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.