Monday, July 25, 2016

Survivalship in a world of dis-information: information, signals and noise (part 2) - How I made money with Brexit

In the previous post, we have seen that we live in a world that, they say, is bombing us with information. To me this assertion is deadly wrong. We live in a world which is bombing us with noise and biased information.
Among the others, the problem with this so-called  information is that this so-called information is quite often copied and pasted from one newspaper/TV news to another, hundreds of times. So the source is mostly the same, typically it is an institutional source, from a government's spokesman, and the outcome is that information is unavoidably biased and amplified at every stage of replication: you look at the event of the notice always from the same angle, super shiny. If there is a blind spot, you cannot see it.

Plus, the information we are getting is so overwhelming that, as a matter or fact, becomes useless: what kind of useful decisions can we take if we do not understand the root causes behind events and we have no time for thinking in a clear and unbiased way?

So, are we really talking about information, or about noise? Are we dealing with useful signals, or with glitches, spikes?

We have to be clear about what information is, and what is not.

There is an engineering branch, called information theory, which is extremely important and, to me, fascinating. It is not so trendy as microprocessors and fiber optics.  Yet, bear in mind that the personal computer, the mobile phones, the internet are based on the theories developed in the '40s by the founders of the information theory. These theories are high abstract and mathematical models which paved the way for the revolution of the digital media and the fall of the analog systems.
You can find all the details about its founders, types like Shannon, Hartley, Nyquist on internet. Shannon is the pillar.

Coming back to our original question, what is information for our purposes, within the scope of this blog? Information is whatever proves to be useful to take your decisions.

In information theory, the concept of information is strictly tied to the concept of the likelihood of an event to occur. If a remote event occurs, the information is very valuable. On the contrary, if an event is expected to happen with high probability, the information it brings is poor.

It is a (philosophical?) point that is very important to understand. Information is not only the news that you learn about an event that has occurred. This is a news. Information is linked to the expectation you had if that event would occurr or wouldn't. The less likely the event to occur, the most important the information content.

Let's make a real example: Brexit.

Brexit was mostly unexpected. The news carried out by the outcome of the referendum fetched a huge information content. It was a huge information content because it was highly unexpected. And, since the information it brought was important, the effects were immense.

NOTE: for geeks, if we consider I as information, and p(E), the likelihood p of an event E to occur, we can say  that

I ~  1/p(E)

where the symbol ~ means "proportional to". So if the likelihood of an event E to occur is remote, the associated information content is high. 

Information is always conveyed through a signal. That is, a signal is the carrier of the information. In the case of Brexit, the signal was the outcome of the referendum poll.
So, signal and information cannot exist without each other and they are often used interchangeably.
Anyway, there is a distinction. A signal always, ALWAYS, carries noise, which hides the true information. In electronics, noise is simply an unintended electric quantity that superimposes or modifies or distorts the useful signal. Useful signal is another term for "correct information".

A corollary, ie an immediate consequence of this definition of information, is that most of the news we listen on the radio, watch over the internet, does not bring information, but noise. They are completely useless to help us take the right decisions. They can flow so fast, their intensity can be so large, that we lose the real useful information hidden inside these signals.

Let's move back to the Brexit's example.

While giving the news, the opinion makers were repeating that old, uneducated (not to say boorish) people leaving in the suburbs or in god's forgotten lands had decided for the future of the young generations, driven by populist leaders like Nigel Farage.
Is this information? No, it is not.
The information was that there was a referendum, the outcome of the referendum was highly unexpected, and it created panic in those who were not ready for such a change.
Is the blame on old generations noise? yes it is. Why? well, let's just make the following observations:

1. if democracy is so valuable for young generations, why didn't young people go to vote on mass?
2. if young people are so attached to the euro-values, why did they consider not important to fight for these values putting a cross in a poll station? it was too much of an effort?
3. since young people are complaining that whatever they vote, nothing changes really (so the hype about "occupy Wall Street", Podemos, Movimento 5 Stelle), why did not they use a "people's tool", like a referendum, to change things?
4. if you are getting older and your future is detrimental, and all you can hear from the government is that if you vote against Europe you make a mistake without explaining the reasons why your conditions are worsening, what do you do? you protest to change those things that the policymakers have not been able to change until now. It is simple, straightforward. It is called vote of protest. Why are you so scared if you believe you are working in the right direction despite what old generations and unemployed people think? On the medium and long run, people will be better and nobody would vote for a Brexit.
5. People vote against something if something is not good for them. Did the old took away Erasmus from the young generations for the sake of spiting him or was there something else more important at stake?
6.  Are there any other points we missed in this question list?

This is an example of the use of LOGIC. It is bizarre that journalists that are supposed to have studied philosophy, of which logic is a branch, forget about how to implement what they used to study at the high school or at the college when they have to apply it to everyday life.
Well, actually, they did not learn how to apply logic: they simply passively learned what others had written.
Nevertheless: by using logic, you decrease the amount of noise and start seeing the right pattern. The problem with the correct use of logic is that it requires time, energy, memory and, above all, training.  The nice side is that it is a never-ending process.

NOTE: for geeks, the simplest form of applying logic with news is the equivalent of a low-pass filter in electronics or a moving average in a chart. You narrow down the fluctuations and look into the real pattern of data. The problem is "what do I measure to get the right information? what correlation analysis shall I perform? what regression analysis shall I run? what may be the links between two different events that occurred far away in space and time? what model validation do I need?", in other terms LOGIC is an active and self-learning and energy-consuming process, while low pass filters and moving averages are simple passive and low power demanding tools, like a google search with key terms. 

So, information is essential to drive you take the right decisions. Noise is whatever is superimposed to the correct information and drives you take the wrong decisions.

Now, in engineering the noise can have a stochastic (ie chaotic) nature or a deterministic (yet unknown) nature.

To adapt the engineering noise into real world news, we can think about the hype on Brexit as a  stochastic noise: you cannot foresee all the stupid things the policymaker and opinionmakers can say about the causes of the vote. Nevertheless, some newspaper will be left-wing biased, other right-wind biased: this deterministic approach is known and you may take it into account. You know that a populistic right-wind newspaper will mostly blame European bureaucrats in Brussels, and a left-wind populistic newspaper will blame their so called rightish populist leaders.
In order to train properly your logic, you have to demolish both positions as far as you can: what is left, is the real information, the real causes of the Brexit according to YOUR brain. 
When you understand the root causes, you can start taking advantage of the outcome, whatever it is.

I have made mine this famous quote by the English philosopher Herbert Spencer:

In other terms, I do not follow the attitude of the typical teacher who repeats like a parrot the concepts she has studied on textbooks without ever applying them to the REAL life.

The ultimate aim of knowledge is action.

In the case of Brexit, it was very simple to make money whatever the outcome would have been. I followed this approach.

1. If the Brits voted for the leave, this would have send a huge shock throughout the markets. So, Gold would have skyrocketed as a response to the collapse of the fiat money system.
2. If the Brits voted for the remain, this would have reinforced the EU leaders to go on with the austerity plan. The rage of the lower class would raise, because their protests would have been ignored so the risk of riots and protests in UK would ramp up. In this case, Eurozone would have breathed only a momentary sigh of relief, and gold would be constant, or slowly rising, due to presence of world spreading negative interest rates.

So, in any case, a bullish position in gold was a win-win strategy because this referendum was a lose-lose for Bruxelles and the European Central Bank. To get a risk-free leverage effect, the position was buying gold mining stocks. I did not use futures, nor other derivatives. If I had been British, I would have taken FURTHER profit by buying gold in Sterling two days before the vote, so taking advantage of the currency exchange.
1. Leave wins: sterling collapses, gold skyrockets in pounds, I sell the gold I bought in pounds and I kill two birds with one stone.
2. Remain wins: this was what markets were expecting, no information, so things would not change. I keep gold in view of lowering interest rates that kill people's savings.

And I made money due to this approach. I paid up my Summer holidays entirely. Correct information, logic-proof, and separation between noise and useful content were extremely important to take correct decisions.

It took me three years to get to this point from zero, while changing country, job, colleagues, and working as an engineer in aerospace companies, not as an economist immersed in the "right environments" or as an investor. And If I can do that, you can do that too. You have to change "vision" and exercise your logic constantly: not an easy task, but rewarding.

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