14th July 2013: 4 Reasons I Trade

I’ve spent part of the past week reading about how hedge funds can now advertise; the value of index funds; and Mike Bellafiore‘s response in his new book The Playbook (Upper Saddle River, NJ: FT Press, 2013) to the death of intraday trading. I reflected on the different perspectives as I planned a possible new PhD chapter on vega (volatility) arbitrage, and gathered resources for a Bayesian inference engine (part of multi-asset quantitative trading). Here are four reasons I still trade:


1. The financial media uses character archetypes that I dis-identify with. CNBC is basically entertainment. Other news media reduce financial trading to easily digestible character archetypes: a technique I learned from Hollywood script-writing. The common character archetypes include: (1) the young rookie at an intraday arcade who will likely not survive what is a transitional job; (2) the newly retired professional who has taken trading courses; (3) the ‘pro-am’ (professional amateur) trader who has an expensive, video-game like office (Evan Davis’s The City Uncovered documentary); (4) traders who have emotional meltdowns (Lex Van Dam and Anton Kreil‘s Million Dollar Traders series); and (5) the obligatory journalistic disavowal of all of the above. Whilst each of these character archetypes have warnings they also do not highlight the successful cases documented in Jack D. Schwager’s Market Wizards series, and similar books. The gap between the two is a little like the difference between Freudian abreactive therapy and Ericksonian solution-focused brief therapy: the first focuses on remembering and reliving the past, and the second on moving forward.


2. To develop your trading playbook you need to carefully screen and evaluate information. Bellafiore contends in The Playbook that all traders need to develop a collection of trading set-ups and strategies that reflect individual personalities and preferences. This requires immersive action-reflection cycles in the financial markets. It demands careful attention to money management rules. A deep study of financial markets history and cultural ethnography can also help. This knowledge emerges from research and experience. It is usually the opposite of what the financial media stresses, or the introductory material found in many courses on foreign exchange and options that target new traders. Alpha generation lessons on how to structure a trade and when positive expectancy might exist can be applied to many areas of your life.


3. Market inefficiencies can be relational. Most academic research and financial media coverage is influenced by the strong form of the Efficient Markets Hypothesis (EMH): markets reflect all public information; that is known equally to all market participants; and there are no transaction costs. Market participants are closer to the weak form of the EMH. Consequently, financial media coverage often mistakenly contends that market inefficiencies are zero-sum, and that disappear once identified. This creates a scarcity narrative or a ‘race to the bottom’ dynamic. However, behavioural finance proponents note that market inefficiencies can also be relational: assets under management size; fund style; or investor capital outflows due to fund ratings can affect some traders and not others, for instance. George Soros, Michael Steinhardt, Jim Simons, and other fund managers have used this insight. The late psychologist Ari Kiev taught game theory to traders at Steve Cohen’s SAC so they could work out what other traders and fund managers were possibly doing. It is also why the study of market microstructure (order, price, and trader dynamics in markets) has changed the knowledge base of trading in the past decade. For instance, high-frequency trading (HFT) changed the asset price and time series dynamics that some intraday traders had relied on. HFT was a possible regime change in markets. But it didn’t end trading, altogether. Rather, it meant that individual trading playbooks had to be updated.


4. Trading psychology focuses on performance. I have most of the books by trading psychologists Ari Kiev and Brett N. Steenbarger. This week, I added two new additions: Denise Shull‘s Market Mind Games (New York: McGraw-Hill, 2011) and Jason Williams’ The Mental Edge In Trading (New York: McGraw-Hill, 2012). I downloaded Doug Hirschorn‘s PhD on trading psychology and performance evaluation. Trading psychology has introduced me to John Coates’ work on neuroscience, and reintroduced me to Mihaly Csikzentmihalyi‘s study of ‘flow’ or optimal, mindful states. This body of work can be applied to many different areas of your life. It illustrates how rigorous academic research can be utilised in professional domains. Trading’s performance expectations are now showing up in many other industries where life-long employment is no longer a given. Trading’s mindset, pace, and action orientation gives me some of the frameworks and methods to self-disrupt my job, and to accelerate action-reflection cycles where a ‘winner-takes-all’ dynamic exists. For instance, academia used to be like the bond market: 20-to-30 year cycles and an expectation of life-time academic tenure. Now, it is more like options, futures, and foreign exchange markets: more short-term time-frames; faster decisions; and more volatility. I’ve had multiple career changes in academia over the past 10 years. The trading experience changed my expectations of what an academic career would be like.


For most people, still put your money in a low-cost index fund, though, like Vanguard or Dimensional.

16th February 2012: Ari Kiev & Trading Psychology


I’ve been reading the late trading and sports psychiatrist Ari Kiev during my daily work commute. Kiev achieved influence in the 199os through a series of books for Wiley Finance on stress and trading psychology, and work for SAC Global Investors LLP. You can read an example of his insights here. But I didn’t know of Kiev’ early work on depression and suicide prevention. Above is the first of an 8-part seminar on Kiev’s trading insights.