PERFORMANCE ANNOUNCEMENT
As Of: January 27, 2003
THE NEXT BIG THING
The business of Wall Street is constantly evolving. In the 1970's we saw the birth of the discount broker. In the 1980's, institutions adopted program trading and derivatives came of age. Meanwhile, as the stock market climbed, and on the heels of the highly advertised success of Peter Lynch, retail investors flocked to mutual funds. Of course the 1990's will always be remembered for the Internet. An immense quantity of information became available to the average person. It was no longer necessary to call a broker to get stock quotes, ratings, or financial information. The discount brokers moved to the web so individuals could place their own trades at minimum cost. And people believed we were in a "new paradigm" where stock prices would always go up. "Buy and hold" became the mantra of Wall Street.
What next? Well, we now know that prices do not always go up. Stock indexes have fallen for three years in a row. Investors are searching for an answer. At the start of the new year, the Wall Street gurus put forth prognostications on where we can expect to be at the end of the year. Investors hung on every word as if this would be their salvation. But already in the month of January we have learned that the volatility during the year may be more important than where we end up at the end of the year. If the market ends the year up 4% (or maybe down 6%), but has a 30% swing between its low and high during the year, one has to ask if there isn't a way to use volatility to make money instead of just betting on the year-to-year change in the market. In just the first seventeen trading days in the month of January, the Dow Jones Index went up 5.32% and then dropped 9.06%. This leads us to THE NEXT BIG THING.
Multi-directional trading will be the next big thing to hit Wall Street. It is already here, and has been here for quite a while in the form of hedge funds. Unfortunately hedge funds have only been available to the wealthy, employ non-public trading strategies (i.e. you don't know what is going on with your money), and have had some notorious blow-ups. But the concept of using short selling, options, derivatives, and futures to hedge and make profits regardless of the direction of the market is a valid concept that will slowly move into the hands of the retail investor. A "fund of funds" wrap is being used to lower the minimum entry requirements and tempt the individual investor into the hedge fund arena, but I do not see this as a lasting solution. The fees are typically too high and the selection process is too vague because it is too difficult to define most hedge funds in terms of a fixed style. Ultimately the individual investor will learn to adopt hedge fund strategies himself, or will find an advisor or investment manager to implement these strategies on an individual basis in a manner that is sufficiently transparent to the investor to provide confidence and safeguards.
Investors who are conversant with multi-directional trading strategies could have been taking profits as the market rose in early January while simultaneously putting on short strategies. Then as the market turned down, the same investors could have been taking profits from their short positions and reentering new long positions. It is quite reasonable to believe that a good trader could have held on to a 5% to 8% profit out of the approximate 14% move (up & down together) that the Dow Jones made during the last seventeen trading days. It is most likely that the majority of retail investors have not made anything during the month of January and in fact have a loss for the year to date. Of course multi-directional trading is just as hard as one direction trading. It is always possible to lose money in the markets. But multi-directional trading introduces the possibility of managing risk and enhancing profits in ways that simply are not available to the long-only investor.
It will be a long slow process of education before the average retail investor understands and accepts the benefits of multi-directional trading, but it is the next big thing that will sweep across Wall Street. I can picture a time in the future when it will be considered negligent if a person doesn't hedge and trade all the market directions. If nothing else, pure competition will drive investors to implement strategies to make money in flat markets and down markets. Comparisons to an index like the Standard & Poor's 500 will become irrelevant. Performance will always be expected to be positive relative to a benchmark of zero and comparisons to a riskless rate of return such the U.S. Treasury Bill rate.