Trading Is Hazardous to Your Wealth [pdf] (2000)
faculty.haas.berkeley.edu
faculty.haas.berkeley.edu
This is likely a controversial opinion: 90% of the time, someone who wants to break out of the "rat race" or achieve wealth for some future vision should go the startup route, or if the wealth part is not as important, do freelance/consulting. However, I believe there are 10% of people where trading the markets provide the better way to achieve the same goal. The reason being that for certain personality types (you need to be smart, disciplined, and creative to beat the market, and it still requires a lot of time), I suspect trading offers a higher expected value of return than starting a bootstrapped company. Startups, especially those not started by someone wealthy, have a higher failure rate than day traders. If you are not passionate about anything you can get funding for (would SpaceX have been successful if it were Elon's first company?), and you fit the criteria, trading is not as terrible an option as its reputation suggests.
1) Trading fees. If the house takes a cut of 0.1% on every transaction, then on average those who trade more lose more money.
2) Risk/reward tradeoff. If you buy deep out-of-the-money options, you might have a 5% chance of profitability, but expected return of $0 (neither positive nor negative). 95% of the time you lose $X, and 5% of the time you make $19X. If traders are pursuing riskier strategies, you'd expect most of them to lose money.
For point 2, if there is an expected return of 0, then on average this should push the portfolio toward 50% chance of profitability.
It is the psychological factors combined with a non-random market that ensure most traders lock in losses (usually after riding them too long or not long enough).
If you trade derivatives, fees can be very low (because these are highly-leveraged products but if you are smart you know you shouldn't take any leverage). This can save substantial money if you trade frequently.
> Risk/reward tradeoff. If you buy deep out-of-the-money options, you might have a 5% chance of profitability, but expected return of $0 (neither positive nor negative). 95% of the time you lose $X, and 5% of the time you make $19X. If traders are pursuing riskier strategies, you'd expect most of them to lose money.
There is more to trading than predicting the direction of a stock/currency. You can provide liquidity and arbitrage a stock and its derivatives. Having traded for a while, arbitrage opportunities do exist; though sometimes you might have to be patient and cut off trading until an opportunity arise. This can be quite a time (like a year with no trading opportunity) and will require a lot of self-control.
It exist due to "absorption barriers", due to the ergodicity of the process - betting too big and hitting "uncle points".
It's a bias present in most people, especially otherwise intelligent people: not understanding that there is a huge difference between expected value and ergodic properties. Between expected returns and risk. Just look up what VaR is, the concept is ridiculous, yet so widely used.
How much should the win (5/6) value be in a game of Russian roulette for you to play the game? The answer is that for most people it is not any number, that value doesn't exist.
Can you expand on this? Are you claiming that the stock market is ergodic, or that it is not?
Though I suppose even if you broaden "the market" even to all of civilization - it is also non-ergodic, at least since nukes and hydrogen bombs were created.
https://medium.com/incerto/the-logic-of-risk-taking-107bf410...
Only if the humans were making decision to buy and sell randomly.
This seems highly unlikely
Sure, there are people that have the skillset and capital to earn a living from day trading that don't have the skillset or interest in running a business who'll be better off trading. But successful businesses selling products or services can consistently earn very large multiples of their initial investment, and day traders can't. Short term financial bets are much closer to a zero sum game than starting businesses. And we've already established that 90% of day traders fail, just like startup businesses. More than 90% since the criteria in this study is beat the index, not earn a living.
Tech stack: I love Ruby, but use Python and a custom language that interfaces with the broker I'm using for execution. More and more decent broker API's are starting to pop up out there. So, you can likely use whatever you're most comfortable with. Alpaca has a decent web API, for example.
I honestly wouldn't recommend getting into it, though, unless you really enjoy geeking out over this stuff and have a decent breadth of knowledge to find your edge. You're also competing against some brilliant PhD types who are just as obsessed and hard working as you. My stuff works in part because it's taking advantage of some things that are too small for the big boys to pay attention to.
I've spent a lot of time on a automated trading side project of mine but haven't found the strategy yet.
In retrospect time has been spent in completely the wrong areas ( setup a solid backrest platform first, duh )
Backtesting is great for validating ideas initially. Especially, to see if it holds up through abnormal markets like '08, or the volpocalypse, or the recent crash. Watch out for curve fitting, though.
Do you apply ml techniques? I don't suppose you could point a little in a good direction to follow
Something like using NLP on SEC filings the second they come out to catch an initial jump in the underlying would be cool to try out.
Warning: it is a lot of fun, thrilling, but hard to make money. My winning algos took a while to research, longer to automate, and often lost alpha quickly.
The main reason why 90% lose money is costs. That is it. Most people probably are optimised for losing money but the main issue is really costs/overtrading.
But related to this, most people believe that edge on profitable trades is very large...but in most markets, institutional-grade costs will still be a big chunk of your edge i.e. costs matter hugely.
The fees are baked into quoted price ("the spread") but the execution cannot be worst than the NBBO (National Best Bid Offer).
They are making money on the spread for sure, probably crossing some trades internally as well. They also make money on the margin rates.
You don't think it's at all strange that 80% of share volume coming out of Robinhood is sold off to broker-dealers attached to large systematic hedge funds?
I'm sure you could think of a thing or two to do with terabytes of retail trade logs and behavioral advertising data.
The rule is that at the time of the execution, the execution cannot be worse than the NBBO.
I'm dont work at a broker dealer anymore, i'm a retail investor. I think where we are is awesome. Ten years ago, these trades cost $7 to $20 ($1 for iB) + spread.
Twenty years ago, they cost $10 to $50 + spread.
Twenty five years ago they cost $35+ + spread.
These numbers are not even inflation adjusted. In think where we are is awesome and a big win for customers.
I'm just saying that systematic hedge funds make directional bets and hold positions overnight. These activities move the midpoint.
That is a hidden cost not visible in spreads or commissions. The SEC can't even measure that cost, only the intermediaries themselves can.
They need to compete like a human - using their pattern matching skills and reason on the fundamentals. Algorithmic traders that attempt sentiment analysis get fooled into doing things like buying Nintendo stock because female Bowser art was trending.
Edit: Found the article!
https://www.businessinsider.com/forgetful-investors-performe...
There's some other interesting effects with index funds too. Sometimes the price of ETF index funds gets out of whack with the actual holdings. When that happens, there are corrections that get brokered with well bank-rolled partners. This probably accounts for a bit of performance loss as well.
At least, version 1 of hedge funds did this to version 1 of index funds. It's now so complicated that all you can count on is the smartest, fastest-moving guys having a slight edge.
A lot has changed in 20 years. The conclusion may still be the same, but spreads are much tighter (thanks in part to HFT) and trade commissions no longer exist.
In US.
And judging from the rest of the comments, sounds like there will be lots of short term capital losses also to offset the gains. Also sounds like having lots of taxable gains might be a pretty good scenario here!
Trading is hazardous to your wealth, period.
Most of the reported difference in net performance is due to the impact of commissions and spreads: As trading goes up, gross return was not impacted, but net return was.
Retail investors in 2000 were getting fleeced. (And if you think that's bad, take a look at commissions in 1980.)
Imagine if, within the next 20 years, it becomes normal & accepted wisdom that joining a startup and taking their basically worthless 'equity' is more likely to lose you money than day trading. Just kind of an interesting juxtaposition- Hacker News, Website Devoted To Risky Startups, Decries Risky Day Trading
How is that not obvious already?
Stock Market: you have access to the cap table, debt, overhang, etc.
Startup Equity: Unknown denominator. Unknown multipliers.
Stock Market: you can sell almost any time (unless you're trading penny stocks, etc.)
Startup Equity: you wait for a liquidity event, or hope your company is large enough to have an active secondary market.
Stock Market: you can buy/sell at any time
Startup Equity: you have the privilege of exercising an option into IL-liquid holding that you pay for now (sometimes forced to if you leave the company) but have little idea of the future value of.
To be fair, i'm working at a startup, I left a public company to do so. I'm here because I have huge impact on my product, I'm learning more, have more impact at the company level, low BS, low regulatory strangle, dynamic team, etc. I think it is rare to have positive expected value on startup equity unless 1. You are the founder or 2. It is a pre-IPO company. Your odds are probably better buying out-of-money NASDAQ Compsite options.
This go-around, there is a lot of private capital, so companies stay private for a decade or longer and lock employees out of liquidity events (meanwhile, founders can negotiate to take some cash off the table during a financing round.) The incentives are skewed. In the 90s bubble, companies with a $50M valuations could go IPO -- you could hopefully sell after your lockout. (Oh, and houses cost a tenth of what they do now.)
This go-around, there is HN, Quora, Blind, and so it is harder for people to get suckered into starry visions.
That said, it is still worth considering working at startups for the high-learning, low-BS environments you can find as compared to big companies.
By definition in order for you to make more than the market, someone else has to make less than the market.
Assuming that knowledge has superlinear returns (I consider this to be obvious without proof required), of course less than 50% of participants will 'win' - those at the bottom are totally useless and burning money, whilst those at the top are quite skilled indeed.
It's fair to say that one should not expect to be in that upper echelon, but I don't think it's reasonable to state 'most people lose' and just leave it at that, it's blindingly obvious that most people lose, it would be impossible for them to not.
(Adjusted for balances - a guy with 20 billion quid can lose 1 pound each to 7 billion market participants and in that case 'almost everyone wins more than the market')
even if you quit your day job to trade full-time, they can collect information in ways that you can't (eg, satellite imagery), and they may also have direct lines to an exchange to execute trades faster than you. unlike you, they trade in large enough volume that they can get people to pick up the phone to trade after the exchange closes. they have access to entire classes of investments that are closed to you due to capital requirements.
I would argue that working for an institution that gives you access to satellite imagery also implies you can’t really play below a certain threshold of volume.
Otherwise it’s like hunting deer with a ballistic missile: you will kill the deer, but for that money you could have raised a whole tribe of them.
> One of the most dangerous investment chestnuts is the idea that you can successfully diversify your portfolio with a relatively small number of stocks, the magic number usually being about 15.
> …
> The reason is simple: a grossly disproportionate fraction of the total return came from a very few "superstocks" like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market.
Maybe 'Less Than Excellent Trading Is Hazardous to Your Wealth'? Don't do a trade unless you have an excellent advantage on it...
If you can find any reliably bad strategy (in a fee-less market), then you have necessarily found an outperforming strategy that is the opposite.
another way of saying this is: the average of all trading strategies is the market.
the parent, maybe mistakenly, stated any strategy will have average returns, but consider the naive strategy of putting all of your money in a small number of (often highly correlated) stocks. that trading strategy will underperform the market on average.
The bid/ask spread is an example of such an inefficiency. Take a hypothetical case where you just buy and sell the exact same stock over and over, but the price of the stock never changes. Every time you complete a bid or sell order, you would lose an amount equal to the gap between the bid and ask prices. Repeat the cycle enough times, and you will lose all your money, but the stock price will never have changed. What's the opposite of this strategy? To never trade at all?
The idea that you can just reverse a losing trading strategy to come up with a winning strategy is absurd, because it completely disregards the entropy inherent to an inefficient system.
Being the market maker creating that spread. Who also gets financial incentives from the exchange for doing so.
If people believed they could become a medical doctor by taking a weekend boot camp, you would see extremely high failure rates.
But that high failure rate would not suggest that it’s impossible to become a doctor.
Same with trading, if a person thinks they will make a few trades as their side hobby, it’s going to go about as well as the hobbyist surgeon. But if you’re obsessed with trading for a decade you can become quite competent.
https://i.imgur.com/IbygTNX.png
https://old.reddit.com/r/wallstreetbets/comments/gjkpel/4k_1...
https://old.reddit.com/r/wallstreetbets/comments/gj0v2v/35_1...
Most people do not fully internalize survivorship bias and are tempted to jump in on the easy money.
In fact, he just dumped all of his airline stock recently due to Covid-19.
It doesn't matter if you trade based on research or not, you're still a trader.