An ‘Almost Free’ Trade

Over time and through
experience I’ve developed my own trading methodology that I call truth trading.
It’s a combination of quantitative and qualitative strategies, which I believe
is important these days in the face of increasing competition on the systems,
stat arb, and algorithmic trading fronts. I start with a fundamental macro
economic hypothesis, drill down to the micro meaning for specific markets,
determine whether there is a profit potential, and finally select the best
trading vehicle to profit on the idea. It’s not a strategy that can be summed up
simply. It’s sometimes contrarian and sometimes trend following, sometimes
fundamental and sometimes technical.

One example of this strategy
that illustrates it well was when traders were pricing into the Fed Funds
futures a 100% probability of a quarter point rate hike. Obviously the actual
probability was much lower. A pause was a very real possibility based on
comments made by the new Fed chairman. The 100% price made the trade almost
free. The Fed did indeed raise rates a quarter point, but had they paused, the
payoff was absolutely massive. If I’m remembering correctly I think the gain on
margin would have been about 300%. So that was a trade I was fine with losing
money on. The strategy has generally worked well in the Fed Funds futures, which
often contain a great deal of emotional and political bias in the price.