Tweet was posted in May 5th 2019 where Chinese import tax hike to 25% from 10% was proposed.
Immediate negative effects were most prominent on Hong Kong and Straits Times stock index. An observed 4.5% drop.
Immediate effects were negligible on the Shanghai index as bad news seems like it was already factored a few days prior to the tweet. An observed 6% drop prior to the tweet.
Effects on the SnP was negligible. An observed 0.45% drop. The London Stock exchange (FTSE) seems to be humming to its own rhythm.
The key hypothesis: customers of established companies with short term negative sentiment are more sticky that assumed
The key ratio of concern will be the Sharpe ratio measured by monthly average as well as yearly average
To bench mark against S&P index to figure out if there is in fact an Alpha when deploying such strategy
Fund clients expect a returns during market down turns as well as during bull markets
need to figure out how to avoid the buy trigger which will continuously trigger 2.5% losses during a period of market downturn.
A good way to hedge and generate leverage would be to short the same amount on the S&P index (SPY) every time you attempt buy into a position utilizing the strategy.
Miscellaneous to take into account
dividend paid out by S&P index as well as any paid out by strategy
Good quality decisions do not always yield good outcomes
All decision makings in real life are made under uncertainty. All decisions are essentially bets about the future
Decisions made in Chess are not made under uncertainty because every single permutation can be pre-computed unlike Poker.
Most real life decisions are not zero-sum games
On outcomes
Real life outcomes are probabilistic
Outcomes are influenced primarily by the quality of our decision (skill) and luck
While the outcomes might not always be positive, having a process in place to constantly improve the quality of decision making will tilt the odds in our favor
Implications
Do not change strategy drastically just because a few hands did not turn out well in the short run
For each premise understand what the base rate is
Learn to be at peace with not knowing
Recognize the limits of our own knowledge
A great decision is a result of a good process. A good process attempts to accurately represent our own state of knowledge
Watching: It is free to learn from other people’s experience
Cognitive biases that impede good decision
Decisions are the outcomes of our beliefs
Hindsight bias impedes against quality decision making
Guard against black or white decision making
Availability bias means lagging any prior conflicting data, our default setting is to believe what we hear is true
Selective bias and consistency bias, means we are unwilling to change our mind despite contrary signals from the environment
Avoid attribution bias
Related Readings
Theory of Games and Economic Behavior, Jon Von Neumann
Ignorance: How it drives Science, Stuart Firestein
This documentation is an extension on the strategy of loss aversion and reversion to mean. Its aim is to quantitatively identify the point in time when the effects of mass hysteria resultant from bad news has subsided.
For clearer reading of signals, entry should be done at end of day instead of beginning of day.
Heuristics
Only consider a purchase if there are funds available for deployment
Only consider companies with my circle of competence.
To mitigate intraday noise, only execute orders in the last hour of the trading day. Make sure spreads are narrow.
Only consider entry if the expected value for mean reversion of the company’s industry is above 0.1
Only consider entry if the expected value for mean reversion of the company’s industry is above 0.2
Large dip is qualified if RSI was below 30
Only enter when MACD histogram down trend receeds
Enter at historical support level
Exit at 5% capital gain
Stop loss at 2% capital loss
Successful attempts
Listed below are 3 successful entry attempts during early 2019 where a 5% capital gain were captured.
SVMK trade entry on 15th Feb 2019
MDB trade entry on 17th Jan 2019
TSLA trade entry 5th March 2019
MDB entry on 30th Sep 2019
The key characteristics of these entry were:
Dip classification
>10% drop in share price
Trading volume accompanying large dip should be at least 2.5X of 10 day moving average
In 3 month time frame, RSI of previous day was in the oversold range of <30
In 3 month time frame, MACD negative divergence is peaking and then tending towards zero
Entry
In the 30 day chart, sales volume is less than 10 day moving average
Proper timing of entry could result in a lower denominator to work on for the targeted 5% gain. This would result in overall lower holding period in positions.
Failed attempt type 1: Entering too early
Depicted is an example of entering the position too early
Dip classification
>10% drop in share price
RSI of previous day was in the oversold range of <30
Entry
In the30 day chart, negative sales volume was still more than the 10 day moving average
Failed attempt type 2: Trading companies with too recent IPO
Dip classification
>10% drop in share price
No RSI available
In the30 day chart, there was not enough data to plot the 10 day moving average
To check if price recovery is due to covering of prior shorts
Failed attempt type 3: Trading companies with a steady and consistent down trend and negative fundamental news
Dip classification
>10% gradual drop in share price
Continuous downtrends observed during 6 months, 3 months or 1 month window.
Failed attempt type 4: Trading companies with a steady and consistent down trend and negative macro news
Dip classification
>10% gradual drop in share price
Continuous downtrends observed during 6 months, 3 months or 1 month window.
Failed attempt type 5: Trading companies with a steady and consistent down trend and negative macro news
Dip classification
>10% sharpe drop in share price
Continuous downtrends observed during 6 months, 3 months or 1 month window.
Raise only the funding you really need and grow judiciously.
Alignment from all parties on exit strategy is extremely important
Best time to sell a company is when the future has never looked brighter
On VCs
Interest of VCs might not be aligned with interest of founders and angel investors
VCs need to satisfy the needs of their LPs
Need their successful companies to generate a minimum of 10-30X return for their fund to perform respectably, taking into account overall failure rates
They thus need to wait longer to exit and work their investments harder.
They are ok to accelerate the growth of their investments with their capital or blow it up quick for a capital right off. The latter helps minimize management overheads.
They will block a sale if the return multiples do not meet their expectation
VC return multiples of term sheet valuation
Series A – 10X return
Series B – 4-7X returns
SEries C – 2-4X returns
VC funds have been getting bigger overtime. The need to deploy their capital forces them to seek for opportunities where likelihoods are slim.
Companies with VC money tend to exit at year 16 on the average
On Angels
Invest much less money than VCs
USD10,000 to USD250,000
Happy to exit in a few years with a 3-5X return
In the 50s and 60s
prior successful entrepreneurs or senior executives
allocate around 5-10% for angel investing
has experience and inclination to be great mentors and valuable directors
Companies with angel only money tend to exit at year 4 on the average
Drivers of acquisition
trend has been dramatic shift towards earlier exits
huge amounts of cash on balance sheets of large corporation
growth in Private equity and buy out funds
Insights on Growth
The first USD10 to USD20 million valuation are the easiest and less challenge on the skills of the CEO
It is easy for young companies to maintain year on year compound annual growth rates of 100% or even 200%
Knowledge of how hard it is to be a CEO and lots of money in the bank is usually a huge deterrent for serial entrepreneurship.
VCs replace CEOs of 75% of companies within 18 months of their initial investments
Founder’s shares get trapped in an illiquid private company for another 5-10 years
Use a 2 year time horizon
year 1 develop technology
year 2 develop distribution
On valuation
A lot of factors that have the biggest impact on a company’s short term value fluctuation will be out of management’s control
The factors will also be unforeseen
General valuation multiples
SAAS companies are typically valued at 3-4 RR
Service body shops 0.5 of per staff revenue or PE ratio of 3-4
On sales process
Typically 4-5 months
CEOs must focus on the business to ensure metrics are at their best during the sales to maximize valuation
can add up to 10-20% more valuation
Until the very last phase of the sales, it is best to delegate the sales process to a professional
Business broker or M&A advisor – use them as the bad guy
big firms shoot for exit above USD100million
2-3% of final value
boutique firms shoot for USD20-70 million
4-6% of final exit value
Related references
Evolution and revolution as organizations grow, Larry Greiner Harvard Business School
Raising money: The canadian guide to successful business financing, Douglas Gray and Brian Nattrass
High Anxiety or Great Expectations, Bart Schachter and George Hoyem, Venture Capital Journal
The successful investor is not very different from an investigative journalist or a crime detective
Most useful data are public.
The only difference between the successful investor and a mediocre one is the amount of work he is willing to dedicate towards validating all the key assumptions.
Investment relationships team of all public companies are very willing and helpful with providing information.
More qualitative data can be obtained by calling up customers or ex-employees of competitors
Once you are able to reconstruct a company’s business model, you will be able to predict generally whether a company will make or miss earnings
Legacy technology companies tend to have a longer half life than expected. The key is to determine how much longer the half life is and if there are legal protections that will extend it.
Beyond the core functionality, it is important to go into the realms of human psychology (adrenaline and dopamine) to figure out the defensible strategy
Smaller funds are structured to incentivize playing to win (1%-2% carry) while bigger funds are structured to incentivize playing not to lose (expecting only returns matching LIBOR rate of 2.5%) . The difference in mind set results in very different strategies.
Related References
Knee jerk oversell on news of new entrant into market
Tweet was posted in May 5th 2019 where Chinese import tax hike to 25% from 10% was proposed.
Immediate negative effects were most prominent on Hong Kong and Straits Times stock index. An observed 4.5% drop.
Immediate effects were negligible on the Shanghai index as bad news seems like it was already factored a few days prior to the tweet. An observed 6% drop prior to the tweet.
Effects on the SnP was negligible. An observed 0.45% drop. The London Stock exchange (FTSE) seems to be humming to its own rhythm.
