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Victor Niederhoffer



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Lessons from the Market Moves of May and June

The market's moves over the last two months provided many opportunities for heroism, cowardice, survival, disaster and guidelines for proper and wrongful demeanor in the business of everyday life. I was subjected to all these qualities and opportunities, good and bad, in the middle of the fray at every moment during this period, participating as a buyer and seller of individual stocks, derivatives, commodity markets, manager of a trading group, head of a firm and family. borrower and lender, giver and receiver of advice, focus of rumors and buffer for those seeking a safe harbor. I thus feel qualified to give a first-hand account from the firing line of lessons that I have learned for the benefit of myself and others.

First let's put some things in perspective with some stock market numbers:

             Dec 15, '05    1272.7
             Dec 31  '05    1248.3
             Jan 27, '06    1283.7
             Feb 28, '06    1280.7
             Mar 31, '06    1294.8
             Apr 30,' 06    1310.6
             May 31, '06    1270.1
             Jun 30, '06    1270.2

My goodness, June was unchanged! We're back to where we were in the middle of last December, and we're up about 2% for the year. How could we all have missed so many opportunities, made so many mistakes, come so close to the edge, given so much poor advice to others, lost so much money, and generally equipped ourselves as Boppo in the childhood game, or Linus in the Peanuts comic strip? What secrets are there in our hearts and others that could have led to more appropriate behavior?

  1. Never Get in Over Your Head. The first lesson to learn is that the key to success in business is never to get in over your head. When you do, you become prey for those who have more capital. Random events, and events precipitated by the strong, can force you to give up at the worst possible time. Such opportunities to be forced out came on May 24, 2006, when the market hit a low of 1245.3 only to close up 2 on the day at 1258.7,on June 8, 2006, when the market hit a low of 1235.2 only to close up 2 at 1258, and June 13 and June 14, and June 27, 2006, in the market's darkest hours when it closed at 1223.7 and 1239.2, respectively. Who among us was not forced to liquidate at the bottom, who could not sleep because of life-threatening fears, who could not have retired or beggared himself for life, who did not have an army of friends and foes who showed their true colors during those periods? The ones who rose to the top were those who had a prudent reserve for all emergencies, who had their canes available for forays, who were able to calm their colleagues' panic, and meet the stormy forces of fortune with a steady and resolute hand.
  2. Where you end up is path-dependent. Look at all the fortunes made and lost during May, that could and should have been made, and look at where the market ended the month: exactly unchanged. How shameful for those who sold at the bottom, didn't buy at the bottom, or didn't add to their positions during all the opportunities that the market provided as it declined inexorably at the end of each day and scared the daylights out of everyone by going down consecutive Fridays and Mondays in a row, and gave small rises to induce everyone to get out right before heroic once-in-a-decade moves up before cardinal events. Unless you take account of that path dependence, and the ability of the market to perform violent gyrations to see exactly how much pain you can take, you're a dead duck.
  3. Counting helps. Having a foundation based on proper counting enables one to withstand the temporary moves in the tide, the squalls that always come and go, the incessant false rumors, misinformation, disinformation, harmful popular myths and self-interested propaganda disseminated by those with opposite positions to your own. I can point to some good I've done in this direction. I start out with the knowledge that in periods like this with the earnings yield well over the bonds yield, there has invariably been a good rise on a year-to-year basis. But how to get there? Certainly, moves after bad months, and bad series of weeks were relevant in that they almost always lead to reversals except during period like 2002 where runs of negativism spawned by the aftermath of 2001 rule the day. The series of massive declines in the last half hours or the day, and the runs of down Fridays and Mondays provided further opportunities for counting to come to the fore and save the day.
  4. When fear is greatest, that's the time to come in. The Federal Open Market Committee meeting on May 13 was the start of the 10% decline; the CPI on May 20, was the climactic follow on qualitative events. These were vivid, life-threatening events. I hypothesized that the next CPI and the next FOMC meeting would bring opposite moves. Who had the courage to withstand them given what happened before? Only the strong. Who had the courage to go against the tide of mutual fund redemptions, the extremes of bearishness among the advisers and the public, the storm of negativism from all the media, the assurances from the prudents that any rally was just a dead-cat bounce, a temporary oasis before the inevitable move back to the long-predicted Dow 5000?
  5. Don't listen to doomsday scenario-ists. They establish a position, then look for anything in the world that is bad, sell the market with all the meager forces at their command at the time that the adversary is most vulnerable, and then point to how bad the market looks and acted. Are you victimized by such talk? Are you a card-carrying member of such a club or forum? Get out of it if you don't want to experience the same fate as all other doomsdayists have, are or will experience.

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