Good article on recent historical attempts to regulate the swaps/OTC derivatives markets from the Post.

And on another note, Andrew Lahde quits his hedge fund and tells people to regulate their lives:

Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? They will all be forgotten in fifty years anyway. Steve Balmer, Steven Cohen, and Larry Ellison will all be forgotten. I do not understand the legacy thing. Nearly everyone will be forgotten. Give up on leaving your mark. Throw the Blackberry away and enjoy life.

Couldn’t say it better myself.

A thought just occurred to me — you know how people often denigrate paper-trading because it lacks the pressures and tensions that come from trading real money? I don’t dispute that, but my thought is that the best way to trade real money is to trade, at least emotionally, like you’re paper-trading. Maybe that’s why people often seem to do so well paper-trading; when there’s nothing at stake, it seems easy. Losses don’t hurt, gains don’t really matter that much, and strategies are much more easily followed without the weight of emotion bearing down on you. Who would revenge trade in a paper-trading environment? It’d be silly, right? I think the same thing is true in a real money situation.

Sort of a continuation of my last entry and a further meditation on things…

I look at my latest writing here, and for the average investor or trader who might happen by, it probably seems like a whole load of nothing, especially for the ones who seek answers, who want to learn other people’s opinions about things, who need someone to tell them what to do, or at least give them ideas about what to do. My earlier posts, when I started writing this blog, were about individual stocks, musings on various companies, and speculations on what might happen to them in the future, and I got much more attention for it. I’ve fallen for the trap of “other people’s opinions” many a time, but it’s my firm belief now that the best ideas come from within, perhaps after long and continuous exposure to the market environment and the various attitudes toward it, but nonetheless from something that isn’t influenced.

It’s analogous to the art of writing; the best writing comes from within, but only after long periods of reading and absorbing other writing, until it becomes part of your core and the words come naturally and unbidden. Those writers who consciously mimic other writers’ styles and techniques may occasionally come up with something readable and interesting, but often the results are only a shadow of the original.

I’ve been following a lot of trading and investing blogs as my professional life has moved more into this realm, and I find that it’s solidified my own philosophy about the markets, especially in the past several months. One of the things I still find fascinating is the incredible faith people have in systems trading, “technical indicators” and algorithms they’ve created for themselves, that they stick to rigidly. It seems like such a strange thing to be wedded to, especially when the only thing that is clear about the markets is that they are often unclear, changing, mutable.

When their system points them to some trade that they don’t take, these people grumble that they should “always be following the system” and it’s their lack of discipline in doing so that causes the issue. When their system starts to put them in harm’s way, they get defensive and stop using it and begin to doubt themselves. When the system puts them in a bad trade, they often blame their mistaken reading of their system: “it needs tweaking”, “I’m misusing it”. In some way, it seems almost religious, the need to devote oneself to a rule-set and the self-flagellation that happens when one fails to follow it.

In fact, for me, the need for discipline is not in following a system, but in money/risk/bankroll management, which all refer to the same concept. One, don’t take outsized risks and two, cut your losses. It’s the simplest thing in the world, but also the hardest thing in the world; saying it is one thing, but following it is a whole ‘nother story… and where human behaviour lies. In Vancouver’s frozen property market, with its record level of homes for sale, I’m sure there are more than a few people who aren’t willing to take their losses and will wonder why they weren’t able to, in retrospect. Everything seems so obvious until you add in human nature. People have been doing the same thing for years; they haven’t changed in aggregate, and they probably won’t in any of our lifetimes.

I try to bite my tongue around people who advocate a system that doesn’t revolve around the mechanics of defensive trading — it’s bound to encounter a market that’ll teach it a few lessons. These people are cultivating the wrong thing, I believe. They want, like good religious folk, to subsume their wills to something they feel is bigger than them, that they can abdicate their responsibility to. I think being open-minded towards the markets will be much more profitable in the long run than being close-minded; if you can learn adaptation, you’re much better served when the environment starts to turn.

What an ignominious end to the Nortel saga; talk about the death of a company in slow motion.

Last week, Nortel executives reduced financial guidance for the year, warning that the company would shrink by about 4 per cent. Saying that the status quo was no longer an option for the maker of network equipment, officials said they had begun talking to potential buyers for the metro ethernet networks unit.

The division, one of the fastest-growing portions of the company, makes gear for delivering multimedia content over local broadband networks. It accounted for 13 per cent of Nortel’s $5.38-billion (U.S.) in revenue in the first six months of the year.

You know it’s bad when you’re selling off the future of the company! It’s the inability to think beyond the current situation that causes a lot of problems.

Mutant, one of the very few posters on Metafilter worth reading for in-depth knowledge of the financial and banking industry, has posted another of his detailed collections of links on a theme, this time the expanding markets of hedge funds (perhaps “alternative investors” is more accurate?) He ends with a link to a Financial Times’ article on a more organized take on poker backing, which is something I’ve always found reminded me a lot of investing.

One of the things the article makes clear to me is that poker is perhaps not the best investment at the moment, as by its nature and reputation, it rarely attracts the kind of player that isn’t in some form a gambler (i.e. someone who plays for excitement). Perhaps that will change if this becomes more developed, although I imagine that it would take a lot of the spirit out of the game and is probably antithetical to the reasons most people get into poker. Once you start seeing accredited educational institutions with poker majors, the poker industry would dry up. Or maybe not — the financial trade is bigger than its ever been. All of these changes have come on the back of networks and technology.

One of the more interesting conventions they use in the article, at least in the latter half, is calling the BadBeat poker players “traders”. I find this a little imprecise — one of the main distinctions between poker and finance in my opinion is that there really isn’t a “market” in poker, one where you can take opposite sides of a position.

In these “interesting times” (not sure if there really is a Chinese curse about that — it sounds made up to me), my take on things is to stay defensive, cautious and aware of the volatility. But be opportunistic.

Also, I’ve learned more in the past two weeks than I have in the past decade (that might be a bit of hyperbole, but I’m thankful for the experience), in terms of my personality and the markets.

I’ve been looking back at my performance in 2006 and 2007, years where I drastically underperformed the commodity-heavy TSX and dallied around the S&P 500, and it’s amazing to recall trades that I don’t remember doing, or trades that I made but which, in hindsight, are totally at odds with my core tenets when buying or selling equities. At least three times during that period I went predominantly into cash, only to succumb to the siren song of “doing something”. Each time, sitting pat would have done me more favours. Although I had some big winners in those years, my profitability was undercut by these haphazard and ill-considered trades, often done with very little insight into market structure or sentiment. As I get older, this awareness of the overarching market becomes more important and stronger in me (I think?).

In 2004, another year which performance I was unhappy with, I recall exactly what led to it. I had done very well the year before, and was telling this to a friend of mine who, sitting on a substantial cash hoard, asked me to manage it. Being a neophyte in those areas (still am, in my opinion), I tried for several months, but was unhappy managing someone else’s money. I ceded control back to him, and he proceeded to dabble and then wholeheartedly trade while I was still under the impression I was a “medium-term investor” and buying Benjamin Graham reprints. Since I’m only human, I’d hear about the big gains (never the losses) that my friend would make, and how he was pulling money out of the markets like nobody’s business. It started to affect how I made my decisions, and I started to do things like daytrade and hold very short-term positions, things I had never done up to that point. Now, that might be a profitable way to work for some, but for me it was poison to my account, and that year I barely eked out a gain. My friend went on to lose the bulk of his account on a highly leveraged trade; he came back a year later with an additional sum he had kept back (”never to be touched”) and saw the bulk of it disappear when his large holdings of VIX options expired worthless. I’ve never been touched by a substantial loss that has blown me out, thankfully, and I hope that by living vicariously through him I won’t have to experience it firsthand, although I suspect it’s a difference in our temperaments that was a major factor.

That said, that doesn’t explain 2006 or 2007, most of which happened because I wanted the feel of “being in the market” without the work of actually watching regularly what was going on, seeing what factors were influencing it, and devoting real attention to it. Part of it was that I was working a job that took a lot of focus and didn’t allow for that kind of attention; one of those was going to suffer, and in the end it was my investing. It’s only now, that I’ve started to shift that balance, that I feel I have a better grasp of things. I’m a poor short-term trader, I am sure of it now, and don’t enjoy its tick-by-tick lifestyle. I like the bigger picture, the vast global interplay of factors, only a few of which I might have a handle on. Nobody knows everything (or anything, if William Goldman is to be believed). It’s been an interesting past while. I don’t consider myself an investor in the vein of Warren Buffett anymore, if I ever did, and it feels weird to have my site named as it is, but I’m not really a “trader” either. Is there something in between?

On a related note, I’ve started reading the various Market Wizards books by Jack Schwager, which have been recommended by various people I know. They’re interesting books, in that they expose you to the philosophy and personality of various traders, successful at the time of writing. The earliest of the three from 1989, Market Wizards, contains the most profiles of “old hand” traders, many of whom are still doing well. The latest one from 2001, Stock Market Wizards (not to be confused with The New Market Wizards (1992) — Schwager obviously likes his brand, maybe a little too much), is in some ways more interesting to me because it contains interviews with less well-known traders. One of them, Michael Lauer (mentioned here), was indicted on fraud earlier this year, while some are untraceable, even to Google’s all-seeing eye.

The guy that stands out for me from the last book is Stuart Walton, who current runs Trek Capital. I identify a lot with his story; there are a lot of things I see in myself, notably his interest in writing and drawing and the ability or need to work alone. The main difference to me is that he started really trading during the boom years of the 90s (a.k.a. the years when people quit their jobs to trade because it was “easy money”), after numerous failures and false starts, and did very well until 1999, when his Reindeer fund at the time took a loss for the year and he closed shop. (The performance is here in PDF form.) He then started a new fund, which lost 35% for the year, closed that, and now his latest, open since 2002, appears to still be viable. I wonder if the techniques and philosophies he developed in boom times are still serving him well or if he’s adjusted? I feel like he must have, much like I have — that’s the market, a movable feast.

(Similarly, I recently read Andy Kessler’s book, Running Money, another guy who ran a fund from the mid-90s to 1999 and then shuttered it — funny how that worked! I guess I have to give them credit for realizing when they couldn’t keep making people money.)

It does make me wonder about hedge funds, though — it’s been pointed out quite often that there’s a confirmation bias at work with them, where the indices that measure them often don’t factor in survival rate. For me, it would be instructive to revisit some of these traders, rather than solely interviewing them at the top of their game. Maybe there’s an epilogue and I haven’t gotten to it yet. It reminds me a little of the issue I have with the financial media, from major news outlets to bloggers — things can be said, analysis made, without any accountability at a later date. So rarely do people revisit the stuff to see what one’s track record really says.

Terrific account of the mindstate of a forex trader who can’t unhook himself from a trade that consumes him. The more leverage, the more terror and elation, I suppose.

Interesting article by Joe Nocera (the editor of Smartest Guys in the Room) about Carl Icahn’s reputation as “an activist investor” and his dealings at XO Communications. “Activism” in this case meaning to the benefit of the bulk of shareholders, which I find a somewhat degraded version of the word already.

Guys like Carl Icahn like net operating losses. If they can get their hands on them — which they can if they control 80 percent of the company with the losses — they can apply the losses against their corporate tax bill. So in November 2005, at a time when XO’s stock was around $3 a share, Mr. Icahn proposed the following deal: He would buy the company’s fiber optic assets for $700 million and take the net operating losses as well. The other XO shareholders would be left with the worthless wireless frequency — and they would have to use most of the $700 million to pay off the debt it owed to … Carl Icahn!

Let’s dwell on this for a minute. In his role as board chairman, Mr. Icahn was telling XO’s shareholders that it was in their best interests to sell. And yet, he was also saying that it was in his best interest to buy. It couldn’t really be both. Naturally, Mr. Icahn’s cronies on the board agreed to the deal. R2 Investments, however, reacted by filing a lawsuit, claiming that Mr. Icahn and the board were violating their fiduciary duty to the company’s shareholders.