Dan AtkinsonHigh-conviction trading is one of those expressions with an obvious appeal. It sounds admirably forthright, perhaps even courageous. After all, who would wish to be known as a “low-conviction trader”? Who could have any confidence in someone who, apparently, has little faith in their trading strategy?
More on that in a moment.
Diversification rejected in search of returns
First, what is high-conviction trading? In short, it is the trading equivalent of the perhaps better-known high-conviction investing. When looking through details of different investment trusts, you will come across portfolios whose selling point is the careful selection of a relatively small number of high-conviction stocks that are then held for the long term.
High-conviction trading differs from high-conviction investing in that the “long term” element is much less pronounced, if it features at all. But the essentials are the same: to focus on a relatively narrow range of assets and, critically, to back your judgment by playing for meaningful stakes.
That sounds very buccaneering, but it does, by definition, cut right across what is supposed to be the objective of every investor or trader – diversification. Market novices are usually inducted into the verities of diversification before they have conducted a single trade. In the world of investment, this orthodoxy has an even stronger grip.
It is notable that even diversification’s advocates cannot always agree on what it is. To some, simply buying an index such as Britain’s FTSE 100 or the Dow Jones in the US provides diversification by spreading your money across 100 or 30 top stocks respectively.
To others, this is simply untrue, because the stocks in question may be diverse in terms of the business sectors they represent but not in terms of their market status – by definition, they are all currently market favourites, which is why they are in the indices concerned, and that means they are almost certainly over-bought on the basis of past, not future, success.
Looking for a big win
Elaborate schemes for “true” diversification involve various country and sector weightings and attempts to ensure the various elements in a portfolio or trading strategy are as “uncorrelated” as possible, in other words they face different risks and are unlikely to move up or down at the same time.
To the high-conviction trader, these arguments inside the diversification camp are beside the point. Such a trader objects to diversification simply because the more diverse a trading strategy, the less the chance of a big win.
A high-conviction trader would entirely agree, but would argue that this is the whole problem. The more bets are hedged, the less chance that any one of them will prove to be highly profitable, because the available funds are spread thinly across too many different assets.
Taken to its logical, and absurd, conclusion, it would be like placing equal bets on both the teams in a football match. Only by foregoing a significant amount of diversification can traders make a decent profit, but by doing so they undermine the argument for a diversified trading strategy.
This, as we say, is the argument from the high-conviction perspective. Should that argument appeal, how should you go about formulating a high-conviction trading strategy?
At the risk of sounding trite, the first things you need are some convictions. These can arise only from deep research and scrutiny of a range of assets before selecting those relatively few that will be traded.
High convictions do not emerge out of thin air but need to be tested and tested again, with every assumption checked and double-checked. This process will involve sifting assets and discarding those that either seem to offer little scope for high-conviction trading or simply do not appeal, perhaps for subjective reasons.
Rationality ought to underpin high-conviction trading, but convictions are deeply personal and not every decision can be entirely objective.
A special appeal to CFD traders
Once a small range of assets has been selected, the time has come to back that selection with significant funds. If you find yourself reluctant to do so, perhaps you should revisit your decisions – it could be that, subconsciously, you are unhappy with the selection and that it ought to be looked at again and amended.
High-conviction trading is not for everybody, but it has a certain appeal to those who trade contracts for difference (CFDs). After all, CFDs are based on convictions or, at the very least, on taking a view, with the broker or other CFD provider standing on the opposite side of those views.
It is possible, just about, to construct a safety-first CFD trading strategy, but, to go back to our earlier point, such a strategy, by refusing to play for meaningful stakes, is unlikely to generate any meaningful returns. Big, bold trades have a profit potential missing from overly hedged and diversified strategies. But a relentless focus on the assets in question is essential to ensuring that you remain on top of developments.
As the renowned Swiss-American trader, the late Max Gunther, advised: “Put all your eggs in one basket – then don’t take your eyes off the basket.”