Thursday, June 4, 2009

The Cheetah Theory

The Cheetah theory of trading says that the best traders will wait until they are absolutely certain of catching their prey before they strike. The theory, attributed to the mysterious 'master trader' Mark Weinstein (who was profiled in the book Market Wizards; Interviews with Top Traders), is all too relevant today. The cheetah, the fastest animal in the world, can be represented in the equities market by high frequency algorithmic traders. Their algorithms lurk on the sidelines until the market conditions are just right then they strike. The cheetahs' prey,the gazelle, zigs and zags because he knows that the cheetah can only catch him if he runs in a straight line. The gazelle can be represented by canny investment managers with their own algorithmic trading systems. The prey that actually gets eaten, let's call them wildebeests, can be represented by less energetic fund managers or retail investors. So what we have in today's market, where something like 70% of the daily volume comes from high frequency trading, is cheetahs and gazelles running in circles. And the Wildebeests are still getting killed when they enter the market. The cheetahs and the gazelles are winning a little bit day-by-day while the weary Wildebeests are increasingly staying at home. This means that the so-called 'dry powder' (CNBC, of course) of billions of uninvested money is still not coming onto the market. I wonder if this is a permanent trend.

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