Benchmarking Hedge Fund Algorithms

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Video Transcript:

Let’s focus on who does the stories already. What are the good guys are doing and why they’re succeeding? Because we need these stories in order to convince ourselves that we’ll be able to do so.

So after these attempts of working on the system, I also tried to go to the big hedge funds and work with them and to see why they succeed. For me, it was extremely important to figure out what is the key to success for the hedge funds. And luckily, again, as Jeremy said, I got the opportunity to work with Fund the Funds. Fund the Fund is an organization that does the diligence, does the test of multiple hedge funds and decides whom to invest. So I got to the Fund the Fund that give me the carte blanche to go and check all algo trading funds in the country. So I went to 35 funds and I had a very personal conversation with them about technology, about their algorithm, about everything.

And again, this is a kind of internal joke, because everybody asks me, “Why would they tell you this? Why would they tell you their story? Why would they tell you about…?” And apparently, these people are also very much alone. They have nobody to tell and to share what they do. And because I look like I look, all of them were really willingly sharing with me all the details of their frustrations and what works, what doesn’t work.

And what I got from it, it’s very interesting statistics. First of all, I noticed that people that succeed are between ages 40 and 50, and even closer to 50. So this is what’s kind of weird for me because you have much more creative energy in the beginning, and why would it happen? It’s not so hard to build a system. Come on, every 20-year-old guy that knows a little bit of programming can build a system.

So I started to do the mathematical thing. I decided, okay, I want to quantify it. I want to do all the things right and figure out what’s going on. So I created four phases system. Each fund got from me the grade, and what phase he’s in. Apparently, all the people that go into the trading industry, they go through the phases. They don’t have mentorship schools. Nobody teaches you how to do that. So you have to do it on your own. You have to do it by yourself.

So, first of all, in phase one people create successful algorithms. And usually, since they’re smart, they try to do it as HHH. They don’t try to fool themselves. Sometimes it happens, because, again, you’re lacking understanding, but still, usually, this phase is easiest. So you’re taking the history of the different assets. You’re trying it, you’re succeeding it. Boom. You’re going to your friends, and you’re saying, “I know how to beat the market. Look at these numbers. Let’s put some money together.” So this is the first phase. And luckily for some, their friends have a lot of money. So you can become a hedge fund just because you got some nice idea and your friends gave you a few minutes.

But then what happens? And this is such a painful phase. Lots of the guys fail on the first one. Why? Because you start trading, and this is the big story is that it just fails. Just doesn’t work. And you have no idea why. You are lacking this understanding of why. Especially if you build a black box system and if you build a system that you don’t understand yourself how it works. And this is a big issue for most beginners. They don’t understand how it works. So suddenly it stops working, and they don’t know how to bring it back.

I remember the story that I was in one of the offices, and it was 20 people trying to figure out why their system stopped working. And I would ask them, “Guys, so how did you build it? What are you basing it on?” And they were not able to explain. 20 people. So their thought process was not about what they’re trying to do, but rather how to make their algo succeed. So this is a very hard phase is to adapt your system to different market conditions that happen every day. Once you succeed with this one, your chances are much better, much, much better.

But then you get into the scalability phase. The scalability phase is when you get out of your hundred dollars or a few million dollars to the normal numbers of tens of millions of dollars. The number of issues here is immense. First of all, to gain new money, to get the money, to manage the money, to know how to talk to the crowd. What to do, what not to do. It really requires a team. But then if you pass this, you become a company that, close to the story of renaissance to medallion fund and anything else.

And I saw this company and these companies are not one, not two, but out of 35, there were 12 companies like that. You’re not aware of them, or maybe you are, but the regular people are not aware of them because they don’t accept their money. So you don’t know that they exist, but this is the whole world of the existence of HHH and BFO.

This is just from JP Morgan, the numbers that regular funds have. So as you can see, Rob advisors are not the story for us to compete with. Their percentage is very, very low.

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