BijaAdvisors

Seeds of Thought

Better Decisions, Better Results

Cognitive Science Meets Investment Management

Issue 15-32
August 24, 2015

Deep Breath Review

Investment management is fundamentally a mental game. Equanimity is defined as mental calmness,
composure, and evenness of temper, especially in a difficult situation. Achieving equanimity in
moments like these increases your odds of seeing things clearly and objectively. While just about
everything else hitting your Inbox in these moments is designed to speed up your thought process, Im
going to try to slow it down. I will attempt to do so by reminding you of relevant topics weve discussed
in quieter moments, when your mind wasnt so agitated, followed by some updated charts and thoughts,
as well as the rationale for taking profit today on SAR1, the trade that went out to Bijas subscribers last
Thursday.
from Seeds of Thought (Issue 15-30, August 16, 2015)
Until now, you could have selected just about any currency to express a bullish dollar view and
done very well. What Im suggesting here is that going forward, you may not be so lucky. Its
very possible that currencies like EUR, CAD, AUD and the others that CBs use to diversify their
reserves may not perform nearly as well (here, "well" means poorly against the U.S. dollar) as
they have been. There are a couple of ways to take advantage of this.
The most obvious is to express the view directly via low yielding, temperate emerging markets
against the dollar. If you believe as I do, that the global slowdown story is playing out in stages,
then stage 1 was mostly about the bottom of the supply chain; raw materials and commodities,
which is why the tropical emerging markets were hit so hard. The shift lower in the cost of inputs
did wonders for the trade balances of the temperate emerging markets; primarily those that
import raw materials and export finished goods. Stage 2 may still be in its early days, as faltering
global growth begins to show itself through reduced demand for those finished goods, resulting
in exports slumping more in line with imports for those temperate emerging markets, like China.
If that's the case, we may see a dramatic reversal in the record trade surpluses we've witnessed
lately. Of course, that will filter down to the tropics as well through another round of reduced
demand for commodities, so tropical emerging markets may not be out of the woods yet, but
going forward, shorting temperate emerging markets may be a good bet for playing catch up.
Going back to the impact on EUR, an interesting way to express that idea would be via options
using the same EM currencies, but against the EUR, thereby allowing you to take advantage of
the lower cross vols that are the result of the high correlation between EUR and EM until now.
Theres also a possible additional bonus that comes with expressing the view this way. If, as I
believe, the US economy begins showing its own flaws, similar to those seen in just about every
other country in the entire world, thereby altering the expectations for Fed moves and US interest
!
Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-32

rates going forward, EUR vs EM should not only keep up with USD vs EM, but perhaps
significantly outperform.
from Seeds of Thought (Issue 15-20, April 17, 2015)
As you know, I dont buy into the idea that the US economy is somehow different from the rest
of the world. Weve seen other episodes since the financial crisis when investors (and
policymakers) were lulled into thinking that one country or another was uniquely positioned visa-vis the global economy, only to have the data come back in line, and the rate differentials and
currency snap back as a result. According to the data, I believe its time to position for a
potentially dramatic reversal in EUR/USD. When the same setup occurred in October 2010,
EUR/USD experienced a 26% reversal over the next 10 months. Given the macro fundamentals,
it isnt surprising that the expected reversal of Q1s disappointing results isnt materializing, even
with the positive shock offered by the collapse in energy prices. The US economy is not immune
and at some point, discussion around the Fed will shift back from when to if, and with it the
interest rate differentials and exchange rate should follow.
from Seeds of Thought (Issue 14-2, October 16, 2014)
Woods Shock refers to a state of confusion that can beset people in the wilderness. None of the
rational abilities that the victim had before being lost are useful to him anymore. In severe cases,
the actions of even the most experienced outdoorsmen can seem inexplicable. Hikers have
abandoned full backpacks; hunters have left their guns behind. Killip neglected to make fire or
shelter. But in the light of recent advances in neuroscience, woods shock can now be seen as an
emotional survival response associated with the failure of the mental map to match the
environment. Thrashing does not save a drowning person either, but its just as natural. Those
who can float quietly have a better chance. - from Deep Survival: Who Lives, Who Dies and
Why by Laurence Gonzales
Stock car racer, Dale Earnhardt Sr was known as The Intimidator to his competitors and fans.
He earned that reputation because he rarely got flustered. In the heat of a race, with cars trading
paint at close to 200 miles an hour, when everyone elses minds were racing, Dale was cool and
calm. In fact, it wasnt unusual for Dale to doze off while waiting to start the race or during a red
flag. Like Neo in the Matrix, his ability to slow things down, including his own heart rate,
allowed him to see the field more clearly than his competition. The result was 76 victories and 7
Cup Championships; tied for the most of all time.
Having traded emerging markets since 1994, Ive seen my share of ugly markets. What Ive
noticed is that when liquidity drops, volatility picks up and uncertainty abounds, traders and
analysts tend to speed up their thought process, often compounding their problems or turning
opportunity into calamity. Much like an auto race at 200 miles per hour, it is those who can stay
calm and rational, who can see the field clearly, who tend to profit from the situation. I thought I
would share a few things that go through my mind at moments like this, things that have proven
helpful for me in these situations.

What was the precise trigger for the move? You can always come up with a reason, but if you
are reaching to draw a conclusion, be careful about jumping on it.
Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-32

If the move is coincident with your underlying view, but wasnt specifically triggered by it,
consider taking profit, saying thanks very much and waiting for another opportunity to get
involved. Fear of missing the big opportunity, especially if youve been calling for it, can
inflict great psychological pain, affecting your trading for some time to come; particularly
that moment when your prediction actually does come true.

Markets driven purely by illiquidity, are typically illiquid in both directions, so be careful
about using naked risk reversals. They are cheap for a reason.

Vol spikes tend to be short lived. Front dates spike faster and come down faster. If youre
sure this is the big one, consider back dates. If youre wrong, theyll probably give you time
to cut your losses without as much pain.

Be wary of using FVAs (Forward Vol Agreements) to bet on a spike in implied vols. If what
you think is going to happen, does, the inversion of the curve will likely eat up much of what
you were hoping to capture.

Take a step back. Pull those charts back. See if we are teetering on the edge of a multi-year
level or just in the middle of a range.

Very often, what markets like these can offer is lots of low hanging fruit, where you can
structure for a number of different outcomes, with favorable odds, but you have to be willing
to look in the places everyone else is ignoring.

Current Thinking
I continue to believe in expressing the above views via EUR, however if youre a tactical trader the
Bollinger Band / RSI combo suggests you will likely have better entry levels before we reach the
ultimate goal.
I am looking at option strategies to begin getting long US equities again.
Although SAR1 has not hit any Reassessment Trigger, the primary reason for initiating the position was
for vols to catch up to the move in forwards. I thought we wouldnt see that happen without another big
spike in the forwards, but it did. Therefore, after 4 days in the trade, I am taking profit on the position
today. Although a move in vols from 1.25 to 2.6 may not seem like a lot, because this position was vega
intensive on a pair with very low implieds, and sized to reflect a combination of high conviction and the
anticipation of very low interim p&l volatility, it didnt require a huge move to generate outsized returns
(5.4% to the portfolio).
Here are a few of the charts that originally accompanied the above excerpts, but updated to reflect the
current moves.

Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com

Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-32

The US/EU Surprise Index made up a significant amount of ground since it was used as a reason to get
long EUR/USD back in April, but as the chart shows, it stills has plenty of room to go. (White line in the
chart below.)

Although EUR/USD has jumped more than 10% since I recommended positioning for a potentially
dramatic reversal back in April, I believe theres plenty more room for it to run before its over.

About the Author

For nearly three decades, Stephen Duneier has applied cognitive science to investment and business
management. The result has been 20.3% average annualized returns with near zero correlation to any
major index, the development of a billion dollar hedge fund, the turnaround of numerous institutional
trading businesses and career best returns for experienced portfolio managers who have adopted his
methodologies.
Mr. Duneier teaches Decision Analysis in the College of Engineering at the University of California
Santa Barbara.
Through Bija Advisors' publications and consulting practice, he helps portfolio managers and business
leaders improve performance by applying proven decision-making skills to their own processes.
Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document

Bija Advisors Seeds of Thought

Issue No. 15-32

As a speaker, Stephen has delivered informative and inspirational talks to audiences around the world
for more than 20 years on topics including global macro economic themes, how cognitive science can
improve performance and the keys to living a more deliberate life. Each is delivered via highly
entertaining stories that inevitably lead to further conversation, and ultimately, better results.
Stephen Duneier was formerly Global Head of Currency Option Trading at Bank of America and
Managing Director of Emerging Markets at AIG International. His artwork has been featured in
international publications and on television programs around the world, and is represented by the world
renowned gallery, Sullivan Goss. He received his master's degree in finance and economics from New
York University's Stern School of Business.

Bija Advisors LLC

Web: BijaAdvisorsLLC.com
Email: info@bijaadvisorsllc.com
Twitter: @BijaSeeds
Podcast RSS: BijaSeeds
LinkedIn: Duneier
Phone: 805.452.9429

In publishing research, Bija Advisors LLC is not soliciting any action based upon it. Bija Advisors LLCs publications contain material based upon publicly
available information, obtained from sources that we consider reliable. However, Bija Advisors LLC does not represent that it is accurate and it should not be
relied on as such. Opinions expressed are current opinions as of the date appearing on Bija Advisors LLCs publications only. All forecasts and statements
about the future, even if presented as fact, should be treated as judgments, and neither Bija Advisors LLC nor its partners can be held responsible for any
failure of those judgments to prove accurate. It should be assumed that, from time to time, Bija Advisors LLC and its partners will hold investments in
securities and other positions, in equity, bond, currency and commodities markets, from which they will benefit if the forecasts and judgments about the
future presented in this document do prove to be accurate. Bija Advisors LLC is not liable for any loss or damage resulting from the use of its product.
Copyright 2015 by Bija Advisors LLC.; BijaAdvisorsLLC.com
Reproduction or retransmission in any form, without written permission, is a violation of Federal Statute
Important disclosures appear at the back of this document