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Wayfinding in a time of chaos (field notes, part II)
A recent thread posited that, for various reasons, we have recently entered a high-chaos regime in assets.
This one explores some loose thinking on how we might navigate such a regime.
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A recent thread posited that, for various reasons, we have recently entered a high-chaos regime in assets.
This one explores some loose thinking on how we might navigate such a regime.
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What we’re dealing with here is nonlinearity — unfortunate, because our brains aren’t particularly well at processing nonlinear phenomenon, so the best way to understand the problem is often through metaphor.
So let’s talk about constructive and destructive interference.
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So let’s talk about constructive and destructive interference.
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Instead of me talking about this, we’re just gonna go to Khan Academy since it’s super the best.
We want to understand is how waveforms interact when they meet, since we are hypothesizing that the market is being driven largely by convex instruments.
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We want to understand is how waveforms interact when they meet, since we are hypothesizing that the market is being driven largely by convex instruments.
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So when the waves match up constructively, we get… uh… “mooning.”
One way to think of the “gamma cannon” effect is a group of people gathering together to deliberately sculpt a constructive interference crescendo by all humming the same pitch.
But like… in the market.
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One way to think of the “gamma cannon” effect is a group of people gathering together to deliberately sculpt a constructive interference crescendo by all humming the same pitch.
But like… in the market.
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Now of course, a waveform doesn’t just have the up part — it’s an extension equally up and down, we just experience those bits sequentially because we’re temporally bound beings.
And so the mooning generally eventually finds its couplet: dumping.
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And so the mooning generally eventually finds its couplet: dumping.
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And as noted above, interference has another form: destructive interference (which, as an aside, is how noise cancelling headphones work) which can stall out or entirely negate other waveforms in play.
So we can sequentially moon by (temporarily) contradicting the down pulse
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So we can sequentially moon by (temporarily) contradicting the down pulse
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So if we’re in this chaotic, convexity-centric environment we should expect a few things:
1. Constructive interference will produce extreme, bull-whip like outcomes
2. Destructive interference will make mean reversion hard to time
Already pretty useful, but let’s keep going.
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1. Constructive interference will produce extreme, bull-whip like outcomes
2. Destructive interference will make mean reversion hard to time
Already pretty useful, but let’s keep going.
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We can also use this manner of thinking to form some hypotheses:
1. Linear analysis traditions will be of questionable utility in this regime, and get chopped up
2. Path-dependency is an anti-pattern in this nonlinear world
Alright so what do we do about it?
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1. Linear analysis traditions will be of questionable utility in this regime, and get chopped up
2. Path-dependency is an anti-pattern in this nonlinear world
Alright so what do we do about it?
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The first thing to note is that you don’t have to play, at least when it comes to your own money (if you’re an asset manager you’re screwed ).
As the chaos self-snowballing, the certainty of flat returns (cash) can become attractive.
It may be the ultimate contrarian move.
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As the chaos self-snowballing, the certainty of flat returns (cash) can become attractive.
It may be the ultimate contrarian move.
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But let’s assume we’re gonna keep playing. Where can we find control amidst chaos?
- Where we play
- Our risk amplitude
- Signals we look at
Let’s look at examples of these.
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- Where we play
- Our risk amplitude
- Signals we look at
Let’s look at examples of these.
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Some markets are less susceptible to chaos because they’re massive and deeply liquid.
The recent attempt to gamma squeeze the silver market (lawl) provided an example as the “gammeme” squad’s attempt to make a wave failed.
Poseidon swatted it away like a child’s toy.
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The recent attempt to gamma squeeze the silver market (lawl) provided an example as the “gammeme” squad’s attempt to make a wave failed.
Poseidon swatted it away like a child’s toy.
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I’m sure some people will be upset by the above, so let me just say that I have no problem with collaborative wave-making, this was just a hilariously ill-informed attempt.
If you want to understand why, read @kweiner01's piece below.
12/ https://monetary-metals.com/thoughtful-disagreement-with-ted-butler/
If you want to understand why, read @kweiner01's piece below.
12/ https://monetary-metals.com/thoughtful-disagreement-with-ted-butler/
So bigness and liquidness can help blunt the chaotic edge. More specifically, massive markets tend to be less subject to the confluence of small waves and it takes bigger, broader confluences to make them whiplike.
“Safety,” after a fashion (or at least peril reduction).
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“Safety,” after a fashion (or at least peril reduction).
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And there are also markets which are more natively convex, like the bond market.
The way we price and trade bonds has always been convex in nature. This is probably familiar stuff to many of you, but here’s a link just in case it’s not.
14/ https://www.investopedia.com/terms/c/convexity.asp
The way we price and trade bonds has always been convex in nature. This is probably familiar stuff to many of you, but here’s a link just in case it’s not.
14/ https://www.investopedia.com/terms/c/convexity.asp
Bonds are a window to the next topic: risk amplitude.
The bond market allows you to select the amount of convexity you’d like by picking where on the curve you want to play. The short end realizes less convexity; the long end more.
Duration = slider for convexity exposure.
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The bond market allows you to select the amount of convexity you’d like by picking where on the curve you want to play. The short end realizes less convexity; the long end more.
Duration = slider for convexity exposure.
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In addition to being massive and liquid, bonds are “natively convex” which means that historical thinking about their price movements already incorporates some notion of convexity (unlike equities, where things like fundamentals, P/E, etc. generally rely on linear logic).
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Options, obviously, are also natively convex. But naively wandering into the vol markets is bad (our nonlinear intuition is poor).
If you’re gonna play, follow some vol people on here or read a book so that you can bleed out slowly vs. being clubbed like a baby seal day one.
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If you’re gonna play, follow some vol people on here or read a book so that you can bleed out slowly vs. being clubbed like a baby seal day one.
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These ‘natively convex’ expressions are nice since the historical body of work on them applies to this convexity-dominant environment.
If you go read about them it’s still relevant in a way that other things (hi there value investors!) simply are not in the current regime.
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If you go read about them it’s still relevant in a way that other things (hi there value investors!) simply are not in the current regime.
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Finally: thoughts on signals.
While I’m personally a fan of appropriately-applied charting, my sense is that it can be challenging to apply in a convexity-driven regime, as many of these patterns were codified to detect sentiment in linear environments.
That’s problematic.
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While I’m personally a fan of appropriately-applied charting, my sense is that it can be challenging to apply in a convexity-driven regime, as many of these patterns were codified to detect sentiment in linear environments.
That’s problematic.
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It's problematic both because the environment is increasingly non-linear and also because… well… sentiment is sort of dead.
Holders of the underlying are increasingly passive investors, and the rest are just model jockeys.
This might even kill the market, eventually.
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Holders of the underlying are increasingly passive investors, and the rest are just model jockeys.
This might even kill the market, eventually.
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Anyhow, until the markets self-immolate, what kinds of non-sentiment signals should we be looking at for clues?
Well, it seems that two big ones are probably liquidity and volatility.
Let’s talk liquidity first.
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Well, it seems that two big ones are probably liquidity and volatility.
Let’s talk liquidity first.
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Liquidity is sort of a big topic, and I don't understand all of it.
But one of the more fascinating bits for me was this talk by @HariPKrishnan2 which helped reveal that liquidity is a subtle beast w/ many facets.
Just watch it the man is a genius.
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https://www.realvision.com/shows/the-expert-view/videos/will-a-recession-kill-etf-liquidity
But one of the more fascinating bits for me was this talk by @HariPKrishnan2 which helped reveal that liquidity is a subtle beast w/ many facets.
Just watch it the man is a genius.
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https://www.realvision.com/shows/the-expert-view/videos/will-a-recession-kill-etf-liquidity
I do my best to track relevant liquidity for the assets I'm involved in.
It’s my sense that higher liquidity levels empower the wave makers which leads to… well… “waveform diversity” — a fairly robust state in which no single waveform archetype dominates price movement.
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It’s my sense that higher liquidity levels empower the wave makers which leads to… well… “waveform diversity” — a fairly robust state in which no single waveform archetype dominates price movement.
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Decreased liquidity, on the other hand, would appear to encourage waveform convergence, and when this happens we begin to see the curious harmonics of constructive interference — the waves get bigger.
TL;DR: mooning is not always a good omen.
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TL;DR: mooning is not always a good omen.
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And also: track volatility, even in all assets you don’t care about.
Volatility is contagious — it has a tendency to leap from one thing to the next, so it’s good to track occurrences to see if it’s starting to spread.
My crude version (achievable on TradingView) is below.
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Volatility is contagious — it has a tendency to leap from one thing to the next, so it’s good to track occurrences to see if it’s starting to spread.
My crude version (achievable on TradingView) is below.
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Why track this? Well…. look — there’s this thing called “sympathetic resonance” which is why you sound great singing in the shower.
It also gradually encourages synchronicity of waveforms, and it’s why volatility-driven regimes tend to lead to big crashes.
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It also gradually encourages synchronicity of waveforms, and it’s why volatility-driven regimes tend to lead to big crashes.
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You may think that’s bullshit (understandable - after all, I did use the word “synchronicity”), but volatility does breed volatility.
And waveforms happening within the same space do have a tendency to converge...
Here, just watch this:
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And waveforms happening within the same space do have a tendency to converge...
Here, just watch this:
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