Protecting your strategies
- Thread starter gmst
- Start date
Keep in mind that most rapes go unreported.
In the 70's Italy had stringent (on paper at least) exchange controls. They were designed to prevent money from leaving the country. My partner and I had an office in Lugano, Switzerland less than 50 miles from the Italian border. Lugano's primary industry was handling flight capital from Italy -- the Lira went down a tiny bit nearly every week.
A client of ours had devised a method to help Italians get around the controls. In a fairly short period of time we figured out the basics of his methodology and in less than a month figured out a way to do it in a way that scaled. We approached him with our calculations and we ended up partnering with him in that business. BTW ... we offered him our calculations without charge and warranted not to compete with him. That went a long way toward cementing a relationship of some years ... in fact till his death.
If you own something figure out how to protect it or, better yet, figure out how to scale it and finance the larger size. If you can make enough in a short period losing your edge, while still unwelcome, is less painful.
In the 70's Italy had stringent (on paper at least) exchange controls. They were designed to prevent money from leaving the country. My partner and I had an office in Lugano, Switzerland less than 50 miles from the Italian border. Lugano's primary industry was handling flight capital from Italy -- the Lira went down a tiny bit nearly every week.
A client of ours had devised a method to help Italians get around the controls. In a fairly short period of time we figured out the basics of his methodology and in less than a month figured out a way to do it in a way that scaled. We approached him with our calculations and we ended up partnering with him in that business. BTW ... we offered him our calculations without charge and warranted not to compete with him. That went a long way toward cementing a relationship of some years ... in fact till his death.
If you own something figure out how to protect it or, better yet, figure out how to scale it and finance the larger size. If you can make enough in a short period losing your edge, while still unwelcome, is less painful.
I used to be very concerned about this. I think that all traders who have a quantifiable edge are naturally a bit paranoid about it. This was a point of debate for a while internally. Setup a CTA and allow all clients the opportunity get a list of every transaction, or setup a CPO and keep things more secret?
After numerous meetings with fund of funds, family offices, marketers, FCMs, etc. I realized that the reverse engineering argument is all about incentive. If your system is good enough to copy it probably has a certain discretionary element to it, or if fully automated it is not simple. If it isn't discretionary or complex, then there are already many other traders doing it almost exactly like you are.
What it comes down to is that FoFs, Family Offices, Marketers, or any other placement/fundraising group has almost no incentive to steal your system. They've built a business around their ability to locate/hire the talent, not ripoff the talent. Their time is much better spent just having you execute your own system.
Re: FCMs, Brokers, Props, etc... Why would any serious CTA ever consider using a group that was even slightly sketchy? Ideally, the FCM will also serve as the primary broker. I don't have any use for intro brokers. So that eliminates having to worry about the middle man. Additionally, the FCM should never operate a market-making or prop desk. They must only be an FCM. That's it!
Your analysis/automation software should never be in the hands of any third party. As mentioned before, reverse engineering a complex strat with only transaction data is incredibly difficult. With even part of the code it gets much easier. That is my problem with companies that profess to take you all the way from raw data to execution. Who really owns the system in that case? All procedures and code should remain very well protected.
The most likely problem is going to come from your own programmer or IT specialist. Make sure that any such individuals who might have access to any significant part of the system are internal employees and properly incentivized to make sure that they never get any ideas. They should be compensated based on the profitability of the program and they should also be able to participate for free. Don't ever give them any reason to want to run it on their own. Just make sure that they will always make more money running it for you. If they aren't worth profit sharing, then they shouldn't have access to any key portions of the strat. Obviously, NDAs, Non-Competes, and Non-Circs are always necessary.
IMO, if you've taken those precautions and you aren't advertising how your system works, quit worrying about getting ripped off, and just worry about growing your assets and network.
With the amount of work it takes to reverse engineer a system, wouldn't the person be better served to just make their own system? Just a thought. Why are traders so extremely paranoid? It's something I've seen throughout the community as a general rule.
IMHO opinion, it is misguided to worry about someone reverse engineering your algo.
The basic problem is that you do not know how many parameters were used in developing the system. For example if you have 1000 trades, it is trivial to replicate all the trades if you use close to 1000 parameters to do so, and essentially perform a curve fit. You can be pretty sure this model will perform poorly out of sample. Since you do not have a clue about the model complexity, there are literally an infinite number of solutions to the in sample problem.
Another way to say this is that reverse engineering the algo is just as difficult as developing the algo in the first place. If you look at any set of historical data, it is trivial to come up with a strategy that generates "winning" trades within sample. The challenge is how ensure robustness out of sample.
If someone were to examine your trades, they really have no more information than the raw data itself.
The basic problem is that you do not know how many parameters were used in developing the system. For example if you have 1000 trades, it is trivial to replicate all the trades if you use close to 1000 parameters to do so, and essentially perform a curve fit. You can be pretty sure this model will perform poorly out of sample. Since you do not have a clue about the model complexity, there are literally an infinite number of solutions to the in sample problem.
Another way to say this is that reverse engineering the algo is just as difficult as developing the algo in the first place. If you look at any set of historical data, it is trivial to come up with a strategy that generates "winning" trades within sample. The challenge is how ensure robustness out of sample.
If someone were to examine your trades, they really have no more information than the raw data itself.
sorry but it is clear what you write makes sense theoretically, but you don't have any real world strategy development experience. Real world strategies that work are typically simple in nature - with most of them containing < 10 parameters. Its not that hard to figure out the basic premise behind the trading strategy given sufficient number of entries/exits.
Btw, thanks epic for that post. Useful!