being prepared to take on risk can be a competitive advantage
trading is a risk-taking endeavor.
one of the most effective ways to compete is to be more willing or smarter about taking on risk than your competitors.
on the extreme end of things, you see this in risk-premia harvesting.
risk assets tend to trade significantly cheaper than the expected value of their cash flows.
that's cos their cashflows are uncertain and the attractiveness of those cashflows dependent on all kinds of uncertain things like shocks in inflation, rates, growth, politics etc.
so, in exchange for taking on those risks, you receive higher expected returns than the trader or investor who avoids them.
but you have to be smart about how you take on and manage these risks - or you'll get yourself rekt.
diversification, sizing, and (maybe) tail hedging.
now an example from a faster style of trading...
sometimes you'll notice a relative value or arbitrage opportunity.
thing A might be trading rich compared to similar thing B (or a basket of similar things).
you could trade the spread or arb
long B / short A
that gets you market neutral, but it involves double the trading costs and less execution
freedom than trading a single leg.
so, you could just trade the leg you think is mispriced and wear the market risk.
short A
this is often acceptable if you're taking a lot of trades: either by turning over fast, or trading broad (lots of different stuff).
doing this, you've exchanged more variance for greater expected returns.
often you have to do this or you won't get the trade.
but, even if you don't, it potentially allows you to be more competitive even if you're not technically as good.
if your costs are lower (cos you're prepared to wear more risk) then your hurdle for the mispricings you're prepared to go after can be lower than your peers.
going back to a slightly longer timeframe, we also see slower-moving inefficiencies persist in the market longer than we might expect.
trend-effects, post-earnings announcement drift, business hour seasonal regularities, turn of
month window-dressing effects.
these things are very well known. why do they seem to persist?
maybe because they are noisy, blunt, slow converging edges?
harnessing them requires taking on a lot of variance, relative to the expected returns.
so they are not super-competitive games. they might just be ones that you can compete in.
exchange a bit more variance for easier returns.
- harness risk premia.
- go after economically-sensible, slower-converging inefficiencies.
willingly accepting more risk for less competitive return sources is a good trade-off for most individuals imo.
beep...boop