Kelly Criterion Part 2: Avoid Lotteries and Reverse Lotteries

Somewhere along the way someone probably told you not to play the lottery – that it’s a dumb idea.  And this is true.  The typical state lottery pays out about 50% of the money it takes in as prizes.  The other 50% is retained by the state to build parks or educate kids or some such nonsense 😉  It’s no exaggeration to say that lotteries are a tax on people that are bad at math – a sort of tax I heartily approve of.

There’s an interesting intersection between trading and lotteries you may not have thought about.  One aspect of a lottery is the deficient payout – in the typical case $0.50 is paid out for every $1 payed in.  In other words playing the lottery has a profit factor of 0.5.  Another aspect is the extreme imbalance of payouts – infrequent huge wins paired with frequent small losses.  This later aspect is what I want to investigate today – especially the idea of lotteries where the payoff is greater than pay-in.  In other words, “good” lotteries.

Continue reading

Choosing The Right Broker

Most of my readers, like me,  approach trading from a retail perspective.  A “retail trader” is a person that executes trades through a broker.  The alternative is an “institutional trader” – someone who is part of a company that has their own exchange memberships and clearing ability and thus can function as their own broker.  So if you’re going to operate as a conventional retail trader, you need a broker.  And it turns out that choosing a broker is very complicated.  What makes it worse is that you have to choose a broker before you can gain any real trading experience.  So traders are at the most ignorant point in their careers when they have to make this important decision.  I’m going to walk you through some aspect of the process, and hopefully at the end you’ll know enough to proceed. Continue reading

Monkey Math Part 1 – Deciding If Trading Systems Work

I realized this morning that it’s been almost an entire year since I wrote about the trading system development process pictured at right.  That’s almost criminal, because in all that time I’ve never really gotten around to explaining the heart of the system development process: testing systems to make sure they work, and refining them when they don’t.  This corresponds to the formal specification, backwards/forwards testing & re-work boxes in the diagram.

These steps are in some sense the most dangerous parts of system development process because it’s easy to fool yourself into thinking a system works when it doesn’t. Continue reading

Get Over It – They Already “Stole” Your Trading Strategy

New traders think about strategies in a very peculiar way.  I started thinking about this today because I saw traffic from the following search term:

“is there anything i can do to protect my trading strategy”

Now, you may be wondering what this person wants to protect their strategy from.  Marauding bandits?  But maybe like me you’re not wondering, because you have (or had) the same anxiety.  The possibility that you’ll go to great lengths to discover a wonderful trading strategy, only to have someone else learn about it from you and make all the money.  This third party might learn your strategy because you told them, or more nefariously they might learn it without you knowing.  For example your broker might watch your trades, marvel at your amazing profitability, deduce the underlying strategy, and then duplicate (or even front run) it.

Please, please, please stop worrying about all this. Continue reading

Futures Scalping Part 1: Introduction

Now that I’m more or less finished with the speculative alternatives to investment series it’s time to start looking at a new trading method.  I’ve chosen scalping in the futures markets because it’s about as different as you can get from what I’ve covered thus far.  Different instrument, different time scale, different philosophy.  I believe scalping is one of the most advantageous methods for small traders because it can provide large returns while requiring limited capital and having fairly well bounded risk.  Unfortunately scalping is also one of the most difficult methods to learn – it took me years to learn to scalp successfully and almost all of my initial trading losses were from failed attempts at scalping.  So I’m going to advise you to be very careful here.  But it is worth your time to learn this. Continue reading

We Have Met The Enemy And He Is… Dumb?

If reading this blog hasn’t convinced you that I’ve got a huge ego, well, let me make another attempt.

Once of the best things that happened to me back when I was just learning to play poker was discovering that many of my opponents were dumb.  I don’t mean tourists uneducated about poker or gambling in general.  I mean dumb.  I’m talking about the sorts of people who regularly lost that ongoing battle of wits with their VCR (yes, those things) to record at the right time on the right channel.  The sort of people who can’t make correct change without counting on fingers and/or toes.  Dumb.  I’d be sitting there at the table, and suddenly out of the blue one of my opponents would say or do something so profoundly stupid that I knew right then and there I was facing a blithering idiot.  I remember one lady very earnestly explaining how she used astrology to figure out what her lucky hands for the day were.

Now, why was this such a big deal?  Because I was new to the game and needed courage.  When you’re a newbie it’s easy to believe that everyone else is better at the game, and at least within those limited confines smarter than you.  So it’s refreshing when someone hangs out their “stupid” sign.  Until that lady opened her mouth, I honestly believed she might be a better player than I was and that I might be in over my head.  Turns out I need not have worried.

Trading is the same way. Continue reading

It’s all about the computers, and if you’re clueless here’s a chance to fix that…

I’m not sure how I missed the online education revolution, but apparently it’s happening, for free, while I’m busy drinking beer.  I hate it when that happens…

I think it’s pretty obvious that finance, going forward, is going to be about quantitative skills and computers.  Really that’s been partially true for 15 years at least, and it’s certainly not getting any less true.  Consider: Continue reading

Can We All Stop With The Buffett Bullshit?

The internet is in love with Warren Buffett, and for good reason.  He’s been a very successful businessman, and his firms (first Buffett Partners (BPL), then Berkshire Hathaway(BRK)) have handily beaten the market for over 50 years.  That’s a solid resume, and there’s plenty to learn about how he did it.

What’s unfortunate about this internet man crush is that the object of affection is a fake person.  The Buffett the internet loves bears only a passing resemblance to the real story.  This is too bad, because the real story is far more interesting than the myth.  This is especially true if you’re a speculator as opposed to an investor, because the Buffett fortune is actually built on a bedrock of speculation.

Here are a few aspects of the real story that usually get left out: Continue reading

A Speculative Alternative To Investing Part 5: Dividend Stocks, Program Trading, and Picking our Spreads

(part 1, part 2, part 3, part 4)

Last time we determined that beta neutral spreads are the perfect instrument to use in our speculative portfolio.  Now we need to decide which spreads.  Sadly, that’s as open ended a question as “Which stock should I buy?”.  What I’m going to share with you here is a technique I’ve developed that seems to give good returns on relatively low risk. Continue reading