Moontower #170

This was a brutal week in the investing world. The fraud at FTX was one of the largest overnight destructions of wealth in financial history. It impacts holders of crypto assets, the employees building projects in decentralized finance, equities, and traditional VC firms (Sequoia allegedly wrote down a $200mm investment to zero).

Excerpting from kyla scanlon:

And with FTX and SBF, it’s worse than other times in crypto. It’s so much worse. They posed themselves as these people that were trying to make the world better. There’s a difference between crypto going down because no one believes in it and crypto going down because it’s systematically being rugged…Many innocent people got wrapped into this because they saw Tom Brady or they saw Sam’s face on a telephone pole – and it was supposed to be safe.

In a calibrating industry, it’s easy to find holes to exploit, which is what FTX did perfectly. They saw opportunity, the VCs saw that they saw an opportunity, and people that wanted to be in crypto believed all of them. And of course, it’s like – well why *wouldn’t* you believe them. And that’s the hardest part.

While I agree with everything she says in the post, I want to address what’s unsaid.

There’s way too much obsession with investments as a way to get rich in the first place. It’s misallocated attention. It’s misplaced energy. I feel like the collective benefit of saying this is so diffuse that nobody has the incentive to tell you the truth. Just like Big Food or Big Ag will never commission a study on “intermittent fasting”. No single entity profits from the absence of eating 3 American-sized meals a day.

Same with investing. Who gains from telling people that much of the brain cycles we spend on investing are a waste of time? Maybe advisors with white-glove fees and Vanguard. Vanguard is a quasi-mutual company (investors are owners of the asset manager in a sense). Bogle undercut an industry to tell you what others wouldn’t. There are worse people to be aligned with.

We need a bit of real talk. I’m sorry if you feel like I should have told you sooner (although, I did). At first glance, this talk might sound discouraging. But take a second glance. This should liberate you. This will give you back countless hours of your time that you can use to row towards your goal with strength. Without distraction. And with less reliance on fate.

[This is an edited version of an off-the-cuff thread I wrote when I was too lazy to get out of bed yesterday]

Unless you are already rich, the proposition of earning 6% per year (insert your favorite ERP) with a 20% standard deviation and a fat left tail is not going to lead to the durable wealth you want. At least not on the timeline you want. This is discouraging and fairly obvious if you look at the proposition for what it is (some people might think you earn 10% per year in equities or harbor some other delusions about the proposition. It’s 2022, you’re entitled to “use Your own illusions” — sorry it’s the 30-year anniversary).

But we’re Americans. We are all entitled to do better than average, right? 🤨

So we snuggle up to crypto, privates, self-storage, or whatever makes you feel special. Unfortunately, investing done well, shouldn’t feel comfortable. Truly fat risk premiums feel like caffeine before bed. They make you anxious and insomniac. You should be afraid of feeling warm and righteous. This is the fundamental nature of beating point spreads.

Don’t you think that adjusted for risk (even simply by a street-smart “this sounds too good to be true” instincts) that the propositions of these shiny investments are similar to what you are presented in public markets? That’s actually your best-case scenario, where you avoid stepping on landmines.

Think about it.

There are super rich, savvy people staffing professionals in their family offices with tentacles everywhere bidding on everything. It’s very unlikely to find something special unless it’s your literal full-time job. And even when you do find something compelling in your part-time research, there should be a lower bound to your skepticism that inhibits you from sizing the exposure in a way that would make you rich quickly anyway.

If you put on your ‘equilibrium thinking’ cap you realize that it’s contradictory to think you can get rich quickly, in a prudent way, investing as a part-timer. Someone needs to hold underperformance bags. Unless this is your craft, you should expect to be a baggie if you push. The very conceit that you can find and pull out a meaningful number of diamonds from a coal pile picked over 24/7 by well-capitalized professionals is illogical.

Said simply: If you do not devote your life to the competitive task of investing, you cannot get rich quickly. You might by accident but hope is not a strategy. (Anyone know the money-weighted returns of ARKK or crypto investors? I suspect, despite positive track records in return space, their total dollar p/l is very negative. Sometimes the simplest benchmark is useful — what are your net dollar profits? There are fund managers that have probably made more from fees than their investors have made in p/l.)

And devoting your life to investing is not a guarantee either. It’s a low signal-to-noise endeavor. The best you can often hope for is a “chip and a chair”.

Nothing Good Happens After Midnight

You know exactly what that expression means.

The markets version of this is:

Don’t obsess about investing beyond the point of diminishing returns.

Yes, you should absolutely learn about:

  • compounding
  • saving
  • fees
  • taxes
  • diversification
  • implementing or getting help to construct a portfolio with simple rules

Now stop and go home. It’s that last double-shot Irish-car bomb at last call that causes the morning headache (or coyote morning 😬)

If you want to get rich without being reckless, Naval Ravikant has a valid formula:

  • specific knowledge
  • leverage
  • accountability (own your risks)

[I would actually edit this. My version:

  • do work nobody wants to do because it’s hard or otherwise unattractive
  • leverage
  • scarcity

I’d like to say “accountability” but looking at the new American dream of private gains/socialized losses and all types of bureaucratic capture I need to annoyingly quote Taleb:

Courage cannot be faked; the warrior bore the risk of his deserved glory in the service of his countryman. The ‘primacy of the risk-taker’ has been a feature of nearly all human civilization. When we reward leaders who did not bear commensurate risks we undermine virtue. Society frays as the truly virtuous/courageous bristles as they watch.]

A thought for the time

For the innocents and believers who made careers in crypto and made it their specific knowledge, I’m sad and sorry. I have a closet of FTX swag because I have a friend there and felt terrible watching this week.

I do believe it was a good bet to go into that world (although not to denominate your whole net worth in it… specific knowledge and the numeraire you take its yield in are different) and would have considered it myself. A career in crypto was a reasonable bet because the human capital is fungible with other careers, thus lowering its opportunity cost.

In addition, crypto as a small investment allocation was reasonable. But as an investment, like all investments, sizing is everything.

If you want to go big or go home, it’s best to do so on your skills or personal edge. Not on arms-length allocations to something that is big, accessible by mouse, and widely known about. The risk/reward once it had achieved mass awareness couldn’t be too out of line with other investable assets despite what all the promotors tell you.

And, critically, before you can allow yourself to get excited, remember that any sensible sizing rules neuter the returns to effort. That means you’ll always be disappointed in how much you won when you were right. In chapter 2 of Laws Of Trading Agustin Lebron explains — good trades make you wish you traded bigger, bad trades make you wish you traded less or none.

The very act of trading subscribes you to remorse. In hindsight, you always regret your sizing.

A parting message

Focus on your human capital to get rich. Your human capital > financial capital, it just doesn’t show up on a spreadsheet. In my own life, I don’t even say “investing”. I think of growing assets as “savings plus”. I’m just trying to maximize the chance of meeting my future liabilities.

I’ll rely on myself to get rich (not that anything that vague would motivate me, but you know me by now).

More on these themes from the Moontower Money Wiki:

Money Angle

My buddy Market Sentiment has a great newsletter that tackles a different evergreen market concept each week and contextualizes it with data. He recently created a useful series where he interviews other investment writers about their own frameworks for thinking about investing.

I was honored to be asked. It was also a great excuse to consolidate my own thinking about what people should emphasize. It turned out to be a fair amount of work to put together because the questions were thoughtful. The questions were sent in a document giving me the space to take my time so I could reciprocate with thoughtful answers and links.


  • Interview: Decision-making for investors with Kris Abdelmessih (Part 1)
  • Interview: Decision-making for investors with Kris Abdelmessih (Part 2)

This week I edited the index of all my writing so specific categories could be linked to separately.

For example:

The Risk And Math Of Returns


Gaming and Education

Finally, there was an interesting discussion on Twitter about SBF’s sizing:

Kelly Criterion Resources

Last Call

Last week I wrote about the social club idea I launched with local friends:

I Swear It’s Not Old School

The spirit of this project is to unlock serendipity and growth from the informal yet material bonds that glue a community together.

It’s an instance of a more abstract idea — not all of our values can be measured and of course not all of the things we measure have value.

Check this out:

Fairness is overrated and bragging is underrated (6 min read)

This post resonates not so much because I was interested in co-living (although with my in-laws moving in next door we are in the process of cutting a hole in the fence so the kids can go back and forth!) but I like experiments in motivation. Experiments in appealing to the multitudes within us and the needs that get neglected because they are more squishy than conventional legible desires.

Suppose you live in a house with strangers. It’s typical to designate responsibility with a chore wheel. But what if we re-framed the responsibility as a “brag sheet”? This article provides some experimental models for motivating any group that shares common goals. While it admits that these experiments do not make sense at scale it wonders how many examples abound that lazily accept the large-scale solution.

  • How big can a network become before its governance needs to change?
  • At small scale do we borrow too much from large-scale architecture forgetting that the trade-offs that exist at a large scale may not apply at the smaller one?
  • Choosing a “brag sheet” over a chore wheel may be an example of low-hanging fruit that applies to everything from co-living to motivating our children.

At some scale, overbearing rules might be necessary to impose order. But it would be nice if we could adhere to a simple maxim: leave it better than you found it.

That’s my attitude to the internet. Thanks for helping me.

Stay groovy!

Moontower #169

I’ll start this week with an abstract idea I’ve been sitting on in my notes for years. And then I’ll take you through the concrete idea that gave it life (and a reason to publish it).

The Abstraction Sitting In My Notes

Communism doesn’t scale but it can work in small settings where the bonds and norms between people carry more weight.

This shouldn’t be surprising.

If we think of interactions with each other as transactions, money acts like a store of value that is agnostic to how it was generated. It is a commodity but critically it also commoditizes its users. If I sell a guitar on eBay, I default to selling to the highest bidder. But if I was selling it locally I might sell it to the highest bidder, but depending on my preferences, I might also sell it to the next highest bid if having it in that owner’s hands had more meaning for whatever reason. Maybe I’m selling it to a kid who couldn’t afford the higher price but is so bushy-tailed I’d rather hook them up with a deal. (This idea is also why home buyers in competitive markets throw the Hail Mary of writing touching family stories to sellers).

At scale, we use money to “summarize” our values but if we had the time and energy to look closer we could find non-monetary sources of value embedded in transactions. The flexibility in our value rankings is jettisoned in the name of expediency.

Acknowledging this idea explains many behaviors that may seem counterintuitive. The most obvious is what family members will do for each other without any consideration of money. Less straightforward, the sharing economy and open-source come to mind. Some of the explanations become more obvious as status has become more legible and measurable. The existence of “follower farms” indicates exchange rates between status and money. But this compression of value into a single number like followers is similarly lossy as the concept of money itself.

The broader point is we should be open to experimenting with incentive structures, at least on the local scale, to achieve target outcomes more cheaply by addressing a wider range of desires and therefore pressure points. We can allocate more efficiently when we can hack our human instincts.

A Concrete Implementation

Fortune would have it that those thoughts would find a real-life expression.

Friday night served as the grand opening to a local project I’m involved in. It’s been over a year in the making. A group of local friends, about 25 of us, that would have monthly happy hours decided to lease a space to make something of a social club (it’s indeed registered as a 501c7).

The vision for the club is a place to foster community and serendipity. There’s a standing happy hour every Thursday. The first Friday of every month is dinner with partners/spouses. It’s a place to watch big games, have musical jam sessions, host salons and lectures. It’s a studio to video or record podcast interviews. If you meet me for coffee, it’s where I will take you. During the day, it’s a co-working space. With many people working from home, it’s already been used as an on-site for bringing teams together for brainstorming sessions.

It has a co-op ethos, with everyone bringing their own skills (I’m not handy so I did the website), to make it a space owned by all of its members. The members include everyone from teachers and firefighters to tech entrepreneurs and finance folk. A couple of guys built this bar Friday afternoon before the dinner! (it still needs to be finished):

This room is getting a small stage in front where the blue chairs are:

This is the lounge where you walk in:

I’ll talk about this more as this experiment unfolds, but for now, our focus is on finding ways to unlock greater in-person connection in service of both joy and personal growth.

I’ll admit — describing it feels clumsy. It’s not bro-y like Old School, it’s not WeWork, it’s not Rotary or an Elk’s Club — it feels a bit illegible right now. But as it comes into focus we’ll figure out the right language to transmit its essence. To me, it’s about extracting the tangible value that resides in the soft bonds we have with others in high-trust environments for mutual, positive-sum benefit.

That’s a horrible mouthful.

But even with that crypto-ese language, when I tell people about it, it strikes a chord. There’s an appetite for deeper connection as well as the security and increased agency that community brings to our lives Religious, hobby, or work tribes solve for the same thing by coalescing around a common purpose. This is just a different combination of pivot table elements. The common rallying point here is geography + an ineffable quality of, I don’t know, “openness” is the word that comes to mind when I think of this group.

We are documenting all the work required to get us to this point and as it evolves. We are being thoughtful and meta about this entire project, because when it’s done, we want to have the recipe to hand to others who have the same vague sense we did when the idea was born over a year ago — we have a special community of open people and we want to do something I always talk about in this letter — “find the others”.

[There are so many little details from liability to inclusiveness to boundaries to rules to norms to cost-sharing and budgeting that are not straightforward. We will have done something good if we can build a template for others to do this by laying out the details and trade-offs and showing how the experience depends on the design and spirit that you bring to the initiative. Coordination always comes with “tragedy of the commons” risks. We are learning as we go along. We plan to share those lessons to reduce the frictions for others who may want to start something similar in their own communities.]

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

Today is a math one.

The power of negative correlations is powerful when you see how rebalancing increases your expected compounded return.

One of my favorite finance educators, @10kdiver, recently wrote an absolute must-read thread on this topic.

You can use the intuition from this exercise to guide your portfolio thinking more broadly. It’s beautifully done.

However, there is a part I struggled with that I want to zoom in on because I’ve never before seen it presented as @10kdiver does it:

He converts probability to an estimate of correlation!

This is really cool. Reasons for my post:

  1. The meta-lesson

    This is the easy one:

    When I read the post, it was easy to nod along thinking “yep, that makes sense…ok, ok, got it”. Except for that, I don’t “got it”. I couldn’t reconstruct the logic on my own on a blank sheet of paper which means I didn’t learn it. Paradoxically, this demonstrates how good @10diver’s explanation was. Extrapolate this paradox to many things you think you learned by reading and you will have internalized a useful life lesson — get your hands dirty to actually learn.

  2. Diving into the probability math I struggled with. 


    An Example Of Using Probability To Build An Intuition For Correlation (6 min read)

More on liquidity

I’ve argued that illiquidity has a cost because you can’t rebalance (or as I painfully learned this year — tax-loss harvest). I describe a conceptual framework for pricing the liquidity “option” from a rebalancing lens in How Much Extra Return Should You Demand For Illiquidity?

This week, GOAT finance writer Matt Levine talked about liquidity. I don’t do this much but this is so good, here’s a full reprint:

One sort of financial innovation is about adding liquidity. There is some class of thing that does not trade very much for some reason, and you find a way to make it trade a lot. Perhaps the thing is very big and not many people can afford to buy it, so you split it into small pieces so people can trade the pieces. This basically describes the stock market: If you like Tesla Inc. as a company, you probably can’t go buy all of it, for a bunch of reasons of which the most important is that it costs $725 billion. But Tesla is split up into billions of shares, and you can go buy a share of Tesla for about $230. 

Or perhaps the things are very different and non-fungible, making them hard to trade, so you smush lots of them into a big standardized package that is easier to trade. This is roughly the idea behind mortgage bonds, or bond exchange-traded funds, or we talked the other day about a guy who wants to do it for diamonds. There is no visible trading market price for a 1.53-carat VVS1 diamond, because there aren’t that many diamonds with exactly those characteristics, but if you can build some sort of standardized diamond basket then maybe you can create a market price for that diamond, and thus a market.

Adding liquidity is, conventionally, desirable. It reduces risk: If you can sell a thing easily, that makes it less risky to buy it, so you are more likely to commit capital to the thing. It increases demand: If only a few rich people can buy a thing with great difficulty, it will probably have a lower price than if everyone can buy a share of it easily. It improves transparency and makes prices more efficient. Also, financial innovation tends to be done by banks and other financial intermediaries, and their goal is pretty much to do more intermediation. More liquidity means more trading, which means more profits for banks.

Another, funnier sort of financial innovation is about subtracting liquidity. If you can buy and sell something whenever you want at a clearly observable market price, that is efficient, sure, but it can also be annoying. Consider the following financial product:

  1. You give me the password to your brokerage account.
  2. I change it.
  3. You can’t look at your brokerage account for one year, because you don’t have the password.
  4. At the end of the year, I give you back your password and you pay me $5.

Is this a good product? For me, sure, I got $5 for like one minute of work.[1] For you, I would argue, it’s also pretty good. For one thing, you avoid the stress of looking at your brokerage account all the time and worrying when it goes down. For another thing, you avoid the popular temptation of bad market timing: You can’t panic and sell stocks after they fall, or get greedy and buy more after they rise, because I have your password…

Cliff Asness, in “ The Illiquidity Discount,” argues that private equity is essentially in the business of selling illiquidity. If you are a big institution and you buy stocks in public companies, the stocks might go down, and you will be sad for various reasons. You might be tempted to sell at the wrong time. You will have to report your results to your stakeholders, and if the stocks went down those results will be bad and you will get yelled at or fired. Whereas if you put your money in a private equity fund, it will buy whole public companies and take them private, and then you won’t know what the stock price is and won’t be able to sell. The private equity fund will send you periodic reports about the values of your investments, but those values won’t necessarily move that much with public-market stock prices: The fund will base its valuations on its estimates of long-term cash flows, and those will not change from day to day. By being illiquid, the private equity fund can look less volatile. Getting similar returns with less volatility is good; getting similar returns and feeling like you have less volatility also might be good. Asness writes:

If people get that PE is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? “Ignore” in this case equals “stick with through harrowing times when you might sell if you had to face up to the full losses.” What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if it’s simply not shoved in their face every day (or multi-year period!)? 

Last Call

My wife’s birthday was this week. She just wants help raising money for a personal cause:

From My Actual Life

People think I’m mean.

If you are curious about the outcome.

[The post-script to the outcome was Zak agreed without a fight to share the pain — both will donate 37.5%]

[The post-script to the post-script: one of the best option traders on the planet stuck true to his word and sent Max extra candy in the mail]

Stay groovy!

Moontower #168

It’s Halloween so Moontower should spook you. We’ll get to that.

But first, let’s pretend this is a normal post. I’ll follow the little formula:

  1. Hey here’s some cool thing I read:

    [Inserts link] Book Review: San Fransicko by AC10 (formerly Slatestarcodex)

  2. Offer a tantalizing bit:

    San Fransicko is subtitled “Why Progressives Ruin Cities”. It builds off the kind of stories familiar to most Bay Area residents:

    In the spring of 2021 two colleagues and I went to San Francisco. We first went to check in on the open-air drug scenes in the Tenderloin and United Nations Plaza. It was the usual scenes of people sitting against buildings and injecting drug needles into their necks and feet. There was garbage, old food, and feces everywhere. After a couple of hours, we decided to go out to eat in the Mission. Work was over. We were all looking forward to a relaxing dinner. We were eating ice cream and walking along Valencia Street when a psychotic man, perhaps about thirty years old, began following us and screaming obscenities. When we turned around to look at him, he screamed at us, “What are you looking for, huh! WHAT. ARE. YOU. LOOKING. FOR!” and started walking faster toward us. We walked faster until the man found other people to verbally assault.

    Things haven’t always been like this. San Francisco used to be one of the safest and most beautiful cities in the world…

  3. Provide my own twisty commentary:

    The failed-stateness of San Francisco is common knowledge by now. I don’t even lock my doors when I park there. Just leave nothing in the car so I don’t have to risk a call to Safelite. [As I type that it occurs to me that Safelite’s cap-ex would have been best spent on whatever graft necessary to save Chesa Boudin’s job.]
    Oh wait, Chesa’s influence on SF’s decay is not so cut-and-dry. Why?

    Read the Slatestar review of the book!

    The post is done in a fun format. He dissects 10 of the book’s claims put forth by author and failed gubernatorial candidate Michael Shellenberger. Sometimes AC10 agrees, sometimes not, and sometimes you’re left with a non-verdict. This isn’t surprising. Books in this genre are axes because while they start with nuggets of truth, to fill a few hundreds pages with persuasion, you need to turn a lot of greys into blacks.

    Anyway, once each claim is given its trial, AC10 goes raw and says how he really feels in the actual review. I like Spock-treatment giving way to Judge Judy flow. It’s kinda like Stairway To Heaven. It starts like “oh this is interesting” nod along, nod along, ok it’s getting repetitive, now tedious, I mean it’s good and all, but also like enough already — then, finally — boom. Enough talk, weapons drawn. Energy sword cuts through the night sky as an unholy, pentatonic run screams from above as Bonzo shakes the ground, the Earth splits swallowing both civility and the quaint illusion that it ever mattered.

    [Aside: if you have never seen this deleted scene from Almost Famous, correct that when you have 12 minutes. The older brother holds the DNA from which all fanboys have been cloned and Frances McDormand’s listening expressions required not a minute less than 10,000 hours in front of a mirror. You’ll never hear the song the same way again. Cameron Crowe is a worthy rabbit hole at 2am.]

    Fun aside, the most useful exercise living inside the AC10 post is watching him reason through the claims. Since SF exists in the national conversation as a political football bouncing its way through debates on crime, public school lottos, sanctuary city status, drugs, NIMBYism, and cyberpunk levels of wealth disparity, the breakdowns have something for everyone no matter where you live. With humor and an eagle-eye, AC10 shows why his book reviews are often better than the books themselves.

Very well.

I kept the usual formula sweet and short so you will actually read the book review.

[Run along and read it]

Look at you. [deep satisfying sigh]

So kind to come back after reading that long post.

Oh wait. Is something wrong? Did your brain melt out of your cranial orifices when you got to claim #7?

I had to read it 2x just to make sure the words were in the same order as the first time I read it.

Talk about a record-scratch moment.

Naturally, I had to stop my entire life and go down a Jim Jones rabbit hole. It’s Halloween. Go ahead and indulge your morbid fascination with cult leaders and mind control. There’s a lot to learn from them in my humble-even-if-you-think-it’s-deranged opinion:

  • Jonestown: The Life and Death of People’s Temple (85 min)

    This film is loaded with real footage, audio and interview. This is some crazy stuff captured on film. Be warned.

  • The Jonestown Massacre: Paradise Lost (100 min)

    From the description: This feature-length docudrama tracks the final build-up to a horrific doomsday

    This is a dramatization. I watched it second. It’s more haunting than the documentary.

I watched them back-to-back in the same sitting. The way truth can be stranger than fiction is so…ugh words feel ineffectual. Trust me on this.

Warning: the expression “drink the Kool-Aid” will become offensive to you. What you think happened, isn’t what happened. Seriously, it’s an expression that needs to die.

This was all written under the influence of this song (which comes from an epic album btw)

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

This week I wrap and recap the month-long “real talk” series on trading/investing. I felt compelled to distill and consolidate these thoughts and append them to my progressing-like-molasses Moontower Money Wiki.

As a reminder, this wiki is my treatise on investing, broken into bite-size parts residing under 2 major headings:

  • The Nature Of Markets
  • Implementation

It’s intended to be a manual. The first part of it is only half complete and at the pace I’m moving my deadline is death.

Anyway, this month’s series has been encapsulated in:

  • Special Topic: “Do You even Trade Bro?” (Link)

    It’s a touch irreverent and subdivided into:

    • The Fundamental Misunderstanding
    • A Warning About Options
    • If You Insist On Trading…
    • Is The Brain Damage Worth It?

Personal comment: If you find this stuff useful, share it. I don’t know what the right balance of how often I should even say something like that. I’m always torn between the utter naivete of “if it’s useful people will find it” and being a whore I can live with. But I’ve noticed that I keep landing in interesting conversations and opportunities as this (whatever “this” is) and I think that will be true if I keep being useful so there’s a whole virtuous loop and all that jazz that me and others have definitely spent too many words describing but the most important takeaway is that it’s real.

[I encourage anyone who thinks they have something to share to drown their self-limiting beliefs in the toilet and get on with the sharing already.]

Last Call

I posted this. Don’t judge. (I kinda did get judged but whatever. I’m secure, I swear.)

To which I get this mind-blowing reply from resident math genius @quantian.

We learn of “digital roots”. It’s easiest to show by demonstration.

The digital root of 231 is the sum of the digits: 2 + 3 +1 = 6

You can do this for any number, just proceed until the final digital root is a single digit.

So for 489, we go:

4 + 8 + 9 = 21

(then 21 gets reduced)

2 + 1 = 3

So the digital root of 489 is 3.

After reading @quantian’s explanation, I summarized the conclusion:

Any number minus its digital root must be wholly divisible by 9.

So 489 – 3 = 486.

486/9 = 54


Gets better though.

So we can recap the rules:

  • Any number with a digital root of 9 is divisible by 9
  • Any number with a digital root of 3 is divisible by 3
  • Any number minus its digital root is wholly divisible

Add this to any number ending in 5 being divisible by 5 and even numbers being divisible by 2 and you have a playful set of numeric wonders. And as @jadam2122 recommends, your digital clock becomes a fun toy for the kids.

And I’ll address the question some if not many want to blurt out…what’s the point?

The point is wonder.

I have zero doubt that there are readers who know the practical application of these observations (and I welcome them, and will even share the ones you send). But we are pattern-matching machines. Narratives, math, music, concepts. It’s all around us.

It’s true, in this letter, we often talk about how being a pattern bloodhound often leads us astray with confirmation and availability bias. But this ability to match patterns is also a skill from chess to trading to persuasion to self-awareness to diagnosis and to discovery. It’s a power we learn to wield. It uncovers the seams between disciplines.

If every time you saw a pattern, you dismiss it because its application was not-yet-apparent then your mental library of patterns would grow too slowly and the probability that you would match new stimuli to a small library would be tiny. You would deprive yourself of insight but also that feeling of wonder.

And that feeling of wonder is what leads to the next question.

And before you know it…you grow.

That’s why you’re here. Right?

Last Call

For all the San Fransicko talk, so much of it well-placed, it’s weirdness is exactly why it’s seductive. Yinh and I joined 12 friends on Friday night to don costumes for a night out in the Mission.

We started at Hawker Fare before hitting up Valencia Room and making it to a couple of classic Market Street spots that feel like archetypal SF — the piano bar Martini’s and the karaoke stage at The Mint.

I realized something about that seduction of SF. It’s weird and age-blind. The young and the old are out to play without restraint. It felt totally lacking in self-consciousness. I learned extensively of a sexual fetish that I’ve never even heard of before. Think of how weird that needs to be to find out about offline!

Coming back to reality was tough. When we got home after 2am I immediately went to email to check what time the 6-year-old’s final soccer game would be the next day, (since I’m the coach I should know, but I didn’t, and I couldn’t check when we were out because I, of course, left my phone in the Uber).

9am. The earliest game we had all season. Why wouldn’t it be?

Stay groovy.

Moontower #167

Indulge me as I weave through a reflection I’ve been lingering on for a few weeks.

I was listening to software entrepreneur Travis Kimmel on the Mutiny Podcast (link). The whole conversation is fascinating and honestly quite dense when it gets into finance. There is a section where Travis, who studied philosophy, discusses the role of liberal arts in business.

He used a word that keeps unfolding itself in my head — “generative”.

He approaches the word came from its anti-thesis — skepticism. Travis is a fan. “Skepticism enforces discipline”. That’s a tight phrase describing a critical function for investors and traders — scrutinizing claims. Naive optimism can easily domino into over-extrapolation which is a fancy word for what hindsight simply calls “stupidity”.

Skepticism plays a key role in sound decision-making. The Big Five personality test has a dimension called agreeable/disagreeable. In Being A Disagreeable Investor, I point to the advantages of being disagreeable. [FWIW, I have median scores on 3 of the Big Five traits but score higher than the 90th percentile on “conscientiousness” and “agreeableness”. I interpret conscientiousness as the ability to jump through hoops. Combined with a standardized test, getting through a selective college signals high self-control + satisfactory IQ. As far as me being “highly agreeable”, I’ll just be happy that firms I worked for didn’t give people that test and screen me out.]

Back to Travis. Despite, celebrating skepticism he argues that skepticism cannot exist on its own. It must be part of a team because it is fundamentally “non-generative”. It is a razor that reduces. It does not build.

Seeing it phrased this way was a personal revelation. It unlocked a reinterpretation of my work history. It goes like this:

  • The first 12 years of my career I was on the trading floor. I was in the mix of hundreds of people. It was social and often raucous. I got to see what my competitors were doing because they stood next to me all day. When a smart competitor did something others did not it was like watching an “alien move” in chess. Why did they do that? What were they seeing? By observing what happened before and after, you could use pattern-matching to reverse engineer decisions and strategies. This allowed you to learn more from a given sample of trades than you could in fully electronic markets where you can’t easily tie the tape back to its actors. High learning rates are addictive. The job was fun.
  • When I moved upstairs to the hedge fund my early impression was it appeared quiet and academic. Without the roar of a pit to direct my attention, I had to re-train my senses and build new tools to “see” markets. Since I was hired to build the commodity volatility business I also had to guide decisions about infrastructure. My first few years at the fund were long hours and lots of collaboration with dev teams. I loved it. For new reasons. I was building. It was highly generative.
  • Once the cockpits and engines were built, it was time to pilot the plane. Like the trading pits, I was back to the daily dogfight. Trading is a constant parade of mid-air decisions for 7 hours. Except this was a lot less fun than the pits. On the floor, there was a Ralph Wolf and Sam Sheepdog camaraderie that came with being shoulder-to-shoulder with your adversary. Everyone is both an opponent but also a possible future employer/employee. My first backer was a guy in my pit who worked for another firm. The people who have my old job are friends from my pit days. Upstairs, you have your team to talk to which is great, but it’s one outlet. Otherwise, you’re always chatting with brokers. Voice brokers can be friends but they are always balancing a fiduciary conflict. There’s no escaping the poker dynamic of those interactions.

With the lower learning rate off the floor, only occasional forays into building after the initial heavy lift, and a dip in social stimulation (I’m no life-of-the-party but self-identify squarely with extraversion) the job became tedious.

This arc combined with writing as a larger part of my life and the urge to self-align with projects where “agreeableness” holds more value to make leaving the gig inevitable. When I think about work, I realize that the right fit for me will need to tilt more towards being “generative” and I never saw it in those terms so clearly. So thanks for the language Mr. Travis Kimmel.

If interested, here’s how I personally apply this to myself.

I’m not much of a consumer. I rarely buy stuff and I don’t collect anything. Every piece of matter that seems to accumulate in my life feels like a liability I have to service. Things own me, I don’t own things. I feel bad when I don’t maintain things, but I also have zero desire to maintain them. So minimalism is less of a design aesthetic and more of a gate-protector of my time (ironically, I’m not much a fan of minimalist, cold modern spaces. I like rich environments that feel tied to the past with taste in ways I don’t possess but love to admire).

I feel like I was supposed to be some kind of bizarro librarian. Bizarro because I don’t read that much. But I collect ideas. I collect them for synthesis. Ultimately, I want ideas to be combined so they are useful.

Collection and synthesis are generative functions. A team needs both with skepticism sprinkled in to “enforce discipline”. The functions are then passed to a do-while loop known as practice.

The requirements of practice act as a filter on the vastness of ideas one could choose to collect and index.

Applying this logic personally, I’m increasingly of the mindset that my constraint is “how do I teach” effectively. “Effectively” means arming others with the ability to improve their outcomes from learning. I’m not interested in teaching trivia. I want to enable agency in service of growth.

Finding smoother ways to both represent and communicate lessons is a generative task. If I shed restraint for a moment, I admit it’s actually compulsive. It stirs me in ways that the video game of trading does not.

I’m more interested in being obsessed than the actual output of a job (in the case of trading, the output is cash baby). But I’d rather be obsessed than rich.

Some are obsessed with being rich. Some have obsessions that lend themselves to getting rich (the best athletes, programmers, portfolio managers). I think my best chance of being happy with how I spend my time is being obsessed. And who knows, maybe that will lead to getting rich.

(I was born in America and have gotten lucky enough to consider myself rich by any broad objective standard. I purposefully live in a place that makes me feel like a small fish in a big pond so I don’t think of myself as rich but I’d be an ass to bring that attitude to a global perspective. Words have scale dependence.)

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

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Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

This month’s consolidation of ideas on the meta of trading continues with:

Trading Is A Team Sport (13 min read)

It covers:

  • The importance of building a team
    • The value of multiple perspectives
    • How a team reduces bias in practice
  • Building the team (mostly in a retail context)

Last Call

I just want to give some love to a few people doing great work. Notice how related and leveraged their journeys are to the permissionless internet. It feels like the singular most important force, for good and bad, of the past generation.

Paul Millerd

Paul is a friend who I’ve gotten to know from ping-ponging lots of ideas with over the past few years. I highly recommend his book Pathless Path (my review and notes).

He just published his 200th newsletter issue and it’s an amazing summary of everything he’s been sharing. It’s full of concise representations that you can carry with you as make decisions about your own path.

See The Great Digital Creator Arbitrage Opportunity (Boundless)

Kyla Scanlon

Kyla is a juggernaut creator on TikTok, Twitter, Youtube, Twitter, Substack and now Bloomberg who is pumping out funny, provoking, and highly educational finance content covering topics du jour. Unlike the common grift that typifies this niche, Kyla is the real deal, bringing the right mix of knowledge, skepticism, and humility to a fundamentally complex subject.

You can follow her on your preferred platform from her website:

Noah Bragg

Noah founded

I used it to create another website this week using Notion as my CMS or “content management system”. The website is a private project I’m doing with a few local collaborators but this showcase is filled with inspiration.

The latest website I built was up and running in minutes with a clean URL which is simply the domain I bought. I will be building another website soon for another project and it will also be built on Notion using Potion (my current online home is already built that way).

Noah is highly responsive and patient in dealing with a tech-handicapped fogey like me.

Millions of users, including many Moontower readers, are organizing their knowledge in Notion. You are one step away from turning that into a clean, beautiful, online property.

[None of these people pay me for endorsing them. In fact, it’s quite the opposite. I pay all three of them for their work.]

Moontower #166

One of my deepest held beliefs is that our need for coherence is a profound source of misery. We agitate for universal theories to tie everything together. Our obsessions with gurus, religion, ideology, macro, or even astrology are symptoms. We search for meaning as if it is something that’s “out there” to be discovered. I’m not holding my breath.

These quests are actively destructive when taken too seriously. When people become overly invested in any of these expeditions, we are sentenced to watching the mental gymnastics routines their precious egos cling to. It’s worse than just being cringe. It’s insidious. They dehumanize opposition so they don’t even have to consider reasonable antagonistic stances.

I just picked up Simone de Beauvoir’s book The Ethics Of Ambiguity because its description vibrates with my own feelings. I’ll report back after reading it.  (See How The Need For Coherence Drives Us Mad to see if you’d be interested in reading it.)

In the meantime, I’ll share a technique that I use to resist the seduction of coherence.

A Drawer Of Curiosities

In my notes, I keep an ever-growing list of “tensions” and “paradoxes” that I encounter from reading or experience. It is a constant reminder that every bit of advice you’ve ever heard is not universal. My buddy Jake likes to say that seat belts are the only free lunch. To which I respond, “unless the presumption of safety encourages drivers to speed or drive more recklessly”. Let’s be blunt. My response is utter ankle-biting tediousness (what I call tedious some people consider their personality). The larger takeaway is there are paradoxes running loose everywhere and if we run around trying to corral them with some ill-conceived notion that it makes us “more right” or there are truths we can somehow own and wield, then we’ve done nothing but build intellectual totems to hubris.

Instead of trying to resolve the paradoxes, maybe just accept them. Name it to tame it, put it in a drawer, and move on. You don’t need the world to bend around your own brain to protect your ego. You can just have a big list that reminds you that the task is futile. That’s the antidote.

[See A Drawer Of Curiosities for excerpts from a couple of studies that speak to the benefits of acknowledging and living with paradox. I have long thought this was important and was discussing it with a friend who said there’s actually some biology behind our resistance of paradox. They sent me the links found in the appendix of that post.]


I keep another type of list that is unexpectedly satisfying. A graveyard of ideas and projects that I’ve abandoned. It’s a form of closure. It’s a form of loving and losing. There’s no need for shame or regret because you didn’t learn to play the guitar or start that business. Most text editors have a “strikethrough”. Use it.

The things you actually did instead were a filter. They revealed your priority. (If you have a problem with your priorities that’s a separate issue). By acknowledging that you will only execute on a fraction of your ideas, you lower the stakes of having ideas, and the more ideas you allow yourself to have, the more fun life will be.

A close-minded young person feels tragic. But weirdly, I think it’s even more tragic for older people whose years give them a perch to see how wide a range of experience exists across the world and its people — and then they ignore that information. It’s like locking yourself in a room with 1 friend, setting the thermostat to your preferred temperature, throwing away the key, and talking about the same old shit until you die.

Take chances intellectually and in life. List them. If there’s nothing on the list, maybe fix that. You still have time before you yourself are in a graveyard.

Scavenger Hunt

In How to turn problems into a curiosity engineAnn-Laure Le Cunff describes a fun game renowned physicist Richard Feynman played as he navigated life:

One of Feynman’s most enduring characteristics was that he loved problems. Instead of avoiding them or trying to solve them as fast as possible, he would seek interesting problems, keep them in mind, let them simmer, and constantly try to connect his everyday experiences to these big questions.

“You have to keep a dozen of your favorite problems constantly present in your mind, although by and large they will lay in a dormant state. Every time you hear or read a new trick or a new result, test it against each of your twelve problems to see whether it helps.”

Similar to Alice who discovers a strange world through the looking glass, the questions you choose to keep in mind act as a mirror that reflects the world around you and makes you look beyond the surface of the glass.

Your favorite problems form a prism that separates incoming information into a spectrum of ideas — a frame that allows you to deliberately filter distractions, direct your attention, and nurture your curiosity. In short, your favorite problems become a curiosity engine.

Creating a list of favorite problems offers many benefits:

  • Turn stressful situations into intriguing problems to explore
  • Filter information based on whether it relates to one of your favorite problems
  • Connect with fellow curious minds who are interested in similar problems
  • Focus your attention on ideas that arouse your curiosity
  • Notice relevant patterns and potential solutions across seemingly unrelated topics

Let’s ignore yet another advice tension (Feynman is unknowingly inviting people to double-down on confirmation bias) to give this idea respect. Feynman is saying “life is a scavenger hunt.” It wouldn’t be fun if you knew where everything belonged. If everything just snapped into place.

Instead of starting with airtight beliefs, go trick-or-treating. The questions are your plastic pumpkin and the world’s wonders are the candy. Surprises will taste sweet if you are looking to grow, and bitter if you are afraid.

Like Halloween, you choose who you want to be.

Money Angle

Personal portfolio update: We closed on the sale of the Texas property we bought in Summer of 2021 this past week. The sale took a long time because showing it was a bit of a challenge with tenants. We asked an aspirational price in the Spring, probably 6 weeks too late to catch the insanity but still got a bid through the asking price. Unfortunately, the stock market dropped and 4 days later the buyer pulled out. We cut the home price 10%, and got into another contract quickly, but then the closing took 2 months. Alas, it’s done. We put about 40% of the proceeds into homebuilders and a world ETF and the balance in 4% t-bills. We will have a chat with our accountant this week about end-of-year tax management (selling investments that have gotten crushed in taxable accounts to offset gains on the property. Should be educational.)

Moving on…

Investing is hard. It’s a game in a complex environment. It’s hard to tell a bad decision from a good decision just based on the outcome because it’s a low signal vocation.

That said, I’ve harbored some suspicion that analytically-weak investment managers would find it convenient to hide behind those concessions. Synthesizing decisions in an open environment is much harder than solving a problem set. But what if you can’t even solve a problem set? Am I supposed to believe you can do all the hard stuff, but just choked on the solvable stuff?

This isn’t the first time I’ve wondered this. See Can Your Manager Solve Betting Games With Known Solutions?

Today’s post is in a similar vein.

Bet Sizing Is Not Intuitive (8 min read)

Humans are not good bettors.

It takes effort both in study and practice to become more proficient. But like anything hard, most people won’t persevere. Devoting some cycles to improve will arm you with a rare arrow in your quiver as you go through life.

Skilled betting demands 2 pivotal actions:

  1. Identifying attractive propositions

    This can be coded as “positive expected value” or “good risk/reward”. There is no strategy that turns a bad proposition into an attractive one on its own merit (as opposed to something like buying insurance which is a bad deal in isolation but can make sense holistically). For example, there is no roulette betting strategy that magically turns its negative EV trials into a positive EV session.

  2. Effective bet sizing

    Once you are faced with an attractive proposition, how much do you bet? While this is also a big topic we can make a simple assertion — bad bet sizing is enough to ruin a great proposition. This is a deeper point than it appears. By sizing a bet poorly, you can fumble away a certain win. You cannot afford to get bet sizing dramatically wrong.

Of these 2 points, the second one is less appreciated. Bet sizing is not very intuitive.

To show that, we will examine a surprising study.

The Haghani-Dewey Biased Coin Study

In October 2016, Richard Dewey and Victor Haghani (of LTCM infamy) published a study titled:

Observed Betting Patterns on a Biased Coin (Editorial from the Journal of Portfolio Management)

The study is a dazzling illustration of how poor our intuition is for proper bet sizing. The link goes into depth about the study. I will provide a condensed version by weaving my own thoughts with excerpts from the editorial.

The setup

  • 61 individuals start with $25 each. They can play a computer game where they can bet any proportion of their bankroll on a coin. They can choose heads or tails. They are told the coin has a 60% chance of landing heads. The bet pays even money (i.e. if you bet $1, you either win or lose $1). They get 30 minutes to play.
  • The sample was largely composed of college-age students in economics and finance and young professionals at financial firms. We had 14 analyst and associate-level employees of two leading asset management firms.

Your opportunity to play

Before continuing with a description of what an optimal strategy might look like, we ask you to take a few moments to consider what you would do if given the opportunity to play this game. Once you read on, you’ll be afflicted with the curse of knowledge, making it difficult for you to appreciate the perspective of our subjects encountering this game for the first time.

If you want to be more hands-on, play the game here.

Devising A Strategy

  1. The first thing to notice is betting on heads is positive expected value (EV). If X is your wager:

    EV = 60% (x) – 40% (x) = 20% (x)

    You expect to earn 20% per coin flip.

  2. The next observation is the betting strategy that maximizes your total expected value is to bet 100% of your bankroll on every flip.
  3. But then you should notice that this also maximizes your chance of going broke. On any single flip, you have a 40% of losing your stake and being unable to continue this favorable game.
  4. What if you bet 50% of your bankroll on every flip?

    On average you will lose 97% of your wealth (as opposed to nearly 100% chance if you had bet your full bankroll). 97% sounds like a lot! How does that work?

    If you bet 50% of your bankroll on 100 flips you expect 60 heads and 40 tails.

    If you make 50% on 60 flips, and lose 50% on 40 flips your expected p/l:

1.560 x .5040 = .033

You will be left with 3% of your starting cash! This is because heads followed by tails, or vice versa, results in a 25% loss of your bankroll (1.5 * 0.5 = 0.75).

This is a significant insight on its own. Cutting your bet size dramatically from 100% per toss to 50% per toss left you in a similar position — losing all or nearly all your money.

Optimal Strategy

There’s no need for build-up. There’s a decent chance any reader of this blog has heard of the Kelly Criterion which uses the probabilities and payoffs of various outcomes to compute an “optimal” bet size. In this case, the computation is straightforward — the optimal bet size as a fraction of the bankroll is 20%, matching the edge you get on the bet.

Since the payoff is even money the Kelly formula reduces to 2p -1 where p = probability of winning.

2 x 60% – 1 = 20%

The clever formula developed by Bell Labs researcher John Kelly:

provides an optimal betting strategy for maximizing the rate of growth of wealth in games with favorable odds, a tool that would appear a good fit for this problem. Dr. Kelly’s paper built upon work first done by Daniel Bernoulli, who resolved the St. Petersburg Paradox— a lottery with an infinite expected payout—by introducing a utility function that the lottery player seeks to maximize. Bernoulli’s work catalyzed the development of utility theory and laid the groundwork for many aspects of modern finance and behavioral economics. 

The emphasis refers to the assumption that a gambler has a log utility of wealth function. In English, this means the more money you have the less a marginal dollar is worth to you. Mathematically it also means that the magnitude of pain from losing $1 is greater than the magnitude of joy from gaining $1. This matches empirical findings for most people. They are “loss-averse”.

How did the subjects fare in this game?

The paper is blunt:

Our subjects did not do very well. Suboptimal betting came in all shapes and sizes: overbetting, underbetting, erratic betting, and betting on tails were just some of the ways a majority of players squandered their chance to take home $250 for 30 minutes play.

Let’s take a look, shall we?

Bad results and strange behavior

Only 21% of participants reached the maximum payout of $250, well below the 95% that should have reached it given a simple constant percentage betting strategy of anywhere from 10% to 20%

  • 1/3 of the participants finished will less money than the $25 they started with. (28% went bust entirely!)
  • 67% of the participants bet on tails at some point. The authors forgive this somewhat conceding that players might be curious if the tails really are worse, but 48% bet on tails more than 5 times! Many of these bets on tails occurred after streaks of heads suggesting a vulnerability to gambler’s fallacy.
  • Betting patterns and debriefings also found prominent use of martingale strategies (doubling down after a loss).
  • 30% of participants bet their entire bankroll on one flip, raising their risk of ruin from nearly 0% to 40% in a lucrative game!

Just how lucrative is this game?

Having a trading background, I have an intuitive understanding that this is a very profitable game. If you sling option contracts that can have a $2 range over the course of their life and collect a measly penny of edge, you have razor-thin margins. The business requires trading hundreds of thousands of contracts a week to let the law of averages assure you of profits.

A game with a 20% edge is an astounding proposition.

Not only did most of our subjects play poorly, they also failed to appreciate the value of the opportunity to play the game. If we had offered the game with no cap [and] assume that a player with agile fingers can put down a bet every 6 seconds, 300 bets would be allowed in the 30 minutes of play. The expected gain of each flip, betting the Kelly fraction, is 4% [Kris clarification: 20% of bankroll times 20% edge].

The expected value of 300 flips is $25 * (1 + 0.04)300 = $3,220,637!

In fact, they ran simulations for constant bet fractions of 10%, 15%, and 20% (half Kelly, 3/4 Kelly, full Kelly) and found a 95% probability that the subjects would reach the $250 cap!

Instead, just over 20% of the subjects reached the max payout.

Editorialized Observations

  • Considering how lucrative this game was, the performance of the participants is damning. That nearly one-third risked the entire bankroll is anathema to traders who understand that the #1 rule of trading (assuming you have a positive expectancy business) is survival.
  • Only 5 out of the 61 finance-educated participants were familiar with Kelly betting. And 2 out of the 5 didn’t consider using it. A game like this is the context it’s tailor-made for!
  • The authors note that the syllabi of MIT, Columbia, Chicago, Stanford, and Chicago MBA programs do not make any reference to betting or Kelly topics in their intro finance, trading, or asset-pricing courses.
  • Post-experiment interviews revealed that betting “a constant proportion of wealth” seemed to be a surprisingly unintuitive strategy to participants.

Given that many of our subjects received formal training in finance, we were surprised that the Kelly criterion was virtually unknown among our subjects, nor were they able to bring other tools (e.g., utility theory) to the problem that would also have led them to a heuristic of constant-proportion betting. 

These results raise important questions. If a high fraction of quantitatively sophisticated, financially trained individuals have so much difficulty in playing a simple game with a biased coin, what should we expect when it comes to the more complex and long-term task of investing one’s savings? Given the propensity of our subjects to bet on tails (with 48% betting on tails on more than five flips), is it any surprise that people will pay for patently useless advice? What do the results suggest about the prospects for reducing wealth inequality or ensuring the stability of our financial system? Our research suggests that there is a significant gap in the education of young finance and economics students when it comes to the practical application of the
concepts of utility and risk-taking.

Our research will be worth many multiples of the $5,574 winnings we paid out to our 61 subjects if it helps encourage educators to fill this void, either through direct instruction or through trial-and-error exercises like our game. As Ed Thorp remarked to us upon reviewing this experiment, “It ought to become part of the basic education of anyone interested in finance or gambling.”

I will add my own concern. It’s not just individual investors we should worry about. Their agents in the form of financial advisors or fund managers, even if they can identify attractive propositions, may undo their efforts by poorly sizing opportunities by either:

  1.  falling far short of maximizing

    Since great opportunities are rare, failing to optimize can be more harmful than our intuition suggests…making $50k in a game you should make $3mm is one of the worst financial errors one could make.

  2. overbetting an edge

    There isn’t a price I’d play $100mm Russian Roulette for

Getting these things correct requires proper training. In Can Your Manager Solve Betting Games With Known Solutions?, I wonder if the average professional manager can solve problems with straightforward solutions. Never mind the complexity of assessing risk/reward and proper sizing in investing, a domain that epitomizes chaotic, adversarial dynamics.

Nassim Taleb was at least partly referring to the importance of investment sizing when he remarked, “If you gave an investor the next day’s news 24 hours in advance, he would go bust in less than a year.”

Furthermore, effective sizing is not just about analytics but discipline. It takes a team culture of truth-seeking and emotional checks to override the biases that we know about. Just knowing about them isn’t enough. The discouraged authors found:

…that without a Kelly-like framework to rely upon, our subjects exhibited a menu of widely documented behavioral biases such as illusion of control, anchoring, overbetting, sunk-cost bias, and gambler’s fallacy.


Take bet sizing seriously. A bad sizing strategy squanders opportunity. With a little effort, you can get better at maximizing the opportunities you find, rather than needing to keep finding new ones that you risk fumbling.

You need to identify good props and size them well. Both abilities are imperative. It seems most people don’t realize just how critical sizing is.

Now you do.

Last Call

Trevor Noah is leaving the Daily Show. December 8th is his last episode. Noah is one of my favorite observers of humanity.

I know who I want to take the baton.

Comedian Mo Amer.

I’ve been watching his show Mo on Netflix but just watched his 2018 stand-up special Vagabonding. It reminded me of Noah’s Afraid Of The Dark special.

I have a weak spot for comedians that can do voices (and for that matter, I also love it when animals are anthropomorphized with voices. Think any talking animal in a Super Bowl ad. It’s catnip to me.)

Moontower #165

I just got back from the StockSlam Sessions in NYC. It was an epic week of meeting new friends, seeing old faces, and doing something I haven’t done since my 20s — going home at 2 am four nights in a row. If I were drinking these days I could never have done that at this age (not to mention fitting a workout in on 2 mornings).

The sessions themselves were a raging success. The feedback on both fun and learning was super encouraging, so we have plenty to chew on. I’ll circle back on that when it makes sense.

I wasn’t in the writing jumpseat all week so today is a brief one.

An empathetic thought

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

Last Sunday, I mentioned for October I’ll be stringing together a few non-technical posts about trading. Last week I published Trading Vs Investing.

This week I give you:

Celibacy Vs Condoms: The Answer To Whether You Should Trade Options (17 min read)

Here’s the table of contents:

1 Think Before You Even Get Aroused

2 Why Anyone Would Trade An Option?

3 Wear a Condom

4 Conclusion

Last Call

Some random stuff I enjoyed:

  • Notes From An Interview With Serial Entrepreneur Keith Schacht (7 min read)

    I liked the attitude and insights in this pod and took some notes.

  • The Midwit Trap: Why are we so dismissive of simple solutions? (philo.substack)

    This is a cool post demonstrating how people outsmart themselves. A few vectors in particular:

    • Confusing complex for smart
    • Misdiagnosing Pareto distributions
    • Ignoring bottlenecks (ie Theory of Constraints)
    • How “we share 99% of our DNA with chimps” reminds us that just 1% can be a giant difference
    • Hidden “divide by zero” problems where long logic chains become fragile because they rely on every statement being true (this one reminds me of why quarantining risk is an underappreciated tactic — see I Felt Bad For Picking My 3rd Grader Off)

From My Actual Life

Shout out to Chris and Avi who got me to my first death metal show. It was at Monarch in Brooklyn and was headlined by Blood Incantation. Loved the “leave it all on the field” performance. They performed 4 long songs with super-heavy, psychedelic grooves. The drummers of these bands are aliens.

The names of the other bands are also morbid MadLibs:

Full Of Hell, Vermin Womb, Mortuous and God Is War

Stay friggin groovy!

Moontower #164

I threw a $500,000 purchase price and a 7% 30-year fixed rate into a mortgage calculator. That’s a payment of $3,327.

Earlier this year, if you secured a mortgage at 3%, you could have bought a home for $790,000 and had the same payment.

Since housing hasn’t dropped 36% this year homes have gotten much more expensive to own. Considering you can buy 1-year t-bills yielding 4% that are state-tax free and nominally risk-free, the investment case for RE is looking pretty poor unless rents skyrocket or real estate craters to bring cap ratios back up.

If the higher rate environment leads to a recession and lay-offs then I’m doubtful that rent increases are going to be the primary normalization pathway. It feels like employment trends will be a clue to how quickly housing will re-price lower (it’s already started of course). The yield curve is inverted, so the bond market is suggesting that the rate hikes in the near term will slow inflation and the economy.

This is all just simple observation. Like looking out the window. And as one does, when they sit at a window, one muses. And muse I shall.

Musing #1: Bid-Ask Widening

A year ago the people that paid ridiculous prices for RE were market orders. “Fill me at any price”. Many of them were immediately in the money (ie they probably could have turned around and sold a month later for more. Maybe not net of transaction costs but you get the idea). This isn’t shocking. When optimism turns to euphoria, the rate of change of the returns themselves can explode into a parabolic curve. Of course, such curves are unsustainable. The smug moment of being in the money is short-lived in the same way that a fund that buys a ton of stock going into the close usually gets a favorable mark on their daily p/l. Their sloppy buys drove the price higher in a short period of time. The real sellers didn’t have time to react before the close. But as soon as they check the comps overnight, you can be sure the supply is coming tomorrow morning.

I think of it like water going down a drain…once most of the water is through the drain the remaining liquid swirls quickly around the drain before you hear that sucking sound. Whoosh. The last bid is filled. With maximum punnage — the liquidity is gone.

In the meantime, many other buyers were priced out. You can think of them as limit bids. It’s an imperfect analogy but it will suffice. As things go south now, some of those bidders might be anchored to their original bids which were “cheaper” than where the home traded. However, if they get filled on the way down, they actually have more negative edge even though they got this theoretical house for a cheaper price than the original buyer. You could belabor this with a stylized model but understanding this concept is a big step towards understanding trading.

Anyway, the old limit bids are probably the new ask and the real bid/ask spread is wide. Prospective buyers are adjusting their bids much lower to keep the monthly payment constant or at least manageable, but sellers who likely have cheap financing from the prior low rate regime do not have to cross the spread. If current prices are 5% off their highs but the new mortgage math means homes they should be 20% lower (similar to the stock market) the current listing prices are the “asks” of a wide market.

Buyers lifting those offers are giving up edge for convenience/immediacy. That’s the usual reason people willfully give up edge for anything. Sellers hitting bids either need to (relocation, getting laid off, divorce, or any other life thing that shuffles liquidity needs) or they think rents aren’t going to increase as part of the normalization process.

Musing #2: Price Can Ruin Any Investment Idea

Always promotional, the real estate industry in an effort to pump bids, always finds an angle. They look at CPI and rates increasing, and peddle “RE is an inflation hedge”.

I mean, sure. But price matters.

By that logic, RE was also an inflation hedge 6 months ago, so are real estate prices supposed to be higher today given the elevated inflation of the past 6 months?

A few weeks ago Tom Morgan published Eight Investing Gems, which was a list of underappreciated, evergreen concepts sourced from investment professionals. I was flattered to be asked and my response fit well here:

Markets are biology, not physics, and that’s important because every good idea can be ruined by price. For example, real estate with a mortgage might be a good inflation hedge, but if history has taught everyone that lesson then it will be less true going forward. In other words, the price today already incorporates that (imagine paying 3x for your current home… how’s that going to work out as an inflation hedge?)

Prices are what matter. Not blanket, lazy sentences like “RE is an inflation hedge”. You’re not trading sentences.

[It’s also not clear that RE is an inflation hedge during periods of inflation]

Musing #3: Bullwhips Everywhere All The Time


The bullwhip effect refers to a scenario in which small changes in demand at the retail end of the supply chain become amplified when moving up the supply chain from the retail end to the manufacturing end.

With Covid closings followed by re-opening, this effect has received lots of attention. It’s not new. The famous beer game lets you play as a retailer, distributor, manufacturer, or wholesaler to make ordering decisions that balance your inventory against your customer’s demand. Orders are a proxy for demand, but the lag times in delivery lead to over and underreaction in ordering decisions.

Bullwhips feel like an apt analogy for the over and under reactions that happen in our largest markets:

  1. The underbuilding of homes since the GFC. Builders’ PTSD and higher lending standards for the past decade have contributed to a housing shortage. In the past, I might have associated building velocity with the credit cycle, but the excess of the mid-aughts seemed to have chastened builders despite the loose monetary conditions of the 2010s.
  2. Energy prices, in the wake of shale’s “growth at all costs”, busted in the mid-2010s. They surged back recently as the reality that fossil fuel transition will take longer than expected has collided with underinvestment in production. Drillers were scolded both from their investors (overproduction) and would-be investors (ESG).

[Just FYI, def not advice:

I sold my energy overweights in the Spring and recently started dollar-cost-averaging back in as I add investment exposure in this pullback. Overall, still overweight cash which I’ve been moving directly into T-bills. I’m in the midst of trying to do a rebalance from RE to equities but need one leg to close first so I don’t get middled. I hate illiquidity. In case curious, my prior energy exposure was XLE in an IRA, but I’m re-entering via deferred WTI futures. Instead of a div yield, you get a theoretical roll return. I am not an especially active trader/investor so I figure I’ll share stuff like this when I’m actually doing something. Again, I’m more weighted in cash than most sane people and don’t consider myself a good investor — I mostly try to avoid disaster. I just want to have my assets match my future liabilities — if I want to get rich, I’ll try a higher signal route of relying on myself not random number generators.]

  • Musing #4: Too Many Assholes Playing A “Loser’s Game”

Read this essay:

Too Many Assholes (7 min read)
by Jared Dillian

Jared is an author. He’s published a couple books, one was fiction. He was an index trader for about a decade before becoming a full-time writer amongst many endeavors. Jared is an exceptional financial writer. I read his professional letter regularly for most of the past decade.

This particular essay starts out:

This will be the only financial essay I write, I promise.

His substack is about culture and life not investing. So when he paused to write a single finance post in this collection, I paid attention. It felt very familiar. It has the same feel as his paid daily writing.

I want to offer a perspective on his writing. When people ask him for a free sample of the paid letter he doesn’t give them out. It’s for the same reason I give when people ask me if they should sub to his letter. The individual letters are not useful if you are looking for a great stock tip or definitive proof that the letter will make you money. So if you ask for a single letter, you miss the point. He’s capturing the broad strokes and he’s repetitive. And this is valuable in its gestalt.

I’ll re-hash my Twitter thread on Jared’s post:

This essay could have been called “play the cards not the man” but Jared is a snappier writer so he cut to the heart. It sounds like a folksy kind of essay but it’s deep. If you can internalize his essay you risk making small mistakes, you’ll almost definitely get the timing wrong, but there will be no catastrophes. Since survival is the goal in what Charley Ellis called the “loser’s game” this essay is an irreverent treatise in financial self-preservation.

Jared brings up contrarianism which by definition is required fo outsized returns. But at the turns in markets, the contrarian instinct is defensive. Yes, it can be expensive mid-trend but I’m not advocating for perma-contrarianism anyway. Sometimes contrarianism is common sense when LPs in private funds are climbing over each other to pay 20x revenue for profitless companies.

Options trading provides a well-balanced education in contrarianism. You spend a lot of time fading “point spreads that went too far” so you learn to deal with the discomfort of positions that are against the crowd. And of course, you do need to manage risk around that carefully (position limits are key because once a price enters la-la land there’s no restraint on it go to la-la-la land). At some point, you are selling because you are approaching “there’s nobody left to buy” territory and that is the exact point in time when it’s hardest to do that.

Playing the hindsight game, in the Spring I sold my energy stocks (a touch early but again it was a small mistake) despite being bullish. The thinking: Everything about oil looks bullish but everyone else sees that too. It’s insane to be bearish. But then you have to switch into the mind of a seller…there is no opening seller. So the price must contain a massive premium in it to attract any sell flows.

And that is enough to pull the trigger to sell for me. Yes, I could be wrong, but the risk/reward said “sell”. No fundamentals. Pure psychology.

[This isn’t any kind of victory lap. I’m losing money because I’m basically a long only investor and my current life is not a trading seat where I have the advantage of being in the mix.]

The question to focus on is “What psychology is in the price?” The price includes all the spreadsheets already. It’s the sum of the emotions and the nerds.

Jared focuses on sentiment. It’s not too useful when the game is played near the 50-yard line. In that zone, I’m perfectly fine to outsource to passive collection of market risk premium. With stocks, you know the proposition — earn 5% over the risk-free rate, give or take 15%, and experience a double-digit peak-to-trough drawdown every other year, and something like a 50% drawdown once a decade. Fat tails. That’s the deal. Over the long-run you’ll make money, but sizing that proposition is a personal matter.

The psychology matters more at the turns. The edges of the field. Marching through the redzone, from the 20-yard line to the goaline, can feel dramatic in compounding space. The 5-yard line to the goaline — this is the blow off top in Doge or the Volkswagon short squeeze in 2008…where the bulk of a total return can come from a short time. This is when things are obviously unstable. Sticking around to find out which down is gonna be the pick-6 is baggie roulette.

You don’t need to be some market genius when things feel crazy. Just realize that the only way the price can make sense is if someone crazier came along. Unless you have a very special edge in that game (I suspect at these critical turns the internal mechanics of liquidity are understood by a handful of insiders/clearing firms/exchanges, perhaps it’s a short squeeze, that connect the trading world to the credit/banking world. If that’s the case, you, sitting at home in your pajamas, are playing no-limit hold’em with a worse than random hand against people who know their cards.)

If you don’t have a hero instinct and just try to get the broader picture roughly right you can avoid the giant mistakes. That’s 95% of the battle. 2021 was stupid euphoria. That was obvious even in real-time. Sure you could have been early to that realization and looked foolish for a while but zoom your perspective out and ask yourself:

“Am I feeling fomo or fear?”

That will tell you what everyone else feels and that tells you what’s in the price. You know what that’s called: empathy. You are putting yourself in the minds of others and therefore the price. It sounds like soyboi shit. But that shit is full is wisdom if you can channel it.

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

I’ll be squirting out some new posts about trading over the next weeks. They aren’t technical. Here’s the first:

Permalink: Trading Vs Investing

Trading is a business. Like a casino. You spread the risk over a bunch of tables and let the law of averages1 do its magic. Investing, whether it’s as a shareholder, LP, or creditor (ie allocating capital in the primary or secondary markets, but not as a member of management) is something you do in a business. You can invest in a casino. You can invest in a bank. You can invest in a trading business. The point is that investing and trading are actually different.

The distinction seems subtle because the language and mechanics of investing and trading overlap. Traders talk about diversifying as much as investors do. Restaurant owners don’t. Traders and investors both talk about position sizing. Software founders don’t. This makes it easy to confuse trading for investing but the former is a business, not an investment strategy. You would not compare Optiver, Jane Street, or SIG’s returns to a portfolio manager’s. Trading firms think in unit economics just like any business (“how many fractions of a cent of edge do I get per contract?”). The portfolio manager doesn’t have a similar analog. However, if we look at asset management, it collects fees. So if we zoom out, we are at the business-level of abstraction yet again.

There’s an interleaving of concepts that binds notions of “trading” to “investing” in a way that can mislead investors. When they trade are they trading like they are a business, like they are providing a service (temporary liquidity in exchange for a theoretical fee which resolves the desire for a buyer or seller to transact in the absence of a natural counterparty) or are they rebalancing investments? The distinction is one of framing and like all frames, it has a tyrannical grip on one’s downstream decisions. The subtlety can be confusing to new investors who can’t escape terms like “daytrading” or that Robinhood calls itself a “Stock Trading and Investing App”. You wouldn’t take a Porsche off-roading any more than you should confuse these 2 endeavors.

And yet you might for all the superficial similarities I already described. It’s totally understandable. To create the appropriate distance between activities of “trading” and “investing”, I’ll offer 2 thoughts.

  • Time Horizon

In trading, the bets have endpoints. Whether it’s an upcoming catalyst or event, an option expiration, or time to roll a future there is a time when you get to “see the river” to borrow a poker term. Price and reality must converge. Extrinsic values go to zero. Future prices meet spot prices. With equities, the metaphor needs massaging. Perhaps news or earnings is more like the “flop” or the “turn” whereas M&A activity serves as a defacto endpoint.

With investing, the duration of the trades is typically much longer. Stocks are perpetual claims. Perhaps semantically awkward, I prefer to re-brand investing as “re-investing”. This focuses us on a company’s need to compound returns on capital internally. If an oil company sits on massive reserves, but the price of oil shoots to a price that destroys all future demand, the stock would plummet because it no longer has a forthcoming stream of earnings. Yes, its book value would immediately increase, but that is a smaller portion of its discounted perpetuity value.

The “re-investing” frame explains why a market would discount such a one-time windfall. You can even think of a “cheap” stock as a company that the market has decided has a low future return on invested capital. By not increasing their bids, investors are manifesting trader thinking — they are focused on return per trial. Thinking of investments through the lens of how a company re-invests, stretches “repeated game” thinking longitudinally into the future as opposed to traders or casinos who think of edge per trade cross-sectionally.

  • Seeing The Present Clearly

Since the compounded return of an investment depends on how a company re-invests, it requires distant foresight into an inherently complex system. Long-term investing, like long-term weather forecasting has an irreducible bar of uncertainty that sits unpleasantly high off the ground. There’s only so much you can say about a system governed by chaos, biological, and evolutionary forces as opposed to tidy physical properties. Feedback loops are long, causation is opaque, and the signal-to-noise ratios are too low to prove an edge. This leads to a paradox. If a manager’s edge is unprovable, then there’s a chance you can actually access it, you’ll just understand it post-hoc. If the edge was provable, the manager would extract all the excess alpha for themselves by either choosing strategic investors or charging ransom fees.

Trading on the other hand is a provable edge. Because it’s a business. You rake a tournament, take the profits off the table and hunt for new players. Markets might imply or try to tell us something about the future. The business is to find market prices that say something contrary but have visibility to resolving and taking both bets. Arbitrage is an extreme example of this. If one person thinks the USA basketball is 90% to win the gold and another thinks the field is 15% to win the gold you can bet against them both and get paid $105 while knowing you’ll only owe $100.

The business process around this involves measurement, not prediction. There’s no thematic vision of what the world looks like 10, 20, 50 years hence. Instead, you find others who express strong opinions that disagree and build a machine that lets you bet against both of them. You are passionately agnostic. You are in the business of seeing today clearly. Not having visions of the future. That’s your customer’s job. That’s the investor’s job.

A Skinny Bridge

Coming from the trading world, I’ve wrestled with my understanding of investing. I don’t believe in crystal balls. I don’t think any “long term” investor can prove they are special because of the limits of data and sample size. Putting faith in track records feels like betting on coins that just had a long streak. There are a lot of funds out there, it’s inevitable some will have long streaks by chance. Survivorship bias makes the proportion of lucky funds even more visible.

This is a discouraging place to settle. Attempting to invest in a trading business as opposed to doing the trading business, leaves you in the same epistemological rut as choosing any business to buy. They are just businesses, to be compared with any other business. In fact, the search is pointless. Most are capacity constrained which means the best ones don’t need your money anyway. Where does that leave me? I don’t trust most people who would take my money to manage it and I don’t have the expertise to invest to the impossible standard of risk-reward that the business of trading anchored me to. And I need to take myself seriously — I just spent this entire essay explaining how it’s a fallacy to compare trading to investing in the first place.

Is there a reconciliation?

I think so. I see a skinny bridge between the business of trading and what it prescribes for investing. It lies in portfolio construction and asset allocation. At one level of abstraction, the investors with their coherent visions of the future are simply tourists in the traders’ casinos. But if we zoom out and aggregate the consensus of competing investors we end up with a total market price. It’s not one market however, it’s many. There are equities, bonds, and commodities. They exist across geography and sovereign systems. These are the legos that can be stacked to construct payoff shapes — carry, insurance, momentum. Those can be described in other language as well — concave/convex, convergent/divergent.

The asset classes themselves contain a risk premium above risk-free rates (by induction — stocks should earn more than t-bills because you need extra compensation to hold something that tanks every now and then). By combining these asset classes under battle-tested principles of risk management, the hope is to capture the weighted average risk premium of your allocation without relying on forecasts. Just like trading businesses. Just like casinos2.

Wrapping Up

Trading and investing are sufficiently different that you should be conscious of what mode you are in when you click a buy or sell button. The awareness will likely lead you to pressing buttons less often, or systematizing when you push the buttons. Unless you’re in it for the thrill, you want to minimize your points of contact with the fee-generating businesses that want you to feel like you are doing a good thing by “investing”. You are doing a good thing when you invest, but be careful — sometimes what looks like investing is trading. And the bar for doing that productively is much higher than they want you to believe.

Last Call

I’ll be in NYC this week for the StockSlam Sessions with Steiner and Tina.

Paul Millerd recently interviewed Steiner. My favorite thing about talking to Steiner is his experience and perspective on high school kids. It’s easy to focus on negativity, but Steiner teaches at a diverse public school in NJ and sees so much positivity and optimism in how the kids treat one another. I get it, that doesn’t get the clicks. The incentives aren’t really for truth so we shouldn’t be stunned when the happy news is more correct (this would actually make a neat Bayesian homework problem to make the point).

Steiner’s experience is anecdotal so I’m not generalizing. I’m just saying — this isn’t going to be negative, click it anyway:

Training Elite Wall Street Traders (podcast/video)

From Paul:

This conversation was a delight and I think you’ll enjoy it. We cover:

  • Ending up at Penn and not really knowing what he was going to do
  • Figuring out he enjoyed math and finance
  • Getting a job at SIG
  • Joining the training team
  • Leaving finance to spend more time with his kids
  • Becoming a high school teacher
  • How he thinks about teaching & mentorship
  • His 20-year journey in creating his game “Stockslam”

From My Actual Life

I’m going to the Greek in Berkeley tonight for the 3rd time in as many weeks. We are seeing the Aussie band King Gizzard and The Lizard Wizard. They are the most prolific band of the past decade. They release more than 1 album per year. Last month they dropped 3 albums. Not a typo. They have played over 100 different songs on their current tour and the range of music goes from metal, to pop, to spoken word. They are far out. The music videos are a trip too.

Funny thing about these tickets. I bought them a year ago thinking they were for 2021. I didn’t realize the date was off by a year until the morning of. And this worked out for the better because tonight’s a date night. Yinh and I are celebrating our 13-year wedding anniversary. We got married in Mexico and I remember the all-nighter she needed a few days before the flight to get this document to the printer in time to get into to the guests’ welcome bags:

Moontower #163

Lately, I’ve been watching Pirates of Finance episodes during my weekly cardio sessions. Jason and Corey are a special combination when they just riff on whatever pops in their head. A recent episode, The Gamification of People, provoked some musings.

Where Exactly Are We Racing To

The pirates revisit Malcolm Gladwell’s discovery that the best hockey players in Canada were disproportionally represented by athletes whose birthdays were just after the grade cutoff. So children who are the oldest in their class or hit puberty in their class first have an advantage.

If you are a summer birthday you understand this. The school year starts, and some student brings Rice Krispy treats for the class and you think “this mf is a whole year older than me”. Jason remarks that even though he has no kids, he has heard that parents in affluent suburbs hold their kids back at a young age so they can be swept up by the positive reinforcement loop of being a better athlete or student. A ”snowball effect” builds as a confident child draws more attention from coaches, gets into the higher track in class, and is even less likely to be diagnosed with ADHD.

Via WaPo:

Researchers found the youngest children in a grade — those born in August, just before the cutoff — were significantly more likely to be diagnosed with ADHD compared with those who were born the next month and became the oldest in their class.

Corey notes that as knowledge of Gladwell’s chapter in Outliers spread, the efficient market mechanism kicked in. Parents started holding their children back a grade. Jason, who admittedly has no kids, sounded skeptical. Jason, if I was in the comments section of the livecast, I would have told you — the practice is called “redshirting”. Like the NCAA athletes.

Our local school district is extremely strict about not allowing it. By making the date cut-off a redline, they don’t have to deal with every case-by-case plea to hold kids back. In fact this week, I was chatting to a mom of triplets at my kids’ school, who despite a totally valid reason (in my totally unqualified opinion) for holding the kids back, did not get an exception.

The impulse to redshirt your kid, even though you risk them being bored by playing “down” a level, for a competitive advantage is classic Moloch — a race to the bottom. If a parent doesn’t hold back their kid in such a community are they now doing them a disservice? I mean what a miserable question to entertain. But here we are.

A few years ago, schools in our area decided to move the scholastic calendar to start in early August. Why? So they can have more time in class to prepare for the end-of-year standardized state tests. What has been the cost of this intervention? Togetherness. My kids now go to school a full month earlier than their cousins in NJ. The end of August is a classic time for vacation with both camps and school out of session. I know, I know — violins. I won’t turn what amounts to a high-class problem into a crusade, but the point is the school is reaching for an artificial advantage. If every school adopts this calendar, the advantage goes away and we are just worse off. It’s all frustratingly familiar.

Let’s go back to Corey’s point about market efficiency. Mechanically speaking, he’s right. But it’s actually more interesting as a demonstration of the flaws in market-maximalist thinking. If you graduated from U of Chicago, turn back now. You’ve been warned.

The market is a servant of our collective values. If we choose the wrong values we are asking to be consumed by the “paper-clip maximizer”. This is exactly why AI research is so concerned with safety. We tell the system what to optimize for and it will do so faithfully — but without an appreciation for what we forget to tell it.

Market-based thinking needs to be accompanied by a responsible understanding of our values. This runs head-on into an accounting problem — “not everything that we measure matters, and not everything that matters can be measured”.

A specific instance of this is negative externalities. The textbook examples are companies that socialize the costs of pollution while capturing private profit. More oblique examples abound in Corey and Jason’s conversation. How does the UI of investment platforms “nudge” our behavior? Are those nudges good for the clients, the company, or both? They give the example of a robo-advisor that tells you the concrete tax cost of selling appreciated assets. It’s an effective speedbump because investors hate paying taxes. It seems like a win for both the advisor and client. But how do we compare the sure tax savings against the theoretical risk reduction that happens by cutting concentration? This is hardly straightforward. You don’t have to be THAT cynical to think that a tie goes to the robo-advisor’s interest. Would a more nuanced speedbump that considers the trade-offs of different actions fulfill fiduciary responsibility better? Is it worth the brain damage to clients?

I don’t have answers to any of this. One of my beliefs is that our dashboards of cost/benefit are woefully underpowered. Partially because of incentives — commercial interests talk their own book. But also because of irreducibly complicated chains of causation. Even if you could construct higher fidelity models of reality, internalize all the externalities, and identify the “best” values you’d still fail. Because on average people don’t really want the truth. We are cognitive misers. We either want the laziest solutions or we want to keep our delusions intact.

I’m pro-markets. But any platonic idea that they are “free” and not downstream from laws motivated by imperfect actors is an illusion. That markets do a generally effective job in allocating resources reminds me of that Twain bit: It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so. Misplaced confidence is more dangerous than things we know are dangerous because things that appear safe become load-bearing. If a money-market account defaults, that is far scarier than BTC going to zero because we size our exposures in proportion to how safe they are.

We need to be careful about what values we ask markets to chase. Free market maxis love to cite the law of unintended consequences against nudgy top-down policy. That’s valid. But the sense that markets, whose guardrails emerge from human negotiation and therefore limited foresight, aren’t immune to unintended consequences is a fantasy.

No idealogy is so important that we can’t inquire — who’s serving who?

Ouija Boards

Corey and Jason struck another nerve. They get into the topic of sales. They acknowledge that while they have an idealistic aversion to sales, that’s not a practical position. Everything is sales because sales is persuasion. From getting clients to finding a mate. No controversy there.

Consider the used car dealer’s tactics — lying, creating urgency, and so on. Yes, it’s cringe, but…it’s also a strawman. The best salespeople don’t look like they are selling. And they often aren’t in the conventional sense. They aren’t trying to convert you, they just cater to your bias. That sounds nefarious but it doesn’t have to be. If I am in the market for an investment fund, tell me why I should want yours. I’m buying one either way, put your best foot forward. It’s hard to distinguish “talking your own book” from “the manager is employing strategy X because they believe in it”. They are already betting their career on it. Where does belief end, and conflicted interests begin? It’s a tough question. Sure, the benefit of a doubt needs to be earned but assuming everything is a scam will leave you in a cave.

Back to the tactics. The pirates mention “mirroring” and saying people’s names (“John Smith, let me tell you something about this car”) as examples of manipulation often found in sales guides or books like Cialdini’s Influence (brief notes from an interview with the author here). Corey acknowledges that some people do this naturally.

I felt seen.

If a server tells me their name, I use it. I tell myself this is a way to be kind. I take the Zeroth Commandment seriously. But am I post-rationalizing an adaptive behavior? Have I figured out that being kind is a way to get what I want? Am I manipulative?

I feel like I’m shooting airballs here because I just don’t f’n know. There are 2 kinds of people. Those that are full of shit and those that admit it. It’s a bit of a cope, but I’m old-fashioned in thinking intentions matter. It makes you sound smart to moan about the road to hell being paved with such intentions. It sounds smart because there’s truth to that. But it has less to do with intentions themselves and more to do with reality being sloppy spaghetti. The arrows of causality are far more bi-directional and recursive than our coherent explanations suggest. Well-intentioned people often come off looking like Steinbeck’s Lennie strangling the objects of their affection by not knowing any better.

Still, discounting intentions fully in deference to optimization is a cope of its own. Incentives are Oujia boards. They guide us to what we want while we tell ourselves stories about how our beliefs make sense. We spell out the letters of whatever serves us individually.

And then we look at one another “Did you move it? I wasn’t moving it. What does it spell?”


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The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

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Money Angle

With the StockSlam Sessions rapidly approaching, I want to thank Jeff Malec at RCM Alternatives for inviting Tina, Steiner, and me to his show. You can listen to the pod or watch on Youtube. Steiner is an offline guy, so foremost this is a nice introduction to him.

  • The Game of Trading with SIG Alums Kris A, Tina L, & Steiner (Link)

    We have a little saying over here on The Derivative, “The More, The Merrier”, and on this week’s episode of The Derivative, we’re not chatting with one guest, but THREE! Class may no longer be in session, but we are taking a trip down the SIG/Susquehanna memory lane and having our own class reunion with Kris Abdelmessih, Michael Steiner, and Tina Lindstrom.

    If you’re interested in learning how big trading firms find and teach their traders, hold on to your seat because these three give you the answer key! Kris, Tina, and Michael are in session with Jeff and discussing competing with peers, finding an option’s fair value, making markets, and being in the game of trading, educating kids with board games, and of course Steiner’s new trading board game: Stock Slam! Discover how the game works and how you can join up with these three in NYC for a live session in this three-of-a-kind episode

We are doing these sessions because trading is a neat laboratory to learn about decision-making. Weighing risk-reward, thinking adversarially (this thread by @0xDoug is in my hall of fame), resisting confirmation/hindsight biases, using probability, considering counterfactuals, not “resulting”, and much more. So much of my writing focuses on these “meta” topics because trading gave me a better education than school ever did.

If we can help people practice thinking this way, it’s a like growing new brain lobe that’s adaptive for many real-life situations.

The following is adapted from a thread I wrote that demonstrates an idea in a trading context:

People understand that even though insurance has negative expectancy it can still improve a portfolio that is focused on compounded returns. It makes no sense to look at the line-item of insurance divorced from the optionality it gives you in the rest of your portfolio.

(I could pull lots of links on this idea, but let’s be brief).

This concept is fractal. Let’s zoom in on the smallest portfolio — a spread. You don’t necessarily care about the p/l of any individual leg of a spread trade but the performance of the spread overall.

Before we consider a spread, let’s just look at the single position. Suppose you buy something for $4 when it’s worth $5 but then sell it for $4.50. You made both a:

  • +$1 expected value trade
  • -$.50 EV trade.

If you knew it was worth $5 you negated half a good trade with a bad trade.

In real life, you often might like the price of a spread but it’s hard to tell which leg is the “good side”. That’s one of the reasons you trade the spread. Once you do the spread you don’t care about the individual p/ls.

Another reason you may do a spread is that you might like a trade (ie maybe vol is cheap in X) but can do it bigger if you spread it. This is one of those questions that comes up a lot on real trading desks. Do I like the outright, or do I like the trade better paired against something else (and assuming I can do the trade bigger if I spread it)? Do I like being long z units of X exposure, or do I prefer 5z units of (X-Y)? The answer depends on understanding the distribution of the outright vs the spread and the relative price of each within those distributions.

Finally, there’s the general lens of how I approach trading (which I discuss in the RCM interview). Liquid markets tell us a lot about “fair value”. If we take fair value as the consensus “outside view”, then we can examine illiquid markets for pricing discrepancies compared to that outside view. Of course, those markets have their own idiosyncracies, so you need to take an “inside view” and normalize as much as possible to the liquid reference asset. This is a standard way to identify possible opportunities. It’s a mix of art and science. The science is in the measurement but the art is in handicapping how much the differences should matter. This isn’t arbitrage. It’s informed betting. If you need certainty, you will either be too late or the strategy will have the lifespan of a mayfly.

[I actually googled “shortest lifespan” and was met with irony:

We often hear that mayflies, like the whiteflies of the Susquehanna River, have the shortest lifespan of any animal on Earth, just 24 hours for many species.

SIG is named after that river.]

Now let’s broaden the concept to investing. For that, I turn to Byrne Hobart’s paywalled post Assuming Efficient Markets to Exploit Market Inefficiencies:

If there’s an efficient market A and an inefficient one B, A is easier to trade in, but B is probably the one that’s mispriced. So that price inefficiency partly represents a measure of how hard inefficiencies are to exploit! In the case of Druckenmiller’s recession call, he actually made the paradoxical judgment that inefficient market B was priced incorrectly relative to A, but that A was the one to bet on—because the specific inefficiency at hand was that a recession was likely and it wasn’t being accurately reflected by anything.

This raises an important point, because there are two broad ways to look at relative inefficiency. One is to just stick with the relative argument: if stocks are pricing a boom and bonds are pricing a recession, bet that one of these will go away. But that’s a frustrating conclusion to draw, because it basically amounts to saying: The market is telling me something important, and I don’t care what it is. The relative-value bet works equally well regardless of which thesis is right, but it’s still outsourcing a lot of judgment to the market. And annoyingly, once the valuation gap closes, you have two problems: first, you haven’t figured out why the discrepancy existed in the first place, and if there’s an inexplicable 1-standard deviation change in some correlation, there is no law of the universe saying it can’t go to 2 or 3. (There is a weaker law saying it can go to 20, when enough levered participants are betting on it.) The other problem is that real-world theses produce additional ideas; an argument that the economy is going into a recession has second- and third-order consequences, and generates more ideas.

This kind of tradeoff, between a low-risk claim that two views are contradictory and a higher-risk claim that one of them is right, extends far beyond finance.

Through games, direct instruction, and making connections between abstract concepts and examples in the wild, Tina, Steiner and I want to see if we can help others get better. And selfishly, I want to think better, so I’m stoked to be a part of this.

*Applications are closed and invitations already went out but these sessions are an experiment to guide how we test and improve the transfer of knowledge. If you didn’t get accepted it’s because space was extremely limited compared to applicants. This is not meant to be exclusive, we are going to figure out how we can spread what we learn. As Axl once said, we just need a little patience [bandana sway].

Last Call

A friend recently mentioned that she willfully puts on blinders about big questions. She prefers to focus on the practical because it can be painful or lonely to dwell on the large problems we see in society.

I’m sympathetic to this view. It brings me to a conclusion I’ve come to over the last few months. You can’t tear down people’s constructs without offering another way. It’s a riff on “the best way to complain is to build.” If you succeed in providing people an alternative the old will crumble away on its own. You don’t blow up someone’s house without having a better one waiting for them. With a bow on it.

It’s the same reason you wouldn’t tell young kids you can’t pay the rent. They can’t do anything about it. Being around Steiner again has been inspiring because he really understands this. Steiner doesn’t criticize unless he has a solution. He can lament, but won’t pontificate. He recognizes that whining without proposing thoughtful solutions is not just annoying, it’s intellectually lazy.

From My Actual Life

Kids are funny.

Moontower #162

The paradox is that you write to become more fully yourself, but then you find it hard to live with the self you’ve become. I do what I can to remain a possibility instead of a reality. Thus the flow. And, next week, the effort to erase this too.

-Freddie deBoer on why he feels the need to write frequently. I don’t think you need to be a writer to appreciate that feeling.


I’ve got this friend and neighbor who I hike walk with after we drop the kids off at school sometimes. It’s like 90 minutes of dorm-room musings befitting of the Moontower scene. Those conversations have influenced a few of these weekly letters.

This recent one was no different. It got me thinking about diversity.

See, this friend has an early-stage startup in the education space. The internal research at his company parses diversity across many dimensions. You are familiar with the capital “D” types of diversity — race, religion, gender, age, sexual orientation, socioeconomic, etc.

Interestingly, he expressed concern that his team might not be diverse enough. Not in a visible way. The team runs the gamut of the capital “D” diversity categories. But he was interested in cognitive diversity. He was concerned that an intellectual echo chamber of fancy-college liberals could lead to blind spots in their collective decision-making.

Now I don’t have much team-building experience. So I flexed some knowledge I recently read. (This is why people read right? To at least have a tennis racket when they find themselves on the court of conversational Wimbledon.) And now you too shall witness the fact that I read a book. Confer prestige heavily and without reservation, my esteemed landsmen.

Nah, really I actually read a book and it said some cool stuff. I’ll get to that in a sec. First, I want to re-surface some points professor Mauboussin made about cognitive diversity. He described it as the training, experience, and personality that make an individual unique.

He writes:

I think one can make the case very seriously and quite rigorously that social category diversity contributes to cognitive diversity, but it is cognitive diversity that we’re after.

He describes a less-talked-about form of diversity as well.

“Values diversity”. You might think about it as a sense of purpose, and on that, you actually want to be low. We want a common mission, even if we are of very different backgrounds, we’re pulling in the same direction.

In other words, my friend’s instincts about diversity are correct. Visible diversity is an imperfect proxy for intellectual diversity.

Back to the book I was reading — Superforecasting by Phil Tetlock and Dan Gardner. The book’s main thesis, which falls out of the lessons from the Good Judgement Project, is that it’s possible to become a well-calibrated forecaster in complex (but not all complex) domains. How good can you become? The best are able to consistently beat prediction markets, something even demonstrably above-average forecasters struggle to do.

This is rightly provocative because markets are effective truth-finding mechanisms. They are an ancient way of coordinating human behavior (democracy is another example of a human-coordination machine…for a contrast between markets and democracy see Dinosaur Markets).

If you read this letter regularly you know I have a lot of respect for the efficiency of markets. It’s not a strong-form academic belief. It’s more of an informal razor: “my null hypothesis is there’s no easy money and the burden of proof is on investors who think otherwise”. The academic compromise is markets are “efficiently inefficient”, reflecting the idea that there’s a cost associated with finding inefficiencies so some amount of inefficiency always exists to justify the hurdle of hunting for it.

To appreciate why markets, under certain conditions, triangulate on the truth, I paraphrase Tetlock’s explanation of how the “wisdom of crowds” works:

Bits of useful and useless information are distributed throughout a crowd. The useful information all points to a reasonably accurate consensus while the useless information sometimes overshoots and sometime undershoots but critically…cancels out.

The Role Of Diversity In Truth-Finding

The “under certain conditions” is an important asterisk. The expression “wisdom of crowds” is actually a modern idea that plays off the “madness of crowds”, a term coined nearly 200 years ago by journalist Charles Mackay. For the crowd to generate wisdom, it needs diversity. In other words, the errors in judgment need to be uncorrelated to cancel out.

In Tetlock’s studies, they tested the forecasting abilities of individuals. They were rigorous in their experimental design. They were curious how teams of forecasters would perform against individuals. They further experimented with the composition of those teams.

The eye-opening results underscore the importance of diverse thinking:

  • Teams are more effective
    • The results were clear-cut each year. Teams of ordinary forecasters beat the wisdom of the crowd by about 10%. Prediction markets beat ordinary teams by about 20%. And superteams beat prediction markets by 15% to 30%.
    • “Emergence”: teams are more than the sum of their parts. This cuts both ways…even actively open-minded individuals could surrender to “groupthink”
  • “Diversity trumps ability”
    • This provocative claim highlights how the aggregation of different perspectives can improve judgment. The key to diversity was, unsurprisingly, cognitive diversity.
      • The revealing result: When they constructed the superteams they optimized for ability and those teams happened to be highly diverse because the superforecasters themselves were highly diverse. They did not optimize for diversity first, but it turned out the most diverse teams were the most effective.
  • The asymmetry of the extremizing algorithm
    • The “extremizing algorithm” is a technique where you boost a 70% prediction closer to the extreme, perhaps bumping it to 85%. It’s a technique that is employed when the forecasters have diverse perspectives because it leads to better-calibrated forecasts.

      You do the opposite (push the forecast probability closer to 50%) to combat “groupthink” if the team is comprised of people who think the same or possess similar knowledge. (The use of the extremizing algo allowed teams of regular forecasters to actually perform better than some superteams!).

      My own observation: this is the same logic by which correlated observations “shrink” the sample size, an idea familiar to data analysts.

Example Of Cognitive Diversity

My friend with the start-up gets it. He is concerned that the visible diversity on his team might be a poor proxy for what he really wants — cognitive diversity. If you are an oil company you need geologists, finance people, managers, political connections, real estate expertise. This is a clear example of needing to pull together many object-level competencies.

But cognitive diversity is not just “what do they think about”, but “how do they think”. For an example of what I call meta-cognitive diversity, Tetlock uses the “hedgehog” vs “fox” duality. As a pre-defense of Tetlock, he warns about overstating this dichotomy. (He exemplifies non-binary thinking throughout the book, doing an honest and eloquent job of pointing out tensions and caveats, not unlike the superforecasters themselves).

I’ll take a stab at describing hedgehogs and foxes:

  • Hedgehogs

    Hedgehogs are specialists. The 10,000 hours crowd. The natural endpoint for the logic of economic comparative advantage or simply the rightful throne of the devoted craftsman. The “specialization is for insects” objection is too reductive. We are better off when Eddie Van Halen wants nothing else than to just be Eddie Van Halen.

    But there are trade-offs. Hedgehogs often filter observations through the lens of their expertise. (My online friends have a good-natured running joke that I see everything as an option — classic “when all you have is a hammer, everything is a nail” thinking). But a camera lens’ usefulness depends on the context. Sometimes that fisheye or telephoto lens is exactly the wrong tool for the job.

    This is inconvenient for the status-aware hedgehog whose incentive to remain consequential leads to motivated reasoning and self-delusion. Academic researchers who become famous for writing about an idea that catches fire have a lot to protect. They become fast friends with Mssr. Confirmation Bias and Madame Overconfidence, the very enemies they used to fight when they were building their reputations of good work. It’s like America fighting against the same Afghans they armed as rebels in the 80s. As DiCaprio’s character in Up In The Air would attest, the warm embrace of fame beats the cold loneliness of cultural anonymity.

  • Foxes

    Foxes are generalists. Businesspeople, investors, politicians, administrators. It’s an imperfect description of course but you know the type. The disadvantages of being an “inch deep and a mile wide” are established. That person is never going to design a bridge or coach a professional sports team. Some are self-aware enough to recognize when they “know enough to be dangerous”. Many are not. Their advantage, however, is their mercenary relationships with lenses. The ego cost of finding the most useful lens is much lower, making foxes at least psychologically fit for reasoning across domains.

Remaining careful not to play into false binaries, the hedghog/fox continuum reminds me of the importance of shifting between diffuse and focused thinking modes. Diffuse thinking (see More Shower Thoughts Please) provides both inspiration and the ability “see over the neighbor’s fence” while focused thinking enables us to synthesize those scattered insights into a useful output. Most of my posts start either in the shower or when I’m taking a walk. (I strongly recommend this old New Yorker piece Why Walking Helps Us Think). “How we think” is a dimension of diversity.

The Complicated Discourse Around Diversity Is Inevitable

When I described the thrust of this piece to my wife, Yinh, she yawned. “So you’re writing a post saying ‘diversity is good’? Who is this news to?”

I immediately got nervous that I was belaboring an obvious point. I asked her why she thought it was so obvious and she started citing studies and initiatives that could easily have 10x’d the length of this post.

Now I can take feedback, but I’m not above quibbling en route to my final destination. So let me get this straight. You read a bunch of stuff arguing that diversity is good, now it’s obvious to you and presumably everyone else who reads, so I shouldn’t spend any time making arguments that diversity is good. I mean, this post is to a Moontower reader as that other research was to you. Next time just put my head in the washing machine woman.

But she still has a point. Diversity, in its many forms, is widely celebrated. In-breeding is taboo. I was just watching the National Parks series on Netflix with the kids and learned that rainforests, the most biologically diverse ecology on land, are the origin of more than 25% of modern medicines. So why do I feel the need to cheerlead an “obvious” point?

The short answer is I don’t think the case is closed on the merit of diversity. I know it’s exhausting to hear me say this, but it depends on contexts. For example, whenever America’s dysfunction is compared to a homogeneous European country, I scratch my head. If we are tribal in nature, our default wiring might simply make governing a melting pot inherently more difficult. I think diversity makes us stronger overall, but some measures of local harmony should expect to suffer. I’m even open to the possibility that tolerance runs counter to our natural instincts. (It just makes a normative approach to overriding our base impulses require extra care. Law-making is always a tug-of-war between collective values and the animals within us.) In other words, I can appreciate how diversity can be a headwind.

But there’s more.

Even if we wave a wand and agree that diversity is an unalloyed good, there remains the harder question. At what cost? The lightning rod version of this question is you have a white student and black student who look the same in all other ways and you need to choose one (the premise is unrealistic, but this is the collapsed version of how these questions get passed around the media and people extrapolate entire political identities on how they’d answer such a fake question). If everything else is the same and there is a non-zero probability that social diversity leads to cognitive diversity, then the optimal (although not necessarily morally fair which is a different criteria battleground) decision gate would say select the black kid (assuming the majority of the student body were white).

Still, even if we agreed on that, a harder question remains. What if the black kid had a slightly worse score on a standardized test? From a strictly efficient-utilitarian point of view (again, moral consideration aside), then we are faced with trade-off on a diversity-competence frontier. In a purely academic sense, I was likely an inferior hire at SIG, but perhaps something about how I thought or acted might have made my “diversity” or “complementariness” worth more than just hiring yet another 1600 Math SAT kid from MIT (or they just exhausted the supply of those, I’m not trying to flatter myself here). The point is that the merit of diversity is fairly intuitive, but doesn’t lend itself to legible number-crunching in the way test scores do.

Pricing “diversity” could very well be a fool’s errand. But I have one final bit of intuition to sprinkle on the problem. In There’s Gold In Them Thar Tails: Part 2I rehash how nature uses diversity as fuel for evolution.

  1. Diversity is an essential input to progress. Nature’s underlying algorithm of evolution penalizes in-breeding.
  2. In addition to a loss of diversity, signals decay as you get closer to the extremes. This is known as tail divergence. The signal can even flip (ie Berkson’s Paradox).
  3. The point where the signal noise overwhelms the variance in the candidates is an efficient cutoff. Beyond that threshold, selectors should think more creatively than “just raise the bar”.

At some point, incremental diversity is worth more than incremental “signal”. Evolution acts like a basket of options (I really am a hedgehog). It sees a mutation. If it’s useless, discard. If it’s adaptive, exercise it and let it multiply through the population out-competing those without the adaptation. When discernment becomes random, select for diversity. The downside is limited, the upside is massive learning.

Wrapping Up

Diversity is valuable. The word is highly politicized today. There are many arguments, with varying degrees of merit, harping on diversity in the name of fairness. Those are debates that need to be had. But this is not that debate. This has been an argument that diversity is important as a matter of efficiency and flourishing. Perhaps the argument isn’t needed, but I suspect that many reactionary arguments against the equity angles of diversity may dilute the value of diversity as a general concept.

We have seen diverse dimensions all around us: social, cognitive, and values themselves. It’s worth unloading the hangups artificially narrowing the meaning of a beautiful word — “diverse”.

Today’s letter is brought to you by the team at Mutiny Fund:

How can you access a multi-asset strategy concerned with protecting assets and growing long-term wealth?

The Cockroach Strategy seeks to achieve higher long-term, compound growth compared to traditional stock/bond-focused portfolios with more limited drawdowns. ​ It is intended as a total portfolio, a ‘set it and forget it’ approach that strives to give investors peace of mind and meaningful capital appreciation.

The Cockroach strategy consists of a diversified ensemble of assets including stocks, bonds, commodity trend strategies, long volatility strategies, and gold. It is designed to perform across multiple macroeconomic environments: growth, recession, inflation and deflation.

The Cockroach strategy gives investors exposure to asset classes designed to perform in each of those environments including stocks, bonds, commodity trend strategies, long volatility strategies, and gold.

Click Here to Learn More

Disclaimer: Investing is risky, and you are reminded that futures, commodity trading, forex, volatility, options, derivatives, and other alternative investments are complex and carry a risk of substantial losses; and that there is no guarantee the strategy will perform as intended.

Money Angle

I’m trying to read books again. I’m like the opposite of a junkie. I start and just give up. I struggle to watch movies for similar reasons. It’s hard for me to sit still and be passively entertained for extended periods of time.

[I recently admit that I haven’t seen Animal House, I saw Trading Places after I had been a trader for a decade, I saw Caddyshack 2 years ago. I’d like to claim ESL but I was born in Brooklyn. Also I’d be doing a disservice to immigrants, many of whom have large movie repertoires because it’s an effective way to learn English. I have no excuse. I could have watched more classic movies instead of fraying the tape of the Dazed And Confused VHS.]

In an era of amazing tv shows, my diet mostly consists of those that come in 30-minute episodes. I’m making my way through all the seasons of Curb Your Enthusiasm again. I’m also watching it backwards. For example, when season 3 ended, I go to Season 2, episode 1. This isn’t the first time I admit to being a serial killer. Pun intended.

Back to books. To get my groove back, I committed to reading 1 chapter a day. It worked. The streak is intact and I got to cross a title off the list that I’ve wanted to read for a long time: Superforecasting — The Art And Science Of Prediction by Phil Tetlock and Dan Gardner.

I really enjoyed this book and would consider it canon for aspiring analysts and traders. You can find my notes below. Here are the high-level takeaways:

  • The world is complex (a butterfly flaps its wings and small change in initial conditions leads to disproportionate outputs). So our ability to forecast is existentially limited.
  • But some people are demonstrably better forecasters and it’s not just luck. They are consistent.
  • Those people are not geniuses. But they have a mix of qualities and procedures that enable them to forecast at a high level.
  • The key to getting better, same as in sports, is useful feedback and iteration. It takes hard work, “deliberate practice” and a commitment to get better.
  • Getting better is necessarily a conscious, painstaking process because our natural biases conspire against our judgment in areas where causality is opaque. Which are most questions of interest.
  • How groups can hinder or improve forecasting. The role of diversity in group decision making.
  • In many contexts, making accurate predictions is actually undesirable. Regrettably, I want to shout Moloch everywhere I look. The expression to look for in the notes: “kto, kogo?” It’s a disheartening idea.
  • The leader’s dilemma: balancing decisiveness in the face of uncertainty and intellectual humility
  • Objections, progress, and goals in the endeavor of forecasting

    Continue to…

    Notes On Superforecasting (Moontower Book Guides)

Last chance to apply to the free StockSlam workshops I’ll be hosting with Tina and Steiner in NYC the first week of October.

Details and application:

Last Call

A year ago, I talked about seeing comedian Sheng Weng at the Punchline in SF:

His powers of observation on the mundane details of daily life are Seinfeldian. His signature tone and voice deliver self-skewers that you can’t help but turn on yourself.

One of our friends said it was the hardest she can remember laughing for so long. Sheng’s a craftsman and the more you listen to him the better it gets.

He’s actually Yinh’s college friend (they bonded over their rhyming one-syllable Asian first/last name combos). This spring we were supposed to go down to LA to see the taping of his Netflix special (Ali Wong produced it) with my friend Khe and his wife. We had to audible at the last second and missed it, but…it’s finally out!

Check out Sweet & Juicy (Netflix)

Speaking of Khe, he has been a most generous sherpa to so many people trying to raise their productivity game. He’s an alien jedi.

Check out his upcoming bootcamp. Oh yea, it’s totally free.

If you are curious at all as to why I’m always touting Khe and his community, do it.

Sign Up For The Free Bootcamp

The $10K Bootcamp is a free 3-day event hosted by Khe Hy from RadReads. During this free event, we’ll teach you how to design a system to achieve your goals (while working waaay less). You’ll learn how to:

  • Stay focused on the most important things in life
  • Think bigger (versus making smaller things better)
  • Stop putting things off until some imaginary future date
  • Invest in improving your mind, career and relationships

Event Details:

From My Actual Life

I saw Nine Inch Nails last Sunday night at the Greek in Berkeley. (Between Leon Bridges last week and the upcoming King Gizzard and The Lizard Wizard show I think I’m asking to be swallowed by the Earth. The Hayward fault runs beneath Cal’s football stadium and the theater. At least I’ll be in my happy place when the worms eat me).

I never owned a NIN album but since I’m alive I know like 6 or 7 songs. Any preoccupation I’ve ever had with Trent Reznor revolved around him renting 10050 Cielo Drive in the Hollywood Hills — the home where the Manson apostles murdered Sharon Tate and her celebrity friends. The recording studio in the house was called “Le Pig”, a reference to a song on the Beatles’ White Album from which Charles Manson inferred a lot of craziness. The killers smeared the word “pig” in blood on the home’s front door. Downward Spiral and Broken were both recorded at Le Pig. The music video for Gave Up features images of the house and studio. (Not to be extra creepy after I already used the word “serial killer” once in this letter, but the house I used to own here in CA looked similar to that infamous abode before we renovated it).

But I must admit. NIN is in the running for best show I’ve ever seen (n of roughly 200). The gulf between the recorded & live experience is indescribable.

The Greek felt like a rave at a temple. In black t-shirts.

Moontower #161

I learned a new term.

“To Go On Account”

A pleasant term used by pirates to describe the act of turning pirate. The basic idea was that a pirate was more “free lance” and thus was, more or less, going into business for himself. — The Pirate Glossary

It applies to several parts of today’s letter. Oh and don’t miss the special announcement at the end.


Last week, I shared the Engine Model. It was a blueprint for designing an integrated life. I paused my regular workflow to write that post for myself as my trip transitions from a three-lane expressway of exploration to a local 2-lane highway. I like doing meta-writeups like that for the same reason I like reading others’ frameworks…it’s a form of “trail magic”.

Via thetrek:

The term “trail magic” was coined by long-distance hikers to describe an unexpected occurrence that lifts a hiker’s spirits and inspires awe or gratitude. “Trail magic” may be as simple as being offered a candy bar by a passing hiker or spotting an elusive species of wildlife.

For those on a similar journey, or see a similar juncture in their future, I hope the post can at least provoke if not be practical. One area I wish it was more practical, was on monetization. That’s a tough topic, so let me back up.

Reputation is the longest-duration asset you have. [The great grift of 2021 will forever be trapped in the amber of my mind as the moment a bunch of business-famous influencers decided the bid to sell their reputations was juicy enough to finally smack. It was a calculated bet on the shortness of your memory.] If you are not a sociopath, your ethical boundaries extend beyond the borders drawn by law. But the law alone seems to fence some people in just barely. Oh my god, fan me now. Watching literal lawmakers insider trade is an act of contortion so lithe it allows them to limbo even under that low bar.

[Collecting myself.]

Where was I? Oh yes, being an f’n normal human. So in that post I didn’t wade into specific monetization models because I don’t know much about them.

Instead, I address them in principle:

Once you begin thinking of your work as an engine, as self-integration, and not a single bilateral transaction with one employer (or overlord if you are especially cranky about your choices) you have replaced an existential problem, namely the rejection of over-compartmentalization, with a technical problem. The technical problem is “how do I sustain such a life?”

This is new to me and I’m learning on the fly so I’m not the best guide here. But I can offer my philosophical perspective, knowing that it will likely evolve with experience. I still think it’s important to lay out principles as a tether to your values as you head out into the unknown. 

  1. Extract less value than you create

    This is obvious. Strip-mining is not a renewable strategy. I’d rather underpromise and overdeliver. This isn’t altruism, it’s good business. If you leave the high-pressure race, you have chosen to focus on the long-term. The advantage is you can use a different playbook that relies more on compounding which pays off with time, instead of quick, but hard-to-repeat scores.

    From Working For Free:

    In business, I always enjoy the Costco example. Charlie Munger has written:

    “When other companies find ways to save money, they turn it into profit. [Costco] passes it on to customers. It’s almost a religious duty. [They] sacrifice short-term profits for long-term success”.

    It’s not as hokey as it sounds. Think of it this way. They are hiding profits in the customer’s own pockets. They will be return customers. That profit is hidden from competitors’ wandering eyes and the IRS. The strategy commits Costco to keeping the customers happy because the profit is realized over the long-term. It’s simple but requires rare discipline.

    The profit that “sits in your client’s pockets” has a bookkeeping entry called “trust”. The fact that it doesn’t capitalize as an asset on your personal balance sheet is a shortcoming of accounting. You can’t let it fool you from the reality that you have stored your future income with your clients and in their word of mouth.

  2. Price your attention carefully

    When you consider a project, you must decide how much to charge. If the project requires diesel fuel and you are a sports car, it might not run or it might be inefficient. This feels like a one-off transaction. You should probably quote a “go-away” price. At some price, you’ll suck it up. But this should be rare.

    You want projects that have recyclable exhaust. If you suspect the exhaust is especially powerful, maybe you charge less. The point is to price your time or effort holistically. What is the first and second-order cost/benefit of taking on a particular project?

    An example of holistic thinking: I don’t paywall my letter because the loss of subs would cut off a valuable inbound fuel source. The cash would not be worth it. Instead, I reframe the forgone income as “marketing cap-ex”.

I don’t know much about monetizing an integrated body of work. I’m not especially commercial-minded. But I have friends that are further ahead on this path that I can lean on. In thinking about creating your engine, realize you are not alone.

Identify your own principles. It’s a way to stay “green” as you experiment with sustainable business models that empower you to stay on the path.


In the past year, I’ve been approached by companies that want to sponsor this letter. Extra cash would make it easier to justify doing stuff like hiring a designer. I have some fairly irreverent ideas for Moontower swag that would be decidedly, umm, [lowers voice] befitting of the namesake?

So I was open to the idea. Especially since I will never paywall this letter. The only issue was most of the potential sponsors didn’t get me too excited. And the higher their bid, the less exciting they are. Go bumhunt somewhere else.

When I write to “find the others” I mean it. You make this effort worth it for me. You see, if I had to pick a single external metric to grade the body of work I’ve been calling Moontower, it would be the quality of its subs. By quality, I mean thoughtful people who care about getting better as co-passengers on this ferris wheel.

Out of respect to both you and me, I’ve been guarded about who I’d let get mindshare here. While I haven’t done a formal survey (I’m working on one though), I can tell this readership is smart and has many ultra-successful people within it. Almost all of you want to invest better and live better. You’re a pretty dream demographic to marketers. Fortunately, instead of me wrestling with which sponsors to match with, the answer landed in my lap.

My friends Jason Buck and Taylor Pearson asked me to sponsor the letter. They manage a fund of funds that comes from the “all-weather” style of investing. Many of you are familiar with that term because of Ray Dalio, but Bridgewater is to Kleenex as all-weather is to “permanent portfolios”. I have been invested in Jason and Taylor’s fund for nearly a year and I’m doing my own research now on how to be more hands-on transitioning my own portfolio to be more “permanent” 1.  The exhaust of this research will be making its way into these letters so we can learn together.

In addition to the sponsorship and in keeping with my desire to keep this totally inclusive to everyone I have added the ability to be a patron of Moontower.

If you hit this button you will see the choices.

If you pay you don’t get any special posts, but if there were interest amongst patrons for higher levels of 2-way interaction I’d be happy to explore that.

There’s no pressure. It’s not like tipping in U.S. restaurants where it’s expected because servers don’t make a serious wage. I pay for about 20% of the publications I sub to. And it’s never about “is it worth it?” for me. It’s just, “do I want to support this?” I turned the feature on this week and there is seriously zero pressure. I already get a lot from your attention.

[For the more accounting curious…since I’m not a W2 employee and I incur expenses to run these sites and have a home office, any income I receive up until my costs are recouped is like an untaxed dollar. We aren’t talking real money, but eventually, I expect to have built a biz where I re-purpose a portfolio of solutions to my own problems so that it solves other people’s problems too. So these moves can be seen as practice with live rounds.]

By the way, a quick shout-out to my first paying sub, Max S., who signed up shortly after I turned that feature on. As soon as I get some swag made, I’ll be asking for your address man!

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Money Angle

I feel lucky that Jason Buck reached out to sponsor the letter because I love what he’s doing (Yinh and I were early investors in their latest fund). In addition to managing a fund, Jason is co-host of what I think is the most underrated show on investing YouTube, Pirates of Finance.

In season 3, Jason and Corey Hoffstein changed the format so that there is zero preparation. The conversation is totally off the cuff. And it totally slaps.

It is free, buried booty that our theoretical economist says can’t exist because of efficient markets. But it exists. I’ll prove it by digging up 3 themes from their amazing recent episode Decision-Making Under Uncertainty and mix them with my own thoughts. We’re blending Moontower and Pirate rum up in here today.

Why ETFs Might Be Unsuitable For Some Strategies

ETFs are liquid structures designed to faithfully track NAVs (“net asset values”) because the arbitrage mechanism is outsourced by the issuer to an Authorized Participant. These AP’s are a subset of the market-making community.

The Pirates wonder:

Is the ETF structure, whose allure is transparency, the correct home for opaque, illiquid, or bi-lateral (ie there’s credit risk in the basket) instruments such as inflation swaps? What about semi-liquid holdings like corporate bonds or even TIPs?

The answer to such questions partially rests on the liquidity of the underlying holdings. Consider a question they allude to but I’ll make explicit:

If you hold long option or long convex positions via ETFs (or for that matter directly) will you be able to monetize them when they pay off?

This is a real and highly underrated concern. Bid/ask spreads are positively correlated with volatility. So how useful is it if the paper profit on a convex position can’t be crystallized because the bid-ask is wider than the parted Red Sea?

Suppose you buy a way OTM put option for $1. It explodes to $20 but the bid-ask is now $16-$24. Sure, you can sell it for a 16x return, but when that option was originally valued for $1, the pricing incorporated the idea that in some rare states of the world the option is worth $20. If you can never realize that $20, then you entered into a pretty negative expected value situation when you paid $1 for it in the first place.

Trading is hard enough, you can’t afford to not maximize small edges. In a separate interview Corey talks to option trader Darrin Johnson.

I paraphrase Darrin:

When you sell tails, you need to capture the entire premium. The hit ratio of selling tails is high but when you lose you lose many multiples of the premium. If you fail to collect the full premium, it will not make up for the losing trades. The difficulty of selling tails is even trickier yet.

Darrin explains how betting against longshots leaves you uncertain if you have an edge in the first place. In my words: good luck differentiating between a 50-1 shot vs a 100-1 shot. That’s the difference of 1 probability point but it’s massive in payoff space. [I discuss that idea further in Tails Explained.]

When volatility increases, transaction costs go up for everyone. Since market-makers are part of “everyone” then the cost of their own hedging (ie replication) goes up as well, so they charge wider-bid ask spreads to keep them whole. MMs represent the marginal supply of liquidity so can they pass the transaction costs of their own “COGs” to those demanding liquidity. We know the house wins both ways, but the house edge itself is correlated to what markets are doing. If the house’s margins above their “COGs” expand in times of stress, you need to haircut the expected risk mitigation from defensive positions. That cost will show up when you try to roll or monetize.

There are cases where that bookie’s vig will not be too punitive even in a volatile market. For example, if the option you buy is now so far ITM that it no longer has meaningful extrinsic value, then you can simply trade the underlying to monetize (although re-hedging will put you face-to-face with the market-makers again).

This brings us to the next theme.

Destination vs Path

If you have a view about the expected return of an asset in 5 years should you care about the path? Depends who you ask. Anyone marked-to-market (HFs, market-makers, futures traders) will say yes especially if they are managing money for others. PE, RE, and bond investors are more likely to say no. The Pirates have a nuanced discussion about whether it’s even possible to manage to path versus manage to terminal value.

I’m biased by my path-or-die experience in trading. Mark-to-market is the goddess of tomorrow, you can’t afford to piss her off.

Here are a collection of arguments that I offer her as tribute.

  1. Bond investors who ignore path are fooling themselves.

    In Why Volatility Still Matters To Buy-And-Hold Investors, I summarize one of Cliff Asness’ pet peeves:

    You may hear some people say they want to buy an individual bond rather than a bond fund. They worry that bond fund prices move around and have no real expiration, so when interest rates rise your losses are somehow more real. But if you buy a bond and hold it to maturity you can put your head in the sand, and never lose.

    This is nonsense.

    You have lost in a real sense since the money you are being returned is worth less in a world in which rates have risen to compensate for inflation. The bond fund is effectively taking your loss today rather than later. If you sell your bond for a loss, you can reinvest at a higher yield going forward. That’s a similar experience to just being in the bond fund. Holding to maturity does not mean you have less risk. It’s an illusion. A real vs nominal illusion.

  2. Using stale marks to “smooth volatility”

    Having a preference for private assets that are less volatile simply because their marks are stale is like not getting bloodwork because you don’t want to find out your cholesterol and blood sugar are too high.

    The slow-to-mark investments are still volatile. The fundamentals of the private business are correlated with the public market volatility.

    Even if you don’t believe your investment should be marked down, then you should be sad you can’t redeem your private investment at par to rebalance into public stocks after the market drops 20%. Giving up liquidity without a premium because it will behaviorally “save you from yourself” sure feels like you sold the option to rebalance at zero.

    I walk through that argument in How Much Extra Return Should You Demand For Illiquidity? (7 min read)

  3. Market prices are clever. They can balance the wagers of path vs terminal value investors simultaneously!

    In What The Widowmaker Can Teach Us About Trade Prospecting And Fool’s GoldI show how the calendar spread options are priced so that the path of the gas price is highly respected, even if there’s strong consensus about the terminal value of the spread (ie the March-April futures spread which is a pure bet on in winter gas being in short supply).

    The OTM calls are jacked, because if we see H gas trade $10, the straddle will go nuclear.

    Why? Because it has to balance 2 opposing forces.

    1. It’s not clear how high the price can go in a true squeeze or shortage
    2. The MOST likely scenario is the price collapses back to $3 or $4.

    Try to think of a strategy to trade that. Good luck.

    Let me repeat how gnarly this is: The price has an unbounded upside, but it will most likely end up in the $3-$4 range. The vertical spreads all point right back to that price range.

    The market places very little probability density at high prices but this is very jarring to people who see the jacked call premiums.

    That’s not an opportunity. It’s a sucker bet.

    Another common example:

    In options land, many investors like to buy 1×2 ratio spreads because the payoffs look amazing for low-probability events. For example, if a stock is $100 and you can buy the $115 call and sell 2 of the $120 calls for zero premium, you think to yourself:

    a) “If the stock does nothing or goes down I break even”
    b) “If the stock goes to $120, I make $5” (or $1 if the stock goes to $116)

    c) “I don’t start losing money until the stock goes over $125. That’s 25% away! This is risk-free return”

    Nah dog. That’s first-time-at-the-rodeo thinking.

    The reason the 1×2 is so cheap is the call skew on the $120 strike is pumped up because someone has been buying them like crazy. That’s where the bodies are hidden. The question you need to ask yourself is “conditional on the stock going to $120 did it get there fast and sloppy, or slow and grindy.” If it goes there in a fast way, the market-maker community will be short beaucoup gamma and be scrambling to buy the $120 calls back. You sold some teenies and went to Santorini and are now getting a margin call on the beach because the 120s you’re short are blowing the f out.

    The path-aware trader is plotting how to be long the scenario where your vacation abruptly ends.

  4. If path is so important, how can you manage to it?

    a) Avoid excessive leverage

    b) Pre-determine when you will cut losses (beware this can be a big topic with lots of room for disaster)

    c) If you insist on betting on terminal value, do it in fixed premium ways where your max loss is bounded. Now you don’t have to worry about mark-to-market risk.

    In There’s Gold In Them Thar Tails: Part 2I cover the topic of path, how to exploit investors’ lack of appreciation for it, and how Jon Corzine became a symbol for path-blindness.

“Long-Short Portfolios All The Way Down”

You’ve heard the expression, “turtles all the way down”.

Corey says “Long/short portfolios all the way down”.

This is an acknowledgment that every trade you make is relative to something else. If you buy a stock denominated in dollars, you are betting that the stock will outperform dollars. It’s a powerful idea. If you want to short XOM but can’t get a borrow, you can buy all the components of XLE except XOM while shorting XLE. Voila, you are now short XOM.

The pirates offer more great examples:

1. Rebalancing

You start with a 60/40 portfolio and stocks go up so the new portfolio is 65/35. You can think of a regular rebalance to get you back to 60/40.

Or you can re-frame the accounting to an algebraic equivalent:

You own a 65/35 portfolio + a long 5% bonds/short 5% stock overlay

It seems like semantics, but just as different words can refer to very similar things, there remains meaning behind the distinctions. And the subtlety here is useful because it forces you to look at the accounting of subsets of a larger position. Corey argues that this lets you think about how things are contributing to your portfolio at any given time or even over time


This lens is the gateway to better p/l attribution. In the 65/35 example, the intuition is fairly basic. Rebalancing trades profit when the market mean reverts and lose money if the market trends. Gamma-scalping works the same way. It’s just rebalancing for option traders. If you trend, your “daytrading p/l” will be negative if it is dominated by gamma scalps and you’ll regret going into work that day (because you will presumably have been hedging your growing delta, for example, you sold the VWAP but the market closed on its daily high.)

I agree with Corey. Seeing the world as long/short portfolios focuses you on the relative nature of every decision! Every time you are long X, you are short [not X]. If you buy a house and it goes up in value along with every other house in your state, when you sell it, did you really make money if the neighboring cost for shelter has appreciated all around you. Start seeing your decisions as long/short portfolios and it has a funny way of focusing you on what you’re specifically rooting for.

2. Corey poses another thought exercise:

Which do you think has a higher tracking error to a passive 60/40?

a) Replacing the passive equity with small-cap value exposure

b) Layering 60% exposure to the SG CTA Index on top

I promise the discussion thread will make you smarter.

I’ll sprinkle in a related idea that comes from options land.

It’s natural for vol traders, especially dispersion traders, to think about positions as a series of long/short portfolios. That’s because all dispersion is “dirty” dispersion. [If you need a refresher see Dispersion Trading For The Uninitiated].

If you sold SPX index vol and only bought vol on value names, your net position is:

  • short growth volatility
  • long value volatility (you are net long, because if you tried to balance your gross index and single name greeks, you’d necessarily have to overweight the value names. This is extra true if you theta-weight the spread since the value names are lower volatility than the growth names.)

If you had this position on before Softbank started buying the hell out of tech calls in the summer of 2020, you got rocked.

But if you put that same position on right before the Covid vaccine was announced, you killed it as value names surged while growth names barely moved relative to their vols.

Index traders are keenly aware of these “synthetic risks” because at some point you’ve been unknowingly exposed to a risk factor that took a bite out of your p/l. That prompts you to slice and dice your risk to further your understanding of positions. Risk management evolves one bruise at a time. The inevitable body shots and jabs hurt, but also teach. You just have to get your overall controls robust enough to survive the haymaker.

[Speaking of teach…did you know that if a stock is halted, you can compute what price the market is implying it will open at? Just compute the price the SPX cash index would need to be at for the futures to be priced fairly to back out the halted stock’s implied price.]

Corey is spot on. It’s long/short portfolios all the way down. This is native vision for derivatives traders.

In closing, know that I’m not just shouting my friends when I say to watch Pirates. That’s seeing causality backwards. Jason is sponsoring Moontower and I met these guys in the first place because I was attracted to how they think (well that’s half of it…there are plenty of brilliant people out there I have zero interest in hanging out with. These are friends that got through the important funnels after I noticed they were smart.) I always learn when I listen to these guys. They’re entertaining and always have good stories.

Actually, you know what? F those guys. Hoggin all the cool in the room.

Last Call

This was a dense issue. Reading is the worst. I know.

Instead of more links to ignore, I will leave you with an invitation to learn in-person.

Me and 2 old friends who all traded at SIG together are going to host 3 free teaching sessions in NYC the first week of October.

We are ridiculously stoked to meet many of you. That said space is limited so there’s a short application.

You can find the details and application in this thread: