Day Trading & Forex Forum

MrGecko

Any two shares will have some correlation - that is, they behave in the same manner to some extent. High correlation stocks often fall within the same sector - e.g. Rio Tinto and BHP Billiton being mining stocks (r^2 -> 1); shares that show no discernable pattern have 0 correlation (e.g. BHP and Vodafone), and assets that move in opposite directions have r^2 -> -1 (e.g. equities and bonds).

All these are are measured in normal market conditions. In a crash, everything drops - so, for example in the FTSE100, shares that have previously behaved in opposition to each other (r^2 -> -1) start to exhibit the same price movements (R^2 -> +1).

It basically means that the ebbs and flows of different assets are wiped out; everything falls, ergo their correlations increase. In a "perfect storm" crash, all assets will drop together, despite their correlations during normal market conditions. It is of interest for hedging; there is something known as a "platinum hedge", which IIRC is the only way to prevent a portfolio being wiped out.

In my day there was actually a specific time and place for these cheeky few; every social (read circle) had a set timetable, with slots allocated for playing games and vomiting, singing songs, chatting up the filth, before more drinking, dancing, and getting your c0ck out.

It has been known for certain individuals to open, close, and seal the deal in between the singing and the dancing. Attached is the only newspaper cut out I can show my mum.

Attached Thumbnails

 

__________________
"The gambling known as business looks with austere disfavour upon the business known as gambling", Ambrose Bierce

"That's him - Iceman. It's the way he flies, ice cold, no mistakes. He wears you down, you get bored, frustrated, do something stupid and he's got ya", Goose, Top Gun

grantx

Mr Gecko,

Thank you for the excellent clarification. Presumably, by extension, hedging a portfolio via futures will be subject to a massive mis-match. But wouldn't this present a potential oportunity arbitrage - long one, short the other (depending which side is out of line)?

Grant.

CHRISTO9HER

I really think that the academics get a hard time from traders, always going on about how academics are wrong about the EMH etc etc. We should be giving the academics credit for all the wonderful tools that they have brought to the financial arena i.e. things like the BS formula, as well as forming the techniques to value pretty much every kind of exotic option that anyone can think of. We should let them have their fun with the EMH, if you can only make a trading profit from luck, then great, all pro traders are very lucky people!!

But you're right about the academics motives not necessarily being purer or more noble than some guy trying to sell a load of crap; one of the things that has put me off going down that road is that it seems that they spend their entire careers trying to seek validation from their peers. I think that they all dream about having an equation named after them every single night!!

In a way, traders and academics are polar opposites; traders (for the most part anyway) dont give a damn about getting the validation, they only want the profit, and academics dont concern themselves with money too much and spend their lives seeking the validation.....I actually think that the traders priorities may be the healthier of the two!!

grantx

Chris,

Traders, academics - never the twain shall meet.

Grant.

GammaJammer

Pretty much what did for LTCM in the end....

__________________
"That which doesn't kill me makes me stronger"

CHRISTO9HER

Indeed. I just finished the book about LTCM, "When genius failed". I think that they were actually too clever for their own good....so clever that they couldnt see how unclever they were being. Meddling in things like merger arbitrage without doing the research etc

GammaJammer

Two things undid them imho.

1) Outright greed (both theirs and other people's). Overleveraged in the first place, notching UP that leverage at the worst possible time. And then the street got wind of their positions and forced things even further against them when they were supposed to be co-ordinating a bailout. Nice!

2) Total lack of common sense (all their theories were great, and in the long run many would have worked just fine, but that doesn't take into account the vaguaries of the market in the shorter term. As John Maynard Keynes famously said, "the market can remain irrational longer than you can remain solvent".

All in all it's a fantastic salutory tale, and if I were employing trainee portfolio managers I would actually make it compulsory reading.

GJ

__________________
"That which doesn't kill me makes me stronger"

blancspa

What does it imply ?

thank you for your reply