To print article, click
Print on your browser's File menu.
Go back
Go back
Posted 3/29/2001
Related Resources
Keep track of Victor Niederhoffer and Laurel Kenner's picks on their Recommendations page.
Also follow their HighVolatility portfolio.
Check out MoneyCentral's Stock Wizard
Use MoneyCentral's Mutual Funds Wizard
|
The Speculator
Even a bad market rewards risk-takers
If you're waiting for the right time to invest, you'll never make any money. Meet a brave day trader whose quick wits and market sense put smiles on our faces.
By Victor Niederhoffer and Laurel Kenner
The bird flew too high or too low, the dogs were too far or too near. Things never did suit exactly. He was too fussy, too hard to please, too cautious, too much afraid to miss and to risk his fine reputation for the crack shot. Unless his ways are changed, he’ll never fight a battle.
-- Friend’s description of Confederate Gen. Joseph Johnston, quoted in "The Genius of Robert E. Lee" by Al Kaltman
Gen. Joseph Johnston lost the Civil War for the Confederacy by waiting for the perfect moment to fight. His hesitation was replayed in the stock market over the past few days. Just as people were worrying about when the bottom would come, the Dow ($INDU), S&P 500 ($INX) and Nasdaq ($COMPX) began a three-day, 9% rally from last Thursday’s lows -- about as much as in an average year.
 Money Plus. Easy online tools and free Bill Pay, too. |
There was a broad, operatic structure to the events leading up to the rally. Warren Buffett issued a bearish report to shareholders. Robert Prechter, who has been wrong about the market for 14 years, resurfaced to warn things would only get worse. The Dow Jones Industrial Average fell almost 20% from its high.
At that point, though, it was no longer a matter of taking an unholy joy in the financial demise of uppity entrepreneurs, young traders and strivers new to the market seeking to improve their financial situation by trading New Economy stocks. Major magazines took notice. Japan, the U.S. and Europe were said to be about to go down together. People became genuinely worried.
Big risks make great trades
Then, as suddenly as the bear market began, things changed. The Nikkei rallied 7.5% after President Bush met with Japan’s prime minister and a solution was found for Japan’s troubled banks. And then suddenly, the U.S. and European markets were off on a tear.
The perfect trade is the worst trade. A great trade is great because it’s uncertain. That’s why we get paid to be in the market.
One person who takes a lot of risk is James Lackey, a 6’1”, 220-pound Gulf War veteran who trades for a living in Boca Raton, Fla. Some towns have artist colonies; Boca has several hundred day traders. They work for themselves at various trading shops, or for the huge Schonfeld hedge fund, or for JGM Securities, or at Spear, Leeds & Kellogg, now a Goldman Sachs subsidiary. A young man -- hardly any women enter the business -- can try his hand trading for one of the hedge funds for a salary of maybe $2,000 a month and half of the profits after commissions. If he’s any good and still likes it after a year, he can stay, maybe negotiate a better deal there or at the other shops. The shops, of course, will stay: Fifty traders doing 50 trades a day works out to $6 million a year.
At 33, Lackey is a veteran of this world. He left a job as a stockbroker five years ago to trade a $100,000 account at Broadway Trading. At that point, it was just three other guys who sat on folding steel chairs and used new trading software to take advantage of rules favoring small traders. He lost $30,000 in six months, made it back and worked his way up to supervising 10 traders, each working a sector. He gave seminars for $10,000 at the local trading houses. When his firm blew up on a bad short -- not his -- he returned to Broadway early last year, starting from scratch with a $100,000 stake from his brother, whom he had taught to trade. In nine months, he made a ton of money.
At the market’s low last Thursday afternoon, he was standing on his chair yelling at the 50 guys in the Broadway office to get full long or go home.
“Microsoft (MSFT, news, msgs) and Intel (INTC, news, msgs) were each up 2-plus each when the Dow was down 375,” he wrote us after the close. “That wasn’t short-covering, that was a Fidelity-type move. It takes a lot of cake to make those stocks go up in the face of Dow futures selling. Right at the close Goldman sold 90 cars (futures contracts, each valued at about $300,000) 5 points below the market and it came right back. That is panic buying. They should gap ‘em to the moon tomorrow.” (And gap ‘em they did, as mentioned above.)
Laurel spent the day with Lackey on Monday, watching him trade. Broadway is located now in a fine new 10-story mirrored office building with Porsches, Explorers and Lackey’s new Firebird in the parking lot. His day began with a pep talk to the 24 new traders at the firm’s hedge fund, JGM Securities.
“Do not think the market is going to crash here,” he said, pacing back and forth in denim shorts and a yellow T-shirt. “If everybody knows something, it ain’t going to happen.”
What’s going to happen, he tells the group, is portfolio-switching. Plenty of fund managers left after a bad year. First thing the new guy’s going to do is sell the inherited positions. “Nothing’s going to run like the old days,” he says.
Nothing much was going on in the market that day, and Lackey turned off his three monitors at 3:45 p.m. “The strong stocks get weak and the weak ones get strong. Everybody gets chopped. I quit. Can I get an egg roll? This is chop suey.”
Dear Speculators.. .
Lackey summarized his trading philosophy in a letter to us, part of which we reprint here:
“Get the joke.” I learned that line from my friend Tony Forte, an old Wall Street veteran who is now in heaven. When I was 25, a brand-new trader, guys would yell, “I can’t believe the stock is going down on good news.” I was new, but I would say, “Nobody cares,” and Tony Forte would say, “Ya see, Lack gets the joke.” He took me under his wing only for a short time until I realized that Wall Street is telling jokes all day long and it was my job to get the joke. Then Tony Forte sent me out in the speculation world to learn my own style of comedy. Ya see, telling jokes is harder than writing them. It is all in the timing. Trading well is all about timing. Quick little one-liners are good for small laughs and small profits. Huge detailed stories have the potential to bring the house down, huge profits, but considerably more risk.
This remarkable letter was the beginning of a regular correspondence between Lackey and Vic.
- Mr. Lack: I am over 100 years old, and I
have read every financial book and every financial column over this
period since I wrote my thesis on this subject. And during that time, I
have seen few if any analyses so poignant, so laden with meaning, so
philosophical. My hat, revealing much gray, is off. -- Vic
Thanks again for the book. I was up till 2 a.m. reading, saying yep, yep, yep, damn I am lazy. That is the only excuse I have for not utilizing more pure science.
I have so many new ideas that I need to test. If a stock is up two days in a row more than 1% each day, what is the probability of a third day? I bet it is high and up more than the 2% at some point on the third day. Anyway that pattern has worked well for me in my head.
The environment in my office is not good. Every trader is complaining more than we complained in the Army about the chow. The first rally off the crash is over. What is the best sector to be in for the next rally? I am not good making macro calls. I trade a small-enough account that it hasn’t mattered to me in the past. Now I am trying to look at the markets as if I am trading a $10 million line. Right now I am not willing to risk ten bucks because I do not have any edge whatsoever. Boy that was tough for me to admit, but I feel so much better saying that. -- Lack
A very humble and deep post, Mr. Lackey. The one thing I believe you might wish to pay more attention to is the principle of ever-changing cycles. They changed as of year-end. Now question their persistence. Value Line 1-ranked stocks always tend to bounce back after a bad quarter. Last quarter they were down 16%. They’d be a group of 100 stocks to confine purchases to as they all have high forecasted quarterly comparisons. Many of us talk a much better game than we play, but if you sell after two big up days instead of buying, over the long term the wallet shouldn’t be overly empty. -- Vic
Have day traders considered the possibility that they are playing in a game where they can’t win? The vig (trading commissions and the like) relative to their average gain and loss and all that? The high profits that the market makers seem to make? The overnight moves that would have been in their favor if they had only had the capital to hold, especially after big down days? The limited availability of stocks on the short side, and limited ability to trade NYSE issues? Door would seem to be much more widely open on buy-and-hold strategies, especially those lasting at least three or four days. -- Vic
My firm, Broadway, would argue that I am profitable because I pick up the spread, buy on the bid or sell on the offer over 50% of the time. If you hold positions for three days, there will be significant time frames where your stocks do nothing or go against you. The real point of day trading is that you lower your overnight risk. I agree that if buying power is not a concern, three-four days makes the most sense. When you argue that day trading does not work, what is really meant is overtrading. -- Lack
Mr. Lack: Jack Barnaby, the coach with the highest winning percentage, had a rule: Wait until his boy had a win before laying into him for his errors in form and character. When are you going to learn not to say things like do or don’t buy a down open on a particular day until you test it? Of course it depends on the size of the open and the previous day. But what’s wrong is not that you don’t know, but that you are ready to advise your brother and others when you haven’t bothered to test. That said, nice day. It was very hard to predict today, and covering 5 points from Nasdaq’s low isn’t at all something to be overly denigratory about. -- Vic
Recent Articles
• Riches to rags and back again, 3/22/01
• Questions about the wild market? We've got answers, 3/15/01
• 5 rewarding stocks from the ragged edge, 3/8/01
more...
He and his wife, Jennifer, are expecting their second child in July. His goal is to buy her a big house, then to race cars for a season. Right now, what he wants to do most is teach his 5-year-old son, Austin, to play center field.
We salute Mr. Lackey for his independent spirit and quest for knowledge. We think he’d do a lot better, though, if he slowed down and traded in a more economical manner, to avoid paying so much in vig and commissions.
We challenge him to place just one stock trade a day, giving it his best shot, along with trading index futures. Should he decline to take us up on that, we propose that he cut us in on his action: We’ll take 5% of his gains and 5% of his losses every day, in the spirit of a New York street game. We suspect we’d have 80% of the chips shortly.
A word of caution
After this week’s rally, we’re expecting a pullback. We advise reducing margin exposure to zero, from 50% at Thursday’s open, and increasing it again to 50% at Friday’s close.
At the time of publication, Victor Niederhoffer did not own any of the equities mentioned in this column. Laurel Kenner owned IBM.
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.