Introduction
In an effort to share some of my thoughts publicly in a more organized medium than Twitter, mostly for myself, I’ll be putting out a series of posts this year on random thoughts, theses, things i've learned etc. This first post goes through principles on taking risk in markets. Honestly, if you’re a seasoned trader you’ve probably noted everything here somewhere and likely won’t find it useful - starting on a pretty basic note. For everyone else, I hope you enjoy and get some sliver of value.
First thing - disclaimer: nothing here is financial advice and everything represents solely my personal view and not the views of my employer, friends, local church, or anyone else other than me. I am not a registered investment advisor and nothing I say should be taken as doctrine. Again, this is largely self-indulgence, don’t take me too seriously. I’m constantly learning and my views are always evolving.
When it comes to taking risks, investing capital, optimizing a portfolio, deciding when to act, I find it useful to lean on a framework I can look back on to check myself and keep myself honest. In minimal particular order, here are some key elements of that framework.
Prelude: Everyone is a trader
Most people in the world would not self-describe themselves as traders. Entrepreneurs might focus on building companies, teachers care most about their children, doctors and nurses the well-being of patients etc. However, they’re all traders in their own right - every decision you make from your youth to present culminates in a snapshot of where you are today. Entrepreneurs who don’t look at prices daily to focus on building a company, and thus equity value, are making a trade. Doctors who sacrificed social life in their 20s to trudge through residency made a trade, and so on. Decisions have various horizons of commitment and everyone is constantly making tradeoffs.
The quintessential definition of “trader” just means people who turn decisions into capital directly via the platform which offers outcomes more quickly than broader career choices or building a company from scratch - that platform is the market. This post is catered more towards a reader fitting this classic definition, though as we now know - everyone should be able to find some value somewhere in here.
Position Sizing
One of the biggest fallacies I often see in traders is once they make some money, or lose it, position sizing in notional terms supersedes position sizing in percentage terms.
For example, if you have $1m in liquid capital and any bets you take on smaller higher risk-return investments, such as venture or random shitcoins, is say $10k - that’s fair and dandy, but, if you find yourself later having $10m in liquid capital, you need to adapt your sizing to make positions bigger.
People often have trouble overcoming this hurdle for a variety of reasons. One of the biggest reasons is people overemphasize thinking about expenses outside of the screens in the real world - rent, food, mortgage, going to the club etc. so the notional figure of “what you’re willing to lose” priced in reality unfortunately stays the same as you get richer. Removing your portfolio value from comparisons to life expenses is difficult, but necessary, if you wish to continue linear/convex growth. Keeping your check size anchored to a bias established in a different regime is a sure fire way to trap yourself in flatlining growth.
The same works for the other way, down size allocations after capital losses. Always think in percentages.
Value at Risk
I define VAR as the amount of capital I could have by throwing everything liquid I own into a single asset, often this is dollars. However, thinking about value at risk only in dollars handicaps the ability to view how you are performing relative to an entire universe of potential target assets. For example, if you’re generally bullish on BTC and ETH, you should divide your portfolio by both prices to see what kind of deltas you can pick up on those. Then, calculate your VAR as often as possible, say at least daily, which will make it easier to buy dips and de-risk rips and systematically benchmark yourself to passively holding. It’s also fun to calculate your VAR against something you may never touch, say Gold or Stocks, just to see what happens.
Liquid vs. Illiquid
I’ve made a point to explicitly use the term liquid portfolio rather than just portfolio in areas of this post because the distinction is necessary. You should mark your illiquid NAV on venture investments, vesting things, etc. but it's important to split it out cause that value can move viciously. Sizing positions based on something you can’t sell is poor practice and you will find yourself dry on powder for opportunistic trades because you may overcommit capital based on marks which can’t be realized. When it comes to most forms of debt, I always mark it as a liquid liability to keep myself honest on net assets and liabilities. However, for something like a mortgage, there is a case to be made for marking it as an illiquid liability and removing it from your current NAV as payment installments are a drag on monthly flows but not instantly redeemable liabilities by your mortgage issuer. We will get more into debt, particularly leverage, next.
Debt
Debt is an incredibly powerful tool, the general way I think about it is if you’re optimistic about the future and your ability to build or invest in things which outpace your cost of borrowing, consistently being in some degree of debt makes sense. That being said, if your portfolio experiences a drawdown the debt will become a larger percentage and being forced to sell things down to pay liabilities is a terrible position. So use debt conservatively. With great power comes great responsibility, which brings us to the next section.
Futures and Options
Mastering derivatives is necessary for any investor, whether you’re a trader or not. Some people may say that’s not the case for venture or more private equity focused style people but the lines are more blurred today than ever before. Knowing where the curve sits on locked investments you’ve made, how to hedge future cash flows, patiently entering or exiting markets via options, collecting or paying premium at opportune moments in volatility, and knowing the rate you can convert liquid assets to synthetic to raise cash all benefit any portfolio - even if you opt to never engage in any of the above, the knowledge itself is worth obtaining. Typical order of learning is calendar futures first, then perpetual futures, and then options - plenty of resources online, maybe an eventual post from me, but also trial by fire is a great way to truly learn.
Data
Compounding effects on data production are creating exponentially vast troves of information online which are impossible to stay on top of without a routine framework and some degree of automation. Even if you’re exclusively a venture investor, it’s useful to know when holders of your bags are making moves - adding/removing liquidity, staking/unstaking, etc. So much is out there that splitting out useful metrics from noise is constantly becoming a larger parsing problem. There is no golden rule here on what to prioritize and how to ingest it all but some pointers:
If it was already built, don’t rebuild it. Use tools which exist first
If it’s not built, build it in the most minimal viable product way first
Maintain a daily routine of things you check on in order - I like to check favorite metrics at least once in the morning, once in the evening
Counterparty Risk and Custody
One of the largest risks you rarely think about until it bites you in the ass is counterparty risk. When not self-custodying, know the places you’re dealing with well. For centralized services there are always humans on the other end - get familiar with them, meet, chat etc.
Keep in mind self-custody is a risk in itself - having 100% of all your assets in a hardware wallet is likely not the optimal ratio for most people. Events which may seem impossible could occur in the most unpredictable ways. The gist of all this is ensure in as many diverse tail risk scenarios you can think of, you might take a punch but never get KO’d.
Trial by Fire
Caveat first - do your research, research is good. Analyzing everywhere you can deploy capital and selecting only the best positions after thorough research is noble and idealistic. That out of the way, sometimes the best way to learn is to put trivial capital at risk without having the most comprehensive understanding of what you’re getting into. This is contradictory to all financial wisdom from pundits - the emphasis is on trivial capital and the value placed on learning by execution.
If the position increases in value and the position size becomes more meaningful, you will naturally dig more into what is actually going on under the hood. From there you can choose the right size for more conviction. Of course having conviction sizing from the start is more optimal, but frankly not always feasible if the rate of places to deploy capital exceeds your capacity to analyze all of them. Ask yourself, will you pay more attention to assets in your “watchlist” or ones in your VAR?
The other spectrum of thought here is everything above will cause burnout and spread too thin, instead focus on a few select high conviction plays, research a ton and engage in only the number you can spend time focused on frequently. I respect this mindset, enough to say it’s valuable to be able to toggle into this style at will - consolidate, rebalance, and reset.
With all that said, the reason trial by fire exists as mentioned above is your individual capacity to analyze everything. Over time, it’s important to build a network of peers, investors, and potentially even a team under you to help get information in a streamlined way and weaning off trial by fire. A natural segue to the next section.
Parties are more fun with friends
The market is a savage, ruthless place where fortunes are made and lost. Back in 2016, it was fairly easy to keep up with everything in crypto as you had BTC, ETH, a smattering of a few shitcoins, and limited things to do. Now, developments are tangentially happening rapidly in various sectors, information the size of the Library of Alexandria is released and is compounded everyday. It’s impossible to keep up and severely overwhelming. Navigating these waters alone is depressing, challenging, and suboptimal.
A network of peers you chat with daily over apps like telegram and discord, a few key mentors to lean on for bouncing back ideas, and generally just constantly being in conversations - catching up with people, shooting the shit, going to events etc. will all make this journey more fun, collaborative, and mutually increase everyone’s odds of success.
Your network is an ever evolving yet expanding organism, some people will come and go, others will be with you forever - over time relationships get stronger, bonds are formed, and opportunities multiply. Build, care for, and prune your network tenderly.
Diversity of opinion is valuable too, talking to people who may have different views on assets, theses, trends keeps your views honest and in-check. Getting trapped in a thought bubble of identical viewpoints is blinding.
You
And last point here keeping all the above in mind, at the end of the day risk taking is still a solitary journey. You are the final decision maker, relying on others to drive your decisions and copying others can work but the decision to do so has to be conscious and malleable. There are no experts in the room, nobody has a crystal ball, everyone is always figuring it out. Keep that at the forefront of mind and thanks for making it this far down my ramblings.
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