Trading As I See It

  • Posted by
  • on January 14th, 2010

Pros know this, but every now and then I remind myself of the truth.  As speculators, we have a crazy goal to enter before anyone sees what we see, hoping the rest of the universe will immediately see our brilliant idea and follow us in.  Absurd when put that way, but not far from the truth.  So how do we gain an edge?

It’s my belief that we need someone to make a mistake.  Someone needs to sell that stock just as it breaks out. Someone needs to puke it out after days or weeks or months of a downtrend, at which point we strike.  Someone needs to buy that hot stock they missed, just as it rolls over to facilitate our short sale.  Who is that someone? It might be me, it might be you. It might be Fidelity Magellan, it might be CALPERS.

The bottom line is, from the point of transaction, one side is going to be wrong.  They might be taking a huge profit on a long, but perhaps it’s going much higher and we think we can profit from that.  They might get stopped out of a long just as it prepares to launch into orbit, and hand us a better price on our short cover.  We might pick a bottom too early, giving that seller a counter party to unload his dog of a stock.

Let’s not forget…we are swimming with sharks here, from both a funding and information standpoint.  Smart people with deep pockets and global connections may be on our side, or may be against us any time we transact.  Not exactly the profile for those I’d like to battle, but in the markets we’re anonymous.  If we knew who was taking the other side of our trade, we may be more or less likely to pull the trigger.  It’s these faceless opponents who present the opportunity for us to both win and lose.

Do we have a chance against these sharks? Absolutely! We have 2 sources of edge that we can use…size and discipline. While the giants may have deep pockets and great information, they can’t act without being noticed.  They may act due to liquidity needs, end of quarter window dressing, or strategic decisions outside their control.  This “time arbitrage” is one of the least discussed but most powerful sources of opportunity in the market. With it, a speculator with complete freedom can be a 40 foot vessel in the ocean…strong enough to handle the waves but nimble enough to head for safer waters when conditions warrant.

Having the greatest plan in the world will not ensure that we win on a given trade.  But taking the time to plot all possible scenarios puts us in a position to act rationally instead of on impulse. The more often we follow our plan while the world acts on impulse, the more opportunities we have to gain an edge.  Acting on impulse is great…for the other side.  The discipline needed to both make a plan and execute it puts us at an advantage to those who don’t.

I find this game at times exhilarating, at times exhausting, but always challenging.  The idea that one can’t do it is nonsense…even a zero sum game provides winnings to the few who apply consistent edge against the many.  We DO need people to act on impulse to give us opportunities, just as a QB needs single coverage and an extra blocker to beat a blitz.  Styles vary, but 100% of the winners are folks who apply a set of consistent methods to take advantage while others are unprepared and trapped in emotion.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

blog comments powered by Disqus
Derek Hernquest Blog