May

19

PhilIn our garden we grow about two dozen different varieties of vegetables as well as strawberries and blueberries. Naturally all of this bounty makes for a tasty treat for the local critters. In particular the local rabbit population has clearly been eying our garden as a source of gourmet delights.

Recently I was watching a young spring rabbit running back and forth along a fence. He ran to one end ducked under and then ducked back and ran to the other end and ducked under and ducked back. Each of the holes under the fence would have been unnoticeable to my eye were I not watching him use them. Occasionally the rabbit would make slight improvements to the holes by digging them out a tiny bit more. The fascinating thing to me was that the rabbit was not just going back and forth to these holes but he was actually sprinting at full speed. Finally I realized he was practicing his escape routes. And at the same time he was fine tining his holes if he could not get through fast enough.

Traders, like rabbits, must be quick and nimble. Perhaps the metaphor extends beyond just speed. The rabbit can teach us that the smart trader must also have multiple entry holes and multiple exits to escape the many predators and deceptions in the market. When we decide on a trade perhaps the better one is one that allows entry over several periods and can be exited over several periods in the future.

In the same manner the rabbit can teach us the importance of practicing our escapes at speed. For the novice trader this can take the form of paper trading real time prior to the first trade. This might be good advice for a new system regardless of one's trading experience. No one ever lost money by paper trading. Even for experienced traders the idea of practice translates, at a minimum, into back testing our trades before we take them. The rabbit can teach us much.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Scott Brooks adds:

This is the "prey" side of the equation. The predator side of the equation is also worth looking at. It involves learning the habits and escape routes of its prey. My good friend Phil mentions how he wouldn't have noticed the escape routes had he not chanced upon the rabbit using them. Noticing things like this is the mark of a predator.

Even though Phil may not have noticed the escape routes if it weren't for the visual observation, predators in the wild rely on more than their eyes to spot the routes of their prey. Probably their most important sense is that of smell. We as humans can't really understand an animals sense of smell and just how acute it really is. But having spent thousands of hours in the woods, I've witnessed first hand just how incredible a wild animals sense of smell really is.

These escape routes that this rabbit is so meticulously putting together will very likely be his undoing. Coyotes and dogs often hunt in packs or small groups (I know my two dogs, Rex and Layla, hunt as a team and have ambushed many a squirrel, rabbit and chipmunk). These canines can smell the path that the rabbits have been using and know where they're likely to travel. All they have to do is set an ambush. One coyote chases the rabbit through hole A while the other coyote waits at hole B.

I've witnessed, in the wild, coyotes hunting as a pack, almost corralling a deer into an ambush. Once, I was up in a tree stand and saw some coyotes chasing a deer. I then heard a noise behind me and noticed that some coyotes were coming thru the woodlot in the opposite direction. The deer was running from the coyotes across a harvested corn field toward the apparent safety of my woodlot, not realizing that an ambush was waiting.

The coyotes thought they had the ultimate trap set up and were about to go "long" a deer. I was also long deer that day too. But the deer coming towards me was too small for my tastes, so I decided to let that deer live another day. I changed to a short position on the deer (I sold his life back to him and will buy it back in a few years), and went "long" coyotes.

I drew my bow back, took careful aim and "placed my trade" on the nearest coyote. The ultimate arbitrage…..the predator became the prey! This quickly displayed just how weak the coyotes position really was, as I was able to break apart their entire portfolio for the day with that one shot (er….ummmm……I mean trade). I profited well on that coyote trade. I'm still short that deer, but hopefully in a few years, I'll have the chance to "cover my short" on him!

I wonder how many examples of this there are of predators in the market……and how many examples of predators becoming prey there are? As Professor McDonnell points out people learn that they need to set escape points, to protect themselves. But in many cases, they only end up bringing about their own demise. For instance, so many people set stops at the round, rather than a few pennies above and then wonder why they get a fill so far below their stop, not even realizing that the masses were trying to use that same escape route. The smart predators sniffed it out in advance and capitalized on it.
 


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