Lesson 2: Seeing All Sides of a Trade (Updated 11/08/2005 06:27:38 PM )

“[The Navy] gave me my command, a checklist, a target, and a button to push.  All I had to know was how to push it, and they’d tell me when.  They seem to want you to know why.”

--Captain Frank Ramsey (Crimson Tide)

Objective

To improve your awareness that, in any market, there is rationale for prices going up, prices going down, and prices going 'sideways.'  A wise market participant 'sees' all of these perspectives before initiating risk.

Terminology: Markets, Bulls, and Bears

Like any market, financial markets are places where buyers and sellers meet.  These buyers and sellers may be trading stocks, bonds, real estate, commodities, currencies, or other financial assets.

Why do buyers buy and sellers sell?  Simply speaking, buyers buy an asset because they think it will increase in price.  This optimistic perspective is often referred to as being bullish.  Conversely, sellers sell an asset because they think it will decrease in price.  This pessimistic perspective is often referred to as being bearish.

To make sense of financial markets, it's important to realize that bullish and bearish perspectives necessarily coexist in a market.  After all, a buyer (bull) purchases an asset from a seller (bear), and vice versa.  For a transaction to occur, someone must be bullish and the other must be bearish.  Follow?  Now lets head to Minyanville to observe how experts apply this axiom.

Critter World

Prior to the the U.S. equities (equities = stocks) market opening bell (9:30 am Eastern time), Todd Harrison usually posts a morning missive that frames the financial market environment as he sees it.  Please read these recent examples of Toddo's morning missive: example 1, example 2, example 3.

It should be apparent that central to Todd's assessment of the financial market environment is his ongoing conversation with Hoofy, Boo, and other critters.  Drawing from the Minyanville Dictionary, let's meet the critters:

Hoofy (the bull): the resident bull of Minyanville.  The optimist with the 'glass half full' view.

Boo (the bear): the resident bear of Minyanville.  The pessimist with the 'glass half empty' view.

Sammy (the snake): represents tendency for a sideways, slithery market.

Snapper (the turtle): represents tendency for sudden, rapid increases in prices (a.k.a. 'snapback rally')

Daisy (the cow): represents the need for reason, balance, and keeping emotions in check when developing a market viewpoint.

Quick side note: although not an official 'critter', who is Elmer? (betcha can't guess how he got this moniker)

Todd and the other Minyanville professors frequently evoke the critter contingent when assessing market conditions and when making financial decisions.  Note, for example, that posts to the Buzz and Banter nearly always include a critter icon.  The animal icon often symbolizes the perspective of the post's (or the poster's) content.  

Note that seeking to understand the other side of the trade can sometimes lead to spirited debate as well!

Application...

Lets try our hands at seeing both sides of a trade.  First, read this piece by Brian Reynolds.  Then, read this Mailbag reply by Succo and Reamer.  Then, read this morning missive from Toddo.  Finally, this post by Jason Goepfert.

Charts courtesy of StockCharts.com  

I'm writing this on the evening of October 12, 2005.  Earlier today the S&P 500 Index (SPX) closed at 1178.  Two graphs of the SPX are shown above.  On the left is a 6 month daily chart of SPX prices; on the right is a 2+ year weekly chart of SPX prices.  (Note: these type of stock charts are called 'candlestick charts'.  We'll talk more about these later, but if you want more info on how to read candlestick charts, click here).  Stated another way, these charts are of the same thing (the SPX) but in two different time frames--shorter term on the left.

OK, so today's closing price was 1178.  You can be sure that tomorrow morning there will be plenty of bulls betting $billions that the SPX is going higher, and that there will be plenty of bears betting $billions that the SPX is going lower.  Using content from the Minyanville posts you've read above, and the from the above charts, let's build an argument for Hoofy and one for Boo.

Table 1:  Example of Seeing Both Sides of a Trade

We could likely add additional tidbits as well... 

Of course, by the time you're reading this, you'll be able to see how this scenario turned out.  Did Hoofs, Boo, or perhaps even Sammy prevail???

Hopefully you can see the power of this approach.  You might be a rip-snortin' bull on some stock or market, for example, but taking time out to view Boo's side of things is usually time well spent...

Quick Quiz (see bottom for answers)

2.1) Whenever buyers and sellers meet in a market, there is always a 'bullish' and 'bearish' case.

1. True
2. False

2.2) An optimistic perspective that views higher prices as likely is known as being

1. bullish
2. bearish
3. snakish
4. objective

2.3) The resident bear of Minyanville is known as

1. Hoofy
2. Boo
3. Sammy
4. Snapper
5. Daisy

2.4) High amounts of debt and leverage may saddle banks with excessive non-performing loans.  Such a claim, if true, supports a case for which critter?

1. Sammy
2. Snapper
3. Hoofy
4. Boo

2.5) Suppose that SPX prices fall for 6 consecutive sessions.  An analysis indicates that out of the last 10 times that a similar situation occured, the market was higher 5 trading days later by an average of 3.1%.  Such an arguments supports a case for which critter?

1. Hoofy
2. Boo
3. Sammy
4. Daisy

Answers: 2.1) a 2.2) a 2.3) b 2.4) d 2.5) a

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