Trading Is a Form of Combat: Lessons From 2010

NEW YORK ( TheStreet ) -- The engines have cooled and the 2010 flight is in the logbook but the mission isn't over until we debrief so we can improve our execution for 2011.

After every mission I flew as a fighter pilot we conducted what is known as a "debrief." The goal of the debrief was to determine if we had achieved the mission objective and the reasons why or why not, with the purpose of garnering lessons learned that would be applied to improve our execution on future missions. The lessons learned from previous missions were reviewed in "briefs," pre-flight meetings that aligned pilots with the objectives set out for the new mission.

There was no ego or rank in the debrief room -- we were brutally honest with each other so we could get better and win the next time we got airborne. When your life and those of your squadronmates is on the line, it doesn't get any more serious.

Trading is a form of combat. Precious capital should be put at risk only after a thorough planning process that includes extensive contingency planning and risk management discussions. Tactics need to be mapped out to support an overall strategy. The conflict takes place on an electronic battlefield where the party with the best training, technology, and discipline wins. In the end, there's a winner and a loser and if you lose in trading you get to go home and try again tomorrow, if you still have capital. In actual combat situations you don't have that luxury.

Treating investing and trading as a form of combat can help you even the odds. If you think Wall Street heavies will take it easy on you because you're a "small investor" or that they don't view their trading with a "take no prisoners" mindset you need to do something else with your hard earned capital.

Let's take a look at how the Wall Street battle field matured in 2010 so we know what we're up against going forward.

The "flash crash" on May 6 showed what can happen when financial superpowers make mistakes. Large financial companies employ high speed algorithmic trading systems built by "quants" that execute trades in a fraction of a blink of an eye. High frequency trading lets computers fire orders on their own based on emotionless programs. To someone who grew up with the movie War Games, this hands off approach is going cause more collateral damage down the road. Drones may be replacing manned fighter aircraft over the real battlefield but at least there's always a human in the loop.

2010 saw some typical insider trading scandals but Main Street learned something new. This year we discovered that hedge funds engage "expert network" of consultants, agents who are often former employees of companies who have inside knowledge of companies the hedge funds invest in or trade around. Although Uncle Sam believes this is illegal and has moved to shut this practice down, money finds a way of getting information. And if you believe the "financial reform" regulation passed this year will do anything to stop this practice or many of the other practices that caused the financial tsunami I've got some prime real estate in central Florida for you.

We always knew that trading super powers had deep pockets. Now we know those pockets are even more so now because they have a government put in place. They know the government will step in to prevent another melt down.

As a retail trader looking at the odds of success against such formidable forces one can be forgiven for thinking they cannot win; unfortunately many retail traders do not. Our brief for 2011 is based on the two guiding precepts required for a retail investor to succeed in this hostile environment: discipline and risk management.

The biggest lessons learned from 2010 are that retail investors who were disciplined and effectively managed risk did well. Not having a well thought out plan and being prepared for the wild swings in 2010 left many retail investor bloody and bruised. Two options services I oversee returned 30% ( Options University ) and 51% ( Fox3 Options ), by focusing on discipline and managing risk.

The trading year was a vertigo inducing ride with a summer nadir and end of year zenith. Threats of a dreaded double dip now sound like they came from the crazy cat lady down the street. The DJIA crossed the finish line up 11% for the year while the tech heavy Nasdaq finished up 17%. The S&P 500 ended up 13% with half of that gain coming in December. The market is back to levels not seen before Lehman Brothers flamed out.

As we look forward to our 2011 mission we must assess the threats to success, and there are many.

Sovereign debt woes will continue to pop up along our route of flight. From the first shot out of Dubai to the potential conflagration with the PIGS and their barn mates, the market tentatively treated each event as the Fred Sanford "big one," and then seemed to ignore it. But the big one finally got Fred.

Aside from the sovereign debt issues overseas we have our own troubles at home. California is bankrupt and decided to re-elect the same people who put them there (see: insanity, definition of). I believe this year we will see the state move closer to asking for a federal bailout, which I'm sure everyone in the flyover states will fully support.

New York is in a similar situation and the union slowdown during the Christmas blizzard gives all Americans a look at what the future holds when states or the federal government moves to reign in unfunded pensions and bloated budgets. "Austerity measures" in the United States should equal fun at the DMV. At least some towns in one of the three stooges states, Illinois, took "drastic" measures recently by raising the retirement age for workers to (gasp!) 55 from 50.

Global super power China is both stepping on the brakes and accelerating at the same time, causing smoke to cloud the true picture of what is happening with our preferred banker. More troubling to me personally is Beijing's continuing focus on building up their conventional military forces and its failure to sit on its little brother North Korea.

The Fed continues to print money but if you call it something quaint like "quantitative easing" you can effectively hide the real issue from mom and pop on Main Street. We can only kick that can so far down the street and we're coming close to the dead end.

We were treated to good and bad news throughout the year on housing but anyone who pays a mortgage knows the real story. Foreclosures, shadow inventory, mortgage rates, etc. are themes that will continue to drag on the economy. Unemployment and housing are speed brakes sticking out in the economic wind and while people spent more this holiday season than last, I don't think the coast is clear just yet.

Firing line: This all may sound just a tad bearish. It is. But another lesson learned in 2010 is one that has been learned year in and out: don't fight the tape. But I've found that it's always better to plan for the worst. Be disciplined and manage risk. Happy hunting in 2011 and make sure you hedge.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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