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Part 2: The New Laws > Approaches and Attitudes

Chapter 3. Approaches and Attitudes

Investing and reason frequently give way to speculation and emotion.

Although attitudes have begun to change in recent years, there is still widespread reluctance to admit that market players are often irrational. This is despite the fact that most people, even those who have never traded a share in their lives, intuitively understand the cliché that fear and greed are the primary drivers of investor behavior. Some textbooks and personal finance tomes make reference to the emotional elements that influence buying and selling, but many commentators still appear to believe otherwise. They argue—or tacitly support the view—that thoughtful analysis and levelheaded decision-making invariably dictate future stock price movements. That is somewhat ironic, of course, in light of the equity bubble that developed during the 1990s, the collapse that followed, and the recent resurgence of interest—as Figure 3.1 seems to suggest—in the most speculative shares. Nonetheless, for today’s investor, it is more important than ever to understand the emotional elements that have come to the fore in the share-trading arena. Otherwise, they risk being swept up in a tide that can lead to underperformance and substantial losses.

Figure 3.1. OTC Bulletin Board Average Daily Share Volume (Source: The NASDAQ Stock Market, Inc.).

One of the things that some observers fail to see—especially those who have not had real money at stake in volatile conditions—is that, contrary to desire, people cannot always help themselves. Rather than seeking to maximize returns and coolly looking out for their own interests, individuals occasionally stray from a preferred course of action because of fear, anxiety, impatience, or other distractions. However harmful it might be to their bottom lines, they can get “spooked” into doing things they really should avoid. Or, they give in to a moment of temporary madness, which they later regret—even if they have considerable experience or a long-term record of success. Regardless of whether they rely on others for stock selection and timing or come up with investment strategies on their own, market participants are vulnerable to a variety of negative influences that lurk in the trading arena—and in themselves. Arrogance, stubbornness, and complacency, for example, can be real drags on performance when they cause players to misstep or otherwise take their eyes off the ball.

Investors can also be affected by concerns about forces that are supposedly capable of pushing prices up, down, and around at will. To a certain extent—more so, it seems, when conditions have been especially unsettled—share traders almost always have an air of paranoia and suspicion about them. Sometimes they fear there is a wild marauder out there with the inside scoop just waiting to pounce and take advantage of their naiveté or misfortune. Although logic and history suggest otherwise, some participants worry, in fact, that an abundance of such creatures exist, and are secretly on the lookout for any sign of them. Strange as it sounds, more than a few occasionally accept as true that these “insiders” are all-seeing, especially when it comes to an awareness of supply and demand. “They” know, for example, when most players are wagering on a short-term rally, and “they” immediately take advantage of this by driving prices down to trigger stop-loss selling. That is a bit ridiculous, of course, but the view is not totally out of line in a world where people are quick to blame others when things go wrong.

Ironically, the belief that there are those in modern times who have the ability and resources to impose their will on the marketplace is not as far-fetched as it sounds. As the old saw has it, just because you are paranoid does not mean they are not out to get you. Conventional wisdom says that no one is bigger than the market. While true in a general sense, there are increasing occasions—throughout the year and during the trading day—when air pockets form in the prices of shares and related securities because of the overall decline in trading liquidity that has occurred since the Bubble burst. When this happens, it allows operators with ample resources, an opportunistic approach to making money, and the ability to act quickly, to seize the moment and shake things up. By spending a relatively small amount to kick-start short-term momentum, an aggressive player can often trigger a forceful response from other traders looking to pounce on whatever action crops up. Ultimately, the instigator hopes to unload the recently acquired position at profitable levels.

There is no shortage of such operators, either on or off the exchanges. What makes life difficult for the speculative crowd, of course, is not knowing who is ultimately behind any of the buying and selling that does take place. For example, while a floor broker[1] on the New York Stock Exchange may represent various institutions—some small and others large—for reasons of client confidentiality, other participants can never really be sure who the agent is acting for on any given occasion. Mind you, educated guessing is a frequent pastime. The same applies to the various electronic dealing networks, which generally promote anonymity as a selling point, especially for institutional fund managers who are worried about the impact of their potentially market-moving interests. As a consequence, when orders do come in, there is usually some momentary combination of wariness and expectation that arises in players’ minds that the flow may be part of a much larger picture.

Not surprisingly, many sharp operators try to capitalize on these sentiments, aided by electronic capabilities that allow individual and program orders to be quickly routed to an appropriate venue. They hope that by sending a well-timed burst of business, they can set off a charge that can boost their own performance. Nonetheless, sometimes the interest is for real, and the buying or selling that initially knocks the market off balance is the beginning of a significantly larger order. The reasons for this type of approach are numerous, but much of it has to do with style, perspective, and the resources at the disposal of many modern operators. A significant proportion of hedge fund managers, for example, are assertive by nature, and many are willing to stir up potentially self-defeating momentum at the outset of a trade to quickly get a large chunk of the position on board. Psychologically, at least, it can be quite beneficial to have a purchase or short-sale “in the black” almost from the get-go. For executions that do not work out, the activity sometimes gives a useful read on sentiment and supply-and-demand conditions. It can also provide interesting feedback on stock selection methods—and, perhaps, an opportunity to go the other way.

Action Point

Although the immediate financial and psychological consequences can be upsetting, poor investment decisions often provide uniquely valuable information. On the one hand, they can open up an opportunity to explore personal shortcomings that need to be addressed; on the other hand, they may reveal useful data about underlying technical factors that can help investors to fine tune their overall approach. The key point is not to treat such events as skeletons in the closet but as valuable lessons in the art of investing. When incorrect choices are made, try writing the facts down and focusing, dispassionately, on what went wrong. Apart from anything else, this will help desensitize the ego to any sense of vulnerability associated with admitting mistakes. That alone can often make the difference between mediocre returns and star-quality performance.

Traders and alternative investment managers are less hemmed in by turnover restrictions than many traditional buy-side operators. For a start, most old-line firms generally prefer to work quietly and limit the collateral damage caused by their buying and selling activities. This is mainly because positions are usually acquired with a longer-term perspective in mind, often following a lengthy review process. The underlying premise is that these fund managers are taking advantage of opportunities on behalf of their clients; they are not trying to rattle the market. Similarly, it is difficult for these investors to rapidly cut positions that fare poorly or to trade out of a string of short-term winners without raising more than a few eyebrows. Although many long established players have, in recent years, joined others and adopted a more active approach to investing, the shift has not been so dramatic as to turn them into poster children for institutional speculation. They also have reservations about being seen to be pouring fuel on the volatility fire.

Most hedge funds also do not have the same restrictions in place that their long-only rivals have with respect to position limits and portfolio concentration. Although the majority are subject to some sort of risk-control procedures and exposure is monitored by prime brokers and principals—and, to a lesser extent, large institutional backers—they often have considerable leeway in how they structure the makeup of their investments, at least in the short-term. Aggressive operators, especially those with a well-established track record, frequently have very flexible parameters under which they can operate. In addition, because they tend to be lightly regulated and fairly secretive by nature, it is usually difficult for anyone but the employees of their clearing firms to know exactly where they stand. This can provide an easy opening for managers to adopt potentially risky weightings.

Resources are usually not a problem either. While not all alternative investment funds employ leverage or trade derivative instruments, many do, and this can substantially boost their firepower when they need it. Combined with the willingness and ability of hedge fund managers and large speculators to take sizable positions on a moment’s notice, it gives them the potential to throw their weight around and unsettle short-term equilibrium. While manipulation per se is prohibited under current laws, aggressive trading tactics are not. This opens up the possibility that those who choose to do so can cause some real damage in the marketplace—especially if they are reasonably plugged into what is going on, as most sizable operators are. Consequently, there is some justification for fears that players may come in and wreak havoc in the equity market, and traders’ antennae are sensitive to that possibility. If there is even a hint that such activity is on the way, the crowd is usually quick to respond.

It is not only flesh-and-blood operators who can upset the applecart, but “virtual” players, too. Not the kind found on some kid-friendly Web sites, but those that seem to form from the mass of concentrated energy that frequently builds up as a result of various modern developments. Technological advances, for instance, have provided a wealth of benefits to people inside and outside the investment world, but they have also had another effect. They allow many market activities that were formerly staggered because of structural or other limitations, or that required some measure of human intervention, to proceed unchecked and at breakneck speed. With a few keystrokes or the click of a mouse, it is relatively easy for an individual to send one or more trades to any number of venues without thinking twice. Although there are restrictions on the size of orders that can be funneled through some electronic gateways because of exchange rules[2] or built-in safeguards, rapid-fire wheeling-and-dealing can be a potent weapon.

When several operators start heading in the same direction at the same time, it can create a short-term tidal wave of buying or selling pressure that can temporarily disrupt markets, causing prices to swing sharply. Partly because of the way breaking news is widely and quickly disseminated, and partly because there are many more active players in the game looking to pounce on anything that moves, the pulse from even a few tiny orders can sometimes set off a feeding frenzy that fosters the illusion, at least, that a major trend is underway, or that a large-scale operator is aggressively trying to get a position on board. Regardless of whether it is true or not, the simultaneous actions often set off a self-reinforcing response from others in the crowd. Some traders quickly join in, looking to scalp a small profit from the short-term momentum. Others move out of the way, hoping not to get badly caught on the wrong side of things. Those that remain soon learn the hard way that it usually does not make sense to stand in front of a speeding train—even an imaginary one.

Sometimes the action is not just a coincidence. Because of significant improvements in the quality and reach of numerous communications networks, passing information along to others is a cinch nowadays. Emails can be forwarded to group contact lists at the press of a button, recommendations can be sent out by broadcast fax or telephone messaging programs, comments can be shouted through squawk boxes or overhead PA systems—all offering ways to let many people know fairly quickly what is going on. In addition, most market participants have multiple points of contact with each other, as well as with information sources such as Bloomberg and Reuters. Hence, when something big—or potentially big—is going down, global voice and data pathways quickly fill up with intense two-way traffic, mirroring the flash of activity that appears on a brainwave scan when complex thoughts set multiple nerve endings alight. This real-time storm can generate significant power that usually finds its way to the trading floor.

Arguably, while much of the synchronized reaction is not necessarily the result of collusion, it can often seem that way. At times, in fact, there is a common bond between some market participants that can produce an amplifying effect. As has always been the case in financial markets, there are influential analysts, newsletter writers, investors, and traders that many people pay attention to. Some are smart and savvy operators who are usually on top of things and have a keen sense of timing. Others may have had their reputations strengthened by some degree of investing success, even if it was only recent in nature. A few survive on past glories or the halo effect of an active public relations effort, with little in the way of current results to show for it. Whatever the case, these individuals can sometimes trigger at least a temporary stampede either by recommending an idea or by executing a trade for themselves and letting others know about it afterwards.[3] In some instances, they do not need to say anything at all, as eagle-eyed competitors absorb what is going on and play follow-the-leader.

Action Point

As in most aspects of life, there are generally a few leaders and many followers, and it is usually in investors’ interests to know who the movers and shakers in the share-trading arena are. When it comes to analysts, for example, there are services available, such as www.starmine.com and www.zacks.com, that methodically separate the wheat from the chaff by determining whose opinions matter most in assessing various companies’ prospects. On the money management front, consistent long-term performance is usually the best guide, though it is worth remembering that no one always gets it right. As an aside, it often seems that those in the trend-setting group are not necessarily the individuals who get the most air time on radio and television.

Ironically, given the secretive and suspicious mindset that many players—especially traders—have with respect to others cottoning on to what they are up to, it seems that some are only too happy to talk about what they have done once they have established a position. The reason is that while this chatter sometimes provides an ego boost or serves as a method of rationalizing away doubts about a questionable course of action, it also has a valuable marketing purpose. Whether admitted or not, the basic idea is to get other people interested in putting on the same trade. Theoretically, at least, this will then spur additional buying or selling support that can add to the overall momentum, boosting the returns of the earliest players in the game. It is sort of an offshoot, perhaps, of the greater fool theory.

Although such efforts have long been a feature of financial markets, many outsiders, especially smaller investors and some relative novices, have occasionally taken these promotional efforts at face value, not looking at what was being said in the context of why it was suddenly being brought to light. Numerous analysts and firms, of course, also overstepped the line in a major way during the 1990s. They allowed misplaced incentives and various conflicts of interest, triggered in large part by the fat fees flooding into brokers’ coffers during the IPO boom, to unduly influence their recommendations and public pronouncements. In some instances, as the press, the SEC and various Attorneys General discovered[4] in the aftermath of the post-Bubble collapse, there were blatantly fraudulent attempts to foist bad ideas onto the public to gain favor with prospective issuers. Nowadays, there are rules[5] in place that bar analysts from being compensated on the basis of specific investment banking transactions. Moreover, researchers generally must disclose anything that might be relevant to what they are advocating. Although it is not a cure-all, it does limit some of the more outrageous puffery.

Still, nothing can prevent some operators from relentlessly tooting their own horns to get a full-fledged concert going. However, for most speculators, motivation does not really matter. In their minds, anything that can serve as a spur to get prices moving has value, especially in an age where many players are aggressively boosting their turnover. Fact or fiction, marketing fluff or overheard tidbit—if it has the potential to trigger notable share buying or selling, many short-term operators will do what they can to try make the most of it. Sometimes that includes passing along rumors or hearsay from the trading floor or other markets that would be given short shrift if analyzed in the cool light of day. At other times, facts can end up twisted or exaggerated, though still plausible, when minced through abrupt conversations and the sloppiness of modern communications. With numerous participants increasingly focused on headlines, tickers, bullets, and sound bites, there is rarely enough digging to see where the roots lie.

As odd as it sounds, many modern players do not even pay all that much attention to “fundamental” information, truthful or otherwise. For them, it is the trading volume and intrinsic behavior of the prices themselves—range between the high and low, rate of change over time, previous areas of congestion, levels relative to other shares and the overall market—that really matter. Sure, if an earnings report sets off a wave of sell orders that drives a stock beneath a previous low—which happens to be a widely watched technical level—many traders will concede that it was poor fundamentals that did the trick. But more than a few technical types will argue that “the charts” indicated a decline was due to happen regardless, and the news was merely one of any number of possible catalysts that could have caused it to occur. Whether that makes sense or not, the reality is that numerous operators are avid followers of methods that focus almost exclusively on divining supply-and-demand characteristics.

In fact, given the expanding interest in short-term trading and active investing, awareness of key technical levels has become an important priority for many participants—even those who are traditional long-only investors or who otherwise tend to rely on textbook fundamentals. One reason why is that the data sometimes creates at least a psychological draw to certain prices that can be almost self-fulfilling. Like a huge magnet waved over a pile of iron filings, a widely watched chart point can cause all the action in the market to magically rise up and clump to it—in spite of anything else that may be going on at the same time. It can also serve as a sort of energizing force that draws out a range of operators looking to aggressively tap into the pent-up energy. Consequently, this can trigger a frenzied round of buying and selling when certain targets are breached.

For example, if over the course of two weeks a stock has twice sold off after rallying to $60, and once again approaches that point, several things may happen. Some short-term players may take the view that “resistance”[6] will remain intact, and they will look to liquidate longs or set shorts at or near those levels. They will, however, be quick to reverse course if the trades do not immediately work out. Others may decide in advance to buy any “breakout” above that price, speculating that temporary momentum will likely drive the security much higher still. Some who are already betting against a rise will get set to cover their positions if the shares rally any further. To cut their losses, they will transmit market, limit, or “buy-stop” orders, with the latter often placed just above the last notable high. A few holders may leave offers in the market, but will look to cancel them at a moment’s notice. Others will sit tight, hoping that this time the shares will finally be off to the races.

Then, especially in the case of a widely followed issue where there has been a large build-up of speculative interest with numerous stops in place, an aggressive operator may try to get something going by forcefully buying shares in an attempt to drive prices above the $60 level. Once that starts—if the initial read of the market is correct—it will likely set off a chain reaction from short-term traders and tape-watchers[7] that will aggravate a temporary supply-and-demand imbalance. Consequently, prices will shoot higher, creating a self-feeding surge that drags the crowd along like a torrent of water rushing through the crumbling wall of a broken dam. Although such efforts do not always work out as planned, the widespread interest in technical analysis[8] has, ironically enough, given many speculators a sort of roadmap, guiding them to stress points where action will most likely be found. Not surprisingly, such moves can create a short-term blast that burns those who are not fast on their feet.

Action Point

Stop-losses offer a useful means of dealing with the uncertainties and risks associated with virtually all investment decisions. Yet, as with many longstanding share-trading tactics, they have limitations that have become especially pronounced in recent years. For one thing, they should be viewed as a potential form of protection, not as an absolute method of avoiding losses. For another, setting the appropriate levels is an art, not a science. Indeed, there is a real risk that investors may occasionally get “stopped out” at the very point at which a market is poised to reverse in their favor, especially given the approaches employed by today’s aggressive operators. Nevertheless, one important rule to follow is: once a stop is in place, avoid the natural temptation to cancel it if the price of the security nears the chosen level. Unless a truly valid reason can be found to justify the action, it can often turn a small loss into a financial black hole.

Gaps in available liquidity and unsettled conditions since the Bubble burst have induced more than a few participants to latch on to mechanical methods and relatively simple, almost instinctual, approaches to playing the market. Even many traditional long-term investors have found it hard to rely on a densely constructed fundamental outlook, because increased volatility, unusual macroeconomic circumstances, and a rise in random geopolitical disruptions are difficult to factor into forecasts. It is also tougher to develop concrete views based on a variety of shaky expectations. In fact, this pall of uncertainty forms part of a broader sense of worry and doubt that has seeped into the investing landscape since the spring of 2000. Not surprisingly, it has created an environment where investors are frequently on edge, and where there is considerably more anxiety influencing behavior than there was during the go-go days. One result of all of this is that participants are often quite jumpy and quick to react to even the threat of danger by relying on reflexes and practiced routines.

In the modern environment, market operators seem to be insecure about many things. For a start, they are not only nervous about the big picture going forward, but about personal financial circumstances as well. Even when participants were rattled by the failure of Long Term Capital Management in 1998, the 1997–1998 Asian Economic Crisis, and the 1994–1995 Mexican Crisis, the collective spirit, while unsettled and downbeat, seemed to be somewhat reassured by the fact that the global economic engine still had a bit of “oomph” to it and that authorities gave the appearance, at least, of being on top of things. In recent years, though, the backstop of hopefulness has diminished to some extent. Despite huge amounts of fiscal and monetary stimuli, conditions have yet to fully return to the lofty levels seen when equities were flying high. Indeed, the mood occasionally seems like that experienced by a lottery winner who somehow loses the ticket—once euphoric, now somber and easily rattled.

A continuing sluggish international economy and increased competition at every level have also stirred anxiety in countless employees, both inside and outside of the investing arena. Many are worried that other countries or companies will continue to siphon away jobs, or force their own firms to economize by firing staff or even by shutting down completely. Aside from that, in the financial markets in particular, there is an incessant fear that only certain operators really know what is going on and will ruthlessly exploit that knowledge. Even those who are intelligent and street-smart in their own right, who focus on specialized areas where they seem to have an edge, feel threatened when prospective rivals even glance their way. What is more, market-moving events that occur outside of their own immediate areas of interest sometimes stir worries that there are forces at work that might suddenly ruin their bread-and-butter investing strategies.

Indeed, it is safe to say that no small number of institutional operators worry about underperformance and failure—and not just from the point of view of their backers or underlying investors either. The financial services industry has been wracked by thousands of layoffs since the 1990s ended, and even the boom in the alternative investment sector seems to have slowed down somewhat following the hectic pace that occurred in the wake of the post-2000 stock market collapse. Although brokers, traders, and investment managers have always known they are employed in a cyclical industry, traditionally subject to great waves of hiring and firing, it seems that for some remaining employees there is—probably justifiably so—a sense that a sudden job loss at this point in time will likely lead to a forced career change, along with all the personal disruption that entails.

There is another, more depressing side to the prospect of investment losses and lagging returns. Financial services industry professionals share with most other Americans of working age nagging concerns about whether they will have enough money to live on when old age sets in. With short- and long-term interest rates having reached historically low levels in recent years, the macroeconomic and market outlook still largely unsettled, and the underfunded social security system likely to be a drag on growth going forward, the prospect of generating the sort of outsized returns that can build healthy retirement nest eggs seems somewhat remote—despite occasional bouts of market euphoria. True, history suggests that when times seem bleakest, the investment opportunities are often the greatest, but some would argue that the paralyzing fear and widespread revulsion for equities that typically accompanies a long-term bottom—a necessary precursor to a major wealth building rally—has yet to be seen. Whatever the case, the emotional fallout from the dramatic boom-and-bust does not appear to have fully played out yet, and money worries continue to have a strong influence.

All of these factors have instilled in a cross-section of market participants a general sense of insecurity that has had a very peculiar effect. Indeed, the contrasts are striking. On the one hand, many players have not fully abandoned riskier pursuits despite the new uncertainties. They have, in fact, moved towards a more speculative approach and are more willing to employ aggressive tactics such as leverage on a regular basis—as Figure 3.2 seems to indicate. They are also becoming increasingly involved with a host of volatile instruments and complex strategies of the kind that offer more bang for the buck—but more reasons to duck. Others have decided to focus almost exclusively on short-term trading, shedding any pretense that they are in it for the long haul. Admittedly, such strategies do have an appeal in the sense that there is less exposure to overnight uncertainty and the problems of a world filled with random disruptions. Nonetheless, most require specialized skill sets that many people simply do not have.

Figure 3.2. NASD Margin Buying as a Percentage of NASDAQ Volume: Ratio of Balances in Clearing Firm Customers’ Cash and Margin Accounts to Dollar Traded Volume (Source: The NASDAQ Stock Market, Inc.).

On the other hand, countless traders are more concerned than ever with losing money, which is causing them to rely on tactical measures, such as stop-losses and itchy trigger-fingers, that are supposed to take them out of losing positions before too much damage is done. Unfortunately, the problem for individuals who trade—as opposed to invest—is that their emotional state is often a significant factor in their success. Nowadays, that frame of mind is likely to be one of nervousness and confusion. What is more, regardless of what mechanisms are in place, losses are the usual result for those who operate from a position of weakness, with insufficient resources at their disposal to cushion the inevitable setbacks. In the modern era, it seems that many players are like desperate bettors wagering their last few chips at the casino—inevitably left with nothing in their pockets and no way to get home. These two somewhat contrasting perspectives—the urge for fast cash and the fear of losses—have fostered an anxiety-ridden approach based on quick moves in—and even quicker ones out.

Action Point

Although it is usually not the best course of action for most investors and can potentially lead to substantial financial and emotional pain, once individuals have decided to engage in short-term trading, it is crucial that they avoid some of the basic pitfalls. More often than not, a failure to pay heed to the essential rules of speculation will lead to a very unhappy ending. Perhaps the most important are the same warnings given to gamblers on their way to Las Vegas: Do not bet more than you can afford; avoid putting all your eggs in one basket; shoot for the consistent percentages rather than the big score; employ only a limited portion of your capital at any one time; and bet with your head, not your heart. At the very least, these words of wisdom may prevent you from being knocked out of the game before it really even gets started.

As with speculation in general, the downside of this money-making strategy is that not many people have the self-restraint, opportunistic flexibility, self awareness, and hard-knocks experience to weather what can be an extreme roller coaster ride. In addition, even though there seems to be more individuals moving in that direction, modern conditions make high-turnover methods much tougher to work with than they used to be. The pace of the markets has accelerated, and information flows have occasionally become disjointed. Often market participants have little opportunity to really get to the bottom of what is going on and must operate by the seat of their pants instead—clearly not the best way to make significant financial decisions. Under current circumstances, there is rarely enough time to adequately digest new developments because of the lag between when high-impact headlines hit the tape and when the full details are eventually released.

Informal communications are also short and frequently ambiguous in the Information Age. Although most people do not pay by the word to transmit electronic messages, they often act as though they do. In the financial markets, even important details are occasionally sacrificed at the altar of brevity. More often than not, the goal is simply to get something out—orally or in writing—before anyone else. Much like hard-nosed reporters rushing to scoop the competition in order to bolster their reputations, market participants, especially those who interact most closely with active traders and hedge funds, often feel compelled to do the same. They press ahead as if they might live or die by the speed with which they can keep their contacts informed. Sometimes it even seems like a game, as a desk full of salespeople find themselves hunched over keyboards rapidly tapping out the latest updates—often with two fingers—as they look to score points against various rivals.

The other great risk of modern methods is the ease with which errors and omissions can slip by, especially in the heat of a volatile market moment. Mirroring the decline in standards in the population at large, writing skills have been deteriorating for years. Spelling and grammar do not seem to matter much anymore, while the urge to carefully review one’s thoughts has largely fallen by the wayside for most routine communications. The financial markets have always favored very short sentences, of course, because prices can whip around in the time it can take to grind out a long request. Indeed, nearly everyone who operates in this environment understands the limited vocabulary of dealing and the invariably negative consequences of sloppy language. To outside observers, trading interactions can sometimes sound like nothing more than a series of grunts and syllables, which might go something like this:


“20 for 14, 3 at 24.”

“Hit it.

“12 Done. Offered at 11.”

“8 low.”


Generally speaking, this conversation will leave little room for doubt in the minds of most experienced U.S. stock market operators.[9]

The same cannot be said, however, for many other exchanges that are now taking place during trading hours, especially those typed out on a keyboard, because much of the editing and altering that does take place is not standardized. Some operators are choosing to write messages using capital letters, while others prefer lowercase. Periods and commas are frequently omitted, as are transition and linking words that can make rapid scanning easier for the reader. Space constraints also play a part. Reporters, editors, analysts, traders, and others are often hemmed in by the length or width of a scrolling ticker, newswire line, broadcast slot, or electronic message, at least in terms of the most relevant points. Unlike oral or handwritten communications, it is difficult to squeeze extra characters through a fixed-length window.

The methods for handling the problem can vary significantly. Sometimes writers economize by leaving out words or by substituting others that do not quite fit in terms of meaning. They may abbreviate terms in a confusing way or fail to highlight a shortened version with the necessary punctuation. Occasionally, acronyms that have more than one meaning are used, and it might not immediately be clear which one is being referred to until more of the accompanying detail is read and digested. Once in a while, they leave out quotation marks as well, which can create major confusion about the actual source of a report. In the case of a few messaging systems—such as that offered by Bloomberg—the standard page size used for subscriber-to-subscriber transmissions does not leave a lot of room for details. What happens then is that participants either cram as much as they can onto the allotted space, making it difficult to quickly glance through the text, or they cut out what they believe is unimportant—and occasionally get it wrong.

While the quality and depth of the information flowing around leaves something to be desired, the speed and volume of data causes problems in its own right. When the action heats up in dealing rooms or on the trading floor, communications networks get hit with large amounts of voice and data traffic that can be overwhelming. With volatile price action, flashing quotes and indicators, shouts and squawks, constantly ringing telephones, and considerable time pressure, things sometimes go wrong. Salespeople may misunderstand a report, traders may get an instruction wrong, fund managers may overreact to a news headline, and everyone may feel—temporarily at least—that they would rather be somewhere else. Nonstop action can boost energy levels and make the day go by quickly, but too much of a buzz can be exhausting and unsettling. Throw a few cups of coffee into the mix, and pretty soon people are bouncing off the walls and their typing fingers get extremely twitchy.

Action Point

Because the act of buying and selling securities can seem so straightforward on the surface, especially with all the point-and-click systems that are available, it is easy to fall into the trap of thinking that physical and emotional well-being do not necessarily have any impact on performance. However, experience suggests it is almost always better for investors to walk away than to step into the mix when distractions such as exhaustion or illness might force them to take their eyes off the investment ball. It also makes sense to be aware of the impact that the modern stock market environment can have on one’s state of mind. The pulse of technology and the rhythmic hum as flickering data flashes by can be mesmerizing and almost hypnotic, leading to actions and words that are not necessarily well thought out—and potentially dangerous to the bottom line.

The result is that market participants are often primed to react quickly to anything that comes their way. What makes it worse is that even when individuals are criticized over an erroneous call or are ridiculed because of a poor off-the-cuff interpretation of developing circumstances, they risk either being marginalized in the eyes of clients or colleagues or losing out on profitable investment opportunities if they do not continue to let contacts know what they believe is taking place as soon as new information comes their way. When market-moving developments unfold in the current environment, those who are plugged in and at the center of the action are the ones most likely to benefit—in terms of gains realized or losses avoided. Simply put, many have adopted the battle cry of the Wild West: You are either quick, or you are dead. For most participants, the choice appears to be relatively straightforward. In reality, it tends to pump up the irrational volume.

Unfamiliar geopolitical developments have also played a part in making people anxious and emotional. While a variety of wars, natural calamities, and one-off shocks have affected markets throughout the ages, it often seemed that once the initial reaction wore off, there was invariably some quick rebound towards relative normality. Indeed, despite the frequency of upheavals over time, humanity has usually managed to roll with the punches and bounce back. Events since September 11, 2001, have struck a strange chord in many people, however. The icy randomness of terrorism—in terms of time, place, and the scale of the damage done—as well as the incomprehensible willingness of individuals to sacrifice themselves and others for a cause few in the West understand, has shaken traditional perspectives. In many cases, Americans do not really know where they stand. For some, it is hard to return to normal when no one is quite sure what that term means anymore.

Consequently, there appears to be more of a structural insecurity affecting the U.S. financial markets now, one that echoes with every strange noise, every unusual act, and every odd movement. When traders hear reports of an unidentified explosion in the center of a large metropolitan area, their initial reaction is to try and sell shares. Never mind that it might be an accident, that the incident in question might be confined to one small area or building, or even that it might have nothing at all to do with the securities actually being dumped onto the market. What matters most is that the news might signal the start of something bigger and more ominous. It reflects a generalized fear of a dark and scary unknown, a chaotic force few have reckoned with in their lifetimes. Under those circumstances, it seems that many operators take the view that it is better to act quickly in the hope of saving a lot than to act slowly to avoid losing a little.

The combined power of two modern developments is probably amplifying these worries. To begin with, one of the many benefits improved technology and communications networks have given market participants is a sense of independence and flexibility. Traders and investors no longer need to gather in one location or rely on large-scale intermediaries and single points of contact to get their business done. There are various interactive systems and electronic pathways in place that allow players to be based nearly anywhere and trade nearly everything without needing to have anybody else around. In fact, the current investing framework is well suited to an era where email is gradually replacing “snail mail” and instant messaging programs are gaining ground on the telephone. As anyone who lives or works with the younger generation can attest, it has gotten to the point where individuals will sometimes forego a chat across the room in favor of communicating by IM instead.

The trend towards disintermediation—the gradual whittling away of middlemen—in the financial services industry is also playing a part in minimizing personal contact with others. With the widespread use of electronic trade routing, direct access dealing systems, and ECNs, there are now a smaller number of links between those who have the orders and the locations where the actual trading takes place. True, like an iceberg floating on the high seas, there is often much below the surface that conceals the full extent of the dealing structure that exists. Nonetheless, the reality is that technology makes it easier and seemingly more desirable to cut out much of the human interaction that was a necessary evil of the way things used to work. By eliminating extra steps and minimizing the natural dawdling associated with personal conversations, market participants can presumably focus more time and effort on making money—bolstering demand, as Figure 3.3 suggests, for an assortment of modern day trading tools.

Figure 3.3. New York Stock Exchange Market Data Devices (Source: New York Stock Exchange).

This efficiency and relative isolation has a downside, though. As in the real world, where many people have migrated away from frequent socializing with others in favor of communicating through electronic methods, the switch from voice to data sometimes causes interactions to be more formal and less open. This appears to reduce the natural bonding associated with oral communication and physical proximity that can often lead to interesting insights and synergies. What is more, human ties, even incidental ones, frequently provide a calming influence and a useful emotional outlet when things are not going well. Sure, typewritten messages can be funny, sad, upbeat, or interesting, but they do not seem to offer enough of the emotional “glue” that enriches human relationships and makes people stronger, especially in the face of uncertainty and turmoil. As a result, while it is now a relative breeze to get on with wheeling-and-dealing, the emotional consequences may be somewhat more negative than people realize.

Industry trends clearly add to the skittishness and insecurity that many professionals face. Various operators have crammed into the marketplace, driving down commission rates, depressing compensation arrangements, and pressuring returns as strategies get overcrowded with too many individuals doing the same thing. Frequently, this creates a shaky supply-and-demand position that can cause a rapid rush for the exits if conditions suddenly change. It can go the other way as well. Sometimes the stampede is not caused by players trying to get out of a position, but by the widespread desire to get in. Whatever the case, in their haste to be a step ahead of the crowd, players sometimes imitate the actions of drag-racers. They rev their engines hard as they anticipate the moment when the run of flashing red and yellow lights will suddenly turn to green. Then, they put the pedal to the floor, hoping that they will be first off the mark—and will not have a false start.

Finally, as with the proverbial chicken crossing the road, one of the reasons players seem quick to trade is because they can. Despite the fact that even a few seconds of thoughtful analysis could provide a more intelligent outlook and a basis for better investment decision-making, the modern day quest for action is difficult to overcome when all it takes is a touch, click, or peck. With the convenience technology has to offer, it appears so easy to sit back and flick a switch or push a button to make things happen. Like playing with the television remote, flicking between channels and never really settling in any one place, jobbing in and out of the markets can seem like an amusing way to while away the time. Unfortunately, this feeling of electronic command and control can sometimes stoke the costly illusion that success can be achieved with relatively little effort. In reality, however, nonstop trading and the urge to act on irrational impulses can be a financially precarious waste of time.

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