Profiting from the Auction Process

Ch2 - Timeframes

There is a buyer for every seller in all markets but who is holding the inventory matters.  In the housing market there was initially a close balance between the long time frame buyer and seller.  As markets heated up, imbalance developed between builders (sellers) who couldn't meet demand.  Price began to auction higher.  With prices rising (advertising opportunity) more and more local builders entered to the market, building for contract / speculation.  Finally inexperienced individual investors were buying 2nd / 3rd houses w/ no money down hoping to flip them in 6 months.  Once the imbalance of demand shifted, the market became oversupplied w/ inventory being held by the shortest of timeframes.

Unlike housing market w/ slow moving inventories, securities markets enable extremely fast build up and liquidation of inventories which makes it difficult to assess market conditions.

Lack of continued large transactions / volume on breaks of values are likely to return to value and be characteristic of balanced markets

Ch4 - Auction and indicators

Art auction - auctioneer starts at some price, if he hears no bids, he drops until bids enter.  Then as bidders enter, the auction quickly increases beyond in the initial bid price.  Finally bidders drop out as price gets too high.  This is a 1 way auction and different than a continuous 2 way auction but similar ideas apply.

Normally as price goes higher demand / volume / speed of transactions will dwindle.  However there are times when higher prices have the opposite effect.  It serves to increase demand rather than shutting it off.  This type of action tells you the auction is far from complete.

Intitial balance (IB) is first 2 30min periods.  Range extension beyond this helps gauge buyer / seller strength.  Auction outside the IB gives clues on the day type.

Ch 5 - Long term auctions

Auctions that occur near bracket extremes provide significant information about the odds of the bracket holding. For example, if an auction that pushes toward the upper extreme occurs on heavy volume, the odds are high that the bracket will not be able to contain the upward movement. Conversely, if low volume accompanies an auction at a bracket’s upper extreme, then it is likely that higher prices are effectively cutting off activity; higher prices are not being accepted as “fair,” the bracket’s extremes are affirmed, and more balancing activity can be expected.

 Markets communicate their need to balance via declining volume, thus the same information that reveals the likelihood of bracket containment is also helpful for identifying when a new bracket is beginning to form. One auction isn’t enough to make this determination

 Once the market leaves a balance area, price often moves rapidly (at least initially) in a nonlinear fashion, liquidity shrinks and opportunity is lost

Ch 6 - Intermediate Auctions

Price has to auction too high before the market realizes it’s too high, and too low before the market realizes it’s too low. In effect, what happens is that price auctions higher until there is a lone bidder; when higher prices cut off activity, then the auction has gone too far.

Trends end in either of two ways or a combination of the two. 

• The first, less-frequent type of ending occurs when volume—which is in the direction of the trend—simply dries up, as if the participants that were driving the directional move are “all in” and there is no one left to participate. The transition is relatively quiet and calm; the market just sits there, lulling market participants into a state of complacency and stasis (several day highs or low at or near the exact same price).
• The creation of “excess” is the second and most common end to a trend. Excess occurs when a market makes a dramatic price high or low on low volume and opposing buyers or sellers react quickly and aggressively by auctioning price in the opposite direction. This type of trend end is often stormy and sudden
• An excess high or low occurs on light or low volume. Most of the investing world, however, thinks the opposite is true. For example, many investors believe that capitulation at the end of a downward auction—when all the sellers finally sell—occurs on heavy volume. But this would go against all the principles we’ve talked about. For example, a market may experience a period of healthy volume as the stragglers (Gladwell’s “late majority” or “laggards”) get rid of their inventory, but the final prices, manifest in the excess spike, are not made on heavy volume. The volume most people incorrectly ascribe to capitulation is actually a result of the action in the other direction, when buyers show up in force and the price spike down is quickly rejected. Confusion occurs due to the fact that after the excess high or low is in place, there is often a dramatic pickup in volume as part of the counterauction.

When an auction attempt fails to establish value in one direction, and price re-enters a previously accepted value range, the odds are good that the market will auction down and explore the opposite end of the accepted range

Ch. 7

Good Short term Trades - 

• break of 2 day balance, monitor closely for continuation once breakout occurs
• Fade bracket extremes when price hangs out at one extreme defined by multiple days of overlapping value.  Opposite of breakout trade.
• occurs on decreasing volume into range extreme
• New highs, then overlapping volume.  Once bids cease to dominate, market will explore in opposite direction
• Bracket breakout - longer term (weeks to months of price bracket) that breaks and then rejects previous range extremes

Following a balance / neutral day trade with any directional auction the following day.

P or b type profiles that extend need HVN as continuation.  In addition they need the following day to be followed w/ extremes pushing away from the P or b bulge, otherwise they can easily retrace

Trend => balance => go with break of balance in either direction

P( or b) shape at Daily balance( or low) usually leads to trend the other way esp when close is near the opposite end of value (ie: if P shape and near /below value area low)

Ch. 8

b shape profile breaking from previous balance.  Look to sell near the upper side of hvn (prob around VAH) for continued move lower.  Example shows that occur, but if buyer steps in and creates a P on that day.  The following day look to buy lower side of hvn (prob around VAL)

• Open Drive - driving against intermediate trend and inside previous days range is unlikely to elongate the profile because it won't attract as much attention.  However, open drive w/ intermediate trend and out of balance will attract attention and likely to elongate. The following day, you expect market to open outside of value in the direction of the drive or at least build value outside previous days value.  
• When you see development contradict  the above, risk of reversal increases.  If not maintain position and let the market work for you
• Open Test Drive - market lacks the initial confidence immediately following the opening bell. It will test a known reference point before rallying. Often large institutional orders will wait for 15mins before executing.  
• Open rejection reverse - rejects previous days range but finds strong opposing force back into it and one time frames back.
• Open auction - no conviction (low confidence opening) on either sides w/ trading above and below open randomly. If inside previous day's value area a non-convictional day is more likely.  
• if opening outside of yesterday's range odds are good of a move in either direction.
• if market enters previous value area and builds, odds are good the market will continue to the opposite side of the days range (or value area)
• no reason to trade in first 5 periods of an open auction.
• low confidence opening (OAIR) after a balance-ish type previous day.  market re-enters value and trades to value low and previous low of day
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Earnings Growth Gap

CAT Gap example, stock price was never justified by its earnings.  Good stocks don't become cheap. 

https://docs.google.com/document/d/1sZJ_7keR1XuGViiAVX040D1Ehb0F0D6w3MlzeXMh8PA/edit

Zero to One - Peter Thiel

Ch 1.

• Horizontal(copy) vs Vertical (new) growth.  Horizontal is moving 1 to n, but vertical is going 0 to 1.  Both are needed but technological advancement is going vertically from 0 to 1.  Globalization is an example of Horizontal growth as it's just a wider market
• Startups are better at going vertically than established companies

Ch. 2

• The 90s weren't fantastic, there were many crises along the way.  The dotcom boom was only Sep 98 - Mar 2000.
• Dotcom crash Lessons
• Make incremental advances
• Stay lean and flexible - iterate instead of having a strict plan and being inflexible
• Improve on competition - easier to start with existing customer base
• Focus on product not sales - if product requires ads or sales ppl, it's probably not good enough
• However, real lessons are probably the opposite
• It's better to risk boldness than triviality
• A bad plan is better than no plan
• Competitive markets destroy profits
• Sales matter just as much as product

Ch 3.

• Monopolies that are the result of great technology are the businesses you want to be in
• Google is a company like this, they dominate most of the search market.
• Framing them as a Search company they are a monopoly.  At $17B in revenue and $37B online advertising total, they dominate.  However, looking at global advertising, they only own 3.4%
• Framing them as a product or tech company they had $2.4B vs a tech market of $1T
• Non monopolists define their market as an intersection of various smaller markets
• money and margins are everything
• Monopolists disguise their monopoly by framing their market as a union of several large markets.
• "We face an extremely competitive landscape in which consumers have a multitude of options to access information" = Google is a small fish in a big pond.
• can afford to think about long term future as money is not everything, just important
• History is a progress of better monopolies replacing incumbents

Ch. 4

• Competition is a destructive force instead of a sign of value.   
• Pets.com PetStore.com Pettopia.com, all selling the same stuff and unable to differentiate.  There is no reason to be in this business.

Ch. 5

• DCF is the way to value businesses.  Businesses that have high growth will be valued much more than low growth businesses because most of the value in low growth businesses is in the near term.  
• Tech companies value will come at least 10 - 15 years in the future
• Zynga - rapid short term growth claiming they have a psychometric engine that gauge appeal of new releases.  How can you reliably produce a constant stream of popular entertainment for a fickle audience? (nobody knows)
• Will this business be around a decade from now?  Numbers won't tell you, it's qualitative.
• Characteristics of a Monopoly
• All are unique: proprietary tech, network effects, economics of scale and branding.
• Proprietary Tech must be at least 10x better in some important dimension to lead a real monopolistic advantage
• Tablets before 2010 had a non-existent market despite Microsoft / Nokia having products.   Until iPad was released, it was clear Apple made an order of magnitude improvement
• Network effects - must start with especially small markets.
• Economies of scale - fixed cost of creating product can be spread over larger quantity of sales.  Many businesses only gain limited advantages by growth. Ie: yoga studios vs software which has 0 marginal cost of producing another copy.
• Branding - ads, stores, materials, speeches, price, design
• Monopoly needs to start with a small targeted audience, concentrated together with few or no competitors.  Paypal initially wanted millions of palm pilot users who had no need for their products.  Pivoted to a few thousand eBay powersellers and they had 25% that market quickly.

Ch. 6

• Don't be well rounded.  A definite person determines the one best thing to do and does it.
• The greatest things Jobs designed was his business.  Apple imagined and executed definite multi-year plans to create new products and distribute them effectively.
• Find a definite future.

Ch. 7

• VC expect returns to be normally distributed.  Bad fail, most flat and good ones return 2x to 4x.  But they follow a power law = small handful radically outperform all others.
• the best investment in a successful fund outperforms the rest of the fund combined
• Only 1 rule: invest in companies that have the potential to return the value of the entire fund
• this will eliminate the majority of investments
• ie: Andreessen invested in Instagram in 2010 for $250k, 2 years later sold it for $78M.  As a $1B fund, they would need 19 instagrams just to b/e.
• VCs must find a handful of companies that go from 0 to 1 and back them with every resource
• Focus relentlessly on something you're good at, but make sure it will be valuable in the future
• Join the best company while it's growing fast.  The differences between companies dwarf the roles inside companies in terms of their equity.
• .01% google is worth more than a startup you create that will most likely fail

Ch. 8

• Most of the easy 'secrets' have been solved and new advances are either impossible or extremely hard at this point.  There are many left to find, but only relentless search will get you there
• Cures for cancer, dementia, disease, age, metabolic decay.  Fossil fuel alternative.  Faster travel on the planet and beyond it.  
• Airbnb addressed untapped supply and demand.  Uber did also.  Insights that look elementary can support many valuable businesses.  What do people already have or do that can be untapped?
• 2 types of secrets:
• Natural - physical world
• People - communication / interaction
• What fields have not been standardized or institutionalized
• ie: nutrition, it's hard to study and most studies are old and wrong.

Ch. 9

• Management is important.  Everyone should be committed to the same goal and have some history of working hard and succeeding.  
• Management should not be taking large salary, but primarily paid if equity does well

Ch. 10

• You'll attract good employees if you can explain why your mission is compelling and why you're doing something important that no one else is going to get done.
• Employees need to all be different in the same way.  A tribe of link minded fiercely devoted people.
• Make everyone responsible for one thing.  Defined roles reduce conflict

Ch. 11

• Sales works best when it's hidden.  People who sell advertising are account executives.  People who sell customers are in business development.  People who sell companies are investment bankers.
• Distribution is essential, despite what engineers think. If you build it they won't come.  Inventions w/o an effective way to be sold is a bad business, no matter how good the product.
• Customer Lifetime Value (CLV) amount of profit earned by customer must exceed avg cost to acquire (Customer Acquisition Cost, CAC)
• Businesses with complex sales model, achieve 50% - 100% yoy growth over the course of a decade.  Good enterprise strategy starts small.  Once you've got a pool of customers, then you can go get bigger deals.
• Marketing / Advertising work for relatively low priced products that have mass appeal but lack a method of viral distribution.
• Facebook / Paypal.  Initial userbase of 24 people.  Realized paying people to join was the best acquisition strategy, at $20 per customer and 7% daily growth.
• Want to acquire the most valuable users first.  To Paypal that meant a niche ebay PowerSeller.
• Need to sell your company to the media, don't ignore them.

Ch. 12

• Machine + Human is much better than AI.  AI is good at filtering but humans much better at determining accuracy of what is being filtered.
• Companies that look to improve / complement human effort is the best.  However most schools seem to think that replacing human effort is the primary goal.

Ch. 13

• cleantech failed because they couldn't make break thru tech, only small incremental improvement
• they were unable to get any of the 7 main questions. engineering, timing, monopoly, people, distribution, durability, and secret.
• monopoly doesn't exist because consumers don't really care how electricity is generated.

Ch. 14

• founders are weird people.

Mark Douglas Think Like a Professional Trader

First you have to identify an edge
Once you have an edge, fear is what prevents you from realizing your system's edge

3 development stages

• Mechanical - moving stops at this stage will cause you to perform worse.
• Subjective - understand nuances of your strategy, you can move stops based on your gauge of high / probability once in the trade and gain more edge
• Intuitive - in the zone and you can sense the flow but can't really explain it - generally only lasts for a couple hours a day.

Euphoric trading generally leads to bad draw downs

Learning to trade without fear is believing you don't have to know what is going to happen on a trade by trade basis to win or make consistent money.

• The edge will only appear over a series of trades.  
• Trying to only enter trades that are 100% winners leads to not placing stops because you think the trade will work no matter what so a stop is not needed.
• Prices moves because other traders buy / sell after you.  You need other people to move price.  If they don't appear there is nothing you can do about that.

The information displayed on the screen is not inherently threatening.  Markets become threatening when your expectations define information as:

• being wrong
• losing
• missing out
• leaving money on the table

3 types of traders

1. Consistent winner w/ small draw downs that are a normal part of any system
2. Semi-consistent trader w/ extremely large draw downs that are the result of trading errors
• don't define risk in advance
• define risk but don't take the loss where system's edge is likely to work
• hesitate - getting in too late
• jump the gun - get in too soon when signal never develops
• get out of winning trade too soon - leaving money on the table.
• let winning trade turn to loser w/o taking profits
• move stop closer to entry point, get stopped and market trades back in your favor


3. Consistent loser w/ large wins

Large Institutions create reverse auctions where they drive price one way, collect stops and then drive it back.  Most technical analysis has no relationship to why these large institutions drive price. Technical indicators quantify the collective information

Change your expectations of the outcome from a winner to that just something random will happen.

Your state of mind is always the absolute truth.  Nobody can tell you that you're not feeling fearful or confident.  How you interpreted market events to get you into that state of mind can be dysfunctional.

• dysfunctional belief - the reason for putting on the trade has almost no correlation with why the market actually went for or against you.  
• analysis just puts you in a position to recognize when the likelihood of a trade has a particular outcome

The goal is to get to the point where anything that is inconsistent with what you're trying to accomplish does not enter your mind anymore

• anything that you're thinking, saying - negative thoughts, wasting time, unnecessary chatting
• doing - moving stops, trading where you shouldn't or marginal trades, feeling bored.
• deliberately refocus your attention on your goal - always go 1 step further.

Stop analyzing - technical analysis does not improve 'in the moment'.  If you get a signal, take your trade with your plan.  Stop thinking and trying see why the trade will work or not

• An identical setup has a random outcome.  The same people involved with that last trade are no longer here
• Disconnect the mechanism in your brain that any similarity in the past has any bearing on the future.  That is the difference in thinking in probabilities that separate good traders from everyone else.

Trade for a new reason - acquisition of new skills not the outcome of the trade.

• Take 20 trades in a row and set up the risk to take it assuming 20 losses in a row.
• You have to be completely comfortable losing the $ amount of 20 losses in a row.
• Rarely has he met a trader that doesn't have a problem after taking 3 losses in a row.
• Once you have the skills you'll make all the money you want but you have to be comfortable potentially losing every time.

Professional Mindset

• Anything can happen
• Every moment is unique
• Edge is an indication of a higher probability of one thing happening over another
• There is a random distribution between wins and losses on any given set of variables that defined an edge
• You don't need to know what will happen next.

Rebalancing and Indexes

This rebalancing issue may explain why most active managers underperform: According to Hendrik Bessembinder, a finance professor at Arizona State University, the entire gain in the U.S. stock market since 1926 is attributable to the best-performing 4 percent of listed companies, and the cap-weighted indexes captured all of it because they don’t rebalance.



Link to Article

Synthetic VXX 2006 to Present

Synthetic VXX prior to 2010

VXX hit a low in early 2007 at a synthetic price of 25k.  During the 2009 low it went to a synthetic high of 162.5k.  This was nearly 550% above the all time low and took nearly 4 years to recover.

https://flare9xblog.com/2017/12/02/vix-term-structure/

Assuming a short VXX position held through that bear market the following would not have led to a margin call.