April 12, 2010

Andrew Lo, the Right Kind of Finance Academic


MIT's Andrew Lo is perhaps the most market-savvy academic out there, probably because he runs a hedge fund as well as MIT's Laboratory for Financial Engineering (you can check out my previous posts on Dr. Lo). Not entirely coincidentally, he is a proponent of technical analysis (as his presentation to the MTA a couple of years ago can attest to) and an opponent of the random walk theory of market prices (he is the author of the transparently and aptly titled A Non-Random Walk Down Wall Street). All this to say that I read his interview by Mike Hogan in the latest Barron's with great anticipation and I was not disappointed.
Here are a few notable excerpts (emphasis mine):
The years 2007 through 2009 were all about liquidity or the lack of it. Just as we have in every previous meltdown, we saw an unwinding of liquid positions to cover illiquid positions in 2008 and a sudden flight to quality. Correlation is the flip side of liquidity. It is only when there is a liquidity shock that you discover how correlated supposedly uncorrelated assets really are. [...]

We financial designers often try to think like physicists. But it's human beings who invest in the stock market, and they have feelings and behaviors that change with changing circumstances. Unlike physical laws that have operated exactly the same over billions of years, economic laws depend on who happens to show up in the market on a given day and how they feel about what they see when they get there. [...]

As a consequence of population growth and better communications, the [financial-services] industry is much more complex and competitive today, which has been a boon to investors. We have more liquidity, commissions are at the lowest they have ever been, and individuals can gain access to 60 markets around the world in the click of a mouse. But given the speed with which bets can flow back and forth across borders now and assets can align with one another, it's increasingly difficult to find the diversification investors need to manage their way through market swings. [...]

April 9, 2010

Metacognition and Other Great Leaders' Tricks


I like David Brooks latest NYT column for a change (when he stays away from political sujects, where he's too transparently partisan, his columns usually make for an interesting read). His subject is leadership and how great leaders are not always the "superconfident boardroom lions" of popular lore. This type of leader actually gets in trouble more often than not. Brooks then goes on to describe the other type of leader, the "humble hound", and I thought much of the qualities and outlook he comes up with would also perfectly describe what a good trader should be. We all know the devastation the overconfident type of trader can wreak. A better mindset for a trader would be as follows:

The humble hound leader thinks less about her mental strengths than about her weaknesses. She knows her performance slips when she has to handle more than one problem at a time, so she turns off her phone and e-mail while making decisions. She knows she has a bias for caution, so she writes a memo advocating the more daring option before writing another advocating the most safe. She knows she is bad at prediction, so she follows Peter Drucker’s old advice: After each decision, she writes a memo about what she expects to happen. Nine months later, she’ll read it to discover how far off she was.

In short, she spends a lot of time on metacognition — thinking about her thinking — and then building external scaffolding devices to compensate for her weaknesses.

She believes we only progress through a series of regulated errors. Every move is a partial failure, to be corrected by the next one. Even walking involves shifting your weight off-balance and then compensating with the next step.

She knows the world is too complex and irregular to be known, so life is about navigating uncertainty. She understands she is too quick to grasp at pseudo-objective models and confident projections that give the illusion of control. She has to remember George Eliot’s image — that life is like playing chess with chessmen who each have thoughts and feelings and motives of their own. It is complex beyond reckoning.

She spends more time seeing than analyzing. Analytic skills differ modestly from person to person, but perceptual skills vary enormously. Anybody can analyze, but the valuable people can pick out the impermanent but crucial elements of a moment or effectively grasp a context. This sort of perception takes modesty; strong personalities distort the information field around them. This sort of understanding also takes patience. As the Japanese say, don’t just study a topic. Get used to it. Live in it for a while.