The Tao of Trading - introduction - Ariel Faigon (2008)

Intro   Case   Pivot   Position   Simulation  


  • Introduction: Why Trade?
  • The self evident case for trading
  • The Optimal Trading Problem
          1) The optimal pivot sub-problem
          2) The optimal position-size sub-problem
  • Some simulations of the ideas

  • Introduction: Why Trade?

    For years many of us have been 'trained' to be passive in the markets.

    The "buy and hold broad passive indexes" mantra is alive and doing great. I'd go further and say that the "indexing" philosophy makes perfect sense for most investors. Pioneered be Vanguard's John Bogle, this indexing philosophy boils down to two sound ideas:

    I actually believe that if your goal as an investor, is to put minimum effort into investing, then "Buy and Hold"ing the broadest asset class (or even better: a diverse mix of broad assets) is a near optimal strategy.

    But this section is titled "Why Trade?" what gives?

    I've been a passive investor for years, but the more I looked at the data and analyzed it, the more I became convinced that I can do better by being active. Much better, actually. Moreover, the more active I actually got, after careful analysis of the data and testing of the models, the better my results compared to the market (with the S&P500 as my benchmark) have gotten as well.

    I started collecting financial data about 2.5 years ago, in Feb/March 2006. It took me some time to have enough data to make sense, build models, back-test assumptions and strategies, see what works more often than not, and what works better under different conditions (which I call "current market preferences"). These years have been a long learning journey for me. I've made numerous mistakes and wrong calls, and learned from them. I also had some significant good calls which led to out-performance. Overall, in these 2.5 years I've done significantly better than any of the broad US indexes (S&P500, Midcap, SmallCap) while assuming significantly less risk. See [trading record on] for a reference. I know I can still do better.

    To be completely honest, I also applied some shortcuts by learning from other people's experiences, as long as they seemed honest, convincing, and above all, had a real documented record. Each of these Guru-site discoveries has helped me make crucial improvements to my own methods. Among these I especially value: Henry To of, Steve LeCompte of, Walter and Hickey of, and William Dirlam of I've also learned a lot from watching a few of the top performers on

    After going through this learning process, and thought transformation, I now believe that given three conditions, one can do much better by being actively trading, than by being passive.

    The three conditions are:

    The good news is that if you do meet these three pre-conditions, you can cross the chasm. You can become active, and profit from the activity, while enjoying it at the same time.

    The following are my thoughts trying to frame the problem of "Optimal Trading", and to take some steps towards its solution.

    My solutions are not optimal in the sense that I don't have a formal mathematical proof of them being optimal. Finance is an inexact science and the data is dominated lot of random noise. What I do have, is a lot of evidence that categorically shows their superiority over buy and hold, both in total returns, and in risk adjusted returns.

    If you're ready for the journey, read on.

    The rest of this article, is divided into 3 parts:

    The self evident case for trading
    Lays out the initial case for being active vs. the alternative of Buy and Hold.

    The optimal pivot sub-problem
    Attempts to optimally solve the question of when to buy or sell.

    The optimal position-size sub-problem
    Attempts to optimally solve the problem of how much to buy or sell at each decision point given by the Pivot solution.

    Validation of the thesis
    Some simulation examples showing that the method and approach has some validity.

    Disclaimer: there's much more to the method than presented here. These simulations are of a very early version, employing gross simplifications of what I'm actually using. Since writing this, me and my friend Adi, have made many improvements and changes designed to reduce both risk, and number of trades. As presented, the method is not really viable or practical. It is far from optimal when market conditions change to a bull market. Trying to follow this simple method at home may result in great risk exposure, too much activity, and sub-optimal results. A fair warning.

    Intro   Case   Pivot   Position   Simulation  

    Disclaimer: this should not be considered as investment advice. It is merely describing my own thoughts and actions.

    Feedback is welcome.

    -- ariel