Storm Copestand
Traders Magazine Online News

Conquering Fear in Trading

In this exclusive to Traders Magazine, therapist Storm Copestand examines how traders can manage expectations and conquer their fear during the entire execution process.

Traders Poll

Amid changes in builder, do you think the CAT project will be completed by 2020?

Free Site Registration

March 1, 2009

A Dollar and a Dream

Everyone still loves a winner. Even in these dark times on the Street, as careers grind to a halt, deferred compensation plans wither on the vine, and politicians and editorial writers rail against bonuses, Wall Street remains proud of its strict merit pay model. We are rightfully disdainful when we read of how the teacher unions fight merit pay, terrified of being

individually judged by objective criteria. Wall Street, on the other hand, has long thought of itself as the polar opposite. Sought out by the ambitious as the ultimate meritocracy, it is a place where a rock star on the trading floor can make 10 or 100 times what the next guy gets. Firms brag about their "eat what you kill" culture: Make money and get paid a lot, lose money and get shot.

The Fittest

Traders choose their counterparties with a similar ruthlessness. Algorithms and crossing systems that produce regular good results get richly rewarded with flow, while weak algorithms are shunned like the money-losing traders, with volume gradually drying up as the business unit inevitably atrophies.

And mostly this system of "survival of the fittest" works, until you confront something known as the "reverse lottery" problem, and realize that there is a hole in the logic of paying people and allocating flow based strictly on results you can see. The hidden flaw is that in probability games, observed outcomes often obscure an ugly reality.

For example, let's say I walk into my friendly local casino. I wander over to the blackjack table and begin playing, betting $50 at a time. I have a very simple strategy: As soon as I am up $100, I will immediately stop playing, get up from my seat, and walk out of the casino for the day. But if I am losing, I will doggedly continue playing, digging myself into a deeper and deeper hole until I either rally back and make my $100, or until I bankrupt myself by blowing my full $100,000 credit line.

The asymmetrical payouts in this game make it far more likely that I'll be a winner. Win two quick hands and I've made my money for the day. But to lose, I need to lose 2,000 more hands than I win. So while my expected profit for the long run is exactly zero, on any given day, I have a 99.9 percent chance of walking out up $100 (making a few simplifying assumptions). If I played every workday, there is a 78 percent chance of wrapping up the year having made $100 each day for all 250 business days, producing $25,000 in profits. And since most days I will have barely dipped into my credit line, my likely return on average capital would be well north of 100 percent.


Reverse Lottery

View Comments () | Post a Comment | More "Brave New World" blog entries

View Comments

Post a Comment

Not Registered?

Posting a comment requires that you are registered to Bedrock Blogs. Please fill out the fields below to register and post your comment in one easy step.

Comments you post appear as coming from the username you choose here.

This site uses your email address for logging in. It is not displayed publicly.

(offensive materials and/or spam will be removed, no HTML allowed)

Already Registered?

If you have already registered to Traders Magazine, please use the forms below to login. When completed you will immeditely be directed to post a comment.

Forgot your password?