Rusty, a good friend from my college days (and a bit beyond), has been asking some interesting questions in one of my posts below on trading. Here’s his latest comment:
Hi Jay –
The Vanguard funds have worked out well for me. Besides capturing the market return, they’ve had the other benefits of requiring absolutely none of my time, and I sleep a little better at night.
Regarding efficient markets, I think it depends on what you’re investing in. Are you looking at very small companies with a relatively small number of transactions? I might be convinced. If you’re trading GE and Microsoft, or more generally stocks in the S&P 500, I’m less inclined to agree. With millions of shares traded per day, that’s an efficient market. The people trading GE (as a whole) know a lot more about GE than I do.
If you actually generate the returns you’re expecting trading stocks in the S&P 500, that is an amazing feat.
Two other comments, if you will. I think it’s one thing to be able to say, “We’re in a tech bubble” or “These tulips cost way too much.” But it’s really hard to invest against a bubble. Greenspan was warning of irrational exuberance a couple of years before the bubble popped. Shorting too early would have cost quite a lot, not to mention passing up the rest of the ride up.
Besides that, I can’t think of how you’d try to exploit popularity in the 1-5 day time frame. That’s mindblowing to me, and I’d love to hear more about that. Are you researching these companies, or is your selection based on some kind of technical analysis or trend detection? I’m intensely curious.
Finally, the big question for me. Why aren’t others discovering this, and competing away the returns? Why isn’t some mutual fund company advertising a fund that returned 70% on average over the past 6 years?
Greatly enjoying this,
I started writing a response in the comments, but thought I’d put in a post so others can join in if so inclined.
Okay, one point of clarification. When I discuss my system, I am not referring to Tarzan. Tarzan was/is an experiment, but I do not trade it currently, though there are a couple very good ideas cooked into it (I think). If you read the original post on Tarzan, you will see a reference to my early attempts at Collective2 which performed great but were ill received. That system was the alpha of my current trading system, the one I talk about when referring to my own trading.
A point of agreement. I think it is of the utmost importance to sleep well at night and have that as one of the bedrock requirements of my system design. For me, that entails being fully in cash every night, even though that tends to degrade the performance a bit in the long run. I’m just very prone to frustration at being burned by the overnight news cycle, even though it helps overall. So I simply don’t mess with it, and have actually tried to make it an advantage.
Another clarification. It seems that some of my comments are being taken to refer to macroeconomic conditions. Another of my goals, however, is to build a system that is as uncorrelated to the broader market as possible. So, for instance, in the past few days, when the market was moving up, I was almost entirely short, and did okay… which is not to say that happens every time.
Which brings me back to that post I need to write on my basic approach. Suffice to say I find it MUCH easier to gain an exploitable edge in the 1 day time frame than any other time frame I’ve evaluated. And no, I don’t actually know the names of the companies I’m buying or shorting day by day.
The last question is pertinent (though once again, those results are against a system I don’t actually trade)… I’ll probably need to address it at some point as well. But I think the answer is roughly this: 1) fast-trading systems degrade with the amount of capital invested, so my technique would probably be terrible for a mutual fund; and 2) it took me a couple thousand hours to get here, so though others may be able to get there much more quickly, it is probably a reasonable barrier to entry for the average personal investor/trader.