The Holy Grail of Trading Strategies

Successful trading boils down to having a strategy with an edge and then executing it effectively. When we are talking about strategies with an edge, nothing can beat a good arbitrage strategy. Arbitrage allows the trader to take advantage of price differences between different markets and exchanges, and when done correctly, it offers what we traders call “free cash". Not only do they offer the most edge, but arbitrage strategies are generally fairly straightforward to execute. Sounds too good to be true?

While these golden strategies can be extremely tough to find, they do indeed exist. Since today's voracious automated trading bots are quick to sniff out any arbitrage opportunity, and even quicker to suck the life and profits out of them, the arbitrage trader must hunt quietly, swiftly, and skillfully. Unfortunately, I am unable to hand out current arbitrage strategies since I don’t possess the holy grail at the moment, and even if I did I'm sorry to say, I wouldn't share. Instead, I would milk it for every penny I could before it inevitably disappeared. Crowds are kryptonite to an arbitrage strategy, so once in possession, the arbitrager should keep their lips sealed. What I can do is share some examples of arbitrage strategies from the past, hoping that they can provide some type of guidance in one's arbitrage quest.

This first tale, taken from my book, takes us back to the beginning of my trading career, and not only provides a great example of arbitrage but also illustrates how ruthless the trading business is……

When I first started trading back in 2001, all the separate exchanges that traded U.S stocks were not linked together like they are now, so on one exchange, a buyer might be trying to buy XYZ stock at $10.25, and then on another exchange, a sucker–sorry, I mean seller–might step in and try to sell XYZ at $10.00. It doesn’t take a genius to realize that this market fragmentation presents an opportunity for a skilled arbitrager.

The savvy veteran traders at my first trading job would wait for that sucker to offer XYZ stock at $10. They would quickly buy in and then immediately sell on the other exchange at $10.25, for a quick .25 cents of free cash. They were taking advantage of the exchange arbitrage to make these lucrative trades, but also of the inexperienced traders, such as myself, who were often supplying the bait.

At the proprietary trading firm, Zone Trading (which is now Kershner Trading) in Austin, Texas, I sat together with the rest of the wide-eyed rookies on one side of a highly segregated office; on the other side sat the savvy veteran traders. Some of my first, but not fondest, memories of trading were watching those guys sitting frozen with their eyes glued to their gigantic old-school CRT monitors. Their itchy trigger fingers–which had been conditioned by countless kills while playing their favorite 1PP shooter games–would hover over their keyboards.

We rookies would go about our business on our side, eagerly learning the ropes of our exciting new profession. Inevitably though, one of us would make a slip on the keyboard and place a bid or offer that was out of whack with the other exchanges, thus offering a juicy scrap for our “co-workers”. When that erroneous order would hit the exchange, a feeding frenzy would ensue. The thundering sound of fingers pounding on keyboards would wail from the veterans’ side, followed by an eerie silence and then a scream of agony from the hapless rookie trader who was caught in the trap.

This cruel game, where your supposed “teachers and mentors” preyed on your every mistake, provided quite an eye-opening introduction to the world of trading. However, I somehow survived this trial by fire, and I am proud to tell you that I never adopted this cold-blooded strategy when I became a veteran (I was way too slow on the keyboard to compete for the scraps).”

The second arbitrage strategy I mentioned in my book took place in the wild cryptocurrency markets…

“A good arbitrage strategy is one that offers a superior edge and is simple to execute: buy on one exchange at a low price, and sell on another for a higher price. An excellent example was an inter-exchange arbitrage opportunity involving Bitcoin in 2017 and 2018.

The cryptocurrency markets were crazy at this time, and Bitcoin was prone to wild price fluctuations. Since Bitcoin isn’t traded on a centralized exchange, the insane action was spread among multiple exchanges. This market fragmentation proved to be very inefficient, resulting in huge price differences between exchanges, providing an environment ripe for opportunist arbitrage traders. It was as simple as buying Bitcoin on one exchange for perhaps $5000, and then transferring it to another exchange and selling at perhaps $5500. While simple and effective, there was a little risk. Sometimes it would take up to half an hour for the transfer to process, and during these wild times, there was a chance that the price could swing against you. However, if the price difference was big enough, it was definitely a risk worth taking.”

Finally, I will include the story from my book of another arbitrage strategy I was lucky, REALLY lucky, to find. This tale takes us back to when my trading career was on life support and I was desperate for a winning strategy. Here is the link to the YouTube video from this crazy story. https://www.youtube.com/watch?v=Y5i4IkkYMWw

“A logical place to look for arbitrage was at the cryptocurrency markets. While volatility in equity markets sat dormant in 2017, things were wild in the cryptocurrency markets. Bitcoin had just gone from $800 to $20,000 in a year! Of course, I had missed that whole move, but I knew there must be opportunities with all of this volatility.

I didn’t have the capital or the time to carefully study these markets and develop strategies; I was looking for a get-rich-quick type of deal. If I heard a rookie trader utter these words, I would slap them upside their head, but I was permitted to go this route because I was experienced enough to know exactly what I was looking for. And I was desperate.

I was looking for the holy grail of glitches–a golden arbitrage strategy. I knew there were arbitrage opportunities in these untamed and relatively bot-free crypto markets; I had seen it with my own eyes. Sadly, the inter-exchange arbitrage Bitcoin opportunity I mentioned in chapter 3 had been discovered by the masses by the beginning of 2018. The crowd, and the bots, had narrowed the price difference between the exchanges, sucking out the edge from this once bountiful strategy. Although I was late to the party, it still gave me hope that other similar strategies were waiting to be discovered.

To find this sacred strategy, I went to places even wilder and more chaotic than the crypto markets: YouTube and Twitter. Yes, this seems like another bout of hypocrisy after all of my jibes; however, while I still stress caution about using these platforms for trading education, I do think there is valuable content available for those who know how to filter through all the garbage. Thankfully, sifting through bullshit is one skill I have developed over the years working in finance.

I knew the odds of finding anyone sharing valuable secrets were long, but I typed “crypto arbitrage” into YouTube and went to work. After a few days of searching and listening to countless idiots spout nonsense, I unearthed a video from a young man named Hien. He was the leader of what he called his “wolfpack”, a group that bonded over trading crypto and selling specialized tungsten rings. Despite that odd combination–and the fact that this video had only a couple of dozen views and looked like it was filmed in his garage–it piqued my interest. He talked of an ICO (Initial Coin Offering) arbitrage opportunity. The more I listened, the more I realized the guy was talking some sense; he was explaining a legitimate arbitrage strategy.

I won't fully explain this strategy because it’s fairly complicated and technical (I have included a link at the end of the book to the actual YouTube video where he explains the strategy), but it revolved around an ICO (crypto's version of an IPO) auction that took place every 23 hours for about six months. Since we were into about the third month of the ICO, I was able to back-test this wolfpack strategy, and my results showed that it was golden! It seemed to have plenty of edge and was hidden from the masses. I was ecstatic about my findings, but to execute this strategy, I needed Ethereum tokens as leverage. John came to the rescue, letting me borrow a big chunk of his personal holdings of Ethereum.

I began trading this new strategy at the beginning of 2018. It was a totally different trading process to what I was used to, being much more complicated and with even less room for error. The whole process for the trade usually took about 30 minutes and involved not only trading the coins but shuffling them back and forth from my crypto wallet to this auction, and then to the exchange. When I'm equity trading, one little slip on the keys can mean losing a sizable chunk of cash, but a one-digit error in an address during any part of this complicated crypto strategy would have meant I (or, rather, John) lost everything.

I was initially disappointed with my results, but it didn't take long for the profits to start rolling in. The auctions lasted only a couple more months, so once I gained confidence in the strategy, I kept upping my trading size. All my profits were in this Ethereum token, and out of necessity, as soon as I made any profits, I would quickly exchange the Ethereum into dollars. It turned out to be a wise decision not to become a HODL; as soon as I started trading this strategy, the crypto markets crashed, and the value of this Ethereum token went from $1400 to $400 in a few months. It also meant my bottom-picking tendencies would have meant I would have gotten sliced to pieces by the falling knives if I had stepped into this market with anything other than a glitch strategy.

Since this auction happened every 23 hours, I traded at all types of unusual times and in strange places. I remember the many times I had to set my alarm for the middle of the night and then attempt to execute this complicated strategy while still half-asleep. Other times I found myself doing it on a bus or tram on the way to my teaching job. Occasionally, I would find a little corner in the corporate office between my lessons to quickly punch out some profits. I even took a break from a wedding I attended to attempt this trade. I say attempt, because I soon realized how drunk I was and prudently decided that hitting the dancefloor would be a smarter alternative.

Fortunately, and perhaps miraculously, I always sent these tokens to the correct address. When the strategy ended, I had a nice little haul of $30,000, which saved my ass. Thanks to the Hien and the Wolfpack, I could now comfortably pay my rent and bills, save a little, and even have a little fun on the side.

Relieved and grateful, I wrote an email to Hien thanking him, and tried to explain that by sharing this video, he was handing out free money to anyone who listened and happened to know the value of a good arbitrage strategy. I assumed he was oblivious to his kindness, as there is never any benefit to randomly sharing an arbitrage strategy; crowds only hurt these magical cash-making miracles. Who knows, maybe he was just a kindhearted soul. I have no idea what his motivation was because he never answered my email. He probably thought, “I just saved this guy's ass, the least he could do is buy one of my tungsten rings!”

As you can see it is possible to be handed one of these magical strategies, but don’t count on it! Finding an arbitrage strategy by yourself is challenging, but possible. I hope that these examples can be of some help in your quest.