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Can you trade on rumors? One possible model

Posted on November 8, 2010 at 1:48 pm

In Tradestream, I spent a whole chapter looking under the covers of investing/trading strategies that focus on rumors.  Greater sentiment analysis (like the hubbub that erupted after Prof. Bollen published a paper on using twitter to predict stock market swings) is in early days but at its core is a desire to use news/chatter to better gauge future stock moves.  Bold and audacious, but not nearly there yet.

Rumors: A Model

In the book, I developed a model upon the one Cass Sunstein (co-author of Nudge and just a prolific writer/thinker) used in his most recent book, On Rumors: How Falsehoods Spread, Why we Believe Them, What Can Be Done.

Rumor transmission often involved the rational processing of information, in a way that leads people quite sensibly in light of their existing knowledge, to believe and spread falsehoods.  This problem is especially acute on the Internet — Cass Sunstein, “She Said What?  He Did That? Believing False Rumors,” Harvard Law School Public Law Working Paper No. 08-56 (November 2008), 2

Sunstein describes a useful framework with which to understand how rumors get started and how they get propagated — influencing decision making.

Sunstein describes the various actors in the social transmission of false information.  While he focuses on rumormongering, I try to apply this framework to investing.

  1. Propagators:
    1. self-interested, varying degrees: they may own a stock and work to discredit those who don’t like it or are short
    2. altruistic: sincerely interested in promoting some type of cause — these guys don’t even realize that they are spreading falsehoods
  2. Priors: success or failure of rumors depends on how closely they approximate the prior beliefs of those who hear them
    1. motivations: people don’t enjoy hearing bad things about ideas/people close to them and conversely, they are more open to receiving false info about something they dislike
    2. beliefs: Sunstein says that people who have strong prior beliefs usually do so because of what they know and therefore, require a lot of supporting information to upseat those beliefs
  3. Cascades: the mechanisms of rumor transmission, why/how/when people accept/reject a rumor is intimately connected to how the information affects their personal desires
    1. informational: groups of investors are led to accept a thesis in spite of individuals’ private info.  Think of all the hating that goes on on Yahoo Message Boards.
    2. reputational: people can be led to believe things in conflict with their priors but do so to curry favor with others.  This is equivalent to a fund manager on CNBC pumping his portfolio — as an expert — his status and street cred influence others’ beliefs (whether correct or not)

So, we have to narrow our focus down to why stocks move they way they do when unsubstantiated news — rumors — are floated.

Rumors and Preannouncement Trading

I chose to focus on rumors surrounding M&A announcements.  Many times, the Wall Street Journal will publish stories on unsubstantiated mergers and acquisitions.  Target stocks will jump and acquirer stocks drop.  That said, though, many of these rumored M&As fail to consummate.

“While sellers lose money when a rumor precedes an actual announcement, in most cases rumors fail to materialize into public announcements.” Rumors and Pre-Announcement Trading: Why Sell Target Stocks Before Acquisition Announcements?” (Gao, Oler)

Given the research of Gao and Oler:

On average, stock prices of rumored firms drift down to their pre-rumor level over a 70-day period after the initial price jump when a rumor is published and that only 12% of rumored takeovers materialize into actual announcements within 70 days.

So, really, Tradestreaming would be all about finding the right side of this strategy — where the numbers, data and probability is with the investor.  That would mean taking the other side of the trade.

The Antitakeover Strategy

  1. Research WSJ for reported but unsubstantiated M&A
  2. Remove all mega cap firms (<$20B)
  3. Short a basket of rumored acquisition targets and hold 70 days after the rumor first appeared.  You can hedge by going long the market if you like.
  4. Strategy performs even better during periods of increased M&A activity


The researchers found that this strategy would put up 4.2% in abnormal returns — when you further restrict the strategy to hot M&A years, profits go up to 12.7%.


  • Stock-bond correlation falling, bullish for stocks?

    Posted on November 22, 2010 at 11:42 am UTC

    Bloomberg out with a piece on the falling correlation between bonds and stocks.

    Pioneer Investments, Security Global Investors and Citigroup Inc. say the broken connection is bullish as the greatest number of S&P 500 companies in a decade post earnings growth. During the bull market from 2002 to 2007 when the S&P 500’s price and profits doubled, the correlation averaged 0.15, data compiled by Bloomberg show.

    The article believes that this change derives from a change in investor behavior — no longer are investors buying and selling based on macroeconomic factors but instead are returning to invest based upon profits and prospects.

    Could be — the truth though — like everything in life — is probably somewhere in the middle.  The story of a change in correlation here is probably more about the dislodging of the bond market than about a return to proper pricing of equities.

    Source: Greed beats fear with stock-bond correlation falling (Bloomberg)


  • Tradestream Radio now on iTunes

    Posted on November 19, 2010 at 4:07 pm UTC

    Following up on our first episode of Tradestream Radio published yesterday, you can now subscribe to us on iTunes here.

    Check it out and keep the suggestions coming.  We aim to make this the best investing podcast out there.


  • Tradestream Radio Episode 1

    Posted on November 17, 2010 at 11:38 am UTC

    This week’s Tradestreaming Radio is live.  I discuss


    Hi, this is Zack Miller, and you’re listening to Tradestreaming Radio. I’m the author of www.newrulesofinvesting.com and the author of the recent book Tradestream Your Way to Profits: Building a Killer Portfolio in the Age of Social Media. And, Tradestreaming Radio is our home in the internet radio space, and we hope to use this forum to expound upon some of our ideas and bring in some interesting people who have ideas of their own that I think you would find quite interesting.

    I, myself, am focused on sort of the intersection between online media and investing. And, my book, Tradestream Your Way to Profits, outlines eight strategies that call from my experiences as a business development person at Seeking Alpha, a hedge fund analyst, and now a independent asset advisor.

    So we can just jump right into it.

    So tradestreaming as a theory, as a philosophy is all about finding the most valuable information from the most valuable person with that information, making that available through social media. One of the strategies that I find most appealing from this vantage point is insider trading, right? So, tradestreaming is finding people who have a strategy that’s been proven to work either academically, or in practice, hopefully the marriage of the two.

    Insiders, we’re talking about corporate insiders now, have the ability and have the demonstrated ability to outperform markets over the long-term. And, I devote an entire section of my book, an entire chapter, to an insider trading strategy. It’s a two-tiered strategy, and I wrote about it recently on the blog, check it out there. But, I talked about the Muzea  model, a behavioral model. He was broker-sum-insider trading strategy guy named George Muzea, who wrote a book called The Vital Few vs. the Trivial Many: Invest with the Insiders, Not the Masses. And he attributes outperformance by insiders to a behavioral basis. So, he segments insider trading activity by looking at the behavior of insiders, and trying to get into their heads to better understand the rationale behind their trades.
    So therefore if you were going to implement a strategy based upon Muzea you’d want to focus on who is doing the trading, what Muzea calls value insiders, 70% of trades done by insiders with a long-term view of their firm.

    He also segments out catalytic insiders. These are corporate types not concerned with book value of their firm, but rather they see, you know, a temporary anomaly in the pricing of their stock and they may step in to buy or sell the stock.

    I found that there was another model, the Seyhun model. Nejat Seyhun is a professor of business at the University of Michigan. Wrote a book called Investment Intelligence from Insider Trading. He creates a bit more detailed model where he creates a hierarchy of insiders ranking in order of their access to higher quality tradable information.
    So starting at the top you have senior management, C-level executives who have their management finger on the pulse of their firms. Though they’re not allowed to trade on what’s called insider information, which would be, you know, private, or non-public information, that if made public would obviously affect the stock price. Definitely they have a view of their firm. You know, they see sales reports, they know about partnerships they’re working on. And, you know, they know better than anyone else the dynamics of their industry. They are quality players and when they step in and buy or sell their stock, particularly on the buy side, people should take notice.

    Then next down you have officers, employees of the firm, not senior enough to make senior decisions, but definitely affect the operating of the company as a whole. You have directors, people who sit on the board of directors but are outside of the firm. They have very little information, right? So, they’re sitting at quarterly board meetings, or something like that. They’re not actually part and parcel of the day in/day out inside of a company. And then you have large share holders, these are hedge fund guys, institutional types who own more than 10% of the stock.

    So the strategy here is, and you know, you can read the book for more information, but it’s to focus on active versus passive insider transactions. We want to focus more on the buy side. You know, particularly corporate insiders sell stock for all types of reasons, particularly in technology stocks. There’s options, you know, exercising all the time. And a lot of that is just noise. That’s people getting liquid. It’s diversifying out of their holdings. The research shows that on the buy side when somebody steps in with their own hard-earned money and decides to purchase their own company’s stock it’s a lot more indicative of future price movements.

    So, we want to focus on buys, not sells. We want to look at clustering and consensus. Insider trading activity is a much better indicator of future movement in stock price when multiple insiders are buying at the same time, called a clustering, without a conflicting trade, and that’s called consensus. We want to look for three or more insiders stepping in and all participating in buying or selling their stock as an indicator.

    This strategy works better looking at small caps. We want to mirror corporate insider buying, so less than a billion dollars is sort of the sweet spot for this strategy. We want to look for earning surprises. It’s a good idea to look for insider buying activity in firms that recently reported a positive earning surprise for some reason. You know, we’ll see insider buying as continued momentum play there. And bigger is better. Larger purchases are better signals than smaller ones. We want to look for purchases over 10,000 shares. Obviously, you know, how big the purchases will also depend upon the price of the stock. So, 10,000 shares in a stock that’s worth $1 is not necessarily a great signal, but in general that’s, we want to see a larger purchase. Obviously we want to see corporate insiders putting more money up to show more conviction.

    So in all these methods, all these methods improve returns. The three most important determinants of quality are, to repeat, top executives. We want to see the C-level executives buying. We want to see them buying in small firms, right? The fact that somebody at 3M is buying is a good thing, but not as good as somebody, you know, at a smaller micro cap. And, we want to see a big position. We want to see them stepping up.

    So, to quote a research report by Piotroski and Roulstone entitled Do Insider Trades Reflect Superior Knowledge About Future Cash Flow Realizations? They said we find strong evidence that insider trades are associated with the firm’s future earnings performance. Consistent with insider trading on the basis of both security misevaluation and private information about future cash flows. So, you know, obviously to do this it’s going to take some legwork, right? So, you know, I haven’t found a perfect system that mimics the Seyhun model. There are some premium sites that allow you to do such a thing.

    You know, you can actually theoretically do this through using the SEC database, or through Yahoo Finance, which is free. A site called J3SG, which is kind of a funny name, but it’s a good site that follows insider activity. They have a free version and a premium version. The premium version actually does a lot of this for you. There’s Guru Focus, which a lot of people use.

    A new blog, which I think is really helpful called Insider Monkey, which is following a lot of insider movements and expounding upon some of these theories that I’m talking about. Asif Suria has a site called SINLetter that actually does, you know, a rundown on insider buying and selling.  Finviz is a screener that can be used to screen for some of these types of stocks. Insider Cow and Old School Value insider buy screener, are some of the resources that I put up there. You can find that all on the blog. I would definitely check out that strategy, that’s the insider trading strategy.

    So, next up in Tradestreaming Radio for this week I wanted to focus on what we call ‘trend watch’. This is something that I’ve chosen that I think is interesting. I hope you find interesting. Today’s trend has to do with consolidation in sort of the second generator online broker platforms.

    Obviously, you know, we have two big players, well, three big players in the online broker space. We’ve got Ameritrade, Etrade, and Schwab. The reason I stumbled upon that is because Schwab, you know, I don’t think is a classic online broker. Obviously they do have online brokerage access.

    We’re seeing second generation platforms that emerged more recently begin to consolidate, and the first thing we saw last week is interactive brokers, it’s a platform that a lot of new investment advisors, registered investment advisors, RIAs, are building their portfolios on. They do a lot of this mirroring type thing where you can actually manage your portfolio and bring in managed accounts that are executed automatically when you make a change in the model portfolio.

    Interactive Brokers took over a 6% position in trade station. We saw Ameritrade enter this fray with the ThinkOrSwim purchase. I guess that’s probably about 18 or maybe 24 months ago already, and reportedly in the industry that was a great purchase on their behalf $600, $700 million. I don’t remember the exact number.

    And, now we’re seeing, you know, consolidation, or perhaps potential consolidation at the second generation brokers who really have built, you know, really powerful technology platforms. That’s what they are first and foremost. And they’re technology platforms that are attracting sort of the next generation investment advisor business. So, I’d keep your eye on that.

    Next up on Tradestreaming Radio is our deal watch. Just this week we’ve launched Tradestreaming Marketplace We’re going out and sourcing the best of breed financial/investing products, negotiating on our community’s behalf and offering really valued added deals.

    This week is what I like to call value investing in the sports betting marketplace. So, I like to tell the story about famed value investor Joel Greenblatt, who as you know probably as the author of The Little Book That Still Beats the Market. And, he’s the founder of The Magic Formula, which is posted returns of, you know, about 40% a year for 20 years. He explains his results when you ask him. It’s nothing more than a focus on what makes a good investment in the real world. And, he throws in a little sixth grade math to boot. In Greenblatt’s world this strategy extends to schooling. He’s also focused on turning around failing schools in the New York area, and he’s had great success with that.

    So the way I think of it is value investing can be applied to an educational model, it can be applied to anything. I’m an investor who uses valued based principles in my investing strategy and tradestreaming, in my book. Everything that  I’ve written about on my blog is about identifying and investing in low-risk/high-pay off targets. And, that’s what got me thinking about sports betting.

    I’m not a gambler at heart, for sure not, but I do believe the internet has opened up new markets that weren’t easily accessible before. We’ve seen examples in online Forex, obviously offline Forex is a huge market. It’s extremely easy now to open up an online Forex account and be able to trade currencies. We’ve seen peer to peer lending, the prosper.coms of this world. I wrote about this in my book as well. This has social value for sure, but it’s also an opportunity for enterprising investors.

    So, why would somebody bet on sports? There’s liquidity. You have marketplaces now where you can find bid and ask. There is some transparency. You can see sort of the, you know, price movements. You can get your hands on historical data, so you can build strategies that take advantage of this. It’s odds based success. So, just like investing, you know, you don’t have to be perfect 100% of the time, but if you can be more, you know, more than half the time right you can actually make money this way. There’s continuous pricing. And, what a lot of people like about it, and this is sort of the gambling aspect, is the instant gratification.

    So, I was drawn to a new book on the market written by Daniel Fabrizio. It’s called Sports Investing: Profiting from Point Spreads. The title was compelling, obviously, because you know all of a sudden, you know, instead of betting it was investing in sports. That’s not quite accurate, but you know, it sort of took it out of the gambling realm and turned it into something that’s more familiar to me.

    So, I like this book. It does a few things really well. It differentiates between investing and betting. It uses data to formulate some winning strategies, and a few of the strategies in the book are- one strategy is value, one’s contrarian, one’s momentum based.
    There’s details on how these strategies work with each of the major sports, so football, baseball, basketball, hockey. Sorry, no soccer. There’s a section on Monte Carlo analysis to advise how to manage your portfolio and position size, this is sort of the bank roll in sports betting lingo. And it explains how to lower vigorish, which is the equivalent to a spread in a stock. This is where sports books make their money, their commissions.
    It’s an introductory book. It’s very short. It’s not made for an advanced sports better, but for me, who’s a neophyte in this whole thing it was a good introduction, and gave me a little bit of meat to be able to go onto the next step.
    Fabrizio doesn’t just write books, he actually has a full blown sports betting platform. He’s not a marketplace, but he has a research tool called sportsinsights.com

    I took out a subscription there and basically all the theory that is, you know, elucidated in the book comes to life in Sports Insights. And Sports Insights was developed in part by a Quant from MIT. And, you know, in there you can get access to contrarian value strategies. There’s strong historical evidence to show that betting against popular opinion can be profitable, so obviously value investors know that. The same holds true in sports.
    There’s a momentum strategy. Some investors like to let the winners run. And, sports investors can find strategies, odds-based strategies, that work in that way.

    There’s also a fundamental analysis tool where you can rank a team, you know, based upon whatever is going on, you know, in that team itself, or in an individual player himself. And, just like you have in real life investing there’s special situations. So, you know, Sports Insights allows some betters to zero in on certain intangibles of the game, or the direct correlation of how two teams match up against one another.
    It’s not perfect, and Fabrizio is the first to tell you that, and he warns against, in general, using any platform that makes bold and audacious claims.

    I feel that having spent some time managing this system, it’s a great system, it’s a great way to get your feet wet in sports betting, particularly if you have the value investing bent. And, the deal is great. I mean, so we went out there, basically you get a $40 book, which is Sports Investing: Profiting from Point Spreads, Fabrizio’s book. You get six month premium access to Sports Insights, which is worth about $600. And, we’re putting together an exclusive webinar for anyone that purchases this package through Tradestreaming.com called The Three Secrets Investors Should Know to Make Money in Point Spreads. It’s going to be led by myself and by Dan, and it should be great.

    And, on top of this there really is no risk. So, again, you want to lower your risk whenever you make a purchase, whenever you’re investing in anything. There’s a 30 money-back guarantee. So, you’ve really upped your odds for success. Check it out on the site. We’re selling it for $399. You know, it’s about 40% off retail price. Check it out. Let us know, and join the Tradestreaming revolution. Thank you for listening, and I hope you will join us again next week.


  • CSFB Hedge Fund Strategy update

    Posted on November 16, 2010 at 10:36 am UTC

    CSFB just updated its hedge fund indexes for the end of month October, 2010.

    Benchmark Performance Summary

    Index Value Return
    Currency Oct 10 Sep 10 Oct 10 Sep 10 YTD
    Dow Jones Credit Suisse Hedge Fund Index USD 449.66 441.18 1.92% 3.43% 8.02%
    Convertible Arbitrage USD 358.04 351.09 1.98% 1.11% 9.64%
    Dedicated Short Bias USD 56.25 58.35 -3.60% -11.28% -15.64%
    Emerging Markets USD 378.65 370.46 2.21% 4.77% 10.10%
    Equity Market Neutral USD 234.53 232.36 0.93% 3.66% -0.03%
    Event Driven USD 515.25 506.16 1.80% 3.20% 8.22%
    Distressed USD 585.07 577.45 1.32% 2.07% 6.98%
    Multi-Strategy USD 485.48 475.17 2.17% 4.03% 9.10%
    Risk Arbitrage USD 321.81 323.82 -0.62% 2.31% 3.50%
    Fixed Income Arbitrage USD 235.87 233.30 1.10% 1.55% 11.00%
    Global Macro USD 722.14 710.64 1.62% 2.72% 11.10%
    Long/Short Equity USD 505.12 495.20 2.00% 5.09% 5.18%
    Managed Futures USD 294.74 282.62 4.29% 2.77% 11.00%
    Multi-Strategy USD 368.24 360.93 2.03% 2.79% 7.14%


  • Blowing up the fine print in financial product marketing

    Posted on November 9, 2010 at 1:45 pm UTC

    As a user of various financial products over the years, I sometimes wonder what it is I actually own (most of the time this occurs sometime after hitting some single malt before bed and sometime before day break).  I dunno — I read the labels on food that I ingest.  Just thought it might be interesting to know what’s in the mutual fund into which I invested all my life’s savings.  Just for kicks, you know?

    So, I decided to do a little sleuth work and *pull back the covers* on the disclaimer language on some of the most widely held financial products.  What I found written in Arial font size 6 might be a little surprising to owners of mutual funds and ETFs:

    Of course, past results are not at all, in any way, form, or fashion indicative of future performance.  No way and it doesn’t even matter that we have to say that.  We probably would anyway just to cover our own asses.  Anyway, in terms of performance, it’s really just a crapshoot.  Who wrote that Random Walk thingie again?  We’re not big fans of him (he’s probably an academic).  We don’t love Bogle either — he’s the one who tried to force us into buy and hold strategies.  Cramer’s more our speed, if you care.  We sell/market financial products that trade in a secondary market so we don’t really care all that much anyway how they perform.  As long as we grow our assets under management and provide liquidity to the products.  In fact, we’re not quite sure what to make of all the blogger research that shows that our ETFs don’t come close to tracking the indices they’re supposed to follow.  And those leveraged ones — the 2x, 3x, 4x, XXXs — who really understands how all those things work?  I mean, can you really use daily future rebalancing as part of a core strategy anyway??  Thankfully for us, it’s products like these that enable us to raise our management fees in an environment that continuously pushes fees down.  We had it good with mutual funds — whose stupid idea was to transition to lower-fee ETFs? By the way, if you really want performance, why not try just giving your money to one of those fancy hedge fund vehicles?  They seem to know what they’re doing, right?  Man, I’d like to be in their shoes.  Me?  I’d be David Tepper or maybe  Bill Ackman.  Yeah, Ackman.  With his build and that gray heirhair, he’s totally a baller investor. Also, you should know, that we don’t really believe all that new-fangled behavioral research that shows that for investors, our products are sort of like drugs in the hands of addicts.  In essence, there’s no way these people are going to make money in the market anyway.  So, why not provide a vehicle that purports to do as much.  Is that so bad?  Is it?

    Wow, who knew what was written in all that small print?

    photo courtesy of somegeekintn


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About Tradestreaming

Tradestreaming is a community of investors learning directly from experts. I’m Zack Miller, investor, entrepreneur, and founder of Tradestreaming.com and I literally wrote the book on how to invest in the age of Facebook and Twitter. Tradestreaming is the resource I’ve created to help me become a better investor.  I believe it will help you … Continue Reading