Trading Biases

Source: ZeroHedge, Oct 2017

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On Reading Well

Source: Farnam Street, Oct 2017

For us to get the most out of each book we read, it is vital to have a plan for recording, reflecting on, and putting into use the conclusions we draw from the information we consume.

Before Reading

  • Choose Your Books Wisely
  • Get Some Context
  • Know Why You’re Reading the Book
  • Skim the Index, Contents, and Preface
  • Match the Book to Your Setting or Situation

While Reading

  • Make Notes
  • Stay Focused
  • Mark Up the Book
  • Stop and Build a Vivid Mental Picture
  • Make Mental Links
  • Keep Mental Models in Mind

After Reading

  • Think About What You Can Apply
  • Teach What You Have Learned
  • Catalogue Your Notes
  • Reread (If Necessary)

In Memory of V. Voevodsky

Bitcoin Mining’s Electricity Costs is Hugely Expensive: US$500 million upwards

Source: Digiconomist, Oct 2017

According to Quartz the employees estimated that each 1,000 miners were equal to 10 petahashes per second in processing power. All 21,000 Bitcoin mining machines together would then be equal to 210 petahashes per second in processing power. At the time, the total Bitcoin network processing power was 6 exahashes per second, hence we find that the Inner Mongolia mine represents close to 3.5% of the total network. Since the Bitcoin price around this time was $3,500 per BTC, and rapidly going up, these Bitcoin mining machines alone were already generating almost $250,000 per day (based on a total daily block reward of 1,800 coins, and 200 coins in fees).

The total daily electricity bill amounts to roughly $39,000, meaning the facility consumes around 40 megawatts of electricity per hour.

the Inner Mongolia mine made up only 3.5% of the total Bitcoin network at the start of August (the network has expanded significantly since).

Related Resources:

1. CoinTelegraph, Oct 2017 <about US$2.5 billion>

At that time, it cost an average of $150,000 a day to maintain the Bitcoin network. Today, this figure is at a staggering $6.7 million (if we assume a $0.12/watt cost and multiply that with the estimated 56,209,833 KWh of electricity that the Bitcoin network consumed on Oct. 13, 2017).

2.  Digiconomist, Oct 2017

Why Women Want to Have Sex

Source: The Star, Oct 2017

It’s Physical

In a study conducted at the University of California, Los Angeles, United States, 141 women were asked to observe photos of shirtless men, then rank them according to attractiveness. Lean, athletic-looking bodies were seen as more desirable than both bulky and skinny types.

Women tend to perceive big muscular men as threatening. It’s possible that spending all the time bulking up is seen as self-centred, which means she may not get what she wants from you, in terms of time commitment and attention.

The Heat Of The Moment

Cuddling causes a woman’s testosterone to surge, a recent Canadian study found. The increase in testosterone levels may cause androgen receptors in her clitoris to switch on, leading to arousal.

How else to get her into the mood? Have a good sense of humour and your chances increase by 25% – and if you’re looking for a mate to settle down with, those chances go up by 31%, says a study in the Journal of Psychology.

The Next Step In A Relationship

A study published in the Journal of Sexual Medicine found commitment to be the key to sexual motivation in women of all ages.

There is no need to get spooked and cut ties with the woman you’re seeing. Commitment does not mean marriage, but rather a serious promise of exclusivity that shows an investment in the relationship.

Bitcoin: Asset, Currency, Commodity, or Collectible

Source: Musings on Markets, Oct 2017

every investment that I will look at has to fall into one of the following four groupings:

  1. Cash Generating Asset: An asset generates or is expected to generate cash flows in the future. A business that you own is definitely an asset, as is a claim on the cash flows on that business. Those claims can be either contractually set (bonds or debt), residual (equity or stock) or even contingent (options). What assets share in common is that these cash flows can be valued, and assets with high cash flows and less risk should be valued more than assets with lower cash flows and more risk. At the same time, assets can also be priced, relative to each other, by scaling the price that you pay to a common metric. With stocks, this takes the form of comparing pricing multiples (PE ratio, EV/EBITDA, Price to Book or Value/Sales) across similar companies to form pricing judgments of which stocks are cheap and which ones are expensive.
  2. Commodity: A commodity derives its value from its use as raw material to meet a fundamental need, whether it be energy, food or shelter. While that value can be estimated by looking at the demand for and supply of the commodity, there are long lag and lead times in both that make that valuation process much more difficult than for an asset. Consequently, commodities tend to be priced, often relative to their own history, with normalized oil, coal wheat or iron ore prices being computed by averaging prices across long cycles.
  3. Currency: A currency is a medium of exchange that you use to denominate cash flows and is a store of purchasing power, if you choose to not invest. Standing alone, currencies have no cash flows and  cannot be valued, but they can be priced against other currencies. In the long term, currencies that are accepted more widely as a medium of exchange and that hold their purchasing power better over time should see their prices rise, relative to currencies that don’t have those characteristics. In the short term, though, other forces including governments trying to manipulate exchange rates can dominate. Using a more conventional currency example, you can see this in a graph of the US $ against seven fiat currencies, where over the long term (1995-2017), you can see the Swiss Franc and the Chinese Yuan increasing in price, relative to the $, and the Mexican Peso, Brazilian Real, Indian Rupee and British Pound, dropping in price, again relative to the $.
  4. Collectible: A collectible has no cash flows and is not a medium of exchange but it can sometimes have aesthetic value (as is the case with a master painting or a sculpture) or an emotional attachment (a baseball card or team jersey). A collectible cannot be valued since it too generates no cash flows but it can be priced, based upon how other people perceive its desirability and the scarcity of the collectible.  

Investing versus Trading

The key is that cash generating assets can be both valued and priced, commodities can be priced much more easily than valued, and currencies and collectibles can only be priced. So what? I have written before about the divide between investing and trading and it is worth revisiting that contrast. To invest in something, you need to assess its value, compare to the price, and then act on that comparison, buying if the price is less than value and selling if it is greater. Trading is a much simpler exercise, where you price something, make a judgment on whether that price will go up or down in the next time period and then make a pricing bet. While you can be successful at either, the skill sets and tool kits that you use are different for investing and trading, and what makes for a good investor is different from the ingredients needed for good trading. The table below captures the difference between trading (the pricing game) and investing (the value game).
 
The Pricing Game
The Value Game
Underlying philosophy
The price is the only real number that you can act on. No one knows what the value of an asset is and estimating it is of little use.
Every asset has a fair or true value. You can estimate that value, albeit with error, and price has to converge on value (eventually).
To play the game
You try to guess which direction the price will move in the next period(s) and trade ahead of the movement. To win the game, you have to be right more often than wrong about direction and to exit before the winds shift.
You try to estimate the value of an asset, and if it is under(over) value, you buy (sell) the asset. To win the game, you have to be right about value (for the most part) and the market price has to move to that value
Key drivers
Price is determined by demand & supply, which in turn are affected by mood and momentum.
Value is determined by cash flows, growth and risk.
Information effect
Incremental information (news, stories, rumors) that shifts the mood will move the price, even if it has no real consequences for long term value.
Only information that alter cash flows, growth and risk in a material way can affect value.
Tools of the game (1) Technical indicators, (2) Price Charts (3) Investor Psychology (1) Ratio analysis, (2) DCF Valuation (3) Accounting Research
Time horizon
Can be very short term (minutes) to mildly short term (weeks, months).
Long term
Key skill
Be able to gauge market mood/momentum shifts earlier than the rest of the market.
Be able to “value” assets, given uncertainty.
Key personality traits
      (1) Market amnesia (2) Quick Acting (3) Gambling Instincts
      (1) Faith in “value” (2) Faith in markets (3) Patience (4) Immunity from peer pressure
Biggest Danger(s)
Momentum shifts can occur quickly, wiping out months of profits in a few hours.
The price may not converge on value, even if your value is “right”.
Added bonus
Capacity to move prices (with lots of money and lots of followers).
Can provide the catalyst that can move price to value.
Most Delusional Player
A trader who thinks he is trading based on value.
A value investor who thinks he can reason with markets.

What is Bitcoin?

The first step towards a serious debate on bitcoin then has to be deciding whether it is an asset, a currency, a commodity or collectible. Bitcoin is not an asset, since it does not generate cash flows standing alone for those who hold it (until you sell it).  It is not a commodity, because it is not raw material that can be used in the production of something useful. The only exception that I can think off is that if it becomes a necessary component of smart contracts, it could take on the role of a commodity; that may be ethereum’s saving grace, since it has been marketed less as a currency and more as a smart contracting lubricant.  The choice then becomes whether it is a currency or a collectible, with its supporters tilting towards the former and its detractors the latter. I argued in my last post that Bitcoin is a currency, but it is not a good one yet, insofar as it has only limited acceptance as a medium of exchange and it is too volatile to be a store of value. Looking forward, there are three possible paths that I see for Bitcoin as a currency, from best case to worst case.
  1. The Global Digital Currency: In the best case scenario, Bitcoin gains wide acceptance in transactions across the world, becoming a widely used global digital currency. For this to happen, it has to become more stable (relative to other currencies), central banks and governments around the world have to accept its use (or at least not actively try to impede it) and the aura of mystery around it has to fade. If that happens, it could compete with fiat currencies and given the algorithm set limits on its creation, its high price could be justified.
  2. Gold for Millennials: In this scenario, Bitcoin becomes a haven for those who do not trust central banks, governments and fiat currencies. In short, it takes on the role that gold has, historically, for those who have lost trust in or fear centralized authority. It is interesting that the language of Bitcoin is filled with mining terminology, since it suggests that intentionally or otherwise, the creators of Bitcoin shared this vision. In fact, the hard cap on Bitcoin of 21 million is more compatible with this scenario than the first one. If this scenario unfolds, and Bitcoin shows the same staying power as gold, it will behave like gold does, rising during crises and dropping in more sanguine time periods.  
  3. The 21st Century Tulip Bulb: In this, the worst case scenario, Bitcoin is like a shooting star, attracting more money as it soars, from those who see it as a source of easy profits, but just as quickly flares out as these traders move on to something new and different (which could be a different and better designed digital currency), leaving Bitcoin holders with memories of what might have been. If this happens, Bitcoin could very well become the equivalent of Tulip Bulbs, a speculative asset that saw its prices soar in the sixteen hundreds in Holland, before collapsing in the aftermath.

Reality Checks

Combining the section where I classified investments into assets, commodities, currencies and collectibles with the one where I argued that Bitcoin is a “young” currency allows me to draw the following conclusions:
  1. Bitcoin is not an asset class: To those who are carving out a portion of their portfolios for Bitcoin, be clear about why you are doing it. It is not because you want to a diversified portfolio and hold all asset classes, it is because you want to use your trading skills on Bitcoin to supercharge your portfolio returns. Lest you view this as a swipe at cryptocurrencies, I would hasten to add that fiat currencies (like the US dollar, Euro or Yen) are not asset classes either.
  2. You cannot value Bitcoin, you can only price it: This follows from the acceptance that Bitcoin is a currency, not an asset or a commodity. Any one who claims to value Bitcoin either has a very different definition of value than I do or is just making up stuff as he or she goes along.
  3. It will be judged as a currency: In the long term, the price that you attach to Bitcoin will depend on how well it will performs as a currency. If it is accepted widely as a medium of exchange and is stable enough to be a store of value, it should command a high price. If it becomes gold-like, a fringe currency that investors flee to during crises, its price will be lower. Worse, if it is a transient currency that loses all purchasing power, as it is replaced by something new and different, it will crash and burn.
  4. You don’t invest in Bitcoin, you trade it: Since you cannot value Bitcoin, you don’t have a critical ingredient that you need to be an investor. You can trade Bitcoin and become wealthy doing so, but it is because you are a good trader.
  5. Good trader ingredients: To be a successful trader in Bitcoin, you need to recognize that moves in its price will have little do with fundamentals, everything to do with mood and momentum and big price shifts can happen on incremental information.

Do You Need a Blockchain?

Source: Adjoint, date indeterminate

What do I need that my traditional database is not giving me?

  1. Do you need a database in the first place?
  2. Does your application depend on extreme fault-tolerance?
  3. Does my application depend on a shared writes from parties with potentially unaligned interests?
  4. What time horizon do I need writes and reads to be consistent?
  5. What groups of parties (agents) need to be responsible for consensus?
  6. Is a trusted third party needed to audit transactions?

Smart Contracts