Is short selling bad for your psyche?

Is short selling bad for your psyche? by Laurent Bernut

Answer by Laurent Bernut:

“Lo que no mata engorda”, what does not kill you makes you fat. Bob Baerker, a respected short-seller, sums it well.

You are probably alluding to the good and evil battle between the righteous short seller who perceives wrong, the arrogant and corrupt management who falsify their financial statements and price that stubbornly goes up until the final collapse.

Fairness will kill You

Fairness is one of the very few built-in traits in humans. Numerous studies have been conducted on fairness in toddlers. It appears that our sense of fairness predates our language. Even children who turned out to exhibit clinical psychopathic tendencies, dysfunctional amygdala, react to fairness.

So, as short sellers, every now and then, we are tempted to right the wrongs. We engage in a duel with companies and the multitude who buy into the frenzy. One sane mind against a raging mob is still an unfair fight.

A simple advice is to wait until the mob has changed side and starts liquidating its position. You will be vindicated.

Short selling: the spinal tap of investing

Stress volume always at 11

In spinal tap, they can turn the volume at 11. On the short side, stress volume is always at 11, even when it works in your favor. In that sense, short selling is corrosive for your psyche until You learn to manage stress.

It takes time to get there but here are a few techniques that will help You:

  1. Plan your exits: the short side is a bumpy ride. I used to maintain between 40 to 60 shorts at all time. That’s a lot of bumps. It all changed when i set up hard exit rules. Having hard rules for exit is a tenfold reduction in stress. All my Long Only colleagues were glued to the newsfeed to guess what to do next. Meanwhile, as nothing flared up, i was left watching spiritually awakening and highly educational content on Youtube
    1. partial exit: take risk off the table as a short squeeze starts. No-one knows how far price will retrace and gains evaporate, so reduce size
    2. stop loss: never enter a short w/o a stop loss. Never override stop loss. No exception
    3. reversal: there are quite a few false positives. Sometimes, shorts turn into Longs before they trigger a stop loss. Do not ignore what the market is telling you. Market is right, or it can afford to stay wrong, you can’t
  2. Quantify your risk: risk is not a story in the US, China or wherever. Risk is a budget: how much you can afford to lose and keep trading. Accept you could lose that much because:
    1. This is called pre-mortem. It actually releases endorphine and facilitate recovery. The quicker you can put a bad trade behind you, the quicker you can focus on the next one
    2. More often than not, you will lose. Quantification helps you get better at money management
  3. Practice mindfulness: every other spiritual guru talks about mindfulness. In its simplest form, it is the ability to observe what is happening without being sucked into the emotional roller coaster
  4. Welcome to the dark side: the short side will test the darkest corners of your psyche. It will go and elicit fears so deep you did not know you had them. Great, fear dissolves when exposed. I used to journal fears and work through them using Byron Katie’s The Work. Van Tharp recycled this in his fantastic “trading beyond the matrix”. Fear elicitation is a great tool to help you work through your subconscious phobias.


Viktor Frankl, who happened to have survived Auschwitz and Birkenau, said between stimuli and response there is something called freedom. You have the choice of how you will respond. So, fear happens, losses mount. How you choose to deal with them is your path to emotional freedom

Is short selling bad for your psyche?

#Quora: How do normal day traders manage to profit 200-300% annually and hedge funds are able to return only 20-40%?

How do normal day traders manage to profit 200-300% annually and hedge funds are able to return o… by Laurent Bernut

Answer by Laurent Bernut:

Day traders have one person to answer to: themselves, HF dudes don’t. Sticky Vs Fast money. It is not that they can generate good returns, it is that their clients will not allow them enough wiggle room. So, they are stuck in the month to month tyranny of positive returns. Size-Matters

HF is a fixed cost business

Keeping the lights on at any HF will cost You between half to one million USD per year. There are cheaper arrangements, but those funds are not institutional grade: pension guys will not even look at them. That is all before the principals can extract a dime out of it.

Now, contrary to popular beliefs, HF is a fixed cost business. You have bills to pay and for that You need to attract investors and raise your AUM. Performance does not pay the bills. Performance attract investors who pay the bills. Guys who waltz in with 10M thinking their performance will take care of the costs, stay at 10 forever

HFs are expensive underachievers.

In the mind of an investor, why would You invest with a HF when You can get cheaper better elsewhere? Yeah, yeah, yeah, the low correlation to the markets, downside protection, asset class diversification, i hear You, but who cares: 8 years of bull markets tend to dull people’s perception of risk and frankly. Every time the market had a hiccup, those wise dudes tumbled hard anyways. That is a fact, but that also has to do with the nature of the people they cater to.

Sticky Vs Fast money

HFs are stuck in a rut where they struggle to attract sticky, pension type money. Calpers pulled out of the HF game and many other endowments, pensions follow suite.

It takes roughly half to one million USD to keep the lights on. So, they market to fast money schmocks who put pressure on them. If You don’t perform 2–3 months in a row, or if You lose me 5%, i will cut You off. HF wise dudes don’t like those nervous investors, but they have no choice. Those Shylocks are the guys they have to perform cosmetic surgery with, as in lock their mouths to those guys’ money-makers, in order to one day reach institutional size.

What happens when You are not allowed to lose money? You don’t take risk. When you are up on the month, You take money off the table. When You are down, You cut risk. You never allow positions to fully develop.

At the heart of it are three things:

  1. Mismatch between assets and liabilities: HFs fund their LT strategies with short term funding. This cannot work. This is really the heart of the problem, from which everything flows
  2. Poor portfolio management skills: I started my career building portfolio management systems. Think of this as flying on instruments.If You don’t have good instruments to land at night on foggy days, game over. When i take a look at my HF buddies portfolio management systems, of course they struggle. I have seen only 2 which were investment grade in 15 years. Bottom line, these guys fly blind, no wonder they crash
  3. Short selling incompetence: selling futures as a hedge is for tourists. Most guys who come from the Long institutions think they are good at short selling. 2 years in, they give up on short selling. You don’t learn MMA by signing up for the UFC octagon, You train at the gym first

Institutional HFs

SAC/Point 72, Millennium, Balyasny are successful have a different philosophy. Investments are leveraged and managers have a tight stop loss. As a result, they generate 15–18% p.a. for their clients. Now as a manager, at -5% your AUM is cut in half. At -7%, stop loss. There is a direct disincentive for managers to take extra risk. Very few managers have the patience and discipline to clock in boring returns month in month out.

Do individual investors roll up into HF managers

Some do in the CTA world. This is how Paul Tudor Jones started. The game has changed though. It used to be easy. Ken Griffith started trading bonds in his dorm. Now, according to him, he would never be able to pull this off.

My thoughts on this. I used to want to start up a HF. We were quite advanced and then the cost of the whole thing hit me. I would be bankrupt before we would have enough assets under management (AUM) to be deemed investment grade. So, i rewired my thinking. I promised myself i would do whatever it takes never to need investors. Welcome to MT4 Forex Autotrade: trading 24/5 leveraged 100:1. It has been a long arduous road, but now we do not need investors. Autotrading puts wine (my kind of food) on the table

How do normal day traders manage to profit 200-300% annually and hedge funds are able to return only 20-40%?

#Quora: How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse than -5%, and has a starting amount of $2…

How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse t… by Laurent Bernut

Answer by Laurent Bernut:

Experience has taught me that people like this are a plague. They are not risk adverse. They are conservative to the point of being risk seeking: by refusing to accept moderate waves of volatility, they invite left tails tsunami. If You cannot afford to turn his money away however, here are the formulas

A. Psychology of conservative people

If You can’t stand losing, then You shouldn’t play. When they say they are willing to accept modest returns as long as You don’t lose much, what they mean is they do not want to lose at all.

Conservative is not synonymous with risk adverse. They are opposite in fact. Risk adverse means You have articulated and pieter_bruegel_the_elder_-_the_parable_of_the_blind_leading_the_blind_detail_-_wga3512quantified your risk appetite. Conservative means You are afraid of taking any risk. You are ready to discount your ambitions to the point they will be met with certainty. Kodak, Nokia were risk adverse…

It also means they are afraid and think everything is risky. It is your responsibility to educate them on risk. Do not step into dissertation mode about China, the Fed, Venusians landing in Central Park and Yoyogi park in Tokyo (i will sacrifice myself and volunteer if those sexy Venusians want to perform tests on my body). Risk is not a story, risk is a number.

Secondly, if You deliver, they are likely to demand more over time: 8–10% turns to 10–12% etc. Two reasons for this: you will be put in competition with other managers who promise they can deliver better with the same risk. Since your returns are underwhelming, You will be in constant competition. Secondly, and this is more insidious, they become overconfident. Since they believed everything was risky but now are making money, and they still don’t understand risk, they turn euphoric, literally drunk on testosterone and dopamine. They are laughing their way to the bank until the day you start losing again.

B. Market’s money

The strategy is to start small with minimum risk and increase gradually as you generate performance. Then, before year end, you reduce risk so as to start the new year afresh.

Many people do the gradual increase well, but forget about the decrease. Investors think in calendar years.

Example: first quarter, you generated 2%. You can now increase risk by x% of your gains (10–33%). So instead of risking 0.10% per trade, you would risk, 0.12% and so on and so forth.

Comes November, You are currently risking 0.20% per trade. Now, it is time to de-risk down gradually down to 0.10% so as to start January with a low risk, low concentration portfolio, ready for the new year. Remember: in the investors mind, January is the beginning of a new year, not the continuation of last year’s market.

C. Risk:“how much is enough?”, Steven Seagal, obese mythomaniac

You will often read that you should not risk more than 1–2% of your capital per trade. This does not mean position size, but equity at equity at risk. In your case, if you apply that rule over 5 stocks, one bad month and game over for good. So, get a better bad idea …

What is the maximum risk You can afford on each trade? This is one of the thorniest questions in financeI have pondered that question for years, until one day i came up with a simple elegant solution. Input variables

  1. Drawdown tolerance: If Your investor redeems, game over. he said he would tolerate -5% max drawdown. So, in order to be safe, you should probably calibrate your risk to a fraction of this. If You calibrate at 100%, he will redeem and this is one time where being right is bad, very bad. Besides, you need to rebound from drawdown, so let’s say somewhere between 50%-66.67%, say 2/3
  2. Avg number of positions: over 1 turnover cycle, what is your average number of positions? let’s say: 50
  3. Loss rate: over 1 turnover cycle, what is your average loss rate. In case You don’t know use 60% as loss rate (Yes, it means you lose more often than win, and it is called prudence)

Equipped with this:

Max risk per trade = Drawdown tolerance / (Loss rate * Avg #positions)

= 5% * 2/3 / [50* 60%]

Max risk per trade = 0.11%

Now, that was the max risk per trade. Let’s move to the min risk per trade. This is a fraction of that: usually 40%. So, your min risk per trade would be around 0.05%

Add trading has a cost: 0.036% blended avg, between DMA and high touch at Credit Suisse for example (as a good friend complained again this morning while we were naked in the gym shower !?!).

Now, You probably start to understand why i mean that those customers are toxic. When You go through a drawdown and you will have rough periods, You will simply not be able to dig yourself out.


Once in early 2013, i was cruising at a hedge fund party nursing some nasty Chardonnay and some dude who just launched was explaining his strategy:

-“fundamentals pairs trading”, he proudly said

-“So, You must be Long Toyota and Short Mazda, right? Mazda has gone up 400% and Toyota 30%. That must be a painful trade? ”, i asked

-”Nah, positions are small anyways, so no it does not hurt”, he confidently replied

-”Well, if they are too small to hurt, do You think they are big enough to contribute?”, i candidly asked

And he did the unthinkable rudest thing someone can do in Japan. He gave me back my business card and walked away

How should I manage a client’s portfolio if he wants a 8-10% return and no negative years worse than -5%, and has a starting amount of $2…

#Quora: Do most quantitative trading strategies have limited capacity?

Wasting water leaks into overfilled glass photo against white

Answer by Laurent Bernut:

The best answer to that question comes from my ex-boss, mentor and more importantly dude friend: “You are at capacity when inertia sets in”

This means that when managers become reluctant to take a trade, this is when they reach capacity. It might be at 100M or at 2B. It is after all subjective. The same can be said about algorithmic strategies.

Algorithmic strategies are more scalable than humans. They can be deployed across larger universes and shorter periodicities. So, diminishing returns kick in later. Market impacts happens and returns come down eventually.

There are three reasons:

  1. Volume market impact: some strategies arbitrage inefficiencies. So, trading naturally correct them. They have built in capacity constraint
  2. Competition: market participants copy each other. Pie does not grow, it gets fragmented
  3. Conceptual shortcomings: that is the hardest problem to solve. Problems are often solved at a different level than they were created. There are four ways it can be solved
    1. go wider: expand your coverage universe
    2. go bigger: accept market impact as a necessary cost of doing business. This means expand limit orders, but it also means refine signals so as mitigate slippage
    3. go deeper: elicit trading: bait other market participants to take the other side so as to create volume. This is the new old thing. Remember “Reminiscence of a stock operator” when the veteran trader tests the market by observing how fast his orders were filled. HFT have perfected that craft.
    4. go different: money management is the new new old thing. Getting in is a choice, getting out is a necessity. Trades do not have to be all-in and all-out. Scaling in and out mitigate capacity issues

Do most quantitative trading strategies have limited capacity?

#Quora: If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ people?

If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ peop… by Laurent Bernut

Answer by Laurent Bernut:

No, but for different reasons that the instructive and brilliant answers given by people far more intelligent than yours truly. Making money in the market is a side effect. Yes, You read correctly. Would You like to know why ?

(An entire section of my upcoming book on short selling is devoted to this topic so stay tuned)

The biology of trading:Inner alignment 1

To all of You who believe markets are efficient and think of yourselves as rational investors, how many times did You check your mails today ? 10–20 times. That is Dopamine in action. This is the reward circuitry. Not even Paris Hilton has a life exciting enough to check mails continuously. We do so because our brain releases dopamine (feel good hormone) for mild uncertain rewards.

Have you ever found yourself overriding your risk limit just right around the wrong time? Overconfidence is the ubiquitous plague of traders. Rational investor, would You like proof of overconfidence? Divorce statistics, i rest my case with your multiple ex-wives

Now, when your performance sinks and you can’t think straight, do you pass up trades? Do you find yourself exhausted, irritable? Cortisol

Your average pension fund manager is the direct descendant of someone who woke up in a cave and started running after mammoths for breakfast. Not exactly savvy with probabilities but the survivors got the girls…

The hard wired mind of trading

In the 60s Michael Gazzanika developed the theory of split brain. We, humans, pre-consciously rationalise our decisions. Take a look at the junk in your portfolio. A solid third of it would not even be there if you had to do it all over again.

Do You find it hard to execute stop losses (Oh, the chapter on the psychology of stop loss is worth the entire book multiple times, i will refund anyone who does not have a aha moment there) ? Ego prevails over profits. Valeant (VRX), case in point…

Subconscious beliefs and fears

Fears exist in the shadows. In his book, Daniel Goleman (the EQ dude) describes elf deception as a built in mechanism that covers its own tracks. we rationalise all the time. Proof? when was the last time you got laid (Maslow pyramid about reproduction)? when was the last time you rationalised a decision ?

Market participants do not trade to make money. Proof?Look at the junk that fester in your portfolio… Some of us trade to prove to someone dead 20 years ago (i-e father, mentor, bully at school, whatever) that they are worthy individuals. Dude, You are beautiful, You are worthy of love.

The floating world of beliefs and fears

Finally, floating at the surface like ice cubes in a single malt are conscious beliefs and fears. Fears of losing your job, fear of missing out, fear of pulling the trigger, fear of inadequacy (smart guys are buying that Enron thing so i will join the party)

Of course, there is the belief You cannot time the market. Who told you that? Journalists and analyst who hug the mike and more importantly yourself when the thing you just bough went south…

Now, let’s quip the IQ myth. Self deception is a mechanism that covers its own tracks. High IQ dudes always have spectacular excuses. I know two types of traders: those who make money and those who have excuses. Which one are You

Bottom line: born to lose

Bottom line, your biology f@#ks you up. Your beautiful mind comes delivered with amazing features, most of which will get You killed on the markets (try fairness for instance). Then, your ego, your subconscious deep rooted fears will supersede your best intentions. Then, there is this floating junk of unchecked beliefs irrational fears.

So, no wonder 90% of the people lose money.

Now, why do 10% succeed? The hero’s journey

They succeed simply because of their inner alignment of their biology all the way up to their daily routines. Great traders are not smarter, they have smarter trading habits. Making money is just the yardstick of inner alignment.

Would You like to know about the three scientifically proven methods to re-align yourself? Then, please follow, or subscribe to my (free) website, or help launching the book

As Arnold, Ze Great Governator said: “Ze hardest part of putting on muscles is getting to ze gym, jaa”

If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ people?

I’m good at shorting, is it possible to start a short biased hedge fund?

I’m good at shorting, is it possible to start a short biased hedge fund? by Laurent Bernut

Answer by Laurent Bernut:

Excellent answer from Bill Chen, to which there is little to add. In my opinion, short-selling is widely misunderstood even by professional sophisticated investors. To add insult to injury, FED and ECB are the official sponsors of the longest bull market on record.

Short-sellers are like sharks…great-white-shark-sharkspictures.org_

Did You know that deep in the quiet comfort of your house, there is something 150 times deadlier than a shark ? It is called a bed. The probability of dying after falling out of bed (literally) is 1/2*10^-6, while ex-sanguination from an exploratory shark bite is 1/150*10^-6. Sharks are misunderstood and fragile. So are short sellers.

Adding a short component to a long strategy reduces volatility of performance, increases leverage and reduces drawdowns in terms of magnitude, frequency an period of recovery. Now, this is neither how they are perceived nor marketed.

They are perceived as predatory, nefarious and risky in nature. I lost half of my pension in 2008 to supposedly buy and hold low risk mutual fund #de-friendBuy&Hold.

Short biased funds are relative players, just as your average mutual fund. Their benchmark is just the inverse of the index. When the market goes up by 10% and they clock +8%, effectively they have outperformed. The only problem is that investors lose -8% in absolute. No-one likes to structurally lose money, right ?

Wrong, 3/4 of mutual funds trail their benchmark year in year out. Investors make money in absolute but lose versus index funds. Worse even, mutual funds lose both in absolute and relative during bear markets. So, here is an interesting perception gap:

Short biased funds lose money during bull markets but make some during bear markets. Rationally speaking, they serve a more important purpose than mutual funds. Logically speaking, you do not need a mutual fund, but you do need a short biased fund in order to protect you from downturns.

The problem is that most of them will have died by the time we hit a bear market. The second problem is that short selling is still perceived as evil, when all they do is provide hedge in good times and absolute performance when no-one else does

BTW, small difference of opinion with Mr Chen, redemptions do not come during outperformance during bear phases. They come during early bull markets, when bearish sentiment as well as AUM peak. Short funds handle regime change quite poorly. The same happens with Long Only. Managers can underperform and still grow assets in bull markets because everyone makes money. Long Only underperforming in bear markets is bad…

Prometheus and capitalism

Monetary authorities around the world have mutually decided that bear markets are bad. So, they play god with the markets. They do whatever they can to prop them up. Their latest trick was a sucker punch to the very foundation of capitalism: negative interest rates. In what parallel universe does it make sense for a borrower to be paid to borrow money ?

This begets an interesting question: if they are blind enough to think they can tame the markets, will they be competent enough to solve the problems they have created ?

Anyhow, the point is the only trade in town is: when a tired bull market wants to go down, buy everything and wait for the monetary cavalry to show up with their QE heavy artillery.

This market manipulation is damaging for all market participants. It rewards complacency and bad behavior on the long only side (double down on losers) and wipes out short sellers. In March, i lost -15% in 3 weeks. This bull is tired but central bankers will not admit it until …

What’s the solution then ?

Once upon a time, mortgage bonds were boring. Then, someone figured out a way to package and MARKET them as low risk / high yield investment securities. Shortly thereafter, every other math wiz kid and smooth salesman became fluent in CDO linguo.

Same with short selling. As long as we are the “usual suspects” and default scapegoats for markets falling, speculation, corporate greed, obesity, erectile dysfunctions and all other evils on earth, small or large, then AUM will have wild swings. Picture a young promising executive pitching a short fund during an investment committee Monday morning 9 am

-“ things look a bit dicy here, i would like to start allocating to a short biased fund”, says the newbie

-“sure, buy a dividend fund or allocate more to government bonds funds”, replies the chairman

-”3% dividend is not going to cushion much when the market goes down -50%. Actually, government bonds are the reasons i am getting a bit nervous”, replies the young man

-”Now young man, how do you think our investors will perceive us if they know we are buying a short fund ? They will think we have no confidence in our economy. They will cease to see as patriotic, hard working, disciplined investors, prudent risk managers. They will think of us as short term traders, evil speculators. Rest assured they will redeem”, slams the chairman

-”You are right sir, but our clients will redeem anyway if we lose them money. Short sellers are just as patriotic, hard working and probably more disciplined than Long Only. Short sellers just happen to make money when no-one else around does. At least, if we make money for our clients, we have a chance to keep them. If we are one of the few who make money during downturns, maybe we could even grow assets. Look at Mr Paulson”, whispers the newbie as he shrinks and recoils away

-”You are a bright and talented young man. May i suggest a bit more optimism and team spirit for the rest of your career ?”, concludes the chairman with a paternalistic threat

The reason why John Paulson’s AUM exploded is: he made money when no-one else did. He stood out as a clear winner in a crowd of losers. Short selling is the most important and most valuable skillset. It just has bad press and needs to be repackaged.

Speaking of which, I am writing a book about short selling. 3/4 done already. It is about trading edge: statistical, mental and portfolio construction

I’m good at shorting, is it possible to start a short biased hedge fund?

How significant is following the news for forex trading?

How significant is following the news for forex trading? by Laurent Bernut

Answer by Laurent Bernut:book_buy_sell_sell_new_1024x1024

I know two types of traders: those who trade the newsflow and those who make money. 1) How the brain perceives news 2) What news matters and what does not and how to know which is which 3) Stop Loss and newsflow

  1. The engineered poison of newsflow: Mice on cocaine, fight flight or freeze

A. Play this game to know how brainwashed You really are

Every day, write down whether you agree with the market comment of the chrematocoulrophone (1) “du jour” on Bloomberg TV. They do a superb feat. When market tanks, they dust off some perma-bear and when markets roof it they fish out some perma-bull. Those financial jesters (1) perfectly rationalise what is happening.

Now, take a piece of paper and write whether 1) you agree with the dude 2) whether he is bull/bear. At the end of the week/month, line up agreement and compare the results with your bullish/bearish view of the world. This is confirmation bias in real time.

B. How the brain perceives news

I want to be the first subscriber to a news channel that reports financial trains arriving on schedule. Currently, financial trains have to either beat their consensus timetable or derail to show up on the news. Until then, Disney Channel is good

News is engineered to elicit reaction: sell paper, trade. It activates the mesolimbic reward circuitry (think mice on cocaine) and/or the stress response: fight, flight or freeze. It is crafted to be sensational. The brain picks up on the noise, the flashes, the tone of voice (try and speak like a newscaster to your friends and see how weird it actually sounds)

The problem with either brain trigger is that it distorts reality. Reward circuitry is dopamine which creates cravings, hence the strong addictive mechanism. This is the euphoria superman drug. Bad news for risk management

The stress response releases a powerfully corrosive drug named cortisol that kills libido, constricts bowel movements, triggers panic attacks and inhibits the pre-frontal cortex, otherwise referred to as the thinking brain. So, Yes, science says that being glued to the newsflow actually makes You dumb. Two ways to prove it: anyone who has been on a trading floor when there some “major news” breaks out knows what i am talking about…

More importantly, when you unplug from the matrix, isn’t your thinking any clearer ? You start to have ideas, think more strategically. The brain fog dissipates. This brain fog comes from staring at the newsflow all day.

Newsflow is literally neurotoxic

2) News that matter, those that don’t and how to spot them

Here is a simple test to assess whether news and more importantly their source have worth following:

  1. news can reverse a trend: if any news does not have the power to stop and reverse a trend, then it has no market impact
  2. Persistence: some news cause knee jerk reactions, but then trends resume their course as if nothing happened.

So, in terms of importance, these are the 3 major news that we follow each month

  1. FOMC: everything in the world is priced of the US 10 year bond. In December, when the Fed raised rates, January was not a happy month…
  2. BoJ: October 2012, Bank of Japan decides to debase its currency. It did impact not only Japan but the rest of the world
  3. ECB: has diminishing persistent impact
  4. Pegs: The Swiss have done a great job at fending off “evil speculators”. Brexit too. We have currency peg alerts on Google, but we stay away from pegged currencies such as HKD, HUF etc anyways

The rest, whether it is non-farm payroll, CPI, PPI, MoM retail numbers, consumer confidence survey, housing starts, inventory or tea leaves expert forecasting, all this rarely elicits anything beyond: “yeah, yeah, pass me the salt, please”. There is immediate market impact, but no trend inversion and no persistence of signal.

Useless does not mean worthless. It means those indicators will be baked in the thought process that will ultimately lead to the decision on rates. They are important components, like the windshield on your car, but what You care about is your automobile, not its parts

3) Stop Loss and news

Beginners want to stay in control. Veterans know control is an illusion. Beginners like to keep a tight leash. Veterans allow markets to breathe. Beginners’ tight stop losses get tripped all the time. Veterans love their long lunches…

Tight stop losses means bigger positions. Combine this with crushing leverage and this is a recipe for a toxic neurococktail: cortisol is a powerful chemical that numbs any pains. It is present in all traders experiencing high stress and in harmful concentration in those who blow-up. Game Over

Forex seems to have more randomness than other data series (at least those i have worked on) on identical sub 30 mn periodicity. I don’t know why and it is irrelevant, frankly. What matters is how the noise gets cancelled in the order management logic.

To that effect, i am the proud inventor of French Stop Loss. We follow a scale-out/scale-in model. Rather than anchoring all stop losses on the latest position’s stop loss, we use the one prior (+ a cute little zest “bien sur”). This gives a lot more wiggle room to positions. Cons: This reduces position size and performance acceleration, Pros: this reduces the number of stop losses, increases win rate, lowers avg loss. Bottom line, this stop loss method is fashionably late, hence French Stop Loss, of course

The point of that digression is that allowing the market to digest knee jerk reactions to news materially increases trading edge


We have three configs for our risk management: autopilot, monetary cavalry and Elvis. Autopilot is our standard config. It is on except for one week every month

Elvis does exactly what it says on the tin: rock n’ roll… Our metric is reproduction rate. Our units are Buffets and absolute. But, damn, those valleys are a seriously bullish signal for the adult diaper industry

More importantly, monetary cavalry is named after the main central banks. The week they come up with some announcement, we tighten risk. This is the only type of news where we take action to reduce risk. Sometimes we end on the profitable side of things, and sometimes we don’t. We have made a conscious decision to earn a little less than we could, because we do not want to lose a lot more than we should, and neither should You

How significant is following the news for forex trading?

#Quora: How does one address the issue of regime shift in algorithmic trading?

How does one address the issue of regime shift in algorithmic trading? by Laurent Bernut

Answer by Laurent Bernut:change-of-season

Fascinating topic that has kept me awake for years. It is a thorny issue. As the patent clerk Einstein used to say: answer are not at the same level as questions. Answer is not at the signal (entry/exit) level. These are position sizing and order management issues.

Definition of regime change

Everybody has a savant definition, so i might as well come up with a simple practical metaphor. imagine You drive at 150 km/h on the highway and then all of sudden, this 4 lanes turns into a country road. If You do not react quick, you will go tree-hugging.

There are three market types: bull, bear and more importantly sideways. Each type can be subdivided into quiet or choppy. So, we have six sextants. Regime change is when market moves from one box to another.

It can be either a new volatility regime, or a move from bear to sideways, sideways to bull or vice versa. Markets rarely move from bull to bear. There is some battle between good and evil.

Why it matters?

Many strategies are designed to do well in a particular environment. They make a lot of money that they end up giving back when regime changes. Examples:

  1. Short Gamma OTM: sell OTM options and collect premium. Pick pennies in front of a steam roller. 2008–2009, August 2015, CHF depeg, Brexit etc. 1 day those options will go in the money and game over
  2. Dual momentum: trade the shorter time frame but determine regime on longer time frame. When market hits a sideways period, market participants get clobbered on false breakouts like poor cute little baby seals
  3. Mean reversion: works wonders in sideways markets until it does not. An extreme version of that is Short Gamma
  4. Value to growth and vice versa: that is probably the most lagging one. By the time, my value colleagues had thrown the towel and loaded up on growthy stocks, market usually gave signs of fatigue…
  5. Fundamentals pairs trading: relationships are stable until market rotation. For instance, speculative stocks rally hard in the early stage of a bull market, while quality trails. Example: Oct-Dec 2012, Mazda went up +400% while Toyota rallied +30%

The vast majority of market participants are trend followers, whether it is news flow, earning momentum, technical analysis. Trending bulls they do great, trending bears, they can survive. Sideways is where they lose their shirts on false positives.

The issue often boils down to how to enter a sideways regime without losing your shirt

The value of backtests

I agree that backtests will help you identify when your strategy does not work. This is actually the real value of backtest. This is when you modify the strategy and adapt the position sizing to weather unsavoury regimes. Then trade this version, not the ideal fair weather strategy.

Reason is simple: everybody’s got a plan until they get punched in the teeth. So don’t lower your guard, ever.

Asset allocation across multi-strats

Some market participants like to develop specific strategies for specific markets: sideways volatile, awesome for pairs trading, great for options strangle/straddle short. Breakouts are good for trending markets etc.

How do You switch from one to the next ? Fixed asset allocation is as clunky, as primitive and as MPT as it gets. There is something far more elegant and simple:

  1. Calculate trading edge for each sub-strategy: long Trend Following, pairs etc
  2. pro-rate trading edge for each strategy
  3. Allocate by pro-rata
  4. Allocate a residual minimum even to the negative trading edge strategies

This is a simple way to put money where it works best

Regime change for single strategy

When not to trade

Van Tharp believes that there is no strategy that can do well or at least to weather all market conditions. I believe there is more nuance. Is the objective to make money across all market regimes? For example, sideways quiet are preludes to explosive movements. In order to make any money, you need to trade big and if you are on the wrong side when things kick off, game over

We trade a single unified (mean reversion within trend following) strategy. What follows is our journey through solving the regime change issue. We found that the three best ways to manage regime changes are

  1. Stop Loss:
  2. position sizing:
  3. order management:

Stop Loss

Regime changes are usually accompanied with rise in volatility. Volatility is not risk, volatility is uncertainty #de-friendSharpeRatio

We used to have a complex stop loss rule. Now we have a uniform elegant stop loss. It just lags current position. It is fashionably late, hence its name: French Stop Loss.

The idea there is to give enough breathing room to the markets to absorb changes without giving back too much profit.

Our solution is to consider stop loss as a fail safe and allow the market to switch direction bull to bear and vice versa within the confine of a stop loss.

The result is we end up switching from one regime to the next more fluidly. We have reduced the number of stop losses by 2/3, which in turn has materially increased our expectancy.

Stop losses are costly. They are the maximum you can lose out of any position.So, unless you have a kick ass win rate or extremely long right tail, you want to reduce their frequency and allow the market to transition.

Position sizing

The first thing You need to understand is that You cannot predict/anticipate a regime forecast. You will find out after the facts. This has some immediate consequences on position sizing: always cap your portfolio risk

Many position sizing algorithms use equity in layers or staircase. We base our calculation of peak equity. So, drawdowns however small have an immediate impact on position sizing. This slams the break much faster than any other method i know.

The other side of the equation is risk per trade wich oscillates between min and max risk. When regime becomes favourable again, it accelerates rapidly.

The whole premise is early response to change in regime through position sizing

Another feature is trend maturity. Betting the same -1% at the beginning and at the end of a trend is asking for a serious kick in the money maker. Trends are born, grow, mature, get old and eventually die one day, just like believers in Efficient Market Theory. So, risk less as you pyramid.

Order management and hibernation

Along with the position sizing comes a vastly underrated feature in most order management: trade rejection.

Secondly, we use a position size threshold. When markets get too volatile and we experience some drawdown, stop losses dilate. As a result, position sizes get smaller. When sizes are too small, trades get rejected.

Order management is vastly under-utilised in most systems i have seen. It is often binary, all-in/all-out, or one way scale in or scale out.

In our system, taking profit off the table is a not a function of chart, technical analysis but driven by risk management. Until price goes a certain distance, exits are not triggered. If exits are not triggered, entries cannot be triggered either. Since volatility goes up and position sizes get smaller, the system drops into hibernation.

We have factual evidence that hibernation during an unfavourable regime is a powerful mechanism to weather regime change. It involves a lot more sophistication than muting indicators, slope flattening etc. It encompasses position sizing, order management, stop loss and to a lesser degree signals.


Multi-strat asset allocation based on pro-rated trading edge is the easy way to go.

Single strat across multiple market regimes means acceleration/deceleration but also hibernation. This is not an easy problem. There is one thought that kept me going through the frustration of figuring this out: “Building a system is like watch making. Time will always be off until the final cog fits in”

How does one address the issue of regime shift in algorithmic trading?

Can the Quant Meltdown of August 2007 repeat again in the future?

Can the Quant Meltdown of August 2007 repeat again in the future? by Laurent Bernut

Answer by Laurent Bernut:

This is an excerpt from the book i am writing on Short sellingimplosion

Start with the Shorts in mind

In August 2007, cross sectional volatility took all markets around the world by surprise. Indices did not move much in aggregate, but constituents jumped and crashed 2-3% across the board for two days. Then, rumours of quants funds, such as Goldman Sach’s flagship market neutral unwinding, started to spread. This was the beginning of the end for quantitative market neutral funds. Their short books were the culprits.

Quants had built those models where they had an arbitrage Long good / Short poor quality stocks. Since they were market neutral, the cash proceeds from short selling could be used to leverage up almost ad infinitum. Some funds were levered up 7 times. Leverage was used to magnify otherwise underwhelming returns.
Quality was working well on the Long side. All they had to do was match exposure on the short side. They had to continue short selling in order to match the natural expanding Long side. It all worked well until volume started to dry up during the summer months.

Liquidity on the short side and chain reaction
They eventually realised it would take them weeks to unwind their short positions. So, they proceeded to pare positions down to manageable liquidity. Since everyone with roughly the same models came to the same realisation around the same time, it triggered a chain that culminated into a messy cross sectional market.

Not so safe after all
Back in those days, market neutral funds were marketed as safe investment vehicles: equity returns with fixed income volatility. When some funds started posting -4 to -8% returns during seemingly quiet markets, investors panicked. Soon enough, redemptions started to come through.
Those redemptions forced managers to close positions, thereby adding more volatility. Prime brokers asked for larger collateral as Value At Risk (VAR) increased, thereby forcing funds to reduce leverage. With reduced leverage, increased volatility and piling redemptions, it was game over for market neutral funds.

Morale of the story
It all started with one simple mistake: in their minds, the short side just happened to be some byproduct of the Long side.
Morale of the story: whatever has the power to kill a business is not a sideshow. The short side may command higher fees and reduce risk, but when neglected it has the power to bring a business down.

This will happen again in the future as long as market participants do not take the dynamics of the short side into acount

Can the Quant Meltdown of August 2007 repeat again in the future?

The short-selling world according to DARP

Most market participants look at the short-side through their Long Only perspective. They believe that if they apply the same logic that has made their success on the long side to the short side, WorldAccording toGarpthen it should work. It should work but it does not. The Short side is still Terra Incognita, a vast continent populated with savage speculators. It obeys its own rules, its own dynamics. Newcomers to the world of short selling tend to be either too early or too late. Profitable shorts are at least as plentiful as long ideas. Market participants just don’t look for the right clues.
Stage 1: Contrarian shorts: from stratosphere to ionosphere
Market participants often come to short selling from the Long side. They believe in fairness. What is cheap should progress to fair valuation. Conversely, what is expensive should revert to fair valuation. Fairness is one of the very traits that transcends culture, race, and age. Toddlers have deep sense of fairness, long before they can speak. We are hardwired for fairness in a world that is not. Carrying that subconscious belief in the markets is a deadly virtue.
Market participants often see themselves as the lonely voice of reason amidst a delusional crowd. They may be right, eventually, but meanwhile  one single individual battling a mob is still an unfair fight. Stocks that have reached stratospheric valuations often have enough momentum to push to the ionosphere, before gravity reels them back in. Stocks on PE of of 100 have escaped the gravity of reason. They might as well go to 150, 200 or 3000. This is the rarefied atmosphere of permanently high plateau, paradigm change, because like before, “this time, it’s different”
Short selling something that does make sense does not make sense either. As Keynes used to say, markets can stay irrational longer than we can stay solvent.
From a portfolio construction perspective, this does not make sense either. On the long side, market participants expect fundamentals to improve and stocks to go up. They are in for the long haul. Meanwhile, on the short side, they expect imminent collapse. So, they are Long trend following and short mean reversion. Those have diametrically opposed reward to risk profiles. They have different P&L distributions and different sets of risks. Risks that are different do not cancel each other out but compound as they quickly realise. It is always painful to watch a short book accelerate faster than a dull long one.
Once market participants re-acquaint themselves with the old adage “the trend is your friend”, they are scarred enough to move to the next stage.
Stage 2: crowded shorts: the province of fundamental short sellers
The last 5% around the top and the bottom have claimed more market participants than the 90% in between.
When short selling by anticipation fails, market participants turn to shorting by confirmation. They wait for fundamentals and newsflow to deteriorate enough to place a trade. They have been scarred before, so they want every box ticked, every fact checked.
What they fail to realise is that if there is sufficient evidence to conclude that it is a short, there has probably been enough warning signs for long holders to bail for some time.
By the time short sellers have accumulated sufficient evidence to build a short case, long holders have left the building. Short sellers are left battling with one another over a dry bone. Those shorts  make sense, but they rarely make any money.
In fact, the reward to risk curve has inverted. Outcome is binary: either stocks goes to zero, either there is some corporate action: takeover, management change etc. One of my  London ex-colleagues used to say that a distressed stock going from 1 Euro to 50 cents is still a 50% decline. True: 1 to 0.50 is -50%, but only after 6 or 7 nasty short squeezes. The question is not whether stocks will get to zero, the question is will you still be there by then ?
In my time as a dedicated short seller, brokers used to call and pitch “structural shorts”. Structural shorts trigger a deep seated Pavlovian reflex: it makes me want to
  1. buy the stock
  2. graciously offer the borrow for free
  3. and send a box of chocolate to whomever wants to short. Chocolate  is a good therapy for smoothing the rough short squeezes ahead
Stage 3: Frustration and the despair of structural shorts
Contrarian shorts hurt. Fundamental shorts do not contribute much either. At this stage, market participants realise that the beliefs they hold about short selling may be right in theory, but still losing money in practice. Frustration and despair sets in. They have a couple of shorts and “hedge” their portfolios via futures. At that stage, market participants have literally no idea on what and how to sell short.
What happens when we lose your car keys in a dark corner of a parking lot? We go and look for them under a lamp post, where there is light of course. Market participants look for those structural shorts that will go down forever so that they can throw away the key and go back to their longs.
Market participants who publicly profess their hunt for structural shorts are unfit for managing people’s money for two reasons:
  1. Divorce from reality: Structural shorts are like market gurus: they are a dime a dozen. Profitable structural shorts are like market wizards, good luck finding one. Borrow is expensive and long holders have left the building a long time ago
  2. Abdication of responsibility: when they say they want structural shorts, what they mean is they do not want to be bothered with the short side anymore. They want to find something that they can throw in the short book and “forget about it”. This is an implicit acknowledgement of failure. They are happy to collect fees, but reluctant to do the work. There is obviously no hedge, no downside protection, no free lunch and eventually no happy ending.

At this stage, market participants resort to futures. They realise their vulnerability both versus the markets and versus their investors. The problem is futures do not offer much protection when markets tank. Besides, investors are understandably reluctant to pay exorbitant fees for something they can do themselves. They are willing to pay as much

Stage 4: Unplug from the matrix: reality is the time in between the “shoulds”

Between the time when Valeant was puffed up to “unsustainable valuations”, and the first analyst to throw the towel with a “Sell” rating, share price actually did go down by roughly -80%. There was no “beam me down Scottie”, exchange between share price and the deck of the Enterprise. Share price did go down over time, but market participants were institutionally blind to it.

Persistent short sellers one day wake up to the fact that between the time when “valuations should normalise” and when “company should collapse”, there is an extended period of time when share price actually does come down. Reality is the time in between the “shoulds”.
Stage 5: DARP: the un-sexy flip-side of GARP
Under-performing stocks are everywhere. They rarely reach extreme valuations, so they never feature on everyone’s target short list. They just trail their sector, the benchmark and eventually drop in absolute as well. They just slowly fade into oblivion, and this is why we have a collective institutional blindspot. There are three main reasons for this: psychological and wrong assumptions
Analysts color blindness
Analysts are color blind: everything has to be either rosy or dark grey. They are usually prompt to raise their ratings and their estimates when fundamentals improve. They are late to downgrade their ratings as they do not want to jeopardise their relationships with corporations, infuriate their investment banking colleagues and volunteer for the next chopping block. Estimates fall but not nearly as fast as they were once raised. There is built-in institutional inertia to factoring decline in ratings and estimates. Meanwhile, old stock market darlings just drop off the conversation and gradually fade into oblivion.
The second reason is psychological. As scientific as it may sound, fundamental analysis is inherently subjective. Facts just aren’t data; they are weaved into “logical” arguments called investment thesis. For fundamental participants to admit a stock could be a short, they must first go through the intellectual divorce of accepting that it is no longer a Long.
Fundamental market participants grieve their way into short selling. They go through the Kubler Ross cycle of grief. Only in the final stage do they finally wake up and accept that the stocks they once loved could be short. Everything prior is discounted, or ratonalised.
DARP: the un-sexy flip side of GARP
Many market participants invest on the Long side following a Growth at Reasonable Price (GARP) methodology. They look for visible growth prospect with reasonable valuation support. They shy away from hyped stocks.
Frothy valuations is the premium market participants put on growth prospects. Once growth prospects disappoint, the premium gets arbitraged away. Valuations come down to reasonable level, on par or at a slight discount versus their peers. This gives the illusion of fair valuation or discount relative to peers.  There is no news flow that would draw attention, such as big earnings revision, or product recall. Yet, growth may continue to be sluggish. Growth stocks move to the value camp, and value stocks drift to value traps. Stocks imperceptibly under-perform their peers, the market. Welcome to the world of Decline at Reasonable Price (DARP).
This notion of DARP is difficult to comprehend for most fundamental investors. They practice Growth at Reasonable Price (GARP) on the Long side.  So, they believe they should do the opposite on the short side. They naturally tend to look for unreasonable valuations coupled with unsustainable growth prospect, or even imminent collapse. As we saw before, the last 5% to the top and from the bottom have claimed more participants than the 90% in between.
Investors struggle to find shorts because they look for the wrong clue. They focus on rich valuations when they should look for relatively sluggish growth. This puts a glass ceiling on share price appreciation, i-e the famous “valuations stay cheap for a reason” argument.
In a nutshell, there is no smoking gun on the short side: profitable shorts do not stand out. The best way to picture a profitable short is to think of it as dull long stocks. On the short side, boring is good. Boring under-performs.
Conclusion: Empty your cup
The short side is is a vastly unexplored continent: the Terra Incognita of short-selling. It has its rules and its dynamics, largely unexplained.
Market participants come to the short side full of the assumptions they carry over from the Long side. The theory that they bring along has a sobering encounter with reality. This brings frustration, disappointment, anger and eventually atonement.
Yet, success on the short side carries its own rewards. Those who master the skill can craft their own performance profile, levy higher fees, attract and retain investors.
The short side has more than one paradox. Whilst volatility is elevated, success comes from looking for stocks that other investors casually dismiss as boring.
Let us know what You think, your experience. Comments are always welcome. Please share with your friends and colleagues