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Posted 7/17/2003
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Summertime -- and the losing is easy
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By Victor Niederhoffer and Laurel Kenner
Summer is a bad time for trading, and a good time for going fishing and telling stories. The Spec Duo, out in their rowboats with rods and reel, found this week ideal for sharing a some market reminiscences of their own.
Beware of those switches
Vic’s grandfather Martin was the archetypical early 20th-century speculator. Whenever a stock moved against him, the reason was that they wanted to take it down. As soon as he got out, the syndicate would buy and a squeeze would take it to the roof.
It happened often to him on such stocks as American Can, Radio Corp. and Western Union. He always sold just before the big rally. So he’d adjust his trade the next time. Instead of betting heavily on Can to rally sharply, he’d short an odd lot at first, and sure enough the Fed would lower interest rates and he’d be stopped out. Then he’d buy Radio (later better known as RCA), but it would be announced that the government was opening the airwaves. Finally, he’d switch to buy-and-hold with a staple like the Hat Corporation of America -- hats would never go out of style -- and he’d buy at 100.
Martin’s wife, Birdie, was still holding Hat at 1 or 2 when I last visited her at the old age home in Miami.
Robert Bacon had the answer as to how to avoid this problem. It’s the switches that kill you, he’d point out -- not the bad bets.
It all changed in 1951 with the publication of Bacon’s landmark "Secrets of Professional Turf Betting." "It’s all here,” Martin said, “and it’s so easy. I’ve been studying it in between learning Esperanto, which is going to be the next international language. The problem I’ve been having is that I’ve been switching too much.”
He showed me a copy of the book and turned the pages to Chapter 4, “Keep out of Those Switches.” “Bacon,” Martin explained, “says the professional never varies the size or direction of his bets. He invests on the long side only. The amateur believes in consistency to such a degree that he believes that all stocks at all times should move in one direction, while at the same time being wildly inconsistent in the size of his own investments and the stocks he selects. It’s not the stocks or the market that kills these players. It’s the switches!”
“Investing is simple,” Martin concluded. “But the Wall Street game is clouded by an endless number of minor contradictions and open switches and deadfall traps in order to lure the average investor into doing everything wrong.”
The big switch
If Vic’s Grandpa Martin was the archetype of the early 20th-century speculator, the hundreds of young men at Broadway Trading played the same role in the early months of the millennium. In a decrepit building a few steps from the New York Stock Exchange, they spent their days gazing at terminals, using an arcane software system to buy and sell dozens of stocks a day. Broadway was one of the first day-trading firms, and the stunning successes of some of its traders were well publicized. In the year 2000, dozens of people signed up every month for trading classes in hopes of making millions.
For a few months in early 2000, Laurel joined them, playing the role of a neophyte trader. She had recently left Bloomberg after five years as the wire service’s chief stock market editor, and her goal was to write about the day-trading business. The following account memorializes what actually happened. As it turned out, the Standard and Poor's 500 ($INX) hit its all-time peak the very week she began.
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Monday, March 20, 2000. “They’re having system problems this
morning, and there’s no desk for you,” says the office manager,
Caroline. “It’ll be about an hour.”
I take the elevator down to the street. Another woman is in the elevator. I ask her if she’s a day trader. She immediately knows what I’m really asking. “Yes,” she says. “There’s another woman here, too, a lawyer who used to be a broker.”
That makes three women among a few hundred traders. My companion asks when I start.
“Today, as soon as they find me a desk.”
“You have to be aggressive,” she says. “I had to wait a month for a desk.”
In an hour, the office manager takes me to a desk in a corner in the very back of the second-floor trading room. The stars are up on the 15th floor. A couple of guys are on my row. The room, in fact, is full of guys. Four Orthodox guys in yarmulkes, beards and side curls occupy the row in front. All the guys ignore me. I wait for my machine to boot up.
One of the traders speaks to his stock. “Come on, baby! Bounce!”
For the next hour, the room is silent except for a string of quiet obscenities emanating from the trader to my right.
Genome stocks and biotechs are getting slaughtered. Human Genome Sciences
At 3 p.m., the Nasdaq index ($COMPX) is down 162 points. “Just fell out of bed!” says a voice. The guy next to me puts his face in his hands. “Jesus!” he says under his breath.
Gene Logic
The speaker gives a continuous stream of live prices from the Chicago S&P futures floor. It sounds just like the racetrack. Right now, the futures are diving. The Nasdaq is falling, is what the trouble is. Down 174 points now. It’s doing just what it did on last Monday, and on the Monday before that, before even bigger drops on Tuesday. I try to reason things out: If I were a market maker, I think, I would want to drive down prices now so I could buy at the low and have inventory to sell when the Fed meeting is over tomorrow.
Tuesday, March 21, 2000. First day of spring. A miserable day that threatens rain. Nerves are fraying.
“Roberto, shut up, please. I hear you giggling.”
S&P futures are diving.
“F---.” “F----er.” “I’m sick to my f---ing stomach.”
“All I know is, Rambus
“I’m not touching biotechs.”
Obscenities from all points. Most combine four-letter words with various words referring to females and their anatomy.
The speaker goes dead. A general cry of anguish.
The Fed raises rates a quarter-point, as expected, and the market does what it wanted to do in the first place, as Vic would say: It shoots up. It is, in fact, one of the biggest low-to-high gains in S&P futures ever. Even some of the biotechs come back.
Wednesday, March 22, 2000. The fellow at the end of my row is in a surly mood. He’s down $3,000 today.
Thursday, March 23, 2000. The Broadway software is horribly complicated with an endless list of commands to memorize. Worse, you can’t use it to buy New York Stock Exchange issues -- only stocks listed on the Nasdaq. “This is a terrible deal,” I had written in my training notes. “This is for crazy degenerate gamblers or people who think things must be hard! There are so many other ways to figure out the market!”
This is brought home today as I buy 1,000 shares of Rare Medium Group
Thursday, March 24, 2000. Although nobody realizes it at the time, the Nasdaq will peak today. It’s a beautiful spring day outside, but the trading room is as dark and closed as a Vegas casino. The guy next to me is up $3,500. He owns four tech stocks: 200 shares of BEA Systems
At 2:51 p.m., my neighbor’s $3,500 profit has disappeared. He is down $414. At 3:28, he is down $1,500. In the next several weeks, his loss exceeds $30,000. Eventually, he stops coming in. His friends are still watching his positions when I leave the trading floor for good.
In the weeks and months to come, many of the traders follow suit after losing tens of thousands of dollars. Margin calls come daily. Many traders short the market. They make money until the market takes them, too, squeezing them out in one of its periodic rallies.
In the market, that would translate into this: Day traders didn’t have anything left after the mutual fund money stopped pouring into hot sectors, especially not after paying taxes, commissions, SEC fees and spreads.
When Broadway finally was sold three years later, the trading rooms were deserted, except perhaps for ghosts who ventured out from the nearby Trinity Church graveyard. The graveyard is at the end of Wall Street, and I used to walk there during lunch on the days I was trading. Some said it was the bear market that did the day traders in. But I knew what Bacon would have said: It was the switches.
Final note: Vic and Laurel answer all critiques, comments, and questions sent to them by e-mail. Visit our Web site for trading stories, ideas, philosophy and comment.
At the time of publication, Victor Niederhoffer and Laurel Kenner held no positions in the securities mentioned in this article. They have positions in Standard and Poor's 500 Index futures.