You have been told many times that successful trading rests on thorough research. The winning trader will have done their homework before risking a single penny in the market.
This is as true of day trading strategies, as of any other. In the popular imagination, day traders skip from one market play to the next relying on little more than instinct, and an eye for a bargain. But the reality is that even the most rapid-fire trading needs to be rooted in extensive knowledge of the asset in question; its characteristics, recent trading history, and likely reaction to external developments.
A question of focus
Not everyone agrees on the importance of research. In a famous book entitled A Random Walk Down Wall Street, published in 1973, Burton Malkiel, a professor at Princeton, suggested that “a blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts”.
But let’s assume, with respect to Professor Malkiel, that you are committed to effective research before getting stuck in to your trading career. What sort of research? How broad? How deep? What is it, exactly, that you are looking for?
To a great extent, this will be determined by your trading approach. Let us suppose you have, for example, decided to trade . How wide will you set your focus? If you, for example, you are interested in both soft commodities, such as wheat and coffee, and hard commodities, such as and , then your research will be broader but more shallow than if you had decided to focus on just one or two fuel commodities, such as oil, or , or .
This need not matter, as we shall see. Indeed, there is a case for a trader to study a range of asset classes. But for now, let us look at the opposing case, the one that urges a sharp, narrow, and deep focus on a few assets with the aim of knowing them better than most other traders in the market.
Someone who reads a lengthy article about Zulus probably knows more about them than anyone in their street. If that person goes on to read any books in the library about Zulus they probably know more about them than anyone in the town, and if they take a flight to South Africa and spend some time meeting Zulus and studying their history they would probably be one of the best-informed people on the topic in the UK.
His point was that, for a relatively small amount of effort, it was possibly greatly to leverage your knowledge about Zulus – or about anything else.
An obvious application of this principle would be the one we touched on earlier: to zoom in on two or three assets in a particular class – the correlated, in other words do they move together and in the same direction? Are they negatively correlated, in other words do they move in opposite directions? Or is there a more complex relationship that can be nevertheless be discerned through diligent research?, and in , for example, or the , and in . Learn everything there is to know about their properties, their trading record and, as important as anything else, how they react to each other. Are they
Aside from trading in currencies could have a laser-like focus on how they react to interest-rate changes, or balance of payments figures. A commodity trader could make themselves expert in price changes in response to political tension or trade disputes. , this approach can be used elsewhere. Someone trading
The case for a wide angle
Whether this “Zulu” principle is applied “vertically”, to a handful of assets, or “horizontally”, to a specific aspect of a larger number of assets, it promises above-average rewards in return for intense specialisation. But it does, by necessity, involve a greatly reduced “tradable universe” of assets. In the former case, the trading style is deliberately based on a small number of assets, in the latter case the aspects on which the style is based will manifest themselves in relatively few assets at any one time.
Sceptics may urge traders to take an opposite approach, widening the “opportunity set” to its maximum practical extent and conducting sufficient research to be able to spot profitable openings whenever and wherever they occur. Should one asset class go flat for a while, another may fizz with opportunities.
Whichever approach you take will be a matter of personal taste. You may try to join the two, perhaps making yourself an expert on the links between oil prices, and shares in groups such as and along with the implications for the currencies of oil producers such as and and heavy oil importers such as .
Finally, be assured that research does pay off. The final tally of The Wall Street Journal’s ten-year experiment was announced in 1998. Professionals came out on top in 61 out of 100 contests, the dart-throwers won the remainder.