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I mean, we've all been told the same thing, have patience.
And let's not even get started about the whole cut your losses mantra.
But how do we do that?
How do we have patience?
When do we actually cut our losses?
All the seeders and traders, they all say the same thing, but they have different systems.
And it's as if they were starting from these lofty principles and they're magically arriving to successful trading outcomes.
But the reality is it's not magic.
They're starting with solid research and a solid process, which just so happens manifests itself into these trading principles.
Markets speculation and risk.
This is the chat with traders podcast.
It's chat with traders episode 276.
Hello, this is Ian Cox, Tessa's co -host.
Tessa's taking some well deserved time off and relaxing somewhere where it's warm and tropical.
I'm glad she's getting the chance to take this much needed break.
Well, I'd like to introduce to you our latest guest.
His name is William Gogolak.
As a risk officer with the Chicago Mercantile Exchange, William was setting margin requirements and saw a wide variety of traders accounts and what separated the winning traders from the losing ones.
Before leaving to pursue his own trading and obtaining a PhD in finance, where he shared his knowledge of quantitative analysis and market experience with his students at Carnegie Mellon University.
Combining his market experience with knowledge of statistics and understanding the importance of probabilities helps William create his custom buy the dip strategy with futures and leveraged ETFs.
Okay, let's get right to it.
Hey, Will, where are you based out of?
I am in Pittsburgh, Pennsylvania.
Okay, great. What are you doing there?
So I'm currently a faculty member at Carnegie Mellon University teaching in Heinz College, just some basic finance tips and tricks, I guess.
Okay, great. Yeah, let's dive into your background.
How did you first get interested in the world of finance and investments?
Yeah, well, it's always fascinating to hear about people's stories, their unique backgrounds and kind of really how it shapes their path in life.
So I grew up in Indiana, not necessarily a farm boy, but also not necessarily a big city either.
Grew up just outside of Chicago.
And with that whole dynamic between the grain trade and the board of trade, it creates a unique backdrop that blends the rural and urban dynamics together.
Maybe it's just like a Midwest thing, but I always had a knack for research.
I always had a knack for markets.
What are these ticks?
What are these pips, 10 ticks, five pips?
And just trying to figure out the lingos, it was something that always interests me.
I think transitioning to my adult life in Chicago, when you drop a kid off on LaSalle Street who's interested in markets, it's like thrown in into the heart of all of it, right?
It's a seed planted in fertile ground.
So there's something about being that environment that just drew me into the world of finance, the hustle and bustle of the pit, the intensity of markets, the constant hum of activity.
I mean, it became almost addictive and I didn't exactly start trading from the crib.
Okay, I'm not one of these trading prodigies, but the markets always had my attention.
And seriously, what other profession aside from boxing do you start the day with a bell ringing?
So it was just a natural progression, finding my way from rural parts of Indiana to the trading floor.
Uh -huh, so were you introduced back when you were in Indiana to farmers who sold their grains on the futures contract?
Or did you know anyone in the business?
Yeah, exactly. And so that's right.
So it was super interesting because one of my neighbors, I was a kid, he was a grown adult, set up a trading desk in his basement.
I think he's a fairly well -known trader.
And so I got to see the speculative side and then like just also connecting the dots, 20 minutes outside of where I grew up was just farmland.
So it's like, what do these two people have in common?
Like nothing. So I did get to see both sides of that.
And I think that provided a very interesting backdrop into what shaped sort of my career progressions.
Mm -hmm, so you got exposed to the commodity side as in grain, soybeans, that kind of thing?
Yeah, so I'm talking grain, soybeans, cotton, cattle, corn, wheat, I guess we keep going, right?
But yeah, all of the, I would call them CBOT, the Chicago Board of Trade Products.
So did you know where you wanted to work right out of college?
I mean, what did you...
So I ended up working at the Merck, the Chicago Mercantile Exchange for CME Group.
But before that, I had landed an awesome job on the floor of the Chicago Options Exchange.
Now, imagine a rookie being thrown into the mix, working side -by -side with these personalities of traders.
And what was my role?
Well, I guess I was the data guy.
And honestly, I had zero clue what I was doing.
But hey, we laughed and learned.
I take what I do seriously, but I don't take myself seriously.
And whether that's in the classroom, in my work or in trading.
And I believe that this job before going to the Merck was actually a pivotal moment for me when I knew what I wanted to do.
And that was research and markets.
And I kind of just went off and did that.
Okay, so you knew early on that you wanted to get into research while you were at both the Options Exchange and then later you moved to the CME itself?
Yeah, so then later I developed myself professionally in what would call my first real job at the CME Group at the Chicago Mercantile Exchange.
What kind of positions did you hold when you first arrived at the CME?
Yeah, so when you work at the Exchange, you see everything.
And you really do see everything.
So during my time at CME, my role revolved around setting daily margin requirements for equity index futures and a few other smaller ancillary markets.
So back then, the market risk team was distinctly separated into asset classes.
And I was part of the equity risk desk.
And our primary focus was on consistently analyzing stress testing and ensuring that there are enough chips on the table from all market participants to cover any large potential market moves.
And doing that with a level of confidence as well.
In fact, it was 99 % confident that there would be enough chips on the table to cover any one day market move.
So there's 252 trading days in a year.
That means that our margin requirement would only be allowed to be breached 2 .5 times a year or two days out of the year.
1 % of the time. But there's a fine balance to setting this margin requirement.
Because if you keep the margin requirement too high, customers complain and they say, give me lower margin.
And if you keep it too low, it puts the entire system at risk.
So there's a balance there.
Now, the role of the Exchange is multifaceted and margin acts as the initial safeguard for the stability of futures markets.
And that's just one piece of the puzzle.
But that's where I fit in.
So what year are we talking about when you were first at the CME?
Oh, this was probably just more than 10 years ago.
And so setting the margin requirements, that was something that the Exchange felt that it was necessary to have a human input as opposed to having a computer algorithm figure out the optimum margin requirements.
Yeah, so I mean, there's a lot to setting that requirement.
They have a system, SPAN, excuse me, S -P -A -N.
And that system has worked quite well over the years.
It's sort of a VAR based model.
And if you really think about what is a margin requirement, it is VAR.
But at the end of the day, there is a human element to it as well, making sure that there's plenty of safeguards in place.
And you know, it is just one, margin is just one of the safeguards.
And there's more and more added each day, interestingly, I guess, for banks, the responsibility now falls on the American taxpayer, or at least the treasurer for that matter.
So what other aspects to managing risk are there then setting the initial margin requirements?
What about maintenance?
Does the maintenance level fluctuate with the initial margin requirements at kind of the same rate, or how does that?
Yeah, in most markets the maintenance margin is a direct function of the initial margin.
Now, when you start adding options to your portfolio, you've just introduced a lot of new risk factors, not to mention a moving delta, right?
So your gamma. And then correlation is brought into the mix as well.
So if you're long S &P, short NASDAQ, you will get margin credit for that.
But the way that it's kind of viewed is like its own position.
There are benefits to having a diversified portfolio or a delta neutral portfolio to help bring your margin down.
And how often did you find that raising the margin requirements would end up creating margin calls on people with positions?
Okay, so you don't, in my opinion, you don't want to do that too often, because what it does is it creates additional stress on the market, and there's actually a provision for this called pro -cyclicality.
And then there was a law regulations created called anti -pro -cyclicality.
And so what you're doing is you're promoting the cyclical selling of additional securities.
So, I mean, there's a balance there to have it sufficiently high enough, whereby you don't induce selling.
The Merck has been on the hook for, at least in headline saying that at some point they have caused something, but me personally, I don't think I'm a believer in that.
CME was once called the egg cheese and butter exchange.
And now it's grown to be a systemically important financial institution, quote unquote.
And they really haven't had any major disruptions, which is truly remarkable, at least to my knowledge.
I mean, they haven't had a technical default of a portfolio, meaning if you make money on CME, you're gonna go to the cage and get your chips and you'll be able to cash in for cash.
So not only have they provided us an arena and a marketplace that works pretty darn well, but they've also achieved just a darn good business where they got one of the highest revenue per person in the entire S &P.
And I think there's a night at the top of that castle that runs a pretty good castle.
So maybe it has something to do with the management in charge.
Uh -huh. I've often heard over the years, the gold bugs argue that there are more than 50 times as many paper gold contracts being traded than physical gold available to deliver.
And they argue that if just a few percent of traders stood for physical delivery, it would blow up the exchange due to insufficient physical gold available in the vaults.
Do you know, is this true?
And if so, why is it allowed?
Yeah, so the question of whether it's more derivatives than the physical asset really depends on a lot of factors and specifically the risk tolerance and the diversification and the liquidity of that position.
So not only does CME provide the buyer of last resort, meaning we will buy all of your gold if you want to sell all of your gold, but it's also a matter of liquidity.
I mean, CME has partnerships with liquidity providers, meaning there are people that are on the exchange and are sufficiently capitalized to take on any trade that comes through the exchange.
So it's not like the Merc has to, if the guy wants to sell all his gold, it's not like the Merc has to buy it all.
I mean, there will be liquidity on the other side because you and I both know the firms who are actively engaging in that market.
And oh, by the way, if you want to sell your gold, you're gonna have to do it in that large of a size, all of the world's gold.
You're gonna have to do it at a very high liquidity premium.
And there's definitely a market maker on the other side who's willing to take you up on that.
I see, but most of these contracts, they settle in cash, right?
But as far as the people who are long gold, if a very small percentage of them, the gold bugs argue 2 % or less of them actually stood for delivery and say, okay, I want my physical gold that the COMEX warehouses wouldn't be able to deliver.
Is that kind of an intentional flaw that they say, well, that's a very low probability or what's the reasoning behind that?
It seems like it's very risky, no?
Well, I mean, they're cash settled, excuse me, they're delivered in physical gold on the day of delivery, but it's cash settled on a day -to -day basis.
So it's not like all of that gold would need to be delivered on a single day.
The gold delivery would take place at the end of the contract.
And then there's limits, Ian, where if you're getting towards the delivery period, you actually have to show proof that you can sell the amount of gold that you have and or can buy the amount of gold that you own in the derivative.
And if you can't, well, you would have to roll your position into the next contract.
So there would never really be a situation where you would take on all of these gold bars.
The delivery process and the delivery window leading into the 20, 30 days heading into delivery, whatever it might be for gold would like stop that from happening.
Can you tell us what happened with oil and why did it go negative in price in 2020?
How is that even possible?
Oh, okay. So yeah, this is a really good just economic argument.
So of how derivative exchange worked.
When there's a central point of delivery where all the oil goes to, and that happens in West Texas.
So when we talk about what the price of oil is, that's the price of oil in West Texas.
By the way, there's many other prices of oil where delivery is taking place that isn't in West Texas.
But the ones you see on TV is usually Brent and WTI.
So what happened at the West Texas port is the boats were coming in to deliver the oil and there was nowhere to store it.
So there was no buyer who was willing to accept that oil that was on the boat.
They said, we don't have anywhere to put it.
And then the guy on the boat said, well, where do you want me to do with it?
I was supposed to give it to you for $65.
And what the guy in Lynn said was here, here's 10 bucks, turn around and go back home and take your oil with you.
So what happened was the people at the delivery point were actually paying to not store the gold, or excuse me, not store the oil.
And that's what caused a negative price.
I see. So it was a very, obviously once in a lifetime or once in a hundred or a thousand year event because of the constrained ability to store the oil that was coming in at that time, right?
Yeah, I mean, the question is why were the tanks full is because of the coronavirus.
I remember looking out my window out on Michigan Avenue and every maybe half hour two cars would pass by and it's like, well, gee, no one's driving, no one's burning gas, no one's in factories.
And we just ended up with way more oil in these tanks than we needed.
So that that meant that there was too much supply and they started paying to make them go away.
So did you get a chance while working at the CME to see the different types of traders accounts, what they were buying, what they were selling, any kind of analytics on common mistakes that losing traders do and separate successful traders from losing traders?
Oh yeah, absolutely.
So in my experience working at the exchange, I had the opportunity to observe a diverse range of trading strategies.
And on one end of the spectrum, you've got these Daredevil types who wake up, throw wind in the caution and practically roll the dice with their entire account.
And not surprisingly, this often ends in some serious losses.
And on the flip side, I've had the opportunity to monitor and review trades from some incredibly skilled traders.
And what hit me hard during my time at CME was how critical comprehensive risk management is for the game.
Like sure, we all chat about where to buy and when to buy.
But what I noticed was the ones that were making real money, the prop firms that were true professionals, they get that it's way more than just picking a direction.
So even the exchange itself does not pick a direction.
You cover both sides of the trade.
You come to CME, you've got to cover the longs and the shorts.
So they're actually directionalist.
And really good traders understand that, that the market could go anywhere at any time.
And they are actually, I believe, good traders are really just good risk managers.
As I see it, and they know a lot about the big picture too.
They're juggling a whole position, considering factors like their gamma, their theta, their vega.
And these insights, Ian, they extend beyond just options trading.
Like in the realm of futures, where we take on delta one positions, there's recognition that the rate of change can vary throughout the day, which like is by definition, like that is your gamma.
So there's, and also there's obviously increased volatility surrounding specific events.
So like having this second derivative approach, and I found that I think the distinction between some of these good traders and the outstanding ones lies in their ability to navigate market directions, but also their holistic approach and understanding and managing their entire portfolio.
That's probably one of the biggest things that I picked up while I was there.
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Now, did you pick this up because you're interested in observing individual accounts or did you guys have analytics tools that would actually analyze this and then you would review it and other your fellow coworkers would also look at this and then your bosses would talk about it?
Yeah, so basically, well, where did you gather this market data?
I think a lot of it was through observation of trading accounts because we did have account level positions.
The problem with that, the answer is we actually talk to these people.
But the problem with reviewing their accounts is you never know that if it's actually a hedge or not, because the futures market and futures and options are, I mean, by their existence from black shoals are hedging vehicles, not really speculative vehicles.
So you don't know if they're actually hedging what's on the other side of the trade.
So that's the problem with just reviewing the account.
But then we did have an opportunity to talk to some of the big accounts and the prop firms, they traded directly with the exchange and didn't have to go through a futures commissions merchant.
They were a future an FCM themselves.
Yeah, we would meet with them and talk to them and we would do these.
They still do them today, I'm sure.
Might be a little different, but you would have interviews and talk to the risk managers and some of the traders and find out more exactly about what the risks there might be in their portfolio.
I see, so again, risk management sounds like the very key differentiator between the successful traders and the ones that lose money?
I would say that a good trader is nothing more than a good risk manager.
Aha, so how does that look then?
Say you have two traders, a beginner and a very experienced one that say they're both bullish on oil, for example, and they both go long contract of oil.
What would be the difference that a successful trader, how would they manage that position versus the inexperienced trader?
Yeah, so it's a really good thing, a really good question.
And it's one of the things that kind of gets under my skin when it comes to reading some of these books on trading and definitely not podcasts, podcasts are great.
Listen to all your podcasts.
It's just the consistent just rehashing of trading principles.
I mean, we've all been told the same thing, have patience.
And let's not even get started about the whole cut your losses mantra.
But how do we do that?
How do we have patience?
When do we actually cut our losses?
What I've noticed is that all the seeders and traders, they all say the same thing, but they have different systems.
And it's as if they were starting from these lofty principles and they're magically arriving to successful trading outcomes.
But the reality is it's not magic.
They're starting with solid research and a solid process, which just so happens manifests itself into these trading principles.
So I really think it's about knowing your strategy and understanding what hand you're being dealt and what hand you're holding at every given point in the market.
So different traders and trading the same contracts would have different risk management levels that they're looking at that both can be effective.
Is that right? Because they have different, they're applying different strategies and for this position.
Well, let's just assume that they're even just applying the same strategy.
Okay, you get into the strategy and let's say that you get into a strategy and they both have a 60 % probability of win.
Well, what happens immediately after the next tick?
That probability changes.
And if there's one trader that doesn't know their probabilities and the other trader does, well, one's gonna be more successful than the other.
So it's more of a dynamic process than a discrete one where we just pick on the chart, click and say, go.
And we all have, we make our money.
I see. So it's a process of adapting to the market changes as a change that differentiates a successful trader from one that is not?
Yeah, I'd say so. I see.
So what are some of the, you mentioned that cut your losses.
Give us an example of most traders are accustomed to, well, set your stop loss at 5 % below or 10 % below or set it at just below support levels and then just let it run.
What's your view on that?
And would you make any adjustments or additions to that, to those statements?
Totally, all right.
But yeah, before we jump into the nitty gritty, let me sketch out the different kinds of analysis that we could be diving into here.
So if I were to break down all the investment research into just three main buckets, which is kind of funny, but it's okay.
And in fact, this is how I arrange my class when I teach financial investments at CMU.
So first up, we got financial, a fundamental analysis.
Fundamental analysis, it's like saying, I'm gonna pick up this stock because of these three solid economic reasons and for these financial reasons.
Okay, it's like saying, I'm gonna put my money here because the company's financial health is good, earnings are good, overall economic conditions look solid.
It's all about understanding the core factors of a company's value.
Then there's technical analysis, which is a bit like reading the language of stock charts.
You're looking for patterns and trends, and when certain lines cross each other, and when the price hits a specific point, it signals an opportunity.
But then last, you got quantitative analysis.
And quantum analysis involves crunching numbers and looking for anomalies or irregularities inside of the data.
It's finding those hidden patterns that might not be obvious at first glance.
And when you spot those, that's a cue to take action.
So honestly, not many folks can dive into all three of these trading methods at once, like drinking from a fire hose.
But I'm pointing this out because anyone trying to step into the trading game, figuring out where to start, which one of these three places is probably the trickiest part.
I mean, once you find something that works for you in those archetypes, you got half the thing licked.
And it's so funny because you got one group of people saying, stick with the economics, value and supply and demand, professors and academics.
Well, there's another camp that's like, just follow the data and price means everything.
So if you're just approaching this, it's so confusing.
It might take you ages to figure out what suits you best.
I believe that a good starting place, Ian, to answer some of these questions, when to cut your losses.
When should I get into trade?
What does it mean to be patient?
I think a lot of those answers is in quantitative analysis.
I think when you look at the quantitative analysis of whatever position you're in, those two oil traders, two exact same people, one's not doing quant analysis, one is.
The one that's doing quant analysis is gonna have a better way to enter and exit their positions using some of these principles.
Can you give us an example of a trade using quant analysis?
Exactly what are you looking for with quant analysis?
And does it differ much from commodity to stock to futures contracts, whatever?
Yeah, so I mean, does it differ?
Not really, but to get into what it is.
I often find myself drawing parallels to a poker table.
So even if you're not a poker enthusiast, you can at least appreciate the basic gambling analogy.
Think about when you turn on the World Series of Poker.
The bottom left, there's that little tiny screen for each player's hand that displays the probabilities of a winning hand.
I'm not sure if you're familiar with this, Ian.
No, not exactly, but please continue.
Yeah, so when you're watching poker on TV, they show you the player's cards, and then they show the probability of winning.
And it's thrilling for viewers because we witnessed the player's actions with these calculated probabilities, which offers insights into their strategies, personalities, et cetera, of the player.
Now, imagine the same scenario in trading.
Much like the poker player facing a hand, traders consistently confront the uncertainty of market returns.
And the key here is to understand your probability of success.
It's analogous to the poker player who armed with a few fundamental heuristics can reasonably calculate their chances of winning, let's say, regardless of the opposing player's hands.
And I think, sadly, many traders overlook the critical aspect.
They don't know their probabilities.
So when to make the right move in trading, everybody knows when to make the right move.
We're all waiting for this line to cross that line.
And you jump in because there's a just 60 % of chance.
But here's the thing.
You're not sure about the whole journey the trade takes from open to close.
That's where bringing in some basic quant statistics can be a big game changer for some of your listeners.
Imagine if you're a technical trader and you want to add a bit of number crunching to your strategies.
The first thing I would do is start by pooling some basic descriptive statistics of your trading returns.
Look at how the trade has returned, has behaved, at the one minute mark, the five minute mark, the one day, the one month, whatever suits your system.
This simple step helps you figure out the distribution of returns post execution.
And why does this matter?
Well, it's a straightforward way for you to answer some of those nagging questions like, should I bail this trade?
Well, if the position is in your favor, and it's in line with what happens only about 5 % of the time, chances are it's a smart time to cash out.
Also on the similar conclusion can be inferred from the downside.
So adding a basic touch of quant analysis can really give you a potential edge and shine light in dark corners on making some of these critical decisions in the market.
I see, wouldn't the quant analysis though be reflected in the chart action?
Like say, for example, most of the time a stock is kind of trending upward, but in this rare exception, the stock makes a huge spike upwards that looks like a giant wick on the chart.
And statistically that's a rare event, but you could look at the chart and you say, oh, I can see that's a very rare event.
Wouldn't that be confirmed by quant analysis or are you talking about something different?
No, yeah, I think so Ian.
I think if you look at the chart and you say, well, it's gone up a lot, right?
Let's quantify that, what it means by a lot, is that in the top 5 percentile, 10 percentile, 30 percentile and then make some decisions based on that.
If the market spikes, and it's only in the top 30th percentile, that can mean that the thing still has room to run.
And drive this and let's say it's just after a fed announcement.
Oh, now to really get it up, it keeps going, right?
So being aware of the context of the market also important.
But yeah, you see this on a chart, absolutely.
But it's unbounded, not bounded by anything.
So the use of quant analysis is done after you make the trade and you're monitoring it the whole time through or is this something that you do a bunch of back -testing on and you say, well, based on the back -testing, this is what I can expect.
Yeah, so I mean, the back -test provides a good place to start, but then what I'm, I guess, suggesting here is what to do with that trade after it's been executed, which you could also back -test.
So did you have these ideas when you were working at the CME and were you able to trade your ideas while you were there?
Oh, so good question.
I mean, after grinding at the Merck for more than a half decade, I thought, hey, why don't I try this on my own?
So I ditched the Merck and took a different job to pay some bills all while diving into the world of trading.
And I got so into it that I decided to take a plunge and get my PhD and want analysis.
I figured if I'm already doing the work, why not throw 150 grand at it and slap a comment after your name?
So, you know, there's this whole hype around, by the way, PhDs, I think, in the trading world.
And I used to think like that, Ian.
I used to idolize them.
And, but I mean, the deal is not every great trader needs a PhD.
And trust me, not every PhD is even a proficient trader.
So, you know, there's probably a lot of your listeners out there thinking, especially if they're younger, I mean, hey, should I get into this?
Should I get into this PhD thing?
Is that gonna help me?
Kind of, it's gonna help you.
It's gonna help you become a better researcher and understand how to do hypothesis testing and setting up the hypothesis and working within.
I mean, you can't really get out of a PhD without doing any programming.
So you do leave with some of those skillsets, which opens the door, in my opinion, two places.
One, a prop firm and two, academia.
I decided to go to academia.
So if you're not really interested in doing those things, you really don't have to.
I just, I do have the great pleasure now being so far removed from the Merck that I could trade my strategies on my own.
So was the catalyst for you to leave the Merck because you wanted to trade on your own, which you were prohibited due to restrictions?
I think that's part of it.
I think that's part of it.
I mean, I'm more of a, I consider myself more of a professor that does trading than a trader that does professing.
You know, I'm more interested on the research side of thing, but I would say that had something to do with it, Ian.
Why not? Is there any very simple entry -level quant tools that a trader could use that you could give an example of that a trader could implement fairly easily to enhance your trading?
Oh, sure. So to become oriented, orientating yourself in the market, I think that's just a good place to start.
And people in academia have been doing this for years.
And really what you're asking me is how do I actually turn the market into a probability machine?
Like, well, how do you do that?
How do you come up with these probabilities and know when to get in and out?
So let's just take it out of the market context for a second and let's talk about weather.
When we talk about it in the market sense, I think it brings up a lot of so many biases, right?
We're all reminded of that one trade and we can't clear our minds.
So I'm here in Pittsburgh and a place that has all four seasons.
And let's say Ian comes to me and says, I want you to predict tomorrow's temperature.
What's the best way that I could go about predicting tomorrow's temperature?
Well, first off, tomorrow's temp is probably gonna be a lot like today's temperature.
Also, there's another day out there that I could use, the 365th lag.
So tomorrow's temp is probably gonna be a lot like today's temp.
And that temp is probably gonna be a lot like what it was a year ago.
And then I could use the 730th lag, the 1095th lag and so on and so forth.
So even as a child growing up in Indiana, you could answer questions of when it's gonna get warm.
Well, it's gonna get warm probably after being cold for 90 days.
So sometime around the 91st day, it starts to be spring and warm up again.
So I mean, the same thing could be true in markets.
When will the market turn back up?
When will the market probably turn back up?
Well, after being down for nine days in a row.
So there's definitely places to look in.
Your question was, what are some simple things that people could look into to enhance strategies through quant analysis?
Look into streaks after something happens n times in a row.
Queuing theory, basic statistics of mean, medium and mode, whereas price relative to its mean, medium and mode, cycles and waves, distribution of forward returns, given existing conditions.
And then you have probability distribution.
So those are all really good places to start.
Well, this is a good segue.
Apparently you have a buy the dip methodology.
Would you care to share with us?
Yes, absolutely. I mean, people talk a lot about buy the dip, I guess not anymore, because of 2022.
Basically defining buy on the dip is a hard part in part of these discussions, especially what you see on Twitter and other sites.
What is the dip? Let's define the dip.
So are we waiting for it to be X percentage off its high, or are we waiting for a certain number of days off this high?
All those might be good strategies, but I kind of take a different approach.
What I try to do is compare the price, current price, and measuring it from a distance to an average price.
So I would define a dip as when current price moves X below an average price.
That's usually a good indication to buy.
I see. Is this where the price of the average true range expands significantly, like a kind of violent downdraft?
I would say more so, yeah, it's like an average true range, but I'm talking more so just a moving average, so price from the current moving average.
I see. So then in particular, do you look for certain moving averages to be breached or held at support?
Kind of what do you look for?
Yeah, so I like using a super long moving average, like the average of the last 1 ,000 bars.
You can make that your benchmark.
It's a pretty go -to average price based on some research.
Now, whatever timeframe you're working, so you could simply just use the 1 ,000 bars.
So when the price takes a dip, say 3 % below this very lengthy average, there's some research to suggest on my end that it's a good signal that the market might be in a shorter term overreaction.
So like the 1 ,000 minutes, so let's say we're using a 1 ,000 minute moving average bar.
One minute bars, 1 ,000 length moving average.
So that's about 16 hours, give or take a coffee break.
So if the market goes down 2 % to 3 % from its 1 ,000 minute moving average, that's a pretty good time to buy.
Now, let's say you're using a five minute bar instead.
You can still roll with the average price of 1 ,000 bars.
Quick math on that, that's 38 hours.
So yeah, it's like an average price over the last three and a half days.
And one current price moves again, about two to 3 % off of that average.
It's usually a good sign to say that it might be overdone.
Speaking of being overdone, do you ever look at other indicators like the VIX index or any other relative strengths?
Okay, so that's good.
So you're paying attention, thank you.
I thought you were gonna say some technical indicator that says overbought and oversold on it.
No, I don't use RSI or anything like that.
But yes, I will use the VIX.
There's a lot of information in that VIX.
It tells you a lot, and you could basically apply some of these same quantitative strategies on the VIX to tell you and infer information about the S &P, which is pretty sweet.
But yes, I will be bringing in other indicators and there's a ton of information in the VIX.
What I don't use, just to get back at what I was saying, was that I don't use like an RSI because there's additional inputs that are in there that I believe makes that indicator a biased indicator.
So I use price alone with some quant analysis.
I see. How many different inputs of quant analysis go into your model and do you frequently find that there's so many that it tells you just to wait?
I mean, how often are you getting signals to buy?
So that's a great question.
I mean, part of the reason that people don't like buying the dip is that you have to wait for a dip, right?
Or you have to force yourself into a dip, which I don't like.
But if you're using, say, between 10 and 15 factors, one of the factors may just be how far away are you from the moving average?
And another one might be how far has the VIX moved in the past five days?
Like from a principal component analysis, from understanding what are the factors that really drive the returns and drive the signal, it's really those two things.
So I mean, you could throw in other factors, but I haven't been able to really get much out of them.
You could keep them in the model, because why not?
They're not harming you.
If you're using the fast bars, if you're using a, say, a one minute bar, and you're waiting for a good setup, I don't know what my statistics are.
Yeah, I mean, you get a trade at least three times a week.
It's kind of like a swing trade.
Then sometimes you get stuck in these long trades, which I guess we could go into, and probably what you're going to ask me about next.
So what type of instruments do you trade with this buy the dip strategy?
Okay, so I would recommend, if you're looking into something like this, futures are a really good way, because it keeps your margin requirement low.
Levered ETFs are okay too, but you just got to be careful with those.
So buy at your own risk.
I mean, this whole strategy is buy at your own risk, because what you're doing is basically dropping, trying to pick up a falling knife, which will work, but you have to maintain good risk tools.
And I could go into that, but you could use levered ETFs or futures.
I prefer the futures because, man, we've seen what happened to some of these ETFs, like the VIX vortex, those things just blew up.
And I don't even know what happened with those people's money.
So it's very challenging to sit there and you got to know the product really well, and the risk management that they impose on the product.
We have circuit breakers these days, where if you did own something like the TQQ, the triple NASDAQ, three times the day returns, the circuit breaker is what, almost 10 % on that thing.
But I mean, you're getting whacked by 30%, at least, on that TQQ.
Notwithstanding, you don't even know what their margin requirements are.
So it's just something you got to be careful with.
That's why I prefer just making your own instrument with the futures if you can.
Then what do you look for risk management when you're buying something on the dip?
Is it - Yeah, you just start with a low position size.
You just start with the low position size.
You start building a position over time, and you kind of just have to do this, especially when you're using leverage.
And you take what the market gives you.
In the email that you sent to us, you mentioned that your comprehensive research and experience in the realm of trading has led you to discern that markets necessitate contextualization within the framework of conditional probabilities.
Could you expand on that?
Say we go back to that poker hand.
So market setups can be deceiving.
Like, you could start a good poker hand with a pair of threes, maybe a spade and a club, both black cards.
Seems promising, right?
You got a pair of threes and you probably have the winning hand right now.
However, when new cards are shown, much like the flop and poker, it can quickly transform your outlook.
So picture a flop with a king of hearts, a queen of diamonds, a jack of hearts.
All red cards, much higher than yours.
Suddenly, what seemed like a winning hand moments ago becomes a losing one.
And in essence, success in trading is like that of poker.
It hinges on knowing your odds.
Without a clear understanding of your probabilities of success at every moment, the principles and advice often just lose their effective.
You got to know your hand, gauge your odds and play your cards wisely in the unpredictable game of the market.
Say in stock terms, if somebody's long as stock and then they go through earnings and earnings disappoint, the stock has an initial gap down, then would that then be an example of, well, given the framework of what's going on right now, just get out of the position because it's not a disappointed earnings
and the market has voted.
Yeah, I would say that just depending on what your original framework was, if you're coming from a fundamental analysis framework and you buy stocks that have good earnings and then you don't have good earnings, you got to get out of the stock.
Now, if you contrast that with buy on the dip, which is probably one of the challenges with mean reversion is that, well, I bought it at 30, I love it at 20.
And that is true, in of a sense.
And that's just one of those things that if you're doing analysis on a buy on the dip strategy, you could get caught up in a trade if you don't have proper risk management and position sizing.
So I would say in the context of, this is what I meant by contextualizing your position.
In the context of fundamental analysis, you get out of the trade.
In the context of buy the dip, quantitative analysis, you buy more.
So I think we just need to be very clear on what we're suggesting to each other when we're talking about strategies because contextualizing them within your framework of how you analyze the market is super important, right?
It's of the utmost importance to my opinion.
Excuse the last interruption here.
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Thank you. Now back to the chat with our guests.
So do you ever look at commitment of Traders report and to see the extremes in bullishness or bearishness and say a lack of reaction when on really, really good news or actually a bounce upwards on really bad news as an indication of this contextualization that the bears have run out of steam or the bulls
have run out of steam and it's ready to reverse course?
Yeah, so the commitment of Traders, it's printed and made by the regulators at the CFTC.
And what the report does, it breaks down the open interest of futures and options markets for various commodities.
And it basically says, what are the activities of different market participants, including the hedgers and the speculators?
So I believe that commitment of Traders report actually is one of the features or one of the reports in the market that I think is technical in nature, meaning overbought and oversold, that actually gives us a lot of information about where prices and why it's there.
The problem with a lot of these reports, Ian, is that they're so delayed, they don't get published always at the same time.
It varies by market that what you're trading.
So there's this huge lag effect.
And then not to mention there's all these revisions.
I'm not sure if the commitment of Traders report gets revisions, but relying on some of those reports from the government are just, they're not always timely as the market.
So that's one of the reasons I don't like it.
But I think it's one of the few that really does tell you about what people are actually thinking and why they're expressing their bets the way that they are.
Do you ever look at that for yourself in your own trading as times to increase your position or decrease your position based on rare extremes that you see in that - Not really, not really.
I think more points towards the VIX.
There's plenty of mean reverting strategies that use the commitment of Traders.
I just haven't done that.
Perhaps maybe it's a good place to look into.
So what do you do then during these times with incredibly low VIX numbers that we see in these long grinding upwards bull markets?
Yeah. How do you buy the dip then?
Well, that's the thing, right?
So it's always worth carrying some position in the market.
I mean, I'm talking an equity long, okay?
Because in the buy the dip strategies, how the buying principles work with buy the dip, it's oftentimes what they do is they say either you're in a trade or you're not, right?
So you wait for the trade.
When you get the trade you enter and then you get out when it reverts back up and then you sit there and you wait again.
I actually don't find that to be entirely productive.
I mean, what's a good thing to do is be in the market, right, because there's this natural tendency for economies to grow and whatnot.
And then once you get an opportunity to buy the dip, you could slowly begin to add leverage to that position where you end up actually building a portfolio, a levered portfolio as the market continues to go down.
So while you're waiting, you just sit there and wait.
So we went through an expansionary period in the markets right after COVID, everything mean reverted, it went back up and you have a long Delta One position.
2020 comes around, you begin to sort of get into a position and then that bounces back and then now you're sitting towards that high again and you're thinking to yourself, okay, do I de -lever this position and just get back into the Delta One or do I keep letting my dip strategy ride?
Yeah, I'm just curious, do you ever see a time where the dips in the US markets get shallower and shallower because of the necessary money printing that's needed to just even service the debt with the runaway debt situation?
And the reason why I ask this is because I notice other markets in the world like Argentina, Venezuela and Turkey, their stock markets perform incredibly nominally because of the massive money printing, despite the economy not doing so well.
Do you see traditional technical analysis being impacted by massive money printing that flows into the markets?
Pretty good, that's exactly where I was gonna go.
So first of all, the dips get shallower and shallower at the top, so there's actually some, based on some of my research, to suggest that perhaps maybe at the top of a market, like we're getting towards our highs again, it's actually not a bad time to do a dip strategy on a shallow dip, so that's just
one thing there. I think your question was more along lines of macro houses on economies.
Yeah, so think back to like the depression.
In 1929, there was no financial safeguards, I mean, very little.
And then over time, we've built up all of these safeguards to protect not only American workforce but also support American markets and American banking systems.
So yes, empirically, what we have seen is our dips are getting, maybe not shallower.
They are getting shallower, but I'm not totally convinced of that.
But they are quicker, a lot quicker.
Think about our most, think about people that are relatively new to the markets.
What I mean by that is one or two decades.
We've seen some hard and fast dips, right?
That's what we believe to be a dip.
And there was lost decades in the past.
So they're actually happening more frequently and at a faster pace, which actually sets up for a really good trading opportunity.
Any other advice or suggestions that you would like to present that traders may not have considered?
Yeah, so I would just say, if you're getting into trading, starting with a research frame of mind is a good place to start.
That doesn't mean you need to go get a PhD in finance or go spend a bunch of money on courses or whatnot, but pick up books on games of chance.
There's actually a book called Games of Chance that's worth reading.
Pick up books about how systems work.
Those are really good things to help orientate yourself in your trading.
Like if you're obsessed with this and you're obsessed with researching the markets, you're gonna find a way to start to connect the dots with anything you read and do.
So I would just urge people to, especially if you're new to the market, to hone in on how your system behaves and just general market behavior in the context of quantitative analysis.
Great, well, what are you most excited about now as far as any goals that you're working on right now?
Yeah, so I'm working on creating all these probabilities and figuring out a way to always know what the probability in the market is, whether it's an up or down.
Like if you think about the scale from negative 100 to positive 100, meaning negative 100 is completely short, always be short, pressing your short and positive 100 is 100 % long, more than 100 % long and pressing your long.
You know, where are we right now?
Like what is the market presenting?
What price, the market is showing us a price right now in the S &P, where is that on that spectrum?
So I'm super excited to look into where I should be orientating myself at any given time in the market, which I think is really impactful to make some research and trading decision.
How often do you get impacted by paralysis analysis?
When you have an idea and you have an inkling that it might work, just you could go with it and you could start trading that idea in low numbers.
Definitely continue to research that idea, but I find there's no better way to test the system than in the real market.
So start low, get to know it and that's probably the best way to do it.
So nothing holding you back there.
Oh, great. Will, I wanna thank you for sharing your experience there at the CME and your, all the things that you've learned in the statistics, in the markets with us here at Chat with Traders.
Thanks for coming on the show.
Thank you, Ian. You've reached the end of this episode of Chat with Traders, but rest assured, there are more episodes loaded with real market insight and zero hype on the way soon.
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