Stock market investment would seem like a good way to test predictive skills, have there been any attempts to apply lw style rationality techniques to it?
Stock market investment would seem like a good way to test predictive skills...
I disagree and hope that more people would update regarding this belief. There is no alpha (risk adjusted excess returns), at least not for you. Here is why:
For all intents and purposes, stocks markets are efficient; even if you don’t agree, you would still have to answer the question “to what degree of inefficiency is there that will allow you to extract or arbitrage gains”? Your “edge” is going to be very very small if you even have one.
Assuming you have identified measurable inefficiencies, your trading costs will negate it.
The biggest players have access to better information, both insider and public, at faster speeds than you could ever attain and they already participate in ‘statistical arbitrage’ on a huge scale. This all makes the stock market very efficient, and very difficult for you, the individual investor to game a meaningful edge.
The assumption that one could test for significantly better predictive skills in the stock market, would imply that risk free arbitrage is common – You could just buy one stock and sell an index fund or vice verse, then apply this with the law of large numbers and voila you are now a millionaire but alas this does not commonly happen.
I happen to disagree. I don’t think this statement is true.
For all intents and purposes, stocks markets are efficient
First, there are many more financial markets than the stock market. Second, how do you know that stock markets are efficient?
your trading costs will negate it
That seems to be a bald assertion with no evidence to back it up, especially given that we haven’t specified what kind of trading we are talking about.
The biggest players
The biggest players have their own set of incentives and limitations, there are not necessarily the best at what they do, and, notably, they are not interested in trades/strategies where the payoffs are not measured in many millions of dollars.
The assumption that one could test for significantly better predictive skills in the stock market, would imply that risk free arbitrage is common
I don’t see how that implies it. Riskless arbitrage, in any case, does not require any predictive skills given that it’s arbitrage and riskless. You test for predictive skills in the market by the ability to consistently produce alpha (properly defined and measured).
Upvoted because your reservations are probably echoed by many.
I happen to disagree. I don’t think this statement is true.
I’d like to change your mind specifically when it comes to “playing the stock market” for excess returns. My full statement is “There is no alpha (risk adjusted excess returns), at least not for you”. This reflects my belief that while alpha is certainly measurable and some entities may achieve long term alpha, for most people this will not happen and will be a waste of time and money.
First, there are many more financial markets than the stock market. Second, how do you know that stock markets are efficient?
First, OP mentions stock market I’m not particularly picking on it. Second, for all intents and purposes for the individual, it is. Think about it this way, instead of saying whether or not the stock market is efficient, like it’s binary, lets just ask how efficient it is. In the set of all markets, is the stock market among the most efficient markets that exist? I would see no reason why it wouldn’t be. Have you ever played poker with 9 others of the best players in the world? Chances are you haven’t, because they aren’t likely to be part of your local game, but the stock market is easy to enter and anyone one may participate. While you sit there analyzing your latest buy low and sell high strategy, you are playing against top tier mathematicians and computer engineers synergistically working with each other with the backing of institutions. A lone but very smart and rational thinking programmer isn’t likely to win. Why would you choose to make that the playground for you to test your predictions skills? There are better places, like prediction book.
That seems to be a bald assertion with no evidence to back it up, especially given that we haven’t specified what kind of trading we are talking about.
Even dirt cheap discount brokers charge about $5 a trade, but if you were something of a professional then you could join a prop firm and get even cheaper maybe .005 per share. But now you have the problem of maintaining volume of trades in order to keep that rate. If you are a buy and holder you would still need to diversify and balance your portfolio with transaction trades, 1. To prove you statistically did better than the market rather than variance. 2. Prevent individual stock risk. If you have a strategy of anything other than a buy and hold strategy you will incur more trading costs.
The biggest players have their own set of incentives and limitations
Any incentives and limitations that big players have are more adverse for the individual. Strategies that are ignored by the truly big players are picked up by the countless mutual fund managers that year after year try to beat the market yet the majority don’t what makes an individual think they could do better?
I don’t see how that implies it. Riskless arbitrage, in any case, does not require any predictive skills given that it’s arbitrage and riskless.
I should rephrase, when I say arbitrage I mean statistical arbitrage. But strong stat arb might as well be just as good as riskless if you truly have an edge. Assume you have a measured alpha of a significant degree and probability. One would essentially be orchestrating a “risk-free” arbitrage by simply applying your alpha producing strategy and simultaneously shorting S&P etf’s to create a stat arbitrage. But that doesn’t happen commonly, because free lunches are quick and leave none for you. Strategies by nature are ephemeral, they last until rational agents exploit it until there is nothing left. For example there used to be a strategy where monitoring the monthly reported cash in flows to mutual funds could predict upward movement in equity markets. The idea is that with lots of cash, fund managers start to buy. This was exploited until this strategy no longer produces a measurable edge. Unless you have reason to think that you will discover a neat unexploited strategy, you shouldn’t play the stock market, just buy etfs.
I have personal experience in this industry and I think I only know one person that has been able to pull it off and is not lying about it. His experience is consistent with my beliefs that the stock market is getting more efficient. His earnings were the greatest during the earlier part of his career and has been steadily declining.
A great deal of things will not happen “for most people”. Getting academic tenure, for example. Or having a net wealth of $1m. Or having travelled to the Galapagos Islands. Etc., etc.
First, OP mentions stock market
Yes, but that’s the basic uninformed default choice when people talk about financial markets. It’s like “What do you think about hamburgers? Oh, I think McDonalds is really yucky”. Um, there’s more than that.
If you look at what’s available for an individual American investor with, say, $5-10K to invest, she can invest in stocks or bonds or commodities (agricultural or metals or oil or precious metals or...) or currencies or spreads or derivatives—and if you start looking at getting exposure through ETFs, you can invest into pretty much anything.
The focus on the stock market is pretty much a remnant from days long past.
A lone but very smart and rational thinking programmer isn’t likely to win.
I don’t know. It depends on how smart and skilled he is.
He might also join forces with some smart friends. Become, y’know, one of those teams of “top tier mathematicians and computer engineers” who eat the lunch of plain-vanilla investors. But wait, if the markets are truly efficient, what are these top-tier people doing in there anyway? :-/
Why would you choose to make that the playground for you to test your predictions skills?
Because the outcomes are direct and unambiguous. Because some people like challenges. Because it’s a way to become rich quickly.
Strategies that are ignored by the truly big players are picked up by the countless mutual fund managers
Mutual fund managers are very restricted in what they can do. Besides outright constraints (for example, they can’t go short) they are slaves to their benchmarks.
But strong stat arb might as well be just as good as riskless if you truly have an edge.
Oh, no. “Riskless” and “I think it’s as good as riskless” are very, very different things.
a “risk-free” arbitrage by simply applying your alpha producing strategy and simultaneously shorting S&P etf’s to create a stat arbitrage.
That doesn’t get you anywhere near “riskless”. That just makes you hedged with respect to the market, hopefully beta-hedged and not just dollar-hedged.
Strategies by nature are ephemeral
True, but people show a very consistent ability to come up with new ones when old ones die.
In any case, no one is arguing that you can find a trade or a strategy and then milk it forever. You only need to find a strategy that will work for long enough for you to make serious money off it. Rinse and repeat, if you can. If you can’t, you still have the money from a successful run.
Disclaimer: I day trade, so this might be influenced by defensiveness.
The thinking patterns I’ve learned on LW haven’t really helped me to discover any new edge over the markets. Investment, or speculation, feels more like Go or blackjack as an activity. Being a rationalist doesn’t directly help me notice new trades or pick up on patterns that the analysts I read haven’t already seen.
On the other hand, the most difficult thing about dealing with financial matters is remaining calm and taking the appropriate action. LW techniques have helped me with this a lot. I believe that reading LW has made me a more consistent trader.
I’m not sure that the above was written clearly, let me try again. My proficiency as a speculator goes up and down based on my state of mind. Reading LW hasn’t made the ups higher, but its made me less likely to drop to a valley.
On a tangent, while I’m thinking about it.
Has anyone else just been baldly disbelieved if they mention that they made money in a nontraditional way? The only other time I’ve seen it happen is making money at Vegas. I’ve met people who seem to have ‘The House Always Wins’, or ‘You Can’t Beat The Market’ or ‘Sweepstakes/Lotteries Are A Waste Of Money’ as an article of faith to the point that, presented with a counter example, they deny reality.
At my current level of investment, I probably have received substantial benefit from other skills that seem Less Wrong related that are not predictive, like not panicking, understanding risk tolerance and better understanding the math behind why diversification works.
But I suppose those aren’t particularly unique to Less Wrong even though I feel like reading the site does help me apply some of those lessons.
I would guess that to the extend that some hedge fund uses lw style rationality tecniques to train the predictive skills of their staff, they wouldn’t be public about effective techniques.
Stock market investment would seem like a good way to test predictive skills, have there been any attempts to apply lw style rationality techniques to it?
I disagree and hope that more people would update regarding this belief. There is no alpha (risk adjusted excess returns), at least not for you. Here is why:
For all intents and purposes, stocks markets are efficient; even if you don’t agree, you would still have to answer the question “to what degree of inefficiency is there that will allow you to extract or arbitrage gains”? Your “edge” is going to be very very small if you even have one.
Assuming you have identified measurable inefficiencies, your trading costs will negate it.
The biggest players have access to better information, both insider and public, at faster speeds than you could ever attain and they already participate in ‘statistical arbitrage’ on a huge scale. This all makes the stock market very efficient, and very difficult for you, the individual investor to game a meaningful edge.
The assumption that one could test for significantly better predictive skills in the stock market, would imply that risk free arbitrage is common – You could just buy one stock and sell an index fund or vice verse, then apply this with the law of large numbers and voila you are now a millionaire but alas this does not commonly happen.
I happen to disagree. I don’t think this statement is true.
First, there are many more financial markets than the stock market. Second, how do you know that stock markets are efficient?
That seems to be a bald assertion with no evidence to back it up, especially given that we haven’t specified what kind of trading we are talking about.
The biggest players have their own set of incentives and limitations, there are not necessarily the best at what they do, and, notably, they are not interested in trades/strategies where the payoffs are not measured in many millions of dollars.
I don’t see how that implies it. Riskless arbitrage, in any case, does not require any predictive skills given that it’s arbitrage and riskless. You test for predictive skills in the market by the ability to consistently produce alpha (properly defined and measured).
Upvoted because your reservations are probably echoed by many.
I’d like to change your mind specifically when it comes to “playing the stock market” for excess returns. My full statement is “There is no alpha (risk adjusted excess returns), at least not for you”. This reflects my belief that while alpha is certainly measurable and some entities may achieve long term alpha, for most people this will not happen and will be a waste of time and money.
First, OP mentions stock market I’m not particularly picking on it. Second, for all intents and purposes for the individual, it is. Think about it this way, instead of saying whether or not the stock market is efficient, like it’s binary, lets just ask how efficient it is. In the set of all markets, is the stock market among the most efficient markets that exist? I would see no reason why it wouldn’t be. Have you ever played poker with 9 others of the best players in the world? Chances are you haven’t, because they aren’t likely to be part of your local game, but the stock market is easy to enter and anyone one may participate. While you sit there analyzing your latest buy low and sell high strategy, you are playing against top tier mathematicians and computer engineers synergistically working with each other with the backing of institutions. A lone but very smart and rational thinking programmer isn’t likely to win. Why would you choose to make that the playground for you to test your predictions skills? There are better places, like prediction book.
Even dirt cheap discount brokers charge about $5 a trade, but if you were something of a professional then you could join a prop firm and get even cheaper maybe .005 per share. But now you have the problem of maintaining volume of trades in order to keep that rate. If you are a buy and holder you would still need to diversify and balance your portfolio with transaction trades, 1. To prove you statistically did better than the market rather than variance. 2. Prevent individual stock risk. If you have a strategy of anything other than a buy and hold strategy you will incur more trading costs.
Any incentives and limitations that big players have are more adverse for the individual. Strategies that are ignored by the truly big players are picked up by the countless mutual fund managers that year after year try to beat the market yet the majority don’t what makes an individual think they could do better?
I should rephrase, when I say arbitrage I mean statistical arbitrage. But strong stat arb might as well be just as good as riskless if you truly have an edge. Assume you have a measured alpha of a significant degree and probability. One would essentially be orchestrating a “risk-free” arbitrage by simply applying your alpha producing strategy and simultaneously shorting S&P etf’s to create a stat arbitrage. But that doesn’t happen commonly, because free lunches are quick and leave none for you. Strategies by nature are ephemeral, they last until rational agents exploit it until there is nothing left. For example there used to be a strategy where monitoring the monthly reported cash in flows to mutual funds could predict upward movement in equity markets. The idea is that with lots of cash, fund managers start to buy. This was exploited until this strategy no longer produces a measurable edge. Unless you have reason to think that you will discover a neat unexploited strategy, you shouldn’t play the stock market, just buy etfs.
I have personal experience in this industry and I think I only know one person that has been able to pull it off and is not lying about it. His experience is consistent with my beliefs that the stock market is getting more efficient. His earnings were the greatest during the earlier part of his career and has been steadily declining.
That’s a remarkably low bar.
A great deal of things will not happen “for most people”. Getting academic tenure, for example. Or having a net wealth of $1m. Or having travelled to the Galapagos Islands. Etc., etc.
Yes, but that’s the basic uninformed default choice when people talk about financial markets. It’s like “What do you think about hamburgers? Oh, I think McDonalds is really yucky”. Um, there’s more than that.
If you look at what’s available for an individual American investor with, say, $5-10K to invest, she can invest in stocks or bonds or commodities (agricultural or metals or oil or precious metals or...) or currencies or spreads or derivatives—and if you start looking at getting exposure through ETFs, you can invest into pretty much anything.
The focus on the stock market is pretty much a remnant from days long past.
I don’t know. It depends on how smart and skilled he is.
He might also join forces with some smart friends. Become, y’know, one of those teams of “top tier mathematicians and computer engineers” who eat the lunch of plain-vanilla investors. But wait, if the markets are truly efficient, what are these top-tier people doing in there anyway? :-/
Because the outcomes are direct and unambiguous. Because some people like challenges. Because it’s a way to become rich quickly.
Mutual fund managers are very restricted in what they can do. Besides outright constraints (for example, they can’t go short) they are slaves to their benchmarks.
Oh, no. “Riskless” and “I think it’s as good as riskless” are very, very different things.
That doesn’t get you anywhere near “riskless”. That just makes you hedged with respect to the market, hopefully beta-hedged and not just dollar-hedged.
True, but people show a very consistent ability to come up with new ones when old ones die.
In any case, no one is arguing that you can find a trade or a strategy and then milk it forever. You only need to find a strategy that will work for long enough for you to make serious money off it. Rinse and repeat, if you can. If you can’t, you still have the money from a successful run.
Disclaimer: I day trade, so this might be influenced by defensiveness.
The thinking patterns I’ve learned on LW haven’t really helped me to discover any new edge over the markets. Investment, or speculation, feels more like Go or blackjack as an activity. Being a rationalist doesn’t directly help me notice new trades or pick up on patterns that the analysts I read haven’t already seen.
On the other hand, the most difficult thing about dealing with financial matters is remaining calm and taking the appropriate action. LW techniques have helped me with this a lot. I believe that reading LW has made me a more consistent trader.
I’m not sure that the above was written clearly, let me try again. My proficiency as a speculator goes up and down based on my state of mind. Reading LW hasn’t made the ups higher, but its made me less likely to drop to a valley.
On a tangent, while I’m thinking about it.
Has anyone else just been baldly disbelieved if they mention that they made money in a nontraditional way? The only other time I’ve seen it happen is making money at Vegas. I’ve met people who seem to have ‘The House Always Wins’, or ‘You Can’t Beat The Market’ or ‘Sweepstakes/Lotteries Are A Waste Of Money’ as an article of faith to the point that, presented with a counter example, they deny reality.
At my current level of investment, I probably have received substantial benefit from other skills that seem Less Wrong related that are not predictive, like not panicking, understanding risk tolerance and better understanding the math behind why diversification works.
But I suppose those aren’t particularly unique to Less Wrong even though I feel like reading the site does help me apply some of those lessons.
I would guess that to the extend that some hedge fund uses lw style rationality tecniques to train the predictive skills of their staff, they wouldn’t be public about effective techniques.