Everything Is A Trade
A deeper look at my macro thesis and how I play the markets.
Welcome! Enjoy a weekly dose of wealth & wellness. Join 24,000+ getting WHealthier!
Image generated by MidJourney AI with the prompt “Everything is a Trade”.
Like this creation, and my thoughts? Purchase the NFT on OpenSea!
This NFT is not only a collectible that encapsulates the idea behind this post, but grants you 30-minute access with me. The 3-day auction starts now! Full details here.
Everything is a trade. Well, not quite everything.
Just as the Romans observed ‘all roads lead to Rome’, there is a place where I believe almost all capital eventually leads. At which point, that asset will too become a ‘trade’, as the risk-adjusted return will be better elsewhere. But more on that in a minute.
First, I’m articulating a working thesis that I’ve cultivated over the past decade, having made many mistakes along the way, and failing to follow the principle I’ll outline here.
My hope is I can not only clarify my own thoughts but help you better navigate how you think about investing.
Where It All Started
Having success in poker early led me to begin investing at a young age. I quickly realized that to succeed in life, one needs to not only learn how to make money but also how to benefit from the money one made.
It’s a sin we aren’t taught how to manage finances and invest and have to learn for ourselves, as it’s critical to amassing wealth, which is essentially freedom. In an upcoming article, I’ll highlight my vision for a world where the latter is less important. In the meantime, subscribe here to be notified when it drops.
My mission is to help others live WHealthier lives. My goal is to scale this to 100,000+ subs by the end of 2023. If you share this with one friend right now or Tweet this out, we can get there!
But I digress. Ask other wealthy people what to do with your money and you’ll typically get one of two answers: stocks and real estate.
I started with low-cost index funds as paying the least ‘rake’ to own an asset resonated with me from my experience playing poker (the house is the biggest winner in every poker game thanks to the money they take from each pot).
As my investing career progressed, I learned about diversification. There was no single asset that should comprise the entirety of one’s portfolio. Instead, a basket of noncorrelated assets would ensure one could grow their wealth while minimizing downside risk.
My portfolio expanded to include real estate and gold. My plan was to make more money and proportionally allocate it to my diversified portfolio until I read an article that fundamentally changed everything.
The Dow to Gold Ratio
The Dow/Gold ratio measures the number of ounces of gold it takes to buy one share of the Dow. The recommended way to trade this is extremely simple.
When the ratio goes below 5, buy the Dow Jones Industrial Average index.
When the ratio goes above 15, sell the Dow and buy gold.
In other words, when the entire Dow can be bought for five ounces of gold, buy stocks. When it takes 15 ounces or more to buy the Dow, sell stocks, and buy gold.
Over the past 100 years, you would have made a total of six trades based on this strategy. Notably, it outperformed simply buying and holding the Dow.
The premise is simple: buy things when they are relatively undervalued and sell them when they are overvalued.
I extrapolated the first principle behind this and applied it to life. Instead of looking at investments through the lens of ‘everything has value and therefore you should own it’, I began to see things as how they are valued relative to one another. This subtle, yet profound shift has slowly led me to where I am today.
Down the Crypto Rabbit Hole
It made sense to me that assets had value relative to one another, but it wasn’t until I learned about Bitcoin that I fully internalized this principle. After a deep dive in 2017, I awoke from the matrix and realized that our entire financial system is one giant scam, fiat currency always fails, and Bitcoin is essentially a highly leveraged option call on history repeating itself, as it has thousands of times throughout history.
My poker background had me attempting to quantify the value of Bitcoin. If all fiat is a scam that would eventually fail, and society ultimately converges on one commodity as a global store of value, then what is the fair value of one Bitcoin?
I started small. If the market cap of gold is $10 Trillion, and Bitcoin is a better form of money than gold, then surely Bitcoin is at least a $10 Trillion asset (this would put the price at ~$500,000).
This excited me, as the current price of Bitcoin was less than 1% of that at the time. It seemed like such a trivial buy that I was concerned I was missing something. I felt as I often do in a hand of poker when it’s so glaringly obvious my opponent is bluffing that I’m hesitant to call, thinking they’re out-leveling me.
The Relative Value Theory
I came up with this idea of what I loosely defined as a ‘relative value theory’ based on my understanding that all value is subjective.
Here’s a key excerpt from the piece above.
Let’s examine one the most essential commodities, food. Surely, if intrinsic value is subjective in its most quintessential form, then it’s likely to be true elsewhere.
Despite maintaining stable prices, our demand for food, as well as the value we place upon it, changes based on how hungry we are.
For example, if I hadn’t eaten in a week, I’d pay a lot more for a banana than if had I just finished a meal. And, if I were hungry enough, I may even trade you an ounce of gold for that banana. To someone who’s starving, a piece of fruit has more intrinsic value than a piece of metal.
Remarkably, in my research for this article, I found that this idea of Relative Value Theory (RVT) had previously been pioneered by Silviu I. Alb. In his paper, he finds:
RVT’s implications on finance theory are significant. Most notably, asset values are relative.
Since all value is subjective, it seems to me that the best way to measure value is to one asset relative to another. Assets are all competing for a finite amount of capital allocation, so it’s not enough to simply measure the ratio of the Dow to Gold, but rather one must include other assets, such as real estate and Bitcoin.
The question I wrestle with in the midst of ‘The Everything Bubble’ is, which asset is the most undervalued? That is the fun, never-ending challenge of the global macro puzzle.
Since markets move in cycles and assets fall in and out of favor based on speculative demand, sentiment, macro factors, and underlying fundamentals, at some point the delta between two assets increases to the point where it’s more favorable to swap between them. This is precisely how the Dow/Gold ratio works.
My approach shifted from buying and holding forever to swapping between which assets were the least valued relative to their fundamental value.
Everything Is a Trade
Trading and investing in cryptocurrency helped cement the idea that markets move in radical sentiment-driven cycles. Speculative ponzis (alt coins) move into raging bull markets while speculators chase returns at the expense of Bitcoin. Ultimately the chickens come home to roost.
The nature of the way cryptocurrency trades led me to temporarily allocate capital outside of Bitcoin, with the hope of trading the overly hyped crypto token (aka ‘shitcoin) for more Bitcoin than I would have had if I simply bought and held it.
While I made mistakes and sometimes lost capital, overall this strategy worked well and I profited in Bitcoin terms during the 2021 bull market. I documented the majority of my trading history in this recent Twitter thread.
Believing that everything is a trade requires one to be agnostic and avoid getting married to any one asset. Maximalist thinking, while sometimes charming and admirable leads to underperformance. Hearing people define themselves as ‘gold bugs’ is missing the point of the game.
Just how in poker the purpose of the game is to win as many chips as possible, in investing the purpose is to return the highest amount of capital. Amateurs get married to their pocket aces, while professionals are able to recalibrate street by street to determine if it’s still profitable to continue putting money in the pot.
Your hand is not what matters, but rather how your hand matches up to your opponents’. The same principle of relative value applies to investing. Hypothetically, if the price of gold went up 10x in 6 months, reducing the Dow/Gold ratio to 1, only a fool would continue to hold gold when they can buy relatively undervalued stocks.
The point of the ‘relative value theory’ isn’t to own any one specific asset, but rather to own the asset which has the least value relative to all the other ones.
If Bitcoin becomes temporarily ‘overvalued’ due to a huge pump in price and wild demand, I’ll sell it for cash and buy it back later. I do that despite believing fiat is the greatest ponzi of all time and Bitcoin is the best invention in human history because I ultimately believe that making that trade can buy me more Bitcoin in the future.
This is why I began to exit cryptocurrency and move into fiat nearly a year ago, despite never losing faith in Bitcoin and its promise to build us a better world.
Investing and poker are both games, and it’s crucial to treat them as such. Always playing your favorite hand (like T8ss) despite an opponent pricing you out of the pot is akin to a trader who holds an asset because they like it. To me, that’s careless, arrogant, and foolish. I play the game to leave with the most amount of chips, and in both poker and investing, money is what we use to keep score.
The hand you win the pot with isn’t what matters. Your net profit is.
Portfolio Construction and Trading
The fact that I view everything as a trade doesn’t preclude me from having a balanced portfolio. Quite the opposite. Poker has taught me that every bet has risk, and even high conviction, high probability outcomes can go awry. I never put all my eggs in one basket.
Alb’s findings on the Relative Value Theory (RVT) confirm this to be true.
The RVT also indicates that diversification not only reduces risk but also increases cumulative returns, thus contradicting the view that returns can be improved by simply undertaking more risk.
Here’s an example that illustrates why diversification is important in investing, especially when it’s high risk.
Investment A returns 1.4x half the time or loses 20% the other half.
Investment B returns 1.35x half the time or loses 21% the other half.
Assuming outcomes aren’t correlated, despite A clearly being a better investment than B, the best portfolio is some combination of both.
Let’s assume the portfolio can earn 10% per year. The reason the risk of a portfolio comprised exclusively of A is worse is that half of the time it results in a 20% drawdown. This means that the investor is compounding less money each year, which results in an overall lower long-term portfolio gain.
If instead the investors buy A and B, the risk of the max drawdown is decreased from 50% to 25%, and therefore, they will be more likely to compound their wealth from a higher baseline, resulting in higher overall returns for the portfolio in future years.
Asset Values Are Relative
The above explains why diversification is important, and also why being ‘all-in’ on one asset is foolish, despite it having the best asymmetric upside and expected value.
Therefore, I own other assets such as mobile home parks and invest in start-ups.
However, the relative value theory can also apply to real estate, and one can view all property as a trade. This theory is harder to execute as there’s a large time and capital requirement to move in and out of a physical property, but the same principle applies.
If the price of an investment property appreciates dramatically as the city recently experienced heavy job growth, and we’ve already value added such that we cannot increase the cap rate, then selling would be ideal.
The reason this isn’t always practical is due to the cost of selling, capital gains, and the opportunity cost of the time required to find and rehab a new property vs. simply letting its cash flow pay for one’s lifestyle.
All things being equal, however, if one could immediately swap the property from a city that has already boomed (like Boulder) for a city that’s about to boom (say Northwest Arkansas), with none of the above friction, then I’d make the move.
Naturally, trades of this nature are as easily possible when moving in and out of stocks, gold, and Bitcoin, so it’s a much more viable strategy in capital markets.
The same phenomenon is true in capital markets. The market cap of the world’s 866 unicorns is roughly the same as Apple. Shoutout to Packy McCormack for the awesome infographic.
I’m not saying Apple is a bad stock to own, but given that capital is finite, the question becomes whether is it worth the opportunity cost. Hypothetically if you could swap Apple for a portfolio of 866 unicorns, which one do you think is more undervalued?
Put another way, if 1/866 unicorns become as valuable as Apple, you get the other 865 for free. Using the Relative Value Theory, I’d argue that Apple is overvalued relative to the rest of the world’s unicorns.
Risks of Trading
Conventional wisdom is simply to buy and hold stocks and real estate and hold them for life. This is based on the premise that most don’t have the time, acumen, or knowledge to profitably trade in and out of assets through market cycles.
I tend to agree. I don’t recommend trading as a strategy for most people, despite it being the option that can theoretically produce the highest returns.
There are several reasons for this:
Opportunity Cost: Trading requires a lot of time, research, and due diligence. Most are better off spending more time earning their capital doing what they do best, than automating their investment strategy through vehicles such as passive index funds, buying and holding Bitcoin, and cash-flowing real estate.
Market Timing: Macro is a challenge. If one gets it wrong they risk winding up with less capital than if they simply bought and held, while suffering losses from the opportunity cost of the time they invested.
Temperament: Pulling the trigger on a trade at the right time requires a particular acumen. Most buy high and sell low when they should do the opposite.
To maximize the value of a trade, one has to be against consensus and be correct. In my experience, these are the hardest times to act. For example, buying Bitcoin 5+ years ago before the previous cycle high was an out-of-consensus bet. Most thought it was crazy, whereas buying the top of the latest cycle at $60,000+ was in favor. Of course, the opportunity lies in the former, whereas the smart money was exciting at the top when most were buying.Stress: Like poker, trading is stressful. It’s guaranteed that a trade will go against you at some point, and you will lose money. To trade profitably, it’s imperative to have great bankroll management, set stop losses, and manage one’s emotions. Most perform worse under pressure and especially while losing, costing themselves a fortune. I’ve seen it time and again at the poker table and in markets.
Final Thoughts
The Relative Value Theory is the idea that all asset value is relative and inevitably all assets will be over or under-valued depending on sentiment, psychology, market conditions, and underlying value.
From a trader’s perspective, this presents a great opportunity to understand the macro and trade in and out of assets depending on their fundamentals.
While I firmly believe the best asset to hold for the next decade is Bitcoin, diversification is key to minimizing the risk of ruin and maximizing returns.
While I personally view everything as a trade thanks to the Relative Value Theory, I believe most are better off constructing a balanced portfolio and automating the process, or outsourcing their investing to someone they trust.
I hope this article helped level up your view on investing, markets, and capital allocation. Drop me your thoughts in a comment below.
Until next time…
Alec
Investment Opportunity With Me!
P.S. I recently started a syndicate on AngelList that allows accredited investors to invest alongside me in my favorite startups. I hope to syndicate 5 deals next year.
Join my syndicate here to be notified when they drop.
No commitment is required, you can personally vet each deal and decide for yourself whether to fire. The minimum commitment is as low as $1,000!