Strange Things That Have Been Happening in Financial Markets | Hacker News Reader

Strange Things That Have Been Happening in Financial Markets

bloomberg.com

151 pointsswamp40113 comments

> The number of assets registering large moves—four or more standard deviations away from their normal trading range—has been increasing. Such moves would normally be expected to happen once every 62 years.

This is very troubling. It means traditional models are not working to capture the market correctly at the moment. It was a leading indicator for the 2007 financial crisis - 3 sigma events happening with increasing frequency that were ignored because there were profits to be made from poor risk management.

The 62 year estimate is based upon an assumption of normally distributed data. Everyone in the industry knows the distributions are significantly fat-tailed. Maybe things are getting more volatile, but the 62 year estimate is just mumbo jumbo.

Edit: also implicit in the 62 year estimate is constant volatility, but the same article mentions changes in the volatility of volatility... third order changes in something he was assuming was constant earlier.

Totally on point. That is why 100-yr events seem to happen every 7 or 8 years :-) Normal distribution assumptions are great for coursework, terrible when you are managing real money.

Slightly off-topic but we are really bad at predicting these "very unlikely events" that actually happen more often than expected. Whenever I hear a similar story, I am reminded of the 3 nuclear reactor disasters (Three Mile Island, Chernobyl, Fukushima), each of which shouldn't have happened in 15000 years.

Where did you get the 15,000 years number? I have never seen that before and would love it if you could provide more resources.

It is very anecdotal, I believe I read it in an article long time ago around the time the Fukushima disaster happened. It is probably an inaccurate number.

The point is, all 3 faults/human errors shouldn't have happened according to statisticians/mathematicians.

A normal distribution assumes independent random samples. That clearly doesn't happen in a market where people and algos are reacting to the same news. Moves end up more like step functions in both panicked or excited market and will then overshoot buying and selling.

Maybe there could be some technical result like "if everyone in the market assumes distribution X and trades accordingly, that makes the real distribution more fat-tailed than X"? No idea if something like that could be true...

Or maybe human behavior and personality consistently resists the enforcment of technical rules, and watches for, and then willfully denies attempts to restrain behavior it (subsets of the collective population) instinctively desires to engage in.

Maybe some of us know that we're being watched, and simply defy any stupid egghead's function curves, for the sheer amusement of seeing disappointed faces.

Maybe there are sadistic people roaming free, and they feed on the souls of the damned.

How would that fit in with modern quantitative economics?

Well, that would depend on the size of that population, would it not?

A single middle-class person working to make as contrary to prediction market choices as possible would, I think, have a not significant influence

Even if they optimized for the size of the influence as well as the strangeness.

I don't expect the total population of people doing that to have a significant impact on the market.

There isn't much reason to do it, and it probably costs money over time, leading the people who do that to have less money over time,and so for their doing that to have less and less of an impact over time.

Not all people carry the same degree of influence over a market.

Not all people act according to or within the rules of a market.

Not all human behavior can be scoped to a form of market activity.

What would the bald destruction of a market, or set of markets, represent to the context of such narrow minded economics?

If some quants can predict these alleged flights of fancy, they'll trade against them and make some good money.

Acting, or according to your context merely "betting" against an adversary is fine, but this assumes the capacity to act against an adversary, and that the actions taken will be big enough to have an effect.

You can't realistically take actions against a belligerent force that has an overwhelming capacity to watch your every action and imprison or execute you. You can't take actions against forces that exist outside a legal framework and the juridictions you are subject to.

Placing bets is not taking direct action. It means sitting on the sidelines, and hoping that legal mechanisms take their natural course in a civilized society.

I thought that it was customary to add a 'smile' to most financial distributions (i.e. increased probability of extreme events), I don't think that anyone believes that a normal distribution accurately measures anything much in finance.

So the real question is, if you think the market is gunna go down in flames soon, how do you short... everything?

So many ways... For small timers: inverse ETFs, put options, CFDs (for non-US folks) For big timers: the above plus: short futures, OTC options, equity swaps, CDS, plus anything bespoke you can afford

I haven't looked into it in years, but my recollection is that you don't buy the inverse ETF, you short the corresponding long ETF.

That's because there is inherent "decay" in the price of the ETF - if the market just keeps going sideways, the ETF slowly trends downward over time.

So if you buy the inverse ETF and the market doesn't go up at all, you still don't have a profitable trade - you should short the long ETF.

Is that still the case ?

Or, just buy the ETF that preforms well when there is an economic downturn. Possibly GDX and GDXJ (gold mining ETFs).

No, you're missing the point. If my understanding is still current (I suspect it is) these ETFs "decay" over time.

Which means you can be "right" but if what you're right about doesn't happen fast enough, you still lose money.

That's why people suggest shorting the ETF that is opposite your prediction.

You buy an ETF that shorts the S&P500: http://www.proshares.com/funds/sh.html

Be careful with inverse ETFs especially if they are leveraged to move 2x or 3x in the opposite direction of the underlying index. They try to be inverse for each single trading DAY so if the market moves back and forth you can take geometric losses. For instance, if you have 100 dollars in an inverse etf and the market goes up 10% your inverse etf will go down to 90 dollars. The next day the market drops 10% so you think "hey my inverse ETF will go up 10% so I'm back to where I started" Nope a 10% gain on 90 dollars puts you at 99 dollars. If the market moves sideways for a while your investment will continuously decline.

Is there a way to bet that something will grow more slowly than normal? S&p 500 has been growing about 10% per year. How would I "short" it and bet that it will grow 5%? Can such a position be constructed?

Straddle option on SPY with K=1.05 x SPY today.

https://en.wikipedia.org/wiki/Straddle

If you want to get clever and derisk a bit you can also limit your losses in the tails with way out of the money calls and puts.

If you have never traded before, don't try to jump in without knowing all the possibilities. A more likely scenario to unfold, is that Janet Yellen does NOT raise interest rates and instead, starts QE4. In this scenario, the dollar will tank and stocks (priced in dollars) will go up. Just be cautious.

Look at Exter's pyramid and decide which level(s) can withstand whatever you flames you think are coming, and then divide your assets among those levels in proportion with how bad you think things might get.

https://en.wikipedia.org/wiki/John_Exter

There's Taleb's "tail risk fund".

Wait for it to tank, then buy.

Catching a falling knife is always a good idea.

Whereas catching knives thrown on upward trajectories...

Would happen if you were shorting

High reward goes with high risk. I honestly think there's a gap in the market for a falling knife fund.

When you catch all the falling knives with an index fund, some will sink, but most will rebound.

Central planners delegating to econometric models that are based on statistical historical patterns wonder why the "system" doesn't do what they expect; either its time for some new theories, or rediscover some economic schools of thought that have consistently rejected the historical schools.

How do you know options skews aren't already pricing this factor in? Usually this effect is counterbalanced by the vol smile. Edit: vol smile is how options very far away from the strike tend to be priced at a premium versus what black scholes would suggest. The sellers of these options demand a higher premium than "normal" to account for the fact that the data isn't actually normally distributed.

Strange things happen when interest rates are near zero. Things other than the cost of money start to have outsized effects.

(One argument for a higher minimum wage is that it might cause some inflation, which would bring interest rates up a bit and get rid of some of these strange effects.)

Higher minimum wage ??? So you want to punish the job creators for being successful ? Everyone knows that trickle down is the way to go. If it fails to trickle down you need to "inject" more money into the economy until it trickles down /s

Oops downvoted before noticing the /s (I assume thats sarcasm)

Yes, the "/s" is commonly used on sites like reddit to denote sarcasm.

Editor's note: This article has been updated to include another strange thing.

Well, I laughed. That's the kind of thing "Cracked.com" won't inform you about on their "Seven strangest occurrences in the financial markets" list. Hats off to the Bloomberg Editors.

But interest rates have been steadily coming down since the early Reagan years, and any reverse is going to be an epochal change. And that's where we are.

There seems to have been a push recently, among the news sites who want to be seen as respectable, to be transparent about edits, updates and even retractions of articles. I, for one, welcome this change.

Can somebody ELI5?

Basically a regime of very low interest rates alongside tighter regulatory requirements creates things that haven't been seen before. Negative swap spreads for example mean that investors consider credit risk of swaps lower than US treasuries, which are supposed to be the golden unattainable standard of safety. The reason for that is that swaps are collateralized, that is counterparties in a swap are obliged to give each other money they are owing pretty much each day so you are on the hook just for 1 day market movement. Not so with treasuries and faith in US treasury seem to down.

Negative corporate bond inventories happened because new rules make it very burdensome for banks to hold corporate bonds because of reserve capital requirements. So bank sell their inventories and because there are many non-banking financial institutions that seem to have an appetite for corporate bonds, banks sell even more bonds than they have (being "short").

For the same reason synthetic credit is popular. Instead if holding an asset (corporate bond in this case) you recreate synthetic position with derivatives. For example, if you buy a right to buy a bond at a certain price and at the same time sell a right to sell a bond at the same price, it is essentially the same as if you bought a bond (bond forward strictly speaking, but we will omit the difference here).

Have you ever met a five year old?

OK, I'll bite. Imagine your mom gives you cookies and everyone in your school is willing to exchange cookies for other nice things. Lately your mom was giving you so many cookies that you accumulated lots of them. Your friends now come to you to borrow cookies more willingly than to your mom, despite her historically being more respectable cookie provider, just because she might not have too many left now.

At the same time you friend Tom opened a lemonade stand. He sells cookies with lemonade and this combo sells especially well. He wants to borrow cookies from you, promising he will sell a lot of stuff an then will buy and return more cookies than he borrowed to you (interest).

You see that lemonade stand does very well and you want to do it yourself. But unfortunately your mom forbids you to do so. So you do next best thing: you give Tom all of your cookies, and then some more that you - in turn - borrowed from mom and other friends, hoping that Tom will turn them around and return even more cookies to you.

Brilliant! That just made me realize that borrowing creates surplus which in turn creates larger and deeper networks. That works really well for everyone if supply and demand are stable and no one gets very greedy. But if not, then things can go bad for everyone.

For example if Tom's stall does not work well, then the "cookie crumbles". Your mom, of course, being your mom will still give you cookies, no matter you did not make wise decisions earlier and you will still hold on to your incumbent position as a cookie distributor even though you don't deserve it anymore.

This goes on for a while, till people don't want your mom's cookies anymore because, all their moms have also started distributing cookies generously.

Then a new kid comes to your neighbourhood with an exciting new flavor of cookies and suddenly it seems cool to be having those cookies. Your mom, obviously does not like it and tries to out-law or regulate those cookies. But then, the train has already left the station.

"Your mom, obviously does not like it and tries to out-law or regulate those cookies. But then, the train has already left the station."

That couldn't happen while your are living at your mom's house.

Just remember that your mom doesn't accept any other kind of cookies for paying taxes. OK.. maybe we stretched the metaphor a little too much there.

new flavor? did you just hint at Bitcoin

I love your explanation.

Just for the record. At the end of the day, your mother is the only able to do cookies and she is not limited in the ingredients. Your friends should remember that she could not be willing to do more but that doesn't mean that she can't.

Can you recommend an economics book or two?

Really depends on what you want to know. If you are totally new to the concept of money system, YouTube videos like this one [1] (it has three parts) have the best return on your time. Politically loaded but gets basics right.

If you want very condensed crash course in investing, economics, corporate finance etc., I can recommend CFA exam preparation materials. You do not need to take exam to get them, there are plenty of used books available for sale, and you can get them on the cheap as you are not worried about them being up-to-date

[1] https://www.youtube.com/watch?v=I_x626joik0 https://www.youtube.com/watch?v=l_IgcmsqnVM https://www.youtube.com/watch?v=rxZhtGeRa-M

thanks! sounds nefarious.

Likely not intentionally so, but it is effectively a game of hot potato with debt. Someone, somewhere has to be constantly taking on more debt to ensure the whole system keeps going.

Why? Why is eg constant debt not sustainable?

Money spent on debt servicing is money not spent on goods and services.

Why? What happens it? It gets buried in a hole?

The money you spend servicing debt is the money somebody else earns on their savings. And many people (retirees are an extreme example) happily spend such money on restaurant dinners and new cars.

If only it was so.

http://www.bankofengland.co.uk/publications/Documents/quarte...

Could you simply respond to the point? I already understand how modern central banks work so a reference to a 14 page intoduction doesn't help.

According to your claim, debt interest just disappears while i know for a fact that it does not since i've used such money myself (earned on my savings) in the past to buy stuff.

Earnings on savings are independent of debt repayments.

If you look at page 3 of the document, it talks about how repayments are basically an accounting alteration of the debtors deposit account.

Meaning that said account is reduced by the mount paid, but does not show up with a matching increase on any other account ledger (the banks own or any other).

Debt and savings are wholly uncoupled, no matter what mainstream economics likes to think.

The central banks pay out profits earned to their respective governments.

It depends on the amount of debt. Complex things like this cannot be condensed into black or white simplistic answers.

To be fair, in the context of reddit where it became a thing, the ELI5 subreddit defines the term as meaning layperson-accessible explanations, not patronizing "treat the asker like a literal five-year-old child" explanations.

The explanation for 5 year old would be, the adults are doing things they have never done before, so they see things they never seen before. And things people never seen before are often considered strange.

Sounds like a furry orgie.

The entire thing has become a joke. It's all fake and manipulated and people are making tons of cash for nothing.

So what should Joe Investor who is not a sophisticated investor, but likely has a ton tied up in say, an Index Fund, be doing right now?

Stay the course if the investment time horizon is 20+ years. Make sure you have an asset allocation you are comfortable with and aren't taking on too much or too little risk. Do nothing and ignore the noise.

Taking too much risk I understand, but what does it mean taking too little risk in this context?

If you're 30 you probably shouldn't have a bunch of money in govt bonds. If you're 65 it may be a really good idea.

I didn't sell everything, but I did sell a few things to take some profits and dumped a few losers to help offset those capital gains with some losses on things I really wanted to get out of. I'm going to over 75% cash right now. If the market drops 20% then I'm going to slowly start dollar cash averaging in to see if it trends back up. If it doesn't I'm just going to stay cash heavy.

If I had been smart enough to buy Google, Facebook, or Amazon a few years ago I would be taking some or maybe all profits there. If Apple goes below 100 I will start buying again and possibly selling covered calls on it.

My IRA's have a really long time horizon so although I'm still putting cash in them every month I'm not buying anything. I'm not selling anything in there either because I just buy SPY (S&P ETF) and occasionally some down and out sector ETFs every month.

Cash out. Wait for the bust. Buy back in.

One thing I've learned from HN over the years - be sure to ignore all financial and medical advice!

And what about if the majority of that is in a 401k?

I don't necessarily agree with the market falling, but there is no reason you can't move your 401k indexes into a cash position at the brokerage and rebuy later. Not that I think thats a good idea

Same applies. Change allocation to cash. Then change back after crash.

The trouble with switching to cash is then you've got to pay income tax on the capital gains. You'll be buying back in with less (proceeds - taxes).

Investment funds will offer a cash investment option. This invests in currencies. Along with government bonds it's considered low growth low risk investment.

Nobody would advocate actually withdrawing from an investment account. Just move it to safer investment options.

Moving it incurs capital gains taxes.

Even if you passively invest in a mutual fund, the funds internal transactions show up as capital gains that get reported to the IRS, and you have to pay the tax.

Not if it is in a tax deferred retirement account: there are no cap gains incurred by reallocating or NAV distributions unless there's an actual cash withdrawal. This is specific to 401ks & traditional IRAs only.

You are woefully misinformed. I hope you have not been keeping money in a particular 401k fund because you thought you couldn't change the allocation without paying taxes...

Not if it's in a 401k.

So... its time to raise interest rates?

I'm quite curious to see whether that'll happen before the elections...

Next month. Bet on it.

What are the best ways to bet on it, in terms of where to put money now?

The actual best way to bet on the event is to use fed fund futures http://www.cmegroup.com/trading/interest-rates/stir/30-day-f... which are a futures contract whose value is determined by the fed funds rate (the rate people refer to when they talk about raising interest rates)

Their interesting feature is that you can imply the probability of a rate hike in December/January/March/... from the yield curve. It's 66% for December:

http://www.cmegroup.com/trading/interest-rates/countdown-to-...

I think the simplest thing would be sell Euros and buy Dollars.

No, if there is another economic collapse, the fed will do more QE, which devalues the dollar. The best is to buy gold with your Euros.

But the world at the same time would migrate to dollars with liquid funds, causing for the near-term a drop in prices of other currencies in relation to the dollar.

Mattress

It's likely already factored into the stock prices.

That can't happen without crashing the entire system. Interest rates are effectively zero because everyone (governments, businesses, citizens...) is carrying all the debt they can handle. If they try to raise the interest rates the entire world will go bankrupt. As usual, Bloomberg points the finger at bank regulation. The banks should never have survived the 2008 crash, but $2.5Trillion buys you a lot of time. Remember, all that QE went to pay down financial sector losses from the crash. It didn't do anything to ease the debt logjam.

I wonder if the other factor besides interest rates is the prevalence of algorithmic trading.

When I see these swings and I hear these "flash events" it reminds me of extremely fast decisions made by machines based on very small changes.

I'm curious is there an index where we can see how much trading happens almost unattended on a daily basis via algorithmic systems? I wonder how that would map against the last decade of "systemic changes" in markets?

I'm not very well informed on the markets, but is any of this related to the fact that gold is at a five year low and seems to keep going lower at I time that (I assume) people are looking for a hedge against uncertainty (what I thought gold was).

Another strange one:

https://pbs.twimg.com/media/CTqP8JhUcAA3Mwz.png:large

Any explanation for that?

Of course not, that would be ridiculous. It's just a pretty picture made by cherry-picking years to superimpose and imply...something. Maybe there is some seasonality, but if you think the two graphs are impossibly correlated, it's just because you want to see that (and the author chose the data well).

This all sounds important and exciting. But as an outsider, unlabelled graphs etc leave a lot of meaning to guesswork.

Good introduction to the importance of fat tailed distributions in financial markets:

http://aida.wss.yale.edu/~nordhaus/homepage/documents/statis...

Physics has 3 laws that explain 97% of event while finance has 97 equations that explainless than 3% of events.

God's a bit better than Mammon at system design ;-).

Problem only is, that many today only believe (and follow) in Mammon and not in God any more!

You can believe in God or not, but what is better to believe in, when it comes to build and uphold communities?

Neither.

Humanity has probably spent more man-hours on the last 3% than the first 97.

Is that a bug or a feature?

Feature. Progressively more difficult level design.

Alternately, Feature, 100%ers can now sink untold hours polishing off those last few items they didn't quite get the first time through.

Not even sure what you mean.

That is a key feature of capitalism.

Physical gold is the only reliable asset if the markets collapse in case of a crisis similar to 2008. It's five years low and good time to buy!

Not every comment mentioning gold is automatically downvote-worthy. In case of market collapse, gold does tend to have more utility than other assets.

If you're looking for a multiple on the gold trade, look into the gold mining sector. When gold moves a little, the gold miners move a lot. GDX and GDXJ are some good basket ETFs. GDXJ is the junior mining companies and has a higher multiple than GDX. It also works in the inverse too though, if gold goes down, these go down even more.

> It's five years low

So the commodities market is collapsing?

Shorting long-term bonds with high modified duration would yield gains when interest rates rise and bond prices fall. Black swans and fractals: we can't predict the future but sometimes Blackswans flock together, e.g., autoregression, feedback patters, volatility of volatility, etc.

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