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Are random trading strategies more successful than technical ones?

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Re: Are random trading strategies more successful than technical ones?

#51

Post by Kranar »

kriops wrote: post #26
JustFinishedBSG wrote: post #18

Earlier quoted context omitted.

This is a misunderstanding of zero-sums games. Zero-sums game are actually proven to have a winning strategy. Chess is a zero sum game.

Chess is not believed to be a forced win for either player though.

OPs claim is poorly stated. He's referring to Zermelo's theorem which states that a finite game with two players that's deterministic and zero sum with perfect information and no possibility of a draw must have a winning strategy. It's not difficult to prove that this must be true and you likely can intuit why it's true (imagine building a decision tree for such a game).

But all of those qualifiers I mentioned are needed, and that's a lot of qualifiers. If any of them are no longer true then there is not guaranteed to be a winning strategy.

In chess, it's possible to end the game in a draw, so Zermelo's theorem does not apply to it and OPs claim is wrong about chess.

I'm fairly certain one can trivially disqualify one of those criteria when it comes to financial markets as well.

Re: Are random trading strategies more successful than technical ones?

#52

Post by jareklupinski »

rubyn00bie wrote: post #17

Prices are pretty well modeled using Brownian motion. Most economists should know this while almost no one in the normal population will be aware of it. Sometimes people are just lucky, but overall the more trades you make the more you'll converge on the average return rate. I would also like to note, that predicting price is different from predicting an overall increase in the value of the underlying security. https…

> Brownian motion is the random, uncontrolled movement of particles in a fluid as they constantly collide with other molecules

sounds like the economy to me :)

Re: Are random trading strategies more successful than technical ones?

#53

Post by veeenu »

OnlineGladiator wrote: post #43
veeenu wrote: post #28

Earlier quoted context omitted.

This is widely known among practitioners, but there is a caveat -- a 1/N portfolio bears a much higher risk than, say, a cap-weighted portfolio or a risk-parity asset allocation. A 1/N portfolio receives an equal contribution in terms of volatility from each asset, meaning that very risky assets significantly increase the portfolio's volatility, while not necessarily contributing proportionally better returns, due to…

> This way, 1/N ends up performing very poorly on a risk-adjusted basis while undoubtedly at the same time outperforming any other kind of allocation on the basis of return alone. I fear I'm misunderstanding you. Are you saying despite having higher returns, the higher risk makes this strategy worse? That really feels like handwaving to me, since the only thing I care about is ROI. I understand nonlinearity and how i…

You are not misunderstanding. While there is no doubt that there is a premium on taking more risk, ROI is also a very debatable metric to consider in a vacuum, though. If you only care about ROI then you either can afford to risk everything because you have cash/safer investments in place (so you are really taking less risk), or you are YOLOing.

> it could tank your investment, but if it doesn't and you make more money then you're criticizing something that never happened

This way of reasoning is basically survivorship bias in a nutshell, and per my direct experience as a financial professional has brought down many investors who were too confident about their "strategy".

To bring this argument to the extreme: if you cared only about ROI, you could just go long some penny stock with exaggerate leverage and make big money "unless proven otherwise". In practice, what happens is you get euphoric for a couple days while you see the money shoot up to the sky, and then lose all of it to a margin call at the opening the very next day. I've seen it happen with my own eyes.

Re: Are random trading strategies more successful than technical ones?

#54

Post by bumby »

veeenu wrote: post #28
cschmidt wrote: post #6

This reminds me a bit of a classic paper called "1/N". It compared a portfolio of putting equal money into each security, vs a bunch of fancier approaches. The 1/N almost always won. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=911512

This is widely known among practitioners, but there is a caveat -- a 1/N portfolio bears a much higher risk than, say, a cap-weighted portfolio or a risk-parity asset allocation. A 1/N portfolio receives an equal contribution in terms of volatility from each asset, meaning that very risky assets significantly increase the portfolio's volatility, while not necessarily contributing proportionally better returns, due to…

Interestingly, low volatility investing has some studies that show it can provide better risk adjusted returns than naive 1/N allocation or traditional Markowitz optimization

Re: Are random trading strategies more successful than technical ones?

#55

Post by veeenu »

samvega_ wrote: post #46
veeenu wrote: post #42

Earlier quoted context omitted.

The assumptions underlying Brownian motion of prices have been disputed for quite a while now: the normality hypothesis can be rejected on most if not all historical financial returns series, as it turns out that most returns are actually fat tailed processes with very significant (and variable over time) correlations between distinct assets, which makes research around portfolio theory even harder to conduct.

Which assets are that?

Most if not all of them. Especially during a downturn, all assets of all classes tend to correlate and produce negative returns. During big crises, stocks that before seemed uncorrelated/anti-correlated have a tendency to increase their correlation and go down together; at the extreme, even bonds cease to act as a diversifier against stocks plummeting.

Re: Are random trading strategies more successful than technical ones?

#56

Post by jcrben »

veeenu wrote: post #42
rubyn00bie wrote: post #17

Prices are pretty well modeled using Brownian motion. Most economists should know this while almost no one in the normal population will be aware of it. Sometimes people are just lucky, but overall the more trades you make the more you'll converge on the average return rate. I would also like to note, that predicting price is different from predicting an overall increase in the value of the underlying security. https…

The assumptions underlying Brownian motion of prices have been disputed for quite a while now: the normality hypothesis can be rejected on most if not all historical financial returns series, as it turns out that most returns are actually fat tailed processes with very significant (and variable over time) correlations between distinct assets, which makes research around portfolio theory even harder to conduct.

Depends on your timeframe right? Shorter time periods are a bit more random. But there's also clearly some autocorrelation which makes sense given the inflationary / deflationary expectations at play

Re: Are random trading strategies more successful than technical ones?

#57

Post by veeenu »

bumby wrote: post #54
veeenu wrote: post #28

Earlier quoted context omitted.

This is widely known among practitioners, but there is a caveat -- a 1/N portfolio bears a much higher risk than, say, a cap-weighted portfolio or a risk-parity asset allocation. A 1/N portfolio receives an equal contribution in terms of volatility from each asset, meaning that very risky assets significantly increase the portfolio's volatility, while not necessarily contributing proportionally better returns, due to…

Interestingly, low volatility investing has some studies that show it can provide better risk adjusted returns than naive 1/N allocation or traditional Markowitz optimization

Yes! There is a number of widely known inefficiencies (low vol, mid cap stocks, the trend following anomaly, long volatility oriented strategies...) that consistently produce better risk-adjusted returns. Some of them aren't really popular enough to stand out and reach their full capacity, others (trend following especially) are so counterintuitive that in practice almost no manager nor investor ends up being able to sustain the emotional pressure, eventually everybody cries uncle and there is no way the anomaly gets crowded enough to go away.

Re: Are random trading strategies more successful than technical ones?

#58

Post by bumby »

OnlineGladiator wrote: post #43
veeenu wrote: post #28

Earlier quoted context omitted.

This is widely known among practitioners, but there is a caveat -- a 1/N portfolio bears a much higher risk than, say, a cap-weighted portfolio or a risk-parity asset allocation. A 1/N portfolio receives an equal contribution in terms of volatility from each asset, meaning that very risky assets significantly increase the portfolio's volatility, while not necessarily contributing proportionally better returns, due to…

> This way, 1/N ends up performing very poorly on a risk-adjusted basis while undoubtedly at the same time outperforming any other kind of allocation on the basis of return alone. I fear I'm misunderstanding you. Are you saying despite having higher returns, the higher risk makes this strategy worse? That really feels like handwaving to me, since the only thing I care about is ROI. I understand nonlinearity and how i…

>Are you saying despite having higher returns, the higher risk makes this strategy worse? That really feels like handwaving to me, since the only thing I care about is ROI.

There’s lots of metrics that try to balance the risk and reward. Often, the risk is based on the volatility of the asset. The common alpha metric does this by incorporating the assets volatility compared to the overall market volatility. There’s others like Sharpe ratio etc.

Factoring that volatility is particularly important in long-term investing so your choices don’t, as you say, tank your investment. So maybe you interested in cyclicals over the last nine months and your investments went gangbusters. Does that mean that same strategy will work in perpetuity? Probably not, because cyclicals tend to have high volatility. Risk -adjusted metrics attempt to quantify that risk.

Re: Are random trading strategies more successful than technical ones?

#59

Post by dandelany »

stouset wrote: post #22
rubyn00bie wrote: post #17

Prices are pretty well modeled using Brownian motion. Most economists should know this while almost no one in the normal population will be aware of it. Sometimes people are just lucky, but overall the more trades you make the more you'll converge on the average return rate. I would also like to note, that predicting price is different from predicting an overall increase in the value of the underlying security. https…

Further, every time you trade, the overwhelming likelihood is that the counterparty to that trade is a financial professional with dramatically more access to company-specific research and information than you. This imbalance is minimized when you trade infrequently and maximized when you trade frequently.

Meanwhile in the Theranos thread next door… “What just amazed me is how gullible all the investors were, and how they didn't do due diligence, hire outside experts, or anything. Weird.” Financial professionals do dumb things, sometimes en masse, and I think there are still some opportunities to make money if you have a good nose for BS/mass delusions.

However, the problem with this strategy is, as Keynes put it: “The market can stay irrational longer than you can stay solvent.”

Re: Are random trading strategies more successful than technical ones?

#60

Post by simorley »

Kranar wrote: post #51
kriops wrote: post #26

Earlier quoted context omitted.

Chess is not believed to be a forced win for either player though.

OPs claim is poorly stated. He's referring to Zermelo's theorem which states that a finite game with two players that's deterministic and zero sum with perfect information and no possibility of a draw must have a winning strategy. It's not difficult to prove that this must be true and you likely can intuit why it's true (imagine building a decision tree for such a game). But all of those qualifiers I mentioned are ne…

> In chess, it's possible to end the game in a draw, so Zermelo's theorem does not apply to it and OPs claim is wrong about chess.

Isn't it even assumed that a perfect game of chess is a draw. Once chess is solved, it'll be all draws.

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