The Long Game

"Win or lose, everybody gets what they want out of the market." - Ed Seytoka

Everybody gets what they want out of the market.  Contrary to what they say, many people are looking to maximize thrills by betting huge and minimize the emotional toll of grinding through the ups and downs of winning and losing.  Trading is a game made for masochists.  Its not a game that will make you happy in the long run.  Being a trader is similar to being a drug addict.  It is hard to stop once you get into it.  It dulls the senses, making other non-trading experiences less interesting and fulfilling.  One of the greatest traders ever, Jesse Livermore, considered his life a failure and killed himself in the end.  

You get to choose whether you want to play a long game or a short game.  Those that want to play a long game will innately trade in a way to ensure their long term survival.  They can sense when they are in danger and betting too big, and reduce size and cut losses to live to fight another day.  Those that want to play a short game take huge risks and YOLO.  They are overconfident, but also know that they are living on the edge.  Its thrilling and exciting, but it doesn't last long.  They don't have the patience or the desire to play a long game.  

Why would anyone want to play a short game over a long game?  Its because of the emotional toll of trading.  The basic principle of this emotional toll is the pain of loss vs. the pleasure of gains.  It is widely known that the pain of a loss is felt greater than the pleasure of a gain.  Losing $10,000 will be much more painful than winning $10,000 is pleasurable.  Let's roughly estimate for gains and losses of equal amounts to be:   Pain of Loss = 2 x (Pleasure of Gain).  In order to emotionally break even, you have to have at least twice as many winners as losers (of the same size), or at least 67% winners to be emotionally "winning".  That is extremely difficult to do.  

Thus, to maximize the pleasure from trading, traders will often choose to incorporate a high winning percentage strategy, which means taking many small winners and letting losers run, in order to increase their winning percentage.  That's a formula to maximize long term emotional "gains", but not the formula to maximize long term financial gains.  Partially its because markets tend to follow trends more often then not, which means that letting losers run is a very bad strategy.  Its also because when you hold on to losers and cut your winners, the size of your losing trade becomes bigger relative to the size of your total account balance.  You end up taking bigger risks in the worse spots, and taking smaller risks in the better spots.  That is a long term loser of a strategy.  Yet, this is an emotionally appealing strategy from a reptilian brain wiring of win = good, loss = twice as bad point of view. 

A huge majority of human beings have this emotionally reptilian brain (including me).  It means that most of us are not emotionally designed for optimal trading.  We feel pleasure from taking winners.  We feel more pain from taking losses than from holding losers in the hopes that they turn into winners.  The longer we hold on to losers, the harder it is to take those losses, especially after all the mental capital that was spent holding on and hoping that the losing trade would come back and turn into a winner.  

A disciplined, winning trading strategy usually maximizes pain (lots of losses) and minimizes pleasure (larger, but much fewer wins).  That is why trading successfully is for masochists.  You have to enjoy the pain of taking losses, with the long term view that your short term emotional pain will lead to long term financial gain.  A lot of traders know this, but subconsciously cannot follow this strategy because its emotionally painful.  For those who are emotionally invested in their trading/investing accounts, being disciplined and taking lots of losses is self-induced torture.  That is why many choose to bet huge, to YOLO, to get away from the grind of this self-induced torture.  It is the strategy that maximizes long term emotional happiness, but also maximizes the probability of blowing up. 

You don't have control over where prices will go, but you do have control over how much you bet.  In my early days in the markets, I thought it was all about picking the right direction, whether it be up or down.  And while being a good forecaster and predictor is important, its less important than knowing how much to bet.  You can be the best predictor of prices in the world, but if you are bad at choosing bet size, you will either blow up or make very little.  

It is during losing streaks like the one that I am in right now that remind me of the importance of money management.  Its sucks to be in a deep drawdown but you can't allow your emotions to take over.  If you do, you'll try to find a quick way out of this painful spot by betting big, to make that quick comeback, to feel much better again.  That is dangerous.  That is the psyche that destroys trading accounts.  Been there, done that.  During losing streaks, it can feel like Chinese water torture.  Taking short cuts to try to relieve the pain of losing is lethal.  In order to win in the long run, you have to be a masochist.  You have to accept short term emotional pain as part of the process to achieve long term gains.  

The latest COT and options data shows no major changes, investors are dug into their heavy net long positioning, with lots of call activity and its working, so I would not expect anything to change until you start seeing bigger moves up and down.  This upward grind during a seasonally weak time period is a horrible market for my style of trading.  The nosebleed valuations make any long term longs a poor risk/reward trade.  It feels like insanity to be short this market.  But historically, these type of overvalued markets with investors heavily allocated to equities occur near market tops.  But market tops are usually a process that takes many months before the trend changes, so we have to patient, but persistent in looking for the big down move.  Its a tricky balance to maintain, but there will be great opportunities for those with a bearish bias in the next 12-18 months.  

The bond market weakness is partially reflecting election uncertainty and the fear of a potential big selloff like you saw in the past 2 elections.  The bond weakness is also showing the unfavorable supply/demand picture for Treasuries.  The giant fiscal deficit means lots of Treasury issuance, much of that having to be taken in by non-public investors.  Until the Fed restarts QE, bond investors face this hurdle of heavy supply.  This supports the long term bear thesis which is predicated on equity valuations being extremely high relative to bond valuations.  

Equities are at the bottom of the corporate capital structure, and face the most risk during economic downturns.  Therefore, earnings yields (inverse of the P/E ratio) should naturally be lower than long term corporate bond yields, due to the added risk of equities.  With long term investment grade corporate bond yields around 5%, the fair value for earnings yields should be above 5%.  Or put another way, the P/E ratio should be below 20 in this high government deficit, heavy Treasury supply market.  But with an estimated 2024 S&P 500 earnings of ~$250, the current P/E ratio based on 2024 earnings is approximately 23.4.  Based on this metric, the market is at least 15% overvalued. 

Still stuck short and not looking to hold beyond this week.  Post October opex week is a seasonally bearish time of year.  With many already assuming that Trump will win, there is plenty of room for the crowd to migrate towards a more neutral positioning ahead of the election.  The market is pricing in a quite optimistic scenario and assuming that you will have a post election rally after a Trump win.  So many assumptions for the base case optimism on the Street right now.  If even one of those assumptions comes under question over the next 2 weeks, you can have a quick dip lower (likely to be bought immediately).  The bears have one week, perhaps two weeks max, before the probabilities shift much more favorably to the bull side.  I will let the shorts play out this week and get out.  Its been a terrible ride for shorts, but this pain will set up a much more favorable environment for shorts with the tenacity and patience in 2025.