Tuesday, January 3, 2012

Contradictions and Categories

It seems the two immutable rules of trading directly violate each other.  The first says to ride your winners and cut your losers.  Seems simple enough and everyone from Livermore to Paul Tudor Jones extol the virtues of taking small losses and giving your winners room to breathe.  But the second rule says to buy low and sell high.  Seems simple enough and everyone from Benjamin Graham to Warren Buffet extols the virtues of looking for beaten down and undervalued securities and selling them once their value becomes fully realized. 

This reminds me of an old fable where this guy tries to sell both a spear that will penetrate anything and a shield that will block anything.  In reality, you are getting a shitty spear and a shitty shield.  These rules, like all things related to the market, are dependent on the current market structure and timeframe.  The first rule would suck ass in 2011 where your winners quickly become losers and your losers may become winners (or become bigger losers).  The second rule during the 1990s would have made you less popular than a Japanese Prime Minister as overvalued garbage like Iomega was killing it. 

In essence, these two strategies form the yin and the yang for the stock market (and perhaps any market).  All participants can only think one of two things when they see something go up (or down) in value.  Oh wow this shit's selling like hotcakes...I better get in on this before I get left behind.  Or oh wow this thing already went up too much.  It's definitely coming back down.  That's exactly what those two rules say.  The first says ride the trend as you never know when the trend will end.  The second says fuck the trend as it's over.  Jumping on it now is the sucker's play.  Does this sound familiar?  Isn't this nothing more than value v momentum investing?  Or trend following v mean reversion?

The irony is the "dominant" group is always the wrong group.  If there are 100 people in a stock market and 95 of them are trend traders, I guarantee you the market will be chop city.  If 95 of them were mean reversion pessimist fucks, then it would look like the LTCM equity curve pre-1998.  Simply because the market only moves when the majority people are on the wrong side of it.  If the market was truly efficient it would be dull as fuck.  Might as well watch Transformers 3. 

This brings me to 2012.  2011 was a clusterfuck mean reversion kind of year punctuated by a mean downtrend in August.  This told me most of the money were trend followers, which makes sense.  Looking at a monthly chart, the last 14 years were a wash for buy and hold investors, but for trend followers it looked clean and easy (depending on timeframe of course). Is it time for some sideways chop suey for our buy low sell high friends? 


My First Jam of 2012