Tuesday, February 21, 2017

Levels of Difficulty

Not all markets can be traded using the same strategies and tactics.  Some are much easier than others.  You can think of it like playing poker against rookies, casual players, and professionals.

First, you have the home poker game, filled with rookies and casual players who have very little understanding of the fundamentals of winning poker.  The Wall Street equivalent is the pink sheets/OTC/small caps.  Those trading in these markets are mostly rookies and casual players.  These traders will make many mistakes, chase momentum in pump and dumps, buy dips in permanent downtrends, and get caught up in the hype of meaningless press releases.  Basically, their ignorance provides the liquidity for insiders and promoters to profit from selling into the volume created.

The next level is the low to mid limit poker games in the casino.  You have mostly casual players with a small number of low level professionals sprinkled among them.  The Wall Street equivalent are large cap stocks.  Large cap stocks is usually traded by a mixture of casual investors, some professional traders, and a lot of fund managers.  These traders make fewer mistakes, usually have a good understanding of company fundamentals, but often get caught up in the hype, fall into value traps, and fall prey to more informed traders who have insider information.  

The highest level of poker is in the high limit poker games filled with professional poker players.  You have almost no newbies or rookies.   The Wall Street equivalent is the forex and futures markets.  Although you will find a lot of newbies and rookies in the forex and futures markets, their size is so small, that they have almost no impact on the market, and are mostly cannon fodder for the big boys.  Those are the high frequency trading firms, futures-focused hedge funds, and professional independent traders who have found an edge from years of experiencing studying and trading these markets.  These waters are filled with sharks, with lots of fish, but they being so small, that they aren't enough food for the sharks.  The sharks feed upon themselves, with the big sharks eating up the smaller sharks.

It also happens that the easiest markets to predict are the ones that are the least liquid.  In general, the more liquid the market, the more professionals there will be trading in that market, making it less predictable and harder to find an edge.  I always recommend traders who just start out to focus on finding an edge trading small cap stocks.  That is the easiest game in town, with enough liquidity for beginners.  In fact, I think those who have a lot of capital and are experienced should still trade these small caps if they don't want the stress of having to trade more unpredictable markets.

But there are a lot of traders out there who only want to trade the most liquid markets, who only focus on ES or big cap stocks, with every little edge, banging their head against the wall.  The easy money is in trading against the rookies and casual traders/investors.  That is only found in the penny stock/small cap world.

This market is amazing.  It is bubbly.  And we still haven't even gotten any details of the Trump tax plan.  There has got to be a top around the corner but once you get bubble like behavior, it becomes dangerous to fade the rally.  Still waiting for clearer signs of topping, and we just aren't getting it.

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