That leads them to pass over high-probability sources of returns in favor of more marginal ideas.
Or they overcomplicate the trading of a good edge.
2/n
In my 20 years of trading I have noticed this cycle play out again and again with traders that "make it":
1. Overconfidently reach for returns
2. Get humbled by the market
3. Simplify + concentrate on clear, high probability edges.
1/n
That leads them to pass over high-probability sources of returns in favor of more marginal ideas.
Or they overcomplicate the trading of a good edge.
2/n
It is 2015. You look at a simple strategy.
You hold an equal dollar exposure to:
- Cap Weighted US Stocks (VTI)
- 20+ Yr US Treasury Bonds (TLT)
- Gold (GLD)
And rebalance each month.
(I've extended back a bit with mutual fund prices.)
3/n
You'd have 4x your money from 1997 to 2015.
It makes sense. It's harnessing two big sources of risk premia (equity + duration).
It diversifies across 3 macro assets that tend to outperform in different econ environments
4/n
And here is where it gets dangerous!
There are good ways to try to "do better", and there are bad ways to try to "do better".
5/n
For example:
1. The asset universe is US-centric. Global diversification would reduce concentration risk that the US underperforms in the future.
6/n
3. The assets have different levels of volatility and their volatility changes over time - managing this so that each asset's contribution is more equal over time would be helpful.
7/n
What are the bad ways?
The bad ways *decrease* the probability of you making money in an uncertain future. They add ways to screw up
8/n
We call this x-sectional momentum.
So, you, say, "I'm gonna use this effect to improve returns"
9/n
1. Rank each asset by its total return over the past 12 months
2. Hold only the top asset (with the highest returns).
10/n
It was more volatile but would have out-performed in returns quite significantly...
So, emboldened by the glory of the backtest, you trade the momentum strategy.
11/n
Oops... not so hot.
You underperformed the diversified buy and hold strategy quite significantly.
What happened?!!
12/n
Then, in overconfidently reaching for extra returns, you added a much lower probability active bet (x-sectional momentum) to it.
You added a new way to screw up!!
13/n
Was there ever enough evidence that we should have been overconfidently overlaying that momentum strategy?
Let's look....
14/n
1. Take monthly observations for each asset
2. Rank each asset each month by their previous 12-month total returns
3. Calculate the difference between the next month log returns of the top and bottom-ranked asset
4. Plot the mean of this difference by year
15/n
But much less since 2000...
But imo, there was really nowhere near enough evidence available to us in 2015 to be making such a drastic active bet on x-sectional momentum.
16/n
Our edge comes from being exposed to risk premia.
And the smooth performance (vs just buying stocks) comes from the volatility-reducing diversification effects of holding uncorrelated assets.
17/n
It's an overconfident bet on an uncertain effect.
18/n
If you wanted to trade the x-sectional momentum effect, you should have done it *in addition to* the simpler diversified strategy, not *instead of it*.
19/n
You'd have some exposure to the momentum effect - but you wouldn't be cutting yourself off from the high-probability diversified risk premia effects.
20/n
Don't add ways to screw up high-probability good things.
Look to maximize the chance of making money in an uncertain future - rather than reaching for lower probability excess returns.
Keep it simple. Don't try to be a hero.
21/21
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1/“What would need to be true for you to….X”
Why is this the most powerful question you can ask when attempting to reach an agreement with another human being or organization?
A thread, co-written by @deanmbrody:
2/ First, “X” could be lots of things. Examples: What would need to be true for you to
- “Feel it's in our best interest for me to be CMO"
- “Feel that we’re in a good place as a company”
- “Feel that we’re on the same page”
- “Feel that we both got what we wanted from this deal
3/ Normally, we aren’t that direct. Example from startup/VC land:
Founders leave VC meetings thinking that every VC will invest, but they rarely do.
Worse over, the founders don’t know what they need to do in order to be fundable.
4/ So why should you ask the magic Q?
To get clarity.
You want to know where you stand, and what it takes to get what you want in a way that also gets them what they want.
It also holds them (mentally) accountable once the thing they need becomes true.
5/ Staying in the context of soliciting investors, the question is “what would need to be true for you to want to invest (or partner with us on this journey, etc)?”
Multiple responses to this question are likely to deliver a positive result.
Why is this the most powerful question you can ask when attempting to reach an agreement with another human being or organization?
A thread, co-written by @deanmbrody:
Next level tactic when closing a sale, candidate, or investment:
— Erik Torenberg (@eriktorenberg) February 27, 2018
Ask: \u201cWhat needs to be true for you to be all in?\u201d
You'll usually get an explicit answer that you might not get otherwise. It also holds them accountable once the thing they need becomes true.
2/ First, “X” could be lots of things. Examples: What would need to be true for you to
- “Feel it's in our best interest for me to be CMO"
- “Feel that we’re in a good place as a company”
- “Feel that we’re on the same page”
- “Feel that we both got what we wanted from this deal
3/ Normally, we aren’t that direct. Example from startup/VC land:
Founders leave VC meetings thinking that every VC will invest, but they rarely do.
Worse over, the founders don’t know what they need to do in order to be fundable.
4/ So why should you ask the magic Q?
To get clarity.
You want to know where you stand, and what it takes to get what you want in a way that also gets them what they want.
It also holds them (mentally) accountable once the thing they need becomes true.
5/ Staying in the context of soliciting investors, the question is “what would need to be true for you to want to invest (or partner with us on this journey, etc)?”
Multiple responses to this question are likely to deliver a positive result.
