Market Sense and Nonsense: How the Markets Really Work (and How They Don't)

Jack D. Schwager... wow, my all-time favourite author behind Michael Covel... This book ate up a lot of my time. The moment I started it, I just cannot put down. However, the ending was actually very disappointing (LOL). To sum it up, I think I was misled by the topic of this book, haha...

The title of this book made me genuinely curious. As I flipped through the few chapters, I am attracted by the tons of investment misconceptions. Some good examples are listed below:

People are risk averse when it comes to gain, but are risk takers when it comes to avoiding a loss. It explains why traders tend to let their losses run and cut their profits short.  

Bankrupt stocks continue to trade at some level meaningfully above zero for quite some time before finally fading into oblivion. Why? Because even though the likelihood of the stock eventually going to zero is virtually 100%, people will rationalize: "I bought it at $30 and it is down to $1. I have already lost $29, and the worst case is only a $30 loss. I might as well take a chance." People are risk takers when it comes to trying to avoid a total loss, a fact that explains a lot of market behavior. 

In a chess tournament, all the players know the same rules and have access to the same chess books and records of past games by world champion, yet only a small minority excel. There is no reason to assume that all players will use the same information with equal effectiveness. Why should the market, which in sense represent an even more complex game than chess (there are more variables, and the rules are always changing) be any different?

Some market participants, however, are not seeking to maximize profits, but are operating on different agendas. We consider two such classes of market participants: hedgers and government. 

Although it is open possible to identify when the market is in a euphoric or panic state, it is the difficulty in assessing how far bubbles and panics will carry that makes it so hard to beat the market. One can be absolutely correct in assessing a fair value for market, but lose heavily by taking a position too early. 

The best prospective years for realizing above average equity returns are those that follow low-return periods. Years following high-return periods, which are the times most people are inclined to invest, tend to do slightly worse than average on balance.

The reason why risk assessments based on the past track record so often prove to be fatally flawed is that they are based only on visible risk - that is losses and volatility evident in the track record - and do not account for hidden risks - that is, sporadic event-based risks that failed to be manifested during the track record period. 

Good performance is not necessarily a positive attribute. Sometimes superior past performance may reflect the willingness to take on greater risk rather than manager skill.

It should be noted that because of their much more greater high frequency of trading, hedge funds account for a much larger portion of each market's trading activities. Big fish can do very well in a small pond, but if there are too many of them, they will starve. So, the advice that investors should include hedge fund allocations in their portfolios will remain valid, as long as this advice does not become too popular.

Investors always seem to ask hedge funds the question: How much leverage do you use? This question is flawed on two fundamental grounds. First, the question is meaningless, given that it ignores units of measurement: the underlying investment (that is, what is being leveraged). Second, it implicitly assumes that there is a direct connection between leverage and risk. Not only is this assumption false, but it is even possible - in fact, entirely common - for a higher-leveraged investment to have low risk.

A maximum leverage constraint applied uniformly to all prospective investments regardless of portfolio content is analogous to a traffic law that applies a 40 miles per hour speed limit to all roads, in all conditions. 

Increasing leverage can increase risk if leverage is used to increase net exposure to the market. If, however, leverage is used for hedging to reduce the portfolio's next exposure, then it actually reduce risk.

Although leverage can be dangerous, the knee-jerk reaction many investors have to leverage can lead to nonsensical investment biases. Investors need to focus on risk, not leverage.

There is a common belief that hedge fund managers will object to managed accounts because they will be concerned about the confidentiality of their positions. This perception is based on faulty logic. How many hedge fund managers don't have a prime broker? Presumably zero.

A portfolio with a small number of uncorrelated holdings is effectively more diversified than a portfolio with a large number of significantly correlated assets.

With such a long list of great examples, this book must be super good to me? The answer is no. As I mentioned above, I was misled by the topic of this book. I thought it is a pure rational versus irrational stuff in regards to financial markets. Ended up, I think the author mainly focus on investing in hedge funds. This is the main thing that disappointed me at the end. After finished the book, I have a weird feeling that the author is pushing hard for hedge fund in general and fund of funds in particular.

Overall, this is still a nice book to explore. At least, the 55 investments misconceptions will get readers to think (think hard) and there are definitely certain values behind it. As such, for a full rating of 10, I am going to rate it at 8. Frankly, I prefer Jack D. Schwager's other books... 

Trading Beyond the Matrix: The Red Pill for Traders and Investors

After reading three "boring" books, time is just right to get back to my favorite stuff. So, here I am with this book after digesting an impressive interview between the author and Michael Covel.

The preface at the beginning of this book really spur my interest on this book. The author was inspired by the movie of "The Matrix". As a result, we got this so called "red pills" for traders and investors instead of "blue pills" as seen in the said movie. I love the said movie so much, although I admit that I am still very confused over the amazing contents. But, those days, the "red pills" did inspired me...

Ended up, this book caught me in different mix feeling throughout the journey of digesting it. First of all... the famous SQN as mentioned umpteen times in the book puzzled me more rather than strengthen my belief that a simple statistic like SQN actually works in real life. In my humble opinion, SQN alone is too predictive. A statistical stuff alone are just a guide and there is no way to prove a system workable unless it can performs regardless of the products, regional and any circumstances. The contradict part of it are the author's belief that we need to adjust different set of mechanical trading system for different markets or products. So, the predictive element is actually strengthen in a way that we need to "predict" the robustness of a system and we need to "predict" whether such system workable in a particular market. To me, I rather believe that products will change every single moments. Hence, the more a system adapts to different circumstances (regardless of products and regional issue), the more robustness it should be. If that is the case, is there a need to prepare different systems for different products?

Secondly, the author mentioned that: "The biggest mistake people make is to try to design one system to fit all markets." Well, I am not too sure about this. I would prefer to filter out the products while maintaining "one" system for the remaining products that I choose. As mentioned above, the more a system able to react to any circumstances, the more robustness it can be. Of course, we may not be able to apply "one" system to all products in general as the results may vary significantly. However, we have the choice to choose which products (with high profitable returns) to trade and which products to trade off. Again, it is all about "prediction" if we try to choose particular system for particular products. The contradict part arise when the author himself admit that: "If prediction has nothing to do with trading well, what do we try to achieve when we open a positions? It seems to be prediction." Sounds contradict, right?

Apart from the above two points, I actually like this book so much. The chapter on "My Inner Guidance" was surprisingly good even though I never believe in god. The author's relationship with Mitzi especially caught my mind as now I believe we really becomes who we are thanks to our grown up process. This brings up to a very excellent opinion from author at the earlier part of the book: "Every part is established with a positive intention, quite often to protect you from something, but you tend to forget about each part once it is established, as well as its intention. Consequently, a fear part designed to protect you from fear actually ends up bringing up fear all the time and producing fear in your life. One of the things you need to do to resolve the conflict is to go back to the part's original intention and give it positive things to do." As far as I am concern, god does not exist, But, the belief of positive thinking and raising our consciousness are so important to human beings like you and me.

Overall, this is an excellent book for traders. In general, all psychology stuff presented will surely help traders overcome lots of hurdles and tough moments in the cruel world of trading. The best part... the author provided cases of studies with successful traders sharing their journey with the readers throughout the whole book. Moreover, a UK friend of mine mentioned that the only way to get Van Tharp's psychology stuff is to attend his expensive courses. Now, it is all here in this tiny book (To me, any book less than 300 pages are consider not thick).

As a conclusion, I highly recommend this book even though there are certain points that does not sounds appealing to me as mentioned above. For a full rating of 10, I am going to rate this book at 8. This book further enhance my belief towards a better trader as well as a better and happy person.

Lastly, listed below are three excellent quotes that I think will be useful for my future references:

Entry by itself is relatively unimportant. Entry with your initial stop-loss is very important in setting up what 1R means.

Anything is possible. But, trying to be right is a sure path to disaster because of the psychological issues involved, and trying to predict is a path to disaster because, in my opinion, no one can really do it.

How do you think you'd perform as a trader if you were feeling "guilt", "shame", "fear", "grief", "anger" or any of the other lower emotions? It should be clear that you wouldn't do that well. You need to be at a minimum level of "acceptance" to expect to have much chance of successfully trading the markets.