One thing I’ve learned over the past year is that a lot of people don’t understand money flows and the differences between negative, zero, and positive sum games. If you’re going to invest in any sort of asset, or trade any sort of market, you need to know how money is flowing through it. You need to understand the game you’re playing.
First, to understand positive/zero/negative sum games in the markets, we need to talk about expectancy. Expectancy is very simple…it’s the average profit or loss an investor or trader can expect to make. To calculate expectancy among a group of investors, all we need to do is take their net profit/loss as a group and divide by the number of investors. There will be a net profit if it’s a positive sum game, net zero if it’s zero sum, and net loss if it’s negative sum. Thus, an investor will, on average, make money in a positive sum game, make nothing in zero sum game, and lose money in a negative sum game.
Positive sum game. The amount of money flowing out to investors is greater than what investors put in. There is a net profit. Thus, an investor will make money on average. There is a positive expectancy. That doesn’t mean every investor makes money. Some may actually lose money. It just means that investors make money on average.
Zero sum game. The amount of money flowing out to investors is the same as what investors put in. There is no net profit or loss among the group. Thus, any winning investor is paid out by a losing investor. Even if you have some winners, the expectancy (the average profit) among investors in the group is $0, because the winners were paid out by investors who lost money.
Negative sum game. The amount of money flowing out to investors is less than what investors put in. There is a net loss among the group. While you may have some individual winning investors, the group as a whole has lost money. This is a negative expectancy … investors lose money on average. Any winning investors were paid out by losing investors, but the winning investors didn’t get as much money as was originally put into the system.
Now, let’s get into each type of game in more detail. In each game, I’ll outline a hypothetical system of 3 investors, and show how money flows among these investors. I use a small number for ease of illustration…obviously in the real world we’re dealing with millions of investors. But the number of investors is irrelevant…the mathematics of the money flow remain the same whether you’ve got 3 investors or 3 million investors. I’ll then go over some real-life examples.
Positive Sum Game
Three investors each put $100 into an asset. Thus, the pool of investment money that’s gone into the asset is $300. The asset also has a separate cash flow (not new investor money) that can go into the asset. Let’s say that separate cash flow is $100. Thus, now the total pool is $400. The total pool is greater than the money that investors put in, making this a positive sum game for investors. The expectancy of the investors in this scenario is ($400 / 3) – initial investment of $100 = $33.3. This is a positive expectancy.
Now, that doesn’t mean every investor makes $33.30 here, or even makes money at all. This is just an average profit. One investor might end up taking $200 from the pool (thus making $100 and giving him a 100% return on his initial investment), while the others only get back $100 and thus don’t make money on their investment. Or, perhaps one investor ends up taking $150 (50% return), and the others end up taking $125 (25% return of each). Or, perhaps one investor takes $300, and the others only get $50. Thus, one investor wins and the other two lose $50 each. But regardless, the average profit is positive.
The key aspect of any positive sum game is that you have money coming into the system that is not new investor money. There are separate cash flows, and investors aren’t just paid out by other investors.
Real Life Example: Investing in a Profitable Company
Investing by buying shares of a profitable company can be an example of a positive sum game. When you invest in a profitable company, you are purchasing the right to a portion of that company’s profits. The company can then share their profits with you in the form of a dividend. Thus, you can make money without having to sell your stock to a “greater fool“. You don’t need new investor money to come in.
A company can also use those profits to buy shares back, which is ultimately returned to you, the shareholder, in the form of share price appreciation (same demand, lower supply = increased price).
A company can also use those profits to expand its operations, leading to growth and future profits, which can then be shared with you down the line.
Note I’m only talking about the game here in terms of investors. Given that companies hire and pay employees with their cash flows, who then turn around and put that money into the economy, there’s more people that benefit other than just investors. There’s a positive sum game in terms of the overall economy. A profitable company also puts out a product that people want and use (this is why they’re profitable!), and thus provides a non-economic net benefit and can be considered a non-financial positive-sum game.
Real Life Example: Investing in Index Funds
This is really just an extension of investing in a profitable companies. Now, you’re just investing in a large group of companies simultaneously. Many of those companies pay dividends. They also all hire employees and are part of the entire economy. They tend to grow with the economy and the overall population. Now, that’s not to say that the overall stock and bond market is always tied to the economy. You can have stock market bubbles where things can get detached from reality and economic output (like the NASDAQ bubble in 1999, or the recent bubble in tech stocks), and the game becomes more zero sum. And actions by the Federal Reserve can impact how the stock market relates to the economy (such as how quantitative easing can influence stock market prices). But overall, over very long periods of time, the overall stock market tends to be a positive sum game, with a positive expectancy for the average investor.
Zero Sum Game
Three investors each put $100 into an asset. Thus, the pool of investment money that’s gone into the asset is $300. There is no other source of money inflows. There is only $300 total available to all the investors. The amount of money that can come out is the same as the money that went in. This is a zero sum game.
The expectancy of the investors in this scenario is ($300 / 3) – initial investment of $100 = $0. This is a zero expectancy. The average investor will not make or lose money. Any winners must be paid out by losers. For example, one investor might take $300 out of the pool (making $200 off his initial investment), while the other two lose $100. Or two investors take $150 each (making $50 off initial investment), while one loses $100.
Real Life Example: Poker
While poker is not an example of an investment, it’s one of the easiest illustrations of a zero sum game. Each player puts money in the pot. One player ultimately wins the money from that pot. The other players lose. The winning player is paid out by the losing players. The amount of money that came out of the pot is the same as the money that went in.
Real Life Example: Day Trading
Day trading is a zero sum game. Any money that one trader makes is money taken from other traders. For example, all of the money I’ve made through day trading is money I’ve taken from other traders. I’m basically a professional poker player playing a giant game of poker with thousands of other players. We are all competing against each other to take each other’s money. This is why, despite numerous requests, I’ll never teach my exact trading strategies to others. I would simply be giving away my edge and giving someone a better ability to take my money. This is also why you should be wary of anyone who is trying to sell a specific trading system. If the system works so well, why would that person be giving the edge away? Most likely the system doesn’t work well and the person is just trying to make money off of selling education systems or off of subscribers. The best trading educators teach general concepts (like InvestorsUnderground), but ultimately leave you to do the hard work of getting the specifics. And no matter how hard you work at day trading, you may not be successful. Since it’s zero sum, not everyone can win no matter how hard they work. Statistics show that most day traders lose money, and less than 1% can consistently make money over the long run. This is why I usually steer people away from day trading despite my own success with it. And if, after all these stats, you still want to be a day trader, make sure you read Michael Goode’s excellent series on it.
Real Life Example: Bubble Assets/Unprofitable Companies/Meme Stocks
Investing in any bubble asset, unprofitable company, or meme stock (like AMC or GME) is going to be a zero sum game. Since the underlying cash flows of the company are insufficient to help pay out investors, the only way for an investor to make money is to sell the asset to a “greater fool.” Thus, one investor’s gain is another investor’s loss. For example, anyone who made money on AMC by cashing out when it had skyrocketed well above 20 was paid out by people who bought the stock at those high prices and are now sitting negative on their investment. In fact, AMC insiders like the CEO made nearly $1 billion dollars by selling into the retail frenzy.
So you know who’s down nearly $1 billion now? That’s right, all of those retail bagholders who bought into the frenzy. The only thing they got out of it was an NFT of a medal.
This is why you should be wary of when you hear about people who made money on some bubble asset like the recent meme stock craze. Anyone who made money was paid out by losers. However, due to survivorship bias, you usually only hear about the winners. It can make it seem like investing in these bubble assets is a good idea, especially when you see the skyrocketing prices. But you don’t hear about all the losers. A similar thing happened with the 1999 tech bubble. You’ll hear about people who made fortunes during that time. But you don’t hear about the massive amounts of people who lost fortunes during that same time. If you want to read some interesting stories of people who lost a lot of money during that time, check out these tweets from @mailboxymoney6 here, here, here, and here).
Negative Sum Game
Three investors each put $100 into an asset. Thus, the pool of investment money that’s gone into the asset is $300. There is no other source of money inflows. There is also an additional source of outflows other than investors…a non-investor(s) taking money from the asset. Let’s say this non-investor takes $100 from the pool. Now, the pool of investment money that is available to investors is $200. That’s $100 less than the total money that was put in. Investors as a whole can only be paid out less money than they put in. This is a negative sum game.
The expectancy of the investors in this scenario is (($300 – $100) / 3) – initial investment of $100 = -$33.33. This is a negative expectancy. The average investor loses money. Now, that doesn’t mean everybody loses money. Like a zero-sum game, you can have winners paid out by losers. But even though you may have some winners, the average investor loses. For example, one investor might take the remaining $200 out of the pool (making $100 off his initial investment), while the other two lose $100. You have more losing investors than winning investors in a negative sum system.
Negative sum investment games generally aren’t sustainable over the long run (while they can go on for remarkably long periods of time, they usually come to an end at some point). This is because they completely depend on recruiting new investor money into the game to keep going. Since there is an entity siphoning money out of the investment pool, you have to constantly bring in greater fools to be able to pay out some investors. However, the supply of greater fools is not infinite. At some point, you run out of greater fools, and investors can no longer be paid out. Money continues to get siphoned out of the system until it collapses.
Real Life Example: Ponzi Scheme
A Ponzi scheme is a negative sum game for investors. First, there is only one source of money inflows (new investors). The only way investors can be paid out is through money from other investors. This would be zero sum, but the people operating the Ponzi scheme are siphoning some of the investors’ money. Thus, the pool of money to pay out early investors is less than what was put in. The operators of the Ponzi must continuously recruit new investors into the scheme to keep it going so they can keep paying the early investors and also so they can hide the Ponzi. These schemes can go on for long periods of time…Bernie Madoff’s Ponzi scheme went on for over a decade. Ultimately, though, they aren’t sustainable as new investors eventually dry up (assuming the Ponzi is not exposed before that).
Real Life Example: Crypto
Crypto is a negative sum game for investors. First, there is only one source of money inflows (new investors). Unlike stocks, there is no underlying company with its own separate cash flows. Crypto tokens are just empty greater fool assets. Because there is only one source of inflows, crypto can never be positive sum. Anyone who makes money in crypto must be paid out by someone losing money in crypto.
You might then ask, “Doesn’t that make crypto zero sum?” No. It is negative sum because there is an additional source of outflows: crypto miners. Miners are rewarded with crypto, and thus when miners extract crypto from the pool and sell crypto to pay their electricity bills, they are taking money out of that pool…the money investors have put in. Thus, the aggregate amount of money in the pool available to crypto investors is less than aggregate amount of money that was put in.
This is why crypto has often been compared to a ponzi scheme. They are both similar in money flows. They both have only a single source of inflows, and they both have a non-investor taking money from the pool. They both depend on recruiting new investors to keep things going. But they are both unsustainable because the pool of new investors is not infinite, and the system eventually collapses because investors keep competing for a smaller and smaller pool of money. In fact, crypto miners create the risk of the crypto miner death spiral (which would be a cool death metal band name), where the price of crypto falls below production costs and forces miners to sell (two such death spirals have happened in the past…December 2018 and March 2020). Estimates vary where that death spiral point is, ranging anywhere from $17K to $34K.
I’ve heard some people say, “Well, that’s just true for shitcoins. Bitcoin and Ethereum are great investments. They’ve been around the longest and have the most money in them.” However, all crypto tokens share the same negative sum structure. The market cap or age of the tokens is irrelevant. When you have a zero sum game of empty tokens that have separate entities (miners) extracting money from the investment pool, then it mathematically must be negative sum.
When you have a zero sum game of empty tokens that have separate entities (miners) extracting money from the investment pool, then it mathematically must be negative sum.
One person tried to tell me that she was invested in crypto for the long term, and thus it wasn’t negative sum. She thought that only the time frame mattered, comparing short term trading of stocks (zero sum) to long term index fund investing (positive sum). However, it’s not the time frame per se that changes the game you’re playing. The reason why long term investing is positive sum, while short term trading isn’t, is because with short term trading, the time frame is too short for a company’s separate cash flows to matter. For example, dividends don’t matter if you’re a day trader, but they matter if you’re a long term investor. You can also have instances where you initially invest in an unprofitable company (zero sum) that eventually becomes profitable and rewards shareholders with those profits (positive sum). Thus, holding for the long term in this case can transform a zero sum game into a positive sum game. With crypto, however, there is no underlying company and no separate cash flows. Thus, crypto will always be negative sum, whether you hold your crypto for 10 days, 10 months, or 10 years. You still can only make money by selling to a greater fool, and during all that time you’re holding, miners are continuing to extract money from the investor pool. Crypto is very much like a rigged poker game where a referee is constantly taking money out of the pot. And don’t let the large market cap or huge rise in price over the past few years fool you. The price of crypto is largely fictional, and winners can still only be paid out by multiple losers. The primary winners in crypto are whales who were in early, exchanges, and miners.
Crypto will always be negative sum, whether you hold your crypto for 10 days, 10 months, or 10 years.
And what about some of those crypto millionaires that you hear about, like the Dogecoin millionaire? Remember that since it’s a negative sum game, unrealized gains aren’t true gains. If someone hasn’t cashed out their crypto, they haven’t actually made any money (as of writing this, that Dogecoin millionaire guy still hasn’t cashed out from what I understand, and his unrealized profits have fallen substantially). The only way to make money is to cash out, which means other people will have to take the loss. But due to survivorship bias, you rarely hear about the losers, even though mathematically there will be way more losers than winners in crypto due to the negative sum nature.
Due to survivorship bias, you rarely hear about the losers, even though mathematically there will be way more losers than winners
Miners aren’t the only things that make crypto negative sum. The stablecoin Tether is used for approximately 70% of all transactions in the crypto ecosystem. You can think of Tether as casino chips; you trade your real $ for Tether, and then buy/sell crypto with Tether. However, the problem with Tether is that it’s not backed 1:1 by real money. Thus, the chips people are playing with don’t represent real $, which has been siphoned out of the crypto ecosystem and replaced with Tether. This is also why crypto prices are mostly fictional. For example, the current real price of Bitcoin as of writing this is not $36K in real dollars. It is below that; for example, GBTC, the Bitcoin trust that does not involve Tether, is trading at about 30% below NAV as of writing this.
Given that the crypto markets are unregulated, they are also full of rug pulls, scams, and front-running/manipulative tactics by exchanges. All of these contribute to the negative sum nature.
Real Life Example: OTC Pump & Dump Paid Stock Promotion
While you don’t see them much anymore due to SEC crackdowns, paid stock promotions were quite common on the OTC markets a decade ago. This is where a group of insiders, who have a large number of shares of a penny stock for no cost, pay for the stock to be promoted either through hard mailers or through internet ads. This paid stock promotion encourages people to start buying the stock.
– NXTH stock promotion mailer from January 2010
The stock promoters may also engage in manipulative trading techniques like wash trading (something that is also quite common in crypto … for other similarities between crypto and OTC penny stocks, check out my post here) to create the appearance of interest in the stock. People start to buy the stock. But who are they buying the stock from? The insiders who got their shares for free. Eventually, the insider finish selling their shares, and the stock promotion stops. Suddenly there is no one left to bid on the stock, and it collapses, leaving all of the retail holding the bag, while the insiders walk away with millions.
– JAMN stock chart from 2011. JAMN was an OTC stock promotion.
This is a negative sum game. Investors are putting their money into the stock. However, the insiders got their shares for free. They never put any money into the pot. They are only extracting from the pot. Thus, the insiders are being paid out by the investors. Yes, a few investors who are smart enough to exit before the dump can get out with a profit, but that only comes at the cost of another investor losing. In aggregate, the amount of money that investors can extract is much less than what they put in.
Know What You Own
The bottom line is that you really need to truly understand what you own. If you’re going to put your money into something, understand what type of game you’re playing, and act accordingly. Understand where money is going, and who the primary winners and losers are most likely to be. If you understand money flows and the game you’re playing, you’ll be more likely to make money and less likely to lose money. As the old saying goes:
God give me the strength to invest in positive sum games, trade zero sum games, and avoid negative sum games, and the wisdom to know the difference.
– Moi
Disclosure: Due to the negative sum nature and system risks in the crypto ecosystem, I have a small MSTR short and some long-dated BITO puts. I am also an InvestorsUnderground affiliate and receive a commission for anyone who signs up for their services through links on my site.
You’ll often hear traders talk about “conviction” on a trade, and even mention sizing in when conviction is high.
But should conviction dictate your trading decisions?
Defining Conviction
Conviction can be defined as “a strong belief or opinion” or “the feeling of being sure that what you believe or say is true.” Now, there’s nothing wrong with having conviction when entering a trade. Often, it is conviction that causes you to take the trade in the first place. You have a strong opinion that a trade has a high probability of working in your favor, so you decide to take the trade.
However, conviction can also cause problems when taking a trade, particularly after you’ve placed the trade.
The Problem With Conviction
Because conviction represents a strong belief, that belief can cause you to overlook evidence that the trade isn’t working, or that your trade or investment thesis is not correct. You can get stuck in confirmation bias, only looking for evidence that you’re correct and ignoring evidence that you’re wrong. Perhaps you’re so convinced the trade or investment will work that you put in a ton of size on it, risking more than you usually would. Or perhaps you decide not to obey any stop losses because you have such high conviction.
In all of these examples, your conviction has simply become poor risk management and/or a choice to ignore reality. You are confusing conviction with what you want to happen. However, what you want to happen may not be what is happening. And you can watch your money bleed away before your eyes as you let your conviction overtake you.
The $AMC apes/WSB army are also an example of conviction gone wrong. There is still a group of bagholding $AMC shareholders that are convinced that $AMC is being manipulated, that the shorts will get squeezed any day now, that $AMC is worth much more than its current value, and there’s a big conspiracy against them. Yet they ignore the evidence right in front of their eyes that they simply chased a short-term squeeze and got caught in a bubble. The $AMC insiders (like the CEO Adam Aron) have taken advantage of them and sold nearly $1 billion in stock to these bagholders.
Always Assume You Can Be Wrong, Even If You’re Convinced You’re Right
Whether you’re an investor or trader, you must always assume you could be wrong on an investment or trade, and you need to plan accordingly. This can be done through appropriate position sizing, diversification, and/or stop losses. Even if you feel there’s almost no chance of you being wrong, you still should prepare as if you could be wrong. Crazy things can happen in the markets, and you should always be prepared for a black swan event. You never want one trade or investment to wipe you out, even if your conviction is high or if the chance of something bad happening is small. If anything, you must at least account for the fact that your timing might be wrong. For example, Michael Burry was right regarding shorting the housing market, but he was early and his investors at first wanted to withdraw their capital.
For me personally, I no longer let conviction influence my position sizing or planning on a trade. I still only risk 2% of my capital per trade, even if I feel 100% certain on something. This is important, because keeping my risk at a fixed level allows me to be more objective about a trade. There’s an emotional component to conviction, and you can lose objectivity if your conviction is high. Interestingly, I’ve had some trades in the past where I didn’t have high conviction, and made great profits, and also other trades where I had high conviction, and ended up taking a loss. But in all those cases, I followed my trading plan and didn’t let my conviction level influence that plan.
I’m even starting to do long-term shorts again (despite swearing them off in the past). However, I’m much smarter about how I do them. I keep my risk fixed, I’m careful about my entry timing, and I view them as just another trade so that I don’t get emotionally involved in them. For example, I’m currently short the crypto markets through a small MSTR short and some BITO and MARA puts. My conviction is high…the crypto markets including Bitcoin & Ethereum are an unsustainable bubble, there’s massive systemic risk, and there is limited upside with tons of downside for a variety of reasons (including negative sum ecosystem for investors, lack of widespread use cases beyond speculation, extreme leverage, Tether fraud, and unsustainable energy consumption…you can read my reasons in more detail here, here, here, and here…also read the link list towards the end of the first one). However, despite my high conviction, I still use the same position sizing and risk management that I would do for any other trade. This keeps me stoic and indifferent about the eventual outcomes of these trades. Also, while I’m 100% certain I’m right about what will eventually happen to crypto long term, I can’t be 100% certain about the timing so I still need to manage risk.
Signs that Conviction Might End Up Blinding You
You don’t have any risk management in place. This could be not having a stop loss or using too much size in a trade or investment.
You think you can’t be wrong. No matter how convinced you are, remember that there still may be chance you’re wrong (remember the potential for Black Swan events), especially if you’re ignoring evidence contrary to your trade/investment thesis (more on this later). Also, remember that even if you’re 100% right on a trade or investment thesis, your timing could still be wrong. For example, if you’re convinced something is a fraud, remember that frauds can go on for long periods of time. Bernie Madoff’s fraud went on for 16 years, despite some people calling fraud in the 1990’s. The Wirecard fraud went on for 8 years, despite some journalists calling fraud very early on. Also, remember that the market can stay irrational longer than you can stay solvent. Bubbles, pump & dumps, and irrational market behavior can last much longer than you think they can.
You ignore or dismiss evidence contrary to your trade or investment thesis. This can be as simple as ignoring the price action telling you you’re wrong on your timing. Or, for a longer term trade or investment, it might mean ignoring evidence of problems with the trade or investment. For example, the $AMC apes have long ignored the massive insider selling, or have ignored the facts that their concepts of “naked shorts” are simply wrong. Or, I’ve seen crypto critiques dismissed as “FUD” despite very strong evidence of numerous issues within the crypto ecosystem (such as the Tether fraud).
Your identity is getting wrapped up in your investments or trades. For example, the $AMC apes have their own website like it’s a club. Or there’s the recent trends on Twitter for Bitcoin investors to have “laser eyes” in their profiles, or ethereum investors to add “.eth” to their Twitter names. Letting your identity become your investments or trades is a sure- fire way to lose objectivity about those investments or trades.
You get emotional with every swing of your investment or trade, and spend too much time watching it. Good traders/investors tend to be more stoic regarding how their positions go.
Would You Rather Be Right, or Would You Rather Make Money?
If you’re more focused on being “right” about your trade or investment, then that’s a sign that you’ve let conviction overtake you. Every trade or investment should just be one among many trades or investments. Don’t place too much importance on any particular one. Also, don’t get so caught up in trying to be right that you end up losing too much money if things go south on you. One hallmark of any good trader or investor is risk management. For traders, that means cutting losses when they’re small and not taking position sizes that are too big. For investors, that means staying well diversified, not sinking too much into any one investment, “knowing what you own” (and I mean truly knowing it…a lot of people think they know what they own but really only have a surface level of knowledge), and paying attention to your original investment thesis and being open to change your mind if that thesis might be invalidated.
Prepare, perform, profit, my friends…
DISCLOSURE: In addition the long dated MARA/BITO puts and MSTR short mentioned earlier, I have a small long term TSLA short and SARK (short ARKK fund) long.
2021 was an interesting trading year for me. It was a year I started off with a bang and ended with a whimper.
It was my best year ever in terms of absolute $ profits. However it wasn’t my best year in terms of percentage returns on my capital. Also, pretty much all the money I made in 2021 was made in the first three months of the year. I spent the rest of the year mostly flat. Now, this isn’t out of the ordinary for trading. I read a stat somewhere that profitable traders typically make most of their money on only 20% of trading days per year. This stat, in fact, highly influenced my risk management the past three years, and encouraged me not to worry if I had relatively long periods of time when I was flat. The profitable days will come, so manage your risk and make sure you keep the profits you make by regularly paying yourself. I’ve continued that practice, paying myself a salary from my trading profits every 2 weeks, and putting those profits away in lower risk long term investments. I also withdraw more if I’m struggling or in a drawdown to protect my capital. I did this in 2020 when I was in the middle of a 50% drawdown, withdrawing a huge chunk of my capital and shrinking my overall account size. I did it again this year when I experienced a similar drawdown. In fact, this year I paid myself about 70% of the profits I generated. Being a good trader isn’t just about making money…it’s about keeping the money you make. You can’t call yourself a good trader if you can’t keep the profits you make.
Being a good trader isn’t just about making money … it’s about keeping the money you make.
Here’s a graph of my cumulative percent return for 2021. You can see how I made all of my money from January through March, then had ups and downs for the rest of the year to finish mostly flat.
Overall, I finished with a 431% return on my capital. Here’s a summary of stats for 2021:
Cumulative % Return
431%
Average Daily Return
0.77%
Largest Drawdown (Peak to Valley)
-50.7%
Largest 1-Day Drawdown
-21.9%
Largest 1-Day Increase
16%
% of total trading days that were green
51%
% of total trading days where account hit all time highs
18%
Total Number of Trades
758
Winning Trade %
52.1%
Ratio of Gains to Losses
1.33
Win/Loss Ratio (Average Winning Trade/Average Losing Trade)
1.23
Max Consecutive Winners
11
Max Consecutive Losers
7
So why would the year start off so well but then end in a whimper? There’s a few reasons. First, two of my best strategies are shorting gappers and multiday parabolic runners, and there were TONS of these opportunities in January and February. Thus, my profitability was influenced by the sheer number of opportunities available. Second, in the summer I had such a big cushion for the year that I decided to experiment with new trading concepts and strategies. For example, I started experimenting with selling call options (call credit spreads) after reading many Twitter posts by @team3dstocks. Initially I had a lot of success with them, but then it started to fall apart. It eventually lead to my biggest drawdown of the year in August when I got auto-exercised on the sold call option portion of the spreads on TSLA and AMC when I misunderstood the process of what happens when part of your credit spread expires in the money (up until that point all of my spreads had always expired out of the money). I ended up with massive short positions in both, and they both gapped up the following Monday. I took huge losses on both in combination with a $3 million margin call (no, I didn’t lose $3 million…that was just the amount of money needed to cover the margin of the trade). Fortunately I was able to take a liquidation strike and not have my account restricted from trading on margin.
I also experimented with some changes to my existing strategies, as well as other newer concepts like the VWAP Boulevard concept that @team3dstocks had mentioned. I took a lot of lumps while working on these.
By November, I had tossed out most of the newer strategies that I had tried, keeping the few that seemed to have an edge. This is typical for trading. You’ll test out numerous strategies and spend tons of time on them, but eventually you’ll only find a few that really work for you. For example, after testing 10 trading concepts, you might only find 2 that really work. Because of this, trading is one of those activities where you can do a huge amount of work often with little to show for it, because you’re spending so much time evaluating strategies that eventually don’t pan out. The funny thing is that out of the various strategies I tested, the few that I’ve kept were just variations of my existing strategies anyway.
…trading is one of those activities where you can do a huge amount of work often with little to show for it, because you’re spending so much time evaluating strategies that eventually don’t pan out.
Even though in November I was done trying to experiment with new strategies, I still struggled to get any upside momentum going in my accounts because there were still weaknesses that were cropping up in the newer concepts that did have an edge. For example, for one newer strategy, I had some losing streaks that revealed a problem with the strategy. Those losing streaks would result in adjustments to the strategy which will enhance profitability over the long term, but in the short term my performance is adversely affected. Whenever you have a new trading strategy that looks good, be rest assured that the market WILL expose its weaknesses at some point. Every time I’ve thought I had a newer strategy “dialed in”, the market would come around and tell me that it wasn’t. Often, the tweaks that were needed were fairly minor too…sometimes just a minor tweak would stop a losing streak of 3-4 trades in a row without missing out on most of the profitable trades (like even just a time of day adjustment). But the only way to discover these weaknesses is through data collection and getting as large of a sample of trades as possible.
Whenever you have a new trading strategy that looks good, be rest assured that the market WILL expose its weaknesses at some point.
Here’s a year-over-year comparison of my performance.
2019
2020
2021
Cumulative % Return
294.2%
1233.3%
431%
Average Daily Return
0.59%
1.17%
0.77%
Largest Drawdown (Peak to Valley)
-22.5%
-51.5%
-50.7%
Largest 1-Day Drawdown
-15%
-16.3%
-21.9%
Largest 1-Day Increase
+15.5%
+18.9%
+16%
% of total trading days that were green
54.7%
50.2%
51%
% of total trading days where account hit all-time highs
26.7%
22.9%
18%
Total # of Trades
643
1098
758
Winning Trade %
61.9%
52.7%
52.1%
Ratio of Gains to Losses
1.40
1.46
1.33
Win/Loss Ratio (Average Winning Trade / Average Losing Trade)
0.86
1.31
1.23
Max Consecutive Winners
17
12
11
Max Consecutive Losers
12
21
7
You can see similarities in some stats among the years. For example, one similarity between 2020 and 2021 was a big 50% drawdown in the late summer. In both instances, they were caused by me experimenting with new strategies. In 2020, it was me repeatedly trying to do a long term short on $GSX. You can also see that 2020 was my best year in terms of % returns, but of course I made more absolute $ in 2021 simply due to having grown my accounts much larger.
My Trading Goals for 2022
Given these stats over the past few years, and the causes of my ups and downs, here’s my goals for 2022:
Focus on my existing strategies and avoid trying any new strategies. It was trying new stuff that was responsible for big drawdowns in both 2020 and 2021. I can make a lot of money with my existing strategies…there’s no need to add more. Just stick with my existing strategies and refine them if needed.
If I do have a new strategy in mind, don’t rush into trying it with real money after backtesting it. Paper trade it for a VERY long time. There’s no need to rush into trying a new strategy even if I think I’ve thoroughly backtested it. I can iron out the kinks with paper trading while making money with my proven existing strategies before I put any real money on the line with a new strategy.
Improve the efficiency of my trading. Focus on the best setups and improve my winning trade percentage. Make more with less. I’d like to be in the 70%+ winning percentage range, and focus more on setups that can give me a minimum of 2R per trade.
Eliminate the big drawdowns. Avoiding new strategies that aren’t thoroughly tested will help a lot with that.
Imagine a poker game. Imagine all the players putting their money in the pot, but only one player wins that money. It’s a zero sum game…one player wins, but the rest lose.
Now, imagine a referee for that poker game. His fee is to take money from the pot during each round. The game is now no longer zero sum for the players…it’s negative sum for the players because the amount of money that is available to the players to win is less than put in.
There will still be a winner in each game, but even though there’s a winner, it’s overall negative sum for the group of players involved. And for any person to keep making money, you have to recruit new players to play since some players will eventually lose their money.
Now, there’s another twist. The players aren’t putting cash into the pot. They exchange their cash for chips, and play with the chips. But unbeknownst to them, the casino taking the chips is pocketing some of the money, and thus the chips aren’t fully backed 1:1 by $.
Thus, the amount of chips that are being played isn’t reflective of the real $ that went in…there’s more chips than real $, meaning some players will get screwed when they try to cash in their chips. And hold tight, because it gets worse.
Some of the players have hidden cameras so they can see other players’ cards. This puts them at a distinct advantage over the other players. They consistently win more often, wiping out many players along the way (while simultaneously recruiting new ones).
On top of that, these players are in cahoots with the casino. They advertise how much money they’re making at this poker game. It’s the poker game of the future. They encourage others to play. But nobody hears about the players that are losing.
This game continues as long as there’s new players to keep playing the game. The small number of players with the hidden cameras or the most chips are able to just keep taking from all the new players. The games don’t stop until there’s not enough new players.
And remember, this entire time, there’s still a ref siphoning money out of the pot each and every game. So you’ve got a rigged game where there’s a few winners (the ref, a few players) and many losers (all the other players).
Would you play a poker game like this? Most would say no. But that’s the game you play if you invest in crypto. The miners are the refs. The crypto exchanges and whales are the players with a lot of chips or hidden cameras. The chips are Tether.
Keep this in mind whenever you think about putting your money into crypto. You’re playing a rigged poker game under the guise of the “future.” Eventually, it can only end one way for most players. No one can say when it will happen, but it will happen.
DISCLOSURE: Given the massive systemic risks in the crypto ecosystem, especially in regards to Tether, I own some long-dated BITO, MARA, and MSTR puts, as well as a small MSTR short position.
DISCLOSURE UPDATE 01/23/2022: I have closed out my long-dated MSTR and MARA puts. I continue to hold BITO puts and a small MSTR short position. I may re-enter new short positions on any crypto market bounce.
In 2011, while browsing Yahoo Finance, I was served an ad for Jammin’ Java.
However, this ad wasn’t for their coffee. It was for their stock.
Jammin’ Java was company trading on the Over The Counter Bulletin Board (OTCBB) under the ticker symbol JAMN. The company sold Marley Coffee … yes, a brand of coffee with Bob Marley’s name attached to it.
The internet was flooded with ads for JAMN. But the ads were focused on the stock, not the coffee. Now, there were some videos with Rohan Marley (Bob’s son) that seemed to be focused on the coffee, but even with those videos, they made it a point to show the ticker symbol for the company.
Why would a company that wants to sell coffee advertise its stock?
Because they wanted to hype the stock up so they could sell it at a high price, and let insiders get rich while leaving others holding the bag.
It was a classic OTC pump and dump campaign. But, rather than sending out hard mailers across the country to people’s mailboxes as had been previously done with other pump & dumps, the stock ads were primarily done on the internet.
The campaign was very successful. In early 2011, JAMN went from trading around 50K shares per day at a price of around 50 cents, to over 1 million shares per day. The stock eventually went parabolic, hitting a high of $6.35. And, like every other pump and dump, it would collapse and lose all of its gains.
JAMN now trades for .001 cents.
Before the SEC cracked down on OTC pump and dumps, they were common. I’ve even written about them in the past in their connection with the nutrition industry. One factor in common with all of them is they involved advertising the stock in some fashion. For JAMN, it was through internet ads. For many others, it was often through pamphlets or newsletters you’d get in the mail like these ones for MSEH:
Or this one for NXTH (which still trades for .005/share). This one even included Shaquille O’Neal in the pump.
You’ll note that all of these focus more on the stock rather than the company and its product. And that’s because the intent is to get you to buy the stock so that the people behind the paid pump could dump their shares (often which they had obtained for no cost at all) on you. The fine print would disclose that these were paid stock promotions, like this one for MSEH:
“Swiftwood Press, LLC…was reimbursed by Northbound Marketing Group LTD for certain expenses it incurred in connection with its analysis and investigation of the companies profiled herein….Northbound Marketing Group LTD received monies from shareholders and paid seven hundred fourteen thousand, one hundred six dollars to marketing vendors, to pay for all the costs of creating and distributing this report.”
But people usually don’t read the fine print.
Crypto: The New Paid Pump
You don’t see as many paid OTC stock promotions since the SEC has cracked down on a lot of them. But that hasn’t stopped paid promotions in general. They’ve just found a new home: cryptocurrency.
This was on the side of a London bus: an advertisement to buy Bitcoin.
The ads also appeared in the London Underground, and the ads eventually got banned. This also isn’t the first ad to get banned in the UK. Here’s another one encouraging investment in Bitcoin.
Full-page ads to get people to buy Bitcoin also appeared in Hong Kong tabloids. I wish I had screen captured them at the time, but I’ve been served Facebook ads in the past on Bitcoin.
And it’s not just ads for Bitcoin. It’s also ads for other crypto, like this ad with James Altucher.
Legit Companies Don’t Advertise Their Stock
Whenever you see paid ads promoting an investment, that’s a major red flag. The people promoting the investment aren’t looking to help you. They just want you to buy at a higher price. They’re playing the greater fool game, and they’re hoping you’re the greater fool.
They’re playing the greater fool game, and they’re hoping you’re the greater fool
Legit companies don’t advertise their stock. When I go to Costco’s website, I don’t get advertisements to invest in Costco. When I see ads for Target on the internet, those ads don’t tell me to invest in Target stock.
Why? They don’t need to. They have real products to sell. They make money through their business operations…not by selling stock.
Crypto is nothing like this. There is no underlying company or asset. Its only value is what someone else is willing to pay for it. It’s purely based on belief.
The Similarities Between OTC Pumps and Crypto
Crypto is more similar to the OTC pump and dumps. Here’s a list of the similarities:
1. LITTLE OR NO UNDERLYING BUSINESSES OR ASSETS
Most OTC pump and dumps were shells with no business operations. Of the ones that were business operations, they had little to no revenue and severe losses (JAMN had a cumulative 750K loss through April of 2011). Crypto is the same. There is no underlying business or asset for crypto. There’s literally nothing underneath it other than people’s beliefs.
2. PARABOLIC MOVES
Parabolic moves were common with really successful pumps. JAMN wasn’t the only OTC pump & dump to undergo a parabolic move and crash. Here’s LEXG from 2011.
Similar to the parabolic moves that some OTC pumps like JAMN and LEXG went through, cryptos have undergone parabolic moves and now in the midst of collapses.
3. LITTLE REGULATION
The OTC markets have much less regulation than the NASDAQ or NYSE, making them ideal for scams. This is similar to the crypto world, where there’s very little regulation which makes them a hotbed for scams.
OTC pump and dumps are a negative sum game for everyone but the stock manipulators. This means investors as a whole lose money. It has a negative expectancy for investors, meaning the average investor loses money.
This means that, just like the OTC pump & dump, crypto has a negative expectancy … the average investor will lose money on it.
This is very different from the stock market. The average investor who invests in index funds over the long term will make money and have a positive expectancy. It’s a positive sum game because the stock market is tied to economic output. There are real companies with real assets, cash flows, profits, and products underlying the stock market. That’s not true with crypto.
5. EXCITING LANGUAGE
If you look at the paid OTC mailers I showed you earlier, you’ll see a lot of language to excite you. Not only are there mentions of potentially large returns, but you’ll see words and phrases like “Revolution”, “the Saudia Arabia of Natural Gas”, “reshaping our country”, etc. They all promise that you’re getting in on the cusp of something exciting and new. Of course, these claims weren’t even close to reality.
The claims being made about crypto are no different. I’ve seen massive price targets put on crypto (like $250K for Bitcoin). I’ve heard crypto described as “revolutionary”, “disruptive,” “like the beginning of the internet”, “you’re getting in on ground floor”, “the latest technology”, etc. Of course, none of it’s true.
The emperor has no clothes, yet there’s a lot of people getting all excited about how good the emperor’s clothes look.
It’s not revolutionary or disruptive. “Blockchain” on which cryptocurrencies are based is simply technobabble for a type of encrypted decentralized database, and there’s nothing revolutionary about it. It’s not “disruptive” either. The last time I checked, Bitcoin, despite being around for 12 years, is only accepted by less than .01% of U.S. businesses (many of which are likely just crypto-related companies anyway). It’s extremely energy inefficient (currently, the average Bitcoin transaction takes enough energy to power a U.S. household for over 40 days…the same energy that it takes to do 1 million Visa transactions). It’s extremely slow (the Bitcoin network can only do around 7 transactions per second). The massive inefficiencies and energy consumption make them unscalable. The volatility makes cryptocurrencies unusable as currencies or as stores of value. They contribute to massive hardware waste. It’s unsustainable since the massive energy consumption only grows as the network and price go up. It’s also not like the beginning of the internet. From the 12-year period of 1992 to 2004, the internet showed rapid development and expansion to where EVERYONE was using it and it became a major component of everyone’s lives. In the 12 years of Bitcoin and all its crypto children, the only substantial changes have been in the prices, and the massive network energy consumption. I could go on and on, but there’s a massive gap between the supposed promises and language surrounding crypto and the reality. The emperor has no clothes, yet there’s a lot of people getting all excited about how good the emperor’s new clothes look.
I usually don’t care if people want to play greater fool or zero sum games. Hell, I’m a day trader which is a zero sum game at best. But, I’m very real with people when it comes to day trading. I tell them the stats that 80% of day traders lose money and less than 1% are able to predictably and reliably make money over the long run (which means that I’m in that 1%). I tell them it’s zero sum so that for someone to win, someone else has to lose. I usually warn people against getting into it, even though I day trade myself. And I tell them if they’re going to do it, prepare for a long, hard road before you get consistently profitable (if you ever do).
But people aren’t real when it comes to crypto. I don’t think your average Joe who has gotten into it is dishonest. I just think the person gets caught up in the excitement and emotions about it, and is unable to view it objectively. I think many aren’t aware of the risks (particularly the systemic risks), and/or downplay the risks and overestimate the upside if they do know about them (people in general have poor conceptions of risk/reward…look at the people who are willing to risk COVID but not get vaccinated). I think a lot of people also don’t know just how bad the energy consumption is, and if they do know, they have a tendency to greenwash it. I also think people don’t understand why it’s a negative-sum game.
I’ve gradually become more outspoken against crypto…moreso than your run-of-the-mill stock pump & dump simply because crypto costs all of us without giving us any real benefit. Its massive energy and hardware costs, carbon footprint, and enabling of ransomware (the Colonial pipeline ransomware attack was very costly) are serious problems. I’ve got no problem with people that want to speculate, but unfortunately this is an instance where people’s speculation are costing everyone else…not just the speculators.
I’m the type of person that, when I’m a neutral observer, I’ll read arguments from both sides to get a better idea of what’s going on. And every pro-crypto argument I’ve seen fails miserably. And the only pro-arguments I’ve seen for crypto come from people with a vested interest in it. So you need to ask yourself the question: who’s going to be more objective in their assessment of it? Would you believe independent scientists on the impacts of cigarette smoking on lung cancer, or tobacco companies?
I’ll note that I have friends who have invested in crypto in one way or another, so if you read this, this isn’t anything personal against you. But, just like in the fitness industry, I’m a skeptical, evidence-based person and the evidence isn’t in crypto’s favor.
…what has crypto actually done? What effect on society has it had, other than its ability to generate wealth for the wealthy and arbitrarily make a few others rich? What product has come out of crypto that you use? If crypto was to be entirely eradicated tomorrow, what hole would it leave in the average person’s life unless they’d put money into it?
If you want to read further on crypto, why the major arguments for it fail, scientific sources on its energy consumption, and the problems with stablecoins like Tether, here’s some sources (list updated 02/04/2022):
And this video is probably one of the most thorough educational videos on crypto, NFTs, and Web3 that you’ll find anywhere. It’s over 2 hours long, but has had 2.5 million views as of 1/27/2022.
Crypto-currencies are pyramid schemes designed to enrich the few on the basis of FOMO in the many
DISCLOSURE UPDATE 6/17/2021: When I originally posted this, I had no position in any crypto related instruments. However, given the extreme bubble and the high probability of a collapse of the crypto ecosystem due to a variety of factors, I now have some long-dated MSTR puts.
DISCLOSURE UPDATE 11/15/2021: Given the massive systemic risks in the crypto ecosystem, especially in regards to Tether, I recently decided to grab some long-dated BITO and MARA puts.
DISCLOSURE UPDATE 01/14/2022: Given the massive systemic risks in the crypto ecosystem, especially in regards to Tether, as well as the limited long-term upside and large downside risks to crypto, I recently decided to take a small MSTR short position. However, I may not hold it long term as it will depend upon the daily short interest I have to pay on the position.
DISCLOSURE UPDATE 01/23/2022: I have closed out my long-dated MSTR and MARA puts. I continue to hold BITO puts and a small MSTR short position. I may re-enter new short positions on any crypto market bounce.
February ended up my best month in terms of absolute profits, and my second best month in terms of % return on my capital (122%) … just narrowly missing my best month of 124% in June 2020. It could’ve been better…I didn’t let some winners run enough, and I missed some what would’ve been really profitable trades. I wasn’t green every day, but I was green on most days. Approximately 6 out of every 10 trades were winners, and the size of my winners exceeded the size of my losers. The net gain on my winners was over twice the net loss on my losers. This is what I talk about when I tell new traders that they need to think like the casino and not the gambler. You need to have a statistical edge. You’re not going to win every trade. You’re going to have losing days. You will also have losing streaks. But if you have a statistical edge, you’ll make money over time. It’s not what you make in one trade. It’s what you make when you take 100 trades of the same setup. So do you have a statistical edge in your trading? If you don’t know, you need to start keeping a detailed journal. I generated these stats using Edgewonk, a trading journal that has a lot of cool stats to help you improve your trading.
Unless you’ve been living under a rock for the past week, you’ve probably at least heard about the GME/AMC debacle. It’s been framed as the common man beating Wall Street, the little guy beating the big guy, David vs. Goliath, the Rebellion against the Empire…
Except it’s none of those things. It makes for a good, gripping story, but, like Gary Taubes’s “Good Calories, Bad Calories” book (Gary is really good at coming up with compelling, yet false, narratives), it’s a story that just isn’t true.
The unfortunate thing is that false narratives have consequences. Gary’s false narrative leads people to an irrational paranoia surrounding carbs, a bad relationship with food, and potential struggles with weight loss when his “solution” doesn’t work. The GME/AMC false narrative perpetuated by Wallstreetbets and then spread through the echo chambers of social media has the consequence of causing a lot of people to lose money…some people who can’t afford to lose it.
Now, throughout this piece, some of you may read things you don’t want to hear. But that’s exactly why you need to hear it.
…throughout this piece, some of you may read things you don’t want to hear. But that’s exactly why you need to hear it.
THE TL;DR SUMMARY
If you’re too lazy to read this whole article, here’s a summary for you:
The restrictions placed on GME/AMC trading by Robin Hood and other brokers were not conspiratorial or corrupt in nature. They were necessary to manage the risk caused by the volatile stocks. The brokers and clearing firms were following regulations that have been in place since 1974.
The “little guy” didn’t win. Most little guys lost, and Wall Street won big. Only a few hedge funds with short positions lost.
Shorting is not “bad”, and the anger directed at short sellers is misguided.
GME/AMC became giant pump and dumps, and WSB orchestrated the pump.WSB did more to hurt the average Joe than it did to hurt Wall Street.
The market isn’t rigged against you.
The real reason most retail traders lost money on GME/AMC is because they showed the same bad habits that retail traders have had for years.
I’m not going to go into too much detail as to what happened. Gamestop (stock ticker symbol: GME) and AMC Movie Theaters (stock ticker symbol: AMC) made massive moves up to 1500% this past week due to a combination shorts squeeze/gamma options squeeze. The moves were initiated by a group of traders on the reddit forum /wallstreetbets. Both were heavily shorted stocks, with the hedge fund Melvin Capital and the well-known short seller Citron Research/Andrew Left having short positions. These funds were forced to close their positions which contributed to the massive move in the stock. If you want a more detailed explanation of the GME short squeeze/gamma squeeze, check out Sahil Bloom’s article on it (I highly recommend following his “Allegory of Finance” threads).
POPULIST RAGE
With these funds being forced to close their short positions, and with some WSB people now making money off the squeeze, the events began to take on a David vs. Goliath narrative. Wall Street was losing. The little guys were finally taking out those evil hedge funds.
Mr. Hedge Fund, don’t make me angry…you wouldn’t like me when I’m angry
The story took a conspiratorial turn when Robin Hood and other brokers restricted trading in the stocks due to the extreme volatility. This was viewed as the Big Guy changing the rules to stop the Little Guy from winning. The populist rage swept through the media. Even politicians started to get into the act, with calls for increased regulation. “Those corrupt brokers are in on it! The market is rigged against us!” said the little guy.
Suddenly, more and more people wanted to get in on the GME/AMC action. Everyone wanted to kick Wall Street’s ass now. “Let’s all herd together and buy more stock, forcing those evil shorts to cover more!” they yelled. I saw people on my FB feed now wanting to jump in. WSB became full of people exclaiming “Hold the line!”, encouraging people not to sell their positions. It was war.
Unfortunately, it was a war against the wrong people. It was a war based on misinformation and misconceptions of what was happening. And a lot of the little guys are now holding the bag.
Let’s get into all the misinformation and misconceptions, why the whole story was wrong, and why the suits won (spoiler alert: it’s not for the reasons you think).
ROBIN HOOD: TAKE FROM THE RICH, GIVE TO THE POOR, OR VICE VERSA?
First, let’s address the idea that Robin Hood was somehow conspiring with the suits by restricting trading in the stock. The reality is much less nefarious.
When you trade stocks through a broker with a margin account, you’re not the only one taking on risk. The broker takes on risk too, and there are regulations in place to make sure your broker manages that risk appropriately.
The decision by Robin Hood to restrict trading wasn’t due to some conspiracy with the suits. The restriction on trading happened across multiple brokers, not just Robin Hood. In fact, even some of those evil hedge funds were restricted from trading the stock. And there weren’t just restrictions from the long side. I wasn’t able to short GME at Cobra Trading because their clearing firm Wedbush wasn’t allowing shorts (I was able to short at Vision Financial, however).
The restrictions were necessary because the volatility had gotten extremely high. There were so many people with accounts trading these volatile stocks that the clearing firms didn’t have the cash to make sure that trades would be settled. Here’s an excellent explanation as to why Robin Hood and other brokers had to restrict trading in GMC and other highly volatile meme stocks.
Good explanation on today's trading halts by Robinhood and others in tonight's Closer. pic.twitter.com/N89T4Lw4bD
The fact is, Robin Hood and the other brokers were simply following the regulations that have been in place since 1974. There was no corruption or anything nefarious. Really, the restrictions on the stock were the fault of WSB and the masses of traders who created such massive volatility in the stock that put the brokers at risk. The WSB army didn’t hurt Wall Street, but it was starting to hurt the brokers that WSB traded through, and the brokers had to put a stop to it. WSB was biting the hand that fed it. And, as a result, WSB ended up hurting the retail traders.
WSB was biting the hand that fed it. And, as a result, WSB ended up hurting the retail traders.
The fact is, the brokers and clearing firms have every right to manage their risk. This is why the class-action suits being brought against Robin Hood won’t amount to anything. In fact, it says right in Robin Hood’s customer agreement form (the thing that most people don’t read) that they have the right to restrict your trading. Under section 16, “Restrictions on Trading.”
I understand that Robinhood may, in its discretion, prohibit or restrict the trading of securities, or the substitution of securities, in any of My Accounts.
People acted surprised at the restrictions on trading. But restrictions on volatile stocks are nothing new. For example, Interactive Brokers has been placing margin restrictions (often overnight without warning, forcing liquidation of people’s positions) on volatile stocks for years.
Also, it’s not like Robin Hood prevented people from taking profits on their positions. They only restricted people in the creation of new positions or adding to their existing positions. If anything, that may have saved people from losing even more money on the ensuing stock dump. In trading, adding to a loser usually isn’t a good idea and only compounds losses (this is different from dollar cost averaging on long-term investments, assuming it’s actually a good investment).
That said, it doesn’t mean I think Robin Hood is totally innocent in all this. As Packy McCormick writes, Robin Hood’s business model encouraged reckless trading that eventually led to Robin Hood getting a margin call of its own and having to get $1 billion to avoid a cash liquidity crisis.
Another irony is all the little guys using Robin Hood and other free commission brokers to do their trades in their fight against the big baddie hedge funds. They don’t realize that these brokers sell their order flow to high-frequency trading institutions like Citadel. How else do people think these commission-free brokers make their money? They’ve got to get it from somewhere. By using Robin Hood, you’re helping out the big guy. My two main brokers Cobra Trading and Vision Financial don’t sell their order flow. I pay commissions (0.004 to 0.005/share) and I can route my orders directly to exchanges. You get what you pay for.
The populist rage spilled over to hedge funds. But no, not just any hedge fund. It was hedge funds that like to short stock, because shorting is the work of Satan.
A short is nothing more than a bet that a stock will go down, just like a long is a bet that a stock will go up. So I ask all the people out there who think shorts are “bad”…why is it only OK to bet that a stock will go up? I didn’t know that betting on a stock direction was moral if the bet is for one direction, and immoral to bet on the other direction.
Why it is only OK to bet that a stock will go up?
People that know me personally know that I’m a “good guy.” I’m extremely ethical in the way I run my businesses and the way I treat others. So because I make a lot of short bets in the stock market, does that suddenly make me evil and manipulative? Why? I’m only betting on price reversals.
Me shorting the stock isn’t going to impact the price. The stock is going to go up or down. Either I’ll win or lose. Big deal. The bet that I take is irrelevant to the outcome.
“But shorts manipulate the market!!!” you say? Where is your evidence for this? And I want hard data, not speculation. Remember, I’m an evidence-based person, and not just in the exercise/nutrition industry.
The fact is, when you look at the hard data, the evidence shows the opposite. As Michael Goode writes:
“While bear raids are legend on Wall Street, there is much less evidence of bearish stock price manipulation than there is of bullish manipulation, even back in the wild days before there was much stock market regulation. So while tens millions of dollars of illicit profits are made each year in pump and dump schemes there have only been a couple of ‘short and distort’ schemes prosecuted in the last couple decades (in fact, of the two cases of which I am aware, Anthony Elgindy’s case involved no distortion; his crime was conspiring with FBI agents to gain information on companies actually being investigated by the FBI).“
“I don’t think you understand how shorting works. Nobody shorts a stock to “ruin” the company. Shorts can’t “ruin” a company no more than longs can make a company successful. Shorts are only betting that the stock will go down for some reason (fraud, bad business practices, bad financial position, highly overextended and thus high probability of reversal, etc.), no different from longs betting a stock will go up for some reason (good product, etc). Enron didn’t fail because of shorts. It failed because they were engaging in fraudulent business practices. Jim Chanos just happened to be short. Luckin Coffee didn’t get delisted because of shorts. It got delisted because it was engaging in fraud. Carson Block just happened to be short. But Block or Chanos didn’t force those companies to fail.”
The person went on to say that he had just turned $4000 to $40000. My response:
“I think that’s great! But also keep in mind, if you made that money on GME or one of the other short squeezes, the very thing you’re hating on (shorts) is the reason you made that money. You can’t have short squeezes without shorts.”
The funny thing is, in my own anecdotal observation, I’ve found shorts to be much more knowledgeable about the companies they investigate than longs. It takes a lot of due diligence to dig up the dirt that people like Carson Block do.
Of coure, nobody loves to shit on shorts more than billionaire-now-turned-man-of-the-people Elon Musk. Musk, despite being a smart guy, also has a huge amount of Dunning-Kruger in him (his pontifications on COVID were one example) and says some really stupid things…like this comment on shorts.
u can’t sell houses u don’t own u can’t sell cars u don’t own but u *can* sell stock u don’t own!? this is bs – shorting is a scam legal only for vestigial reasons
Never mind the fact that people buy houses and cars (including Teslas) with money they don’t own (they borrow it from the bank). Also never mind the fact that most people buy Tesla’s stock with money they don’t own, since they’re using margin accounts.
The irony of this tweet is that Elon wouldn’t be nearly as rich as he is without shorts. @team3dstocks on Twitter explains this very nicely:
“Shorting is a scam”… says the man who’s now worth over $200 bili because of bent shorts. Sit down. 🪑 https://t.co/Cxn4V7M5oC
He (Elon) complains about shortselling meanwhile EVERY big investor/fund that invests in stocks (including $TSLA) do so confidently b/c they have the security of being able to hedge their portfolio with Puts. And for dealers to write Puts, they have to SHORT the stock to hedge. https://t.co/wVeII02g0E
Not to mention shortsellers provide incredible liquidity & slow down the descent of tanking stocks (via covering). So for him to tweet out dumb shit like this to make shortsellers look bad to his minions is hypocritical as fuck. $TSLA wouldn’t exist without shortselling, period!
With the Fed and its constant QE and printing money, low interest rates, and massive influx of retail into the markets, you have an environment where every dip will get bought and the markets will just continue to climb. You will have constant speculation and ignorance of risk. The quality of the companies are completely irrelevant. For example, the evidence is absolutely overwhelming that GSX Techedu is a complete fraud. But that hasn’t stopped the markets from bidding it up to $150/share, and wiping out shorts in the process.
The other problem with long-term shorts is they can get crowded on the short side. Funds take long-term short positions when a company is in bad shape. It’s the reason why short interest on GME was so high. It becomes pretty obvious to many that the company is in bad shape, so you can end up with a lot of shorts on the trade. Adding fuel to the fire is when well-known short-biased entities like Citron (Andrew Left) or Muddy Waters (Carson Block) publicize their short positions and their evidence against the companies they’re short. This invites a lot more shorts (including retail shorts) to join the trade. This can make the short side VERY crowded.
And here’s the additional problem. When you advertise your short position, you’re inviting people to trade against you. This includes other big funds. And with the various factors I mentioned earlier that favor stocks going up, and a highly crowded short, you’ve now got the ripe conditions for a major short squeeze.
This is what happened to GSX Techedu last year. Many short-selling firms published their criticisms of the company when it was trading in the 30’s and 40’s. It proceeded to then more than triple in price in a matter of weeks, hitting $150/share, and blowing out the positions of some of those firms in the process. And what happened to GME this past week is what happened to GSX Techedu, except it was like GSX on steroids given that the short interest was much higher, you had the WSB army and way more retail piling in, and you had the options gamma squeeze on top of it.
After all this happened, I predicted that you’d see short-selling firms to no longer advertise their short positions, as to not crowd their own trades. In fact, I texted my friend and business partner Chad Landers on January 27th and said this:
The market has a way of closing the gap. When someone finds an inefficiency in the market to be exploited, the market eventually adjusts. It’s why most public trading strategies stop working. When everyone starts following a strategy, the trades get crowded and they no longer work because everyone’s trying to buy and sell at the same time. The same is going to be true with the WSB army. The strategy of finding heavily shorted distressed companies and inducing a squeeze won’t work for very long. Funds will stop taking long-term short positions, or adjust the way they do their short positions. Well-known short-sellers will stop advertising their short positions. Big funds will find ways to take the other side of the WSB strategy and shut it down.
It’s the reason why I’ll never tell people my exact strategies, how I choose entries and exits, etc. I don’t want to crowd my own trades and ruin my edge. Sure, I’ll teach people the concepts my trades are based around, but I’ll never give the specifics. It’s why you want to be wary of any trading service that teaches you an exact strategy. If the strategy works so well, why are they giving it away and potentially ruining its edge? The best trading education sites give you concepts, and you need to develop your own specifics from those concepts. @shortdapos on Twitter also recently talked about this:
It’s also the reason why I won’t manage or trade other people’s money. It would crowd my own trades. Plus, becoming a fund manager puts me under a different set of regulations and required licensure.
THE MARKET IS RIGGED … AGAINST SHORT SELLERS
All of the people bitching about how the market is supposedly rigged by short sellers (despite the evidence showing the opposite as I pointed out earlier) don’t realize how difficult short selling is and how the rules and market structure strongly favor the long side. I already mentioned the various factors that work against long-term shorts earlier.
There’s even more factors working against both long-term and short shorts.
For example, when you’re short, you have to pay short interest on your position. This short interest can be very high…sometimes 100% or more annually of your position size, making long-term shorts unprofitable.
Some stocks (like many of the ones I trade) are hard-to-borrow. That means you need special brokers like Cobra Trading, Vision Financial, or Centerpoint Securities to be able to locate shares. You also pay a per-share fee to locate these shares. Sometimes the fee can be substantial. For example, to short GME, I paid $1.73 per share just to locate shares (my commissions, by comparison, are only 0.005 per share). You also have to locate these shares ahead of time to reserve them. So if you pay for them and don’t use them, you don’t get that money back. It also adds to your loss if you happen to get stopped out on a trade. Some brokers, like Centerpoint or Tradezero, charge you extra to hold the short overnight…as much as 5 times your original borrow cost. So if I had shorted GME at Tradezero, I would’ve paid $8.60 per share just to hold the short overnight.
Borrows are first-come, first-serve (some brokers like Interactive Brokers don’t even let you reserve ahead of time…you just try to short and either the borrows are there or they aren’t, and they’re usually gone by the time you want them). It’s why I have to wake up at 4 AM each day to do locates. I’m on the west coast, and I’m competing with traders on the east coast for borrows who are up at 6-7 AM. Now, the fees and early wake time are worth it to me…I make way more money than what I pay in the fees (GME dropped over $200 per share from my $350 short entry, so the $1.73 per share borrow fee was no big deal).
On top of all this there’s the uptick rule. If a stock falls by 10% or more during the trading day, the uptick rule comes into effect. This means you can’t short the stock by simply hitting the bid. You can only short on the ask (i.e., you have to put in your order at the ask or higher, and wait for the price to come to you to fill your short). So you can have a stock that skyrockets 300% within days, and drops a mere 10%, and the uptick rule goes into effect, which is pretty ridiculous.
The bottom line is that shorts are an imaginary bogeyman…
…and the hatred for hedge funds taking short positions, and for shorts in general, is ridiculous.
On Reddit, HFs are reaching cop and Trump levels of hate. How did we get labeled the ones who fuck over the poor for shorting stocks while every public company executive makes $3+mm per year, PE is making out like bandits, pump & dumpers are running amok, and stocks are RIPPING?
Reading all these moron takes on short interest and hedge fund conspiracy theories, I think I can now truly appreciate how doctors must feel when they stumble into a "big pharma is making money giving our kids autism with vaccines" discussion.
Scapegoating a single supposed villain (hedge funds taking short positions in this case) has a powerful emotional impact on people. It’s why it’s so easy for people to believe Gary Taubes when he points to carbs as the cause of obesity. Unfortunately, in both cases, the fingers are pointing at things that aren’t even villains. This leads to unfortunate outcomes. In the nutrition world, it leads to unsustainable dietary practices and an irrational fear of carbohydrates. In the finance world, it leads to people making threats to the children of fund managers.
The fingers are pointing at things that aren’t even villains
That’s not the say there aren’t some bad apples in the hedge fund industry. There are. For example, Rajat Gupta was a hedge fund manager who was sentenced to prison for fraud and insider trading. That’s also not to say that there aren’t games that go in the markets, particularly on the day trading side. High-frequency trading algorithms, order spoofing, and other games are ever present. These games don’t matter as much if you have longer time horizons, though. And, ironically, all the WSBers and retail traders who piled in trying to “bring down the suits” helped the suits who like to play these games.
Really, there was so much irony and contradictions in this situation it’s both amusing but also sad when you consider the consequences of it.
…insane prices as some sort of heroic act was just one of the most surreal and mind blowing thing I have ever witnessed and most incredible demonstration of herd idiocy… I can't believe this, I cannot… 😶 $GME$AMC#WSB
If these big baddie hedge funds are so good at manipulating the market, why is it that they’ve mostly underperformed the market in recent years? If they could manipulate the market so easy, they’d be dramatically overperforming it.
You also have to consider that there are hundreds of hedge funds, all competing with each other. They’re all trying to beat the market and attract more investors. It’s not like they’re all conspiring with each other. It’s pretty tough to manipulate the market when you have hundreds of other funds competing against you.
However, you certainly can manipulate the market when you’ve got a message board filled with millions of retail traders who will chase anything that moves.
MARKET MANIPULATION … BY WSB, NOT THE SHORTIES
It’s ironic that all the people decrying “manipulation” are in fact engaging in manipulation. As I wrote recently in this FB post, GME and AMC are giant message board pump and dumps. I’ve seen many of these in my years of trading, but this one is just on a much more massive scale. It’s just a game of musical chairs, but at some point the music stops, and retail is always the one left without a chair to sit in (the retail that decided not to take profits). And people on WSB forums were encouraging people not to sell/take profits (“Hold the Line!”), which was just asking them to become bagholders. The only little guys who didn’t get screwed on this were the ones who decided to take profits while they still had them.
The fact is that the demand generated for GME was completely artificial. Yes, WSB/retail might have lit the fire that caused the short squeeze, but the squeeze is done now. But everyone kept trying to keep the demand going by constantly telling everyone to “hold the line” or buy more. The difference with this pump and dump and others is that it’s just out in the open. But it’s a pump and dump, nonetheless.
As I wrote in that FB post, trading is all about supply/demand imbalances. GME skyrocketed because WSB decided to artificially create demand/pump a highly shorted stock, which then created further demand through forcing long-term shorts to cover and also generate a gamma squeeze through the options. This is what happens when one side of the trade is crowded. In this case, the short side was crowded (a huge % of the float was short GME), and demand then drastically outweighed supply.
However, what happens when the long side of the trade becomes crowded? Eventually, demand starts to dry up. As the price goes higher, you’ll get less and less people willing to buy, and the early shorts are already gone so there’s no covering shorts to fuel the price higher. Now the trade is crowded on the long side, which is then a recipe for a massive panic sell. You don’t want to be on the wrong side of a crowded trade. For the same reason you don’t want to be short like everyone else (Citron learned this the hard way), you don’t want to be long like everyone else.
Trading is a zero sum game. For someone to win, someone else will lose.
Trading is a zero sum game. For someone to win, someone else will lose. And you only win if you take your profits. Retail kept crowding the long-side of the trade, and they got the opposite of the short squeeze and ended up holding the bag.
Turns out playing a game of Prisoners' Dilemma with a few million of your closest friends was never going to end well. Who knew?
One major false aspect of this entire narrative is that somehow the little guy finally stuck it to the big guy. But as Jamie Powell writes, high-frequency trading firms, market makers, investment banks, and yes, hedge funds, are reaping big profits right now. Here’s an excerpt:
And as @pitdesi tweeted, Silver Lake was at risk of losing most of the $600 million in debt they put into GameStop in 2018. So WSB actually helped the suits by helping them to get out with a $113 million profit.
Silver Lake sold 44M shares of $AMC on the Reddit rally; avg exit price: $16.05
They were at risk of losing most of the $600M debt they put into the company in 2018, but were able to sell out in this rally with a $113M profit!
So, the suits won…and they won big. And they won big because of all the little guys piling into the market and chasing trash. And, as usual, the little guys were left holding the bag.
All these “little guys” think they’ve won because a few funds with big short positions blew up. They don’t realize way more big boys have won than lost on this. And all these WSBers urging everyone to “hold the line” just caused everyone to become bagholders.
Do you really think your little 1 share buy orders would be enough to overcome the big boys, even if there are a lot of you?
One of the guys at Gravity Analytica showed a snapshot of the time-and-sales for GME on Monday 2/1. Lots of tiny buys, followed by a huge sell, overwhelming all of the tiny buys.
The people with the bigger pockets were just selling into all of you buying into misleading WSB information on GME.
The bottom line is this…WSB pumped a stock hard, sucked in a lot of retail and Wall Street benefited big from the stock pump.
The bottom line is this…WSB pumped a stock hard, sucked in a lot of retail and Wall Street benefited big from the stock pump.
IT’S NOT ME (THE MARKET)…IT’S YOU
Quit claiming the market is rigged against you. It’s not. It’s just that most retail traders have terrible habits that make it seem like the market is rigged against them.
The market is rigged. It is rigged to reward traders who are thorough, calm and most importantly – patient. That is how it is rigged. If you are thorough, calm and patient you will beat Wall St. If you aren't. You won't.
If the market is rigged against the little guy, how is it that I’m able to show the trading performance that I do? Here’s my returns on my day and swing trading accounts since January 2019.
My friend and business partner Chad Landers is more of a buy-and-hold long-term investor. He’s been out-performing the bull market for the past 10 years, averaging around 26% per year. How can he, a personal trainer with his own gym, do this if the market is supposedly rigged against him?
You want to know why we’re able to do these things?
It’s because we don’t behave like the typical retail trader or investor.
You want to know why I do most of my trading in the small cap market?
It’s because the small cap market is dominated by retail traders, and retail traders have really bad habits. My trading strategies are built around taking advantage of those bad habits. And because retail traders have had the same bad habits since the dawn of online trading (and will continue to do so…GME/AMC are the poster children for these bad habits), it allows me to consistently make money in a variety of market conditions. Sure, there’s some limits to my scalability of my returns with the small cap market, but I don’t care. I still haven’t come close to those limits yet.
Retail traders have really bad habits…GMC/AMC are the poster children for these bad habits
Retail traders LOVE to chase trash, no matter how high. They will chase stocks that are up 1000% within days with no thought of the risk they’re taking. They get major FOMO and want to get in because everyone else is. They think the move is just going to keep going higher and higher. Judging by my FB feed, there were a lot of retail newbie traders buying GME in the 300’s, despite it having already run 1500% in a matter of a few weeks. These people were just asking to become bag holders.
That’s not to say that GME couldn’t have gone higher from the 300’s-400’s. However, the probability of it going higher was rapidly vanishing.
That’s another problem that retail traders have. They don’t think in terms of probabilities. They only think in terms of the reward and not the risk. They have poor assessments of risk-reward setups. The downside risk of GME was EXTREMELY high. Retail kept buying GME in the 300’s thinking “gamma squeeze!”, despite the fact that the squeeze was over. They were late to the party.
To everyone out there trying to figure out what the net shares held short is for $GME. Stop. No one's data is accurate. No one's calculation is accurate. And, it doesn't matter anyways since you can't estimate buying pressure for any day in the future based on past trading.
Retail traders often don’t take profits when they have them. This is evident by all the WSBers wanting to “hold the line” despite some probably being up nicely on their positions. They treated their trade like a long-term investment, watching their unrealized profits whither away as they became bagholders. Peter Robbins recently described what’s most likely going to happen here.
Last week many new traders learned lessons on Short Selling and about a Short Squeeze.
Stay tuned for next weeks lessons on Paper Profits and Bag Holding.
Retail traders get emotionally tied to their trades or investments. This clouds judgement. The response by so many retailers to the warnings we gave about GME or AMC was predictable. They claimed we were just short and trying to bash the stock to bring it down. They ignored all the warning signs because they were emotionally caught up in the “we’re going to bring down the suits” war, which was a completely false narrative to begin with.
I made this mistake with my GSX trade last year. I got emotionally tied to the short position (“Its a fraud!!! You hear me? FRAAAUUUUUUDDDDDD!!!!”), and so I kept trying re-short it as it went higher, despite it not being a part of my usual strategies. I eventually and wisely gave up on it. It’s another reason why I won’t do long-term shorts…it’s too easy to get emotionally tied to the trade.
The funny thing about the responses I or other experienced traders would get regarding GME is that any trade I do take on GME is just another trade to me. I’m not emotionally tied to my trades and their outcomes. 60% of my trades are winners and 40% are losers, and I generally don’t hold my trades longer than a day or two. Whether I win or lose on any GME trade I would take, I don’t care. It’s just one among many trades that I’ll take. I make money over the long run because I win more often than I lose, and the size of those winners exceeds the size of the losers. I’m thinking like the casino, not the gambler. If you want to make money trading the markets, you have to learn to think like the blackjack dealer at the casino. The dealer doesn’t win every hand, but statistically over time, the casino wins more often than it loses, and takes the money away from the gamblers. The retail traders are the gamblers in this scenario. They’ll win some, but over time they’re the bagholders because they’re acting like gamblers and not the casino.
They’ll win some, but over time they’re the bagholders because they’re acting like gamblers and not the casino
Now, I’m not saying I’m a total robot. I still feel emotions when I trade, and they’ve occasionally impacted by trading judgement. But I’m much closer to trading like a robot than when I first started out, and I trade much better because of it. You want to stop giving money to the big guy? Then you need to stop trading like other retail traders who trade on emotion.
When retail traders lose, they’ll blame the supposedly rigged market on their losses. Barstool’s Dave Portnoy said he lost $700K on GME and AMC, and then proceeded to blame Robin Hood’s CEO Vlad Tenev for his losses. My response:
Nobody stole it from you. You chased parabolic trash like every retail trader does and you lost. You had no idea what you were doing and you lost. You gambled and you lost. https://t.co/ifqBEl0wnX
Look, I get it. When you first start trading and you’re struggling, it can be tempting to want to blame anything else other than yourself. When I first started, I would often blame the pattern day trader rule on my lack of success. I constantly felt like my hands were tied by it. I bitched about the rule and even sent letters to the SEC and FINRA. Why should these big organizations restrict my trading! It wasn’t fair! The market was rigged against me!
But all the bitching and moaning about it wasn’t going to change anything. The rule has now been in place for 20 years. It’s not going anywhere. So you have to find a way to work around it. What I did was open accounts with three different brokers. That way, I got at least 9 day trades per week rather than 3.
The PDT is now a distant memory for me since my account sizes are well beyond it. I still think it’s a bullshit rule, but it doesn’t matter what I think. You’ve got to work with the environment you’ve been given. You can bitch and moan about hedge funds or shorts or whatever supposed market evil is out there, but those aren’t the reasons why you’re not making money in the markets. You’re not making money in the markets because of YOU.
You can bitch and moan about hedge funds or shorts or whatever supposed market evil is out there, but those aren’t the reasons why you’re not making money in the markets. You aren’t making money in the markets because of YOU
Retail often jump into trades with no plan and no exit strategy. I’ve gotten messages from people asking me what they should do with their GME or AMC positions. My question to them is, “Did you have an exit strategy before you entered the trade?” Hope is not an exit strategy.
Hope is not an exit strategy
THE HARDEST EASIEST WAY TO MAKE MONEY
Another reason retail traders usually lose because they’re trying to get rich quick. They think trading will be easy money. Here’s a text exchange between Chad Landers and I:
Of course, these people will be in for rude awakenings if they haven’t already. Trading is the hardest easiest way to make money. The only easy part is pressing the buttons. The hard part is actually making money over time. And when you tell people that it’s really hard, they don’t want to hear it.
Yup. the good old "hey bro I have $X amount, what stock should I put it in" question from friends & family. and when u try to protect them or explain that trading is NOT easy, they say "u're just trying to keep all the money to yourself. U're a bad friend" etc. Drives me irate https://t.co/l9ZUFyYEeq
Another reason the retail traders lose to the suits over time is because they chase whatever happens to be the hot trend, and usually by the time a lot of them get in, it’s too late. I was seeing a bunch of people of people on my FB feed talking about how they were buying some GME shares and how they want to screw the suits. Keep in mind most of the people in my FB feed aren’t traders but rather fitness professionals. Nate Michaud of InvestorsUnderground mentioned that close family members of his were forming scary opinions regarding GME. The wild conspiracy theories that WSB was promoting and that people were starting to believe were getting out of hand.
Reading Wall Street Bets these last few days and I absolutely understand how things like QAnon get started
I got a PM from someone claiming GME is going to $1,000. The delusion is strong.
These are huge red flags. Usually when everyone and his grandma are getting in on the action, and you’ve got a cult-like mentality surrounding a stock and people becoming detached from reality, it’s a sign that the party is coming to an end, if not having ended already. This happened with Bitcoin back in late 2017/early 2018. I remember my FB feed being loaded with fitness professionals talking about bitcoin…FITNESS PROFESSIONALS. Everyone and his dog now were in it (maybe that’s why we now have dogcoin, err, I mean dogecoin?), people had formed cult-like beliefs surrounding Bitcoin, the trade had become super-crowded, and it had a spectacular crash during that time.
The same thing happened with the housing market in 2007-2008. Everyone and her mom were getting into buying houses, flipping houses, taking out mortgages, etc. This is dramatized in the movie “The Big Short” in the scene where Michael Burry (played by Christian Slater) meets a stripper who has taken out mortgages on 5 houses and a condo. We can check out a chart of the Case-Shiller home price index to see what happened next.
You can see the chart going parabolic before it crashes down, exactly like the Bitcoin chart. FOMO is a big factor behind these parabolic charts. People hear about other people making money on something, and they want a piece of the action too. They don’t want to miss out, so they jump in, risk be damned. And when enough people with FOMO have piled in, well, it’s fairly predictable what eventually happens. And this is exactly what happened with GME.
WHAT GOES UP MUST COME DOWN
In fact, parabolic charts are a great warning sign of impending crashes, because such parabolic moves are unsustainable. As Nate Michaud of InvestorsUnderground writes, gravity eventually has to take over. Because it always does. It’s just basic supply/demand dynamics…something the retail crowd didn’t consider with GME or the other recent high flyers.
The parabolic move in GME is nothing new to the stock market. So many people are new to the markets right now that they think this is somehow unique. It’s not. These parabolic FOMO-driven short squeeze moves are common, especially in the small cap world. They’ve happened before many times, and the end result has always been the same. Here’s a sample:
DRYS in November 2016GNUS in mid-2020TRTC January 2018SPCE early 2020NKLA mid-2020KODK mid-2020RKDA early 2018KCPC mid-2017IMTE mid-2018GENE early 2015IGC August 2020IGC Fall 2018
Volkswagen had a famous massive short squeeze in 2008.
I could give dozens and dozens and dozens of more charts like this. They all end the same. Now, while the housing market and bitcoin did eventually recover after a number of YEARS, that’s the exception and not the rule. The vast majority of the time these parabolic stocks never recover back to their original high flying prices. Why? Because the demand was never real to begin with. Once the early shorts are squeezed out, there’s nothing to keep the party going. So if you bought GME in the 300’s and you’re holding because “you only lose if you sell”, well, good luck with that. “You only lose if you sell” is a bagholder mentality.
These parabolic moves aren’t anything new to we experienced traders. The only thing surprising to us is the number of parabolic moves that have been happening in recent weeks. I wrote a FB post about this recently, where I had posted 10 parabolic runners that had all gone just within a week…and that’s just a sample! Under normal market conditions, you might get a few parabolic runners per month. This is suggesting that it’s an all-out stock mania-frenzy out there right now, which is why we experienced traders have been warning people to be careful as we know how all of these end up turning out.
And this is another thing that retail does and why most end up being bagholders in the long run. They don’t even look at a chart of what they’re buying. They don’t ask the important question, “Is this sustainable? What happens if demand dries up?” Demand for a stock is not infinite. If you’re buying into these parabolic runners (like GME), you’re just playing a game of musical chairs. And the music will stop at some point. It’s a FIFO game of who can sell to the greater fool.
It’s a FIFO game of who can sell to the greater fool.
The fact is that many retail traders/investors have NO IDEA what they’re buying. In trading we have a phrase “know what you own.” Many people really don’t know what they own. They don’t read SEC filings, they aren’t familiar with a company’s financials, they don’t know how dilution works, etc. This isn’t only evident from GME…it’s been evident for all of the parabolic runners I showed you earlier. GNUS is a perfect example. All the experienced traders knew that GNUS was a big-time diluter and there would be a ton of warrant-holders exercising and cashing in on their warrants since the stock was up so much. This would have the effect of diluting the current stock owners and decreasing the stock price (since the supply was dramatically going up….remember it’s all about supply/demand). But the GNUS “true-believers” didn’t listen…they had bought in the 3’s, 4’s, and all the way to the 10’s and kept thinking it would come back when it collapsed. They got sucked up into the story like many retail traders do. They began to invest in the trash rather than trading it. They didn’t listen to the more experienced traders. The same thing happened with GME and AMC.
Which brings me to one of my lessons…
LISTEN TO THE EXPERIENCED TRADERS!
We know way more than you do. We’ve been at this game for a long time. Stop assuming every experienced trader that gives you a warning about a stock is just trying to “bash” it. We were telling you to take your profits on GME if you had them. We were also warning people about buying it when it was up in the 300’s. Yet you just kept yelling “DIAMOND HANDS” and trying to get everyone to hold.
$GME The new guys forget that we’ve been doing this for years. We’ve seen every bubble/sector hype come and go. Ebola, forklifts, shippers, weed, blockchain etc. we’ve seen how they all end. So when we kept saying “LOCK UR GAINS & RUN” they thought we were just “hating”. Oh well https://t.co/6tekpc34vQ
I’m amazed at the amount of hate that Nate Michaud of InvestorsUnderground gets when he posts warnings about stocks. The fact is that he turns out to be right most of the time. He’s an expert at trading, and people should listen to experts more. It reminds me of all the countries (like the U.S.) that didn’t listen to the experts when it came to COVID. The countries that didn’t listen are the countries that have fared the worst.
By continuing to tell everyone to “hold the line” and also keep buying GME to “screw the suits”, WSB and others just crowded the long side of the trade. The fact is that the big short funds were already out. The people pushing the “us vs. them” narrative only created a situation for a massive panic sell and a lot of bagholders. Nate Michaud of InvestorsUnderground put it perfectly here:
FACTS: Big hedge funds blown up.
The longer folks push this narrative at current levels more retail traders will lose in the end.
Isn't this against the goal?
At what point does confirmation bias screw you in the end?
These are college students using money they don’t have to buy stock that will be worthless in a couple of weeks based on this sense of false comradery.
Reading their stories on WSB is sad and they keep “holding” because losers keep mashing “diamond hands” on the keyboard.
My question for the people who were buying GME and/or AMC:
WHAT WERE YOU THINKING?
If you were up big on GMC or AMC and your profits are now gone, why the hell didn’t you take the profits when they were there?
$GME it doesnt matter. I have a simple risk management rule: never, EVER let a big winning trade turn back into a loss or breakeven. NEVER. I dont care if it’s the trade of the century. True sustainable profitability should come from hundreds of trades, not occasional lucky ones. https://t.co/B9KQFsZK6C
If you bought GME and AMC near their peaks and now you’ve got big losses, why the hell were you chasing a stock that was up 1500% within a few days based on ARTIFICIALLY-PRODUCED demand?
The after effects of a gamma squeeze may be underestimated. As OTM calls get further and further out MM’s will unwind their “hedges” which creates the reverse augmented effect on the way down. Don’t let a principle destroy your life. $GME
While all of you inexperienced traders were buying GME in the 300’s because you bought into the storyline, I, the experienced trader, was selling (I shorted at 350). I was also posting warnings, but again I got the usual response. Someone PMed me based on my posted warnings and said “We have you running scared.” That was a headscratcher to me because I wasn’t scared at all. GME was just another trade to me. I didn’t care about the story. All I cared about was the odds. And I knew the odds were strongly in my favor based my past experience. And I had risk management in place if the trade wasn’t going to work out (something retail traders often don’t have…proper risk management).
The fact is that people got greedy. People usually accuse Wall Street of greed, but this is a classic case of greed by the average Joe. And when everyone is being greedy, that’s when you should be fearful.
RETAIL TRADERS … ONLY HUMAN
Now, I’m not saying that retail traders are “dumb.” I hate the term “dumb money.” Even experienced traders can make poor trading decisions (Citron and Melvin Capital’s shorts obviously weren’t good decisions on a risk/reward basis). Every experienced trader has been a bagholder at some point in his or her career.
It’s just that retail traders are subject to human nature. Experienced successful traders have learned over time to overcome their human nature. Retail traders aren’t dumb…they’re just inexperienced.
TODAY’S LESSON, KIDS
Basically we have a massive pump and dump where retail pumped stock on other retail, Wall Street won big, most retail lost, and retail is celebrating.
You want to stop giving money to the big guy?
Then stop helping him out.
Stop doing the little guy stuff that the big guy takes advantage of.
Stop chasing trash stocks that have run parabolic.
Stop letting FOMO influence your trading or investment decisions.
Stop making trading or investment decisions based on what everyone else is doing.
Stop chasing the latest hot trend in the markets.
Stop thinking just about your potential rewards and start thinking about your risk as well. Start practicing proper risk management.
Stop gambling. Try to learn to become more like the casino rather than its patrons.
Stop thinking you’re going to get rich quick.
Stop blaming a rigged market or outside forces on your losses.
Stop buying into false narratives surrounding certain stocks. Dig deeper. And don’t just look for what you want to hear.
Stop looking for evidence that just confirms your biases. Know what you own.
Stop buying into conspiracy theories surrounding stocks. Make sure your trade ideas are grounded in reality.
Disclosure: I am a full-time day trader who makes trades mostly from the short side. While I did have short positions in GME and AMC during the process of writing this, I no longer held positions at the time of publication. I’ve been a member of InvestorsUnderground since its inception, and I receive an affiliate commission if people sign up with their services through affiliate links on my site. I am a member of Gravity Analytica, but have no affiliate relationship with them.
