Trader Dyanamics Toolkit: Asymmetric trading

History is full of battles with victories for the underdog. Whether it is David and Goliath, Alexander the Great, or Mao Tse Tung,  humanity has a habit of routing for the weaker competitor. Markets, are not the same. There are no cheerleaders for bad traders. They tend to get wiped out pretty quickly. That is why you see so many sites comparing trading to battling a vastly superior enemy.

In battle a great leader with a good strategy and well trained and bold followers can achieve more than a great army with no cohesive structure or strategy. This theory can be applied  to trading as well. During the financial crisis,  it was the giant face less banks  with their armies of employees and vast resources that went broke. The smaller hedge funds run by great traders like Paulson or Soros made lots of money.

This is an Asymmetric battle.

Asymmetric warfare is war between belligerents whose relative military power differs significantly, or whose strategy or tactics differ significantly.

Independent traders often think they are at a disadvantage because of the resources available to big banks and funds. However, trading on your own with small lots can be quite an advantage in this fast paced world. As we have seen after the multitude of bank failures financial institutions are placing layer after layer of risk management in their trading models.

Understandably, the high frequency traders make money in milliseconds from slight changes in the market, but we are not competing with them anyway. Most independent traders these days have access to as much information online as a corporate trader.

Most technical analysis packages have all the signals needed and so much news and so many pundits can be easily followed on Twitter. All this can have negative implications, the fog of war.

New traders depend on too much information to make a decision. This multitude of information channels makes rapid decision-making difficult and takes out the edge of being a private trader. This is a problem the majors are faced with, the analysts, program trades, risk managers, hedging strategies, and compliance and regulatory issues makes information sharing and trading quite a challenge for larger funds. Funds spend most of their time trying to put together exotic products to circumvent complex financial regulations.

The principle of asymmetric warfare is to move fast with stealth without the enemy knowing your actions. Private traders can do that. Smaller traders trade smaller contracts so don’t need to worry about moving markets and don’t have risk managers and compliance officers monitoring all our moves.

Use these advantages to level the playing field. You make rapid decisions, pounce and ambush trades and leave quickly if necessary. That is the edge of a mercenary.

It’s the only way to survive in the market and consistently take on the big players. Every day, with every trading decision.

• Analyze information rapidly 
• Make quick decisions based on available information 
• Act. 

Asymmetric warfare is also about getting out quickly when things are not going your way. The market is volatile but having a predetermined point at which losses are unacceptable is an important security factor in trading.

That point must be clearly established based on your money management criteria.

Signal contagion

To make all this easy you need a well-defined system and entry and exit points. Often traders need the comfort of having lots and lots of signals (MACD, RSI, Stochastics, MA, Bollinger), you know what I mean.

All these signals come from the same information, price, they just present it differently. It gives people comfort when they see numbers they are familiar with or colours going from red to blue, but just like the mercenary that is aware of every single noise or movement and quickly  decides whether it is hostile or not, the trader should be cautious about his signals.

Lagging signals should predominantly be used for confirming a particular trading hypothesis. There is too much noise in the markets and too many unknowns to rely entirely on signals.  Furthermore, many traders like numbers and lines and pivots to predetermine entry and  exit points. Therefore you should always be wary of congestion areas on a chart where traders are stop hunting and testing the will of their opponents.

Last night was a great example of this.  Federal Reserve Chair says stocks are not overvalued. Promptly a new record for the S&P. Prior to that the market was going down stop hunting. Very few lagging signals would have seen this coming but a careful analysis of the readily available information, your trading signal and rapid action would have got  you on the right side of the trade.