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.
In the "win-lose" games of active trading, your "edge" comes from:
- Buying from someone too cheap
- Selling to someone too expensive
At least on average.
To do this, you need to know who you are playing against.
🧵on "edge", where to find it, and how you can compete 👇
If you are a market maker, it is relatively clear to understand who you are trading against.
If you're a positional trader, it is perhaps less clear.
On a trivial level, you're probably trading with a market maker.
But understand that "the market line" is set by the supply/demand pressures of other aggressive traders.
- End users (wealth mgmt, retail)
- Aggressive prop traders doing short term risky arbs
- Informed positional traders with pricing models + (maybe) info advantages
It's easy to lose money trading if you:
1. Trade too much (paying fees + impact on each txn)
2. Size positions too big (high vol hurts compounding ability + gets u rekt)
3. Shorting positive drift/risk premia
It's hard to lose money consistently if you avoid these things.
However clueless you are, you get to trade at market prices.
Imagine we can know that an asset has a fair value of $100.
You might think it's worth $150.
But if it's quoted $99 / $101, you can buy now at $101.
You were totally wrong but you still bought close to fair value.
The same mechanisms that make it hard to get an edge also make it hard for you to trade at really bad prices.
In a simple model, you might say that prices are set by:
- (risky) arbitrage and relative value in the short term
- pricing/valuation models in the long term
@InBraised If you can trade for free, then your optimal trading strategy (given reasonable return estimates) would be incredibly hyperactive.
You would continuously change portfolio weights according to your latest return estimates.
@InBraised In the real world, this would kill you, because trading frictions would eat away at your PnL.
So, one way to avoid hyperactive rebalancing is to only calculate your return estimates periodically (say once every day, or every week, or something).
@InBraised But this isn't optimal because, if your alpha is good, you want to be calculating it as often as possible. You just only want to be trading when the increase in expected returns from the new position is much better than the old position.
When we talk about something being "stationary" we mean that the observations look like they could be drawn from the same "bag of observations" (distribution), regardless of what time we choose to look at.