Scalability and Replicability of Trading Strategy
We've all heard stories of trading "prodigies" (Jan Smarek, Tim Sykes, etc.) that created insane returns for themselves early on (turned 10k into 1M)--but we almost never see these guys killing it with their own funds, or even running a desk for a bigger institution.
So a couple questions:
If making money on riding momo or shorting pennies is so easy, why can't your average prop guy replicate the gains some of these guys allegedly made out of their basements with pennies? On a bigger scale, why can't even the most quant-y of HF's post bigger than a 30-40% return in their best years with big, leveraged bets, with the benefit of HFT, even as these guys seem to go triple their money in a couple of years or whatever? They (esp. Sykes) don't strike me as anything special or sophisticated strategy-wise, so shouldn't just about anyone be able to "ride the wave" day trading and make insane returns like they do?
Fooled by randomness
Scalability, leverage and their risk profile.
But we DO know that highly levered, risky bets are made by the top HF's. Besides, I doubt any of these momentum-riding young kids either (a) could match the intraday trend-riding that advanced algorithms at top quant places could, or (b) were taking out massive amounts of debt to fund their day trading. So why can't you or I, or the top HF's, match their (supposed) yearly returns?
Define highly levered?
Take the E-mini which is arguably the most liquid product in the world, a rough industry standard for leverage would be to pick up one contract per 10-15k in equity (initial margin is roughly 5k, intraday 500). Currently 1 contract is worth just shy of 100k. Some of these day traders go as low as 5k in equity per contract for intraday trading, some even lower, yikes! So that is anywhere from 10-20:1 leverage.
Now, take a $50M fund using similar leverage, you are talking about 5,000-10,000 E-mini contracts. $100M fund, 10,000-20,000 contracts, $200M fund 20,000-40,000 contracts. I believe position limits are 100k E-mini contract equivalents.
If we pierce the Globex highs on selling, and a day trader jumps on short hitting the best bid you can get on the action with 100 contracts without trouble. But you can't just slam in with 5k contracts, let alone 40k contracts. Just not big enough or fast enough, now HFTs control thousands of contracts and execute in milliseconds so I get your point. But it would also cut both ways in regards to your stop loss orders.
Bottom line, those guys couldn't do the same returns on hedge fund size, especially without huge leverage, and at that point its just not scalable. If you unwind their leverage these guys may only actually be pulling 15-18% returns per year. If they aren't on futures, they may be 'pyramiding' which has an insane risk profile, if it works you get amazing returns. If it turns south, you are done.
Firstly, how do you know about these "insane returns"?
Secondly, yes, certain strategies are inherently not scalable to an institutional context. That's due to a whole variety of constraints on institutional leverage, as well the natural market liquidity constraints.
So a HF wouldn't be able to trade 100x the size of some random penny stock. Specifically, they wouldn't be able to move such size in the mkt. Secondly, if they were to try and short it, they wouldn't be able to borrow. Finally, given the costs of putting a position on (lots of people need to work on the various aspects of the trade), it just makes a strategy like that non-viable.
What do you mean by "wouldn't be able to move such size in the market"? Your other points make sense, and when I think about it from a leverage/risk-tolerance perspective, it's becoming clearer to me why "little" strategies aren't scalable to a HF (or even any prop desk).
To replicability: it's pretty clear that the Sykes of the world (and his "students"), intolerable though they may be, do make decent coin with very high initial returns. Do I totally believe that the numbers are what his plastic informerci-website say they are? Not at all. But he clearly has made good money. What's preventing you or me or any retail investor from turning $20K into $500K with momentum swing trading or penny stock strategies, risk be damned? Your average small-money stay-at-home day trader couldn't care less about scalability, and the concepts behind such reckless strategies shouldn't be that hard to nail down.
By "not being able to move size in the mkt", I mean that there's not enough liquidity in the mkt to allow one to put on larger positions.
As to some people making high returns, I don't really ascribe a lot of weight to these things. Firstly, we don't know whether these returns are real. Secondly, you don't know the methods used to generate these returns. With penny stocks especially, it appears that there's a lot of room for all sorts of shenanigans. Finally, you have to take the potential presence of survivorship bias into account. So, all in all, yes, there might be something there, but there's a combination of factors that, probability, cost and risk adjusted, makes these "strategies" not worthwhile.
i would be highly skeptical of any returns u see splashed in internet ads...i would suggest that most of his money comes from selling, not trading. Nothing wrong with that, just saying...
You will know things have gone wrong if u see me here in a few years selling "the Bondarb, No-Fail, Gauranteed, Sit-At-Home and Get Rich Trading System"
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