Thursday, December 24, 2009

Why Quiet Markets Reveal the Best Traders

Following my recent post highlighting a few difficult realities for traders, several readers questioned the following generalization:

Quiet markets reveal the best traders

Let's take a look at why that's the case:

1) Flexibility - When traders first get off the ground, their natural tendency is to follow what the market is doing. That leads them to follow perceived trend and momentum. Under certain market conditions, one can make significant money buying strength and selling weakness. Over time, however, traders making their living this way wind up being one-trick ponies. We saw that in the late 1990s and then again when traders had slam-bang years in 2008, only to wither in 2009. Quiet markets demand that successful traders either execute trend ideas in a countertrend fashion (buy dips, sell bounces) or outright trade in a countertrend manner (fade both strength and weakness). When a trader can make money in a quiet market, it generally reveals an ability to adapt to shifting market conditions.

2) Patience - Quiet markets don't move around as much and, for long stretches of time may not move much at all. The best traders are patient at those times and either don't trade or trade very selectively. The ability to not overtrade during quiet markets generally reveals a discipline that will serve a trader well in any market environment. The best traders keep their money in quiet times and then make money when things pick up.

3) Adaptability - When the market goes quiet, there are often sectors and individual stocks that are moving well. The best traders will find the spheres of opportunity and concentrate their efforts on those. They realize that what you're trading is as important as how you're trading. Similarly, even in quiet markets, morning hours will offer much more opportunity than later hours. The best traders will find the times of best opportunity and make the most of those.

Consider an analogy: a hotel located in a college town can make money with ease during periods when the school is hosting its homecoming games or holding its graduation ceremonies. It's in the dead of winter, when no events are scheduled and family travel is light, that the best hotels hold their own. They adopt unique tactics (advertising to locals for getaways; creating package deals that combine dining, lodging, and entertainment) and contain their overhead so that they can stay profitable in the leanest periods.

Traders face similar fat and lean periods in their businesses. It's the ones who adapt their tactics to market conditions that survive over the long haul.



mind like water said...

I completely agree that quiet markets reveal the best traders and I have one to add - Quiet markets reveal the best traders because the best traders do not take breaks during quiet times. Quite the opposite, in fact. The best traders use the quiet time to refine their process and preparation. In short, they train. To use an analogy - Kobe Bryant doesn't hang out at the beach all summer even though the season is over. He is working harder and pushing himself more than the other players in the league. He is using the quiet time to make his skills even better. He is practicing, just like the best traders are right now.

BalaB said...

Yep. Excellent post. Only trading when you feel the time is right is one of the rare cases in life when its okay to be a Prima Donna.

Happy Holidays

Jorge said...

Dr. Steenbarger,

I would say that shifts in markets reveal the best traders. Let's keep in mind just as some traders are natural trend followers, others are born contrarians (who do well with mean reversion in quiet markets, but get crashed to pieces when fighting trends - as many gurus who "predicted" this or that, but lost their money and their clients' in the process). Also low volatility encourages overleverage - which proves fatal when markets pick up in speed.

Mind like Water
"... because the best traders do not take breaks during quiet times... [they] use the quiet time to refine their process and preparation" Excellent point!

Merry Xtmas to those who celebrate, best trading to all


Matt Fahmie said...

Thank you for the clarification Dr. Steenbarger. Much appreciated and great post.


kseries said...

Hi Brett
Long time viewer...1st time posting.

I also agree that quiet markets reveal the best traders because they tend to have the most discipline, patience, and flexibility.

In 08, a trader could have made large amounts of money whether you're a trend or a counter trend trader. With so much volatility, it didn't matter.

In 09, i believe trend traders have had more trading opps and likely a better year then counter trend followers.
For the most part, the counter trend traders have missed their long entries since the market has had narrow pullbacks but they've definitely been able to short into the market's strength on a daily basis.

Mind Like Water- I agree with you 100%. You wouldn't believe the amount of traders who have given up or are waiting for good times to come back again rather than working on their trading. It's no accident that Kobe is great year in and year out.