Over the past week, we've all watched stock markets and crypto markets experience large price declines, sharp movements, and heavy trading volume. For many, volatility in the markets leads to fear and sometimes even panic. Based on my 15+ years of experience, I have come to view these periods with excitement, since outsized opportunities become available to those who stay calm while others panic. In reflecting on my own trading during extreme market movements in the past, I came up with a list of lessons that I've learned that I'd like to make available for others.
I've traded in two very distinct capacities:
1. Arbitrage and active trading. I worked for one of the largest market making / high frequency trading firms in the world for most of my career. I've traded through some of the most volatile periods across the US, Europe, and Asia.
2. Positional trading and long-term investment. I've personally traded my own book for the past 15 years and have learned a lot during that time. Much of that perspective has been shaped by my direct professional understanding of market structure and how various market participants behave.
Arbitrage and Active Trading
- Know where the market is. When the market gets busy, different trading venues can have different prices. Highly correlated products can temporarily trade out of line due to asymmetric information or temporary supply and demand differences. It's important to connect to multiple different venues.
- Pay attention to system health. When the market gets busy, data feeds can become delayed. It's important to have best-in-class data providers. Crypto exchanges are notorious for having poor quality data feeds.
- Stay ahead of trends. When I was trading stock index options during the 2010 flash crash, we had an open line with brokers and there was an extended period where only option buyers were coming in (option time-value premium increases when markets fall). We decided not to sell anything until we saw the first option sellers come into the market. We stuck to our guns and missed what appeared at the time to be profitable selling opportunities that later would have turned into big losers. It ended up being our most profitable day in history.
- Establish redundancy in your system. In busy markets, systems can temporarily fail. Establish and maintain multiple exchange accounts, have multiple ways to cancel orders (i.e. desktop and mobile), confirm positions between your ledger and exchanges or trading partners, etc. You don't want to be surprised hours later or the next day when a trade (position) comes in that you weren't expecting. And you certainly don't want to be locked out of the market because your broker or exchange is experiencing high traffic.
Positional Trading and Long-term Investment
- Be prepared. Know your strategy and stick to it. In the short-term, the market can go up or down for non-sensical reasons, but that shouldn't alter your well-researched and thought out strategy. Know your exit strategy ahead of time. Research has shown that the biggest mistake people make is funding new trades by selling winners (which then keep going up) and not selling losers (which then keep going down). Your reason to sell should be as well thought out as your reason to buy.
- Be aggressive. Once you decide to enter or exit a position, do it immediately. If you want to buy, don't wait to see if it goes down a bit. Otherwise you'll watch it run against you and regret not acting sooner.
- Sentiment is reflected in the price already. People are reading the same headlines as you. To make money you need to think independently and ignore emotion. I've had the best success being a contrarian, particularly when it comes to small trader ("retail") sentiment. For example, this article came out right before the market tanked.
- Keep a log of your decision making. If you decide to make a trade or not make one, make an entry in a journal. I've found it helpful to refer back to this and learn, without being influenced by unknowns at the time that become known and seem obvious after the fact.