1/ Leveraged Trading (Robert Carver)
Thread with quotes from the book
"Because leverage is so dangerous [due to blow-up risk and higher trading costs], deciding how much to use is the single most important decision any trader has to make." (p. xv)
amazon.com/Leveraged-Trad…
Thread with quotes from the book
"Because leverage is so dangerous [due to blow-up risk and higher trading costs], deciding how much to use is the single most important decision any trader has to make." (p. xv)
amazon.com/Leveraged-Trad…
2/ "People are obsessed with finding the elusively perfect trading rule when it is far more important to control risk and trading costs. Instead of trying to predict price changes in a single market, diversifying across many markets is likely to be far more rewarding." (p. xvi)
3/ "Limit your trading to the absolute minimum. Do not assume you will make sufficient profits to cover costs that are inflated by over-trading.
"Leverage magnifies the three mistakes retail traders typically make: overconfidence, over-betting, and over-trading." (p. 4)
"Leverage magnifies the three mistakes retail traders typically make: overconfidence, over-betting, and over-trading." (p. 4)
4/ "Most 'celebrity' traders don't make huge fortunes from trading, although some make a living from trading courses and kickbacks paid by brokers for new customers. You can buy a briefcase full of fake money on eBay. Truly successful traders usually keep low profiles." (p. 5)
5/ "A trader who is pessimistic about likely performance won't use too much leverage.
"If things go well, he will be pleasantly surprised and should bank the gain with cool detachment.
"For realists, avoiding mistakes is paramount: controlling risks and trading costs." (p. 6)
"If things go well, he will be pleasantly surprised and should bank the gain with cool detachment.
"For realists, avoiding mistakes is paramount: controlling risks and trading costs." (p. 6)
6/ "Even putting money in the bank involves risk: the bank going bust or inflation depreciating your wealth.
"Addicted losers take dangerously large risks when the odds are against them: long-shot horses, slot machines, dodgy unregulated products, binary options, or day trading.
"Addicted losers take dangerously large risks when the odds are against them: long-shot horses, slot machines, dodgy unregulated products, binary options, or day trading.
7/ "Smart gamblers take modest risks when the odds are favorable and where they have a proven edge: card counting in casinos, long-term investing in diversified portfolios, or trading with a system." (p. 28)
8/ "The presence of clearing houses does not mean that exchange trading is completely safe. Brokers still hold your cash in their own accounts. Should your broker go under, government insurance and bankruptcy court might still repay your money, but it could take a long time.
9/ "Nevertheless, brokers trading on the OTC market have a much higher failure rate than those who pass customer orders on to exchanges. As well as the safety net offered by the clearing house, brokers who are exchange members are governed by stricter rules." (p. 41)
10/ "Be wary of brokers advertising superficially cheap deals. 'Trade for free with zero commission' usually means their trading spreads are wider than the competition's.
"Disregard maximum leverage limits: sensible traders never use as much leverage as brokers would let them.
"Disregard maximum leverage limits: sensible traders never use as much leverage as brokers would let them.
11/ "Ignore brokers who claim to have some special insight into the markets. They don't. The last thing you need is a broker who wants to give you advice. These brokers charge higher fees or will find some other way of extracting money for their 'valuable' advice." (p. 45)
12/ There is a substantial evidence that, as a whole, the recommendations of experts *subtract* value from a portfolio. For example,
Professional stock analysts (Anomalies and News):
Misguided Beliefs of Financial Advisors:
Professional stock analysts (Anomalies and News):
Misguided Beliefs of Financial Advisors:
13/ Some rule-based systems indirectly trade against these analysts by, for example, buying high-quality stocks and shorting low-quality stocks:
Quality Minus Junk
Doing this leads to factor exposures similar to Warren Buffett's:
Quality Minus Junk
Doing this leads to factor exposures similar to Warren Buffett's:
14/ "Humans enjoy being right when they've made money and want to quickly bank their profits in case they evaporate. When losing, they don't want to sell, thus admitting a mistake.
"Simple trading systems (trend following and momentum) exploit these biases." (p. 48)
"Simple trading systems (trend following and momentum) exploit these biases." (p. 48)
15/ More stuff:
Demystifying Managed Futures
aqr.com/Insights/Resea…
Enduring Effect of Time-Series Momentum on Stock Returns Over Nearly 100 Years
Two Centuries of Trend Following
Time Series Momentum
Demystifying Managed Futures
aqr.com/Insights/Resea…
Enduring Effect of Time-Series Momentum on Stock Returns Over Nearly 100 Years
Two Centuries of Trend Following
Time Series Momentum
16/ "Simple systems make better trading forecasts than the vast majority of human traders.
"You can easily apply the same rules to many different instruments. Diversification is the holy grail of finance and results in a significant improvement to your expected returns." (p. 48)
"You can easily apply the same rules to many different instruments. Diversification is the holy grail of finance and results in a significant improvement to your expected returns." (p. 48)
17/ More on the power of diversification:
Death of Diversification Has Been Greatly Exaggerated
Value and Momentum Everywhere
Strategic Allocation to Commodity Factor Premiums
Death of Diversification Has Been Greatly Exaggerated
Value and Momentum Everywhere
Strategic Allocation to Commodity Factor Premiums
18/ Annual risk = (Notional exposure in home currency) * (annual standard deviation % returns)
(p. 58)
The author uses a consistent set of units for signals and risk management, making the calculations largely a matter of dimensional analysis. *Everything* is volatility-scaled.
(p. 58)
The author uses a consistent set of units for signals and risk management, making the calculations largely a matter of dimensional analysis. *Everything* is volatility-scaled.
19/ "Experienced traders target *risk* rather than profits. Returns are pretty random at short time intervals, but the volatility is relatively predictable." (p. 62)
Target risk = annualized standard deviation
Required leverage factor = (Target risk) / (Instrument risk)
Target risk = annualized standard deviation
Required leverage factor = (Target risk) / (Instrument risk)
20/ "The optimal Kelly risk target is equal to your expected Sharpe ratio.
"Negative skew or high kurtosis reduces the optimal leverage. For FX carry (modest negative skew), optimal leverage is reduced by around 5%." (p. 66)
The author elaborates here:
qoppac.blogspot.com/2018/06/kelly-…
"Negative skew or high kurtosis reduces the optimal leverage. For FX carry (modest negative skew), optimal leverage is reduced by around 5%." (p. 66)
The author elaborates here:
qoppac.blogspot.com/2018/06/kelly-…
21/ "I calculate all costs in risk-adjusted terms: as an annual proportion of target risk.
For target risk of 15%/year and costs of 1.5%/year, your risk-adjusted costs are 1.5%/15% = 0.10.
"This is how much of your gross Sharpe ratio will get eaten up by costs." (p. 68)
For target risk of 15%/year and costs of 1.5%/year, your risk-adjusted costs are 1.5%/15% = 0.10.
"This is how much of your gross Sharpe ratio will get eaten up by costs." (p. 68)
22/ "Holding costs for FX are often very high. Unless you are day trading, execution spreads make up only a fraction of your total costs.
"Look for a broker who is happy to operate with a funding spread of 0.4% or lower, depending on how volatile the market is." (p. 80)
"Look for a broker who is happy to operate with a funding spread of 0.4% or lower, depending on how volatile the market is." (p. 80)
23/ "Undated products have narrower spreads but higher holding costs (interest margins charged by brokers on funding).
"Dated products (futures and products based on futures) have wider spreads but lower holding costs. Slower traders should prefer dated products." (p. 83)
"Dated products (futures and products based on futures) have wider spreads but lower holding costs. Slower traders should prefer dated products." (p. 83)
24/ "From 2001 to early 2015, the Swiss franc to euro exchange rate had extremely low risk, as the exchange rate was strictly controlled by the Swiss Central Bank. Traders took advantage of the 200:1 leverage allowed by certain FX brokers and speculated that the banks would
25/ "continue holding the rate down. Unfortunately, the Central Bank changed their minds. They allowed the FX rate to move freely in Jan 2015. It increased from 0.83 to 1.00 in a matter of minutes. This wiped out the accounts of thousands of traders who used too much leverage.
26/ "Broker and exchange leverage limits are usually far too generous. Sensible people should set their own leverage limits to reflect the worst possible scenario.
"Estimate the worst possible loss that could occur before you have a chance to close your position." (p. 95)
"Estimate the worst possible loss that could occur before you have a chance to close your position." (p. 95)
27/ "Large daily and monthly losses are more common than normal distributions suggest.
"At 16%/year volatility, a 7% S&P 500 daily drop should only happen once every 3.4 billion years. There have been six such falls in the last 40 years, with four in 2008 alone." (p. 96)
"At 16%/year volatility, a 7% S&P 500 daily drop should only happen once every 3.4 billion years. There have been six such falls in the last 40 years, with four in 2008 alone." (p. 96)
28/ "Under Kelly, the optimal risk target (in volatility terms) is equal to your expected Sharpe ratio.
"Most professional traders are wary of that target. First, the Kelly criterion makes unrealistic assumptions about the statistical distribution of returns.
"Most professional traders are wary of that target. First, the Kelly criterion makes unrealistic assumptions about the statistical distribution of returns.
29/ "Second, there is a great deal of uncertainty about the real Sharpe of any system.
"Finally, a gross Sharpe is a pre-cost return. Using expensive products to trade will bring the Sharpe ratio down substantially.
"Most use a more conservative target of half Kelly." (p. 98)
"Finally, a gross Sharpe is a pre-cost return. Using expensive products to trade will bring the Sharpe ratio down substantially.
"Most use a more conservative target of half Kelly." (p. 98)
30/ "Diversifying your trading across multiple instruments can easily improve your expected Sharpe ratio by a factor of 2.5.
"A Sharpe of 1 on an individual instrument is extremely optimistic. Some will do this for a year or two, but very few have consistently done it." (p. 117)
"A Sharpe of 1 on an individual instrument is extremely optimistic. Some will do this for a year or two, but very few have consistently done it." (p. 117)
31/ "If day trading is so difficult, why is it so heavily promoted among self-proclaimed trading experts?
"Most 'experts' are earning kickbacks from brokerage firms, which love day traders (as they generate much higher profits). Don't be taken in by the hype." (p. 118)
"Most 'experts' are earning kickbacks from brokerage firms, which love day traders (as they generate much higher profits). Don't be taken in by the hype." (p. 118)
32/ "Systematic hedge funds are constantly looking for ways to diversify the set of instruments they trade. When I was working at AHL, I recruited Ben, a smart young graduate, and assigned him his own project: adding a large batch of new instruments to one of our flagship funds.
33/ "Ben probably thought this boring and mechanical task was a waste of his abilities.
"I said, 'You probably don't appreciate this right now, but this project will add more value to this company than pretty much anything else.' I was right." (p. 166)
"I said, 'You probably don't appreciate this right now, but this project will add more value to this company than pretty much anything else.' I was right." (p. 166)
34/ "Don't expect diversification to improve returns. It's good because it reduces risk.
"Most traders would prefer to swap diversification for higher returns. This is done by applying leverage and running the strategy for each instrument at a higher risk target." (p. 166)
"Most traders would prefer to swap diversification for higher returns. This is done by applying leverage and running the strategy for each instrument at a higher risk target." (p. 166)
35/ "Diversification (using a diverse set of more expensive instruments with lower minimum capital requirements) is nearly always better than trading a smaller number of cheaper instruments with higher minimum capital requirements." (p. 169)
36/ "When looking at backtests, it's important to use as many different instruments as possible so we know that the results aren't just a fluke (and that the author hasn't cherry-picked). It's also important to check the statistical significance of the results." (p. 169)
37/ "You get more diversification from adding instruments that are as different as possible from ones you already have.
"Correlations of trading systems for a given pair of instruments is nearly always much lower than the correlation of the actual instruments' returns." (p. 173)
"Correlations of trading systems for a given pair of instruments is nearly always much lower than the correlation of the actual instruments' returns." (p. 173)
38/ "The logic for adding multiple trading rules is the same as for multiple instruments: they provide diversification.
"Adding instruments is better than adding new rules, but adding rules doesn't require a larger minimum capital requirement." (p. 194)
"Adding instruments is better than adding new rules, but adding rules doesn't require a larger minimum capital requirement." (p. 194)
39/ "Decisions should be made on backtests done with many years of history and over large numbers of instruments.
"But they should assure you that it's safe to trade without a stop loss. [Just close a trade when the opening rule(s) have reversed.]" (p. 238)
"But they should assure you that it's safe to trade without a stop loss. [Just close a trade when the opening rule(s) have reversed.]" (p. 238)
40/ "Divide the raw trading rule forecast by instrument risk to get a risk-adjusted forecast." (p. 246)
Volatility and the Carry Trade
Alpha Momentum and Alpha Reversal
Volatility-Adjusted Momentum
Volatility and the Carry Trade
Alpha Momentum and Alpha Reversal
Volatility-Adjusted Momentum
41/ "If you have extra capital, you're almost certainly better off using it to diversify your strategy across multiple instruments than to implement non-binary trading [position size based on signal strength]." (p. 252)
The author explains this in detail:
qoppac.blogspot.com/2016/03/divers…
The author explains this in detail:
qoppac.blogspot.com/2016/03/divers…
42/ "Making small adjustments every day is a nice idea in theory, but every time you trade, you lose money: the execution spread + commissions.
"It's necessary to avoid making frequent small adjustments: only trade when your position is way off target." (p. 254)
"It's necessary to avoid making frequent small adjustments: only trade when your position is way off target." (p. 254)
43/ "I can save almost half my costs in corn futures if I can capture the bid-ask spread. However, these are already cheap to trade, so benefits are minimal.
"Avoiding bid-ask in spot FX is also of limited benefit: the funding spread makes up most of total costs." (p. 302)
"Avoiding bid-ask in spot FX is also of limited benefit: the funding spread makes up most of total costs." (p. 302)
44/ "If you're looking for trends that last a few hours, you can't wait patiently. Only market orders make sense. Traders looking for fast-moving trends will *always* pay the execution spread. Combined with the high volume of trades, this becomes prohibitively expensive." (p.305)
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47/ "Short-term mean reversion trading isn't easy, since it's hard to find assets that exhibit that kind of behavior. The advantage is that we can use limit orders when opening new positions and will always capture the bid-ask spread when trading normally." (p. 306)
48/ Summary:
* Systematic > discretionary
* Be careful with leverage
* Execution costs and financing spreads matter
* Adjust signals for volatility
* Measure position sizes in dollar * standard deviation units
* Diversification works wonders: add markets and create ensembles
* Systematic > discretionary
* Be careful with leverage
* Execution costs and financing spreads matter
* Adjust signals for volatility
* Measure position sizes in dollar * standard deviation units
* Diversification works wonders: add markets and create ensembles
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