BUILDING A HEDGE FUND #2: THE BIG IDEA

Let’s make it clear: if you want to succeed in today’s world and achieve your goals, you need to come up with an idea. We live in an era of new ideas and innovation. It is not only big conglomerates or multinational companies who can make billions of dollars. History is being overwritten. Today’s billionaires aren’t large companies’ CEOs, but individuals with brilliant ideas. They are inconspicuous and you wouldn’t recognize them in a crowd. They don’t wear trendy clothes or ride in limousines. They don’t have to show off their wealth, because they have something the others don’t: ideas, abilities and skills to fulfil them.

 If you want to succeed in trading, you need one thing - a high level of creativity and invention. Forget about brokers’ promises - most of them are just sellers and liars, good at marketing, but not at trading. Forget about all the latest and the greatest software there ever was. None of these will help you to become a better trader. You only need one thing - a constant source of new, good and original ideas. And you need it 24/7. Why do you need it 24/7? Because most of your ideas won’t work anyway, or will fail really soon after their implementation. I know they will; I experience it every day. This is why you don’t only need one good idea, you need to have at least a dozen every day (or at least a dozen every week). All my trading career has been built on my only valuable quality (and also an advantage) - to be  creative constantly. Trading isn’t an exact science like math, it isn’t only logic. It’s especially about ideas and creativity.

 I became more aware of that when I decided to build a hedge fund - I decided to enter an unforgiving world of pure capitalism, where only the best survive. It’s a world full of unmerciful competitors, where lots of them have significant advantages like almost unlimited funds, coworkers with Nobel Prizes and technologies that you cannot find anywhere else (maybe in Pentagon or NASA). When I decided to become part of that stream, I knew that I’d have to come up with something new, which could give me at least a little chance to survive for a while and let me try to succeed (even though chances for success are really small). So, my plan for the next day in Singapore was clear: to find an area which I could possibly innovate. As a matter of fact, there were only three options and I rejected the first two right away.

Option 1: Edge

 Most people, when creating a hedge fund, rely on this less appropriate, less stable and the most risky part: they try to find an advantage in markets using an edge and build a future career on it. The edge might be a new and great system, a unique algorithm, statistical arbitrage, new option combinations or just a couple of excellent traders, hired by private funds who are willing to share profits with them.

 Going this way, I’d encounter a couple of obstacles - there are well incumbent companies that are very well equipped to continuously find the best edge. They have the best technologies and human resources you can imagine. Your chances compared to these guys’ aren’t big. Yet, a bigger problem is that every edge will sooner or later fail.

 There are no exceptions. Forget about utopia as an ever lasting edge. There isn’t anything like this. For more than a decade, I’ve seen everything you can imagine: excellent discrete traders whose edge suddenly stopped working, ATS developers trying all possible methods - from simple strategies based on Larry Williams’ style to complex and ultra complicated statistical and option arbitrage. Basically, after some time, all these ways started to crumble and they couldn’t  earn money any more. For some, it’s been 3 months; for others even up to 7 years. But they all failed. It is logical. In today’s connected age, modern technologies, regulations, interest rates manipulation and hyper-fast changing markets, we can see edges failing every day at a faster pace than ever before. The party gets over too soon. Welcome to the 21st century trading. I don’t want to be part of this game and I won’t start building a hedge fund by a never ending new edge search.

 By the way, you might be a little depressed (but this is the reality, don’t close your eyes to it) and wonder what the solution is? There is one - to be creative and replace one failing edge with a new one (and of course, diversify). That brings us to option 2.

Option 2: Workflow

 As we already know, the edges are failing (you might not know it yet, or don’t want to believe it, but I know it very well). It’s time to move on and ask yourself how you can prepare for it.

 One thing is the portfolio, containing as many strategies as you can handle. The other thing is to come up with new systems providing good results, passing all robustness tests and replace the old, failing ATSs. What you need is the workflow. What do I mean by this workflow?

 All you simply need is a tuned up process that will help you create and test new strategies. You don’t have the luxury to take a month off and search for a stupid pattern similar to Joe Ross’ simple patterns. That might have worked 50 years ago, but not today. If you want to stay in the markets, you need to find a way on how to have new and robust systems which you’ll get from an automated process without your participation - so that you can spend time doing other, more important trading related activities.

Personally, I’ve been improving my workflow for the last 5 years and I cannot imagine any other “big idea” that could dramatically improve it. I use highly specialized, target oriented “smart codes”, genetic programming and a fully automated process for my strategy farm (at this moment, 2 high-end servers) to non-stop generate, test, compare and evaluate new and new strategies. I have to be realistic here - I don’t think I’ll have any new breakthrough idea to revolutionize this process. This area isn’t  the right one for my big idea either, so I need to move on to the third one, the most important area.

Option 3: The bigger picture

 This area is really important when you want to be a successful trader and, to my surprise, lots of traders (even multi-billion funds - really!) spend the least time thinking of new risk-management tests, position sizing and portfolio management.

 The world of finance is really full of paradoxes nowadays: ultra modern technologies searching for new edges and new opportunities, but still using old position sizing methods from Ryan Jones’ times. We call simple stop losses risk management and we find it needless to think about portfolio management. These are the areas with almost no progress in the last years; you can find nothing new about it. But you can still find and implement new ideas in these areas and come up with something new, a game changer that can dramatically affect the outcome of your trading portfolio. You need to leave the dogma, let the old, no longer valid ( but still often used ) economical theories, start thinking outside the box, think abstractly, use your imagination and find a way how to redefine a whole area of risk management, position sizing and portfolio management.

 And that’s exactly the part I’ll revolutionarize with my BIG IDEA.

And the best part is that, by coincidence, I had the idea some time ago. I was halfway finished and all I had to do was to complete it and carry it out.

If you want to read the previous part, go here.

To find out how which automated trading system was in the beginning, download this free ebook.

 When in Singapore, I also visited the Stock Exchange (SGX). Very inspiring, indeed. I met some great people from SGX there. 

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