or: how to quit your job to riches!
Recently I had a thought-provoking email exchange with a reader of this blog. It was with a fellow who wanted to startup an algorithmic trading business and was seeking my advice. Its arrival was timely for me and I hope the advice I provided the aspiring entrepreneur was helpful.
The conversation forced me to reconsider familiar terrain from a different perspective, so I share it along with some further thoughts in the hope that it might act as something of a counter-weight to articles and blogs entreating you to “learn algo-trading!” (as though it were a fun! weekend hobby) or “make a million % trading the xyz” and more nefarious advertisements selling the trading equivalents of male-enhancement pills & potions (“I turned a used bus ticket and some pocket change into $7M in 2 months trading the e-mini!”).
I’ve changed the writer’s name and all identifying characteristics for obvious reasons. He wrote: Read more…
I’ve been saving the above image in a stubbed-out blog post I’ve wanted to write since a conversation I’d had in Jerusalem last fall. The recent attention to high frequency trading and all of its attendant evils has reminded me that the topic is relevant and so I relate various thoughts at the risk of jumping on a cacophonous bandwagon of rumbling misinformation.
First of all, the conversation. It was with a talented guy who acted as the CFO for a variety of companies including a small startup hedge fund which traded US equities at a high frequency. Although he was a part-time cfo, he seemed pretty plugged-into their trading operations and noted that they use an agency-only brokerage service for automated traders I’m familiar with and that they were “looking at full data for many” hundred stocks concurrently. He remarked that their trading was going well but that their hit rate was something like 4% and dropping. By hit rate, he meant that they were placing limits frequently and generally pulling the orders if they didn’t get hit immediately. He didn’t specify, but I imagine that “immediately” might range from milliseconds out to a second or twenty. If the market is composed of makers and takers, then these guys were definitely makers of liquidity in the strict sense that they were placing limits and making markets.
At the time I thought it was interesting because it seemed that so many people were focused on the very, very short term trade that the frequency was becoming saturated. It looked like a reminder that trading frequencies populate a spectrum; in this case, this part of the spectrum was becoming so saturated that returns were becoming increasingly difficult to obtain as more players crowded into it. I’m not sure how this hedge fund has fared, but at the time I remember thinking that they were going to have a tough time competing if they were only geared for high-frequency trading as the space becomes increasingly expensive to play in as the inevitable talent and technology arms race marches on.
Lo and Khandani provide the below image illustrating this phenomenon happening to a class of contrarian strategies Lo & MacKinlay had described in 1990. The strategies stop working as people squeeze out the alpha.
A reader of this blog (hey – I’m as surprised as you are!) sent me an email recently detailing a strategy they’d developed. While the details of that strategy aren’t relevant here, they sounded good and they got me to thinking about the process of selling a trading strategy. This is an activity that I’ve spent some time on and have decided just isn’t for me.
There are a lot of difficulties with selling a trading strategy. One of them is a consequence of the foundational problem of back-testing about which I first started posting on this blog. For any given period of time (that has already elapsed!), it’s not difficult to generate a good number of pretty impressive strategies. All you have to do is try a good enough number of random strategies and some of them will prove to be too good to be true.
Presumably, any credible person who might be listening to your pitch will be at least intuitively aware of this fact and will thus be highly suspicious of any back-tested results you might present. For this reason, it’s impossible to sell a strategy on the basis of back-tested results. Only auditable, real-world returns will be considered valid by any serious person. Of course, you might find someone who’s less particular, but then you’re flirting with fraud rather than a legitimate sale.
So let’s say you have impressive, verifiable results. You still have to answer the question:
If this strategy is so good, why are you selling it? Why not just trade it yourself?
I hope you’ll forgive me a post as off-topic as the picture accompanying it is peripatetic. As far as I can tell, it has no algorithmic trading application. But I’ve spent my life around software and it’s pretty rare that I find something that truly wows me.
And Shazam is one of those rare beasts.
I don’t know how they do what they do, but what they do is really something else. Install a free iPhone application (I think there are other implementations available as well), start it up and point the phone’s mic at the source of some music. In a few seconds, the software will identify the song, download its album cover and assorted info, and point you to where you can purchase the song. It’s not perfect – it couldn’t identify the beginning of Beethoven’s 5th, but it was able to identify Carmina Burana and had no problems with any popular music I pointed it at.
I’m certain that if you had a contest between this system and your favorite neighborhood audiophile, Shazam would win hands down for speed and accuracy. It’s really something else.
Inevitably one of the first ideas people have when they start thinking about how to write a trading algorithm turns out to be among the hardest: trading the news. The problems are many and in some cases not so obvious…but the natural appeal of the idea seems universally compelling.
Just after the dot.com craze, a brilliant friend of mine (who had just sold his web consulting startup) decided to write a book. The premise was glorious. A bunch of clever college-age kids formed a startup to predict the stock market. The method they used was to constantly comb the web with ultra-sophisticated algorithms which would run across giant server farms overnight and ultimately generate tomorrow’s headlines. Based on the headlines that their system generated, they would place trades that would take advantage of these predicted events.
Sadly, my friend never went on to complete his book, so I don’t know how it all turned out. (Instead, he went on to start another successful company, this time in the field of robotics.) While he was writing it, I loved getting new drafts as they were filled with clever ideas. But the core idea of predicting headlines and then using those headlines to trade always struck me as especially cute.
For those of us without access to news-predicting algos, writing strategies based on the news is rather less straight forward, though there are a growing variety of products and services aiming to fill the gaps. Today must have been trading-the-news-day as I found a few articles on the topic in my mailbox and even received a cold call from a vendor, Need to Know News, with just such an offering. Below I’ll look at some of these offerings and consider some of the issues involved in writing trading strategies based on the news. Read more…
Normally I spend my design-oriented thoughts on object models – when I’m working on StratBox – or about volatility, latency, executions, &tc – when I’m working on a trading strategy. But a recent trip abroad has inspired me to consider more fanciful design horizons.
After more than a year of blogging I’ve finally decided to refresh the look of the site and you’re looking at the first iteration of this effort. Blogging software is pretty remarkable as it allowed me to essentially change the “skin” of the blog without affecting its content. This is like Kirill Grouchnikov‘s lovely open source “Substance” Look&Feel for Java which does the same trick for swing-based applications: just include his magic code and your system automagically looks a lot better!
More substantively, my recent trip to Israel and the subsequent agreement to open a Tel Aviv office to take advantage of a felicitous new partnership and Israeli algorithmic talent, has led to a broadening of our mission. This in turn led to the foray into graphic design I describe below. Read more…
Although we’ve been in business since 2005, we’re still something of a start-up and certainly an entrepreneurial entity, so when a VC friend of mine suggested checking-out meetup.com‘s technology and business groups I was open to the idea. This past week I attended my second meeting of the “ny tech” group and was as impressed the second time around as the first. It’s quite a production – from the venue, to the organization, to the ideas, people and products being presented – all for $5! (Though they sadly announced a price increase to $10 starting next meeting.) If you have even a small inclination towards entrepreneurial ventures or emerging technologies, it’s well worth a look-see.
This week we spent a few hours at the tradetech conference to see what people in the industry are up to and see some demos. Their “certified” logo inevitably reminded me of an old colleague who would from time to time mimic an old saturday night live skit. We saw some interesting things and, most importantly, found that our creative niche remains our own.
The booths we checked out included a few of the big sell-side firms shilling their creatively-named execution quality algos and their white-labeled oms/ems offerings. They had, by far, the best shwag (I should thank Merrill for their nice umbrella and commend citi for the very knowledgeable lady at their booth) but their algo offerings weren’t very interesting to me as they aren’t of the alpha-seeking variety.