macrocephalopod

Thought experiment based on a line in @GZuckerman's book "The Man Who Solved The Market" where he describes how Renaissance trade their signals "to capacity" to make it harder for others to discover the same signals. What would that look like?https://twitter.com/macrocephalopod/status/1357291507196264450?s=20 …

Every trading strategy has a capacity -- the maximum amount of capital that you can put behind it before P&L stops going up. Trading a signal "to capacity" means finding this maximum and exploiting the edge as much as you possibly can.

You can simulate it with a simple model. Generate a signal and some returns so that the signal predicts returns -- with most predictability on the same day, but some predictability 5-6 days into the future.

Now simulate trading this signal, where you include both temporary and permanent market impact in the simulation. The temporary impact scales like (trade size)^3/2 and the permanent impact scales linearly with trade size.

The temporary impact is what prevents you scaling the signal arbitrarily since it grows faster than the size of your trades. The permanent impact represents how you distort the market by trading the signal.

Experiment to find out where the point of maximum P&L is, and record the returns that come out of the simulation (they are different to the input returns because they include the permanent market impact that your trading generated)