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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35361  
Subject: Strong Hands/ Weak Hands Date: 11/28/2002 6:01 PM
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Consider this situation: You buy 10,000 shares of Sunshine Mining (issued shares = 50 million) at 70 cents –-or 2.8% of your account -- on a hot tip from your Canadian hunting outfitter, Frenchy Jim, that Sunshine's field geologists have renewed their lease on the cabins they are renting from him and have been telling him he ought to think about building some more. A month later the company makes a favorable press release on their now completed survey and share prices go to 2.50. You sell half your position. On the strength of their stock price, Sunshine latter announces a 10 million share stock offering at $3/share, which is favorably received. As the company moves equipment into the area to begin operations, the price rises further, hitting 3.75, and you sell another half of your remaining position. But by now, the local tribes are beginning to get annoyed and don't want to see yet another watershed destroyed and file law suits that Canadian government insiders are considering favorably. When word of that leaks out, the stock instantly falls to 50 cents, and you close your position.

How many hands were involved in trading those 10,00 shares, and which were the strong and weak ones? I'd suggest that the trader, and those who sold to him or bought from him, were both strong or weak as circumstances changed and the money was transferred from one account to the next. If the trader had foresight, he would have managed his position differently. But shoulda/woulda/coulda doesn't cut it. In retrospect, did he do a good-enough job? More importantly, given how he managed the trade, is it likely that he would ever blow up his account so badly that he would put himself out of the game?

Let's continue the story.

Sunshine's stock languishes further, falling to 15 cents as the law suit drags on. Our trader, who knows the area well from years of hunting with Frenchy, suspects the real value of Sunshine's property holdings might not be in the minerals they will likely not be able to access, but in the standing timber and the land as recreational property. To confirm this he does his DD from the viewpoint of a control investor this time. Convinced he is seeing an opportunity, he puts together a partnership and quietly begins buying again, ending up owning 5.5% of the outstanding, at which point he launches a proxy fight, --the stock jumps to 50 cents on the news-- wins, kicks out the old board of directors, concedes the law suit, and announces plans to reshape the company as a steward of the land with exclusive access to the best hunting and fishing facilities in the area, and shares jump another 50 cents, beginning a slow climb that reaches 2.50 by year's end.

Again, who were the strong hands and the weak hands?

My point is that at every price point for any stock, some people are buying or selling correctly, given their time frame and investing intentions and their understanding of what the company's situation and prospects are, and some are buying or selling at prices that will prove to have been too cheap or too dear had they done their homework in manner that would have enabled them to make a prudent timing decision.

Buying prudently, on the basis of good DD, and then being vindicated in one's judgment when the stock does go up as expected, but then riding those gains down as the market declines until the issue is trading below where one entered, (and in fact is oversold, were one to take a fresh look at the issue,) but giving up on it in disgust and selling for a loss is one of the classic pattern I was pointing to of how money moves from weak hands to strong hands.

As I keep saying, mistakes, errors of judgment, and the truly unknowable and unforeseeable are going to happen. That's simply the nature of investing. But an investor's concern is, first, to preserve capital (by avoiding being one of the weak hands) and, second, to appreciate capital by attempting to be one of the strong hands. Knowing which is when, and how to do it, is a matter of experience and judgment that whining about losses only distracts from the learning process by displacing attentions from one's own actions (which one can control) to those of others (which one can't control, but can manage oneself with respect to).

Dings are going to happen. Decimations/devastations don't have to. (A linguistic note: the two words, though commonly conflated in modern, informal usage, imply different magnitudes if one is aware of and respectful of their etymologies). If huge losses do happen, complaining about them might elicit sympathy, and looking for someone else to blaming might make the loser feel better, but neither tactic fixes the problem of the loss, nor puts into place mechanisms and attitudes for coping which the huge variety of investing problems and further losses that await the unprepared.

Though I've run this example using stocks rather than bonds, the dynamics are the same. How does an investor make good decisions in the face of uncertainty, without betting too little or too much? Where is the proper balance between reward and risk? On whose shoulders must the final decision and the final responsibility lie? It's a scary job, and one that we aren't trained to do by the schools, who emphasize conformity, compliance, and group control, not individual courage or contrarianism. So, obviously, when we use group-think as our decision process –-and the stock investing has become a national sport, on the par with football-- we feel entitled to blame the group if our team fails. We whine and want to change the rules, enacting laws to banish the bad guys (or, these days we just bomb them).

Charlie

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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5441 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 2:40 PM
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Charlie,

You're one smart, well educated guy who impresses the hell out of me! I think I understand the point you're making, but it seems more work than I care to do. So sticking with Vanguard's Total Stock and Bond indexes (in the form of Vanguard's Balanced Index Fund) more suits my lethargic lifestyle. But I sure enjoy reading your posts.

db, phd

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5444 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 3:53 PM
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db (phd),

I love fan mail, especially such flattering, enthusiastic comments as yours. Yes, I'm well-educated (thanks to having grown up poor enough to have received public monies to attend good schools), but not smart, merely working very hard, trying to understand this stuff.

Too often we think we understand the investing terms and phrases we use, such as "the transfer of wealth from weak hands to strong ones", but, when pressed to provide examples or to explain its mechanisms, our understanding becomes like the opening page of Dickens' Bleak House with the fog and mud of our opinions obscuring all. That's why I spun out that story of Sunshine Mining, to test my understanding. But against it needs to be set the arguments upatnite is laying out as to where that $8 trillion really went. If Gates didn't sell his shares and the price of his stock declines, then, yes, value vanished into thin air, with no one else capturing it, like the echoing, reverberating cries of the loons that enchanted Thoreau.

But if trades are done, then, I'd argue, the term does apply, and if one were to go back and review the trades that happened from 9/99 to 9/01 and match traders-and-dollars to pockets-filled-or-emptied, one would see a pattern of transfer from those who bought high (weak) to those that sold short (strong). So, in lamenting the decline of the market, at least two groups need to be distinguished: those whose estimated (aka, phantom wealth) was diminished and those whose real wealth (dollars spent that weren't recaptured, for stocks being sold at lower prices than they were bought.)

Both parties feel poorer, but only the latter are truly worse off, not that absolute income is the only important economic determinant of well-being, as Frank H. Robert argues in his Berkeley lecture, "Does Growing Inequality Harm the Middle Class?" [use Google to locate the text]. In fact, I'd argued that they are multiply poorer, for being at further disadvantage of the over-classes who had the wherewithal to have sidestepped much of the crash, as opposed to the "middle class" DIY'ers of 401k ilk, which is why I hammer on avoiding unacceptably large losses in the first place. Losses are arithmetic, but one's recovery rate has to be geometric, and investors dig themselves into a hole they can't get out of, financially and psychologically, so that they give up on markets altogether for longer than is in their best interests, as another poster suggests.

I understand the point you're making, but it seems more work than I care to do.

Yes, theory needs to be distinguished from practice and I'll admit upfront that I use this forum to explore ideas, just as I use markets to test them. So what I say or do should have no bearing on what anyone does about their own choices. If your investments match who you are as a person, then you are doing exactly the right thing.

Where a lot of investors failed themselves recently is in letting themselves get sucked into a game beyond their interests, abilities, and skills. They won a couple of easy hands in the go-go days and thought they were investing geniuses. But when they were dealt different cards, they didn't know what to do and froze like deer in the headlights. Rather than reversing and either stepping aside or going short, they held all the way to the bottom and then sold in disgust, which brings us back to the point where this discussion of weak hands/strong hands began. What happened then will happen again. Markets go up and down, and the rewards go those whose know its history and who plan their activities accordingly.

Charlie, NCNE [no certificates, no education, to borrow a handle that isn't really accurate, but telling nonetheless]

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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5445 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 4:21 PM
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Charlie,

A trusim in academic circles is that if you really want to know a subject matter, teach it. I'm a willing student even if I may not be a willing implementor. Just think of me as the student who doesn't show up for lab sessions, but don't flunk me before I get exposure to your lectures.

db, Piled Higher and Deeper (in BS, of course)

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5446 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 8:18 PM
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Db,

Two explanations suggest themselves if you didn't understand the point I was making about strong hands/weak hands: the piece was badly written, or the piece was badly thought.

I wouldn't claim that I write like an angel plays a harp, but I strum a good enough linguistic guitar to belt out the literary equivalent a campfire melody. So I don't think any difficulties you had were due to failures of rhetorical structuring, which I'm generally careful about to the point of heavy-handedness, but rather to a possible logic fault in my middle paragraph, that serves as a summarizing transition.

My claim in that paragraph was that at each price point there are some people who are buying or selling correctly and some who are not, which is a tautology and therefore trivially true, but I assumed those acting correctly were the strong hands and their counterparts were the weak hands. But some reflections on this morning's trading –occasioned by this afternoon's walk-- cloud the issue. Let's take a look. I did four trades on SPY:

B94.42 9:54:51
S94.55 9:59:19

B94.30 10:07:37
S94.304 10:15:56

B94.19 10:32:34
B94.11 10:33:43
S94.204 10:37:15

S94.51 10:51:41
B94.35 10:54:00

The arithmetic says three wins and a scratch. Plot them on a 1-minute chart and you'll see I was trading counter-trend in a choppy market (which is what I prefer). Take a look at the fourth trade, which was actually a high risk move. The smart play, had I recognized soon enough that the character of the market had changed from a downward channel to an upward one marked by the 10:30 reversal, would have been to enter long after the reversal, ride through the bull flag and then exit at the move measured out by the distance from the reversal to the flag. Instead I shorted the flag. But my entry and exit were crisp and I got way with it. And the bottom line is that on all trades I took money out of someone else's pocket. I was the stronger hand.

But look at my earlier trades. I went long, but I just as easily have gone short as you'll see from looking at a chart of the opening hour. In other words, I could have taken the other side of my own trades and still made money if my exits had been proper, which raises this paradox: How can I be both be the strong hand and the weak hand at the same time? I can't be, of course, for the trivial reason that I can't be both long and short the same time IN THE SAME ACCOUNT. The persistence of my identity as a trader doesn't matter. But the separateness of the accounts does matter. That's the crucial difference. In buying or selling to myself, simultaneously reversing, one account would have gained money and the other one would have lost. The trade Account “A” did would have been correct and strong, and Account “B” would have been wrong and weak UNLESS third parties become involved, which they do. To go short I have to borrow the shares. I'm not borrowing from myself, but from someone else, and it is their money I pocket, whether I'm doing my trades one leg at a time and exiting to cash before initiating a new position or Stop-and-Reverse (so that I'm in the market continuously).

The distinction that has to be made is between mark-to-market value and cash-in-hand value. Both can fluctuate, waxing and waning like the moon, ebbing and flowing like the tides. Each has their own purposes and realities, but they aren't the same thing. So, $8 trillion didn't just disappear when the market declined from its highs. Some of it did seem vanish like the morning dew, but is really part of the hydrologic recycle, and was recycled from weak hands to strong hands. Other parts of that estimated $8 were just accounting fictions and ledger-sheet ghosts, good for nonce bragging rights at the water cooler, but little else.

Charlie

PS You're right about teaching being a path to learning. (Pity the poor genie pigs!) I never learned so much about writing as when I taught the lower division rhetoric series at OIT (though I still don't speel too good.)


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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5447 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 8:46 PM
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Oops. I can't do math too good, neither. 94.30 minus 94.304 is a loss, not a gain, which is what I classified it as earlier in the text by identifying it as a scratch (aka, a negligible win or loss).

The corrected claim should be that on three of my four round trips I took money out of someone else's pocket, but on one of the four I gave someone 4 mills per share.

My apologies, and a rant, once again, that TMF doesn't allow the author to edit his own posts within a reasonable time frame.

A further clarification while I'm at it. The first and third were trades. The last was closer to a scalp. The second was a mistake I was able to salvage. Generally, the chunk I'm trying to take out of the market is a dime and my holding period is minutes, so what I do is a long ways from investing and is nothing I'm recommending that anyone try for themselves unless they are already doing it. What I'm reporting is simply data I have at hand to make a larger point about markets which does have general relevance: "Which losses are real? Which are phantoms?"

Charlie

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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5448 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/29/2002 10:44 PM
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Charlie,

I think I understand your point, but I'm lazy enough that I doubt it matters. I'd rather leave the driving to Vanguard (or the market as a whole). Still, intellectual curiousity has this cat sniffing around. The strong hands - weak hands distinction is not new even to me, although the rapid suffling of who's who is.

db

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Author: imcharliehm Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5450 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 11/30/2002 12:43 PM
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db,

I can respect your choice not to engage the inquiry I'm pursuing, but that doesn't mean I'm not disappointed. I'm trying to fry a larger kettle of fish than the few bucks one might make or lose in markets, but to get there I need the intervening steps I'm tracing out, one of which is personal responsiblity for one's investment choices.

I've got the essay blocked out, but I need to run some key concepts past my editorial board --i.e., friends who work in the area of moral philosophy-- before I launch my attack on "middle class" values.

That's the larger context within which I'm working: the meaning/purpose of life. This investment stuff is merely concrete examples of the sorts of conflicted choices people make for themselves.

Charlie


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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5491 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 12/3/2002 4:27 PM
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Charlie,

I'm always happy to read and comment on your ideas. One of my responsibilities in my previous life was doing just that for a bunch of ego-driven doctoral-level engineers, computer scientists, and linguists who worked in my research center. Of course, I can remember the days when I was one of that bunch.

Although I indeed may be morally and philosphically lazy, what I was adressing was the narrow decision I've made about how to invest my portfolio, given my skill level and known uneven attention to details. I also need to devote time to financial planning for my 89 year old mother who will be moving into a resort retirement community here in the Santa Barbara area. She has a substantial portfolio that needs to be balanced between the goals of not reducing capital and staying ahead of inflation.

Good luck with your writing.

db

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Author: iamdb Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 5500 of 35361
Subject: Re: Strong Hands/ Weak Hands Date: 12/4/2002 12:08 AM
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Charlie,

I think I did understand your idea of strong vs weak hands, although that is not the way I'm used to thinking about the strong/weak hand dichotomy.

In my experience, the strong/weak hand distinction is usually made regarding the ability to hold an asset during adversity: Strong hands can weather an adverse condition; weak hands are likely to fold during a similar situation.

You seem to be using a strong/weak hand distinction situationally, with role reversals depending on a current event (buying/selling). This seems different from strong/weak hand distinction as a more or less abiding condition. The party with substantial assets might be thought to have stong hands; the party with less substantial assets has weaker hands. That is, the playing field is inheritantly unequal rather than situationally unequal. For example, this is how a larger competitor might drive a smaller competitor out of business through a period of price slashing.

db

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