If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ peop… by Laurent Bernut
Answer by Laurent Bernut:
No, but for different reasons that the instructive and brilliant answers given by people far more intelligent than yours truly. Making money in the market is a side effect. Yes, You read correctly. Would You like to know why ?
(An entire section of my upcoming book on short selling is devoted to this topic so stay tuned)
To all of You who believe markets are efficient and think of yourselves as rational investors, how many times did You check your mails today ? 10–20 times. That is Dopamine in action. This is the reward circuitry. Not even Paris Hilton has a life exciting enough to check mails continuously. We do so because our brain releases dopamine (feel good hormone) for mild uncertain rewards.
Have you ever found yourself overriding your risk limit just right around the wrong time? Overconfidence is the ubiquitous plague of traders. Rational investor, would You like proof of overconfidence? Divorce statistics, i rest my case with your multiple ex-wives
Now, when your performance sinks and you can’t think straight, do you pass up trades? Do you find yourself exhausted, irritable? Cortisol
Your average pension fund manager is the direct descendant of someone who woke up in a cave and started running after mammoths for breakfast. Not exactly savvy with probabilities but the survivors got the girls…
The hard wired mind of trading
In the 60s Michael Gazzanika developed the theory of split brain. We, humans, pre-consciously rationalise our decisions. Take a look at the junk in your portfolio. A solid third of it would not even be there if you had to do it all over again.
Do You find it hard to execute stop losses (Oh, the chapter on the psychology of stop loss is worth the entire book multiple times, i will refund anyone who does not have a aha moment there) ? Ego prevails over profits. Valeant (VRX), case in point…
Subconscious beliefs and fears
Fears exist in the shadows. In his book, Daniel Goleman (the EQ dude) describes elf deception as a built in mechanism that covers its own tracks. we rationalise all the time. Proof? when was the last time you got laid (Maslow pyramid about reproduction)? when was the last time you rationalised a decision ?
Market participants do not trade to make money. Proof?Look at the junk that fester in your portfolio… Some of us trade to prove to someone dead 20 years ago (i-e father, mentor, bully at school, whatever) that they are worthy individuals. Dude, You are beautiful, You are worthy of love.
The floating world of beliefs and fears
Finally, floating at the surface like ice cubes in a single malt are conscious beliefs and fears. Fears of losing your job, fear of missing out, fear of pulling the trigger, fear of inadequacy (smart guys are buying that Enron thing so i will join the party)
Of course, there is the belief You cannot time the market. Who told you that? Journalists and analyst who hug the mike and more importantly yourself when the thing you just bough went south…
Now, let’s quip the IQ myth. Self deception is a mechanism that covers its own tracks. High IQ dudes always have spectacular excuses. I know two types of traders: those who make money and those who have excuses. Which one are You
Bottom line: born to lose
Bottom line, your biology f@#ks you up. Your beautiful mind comes delivered with amazing features, most of which will get You killed on the markets (try fairness for instance). Then, your ego, your subconscious deep rooted fears will supersede your best intentions. Then, there is this floating junk of unchecked beliefs irrational fears.
So, no wonder 90% of the people lose money.
Now, why do 10% succeed? The hero’s journey
They succeed simply because of their inner alignment of their biology all the way up to their daily routines. Great traders are not smarter, they have smarter trading habits. Making money is just the yardstick of inner alignment.
Would You like to know about the three scientifically proven methods to re-align yourself? Then, please follow, or subscribe to my (free) website, or help launching the book
As Arnold, Ze Great Governator said: “Ze hardest part of putting on muscles is getting to ze gym, jaa”
- buy the stock
- graciously offer the borrow for free
- and send a box of chocolate to whomever wants to short. Chocolate is a good therapy for smoothing the rough short squeezes ahead
- Divorce from reality: Structural shorts are like market gurus: they are a dime a dozen. Profitable structural shorts are like market wizards, good luck finding one. Borrow is expensive and long holders have left the building a long time ago
- Abdication of responsibility: when they say they want structural shorts, what they mean is they do not want to be bothered with the short side anymore. They want to find something that they can throw in the short book and “forget about it”. This is an implicit acknowledgement of failure. They are happy to collect fees, but reluctant to do the work. There is obviously no hedge, no downside protection, no free lunch and eventually no happy ending.
At this stage, market participants resort to futures. They realise their vulnerability both versus the markets and versus their investors. The problem is futures do not offer much protection when markets tank. Besides, investors are understandably reluctant to pay exorbitant fees for something they can do themselves. They are willing to pay as much
Between the time when Valeant was puffed up to “unsustainable valuations”, and the first analyst to throw the towel with a “Sell” rating, share price actually did go down by roughly -80%. There was no “beam me down Scottie”, exchange between share price and the deck of the Enterprise. Share price did go down over time, but market participants were institutionally blind to it.
How can Renaissance Technologies make so much money from financial markets by hiring scientists/m… by Laurent Bernut
Answer by Laurent Bernut:
I have never worked at Renaissance, so please take my answer with a grain of salt, but here is a first hand story that could shed some light.
On June 22nd in NYC, my colleague, who is also ex-US Department of Defense consultant and myself, met with one of the foremost US experts on sonar detection (good luck finding him on Facebook, LinkedIn). He is a physicist with multiple PHDs, geeky funny. His expertise is signal processing. He is the real “Hunt for Red October”.
It was one of the most refreshing experiences ever. He explained his world. I explained mine. Cotes de Provence Rose, beer and wild berry Zinfandel helping, we tumbled down the rabbit hole talking even about epistemology, the philosophy behind math.
His world, signal processing, bears uncanny resemblances with ours. We explored Bayesian probabilistic determinism, which models (Gauss, Poisson etc) to apply to distributions, the cost of false positives (think trading edge), arbitrage between time and action with sparse data (confirmation). We spoke the same language. We were talking real problems: how do distinguish signal from the noise ? How fast ? What is the cost of being wrong ? What is the cost of being right ? Which statistical law applies to randomness ?
We entered a massive time distortion. We started around 2 pm and a couple of bottles down the road, but then after what seemed like 5 minutes, we were hungry. It was 10 pm. We could have gone on forever (*)
Compare this with glorified journalists, otherwise referred to as fundamental analysts.
- “This is fairly valued”… life is unfair darling, so do you really think markets are fair ?
- “On a sum of the parts valuation”… Frank N. Stein zombie valuation
- “Fundamentals are strong”… Make fundamentals great again…
- “Long term story is still intact”… Some HF reality TV celeb says that about Valeant by the way…
- “On a DCF basis, our target price is +10% above current market valuation” … stop tinkering the terminal value to rationalise your subjective views
- “i think there is 80% chance that” … bad arithmetic meets emotional roller coaster
- “top quality management” … was also said about Enron, Bear Sterns, Kodak, GM, Chrysler, Valeant
Too much B/S bingo, too much theory,
Bottom line: “In theory, theory and practice are the same. In practice, they are not”. Yogi Berra, Yankee philosopher
Physicists approach the markets as a statistical problem. This is practical.
MBAs have too much untested theories in their head. It is costly and time consuming to unlearn all that junk.
(*) There is no way i could ever afford someone of that caliber; he charges something the size of Liberia’s national deficit per hour. But, he wants to send his granddaughter to Mars and he thinks our algo could be the right fuel, so we invited him to have fun with us. Maybe good guys do not always finish last…
My answer to What is the point of hedging a portfolio instead of closing losing positions?
Answer by Laurent Bernut:
It seems like You are experiencing pain right now. This is clouding your judgment. So, let&s do a step-by-step approach’ 1. Emotional relief, 2. Boundaries, 3. Recovery 4. New rules
1. Emotional and Financial capitals: forgiveness and dissociation
You can recover from financial losses over time, as long as You recover from emotional losses. So, We need to get out of your emotional pain first.
The power of forgiveness
Forgive yourself for losing money. Make peace with yourself. You made a bad a decision. It is alright. In Jungian archetypes, this is called re-parenting the orphan. You soothe yourself as if You were soothing your child who got hurt. This is no new age fell good stuff: i am a professional short seller, not a cat lady.
There is solid academic research that links forgiveness and learning ability. Bottom line, if You beat yourself up, You create trauma and are statistically more prone to relapse. The Village People masculine approach to taking losses like a man may result in storing memories in the hippocampus (trauma, pain), rather than the pre-frontal cortex learning centre.
“No problem can be solved at the level it was created“, Albert Einstein, patent clerk
This is a cool jedi trick. Put yourself in the shoes of someone You respect for her investing/trading skills. Really feel being that person. How would she react ? Would she be calm, composed ? Would she have slow or fast breathing ? Try to emulate this person both physically and mentally.
While You do that, exhale twice as long as You inhale, and widen your vision from tunnel to peripheral, look up a bit.
When You have impersonated this person, ask yourself how would this person solve the problem ? Take a pen a paper and write it down. Do not commit to memory. The chemical reconstruct we call memories are highly fickle and inaccurate.
This is a powerful exercise that frees up some mental bandwidth. Stress triggers the fight flight syndrome. This hijacks the prefrontal cortex and hijacks the thinking brain. This exercise frees up mental bandwidth. Practice often and You will be the iceman on the trading desk
2. Set boundaries
“Hope is a mistake“, Mad Max, Aussie philosopher
If You ask this question, it is probably because You thought this “soft patch” would go away and You would be back on happy street in no time. You ignored the signals and You got caught in a storm with a t-shirt, didn’t You ?
Stock repair strategies as we use in options world never really do the job properly and they cost a lost of mental capital. Bad idea. Same applies to your situation.
You were probably optimistic and failed to think about stop loss. You probably don’t believe in them and may buy into the “buy and hope” fairy tale. Well, the best car in the world would not even sell 1 unit if it did not have good brakes.
At this stage, You will have to decide a NUMBER of the loss You can afford to sustain. Not maximum pain, just how much can You afford to lose so that You can recover within 6 months ? Repeat the exercise and stretch the time horizon, 1 year, 2 years 3 years, 5 years etc. Stop when You come to the same number at various intervals. Focus on the recovery period.
This neat jedi trick invokes the “future self” and reframing: it focuses on recovery as opposed to pain.
Write that number down and commit now to liquidating everything if your losses reach that point. No negotiation, no investment committee, just out
The way to make it more acceptable is to tell yourself being right means following a process, being profitable is an outcome, not a process thought.
3. Recovery: two certainties in life: death and short squeezes
“There are unknown unknowns”, Great War Criminal
There is no way to tell how long a bear market will last. Forget about the talking heads, They did not see the bear coming, so they probably won’t see it go either
One rule of thumb about hedging: it gets expensive during sell off, so be patient. Wait for a squeeze to hedge. They come once a month. Politicians feel compelled to flap their mouth at regular intervals during bear markets… So, don’t worry, someone is coming.
When short squeeze comes do this:
- Reduce your exposure: reduce size of positions that stress You the most. Reduce until You can sleep if You are not mathematically inclined. You have to do it, it is part of hedging
- The smart way to reduce risk is to sell call against your holdings: You collect premium and reduce exposure
- Do not trade VIX options to hedge: this is for losers, amateurs and TV talking heads
- Long put spread: skew changes marginally during squeezes. So, this is time to put on put spreads. Put spreads are volatility structures that will make money if the markets fall between a ceiling and a floor. Risk is capped and so is profit potential. It is not very risky
- Don’t waste time looking for the golden fleece of safe asset class that does well in bear markets: The only asset class that fits this profile is cash.
- Avoid short selling yourself, delegate: short selling requires a level of skills that takes time and practice to mature. You should delegate this to a professional short selling manager.
- Be careful with selling index futures: Shorting S&P futures while being Long small caps it not a hedge. You are implicitly Long small caps and short large caps. Large caps fare better in bear markets, small caps get crushed. So, this feeling of being hedged is illusory at best
4. New rules
“The best time to repair the rof is when the sun is shining“, JFK, Great XXth mystery
Hedging is like swimming lessons, It is a bad idea to think about taking swimming lessons when You are drowning.
The market is a joint venture between Murphy and Marcelus Wallace. Murphy makes sure that if something goes wrong it will. Then, Marcellus gets medieval on your a@#.
Bottom line: be prepared. Decide your hedging strategy before you put on a trade.
The best advice about position sizing I can ever give is: size your position not thinking how much you could make, but expecting them to fail and how much You can afford to lose.
What is better in the end, earning a little less than You could, or losing a lot more than You should ?
Good luck, and practice the first two mental exercises. May the force be with You
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My answer to Do simpler trading strategies make the psychological aspects of trading more manageable thus making th…
Answer by Laurent Bernut:
Excellent question. Complexity is a form of laziness. 1) The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication 2) Simplicity is the exact opposite of easy.
Complexity is fragile
I have met many people trading complex strategies. I have had the privilege of meeting many people with long track record. I have yet to meet trading complex strategies with a long track record.
Complexity gives an illusion of control. It is also highly specialised. So, it tends to fall out of sync. then, traders start drifting and tweaking and add one more widget instead of subtracting.
As the Great Chinese philosopher Bruce Lee used to say: ultimately, perfection runs into simplification.
Complexity is a form of laziness:
People who settle for complex solutions have not worked hard enough to simplify them. It is easy to throw another oscillator in the mix. It is simplistic to optimise for a moving average. Below is my screen, no indicator, no oscillator, nothing, just the purity of the price:
In fact, the opposite of simple is not complex. The opposite of simple is easy.
The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication. We can understand it. It intuitively imposes itself.
Simple is not rigid, it is fluid
You will know that You are on the right track when You start subtracting instead of adding to your strategy.
I started off with 9 exit conditions. Now, I have 2: trend reversal and stop loss.
I started off with 3 distinct strategies. Now, i have 1 unified strategy. It knows when to suspend trading, reduce risk. Hint: the answer is not in the Buy/Sell signal but in position sizing and rejection of small orders…
But behind this simplicity there is immense relentless kaizen. It took me years to see what was in front of me. We do not see things as they are. We see them as we are.
Simple is a way of life.
The false comfort of complexity
People are intimidated by complexity. If it is simple, they believe that anyone could do it, therefore it cannot work. Picasso once drew a picture on a napkin to a restaurant owner and then asked for an astronomic sum. He then told it took him 30 years to draw those simple lines.
People often mistake simplistic and simple. I often ear that what i do is superficial. Perfect, “let’s step into the math then” and 5 minutes down the road, they have an angelic blank stare and conclude it is too complicated.
- Stop Loss: 2nd most important variable
- Position sizing: money is made in the money management
- Exits: You have to get off the bus at some point
- Entries: vastly overrated
- Above all: clarity of purpose, of formalisation. Be specific, very specific
Part 1: Making money on the markets goes against nature
Why we cut our winners
Part 2 How to re-write the story of stop loss
1. Accountability: take responsibility
2. Reframing stop losses
3. Identity association
- It becomes quantifiable and measurable: one trade is random. 100 trades are a data sample.
- It removes the incentive to cheat: being right is no longer an individual trade decision. You can lose money and be right. In fact, this association is stronger than the outcome orientation. It involves the neo-cortex in relationship to the dorso-lateral cortex (siege of identity). It literally rewrite the neural pathways to your identity
4. Clarity: Stop loss is a price, not a fundamental story, not a valuation exercise
- Stories: prior to becoming a superstar with Emotional Intelligence, Daniel Goleman wrote an even more interesting book about the lies we tell ourselves. He argued that self deception is a built-in feature that covers its own tracks. We rationalise our bad choices. We will change our beliefs in order to match our actions. If You find excuses to avoid the gym, then You will fabricate excuses to allow losers in your portfolio.
- Valuations: Earnings estimates are notoriously inaccurate and jumpy. Forecast accuracy for analysts earnings estimates 1 year out within +/-10% range peaks at 25%, half a coin toss !
- Stop losses are necessary to calculate position sizes. If You do not set a limit on how much You can afford to lose, You may fail to appreciate what the market has in store for You
- Emotional interference: Once we enter a position, emotions kick in. Think of it as a prenuptial agreement. Commit to a price in writing, write it close to entry cost and price. Do not trust your brain with some abstract stop loss price. Your brain will renegotiate and it will trick You into a suboptimal decision (marketing buzzword for stupid mistake).
6. Pre-mortem: enter each as if You expect them to fail
- Conservative position size: if you enter a trade expecting it to be a stopped out, You will naturally take smaller bets. You will stay out of illiquid issues
- Pre-packaged grief: we normally expect trades to work. When they don’t, we grieve our way to stop loss (Kubler-Ross). We negotiate with the inevitable. Now, if we expect every trade to fail, those which work will be good surprises. That do not perform as expected. It removes the emotional toll.
7. Execute the stop loss: re-parenting
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:
- Reduce: bet sizes as soon as You perceive a short squeeze
- Ride the squeeze. Do not short sell on the way up, but trim Longs that got clobbered in the downturn
- 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:
- Open Risk (pink bars) = Shares * (Cost – Stop Loss) / NAV
- CTR (Contribution, light green) = [Shares * (Price – Cost) + Realised P&L] / NAV (Scale out model, hence realised P&L)
- Weight (blue bars) = Market Value / NAV
- 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 Tyson 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:
- Reset the stop losses lower: swing high + n * ATR
- Reload existing positions
- 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
- 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
- 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.
- Mental reframing: We are hardwired to do the exact opposite of the triple RLoss 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…
- 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.
- 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.
- Fundamental shorts: Fundamentalist grieve their way into Short-selling ( ). 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
- 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.
1. Structural shorts are a form of a laziness
- I don’t want to bother with shorts: they are not fun. They are complicated, unsexy and messy
- I just want to go Long, have fun, find 2-3-4-10 baggers and be a rockstar, but:
- This is a hedge fund: so we need to hedge, right ? But also I want to:
- Charge big fees: no-one is stupid enough to pay 2-20 if I just sell futures or buy ATM puts
- So, I need to find shorts (… so as to generate cash and buy even more Longs…)
- 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
- Successful shorts must be replenished
- the Short book needs constant attention: shorts have naturally shorter cycle and shorter lifespan. So, they need constant attention
- Unsuccessful short must be weeded out: unsuccessful shorts balloon. So, You are left with more of something undesirable
Happy New Year from Alpha Secure Capital. This was an answer to a question on Quora. It has been read by more than 16,000 people.
Now, I am a digital nomad investor: Viet Nam, Singapore, Tokyo, KL, Venezia, Palermo, Reikjavik. Rents get paid in our sleep, balance gets bigger by 1-3% every week. Dream life, hey (*) ? Well, it came at great sacrifices.
Autotrade sub 30 mn is the tallest order in the trading industry. On the one hand, there are HFT shops, with whom there is no point competing. They already do a wondeful job at killing each other not so softly. On the other hand, point and click prop shops ecking penny after penny. Then, there are Delta one and deriv desks arbitraging small corners away. All those guys have the money, the resources, the access, the info, the programmers You will never have. You are outgunned, outnumbered and let’s face it: outside. Now, let the race begin.
It took me 15 years to mature the concepts, 3,694 hours to code, 3 2/3 years to run and a lifetime to refine them. This has consumed my life, my waking hours, my sleep. Ever woke up breathless and feverishly write equations ? I nearly burned the house not once, but twice, because i forgot that there was something on the stove, while i was wrestling with some C#. Once, my wife came yelling at me for not taking care of our screaming baby. I just did not hear our daughter crying… on my lap. Well, code would not compile…
Then, there is the sheer frustration of never being enough. Then there are bugs. One rule of thumb, never add, always subtract, always come to simplicity when solving bugs. Then, there are “100 year flood”, perfectly rhyming with the late “100 nights of solitude”. Then, there are platform issues. They are not meant to do scale-out/scale-in and adaptive position sizing. Then, there are those small issues that You will have to face one after the other. There will be times where You wander and meander like Ulysses, “what if this, what if that ?” But there also those immensely gratifying days when You wake up with light and equations flowing through like when I found my personal holy grail of position sizing
After the Daedalus of development, one day the end will be in sight; it will be there, almost, just a few modules away. But then, there are those shortcuts You took 10 iterations ago that will come back and bite You. They stand between You and the finish line. And You know that tackling them means overhauling the entire architecture.
This is the realm of frustration. The last mile is always the hardest. Please remember this though: autotrade is like watch-making. Until the last cog fits in the right place, your clock will always be off, so don’t give up, never give up.
Then, You run your own money, face drawdowns, go back to fix the last few bugs. Then, You run it on small amounts. The best moments are not when You make your previous monthly salary in a week while kitesurfing or going wine tasting. The most beautiful moments are when You make those few hundred dollars week after week and when You finally know it is viable. It feels like watching a flower blossom. This is the best sleep You will have in your lifetime, well at least for 3 months …
Here are the lessons I learned. A viable trading system is built backward:
- Focus on the short side: the short side is notoriously harder. If Your system works on the short side, it will work on the Long side. Any 3 star Michelin chef can flip burgers. Now how many Burger king employees can do 3 star meals ?
- Focus on the exit first: a race is never won until the finish line is crossed. Some of your positions are marathonians, some are sprinters. You never know until You see them on the field.
- Stop loss: it is the only variable that has a direct influence on 3 out of 4 variables of your trading hedge
- Money management is key: how to preserve capital when your system won’t work and how to take calculated risk when it does ? This is where the heavy mathematical artillery should be concentrated, not on the entry. Think about it: everyone owns Apple. The difference that makes the difference is how big You are
- Simplicity: complexity is a form of laziness. If your solution is still complex, it means You have not worked hard enough to find a simple one. There is no exception to this truth
- Symmetry: once the short side delivers, translate it to the long side. You will have unambiguous signals, unified risk management
- Watch Star Trek and the original Kardashians, they were not as villains as the newer ones, breaking bad, desperate house wives etc
- Then, last and very least, but first take the dogs out. And then finally, sorry don’t forget to water the plants first. And then finally, oops have You called your mother yet ? And then finally, take the trash out and after a good night of sleep, You may think about entry. Entry is at the very bottom pile of the priority list of an autotrade strategy, long after labeling priorities on multiple positions
In the end, You will realise that the goal was never about money. It was first about the freedom from a paycheck and the long term uncertainty of retirement. Rich and wealthy are not synonymous. Rich should be the experiences You accumulate over your life. Now, we live out of our suitcases, frugally as usual, but what a life! Speaking of which, time for a Prosecco with our neighbours, our landlord the architect and his buddy the last Gondola maker in Venezia
(*) Now, the highlights of our week is to hunt for consecutive stop losses. We have excess capacity. We have suffered a great deal coming up with our strategy on MT4. Most modules had to be built from the ground up. We genuinely want to spare this Sisyphean ordeal to aspiring autotraders.
So, we will choose 2 or 3 people and help them build their strategy.
I can help anyone formalise their own strategy through a thorough guided discovery process. This is not pleasant.
Then on the MT4 coding side, the person I work with is a senior programmer for the US Department of Defense (be nice to him or he will bring democracy to your computer…). I can code alright, but his stuff is military grade… Reach out if You are interested, or if You like what You read