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Tradecraft – Hedge Funds for the Masses!

On September 14, 2009, In Good Articles, by ElfLord

IN A FREE COUNTRY with free markets, we must each make our own decisions about how to invest our assets. From real estate to Research In Motion (RIMM), Home Depot (HD) to hedge funds, there are many choices for those of us with an open mind and a penchant for profit. The ultimate arbiter isn’t research reports, but the bottom line. So whether you watch the market minute by minute or never check your statement, make no mistake: We are all portfolio managers.

As has been widely noted, the biggest long-term determinant of a portfolio’s performance isn’t security selection or market timing, but asset allocation. And while hedge funds like mine have been regulated out of reach for most investors, a hedge-fund-style philosophy of asset allocation is an option I think you should investigate.

First, let’s define some terms. Like mutual funds, hedge funds are simply investment pools managed by a portfolio manager. While most people assume that hedge funds trade frequently and take big bets on financial esoterica like derivatives, the main difference is that hedge funds have tremendous flexibility in how they can allocate their assets. Hedge funds can invest in almost anything. They can sell short, use options and futures, and even take positions in illiquid securities like real estate and collectables. (more…)

Thought of the Day (September 13, 2009)

On September 13, 2009, In Thought of the Day, by ElfLord

One of the basic problems that most traders face is dealing with risk. For example, two primary rules to successful speculative trading are: Cut your losses short and let your profits run. Most people cannot deal with those two rules. For example, if making money is important to you — as it is to most people who play investment games — then you will probably have trouble taking small losses. As a result, small losses turn into moderate losses, which are even harder to take. Finally, the moderate losses turn into big losses, which you are forced to take — all because it was so hard to take a small loss. Similarly, when people have a profit, they want to take it right away. They think, “I’d better take this now before it gets away.” The bigger the profit becomes, the harder it is to resist the temptation to take it now. The simple truth is that most people are risk – aversive in the realm of profits — they prefer a sure, smaller gain to a wise gamble for a larger gain — and risk seeking in the realm of losses — they prefer an unwise gamble to a sure loss. As a result, most people tend to do the opposite of what is required for success. They cut their profits short and let their losses run.

– Van Tharp, Market Wizards by Jack Schwager

Thought of the Day (September 12, 2009)

On September 12, 2009, In Thought of the Day, by ElfLord

Each market day spawns excellent trading patterns. But many skilled participants still wash out through bad selection and poor timing. Why doesn’t their experience save them from ultimate failure? The answer holds great wisdom for every trading aspirant. Simply put, long-term survival depends much more on personal discipline than on market knowledge.

– Alan Farley, The Master Swing Trader

Thought of the Day (September 11, 2009)

On September 11, 2009, In Thought of the Day, by ElfLord

I believe in the sun even when it is not shining. I believe in love even when I cannot feel it. I believe in God even when he is silent.

– Written on a wall at Auschwitz concentration camp during WWII

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

ZF Capital

Tradecraft – Hedge Funds for the Masses!

Thought of the Day (September 13, 2009)

Thought of the Day (September 12, 2009)

Thought of the Day (September 11, 2009)

Tradecraft – Liquidity Is for Losers

Thought of the Day (September 10, 2009)

Thought of the Day (September 9, 2009)

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