How to improve odds of trading with the least skilled traders?

[Lucky C]

In most investments, the odds are high that your transaction will be with someone more skilled than you, simply because the best investors/traders in the world would have a larger volume to trade and might trade much more often than you. Just as if you went to play poker at a casino as a non-professional, the odds are good that you would be facing off against at least one player the table much more skilled than you, since although there are more non-pros than pros, the pros are the ones who spend all their time there.

When it comes to trading to take advantage of inefficiencies (as opposed to e.g. long term investing based on value), depending on the strategy, it may be worth it to seek out the least skilled competition and avoid investments with higher probability that you'll be trading against the pros. Are there proven ways to do this?

The first thing that comes to mind is micro-cap stocks since the wealthier pros are unlikely to bother with stocks worth only $100 million or so. However this may not be the case, since I think beginners would be most likely to trade stocks of companies they're familiar with. Maybe a company with high name recognition but small market cap would make sense?

Another thought is that supposedly "dumb money" trades more in the first hour of the market opening whereas the "smart money" trades more in the final house before the market closes. So a trading strategy designed to exploit dumb money may work best if only conducted in the first hour of trading.

I would also be interested in other markets besides the stock market that may offer either a better probability of trading against low-skill traders, or at least have the ability to gain information about the skill level of traders as it fluctuates over time so in order to choose when best to participate.

[Lemur]

Not only the pros, but you're also playing against the algorithms. The good news is, professional fund traders have restrictions on where they can put their money. Going all in on TSLA is one way to lose your job for instance. But you could do that if you wanted too.

I've been doing something accidental to what you describe...trading against less skilled traders. For instance...I browse Reddit to get an idea of the sentiment behind certain stocks. Sometimes a stock catches fire by retail traders, IV gets driven up, and there isn't any real valuation behind the push. Just hype. Those stocks I like to sell options on for instance.

Those stocks I might also own for the long-term if they're worth something, I can catch good dips for the long-run. Usually they don't fit my screener, but I don't mind speculating for swing trades.

Otherwise...holding for the long-term on stocks you feel are undervalued or fair valued will always win out in the end. Not always the case but I get the feeling less skilled traders have much higher turnover in there portfolios.

[white belt]

I listened to an interview with Jack Schwager on the Market Huddle podcast where he talks about his latest edition of his book called Unknown Market Wizards: the best traders you've never heard of. In the interview, he mentions a trader in the book who built his entire strategy by getting in early (and exiting relatively early) on trends he identified based solely on keywords on social media. I believe the trader eventually built it into some kind of platform that sells such data to other traders, but you can listen to the interview yourself or check out the book because it might give you ideas. It also might give you some inspiration for some unconventional strategies that small traders can employ. I think there was another trader who was self-taught and built an entire strategy on trading around quarterly earnings reports.

Personally, I think I agree with Lemur that certain social media platforms and websites are probably a great place to check out. If people are on reddit, talk about sports betting/gambling, talk about Davey Day Trader, or use "stonk" memes then it's probably a good place to start. I believe there are many traders in the Robinhood crowd who got into day trading during COVID lockdowns as an alternative to sports betting, and since the market has rallied many of them may actually believe they have some sort of investment skill.

[Lucky C]

@Lemur
Yes that's exactly the kind of thing I'm talking about (selling options on stocks with IV that's too high). On the other hand I have read that some of the pros / big traders have been already capitalizing on the inefficiencies from these overhyped issues. So there may already be some competition, but maybe it is possible to emulate what the pros are doing and share in some of their profits.

@white belt
I have been reading the New Market Wizards, in which one of the interviews got me thinking along those lines. I didn't realize Schwager just came out with a new book. I'll have to check it out.

At a high level view, my thinking was that some trading systems might not be very profitable if applied broadly to all stocks or index funds, but profitable if the same exact trading rules are applied to only the most "unprofessionally" traded stocks. On the other hand, some other trading systems might only be profitable when applied to broad indices but would fail if applied to individual stocks that have wild swings relative to the index. If you tried to apply one of the strategies too broadly it would hurt performance, but combining the uncorrelated strategies in their own niches would improve reward to risk ratio.

I just don't know if there is a reliable screen that can be applied to stocks, or a market other than stocks, that can result in consistent higher probability that you will transact against an unskilled or lower information trader. Even if the probability is only a few percent higher that could make a difference. But I don't know if there is any way to determine these probabilities rather than relying on intuition e.g. "it seems like TSLA is being traded more by non-pros compared to BRK..."

I imagine if you had all trading data at your disposal, you could screen based on ratio of transactions of < 100 shares (or even < 10 shares) to transactions of 100+ shares. But that would be a lot of data for an individual to handle unless only recording transaction data over limited time periods on a few hand-picked stocks.

[jacob]

To avoid the most skilled people, you have have to go where the big money isn't.

From a business perspective, it's standard economics, like a mining operation.

A trader god who is capable of consistently making $10-100k/day on most days is not going after thin liquidity. They'll be in deep stuff that allows lots of liquidity. Futures, currencies, commodities, big stocks.

Furthermore, analysts cost money. Something like GE will have dozens of eyes looking at it. An obscure company from Israel or Argentina will not. An obvious way would be to look for companies followed by no analysts.

Likewise, a quant team which may cost the business $300k/year in salaries (->1M/year when you include profit share and overhead) is not going to be looking for inefficiencies of less than $1M. Insofar they even identify it, they're not going to trade it seriously if it requires active effort as opposed to spending time looking for bigger elephants. Likewise, algorithmic infrastructure also costs money ... it's one thing to trade GE on a colocated machine paying $$$$/year for a level 2 ticker feed. Whereas trading that Argentinian company from above probably requires physically calling a broker dealing in such matters thus excluding algo traders.

It might be worthwhile to look outside the paper markets. Used cars, machine parts, real estate, collectibles, websites, vending machines, laundromats, ...

[Lucky C]

My first thought was "but an obscure company in a smaller market will not have a lot of trades from the likes of RobinHooders who are new to trading," but perhaps it is better to eliminate the top 10% skilled traders than to find stocks with the max number of bottom 10% traders? After all, traders in the middle of those extremes should still make bad emotion-driven decisions. Additionally, if I'm looking for repeatable emotion-driven patterns, a collection of average-skilled/older traders could be more predictable than a collection of young chaotic novices? Finally, what I had in mind as an uncorrelated strategy may work best in stocks that are trading more or less sideways - not part of a bubble and not crashing - and not highly correlated to the major indices.

Yes, I was going to mention Craigslist as an example of a low-skill market, though it is not so appealing to me to be a Craigslist trader. But maybe if i focused on a niche like electronics repair with a trader mindset (e.g. look for free items that may just be a blown fuse rather than look for a challenge to build skills) that would be more satisfying.

Websites- I remember checking out Flippa a couple years back, and the game appeared to be to engineer a website to look like it had good growth, even if paying much more to get the (fake?) growth than you would get from ad revenue, in order to sell on Flippa to a low-info buyer who thinks the growth will continue after they take over the site (it doesn't). Anyway I'm sure there are more ethical ways of going the website route.

[white belt]

I think Jacob made good points with other market possibilities. The inconvenience/inefficiences of transacting in such markets is what makes it possible to turn a profit. I know Ego makes good money flipping items tenants throw out and from flea markets. Check out this thread for ideas: viewtopic.php?f=6&t=7474

[nomadscientist]

Personally, I think I agree with Lemur that certain social media platforms and websites are probably a great place to check out. If people are on reddit, talk about sports betting/gambling, talk about Davey Day Trader, or use "stonk" memes then it's probably a good place to start.

Six months ago maybe. 1-2 months ago even the instagram memes switched back to "day traders are idiots who always lose their shirts."

Also, hedge funds are quite sharp and not that conservative, despite being big corporations and therefore crazy on some level. They're good at finding trading ideas and dumb money. They employ some of the smartest people in the world to think about only this all day. Hedge funds were using machine learning to trade based on social media data a decade ago. Social media is long since not new. You won't make money doing this on your laptop unless you bring something more, where "more" is relative to a moving target with excellent opsec.

It's the difference between trading BTC now and trading it in 2014, where the skill isn't in trading BTC but in realising that BTC is something significant in 2014. With hindsight, I think Robinhood was a real opportunity in the early corona days. The money tidal wave was so large and sudden that the hedge funds couldn't eat all the upside. A moderately intelligent investor (like Portnoy himself - not a fool) could probably have done pretty well provided he was conservative in timing the exit. I, like most moderately intelligent investors, wrote it off as day traders always lose their shirts.

[white belt]

@nomadscientist

Good points. I can’t remember the specifics of the social media trader in Market Wizards, but he was outside of a hedge fund and made significant returns. As Jacob pointed out, there are opportunities for the individual reader that accredited investors/funds won’t exploit for a variety of reasons.

I think the key for what OP is trying to do is to understand both why a strategy will work and also why it won’t/can’t be exploited by Wall Street (regulatory reasons, doesn’t scale, etc).

Edit: I believe what you are describing in your last paragraph is using macro trends or looking at larger flows when evaluating investments. You still could have made significant money from BTC just investing a few months ago when it was at 1/3 of current evaluations. Of course hindsight is 20/20, but the individual has an advantage in that he doesn’t need to generate enormous capital in his returns (100k profit is huge for an ERE individual, but chump change for most funds).

[Alphaville]

Good points. I can’t remember the specifics of the social media trader in Market Wizards

what edition of market wizards is this? ive been looking for this book and various versions go back decades but there are multiple flavors.

[white belt]

what edition of market wizards is this? ive been looking for this book and various versions go back decades but there are multiple flavors.

Here is the interview: https://markethuddle.com/podcast/holida ... er-part-1/

Here is the book that focuses on small scale “unknown” investors: https://www.amazon.com/Market-Wizards-t ... 097&sr=8-4

Of course caveats for any Market Wizards are that survivorship bias may be a factor and exactly copying these strategies likely won’t work because there are probably many people trying to do the same thing. Nevertheless I think they serve as good sources of inspiration (I haven’t read the book yet, but just the interview made me think).

[nomadscientist]

Edit: I believe what you are describing in your last paragraph is using macro trends or looking at larger flows when evaluating investments. You still could have made significant money from BTC just investing a few months ago when it was at 1/3 of current evaluations. Of course hindsight is 20/20, but the individual has an advantage in that he doesn’t need to generate enormous capital in his returns (100k profit is huge for an ERE individual, but chump change for most funds).

I am talking trading specifically. If you trade BTC today (as opposed to buy and hold in belief it will become a reserve currency) then you are competing with hedge funds. In 2014, you were competing mostly with private citizen, some unsophisticated, many ideological zealots. A smart individual trader might have been able to make a profit on the churn back then. Today, will almost certainly lose it all if he keeps going long enough.

[Alphaville]

Here is the book that focuses on small scale “unknown” investors: https://www.amazon.com/Market-Wizards-t ... 097&sr=8-4

aaaah that makes sense, thank you

probably a better start for me than reading about hedge fund managers who can sway markets

[unemployable]

I think Jacob made good points with other market possibilities. The inconvenience/inefficiences of transacting in such markets is what makes it possible to turn a profit.

You want to be buying from forced sellers and selling to forced buyers. Regarding the latter, I do some casual flipping and ebay was a goldmine last spring for selling stuff you can't find in big box stores. It was the only thing open!

reddit.com/r/flipping may be of interest.

You can always find free ski gear around apartment buildings in Colorado ski towns in the spring, at the end of April or May when winter leases end. People just leave all their stuff out.

[white belt]

@nomadscientist

I’m not sure I follow. I agree that you are now competing with hedge funds who may have an information edge, but I also still think there are opportunities for success for the disciplined individual who is following their own set of rules. Certainly you are not going to outperform the hedge funds at the same game, but you are playing a different one entirely. If an ERE trader’s goal is simply cover 10k of living expenses with a few trades in a year, that is entirely different than a hedge fund that needs to answer to clients, stay within guidance from compliance/legal, and generate annual returns in the millions.

Edit: I guess the fundamental question I’m getting at is, is it easier for an individual trader with a portfolio of $100k to generate $10k of returns vs a trader with a portfolio of $1 million to generate $100k of returns vs a hedge fund with $100 million to generate $10 million in returns? Maybe I’m getting my lines crossed by conflating trading and portfolio construction a bit.

[Alphaville]

Maybe I’m getting my lines crossed by conflating trading and portfolio construction a bit.

yes. read jim paul.

https://www.amazon.com/gp/product/B00MNMHBA0/

a very good book, with both @jacob's and nassim taleb's seal of approval

[nomadscientist]

A hedge fund may not beat you on a 40 year time horizon, because a hedge fund does not have a 40 year time horizon. But a hedge fund is very likely to beat you on a 3 months time horizon, due to information asymmetry, and also other advantages.

I am not totally ruling out the possibility of niche areas where this is not true. But in 2014, likely was not true of the broad BTC market.

[IlliniDave]

I don't trade, but just curious, what's the point?

If there's a stock you want to buy, or sell, and you think the price is favorable, what difference does it make who you transact with?

Or is this just about finding idiots and trading whatever they want to trade assuming they will have it wrong in a way that favors you?

[Alphaville]

I don't trade, but just curious, what's the point?

for me the idea of trading (in financial markets) is for fun (assured) and profit (maybe).

the fun part is that it's an intellectual challenge in real-world terms that can keep your mind active and engaged; the maybe-profit opens up the possibility of semi-ere plus the chance of working from anywhere in the future.

im not interested in buying & selling used cars, potatoes, scrap metal, cattle, etc, although i know people who do that in various degrees.

[Lucky C]

@IlliniDave

Say I have a trading strategy that's designed to capitalize on the mistakes that unskilled traders often make. The trading strategy might be expected to lose money per trade on average if most of my trades have a smarter pro on the other side. However the same exact strategy might be profitable if restricted to only small stocks with thin volume, for example. Such a strategy may work well for a small trader like me since I wouldn't be competing with the smarter money / smarter algorithms.

Realistically, what I have in mind for the strategy probably won't work well, but it's worth exploring in the off chance that it's profitable because it could offer returns uncorrelated to my current strategy / the stock market.

Also worth thinking about in general since the concepts could be applied to other markets outside of stocks.