Trading perspective from a Hedge Fund Manager. Part5/5

MarketAce · #1 (**permalink**) 04-02-2008, 07:58 PM

PART: 5/5

So, what did I learn from all of this?

Our Organizing Principles in trading, investing, risk control:

I. First and foremost, identify causality.

An investor or traders’ ability to objectively and precisely identify causality in the stock market; to recognize sequential profit-patterns is in fact the most important skill-set that ultimately separates the profitable investors/trader from the herd.

Causality defined as the directional relationship between one event (cause) and another event, (effect) which is the consequence of the first. Just as we have all observed this cause and effect in motion, as we’ve watched billiard balls sequentially striking each other as; A causes B, causes C, and so on; there is a parallel causality in the markets, where one event, such as the NASDAQ trending in a certain direction, causes an event which sequentially causes another that can be exploited for exceptional gains.

How do we as investors and traders objectively and precisely sift thru the incomprehensible ocean of data, to construct a quantitative trading strategy, to make the incomprehensible, comprehensible?

II. Optimize:

Science explains how our brains are designed to filter, generalize and seek meaning from our sensory input. The result of this is often that our perceptions are distorted and or emotionally biased causing us to make decisions that are less than productive, less than profitable.

Computers on the other hand are a series of binary tools that are designed for absolute objectivity and preciseness. Computer technology can distill a lifetime of market experience into mere moments of processing time, enabling us to search for profit-patterns that have occurred over the last 30(+) years; across an unlimited number of global markets. Profit patterns that have occurred hundreds if not thousands of times during a time period (large sample size); and which correlates to a predefined “what is true,” marker, that allows for high probability entry and exit points.

“What can be done with fewer assumptions is done in vain with
more.” - Occam’s Razor

III. Simplify by finding what is true

Defining “what is true” in an ocean of incomprehensible data to analyze is an exercise in stubbornness and persistence, as you will surely identify what is not true, infinitum, before ever arriving at – what is true. Nevertheless, one significant example of what is true is, “the traded price;” that pivotal “aha” moment in an ocean of incomprehensible analysis.

What can be simpler to analyze than the traded price? What is truer, than the mirror reflection and decisive finale of when sellers meet buyers in the stock market?

“Things should be made as simple as possible, not simpler.”
- Albert Einstein

IV. Quantify, Systemize, before a penny is invested

Once you’ve identified what is true, then technology allows us to mathematically isolate the market conditions that correlate and lead up to highly profitable trades by quantifying the highest probability entry and exit signals. (The historical tendency of one thing to move in tandem with another.)

These Profit Patterns are identified when, and only when, you know the following:

· What to buy.

· When to buy.

· When to sell.

· Amount of profit made historically.

· Amount of losses incurred, historically.

· And, your market weightings and exposure.

This is vitally important to any investor because by being so selective in entry points, you accomplish three things. First, you filter out the confusing, complicated, or undefined risk. Second, you save your money for the trades that have the best chance of winning. And third, you never irrationally place trades when you don’t know if the odds are in your favor.

These predefined surgical-strikes are quantitative and systematic with no discretionary overrides eliminating the discretionary or emotional investments and trades.

“Whether you’re playing blackjack or trading, your profitability depends on your edge and how many times you get to apply that edge.” - Blain Hull

Avoid the Confusing, the Complicated, the Void of any real risk management by focusing exclusively on mastering four organizing principles; what you’ve identified as true - and your strategy to exploit the profits from it.

Kevin Teeple

DISCLAIMAIR: Neither Kevin Teeple nor KTM Funds are licensed stock brokers; registered investment advisors, or certified financial planners and therefore do not render any financial advice whatsoever. The sole purpose of this article is for informational and educational purposes only. The opinions, statements, and experience expressed in this article are meant to be educational only for your adult consideration, and not to be considered financial advice whatsoever. None of this is meant to substitute for your own counsel with certified financial professionals as we adamantly suggest you always seek counsel before undertaking any investment or trade.