5 Takeaways From Todd Simkin on The AlphaMind Podcast

Episode link: https://www.thealphamindpodcast.com/117-susquehannas-todd-simkin-great-traders-are-made-not-born/

About the episode: In this episode, we had the privilege of sitting down with Todd Simkin, currently the CEO of SIG’s Reinsurance business and a veteran at Susquehanna since 1997. Todd has played pivotal roles within the company, from being a trader to overseeing the day-to-day operations and even spearheading firm-wide education and trader development programmes.

Todd is possibly one of the pre-eminent minds in the world of trading, possessing a deep understanding of what contributes to the making of great traders. We were honored that he was willing to converse with us and share with our audience some of his reflections and insights into what goes into the creation of successful traders.

The entire podcast is terrific. These were my favorite parts (emphasis mine):

1) What aspects of trading do students have the most difficulty with?

The most difficult aspect, not just for our students, but for our experienced traders as well, is handling the noisy outcome and the noise that comes after the fact. As I mentioned before, the types of people that we tend to hire are those with backgrounds in computer science, physics, finance. However, many of these individuals come from fields where if you can figure out a system, then you can move forward. Biologists are very much in this camp; if you can describe the way biological systems interact, no matter how complex they are, once you’ve described them, you can build on that. You’ve got a description of an underlying process. Germ theory, for example, once developed, everything that can bolt onto germ theory ends up being correct because germ theory itself is a good underlying description of the interaction of germs and health.

But in our world, once you’ve figured out how a system works, it changes the way you behave and once you behave differently, the system itself changes fundamentally. So, we are in this world of constant change and part of that change is our own impact on it. For an astrophysicist, the way a star behaves has nothing to do with whether or not we’re observing it. But for a trader, the way a stock moves has everything to do with our perception of how that stock should move. Once we have an opinion about it, we then go out and do something differently, and somebody else can see what we did and they’re building that into their system and their model of the way the world works. So, dealing with this constant change, I think, is the biggest surprise, especially since we’re bringing in really high-level smart people. We’re not bringing in people who are used to being wrong, and we’re putting them in a world where they’re going to be wrong a lot. Not necessarily in the direction of the trades they make, but certainly wrong in terms if they only evaluated the outcome. Even wrong in terms of having to change their mind frequently, and being open and willing to change your mind and having the right mindset to say this. “This, I think, is correct for now. But it might not be correct tomorrow.” It’s a new experience for a lot of these people who are accustomed to being A+ students, to getting things right. And we’re putting them in a world where they’re not getting a lot right all the time.

2) Okay, you’ve mentioned that being smart is important. I understand. But are there any other qualities or attributes that you think, if added, would not only ensure a successful journey through the program but also a flourishing outcome?

We’ve given a lot of thought and had many discussions about this. When considering an individual, I believe that a combination of three key skills is essential. These are strong quantitative and analytical skills, which are separate from strong interpersonal skills. They are not negatively correlated, but rather uncorrelated. We’re looking for people who excel in both of these areas.

Quantitative and analytical skills are important, as are interpersonal skills. The ability to communicate effectively with others, whether it’s brokers to develop order flow or peers in the trading world, is crucial. It’s important to be able to learn from and teach others, which is a key part of our culture.

The third dimension is gambling skills. Once you have information about what is fair value and can draw the order out of the market, it’s important to take appropriate risks. Can you identify what risk looks like? Are you taking up the right amount of risk?

The individual we’re looking for excels in all of these areas. We’ve found that being exceptionally good in one area does not compensate for lacking in the other two. We’ve encountered great gamblers with poor interpersonal skills who didn’t succeed with us in the long run. We’ve also met incredibly analytical people who excel at quantitative research but can’t make decisions when it comes to putting money at risk in the trading market. Their gambling skills are low, but their math skills are high. That doesn’t work. They end up not trading.

So, finding the right balance between these three skills is crucial for us.

3) On what it means to develop your “risk-taking” — It’s not “I need to take more risk” but the education of what taking risk means. To learn to think of it in ways that are more complete than how you thought of it before

One of the things that I frequently see from the outside, when talking to non-traders or non-finance people about our role, is they say, “Man, what you’re doing looks really risky.” What they often mean is, “What you’re doing looks really reckless.” They do not make a distinction between measured risk and the ability to see where you’re taking appropriate risk for the amount of capital that you have or the amount of information available on the market. They equate doing something that is going to have a big outcome one way or another as risky. However, I can take tons of positions that look risky, but are really just reckless. That really just means I haven’t given anything enough thought and therefore, this is not a smart risk for me to take.

Likewise, I can take positions that have huge outcomes, bigger outcomes than what we would normally see, but it’s because I’ve got much better research, much better information, and a much better handle on what the risk looks like. I can offset that risk with hedges or I can naturally offset that risk with other positions that we have. Then, I’m not doing something that’s reckless. In fact, I’m doing something that is reducing our risk of ruin, which is better for us. But it looks riskier to people who don’t understand that underlying concept.

Being able to talk through that with somebody and develop their education around that is important. I firmly believe that I can get anybody to understand it, if you give me enough time with them and I can really talk through different examples and different scenarios with them. That’s exactly what our approach is to developing traders as opposed to looking for natural-born traders.

I don’t need somebody who comes in, Wild West style, slinging their guns ready to take on gigantic risks where they don’t have good underlying information. That’s reckless. That’s not what I want. But I can take somebody who is not inclined to put on risky positions and explain why this ends up working out best in the long run. I can get them to feel that this is not a risky endeavor, just because they take on a position that has volatility but in fact, has positive expectancy. We can talk through the appropriate balance.

4) On growth mindset

I believe that anyone can improve on the three dimensions – risk-taking, quantitative and analytical skills, and interpersonal skills – with appropriate training. We, as a firm, are strong believers in the growth mindset. This concept, popularized by educator Carol Dweck, suggests that people are not confined to a fixed set of characteristics. Instead, they can grow and change over time. Once you accept this idea, you can start to teach people skills that they might not be comfortable with today. This could be anything from taking risks, improving their understanding of quantitative models, or enhancing their interpersonal skills.

I believe that one of our fundamental strengths is our philosophical approach to trading. We maintain that if someone is not a good trader, it’s not their fault. The burden lies on us to do a better job of training them. This may seem tangentially related, but hopefully, I’ll be able to connect it back. Are you familiar with the classic problem of the ball and the bat costing $1.10?

[Kris: This part is great. I assume you know the bat and ball riddle but Todd’s about to re-state it and where he goes with it is neat]

I will state the entire problem so that your listeners can think along. The question is:

A ball and a bat cost $1.10 together, and the bat costs $1 more than the ball. How much does the ball cost?

I’ll pause here for a second so people can think about it.

The classic result of this is that people give a quick intuitive answer that is incorrect. The intuitive answer here, which is incorrect, is to say that the ball costs 10 cents. However, that does not satisfy the criteria because if the ball costs 10 cents, then the bat would cost $1 more than that, which would be $1.10. The two together would cost $1.20, which is too much. We want them to be $1.10 together, therefore the ball must cost five cents.

So far, so good. All we’ve said so far is that people answer intuitively and there’s not all that much that’s interesting about it until you start digging deeper into it. Recently, just this past week, I saw research come out. I’m not sure when the research was conducted, but Andrew Meyer and Shane Frederick went back and asked 93 variations on this problem. They surveyed a variety of people, with thousands of participants from sources such as Google Surveys and Mechanical Turk. The results were consistent with the original research, indicating that most people give the intuitive answer rather than the reflexive one.

One variation of the question was particularly interesting. The question was posed as, “The bat costs $1 more than the ball. How much does the ball cost?” with a prompt to consider if the ball could cost five cents. This prompt doubled the number of respondents who answered five cents, though it only increased to 31%. The majority still got it wrong.

[Kris: gets better]

Another variation asked the same question, but with a bold statement underneath saying, “The answer to this question is five cents. On the blank below, write five cents.” This led to 77% of people writing five cents as the answer, which means that even when explicitly told the answer, 23% of people still got it wrong. This relates to trading in that some people fall into what Meyer and Frederick call the “hopeless group.” Even when told the truth, they can’t comprehend it. They won’t believe it or share it. [Kris: I hate to say “let that sink in”. But let that sink in]

However, a significant number of people fall into another group. If prompted, they can think about things in a better way. These are the people who, when asked to consider whether five cents makes sense, can recognize their initial error. With prompting and education, they can arrive at the correct answer. This is the approach we take in our education programs, ensuring we provide enough context for people to improve their decision-making process.

5) Why is the answer to every trading question “it depends”?

There’s more information available than we’re ever going to be able to access, and we’re never going to be able to process everything. The right approach at one time might be the wrong approach at another time, given a slightly different set of circumstances. “It depends” is often the answer to what to do next. Starting a new line of questioning with “What does it depend on?” can be a great way to determine how you should change your answer based on the information you find.

However, if you start with a set action, such as “buy 10,000 shares when this happens,” you may find that changing the initial conditions slightly can dramatically alter the outcome. Even a small change in your behavior can significantly impact how others react. There’s no set answer, and to the extent that there is, machines are taking care of that before you’ve even had the chance to see the opportunity for the trade.

So, given that you’re able to see a trade and make a trading decision, the right approach is going to depend on many factors. All these factors will require analysis and reflection. Starting with the understanding that your answer is going to depend on something will lead you to ask the right questions and get the right people to weigh in with the correct information.

Another important point is that rarely is there one answer that is right in all cases. Just yesterday, I was sitting on the trading desk, and on the other side of the desk was one of our senior index traders. He was talking to one of his junior traders, and I wrote down what he said because it was so insightful. He said,

“I’m not saying do this going forward. I’m saying try this for today.”

He was giving advice on something to do, and importantly, the point he was making was not about revamping the way we approach trading forever. Instead, he suggested running a test, seeing this as an opportunity to get feedback from the marketplace about what would happen differently if we did something differently.

Sometimes, this approach might cost us, and we might not make as much money as we would have if we had done it the way we did before. But sometimes, it’s going to give us information that will allow us to grow in a new direction. So, “I’m not saying do this going forward. I’m saying try this for today.” I think that phrase is an important one for traders. And that’s the answer to “it depends.” Don’t change what you do forever. Change what you do right now, and see how that leads to a different impact and how that’s going to change your participation in the market in some way.

Also, check out Todd’s exceptional interview on The Knowledge Project (with my notes of course).