
The Line Between Aggressive and Crazy - apsec112
https://rhsfinancial.com/2017/06/line-aggressive-crazy/
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OisinMoran
It's worth noting that for a finite number of bets (the number being known to
the bettor) the Kelly Criterion is not the optimal strategy. Intuitively, the
closer you are to the end the less worried you should be about going bust (as
you won't be missing out on more of these great odds).

Gwern details this extensively here: [https://www.gwern.net/Coin-
flip](https://www.gwern.net/Coin-flip) well worth checking out.

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kartickv
You should be worried about going bust, because life goes on after the
exercise ends. Am I missing something?

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darkerside
Think of it this way. With one final chance left, you should really bet 100%
to maximize your expected value.

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goldenkey
That seems contrary to the criterion... Expected value dismisses risk and the
fact that once someone loses their money, it is much harder to gain it back.

If you have 100 dollars..and you lose 50% of it on a fair coin bet, you now
have $50.

Say you play again..You win. Youll only have $75 ($50 times 150%.)

Thats the basis of risk analysis. That losing and winning arent equal for
finite bankrolls just because their probabilities are equal.

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Animats
There was a great moment in financial history when only a few people had
figured out how to use computers to price things, and they made a lot of
money. Thorpe did very well at blackjack because the casinos didn't know that
a winning strategy against them was possible.

Now everything financial has been analyzed to death and nobody can make money
with technical analysis.

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ThrustVectoring
Technical analysis is playing heads-up against math PhDs who get paid $250k a
year to try to beat you. Yeah, you're not going to be in for a good time.

This article is more about how you manage risk and learning what your
_personal_ risk tolerance is. If you take more or less risk than you "should",
then all else equal, you'll wind up with less money.

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jackhack
100% correct.

Besides, these are not "just" math PhDs, but math PhDs backed by some of the
largest private equity trading firms in the world, armed with multiple
datacenters of 5000 blades each, running machine learning algos and playing
"what if" scenarios 24 hours a day, to build rulesets and aligned structured
positions so they can scrape news feeds and react in milliseconds.

Anyone who thinks they can sit at home and day-trade with these sharks without
being fleeced is a fool. But then, anyone who is a fundamentals trader and is
still in this outrageously irrational market is also a fool.

One of the first things I learned as a trader: "The market can remain
irrational longer than you can remain solvent."

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MsMowz
This is fascinating, and really makes you consider the volatile nature of
markets from a different perspective. That is, it seems to imply that your
return is less about the choice of companies to invest in and more about your
general exposure, which seems consistent with the rise of index funds and
diversification in general.

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zaroth
Or in other words, don't pick your stocks, pick your leverage. Interesting
read, only thing missing was a deeper dive into the tools used to produce the
graphs, or even better, a link to a Github which would reproduce them from the
raw data.

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nothrabannosir
Most of those graphs are straight out of Excel.

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zaroth
Sorry, I meant the calculations, not how to render the line chart!

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j7ake
I don't really understand the equation.

Plugging in an average stock market performance (over last 20 years):

Return: 8% Standard Deviation: 17.72% Risk free rate: 3% (guess)

This gives f = 1.59.

This means the optimal strategy is to be putting 159% of your money in an ETF
index?

This strategy is in stark contrast with the typical 70%-30% allocation of
investments. How do we reconcile this? Intuitively, the function of your age
needs to be included in this equation (I think somebody commented on this
already).

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dmichulke
Isn't risk-free currently more like 0%?

Alternatively, where can I get my 3%? No ICOs please ;-)

~~~
ThrustVectoring
You can find FDIC insured bank accounts at 1.25% nowadays. There's also
I-bonds at 1.9% inflation-linked, with a purchase limit of $10k/yr and a
1-year redemption lock-out.

3% is more accurate for the cost of margin loans or the opportunity cost of
pre-paying a mortgage.

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alexpetralia
Related concept explained by Nassim Taleb: [https://medium.com/incerto/the-
logic-of-risk-taking-107bf410...](https://medium.com/incerto/the-logic-of-
risk-taking-107bf41029d3)

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jiggunjer
I'm not sure how applicable to criterion is to investing. The main differences
are you typically don't lose your entire 'bet', and bets aren't decided in a
single moment but the outcome is slowly revealed over time.

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zimablue
I don't think that changes the conclusion, you're just moving from discrete to
in theory continuous but in practise modellable as discrete.

~~~
jiggunjer
It prompts very different behavior, to extend the coin flip metaphor: If you
could slow down time and see the flip turning bad, you could quickly withdraw
your bet. Then you'd be much more likely to bet a higher fraction.

~~~
padobson
I was thinking about this while reading. The Dot Com and Sub Prime mortgage
crashes took a lot of people buy surprise, but not everyone. Moving into
T-bills, cash, or precious metals at the beginning of those downturns would be
enough to make the 2x Kelly and 3x Kelly perform better.

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paulpauper
_Criterion can tell us what was behind the biggest blowups in finance, why
levered ETFs are generally a bad idea, and how aggressive investors can
maximize their wealth without risking ruin._

That is not necessarily true regarding leveraged etfs.

Leverged ETFs when used as a substitute for being fully invested can be more
safe than being fully invested in the non-leveraged version. The idea being
one puts 1/3 of their capital in the 3x S&P 500 ETF and the 2/3 in T-bills.
The maximum loss, no matter what, is still only 33%.

Ruin (if it is defined to mean 100% loss of capital) is impossible with a
leveraged etf [it just means your wealth asymptotically approaches zero], but
it is possible with margin debt.

~~~
ThrustVectoring
That only helps you if your rebalancing period is less frequent than it should
be, letting your leverage drift up on good days and down on bad days. If the
market goes down by 16.6%%, your levered ETF goes down by 50%, and your
portfolio is now 80% treasuries and 20% 3x levered ETF.

If you rebalance daily in order to maintain your desired stock exposure, you
end up owning the S&P 500 as your buy and sell orders of the levered ETF
counteract the ETF's buy and sell orders on the underlying index to maintain
its leverage. All you're doing is paying higher fees, trading costs, the
spread on T-bills vs institutional margin costs, and realizing capital gains
and losses pointlessly.

What you want is to buy call options on the S&P 500 index. The market is far
more efficient here and way better for you.

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whitecream
There seems to be an error in the calculation: b (the net odds) should be 1.5,
not 2.5

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erezsh
I was really surprised the article overlooked such an elementary mistake.
Makes me wonder what else they didn't double-check.

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Udik
> Because my bet is only valuable to you for as long as you have money to keep
> making it. But if you bet too much, you will eventually go bust.

Funny how this seems also to work as an argument against Pascal's wager.

