I have a rather thick book in my trading library called “The Futures Game: Who Wins, Who Loses, Why?” It was written by Richard Teweles and Frank Jones and the edition I have here as I type this is the revised edition from back in 1974. What could a 1970s book about the futures markets have that is relevant to the markets of today? I mean – imagine that you worked in the futures business, and took leave of absence ... say you left for a year or two to sail around the world, or “find yourself”, ... when you return and look for employment the interviewing person will say something like this “... you are out of touch, it’s all changed, and all different now, better retire because this is a whole different world”.
Yeah. Right! Whatever you say. But wait! Did he say something that sounded a bit like “This time it’s different”? Well ... maybe he did in a way. Hmmmm!
But I am already beginning to get diverted and ahead of myself. I need to drag it back to that book for a bit. This book was the 2nd edition of the best selling classic “The Commodity Futures Game”. It provided a lot of information about everything in the commodity markets, but the bit I value the most is that it reproduced the results of many surveys of brokers’ client books, the number of winners, losers, the money flow from different classes of traders to and from other classes of traders. That’s vital information! I have discussed the effects of group think in this blog, and I have also discussed the mass hysteria of crowds. Well, if you are in the market and you are a member of the wrong crowd, that could be an expensive mistake! Also, brokers surveys are not so common, and if they are specialized, the big picture might not be visible from them. So I hope to cast some light on this subject today, and maybe provide some hints as to good trading traits which might be worth the getting for people who are involved in this game, or career.
I am going to focus mainly on small traders within the totality of traders, as that is the group most readers will, I think, identify themselves with.
Let me give this quote for a start:
>>>“The Skills of The Trader
The bald unyielding fact is that small traders, as a group, seemingly possess no basic forecasting or special forecasting skill. They hold 46 percent of the value pf all contracts and their gross profits are zero. Substantial losses occur when commissions are included. On the average , then, a small trader has the expectation of losing money – the losses over a reasonable period to equal commissions. It is evident that small traders do not require ... profits to continue trading.
... the needs of some small traders may be met by merely playing the game. Having something that is dynamic and fast-paced to get up for in the morning is so exciting that the trader may be ... willing to risk losing money for the privilege of speculating. Second, traders may continue to trade because they believe they can forecast prices. .... they tend to remember profits and forget losses.
... the small trader may continue to trade because his or her group is amorphous and consists not of a crowd but of a parade. The successful small trader becomes large as a result of competence, whereas the unsuccessful small trader is eventually forced to withdraw from the market and is replaced by new blood.
.... small traders may be convinced that their latest mistake is also their last mistake and that, having learned, there is nothing ahead but smooth sea and blue sky.”
.... On the other hand, small traders have years in which they post impressive profits. ....This performance may well be explained by the tendency of small traders to rely on long-run trend following methods .... which may enable the small trader to reap extremely high profits in years when such trends are of long duration.
But later we see that “Larger traders generally tend to view markets as trading markets rather than trending markets. They may ..... tend to sell certain rallies and buy certain declines.
... It should be emphasized that there is a considerable difference between a winner in any given year and a consistent winner over a significant period of time. .Although the studies .... indicated that a trader in any given year has an approximate probability of one in four of achieving a net profit, the probability of extending his or her supremacy consecutively drops precipitously. Of the 25% who win in any given year, only 2% manage their skills in a consistent manner .... <<<
And about the small traders who succeed?
>>>.. Successful trading is reached, if at all, by following a series of successive approximations. Early in the process ignorance is the rule, and traders know that they know nothing. ... Given enough time, patience, and perseverance, successful traders enter ... a state in which they believe that they know something and no more. In this state they are “inner directed” and not “other directed”. The “other directed” individuals react to what other believe about them ... roles and values ...derived from what their peers expect of them. The “inner directed” individuals hold to the thoughtful courses they set for themselves.
... a viable approach to trading ... only if (decisions) are reduced to principles and followed with great effort. ... The propensity for traders ... good feelings will come as a result of the successful plans that have been conceived and executed by a meticulous, thoughtful trader. .... There is a constant temptation to spill out over the boundaries of the well-defined role of trading.<<<
Although that is “dated” I propose that it gives a good insight into the nature of what faces a trader who wishes to be profitable in the markets of today. We may argue with the percentages, but I think/believe that the overall conclusions are about right.
Now at this stage let me mention a certain idea. If anyone has read “Extraordinary Popular Delusions & The Madness of Crowds” by MacKay (discussed here last week) or “The Crowd” by Gustav LeBon, then a certain concept arises. It’s counterintuitive, but when a trend gets going, and it enters the public psyche, it's end can be forecasted via rational methods. Yet traders, the Banks and market makers sell into 3 std deviations with a wish that it is so. Let’s me be blunt about it. You have to ask yourself “Are they burning witches yet?” Or “Are they breaking the legs of those who dissent yet?” If they aren't, it can go further! Ask “Are they conscripting the social age groups who oppose and sending them to war with no right to speak out yet?” If not: then the trend can go a lot further! But it might stop sooner too.
Now this seems to be all about ideas, and the acceptance of ideas, and not about fundamentals and that might bother some readers. Please read on and I'll make sense of it soon.
This possibility of trends to go further than anyone would believe creates two problems, one for the establishment (market makers) who sold the rally short, but still it goes, and the other for the trader who just wants to make money and avoid losses.
At this stage I would like to introduce Tony Plummer in his excellent book “Forecasting Financial Markets”, now in it’s 6th edition which goes into individuals and crowd conformation and practical implications for traders in some detail.
This comes from Tony’s introduction, the first words in his book:
Making money by trading in financial markets is a formidable task. This is a great truth that is almost impossible for one person to teach to another. It can only be realized by the very act of trading. Accordingly, very few people enter the trading arena with their eyes fully open to the psychological and financial risks. Indeed, they approach markets in the same way that they might approach a lake containing a fabled treasure. They feel that all they have to do is set up appropriate pumping equipment and the treasure is theirs. What they do not realize is that – as in all good fairy stories – the lake has magical properties, designed to protect the integrity of the treasure. Most people who touch the sparkling water of the lake are doomed to be transformed by it: they become treasure protectors instead of treasure hunters.
The problem is that there is an energy in financial markets (and, indeed, in economic activity) that somehow coerces and organizes investors into a single-minded unit. There is nothing sinister in this: it is just nature ‘doing its thing’. However, the force is a psychological one, and it is so powerful that investors do not recognize it until they are finally caught in a disastrous bear market that wipes out months, if not years, of hard work.
The corollary of this is that truly great traders are very rare – only a few have the special clothing that protects them from the secret effects of the lake. Jack Schwager’s books on ‘Market Wizards’ would not otherwise be best-sellers.1 What is it, though, that separates such traders from the rest of us?
If this indicates that trading is not about what learner traders think it is about then I am getting somewhere!
So let me now mention this news item from Zerohedge today :
>>>” Hugh Hendry Capitulates: "Can't Look At Himself In The Mirror" As He Throws In The Towel, Turns Bullish
"I cannot look at myself in the mirror; everything I have believed in I have had to reject. This environment only makes sense through the prism of trends." - Hugh Hendry
First David Rosenberg, then Jeremy Grantham, and now Hugh Hendry: one after another the bears are throwing in the towel.
As Investment Week reports, speaking at Harrington Cooper's 2013 conference this morning, Hugh Hendry said "he is no longer fighting the two-way feedback loop which is continuing to boost risk assets." The reflexive feedback loop envisioned by Hendry is the following and centres on the currency war being played out between the US and China, "in which US QE prompts dollar-denominated investment to head to China, and China fights the resulting upwards pressure on its currency by manufacturing an investment boom. Hendry said this creates a "global supply glut", leading to falling US inflation expectations (as this supply far outweighs US domestic demand) - which in turn prompts the Federal Reserve to loosen policy once again." Rinse. Repeat.
Of course, there is a limitation here as we have explained previously, namely the amount of "high-quality collateral" which the Fed and the other central banks can and are rapidly soaking up, in the process destroying bond market liquidity, but that "discovery" will be made by the Fed far too late, despite even the repeated warnings of the Treasury Borrowing Advisory Committee.
And since Hendry is constrained by daily, monthly and annual P&L, he simply does not have luxury of waiting for the "fat tail" event, which incidentally will be quite terminal and thus hardly profitable for anyone exposed to fiat-denominated assets.
So the end result is that Hugh Hendry is merely the latest bear to throw in the towel:
"I can no longer say I am bearish. When markets become parabolic, the people who exist within them are trend followers, because the guys who are qualitative have got taken out," Hendry said.
Now there is a pattern here I am trying to illustrate. Hendry and his peers know what is the sensible thing for the market to do. But if the market chooses (or is persuaded) not to be sensible, then he recognizes what the maddened crowd of trend following investors/public will do to his career, and hedge fund if he remains in their way.
So what or who is “in charge” of the market we trade to the best of our abilities? I often refer to “the people in charge”. It is not quite the same as “the Powers That Be”, because the powers changes hands more often than many people notice. Indeed many people have great power just for a little moment, but fail to see this, and do not exercise it while they have it. Have you ever had a conversation, and later thought to yourself “I should have said ....” Well that would be a minor example of what I mean.
This has been entirely a psychological discussion so far. But ideas must be executed or nothing happens. I want to look at it all a different way now. Let’s look at some prime movers of price.
A quick observation first: There is a lot of discussion about Bitcoin lately. Bitcoin, I remind readers, has been around for about 4 years, but now it’s the new black, to use fashion vocabulary. Why now? Why so much? Could it be an idea is spreading through the individuals who look at alternative currencies, and they are receptive to it, and some are acting on that receptiveness. I would mention that a Bitcoin today costs the same to “make” as it did last week. But the precious metals have let some of their alternative currency supporters down recently. Maybe these people are looking for an alternative, alternative currency? Has the underlying fundamental situation changed/ No. But the price of gold and silver fell recently. So lets get back to my choice of the word “fashion” above. Could a new fashion be starting? Are the Bitcoin’s new supporters being led? If so, by who or what are they being lead. Every crowd needs a leader after all.
So here are some suggestions as to what may be going on.
The price of gold’s strength has “let down” or disappointed some supporters of alternative currency, and they are switching their allegiance to another alternative currency, Bitcoin.
A low price of gold has an effect upon some traders. Some buy because it’s better value, but others sell because it went down.
The Bitcoin has been “in the news” recently. This represents a marketing campaign for a new fashion, or crowd, and the marketing campaign is creating brand loyalty in new minds, who now have a new leader for their crowd. I hope Litecoin do not buy too much advertising - ooops! I meant news coverage – for advertising would create an alternative brand to Bitcoin. (Is it just a brand? I suppose every national paper currency is a dominant brand)
Wait a minute!
Price change changes traders behaviour.
Price level changes traders behaviour.
Marketing penetration and brand image changes traders behaviour.
Exactly! And that includes you, me, everyone, and our mental processes which before now we thought were rational!
Now go back and re-read what the first quote said about successful small traders!
But if that is the case, why are Hugh Hendry, and the other fund managers switching course?
Here is a perplexing question:
What if your current beliefs guarantee that you can’t get to where you want to go?
You might be worried about your lack of adequate resources, knowledge, investment capital, training, backup staff and services. These are all things which it is better to have, but the small trader just has to make do with what he has.
But your beliefs? Who or what is in charge of your beliefs?
You better believe me when I tell you this. It’s the price! It’s the brand! It’s the fashion! (OK say trend instead of fashion if you prefer – but why not say “mania” instead).
The role of leadership is completely underestimated by most small traders in my opinion. Mainly because leaders are not always people. They can be things. Totems get used. A totem is what exactly?
Here is Mirriam-Webster’s definition:
: something (such as an animal or plant) that is the symbol for a family, tribe, etc., especially among Native Americans
: a usually carved or painted figure that represents such a symbol
: a person or thing that represents an idea
That last one is particularly interesting.
Now while we are looking at all this, have a listen to this discussion about modern gods, religions, and people’s beliefs on Youtube by SGTBull07. It will take 5 mins 41s but well worth it imo.
Our trading “game” is now looking anything but straightforward. However I hope that you have gained a fresh insight into your inner motivation in choices of asset from my thinking on this part of “the game”.
Did you ever consider that the price itself could be whispering to you, and your subconscious might be saying: listen to this guy, he’s the leader of our group, and your conscious might be altering your weightings of the factors of importance on the back of all that? It’s worth considering.
Let’s look at a small part of what Tony Plummer said above:
– the lake has magical properties, designed to protect the integrity of the treasure. Most people who touch the sparkling water of the lake are doomed to be transformed by it: they become treasure protectors instead of treasure hunters.
Now consider that a leader of a group, might decide to call the most committed members of his or her group disciples. And extremely committed, or very smitten disciples sometimes can not maintain their degree of comittment, as it is so intense it lasts for a short while as it were. This gives a possibility for disillusionment to set in, often beginning first with these most committed of followers. The prior excess of respect is followed by a bitter sense of betrayal. John Lennon apparently got shot by a disillusioned ex-follower. Recruitment of spies and informants by intelligence and police services is often targeted at similar profile ex-disciple type people .
In the circumstances it is natural that an ex-physical gold "disciple" would become a Bitcoin devotee, almost as a reflex action after gold is discredited in his or her peception. This describes some of what I see in the internet discussion at the moment. Of course, if Bitcoin required greater marketing effort to compete with gold, and gold is being suppressed, that extra marketing which came from certain news services reporting an unexpectedly large and fast rise in the Bitcoin price would be purely circumstantial I guess. Nothing to see there folks.
I hope that this whole subject now has a more specific meaning for readers. But it's effects on one are subtle, subconscious, and above all, emotive based rather than logic based. And not good for trading success.
And so the next time price goes up or down, it might be a little easier to recognize that part within, which wants to “accept the leader”, the part deep down that feels either euphoric or betrayed. Mind you, at the moment you would be in good company, what with all those hedge fund managers and all. A problem remains. They might not drop their card on your table before they quietly leave the ballroom and nonchalantly stroll towards the lifeboats.
Best wishes to all.