Traders operate in a dynamic, probabilistic and opportunistic environment characterised by uncertainty and risk. Market movements are driven by government financial policies, unpredictable news, intentional mis-information, chat-room hype, program trading, earnings reports, business fundamentals and the rampant trader emotions of fear, greed and hope that can dramatically impact price and volume action in both stocks and options. The markets are a zero sum game and utterly impersonal. Other traders have no regrets about taking your money and eating your liver for lunch, presumably with some fava beans and a nice Chianti. The marketplace that provides these trading opportunities, however, has some dynamic characteristics that retail traders would do well to consider. Electronic program trading accounted for 10% of the daily NYSE volume in 1988. In 2005 that number rose above 50% and now rides at the 70% level. The volume of retail trading on the NYSE is less than 5%, often dropping to the 3% level of total NYSE daily volume. In addition, 15 years ago 40% of NYSE outstanding shares traded hands each year, while that percentage had more than doubled to 94% in 2004 and now stands at a frothy 98%. The churn rate continue to rise, which reflects a growing willingness of both the institutions and the retail sector to practice market timing, dumping losers and seeking new winners. The buy and hold philosophy that predominated for many years has steadily eroded as higher investment returns are sought. Facilitated by the rapid development of the electronic marketplace over the past few years, market liquidity has vastly increased, trading spreads and transaction costs have dramatically decreased, and easy access to instant market news, sophisticated technical analysis algorithms and inexpensive programmable system testing and backtesting software have all served to enhance market dynamics. It should also come as no surprise to learn that some of the most successful traders are also skilled poker players (such as Bob Bright) who are consistent winners. Trader Monthly magazine is read by many institutional and commerical traders and one of the regular columns is "The Card Shark", wrtten by a 1o time world series of poker champion, and which is devoted to tactical poker. More than a few professional trading firms require traders to be rigorously educated in not only the legal and mechanical aspects of trading, but also in the application of mathematical modeling and game theory. They do so because market activity ultimately revolves around the psychological components of fear, greed, ignorance and hope and game theory can provide an extremely valuable tool for understanding, evaluating and defining trading probabilities in that emotionally dynamic market environment. A good working knowledge of game theory is a basic component of consistently successful traders because it can improve the probability or odds of winning trades and therefore provide an edge. Skilled poker players develop the ability to read “tells” of other game participants. These are the facial expressions, hand movements, body language and vocal signals which other players in the game may unconsciously exhibit in response to the cards they are dealt and are holding. The ability to read “tells” can provide a significant edge, and in a similar fashion, traders must learn to recognize “tells” when trading …the idiosyncratic behavior that each stock or option exhibits when subjected to various market conditions and forces. “Tells” are typically the actions of program trading, market makers, NYSE specialists, or other large traders that are revealed in the dynamics of the bid-ask spread, price-volume vagaries and unusual activity in options volatility and pricing. Although there is no simple roadmap for detecting these “tells”, those traders that do invest the time to study and understand such behavior will be rewarded with knowledge of significant edges that can be effectively utilized to increase the probability of success for multiple trades. Among the sites that seek to quantify these tell signals http://www.markettells.com/ is worth a look. This is a fee site, but a free trial is available. I will highlight a few other such sites during the week. Next Monday: Dealing with Uncertainty
Monday, July 09, 2007
Monday Series: Part 2 - The Game
"Trading is a bit like flying an airplane. Most of the time it's not very interesting, but every once in a while it's horrifying." That's a quote from Curtis Faith, who was 19 when he was selected to be one of the legendary Turtles in 1983. The most successful of the Turtles, he racked up profits of over $ 30 million in the next four years and then basically retired from trading. His new book....THE WAY OF THE TURTLE....is a great read and an extensive interview with him can also be found in the June 2007 Active Trader Magazine. One of the points he makes is that the Turtle system (which is not very complicated and has been discussed, reviewed and modified by many) would not fare very well today because of changed market dynamics. This is an issue worth exploring because, personally speaking, I like to lmit those "horrifying" times to the absolute minimum........