“[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)

UMV101: Seeing Both Sides of a Trade (Updated 04/30/2007 12:14:11 PM )

Introduction

Buyers of securities usually think prices will increase. However, buyers purchase from sellers who likely think prices will decrease.  Same transaction, two competing viewpoints.  Regardless of your position, you're better off understanding what the other side of the trade is thinking.  Developing such balanced perspective is central to effective financial market thought process.

Effective market participants can see both sides of a trade.

Markets, Bulls, and Bears

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

Why do buyers buy and sellers sell?  Generally speaking, buyers purchase an asset because they think its value will increase.  This optimistic perspective is often referred to as being bullish.  Conversely, individuals sell an asset because they think its value will decrease.  This pessimistic perspective is often referred to as being bearish.

It is important to realize that bullish and bearish perspectives necessarily coexist in financial markets.  After all, a buyer (bull) purchases an asset from a seller (bear), and vice versa.  For a transaction to occur, someone must be sufficiently bullish while someone else must be sufficiently bearish.  Studies of successful financial professionals suggest that they often possess superb capacity for grasping competing market perspectives and for applying them towards investment and risk management strategies (e.g., Schwager, 1989; Soros, 1987; Steinhardt, 1998).

Minyanville's Critters

Minyanville founder and CEO Todd Harrison created a group of animated critters to help identify and express the perspectives of buyers and sellers.  Hoofy is the resident bull of Minyanville--the optimist who sees the glass as half full.  Boo is Minyanville's resident bear--the pessimist who sees the glass as half empty.  Together, Hoofy and Boo symbolize the balanced perspective that Minyanville seeks to provide.  

Todd and other Minyanville professors frequently integrate Hoofy and Boo into their commentary (here, here, here, here).  By asking questions such as What would Hoofy and Boo think about this particular situation? the professors are more apt to consider viewpoints of both buyers and sellers when assessing market environments and making financial decisions.  Use of such 'metaphorical imagery' and associated storytelling can increase rates of knowledge transfer in experiential learning environments (Swap et al., 2001)--particularly for online learning venues (Chen & Wells, 1999; Wolfe, 2001).  Financial website commentary that contains metaphorical imagery likely helps learners develop market awareness (Ford, 2006; Ford, Kent & Devoto, 2007).

Minyanville's critters, therefore, are meant to help develop balanced perspective--a necessary factor for effectively navigating financial markets over time.  At Minyanville, this is commonly referred to as seeing both sides of the trade.  

Application...

Lets try our hands at seeing both sides of the trade.  The time frame is early January, 2007.  There has been strong uptrend in prices since last summer (see chart below), with the major stock market indices close to or at historical highs.  Some respected professionals think markets can still move higher.  Plus, a weak dollar may put a bid under stocks.  Recently, buying of stock market futures has been unusually strong (here, here).  Who knows?  With central banks indicating that they to rotate more than $4 trillion of currency reserves into equities, perhaps it's the Fed or other central banks buyin' 'em!  

On the other hand, some sense that the positive tone in the market is diminishing from a technical standpoint.  Commodities have fallen sharply, and some wonder whether that is a precedent of lower stock prices.  From a seasonal standpoint, January often includes significant stock price declines.  Structural issues related to option selling behavior have compressed volatility to levels where large movements are possible.  

Chart courtesy of StockCharts.com  

Table 1 summarizes these perspectives:

Table 1:  Example of Seeing Both Sides of a Trade

By the time you're reading this, you'll be able to see how this scenario turned out.  Did Hoofy or Boo's view prevail?

Balanced Perspective

Hopefully you can appreciate the merits of this approach.  Whenever buyers and sellers meet in a market, there is always a 'bullish' and 'bearish' case.  Before slapping on risk in either direction, smart market participants want to see the other side's viewpoint.

References

Chen, Q. & Wells, W.D. (1999). Attitude toward the site. Journal of Advertising Research, 39(5), 27-37.

Ford, M.W. (2006). Outside the lines: Exploring student use of web-based vicarious learning about financial markets. Journal of Business and Leadership, 2(2): 325-333.

Ford, M.W., Kent, D.W. & Devoto, S. (2007). Learning from the pros: Influence of web-based expert commentary on vicarious learning about financial markets. Decision Sciences Journal of Innovative Education, 5(1): 43-63.

Schwager, J.D. (1989). Market wizards. New York: Harper Collins.

Soros, G. (1987). The alchemy of finance: Reading the mind of the market. New York: Simon & Schuster.

Steinhardt, M. (2001). No bull: My life in and out of the markets. New York: Wiley.

Swap, W., Leonard, D., Shields, M., & Abrams, L. (2001). Using mentoring and storytelling to transfer knowledge in the workplace. Journal of Management Information Systems, 18(1), 95-114.

Wolfe, C.R. (2001). Plant a tree in cyberspace: Metaphor and analogy as design elements in web-based learning environments. Cyberpsychology and Behavior, 4(1), 67-75.

Quick Quiz (see bottom for answers)

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

1. true
2. false

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

1. bullish
2. bearish
3. snake-ish
4. objective

101.3) The resident bear of Minyanville is known as

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

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

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

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

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

101.6) Match each critter with the most appropriate viewpoint.

101.7) When market participants are bullish, they tend to want to ____; when market participants are bearish, they tend to want to ____.

1. do nothing, sell
2. buy, do nothing
3. buy, sell
4. sell, buy

101.8) Janet has read some positive commentary about Bank of America (BAC) and is considering buying stock in the company.  To obtain a more balanced perspective, which of the following might be worthwhile before she buys her shares?

1. Locate research reports with a negative opinion on BAC and understand why those analysts don't like the stock.
2. Call BAC's investor relations department and get their opinion on the stock.
3. List potential reasons for what could go wrong with an investment in BAC.
4. Both a and c should help provide more balanced perspective.

101.9) Last weekend you were enjoying a meal at Chipotle Mexican Grill and your friend mentioned that Chipotle is a publicly traded company (symbol CMG).  Interesting, you thought.  Good food, good crowds, plus you go there a lot.  How should you follow up?  If you seek balanced perspective, rank the actions below from most intelligent to least intelligent follow-up.

1. Visit a number of Chipotle stores and see if the food and crowds are consistently good.
2. Immediately buy some CMG shares.
3. Seek out opinions of those who don't like the stock.

101.10) While watching the news last night, you heard a well known economist claim that interest rates are about to drop.  You should

1. seek plausible rationale for why interest rates should not decline.
2. buy some bonds, since bonds generally do well in declining interest rate environments.
3. start shopping for a new car, since your monthly payments will be lower as interest rates come down.
4. believe him.  After all, the guy is an expert.

Answers: 101.1) a 101.2) a 101.3) b 101.4) d 101.5) a 101.6) Hoofy b, Boo a, Sammy c 101.7) c 101.8) d 101.9) c,a,b 101.10) a

Copyright© 1999-2009 Matthew W. Ford.