Improving your trading/investment skill: Make a two-sided market!

Attention:  Your opinion is your biggest mistake!

When I started in the investment business I knew a lot about the economy, politics, and quantitative analysis.  That is why I was hired by a firm that had an all-star cast of traders.

My first lesson was about what I did not know.

The owner of the company, and the leader of many traders of exceptional skill, is a real genius in options trading.  He understood complex relationships in the options market before the computers provided a guideline of "theoretical values."

The computers caught up with the edge we had in the old days, but there is still an important lesson.

Make a two-sided market!

This means that you must think about both sides of a trade.  When a rookie trader expressed an opinion about a stock, our leader would immediately challenge with the other side.  What would make you sell?  Where would you buy?

He was teaching a key skill.  I learned it, but it is difficult to grasp.   Most people do not understand, and probably never will.  If they like a company and the stock, the price does not matter.

The Football Analogy

I enjoyed this article about the comparison between trading and NFL gambling (HT Abnormal Returns).  Investing is not like gambling, but there are important comparisons.  Investors enjoy a significant long-term advantage. Gamblers have negative edge, whether they realize it or not.

With this background in mind, please join me in taking a closer look at the lesson.

Tonight's football game is a great contest between a strong San Diego team and an aspiring Kansas City team that got off to a slow start.  KC is a tough place to play.  My newspaper reports that SD is a three-point favorite.

Most "investors" in the football market form an opinion about who will win.  Their analysis ends there.

Suppose you like the SD chances.  Back in the day, as a member of our trading group, our leader would challenge you.  How many points would you lay?  6?  7?  7 1/2?  Eventually the trader would realize that there was a limit to his opinion.  You can imagine the opposite for the KC loyalists.

The question was what bet you would make within the group.

The Conclusion

The football lesson is obvious.  At some point spread you should take KC.  At another you should take SD.  At the time I am writing this, the game is still in doubt.  I do not know what will happen, and I have no opinion.

It is a nice illustration for the market.

Whether you are a trader or an investor you should have a buy and sell price for everything in your portfolio.

 If you do not have a two-sided market, you need to reconsider your approach.  I have a price target on every stock in my portfolio — and you should, too.