The Market is Always Right

I am a trader. Not like some antiquated Dutch tulip dealer, although that market is pretty cool and my knowledge of it even helped me score points with my old game theory professor at Yale. No, I trade futures, and the futures are...well...in the future.

Gee, no kidding I hear you saying. Yes, I say, and futures contracts have been around for a long, long time...Japanese rice merchants figured out back in the 16th century that a farmer and a rice wholesaler or trader did not want prices to be fixed over time, and in fact prices could not be fixed over time. Charts were created, the x axis being time and the y axis being price. They even created one of the most popular visual aids ever invented to track the market: Japanese candlesticks. Red if the price opened high and closed low, green if the price opened low and closed high, candlesticks could track price over time irregardless of where things in the rice paddies stood.

See, if you farm rice, and you think your fellow farmers out there are going to flood more fields next year and try to produce more grain, you kind of have inside information...that the supply of rice will be higher come harvest time. So if the "spot" price or price right now is at X, you can reasonably expect more supply will make the price drop to X-1 in the future. So you would want to sell your future rice harvest at today's price, would you not?

Enter futures contracts! Clever rice traders began to offer a futures exchange where a farmer could sell his future harvest at a definite price today. And if that farmer was right, if his neighbors did plant more rice and create more supply, relative demand would fall and the price per bushel of rice would drop. Relative to his fellow rice farmers, he would pocket a nice profit. Heck, he could even buy back his own contract, essentially taking ownership of the physical commodity, and keep the difference!

But what if he was wrong? What if instead of an increase in supply there was an increase in demand? This falls under the aegis of "imperfect information". You just can't know all there is to know. Maybe a sudden increase in population, a blight on the rice harvest, or royal government decree to purchase rice...these things happen. Our rice contract speculator would suffer a nasty loss relative to his peers. And what if he didn't just sell his own farm raised rice crop, but also that of his father-in-law, what then? Disaster. People have routinely committed suicide because of financial missteps. Let us hope that our trader's father-in-law has a gentle disposition.

I have seen the evolution of futures markets in commodities such as rough rice, gold, oil, and now cryptocurrency. You can go long (betting the price is going up) or go short (betting the price is going down) the stock market, too. But they all have one thing in common: a zero sum game is going on. If you win, it is because somebody else loses. Returning to the rice trader example, for every buyer there is a seller. If you think the price of rice is going lower, and you sell your commodity at today's price, the buyer of your contract is betting that rice will go up, or "rally" in price. A good example is when a wholesaler needs to secure a rice harvest at a certain price because he has to satisfy business interests for the actual grain to be eaten or processed further. These businessmen need to know their raw materials costs so they can mark up to the retail market and have a secure profit margin.

There's a funny yet all too true saying about trading: "I'd rather be lucky than smart." It's a fact. Most fortunes made come about just because of dumb luck, not skill. You just happened to be in the right place at the right time. I've seen traders during the dot com bubble speculating without any more than a ruler and a crayon, drawing up so-called technical charts and forming opinions about "support" and "resistance" or "head and shoulders" and my favorite, "Adam and Eve bottom". Most of it is self-fulfilling prophecy. It matters because people want it to matter. Same thing with whole numbers, percentages based off moving averages (prices either simple or exponential over a period of trading days such as 20, 500, or 200) or repeating fractions found in nature, also known as Fibonacci. You might have seen a cross section of a nautilus shell, how it creates a symmetrical spiral from tiny to large, with each chamber growing by the same ratio...that's Fibonacci.

All this is well and good, but what about knowing when the market is right and you are wrong? How do you stay clear of that kind of human error? Well, that's why most money in the markets these days is computer driven. When you trade today, you are buying or selling from a computer algorithm. Flash boys, geeks from Silicon Valley, social sentiment trackers, heck they are even re-routing wires to beat the other trader's data feed by a few milliseconds and gain an edge. It's a tough racket pal, and you have to bury your emotions deep. What was it that Gordon Gecko said in that movie Wall Street? Oh yeah...if you want a friend, go buy a dog.

That's why the minute you realize the market is right, you have got to close out your position, lick your wounds, and live to fight another day.

Stop loss. Just what it sounds like...stop the loss by setting a price change at which you say, just like a masked Mexican wrestler caught in a hammer lock, "No mas!".

The market is always right. You can whine and scream about a conspiracy that's causing your position to "go against you". No matter: the market is always right and you best not forget it.