Tuesday, 29 July 2014

No time for losers

20:18 Posted by The Thalesians (@thalesians) No comments
Whenever I emerge from South Kensington station in London, a sense of happiness envelopes me. It isn't because the women are slightly more beautiful there, indeed, I once spotted Liz Hurley in the streets of South Ken. It isn't because the cars are that bit shinier and more Italian (Ferraris) than elsewhere in London. Instead, it is because of the memories the area conjures up in my mind, reminding me of my university days at Imperial College, a time when hair used to be welcome on my head. Several years ago, I made this pilgrimage back to South Kensington and Imperial College across from the City, where I worked at a little place called Lehman Brothers, to see an Imperial alumni lecture.

The lecturer was Brian May or I should say Dr. Brian May, also known as the guitarist in Queen. His lecture dwelt upon physics and in particular the subject of his PhD in the field of astronomy. I was constantly expecting him to discover a guitar from beneath the stage for an impromptu concert playing the chords to We Are The Champions, before the audience would begin to revel in the refrain (the lyrics of which, I have partially written below). According to the lyrics, for champions, there is "no time for losers".

We are the champions.
No time for losers
'Cause we are the champions of the world.

When it comes to trading I would disagree with that notion. Every successful trader is never continually a champion. Instead a trader, needs to navigate that route between perpetual loserdom (a word which I suspect I have made up) and championdom (another word for which there is no dictionary entry). After all, to make gains trading, a trader needs to battle through losing trades to get there. Where a trade has virtually no losing trades, it suggests that their strategy relies upon ideas such as heavily leveraged option selling. Either that or the capacity of the strategy is severely constrained. Indeed, a very high Sharpe ratio might seem welcome, but it does not tell a trader whether the strategy itself is unstable and prone to sudden breakage, either through a drawdown or simply the permanent breakdown of the strategy.

Approaching the subject from a systematic trading perspective, we can usually compare losses with our historical backtest. If they seem in line with historical losses, it gives us some comfort that the losses we have observe are not unusual. Alternatively, if they are blown out of all proportion to historical losses, it can be an indication that something more is afoot. Of course, one thing we cannot backtest is pain (from personal experience!) In any case, whether we are discretionary or systematic traders, we should know how to react to losses, above a certain level.

Losses are never pleasant in trading, but they cannot be avoided. The key is understanding why they have happened and to learn from them. So for traders, there has to be time for losers to somewhat paraphrase Queen.

My book Trading Thalesians also has some colour on this topic of examining historical returns and also understanding the risk of trading strategies (mixed in with a bit of ancient history).


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