Sunday, 30 November 2014

What's the best way to trade?

20:03 Posted by The Thalesians (@thalesians) No comments

Boston is to America what Cambridge and Oxford are to Britain. Indeed, the neighbouring town to Boston, Cambridge is named after its English predecessor and has within it both Harvard and MIT. Boston also served as one of the hot beds of the American revolution, being the home of the Boston Tea Party. However, I must confess that my knowledge of American history, is somewhat sketchy, although I'm endeavouring to improve. Indeed, if you have any suggestions on history books to read about America, I would love to hear from you!

Walking along the streets of Boston, it seems easier to become immersed in history than perhaps in other large American cities. Whilst skyscrapers occasionally dot the landscape in Boston, there are regular reminders of the past, such as the historic houses of Beacon Hill or Quincy Market, which today is thronged by tourists eager for lobster roll.

I took many photos on my recent visit to Boston, which was perhaps too short, including the graffiti at the top of this article. The graffiti suggests it is "not art". Whilst the point is somewhat simple, it made me think. What precisely qualifies as art and what doesn't? I am sure that artists have grappled over the ages with this question. Personal taste clearly plays a role, as well as so many other metrics, such as originality. For someone who is versed in mathematics, a well written proof can in itself seems artistic (although perhaps artists amongst you might disagree?)

When it comes to trading, we might attempt to ask a similar question: what precisely makes a trading good strategy? Is there a best way to trade? Moreover, what makes a trading strategy good enough for me to run? There might be commonalities which govern "good trading" such as not leveraging up more than you can afford. Yet, as soon as we get to specifics, here again, the answer to the question is related to the person making it.

Each investor has their own criteria for what would make a successful investment and the capital available to them differs hugely. Some investors have a long time horizon and are less leveraged. Hence, investments in more illiquid assets are more feasible for them. Some might prefer a more discretionary style, whilst others could be more comfortable with systematic strategies. When I'm trading my own capital, I am much more sensitive to drawdowns, in particular because I employ a modicum of leverage. As a result, I prefer high frequency strategies in liquid instruments, which typically have higher risk adjusted returns. They can of course have drawdowns, when a strategy becomes crowded out, and part of my job is to identify where these points could occur (somewhat difficult, but I am willing to give it a try).

I am also running fairly small amounts of capital on my personal account compared to when I was in bank. Everything is relative, when it comes to risk taking. Thus, the fact that these types of higher frequency strategies have lower market capacity are less of a concern. For a hedge fund running billions of dollars, there would be capacity issues. Indeed, in that scenario, the solution would be to come up with a large array of different high frequency strategies. The cost here is not so much purely the cost of capital, but also the cost of time. Even once we have identified the frequency or the assets we would like to trade, there are a massive number of other choices which we have. By the time, we have actually chosen a trading strategy which we believe is suitable for our investment style, we have discounted countless other ones.

What seems clear is that other investors faced with the same question, could have chosen totally different strategies, once they have jumped through all the hoops necessary to come up with a trade. Hence, whatever we have chosen to trade has been tailored for us. Whatever constitutes the best way to trade is merely the best for you, rather than for everyone else.

My book Trading Thalesians - What the ancient world can teach us about trading today is out in late October on Palgrave Macmillan, has some colour on the topic of learning from the past (mixed in with a bit of ancient history). You can order the book on Amazon.

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