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@Quora: If most people lose in the stock market or gambling, then would I make money by doing the opposite of the average person?

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My answer to If most people lose in the stock market or gambling, then would I make money by doing the opposite of …

Answer by Laurent Bernut:

Statistically speaking, You would be exactly in the same position as the person You go against

There is something called the serenity prayer. Here is a simple adaptation:out_of_balance_-_Google_Search
Allow me to go with the flow when it is in the right direction
Allow me to stand against the crowd when they are running in the wrong direction
Give the wisdom to know which is which

An ethousiastic reader commented on an answer I provided about predictive technical analysis, saying that the win rate of Fibonacci and  iterations of it such as de Mark have a win rate of around 40%. He said I was an idiot (true) but more importantly if it was the case, people would do the opposite and win (false). While I have rarely been accused of being intelligent, probabilities still do not work like that.

There are three types:
Clear wins
Clear miss
Near miss/win

The third category is between 10 to 30%, 10 for simple (elegant) systems, 30 for simplistic (naive) stuff. So, doing just the opposite of what everyone else does will not make You a hero. Sell Apple short because everyone else is buying will achieve one thing only: provide liquidity for other buyers, thank you very much

How to tilt your trading edge

This is an important point for people who develop systematic automated strategies: improving the trading edge comes from reducing false positives, or moving near wins (small losses) into near misses territory (small wins). The compounding effect of tilting the win rate and the average win has dramatic impact on the overall gain expectancy.

For example, in our strategy, we have introduced a lag in the stop loss, called “French Stop Loss”, because it is fashionably late “bien sur”. This gives additional wiggle rooms to each trade. They can mature and are rarely stopped out. Not all of them succeed however. Some are closed because trend reverts. This is far less costly than stop loss though as trend reversals occur around break even. The number of stop losses has come down by almost 3/4 and now trades are closed around the break even point. This has considerably reduced erosion and has allowed us to increase the number of pairs traded from 12 to 36.

If most people lose in the stock market or gambling, then would I make money by doing the opposite of the average person?

@Quora: How do i improve the sharpe ratio of my trading strategy?

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My answer to How do i improve the sharpe ratio of my trading strategy?

Answer by Laurent Bernut:

Reverse engineering Sharpe ratio is the trademark of some very large shops, with a large pension fund clientele… Like diet, it is simple in theory but not easy in practice.

How to boost Your Sharpe

The basic idea is to generate consistent returns however puny and then magnify them through leverage. Here is how it is done step by step:

  1. Collapse volatility: only one way to do it, collapse net exposure (Long -Short market value) to a band +/-10%. That is tantamount to market neutral. Few strategies can achieve this.
    1. The most common way is pairs-trading. This has built-in market neutrality, but some unpleasant side effects such underwhelming returns and left tail risk
    2. Another way to achieve low net exposure is to run series not on absolute but prices relative to the benchmark. The long book outperforms while the short book underperforms. It then becomes a matter of controlling net exposure. This reduces the correlation risk
  2. Generate low volatility consistent returns: returns can be nanoscopic, it does not matter, as long as they are positive. Consistency matters more than quantity because the denominator is a function of volatility of returns , i-e consistency
  3. Leverage up: if your net exposure is +/-10% and your returns are consistently positive, then You happen to have a low 54d10607d7130_-_pufferfish-bdb80n-deapparent risk profile. So, your prime broker will be willing to extend your leverage. Now, if you clock +0.20% at 200% gross exposure and your PB accepts to lend 4 times, you could wake up with consistent +0.80% per month. times 12 and before You know You will be on the cover of magazines

Limitations:

  1. Very important: Read this Sharpe ratio: the right mathematical answer to the wrong question by Laurent Bernut on Posts
  2. Pairs trading has a nasty side-effect that few people are aware of. It is essentially a mean reverting strategy. It works very well until it blows-up. It does not need to blow up “a la LTCM”. It takes a loss of 3-4% in one month and a full year to recover
  3. Most market participants do not understand Sharpe ratio. They assimilate volatility and risk. Volatility is an expression of uncertainty. Risky strategies are not necessarily volatile, they have open ended risk like short Gamma strategies

Conclusion

Sharpe ratio is part of the Modern portfolio theory package. This dates back to one of the major crimes against humanity of the otherwise barbaric XXth century: the year the US army drafted Elvis. Doctors prescribed pregnant  to smoke cigarettes to calm anxiety back then… Maybe it is time we upgraded our repertoire

How do i improve the sharpe ratio of my trading strategy?

Better System Trader: Questions from the audience

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These are questions from the audience on the Better System Trader podcast with Andrew Swanscott. I am honored and humbled by the interest of listeners. We did not have time to cover all questions, so here are some written answers. If You have questions, please feel free to ask

Trading Psychology

From: Jim

The mind plays tricks on us, even with a successful system, as a system trader, what methods to use for the mental part of the system trading?  So meditation, journaling but how to implement them in one overall plan?

EXCELLENT QUESTION: Part 2 of the book will focus on this

  1. You cannot trust your mind. Michael Gazzanikas 1964 split brain theory. Self-deception: (Daniel Goleman) is a built-in feature. It happens automatically and covers its own tracks and designed to deceive us.
  2. Accountability: simple exercise to test validity of prediction and convince us we are unable to predict.
  3. Reframe from outcome to process: develop a system, account for signals generation and be honest about signal execution
  4. Daily market journal: write what You think markets, thoughts, things that happen, small comments, ideas, formulas. Do the James Altucher method: keep a moleskin with You at all times. Deliberate practice: activates the Default Modal Network (Olivia Fox Cabane)
  5. Write about the thoughts that cross your mind:
    1. dreams and aspirations when making money, why You keep doing that, why You like it. How does it manifest in the body
    2. fears, pains, detail, reflexes (ex: read the press, look for expert opinions): be specific and commit to writing or dictating. Very important
  6. Walk through your fears: meditate and manifest your fears. Seneca was history’s first investment banker. He also happened to be the founder of stoicism school of philosophy. He advocated one day a month of living frugally as a form of inoculation.

The view from the short-side: how we process emotions and the market signature of the 5 stages of grief

Another post on the topic:

Amygdala and the neurophysiology of Greed and Fear

From: @trader1970

So far as a Trader what is the biggest fear that you have not been able to overcome?  How do you manage this situation?

  • My father had a hemiplegia (brain stroke) when i was 7. He never regained motor skills and speech ability. We fell into severe poverty. As a result, I have a deep seated fear of becoming handicapped and not being able to feed my family anymore. Personal and vulnerable. Markets related fears I can deal with, I am a short seller, this is a versatile skill
  • How does it manifest itself in trading:
    1. Diversify sources of revenue: we have a real estate business that generates enough to cover our primary needs. That provides peace of mind. My family is safe from harm
    2. Frugal lifestyle
    3. Systematically take less risk: when making sizing arbitrage ask yourself, would You be satisfied with earning a little less than You could or losing a lot more than You should ?

 

Position sizing

From: Bass

Tell us more about risk management, Volatility based Stops and position sizing.

  • It really depends on your customers: Investors are like teenage girls: Teenage girls say they want a nice guy and they fall for bad boys. Investors say they want returns but they react to drawdowns:
    1. Magnitude: never lose than what investors are willing to tolerate
    2. Frequency: never be the last person investors think about before going to sleep
    3. Period of recovery: never test the patience of investors
  • Risk is not a story, risk is a hard number: it manifests itself in individual trade risk per trade (RPT), in aggregates exposures. Example: Long small caps / short futures is synthetically residually Long large caps as the index is primarily composed of large caps
  • Volatility stops: swings +/- 3 ATR. Volatility is as welcome as Kanye West at an award ceremony. Bad news, volatility is like Monsieur Kardashian bad manners: it is here to stay. Your job is to ride it and the way to do so is position sizing. For example, biotech and internet stocks are more volatile than department stores for example. So, size them accordingly.
  • used in position sizing. Rank trades by size (bigger first) so as to go for better volatility signature

 

From: Derek

Hi Laurent,

I have been following your website ASC for quite some time and also your answers on quora. I have something related to an answer you had to a quora question In investments, does more risk really equal more return, in the long haul? Your answer immediately clicked with me and it logically made sense to me. Laurent – you may want to quickly summarize what the answer was before we move on to the next part of the question. I’ll ask you what the answer was.

 Would you please elaborate on your convex position sizing method for a risk per trade and draw down module. This was discussed as an answer on Quora. I understand that as you make money you will allocate a larger risk budget using a convex surface with a max risk budget of -0.30. But i do not understand the reverse side of this, the draw down part.  As we get more draw down we should decrease our risk budget again using a convex surface. It starts at 100 and bottoms out at around 35. I do not understand how that part works.

 Also how did you come up with this method? Can you give a practical example of when you used this both for drawdown and additional risk scenarios?

Thank you very much

Derek

Here is a complete article on the topic. Thank You very much for asking

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

  1. Long Side: people add risk. Short side; frequent squeezes, start from manageable risk then reduce
  2. Metaphor of accelerator and brakes. Optimum fuel consumption happens when You do not solicit brakes. It clicked while listening to Larry Williams interview on the famous Better System Trader after bringing my daughter to the Hoikuen (crèche in Japanese)
  3. Market Value (MV) = AUM * Risk Per Trade (RPT)
  4. Most position sizing formulas will use one side RPT usually to calculate risk. In my case, this is convex so as we make money take more risk. This is accelerator. You want this to be responsive and nervous so to re-accelerate quickly after drawdown
  5. Meanwhile, when strategy stops working, You need to trade minimum risk. The problem with conventional formulas is that brakes are spongy and re-acceleration slow. You can get whipsawed. Which then erodes emotional capital, which leads to downward spiral. (Feedback loop between emotional and financial capital). By allocating a convex surface, AUM drops dramatically very quickly but then re-accelerates as there are signs of life
  6. Practical example: ETF. At the moment squeeze so drawdown, then surface immediately reacts and I naturally trade smaller. Residual open risk in my latest short entry was -0.12%, down from min risk at -0.25%

Trading Edge

From: Marcia

During your interview in episode 32 you talked about the “Edge” formula, which is, I think, ” (%wins X Average Win) – (%Losses X Average Loss) “? Would you talk more about that and what number you are looking for, or, what insights the number gives YOU?  thank you

Thank You very much. I am writing a book on short selling. Part 1 is about how to build a statistical trading edge. Part 2 is about building a mental trading edge. Part 3 is about constructing a portfolio with a positive trading edge. On the Long side, the market does the heavy lifting. On the short side, the market does not cooperate, so building a trading edge is critical

  • I am looking for positive number. I have never looked for a specific number, thank You for the suggestion
  • Use as asset allocation tool:
    • Plot trading edge by side and strategy
    • Pro-rate trading edge
    • Allocate resources (trading AUM or surface) based on trading edge, with floor and ceiling
  • This is useful for multistrats portfolios where You would systematically allocate resources to the best performing strategy

Shorting strategies

From: Adonis

What are the 3 most successful triggers he uses in going short? Does he use daily or weekly charts?

There were originally several variations on two strategies (mean reversion and trend following). Over time i have managed to merge them into one.

  1. Define trend: lower highs, lower highs
  2. Wait for roll-over: maximum information: volatility, swing high
  3. Enter on next bar

Exits:

  1. stop loss: full
  2. trend reversal (logical time exit): entry qualified on the other side happens within stop loss
  3. partial exit: risk reduction, take profit objective is to break even

Now, the delicate part is not in the signal module. Trading suspension for example is not a signal issue but a position size one. If sizes are too small, then trades are rejected. For example, sometimes currency pairs flip-flops between bull and bear. So, we count entries and add penalty for each full exit. This reduces risk per trade. If the overall equity is ain a drawdown, then position sizes get smaller. If they are too small, they are automatically rejected. This allows us to trade more pairs as some of them stop trading.

 

From: Graham

How do you simulate borrowing costs when testing a shorting strategy?

Everything at General Collateral (GC) +0,15% added to slippage. The question is probably related to hard to source issues or crowded shorts.

Do not short issues with borrow >5%, except on the Long side: squeeze box. Do not squeeze people: it is bad karma

 

From: Nikhil

1)  Majority of ideas for a short strategies seem to fail rigorous testing on larger time frames so one should focus on more active time frames [5min to 2H based data] instead of passive time frames [Daily to Monthly based data]  ?

Assumption: Nikhil may trade breakdowns, because this is a classic symptom or rebound higher than entry which leads to false positives.

Solution is not in better entry signal, but in partial exit and better money management, Trading system has 3 components: exit/entry, money management and mental.

 

2) Can you highlight a basic idea on a short strategies variable for further research for those struggling with constructing a short only strategy ?

JNK Short

Sure, check post on JNK attached. It is a scale-out/scale-in system.

There are 2 certainties in life: death and short squeeze. Use squeezes to your advantage

3) What opportunities do you see in the financial industry going forward for new generation of entrepreneurs (non trading/investing related) coming up ?

At the moment, everyone wants to be in the HF game. I entered the HF game in 2003 when it was still in infancy: a bunch of cowboys blowing stuff up in their kitchen. HF is bound for yet another healthy correction.

I believe the future to be threefold:

  1. Algorithmic assets allocation: fire your financial advisor. If You don’t know why, he probably does. Machines do a better job and they don’t get kickbacks…
  2. Separately managed accounts (SMA): open a brokerage account and let algo do the heavy lifting. Funds running costs are prohibitive. Besides, there is a proliferation of single brain cells parasites called compliance. They are the TSA (US airports officers) of finance: utterly useless at catching problems but extremely annoying
  3. Active management “soft patch”: SPIVA.com. The overwhelming majority of funds underperform the index and they are more expensive than ETFs. There is a gambler’s fallacy going on: ETFs have outperformed active managers so far, but the latter will be better equipped to navigate volatility and downturns. That is gambler’s fallacy: if managers failed to outperform during easy times, why would they even succeed during hard times ?

As for non-investment profession, I honestly don’t know

 

From: Ola

I am using market filters to keep me out of bear markets for my long only strategies for stocks, and I’m cashed up for periods of time. I find this a bit boring. What type of indicators or price action should I look for to create a short strategy to complement the long strategies? I’m looking for something simple and robust to be used on the daily time frame.

Best regards,

Ola

Check JNK trade attached. 1 Define trend, 2, enter on counter-trend move 3 exit partially as rebound comes

 

General trading

From: Bengt

Hello, it is often said that short trading is very difficult to make money off: Do you agree with this? If so, do you think it is a matter of the odds not being on your side or is it too much to handle mentally?

EXCELLENT QUESTION: “This is space, the environment does not cooperate… You solve one problem after another, and if You solve enough problems, You get to come home”, The Martian.

Andrew, Allow me to explain why people fail on the short side: they think from a Long perspective. This is deep shit that no-one has ever explained in statistical and psychological terms. Fascinating theme, I am writing the book on the topic and how to build a sustainable short selling practice

Example: 4 stocks: A,B Long C,D short, all start at 100

Start: Long exposure 200%, Short exposure: 200%, Gross exposure: 400% , Net exposure 0%,

A goes up by 10%, B drops by 5%. C drops by 10% and D goes up by 5%

End: Long exposure 205%, Short exposure: 195%, Gross exposure: 400% , Net exposure +10%,

Bottom line:

  1. On the long side, the market does the heavy lifting for You. There is a bigger bet on something good
  2. On the short side, the market does not cooperate: there is a bigger bet of something that does not work
  3. Net exposure is +10%. The main reason why people fail is that they want to short a throw away the key when they should be working more on the short than the long book. Just to stand still they should keep running: this is a Sherlock Versus the Red Queen effect

 

On the other end of the spectrum: is there an outer limit, odds-wise, for profitable long term trading, or is an 800-day breakout tougher to handle mentally than a 2 day breakout?

Best regards: Bengt

The problem is false positives: You will have many more false positives because of poor trend formation with shorter periodicity. You will deal with being systematically late. A more robust statistical approach is to deal with exits so as to move the needle from “near win” (false positive) to “near miss” (partial win)

 

From: Rob

Please ask for the following:

1) What works better in the forex market – momentum or mean reversion?

Mean reversion works until trend following works. It is a question of periodicity and tolerance for stop loss.

My strategy is a combination of both.

Post about two types of strategies:

Regardless of the Asset Class, There Are Only Two Types of Strategies

2) If you had to start over from the beginning with the knowledge you have now where would you focus on and what would you throw away?

  1. Psychology: clarity about beliefs. 90% of trading is mental, the other half is good math
  2. Trading edge is not a marketing gimmick: it is a number
    1. Money management: example of convexity
    2. Exits: stop loss is the 2nd most important variable

3) You have said in the past to focus on exits and not entries – but how exactly do you do this? Is it a matter of thinking about when you will exit if you are right or wrong?

Never think about right or wrong, it is the wrong mental association that will lead to death. Think about profitable. I am writing something on the psychology of stop loss. This article is potentially the most or second most important post I have ever written.

The best analogy is diet. Diets don’t work. We are all getting fatter and there has never been as much information on diet. Diets fix the wrong thing. The problem is not what we eat. The problem is how we think about we eat. Same goes with stop loss and exit.

This is not a mathematical problem. This is a psychological issue about the meaning we ascribe to closing positions. If we associate stop loss with being wrong, the ego will revolt.

IAU option trade anecdote funny and excellent example to talk about emotional capital and Zibbibo viognier white wine blend from Etna

4) What do you think about fixed fractional position sizing

it is a good basis of any position sizing algorithm. Now, it is a bit simplistic for 2 reasons:

  1. Uniform risk taking through the cycle: think of it as a car. Sometimes it is good to accelerate, sometimes You need to decelerate. Win rate changes through the cycle and so should risk
  2. Dissociation: Long and short sides rarely work well at the same time. Since they have different win rate, they should have different risk numbers

Dissociation by side of the book, strategy using trading edge or win rate. Please check my post on convex position sizing

5) Please talk more about stops. you said in the past your stops have a large impact on your P&L – but how do you calculate your stops. What are the considerations when using a mean reversion vs momentum strategy and type of market forex vs futures.

Sure, happy to explain the equation

The game of two halves: an elegant two-step process designed to cut losers, run winners, while maintaining conviction

Now, for mean reversion strategies, the equation includes another variable: frequency. Let me give You a simple example. If you clock +0.5% per month and then have -6% month, it will take roughly a year to make that back if everything else works. So, a simple idea is to empirically come up with a patience factor. Example: never allow losses to be greater than 4 months of average profit. The difficulty though is correlation. Accidents travel in group.

Another important point on mean reversion, never trade open risk strategies. Example: short naked gamma. I was having dinner with some options portfolio managers friends. Short OTM gamma is still marketed to unsuspecting investors. Those are scams: they show consistent returns until they blow up

From: John D

I trade a long term trend following (trade every 1-3 months) system on stocks indices currencies and commodities. What type of exits would you use on this type of system?

Trailing ATR stop? Time stop? Both?

John D, You are right on all of them

Three stops:

I have developed something called box concept. Once in a trade, there are three possible scenarios:

  1. It does not work and needs to be stopped out. That is a floor or ceiling depending on whether You are Long or Short
  2. It works well and warrants some de-risking: take money off the table and leave a portion for the long right tail
  3. It goes nowhere: this immobilizes resources and needs to be dealt with

The concept is that whatever happens, it will trip one of the mines and will be dealt with. This is how it is done in practice

  1. Isometric staircase stop loss: swing +/– allowance for volatility. Markets do not go up in straight lines. They go up or down, retrace and resume their course. This method allows markets to breathe
  2. Partial trailing stop loss: take some money off the table so as to reduce risk, but leave a residual for the big trend. After taking some money off the table, it makes sense to re-enter and a add a little bit more risk.GBPJPY
  3. Time stop: buying power and trading frequency. Some stocks do not move enough to warrant either a stop loss or a risk reduction. These are the harder ones to spot. The solution is to timestamp them.

About timestamp:

A powerful two step process to deal with the endowment effect: The game of two thirds, or how to deal with free loaders in your portfolio

 

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

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Introduction

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

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

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

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

 

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

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

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

On the short side, the market does not cooperate:

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

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

 

  1. Two types of algorithms and two types of people

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

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

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

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

 

  1. Regime Change, transition and drift

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

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

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

 

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

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

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

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

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

 

Part 2: Convex position sizing

  1. Philosophy of the convex position sizing

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

So, I started out with a list of demands

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

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

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

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

 

  1. Fixed Fractional Position Sizing revisited

Fixed Fractional Position Sizing algorithm basic formula is:

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

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

 

  1. Convex Risk Per Trade

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

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

How to calculate min and max risk per trade

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

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

 

  1. Drawdon module

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

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

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

 

Part 3: Convex position sizing in action

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

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

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

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

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

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

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

 

Conclusion:

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

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

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

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Answer by Laurent Bernut:

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

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

Between Charybdis and Scylla: Open Vs closed risk dichotomy

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

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

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

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

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

Accelerator and brakes

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

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

Trading Journal 20160203

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Trading Journal 20160203

1. Trading Journal

2. Tip of the day

Trading Journal

As explained in a previous post, Shorts entered after a squeeze offer better visibility and have higher probability of success. So, the alert pad came back quite full. Most of the signals are frequent flyers on the short side.

Shorts are like a glasses of wine, they tend to be depleted, so they require regular top-ups. Let:s not complicate things here.

Here is how to read the above table

  1. Stop Loss: it has a dual function, one obviously to put a quick end to a bad trade for now. The second function of a stop loss is to calculate a position size. Those are isometric staircase stop loss using a multiple of ATR 2.5 or 2.6
  2. Limit: Entry is a choice, exit is a necessity. This has been severely back-tested and reinforced in real life trading: this strategy works best over time if we do not chase stocks. Stop Loss and Limit are used to calculate position size
  3. ATR: Average True Range 20 days, simple average.
  4. Weight: suggested position size. This is a Fixed Fractional Position Sizing method or equity at risk that assumes -0.10% risk per trade. This is a clean simple multiplier
  5. Risk Adjustment: this is the -0.10% factor
  6. Equity at risk: position sizies are rounded to the nearest lot and this gives residual equity at risk
  7. Ranking order: the bigger the better. For a same risk budget, the trade suggesting the largest size comes first. There is no “qualitative/fundamental” assessment here. Size is a primarily a reflection of the volatility signature

For the record, I have placed orders on some of those ETFs. I am not suggesting You should buy/sell/short sell or buy to cover any of those signals.

As You can see, the numbers at the right side of the charts are the same as the ones on the table. In fact, I go through every chart and write those numbers.

SJNK is another junk bond ETF. It has low volatility and clean trend. Those are rare and nice shorts: bearish calm

On the Long side, the information is below the swing point. Interestingly enough, the algorithm flagged a partial exit shortly before this re-entry. Re-entries are possible only after a partial exit has been performed.You

The logic is simple: take risk off the table before adding some. Adding to a position with open risk compounds risk. It works until it does not

 

Tip of the day

Whatever asset class and time frame, we all trade the same thing: risk. So, the first order of business after entry is to reduce risk.

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

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

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

Turning away from the gates of Valhalla

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

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

Two certainties in life: death and short squeezes

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

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

The triple R methodology to weather a short squeeze

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

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

In practice, it looks like the chart below:

​Reduce

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

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

Above is a picture of my portfolio in late January:

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

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

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

Ride

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

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

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

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

Reload

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

“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…

 

 

Short-selling: “Come with me if You want to live”

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The 30s’ are usually remembered as the “Great Depression era”. Yet, from 1932 to 1937, despite abject poverty on main street, what was left of Wall Street enjoyed an exceptionally resilient bull market. The government had found a new tool called pump priming, inspired from an economist (only they can get away with such awful track records on the markets) named John Maynard Keynes. The government loved it and they feel asleep on the button. Sounds familiar ?

We have enjoyed a synchronous long smooth bull market. It has been good to all participants. Yet, no bull market has ever boosted anyone’s IQ. If anything, this Fed sponsored bull market has made participants fat and complacent: low interest rates pick up the tab anyway. Now, that the Fed has decided to tighten the purse, things may get a bit more turbulent out there.

Short-selling is the most underrated skill on the markets. It is neither a nefarious conspiracy nor an anti-patriotic gesture. It is a rare, versatile and immensely valuable craft that will ensure your survival in the most turbulent times. Markets have dropped by 50% twice in the last decade. If You would like to retire on returns rather than stories, then this is something worth learning.

Why You should listen to me ?

“Too many people look at “what is” from a position of “what should be”, Bruce Lee, Chinese philosopher

come-with-me-if-you-want-to-liveThese days, everybody seems to have an opinion on short-selling. Short sellers seem to proliferate faster than syphilis on a ship. I cannot but feel humbled in such illustrious company. I have been in the alternative space for 15 years (hedge funds and large institutions). For the past 8 years, I was a dedicated short-seller with Fidelity Japan.

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, having to do worse than the worst market on earth, good morning. These days, it feels somewhat refreshing to be around -50% net short.

While every other freshly minted guru has some elaborate speech about how short selling should be done, I have earned my short selling-skills the hard way and I have the scars to prove it. It is all lovely and cosy but the only tiny difference is that in the real world You can’t hit the reset button after Game Over. So, Come with me if You want to live

Why should You master the craft of short-selling ?

There are three obvious reasons:

  1. The secret to raising AUM is to perform when no-one else does. So, if You are a professional in the alternative space, just remember that when it is Babylon on the markets, investors will worship the Jamaican Prophet His Almighty Bob Marley
  2. Markets go up and markets go down: why not profit from both ? It takes a little more skill, that’s all
  3. A stronger version of yourself: In the world of short-selling, the market works against You. Either it will forge excellence out of You, either it will crush You. It is that simple. So, even if You decide to stay Long Only, learning to sell short will undoubtedly make You a formidable market participant.

Why do most people fail at short selling ?

“In theory, theory and practice are the same. In practice, they are not”, Yogi Berra, American Philosopher

Market participants approach short selling the same way they approach long buying. They do their analysis, watch some of it being validated and then happily conclude it is just the inverse of going long. That all works well until it is time to put theory into practice.

A couple of short-squeezes that would turn Barry White‘s rich baritone into Barry Gibb‘s high falsetto, a couple of quarters of humbling losses down the road, and they conclude that short-selling is dangerous. What they do not realise is that on the short-side, the market does not cooperate, stock picking is just not good enough. Market participants fail to understand the dynamics and the mechanics of short selling.

On the long side, picking stocks is sufficient. The market does all the heavy lifting thereafter. Stocks grow bigger, everything works in tandem: they contribute more both in terms of alpha and exposures. Losers shrink and hurt less.

On the short side, the market works against You. Winning big literally means watching your portfolio shrink like a magic skin:  You have smaller victories when successful and bigger problems when unsuccessful.

Picking stocks is just the start. The real work of extracting alpha comes after that. This is hard, frustrating work, when it works at all. This is why people keep looking for structural shorts all the time, something they can sell short and throw away the key. Structural shorts are like market gurus, they are everywhere. Profitable structural shorts are more like market wizards, good luck finding one. They are so rare they make Big Foot look like a frequent guest on the Saturday Night Live show. Welcome to the mechanics of short selling: scarce poor quality borrow leading to short squeezes, prohibitive interest fees and dividends payable.

The MMA of short-selling

Martial arts are a good analogy for the markets. If Long only was a fighting sport, it would be English boxing, Queensburry rules. If Short selling was a sport, it would be MMA, Vale Tudo. Floyd Mayweather is the undefeated champion of the world. He is a solid contender for the title of the best boxer of all times. Yet, should he face Conor McGregor in the octagon, MMA style, he would be dismantled, dismembered and disfigured long before the first round bell has a chance to save him.

On the Long side, all You have to do is pick stocks and the market does the rest of the work for You.

On the short side, not only do You have to do that, but You will have to master those skills:

  1. position sizing: successful shorts shrink, unsuccessful ones hurt fast. Learn to size position so that they may contribute if successful, but not wound if not
  2. Milk your ideas: successful shorts shrink. So, it is not enough to find them, You must constantly work at them to extract alpha
  3. Consistent idea generation: a healthy short book shrinks, so You need to come up with at least twice as many ideas as the Long side just to keep up
  4. Market timing: two certainties in life: death and short squeezes a la Barry Gibbs. Use the latter for trading purposes before the former catches up
  5. Superior understanding of risk: risk is a number, not a pretty paragraph at the end of a dissertation. Short sellers naturally develop a keen understanding of hedges and probabilities.
  6. Process versus outcome thinking: if investment is a process then automation is a logical conclusion
  7. Mental fortitude: would You like to be the iceman on the trading floor when everyone else panics ? After a while, bull markets, bear markets, they all taste like chicken

The good news is that short-selling is a skill. It can be acquired, perfected and expanded. It is also a versatile and valuable one. Remember this: with this skill, You can go Long without breaking a sweat, but can Long-Only do your job with the same ease

How does it work in practice ?

Short selling is a high pressure sport. Those who have only gone Long will suddenly be confronted with unfamiliar levels of stress. Volatility, uncertainty, fear, stress, pressure constrict the thinking brain (prefrontal cortex). Whatever mental bandwidth is left will be thankful for clear, unambiguous and simple instructions. So, do not be fooled by the apparent simplicity zen appearance of the charts. It took years to mature and thousands of lines of code to come to this level of clarity. In time, I hope You will learn to appreciate the gift of simplicity.

The above chart is designed to be intuitive.

  1. Price Bar colour: Down trends are coloured tomato. Uptrends are coloured olive. Back in 2012, the original name of the strategy was Olives & Tomatoes. (no wonder it initially failed to garner traction in my venerable institution…)
  2. Swings: swing high bars are coloured in green with a green annotation above the price bar. Swing low bars are coloured red annotation below the chart
  3. Annotations above/below swing bars:
    1. Olive (above) / Tomato (below):
      1. Stop Loss: Single number above/below all annotations
      2. Target price: target price is a risk management level. It is not an expression of fair value. Life is unfair, so are the markets, get over it
      3. #ATR: Average True Range [20 bars]
    2. Mauve (never trust a Frenchman with the colour code): Remaining balance. When engaged in a position, the algo calculates the quantity to exit so as to break even on the trade thereafter and prints remaining balance
  4. Dotted Green/Red Line: isometric staircase stop loss. Stop losses are reset for all positions. Those who fail to honour them will be unapologetically de-friended: may You be chained, eagles devour your liver and Justin Bieber fill your ears
  5. Black triangles: represent entries. Stacked triangles mean single entry, multiple exits. Above/Below is a precious roadmap that contain all the values for the journey ahead
    1. Ceiling/Floor: this is the equivalent of stop loss.
    2. LoB: is the equivalent of a Limit or Better price. Do not chase stocks past that point as probability recedes thereafter
  6. Red/Green inverted triangles: mean unprofitable/profitable exits. Stacked triangles mean final exits of multiple positions
  7. Moving Average: we all love our Christmas trees. This has no bearing on the strategy, but users have found it easier to anchor their beliefs around a long term moving average.

Charts have all the essential information You need to know to go on your journey: bullish/bearish underlying trend and exit roadmaps. It is kept simple by design. For example, position sizes have been removed in this version. They are calculated separately in the alert table. It all comes down to essentialist philosophy: focus on the essential few and let go of the trivial many. With this tool, You have a sustainable fighting chance against the markets.

Trading Journal

The above chart translates into real trading: multiple entries and exits. Green column is entry. Salmon is partial exit and grey is final exit. As soon as a position is entered, the first order of business is to take some money off the table so as to reduce risk.

Above is JNK, the ETF for high-yield bonds. When the first trade was taken, the chrematocoulrophony (chremato: money, phone: voice, coulro: clown) or consensus on The Street was talking about “Buy the dips”, “value hunting”. These days, everyone talks about the implosion of the high yield space. Bottom line, the hardest trades often offer the best rewards. Stick to your system.

Alert table

The table contains the same information as charts, only in a more compact numerical form.

Types of Alert:

  1. Long Limit / Short Limit:
  2. Profit Taking: A swing has been recorded and the market is about to rebound/drop so time to take risk off the table. Exits are executed at market price: entry is a choice, exit is a necessity
  3. Trend reversal: Trend has changed from Bull to Bear and vice versa. Close open positions at market
  4. Stop Loss: remember the curse of Prometheus: liver may regrow, but Justin Bieber that is rough
  5. Weight: is derived from a fixed fractional position sizing method set at -0.10% (equity at risk method) for simplicity;s sake

That’s it, everyone is set. Happy trading. Two things, I trade the same signals that are shared on the website. Call it front-running or camaraderie. Rather than 5 pages of lawyerly bizantyne disclaimer, one sentence suffices: You are responsible for your own choices.

Conclusion      

“The time to repair the roof is when the sun is shining”, JFK, modern mystery

Short-selling is a habit. It takes time, mistakes, patience to unlearn bad habits and form new beneficial neural pathways. The best time to do so is when urgency forces focus, but not critical enough to be a question of life and death.

The Fed has ended its life-support, which means more turbulence ahead. This is a good time to learn how to ride volatility with serene equanimity.

Has anybody gotten rich through automated trading?

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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…

Sisyphus stones
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:

  1. 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 ?
  2. 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.
  3. Stop loss: it is the only variable that has a direct influence on 3 out of 4 variables of your trading hedge
  4. 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
  5. 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
  6. Symmetry: once the short side delivers, translate it to the long side. You will have unambiguous signals, unified risk management
  7. Watch Star Trek and the original Kardashians, they were not as villains as the newer ones, breaking bad, desperate house wives etc
  8. 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

Has anybody gotten rich through automated trading?

How complex are the algorithms used by financial institutions such as Goldman Sachs and other hedge funds in their proprietary trading so…

/2 Comments/in , /by

This is an answer to a question on Quora. It got re-posted and shared across Quora users.

Answer by Laurent Bernut:

Complexity is a form of laziness
Complexity is fragile: it works until it does not

There are two types of algos: low-latency and systematic algos.

Low-latency is the realm of HFT. Those algos can be quite intense. Read dark pools or flash boys. There are now algos gaming other algos. It is a bit like the “sperm war” in the “red queen”, a book on evolutionary psychology.

At the other end of the spectrum is systematic trading. It stems of the belief that if investment is a process, then it should be automated. Those algos are conceptually easy to understand. They are not however always easy to program.

At the end of the day, algos are a reflection of the philosophy, beliefs of those who design and code them. Those who have not mastered their craft will gladly put lipstick on a pig, by adding complexity to flawed concepts.
Those who have worked a bit harder will simplify. Simplicity is not easy

Sorry for the philosophical answer

How complex are the algorithms used by financial institutions such as Goldman Sachs and other hedge funds in their proprietary trading so…