What all great traders have in common
We all hear the term
tossed around – “zero sum.” Or “zero sum trading.” Or “zero sum nature of the
markets.” Larry Harris, the Chair of Finance at the University of
Southern California has this to say about the concept of zero sum in his famous
white paper on the topic:
“…winning traders can only profit to the
extent that other traders are willing to lose. Traders are willing to lose when
they obtain external benefits from trading. The most important external benefits
are expected returns from holding risky securities that represent deferred
consumption. Hedging and gambling provide other external benefits. Markets would
not exist without utilitarian traders. Their trading losses fund the winning
traders who make prices efficient and provide liquidity.”
There it is – winners take from losers. Now
market losers can often have great reasons for losing, i.e. hedging, etc. And,
of course, many people lose simply because they used bad trading strategies.
Trend followers go to the market to trade trends
to make a profit. However, they are just one group of market players and, as we
all know, not all market players are doing the same thing for the same reasons.
Fannie Mae could be making a change in their bond portfolio. A major investment
bank could be trading a strategy that will not tolerate volatility. Bottom line:
people trade for different reasons for different goals. George Crapple, a trend
follower with 25+ years in experience, makes the point:
“So while it may be a zero some game, a lot of
people don’t care. It’s not that they’re stupid; it’s not speculative frenzy;
they’re just using these markets for a completely different purpose.”
Whatever their goals are, many people have
trouble coping with the market reality that for every winner there is a loser. A
recent USATODAY.com reader asked, “When a person loses money in the stock
market, does that always mean another person is winning? Is the stock market
simply like a casino where one man’s lost is another man’s gain?” Matt Krantz at
USA TODAY responded:
“And to answer your question directly, yes, if
you sell a stock for a gain, that was a loss for someone else. Remember that
there are only a certain number of shares outstanding of any company. That
includes every company ranging from General Electric to XM Satellite Radio. If
you buy shares, someone on the other side of the trade is selling them to you.
If the stock rises after you buy it, you have taken a gain that would have
belonged to the investor that sold the stock to you.”
On the other hand, one person who recently wrote
me, missed the zero sum point entirely:
“It’s part of cycles. Planets move in cycles,
market has cycles, people has cycles…there’s no difference…Seriously, angles
are largely a representation of market cycles. Drawing Astrological line are
just like drawing a 1×1 line on your chart. They should be taken in the same
manner. Separation of both creates mysticism and confusion. After looking deeply
into Astrology, I found myself feeling stupid about separating it from the
start.”
This type of thinking will not make you money.
Period. Trend followers do not think like this. Traders who are rational do not
think like this. If you trade the markets in terms of cycles, astrology or any
other non-reality based approach you are giving your money to the winners in the
great zero sum game every time.
How should you come to accept the zero sum world?
You acquire detachment. You obtain objectivity, and you search for traders who
role model both of these traits. You might find a role model in the
NewYorkmetro.com article titled “George Soros’s Right-Wing Twin” about Bruce
Kovner. Michael Marcus mentored Bruce Kovner at Commodities Corp and explains
why Kovner’s objectivity made him great:
“If you can find someone who is really open to
seeing anything, then you have found the raw ingredient of a good trader, and I
saw that in Bruce right away.”
Kovner accepts the zero sum game reality of the
markets, a sure sign of the self-confidence that allows trend followers (and all
great traders) to cut their losses and move on…to ride the winning trades all
the way to the bank.
Never forget that it’s you and you alone in the
zero sum game. It’s not you and your friend or you and your broker fighting
together. You are left to objectively use your mind to determine the best course
of action in order pull a profit from the other traders in the world who are
competing with you at the game. You dig deep to develop a winning course of
action. You can’t let fear and greed overwhelm you.
Michael Covel
Michael W. Covel is the founder and President
of Trend Followingâ”