Changing of the Guard on Wall Street

Over the last 5 years I have analyzed every single movement of price action in the stock market that I could get my hands on. Every minute, every hour, every day, every week. I have dissected thousands of trading days like it was a kid with lice, strand by strand picking out the eggs with a fine-tooth comb. Thousands of stocks over and over until I couldn’t see straight. Between the equities and options market, I have spent well over 10,000 hours studying price action in the last half-decade.

So, no, I do not mean I watch “Mad Money” when I have free time. I don’t sit around and watch CNBC all day to try and make sense of the global economy. I don’t use old school technical analysis with random moving averages. With the help of mentors, and my own insane work ethic, I have formulated my own strategy based off of price action. Price action is not random and is the only objective measure in the markets.

In the beginning I crunched the numbers, analyzed the data, and ultimately lost a bunch of money. At the end of the day I could not take the overall subjectivity and extreme chaos within the markets. No one could give a straight answer. Further, I was appalled at the fact that every financial pundit on the planet was not held accountable for their less than miraculous stock picking skills and “professional” advice. It was like Shaq giving advice on making free-throws.

Yes the market is this gargantuan, almost mythical, creature — moving trillions of dollars every single day. Even then, though, how can it be that so many individuals can be so wrong every day. Every. Single. Day.

If you turn on the news after the market closes, no one ever has a clue why things are happening. Markets go up because of China, go down because of Interest Rate worries, go up because it’s Tuesday and then go down because Oil was up but then went down. Wait what? In the public eye, the scene from Wolf of Wall Street is accurate. If the public thinks that the market is so overly complex, it opens the doors to those with the intellectual know-how a platform to not only sell services, but charge outrageous fees without repercussions due to lack of performance. The market, after all, cannot be beaten…right?

The fact of the matter is that we have accepted this as fact as a society. We turn on the news and are offered horrendous Options Trading products, a “Professional Stock Tip” of the day, and then they are never heard from again. The financial news outlets are no more than an infomercial peddling their own agenda. The worst part, 60-year old men in their underwear are using their retirement money to trade off these ideas.

We currently live in an era where it’s not about being profitable, it’s about getting the most clients, charging your management fee, and letting the chips fall where they may. The overall benchmark is to “beat” the market, but over the last decade that has gone by the way-side. The mantra “no one can beat the market” has been spread by Fund Managers who can’t beat the market, of course that is a self-fulfilling prophecy and of course they would believe that (and subsequently sell that pitch to their clients).

‘Wall Street’ is old money.

There I said it.

It is a bunch of old white dudes sitting around in neck-ties with advanced degrees talking over and talking down to the average investor. It’s an “Old Boys Club.” Don’t get me wrong, some of the brightest minds on the planet are working in Finance. Never in a million years would I put down the Hedge Fund industry’s talent pool. Every Hedge Fund manger out there has better test scores than me, every Asset Manager has a higher degree than I do. But you know what, it doesn’t matter on Wall Street. The markets do not care about your Wharton MBA, your CFA Certification, or the $10B in Assets Under Management that you control. At any one point in time, the market can, with one fell swoop, destroy everything you have ever created.

Hedge Funds, a necessary evil, sell the ambiance of fake security to high net-worth individuals. Total industry assets are at record highs, testing almost $3 trillion dollars. Better yet, on average, hedge funds returned only 2% in 2014 (net of fees, the average return was negative) – compared to an industry return of almost 14%. While I understand that Hedge Fund performance is often strangled by its own risk metrics (i.e. Sharpe Ratio), it comes to be stood yet again that our end goal has changed into “preservation of capital at all cost.” In 2008 Hedge Fund returns were only -25%, compared to -37% of the S&P — congratulations?

Furthermore, let’s assume we have a fund with a 2% Management Fee and a 20% Performance Fee (the standard within the business). A hedge fund would have to make 15% to achieve the same returns as someone making 10% investing their own money. That’s a 50% greater return in one year. Is the value proposition here that much higher?

Here’s the thing, with everything I have mentioned above, Hedge Funds are still the angels dressed in white. High Frequency Trading is apparently the villain in this mythical world. Ever since “Flash Boys” came out, everyone wants to start pointing that direction. After all, if we don’t understand it that has to be a problem, right? Don’t get me wrong, the High Frequency Trading world is arbitraging millions of dollars every day out of the market. However, if you think this is any different than market making in the early 2000s, you are quite naive (not to say that it is acceptable, but at a certain point, someone will always be the fastest to market). My point here, High Frequency Traders change their business model based on opportunity – so in the end, they are taking the risk. But for some reason Hedge Funds get a pass as they consistently under-perform.

It’s time to update our business model, the outdated 2/20 Fundamental Model is causing more harm than good. Below-average Analysts and Fund Managers are facing increasing pressure to perform in this environment, as it seems Hedges Funds are closing their doors almost weekly. And when compensation is highly correlated to performance, it poses giant vulnerabilities on the risk-taking front. Further, the market is so over-saturated with Hedge Funds right now, it’s beginning to be a joke. Any 22 year-old with a Finance degree and a rich uncle can start a 10M shop, it’s ridiculous. As we see an increase in the Hedge Fund pool, we are also seeing an increase in market illiquidity. Positively correlated with negative returns? You betcha.

So what does that mean for investors and traders alike?

First off, the market is not rational and those investors that try and rationalize market mechanics in the midst of the extreme volatility we are seeing, are merely the most stubborn mule in the room. While I understand that fundamentals are what drive the economics on a global scale, what’s more important is the timing of when these events effect market price. For example, in 2015 the writing had been on the wall that the global economy was slowing to a screeching halt.  However, the market did not budge, down less than 1% on the year. As we turn the calendar into 2016, the market drops 10% in the first two weeks. Risk happens fast, as they say. Hope you didn’t take vacation.

The worst part about this is that yet again, financial news streams provide zero value. CNBC airs a “Markets in Turmoil” special session on Sunday January 18 – after an 8% drop in the markets to start the year.  Yet again, thanks for providing such amazing value.

The good news: traders are sick and tired of the game being played and are taking things into their own hands. From an educational perspective many traders like myself have taken this as an opportunity to provide amazing value to potential investors. It is still few and far between, but there are a few amazing educators in this space. In addition, algorithmic traders are the hottest commodity on planet earth right now. These traders are nowhere to be found on mainstream media, except maybe mistakenly grouped together in the High Frequency Trading world. These traders (‘quants’) are developing risk-averse, delta-neutral strategies, that make money virtually in any market condition. Humans are becoming machines, and the idea of “I think the market will go up” does not even exist (as it shouldn’t). In an ever changing environment, the only way to be successful is to be adaptive. Things are happening at record speed, and the fundamental and technical metrics being used by Old Wall Street are going the way of the dodo.

Right now we are on the verge of the biggest paradigm shift in the history of the financial markets. Other than the invention of computerized trading, almost nothing has changed in this industry in the last century. We still use the same metrics and offer the same value propositions. Hedge Funds, as they stand today, will eventually diminish into virtually nothing. The adaptive strategies will take over, which in turn will create a much more level playing field for the individual investor.

So, to the individual investor, it is time to do your research and turn off the TV. The amount of educational content on the internet is unbelievable. The markets are not as crazy as you think they are, you are just fed negative headlines from news stations that are on pace to receive lower Nielsen ratings than ABC’s comedy “Selfie.”

Investment moguls like Warren Buffet and George Soros use strategies that only work for their portfolio types, and should not even remotely be considered by anyone else. Actively managed portfolio’s that use sound, risk-based, strategies will provide far greater opportunity to the individual investor than placing  your funds with an advisor who gets paid based on quantity of clients. Wall Street is the only investment vehicle on the planet where the barrier to entry is zero and your upside wealth generation is infinity. There is no get-rich-quick scheme and it is definitely not easy. However, you owe it to yourself to become educated. Demand performance. Stop painting a broad stroke over “Wall Street” when you yourself have put zero effort into a) being a part of the change or b) educating yourself. We are on the forefront of opportunity, seize it.

 

“Through every generation of the human race there has been a constant war, a war with fear. Those who have the courage to conquer it are made free and those who are conquered by it are made to suffer until they have the courage to defeat it, or death takes them.” Alexander The Great

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