Nov

8

Trend is the basis of profits; no trend, no profits.

Trend is a function of time. 3-5 hours does not allow for trend moves of any real magnitude; day traders play with a stacked deck. The dream of daytrading is in fact a nightmare for most everyone. It can be done, but not for massive profits.

Nick White writes:

There is an excellent discussion of the dynamics of this point in the gentleman from Amioun's first book.

I quote / summarize / paraphrase at length:

Take a regular dentist. A priori, we know he is an excellent investor and has an expected annual return of 15% over t-bills with a vol of 10%. Dentist builds a trading room in his attic, deciding to spend every day watching the market and drink cappuccino. He buys a bloomberg and lots of expensive PC's to automate his trading etc etc. His 15% return with 10% vol per yr translates to a 93% probability of success in a given year. But seen at a narrow time scale, this translates into a mere 50.02% probability of success over any given second. OVER THE VERY NARROW TIME INCREMENT, THE OBSERVATION WILL REVEAL CLOSE TO NOTHING,. Yet the dentist's heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows red on his screen.At the end of each day, the dentist is knackered and emotionally drained Minute by minute examination shows that each day (given 8hrs / day) he will have 241 pleasurable minutes against 239 unpleasant ones. These amount to 60,688 and 60721 per year. Given that an unpleasurable minute is worse in reverse pleasure than the pleasurable minute is in pleasure terms, then the dentist incurs a large defecit when EXAMINING HIS PERFORMANCE AT HIGH FREQUENCY. In contradistinction, imagine the situation where the dentist examines his portfolio only upon receiving the monthly account from the brokerage house….67% of the months will be positive, he gets only four negative pangs of pain per year, and eight uplifting ones. THe efffect is magnified at the annual level where, for the next 19/20 years, he will have a pleasant experience looking at his annual statements.
Scale Probability
1yr 93%

1 qtr 77%

1 mth 67%

1 day 54%

1 hr
51.30%

1 minute
50.17%

1 second
50.02%

The net net of all this is as follows:

If we look at the ratio of noise to non-noise then you get the following. Over one year we gets .7 parts noise for every part of performance. Over one month we get 2.32 parts noise per part of performance Over one hour, 30 parts noise for every part performance Over one second. 1796 parts noise per part of performance. Therefore:

Over short time increments, one observes the variability of the portfolio, not the returns…you just see variance and little else. This is emotionally difficult to parse…even though at any moment you see a combination of both variance and return, your brain can't tell the difference. This explains the burn-out rate amongst people who constantly expose themselves to randomness (especially given greater effect of negative experiences than positive experiences).

Kim Zussman writes: 

The analysis is flawed:

1. A regular dentist should not day trade because of opportunity cost and squandering what he paid for his profession's barrier to entry
2. One can only know their returns ex post. If you could know them ex ante there would be no psychological issues - fear comes from uncertainty.
3. Irregular dentists are another story

Rocky Humbert writes:

Kim writes: "If you could know them ex ante there would be no psychological issues– fear comes from uncertainty."

This is not correct.

Fear is a pre-wired response in most people, and can have little to do with the rational analysis of a situation or uncertainty.

Example 1: While waiting to mount an extreme amusement park ride (roller coaster etc), the symptoms of fear (sweating, elevated pulse, etc.) are a genuine physiological response regardless of the fact that the odds of injury on the ride are miniscule.

Example 2: If you are engrossed while watching a horror movie, your limbic system kicks in … just as if you were being chased by the Blair Witch.

Example 3: Phobias are real, and irrational. A person who is afraid of flying is not interested in the fact that his plane will almost certainly not crash. Yet, people are not afraid of driving to work — even though the odds of dying during a commute are much higher than on a cross-country flight.

The emotional fear/greed response to P&L mark-to-market are real– and I believe genetically pre-disposed. They are analogous to phobias and obsessive-compulsive disorders. Hence, I believe Nick's post about timeframes is extraordinarly profound and accurate.
 


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4 Comments so far

  1. DH. on November 9, 2010 6:30 am

    to Larry’s point…what about someone who trades on small time scale but not daily…are they ‘day trader’…in terms of prospects?

    DH.

  2. Sumit Agrawal on November 10, 2010 4:33 am

    Why is only trend basis of profits? Why not the correct perception of volatility be a basis of profits?

    If one has a view of longer term trend,yet gets occasionally fooled by shorter-term volatility, is his system not incorrect or his positions over-sized or his predictions incorrect?

    Is anyone excused from short-term tribulations before reaching the middle of the ocean and the faraway shores. Should one ignore the winds on the way and how fast they blow?

    Even if one is a good forecaster of longer term direction, and his edge deteriorates with the shortness of the duration,one can not be called a good trader if one ignores these short-term setbacks and looking at them as a play of variability.

    He may be fooled who thinks he can profit in long term without caring about short-term. Whatever happened to cutting your losses, to technical analysis?

    Even if this is just a play of variability, should one not be penalized and shook-up for its under-estimation.

    Its not-for-nothing that the mind can’t make out between trend and volatility. A large position, previous losses, absence of a system, all can hamper risk-appetite (and what others may call, objectivity)

    Perhaps the strategy of waiting for the longer term trend to pan-out works in scenarios where trend is much larger than the volatility. I do not think it will work for trend traders in reversal scenarios or even when the scenario develops where volatility supersedes trend. It may not work well for contrarian traders either.

    best,

  3. Sam Humbert on November 10, 2010 10:34 am

    A recent back-and-forth on the merits of daytrading, between Dr Niederhoffer’s former colleague James Altucher and DailySpec contributor Dave Goodboy:

    http://www.businessinsider.com/reasons-not-to-be-a-day-trader-2010-11

    http://tinyurl.com/jamesdeepend

  4. vic on November 10, 2010 1:04 pm

    One would hope that that former colleague is now on the straight and narrow path, and that he has learned that the reason day trdaing doesnt work is because of the vig and rake, and the better equipment , and almost as much the more extensive capital that the competitors have. it reminds one much of the bucket shops that flourished so much in the days of my grandfather, and led in an ineluctable way to Livermore’s suicide 40 years later , with the bad habits he learned. gamblers ruin a problem also. vic

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