The Efficiency of Practicality

Dear traders,

today’s traders seem to be missing the point. While it pays to pursue efficiency in a profession that is predictable and repetitive in nature, applying the same logic to trading the financial markets now – when prices are far from predictable and patterns are in no way repetitive – may prove counterintuitive.

It is in this sense that the pursuit of efficiency could be a possible distraction, made even more dire at the cost of effectiveness. While a system must be efficient to allow a degree of sustainability, how much is too much a give? 

This article aims to quantify efficiency and teach traders the art of compromise. It is not the efficiency of the system, but the approach a trader takes towards trading that defines and edge. In a world whereby the only constant is change, there is only one correct axiom – no one ever broke banking profits. 

Keeping Your Eyes on the Prize

Welp, it’s COVID-19 season. With corporations undergoing urgent restructurings and budget cuts translating to retrenchment and layoffs, I would imagine that many would be struggling financially (if not emotionally), from the current situation. As the gloom began to loom over my family, I decided that I would do something different to uplift our spirits. I thought “COVID’s going to happen anyways. Yeah it’s a bummer, but there’s really no point feeling down over it. It will continue happening, no matter what we do.” You know what they say. Consequences are inevitable, suffering is a choice. Well, why not look at some family photos? Surely binging on good memories would make getting by this period a tad bit more palatable.

So we reminisced about one of the more memorable childhood getaways I had with my folks to New York. I recalled standing on the 86th Street Subway platform, staring in awe as the masses in suit and tie seemed to be in some form of organized mass hysteria. Everyone seemed to be rushing somewhere.

I remembered that 86th Street was served by two services. The local and the express. As I took pleasure observing the boarding patterns of average “in a rush” commuters, the greatest conundrum dawned upon my 9-year-old mind. I pondered “Everyone seemed to be in a rush, yet no one is queuing for the express service. In fact, no one was queuing for anything. Everyone was simply boarding the first train that arrives. There is no observable display of preference whatsoever between the express and local service – despite everyone being in a rush, and despite the express line to be, as universally understood, the faster service. Why?”

I never really got an answer, not until recently when I found myself straddling a 20-minute deadline to get to Promenade to make it for dinner with my girlfriend did I really grasp the concept. As I stood at Macpherson, I saw the local (Downtown) line arrive in the docks of the station. I glanced at the express (Circle) line platform and it is empty. What did I do?

Without a blink I hop the local. It doesn’t matter that express is 6 stops while the local is 11. It doesn’t matter that it may come 30 seconds after the local leaves the station. It doesn’t even matter that it may arrive at Promenade before the locals. If you are a long-term commuter, you know that it’s dumb to take the chance of missing your date for the possible advantage of getting there 10 minutes earlier.

The crux is to always keep your eyes on the prize rather than optimizing the means of achieving it. The goal in commuting is to get there on time. The goal in trading is to preserve capital and turn a profit. Sometimes both goals are best achieved at the cost of some efficiency.

Speed and Efficiency are Unifying Values but Bad for Trading

Living in today’s world where speed and efficiency are unifying values that connect us all, we often find any form of inefficiency to be every form of abhorrent. We want our cars to be efficient, our internet searches to be efficient. Yet when it comes to trading, inefficiency is often overlooked as the key to winning.

Take this for instance. Dental surgeons are the most efficient and adept humans I know. They’d inject you with a shot of Lidocaine and extract a tooth with so much finesse you wouldn’t feel so much as pinch. But get this, dental surgeons practice in the world of certainty and absolute control. They can do 1000 extractions feeling secure, knowing the results will be positive nearly every time as long as they follow the standard operating procedures.

As traders, we wilfully forfeit our privilege and luxury of complete control. We work our magic in a murky world of smoke and mirrors, probabilities and possibilities, making decisions in an environment with parameters changing every second, where each of our actions could result in a million different outcomes, all slightly different from each other. In fact, in this world of trading, if I’m utterly downright wrong 300 out of 1000 trades, I would still be considered a near genius in this field.

That is why gunning for efficiency can prove deadly in trading. Novice traders hear repeatedly the cliched axiom – cut losses short and let profits run. Yet anyone who has traded for real for any amount of time would know how stupid that concept sounds. If you do not yet know, the fact is that you CANNOT DO BOTH. You either let profits run at the expense of incurring very steep drawdowns or cut losses quickly. In which you better look for profits somewhere else to offset those losses or risk blowing your account from a thousand small losses.

Price rarely trends and even when it does, it never does so in a linear progression. Movements often retrace and the difference between a retracement or reversal is only evident in hindsight. “Trading gurus” love to show the few hand-picked charts where they show uninterrupted profits by buying at the absolute trough or a selling at the absolute peak. Absolute trickery. Wait long enough and any winning trade will turn into a loser. Who amongst the equity investors would have thought that holding Dow from 8000 “for the long term” was going to turn out badly 10 years later?

Trading is and always will be, the art of the compromise. It is the domain of the presently practical rather than the realm of the idealistically possible. That is why we need to throw our modern instinct for efficiency aside once we start trading. Much like New York commuters who know to take the train when it comes, experienced traders know that profits must be booked lest they vaporize like water on a stove.

In this world where the only constant is change, the correct axiom is this – No one ever went broke banking profits.

Wishing you a great trading week ahead,
Davin Wu Jie Ming