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The Idiot on the Other Side of the Trade


So who's the idiot now?

The good thing about writing market commentary every day is that serves as my own diary of sorts. The bad thing about writing daily market commentary is that it also serves as my own diary of sorts.

Earlier this week, I shared a couple of excerpts from columns I wrote back in the day. I suspect more than a few of you found them funny - perhaps even a few of you found them naïve.

Man, I hope so...

While I don't want people to lose my point that what Alan Greenspan said in Jackson Hole last week is no different from what he said in 1999, I also want people to take away a broader lesson.

If you demonize the person on the other side of the trade, you are writing yourself a ticket to the poorhouse. Up until last year, our team had been blessed by broadly clobbering the market. Name a relevant comparator and we chewed it up and spit it out. Many people did this up through March of 2000, but we managed to keep doing it through the end of 2003.

Wow, was I arrogant. Anyone who was shorting a biotech stock we liked was a moron who didn't know a tonsil swab from a rectal probe. When a stock went against us, it was a pack of idiot retail shareholders who got scared out of a position because they didn't listen to us. We were the masters of our domain (back before Seinfeld made that mean something else).

That attitude continued into 2004. While we had serious macro concerns due to the election's effect on FDA policy, on individual names we were as arrogant as ever. While those who have known us for a while point to the Genta (GNTA) debacle as the proximate cause for our performance detonation, that was only a small piece - and if we include our call to do the $8.50 puts as a formal part of our performance calculations, Genta was a wash for us.

I'd like to say I wised up when it came time to write the 2004 year-end review of our performance. Or even when our subscription and renewal volume dried up. The urge to see the other side of the trade as an idiot is so strong, it persisted.

If you see the other side of the trade as an idiot, you completely close yourself off to information that could be crucial to your own risk/reward analysis. They may have a tiny piece of the puzzle you're missing. Or they may have a perspective that completely flip-flops one of your crucial assumptions. If you think they are an idiot, then I guarantee you'll miss it.

Idiots on the other side of the trade abound. I'm going to pick on Toddo because I know he can take it and because I'm pretty sure he didn't actually make this mistake but his position at the time was very well known to the readers here.

It's very popular in certain circles to assume the folks that set monetary policy have no idea what they are doing. That view was somewhat underground for a number of years but it's very broadly advertised now. When Alan Greenspan made equity valuations fair game for monetary policy in 1999, those who thought he was an idiot heard the following:

"Blah, blah-blah blah, blah, blah blah."

What they should have heard is this:

"When I think the economy is too hot, I'm going to strangle the stock market as best as I can. When I think the economy is too cold, I'm going to boost the stock market as much as I can."

In 1999 (and especially in late 2000), I thought Alan Greenspan was an idiot and I did not take into consideration that what he wanted to do was cool the economy down via the market. He told me in 1999 in terms as plain as the nose on my face, but I thought him an idiot and didn't listen.

Todd was a macro bear in 2003 and absolutely had his head handed to him on a platter in a manner only those of us who write daily commentary can truly understand. Alan Greenspan knew the economy was in trouble - all the signs said so. People who bet that those signs would continue to deteriorate were ignoring what Mr. Greenspan said in 1999. While not all those who ignored him thought he was an idiot, I'll go out on a limb and guess the majority of them did.

Whether we look at it from a macro level or down to the micro level of a specific strike of a specific expiration of a specific option on a specific company, assuming the other side of the trade is a moron will lose you money.

Listen dispassionately. Respect their opinion. Honestly incorporate their views into your analysis, though do not feel you have to defer to their views. Gather as much information as you can and then make the decision.

On a panel at MIM-2, Herb Greenberg told a story about a fund manager he really respects. This manager invites bears into his office to chat about stocks he is long. He does this often so he can understand the other side of the trade.

Smart fella.

Avoiding the temptation to demonize the other side of the trade is difficult. I find myself relapsing all the time, though I think I do it much less now than I did a year ago. While it may be a coincidence, our performance is improving and our Subscriber base stopped declining.

Learn from my mistake and open your analytical mind to the other side of the trade.
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