Two of those “advantages” aren’t as much “advantages” as the market telling you that it thinks it knows better than you. The fact that you have lower trading costs and lower slippage (actually the same thing) is because the market doesn’t respect you.
Re: information acquisition cost. Sure, you might have one small piece of information that BigTradingFirm doesn’t have, but they have plenty of information you don’t have. The relative value of the information is what matters.
To elaborate on the information acquisition cost point; small pieces of information won’t be worth tying up a big amount of capital for.
If you have a company worth $1 billion and you have very good insider info that a project of theirs that the market implicitly values at $10 million is going to flop, if the only way you can express that opinion is to short the stock of the whole company that’s likely not even worth it. Even with 10% margin you’d be at best making a 10% return on capital over the time horizon that the market figures out the project is bad (maybe O(1) years), and that mean return would come with way more risk than just buying into the S&P 500, so your Sharpe would be much worse.
In general this kind of trading is only worth it if your edge over the market is big enough. If you just know something the market doesn’t know that’s not very useful unless you can find someone to bet on that exact thing rather than have to involve a ton of other variance in your trades, and even if you try to do that people can figure out what you’re up to and refuse to take the other side of your trades anyway.
“Sure, you might have one small piece of information that BigTradingFirm doesn’t have, but they have plenty of information you don’t have. The relative value of the information is what matters.”
As an example, let’s say you’re a scientist who works in the field of bioprinting. A new company IPOs, planning to make artificial tissue for transplant via bioprinting. You’ve been working with similar technology for 25 years, know the founder personally, and are certain that the tech won’t work and the founder’s a dishonest-yet-charismatic person with a history of exploiting others to make themselves look good. So you short the stock.
A hedge fund doesn’t have your experience. But they do have lots of information about your industry, historical performance of companies in this sector, advisors (including from your peers), regulatory insight, and much more. They understand that the CEO can be replaced, the product can pivot, etc. They have better overall judgment about how to weigh and synthesize all the information about the company into a prediction about where the price will go.
Suppose as a domain expert you highly suspect company X will fail within timeframe Y. This company is pretty small and there is a reasonable amount of irreducible uncertainty so you (or anyone else) could make a maximum of $10k off of this bet. It costs you ~nothing on the margin to take this opportunity, but it would cost BigFund more than $10k in opportunity cost to acquire this information and act on it, so it’s not worth it to them to bother with it.
Also, the market underestimating me is a good thing for my bottom line.
Two of those “advantages” aren’t as much “advantages” as the market telling you that it thinks it knows better than you. The fact that you have lower trading costs and lower slippage (actually the same thing) is because the market doesn’t respect you.
Re: information acquisition cost. Sure, you might have one small piece of information that BigTradingFirm doesn’t have, but they have plenty of information you don’t have. The relative value of the information is what matters.
To elaborate on the information acquisition cost point; small pieces of information won’t be worth tying up a big amount of capital for.
If you have a company worth $1 billion and you have very good insider info that a project of theirs that the market implicitly values at $10 million is going to flop, if the only way you can express that opinion is to short the stock of the whole company that’s likely not even worth it. Even with 10% margin you’d be at best making a 10% return on capital over the time horizon that the market figures out the project is bad (maybe O(1) years), and that mean return would come with way more risk than just buying into the S&P 500, so your Sharpe would be much worse.
In general this kind of trading is only worth it if your edge over the market is big enough. If you just know something the market doesn’t know that’s not very useful unless you can find someone to bet on that exact thing rather than have to involve a ton of other variance in your trades, and even if you try to do that people can figure out what you’re up to and refuse to take the other side of your trades anyway.
“Sure, you might have one small piece of information that BigTradingFirm doesn’t have, but they have plenty of information you don’t have. The relative value of the information is what matters.”
As an example, let’s say you’re a scientist who works in the field of bioprinting. A new company IPOs, planning to make artificial tissue for transplant via bioprinting. You’ve been working with similar technology for 25 years, know the founder personally, and are certain that the tech won’t work and the founder’s a dishonest-yet-charismatic person with a history of exploiting others to make themselves look good. So you short the stock.
A hedge fund doesn’t have your experience. But they do have lots of information about your industry, historical performance of companies in this sector, advisors (including from your peers), regulatory insight, and much more. They understand that the CEO can be replaced, the product can pivot, etc. They have better overall judgment about how to weigh and synthesize all the information about the company into a prediction about where the price will go.
Suppose as a domain expert you highly suspect company X will fail within timeframe Y. This company is pretty small and there is a reasonable amount of irreducible uncertainty so you (or anyone else) could make a maximum of $10k off of this bet. It costs you ~nothing on the margin to take this opportunity, but it would cost BigFund more than $10k in opportunity cost to acquire this information and act on it, so it’s not worth it to them to bother with it.
Also, the market underestimating me is a good thing for my bottom line.