Is it possible that market success can be achieved by going against common knowledge and popular ‘rules’ in the market?

We accept as a fact (whether true or not) that 80% or more traders fail after their first six months or year of dedicated trading. Many people attribute this to emotional failure or a variety of other sources. I wanted to add a quick, generalized comment on one possible reason why this is so.

Money flows from those “out of the loop” to those “in the know.” Money flows from the uninformed masses to the informed and experienced minority. The ‘mass’ rushes in at just the wrong time and exits at just the wrong time - when everything feels too comfortable or too painful. Their decisions are made either with ill-informed information, untested strategies, tested strategies that no longer work given current market conditions, or strictly on their emotions (greed or pain tolerance). Those professionals who are on the opposite side of their trades are profiting from their lack of experience.

There are rules to the stock market game and we must know those rules to be successful. Rules might include generalities such as “follow trends,” “let winners run and cut losers short,” “follow strict money management,” etc. Some rules are not meant to be broken, as they create higher probabilities of success, or are timely strategies that have been used by market professionals through the years.

What I am addressing is common knowledge, or common rules of the game. These generally refer to technical analysis, such as enter a trade at a retracement to a moving average, enter a trade at a test of a trendline, exit at the break of a trendline. I refer to things that “should” work and feel comfortable to execute.

“Fading the crowd” and “playing against the prevailing opinion” is extremely difficult, and is something I am struggling to learn with consistency and comfortability, because taking these actions are psychologically unsettling. Selling when everyone wants to buy creates strong internal resistance, and it becomes so easy to go along with rising prices and join the crowd and ride the market to higher levels and riches.

But it doesn’t work that way. How many times have these events happened to you?

• You can’t stand it any longer and so you buy, yet moments after you buy, the market reverses and you are sitting on losses
• You can’t stand these losses any longer, and so you sell out, only to see the market stall and reverse upwards
• You study and find a great opportunity, yet the next morning, the stock gapped up in your favor, and you cannot compel yourself to buy now at higher prices
• You see a trade you like and you enter, place your stop at the proper place, then get stopped out, only for the market to violently rally in your intended direction afterwards
• Hear that a company has excellent earnings or news and the stock will rise quickly, you enter, yet the stock plummets on great news

There are many experiences which are frustrating in the market and there is no way to avoid them. But professionals not only avoid them more than novices, but they seek out such moments and enter trades where your stop-loss is being triggered, and are shorting the stock to you when you “just can’t wait” to get in.

“That’s not fair!” you say, and maybe it isn’t. But remember (especially in the futures and options market), every dollar you lose is a dollar gained by someone else, and the vast majority of traders lose while the small minority of traders win.

This concept is very difficult to understand, but allow me to attempt a explanation that makes sense to me.

I loved watching ABC’s The Mole, a reality TV show with great psychological concepts dealing with game theory and misdirection of information. The premise - and rules - are simple:

• 10 (or more) players must work together to complete challenges that require teamwork and win money for the group pot
• A mole - an insider - is hired by the producers to sabotage the team and work against them to keep them from winning money
• Players who cannot identify the Mole on weekly quizzes are eliminated
• The winner correctly identifies the Mole on the final quiz and collects the entire money earned

While it seems simple, consider the game if these rules were applied exactly as stated (much like rules are applied exactly in the stock market)

• All the 9 players would cooperate with each other and win money by completing each challenge successfully
• The Mole would openly sabotage the game and everyone would know who the Mole was

So how do you win the game? Or what strategy do you use (as a player) to win?

• Successful players must draw suspicion to themselves, and behave like the Mole by losing challenges (as they are not supposed to do)
• Successful Moles must gain trust and win challenges (which they are not supposed to do), and behave like players
• Players who win challenges and cooperate excessively (as they are supposed to do) are never suspected for being the Mole and are deceived by “pretending” Moles.
• Typically, the game winner is the person who drew the most suspicion and many players strongly believed he/she was the mole

Back to the stock market.

We are told certain ‘truths’ about the market and develop certain strategies that make sense. However, there are professionals in the market which are doing the opposite of what is expected, and the opposite of what is taught in “classic technical analysis books” and fading the crowd and collective knowledge and making big money while the crowd loses it to them.

There are so many “headfakes” and false moves that are designed to draw in retail traders while professionals either establish positions or unwind them. Because “big money” needs liquidity to enter and exit positions, they attempt to create situations that draw in unsophisticated traders and play against them. Also, if every trader were successful, there would be no inefficienies the market to exploit, and this would decrease the profits of the “big money” and they certainly would not allow this willingly.

I will be developing this idea in further posts and discussing potential strategies to take advantage and put yourself on the right side of the trade with confidence.