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Posted 5/12/2000
Kenner & Niederhoffer
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5 rules to ace the market game
Are markets rational or a game of chance? These well-tested rules will help give you the winning edge to ensure your survival in these competitive times.
By Laurel Kenner and Victor Niederhoffer
"No victor depends on chance; instead, skill, science and study are the winning words."
-- Tom Wiswell, checkers and chess champion
Wall Street has long seemed to many new investors more like a chaotic game of chance than a rational business. And that is half true. It is a game, but it is not chaotic – there are rules, if only you know where to find them.
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In a moment we'll offer five of those rules for your consideration, but first let's take a look at the past week -- which looked like nothing so much as a chess match between bears and bulls well schooled in historically successful stratagems.
The adversaries adjourned for the week with the headline index -- the Dow Jones Industrials -- close to where it started. Yet the bears were wildly successful in their play on the Nasdaq ($COMPX), sending its composite index down 8% for the week despite decent recoveries on Thursday and Friday.
Care for a game-by-game highlight? It looked like this:
Monday: Bears went for the "Cisco can't continue its growth" gambit, ripped from the pages of the conservative financial weekly Barrons. The Dow was unchanged, but the Nasdaq was wounded for 2% and Cisco ended up down 7%.
Tuesday: Bears managed to open the day with the Nasdaq futures limit down, which has been an effective tactic over the past few months. Bull pulled this one out though, rallying 1% from lows to the close. Bears got an unexpected boost from Robert Parry, president of the Federal Reserve Bank of San Francisco. In a speech to financial planners in California, he said the Fed should proceed with caution on any more rate rises. That sounded like great news for the bulls. But in the Q&A session after the speech, he said he didn't see a 50-basis-point hike in the discount rate at Fed's policy meeting on Tuesday as being "inconsistent with caution." Perhaps Parry took a cell phone call from his boss in Washington between the two remarks. In any event, score another for the bears.
Kenner & Niederhoffer
Victor Niederhoffer has traded stocks, currencies and futures worldwide for the past 40 years; he is the author of "The Education of a Speculator." Laurel Kenner is a trader and former Bloomberg markets editor. In a special series of weekend columns for MoneyCentral, they'll assess the past week's Wall Street performance and next week's prospects. Let us know what you think in the Start Investing Community.
Wednesday: Bears crashed behind the bulls' offense on this day, hoping to break their will. They tore the Nasdaq down 6% after a seemingly strong earnings report from Cisco and a scare over an Intel (INTC, news, msgs) chip-production fiasco. The game was adjourned overnight with the bulls' forces crumblng. Bear requested the resignation of the bull after hours, as Applied Materials (AMAT, news, msgs) took a dive after another sterling earnings report. Many spectators left the game, apparently; Nasdaq volume fell 22%.
Thursday: The bulls are always the most dangerous when cornered. They used a weak retail sales report to mount a full frontal Thursday, and the game was joined. Intel ended the session up 9%, and the Nasdaq was up 6%.
Friday: Bulls pulled off another rally in the morning on a quiescent producer price index report, but bears battled back to end almost even.
Overall you'd have to say it was the bears' week. Bulls' chances of successfully battling back in the coming set of five games, however, are excellent. It's options expiration week, which means the games get even more arcane than usual. The bears will undoubtedly attempt to administer a final death hug. But we note that 90% of the time options expiration weeks end higher than they started, and the average positive bias is 1.5%.
Win with wisdom
Games like these are fun, especially when you're winning. But the chances of winning are increased by following the wisdom of masters. For 20 years, Vic was privileged to take lessons in board games from world freestyle checkers champion Tom Wiswell, who passed away in 1998 at the age of 88. During his career, Wiswell wrote 23 books on board games. He never finished his last book, which he worked on daily for the last 20 years of his life. It was a series of proverbs applicable to games, life and markets.
With hats off to Tom, who never removed his own hat, we will record five of more than 10,000 proverbs he composed, with our own comments on how they are applicable to today's market.
Moves that disturb your position the least disturb your opponent most.
This was Tom's favorite proverb. (Bobby Fischer had a similar one: I always like to grab all my pieces with my fist.)
The meaning: Keep your pieces – that is, your stocks – in a tight formation. Don't churn. Don't go in for excessive trading. Unless there is a good reason to sell a stock, don't do it. Buying and holding randomly selected stocks has been good for 10% a year for more than 100 years.
Take care of the draws and the wins will take care of themselves. (A draw is a win for both players.)
The meaning: Survival is key. Be careful. Don't overextend. Each time you go for a win, especially when it involves margin, you weaken your position. The biggest mistake you can make in markets or games is getting in over your head.
Success in opening can lead to a weak middle game and finally defeat in the ending.
The Education
of a Speculator
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The Education of a Speculator at Barnes &
Noble.The search for the right move while you are playing is helped by the research you have done before playing.
The meaning: Study hard before the market day opens. Plan for all contingencies. Don't make spur-of-the-moment decisions. It's too easy to be influenced by some ephemeral reason during the day that should have required careful preparation in order for a proper decision to be made.
When your opponent invites you to make a very inviting move, remember the story of the spider and the fly.
The meaning: Deals that promise you more than 10% a year risk-free guaranteed will lead you to the poorhouse. If the story on a stock is too good to be true, chances are it is.
We'll offer more rules in future columns. Only 9,995 to go.
Update
In our previous columns, we introduced two indexes representing different approaches to stock-picking. Our Down 35 list identified companies that fell from above $200 to below $100 in the March-April rout of the Nasdaq, and hypothesized that, like elephants, big stocks would tend to return on the path they trampled. Last week, we introduced the Insider 20 -- the worst performers in the S&P Midcap Index in which the last transaction in the company's stock by officers and directors -- was a purchase. Here is a progress report.
Our Insider 20 list rose 2.1% in the week ended Thursday, even as the Dow industrials fell 0.3%, the S&P 500 dropped 1.7% and the Nasdaq lost 8.3%. Thus, in its first week, our stocks showed superior performance of three percentage points relative to the market, almost the entire excess return over a year that is memorialized by the academic studies.
The Down 35 fared much less well; it fell 15% in the same period.
As we mull this week's results and prepare for the future, we recall Tom Wiswell's guidance as he approached his 90th birthday, with his own end game in sight, "A good scare may eventually help you to make a good score."
E-mail Laurel and Victor at lkvn@hotmail.com.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.