There is an argument that has always been used by people who are fixed on the achievement of extremely high profit targets when they are confronted with the real-world evidence which shows that “top player” audited market performance values have been at most of about 20-30% annually and in average about 7-10%. This argument is that we do not see bigger figures in long term audited accounts because these accounts play “big money” and therefore they cannot have the “freedom” that small money has. The logic behind this argument is that the “little guy” has an inherent advantage due to the simple flexibility around the way in which money is invested and how they can get in and out of the market in a “quicker” and more efficient fashion. On today’s post I am going to talk about the “little guy” advantage, why this is NOT as important as you think along with some evidence that this is in fact the case.
The idea here is that volume plays a fundamental role when we trade in the market. When John Doe wants to trade with his 10K account he can easily get in and out of the market and therefore he has a lot of flexibility of when and how he trades his account. On the other hand the idea of volume dependency suggests that a “big guy” who is trading with a 50 million account cannot effectively do this since he depends on the liquidity the market has to offer. In essence what we’re saying is that the “big guy” doesn’t have as much flexibility because he depends dramatically on the actual offers inside the market while for John it is always very easy to get in and out as the market always has enough liquidity to fill his orders. Therefore since John has more flexibility he can get more profit and effectively the average compounded yearly profit to maximum draw down ratio we see on long term audited performers should not be applied to him because he is not a “big guy”.
However we can easily destroy this argument in several ways. The first important fact is that “big money” has access to better liquidity and they also do not trade from a huge account with 50 million dollars or whatever huge quantity. When people trade money in this way they distribute their money along many smaller accounts which are allocated to individual traders or small trading groups which then use this money to trade. They therefore have the “small money” advantage with the added plus of trading on a far more superior architecture and a much more professional environment, added to the fact that the money they lose isn’t theirs so there is a lot of psychological pressure relief that retail traders do not have (as they lose their own money).
The above argument is further reinforced by an in-depth analysis of long term audited performers on the Barclay Currency Trader Index. Who makes the most money? In contrast with the proposition that volume is “worse” for long term performance the truth is that the larger players here make the most money. If you divide accounts into those that trade more than 10 million and those which trade 1 million or less you’ll find out that large players are making a lot more money in the long term. Having more money is not a disadvantage in regards to execution or getting “in and out” as money management is in most cases NOT centralized and execution conditions and trading environment are MUCH better than what any retail trader could have.
However there is an advantage the little guy has which the large guy doesn’t have which is related to risk taking. Although both types of market participants have the same inherent average compounded yearly profit to maximum draw down long term “cap” the funds with larger accounts cannot have the luxury of withstanding moderate to high draw down levels because they will be destructive to their image towards their customers. While a small retail trader could – for example – trade to make 100% a year with a 50% worst case scenario (which is determined by Monte Carlo simulations of his or her portfolio) a trader managing more than 1 million would never take such a risk – with the exact same portfolio – because if a worst case scenario materializes it will be devastating for their track record. They would rather trade to make 20% a year with a 10% worst case scenario because this preserves the integrity of their trading performance even if they have to create a new portfolio due to an inherent failure of the current portfolio’s characteristics. This strategy makes more sense regarding long term profitability and account growth.
So there you have it, the little guy does have an important advantage over the big guys which is NOT related to execution or how the “little guy” can trade but it is related to the fact that the “little guy” doesn’t need to show anyone audited performance, has no customers and therefore can take larger amounts of risk. This means that yes, you can be more profitable if you’re a retail trader but you will always be more profitable at the expense of a higher draw down and a higher worst case scenario value. There is no free lunch in trading and the inherent limitations shown by audited performers apply (as the past 25 years of evidence on the Barclay Index have shown).
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