Cryptocurrencies: Imagine you know with absolute certainty what is going to happen in the future.
“Give the people contests they win by remembering the words to more popular songs or the names of state capitals, or how much corn Iowa grew last year. Cram them full of noncombustible data, chock them so full of ‘facts’ they feel stuffed, but absolutely ‘brilliant’ with information. Then they’ll feel they’re thinking; they’ll get a sense of motion without moving. Remember, the firemen are rarely necessary. The public itself stopped reading of its own accord.”
— Ray Bradbury (1953): Fahrenheit 451
Brave New World
Imagine a world where people watch excessive amounts of television, a world with wall-size television sets, and a world where people listen to music with “Seashell Radio” sets attached to their ears. Ray Bradbury did. It's the future he imagined in his 1953 novella Fahrenheit 451.
Aldous Huxley wrote in Brave New World about the danger of giving the state control over new and powerful technologies. Huxley wrote of the ‘World State,’ the consumer society whose values on the surface appear heartless, or even savage, but instead are the mirror of society’s economic values. A world where happiness is defined at the level of your material prosperity.
Huxley’s Brave New World is full of people who do everything they can to avoid confronting the truth about their situation. A society controlled by the World State who promotes happiness above truth. The thing is, Huxley wrote Brave New World in 1931.
George Orwell’s 1984, written in 1949, is another novel about a future world controlled by an all-powerful state.
A world where the future Orwell described is ‘like a boot stamping on a human face forever.’
Orwell, Huxley, Bradbury, all describing a future that is looking more and more familiar. In Orwell’s world, control is maintained by constant government surveillance. Big brother is watching you.
In Huxley’s future, technology is used to control the masses. A society where everything you do is recorded, from your first breath until last.
And in Ray Bradbury’s Fahrenheit 451 the people are bombarded with non-stop 24 hour news filled with facts and trivia. A world where people feel smart but in truth have been pacified. A future where careful and controlled outflows of information are used to stop people thinking and challenging the system. A world of passive slavery. What better way to control a society than to make its citizens believe they are in control.
Buy a new iPhone, binge on Netflix after a hard day’s work, and spend your break and travel time checking out the news and social media. There, there. You’ll feel better soon.
What have these three classic dystopian novels got to do with cryptocurrencies?
Imagine for a second that you know with absolute certainty what is going happen in the next twenty-four hours. Imagine you could see into the future, but only the next twenty-four hours. Think of it as getting tomorrow’s newspaper today.
How would you use this power?
Biff Tannen, in ‘Back to the Future’ stole Gray’s Sports Almanac — the year 2000 edition, from Marty McFly. A complete sports compendium from 1950 to the year 2000.
Priceless in 1955.
At first, Biff would do ok, but as his bank balance grows, the limits on his bet size would restrict the future growth of his wealth.
Armed with the Almanac, Biff could become the wealthiest man in the world, if he used the knowledge wisely. He’d have to make losses as well as winning bets and gradually make his fortune. No bookmaker would be able to pay out an all-in bet, and even if they did he’d guarantee no bookie would do business with him again. Unless, of course, the bet size was ridiculously small.
Biff would be limited to betting on individual events. And because, as we know, Biff is not that smart; he’d be unable to build a bigger picture out of the sports data he had.
Building an accurate picture of the future is a skill very few people possess, but among those who do are some of the greats in investing and speculating.
If you can develop the skills to assign a probability to future trends, you’ll be able to lengthen your investing time horizon.
If you’re not looking at fundamental data or observing shifts in human behaviour; then, you’re limited to trading with technical charts over much shorter periods of time.
In the early 1990’s Faith Popcorn published ‘The Popcorn Report,’ where she talked about her societal observations and how they were connected. In the book, Popcorn spoke about the trends most likely to dominate in the following ten to twenty years.
In 1992, she talked about cocooning. A phenomenon where people would spend more of their leisure time inside the protection of their home. She wrote about ‘Info Buying’ and ‘Screen Mail’; impressive since this was two years before the home computer boom of 1994-5. A boom driven by the newest fad in town — the world wide web.
Travel to Australia in 1985, and home entertainment meant, if you were lucky, a 14-inch colour portable with a coat hanger jammed down the back. Fast forward to today, and home design in Australia is superb. Complete, of course, with entertainment room.
Look at the reviews Popcorn gets on Amazon. Some people, just don’t get it. Figuring out the future is not about getting the small details exactly right. It’s about the big picture.
What if you could use your thought processes to build up a picture of the trends most likely to dominate in the next twenty years. You’ll be wildly wrong with some of your predictions, but you don’t need to be 100% correct.
Go back to 1995. What would you do with this information?
A group of young computer software engineers had just started a business. They were a brain tank. Seven guys: five Ph.D.’s, an MSc and a lowly post-grad. They were giving a talk, a debate, about their vision for the future of computing.
One guy stood up and started with…
What if the computer of tomorrow was held in your hand? A device you took with you everywhere. What if the programs were colourful icons, like jelly beans you clicked with your finger? And what if they were everywhere. Inside the bus, even on the side of the bus, at work, at play. Everywhere.
And what if companies that sold similar products but needed advertising to differentiate and promote their brand used this portable device to advertise. An entirely new way of being social, and at the same time being entertained. All driven by advertising.
But what’s coming next?
If you can guesstimate the likelihood of future trends by observing what is happening in society; then, you’ll own something as valuable as Biff’s Almanac.
The most successful investors and speculators, like Warren Buffet, Charlie Munger, and George Soros, spend much of their time estimating if the geopolitical and financial environment will support their investing ideas.
The 5% club use tools like the trilemma to ask questions about the market as discussed in Games without Frontiers. Tools like the trilemma are used to give you an indication of the trends most likely to dominate over the long term.
If you can figure out the most likely shifts in society, then you can use your observations of actual market behaviour and trend and adjust your expectations as the market gives you new information feedback.
If market behaviour matches your expected long-term view, then each data point that supports your hypothesis builds on the last allowing you to build up a big picture overview of complex markets.
Getting on trend will help you trade the right market at the right time.
After that, it’s about the price of entry measured against risk.
Rise of the Machine
The latest financial market research suggests that instead of following a random walk, where each event in a market is treated as an independent event like the throw of a dice, markets change state between random and non-random. Sometimes markets have a memory just like the game of blackjack.
The 5% club attempt to find when markets transition from random to less random, within the context of larger multi-year trends.
By asking what the probability of an event given the evidence of previous events is, you’re using a technique called Bayesian analysis.
Bayesian analysis is one method used by the 5% club to put a number on risk.
Here’s a simplified version.
Use an initial belief probability before you have any results. = P(H)
Assign the probability of seeing the conditions given the market is in an accumulation phase. = P(D|H)
Assign a probability of seeing the conditions given the market is NOT in an accumulation phase. = P(D|H1)
(NOTE The values in step 2 and 3 do not have to add up to 1)
Here’s the formula with some assumed values.
P(H) = 50%
P(D|H) = 95%
P(D|H1) = 30%
Substitute into the formula, and you get an initial probability of 76% that the market is in an accumulation phase.
For your next assumption, you can use the same formula using 76% as the value in step one and adjusting your values of steps two and three as new market information is generated.
When you speculate and invest in any financial market, including cryptocurrencies, you are up against some of the smartest people on the planet. Wall Street banks and hedge funds recruit the top minds in math and science. They hire from Ivy League colleges, and compared to you they have unlimited resources.
They can run positions for months without marking their losses to market. Do you think they’ll let you turn up with your technical charts and allow you to turn the market into your ATM cash machine with their money?
It’s possible to take your seat at the table but to do that you’re going to have to understand how to manage risk and how to build different positions depending on the current conditions of the market you are trading and speculating in.
Today most of the volume going through financial markets is driven by computers. The top brains recruited from the best schools are attracted to the financial industry because of the obvious rewards.
Today, when you enter into a market, you’re up against algorithms. Code that’s written and specially designed to extract profits from the markets by taking advantage of specific market setups.
In Deus-Ex, we talked about the big four market conditions algorithms are designed to trade: Arbitrage, trend following, volatility, and market making.
The difference between the Wall Street banks, hedge funds, and the 95%, is that the big banks and funds have specially designed their systems to sniff out opportunities. They hire data scientists and programmers to build and implement their computer powered investment strategies.
How much money are they spending? Put it this way. This year, in 2018, the amount of money managed by quant-based funds is set to break $1 trillion.
Since 2011, New York-based funds have been turning away from traditional trading methods and metamorphosing into quant driven businesses. The amount of money the New York quant funds manage has increased by 733% in the last six years.
Contrast this to the 95% who purchase automated trading systems and have no idea how they work or when the underlying market conditions have changed.
It's why finding an edge and managing risk is so important. How can you compete against organisations who recruit the best programmers and scientists on the planet, and who spend billions of dollars to develop systems that push the boundaries of computer power and trade execution speed?
Box of Scraps
Inventor Cractacus Potts retreats into his garage (cave) and rebuilds a magic car. Cractacus builds a vehicle, an object of beauty, out of nothing but scrap. A vehicle to win the heart of his girl, and the love of his children. Transport to his true destiny. To be born again.
Inventor Tony Stark is captured and is forced into a cave, (a real one) and builds a magic suit and a new heart. (A miniature arc reactor) Powered by his new ‘heart’ — An object of beauty created from an object of evil and nothing but scrap — Tony uses his magic suit to break free. Transport to his new destiny. To be born again.
Cractacus builds his magic car. Chitty Chitty Bang Bang. It’s the start of a new life. A great adventure. An adventure where he saves himself, his children, and the love of his life.
Tony builds his magic suit. The Ironman suit. It’s the start of a new life. A great adventure. An adventure where he saves himself, his children (humanity) and the love of his life.
Same story retold.
In the movie Ironman, Obadiah Stane steals Tony Stark’s new heart and magic suit and recruits his best engineers to copy it.
Frustrated through their lack of success, and fed up with their excuses Obadiah confronts his chief engineer. Moving in close and inches from his engineers face, Obadiah shouts, “Tony Stark was able to build this in a cave with a box of scraps.”
The engineer lifts his arms, “Well I’m sorry. I’m not Tony Stark.”
Financial markets are dominated by big players with (compared to you) unlimited resources.
How can you compete?
You have one advantage compared to Wall Street and hedge funds. You don’t have hundreds of millions of dollars to put to work. They do. You don’t.
If the big players think a market is going up, they can’t just buy it. If they did, they would put the price up on themselves. The market, especially the cryptocurrency market wouldn’t be able to absorb the huge buy orders. Remember prices go up because of an imbalance of buy orders to sell orders.
They have to build positions. And they do that by disguising their activities. Their tactics include executing large sell orders when they are looking to buy. If, after they execute a large sell order, the order gets filled quickly, they know there is new demand or buying present in the market. But if prices gap down or go down with little resistance, then the big players know there is no demand in the market and that the price should fall.
They drive prices down with sell orders to flush out the 95% weak hands. The tell-tale sign of the 95% abandoning reason and flipping into emotion mode is the appearance of an emotion bar.
The big player's place buy orders to test overhead supply, and they place sell orders to test new demand. This is the cause of the price cycle.
When the big players have accumulated their full position, they gently give the market a nudge by placing buy orders to ignite a new trend. If you see a wide range up bar breaking previous accumulation highs on very high volume, it’s a market ‘tell’ the big players are fully positioned for a new trend.
All they need to do now is light the match, and as prices rise the big players start taking their profits. During the trend, they offload their positions for a profit to the 95%, who are buying on hype and media news.
Some readers might be thinking this isn’t legal. It is. Or, that it isn’t fair. It isn’t.
But this is the reality. Being aware of this behaviour puts you ahead of most traders and investors.
What’s your story? Most traders and investors never change. Their behaviour is the same, generation after generation. In 2018, the US stock market has been going up for nine years. Eventually, it will end. The way it always does, with the masses, the 95%, caught on the wrong side.
The big players will be out. Their profits realised.
The 5% club, understand the activity of big Wall Street investment banks and hedge funds. They are aware of how markets move and don’t listen to news or tips from gurus for guidance.
The 5% club can compete with the big players because they have built something beautiful from a box of scraps. They’ve worked hard to understand the market, and they’ve used their imagination to create tools, that, while not being as sophisticated as the big banks and funds, get the job done.
And that’s what you need to do to compete with the big players in the new quant driven markets.
Using free or readily available information, a box of scraps, the 5% club build tools that obey the power law. Tools that give them the information they need to read the actions of the big players and the reactions of the 95%.
But it’s not enough to be shown. If you want 5% club membership, you’ll have to do the work. Like Cractacus Potts and Tony Stark, you’ll need to retreat into your cave and build something from a box of scraps.
Think Like DaVinci
What have a needle and jelly got in common?
The 5% use their imagination to build tools they own and trust. They assign probabilities to observations about the world around them, and they monitor and update their beliefs as new information becomes available.
In this series, we’ve discussed how the most successful and consistent speculators, traders, and investors approach the markets.
Guns and Butter covers government control, currency manipulation, and confiscation.
Games without Frontiers discusses geopolitical environments and the free tool you can use to assess the likelihood of future trends.
Puppet on a String covers the dangers of groupthink and how your inbuilt biases, useful in most areas of your life, can blow up in your face if you use them unchecked in financial markets. Puppet on a String talks about shifting your mindset away from unbooked future profit and towards risk.
The Hidden Hand discusses how human biases lead to bubbles and crashes and why the majority are almost always wrong.
Electronic Cocaine extends the conversation about built-in biases and introduces the price cycle. In Electronic Cocaine we talk about the dangers of waiting until everything looks good and safe before making a trade decision, and why, paradoxically, when the only way is up the opposite is most likely to be true.
Chariots of the Gods introduces the MIT blackjack team and the concept of building edges based on the observation of conditions.
Shapeshifter goes into how human built-in pattern recognition that saved us in our primitive past acts against us in financial markets. Shapeshifter introduces the random and non-random behaviour of markets and introduces expectancy to show how your biases drive your decision making.
Revolver goes deeper into expectancy and shows how the 5% club use it as a filter to exclude low probability decisions. Revolver discusses why it’s not how often you win that matters, and instead talks about the advantages of using expectancy as the metric to measure your performance.
Thinking in Threes covers the benefits of having three good reasons before you take action and the benefits of observing three market characteristics and grouping them to form a Plus-One day — a day named after a Plus-One card used by the MIT blackjack team.
Escape Velocity looks at the level of trust you have in your decision making. It discusses who makes the rules and asks if the accepted market dogma is true or false.
The 4th Dimension is about giving up control and trusting your analysis, and introduces the 4th dimension of financial markets — fear. The 4th Dimension covers the tools you can use to gauge the level of fear in any market and how you can use this information to your advantage.
Heatseeker focuses on using your head and not your heart to make trading decisions. Heatseeker contrasts the tools used by the 95%, against those used by the 5%, and talks about embracing simplicity over complexity. Heatseeker discusses another tool used by the 5% club to assess the likelihood of a condition being true.
China Crisis is about the power of guesstimating, and goes deeper into the art of asking the right questions. China Crisis shows how asking questions can help you build an edge.
Event Horizon is about being efficient. It’s about being patient and finding the highest probability setups. The 5% club are efficient; they don’t jump around trying to find opportunities, unlike the 95%, who hop from trade to trade. Event Horizon is also about trading with a point of reference, and why having a point of reference separates the 5% from the 95% by allowing the 5% to use efficient money management and position sizing.
Deus-Ex talks about what the 95% do to try and become consistent. Deus-Ex is about the mistakes the 95% make when they embrace complexity instead of simplicity.
Close Quarter covers the concept of value and compares the difference between investing in an idea before and after the idea is available to the general public. Close Quarter talks about the tools used to analyse the price and value of an investment idea.
Machine Gun Preacher discusses the catalysts behind jumps in technical advancement and about the motivations behind the technology of the modern world. Machine Gun Preacher also covers the importance of context. The 95% trade the same system all the time. The 5% adjust their trade expectations and risk management depending on where a market is trading within the price cycle.
Ignitus, this article is about using your observations to assess the likelihood of longer-term societal trends. The 5% use simple non-complex tools to evaluate the probability of both long and short-term trends. Ignitus talks about the rise of quant-based trading algorithms and how you can compete with them by using simple non-complex tools.
The 95% trade with no edge and no imagination. They don’t understand expectancy, and they’re always trying to win. The 5%, in contrast, trade using simple tools they understand. The 5% don’t focus on win rate; they concentrate on expectancy. They know you can win 80% of the time and still go broke because your wins are small and losses big.
This article started by quoting from Fahrenheit 451, one of three classic dystopian novels, the others being A Brave New World and 1984.
Fahrenheit 451 describes a world where the public have stopped reading. They watch wall-sized television sets and are dumbed down by constant news and trivia. 1984 is a future controlled by an all-powerful state that uses fear as a weapon of control. A Brave New World is about a future where the public is controlled by technology. A world where everything you do is recorded. From your first breath to your last.
The 5% use their imagination, and although these books are fiction, it’s clear, that in 2018, society is leaning towards a future described in these books. The 5% use simple references and heuristics to ask the right questions.
If they are correct in their assumptions, then they have uncovered a long-term edge.
The 5% think like DaVinci. Earlier we asked the question: What has a needle and jelly got in common? Stupid question? Maybe. But why not start with this; they are both smooth, and water runs off both surfaces.
The 5% club assign probabilities to outcomes. They start by asking the stupid questions and build from there. The 95% think it’s a waste of time and listen instead to someone else’s opinion.
The 5% wait for the probabilities to shift in their favour. They recognise the point of ignition. The moments in time when the market changes state.
Are they always right? Of course not. But by using two systems, the first to gauge the likelihood of a long-term trend or condition, and the second to estimate the likelihood of a market’s current location within the price cycle helps give them an edge.
The 5% dare to venture outside of Plato’s cave and see the cause of the shadows on the wall.