How Does Leverage Affect Trading Returns? The Kelly Criterion | Coffeezilla Follow-up
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- čas přidán 24. 08. 2024
- Todays video is a follow-up to the video I did earlier this week with Steven from Coffeezilla, "The Truth About Trading Gurus". Let's look at some of the lessons that can be taken from the world of gambling that might help a trader with sizing their trades. We look at the Kelly criterion (also known as the Kelly system or Kelly formula), to see if it can provide any insights to investors. How does leverage affect trading returns? Let me know your thoughts in the comments section.
Patricks' Books:
Statistics for Traders: amzn.to/3eerLA0
Financial Derivatives: amzn.to/3kwsPSr
Corporate Finance: amzn.to/3fn3rvC
Visit our website: www.onfinance.org
Follow Patrick on Twitter Here: / patrickeboyle
Patreon Page: / patrickboyleonfinance
A reading list on this topic:
Ed Thorpe Books: amzn.to/3hG5gW4
Fortunes Formula by William Poundstone: amzn.to/2YZAr7N
When Genius Failed by Roger Lowenstein: amzn.to/3jhsUIW
Link to the coffeezilla video: • The Truth About "Tradi...
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finally a better microphone it helps so much
More about Options and wallstreet bets
There are gains on wallstreetbets like making 2 million in 3 month, how to do that?
And how much money do I need to setup a Hedge Fund?
I know you need 5 things to set up a Hedge Fund:
1) You need a seriously strong and FULLY AUDITED "Track Record" (3 years or more) -->fully audited = one of the top accounting firms has audited your Track Record.
2) An Offshore Registered Fund -->E.g. Cayman. They have "plug and play" set ups. Lawyers included.
3) An Onshore Management company -->Contracted by the Offshore Fund to manage the assets of the Fund.
4) A Third party Administrator -->He is the "Bodyguard" who ensures that the Investment Manager can only direct Assets Under Management (AUM)
to agreed investments as per the Funds mandate which are agreed by the investors.
5) A Prime Brokerage Agreement (with an Investment Bank)
-->who collateralize the offshore funds capital and allows the fund to borrow against those funds to go long
and short assets synthetically using Derivatives or physically.
No Investment Bank will enter a Prime Brokerage Agreement with a Hedge Fund unless they have
$25mln minimum in AUM and the Track Record.
Is this true?
This sounds about right, plus you need to register with a regulator in both the onshore and offshore jurisdictions. Most IB's require starting capital close to $100m nowadays, and they have to believe in your ability to raise more capital quickly in order to open a prime brokerage account. If you are going to Trade OTC derivatives you will need to negotiate an ISDA master agreement.
@@PBoyle Oh ISDA master agreement, thats the scene from the Big short.
Link: czcams.com/video/Qo1OSqBQYmk/video.html
Currently an Analyst in the Sales & Trading division at an investment bank. So hard to find straight shooters talking about finance on YT. Thanks so much Patrick and keep it up, you’ve got something here!
Thanks Jackson, glad you find it helpful!
Scientist: "Alright so the coin has a 90% chance to land on heads, and there's an equal reward for calling either side correctly."
Participant: *Puts everything on tails*
Scientist: o\_/o
Scientist : Can I place a negative bet?
Casino: ???
@@hypothalapotamus5293 The equivalent to YOLOing it all on a 0 day OTM option :D
It would be funny, if this wasn't how elections sometimes, or a lot of times goes
Place 10% on heads, 90% on tails.
We're equal now bthc
10% of the time it lands on tails, 100% of the time.
Honestly I’m so happy to see someone doing this. I work as an investment analyst at one of the big 3 consultancy firms, used to help on the client teams for hundred million and billion pound pension schemes before transitioning to the responsible investment team. The work that goes into making a multi billion pound pot so that it can grow to meet it’s liabilities and reliably pay an income for members is truly staggering to me, and the thought that there are people who get you to believe that you can get 400% a year or 2% a day and live off the income like it’s nothing makes me sick beyond belief. Thank you for all that you’re doing.
2% per day compounded is a lot more than 400% per year. You are right though, this whole trading guru industry is a scam. It doesn't just exist in the trading industry, there are loads of 'property development' fake gurus as well. They prey on young people and people without the sense to realise they are con men.
"Excess leverage will definitely wipe you out"... Bill Hwang tried to prove otherwise, but...
Investment banks are leveraged 30-100x on the basis their risk management and hedging strategies are impecable
What could possibly go wrong
That was a great interview on Coffeezilla, Patrick.
Thanks!
I second that!
It is a year later, and that is how I found you too a few days ago and subscribed. That video has legs and I really enjoy your teaching style.
Patrick is the hidden jewel of CZcams. Thank you sir for educating us, Robinhood fools
What a time capsule. Almost 100x the subs you had when you released this video. Well done
Can’t believe I just discovered your channel. Your videos are very well done. You have a beginning, a middle and a conclusion. Obviously well researched, intelligent, and interesting. Thank you!
Thanks and welcome
Easily the best finance channel out there.
Just wanted you to know I have been watching your videos long before your interview with coffee and I think you do a great job of educating us on the real fundamentals of trading and not no guru crap. Many thanks 👍
I appreciate that!
I met Patrick on coffeezilla and you deserve all the subscriber grow. Thank you for teachings and expertise 😀
Thanks! 😃
I saw you on Coffeezilla. Came over and subscribed in the first minute. Finally got around to watching a video. Not disappointed.
Hello. I found you through that Coffeezilla video, which also happened to be the first time I had ever watched a Coffeezilla video. An excellent decision by the CZcams Algorithm to send me to that particular video. I have only been through these two videos, but I am liking the content thus far. I am now a subscriber of both of your channels (as well as clicking the like button and all of that jazz). And I have a little time, so I think I’ll click on another video after I finish this reply. Cheers.
this channel needs to blow up. Extremely valuable knowledge to feed on here. Thanks Patrick! Cheers from a Norwegian follower
One of the interesting things about the kelly system is that if you could reliably predict the actual risks attached to an instrument, rather than having to make do with estimates that are definitely wrong but hopefully not by too much, there would be an objectively correct trading strategy, particularly in derivatives markets where the results are more binary, like options or swaps.
I'm here from Coffeezilla and I'm loving what I'm hearing. You sold me on not trading for money I care about, but the underlining concepts like probabilities, risk management, black swans, and statistical analysis is quite applicable outside of trading, so here's a sub.
this channel is so underrated , so glad i found this channel
I played poker professionaly for two years and, I've been studying trading for a past years with broke-even results. For my little knowledge acquired in the past year on trading my current conclusion is that trading is harder mainly for one simple reason, CALCULATING THE PROBABLITY OF A WINNING POSITION. (Simple example) If you're drawing for a flush with one card to come the probability of hitting the flush is simply calulated by the number of suits remaining time 2= 18%. If there are $100 in the pot before last card to come and your opponent bets $20 you'll need to call $20 to win $140 (100+his 20+the 20 you'll put in. This means that you're pot odds are 14.5% with the probability of hitting flush on next card of 18% which is printing money in the long run. When it comes to trading how can I correctly risk a % of my account without knowing the probabilty of the trade to go my way?!?! I will always under invest or over invest without that information.
As someone who is also a former poker pro, and now spends the majority of his time on investing/trading, i'll say that you're working under the assumption that the two are fundamentally similar. There are some concepts that are transferrable (like Expected Value), but I would say investing is probably more similar to sports betting than poker.
That said, you've picked a very simplistic and not very realistic example to make your point. You're talking about a very simple pot odds calculation where there's only one card to come and you always make the best hand, but thats not really representative of making money over the long term at poker. You are assuming near perfect information (your flush always makes the best hand and/or your opponent doesn't have a higher flush, or the board is paired and you're drawing dead, or card removal for possible outs) which again you just don't have. A more accurate representation would be constructing a range for your opponent, which would always involve some guesswork and would be analogous to the uncertainty involved in whether a trade would make money over a given sample, or also constructing a complete range for yourself in this spot so that you are balanced and not exploitable. You can't say for certain whether this range will be profitable over the long term, you have to make educated guesses (through modeling, study, intuition etc) and press likely +EV edges, and the same applies in investing.
the answer is easy... Options
Backtesting is the only way, and the only way you can sleep at night.
If I track 100 cars passing a street, and find that whenever there is a blue car there's a red car behind it 60% of the time, that would be a coincidence possibly.
Say I do the same experiment with 12 different streets, but 1000 times over the course of 10 years, and find red comes after blue 60%. That is backtesting or quantitative alalysis.
A lot of traders use this method with technical indicators to create a system. Look up NNFX channel.
Nice stuff! One complicating factor is that odds and the chance of winning are connected. You know the given odds on a bet, and you may know how often you're right. But chances are, the higher the odds, the lower the chances that you're right. Meaning you can't compute the actual Kelly Criterion, because one value is unknown and must be approached conservatively.
From coffeezilla!
I found an edge of around .1% in blackjack in a casino with unusually favorable rules for the player. Started with $100, making $5 bets. @$200, $10 bets @300, $15 bets and so on. Took hours to reach table limit of $200. Stared playing 3 hands of $200 each. Absolute max they let me play. 12 hours into my play, I was up $25,000 when they stopped me from playing. A few days later, they changed their rules forever.
Hey Patrick, thanks for the great content you've been providing so far, I'm learning a lot. I was hoping that you could create a video explaining market makers and how they make money of payment for order flow.
Great suggestion!
Citadel and Two sigma are the 2 biggest players in payment for order flow
I have absolutely no intention to ever trade stocks but your content is amazing, you have a gift of explaining very complex stuff in a simple manner.
Have you considered dividend growth investing? Simply accumulate shares of quality dividend paying ETFs by dollar cost averaging. Enable Dividend Reinvestment Plan (DRIP). All you do is purchase and never sell and you will be owed and increasing amounts of money which will go toward making you ever increasing amounts of money.
You won't have to worry about complex trading. Only on trying to purchase shares of the ETFs as cheaply as possible while being paid ever increasing amounts of money by the ETFs the entire way until you are ready to retire. Never know, might be worth sinking your teeth into it.
One thing I learned for day trading liquid stocks is when the pivot point is hit and all the buy stops are hit, the majority of times the stock will go up a little and then come back down. The more optimal buy is the high of that bar which some call the second entry.
Some times the stock is too strong and will not pullback.
The Plain Bagel comment section got me here but I'm glad you did a video with Coffeezilla too.
This is so freaky. I've gotten into card counting this past month and have discovered Thorpe's work. Been a fan of Coffeezilla and enjoyed the interview he had with you. Now the two worlds collide? Keep up the great content.
This is Gold. Listen to it 10 times then 20% more
You should really do reviews of these trading "gurus" , you will spread so much awareness, potentially save peoples livelihoods and possibly lives (People have committed suicide losing money) and the concept of making money slowly over a decade or so and the power of compounding interest. Great content.
10:40 my brain did ouch. I did understand 2*p-1, coin flip probability 0.5, so bet 0 on coinflips. But thanks for the info, looked up the Kelly formula, now brain only less ouch.
An interview on Coffeezilla was how I came across your channel. I can not thank you both enough!
long journey from 7k to almost 500k! Good job!
Patrick please answer! The advantage on the coin toss game is 20%. But that is my expected gain after each toss ? It is not 20% so how do I calculate my expected gain ?
From the other side of the world, Your content is truly educating. THANKS A LOT
True, thanks to Coffeezilla we now know you. Your commentary is informative and hilarious at the same time. Loving it!!!
I was just thinking about it today about leverage in the Futures Market. Specifically the es futures. I'm definitely going to check out Edwards books and the Kelly criteria regarding the bet sizes. Thank you for the video
Glad to help. When you look at most financial disasters, excessive leverage is the culprit.
Patrick
I just subscribed because you impressed me on Coffeezilla and I trust Steven. I had not heard of you prior to the referred channel. Looking forward to enjoying real red meat.
Posting again in hopes you see it Patrick!:
Patrick, I like your mention of the greedy gambler who bets 100% of his position with each iteration of his gamble, but I'd like to ask you a question about the analogy. In a true gamble, you can't cover your downside- you can't use leveraged inverse products as hedges on a bet or stop-loss orders to limit your losses. As a day/swing trader myself, I'm a 24 yo that never went to college. I speculate, do some analysis, and use 100% positions with those sorts of downside measures. I started with $2000 and used that without adding more to reach $5000. I feel like gambling is a very apt metaphor for the kind of trading advertisers try to preach to the masses. Generally though, I'd say that it's the idea of trading like gambling that sort of keeps the general public from realizing how profitable trading volatility really can be and learning how it happens.
For example, with the continuous utilization of margin I can double my principal growth with the same %-returns and halve my principal exposure (1% - mine, 1% margine), provided that I am adapting to losses with less risky positions to follow (increasing my ability to hold within my 2% tolerance). Using these techniques alone I've made 300% in a year by reinvesting profits & dividends. That 300% is even after I suffered serious hits to my portfolio, spaced months apart, on the level of 20% or 30% at times or more, but not once I started limiting my losses to a 2% loss margin per trade as a rule have I been at a loss by week's end. I sell my positions within days or weeks but never hold longer than two weeks so I can shift to new opportunities in the markets.
I think I'm a day trader, but it seems like others who trade day to day are constantly losing money while risking much lower positions. Do you think the principles expressed in your analogy applies to traders that practice more sophisticated techniques? I wouldn't consider myself a gambler because of the category of trading that I perform. But I'd be interested to know your opinion about these techniques and perhaps any experience you have with them or the perception of money management techniques in general.
Thanks for the excellent videos! You're a great educator and presenter!
Thanks Carl, I think most day traders lose money because they take a random approach to markets and hope to get buy on good luck and some sort of innate natural skill.
The ideas behind the Kelly formula hold for any speculation that has a positive expected return. If you use risk management techniques, that then adjusts both the volatility and the distribution of your returns and if done well can allow larger position sizing.
After I did the interview on Coffeezilla, I received a lot of messages from people telling me that there is a big difference between trading and investing, and I guess that all comes down to how you define the terms. Most of my trading strategies have holding periods of less than a day, but I consider them investments as they have a positive expected return.
A blackjack player like Ed Thorpe, is not gambling in my opinion, even if he is playing a 'game of chance' as when the odds are in your favour, it is an investment rather than a gamble. Most good traders have no interest in exposing themselves to risk without return, and don't hold out hope of being lucky.
@@PBoyle I'm watching your video on portfolio management dealing with risk & return, so I'm getting a better understanding of that point about risk that you made. Thank you for explaining that to me, the work you do is amazing and I for one deeply appreciate your content Patrick! Thanks so much for your response :)
Little late to the party, but making my way though your videos on my vacation lol. Happy I found your channel! Best of luck for 2021
Was thinking of incorporating the kelly criterion into what I do. You just gave me the impetus, thanks :)
I am very happy to learn about the Kelly Criterion. 2% daily compound interest for 365 days is 1.02^365=1377. I would like to play against a person who does not know that ... Please tell me why I should no go SHORT in January if we have extreme positive cash flow in funds and extreme put/call ratio and extreme fear&greed index now?
Well because you would've lost all your money. Hindsight is a bitch!
I'm here because of the coffeezilla interview but new to both channels now.
You honestly scare me even more about my decision, but I'm still new to trading/investing. I am just looking for a career I can be passionate about and still be sustainable. It seems your channel should help me whether I decide to active trade or even become passive and pursue a new career. Pre-thank you for all the free content and amazing information.
wow, you have a gift for explaining complex things. Thanks so much.
Glad it was helpful!
I'm already hooked on the channel. Keep the videos coming, Patrick!
One of my best friends from high school works at a hedge fund and basically compared day trading to a mom and pop general store competing against Walmart. They have the infrastructure(high volume trading is all about having the minimum possible amount of fiber optic cable as close to the stock exchange because a few milliseconds to execute hundreds of trades a minute trade be the difference between profiting or losing tens to hundreds of thousands of dollars), everyone at the company is recruited directly Ivy League schools. Each hedge fund you’re competing against is backed by an army of the absolute best researchers, mathematicians, programmers, analysts, actuaries, and experts on entire industries with the money to eat massive losses until they come out on top.
Patrick: Thank you for your generosity in sharing your knowledge and Wisdom. You are a true master, and teaching is in your soul... I stumbled upon you by chance, but you have a new subscriber, happy to have found your valuable content. I sincerely commend your vocation to teach and share your knowledge. Thank you very much. Best regards
thank you for appearing on Coffeezilla.
Thanks for investing your time in these videos, they are wonderful!
I greatly enjoyed watching it!
Glad to have found you. You and SMB Capital seem to be the only ones out there teaching it right.
Jim Simmons: I hope we will have 25-30% return on investment this year
CZcams Ad: Are you bored working in office, boring jobs and coworkers. What if i tell you that you can work 15min from your computer and make 300-400% return on investment every year, go to the link in the description and you won't regret it.
Even 25-30% seems delusional to expect those returns year after year.
@@mostxtremenoob6384 There are a handful of people in the world who could do averaged 30% for 30 years on the smaller size (low / sub billion) Something like a peter lynch, and if you just take this 19 year old kid's course YOU TO can do it!
honestly 25-30% ROI is pretty insane. With inflation in consideration (and taxes gurus like to forget about that) if you can make a stable 4-5% return you are doing pretty good
@@user-tk2lf1dv3s i mentioned Jim Simmons because he is notorious for returning 20-30% on average for over 20 years. That's why Warren Buffet in every interview is pointing out that there are not many people who are making these big returns, so the smartest idea is ETF/Index. Many hedge funds are trying to be the smart money and still their avg is below 8% (the S&P500 avg).
Wow. Every single sentence is packed with valuable information. Btw, I bought your new book after finishing your statistics playlist :)
Wow, thank you! Im glad you are finding it useful.
"The Plain begal" interview was the best one I've seen you in. The host richard had great interview skills. The interview flowed well and was very informative. You both vibed off of each other.
🧡💛💚💙 Im a day trader for 10-11yrs and the only thing that keeps you around is Risk management. People seem to ignore me when I say that all you need to do is consistently win on $10 bets for 2 months and then bump your size up and adjust risk upwards
Everyone wants to do 50x-100x leverage and not committ...
🧡💛💚💙
what do you mean? can you elaborate?
He means slow and steady gains will out last the guys trying to hit home runs.
@@meepo1862 🧡💛💚💙 What I mean is; when you see someone making $100,000 per month or more, its not that they have 100% win rate and they never lose
Its just that... when they win, they up their risk. When they lose, they lower their risk.
Its that simple.
Same information.
The quiz show betting was illegal. I would not try to corner the wins in illegal betting. Johnny Stomp might pay you a visit.
i saw you in cofezilla and your content seems super educational.
Thanks!
Hands down, this guy is a legend!
I don't do leverage anymore. I got wrecked enough times to know how bad it is. Wish I would have seen this earlier.
My 2 favorite stock channel.. Raging Bull and Patrick Boyle 😂😂😂
Yikes lmao
www.ftc.gov/system/files/documents/cases/1_-_complaint_1.pdf
Amazing video on Coffeezilla Patrick...so much clarity, thank you!
Can I conclude that if I have 100k? I will invest 20% of it to see how it goes for a few months to see how my skills then adjust from there?
My first comment ever on youtube. A very informative video, and just the sort of content one needs to get on with the learning process. I thank you , and yes I have subscribed.
I just really like watching you. I'm broke and have no idea about money, let alone the in depth finance you do. I still keep watching though. I just like you. 😂💖
This is so great ! Thank you for sharing this patrick
Many options guru's also like to quote statistics that writing options (market makers) win ~70% of the time. Although this may be true, Patrick makes a good point that the size of the profit loss the other 30% of the time may be sizable enough that it is a losing strategy in the long run.
Thanks you for an honest, straight talk content.
Hey Patrick, great video, although I have a couple of questions.
First, I don’t understand the formula you gave of 2*P-1. Imagining a coin flip where P=0.5, that gives 2*0.5=1. That doesn’t seem right to bet 100% on a coin flip. What am I missing here?
Secondly, you mentioned not really recommending to use the Kelly Criterion in financial markets. I was wondering if you could expand on your reasons for this. Some professional traders like Anton Kreil do advocate the use of the Kelly Criterion to help with position sizing, since retail traders don’t have someone else managing them. The Kelly score can help them increase position sizes when winning while decreasing position sizes when losing, similar to how a hedge fund manager might allocate more capital to his more profitable traders while reducing the capital allocated to his less profitable traders. Just curious to hear some of your expanded thoughts on this.
Cheers!
As a math major, I can't help but blush when he explains stats and prob concepts using real-world examples! Good work and nice storytelling!
great content dude but you're scaring me out of the market.. I had made 15,000 using leveraged returns more than doubling my money. Then the market fell off in September and my short term dis call got wiped ... You're making me re think my trading strategy for sure. Thank you for the information!
Thank you Agent 47!
first time hearing about the kelly formula - watched 3 videos on it, very interesting!
I got seven tails in a row on my game at elm. A .78% chance of that and even betting optimally, I still ended up with about 10% of my starting balance. Brutal!
Thank you Patrick. But what a bout leverage plus computing stop loss (like i do not know always 1% of trade)? This way it is kind of Kelly Criterion applied to trading with leverage?
I bought your book when i was first getting into trading... Didnt realize you had a channel!
I've been trading options for about 6 months now and coming across your videos you mention stuff that took me months to learn and totally understand, like market correlation, trade allocation, etc. Great stuff!
Do you still trade options or did you wipe out?
@@luvon1114 Wiped out
@@bryceblankinship really? What happened?
@@luvon1114 Same day exp zoom calls and it was not a good day for zoom.
I go to an interest calculator and do those calculations on a weekly basis. Right now, I have to do 22% for 20 yrs, and I'll have 7M, approx. lol. 22% seems easy, I pick winners all the time, lol.
Fantastic video. I learnt a lot in risk management from the Kelly approach. Thanks man. Look forward to more of your future videos.
Glad you enjoyed it!
@@PBoyle I actually have a question. I am a college student currently studying finance, investment and portfolio management. I understand the importance of diversification and how to diversify properly with calculating risks and returns with Maths. I also want to start investing and trading stocks. Personally I think I will not be doing day trading as it is going to be hard for me to keep trading daily with my school projects and all. So I will be doing swing trading over weeks or one or two months long hold periods. Plus, I do not have much starting investment capital to work with as I am only a student (Less than USD$5,000). Is there any advice you could give me in creating my portfolio. Like which are the industries you would recommend me to look into investing. My main goal right now is capital growth not really preservation. So equities makes sense, but I am not too sure which industries to focus into that will give me the highest returns in regards for risk.
And look at you now! Fantastic!
Very instructional video on this topic. Thanks.
824 Thumbs Up and ZERO Thumbs Down.
Unheard of. Great content.
Yep I subscribed after watching that video...
I really shared your videos sir Patrick Boyle in my facebook account coz I am sure that this is really a good education that it could not be found in some schools of business out there and many of my country men in the Philippines are in need of FINANCIAL LITERACY.
Many of the concepts mentioned were apart of my AP Statistics curriculum!
i remember my silly american ass didnt stick to patricks vid when i first discovered him bc i ‘didnt like his accent’, well 1) im much more tolerant now and 2) patrick has found his place on youtube, he is a seasoned professional that has a knack for providing good commentary and detailed explanations, sorry i was a douche patrick but i love you and im reading your last book rn (well when im done watching this of course)
Patrick deserves a million subscribers!
How do you explain Renaissance Technologies?
Wow time flies brother still doing some of the best work in finance entertainment 👏 👌 thank you sir you are OG now.
Incredible channel regarding finance.From coffeezilla.
I came from CoffeeZilla , subscribed , great content
Hi, Patrick. Thanks for the video! I'm interested in digging into this Kelly criterion even further now. I just ordered your book on Statistics for the Trading Floor as a way to say thanks for the info. Cheers! 🍻
That lesson on the Kelly principle changed my life! What a f*cking good video sir!
loved that colab with coffeezilla
This channel is great. I am not a "new" subscriber. Not even a trader, and much less a gambler.
Great content! Thanks a lot
Great channel thank you for your time making these
Brilliant info, I'll stick with index funds and holding for the long term with no leverage for my main portfolio,
I'll have a bit of fun money for trading but again with no leverage
people are sleeping on this amazing channel
Trading without counting leverage/money lended from broker was over the board, people didnt even know how to use it, haha
However, there should be an equation to consider the winning vs losing ratio. On the coin example it's all or nothing, on trading it's more like 1%~2% loss, vs 2%~5%~10% win.
Here from Coffeezilla, watched a couple of your videos, much
Welcome!!
Glad to be a subscriber, hope to learn a lot from you .