Macro Alpha Primer: Stacking Edges To Identify a Sucker

How macro connects to the intensity and elite performance of trading

Sep 04, 2024

Today, we are bringing together the Macro Alpha Primers to an end with a Synthesis Primer. In macro (and life), the more you learn, the more you grasp the complexity of variables and their relationship to each other. As you move to higher levels of learning, you need to synthesize information based on presuppositions that have a strong foundation. This is what we will be doing in this primer. There are two primary ideas I will use to contextualize this synthesis:

Idea 1#: Quantifying all moving parts in macro fundamentals, momentum, and mean reversion in price, correlations, and positioning creates the framework for obtaining an edge in markets. An edge (specially in the realm of alpha generation) is obtained by identifying when a player is/has incorrectly interpreted the moving parts of the system and thereby is constrained to unwind their position. Since we are no longer trading in the pits, the primary way to correctly identify if an agent has incorrectly interpreted the moving parts and is constrained to unwind their position is quantitative. The main principle you want to employ here is building a model that properly accounts for all variables as they relate to each other in all collocations and through all periods of time. If you can accomplish this, then you can know WHEN and WHY an agent is wrong. This is a required prerequisite for taking bets and Idea #2.
Idea #2: The goal of taking a bet in markets (or life) is to match your patience with the impatience of market participants. How would you know if market participants are being impatient? In how they are paying premiums or discounts based on the quantitive models laid out. The informational edge you have developed provides you with the tools to correctly interpret the risk-reward of an asset which is a direct reflection of the patience and impatience of market participants. Once you have identified a bet to take, you must have a different time preference and risk tolerance than the market.

Everything from all of the primers funnels into these two ideas. Here are all the previous primers:

Process:

Precision in your process is the differentiating factor that allows you to utilize leverage in order to increase your overall risk-reward. In order to employ optimal discretionary decision-making at the specific points where systematic models/strategies fall short, measurable processes must be in place.

All of the educational primers I have written thus far can function as tools for you to build your own spreadsheet with inputs. In today’s world with AI, you don’t even need advanced math degrees to build out these processes.

Brainstorm: I don’t know math ?

Capital Flows

July 25, 2023

Hey everyone,

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If you build out some basic spreadsheets detailing all the inputs and processes you need to perform, then you can build AI bots in ChatGPT to run processes for you. Think of this entire process like a business (see my first article on this: link)

The thing that most people miss is that this process is exactly the same for any business. Due to the liquidity in financial markets, leverage is easily accessible. This is why intellectual performance is reward so quickly and with such extremes in markets.

“Clear thinker” is a better compliment than smart

-Naval

Stacking Edges:

What you will begin to realize is that there are differing edges you can stack with each other to have a better risk reward. One of the simple ways a friend of mine explains this is “pages in the book.” To put on a trade, he wants to see multiple reasons (or pages) for the trade to work out (see one of our convos here: Link). The goal is to identify a trade with positive asymmetry in multiple outcomes.

At the end of the day, I can always find a trade to put on where I have optimal stop placement and holding period. The more important question is, is this the best trade I can put on right now and how does it contribute to a portfolio of bets? This requires constant mastery (link):

Pulling Things Together:

We will end with this story: Link

Profile: Shigeru 'Sugar' Myojin - As sweet as it comes

When Travelers Group completes its $9bn (pounds 6.3bn) purchase of Salomon later this year, Shigeru "Sugar" Myojin will receive Travelers shares worth $11.4m. But that won't be his biggest payment, even in the last 12 months.
Myojin, a trading legend from the City to Wall Street to Tokyo's Otemachi district, made $31.45m last year, including a $10m bonus and almost $19m in deferred pay-ments for his work as the point man for Salomon's mammoth proprietary trading business.
Now that Salomon will be merged with Travelers' Smith Barney into a global investment banking network, all eyes will be on Myojin to see if he can continue to work his high-wire trading magic under the sober regime of an insurance company.
"The worry people have is that he will be somehow forced to report to a risk-averse chief executive officer who may give him a hard time about some of the positions he wants to take," said Roy Smith, professor of finance at New York University's Stern School of Business. "I'm not so sure this is true. Why would they want to disturb him?"
Myojin, nicknamed "Sugar" by a colleague from Texas who couldn't pronounce "Shigeru", is no stranger to big money. As head of a business that risks millions for Salomon every day, betting on bonds and currencies, precious metals and coffee, he is also used to being in control.
He operates from Salomon's cavernous trading floor next to Victoria Station in London, making split-second decisions on whether to buy a load of German bonds or sell Japanese bond futures, and leads a group of some three dozen Salomon proprietary traders worldwide.
The 48-year-old trader, the last of a long line of super-traders that gave Salomon its cowboy reputation in the 1980s and earned then-chairman, John Gutfreund, the title of "King of Wall Street", almost retired two years ago.
Salomon, reluctant to lose its money machine, offered Myojin the position of vice-chairman and head of its proprietary trading business, its most important. He got a salary of $520,000 and an incentive package that tied his bonus to trading profits he generated, which means extra pay in tens of millions in good years.
For Myojin, there have been lots of good years. In 1991, profits from his trading are said to have accounted for almost half of Salomon's $919m in pre-tax profits. He also had big years in 1989 and 1990 and in the last 12 months has helped Salomon earn about $650m in trading for its own account.
While many big investment banks engage in proprietary trading, Salomon is known as the biggest gambler on the block. It takes extraordinary positions, mostly in bonds and bond futures.
Will it change under the leadership of Travelers' boss, Sandy Weill? Early signs suggest it will be business as usual. Under the new management board, Myojin will share responsibilities for global arbitrage with the old Salomon team, including Costas Kaplanis and Robert Stavis.
Analysts and former employees believe Weill will continue to give Myojin a free hand to risk money on big bets. Indeed, Travelers' deep pockets can cushion the blow from any losses that proprietary trading might develop, losses that historically made Salomon's quarterly earnings figures among the hardest to predict on Wall Street.
"He's the most important person to help Sandy Weill control the risk of proprietary trading," said Michael Holland, head of fund manager Holland & Co, who worked with Myojin at Salomon from 1989 to 1992. "They've got to keep him."
Myojin, dogged by the Japanese press for his wealth during his years with Salomon in Japan, doesn't give interviews - declining to talk even through a Salomon spokesman.
But despite a low profile, his eccentricities are legendary. While heading Salomon's Japanese office in the 1980s, he was known to carry a baseball bat and had a US army helmet on his desk. He rode a bicycle through the trading room and threw a cream pie at an employee.
Described as a slight man prone to outbursts of laughter and sudden mood swings, Myojin exerts strong control over his staff and expects the same sort of commitment to the markets from them as he has. Employees in Japan had to attend tennis weekends with him at Tokyo's fashionable Ariake club or parties at his home in the mountains. Staff prayed with him at a Shinto shrine on the day before quarterly expiration of futures contracts, when there is traditionally heavy trading.
Although the pressure of risking millions of dollars takes its toll on many traders, Myojin's staying power is attributed to his ability to keep a golfer's cool. "He is not someone who ignores risk. But he has an enormous amount of confidence in his ability to make money," Mr Holland said.
Myojin, born in Nagoya, Japan, got his first job in 1973 as a salesman for Yamaichi Securities, where he would call on clients by bicycle around Shizouka, west of Tokyo. After a two-year stint, he moved to London for Yamaichi. He transferred to Salomon in 1979 and returned to Tokyo to run the yen bond desk.
In 1985, the Japanese government allowed futures on Japanese bonds to be traded for the first time. Myojin travelled to New York to research how futures trading worked beforepreparing for the new products.
Myojin decided the futures were overpriced. He sold them and bought the underlying bonds, making enormous profits for Salomon and upsetting established Japanese firms such as Yamaichi and Nomura Securities.
He had intended to retire in 1995 to study Western art, but continued with Salomon and moved to London, where he lives with his wife and two daughters.
As a member of the management committee of the new Salomon Smith Barney, Myojin will be a key player in making the new company work and making sure that Sandy Weill's biggest bet ever - that Salomon and Smith Barney can work together - doesn't become his most disastrous of all.

Who will you decide to be?