Wednesday, February 15, 2017

What In The World Are You Trading?

The beauty of financial markets is that, quite literally, you can trade almost any publicly listed asset in the world.  If you want to buy stocks in India, Brent crude oil, Japanese currency, or a curve spread in European interest rates, it's very doable.  Despite this historic access to global assets, something unheard of for the public just a few decades ago, we find traders locked into trading the same things, the same ways.

Too often developing traders focus on finding the right trading signals and setups; some hidden formula for making money.  The reality is that trading success is as much about what to trade (and when) as how to time market tops and bottoms.  The past six months in the U.S. stock market have been quite bullish, but notice from the excellent chart from Finviz that sector performance has varied widely over that period.  If you were trading interest rate sensitive utilities and consumer shares or healthcare issues, you barely made money if at all.  If you were trading financial shares, such as banks, you likely killed it.

What you trade is as important as how you trade.

Some years back, a successful trader I knew well found it difficult to make money trading stocks because volatility had declined.  He scanned the universe of commodities and found several that moved similarly to stocks when stocks were volatile.  He began trading those commodities and--lo and behold--he started making money again on a sustained basis.

When I recently visited SMB, I met with several traders who were achieving unusually positive results.  I quickly calculated their Sharpe ratios and found that, not only were they making significant money: they were doing so with excellent risk/reward.  It was clear in speaking with them that they had leveraged technology to identify stocks with the right kind of movement, that provided the best opportunities for that day.  Had they traded the exact same patterns in large cap energy or retail shares, they would have struggled for profitability.  

A macro portfolio manager who I recently worked with also had achieved consistent profitability with excellent risk-adjusted returns.  The strategy involved tracking macroeconomic data in detail and identifying which economies were accelerating and decelerating.  The portfolio then went long the growing economies and short the weakening ones.  Results were not only positive, but completely uncorrelated to the major market indexes.  All because that trader looked in places in the world that others were ignoring.  While the great majority was focused on the U.S. President's policies and trading only U.S. currency and rates, the successful trader was long some Latin American assets, short others; long some Asian assets, short others.

If your trading results have been subpar, consider the possibility that your problem may not be psychological and may not even be with your methods.  Instead, you could be like the gold prospector who is digging where everyone else has been mining.  If you wanted to successfully mine for gold, you'd conduct geological surveys, inspect the land, and go somewhere promising where no one else was looking.  Purchasing better equipment and doubling down on your "passion for mining" can't help you if you're digging in the wrong places.

Further Reading:  Reflections on Opportunity