Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
Charts & Analysis

Systems or discretion?

Weird thing. Our systems – which end up being short or long, depending on the trend,are doing wonderfully in these markets. In the last couple weeks, we made over 7% and the last two days have been about trading larger capital, with a 0.75% return in that period.

We’ve been working with another system that has closed the month with around 5% return. A third one, that occurs only once in a while, has provided a 29% return in a few days and has provided no other entries.

Meanwhile, my discretionary trade (Long nifty) continues to make losses. I have been adding and rolling over, but it’s tough to fight the feeling that this could be a seriously losing battle. I’m close to stops – stops I thought wouldn’t get triggered but that’s why you have stops. I remain confident about that trade – why else would I stay in – but the wave of selling, and sustained downsides is emotionally challenging.

It’s largely emotions that creates problems with investing. Systems are good that way – you have a certain knowledge of how bad it might get, and you can design systems that work with your risk appetite. Yet, even systems have emotions – unless you constantly research them, you can get into system fear – i.e. running away from tweaking, observing or even training your system because you’re not quite confident of it.

Take trend following. It hasn’t been easy – for a few months, there really were no trends other than really short term ones. Stocks reverted to some levels and stuck there – once in a while they would move around, but get back there. Come october and a down trend sets in – but many trend followers were simply sitting on the sidelines, since they weren’t confident of a system! Mean-reverters who made a killing till now, went all in – and they’re in fairly bad shape. So there’s a time to follow trends, a time to do mean-reversion, and a time for other kinds of strategies. But how do you identify what market works for what?

Is it a function of volatility? Daily option implied volatility or the Average True Range (ATR) specified as a percentage of move? Or do you take the ADX – a directional index? There’s something out there that gives you quantifiable info – not just someone saying “yeah, I think it’s going to trend today”. We have to find this – and I would imagine something like this would reduce risk or improve performance. Any little bit also helps – as long as we keep it simple and don’t over optimise.

Constant research is required . Just because our systems do well shouldn’t mean we give up the research. But we have been guilty of that, and there are plans to fix it. More systems, more work, but hopefully we’ll have alternatives when these systems go down.

An interesting thing we have been hearing from people is that they want us to use systems that have ultra-low risk. Arbitrage. Or mispriced butterfly-able options. Or pair trades. This kind of thing makes absurdly low returns but their deal is to leverage themselves, thus increasing returns. So they would do a single arb trade giving them 0.05%, twenty times a day, which makes 1% a day. Or they lever themselves 10:1 and get their 0.5%. We’ve been looking at such stuff and we realize that too many times, people talk only about their arb successes, not failures. So one day they see the model break down and take away all their profits.

Just recently there was talk of a pair trade of ICICI bank versus SBI – the former being oversold, so the deal was to buy ICICI and sell SBI. And then there was a day when ICICI fell 28% and SBI was UP 4%. Model went into the gutter – and any trade leveraged 4x followed it with complete loss of capital.

But there is a time to arb too – if the returns are decent enough that you don’t have to lever yourself up the wazoo to make the grade. This is one time where everyone and his uncle is doing arb – and thus, diminishing returns for everyone.

Systems need a macro-view; something that tells someone that a certain kind of market is underway. A lot of discretionary traders use such macro-indicators implicitly, sometimes without even knowing it – like gap moves, increasing volumes, number of stocks hitting new highs, the advance decline ratio, or volatility measures. Systems have got to transcend from a micro-analysis to using macros too – something I must test and see.

  • Anonymous says:

    >How about a system called Randomness ?

  • Anonymous says:

    >Hi there friend! It has been a long time seen ya, Remember me? I had advised you that everybody gets what they want?

    Seems you only wanted fame & excitement.

    So long buddy.

  • Deepak Shenoy says:

    >Anon2: Don’t get the ref, but yes, everyone does get what they want don’t they? You probably got what you wanted, and I’m getting what I want…am still in the markets, doing the same thing, just in a bigger sort of way. How are things with you buddy?

  • Anonymous says:

    >Well, me doing fine. Thanks.

    Just wanna tell ya: A person who tries to fool in the public eventually fools himself in private.

    God bless.

  • Deepak Shenoy says:

    >C’mon mate, do me a favour and get in touch on email. Being “anonymous” doesn’t quite do you justice, as it makes you look like a random coward that I don’t think you are…and I’m honestly intrigued.

    I can tell you this: People make big global statements like yours when they’ve lost too much money or when they’re just ticked off at not participating. Take care, and don’t lose your heart.

  • Anonymous says:

    >Hmmm….thank god you’re intruiged. You know me well already buddy (via emails). I’m not being coward, just a well wisher who doesn’t have guts to tell ya on face that you’re drifting n losing focus. You’re very talented but use it wisely man…..don’t waste it in capital markets. Just think that it’s kind of brain-drain.

    As for me, I neither lost money(kinda lucky to sell at 18K) nor have any left-out feeling.

    That said, I’d continue to be your well-wisher irrespective of what ya think of me.

    -A buddy

  • Nitin Gupta says:

    >Hi Deepak,

    I am developing some systems for Nifty Index Futures.

    Could you throw some light on Regime switching and usefulness of it for Trend Following