ZF Capital > 2009 September

Tradecraft – Liquidity Is for Losers

On September 11, 2009, In Good Articles, by ElfLord

NO MATTER AT what level you play the trading game, you’ve got to understand what business you’re really in. And when you buy XYZ Widgets at 90, you aren’t getting into the widget business. You’re getting into the business of providing liquidity to a company’s float — in this case, XYZ above 90.

What moves stocks, bonds or anything else is the relationship between demand and supply. By definition, traders and speculators profit by adding liquidity to illiquid markets. Doesn’t matter if it’s Cisco Systems (CSCO) or soybeans, traders narrow the spreads between the price at which someone’s willing to sell and the price at which someone else is willing to buy, bringing down the cost of execution. Trading isn’t about predicting the future, but about gaming the liquidity demands for a particular security. Generally speaking, I want to be long illiquid markets and short liquid markets.

First, a little background. You can’t imagine how drastically the liquidity picture has changed in just a few short years. Back in the early 1990s, when most market pros still referred to the Nasdaq as the “over-the-counter” market, stocks traded in eighths. That meant there were only eight “price points” within a particular dollar increment in which you could own Nasdaq stocks. And while 12.5 cents — one-eighth of a dollar — was the minimum spread between every price fluctuation, many stocks traded with half-point spreads or more. With mutual funds exploding in popularity and a huge influx of Internet-driven retail trade, this made making markets a very profitable business. In a sense, you had a big “edge” on every trade. (more…)

Thought of the Day (September 10, 2009)

On September 10, 2009, In Thought of the Day, by ElfLord

Charts do not reduce risk. They turn what seems like risk into the reality of choices. Charts are simply a way to accumulate and express, and perhaps act on, perceivable information.

– Justin Mamis, The Nature of Risk

Thought of the Day (September 9, 2009)

On September 9, 2009, In Thought of the Day, by ElfLord

It’s the ability to believe in the unpredictability of the game at the micro level and simultaneously believe in the predictability of the game at the macro level that makes the casino and the professional gambler effective and successful at what they do. Their belief in the uniqueness of each hand prevents them from engaging in the pointless endeavor of trying to predict the outcome of each hand. They have learned and completely accepted the fact that they don’t need to know what’s going to happen next. More importantly, they don’t need to know in order to make money consistently.

Because they don’t have to know what’s going to happen next. They don’t place any special significance, emotional or otherwise, on each individual hand, spin of the wheel, or roll of the dice. In other words, they’re not encumbered by unrealistic expectations about what is going to happen, nor are their egos involved in a way that makes them have to be right. As a result, it’s easier to stay focused on keeping the odds in their favor and executing flawlessly, which in turn makes them less susceptible to making costly mistakes. They stay relaxed because they are committed and willing to let the probabilities (their edges) play themselves out, all the while knowing that if their edges are good enough and the sample sizes are big enough, they will come out net winners.

The best traders use the same thinking strategy as the casino and professional gambler. Not only does it work to their benefit, but the underlying dynamics supporting the need for such a strategy are exactly the same in trading as they are in gambling. A simple comparison between the two will demonstrate this quite clearly.

– Mark Douglas, Trading in the Zone

Tradecraft – Spring Training for Traders

On September 9, 2009, In Good Articles, by ElfLord

FROM PHONE SERVICES to floor cleaners, my office gets 10 calls a day from people selling something. But just because it’s offered doesn’t mean you should bid. There are a lot of companies I like and a lot of stocks I think look promising. That doesn’t mean I buy them. To paraphrase Gordon Gekko, I look at 50 deals a week. I choose one, and then watch it like a hawk.

In trading, as in most games, the best advice is usually the simplest. Not just because it’s the easiest to remember, but because it works. And I never got a hit at bat or made a dollar in the market before I started adhering to one simple principle: Keep your eye on the ball. What most people don’t realize is that 90% of “trading” is watching. I’m a trader, but there are many days I don’t make a single transaction. And when it seems the whole world is kibitzing about Greenspan or the gross domestic product, I do what I always do: watch the market and watch my stocks. In my experience, the best indicator of the market is the market — not the pundits, not the analysts, not the media, not the Fed, not hemlines or the stars.

That’s why it’s vitally important you follow your portfolio’s prices. The occasional earnings-inspired blow-up aside, the big moves don’t happen overnight, but develop over time. Meaningful trends take weeks or months to unfold — they don’t simply materialize out of nowhere. The Nasdaq didn’t drop 60% overnight, but over the course of a full calendar year. Nobody can say they didn’t have ample warning. If you’ve been long the major liquid names, you’ve had plenty of opportunity to get out. But you had to be watching your holdings — and you had to have the guts to get out. (more…)

Thought of the Day (September 8, 2009)

On September 8, 2009, In Thought of the Day, by ElfLord

We typically trade our beliefs about the market, and once we’ve made up our minds about those beliefs, we’re not likely to change them. And when we play the markets, we assume that we are considering all the available information. Instead, we may have already eliminated the most useful information by our selective perception.

– Van Tharp, Trade Your Way to Financial Freedom

Tradecraft – Your First Loss Is Your Best Loss

On September 7, 2009, In Good Articles, by ElfLord

THE REASON THAT pain hurts is because it should. Pain is nature’s way of telling you to get out of harm’s way. And when the market moves and I’m losing money, it hurts. That kind of pain is the market’s way of saying, “You were wrong.” And now that so many people are hearing that message from the market, it’s time to think about trading losses, what they mean and what to do about them.

While I do the requisite research, and I try hard to be right all the time, I also give myself permission to make mistakes. I’m never surprised when things don’t turn out as I expect. Contrary to popular belief, trading isn’t about always being right, but about dealing with the inevitable experience of being wrong. The trick isn’t to never be wrong about a company, but to recognize when you’re wrong and do something about it. As my mom says, “Life is the story of Plan B.” This starts with a very basic part of the game: admitting defeat and taking a loss. That’s tough for many people to do, because it means putting ego aside. Say you buy stock in SuperDuperTech at 50. When it falls to 40, most people begin the blame game. From election uncertainty to earnings jitters, interest rates to inflation, people will attribute a loss to everything under the sun — everything, that is, except their own analysis, which somehow remains infallible. (more…)

Thought of the Day (September 7, 2009)

On September 7, 2009, In Thought of the Day, by ElfLord

Trade with the trend, not against it. This so fundamental it scarcely needs discussion. But as soon as you think the trend has turned, sell quickly. Hundreds of losses have been incurred because it was hoped that the trend had not reversed.

– Humphrey Neill, Tape Reading and Market Tactics

ZF Capital

Tradecraft – Liquidity Is for Losers

Thought of the Day (September 10, 2009)

Thought of the Day (September 9, 2009)

Tradecraft – Spring Training for Traders

Thought of the Day (September 8, 2009)

Tradecraft – Your First Loss Is Your Best Loss

Thought of the Day (September 7, 2009)

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