A Source of Loss, from Ed Stewart

February 20, 2015 |

One of the biggest sources of undue loss I have seen with active traders (decent ones, not the chronically hopeless) is managing day-based strategies on an intra-day basis, using untested assumptions about how this shorter time horizon operates based on the day time horizon idea(s).

Another is having a day-based system, and then managing it intraday based on ones P&L since entry. I have found that these two things are very good at turning a profit into a loss more often than should occur.

On the other hand if you have a day-based system and then do the opposite intraday of what people managing their equity tend to do, and test it, it is abnormally likely to be a decent entry point for a fast profit.

anonymous writes: 

As usual sir you have identified an excellent discussion point.

Within the HF community, the mismatch you mention is called being '5 minute macro'. What this means is trading substantial macroeconomic themes with day trader stop losses.

It is a dead giveaway when a Portfolio Manager of a discretionary bent ( managing say 150 million) sells 200 EURUSD because the U.S. is going to raise interest rates in the third quarter and puts a 30 pip SL in.

Genuine macro trading barely exists anymore. The names that come to mind are Bruce Kovner, Nick Roditi & Stanley Druckenmiller. This is probably a combination of conditions not being conductive in recent years (overall and with exceptions) but it is more to with investor preference for not wanting to lose any money.

Stanley Druckenmiller has an interview somewhere on You Tube in which he talks about how investors used to say that he wasn't trying if his years result was within +\- 25% and 'risk adjusted' returns be damned.

If one's method is genuine macro then one must have a reasonable degree of volatility in performance and long flat periods.

Consider this: The underlying assets that macro traders speculate in have volatilities generally in the range of 10% (currencies) to 60+ percent (energy complex). How then is a genuine trader of macro themes to keep his stop loss to 3% peak to trough (a common number in brand name macro establishments) with a Sharpe Ratio of 1.0 when the underlying all correlate and have huge volatilities… The only answer for these poor souls is tiny position sizes or perfection in entry and exit.

Interestingly, the Principals at the brand name shops do not have these same restraints…. Some allowing themselves 20% hard stops and 3+ consecutive losing years….. It's almost as if the 50-100 PM's at a large macro shop whose names are not above the door have the game tilted against them by their own sponsors… Almost as if they are all window dressing to make the firm seem more deep and substantial to conservative high fee paying 'investors'.

anonymous writes: 

"A perfectly timed trade" the macro trader thinks to himself. His well timed entry has lead to a very quick 30 ticks of open profit. Utilizing his trusty 5 minute chart, he sets a stop-loss just beyond the recent resistance zone. "It's time to sit back, be patient, and let the market do the heavy lifting," he thinks.

Yet the market throws a curve ball, as usual, and now the position is back to breakeven, leaving the trader biting fingernails as the P&L window flickers between red and green. "Perhaps I was early going in with my maximum position size" he contemplates. Clearly, the position will now get stopped out. Within minutes, he has exited with a few ticks of profit."… At least I covered the transaction costs, and green is always better than red".

Only now the market reverses big in what would have been his favor, dwarfing the prior move. "Four times my initial risk… and I missed it!" he observes in anguish. Price breaks a recent low, so the trader shorts again. "Price has now confirming my macro analysis - and a teeny risk is always worth the 20X reward" he rationalizes. The market reverses again, furiously, and stops him out again. Yet within seconds, price has rebounded 20 ticks from the exit point, which restarts the cycle. This train wreck of logic continues until the trader decides to take a break in order to "reset the bearings" and focus on the big picture.

At this point the directional move the trader has anticipated blasts off. He waits for a low risk pullback "I can't afford a stop loss that far from resistance, after all" but it never occurs. Having missed the original move and now seeing the market overextended, the contrarian side looks very promising - "clearly, this has become a reversal market". Yet when his resting limit buy order is filled, there is no rebound - indeed it is instantly underwater by 10 ticks, and within the hour he is down 100 ticks. He adds, and adds again…

At this point if he is with a big fund, (if Anonymous is correct, and I'm sure he is), the manager calls– the trader's call option value with the firm is now zero. "How could my correct analysis have lead to this point?" He thinks to himself as he cleans his desk and is escorted from the premises.


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