6 ms·

One clarification - these mom & pop prop shops aren't necessarily competing against big baskets of MIT PhDs. If your book size is only $200K, the big players (

One clarification - these mom & pop prop shops aren't necessarily competing against big baskets of MIT PhDs. If your book size is only $200K, the big players (i.e. scores of MIT PhDs) won't even bother competing with you on the same strategies. Alpha from these strategies may very well be orthogonal to hedge fund alpha. That said, you're still playing a zero sum game with other mom & pop shops and the general large-scale movements of the market. You need to be confident that you have better information / forecasting ability than the others, or technology infrastructure that enables strategies no one else can execute. Source: I work in the industry.

deleted 11y ago
[deleted]
exelius 11y ago
Yeah, most people don't realize that finance is a zero-sum game. That leads to arms races which over time remove the lion's share of the profit (companies will spend money on a better solution to a problem until such time as a better solution costs more than the value of the opportunity). I expect this to replicate itself on the low-end as well.
- joosters 11y ago
  The 'zero-sum game' part is meaningless and adds no insight here. It doesn't matter whether you believe trading/gambling is zero-sum or not. For instance, imagine you have a poker-playing bot at a poker table, where the house takes no cut of the stakes. Zero-sum? Yes. But your bot has to be better than the other players, and win more than its running costs in order to profit. Now imagine the same situation but the house does take a cut. Zero-sum? Not any more. But your bot still has to be better than the other players and its running costs in order to profit. The house 'rake' just increases your operating costs. I think you are confusing the issue with large scale HFT (where companies pay more and more for slightly faster comms), which is a world away from the trading strategies the article is talking about.
  - SonicSoul 11y ago
    Think you missed the point. All he was saying (I believe) that no matter how good your models are it's still a race between the players to get the biggest share of the pot. The more players the less chance you have
    - joosters 11y ago
      That's true of many endeavors, and is unrelated to any 'zero-sum' argument.
  - jsprogrammer 11y ago
    Another way to look at your 'profit' is just as an increase in the operating costs of all the other players and the house. I think the zero-sum part implies that this type of trading is not actually productive. At this point, it is literally just modifying numbers represented as fluctuations in local electro-magnetic fields instead of something useful like carrying spices from one continent to another.
    - deleted 11y ago
      [deleted]
  - fluidcruft 11y ago
    That's the logic suckers use when buying bitcoin mining hardware.
- barrkel 11y ago
  I don't really see how finance is a zero-sum game. I mean, trading in paper without any insight into the capital allocation the paper is abstracting, and observed over a very short time horizon, it's more or less zero-sum. Many synthetic products just distribute risk differently. Etc. But finance more generally is helpful for efficiently allocating capital towards wealth generating industry - and by industry I mean it literally, people physically doing things, creating things, generating wealth by the sweat of their brow. When you own a share of a wealth-generating enterprise that grows in value, you're acquiring some fraction of the discounted future returns on that effort today. This isn't zero-sum; it's a slice of tomorrow's wealth, today. And it's backed by real action, actual things, products and services that you can use or exchange with other people for things you prefer more. These are things that didn't exist before the capital allocation, and may never have come about without it.
  - ericjang 11y ago
    Sorry, it was not my intention to suggest that trading is not productive, or that it's truly a zero-sum game. You probably know this already, but I'll provide some more context for the interested: In reality, two parties can walk away from a trade believing (in the moment) that they got the better deal. Otherwise, they wouldn't be trading in the first place. This results because people have different utility functions. A farmer might be willing to buy insurance that gives him negative expected value, because his utility function incorporates a larger risk term than the insurer. A fur trapper sells furs to a buyer because 1 pelt is not scarce to him. With derivative contracts this analogy gets a bit abstract, but the justifications hold. Liquidity providers add liquidity to the market precisely because they think that the rebates are "worth more" than the liquidity they are providing. A liquidity taker might still fill their trade because they have a different utility function. The net gain for society would be the net gain in total utility, if we were somehow able to convert them into normalized units. However, if the liquidity taker is a nearly identical firm with a nearly identical utility function, then that implies that the liquidity provider and taker disagree over who is on the losing side of the trade. One party has better information or luck than the other and the future eventually reveals which was the better choice. To put it another way, I believe it is a zero sum game if players with identical utility functions (i.e. two small prop shops with $200K book) trade with each other. Both probably have identical utility functions, and future events will reveal whether buying or selling was the correct choice in terms of utility. There are quite a number of such players swimming in the market, so there is a zero-sum game of "who knows more" that goes on underneath the actual net utility provided by liquid markets.
- pjlegato 11y ago
  > finance is a zero-sum game It's not, because new money is always entering the system from the real economy. For example, there is not a fixed amount of money invested in the stock market that the players just trade among themselves in a zero-sum game. Under normal economic conditions, people make money in some other non-finance industry and invest it in stocks, increasing the total pool.
- dasil003 11y ago
  That's why the winning move is not to bet your own money, but instead to convince some whales to pay you fees to invest their money. From that perspective good algos are really just a marketing cost.
  - matiu 11y ago
    This is true. As a fund owner, you know the magic formula: If your fund customers win, you win, if they loose, they loose. It's a good position to be in.
    - TuringNYC 11y ago
      Not quite. There is a cost to building the system. The surrounding code could be massive. Also throw in accounting, reporting, regulatory requirements, etc and you are down quite a bit of overhead costs. Without the profit sharing, even charging a 2% expense would not cover all these -- especially your time value given someone with such skills can easily be making 200k on simple salary.
murbard2 11y ago
Yes and no. If it can be automated, no amount is too small to collect. A hobbyist best shot is to do... things that don't scale. Source: I do too.
- tomp 11y ago
  I'm not sure about that. If a $2bn hedge fund finds 100 different "alpha strategies" for turning $20k into $200k, that's still just 1% to their bottom line. Probably not worth the time.
  - murbard2 11y ago
    That's $20,000,000 which is enough to warrant at least 10 people working on it.
    - kittenfluff 11y ago
      Remember that a hedge fund only sees 20% of the profit that it generates on behalf of its investors, and a large part of that goes into staffing and infrastructure costs, not to mention that quant traders like to be paid sizable bonuses (and therefore would not want to work on a trade with a small upside). I find it extremely unlikely (almost inconceivable, in fact) that a hedge fund would divert 10 researchers to work on a trade with $20m of potential upside.
      - sokoloff 11y ago
        "Standard" hedge fund compensation is 2-and-20 (2% of funds under management and 20% of gains), so a $2B fund would yield $40M in the 2% management fee. That's the "keep the lights on money".
      - murbard2 11y ago
        Ten people, not ten researchers, but that would be towards the upper limit. Point is, $20M is nothing to sneer at, even for a billion dollar hedge fund.

deleted 11y ago

[deleted]

exelius 11y ago

Yeah, most people don't realize that finance is a zero-sum game. That leads to arms races which over time remove the lion's share of the profit (companies will spend money on a better solution to a problem until such time as a better solution costs more than the value of the opportunity). I expect this to replicate itself on the low-end as well.

joosters 11y ago
The 'zero-sum game' part is meaningless and adds no insight here. It doesn't matter whether you believe trading/gambling is zero-sum or not. For instance, imagine you have a poker-playing bot at a poker table, where the house takes no cut of the stakes. Zero-sum? Yes. But your bot has to be better than the other players, and win more than its running costs in order to profit. Now imagine the same situation but the house does take a cut. Zero-sum? Not any more. But your bot still has to be better than the other players and its running costs in order to profit. The house 'rake' just increases your operating costs. I think you are confusing the issue with large scale HFT (where companies pay more and more for slightly faster comms), which is a world away from the trading strategies the article is talking about.
- SonicSoul 11y ago
  Think you missed the point. All he was saying (I believe) that no matter how good your models are it's still a race between the players to get the biggest share of the pot. The more players the less chance you have
  - joosters 11y ago
    That's true of many endeavors, and is unrelated to any 'zero-sum' argument.
- jsprogrammer 11y ago
  Another way to look at your 'profit' is just as an increase in the operating costs of all the other players and the house. I think the zero-sum part implies that this type of trading is not actually productive. At this point, it is literally just modifying numbers represented as fluctuations in local electro-magnetic fields instead of something useful like carrying spices from one continent to another.
  - deleted 11y ago
    [deleted]
- fluidcruft 11y ago
  That's the logic suckers use when buying bitcoin mining hardware.
barrkel 11y ago
I don't really see how finance is a zero-sum game. I mean, trading in paper without any insight into the capital allocation the paper is abstracting, and observed over a very short time horizon, it's more or less zero-sum. Many synthetic products just distribute risk differently. Etc. But finance more generally is helpful for efficiently allocating capital towards wealth generating industry - and by industry I mean it literally, people physically doing things, creating things, generating wealth by the sweat of their brow. When you own a share of a wealth-generating enterprise that grows in value, you're acquiring some fraction of the discounted future returns on that effort today. This isn't zero-sum; it's a slice of tomorrow's wealth, today. And it's backed by real action, actual things, products and services that you can use or exchange with other people for things you prefer more. These are things that didn't exist before the capital allocation, and may never have come about without it.
- ericjang 11y ago
  Sorry, it was not my intention to suggest that trading is not productive, or that it's truly a zero-sum game. You probably know this already, but I'll provide some more context for the interested: In reality, two parties can walk away from a trade believing (in the moment) that they got the better deal. Otherwise, they wouldn't be trading in the first place. This results because people have different utility functions. A farmer might be willing to buy insurance that gives him negative expected value, because his utility function incorporates a larger risk term than the insurer. A fur trapper sells furs to a buyer because 1 pelt is not scarce to him. With derivative contracts this analogy gets a bit abstract, but the justifications hold. Liquidity providers add liquidity to the market precisely because they think that the rebates are "worth more" than the liquidity they are providing. A liquidity taker might still fill their trade because they have a different utility function. The net gain for society would be the net gain in total utility, if we were somehow able to convert them into normalized units. However, if the liquidity taker is a nearly identical firm with a nearly identical utility function, then that implies that the liquidity provider and taker disagree over who is on the losing side of the trade. One party has better information or luck than the other and the future eventually reveals which was the better choice. To put it another way, I believe it is a zero sum game if players with identical utility functions (i.e. two small prop shops with $200K book) trade with each other. Both probably have identical utility functions, and future events will reveal whether buying or selling was the correct choice in terms of utility. There are quite a number of such players swimming in the market, so there is a zero-sum game of "who knows more" that goes on underneath the actual net utility provided by liquid markets.
pjlegato 11y ago
> finance is a zero-sum game It's not, because new money is always entering the system from the real economy. For example, there is not a fixed amount of money invested in the stock market that the players just trade among themselves in a zero-sum game. Under normal economic conditions, people make money in some other non-finance industry and invest it in stocks, increasing the total pool.
dasil003 11y ago
That's why the winning move is not to bet your own money, but instead to convince some whales to pay you fees to invest their money. From that perspective good algos are really just a marketing cost.
- matiu 11y ago
  This is true. As a fund owner, you know the magic formula: If your fund customers win, you win, if they loose, they loose. It's a good position to be in.
  - TuringNYC 11y ago
    Not quite. There is a cost to building the system. The surrounding code could be massive. Also throw in accounting, reporting, regulatory requirements, etc and you are down quite a bit of overhead costs. Without the profit sharing, even charging a 2% expense would not cover all these -- especially your time value given someone with such skills can easily be making 200k on simple salary.

murbard2 11y ago

Yes and no. If it can be automated, no amount is too small to collect. A hobbyist best shot is to do... things that don't scale. Source: I do too.

tomp 11y ago
I'm not sure about that. If a $2bn hedge fund finds 100 different "alpha strategies" for turning $20k into $200k, that's still just 1% to their bottom line. Probably not worth the time.
- murbard2 11y ago
  That's $20,000,000 which is enough to warrant at least 10 people working on it.
  - kittenfluff 11y ago
    Remember that a hedge fund only sees 20% of the profit that it generates on behalf of its investors, and a large part of that goes into staffing and infrastructure costs, not to mention that quant traders like to be paid sizable bonuses (and therefore would not want to work on a trade with a small upside). I find it extremely unlikely (almost inconceivable, in fact) that a hedge fund would divert 10 researchers to work on a trade with $20m of potential upside.
    - sokoloff 11y ago
      "Standard" hedge fund compensation is 2-and-20 (2% of funds under management and 20% of gains), so a $2B fund would yield $40M in the 2% management fee. That's the "keep the lights on money".
    - murbard2 11y ago
      Ten people, not ten researchers, but that would be towards the upper limit. Point is, $20M is nothing to sneer at, even for a billion dollar hedge fund.