Expert Profiles: Jez Liberty Sees Vast Automated Trading Potential

Expert Profiles gives Automated and Algorithmic trading system developers and theorists a chance to introduce us to their concepts and strategies.

Our expert featured in this edition of Expert Profiles is Jez Liberty.

Jez is extremely passionate about Automated Trading and its technology. We’ve enjoyed Jez’s posts on Automated Trading at his blog, Au.Tra.Sy blog.

Here’s Jez’s interview:

What made you choose to develop Automated Trading systems?

I have a long-held fascination with the trading world and a passion for technology. So automated/mechanical trading system sits at an ideal crossroads for me and represents an exciting topic to work on.

Additionally the prospect of going into a corporate career never appealed to me; whereas automated trading systems can give you independence and more freedom (and hopefully better wealth).

What are the challenges of developing Automated Trading systems?

There are lot of information out there and it can be hard to know what to pick to get started. In my case, I started trying to automate Technical Analysis patterns with “brute force” backtesting/optimization, which did not prove successful (I am skeptical on the long-term profitability of that approach). Further down the line, I stepped back and got more interested in learning about the nature of the markets, statistics and money management. This led me to have a clear vision of how I could succeed in trading automated systems.

But developing and trading an automated trading system is also a long process, far from the get-rich-quick scheme, that many dubious salesmen would have you believe. So you have to put in some hard work. But the reward and payoff are definitely worth it!

Working on your own can also make you feel isolated. However, my blog and other blogs such as Online Investing are a great way to engage and collaborate with like-minded people.

Can you expand on what information led you to your clear vision?

Sure. One thing you quickly realize is that academics and institutions are not always “on the money” with their theories.

Classic financial models (such as Markowitz Modern Portfolio Theory) make basic flawed assumptions about price distributions, yet they are still a cornerstone of many institutional models. We know by evidence that market distributions exhibit fat-tails, for example. They are non-normal. There are quite a few of these academic misconceptions such as assumed normality and stationarity of price distributions, or even mistaking variance for risk! The latter is simply not true and LTCM is a classic illustration of this (their equity curve was really smooth right until they crashed).

So it pays to read alternative authors and theories, and make your own mind up. I always like to say that even Galileo was considered an heretic in his time.

Another point is Money management (i.e. risk and position sizing). It is often overlooked. However, this is an absolute necessity for successful systematic trading. Successful trading strategies are often fairly simple. The complexity lies in the money management area.

Finally, from a mathematical point of view, it is critical to use robust statistics for analysis, as well as rigorous procedures for back-testing to avoid pitfalls such as data snooping.

What are the opportunities?

The bottom line is that the markets do not conform to the theory and models still used by many institutions. And there are relatively simple strategies to profit from these inefficiencies. Trend Following is one of them. It is no coincidence that most successful Managed Futures funds are systematic trend followers. It is also no coincidence that when the markets went into panic in 2008, most Trend Following funds “cleaned up” while other quant-oriented hedge funds, supposedly sophisticated and staffed with armies of PhDs, just imploded.

I think it is important to have focus. Mine is now on Trend Following as a mechanical trading strategy. And I would recommend it to anybody wanting to trade in the financial markets or simply wanting to take responsibility for their investments: it is simple, yet effective.

But before 2008, was Trend Following not coming out of lackluster periods in terms of performance?

Yes, it is true that Trend Following can alternate good periods after bad periods (note: Buy and Hold strategy is even worse for this). However, Trend Following is a strategy designed to perform well in the long run over different types of markets. The single most important aspect for a strategy is survival over the bad periods. Unless you are a trading genius like George Soros or Paul Tudor Jones, it is impossible to keep excellent and consistent performance year after year (think LTCM). Over the last 10 years Trend Following has performed very well.

Any more opportunities?

Technology! I believe we are currently living through an information revolution, similarly to the industrial revolution in the 19th century. It is much easier to access knowledge and communications. This makes it more accessible for anybody to educate themselves. Technologically  speaking, with the advances in software, computing power, market access, it is also much easier to develop, test and implement an automated trading system.

The internet in general also brings more opportunities to connect and collaborate. I have already witnessed this with my blogging, which is very exciting.

Can you see other downsides to the automated system trading approach?

One of the main incentive for people to use an automated trading strategy is to remove emotions linked to trading. However, this is only partially true.

A system will have highs and lows, triggering positive or negative emotions. A large drawdown, for example, might make you want to stop trading the system, whereas rapid new highs will make you want to take some profits.

It is harder than one thinks to stick to the system 100% of the time.

Have there been any big lessons during the development process?

I think it is very important to invest in the right tools and education. Take your time and use your common sense.

What are your predictions for Automated Trading? How will it change–or change us–in the future?

I believe that, in general, we cannot predict accurately… But if I had to make an educated guess, I would say that basic human nature is not going to change. This includes greed and fear as major dynamics of the market. This is what creates inefficiencies and opportunities.

Even with the advance of technology, these basic traits will prevail. However technology is a formidable tool, an “enabler”, making it easier for the enterprising trader to implement profitable strategies.

Final thoughts?

I just want to tell the readers that they can take ownership of their own investing and be profitable. Systematic and automated trading offers you the best opportunities. Find your focus. Remember to worry about risk and survival before return optimization. Successful strategies are simpler than you might think. Do your homework and be prepared (including psychologically). This should get you a long way towards successful automated/systematic system trading.

For more information about Automated Trading, see our last Expert Profile, Ben Gimpert of Something Modern Logic.