Today’s “Long Story Short” discusses a few high-priority trading concepts to guide you. Kollider’s series is purely educational and not investment advice. Please do your own research.
Trading is a creative pursuit.
The space is infinite, the exchanges are plentiful, there is a limitless number of choices, and the right time horizon is unknown. A piano has fewer options.
Despite this seemingly endless array of possible configurations, you still have one mandate when you trade. You need to end up profitable.
But don’t feel overwhelmed. In today’s “Long Story Short,” we’ll discuss a few concepts that will help you kick off the new year the right way.
Just Be Curious at First
In its early stages, trading is more like making music than solving maths puzzles. This is largely because there is nothing immediately apparent to solve.
This is where design thinking can be helpful. Just as you would when writing a novel or starting a company, you have to start with the divergence part of design. Do not attempt to solve the problem right away, because there isn’t one yet. Try to discover it.
Look at different exchanges. Look at different products. Watch how they change minute by minute. It would be wise to start with a platform like TradingView, since it provides a visual representation of multiple markets.
Are the prices trending in one direction or fluctuating? By what percentage do prices change? How are the volumes (e.g., bottom of the chart for TradingView) changing? When volumes increase or decrease, how do the price directions and magnitudes change with them?
Do previous price changes correlate with future movements? Does higher volume tend to result in higher volume for a while? If so, when does it stop?
What changes if you move to hourly or daily instead? Check out how these behaviours and patterns were a year ago. What about five years ago?
Compare different product prices and see how they move together, if at all. Is their correlation steady? How often do they break their correlation?
You may want to dig deeper into the markets you are looking at if you see relationships that seem to hold strong. Is it an ETF based on an index or is it actively managed? It would probably be best to just read more about how that particular ETF works.
Is it a cryptocurrency derivative? For a better understanding of how a derivative is traded, it may be a good idea to read the contract definitions and determine if the exchange has its own unique mechanics. For example, funding can affect your prices, especially in the short-term.
And if you want to be more adventurous, you can dive into other inputs aside from just prices and volumes. Are there movements in related markets after mentions of a particular product or company? Can macroeconomic news (such as changes in central bank rates) be relevant? What impact does it have in the short-term (e.g., 1 minute, 5 minutes) compared to the long-term or medium-term?
These behaviours can change dramatically depending on the product, exchange, and time. Initially, you simply want to see how prices, volumes, time, and other inputs relate to one another.
Converge Your Discoveries
When you’ve got markets and price dynamics figured out, it’s time to move on to convergence.
The challenge at this point is to use what you’ve seen so far and translate it into a model you can actually trade. At its essence, trading is just buying and selling something at certain time frames. With your divergence exploration, you probably got a better sense of how some market prices might move. Therefore, the next step is for you to converge your ideas, or simply, identify how you can methodically execute whatever patterns and ideas you’ve observed.
Strategy frameworks come in handy here. We’ve covered a few before that you can look into including market making, spread trading, and momentum trading (albeit very briefly, but enough to give an idea of discretionary trading in general). All of these are simply different constrained ways of seeing and interpreting the market to result in buy and sell orders.
Though you could exercise a bit of creativity here and come up with your own strategy framework, it’s probably wiser to use a common one, like those we’ve discussed before. Use whichever one you pick to view markets in a structured way. Perhaps you could fit a specific product into a market-making framework. Or, if you’re considering two products, think about how spread trading might work.
You might already be able to see if a particular framework would be useful for a product. For example, a product whose price tends to trend in a single direction for days without much fluctuation is probably not a good candidate for making markets. Definitely possible, but unnecessarily difficult. In similar fashion, two products with very little correlation would not make for good spread trades.
As you dig deeper into the details, you might need to calculate technical aspects precisely. For example, in a spread trade where at least one of the products is a crypto perpetual swap, you’d probably benefit from understanding how to hedge your delta.
There are more granular optimisations that you could do, but starting out with broadly fitting to a common strategy should give your trading a good foundation.
Scale to Your Skill and Survive
No strategy will ever be flawless. You’ll have to keep trying to improve your trading and go through the steps above repeatedly.
You can thrive a great deal by playing for survival. Eventually, as your skills improve and your strategy performance improves, you may want to scale up your orders and max positions. It’s possible that your strategy can handle more. Observe how the changes in these sizes affect your P&L, ROI, and sharpe ratios.
Don’t be afraid to scale back whenever necessary. Markets change constantly. A redesign might be needed to adjust to the new dynamics.
As a general rule of thumb, lower your sizes whenever there is a lot of uncertainty that could cause you to gamble (as opposed to taking calculated risks). Remember that this all takes skill and practice. You’ll increase your competitive advantage over time, but it’ll be gradual.
So, finally, be patient and you’ll have many more fruitful years of trading ahead of you.
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