One of my pet peeves about trading is how the general trading population can only think in terms of “up or down.” As a result, people tend to under-appreciate market commentary that is not related to correctly predicting/forecasting/guessing “up or down.” I wanted to discuss the various forms of analysis that you can make use of:
- Correct directional analysis. This is unquestionably useful when correct, but very few people are right significantly more than about 55-60% of the time. Very few. If you take a longer time horizon, that number could be higher. But it would be unrealistic to think a directional trader would be right that much more frequently. So what people spend the most time looking for is something that is just a little better than a guess. You can see this when looking at “expert” analysis – most of the time, you have a bunch of experts saying something will go up and a bunch of experts looking at the exact same environment saying that same thing will go down. And interestingly, if too many of the “experts” agreed that something is going to go down, it is probably more likely to go up. So don’t look for people who are “right” – look for people who make sense to you. Because at the end of the day, the most important “expert” has to be you. Otherwise, you should not be actively trading. But even still, directional trading is not going to be very high probability.
- Incorrect directional analysis. What is more valuable, someone who is right 55% of the time, or wrong 60% of the time? The problem is, you probably don’t have enough of a sample to know which is which. I’m not saying to go look for people who are consistently wrong – I’m just trying to get you to expand your mind on what useful commentary is. Sometimes, listening to someone you disagree with can help you strengthen your view on something much more than listening to someone you agree with. That is useful.
- Analysis that shows that something can NOT move much in one direction. Over a decade ago, a colleague really liked buying corn when it was under $2. The logic was basically that it “couldn’t” go down much more. If it did, it became a more viable energy alternative. It just sat around $2 a bushel for a number of years and then in about 18 months shot up to $7. Another example would be last year, where rates were very low but the Fed seemed reluctant to go to negative rates from the zero lower bound. EuroDollar calendar year spreads that were 10bps are now over 50bps. Don’t just think about where a trading structure CAN go. Also think about where something CAN’T go.
- Analysis that shows a trading structure will trade in a tight range. My head wants to explode when I hear “That structure has been in a tight trading range for a long time. You can’t make any money off of that.” So some trade is structurally rangebound – chops around in a predictable range – and you don’t know how to make money on that? Really?!? Depending on the nature of the trade, these types of structures can be high probability, more frequent, and more stable, which leads to a valuable longer-term P&L cushion. The key is choosing the right types of structure and correctly assessing the conditions required for an eventual breakout. Don’t dismiss a structure that barely moves – many times, it can have a significantly higher expected value than a directional trade that can move much more.
Get out of your habit of only looking for “correct up/down” analysis. There are many other useful forms of information and analysis out there. What you should be looking for are any analyses that get you to form a strong tradeable opinion about the potential direction and range of any trade. You should be able to make money if something goes up, down, or stays the same.