Saturday, September 27, 2014

Ten Things Your Trading Track Record Says About You

Having spent a number of years in recruitment roles at trading firms, I'm accustomed to seeing trading track records.  A track record is a bit like a college applicant's SAT score:  it doesn't guarantee you admission, but it gets you in the door for a look.  Skilled recruiters can read quite a bit from a trader's track record.  Here are ten of the most important things your track record says about you and your trading:

1)  How honest are you? - You'd be surprised by the number of track records that are inaccurate.  There are ways a good recruiter can identify this, but as we saw with the Madoff scandal, what looks too good to be true usually is.  Overfit system results are another example of dubious track records.  A valid track record is independently verifiable.  One candidate I heard of produced a seemingly stellar track record with multiple years of solid earnings.  When the due diligence process called for several years of IRS returns to verify income, the candidate mysteriously dropped out.  We can trust in the Lord, but all others should have verifiable track records. 

2)  How correlated are you? - Are you basically following general market returns, or are you adding alpha with something unique in your trading process?  Low correlations often speak to the creativity of a trader's idea generation.

3)  How much do you make on a risk-adjusted basis? - If you are correlated to the general market, then you want to show that you are making more per unit of risk taken than the general market affords.  A high Sharpe ratio suggests that you not only make money, but do so consistently, with solid risk management.

4)  How well do you perform across market conditions? - A good track record is long enough to demonstrate your performance in volatile and non-volatile markets; during uptrends, downtrends, and ranges; and during different market regimes.  Are you a one-trick pony, making money only in one kind of market, or can you be profitable across a variety of market conditions?

5)  How much do you draw down? - This is part of performing on a solid risk-adjusted basis, but captures more specifically how you avoid blowups.  A good track record should demonstrate that you play good defense as well as offense.

6)  Where do your returns come from? - Do you make your money predominantly from one market and one kind of trading, or do you employ multiple strategies across multiple trading instruments?  Do you profits come more from shorter-term trading or longer-term holds?  Do you make more money in morning trading if you're a daytrader, or in the afternoon?

7)  How well do you trade size? - Are your largest trades your most profitable ones, or do you tend to lose money when you're more aggressive?  Does conviction in an idea lead you to trade it well, or does it beget overconfidence and poor risk control?

8)  Is your performance getting better or worse over time? - Performance always rises and falls, but if you see steady improvement, that suggests a positive learning curve.  A steady decline from a successful trader can be a sign that a trading strategy that worked well at one market period no longer is yielding positive expected returns.

9)  Are there patterns to your performance? - Look at periods where you have undergone personal stresses as well as positive periods in your life.  Do these correspond to trading performance?  Do you tend to trade well after a period of flat performance or drawdown, or do the losses tend to snowball?  After winning periods, do you tend to hold onto your winnings or give them back?  Trading patterns can be great ways to identify psychological patterns?

10)  If someone else had your track record, would you give them your money to invest? - That's where the rubber hits the road.  If you wouldn't invest in someone else with your track record, perhaps you should not be overconfident in allocating your capital to your own trading.  Viewing your performance objectively is a great way to determine how much risk you should take in your trading.

Further Reading:  The Challenge of Hiring Successful Traders