Genius level stock trader

Foreword

I’ve been receiving a bunch of correspondences from various folks boasting about their (or their acquaintances’) trading prowess. In almost every case, these are folks who haven’t really been trading that long, or at least, their success hasn’t really materialized until the last few trades.

That concerns me, because the first thing you learn in quantitative finance (i.e.: quant trading), is that you need to be able to separate skill from luck. Lying to yourself rarely ends well.

FWIW, I believe that it is possible for individuals to do well (risk adjusted) in the market, and consistently.  But it’s hard enough that for the most part, most people shouldn’t try.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

It’s good to be great, it’s better to be lucky

Most people don’t seem to realize that it is extremely easy to be lucky.

Quite a few of my friends know this(1) — my best trade was a ~40x return in about 3 days.  It was my first ever options trade, I had no clue what I was doing, but I turned ~$200 into ~$8,000 before the end of the week.

That doesn’t mean I’m smart, successful or even had any clue what I was doing.  It just meant I was lucky.

But nobody (other than my wife) knows this next part: My next few trades were also winners.  None got close to the 40x in 3 days metric, but most of them did pretty well (30-50% gains in a few hours/days). In all the trades, I correctly called for gold/silver to go up, and I was just trading in and out of short term calls on GLD and SLV — the 40x was a 7DTE call on SLV.

All these mean nothing.  This entire episode happened during April of 2011 — I thought gold/silver would go up, because I read an article that said gold/silver would go up.  And like an idiot, I believed it without question.  That’s all.

I didn’t know it at the time, but the author of the article had been writing about gold/silver going up for years.  They would go on to continue writing about gold/silver going up pretty much all the way up to today. Other than for that ~2 weeks when I started reading their work, they were basically always wrong.

Yet I made a ton of money (percentage-wise) in a very short period of time.  Ergo, not genius, just pure, dumb luck.

Winning consistently vs winning big

Another thing that people don’t think very much about is consistency vs absolute magnitude.

The absolute return you make from a few trades means almost nothing in terms of how good you are. For reference, see the 40x gains I had above.

Instead, it is the ability to consistently do well that is a hallmark of those who really and truly know what they are doing.

Given that market/business cycles take around 8-12 years, at a minimum, if you want to prove that you are “good”, you’ll need to at least be outperforming the market by around a decade or more. This shows that you can outperform in any stage of a cycle, and not just be good at buying levered products (SSO, UPRO, etc.) during a bull market.

Finally, mathematically, ~10 years is also a decent measure — assuming any active trader has a 50/50 chance of outperforming the market, then being able to outperform over a 10 years period means they are 1 in a thousand (2), which gives some confidence and credibility towards their claim of greatness.

Diamond in the rough

So, if you come to me showing the latest 30% gain you make in a single trade, know that:

1. I am happy for you. Really. The curt tone is probably just because I’m jealous.
2. I can’t tell if you are good or just lucky, and given that most people fall in the latter bucket, I’m just gonna stick with the default option.

This doesn’t necessarily mean you’re not good. It just means you haven’t earned it yet.

Footnotes

1. I typically use the story above as a way to warn others when they seem to be overly sure of their prowess.
2. More accurately, 1 in 1,024.