If you think you have a knack for day trading, learn best practices from Quantiacs’ Alex Foster
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A lot of investors have hopes of scoring big by day trading. While money can be made, it isn’t as easy as having a good hunch about the market. Alex Foster, vice president of operations with Quantiacs, talks about the ins and outs of day trading and what to avoid, such as using your credit card to fund your hunch.
While day trading isn’t for everyone, Foster says there are tools that can give you a good idea of how well you’ll do – before you ever put money on the line.
JennyHoff: Alex, thanks so much for joining me today.
AlexFoster: Thanks, Jenny, for having me. I appreciate it.
Hoff: Alex, first give me a little bit of your background, how you got into trading yourself?
Foster: Now it’s a great question, and of course risk capital and the concept thereof is something I’ve given a lot of thought to over the years, both personally and professionally. And I guess I’ll give you a little synopsis of my background here. My name is Alex Foster, I’m in the heart of Silicon Valley, and I head operations at a large quantity investment firm called Quantiacs.
I have a fairly unusual background I suppose. I originally studied physics and kind of realized a few years into my degree what the life of an astrophysicist actually looks like, and frankly made a decision to shift into business. And so I spent my graduate program researching the sort of information systems and data driven side of health care and health economics, and after which I spent a few months initially with NASA before I joined the Wall Street Journal.
And I left the Journal in 2007 to join Google and fell into the startup world after that here in Silicon Valley and absolutely loved it. I loved the entrepreneurial energy of the valley and I kind of fell into the deep end, and picked up a few programming languages and began eventually consulting for investors and venture capital.
I ended up directing a large startup accelerator for a year. That being said, I came from two generations of professional commodities dealers and brokers. And so I had always been involved in the investment side of things.
So, it didn’t take me long to see the overlap some of the machine learning applications and the data science of the life sciences within quantum finance and investment, so I quickly joined the investment space and the hedge fund world, and I’m still here today.
Hoff: OK, so in my intro I talked a little bit about this article where a guy got himself $10,000 into credit card debt because he wanted to take advantage of the dip in the market – he was your kind of casual day trader – and he ended up losing that money. Before he knew it, he said he had to put his savings into it and he had $10,000 in credit card debt.
So this guy was using his credit card to assist in his trading. If someone does decide to day trade what kind of expendable money do they need to have and should they consider money they’re willing to lose like they’re going to a casino?
Foster: Sure. And yeah, it’s a little crazy, isn’t it? Just to be clear I’m not speaking in any professional capacity here, lawyers always require us to make clear that nothing here should be construed as investment advice or any professional advice whatsoever, nor it is an offer for investment.
With that out of the way, clearly it is absolutely insane to invest longer term on credit card debt. No. 1, you’re talking about interest rates ranging from perhaps 18 to 25 percent on cash advances especially, and that means that you are going to have to outperform the best investment funds out there by twofold just to cover the debt cost and actually make a return. And that is a tough proposition for any trader, no matter what their experience level.
Hoff: Yeah, I bet. And, this guy said the lessons he learned in his Reddit list, but a lot of people kind of responded saying, “Well, this just shows you that you can’t really day trade. It shows you that that money needs to be considered to kind of throw away money.”
When you do try to get into day trading, how do you have to view the money that you’re going to be using.
Foster: Absolutely, that’s a good question. And risk capital and the concept there it’s something I’ve given a lot of thought to over the years. And obviously the answer is a little more complicated than most would think. Of course, it depends on your personal life situation, it depends on your net worth, your earnings, your family obligations, it depends on your debt obligations, your location, savings, etcetera.
And so at the end of the day if you have a few million bucks in the bank, the amount you should consider risk capital varies profoundly depending upon whether you’re a 25-year old young professional or a 65-year old about to retire. And so it’s absolutely always critical to I think take a few safety precautions. And No. 1, always set aside a rainy-day fund, that’s generally advisable to be six to 12 months’ living expenses in cash, in a savings account, perhaps on the higher end of that or more if you’re an older individual.
And secondly it’s always advisable to pay off any debt greater than market returns, and typically of course that’s anything other than your mortgage or student debt sometimes falls underneath 4 to 5 percent. And so it’s always in your best interest to pay that off before risking any capital.
Hoff: And you are risking money with this, right? I mean, to be clear when you’re day trading you basically have to consider it a little bit like there’s a good chance you’re going to lose that money, and so you need to be willing to stomach that.
Foster: Absolutely. I think it’s critical here to distinguish between investment and speculation. And what we’re talking about is speculation. If you’re holding long term value stocks or equities or even bonds or crypto, it is a far different proposition than speculating for the short term in any markets.
Hoff: So speaking of crypto another note is that we’ve recently published a story on our site that bitcoin and other crypto currencies will no longer be able to be purchased with a lot of the major credit cards. I think probably when it rallied like that and went up so quickly a lot of people were using whatever they could to buy some of it, and they think it’s just too risky of a proposition, at least to these credit card issuers. Do you consider it kind of similar to day trading in a sense where one day maybe it’s up really high and then it can crash the next day? Or like you just mentioned do you consider it a little bit of a safer investment?
Foster: Sure, I guess let me say firstly that this is a very interesting and unprecedented situation. The U.S. government especially considers crypto a commodity. And this is not just like gold or oil or corn for any legal and tax purposes. So, the vast majority of crypto, and by crypto, I mean crypto currencies particularly it’s used for mostly legitimate purposes. It’s not day trading. And so you really have to ask the question here – legally and morally and otherwise, what right do credit cards have to tell us what legal goods we can buy with our money?
And secondly, yes, clearly trading crypto is by any objective measure more risky than day trading equities or futures, with a few exceptions. But no, clearly it is a far more volatile market with much less precedent and stability, and I would advise anybody trading within crypto to be very cautious and be very responsible in setting their limits knowing their boundaries and knowing when to call it.
Hoff: OK, yeah, I mean, I guess doing a lot of research, and again getting in that mindset of saying, “OK, I’m willing to lose this money. I’m going to go invest in this new cryptocurrency. Maybe I’ll get a really big payout, maybe it’s just going to go to nothing.” So you’d have to be willing to definitely do that. And I’ve heard that also with day trading.
I’ve also heard that for an individual to kind of casually day trade it’s basically a lost cause – that hedge funds and other firms have supercomputers to do trades in milliseconds based off of information coming in at that moment that an individual just cannot hope to compete with. What would you say to that?
Foster: Well, I would say that it’s absolutely not a lost cause, I think that what we’re really talking about here is high frequency trading, and frankly high frequency trading is dying a slow death. The truth is day trading can certainly be profitable for a lot of folks if you are disciplined and you go out of your way to educate yourself and learn about the technicalities and how the markets work.
I think that starting out, the vast majority of people simply will not make it because of the various biases and emotional attachment and irrationality. It’s probably not going to be profitable for most because most don’t have an edge and they don’t even know the concept of an edge. You really need to make clear your unique advantage over other folks in the market if you’re going to succeed longer term. And if you don’t have a statistical edge you’re not going to make it very long.
Hoff: So what would an edge be? How would somebody have an edge?
Foster: Right, an edge is frankly a unique insight, and this is the beauty of how democratized and how excessive much of our publicly traded markets are. If you are a professional in almost any capacity you probably have insights into your industry that the biggest funds out there sometimes don’t have. And all it takes is a unique insight, and the value of an investment really boils down to how unique that knowledge is to you, how asymmetric that is, and frankly what are the odds of that event even happening?
And it’s a common issue in my line of work because there’s an in-force, it’s called alpha decay. And it sounds technical but long story short it means that any opportunity, any exploit in the market really has a limited shelf life, because when you have an efficiency and you have an opportunity to profit other people will eventually come in.
Hoff: OK, so how could somebody if they wanted to get started as a day trader kind of gets started? Either what would you say they need to consider and when do they know that they’re not going to be able to make it?
Foster: Sure, and of course No. 1, it all comes down to what we had talked about earlier, you have to set aside some cash in the bank, a rainy-day fund. You want of course, and it goes without saying, that if you are an employee with a 401(k) fund or a pre-tax retirement account, especially if your employer is matching, you absolutely have to contribute to that, at least up to the point that your employer is matching.
And so when you have a retirement account set aside, you’ve paid off your debts, and you have some cash in the bank then you can start thinking about setting aside some risk capital, and when you have that, think about your edge, think about how much time you have available, think about what insights you have into your professional markets that others might not. And at that point you have to acknowledge that if you’re going to succeed professionally as a full-time day trader it is a lifestyle. If you’re on the West Coast in the States you’re up at 5 a.m. seeing what’s happening in the pre-market. You are spending most of your free time doing research, and it’s certainly not as glamorous as I think a lot of people believe it to be.
And so, if you’re starting out – No. 1, prior to trade is to absolutely get a simulated account. There are lots of free options out there, even from some of the large brokerage and you need to actually do it. I mean, especially I’m speaking from personal experience here, but the best way to learn something is by actually doing it. And you’ll see pretty quickly that a lot of these trends and these opportunities that seem so evident are not so profitable when you account for things like transaction cost and commissions and other factors and slippage in the market when you don’t actually get the price you think you’re going to get.
So if you’re starting out absolutely trade, if you’re going to day trade, trade on a simulated paper account and go from there. Do it for a month or two. And if things are going well for you then you can start to scale in with real money. And there are a number of amazing even free options out there right now, for example you have Robin Hood who’s at this point only mobile but they have no commissions. You have even low commission brokerages like interactive brokers, of course of the mainstream discount brokers, you traded, etcetera.
But it is more accessible than ever before, and it’s not difficult to get. The paperwork required for most of these accounts is trivial; it’s no more than a bank account. But, think about your strategy, I mean, very clearly articulate in detail what your edge is, what your strategy is, and which markets you’re going to trade. A lot of people think they can just invest in a commodity like gold or oil. And there are ETF’s for that but there are big downsides.
And you don’t precisely match the performance of the underlying asset, and so there’s over time often diminished return. But if you’re going to trade something like futures for example you’re talking about a futures contract with a value of perhaps $50,000 or $100,000 or $150,000, and so not a lot of people can get into that without significant leverage, and that introduces a whole new set of risks and challenges.
Hoff: During the bull market that we just had I think there was pay a lot of confidence for people who were trying this out because I mean you could make money pretty well. Every day it was going up and it’s kind of hard to envision then the good days are going to come to an end, of course they did, of course they do, they always do. Do you think there’s kind of a false sense of confidence that somebody who day trades on their own can get if there happens to be a bull market and they’re doing well? When should they start recognizing red flags and risks?
Foster: Now you’re absolutely spot on, and this is I think the No. 1 Achilles’ heel for all traders and all new and even moderately experience traders. Greed is a big problem, and I’ve committed these sins myself, I know most of my investor friends have as well. But it is very hard to maintain discipline and stick to your structural and strategic rules when you’re starting to actually make a lot of money.
It’s very easy as well to perhaps double down if you are in decline, and this is the downfall of even some of the biggest banks. Countries for example, France – their national endowment fund, they lost billions because they kept injecting new good money to chase bad. They were investing in the beginning of a downturn thinking that they were already at bottom.
And so have your stop losses absolutely set. And it’s frankly best to just automate that so you are not inclined to intervene.
Hoff: OK, so automate it. If your day trading though how would you automate it?
Foster: Absolutely, so almost every brokerage out there has the ability to very easily create stop losses. And there are several types of stop losses. We’ll just go over a couple of the very basic ones here, but in the beginning a straight stop loss is simply a point at which you’re willing to cut your losses and you can automate that by simply creating that order ahead of time. And there are other forms; you have trailing stops for more advanced investors that simply trail the average or the moving price by a certain percentage or a certain number of ticks or points.
These things are very easily automated, the concepts and execution is not difficult. And it’s something that even the best traders automate because they don’t always trust themselves to make these calls appropriately when the time comes.
Hoff: What kind of mindset do you need to have? What kind of constitution I guess do you need to have to participate in this kind of day trading? Because like you said there’s a lot of biases, there’s ego, there’s fear, there’s just so many emotions that kind of come into it that people think that somehow they’re not going to be affected by that and it’s really hard to stay unaffected when you see your money going down to zero. So what kind of mindset do you need to have to even have a hope of surviving?
Foster: The psychology of successful traders is, I mean, there’s no end of speculation, and also research and formal academic research too on what really makes for a spectacular trader. And honestly it does vary depending on who you’re talking to. I would say personally that intelligence and professional experience has very little to do with it. Honestly those who succeed did balance a very precarious combination of optimism and frankly self-confidence and realism.
And you always have to be willing to walk away if things don’t go your way, because that is how the majority of new traders get into trouble if they don’t cut their losses. They cut their winners instead of their losers.
Hoff: OK, so it basically takes a rare mindset and you have to know who you are and what you are in order to even have a hope.
Hoff: Because, I mean, I’ve read as far as long term investments go, I read you just put your money in there and like you said or automate money going in there every month and you just have to ignore what’s happening with the stock market, because there’s always going to be corrections.
Hoff: There’s going to be dips, there’s going to be highs, and you just can’t, you’re not going to time the market, it’s impossible.
Hoff: Nobody could time the market.
Foster: This is true for maybe 90 plus percent of investors out there, probably more. You’re going to be best served by simply sticking with mainstream, very boring index funds. And depending on where you are in life you might consider the addition of bond funds and other income producing assets like dividend funds. But at the end of the day if you’re not going to be actively involved in structuring your portfolio you are almost certainly best off simply sticking with mainstream, very low fee index funds.
And that last part is important because most people don’t realize within many 401(k)s these mutual funds are charging 1 to 2 percent every year regardless of how they perform. And that adds up to significant sums of money over the long term.
And when you’re talking about a boring, easily accessible ETF that tracks maybe your Nasdaq or the S&P 500, most of these charge only a few basis points, we’re talking about small fractions of 1 percent. And it does absolutely add up over decades.
Hoff: And you’re talking about Vanguard or someplace like that.
Hoff: Where you can easily go in, you have the fund, you stick your money in, you pay one little fee for buying it and then you just leave it and let it go.
Foster: Yes. And of course I kind of hate absolute generalizations here, I think that some investors can do better by getting involved if they objectively have an edge and some unique insight. And if you’re willing to dedicate a few hours a week I think that most folks out there could conceivably do better by sort of moderately getting involved in actively managing their assets.
And of course that’s not to say day trading; this is to say, “Think about the global economic contexts where various trends are moving in industry, what’s emerging, what’s likely to come together to as a confluence.” So for example maybe the merger of data science technologies and biotechnology, it’s going to open up incredible markets in live sciences, drug development.
And so I think about these longer term trends, and unless you’re talking tick and minute charts as a day trader you’re probably best off sticking with the next funds unless you’re really willing to dedicate the time.
Hoff: OK, so let’s give an example. So the other day let’s say I had this conversation with somebody who is a believer that everything is kind of already priced into the market. And I said, “Hey, robotics is really taking off and there’s this company that created Pepper in Japan, and this is a robotic company and I want to invest in this company because I think that this is going to be the way of the future.”
I was told by this person, “If you think that and you’ve read that, the market’s already priced that in.” What do you think about that?
Foster: Yeah, the concept of price and market efficiency I can’t tell you how dumbfounded I am that it has just consumed the academic career of just hundreds of researchers. And it’s baffling to me because it’s so obviously impossible. I mean, there is absolutely no way that any intelligent, rational person could claim that the markets are pretty efficient. And I don’t think you’ll hear this from even the more conservative academics.
I think you have to realize that just by the very nature of information dissemination and how we publish newsworthy and relevant materials, there can never be perfect efficiency. Someone’s always going to be able to obtain that edge a little quicker or faster or more accurately than someone else.
And that all said the markets are somewhat efficient, there are certainly well-documented, longstanding research studies that of course, I mean, if there’s an opportunity to profit, if there are exploits to be had someone will come in to fill that gap, and that really is what market efficiency is all about, making the information symmetric and efficient all around.
Hoff: So maybe in this case my edge would be if I worked in the robotics industry or I happen to have keen insight into that, that was my job as a journalist, I covered that and I happened to see all of this development maybe before it hit mainstream news so much, that would be kind of my edge where I could say, “You know what? I think that I could before the market catches on make a good deal on this.”
Foster: Absolutely, and of course there’s a fine line here between insider trading and leveraging your unique insight.
Foster: And of course something we’re saying here should be construed as soliciting insider trading. But that all said if you’re in the robotics industry you see your suppliers selling out of a particular component that’s in high demand in various parts of the world, in various industries and verticals. And you see many retail or inventory just completely sold out for months on end, which for example this happening right now you have trends in tech in silicon chip makers and graphics card, many factors. Inventories and retail supplies they’re sold out around the world, and it’s highly indicative of the demand to support the emergence of cryptocurrency networks.
And so, yes, I think that it’s absolutely possible for most people to leverage what they know to have and create an edge in their investment.
Hoff: So just going to there’s a little bit further, let’s say I work within an industry, I kind of see a trend happening, how do I make sure that I’m using my edge by trading well without stepping into illegal territory of having information and using that to make a trade? Just for people to clarify like what would be legal and what would be illegal.
Foster: I’m probably not the best authority on legally determining what the big concerns are in trading. But that said at the end of the day if it is proprietary information, inside of your own organization that has not been publicly disseminated, yes, you do not want to make an investment decision or act upon that especially if you’re a senior executive or management personnel in that organization. Now that said if that information is public in almost any way, it’s absolutely fair game.
Hoff: OK, so use your edge, know your industry, see the trends that are happening, concentrate maybe on that industry or whatever your level of expertise is before venturing out into other territories. But just don’t do it to the point where it just happens to be information you’re privy to and nobody else is and using that.
Hoff: So what would you say people need to do to get started into this game? And I’ve kind of asked you this, but I guess, what are the three best practices?
Foster: And I think there are absolutely a few best practices. No. 1, of coursem educate yourself, read the literature, know your tax liability, and tax situation because I think most traders underestimate the tax implications. Clearly you are talking about short-term cap gains or long-term cap gains, and in most states that adds additional tax liability with regard to income taxes. And so think about these things ahead of time and you can avoid years of a lot of trouble.
The second and frankly I think this is probably one of the most critically important suggestions I have – don’t discount the opportunity to back test and actually model your strategies. The burdens of algorithmic trading platforms, and some of these are even free, allows anybody even with just modest technical skills to algorithmic program their strategy.
And this sounds like a pretty big technical challenge, but it’s frankly not. Take for example the platform we developed at quantiacs.com. We have a tool that allows anybody without the programming knowledge to develop a training algorithm and back test it on 20 years of data, completely free. And you can do this with retail programs. There’s a handful, I’ve personally used everything from the low level publicly available platform called Trading View, and there’s others, there’s one called Ninja Trader, and another called Multi Charts. And most have either free trials or demos or completely free to use but not trade on options.
And so if you think you have a strategy or a set of rules, a set of logic that you want to trade by it’s incredibly easy to program this into an algorithm, actually see how that would perform over various periods of time with realistic risk metrics and components. It’s not difficult.
And so if you can do that and you can show over hundreds or thousands of trades that you have a significant edge, what you want to look for of course is a flat, low volatility equity curve. You want to minimize your draw down, you want to minimize the most money that you lose. So from the very peak of how much capital you’ve made you want to minimize how much that conceivably can drop.
And this is the first metric that any professional hedge fund to look is your either a sharp ratio or a sort of moderate ratio, and they’re all just measures of risk adjusted performance and volatility. And as a day trader you want to be accomplishing the same thing.
And so I think this is the biggest or one of the biggest mistakes a lot of day traders make is they shoot for the moon. They think that, “Oh, I can shoot for 5 or 6 or 10 percent in profits per day.” And not realizing that if you could actually accomplish that you would be the richest person in the world in a matter of a couple months. It’s completely unrealistic.
Shoot for small, sustainable, reasonable goals. I mean, we’re talking about small fractions to large fractions of 1 percent per day. Of course depends on how much risk capital you have at hand, how much capital you’re willing to trade with, but suppose you have $10,000, if you make just 1% a day, $100 a day and you do that consistently throughout the course of the year you’re going to outperform almost every fund out there. You’re talking about hundreds of percent return accumulated over the course of the year. And of course this varies depending on your tax liability, but nevertheless it’s an incredible accomplishment, and very, very, very few can do that consistently.
Hoff: Wow, so it’s definitely one of those things where get your head on your shoulders, you’re not to make tons of money overnight, and you need to be prepared for the actual return that can happen. And that’s only if you’re very good, and you do these things.
Hoff: So that’s great. A lot of really fantastic advice. We have to wrap it up here now but I always ask my guests what gets you charged up about the possibilities that come with day trading?
Foster: Absolutely, and for me it’s no doubt the ongoing sort of democratization of the entire industry. It was not long ago that the algorithmic approaches that I was talking about were reserved for only the most well capitalized, largest banks and investment funds out there. And now you have anybody with a broadband connection, a decent computer, and a few thousand in risk capital, it allows anybody with these sort of core requirements to access the algorithmic programs that were only available to the biggest ones out there just a few years ago.
And that is really exciting to me. I think we’re seeing this same concept of sort of distribution, decentralization in cryptocurrencies as well. It’s one of the biggest developments to come in finance for a very long time, and I sincerely do believe that it’s going to disrupt and really force us to reconsider how inefficient many of our bloated financial institutions are. And so there are absolutely no barriers to the entry.
And so I do think that the ongoing decentralization and democracy of investment across the world, across the board is an incredibly exciting, and the technology is only emerging to allow individuals to not just compete but actually outperform leading investment funds.
And we’re seeing one of the interesting insights that we have here at Quantiacs is that we are able to have a high level overview into which algorithms actually perform and which don’t. And this is something that’s traditionally been very secretive across the hedge fund industry. And so we are seeing computer science graduate students and professors create algorithmic programs, strategies that easily out performs out of the top hedge funds out there.
Hoff: Oh, wow.
Foster: And that absolutely makes me want to go in the inside.
Hoff: Yeah, interesting, interesting space to play in and to know about. And so I really appreciate your time. I think that we launched off with this guy using his credit card to fund his day trading exploits. Not a good idea, but at the same time if you want to go into day trading there are some best practices, you’ve mentioned many of them in here. And I really appreciate it. I hope good luck to everyone who wants to try it out and take your advice to heart.
Foster: Thank you, Jenny. It’s great to talk to you.