Welcome to the derivative by RCM alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Happy main day people. Yep. That's main with an e, which is where I am right now on vacation. But through the magic of technology, I'm still here with you today. And I'll be back the next week too with our growing list of Voll episodes, which may end up being back to back to back, so sorry about that. But these guys are good. We gotta get them on. On to this episode where we have Augustin LeBron, a Jane Street prop trader turned tech company consultant after he authored the laws of trading, which blends his real world experience with a unique view on decision making for everyday life. We get into a hypothetical experiment on whether you should green light a crypto investment at a prop firm and much more. It's fun. Send it. This episode is brought to you by RCM's managed futures group. Managed futures are having a day, people. Go to rcmalts.com to sign up for all the great content there and pick up the phone and call 1 of the specialists to hear what's going on under the hood. You won't wanna miss it. Now back to the show. Okay. We're here with Augustin Lebron. Welcome. Thanks for having me. Glad to be here. So I was gonna say it's a very French nobility sounding name, but I guess gathered now, you told me it's a Spanish nobility sounding name. So what's the background on the name? Yeah. So my parents are from Argentina, so it's a Spanish name, at least my 1st name. My last name, it turns out that way, way back in the midst of time, my family was from France, but then they moved to Spain, and that's how the U turned into an o. At least that's the story I'm told. Who knows if it's true or not? You go back to Argentina ever? Yeah. Definitely. Yeah. All my family's still there. I mean, parents are outside of the country, but my whole extended family is still there. Love it. We my sister got married in Colonia in Uruguay right across Nice. Buenos Aires. So we spent a couple weeks down there and did all the way down to the glacier, Mendoza. Oh, awesome. A good some good wine? Yep. It was it was a fantastic trip. Need to go back. Great. What's their economy doing these days? What's their currency doing? I just I talked to my mom a couple days ago. It sounds like, inflation and devaluation seems to be the order of the day in Argentina yet again. It seems like for the, whatever, the 10th or 11th cycle in the last hundred years. So Yeah. And who I think that's why I always wonder who would buy those bonds ever. Yeah. I don't I don't get it. Right? Like, I mean, maybe people have wised up in the sense that now they're US dollar denominated bonds instead of peso denominated bonds, but I don't think it makes a functional difference, honestly. Yeah. And how do the people deal with it? So, like, how does your mom deal with it? They're just like, oh, here it goes again, or do they have some strategies for protecting their money? Yeah. So, yeah, it's it's tough because, again, like, Argentina is 1 of 1 of these countries that still has a fairly bright divide between the haves and the have nots. And so the the way it manifests for the haves is, oh, I can't travel outside the country because I'm limited on the US dollars I can buy, which is, like, 1 of these rich people problems that the vast majority of people in Argentina don't have. It's just, like, the price of food's going up, and I have less and less money to spend on necessities. So yeah. And right. But it doesn't get to the point of, like, bread lines and that stuff. It just Look. I mean, eventually, they're gonna get rid of the government, and somebody else is gonna come in, and they're gonna do something. It's like we've seen this this game played a lot of times. So I love it. We didn't come to talk about Argentina, though, even though it's fascinating. So you started in life as an engineer from what I gathered from your bio. We've had a lot of former engineers turned hedge fund managers and investors here on the pod. A bunch of our customers are engineer type. So just take me through what do you think is the link there between, like, people who get or engineers and people who kinda get financed, for lack of a better phrase? Yeah. No. I think I think there's probably 2 big links. 1 of them is trading and engineering both you're doing the same thing, which is trying to make good decisions with uncertain or incomplete information. Like, in engineering, when you're doing a design, you have you have to use your good engineering judgment because you're not gonna be able to get all the data to really make a data informed decision. You have to sort of merge your your your beliefs and your prior information with data. And that's the exact thing in trading, for sure. And the the other thing I think is they both yield to a very analytical mind mindset, at least from my perspective. And so I think that's a natural connection as well. And how did you make the jump from engineer to prop trader? Yeah. So I I made kinda made the jump via poker because I was playing a lot of online poker during you know, while I was an engineer, like, at night. I was making money, and I thought, well, maybe I could do this. But I had engineer friends who did turn into poker pro poker players, and it was it's a soul destroying existence. And so I wanted to find a job that was kinda half poker and half engineering, and, of course, that's trading. And so that's kind of the the genesis of my move. And did they recruit you out of poker? No. So I just I started applying for for jobs at prop trading firms and that sort of thing in early 2008, which is probably not the greatest time to be looking for a job in finance, you'll if remember that far back. Yeah. But, yeah, it worked out okay. I have friends in prop firms here in Chicago, and they'll actually recruit look at, like, online trading leaderboards and stuff and recruit those guys to be like, hey. You get game theory. We can teach you the finance stuff rather quickly and just go for it. Yeah. Although I I press them because he tells all these great stories of how they got the guy, and then I'm I'll save that in the back of my head and, like, years later be like, how'd that guy end up? I'm like, he he didn't he blew out or he didn't blow out, but he didn't make it either. Yeah. It's it's a useful indicator. It's not like it's not like if you only hire poker players, you're gonna do great. Like, poker player is a good starting point and then we'll see what else we need. And do you think, like, the engineering you think you're just a blank slate and you go and then you learn engineering and then that opens up your eyes and you're like, oh, now I wanna get training? Or do you think it's, like, in there it's in your brain, that mindset, and just at school level, there's no you can't you know, there's no avenue to express that except for maybe engineering. And then as you get older, like, oh, cool. There's here's all these other avenues. Yeah. I think that's right. I think certainly from from looking back to kind of the way I thought about things in high school was I liked all the mathy, techy, science y things. That's I just naturally gravitated towards that. My dad was an engineer. It's like, okay. Well, I guess I guess I'm gonna do engineering. Right? I didn't really think about physics or math or anything like that. It seemed very natural to go in in the engineering. But as you say, as you sort of get out into the world, you start to discover, oh, man. Like, there's a very wide array of places where where this can be applied. I'm worried. We're wasting all that good trading talent on, like, web 3 projects and things that are building apps for people instead of, getting in there and finding out edge and trading. So then eventually you made it to Jane Street. So tell us a little bit about Jane Street and what you did there. Yeah. So Jane Street is, I guess, by now, certainly wasn't in 2008 when I started, but by now, 1 of the more well known prop trading firms in the world. And I started off as a trader. I traded a bunch of different products over the years, ETFs, options, did a bunch of stat up stuff. Over time, my career, I kind of moved in the direction of doing more research and development. I think people's careers just sort of naturally, you know, move in in in directions, and then that definitely happened to me. So, yeah, I got to see a lot of the business over time. And what what was their model when you joined them? You put up some cash or they put up all the cash and you had to earn back? What what did the model look like? You get paid a salary, and and at the end of the year, you get a bonus. Right? Oh, okay. I think now I'm fond of I'm fond of saying that there are basically 2 kinds of prop trading firms. The ones that have you put up cash are maybe there's some good ones out there, but by and large, especially the ones you see I'm sure you've seen them in Chicago. Like, they're they're kinda scams, honestly. Yeah. Well, there have been some good ones in Chicago, but it's definitely a a well, yeah, it's it's way better for the firm than the guy coming in as the trader. Yeah. And as an outsider, you can't tell. Right? And so that's that's the challenge. But it's a great way for the firm to be like, hey. I'm gonna it's basically a free call option on all this young talent. They're gonna have fund their their early losses, and we're gonna profit off their later successes. Yep. So I never knew. And then Jane Street's kinda more more into, like, some market making and some different stuff. Right? Yeah. Exactly. Jane Street's, like, possibly famously the the big 1 of the biggest market makers in in in ETFs around the world. Yeah. That's kind of 1 of the big things they do. And so tell us, you got any fun juicy stories from back in the day there of someone blowing up or them taking the other side of something big? Yeah. I don't know. So many random stories. Certainly, like, the things that I I think back to the most in terms of, like, pure pure trading was when I did trading in base metal options on the LME. It's a fairly close shop. And and so, yeah, it's very much about kind of knowing where the toxic flow is coming from and knowing sort of how to position yourself so you're not gonna get run over as a market maker when some huge, you know, metal trading company comes in, wants to do a bunch of size. Very, very much the opposite of what you would think of as as we'll say, like, the modern high frequency, you know, low edge done 1000000 times kind of trading that I also did a bunch of. So it's, like, kind of 1 extreme for me. So what did what'd you think about LME canceling all those trades? Like, if you've been in that Like, I think it's ridiculous. I think it's you know, all of the

As you might see Cliff Asness say on Twitter, I basically agree with. Right. And then that comes into your some of your philosophy on it. Like, how do you work that into your model? Right? Of, like, talking about, like, hey. If you don't think that's ever a possibility, it definitely is a possibility. Right. Exactly. Like, if your career in trading is long enough, you will discover 1000 things that you're like, I didn't even know that was a possible way I could lose money. Oh, yeah. It is actually a way you could lose money. And I I think if it had been that other way I don't know exactly how it would have been the other way, but the the gains because we had a bunch of managers and trend following stuff that were long. Right? They're long 1 or 2 contracts of nickel and may it was up enormous amounts of money, like, hundreds of thousands of dollars per contract. So it's just this out of the blue over 2 days, like, outlier gain, right, that they weren't necessarily counting on. Yep. It was fun to see on the but you almost looked at and you're like, is that a real print? So I can kinda see that side of it. Like, it didn't even feel real to those involved. Yeah. But as Cliff, as you point out, is noting on Twitter, like, there were trades up there. There were people taking the other side. So Yep. By definition, those should have been legit. Yeah. And look. It even happened during the flash crash. Like, as as I'm sure you know, like, people like Jane Street among many others were down there at the bottom of the flash crash buying and providing incredibly valuable liquidity during this event, and then those trades got canceled. Right? And so, you know, if maybe you bought down there at the bottom, you sold maybe halfway back up to the recovery, your trades at the bottom got canceled. Your sells halfway back up didn't get canceled. In fact, you got penalized for being a legit liquidity provider. Right. And be like, hey. Cancel my sales. Well, we can't do that. That was because then I have to cancel that guy's buys, then the whole thing stops. Right? So, like, where do you stop? So how do you feel some of that is I mean, in the flash crash, I don't even know who was in charge of doing that. Well, that was n NYSE and 1? But do you think it's partly the problem of these 4 profit exchanges. Right? Yeah. Partly. I think also, I think that the exchanges are by and large always at least a few years behind of what market structure actually operates like day to day. And so, you know and especially the NYSE. Right? Like, NYSE has always been kind of an old boys club. I don't think that's and I'm not telling any secrets here. Yeah. And so the idea that a bunch of guys are gonna get together in a room and decide which trades get canceled and which ones don't, and that that doesn't really reflect the reality of how electronic markets work. Like, yeah, that was kind of bound to happen. If they're 1 of the biggest market makers now, how do you view that whole space? Right? There's a lot of you're on FinTwit, so to speak. Lot of talk, right, of, like, oh, the massive market makers, they make GameStop do this. They make the S and P peg here because they have this gamma exposure. Having been in the throes of it, what's your view on the power of those large market makers? Yeah. So, I mean, somewhat predictably, the feeling that you have as a market maker, even a large market maker, is you are 100% the person with the least power. Right? Because you're always there willing to buy and sell. Like, you're not moving prices. You're not taking. You're always there providing. The flow is pushing you in directions, and the whole game is just trying to, like, not get run over by flow. Right? So the idea that a large market maker is moving stocks is, to me, insane. Like, in my years of doing this and in my years of talking to people, I have never seen literally never seen an evidence or an instance of somebody in a market making position saying, I'm just gonna move the stock to a place that I think is not fair. That's crazy. Well, I think they'll their argument would be, no. It's not them moving the stock. It's them delta hedging their options exposure. And in turn, that's what moves us. It's like a knock on effect of them trying to trying to remain delta neutral so they don't have that exposure creates knock on effects where they they push the price. Yeah. And, look, I think we've seen certainly over the course of of the years many instances where the derivatives market pushes the the underlying market because it's gotten too big for the liquidity that's that's available in the underlying market. But I think at that point, your model of the underlying being fair is broken. Right? The the fair price is somewhere between the underlying and where the derivatives are trading. Right? And you see that all the time in crypto. Right? Like, the idea that the fair price is in the perpetual future and not in the in the cash coin is a pretty standard thing to think. And so, you know, I think that's more a mistake about your mental model of where fair is. My mental model? No. No. Not yours. I mean, just whoever disagrees with with the notion. And you threw a throwaway word there. I wanna dig into toxic flow. So tell me how the market makers think of toxic flow, how you used to think of that versus normal flow. Yeah. So I would say there's definitely 2 canonical kinds of toxic flow. 1 is size where you know, I'm just gonna, like, take a very stereotypical example. Like, your your broker calls you up and and the broker says, okay. I got a client that's got 1000 contracts to buy in this thing. And you're like, yeah. I can give I can show you this price if that's all they wanna do. Right? And then you show the price, you print the trade, and then the broker calls up, calls back, you know, like, 3 hours later. He's like, oh, he's got another thousand to do. And it turns out that that, like, he's actually called 10 other market makers and that you're just gonna get run over. So that's like, you're gonna get run over on price impact from their sides. Right? That's 1 kind of toxic flow. And the other kind of toxic flow is just information. Usually, it's it's more short assuming it's not like illegal information. It's more kind of short lasting. Like, I'm a market maker and I've got a quote here and there's information on some other exchange and somebody's got gets that information before I do, they're just gonna take my quote. And that's toxic flow because I'm trading against somebody who has some information about the future that I don't. Or already in high frequency already has the other side of the trade, essentially. Yeah. But and so how do you combat that toxic flow in in the modeling in the of just step aside? Right? Do they have limits of, hey. We're only putting so much out there because you never know when this large player comes and wipes you off the books. Yeah. It it's definitely market by market dependent. Certainly I mean, obviously, as a market maker, you fade away from your position so that you're always kinda trying to close. Right? Because inventory is just risk that that you're not getting paid to take most of the time. And so, yeah, that's kind of the natural way to do things. But also just especially in the stuff that's more human directed as opposed to automated, it's just kind of getting a good memory and a good feel for, oh, this broker usually, you know, sends good orders, this broker does not, or, you know, this is the signature in the market that I see of, like, a TWOP order that's probably pretty dumb or, you know, this is something that looks pretty smart. Like, you have to sort of have that intuition or develop it over time. And how did you how do you feel it's the from when you were there to now, how much was automated back then versus how much is automated right now in terms of the market maker space? Yeah. Look. It it definitely gets more automated over time. For a given strategy or a given set of products, it definitely gets more automated over time. Like, when I started well, let's say, like, my boss on the options desk, when he started, you know, being the market maker of, like, 5 stocks was a lot. Right? And when I was doing it, like, being a market maker of a 100 stocks, it was kinda, like, reasonable or close to the limit. And now probably you can market make, you know, 1000 stocks with 1 person or a couple of people. So the level of automation for a given trade probably goes up over time. I think that's inevitable. But, also, there's always new trades and new things that require, at least initially, a lot of human intervention that kind of over time get automated. Some of the stuff in your books about having edge and edge is the need for a marginal player. Right? Like, you don't have an edge unless you know someone who doesn't have an edge. Yeah. So how do all these huge firms basically coexist? Or how is there enough marginal players to feed the beast that are Citadel, Jane Street, Susquehanna? Yeah. What are your thoughts on that? Yeah. So there's a couple of things I might say. 1 is that market makers fundamentally provide a service to the world, which is kind of this idea of immediacy. Like, if I wanna buy IBM stock, if market makers didn't exist, I would have to sort of sit there waiting under the metaphorical button willow tree for somebody to show up who wants to sell IBM. Right? So the service that market makers provide, you know, there's sort of a natural profit that they should take for that service. Right? So that that's kind of 1 side of it. It's kind of hard to avoid. Right. The rest of the world The other side of especially recently, it's like, no. That's a utility that they should just always be there. Right. Exactly. No. They're not. Yeah. And the other side of, I think, the edge is, look, 1 thing that we know is that markets are incredibly complex, heterogeneous. The world is incredibly complex, and nobody has a monopoly on the information that goes into the value of of a security. Right? So you and I, like, we can specialize in 1 kind of information. And then maybe Warren Buffett, you know, sits in his office drink drinking cherry coke and specializes in a totally different kind of information. And and there's gains from trade for both of them trading with each other. Like, maybe maybe you and I make money on that trade sort of over the short term, and then Warren makes money over the next 3 years. Like, we're both happy to have traded. Right. Which is the kinds of, like, noneconomic players at at certain time frames. That's where I think people get confused. I can be a noneconomic player at the 2 minute time frame, but Yeah. An economic player over the 30 year time frame. Yeah. I wanna own this regardless of price right now. Exactly. And if, for example, if I'm an equity market maker, I'm I'm just a hedger in the SPO futures. Right? Like, I I have no edge there. I I would love to be able to advertise to the world. Hey. This these are hedging trades that I'm doing. Right? I have no information. And then you touched on that too of, like so you're some of these groups are looking, they're building models to analyze flow and types of flow and assign a player rating essentially to that. Right? So they kinda know that's dumb flow, that's smart flow, that's talk

To flow. Mhmm. Yeah. Like like, a very classic example that doesn't work anymore, but, like, odd lot orders used to be sort of very, very good trades to trade against because that was almost indefinitely almost invariably retail traders doing less than a 100 shares. Right? So but, obviously, that's not the case anymore. Like, round numbers used to be a thing. It's not a thing anymore. So, like, all these things sort of get competed away. And what's the thing today? Who knows? You've been out of the game. Yeah. Certainly, in in in in traditional finance markets, I couldn't tell you what the what the thing is to do today. Although, I will say the following. The thing that surprised me over time as I kinda got into it more is how cyclical some things are. So some trades that kind of are good, and then they go away because they get competed. They kinda come back and, like you know, it's like this whole history doesn't repeat itself, but it rhymes. Like, I feel like trading strategies have a similar sort of lifestyle or lifespan where they're good, they're bad, and then, like, some weird variance of it is good again many, many years later. And how do you view that as of, okay, this model's broken or it's on pause or, like, as as you're you have that trader philosophy, that trader mindset and all back to your some of your laws, like, do you view the model? Is the edge gone or just resting? That that's 1 of the hardest questions, I think, to answer. I don't think there's I'm not aware of a universal answer to that question. It's very, very case by case. But, certainly, if you have a strategy that's trading thousands of times a day and it starts to do bad for, you know, like, a couple weeks, then probably something about the world has changed. Right? Whereas if it's more episodic, you know, you're only doing a few trades a day, it's gonna take you more time to figure out that maybe it's not doing well. So Yeah. Which is the push to higher higher frequency because then I have more information to feed my model. We've seen a little bit of that in the volatility machine learning space over the past couple years of, like, thing things are happening that these models have never seen. Sure. Right? And if you're and especially in volatility events Mhmm. Widely spread out. Right? Like, 1 every 3 years. So how do you model something on those events Yeah. With any reliability? Yeah. And I think that's 1 of the most interesting questions as a trader, as a trading firm, is how to allocate the smartness between the human brain, the well trained human brain that is good at 1 thing and the machine that is good at something else. Like, sort of where does that balance lie for any given strategy, I think, is a really interesting question. There's a lot of alpha in just making good decisions about that, I think. And so where do you come down on that of, like, right, there was this big rush to, hey. We've got the super duper AI hedge fund that we don't need the humans. It's gonna find all these patterns to all these things. I'm broadly skeptical of that. I think I think 1 thing I probably believe is if you already have good features, features that have alpha that you sort of have developed because human brains are good at this stuff, combining them in AI machine learning ways is probably a good thing. Like, there's probably good ways to do that. But, hey, AI, go find me some good features is very, very, very hard to do. And I'm kind of broadly skeptical of of the bill people's ability claimed ability to do that. And or it, like, finds the thing that the junior trader just the 1st day on the desk is like, hey. Why don't we do this? Right? So to me, it's gonna find the simple stuff 1st, but maybe not. I think it and the power of those who would argue it are like, no. It right? It'll find these the yen does this versus the Argentine peso and that's a signal for the French bonds or whatever. It's like but then it's like, okay. Is that causation or just random? So there's a lot a lot to unpack there. So you wrote the book and then you're doing consulting. So what does that look like? Who who are you talking with? Who are doing consulting for? Yeah. So it's interesting. This this grew out of my consulting and technical consulting where I'm doing a lot of machine learning consulting and that sort of thing. The thing I'm fond of saying is that every technical consultant turns into a management consultant whether they want to or not. Not. Because a lot of the same stuff would come up again and again around hiring, around management, and that sort of thing. So over time, I started to do more of that stuff. Got they're like, hey. I like what you're saying. Do you know anyone who can help us with the management side? Right. And and my answer wasn't was always like, no. I don't necessarily know somebody, but let's talk about the process by which you're gonna find that person. And that's like, a lot of the time, it's it's amazing how important everybody says hiring is incredibly important. But if you look at their revealed preferences in terms of how they behave, they're you know, a lot of companies are really behind behind the curve on that. And so you're mostly working with tech companies? Yeah. Yeah. Definitely. That's the And so it's not nothing to do with the trading side, but you kinda take some of those lessons and apply it to their businesses. Yeah. It it's amazing how how having a an experience and thinking about markets. Like, the market for talent is exactly the market like, the market for for something else. Right? There's there's you have to figure out how to how to buy, how to sell, adverse selection, all this stuff. It all applies. So take us through, like, some examples there. How do you how do you help those companies deal with that? Especially in today's world. Like, oh, you want that developer and he costs $800 and he's got 6 other jobs he's working for and they're gonna offer him a pool day every Tuesday or something. Yeah. So, I mean, I think 1 of the biggest failure modes of especially small tech companies that that I see a lot is the idea that, oh, we only hire a players. And so we're gonna go off and hire some we're gonna look for some a players. But, of course, these tech companies, a, can't compete with with big FANG salaries. And so, in fact, they're not gonna they're never they never had a shot at the a players, the supposed a players. Right? And so thinking very clearly in a very money ball sort of way about who is the person you need and how do you incentivize them and get them excited about your particular startup or your particular company is a thing that there's a lot of alpha in that and being able to tell the story of your company to attract the right people so that they do say, okay. Well, okay. I'm not gonna go to FANG, but the reason I'm not gonna go to FANG is because I'm gonna take a lower salary here, but I believe in the upside of this company. Like, that's how you sort of solve this this kind of comp problem that a lot of small companies have. But and but does that just pure narrative and getting them to drink the Kool Aid, so to speak, or is it giving them equity and giving them options? Yeah. It's I mean, obviously, it's equity. I mean, 1 of the principles I always used to tell people is it has to be the principle of no worse off. Like, conditional on them believing in the future of this company, they have to be no worse off taking your offer than somebody else because otherwise, that's unstable. Yeah. And some of it is obviously, you know, convincing people and convincing people that you're convinced, but also signaling the right things in the in the whole hiring process. Right? How do you talk to people? How do you evaluate them? Is this a process that they want to go through that they're excited that they find compelling that they can tell their friends, hey. Look. I didn't get the offer of this company, but it's I really like their process. Why don't you go apply? That's that's where the real good stuff comes from. And do you do you see any of that slowing down or, how does right fang Microsoft's on a pause? I think Apple said they're on pause. So Yeah. Right now, certainly in the last 6 months, it's been yeah. It's it's gonna be there's gonna be a reckoning, I think, for tech talent if this continues. I feel like there are a lot of people stuck in those FANG jobs just kind of doing good in financially, but perhaps not in terms of the value they provide the companies. So I think there may be another shoe to drop here. And how did the stuff I've been reading, like, all these employees that had stock based compensation, even if the public could trade it or even in the private markets of, like, a down round of, like, how does how do you handle all that that stuff? Or that's something that I'm excited here. If if you're a small company with capital and wanna hire people, there's probably no better time than now to to pull out really, really good engineers from companies that that, you know, they're looking for something else now. Yeah. But they're a little jaded perhaps. But, yeah, to to your benefit. Yeah. And so do you you never talk with, like, aspiring prop traders or do any consulting like that? You've moved totally I do I do consult with with trading firms as well. Yeah. Sometimes I get I get DMed and, you know, it turns into a good conversation. Yeah. And what does that look like? They're looking at hiring or they're looking at, hey. The whole the whole sheet match sometimes. Yeah. Yeah. Yeah. I think, look, a a lot of the time, prop trading is a lonely business because it's very competitive, and there's not a lot of information sharing out there. Unlike, say, software. Right? Like, you can read 1000 blogs on Medium about how to build software, and you can kinda get a sense of what the industry believes about how to do this. Yeah. In prop trading, it's everybody's in their own little island. And I think a lot of the time, just having somebody from the outside come in and say, hey. We're doing this. Does this sound crazy or sensible to you? Is is pretty valuable. I think, you know, I've done that a bunch and and yeah. So that was gonna be my little game I wanted to play here. Let's kind of instead of going through all the laws of trading in from the book, let's do a little, role play experiment. You don't have to put on any costumes. The let's say we're at Lane Street. Lane, not Jane. Lane Street prop firm, and 1 of the traders says they wanna allocate money to such and such crypto product, maybe a yield play, maybe a trader who jumps in and out of shit coins. Yep. So either as that consultant or you're we're working at the firm and you wanna apply these laws, how do you how do you kinda start to construct an idea of, like, okay, let's move ahead with that or not? Yeah. So I would say as a baseline, we need to make sure

That the incentive structures for people at the firm are aligned in terms of, like, comp and that sort of thing. We could probably talk about that forever in terms of, like, what is a good incentive aligned comp structure for a trader at a firm. But leaving that aside, assuming that's all settled, obviously, question 1 is, like, where's the edge? Like, is gonna let you off the hook. Give us that us 2 minutes on what that incentive structure traditional hedge fund manager that that takes 2 and 20, obviously, is incentivized to to put more more volatile positions on than the investor is. This is just like traditional hedge funds. Right? Because they get paid on the upside and don't lose as much on the downside unless you have high watermarks, in which case you have the risk that they're gonna shut it down and open up a new 1. Similar sorts of things apply in in prop trading firms. Right? Where you're like, if you give somebody a bonus today for a trade that's gonna realize over the course of 3 years, you know, they're gonna be incentivized to just kind of do the trades that only blow up in 3 years. We saw that in investment banks. There's, like, there's 1000000 ways of screwing up incentives is all I'm saying. Yeah. Of that of their incentives are gonna inform their trades, your base. Exactly. Yeah. Right? Like, well, I get paid quarterly. So, no, I'm not putting on this thing that sits there for for 6 quarters before it pays out. Exactly. Right? But in overall, do you think that leads to more and more risk taking? Yeah. Look. I mean, it can lead to risk taking or it can lead to the opposite. I, you know, I do know of prop firms that that don't pay out a huge percentage in bonuses. And so, you know, that trader is gonna be incentivized to just do a good job, not do a great job. Not get fired. Yeah. It's the office space. Like, I only work hard enough to not get fired kinda thing. I like it. And then just on last bit on this number. Like, we run across a lot of hedge fund guys start up because they were at such and such firm, and they didn't get their bonus because they got netted out against the rest. Right? Like, hey. I killed it in nat gas trading, and this idiot over here was trading lumber and lost a bunch of money for the firm. So I didn't get paid out. I'm gonna go start up my own thing. Right. Exactly. Yep. That's just great. That fuels a lot of talent out there in the in the industry. So sorry. Cut you off. Yeah. So anyway, so getting back to this sort of specific idea, like, 1, where's the edge? Like, what is it that you figured out that the world does not know or what is it that you can do that the world cannot? And that's kind of the baseline. Right? Like, tell me a story here. And sometimes that story is show me some data, of course, but usually it's a little more than that. Right? Like, why is this available to us and not to somebody else? Last question 1. Crypto if I come back and be like, well, because look at it. We can get on this exchange, so can everyone else. But look at the volatility and we can harvest that. Right? To me, that's where I'm used that specific example. It seems weak there of, like, that you actually have an edge. It just looks shiny and there's a lot of potential profit there. Right. I mean, look, a lot of the times in in crypto, the edge is, like, we're willing to do sketchier things than somebody else. I don't know if that's an edge, but, you know It's something. Right. I guess that is it. It's like, yeah, we're willing to, like, literally take these things on our balance sheet and trade in and out of them when Right. Yeah. Okay. So yeah. So edge, 1st question, certainly. Question 2 is, I would say, okay. Given that this is your edge, this is the thing you believe, is this the most liquid instrument to be putting this trade on in? Like, a lot of the times, you you think of yourself as having an edge in this 1 thing where in fact, like, your edge is more diffused than that and probably maybe there's a more liquid instrument to put that on it. Like, for example, I I like, an equity analyst looks at this company and says, oh, I really like this company. Good. Blah blah blah. We should buy it. Right? And you dig into why they think the company is good, and it turns out they think the whole sector is good and undervalued. Like, well, why are you buying this 1 company? Like, probably you should buy, like, the sector ETF or something. Right? And so always finding the most liquid instruments to put on the risk, I think, is a really big thing. And in in this case, if I'm like, oh, I really love Solana. You're like, well, that's Do you really love Solana or do you really like, you just think, like, crypto's undervalued or do you think crypto's gonna go up? Right? And, like, why Solana and not something else? Right? Yeah. Yeah. And that's interesting because that the illiquidity there might drive your supposed edge. Right. Oh, I I like Solana because, like, look at all these Axie Infinity players. It's like, well, why don't you just buy Axie token then? You know I mean? Like, it it goes both ways. Got it. Alright. I like that 1. So there's that. And what and but what's the why in the liquidity? I mean, just to reduce friction of your edge? Or Yeah. More liquid instruments are just gonna be cheaper to trade. Right? Okay. Not not the in case you're totally wrong and we need to get out of a huge Well, so this is gonna be the next thing. The liquidity thing is is for is also kind of the risk thing. Right? This is kind of they relate. Right? If I have a position on how how hard or easy is it for me to get out of it, A liquidity risk is, I think, systematically undervalued even within trading, but certainly outside of trading. And so, like, what is the risk of me having this position on? When I wanna get out of it, are are we all gonna be rushing to the exits? Like, all these sorts of questions relate to the to the next thing, which is the risk thing. Like, you know, what's the worst case scenario? How likely is it? How can we hedge it? Is it is it a thing we should hedge or not or just take the risk? Are we getting paid to take that risk? These are sort of the risk questions. Right? They relate to the liquidity question. And then I think in your book, the example of LTCM had a issue there. Right? Like, they it was massively into that trade and then they didn't know there was others massively into that trade. Right. Exactly. And the thing that's cool about LTCM is like, oh, well, the on the run off the run trade is totally uncorrelated to the Russian bond trade. Like, clearly, are uncorrelated except for the fact that LTCM had both of them on. That's the correlation. Right? Right. And so enormous size. So when they're blowing out 1, they gotta blow out of the other to get out of it. Yeah. Exactly. Right? So, like, I created the correlation. Just like in the mortgage prices, it's the exact same thing. Right? Like Yep. Before 2008, house prices across The United States had never gone down sort of universally. Or, like, the correlation between different cities, metro major metropolitan markets was very low. Okay. Well, so now everybody puts on these bets where we're we're trading these these structures that have mortgages across the country. It's like, okay. Great. Now now we've just manufactured the correlation that we're relying doesn't exist. I like that. Where where does that in today's world? What's the hidden someone's creating the correlation that's gonna screw it. Yeah. It's a good question. I think, certainly I mean, if if 1 thing that COVID taught us is that there's a lot of correlation in the supply chain that we didn't really realize existed, that's definitely a a learning. Right? Like, these sort of hyper efficient supply chains with not very much slack that makes everything very correlated in the sense of, like, a problem in 1 supply chain will destroy 10 other ones. Yeah. The and back to crypto, I think there's some there too. Right? Oh, this Celsius blew up and it it's affecting all these other prices. Yeah. Exactly. Because everything turns out owed money to everybody else. So so next? Yeah. So and then and then sort of model things. Like, how are we gonna execute this trade? Like, what's the efficient way to execute it? Sort of implementation details are super important. That'd be kinda next. Right? Yeah. Kinda running down the list. You know? And so in my crypto world, that would include, okay. We gotta go open accounts at all these different exchanges perhaps, or what does that look like if we have to send money to offshore Yep. Back to our and that's the goal bar. They're all intertwined too. Are we as I'm implementing my margin? Yeah. How are we gonna execute? Are we gonna take? There's a take fee. Are we gonna provide? There's a provide rebate. Are we gonna make more money providing than we would taking? You know? These are these are pretty useful questions to ask. Yeah. And then and then and that relates to the to the next thing, which is cost. Right? Like, what are the cost of putting this trade on? Anytime, I'm sure you've seen this. Like, anytime you're trying to put a new trade on, there's always a cost that you didn't quite appreciate, you didn't quite factor in. You do like, you trade it in small size, and you're like, oh, wait a 2nd. Where where am I losing the money? And you're like, oh, I'm I'm getting, like, net grossed on this 1 random fee or something. Right? Like Yeah. There's always a cost you didn't realize. I used to so I was on the board of trade bond pit as a clerk way back in the day, and I would paper trade. Right? So I'd have my card. Oh, I bought 10 here, sold them here, right, to kinda learn how to trade. And I would always do pretty well because I'd be down a 100 ticks, do a 100 lot, make a tick, get it back. Right? Now I'm back to even. So when I went to real world trading, it was like, oh, not there's cost that I didn't consider. There's margin that I didn't consider. There's position limits I didn't consider. I'm like, no. You can't just throw on this under lot. Right. So, yeah, that's very, very real world. Yeah. I can't, like, I can't Saint Petersburg paradox my way to flat, like, if I keep doubling every time I lose. Right? Yeah. I what's it called? I thought it was the anti Monte Carlo or the reverse Is it? Maybe it has multiple names. I thought it was the same thing for Paradox, but You're probably right. And so in my I'm going back up to the risk and trying to stay on our grip. So if I wanted if I'm like, oh, I'm getting into this yield farming deal where I'm making 14%, how would you think about those risks there and what those costs are that you're not quite considering? For that 1 for that 1, it's pretty clear. Like, why am I being paid 14% to give you my money? If it's supposedly if my principal is supposedly protected, where is this 14% coming from? I think that's the number 1 question that anybody should ask themselves. If and, like and you will get a variety of incredibly complicated sounding answers. And 1 thing and look. Like, I'm happy with the complication. Like, don't get me wrong. But being really, really, like just think of, like, think of, like, an old timey farmer that's just really skeptical

About everything and wants it explained, like, you know, like, I'm 2 years old. Yeah. Yeah. Be that guy. Be that person. Like, I'm I'm not getting it. Can you just, like, dumb it down even more? Do not be afraid to get it dumbed down to the point where you understand it. And if they can't do it Yeah. And so with our hypothetical prop firm here, if we're saying, okay. We understand that it's a Ponzi. We understand that they're paying that yield by getting new investors. What is that automatically off the table? Or you say, okay. I understand that risk. As long as I'm not the last 1 holding the bag Yeah. Maybe we're still fine go getting into that trade. Yeah. That's a that's a good question. The moral issues there, but just on a pure trading front. Yeah. I don't know that I'm at least for myself. Again, aside from the moral issues, I don't know that I would be I would think of myself as having an edge in figuring out when the Ponzi is gonna blow up. That's not the kind of edge that I've historically done well with. Yeah. And so I would be skeptical about my own personal ability to figure that out. Whereas, conversely, if I was some, like, hyper well connected person who knew everybody and who knew everything before everybody else, like, okay. Maybe that's a trade for me. Yeah. Once you hear a a whisper, you say, I'm out. I'm out of this. Okay. What what was the next 1? Where would we have cause? On on specific trades, I think it's it's it's sort of they get sort of a little bit more tenuous, but, certainly, there's considerations about kind of we've already talked about the alignment thing technology. Like, how how are we getting sort of how are we executing this progressively more efficiently over time? Right? It's kind of a big thing. Like, I start a trade. Maybe it's very manual to begin with. But like we said before, how do we get to the point where this is pretty automated? Because the scarce resources is human being time. It's always the the scarce resource. And so let's figure out how to, you know, use technology to automate this thing so that we can put this on autopilot and go look at the new thing. Right? So that's that's once it's sort of been going. Right? How do you how do you view that, like, in the high frequency guys, just the race to 0 there? Right? There's oh, you're spending 1000000 dollars? I'm spending 10. You're spending 10? I'm spending a 100. I'm getting a you got a fiber optic line? I'm getting a radio tower. Yep. Right? Like, seemed like a race to 0 in many ways. Yeah. Yeah. That's that's definitely I mean, again, if you have a competitive advantage in that, then maybe that's a thing for you to do. I you know, that's not a game. Like, the hyper speed stuff is not a game that I ever played in. Yeah. But yeah. It's interesting 1 to think about. Like, it's cool. I can do the technology, and I understand the concept of, like, you need to always be improving your technology to have keep maintain your edge. But at some point, you have to bring the economics back into the picture and say, like, hey. Well Yeah. I might have an edge, but if it costs a $100,000,000 in technology and I only make a $101,000,000 on the edge, is it is it worth it anymore? Exactly. What was next on your list? Alignment I think alignment technology. And then the last 1, I think, is adaptation, which is this idea that, look, markets are always getting more efficient over time. That's just the nature of the beast. And so, again, like, this new trade that we're talking about, is it a stepping stone to a whole new world that we can that we can expand into? Right? Like, is this is this just kind of a 1 off or is this something that has the potential to be a beachhead for something new? Right? I think that's an important consideration as you're growing where all other things being equal, you probably would rather do the 1 that, you know, it feels like a beachhead to something new because you're you know that over time, those strategies that you're running now, they're still profitable, are going to be unprofitable, and you're gonna have to find the next thing. That's the treadmill that we're on as traders. That's fine. You have to accept that. And but how do you approach that problem? So, okay, I accept that I need to be adapting, but, okay, how do I adapt? What if I'm in a losing streak? What if I'm in a right. What does that process look like? Education or training or mentorship? Yeah. I mean, some of it is pretty Darwinian. Right? Like, there's a lot of companies out there that were awesome when all trading was done in person on the floors that couldn't adapt to to the transitional electronic markets. Right? Yeah. And I think similarly, you know, stuff that used to be very obvious before REGNMS. Like, just like easy trades in on before REGNMS happened, like, okay. Well, those are gone now. New trades showed up because of REGNMS. So, again, like, that's sort of this adaptation. And remind us, the listeners and maybe me, what REGNMS did. Yeah. So right. Sorry. REGNMS is so it's a regulation, SEC regulation that says that, essentially, if you are I'm gonna sort of butcher it for the sake of the the conversation, but exchanges listed or lit exchanges, you cannot you cannot fill an order for a customer at a price that is worse than they could find on some other exchange. Right. Right. So that that took away the whole level 2 so spandex guys, that kind of stuff. Yeah. All that stuff. And other things too. Like, used to be being a specialist on the NYSE was just like a license to print money because you you would just, like, put the book kind of wherever you wanted to. And Yeah. That's kind of disappearing or gone now too. So yeah. What's the next thing? I I don't know. So, basically, you're saying, like, there's no who knows if you can adapt. You maybe can't adapt, and you have to go find something else. Yeah. So if you don't know how to adapt, maybe go look for another job. Yeah. Yep. That's that's the harsh reality. The secret sauce of, like, no. You start doing this exercise every day, and then your brain will adapt to become a better trader. Yeah. Not that I'm aware of. If if you find out, you let me know. Yeah. Doesn't exist. Yeah. And part of me on the adaption too is, like, I'm always that's 1 of my crypto pans. It's like, okay. Well, when did once this becomes big enough, doesn't Apple just say, cool. Here's our new protocol and our new thing that everyone's already connected to and, boom, that kills, like, these 10 protocols that are we're trying to build something that competes with. Or Amazon or any of those big companies could just say, cool. Thanks for taking this to the the 40 yard line. We're gonna take it the rest the rest of the way down the field. Yeah. There's 2 sides of that. 1 is they may not like look. There's endless supply examples in history of large incumbent companies that just could not adapt to a change in technology. Right? Like Kodak famously. Kodak invented the digital camera, and they still lost. Right? That's insane. Which is insane. But you're I think you're seeing that now. Like, FTX is quite clearly consolidating in the crypto space, like buying small exchanges, buying people that are distressed, etcetera. So that consolidation's gonna happen. That might not necessarily be bad for you as a as a small player to, you know, kinda get somebody cut a check and just buy you out. And it's like, okay. Great. That was good. Like, Yeah. Thanks. I did my part. Next thing. Right. Yeah. And then switching gears a little bit, I wanted to ask you about trend following coming back to edge. Right? Mhmm. We're like, hey. You gotta have edge. The markets are gonna adapt. Things are gonna adapt. But then here, we have this thing trend following that's been around for 40 plus years or longer than that, but people have been doing it professionally and managing money with it for 40 plus years. Like, do you explain? Right? There's no real edge there. I can write up the trend following model on Excel in, you know, an hour and be trading something like that. But so how do you explain, like, that there's still edge long term in that, but not really any edge? And that that markets don't adapt and kinda kill that as a factor. Right. So, I mean, you might be able to tell me more than than I could tell you on this. A couple of thoughts that come to mind certainly is we use the label trend following for a thing, and I'm pretty sure that the thing that was called trend following that you did 20 years ago is not the thing you do today. Right? It's still kind of under this broad umbrella of trend following, but the but the implementation details are very different probably. And the thing that's clear is that details matter. Every little detail matters in order to create a profitable trading strategy. And so I can give you that Excel spreadsheet that says, oh, look. Like, there's positive serial correlation. Let's just do this. And I give that to 10 people, and 10 people implement it in 10 different ways, and 9.5 of them are going to lose money doing it. You know what I mean? Like, there's a lot of baked in knowledge that about these things that that that changes over time, but but that also kind of gets competed away. I don't think the edge and trend following is what it was, like, 30 years ago. Maybe I'm wrong. You tell me. But Well, yeah, there are a few things. 1, there's definitely some managers that are still trading the same model they were trading 40 years ago. May they've added some more markets. They've added other stuff. And then there have been right? In order there was a down period from, like, o '9 to '20. Essentially, it was flat. It had a few good years, but essentially, it was flat during that whole period. And a lot of trend followers added, okay. I need to add more long equities. I'm gonna add long bias. I'm gonna add a couple of these pieces that in that period made it better. But then those have been the underperformers in this 2 year period as commodities. Yeah, they're I feel like they've done it, but I think the core essentially is still there. Yeah. I guess the thing I would say is is there selection bias. Right? Like Yeah. Trend following as an idea may be still there. But if you look at, like, of the 100 firms that did trend following 20 years ago, how many are still here today? Like, I'm guessing it's not a huge number. Right? And so there's sort of the cycling in and out that, you know, probably exist as well. Yeah. It just was interesting to me reading through, like, okay. But if you have to have an edge, but if the edge is is also a factor, there's been some papers. Right? Like, as soon as the factor becomes published in an academic paper, it ceases to be

Be a reliable factor. Yep. Right? Because, basically, you've publicized the edge. Everyone hammers it to the point where it's no longer an edge. Mhmm. So I don't know if there's a question in there, but it's it's of interest. Yeah. Like like you said, I think these things can be very cyclical. And, you know, when when when things are kinda good and or bad for years and years, you just don't have a huge sample size. And so, like, there's probably some amount of, like, you know, the people who are who who continue to do trend following and do it well, like, probably they're good at it, but also probably they got lucky. Like, there's probably a little bit of both. Yeah. And for me as an investor in it, I think the edge is your willingness to endure years of down. Sure. Right? Or your willingness to endure a 30% drawdown. Yep. Which doesn't sound like an edge. You want you want the edge to be like the program eliminates those, but part of it is like, yeah, this may and other people could argue, that means the model doesn't work. Right? If it has these 30% drawdowns, maybe it's not the edge you're looking for. Yep. But I digress. Gonna finish it up with your hottest take. Unless you got any you got any other thoughts on our theoretical crypto No. Lane street? No. This is good. We're missing? No. I mean, I think it's I think the 1 thing I do wanna say is it's more of a conversation than a I'm gonna ask you questions, you're gonna give me answers. Like, it's much more interactive than that. I think that's where the good stuff comes from. Yeah. Of like and that's an investment committee or even asking yourself as a personal trader, like, putting it down on paper and Yeah. Really thinking through those those concepts. Yeah. For sure. And then it's funny. Right? Because you could do that whole exercise and never have come within 1000000 miles of, like, GameStop. Right? And then you have some guy who's just like, whatever. This thing's going to the moon. And so I'm getting this thing that's what makes this thing wonderful. That's the crazy part of, like, how do how do you reconcile those 2? Yeah. Yeah. So let's see. So hottest takes. I'm gonna give you a very, very hot 1 because it's it's blowing up on finance Twitter as we speak, which is stop orders. My my hot take, which is not hot for professionals, but it's apparently hot for for amateurs and retail people is if you are frequently getting stopped out of positions, you're doing something wrong. Like, if if if you're hitting your stop limits fairly frequently, whether it's through specific stock market orders or whatever, you're, like, you're trading too big. Like, this just kind of it shouldn't be a hot take, but apparently, it is. Well, I think because because they'll take that as you to mean don't use stop orders. Right. And and I would say, like, don't use stop orders as a separate thing. Like, stop market orders are, like, poor are almost always a poor way of executing things in reasonable markets for a variety of reasons that probably we don't have time to get into. But, like, people kinda conflate the 2. I don't know. There's a lot of, I think, confused thinking on the subject. So that's my, like, immediate hot take. Yeah. Because I would say from a allocator and investor standpoint, like, if I'm doing my due diligence on you and you're like, oh, we don't ever use any sort of stops. And where I work, well, it makes me a little nervous, but then tell me more. It's like because we only risk 10 bps of our overall portfolio on each position. And if that goes to 0, we only lose 10 bps. Okay. Fine. Yeah. Right. But there's a big difference between using a stop market order, and I'm gonna gradually scale down my positions as things are going against me. Like, these are 2 very, very different things, and people kinda confuse the 2 for some reason. Yeah. And then I we had a manager once who used stops, believe them, passed everyone's due diligence. I got my stops in place. But he would he'd be like long gold. He'd get stopped out and then get back long the next day. Like, what what are we doing? Like, so so you don't really have a stop. You just have a a mechanism for locking in losses. Exactly. Right? Like and that's that's the thing that's amazing. Like, that's the number 1 question that you should ask is, like, okay. You're gonna get stopped out. Now what are you gonna do? And if the answer is like Get back in. And then what? We had a had a guy at a prop firm once, and he he analyzed all his data, 1 of these traders, he's like, basically, he found out, like, when I start losing, then I really start losing. So he had the team, like, code into his machine. He couldn't put any more trades in after he was down after he'd lost, like, 16 trades in a row. I can't remember what the number was or something. But then the I was talking with the programmer guy who's back on saying and he would call me up and be like, unlock it. Unlock it. Unlock the machine. What is this? Yeah. Crazy town. But it worked for him. It's also like just, hey. Whatever works for you, make it happen. And then to me on the stop thing, like, as you're if it's you're basically too tight. Right? Yeah. If you're getting stopped out over the time, the volatility is greater than your stop. It needs to be volatility based or or something. Yeah. So that was the immediate hot take. Yeah. My longer term hot take is that I don't think the leveraged ETFs should be a thing that retail is allowed to trade. That's that's my other hot take. It's a very unpopular take among professional traders, Yeah. They're just a disaster. Why so? Because because Oh, it's like because because of the the rebalancing that they do and the and the force trading they do, they they just they basically just lose money over time. That's just all that they do. They're just the mechanism to lose money over time. And retail just loves to, like, say, oh, I'm, like, super leveraged, like, VIX something something. And it's like, yeah. You're going to 0. There's nowhere else you're going. Right. And I think a few sites started to do that, but like this levered ETF should be used for like a 1 or 2 day outlook. Right? Like essentially that's what it's there for. Not for like, I'm double long nat gas for the next 6 years. Yeah. Like, intraday, fine. Whatever. But, you know, if you're trading intraday, you probably have access to products that are better than those. Or even if you don't, that's fine. But retail shop should probably not be trading intraday anyway. So what are we doing here? And and even a bigger question of, like but you're not gonna allow someone to do a a cash crypto ETF. Yeah. But I can triple lever Yeah. I can triple lever Tesla short ETF. Nuts. And we did a blog post once on levered nat gas ETF versus the 2 x short nat gas ETF. Yep. Over 3 years, they both were down, like, 92%. Exactly. They should be right? It should be something looking like this. Exactly. And they they both just do this. And they both just went down because it's like Absolutely. And the the proponents will say, well, that's not what they're for. You don't buy and hold them. But, yeah, does the retail space know that? No chance. No chance. So thanks for being here. Good luck. Tell everyone where they can find the book and where they can find you on Twitter and all that good stuff. Yeah. So, yeah, you can find the book on Amazon. It's called the laws of trading, and you can find me on Twitter at augustine lebron 3. 3. Are there ones and twos out there? Apparently not, but that was all that was available. You got another book in you someday? I have no idea. I think if I do, it should probably stay in there. It's a it's a it's an ordeal for sure. I bet. Yeah. Yeah. Alright. This has been fun. Thanks so much for your time. We'll talk soon. Enjoy it. Bye. You've been listening to the Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at r c m alts, and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to And be sure to leave comments. We'd love to hear from you. 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