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More ruminations on what trading can teach us about non-trading things. A thread...
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Recently reading @SinclairEuan's excellent "Positional Option Trading", and he reminded me of something I hadn't thought about for a while:
Great trades start with a known risk premium and then add idiosyncratic inefficiencies on top to get more alpha.
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Great trades start with a known risk premium and then add idiosyncratic inefficiencies on top to get more alpha.
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The risk premium is a long-term thing. The vol premium or the carry trade aren't going anywhere.
But you can't really build a business on them alone. Too many people know about it, so returns are at best "ok" (i.e. low Sharpe) but with terrible tail behavior under stress.
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But you can't really build a business on them alone. Too many people know about it, so returns are at best "ok" (i.e. low Sharpe) but with terrible tail behavior under stress.
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You need the extra juice from finding relatively short-lived inefficiencies to make it a trade worth doing.
This is why trading is labor-intensive: you need to keep improving your edges because inefficiencies disappear.
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This is why trading is labor-intensive: you need to keep improving your edges because inefficiencies disappear.
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The insight in this thread isn't a huge one, but rather a different window on something we all know:
Many non-trading situations can be broken down in this exact same way!
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Many non-trading situations can be broken down in this exact same way!
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In the angel and VC investing world, most of the investment decision is made on the basis of the people involved.
Yes, you need a good idea and a good plan, but the most important piece are the founders.
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Yes, you need a good idea and a good plan, but the most important piece are the founders.
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Another way of saying this is that the founders have identified their risk premium: the long-term durable thing they're good at that they'll probably be good at their whole lives. Sales, or developing good tech, or whatever.
But like in trading, that's not enough.
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But like in trading, that's not enough.
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You also need the inefficiency: the small insight you've discovered about the world that others have missed. The reason that *this* business exists and not some other.
These opportunities are short-lived, so you usually need to act fast.
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These opportunities are short-lived, so you usually need to act fast.
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In venture-land, a good investment is one where where the people are the right people (the risk premium) and the immediate business case is solid (the inefficiency).
But wait, there's more.
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But wait, there's more.
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In deciding what to study in university, or what job to get afterwards, the same calculus applies.
The risk premium is the thing that you *love* doing, something you're interested in for its own sake.
Irrespective of how much you could make doing it.
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The risk premium is the thing that you *love* doing, something you're interested in for its own sake.
Irrespective of how much you could make doing it.
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And the inefficiency is the specific job situation you can find to exploit that risk premium.
A lot of the time, the two don't come together. Sometimes we get a job because it's available, even though it's not what we *want* to be doing.
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A lot of the time, the two don't come together. Sometimes we get a job because it's available, even though it's not what we *want* to be doing.
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And so we end up at best satisfied with the job, and at worst hating it. Makes sense: you're doing crappy trades with your life.
You always hear the career advice "follow your dreams". This is terrible advice.
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You always hear the career advice "follow your dreams". This is terrible advice.
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It focuses on the risk premium and ignores the fact that, to make it a success, you're going to have to grind away to develop those exploitable inefficiencies.
Just like in trading. "Follow your dreams" is like "Just go sell vol".
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Just like in trading. "Follow your dreams" is like "Just go sell vol".
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Yeah maybe, but you'll probably have to work really hard at it. If you want to make it a success.
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