Why the answers to trading the markets are in three hundred six-packs.
Most of the people that know what they are doing look for patterns. We know history is no perfect guide for what happens in the future, but what else are you going to do? So, we take a series of numbers and we look for trends. Are prices increasing or staying within a range, or do they revert at a particular point more often than others? It’s actually fairly easy to spot if things are going a certain way. The hard part is trying to identify when they do not.
It is the reason why CTA’s or so-called momentum trading strategies don’t always work. When everyone is heading to the exits at the same time, it doesn’t matter how good your model is, and you will get filled at the worst possible price. Playing the direction of the market is a mug’s game anyway, as they are too difficult to predict. Trading one against the other however, does increase the odds enormously, but we do have to manage our stack.
Look at it this way. If you have £10,000 to invest, would you bet it all on black? We could get lucky of course, but that only takes us so far. However, taking a series of £100 bets whilst doing the same gives us a much higher chance of walking out of the casino with at least half the money we brought in. That’s the risk management. The day job is finding relationships between prices that have done one thing more often than not.
Clearly, some patterns are more random than others. For example, buying orange juice futures against selling Tesla may trade in the same way some of the time, but there is no reason why they should do so again in the future. Combining securities that have something in common, makes it much more likely that they stay within certain trading ranges.
Take Gold and Gold miners for instance. One is a commodity, the others are companies that dig it out of the ground. Both are subject to the same drivers of demand and as such their valuations are also invariably linked. You would not see one go up 100% whilst the other goes down, whereas in our former example there is no reason they could not. As such, all we have to do is wait for prices to get to levels we have identified to work in the past and take our chances.
Not surprisingly, the difference between creating a money printing machine versus burning through endless lines of worthless code is very small. But hey, to win Wimbledon, you have to play tennis, and the trick is to attack the markets like the Spartans in the hopelessly overrated 300 (2006). Use your shields to prevent big losses from position sizes that are too high relative to the money you have. Use your archers when you see a nice repeatable pattern and let loose. Finally, bring in the swords and spears to clean up. If you can make it work with £10,000, there is no reason not to borrow money and do it with a billion.