Stock trading: Is Short Interest Ratio (days to cover) no longer a useful indicator for short selling?

My answer to Stock trading: Is Short Interest Ratio (days to cover) no longer a useful indicator for short selling?

Answer by Laurent Bernut:

This ratio gives the illusion of usefulness. There are two variables here: volume and utilization. Volume tends to dry up in down markets but picks up in climaxes. So, number can improve as everyone else sells !

I actually built something akin to days to cover back in 2005, before it was even popular as Short Interest ratio. I thought back then it was slicker than shorting fee, which was a lagging indicator. I then realised the paradox of a declining number in a selling frenzy.

Market cap bias

Another distortion came from the market cap bias. Small caps are apparently hard to short because of liquidity constraints. Yet, older listings sometimes have surprisingly high percentage of borrow available. This means if You can sit through the volatility (I can’t personally), You may have a chance.

On the end of the spectrum are large caps with complex capital structures. They are liquid but hard to short.

Example: big institutions have complex capital structures and can be heavily shorted by all sorts of participants such as fixed income arbs, L/S, P/E mezzanine holders etc. They can be heavily shorted while having 0.1 days to cover. So, You can’t source the borrow or find it usury and poor quality while having the illusion of liquidity.

Borrow utilisation: clean and simple

I then moved on to something simpler, robust and unambiguous: short utilisation.

Short utilisation = Shares borrowed / Shares available for borrow

This has one variable. It unequivocally says if it is already heavily shorted. As a general rule of thumb, i cover my positions when utilisation exceeds 55%.

This is standard risk management procedure for two reasons:

  1. Limited reward to risk: beyond 2/3, it is fair to assume that bad news is old news. So, outcome is binary: either collapse or increased risk for minimal reward
  2. Cost: Short selling is a costly sport. The more heavily shorted, the more expensive it quickly gets.
  3. Short squeeze frequency: there are not many buyers of heavily shorted stocks. So, any bit of buying pressure can snowball into a short squeeze. It may not trigger my stop loss initially, but enough amateurs flushed out and it could eventually

Chain reaction, bad borrow, cost, limited downside, so why bother ?

Complexity is a form of laziness:

As with all indicators, work the math backward so as to understand what it is supposed to measure. In the case of “days to cover”, it is an imperfect view on short liquidation. It encourages a behavior to take small positions so as to avoid liquidity traps. It does not deter from taking positions however. Short ratio “days to cover” is a imperfect mathematical answer to a valid question: “if i short this stock, do i run the risk of not being able to cover in case of a squeeze ?”

Gandhi said that ahimsa non-violence is not avoidance of violence, it is avoidance of conditions that could lead to violence.Ahimsa

Do not short stocks that are  illiquid or prone to frequent short squeezes, and You will worry less about being stranded.


So, You are better off staying away from heavily short stocks altogether, which is recaptured in borrow utilisation.

Stock trading: Is Short Interest Ratio (days to cover) no longer a useful indicator for short selling?

Convex position sizing algorithm: something your brain can trade through euphoria and depression


There are two position sizes: too little or too much. Too little when it is working and too much when it is not. Of course, our inner idiot compels us to take too little risk when we should be bold and vice versa when we should be prudent.

Position sizing is this critical juncture between financial and emotional capital. Deplete the former and it will take effort to rebuild. It is a complicated problem, but not a complex one. Break the latter and “Game Over”.

On the short side, position sizing is even more critical: failures get bigger and painful, while successes shrink away. Over the years, I have experimented with many position sizing algorithms. Many of them were brilliant, but I would always drift away and abandon each one of them after a while. Then, I realised I looked at the problem from the wrong angle. Convex position sizing is the story of my journey

If You have encountered “fear of pulling the trigger” or if You routinely take too much/too little risk at precisely the wrong time, then this position sizing algorithm might be for You.


Part 1: The correct mathematical answer may not be the right one

The first part of the journey was to find out why I consistently drifted from conventional algorithms.

  1. Short selling is not a stock picking contest, it is a position sizing exercise

On the short side, the market does not cooperate:

  1. Volatility is elevated: that rules out systems like equal weight.
  2. Concentrated bets is a bad idea, as their volatility drives the short book and consequently the entire book
  3. Short squeezes are frequent: expect all shorts to rally >10% over 5 trading days
  4. During bear phases, correlation goes to 1. Expect Longs and Shorts to go against You at once
  5. Unprofitable trades balloon rapidly. So, the natural tendency is to be conservative and take small risks.
  6. Unlike the long side, there are no 2-3 baggers. Winners shrink and contribute less. So, there is an opposite tendency to oversize positions.

Bottom line: the short side is less a stock picking contest than a position sizing exercise. Winners get smaller and loser get bigger. The difficulty is to size positions so that they contribute when successful, but do not torpedo performance when unsuccessful.


  1. Two types of algorithms and two types of people

There are two types of position sizing algorithms: aggressive or conservative. Risk seeking systems will have You bet beyond your comfort zone, and sometimes lose more than You should. System failure means cumulative losses have permanently damaged your ability to bounce back.

Conservative systems will have You bet small and earn less than You could. Failure means returns are not attractive enough, and/or period of recovery after a big loss is too long.

There are also two types of people when it comes to risk: risk seeking or risk adverse. Risk seeking people have higher tolerance for the volatility that comes with bold choices. If they go too far, they may no longer have the resources to bounce back.

Risk adverse people accept underwhelming returns in exchange for low volatility. Their downfall is they are sometimes conservative to the point of being risk seeking. Failure does not mean they aim too high and miss their target. Failure means they aim too low and succeed.


  1. Regime Change, transition and drift

Now, the world is not Manichean. There are times when it is wise to be conservative, settle for a risk adverse system, accept to earn a little less than You could.

There are also times when it pays off to be aggressive, ride a risk seeking system, but potentially lose a lot more than You should.

The problem is that most position sizing algorithms are good at either one or the other. They are not equipped to transition smoothly from equity growth to capital preservation. A core principle is that systems must be followed throughout a cycle in order to achieve predicted results.


  1. The correct mathematical answer may not be the right one

The problem with many position sizing algorithms is not to find the optimal size that will achieve desired geometric returns. The difficulty is keeping executing through euphoria and depression. Of course, optimal f is the correct position sizing algorithm. The problem is my inner idiot thinks he knows better.

For example, “fear of pulling the trigger” is simply the inner idiot (often referred to as amygdala) saying those bets are too big. This fear gets reinforced after every loss in the thalamus. It eventually gets to the point where the brain overrides the algorithm, but rationalises decisions. Self-deception is insidious, it covers its own tracks.

I did not abandon any of the position sizing all at once. I just gradually drifted away. I failed because my inner idiot constantly second guessed what the algorithms suggested. Discipline is futile. It’s like diet: everyone puts those kilos back on in the end.

I therefore realised that the only way to makes more sense to build a position sizing algorithm that the brain can embrace and then figure out the math.


Part 2: Convex position sizing

  1. Philosophy of the convex position sizing

Convex position sizing algorithm was conceived backward. Math is subservient to the brain. It may not be the optimal mathematical solution, but it is one my inner idiot will have no problem executing during triumph and disaster.

So, I started out with a list of demands

  1. Trade at optimum risk: (accelerator)
    1. Accelerate to maximum risk during run-ups, but
    2. Decelerate quickly as soon as there is a drawdown
  2. Absorb volatility: (brakes)
    1. allocate maximum equity, but
    2. reduce risk drastically during severe drawdowns
    3. Avoid whipsaws due to premature re-acceleration
  3. Reduce risk for each new re-entry: (trend maturity)
  4. Simple input variables (risk appetite)

The best analogy is fuel efficiency. Flooring the accelerator and then slamming the brakes is not a fuel efficient way to drive. These are aggressive systems like Kelly criterion, optimal f and Fixed Ratio Position Sizing (FRPS). Driving like Mrs Daisy is lovely, but not necessarily the most competitive style. These are systems like constant Fixed Fractional Position Sizing (FFPS), equal weight.

Convex position sizing algorithm runs at optimum acceleration. It will take on risk as equity curves rises and reduce as it comes down. It will slam the brakes to avert accidents and then re-accelerate smoothly. Risk Per Trade is the accelerator and Equity would be the brakes.

One of the strengths of the algorithm is smooth transition from risk seeking to risk adverse. The algorithm focuses on drawdowns. As soon as there is a drawdown, risk is reduced. Conventional position sizing algorithms focus on winning streaks and thresholds. They are therefore slow to react.


  1. Fixed Fractional Position Sizing revisited

Fixed Fractional Position Sizing algorithm basic formula is:

Market Value = Risk Per Trade / Distance to Stop Loss * Equity

Most formulas focus exclusively on Risk Per Trade (RPT). With the notable exception of Market’s Money, few of them consider Equity (capital allocation or surface). The idea became clear to use both sides, one for acceleration, the other for deceleration.


  1. Convex Risk Per Trade

In practice, this is what Risk per trade looks like:image (1)

Risk per trade oscillates between a minimum and maximum. Trends mature, so risk per trade is reduced for each re-entry. Convexity comes from the ratio of min/max risk. In this example, min risk is set at -0.25% and max risk at -1%. The bigger the ratio the steeper the acceleration.

How to calculate min and max risk per trade

  1. Max Risk per Trade: Risk Appetite / [AVG number of positions * (Long Term Loss Rate + 2 STDEV(Loss Rate)]
    1. Risk appetite: is not a mathematical number. It is the drawdown investors are willing to stomach before redeeming. Whatever You think that number is, divide it by 2. This is a clear case where You do not want to be right !!!
    2. Long Term Loss Rate: ideally, this is the win rate through the entire cycle. When there is not enough sample data, default to a conservative 2/3. That means 2 trades out 3 will fail. 51% Win rate is for fairy tales, and Prince charming is not coming
  2. Min Risk per Trade: this is the minimum RPT that would still allow trading during drawdowns
  3. Position count: Trends mature. Risk should therefore be reduced after each entry so as to avoid giving back profit on last entries

Risk appetite is one of the two input variable of the entire posSizer algo. Everything else is calculated.


  1. Drawdon module

image (4)This is the equity allocated to each trade. The objective of this component is to absorb small daily volatility. As a drawdown becomes severe, surface is exponentially reduced so as to collapse residual risk. Note the slope of the curve. Small recovery results in rapid increase of the surface.

Trading floor: this is the second input variable. This is a percentage of equity balance that will be allocated if drawdown exceeds tolerance. A good example here is Millennium partners. After a drawdown of 5%, equity is automatically reduced to 50% of initial capital.

When investors say they can stomach a 20% drawdown, what they mean is they will think about redeeming after a 10% drawdown. So, it is wise to cushion the blow with this drawdown module.


Part 3: Convex position sizing in action

This posSizer runs on auto-trade Metatrader MT4. We trade closer to 30 currency pairs, leveraged at 100:1 on 15 minutes periodicity. This is probably as aggressive as it can be.

It feels like being in a driverless Formula 1, without a steering wheel, pedals for accelerator and brakes. Yet, thanks to this algo, there is no need to stay glued to a screen all day. This posSizer provides priceless comfort when most needed. It will smoothly handle trouble: reduce risk, collapse it if necessary and then re-accelerate rapidly.

This is what it looks like in practice. Below is a hypothetical equity curve (GS stock price). The real equity curve does not have those big drawdowns, so it is harder to distinguish.image

Blue and pink lines are min and max market values per trade (MVPT). Green lines are market values for each position n1 to n4. Orange line is first entry without the drawdown module.

As equity curve rises, MVPT rises in unison. MVPT reacts rapidly to each drawdown but still remains closer to the upper bound until a more pronounced drawdown happens. Risk is reduced for each new tranche.

The drawdown module kicks in during severe drawdowns. This is the difference between the orange and green dotted line. MVPT goes down even further than minimum risk. There are times when even small positions seem too big. This ensures trades go through but at bare minimum risk. This reduces concentration, which in turn sets the stage for a rebound.

One of the problems of FFPS is premature re-acceleration after a drawdown. This leads to whipsaw in sideways markets. This is again a potential reason to drift from suggested positions. After a severe drawdown, the orange line rises faster, while the dotted line adjust re-acceleration to the speed of recovery. For example, the first drop below min risk was followed by a prompt recovery. The second one was more gradual.



Under extreme stress, every degree of freedom, every bit left to interpretation has the potential for costly human error.

Position sizing often overlook the most important component in any trading system: our inner idiot. This algorithm reconciles math and affective neurosciences. It helps us “meet with Triumph and Disaster, and treat those two impostors just the same”, extract from Rudyard Kipling, “If”

In investments, does more risk really equal more return, in the long haul?

Answer by Laurent Bernut:

This morning Palermo time, Andrew Swanscott from Better System Trader podcast interviewed me. The above question came up.

The answer is Yes and it is No, the real question is when. Best analogy is driving, will driving faster get You to destination: Yes when on the highway but No when in downtown.
I define my identity as a professional short-seller. As such, I have a different relationship with risk than most people. There is an interesting paradox in short-selling:
  1. If You are wrong, your position balloons and hurts immediately
  2. If You are right, it helps less and less
So, the whole game is of short selling is about position sizing and risk management:
How can positions be sized so that they would contribute but not hurt ?
This is probably one of the tallest order in fund management.

Between Charybdis and Scylla: Open Vs closed risk dichotomy

People perceive risk as either static, as in constant or completely random.

The perilous trip of the ship of Ulysses between Scylla and Charybdis.

The perilous trip of the ship of Ulysses between Scylla and Charybdis.

Well, it is somewhere in between and it depends on how You trade risk in the first place.

It reflects back on the concept of open versus closed risk. Open risk is the tropism of mean reversion strategy. Everything hums fine until the big iceberg. Closed risk means risk is capped.
Your view of the world will shape your risk profile. If You run an open risk model then because of its inherent unpredictability You are condemned to run it at low risk ad perpetuitam.
If You run a closed risk, then You can accelerate and decelerate within the bounds of your risk tolerance.

Accelerator and brakes

This is one of the most profound discoveries I made in 2015. there are two types of people when it comes to sizing a bet: those who take risks and sometimes get hurt along the way and the risk adverse crowd who will consistently take minimal risk.
I think this relates to the essence of the question: Can I build a system that preserves capital when strategy does not work but takes risk when it  does.
I think I can answer this one with good wisdom. Please read this post:
The thought behind the math was this: is there a middle ground between pedestrians and F-1 racers ? I think I found the formula. Please read the above post. We have used it and it does wonders, beyond what i theoretically expected in fact:
  1. When good times roll over, risk per trade is extremely responsive: brings risk to minimum right away.
  2. Concentration decreases: smaller risk per trade means smaller positions, means lower concentration , more positions, diversification
  3. But because surface does not change dramatically, position sizes are fairly reasonable. They do not swing from 0.15% to 15%
When the sh*** hits the fan, everything goes into Guantanamo, but it can still trade and thereby reboot itself.
  1. The skew of the convexity means that every marginal cgains translates into buying power restoration
  2. That posSizer is the best sleeping pill i know
I am sorry if i came across as boasting this position sizing algorithm. The point was that nothing is static. The answer You are looking for is in your position sizing algorithm.
Subscribe to my website to get free material, resources. Subscribers have free resources, files, code. Moreover, your feedback keeps me going on Quora
In the end, ask yourself this question every time You think about sizing a position: can I live with earning a little less than I could or lose a lot more than I should ?

In investments, does more risk really equal more return, in the long haul?

Better System Trader 2nd Interview:


Andrew Swanscott has one of the best podcasts on trading out there. He has brilliantly interviewed world trading champions, legends such as Van Tharp, Larry Williams, Jerry Parker, Perry Kaufman etc. In each episode, there is a nugget of wisdom. One word of caution though: Better System Trader is more addictive than chocolate.BetterSystemTrader

It was an honour to be interviewed on episode 32.

With the recent “soft patch” in global markets, Andrew decided it was time to catch up and go deeper into topics such as psychology. Markets are stressful on the long side already. On the short side, pressure is something else entirely.

Thank You very much for all the questions and comments on the website. If You have questions You would like to ask on the podcast, please go to the link below:


Topics covered this time will probably be:

  1. How to improve your trading edge ? (This is a question from a reader, thank You). A post will follow shortly
  2. Sherlock Vs the Red Queen: why people fail at short selling ? You will understand the trappings in which people coming from the Long side fall. This topic has never been approached from a statistical perspective.
  3. The psychology of Stop Loss: did You notice that your desk is cleaner when You can’t close a bad trade ? We all know that cutting losses and riding winners is the key to success. We will go through evolutionary psychology, affective neurosciences. We will teach You how to reframe stop loss and trade like a psychopath
  4. Jedi trading: if You want to be the iceman on the trading floor and if You want to switch from fight, freeze or flight syndrome to flow state in less than 2 minutes, then practice this technique
  5. if we have time: why You should not be afraid of this bear market, Einstein and monkeys and the importance of Chuck Norris


@Quora: In trading, how can I stop getting emotional?

Answer by Laurent Bernut: @Quora: In trading, how can I stop getting emotional?

Excellent answer from @Nate Anderson. Viktor Frankl (Man’s search for a meaning) survived both Auschwitz and Dachau. One of his most profound lessons was that: “between stimulus and response, there is a space called freedom”. You cannot control what is happening to You, but You can control your response.

The paradox of systematic traders and psychology

Every systematic trader who writes about building trading system devotes a lengthy chapter on psychology. Meanwhile fundamentalist hardly ever talk about psychology. You would think that mechanical traders would care less about psychology and people who rely on their judgement talk more about it.
My theory is that systematic traders experienced mentally devastating losses which prompted them to develop systems so as to remove emotions. Along the way, they managed to quantify their systems and realised that after all is said and done: 90% of trading is mental, the other half is good maths.
Bottom line: Your emotional hijack means You do not have system yet

The counter-intuitive trick about system development

Most people who develop systems fail to execute. There are two reasons: they focus on the wrong thing and they don’t have faith in their system.

Wrong focus: the only soldiers who do not have exit strategy are kamikaze

People focus exclusively on entry and consider exits as an after thought. They have it completely backward. Entry is a choice, exit is a necessity. Emotions kick in once a position is in the portfolio, not before.
Real life example: Long IAU strike 11 April 2016 options at 0.20 on entry date. Actually, I had my eye on the 12 strike but a fat fingered Viognier Zibibbo called Abraxas (how can You not surrender to that deadly combination ?) got in the way of trading. I felt bad for a couple of days and then moved on, c’est la vie.
Now, let’s say i would have bought in the chrematocoulrophony (financial jesters) and sold the same option on that day. Current value is 1.20 with 2 months time value left. That is -500%. This thing would have drilled a hole in my portfolio through the center of the earth and pop out somewhere in Antarctica. It would have drilled a hole in my brain. I would feel trapped without a way out.
Bottom line: system development starts with the exit in mind.

Corollary: Peace of mind

Before: no clear exit strategy. I used to read every single news, check prices 2-3-5-10 times a day. I was always torn between running positions a bit longer (greed) and taking money off the table (fear).
After: exit strategy for every contingency: It brought immense peace of mind. There were three booby traps: stop loss, profit target and on the time axis trend reversal. I knew that unless an exit condition was tripped, positions would run their course. I had harnessed volatility. I checked price once a day, the rest of the time, I was one of the heaviest users of  YouTube on earth. This lead to surreal conversations with my boss:
– “What ! Are You watching another Shaolin flick ?”, he laughed
– “Why ? You are not ?”, I replied vaguely outraged by his lack of cultural curiosity “Time for some off-site (code word for plundering the Roppongi Enoteca wine shop) ?”
– “it’s only 4:00 pm”, he said looking for a feeble excuse
– “Yeah, I know late start, let’s get into position for the happy hour”, with high conviction for the day

Systematic execution and pregnancy

Developing a system that works is the hard part. And then executing it day in day out is the hard part. This is where a lot of guys trip in the carpet. They spend considerable time developing a strategy that they run until it stops working. Then, it is back to the drawing board, tweaking endlessly, waterboarding it until it confesses. Two reasons:
  1. Complexity is a form of laziness: I have seen a lot of systematic strategies. The most fragile ones are always the most complex ones. Optimisation is the poor brain solution
  2. Faith: We trade our beliefs. The best example is Markowitz, the father of the half century old modern portfolio theory (MPT). At the end of his career, a journalist asked him the composition of his portfolio. The inventor of the efficient frontier candidly replied: 50% stocks, 50% bonds. I rest my case
Bottom line: systematic trading is like pregnancy. Either You are pregnant, either You are not. Sorry, but You can’t be un-pregnant on ladies night.

Trading is 90% mental, the other half is good math


Ray Dalio meditates, twice a day. I rest my case. I meditate every day, sometimes twice during rough markets. Before trading, I seat in silence 2 to 5 minutes until presence.
Check Rande Howell at Trader State of Mind. His work is unique and transformative. He works on the Pearson Marr or Jungian archetypes. I cannot recommend his work highly enough.
I would highly recommend the App called It is reasonably priced and has excellent guided meditation.

Journal your journey:

Journal your journey through the markets. Journal your emotions, when You are making money and when You aren’t. Pay particular attention to your fears when losing money.
I am working on a format that could be useful and meaningful using Google sheets and Evernote. There are some elements of Nathaniel Branden’s stem sentence completion exercise. Mr Branden is famous for his work on self-esteem and deep belief elicitation. There are also elements of Byron Katie’s work. Finally, it is brought together in a quantitative format using Google Sheets.

Trade with fear

Some charlatans recommend to trade without fear. That is not how the brain works, at all. Tell the antelope that a lion is just a confused cat. Fear is a signal. Fear is an evolutionary mechanism that has kept You alive to this day. Ignore it, it grows and soon enough it infiltrates your trading, it cripples your action.
Fear exists in the shadow. Name it, face it, and then physically walk through it. This is why it important to journal your experience.
Fear is vastly underrated. It keeps You sharp. Size your positions as though You expected them to fail.


Athletes train to visualize their performance. There are clinical studies that show that athletes who visualize their performance have more muscle mass than those who don’t. Surprisingly enough, those who simply visualise without physical effort have higher muscle density than those who neither train nor visualise.

Visualisation does not mean seeing oneself on the podium with a gold medal, laughing under the cameras. That is wishful thinking. Visualisation is rehearsing procedures to overcome obstacles, feeling fear arousal and bringing calm response. It is about setting anchors that will trigger neuro-physiological responses.

At elite level, athletes are in similar physical shape. The difference that makes the difference is mental preparation. Best example is Conor Mc Gregor versus Chad Mendes. He won the fight mentally before he won it physically. He was on the ground, pummeled by some severe elbows to the head. Meanwhile, he was laughing: “is that all You got ?”



Airplane pilots have checklists. Firefighters have checklists. Surgeons have checklists (read Atul Gawande’s “Checklist manifesto”). Bottom line: these are highly skilled, highly trained professionals who have responsibility for human lives. They swear by checklists.
Meanwhile, finance people believe it is beneath them. Investing is supposedly an art. Checklists free up some precious bandwidth that can be used for thinking. In this ultra competitive sport called trading, every extra bit of mental bandwidth spared is a competitive advantage over emotional traders.
Great investors are not smarter, they have smarter habits. Break all your tasks in small specific checklists.
Example: my short sell checklist
  1. Check risk per trade and lots: if position small (i-e too volatile), then reject
  2. Check exposures & balances: if trade exceed risk, then reject
  3. Check borrow cost and availability: if expensive, then reject
  4. Set Stop Loss on platform GTC
  5. Sell Shares at Limit validity 1 day
  6. Take break, do something else: cool down and refresh (2-5 mn)
  7. Verify one last time and send
My entire workflow is broken down into small checklists: Buy to Cover, Buy Long, Sell Long, trade reconciliations, trading signals, portfolio management system update, etc. This helps a lot during stressful times.


When we are on the bus in a new city, we check every stop, every building. We are afraid of missing our stop. Before getting on the bus, our stress hormones are mildly activated. Once in, stress hormones go up. Bottom line, exit matters. Think about them before entry

Success is habit. Unfortunately, so is failure. They have the best habits.

Trading is mental: profits are a side effect of inner alignment between deep seated beliefs all the way to daily routines.

In trading, how can I stop getting emotional? What-do-the-fund-managers-that-consistently-beat-the-market-do-differently-when-picking-stocks-than-those-who-cant-beat-the-market
Great fund managers are not smarter, they have smarter portfolio management habits. Making money is not about trying to be right, it is about accepting to be wrong and move on. That is much easier for married men…

Portfolio Manager serenity prayer

No manager consistently beats the markets. Every style has its peaks and valleys. The difference is how managers weather those periods. Profits look big only to the extent losses are kept small. If You know when your style is out of favour, then fold, take less risk. Making money is about accepting to be wrong and move on.

Risk and trading edges are not stories, they are numbers

Finance is the only industry where science fiction is smack in the middle of the marketing pitch and nobody calls the bluff. Ask any manager what their trading edge is and they will weave some positive science fiction story that would put LafayetteRon Hubbard to shame.
Read Jack Schwager’s and Mike Covel’s books and the common thing between all market wizards is their understanding of risk. Risk management is not part of the business. It is the business.
You just cannot meditate enough on this formula
Stop Loss is the 2nd most important variable
Look at the above formula. Stop has a direct impact on the following variables in your system :
  1. Win%: the tighter the stop loss, the lower the win rate
  2. Loss% (1 -Win%): and vice versa from above
  3. Avg Loss %: stop losses cap your losses. BTW
  4.  You can’t buy if You are fully invested
  5. Position sizing: anchor your stop loss and limit prices for position size
Many books were written about cutting losses short and running winners. Very few were written about riding losers and cutting winners.

90% of trading is mental, the other 50% is good math

Making money in the markets is like diet: simple but not easy: eat less, exercise more. Simple, yet the number of obese people continues to go up, not easy. Making money in the market is simple: buy stuff that goes up and short stuff that goes down.
The difficult part is the inner chatter, the beliefs we hold. Great managers have exceptional inner alignment from deep subconscious beliefs to daily routines and habits. Setting a stop loss and honoring it is not a debate: it is a habit.
Some people have subconscious beliefs that they are not worthy of the money they make. So, they sabotage. Some people have fairness as a core value, so stocks should revert because they are too expensive or too cheap. Well, life is unfair and so are markets. Fairness is hardwired in us, It is also a destructive belief.
I have an exercise about eliciting deep habits, but it is a daily struggle.

Complexity is a form of laziness

Long term performing managers have worked hard to simplify their process. Complexity is fragile.
Stress is designed to de-activate the thinking brain. It is an evolutionary built-in feature. If You start thinking that the lion chasing You is in fact a confused cat with some unresolved oedipian complex, then You are lunch.
Markets are stressful. So, it is impossible to execute complex sequences under heavy stress. This is why people make stupid (referred to as sub-optimal) decisions under stress.
Fear makes anyone piss their pants. Fortitude is the ability to work with wet pants.

Grandmother’s advice on advises

Only take advises from people You want to look like. That just took care of 95% of glorified journalists otherwise referred to as experts and market gurus.
You are 100% responsible for your own decisions.
The attitude towards mistakes is fundamentally different. I worked with one fund manager who one day called me to his office to talk about a stock he had some loss. This stock was literally the best performer that year (pure veteran’s luck). After being told that I should have insisted, I finally answered: “R…, if we are here having this conversation, it is because 1) i told You to buy 2) You did not and thought it was a stupid idea 3) You watched it go up 4) You felt frustrated 5) You bought at the peak 6) Now You nurse a loss, feel frustrated and want to blame somebody.”
There is an interesting book called mindset about fixed versus growth mindsets. Finger pointing is a classic fixed mindset attribute, quite destructive in trading

Why is humility an essential trait of profitable short-sellers ?

January 2016 was a difficult month for investors. According to Barry Ritholtz:s, 93% of investors lost money. Feeling helpless and crushed while watching your investments melt away is a terrible feeling that takes a devastating toll on emotional capital. There can’t possibly be anything worse feeling, except perhaps a skill aspiring short sellers have to master, humility.

If You want to profit from a bear market and if You want to hold your short positions long term, then You probably should read this article.

Turning away from the gates of Valhalla

In January, my performance roared out of the gate. i was up at around +5.9% mid-month. i was timidly positioned for a cautious slow start with a gross around 150% and -0.12% risk per trade. Despite being ridiculously conservative and vastlyunder-participating, performance was there day after day. Returns were not only one-sided either. It was quality performance : Longs pulled their weight too: sugar, gold, Fixed income, Forex USD Bull. This is the stuff hedge funds are made off. i have long argued that the secret to AUM is to perform when no-one else does. This was it. And then, i saw it coming. i even wrote a post about it on the first day it happened, January 20th . A short-squeeze was under way. At this point, i could have closed all positions, walk away with +5.9% and be the one who closed right at the bottom. The gates of heaven were opening: Valhalla, shiny and chrome.

But then, i did the unthinkable. i went to work, methodically reducing bet sizes. i chose to take as little profit as necessary. i chose to forfeit all those profits and promises and then sat by the side of the road, waiting for the market to humble me all over again. And sure enough it did. It peeled off rock star returns, money for my family, fame, marketability, anything anyone would have aspired for. By the time Mrs Market was done with me, i had lost 90% of my gains: i went from +5.9% to +0.59% in less than a week. i was humbled alright, but i ended up profitable still. More importantly, I am better positioned now for round 2. Humility is a critical skill and below are the lessons from my journey

Two certainties in life: death and short squeezes

There are two certainties in life: death and short squeezes. There is no way to predict how long, how brutal short squeezes will turn. Why they happen is irrelevant: exhaustion of selling pressure, irrelevant but reassuring good news, government gesticulation, monetary intervention. Whatever the reasons, short squeezes are part of the short landscape and i have to deal with them.

Someone told me that short selling a stock at $1 can still yield a juicy 50% return if it drops to 50 c. True, at least in theory. The real question is would he still be there after price rallied from 52 c. to 70 c., or 30% in 4 days ? Very few people have the testicular fortitude to hold steady. i don’t, and this is why i have developed a methodology that enables to ride short squeezes.

The triple R methodology to weather a short squeeze

Short squeezes happen with 100% certainty. It is not about if, only about when. Rather than thinking of them as pestilence, i came to appreciate them and make good use of them. After all, they provide good entry points, plentiful borrow and flush amateurs (it is hard to feel sympathy for impatient people who jump in the water after vaporetti). Without further ado, here is the triple R methodology:

  1. Reduce: bet sizes as soon as You perceive a short squeeze
  2. Ride the squeeze. Do not short sell on the way up, but trim Longs that got clobbered in the downturn
  3. Reload: once the squeeze fades: lower stop losses and top-up existing positions

In practice, it looks like the chart below:


i am a trend follower. My objective is to ride positions as long as trends are valid. So, as soon as i see a squeeze coming, i reduce risk. i cannot control how vicious and how long they will last, but i can control how much damage they will inflict to the portfolio. So, the first step it to reduce bet sizes, so as to capture some profit and reduce subsequent potential damage.

Whether You trade German Bunds, US equities or colorful language with your significant other, You deal in one thing: risk. Risk is not a story. Risk is number. Since there is no way to predict how unpleasant a squeeze will be, it is prudent to bring risk to neutral as soon as You see it happening

Above is a picture of my portfolio in late January:

  1. Open Risk (pink bars) = Shares * (Cost – Stop Loss) / NAV
  2. CTR (Contribution, light green) = [Shares * (Price – Cost) + Realised P&L] / NAV (Scale out model, hence realised P&L)
  3. Weight (blue bars) = Market Value / NAV
  4. Weight at risk (orange bars) is weight (blue) where Open Risk (pink) is still negative

In simple terms, i try to bring the orange bars to neutral. At the onset of a squeeze, my objective is to have as many positions as possible with a neutral or positive risk carry. There are several ways to do it, but if You are new to the method, just halve your positions. Example: if You have -0.50% open risk and +0.25% profit, halving the position will reduce risk by a factor of 4: from -0.50% to -0.125%.

Important: make a note of the mental chatter while You are closing your positions. Which side wins: fear with “close it all, You don’t know what tomorrow is made off” or greed “just one lot, and leave everything on the table, that’s the way to get rich”. This mental chatter is an important window into your psychological market make-up. Journal your thoughts and emotions, You will find treasures


“Everybody’s got a plan until they get punched in the teeth”, ​Mike T​yson Mysteries

Now that all the hatches are closed, that i am safe and sound in the cockpit, time to find this bottle of stiff spirit and roll with the storm. The only permissible trades are Longs: close poor performers during squeezes and buy resilient stocks as they underperform.

The hard part is to accept to let go of your paper profits. You have to accept that short squeezes will come and go, that they will wreck your portfolio and that You will have to watch it happening and keep calm. This is part of the game. Roll with the punches.

Important: Journal your fears. There is a tremendous wealth of information here. This is an exceptional opportunity to learn about what makes You tick.


“it is not about how about hard You can punch, It is about how hard You can get punched and keep coming back”, Rocky Balboa

The whole purpose of the method is to go past the squeeze and reload. Alright, i got humbled, but i am still standing and now it is my turn to hit back. In the above chart, the positions with long green bars have gone through multiple stages of reduce/reload. Australia, Junk bonds, oil, natural gas and Jim O’Neil’s BRICs have delivered over time.

Once the squeeze is over and stocks start to roll over again, it is time to:

  1. Reset the stop losses lower: swing high + n * ATR
  2. Reload existing positions
  3. Reallocate resources to new promising shorts

Example: SPY was entered at 202. It represented -3.8% of the portfolio. Only 0.8% was necessary to cover so as to ensure break even on the remainder position. Previous stop loss was at 209.92. Current stop loss is at 201.23, below cost. This gives +0.15% of positive risk carry to be deployed to another tranche of SPY.

​Short-selling is not like Long buying: You cannot buy once and throw away the key. Shorts shrink, so You have to keep topping them up. Every time a stop loss is lowered, residual risk decreases. This goes far beyond eliminating risk. Positions continue to accumulate positive carry along the trend. This gives a distribution like the chart below where best performers have 5:1 reward to risk.

The -1 peak stands for positions being stopped out. Failure is the primary ingredient of success.

-2 and below positions are positions that woke up way below their stop losses. EWM was a good case in point: i closed a Short, open a Long and a week later the position lost 30% overnight. Volatility was high, so size was small anyhow. It was unpleasant but not hurtful.

As You can see, the methodology is simple: reduce risk, ride the storm and reload. Yet time and again, i have failed to execute and in the beginning at least so will You. Now, would You like to know why ?

Marshmallows, or why i used to fail to execute a simple methodology as the triple R

90% of trading is mental, the other half is just good maths. The triple R methodology relies on three principles

  1. Commitment: this methodology only works if i am committed to hold your positions long term. If i just want quick gratification, i will take profit too early and never allow them to fully mature. Similarly, i would never have the stamina to be slapped around so much
  2. Clear trading plan: commitment is directly proportional to the clarity of the trading plan. People don’t fail because they don’t have a plan. They stumble because they have complex ambiguous ones.
  3. Mental reframing: We are hardwired to do the exact opposite of the triple R​Loss aversion: Kahneman Tsversky have demonstrated that we are risk adverse with profits and risk seeking with losses (i am writing an awesome must-read & practical post about this + Jungian archetypes and neuro-chemistry BTW, so stay tuned)Process versus outcome: performance is the outcome of a good process. ​​delayed gratification: the single predictor of success in life is whether You will eat the marshmallow. Behind the adorable cruelty there is a profound principle Faith: it is simply the perseverance to trust and execute a plan. In the Jungian archetypes, those are the resilience of the orphan combined with the vision of the magician and the discipline of the ruler

Beyond the fascinating academic research on the brain, i came to find a simple conclusion. The reason why i failed was poor habits. As soon as i became conscious of my habits, i became able to fashion new ones. A simple habit is to reset stop loss. Another is to take profit at the onset of a rally. A third one is strict position sizing. All those habits have fashioned my investing style.

So, when the short squeeze was upon us, it was not hard to step aside and let it pass, however petulant it could be. It is a habit now.


“if You can meet triumph and disaster, And treat those impostors just the same”, Rudyard Kipling

The short side is the Antarctica of the markets. It is out there, not too far from civilization, but vastly unexplored at the same time. My stance on short selling is simple: if You think a stock is short, don’t fool people with writing a book about companies fooling people, don’t talk your book to Bloomberg reporters, don’t sue companies. Just locate some borrow, place the trade and let the market give its verdict. Those are no market wizards strategies, those are marketing wizard gimmicks.

Being a good short seller requires a lot of humility. A short squeeze is always around the corner. It takes a lot of strength to forego instant gratification for the sake of long term rewards. So, when the month ended at +0.59% instead of +5.9%, did i feel bad ? Of course, it hurt, but then: Mr Short Squeeze, is that all You got ? Now, my turn…



My @Quora comment on an answer to What does it mean to short the volatility index?

My @Quora comment on an answer to What does it mean to short the volatility index? :

My @Quora comment on an answer to What does it mean to short the volatility index?

Don't You have a better bad idea ?

Get a better bad idea


If You ask this question, it means one thing: You are an amateur and You are not worthy of trading it.
VIX is one of the hardest instruments to make money on. I know only one person who can make money out of VIX, my ex-boss. That is not because he is a spectacular investor (sorry dude). That is only because VIX is the ultimate mean reverting instrument. It is like Harry Potter’s philosopher’s stone. Only those who are pure mean reverters at heart can touch it. The rest, they may suffer from some reverse Midas curse, they touch it and they turn to sh!t…
I have watched the skew on it [silently swallowing my saliva] . It mean reverts by definition. This means You Long it when no-one wants it and You sell it when people panic. OK, easy so far. The problem is how do You size it and where do You stop it ?
My ex-boss showed me how he does it. He milks it well on his PA account. He has tripled his size, but it was funny to watch how scared he got when i asked him if he would like to do it as a job. He said no 8 times in a row, waving hands and getting all agitated (he had to be sedated with some Pinot Noir thereafter), and the guy tripled his account… I can’t do it and I am a professional short seller: Babylon on the markets like now, and I am ridin’ that bus (so much for slow humble start…) . But VIX you said, why don’t you go first ? I am too scared
Jon Cooper
+1; this is pretty much the consensus view among successful structured index vol traders I’ve known. Also, you really want to do this on a portfolio and cross-market basis if possible for diversification’s sake. Some people use various flavors of vega weighting but the most successful ones I’ve known use simple, old school  breakeven and max loss analyses.
Gopher Lee
So trading the VIX is stupid? Okay. What about trading regular european options?  Where do I go to learn to short sell? How can I trade individual stock options on the Taiwan & Korean stock exchanges? Nagoya Stock Exchange?  There are A lot of opportunities in overlooked exchanges.
Laurent Bernut
Hello Gopher, I have been invited to post a trading journal on Whotrades. I will post signals, my trades on my website: Alpha Secure Capital | Alpha Secure Capital as well. I am honest about the stuff that I trade, how I do it, how i approach risk and so on. Is this the kind of stuff You would like to read ? Trading Journal 2016/01/20
Yesterday I went Long IAU, the ETF for gold. I go out of my way not to know what i trade but when something comes with a Buy signal amidst capitulation, something tells me the inverse correlation force is strong with that one. It turned out to be gold. OK, so I placed a limit order and then realised i could do something better with the remainder risk budget. I bought April calls OTM 12 for 0.20. There is a lot of theta there still. Plus, with my trading style, I will sell some underlying to cover the cost. In fact ETF needs to move less than 3% to get there. OTM reward to risk is 7:1 + underlying to compensate. Well, it has a lot of kick for not much. Doe sit help ?
Now if you want o short using options, I would buy put spreads or sell call spreads. It caps the risk neatly. You may even go as far as 3 by so as to have a bit more juice. Makes sense ?
And yes VIX is stupid for those reasons:
  1. Let’s say You short around 40. Every now and then it shoots up to 60. Well You are forced to close unless You wait until it comes down again.
  2. Meanwhile, it drills a very visible hole in your portfolio
  3. Since the key to raising AUM is to perform when no-one else does and You just got bitch slapped twice, investors rightfully conclude You don’t know what You are doing and pull the plug.
  4. OK, round 2. You got burned once and decide to wisen up next time: size position a little more conservatively Well, if it does not hurt in the first place, how could it contribute then ? It is not a hedge, it is a “feel-good hedge”
  5. Meanwhile, it is expensive
  6. Bottom line: get a better bad idea

What are your best short selling ideas right now?

Answer by Laurent Bernut:

This is answer to a question on


Life is unfair, so are markets, get used to it

This is a novice question that lead to two unprofitable biases: fairness bias and confirmation bias

When new to the fascinating short world, we want to short overvalued stocks. They believe that this has gone too far and that it “should” go down (same grammatical “should” as there “should” be peace on earth BTW).
We are hard wired for fairness. Even before speaking toddlers understand fairness. One of the subconscious beliefs behind this reversion to the mean is fairness.
Well, life is unfair, markets are unfair, let’s just get used to it. Overvalued stuff  often becomes ridiculously overvalued. Remember this please: pioneers are the ones with arrows in their backs

2nd stage, when we have lost enough money playing vigilante, we often turn ultraconsetvative. We want every box to be ticked, every fact confirmed. Every bit of information has a price tag in the markets. So stocks drop like stone, waiting for confirmation is an expensive habits.

If you want to be consistently profitable in the short selling world, change your mindset from outcome (need to be right bias) to process (probabilities). Probabilities are calculated risk assuming <50% hit ratio.
Short selling is a psychological & probabilistic game

What are your best short selling ideas right now?

Why do 100% of economists say that it’s hard to predict stock prices?

amygdalaAnswer by Laurent Bernut:

“Forecasting is a difficult business, particularly when it is about the future”, Yogi Berra, modern American philosopher
Economists are extraordinarily helpful at predicting … the past. They will give today a savant explanation as to why their predictions for last week did not pan out. Economists gather some attention during bear markets when all predictions turned out be wrong anyways and investors want to gauge the “real economy”. Now, not only economists are wrong. Analysts are appalling and strategists are laughable. We, as a species, are biologically incapable of forecasting anything.
Experts cannot predict
In early 2008, before the GFC, my friend Marco Dion, quants guru at JP Morgan, wrote a piece about analysts earnings forecast accuracy 1 year out.
The probability of being spot on is a whooping 2%. The correct terminology for such low percentage is statistical error: “oops, I got it right”…
The probability of being +/-10% was 25%. That is half a coin-toss.
I used to compile strategists’ predictions published in Barrons and measure forecast accuracy twice a year. Fasten your seatbelt. If You thought analysts were bad, You haven’t seen anything yet. Forecast accuracy of Barrons roundtable was 17%. That is simply a few notches below useless, that is laughable.
(The primary reason why strategists were so low is primarily the broad range of questions from interest rates to currency, S&P levels. Within their domain of competence (fixed income, equities or currencies), they were relatively OK  but were tragic everywhere else)
Why we can’t predict 
Our “ability to predict” is located in the prefrontal cortex. It is the siege of our thinking brain. Now, within that brain, there are several regions invoked every time we make a prediction.
“High conviction” predictions trigger a zone called the ventro-median prefrontal cortex. The interesting part is the dorsolateral cortex, where our ego and identity gets activated. Hal Hershfield has observed through fMRI dual activation in those regions when subjects asked to make projections about their financial well being claimed to have good financial literacy. In other words, people who claimed they knew something about the subject were also more prone to overconfidence. Our forecasts are contextual.
A third thing that makes it even more interesting is something called recency bias. We extrapolate tomorrow based on what we know today. Have You ever wondered why analysts earnings prediction go in straight line up through the next 20 years ? It does not even dawn upon them there could be a dip.
Maybe we asked the wrong question in the first place
Back in the 60s, there were a series of studies conducted at Yale University where subjects were asked to send electric shocks to test subjects if they answered wrong (Milgram experiment )Milgram_Experiment_advertising. Of course, test subjects were actors and no shocks were sent, but the interesting part was that few people rebelled. The objective was to measure compliance to authority, specifically how could people obey nazi orders and send victims to a certain death. We are conditioned to respect figures of authority and experts.
Yet, in finance, we still avidly seek the opinions of experts who continue to prove time and again that they are hopeless at it: they are still several standard deviations below a coin-toss. So, why do we still rely on them ?
Rather than running an ugly contest on who’s worse at forecasting, maybe we should ask ourselves a better question: despite overwhelming evidence that we are hopeless at forecasting, why do we keep doing it ?
Our fear receptor is a region in our brain called the amygdala. These are two glands in the center or our brain. They are our fear receptors. The amygdala has helped our ancestors survive saber tooth tigers. It has not evolved for thousands of years. In the Jungian and later Pearson Marr archetypes, amygdala could be compared to the orphan.
Now, our primitive brain does not know the difference between a saber tooth in the bush and a news headline. Uncertainty triggers fear. This fear activates the amygdala.
So, we rely on “experts” who know better and can reassure us and soothe our uncertainty. In other words, we delegate our fear management to experts.
Is there a better way then ?
Uncertainty is not going away anytime soon. Uncertainty and risk are part of life. Rather than delegating fear management, maybe we should learn to live with it, to make peace with it. Fear exists in the shadow and evaporates when brought to light.
  1. Mindful meditation: There are several techniques designed to reduce fear, one of the best being “mindfulness meditation”. I would also recommend the work of my trading coach Rande Howell (trader’s state of mind).
  2. Risk is a number: The second way is to quantify risk and stop loss. Risk is not a paragraph at the end of a dissertation called investment thesis. Risk is a number: know how much you are willing to risk and can afford to lose before entering any trade.
“Forecasting is a difficult business, particularly when it is about the future”, Yogi Berra, modern American philosopher
We are hopeless at forecasting. Forecasts have been wrong and no matter how technology evolves, they are likely to be wrong in the future as well. (I had this conversation with Nate Silver in Hong Kong actually). Even if forecasts accuracy doubled, it would still be below a coin toss. So rather than trying to improve them, how about learning to live without them ? How about growing comfortable without discomfort ?
If You are interested in how “Greed and Fear” tricks our brain: Amygdala and the neurophysiology of Greed and Fear. and, don’t forget to sign-up if You want to receive free bonus material

Why do 100% of economists say that it’s hard to predict stock prices?