Book Review: The Laws of Trading(astralcodexten.substack.com)
astralcodexten.substack.com
Book Review: The Laws of Trading
https://astralcodexten.substack.com/p/your-book-review-the-laws-of-trading
9 comments
> But retail trading: They’ve figured out how to plow a field with a spoon.
Have they, though? Or, perhaps a better question, who is "they" and how do they make a living retail trading?
Aren't most successful retail traders successful by being on the correct (lucky) leg of the random walk?
I have been under the impression that the ratio of successful to busted retail traders is quite close to zero.
Have they, though? Or, perhaps a better question, who is "they" and how do they make a living retail trading?
Aren't most successful retail traders successful by being on the correct (lucky) leg of the random walk?
I have been under the impression that the ratio of successful to busted retail traders is quite close to zero.
Arbitrage of relevant information can be a powerful advantage of amateur retail traders, living as they do outside the Wall Street bubble. Participation in the academic world, frequent international travel, and use of several foreign languages all helped me to make decisions that professionals might have overlooked.
Ironically my best investing decision ever came about due to a drinking session in a KTV in Beijing. My assigned Chinese "companion" was flaunting her new iPhone 4, so, curious, I asked her in my rather limited Chinese: "Are these iPhones popular here". She responded, eyes glowing, "是！我们都有！” ["Yep, we all have them"]. Readers can guess the rest of the story.
Ironically my best investing decision ever came about due to a drinking session in a KTV in Beijing. My assigned Chinese "companion" was flaunting her new iPhone 4, so, curious, I asked her in my rather limited Chinese: "Are these iPhones popular here". She responded, eyes glowing, "是！我们都有！” ["Yep, we all have them"]. Readers can guess the rest of the story.
It is still survivorship bias though. Phones selling like crack in Beijing means buy APPL and hold for how long? You predicted a new phenomenon but you didn’t know E(X) for that investment for the market in general without a lot of other data.
For sure. Nearly all retail traders lose. But it’s primarily a result of unrealistic expectations and low barrier to entry.
If there were YouTube ads for weekend boot camps to become a doctor in 3 days and start making 6-figures next week, we’d ask why 99% of doctors fail.
Aside from luck, many appear profitable for a while, maybe 1-2 years, but even most of those have tricked themselves. They use too much leverage and beat the market until an infrequent correction happens and wipes them out, or they follow scammy systems that have high win rates and a very long duration before they hit a drawdown that wiped out all prior profits. Picking up pennies in front of a steam roller.
For instance, you can pick whatever win rate you’d like, but it won’t necessarily be profitable. The scammer selling the course understands how that works, but the newly certified trader doesn’t.
Determining who “they” are is honestly hard, because luck and leverage can pave a long runway. If someone starts a business, and exits 5 years later with 7-figures in the bank, is there a way to know if they’re successful at business or just lucky? It’s hard to answer that question, good business people still exist.
If there were YouTube ads for weekend boot camps to become a doctor in 3 days and start making 6-figures next week, we’d ask why 99% of doctors fail.
Aside from luck, many appear profitable for a while, maybe 1-2 years, but even most of those have tricked themselves. They use too much leverage and beat the market until an infrequent correction happens and wipes them out, or they follow scammy systems that have high win rates and a very long duration before they hit a drawdown that wiped out all prior profits. Picking up pennies in front of a steam roller.
For instance, you can pick whatever win rate you’d like, but it won’t necessarily be profitable. The scammer selling the course understands how that works, but the newly certified trader doesn’t.
Determining who “they” are is honestly hard, because luck and leverage can pave a long runway. If someone starts a business, and exits 5 years later with 7-figures in the bank, is there a way to know if they’re successful at business or just lucky? It’s hard to answer that question, good business people still exist.
The difference being that in two of the alternatives you list skill has a role to some non-trivial degree, while retail trading (not traditional long-term investing) is dependent almost 100% on pure luck. Even with traditional long-term investing luck plays a much larger role than it does for business, or any skill-based profession.
I was always under the impression that the reason retail investors can succeed lies in the difference in volume. A retail investor finding a niche that earns them, say $100,000 in a year with moderate risk, is great for them. This may not he worth looking at for an institutional investor if that's the cap for the volume and they're trying to invest $100,000,000.
A retail investor may only need a small, fertile, family farm. An institutional investor isn't even looking at something under 100 acres.
I don't really know, not my field.
A retail investor may only need a small, fertile, family farm. An institutional investor isn't even looking at something under 100 acres.
I don't really know, not my field.
You're on the money. Strategies don't scale. This is an observation many outsiders (and disenfranchised people with the market) often miss. You can do really dumb things as a retail investor and get away with it because you don't impact order flow. It's arguably harder to generate 1% of 100,000,000 than 1% of $100,000.
The people GP was talking about--keeping super complicated Excel spreadsheets and whatever--are almost certainly not investing. They're day- or swing-trading, playing "technical analysis" games, and engaged in all manner of snake-oil "strategies".
I'm also talking about day-trading here. A retail investor might find worth in being a market maker for a few things which each have a daily volume of $25,000 and 1% margins. An institutional investor may see that $25,000 volume as a rounding error.
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I love it that the author says "understand why you're trading", when in reality market makers are usually the least informed players in the market. They don't know what instruments are worth, they mostly just believe whatever "the market" believes, and tweak a bit around that.
That's true to an extent at the base level, but there is a pretty large pre-trade/post-trade analytics infrastructure in place to analyze trade quality and market trends. It's not uncommon to lose weeks worth of profit due to predators dumping shares into slow-moving MMs since such predators can send orders faster than MMs can cancel them in reaction to significant market movements.
Some fundamental understanding of the asset class and market microstructures is needed (if not on the tech side then the quant side, but ideally both) so you know what you're trading. Given the sheer volume that goes through your typical broker-dealer, that's quite a reasonable investment to make.
Some fundamental understanding of the asset class and market microstructures is needed (if not on the tech side then the quant side, but ideally both) so you know what you're trading. Given the sheer volume that goes through your typical broker-dealer, that's quite a reasonable investment to make.
Very true. MMs have to always be adjusting their marks due to new trades made, market moves, interest from other players, etc. Like you said, if an MM's bid keeps getting hit and they don't lower they get dumped on until they do adjust.
Yeah, I think there is a tendency to over-simplify the duties of responsibilities of a MM as "printing money", as if it's a passive business that solely relies on existing infrastructure (of course, just the existence of a boat load of directors and MDs all with their niche electronic trading/MM products is an indication it's not so simple, but I digress) and scale -- that is just not true.
I try to explain to retail investors and outsiders interested in markets that this whole operation requires a truly mind-boggling amounts of money and brainpower to keep going on a regular basis, but it's hard talking to people who have never experienced working in the industry.
I try to explain to retail investors and outsiders interested in markets that this whole operation requires a truly mind-boggling amounts of money and brainpower to keep going on a regular basis, but it's hard talking to people who have never experienced working in the industry.
For sure. The infrastructure costs, both initial and maintenence, are astronomical. The underlying infra of a single shop, not to mention the entire market plumbing, is so complex and severely underestimated in general.
The market makers do understand why they are trading and understand it has nothing to do with fundamental value. That may be your reason for trading. They are there to rapidly and correctly assess short term supply and demand so they can extract compensation for providing liquidity. And that’s a good thing. A market made of heterogenous actors with different objectives and time scales is far more robust.
Well, we're trading because the last 30,000 times we traded in the last day we made most of a basis point per trade on average
This is entirely wrong.
MMs aren't doing deep analysis like a hedge fund, but they do have insight into the buy/sell interest across the market.
And how do you think one makes a market if they don't have an idea what something is worth? Prices aren't necessarily values, MMs value instruments and then trade accordingly at prices quoted. They don't search for misvalued items like a l/s fund, but they always have a theoretical value and make a market around that internal number when asked.
MMs aren't doing deep analysis like a hedge fund, but they do have insight into the buy/sell interest across the market.
And how do you think one makes a market if they don't have an idea what something is worth? Prices aren't necessarily values, MMs value instruments and then trade accordingly at prices quoted. They don't search for misvalued items like a l/s fund, but they always have a theoretical value and make a market around that internal number when asked.
> A book about trading isn’t ever actually about trading
Hmm, would "A Random Walk Down Wall Street" [0] qualify as another exception? It's been a while, but I seem to recall it as neither a "I'm genius invest with me" nor "let's point and laugh at those guys".
[0] https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
Hmm, would "A Random Walk Down Wall Street" [0] qualify as another exception? It's been a while, but I seem to recall it as neither a "I'm genius invest with me" nor "let's point and laugh at those guys".
[0] https://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street
I recall it mostly as efficient market BS...
There's always a plethora of misinformation about trading, so here goes.. Retail and institutional is the difference between playing in a casino and being the casino.
It's important to understand - on the whole - he average probability of guessing the direction of a trade is 50/50. Any obvious (and virtually all non-obvious) edges, arbitrage for instance, are removed by the market participants. That's what a market IS.
In that respect, 'random walk' is correct. However, that does not mean all participants cannot expect profitability over the short or long term. Which are also themselves, very different things.
For retail traders, transaction cost (commissions + bid/ask spread) make it a negative expectancy.
In fact, bid/ask spreads and commissions ARE PRICED right at a level to remove any positive expectancy, but leave the APPEARANCE of a possible positive one.
Getting that up just a couple percentage points to a positive expectancy is difficult in the short term, and VERY difficult over the long term. Not impossible. That's why about 70-80% of active retail traders are losing overall at any given time.
For firms, order flow and much lower transaction costs make for a positive expectancy. The value of order flow alone is responsible for the zero-commission trading industry.
Skill isn't the issue. The trader with skill level at lose a little or break even trading - from his bedroom - would very possibly be winning on the big banks trading desk. Even if executing the SAME trades they were at retail. More so, the more frequent the trading activity.
So if big institutions have a built in edge why do they sometimes fail? Easy, they still sometimes make stupid bets (ie.. Silicon Valley Bank's bond bet which killed it).
It's important to understand - on the whole - he average probability of guessing the direction of a trade is 50/50. Any obvious (and virtually all non-obvious) edges, arbitrage for instance, are removed by the market participants. That's what a market IS.
In that respect, 'random walk' is correct. However, that does not mean all participants cannot expect profitability over the short or long term. Which are also themselves, very different things.
For retail traders, transaction cost (commissions + bid/ask spread) make it a negative expectancy.
In fact, bid/ask spreads and commissions ARE PRICED right at a level to remove any positive expectancy, but leave the APPEARANCE of a possible positive one.
Getting that up just a couple percentage points to a positive expectancy is difficult in the short term, and VERY difficult over the long term. Not impossible. That's why about 70-80% of active retail traders are losing overall at any given time.
For firms, order flow and much lower transaction costs make for a positive expectancy. The value of order flow alone is responsible for the zero-commission trading industry.
Skill isn't the issue. The trader with skill level at lose a little or break even trading - from his bedroom - would very possibly be winning on the big banks trading desk. Even if executing the SAME trades they were at retail. More so, the more frequent the trading activity.
So if big institutions have a built in edge why do they sometimes fail? Easy, they still sometimes make stupid bets (ie.. Silicon Valley Bank's bond bet which killed it).
Look at Nvidia stock, the market knocked it all the way down and then all the way back up. There is no efficient market. Its really about making a contrarian bet. The reason traders lose money is that most of the time there are no good trades to make. If as a retail trader you made a trade once every two years, things would be different.
Another thing, it takes a while for news to price in. If inflation craters and it means the QQQs should be 10% higher, that move CANNOT happen in one day.
Another thing, it takes a while for news to price in. If inflation craters and it means the QQQs should be 10% higher, that move CANNOT happen in one day.
I have a family member who was a speculator for about a decade and worked in a secondary role for investment banks for the rest of their career. Their advice, as a retail investor, was to just build a diverse portfolio so you are profiting from the market averaging above inflation in the long term. Obviously, later in life you want to transition toward more stable investments like bonds so your retirement money isn’t gone if there’s a crash, but that was the core idea. Is that not sound advice? Based on your comment, any investment at retail is a loss on average.
The comment was about short term trading (eg "day trading") I think. The reference to long term was in the context of regular short term trading over a long period.
Investing in a market spread (eg an index tracker) over the long term with infrequent trading during that time is a different strategy that trusts the market rather than the individual's "skill".
This latter is presumably what your relative was (correctly) advising.
Investing in a market spread (eg an index tracker) over the long term with infrequent trading during that time is a different strategy that trusts the market rather than the individual's "skill".
This latter is presumably what your relative was (correctly) advising.
I think that's consistent with their comment. They said it's still possible to expect profit over the long-term, you just won't have an edge over the market as a whole.
In US equity markets, retail get tighter spreads than institutions and lower transaction costs. Retail can trade at tighter spreads than the nbbo with ‘zero’ commission (yes, there is still payment to the broker, but this commission is missing out on an even tighter spread). Institutions trade at actual exchanges, pay fees for trades, fees for connectivity, fees for market data, etc. Institutions can have advantages with eg cheaper financing.
I think most of what you have written is basically false, at least for US equity markets.
The reason institutions like trading with retail (for equities in the US) is not that they get to charge big commissions. It’s that they don’t have to pay for the high risk of adverse selection. I.e. trades with retail tend to not be regretted because the market is not particularly likely to quickly move in the direction that favours the retail trader.
If you are retail and you have some actual edge, you could find the brokerage which gives the tightest spreads (mostly this means the one with the worst traders except some take much more pfof). But there are likely better ways to get leverage than trading on your own account, eg selling a newsletter or working for a trading firm where you have more capital.
I think most of what you have written is basically false, at least for US equity markets.
The reason institutions like trading with retail (for equities in the US) is not that they get to charge big commissions. It’s that they don’t have to pay for the high risk of adverse selection. I.e. trades with retail tend to not be regretted because the market is not particularly likely to quickly move in the direction that favours the retail trader.
If you are retail and you have some actual edge, you could find the brokerage which gives the tightest spreads (mostly this means the one with the worst traders except some take much more pfof). But there are likely better ways to get leverage than trading on your own account, eg selling a newsletter or working for a trading firm where you have more capital.
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Very well written
Enjoyed the analysis, thanks for sharing.
Enjoyed the analysis, thanks for sharing.
Enjoyed reading this book review. I am encouraged to buy the book. Thank you for sharing.
Waiting for Jumpcrisscross's commentary...
> In as technical a field as trading, sheer willpower is often what gets things done in the end.
Institutional and retail trading are as different as Microsoft and a solo startup side project.
Some principles transfer, like gambling theory, expected value, risk of ruin.
But retail trading tends to be more like the person who just really loves Excel, and they’ve somehow built an inefficient monstrosity of linked Excel files that only they understand, to accomplish what should be handled by an enterprise ERP. But it works. And it turns out you can make a living this way.
Institutional trading is no doubt one of the hardest games one can engage in.
But retail trading: They’ve figured out how to plow a field with a spoon. Either because they are obsessive about fields, or spoons, and it just happens to be the case that one can make a living plowing fields.