Applying the "Rules of War" to the Market

Jay's market outlook for 24th Aug : European and US markets both declined, and Asian markets are also down this morning. The global short-term trend is clearly down now. we can expect stocks to fall here as well in keeping with the global trend.



Applying the "Rules of War" to the Market, from David Baccile

Bevin Alexander's "How Wars Are Won" details 13 rules for waging war. I'm just beginning the book and hope to provide a review when done. If it is anything like the short 10-page introduction, it will be a rewarding read. I will provide some quotes from the introduction and add some of my thoughts on how these rules of war may apply to the markets.

Both countries (France and the U.S.) tried to fight a conventional, or traditional war against the Vietnamese Communist forces, but the Communists insisted on fighting a guerrilla war. That is to say the Vietnamese used different weapons, and with those weapons they were superior. They, like the September 11 terrorists, eluded strength and struck at weakness.
The rule "eluding strength and striking weakness" is an old rule that all great warriors and commanders such as Napoleon have used to gain advantage.

How may such a rule apply to the markets? In the markets we are not matched against one great commander but many, many great commanders. Large Wall Street dealers with unmatched capital and sophisticated hedge funds both attract the brightest minds in the world to employ technology and methodologies to their advantage. In addition to this group, we are up against large money managers with teams of trained analysts and traders.

How do we, as smaller traders / investors, then elude their strengths and strike at weakness? First, we must identify the weaknesses and they - let's identify "them" as the Chair's "Market Mistress" - do not all share the same weaknesses.

Areas of Weaknesses for the Market :

1. Tied to a benchmark. Perhaps the second worst concept ever created was that of comparing performance to a benchmark (the first being CAPM). Most money managers are pleased if they can beat a benchmark every year by 100 - 200 basis points every year. They adopt rigid styles to keep them invested in a similar fashion to their chosen benchmark.

2. Short-term orientation. With some notable exceptions, Money managers, hedge funds and dealers focus on short-term success. When this short-term orientation is combined with a rigid style, the result is a flocking, or herding of managers within similar styles into the sectors and stocks that are "working" and out of those that aren't.

3. Success get punished. A money manager or hedge fund that performs well is then "rewarded" with a flood of new money as investors seek to garner their share of any prospective success of this talented manager. The additional funds, reduce the managers ability to capitalize on his advantage and the alpha is diluted. This leads to a fourth weakness.

4. Size matters. Successful money managers typically manage large sums which often limits their universe of potential investments. Liquidity constraints may keep a manager from investing in potentially fruitful areas.