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Meeting with XC (Part 1)

On August 22, 2017, I met with a financial adviser to share my story, to learn about his, and to hear any ideas or suggestions he might have about transitioning my career toward the IA domain.

Although I have removed/changed his name (initials), I would feel comfortable recommending XC to anyone looking for a financial adviser. Please e-mail me if that might be you.

I was shocked to realize our meeting had lasted 100 minutes. XC was very generous with his weekday time.

As part of their service, XC’s firm trades securities for clients and he believes their edge is 25-50 basis points. For smaller net-worth clients they use ETFs. For larger net-worth individuals they use individual equities. They do a fair bit of covered call writing as a mechanism to defer capital gains taxes. On two occasions he mentioned an example where someone with a large equity position and low cost basis would trigger heavy capital gains upon sale.

I am very curious to know more about their trading edge. Does he believe in CCs as a mechanism for outperformance? Where did they procure their trading expertise? How were they trained? Do they make consistent efforts to improve? If so then how? I believe it’s important to remain focused on realistic returns but I would also recommend any self-directed investor to aim higher than 50 basis points.

XC believes the money management industry is a highly competitive space with a low barrier to entry. He estimates a start-up cost of $50K to start an IA—much higher than I would have guessed!—and significantly less on an ongoing, annual basis.

He thinks my best chance for success is to find people interested in my particular type of trading and/or what I offer. I asked if he thinks the average investor is educated enough to understand what I do and he said no: the average investor doesn’t really care much about how the IA generates returns. This struck me as contradictory: why try to find people interested in my type of trading if they can’t understand what I tell them?

XC recommended I subscribe to LinkedIn professional as a way to find others who share my niche expertise and interest. His preferred approach to networking is finding someone else who knows the target and asking that person to refer me.

He also suggested I speak with the Ross School of Business (daughter’s alma mater) to find others working on related [option trading] projects.

I will continue next time.

Ego and Trading Do Not Mix

I do not believe ego has any place in trading or in trading-related discussion.

It occurred to me that I may sound overly confident and opinionated at times when talking about financial topics. I could talk passionately when discussing many topics covered in this blog, for example. These would include option fundamentals, tenets of trading system development, financial chicanery and fraud, etc. Conviction, in general, can probably be mistaken for ego even though it may only be the manifestation of passion.

I hope I never sound too proud of my track record because past performance is no guarantee of future returns. Bill Miller epitomizes this lesson. While at the helm of Legg Mason (LM) Value Trust, Miller is credited with beating the S&P 500 every year from 1991 through 2005. For this longevity, Miller was a legend—and then the wheels came off. Miller led the smaller LM Opportunity Trust to big losses from 2007 through 2011 with a $10,000 initial investment shrinking to $4,815 (vs. $8,565 for an identical S&P 500 investment). Miller went on to trounce the benchmark in 2012 and 2013 before underperforming in 2014, 2015, and the first half of 2016 [after which he was no longer retained by LM].

Remembering that it can happen to Bill Miller should be motivation for me to maintain a large dose of humility at all times. Miller teaches us that a brilliant record yesterday does not justify inflated ego today. I feel strongly that historical trading volume and historical performance don’t make a damn bit of difference because tomorrow can be altogether different. And yes: I would pound the table passionately in support of this argument.

A corollary to this is that historical performance should not be a criterion for someone looking to hire an investment adviser.

I disagree with said corollary and that puts me in a catch-22 situation. Some have told me that promoting a strong track record is the most critical requirement for raising assets. This brings me full-circle to posts such as this, this, this, and this.

I guess it all comes down to modesty and gratitude: two things I think traders should never be without. I truly believe that how good I am as a trader will only be revealed after I click the “place order” button for the final time. Representing as if I know the answer to this any sooner through ego symptoms like arrogance or condescension would be deception at its finest.

My Take on Asset Managers

Today I want to discuss my dynamic attitude toward the asset management industry.

I consider the following terms to be synonymous: asset managers, wealth managers, and investment advisers.

Throughout the course of this blog, I have not been so kind toward the asset management industry. Examples of posts where I have expressed a negative bias are here, here, and here.

I was a big more neutral toward asset managers here.

I was more positive and understanding when I decided to challenge my previous claim that the financial industry has brainwashed America.

After some further deliberation, I reached some logical conclusions here.

The asset management industry is far from perfect. Some advisers are shady and others are fraudulent. Some advisers incorrectly assert that options are too risky for retail investors while others are ignorant about derivatives altogether. Although this may represent a breach of fiduciary duty, an alternative perspective is warranted.

Without the services of asset managers, many people would basically be storing their money under a mattress. Interest rates were close to zero for nearly a decade while the average annual stock return is upwards of 11% (S&P 500 since 1926). If not for wealth managers, stocks would be an inaccessible vehicle because so many are clueless about how to do it.

I probably have two paths if I choose to bypass the asset management industry: trade for myself or bed mattress [crawl space]. One need not be a genius to be a self-directed trader but I have discussed some prerequisites. Also, as CJ suggested with the analogy of brushing teeth, the average worker may lack the flexibility to do this altogether.

Asset managers may be flawed but in the end I believe they are necessary. Regardless of their ignorance about derivatives, their consequent lower performance, and their expensive fee structure (debatable), the difference between mattress and stocks is significant. Net-net, they have a wide margin for error beyond which they can still provide a valuable service and achieve their advertised goals.

The Relationship between Success and Credibility (Part 4)

Today I want to conclude by further emphasizing the respect I give to those sharing losing trades.

Gloria Loring taught us that we cannot have the good without the bad so I see little point in trying to overlook the losers. I believe I have at least as much to learn from the losers as I do the winners because the former can deliver me to Ruin.

When people suffer catastrophic loss, they tend to go quietly into the night. Maybe this is in hopes of preserving a positive self-concept or minimizing damage to personal reputation. A sense of shame may also play a role. Sharing failure with others could prevent the rest of us from repeating similar mistakes but Schadenfreude is a coping mechanism too.

On a smaller scale, this phenomenon of “going quietly into the night” seems to happen with regard to any losing trade.

As discussed last time, a great way to improve as traders is to understand mistakes we are most likely to make. These include mistakes made by others. I would prefer to hear a presentation on losing rather than winning trades because the latter, in my opinion, is more likely to be contaminated with self-promoting conflicts of interest.

I have considered creating a seminar on “ways to save thousands in the financial markets.” In this program I would discuss financial frauds and shady practices that I have encountered during my years studying the financial/trading landscape. I definitely believe one key to long-term trading success is to avoid being derailed by the tempting offerings (e.g. black box systems, trading newsletters, trader education programs) professing mouthwatering performance numbers. These are more likely to rob you blind should you get suckered in.

Ironically, I decided not to move forward with this seminar idea is because I questioned whether the negative is marketable. People often don’t like to hear the negative. Even I prefer to focus on the positive but I had to grow up sometime and realize that it’s not all winning and roses out there. Losing is part of life and I believe I have much to learn from its lessons.

I have often thought that a string of early wins can be a curse for those new to trading. If they assume this early success to be representative of future win rate then they may increase position size too fast. This leaves them vulnerable to the possibility of catastrophic loss when Mr. Market decides to change his mind.

I once heard “that’s why it’s called trading, not winning.” Sometimes it takes time for the reality of losing to set in.

The Relationship between Success and Credibility (Part 3)

A trader who never wins has no/little credibility with me. A trader who wins but has a small sample size to show has no/little credibility with me. Today I want to consider a trader who usually wins and has losing experiences to share.

I hypothesize that a high percentage of traders would make similar mistakes given a particular trade or difficult trade situation. Although an interesting concept, in practice I would have a very difficult time ever finding a large sample size of people holding the same option position. As more traders share details about different mistakes, though, the probability increases that some of the [theoretically] common ones will be covered. This can be useful education for that high percentage of traders mentioned above [minding the possibility of curve-fitting if said lessons pertain to overly specific circumstances].

Scarcity makes losing lessons from winning traders especially valuable. I have been disgusted with the absence of losing trade talk in times when the market has gotten really nasty. September 2015 sticks out in my memory. In one month, the market corrected 10% while volatility tripled: nightmare conditions for any positive delta, negative vega trader. I facilitated a six-person trading group at the time and the only one who talked about losing trades was me!

I think losing lessons from winning traders are much more relevant than losing lessons from losing traders. What seems important to losing traders may not actually be: they lose regardless so how would they know? What seems important to winning traders is noteworthy because they usually make it work.

We should be aware that one reason winners brag is because winning sells. I am always on the lookout for conflicts of interest when I hear discussion of winners.

Losing, on the other hand, gives rise to a different set of emotions and perceptions. Nobody wants to be a loser and people do not want to be on a losing team. Dayananda Saraswati said it really well:

     > In life, loss is inevitable. Everyone knows this, yet in the core
     > of most people it remains deeply denied – “This should not
     > happen to me.” It is for this reason that loss is the most
     > difficult challenge one has to face as a human being.

I perceive added sincerity and greater relevance when people share experiences about losing.

I will complete this mini-series next time.

The Relationship between Success and Credibility (Part 2)

Last time I began discussion about credibility. Before I proceed to distinguish between losing traders and losing trades, I want to expound a bit on sample size.

I recently found a new Meetup that advertised the following:

     > Organizer/Facilitator is experienced with US stocks
     > and options. He quit his job and invest [sic] safely in
     > Singapore using US stocks for passive income. With
     > 5% monthly returns, he able [sic] to enjoy more time to
     > document his trades, analysis [sic] and exploration.

This raised multiple points of scrutiny for me so I messaged the organizer: “what about 5% monthly returns do you think is not an ‘overnight, get rich quick scheme?'”

I was challenging his notion of “safely.” Plenty of people would be making 60% per year if it were reasonable to do so.

He responded: “nope, because it’s about consistency every month with due diligence done to ensure capital is always safe.”

Rather than target his use of “ensure,” I replied: “calculating returns based on invested capital is meaningless. Anyone can be ‘brave’ and take excessive risk on a sliver of their portfolio. If you succeed and make 5% per month on that then the actual return on total net worth is only a fraction.”

He asked “well if u find it meaningless, how would you calculate your profits from your experience of trading?”

“On a trade-by-trade basis I think it’s okay to use invested capital in the denominator if it is relatively consistent across the set of trades (or if you have a logical plan for dealing with the significant differences when it’s not). For overall performance, though, I think you must divide by total net worth.”

In response, he wrote: “that sounds reasonable as well. 80% of my net worth is traded to achieve my 5%. Remaining 20% I trade on good market condition for other strategies. I don’t really do any day to day trades, so I can only summarize my trade results after 1-2 months for each trade.”

I asked, “5% for how many months?”

He responded, “10% for 2 months averages out to 5% per month.”

There’s our gremlin!

Two months is virtually meaningless as a track record because it is such a small sample size. I discussed in the last post how Mr. Market sometimes allows much longer tastes of success due to no particular trader skill whatsoever. All credibility with me was therefore lost.

As they say on Shark Tank, “for that reason I’m out.”

The Relationship between Success and Credibility (Part 1)

Recently I have been trying to slim down my Drafts folder by completing some blog posts. The current topic is whether consistent profitability ought to be a sufficient or necessary condition for credibility when listening to others talk trading.

This post goes back to “Mr. Know It All” who I introduced here and proceeded to discuss here.

Actual success does not mean I know what I’m talking about. I could be far too aggressive with regard to risk management and lucky not to have gotten clobbered [yet]. In my experience, Mr. Market offers extended tastes of random success between the occasional, inevitable days of reckoning where most traders will be forced to pay the piper.

“Actual success” is a term that demands operational definition. Claims of profitability are more encouraging when backed by large sample size. Generally people claiming profitability are not forthcoming with enough details to assess validity of those claims (e.g. number of trades, time interval, and position size relative to whole portfolio). This is especially true for strangers or acquaintances.

Mr. Know It All offered unexpected transparency when he admitted a track record of losses. I wondered if he planned to continue [losing money]. Was trading futures his substitute for buying lottery tickets? He clearly enjoyed being listened to and viewed as some sort of authority but why would I follow anything he said?

If you believe the statistics then most traders lose, but should they all be ignored? My initial response was affirmative unless I just want to lose a little over a limited period of time. This is a gambler’s mentality, though, and I am here to trade as a business. Traders who lose because of excessive position sizing may have some useful knowledge to share provided I am less susceptible to greed and able to trade smaller.

I do not believe disciplined traders should lose on a regular basis—certainly not to the extent of being net negative over an extended period. These people should be trying to learn from others rather than looking to soak up spotlight for themselves.

I will continue next time.

Welcome to the Ann Arbor Algos

I wrote this back in April 2012 but it never got finalized. I did post it on Meetup.com without any success. This group concept is different from those discussed here or here because trading system development is the primary focus.

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I have seen a number of Michigan investing/trading meetups over the last few years and inevitably, most of them ultimately fail.  In some cases, the organizers just gave up. In other cases, the organizers were for-profit entities electing to move in new directions to market their wares.

I am an independent trader in search of other independent traders without any commercial interests. My hope is to form a small group of traders working together to develop trading systems.

This group is for a very specific type of trader. You should:

     –Be knowledgeable about trading strategies.

     –Understand why a trading strategy does not necessarily make for a trading system.

     –Be practiced at critical thinking.

     –Have experience working in groups.

     –Be willing to purchase AmiBroker (www.amibroker.com) and data as desired.

     –Have AFL programming expertise and/or be willing to spend time learning the language.

     –Have trading strategies available to be systematically tested by the group.

     –Have hours available every trading day for project-related phone calls and e-mails.

     –Not think this will be a place to steal profitable ideas without contributing anything of your own.

     –Not be looking to enroll our members in your educational company or investing service.

     –Have a general understanding of what system development entails.

My hope is to find 3-10 investors/traders to work together on this project.  Please contact me if interested or sign up at http://www.meetup.com/Ann-Arbor-Algos/.