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THE TRADING SCENE
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Humans have traded since the dawn of history —it was safer to trade with your neighbors than to raid them. As society developed, money became the medium of exchange. Stock and commodity markets are among the hallmarks of an advanced society. One of the first economic developments in Eastern Europe following the collapse of communism was the establishment of stock and commodity exchanges.

It took Marco Polo, a medieval Italian traveler, 15 years to get from Italy to China. Now when a European trader wants to buy gold in Hong Kong, he can get his order filled in a minute.

Today, stock, futures, and options markets span the globe. In India alone, there are 14 stock exchanges. There are over 65 futures and options exchanges in the world. As Barbara Diamond and Mark Kollar write in their book, 24-Hour Trading, they make markets in nearly 400 contracts — from gold to greasy wool, from Australian All-Ordinaries Index to dried silk cocoons. All exchanges must meet three criteria, first developed in the ago-ras of ancient Greece and the medieval fairs of Western Europe: an estab­lished location, rules for grading merchandise, and defined contract terms.

Individual Traders

Private traders usually come to the market after a successful career in business or in the professions. An average private futures trader in the United States is a 50-year-old, married, college-educated man. Many futures traders own their own businesses, and many have postgraduate degrees. The two largest occupational groups among futures traders are fanners and engineers.

Most people trade for partly rational, partly irrational reasons. Rational reasons include the desire to earn a large return on capital. Irrational reasons include gambling and a search for excitement. Most traders are not aware of their irrational motives.

Learning to trade takes hard work, time, energy, and money. Few individ­uals rise to the level of professionals who can support themselves by trading. Professionals are extremely serious about what they do. They satisfy their irrational goals outside the markets, while amateurs act them out in the marketplace.

The major economic role of a trader is to support his broker — to help him pay his mortgage and keep his children in private schools. In addition, the

role of a speculator is to help companies raise capital in the stock market and to assume a price risk in the commodities markets, allowing producers to focus on production. These lofty economic goals are far from a speculator's mind when he gives an order to his broker.

Institutional Traders

Institutions are responsible for a huge volume of trading. Their deep pockets give them several advantages. They pay low institutional commissions. They can afford to hire the best researchers, brokers, and traders. Some even strike back at floor traders who steal too much in slippage. The spate of anests and trials of Chicago floor traders in 1990 and 1991 began when Archer Daniels Midland, a food processing firm, brought in the FBI.

A friend of mine who heads a trading desk at a bank bases some of his decisions on a service provided by a group of former CIA officers. They scan the media to detect early trends in society and send their reports to him. My trader friend culls some of his best ideas from these reports The sub­stantial annual fee for those experts is small potatoes for his firm compared with the millions of dollars it trades. Most private traders do not have such opportunities. It is easier for institutions to buy the best research.

An acquaintance who used to trade successfully for a Wall Street investment bank found himself in trouble when he quit to trade for himself. He discovered that a real-time quote system in his Park Avenue apartment in Manhattan did not give him news as fast as the squawk box on the trading floor of his old firm. Brokers from around the country used to call him with the latest ideas because they wanted his orders. "When you trade from your house, you are never the first to hear the news," he says.

Some large firms have intelligence networks that enable them to act before the public. One day, when oil futures rallied in response to a fire on a platform in the North Sea, I called a friend at an oil firm. The market was frantic, but he was relaxed — he had bought oil futures half an hour before they exploded. He had gotten a telex from an agent in the area of the fire well before the reports appeared on the newswire. Timely information is priceless, but only a large company can afford an intelligence network.

The firms that deal in both futures and cash markets have two advantages. They have true inside information, and they are exempt from speculative position limits (see Section 40). Recently, I visited an acquaintance at a multinational oil company. After passing through security that was tighter

than at Kennedy International Airport, I walked through glass-enclosed corridors. Clusters of men huddled around monitors trading oil products. When I asked my host whether his traders were hedging or speculating, he looked me straight in the eye and said, "Yes." I asked again and received the same answer. Companies crisscross the thin line between hedging and speculating based on inside information.

Employees of trading firms have a psychological advantage — they can be more relaxed because their own money is not at risk. Most individuals do not have the discipline to stop trading when they get on a losing streak, but institutions impose discipline on traders. A trader is given two limits — how much he may risk on a single trade and the maximum amount he may lose in a month. These limits work as stop-loss orders on a trader.

With all these advantages, how can an individual trader compete against institutions and win? First, many institutional trading departments are poorly run. Second, the Achilles heel of most institutions is that they often have to trade, while an individual trader is free to trade or stay out of the market. Banks have to be active in the bond market and food processing companies have to be active in the grain market at almost any price. An individual trader is free to wait for the best trading opportunities.

Most private traders fritter away this advantage by overtrading. An indi­vidual who wants to succeed against the giants must develop patience and eliminate greed. Remember, your goal is to trade well, not to trade often.

Successful institutional traders receive raises and bonuses. Even a high bonus can feel puny to someone who earns many millions of dollars for his firm. Successful institutional traders often talk of quitting and going to trade for themselves.

Only a handful of them manage to make the transition. Most traders who leave institutions get caught up in the emotions of fear, greed, elation, and panic when they start risking their own money. They seldom do well trading for their own account—another sign that psychology is at the root of trading success or failure.

The Swordmakers

Medieval knights shopped for the sharpest swords, and modern traders shop for the best trading tools. The growing access to data, computers, and software creates a more level playing field for traders. Prices of hardware fall almost monthly and software keeps getting better. It is easy for even a

computer-illiterate trader to hire a consultant and set up a system (see Section 24).

A computer allows you to speed up your research and follow up on more leads. It is not a substitute for making trading decisions. A computer helps you analyze more markets in greater depth, but the ultimate responsibility for every trade rests with you.

There are three types of trading software: toolboxes, black boxes, and gray boxes. A toolbox allows you to display data, draw charts, plot indicators, and even test your trading system. Toolboxes for options traders include option valuation models. It is as easy to adapt a good toolbox to your needs as it is to adjust your car seat.

What goes inside a black box is secret. You feed it data, and it tells you when to buy and sell. It is like magic—a way to make money without thinking. Black boxes usually come with excellent historical track records. This is only natural because they were created to fit old data! Markets keep chang­ing, and black boxes keep blowing up, but new generations of losers keep buying new black boxes.

Gray boxes straddle the fence between toolboxes and black boxes. These packages are usually put out by prominent market personalities. They disclose the general logic of their system and allow you to adjust some of their parameters.

Advisors

Advisory newsletters are colorful splashes on the trading scene. Freedom of the press allows anyone to put a typewriter on his kitchen table, buy a few stamps, and start sending out a financial advisory letter. Their "track records" are largely an exercise in futility because hardly anybody ever takes every bit of advice in any newsletter.

Some newsletters provide useful ideas and point readers in the direction of trading opportunities. A few offer educational value. Mostly, they sell out­siders an illusion of being an insider, of knowing what happens or is about to happen in the markets.

Newsletters are good entertainment. Your subscription rents you a penpal who sends amusing and interesting letters and never asks you to write back, except for a check at renewal time.

Services that rate newsletters are for-profit affairs run by small businessmen whose well-being depends on the well-being of the advisory industry.

Rating services may occasionally tut-tut an advisor, but they dedicate most of their energy to loud cheerleading.

I used to write an advisory newsletter: worked hard, did not fudge results, and received good ratings. I saw from the inside a tremendous potential for fudging results. This is a well-kept secret of the advisory industry.

When I was getting into letter writing, one of the most prominent advisors told me that I should spend less time on research and more on marketing. The first principle of letter writing is: "If you have to make forecasts, make a lot of them." Whenever a forecast turns out right, double the volume of promotional mail.

Trading Contests

Trading contests are run by small firms or individuals. Contestants pay organizers to monitor their results and publicize the names of winners. Trading contests have two flaws—one mild, and another possibly criminal. This is a scandal waiting to be explored by investigative journalists.

All contests hide information about losers and tell you only about winners. Each dog has its day in the sun, and most losers have at least one good quarter. If you keep entering contests and taking wild chances, eventually you will have a winning quarter, reap the publicity, and attract money management clients.

Many advisors enter trading contests with a small stake, which they chalk off to marketing expense. If they get lucky they receive valuable publicity, while their losses are hidden. Nobody hears about a contestant who destroys his account. I know several traders who are so bad they could not trade candy with a child. They are chronic losers—but all of them appeared on the list of winners of a major contest, with great percentage gains. That publicity allowed them to raise money from the public—which they proceeded to lose. If trading contests disclosed the names and results of all participants, that would promptly kill the enterprise.

A more malignant flaw of trading contests is the financial collusion between some organizers and contestants. Many organizers have a direct financial incentive to rig the results and help their co-conspirators obtain publicity as winners. They use it to raise money from the public.

The proprietor of one of the contests told me that he was raising money for his star winner. How objective can a judge be if he has a business relationship with one of his contestants? It appeared that the amount he could

raise depended on how well his "star" performed in his contest. That highly touted star promptly lost money put under his management.

The worst abuses can occur in contests run by brokerage firms. A firm can set up contest rules, attract participants, have them trade through the firm, judge them, publicize their results, and then go for the jugular—raising money from the public for winners to manage, thereby generating fees and commissions. It would be easy for such a firm to create a star. All it would have to do is open several accounts for the designated "winner." At the end of each day it could put the best trades into a contest account and the rest of the trades into other accounts, creating a great "track record." Trading contests can be an attractive tool for fleecing the public.

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