Playing the Long Game

In the gambling world, the vast majority of players have a negative expected value (EV) on their bets.  They should either not play, or if they must, in order to maximize their chance of winning, they should bet just once.  That would give them almost 50% odds of winning on most even money payout games.  But for the positive EV gambler, you can maximize your equity growth by following the Kelly formula.  For example, if you win about 60% of your even money bets, you should bet 20% of your capital on each trade to maximize the growth rate of your bankroll.  

Now 20% on each trade sounds ridiculous and too risky but that's what the math says.  If you want to be more conservative and bet with half Kelly, so 10% on each trade, that's still going to cause a lot of fluctuations in your account equity.  Even with a 60% win rate, the odds of losing 5 in a row, are 0.4 x 0.4 x 0.4 x 0.4 x 0.4 = 0.01.  So on average, after 100 trades, you will have had one losing streak of 5 trades.  Even at half Kelly, that's a 41% loss after 5 trades.  A lot of traders would consider losing 40% almost like blowing up, but that would just be a standard, normal losing streak for the half Kelly bettor.  It would also take a stubborn and unflappable mentality to withstand that kind of loss and stick with the same strategy.  Those are uncommon traits. 

In trading, if you have an edge, just like in gambling, you have to bet big to win big.  But you can't be out of control and start betting bigger and bigger to make up for past losses, you have to do the opposite.  And if you are winning, you have to bet bigger and bigger to maximize your growth rate.  Its not natural for most people to bet that way.  Most want to bet smaller and less often after wins to protect their winnings, and bet bigger and more often to turn a loss into a win.  

In this business, there is no pre-determined income.  No guarantees. You don't know when the opportunities will come, and usually, the best opportunities come all at once.  Trying to make money every day, every week, or even every month just leads to a lot of overtrading, betting too big, and forcing trades when the probability is not that favorable.

That's why when you have a good market for your style, you've got to be a pig.  You can't be satisfied with singles and doubles, you need to go for home runs when things are running hot.  That is to make up for the majority of the time when the markets are tough and you have to just grind for small wins, or to break even, and stay disciplined to avoid those big losses that are account killers.  

This brings me back to the current market.  My bread and butter pump and dump setups are just not working in this small cap HODL environment.  The parabolas are extended and go on for longer than in a typical market.  It has been a painful time to be a short seller who holds longer term positions, because so much junk is flying higher, and staying high.  I know that in a year, almost all of them will be down 60-90%.  

Fundamentals aren't important right now, its all about finding the hot sector and piling in and chasing momentum.  I've been fighting that momentum, so its been a grind for the last few weeks. 

The bears that have survived so far are the ones who have been quick to cut losses, and avoid taking a stand on companies, even if they look fraudulent or are just a lot of hype.  It is one of those rare, extended time periods when the negative EV players are on a hot streak.  Retail investors are making a lot doing all the wrong things, ignoring long term fundamentals, chasing hot story stocks, buying stocks in companies with low share prices, thinking they are cheap.  Its working for them for the last 2 months of 2020, and even better during the first 2 weeks this year.  

The overall short interest as a % of S&P 500 market cap is now at the lowest levels in the last 20 years.  There aren't really many shorts left in this market, most of them have gotten run over and have thrown in the towel.  The short interest in TSLA has gone down huge over the last 12 months.  This week, GME, a stock with over 200% of its float shorted, squeezed up 100% on air.  Shorts got absolutely destroyed on that stock, and a lot of other heavyily short names also had big short squeezes.

its a very difficult time for the short sellers, and with record high valuations and excitement among retail investors, it probably means that a very good period for short sellers is just around the corner.  The US stock market hasn't had a proper bear market in 13 years.  The last one, from October 2007 to March 2009, laid a great foundation for a long bull market.  Those big drops in 2011, 2015/2016, 2018, and 2020 were too brief to reset the stock market to a more long term sustainable path. 

Now we're seeing what happens after so many years of big gains and quick recoveries.  Rampant greed, Wall Street feeding the ducks with lots of SPAC IPOs which will end up being albatrosses considering how much money is chasing the EV, Solar, Biotech, and other hot sectors.  Since most IPOs have a 180 lock up period, you will start to see a lot more supply being unlocked and free trading later this year.  I think that's what kills the momentum in these go go names, just the sheer supply of hot SPAC garbage that will come public in the coming months.  

On Friday, we got the post Biden stimulus selloff, exacerbated by a big opex Friday.  I was waiting for a bit higher to short, so missed the short entry on Thursday, but I don't see much downside after Friday's selloff.  Post 2008 modern markets have a tendency to keep trending up and maintaining very overbought levels for an extended period of time.  And bubbles usually top out with a parabolic blowoff phase, and I don't think we've seen that yet.  

I am still in buy the dip mode, sell the rip mode is still a bit risky unless they are nearly perfect setups.  And Thursday was not close to being a perfect sell setup.  I might even go long on this small dip on Tuesday, as I expect another all time high after inauguration and the Biden stimulus talks get more serious.