Books that have significantly influenced your trading perspective

Discussion in 'Educational Resources' started by ArbitRAGE, Dec 31, 2010.

  1. Hey, I bought the book and I don't regret it. I don't say that very often about trading books.

    Mr. Brandt's reported performance over such a length of time is very impressive indeed. However, that does not mean I should suspend my critical thinking when reading his book. With this in mind, consider his argument on page 13, wherein he describes a casual survey he conducted among about a dozen or so consistently profitable professional traders. When presented with a choice, each of his "professional" brethren preferred to make a given return with a 30% trade success rate rather than with a 70% success rate. His argument is that there is no margin for error in the approach that needs to be right 70% of the time in order to produce its expected results. By his account, novice traders overwhelmingly choose the 70% approach.

    Although I don't exactly consider myself to be a greenhorn, I emphatically assert that I do not move in his lofty circles. Even so, I would take the other side of his argument. I would argue that the lower success rate has less room for error. Before going further, let me assure you that I am well aware the success ratio of trade entries is but one piece of a decidedly larger puzzle. I am also aware that newcomers tend to overemphasize this particular piece. However, even with all else being equal, I would prefer greater accuracy given the choice. My reasoning is simple. The lower the success rate, the more dependent the trader becomes on any given profitable trade, because it represents a more important percentage of overall profitability. Therefore, for any misapplied would-be profitable trade (as we are all prone to do, which the author has himself demonstrated in the book), the opportunity costs are more significant relative to overall performance. As with the company whose profits are generated by fewer clients, a loss of one such client would more materially impact negatively on the bottom line than would the loss of a client to a company that has more paying clients. The company with a more diversified client base is more likely to have stable financial performance, all else being equal and apart from overall profitability. Similarly, my view is that the trader with a higher success rate, all else being equal, will have more stable performance.

    Perhaps I am missing something in my reasoning, and I invite you to correct me if this is so.

    Although I limit my trading to intraday, which I understand Mr. Brandt would believe to be to my detriment, I can relate to the gentleman on a couple of levels. First, I, too, have no use for indicators (although I don't have much use for most chart patterns, especially ones with diagonal lines). Second, my initial protective stops are also fairly tight in relation to the setup. However, we once again diverge on where I think his logic is flawed (despite his superior performance over an extended period of time). On the one hand, he points out on page 21 that charts are trading tools and not useful for price forecasting. Yet on the other hand he looks for measured moves, which is very much like price forecasting. Did you notice how he would sometimes exit at his profit target well before the end of a move whereas at other times he would exit well before the intended target as a result of the price action dictating an earlier exit? Makes targets somewhat superfluous and even counterproductive, wouldn't you say?

    And so I say again, it was an interesting and thought-provoking book. I'm glad I read it. However, simply because Mr. Brandt has shown outsized returns does not mean that I should necessarily chew and swallow with my eyes closed.

    I'm just saying. :)
     
    #11     Mar 14, 2011
  2. Not only is the trader with a 30% success ratio more dependent on a single winning trade, he's also less able to determine the moment at which his 30%-win rate trade strategy has gone off the rails. You can easily have long stretches of losers with a 30% win rate which seem like nothing out of the ordinary, but are actually a reflection of a strategy which is unsuited to current conditions. With a 70% win rate, even 5 or 6 losing trades in a row will be unlikely. The 30% win rate strategy may have some other characteristic, like losing trades never being over X-amount, and seeing losing trades of over X-amount during a losing streak could alert the trader that something more than just the run of the mill losing streak is going on, of course.

    Does look like a pretty good book, though.
     
    #12     Mar 14, 2011
  3. I agree. This argument had also occurred to me at the time I read the book. However, that was awhile ago, and I totally forgot to mention it in my response to darkhorse. Thank you for bringing it up.
     
    #13     Mar 14, 2011
  4. Cool, and you're absolutely right. A suspension of critical thinking is never called for. You bring up some interesting points in this reply that are worth noodling over.

    I would characterize the argument a little differently. It is more that the methodology with the 30% hit ratio is going to be far more robust. It will be more armored against losses, since routine losses and aggressive risk control in respect to extended loss periods are already part of the program.

    This 30% preference is also based on a rule of thumb awareness of how profits and hit ratios are typically distributed. In Stock Market Wizards, Steve Cohen is on record saying his best trader was only right something like 63% of the time. In other words, 63% is given as the high-end outlier among the sharpest group of short-term traders in the world.

    Given the above, and given that markets have a historical tendency to distribute profits in a very "lumpy" fashion -- often rewarding a trader in a handful of great periods a year -- the lower win ratio also has a higher likelihood of robusticity in terms of conceptually fitting the profile of how gains are distributed.

    To further back up the distribution argument, Kenneth Grant, author of "Trading Risk," was a risk manager for many of the top dog managers at one point -- Jones, Cohen, Bacon and so on. In his book Grant remarks offhandedly that the vast majority of great traders he worked with had a 90/10 profit distribution, meaning 90% of their bottom line profits come from 10% of their trades.

    This in turn suggests a profile of boxing and counterpunching for very small amounts in play, then "pouring it on" in those isolated instances when all the stars align. And once again this is a 30% profile, not a 70%...

    But to some degree the even more straightforward observation, which I agree with, is that newbies are routinely bamboozled by the notion of a high winning percentage statistic. It's not relevant to long run success and may even be detrimental if undue emphasis or leverage is placed upon it.


    I would argue the cost of greater accuracy is a diminished opportunity set (relative to catching meaningful moves in deep and liquid markets with a meaningful amount of capital in play). This is because the biggest and most powerful trends are most often born in periods of high uncertainty.

    How do you catch a monster move born in uncertainty? You take multiple shots with small controlled risk and lever up opportunistically as conditions dictate. The real world manifestation of this is a series of small, low-risk probe type opportunities coupled with the profits from major outlier moves.

    I think one challenge for many new traders (not speaking to you necessarily at all) is that they don't give a lot of thought to how profits are distributed, or what a "loss" really means. By many professional traders' estimation, a small controlled loss is not necessarily a failure or a setback so much as an investment.

    Yes and no. The question of dependence is debatable based on signal frequency.

    For example, if you know from statistical records that you take 120 trades a year on average, you will certainly have a large enough opportunity set for the law of large numbers to work out in your favor.

    Where N equals number of trades, lower average hit rate increases the odds of a dry spell for shorter periods of N, but as N extends, probability closes the gap.

    The Bear Stearns High Grade Structured Credit Opportunities Fund had positive returns for 40 months in a row. Then it blew up. Vic Niederhoffer has had more than his fair share of 30 and 40 month net positive return months -- followed by repeated blowups. Merger arb guys are known for "eating like birds and shitting like elephants" or otherwise "taking their volatility all at once."

    In other words, the flip side of your argument is that artificially high stability tends to sacrifice robusticity. There is the danger of the relied-upon mechanism that produces that stability suddenly going poof. The real world instances of this are legion.

    I would further argue the client diversity argument is misapplied. The trader with the "steady eddie" methodology is typically relying on one strategy, or one market, or one prevailing set of market conditions. He is the one more exposed to potentially violent change.

    Strategies with lower hit rates and higher R multiples, in contrast, almost by definition tend to apply a greater number of markets and a more diverse set of market conditions. Being able to exploit opportunities in 30 different markets is akin to having 30 different clients. Very different than the guy who makes all his money in merger arb, or day trading the DAX, or some other very narrow strategy as high hit rate approaches tend to be.

    Yes, I did notice that and I'm not sure why he uses profit targets. I'm not a fan of them myself, except on a fluid situational basis.


    Of course. If I challenge someone's viewpoint or perspective, the idea is getting them to think more, not less.
     
    #14     Mar 14, 2011
  5. Syprik

    Syprik

    These two have led to numerous strategy ideas for me over the years...

    Trading and Exchanges: Market Microstructure for Practitioners - Larry Harris

    Options, Futures, and Other Derivatives - John Hull
     
    #15     Mar 14, 2011
  6. Hull is a great book, but I need to take some more math courses to fully grasp the Black Scholes model.

    RE: Diary of a professional commodity trader, heres a video by the author:
    http://www.youtube.com/watch?v=n51dGHyJhZ8

    Seems remarkable, I'll def check it out. I tend to trade relatively long term, yet I wouldn't question the legitimacy of short term trading. After all, HFT is a hybrid form of short-term trading (usually micro-seconds).
     
    #16     Mar 14, 2011

  7. The "single winning trade" argument is invalidated by a sufficiently large sample size of N. It may be true that a certain strategy has higher odds of a losing month, but that does NOT translate to higher odds of a losing year, because 12 months is a sufficiently expanded length of time for N to fully express historical averages.

    The 70% winning strategy, in contrast, almost always requires significant sacrifices to maintain -- usually in the form of very low R / reduced profits per trade. That is why high hit ratio strategies tend to be the province of day trading, merger arb, options selling, and so on, all of which present their own special challenges -- not least capacity constraints and "flash crash" risk (as greater amounts of starting leverage typically have to be employed to make the light worth the candle).

    Re, moment going off the rails, etc., short answer this is a non-issue for discretionary traders who are not reliant on mechanical signals or optimized paramaters. Slightly longer answer, this also goes back to robusticity and diversity of opportunity -- the more markets a strategy can trade, and the wider opportunity set of conditions it can handle, the lower the odds of permanent degradation, regardless of whether the strategy is discretionary or mechanical.

    Again too, based on simple empirical observation of successful traders running meaningful amounts of capital ($10MM plus) across the market landscape, the strategies that seem to have the most diversity, longevity and ubiquity over time tend to trend towards a focus on higher R in concentrated profit periods, a minimized or ignored focus on winning % as a key statistic, and acceptable levels of daily and monthly volatility deliberately incorporated into the program.
     
    #17     Mar 14, 2011
  8. olias

    olias

    You're absolutely right. Everyone should keep a healthy skepticism regardless of the 'credentials' of the author.

    Otherwise we are susceptible to falling for 'The Emperor's New Clothes'
     
    #18     Mar 15, 2011
  9. Hustler magazine..........

    It taught me the value of a good bottom.

    :)
     
    #19     Mar 15, 2011
    Naik likes this.
  10. Darkhorse, I sat down a few minutes ago with the intention of responding to your post addressing my comments about the book. As I read your lengthy, carefully considered and well-written reply again, it occurred to me that you have raised a number of additional points, each of which I would have to respond to and then construct my own counter argument at some length. That was when I realized this undertaking would probably take me a couple hours. And while the subject matter would make for an excellent discussion, writing a detailed response worthy of your post just isn't in me right now, especially since I just returned from the gym.

    I think you're a really smart guy. Even so, I will continue to hold my own somewhat different views. Perhaps I do so at my peril, but there is no sign of my imminent demise just yet. And so, let us be modern and agree to disagree.
     
    #20     Mar 15, 2011