A Different Perspective; Unlimited Capital...

We're happy to publish another subscriber contribution, this time from George Swanson. You can find more of his work here and here. 

Capitalist Pig Bob and I met through Facebook. It was purely coincidental we became friends through this media, for I know nothing regarding capitalism, politics, and so forth. My ignorance to these topics may prove to be a valuable asset to those who follow my publishing’s. On the other hand, there is one thing I do know, and this may be the main reason Bob and I became acquainted. That issue is the financial markets.

I base all trades, investments or otherwise, upon mathematical principles required to have basic regulation within the markets. It all began with the simple precept that barring no limitations on capital, you can profit off each and every trade transaction utilizing a compounding position to roll down your cost average. Over time, this simple principle has proven to have some very complex mathematical structures, yet they are adhered to under every circumstance of the market cycle.

The trade technique removes the very principle under which this site (POTC) was constructed, hence, I tip my hat to Bob for keeping an open-mindedness which so many individuals lack.
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The technique removes the psychology which effects and influences every traders decision making capabilities. These influences typically occur when those decisions most impact the outcome of the trade. Psychology is born of the human psyche, it is more difficult to remove this element from trading habits than it is to attempt finding cognitive reasoning to explain what, where, why, or how something has occurred. The mind is always looking for a logical explanation to reason why something has occurred. The logical reason is there, but beyond the scope of what many can readily identify, hence the continuous attempt to create organization out of perceived chaos.

The psychology of trading, or those individuals involved in its practice, is not the topic of this writing however. So, I do not want to go any further in that topic. Once the mathematical rules which apply to the markets are identified, it makes for terrible writing. It is quite bland, boring, and just does not prove to be very interesting to monitor day by day. These rules are required for basic market regulation, for regulation is required to insure liquidity. Liquidity is required to sustain volatility, and volatility is required to increase professional profitability. Volatility, and the promise of profitability to market newcomers, is required to bring fresh money into the market. It is a cycle which most never escape, almost akin to a hamster in a ball. The onlookers know the hamster will never get to touch the object of desire, and the hamster probably does not even realize it is contained within a ball.

I asked Bob for a topic he would like me to write about. His suggestions were “Your best pairs trade idea with Jan 2010 strike.. or Where you see the S&P ending up by Dec 31, 2009.. or How do you think Obama's presidency will or will not affect the markets..”.

I will touch on each topic, and keep each very brief. I will start by addressing where the S&P will end up by Dec. 31, 2009. This question, or any variance of such question, is one of the most popular root causes to a traders account depletion. It is typically referred to as “speculation”. Speculation is an educated, or assumed so, guess. A guess is hope. Hope relies on luck. Relying on hope and luck makes for one broke trader. Even “controlling” risk:reward ratios, or whatever cognitive reasoning (see above) you use to counter this statement, the variables leveraged against you are insurmountable. Yes, some do walk away with fortunes, but see if they do this consistently.
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Professional money is made consistently, it does not rely on speculative conditions. Speculating where XXX will be on such and such a date is gambling. Gambling is only truly gambling when you are oblivious to the true variables which effect the outcome of a scenario. Does a professional gambler actually gamble? No, he does not. He will increase or decrease leverage, increase or decrease exposure, given the percentage calculation outcome of probability. This is similar to the market, if you counted all cards, the last card is always known. That last card is rule adherence, it must be abided by. So, back to the question, where and when. When is the most misleading variable to many an analyst, especially technical analysts. Ask any analyst what time frames he uses to analyze a security. It is pretty amazing, you always get a different answer. The markets trade in one time frame, that is current. This may sound pretty off the wall, but this piece of information is crucial. When one analyzes time on a chart, they note it on a horizontal axis. The markets are not bound horizontally, they are bound vertically. Once a traded issue exceeds an absolute price momentum change it becomes bound to that point. That point plays a roll in the compensation required to keep the issue regulated. Regardless of the time it takes to compensate, it will compensate. This is the primary reason why professional money is made utilizing stock, not options. Options can be used to hedge, or insure a position, but they are not the primary trading vehicle for wealth accumulation. The professional options market is made on the bid/ask spread and premium sales. Theta is time decay, you do not want to expose your capital to time decay when time is not an issue or objective of the market you are trading. So this is what I can tell you of the S&P for the remainder of the year, or beyond. The SPX is obligated to shave 15% off its posted high (since March), the higher the S&P goes, the larger this percentage will become. I do not guarantee this happens by year end, but I guarantee it will happen. How you play that information is on you, for how I play it would scare the crap out of most traders. Any drop beyond 15% is purely speculative and will not be participated in by the likes of me.

Next question, “How about something about your best pairs idea with Jan 2010 strike..”. First off, the only way I would commit to a Jan 2010 strike would be by playing extremely deep “in the money” options. This would be where you are buying pure intrinsic value only. When Jan 2010 rolls around, if you need to calendar roll the position out, you can do so at almost no cost. With that being said, I can guarantee (yup I said it!) a profitable return IF (always that damn “if”) rules are followed! The pair trade would be long DIA, short QQQQ. The trade needs to be delta balanced (when referenced to a third issue (beta weighted)), deep “in the money”, and averaged in if the spread widens. The trade requires exiting when up to 15% of capital is utilized in the trade.

Last question, “Why and how you believe Obama's presidency will or will not affect the broad market..”. Frankly, I could really care less. Markets react to any and all input collectively. When they need to compensate, they will find a reason to do so. There will always be an “after the fact” reason to why something happened. Obama will be the equivalent to Goldman Sachs, or Google, or AAPL, or war, or any other mentionable reason one could use to explain the markets behavior. All in all, it is just one more source of smoke, or one additional mirror to the larger picture of being able to play this game with unlimited capital.

With that, I bid you a great day.

If you would like to view more of my writings, you can visit www.channellines.com and http://thetradingtruth.blogspot.com