Eric Johnson
10-04-2017
A new idea for investment management. When most people invest, they do so with the goal of making as much money as possible. This is completely reasonable and logical but I feel it also leads to illogical behavior. When you see someone who bought Bitcoin 2 years ago, or who has owned a FANG since 2013, you see that they have made money and you experience the fear of missing out (FOMO). You feel an implusive need to own what your colleague owns so that you too can have a share of their earnings. Or perhaps you run a trading algorithm and are having success with its trades, so you want to expand its exposure and try to run it in a new market. I argue these actions and ideas are illogical and that they hold investors back, because although the goal to make a lot of money is clearly reflected in their execution, the techniques posed lead to more trouble than they are worth.
My idea is to invest solely based on goals. This is not a formula or tip on how to decide what to buy. Imagine you run a fund. For a reasonable time period (day for HFT, quarter for L/S equity), derive a goal x (return on invested capital) that you would like to return over your period of time. The derivation of the goal should be causal (in that it does not depend on information that will only be available in the future), and should be strictly tailored to your funds independent needs. Once you have this goal, start investing your strategy like normal, hopefully you do well. For each time period over which you decided to define your goal relative to, once you hit your goal x, exit the market and stop all exposure. Either hold the money you made in cash or buy a bond that will expire by the time your time period ends. If your goal was well defined, then you should have made enough money to pay your expenses, satisfy investors, and satisfy yourself (with a bonus). From the moment you hit your goal, you can be completely sure of your success for the time span on your goal. Thinking and operating in this manner systematically eliminates greed in your investments. Because it makes you work towards something tangible, it makes you more logical and efficient with your actions. Additionally, it inherently creates metrics for you to live up to and evaluate yourself upon. This feedback loop can again serve to make your system more efficient and mechanical with its well defined output driven metrics. With this feedback you can also constantly adjust and update goals (for the next time step) to recalibrate with performance and needs.
If you are running an algo and its trades get you to x during the day, then turn everything off and don’t run any risk of the algo breaking by leaving it on. Take your money and run. Every algo (and strategy) has a flaw, and even if something works, it is guaranteed to never work forever. For this reason, its best to get out as soon as the thing you built worked enough, and don’t stick around to find out what happens when it breaks.
Ideas for good fit use cases
Pros of this strategy
Cons of this strategy
Thesis
To minimize investment risk, spend as little time as possible exposed to the markets/source of risk. You can’t lose any money if you lack exposure.
Proof and Explanation of my claims
Why should it work out that quitting on an investment after it reaches a certain critical mass will lead to more success over the long run? There is science that shows when your investment is doing well it is comparable to being on drugs. Drugs are addictive and so is making money investing. The trouble comes when drugs start to harm you or making money is not easy anymore. Because of the addiction, drugs can ruin a person and greedy investing has ruined many funds. Being forced to quit a drug is hard but helps addicts in the long run to live better lives. I think being forced to quit investments will work similarly for funds. E.g. after your bet on FANG stocks made your fund 20% over a quarter, you pull out your money. Then spend the free time you now have researching a new thesis, finding a new opportunity. Set a new goal and repeat.
What happens when you set the same goal and just keep repeating the same strategy? I guess my thinking for this strategy is that it works best for HFT firms. Their algos run on miniscule arbitrage opportunities and have potential to make or lose a lot of money in a short amount of time. As opposed to a more fundamental long equity fund, a HFT fund is using math and probability to evaluate prospects and make decisions on a very short time scale. When the algos work and hit their daily goal, I think it makes the most sense to turn them off and do something safer with the money you made. In my opinion, a fund should be optimizing for survival, not profit. As long as your definition of survival includes sufficient profit within it, if you can survive, you will make more than enough money and hopefully continue to do so for a long time. However, if your only goal is to make a insane amounts of money, you get greedy and eventually get yourself into situations that wipe out any previous money you had accrued.