What's Your Advantage?

Meir Barak |

meir_barak.JPGMaking a living requires an advantage. Do you have some kind of advantage in your profession? Of course you do! If you had no advantage to offer, your client would go to your competitor. As with every profession, the same is true for stock traders - for success in the markets, an advantage is essential.

Pinpointing your Own Advantage

Trading is like managing your own business. As with any business, if you fail you'll need to close the business, fire the manager (in this case, yourself), and start looking for a new source of income.

Prior to investing in any business, you need to ask the following: Who are your competitors? How can you beat them?

The owner of a business needs to understand his or her advantage. Is the advantage in quality? Service? Location? Products? Without a clear advantage, your business will almost certainly fail. If you’ve decided to become a stock trader, you must be able to identify the advantage and make the best use of it, operating just as you would in any other business activity.

Most of the public can be defined as long-term investors. They believe in their ability to identify companies which, that will rise in value in the coming weeks, months or even years. The media is full of calculations, showing the millions you could have made had you bought 1000 shares of Microsoft stock in 1980. Warren Buffett is celelbrated for having made billions through long-term investments. Generations of investors were nurtured on these tales of good fortune and attempts to duplicate them.

Cold Water on the Myth of the Billionaire Trader

Wake up! Just because a select few got lucky does not mean that most people make money investing in the long term!

History ignores the greatest majority of investors - the 90% who lose their money. The tough reality is that many investors who made hundreds of percent profit in the 1980s and 1990s lost everything in the decade between 2000 and 2010.

Let’s examine what might have happened had you bought the ETF (Exchange Traded Fund) of the S&P 500 known as SPY in January 1999, and sold it in August 2011:

SPY_Market_Returns.jpg

In January 1999, you would have paid the identical amount for this ETF as in August 2011, whereas in that same timeframe, you could have received a risk-free yield from any bank of at least 50% based on interest rates at the time.

The Long Term

Let’s assume you're reading an article about a company with wonderful prospects. Let’s assume that the analysts also like this company. Do you have any advantage?  You and another half-million people have heard about this company and read the same article. Where is your advantage over other readers? The public company’s typist, who for a minimum wage typed up the quarterly report before it was published, knows more than you. The typist has the advantage, not you. Remember:

  • No one can predict price movement over the long term. I can't, you can't, nor can the best analyst in the world. Beware of anyone who claims otherwise. 
  • There is someone who will profit and someone who will lose from every analyst recommendation. 
  • Behind every stock transaction, there is a buyer or seller who feels he or she is smarter than you. 
  • The big money is not where information is clearly divulged to the public. If 90% of investors lose their money, then they’re clearly doing something wrong!

The Mid-Term

A range of several weeks to months is the inherent advantage for hedge funds. They operate with large sums, making it difficult for them to maneuver in the short term. Due to the capital they hold, they can support stock prices for significant periods of time, which increases their chance of profit. Their advantage is in shifting large amounts of money and being somewhat skilled at knowing where money is currently flowing. Although, they still sometimes lose.

The Short Range

The very short term, measured in seconds or minutes, is the market makers’ and specialists’ advantage, which we will learn more about later. They, in contrast to the rest of the general public, pay no commissions. They receive the commissions! Because their role involves coordinating real-time buy and sell commands, they know far better than we do which direction the wind is blowing, and they take advantage of the very short term. You will never find them buying a stock because they believe in the company’s product or management!

An Example of “Advantage”

When long-terminvestors want to protect their investment in a stock, they generally use a protective “stop order,” which will automatically perform a sale if the stock price drops lower than a specific figure. The stock exchange’s hours of activity overlap the working hours of the average investor, making it difficult for such a person to constantly follow the price movement in real time. The average investor relies on the broker to carry out the automated stop order.  

How does that help us? Average investors, whom we will call “retail investors,” review their investments at the end of each week and place protective stop orders into the system according to the price movement during the week that passed. These stop orders await automatic execution while the retail investors are at their day jobs. The automated stop orders will be executed when the preset conditions appear.

Our Advantage:

Looking at the stock’s graph, it’s easy to estimate the point where automated stop orders will be executed. Can this information be used to someone’s advantage? Of course it can! 

Let’s say that at a certain price, we see a strong chance for a heavy concentration of stop orders. In other words, if the stock price drops to this figure, a large number of stop orders will go live, which could likely push the stock price down further. Can we profit from the expected drop?  We sure can - we can sell “short” (which we’ll learn more about later) and profit from the price drop. This is how making use of information can be an advantage.

I relate to stock trading just as any other business. I won't trade without an advantage. I know that competitors are operating against me and want my money no less than I want theirs. I know that to survive and profit, I must identify my advantage and maximize it. I recommend that you, too, relate to your money with due respect and conduct yourselves accordingly.

 

To begin your own journey toward financial independence, visit Meir Barak's site Tradenet and check out his book "The Market Whisperer".

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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