Sunday, June 12, 2011

What Richard Pryor Can Show Us About Trading

Do you remember the movie Brewster's Millions with Richard Pryor?
"Brewster is a minor league baseball player. Unknown to him, he had a (recently deceased) rich relative. In order to test if Brewster knows the value of money, he is given the task of disposing of $30m in 30 days. Brewster isn't allowed to have any assets to show for the $30m or waste the money in any way. If successful, Brewster gets to inherit $300m. The biggest problem of all however, is that Brewster can't tell anyone what he's doing, so everyone thinks he's crazy. Add to this the fact that if he fails, two scheming trustees will get their hands on the money, Brewster's task is not an easy one." Written by Rob Hartill

What can Richard Pryor teach us about trading?
We strive to make large sums of money, without draw downs using our trading plans. What if we tried to lose large amounts of money, on purpose? Are the two plans diametrically opposite?

I forget how the movie ends, but it was produced in 1985. No spoiler alert.
Richard Pryor and John Candy are close to ruining the whole thing by being lucky.

What does luck got to do with it?
Maybe in the comments section you can add more components, but I am conveniently breaking down my conceptualization of trading into three parts - Knowledge/Experience, Natural Talent/Skills and Luck Dependency. Luck remains constant, and is shared by everyone. The probability of chance is 50/50 chance of winning. To increase the probability of success you need a trading edge. The other two parts determine your success rate.

Legend A - Knowledge & Experience B - Natural Talents & Skills C - Luck Dependency

What does talent have to do with it?
I have seen other blog articles of what natural talent or skill is required to learn how to trade. You can add your own criteria, but here are just a few to get the idea started. There are a lot of professional traders who blog. Too many to mention here. Go to community to get involved.

Natural Talent or Skill in:
  • Analysis
  • Emotional Quotient
  • Vision/Perception
  • Motivation
  • Preparation
  • Consistency
  • Persistence
  • Bravery
  • Self-analysis
  • Risk-Taker
  • Flexibility
  • other things you can name....
What does knowledge have to do with it?
Knowledge is the sum total of experience, study and reading you have absorbed.
Knowledge is the first step of taking that information and assimilation into your trading repertoire or skill set.

Knowledge is knowing when or how someone is "gaming" the system and where the sharks are. HFT  remains constant, and is shared by everyone.
Knowledge is knowing what software & hardware to use to get the best results. Latency Arbitrage & Liquidity Detection is also shared by everyone.
Knowledge is knowing the different time frames for different styles.
Knowledge of back testing and algorithmic programming.
Knowledge of relative valuation techniques.
In this conceptualization, knowledge can incorporate any style and class of asset. I will not delve into particulars. Just know they are stacked here.

So why do new traders have a low success rate?
In my conceptualization, the Venn diagram changes as we develop as traders. All three circles are not the same size.  This explains why new traders have trouble in the beginning. Luck may remains constant, and can be factored out since it is shared by everyone; However the luck dependency circle actually has other things added in.

LUCK Dependency = Luck + undeveloped talent skills + unknown knowledge & experience

As we acquire knowledge the stack grows, the reliance on luck diminishes; As we assimilate and develop talents the equilibrium changes. As we get better, the knowledge and talent circles grow. There may be people who can start out right away making money with natural talent but that is unusual, but don't tell me that new traders are doomed to fail at this endeavor.

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