Moontower #246

Friends,

I finally caught up on a ton of articles I clipped to read.

Here are 3 that I found notably interesting:

Revenge of the Tipping Point (30 min read)

David Epstein interviews Malcolm Gladwell about his new book. There is a section about why Harvard prioritizes unconventional athletes (think fencing) in its admissions process. From the 1/3 rule to Harvard’s function, this discussion keeps reverberating in my skull. The entire interview is interesting, but the section on college admissions will rile you up.

In Defense of Sport Betting (8 min read)
by Isaac Rose-Berman

Isaac’s substack is terrific for understanding the gambling industry broadly, especially the online world. The title is misleading because the post is not advocating for sports betting so much as calling it the least of the gambling evils. It’s full of useful context and proportions.

Reflections on Palantir (24 min read)
by Nabeel Qureshi

I always enjoy Nabeel’s writing. His writing inspired my old post We Don’t Need No Education. His latest post talks about his 8 years at Palantir. It’s a terrific look behind the scenes at their culture, the use of FDE’s or forward deployed engineers, and the navigation of morality in the defense business.

Today’s final rec is funny but also a lead-in to today’s Money Angle.

It’s one minute from an old Nate Bargatze bit.

Money Angle

The “worst time traveler” investing style

I’m going to share 2 studies, one new and one old that say something that is counterintuitive to most people but probably not to traders:

Even with perfect foresight of market movements, there’s no guarantee you’ll be a better investor.

The old one first:

Even God would get fired as an Active Investor (7 min read)
via Alpha Architect

This post from 2016. It demonstrates how a hypothetical portfolio built with perfect knowledge of the top-performing stocks over the next 5 years yielded impressive returns (29% CAGR) but also experienced significant volatility and a 76% drawdown.

Even a ‘perfect’ long portfolio can bring a long-only investor a ton of pain.

The hypothetical long/short portfolio, again with perfect foresight, achieved a remarkable 46% CAGR but still faced a 47%+ drawdown.

For investors who are benchmarked the news is still tougher — The god portfolio still underperformed SPY for extended periods that make it hard to stick with.

When a Crystal Ball Isn’t Enough to Make You Rich (20 min read)
Elm Wealth

Victor Haghani and his team discuss an experiment where participants were given historical front pages of the Wall Street Journal and tasked with trading stocks and bonds based on the news.

Hijinx ensue.

The majority of participants, despite having access to “future” news, failed to generate substantial profits. Many even went bust. This highlights the difficulty of translating information into profitable trading decisions. (It’s why opinions are worthless. The question is always “ok, what’s the trade?”)

Notable findings:

Trade-Sizing Crucial: The disappointing results stem primarily from poor trade-sizing decisions. Participants often overleveraged, leading to significant losses when their predictions were wrong.
Experience Matters: Seasoned traders fared significantly better (they even get a senior Jane Street traders to try it), demonstrating the importance of experience in interpreting information and managing risk.

It’s not shocking that Haghani, one of the principals of LTCM back in the day, reminds us that there is little value in the crystal ball without sensible trade-sizing.

You can try the game yourself:

🔮Crystal Ball Challenge

Haghani is also half the duo behind the famous Haghani-Dewey study where economists and investment folks, many with graduate, degrees embarrass themselves with their inability to size bets on a coin weighted in their favor.

You can play that game too:

🪙Elm Wealth Coin Flip Challenge

My synopsis of it was a very popular post when I published it 2 years ago, (see Bet Sizing Is Not Intuitive) because the conclusion is profound:

Like these crystal ball/god studies, prediction is just not enough. Betting and trading require a far richer set of practices than just having an edge. Edge is a necessary but insufficient criterion for sustained success.

Money Angle For Masochists

In the spirit of these games, I’ll remind you of this riddle from Philip Maymin’s Financial Hacking (GOAT-tier trading book — if I’m ever tasked with developing firm or education department this is required reading).

This is excerpted from my extensive guide to the book:

🧩How much would you pay to know the closing price of SP500 in one month?

I can tell you where the SP500 will settle in one month. How much would you pay for this information? (And then, what would you do with it?)

Let’s say you give a number like $ 10 million, and I accept it. The S& P 500 is currently at 1000. I gaze deeply into your eyes and tell you the truth: in one month, the S&P 500 will close that day’s trading at a level of…. 1000. Oops! Now what? How are you going to make money? You owe me $ 10 million in a month, and I will collect. There is no point in buying or selling futures at the same price at which you expect them to expire. So what can you do? [He doesn’t mention the strategy of announcing your shot on social media and using it to gain followers. The value of this will depend on whether you have something to monetize or follow it up with…and if you do not already have a following it’s likely you don’t have skill in monetizing one so again the value of the follower windfall depends on its beneficiary]

All you can do is hope the market moves in the meantime, and it really is a hope, because you have no other information about what is going to happen over the course of the next month, not the volatility, nor the volume, nor the highs and lows. All you know is that it will be at 1000 again a month from now.

So how do you time your entry points? Say you have $1 million of liquid assets and say that this much money would let you support up to $10 million in notional, because futures have a haircut of about 10 percent.

Suppose you are very lucky and the S&P 500 jumps down to 900 before you even have a chance to put in your order. Now you would want to buy. But how much? Do you put your entire amount on the line, such that even a single tick against you triggers a margin call?

Ultimately you can perhaps do best if you are able to buy and sell options, but there won’t always be a liquid options market at every strike you need at the asset that you want to trade, and besides, we haven’t really discussed options yet. [Kris: This is actually the key — you could use options to structure a bet on terminal value but this riddle in general is insightful because it shows just how much you are missing if you don’t understand options]

This is the exclamation point on the matter:

These kinds of practical issues are ignored in standard textbook discussions of riskless profit opportunities but they are precisely the issues that financial hackers worry about most. And you will almost surely never experience anything with this level of certainty at any time in your career. There will always be doubts about your model, your inputs, and your forecasts…According to standard theoretical concepts of arbitrage, none of those questions matters. According to real-world practical experience, you can’t even begin to trade until you have answered all of them.

Stay Groovy

☮️

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