Tuesday, March 14, 2017

The Trade That Made No Sense



We were were in agreement that we had to find a better way.

Clockwork and I started our trading careers as  professional minimum wage traders. We meticulously manufactured small profits--all amounting to a low payout that, after being chewed up by commissions, profit split, platform fees, and the occasional compliance fine, would fail to sustain even a mediocre life quality in high-priced NYC.

Every day, we would trade with the same bullshit trading piker mindset.

 We would look for tight consolidation patterns, squint at the level II for a large order that could be our exit to reduce slippage, buy the first tick-up with a tight stop, and hurriedly try to sell it for 10 cents. 

Yeah 10 cents. Why so little?

Well, every time a winning trade came back to our entry--which was literally every time it felt like--we would experience immense regret that we didn't sell it. Because we "knew" it would happen.

"Welp, looks like they're gonna run the stops again."


We had trapped ourselves psychologically. Taking mediocre ideas and trying to take mediocre profits before the trade proved its true colors--that it was a mediocre trade with little chance to form the sustained, powerful trend that's worthy of holding. Our only saving virtue, one that would ensure profitability, was being too cynical to believe in our own trades--because being patient and riding a winning trade was a sucker's game. Something they wrote about in trading psychology books from 20 years ago before the HFT's made the market too annoying to trade.

I joked about going to law school. He joked about getting an MBA. Enough was enough...  this was the final straw. If you don't make real money in a risk-taker's job, you might as well just quit and get a real job. And if you're about to quit, you might as well empty all the bullets and see what happens (especially on someone else's dime).

"Let's trade bigger and if we blow up, we blow up. Who cares at this point?"

We had a clock in our heads at this point--now or never to make this trading pipe dream a reality.

But we agreed the solution wouldn't be to increase size with our current piker bullshit trading strategies.

We needed to find scale-able strategies where we could hold positions with both size and conviction.

The type of strategy that would make us real money, the type of money that attracted us to trading in the first place.

First, we needed better...

...Role Models.

Slow Trot was one of the best traders from Crazy Capital Group. He had been trading for 14 years. He wore shorts, flip-flops, and an old raggedy t-shirt. He spoke with a slight Texan 'twang in his voice. He took his seat at the bar and ordered all of us a drink. We wanted to pick his brain. 

Slow Trot  told us about all the weird shit that guys at Branch B would do to make money. It was a whole different world outside of the repackaged vanilla technical strategies that over-saturated trading education circles.

Secret sauce trading strategies that included:
  • Buying thinly-traded ETN/ETF when they were mispriced from their NAV on price spikes
  • Preferred stock and warrant arbitrage
  • Trading the opening and closing imbalances
  • Having huge in positions in stocks I've never heard of, stocks that barely traded 10k shares a day
  • Exploiting an odd-lot algorithm glitch on shares of BRK.A when it was priced in the 100,000s
Slow Trot told us about the day the entire firm bought stocks during the flash crash. Their attitude stuck with me:

"It was someone else's money."

Copycat Trading

We decided to model ourselves after the best traders at the firm. 

Lucky for us, our firm implemented a new link-up system where we could see the real-time risk monitor, including all positions and respective PnL, of the best traders at the firm (provided they agree to a link-up).

I recorded their best and biggest trades on a daily basis, to see if there was something I could learn from the pro's.

One particular ticker caught my eye: AEPI

For one week, I noticed that every day Slow Trot and his buddies would be shorting AEPI Industries a few minutes before the close and covering afterhours for a profit.


AEPI: Chemical company. Thinly traded -- at most 200-300k in volume on a "highly traded" day. Never heard of them in either real life or the circles of FinTweet. Yet the most highly profitable ticker for the firm for the past month.

I couldn't understand what the edge was on the trade. Who is giving this money away?! This wasn't a day trade. Position trade. Technical trade. Fundamental trade. Trend trade. Mean reversion trade. Scalp. None of those labels could aptly describe what was going on here. AEPI was a mystery box that I couldn't wrack my head around. For starters, it made absolutely zero sense how all of these traders could close their positions at reasonable prices during the afterhours market (when there is "supposed" to be far less liquidity and very wide bid/ask  spreads), let alone why the stock would move at all afterhours with no news. 

The AEPI trade was more a weird phenomenon or glitch that kept repeating, over and over and over again.

The stock would trade close to half of its daily volume in one 5 minute bar from 4:00 to 4:05 and always trade in the same direction. DOWN. It never upticked, not even once.

And traders were making money hand over fist betting that it would keep repeating itself. They made their entire week/month on one pain-free trade that lasted a few minutes while pikers like myself would grind all day to pay the bills.



There was no explanation from anyone as to why it would work.

To exacerbate my FOMO (fear of missing out), new traders on the desk started joining the trade, with no better an understanding on what was going, and would reap the rewards.

I had a voice of reason telling me "don't take risk on something you don't understand". Then I told that voice to cram it. I thought about some of the strategies that the top guys used. Did they truly understand their edge at every micro detail level? Not really. They just did what worked. I had to turn off my brain and leave the skepticism at home. This was free money and I just didn't know why yet.

The Next Day

Do I even have to tell you what we did next? There was only one logical course of action.



We saw Slow Trot get into the trade a few minutes before the close. We jammed into it as well.

Then we waited, in great anticipation.




Funny thing happened: the stock upticked.


Our positions were immediately out of the money.




Faced with paying up a big one point spread to take a loss, we chose to keep holding.

Then we saw the "pro traders" add to their positions so again, we just followed along and did what they did.

This was definitely going to end well.


The Day After That

The next day we hoped it would just stop and let us minimize our damage. Okay, the glitch stopped working but that doesn't mean there's reason for the stock to move up right?

At the open, our hopes were dashed. AEPI refused to slow down.

Our max-loss limits were triggered on the open and the firm liquidated our positions.

It was my worst loss of the year. It wiped out the last 3 months of hard earned piker trading profits. The firm as a whole took quite a beating.

They say the best trades have 3 phases:
Innovators.
Imitators.
...and Idiots.

And once the idiots hop on the bandwagon, the trade gets over-crowded and stops working.

Even though I don't know why the trade ever started working in the first place, I at least know why it stopped working.

Aftermath

To this day, I still have no idea what was going on in AEPI. I have many questions.

1) How did someone find out about it?
2) Why did this trade have an edge?
3) Why did it stop working?
4) Was this a case of a trader knowing something but not wanting to spell it out for legality reasons?
5) How was everyone else so willing to hop onto a trade that seemingly had no clear logical explanation for why it worked?

There's a lesson here about not getting into trades you don't understand, but I didn't start this blog to impart wise lessons. I'm just an idiot.

Sunday, February 12, 2017

Stepper!

The Firm Next Door


There was another prop firm sharing the building floor with us. Let's call them Lemmings Capital.

Lemmings Capital was a small outfit run by a rotund bear-bodied Russian, Ivan, and Bob, a balding, bespectacled man who always sported an worn-out adjustable cap. Supposedly, they were both "traders back in the day" i.e. the SOES bandits era. I would pass by both of them in the common areas frequently, but never make eye contact nor acknowledge them in any way. Maybe it was because the memory of ease-dropping on a conversation my head trader had about those two where he remarked,

"I don't know how those two sleep at night." 

It was always different faces shuffling into Lemmings Capital around 8am in the morning. Mostly young recent college graduates, many of whom English was not their first language. Some majored in the humanities. Others did social sciences or communications. One of them pursued a theater degree. Not sure if anyone with an actual finance background ever traded there. You wouldn't see the same face for longer than a month, but you'd see the same familiar expression. Fresh out of school. Deer-in-the-headlights. Clueless. 

One slow summer trading day, many traders were out in the kitchen to watch Euro 2012 on ESPN. I made small talk with one of their traders, Billy, asking him about the strategies that his firm used. What was the training process like? What setups did they look for? What did their mentors instruct them to call out on the desk?

"Well, we look for steppers."

"Oh, what's a stepper?" I asked with eyebrows in-quizzically furrowed, trying to mask the smirk that would give away that I already knew the answer. 

It was an "advanced level II strategy", he told me. He proceeded to explain further.

"Stepper!"



A stepper refers to a large order, bid (ask) that steps up (down) in price. Say a stock like AAPL is normally showing between 100 to 1000 shares on the bid or ask. A slightly bigger order would be 5000-10000. An unusually huge order, worthy of the "STEPPER!" shoutout, would be 50,000 or greater.



This is supposed to be the "large buyer" or "whale". That's the guy you front run with your small piker buy order. It's first level logic -- a buyer with a lot of shares to buy must send the stock price up, right? You scoop up shares in front of it and see where he takes you. The stepper then "steps up" through the price in order to jockey for fills, rewarding any and all scalpers for their parasitic trading.

Traders at Lemmings Capital were instructed to look at liquid S&P 500 large caps for these large orders and then loudly call out "STEPPER" upon spotting one, so others can jump on, ride the wave, and get paid their two to five pennies a share. This was called teamwork, they were told. They'd be each other's eyes and ears. So everyone else can eat and pay their rent. Don't be silent, be noble and selfless.



These pikers were just getting in front of large orders with size and trying to make pennies, with their exit plan being to hit the big order when it started getting taken rapidly. It was pure, mindless order flow scalping in an environment where manual order flow scalping had basically been left for dead by the rise of HFT.

9/10 times, you would either lose a few pennies as the order failed to the move stock before being taken out, or make a few more pennies if you were fast and able to take advantage of the microscopic reaction. The gross profit or loss would barely make a dent. Traders were encouraged to trade max size to squeeze the most out of a tiny move. It's the small trading fees that would add up over time. Needless to say, Lemmings Capital did not have a high margin business plan.

That other 1 out of 10 times... well, you got fucked.



 The HFT algo would either yank the bid quickly and hit the remaining bids underneath or a seller would take out the bid in one shot, what Billy told me was called "one-printing". Then the rest of the bid side would thin out quickly. This would happen before anyone could react, trigger all the tight stop losses, and traders step on each other to panic out, exacerbating the severity of move by just a few more ticks for the next one out. Bob and Ivan taught their traders to be "be disciplined and always use a stop loss", so they always got out, no matter what.


A few minutes later, the stock would trade right back up to the original price where they had gotten in.

Agony. 

Lemmings Capital was another burn and churn firm profiting off the trading commissions rather than teach an edge and make money through a profit share. The firm required small deposits from new traders so they weren't really taking any risk in the first place. None of the poor souls had any clue what their (lack of) edge was.

Slowly but surely, every trader blew up their accounts, one algo-driven shakedown at a time.

Once your loss exceeded your deposit, Ivan would let you know you were being cut off. Then, I don't know, maybe you put your head down and start to cry because you failed.

Bob would take you out in the hallway, put a hand on your sullen shoulder--like an empathetic veteran manager consoling a pitcher who had just surrendered a crooked inning--and give you the good ol' pick-me-up speech.



"Brother, I've seen the progress you made, you are so close to making that breakthrough. This happens to every trader the first time around. You remind me of myself when I first started trading, that's the kind of special talent you have. You're selling yourself short if you quit now. Give trading another chance, I really believe you're one of the few who will make it."

Translation: Make another deposit with us.

Ivan and Bob spent more time conducting interviews than they did actually trading on their own desk. According to them, everyone was a special trading talent.

 I asked Billy if he made any money at all since he started. Not overall but just one profitable month, and if not even that, one profitable week?

"No, but I feel I'm close. It takes at least year to be profitable they said."

I think he left a month later to take the CFA or something like that.