We're very happy to have caught this one.
I've followed @cloudy_cl, Chief "Inshallah" Trader on Twitter for a long time, and apart from his banter, he has some fantastic insights, especially more recently (I reckon he's cracked the code about providing top level insights from a perspective of experience).
In this case, his experience comes from one of a quant perspective, but like with many successful quant guys, he understands the absolute requirement for discretionary views too (basically, what is the context of the market from a human perspective and not just what a model is shouting at you).
Which is what this piece is focused on.
It's excellent, so make sure you bookmark it for future reading.
Without further ado, I welcome Cloudy to the floor!
The aim of this piece of writing will be to elucidate my thoughts upon the nature and importance of intuition in the context of Quantitative & Discretionary Trading.
N.b, in italics are my accompanying comments, caveats and further reading.
This is by no means a comprehensive piece of writing designed to quash any and all doubt, nor make every piece of analysis explicit - I do not have the time, patience or care for that - but an essay that is first and foremost designed to make you think.
With a healthy dose of snark!
This would never have been produced without a prompt from the excellent @VitruviusCurve’s thread on "Do Quantitative Traders have 'gut feel'?"
Gut feel = the role of intuition in trading the financial markets
Go shitpost in his comments, he loves it.
I had initially planned to just release this essay to my followers on Twatter, most of whom have been following my shitposts for a while and thus know my background.
This essay however has morphed beyond its initial scope and so now is aimed at a much wider audience, thus I thought it’s appropriate to tell you a little about myself and why exactly I know what I am talking about.
- 30 Years actively trading at institutional level.
- Cut my teeth in Physical Commodity Markets trading Oil, Metal and whatever I could get my grubby mitts on.
- Moved to Commodity Derivatives to Equity Derivs et al. Got very well versed with Quants here.
- Currently, running a multi-strat HF in London with a focus on Crypto, Equity Indices and Special Situations Trades.
- My partner is the Quantitative, myself being the Discretionary Chad, we are Yin-Yang personified.
Caveats and Twists
I do not believe in objectivity at all, especially when it comes to money and even more especially when it comes to human programmed automatons.
Essentially anything programmed by a human to act on their behalf.
This is because our "reality" (you can assume this to be your sense of the world) is a function of the inputs into our mind.
Whilst those inputs might* be the same - there is absolutely no guarantee they are being processed the same way. The simplest example of this would be the idea that everyone feels pain differently.
*Quantum Superposition tells us how.
Let’s say you took a robot and pinched two people with the exact same force in Newtons. Whilst the force might be objective and cold, the subsequent feelings of pain - and therefore the person's reality could be very different.
For a photon of light can behave both as a particle and a wave at this same time, and it’s only upon observing it does it collapse into one state or the other - Our mere observations can change our perceived objective reality. How could one claim to be objective when one has an influence on the outcome?
To me, Descartes’ Demon is a perfect summarization of this.
For those not familiar...
Following this only leaves "objectivity within reason", e.g.: Controlling all variables apart from one... which works very well in natural science.
I don’t think I need to explain that it doesn’t in markets. Thus, the concept of objectivity within markets is shot down.
You know that you yourself are incapable of reaching an objective outlook, markets are merely the interaction of millions of traders, thus it would follow that the interactions of millions of non-objective (subjective) participants would also be chaotic.
Following this I would also like to give an aside to Emotions...
This is lifted directly from "The Laws Of Human Nature" - Greene
Emotions evolved for a different reason than cognition. These two forms of relating to the world are not connected seamlessly in our brains.
For animals, unburdened by the need to translate physical sensation into abstract language, emotions function smoothly, as they were meant to.
For us, the split between our emotions and our cognition is a source of constant internal friction, comprising a second Emotional Self within us that operates beyond our will...
This gives an interesting light to the excuse ’I was not myself’ you give after a rather emotional outburst. Could it be that when we give into our emotional selves, we truly see our character?
I believe this makes sense as you are suddenly making decisions without the need to temper your thoughts, the ’emotional’ self is in control and any unsavoury aspects of your character you may have been repressing consciously will suddenly have the opportunity to make an appearance.
Many might be tempted to imagine that we have somehow tamed this Emotional Self through all of our intellectual and technological progress. After all, we don’t appear as violent or passionate or superstitious as our ancestors...; but this is an illusion*.
Three Words: Wall Street Bets:
Progress and technology have not rewired us; they have merely altered the forms of our emotions and the type of irrationality that comes with them...
Our continual connection to social media makes us prone to new forms of viral emotional effects.
Ties in beautifully to what Jung says about how, although we may have become outwardly more ’civilized’ we are actually regressing internally. Less introspection and more outside projection.
These are not media designed for calm reflection. With their constant presence, we have less and less mental space to step back and think.
We have seen this play out time and time again within financial markets. Whether it’s Tulips, Technology Stocks or failing retailers, the madness of crowds has always been a visitor in the arena of markets.
The Quantitative among us would have us believe they have evolved past this!
They would have us believe that Nein! Only cold-hard statistics can save us from ourselves, only by the nail of silicon will irrationality within markets be crucified.
But they forget that whilst the code itself might be pure, the code was a by-product of an all too human creative process...
They forget the algorithm does not control man, man controls the algorithm.
In the midst of a major market stress, the algorithms could still do their job, but man throttles them...
Objectivity Within Human Programmed Automatons
I have previously talked about how emotions colour every single part of our perception. Emotions are continually affecting our thought processes and decisions, below the level of our awareness.
And the most common emotion of them all is the desire for pleasure and the avoidance of pain.
Also known as Hedonism!
Our thoughts almost inevitably revolve around this desire; we simply recoil from entertaining ideas that are unpleasant or painful to us.
We imagine we are looking for the "truth", a concept debunked in the above paragraphs.
The Quantitative among us have regressed into their bubble of mathematics to avoid the brutal reality that some things in markets... simply cannot be modelled.
Uncertainty and trading are two sides of the same coin.
The Discretionary among us indeed understand this uncertainty far better, however suffer from lack of true structure within their thinking.
This is where a hybrid approach of Discretionary guided by Quantitative comes in.
Brings to mind a quote from Le Bon from his book 'The Crowd':
The masses have never thirsted after the Truth. They turn aside from evidence that is not to their taste, preferring to deify error, if error seduce them. Whoever can supply them with illusions is easily their master; whoever attempts to destroy their illusion is always their victim.
When we are holding on to ideas that bring a release from tension and soothe our egos, they make us feel superior. I have previously done a thread on emotional triggers within markets and will repeat them here;
- Are you angry? Angry at the market, or yourself?
- Are you upset? Upset at the market, or yourself?
- Do you enjoy it more when you are correct on a long or a short?
- Do you enjoy the thrill of shorting in a rampaging market?
- Are you scared of the market turning against you?
What makes you think that when you are coding a quantitative strategy, you are not falling prey to those very same emotions?
What makes you think that your lovely momentum factor isn’t a by product of your very human tendency to chase trends?
What makes that Quant who’s programming a shorting strategy not believe he is relying upon his very human urge to be "different" and short within strength
As you start your "Alpha Research Process" you are relying on what?
Anyone who has ever tried this approach understand it’s a completely fruitless exercise. Instead, even your cold, silicon-worshipping brethren rely on their very human creative powers at every step of their strategy development process.
"Objective" Trading systems merely take the human execution error out of the equation.
Approaches like HFT/UHFT are in their own league, they are arbitrage
plays, not speculative.
Intuitions Role Within Markets
A simple way to quantify mean-reversion in markets would be to use the Bollinger Bands Technical Indicator.
Go long when a candle closes below the n σ lower band, and go short when a candle closes above the n σ upper band.
Now academics love Technical Indicators because when examined in isolation they provide ample evidence of poor predictive capabilities in the long run.
Academics love patting themselves on the back, and that is why we are awash with papers detailing the failings of single technical indicators - those people would scoff at the above statement.
Indeed, I would not fault them... but when did anything work in isolation in markets...
Say we were to filter the underlying trend of the market by a n period moving average, if the price is above the MA = uptrend, if the price is below = downtrend.
This concept has alpha, we deploy this strategy at my fund.
But why does a simple combination of two of the most debunked technical indicators work here?
Debunked is used extremely loosely here, as if anyone publishing quantitative markets trading research for a living is worth a dime
Because Mean-Reversion is an emotional phenomenon!
Investors are generally loss averse & fearful > Over-Zealous in selling off assets during volatility shocks > Price sells of to an extreme as negative momentum effects kick in > People pile in seeing it as "cheap", positive momentum effect > FOMO > Phenomenon of mean reversion.
This is also a reason why, again in the words of @VitruviusCurve, you must embrace both momentum and mean-reversionary outcomes.
- The σ you use is a proxy for FOMO, think of it as the willingness of market participants to BTFD.
- The MA you use is a proxy for crowd sentiment*.
*Two Words: Recency Bias - this concept has the most alpha out of any other mental heuristic.
Our Quantitative Brethren’s 'Objective Statistics’* is rooted in the emotions of crowds... and when have those crowd emotions ever been stable?
Think: "When Asset X moves blah blah down, it goes back up blah blah percent in blah blah time"
Hence, the phenomenon of Alpha Decay...
This all serves to make a simple, but extremely powerful point;
Pure mathematics cannot serve as an effective proxy for Human Emotions because they are rigid, unlike the fluid nature of emotions
I am using the definition of the "market" merely being the representation of thousands of emotional interactions between traders.
This is why you see the performance of quantitative strategies taper off!
Again, Alpha Decay is rooted in social effects, not mathematical.
The phenomenon the initial mathematics captured either broke down, was arb’ed away or shifted to something else!
The best example of this in recent history would be anybody who has been shorting TSLA. Historical statistical comparisons show us that is it "over-valued" and the asset price gains are 'unsustainable'... yet it kept on going up.
What the Quanty boys had failed to account for was the cult-like emotional effects that bonded the mainstays of the stock together. As I write this we saw the Trump SPAC go on an absolutely parabolic rise, does anyone seriously think a failed businessman like him will do anything with the SPAC? Fuck No! We are merely seeing the emotional allure of the man being translated into price action.
Understand this and when the next $GME comes along, grab on, ride the price action, and jump off...
Within VC’s original thread, he talked about the concept of watching your trades. Now this could be on the tick level or on the DOM level (I always used the DOM) but the underlying point is you should be watching trades.
Whilst at first this might seem like a passive, useless activity, when you understand the concept of Neural Plasticity it has very far-reaching consequences...
I will reference now another thread I wrote upon this topic:
"It’s not just repeated physical actions that can rewire our brains. Purely mental activity can also alter our neural circuitry, sometimes in far reaching ways.
In the late 1990s, a group of British researchers scanned the brains of sixteen London cab drivers who had between two and forty-two years of experience behind the wheel.
When they compared the scans with those of a control group, they found that the taxi drivers’ posterior hippocampus, a part of the brain that plays a key role in storing and manipulating spatial representations of a person’s surroundings, was much larger than normal.
Moreover, the longer a cab driver had been on the job, the larger his posterior hippocampus tended to be" - The Shallows, Carr.
What this short extract, and more importantly the concept being talked about, really implies is that;
Every input into your mind has a subtle & unconscious effect on the way you process information.
It is also why I am a big advocate of being very quick with your blocking fingers and to thoroughly filter your life. We might be able to consciously tell ourselves that we don’t care about what the idiots say, but to our Lizard Brains, Information = Information, and it all gets processed just the same...
Now it is clear to see that when you are watching trades you are not merely passively observing what the screen is showing, instead your unconscious mind is learning and relearning patterns within the markets that you are not consciously aware of...
It is developing gut-instincts
There is a reason that every single legendary discretionary trader spent a very sizeable amount of time in front of charts... Some part of them understood this concept of needing to observe markets in action to develop their innate skills.
Indeed, some of us are born with a better capacity to absorb unconscious information, but every single one of us can develop the same capacity with consistent, conscious effort.
The distinction between watching trades vs charts is also very important too. When the psyche has something to lose, for example the pain of a losing trade, the mind’s attention centres light up much more strongly therefore you open yourself up to absorbing much more unconscious information.
This also ties in with our innate negativity bias. The human brain has evolved to place a much bigger emphasis on negative emotions than positive (as that was tantamount to survival at the time) and this leads to negative ideas commanding much more attention than positive.
I see the power of these unconscious pattern recognition skills everyday on my trading floor. A trader might execute a trade and immediately go pale or look uneasy...
Their unconscious pattern recognition skills, their intuition, merely had to float an idea up to their conscious mind to let them know they made a mistake... 9/10 times it is correct.
"Intuition does not say what things mean but sniffs out their possibilities. Meaning is given by thinking" - Carl Jung
WTF does this have to do with Quants?
Well this whole essay serves to act as a starting point to understand and think about the 'Alpha Generating Process'.
Why do we deploy the strategies we do? Choosing our strategies, Quantitative or Discretionary, is a creative endeavour!
Aside from pure arbitrage plays such as HFT or especially UHFT, at least one part of your trading process (and I can likely guarantee more than one) relies upon human input.
How you choose your actions here is a direct product of your personal creative process.
You are not painting a picture with paint, you are painting it with data - Discretionary & Quantitative.
The market is akin to an abstract painting - everyone will see something different and nobody is correct.
I am super proud of this line.
Above, you can see a picture of one of my favourite artists of all time, Jackson Pollock.
Much of his work at a glance looks chaotic, noisy and messy* but upon closer inspection one can see how the lines join together, how there is order in the chaos, how every market participant might be joined to another thorough a seemingly incoherent web of trades...
The Discretionary trader will aim to watch and absorb the painting, relying upon pre-existing information filtering process’ and Jung’s "Free Association."
More on this later...
The Quantitative trader will aim to methodically work through the painting, aiming to convert first principles research on investor behaviour into mathematical syntax.
Both will utilize their creative powers to do so.
There is no objective answer, they are two sides of the same coin.
Understand... Creative Powers & Intuition are not cousins, they are twins. When an idea "suddenly" pops into your mind, it’s not sudden at all.
It has been simmering within your subconscious just waiting for the correct external stimuli to break through the surface of your consciousness, this is where Jung’s "Free Association"* comes into play.
*Free association is the process of letting your mind wander and form conclusions on its own.
Below, I would like to share an excerpt from "Man & His Symbols" - Carl Jung:
"A colleague told me of an experience he had during the course of a long train journey in Russia. Though he did not know the language and could not even decipher the Cyrillic script, he found himself musing over the strange letters in which the railway notices were written, and he fell into a reverie in which he imagined all sorts of meanings for them...
...One idea led to another, and in his relaxed mood he found that this “free association” had stirred up many old memories. Among them, he was annoyed to find some long-buried disagreeable topics—things he had wished to forget and had forgotten consciously...
...He had in fact arrived at what psychologists would call his “complexes”—that is, repressed emotional themes that can cause constant psychological disturbances or even, in many cases, the symptoms of a neurosis... ...This episode opened my eyes to the fact that it was not necessary to use a dream as the point of departure for the process of “free association” if one wished to discover the complexes of a patient. It showed me that one can reach the centre directly from any point of the compass. One could begin from Cyrillic letters, from meditations upon a crystal ball, a prayer wheel, or a modern painting, or even from casual conversation about some trivial event..."
Now I would like you to direct your attention right at the of the passage where it reads "One could begin from Cyrillic letters, from meditations upon a crystal ball, a prayer wheel, or a modern painting, or even from casual conversation about some trivial event."
This is what I believe is the most pertinent point to trading markets - Ideas can come from anywhere.
The medium does not matter...
Many of us will have gone through long periods of stress where we have a tough problem to solve and no matter how much mental energy we devote to it, ideas stubbornly refuse to appear.
Upon abandoning said problem and moving onto something else, we are suddenly struck by the answer - usually whilst doing something very mundane - the perfect climate for free association to occur...
Remember, our subconscious is always working*, even when your conscious mind is not!
Beware: This is a double-edged sword - the mind does not see good or bad, it merely sees information. If you do not filter what you are exposed to, you might just end up devoting much of your subconscious mental energy to topics your conscious mind would be loathe to...
This is where trade-watching again becomes so important. As you are going about your day your mind will constantly be re-watching the tape, constantly seeking connections and through neural plastic processes it will become much more receptive to alpha research over time...
I have focused on trade-watching throughout this essay, however this is not the only technique one can utilize to become more receptive to effective alpha research.
Another key technique I have learnt over the years is extremely simple:
Pen and Paper! No Technology! Spend some money, get a nice set - I still have the same pen from 15 years ago and the same type of notebook
Start with an observed phenomenon in the markets, let’s take the tendency for the market to shit itself in the week leading to Option Expiry Friday. Start with that as your point, now build a chain of reasoning;
- The market has dropped x% for the past n months around Option Expiry (OpEx) Friday.
- So what? Why is this happening?
- Who is being forced to sell?
- Why does the market go right back up the next week? Who is buying?
- Why is it always staying within the same range as it sells off?
- How could I verify my information?
Hint: Financial News will not help you here.
- How could I deploy capital to trade this phenomenon?
LOL, Something Sven and VIX Technical Analysis crew have never bothered to ask themselves.
The Philosophy nerds among us will understand this as "Socratic Lines Of Questioning."
I prefer First Principles Research.
These are highly probing questions that are very difficult to answer but as with anything...
Anything worth doing was never easy.
Notice how I have not specified anything to do with Discretionary or Quantitative trading here at all... This was on purpose, as I would like to use this point to illustrate how Quantitative and Discretionary Traders are two faces of the same coin.
Both traders use this process in their alpha research process, just the key difference between them would be how the strategy is deployed.
The Quantitative trader would aim to remove all human execution error out of the equation and use statistics to determine if the strategy is viable, whereas the Discretionary trader would use... their discretion!
Healthy Psychology & Intuition
'What we already know will block what we have not learned yet.'
This is lifted directly from "The Disciplined Trader" - Douglas, essentially the bible of Trading Psychology.
Obviously, acknowledging there is something that we need to learn is not as easy as it sounds. In fact, acknowledging that we don’t know something or that what we do know isn’t very useful or effective presents us with one of the major paradoxes of life.
The dilemma we are confronted with is how can we know what we don’t know when what we have already learned will block our perception of what we haven’t learned yet. For example, once we learn that trading is easy (the first few quick winning trades will establish that belief), it will block our perception of information to the contrary, that trading is probably one of the hardest endeavours one could choose to undertake.
Each of these beliefs—that trading is easy or trading is hard—would result in the perception of completely different choices as being available from the environment, resulting in very different outcomes based on the choices perceived and acted on.
I am tempted to just leave this here for the reader to decipher, but I will prompt you in the correct direction. Focus your attention upon this passage:
Each of these beliefs—that trading is easy or trading is hard—would result in the perception of completely different choices as being available from the environment, resulting in very different outcomes based on the choices perceived and acted on.
The mental state you are in will directly influence what information is consciously (and in extreme cases of ignorance) even unconsciously available to you. Your Alpha Research process relies precisely on those two funnels of information therefore it is only a short hop to understand that:
The mental state you are in will directly affect your alpha research process.
Now immediately you might say "WeLL DuH CloUDy OF CouRsEiT DoEs"*... well what are you doing about it?
If you said this...ngmi.
Are you leaving your mental state up to the whims of others in your environment? Or are you employing Consistent, Focused, Positive effort in creating the path of the least resistance to your peak mental state?
I have done a thread before on practical ways you can influence your mental state (albeit indirectly) and this is reaching to be out of scope for this essay, so I will leave the reader to take the initiative on this one.
The overarching point however is that you want to set yourself up to be in a position where there is the least mental friction between a great idea bubbling away in your subconscious and your conscious actually putting it into practice.
“First say to yourself what you would be; and then do what you have to do.” – Epictetus
There is no conclusion.
As I said at the very beginning, this is an essay written to make you think and 30 years later I am still thinking about this concept.
We will never ever have a definitive answer to this question because, like the best philosophical questions... the answer is always 'somewhere in the middle is the correct answer.'
I have no intention of spoon-feeding you analysis or answers, but I will leave you with this:
- Take responsibility over your mind.
- Take responsibility over your actions.
- Take responsibility over your attitude.
- Consistent Positive Effort can shake mountains.
1% improvement in yourself every day compounds into being a 37x positive improvement in yourself over a year...but this also works for a 1% dis-improvement.
- The best time to start was yesterday, the second best is right now.
- Stop being such a pussy and demand the best from yourself.
I only want to thank my ammi... joking, there’s lots of people I have interacted with through Twitter that have purposely or inadvertently set off Free Associative Processes in my mind.
• The many randoms who come into my DMs with wild stuff that just makes me... think.
Coherent thoughts are appreciated on Twatter Twitter. Shoot me a DM or tweet.
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