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From a very smart friend of mine.
Stuff Traders Have Told Me
Summary: Forget what you may think about stocks, for good or for bad. This is a trader’s market. By that we mean a condition where very specific old-school rules govern price action. Consider the ancient aphorism, “Don’t short new highs or buy new lows”. If you ignored that one in recent days, you missed the new highs in the Dow and S&P 500. Or how about the old ritual of a “Do Not Trade List” for those names where you’ve been burned chasing the herd? Yep – that explains why momentum names are in the penalty box for a while longer. And then there is another tattered piece of wisdom: “Instead of yellin’, you should be selling; instead of cryin’, you should be buying.” No, none of these will ever win a Pulitzer, but in a world where near term sentiment clearly rules the roost these rules clearly matter. After all, “The bank doesn’t ask how smart you are when they cash your bonus check.”
If you want to know the substance of someone’s character, watch them trade a real-money portfolio for a week or two. Tell them they have to make money every day and will have their results posted to their Facebook page (if under 40) or on the cover of the WSJ (if over 40). At the end of that period you will know more about them than their best friends, their spouse, and probably their shrink. You will know how they cope with loss, rejection, euphoria, regret, praise and every other emotional extreme. Only golf and high stakes poker come close to revealing a person’s essential character, but you can get lucky on the greens or at the tables for a day. Two weeks of trading is a much more complete emotional crucible.
Over a few decades in and around trading desks, I have had the opportunity to watch dozens of very successful traders go about their business. Most of them have a very set process for getting through their day. They follow it without thinking, even if their personal demeanors are different. It is sort of like watching a prison movie; there’s the snitch, the boss, the scrounger, the weasel… But they all know the basic rules of getting through the day without getting killed.
Looking at the state of global equities – and especially U.S. stocks – it is clear that we are in a “Trader’s market”. I mean that in the old-school sense of the words, as it denotes a heavily rules-based environment. You can talk Shiller P/Es, Fed policy, ECB policy, Chinese slowdown, and any other 30,000 foot topic until you are tired from stamping your foot, arching your eyebrow and wagging your finger. It doesn’t matter at the moment.
Take, as an example, the old trader’s rule: “You don’t short new highs, and you don’t buy new lows.” As an analyst, this one always infuriated me. At the same time it has the odor of ancient wisdom about it, like the basement of an old beach house. The chance that you possess the marginal information to catch a stock at an inflection point is essentially zero. Traders know that; analysts tend to forget it. You wait for the price action to stabilize before you take a position, for this means the market has truly absorbed the marginal investor’s point of view. Then, and only then, is it time to take the alternative stance.
U.S. stock markets, specifically large cap equities, are making new highs. Does it matter that the Russell 2000 basket of smaller cap names hasn’t done as well? Not today. And probably not this week, if the price action pulls more money into equities. Bottom line: don’t make the game harder than it has to be. Don’t short new highs.
Moving on to something that may sound like witchcraft, but is actually a “Thing”: Do Not Trade lists. Its constituents are names that a trader has either lost money on consistently or a whole bunch at once. Now, imagine what names might be on a lot of traders’ lists at the moment. Yep – momentum names that took a hit over the last two months. After all, don’t forget the trader’s mantra: go with what’s working. And those names were market leadership until early March. When, all of a sudden, they weren’t anymore. Bottom line here: the momentum names of 2013 are in the penalty box with a lot of traders at the moment. They won’t be off the Do Not Trade list for a while. Best to look elsewhere for new leadership.
On a different note, consider the homespun appeal of “Instead of yellin’, you should be sellin’; instead of cryin’, you should be buyin’”. If you hear this one, chances are good that something has gone wonderfully right or horribly wrong with your pad. In either case, your first instinct towards emotion is actually wrong. Celebration is for cheerleaders and 100th birthdays. If you feel that euphoria/depression, chances are other traders feel the same way. Which means the trade is over.
If there is an actual positive about the new highs on the Dow and S&P 500, it is that no one is “Yellin”. In reality, no one seems to care. It doesn’t make the evening general interest news, get retweeted 10,000 times, or dominate cocktail parties. The bearish case continues to get serious attention. Yes, the VIX is 2 standard deviations away from its long run average on the downside. But that’s not really yelling. That’s more like a bear yawning.
The upshot of all this is clear, if unexpected: U.S. equity markets are going higher in the near term. If they aren’t, they still are not going to have a “Road to Damascus” experience and change course. That’s how a trader would see this market, based solely on the price action. Yes, you can parse the data a 1,000 different ways, but in the end the only thing that matters is where things close.
Which brings us to our final bit of trader’s wisdom: “The bank doesn’t ask how smart you are when they cash your bonus check”. There are plenty of ways to prove your intelligence. But only one way to prove you know how to trade.
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