I read a comment on here recently where someone was arguing that "strong hands" don't trade algorithmically. The comment was made in the context of directional trading, so I'll keep my discussion limited to that realm, although there is probably a whole other realm of non-directional, counter-directional, portfolios of strategies, etc., discussion that could be had about "strong hands". Also, let's assume that the "strong hand" in question is a trader, not a long-term investor like a pension fund or something of that nature, otherwise we'll just end up agreeing that there are institutions that can hold through vicious drawdowns, which is true, but doesn't say anything about trading. Anyway, this argument got me thinking. First, is there such a thing as a "strong hand" and, if so, why wouldn't they trade algorithmically? The more I thought about it, the more I actually think they would trade algorithmically because the essence of an algorithm is to apply a structured decision-making process using all available current information. So, in a structured decision-making entry process, there is ONE rational way to decide direction, ONE rational way to set the entry trigger, ONE rational price for entry on the timeframe you are trading, ONE rational place for your initial stop, ONE rational place to move your initial stop to a new stop, ONE way to move your stop on an ongoing basis and ONE way to exit. To think otherwise is to dwell in the realm of ambiguity and subjectivity, which is counter to the whole "strong hand" mentality, which is based, at least partially, on the exploitation of those characteristics in others. So, is this wrong? I actually think this is correct and it seems to be a reasonable approximation of how someone who never got "shaken out" before a position reached its maximum potential on the relevant timeframe (which is what is always said happens to "weak hands") and who was reasonably discerning in picking direction through a series of logical deductions based on objective factors would trade. Essentially, the way a "human robot" would trade. If anyone responds, let's leave aside position-sizing considerations for the moment, since I agree that a "strong hand", if such an entity exists, would likely be sizable and hence face liquidity issues taking a full position at ONE price and exiting at ONE price. Granted. But, I would also assume that a "strong hand" would be able to find sufficiently correlated or non-correlated markets to diversify into, using the same algorithm provided the same signal was being given, so essentially the entire universe of tradeable assets would be the "strong hand's" domain. Also, let's keep the discussion away from conspiracy theories about "strong hands", blah, blah, blah. I'm talking about positions taken in the largest markets on the planet (indices, currencies, oil, etc.), not some penny stock that's manipulated a dozen different ways.
"Strong hands," "smart money" etc. are just shorthand for highly experienced and well-capitalized speculators - the top 1-10% of successful/profitable traders - who are, as a group, consistently on the correct side of market moves. I doubt many of these (if "they" even really exist as a definable class) trade using algorithms. No computer program or algorithmic strategy yet devised can match the experienced human mind in an endeavor such as trading, so naturally the apex of the pyramid will consist entirely of non-algorithmic traders.
Well, an algorithm has to be devised by a human, so it really isn't the creation of a computer, but of the human mind. There are some software packages out there that create algorithms by data-mining, but I don't know if anyone who'd fall into the "strong hands" category actually works with them. So, I'd separate out the creation of the algorithm from its implementation in computer code. It seems to me that once someone reached that 1-10% (or maybe even prior to reaching it, e.g. if someone was a bad trader, but was rigorous in analyzing their mistakes and not making them again, so that ultimately they turned into a good trader), that person would take a step back, see what had worked on the way (having probably made hundreds, if not thousands or tens of thousands, of trades along the way) and what hadn't, and codify it into a set of decision rules, precisely to create the consistency you mention. Maybe then they turn it into an automated program or maybe they don't, but the real key is that the process is always the same. You often see it said, "Good trading is boring" and maybe this is partially why? You go from that initial newbie trader sense that "anything can happen" to understanding that, yes, "anything can happen" in theory, but in practice what happens 99.9% of the time is A-B-C.
I've only ever heard of two types of successful algo trading: a) High-speed HFT-style scalping exploiting all kinds of market microstructure phenomena that I don't know anything about. b) Algos to exploit simple statistical patterns and gimmicky edges that are simple and repeatable enough to be translated into computer code, but invariably fade away - precisely because they are so simple to follow, and can be identified by means of data-mining and statistical analysis. New edges must constantly be designed and deployed to replace fading ones. Computers are good at doing things quickly or doing them 24/7 on a large scale. But after a certain point trading becomes, more than anything else, about recognizing and adapting to changing market conditions more quickly than the next guy. It's not enough to simply data-mine your results to come up with the Holy Grail set of entry conditions, etc. Right now we lack the know-how to produce a mathematical algorithm or computer program that can perform this sort of task as well as an experienced human. I'm not saying that people can't have excellent long-term success as algorithmic traders, just that the best of the best are going to be primarily discretionary players.
Logicman, I really enjoy your posts because I easily relate to them, think about a lot of the same stuff. I've always construed strong and weak hands to describe capitalization. An asset manager (hedge fund, mutual fund, etc) has a large amount of capital to put to work and scales in and out of positions over time. These players can endure large price swings, retracements that, in a much larger time frame, are quite normal, and simply provide an opportunity to accumulate a larger position, but which easily shake out retail day traders and short term swing traders. As a day trader and short term swing trader I want to be part of an accumulation or distribution price swing that occurs when there's a significant imbalance between supply and demand. In effect my trading is boring because when price action indicates support/resistance at a value zone I let the "winning" team take me into my small position and can easily unload with little damage if there's no follow-through. The strong hands can endure a lot wide swings that I can't. If I'm not on the right side of a true imbalance between supply and demand, I'll take my small loss and try again. If I was managing large sums of money for longer term position trading, the technical analysis and price action methodology I use would be meaningless. This is why when the strong hands are at work, a strong trend results and price can stay "overbought" or "oversold" for a long time, wiping out the accounts of the weak hands (smaller retail traders, especially inexperienced ones). I think newbies don't believe anything can happen. They tend to believe what they want to happen will happen even if it isn't happening now. They either trade what they think, not what they see (averaging down or taking large losses). Or they trade what they see (a strong trend), but they have no idea how to enter a trending move and end up buying short term tops/selling short term bottoms, get shaken out by normal price action, then chase again and end up chopped to death.
This is so simple to answer. Yes, there are strong hands and no they do not trade algorithmically. Strong hands by definition discount the price as meaningless and therefore are necessarily basing their trades on something other then price (other then price primarily). This may be a hypothesis, an if-then scenario, a belief about the fundamental market, or an anticipation of an event. They are are "strong" hands because they do not feel the market movement means anything. So, if they are short they aren't going to sell as the market moves against them because they don't see that as meaning anything. It is easier to trade with a strong hand if one uses a risk controlled instrument such as an option or vertical spread. The mentality of the best trader is be strong, unrelenting when right but give like water when wrong. It is as difficult as it sounds.
Weak hand: 5K account, buys 100 shares @ $50 Strong hand: Starts selling lots of 500 shares short until price gets to $45. Weak hand: panicked and sells at $45 for $500 loss. Strong hand buys the shares weak hand sells for $500 gain and then covers the remainig shares for commission loss. Price gets back up to $50 Until we meet again...
Everything I'm seeing for nearly two years now tells me that the changes in market conditions are more apparent than real. There is an underlying logic to them that is non-random. And it's not just the past two years, because I look at old charts and see the same logic and I'm thinking, that's where the "smart money" bought and sold and took as much out of the market as they could. Either that or I'm the test case for "fooled by randomness". Which one it is, I guess I'll know in a few years as it plays out.
I think that both of our styles is to boil things down to the essentials, so it makes for a similar approach and similar concerns. Get rid of all the extraneous issues to focus on what's important. Capitalization is definitely part of being a strong hand, but what I'm seeing is actually fractal and can be applied at shorter intervals as well. The logic scales up and down, although I don't look at anything below hourly because I don't want to be a trading fiend. Just 1-2 trades per day is sufficient, trying to catch the 1-2 real turning points in a 24 hour period. It's funny you mention "overbought" and "oversold" because I think you're right that these terms are exactly ones that a strong hand would ignore, but rather, they'd be holding longs even in a market weak hands thought overbought and holding shorts in one that weak hands thought oversold. Psychologically, it's the feeling of never being afraid of holding on to a position as long as "x" doesn't happen, with "x" being defined strictly logically. I see so many posts on "How do I let winners run and avoid taking profits too soon?", but I think that a "strong hand" has actually optimized for just this part of the trading profit equation (it's like Livermore said, "A trader needs to get paid for being right") and I think there is a very definable the price/time/retracement/re-entry, if necessary logic of how they do it. Good point about newbie's expectations of what will happen. Been there, done that, don't want to do it EVER again.
I've always thought of it this way. Strong hands are those who are currently in profit by a good margin be it bulls or bears at the time. The ones that have the money to add to their position from their current profits if price retraces and thus they are continuing the price direction in their favor. I've never referred to strong hands on an individual basis, I've referred to it as whether the bulls or bears are winning in a certain time frame. Who ever is winning are the strong hands. Just the way I look at it...