Having sold several unborn grandchildren into slavery to pay off a few of this week”s failed shorts, I am further obliged to eat this blog’s words on last week’s tidal-shift-in-the-news-reaction call. (As someone who subscribes to such arcane notions as “truth” and “fact”, I feel it is important to distinguish “right” from “wrong”. Nutty!) Not only am I wrong; if the rally presses on–and it certainly looked on Thursday and Friday like it wanted to–I stand to lose more money. The height of trading disgrace! Damn you, Mr. Unexpectedly, when are you going to learn to take small losses?

While losing money (and grandchildren) can make a guy pouty and petulant, I hope I don’t sound like too much of a sore loser if I say that trader wisdom as a justification of this increasingly irrational optimism we call a rally (or, indeed, any wise saw used to make any trending market movement seem like incontrovertible fact) makes me wanna bite people and throw things at the same time. (Rest assured, fictitious reader, before too long you will hear me winning and complaining, too. Such is one’s fate when one is a small-town tycoon/crank played by Lionel Barrymore.)

The nugget

But I digress; back to today’s target bit o’ wisdom. My great trading error of late, if you’ll pardon my frangolese, is understanding just how royally the global economy is still fucked, and refusing to accept the market’s rejection of said fuckédness. Instead, said wisdom chirps, I should just “trust the tape,” because “the tape never lies.”

Rot and poppycock!

While anyone is entitled to a little linguistic imprecision on the best of days, this bromide is particularly ill-constructed. Its faux-zen chin-stroking tone is especially grating–it smacks of Hollywood bonsai-trimming sessions with Mr. Miyagi more than anything any ancient philosopher would have wasted time pondering. Its use is misleading, inaccurate, and casuistic, cited as proof of free-market capitalism’s irrefutable honesty, but only by people who already believe the free market is honest. It holds about as much truth as a brand name for a pharmaceutical product or a complex derivative.  Let’s dismantle it together, shall we?

2009: Year of the Truth

If the tape never lies, obviously, it always tells the truth. Interesting–let’s take a quick look at 2009’s tape via the indices. What does it “say” about its underlying components, i.e. the value of major American capitalized industry? Until early February, it says, things were mildly weak or slightly improving. Then, suddenly, things got very, very bad. (Tuesday, February 10, 11 a.m.: Geithner spoke. Apocalypse!) Then, just as suddenly, everything got really, really great again!

Yeah. All “true”. Perhaps it’s just a problem of time frame then? Or maybe it’s because I’m looking at indices? Certainly, if we look at an observable event, something you can isolate in time, we can watch the tape spew some oracular genius. OK! Let’s’ look at Capital One Financial this past week. A major event should provide something measurable: on Wednesday after the close, $COF announced earnings. A horrible quarter, results that indicate both the state of the economy and the state of the business. After a strong after-hours drop, the all-knowing tape spent the next two days adding 25% to its common share value, for a 15.4% gain on the week. Capital One Financial is in a bad way, and likely to worsen, which adds up to every one of its dollars now being worth a buck fi’teen? Um, obviously, no. I could see that being the case for, say, the results of $AAPL earnings, their best Q2 ever in a miserable economy. Now that is a strong company, in fact. Aaand the guru tape says… yeah, ok, here’s 1% for your banner week.

He-tape said, she-tape said

Poppycock, say you? I could go on launching anecdotal torpedoes; you could remonstrate, reading it differently; there are a zillion factors I’m not mentioning; we could argue for days. This back-and-forth, when translated from words to buys and sells, is the tape. The tape doesn’t “say” anything at all. It’s just a record of what quants, prop desks, and traders of all stripes think tick by tick, and it doesn’t take a genius to see that no matter what your time frame, it is a record of conflicting opinion as often as it is of consensus. It’s the inverse of that other (equally annoying) cliche about stopped clocks: If the tape reliably “tells the truth” in any one moment, then logically speaking it’s lying the next time it moves. And its honesty is immaterial; no one gives up and goes home if we hit the value on the head, because trading is speculating, and doesn’t give a quarter of a damn about the truth. If the tape pronounced a security’s price incontrovertibly, froze a company’s value in the glare of absolute knowledge, there would be no more buying or selling, because the discovery would have ended, until the company evolved and its value changed. Traders would just walk away–no more action. No edge.

The point here is not to crank out weak semantic wit. It’s to get to the heart of the matter: what we talk about when we talk about tape not lying. Price movement is an expression of conviction, or rather the net of a bunch of conflicting convictions, about value and its likely reflection. I buy $COF at 15 because I believe (whatever the source, it’s just a belief, not a “fact” or a “truth”) it is worth more, or at least other people are likely to think so soon; you sell it short because you believe it is worth less. From the moment we place our bets, the tape appears to reveal the truth like a called poker player turning over cards, making one of us right and one of us wrong, and thereafter, indisputably, one of us is a tape-fighter and the other a genius.

All brought to you courtesy of the booster-rocket refraction of hindsight. When a stock jumps 25% in 13 hours of trading, it may look like the tape was sitting on a mighty strong truth, but it’s really just a sudden consensus feeding on itself, the movement causing more and more $COF traders to reach the same conclusion: Whether short or long, they both needed another share. The ordinary cacophony of opinions suddenly resolves itself into a clear picture of fear (here, the shorts) and its common-law spouse greed (the longs), and tape “truth” is “born”.

The flop

The poker-player comparison is useful for another reason: even if the tape did speak, it couldn’t possibly tell the truth about value, because value doesn’t exist, except as constantly shifting assumptions. I used to think that poker was a lot riskier than trading, because there are so many unknowns, and chance is certainly in play. But at least at the end of a hand, there is order: Cards are turned over, an uncontested winner and loser discovered. The only possible truth for a publicly traded company, as Zero Hedge‘s fabulous tagline reminds us, is bankruptcy and liquidation, the clock stopping for good. Though the tape may anticipate a market death, and will certainly have a lot to “say” about it however late to the party, the one incontestable statement of value takes place in court, not in the market.

So when the twitter stream pops out the old warhorse, I may remonstrate, but the more productive thing to do is to translate its meaningless message into plain old common sense:

Chaos and conviction, fear and greed, have nothing to do with the truth, but everything to do with often-repeated patterns of human behavior.

(Not as zippy, is it? Kinda like, say, actual trading itself–more karate, less kid.)

Struggle against these patterns–order the chaos, fight the consensus, get greedy amidst the fear or fearful amidst the greed–at your account balance’s peril.

To which I have but one more thing to add: we trust this rally tape at our economy’s peril.

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