#64 S2N: How Random is Your Random?

Author

micksonmatch
May 21, 2024

S2N Spotlight

The saying “If you torture the data long enough, it will confess to anything” is often attributed to Ronald Coase, a British economist and Nobel laureate. This is one of my favourite sayings. I love statistics, as they leave a lot of room for creativity. I am far from a true statistician, unlike my friend Professor Tom, who is a subscriber and tenured Professor of Statistics, but I know a little. I wasn’t planning to write about this today, but I came across a post by a market commentator who is on CNBC almost weekly and has a very large social media following. He posted this, and I took exception. Part of my frustration is probably how hard I am finding it to get noticed on social media in a world of noise. Just to complete the circle, here is my Twitter/X handle: https://x.com/s2nnews

The market commentator said, “In the stock market, return sequences are random. Take a look at annual returns by year and tell me if you can decipher any sort of pattern…of course you cannot.”

While I believe the markets are mostly random, at least on a daily return level, the above statement is simply not true, so I posted a reply disagreeing with him with this chart below of a normal distribution and the actual annual returns. It is very clear that the returns are not normally distributed, you can see visually how the returns don’t comfortably sit under the bell curve.

To help make it a little clearer for you, I created the same chart below, but this time I used completely random data. As you can see, the histograms fit more comfortably under the normal distribution curve. We know pretty well in the industry that actual financial returns are not normally distributed.

As expected, I got a response saying that he didn’t mean it the way I interpreted it. I am cross with myself as I allowed myself to kind of agree with the schoolyard bully to avoid too much of a fight and probably seek his approval.

He replied to me, “No one is saying that. The argument is that this year’s returns don’t predict next year’s returns.” I then went on to agree with him, as I think I know what he was trying to say. But on further reflection, his statement is 100% wrong, even though I embarrassingly said I 100% agree.

The probability of the next year being positive when the current year is positive is 66.67%. I was such a wimp in this argument. It is so easy to lose confidence because he has a big following and mine is still small, and I wanted to be his buddy, which reminds me of my 12 year-old self. Message to myself: Trust yourself and don’t be such a wimp.

S2N Observations

If you have been following the markets for a few decades, you would have come across the name Ivan Boesky. What a character! Even the youngsters out there will have heard of Gordon Gecko from the movie Wall Street, where he famously says, “greed is good.” The character was based on Ivan Boesky who ran afoul of the law and landed up in jail for insider trading in 1986. That was after he paid a $100 million fine and helped the Feds get Mike Milken, the “Junk Bond King,” and others on similar charges.

His expertise was arbitrage, and if you are a market junkie like I am, then you must read 2 books that are real page turners and among the best trading business books I have read.

  • “Den of Thieves” by James B. Stewart

  • “Predator’s Ball: The Inside Story of Drexel Burnham and the Rise of the Junk Bond Raiders” by Connie Bruck

By the way, if anyone has a good market book to recommend, please reply with a name.

Yesterday was a big day for crypto. Ethereum rallied 20% look in the table below for further details. I wanted to share something that has been around for some time and is somewhat of an arbitrage opportunity, in the light of my comments earlier about Mr Arbitrage. This is not investment advice.

In the table above, you can see the Bitcoin futures chain on Deribit’s crypto exchange. What the crypto world calls the perpetual is the future that is continuously rolled, so you don’t have to worry that it will expire. Its price is based on the spot market with an interest cost called the funding rate, which is calculated every 8 hours. In the chart below, you will see how wild the funding rate is, as it is driven by supply and demand pressures on the exchange, and we know that crypto is the wild west.

So here is the skinny on the trade. I will stick with a simple version. You have Bitcoin in your account so now you won’t have any exposure to the Bitcoin price. You can go short the March 28, 2025 contract and lock in a 12.7% annualised return. Your risk, assuming you short an amount equal to your Bitcoin held, is that the exchange goes bankrupt. There will be some margin costs for shorting the future, which I haven’t calculated, but my guess is that they will be quite small.

Performance Review

Chart Gallery

News Today