Confusion about risk

When asking many retailer investors what is a risk, their answers often refer to downside risk, which is about asset price falling. However, a risk is not merely about price falling, it is about the variance of price changes including both rises and falls. Therefore, not only during the bad time, also during a good time as well, the risk by definition is high since the changes are much more volatile than normal time. A stock is much riskier when the company is about to release its earnings report every quarter. Before a company's earnings report day, the probability of beating the estimate and the probability of failing to meet the estimate are equal, since the market has used available public information existing to price the stock, the stock price should be seen as a fair price at the point before the earnings report and could be treated as the mean. Once the earnings report is released, the stock price will adjust around the mean; because the adjustment could be very volatile, by definition, the risk at the point when the earnings report is release is significantly high.

On the other hand, if a stock price falls by 50% in one month due to the bad environment, many retail investors will say the market risk is great. The risk is definitely large, but it is not necessarily greater than earnings report releases during a good period. If there are 25 trading days in a month, the stock price only needs to fall by approximately 3% every trading day in order to fall by 50% in one month, so every trading day, it is about 3% change, and comparing with 10% (or even higher) change after earnings report releases, the variance is smaller and the risk is lower by definition.

To conclude, when experiencing a bad market environment, it does not mean we are facing a higher risk.

What is the implication of the recent stock market fall?

 On Monday, the US stock experienced the largest fall as the market was afraid the new Fed chairman would increase the rates. It implies that the US Fed definitely does not provide guidance for the market, as often before the Fed meetings, the market often volatiles more than average. In addition, from what we saw on Monday, the change in the US Fed's leadership shifts the market expectation about the future Fed's policy. However, such volatility that responds to the US Fed's possible policy is often a short term reaction that does not affect the market mean. Often the market is relatively more optimistic when the economic environment is good as when negative news hit the market, the market may fall and but bounce back, and when there is positive news, the market may rise and not fall afterwards. In addition, when the Fed officially announces its monetary policy, the market will definitely respond to the news. This gives even more solid evidence that the current monetary policy does not follow the guidance rule that the market does not know the monetary policy in the future.

When central banks do not follow the guidance rule, markets will be very sensitive to central banks' actions (but not behaviors), this adds more volatility to financial markets. Guidance allows the market to know what central banks will respond to markets, since central banks keep their promises and all actions are expected by the markets. Under such circumstance, the volatility in the market comes from people's expectations about central banks will be minimized. In the future, if central banks try to be more active, they will add more volatility to financial markets.

Let's talk about the space industry

Elon Musk's SpaceX successfully launched the Falcon Heavy rocket on Tuesday. Before SpaceX, launching rockets was often seen as something that had to be done by government; even nowadays, there are some critiques about SpaceX and its several launching failures (the failed deployment of a spy satellite on January 7th is the most recent one). SpaceX's success is huge that it shows there is a possibility for individuals to start space businesses.

Why did no one start their space businesses? This is in many people's mind, the space businesses including rocket launching are too risky. This is still true. Even though Elon Musk has significantly lowered the costs, the entry bar is still very high in this industry. Moreover, the probability of failure is relatively high that SpaceX is relatively experienced, but it still can fail to deploy satellites. More importantly, in this industry, if a company fails, it loses every single penny. However, with the help from the insurance industry, such risk could be reduced by buying insurance but the premium it has to pay is much higher than in other industries.

If Elon Musk's SpaceX can carry on, it sets an example for everyone else that this is a profitable sector with a bright future. His success may indicate in the space industry, the profits could overcome the costs and the risk taken by the companies. This could potentially encourage more companies to enter this industry. When more people work in this industry, there will be more innovations and what we can get from this industry may be something we never think of at the moment.

What possibly is able to determine the exchange rates between cybercurrencies?

 There are several types of cybercurrencies existing, the most well-known cybercurrency is Bitcoin. All these cybercurrencies are designed based on the same ideology. The exchange rates between fiat currencies are much easier to be determined. From the market prospect, the exchange rates between fiat currencies are determined by the Forex market demand and supply. Different fiat currencies are similar but have slightly different usages, though they are also designed based on the same ideology. The key difference between cybercurrency and fiat money is one is centralized and the other is decentralized. Because, fiat currencies are centralized, their values are different from the differences between different centres, such as their economic performances, government credit ratings and etc.; on the other hand, cyber currencies are decentralized, which means everyone is possible to mine cyber currencies, then this make it difficult differentiate different cybercurrencies in terms of their fundamental values. Though people may use their upper bound quantities to determine their value differences, the cyber currencies are almost homogenous currencies, their values are completely determined by the supply. When one cybercurrency's value increases, more people will mine this cybercurrency and increase the supply and lower its value. However, since we know cybercurrencies have upper bound quantities, if we are at the point where no more cybercurrencies can be mined, then the exchange rates across cybercurrencies are completely fixed. The exchange rates are completely fixed, what is the point to have so many different types of cybercurrencies?

Small investors and large investors

I think that a stock price represents the company's value and the accumulation of discounted future growth. Currently dividends seem not as important as previous that many companies do not pay dividends at all but still attract lots of investors to buy their shares, such as Apple (though it has started to pay dividends). Shareholders are the owners of their companies, the reason for shares having values is because shareholders expect they will get dividends from their companies or sell their shares at higher prices. Let's ignore the option of getting dividends, as many companies' dividend yields are only a bit better than bank saving rates, and investors are bearing a lot higher risk. Then investors' main purpose of buying shares is to sell their shares at higher prices. However, shares need actual functions to gain values. Shareholders can use their shares to influence the companies. However, small investors cannot have sufficient shares to make actual influence on the companies; in these ways, shares owned by them do not have functions. Of course, they can sell their shares to large investors and large investors buy shares from small investors and gain influence over the companies. However, there is a situation when large investors do not need small investors' shares. Such situation takes place when the company has only one large investor and the large investor has already gained sufficient shares to control the companies, then small investors' shares become useless so their shares would be valueless and the large investor have a plenty of ways to get profits from the company anyway. Therefore, the share price will be low and almost valueless under such circumstance. 

All have incentives to create bubbles

Sophisticated investors have perfect information about the market, they know the fundamental prices. Usually we think if they explore bubbles, they would hedge against the mis-pricing and bring the market prices to the fundamental prices. However, in reality, this is not the case. They have the incentives to further expand bubbles, and short the market prices at the point where the bubbles burst; this strategy will give these sophisticated investors the biggest profits. On the other hand, because of the existence of noise traders, when the bubble is very small, the sophisticated investors may have to wait every long to get their returns. When the time period is longer, the cost for shorting increases, and if they seek funding from individuals, their sponsors may be impatient and want to withdraw their money from the sophisticated investors.

However, such strategy is only profitable and relatively safe for large institutional investors. Institutional investors are more able to influence the market prices and are powerful to influence and affect the point where the market turns (although they do not have full control of it). For smaller investors, this strategy is very risky, because they do not know when the turn will occur. It is also not ideal for them to short the market if the market is above its real value either, the reason is explained above. So for small investors, their strategy that is profitable and less risky is to long the underpriced assets. And if they want to take some risk to get higher returns, they estimate the size of the bubble that is not likely to burst immediately and hold their assets till the market bubble size reaches their estimation, and sell their assets.

Property sales fall 20% in London

 Property sales in London fell 20% over the past four years. This might show some issues of Britain. Firstly, the population growth is slow and Britain is facing an aging population. Low population growth rate and aging population would decrease the demand for properties in the cities like London. Secondly, there are better alternatives to Britain. When a country has more migrants, the property sales will increase. Property sale drop may indicate Britain has been losing its attractiveness. This could be caused by the Brexit. This may also be caused by the weak economic growth. Trump is a president that is likely to bring things different to the US economy. However, the current Prime Minister is unlikely to shift the British economy from its current. This can be a good thing or a bad thing. Thirdly, other countries become more attractive, so fewer people come to Britain. More and more Chinese students who graduate from British universities find their jobs back in China, many of them believe there are more opportunities in China comparing with the UK. Fourthly, individuals in the UK, especially in cities like London, may find it better for them to rent instead of to buy their flats or houses. Fifthly, it is not a good option for investment, especially for Chinese investors. The Chinese currency is likely to continue appreciating, and the Chinese housing prices in cities like Beijing, Shanghai, increase sharply over time; under such circumstance, the housing market in the UK is not an attractive real estate market.