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I have rewritten this piece that I wrote a couple of years ago, and added a
few thoughts to it, and it seems time to re post it, especially as newcomers
will not have seen it.
TRADE SECRETS
No one in the market is knowingly giving away money. Just as in an
ordinary poker game, in this zero-sum business it's your job to take my
money and mine to take yours. "Us against the market" theory died in the
60's, if it ever had a life at all. And if you imagine that you can pay
someone $3000 and acquire a business that nets you $1000 a day, you are just
being silly. This is an information game and information is the coin of
this realm. If you have some valuable information that might help me, I'll
trade you for some information of similar value -- like it or not, that is
the exchange mechanism in this marketplace of ideas.
As a contrived but apposite example, suppose you have developed an
extremely high probability recurring S&P buy condition which leads almost
always to a quick $3 increase in the S&P, and you let the world know about
it. When thousands of bids to buy in size suddenly hit the S&P pit, do you
really think any of them are going to get filled anywhere near the current
price? Even if the market had enough depth to absorb them all, what floor
trader would choose to sell? In fact, what happens when such knowledge
becomes widespread is very similar to what happens in a takeover situation:
the market estimates the proximity of its current state to the condition
which would cause the price increase, and price then rises with p, the
probability of reaching that condition -- the jump in price becomes a
gradual rise, and the profit declines more or less proportionately with 1-p.
The opportunity simply disappears. I remember a New Yorker cartoon, in
which two fishermen were sitting in their little commercial fishing trawler,
and one said, "If you give a man a fish, you feed him for a day, but to
teach him to fish is just plain stupid."
The S&P and several other markets that I trade are steadily degrading,
which is to say becoming more efficient. I have made measurements that
demonstrate this clearly to me. I understand from Linda Raschke that Perry
Kaufman has also noticed a similar effect more generally in measurements he
has made in a variety of markets. The markets always evolve; how quickly
they change is a function of the information disseminated and their depth.
Market opportunities ultimately and inevitably disappear, evaporating
naturally through the very process by which traders exploit them. Even
non-traders have witnessed this phenomenon vividly in the California gold
rush market of the 1840's and 1850's: after the easy surface gold was taken
out, only the well-financed could profitably search for gold. Today you
need a high tech operation that would boggle your mind -- and your bank
account too, however large -- to make it mining gold in California, and the
return per unit investment is minuscule compared to the return experienced
by the original miners. That is what happens to a market after it, as they
say, "matures".
An inefficiency in a thin market is not of much interest to traders,
because modest exploitation will remove the inefficiency. Of real interest
are only those inefficiencies in deep markets -- deep inefficiencies, so to
speak. This is the reason the largest hedge funds trade currencies. How
deep are the inefficiencies in the various markets? That is a good
question. Certainly the inefficiencies in shorter term markets are not as
deep as in the longer term markets -- the gold in shorter term markets is
closer to the surface and will be extracted more quickly, and short-term
trading opportunities must disappear first. And certainly the derivative
markets are deeper than their volume alone would suggest, because
value-discovering activity in them is absorbed also by the volume of their
underlyings, a lot of which is quite naive and slow to act and react. But
the easy availability of analysis platforms on personal computers, together
with the efficient dissemination of information thru the various media,
makes it now easier than ever to learn relationships that were previously
known only to the few, and you can be certain that in 10 years, and perhaps
in even as little as 5 years, you will no longer be able to accomplish with
your wits what you can accomplish today. A good illustration is the now
highly-evolved options markets. At the beginning of these markets in the
1970's, you could bootstrap yourself up with your own ingenuity and
regularly find delta-neutral/low-gamma hedge positions that not only covered
commissions but also gave you a handsome return, whereas today the potential
returns from market-neutral hedging have diminished to the point where, to
profit reasonably from a deep understanding of options, you have to go to
work for a firm with a floor operation or a firm like Salomon Brothers. And
even for such firms the profit is no longer nearly as reasonable as it was
twenty years ago.
If you possess extraordinary information, I would counsel you not to give
it away, but to trade it for other extraordinary information that you happen
to need, or if you don't want to trade it then at least to get paid
extraordinarily for it, preferably by using it in the market yourself. And
if you really have to give it away, by all means don't give it to a group of
anonymous strangers on a list -- give it to someone in your family. Or to a
friend. Or me (:}). You may naively imagine that your generosity will be
returned if you simply put your information out there for the group to see.
But that will not happen. There are in fact lurkers on every list who never
contribute anything, but merely take what is valuable for their own use.
Put a truly valuable piece of market information on a public list and I
guarantee that you will not only not ever hear from them again, you won't
even hear from them in the first place -- they won't as much as thank you,
they will simply disappear with your information and use it and never look
back, and you'll never know. You'll just notice one day that the market no
longer offers the same opportunity it once did.
And then there are the academics. Academics, of course, get paid not for
taking trading risks but for writing papers. Little information is safe
with people whose career ambition it is to publish the next Black Scholes
equation. In case you didn't know, the Black Scholes model had been derived
and was employed by a number of practitioners for several years before it
was published. It's publication contributed immensely to the disappearance
of both deterministic and probabilistic delta-neutral arbitrage
opportunities in the options market. It should be noted that this process
took almost ten years. Were such a tool to be revealed today with today's
communications efficiencies, the process would be vastly accelerated and
those opportunities would disappear much more quickly.
It goes further. The first step in doing anything extraordinary is
to believe it is possible. Before Roger Bannister ran the mile in three
minutes and fifty nine seconds, it was thought that the four-minute barrier
was insurmountable, a sort of theoretical human physical constant, and that
intrinsic limitations in the structure of the human body made it impossible
for humans ever to run a mile in less than four minutes. And in all of
history no one did it -- until Bannister. However as soon as Bannister
broke that barrier, his own 3-minute and 59-second record was broken in
quick succession in a matter of weeks by many others: the four-minute
barrier was not in the runners' bodies, but rather in their minds.
Similarly, Jack Schwager's Market Wizard interviews demonstrated to many
people that consistently successful trading was possible. Although
Schwager's subjects dealt with earlier and easier -- which is to say, less
competitive and more inefficient -- markets, and although certain of the
more extreme performances could no longer be replicated, the mere fact that
such performances had been achieved led many to develop market skills who
previously had accepted the prevailing academic view that the markets were
efficient and consistently successful trading was not possible. Schwager's
interviews contributed in their own small way to the growing efficiency of
the markets and the disappearance of trading opportunities. Thus, in view
of the four-minute mile syndrome, not only is it unwise to disclose trading
technologies, but it behooves the extremely successful trader not even to
publicize his or her results, as such publication will only increase the
competition and cause those results to degrade in the future.
How is information disseminated? I doubt that someone like George Soros
himself lurks on Internet mailing lists, but probably some of Soros'
employees do, and certain some smaller CTA's read them, so you definitely
have sizeable money looking on there. Exchange floor traders of course are
well-represented on many Internet mailing lists and many read everything
they can, books, articles, courses, etc., about the markets -- and the
floors are very social places where any information becomes common knowledge
immediately once it enters. And of course there are academics busily
reading market materials and trying to figure out how to use them to their
benefit, the university job market being what it is. It is safe to assume
that any valuable information published or posted for public view will be
absorbed rapidly into the marketplace, perhaps even by large CTA's, which is
to say very quickly even in cases of information that relates to longer term
trading. These institutions employ people to develop good trading ideas and
don't have to give their employees anything but a salary and a job and some
incentive pay. And for that, the employees read everything.
Enough said. I have to assume that, for those out there able to develop
original insights into market behavior, this is all self-evident. This is
not meant to discourage the exchange of ideas -- even in a cut-throat poker
game, players develop alliances -- and it is surely not meant to discourage
the free exchange of technical or hardware or operational information. I've
certainly gained immeasurably from all of those, and I've always gladly
learned something from traders more experienced than I, and I hope to
continue to do so in the future. And it may even make sense on occasion
to publish some important market insight for the feedback it generates.
Just be prudent about it.
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