Broadly, there are 3 types of systematic trading strategy that can "work".

In order of increasing turnover:
1. Risk premia harvesting
2. Economically-sensible, statistically-quantifiable slow-converging inefficiencies
3. Trading fast-converging supply/demand imbalances

1. Risk Premia Harvesting - is typically the domain of wealth management, but it's important to any trader who likes money.

A "risk premium" is the excess return you might expect over and above risk-free cashflows for taking on certain unattractive risks
"Equity Risk Premium", for example, is how you say "Stonks, they go up" if you work for Blackrock

(Though, they're really referring to the extent to which they "go up" more than an equivalent less risky thing)
The basics of risk premia harvesting are:
- intentionally expose your portfolio to diverse sources of risk that tend to be rewarded
- manage risk sensibly so no risk dominates at any time
- be patient and chill the f out (hardest bit for most)
A very simple example is the 60/40 stock/bond portfolio.

More balanced implementations include Bridgewater's "All Weather" portfolio and "Risk Parity" strategies, generally, which attempt to equalize risk across assets or risk premia.
"Doing useful things" like providing liquidity in a highly stressed market - or making a 2 sided market at all times are also, arguably "risk premia harvesting".

(You're taking on the risk of getting run over by those who can choose when to trade)
Risk Premia Harvesting is something nearly every trader should do.

All active traders need to be aware of it too

Want to short stocks? You're facing a big hurdle. You need to be right over and above the expected drift in the asset

It's better to play easy games than hard ones
Now the 2nd category: Economically-sensible, statistically-quantifiable slow-converging inefficiencies.

These are noisy tendencies for assets to trade too cheap/expensive at certain times due to behavioural or structural effects.
Examples include momentum effects, seasonal regularities, effects due to indexing inclusion/exclusion.

We can probably lump "style factors" (momentum, value, carry, quality, low vol) and most medium freq "stat arb" approaches in this bucket too.
This stuff tends to be noisy and "slow converging".

It's just a noisy tendency for "cheap stuff to outperform expensive stuff" (say)

So you have to analyze it "in aggregate" over large data sets.

It also means that your P&L is very slow to converge to "expected returns"
So to trade this stuff effectively we need:
- to understand why the inefficiency would persist
- faster converging metrics around what we're exploiting so we're not "the last to know" when the inefficiency disappears
- patience and discipline to "keep swinging the bat"
Useful sources for this kind of stuff include:
- Expected Returns, Antti Ilmanen
- Efficiently Inefficient - Pedersen
- Positional Option Trading @SinclairEuan (which literally gives you stuff to trade)
- Active Portfolio Management - Grinhold, Kahn
Generally, this stuff is less reliable than 1) risk premia harvesting and 3) fast-converging flow effects.

"Home gamer" traders usually spend too much time here, and too little time on risk premia harvesting.

Active managers of size play here tho they'd rather be playing 3)
3rd category: Trading fast-converging supply-demand imbalances

This stuff is the bread-and-butter of proprietary trading firms.

Short term supply/demand imbalances create dislocations in prices which fast traders can "disperse" by trading against and offsetting risk elsewhere.
These trades are conceptually simple and economically sound.

For example, I might buy sell futures on Shanghai INE and buy a similar contract cheaper on Singapore SGX for a profit (after costs).

That's a simple "arb" though it carries risks cos we can't trade instantaneously
More normally though, we're doing riskier trades that we expect to work out on average.

We're serially looking to buy cheap and sell high based usually on simple relative-value models.

The assumption is made that deviations from (relative) fair value will converge...
So models are less about "predicting the future" (as per 2) and more about "extrapolating the present" (Q vs P).

"But you're *predicting* convergence to your model of fair value you're using to quantify cheap/expensive?"

Yeah, exactly.
Advantages of these trades are:
- they're easy to understand and economically simple
- they converge fast to expected pnl. You know quickly when your model is out or you don't have edge anymore. They fit nicely with @KrisAbdelmessih's "measurement and normalization" paradigm
Disadvantages are that they are capital constrained (you can only eat what you are fed) and require significant investment in infrastructure and staff.

Whilst this area isn't practical for "home gamers", the lessons here are crucial for a good understanding of the market.
Takeaways for "home gamers"

- Do more of 1) and less of 2)
- Dig into 3) to understand and appreciate "the terrifying efficiency of the markets"
Here's a "work in progress" model of how 3 and 2 interact - and how you can do 2) by "sitting roughly in the right place with your mouth open"

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More from @therobotjames

20 Sep
Steal ideas, not implementation.

I see you, with your "small but beautiful" pot of capital, trying to make it bigger.

A🧵on easy games, stealing ideas, and not competing in games you don't need to compete in.

First, the Market Gods give no prizes for difficulty.

So, to start with, you'll want to play the easiest, most reliable, hardest-to-screw-up, least-dependent-on-skill games you possibly can.

See linked thread:

Second, the Market Gods give no prizes for originality.

So you want to know what traders who are taking the game seriously are doing. (Especially with their own money.)

Proprietary trading firms
Hedge fund prop capital
Serious solo traders
Hedge funds

Read 21 tweets
20 Sep
We recently looked at VIX Futures and why they tend to trade at a premium to the VIX index most of the time.

How might you apply this understanding?

Let's discuss how you might think about a systematic VIX carry trade based on these concepts.

In the original thread we noted:
- you can't trade VIX
- so there's no market mechanism to stop it from being predictable
- but VIX futures do trade and their price incorporates where the market thinks VIX is likely to go

If the market thinks VIX is going to go up, the futures will likely already be trading at a premium.

Sellers won't sell low if it's likely to go up.
Buyers will be happy to buy higher if it's likely to go up.

Read 24 tweets
19 Sep
If you weren't there, you have no idea how disgustingly decadent pre-GFC sell side finance was.

Whatever you imagine x10.
Silicon Valley is amateur hour choirboy stuff in comparison.
Need a burner account to share stories 😂
Read 5 tweets
14 Sep
Why do VIX Futures trade at different prices to VIX?

Derivatives can be complicated, but the answer to this question is not.

If you understand how the market prices risk then you'll know a lot without needing to know a lot.

Let's walk through it. 🧵👇

Pull up a chart of the VIX index.…

If you're an experienced trader, you'll recognize immediately that this is not a thing you can trade.


Cos it wouldn't look like that if people could trade it.

Cos, just by eyeballing the time series chart, you can tell VIX is very predictable:

- It stays about the same in the short term
- But if it's low it's more likely to go up
- And if it's high it's more likely to go down
- It has a floor under which it's unlikely to go lower

Read 25 tweets
4 May
My focus recently has been on the crypto markets.

I don't have all the answers.

But I thought it would be useful to ramble a bit about the experience of entering a new market.

My perspective here is professional trading, but the concepts are valid for individuals too

First, you've got to work out whether it's worth expending time, effort, and money in a new market.

There's an opportunity cost associated with looking at and implementing new things.

So you put together some "high-level business case" to see if it stacks up

This can be tricky because you don't know what you don't know.

So you seek out people who are doing it and ask them to share some of their experiences.

If you are serious, people will generally be very happy to talk to you. This game isn't as secretive as you might think.

Read 16 tweets
30 Apr
Tail hedging for degenerates. Image
For most of my time, I just thought of tail hedging as the "cost of entry".

A "ticket to the dance" if you like.

You can't predict what happens in the tails - so pay up to cover them & go play hard in the peak of the bell curve, where your tools and models are most valid.
If you're a good trader, you'll tend to find that your highest expected return opportunities appear after massive moves.

Disconnections happen when others risk models are flashing red and they are FORCED to trade (rather than want to).

You want dry powder for these times.
Read 5 tweets

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