Efficient market theory; Total junk still being taught to people?
- Thread starter jbtrader23
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vlad, lines like that one, coupled with your outlandish 98% accuracy claim, lead me to believe your knowledge of trading and of markets is different to most traders' not only in degree, but in kind. and to the extent that the latter is true, i assure you, that in the context of making money, it is unnecessary (although still potentially useful).
when i read books and thoughts from highly successful traders that lament that highly intelligent (usually meaning "highly educated") people are too hung up on being "right" (and losing money as a result), i used to think, "nah man, who could possibly be the freaking stupid..." since then i've come across quite a few of those.
just like "katrina johns" i see (and trade off) these opportunities every freaking day. time after time after time. how much can be made? i'd realistically estimate that 250k - 500k is eminently achievable. that would require trade sizes of about 1500-3000 shares. (this is just MY strategy i'm talking about, of course. there are probably others with potential returns far in excess..)
now, just in the interest of not throwing around only hypothetical numbers, my actual results have me at 45k for the year, usually trading not more 500shares - and, because of a recent massive financial setbank (non trading related), i've had to scale back my positions to about 300-400 shares. (piker lots for many traders
)just for the moment, let's assume (surely an EMH proponent could not begrudge me making an assumption!) that these opportunities are available for the next few years and extrapolate the results into the future. surely that would constitute not only a beating of the allegedly unbeatable market, but an absolute asskicking of it - and yes, given the minimal risk in what i do, on a risk adjusted basis also.
and if these opportunities do cease to exist, so what! there will ALWAYS be others. THAT is the nature of markets. you once had the gall to call EMH an "elegant model". bullshit! how a model that is so utterly divorced from reality - and thus lacking any real explanatory power - can be referred to as elegant is beyond me..
the sad thing is, in its desperation to be accepted as bona fide science, economics is kinda forced into defending its whacko models (not all of which are as absurd as EMH) and hollow assumptions. what else is it gonna say? "markets have a structure and there is rhyme and reason to price movement - we just don't know what it is.." doesn't sound too good, does it?
wisdom without courage of conviction is useless.
wow, try understandin that! anyone help me out here? (can't ask dark, he doesn't talk to me..)
courage OF conviction? i'm not sure that makes any sense...
did he mean OR conviction?
is courage always present any time there is conviction? not necessarily. does conviction even require courage? ti does sometimes...
in any case, the "usefulness" of wisdom is reliant on neither courage nor conviction.
the universe was designed in such a way to ultimately reward decisions of high moral character and punish decisions of low moral character, regardless of any and all intellectual advances and structural stopgaps between here and there.
of course the universe wasn't really designed at all. whatsmore, objective morality sans a proven purpose for life itself is a completely meaningless notion. so even if the universe was designed, it still does not behave in such a way to reward actions of "high moral character". some very good points dark, but spoilt by an emotional and inaccurate conclusion.
the salient reality is that the universe is extremely inhospitable to life and that even to merely exist we are required to expend effort; the achievement of ends requiring accurate determination of means and subsequant action is the extension of this. failure results in either the determination of appropriate means, or in their execution. there's no need to invoke morality. especially not with respect to trading outcomes.
Economics is the only science that when the theory and the world disagree, it is the world that is mistaken.
Explaining the Failure of LTCM: To me the magnitude of the error seen at LTCM comes down to one of three explanations:
I Pick Explanation #1: Personally, I doubt that #2 or #3 are true since by all accounts the people behind LTCM (both the managers and investors) were a highly intelligent level-headed bunch. This leaves the first reason as the most likely. This makes LTCM the big-science Super Conducting Supercollider experimental test of the economic theories used by the group. The results of LTCM's multibillion dollar experimental test of economic theory appear to have been are resounding "NO". (BTW, some people fear that high-energy physics experiments could have a similar catastrophic outcome if a particle accelerator were to create some as yet unknown type of blackhole/strange matter particle that consumes all the matter around it)
That LTCM's hedges would eventually have worked is irrelevant. Until economics can predict how markets and economies can violate economic theory for such long periods of time, economics will be the laughing stock "miserable science" that it is today. I would submit that any large discrepancy between theory and the markets (e.g., LTCM) is prima facie evidence that the theory is wrong.
Life's Rough for Economists: I know that I really should not be so harsh on economics because it does provide a wide array of very useful engineering tools for businesses and governments. It's not the fault of economics that they are locked into a situation of having a sample size of one and very little room for real scientific experiments (its hard to create a national economy in a petri dish and try various experimental interest rate treatments). Moreover, it must be very hard for such a rational bunch of people to try to explain the irrational actions of animal spirits. Thus, its not surprising that economists have such a poor track record in predicting recessions, currency exchange rates, markets, etc. It also explains economist's seeming arrogance when they state what an economy or market should do vs. providing a humble prediction of what an economy or market might do.
Beyond Economic Epicycles: I wonder if economics is where astronomy was before the Renaissance. Perhaps economics is still in the grip of creating ever more convoluted descriptive equations (like Ptolemaic epicycles) that are weak in both predictive and explanatory power. The manual for the Swiss Army says: "When the map and terrain disagree, trust the terrain." Until economics learns to trust the terrain, it won't create viable theories.
Just another bounded-rational person trying to make sense (and cents) from an unbounded irrational market,
Traden4Alpha
Explaining the Failure of LTCM: To me the magnitude of the error seen at LTCM comes down to one of three explanations:
- The theory was wrong: The theories used by LTCM were incapable of predicting the possibility of the divergence that the actual hedges took.
- The people at LTCM were stupid: The people at LTCM were incapable of understanding the implications of the theories they were using.
- The people at LTCM were just gamblers: The people at LTCM knew the risks (the theory did predict them) but they put on the position anyway.
I Pick Explanation #1: Personally, I doubt that #2 or #3 are true since by all accounts the people behind LTCM (both the managers and investors) were a highly intelligent level-headed bunch. This leaves the first reason as the most likely. This makes LTCM the big-science Super Conducting Supercollider experimental test of the economic theories used by the group. The results of LTCM's multibillion dollar experimental test of economic theory appear to have been are resounding "NO". (BTW, some people fear that high-energy physics experiments could have a similar catastrophic outcome if a particle accelerator were to create some as yet unknown type of blackhole/strange matter particle that consumes all the matter around it)
That LTCM's hedges would eventually have worked is irrelevant. Until economics can predict how markets and economies can violate economic theory for such long periods of time, economics will be the laughing stock "miserable science" that it is today. I would submit that any large discrepancy between theory and the markets (e.g., LTCM) is prima facie evidence that the theory is wrong.
Life's Rough for Economists: I know that I really should not be so harsh on economics because it does provide a wide array of very useful engineering tools for businesses and governments. It's not the fault of economics that they are locked into a situation of having a sample size of one and very little room for real scientific experiments (its hard to create a national economy in a petri dish and try various experimental interest rate treatments). Moreover, it must be very hard for such a rational bunch of people to try to explain the irrational actions of animal spirits. Thus, its not surprising that economists have such a poor track record in predicting recessions, currency exchange rates, markets, etc. It also explains economist's seeming arrogance when they state what an economy or market should do vs. providing a humble prediction of what an economy or market might do.
Beyond Economic Epicycles: I wonder if economics is where astronomy was before the Renaissance. Perhaps economics is still in the grip of creating ever more convoluted descriptive equations (like Ptolemaic epicycles) that are weak in both predictive and explanatory power. The manual for the Swiss Army says: "When the map and terrain disagree, trust the terrain." Until economics learns to trust the terrain, it won't create viable theories.
Just another bounded-rational person trying to make sense (and cents) from an unbounded irrational market,
Traden4Alpha
Quote from Traden4Alpha:
Economics is the only science that when the theory and the world disagree, it is the world that is mistaken.
Explaining the Failure of LTCM: To me the magnitude of the error seen at LTCM comes down to one of three explanations:
- The theory was wrong: The theories used by LTCM were incapable of predicting the possibility of the divergence that the actual hedges took.
- The people at LTCM were stupid: The people at LTCM were incapable of understanding the implications of the theories they were using.
- The people at LTCM were just gamblers: The people at LTCM knew the risks (the theory did predict them) but they put on the position anyway.
I Pick Explanation #1: Personally, I doubt that #2 or #3 are true since by all accounts the people behind LTCM (both the managers and investors) were a highly intelligent level-headed bunch. This leaves the first reason as the most likely. This makes LTCM the big-science Super Conducting Supercollider experimental test of the economic theories used by the group. The results of LTCM's multibillion dollar experimental test of economic theory appear to have been are resounding "NO". (BTW, some people fear that high-energy physics experiments could have a similar catastrophic outcome if a particle accelerator were to create some as yet unknown type of blackhole/strange matter particle that consumes all the matter around it)
That LTCM's hedges would eventually have worked is irrelevant. Until economics can predict how markets and economies can violate economic theory for such long periods of time, economics will be the laughing stock "miserable science" that it is today. I would submit that any large discrepancy between theory and the markets (e.g., LTCM) is prima facie evidence that the theory is wrong.
Life's Rough for Economists: I know that I really should not be so harsh on economics because it does provide a wide array of very useful engineering tools for businesses and governments. It's not the fault of economics that they are locked into a situation of having a sample size of one and very little room for real scientific experiments (its hard to create a national economy in a petri dish and try various experimental interest rate treatments). Moreover, it must be very hard for such a rational bunch of people to try to explain the irrational actions of animal spirits. Thus, its not surprising that economists have such a poor track record in predicting recessions, currency exchange rates, markets, etc. It also explains economist's seeming arrogance when they state what an economy or market should do vs. providing a humble prediction of what an economy or market might do.
Beyond Economic Epicycles: I wonder if economics is where astronomy was before the Renaissance. Perhaps economics is still in the grip of creating ever more convoluted descriptive equations (like Ptolemaic epicycles) that are weak in both predictive and explanatory power. The manual for the Swiss Army says: "When the map and terrain disagree, trust the terrain." Until economics learns to trust the terrain, it won't create viable theories.
Just another bounded-rational person trying to make sense (and cents) from an unbounded irrational market,
Traden4Alpha
Good post, T4A.
I think it sums up the debate quite well and makes some very good points.
I like your swiss army map example. Except that I'm one of those who believe that the purpose of economics (and any other science) shouldn't be simply discriptive, to purely explain as best as possible what is observed in the bounded-rational behavior/reality
Albeit that is a very useful objective, economics/finance should also analyze the way reality/behavior should be observed, once the boundedness of that rationality decreases. Economics does not do a very good job of explaining what is, but in many cases that's not what its aim is, so it shouln't be judged solely by how well it does in this respect.
For instance, it is widely observed that people consistently make errors in choosing between different lotteries with cleverly structured payoffs. But I don't think we should adjust the theories to incorporate the occurence of such errors, b/c we think they would persist in the future
Keep up the good posts.
That's all well and good but the fact remains lots of people DO see it and I still make money with it. Proof in the puddin is the eating. How much you ask? What diff does it make? I am exploiting ineffiencies otherwise how would i continue to show a significant return year after year? I am trading X size, maybe if I begin trading 100X then the inefficiency will close. but i have no intentions of upping my size considerably, not in the near future. i'm perfectly content with making a far greater than average return year after year for many years to come. so for me (and others like me), at this size, the market is INefficient is it not? for those trading 100X or whatever the market may become MORE efficient does it not?
Quite a bit, actually. To an ant, the highway surface offers a bumpy ride, to a car, it is very smooth (with some exceptions in southern states I have driven through...
Still beats Ukrainian roads though...). When proponents of EMH say you can't make any money bla bla bla (with all the appropriate ifs/when/conditioned-upons specified as I listed before), they mean any REAL money. You can take any theory literally and rip it apart by saying, well, here's a tiny exception when it doesn't apply. They are not meant to work in each and every case. Presence of such exceptions does not take away much from the essence of the theories. Once again, as I mentioned before, heck, even if there ARE mamoth-size inefficiencies, as long as you can't offer a model that consistently explains the time-series and cross-sectional behavior of stock returns better than EMH, it continues to be the best model. It sucks, you say, and so do many others. Well, the response would be, offer a better one!
A drunk fella is walking home from a bar, he make take a bunch of unpredicted detours, but sooner or later he'll get to his destination. EHM says "he's going from the bar home". At some points he might be going in the opposite direction. But you try and offer a model that would say when he does what.
The example might not be as good as it could have been had it not been 2:30 am... But I think you get the point.
vlad, are you selectively ignoring me now?
from the perspective of the individual trader, $500k per annum is pretty decent wad. do u realise how long it would take the mom and pop investor to turn their $10k grub stake into that kind of money with standard index returns????
you might think this is a "tiny exception", i'd call it a gaping hole.
and do u even realise the futility in seeking a "better" model of the market? do you realise what that implies? if we had an "accurate" model of the market, we'd be able to predict what is going to happen. translated --> BIG freakin $$$. who in their right mind would want to share such a model with anybody?????
the EMH "model" - which is the functional equivalent of an unfunny joke - is academia's way of saying, "we really don't know what the fuck is going on.." and when it's stated in terms of fancy maths symbols and smart sounding bs, it magically becomes "scientific" and is accepted as "knowledge".
from the perspective of the individual trader, $500k per annum is pretty decent wad. do u realise how long it would take the mom and pop investor to turn their $10k grub stake into that kind of money with standard index returns????
you might think this is a "tiny exception", i'd call it a gaping hole.
and do u even realise the futility in seeking a "better" model of the market? do you realise what that implies? if we had an "accurate" model of the market, we'd be able to predict what is going to happen. translated --> BIG freakin $$$. who in their right mind would want to share such a model with anybody?????
the EMH "model" - which is the functional equivalent of an unfunny joke - is academia's way of saying, "we really don't know what the fuck is going on.." and when it's stated in terms of fancy maths symbols and smart sounding bs, it magically becomes "scientific" and is accepted as "knowledge".
Nope, I'm not ignoring you, it's just that I need to be less fatigued to give decent responses to your posts. 10K into 500K does sound like a big hole. If that was happening all over the place, I'd agree with you. In most cases (especially over the last several years), more often it's the other way around.
It's not all that futile to find a better model. Some models have since been offered (like the behavioral over/underreaction stuff) that according to you people should have kept to themselves. The thing is, according to your logic, Black-Scholes should have never made public their stuff either. Not all researchers are like me (I'm not gonna publish the REALLY good stuff I find, maybe just pruned down dry versions), some would rather have their name cited in each and every finance book. Besides, once you get famous, the money does come back to you one way or the other. But the more important point is, even though people did offer some alternatives to EMH, they only work in very special subcases, nothing works as good as EMH for ALL cases.
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the EMH "model" - which is the functional equivalent of an unfunny joke - is academia's way of saying, "we really don't know what the fuck is going on.."
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No, I'd rather say, it's a way of saying we know pretty well what goes on on average. What goes on in each instance, noone has a @#$# idea.
Once again, my response could have been a bit more convincing, but I really am freaking tired. So this will have to do.
Happy trading on Moday to all.
I can't sleep either for some reason, so against my better judgement here goes:
-What constitutes "real" money? 100K? A million? How about billions? Steve Cohen has made billions for himself and his clients with discretionary short term trading strategies. Do billions count as real money? Or was he paid in monopoly money?
-If the best option blows, then why does there have to be a prepackaged model at all? Why waste so much energy defending an outdated conclusion too strong for the data? Meteorologists don't have a packaged model for the weather, they just work with the imperfect tools they've got- and they seem to be getting along fine. (They don't have ego hangups and denial problems from being in the dark half the time either.)
-Ever hear of the phrase "death by a thousand paper cuts?" If you're willing to make a zillion exceptions, why not just go with Elliott Wave instead?
-Since when do stocks have a final destination, unless they go to zero or otherwise stop trading? The detours never stop and there is no "home." If you write off the detours, you write off the theory.