Realization on the markets

Discussion in 'Trading' started by illinimatt81, Nov 6, 2008.

  1. A friend of mine that is well educated from the University of Chicago and works in the industry recently sent me a note on his realization on the markets. I'd like to solicit opinions, and then I'll share my response to him that I already sent.

    Just curious what others think.


    I've come to the conclusion that I don't know a thing about the financial markets. I have studied a lot in the ways of finance theory in the past year and a half, but as of late I've decided that all of that finance theory won't help you make money in the end. Why? It goes back to the efficient market hypothesis, the infamous theory that states that all available information is already priced into the market. Therefore, you only make money for having information that the rest of the market doesn't know (as I side note, I'd have to clarify that you could still be making money but this would be reward commensurate with the risk you are taking alongside the market - I'm taking risk-adjusted alpha here). We means that somewhere out there in the world, someone is already trading with the new-fangled technical indicator or fundamental indicator you just read out of that book you purchased for $80 at Borders. Somewhere out there in the world there are loads and loads of people who know the technical charts and patterns far, far better than you. Somewhere out there in the world there are people who have already done the free-cash flow valuation using a proprietary version with who knows what in there. Basically, a lot of the information is already priced in, and you are likely already late by the time you get there.

    Still yes there are anecdotes of people who daytrade for a living and on this one trade they got lucky and make xxx%. But I'm looking for persistence. I'm looking for edge. I'm looking for something I can step up to the plate with to take a swing, and take as many gosh-darned swings at it because I know when it hits, it's going to be big. I don't have that yet. What I do know is that I won't find it inside the halls of academia, or likely even in a book sitting in my collection. It's adverse selection. If it's lead, it's going to be all over the place. If it's the frickin' alchemist stone, then it'll be in Fort Knox. There are patterns out there, sure as there are reoccurring patterns in nature or human behavior. It's all human psychology in the end. I believe the efficient market hypothesis is a good Newtonian approximation, a scientific over-simplification. It's the subtleties where the money is to be made.

    These are unprecedented times. I watched as the world financial markets nearly took a dive. I watched the market swing at near double digit percentages daily. I watched an African-American president get elected as President of the United States. A couple weeks ago, I looked at a chart of the kurtosis of the Dow Jones Industrial Average using a three year rolling window, and it sure the hell didn't look normal (sometimes the kurtosis was up near the 9's - the portfolio optimization formulas I learned were all a lie!).
  2. Here was my response, I'd take opinions, good and bad on mine too


    Here's my take - we could discuss this for hours. I've only been a student of the markets for about 3 years so take it for what it is, my experience and opinion. This is what works for me.

    We have certainly have had the same thoughts about the market, and gone through a lot of the same reasoning. In my opinion, theory is just that, theory. Whether it be economic, finance or scientific. I 100% agree with you on market psychology being the biggest factor.

    I agree that all information is priced into the market at any given time. The market is forward looking. Indicators are always looking in the past as they are dependent on past data. While they can be helpful at times in confirming entry and exit signals I think there is an over reliance on them. It is easy to end up with analysis paralysis. That's what it sounds like you are plauged with right now. I've acquired and read many $80 books at Borders on signals, chart patterns, market psychology and the like. All of them are useful in gaining a foundation on which to build your own strategy but none of them are good enough alone to succeed. You need to be able to see through the noise and come up with something that works for you. Otherwise, you could get stuck in a pattern of trying to research "the next new thing" yet never take the time to find your own strategy. It seems that the more you know can hurt you because you are trying to consider everything you have been taught.

    I'm concerned that it sounds like you are looking to find the holy grail and "swing for the fences" by making large gains on few trades. That could be a recipe for major drawdowns. If your goal is to develop a system, I would develop one that has a positive expectancy and takes profits from the market in a series of singles and doubles instead of a homerun on occasion. Reduce the likelihood for a large drawdown and live to trade another day. Have proper risk management. Don't fear losses as they are part of the game. Minimize them with stops. Likewise don't fear the market taking away unrealized profits and cut your winners too short. Develop a style that suits your personality best while striving to reduce as much emotion as possible. Each signal is just a trade. When your system says enter you enter and when it says exit you exit without even thinking about it. There is no right or wrong strategy if you find one that works for you. I think you are right to start over and find your own path - and keep it simple!!!

    I have come to realize that for my personality I must adapt with the market and can't rely on technical or fundamental analysis alone. Each approach has merit to me. Each day I have to determine what is driving price action. What is the trend? What news may impact the markets fundamentally if I am trading purely technically? Don't want to get hit by a black swan. Psychology is the largest factor for me as it sounds like it is to you. When trading fundamentally I try to think what the general public is doing since they are not as in tune with the market as someone who follows the market daily. When trading fundamentally buying the rumor and selling the news works for me. I think most of us agree the election of Obama was priced in the market in advance of the election, it only made sense to sell off yesterday and take profits or go short. Yet most of the public can't understand why the market wouldn't hail the news.

    From a technical perspective, when the market was dropping in October, simple support and resistance levels were a good technical to use for me. The intraday triple bottom a few weeks back at 8,000 was a good pattern to go long I only wish I had more than 1 YM contract on the table for that trade but again, risk management had to be considered. Likewise fed days are a great example. Take a look back and see how much the market rallies in advance of a change in rate policy only to sell the news moments later. Of course these are all nice to say after the fact you are probably thinking. You have to think about what the market has priced in and where it is going.

    In any event, rather than comprising a complex, multi-indicator strategy like a MACD crossover on a bearish cross with increasing volume at the 14 day moving average all occurring at a key Fibonacci think simple that fits into some theorectical model instead keep it simple. Look at various charts of different time frames so you have a point of reference. I like 30 day, 1 week, daily and minute. I'm not a proponent of stock screeners. I like trading e-mini index futures (YM, ES, NQ, etc). Sometimes it is easy to get stopped out in whipsaws during fast volatile markets but there are pros and cons to everything. This is also why capital management is key to me. I have small leverage and commissions with the YM and can scale up to more contracts or to the ES when I want to trade size. I believe in getting to know a few instruments and stick with them. Know the nuances, know the players, know the algorithms that trade them and use that to your advantage. There are repeatable patterns everywhere. Screen time is key to me. I like simple moving averages, support and resistance, and volume when trading technically.

    In summary, I think you are smart to find what works for you and stick with it. When you trade this way you trade confidently.