Loved the book camp, truthfully, a paradigm shift. It got to think and understanding the market in a deeper way. A critical component that many retailers in the begining- without proper mentorship - will pay for unfortunately. Kinda interesting to see how effective a simple indicator like a i.e. 3m / 6m trend oscillator holds up when compared to a complex one as mentioned in the article. Sprinkle some risk parity on there and WAM! you got a delicious oscillator, that has a mechanical foundation underlying it.
Hi Kris, I’m curious how you feel about strategy types such as mean reversion, trend following and momentum? Would you classify building a strategy of these types as data mining? IMO there’s a lot of evidence that these strategies work and it’s quite easy to find explanations as for why that might be the case but it’s not as simple as saying “my counterparty is price insensitive and willing to give me their money”.
Good question! The key thing is that those categories aren't edges per se. They're implementations for harnessing particular edges.
Take mean reversion: the tendency for stuff that's gone up to go down, and vice versa. The answer to "why might that be a thing?" is your edge. Say a stock moves because someone needed to do some price-insensitive buying or selling. Maybe they got margin called, maybe they needed to add the stock to their index-tracking ETF. You'd expect that move to mean-revert, since it's not based on any fundamental repricing. Someone comes in and goes "oh look, I can sell this thing that's worth $100 for $105" until it's trading at fair value again. So your edge is to find places where people push price around because they HAVE to trade. You would harness such an edge using a mean-reversion approach.
Same thing with trend: the tendency for stuff that's gone up to keep going up. Why might that be a thing? Maybe stuff trends when an asset reprices based on real information, but that information is slow to make its way through the market. Early movers recognise the new information, push price up, then slower participants figure it out and pile on, pushing price further, until it's finally trading where it should be. Why wouldn't it just reprice instantaneously? That might happen when the market isn't dominated by fast, well-capitalised, informed players. Or when there's no obvious anchor for fair value, and some ambiguity about what something is really worth. If that's true, you'd expect crypto markets to trend, and the E-mini not to.
Now, you're right that "my counterparty is price-insensitive" isn't the full story. But you also don't need to go overboard. "Wealth management tends to hold stocks and bonds, and rebalances towards month end by buying the underperformer and selling the overperformer" is more than fine. It doesn't causally explain every movement in stocks and bonds, but it gives a solid reason for a noisy effect that happens on average at the margins. That's a sensible, practical bar that provides a simple impetus for the trade without going overboard.
You mean like knowing if their inventory is lopsided? No, I don’t think there’s an edge there. A good mm can manage inventory in all sorts of ways without impacting price. And I think the dealer gamma indicators are mostly bollocks - you can't actually know dealers' gamma, you don't know how they'll hedge it, and the market makers themselves understand the feedback effects better than anyone. I guess it probably matters in genuinely extreme cases, but generally it's a super hard problem that gives at best a super small edge.
Hi Kris any thoughts on stuff like commodity spread trading, all weather portfolios, profitability factor and value factor why It doesn't get arbitraged away ?
Mostly attributable to various risk premia, which don’t get arbed away because risk preferences are what they are - in aggregate, the preferable thing is to not bear the risk. The trader thinks differently… better to take the reward and manage the risk. All weather type portfolios manage the risk through diversification for instance. Re commodity spreads - Depending on the spread, it could also be attributable to being an edge that sucks enough that most will stay away (slow to converge, untameable skew, capacity constrained for example).
Loved the book camp, truthfully, a paradigm shift. It got to think and understanding the market in a deeper way. A critical component that many retailers in the begining- without proper mentorship - will pay for unfortunately. Kinda interesting to see how effective a simple indicator like a i.e. 3m / 6m trend oscillator holds up when compared to a complex one as mentioned in the article. Sprinkle some risk parity on there and WAM! you got a delicious oscillator, that has a mechanical foundation underlying it.
Great stuff Kris 👏
Hi Kris, I’m curious how you feel about strategy types such as mean reversion, trend following and momentum? Would you classify building a strategy of these types as data mining? IMO there’s a lot of evidence that these strategies work and it’s quite easy to find explanations as for why that might be the case but it’s not as simple as saying “my counterparty is price insensitive and willing to give me their money”.
Good question! The key thing is that those categories aren't edges per se. They're implementations for harnessing particular edges.
Take mean reversion: the tendency for stuff that's gone up to go down, and vice versa. The answer to "why might that be a thing?" is your edge. Say a stock moves because someone needed to do some price-insensitive buying or selling. Maybe they got margin called, maybe they needed to add the stock to their index-tracking ETF. You'd expect that move to mean-revert, since it's not based on any fundamental repricing. Someone comes in and goes "oh look, I can sell this thing that's worth $100 for $105" until it's trading at fair value again. So your edge is to find places where people push price around because they HAVE to trade. You would harness such an edge using a mean-reversion approach.
Same thing with trend: the tendency for stuff that's gone up to keep going up. Why might that be a thing? Maybe stuff trends when an asset reprices based on real information, but that information is slow to make its way through the market. Early movers recognise the new information, push price up, then slower participants figure it out and pile on, pushing price further, until it's finally trading where it should be. Why wouldn't it just reprice instantaneously? That might happen when the market isn't dominated by fast, well-capitalised, informed players. Or when there's no obvious anchor for fair value, and some ambiguity about what something is really worth. If that's true, you'd expect crypto markets to trend, and the E-mini not to.
Now, you're right that "my counterparty is price-insensitive" isn't the full story. But you also don't need to go overboard. "Wealth management tends to hold stocks and bonds, and rebalances towards month end by buying the underperformer and selling the overperformer" is more than fine. It doesn't causally explain every movement in stocks and bonds, but it gives a solid reason for a noisy effect that happens on average at the margins. That's a sensible, practical bar that provides a simple impetus for the trade without going overboard.
Nice read. Do you think there’s an edge in knowing and understanding a market maker’s biases?
You mean like knowing if their inventory is lopsided? No, I don’t think there’s an edge there. A good mm can manage inventory in all sorts of ways without impacting price. And I think the dealer gamma indicators are mostly bollocks - you can't actually know dealers' gamma, you don't know how they'll hedge it, and the market makers themselves understand the feedback effects better than anyone. I guess it probably matters in genuinely extreme cases, but generally it's a super hard problem that gives at best a super small edge.
Thanks for the thoughtful response. That makes a lot of sense.
Hi Kris any thoughts on stuff like commodity spread trading, all weather portfolios, profitability factor and value factor why It doesn't get arbitraged away ?
Mostly attributable to various risk premia, which don’t get arbed away because risk preferences are what they are - in aggregate, the preferable thing is to not bear the risk. The trader thinks differently… better to take the reward and manage the risk. All weather type portfolios manage the risk through diversification for instance. Re commodity spreads - Depending on the spread, it could also be attributable to being an edge that sucks enough that most will stay away (slow to converge, untameable skew, capacity constrained for example).
Thank you so much Kris.
Also love the writing style, i could read the posts without any ADHD pauses lol
You're very welcome! And thank you, that made my day.