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The obligatory reference for a thread about trading strategies is the collected works of Nassim Nicholas Taleb. http://www.fooledbyrandomness.com/ http://www.f

The obligatory reference for a thread about trading strategies is the collected works of Nassim Nicholas Taleb. http://www.fooledbyrandomness.com/ http://www.fooledbyrandomness.com/ http://www.amazon.com/Nassim-Nicholas-Taleb/e/B000APVZ7W http://www.amazon.com/Nassim-Nicholas-Taleb/e/B000APVZ7W Structuring the trades to reduce your exposure to downside risk while increasing your exposure to upside from unanticipated random events is the hard strategy to implement, but it is the sole strategy for avoiding a gambler's ruin.

kruhft 14y ago
After reading Taleb's books and thinking about his strategy, it's akin to buying lottery tickets. Lots of little losses with a large win on infrequent random events. It sounds more regal when you say "structure the trades to reduce your exposure to downside risk while increasing your exposure to upside from unanticipated random events" though.
- shogunmike 14y ago
  This also has a similar profile to the classic momentum - "trend following" - strategies. Higher quantity of loss-making trades (albeit small losses), but the winners win big.
- tokenadult 14y ago
  Taleb responds to the analogy with lottery tickets by pointing out that lottery tickets have a strictly bounded upside (and a strict bound on the expectation of winning).
  - kruhft 14y ago
    True, risk adjustments can be made to modify those bounds in real markets, unlike with actual lottery tickets where you have no control over the upside and expectation of winning. But the idea is still very similar in it's basic strategy. Given Taleb's understanding and belief in randomness of the market, I see him as "creating his own lotteries" using rather sophisticated techniques that have paid off very well. The cost of entry is small and the potential rewards are high but he loses regularly and consistently and says he was grateful to be in a position where he could execute such a strategy without being looked down upon by his superiors (from Fooled By Randomness).
- jmount 14y ago
  "Buying lottery tickets" is a good analysis. The issue is that normal technical trading (the kind Taleb criticizes) is "selling insurance" in disguise (years of small profits and then a huge "unexpected" blow-up).
- Patient0 14y ago
  Another good phrase: "picking up pennies in front of a steamroller" - which is when you do the opposite strategy (lots of little gains, but with the risk of losing it all and more).
  - sseveran 14y ago
    This specifically refers to a call of strategies that are the equivalent of writing a put option. The short term cash flows from the premium are not commensurate with the tail risk. Both LTCM and CDS on subprime are examples of this type of strategy going up. Typically the options have a duration of years which raises the probability of a tail event significantly.
  - Roboprog 14y ago
    I love this term. One of my friends at work manages trading systems (for use by actual financial experts) and we were discussing this discredited strategy recently. It's killed one or two big companies, despite being a Nobel prize winning idea.
  - ttrreeww 14y ago
    You are not getting it :) The beauty is you keep the profit while the lost is socialized either via bailout or bankruptcy. That is why Wall Street is #1. Then you start another Wall Street firm. Ben will chip in the funding for basically free if you are well connected. (This is also why Wall Street pays out all profit to real people, instead of keeping it within the firm.)
  - monksy 14y ago
    I believe that this was coined in the book "Dark Pools."
- SkyMarshal 14y ago
  >it's akin to buying lottery tickets. More precisely, it's akin to buying mispriced lottery tickets with a high positive expected payoff that hasn't been priced in yet.
- endofeuro 14y ago
  I agree that "it's akin to buying lottery tickets".It is more of a protection than a strategy.
strongvigilance 14y ago
Structuring a trade to reduce downside risk while profiting from unanticipated random events is easy - just buy options. The problem is that everyone else knows this, so they're priced accordingly.
- endofeuro 14y ago
  Excellent point!
crntaylor 14y ago
The canonical way to benefit positively from unanticipated random events is to buy volatility. There are many ways to do this - long delta hedged put/call options, long straddles/strangles, long butterflies etc. But perhaps the easiest way is to buy VIX futures. Unfortunately, if you had a passive long investment in VIX futures since March 2004 (the earliest you could trade them) you would steadily have lost money - despite huge gains in the latter half of 2008 (and to a lesser extent in other periods). The market is well aware that insurance-like products are useful, and so they are priced accordingly. Buying volatility is expensive. The short vol "picking up pennies in front of a steamroller strategy" comes with the risk that you could be completely wiped out in a crisis. This happened to a lot of desks and funds practicing vol arb in 2008. But the flip side is that if you want to buy vol, you need to be able to absorb the punishing losses that can persist for years before you get to the big wins.
jplewicke 14y ago
On the other hand, he's unilaterally refused to disclose actual audited returns for the funds that he's been involved with. This is very convenient for marketing his books and views, but creates an inaccurate impression of how profitable his approach really is: http://falkenblog.blogspot.com/2010/08/nassims-selective-returns.html http://falkenblog.blogspot.com/2010/08/nassims-selective-ret... .

kruhft 14y ago

After reading Taleb's books and thinking about his strategy, it's akin to buying lottery tickets. Lots of little losses with a large win on infrequent random events. It sounds more regal when you say "structure the trades to reduce your exposure to downside risk while increasing your exposure to upside from unanticipated random events" though.

shogunmike 14y ago
This also has a similar profile to the classic momentum - "trend following" - strategies. Higher quantity of loss-making trades (albeit small losses), but the winners win big.
tokenadult 14y ago
Taleb responds to the analogy with lottery tickets by pointing out that lottery tickets have a strictly bounded upside (and a strict bound on the expectation of winning).
- kruhft 14y ago
  True, risk adjustments can be made to modify those bounds in real markets, unlike with actual lottery tickets where you have no control over the upside and expectation of winning. But the idea is still very similar in it's basic strategy. Given Taleb's understanding and belief in randomness of the market, I see him as "creating his own lotteries" using rather sophisticated techniques that have paid off very well. The cost of entry is small and the potential rewards are high but he loses regularly and consistently and says he was grateful to be in a position where he could execute such a strategy without being looked down upon by his superiors (from Fooled By Randomness).
jmount 14y ago
"Buying lottery tickets" is a good analysis. The issue is that normal technical trading (the kind Taleb criticizes) is "selling insurance" in disguise (years of small profits and then a huge "unexpected" blow-up).
Patient0 14y ago
Another good phrase: "picking up pennies in front of a steamroller" - which is when you do the opposite strategy (lots of little gains, but with the risk of losing it all and more).
- sseveran 14y ago
  This specifically refers to a call of strategies that are the equivalent of writing a put option. The short term cash flows from the premium are not commensurate with the tail risk. Both LTCM and CDS on subprime are examples of this type of strategy going up. Typically the options have a duration of years which raises the probability of a tail event significantly.
- Roboprog 14y ago
  I love this term. One of my friends at work manages trading systems (for use by actual financial experts) and we were discussing this discredited strategy recently. It's killed one or two big companies, despite being a Nobel prize winning idea.
- ttrreeww 14y ago
  You are not getting it :) The beauty is you keep the profit while the lost is socialized either via bailout or bankruptcy. That is why Wall Street is #1. Then you start another Wall Street firm. Ben will chip in the funding for basically free if you are well connected. (This is also why Wall Street pays out all profit to real people, instead of keeping it within the firm.)
- monksy 14y ago
  I believe that this was coined in the book "Dark Pools."
SkyMarshal 14y ago
>it's akin to buying lottery tickets. More precisely, it's akin to buying mispriced lottery tickets with a high positive expected payoff that hasn't been priced in yet.
endofeuro 14y ago
I agree that "it's akin to buying lottery tickets".It is more of a protection than a strategy.

strongvigilance 14y ago

Structuring a trade to reduce downside risk while profiting from unanticipated random events is easy - just buy options. The problem is that everyone else knows this, so they're priced accordingly.

endofeuro 14y ago
Excellent point!

crntaylor 14y ago

The canonical way to benefit positively from unanticipated random events is to buy volatility. There are many ways to do this - long delta hedged put/call options, long straddles/strangles, long butterflies etc. But perhaps the easiest way is to buy VIX futures. Unfortunately, if you had a passive long investment in VIX futures since March 2004 (the earliest you could trade them) you would steadily have lost money - despite huge gains in the latter half of 2008 (and to a lesser extent in other periods). The market is well aware that insurance-like products are useful, and so they are priced accordingly. Buying volatility is expensive. The short vol "picking up pennies in front of a steamroller strategy" comes with the risk that you could be completely wiped out in a crisis. This happened to a lot of desks and funds practicing vol arb in 2008. But the flip side is that if you want to buy vol, you need to be able to absorb the punishing losses that can persist for years before you get to the big wins.

jplewicke 14y ago

On the other hand, he's unilaterally refused to disclose actual audited returns for the funds that he's been involved with. This is very convenient for marketing his books and views, but creates an inaccurate impression of how profitable his approach really is: http://falkenblog.blogspot.com/2010/08/nassims-selective-returns.html http://falkenblog.blogspot.com/2010/08/nassims-selective-ret... .