This section incorporates my more reflective thought pieces which I typically write on a weekly basis. I have included around 100 of my Sunday letter’s to the RAPA community. If you would like to continue receiving these letters please complete the contact form below. Note: if you click on the follow the blog via email on the right margin you will receive every post on this site, which may be too frequent for many of you as I tend to record my stream of consciousness. The form below will be a more limited email update around 1 x per week.


Thy Shalt Not Covet

As you have probably worked out from my weekly letters, I am somewhat of a contrarian, but the truth betold I am more of a libertarian. I really don’t enjoy self appointed authority figures telling me or others what to do. My poor parents got to experience this side of my personality early on with my smoking, drinking and naughty school boy behaviour; alas I have grown up! The reason for the confession is this week I finally took the plunge and read Thomas Piketty’s “Capital in the Twenty-First Century.” For those of you who haven’t followed the hype it has been billed by many as the Economic book of the year. I was warned that it comes with a healthy dose of socialistic bias, but I wanted to see for myself.


I won’t bore you with the gory details as this is a major work and reads 600 pages long. To set the scene I will quote from Professor Piketty’s concluding remarks.

“I have presented the current state of our historical knowledge concerning the dynamics of the distribution of wealth and income since the eighteenth century, and I have attempted to draw from this knowledge whatever lessons can be drawn for the century ahead.”

“The sources on which this book draws are more extensive than any previous author has assembled, but they remain imperfect and incomplete. All of my conclusions are by nature tenuous and deserve to be questioned and debated.”

His central thesis is the rich get richer and that isn’t good. OMG is he for real, did he really need to write the most comprehensive historical account of inequality to place this fact on record? Don’t we know this from time imemorial? The 10th Commandment of Thy Shalt Not Covet a few thousand years ago gave us a clue that we won’t all have what we want and that our desires will have us wanting what others have got.

To me there will always be the haves and the have-nots its a fact of life, deal with it. Yes I know that society can become more unstable when inequality distortions ignite simmering flames of economic survival and when jealousy reigns supreme. I get all that, but I don’t get placing more taxes as Piketty is proposing on capital as a solution to the inequality problem. I am not proposing a solution because I don’t believe there is one. I think it best to leave as much up to the individual actors making up society, through the natural self regulating mechanism of trying to better ones self, a natural equilibrium is reached. I am not for one second naively saying that equilibrium is a utopian existence, rather through the natural  process of pain and suffering a middle ground is found, one that works for a period of time. In some cases this middle ground is more equal than other times but it is never equal.

AUGUST 31, 2014

Shadow Trading

Dear RAPA membersI want to discuss a really big topic in both philosophy and psychology and judging by the feedback I get I will consider researching a more detailed paper on this subject. Let’s start with a classic Jung quote.

The Shadow 

We start our lives with our psyche “Whole” but as we encounter life and its challenges and cultural demands we start to split our “Self” by developing our ego through our “persona”, this is the side of our personality which we wish to portray to the people around us. However,  for every positive characteristic there is a dark side – the “shadow“, this is the unwanted even despised part of our personality that we cannot deal with on a conscious level so we push it into the depths of our “personal unconscious”. Ok, so what if I have a dark side so long as it is buried in my unconscious who cares?

It isn’t so simple because the material making up the shadow has energy/libido and when it accumulates more energy than the ego can deal with it erupts usually in a rage or unpredictable behaviour or sometimes even depression. The shadow is an autonomous body within our psychic makeup and its behaviour is wholly unpredictable. Let me give you an example: Mr Jones is a day trader who trades breakouts on the S&P e-mini, he has recently modified his system and he is anxiously testing it on the market with real money. The system requires extreme patience to pin-point its entry with 5 green flags required to enter a trade. Mr Jones has anxiously watched the market all day waiting for a confluence of signals to meet the required entry signal. Nothing happened, the day has frustratingly passed with no trades being signaled, Jones has had to sit on his hands all day showing tremendous restraint and respect for his new system all the time itching to hit the trade button. Mr Jones gets home from his day at the office feeling a little drained, but also pretty proud of himself for withstanding all the temptations and being true to his system. He walks through the front door and his young kids run to greet him. He puts his briefcase down and kisses his wife then she says, “Honey can you do Jordan’s math homework with him a little later”, like a thunderbolt out of the blue and totally unexpected, Jones goes balistic he has a massive argument with his wife shouting how selfish and demanding she is. LOL – does this sound familiar.

What has just happened is Jones failed to acknowledge the unconscious shadow material that was built up during his day. As I stated in the beginning we start our life “Whole” and then due to the stresses and strains of our personal development in our early years our psyche undergoes many challenges splitting into ego and shadow, but this isn’t how things stay forever. Unfortunately for some it does stay split and equilibrium becomes more distorted, but for the most of us and I believe even more so for traders, as we grow older we start working intensly on our own personal development. We start trying to become whole through the Jungian process of individuation or Nietzsche’s process of Ubermensch:

Wholeness for humans depends on the ability to own their own shadow” – Carl Jung.

If you have been paying attention, the shadow doesn’t just develop from bad characterisitics on their own. Nature works with opposing forces, night and day, life and death, creation and destruction, male and female, up and down. With this in mind even when we do good things, stuff that we bring to consciousness as part of our ego persona we are at the same time creating negative energy that is being deposited into our shadow. As the ego and the shadow come from the same source, you cannot have one without the other. The billion dollar question is how do we deal with this material so that it no longer carries the autonomous charge of a walking time bomb, ready to embarrass us or damage our reputations.

In order for us to live the life we wish for, it is incumbent upon us to make known to ourselves the sides of our personality that we don’t like. By acknowledging the shadow we bring to consciousness and diffuse this potent energy; what is extremely interesting is that the unconscious cannot tell the difference between symbolic or real behaviour. In the case of Mr Jones a 1-5 minute symbolic ceremony is probably all that is needed to deal with the trading days negative shadow energy.

AUGUST 17, 2014

Celebrating Life

Dear RAPA membersI was supposed to send out an update of the Leaderboard portfolio’s on Friday; after battling to come up with an easy way to present the portfolio’s progress I have found a solution and delayed it until this coming Friday.During the week I joined a major family gathering in Melbourne to celebrate my mothers miraculous one year anniversary from surviving what was said to be an inoperable cancer with an almost certain terminal outcome. From the darkest of all news, one miracle followed another and my mother survived a difficult operation removing what turned out to be a begnin tumour and is now thank G-d fully recovered.


“…there is much evidence that variations in the framing of options (e.g., in terms of gains or losses) yield systematically different preferences (Tversky and Kahneman, 1986).”

“The term frame dependence means that the way people behave depends on the way that their decision problems are framed (Shefrin 2000).”

One of the most powerful biase’s in behavioural finance is the way we make decisions to problems that are framed in a specific way. I can assure you when a doctor tells a patient that they have cancer with a 25% chance of dying the patient very quickly becomes overwhelmed with a sense of dread despite knowing that there is a 75% chance of survival.

While in Melbourne I met with one of our traders who continues to produce steady profitable returns. He shared something with me that got me thinking. He said that recently he had some client withdrawls despite being profitable. The client response was that he hadn’t made them as much profits as he had made in the past.

The insight I would like to share is that when a potential investor is presented with a performance analysis of a traders return they do not give equal weight to the profit and loss potential. The greed factor almost certainly overwhelms the decision to invest. Let us say the performance presented is a 30% return with a 10% max drawdown. The investor here “says” that he is comfortable with the drawdown but be assured that should the historical drawdown be tested the investor will most liikely bail. The 10% drawdown played very little role in the investment decision, rather it was all about the allure of the 30% return. The fact that drawdown is an essential element of investing is ignored.

I have one further insight that is more an observation than an empirically proven thesis. I believe there is even more risk of losing a client to the dissapointment of underperformance than there is to being in drawdown. When you are in drawdown as an investor you feel trapped, you don’t want to realize your loss. However, when a manager underperforms you still have profits so there is far less of a hold on you.

The best way to keep investors around for the long term is probably to frame your pitch by downplaying your previous performance. If you achieved a 30% return last year, of course show the return, but be sure to highlight that 30% was an exceptional year and that 15% is a more realistic target. Of course this assumes you are after “sticky” money. If not say 30% was a poor year

AUGUST 10, 2014


Dear RAPA membersJust to let you know that we have a number of strategic partners who are actively looking to allocate money. Almost all of our placements have been in the FX space of late and we are still looking for FX managers with track records of more than 12 months in one account. However, there are also opportunities in the futures space. If you think we should take a closer look at you, please send us more narrative on your story, and be sure to load your performance numbers on RAPA as no performance numbers = no capital allocation.Today was the City to Surf run/walk in Sydney; 83,000 people take part in this annual event through the streets of Sydney from the “City” (downtown) to “Surf” (Bondi beach). What an amazingly well organized event that makes its way through heavy suburbia as if the roads were designed for this event; it is a great introduction to my topic for today – adaptability.

The snake which cannot cast its skin has to die. As well the minds which are prevented from changing their opinions; they cease to be mind. ~ Friedrich Nietzsche

The smart folks at MarketPsych lead by trading psychiatrist put out a great newsletter this week, and it is from there that I am taking the material for todays letter.

Psychology professor Philip Tetlock performed ground breaking research on the ability of experts to forecast the future. As you know I am not a great believer in the ability to forecast the future. I maintain that if one has an edge then it is at the margin. I was intrigued to see that Prof Tetlock’s research shares these sentiments. He claims that experts forecasting is near random but there are what he calls “super-forecasters” that are able to consistently make better predictions.

As you might expect, these elite forecasters tended to score better on measures of intelligence than the other participants. But they all shared one other trait too: open-mindedness. In everyday life, open-mindedness may be mistaken for having liberal political views, but in psychology it is thought to reflect how well you deal with uncertainty. Crucially, open-minded people tend to be able to see problems from all sides, which seems to help forecasters overcome their preconceptions in the light of new evidence. “You need to change your mind fast, and often,” says Tetlock.”

This all makes sense for a discretionary trader but what if you are a mechanical trader? I think the message you need to take from this is that because your mechanical system is locked into a certain algorithmic sequence of processing then be aware that your system will not work for all market conditions, and this is where you the captain of your proverbial ship need to take responsibility for managing how you deploy your system and in what conditions.

AUGUST 3, 2014

Second Chances

Dear RAPA membersLast week I asked a few questions to our community of traders and I thank those who answered. One of the questions was, Do you think you will make it as a professional trader, knowing that something like 90 – 95% fail? Everyone said either they have made it until now, or they believe they will succeed.I want to share with you an optimistic observation based on my experience of nearly 15yrs managing money. When I look around the industry locally and internationally and speak to people and read about their backgrounds almost all of them have failed in some shape or form. Failing in the trading world doesn’t necessarily mean that you went bankrupt or that you lost all your clients money, it could mean that but doesn’t have to. For some accounts a 10% drawdown could be a failure, or in some cases flat or small profits could mean failure and the withdrawl of client funds. What I find with the people who have made a long term career in trading is that when they fail they have picked themselves up and reinvented themselves either with new employment or the relaunch of a new strategy or fund.

We often complain about the myopic (short term) nature of investors. Basically if you haven’t performed in a year the chances are high that your investors will be ready to move on. This is annoying for traders who have proven themselves over lengthy periods only to be going through a short term slump. There is a flipside to this short terminism; a trader can always setup a new shop or new strategy or new fund and within a year or two or three of solid performance you can be back in the game.

If there is a message you can take from this note, it is that just because the account you are managing failed or lost its investors doesn’t mean that its game over. It is at these times one needs to reflect and consider where things went wrong and what can be done to improve so that the same mistakes don’t recur. There are very few succesful traders/ fund managers in the investment world that have had continous track records in one account or fund throughout their careers. It is more likely that a successful trader will pull together a series of different non consecutive track records having dealt with failure along the way.

I am not saying that 90% of traders don’t fail, rather I am saying that just because you have failed doesn’t mean that you are part of the 90% of trader that do fail.

JULY 28, 2014

Schrodinger’s Cat – Multiple Realities

Dear RAPA membersAustrian physicist Erwin Schrodinger designed a thought experiment in 1935 describing a paradox in the way quantum mechanics applied to everday objects. The scenario presents a cat that may be both dead and alive, with its status dependent on a random earlier event. I alluded to this paradox in a letter I wrote 3 weeks ago about the fact that quarks change their reality when observed.I recomend this 1 minute video to help explain the paradox. The reason why I bring this up is because manifestations of this scientific discovery keep jumping off the pages of so many articles I am reading across a diverse array of intellectual thought, that I simply felt I had to highlight the point. In essence it is possible for acircumstance to have multiple realities; however, we like to believe that only our observed reality is correct but in fact nature teaches us that there can be multiple realities, it is our observing that forces nature to choose a single reality from the other. I think this is a such a powerful concept, and would like to extend this observation by refracting it through the prism of the media. What I am saying can be applied to any walk of life, I will limit it to Central Banking in this letter. The controlling powers of these institutions have realised that projecting through the media the way they wish the public to observe the said economic conditions is inevitablyhow these conditions manifest in reality. I love the concept of us becoming God like but there is one thing I would like to add lest we think that our ability to shapereality is completely within mans control, I believe Hyman Minsky’s Instability hypothesis and perhaps Taleb’s theory of Antifragility (haven’t read the book but the name sounds promising) help bring some understanding to the limitations of this creative power. There are limits to the reality that we can create, Objective Collapse Theoryand a process called “Decoherence” places some sort of natural governor on how far we can take things. I am well out of my depth intellectually here but intuitively what I said feels right. We can shape reality but in the end we can only go so far.

Before I leave you I have a favour to ask. Below are a few questions I would like you to answer. I use the word “trader” and “investor” interchangeably. Simply click on the reply to email button and respond if you are up to sharing.

Do You Trade For a Living?


If you answered yes to the above, do the fees that you charge clients cover your expenses (including market related salaries)?


If you currently do not cover your expenses from trading, what are you doing to supplement your living expenses?

trade my own funds

Do you believe the market conditions play a role in your trading performance?


If you believe market conditions affect you, how do you address these issues?

Do you believe you have reached your full potential as a trader?


Do you think you will make it as a professional trader, knowing that something like 90 – 95% fail?


Do you think with the adancement of technology you are able to compete with the larger institutions?


Do you believe markets are random, or do you think that you have an edge (explain)?

Do you think that making $$’s is more important than producing favourable risk-adjusted returns?


Do you find non trading days less exciting?


When you have open positions, what do you do to distract yourself from closing trades prematurely?

use automatic systems and supervise system but not specific trade.

JULY 20, 2014

Understanding the RAPA Score – White Paper

Dear RAPA membersIt is important to evolve and improve one’s craft. We have operated the second iteration of the RAPA Score algorithm for more than a year and feel ready to launch a new iteration. During the course of this week you will see different scores representing your equity curve, this may have an impact on your ranking.When we compiled the current RAPA Score we gave certain fixed weightings to various components of the score based on our experience as asset managers. With our new score we have been able to remove the subjective nature of the weightings and produce something simpler and more elegant, kind of like Occam’s razor (the principle that in explaining a thing, no more assumptions should be made than are necessary).

Before presenting the new score it is important to demonstrate that it is superior to the old score. In the table and chart below, you will see the difference between the scores ability to forecast future risk-adjusted returns over a 3, 6 & 12 month period. The improvement may seem small but they are statistically significant and were subject to more than 20 tests using randomly generated dates. In all cases the new score was better than the old. I must add that forecasting the future performance of risk-adjusted returns is probabilistic at the margin. You should view anyone who produces dramatic improvements with a healthy dose of scepticism. You may not fully understand the information presented below before reading the white paper so glance at it now and come back to it if you are struggling to make sense of it.

We understand that it is not everyones cup of tea to read technical documents, but we urge you all to read the white paper which you can download here. We are extremely proud of our achievement and feel that the RAPA Score makes a significant contribution to the asset management landscape. Feel free to share your thoughts with us.

JULY 13, 2014

Cultural Complexes

Dear RAPA membersDid you realize the pilot of an aircraft spends 90% of the journey making corrective adjustments to keep the plane on its chosen flight path? Despite the plane wanting to veer off course for the bulk of the flight it still lands (most of the time) at its chosen destination.I think this analogy mirrors most successful career or life paths. Whilst we may know what our ultimate goal or path is we are often faced with many choices or circumstances along the way that throw us off that path or at least try to and force us as pilots of our own journey to make adjustments to ensure safe arrival at our end goal.

One of the reasons I wanted to meet with Dr Sandford Drob in New York last month was to discuss whether there was a way of forecasting if a patient would overcome a psychic disturbance. My questioning comes from the idea that if society is in the throws of clear neurotic behaviour, can one apply psychotherapeutic techniques to forecast the probable behaviour of society to the said archetypal complex. Dr Drob is a noted expert in the field of criminality and acts as an expert witness in many homicidal court cases.  He said to me this is precisely what the judge looks to him for in a criminal matter. It is his job to advise the court whether he believes the offender is likely to committ the same crime again, and while he believes and the system believes that one can make such probable assumptions, it remains incredibly difficult to do reliably. As an expert in Jungian analysis he believes like I do that one can place society metaphorically speaking “in therapy”.

Jung wrote in 1976: The complex has a sort of body, a certain amount of it own physiology. It can upset the stomach. It upsets the breathing, it disturbs the heart – in short, it behaves like a partial personality. For instance, when you want to say or do something and unfortunately a complex interferes with this intention, then you say or do something different from what you intended. You are simply interrupted, and your best intention gets upset by the complex, exactly as if you had been interfered with by a human being or by circumstances from outside. 

In Jungian psychoanalysis one of the main goals is to make these personal complexes more conscious. This week I was thrilled to discover in my ongoing studies that Thomas Singer has built on the foundational work of Dr Joseph Henderson (1974) a theory called the Cultural Complex. The cultural complex can possess the psyche and physical body of an individual or a group, causing them to think and feel in ways that would be quite different from their rational way of behaviour. In the words of Singer; “The basic premise of our theory, then, is that another level of complexes exists within the psyche of the group and within the individual at the group level of their psyche”. Singer maintains that until now Jungians have not taken full advantage of Jung’s original theory of complexes, and this has left a major gap in analytical psychology.

In future letters I am very keen to work through some of the classic personal complexes which we all encounter every day of our lives. I always like to bring practical relevance to the trading world with the subject of these letters. Complexes and their meaning are unavoidable consequences of the journey towards understanding ones “self”. I believe traders have the unique ability to identify these complexes as many of the day to day doings of a trader have causal affect ladden responses. Together we will examine some of the major complexes, like the father, mother, God, hero, inferior complexes and then hopefully we will get to a major area of my interest the Cultural Complex.

JULY 6, 2014

Creating Reality from a Quantum Mechanics Perspective

Dear RAPA membersI am back from my travels to the US which I believe was a successful trip. In the space of 2 days United Airways managed to lose my luggage twice, the first time resulted in me attending a meeting at the Chicago Board of Trade in shorts, as I arrived in Chicago on Sunday night and no shops were open to purchase clothing and my meeting was scheduled for 8am Monday morning, here is yours truly being photographed by the security guy.

There is an amazing concept in psychology that by simply changing your perspective you can create a new reality and diffuse harmful emotions. To many this seems like hocus pocus but the discovery of Quarks – sub atomic particles in quantum mechanics helps us understand this very concept. You see these building blocks of nature have 2 very unique characteristics: One is that particles are changed when observed, which means the real particle can never be seen. The second is that quarks can be seen in two places at the same time.

Let us revisit the first characteristic. If I am a trader and I know that I am not performing at my full potential, I can decide to analyze my trading behaviour to see where I am going wrong. If I observe that the reason for my poor trading is from impatience and through this observation I gain true perspective on how this behaviour is affecting my performance, then by sheer nature of quantum mechanics and the energy forces of the mind I will have created a new reality and a way forward to trade with potentially less impatience.

One more time; what I am trying to say is that there is no reason to feel locked into a certain emotional state of being. By observing you automatically change reality. The depth to this statement is observing alone does not guarantee that change will take place for the good. In order for a positive new reality to take shape we need a clear perspective and only then can we create a healthy new reality.

I think this highlights the need to engage in a dialectic with a mentor or coach or teacher or partner or analyst or pastoral carer. On our own we struggle to observe and even more we struggle for perspective.

JUNE 29, 2014

Strategic Partnerships & Perspectives

Dear RAPA membersI write this letter from a very different place to anywhere else I have wrriten. It is midnight on Saturday and I am sitting on the sidewalk on Broadway street – Times Square; alongside a whole bunch of homeless people who are kindly sleeping so as not to disturb me. I take these weekly deadlines seriously and wanted to share some of my enthusiasm.This week has been spent with a couple of strategic partners that we look forward to sharing details with the RAPA community in the coming weeks. For me personally it has been a terrific flat out week with not a moment to spare. Frankly that is the way I like it, if I am going to be away from my family then I like to be busy. Along the way I was able to meet with 2 individuals that are at the top of their game albeit from 2 different worlds.

The first person is someone I regard as one of the leading researchers in the field of quantitative finance:

Marcos López de Prado is Senior Managing Director at Guggenheim Partners. He is also a Research Affiliate at Lawrence Berkeley National Laboratory’s Computational Research Division (U.S. Department of Energy’s Office of Science).

Before that, Marcos was Head of Quantitative Trading & Research at Hess Energy Trading Company;(the trading arm of Hess Corporation, a Fortune 100 company) and Head of Global Quantitative Research at Tudor Investment Corporation. In addition to his 15+ years of trading and investment management experience at some of the largest corporations, he has received several academic appointments, including Postdoctoral Research Fellow of RCC at Harvard University and Visiting Scholar at Cornell University. Marcos earned a Ph.D. in Financial Economics (2003), a second Ph.D. in Mathematical Finance (2011) from Complutense University, is a recipient of the National Award for Excellence in Academic Performance by the Government of Spain (National Valedictorian, 1998) among other awards, and was admitted into American Mensa with a perfect test score.

The second person I met with is a deep philosophical and psychological thinker whose books and academic writings I connect with on a very deep level. He is an expert in both Jungian thought and the ancient Jewish Mystical writings.

Sanford L. Drob is a Core Faculty Member in the Clinical Psychology doctorate program of Fielding Graduate University (www.fielding.edu). He is also a member of the clinical faculty of New York University Medical School and was for many years the Director of Psychological Assessment at Bellevue Hospital in New York. He holds doctorate degrees in Philosophy from Boston University and in Clinical Psychology from Long Island University.

Dr. Drob’s philosophical and psychological interests originally led him to the study of contemporary theology with Thomas J.J. Altizer at Stony Brook and analytic philosophy, existentialism and phenomenology at Cornell and Boston University. His philosophy dissertation, which was written under the guidance of the Neo-Platonic philosopher J.N. Findlay, was a study and critique of the philosophical psychology of Ludwig Wittgenstein. Dr. Drob later went on to analyze the spirituality of halakhicJudaism in Wittgensteinian terms. As a doctoral student in clinical psychology he developed interests in the philosophical foundations of the various psychotherapeutic schools, and took a special interest in psychoanalytic and Jungian thought.

Earlier today I started and finished reading one of the most authentic trading books I have ever read, “Chronicles of a Million Dollar Trader” it is a book about: humanity, tenacity, wisdom, ability but most of all sheer determination. If any of you reading this believe you are a great trader, see if your attitude towards success matches Don Miller.

I hope Jonathan Shapiro won’t be mad at me for sharing this article with our small RAPA community. You may recall an earlier Joey’s programme we ran with our No 1 ranked trader Kevin Saunder’s; here is an article that the top Australian business newspaper featured.

Lastly I want to end off by saying that one of the amazing things about leaving your own bubble and travelling to different parts of the world and engaging with experts in their respective fields is that it gives you a whole new perspective.

JUNE 22, 2014

Framing your Portfolio

Dear RAPA members

We launched the RAPA portal on the 5th November 2012, on the 25th of Feb 2013 we launched a new version of our RAPA Score™ and during the course of the next 10 days we will launch a new and improved version of the RAPA Score™. I won’t steal Vladimir’s thunder and will let him introduce you to the new and improved score which he has spent the better part of 6 months working on. 

We have discussed in previous letters how the framing of a question or circumstance can have a dramatic effect on the way we respond to the situation; even in a seemingly irrational way. Lets define a decision frame according to Tversky and Kahneman (1981), “the decision-maker’s conception of the acts, outcomes, and contingencies associated with a particular choice.” Or in my language the way the question is framed has a direct impact on the way the frame is answered.    

A major bias in behavioural finance is the disposition effect; it is an offshot of prospect theory that Tversky and Kahneman founded and is when we cut our winning trades too quickly and hold on to our losers for too long. In trading this is like comitting a cardinal sin. 

The academic literature complete with real world testing leads us to an interesting idea within the way we frame our investment portfolio. Narrow decision frames tend to be sub-optimal (Kahneman (2003)). Therefore traders that invest in only one trade at a time tend to demonstrate more disposition effect than traders that widen their decision focus on multiple trades in a diversified portfolio. It is not enough however to simply increase ones portfolio with multiple trades; rather it is important to treat the multiple trades as part of one great whole otherwise you are likely to still be buffeted by the emotions surrounding each individual trade. 

JUNE 15, 2014

Closed vs Open Systems in Psychic Energy and Money Supply

Dear RAPA membersI write this note with a fair degree of trepidation the subject matter is very close to my heart and an area I have spent considerable amount of time and energy studying. It is complex and it is personal and to convey the idea clearly in a short note is difficult. Anyway here goes.You may have realised that I have a deep interest in Depth Psychology and more specifically the School of Analytical Psychology founded by Carl Gustav Jung. Jung a Swiss psychiatrist was to become a collaborator of the older and more famous Freud and together they became a major force in the field of psychology; specifically in relation to their work on the unconscious and the psychoanalytic therapeutic process. For some time Jung had reservations about the tight, closed, repressive model that Freud had designed to describe the psyche. By October 1906 Jung felt compelled to raise his opposition to Freud in a series of letter’s questioning his insistence on the centrality of sexual conflict as the base of all mans complexes and neuroses.

There were other fundamental differences, however the central theme for Freud was that the prime motivator of human activity and thought is libido, a nice Latin word for sexual energy. This subject of libido proved to be the central theme of difference for Jung and Freud. Jung developed his own theory on the subject which he calledPsychic Energy whereby he wrote that through the evolution of human consciousness and culture one could seperate the human drive from sexuality, and will then took on other forms such as hunger. It took Jung in his Collective Works 20 large volumes to fully explain his model so excuse me when I say it simply like this. Jung doesn’t believe that the psyche is a closed energy system; rather it is mostly a closed system but still open to psychic influences from the surrounding world. In laymans terms Jung believed that the human psyche was plugged into a spiritually infinite dimension, whereas Freud was more closed in his style of thinking, believing that everything comes from within drawing towards entropy from the libido charged sexual conflicts.

Berman where the hell are you going with this?

Last week I touched on the subject of Central Banks and how they are running the show. This prompted me to think about the debate regarding Endogenous Money Supply (closed system) as put forward by the Heterodox Economic Schools of Thought (my camp) and the Central Banks open system. The Y-axis is interest rates i in the diagram above and the X-axis is money supply ms. So Exogenous money supply means that an independent party such as the Central Bank through its printing press can determine the amount of money in supply in an effort to influence the interest rate. Endogenous means from within, so  demand for money will shift outwards (see diagonal left to right downward sloping) if there is an increase in the output in the economy resulting in increased demand for money and therefore influence the money supply. Alternatively the money supply can be influenced by changes in the interest rates as dictated by the demands of the savers and borrowers.

I see strong parrallels between the open and closed system in the money supply model and the internal world of the psyche. However, as someone who believes in a more open psychic model such as Jungs Analytical Psychology I am struggling to fully reconcile the parrallel to my favourite Austrian Schools endogenous (closed) model. My issue being Jung opens his system to an infinite spiritual dimension. The source of this spiritual connection comes through archetypal images and symbols as interpreted through our collective unconscious. With this comes the power for man to somehow grow and become whole – individuate. To believe that Central Banks have the Omnipotence to provide infinite solutions to the economy is in my belief to suffer from a God Complex. I want to believe that a man made institution such as a Central Bank can in fact solve all of our economic problems. This desire I believe comes from the Shadow (usually a negative), an unconscious aspect of the personality that the conscious Ego has not yet identified.

For now I can reconcile the idea of endogenous money with the understanding that an economy is still able to create money through the commercial banking system without the need for a Central Bank and all its political motivations. In a relatively recent debate Professor Steve Keen (closed system) highlighted this point to Professor Paul Krugman (open system) and with this understanding I think I can accept that the term endogenous money supply is not to be understood in the classic Freudian sense but rather similar to Jungs mostly closed but partially open system.

JUNE 8, 2014

What Happened to Austerity

Dear RAPA members It is a long weekend in Australia so I will make this brief. Tomorrow we celebrate the Queen’s birthday which took place in April – go figure.
A friend of mine this week was telling me with pride that he could never pay his monthly credit card bill from his monthly income, rather he paid for it from the access facility attached to his home loan. Does that sound familiar? The ECB this week initiated a further extreme incentive to encourage expenditure by taxing banks with a 10 basis point penalty for any cash left with the ECB overnight.


Economic history teaches us to achieve sustained economic growth you need investment and savings, and by investment I mean productive investment and by savings I mean spending less than I earn.
Ben Hunt wrote an excellent piece this week on the Minsky Moment stating something very sensible. The Minsky Financial Instability Hypothesis calls for a sudden crisis when the debt enduced investment cycle no longer has the cash flow to sustain the “Ponzi” scheme. The difference however when a sovereign engages in a Ponzi scheme is that it can continue to service the debt by simply printing more money. The point I wish to highlight here is that we keep reading and hearing about government deficits and the increase in Debt to GDP ratios of governments as if we are about to have a Minsky Moment. I think we need to prepare ourselves for the potential that government debt may continue to increase for some time before there are any major shocks to the system.
Lastly I decided to take a look at Google’s Trend indicator to see how often the word “Austerity” appears in news headlines. You can see that this term is not on anyones radar at the moment. It is as if the sovereign debt crisis has magically been solved. My parents always taught me that spending more than you earn will lead to poverty and common sense taught me that solving a debt crisis with debt doesn’t solve anything. Time will tell if this monetary experiment will buy the time needed for economic healing.

JUNE 1, 2014

The Common Knowledge Game and the Green Eyed Tribe

Dear RAPA membersOne of the most powerful forces in social dynamics is the power of the crowd. Despite the teachings of classical economic theory we know that the power of the crowd has the ability to overwhelm the sensible wisdom of individual members in favour of a less sensible crowd. One can argue that today we are very much embraced by the narrative of the Common Knowledge Game. We have a prevailing narrative that Central Banks have got this one covered. There was the Bernanke put, now the Yellen put, and in the last week it looks like Mario Draghi is priming the pump for the ECB to further stimulate the Draghi put. The obvious question is when will this Common Knowledge Game change course and how will the process unfold.Game Theorist, Ben Hunt, Ph.D. writes a tremendously insightful letter focusing on the markets from a game theory perspective using a toolbox he calls Epsilon Theory. He kindly shares his wisdom free of charge, sign up here if what follows appeals to your style of thinking. Ben does such a fine job of describing the Common Knowledge Game and how new Common Knowledge Games unfold that I have quoted liberally from his letter.

On the Island of the Green-Eyed Tribe, blue eyes are taboo. If you have blue eyes you must get in your canoe and leave the island the next morning. But there are no mirrors or reflective surfaces on the island, so you don’t know the color of your own eyes. It is also taboo to talk or otherwise communicate with each other about blue eyes, so when you see a fellow tribesman with blue eyes, you say nothing. As a result, even though everyone knows there are blue eyed tribesmen, no one has ever left the island for this taboo.

A Missionary comes to the island and announces to everyone, “At least one of you has blue eyes.” What happens next?

Let’s take the trivial case of only one tribesman having blue eyes. He has seen everyone else’s eyes, and he knows that everyone else has green eyes. Immediately after the Missionary’s statement this poor fellow realizes, “Oh, no! I must be the one with blue eyes.” So the next morning he gets in his canoe and leaves the island. But now let’s take the case of two tribesmen having blue eyes. The two blue-eyed tribesmen have seen each other, so each thinks, “Whew! That guy has blue eyes, so he must be the one that the Missionary is talking about.” But because neither blue-eyed tribesman believes that he has blue eyes himself, neither gets in his canoe the next morning and leaves the island. The next day, then, each is very surprised to see the other fellow still on the island, at which point each thinks, “Wait a second … if he didn’t leave the island, it must mean that he saw someone else with blue eyes. And since I know that everyone else has green eyes, that means … oh, no! I must have blue eyes, too.” So on the morning of the second day, both blue-eyed tribesmen get in their canoes and leave the island.

The generalized answer to the question of “what happens?” is that for any n tribesmen with blue eyes, they all leave simultaneously on the n’th morning after the Missionary’s statement. Note that no one forces the blue-eyed tribesmen to leave the island. They leave voluntarily once public knowledge is inserted into the informational structure of the tribal taboo system, which is the hallmark of an equilibrium shift in any game. Given the tribal taboo system (the rules of the game) and its preMissionary informational structure, new information from the Missionary causes the players to update their assessments of where they stand within the informational structure and choose to move to a new equilibrium outcome. Before the Missionary arrives, the Island is a pristine example of perfect private information. Everyone knows the eye color of everyone else, but that knowledge is locked up inside each tribesman’s own head, never to be made public. The Missionary does NOT turn private information into public information. He does not say, for example, that Tribesman Jones and Tribesman Smith have blue eyes. But he nonetheless transforms everyone’s private information into common knowledge. Common knowledge is not the same thing as public information. Common knowledge is simply information, public or private, that everyone believes is shared by everyone else. It’s the crowd of tribesmen looking around and seeing that the entire crowd heard the Missionary that unlocks the private information in their heads and turns it into common knowledge. This is the power of the crowd watching the crowd, and for my money it’s the most potent behavioral force in human society.

How good a perspective is that? I think Ben hits the nail on the head with this one and the importance and power an effective well marketed message can have on the crowd. With the social media apparatus we have in place today these narratives have tremendous power and ability to gain momentum. We have already seen how politicians and government bodies are using this media to communicate their message. Ultimately the forces of the free market will dictate future Common Knowledge Games, as quantitative easing cannot go on forever. Keep listening to the information flow of the missionary, and never stop looking for blue eyed tribesman.

MAY 25, 2014

Addicts tend to Avoid Warning Flags

Dear RAPA members

My wife and I have a friend who is a drug addict. He is actually quite open with us regarding his drug use and we often engage him with concern that we think it is going to ruin his life. The more we highlight the fact that his behaviour is littered with warning signs, the more he counters us with the fact that none of the typical warning signs have manifested into anything damaging and that he has a beautiful loving family and a successful business. 

On the surface he is right none of his addictive behaviour has resulted in damaging consequences, at least yet; but does this mean he is free of danger and special?  

We decided to take some of the most significant components of the RAPA Score™ algorithm and use them to Flag dangerous addictive behaviour. Just like my friend who is addicted to drugs according to all the traditional warning indicators, we have similar warning indicators for bad trading practise which we will call Flags. Not all flags manfiest in disastrous trading accounts, but on a large enough sample of data our Flags prove excellent indicators for investors to be in cash rather than the trading system they are currently invested in. 

The results below show the aggregated equity curve of our database as “As Is”. The other curves show what the equity curve of our database would be if we went into cash when a system showed a Flag. The Table below presents the different Sharpe Ratio’s after applying our Flag/Warnings. 

We think our Flag tool will provide a meaningful contribution to our members when we integrate it seemlessly into the portal. However, we fully expect those traders addicted to bad behaviour will continue to ignore the warnings in the belief that bad things won’t happen to them.

MAY 19, 2014

Factors of Production and Extrapolation

Dear RAPA membersWe have been lead to believe that the Chinese economic growth story of the last few decades is a miracle. Is it really such an unbelievable achievement? Chinese GDP rose from $263 billion in 1979 to $404 billion in 1990, $1.2 trillion in 2000, $7.2 trillion in 2011, and over $9.4 trillion in 2013; in 30 yrs that is pretty amazing; or is it when viewed in context?In 1994, Nobel Laurette Paul Krugman wrote an article called, “The Myth of Asia’s Miracle.” I dare say he was a little early. Krugman pointed out that growth in any economy comes from increases in labour force participation and productivity. Demographics and education usually dictate the increase in labour force participation and capital and technology take care of productivity.

If you consider the Chinese situation before1979, they were a nation where the leadership operated an “iron rice bowl” policy, i.e. they were promised basic staple foods and lifes basic necessities. What changed is Deng Xiaoping in 1979 introduced a growth orientation to the Communist Parties vision where the focus was in providing the populace with the opportunity to provide their own food.

There was a massive influx of cheap labour together with foreign investment capital. An overwhelming majority of the population were illiterate so the Chinese leadership were able to put projects into commission which started the education process that enabled them to tap massive amounts of labour resources and put them into production, and along with the foreign capital investment in technology this additional factor further increased the pace of economic growth.

After more than a decade of +10% GDP growth the Chinese economy is slowing down with 7% GDP growth and the world is becoming increasingly concerned that the slowdown in the rate of economic growth (2nd derivative) is going to continue and create a slump in world growth. This concern about growth stems from the fact that Mr Market loves to extrapolate and many of the analysts and economists projections have been based on unrealistic super growth sustaining. There is no doubt that the growth has been spectacular, we will ignore for now the quality of the capital investments which some will argue are spectacular failures that will place a large strain on reserves in years to come. The question we need to consider is what the world growth projections will look like with more modest realistic Chinese economic growth.

Krugman points out the labour-capital factor input model is a double edged sword. It is a simple factor of demographics that through 1 child policies there are not the numbers of unskilled labourers to drive extreme growth that many have come to expect. On the technology side the Chinese production line has already enjoyed signficant improvements in technology but the growth from this factor is unlikely to add the growth that it has in the past. I think it is fair to say that it is very important for China to become technology innovators in the years to come, something the US has been very good at and has used as a key factor in its continued economic growth.
In these weekly missives I like to challenge conventional thinking and provide fresh perspectives. I have no idea why I chose to write this subject this week; perhaps on a subconscious level I am tired of the sloppy thinking that extrapolation invokes. I think I have said enough for now!

MAY 12, 2014

Most of us are Suckers – Soochow

Dear RAPA members

One of the investment insights that continues to amaze me at its complexity is how investors like to win regularly, even when in the long run it doesn’t work out to be profitable. When I started managing money for a long short hedge fund back in 2002 the message I gave my investors was that our return profile would be asymmetrical. I said don’t expect regular positive months with consistent 1.5% returns, rather become accustomed to periods of irregular performance followed by large outsized gains. I still stand by these sentiments as I don’t believe anyone trading the capital markets is able to predict with certainty what the market will do: in 10minutes, 1hr, 1day, 1month or 1yr. 

Over the last 2 years I have spent a considerable amount of time meeting and observing traders and investors in the retail FX space; a sector of the market I previously was not actively involved in. I am much more an index futures, stock and fixed income man. What I soon realized in the FX market, was that many trading rookies had found a way to “game” the industry. Before I step on some toes, I must add that I don’t wish to denigrate your craft or your ethics, so if I ruffle your feathers it is only my opinion.   

There are certain trading strategies that traders with no edge (here I am including 99% of the traders deploying this strategy) are able to implement and trade successfully for a considerable period of time before things go bad. Here I am referring to martingale, grid or dollar cost averaging systems. What is amazing about these strategies is that depending on the market conditions and a few lucky breaks here and there it isn’t difficult to get a track record with a beautiful upward sloping equity curve that appears like the holy grail. Wrapped around these returns comes the familiar shpiel that the system uses a sophisticated proprietary algorithm and sexy computer technology. Trust me when I tell you this is b.s. the only holy grail that these types of traders and system promoters have found is the achilles heel of investors which is what makes us Suckers.

In an experiment called the Soochow Gambling Task (SGT) behavioural scientists found that when faced with dynamic decision making, the frequency of gain versus loss was more powerful than the final outcome. In the table above Deck A & B have negative expectancy but win much more frequently than decks C & D which have few winners but a positive expectancy. It is decks A & B that wins the vote from the illogical investor that has this psychological bias towards making things seemingly more pleasant.

There are some really profound lessons to be learned from this experiment. Salesman looking for a quick sale and an easy buck to manage are easily steered down the path of promoting these martingale strategies. The reason is simple, most days they make money – no worries mate. I have already written far longer than I anticipated so now is not the time to prove how most of these strategies are destined for failure. Of course if you can predict the future of the FX markets I take back what I just said.     

MAY 4, 2014

Depression and Creativity

Dear RAPA membersWe have discussed before that the RAPA Score™ is made up a number of components; we can treat these components as flags or indicators in a trading system and backtest them versus a buy and hold (“Allin”) strategy. In these letters we are presenting seemingly random results, but it is important to know that these are not isolated findings. In the coming weeks we will share with the community comprehensive ways in which the RAPA Toolbox can be used to improve your trading.Here we present a strategy that uses one of the flags (components) of the score over the Eureka Hedge Fund database. While the Allin strategy produces a larger $ return it does so with more than double the volatility. RAPA is all about risk adjusted returns and achieves this with its Flag-A strategy producing nearly double the Sharpe Ratio of Allin (Buy and Hold).


I was forwarded a very controversial and interesting article about depression by one of my favourite neuro-scientist provocateurs – Jonah Lehrer. This is a very delicate subject and one I have a particularly uncomfortable relationship with as my father took his own life due to the overwhelming effects of the disease.

In July 2009 psychiatrist Andy Thomson and psychologist Paul Andrews published a 36,000 word paper in which they proposed an idea that would serve as one of the main tenets of a new school of thought called evolutionary psychology; it being quite ironic that Charles Darwin himself was a severe sufferer of depression who once lamented that “I shall probably do little more but be content to admire the strides others made in Science.” The idea these two authors propose is that often good results come from a mind in despair. The pain of a depressed mind often accelerates the pace of research or creative work, as it causes one to withdraw from the world and fixate on the problems perceived by the mind. Their thesis being to allow the mind to solve its own problems without the use of medicinal interventions.

Andrews and Thomson began by focusing on the thought process that defines the disorder, which is known as rumination (this is also the process in which cattle swallow and regurgitate their food which they rechew). Rumination tends to hijack our stream of consciousness with an endless recursive focus on the pain resulting in severly impaired executive functions (working memory). Most researchers in this field believe it is nothing but useless pessimism. Andrews and Thomson however said perhaps the mind, this highly evovled machine is reacting to a stimulus for a purpose. This line of thinking has a long intellectual history with Aristotle stating, “all men who have attained excellence in philosophy, in poetry, in art and in politics, even Socrates and Plato, had a melancholic habitus”.

Andrews and Thomson needed to back their thesis up with some scientific proof. The capacity for intense focus, they note, relies in large part on a brain area called the left ventrolateral prefrontal cortex (VLPFC), which is located a few inches behind the forehead. Human attention is a scarce resource so the brain makes sure there is enough resource to provide this tremendous concentration, at the expense of other cognitive activites, hence the depression.

This is a very big complex subject, with this theory providing a somewhat romanticised idea of depression serving a purpose. For evolutionists it is survival, for theologists it would be a higher self. I myself don’t feel I have any worthwhile contribution to make on this subject, other than to end with a quote from Lehrer, “Wisdom isn’t cheap, and we pay for it with pain.”

APRIL 27, 2014

Rebuking your friend and a New RAPA Score White Paper

Dear RAPA members

We are very excited to release a White Paper for the new RAPA Monthly Data Score. Our objective was to improve on the available performance metrics in the market place and design a filter that would be able to best select managers using a purely quantitative approach across a reputable and high quality database. In the paper we walk you through our methodology and the chart that displays the New RAPA Score findings.

Rebuking your FriendWhile sitting in synagogue on Friday night my rabbi shared an idea from the bible that resonated strongly with me as an allocator of capital. The verse in question comes from Leviticus 19:17 “Rebuke your fellow, so that you not bear sin because of him”. This is actually quite a difficult commandment to fulfill. Let us unpack what the verse means. The verse is saying that there is a positive commandment to go out of your way to rebuke a friend and tell them that they should stop what they are doing as it is not appropriate behaviour. For the sake of this argument lets assume that there is objective agreement as to what is appropriate behaviour. The challenge of course is being able to tell the offender that what they are doing is wrong, without offending them. If your approach is aggressive or condescending then you land up failing in your task as the second part of the verse “so that you not bear sin” is trying to teach us that we need to do it in a way that doesn’t have the opposite effect otherwise we land up with the sin, and society is double the loser. 

My rabbi suggested a novel approach to this verse which I will relate in the context of a capital allocator. When we allocate capital we are firstly on the side of the trader who receives the capital, it is important that the trader realizes this, nothing makes the allocator happier than when the trader is making profits, the trader has to keep this perspective in mind and drop all defences that the allocator has it in for him.

Secondly as an allocator we often see when a trader is making blatant mistakes in their trading; be it holding on to losers for too long or simply trading way too big for their risk profile. It is at these points in time when we allocators feel the need to rebuke our traders; but just like in ordinary society we are often unsure how to go about it. What if we say something and the trader gets upset with us, after all doesn’t the trader know best how to manage the money that is why we gave it them in the first place?  What if the trader tells us he cannot manage our funds because we are breathing down his neck?

It is these very confrontations, both in an ordinary social setting or in a business context that we find so difficult to handle, requiring extraordinary people skills to achieve the objective of constructive criticism. Ok so here comes the novel approach, and it is all about perspective. If we accept that we are not perfect and are likely to make mistakes and we prepare ourselves that at some point in time a friend is likely to tell us that we are doing something wrong, then we will have created an environment in which an objective person can tell us that we are faltering and instead of reacting with aggression and defensiveness we rather act with a mindset of improving our ways, then with this perspective we will have created a platform that makes our friends much more able to fulfill the positive commandment effectively of correcting our mistakes so that we have a more harmonious society and a more profitable fund.

APRIL 20, 2014

Survivorship Bias 2

Dear RAPA members

Today I want to focus on affordable historical market data.  Specifically I want to focus on intraday (tick) data versus end-of-day data due to the complexities and cost of tick data.

Good quality tick data is expensive, for example TickData.com charges $6,000 for a year of US equity data.  While there are many firms to buy data from, I recently came across a new firm QuantGo.com where you can lease monthly access to years of institutional historical tick data instead of having to buy it. For example, unlimited access to five years of US Equities tick data is $250 per month.

I learnt how QuantGo aims to make institutional historical tick data affordable and available to any person or firm with monthly lease access to years of data instead of having to buy it. QuantGo currently covers US Equities, Options, Futures and News and within a month they will be adding ALL worldwide exchanges, for example even the Vietnam exchange.

With QuantGo you remotely login into computer instance(s) in your own private and secure cloud.  It is just like having your own local computer but you remotely login into it. Your computer instance has immediate access to all of the historical data available on QuantGo from tick data to one minute bars.

QuantGo is built on the Amazon cloud, so you pay per hour for computer usage.  Given the recent drops in pricing this is not a major cost, for example to use the equivalent of a desktop computer for eight hours per day in QuantGo will be about $40 per month.  Besides doing research with historical data, some QuantGo clients run their trading strategies from their computer instances.

If you need tick data, then check out QuantGo’s free demo on https://quantgo.com/demo where you can remotely login into a real computer instance and explore the available tick data.  RAPA members will receive a 10% discount by mentioning RAPA on signup.

Let me know what you think as well, happy holidays.

APRIL 12, 2014

Leverage and the Score

Dear RAPA members

This week we got a question from a community member Cameron Wild who is an experienced trader and someone who has been supportive of the RAPA team and its platform. He asks two good questions which I thought would be useful to share with the community along with our response.

Question 1: Leverage.

As I discovered and Vlad confirmed the RAPA score is heavily impacted by leverage in at least 2 ways – max drawdown and expected loss. He even said, “It is a good idea to present the recommendations to what the “optimal” leverage should be.”

Well of course! If you are publishing a score that is a function of leverage then it remains that whoever was lucky enough to have chosen the leverage that you “wanted” gets a better score. From the start you told me that DD of 15%+ are heavily penalised so I showed my strategy notionally adjusted to 2X leverage in order that I wouldn`t exceed this magic threshold. Ok great. But now I find its more complex than that and if perhaps if I`d chosen 1.4X leverage than maybe I would`ve got a much better RAPA score.

This is not what being a portfolio manager is about for me. But I agree that it is a crucial aspect of multiple PM management, ie fund management. So why don`t you help us, indeed help the investors, by openly expressing what you believe is the “optimal leverage” for each PM. Then the next step would be to show on each PMs page a rescaled curve with your optimal leverage. Then it is no longer a function of who was lucky to have guessed the right leverage to display but rather the RAPA score would give an apples to apples comparison. Indeed it would make the Leaderboard look more professional to get rid of silly numbers like annual growth rates of 900%.

I sincerely hope you implement something like this. The other option is to allow us to set the notional value ourselves. Of course that means we`ll just goal seek the leverage to reach our own Max RAPA score. But hey, there`s nothing wrong with that, everybody has the ability to chose their leverage..

It is correct that the RAPA Score is sensitive to leverage. The RAPA Universe dictates to our algorithm a critical expected maximum drawdown threshold which is roughly 15% per annum, after which the score will drop significantly with every 1% extra drawdown. What is important to note here is that RAPA doesn’t choose this number, rather it is “learned” by the algorithm based on empirical evidence. Furthermore the penalties attributed to this drawdown function are not unlimited, they play a big role in the score but are by no means the largest component. We have done exhaustive analysis of the drawdowns of managers in our universe and found that strategies with higher drawdown will in general be unable to achieve a high level of risk-adjusted performance, as compared with strategies that display a lower drawdown. Here is a twofold explanation:

  1. Professional managers that show skill in performance tend to be much more conservative with managing their risk than less skilled managers. It is fair to say that in the current investment climate a fund that is around 20% underwater is close to the end of its road.
  2. Strategies with high drawdown face a much bigger risk of ruin even if the underlying strategy has a positive expectancy.

We find your suggestion very productive. In the near future we will suggest an “optimal” leverage and will show the equity curve with this optimal leverage on a seperate tab on your account section. What this will do is indeed compare apples with apples and will no doubt showcase to the asset allocators strategies that are intrinsically good but over leveraged. To explain it in layman’s terms, the optimal leverage tab will push up many low RAPA Scores that are good in a raw sense but need some improvement around their position sizing – leverage.

Question 2. Track Record Length

I entered a 2X leveraged 3 month track record and found that my RAPA score was 9. This seemed silly to me considering sharpe 3.5 and 11% return. Moreover I see above me on the Leaderboard is another 3 month track record with sharpe -3.75 and -22% return but incredibly it has a RAPA score of 12. How can this possibly be the case? To me this highlights that there is something really wrong in the RAPA calculation. But if you believe the calculation is correct and it is simply the case that 3 months isn`t long enough then you shouldn`t allow anyone on the Leaderboard until 6 months have passed. Or 9 months. Or whatever is long enough.

As for me I was embarrassed by a RAPA score of 9 so I uploaded a full year of data and now I`m RAPA 40. It wasn`t a matter of cherry picking the start date but reverting back to the time of the previous major model upgrade. To the RAPA community – please comment on this post with your thoughts. Just trying to help.

In order for a RAPA Score to currently appear on the leaderboard it needs a minimum of 3 months track record. However, for any of the RAPA allocations we have insisted on a track record of 1 year or more as frankly a RAPA Score or a Sharpe Ratio or a Sortino Ratio or any ratio for that matter over a period shorter than 9 – 12 months is simply not statistically significant. In terms of the design of our scoring algorithm there are both intrinsic and extrinsic components that reward length of track record. Furthermore the combination of a high Sharpe Ratio together with a short track record usually produces low RAPA Scores.


The PSR is defined as

Where Z is a cumulative distribution function of the N(0,1) random variable, n is the number of days in a sample, g3 and g4are the skewness and kurtosis of the underlying return distribution and the SR hat is the estimated Sharpe ratio. The SR* is the value at which the calculation is made.

Without going to deep into the maths, the expression in bracket is the probability that an estimated Sharpe ratio of the daily returns is greater than the value of  SR*. This is interpreted as follows: we observe from the daily data that a trader has a certain level of Sharpe ratio. This is an estimate of a random variable which is a true value of the Sharpe ratio. We want to understand the confidence intervals for this true value. In particular, we are interested if the value of the Sharpe ratio is greater than a certain skill level.

The PSR (probabilistic sharpe ratio) of our algorithm is especially sensitive to short track records, especially when the value of the Sharpe Ratio is high (the variance of the Sharpe Ratio negatively depends on the Sharpe Ratio Squared). In summary in an ideal world we should lengthen the period from 3 months to 9 months before an account appears on the leaderboard. We will consider implementing this in the coming months and thank you for your contribution.

Finally, to address the anomaly of the score of 12 despite its losing performance. The RAPA Score is made up of 5 quantitative and 1 qualitative component. These components are given weightings and together combine to give one score. It could happen that a losing account is given some points for positive attributes, however it will never achieve an average or high score, so any score below 30 is really not something that is attractive and relying on rankings in this area of the RAPA Score is of little or no value.

APRIL 5, 2014

Self Reporting and Back-Fill Bias

Dear RAPA members

This week we will wrap up our look at the various bias’s afflicting the hedge fund industry and the social trading and cap intro platforms in particular. 

We have already looked at survivorship bias, which is the fact that hedge fund databases like Barclays, Eureke Hedge, HFRI, etc don’t include in their current database the funds that crashed or cease to exist, so the current database is naturally inflated by the ommissions.

We also looked at the bias whereby many analysts when doing backtests on various allocation decisions incorporate data in the out of sample dataset that is already known to have survived, thus exhibiting look ahead bias.

The biggest weakness the hedge fund, social trading and cap intro platforms have is managers have no legal obligation to report their performance. This is unlike a listed stock or mutual fund that by law is required to be part of a transparent stock exchange or publish its daily NAV. Self Reporting bias is simply an extension of human nature; when a manager is doing badly and he has in his power the ability to decide whether to expose this poor performance to his peers and competitors who can blame him for not reporting. This bias is still very prevalent even with databases such as Barclays and Eureka who maintain a survivorship free database. In these databases they still show the funds that no longer exist. The problem is with many funds that “blow-up”; they do so very quickly. Reporting to these major databases takes place usually a month after the actual month the trading took place, so with funds that become obselete the last reported month is usually before the bad stuff took place. This horribly skews the data in the survivorship free databases – take my word for it, its true!

One of the ways to avoid this self reporting bias is to do what RAPA tried to do when it launched and currently has in place with a 3rd of its active database. We simply requested that managers provide us with admin rights to continuously update performance so that we could keep everyones performance current and also capture the blow-ups. We got push back initially but we continue to win more and more people over to our autoupdate feature. The more people we convert to autoupdate the better the quality of our database will be.

Say we started a proprietary group of 20 traders a year ago. Today some 365 days later this group has shrunk to 5 traders, i.e. a survival rate of 25%. If I now present to a group of investors my 5 traders, while quietly ommitting to mention that our group started with 20 traders, I have displayed what is known as back-fill bias. With the knowledge of 1yrs performance of a group of traders I already know who have succeeded and therefore report a pro-forma hypothetical performance analysis.

Investors need to realize that data bias’s exist in all shapes and forms, you have now been warned – BEWARE. In the next few weeks we will be releasing the New RAPA Score, as we lock down some of the parameters in our new survival model that we hope will address to some degree these data bias’s.

MARCH 30, 2014

Look Ahead Bias

Dear RAPA members

It seems like last weeks letter on survivorship bias struck a nerve as we had a tremendous response from the commuity so this week we will look at a similar bias that is often easily misdiagnosed. We always enjoy feedback so feel free to reply with your opinion.

A few months ago we were preparing a dataset for a data analyst to do some consulting work and while we were preparing the data we produced the following chart with a very confusing smile.

Smile Anomaly

It took us some time to realize what we were doing wrong and I am sure our findings will highlight to a lot of you potential areas where you could be falling prey to the same look ahead bias..

Let me give you a very simple explanation of how the bias manifested. We took our 15,000 manager track record and created 4yr data strips. The first 3yrs were used as the training sample and the 4th year was our output forecast year. The 1yr output (4th year of the dataset) is certainly not incorporated into the training sample, there is no cheating by peaking ahead at the data here, so where is the look ahead bias that I am referring to? It is actually quite subtle, the problem is that by creating 4yr slices per manager we already know that these managers survived the 4th year. In essence this simple dataset construction is carrying a form of look ahead bias.

There are many other examples in trading where this bias presents itself so we will leave it up to you to make sure that you are effectively dealing with the bias in your backtesting. I will conclude with a simple insight that shocked us when researching the various data bias’s. We believe that the majority of the academic papers in the field of portfolio optimization and econometric forecasting have some form of data bias.

MARCH 23, 2014

Survivorship Bias

Dear RAPA members

We have covered this subject before but I think it is so important I want to go over it again.

For starters lets look at some numbers relating to the SP500 that you were probably not aware of (1990 – 2010);

  • About 1006 stocks were part of the index
  • 402 stocks that used to be part of the index are delisted now
  • Only 189 stocks survived staying in the index from 1990 until 2011
  • About 5.7% of stocks enter/leave the index every year

The obvious question is how does this impact on my backtested returns. I have taken some results from a blog called engineering returns which highlights the mistake so many people make when backtesting their results. I will just the results of a simple mean reverting and trending strategy that picks constituents from the Nasdaq 100, SP100, SP500.


You can see in these results that sloppy work with your data will no doubt present you with misleading and unrealistic results. We often joke in the office that we have never seen a backtest presented to us that is not excellent. Everyone presents these equity curves that go up with almost no drawdown. A word of friendly advice, if the backtested equity curve looks too good it probably is. There are other areas where data can present misleading backtest results, we urge you to really think and spend a lot of time with the way your data is being used in your testing.

We highlight this survivorship bias because when it comes to hedge fund databases or any other voluntary performance reporting platforms such as RAPA there is inherent in the data, a survivorship bias. People are not likely to report their performance if they are losing money. So they may start off with a winning track record and as performance falters these managers may no longer report their performance. However we are left as are the large hedge fund databases with managers track records that are excellent up until the period they stop reporting. What do we do with this information? Working only with the survivors clearly distorts the performance of the current managers in aggregate.

Fortunately we have a major database that records all those hedge funds that stop reporting, we also have our own growing database that has a graveyard of managers no longer reporting. We are very excited to release in April a new and improved RAPA Score which will be factoring survivorship bias into its algorithm. As far as we are aware this is cutting edge innovation.    

MARCH 16, 2014

Social Atom

Dear RAPA members.

Today the RAPA team is together, with my Ukrainian colleagues in the harbour city (Sydney) for a month of close collaboration.

Social Atom

By now you will have got the drift of my overiding philosophy regarding the capital markets. The movements of the markets are highly stochastic. However, within those seemingly random movements we can see a pattern. Mark Buchanan a theoretical physicist supports the theory that the social sciences in many respects mimick the natural sciences. Just as the behaviour of an individual atom is chaotic (random) the overall process of many atoms working together comes in the form of regular pattern formation. They call this burgeoning new field of study “Social Physics”.  

Today is the Jewish festival of Purim which means “lots” and I think fits the theme of the social atom perfectly. What seems completely random isn’t always what it seems.

To perhaps illustrate my point I thought I would add a very simple strategy of trading a 50 day moving average against its 200 day moving average. For some reason the market seems to honour this pattern  (at least over this period) despite a lot of random events along the way. See what I mean ?



MARCH 9, 2014

Death Regressed & Lefties are Creative?

Dear RAPA members.

We have spoken at length about the distortion a dataset with survivorship bias presents. In this study we regress the probability of “death” by the RAPA Score™ using a dataset that is free of this bias. What is evident is the RAPA Score produces a statistically significant forecast of the number of funds that are likely to “die” based on their respective RAPA Scores (the details of the results will be presented along with other studies in a forthcoming white paper we are working on).

Lefties are Creative?

On Friday night we were sitting around the dinner table and it came up that 5 of the 12 people present were lefties. My wife, a righty, said “you know lefties are said to be smarter and more creative”. Naturally as a lefty I have heard those statement many times before, but are they true? As I believe there are no coincidences in life, it so happens that I am reading Creativity: Flow and the Psychology of Discovery and Invention by a guy I regard as one of the leading contemporary psychology thinkers, Mihaly Csikszentmihalyi, which got me thinking.

It turns out the subject of left handers intelligence and creativity is one that has been going on for more than a century. The latin word for left is sinister and it used to be thought that the majority of criminals and “nut cases” were lefties as documented by the father of Criminology Cesare Lombroso in 1903. Roughly 10% of the worlds population is left handed which is a statistic that has been pretty constant for the past 100 years and the latest studies seem to concur with the stated question that left handed people are more intelligent, with a disproportionate number with IQ’s above 140 (see: Dr Alan Searleman research); but what does this all really mean?

As capital allocators we are constantly inundated with managers and traders who believe they have come up with the latest most creative trading system or strategy. King Solomon said “there is nothing new under the sun” so does this mean there is no scope for innovation?

Ok let me get straight to Csikszentmihalyi’s model of creativity, which I believe is a very useful approach to understanding and improving ones creative opportunities. lt comprises 3 essential components:

The first is the domain, which is the place where its symbolic rules and procedures belong. Mathematics is an example of a domain and within mathematics there are nested sub-domains such as algebra and geometry.

The second component of creativity is the field, which includes all the individuals who act as gatekeepers to the domain. It is their job to decide whether a new idea or product should be included in the domain.

Finally, the third component of the creative system is the individual person. Creativity occurs when a person, using the symbols of a given domain such as music, engineering, business, or mathematics has a new idea, and when this novelty is selected by the appropriate field for inclusion into the relevant domain.

What we learn from this model is that creativity isn’t defined by a personality trait, rather it is an idea that has all 3 components described above. The idea could come via chance, perserverance or preordained destiny. To make a creative contribution you do not need to be brilliant or talented, just as it is possible and likely for a creative personality never to make a creative contribution to their culture.
When someone presents a creative new strategy to RAPA should we accept it as creative when its proprieters assure us that there is nothing like it out in the market place, i.e. it is special? If we accept the view as described by the individual, then creativity becomes a subjective phenomenon. Because someone is a wayout dresser or sings with a particular melody or wears their hair in an unusual way or trades when Indicator X intersects Indicator Y at precisely Z time, doesn’t mean they are creative. Creativity as understood by the model in discussion only comes into being when the experts (externals) in the so called area of expertise deem it so.
So when the manager presents his “new” strategy to RAPA he may well believe he has created something new. However, I think this very niche where RAPA sits incubating talent is at the very intersection where emerging manager talent becomes an established manager. It is this reason why emerging managers present the biggest risk and reward potential. The way I see it, by the time a new strategy has been profitable for a suitable period of time it has probably satisfied all 3 model components and made a creative contribution to the hedge fund cultural landscape. Working with this model of creativity our job at RAPA is to try and become leaders in the field (experts) by immersing ourselves into the domain so that we can identify those truly creative individuals within in a contemprorary context and be part of that creative transition from emerging to established manager.     

MARCH 5, 2014

Hussman (HSGFX) Performance Critique

We pride ourselves at RAPA (risk and profit analyzer) at looking through the headline noise of plain returns and focusing on the more telling risk adjusted returns. Firstly to set the scene we  did a study on a very large database with more than 7,000 hedge funds and CTA’s and another 7,000 funds that are now obselete, so our study avoided the classic survivorship bias inherent in live indexes. Our study took the best 25% from our databse based on their RAPA Score™, Sharpe Ratio, Sortino Ratio, RAPA Score >70, % Performance and then stepped through time with a monthly rebalance. We then graph the respective equity curves assuming each method ran the same risk as measured by standard deviation. You can see from the chart below why we are so excited by the quality of the RAPA Score™as a performance measurement tool. Towards the end of this month we anticipate releasing an updated white paper on the RAPA Score with comprehensive tests and analysis. 

Hussman Critique

Over the last 5 years every Monday morning I have religiously logged onto the http://www.hussmanfunds.com/ website to read Dr John Hussman’s weekly letter. It is simply brilliant for its honesty, tenacity and intellectual vigour. Through the learning that comes from these letters I have shaped much of my understanding of the markets and how best to play the game of producing superior risk adjusted returns. I have followed a similar path of sitting every Sunday afternoon and writing a thought piece which I thoroughly enjoy doing, not so sure my family share my enthuisiasm.  

What often happens when you develop a tremendous respect and admiration for someone is that you lose your critical style of thinking, and boy do I have a critical way of thinking. Recently I lifted my head from the pages of intellectual excellence and took a look at Hussman’s performance. Frankly I was shocked how badly things had gone for him the last few years. Whilst I don’t know all the particulars that go into his strategy I am familiar with his market timing model. I use the word timing guardedly as Hussman does not for one minute believe he can predict the market, rather he believes that when a certain confluence of events present, including valuation and market climate then based on history we have an approximation of how the course of events follow from these scenarios in terms of risk adjusted returns. 

I have never met the man and have no incentive to do this study save for satisying my curiosity as to whether John is the star I think he is. Well in my study I am going to be brutal, I know Hussman likes his performance record to be judged from cycle trough to trough or peak to peak. I am too lazy to do that kind of data manipulation so here goes from inception versus the S&P500. 

The most important thing which says it all is the Hussman (HSGFX) Strategic Growth strategy scores a very impressive 62 RAPA points out of 100 versus the S&P500’s 45 points despite the % return outperformance. Of course this means very little to those superficial investors who ignore risk as part of their investment decision and have the benefit of hindsight to say look how much better we did with real money. The RAPA Score algorithm has the benefit of having analyzed tens of thousands of equity curves including the ones that never survived and its models work within the more realistic world of alpha-stable distributions so when a long term strategy that has spent years underperforming produces a RAPA Score of 62 I take note.


The drawdown is quite telling in their contrasts, I would just add that Hussman has incurred quite a signigicant drawdown of late, and as I wrote a few weeks ago theduration is starting to seriously work against him in the myopic investment market we reside. I will end off with one more chart that is quite informative. The chart below focuses on relative performance against the benchmark etf SPY. On an un-adjusted basis the benchmark has clearly taken the upper hand with the first ~10yrs being in favour of Hussman, the last 4 years have seen this advantage switch. What is perhaps more informative is the Beta adjusted relative performance where after adjusting for the markets risk we see Hussman come out tops from inception to today. I guess this metric is more in line with the RAPA style of thinking. 

In summary John Hussman you are still my hero; like you I would love these markets to shake out the junkies addicted to ever weakening doses of QE and set the path for sustainable growth. To quote Ben Bernanke from a Bloomberg article today, “……… you have to do things — very distasteful things“.     

MARCH 3, 2014

Lucas Critique

Dear RAPA members.

We did a study on a very large database with more than 7,000 hedge funds and CTA’s and another 7,000 funds that are now obselete, so our study avoided the classic survivorship bias inherent in live indexes. Our study took the best 25% from our databse based on their RAPA Score, Sharpe Ratio, Sortino Ratio and then stepped through time. We then graph the respective equity curves assuming each method ran the same risk as measured by standard deviation. You can see from the chart below why we are so excited by the quality of the RAPA Score™as a performance measurement tool. Towards the end of this month we anticipate releasing an updated white paper on the RAPA Score with comprehensive tests and analysis. 

Lucas Critique

In the March 17 edition of Fortune magazine they will feature an exclusive excerpt from Warren Buffett’s upcoming shareholder letter. In typical Buffett style he provides lots of wisdom but the following quotes I believe provide a tremendous insight into his views on professionals abilities to forecast. 

Forming macro opinions or listening to the macro or market predicitons of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important”. He quickly follows this advice with something quite staggering for someone who has spent his life “beating the market”. He says that in his will he has instructed the trustee with very simple advice: “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. I believe the trust’s long term results from this policy will be superior to those attained by most investors – whether pension funds, institutions, or individuals – who employ high-fee managers”.

As I discussed in last weeks letter; economics is a waste of time when forecasting the market, to provide a modicum of balance I thought I would share a cute economic theory/critique which tries to explain why economists forecasts are so off when measured in reality. 

Let me introduce Nobel prize (1995) winning economist Robert Lucas. For many he was the most influential macro-economist of the 20th century. This is how he summarizes his critique commonly referred to as the Lucas Critique: “Given that the structure of an econometric model consists of optimal decision rules of economic agents, and that optimal decision rules vary systematically with changes in the structure of series relevant to the decision maker, it follows that any change in policy will systematically alter the structure of econometric models”

What the hell does that mean? I think Nassim Taleb explains the critique well. “Perhaps economists’ forecasts create feedback that cancels their effect. Let’s say economists predict inflation; in response to these expectations the Federal Reserve acts and lowers inflation. so you cannot judge the forecast accuracy in economics as you would with other events”.

I will leave it up to you to make up your own mind about the value we get from economic forecasters and market gurus. From a RAPA point of view we are naturally sceptical until proven otherwise; it is for this reason that the RAPA Score is setup as a scientific experiment to assess the quality and probability of skill.     

FEBRUARY 23, 2014

Economics has No Value in trading the Capital Markets

Dear RAPA members.

I am starting this weeks letter with a provocative heading. The truth is while I believe economics has no value when trading the markets I also believe you cannot lead a fulfilled life without economics. Lets go on a philosophical journey.

Most of you will know by now that I follow a libertarian approach to economics with a firm foundation in the Austrian School. A couple of weeks ago I was reading an academic paper by Adam Knott where he explains how Friedrick Hayek, a Nobel Prize winning economist in 1974, wrote of his belief that Praxeology or as he called it the Pure Logic of Choice could not be applied at the macro market level but only worked a priori with individual action. To me this felt like an act of treason with one of our own turning on the schools high priest, Ludwig von Mises. So I started delving deeper.   

You will see from the elegance of the logic why I am attracted to this field of economic study. The definition is taken with some of my editing from Mises and Rothbard. Praxeology is the scientific study of human action, which is purposeful behaviour. In other words a person acts for a reason. Therefore not all human behaviour is action in the praxeological sense; pure reflexive or unconscious bodily movements are not action. Praxeology starts from the undeniable axiom that human beings exist and act (A), these deduced propositions are true a priori; there is no need to test them they are true always. For if A implies B, and A is true, then B must also be true. 

If this kind of logic appeals to you then read through the Rothbard link I have provided above and when you are feeling particularly inspired take on the big daddy Human Action Mises magnum opus in which he unpacks his theories with elaborate precision, it is an absolute treat. I digress, let me get back to Friedrick Hayek. I have read almost all the main theorists from the Austrian School but the one guy I never read but have been meaning to for some time is F.A. Hayek. I thought I might start with one of his more famous ones The Road to Serfdom but chose a book he wrote towards the end of his life in 1988 called the The Fatal Conceit: The Errors of Socialism

When learning someone new one needs to become used to the style of the authors writing and his/her theories so I will say it is too early for me to comment on Hayek as I find some of his basic theories quite weird and I need some time to fully comprehend them, for instance he speaks heavily against the rationalists and labours the point of the place between instinct and reason, for him this is where the magic happens. He has a type of social evolutionary belief, that tradition is what lies at the centre of market action. This leads to the point of my letter; when developing a theory it is necessary to unpack all the factors making up the proposed theory. Hayek draws on all the great philosophical and economic thinkers throughout history in building support for his theory. What became so clear to me is that economics as we call it today was formerly called Political Economy which itself was derived from the study of Moral Philosophy and therefore it is impossible to seperate economics from ones life.   

Viktor Frankel the psychiatrist and founder of logotherapy a branch of psychoanalysis which places man’s drive to find meaning in one’s life as the primary and most powerful motivating force, rather than Adler’s Nietzschean doctrine of will to power or Freud’s will to pleasure. Yes economic theories may produce beautiful deductive logic, some theories will satisfy the empiricists and others will satisfy the positivists, and others will satisfy the utilitarianists and still others will satisfy the rationilists. I am quite convinced none of these theories will be able to tell you what the Dow Jones will be trading at 1 month, 6 months or 1 year from now.

But if you believe that we are purposeful beings searching for some meaning in what we do then we are required like Aristotle, Kant, Plato, David Hume, John Stuart Mill, Jeremy Bentham, Adam Smith, Alfred Marshall, Carl Menger, John Maynard Keynes, Samuelson, Mises (etc) to explore what it is that drives our actions and where we sit on issues of ethics, morality and factors of production. Economics cannot provide you with answers with how to time the stock market; rather economics can provide you with an understanding of how you go about your search for meaning.

I wish to dedicate todays letter to the memory of Anthony Simmons a school friend who like me emigrated to Sydney, and died tragically this weekend. May he R.I.P.

FEBRUARY 16, 2014

Self Control, Success and the Gym

Dear RAPA members.

A couple of weeks ago a friend of mine sent me a Ted link about character traits of success; researchers from Standford University monitored the progress of a group of 4yr old children who were put in a room with a marshmallow, the children were told if they did not eat it for 15 minutes they would be rewarded with another marshmallow. The ones who ate the marshmallow within this time would receive no further reward. Two thirds of the children ate the marshmallow within the alloted time. The interesting thing is that 100% of the one third who showed self control and waited the 15 minutes went on to have successful careers.

Over the last few months I have been actively working out at the gym and can feel a noticeable improvement in the tone of my muscles, but when walking around the house without my top my kids are quick to comment on the schmaltz around my midsection. My wife is also quick to mention that my 6 pack has been replaced with 6 rolls. To give you some perspective I am a 105kg 6ft.1 unit with about 7kg to lose to be at my goal weight. I am a huge eater needing lots of fuel to keep me going. I told my wife when we got married don’t worry about the quality of the food just make sure there is quantity; I know that if I cutback my calories by 10 or 15% I would be at goal weight within 2 – 3 weeks, so why don’t I do it. The justification I am using with my inner voice is that work is too stressful to have to worry about applying self control to my eating habits. This approach is frought with cognitive dissonance, as I know better. By the way contrary to my initial thoughts allocating money to traders is just as stressful as trading oneself, maybe even more so (a subject for another time). 

Let me explain self control a little more, I will keep this simple and stay away from academic sources etc. What people don’t realize is that self control is regulated by a “muscle” in the brain. Just like a normal muscle there is only so much energy/strength before exhaustion. When I do chin-ups usually by the 25th rep I am at my limit (jokes). This is the excuse I have been using with regards eating more healthily, I am saying I am using all my self control energies for my job. The truth is this is a half truth. Whilst I know that the self control muscle has limited capacity I am ignoring the fact that I have been training this muscle for years and one can always grow and strengthen this muscle. 

To be successful as a trader we require large amounts of discipline and self control. For each of us this comes in different shapes and forms, it may be patience, it may be doing the analysis required for setups, it may be adhering to predetermined stoplosses, etc. I am always amazed at how you can cultivate and develop kids self control. We are strictly kosher and don’t drive or use the computer, cellphone, etc on the Sabbath. In the kids early days (1 or 2yrs old) when the sun set on Friday and we turned off the TV we would get the odd tantrum, but within a short space of time we no longer got any pushback. It is simply a non-negotiable so along the way the kids have developed their self control muscle in this area and a strong self control muscle can be deployed in many other areas as well.

I am sure we have all developed our self control muscles to various degrees over the years, the point I wish to say to myself here is that if losing weight is important to me I must not think that I don’t have the self control capacity to achieve this goal; rather if this is a goal I wish to achieve I just need to reframe my priorities and then draw on my already developed self control muscles and develop them a little more. 

See you at the gym.

FEBRUARY 9, 2014


Dear RAPA members.

We are excited by the progress of our FX Omega product which is developing a following in its various customized white label forms around the world. We have allocated more than $40m to managers all around the world and currently have 11 managers in our Omega programme. In coming months we will start highlighting Omega’s performance but 3 months is still far too short a period to draw any statistically meaningful information, we can however say that we are profitable over this period. lf you are an FX manager and have a RAPA Score of 60 or greater with more than a year track record you may qualify so get in touch.

Duration Expectation

I have been involved in an interesting email exchange a couple of months ago with someone asking my advice as a capital allocator. The guy in question “James” was referred to me by a good friend, the story goes something like this. 

James is a particularly bright guy and is involved in education but in his spare time he is a stock market enthusiast. He claims to have come up with an algorithm that looks at the daily momentum of the S&P500 and based on this algorithm his system provides a daily signal whether to be in the market or not. He has modelled his system going back to 1951 and it produces an outstanding outperformance of the S&P500 over this period (see chart below). When seeing such outperformance common sense tells you that something is seriously wrong. I don’t have all the statistics to hand but I think there are only about 20 people/firms in the world who have been able to outperform the S&P500 over 20yrs. To do it in such convincing fashion as a part timer with no true market experience raises even more alarm bells. All these concerns I voiced with James but he was persistent and I asked more and more questions to understand the process of his backtest and the broad strokes of his algorithm. One of the most common mistakes is mistakenly using hindsight in the data, which is a common feature amongst scientists who curve-fit the data to achieve their intended results in the lab, only to hopelessly fail in the reality of the market place.

We continued our email exchange with all my questions being answered satisfactorily, however I knew there was a missing factor we weren’t considering in the equation. It is subtle and easy to miss but its importance is paramount. We all want to invest in a strategy that outperforms a benchmark, but something we need to consider is what are the typical periods of underperformance. 

For years I have been tinkering with a mathematical model of how the stock market works at the auction level. I believe I can notate the variables making up the market process of buy and sell to explain value but for now it remains a work in progress (it is not a forecast tool but more a descriptive tool) one of its key ingredients isduration. If buyer A has a 1 year view on GOOG and buys from seller A at $300 we have Value A. If the share price of GOOG drops to $250 after 6 months but ends the year at $400 interesting things happen to the the various traders PNL of GOOG over this 1 year period. I believe traders duration expectation is one of the key drivers of value, what is information for one trader is often noise to another. For a day trader the movement of GOOG during the day is of vital importance (information) to a long term trader 1 days return is of no consequence (noise). It is this arbitrage of duration expectation that is one of the key drivers of value and is the reason why value is so volatile; I digress.   

On closer examination we see something interesting in James hypothetical results. In the simple chart below I highlight the fact that Jame’s system underperformed the market for the first 21 years. I can pick other dates that show underperformance. I always try and bring to your attention in my writings that performance start dates are random events in the markets cycle. If you started a long only US equity market fund 2.5yrs ago you would be doing great. This may have nothing to do with your skill but the luck in when your fund started. What I explained to James is that I would never invest in his strategy because his duration expectation was simply too long, unrealistic. I could never take a chance that we could go through another 21yr under performance period again, and who is to say this time the period may be 41yrs or even longer. Even the greatest investors who clearly describe to their investors how they are to judge their performance over full market cycles have a hard time, i.e. bull top to bull top or bear bottom to bear bottom. One of my investment gurus John Hussman, PhD, is having a shocking time the last few years due to his underperforming of the broad markets. Hussman writes a weekly open letter describing his market timing model and is an ex Professor of finance with super pedigree and managing a multi billion dollar fund, but even he is facing career ruin with just 2 years of underperformance; making a mess of his track record if measured on a mid cycle basis. How many Hussman’s are out there able to convince investors to stick around after 2 years of under performance.  I suspect James will find there are no investors that will stick things out for 21yrs.

FEBRUARY 2, 2014

Optimism Bias

Dear RAPA members.

A few months ago we added another math Ph.D. to our full time quant team. Towards the end of last year we acquired one of the most comprehensive databases of hedge funds and CTA’s in the world, which includes more than 12,000 exisiting and failed funds. We have mentioned before that most indexes suffer from survivorship bias, RAPA is not immune; therefore to ensure the usefulness of the information we derive from our RAPA Score we have embarked on a major study and calibration of our proprietary algorithm.  

To keep our team from our own bias’s we have employed 3 consultant data scientists to assist us with our studies. The project has already morphed into a massive programme as the size of the datasets involved and the sheer computation required is taking a lot longer than anticipated. To give you an idea of the scale, because we don’t intend sharing our algorithm with anyone outside our company we had to prepare pieces of data for our scientists to work with. Each piece of data has taken Vladimir’s PC cluster about 4 days of 24hr use to compile the necessary information. The plus side of our research project is that in coming weeks we believe we will be able to share our research studies with you and learn some interesting and useful insights.

The US equity markets have gone more than 850 days (2½ years) without a correction (a correction is defined by most as -10% from the highs). With this in mind you will understand my reluctance to draw any great conclusions from equity managers presenting us with their track records over this period. The markets are currently about 5% off their highs and the press is having a field day whipping up a whole bunch of new narratives about the demise of emerging markets, etc. I am an unashamed bear so this is all music to my ears but lets see how things unfold. What I can guarantee is that we will see many shocked traders shaking their heads in disbelief when the correction comes. You see fooled by randomness is part of our genetic makeup. 

Over Optimism Bias

In last weeks letter I touched on the attribution bias which is another way of describing the over optimism bias. In this weeks letter I want to explore the same bias but from a neuroscience point of view and leave you with an interesting consideration. I will base my insights from a leading expert in the field Tali Sharot, Ph.D. The Optimism Bias: A Tour of the Irrationally Positive Brain.

In rough numbers 80% of people over estimate that good things will happen to them and under estimate bad things. The bias is extremely tilted towards the personal level and fades when describing the optimism people feel for friends and countrymen outside of ones immeditate family. The interesting thing is that the optimism bias is persistent across cultures and genders. Clearly we have an in-built bias so the obvious question is whether it is good for us?

One would naturally think that having unrealistic expectations and failing to achieve them would lead to dissappointment and unhappiness, but research in this field proves the complete opposite that in fact the optimism bias leads to happier people for 3 main reasons:

1) Researchers such as Margaret Marshall have in-depth studies proving that people with low expectations typically suffer from clinical depression. Despite the obvious failures that come with setting the bar too high, the research shows that optimists simply wash away the failure under the belief that the reason for their failure was due to factors outside of their control. These people with optimistic viewpoints tend to suffer less from depression.

2) The act of anticipation is another reason. George Lowenstein the behavioural finance researcher demonstrates through an experiment where you are asked to choose whether you would pay for a passionate kiss with a celebrity. He then asks the subjects whether they would like the kiss to happen now, in 15 minutes, in a couple of hours, a couple of days or a year from now. People tend to choose 3 days as this gives them enough time to anticipate all the delights in an optimal time frame. The same reasoning applies to why we prefer Friday to Sunday even though we work on Friday and on Sunday we have the whole day to ourselves to do fun things. The anticipation of the event is clearly more of a happiness stimulator than the act itself. 

3) Having an optimistic bent changes ones subjective reality, but even more interesting is that it also leads to a change in our objective reality. We often create our own reality through our beliefs. 

An obvious question is why don’t we learn from our repeated failures to achieve the success we mistakenly believe we are capable of? Sharot believes we in fact do learn from our mistakes but amazingly the bias kicks in some more, we in fact only change our optimistic views when it makes things more optimistic. For instance if we thought we had a 50% chance of getting cancer, and we learn statistically our chances of contracting the disease is only 30% then we will update our beliefs to the better 30% odds. However, we don’t update our beliefs when it works against us. If 95% of traders fail and we thought it was only 85% then we will dismiss this new information in favour of our bias.

Ok I think we all knew this at some level, so lets touch on the brain stuff.

The brain has two regions which play an active role in the optimism bias the left and right inferior frontal gyrus. Tali Sharot and her lab conducted a very interesting experiment where they stimulated various regions on the inferior frontal lobe gyrys. When stimulatling the right inferior frontal gyrus for about 30 minutes they were able to stimulate the optimism bias to levels above the natural level, and then they were able to completely remove the optimism bias by stimulating the inferior frontal left gyrus. Behavioural finance scientists have discovered many instances where the optimism bias affects our ability to save or to make rational trading decisions.

Given this information the question I am putting out there, is whether the time is coming whereby we start adopting neuroscience therapies in our efforts to improve our investment performance??

JANUARY 26, 2014

Benevolent Dictators and Overconfidence

Dear RAPA members.

We recently returned from a combined business and family holiday to Singapore. I was last in Singapore in June 2008, fast forward 4½ years and Singapore continues to be this thriving metropolis in south-east Asia. On the surface I find Singapore to be a most amazing success story of a government with foresight and disciplined operational execution. I find the people extremely friendly and helpful and proud of what they have accomplished as a nation. I am not a political person but I suffer from a libertarian affliction and beneath the veneer of this rags to riches story called Singapore; I see the fruits of a 50yr plus benevolent dictatorship first with Lee Kuan Yew and now his son Lee Hsien Loong. So how can I explain this economic success story with the highest GDP per capita in the world, when we know democracy is a joke and is nothing more than a facade, rife with corruption and jobs for family throughout the corridors of senior government, justice and police departments. I can hear the whispers about my comments, “what is he looking for issues with such a success story. Can’t he just accept that a command economy with goodwill can achieve amazing things, just look at China”. I am afraid I just don’t view the world on such a superficial level. I am naturally curious and I want to know, no I need to know why Singapore is such a success when its GDP is almost exclusively service orientated with no natural resources. History has taught us through the ages that almost all dictatorships have resulted in devastating economic hardships for the majority of the population. Kingdoms throughout antiquity had good and bad kings but at the end of the day very few kingdoms/governments survived due to the oppression of its people and the misallocating of resources that is a natural result when a system favours a few over the majority.

So how do I reconcile Singapore’s success? I have a simple theory that 50 plus years is just a speck in time of our history as a trade orientated people. I believe in cycles, both secular and cyclical, driven by demographic and business cycles. For almost a century we have been living through a major Supercycle in Asia with the most populace region on earth emerging from a rural economy into an urban economy with industry and consumption as unstoppable driving economic forces. This against the backdrop of a western economy enjoying growth in productivity unrivalled in economic history. For me the success of the Singaporean benevelont dictatorship is one “fooled by randomness”. I have no doubt Lee Kuan Yew was an incredible visionary with remarkable leadership qualities, but I believe it was his skills with his lucky timing of the various cycles that is the explanation of how a dictatorship is the benefactor of such a tremendous economic success story.

This introduction leads us to the subject of my focus for today, Overconfidence, but first I want to highlight a major milestone that we passed this week. Every RAPA member is important to us and as a larger community we will be able to achieve more so keep spreading the word, the best is still to come.


We are all familiar with the self-attribution bias whereby we tend to attribute favourable results to our talents and effort and poor results to bad luck or misfortune. During bull markets this bias is usually in full blossom with investors walking around like Peacocks showing off how great they are. With the S&P500 up 30% in 2013 there are alot of big swinging dicks out there, to borrow a quote from Michael Lewis’s “Liars Poker”. 

In 2000 Odean and Barber released one of the seminal works in behavioural finance called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” (I have tried for years to get hold of this dataset, if anyone knows of where I can get a copy please let me know). In summary they take 66,000 household accounts from a large discount brokerage from 1991 to 1996 and measure their risk adjusted performance. What they find is that successful investors tend to become overconfident (read: self-attribution bias) which tends to result in more trading, which in the end results in poor performance relative to buy and hold strategies. This is a tremendously important finding and one that can provide clues to allocators such as RAPA when trying to identify managers displaying Overconfidence.

Professor Terrance Odean and Simon Gervais released a paper in 2001 called “Learning to Be Overconfident” in which they develop a mathematical multiperiod market model. In their model a trader initially doesnt know his own ability, but through experience infers through his success and failures a level of perceived ability, the model incorporates the attribution bias. What they learn from their model is that a traders level of confidence is dynamic and usually increases in the early part of ones trading career and declines with experience as one becomes more accepting of ones level of skill. “In our model, the most overconfident and nonrational traders are not the poorest traders. For any given level of learning bias and trading experience, it is successful traders, though not necessarily the most successful traders, who are the most overconfident. Overconfidence does not make traders wealthy, but the process of becoming wealthy can make traders overconfident”.

What appealed to me about this paper and their model is that it can serve as a prediction tool for when a trader is most likely to be displaying signs of overconfidence. This is when a trader is successful but inexperienced, and we see this at RAPA every day. You get a trader who has very little money management experience and a terrific track record of say 8 months to a year. These traders are potentially high risk candidates as they simply don’t have the experience to calibrate their confidence levels to their skill set given the vast amounts of randomness in a return distribution. 

Today in equity markets we are almost 5 years into a bull market which means we should expect aggregate overconfidence to be on display; as allocators of capital it is of vital importance to be aware of these factors and model them as part of ones allocation process.

Regards and happy Australia Day,

JANUARY 10, 2014

Approach Avoidance Conflict

Dear RAPA members.

I will be in Singapore later this week on business followed by some family leisure time, if you would like to meet with me please reply to this email and I will see if we can schedule a meeting I really do enjoy meeting the RAPA community.

Approach Avoidance

Peter and Paul had been researching this incredible trade idea for months. They came up with this ingenius method of structuring a trade that required them to invest $1m with a payout of $5billion if the S&P500 went up 3% in 6 weeks. They factored that they had about a 20% chance of becoming multi-billionaires (please don’t correct my probabilities, I made them up). Peter and Paul could speak about very little in the 2 months since designing their elaborate derivative masterpiece. However, Paul started getting cold feet as the time drew near for him to put his $500,000 stake into their joint trading account. On the day of reckoning Paul could simply not deal with the fear of losing his money and he simply pulled out. Peter was absolutely furious and attacked Paul with a heavy verbal assualt calling him an unstable, lying SOB. Ok he used more flowery language than mine, but the question remains was Paul unstable, how could he agree to the trade only to pull out at the moment of truth?  There is no doubt we have all experienced this type of situation in some shape or form.

To people on the outside this kind of behaviour seems erratic as nothing has changed. In Peter and Paul’s case the unknowns were the same unknowns at the point of executing as they were when conceiving the trade. The answer lies in the fact that whenever we are faced with difficult decisions we encounter this weird emotion called conflict. Desire pulls us towards acting, and fear makes us want to run away. These are two seperate emotions but they act simultaneously in an ebb and flow cyclical manner. This is what psychologists call apporach avoidance conflict. It was the discovery by psychologist Neal Miller and his team who provided us with the empirical evidence to learn something quite unexpected.

I will describe their findings in relation to our example. The changes in the strength of the desire of making billions for Paul were weaker to the changes in the fear of losing the initial $500k investment as the time to trade came nearer. In other words as the moment of truth arrives the change in the desire to make the money is lower than the fear which is accelerating into that final moment of placing the trade. If you are a visual person this diagram may help.

The solid diagonal is the “approach or desire” emotion and the dotted diagnal is the “avoidance or fear” emotion and you can see that equilibrium is clearly not centred. This is part of our primitive biological brain makeup as these results are applicable for rodents as well as man.

There are effective ways to cope or even overcome these conflicting emotions but I will save it for another day I first want to see if the class is paying attention or is still on holiday.

DECEMBER 27, 2013

The Solution

Dear RAPA members.

I have promised my wife that I won’t work this coming Sunday so this will be my last letter (64) for the year. Thank you to the entire community for all your support and we look forward to sharing in our collective success in the new year. Vladimir, Eugene and I live and breathe RAPA and we will continue to give it 110%, if you have any ideas or suggestions don’t be shy, let us know and we will do our best to incorporate the good ones in our future plans. Safe travels and enjoy the time with family and friends.

Do we really care how we came to the solution?

We have all at some stage in our life looked at a map, if you payed careful attention you might notice that there are only 4 shades of colour used to represent different neighbouring countries or states to identify them as unique. Already dating back to antiquity it seemed that 4 colours is all that was needed to identify each region as unique. In 1852, a young mathematician at University College, London, Francis Guthrie came up with this realization of 4 colours. Guthrie didn’t know how to prove this realization so he asked the famous mathematician Augustus De Morgan (1806 – 1871) if he knew of any mathematical proof’s for this statement.

Here is a formulation of the problem:

What is the least possible number of colours needed to fill in any map, so that neighbouring countries are always coloured differently.

You can see in the diagram above it doesn’t matter how complex the diagram, it appears that only 4 colours are ever needed to represent unique regions on the map. What remains is how do we prove it.

It was thought the classic Euclidean Method would be used whereby axioms and postulates would be used to provide a self-evident solution. To this end some of the greatest mathematical minds tried to postulate a theorem, namely De Morgan, Arthur Cayley (1821 – 1895), Arthur Bray Kempe (1849 – 1922), David Birkhoff (1844 – 1944), Percy John Heawood (1861 – 1955), and Philip Franklin (1895 – 1965); and they all failed.

Then out of nowhere in 1976, two distinguished mathematicians at the University of Illinois, Wolfgang Haken (1928 – ) and Kenneth Appel (1932 – ) claimed to have solved the four colour map puzzle with the aid of a computer programme. Without the use of the classic Euclidean Method of proof these two mathematicians have “solved” a problem and have tested their solution on 1,000’s of maps without failure. Now this is where things get interesting as many of the classic mathematicians are not satisfied that a true solution to the problem has been found, despite the Haken-Appel proof.

There are 4 classic methods of proof in the world of logic. 1)Deduction, this shows that something follows necessarily from a set of premises. 2)Reductio ad Absurdum, this disproves a proposition by showing the absurdity of its inevitable conclusion. 3)Contradiction, this shows that an original assumption leads to a contradiction and can thus be discarded. 4)Induction, this shows that something can be established as true if it can be proved for the (n + 1)th case. This is the methodology from which the Haken-Appel proof seeks to draw. Their computer program works with a set of instructions and simply goes through all these sequences and after going through all possible sequences it comes up with a solution.

So have Haken-Appel in fact found the solution to a puzzle that many classical mathematicians list amongst the top 10 unsolved mathematical puzzles. This remains a hot topic for debate and the purest still believe an elegant deductive solution is necessary to solve the puzzle.

This exact debate is how I see the puzzle of extracting alpha from the markets. Just like the 4 colour map puzzle, the solution for extracting alpha from the market remains unsolved in the classic sense. This doesn’t mean that nobody can extract alpha from the market. I think like the Haken-Appel proof there are some unique individuals who have come up with a solution to extracting alpha from the markets, their methods aren’t deductive in that the solution becomes self-evident by following axiomatic postulates. Rather their solutions are by and large inductive by observing results from rule based instructions. 

Today with the power of computer processing and the availability of Big Data we are likely to crack more and more solutions to alpha. This doesn’t mean that we are all going to be rich, as the one axiomatic principle that will always remain is the proof that competition will drive down the amount of alpha available from one solution and force a new puzzle. I think we are in a world of short lasting alpha solutions and the power of computers have made these solutions even shorter lasting. If you want to make money in the markets you need to be good at solving puzzles

DECEMBER 22, 2013

Myopic Loss Aversion

Dear RAPA members.

This Friday the ForexPropel and ForexPropel Plus portfolios completed their first full month with an estimated performance of 0.60% and 1.52% respectively. RAPA has an exclusive distribution agreement with Spectrum Live Capital Management for the retail Australian market with regards our FX products, if you would like more information on how to invest please click here.

Myopic Loss Aversion

You probably have heard of the Equity Risk Premium which was made famous in 1985 by Mehra and Prescott (Nobel laureate). Simply put the return from the stock market less the return from a risk free bond investment gives you the risk-premium. These 2 famous economists then formulated with more than a 100yrs of data a “puzzle” whereby they mathematically produced an equation that suggested the equity premium should be far lower when working with utility maximizing equilibria models. 

Then comes along two behavioural finance giants in 1995 Shlomo Benartzi and Richard Thaler who put forward a theory that sought to explain the equity risk premium puzzle with Myopic Loss Aversion (“MLA”). Their theory demonstrated how when too great an emphasis is placed on short term (myopic) performance investors tend to underweight risk and as a consequence underperform the markets performance. Their theory draws on the seminal work of Prospect Theory (Tversky and Kahneman 1979) by developing the concept of loss aversion, i.e. losses affect us more than gains together with Thalers theory of mental accounting. This is the notion that people tend to make and evaluate decisions one at a time and place them in seperate mental accounts rather than in a broader context. The combination of loss aversion and mental accounting consistutes the concept of of myopic loss aversion. For financial investors this implies that they are averse to losses and evaluate their portfolios at very short horizons.

So here comes the key take-away and I am speaking to myself as much as to anyone. When you make an investment decision for a certain time period there is very little value in constantly monitoring the mark-to-market movements of the investments PnL in the short term. We know that the investment is likely to have almost as many down days as up days but because loss aversion tells us the down days feel twice as bad as the up days the overall sum of emotions is likely to lead us to feeling “down”. If the series of losing days should come early in the investment, the buildup of bad feelings is likely to overwhelm and probably result in a redemption at probably the worst time.

To the traders out there I am sure we have all put on a trade and either gone to bed or done something else only to come back and see that while we were offline there was a temporary sharp drop in PnL, followed by a recovery plus some profit. We all know that if we were watching the trade unfold live we would probably have cut the trade before being stopped out, only to miss the recovery. 

Today with the ability to watch our investments performance in real time from our mobile phones, tablets & computers we are more exposed to the myopic loss aversion bias than ever before. Without a clear trading / investment objective where we detail how we will exit or rebalance our investments we have no chance of loading theappropriate risk-premium to achieve superior market returns.

DECEMBER 15, 2013

Overcoming Regret Aversion

Dear RAPA members.

The year is fast coming to a close and summer in Sydney is in full bloom so these letters may be a little sporadic. Too many distractions when I write laugh.

Overcoming Regret Aversion

One of my peeves is the new age, positive psychology approach to regret. You will hear modern day celebrities, sports stars and “enlightened” people in general comment about an action that got them into trouble or resulted in failure, with a statement like; “I have no regrets, my decision was who I was at that time, I take ownership of my actions, I cannot change the past, it is what it is, etc.” I believe regret is one of the most powerful growth tools known to man. This desire to protect our psyche from anything negative is one of the biggest cop-outs to transformative growth I can think of. Experiencing the guilt associated with a poor decision isn’t meant to debilitate but rather to atone for your mistake and try and eradicate the action from future behaviour. Not all guilt is bad!!

The classic behavioural finance definition of regret aversion is when an investor is so fearful of the regret associated with a poor trade decision that they become paralyzed with fear and do nothing, also known as status quo bias.

There is a great rule of thumb in behavioural finance and neuroscience that teaches us the feeling (pain) associated with a loss is twice as bad as the thrill of a win. Yes I used the word pain as we are able to tell from neural imaging that the loss in fact triggers stimuli to our pain receptors that mimicks physical pain. Regret manifests the same emotional and physical pain we experience with financial loss, it is such an overwhelming emotion; it has within it the power to completely destroy ones confidence and feeling of self worth, but like all things powerful it has an equally powerful energy of transformation when worked through honestly. With this in mind it is completely natural to want to avert regret. 

The idea I wish to share with you as a way to overcome this regret aversion bias is subtle but extremely powerful. So let us unpack the drivers of regret within a trading context. Financial loss associated with irrational, careless or reckless behaviour is the primary cause of regret and many become overcome with fear of this emotion and choose to do nothing – status quo, when facing a decision to enter or exit a trade.  My approach is to add a very simple equation to the: “should I do this trade” I add the following statement “how will I feel if I don’t do this trade?” If you answer both these questions honestly I can guarantee you will overcome regret aversion or the status quo bias. Most people don’t realize that opportunity cost is just as powerful a driver of the emotion associated with financial loss. Try condition your mindset to factor inopportunity cost and you will see that you no longer sit on the fence.

DECEMBER 8, 2013

Hero Archetype

Dear RAPA members.

Last week I described the “trade of my life” buying Bitcoin at $100 and exiting a little north of $1,000. Well what do you know this week my trade looked even better with a steep selloff in Bitcoins touching below $600.

I always like to keep you all abreast of research we do from time to time on the RAPA Score. I think the chart below is a great reflection of how the higher your RAPA Score the higher your expected Sharpe Ratio is likely to be. In this study we group RAPA Scores into decile buckets from 1-10, 11-20, 21-30, 31-40 …..etc and we see how a score performs one month into the future. We then sum all these results per bucket and take the mean and annualize it to get to the Actual Sharpe Ratio. The key take away from this diagram is not to focus on each bucket but rather the upward sloping nature of the results. The higher your RAPA Score the higher your Sharpe Ratio is likely to be. 

Finally, I want to reiterate what I said last week, we will be allocating capital to all absolute return asset classes in the new year. We have already allocated to a number of absolute return strategies in the options, futures & equities space and while these asset classes haven’t seen large allocations to date we hope to address that next year. The more talent we have at our fingertips the better our prospects for raising capital so please be in touch if you think your returns are impressive. 

Hero Archetype

As someone who lived in Apartheid South Africa and was there to experience the birth of the “New South Africa” the “Rainbow Nation” I thought I would say something following the sad passing of former President of South Africa, Nelson Mandela. 

C.G. Jung was one of the great explorers and developers of the collective unconscious, one of his primary areas was the symbolic concept called, “archetype“; however, much of his writing on this subject is difficult to decipher and therefore define. The archetype can be described as a psychosomatic concept, linking body and psyche, instinct and image. The archetype motif or myth is timeless with infinite variations but adheres to the structure of the human psyche, thus reflecting self fulfillment through the struggle of ones self. Jung mentions a few types of archetype in his writings, the one which I want to focus on is the Hero Archetype. The hero symbolizes how the personality formation occurs only through struggle, suffering, and sacrifice. The hero’s triumphs and defeats are the paradigms of the individuals confrontation with the challenges of his or her own individual life – no matter how mundane or exalted. 

Mandela is quoted as saying, “I am not a saint, unless you think of a saint as a sinner who keeps on trying.” When Mandela came out of prison and saw the emotional condition of his family he is said to have been deeply regretful for his failure as a family man. I don’t wish to slight the great man in any way but the point I am trying to make is that Mandela “Madiba” is human, he has no super powers, he is so much more than one mans great actions; rather Mandela is symbolic of a Hero Motif. He is the creation of the collective unconscious of millions of people, South African and from around the world, who themselves at that time in history were able to achieve something great. Mandela and what he stands for is a reflection of the society at the time rising above social prejudice and wanting to move forward peacefully. Unfortunately I believe the Mandela Hero motif has been on the wane for many years, it is my hope and prayer that we all once again become inspiried by the heroism of the Mandela story and we are able to tap into the hero within each one of us to leave a true Mandela legacy that will allow this important motif to remain part of our every day society instead of reflecting the myth that it was one man alone who created a fading legacy.

I wish to carry this analogy over to the Hero Myth of the Central Bank Governor, you can choose the name when the interest rate cycles are accomodative; Greenspan was a hero in his time, then came Bernanke who also became the saviour of the world. People ask all the time how were they able to do it and the answer is so obvious, it wasn’t Greenspan who created a hyper accomodative low interest and a hands-off regulatory environment, it was the people and their collective unconscious that created this environment, the Fed was merely facilitating this need. It wasn’t Bernanke who embraced the concept of solving a debt problem by creating more debt, he was just the engineer who came up with the mechanism, the desire came from the collective unconscious of our society today.  

I guess at the end of the day I believe the greatness of a hero is only reflective of the people around at the time. I think it is time for us all to once again reflect our collective greatness and for a new Hero to be born. I leave you with my favourite South African musician the great White Zulu Johnny Clegg, paying tribute to Mandela. Keep watching beyond 2:30 min for some amazing inspiration.

DECEMBER 1, 2013

I hate Justin Bieber and the trade of my Life – Bitcoin

Dear RAPA members.

You will notice on our landing page we have put a significant amount of capital to work ($25m) in our first year, we anticipate a steady increase in our capital deployment in coming months, and most importantly 2014 will see us shift our allocation focus to the broader CTA asset classes. There is one metric I like to keep an eye on to see if www.rapacapintro.com is increasing its internet presence and I am happy to say with no marketing budget we continue to climb the Alexa Rankings with a global top 350,000. 

I love writing these letters and the feedback has been most encouraging, if you think someone you are friendly with will appreciate them, then please don’t hesitate forwarding.

Bieber and Bitcoin

For those of you who have teenage daughters you may be able to relate to my incredulation. On Thursday this week that scrawny punk Justin Bieber arrived in Sydney. My daughter Gabriella is a “Belieber” so for her birthday she got a ticket to his Saturday night concert. On Thursday I came home from work at 6:30pm and was told my 14yr old had gone with a friend and her mother to stalk Justin at his hotel in the city. My wife and I felt comforted by the fact that they were under “adult” supervision but were concerned that they were not back at 9pm on a school night. I called the mom and said this is ridiculous she said sorry I have a different value system to you and I have not given my daughter a curfew. That is all I needed to hear so I got in my car and drove to the city and arrived at the Sheraton on the Park where I found about 30 “Beliebers” standing like crazed people waiting to catch a glimpse of their Idol. I don’t think it was that cool for Gabriella when her dad cruised into the hotel driveway and got out the car and said, “GET IN !!!!” We fought the whole way home as she was hysterical and could not see anything wrong with staying up the whole night standing on the curb waiting for her hero – Justin. It turns out my daughters mate stuck it out until 1:30am and then threw in the towel. All the while this obnoxious punk was at a strip-joint only arriving back at his hotel at 5am

On the 12th of July 2013 I bought 2 bitcoins for ~$100 each. If you don’t know what Bitcoins are they are in my opinion the ultimate virtual currency. The bitcoin is created using complex cryptography and has an inbuilt algorithm that will allow a maximum number of 21 million possible bitcoins to exist. This makes it different to the likes of our fiat currencies, that can through quantitative easing and a well oiled printing press produce infinite amounts of notes. Like gold, bitcoins are “mined” by computers solving complex mathematical problems which increase in complexity as more coins are mined thus keeping the size of the bitcoin economy predictable and its money supply increasing at a decreasing rate, thus keeping inflation in-check. Well this week Bitcoins traded over $1,000 for the first time and took my return to more than 1000% in less than 6 months. I don’t know about you but for me that was a good enough ride and I took 80% off the table. Let me add buying and selling bitcoins is no simple matter as you need a virtual wallet to house these complex sequences of digits, but I got quite a kick figuring it out and whizzing these codes around the world in a sequence of purchases to lock in my gains, I also sold a portion for cash.

The question on every ones lips is whether the bitcoin price rise is a bubble. In the last 30 days the price is up 473%. I would like to discuss the merits of an asset backed currency like the dollar to the gold standard in a separate letter as I think it is important to understand the clear points Murray Rothbard one of the fathers of the Austrian School of Economics wrote in his brilliant book “The Case for the 100% Gold Dollar” printed first in 1962; however for now the question remains are bitcoins a bubble?. 

I cannot answer that question but what I will say is that just like “Beliebers” do the most ridiculous things in honour and allegiance to their idol, so to do investors who believe in the merits of a virtual currency take their believing to extraordinary heights. One of the big drivers of the most recent rally in the price is the notion that the Chinese are buying the currency as a way for them to externalize their assets from the foreign restrictions in their country, but the stories are getting pretty fanciful, such as Ben Bernanke suggesting their is a place for a virtual currency and other such “supportive” stories. There is still a lot to be understood about the risks the various sovereigns may impose on the currency as well as “hackings” of the various wallet servers, and therefore I think it is very fair to say that the price has gotten ahead of itself caught up in the emotional distortion that comes with a great success story well packaged. I am not yet calling a top in Bitcoins or Bieber stock but the log price is starting to get parabolic and that always makes me nervous.

Finally I would like to make 2 points on why I believe the Bitcoin trade was so successful for me. The first is I fundamentally believed in the logic and philosophy supporting the Bitcoin story (and still do) which gave me the resource to stay with the story, and secondly my position size was so small that I was totally unemotionalwith the trade. The 2 coins I owned at $200 didn’t merit me checking on their price every couple of hours or days. No I researched and loved the concept of this virtual currency that had a limited supply of coins in its lifetime and the ability to be transferred around the world in seconds via a peer-to-peer network. After the excitement of acquiring the coins and setting up my Bitcoin wallet I completely forgot about the investment, I was in it for the long haul, my risks were minimal and therefore I could give this currency experiment ample time to unfold, that was until the mainstream media started reporting about the Bitcoin price rise 10 days ago.

My only regret is I never read about the Bitcoin story earlier; if I spent the same $200 in October 2010 I would be writinig about a $2m profit.

NOVEMBER 24, 2013

Rhythms of Life

Dear RAPA members.

This week I decided not to write anything as I am recovering from an exhausting trip, and for some reason I decided to upgrade my laptop to Windows 8 and after about 5 – 6 hours of battling with different settings and sync options I have decided to call it a day.

Writing these letters has become a big part of my weekly routine and it is a great opportunity to share with members new and old what is going on in the RAPA World.

After 13 days of jetting around the world and meeting so many different people I had one common theme running through my head after each meeting. The active RAPA community members are professional, serious market participants with a down to earth easy going approach; no BS. Instead of giving a half baked summary of the trip and how we envision positioning RAPA for 2014 I thought I would thank everyone for their hospitality and frank and open discussion.

There is one idea I would like to share that fits in well with the way I was feeling by the end of my trip and the new all time highs in the US markets. The entire earths organisms are subject to different rhythms known as the “biological clock”. We have all experienced “just knowing the time” due to the forces of the daily circardian rhythms balancing our lives. By flying across time zones we disrupt our natural circadian rhythms which in turn disrupt our sleep patterns. Sleep is not something that can be replaced, if we lack sleep due to jet lag we go into sleep debt and this my friends is debt that can never be written off. You have to unfortunately slowly repay this debt or it will lead to health complications.

The stock market in my humble opinion is suffering from sleep debt. There is not a true bear in sight, every person with whom I discussed the stock markets in the last 2 weeks told me the markets are going higher. They admit the markets are going up for all the wrong reasons but they believe they will go up all the same. The stock market, the interest rate cycle, the average man’s sleep pattern are all subject to lifes natural rhythms. Karl Marx was a great economist and understood well the natural cycles of the market economy, he could see that through the booms and busts, small segments of society would benefit disproportionately to the masses; and he therefore created a political economy that would eradicate this natural consequence of the economy.

Trust me the stock market needs a rest smiley.

NOVEMBER 17, 2013

The Score and The Sale

By now most of you will know that I am on a round the world trip meeting with RAPA managers, competitors and future strategic alliance partners and importantly stepping away from the insular development phase I have been in for the last few years; taking a step back to look at what we have built and how we can best position ourselves going forward. This week our strategic alliance with Spectrum Live Capital Management (www.slcm.com) went into full bloom with capital flowing into ForexPropel™ RAPA’s first product for the Australian retail consumer. I am in New York at the moment sitting in a really cool coffee shop in their library section (would I be anywhere else) and I have decided to break up this letter in 2 parts. I normally like to think about a topic and then late Sunday afternoon (Sydney time) I usually sit for a couple of hours and write spontaneously, Freud would describe it as free association. Today I am going to do it in 2 parts for 2 reasons. The first reason is my battery only has enough juice to last me the first section but the second more serious reason is I have been chewing on this idea for 3 days and don’t yet have a clear resolution, so my plan is to walk from Central Park to Ground Zero and hopefully come up with a solution. So if this letter only deals with the Score then I have failed to resolve my problem and we will try it another time as I will be going to my first Ice Hockey game at Madison Square Gardens with FX Prophet, so time may become an enemy. 

The RAPA Score 

If you are getting tired of me describing how good our score is don’t because as the more I work with it and understand its nuances the better I think it is and the more you will start to see its application on our portal and its use by other asset management houses.

There is no question MyFXBook is the worlds most popular portal reporting and analyzing FX traders, and this week they announced the introduction of a new scoring method. In the press release they take a swipe at those who score within a closed formulae and promptly share their formulae. One thing I can tell you with certainty the RAPA Score™ is our intellectual property it has over 1,000 lines of code mostly math notation so good luck to anyone who wants to play with it without adult supervision. See below excerpt from MyFXBook:

If the biggest player in this space believes they have a great formulae for evaluating managers and they provide us with the formulae then all that is left for us to do is compare its performance with the RAPA Score™ which of course we did. The results on a quality dataset speak for themself. (Sidenote: I am finding this fast dropping battery meter very distracting, ever happen to you?).

The results are based on a simple equal weighted portfolio construction using the different scoring methodologies. RAPA is the red line which outperfoms in % performance but far more importantly it does so in a less risky way with almost double the Sharpe Ratio.

The Sale 

What has intrigued me since landing in NYC and staying in the heart of Time Square is the energy these street hawkers are able to generate and maintain. It is understandable to be a happy and upbeat for an hour maybe but these guys are going at it all day and under fierce competition from the hawker standing 3 feet away. How are they able to keep up what comes across as genuine energy? It started raining so I didn’t quite make it to the financial district and really beef up my idea but the one insight I have is that these guys are not robots. The energy these guys feed off is “the sale” and to do the sale they need to be able to move within certain parameters. In other words each one of these street hawkers is not just a salesman like a salaried employee in a shop, rather these guys are businessmen with an ability to cut a deal.

As I said these guys need energy in their tank and the only way to get energy is to do sales, to do sales you need to be a good salesman but you also need to be able to cut a deal, loosen parameters, cut your price if that is what it is going to take. On a number of instances this trip I got involved with some barter. I had no interest in any of the things for sale but I played along and in both cases I was able to buy the item at 50% of the asking price. Did he make on me, maybe. But there was more to it, by doing a sale he got some energy maybe in my case not so much but he was also able to send a message to his competitors that he was doing business and perhaps this might lead to them feeling dejected and enhance his chances of doing further sales. Or alternatively you have the street hawker who never budges with his price and this guy will only trade with the really unsuspecting tourist who knows no better and couldn’t be bothered. These deals don’t happen to often but they too provide energy and it comes in quite a strong octane.

The parallel I see quite strikingly is the trade scalper who each day is trying to extract pennies from the market. This applies equally to an algorthmic scalper. You can set the parameters of your trade entry and exit at levels that will seldom be hit and will therefore lead to many tradeless days; for a scalper living off lots of deals this is highly energy sapping even if the computer is watching the market for you all day. So guess what the bulk of scalpers do, they resort to making fine adjustments to their parameters and bingo your limit order is hit and the energy flow of the markets courses through your veins. This is a very slippery slope and I am afraid scalpers who increase their chances of trading with less favourable margin parameters inevitably lose money or simply never make money. The true scalpers in the market are either the ones trading with bazooka machines that no regular guy could compete with or the smart ones who have conquered their need for sucking energy out of the market and have designed their lifestyle for low energy use.

My grandfather used to say, “I make money with a very small margin, I buy for $1 and sell for $2 only a 1% margin”.  

NOVEMBER 10, 2013


Last night I finally commenced my round the world in 13 days trip. I write this email from the Hong Kong airport in a slightly drugged haze having taken the generic of my favourite travelling poison, the result being a drugged stupor that I am struggling to shake. However being the creature of habit I am I couldn’t let the opportunity of writing my Sunday missive pass me by, so here goes.

Separation Anxiety 

Yesterday as I was preparing to farewell my family I could sense within me an emotional disquiet that I diagnosed as separation anxiety. This was certainly not of the clinical variety with severe physiological signs, rather this was simply a feeling brought on by a specific circumstance and I wanted to upack the feeling and see what I could learn from it.  

As someone who sees himself foremost as a family man: husband, father, son and brother the separation from family forces one to strip away these outer garments and focus on ones self. This is confronting as I am no longer Michael Berman the family man but rather Michael Berman the CEO of RAPA embarking on a business trip with a whole series of goals and aspirations without the regular support structures in place. There is nothing wrong with having such a feeling of anxiety about the separation from ones regular support structures, in fact it can be very positive as it can lead to more appreciation for what we have; however it can be a distructive emotion where the anxiety leads to paralysis or an inability to experience new things. 

I wanted to relate this feeling of separation anxiety to traders who have become psychologically dependent on the tools and philosophy of their trade. I am speaking to myself as much as any other trader on this topic. If there is one thing I am 100% convinced about is that the markets are never constant and pass through many different market conditions. Trend, sideways, choppy, cheap, expensive. There is no system systematic or discretionary that works equally well in all market conditions. 

The lesson I think this emotion has taught me when considering it in the context of the trading/investing world is that the successful trader/hedge fund manager, person are the ones that are not afraid to separate themselves from the tools that may have worked for them in the past but are no longer providing the desired results. So separation anxiety can be a good thing because if we didn’t experience some sort of cognitive dissonance we would keep chopping and changing and never be able to identify what works. But to be successful and grow we have to be able to say Good Bye!!  

NOVEMBER 4, 2013


This past week we put our RAPA Score™ to the test once again. We were fortunate to access a very good database (daily returns) of absolute return managers with more than a $100 billion under management. The objective was simply to test whether using the RAPA Score as the performance metric would lead to risk adjusted return outperformance. I am really thrilled to say the RAPA Score™ didn’t dissappoint. If anyone has access to a database of absolute return daily returns and would like to see the results of the RAPA algorithm, please be in touch and we will be happy to publish the results.

To showcase the results in their rawest form we look at the outcome if you chose the top 50% of managers each month based on either their RAPA Score (black), Sharpe Ratio (red) or % Performance (green). As you can see the RAPA Score™ triumphs with a significantly higher Sharpe Ratio than the other methods. This just points to the use of the RAPA scoring algorithm as a screening tool, futher innovations to capital allocation can be made using the superior risk return factors present in the algorithm. 

What is in a Wink 

As a flaneur determined to see deeper meaning in most social/psychological interactions I wanted to share a little insight that I recently gained in the field of body language. I have long held an interest in this subject and study with interest the clusters of behavioural signals people give off in their interactive discourse. A couple months ago I bought “In his Image” a book on the subject based on sources from the Bible.  

We all have that one family member that we don’t trust. I could never put my finger on my distrust of X, until I read a body language explanation of King Solomons interpretation of a wink. Whenever I speak to X they wink at me in the course of the conversation – strange hey! 

Winking is a special manner by which one influences his soul through the eye. Defenders of winking say it is an act of friendship or playfullness, but Eldad Nakar believes strongly that no matter the context it is wholly a negative action. Winkers have a tendency towards dishonesty, mocking others and lying. No need to be defensive as good people also wink from time to time, but as far as body language and personal development goes this is not a good thing to do. 

Trading is the exchange between two people or entities, so be open to all kinds of “body language” and remember no winking.

OCTOBER 27, 2013

Creative Personalities

Dear RAPA members.

We are about to begin the next phase of RAPA’s journey which is to grow our assets under management so that we can allocate more capital to our members. We have spent a lot of time and money learning how to efficiently onboard managers and allocate capital optimally. To begin next month we will launch ForexPropel™ a joint venutre with Spectrum Live Capital Managementnext focusing on the Australian retail investor. We will also start our capital raising for seed investors in RAPA Emerging Manager’s with our trip to the UK and USA next month.. In the year since RAPA went live we have attracted a tremendous cross-section of talented emerging managers; it is now time to take advantage of this talent and raise investment capital.  

To showcase our talent in the chart below, we created a basic filter for inclusion in our RAPA Emerging Manager Fund. A manager needed to have a track record longer than 1yr with a RAPA Score™ greater than 60. We then simply run this rule every month and allocate using a risk parity optimization model, then “rinse and repeat” each month as we step through time. Our backtest model uses no hindsight bias, however its future success is dependent on us finding enough managers to satisfy the two filter rules, as you can see performance has been spectacular. We will be presenting our managers to various capital providers over the next few weeks, many managers have come onto the RAPA platform over the year and not everyone has kept their performance updated. I urge all managers wishing to raise capital to either update your performance on the portal, or those who don’t have Interactive Brokers or MT4 supported accounts please send us a daily time series of % returns in Excel (for us to accept this format we will want to see brokerage statements to verify these returns) so that we can include you in our marketing effort.

Creative Personalities

There is this pereception that creative genuises are tortured souls living on the edge of sanity. I decided to look at the creativity process from the perspective of personality types and explore this generalization. Many of you will be familair with the Myers-Briggs Personality type questionnaire that is often used in business to determine what type of personality you are perceived to be by the world around you; well of course we haven’t strayed too far from my guru CG Jung whose typology model of the mind is the foundation stone of this test.  

Jung believed our personality type to be dominated by a certain character trait, for example being an extremely organized and tidy personality type, but lurking below the surface of consciousness is a “shadow” that wishes to be messy. A psychologist whose work I am very fond of Mihaly Csikszentmihalyi (correct spelling) has developed a theory that creative people do not get stuck on one pole of the personality spectrum but rather oscillate between both poles at the same time. Here are 10 dimensions of apparently antithetical traits that are often both present (see: Creativity): 

1.) Creative individuals have a great deal of energy, but they are also often relaxing. 2.) Creative individuals tend to be smart, yet also naive at the same time. 3.) They are also a mixture of responsible and irresponsible (a better word may be playful or light hearted). 4.) Creative types are often full of imagination and fantasy on the one hand but then deeply rooted in reality. A side note, what is interesting a really creative person will not suggest something bizarre. Normal people are rarely original but they are sometimes bizarre. 5.) They can often be extrovert and introvert at the same time. 6.) Creative people are remarkably humble and proud at the same time. They typically are already onto the next project and have lost interest so they don’t dwell on past achievements. 7.) Creative people are able to transcend the typical masculine and feminine traits in a form of psychological androgyny. 8.) They are also both traditional and rebellious. They must know the rules of their domain but must be also willing to break free from accepted rules. 9.) They are very passionate about their work, yet can be extremely objective. 10.) Creative people have a heightened sensitivity which through feedback exposes them to suffering as well as tremendous joy.

I believe the investment management landscape is so competitive today that to be successful you need to be very creative in how you approach your trading. We are all reading the same research, we are all accessing more or less the same information at the same time, we use the same sentiment and volatility indicators, so if we are all following each other then we are bringing very little if any alpha to the table. The creative amongst us are sure to be the winners in the game called the “markets” we all love, they will be the ones who achieve transcendence with the unification of opposites.

OCTOBER 19, 2013

Irrational Exuberance

Dear RAPA members.

Next month I will be in Hong Kong on the 8th, London from the 11 – 13 and the US east coast from the 14th to the 19th. If you would like to meet up please reply to this mail and I will see if we can set something up as I woul love to meet as many of our RAPA members as possible. 

Shiller PE’s

On the 13th of this month the Nobel committee announced 3 economists to be awared the 2013 Nobel Prize for Economics. The Nobel laureate I wish to discuss is Professor Robert B Shiller from Yale University, the awards were in recogntion of the trio’s contribution to further the understanding of asset pricing.

Shiller has become a household name in economics due to his forecasting the last 2 major market bubbles. I recall reading his brilliantly titled book “Irrational Exuberance” in 2000, rushed into print just as the market was topping. This is a great book that in many ways laid the foundation for the school of behavioural finance to find its place in the mainstream. His main thesis was that markets were discounting corporate dividiends and the volatility in the price of the market could not be justified given the volatility of the dividend stream. 

Last week I wrote about conditional probability and this week it is opportune for me to discuss what I believe to be the first and most important ingredient when calculating a conditional probability when developing a tactical asset allocation model. Shiller believes it is impossible to make short term forecasts about the market but when pushing the time horizon further out he does believe one can make reasonably probable forecasts, and I agree. I hear it all the time from friends and colleagues, the market is driven by sentiment. This is true, to a degree; however, even if this statement were to be true in totallity knowing that sentiment drives the market is not helpful if sentiment itself is a random outcome of variable inputs. The reason why I say it is only partially true is because I believe as does the more famous Shiller that price behaviour is still anchored by valuation.

The very first model that I work with when establishing whether the stock market is overvalued or undervalued is the Shiller 10yr PE Ratio. His 2000 book has a bit of cult following with its own website www.irrationalexuberance.com supplying the updated data for the models he presented. What I find so useful about his PE model is that it takes 10yrs of earnings not the typical 1yr and then adjusts it for inflation, so that when valuing the market you are not taking a current snapshot of earnings and extrapolating that into the future without adjusting for where earnings are in their cycle. Before looking at a valuation of the current market, it is worth looking at how mean reverting earnings are over complete cycles especially when adjusting for inflation.


In the chart below you can see the current Shiller PE Ratio trading at 24.95. The mean is 16.49 making the current market valuation 51% overvalued against its historical average. Working with the Wall Street favourite 1yr historical earnings the PE is 19.89 versus a mean of 15.5 which makes the market only 28% overvalued.

To end off I will show a chart from IE that uses the Shiller PE ratio as a forecast of market returns for the next 10yr period. This chart is not recently updated but you can clearly see how inflated PE ratio’s led to poor 10yr market performance. To quote Warren Buffet: “Price is what you pay, value is what you get”.

OCTOBER 15, 2013

Conditional Probability

Dear RAPA members.

Next month I will be in London from the 11 – 14 November, and the US the week after. If you would like to meet up please reply to this mail and I will see if we can set something up. To get to London I have to travell through Singapore or Hong Kong so if you would like to get together please drop me a mail and I will do my best to try and include a stop-over via Asia. I have had some terrific conversations with many of you and would love to meet up in person with as many people as possible.

Conditional Probability meets a Bayesian

It was 2003 when I read one of the essential finance books (into its 11th edition), “A Random Walk Down Wall Street” by Professor Burton Malkiel. His thesis being the markets are completely random and you are therefore better off investing in the index. This book shook me to my core, I had left a successful career in property to become a full time money manager in 2002, and reading his book made complete sense which made me feel like a complete phoney on a walk to failure. Thankfully it wasn’t long before I discovered behavioural finance and the antidote called “A Non-Random Walk Down Wall Street” by Professor Andrew Lo to at least make me feel there was still a chance of extracting alpha from the market place.

As each trading day passed I felt more convinced than before that the market had memory, and that although the markets were primarily random there was something that fund managers could do to justify their occupation, and so began in 2005 my passion for building models that can exploit this fact.  Let me introduce you to the cast of quantitative analysts who have helped me along the way:

Maurice Shaprio (BSc Honours Mathematics in Finance), Una Perovic (MSc Electrical Engineering), Charis Harley (Ph.D Computational and Applied Mathematics), Warren Wright (Ph.D. Mathematics) Professor Ebrahim Momoniot (Applied Mathematics), Castedo Ellerman (MSc Mathematics in Finance), Mike Oberhaus (BSc Chemical Engineer), Brice Lemke (MSc Physics), Prof Ed Weinberger (Adjunct Professor Financial Engineering), Prof Tom Gastaldi (Statistics & Mechanical Engineering), David Varadi (MBA), Prof Eugene Olin (Ph.D. Applied Mathematics), Vladimir Krouglov (Ph.D. Applied Mathematics), Louis Mercorelli (Ph.D. Mathematics in Finance), Alexandr Sergeevich (Ph.D. Physics), Kora Reddy (B Tech).

Let us consider the concept of randomness at a basic level; the tables below show the S&P500 daily returns since 1985, and the return that follows after a sequence of 2, 10, 11 up days in a row. If the markets are random then theory would have you believe that the average return of the next sequence is 50:50. In our example we see the null hypothesis.


In the 1700’s Thomas Bayes a brilliant mathematician produced what is known as the Bayes Theorom and from this theorom a branch of probability theory called Bayesian Probability has emerged. With reference to our example above what the Bayesian Probability does is incorporate the actual data in its probability calculation and with each new step through time us Bayesians update our model with more actual data. 

Stay with me a moment longer, I may be an idiot but I am not dumb, what my journey down a rocky and twisting road has taught me is that the markets are indeed largely random, however there do exist certain conditional clusters that tilt the 50:50 scale in favour of the skilled fund manager, I hasten to add that what I have learned the hard way is that timing this advantage is impossible. I believe the problem with practioners of conditional probability games, myself included is that we don’t set the game up with the opportunity for enough sequences to result before the parties to the game (investors) grow weary, annoyed or oppositional. Setting up the game to allow ones advantage to flourish is the answer.

As I have a passion for building models and I have a library full of excellent code, I thought I would start a section on the RAPA platform that will start posting regular S&P500 conditional probabilities. To assist me in this endevour I have collaborated with Kora Reddy from paststat.com who seems to share some of my approaches to the market and already has a great database reporting system in place. In future letters I will reference some of the research but my intention is to simply post regular updates on my Wall and hopefully some of you will benefit from the research and enjoy watching it evolve.  

The letter is starting to read long so I will just give you a brief introduction to my research: The first thing is we run our analysis over weekly S&P500 data going back to 1985. Our screener runs more than 90 technical signals through the database to see which conditions are met. The following signals satisfied our conditional statements.

As a quick demonstration of the power of our conditional probability model I will pick one signal “Weekly Aroon Oscillator (14) moved above 70” and show you the backtest results using Bayesian inferences. A final point I would never recommend a forecast on the basis of one signal but rather an appropriate cluster of signals, keep visiting the RAPA website (www.rapacapintro.com) to follow our research. 


OCTOBER 6, 2013

Game Theory

Dear RAPA members.

On the 11th of November in London at a major Forex conference we will launch our 1st commercial product for the Forex sell-side – R3 (R-cubed); an analytical tool to assess the trading skill of broker clients developed withGleneagle Securities. We will also be announcing within the next 2 weeks a white label joint venture with a highly respected company to launch FX Omega in Australia, a fantastic product for FX investors who want to gain access to an array of excellent FX talent in a well constructed optimal portfolio. We have pushed the release of our Behavioural Finance alert tool to the end of October due to there being insufficient hours in the day for our small team; and finally we will be announcing in the coming week a collaboration with a team of quants who share our passion for conditional probabilities with an initiative that will see us making regular posts about high probability market trades.

A final update which makes me really proud www.rapacapintro.com has just turned 11 months, and today we notched up member number 1,700 as well as breaking into the top 500,000 of the most popular websites in the world with an Alexa rating of 469,614. Alexa.com is to websites what RAPA is to traders winkplease tell your friends about us and stay engaged as we are determined to build the most innovative tools for the trading and investing community and enable traders with little or no access to capital the opportunity to fulfill their dreams of being a full-time money manager; we are still at the start of this journey, and my final, final point please visit the incubating Joey’s blog written by journalist Jonathan Shapiro (for those not in the know, RAPA has teamed up with one of its star traders Kevin Saunders to offer a training programme in options trading to a group of novices) a refreshing hectic look at the commitment it takes to become a winning trader.

Game Theory and the Nash Equilibrium

This morning I was at the gym and had my eye on the rowing machine. A girl in her 20’s was on the step machine and suddenly jumped off and placed her handbag on the rowing machine before I could get to it. This irritated me and there was no way I was just going to accept it so I went up to this girl who was now back on the stepping machine and asked her how much longer did she have on the steps before planning to row. She said without any embarrassment another 10 minutes. I said lady you cannot occupy 2 machines at one time and I proceeded to remove her handbag off the rowing machine and began my workout. In the middle of my rowing session she could not control her anger so she jumped off the step machine and came over to me and said “you arrogant prick how dare you be so rude to me”. I won’t discuss the rest of our conversation but let me tell you an insight from this incident that I believe parallels with what is going on at Capital Hill in the USA with the federal budget this past week and the debt ceiling lifting in the next 10 days. To explain my point I needed to dig into my library and pull out that rare gem, Theory of Games and Economic Behavior by the father of Game Theory John von Neumann. 

Game Theory is way too complex for me to grasp fully and is so intensely mathematical I think few are able to work with this type of approach. As an aside there have been 8 Nobel Prizes for Economics from this branch of economic logic. A few years ago Russell Crowe played the character John Nash the brilliant mathematician from “A Beautiful Mind” who won a Nobel Prize for his discovery called the Nash Equilibrium which has been used to solve the Prisoners Dillema amongst other riddles.

Coming back to the lady at the gym she was operating in what the early Game Theorists focused on which was zero-sum games. She felt if she didn’t have both machines at her disposal she lost and I won. It seems the same with the Democrats and Republicans they are playing each other as if the game is zero-sum and neither wants to be the loser.

However, as with the Prisoners Dillema and War and Budgets the game is not a zero-sum game as both parties can be losers and in some cases both can be winners. My “friend” at the gym did not find her Nash Equilibrium and see how we both could be winners. Rather she focused on her on self-interest and tried to play a zero-sum game where she would be the winner and me or anyone else would be the loser.  

I think it is time for the leadership in the USA to stop playing a zero-sum winner-loser game and find their Nash Equilibirum.

SEPTEMBER 30, 2013

PhotoReading, Big Data and Knowledge

Dear RAPA members.

We will announce a lot of new initiatives during the course of October. Today has been a busy day for me, we are moving homes having just sold the house we bought in April 2009 at the height of the financial crisis and we will be renting for a while. Future letters will no doubt discuss the psychological aspects of being on the sidelines of a red hot Sydney property market. As a contrarian I love that I bought at the low, and who knows maybe I sold at the high; but that could be wishful thinking and is due for discussion on its own merit.


As we are moving from a big house to a smaller house, my wife has been on my case about my books. You see I was fortunate to grow up in a house of reading and one of my great passions is buying and reading books. For me having my books in electronic format is just not the same, I like to see them, feel them, smell them, and choose one to read based on my mood of the day. 

From childhood I have been interested in knowledge and in those early days my passion was for general knowledge (see pic above). I would study the newspaper from cover to cover remembering all kinds of facts, btw, nothing has changed much. However, as time marched on my epistemological (just love that word, and it also makes me sound cleverer than I am) pursuits grew stronger and by my early 30’s I was ready to up my game. I came across a form of speed reading called, PhotoReading.This is truly the most unique approach to reading I have ever come across. In a nutshell, you get yourself into a hypnotic state and you literally flip through pages of a book. Say it takes you 1 second to turn a page, you can literally flip through a book of hundreds of pages in mere minutes or roughly 25,000 words a minute. It gets even more amazing as the brain doesn’t function in a linear fashion so you can read the book upside down and start at the end and read forward to the beginning. All you are doing is taking mental snapshots and filing them in the brain.   

If what I said intrigues you visit the website on the link above and check it out for yourself. It wasn’t long before I was devouring books by the dozen and to keep pace I had to start taking books out from the public library. My wife will bare testimony that I had comprehension of roughly 65% accuracy, so PhotoReading became a very important part of my life. The question you might be wondering is do I still PhotoRead and if not why?

There are different ways of acquiring knowledge, some people want to have lots of knowledge and others want deeper knowledge. In my case my need for knowledge changed from wanting lots of it to rather understanding concepts and ideas on a deeper level. It is for this reason as well as the tremendous discipline required to PhotoRead that moved me on from this amazing approach to reading.  

There is a current belief that the biggest thing in computing today is Big Data. The biggest driver of economic growth over the last couple of hundred years has been theproductivity associated with the industrial revolution. However, today leading economic thinkers (including Nobel Laureate Edmund Phelps) question whether there has been an increase in productivity since the building of the information super-highway. 

If you look through the ages at the greatest innovations and theory break throughs, they were not arrived at through inductive logic (number crunching) but rather through deductive logic using abstract principles instead of mountains of information. I went through the phase of believing that reading every analysts research report or daily blog was the most important thing in my day. But my day became a slave to the daily grind of deciphering mountains upon mountains of useless information.

In conclusion I am not saying data or knowledge isn’t useful, because in many cases it is vital. However, I would like to suggest that in order to successfully navigate complex times and situations you require more than breadth of knowledge you need depth of knowledge.

SEPTEMBER 23, 2013

Symbolic Ritual

Dear RAPA members.

We have spent the last few months actively seeking the best FX managers around the world and we continue to search for these rare creatures. We have engaged many on discussion forums and without fail we are approached by aspiring rookies who assure us how good they are and how they can generate 5-10% returns per month. My standard response remains, “you must be the best forex manager in the world”. 

A seasoned forex manager who we have invested with shared this statistical table with us which says it all. Hat tip to Peter Panholzer from DynexCorp. Deutsche Bank have developed the ultimate platform for institutional managers and investors called DB Select with FX Select being their forex platform. What is very interesting from the table below is that of the 149 managers accepted over the last 9 years only 53 have survived with 75% of those dropping out taking place in the first 36 months. The main criteria for being dropped is a drawdown of > 20% in a 12 month period. The clear message is one needs to remain very cautious with FX managers who have track records under 3 years as they are most at risk of “blow-up”. 

 What are the psychological benefits of Symbolic Ritual

I am writing this letter in the middle of the Jewish festival of Sukkoth (Tabernacles) when we leave our homes to dwell in little makeshift booths, in rememberance of our time wondering in the desert. This is the main theme of the festival but there is another very strange custom and ritual that accompanies the festival called the Four-Species. This is one of the weirdest of our customs as we stand in the synagogue holding onto these four different agricultural products each rich in symbolism and wave them back and forth. Actually weird is an understatement! I am usually quite self-conscious during the ritual ceremony, but this year was different, I didn’t feel that weird and I wasn’t self-conscious and neither did a care what the outside world would think. For those few minutes I was teleported into a different world which made perfect sense.    

The great psychiatrist/psychologist Carl Jung writes extensively on this subject, and it was the subject of symbolism that inspired him to divorce himself and his workanalytical psychology from the more internally constrained Freudian psychology.

Jung would describe ritual as a psychic container for transformation of the self. He believed that man expressed his most important and fundamental psychological conditions in ritual and that if the appropriate rituals were not provided, people spontaneously and unconsciously devised rituals to safegaurd the stability of their personality. The ritual itself does not affect the transformation, it merely contains it. If I am going to get all weird and loopy on you let me go one step further and teach you a Jungian term Numinosum that I believe describes my Four-Species experience. In 1937 Jung wrote of the numinosum: a dynamic agency or effect not caused by an arbitrary act of will. On the contrary, it seizes and controls the human subject, who is always rather its victim than its creator. The numinosum what-ever its cause may be – is an experience of the subject independent of his will….. The numinosum is either a quality belonging to a visible object or the influence of an invisible presence that causes a peculiar alteration of CONSCIOUSNESS (CW 11, para.6). 

Jung differentiated  between signs and symbols, saying that a sign was always linked to the conscious thought. Whereas symbols stood for more than their obvious and immediate meaning hinting at something not yet known but produced spontaneously by the unconscious. 

In conclusion we all encounter symbolic rituals during our every day life, in many different forms, they are there to help transform our mundane lives and inspire us as we connect through our collective unconscious. Our challenge is to not only look for the symbols but somehow understand their message.

SEPTEMBER 15, 2013

Addicted to Trading

Dear RAPA members.

We will update you on FX Omega progress towards the end of the month. We remain on track to share by month end our latest research on the behavioural finance heuristic “Disposition Effect”. We believe our approach is possibly a world first, so stay tuned. 

During the course of the week one of our emerging star traders, enquired about engaging a coach to help on some trading exit ideas, there is a thread on the forum that deals specifically with the request. 

Why are we addicted to trading and why is it Bad

Standing in line at my favourite coffee hangout, a guy I know from around, started chatting to me. He told me that once upon a time he was a trader, but he gave it up because, “it is so boring”. This statement needed further probing, how could he find the most exhilarating profession in the world mundane? He said that once he had done his research on BHP and worked out that it was worth $40 and he had invested at the then current price of $25 he had to sit on his hands and do nothing which he found so boring. I couldn’t leave it at that so I asked him how the trade worked out; his answer is the motivation for my letter today. He said that he decided to leverage his trade by borrowiing 90% on margin, and then as sure as day follows night the stock price dropped 12% and triggered a margin call. Needless to say he blew up his account and decided trading was not for him, with BHP trading up to $50 to add a little extra torment.

We will need to analyze a few interesting case studies to lay the ground work to a very insightfull perspective (the book “Sway” was my source). In 1993 the Swiss were looking for a site to use as a dump for the radio-active waste from their Nuclear Electricty programme which was providing Switzerland with 40% of its electricty. When the proposal was put to the local town the response in favour of allowing the dumping was 50.7%. Then a strange thing happened, in a follow up vote they offered each town resident a financial reward of $3,500 and the vote in favour halved. Why?  

In Israel a research study was conducted by asking 40 university students to take a GMAT test as an experiment. Passing of the test would not gain you entry into a Business School. Then the exact same study was conducted but this time the researchers offered their candidates 2.5 cents for each correct answer. What resulted was very strange. The students who were not incentivised did MUCH better than the ones who were incentivised. These two examples fly in the face of rational economic theory – what gives?? 

Researchers at the (NIH) National Institute of Health conducted a series of brain imaging studies by placing participants in an MRI with a computer console and a game that financially rewarded the participant when “zapping” certain objects and creating losses if an incorrect object was zapped. When a specific shaped object was on display no financial consequence took effect; a running cash balance was always on display. Amazingly every time money was at stake a part of the brain lit up called the nucleaus accumbens. This is a primitive part of the brain which is often called the “pleasure centre”. The nucleaus accumbens release the natural drug dopamine and is the part of the brain which drives addiction. The reason is that the threshold for stimulation increases the more the brain is stimulated, so you always need more.

Wait, before we put it all together, there is a very important coincidentia oppositorum (remember I spoke about this concept a few weeks back). In 2006 researchers at Duke University extended the NIH experiment and instead of given monetary reward said that the higher the score the more money would be donated to a charity, and here remarkably a completely different part of the brain came to life called the posterior superior temporal sulcus. This is the part of the brain responsible for social interaction and is also often called the “altruism centre”.

Ok let me see if I can stitch this together. As amazing as the brain is, these two parts of the brain; the pleasure and the altruistic centre cannot function together, it is either one or the other. I am all for the capitalist model of incentivising someone to increase their productivity. However it appears that sometimes the way these incentives are presented can cause us to chase after them and in so doing soak our brains with a dopamine rush. As we stimulate our primitive pleasure centre we tend to do things like my coffee buddy and trade way too big and too often in order to satisfy the insatiable rush. 

In future letters we need to discuss constructive ways in which we can remedy this natural urge, as I am a believer that with the right conditioning we can overcome our biological urges.




Dear RAPA members.

I decided to postpone my Sunday letter so I could include a short tutorial on the RAPA Tools we loaded onto the site overnight.

It was the jewish new year last week Thursday and Friday, yes that is two days, and no our new year isn’t one big party it is serious stuff. In fact it is a life or death, rich or poor time of the year and contains one of my favourite philsophical threads “free choice” and its role in determinism. This topic we will save for a future discussion the other important theme with the new year festivities is the family aspect where families unite and spend time together eating too much. Today I want to focus on this theme.


A couple of weeks ago I went to a lecture by a visiting American Professor of Psychology Dr David Pelcovitz who specialises in adolescent issues and he discussed a very powerful 3 step model that I think is applicable to all relationships and something we can all learn from.  

Pelcovitz bases the 3 steps on an academic study into “affluenza” conducted on children in the Scarsdale, NY area. The children assessed were from a very wealthy strata of society but displayed a disproportionate level of depression; this flew in the face of the natural perception that rich children would be happier with all their possessions and privelages. Let’s get straight to it and see what 3 steps we can apply to counter the factors causing depression in relationships.

1 – Uniqueness: A common mistake is to treat each person in the same manner. We are all unique, we have different personalities, temperaments, skills, abilities, etc. It is a mistake to treat each person the same, rather we should adapt our interaction with these insights in mind. 

2 – Time: When we are together with our children or anyone we wish to build a relationship with the research has proven that spending time is not enough. There needs to be quality time in the relationship where we are “present”. It was found that rich parents are often distracted or worrying about work issues and never truly switch off. As traders this is probably one of the hardest things to do as the markets are 24hrs a day 6 days a week so there is very little time to switch-off. 

3 – Usefulness: In order for us to feel worthwhile we need to contribute. Children who have everything provided for them without having to make effort eventually feel worthless and become depressed. The same applies to all kinds of relationships. To make a relationship meaninful both parties have to put something into the relationship otherwise the party only receiving will eventually start to feel useless.


If you click on the “Tools” button under the “Accounts” menu on the site you will get the following screenshot. We think this is a useful tool that will continue to develop so please make suggestions on the forum. The data is pulled from Yahoo Finance and follows its symbology. We have provided a nice tweak which helps adjust time zones when looking at comparative analysis between say Australia and the USA. In this instance Australia usually follows the USA but is a day ahead so doing analysis on the same date will provide meaningless statistics. The lookback period is how much data to include. The window is the period over which the volatility, beta, correlation calculation steps through time. I will leave it there and continue the discussion on the forum.

As a final comment we have recalibrated our RAPA Scoring algorithm which will cause some of your scores to shift. The changes are mostly marginal but reflect a better application of our proprietary scoring system.


Anticipating Pleasure

Dear RAPA members.

We have allocated a further $1.5m to 2 new FX managers this week taking our managers to 11 and finally passing our goal of a minimum of 10 managers. In coming weeks I will do a separate note on our FX Omega programme to give you an overview of what we have built.

I also want to stress that RAPA is not focused exclusively on FX but open to all absolute return asset classes. However, we have channelled our capital and energy for the last few months on FX to get the RAPA FX Omega programme launched.   

Two final points, one of the Joey’s in the incubating Joey’s programme is Jonathan Shapiro a financial columnist with Australia’s leading financial newspaper, the Australian Financial Review, he is keeping a blog of his Joey experience and it can be followed over here. Tomorrow you will also be able to play with a few new quantitative tools on the website (look under the accounts menu) which you should find useful to provide a quantitative overview of the markets you montior. 

Anticipating Pleasure

In the early 1970’s a Cambridge neuroscientist Wolfram Schultz recorded the brain activity of monkeys when being fed. What Schultz found at a cellular level was the neurotransmitter dopamine being released first when the monkey received the reward, but amazingly after a few instances of presenting the reward the monkeys brain started releasing dopamine in anticipation of the reward. Don’t ask me why but I have spent a lot of time pondering why the brain should start releasing this pleasure drug in anticipation and not only on receipt of the reward. 

I seem to walk around in a perpetual search for deeper meanings so with respect to this seeming anomoly I did a little research and gave it some thought and I have come up with the following two answers that satisfy my curiosity. These may not be the real answers but they are for me. The first reason is an evolutionary physical response which I will relate to the way markets work and the second is a metaphysical viewpoint.

Let me explain how the brains reward/pleasure system works without using complex scientific jargon. In essence we have the most amazing electical circuitry operating within the cells of the body controlled by the brain. After a few examples of stimulus/reward the brains “prediction neurons” start anticipating the reward and begin increasing the levels of dopamine in the body ahead of the physical enjoyment. However, when the expected pattern or results deviate the brains response is to shut down the production of dopamine at the cellular level which causes an electronic shock (“error-related negativity”). When clear reward patterns emerge we have an exquisitely finely tuned electronic circuit built purely on expected results. The evolutionary principles in play have developed this level of anticipation not so much to enjoy the fruits before receiving them, but rather to build this highly complex, finely tuned alert system that is able to detect “errors” in expected patterns and therefore react to them with a speed that is quicker than a system that has to wait for the actual reward to physically manifest.       

I think this is a perfect example of how the markets work. The players in the market try and anticipate the future response of the market to a certain stimulus. So in current day language the announcement of Quantitative Easing is typically associated with the response that the markets go up. When the anticipated response doesn’t happen the circuit becomes broken and to correct it the “dopamine” is immediately shut down to alert the players which causes the typical sharp drops in the market as part of its regulatory response. This is exactly how the markets work on what ever time scale you are operating on. The market is constantly “anticipating” and extrapolating current trends, hence the overshoot typical in the market and the subsequent correction when there is realization that the pattern is broken.

My second more metaphysical response to why the brain operates at an anticpation level, is to prove the brain is so much more than a hard-wired circuit. In fact modern day science is proving the brains plasticity that it can change physically, functionally and chemically throughout life.

I find the idea that we can in fact enjoy pleasure without the physical reward incredibly powerful and oh so human. Holocaust survivor and eminent psychiatrist Viktor Frankl says it best, “Between stimulus and response there is a space. In that space is our power to choose our response. In our response lies our growth and our freedom”.

AUGUST 25, 2013

Simulated Trading Real or Not?

Dear RAPA members.

We have allocated $1m to a new FX manager this week which takes us to 9 managers that qualify for our FX Omega program. This also takes our total capital allocated since inception 10 months ago to more than $10m.   

Our new forum continues to engage with interesting discussion, feel free to drop in and share some of your knowledge or learn from the communities. 

Simulated Trading meets Aristotle

This past week I was fortunate to receive a 1hr gift voucher from my wife and kids to fly a Boeing 737-800 commercial flight simulator. Flying Microsoft Flight simulator on my home PC is one of my hobbies, but crouching into the actual Boeing 737-800 cockpit, strapping myself in and then feeling the thrust and motion through the mechanical pistons in an airport hangar took the experience to a whole new level. It was real – I was flying!

Let us explore the philosophical aspect of that last statement. At this point let me introduce a philsophical theory called Utilitarianism. It is the idea that the moral worth of an action is determined by its ability to create the greatest hapiness amongst all people affected by the decision. Jeremy Bentham and John Stuart Mill were the leading thinkers of the utilitarian school. 

What does the greatest happiness mean. Let us assume a scientist built a happiness machine, and when you are connected to the machine you feel happy. Are you in fact happy? What if you are happily married or at least you think you are, only to find out that your partner is cheating on you. Are you in fact happy? 

According to the Aristotelian school of philosophy this is not happiness, as there are two essential elements required. First, you need to feel the sensation of happiness. Second, and most importantly there needs to be the belief that the cause of the sensation is based on truth.

If we return to my flight simulator experience; as much as I felt like I was flying a Boeing 737-800 I always knew that I was grounded and that if I “crashed” nobody would die. It is this very same Aristotelian world view that the RAPA team applies to those traders who present us with demo or paper trading accounts. We do not accept simulated or demo accounts onto our leaderboard. Our reasoning comes from a deeper understanding of utilitarianism that explains the Aristotelian concept of happiness and the derivation of this logic to simulated trading.

The argument we encounter from people trying to raise money from demo accounts is “this is exactly as if we were trading real money”. But Aristotle has taught us that if the experience isn’t underlined by the belief of truth then it isn’t real. I have yet to meet a trader who was able to bank his “paper” profits or file for bankruptcy from his losses.

AUGUST 19, 2013

Compound Eye Architecture

Dear RAPA members.

We have added a new manager Altus Trading, LLC to our list of FX Omega managers this week, and hope to add a few more in the next few days. We have finalized theIncubating Joey’s programme with 11 people starting the programme. The 11th person being a highly respected financial journalist with Australia’s premier Business Newspaper who will be journalling his experience through the course and delving into the original “Turtle” thesis that a profitable trading system can be taught to a disciplined layman. This should be really interesting.  

In the last letter I spoke about our new forum and a thread called the DrawDown Support Club. Thank you to all those who have contributed to the growing discussions forming a valuable repository of investment knowledge. We are also keen for you to vote on our Martingale discussion

Compound Eye Architecture

Let me start by saying I am no computer scientist but the note that follows was inspired from an article I read by game theorist Ben Hunt, Ph.D. of Epsillom Theory fame, and I believe presents a path our industry has embarked on and will continue with enormous impact on our trading results.

I recall learning in biology how powerful the eye of an insect is over the human eye as it uses a compound structure, which in laymans terms means lots of eyes in one eye bulb. The key difference is that compound eyes do not see in 3-D like twin camera eyes. Instead there are thousands of separate 2-D visual images processed simultaneously by insects each activated by an independent signal. This “compound” system of information processing is a holy grail in computer science and there are 3 critical advances in this area Ben Hunt raises which I think we should all be aware of.  

First, the well known computer company SAP has developed a technology called HANA which is a system of memory that “just knows”. Gone are the days of having to go and fetch information from a database with these systems they have all the information “in their head” instanteously – WOW!!! 

Second, is the ability for networks of computers to share resources of information processing in what is now commonly known as “parrallel” or “cluster” computing. In other words the computation for a particular process is split up into segments and dealt with simulatenously by many computers in the cluster, with the repackaging of the independent results into one output that is much quicker than having to do the whole process on one computer. The most prominent technology associated with clusters is an open-source software that was built from Google technology called Hadoop. Hunt, believes Google is more than 2 generations ahead of anyone on the planet when dealing with simultaneity. Its search engine is a clear example of this technology and it is for this reason that I am backing Google to become the most powerful company in the world if it isn’t already.

Third, is the advancement of statistical inference and its application to software. Ben Hunt mentions a Professor Gary King from Harvard as one of the leaders in this field. I had never heard of this guy but according to his bio at the Harvard link above, one of his areas of research that I believe is applicable to the markets is his work on inferring individual behaviour from aggregate data.

There really is a lot to digest with the Compound Eye Architecture solutions currently being deployed by liquidity providers and high frequency traders, and how this affects our life as traders. If I can conclude with one insight that I have taken from this paper and from my insights into short term trading.

I am no longer convinced by the classic technical analysis trading tools that 99% of short term traders are currently using. There are too many things happening behind the scene, like liquidity games, that are not being factored into the price action of a typical charting software. With the increase in computing power and the speed of its delivery, I fear the short term trader who is not running sophisticated compound models is just going to feed the hungry computer beasts run by the big end of town. I am also inspired by the technological innovation as I believe the ability for “small people” to access the power of cluster networks will allow smart innovators the opportunity to become the Cyborg.

AUGUST 11, 2013

Liar’s – the Truth will set you Free!

Dear RAPA members.

We have narrowed our Incubating Joey’s shortlist to 5 and will be making our final decision on the 2 FREE places in the next day or two following a short interview. I have been pleasantly surprised by the interest and there were many suitable candidates we would have liked to give a place, but we had to keep the numbers manageable. Perhaps some time in the future we will run another programme if this one proves successful.  

I would also like to announce a very exciting project we have been working on which will be launched before the end of October (our 1st year anniversary). We have been working on what we believe to be one of the first Behavioural Finance Bias Alert tools in the world. The aim of this tool will be for our software to track your trading history and identify in real time when your trading activity starts displaying Behavioral Biases. You can only correct bad habits if you know about them, and biases by their very nature often slip below ones conscious stream. Hopefully this alert tool will save our members from making irrational trading decisions.

I have refrained from my typical bearish market views for some time but I feel the need to raise a red flag of caution. “In the ruin of all collapsed booms is to be found the work of men who bought property at prices they knew perfectly well were fictitious, but who were willing to pay such prices simply because they knew that some still greater fool could be depended on to take the property off their hands and leave them with a profit.” as quoted by Charles Kindleberger in 1978 in his best seller Manias, Panics and Crashes.

I find the major global markets incredibly distorted. There is currently only one game in town and that is central bank watching, each word and sentence is being interpreted to the nth degree. It is as if nothing else matters and the elixir to life is reproduced at will by a fiat printing press. We all know that quantitative easing cannot subjucate the business cycle without a reflective cost. So I ask you to reflect on Kindleberger’s words above and make sure you aren’t the greater fool. 

Intellectual Dishonesty

During the course of this past week I had an unpleasant altercation with someone I had been pre-warned was extremely dishonest. It was a private matter having nothing to do with RAPA: Mr A.H. agreed to a monetary value and was due to pay me this week. When I contacted him and said that he owed me x$’s he came back with the most preposterous reason why he didn’t owe me anything. Frankly I could not believe the audacity of the story he was spinning. Try as I might I could not get this guy to see that he was lying. I then started questioning my own version of the story and if it wasn’t for his shocking reputation I might still be questioning my version of the truth. 

So what is my point? I believe during the course of our everyday life we often encounter issues that are too uncomfortable to face up to, so we fabricate a version that is more easily acceptable to our fragile ego’s. What I am describing is not classic lying like Mr A.H, but rather a variation called intellectual dishonesty.

From a trading perspective the drawdown (“DD”) phase is the place where I think the greatest intellectual dishonesty takes place. When we are in DD we often feel embarrassed, ashamed, scared, bewildered, angry, helpless, confused etc…….

There is an old saying that “the truth will set you free” so I thought how can we help people discover when they are lying to themselves or being intellectually dishonest. It is very difficult when in DD to see objective truths, and it is at this very time that getting good objective advice is most needed. About 10 days ago we launched a forum and I recently started a thread called the DrawDown Support Club I plan on mainting a very friendly, warm, objective environment where members can share their DD experience and ask objective help for specifics scenario’s. When you are like a “deer in the headlights” the chances are you will not make good objective decisions. My hope through dialogue and mentoring in this forum members will have a chance for the truth to set them free.

AUGUST 4, 2013

RAPA’s cure for Jealousy

Dear RAPA members.

This week I am dissappointed to report that we did not add any new FX managers to our multi-manager product: FX Omega. We have a number of discussions in the pipeline so hopefully we will get to my magic number of 10 before too long.

We announced last week that we have opened a discussion forum on the website for people to share ideas and discuss topics with like minded people – come join in and have your say.

Lastly, we are running an incubating training programme led by Kevin Saunders starting on the 15th August, there are 2 FREE places available to someone we think will benefit most from learning a strategy that has “edge”. Remember to send a motivating email to info@rapacapintro.com if your interested. There are currently 14 people under consideration.

The Sages of the Talmud teach that being jealous is a natural part of human nature. I am sure you can atest to having felt those uncomfortable feelings of jealousy when learning of your “friends” financial success, or viewing their incredible RAPA Score. Well the Talmudic Sages say this is true except for ones children or students. This insight provides us with a powerful antidote to this destructive natural human quality. 

You see viewing others who are smarter or richer or more successful than us fills us with envy as it makes us feel threatened or inadequate. However, with children and similarly students, with whom we invest time, energy, patience, money, etc it is different. By investing part of ones resources into another entity and observing their success, this no longer produces a fear that the perceived opposition are gaining strength but their is a shift in ones thinking which now enjoys the success as it is now perceived as a strenghtening of ones extended self.  

The beauty with the RAPA business model is that each one of our investments is an extension of this principle so we never get jealous with our managers success; on the contrary nothing gives us more joy than seeing our managers succeed, and lets not kid the financial benefits are great as wellwink.

To conclude we are inspired to build a community of sharing information and skills. We will be bringing some of our quantitative tools online in the near future, and if anyone has things they would like RAPA to do please add it to the wish list thread on the forum.

JULY 31, 2013

Opposites Unite (Coincidentia Oppositorum)

Dear RAPA members.

This week we added two new FX managers to our multi-manager product: FX Omega, which we hope to launch next month.

We allocated $1 million to DynexCorp lead by veteran fx trader Peter Panholzer running his programme from Switzerland. Peter has a remarkable trading history being a dedicated fx trader since 1978; we look forward to the benefits of investing with a strong team, rich in wisdom.

Our second allocation was $500,000 to London based LNG Capital, founded by a member of the prominent Middle Eastern Gargour Family. The strategy is the product of rigorous quantitative research by a team of proprietary traders from leading financial institutions. Portfolio Managers Stephen Miller and Jerome Lorenzi bring 22 & 14yrs fx experience respectively to the programme.

We mentioned during the week that we are running an incubating training programme led by Kevin Saunders starting in August, there are 2 FREE places available to the person we feel to be the most appropriate. Remember to send a motivating email to info@rapacapintro.com if your interested.

Lastly, we have listened to our members, there have been numerous requests for a forum on the website for people to hang out and chat with like minded people. Initially I thought LinkedIn could facilitate the need, and secondly having some forum admin experience I was keen to avoid having to deal with all the nasty robots and trolls that inevitably come with forums. But the people have spoken, so come visit and have your say at the forum.

Coincidentia Oppositorum
“Life invests itself with inevitable conditions, which the unwise seek to dodge, which one and another brags that he does not know, that they do not touch him; but the brag is on his lips, the conditions are in his soul. If he escapes them in one part they attack him in another more vital part. If he has escaped them in form and in the appearance, it is because he has resisted his life and fled from himself, and the retribution is so much death.” – Ralph Waldo Emerson

This week I came across the above quote from the great American poet philosopher which struck a deep chord within my psyche, and I believe demands reflection and analysis in the context of us being traders/investors/human beings.  

I have wrriten at length about the behavioural biases that afflict our investment decisions; in coming weeks I will write some more about these treacherous tricks of the mind, as learning about them in our conscious minds is a first step in trying to avoid them from entering our investment process (side note: the RAPA development team are hard at work developing a behavioural bias tool that will integrate with the platform and provide alerts when biases are being used in ones trading). On a positive note I would like to suggest that Emerson is introducing us to an understanding of how the creative world works by providing us with insights into “opposites” and how they provide us with the ultimate gift of transcendence (growth). 

Many great philosophers like Kant and Hegel deal with the dialectic theory of the unity of opposites, with the mystical traditions of many of the great religions also providing insightful material on this subject, but for this letter I wish to deal with it through the lens of my great “friend” psychologist Carl Jung.

The basic idea behind the unity of opposites is that it defines a situation in which the existence of a thing depends on the co-existence of at least two conditions which are the opposite to each other. In simple terms where man is able to unify opposites such as: good and evil, male and female, dark and light, happiness and sadness, pleasure and pain, etc he achieves transcendence and grows as a person or as Jung would say individuates. One of the beauties I find within the Jungian world is that he has developed this highly complex, insightful, but workable model of the psyche and how its various elements work with each other transendent function, clothed in his own exotic language derived mostly from Greek and Latin mythology.  

So lets get straight to it: Jung believes the SELF is made from the conscious and unconscious minds of a person. When we are born these two components are whole but through our experiences of life they grow apart. The job of each person, the individuation process, is to unify these two parts by bringing the unconscious material once again into its conscious stream. Let us meet some of the actors in the play he calls our mind: ego, persona, shadow, anima, animus, archetype (I will have to describe these in future letters).

I truly believe traders and/or investors have been given the most amazing gift. The unity of opposites coincidentia oppositorum confronts us daily in a very tangible easy to identify way: profit versus loss. Emerson tells us in his quote above that we have in life “inevitable conditions”, one of them is that to make a profit we need to encounter loss. There are many I come across who try and avoid drawdown at all cost, the point being you are trying to deny the very essence of life, there can be no one without the other, and if you think you can escape it, “it will attack you in another more vital part”. Our job as money managers is to embrace this idea of unifying the opposites and transcend from the experience. Drawdown is a consequence of life as a trader, it is how we deal with this fact and integrate it with our profits, another sure consequence of trading life, that will define us as a trader/investor/human being. 

We at RAPA expect to see our managers go through drawdown, as we expect them to make profits; it is however the way our managers react to these inevitable consequences and their ability to unify the experience into a new high watermark, that determines whether they have achieved transcendence – the richest profits of all.


JULY 25, 2013


In the spirit of Richard Dennis’ “Turtles”, a new experiment in trader training is launching in mid-August, namely the Joey Experiment.

A select group of traders will be trained in the skills required to deploy a series of short-term, options strategies in the US markets.

The training will be a three month commitment at $500 per month. The cost is to ensure only serious applicants apply, we are delighted that we have already filled 5 of the 7 available places and wish to offer 2 FREE places to RAPA members who need to provide an email motivating why they would like to attend the course before the 12th August. The applicants who are most suited for the course based on motivating emails received will be notified shortly after the 12th of August (RAPA management along with the instructor will have sole discretion as to who will be chosen for the 2 remaining places). Depending on the level of interest and the success of the experiment we may run a new programme early next year.

Structure – Outline
The training will be lead by the number 1 RAPA performer, Kevin Saunders.

  • Month One – Theory and strategy preparation
  • Month Two – Deployment within a simulated environment
  • Month Three – Trading live

Training will comprise of a 1 hour virtual classroom per day (recorded). Each student will receive a 1 hour, one on one session, per week.

Every student will be tracked on RAPA and performance will be closely scrutinised.

Additional Requirements

  • $10,000 capital to trade with in the third month.
  • Be willing to open an Interactive Brokers account in order to be tracked by RAPA (and to be eligible for possible capital introduction).
  • Each student will eventually want to purchase Optionvue but this will not be a requirement until the trader feels he is ready to make this investment in the trading tools.

This program is suitable for a person who seeks a realistic pathway towards becoming a full-time trader. This program is NOT a get rich quick scheme, nor promises outsized returns. Instead, traders will be trained in producing strong, risk-adjusted performance with low daily return volatility, a key focus. You will be trained in how to manage money, not how to take outsized risks for outsized returns.

Once the trader has shown consistency in producing stable, risk-adjusted returns, opportunities will arise for capital introduction, via RAPA, through a staged process.

From the trader, Kevin Saunders – “Why am I doing this?”
The idea for this program came out of a tough period in my trading; April this year -2.4%. Drawdowns are part of life as a trader, and whenever I am in a drawdown, I always think about evolution. It is my belief, evolution is vital to survival in the markets. Traders that don’t evolve, will likely fall prey to the Darwinian processes that all life is exposed to. Why should we believe that markets are immune to change?

As part of my process, I dedicate many hours a day to research and development. I have devised a new trading method which I intend to teach this select group. If I can isolate trading talent, we as a group, can develop a multi-manager investment product in which all the traders can benefit from the synergies inherent in collaborative action. Not only will the traders benefit from my experience, but I hope to benefit from the inevitable creative processes that will evolve out of this group. New ideas will arise as individuals gradually incorporate their own personalities into the trading process and I hope to build a team that can evolve faster than I can alone.

As a side benefit, I assume we will all benefit from the group experience as compared with the more typical, solitary life-style of the full time trader.

I expect the training process will need to continue until a core group of effective individuals form. In that way, it is like natural selection. When this end goal has been reached, the training program will be discontinued.

About the trader – Kevin Saunders

Dip Financial Markets (FINSIA)

Dux of Victoria – Dip Fin Markets (FINSIA)

National Subject Prize winner : “Derivatives –Applying theory to practice” Series 3 (US)

I came to trading as a hobby in the late 90’s during the dot com boom and after making a lot of easy money in the internet bubble, I also had the misfortune of losing a lot of my profits when the bubble collapsed. This experience made me determined to develop a more robust understanding of how to trade the markets. Deciding to start with formal education, I studied financial markets at FINSIA, the financial industry body in Australia. On completion of my studies I received the Dux of Victoria for the highest overall mark and the National subject prize for “Derivatives: Applying Theory to Practice”. This training didn’t provide any answers on how to make money consistently in the markets, so I continued searching for trading success by getting involved with trader training organisations. First I was a student, then I got more involved with educational content creation using my prior training in digital media. Throughout these early years I kept trading and experimenting with system development. I eventually developed a method which matched my personality and has shown consistent profitability ever since. It was this method of trading that allowed me to transition to being a full time trader. I am the Director of Tribelet Capital Management and currently manage $30 million AUM in both local Australian and offshore accounts. Prior positions held were; Proprietary trader with First Continental Trading, General Manager of TCT Australia, a trader education company.

JULY 24, 2013


Dear RAPA members.

This past week saw continued progress towards the August launch of FX Omega, with the addition of two more first class strategies.

We have allocated $1m to the award winning Danish based dedicated forex manager Capricorn and their fxST programme; in addition to the $500,000 already invested in their behavioural fxMaestro programme.

Our next manager to receive an allocation and qualify for FX Omega was FX Prophet run by an Englishman in New York (Sting: I couldnt resist wink). There are a number of new strategies in negotiation which I look forward to announcing in next weeks letter – stay tuned.

We would also like to make special mention of Kevin Saunders. Kevin has occupied 1st place on our RAPA Leaderboard since inception 9 months ago, you may have noticed that Kevin has consolidated all his managed accounts into an Australian domicled hedge fund Bella Vita. RAPA has allocated funds to Bella Vita and is excited to work with Kevin to market this exciting crude oil volatility strategy as well as assist in quantitative research, risk management and a training joint venture initiative.

Should you be interested in learning more, I recommend you visit: www.tribeletcapital.com.au.

With the housekeeping out of the way let us learn something together.

Law of small Numbers
Last weeks letter the Hot Hand Fallacy got a strong reaction from many people. While I myself am still not 100% convinced by the theory, it shows how strong the cognitive dissonance of this bias is that so many people had something to say. One of the answers offered as an explanation for this theory; being the inability to identify random sequences needs to be explored a little bit deeper as I believe having an insight into this heuristic behaviour is vital for investors and traders alike.

When it comes to learning something in behavioural finance you don’t need to stray too far from the teachings of founding fathers Tversky and Kahneman. These two Professors postulated that there is a mistaken belief, especially amongst statistically & mathematically trained academics that statistical intuition exists. Their experiment findings were quite shocking, Kahneman himself an expert and lecturer in statistics was particularly embarrased by the findings which he and Tversky recorded in their first joint article “Belief in the Law of Small Numbers”.

There are many different examples of this bias, here is one example: Finish the sequence of numbers 2,4,6,_,_,_ if you concluded the missing numbers are 8,10,12 this would be a logical assumption but the number pattern could be 2,4,6,12,14,16,32,34,36,72,74,76… or 2,4,6,10,12,14,18,20,22… Or simply that the next number is larger than the preceding number. Therefore, the conclusion could be incorrect based on lack of information.

This lack of information is the message we need to hear from this study. There are sometimes we simply don’t have enough information to draw a statistically sound conclusion. This applies equally to the RAPA Score. Whilst we believe it to be a superior performance metric to the traditional metrics commonly available, it is incorrect to draw inferences that a RAPA Score with a 6 month track record is equal to one with a 2yr track record. There are two independent factors that are built into the RAPA Score algorithm that focus on track record as we believe this to be such an important factor; however, I can say categorically that while the RAPA Score accurately describes the risk adjusted nature of a traders returns, it too is subject to the law of small numbers.

JULY 15, 2013


Dear RAPA members.

It feels like I haven’t written a note in ages. I have just returned home from a week in Canberra attending the Kanga Cup youth soccer tournament with my 10yr old son. This year it was just the Berman boys – no girls; that mean’t no putting the toilet seat down, no having to pack away clothes every 5 minutes, and the list goes on wink.

We made it through to the semi-finals and the full-time score was 0-0, we went through extra time with the game still level so it was time for penalties. This got me thinking of an interesting behavioural finance idea that was discovered in 1985 by Thomas Gilovich, Amos Tversky & Robert Vallone called the Hot Hand Fallacy.

So who does the coach choose to take the penalties for my sons soccer team? Allow me to paint you a picture from a basketball scene which was the basis of the original body of research. The NBA finals are locked in a tight tussle with seconds left on the clock, and just before the hooter goes for the game to end Team Z fouls a player from Team Y giving them a free penalty shot. However, the player who is expected to take the free penalty shot is injured and unable to play on. The coach is faced with a choice does he choose the guy who has had the hottest hand in the game so far with a shooting success rate of 90% but a career average of 50% or does he go with his number 1 draft who is having a quiet game with a shooting success rate of 45% but a career average of 63%.

In this situation I think most people intuitively believe that the player who is on fire is the one who should take the shot, but Thomas Gilovich would have you believe otherwise; after performing exhaustive statistical analysis he has disproved the idea of a hot hand and will have you believe that the chances of success on a shot will follow your career average and is not influenced by whether you have made or missed one or more similar shots beforehand.

Gilovich offers two explanations. The first one is that people have a bias towards believing such streaks exist, haven’t we all been brought up with this kind of belief?. The second explanation is that people have tremendous difficulty in observing random sequences. Let me try and explain this, in order for a basketball player to have a 50% shooting success rate over a season he will put together many different sequences of success and failure. You do not produce sequences like S-F-S-F-S-F to create a 50% average. Like a coin toss the sequences are randomly dispersed with various length streaks of success or failure, the average over time resulting in success of 50%, having this in mind it is quite feasible for a basketball shooter to string together a sequence of successful shots to present the illussion that they are likely to continue successful shooting, but according to Gilovich this is an illussion.

As a takeaway for the RAPA team these are exactly the kind of allocation decisions we are continously faced with. Who do we allocate our money to? Do we go with the manager who is on fire over the last 4 months of his average 1yr track-record or do we go with Mr Consistency who continues to deliver slightly above average returns now into his 5th year of outperformance?

We are making progress on the FX Omega launch and will send an update in the coming days as we put school holidays behind us in the southern hemisphere and get back to some serious work.

JUNE 16, 2013


Dear RAPA members.

A quick update on FX Omega; we have over 5 traders that we believe qualify for the programme so we are taking positive steps towards a 1 July launch.

As one can expect the most frequently asked question we get is how does your RAPA Score work? To assist with the regular questions that come up we have started an FAQ section under the main menu heading of “about,” we hope this section is a helpful resource to all our members both old and new. We have tried to simplify the explanation of score in this document but it is not a simple concept and is what we believe to be our competitive advantage – so goodluck!


The proprietary RAPA Score sets out to measure the ability of a trader to make profit by assuming a certain level of risk, irrespective of the different asset classes being traded, i.e. stocks, bonds, options, futures, FX. The score is out of 100 and is comprised 95% algorithmic formulae and 5% qualitative assessment based on information about the trader’s background, edge and strategy. The more detailed information, with examples, the trader is able to present the better the prospect of scoring the 5 qualitative points. The higher the score the better the traders skill component in managing money is deemed to be; this is not a holy grail but rather a probabilistic approach to allocating capital for investment. Traders with more skill have a higher probability of making good risk-adjusted profits than those traders that have lower skill, this is common sense and the RAPA Score endeavours to quantify that skill coefficient. As with most things statistical the size of ones data sample plays a significant role in the confidence one places on the data. What this implies is the longer a trader’s track record the more value one can place on the RAPA Score. This is a double-edged sword as we are dealing with emerging managers and want to give traders with shorter track records an opportunity to be part of the allocation process. We have endeavoured to find a balance so that shorter track records are penalized appropriately for the smaller sample size using a process that tries not to create an unfair advantage for older track records. While our algorithm uses advanced techniques to identify the best risk-adjusted returns (see the white paper for more details) we do believe strategies of less than a year can still be lucky and make the RAPA Score or any other performance metric like Sharpe Ratio, less relevant. This isn’t a weakness in the formulae it is rather a natural possibility within the randomness of probability. Note: The RAPA Score is currently being calculated on a separate computer due to the intensity of the computation, and updated 2 to 3x a day. This is why when new accounts are loaded there is no score. It takes our computers about ~1hr to compute all the scores, and we decided to not slow the site server down. When we upgrade our servers in the near future we will automate the scoring on the site.


The formula for the RAPA Score consists of several ingredients that we will briefly explain below.

PSR: The core component of the RAPA Score is the Probabilistic Sharpe Ratio (or the PSR for short). It was invented by Marcos Lopez de Prado. For those interested in more details, we refer to the paper.

The PSR is defined as

Where Z is a cumulative distribution function of the N(0,1) random variable, n is the number of days in a sample, g3 and g4are the skewness and kurtosis of the underlying return distribution and the SR hat is the estimated Sharpe ratio. The SR* is the value at which the calculation is made.

Without going to deep into the maths, the expression in bracket is the probability that an estimated Sharpe ratio of the daily returns is greater than the value of  SR*. This is interpreted as follows: we observe from the daily data that a trader has a certain level of Sharpe ratio. This is an estimate of a random variable which is a true value of the Sharpe ratio. We want to understand the confidence intervals for this true value. In particular, we are interested if the value of the Sharpe ratio is greater than a certain skill level.

This formula is a main building block for the RAPA Score.

DD Potential: Another important ingredient of the RAPA Score is a drawdown potential which measures the expected value of the future or possible maximal drawdown of one’s trading strategy.

Track record: In the RAPA Score we have a special component for the length of the trading history. The larger the trading history that we can observe for analysis the better.

Fat tail risks: The Probabilistic Sharpe Ratio explained above is responsible for quantifying the trader’s risk-adjusted returns. However, it is only valid for the return distributions which have finite variance (or can be approximated by such). The real world return distributions are usually heavy-tailed. This is even more prominent when the trader uses some sort of a martingale trading strategy for the position sizing. We separately estimate the fat-tail risks and penalize those strategies that have a probability of an extreme move.

Divergence from the mean: This component of the score captures the recent deviations from the trading history. It is capable of detecting whether the trader bears more risk or the historically observed trading strategy is no longer valid in the current market conditions.

After the values of the components have been defined, RAPA uses a proprietary algorithm to combine these components together and calibrate these values to receive the final value between 0 and 95. The remaining 5 points are assigned by us on a discretionary basis to traders who actively share information about their experience and trading strategy.


Here is some general advice on how to keep the RAPA Score as high as possible.

1)  Have a clear edge in your trading strategy. The most important thing that we are trying to capture with the RAPA Score is the edge or alpha of the trading strategy. If the trading strategy has a high Sharpe ratio without negative skewness and excess kurtosis, the PSR component of the score will value it highly.

2)  Limit the potential of the Max DD to 15% per annum. RAPA uses a proprietary algorithm to calibrate the score on the hedge fund databases. The value of the max DD of 15% is the critical value such that a greater drawdown than this number will heavily penalize the score.

3)  Provide us with as long history as possible. The length of the track history is very important for us – we have a separate component of the score for it. In addition, the longer the track history, the better the value of the PSR will be all other things being equal.

4)  Do not trade martingale or similar position sizing strategies – these strategies are heavily penalized by the score.

JUNE 11, 2013

A$2m for FX Omega & Risk-Aversion Case Study

Dear RAPA members.

Over the past few weeks we have mentioned that we will be launching an institutional quality optimized risk and position sizing portfolio of 10 or more exceptional quality FX signals in one account with the broker of your choice. We have named this the RAPA FX Omega product and we will keep you updated, the legal documentation is currently being finalized.

We are delighted to announce that we have secured a committment of A$2m to kick-start this initiative in July. We ask you the community to help spread the word and help us find FX traders that qualify for this programme. Our criteria for inclusion are high and we will not sacrifice the quality of this product by including traders that do not meet our screening criteria, namely:

RAPA Score above 40, track record of a year or longer and an account size greater than $10k.

I also wish to draw to your attention that we will be launching RAPA FX Live (an automated performance verification service) this week. Given all the controversy created by the owners of MT4 this past fortnight, we look forward to providing the forex community with a worthwhile alternative to some of the existing performance verification sites.

Risk-Aversion Case Study

You may have noticed that each RAPA account has a risk-version “RA” coefficient on the statistical report as of today. In the case study that follows we will try and explain this tool in a little more detail. I wish to say at the outset that this is not a magical number and nothing dramatic will hinge on it; however, we wish to evolve as managers and we believe part of this growth involves exploring certain concepts that may be used to help us understand the implied risk our managers express towards their strategies given certain market conditions.

We emphasize the word, implied, as we wanted to be able to derive this score quantitatively without asking a series of questions which we feel opens up the test to a series of biased answers.

Risk aversion is the reluctance of a person to accept a bargain with an uncertain payoff rather than another bargain with a more certain, but possibly lower, expected payoff. For example, a risk-averse investor might choose to put his or her money into a bank account with a low but guaranteed interest rate, rather than into a stock that may have high expected returns, but also involves a chance of losing value…”.

In order to estimate the risk aversion we need to agree on the input parameters. The calculations for the risk aversion consist of defining the choice between the “riskless investment”, “risky investment” and also the “resulting outcome”.

The primary model used to derive the coefficient is the Black-Scholes market model. Here the “riskless investment” is naturally associated with the risk-free rate r, the “risky investment“ with the broad market (S&P500 (ETF:SPY) in our case) and the “resulting outcome” of the trader’s return distribution. Below we will look at a real world example.

The chart above shows the comparitive performance of a particular traders equity curve  (black) and the broad market index (SPY=red). We see that the broad market (SPY) is outperforming the risk-free rate of 1% thus reflecting an environment which requires less risk to achieve these returns.  We calculate that the risk-aversion coefficient of the Test account is equal to 17.

Let us look at the same traders equity curve but in a different market condition.

For this data set, the market (SPY=red) is providing less opportunities to generate returns in excess of the risk free rate, therefore this environment requires traders to take on more risk to achieve returns, the risk-aversion coefficient in this case is 5.2.

The natural question is what are the natural acceptable bounds of risk aversion? We know that a risk-aversion of less than one is always bad from the point of view of long-term capital growth. We have estimated that the risk-aversion of most funds is within the bounds of 4-30 those fund managers with small expected drawdowns have risk-aversion coefficients of 10+.

JUNE 4, 2013

Kelly Optimal Fraction, Risk Aversion & Financial Decision Making

Dear RAPA members.

We are happy to announce the following new allocations A$1,150,000 effective 1 June:

  1. Plimsoll                      A$200,000 to A$1m
  2. Steve Kaczmarek        A$250,000 to A$500,000
  3. mvp1661                     A$100,000 to A$200,000

In the research piece that will follow my colleague Vladimir Krouglov introduces a major breakthroughenlightened in our research efforts to uncover the optimal fraction or position size a trader should  make given their risk profile. In our case we can apply this breakthrough technology in the design of  our FX Omega product having a specific investor risk profile in mind. Vladimir will take you on a wild ride showing you how we can derive your risk-aversion coefficient. If you don’t have a clue what is being said don’t worry we will hold your hand in future tutorials with more examples smiley but for now most importantly you will have access to a new RAPA metric.

Kelly Betting

Probably all of you are aware of a prominent formula in Information Theory called the “Kelly criterion” or the “Kelly betting rule”.

Consider a game with two possible outcomes – “heads” and “tails”. Assume that we know that “heads” occur more often than “tails” with probability p>50%. We win $1 when the outcome of a coin flip is “heads” and lose $1 in the case of “tails”. Since the probability of getting heads is more than 50%. This game has positive expectancy. A very natural question is how much to bet in each flip to maximize the rate of growth of one’s wealth after a certain number of iterations. It is obvious that betting the whole wealth will lead to a disaster as one iteration can wipe out your entire wealth.It can be shown that in the simple game described above the optimal fraction (i.e. Kelly fraction) is to bet (2p-1)*100% of one’s wealth.

It is a remarkable mathematical result that even despite the fact that we are interested in the maximization of the long term growth rate the optimal fraction f can be found by the optimization over one bet. In Game Theory such betting rules are called myopic. The corresponding optimization problem is to maximize f over the expected value of the logarithm of wealth after a single bet. In mathematical notation,

Maxf E log(W) = Maxf (p log(1+f) + (1-p) log(1-f)).

It is easy to observe that the solution to this optimization problem is precisely f=2p-1.

Kelly betting strategy as explained above enjoys several other remarkable properties and in the long run will outperform any betting strategy. However, as shown by numerous experiments – it could be too aggressive. Also, the value of the Kelly fraction depends on the value of the a priori unknown value of p usually we can only estimate the value of the parameters of the distribution from historical data. The chart below shows the growth rates of various betting strategies. Observe, that betting two times Kelly fraction yields zero expected growth. This is a very important fact – no matter how risky you allow yourself to be with your trading strategy, you shouldnever trade more than the Kelly fraction.

The Kelly betting strategy generalizes to the case of other distributions of return. For the Gaussian distribution with mean M and variance V the optimal fraction is given by the ratio M/V.

As we see from the above chart the values of f to the left of the Kelly optimal bet represent more conservative investments where some of the long term growth is sacrificed for lower risk.

From the point of view of utility theory these fractional Kelly strategies correspond to investors with a power utility function. In the case of Gaussian outcomes and power utility, the optimal fraction is given by M/V/gamma where gamma is known as a coefficient of the risk-aversion.  This coefficient shows the investor’s attitude to risk. A risk-aversion of 1 corresponds to the Kelly fraction, any value greater than 1 corresponds to power utility functions. If one’s risk-aversion is less than 1, there is something wrong with the trading strategy as it becomes overly risky damaging the optimal growth rate.

Risk Aversion

In the market model with a single risky asset and a risk-free rate it is possible to estimate the coefficient of a trader’s risk-aversion by looking at the size of bets made by this trader and comparing it to the Kelly fraction. However, this is hardly applicable in practice since in most cases it is impossible to describe ones decision process by a single number. In utility theory, depending on the utility the coefficient of risk-aversion is a function over the level of wealth. Some return distributions may even be produced by a non-utility maximizer trader, like for instance in the Prospect Theory of Kahneman and Tversky or the Yaari Duality Theory.

Given one’s distribution of terminal wealth we may nevertheless tell a lot of information about one’s risk preferences and what is more important we can tell something about the rationality of the selected trader.

Ok, lets get back to the problem of determining the risk-aversion and optimality of one’s trading strategy. We will need another ingredient that will help us to do the required calculations – the pricing kernel. The pricing kernel is the fundamental notion in financial mathematics that incorporates the future prices of all stocks on the market discounted by the risk-free rate. With the help of the pricing kernel it is possible to price all tradeable securities on the market. It is not a trivial task to determine the real-world pricing kernel however sometimes we can determine its implied projections from some tradeable derivatives – for example S&P 500 or VIX option chains and futures.

Given the knowledge of the pricing kernel we are always able to transform the given distribution of the terminal wealth into the utility function and calculate its risk-aversion coefficient. Additionally, we may estimate what the optimal starting capital is required to achieve a given terminal wealth and compare it to the actual capital that was used by the investor – this way we may estimate the effectiveness of the trader.

The beauty of this approach is that it works not only in the utility theory framework but also for all preferences that satisfy a first order stochastic dominance meaning that gamble A has first-order stochastic dominance over gamble B if for any good outcome x, A gives at least as high a probability of receiving x as does B, and for some x, A gives a higher probability of receiving at least x.

In conclusion we believe that with we have taken a theoretical model and developed into a real world trading application that can take a strategy and based on a trader’s risk-aversion can ultimately design the optimal fraction or bet size per trade to achieve the best growth rate for your wealth. We will start including the RA coeffcient (risk-aversion) on the RAPA statistical report for each account. This is a highly complex area of research and we will demonstrate in future letters the application of this new position sizing tool to help show you why we are so excited.

MAY 26, 2013


Dear RAPA members.

In these weekly missives I update the RAPA Family on issues relating to the web portal and issues both psychological and financial that may benefit our community and their trading in some way. I know many of you are algorithmic traders and do not concern yourself with the economic machinary driving the very markets you trade in. Others in the community do their own research and are far better economists than me. In this letter I wish to express some deep psychic thoughts on what I believe is currently taking place in the economic/financial world. I wish to bring another contrarian perspective to the mood and consensus opinion in the market place. For those of you interested in   pondering……….

Saviour & Ascension Archetypes

The Global Financial Crisis has given people interested in crowd behaviour incredibly rich material to apply and explore some of the more famous psychological and philosophical theories advanced by the giant “thinkers” of bygone eras. My passion lies in the epistemology that drives the crowd to herd in a seemingly irrational manner when factual information seems to require such contrasting behaviour.

My journey for this article began with the reading of a very different type of autobiography whereby Carl Jung writing in his 80’s recounts vivid memories and observations from age 3 all the way through his adult life, “Memories, Dreams, Reflections by C.G. Jung”; a fascinating article by Pulitzer Prize winner Anne Crittenden, entitled “The Stock Market Scene Today: A Jungian Perspective” providing the central theme to my article, and finally an excellently crafted critique on the comparisons of two famous thinkers “Nietzsche and Jung: The Whole Self in the Union of Opposites, by Lucy Huskinson”. This literary journey which includes  reading the massive Collected Works of Jung (more than 20 volumes) coupled with my personal experience sparked a metaphysical phenomenon in me that both Nietzsche and Jung would describe as the process of uniting opposing forces resulting in personal growth leading to journey towards The Ubermensch (to quote Nietzsche) or Individuation (to use a Jungian expression).

Before I reveal my observations let me briefly introduce you to Jung, so to speak. Jung was born in Switzerland in 1875 and started his career as a medical doctor. He was closely associated with Freud in his early years but eventually split from Freud and developed his own branch of psychology called, “Analytical Psychology”. Whilst he believed in the personal unconscious like Freud he fundamentally differed with him as to the source of the unconscious. Freud believed it was entirely derived from within, via sexual repression whereas Jung believed it was derived from an external source or factor.

Jung essentially saw the structure of the human mind as comprising 3 parts. The first part being the rational mind or self. The second part the personal unconscious, while playing an important part in the individuals personal progress it plays only a minor role in developing herd behaviour at the collective level. The third and most famous part and the source of most of my interest is his concept of the “Collective Unconscious” which is rooted in the primordial collection of psychic energy across multiple generations housing, instinctive energies and effectively influencing the way we tend to feel about and interpret things. According to Jung these Collective Unconscious thoughts can be seen in the form of mythical characters or religious motif’s which he calls – “Archetypes”. This metaphysical psychic energy – Archetype, is so powerful in energy charging that in many instances when an individual is able to identify with a particular archetype it has the ability to overpower ones rational thinking selves. In cases where a society as represented by collective social mood identifies with an archetype(‘s) then the result is often – Mania.

At the centre of Jung’s beliefs is a process he calls “Individuation” in which individuals are pushed to achieve personal growth by balancing the opposing forces that become evident at a conscious rational level with those unconscious (archetype) forces pulling us in opposing directions. Failure to control the rational conscious man with the unconscious mind leads to what Jung calls an “inflated ego”. Jung believed the psyche would “constellate” the conscious mind in an effort to balance the opposing forces within, and where an opposing force develops sufficient dominance over the other, the result is usually a neurosis or an explosion of emotional behaviour.

What we are going to analyse is how an imbalance is created when a collective society so embraces an archetype that the rational conscious mind is dominated to a level that results in a Mania. Jung explained in detail how unhealthy it is for a society to be too attached to its collective unconscious. At these times society is prone to stray from its rational barometer and develop extreme behaviour with a catastrophic reversal being the end result, he called this reversal “enantiodromia” after Heraclitus an ancient Greek philosopher, who believed the world existed in flux and therefore needed a constant rebalancing. I call it simply reversion to the mean.

Allow me to set the scene during the 1st quarter of 2009 for a representative look at how world stock markets “constellated” social mood as represented by our “collective unconscious”. The financial system throughout the world was crumbling at its very core, the world seemed doomed to a depression the likes we had not seen in 75 years, and panic was the order of the day. In short the world was in need of a super hero – a saviour. The saviour archetype was well documented by Jung in 1936 as he witnessed the rise of Nazi power in Germany. Officially on 20th January 2009 Barack Hussein Obama II became the 44th President of the United States of America and to a large extent became the financial worlds hero tasked with saving the world; this worship extended so far that he became the first recipient of a Nobel Peace prize in advance of the supposed work he would do in war-torn countries, how ironic as today I cannot even think of him as a great peacemaker. There are other notable saviour archetypes on the world stage at present some of which are already seeing the dimming of their proverbial stars, e.g. Ben Bernanke, Tim Geithner, Jean Claude-Trichet, Mario Draghi, Angela Merkel, Christine Lagarde,etc. The most recent addition to this saviour pack is none other than Japanese Prime Minister Shinzo Abe. Most notably the leader of the “saviour” pack is not actually a living body as such but more like a representative deity in the form of the world’s Central Banks with the US Federal Reserve (Fed) dominium occupying centre stage and more recently the Bank of Japan (BOJ) sharing the limelight. There is almost universal belief in the power of these central banks ability to avert the current crisis by applying a serum (debt) which was in fact the very cause of the underlying financial crisis. This seeming “alchemy” (a subject which fascinated Jung) which I will call “financial engineering” at the Central Bank level, has introduced yet another archetype on our collective unconscious which together with the saviour has driven our current stock market to manic proportions, with our conscious rational minds completely in awe of the seeming magic and unearthly power these bodies currently wield. There is more.  Crittenden refers to Mircea Eliade a leading scholar of comparative religions and his book Myths, Dreams and Mysteries where he describes the archetype of ascension and she parallels the ascension archetype to the ever upward incline of the stock market during the late nineties. I wish to extend her stock market ascension archetype to the current ascension the stock market has enjoyed from March 2009 until now, where there has been so little pause in the amazing climb that it no doubt conjures up majestic imagery.

We now have a collective unconscious that has been so enraptured with awe at the cosmic majesty of one amazing archetype after another that the embracing collective psyche of our society has effectively abandoned clear rational thought in favour of fantasy. As an intuitive contrarian and a believer in the reversionary powers of the market and the broader Universe, we are likely to feel the dramatic “enantiodromia” effects of a reversal in the markets fortune in the months and possibly years to come. To end with a quote from Crittenden, “Jung never tired of pointing out that only highly developed consciousness of the power of the unconscious can enable an individual to withstand the power of the psychic flood sweeping everybody along. There is nothing more isolating than maintaining one’s individuality in a mass mania”.

MAY 23, 2013


Dear RAPA members.

We would like to revisit the account trading the Ichi EA (A martingale strategy designed to trade AUD suited for sideways markets) that we were invested in. First point is that this was part of an experiment and a way for us to test our systems.

Second point is that according to our old MT4 algorithm we scored this strategy at 80. However, on further development of our mark to market PNL with MT4 we updated our algorithm to capture days in which there were no trades which resulted in us now including floating PnL for those days.

When applying this new algorithm the score drops to 26 with a max DD of 34% substantially changing our view on this strategy. In summary our RAPA Score did all the heavy lifting on this strategy and didn’t require us to do deeper analysis on the alpha component of its alpha stable distribution.

MAY 13, 2013

RAPA Mean Variance Optimization Dataset and Code for R

We thought that quants familiar with R code would like to play around with a dataset of daily real-life data. Here is a pretty generic assembly of code, we welcome any innovative ideas of how best to optimize this dataset.

# MVO Script using RAPA Dataset

					# You need to make sure you have installed these packages.
# You need to change this directory to read where you have save the MVO csv file on your computer.
setwd("C:/Users/mberman/Dropbox/RAPA/R code")
#Read the data.
R = read.zoo('http://rapacapintro.com/MVO.csv', format="%Y-%m-%d", header=T, sep=",")
Index = index(R)
#Transform it into timeSeries for MVO 
R = as.timeSeries(R)
#Specification of the Efficient Frontier.
Spec <- portfolioSpec()
setNFrontierPoints(Spec) <- 50
# Daily Rf rate corresponds to 3% p.a. 
setRiskFreeRate(Spec) <- 0.0001173037 
# Define the constraints 
N = dim(R)[2] #Find the number of strategies. 
min.weights = paste("minW[1:", N, "]=0", sep='')
max.weights = paste("maxW[1:", N, "]=0.2", sep='')
Constraints <- c(min.weights, max.weights) 
# Calculate the efficient frontier
Frontier <- portfolioFrontier(R, Spec, constraints=Constraints)
# Compute the weights vectors of different portfolios on the efficient frontier. 
W = getWeights(Frontier@portfolio)
# Plot the frontier
tailoredFrontierPlot(object = Frontier, risk = "Cov")
# Plot the weights
weightsPlot(Frontier, labels = F)
# Computes the portfolio on the efficient frontier with the maximal Sharpe ratio
tPortfolio <- tangencyPortfolio(data = R, spec = Spec, constraints = Constraints)
# Displays hypothetical performance of the tangency portfolio
W = getWeights(tPortfolio)
returns = R %*% W
returns = xts(returns, order.by=Index)
charts.PerformanceSummary(returns, Rf = 0.0001173037)

We hope you find this useful.

MAY 7, 2013


Dear RAPA members.

I would like to share with you some personal thoughts. l have been a keen student of behavioural finance for many years and I believe the school of thought has made tremendous ground in the last decade, and I believe it can safely say that it is has knocked some serious holes into the efficient market hypothesis. However, my frustration is that we are getting better and better at identifying the issues or more specifically the heuristic bias’s that cause us to do stupid things when trading, but less is being done on ways to combat these evil gremlins occupying our psyche. I shared one such bias of substitution a mere 10 days ago.

Map of Emotions

A couple of days ago I recalled reading a piece on Spinoza’s: Pleasure, Pain, Desire model in Emanuel Derman’s Models Behaving Badly, and I was struck by an idea that could partially satisfy my behavioural finance frustrations. This is a work in progress so lets see if I can develop it a little to give us something tangible to hang onto as traders.

Spinzo developed a theoretical system whereby the sensations (pain,pleasure,desire) or primitives as he describes them were able to explain every human emotion. The map of emotions below is a visual reference to his line of thinking.

So let me bring this home a little, just like a stock option relies on the underlying stock to derive price, the human psyche in its complexity is derived on these 3 underlying emotions at varying degrees of interconnectedness. Ok so this is complex stuff, we are talking about the mind so give me a break.

Spinoza spent most of his life trying to understand how to control the passions which overwhelm the minds ability to reason (the behavioural finance bias) and is the very cause that leads us to poor trading decisions, under conditions of uncertainty.

According to Spinoza, knowledge of the world is made up of 3 categories: adequate knowledge, inadequate knowledge, and intuition. It is beyond the scope of this note to explain how these knowledge types allow us to understand the world.

In the words of Spinoza, The mind does not know itself, except in so far as it perceives the ideas of the modifications of the body. The modifications he describes here are the emotions that are brought to awareness through the body. This is the critical part, we can only understand our physical responses (heuristic biases) once we understand our emotions. Spinoza is teaching us the most amazing lesson in behavioural finance. He is saying that the only way to fix the bias in your trading, is to understand the emotion that is driving the affect. We are not deterministic beings, subject to the hard-wired biases behavioural scientists lead us to believe. Rather Spinoza is letting us in on a major secret. “Freedom of the bias comes from understanding and volition, of reason and desire. Will and understanding are one and the same. Understanding is merely Will pereceived from the inside”.

APRIL 28, 2013

Judgement using Substitution

Dear RAPA members.

We as traders or investors are regularly confronted with the impossible question, “where do we think the markets will be 6 months from now?” (or some such variety).

The human mind is rarely at a loss to provide answers to such difficult questions in our daily life. Invariably we are able to come up with an intuitive or opinionated response. Have you ever wondered how you are able to come up with such an automatic response?

Daniel Kahneman Nobel Laurette and father of Behavioural Finance proposes a system of substitution takes effect. When we don’t know the answer to a difficult question our minds look to substitute the question with an easier one and from there we are able to build our answers; in case you were wondering this usually takes place without conscious thought.

Look at the picture below and then answer: As printed on this page is the figure on the right larger than the figure on the left?

The answer is they are actually equal in size if you measured them with a ruler.

So what is going on here? Your brain has automatically substituted a 2-Dimensional picture into a 3-D image, and with its depth perception it clearly sees the figure on the right as further away and larger. This substitution heuristic has ignored the cues that the picture has been drawn on 2 dimensional paper and it overwhelms your answer to the question.

Let us now come back to the original question I proposed i.e. how do we answer when confronted with the question where the markets will be in 6 months time. There is no definitive answer to this question as we are unable to tell the future of a series of transactions leading to a market price in 6 months, our brains are not comfortable with this situation and so in kicks the thinking part of the brain and what does it do? It looks for related substitute questions it thinks it can answer.

I suggest the most likely response we will come up with is to first establish what the market is doing now. This in turn will lead to a whole series of questions and answers that will ultimately result in the formulation of an answer to the markets likely pricing 6 months from now being a rough extrapolation of what they are doing now.

In conclusion I think it is extremely important to do ones own analysis than rely on the opinions of experts who while being intereviewed on television or the print media are expected to come up with answers to impossible questions, and are therefore likely to be answering complex questions with the brain pacifying ease bias of substitution.

APRIL 24, 2013


Dear RAPA members.

We have split the Leaderboard into a Major League for accounts greater than $100,000 and a Minor League for accounts smaller than $100,000. We welcome feedback on this division and how we deal with traders who manage multiple accounts with slightly different risk profiles.


We have been doing a lot of work on the optimal position size a trader should be trading to stay within a predetermined level of drawdown or financial ruin. This is relatively easy when dealing with single trades but becomes exponentially more complex when dealing with simultaneous trades.

Lets start with some background:

Consider a trading system with the probability p of winning >50% win $1 and losses of $1. This strategy expresses a positive expectancy. How much capital should be placed on each trade to maximize the expected growth of wealth?

Enter the famous Kelly betting criterion; this formulae tells what fraction of capital to bet so that you achieve the goal of long run profit maximization. We know from experience when a trading strategy has an edge applying the simple Kelly rule does not provide suitable risk adjusted results. In the last 50 years the Kelly formulae has been extended by such names as W. Ziemba, E. Thorp, T. Cover and others into a field of quantative finance called Capital Growth Theory.

RAPA uses a proprietary algorithm to analyze the trading statements of member accounts and calculates the optimal f (fraction) of capital that should be traded on single or simulatenous trades, to achieve the highest rate of capital growth within the drawdown restrictions imposed by the RAPA team. Using our technology we can determine if a trader should deleverage to avoid financial ruin or in rare cases increase their position sizes to maximize growth while staying within acceptable risk parameters.

Below is an example of one of RAPA’s accounts and what happens when the trader has a positive expectancy of winning but does not follow the optimal f when trading.

On the chart below the strategy has a positive expectancy. However, we see that it is very easy to overleverage this positive expectancy by betting more than the optimal fraction. We see that 2x Optimal will hit the drawdown threshold with the account being stopped out 4x is a disaster. What is also apparent that under leveraging can also produce sub optimal results by leaving profits on the table

In the next couple of weeks we will provide this as a tool for members to test their own strategies optimal f, with the ability to input your own drawdown thresholds.

APRIL 21, 2013


Dear RAPA members.

Welcome to all our new members. See the “noticeboard” for an archive of our weekly emails. About 2 years ago I wrote a note on mental accounting which I thought I would share with you.

Welcome to all our new members. See the “noticeboard” for an archive of our weekly emails. About 2 years ago I wrote a note on mental accounting which I thought I would share with you.

Professor Richard Thaler is one of the leading figures in the Behavioural Finance academic world and has been credited with the term “Mental Accounting”. Here is one of my favourite examples used to describe the bias.

The Man in the Green Bathrobe

A couple go to Las Vegas on honeymoon and after an enjoyable evening of dinner, theatre and some bedroom activity Joe decides to soak in the night air by smoking a cigar on the balcony of their suite. After what seemed like a short break Joe discovers that Sophie is fast asleep. On his way over to kiss his gorgeous wife good night Joe puts his hands in the pocket of his green hotel bathrobe and discovers a casino chip in his pocket. It has the number 17 on it and an inner voice starts speaking to him, “Joe, this is the one.” Without wasting any time, Joe is off to the casino with his lucky number 17 chip.

He puts the $5 chip on 17 and up comes 17. Next spin he puts his winnings on 17 and again it comes up. Joe repeats this routine a number of times until he reaches the maximum bet the casino will take; he now has $268 million riding on 17 and after what seems like an eternity the ball lands on 18. Joe has lost it all. With the little bit of energy left in him, he walks to his room and flops on the bed. His beautiful young wife Sophie wakes up from her sleep and asks Joe where he has been. He responds that he was gambling, so she asked how he did, and he said “not too good; I lost $5.” This example illustrates how we compartmentalise our finance. Joe put the $5 and then the subsequent $268 million in a separate compartment from his wealth. To him it was never really his. The very same kind of mental accounting happens when we receive a refund from the taxman that was somewhat unexpected. Instead of absorbing the new money into our existing pot, we somehow see this new money as a windfall and worthy of extravagant spending, which is different from how we would treat our own money. I hope you can start to see how this error in judgement could have disastrous effects when approaching trading. I am sure none of you have treated the profits made on a trade as winnings to have a full go with.

APRIL 11, 2013

Meet the Team

Dear RAPA members.

We have been operating flat out for the past 5 months, and we thought it might be nice for you to get a bit of an insight into the 3 RAPA’s driving the business. MB = Michael Berman, VK = Vladimir Krouglov, EO = Eugene Olin.

Where were you born, where do you live and tell us a little about your childhood?

MB – I was born and grew up in the coastal city of Port Elizabeth, South Africa. I lived for about 18 years in Johannesburg and currently live in Sydney, Australia. I had a very enjoyable safe and supportive childhood with lots of my family living in our street. My grandparents on my mother’s side had 4 generations living in one house a few doors down from ours; there were a total of 4 houses in our small street that were family so I always had cousins to play with and a number of school friends nearby as well. We lived an upper middle-class lifestyle, my father was a successful businessman but he didn’t spoil us at all and made us appreciate everything financial, in fact I have to admit I always felt a little hard done by with my pocket money, especially when my father’s cars became more exotic and he wasn’t sharing the wealth.

VK – I was born in Kharkov, Ukraine (former USSR) in a family of academics. When I am recalling my childhood – everyone in my family had a PhD (my grandfather, grandmother, aunt, mother and father), so it is natural that I became a scientist myself. My parents are chemists but as it has happened with many chemists in 70-80’s they were more the applied mathematicians than they were chemists. I currently live in Kiev, Ukraine.

EO – I was born and still live in Kharkov, former USSR.

When did you realize that you were good at Maths?

MB – This is a question clearly intended for my brighter colleagues. I was a terrible student I didn’t bother with homework, this plagued me throughout my whole school career from the 6th grade until matriculation. Early on I did well and was diligent but being the “class clown” as my one teacher wrote in my report was far more appealing. I have an above average grasp of Maths but think of myself more as an astute problem solver.

VK – In the elementary school I realized that languages and music are not for me. I was interested in everything else since then. I remember myself being obsessed with history and archaeology in the mid school. Later I was interested in both physics and chemistry. I quickly realized that I do not like physics that much – it was lacking rigor and was not based on a solid ground. Chemistry on the other hand was very interesting especially the Mendeleev periodic table – a brilliant breakthrough that may be regarded as a mathematical result. Several times I was participating in an all Ukrainian chemistry Olympiad.

I am trying to remember when a transition from chemistry to mathematics has happened. I have changed the school and in the new one we had a very weak chemistry teacher and a very good maths teacher. Also, the maths in the high school become very interesting – probably these two factors were defining for my career choice. As the Olympiad winner I had all the doors in Ukrainian universities open for me and finally I have selected the mathematical department of Kharkov National University.

EO – I cannot remember this, I was always able to solve mathematical problems. At school I was also good in chemistry and physics, and regularly won prizes in the competitions on these subjects. What did you study at University?

MB – I studied a Bachelor of Commerce with a major in Economics and Property Economics. I had read Donald Trumps book “Art of the Deal” as a 15yr old and told anyone who would listen that I was going to be a property developer. I then went on to study a Master of Science in Real Estate. By this time I was becoming more and more thirsty for knowledge and was doing many additional diploma’s in Jewish Studies, Accounting, Finance, Engineering, etc…

After leaving University it seemed that my studies had only just begun and I kept buying books; in fact I think I was single-handedly holding up Amazon’s share price. My obsession at this point was behavioural finance and I decided to go back to University and complete a Ph.D. in this field.

VK – I have been noticed very fast and starting from my first year in the university was involved in the research by the quantum groups group that was lead in Kharkov by (late) Professor Leonid Vaksman. In Kharkov, there are several world class mathematical schools – the study of quantum groups was initiated in Kharkov by the Fields medallist Vladimir Drienfeld.

I think that we were taught a pretty standard course of Maths in the University: analysis, geometry, algebra, differential equations, probability theory and statistics etc. – nothing very special.

After finishing my BSc I met a guy that has completely changed my research preferences and has introduced me to geometry. My MSc and PhD thesis were in the field of geometry.

EO – I studied mathematics. Simultaneously I was learning software engineering because I believe that pure math means nothing without an implementation and computational experiment.

What Academic achievements have you received?

MB – Ph.D.

VK – Ph.D. I believe I have proved at least one interesting and important result in geometry.

EO – I am proud of my latest result which was published in one of the world’s top mathematical journals – Pacific Journal of Mathematics (University of Berkeley). I proved that certain Finsler geometries are asymptotically Riemannian, this means that the anisotropy of the geometry vanishes at infinity.

I was a Senior Research Fellow in our department and as an Assistant Professor I was a scientific supervisor of more than 10 bachelor’s and master’s thesis in mathematics.One of my graduates continues his mathematical career in Kent State University, Ohio.

What are your interests, hobbies, philosophies?

MB – I am first and foremost an epistemologist, let me tell you what Professor Wikipedia has to say about this fancy word. “Epistemology is the branch of philosophy concerned with the nature and scope of knowledge.” I want to know and understand everything, I am curious about relationships at all dimensions, I like to know how things work and who has what and what X thinks about Y and the matrix of connection. I am a very complex person.

I am also an observant Jew; I don’t use the word religious as that implies I am holy which is a little too self-righteous for my liking. Being a believer in one G-d and “observing” the laws and rituals that Judaism entails, allows me to lead a more spiritual, purposeful, communal and disciplined life. At the end of the day I simply want to make a difference.

I am also a libertarian which may seem contradictory for someone with religious beliefs but we were all created with free-choice and I believe the less government, bureaucratic involvement the better.

To match my intellectual passions I love reading novels, movies, TV and beating my son on X-Box.

VK – I believe that my job is my most interesting hobby. Besides that I am interested in a ton of different stuff. Probably one of my biggest hobbies is travelling and seeing new places. I am reading a lot – almost everything from history to detectives. Unfortunately, for the last couple of years I do not have much time for it. Recently, I became a big fan of the ‘Mafia'(party game).

When I think about it I cannot say I have any particular philosophy to promote in this interview except for “to be a good guy.”

EO – I like reading, travelling, working in my garden, riding my retro (released 1969) motor-bike.

I always follow Kant’s Formula of Universal Law: “So act as if your maxims should serve at the same time as the universal law (of all rational beings)”. In matters of science I agree with Popper’s “critical rationalism”.

Did you play a lot of sport as a youngster, if so what, and what do you do to keep fit now?

MB – I am a sport fanatic, almost all sports grab my fancy. In my day I was pretty good at ball sports playing: tennis, cricket, soccer, rugby and golf but probably achieved most as a state level swimmer and cyclist. As a big guy 6ft1 and 102kg of quivering passion I was never built for running but I am proud to say that I have completed more than a handful of marathons and triathlons and in so doing kept my physio smiling all the way to his bank.

VK – I did play a lot of sports when I was a kid – I liked tennis, badminton. I was also bow shooting for quite a long time and even had some achievements in bow shooting. I used to be working out in a gym but not now – when it become warmer in the Ukraine I promise to start running every day. J

EO – At school I played basketball. Currently I go to gym and do some powerlifting because our work implies sedentary life which isn’t good for the health.

What kind of music do you like?

MB – I like to listen to classic music in the morning, most days I have classic on in my office, normally at 4pm when the Aussie markets close I tend to enjoy pop music. I essentially like classic, pop & rock.

VK – I like all sorts of music but working best in silence.

EO – I like rock music. I usually listen to music in my car, because I prefer working in silence.

Where and how did you meet?

MB – I posted a job on Elance in 2010 and awarded it to 2 math geeks calling themselves MathGears; little did I know that I would be “speaking” (via email) to them every day of my life over the next 3.5 years. I probably average about 30 emails a day to these two guys and feel like we know each other inside out. Last year we finally managed to meet in person in Sydney and move from a consultant role to a full-time employment and shareholder level.

VK – Eugene and I were at the same geometry department when I was pursuing my PhD studies. We became friends at least dating back to 2007.Afterwards, I proposed Eugene to be a partner in my Maths consulting business because I thought that I needed a technology specialist.

EO – Vladimir desribed this very well J.

Why do you think you all work so well as a team?

MB – We each have a clearly defined role that we never had to formally specify it just happened naturally. I am the one who brings real life trading and business experience. Having been in the trenches for more than 10 years as a full-time trader I have been around the block. So I fulfil the typical CEO role and Vladimir drives all theoretical model development and Eugene makes it all come to life. Vladimir can probably conceive how to travel through time and Eugene could programme the portal to take you there. If you are wondering what my role is, I am the guy who financed it and found our first intrepid time-space traveller.

VK – I think that our combined experience covers almost all the industry and we complement each other and create a “full production cycle” – from the idea to its implementation. I think that the fact that for the most tasks we may rely on each other and not on the third parties makes us quite unique and hastens our work.

EO – We understand each other “at a glance”. I think this is very amazing coincidence that we met.

What does your average day look like?

MB – It used to be a little more exotic but is now a little more structured. I get up around 6:25am check the markets and respond to a few emails. Pray. Eat a little breakfast, actually quite lot of breakfast by average standards while barking orders for everybody to wake-up and get ready for school. For some strange reason I inherited from my late father this manic happy mood behaviour in the mornings and I can be a little over the top with my singing. I try and catch the 7:15am ferry to the city, if not successful then the 7:35am which is not a direct trip and takes 15 minutes more, either way I am in the city before 8am. On the ferry I read the Wall Street Journal on my iPad. I try not to look up so as to avoid any conversation. When I reach the city I go straight to my local Italian Cafe for my morning “1 large flat white with an equal please” which I enjoy with my own copy of the Australian Financial Review (home delivery) and study it as if my life depended on it. I get the electronic edition as well but prefer to read the paper in hand. All this time I am responding to the most important emails. Who said men cannot multi-task. Between 9:00-9:30am I get to my desk. At about 11am it is time for another coffee and by 12:30 it is time for gym. Being kosher I always bring my own food to the office as there are no kosher eating places in the city. The question of when I eat my lunch is an open one as it usually doesn’t survive until lunch time, which means by 4pm I am starving. To try and avoid these hunger pangs I go for my 3 and final cup of coffee at around 3pm. I usually get home around 6:30pm for dinner with the family and by 7:30pm I am in my study working until around 10:15pm. I then unwind with some mixed martial arts on Fuel TV and a recorded TV programme. I usually check in on my emails and the markets around 11pm and then try to get to bed by midnight.

VK – Quite dull. I usually wake up at 7am at the morning to check if the trading goes well and answer the e-mails. Then I work from 9am till about 5-6pm. I also usually work when my wife goes to bed from 10pm to 11-12pm. For the last couple of months I was busy with moving into a new apartment and rebuilding everything in it and also I will have a boy in less than one month – I would say I am quite busy. J

EO – I get up at 7 o’clock, at 8 I usually drive to my office where I work till 6 PM. After that I either drive to gym or home where I usually work till the midnight. I always allocate at least one hour to study something new.

You are all workaholics where does the drive to work and excel come from?

MB – I grew up with a father who was a perfectionist and an extremely hard worker. I am also a very passionate person and when I latch onto something it isn’t with half-measures. This can be a challenge for me as it is very easy to blur the line between work and leisure/family time. This is amplified with the 24hr global connectivity. I have a very competitive nature and try and become the best at whatever I believe I am good at. Thankfully I am able to switch off 100% every Friday night for 24hrs and connect with my family and myself and of course the BIG guy upstairs.

VK – I think that several factors are important for me here. The most important is the responsibility – sometimes there is work that has to be done today. Tomorrow would be late already. Secondly, I really enjoy what I am doing. Finally, I believe that every achievement doesn’t come easy and requires efforts to be made (even if it seems that it simply came my way).

Probably because I like my job it does not exhaust me and I do not need to rest that often. Sometimes when I go somewhere on a holiday without an internet I do not know what to do J

EO – I think that the workaholism is my normal behavior.

Who are your role models and heros?

MB – My wife and mother are my hero’s and I believe great role models. My late father was also a terrific role model of how to be honourable and tough in business. I have many role models but to narrow things I would say I have deep fascination with the following guys in no particular order, Ludwig Von Mises, Carl Gustav Jung, Joseph B Soloveitchik, Daniel Kahneman, George Soros. Nassim Taleb, John Hussman.

VK – In finance: Taleb, Simons (he is a geometer like myself)

EO – I better say that I honor ideas instead of people, because any breakthrough is the result of a long and hard work of a whole sequence of people.I believe that the level of technology which surrounds us is amazing. None of the futurists could even imagine such things like cloud computing, ebook, Airbus A380 or RAPAcapintro.

What do you believe is your edge, what do you bring to the party that you feel makes you special?

MB – I think I bring a sense of enquiry and non-linear thinking, and envelope that with tenacity and strength of character.

VK – I believe one of my biggest talents is to quickly provide high-level solutions to the problems – to create a skeleton of solution sitting clearly in my mind.

EO – I am a quick-learner and never refuse any kind of work. From the moment when we met Michael I had already had an experience of managing and heavy lifting of large projects. I was working on CRM systems for big (~1000 employees) Ukranian industrial companies.

What are you most proud of with RAPA?

MB – Every new member feels like a part of my family, I am tremendously humbled and proud when people trust us with their time and information and load their data on our site. When I see people using and quoting our technology I get a blast of pride that nobody can describe. From an idea to a business in less than 6 months is a huge and rewarding effort.

VK – I am the most proud with the whole creative process we had when we collectively created RAPA out of the excel spreadsheet. Nothing can compare to this.

EO – We have almost 70 accounts on the leaderboard, this is very exciting for me.

Where do you see RAPA’s challenges going forward?

MB – The challenge for us is raising enough capital to satisfy the demand from our already impressive and fast growing pool of talent.

VK – It is very hard to establish oneself in finance industry and the main obstacle is to have a sufficient track history. We are just starting our journey – all we need is time and a bit of luck.

EO – It is extremely difficult to market any internet project, RAPA isn’t an exception. Thereby I treat our 1000 members as a very good achievement.

Where do you see the future of RAPA in 1 year and 5yrs time?

MB – In a year from now we will have more than 25 traders seeded with our capital taking steps to becoming established traders. Our technology and scoring algorithm will be part of 100’s of traders frame of reference when deciding whether a trader has displayed true skill. In 5 years time we want to be regarded as the official seal of approval and not only a capital provider but an important provider of financial software.

VK – In one year everyone would know what RAPA is, in 5 years everyone would have investments with us.

EO – Success J

We hope you enjoyed this look behind the curtain. Please feel free to email us with ideas and thoughts, we are passionate about building the best product and we can only do that with your ideas, experiences and feedback.

MARCH 13, 2013


Dear RAPA members.

A few weeks ago we did a backtest on the RAPA database demonstrating the superiority of the RAPA Score versus % performance as the metric to measure the success of a trader.

To take our testing a step further we applied our RAPA Score algorithm to 70 of the top ranked US mutual funds and 30 CTA mutual funds and ETFs from 2008 – 2012.

We then applied 5 different performance metrics to a model portfolio and we achieved the following backtest results.

To say we are pleased with our algo’s performance is a major understatement. In the table below you can see how applying the RAPA Ranking based on our scoring algorithm generously outperformed all other performance metrics.

We will be releasign a white paper in the coming days describing these results in more detail. Remember members who have not updated their performance on a rotating 10 day cycle will fall off the Leaderboard.

FEBRUARY 25, 2013

New Score Algorithm Release

Dear RAPA members.

This paper has the potential to be so technical that a graduate math student won’t understand it, so my promise is to try and make it easy enough for a neanderthal like me to grasp.

To really understand what is going on we need to go back a few centuries (1733) to one of the great mathematical discoveries, and here I am referring to what has become known as the Central Limit Theorem and is the foundation for all statistical analysis. Simply put the mean of a large enough number of independent random variables with a finite mean and variance will produce a normal distribution.

Beneath this elegant math is a typical philosophy that permeates society and our subconscious and that is the need for closed-form expressions. Where solutions to every day problems can have infinite permutations we become uncomfortable and to alleviate this discomfort we devise brilliant solutions. The Central Limit Theorem or Gaussian or Normal distribution which ever name you prefer provides one such solution, the problem however, is that one size does not fit all.

One of my favourite subjects relates to the question of whether the stock market movements are random. The entire edifice of modern finance was built on the assumption of randomness, and I have to admit that in many cases it is very difficult to prove otherwise. I cannot even imagine how many tens of thousands of academic papers have proved it, but have they?

A famous mathematician Mandelbrot in the 1960’s brought to our attention the fact that stock market returns were fractal displaying fat tail’s, more recently Nassim Taleb has made the subject more widely known and understood. So what are these fat tails, I always picture a cat when someone refers to “fat tails”.

If you recall one of the key assumptions to the Central Limit Theorem was a finite variance, however fat tail distributions have “infinite sigma”, technically meaning the variance does not exist. Most of the time in finance the distributions are mathematically well behaved, but every so often they encounter a trauma and when such a circumstance takes place the model housing the distribution becomes hopelessly inadequate.

I hope you have stayed with me until now, so that we can discuss the RAPA approach to these issues. There is a family of stable distribution models (including normal) that are able to deal with these issues, the one my brains trust have chosen as the superior one is the Levy process, an alpha-stable analog of the Brownian motion. To avoid getting too technical I will just highlight a key differentiating point, while the normal distribution formuale has two parameters, the alpha-stable formulae has 4 parameters which allow it to deal with beta and alpha which are typical features of manager/trader returns.

Ok we are now ready to look at how this impacts on the new RAPA algorithm release.

  • We have created an algorithm that fits historic returns to the alpha-stable family. This was no trivial exercise. The computational requirement for calculating our RAPA score has increased many many times more than in the past, to this end you may encounter a temporary inconvenience with scores being updated only twice a day. The reason is that we need to run this algorithm on a super computer away from our existing server and update the profile score. We have a solution to make it all work seemlessly on our server but will take us a little longer to programme it.
  • We have researched our databases and found that accounts displaying low alpha (excess kurtosis) should be penalized. Alpha does not just measure kurtosis more importantly it shows the tail behaviour of the distribution. When alpha=2 the distribution is Gaussian showing no fat tails but when it is less than 2 the distribution will always have infinite variance and fat tails. There are two types of low alpha funds: The ones that change their trading style during the course of their track-record (Type I) and those that sell options and deploy martingale strategies (Type II). We can distinguish between Type I and Type II strategies and penalize Type II.
  • We developed further an algorithm that measures the divergence of a traders recent alpha-stable distributions with his historic alpha-stable distributions; when we witness divergence from the past we typically penalize such behaviour.

In conclusion we have significantly enhanced our ability to evaluate a managers performance using a model better calibrated to the reality of traders and investment managers performance. As always we do not look at our models in isolation but further calibrate our models for typical behaviour across a much larger database of returns than the RAPA one. This completes the first phase of the RAPA Score improvement, we will keep you posted with further enhancement releases.

FEBRUARY 21, 2013


Dear RAPA members.

Over the weekend we chose 5 emerging FX traders that we feel have potential despite their short track records on RAPA. The Famous Five as per their usernames are:

Soliton Trading, Jon Grah, Oliver Wang, TPO Trader, Zeng Ming.

We have setup each account with $10,000 and then we opened a 6th account with $50,000 which will begin by allocating $10,000 equally to each manager. However in the larger “optimal” account, we will rebalance at the end of each month and optimize our allocation to each manager based on their respective performance. This may see allocations decreasing or increasing; in the individual accounts the money allocated will remain constant provided the account is not closed due to excessive drawdown. The track records of these managers is still too short to squeeze maximum value out of their respective inter-relationships or reliance on their respective RAPA Scores, but this should be an interesting experiment to see if the tactical allocation overlay the RAPA management applies will add any value to the sum of the individual managers performance. The Famous Five have therefore scored a bonus of an additional $10,000 each to manage and earn fees on. Boy we are generous .

We have developed a technology we call RAPA Grabber which will enable us to show the real time equity curves of the managers we have allocated capital to. This addition should make for entertaining viewing; we hope to implement this on the site within the next 10 days.

During this allocation round I picked up on a very interesting phenomenon in the FX world which I believe places people in a major ethical dilemma and has caused the signal selling FX community to become paranoid. Let me take a few steps back to give you some colour regarding this insight.

When we added MT4 to our list of approved data importers we got a lot of requests to make our leaderboard dynamically update like some of our competitors; I researched this and found MT4 technology provides a very simple way for us to do this but then I realized that the minute you have an accounts investor password you have access to view the trading account real time and therefore apply copying software to mirror the account. This insight matched why so few successful traders were posting their returns on these social trading sites. It made sense to me and RAPA decided to report a more lagged performance in the hope that we would attract more serious traders who didn’t have to give up their signals real time and effectively be exposed to copying.

I am glad we took that decision but during the course of this current FX allocation I encountered the paranoia that these traders experienced when handing over their investor passwords to allow us to copy their signals. I want to thank these traders for entrusting us to act responsibly with their intellectual property. The RAPA team respects the hard work and dedication that goes into building an impressive track record and we commit to working with your signals with the utmost honesty and integrity. What this all means to those at a distance from FX signals, is that you could have an unscrupulous party selling or trading the trade signals of an unsuspecting trader.

You may recall last week I mentioned that DCM Capital were auctioning their brokerage that specialised in sentiment analysis on Twitter. They claim to have spent 350,000 pounds developing the business and attached an independent valuation of 3.5m pounds to the business. This past Monday the auction closed with the highest bidder at 120,000 pounds. I have my theories why this failed so dismally but will need to save it for another time as I have already over stayed my welcome.

In conclusion I wish to alert you to the fact that over the weekend or early next week, we will be uploading a new release of the RAPA Scoring algorithm. We have really pushed the cutting edge envelope on this latest release, we welcome comment as always and please feel free to pass this email around widely so we can expand the community. As our database grows we are able to do more and more empirical work and enhance our scoring calibration. Indirectly we all benefit by increasing the size of the community, in statistics more is always better than less.

FEBRUARY 7, 2013


Dear RAPA members.

In our last email we introduced a new release of our RAPA Ranking algorithm. We claimed that our ranking system was superior to the traditional metrics used when making asset allocation decisions. Let us put RAPA to the test and see if this is in fact the case. For our newer members in case you never knew RAPA stands for (Risk And Profit Analyzer).

In this simple test we took from our leaderboard the top 20% of our RAPA Rankings and compared it to the top 20% on a percentage performance basis, and we did this every month from March 2011 rotating out of the accounts that were not in the top 20% on a Rank and Performance basis. This is what we found.

What you can clearly see in this example is that the RAPA Ranking method produces a significantly higher return with a much lower amount of risk.


JANUARY 19, 2013

Interview with Chess Champion Alex Rabinovich

Dear RAPA members.

Welcome back to the trading year, we have been holding back on our communication to give you all time to settle into the work groove, especially those of you in the southern hemisphere enjoying the summer. Our community continues to grow in the 2+ months we have been live with 547 members at last count, $19.7m of real accounts reporting daily PnL, and a slow but steady growth in posts coming through the Wall feed. Don’t be shy have your say and get noticed.

In the next few days we will be launching an update of our RAPA scoring algorithm; as well as a download feature to assist the research community, but I thought it would be appropriate to kick start the year with an interview of a new member who has an interesting story.

This January 2013 we welcomed Alex Rabinovich and his hedge fund Chessica to the RAPA community. Chessica Asset Management is unique in that its two principals are both Chess Masters. On 20 January 2013, Michael Berman CEO of RAPA caught up with Alex to find out a little more background.

Hi Alex, I am speaking to you from a sun scorched Sydney Australia where the mercury has been hovering around the 40 Celsius over the last week. What is the weather like in Toronto?

Alex: It is not too bad and not as cold as people think. It was actually on the plus side most of the last week. Obviously not as warm as in Australia.

I read somewhere that you were the world junior Chess champion, can you tell us a little bit about your background, where you are from what you studied and a little bit about your chess accomplishments? Full disclosure I am a huge chess fan but not very good.

Alex: I was born in USSR, but my family moved to Israel when I was 12. This is where my chess really moved to a new level. I represented Israel in many European and World championships between 1993 and 1998. In 1996 I took the third place in Europe under the age of 18 and in the same year I took the gold medal in the world team championship for high schools. A few years later I became an International Chess Master. Through my career I was lucky to play famous chess players like Garry Kasparov, Bobby Fischer, Victor Korchnoi, David Bronstein, Peter Leko and more. I quit professional chess when I was 19. I obtained my Software and Management Engineer Degree in Tel-Aviv.

I believe chess styles are very reflective of the player’s personality, how would you describe your chess style?

Alex: My chess style is a mix of strategy and tactics. Looking back, I think my strength was always in my ability to exploit opponent mistakes and opportunities in general.

Tell us a little bit about Chessica who are the players involved and how did you get in business together?

Alex: Chessica is Victor Plotkin and Alex Rabinovich. Victor and I met through our chess circles and found mutual interests in chess and investments. We launched Chessica in 2010. Victor is a FIDE Master which is a very high level in chess. In fact, Victor is much more active a chess player than I am these days.

Can you summarise the Chessica funds trading style and tell us about what instruments you trade?

Alex: Chessica uses a proprietary options strategy. We are market and delta neutral most of the time. Our preference is always to apply our strategy to the most popular and liquid indices like NDX, Russell and similar. It allows for higher profitability and lower risk.

You have had 3 years of profitable performance
2010 = 19.7%; 2011 = 0.2%; 2012 = 37.3
The returns have been outstanding except for one very volatile period in August 2011, this question has probably been asked of you at every single meeting but what went wrong that summer?

Alex: August was a very volatile month on the markets and we would have lost 5%-6% in that month. Unfortunately Victor and I made a mistake with our choice of infrastructure at that time and during a 3 day storm, we had serious outage of internet and access to our investment platform. We have resolved that by adding backup infrastructure. The following months made up for that loss. It was a very expensive lesson to learn, but I am happy it happened when we had a lower AUM.

Chessica appears to be an option trading strategy, can you zone in on some of the aspects which you believe makes your strategy robust and likely to continue to produce market returns?

Alex: The beauty of our strategy is that we make decent returns in almost any market condition. We barely take side (Bullish/Bearish). Our strategy has been making double digit returns since 1995. Obviously the market is getting smarter and it is harder to reproduce those high numbers, but our 2012 returns do show that it is still doable.

When I look at your returns they display a strong beta to the broad markets, what is your typical market exposure that you are comfortable with, in other words does your fund always display a long bias to the markets?

Alex: Most of the time we are market and delta neutral, unless there is a clear sign for a market direction as for example in the beginning of 2013 when it was obvious the market is going up in the short term. In our letter to investors we outlined our outlook for the early 2013 as positive and that we took a bullish position. Having said that, in most cases we will establish a neutral position and will try and keep this balance for the investment term.

What kind of returns are you targeting on an annual basis and what type of volatility can we expect to encounter on the journey?

Alex: Our goal is for the investor to make 10%-15% a year. Anything beyond that is a bonus. We always prefer to lower the expectations and surprise our clients rather than underperform compared to their expectations. The volatility was drastically reduced with the new risk management policy that we implemented in 2012. We had 15 consecutive positive months. I think our last 15 months performance is around +60%. Currently the fund doesn’t charge any management fees. I think that combined with our modest returns is what makes Chessica a lucrative opportunity for investors.

Is there a daily limit of risk you are prepared to tolerate or is it an annual amount, can you tell us a little about your risk management process and tolerance?

Alex: We don’t have day limits as we are not day traders. We apply our risk management approach to our strategy. Our strategy already dictates the size of the portfolio, the exposure, the risk and what our position should look like to avoid unpleasant surprises when the markets open tomorrow.

Trading can be a stressful occupation, what do you do to relax, what interests do you have outside of the markets?

Alex: I am a big sports fan. I play Soccer, Volleyball, Basketball & Tennis.

What personal characteristics do you have that makes you feel that you are well suited to your chosen career of money management?

Alex: I can’t speak of my personal characteristics, but I think money management is about several things: (1) Experience in different market cycles (2) Understand the current market (3) Robust and profitable strategy (4) Discipline. If you have all 4, you are doing the right thing. If you are missing one of them, you better have another big advantage, because I truly believe these are fundamental to a successful investment manager.

Who are your hero’s?

Alex: I wouldn’t call them Heroes, but these people in this or another way had a positive influence on my decisions. My family, Amiram Kaplan( Israeli Chess Federation executive and a friend), Michael Jordan( my addiction to sport is probably because of him), Garry Kasparov( extraordinary chess player and person).

Alex it was great to talk to you.

We hope you enjoyed meeting Alex and we will try and do an interview with our members on a regular basis. Stay tuned for the upgrades I mentioned.

JANUARY 18, 2013

Welcoming R to the RAPA Community

In 2010 I started using the R-project software, as a non programmer. Today I am still a non programmer but have grown in my knowledge and admiration for this amazing open source software and the equally amazing R community who have shared their code along the way to make things easier for newbies like me and quick start professional quant finance programmers new to the language. There are a couple of names that stick out in my mind who have really made an amazing contribution: Brian Peterson, Joshua Ulrich, timelyportfolio, Paul Teetor, Milktrader, Jeff Ryan, Rstudio, Peter Carl, Eric Zivot, Dirk Eddelbuettel, RStudio, Rcommander, etc… Over the years I have always wanted to give back to this community in some shape or form.

In November 2012 we launched the RAPA Cap Intro web portal which matches emerging trading talent with trading capital. In the short space of 2 months we have attracted some impressive talent with a steady growing database; the one way my partners and I thought we could help the R quant finance community is to provide access to a free download of the different traders equity curves. We have no doubt that some of the community will be quick to use this resource and produce some interesting research that we can all benefit from. While there is a fairly large number of vendors who sell CTA and hedge fund monthly databases there is currently no vendor that we are aware of that sells a daily database. With this in mind we would greatly value the R community using this resource and also spreading the word around so that we become better known and the community will benefit from a larger database.

Here are the steps you will need to follow to access this data:

You will need to register, all that is required is a username, first and last name, email & password.

You will need to download the dataset from the Download menu, copy and paste the following code in your R console and you will have the data ready for use in the Performance Analytics package, or any other package you may wish to use.

install.packages ('PerformanceAnalytics')
install.packages ('fBasics')
# setwd(choose.dir())
Data = read.csv('rapa_dataset.csv', stringsAsFactors = FALSE, header=FALSE)
colnames(Data) = c('fundID', 'date', 'equity')
IDs = unique(Data$fundID)
FundList = list()
for (i in 1:length(IDs))
tmpdata = Data[Data$fundID==IDs[i],]
tmprets = getReturns(tmpdata$equity)
FundList[[i]] = xts(cbind(tmpdata$equity, tmprets), order.by=as.Date(tmpdata$date, format='%d/%m/%Y'))
par(mfrow = c(4,2))
for (i in 1:length(FundList))
chart.TimeSeries(FundList[[i]][,1], colorset='blue', yaxis=FALSE, ylab=IDs[i])
chart.Histogram(FundList[[i]][,2], methods='add.normal')

JANUARY 10, 2013

RAPA Equity Curves

The RAPA Cap Intro web portal is pleased to add Meta Trader 4 (“MT4”) alongside its current Interactive Brokers (“IB”) support. RAPA (PTY) LTD is an Australian Registered Funds Manager boutique specializing in matching emerging manager trading talent with investment capital. It is a joint venture with management and Gleneagle Securities an Australian registered Broker Dealer with more than $100m of AUM.

CEO of RAPA Michael Berman, Ph.D. had this to say, “We are delighted to add MT4 to our RAPA platform. MT4 is an enormously successful execution platform that is well accepted in forex circles, with it we hope to add a large new client base to our steady growing community.”

In the 6 weeks that RAPA has been live it has added nearly 400 members to its community and has more than $15m of trader’s assets under management being reported on a regular basis. In the 1st week of December RAPA allocated its 1st capital allocation of $100,000 to the number one trader on its leaderboard a crude oil option writer, Kevin Saunders. RAPA has a further $1.2 million of Gleneagle proprietary funds to allocate to 5 managers at the end of March.

RAPA believes its value add is that its principals all come from a trading background, and have seeded some of Australia’s leading fund managers over the last 20 years. The relationship with Gleneagle provides RAPA with an institutional grade infrastructure as a partner, and the ability to leverage off its back office, compliance and regulatory framework. There is also a high level of competence with the 3 main RAPA executives having Ph.D.’s in Economics and Mathematics combining practical experience with cutting edge technology and innovation. Berman concludes with a passionate statement why he believes RAPA offers a value add proposition, “We believe the culture we bring to the partnership is our key ingredient, we understand traders and trading, we understand the difficulty of investing in an uncertain world and we understand the psychological challenges of managing 3rd party money. Our approach is not arms-length institutional; we are a hands-on full support team with skills in counselling, mentoring, investments, economics, quantitative analysis, compliance and back office and marketing & sales.”

Visit RAPA Cap Intro on www.rapacapintro.com where you can become a member for FREE and grow with this community as it brings new technological and quantitative innovations to its web based platform.

DECEMBER 10, 2012

Trader Interview with Kevin

We have our first allocation of $100,000 going to Kevin Saunders with account U54964xx at the top of the leaderboard on 7 December with a RAPA score of 93 out of a possible 100. Here are some key performance metrics for the accounts 1yr and 24 days history:

Annual ROI of 21.5% a daily annualized Sharpe ratio of 2.46 (RF=0) and a Max Drawdown of 3.22%

The following interview took place between Michael Berman and Kevin Saunders on Sunday 10th December 2012.

How long have you been trading, and what got you interested?

I have been trading since 1999. I came to trading as a hobby during the dot com boom. After making a lot of easy money in the internet bubble, I also had the misfortune of losing a lot of money when the bubble collapsed. This experience made me determined to develop a more robust understanding of how to trade the markets.

What is your full time occupation?

I am a full time trader and money manager.

What is your background both educational and career wise?

Originally I was involved in the digital media field, teaching at Notre Dame University in Western Australia. When I made the decision to change career pathways, I decided to study financial markets at FINSIA (Now KAPLAN Professional). On completion of my studies I received the Dux of Victoria for the highest overall mark and the National subject prize for “Derivatives: Applying Theory to Practice”. Ironically, this training didn’t provide any answers on how to make money consistently in the markets, so I continued searching for trading success by getting involved with trader training organisations. First I was a student then I got more involved with educational content creation using my prior training in digital media. Throughout these early years I kept trading and experimenting with system development and I eventually developed a method which matched my personality and has shown consistent profitability ever since. It was this method of trading that allowed me to transition to being a full time trader.

Tell us about your office setup, where do you live (City is good enough), what kind of hardware do you use, what kind of software do you use?

I have an office in the Melbourne CBD. I use several laptop computers, predominately, an Samsung laptop (8Gb Ram, SSD, Win7 x64). I like laptops ahead of desktops because the battery backup provides a redundancy against power failures.
I use OptionVue options analysis software, a custom Excel Spreadsheet and a custom Java application. The Excel Spreadsheet and the Java application interface with the API that comes with Interactive Brokers’ Trader Workstation. I execute through TWS.

Are you able to code, if so which languages do you do most of your work in?

I don’t have coding skills except for an understanding of how to write macros for excel. I outsource all my coding requirements to 2 trusted specialists.

What kind of trader are you, as best reflected by your personality?

I am an option trader, looking to trade volatility, predominately from short side. The trading cycle is typically 30-40 days so there is not a requirement to remain glued to the screen. This suits my personality and time restraints.

Can you describe your strategy and what you believe makes it profitable over the long term?

My strategy seeks to sell overpriced volatility on both the call and put side and through a staged allocation process, over many days. I will attempt to achieve a better-than-model valuation on a resultant short strangle position. If I am successful at executing with edge, there will be an additional risk buffer to the position. This cannot take the place of the risk management however. It is purely to increase probability of success. Once a strangle has been created, it is all about risk management until completion of the trade.
The strategy will remain profitable over the long term by benefiting from the high probability associated with selling low delta options while addressing the low probability, outlier price events that often plague these kinds of strategies.

What is your attitude towards risk and how do you deal with it?

Risk management is the primary determining factor to whether I am profitable or not. I like to talk about risk by using an analogy. If you live in a region plagued by cyclones, you might receive several cyclone evacuation notices every year. The reality is that 80% of the time, had you decided to ignore the cyclone warning, you would have been fine. Problem is, behind every cyclone warning, there could be Cyclone Tracy, which flattened Darwin in 1974.
When I trade I take every cyclone warning seriously and evacuate. This results in risk adjustment actions (which are expensive) that were unnecessary 80% of the time. I am happy to accept this and the resultant performance degradation, because when Cyclone Tracy hits, I won’t be anywhere around.
Typical options selling strategies don’t do this. This is why they tend to perform in stunning fashion, until Cyclone Tracy hits, often resulting in a blowup of even greater magnitutde.

How do you manage the stress related to trading?

I have learned through necessity, to manage my emotions. This was a process akin to trial by fire. In earlier times, I suffered terribly from anxiety and stress from trading. This was intentisfied with the arrival of my two children, who are very close together in age. There were times when my kids were having high fevers at the same time as the market was crashing.
I found the best way to manage the stress of trading is to develop a daily game plan, in which I have considered every market scenario for the coming session. I will then make a clear decision about how I will deal with each outcome, before it happens. That way I am armed with my key action triggers ahead of time. This avoids being surprised by something the market does and having to make snap decision. It is snap decisions under pressure that will bring forth the emotional rollercoaster. Clarity on how to act, in any outcome that eventuates, is the key. Then the response is unemotional. These days, taking loses or profits have relatively equal emotional impact for me. I have traded long enough to realise that trading is a continuum in which wins and losses will be ever present.

What interests do you have outside of trading?

I studied music at the WA conservatorium in the late 80’s. I have always had a love for music. I play whenever I can and find it to be a great way to have a break and take my mind off trading. My kids are a great distraction as well. I try to leave trading behind on the weekends and enjoy my time with them as much as possible.

How would you describe your strengths and weaknesses?

My strengths would have to be in my ability to come at solutions from creative angles. I have had a non-standard financial background, so when I look to solve a problem I often come at solutions from experiences I have had in very different situations. It is strange how you can have a learning experience in one field and then find it to be helpful in solving a problem that has arisen in a completely different field. Everything I have done, I have done by building it myself. I have not been shown a method from within an institutional context and broken out on my own. Everything has been trial and error (with a lot of error). My weaknesses would be impatience with the evolution of my trading. I am suffering from too many ideas and only one person to realise them. This makes me frustrated and grumpy from time to time.

Do you have any hero’s?

My wife. She somehow finds the time to be a Mum, work three days a week, study a Masters in Public Health and get H1’s for every assignment. That is beyond my capabilities.

What is the ideal size of funds that you would like to manage?

I have done liquidity modelling to $30 Million under the current execution method. After this level, I have contacts in the US that can utilise algo execution to increase efficiency, which could see the strategy built to $100 million.

Thanks Kevin that was really interesting and informative we wish you great success in your trading.

NOVEMBER 27, 2012

Persistence of Sharpe Ratios in Hedge Funds

Recently, we came across a paper that shows that Sharpe ratios of funds with short history are considerably smaller than Sharpes of funds with longer trading history. We decided to check if this result is correct.

To check the argument we divided all funds into four categories:

  • Funds that have more than one year of trading history,
  • Funds that have more than two years of history,
  • Funds that have more than five years of history,
  • Funds that have more than ten years of history.

For each category, we calculate the Sharpe ratios and we fit these numbers to the Student t-distribution. The choice of t-distribution is natural because of the Sharpe ratio’s formula with the standard deviation of returns in the denominator. We will see that indeed, the distribution of Sharpe ratios possess heavier tails than the normal distribution.

On the chart below we plot the fitted densities of the obtained distributions. We clearly see that the observed average Sharpe ratios for each category are roughly the same and is approximately equal to ~0.65. It is interesting that this value of Sharpe is of the same order as the Sharpe ratio of the broad market (S&P 500 before the GFC).

What is more interesting on this chart – are the degrees of freedom of the fitted t-distributions. For the 1yr data the number of degrees of freedom is equal to 2, while for the 10yr data this number is 4. Recall, that the number of degrees of freedom measures overall weight in the tails of t-distributions. We see that for the 1yr data, the number of strange or abnormal funds is much larger than for the 10yr data and Sharpe ratios for the funds that survived more than 10yrs are much more stable. We conjecture that funds with abnormally high Sharpe ratios are in general not capable of surviving enough time and will eventually suffer from big drawdown’s and liquidation.

To conclude, in our study we established that funds with a longer history on average have the same Sharpe ratio as the funds that survived only a few years. However, the distribution of Sharpe ratios around the mean possess much heavier tails for the funds with less history than for funds with large trading history.

NOVEMBER 5, 2012

RAPA Trading Journal

We often hear the terrifying statistic that more than 95% of traders fail. Let us assume this statistic to be true (I believe the failure rate to be closer to 97%). The obvious question is why?

The point I wish to highlight is the simple evolutionary fact that we have been born with a psychological makeup that by its very automatic programming is designed to blow up our trading accounts.

With this in mind we clearly need to be spending less time focusing on our trading strategies; doing endless back-tests, optimizing entry and exit points and then trying to calculate the best position size, and more on our state of mind at the critical points in our research process and then during the trade execution and open position monitoring phase.

There are many benefits to keeping a journal, both psychological and practical but for this short article I wish to focus on just two:
1. Discipline: In my experience I have found most traders lacking in discipline. By maintaining a journal you are forced to commit your thoughts to action; action requires effort, only winners are prepared to make the effort. Furthermore it is human nature to react with instinctive reflex when in stressful situations, by forcing oneself to first write down your plan of action it neutralizes the reflex and allows you to consider the prevailing circumstances. When writing the words or pasting images of charts you are giving the subconscious part of your mind (let’s call it your limbic system) a chance to be checked by your conscious thinking part of your brain.
2. Evaluation: When you are in the moment it is very difficult to objectively assess your actions; by keeping a detailed journal rich with information about your state of mind, the state of the markets, and other important trade statistics you provide yourself the opportunity to evaluate areas of weakness and mistakes in your process as well as your personality. The benefit of a journal is not limited to your own evaluation, as for greater benefit you can bring objective experts such as mentors, psychologists and colleagues into the review phase.

When designing the RAPA web portal we were very mindful of the fact that part of a journal is the work you do on a blog, Twitter account and other social media and we wanted to make it as easy as possible to centralize all posts, so we designed a Wall for each community member. The Wall contains a journal and all social media connections posted automatically to the wall; the level of privacy is determined by the member on a post by post basis with the default of every post set to private “Hide” by clicking on “Share” posts become part of a public Wall.

To further enhance the usability of the journal we have seamlessly integrated the trade and PNL database with each members Wall profile. For active traders and large portfolios it can be very difficult and time consuming to maintain a detailed trade journal. By integrating the trade database members can now do a detailed review of their portfolio and there accompanying posts on any given historic date.

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