Simplicity on the other side of complexity: How to get started in trading systematically!
In the world of trading and investing, it's easy to get caught up in the details. There are so many moving parts and much information to process, especially in today's world, where there is more noise than signals, with social media driving too many conversations.
There are a lot of "simple strategies" that are discussed, right from books written by expert traders to online channels where these are talked about and analyzed. Why, then, aren't every trader who has access to this largely free or low-cost information are also phenomenally successful like the experts?
Traders are being told that their psychology is what fails them. While this is mostly true but there is a deeper reason that drives the underlying aspects of psychology that don't get talked about enough. It is not meditation but comprehension!
Oliver Wendell Holmes famously said,
"For the simplicity on this side of complexity, I wouldn't give you a fig. But for the simplicity on the other side of complexity, for that, I would give you anything I have."
What Holmes was getting at is that there is a big difference between the false simplicity of not understanding something and the true simplicity of understanding something so well that you can see through its underlying complexities to visualize the simple constructs that can explain or encapsulate these complexities. The key is to strive for the latter.
Now, what does this mean in the world of trading and investing?
Very simply, the strategies that are available for free online or in books are just like simplicity on this side of complexity for traders who blindly follow them and don't understand the underlying complexity that was surpassed before they were created. This is exactly why copy trading yields different results for the experts and their followers - most of the time.
The financial market is a complex beast. It comprises macroeconomics, microeconomics, human behavior, fast algorithms, and hidden forces of nature. When you have so many moving parts to navigate before, a simple-looking strategy that seem to work for the creator, actually encapsulates deep research and intelligence with the right context and environments that the creator has done and very little of that gets spoken about. There is no silver bullet in the market, and nothing works all the time and forever. Without the right context, these are just worthless simple strategies - rather strategies that don't work most of the time.
As an example, some traders have created trading systems that are designed with very simple trend-following strategies using something as simple as moving average crossovers. But these strategies also require a lot of context around the asset classes, type of assets, economic environment, market regimes, and many more. This is why not everyone who implements moving average crossover strategies makes money because unless one understands the mechanics behind it - the research, tests, and metrics behind the strategy, it becomes difficult to keep track of everything and make sound decisions. This causes emotionally-driven decisions instead of logical ones, which is a recipe for disaster!
Now on the other extreme of this simplicity spectrum lies the very complex strategies that are discussed at the academic level and where papers are presented at events. Now very few of these are actually implemented in real-world money-making systems. Why because they are created when the researcher is still at the deep end of complexity pursuing it out of academic interest and so when several moving parts are introduced as-is, running it successfully becomes a rocket science. And unfortunately, the world has a very tiny fractional percentage of its population who are rocket scientists!
So then, there are three types of trading approaches:
- The simple ones that are most commonly talked about on open forums but are low value for most traders except for the creators.
- The complex ones that are discussed in a great many academic papers published but remain mostly of academic interest.
- And then the simple one on the other side of the complexity created through true domain expertise that actually powers the money machine.
So, which type of approach is best? The answer is evident it is #3.
And how you achieve that, is by putting in the work. Now there are a lot of emphases that are given in the retail trading world today in putting the work by training the eye from looking at charts. This, again doesn't work. If staring at charts could generate dollars, every educational institution would be teaching just that, won't it?
While learning to read price action from the chart is an important skill to be able to form hypotheses and understand the market behavior but that does nothing to help most traders become profitable. A small section may have become successful that way as they probably have a natural knack for visual pattern recognition or it is just their subconscious trained from years and decades of hit-and-trial experiments and blowing trading their account multiple times. But that's not something that most people can afford to do.
So what is the right way to get to simplicity beyond complexity?
The key is to look for what professional traders at institutions, hedge funds, and prop trading firms do and learn from how they operate. Here is how a lot of them arrive at their trading approaches.
- First is education. Understanding everything about how markets work, how traders behave, how economic environments impact the market, how to sense congenial market environments, and how to leverage technical and fundamental data for decision-making.
- Second is forming one or more hypotheses. What asset classes, asset groups, behaviors, and market actions to trade? These should match the individual trader's capital, risk appetite, trading horizon, goals, and objectives. Hypotheses can of course be adapted from popularly discussed trading strategies. The key is not to blindly follow but apply the domain knowledge to understand the logic behind them.
- Third is creating simple rules for identifying setups that conform to the hypothesis, rules for entries, rules for exits, and rules for position sizing.
- Fourth is testing the hypothesis. There is backtesting, forward testing, and simulation testing - essential means of testing with historical market data, live market data, and synthetic data generated from the market.
- Finally, following the rules, and observing the performance, iterating as needed because markets change all the time, and adapting to changing environments is the key. [Read our post on the Adaptive Market Hypothesis]
The advantage of this approach is that it helps you stay focused on what's important. When bombarded with information from all sides, it can be tough to filter out what's relevant and what isn't. By keeping your approach simple, you can avoid distractions and focus on what will help you achieve your goals.
Finally, simplicity also has a psychological benefit. When you're constantly second-guessing your decisions or worrying about all the things that could go wrong, it takes a toll on your mental state. This can lead to anxiety and even depression. On the other hand, when you have a clear and concise plan that you're confident in, it allows you to approach the market with a sense of calm and confidence. And that can make all the difference in your results.
If all of the above seems daunting, it is because it really is. Trading is not simple and which is why 90-95% of traders fail! But like any other domain, when the right process is followed, success becomes repeatable.
Researchfin.ai provides you with all the starting points.
Our goal at Researchfin is to simplify the journey as much as it is possible to help everyone become a systematic trader.
For starters, we highly recommend that you read the foundational book by our Co-Founder & CEO, Ruban Phukan. It provides you with all the background and domain knowledge to get started quickly. It is already a #1 best seller in online trading and financial engineering categories on Amazon.com. And to help everyone, the book is made available for FREE on Kindle for this week: https://amzn.to/3DRzG5e
Secondly, signup on Researchfin.ai for an invite to our award-winning next-generation systematic trading platform. It helps anyone to easily research, test, and implement stock/forex/crypto trading systems with just a few clicks, irrespective of their trading or coding experience! We will start giving access to people from the week of December 12th, 2022.
And follow us on Twitter @ResearchfinAI for insights, updates, and also notifications on when we launch our educational webinar series soon on Systematic Trading.