AMA

Great questions!

Hey everyone,

Let me start by saying, the feedback on this Substack has been amazing! As I have mentioned in the past, I will strive to maintain a balance between providing sophisticated analysis and educating those of you who are new to financial markets.

I posted a tweet/Substack note saying this article would be an Ask Me Anything (AMA), and you guys had a lot of great questions. Many questions revolved around educational aspects of markets, which is fantastic. The people I'm trying to attract to this Substack aren't those looking for a hot stock tip; instead, they are the ones who want to learn how to think.

There have been some amazing people in my life who have helped me learn, and now I am in a position to provide them with alpha. In my mind, I am simply doing the same with you guys. I would encourage each of you to do the same with others. Ask questions, interact, and help someone else by giving them your time and knowledge. It always means more than you know.

Alright, to the questions!

I have grouped the questions into three sections:

• Process/Building

• Macro/Outlook

• Personal Advice

Process/Building:

When I first started watching markets, a friend sent me the futures dashboard on this website: https://finviz.com/futures.ashx. You essentially want to observe and understand everything on that dashboard. I remember watching it every single day for the first couple of weeks after he sent it to me, and I immediately began to recognize relationships, patterns, and formulate ideas. If you are just starting out, focus on the daily changes; don't get bogged down with 5-minute charts, as you can't learn the WHY behind things with that much noise.

This is a great question. Fundamentally, you want to identify preconditions that skew probabilities and then take some type of convex position toward that situation. For example, let's say there is a precondition where bonds have a 5:1 upside. I can capitalize on that scenario by purchasing a call option that provides me a 10:1 payout if the bond move occurs. Notice, though, that I just stacked my probabilities. I have a 10:1 exposure to a 5:1 situation. So you want to identify preconditions for things because the future always unfolds in connection with the present. We don't skip time, which means the future is always a function of the present.

Tangibly, this means you need to build some type of model that accurately measures the risk/reward of assets. This is done by understanding the preconditions (aka the present) really well. For example, if growth is significantly negative (think recession) and liquidity is increasing (think Fed in 2020), that is creating the preconditions for growth to accelerate. This is a simplistic explanation, and there are qualifications, but your model needs to account for all of those.

Final thing, I use the example of a call option but when you build a strategy using delta ones, you are implying a specific payout profile that is similar to how you construct a payout profile for an option.

This is something many people discuss, but most don't really know how to do it well. I would recommend starting by reading some books on information systems and engineering, as they provide a foundation for structuring the flow of energy and information.

Information is everywhere, but synthesizing it correctly is a skill. This is part of the limitation of AI. When you're trying to solve a problem that is constantly changing, with an information set that is always in flux, and in an environment that is continually evolving, you will realize the limitations AI has. Why? Because it's not just about the information; it's about the rules you use to interpret and synthesize that information. Recognizing when rules need to change requires higher-level thinking that is one step removed from the information itself. However, you need to know when to do this and when not to by constantly moving back and forth between various hierarchies of rules and information.

It's always different, which is why it's so difficult to know. What you want to do is build up a knowledge base around what previous bear markets looked like. In my opinion, the famous saying about the judge and pornography applies here: you know it when you see it. Tangibly, I want to see the yield curve steepen, real corporate profits turn positive, real wages move into positive territory, valuations expand as earnings drop, consolidation after capitulation in asset prices, and some type of policy intervention. Generally speaking, shocks begin bear markets, and policy interventions set the bottom in bear markets, but there are always exceptions.

On a systematic basis, you need to determine the type of bear market and understand how that will establish the preconditions for a specific type of recovery. From there, you can identify the specific signals to look for and how they will be expressed in asset markets.

Identifying when the rules of the game change is crucial. Also, if it's not in a backtest, it will likely be challenging for a pure algorithm to detect it.

This is very real. The wisest man who ever lived said: "For in much wisdom is much vexation, and he who increases knowledge increases sorrow." Eccl 1:18.

Where do you start? Think about what you want to accomplish and who you need to become to get there. Then, create a plan that breaks down your goals into tangible steps and execute them consistently. Personally, I have many different goals, and they are broken down into lists and schedules so that when I wake up, I simply do whatever is on my list.
Success is measurable.

What you need to realize is that your goal is to come up with a basket of strategies that consistently make money. A strategy is nothing more than a business that generates cash flow. There are, of course, many strategies out there (see paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3247865). What I would do is start by identifying your specific edge/competency and then find a strategy with the highest expected returns that overlap with your edge.

At the end of the day, you need to focus and make money. Being a professional means mastering your craft. We all started with one strategy.

To be honest, there isn't really some magic secret sauce to the whole VIX thing. What you want to do is identify all the points on the vol surface and understand why it's moving. The vol surface is simply pricing liquidity at different strikes and periods of time. The vol surface is expressed in two primary ways: 1) through time, as it's reflected in the VIX futures curve, and 2) implied vol at different strikes (think about how vol is priced at 4000 SPX vs 3600 SPX at the same expiration). From here, you need to come up with every possible spread on the vol surface and understand why different parts of the surface have more liquidity than others. You then connect this with macro flows and the WHY behind things.

For example, you need to watch the VIX spot minus the first VIX contract. If the VIX spot is higher than the VIX 30 days out, then it means vol is trading at a premium. And remember, when we talk about vol, we are just talking about liquidity. So if SPX is falling, the VIX spot is likely to spike above the first VIX futures contract and trade at a premium since people in SPX need liquidity NOW instead of 30 days from now. The same is true for skew, which is just taking the 25 or 30 put delta and subtracting it from the 25 or 30 call delta. Essentially, you can see how implied vol or liquidity is being priced in various degrees of direction on an instrument.

This essentially ties in with the discussion above. However, I would say that you need to understand how implied vol works for each market. Implied vol on SPX functions differently than implied vol on commodities. Why? Well, that's a topic for another time, but there are plenty of books on this subject. Read more books, guys!

Great question. This has become very second nature to me, so it's actually a little difficult for me to answer. I have spreadsheets, quantitative models, and algos running at all times. I am finally just getting to a place where I have a good workflow around everything. What I do is a bit different, as I'm constantly trying to connect discretionary information with quantitative signals. Most quant guys don't know much about macro or the "why" behind things. I think the main thing to remember is that this is an iterative process. I cannot tell you how many times I have changed my entire workflow or process—literally hundreds! So I would say it involves a lot of trial and error in search of constant improvement.

The final thing I would emphasize is that success is measurable. So don't fall into the mindset of being complacent. Part of your intentionality should be structuring your ideas, models, information, and strategies in hierarchies based on how their causality relates to one another. Never allow any margin for error!

I actually wrote an article about this: I break everything into innovating, systematizing, and running.

How To Think About Markets, Trading, and Wealth Management

Honestly, it's very difficult for me to answer. I wouldn't view my style as being modeled after a single individual or process.

I usually just point new people to the WifeyAlpha research now.

https://twitter.com/WifeyAlpha/status/1528727115864199170

However, I wouldn't really view myself as trading in any way similar to WifeyAlpha.

Momentum and mean reversion are important, but the longer I think about it, the more I realize they are just shadows on the wall of Plato's cave. I will talk more about this later.

What I would suggest is that you need to break down every single part of the entire market and all the causal forces. Build a model around each of them, delineating them into regimes with signals, and then, from there, you can begin to see things more clearly.

Very interesting question here. There are a couple of differences, but in general, I think LEAPs are great ways to take bets if you price them correctly. The main thing I would ask is, what are you trying to accomplish? Do you have a lot of different bets going on at the same time? Fundamentally, I like the idea of buying really far-dated OTM options on things if you can get them at a good price. A lot goes back to valuing the option correctly.

Interesting question. Unfortunately, I can't discuss the specifics of my risk management process, but I can share some broad principles. In markets and in life, you want to adjust your execution and risk management to the scenario. The problem is, most of the models and systems people build are linear and static. They set stop losses at specific levels without any consideration for the signal-to-noise ratio or WHY something is happening. What I would suggest is to know your environment and time horizon incredibly well. Whether it's intraday, daily, or yearly as you trade or run a business, just be very familiar with the environment and its characteristics. If you can quantify this, you can have an adaptive risk management process that updates as information and signals dynamically change. Most people don't have this and simply use a stop that has statistical significance like an ATR or standard deviation. There's nothing wrong with this, and you can be incredibly successful using it. However, I do things differently.

You need to have models running on every timeframe, and you need to stack them so that they incrementally provide signals for higher or lower timeframes. I have models running on the weekly, daily, hourly, 15-minute, 5-minute, and some tick-based timeframes. But in reality, depending on your capacity, you may only need weekly and daily. Day trading isn't really an optimal strategy for most people unless you have some type of edge. In reality, more people should be looking at weekly charts.

This is a really interesting question to me because it's something I spend a lot of time on. What you have to understand is everyone has different definitions of trend and momentum depending on their lookback period or how they calculate their models. I provided the PDF of all the Tweets from a Twitter account in this article. I really appreciate this guy because he even asked, "Someone please give me the definition of a trend?" No one knows!

There are a lot of things I can't share, but what I would say is you need to understand the various WHYs for momentum or mean reversion happening and the various players executing. Then you need to have a really clear understanding of how flows are driving every move. Momentum and mean reversion are incredibly helpful in themselves; when you connect this to information, it becomes really powerful. Most people don't do this.

I will just say there is a ton you can figure out here if you read a lot and spend a lot of time thinking about it.

Macro/Outlook:

Right now, the forward curve is pricing the marginal probability of rate cuts. Remember, though, the curve prices perception of probabilities, not reality. I don't think we get cuts until the SPX is well below 3600, and credit spreads are blowing out. As I have said in previous articles, I believe there is going to be a window of time where the Fed doesn't cut preemptively as risk assets are falling, which will cause a liquidation. Go back in history and overlay market liquidations with the Fed funds rate. Almost every time they cut into liquidation, and the market keeps falling. What do you think will happen if they don't cut? If you actually go look at the 1930s crash, the final liquidation went on a Fed hike. Insane!

I am bullish on the dollar against the Euro, Pound, and Aussie dollar here. However, I could see a scenario where it chops for a bit depending on relative credit spreads and growth differentials between the countries, given all the central banks have basically stopped hiking.

For CTA:

• First, watch COT positioning which can be found on the CME tool: https://www.cmegroup.com/tools-information/quikstrike/commitment-of-traders.html

• Second, watch HFR performances indices: https://www.hfr.com/family-indices/hfrx

• Third, get a list of all the major CTAs and watch their portfolio. You can look at ETFs, mutual funds etc.

• Fifth, just look at momentum and ATR turning points. Think about the logic of what would cause a CTA to outperform at specific points.

• There are more sophisticated ways to get an idea of CTA positioning, but the methods mentioned above will be helpful. Also, remember that CTAs are not naive; they simply use different signals for executing trades, and a CTA strategy can be essential. Understanding the logic behind these signals is crucial.

Second wave of inflation? Maybe. It’s definitely in the cards. I think the people who are dogmatic and deterministic on either side will continue to lose money. Part of the reason is the question of how much rate hikes and inflation targeting even impact inflation when it has a lot of supply-side factors. Remember, inflation is simply the amount of nominal demand compared to the current level of output. So you need to be monitoring both demand and output. The amount of money in the system is still significant as well.

Recession in Q3? That is what I am betting on but it could always change. For the time being, I want to be short stocks into that period of time. The functions of gold and BTC will likely be somewhat connected to the Fed's reaction function, but I don't see the Fed stepping in right away. I think there will be a time in the future when it will be really clear to buy gold and BTC.

My positioning sizing? Tough to explain here because it's complicated, but if you're new, I would suggest reading Van Tharpe's book on position sizing as a good starting point. I'm not really a Van Tharpe guy, but in terms of consistent returns without knowing much about fundamental information, those guys have good systems.

On the second question: the stock market is pricing in a soft landing and a very rosy future right here. The macro data is decelerating and the market has primarily been driven by the liquidity function because earnings expectations have remained fairly flat while valuations have expanded. Part of this is due to the short-term liquidity injection during SVB crisis. I don’t actually think we would be at these levels in SPX if we didn’t have the SVB crisis.

Long-term trends:

• I am bullish long-term on specific crypto projects and a couple of Web3 projects.

• I think information intelligence will be very valuable in the future. People who know how to interpret information and execute on it correctly will go for a premium. This will especially be true on the geopolitical and international front. The problem is, this type of knowledge base takes years and years to develop. The people who do have this knowledge base are ivy tower academics who aren’t practitioners. This creates an opportunity for people who have the knowledge and can execute.

• Long term I also think we are at peak tech jobs, coders and quants. The entire space has set up a generation of kids to think the way to get rich is by coding or going into AI. I am not saying this isn’t important but in tech like this, everything is a fat tail so only a couple percent of everyone will make a ton of money. Blue color workers and businesses will begin going for a premium. We just heard the CEO of Waste Management say that he can get as many MBAs as he wants for 60k a year but can’t get a single trash truck driver for 90k a year. Think about the pricing power and labor differential!

  • All the people that believed college would solve all their problems are in for a rude awakening.

• Also long term, I would short most colleges out there. On a technological and financial basis, colleges won’t be able to survive. Education is changing dramatically and there will be a lot of ways to make money from it. There are a decent amount of companies out there but a lot of the good ones are private or in VC portfolios.

I don't really buy into the whole idea that we HAVE to have a recession every 7-11 years. Maybe, maybe not. The period before COVID was a pretty long period of time without a recession. Would you want to sit in cash the entire time?

With all that being said, I do believe we have considerable skew to the downside. Unfortunately, Twitter and financial news media have been so bearish for the past decade that it's now cliche to say you are bearish. The bottom line is it's better to view a distribution of outcomes that are path dependent rather than a deterministic one. This doesn't make you feel safer, but it's the truth.

A lot of these so-called "imbalances" have to do with the dollar's reserve currency status. These charts of debt to GDP or valuation are primarily driven by structural factors connected to the dollar. So you really need to have correct attribution analysis when defining the structural dynamics.

Not a huge fan of the “credible evidence” language because in markets, all knowledge is conjecture.

On the global liquidity thing, you need to monitor the level AND rate of change. Do you even know what are in those global liquidity indices? They are primarily rate of change or normalized momentum. This means they are primarily dealing with direction and speed, not ampilutde or level. Notice how bonds have not rallied considerably even though the rate of change in inflation is really low? Its because of the level.

In general, the world has an inflation problem. Inflation by its nature contracts liquidity. Those two things go hand in hand.

You will also notice these “credible” liquidity indices seem to change every year to a new back-fitted version. If there is a real “credible” liquidity index, then you backtest it with a strategy for buying and selling assets. These exist but I assure you they are not floating around Twitter.

One other side note, just realize there is so much IP that exists in the financial industry among private shops and top players. No one is sharing their IP on Twitter. These types of places remain private and secretive for a reason.

Short oil, long oil stocks in my opinion. We will see.

Personal:

Interesting personal questions here: I will share a few beliefs and thoughts.

• There is this section in the Steve Job biography by Walter Isaacson where Jobs is talking about his school experience and says they almost destroyed his creativity with what they were making him do. I think this is very true in general. Most workplaces, schools, and universities aren’t set up to foster creativity and thinking. I think isolation is frowned upon in today’s culture even though great things are created in isolation. We have never been so intellectually deficient as a society. If you go back to the 1500-1800s and see what the educational standards were for University, it would blow you away. These kids would be 12 and have read all the classics, know the majority of classical languages, and be able to recite many books from memory. The bar is so low now.

• No one will ever see all the work you do, they will only marvel at the results: this is the story of every successful person’s life. On a fundamental basis, your motivation can’t come from others, it must come from beliefs and convictions. For me, all of this comes from God and the Bible.

• Yes, I work in markets “full-time” if what you mean by full-time is every waking moment. There are many ways to make money though. For some reason, finance is glamorized. I think you should always be ready to leave your industry in pursuit of something greater. You should strive to be exceptional at life, not just in markets. Markets are only one aspect of life.

• Final thought I will share under this line of questions: rejecting people’s advice is just as important as taking people’s advice. The most important decisions I have ever made in my life were when I rejected everyone’s advice. I am very happy with the results but this also requires to you not act in ignorance or your limitations of inexperience. The risk will always be there though.

Conclusion:

Great questions……….

I hope that the answers helped you think a little. I will leave you with a final idea:

Platos Cave: You should spend some time thinking about the allegory of the cave that Plato talks about. It is probably the best illustration of how you need to think about domains where there is unpredictability, false signals, biases, and uncertainty. The entire idea is that there are these prisoners chained inside a cave and all they see are the shadows of things passing by. They think these shadows are reality since they have never left the cave. In truth, there are actual things passing in front of the light that are causing the shadow. The prisoners don’t know this though.

What you need to remember is that all of these models you build are necessary and helpful. However, most of what you see in markets are shadows on the wall. It is people who think they see reality but in truth, its just shadows on a wall. A lot of people are content with watching the shadows on the wall because they make a decent P&L curve. There is a lot more that you can see but it requires a lot of sacrifices.

Thanks for reading!