Trade a Strategy Not a Stock

Boris Schlossberg

I’ve said this over and over that if you are not reading Matt Levine’s free daily newsletter you are really not an informed market actor. The man writes so well about so many complex financial issues that his daily missive is often the highlight of my day.

This week in a riff on Bill Gross and the meaning of Alpha, Matt truly outdid himself and I am going to shamelessly quote a very large piece of his note because I think it carries so many important lessons to those of us who switched to algorithmic trading.

Levine writes, “Did Bill Gross generate alpha? Well, and what if he didn’t? What is “alpha”? Often you read that alpha is an investment manager’s return above a benchmark—if the S&P 500 returns 10 percent and a stock manager returns 12 percent, he has added 2 percentage points of alpha—but academics and allocators tend to take a stricter view. If he just bought riskier stocks to get that extra return, that’s not really alpha; he’s not demonstrating any extra skill or “really” outperforming the market.
One stricter approach goes something like this:

1. Look at the manager’s returns over time, and get a rough sense of what he actually did to get those returns.

2. Construct some smallish number of mechanical investing strategies that are sort of similar to what he actually did. These strategies could be as simple as “buy all the stocks in the S&P 500 index” or as complicated as “use an optimal trend-following strategy of buying lookback straddles”; they could involve a passive buy-and-hold approach or constant trading; but the point is that they can be totally specified in advance and a fairly simple robot could carry them out.

3. See how much of the manager’s actual performance could be explained by those mechanical strategies: That is, if you had just replaced the manager with a handful of simple robots programmed to carry out straightforward strategies, how close would the robots have come to his actual performance?

4. If the robots’ performance looks nothing like the manager’s, then you have just chosen the wrong strategies: If there is little correlation between the mechanical strategies and the manager’s results, then that means that the manager is doing something very different from what the robots are doing, and you have learned nothing.

5. If the robots’ performance looks a lot like the manager’s—if the correlation is high—but the manager outperformed the robots, then he is adding alpha: He has demonstrated skill that your simple robots can’t match. His strategy is not as simple as “buy all the stocks” or “buy all the stocks with high book values” or “buy all the stocks that went up yesterday” or anything else that you can fully describe in a sentence; his strategy instead involves buying stocks that are good and not stocks that are bad, based on his own mystical intuition or hard work or whatever.

6. If the robots’ performance looks a lot like the manager’s, but the robots outperformed him, then he has negative alpha. Perhaps this just means that he’s terrible and keeps losing money, but if you’ve come this far that is unlikely to be the explanation. Instead, what is more likely is that he has mostly made money, and has attracted investors and made a name for himself, but the way that he has made money is not primarily through mystical intuition about what stocks to buy. His intuition about what stocks to buy is mostly bad—worse than the robots’ mechanical selection—but his choice of strategies worked out fine. “

Now the money line in this whole long explanation is the very last sentence. “His intuition about what stocks to buy is mostly bad -—but his choice of strategies worked out fine.” Substitute the word currencies for the word stocks and the concept can be applied to any one of us. THIS is the key insight that makes me so excited about algo trading. The beauty of algo trading is that you do not have to make great trades. All you need to do is just make good enough trades – AS LONG AS YOUR STRATEGY IS THE RIGHT ONE. This now turns you from a trade idea generator to a manager of strategies, which you can then compile into portfolios to make pips something like this.


Ages ago, when K and I worked for FXCM and ETFs were just becoming mainstream I got excited about the whole idea of “Trade a strategy not a stock.” As usual, I was way ahead of myself, but now, more than a decade and a half later the technology is there and the possibilities for us retail traders are endless.

Why Day Trading is The Safest Trading Strategy There Is

Boris Schlossberg

Everywhere I look, everyone hates day trading. The web is replete with financial writers warning you about the “dangers” of day trading your account and the fact that 95% of retail traders who try it lose money. That may all be true. But I am here to tell you that day trading is not only great, but probably the safest way to invest your money.

Of course you will have to forget everything that you’ve been taught about the subject.

First let’s look at investors. Charlie Munger who is Warren Buffett’s investing partner is famous for saying that if you can’t stand the idea of losing 50% of your capital you shouldn’t be in stocks.

I don’t know about you, but I can’t stand the idea of losing more than 20% of my money, much less 50% and I bet that’s true for 99% of you which is why 99% of retail investors never, ever get returns close to the market averages. Unlike Munger and Buffett you will not hold your ground when the stock are plunging. Most likely you will sell the bottom and buy the top because long term investing is actually a stomach churning affair and few people have the fortitude to stick with it.

Now let’s look at my day trading account. Since June of this year I made 539 trades for an 11% on my account and drawdown of -3% of my equity. I also paid out about 4.5% of my equity in commissions (the 11% is NET of all costs) making Drew Niv very happy. In our BK master account the numbers are a little different but the tone is the same. Since the start of the year we made 5.0% with drawdown of 1.5% and paid out about 2% in commissions making 234 trades.

So I trade a lot. I pay a ton of commission and yet I am able to produce steady returns losing less than 3% of equity MAX so far this year. (And this is true not just of me, but all the top traders in my room who follow our trading protocol).

How is all this possible? I should be bankrupt by now or least should have turned over all my profits to my broker with all that mindless trading I am doing.

Its not only possible, but highly probable if you stop looking at day trading as some get rich scheme and start treating it like a long term investment strategy that delivers absolute returns in any kind of market environment. To do that you have stop thinking like a lottery junkie and start thinking like an insurance company.

What do insurance companies do? They chop up risk into tiny increments. They could care less about making profits and they spend all their time managing risks (mainly by figuring out how they can deny paying you your claims). That’s essentially what we do in chat room. We trade tiny. We could care less about making profits ( like insurance premiums they come to us naturally if we are properly positioned) and we spend all our time trying to eliminate risks so that we can avoid stops as much as possible.

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The problem with trading is most people want a very easy no effort process and very exciting results. The pitch of every signal service out there is “Set it and Forget It and watch the profits roll in”. The reality is the exact opposite. Day trading is a very intense highly focused process with very boring results. You make 10 to 20 basis points a day and you are doing a good job. Once you begin to understand that you can become a successful day trader and make money in any market environment.

In Trading the only “strategy” is STRATEGY

Boris Schlossberg

If you’ve never been on I highly recommend it. Instead of mindless trolling of FB taking idiotic quizzes about which celebrity you resemble most, spend a few minutes on quora where the level of discussion is considerably more elevated and answers to all of life’s questions are crowdsourced with a surprising degree of intelligence and wisdom.

The other day someone posted the following question – what is the difference between strategy and tactics? The person who answered it used World War II as an illustration. The Germans he noted, we far better soldiers that Russians. In almost every engagement the German army was able to inflict far more damage per soldier than the Russians. Put simply 10 German soldiers could easily defeat 50 Russian ones in almost any confrontation because of their superior tactics. My grandfather, who was with the Russian corps of Army engineers was painfully aware of German might and I heard countless horror stories about the Russian front when I was a child.

Yet the Germans lost the war. Not just lost it, but were annihilated by 1945.Why? Because Russia had millions more people and vast swaths of land and was fully willing to sacrifice both resources in order to buy time. Because Russia moved all of its war materiel production behind the Ural mountains outside of the range of German bombers allowing it to rebuild production. But of course the single biggest reason was because Russia joined the Allies and thus aligned itself with an economic block that was responsible for 25% of global output and therefore was able to stand and watch as all those massive resources were targeted against its enemy.

Germany had much better tactics, but Russia had a better strategy. (Mind you I am not arguing that all of this was well pre-thought by Stalin. Russia essentially stumbled into its strategy through mishap and circumstance, while Germany made a massive strategic mistake of declaring war on America) But the point that is important here is that strategy always beats tactics. You can have poor tactics but proper strategy and still win. But if you have excellent tactics but the wrong strategy you will always lose.

I thought that was an interesting point for us traders to consider. In day trading the only strategy that matters is to trade very small size and do massive volume of trades so that the law of large numbers is on your side. It really doesn’t matter if you use pure price action as I do, trendlines as some of the traders in my room do or even some combination of indicators. Those are all tactics. They are important to be be sure. And the better you get at tactics the more efficient and profitable you will become.

But in the end tactics will do nothing for your bottom line if you don’t use the right strategy. That is why the single biggest sin in day trading is to use large size. No matter how good it feels ( I am sure Germans were feeling just peachy in 1941) it will always blow you up in the end.

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So in trading as in life the only ”strategy” that matters is strategy. Do that right and you can make many tactical mistakes and still win.

It’s Not The Strategy. It’s You.

Boris Schlossberg

The other day I did a very simple Excel sort on a whim. I downloaded the last ten years of monthly closing prices for the euro and made a simple rule – buy when there were three months of consecutive declines and sell when there were three months of consecutive rises. Then I liquidated the month following.

Now given that the euro is essentially a bounded product (unlike equities, commodities cannot rise upwards forever) you would think that this simple mean reversion algo would work. Surprisingly, the results were horrid. The strategy lost more than 1500 pips over the past 10 years as the highs kept getting higher and lows lower.

The only time this strategy worked well was in the the last three years when we have had record low volatility and selling highs and buying lows has been the recipe for riches. As counterintuitive as it is to imagine, momentum is the superior way to trade in FX over the long run even though in the present market environment it can be a massive challenge.

Which brings me to my real point today. It’s not the strategy. It’s you. There are only two ways to trade markets – momentum or mean reversion, and frankly it really doesn’t matter which strategy you choose. The best momentum algo will get chopped in range and the best mean reversion strategy will wipe out your account in a strong trend.

The key is to success is adjustment and adaptation. There is no strategy that will work consistently all the time. Some of the smartest traders in the world often make the mistake of arrogance in assuming that they have figured out the markets when in reality they were simply using a strategy that was in sync with the market at the time. Witness John Paulson, witness Long Term Capital Management, witness Bill Miller and countless other investment “geniuses” who blew up the moment the market changed.

At BK perhaps our best quality is that we don’t stay arrogant for long. Last quarter, the record low vol decimated our strategy with the worst return of our career. Instead of repeating the same mistakes, we made adjustments – in all honesty we should have made changes much sooner – but we are human and hubris is the permanent enemy of the trader.

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In any event, the interesting thing is that we did not change our style in order to follow the latest vagaries of the market. We remained momentum traders but we made several key adjustments to adapt to the current low volatility environment. The net result was 1300 plus pip swing in performance our way, proving once again that in trading it is not the strategy, it’s you that is the key to success.