Pedma's Portfolio Management Journal - 01/15/2024
Personal Portfolio Management Journal
Hey there, Pedma here! Welcome to this free edition of Pedma’s Newsletter. Each week, I'll share with you a blend of market research, personal trading experiences, and practical strategies, all aimed at making the world of systematic trading more relatable and accessible.
If you’re not a subscriber, here’s what you missed this month so far:
Research Article #22 - Short-Term Breakout Crypto Trading Strategy - $121,950 Total Returns
Research Article #23 - Risk Premia harvesting Through Dual Momentum
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Portfolio Management Section
The last 15 days have been quite challenging in crypto land. We have certainly slowed down from the momentum we were accustomed to a few weeks ago. It's nothing significant, but I have definitely felt it in my portfolio, having been in this drawdown since the 1st of January. This is a reality that most traders can’t understand, which is why the failure rate is so high in this business. People struggle to cope with prolonged drawdowns without altering their approach based on recent behavior. I can go months without making money, even losing money, and still keep taking every signal that my system gives me. I believe that this is where my business edge lies. It comes from a true understanding of what I am trying to capitalize on and being patient enough to let it play out in the long term. I know that for me to stop making money, momentum would have to cease in the markets I trade. That is the most important assumption I make about my systems. Momentum needs to be present, and I am satisfied to make that assumption. I am not 100% certain it will always return, but I choose to bet that it will, as it has in traditional markets.
Had I not stuck with my system through every drawdown I experienced, I would never have produced the equity curve I have now since last year. Drawdowns and losses are the prices you pay for potential future returns. I like to use the analogy of riding a rollercoaster: you need to pay for the ticket to enjoy the ride.
I've really been enjoying writing these logs here on Substack. It gives me a space to think through ideas, to record thoughts I have for the long term, and to share with interested people. My aim with this newsletter is to document the experiences of an actual trader navigating the market's ups and downs. Often, we see newsletters focused on trading and investing concepts, but it's rare to see someone sharing their thoughts as they experience both the good and bad of managing their own capital over the years. This is an “ugly” business, contrary to what is portrayed on social media. There will come a time when you will see me writing about drawdowns more often than about breaking all-time highs in my equity curve. Right now, I've been in this drawdown for 15 days, and I can tell you that this is nothing compared to the drawdowns I've experienced. Crypto was declining for over a year in a row, and let's not forget that also after Q1 2023, it was challenging until late Q3, early Q4 2023.
Periods like these, as shown in the blue box, are the worst for momentum/trend traders. You can't go long, you can't go short. The price just bounces around in a strange range and can't gain any momentum. That alone lasted more than a year. Imagine trading through that - I did! I know I repeat this often, but it reflects the reality of the markets. Trading is tough, and you really need resilience to make it through the difficult periods. A solid financial foundation in your personal life is essential to cash flow your way through these times. Without a stable cash flow for both life and business expenses, you won't be able to endure it without significant stress.
From my perspective, this is how a full-time trader who isn't super rich should structure his business and personal finances:
Trading Portfolio: It should be substantial enough to provide a significant portion of income a few times a year or every few years.
Liquid Cash in the Bank: Maintain 1-2 years' worth of living and business expenses in the bank. Having less than that risks facing another long cycle of drawdowns without the ability to cover expenses. Having more can lead to an opportunity cost issue, as the capital could be invested in lower-risk assets like treasury bills, a diversified basket of global assets, the S&P 500, etc.
Consistent Stream of Revenue: This aspect heavily depends on your personal financial situation and psychological comfort. Personally, I enjoy working. My systems operate at such a low frequency that I don’t need to be physically trading all the time, allowing me to engage in other activities. I keep myself busy with research, writing this newsletter, and other writing tasks. This provides another uncorrelated income stream for my business. It's not directly from trading, and doesn't heavily rely on the market. This helps extend my financial runway, allowing me to keep less capital in the bank and invest more, as my expenses are met every month with this revenue stream.
In my opinion, this is how you build a solid financial foundation for full-time trading. At 26 years old, I can take more risks than a 46-year-old with a family to support financially. It all depends on your personal life situation. My point is that the market doesn't always provide a steady stream of revenue, and you need to plan for that. It's similar to a beachside restaurant. They know that the bulk of their revenue comes in the summer during tourist season, and they need to plan their staff and inventory accordingly. Trying to maintain the same level of business all year round without planning for the majority of the time, which will be down periods, would be poor financial planning. In a sense, trading is the same. It's a seasonal business that heavily relies on short periods when the market is hot.
Deconstructing Interesting Ideas
Kris discusses an interesting investment philosophy that involves strategies providing small, steady gains for modest earnings in normal market conditions. This aligns with the cash flow idea mentioned earlier in this article. Additionally, he focuses on activities that yield large profits during unusual market behaviors, diversifying between these two approaches. The aim is to make significant gains when the market is favorable, as seen in the crypto realm during 2020-2021, while maintaining a more stable and modest cash flow strategy during downturns.
Most traders tend to follow the crowd, exhibiting herd mentality and being heavily influenced by their emotions. They often prefer trading strategies offering immediate returns, even if these are lower and riskier in the long term. This contrasts with strategies that may earn less or nothing during stable times but achieve outsized returns during volatile periods. In 2021 we had large investors allocated to crypto at the market's peak, influenced by its all-over presence. During this time, crypto brands were featured in major sports leagues, discussed on TV, and widely sought after. This trend-driven and emotionally influenced behavior led to poor decision-making, rather than adopting a long-term strategic approach to the sector.
It's crucial to focus on a long-term strategic approach with robust strategies that leverage fundamental market behaviors, instead of succumbing to short-term thinking and chasing the latest market trends. Prioritizing long-term thinking is essential. While sometimes it pays to make riskier, short-term bets, the returns from these are rarely sustained in the long term.
To explain Lily’s tweet, let’s first get a few definitions right:
"Short vol/long carry in the belly, long vol/short carry in the wings":
"Short vol (volatility)" means betting that the price of an asset will not move much. "Long carry" refers to earning from holding the position over time, like earning interest.
"In the belly" means this strategy is applied to options where the strike price is close to the current price of the asset.
"Long vol" is the opposite, betting that the price will move a lot. "Short carry" implies not benefiting from holding the position over time.
"In the wings" refers to options with strike prices far from the current asset price.
"Construct positions to maximize your reward if you're right, minimize your risk when you're wrong"
This part is pretty straightforward, it means designing your trading positions in a way that you make the most profit if your predictions are correct, and lose the least if you are wrong.
"Clip coupons the rest of the time waiting":
"Clipping coupons" is an old term for regularly collecting interest payments from a bond. In this context, it means making small, steady gains from your positions while you wait for a significant market move.
In essence, our article today revolves around a consistent concept: employing varied strategies for different market conditions. This involves earning modest, steady profits in stable markets and preparing for potentially large gains or losses in more volatile markets, effectively capitalizing on these fluctuations. It emphasizes maintaining a balance and diversifying across these approaches.
Disclaimer: The content and information provided by the Trading Research Hub, including all other materials, are for educational and informational purposes only and should not be considered financial advice or a recommendation to buy or sell any type of security or investment. Always conduct your own research and consult with a licensed financial professional before making any investment decisions. Trading and investing can involve significant risk of loss, and you should understand these risks before making any financial decisions.