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One of Wall Street’s Most Popular Trading Strategies Is Now Failing (bloomberg.com)
63 points by jonbaer 16 days ago | hide | past | web | favorite | 59 comments

So the article seems to be saying that CTAs are failing which is true based on numbers and then claims this is because the environment is too random.

But shouldn't we consider as possible cause the fact that CTAs became common. When multiple parties use the same strategy it can not be winning any more for everybody.

Yes - and there is also a second order effect where latecomers to a well known strategy must focus on marketing and cost reduction to compensate for lower alpha, so each dollar flowing into the strategy is more likely to go to a less innovative, follow+on implementation (such as algorithms packages offered by big banks).

The article notes this:

> Part of the problem, according to critics, is too much money now chases the same trends, undermining what traders call "alpha" — the outperformance possible relative to a benchmark.

Consider the market for a bond. Smart investor figured out that the default risk on the bond is lower then we thought. More people find out and there's a lot of demand for the bond so the price goes up. Now the bond trades above face value, so new investors get a lower % return, and the bond is no longer a good deal, so the price stops rising.

The same issue holds true for stocks, which are also valued based on a claim for some predicted future cash flows.

Yes, and for anyone interested your second paragraph is the definition of a “security”.

I thought that is the definition of an "asset" which is a broader term.

Assets cannot by themselves generate future cash flows. If a house just sits there, it cannot generate cash flows, it needs a tenant to do that. A hundred dollar bill cannot generate cash flows by sitting under your pillow. It needs to be put to work to generate cash flows. Assets can be used to generate cash flows, but they cannot generate cash flows just by existing. Hence the difference between asset and security, though both can be ascribed to have value.

Securitization is about ease of trading - which is helped by but not defined by ease of collecting cash flows.

An asset is exactly something that can generate future cashflows, even if only by being sold. A security is a special kind of asset that can be easily traded on paper without changing it's value or taking on transformative effort.

So, your goose that lays golden eggs is indeed an asset, but it might be hard to trade because many folks aren't well prepared to own a giose. If you wrap it up in contracts about someone who will house and feed the goose, collect and sell the eggs and forward the money to the holder of a deed - congrats, that deed is now a security.

the definition of a security has nothing to do with how they're valued.

I think getting a bunch of smart people to work on making automated trading strategies 24/7 is a tremendous waste of talent

I recently read The Idea Factory [1] which covers Bell Labs in its heyday. Many of the most brilliant human beings of that era worked for very modest salaries, and seemed content to do so. I wonder why it is that nowadays the "smartest" people tend to work in tech or finance and mostly pursue wealth. A few possibilities:

1. The rate of meaningful new discoveries in basic research has slowed significantly compared to the mid 1900s. Most important advances now involve enormous groups of researchers, and require decades of work. So the basic research route is less appealing overall.

2. Technology and finance provide clear avenues for outsized financial returns that simply weren't available in the past. Enrico Fermi, for example, was fairly enterprising. He wasn't an academic ascetic at least, and made some effort to amass wealth. But the best strategies he came up with were publishing textbooks and maybe some dabbling in the stock market (That is if I remember my details from The Last Man Who Knew Everything [2] correctly)

[1]: https://www.goodreads.com/book/show/11797471-the-idea-factor...

[2]: https://www.goodreads.com/book/show/34746094-the-last-man-wh...

> [...] Many of the most brilliant human beings of that era worked for very modest salaries, and seemed content to do so.

IMHO this is so obvious -- cost of living, especially housing, healthcare, and higher-education.

A modest salary back in the 80s was good enough to raise a family on. A modest salary these days rarely does. Let me present some actual numbers:

My father purchased a house for ~30k USD. His annual salary was ~30k USD. He was always insistent on working at non-profits and did that for decades as an accountant/auditor/comptroller.

Today, I cannot easily afford the same house even on a mid-high-end salary because the affordability ratio is enormous 2x or 3x. Forget about affording that house on a non-profit org salary.

Further, Bell Labs was a very safe job, you didnt have to worry about layoffs as much back then. So you could further afford things by making a bet on an affordable suburb. That is a harder bet today -- you move to some affordable suburb (which still isnt as affordable as it used to be) and suddenly you've lost your job. You better hope it is close to a commutable metro area.

Same thing with healthcare. Same thing with higher ed. I joined finance, and later tech, because I saw the writing on the wall -- not because I was "pursuing wealth" but because I was pursuing the same exact lifestyle my dad had as a default.

> [...] Many of the most brilliant human beings of that era worked for very modest salaries, and seemed content to do so. I wonder why it is that nowadays the "smartest" people tend to work in tech or finance and mostly pursue wealth. A few possibilities:

This is something in essence that some of us at MIT get told by faculty upon telling them that we want to go into industry. Behind it, though, there is often a fair bit of arrogance: many of them can not truthfully say that they would not do the same if they had to accept an academic position at a "tier 2" place, long postdoc, etc.

That said, the spirit of the point is perfectly fine. My own personal answer is that I have no personal issue with the compensation in academia; the associated "bureaucracy" which is far more severe today (paper/citation counts, and other things of even less significance) turns me away. It remains to be seen for myself how "industrial bureaucracy" compares with it. However, everyone I know has told me that in terms of personal happiness/fulfillment, people who leave are usually much better off.

I mention this as I had a conversation where someone essentially assumed point 1 or 2 rather than the distinct reason above.

On the other hand, why should brilliant people work for modest salaries, creating wealth for others?

The needs of the many outweigh the needs of the few?

A society grows great when old men plant trees whose shade they know they shall never sit in?

From each according to their abilities, to each according to their needs?

It is a very recent idea that the best society is created by everyone pursuing only their own self-interest.

>> From each according to their abilities, to each according to their needs?

Honestly curious about which country you live in? I know some Nordic countries operate this way, but certainly not the US. Here in the US the above strategy would be a crushing losing one -- because the latter half of the "agreement" does not hold.

Suppose you do offer from your abilities and dedicate your live to research, non-profits, education, whatever. There is no social agreement on the other side "to each according to their needs." It is not as if dedicating your life to good social causes suddenly causes massive medical co-pays/co-insurance/deductibles to disappear. It is not as if dedicating your life to good social causes suddenly lands your children a good education (more likely, you'll end up in an impoverished school district with lots of problems.)

What you're proposing works well when both sides of the agreement are in place. Other than that, people have go into social good knowing full well they may pay the cost.

I have a relative who runs a non-profit community medical clinic for those without insurance. From what I can see, the family lives paycheck to paycheck. If the roof breaks or boiler goes bust I can see them being in a lot of trouble.

They accepted this fact and still do it. But that is a very personal and risky decision. One cannot browbeat others into taking such risky decisions.

The question was what people should do, not how viable that is. It is up to the voters and the legislature to establish a society where doing what should be done is possible.

I agree that people shouldn't be blamed for looking out for their own needs first (within limits - when billionaires use underhanded tactics to expand their empires, they certainly should be blamed). But I also think working only for your own self-interest shouldn't be idealized, as is more and more the case in the US.

As for which country I live in - one where people are taxed based on their income (from each according to their abilities), and that money is used mostly to fund things for the common good, such as medical care, education, and a social safety net (to each according to their needs). The degree of this transfer is greater than in the US, but that's just it - it's only a matter of degree.

No it's not a very recent idea. That's incredibly myopic.

Allocation of capital is one of the most important roles in society, bar possibly the judicial system and maybe the government legislature. Not the most powerful role, but quite possibly the one that has the biggest practical impact on people's daily lives along with entrepreneurs. We want smart people working on it.

There is a lot to say on the subject of whether the financial system regulation is creating the right incentives. But there isn't really much room to debate that designing trading strategies is a waste of talent.

Yes, that and improving efficiency of markets, the go to arguments for wall Street types. I used to be a sell-side trader, allocation of capital was the last thing on our minds. It might add value to the economy in the long run but I'm pretty sure it's way too crowded now with little marginal benefit. If we took the underlying technology and man hours used to make something more useful I think the world would be better off. Something is seriously twisted in its current state

Everyone pisses on quants/traders but the market would be much less liquid if they didnt exist. You couldn’t easily take out millions of dollars out, if there were no eager buyers on the other end. Yes, their intentions are purely greed, but you can’t have liquidity without the arbitragers, traders and speculators.

> I used to be a sell-side trader, allocation of capital was the last thing on our minds.

Bit risky telling someone what their job is, but nevertheless I'd suggest you missed the forest for the trees. The profitability of a trading firm is directly linked to their ability to allocate capital in a way the market likes, and someone with great information thinks that hiring lots of smart people achieves their goals more effectively than hiring small numbers of smart people.

> Something is seriously twisted in its current state

100%, but it isn't the concentration of smart people in finance. That is a good thing - better more scheming bankers than lawyers.

Free market capitalism gives capitalists perfect freedom to operate in the sliver of the Venn diagram that connects what is possible with what customers will pay for. If they step outside that, they go bust.

If there is a problem is probably that the US government didn't let enough companies go bankrupt in the aftermath of the 2008 crisis, and the same idiots that were in charge then are still in charge, or their protegees.

>Bit risky telling someone what their job is

? Because...?

> Allocation of capital is one of the most important roles in society

Well...sure, but I don't see these people working to allocate capital to benefit society.

On the whole, the financial industry's influence tends to be to allocate capital to benefit the financial industry.

I get that liquidity is important, but it's not important enough that we should be siphoning off huge chunks of the money in the economy to give to these people as thanks for maintaining it. Frankly, that kind of concentration of wealth decreases liquidity and ends up, over the long term, being directly counter to the stated goal.

If that is the case, then index funds are antagonistic to that goal. Capital gets allocated to bad-performing companies just because they are in an index that is favorable.

Everyone should then actively decide what specific companies they want to put their capital towards. Instead of baskets of indices.

> But there isn't really much room to debate that designing trading strategies is a waste of talent.

Are you saying it's not a waste of talent?

That and figuring out which ad to show you...

I see your points but then the question becomes how to give them an incentive to leave those fields. It feels that they are the only one that pay and consider you to your true value.

I work in energy, and there's a big debate raging now about the externalities of fossil fuels. People working for the fossil industry make substantial salaries because their industry is not adequately taxed for the externalities their products are causing. If the fossil industries were properly taxed for externalities, my guess would be that salaries would be significantly affected.

Perhaps we should consider fintech and adtech to be similar scenarios? Fintech seems to have externalities that lead to ever growing income inequality. Adtech definitely has externalities on society in the form of increased susceptibility to foreign propaganda and mass surveillance.

I suspect the higher salaries in fintech and adtech are similarly inflated to fossil industry salaries due to the lack of taxing externalities.

Why would higher industry-specific taxes lower salaries in that industry?

No, that does not become the question. They chose money over morals, that's it.

It's not like they are helpless victims to economic principles, so they have no other choice than to work for the scummiest types of companies because they offer good pay.

Sure, you can stop there, if your interest is in moral judgement.

If you’re more interested in shifting the landscape, changing the incentives becomes the priority.

Only one of these puts a stop to the objectionable behavior and wasted talent. So I know which I prefer.

> If you’re more interested in shifting the landscape, changing the incentives becomes the priority.

Or changing laws to make the bad stuff illegal.

I'd be happy to make most ads illegal. In some places they banned all roadside billboards and you know what happened? It made the view better and didn't hurt the economy.

That's certainly one way to change the incentives, and it's one I happen to be open to.

The strange thing is the addiction, people make several million dollars, and then keep going.... Doing bad things for no real motivation (if you v concede that fear of poverty is a fair driver)

Good trading strategies always stop working (after fees) when they get commodified.

Really? I always thought the opposite is true: trading strategies work BECAUSE they get commodified. I mean, it's like self-fulfilling prophecy: if enough mutual funds managers look at the price chart, draw the same magic lines, apply the same magic formulas, then they reach the same conclusion "buy this stock". And then they start throwing their billions USD of assets at it, and the stock price actually starts climbing up.

But people who have better insight into the real performance of those companies can make more money if more people just apply magic formulas.

The most successful fund for the last decade(s) fits more one the magic formulas side (the Medallion Fund from Renaissance Technologies).

EDIT: Oops, I misread your comment.

I think both can be true, depending on the details of the strategy and the conditions in which it’s valid.

Sometimes common knowledge of a strategy can lead to the elimination of the situation in which it works. Participants can anticipate it and so the conditions no longer occur.

In other cases so many participants pike into the strategy, in which there is only so much money to be made, that returns get so thin that only the very most efficient and smart participants can get anything out if it. Arbitrage is a good example, once its known it can get traded out of the market very rapidly.

The stock market is basically a transfer of wealth from one person to another. For a good strategy to work, someone has to make a bad strategy. If everyone gets a good commodity strategy and applies it you will end up in a stalemate. Maybe not instantly but somewhere down the line.

Especially if they are effectively arbitrage - if it is easy money to buy 50 cent widgets, pay 50 cent for transportation and sell them for $5 in an area where they are for sale for $10 then someone can make a further profit by arbitraging your new price - and that is before supply and demand come into play.

At the end of the day arbitrage is zero sum, there is a fixed amount of money to be made from this market inefficiency (based on your margin, your costs and the amount you can buy and sell). Regardless if you are the only one doing it or not (if you are not you are competing for a piece of the pie).

Note that the strategies described in this article are not arbitrage nor zero sum.

These strategies have only been around while the fed has been heavily involved in propping up the US economy with artificially low interest rates and quantitative easing. So I am not surprised that the algorithms and models that have grown up during this period are now struggling now that the fed is trying to back off a bit.

I don't think that's right.

CTAs have been around since the 1970s. Momentum trading has been around basically forever.

The Fed under Paul Volcker raised rates over 20% in the early 80s to head off inflation. Before the crisis of 2008 rates were 5% or so. It's only after the GFC that rates have been lowered to near zero.

Also, according to the article momentum trading failed to deliver after 2008, while rates were low (and the market tripled), not just now.

The fact that trend following strategies are becoming less effective could be interpreted as a positive thing implying that markets are becoming more efficient, as trend following shouldn't work in a completely efficient market.

Trend following strategies are pure market followers and are not based on fundamentals, therefore they do not bring any new information into markets and are unlikely to improve the efficiency of a market.

If an algorithm existed that could predict the future value of stock prices, that same algorithm could be relatively easily adapted to see the future. Not only is that tech impossible, it's also depressing to think that a true Oracle's primary function would be to help traders make more money.

But does the future it sees include the purchases its about to make?

> But does the future it sees include the purchases its about to make?

Yes, absolutely. Go back to Greek mythology (or even the Matrix movies). Many predictions the Oracle made only came about precisely because the Oracle made those predictions.

Why does this article call them CTAs? Being a "commodity trading adviser" is a CFTC regulatory status, not a trading strategy. Those issues are orthogonal. One would have expected them to be referred to as algorithmic traders or algos or something.

My understanding is that CTA is a general term for a hedge fund that uses trend following strategies, primarily trading futures, but not actually restricted to commodities, so it's not a particularly accurate name, just industry jargon.

Too many people doing the same thing in a zero sum game—of course it wasn’t going to work forever.

Any algorithmic strategy will cease to work once it becomes generally known.

I once watched a bunch of card counting videos on YouTube. It didn’t matter who made them, all of them were basically N minutes of the guy cursing and complaining that the other players were getting the cards they should have gotten. This sounds like more or less the same thing.

Predicting the future works until is does not. This happens a lot more frequently than ome might think.

I always thought that HFT is a losers game.

There can only 1 be the fastest and those that invest their money this way, could probably used it in a better way.

And if you are winning. A small error in the algorithm could make you lose all of your profits. Rare events do happen and you haven't covered every case.

The interest rate based system of growth?

Market moves sideways - trend following underperforms ...

From the graph in the article article, trend following has been abysmal for the last decade.

> Between 2008 and 2018, Societe Generale’s main trend-following index made only 3.7 percent, compared with an average gain of 62 percent for hedge funds and a more than tripling in the S&P 500, including dividends.

The market performed incredibly well over this period. These algorithms didn’t even keep up with inflation.

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