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I wonder whether the premise of your question is faulty. If you ask enough people: "In your last 100 flips of a coin, did you get more than 60 heads?" some will

I wonder whether the premise of your question is faulty. If you ask enough people: "In your last 100 flips of a coin, did you get more than 60 heads?" some will truthfully say "Yes." Unfortunately, that does not mean there's anything special about their coin-flipping strategy, or that you will be able to generate a successful coin-flipping strategy. My guess is what you really want to know is "What is my expected gain if I try to employ an algorithmic trading strategy?" I have my suspicion of the answer to that question, but I don't believe your current question will shed any light on the answer.

aerovistae 8y ago
Mostly I believe this too, but I am familiar with some people who can consistently make money year after year. From talking to them it becomes clear that they understand things very, very deeply. See /u/Fletch71011 on reddit-- he's always happy to discuss things. He's made millions trading options, mostly algorithmically as I've understood it. The methods he uses are sufficiently complex that you need to be very well acquainted with the intricacies of derivatives to follow along, but basically he trades volatility instead of price movement. Regardless of whether the price of the asset goes up or down, he makes money. In his opinion, it's foolish to try to trade price direction, and you're basically flipping coins and likely to lose money. I tried understanding what he was doing and abandoned the attempt. I had to conclude I was not quite so clever as he.
- Retric 8y ago
  A 50% chance to lose money per year still allows for very long strings of success. Some strategy's trade ~80% chance of a small win for a ~20% chance of a large loss which means lucky streaks could last for decades.
  - dorgo 8y ago
    So, basically you are saying that it's all gambling and nobody has a better strategy / better information than everybody else. Some are just lucky and it is all because of the survival bias. I agree with you in that it is a possible explanation, but I disagree in that it is the only one possible.
    - PeterisP 8y ago
      I feel that what he's saying is that it's hard to tell if somebody actually has a working strategy or it's just gambling, they can be nearly indistinguishable, and (given the number of people) someone showing a streak of successes is really not much evidence that it's something beyond luck. They may have something, but since you can't determine if it's so and there is a lot of just gambling, then most likely it's that.
      - Retric 8y ago
        That's part, but the reverse is also true. Someone could lose money and still have better odds than normal. Something like skill adds 5% then luck adds or removes 30%.
    - noobly 8y ago
      I didn’t gather that from what he said at all, personally. I interpreted his comment at face value; it is possible to pull a profit over an arbitrary period of time even with 50/50 odds.
- inputcoffee 8y ago
  I am not sure I understand this. It takes just as much skill to guess if volatility will go up or go down as it does to guess if prices will. The best models we know of (say GARCH) will still pace the information in the option prices.
  - fullstackchris 8y ago
    A key part of how options premiums are priced is the expected, or implied volatility (IV) of the underlying (the stock/future/whatever). Therefore you can be an options seller (selling calls and puts) to get high premium, expecting that before the options expire, the IV of the underlying will decrease, making it more likely you can keep the credit received from selling those high-IV priced options. It can also be historically shown that the IV for any underlying is about 75%-80% of the time overestimated, in which the price of the underlying turns out to not be as volatile as what was suggested by the IV.
    - inputcoffee 8y ago
      But 20-25% of the time it is more than 3x as volatile. Taleb built his career on this.
- jjeaff 8y ago
  Markets have been going up for a while now. So anyone with half a brain is making money. But long term, there are essentially 0 investors making money on day or algorithmic trading.
  - hindsightRegret 8y ago
    That's extremely untrue. Especially if we are counting non-retail investors i.e. prop market maker trading
- ww520 8y ago
  Be careful with volatility. I don't know what he's trading on exactly. But a big part of volatility trading is selling insurance, i.e. selling insurance against the direction of S&P. You can make a lot of money collecting insurance premium, but on the event of a payout, like a sudden big drop in S&P, the loss can be very substantial. See XIV and SVXY in February of this year.
  - nostromo 8y ago
    Trading volatility might imply that he's buying options in both directions. Big moves either up or down would be profitable. The only unprofitable move here would be no substantial moves in either direction. (In which case you lose your entire bet, but no more.)
    - pranitbauva1997 8y ago
      The common strategies are delta heding, gamma hedging and gamma scalping for market neutral trades.
    - kgwgk 8y ago
      > Big moves either up or down would be profitable. The problem is that much more often than not the “only unprofitable move” is the one that happens. Options in general are too expensive and that’s why selling “insurance” is profitable most of the time. Maybe he can identify consistently mispriced vol, though.
      - thrwyaltdata 8y ago
        > Maybe he can identify consistently mispriced vol, though. This was the method I used, as described in another comment.
        kgwgk 8y ago
        Very interesting, thanks for the pointer.
    - 8y ago
- lordnacho 8y ago
  As a former vol trader, I think this is possible. I have friends who were former pit locals and are now sitting at home trading options. It is all moving to algos, though. With vol it's one of those specialized areas where it's probably quite hard to learn without having sat on an options desk. Even the way it's presented in the books does not give a good picture of what you're supposed to do.
- philipodonnell 8y ago
  Its not that complicated, he mentioned using off-the-shelf software, there just aren't a lot of retail traders who can open an office in the CBOE and hook directly to the exchange computers while running enough contract volume to essentially make markets.
ngould 8y ago
I think your argument is logically correct, but you are using numerical assumptions that are off by one or two orders of magnitude. Your typical successful algorithmic trader is probably flipping their metaphorical coin 1,000,000 times, and getting 520,000 heads. Each individual trade may only be slightly profitable, but there is often no statistical ambiguity about the effectiveness of the strategy. Individual trading strategies often become less effective over time, though. Whether this kind of success can be sustained at the level of a trading firm over many years is an entirely different question. Whether they can beat the market after fees is a third, also entirely different question.
Ntrails 8y ago
> "What is my expected gain if I try to employ an algorithmic trading strategy?" The market is negative sum, so any abstract strategy has an expected excess return which is negative. It should be everyones assumption without competing evidence Algorithmic strategies include such gems as "buy on mondays and sell on thursdays", and there is no inherent magic to them making them better than my "buying stocks with names I like".

aerovistae 8y ago

Mostly I believe this too, but I am familiar with some people who can consistently make money year after year. From talking to them it becomes clear that they understand things very, very deeply. See /u/Fletch71011 on reddit-- he's always happy to discuss things. He's made millions trading options, mostly algorithmically as I've understood it. The methods he uses are sufficiently complex that you need to be very well acquainted with the intricacies of derivatives to follow along, but basically he trades volatility instead of price movement. Regardless of whether the price of the asset goes up or down, he makes money. In his opinion, it's foolish to try to trade price direction, and you're basically flipping coins and likely to lose money. I tried understanding what he was doing and abandoned the attempt. I had to conclude I was not quite so clever as he.

Retric 8y ago
A 50% chance to lose money per year still allows for very long strings of success. Some strategy's trade ~80% chance of a small win for a ~20% chance of a large loss which means lucky streaks could last for decades.
- dorgo 8y ago
  So, basically you are saying that it's all gambling and nobody has a better strategy / better information than everybody else. Some are just lucky and it is all because of the survival bias. I agree with you in that it is a possible explanation, but I disagree in that it is the only one possible.
  - PeterisP 8y ago
    I feel that what he's saying is that it's hard to tell if somebody actually has a working strategy or it's just gambling, they can be nearly indistinguishable, and (given the number of people) someone showing a streak of successes is really not much evidence that it's something beyond luck. They may have something, but since you can't determine if it's so and there is a lot of just gambling, then most likely it's that.
    - Retric 8y ago
      That's part, but the reverse is also true. Someone could lose money and still have better odds than normal. Something like skill adds 5% then luck adds or removes 30%.
  - noobly 8y ago
    I didn’t gather that from what he said at all, personally. I interpreted his comment at face value; it is possible to pull a profit over an arbitrary period of time even with 50/50 odds.
inputcoffee 8y ago
I am not sure I understand this. It takes just as much skill to guess if volatility will go up or go down as it does to guess if prices will. The best models we know of (say GARCH) will still pace the information in the option prices.
- fullstackchris 8y ago
  A key part of how options premiums are priced is the expected, or implied volatility (IV) of the underlying (the stock/future/whatever). Therefore you can be an options seller (selling calls and puts) to get high premium, expecting that before the options expire, the IV of the underlying will decrease, making it more likely you can keep the credit received from selling those high-IV priced options. It can also be historically shown that the IV for any underlying is about 75%-80% of the time overestimated, in which the price of the underlying turns out to not be as volatile as what was suggested by the IV.
  - inputcoffee 8y ago
    But 20-25% of the time it is more than 3x as volatile. Taleb built his career on this.
jjeaff 8y ago
Markets have been going up for a while now. So anyone with half a brain is making money. But long term, there are essentially 0 investors making money on day or algorithmic trading.
- hindsightRegret 8y ago
  That's extremely untrue. Especially if we are counting non-retail investors i.e. prop market maker trading
ww520 8y ago
Be careful with volatility. I don't know what he's trading on exactly. But a big part of volatility trading is selling insurance, i.e. selling insurance against the direction of S&P. You can make a lot of money collecting insurance premium, but on the event of a payout, like a sudden big drop in S&P, the loss can be very substantial. See XIV and SVXY in February of this year.
- nostromo 8y ago
  Trading volatility might imply that he's buying options in both directions. Big moves either up or down would be profitable. The only unprofitable move here would be no substantial moves in either direction. (In which case you lose your entire bet, but no more.)
  - pranitbauva1997 8y ago
    The common strategies are delta heding, gamma hedging and gamma scalping for market neutral trades.
  - kgwgk 8y ago
    > Big moves either up or down would be profitable. The problem is that much more often than not the “only unprofitable move” is the one that happens. Options in general are too expensive and that’s why selling “insurance” is profitable most of the time. Maybe he can identify consistently mispriced vol, though.
    - thrwyaltdata 8y ago
      > Maybe he can identify consistently mispriced vol, though. This was the method I used, as described in another comment.
      - kgwgk 8y ago
        Very interesting, thanks for the pointer.
  - 8y ago
lordnacho 8y ago
As a former vol trader, I think this is possible. I have friends who were former pit locals and are now sitting at home trading options. It is all moving to algos, though. With vol it's one of those specialized areas where it's probably quite hard to learn without having sat on an options desk. Even the way it's presented in the books does not give a good picture of what you're supposed to do.
philipodonnell 8y ago
Its not that complicated, he mentioned using off-the-shelf software, there just aren't a lot of retail traders who can open an office in the CBOE and hook directly to the exchange computers while running enough contract volume to essentially make markets.

ngould 8y ago

I think your argument is logically correct, but you are using numerical assumptions that are off by one or two orders of magnitude. Your typical successful algorithmic trader is probably flipping their metaphorical coin 1,000,000 times, and getting 520,000 heads. Each individual trade may only be slightly profitable, but there is often no statistical ambiguity about the effectiveness of the strategy. Individual trading strategies often become less effective over time, though. Whether this kind of success can be sustained at the level of a trading firm over many years is an entirely different question. Whether they can beat the market after fees is a third, also entirely different question.

Ntrails 8y ago

> "What is my expected gain if I try to employ an algorithmic trading strategy?" The market is negative sum, so any abstract strategy has an expected excess return which is negative. It should be everyones assumption without competing evidence Algorithmic strategies include such gems as "buy on mondays and sell on thursdays", and there is no inherent magic to them making them better than my "buying stocks with names I like".