In a word, trading is really hard. Markets are extremely competitive, attracting some of the smartest individuals globally, all eager to get rich. Massive hedge funds are established to leverage the talents of these intelligent traders. Not only are they likely smarter than you, but they also have access to more money, information, and technology. This makes them formidable opponents.
However, the world is filled with millionaire traders who possess average intelligence. So, what’s the secret?
Many new traders enter the stock market with preconceived notions about its workings. They often believe that successful trading hinges on predicting earnings numbers, identifying the perfect technical patterns, or being the best analyst. In essence, they view trading as a grand game of chess with fixed rules.
One of the most significant distinctions between successful and unsuccessful traders is understanding the “metagame” of market trading. While strategy development, risk management, and other fundamental concepts are crucial, mainstream trading literature often overlooks three essential factors that we will explore in this article.
If you’ve ever suspected that markets are more complex than merely predicting numbers and identifying trading patterns, you’ll appreciate these three concepts that many new traders fail to grasp.
Mastering most skills is straightforward (though not necessarily easy).
For instance, learning guitar begins with plucking the strings correctly, then understanding the fretboard. Soon, you’re learning chords and playing songs, followed by soloing and lead guitar work. With each hour of practice, you can feel your improvement, and progress is relatively linear. Learning guitar, like many skills, operates within a structured environment where predictable patterns exist, and feedback is immediate.
Trading, however, is different. There are no hard and fast rules, and even when rules exist, following them can still lead to negative outcomes.
Imagine you devise a trading strategy based on selling VIX futures after a significant spike in volatility. After thorough backtesting, you conclude it’s a highly profitable strategy. You’re ready to dive in and start trading.
But your first trade backfires. So do the second and third.
You followed all the right steps in your strategy development, avoided common pitfalls during backtesting, and even conducted forward tests. Yet, the market punishes you. You might feel tempted to return to the drawing board, but that could be a mistake.
The market is a challenging learning environment filled with randomness and unpredictability. Experience, education, and practice do not always translate into improvement.
The “rules” of the market are dynamic and ever-changing.
Markets operate as a player versus player experience.
You’re competing against everyone else aiming to profit in the markets. In every trade, there’s a winner and a loser. For you to win, someone else must lose.
Your competition includes some of the brightest minds globally, with massive hedge funds dedicated to leveraging their talents. They not only possess superior intelligence but also have access to more resources than you. This makes them formidable adversaries.
Just when you think you’ve deciphered the strategies of the best players, the metagame shifts, much like in competitive video games such as Counter-Strike or DOTA.
Some successful traders attempt to compete head-to-head with large hedge funds using similar strategies, though many fail. However, others carve out their niches by playing an entirely different game. For instance, when high-frequency trading (HFT) firms began to dominate scalping, the best scalpers adapted by extending their holding periods and adjusting key factors while maintaining similar concepts.
The stock market is a beauty contest, but not in the way you might think.
John Maynard Keynes, the renowned economist, introduced the concept of the Keynesian Beauty Contest. He explained that traders and investors choose stocks based on what they believe others find valuable, rather than their own assessment of a stock’s worth.
The dotcom bubble of the 1990s serves as a prime example. Many savvy traders profited by buying stocks like Pets.com at inflated valuations, recognizing that most investors were eager for internet stocks and would buy nearly anything. For many, it wasn’t about the soundness of Pets.com or Webvan’s business models; it was about capitalizing on the irrational behavior of investors.
You can observe the Keynesian Beauty Contest by tuning into CNBC, where anchors frequently focus on “market reactions” to news and events rather than the events’ intrinsic value. This is what truly drives the markets.
