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Trading Wisdom

Markets are highly random and are very, very close to being efficient.

If you are a new trader, trading is probably harder than you think it can be. If you’ve been trading a while, you know this. Financial markets are one of the most competitive environments in the modern world. New information is quickly processed and incorporated into prices. This means that you cannot outsmart the market consistently. You cannot invest based on what you think makes sense or should happen because you are up against investors with superior access to information, knowledge, experience, capital and other resources. Most of the time, markets move in a more or less random fashion; you can’t make money if market movements are random. (“Efficient”, in this context, is an academic term that basically means that all available information is reflected in prices.)

It is impossible to make money trading without an edge.

There are many ways to create an edge in the markets, but one this is true—it is very, very hard to do so. Most things that people say work in the market do not actually work. Treat claims of success and performance with healthy skepticism. I can tell you, based on my experience of nearly twenty years as a trader, most people who say they are making substantial profits are not. This is a very hard business.

Every edge we have is driven by an imbalance of buying and selling pressure.

The world divides into two large groups of traders and investors: fundamental traders who base decisions off of financial analysis, understanding of the industry and a company’s competitive position, growth rates, assessment of management, etc. Technical traders base decisions off of patterns in prices, volume or related data. From a technical perspective, every edge we have is generated by a disagreement between buyers and sellers. When they are in balance (equilibrium), market movements are random.

The Inviolable Rules for Traders

1. Reward is always relative to risk: If any product or investment sounds as if it has lots of upside, it also has lots of risk. If you can disprove this, there is a Nobel Prize waiting for you.

2. Asymmetrical information: In all negotiated sales, one party has far more information, knowledge and experience about the product being bought and sold. One party knows its undisclosed warts and risks better than the other. Which party are you?

3.Good advice is priceless: I know, easier said than done. The Street buys the best legal talent, mathematicians and strategists that money can buy. Make sure you have expert advisers and lawyers working for you as well.

4. Motivation:Always ask, what is the motivation of the outfit selling me this product? Is it the long-term stability and financial health of my organization — or their own fees and commissions?

5. Legal documents are created to protect the preparer (and its firm), not you or yours: In the history of modern finance, no large legal document has worked against its drafters. Private placement memorandums, sales agreement, arbitration clauses — firms use these to protect themselves, not you.

6. Performance: How significantly do the fees, interest rates commissions, etc., have an impact on the performance of this investment vehicle over time? Determining for yourself what the actual cost of money is will avoid more heartache in the future.

7. Shareholder obligation: All publicly traded firms (including investment banks and bond underwriters) have a fiduciary obligation to their shareholders to maximize profits. This is far greater than any duty owed of care to you, the client. Always ask yourself whether this new product benefits the shareholders or your organization. (This is acutely important for untested products.)

8. Reputational risk: Who suffers if this investment goes down the drain? Who gets fired or voted out of office if this blows up? Who suffers reputational risk?

9. Keep it simple, stupid (KISS): It’s easy to make things complicated, but it’s very challenging to make them simple. The more complexity brought to a problem, the greater the potential for things to go awry — not just astray, but very, very wrong.

10. There is no free lunch: Repeat after me: There is no free money, no riskless trade, no way to turn lead into gold. If you remember no other rule, this is the one that will save your hide time and again.

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