A Little Sleuthing Can Lead to Big Profits

One of the few experts who got it right was the hedge fund trader and research director I call "Mr. P." He told me in an interview during the week the market was closed that his analysts had noticed a small item in a news story that suggested that mutual funds would have five days' worth of sell orders to clear when trading kicked back into action on Sept. 17. This single clue led him to predict that stocks would trade down the first week purely from the point of view of market mechanics, and that it would seem obvious in retrospect. And so it did.

Two weeks ago, Mr. P called to say that all the pundits calling for a significant bounce in the market precisely off the October lows would be disappointed. He argued that because everyone on the Street was waiting for a rally around those levels once the bombs dropped, the smart money would jump the gun and buy early -- a view that I first discussed in mid-February. (The rally arrived last week. At the end of trading Monday, the Dow Jones Industrial Average was up 8.21% from the lows of March 11; the S&P 500 was up 7.8%; and the Nasdaq Composite was up 9.5%. The bounce in the S&P 500 and Dow began slightly above the October lows.)

You could call this sort of thinking "anticipatory reflexivity," which means that to be successful at trading you must consciously deviate from the consensus point of view and prepare for the reflexivity of other investors' thinking. It's similar to retired hedge fund trader Michael Steinhardt's concept of "variant perception," which I explained in the November 2001 column "Three Steps to Turn Gut Instinct Into Profit."

Three Possible 'Down Cards'

After speaking to Williams, I was struck by the similarity between his team's method and that of Mr. P, who sleeps less than five hours a day, as he constantly reads news from online newspapers around the world -- not analyst reports -- for out-of-the-mainstream clues. When he finds something interesting, he peppers his staff and friends with the nuggets and awaits their reaction, because it's key not just to find something potentially illuminating about the world but also to see how others react to it as well. That's the reflexivity component.