Trading as Warfare

 

1/27/2025 - In the overnight weakness in the US stock market, we can see a reversal of recent strength.  This highlights yet another aspect of strategy and tactics in trading:  the need to be flexible.  Intelligence is not infallible in warfare and in trading and often it can be murky or incomplete.  Notice that, in the days leading up to this decline, the SP 500 made a new high, but many averages--and many sector indexes within the SPX--stayed well below their highs.  When we see the vast majority of stocks and sectors moving higher or lower, we can anticipate a degree of momentum/trend.  When we see breadth waning on an upmove or downmove, that is when we're particularly at risk of reversal.  That means that we must have the flexibility to assess new market information, determine whether it's a game-changer, and respond with fresh tactics and perhaps with a revised strategy.  We put effort into generating our ideas; equal effort is needed to update those ideas as fresh data come into view--  

In warfare, you assess the enemy's strengths and weaknesses and you develop a strategy for exploiting the vulnerabilities and avoiding the strengths.  That strategy is implemented with a variety of tactics, from ground assault to air and sea attacks; from spycraft to guerilla warfare to coordinated amphibious actions.  Similarly, a football team will assess their own strengths and weaknesses and the strengths and weaknesses of the opponent and will develop a game plan--a strategy for victory.  That strategy will be carried out tactically through specific plays and defenses designed to maximize the team's strengths and exploit the opponent's vulnerabilities.  Tactics are what put strategy into action.  Strategies without carefully designed tactics are at best good intentions.  Tactics without underlying strategy are uncoordinated--and often incoherent--action.

In trading markets, strategy defines bigger picture opportunity.  Tactics implement the strategy on a here-and-now basis.  Many of the psychological challenges of short-term traders occur because they operate tactically, without an underlying strategy.

Here's a simple example.  I have created a daily database of the percentage of NYSE stocks trading above their various moving averages, from 3-day MA all the way up to 200-day MA.  Each day, this produces a momentum curve, a measure of how breadth has behaved over short, medium, and longer terms. The database goes back to 2006, so I can see how breadth behaves in various market conditions.  (These data can be found on the Market Charts site).  

This is another way in which trading is like warfare.  Superior intelligence--more and better information--fuels superior strategies and tactics.

Across the entire database, if we divide the percentage of stocks trading above their 3-day MAs into quartiles (roughly 1150 days for each of the four groups), we find something interesting.  Over the next few days, average returns following the strongest breadth quartiles have been significantly weaker than after the weakest breadth quartiles.  In other words, on average, three-day periods of broad strength lead to short-term underperformance; three-day periods of broad weakness lead to short-term outperformance.  We see mean reversion tendencies over the short term.  The exception to this rule occurs when there is a breadth thrust:  very high levels of breadth momentum.  Then we see strength leading to more strength; weakness yielding further weakness.

The day trader who is unaware of such patterns may see a bullish or bearish setup, but can easily be run over by the mean reversion and momentum tendencies playing out over a multiday period.  That leads to frustration, which can further impair trading.  The cause of the frustration, however, is not a psychological conflict or weakness; the cause is due to pursuing tactics in the absence of strategy.  The same problems affect investors, who trade "catalysts", only to lose sight of multi-week patterns playing out in market breadth.  

Trading is like warfare.  The difference is that the trader is both a general and a soldier:  one who frames strategy and one who implements it.  There is always a bigger picture that defines edge and a more immediate picture that guides the execution of the tactics that exploit that edge.  Confidence comes from well-grounded strategies, implemented skillfully.    .