Finance & Investments

Insurance & Risk Management

Retirement & Savings

Edge – the advantage of professionals or why we need an edge when trading

In the moment the screens stopped flashing when the market closed, at exactly 1600 hours Chicago time, and in the second before I looked at my profit and loss figure, the only thing that was going through my mind was – I hope the people in Louisiana are ok. The day was 31.08.2005, the first day everyone realized how devastating hurricane Katrina is, the storm that hit Louisiana two days prior. News outlets reported that thousands of people in distress and showing image of entire neighborhoods flooded. The markets were extremely volatile, and I hadn’t moved my eyes away from the screens the entire day. I was trading for a local fund for just a few months, but in this moment, I knew I had my best day yet. I looked – 2625 dollars. I was ecstatic, filled with satisfaction and slightly proud of myself… a few months later this would be considered a mediocre day. As a professional market-maker (MM) I learned that to be successful you need to have an edge, an advantage when trading. If you do not and continue trading, you will lose all your money. Every slight edge moves the probabilities in our advantage and gives us a chance to get out of a trade for scratch (not lose) or small loss, if the trade is not a winner. The professional traders have many edges, but here I will give a few examples of what amateur traders don’t have. Market and order edge of market-makers MMs are traders in a product, or many products simultaneously, who are ready to buy from any sellers in the market and are ready to sell to any buyers in the market. They do this at prices and volume chosen by them (or by specific exchange requirements). MMs are like an exchange bureau – they have a bid and an ask for many currencies at the same time. They have a few key advantages in the markets they operate – access to many products (some with great correlation), low commissions and algorithms that help them to efficiently execute their trades. Here is a simple example: United states treasury bonds and notes and their derivatives are some of the most traded and liquid products in the worlds. Their futures contracts usually have 4 quarterly expiration contracts. Every 3 months everyone who has a position in the front month (usually the most traded and liquid contract), must exit their position or move it in the next contract. This process is called the quarterly roll. Снимка: Личен архив On the picture we can see the market for a calendar spread – an exchange traded product that represents the difference in price between two futures contracts. The spread allows traders to exit one position in the expiring contract and simultaneously open another in the following. In this example this is the calendar spread between the expiring March 2018 contract in the two-year treasury notes and next contract expiring in June 2018 (3.5 months later). In the grey stripe in the middle are the spread prices. On the left, in the blue stripe are the bids at each price and on the left in the red are the offers at each price. Currently, the best bid is at price 080 and the best offer is at 082. At the bid there are 1,964,945 contracts ready to buy at that price and on the offer, there are 2,457,873 contracts ready to sell. MMs are the ones who have amassed such large orders on both sides of the market. If, for example, a fund manager is long 10 future contracts in the March 2018 contract, and they want to roll their position in the June 18 contract, they can do one of two things – sell the first and buy the latter separately, or they can sell 10 calendar spreads. On the far-right column we can see just that – 10 spreads trade against 080. From all the people who bid 080 whoever has their order first at that price, or whoever has the largest order will get more of those 10 contracts. This is main reason there are such large orders at the best bid and best offer. The goal of MMs is to buy as many as possible at 080 and sell 082. MMs will “sit” at those prices as long as there are huge orders present for them to “lean” on. Should many of the orders disappear the traders will remove their orders and if they bought a certain amount, they will be able to sell at the same price before it disappears. This is their main edge in this case. Their second edge is that MMs have large capital at their disposal. The bigger order they put in the market the larger share of the traded contracts will be allocated to them. In the example above, left of the blue tripe shows my orders on both sides of the market – 24000 to buy and sell. The exchange maximum allowed is 25000. The next advantage professional traders have is a simple, but highly effective algorithm that follows the size on each bid and offer and removes the traders’ order should the size decrease dramatically. The goal is to manage the size a trader buys, or sells, at each price, since the trader doesn’t want to be filled on his entire order, just use its size. Another edge is that their algorithm is hosted (operates) on a server that is located next door to the exchange. This is called co-location, costs quite a bit, but is worth every penny. This advantage allows everyone who is closer to the exchange server to execute and manage their position better and faster, hence making them more successful. The above example is the simplest example of market-making. If you can imagine this with 15-20 such products that trade simultaneously on 6 monitors, then you can glimpse in the everyday life of a professional trader. Now multiply this by a 1000 and will gain some perspective of how algorithms of big funds trade today. Arbitrage Arbitrage is to buy a product somewhere and sell it somewhere else immediately for a higher price with no (or very little risk). There are many products (stocks, futures contracts, etc.) that trade on multiple exchanges. Others trade over the counter (OTC) – not on a regulated exchange but among banks, funds, and other financial institutions. Sometimes there can be discrepancies in prices, which leads to arbitrage opportunities. In the movies we have seen those arbitrageurs talk on 2 or 3 phones at the same time. Today, all this is done via algorithms and is called high frequency trading (HFT). The edge of arbitrageurs of the past and today’s HFTs algorithms is the speed they execute their transactions. And if back in the days you needed 2-3 traders per product, i.e. a trading floor with 1000-2000 people, today you need a few algorithms ran by a couple of people. Which is yet another advantage only large funds and banks have. Statistical arbitrage This is a strategy that is used in short to medium term trades and consists of multiple trades across multiple instruments that [...] Read more

Key word: PLANNING

At LudiArs we believe that everyone can be successful investor who can manage his wealth by himself – without being an expert and without wasting money on extra fees and intermediaries. Yes, a systematic and holistic method is needed to succeed but, as with everything else in life, following predetermined steps with resolve always leads to positive results. In this article we will discuss one of the biggest challenges – Planning when preparing a financial-investment plan. Planning truly is a challenge but you have no idea how easy it can be. Let’s start with the key word PLANNING. No one can deny that planning is one of the most serios challenges we face. This process has always been hard but the events from the past two years made it look almost impossible for many people. On the other had we know that our goals don’t just materialize out of this air and detailed planning is needed. Just as a builder needs architectural planning to construct a building every goal in our life must be though out and planned. This is very true for our finances as well. We all know that investing in financial assets is an absolute must if we would like to protect them from inflation and to grow our nest egg, but do we know exactly what our final goal is? Do we have an exact plan to achieve our exact goals? Do we know how much risk we can take on to follow our investments? In short – investing isn’t the objective; it is part of a process in order to achieve our actual goals in life. What makes a financial plan a success? Accumulating enough assets until retirement from which we can draw until the rest of our life. Great, but are we aware how much we will need? Do we know what we will spend on when this moment comes? No, if we don’t have exact goals to plan for. To prepare a financial-investment plan we need to focus on a few key elements before we even think about the actual investments. What is our current financial situation? What are our final goals we would like to achieve and what is their priority? How to combine our assets without investment plan based on our risk profile? Initially we have to assets the complete financial situation of a client. This includes not only income, expenses and savings rate but also all assets, their value, return, ownership, etc. and determine which assets will be used to finance the client’s goals. Next is setting actual and clearly defined goals we want to achieve. For most people this is secure retirement. We are all realists and know that a small government pension is not enough to live on, let alone maintain a desired standard. An example for a clear goal within a financial plan is an exact monthly amount needed during retirement years. Another is a “retirement property” – a beach our mountain house where we would like to spend our retirement years. Obviously, a financial plan is no easy task – it involves important financial milestones from now all the way to retirement. Parts of those are education costs for children and/or grandchildren, care for our parents, etc. A plan also includes goals that are not absolute necessity but nice things we would like to have or achieve. These can be the purchase of a boat, or traveling the world, or a gift to a cause we support. And since all those goals require large amounts to achieve, a meticulous planning is required. A third important step in the planning process is the group our goals by priority. The most important goals, the ones with highest priority, are our absolute Needs. These can be our retirement income and (maybe) education for our children. Next are our Wants – the beach house, a gift to a charity. And lastly our Wishes – the convertible we always wanted or the catamaran. What does a financial plan try to achieve? A successful plan must provide enough assets in order to finance all our goals without running out until our end. If in the process of planning, we calculate that we don’t have enough for all our goals we check to see if they are enough to cover our Needs – goals with highest priority. If the plan covers those goals, we calculate if there will be enough assets to cover both Needs and Wishes. And so on. How can we handle so many calculations within so many different scenarios? To have a flexible and fast planning at LudiArs we use a Monte-Carlo simulation. This allows us to test the sustainability of the plan. This simulation will be the topic of another article, but in short it allows us to run the plan through 1000 “lives”, simulation different return profiles our assets, savings and investments. The simulation shows how many of those are successful – in how many of those scenarios we have enough assets to cover all our goas without running out before pass away.  If not many of those simulations are successful, the plan must be tweaked. One correction is to increase our savings, to extend our work years. Another is to reduce the amount we plan to have at retirement or may be the sale of a property. Since there are many different scenarios and possibilities a holistic approach to financial planning is the key – looking at the big picture from the beginning in order to play out different developments. Your financial peace of mind in 20 or 30 years start with detailed planning today. It continues with strictly following our financial plan. Step by step, day by day. To reap the fruit from the tree you planted last year you need care and time. Same goes with care for your personal finances, which can provide for secure and more carefree retirement than current retirees. BE PREPARED!

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Why are Bulgarians poor?

Poverty in Bulgaria has many faces, but the more poignant question is why the life of generations of Bulgarians is marked by destitution and lack of funds. No, it is not because we’re stupid or lazy, as some would say. And it’s not because we can’t save. Why, you ask? The short answer – we don’t invest. One would say – “well, not true, Peter has 4 condos in Student City district”. Sure, good for Peter, he has saved, he’s put his money in an asset, is definitely a good example for all, but his “investment” is so erroneous that it can be qualified as a speculation. More on the difference between the two a little later. The long answer to the question “Why are Bulgarians poor?” is not hard, but we get to it by looking at the big picture.   What’s going on in our homeland?   According to NSI more than 1.5 million Bulgarians are under the poverty line, every fifth of us lives with less than 413 bgn per month. If we exclude social transfers (unemployment benefits, maternity benefits, heating, public housing, etc.) the percentage grows to 42.2%. This is half the population. The most affected are the unemployed with 58.9% living under the poverty line and close second, of course, are retirees – 34.3%. The picture gets scarier when we look at the data for those at-risk of poverty, people with incomes close to the poverty line. In 2019 (the latest available data) those Bulgarians are 2.278 mil or 32.5% of the population. Of those 56.9% are single person households with age over 65. The bottom line? Ubiquitous poverty. Lack of funds when we need them most and at a time when our ability to earn is smallest. Meanwhile, the retiree of developed nations travel the world, enjoy hobbies, and live a worthy golden age. I see those two grannies, their equivalent of course, every day. Walking tours in the center of Sofia comprised of those tourists (or at least before the pandemic) shows the difference between the two and it is shocking. The topic of pension systems and social security is too long to get into here and will be discussed in a separate article, but the difference between Bulgarian and economically developed societies is how people invest outside of those government systems. They do it every month and as soon as they start working age.   Why don’t Bulgarians invest?   The answers are plenty but the most common denominator between all is fear. The Bulgarians are afraid that they might lose their savings, and rightfully so. They have seen this happen numerous times in the last 85 years, where they have lost all – whether because of the state, an “expert” advice, or just because they had cash in a bank. Here are some of the examples, which have been widely covered over the years but must be reminded:   State bankruptcies – a few of them   Little known, but widely researched topic lately, are the three bankruptcies of the Bulgarian state during the communist regime – the best kept secret in the 1945-1990 period. Most people remember the 89-92 crisis and fall of the communist party. But this is the third bankruptcy of the state. The first comes in 1960, when after a decade of rapid development of the “social model” the Bulgarian state is left insolvent and BNB stops payments on all foreign debts. Biggest such debts are to USSR, who at the time hold our gold reserves, conveniently transferred to Moscow a few years prior. The second bankruptcy comes in 1978. The reason for it is not only the unchecked development of industries, where we have no market advantage, but also the oil crisis of 1974. The foreign nominated debts balloon to the staggering 6 billion US dollars. Numerous negotiations with the same creditor and a few not-so-valiant gestures by Todor Zhivkov to Leonid Brezhnev lead to two bailout tranches that “patch up” the situation. This fix is a temporary fix as short seven years later the treasury is burdened with newer and larger loans. At the time state-owned enterprises lose market share and economic processes coincide with the call of the USSR. On March 31st 1990 Andrey Lukanov suspends payments on our foreign debts and with no prior notices to the lenders, which in turn crashes the Bulgarian lev and leads to an economic crisis. Family archive Each of those bankruptcies wipes out not only the treasury but also a large part of people’s savings. Each booming growth of the “people’s enterprises” were accompanied with bond issues, not all of which even carried interest. With the first emissions in 1952, 1954 and 1955 the state tapped the savings of millions to finance a utopic regime. Before the 1978 state bankruptcy almost all state-owned enterprises had their own issue, which was sold to (most of the time) unwilling workers. Information from that time confirms that people were made to participate, which of course, strained even more their measly family budget. The crisis of ‘97   The Bulgarian state did not declare bankruptcy at the time (did not stop payments on foreign and domestic debts) but did hit the proverbial bottom in economic development. This is the period, which saw the largest Bulgarian currency devaluation and the complete savings wipeout of two generations. The state, any state, is a poor manager/owner and we should not rely solely on the government for pension or investment. The bonds from the picture are my family’s and I keep them as a reminder of expensive investment lessons.   Bank failures   Even if one decides to be conservative and hold cash in the bank, after all “Cash is King”, they can still lose it all. Numerous banks, which were considered stable at the time, failed miserably in the nineties. Then history repeated itself in 2014 with the spectacular failure of the fourth largest bank, KTB (Corporate Commercial Bank).   Shady investment funds   Life Chose and other pyramid schemes with sophisticated names lured “investors” with the promise of riches. Some would say I’m mocking our parents or our firsts steps in investing but is not so. Schemes and cheats are present today:   Everyone’s favorite cryptocurrencies – from the ICO’s to Dr. Ruja   The popularity of blockchain the cryptocurrencies flourished as stories of riches marked the first adopters in the market/sector. Pictures of mansions and Lamborghinis sparked the imaginations of many who started bidding up prices of each newly minted crypto coin. The initial offerings of those new cryptocurrencies was named ICO (Initial Coin Offering) not by accident – as it very much mirrors the IPO (Initial Public Offering), the first sale of stock on an exchange – a concept well known by the general public. Those ICOs were oversubscribed by “investors” who wanted to become overnight millionaires. Unsurprisingly of course, most of those issues were scams (over 80% according to CoinTelegraph, and over 90% according to CoinDesk). Less than 10% had an actual idea and a team building a blockchain, but almost all of those failed within a year. The results show that over 99% of all “investors” lost all their [...] Read more