the Market Truth

The ability to make consistent money in the markets hinges on one's ability to find a consistent edge - in other words, a reason for the market to pay you for your trading activities. Simply put, strict money management and a mechanical approach to following one's "signals" is not sufficient, and only a small part of the puzzle. As a result, many aspiring market participants fall into the trap that is the illusion that one can predict the future direction of an asset.

Those market participants that come to rely on technical and/or fundamental analysis of a company's stock justify their methods with a the very shaky idea that understanding the past dynamics of a company and it's stock will help one anticipate future movement. The belief that tomorrow's risks can be inferred from yesterday's prices and volatilities has prevailed at virtually every investment bank and trading desk. Modern finance's approach to mitigating risk by preparing for scenarios experienced in the past is simply an extension of the folly perpetrated by the common trader who feels that he/she can predict a future movement based on the theory that "history repeats itself", as Mark Twain said quite well, history does not repeat, it rhymes. With a countless number of market factors changing every instant, one can not rely on the market's past reactions to similar situations as any kind of useful indicator of future direction.

So if one can conclude that predicting future direction is not a reliable method to extract profits from a market, the question arises as to whether it is possible and if so what one should do. What many simply don't realize is that the correct approach to trading is one where the market pays the trader for a service. This service can take the form of many actions undertaken by the trader to the benefit of the market, many taking the form of various "levels" of arbitrage. The idea is that profit potential exists where markets lack efficiency. This can range from the extremely simple true riskless of arbitrage between two fungible securities - such as by buying identical shares on one exchange and selling them on another when a divergence exists - to the complex problem of pricing volatility in warrant and options markets.

The analysis a real trader must go through is the many times daunting task of uncovering inefficiency in a market and then devising a method in order to eliminate it - thereby earning a profit. This is complicated by the fact that many other intelligent traders are competing for the same opportunity, usually resulting in the quick elimination of the truly low/no risk opportunities. In future writings, I hope to go more into more depth on past, current, and future opportunities presented by our financial markets and how to approach them.