Conservative Daytrading

As much as I hate being off by several orders of magnitude on my standard deviation estimate, I still think my dart-throwing monkey has as good a chance of repeating the guy's results as he does...

I think that the information we've been provided is incomplete and unreliable. It's quite possible that Sklansky's objections are valid. However, it's also possible he's onto something. There have been some papers in recent issues of the _Journal of Finance_ that develop models in which momentum trading can deliver excess returns.

And what happens after those momentum ideas become fairly well known?

David asked: "And what happens after those momentum ideas become fairly well known?"


The basic momentum ideas are fairly well known. You can find several examples in Jack Schwager's _Market Wizards_ series of books, especially chapters on Turtle Traders. The _Journal of Finance_ articles provide a plausible explanation: "investors" who identify changes in fundamental valuation inevitably reveal their (originally) private information as they trade; momentum traders accelerate this process and capture a portion of the excess returns from opportunities revealed by the investors.


There are some additional factors that are less well known or ignored.


First of all, there is a maximum aggregate asset level that can be applied to a given instrument, since the liquidity is supplied by the investors who, in aggregate, have a demand curve that declines with increasing price.


As this maximum level is approached (or exceeded) by momentum traders, it becomes more difficult and more risky to trade in larger size. Entry costs rise (the more shares/contracts you try to fill, the higher the price you pay for each additional share/contract), and exits can become disastrous.


Nimble traders who don't get greedy (i.e., keep trading small) can continue to capture excess returns. In fact, their profit rates may even rise as the aggregate level of momentum trading increases. On the downside, this means that the optimal time scale for momentum trading is unstable over time. And if the momentum process accelerates, the risks rise even for small traders.


So momentum trading is not a simple process, and you cannot expect to compound your momentum trading profits. E.g., if you can make 1% per day with a $50k bankroll, you should not hope to make more than 0.1% per day with a $500k bankroll (but you will be better equipped to ride out bad luck).


If you find a successful momentum trading approach, the one way you can increase your profits is to trade more securities. The more successful day trading firms have done this. Bright Trading is a good example. An individual trader can only successfully trade a handful of instruments. But the Bright brothers have what appears to be an effective momentum trading approach that they have been able to teach to a few hundred traders.

> But the Bright brothers have what appears to be an effective momentum trading approach that they have


>been able to teach to a few hundred traders.


If the rules are so simple that they can be taught to novices, then our forums have at least ten people who could program the rules on a rainy Tuesday afternoon and we could all sit around making 1% a day.

Am I correct in assuming you are a believer in the efficient market hypothesis? I sure am but remain intrigued by the studies coming out regarding a possible fourth factor (momentum) that helps explain securities prices, the other three being market (stock v. bond), size (large v. small) and book to market ("value" v. "growth").


If momentum is a small factor, it doesn't negate the EMH. The EMH would still be correct "where it counts", or for all practical purposes. Frantic trading is costly, worrisome, and makes for a hell of a tax riddle come April.


I just read an article that explained the author's belief that there is a small momentum factor that often gets captured by "tax-managed" mutual funds. These tax-managed funds track indices but will ride winners a bit longer even after the index changes composition. Of course, the funds do this for tax-deferral reasons, not momentum/trading reasons. Capturing any momentum premium is a nice bonus for investors owning these funds, and they show that there is a passive, "buy and hold" way to get the premium.

I agree. There ought to be at least ten people reading these forums who can write a program capable of generating excess returns. Some of these people already have, and the rest should consider it, especially those who have often wondered about it.

I would guess that if this sort of momentum trading became more popular, the price fluctuations of high-volume stocks would increase in frequency and decrease in magnitude until this trading approach was no longer profitable.

Very Good.

how much m,oney do ya need for making dayrading succesful??