Thursday, September 24, 2009

Insect survival and trading

I was reading Audubon magazine the other night and was intrigued by the piece on biomimicry and the accompanying magnificent photography. By the way, the original article “Where It All Begins” along with web exclusives is available online.

The article started me thinking about ways in which traders might mimic nature to their advantage. First and foremost, it’s critical for traders to survive. It’s all very well to be king of the jungle, but the king can be taken out by a single bullet. Lots of impressive kills, but vulnerability to that one fatal encounter.

Let’s jump quickly from the single animal to a class of animals—those pesky insects. Insects have been around for several hundred million years, so they’ve certainly passed the survivability test. Most experts seem to agree that insects have survived mainly because of their rapid adaptation to changing environments. This adaptation is furthered by their particularly fecund reproductive powers.

To translate the survival skills of insects into trader terms, they use high frequency adaptive trading systems. I show here an example of a very high frequency self adaptive trading system (presumably "overly adapted" to attain such a perfect equity curve);
the source is irrelevant because unless you’re Goldman Sachs or the like you can’t possibly trade this way. (But don’t you love the image of Goldman high frequency traders as a horde of insects? Of course, high frequency trading has to be automated, so traders get replaced with algorithms, which alas don’t lend themselves to such a compelling image.)

The trader with fingers poised on shortcut keys and monitors covered with charts, quotes, and spreadsheets can’t begin to emulate the mosquito. But we shouldn’t forget that butterflies are insects as well, and they move at a more leisurely pace. And no, in answer to those who slept through biology, snails and slugs aren’t insects.

I’m not claiming that the only winning strategy is adaptive and relatively high frequency. But sometimes nature offers us insights that shouldn’t be ignored. The trader who uses the same strategy day in and day out, blithely ignoring the prevailing environment, will have a short life expectancy. And the trader who waits for that one perfect trade doesn’t have probability on her side. As the high-reproducing insect would say, you just have to do it over and over again!

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