Friday, July 13, 2012

Thoughts on Investing from Dynamic Hedge


When you travel to a different country one of the first things you notice is the change of tempo. Ask anyone from a small town about their first trip to New York and they will tell you that the pace of the city is in their face from the moment they arrive. Similarly, anyone from a big city visiting the South of France or Italian countryside will immediately be disarmed by the relatively slow way of life. Your internalized tempo is out of sync with the place you’re visiting. You can feel it, but there’s no empirical evidence to support your claims. To deal with the change of tempo you can choose one of the following:

1. Take your cue from your surroundings and adjust your internal tempo. When in Rome.

2. Disrupt your new environment by maintaining your foreign pace and hope that the locals catch on. The Footloose strategy.

3. Leave

It can be pretty funny watching an out-of-towner yield to every pedestrian in Manhattan. If you happen to be driving behind this courteous fellow, you’ll soon be insanely annoyed. Conversely, I’ve gone on vacation and found myself getting frustrated over things that no man should be frustrated about while on vacation. Schedules, timing, food availability all somehow conspiring against me. Yet it was just my tempo out of sync with a new environment. Given enough time the tourist starts driving like a madman and the uptight city-slicker finally puts on a pair of flip flops and relaxes. Very seldom does a personality with enough dominance come along and act as a pacesetter to an entire region. When it does happen, they write books about it.

The market has many different tempos. One of the most obvious is between different instruments. Think about the difference in tempo between pairs trading and directional trading. Even within pairs trading there’s a big difference between a sleepy insurance pair like $ACE – $CB and a fertilizer/ag-chem pair like $MOS – $POT. On the directional side, there’s a huge difference between trading Russell 2000 futures $TF_F and 30-Year Bonds $ZB_F — or say Xerox $XRX vs. Netflix $NFLX. If you try to trade one instrument like the other you’re likely to either get chopped to pieces or bled dry from commissions.

The most difficult tempo change of all is the tempo of the market itself. The difference between a bear market and a bull market is like the difference between being in NYC and the South of France. If you don’t heed the subtle warning signs of changing market you’ll find yourself wandering around on the beach in a parka yelling at Frenchmen. Not a good look. Just slightly out or sync with your surroundings. Unlike the tourist, the trader and investor has greater consequences than just looking foolish. So what are our choices?

1. Realize that there has been a market change and make the necessary adjustments to position size or time frame

2. Leave (stop trading and wait for your market)

That’s it. Just two. There’s no trying to disrupt your environment by continuing to act in a foreign manner. That’s just fighting the market. Chances are you’re not Paulson, and they won’t be writing a book about your next trade. With that in mind, always consider the market to be the local and you the visitor. Better yet, consider Ms. Market to be the lead dance partner. Get in sync fast because the tempo is constantly changing. Become acutely aware of the changes in emotion, listen carefully to the changes in rhythm, and watch the changes in energy. If it sounds very squishy, unquantifiable, and unscientific, that’s because it is. The market is trying to tell you something in its own subtle language. The same subtle language of mass human psychology. Charts and indicators and stochastic mathematics are helpful at giving clues, but what it really comes down to is being in the right tempo.


Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.