DUAL REALITY
(this and next several posts is slightly revised version of first training sessions at RealityTrader. We consider concepts discussed vital for success in trading)
Part 1
Before we go into the discussion itself, I want to offer you a couple of situations to think about.
Pretend you are talking to a group of traders. It's just a conversation, an exchange of ideas. They tell you that they have an excellent opportunity coming. Their description of the company is a small gold mining company that has discovered the biggest gold field in Indonesia’s history. You raise your eyebrows. The stock went from under $1 to over $20, they say. Then some ill-wishers start to bash the company. They organize false reports from the biggest auditor that said there was an insignificant amount of gold in samples. Then the chief geologist has committed suicide by jumping out of helicopter. <Where are your eyebrows?> Meanwhile, the stock has dropped to $2 on all this.
So, you ask them what kind of opportunity they see. It is simply fraud. The scale of it is unusual, but the rest is a clear scam. They talk loudly with comments such as "Are you crazy, look at Indonesia maps! Here they are! Don't you see the gold is there? Here are geological reports, drilling, core storage, core replacement, core dumping - compare them to reports from known gold mines. Here is what this politician said and that geologist wrote and what the company CEO claimed. There is a guy on message board who met with some big folks the other day secretly. They told him they are buying this stock big time. He couldn't share the details of course but he knows what he is talking about. We called to company PR and they said they would release good news shortly. Finally, look buddy: First thing I saw when I turned on the TV today was a movie with GOLDberg. Gold is there. It's a sign!"
You may think this is a crazy and impossible story. It is not only a true story, it is just a very small part of it. Old-timers remember the Bre-X story. For those that don’t, the Silicon Investor still keeps the thread alive. If you go to
Subject 5725 and read the entire Sunday May 4, 1997 bulk of posts, you will see all their hopes and eventually their crash.
This is by no means a unique story. By reading message boards, you can see endless variations of it. Traders all of a sudden become experts in drilling results, medical research, software details, surgical tools, drugs, electronic devices, business models. You name it. They discuss it and argue points. They try to make something of it that would help them to predict price movement. Look at OMKT, going from 12 to 60s and back down. Today it trades under 10. Did the fundamentals of the company, business model or its share in market change that drastically in both directions during one year? I never did any research on it, but I really doubt it.
But even more interesting and more to the point of today’s topic is: The same people on message boards that were talking it up while it was sitting in 12-14 range were screaming happily as it went up. They still continue to discuss what happened! So, how come those people talking about Bre-X were so off base? How come those discussions on OMKT were that irrelevant? If you just read the Bre-x story, I have no doubts that you would not believe any word of that group. However, thousands did! They ran the limit of their credit cards, took out second mortgages on their houses to buy more and more! Did it happen because they were not too good at evaluating drilling results? No, it's not the reason. Here is the proof.
In the Spring of 1998, KTEL announces that the company goes on the Internet. The stock soars from $5 to over $20 in a few days. Hot debates occur all over chat rooms and message boards. While a few argue that the company has a brilliant future and that the stock should cost $100, the majority proves that the fundamentals look awful. They say Internet sales won't help much and the current valuation is too high for the stock (By the way, look how solid these arguments are: siliconinvestor.com. According to this opinion, they short the stock in 20s. The following is well known. KTEL goes to over 80, burning shorts, causing margin calls and shares that were borrowed were being called in. All the signs of nastiest short squeeze were evident. The question is; Were those who shorted it correct in their opinion that the stock valuation is too high? Yes, they were!
Did being right bring them money? No, it didn't! As you can see, in the first example, traders were wrong in their assumptions and lost. In the second, they were discussing plenty of different things and the stock went in their favor. Then it moved against them. All this happened in such a short period of time that we can see clearly: all the reasons that they discussed apparently were not what made the stock move. In the third example they were right, yet they lost.
It leads us to that conclusion that the things traders were discussing in all three cases had nothing to do with the stock movement. Really, if one can be right or wrong in his assumptions, yet outcome is the same, doesn't it mean he is looking into something irrelevant to outcome? One of the major realizations that make a huge difference for a trader is that there are two realities in trading. One is "real" reality - reality of what happens to the stock. Second is a reality that a trader creates for himself with his assumptions and his opinions. Intuitively you can feel that the closer those two realities are, the more successful trading is. Are they ever the same? Not really. Remember how different the Bre-X case was with your perception comparing to the perception of that group of traders? That happened because you were a detached observer, with no emotional involvement. Should you have had a position in the stock, your biased opinion would impact your perception. It's quite possible that you sincerely believed the gold is there. The same happens when trader starts with paper-trading. He is cold-blooded when real money isn't on the line of fire.
His calls are way better than his real trades when he goes live. The same happens when a trader takes a position and the stock goes against him. He puts much more weight in every uptick and then in every downtick. A trader sometimes even mesmerizes himself into thinking that the downtick is good for him as it clears all the sellers! Meanwhile, the true reality is that the stock goes against him and his losses become bigger with every downtick. The more he rationalizes, the bigger the gap between true reality and "his" reality becomes. There is a great analogy by John Magee used in his book The General Semantics of Wall Street. There is a territory and there is a map. Are they ever the same? Not really. They might be close if the map is good. But they are never identical. The territory is stock movement. The map is what we think of it and what we make of it. So, here is our answer to the question. If all the reasons that traders discussed had nothing to do with stock movement, then what did? The answer is the stock movement itself! This is the only reality of the market. That's why the market is never wrong. The market just is what it is. It does what it does. As Zen would have put it, market IS.
cont'ed... |
