Double Blind

Knowledge Problem gets it right with their article on The Wooly Concept of Sustainability.

But what do we need to have clear price signals and complete capital markets? In reality, completely clear price signals and full capital markets are impossible, but the way to get them as close to that benchmark as possible is to focus on reducing transaction costs and increasing the clarity of property rights definitions. When transaction costs are low and property rights are as well defined as is economical, then scarcity information flows across time and space.

This is completely correct. Having liquid capital markets to indicate scarcity through price mechanisms and enforcing transactions on such markets is probably the only long-lasting tool that can do the job. The best example is oil – when there is too much demand or not enough supply, you can see this by the rising price. This forces an economy to look for cheaper alternatives to oil, whether it’s nuclear, solar, wind or hamster wheels.

The only time that such markets do not work is when you have a tragedy of the commons situation – thirty years ago we used to see really bad acid rain in the great lakes region of North America, but this was solved by the Canada-US acid rain treaty. The Kyoto protocol is an attempt to mirror this, but it will be doomed to failure because of the huge incentives member countries have to cheat in addition to the negligible effects compliance will have.

But for the most parts, capital markets have done the job that central planning will never be able to do – quantifying the supply and demand of an economic engine to a very fine precision.

So I figured today would be the day the bond market would bounce back based off of the negative reaction from the last Federal Reserve meeting. I didn’t think there would be much of a downswing, but I was certainly wrong:

So here were the errors that I committed:

I did consider this a high probability trade, both in terms of probability of execution (it did happen) and positive expectation (otherwise I would have never entered it), but obviously I thought wrong.

You might see that the stop was 2/32 off the low made for the day, so that wasn’t well placed either. Hypothetically if I lowered my parameters by 4/32, I would have never been stopped out and the trade would have been a mild 3 point less instead of the full 16. I’m happy to say, however, that this was the first fully losing trade of the year. Let’s hope it was the last one!

Just as a side note, I will be moving all of this boring bond-related stuff to Divestor in the near future, as I am redesigning that site. Most casual readers probably don’t care about this sort of stuff.

Here is a low probability trade, as in a low probability of it occurring. If the initial order fills, it does have a positive expectation:

The order should be cancelled if the target selling price is not reached on the 29th. Basically the jist of this order is that there are certain inefficiencies in the market that occur after a Federal Reserve meeting. I’m not sure if there will be sufficient volatility for this order to get filled, but we’ll see. No big deal if it misses, although I’d be slightly peeved if the bond market went all the way up to 110 15/16 and then cratered down. It’s certainly happened before. Since the orders are placed so far away from market, usually they are first in the execution queue at that price if it is touched, so there is a mild liquidity advantage to placing orders in this manner.

Long term, it would not surprise me in the least to see the entire yield curve rise as short term rates rise. However, long term projections in the bond market are always suspect which is why I never do long term trading in this particular marketplace – I leave that to stocks.

Update, later in the day: The target was never reached – it got as high as 110 5/32 and then plummeted down to 109 17/32 for the day. So the order was never filled. That’s fine, the market is always open another day.

One of the issues in the last municipal election campaign (this for the people that ran for council, while the school board has little to do with this) dealt with affordable housing. I paid attention to it, but didn’t have strong thoughts about it one way or another.

Who really wants affordable housing? is an article that explains the political interests of various stakeholders on the issue. There are parts I agree and disagree with in the article, but it’s a fairly thorough analysis.

Richmond is a fairly expensive place in terms of real estate. Figuring out why is beyond the scope of this post (just comb through the Vancouver Housing Blog for some good reasons), but just as an example, while combing through mls.ca, a recent condo development (“Lotus” at 7371 Westminster Highway) is advertising a 570 sq.ft. condo for $284,400. That type of money buys you a house nearly anywhere else in the country.

Just running a simple cost of capital calculation on such a condo leaves you with an interest cost of $1,200/month, assuming a 5.1% mortgage (which is the current market rate for a 5-year term). When you look for comparison purposes at rental rates, I don’t know who would be stupid enough to buy this – you would have to depend on some fairly serious appreciation in order to reclaim your investment.

Week 10, session 1. Run 10 minutes, walk 1. Run 20 minutes, walk 1. Run 30 minutes. This was the longest I’ve ever run in my life. The weather was sunny, relatively warm, and windy.

I decided to try my luck again by running along the northwest side of the dyke in Richmond, which commonly has strong west-to-east winds. Today was no different. Unlike a previous attempt, this one went fairly successfully. I used Google Earth and mapped my distances.

After 30 minutes of running (and one minute of walking), I managed to run about 5.4 kilometers. This was against a strong head-wind about through about 3 of those kilometers. After that, I turned directly around and walked 1 minute and ran 30 minutes in exactly the same course opposite and the tailwind must have helped since I ran about the same distance I did in the first 31 minutes. So that’s about 10.8 kilometers of distance over 62 minutes, which translates into 10 kilometers over 57 minutes and 40 seconds. It was a pretty good run.

This is actually the longest session in the training program, so going from here on in will be strictly about reducing the two minutes of walking down to zero. Judging from what I felt today, it shouldn’t be much of a problem. I’m not sure what to improve on other than making sure that I can consistently run 10km in 60 minutes or less.

Somebody suggest a good book that I can borrow from the library and read. I tend to read non-fiction, although I’m looking for something that will get my mind thinking. It can be fiction or non-fiction.

Most of the time I end up borrowing books and read them in an airplane. I did a lot of flight time in 2005 (some 50,000 miles or so) and thus I got quite a bit of reading done. This year has been less active, but I’ll still need some good material to read. A few books that I’ve read in the past:

I also enjoy books concerning gender relations, human psychology and other sociological issues. Usually I can tell if a book is garbage from the first 20 minutes, so thankfully I can spend my reading time productively.

Suggest a good book!

Updating the previous bond trade post I made:

My models said a higher than 50% chance of it going up and that’s what it certainly did. You’re probably wondering “but you missed the top by 6/32 points and could have made another 6 pips on the trade!”, life never works that way. You can always look back on the chart and ask yourself “what if my entry was this” and “what if my exit was that” which is always why you should be planning your trades, both gain and loss parameters, well in advance.

You probably think this is easy. It isn’t. It involves risk, and it involves considerable mental discomfort every time I do this. There is no other way that it can be a profitable activity. Now that the trade is done, I can relax a little, gloat a bit, and then keep my eyes open for the next good opportunity in the pit of insanity they call the bond market.

There was 15 minutes until my dental appointment was due, so I killed some time by walking through a liquor store. There are a lot of things you can learn by walking into a liquor store. First of all, there is a huge market for beer and wine. There is plenty of product differentiation – there are six thousand types of wines you can choose from and just as many choices of beer. I don’t know how a consumer could possibly tell the difference between the red and white wines other than cracking open a bottle and tasting it, but apparently people get over their confusion over having massive product choice and manage to buy something anyway.

I also notice that the price varies between wines – generally from 8 bucks a bottle all the way up to a hundred. I always wondered how much better the 100 dollar wine tastes, or is it just purely the placebo effect that you shelled out so much cash for it? I’ve had bad wine before, so I know what a good wine tastes like, but what does a great wine taste like? Would I truly get that if I actually paid that much for wine? I intend to find out whether 100 dollar wine tastes good once in my life, but definitely not this day.

There is a special subset of wine called ice wine that requires a fairly expensive process to produce, and thus prices are typically eight to ten times more than regular wine per unit volume. I’ve had some of this and enjoy it a lot. Maybe it’s just because of my sweet tooth. During some of my trips exploring the beautiful expanse of southeastern Arizona, I encountered a winery that served up some really good wines that had ice wine type taste, but not the cost. As it rarely freezes in Arizona, it would be tough for them to make ice wine, but whether they knew it or not, they made some good stuff. Too bad Canada Customs only allows you to take 1.5 litres of the stuff per trip back up the border.

There is a smaller section filled with an equally broad choice of spirits, such as rum, vodka, gin, whisky, scotch and sweeter spirits such as Irish cream. I noticed that Bailey’s finally had some competition – while the 750mL bottles of Baileys was sold out (selling for about $28), there was another knock-off brand of Irish cream that was in the shelf under selling for $20 and it was not flying. I wonder if the taste is all that different, or whether Bailey’s just did an incredible marketing job? I personally prefer Sheridan’s, but what do I know?

It just occurred to me that the best indicator of inflation has to be prices at the liquor store. Liquor has been produced by many civilizations from day zero and will probably be produced and consumed as long as I live. There will always be a market for liquor, despite the fact that it’s perfectly obvious what negative effects it has on society – the fact remains that it will always be a social drug of choice, right up there with caffeine. The failed prohibition of the early 1900′s proved the point that people will have their liquor, no matter what it takes.

Even with taxes on liquor as high as they are, I think prices of liquor are a fairly good gauge of inflation. How much does a 750mL bottle of rum cost? Pay attention to what you can buy it for today compared to what you can buy it for five or ten years from now.

I really consider liquor to be an excess of society – we are rich enough that we can abundantly produce a commodity that really has no net benefit to society (other than bonding people together in drunken laughter). If the price of liquor starts to rise rapidly, it would suggest that we no longer have the ability to produce these non-essential products and something is very, very wrong. In that respect, seeing affordable liquor prices is a sign that we will still be able to afford the other luxuries out there without causing any undo hardship to our wallets.

These are the things I learned from a 15 minute stroll inside a liquor store. My teeth were fine.

According to my financial modelling, there’s a better than 50% chance that Friday’s action will be positive in the T-Bond futures market. The order will be liquidated at the end of Friday if neither the gain or loss parameter is reached since I do not like holding open futures positions over the weekend.

Some of you may ask… “Why didn’t you just short the thing at 111 4/32 and then cover it up at 110 18/32?” It’s always easy to place optimal trades by looking at the chart in the past, but the reality of precision trading is that you can only profit by looking forward. This is just like saying “if I had just chosen the last 6 digits in the 6/49 lottery I could have been a millionaire”. I had no indications that the T-Bond market would drop to 110 18/32 that day, but I do know if it did, that there would be better than likely chance that the T-Bond market would rise to my limit price indicated. My entry point was within 3/32 of the low for that day, which is a good sign so far.

We’ll see whether I’m right or wrong on this one on Friday.

Very interesting post over at janegalt.net about how you could use the Ultimatum game in an attempt to quantify the amount of hate out there. The article links to a fairly decent counter-argument as well.

As a perpetual student of game theory, I find these “take it or leave it” games occur much more often than we would originally perceive, which is why it pays attention to play it well when it does occur. Of course it’s never as cut-and-dry as the textbook game goes, but still, the basis of decision is how to best play the ultimatum game, either as a giver or receiver of an offer.