The View From Inside, The View From Outside
What I can see at the trading desk, and what only becomes clear when I put the trades together
Previous: Episode 10, The Discomfort Is Load-Bearing
Next: Episode 12, It Has Always Been About Process
The account is down 12 per cent on trades already closed. Another signal appears. I check the price data, confirm the contract and work out how large the position should be. I’d like to know whether this trade will be any different from the last few. There’s nothing on the order screen that can tell me.
That’s where we left the second manager in Episode 9’s example: several months into a losing stretch, with the next decision already due.
Now imagine sitting down after those six months with the trades laid out in front of you. The losses that felt relentless at the desk might turn out to have come mainly in three bad weeks. Positions in currencies, commodities and stock index futures all lost money at the same time. Each order looked reasonable on its own. Put them together and you find something you couldn’t see on any one order screen: several trades were vulnerable to the same move.
The order screen was where I had to act. The record is where I can begin to see how those actions added up.
At the desk
When a signal comes in, the work is quite specific. Am I looking at the right contract? Is the price data sound? Have I calculated the position correctly? If I’ve entered twice the intended size, it won’t help to know how the strategy performed over twenty years. I need to fix the order.
The trouble is that the losing trades are specific too. I remember the one that reversed almost as soon as I entered. I remember the one that stopped me out and then took off without me. By the time the next signal arrives, those trades are easier to recall than the many ordinary ones I handled without a second thought.
That is when the larger record can help. Daniel Kahneman and Dan Lovallo distinguished between forecasting from the details of a particular case and looking at what happened in comparable cases. [1] I borrow that distinction here. I need the details to place today’s trade. To know whether the recent losses are unusual, I need to see how comparable trades and losing periods played out. That comparison has to be close enough to be useful. A record from a different strategy, traded at a different size or at much lower costs, may tell me little about the one I’m running.
Two ways to lose 12 per cent
Suppose the review confirms that most of the decline happened in those three weeks. Each trade was taken as intended. But when investors cut their exposure across markets, several of my positions moved against me together. I’d counted the contracts and thought I knew how diversified I was. I had counted the positions. I hadn’t seen what could make them behave like one.
Now suppose the same 12 per cent loss came from failed breakouts spread across six months. One market would start to move, then reverse. Weeks later, another would do much the same. There’s no cluster of positions to explain the loss. I’d want to know how often the strategy had gone through stretches like this, what those repeated entries and exits cost, and whether the account could bear a longer wait.
The number is the same. What I need to investigate is different.
This is why the larger view matters. Herbert Simon and Philip Anderson, working in different fields, both give us reasons to study what happens when parts act together. [2] [3] A trade log can tell me whether I got every order right. The portfolio record can show me that those correctly placed trades put more at stake on one market move than I intended. I need both records to see the problem.
What the record leaves out
Looking back gives me more evidence. It also gives me a temptation: I already know how the story ends.
I can see which signal began the recovery. At the time, it looked like another signal after a string of failures. I can see that a tighter exit would have saved money on a particular trade. To find out whether it would have helped the strategy, I still have to count the long winners it would have cut short.
The records I trust most include what I knew at the time, the orders I placed, the trades I skipped and any change in the capital I had available. In Episode 9, the investor withdrawal mattered because it left the manager trading smaller when the large trend arrived. A review that leaves out the withdrawal can tell me what the rules would have earned at the original size. It can’t explain what the manager actually earned.
I think back to the flowering tree in Episode 6. The Gubbi Gubbi elder could make sense of what was happening beside the stream because he knew how that place changed over the seasons. I was seeing it once. My trading records are a much narrower kind of knowledge, but they let me return to days I otherwise remember only for how they felt.
The next mark on the chart
In the photograph, a pencil marks a position on a chart. The mark is useful because I can see where it sits in relation to the rest of the route. Whoever holds the pencil still has to look up and see what the water is doing now.
At the desk, a bad price needs checking before I send the order. If the review shows that the account can no longer support the planned exposure, I need to change the size deliberately. If I suspect a better exit rule, I need to test it before I trade it. Each finding has a different consequence for the next order.
The wider view comes from records kept while I was still inside the sequence. It can change how I approach the next trade. It can’t give me the one thing I wanted when that signal first appeared: the chance to know the ending before I decide.
The pencil returns to the chart. Episode 12 asks what holds this work together, from the first decision to the review that may change the next one.
Previous: Episode 10, The Discomfort Is Load-Bearing
Next: Episode 12, It Has Always Been About Process
Sources and notes
[1] Daniel Kahneman and Dan Lovallo, Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking, Management Science 39, no. 1 (1993): 17 to 31. Their distinction concerns forecasting. I use it here to think about live trading and later review.
[2] Herbert A. Simon, The Architecture of Complexity, Proceedings of the American Philosophical Society 106, no. 6 (1962): 467 to 482.
[3] Philip W. Anderson, More Is Different, Science 177, no. 4047 (1972): 393 to 396.
Richard Brennan writes on systematic trading, complex adaptive markets, and the philosophical foundations of trend following at atstradingsolutions.com. His published books include The Fractals of Finance, Complex Adaptive Markets, Carved by Impossibility, and The Aussie Turtles Trend Following Guide, co-authored with Adam Havryliv. His forthcoming book, The Trend Following Manifesto, co-authored with Niels Kaastrup-Larsen, is coming soon.
You do not need to predict the future. You need a process that keeps you present for the rare moves that matter.
The Trend Following Manifesto: Building Robust Portfolios for an Uncertain World
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