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Posted 12/20/2001
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The Speculator
3 ways to save when trading stocks
They can't guarantee you'll pick great stocks. But these buying-and-selling maneuvers will save you money and put you ahead of the game from the start.
By Victor Niederhoffer and Laurel Kenner
TRADERS!
- Do you tend to sell at the low of the day and buy at the high?
New stock picks
from market professionals
every day on CNBC.
1. Watch your costs.
J. Paul Getty, the richest man in the world in the 1960s, was once asked why he installed a pay phone in his London home. He answered that a businessman makes a few cents on every dollar of revenue, on average, after paying suppliers, employees, taxes and debt holders. If he gets in the habit of paying 10 cents more for each item than he receives, he'll quickly go out of business. Not only will he lose everything, but a few hundred thousand employees and suppliers also will be out of work.
Like most people, Getty found it hard to behave differently in his personal life than he did in his business. So he ran his personal affairs in a businesslike way, and refused to lose money at home.
Many of the world's richest people today -- Buffett, Gates and Soros -- seem to follow a similar path. If they find it useful to be economical in their activities, it's probably good for the rest of us.
In stock trading, the biggest mistake people make is paying an extra 10 cents or 25 cents out of every dollar in revenue they take in. Time after time, Vic has had some money manager working for him who lost 100% of capital. Invariably, the manager's trades were highly profitable -- before commissions and bid-asked spreads. What happens is that the market and their own money management outmaneuver them. They take in $1, but they pay out $1.10. If they trade often enough, that can be very significant by the end of the year. And unfortunately, most people trade just this way.
Vic has been a relatively active trader for a number of years. During that time, he estimates that he has made well over half a million trades and has never bought or sold at the market. He always buys at a limit a few ticks below the current bid price and sells a few ticks above the current offer price. Try it, especially on the electronic markets, and see if you don't start out with a better feeling.
2. Pick your time and place.
You'll get a better price if the car dealer wants to meet a month-end quota or win a prize and is hungry for a sale. One of the most successful speculators of our generation -- the Mr. P. who's occasionally featured in the columns of our editor, Jon Markman -- has kindly shared for the benefit of our readers his patented method of buying a Jag on the cheap. He waits until 5 p.m. on Christmas Eve. Then he goes into the showroom.
"You must be very tired tonight." (To initiate a query here is key.)
"No, in fact, you're the first customer I've had." (The dealer's downfall.)
"What's your best price on that silver model?"
"Forty-five."
"Oh my, I'm afraid 35 is it for me. Goodbye." (Walks toward door.)
"Just a minute. I haven't sold one all day. It's yours."
"Very good. I need the keys right now. That's the very car my wife wanted, and she needs it tonight as a special surprise." (Had the dealer known that in advance, Mr. P would have had to pay the full price.)
Similar opportunities often come up in markets. Bonds have an inordinate tendency to rise at the end of the month, and on days that futures expire, after all the bulls have evaporated, there is often the opportunity to provide liquidity to the bears at the end of the day.
3. Keep a hungry mien.
Act as if every dime counts -- and as our story about J. Paul Getty shows, it does. Vic's former partner, Steve Wisdom, uses the following technique when buying a car. "The way to beat car dealers, I learned many years ago, is to show up looking indigent, then fanatically beat down the purchase price while appearing indifferent/uncomprehending of the finance angle. The dealer will assume he can sell you the car for no margin and make it up on the back end by putting you ‘on the chart,' i.e., expensive financing. Then show up the next day in normal clothes, take out your checkbook and buy the car for cash."
Steve's method can be directly applied to the market. A similar technique has been adopted very successfully by hedge-fund manager and philanthropist George Soros, who, as far the outside world can tell, has never had a successful trade in the market. When Vic used to trade for him, Soros would bemoan his mistakes every day. At the end of each year, at their annual tennis game, Vic would ask, "How bad was it?" George would sheepishly smile and murmur something like, "Oh, we were up 87%."
In all candor, Vic has never had had a satisfactory day of trading, either. If Vic makes money on a particular day, it's never enough; he should have traded more heavily. If he loses money, it's even more terrible because he has six kids to support.
Point is, it's always appropriate to let your counterparties know about your bad trades. Perhaps they will accommodate with you with a better fill next time, just to keep you in the game. More important, if they feel that you're in the chips, they may not be able to resist the all-too-human tendency to endeavor to relieve you of some of the overplus thereof, as they used to say in the 19th century.
Art of the deal
Our stories of Getty, Mr. P., Wisdom and Soros illustrate two fundamental laws of bargaining that the academics have locked into. When a buyer and seller have room to maneuver to complete a trade, who's going to get the better deal? Whoever is more patient and who is more willing to risk the deal falling apart. By watching your costs and waiting until the key moment, you make the other side more impatient, and thus get the edge. By downplaying your success, you show awareness of your own fallibility and willingness to let the deal fall apart.
These principles are well covered by UC Santa Barbara Professor Theodore C. Bergstrom in an upcoming article for the Journal of Economic Literature, "Economics in a Family Way," (available for download now; see link at left), as well as such books as "Bargaining Theory With Applications" by Abhinay Muthoo and "The Strategy of Conflict" by Thomas C. Schelling.
Here's a practical application of the principle of buying on the cheap, using IBM (IBM, news, msgs) as the example. The advantage of choosing a bellwether like IBM is that there's always a large number of competing market makers offering quotes, with the happy result that the typical bid-asked spread is very narrow, perhaps a penny. When you can get in and out for 1/100th of a percent, the grind of paying excessive costs -- that inevitable albatross of excessive frivolity on the cost side, as alluded to above -- is minimized.
We'll consider what happens when you buy at the close of a day in which IBM declines 3% and hold two days. This sort of drop has occurred a little more often than once a month over the past decade -- enough times to give a significant sample, both from a practical and statistical standpoint.
The nearby table shows the average expectation and the number of trades you make per year by varying your filter.
Average profit per trade after big daily drops in IBM
| Behavior | After 3% Drop | After 5% Drop |
| Change after 2 days | 0.60% | 1.60% |
| Avg. number of occurrences | 1x/mo. | 1x/quarter |
The results show that you make 0.6% after a 3% drop, and 1.6% after a 5% drop. You lose about a third of the time. The variability is highly unlikely to have occurred through chance variation alone, about 1 in 500.
Making 0.6% in two days in eight months out of 12 isn't enough to make you a Getty, but it's a good start. Before too long, such trades could amount to some serious money -- at least enough to pay for your next lesson at the Kennerhoffer School of Bargaining, especially since our lessons are free. They illustrate the value of watching your costs and picking your times. And such trades will make you less hungry.
We'll send a worksheet of our IBM trade to any reader who requests it. (Write to us at dciocca@bloomberg.net.) If you have methods of saving money in the market, we'd like to hear about them. We hope these tips and the trading system will provide our readers with a Merry Christmas this year and all following ones. Thanks very much for all the contributions and good wishes you have sent, which have added much to ours.
At the time of publication, Victor Niederhoffer owned shares of IBM. Laurel Kenner did not own any of the stocks mentioned in this article.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.