Pont
de l’Alma tunnel in 1997, I have become
used to journalists being considered social
pariahs, akin to the people whose job
it is to burn the dead in Indian society,
or wipe the bottoms of old people in
Norwich. Confusing ‘scum bag paparazzi’
with ‘gentleman of the press’, has meant
that, for a decade at least, answering “I’m
a journalist,” to the “...and what do you
do?” question at a dinner party has left
people looking at you like they’re not sure
whether to tell you their life story (“You
know what you should write about?” “No.”
“Me!”), or stone you to death, (“Journalist?
Didn’t you kill our Queen of Hearts?”).
So it has been with some schadenfreude
that we hacks have watched the public
hatred index swing dramatically over the
course of the year, and never once touch
us for a change. Earlier this year it was
bankers (of course, because they caused
the recession. And you’ll get no argument
from me there). Then it was hedge fund
managers (because you were shorting
banks and making money while others
lost their jobs. Boo. Hiss. Ker-ching!).
Then, come spring, it was politicians (for
managing to get the unemployed masses
to pay for ‘flipping’ houses so many times
they couldn’t remember what address to
give the cab driver when they stumbled
out of a Westminster brothel at 4am). And
now, come the Autumn, it’s the bankers
again (hoorah!) because of the really very
stupid bonuses they’re planning to pay
one another while benefitting from public
money and reduced competition.
So, we would think, that hedgies might
have a clean run at things. A chance to, if
not look good, at least not look like public
shit numero uno. So, could everyone please
stop getting busted and diverting their
funds to terrorist organisations? [see p19]
Thank you. That would help a lot.
Martin Deeson - Editor
martind@squareupmedia.com
Contributors
Johan van
Overtveldt
...is the director of the
Belgium-based think tank
VKW Metena, which works
on a breadth of economicsrelated issues. He is the
author of Bernanke’s Test. To
read his final judgement on
Alan Greenspan’s tenure as
chairman of the US Federal
Reserve, turn to p44.
wayne weddington
...is an investing professional
with more then twenty years
of experience in the financial
industry. He is currently a
senior portfolio manager on
one of the world’s top hedge
funds. Read about the day
when he first realised that
he was a small fish in a big
pond on p47, ‘Swimming
with Sharks’.
Jennifer McCormick
...is the owner of the Helium
Foundation. She has been
working in the art world for
the past 15 years, and is well
respected among her peers
for her canny acquisitions
and ability to deliver exactly
what her clients want and
need. She is why Helium has
become renowned as one of
the best art dealerships.
Mike Baghdady
...has worked as a
commodities trader, stock
trader, futures analyst,
options trader and an
instructor for both foreign
currency exchange and
equities markets. Now his
web-based school, Spyglass
(spyglasstrading.co.uk), gives
traders a quantifiable edge
for increasing their success.
1
hedgefundclub.co.uk
industry
Cruise Control
Trading can mean irrational decisions. So let a rules-based
trading system help take the strain, says Mike Baghdady
In addition to trying to make correct
trading decisions, new issues have arisen
that we must attend to such as anonymity to
protect our orders from negative selection
and executing our orders with the least
possible market impact. We also have to
seek liquidity and have an algorithm to help
us find that liquidity; and when we do find
it, we must then have a quality execution.
We need a complete understanding
of the rules behind our trading systems;
we must understand why they are giving
us specific signals at all times, and the
reasoning behind them. After all, what good
is pulling an exceptional profit from a trade
if you don’t understand the series of events
that occurred to make it happen, or the
ability to repeat the action consistently?
While quantitative analysts and
programmers begin with certain
assumptions that they believe should work,
when they are tested in real life they are
quickly felled by variables that the analysts
couldn’t have accounted for or anticipated.
A good trader must be able to adjust
their strategy to account for these variations
and not only believe that the changes they
have made to their strategy will stand up
against a sudden change in volatility, they
must also have the confidence to execute
each trade with a high degree of certainty
that they are more likely to win than lose.
Practically everyone makes poor
assessments of risk and event probabilities
under duress, but fortunately in trading,
“ What good is pulling
an exceptional profit
from a trade if you don’t
understand the series of
events that occurred to
make it happen, or how to
repeat it consistently? ”
46
hedgefundclub.co.uk
human emotion represents a tremendous
source of opportunity for us to profit from.
The best trading systems can show you
a map of human behaviour by identifying
price points on their charts, flagging where
traders have realised they have made errors
in their judgment and are desperately
seeking to act on those realisations and
correct them, to limit their losses.
Within all of these price points are
opportunities that winning traders know
how to profit from because they understand
how the errors other traders have made
manifest themselves in price action.
They are making money by exploiting
the consistently irrational behaviour
patterns of other traders acting on base
senses of hope, fear and greed. That is why
understanding price behaviour works, and
continues to work, because it is based on
the market movements that result from this
systematic and repeated irrationality that is
embedded in every trader in the market.
Strategies based on price behaviour
allow a trader to identify points where
other traders need to enter or exit trades
and to have a good mechanical system that
automates the entire process of trading.
Such a system should provide answers
to each of the decisions a trader has to
make, and because there is a set of rules
that defines what should be done in any
circumstance, decisions are not left to the
judgment of the traders themselves, but to
their systems – reducing the risk of emotion
interfering in an execution.
A profitable trading system that adheres
to the rules and principles of price behaviour
contains five basics elements: optimum
entry; optimum exit; risk control; automatic
execution; and portfolio selection.
It becomes far easier for a trader to be
consistent in his trading if he sticks to a
system he can rely on. If he understands the
rules of his system, he can identify whether
the market conditions are optimal under
his strategy or whether they have changed
sufficiently to keep him out of it.
When new variables come into the
market such as volatility owing to a news
event, or the unwinding of large positions
to identify money-making opportunities,
his system should tell him that the risks
are too high under these conditions, and
that either he shouldn’t trade or should
dramatically cut his size.
When the dust settles, he should
similarly be able to identify the shortterm market directions based on reference
points in the charts that, if executed with
precision, can lead to far bigger winning
trades; or in other instances, tell him to be
patient and allow his trades sufficient time
to develop into bigger wins.
Knowing the rules behind automated
systems and strategies and having the
knowledge and confidence that they work
most of the time makes it easier for the
trader to recognise all the signals, and
thereby trade according to the system,
even during times of trading losses.
It allows the trader to be consistent despite
the inner emotional struggles that they must
overcome after a confidence-shaking series of
losses, or unrealistically large profits.
Successful trading, whether by an
individual at home or within a large-scale
hedge fund, is like flying a plane: you
can largely travel on auto pilot but in the
unforeseen event of turbulence, you can
immediately take manual control and bring
your position back to safety. H
Mike Baghdady is head trader at Spyglass;
spyglasstrading.co.uk