How do short traders better our economy?

How do short traders better our economy? by Laurent Bernut

Answer by Laurent Bernut:

I was a dedicated short seller with Fidelity for 8 years, a bottom Long Only house. I was working alongside Long Only managers. I was often told that having me alongside was a healthy reality check

Plea for the short sellers
Short sellers have a bad wrap. They are the scapegoats from other people's mistakes. We were not the ones making bad managerial decisions. The likes of Stan O'Neil, Richard Fuld, Jeff Skilling and Howard Stinger at Sony are plenty incompetent, blind to risk and arrogant enough to drive their companies into the ground.
We were not the portfolio managers holding on to Enron as a Long all the way down. These are the bad guys, these are the guys of rob You of your pension, not us.
We are bad guys insofar as we unapologetically profit from other people's arrogance and mistakes. If that is a crime, then please I proudly accept punishment

Market impact of short sellers
I am afraid i do not know much about the impact on the economy at large, but at a market level we provide this:

  1. Liquidity: if there are no sellers, there can be no buyers
  2. price discovery: markets where short selling is banned all have wider bid/ask spread.
  3. Lower volatility: markets where short selling is banned are poorly arbitraged.
  4. Better transparency: everybody needs to hedge. Where short selling is banned, hedges are done off exchange in OTC transactions
  5. Honesty: sycophants are the carrots, short-sellers are the stick. If one is held accountable, then one has an incentive to be a good steward

SHORT SELLERS ARE YOUR PENSION ACCOUNT'S BEST FRIEND: absolute risk versus absolute return
Mutual funds are supposedly less risky than Long/Short. Profiting from one side of the markets is like trying to fight Mike Tyson with one hand…
If You choose to profit from one side only, then you are at absolute risk every time markets go sideways or down.

When (not if) markets fall 50%, mutual funds have to make 100% gains to come back to the watermark.
Long/Short post more modest gains on the way up but they protect You on the way down, at least the good ones do.

Risk is much higher going Long Only than Long Short.

Ethical short sellers
Short sellers have to work extra hard. If they want to survive, they have to stay honest to themselves and to the people they serve. I have had extra compliance checks all my career. Every time I shorted something that happened to go down precipitously thereafter, I got an e-mail or a phone call, or in a few cases an inquiry.

At Fidelity, holding a short position when someone else had a Long position always elicited a reality check. It forces managers to re-evaluate their positions, be less complacent, kick the tires a little harder.
They did not always like it but they respected it.

Being a short seller entails an extreme focus on process, a pathological attention to risk and a surgical ability to remove losers. It also means ability to endure pain, criticism. In nutshell, it is ungrateful but we choose to do so because a drop of 50% is unbearable. We provide insurance for the downside

Two ways to kill a bull: Corrida or slaughterhouse
There are two ways to kill a bull: either the corrida, either zapping tired beefs at the slaughterhouse. Guess who gets the horns, the glory and guess who is efficient.

At the other end of the spectrum are firms who put on positions and tell the world. There are also people who go on litigious crusades.
Personally, I believe those practices reflect hubris and greed more than a real attempt at hedging risk. Since our activity is already so poorly understood, those practices cast a bad light on an otherwise useful activity

How do short traders better our economy?

What is the future of Algorithmic Trading?

What is the future of Algorithmic Trading? by Laurent Bernut

Answer by Laurent Bernut:

If investment is a process, then automation is the natural conclusion. “He, who controls the past controls the future”, George Orwell. Before attempting to guess and inevitably fail what the future holds in store for us, let’s take a step back and understand why they are not so prevalent today

Complexity is a form of laziness and the gaze heuristic

Investors inherently distrust “black boxes”. We can accept someone giving us bad directions. We hate when Google maps sends us off course. This has implications on AUM.

Computing power is not the answer, it is merely one solution. AI is an attempt at solving complexity with complexity. Complex problems can be solved with simple solutions. Example: a fast moving projectile bouncing around is rocket science, literally. Now, when was the last time Serena Williams solved stochastic equations? Gaze heuristic. The point is that behind every algo there is a person formalising her current perception, fears, beliefs of the markets.

The hard part is articulating complexity in simple heuristics and only then apply sophisticated solutions. Algorithms that survive have to be robust. Complexity is fragile. For that reason only, i do not share the current enthusiasm on AI. We live in a technological world, governed by sophisticated algorithms (train schedules, traffic lights, chromatography etc). Yet, we have failed to apply our genius to the markets. AI is just the latest attempt.

Instead of thinking about the model logically, we try to discover it through tuning, optimisation, Monte Carlo, neural networks, AI, whatever. It is exactly like tuning an engine until You realise You need to build something called a carburetor.

Asset Allocation algorithms

To me, the immediate future of algorithms starts with asset allocation. There is a growing consensus that asset allocation is the primary driver of performance. Robo-advisors are still in their infancy, but this is where the industry is heading.

Unfortunately, they rely on Markowitz CAPM. It was invented in the year that the US Army drafted Elvis. Since then, doctors have stopped prescribing cigarettes to pregnant women, people have walked on the moon and non-alcoholic beer was invented

Here are a few things that Markowitz did not think of:

  1. Bear markets: this has been a 30 year mega bull markets for bonds. We are officially in the longest equity bull run in history. What happens when trends revert? Correlation will go to 1. Short selling is the asset class that remains terra incognita for the overwhelming majority of investors
  2. Time (synchronicity) is a form of asset allocation: mean reversion is a time frame issue. Any security trends on longer and/or shorter time frames. When trading the same strategy on the same security across multiple time frames, synchronicity smoothes the equity curve
  3. Volatility is NOT a measure of quality: Markowitz defaults to volatility as proxy for quality. CDOs, lending club and sovereign bonds are quality until… Integral of drawdowns is a robust measure of quality
  4. Position sizing is a form of asset allocation: this is where algorithms will find their first low hanging fruit. Risk parity has correlation issues

Time is the wrong container: 1st derivative of time, price and volume is speed

HFT is here to stay. Whether they should be legislated and taxed away is a different debate. For now, most algos fail because they are conceived on wall clock time. Algos will gravitate toward HFT when they are conceived with speed as opposed to wall clock time in mind.

Flash crashes happen in thin markets: mid-afternoon, middle of the night. This is because they are designed to react to wall clock time. We have been conditioned to see time as linear, wall clock time. Volume is not distributed uniformly through time.

Picture a bottling line. Bottles move only when they are filled. Now, imagine two shifts, day shift with everyone along the line, the other with two people and bottles moving every 5 seconds regardless. When everyone is here, they would overflow. When no-one is there, they would move half empty. It does not make sense, does it ?Time is the wrong container: 1,000 or 20 ticks per second are different markets.

The first derivative of time, volume and price is speed. HFT algos do not need to be so quick to react in slow moving markets. Conversely, conventional algos will gravitate toward higher frequency when they are set on speed (i-e constant volume) as opposed to time. Time is the wrong container.

Short selling algorithms

Contrary to popular belief, short selling is the province of algorithms. Firstly, successful shorts shrink, successful longs balloon. So, there is a need for more ideas, more often just to hedge exposures. The way to accomplish this is to systematise the process, hence algos

Secondly, on the short side, the market does not cooperate. Write and test algos for the short side. If they survive the short side, they will thrive on the long side.

Thirdly, the secret to raising AUM is to master the short side. Ask John Paulson about this. Next bear market, when everything drops 50%, all this AI, factor optimisation covariance matrices mumbo jumbo is highly unlikely to garner any sympathy from disgruntled investors. You may not like it, but if You intend to survive, do You have a choice?


The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication.

My own journey into the algorithmic world has been an unquenchable thirst for simplicity. When faced with a complex problem, I work until a simple solution emerges (the answer is rarely better signal processing by the way). This is like peeling an onion: solving one problem leads to the next one. In the end, algos are like iOS, next update is coming soon

What is the future of Algorithmic Trading?

#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…

What’s the best way to learn portfolio optimization?

What's the best way to learn portfolio optimization? by Laurent Bernut

Answer by Laurent Bernut:

In theory, theory and practice are the same. In practice, they are not. Most market participants optimise the wrong thing for the wrong reasons.

Modern Portfolio Theory was revolutionary

Half a century Modern Portfolio Theory was revolutionary in its days, that was before they sent someone to the moon, and Nikita Khrushchev became the Soviet Supreme, and Fidel was kicking Batista’s ass.

It made a couple of assumptions that were good back then but that have plagued generations of traders. It equates volatility with risk. Volatility is not risk and risk is not necessarily volatile.

LTCM had low volatility and so did all the Volatility fund (short Gamma funds) back in 2008. They had exceptionally low volatility until the day before the blew up… Similarly, Paul Tudor Jones, Ed Seykota and a lot of the major CTAs have high volatility but no-one will argue with their returns…

Sharpe ratio, Jensen alpha, Treynor and all that jazz are the right mathematical answers to the wrong question. I wrote a post about that. Conclusion: i actively de-friend the savant clowns who ask for my Sharpe.

Second assumption is linearity of risk. This one is not apparent. Mean variance is mathematically elegant, but it assumes strategies work throughout the cycle. Mean variance is observed through the period and when bad, go back to the drawing board. Old school academic laziness

Example: small caps growth do extremely well at the beginning and at the end of a bull phase. Rest of the time, they oscillate between volatile and outright dangerous. Mean variance optimisation would triumphantly conclude small cap growth is a bad strategy. Good luck explaining that to the cohort of managers baby sitting billions on small caps

What to optimise then

Trading edge = Win% *Avg Win% -Loss % * Avg Loss%

Optimisation and back-testing serve three purposes:

  • Kill your baby: the earlier you disprove your idea, the less time you waste on it. So, electrocute, drown and punch your baby until it either dies or survives
  • Identify when a strategy works and when it stops: no strategy works all the time. Laziness is to optimise so as to make it fit through the cycle.
  • Identify design flows: dropping all the indicators, factors into the masala smoothie blender and press play hoping something will stick is unforgivable academic laziness. Optimisation will give a correct mathematical answer to a myopic wrong question.

Torpedoing decades of layered platitudes probably requires a little more substance.

  1. When: There are times when buying penny stocks or IPOS are spectacular strategies. Other times, it is suicidal. Difficulty is to know when. Optimisation will have you size small or discard the strategy altogether. Buying penny stocks is like wearing bikinis: it is a bad idea to insist on wearing them through the winter
  2. Design flows: many optimisations go equal weight on all factors and equal weight position sizing. When it does not spit out the right answer, add another factor. Sounds familiar ? That is one bad “bad idea”. Design flows are about subtracting factors, simplification, not addition of complex fragility.

How to optimise then ?

  1. Segment time periods: run through very long period, then segment by market regime. Run optmisied series through various regimes. That will tell you when regime has changed. The biggest mistake people commit is to re-optimise when strategy stops working. If you have identified when it does not work, then it is easier to accept
  2. Universe: run large, segment and then large universes again. Few strategies work across large universes. Conversely, humans are notoriously bad at defining the scope of the strategy. If your stuff is mean for small caps, run it for large caps as well. It will give invaluable perspective
  3. IMPORTANT POINT HERE: Long Short strategy conception starts from the short side and then considers long side. My personal favourite mistake of all times is the demise of quants in the summer of 2007 (this is a chapter in the upcoming book). They went Long quality and short bad quality, logical right ? They assumed shorts were the inverse of Longs. Everyone buys Quality of course, but they failed to notice that no Long holder was selling bad quality anymore. Yet, in order to stay market neutral, they had to short even larger quantities of stocks that no Long Holder owned anymore. Shorts became illiquid and hard to borrow. Risk management as in days to liquidate became an issue, so they had to cover which triggered chain reaction short squeezes. They lost -4-5% in seemingly calm markets, when they were making +0.5%. Investors started to redeem. Those guys were leveraged up to the hilt. VAR went up so PBs rquired more collateral which brought down leverage. Redemption + lower leverage made returns look even more underwhelming. Game over. (Oh and by the way, they had low volatility and excellent Sharpe until they really did not)

Personally, i optimise for different purposes than most people. I optimise for buying power. Performance is not a function of stock picking , it is a function of position szing (i am picking a fight here). Problem becomes a buying power or concentration issue. This type of optimisation looks at exits, sizes of exits, position sizing. Answer is not easy as it searches for regime disruptions. That is too tough of a problem to visualise. I need the machine to show transitions.

Sorry if i appear pugnacious today (might also be those stiff cocktails they serve in NYC). MPT did a great job. It showed the way, thank You very much, but now it is now time to innovate and move on. The problem is that it requires a different way of thinking, involving both hemispheres of the brain.

What's the best way to learn portfolio optimization?

#Quora: What’s the biggest mistake that stock market investors make?

My answer to What’s the biggest mistake that stock market investors make?

Answer by Laurent Bernut:

Short answer: Absence of exit plan. The only soldiers who go to combat w/o an exit plan are Kamikaze. They don’t need one because they expect to die. Unfortunately so do a lot of market participants.082115-Tradingsecrets-01

The apparent simplicity of the answer hides sophisticated concepts that can be broken down in two part: statistical and psychological trading edge

I Statistical trading edge

A Stock picking is overrated

Most market participants believe that stock picking is the alpha and omega of alpha generation. Stock picking is merely everything that precedes entry. It excludes bet size and exit. Unfortunately, stock picking has little influence on the statistical trading edge

Trading edge = Gain Expectancy = Win% *AVG Win% – Loss% *AVg Loss%

1 Stop Loss is the most important variable in a trading system

Stop Loss has direct impact on 3 out of 4 components: Win%, Loss% (1-Win%) and Avg Loss%. Furthermore it has impact on trading frequency: the tighter the stop loss the higher the frequency and vice versa for Buy and Hope

Oops, this just proved that exit is the most important factor.

Please read further about the psychology of stop loss, even if you do not agree

2 Don’t call the race before the finish line

As can be seen, entry has some influence on Win% and Loss%, but nearly not as much as exit. The only time the amount of money that has been made/lost is known with irrefutable certainty is after exit, when open risk is closed

The corollary is that poor entry can be salvaged, poor exit can’t. If You do not have a proper exit plan, You will fail to appreciate the exit plan the market has in store for you

3 Money is made in the money management module

Secondly, Stock picking excludes bet sizing. Bet sizing is the most important determinant of performance

Here is an interesting story to prove this point. When I was at Fidelity, I was running my algo across all managers’ portfolios. My unbridled ambition was to help them trade better 0.05% at a time (multiply this 0.05% by 20 and you are in the rarefied atmosphere of outperformers).

It soon dawned upon my thickness that the same stocks were featured in in my esteemed colleagues’ portfolios. Nothing surprising there, everyone has access to the same research and there is healthy cross pollination. What was surprising was that despite low dispersion of holdings, there was high disparity of performance and volatility: despite owning the same stocks, some people were making a killing, while others were getting killed.

Conclusion: the difference that made the difference is not stock picking, it is bet sizing

4 Blow-ups and feed free-loaders

Watch your winners, but watch your losers more closely. Interesting story: i once had the opportunity to analyse multiple portfolios over many years across many managers on a trade by trade basis. The most important findings were:

  1. Winners look big to the extent that winners are kept small: If You exclude the worst three detractors, everyone would have outperformed the benchmark every year: 100% outperformance 100% of the time (before costs)
  2. Free loaders are performance killers: winners and losers are visible, so they get dealt with. The problem is to identify positions that are neither one nor the others, free loaders. They do not contribute enough to compensate for blow-ups and do not lose enough to be visible. They mobilise resources that should be deployed on productive assets. The psychological consequences is called capacity: you are at capacity when inertia sets in, when you do not want to take a trade because you think you are too big

The two issues that cause managers to underperform are directly related to Absence of EXIT policy

II Mental edge: 90% of trading is mental, the other half is good math

Optimism peaks before entry. After that, emotions kick in. The ultimate proof of this is divorce statistics…

1 Pre-mortem

Few market participants give bet sizing the importance it deserves. It is often either conviction (feel good) based or equal weight. Once they are in a position, things change. Or, more accurately, their perception change: they have either too much or too little of a stock.

The concept of pre-mortem is finally finding its way in decision making: Nobel prixe winner Daniel Kahneman, Dan Gilbert (positive psychology Penn U), Hal Hershfield (future self). The idea is to visualise the worst possible outcome and plan accordingly.

If for every trade You are about to take, you visualise a stop loss, something interesting will happen: you will size positions smaller. That is a natural reaction.

In other words, the most important question about fund management is: could i live with earning a little less than i could or could i afford to lose a lot more than i should ?

Again, the only way to grasp this is to mentally think about exit first

2 Kubler Ross: market participants grieve their way to selling

I am a professional short seller. On the short side, you make money by selling along people who liquidate their long position. You lose money by selling short crowded shorts…

There are many psychological charts about euphoria to despondency. They are all nice, adorable and lovely, but they are written from people whose perspective is to go Long. They do not understand the psychology of selling. There is one model that grasp the emotions we go through; the psychology of grief popularised by Elizabeth Kubler-Ross

The view from the short-side: how we process emotions and the market signature of the 5 stages of grief Kubler-Ross by Laurent Bernut on Alpha Secure

Market participants grieve their way into liquidating losers and are too complacent when leaving winners.

3 The psychology of stop loss

Even if You do not agree with what you have read so far, You must read the post below.

All diets w/o exception have failed: statistics show that we are all getting fat year after year. Diets address the wrong problem. They talk about what we eat, not about how we relate to what we eat. Diets are a psychological issue, not a physiological one.

Stop Losses are exactly the same. They are an identity issue, not a statistical one. The ego associates being profitable with being right. So, losing money is an attack on the ego. We rationalise, change our beliefs (Festinger and ognitive dissonace, Gazzanikas and split brain theory) rather than kick out losers.

Read this post to learn how to reframe your beliefs and execute stop losses like you brush your teeth.

The psychology of stop loss: how You can be 100% right despite 60% failed trades by Laurent Bernut on Alpha Secure


Making money in the market is about having an edge. There are two types of edge: statistical and mental. The only ways to tilt your trading edge is to start with the end in mind: think about how you are going to exit before you enter

What’s the biggest mistake that stock market investors make?

How do I overcome an addiction to forex trading?

My answer to How do I overcome an addiction to forex trading?

Answer by Laurent Bernut:

Addiction to Forex trading has all the symptoms of alcohol or drug addiction. It is deceivingly easy. It is accessible. It does not require large amount of capital. It can be done anywhere on a smart phone. It gives immediate feedback.

Alacoholic anonymous:
welcome to addictive personnalities. The best thing You can do is attend Alcoholic anonymous and substitute everything that mentions alcohol with Forex

In fact, I cannot recommend their program highly enough to overcome over-trading.

A. How the brain works:
The reason You want to stop is most likely because You are not about to buy that private jet You saw on the advertisement.
Here is the interesting distinction between gambling addicts and recreational players.

    1. Illusion of success
Forex brokers do an exceptional job at giving the illusion of success. Anyone can open an account with almost no capital and start commanding vast amounts of money. It is so easy, yet it is anything but simple.
This is a form of video games, except this time You can make money. The worst thing that can happen is that You make money initially. The best outcome is You lose and wisely conclude it is not for You.
So, You probably made a bit of money, got hooked and then started losing

    1, The curse of near miss
The brain does not process information the same way. Three outcomes:

  1. Win: addicts and civilians process wins the same way, that is they attribute it to their skills (believe it or not, we attribute wins to our skills even in roulette)
  2. Clear loss: addicts and civilians process clear losses the exact same way
  3. Near miss: civilians process near misses as losses, the same way a clear loss is processed. Addicts process near-misses as if they were wins: it activates the dopamine reward circuit (Nucleus Accumbens NaC)

    2. The dopamine reward circuit and “your brain on porn”
The meso-limbic circuitry is also referred to as the dopamine reward circuit.  At its core, the reward circuit is a primitive guide that will psuh You away from pain and toward pleasure. It had a vital role for our ancestors: eat the wrong berry and You will be someone else’s dinner. Fats forward tot he modern world, this is how addicitons are formed: NaC gets activated, releases dopamine and memories are formed.

The best explanation of this cycle is in this medical video. I understand people would be put off, but everyone should watch this video, especially if You are a parent: Your brain on porn

   3. Beginner’s luck neurosciences and statistics
From the above paragraph, it is easy to understand how people can be driven to play again and again. If they win, they will continue. If they lose a little bit, they will play again to make it back and if they lose, they will attribute to bad luck. There is no losing combination. You are bound to play until You throw the towel

Now, if You are a recreational trader, near-misses will be magnified losses and You are likely to trade more conservatively as a result. In the end, You will make money and everyone will call t beginner’s luck.
No, your brain responded to objective (loss) and subjective (fear of loss) stimuli by adequately reducing risk, which increased your trading edge (gain expectancy)

On the other hand, if You are a junkie, You will overtrade, lose and revenge trade to make it back, which will invariably dig the hole a bit further.

The subtle statistical difference is in the treatment of the near miss. For example, imagine payoff equals loss. If the objective win rate is 48% but You think You win half the time, what do You think happens in the end ?

You are not as good as You think You are, You are just as good as your trading edge and here is the formula:
Trading edge = Win% *Avg Win% – Loss% * Avg Loss%

B. How to cure addiction

Alcoholic anonymous
They have an impressive track record. Their method works.

The habit loop301043
Once an alcoholic, always an alcoholic. Neural pathways of addictions are almost permanent.The brain loves habits. More than 45% of daily activities (a bit more if You work for CNBC) are spent in automatic unconscious mode
Mechanism is simple:

  1. Cue/Stimulus
  2. Routine
  3. Reward

The habit loop is unlikely to change. Whenever the stimulus is triggered, the urge will itch, and the loop will be activated. Rings a (Pavlovian) bell ?

The brain craves its reward and, despite all your best efforts, it will get it. How many people who You know who can’t quit smoking ?

So, the trick is to reverse engineer the habit loop. Substitute the bad routine with a good one, and gradually habits will form. The key here is to identify the cue that triggers the routine.

Whenever the cue happens, don’t fight it, use it. Example, I used to smoke 1 cigarette around 10 am and 1 around 3:15 pm after market close. I changed my routine to inserting two 5 mn meditations on my iPhone.

Cold turkey and study
Personally, I would not hire someone who has a tendency to over-trade. This is usually symptomatic of deeper issues: perfectionism, dissonant self-esteem, poor discipline, addictive personality etc.

It does not mean that compulsive traders don’t make it. It means they have a few more demons than regular people.

There is one silver ling about being compulsive. Those traders are more attune to risk. It is easier to teach them stuff like gain expectancy. BTW, go to my website and download your free copy of trading edge visualiser (
). The intellectual part comes naturally, that’s the mental part that they need to keep in tight check.

It is hard to fight an addiction, but those who are admirable

Use this tool, it is 100% free and it will help You visualise, analyse and then overcome your trading addiction

How do I overcome an addiction to forex trading?

Is a quant trader who does quantitative analysis but then trades discretionarily based on his analysis still considered a “quant”?

Answer by Laurent Bernut:

if Quant means systematic then the answer is easy. Being a systematic trader is like being pregnant: either You are, either You are not. You cannot be half pregnant.

95% systematic with a 5% discretionary overlay is still 100% discretionary for a simple reason: the power of No. It is not the trades we say Yes to, but the one we say No to that turn you into a discretionary trader.
The best example is stop loss. Honoring stop loss is what separates the men from the boys in the trading world.
Now, if You have 5% overlay, You may think this is oversold and it will bounce back. The worst thing that can/will happen is for You to be right.
It will give You license to do it again. By the third time, You will have created a new neural pathway that will rationalise not taking stop losses.
At that point, You are no longer trading a system. You are 100% discretionary.

There is no judgement as to which is better or worse: systematic or discretionary. It is only bad if You are discretionary passing as systematic

Is a quant trader who does quantitative analysis but then trades discretionarily based on his analysis still considered a "quant"?

@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?

The Habit of Short-Selling

Selling short is not antipatriotic. It most certainly is not a hedge to Long. The only commonality with art is that 90% of artists starve. Short-selling is not some shadow conspiracy undermining the economy. No short sellers seats on any board on sinking ships. Short-selling is none of that.
Short-selling is a habit, just like exercise, healthy eating of brushing teeth. t may be mundane and boring, but eventually it is something that makes You healthier, stronger and eventually happier.
I have been a 100% systematic quantitative short-seller in a prestigious bottom-up fundamental house for 8 years. My mandate was to underperform the inverse of the longest bear market in modern history: Japan Equities. Every day, I woke up -100% net short, welcome to my world.


The hero’s journey of short-selling
“Too many people look at what is from a position of “what should be”, Bruce Lee
We, human love stories. We relate to the hero’s journey, because we aspire to be one. Now, ask yourself: do You want to retire on stories or on healthy returns ? If You still cling on to the story, then read no further and see You in the octagon of the markets…
Short-selling is a hero’s journey, but the story of redemption is unappealing. The journey is about unlearning, calculating, mastering emotions, baking the daily bread. Even if You choose never to sell short, that process itself will make You a stronger investor.
Please subscribe to my website. It is completely free and there are useful resources for serious market participants: Alpha Secure Capital | Alpha Secure Capital
The myths of short-selling
“The usefulness of a cup is its emptiness. Empty your cup”, Bruce Lee
  1. Unlimited downside: would You floor a Maserati knowing it has no brakes ? Well, if You can answer this question, either You can’t afford one or You have just fixed their notoriously bad brakes. Rule 0 of short-selling: set your stop loss before entering a position.
  2. Structural short: structural shorts are just like stupid people: they are everywhere. Profitable structural short is The Unicorn of short-selling (capital T, capital U). By the time the word structural short is associated with a stock, Borrow cost, short squeeze frequency, volume etc all suggest that the Long side is no longer the wrong side. More importantly.
  3. Fundamental shorts: Fundamentalist grieve their way into Short-selling (The view from the short-side: how we process emotions and the market signature of the 5 stages of grief Kubler-Ross by Laurent Bernut on Alpha Secure ). This is an expensive process: every bit of information that ultimately leads to a short has a price-tag. Everyone gets burned while short-selling. So, next time around, we take precautions. We want our story straight, our numbers squared, our facts checked and our boxes ticked. Well, if that is what You want: join the crowded short crew
  4. Contrarian shorts: there are two ways to kill bulls: either in 1. a  triumphant corrida with a colorful display of courageous faena as the bull bites the warm dust or 2. zapping them in a slaughterhouse while listening to cheesy pop songs. Second option does not get the glory but does not get the horns either. Selling short is done along Long selling.
The dynamics of Short-selling

1. Structural shorts are a form of a laziness

Back in hedge fund days, My manager took notice of my keen interest in selling-short but also took umbrage at the accompanying trading activity. He then proceeding to instruct me to look only for structural shorts. What he really meant was:
  1. I don’t want to bother with shorts: they are not fun. They are complicated, unsexy and messy
  2. I just want to go Long, have fun, find 2-3-4-10 baggers and be a rockstar, but:
    1. This is a hedge fund: so we need to hedge, right ? But also I want to:
    2. Charge big fees: no-one is stupid enough to pay 2-20 if I just sell futures or buy ATM puts
  3. So, I need to find shorts (… so as to generate cash and buy even more Longs…)
  4. Then, find me shorts i can SHORT & FORGET: throw away the key, they go down nice and easy. I can forget about them and then I can focus on finding 2-3-4-10 baggers and be a rockstar
Well, the fund went bust. This is not character but myth assassination here. There is no such thing as a structural short. The short book shrinks when successful so it requires more attention than the Long book. That is just a plain arithmetical truism.
2. The curse of successful shorts: the Short “magic skin” (peau-de-chagrin)BalzacMagicSkin01
Successful shorts are the “magic skin” of the markets: they shrink as they are successful. This means their good attributes such as Beta, sector  country, currency, market cap bracket, exchange exposures contribute less and less. It means You have less of a good thing when it works. This entails three things:
  1. Successful shorts must be replenished
  2. the Short book needs constant attention: shorts have naturally shorter cycle and shorter lifespan. So, they need constant attention
  3. Unsuccessful short must be weeded out: unsuccessful shorts balloon. So, You are left with more of something undesirable
This leads us to the secret behind successful short-selling. It is a simple yet powerful “haha” moment question that will alter your reality
A suivre…, to be continued…
If You want part II, III and IV, please subscribe to my website. It is completely free and there are useful resources for serious market participants: Alpha Secure Capital | Alpha Secure Capital

The Habit of Short-Selling

To become a quant trader, which research areas should a machine learning PhD focus on?

Answer by Laurent Bernut:

42, for the meaning of life and Sideways markets and position sizing. I know, this looks unsexy and sounds counter-intuitive but… I am highly suspicious of delegating the thinking to a machine. What if You asked the wrong question and more importantly, what if You could not accept the answer…
Sideways markets
Trend following market participants make money in up or down markets, but give a lot of it back during sideways markets. Arbitrageurs compound a lot of small rapid gains during sideways markets but then get carried out as soon as trends emerge. So, rather than focusing on some “feel-good better sameness” smarter entries, focus on losing less. If You can know when You have entered a sideways market and when You are leaving it, the world will be yours
In simple terms, if You lose less than other people in sideways markets, You will be in a better position to benefit from emerging trends.
Position sizing
Trading edge = Win% *Avg Win% – Loss% *Avg Loss%
The Win% and Loss % are entries/exits. This has been ploughed ad nauseam. On the other hand, the field of position sizing is fairly fresh. There are some formulas coming from professional gambling, signal theory. Yet, they have not ignited the same level of passion as entries and exits.
The main reason why they have not sparked fire in the mind of such intelligent people is because most current platforms are signal processing engines. They test entry/exit on one lot/contract. Those one-dimensional engines never take into account the power of position sizing. They are designed to test traffic lights not horsepower.

To become a quant trader, which research areas should a machine learning PhD focus on?