SEE YOU IN THE MACHINE
2019-04-29 12pm EDT | #markets
“I’m an up bettor!”
The year is 1999 and I am not even thirty-years old, sitting on the institutional equity desk at a Canadian bank-owned securities dealer. The voice screaming out over the dull buzz is Tony’s. He is a former TSX floor trader, a little older than me, but still young as well.
This morning the stock market is getting pounded, down size on big volume. Selling is flowing in from every direct line on the trading desk. Our institutional clients have product to pitch and there are precious few buyers.
I know Tony is long for our firm’s book. That’s our job. As proprietary traders we are expected to provide liquidity for our clients. Tony works on the traditional equity desk and I am one row over in the derivative group. Tony has been showing bids all morning long and getting pasted. And the story is no different for me. I am struggling to deal with the waves of selling in the cash market, while also trading the index futures and ETFs markets, which are at times getting even more depressed than the actual stocks. To top it all off, I am also short gamma and getting longer with each sickening wave of selling.
Amidst all this madness, Tony wants to make a wager. Not for the firm (he has already made tons of bets all morning), but for himself.
“Spooz closes up on the day” he screams out, “I want seven to one odds.”
The S&P 500 is trading at around 1,400 and is now down almost 40 handles. It’s not quite lunch and the spooz are down almost 3%. There are no signs of any buying, but here is Tony wanting to bet that the entire decline is erased in the space of the next four hours.
Tony is a great trader so his bid is met with silence from the other traders on his desk.
Although I understand the rational behind his wager, I mentally estimate the odds of him being correct. Sure, that sort of emotional violent swing has occurred in past similar situations. But is 7-1 odds the right price?
Even though I am also bullish, there is a point where taking the other side of Tony’s wager makes sense. Maybe not 7-1. Maybe not 6-1. But there is a number where it makes sense to bet against my prevailing bias.
“It comes at four to one,” I shout back to Tony.
Tony looks at me and grins. We are one in the same. Both willing to make a market in anything.
“How about two hundred pays twelve hundred?” he replies.
“Five-to-one on two hundred is my final offer.”
I want to say the market never rallied and it was a terrific bet, but I can’t. Tony was correct and shortly after lunch, the selling disappeared. Suddenly there wasn’t an offer in sight and we rallied from down 3% to up 0.5% at 3:30pm.
However, lucky for me the bulls pushed too hard too early, and by the close we have drifted back down 1%. I ended up winning, but barely.
In hindsight, maybe five-to-one was the wrong price…
Why does anyone get emotional about price?
I quit my job in 2000 to trade for myself. For the next two decades when people asked me what I missed most, I told them the camaraderie of fellow traders like Tony.
The reason? There was nothing personal about our market views. Everything had a level where it made sense to take the other side. Whether that was a big block of Bell Canada for sale, or a bet about how many Big Macs the summer intern could eat in two hours, everything had a price. (As an aside, I learned the hard way that you should always take the under on food consumption bets - it’s way harder to eat large amounts of food than it appears.)
On the trading desk, there were no cat-fights about whose market call was better. There were no emotional twitter tirades about the absurdity of a certain position.
As traders, we inherently understood, there needed to be someone on the other side of our trade.
So instead of getting angry at opposing views, we were delighted to have someone to trade with.
The strange paradox of investing
As a financial writer, I face an unusual situation. If I post investing ideas in which most people agree, and are therefore more popular, those ideas will by definition most likely be inferior to ideas where the majority have an opposing view.
The wonderfully witty Jim Grant once said, “Successful investing is having everyone agree with you… later.”
Think about that concept for a moment. If they agree with you later, that means they may disagree with you now.
It’s obviously much more nuanced than this as we all have differing time horizons, risk preferences, etc. But the important thing to realize is that the best trades will be unpopular.
Don’t listen to me - listen to the greats
I find it baffling when individual market pundits become personally involved in showing how wrong everyone else is.
How are they so certain they have the ability to forecast the future? After more than a quarter century playing this game, I am continually amazed at the number of new mistakes I make. In another twenty-five years I will be simply discovering new ways to be wrong.
The greatest traders all share one trait - the willingness to admit their mistakes. My all-time favourite investor (hands down the greatest trader who has ever lived) Stanley Druckenmiller is a perfect example. Here he is admitting he got the October crash wrong;
“In 1987, when the market crashed, I was convinced we were going to have a depression. So I’m not poking fun at people who have been wrong.”
If that’s not enough, how about this Druck quote?
“Every great money manager I’ve ever met, all they want to talk about is their mistakes. There’s a great humility there.”
Do you think Stanley gets on twitter or CNBC and argues with those who disagree with his market viewpoint?
Not a bloody chance.
How about that other great investor? You know the one. The cherry-coke-loving octogenarian. Do you think he rails against the short-sellers who believe Berkshire is headed lower?
“We have no objection to anybody selling Berkshire short at all,” [Warren Buffett] said. “The more shorts, the better, because they have to buy the stock later on.”
Understanding how it works
The reason Stanley Druckenmiller and Warren Buffett don’t bother trying to convince the world they are correct is that they understand that there needs to be another side to their trade. They also understand that eventually markets will go where they are going to go. No one is bigger than the market. So ultimately price is the final arbiter.
Yet, in the meantime, would you rather have everyone discounting that price immediately, or there be some uncertainty which enables you to place your wager?
For example; I am bullish on inflation. I believe that in the coming years we will see a pronounced secular rise in the inflation rate. Could I be wrong? For sure! But do I care if you agree with me? Nope. Not a chance. In fact, I would rather you disagree as you would therefore be inclined to overpay for the treasury bonds I want to short. As an inflation bear, you would probably prefer me bearish as my shorting will give you an opportunity to buy t-bonds at a lower price than otherwise would be the case.
I wish the finance community would stay open minded and accepting of a diverse set of opinions. Not only is it critical to markets, but let’s face it - no one is right all the time. Let’s all remember that even Stanley and Warren get it wrong.
It’s frustrating to see individuals attacked personally for their market views. It’s confusing when theories are dismissed out of hand without contemplating their potential benefit. I am not a big technical analysis follower, but some of my best friends practice the dark magic. I would never say that our friendship cannot survive unless they give up their market views. Yet this occurs with other schools of thought. There is too often a hostility flowing through the hard-money Austrian people versus the cryptos versus the gold-crew versus the MMT bunch versus neo-classical economic folk. I am the first one to admit that there might be more benefit to technical analysis, and probably, with all these other schools of thought as well.
I try to stay open to all these theories as, after all, like Richard Feynman argued;
The first principle is that you must not fool yourself - and you are the easiest person to fool.
But if after staying open to the different views, I disagree with your assessment, instead of calling you an idiot, I will merrily realize we have the makings of a trade.
Back on the trading desk, when we disagreed on the price of a stock, instead of betting, we would take another route. Our exchange was automated even way back then, and we had an expression for when conflicting views occurred on a specific stock by two different traders - “meet you in the machine”. We would settle our disagreement by trading.
I wonder what Tony is up to? I wonder if he agrees with me that inflation is headed higher. If not, I am sure there wouldn’t be any animosity, but instead that sly smile followed by a “see you in the machine”.
Thanks for reading,