Program (TaP©) Introduction
Improve your equity trading performance using proven performance management techniques
revised: 15 May 2019
In this series we will look at Principles, Metrics, Examples and Actions that combine into a useful framework to improve your equity trading success. This forms the basis for our 10alpha Program (TaP).
Alpha is used in finance as a performance measure, the active return on an investment. It is a measure against market index or benchmark considered to be representative of the market’s movement as a whole. A 1.0 alpha would indicate a 1% beat on the index; -1.0 would mean the benchmark outperformed the investment.
The aspiration of TaP is to deliver a 10% beat on the benchmarks.
Provide logical, data driven insights into trading to deliver improved performance by individual traders.
Outline a series of Principles that will aid in decision making
Establish a set of metrics that will enable traders to evaluate their trading without emotion and drive significant improvement
Provide a set of examples, supported by trades, that illustrate the Principles
Define a set of Actions for those Principles that can guide the trader in improving performance
Principles are the fundamental, axiomatic rules we will use to help guide our actions to achieve our investment objectives. Principles are at a more basic level than policy, objectives or strategy. However, Principles govern all those areas.
In our case, our Principles will be the touchstone we come back to when making decisions. Without them, investment decisions are made without a cohesive structure, likely resulting in sub-optimal results.
There are two types of principles.
Useful physical examples that we are all familiar with include acknowledgement that seeds grow into seedlings; which grow into mature plants; which produce seeds and the cycle continues. This is simply how things work, no proof required.
A process principle may also be linear, manifesting with a clear beginning and end. Writing a book, project management, building a house, education progression are all examples of linear processes. It is very easy to see the start and the end in any of these.
Situations where a clear cause and effect relationship can be defined fall into the causal principles arena. Economics provides a good example where an increase in supply without an increase in demand causes a reduction in prices. When it rains, things get wet. There are many examples where one event clearly causes the next one or, in concert with other events, causes a subsequent event.
The distinction between the two types of principles is that process principles have no inherent causality between one change and the next. You cannot describe a seed growing into a seedling in any way that has the seed causing the seedling to occur.
Additionally, causal principles may be complex with more than one cause delivering an effect; combinations of causes delivering an effect; or multiple causes delivering multiple effects.
Our Principles focus on process as it is process that will improve the repeatability of our efforts, delivering improved performance. We will find causal principles along the way and those are valuable in tuning our actions in a tactical manner. For example, a causal principle might be, “When the US dollar rises, the price of oil declines”.
Knowing this, we have at least one factor to explain changes in the price of oil. As noted, causal principles may have multiple causes delivering multiple effects. So, this one principle, while perhaps necessary, is insufficient to drive an investment tactic.
The application of process principles requires some generalization of the events sequence such that the principle may be applied to new opportunities. This will enable us to look at a new situation and identify a trade type that has the best probability of profit.
Critically, this series is not about predicting market, market segment or underlying stock performance. It clearly is not about guessing what that performance is likely to be. Instead, performance management is about improving the trade type selection given our view of the market, segment and underlying stock.
Establishing a view of the market, etc., is not within the scope of this work although we will likely touch on it lightly as necessary.
We must measure performance on previous decisions; learn from those decisions; and adjust our process to improve our real world outcomes. That is exactly how performance improvement happens.
Market Dynamics Drive Trade Type Selection
The market is dynamic and ever-changing. We must evolve or lose dramatically. The more recent the experience the more valuable. This also figures into performance management.
For example, we may find that, given the current state for the equities market as of January 2018 (very low volatility, strong uptrend) that writing calls against our long positions has a high probability of failure. With this insight, we can reduce our normal approach to writing calls as a hedge in a way that leaves more profit in our account.
However, perhaps in March or June of 2018 we'll find that the market has a downward bias. That changes what will work, and our tactical learning that short covered calls do not work may turn around completely.
It is not about "never", just about "not now": selection of the right context within which to take a given position type.
Without measuring, we are left with the limitations of our memory (colored by emotions) and the very human tendency to do the same things we have been doing.
Tracking and measuring can tell us when conditions may be changing. We may not catch that volatility is increasing or that a given market sector is failing to match the overall market. If we track and review our bull put spreads or bear call spreads, it is very likely these changes will become obvious. This flag can enable a deeper review into the market, the sector and the specific equities we are trading.
The principles we will cover in coming installments are:
Measurement enables improvement
Trades are independent
Invest in what you know
Portfolio diversification matters
Beware myths masquerading as facts
Fundamentals matter ... but not always
Let winners win ... and limit risk
Lose losers appropriately
Turn losers into winners
Hedging is no panacea
Human nature enables failure
You can see in the chart when these Principles and Actions were implemented. Truly focusing on the data, tracking performance and eliminating low probability tactics in trading have delivered a remarkable improvement so far. The future has yet to be written.
Rules of the Road
It is useful to establish some ground rules for our relationship that will improve communication and enhance any value you may derive from these monographs. To that end:
All comments, pro and con, are accepted and appreciated; not all can receive an individual response;
It's not personal; like HR and Corporate, we're here to help;
We do not provide trade setups, equity selection recommendations or buy/sell pick lists. There are many that claim to help you with that. This is about sharpening your tools and evaluating effectiveness;
All examples you may have to illustrate a point or counter-point are humbly accepted and will be given attribution when used; and,
Any trades I discuss as my own, good, bad or indifferent, are supported by copies of my broker statements -- our no BS guarantee.