March 06, 2014
On the Street in Ukraine, Cartels Falling, and Finding Your Edge on a Cleaner Wall Street
The People Rise
For the past four years two Ukrainian citizens, Eugene Smolanka and Alexey Karakulov, have been MarketPsych software engineers. Both gentlemen are precise, driven, and have unparalleled expertise.
On our company conference call on Wednesday February 26th, Eugene noted that big changes were underway in Kiev, where he lives. Public transportation had been shut down and rivers of protesters were flowing into Maidan Square, a short walk from his apartment. That same day Alexey checked in with us well after midnight. He explained that he had been performing civic duties. Clad in a helmet and wielding a club, he had been protecting protestors marching in his eastern Ukrainian city (Kharkiv). Ukraine's President Viktor F. Yanukovych was voted out by parliament that night.
Throughout the Ukrainian unrest we've been checking the world maps on our website to gauge the intensity of the strife. According to our data, the Ukrainian government was clearly the most unstable in the world the week before the overthrow of President Yanukovych.
The global map above shows the intensity of Government Instability - one of the Thomson Reuters MarketPsych Indices - highlighted in red.
Alexey noted that the emotional fuel for the protests wasn't anger at any one person or political party. The protests were ultimately against unfairness - business cartels, political paralysis, and police corruption - and were stoked by a feeling that the people, all together, could make organic and lasting change. Alexey summed up the mood of the uprising as, "No more unfairness."
After the ouster of Yanukovych, the police stepped back. Per Eugene, "What amazed me a lot is how citizen themselves gathered to stop violence in Kyiv, because police was on side of the titushki [hired thugs]." Eugene noted, "in every district of Kyiv people organized to patrol city and keep peace."
Yanukovych's lavish house was entered by protestors, and Ukrainians were shocked to see video images of his personal zoo, greenhouses, golf course, and the wooden ship that served as his private restaurant. They could see how lavishly the President had been living, presumably at the cost of the country's development.
Now Crimea is poised to secede and join Russia. And given the installation of a new set of oligarchs (from the Ukrainian opposition), whether Ukraine's popular uprising will be sustained is an open question.
On a global scale, the Ukrainian events are evidence of an accelerating paradigm shift. Cartels, corrupt and rigid political systems, and ossified economic regulations are rapidly giving way to open, honest, and free association of people, ideas, and business -- but not without a fight. As investors, we must understand where this trend is heading next so we will not be left behind. Today's newsletter examines how investors can thrive as cartels fall, with an emphasis on finding your edge in increasingly open and efficient markets.
Yanukovych on Wall Street
Most readers of this newsletter have been the victims of financial cartels. The hidden cost of Wall Street cartels takes many forms: from poor fills on market orders, high hidden costs in structured products, and a range of creative exploitation in between.I did not attend his funeral, but I sent a nice letter saying I approved of it.
~ Mark Twain
After the financial crisis the public recognized in themselves that naive visitor to Wall Street who - as he admired the fine yachts of the brokers and traders moored in the marina - asked, "But where are the customers' yachts?"
In response to public disgust, seismic regulatory changes are underway in the financial industry:
- The Volcker Rule separates investment banks from their proprietary trading operations.
- The SEC's dogged prosecution of SAC Capital portfolio managers indicates the days of loose-lipped insiders are over.
- Sales-reimbursed financial advisors are giving ground to fee-based advisors.
- Fiduciary duty may finally be adopted as an industry standard.
As a result of these changes, Wall Street's unfair edge is slipping. Many bank prop traders are losing their usual tip-offs as they leave their firms (such as customer order flow). Well-connected portfolio managers are losing (or declining to exert) their insider edge for fear of prosecution. Some financial advisors are watching their incomes drop as clients turn to ETF's and fee-based competitors.
But entrenched interests don't go down without a fight. As Eugene noted about the Ukrainian uprising, "What terrified me most is when thugs rushed into a hospital and turned off all life support devices for seriously injured ones from Maidan. People have died." While vested interests hold back the prosperity of Ukrainians, so do rent-seekers hold back Wall Street.
The Industries of the Future Are Fair (and Drive Efficiency)
In the long history of uprisings against corruption, only a culture of respect for the rule of law cements the progress made by social revolutionaries. The SEC is enforcing respect on Wall Street. In the Ukraine, the social network - a collective consciousness backed by social technology - is an enforcement mechanism for justice.It is not the strongest of the species that survives, nor the most intelligent, but the most responsive to change.
~ Charles Darwin, The Origin of Species
When I asked Eugene how the protestors organized in the face of sophisticated police communications and jamming, he noted: "An amazing thing was technology that people used during protests: internet-walkie-talkie Zello for self-organization and coordination in patrols, Twitter for rapid information distribution, ustream for streaming live video from different places, including the field." In Ukraine social technology gave the protestors an organizational edge over police.
Google, Facebook, and Apple are considered three of the world's most innovative companies. Let's take a quick peek at where they see our economic (and social) trajectory headed:
- Last week Facebook bought WhatsApp for $19 billion, making co-founder and CEO Jan Koum (a Ukrainian who moved to the USA at age 16) a multi-billionaire.
- Last month Google bought Nest - a maker of predictive and efficient artificial intelligence-based home energy thermostats - for $3.2 billion.
- In December 2013 Apple bought Topsy Labs (a Twitter feed aggregator, organizer, and processor) for more than $200 million.
Today's rising businesses are those at the convergence of information transmission, big data, machine learning, network effects, and predictive analytics. Soon we'll see this wave of change overturning healthcare, manufacturing, power generation, and finance (as we're doing at MarketPsych - contact us if you'd like to learn more about our business).
As an investor, beyond looking to invest IN such companies, you can also learn lessons about how to thrive in today's more efficient markets.
What Is An Edge?
Having an edge is essential in business. Strictly speaking, an edge is the advantage an investor deploys to make money. There are fundamentally three edges. In every case, they rely on an asymmetric advantage:The Edge ... There is no honest way to explain it because the only people who really know where it is are the ones who have gone over. The others -- the living -- are those who pushed their control as far as they felt they could handle it, and then pulled back, or slowed down, or did whatever they had to when it came time to choose between Now and Later.
But the edge is still Out there. Or maybe it's In.”
~ Hunter S. Thompson, Hell's Angels
1. Faster information than others.
- For example, scanning Twitter for the latest information updates. Also, receiving and process information the fastest. This week at a quant conference in San Francisco I was surreptitiously shown a motherboard with an 8 <i>nanosecond</i> I/O processing speed. That's 0.000000008 seconds for a signal in/processed/out.
2. Higher quality information than others.
- Higher quality information used to be asymmetric. For decades Wall Street traders found their edge with customer order flow information, insider tips, or favored "peeks" at upcoming data or announcements, but that world is rapidly dissolving. Those investors that continue to have higher quality information find it in a specific niche of the market they are extraordinarily familiar with. Others perform in-depth research on difficult-to-find but impactful information.
3. Better analysis of information than others.
- In the modern financial markets, most investors' edge lies in a superior synthesis and analysis of information about fundamental pressures, technical set-ups, and market consensus.
4. Risk management.
- All top investors excel in risk management. Great investors map out their risk/reward expectations and are faithful to their targets and stops. Some traders I've met are so diligent about preventing losses that they hold winning positions 8 times longer than losing positions.
Protestors in the Ukraine had an edge in their strength of conviction, large numbers, and flexibility. As oligarchs return to power (this time from the opposition, and in the midst of a secession), they will need a new edge.
Identifying and Sticking With Your Edge
The following questions are worth asking to help you clarify your edge:
1. Ask yourself, where do your asymmetric advantages come from (your edge)?
2. Do you enter investments in which you are not exploiting your edge? If so, is there another type - less definite - edge you are leveraging?
3. Do you ever trade without an edge, such as following the crowd, fear of missing out, buying on rumor, selling to end the pain, etc...? If so please list the behaviors here. Which is your most costly non-edge-related trading behavior?
4. How can you change your investment style to ensure that you don't trade without an edge? (E.g., Would introducing a simple pilot's checklist into your process improve your discipline about only trading on a clear, defined edge?)
5. Could you better exploit your edge by trading in a wider range of products, structures, styles, or time horizons?
6. There are a variety of markets, some filled with novices, and others with smart money. Does your edge occur only under certain conditions or in specific regimes?
Keep in mind that:
- Many investors discount their level of expertise, believing that many share their insights about a product or opportunity.
- Most investors have several edges.
- If you can't identify your edge, then you shouldn't invest actively until you have one.
- The investing you do without an edge is a liability. It carries a large cost to your mental energy and attention.
- What sabotages an edge is often distraction, self-doubt, and inconsistency. Beware of chasing too many opportunities when your edge is too small or too weak. Have patience and take the time to find a structural and consistent advantage.
If you don’t know who you are, the stock market is an expensive place to find out.
~ Adam Smith (George Goodman)
Trading Corner
Humans take time to adapt to new ways of thinking. They learn slowly. After a long period of positive news flow, when sentiment turns negative, market prices only slowly adjust lower, giving investors time to position themselves for the change in trend. This effect is why our MACDs appear to have predictive power - less dramatically but still consistently - over time.God created war so that Americans would learn geography.
~ Mark Twain
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Closing
Without two brilliant and courageous Ukrainians - Eugene and Alexey - MarketPsych's data would be nowhere near as impactful as it is today. We wish them courage and safety during this conflict. We have prepared company resources to support them in case they need assistance.The secret of happiness is freedom. The secret of freedom is courage.
~ Thucydides
Remember that like protestors for social change, investors need to know where their advantages lie, otherwise their efforts may be wasted. The investors who will prosper in the coming decades are those who are courageous, unafraid of using their wits, speed, and the increases in efficiency that technology is bringing. It is the masters of niche understanding, computational power, and algorithms who are at the economic leading edge.
We’ve got speaking engagements globally, including events in London, Orlando, and Poland this Spring. Please contact Derek Sweeney to book us for a talk or training at one of your events: [email protected], +1-866-727-7555.
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We love to chat with our readers about their experience with psychology in the markets and with behavioral economics! Please also send us feedback on what you'd like to hear more about in this area.
Happy Investing!
Richard L. Peterson, M.D. and the MarketPsych Team