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Essence of Trading: What You Want Isn’t What You Need

iStock_000012959689XSmallA dilemma I often witness from my unique position in talking to potential investors and hedge funds is that people often do not know what they need. I have several interesting stories to share addressing this issue. You may find the story relates well to someone you know.

A Small Hedge Fund Doing HFT

The fund manager wants to develop HFT algos and solicit clients based on a sales pitch that his fund can do great with their HFT program. The fund has several models ready and have been seeking opinions from others whether their models are good enough for deployment. The models of course are showing great performances on the historical data.

I pointed out that their models are not even close to what HFT is. Having technical indicators applied on tick data assuming the best fill possible do not produce HFT and they do not work in general anyway. I directed them to read the basics on HFT and told them nicely these models will not work even if they have co-location servers at the exchanges.

Being the only opposing voice obviously does not help. Last time I heard about them was from a friend who had not been able to collect his coding fees of the models from the fund.

What the fund need are slower daytrading models that they have experience working with. After all, a fund has to be profitable. I understand that the fund has no marketing buzz to sell to the high net worth potential clients. Being profitable in the hedge fund space is not enough to get clients these days.

Entrepreneur Turns Daytrader

A successful entrepreneur who made it in the import/export business sold his business and retired in his early 50s.

Out of boredom he started to daytrade the financial markets. First he tried out forex and gave up shortly after. The volatility during the 2008 crisis cost him dearly. Next he set his eyes on the stock market indices. He made a killing at the peak of the financial crisis in 2009 but he has been losing money since. He bled most of his winnings by the end of 2012.

Some mutual friends learned about his frustrations and introduced him to meet with me.

He asked for trading signals to short the stock market top. What he wanted was that the stock market to top out and keep falling. He also wanted people to agree with him that the stock market was going lower.

I pointed out that he was living in the past. He was replaying the history in his mind so often that a rare event like the financial crisis became something that he thought would happen again easily. Every news or event became a sign that the stock market would top out.

He is still learning to snap out of the past and pay attention to what is happening now. A good sign is that he no longer short the Emini S&P blindly just because of some supposedly negative news hit the media. And yes, I convinced him to learn reading the charts and control his risk.

What this guy really need is the truth about the stock market. He is a pretty smart person who was able to grow a business into decent size and have it sold for good profit. Once he started to see the risk side of the trading business he can teach himself to control the risk as he has the discipline necessary. From there it is just a matter of time for him to find his own profitable way.

Retiree Wanted To Become A Daytrader

I met with this retired lady pretty much out of the blue. She is a relative to one of my old buddies in my hedge fund days. She has been very frustrated with her saving and her money has been chipping away for several years. She called one day asking directly if I can manage money for her. It is a surprise call because not that many people know about my side business.

In short, she wanted a very significant return from her limited risk capital. She was willing to risk up to $50,000 and would like to get a return of 50% on that annually. She was and still is a very conservative person. She understands the importance to protect majority of her money so that her basic living cost is covered. Thus the $50,000 is indeed risk money she can part with.

I explained that it was very difficult for me to do this for her because I no longer taking new clients. It would also be very difficult to find an advisor who can promise her the kind of result she is looking for. At the end, I also declined her request to learn daytrading from me because her character will make it very difficult for her to take on risk routinely.

Funny how things turned out. I managed to convince her to take on a part-time job doing things she loves to do. She is now a sommelier, resolved the cash flow problem and a happy person again.

What she need was a solution to her cash flow problem, not money management service. The angle she was looking at was restricted by her past. Hence she was not able to find a solution to her own problem until she has someone open her eyes to other possibilities.

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Essence of Trading: Don’t Blame The Politicians

chalkboard_sacrificeThe latest fiscal cliff fiasco and the ongoing financial crisis in Europe and Japan spurred a lot of discussion on the net. Some blame it on the politicians not doing their jobs. Some blame these politicians being stupid or "not having enough political will". Personally I do not under what this last phrase means at all. At the extreme, there are people blaming other nations being lazy or not willing to sacrifice. We have to wonder if these finger pointing actions address the root of the problem at all.

The Politicians Are Doing Exactly What They Are Supposed To Do

Anyone who is angry with the politicians in how they are handling the financial crisis should chill. Just calm down. Now, read this quote from Jean-Claude Juncker, one of the famous European politicians,

“We all know what to do, we just don’t know how to get re-elected after we’ve done it.”

Politicians are elected to do a job. They will be voted out of the office if they no longer get enough vote to be re-elected. This fact alone is enough to guarantee the politicians would not choose to support any political actions that will reduce their chances of being re-elected. Why would these politicians choose to end their successful careers? They have to act responsibly for themselves, their family members, and possibly their related business partners too.

Now, isn’t it clear that the financial crisis is the result of excessive debt creation? In layman’s terms, these governments (and big corporations) were borrowing so much money they cannot afford to even pay for the interest.

It is common sense that if such debt is removed from the financial system it will induce significant job losses. People out of jobs will blame it on the choice chosen by the politicians. Whoever supported the idea of debt reduction is asking for an end to their political careers as people losing their jobs and money will not be happy voters towards the incumbent politicians.

Catch-22

This is the perfect Catch-22 situation.

Voters will not vote politicians promised to mess up their lives, period. Politicians voted into the office running the governments will not vote in favour of actions that will terminate their political careers. Thus, the voters and the politicians working together to avoid solving the problem together.

As Juncker said, "We all know what to do." The obvious solution is to force a reset of the system, bankrupt the entities that are not functional, and let the system rebuild itself. But such process will surely result in massive unemployment and social unrest, even though the economic system can rebuild properly. Thus, the discussion of any political solution to the worldwide financial issues is a waste of time.

Here we are, right at the root of the problem. Namely, a political system based on electing humans to govern will always fail in crisis situation unless majority of the people involved have accepted the fact that they have to suffer with everyone else in order to turn things around. What I am talking about is not something new. Studies have been done on crisis handling and how tough choices would be made only if the group as a whole believes that there is no other way out.

Translating that into the case of our global financial crisis at this moment, it means that only until majority of all the people in the world are suffering and not doing well, there will be no agreement to a global reset of the financial system. The system may keep failing here and there, but total collapse is not something that will happen overnight. So it may take many years before we see a change in sentiment among people asking for fundamental change.

It is similar to how communism suddenly gained popularity long time ago. Majority of the people at the time was suffering so bad that to these people, the idea of sharing the wealth of others was a good one because they have nothing to lose. At this point, the world is far from reaching such level of suffering among the people. It may take a whole new generation of people coming into working age with next to nothing in their procession, while the oldest population and early baby boomers no longer control the majority of the votes, before significant shift in political sentiment can happen. Even in Japan that has not happened yet.

Every Man For Himself

There is absolutely no point in blaming a particular political party or certain politicians. They are as much opportunists as the politicians you preferred all along. If you do not think that is true, maybe equal them to the other well hated type of people like corrupted corporate executives or robbers. Learning to accept this as a fact of life will steer you towards the more productive matters – how to profit from the situation and avoid being marginalized by the continuous deterioration of the economic condition for those who are not in control.

Significant trading opportunities is right in front of us every day. Money can be made from trading index futures, forex, and other global markets. You can stand still and continue to hope that your job will not be the next one being axed. You can also hope that getting another degree would give you better opportunities in finding a better job. But why put hope on things that are now understood to be not functional?

Take advantage of the system now and make money for yourself instead of wasting your time cursing the politicians for not doing their jobs. Prioritize your time and effort to learn how to money from the markets. As a normal person who is not in the position to change the world, you should focus on take caring of yourself and your family. After all, it is every man for himself.

Leave the world changing goals to the superheroes for now.

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Essence of Trading: Hunt As A Human

iStock_000012892060XSmallIn trading, younger traders often feel pumped when they have to struggle through many trades during the day in order to come out ahead with a profit. For older traders the same struggle is exhausting and often giving them a headache. Over time if a trader has not moved on from liking the experience, this particular feeling towards the struggle itself will become a major obstacle blocking the trader from achieving better performance.

Animal Instinct

This sense of achievement from a prolonged struggle against something we deem bigger than we are, is originated from our ancient ancestors who hunt for food over a very long period of time. It is part of the animal instinct that we have inherited from them. It is the satisfaction coming from the animal instinct we have at taking out the preys after a dangerous fight.

It is a great tool in training someone to fight better and to survive dangerous situations. After all, it is risky business to hunt for a living. But it may not be such a good idea to be addicted to this gratification in trading.

Many traders perceive trading as a fight against something. In particular, fighting a market that is bigger, stronger, and quite unpredictable. No wonder many traders feel good if they have to struggle through a trading day with many setbacks and eventually coming out ahead with profit to spare. It is definitely a great accomplishment.

When this type of struggle happens too often, however, it is not something to be proud of. In fact, it tells you that your trading is not as efficient as it should be. You could be over trading due to your love of the struggle itself.

Hunter Instinct

Just think about our ancient ancestors – they did not stick to the gruesome battles against the animals for long. The moment they figured out how to do it with lower risk and more efficient method, they went for that. Starting with better weapons and defensive tools, they got to hunt bigger animals by choice. Then they also built traps to capture animals without the need for them to be physically presence at the trap.

Traps that work require expertise in hunting the animals. Otherwise they would not work. In another words, the hunting skill was not abandoned. Instead it was utilized in a higher, abstract level to give the ancient hunters more in return.

These changes in the way animals are hunted allow the ancient hunters to secure food more consistently. Planning ahead with better strategies gave these ancient hunters an edge to capture more preys over the competing predators that were driven to hunt purely out of necessity (i.e. hunger).

Hunt As A Human

There is a striking parallel between these ancient hunters and modern traders.

Our ancestor hunters outgrew their own animal instinct from direct hunting. They developed planning and goal driven thinking. Their hunter instinct took over. They figured out that more food for the family with limited human power was way better than the risky maneuver of hunting large animals directly. The hunting skill was still important and obviously honoured among the tribesmen but it was applied in different ways like building traps. As oppose to be the only tool available, the hunting skill became the foundation of multiple survival tools passed down the generations.

Many traders apply their animal instinct in reading the tapes. They observe the markets for a period of time in front of their screens. It is normal to develop a sense of the rhythm of the market. They sense the potential changes and can enter trades to their advantage. They have developed the tape reading skill.

Relying solely on tape reading skill to make trading decisions at the heat of the moment all the time is an exhausting and demanding process. It requires total focus by the traders just like what the ancient hunters did when they were hunting.

It is a good thing to learn to read the tapes but it can only give you a slight advantage in the trading game. Over time if other trading skills are not developed properly, a trader will be stuck with the only skill they have with limited performance. More struggling every day, more likely the person will focus all the energy with tape reading and forget about developing better trading skills. It is the same as the ancient hunters who were hunting because of hunger and failed to plan for the future.

Learning from the successful ancient hunters, we know they did not always hunt by brute force. They used their cunning and wits to improve their hunting results. Their traps built for catching small animals are like traders who have developed good reliable trading setups that consistently extract small profits from the markets. There is no struggle against the market, just execution of well thought out plans for consistent results.

Just remind yourself, as a trader, that you hunt to make a living, not to engage in fights for satisfaction or gratification.

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