Long & Wrong

I am sat here in the pre-dawn gloom feeling gloomy.  The only real source of light is from these monitors but they only add to that gloominess.  I am reading the virtual morning papers and feeling depressed.  Conflict on The Korean Peninsula, mine deaths in New Zealand, cholera in Haiti and  a car bomb in Yemen.

As I glance at Bloomberg TV I am told that Socgen notes that the shelling in Korea is a huge buying opportunity.

So I am thinking about how comfortable I am with profiting from bad news.  If, for example, there was a large-scale terrorist attack would I be sat here watching the rolling news coverage and feeling shock and compassion  or  would I be selling index futures? Or would I be doing both and would it be morally acceptable?

I don’t have an answer.  Perhaps I should decide before it happens, although it happens on a smaller scale every day. Trading provides too much time for thinking and those thoughts are sometimes the start of unpleasant journeys. I was about to apologise for sharing this one with you, but perhaps I shouldn’t.

Updated: After further thought, and contemplation of your comments, I think there are probably 3 cases of making money from bad news. The worst, e.g. the arms merchants, make the problem worse. The best, e.g. the drugs companies, make the problem better and in the middle, where I think we are, there is only a neutral influence. I’m not saying if that is right or wrong, it  could though be worse or it could be better.

As a trader it’s not easy to try to claim any kind of moral high ground. But I am going to at least explore an argument that attempts to show that by trading profitably I am making the world less violent, less obese, less prone to depression and even more trusting of one another.

It all hinges on income inequality. As this increases society becomes a much less pleasant place in all kinds of ways. The graphs at the foot of this page demonstrate the effect, all are produced by The Equality Trust.

So if my trading profit comes at the expense of those richer than me (I am robbing the rich to feed the poor(er) ) I am decreasing income inequality and can feel good about my career. The problem though is that I don’t know where my profit comes from, or even if it makes sense to talk about it coming from anywhere more specific than the ‘black box’ called ‘the market’.

Am I taking money from those worse off than me (because they are the bad traders who lose money over the long-term) or am I skimming off a little profit from the ridiculously wealthy?  In the absence of any way of knowing, I could just think about the average wealth of the market participants. I can be fairly certain that my income is below that average and could therefore conclude that my profits decrease inequality (and obesity etc!). However, it’s not an argument that I am sufficiently confident in to hope our pro-Tobin Tax friend is still reading this!

[Note: In the first graph, Singapore has a very high level of inequality yet a very low murder rate.  Regular readers of trading blogs may have some ideas about that apparent anomaly.]

I have been busy this week losing lots of money trading.  I have also been busy this week losing a little money playing poker.  I have been less busy thinking about this post, it probably shows.

You can’t play poker without realising that for some people gambling is an addiction.  The internet poker rooms display links to people who are there to help if you have a problem.  The forums are full of sorry tales of life-destroying losses.

I have ‘played’ trading for much longer that I have played poker but I am not aware of a similar problem.  If there is one then the  definition is less clear.

I think many of us display elements of addictive behaviour in our pursuit of a trading edge.  Where though do you draw the line between ‘necessary dedication’ and addiction? Frankly, if you aren’t totally obsessed with the markets then you would be a fool to turn on the PC each morning.

If you lost money at roulette in 2009 then only improbable luck will make you a winner  in 2010.  But losing traders generally do so because they believe these losses are the price you pay to learn (there are exceptions, some people pursue losses to confirm their own negative self-image). But generally losses are viewed as temporary and necessary. It isn’t forever and the light at the end of the tunnel is the glow of a flexible and  lucrative career.

(I know this post contains a lot of text.  Trust me though, visually if not intellectually, it’s worth making it to the end)

Trading also seems to lack the quick potential reward that is available through gambling. In poker it doesn’t take long to turn over those 5 cards, in horse racing the result is just a few furlongs away. This immediacy seems a large part of the addictive quality.  At the periphery of trading there now seem to be some products that look to fill that gap.  Spread-betting firms offer 5 minute binaries on the FTSE and DAX. Why wait for USD/JPY to wallow in a 15 pip range for hours (it usually does) when pleasure or pain are just a few minutes away? It is telling that these trades are regulated by the gambling authorities rather than the financial ones.

But someone must be losing at trading so that some people can consistently profit.  Some of this will be a supply of trading-fish who blow their accounts and never trade again.  My intuition though is that there must be consistent losers out there and I am almost certain they don’t feel life is that great. They may, in some sense, be addicted.

This isn’t a complete argument, I have no conclusion, I have been too busy losing money to reach one. If anything,learning to trade is the massive gamble, with hefty rewards but they only become available over years rather than minutes. Our attention spans may be too short to find that addictive in the traditional meaning of the word.

If you replace the word “gambling” with “trading” then the following self-assessment questionnaire probably applies. Perhaps gamblers are just smarter than traders, they look at the theoretically unlimited losses (when short) and realise the risk is too great!

It’s a serious topic, I can’t though resist a less serious video. As a teenager I loved this, not my kind of music though.

… that this will be my last post of the week.  I know it has been a blog-fest, I’m not sure why, but I’m certain you are getting tired of it by now.  I just had to mention the Robin Hood Tax campaign (aka Tobin Tax), the following video is impossible to escape in the UK at present.

That’s it. I’m done until next week.  I need to concentrate on making some money before I am taxed out of existence for making no contribution to society. 

I had written previously of the threat to our little money winner (/loser) if a Tobin Tax were to be introduced.  Whilst it had always seemed unlikely, we live in interesting times where anything is possible.  Financial speculators could have gone the same way as steam train drivers, fax machine salesman and honest politicians.

It was therefore an especially pleasant slice of toast and marmalade this morning when the Sunday newspaper contained a story that the chances of the tax being implemented are diminishing.

The prospects of a global tax on financial transactions were receding fast this weekend amid signs that countries were swinging behind an alternative plan to impose an insurance levy on banks.

Both David Cameron and Alistair Darling expressed support for Barack Obama’s proposals to force banks to pay into a fund that would provide compensation in the event of the failure of a financial institution.

Cameron said at the World Economic Forum summit at Davos that he thought a so-called Tobin tax was unworkable because of a lack of international support, but said he would back an insurance levy if he became prime minister in this spring’s election.

The full article, from The Observer, can be found here. I’m all in favour of taxing banks with an insurance levy, just leave us small-time traders in our garden sheds (is that just me?) well alone.

If you are making lots of money through trading (and ‘lots’ is a very relative term) then you may be interested in the following.  If you are making lots of money through trading and paying  no tax then you may be especially interested in the following from the BBC.

An Oxford University academic has pledged to give £1m of his earnings to charity during the course of his life.

Dr Toby Ord, 30, who researches ethics, believes his donations to charities in developing countries could save 500,000 years of healthy life.

He is launching a society to encourage others to follow his example.

Giving What We Can wants others to pledge at least 10% of their earnings to help tackle poverty in the world

I’m not here to preach (well, only about the foolishness of break-even stops) and I daren’t mention politics (amazing though what can be achieved with 10% compared to the 43% (of GDP)  government taxes) so I’ll say no more.

I definitely won’t point you towards Soc Gen tells clients how to prepare for global collapse because reading it certainly made me feel less charitable.

I had done all of my homework, I was prepared for this.

[Open*]

I was vaguely aware of other voices in the room, people asking me stupid questions, I occasionally mumbled an answer.  I remember feeling nauseous and worrying that I might actually throw-up.  My heart was beating so hard and fast that I thought I might be having a heart-attack. If this went wrong, I had no idea how I could pay the mortgage.  I tried to focus on what was happening but was unable to ignore the nightmarish vision of being homeless and penniless.

[Close*].

24 minutes later it was over and I was £45,000 richer.

I am also a liar, sort of. Let me fill in the ‘*’ and explain…

* The door.

There were 24 minutes between me opening the door and closing it behind me again. I was £45,000 better off only after I had worked there for a year. It was the interview from hell.

My point is that our lives are full of gambles. These gambles, the outcome of which is very often a mixture of skill and luck, have serious financial implications. So please don’t have a go at me, and friends and family do, for being ‘irresponsible’ by trading.  There is a lot more risk-management at work in my trading then is ever possible in real life or in any kind of business venture. I’m not drawn to trading because I am reckless, I am drawn to trading because it is a simple, controllable system. 

Learning to trade, putting it all on 27.

The biggest gamble is investing the time and effort to learn, not knowing if it will ever pay-off.  It takes a lot longer than 24 minutes which is probably why very few, quite sensibly,  take the risk.

[14:31 GMT, I'm really hoping lots of people are gambling on EUR/JPY not breaking through 132.00. I hate counter-trend trades but this was too hard to resist.  My FX trades have improved since Monday, thankfully.]

There has been coverage in the British press this weekend of the renewed interest in the introduction of a Tobin Tax, a tax on cross-border currency trading to discourage short-term speculation. It also looks set to be discussed at the upcoming G20 even if the prospects for global agreement are slim.

To save you the trouble I googled my way around the subject and tried to avoid the inevitable bias by excluding results that include terms like ‘eat the rich‘ at one end and ‘meddling commie bastards‘ at the other!

The most reasoned, detailed, readable  and apparently unbiased guide I could find was a 2003 paper (pdf file) by researchers at The University of Hannover. This examines the affect the tax would have on the forex market (some of the more evangelical proposers of the tax seem to assume there will be no effects, apart from a massive tax take from an unchanged fx market).

I’m sure you will read all of the paper for yourselves (it’s actually remarkably readable even without an economics degree) but some key points are summarised below. All interpretations are my own.

• Taxing short-term currency speculation out of existence, or at the very least dramatically reducing volumes, will decrease overall market liquidity.  Reduced liquidity is associated with higher volatility, a very unwelcome side-effect.
• Contrary to popular belief, asset managers have the greatest effect on short term currency rates, but they are unlikely to be affected significantly by the proposed tax.
•  A low tax rate is required to discourage tax avoidance and to maintain the smooth operation of the interbank market. Tobin initially mentioned 1%; 0.1% or less is now a more commonly discussed figure.
• However a Tobin Tax of just 0.1% could reduce the interbank market by 80%; liquidity would be crippled and volatility increased.
• The fundamental problem is that a low-rate does not discourage speculation, whereas a high rate markedly reduces liquidity.

 So the problem is not simply the added spread/commission (a calculation you could do on the back of an envelope) but the effect of the tax on the market, in particular liquidity and the knock-on effects and costs. Being a paper by academics with greater concerns than my shed-based operation, they fail to conclude that a Tobin tax would lead me to turn off one of these monitors, if not all of them.

My personal view is that taxing an activity rather than the profits that it generates makes little sense.  As financial speculation offers little value to society  then I  favour a hypothecated tax on profits. This could be dedicated to solving the same problems that many people hope the Tobin Tax will address.

Has any one made it this far? I’m impressed. A potentially depressing way to start the week, sorry.

Politicians love to ‘segment’ potential voters so that they can attempt to target specific groups (note this proves that politics is about changing your policies to get you elected rather than campaigning on policies that you actually believe in). This concept gave us – in the UK –  Mondeo Man, Worcester Woman and Pebbledash People.

I thought I would try the same for independent traders, the ones I have met in person and online. I’ll use male names throughout because alliteration is difficult enough without political correctness to think about as well!

Revolutionary Robin is a modern day Robin Hood, robbing the rich to feed the poor, even if his definition of ‘the poor’ includes himself.  Revolutionary Robin abhors the moral vacuum of the market but knows it is the most efficient way to generate money for his charitable causes. The pinnacle of his achievement is trading via tax-free spread-betting (so as not to fund the industrial-military complex with his taxes) and then claiming the tax (that he never paid) back for the charities he supports through Gift Aid.

Flexible Fred is not concerned with how much money he can make but how he can make enough money and fit his trading around the rest of life.  He thinks 24 hour forex markets are compatible with a 24 hour party lifestyle. He can often be found trading AUD/USD at 3AM using way too much leverage after way too much wine.

Owen Outsider gets lots of interviews for jobs in the real world but never seems to get past the stage that involves interacting with real people. His idea of hell is a ‘team building day’ and is happier e-mailing a Linux support forum than calling on friends and family.  He is a very successful trader but struggles to spend his profits once he has bought 4 x 32″ monitors and a PC overclocked to 3.86GHz that will run Metatrader without breaking sweat.

Charlie Chess is only interested in the game, trading for him is an intellectual battle-field.  There is a score kept, much like a chess rating, the units of which just happen to be a currency. This is the pursuit of cerebral satisfaction and any side-effect of generating vast sums of money is considered a bit grubby.  His book shelf is full of weighty tomes with titles like ‘Towards Artifact-free Characterization of Market Topography using Complex Wavelets and Total Variation Minimization’.

So what about the stereotypical trader who is self-centred, money-oriented and for whom there is no such idea as ‘enough profit’? Well he’s been caricatured in enough places already, but also, my experience is that he is actually in the minority.

Trading? That’s just gambling for the middle-classes!

Is that a fair accusation? Lets think about what we mean by ‘gambling’; in its purest form it is just a random guess at a random outcome (Roulette, a lottery, scratchcards etc).   The chances of winning the (UK) National Lottery are 1 in 14 million, even the young and healthy are more likely to have died by the time the draw is made than to win the jackpot. This kind of gambling is, as a wise man once said, little more than a tax on the stupid.

But that is just one form of gambling, when everyone’s chances are equal(ly bad) and there is no skill involved at all. The next step up (or down) the ladder involves the introduction of an element of skill. That skill may be fairly slight (or perhaps I am being unfair on those who bet on the number of corners in a football match?!) or more significant like in poker.

Poker shares much of its strategy, some of its vocabulary and a big chunk of psychology with financial trading. I could spend a post, or series of posts, discussing the similarities and differences between these two activities but that would be a digression. What is worth noting is that this type of gambling is now about both chance and skill. As chance should average out in the long term then it almost becomes possible to say that a poker career is all about skill, this is why the final tables of big tournaments often feature the same (poker) faces.

Jennifer Tilly at the 2006 World Series of Poker. More visually appealing than Doyle Brunson!

So I’ve written a bit about how I see some gambling as 100% luck , and which offers little more than excitement ,and other gambling which over the long term comes down to skill and shares a lot with financial trading. But to set financial trading in context there is a further kind of gambling that is overlooked.

We gamble when we resign from one job to take up a new one. We gamble when we decide to invest the money required to go to university.   These ‘life-decisions’ are gambles and they all have much greater financial implications than shorting one FTSE future contract.  They are rarely thought of as gambling though. A salesman’s job seems very like gambling with clear costs (time, petrol, a PowerPoint licence!) being risked with the hope, but no guarantee, of winning sales.

So is trading gambling? Yes, I think it is. But it is the type of gambling where skill predominates and that seems very different from the ‘wing and a prayer’ alternatives. But if trading is gambling then so is applying for a new job. We all gamble in life, we just need to be comfortable with the risks we take and confident that we have the skills to ensure the outcome we require.