The edges of a successful trader/investor.
When dealing with investments and trading, one needs to
have an edge or will ultimately fail. There are four types of edges that will
determine the success in investing or trading: technology, information,
analysis, and statistics.
Technology:
In current state of the affairs in finance, the ultimate
manifestation of the technology as an edge is high frequency trading. The speed
of execution is essential and whoever has the fastest and efficient program
will be the ultimate winner.
The technology manifest itself as following:
·
Vast quantity of data is processed efficiently
by the market participants through technology.
·
Before the internet, corporate visits by
investors or analysts made a big difference whereas with the emergence of the
internet, valuable company data is accessible for everyone.
·
Developments in AI (artificial intelligence) and
ML (machine learning) has made them powerful analytical tools and they are
getting better as time passes.
Due to high level of competition, it is quite difficult
and expensive to maintain the technological edge. High frequency trading
requires ever greater spending in capital expenditures with decreasing returns.
Before its advent, the market participants relied on linear regression whereas
now it is the neural networks. Despite all this, algorithmic trading is not
always the winner and there are many discretionary traders or investors who are
quite successful in their endeavour. The algorithmic programs must be
programmed by men with differing guidelines and trading perspectives.
Information:
The financial operations undertaken in the capital and
money markets were always based on an information model. According to Georges
Marie Mathieu-Dairnvaell, back in June 1815, Nathan Mayer Rothschild had earned
a fortune by learning early the outcome of the battle of Waterloo ahead of
everyone else by using his couriers and used this knowledge to speculate London
Stock Exchange by first selling short the stocks and once the good news
arrived, he bought back his stocks at a good profit thus making a vast fortune
by defrauding the other stockholders.
In the 21st century, there was one instance
where the trace of capitalizing early on non-public information could be
spotted prior the September 11, 2001 attacks; the week before, there was a
heavy short position in the NYSE, especially the last 3 days of the week and
this has never been questioned by the authorities. And when the market
plummeted after the attacks, the plunge was explained by the panic selling…
Today, there is a deluge of information and people want
to have the information democratised. But knowledge does not make anyone better
in terms of skill because anything that is written in the mainstream is already
known and thus reflected on the prices. Listening to the experts in various
financial channels does not translate into an operational success.
If one needs a valuable information, one must look for it
in other areas and preferably using in one’s favour some legit barriers to
attain it. This could be the language barrier or unrelated field of knowledge,
such as history.
Analysis:
The edge of analysis has to do with one’s analytical
ability to find and analyze the relevant information and then make a sound
investment decision. In theory, it makes sense and in practice, things change.
The markets are filled with professionals who graduated
from highly praised universities and know better than anyone else all the
theories on finance, economic and statistics. Yet, they still get crushed in
the market: only 1% of them beat the benchmark, 4% of them breakeven whereas
the remainder underperform it or are losing.
But the market has nothing to do with being right but
making money. Being right does not provide a statistical edge in the markets
but ego is the biggest and strongest destroyer of money. Thus, making money is
not about being right but it as about making money…
Statistics:
The edge in trading has nothing to do with a fast CPU or
a high IQ; it is a simple number with the following formula:
Trading edge = (1 + win) ^ probability of win X (1 +
loss) ^ (1 – probability of win) – 1
The trader will not be successful until this trading edge
turns positive, and this number must be as high as possible. But the main
factor that affects this is the concept of stop loss which influences the win
rate, the loss rate, and the average loss. Thus, one must accept and manage the
loss to make money in the markets.
