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Risk Management

Retail Traders Have The Advantage of Freedom

Retail traders have a significant advantage over small to medium size funds: they have more freedom to adjust risk and trade a wide variety of strategies and products. This is an edge provided traders do their homework.

Below is what I wrote in a Twitter thread:

Large AUM funds move the markets. If they even face 20% – 50% redemptions during (corrections) that doesn’t affect them much. They can always use their huge marketing and PR departments to make it back when markets recover.

Large AUM is an edge. Many market participants fail to understand this. Large funds can invalidate technicals and fundamentals any time they want. But they are careful and focus on the longer term.

On the other hand, retail has many advantages most don’t realize or exploit. After a 20% drawdown, no one will call a retail trader in the middle of the night and ask for an emergency meeting. Retail has freedom of movement. Freedom is also an edge of some kind.

Small funds and especially strategic allocators are at a disadvantage. Redemptions can push AUM below the threshold for attracting more capital. They are always under pressure to deliver nearly every quarter. Most avoid timing with excuses because it has a bad name.

In March 2008, stocks, bonds, and commodities fell and some funds faced a large drawdown. The models based on correlations broke down. Leveraged small funds were closed. I remember someone I knew who managed a $100mm fund and ended up DJ in a club.

Retail traders have the major advantage of freedom but most focus on what fund managers are doing instead of developing their timing strategies. Timing, if done right, can result in benefits from the losses of small funds that have no maneuvering ability.

Small funds may be stuck with inflexible math models for allocations based on stochastic parameters and during market crashes are noise. Backtests work fine due to data snooping: they won’t select the model that failed but the one that worked well in past.

At the end of the day, passive investors, large AUM funds, and those retail traders who do their homework (not easy) are the beneficiaries of the losses of a large number of aspiring fund managers relying on basically academic models and backtests.

Disclaimer:  No part of the analysis in this blog constitutes a trade recommendation. Read the full disclaimer here.

Charting and backtesting program: Amibroker. Data provider: Norgate Data

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