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Mastering the Lost Art of Short Selling & Intelligent System
Trading DevelopmentBy Laurent Bernut, CEO, Alpha Secure Capital
www.alphasecurecapital.com
AGENDA• IS STOCK PICKING OVERRATED ?
- THE FORGOTTEN FORMULA:
‣ SIGNAL MODULE: IS ENTRY or EXIT MORE IMPORTANT
‣ MONEY IS MADE IN THE MONEY MANAGEMENT MODULE
- “LA CONDITION HUMAINE”: OUR BRAINS WORK AGAINST US
• WHY IS THE SHORT BOOK KEY TO INCREASING AUM ?
- WHAT DO INVESTORS WANT ? FOLLOW THE MONEY
- HOW TO MAKE MONEY SELL SHORT ?
IS STOCK PICKING OVERRATED ?
80% OF MANAGERS UNDERPERFORM THEIR
BENCHMARK
Fund Category Comparison Index 1-yr (%) 3-yr (% ) 5-yr (%)All Domestic Equity Funds S&P Composite 1500 60 86 74 All Large-Cap Funds S&P 500 60 85 87 All Mid-Cap Funds S&P MidCap 400 58 77 88 All Small-Cap Funds S&P SmallCap 600 73 92 88 Real Estate Funds S&P US REIT 42 91 92 Source: S&P Dow Jones Indices LLC, CRSP. Data as of J une 30, 2014
Percentage of Fixed Income Funds Outperformed by BenchmarksFund Category Comparison Index 1-yr (%) 3-yr (% ) 5-yr (%)Government Long Funds Barclays Long Government 98 99 96 Government Short Funds Barclays 1-3 Year Government 45 51 49 High-Yield Funds Barclays High Yield 73 86 85 Source: SPIVA® U.S. Scorecard Mid-Year 2014
WHY?
1. Markets dominated by institutions: average hard to beat
2. Not Focusing on Gain Expectancy
Gain Expectancy = Win% * AVG Win% - Loss% * |AVG Loss%|
‣ Signal module: Entry & Exit
‣ Money is made in the money management module
3. “La Condition Humaine”
WHAT’S MORE IMPORTANT – ENTRY VS. EXIT?
IN EXITS, ONLY TWO TYPES OF STRATEGIES: TREND FOLLOWING & MEAN
REVERSION
High Win Rate = Compounding
Devastating Left Tail
Classic Trend Following P&L DistributionLosses Profits
Long Right Tail = Capital Appreciation
Low Win Rate
Long Short
CLASSIC TREND FOLLOWING STRATEGY P&L DISTRIBUTION
CLASSIC MEAN REVERSION STRATEGY P&L DISTRIBUTION
CHANGE YOUR EXITS, TILT YOUR GAIN EXPECTANCY
Losses Profits
No Left Tail
Compounding
Capital Appreciation
Capital Efficiency
ALPHA SECURE STRATEGY P&L DISTRIBUTION• Positive Gain Expectancy: (Win % x AVG Win%) > ABS(Loss % x AVG Loss%)• Capital efficiency = Compounding * Capital Appreciation• Symmetry: Identical Distribution of Longs/Shorts P&L
Long Short
MONEY IS MADE IN THE MONEY MANAGEMENT MODULE
Gain Expectancy = Win% * AVG Win% - Loss% * |AVG Loss%|
Game of 2 Halves: simple way to cut losers and increase winners1. Calculate AVG Win, divide by 22. Halve bets on losers below -1/2 AVG Win3. Re-allocate proceeds to winners and/or fresh ideas
Game of 2 Thirds: Reduce free loaders4. Add 1/3 of turnover to all entry dates5. Halve positions in 3rd quartile performance on anniversary date6. Re-allocate proceeds to winners and/or fresh ideas
2 WAYS TO IMPROVE GAIN EXPECTANCY
Losses Profits
3 BENEFITS OF THOSE GAMES
• GAIN EXPECTANCY IMPROVES1. Cut losers, increase winners
• GOOD STEWARDSHIP: 1. Maintain conviction, but deal with problems
2. Easy to explain to investors, peers
• EMOTIONAL CAPITAL PRESERVATION1. Fund capacity in when inertia sets in
2. Train the brain to switch from outcome to process orientation
WHERE IS THE SPEED LIMIT?Engine: Signal Module
Transmission: Money Management Module
Driver: “La Condition Humaine”From Subconscious beliefs to unconscious habits
OUR BRAIN WORKS AGAINST US
• Rationalization Machines: Corpus Callosum
• Risk Appetite: Nucleus Accumbens/Anterior Cingula
• Future Self: rostral Anterior Cingulate Cortex
Source: Risk Appetite: NAcc/Acc Kuhnen Knutson, 2006, Rationalization machines: corpus callossum M. Gazzaniga 1962, Self deception: D. Goleman 1985, Future Self: rACC, Hershfield, 2006, Habits: basal ganglia, Wood 2002
GREAT TRADERS ARE NOT SMARTER,
THEY HAVE SMARTER TRADING HABITS
KUBLER-ROSSDENIAL ANGER BARGAINING DEPRESSION ACCEPTANCE
Market Regime
Sideways Choppy Bear Choppy Bear Quiet Bear Quiet Sideways/Bull Quiet
Market Signature
Technical support penetration
Institutions trim weight
Estimates downgradeHigh short utilisation
Ratings downgrade
Low estimates dispersion
Short utilisation increases Crowded Short
Analysts "It's a one-off""But the market is wrong..."
"1) downgrade estimates 2) stretch horizon
"But it's cheap" "… Structural Short"
Lingua Franca
"Inventory Adjustment"
"2) Stretch our investment horizon to n*150% months"
"…for the LT investors"
"but keep our "Buy" rating, LT story still Intact"
ALPHA SECURE
