I smell b.s. too... I'm not sure you have a working grasp of what "institutional money" even means, given your willingness to conflate trend follower strategies with mutual fund strategies. Don't assume something can't be done just because you aren't smart enough to figure it out yourself. I suggest you ponder the following video and then share what you've learned. (Or on second thought, don't, as probability now seems high you won't learn anything.) <iframe width="420" height="315" src="http://www.youtube.com/embed/pCvx5gSnfW4" frameborder="0" allowfullscreen></iframe>
Trading Wisdom 31: Implications of 90/10 "Some years ago in my observation of P/L patterns, I noticed the following interesting trend: For virtually every account I encountered, the overwhelming majority of profitability was concentrated in a handful of trades. Once this pattern became clear to me, I decided to test the hypothesis across a large sample of portfolio managers for whom transactions-level data was available. Specifically, I took each transaction in every account and ranked them in descending order by profitability. I then went to the top of the list of trades and started adding the profits for each transaction until the total was equal to the overall profitability of the account. "What I found reinforced this hypothesis in surprisingly unambiguous terms. For nearly every account in our sample, the top 10% of all transactions ranked by profitability accounted for 100% or more of the P/L for the account. In many cases, the 100% threshold was crossed at 5% or lower. Moreover, this pattern repeated itself consistently across trading styles, asset classes, instrument classes, and market conditions. This is an important concept that has far-reaching implications for portfolio management, many of which I will attempt to address here. "To begin with, if we accept the notion that the entire profitability of your account will be captured in, say, the top 10% of your trades, then it follows by definition that the other 90% are a break-even proposition. Think about this for a moment: Literally 9 out of every 10 of your trades are likely to aggregate to produce profits of exactly zero. It almost makes you want to pack up your charts and go home, doesn't it? Indeed, the main danger in being aware of this concept is the tendency to misinterpret its implications. For this reason, we want to be very careful about how we use the information in driving the portfolio management process and all of its components. "Most people's first reaction when they see their "90/10" score is to assume that it is a problem that wants correcting. This is simply not so; and if they respond by trading less, concentrating their portfolio exclusively on what they feel to be their best ideas, they are likely to be disappointed by the results. The 90/10 rule is hard to overcome, and so I think the better way of looking at it is that you need the 90 to get the 10. To best understand this, let's use a baseball analogy (why not, everyone else does). Think of the situation faced by a .300 hitter in baseball, who, even though he knows he's going to be unsuccessful 70% of the time cannot simply decline to step up to the plate on the 7 out of 10 occasions where (statistically speaking) he isn't likely to get a hit. Truth is, the 7 outs he makes in 10 at-bats are a necessary condition of his .300 batting average, and he can no more expect to be more successful by limiting his at-bats than you can expect to be successful in your trading by reducing your number of transactions. True, just as the batter may know that he does better against certain teams and pitchers and in certain parks than others, so will you as a portfolio manager have some insights into the conditions that are most conducive to maximum profitability - across individual names, market cycles, and other factors. However, in both cases, the individual in question cannot expect to gain any benefit through a lack of participation. "Therefore, the principal lesson you should derive from 90/10 may well be that the lower 90% of your transactions, which are likely to sum up to zero P/L, are a critical component of your success. If properly analyzed, these trades can provide insights into the controllable elements of your portfolio management activities that can be enormously valuable to your bottom line. However, if you fight against this tide, you are likely to fall into a large group of market participants who have very useful skill sets but who inevitably become their own worst enemies." - Ken Grant, Trading Risk JS Comment: Certain aspects of successful trading are misunderstood by the majority of would-be traders, or worse yet never grasped at all. This is another reason why the well-cited 90% failure rate in trading compares to the 90% failure rate of small businesses: A fair chunk of the trader / entrepreneur mortality rate can be attributed to a basic lack of knowledge. A trader who overlooks key aspects of, say, risk management or the way the market distributes profits, for example, is like the baker who opens a pie shop assuming success will hinge entirely on the deliciousness of the pies, without realizing the life or death of the pie shop is just as much about abstract concepts like marketing ROI, cost containment and cash flow. Ken Grant (the author of Trading Risk) has served as risk manager for some of the largest and most successful hedge funds in the world. He draws his conclusions from an observable universe of highly successful professionals. Among these traders, why do you think the 90/10 ratio is so prevalent? And what does it potentially say about critical success factors like consistency, position sizing, and risk control? Buy Trading Risk on Amazon Get Trading Wisdom via e-mail
p.s. Chipmunk: I want to apologize for my overly harsh tone in our back and forth here. In retrospect I didn't get a lot of sleep this week which made me a little crankier than usual. The subject matter at hand is valuable stuff and I felt you were overly dismissive of it, but I didn't need to be that acidic. So, apologies for the extra edge to my replies. I could have made my points without it.
Interesting........ so all this time the concept of "positive expectancy" has been just a fantasy? Back test results are all curve fits? Forward tests are just luck? All coins are fair? No dice are loaded? Leveraged traders like you don't panic and create tails?
At risk of seeming like a mercenary trader sock puppet, this post speaks to my own experience. I've found that outlier wins make all the profit, are impossible to predict, and are made possible by all the churning small wins and losses along the way. He obviously has one, and it seems to me like he's loving it. You, on the other hand..........
Trading Wisdom 32: How Jerry Rice Achieved Greatness "As every football fan knows, Jerry Rice was the greatest receiver in NFL history, and some football authorities believe he may have been the greatest player at any position. His utter dominance is hard to believe in a league where the competition is so intense and conducted at such a high level. For example, the records he holds for total receptions, total touchdown receptions, and total receiving yards are greater than the second-place totals not by 5 percent or 10 percent, which would be impressive, but by about 50 percent... "With regard to most players, [the question of what made Rice so good] usually guarantees an argument among sports fans, but in Rice's case the answer is completely noncontroversial. Everyone in the football world seems to agree that Rice was the greatest because he worked harder in practice and in the off-season than anyone else. "In team workouts he was famous for his hustle; while many receivers will trot back to the quarterback after catching a pass, Rice would sprint to the end zone after each reception. He would typically continue practicing long after the rest of the team had gone home. Most remarkable were his six-days-a-week off-season workouts, which he conducted entirely on his own. Mornings were devoted to cardiovascular work, running a hilly five-mile trail; he would reportedly run ten forty-meter wind sprints up the steepest part. In the afternoons he did equally strenuous weight training. These workouts became legendary as the most demanding in the league, and other players would sometimes join Rice just to see what it was like. Some of them got sick before the day was over. "Occasionally someone would write to the 49ers' trainer asking for the details of Rice's workout, but the trainer never released the information out of fear that people would hurt themselves trying to duplicate it. "The lesson that's easiest to draw from Jerry Rice's story is that hard work makes all the difference. Yet we know - from research and from just looking around us - that hard work often doesn't lead to extraordinary performance. We also know that even after an excellent college career, Rice did not possess outstanding speed, a quality that coaches generally consider mandatory in a great receiver. So there must be something else lurking in Rice's story... "Of course it's true that all NFL players devote most of their work-related time to nongame activities, and that fact is significant. These people, doing their work at its highest level and subject to continuous, unsparing evaluation, don't set up weekday football games for practice; they spend almost all their time on other activities, a fact that we should remember. In the case of Rice, one of the greatest players, the ratio was even more extreme. "He designed his practice to work on his specific needs. Rice didn't need to do everything well, just certain things. He had to run precise patterns; he had to evade the defenders, sometimes two or three, who were assigned to cover him; he had to outjump them to catch the ball and outmuscle them when they tried to strip it away; then he had to outrun tacklers. So he focused his practice work on exactly these requirements. Not being the fastest receiver in the league turned out not to matter. He became famous for the precision of his patterns. His weight training gave him tremendous strength. His trail running gave him control so he could change directions suddenly without signaling his move. The uphill wind sprints gave him explosive acceleration. Most of all, his endurance training - not something that a speed-focused athlete would normally concentrate on - gave him a giant advantage in the fourth quarter, when his opponents were tired and weak, and he seemed as fresh as he was in the first minute. Time and again, that's when he put the game away. "Rice and his coaches understood exactly what he needed in order to be dominant. They focused on these things and not on other goals that might have seemed generally desirable, like speed." - Geoff Colvin, Talent is Overrated JS Comment: Do you have a little Jerry Rice in you... or maybe more than a little? Rice was not known for his speed, yet achieved the hallmark of "greatest of all time" in a position where speed is worshiped. What does that say about what is possible, and what is important, in trading? How hard do you work in the "off-season," or outside trading hours, to achieve your trading goals? How much "extra-mile" type effort do you put into honing, maintaining, and improving your skills? Imagine you were your own football coach - or rather trading coach. How would you break down and rank the various components of your game? How would you score yourself in these areas - speed, agility, strength, etc - as they cross-compare to trading? Have you ever considered a comprehensive self-evaluation of the strengths and weaknesses in your methodology... and your trading profile on the whole... with the goal of creating a series of targeted, area-specific developmental programs and research routines to take you to higher levels? Buy Talent is Overrated on Amazon Get Trading Wisdom via e-mail
Trading Wisdom 33: On Holy Causes "It goes without saying that the fanatic is convinced that the cause he holds on to is monolithic and eternal - a rock of ages. Still, his sense of security is derived from his passionate attachment and not from the excellence of his cause. The fanatic is not really a stickler to principle. He embraces a cause not primarily because of its justness and holiness but because of his desperate need for something to hold on to. Often, indeed, it is his need for passionate attachment which turns every cause he embraces into a holy cause. "The fanatic cannot be weaned away from his cause by an appeal to his reason or moral sense. He fears compromise and cannot be persuaded to qualify the certitude and righteousness of his holy cause. But he finds no difficulty in swinging suddenly and wildly from one holy cause to another. He cannot be convinced but only converted. His passionate attachment is more vital than the quality of the cause to which he is attached." - Eric Hoffer, The True Believer JS Comment: Do you know any traders or investors obsessed by a 'holy cause' - a world or market view so patently one-sided it qualifies as blind obsession? Some holy cause advocates are blatant (ahem, Zero Hedge, cough cough). But others can be more subtle. Is it possible to make a methodology, a market approach, or a view on how markets "work" (or are supposed to work) into a holy cause? For those undisciplined, untrained, or otherwise improperly grounded as traders, why are markets such a common outlet for insecurities and imbalances found elsewhere in life? Buy The True Believer on Amazon Get Trading Wisdom via e-mail