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Intelligent Speculator

      After all the wildness and chaos of 1996, Teresa Lo now strictly limits herself to day trading. Which was not a bad decision at all, the way she sees it. Because she “goes flat” each night – that is, she closes out all of her positions and reverts to cash – Lo says she’s a lot more relaxed these days. And she has more time to spend with her husband and daughter, and on hobbies such as gourmet cooking. On weekends she and her family will treat themselves to a dim sum brunch. And it’s then that she’s able to forget about the market entirely.

      In fact, by any accounts Lo would be considered an excellent day trader, even though she’s not trading as frenetically as before. Years of experience have taught her to work the market with the precision of a neurosurgeon. Lo trades S&P e-minis, which are one-fifth the size of standard futures contracts written on the Standard and Poors 500 Index. She will buy and sell maybe five e-minis at a time, going long or short, depending on what the charts tell her. She rarely holds a position for more than 15 minutes. Her trades are mainly a means of instructing others in the chat threads she leads The Intelligent Speculator (www.ispeculator.com).

      Trading on irrational exuberance

      And she should know. Because the methodical, conservative – she’ll even call it boring – style of day trading Lo uses today is eons removed from the mind-numbing gambles she took when she was in her late twenties and early thirties. That was when she traded heavily in markets as diverse and esoteric as Canadian penny gold mining stocks and Nikkei Index options. Then, as now, Lo’s trading style was built on the theory that markets often behave irrationally. They skyrocket up, and then they crash and burn. And if you jump in at the right time – as Lo has succeeded in doing – you can make a million or more in just months. The trick, of course, is knowing when to get out.

      Lo witnessed these kinds of manic market gyrations for nearly 20 years, when she was growing up in Vancouver, British Columbia, a city famous for its penny gold stock exchange. During that time, the world economy also was in one of its more unruly periods. In the ’70s and ’80s, high interest rates, speculative frenzies, and shortages of basic items like gasoline and sugar created regular boom and bust cycles.

      “Ever since I was a kid,” Lo says, “I remember these weird things about people. I’d stand there and watch moms wait in line for sugar and gas. During the real estate boom, you’d make somebody an offer on a house, and then the piece of paper with the offer written on it would trade hands four or five times.”

      Gold, too, was routinely traded as a speculative commodity. Lo remembers seeing people lined up before the banks opened in order to buy gold. Her own father was at times an avid gold trader. “Every day when the quote came through, everybody had to be quiet,” Lo recalls.

      Indeed, her father, a career military officer, lost money when the markets for both gold and real estate crashed. The memories of those wild market gyrations stayed with her. “I found it so curious that everyone was so preoccupied with buying gold, real estate, whatever,“ she says. “Now, when we look back, we can see that all of those things were parabolic bubbles, where the prices just moved in a trajectory that was completely unsustainable.”

      To find more examples of parabolic bubbles, you need only follow the many penny gold stocks that trade on the Vancouver Stock Exchange. “With penny gold stocks,“ Lo explains, “when there’s a new gold discovery the price will rise from 20 cents to $3 per share. That’s a lot of money. But if you look at a chart and how it moves in terms of the trajectory, it’s no different than what happened to Iomega or Qualcomm more recently.”

      Black Monday: the view from inside

      In 1987, Lo, who was then in her early twenties, took those lessons with her when she went to work as an assistant broker for Canaccord, Canada’s largest independent investment firm. The job gave her a unique insider’s view of the markets. And she quickly saw how astute insiders could leverage their knowledge to trade their own accounts profitably. It was an invaluable insight. Because she was fresh out of college herself, Lo had very little in the way of savings. But as an employee of the firm, that was hardly a problem. Brokers at Canaccord could trade commission-free. Not only that, they didn’t need a fully funded account. Canaccord permitted its employees to trade on generous margins. That is, the firm in effect advanced its employees much of the money they used to buy and sell stocks.

      The market is not a machine, as those who search for the ultimate trading system or indicator believe. Rather, the market is made up of people who act on hopes and fears, whose motivations come from the dark recesses of the mind.

      It’s a system that is common at many brokerages in the United States as well. The margin requirements some brokerages charge their own employees can be as low as 20 percent. “Basically, it was acknowledged that as a broker you weren’t paid any reasonable salary,” says Lo. So these trading privileges were regarded as a perk. As long as traders could reconcile their accounts within the allotted number of days, they could use the powerful leverage the firm gave them to rack up huge gains. Indeed, Lo saw that the firm’s best trader commonly realized annual trading profits of six figures or more.

      Trading on margin is rarely a problem for those who go long in a strongly uptrending market. And the markets in the United States and Canada were steaming throughout much of 1987. Lo began trading in April of that year, focusing mainly on the Vancouver-traded penny gold stocks. In that era, long before Internet trading and the advent of CNBC, Lo’s job at Canaccord provided her with a literal window on the market that was unavailable to those outside the business. Inside Canaccord’s office was a black-and-white TV monitor that provided a live view of the Vancouver Exchange floor. Lo discovered that she could often gauge near-term market sentiment just by watching the expressions on the faces of the floor traders. In true contrarian fashion, whenever she sensed that panic on the floor was universal, it was a signal that a turnaround was imminent.

      However, in the spring and summer of ’87, most traders were caught up in the buying melee, and panic was far from their minds. Penny gold stocks doubled and quadrupled within a single trading day. Stocks of obscure British Columbian mining ventures that sold for 20 cents on Monday might climb to $5 by Friday. Lo built up her profits by quickly flipping in and out of positions.

      By early fall that year, Lo and other traders at her firm were beginning to suspect that a top had been reached. And many gradually cut back on their long positions. “I noticed in about August that it became really hard to make money, because things were just churning,” she says. “So I didn’t try. By some grace of God I stopped trading.”

      But when Black Monday arrived on October 19, 1987, Lo and the firm’s other traders saw a once-in-a-lifetime opportunity. As the market crumbled before their eyes, “one of the floor traders came by with a list of what were thought to be the most highly margined stocks on the Vancouver Exchange.” Lo recalls the man telling everyone, “This list is going to be hit by waves and waves of margin calls. Any uptick, just sell it short.”

      “So we went to work,” says Lo. “The week after the crash was horrible ... just rounds and rounds of liquidations. And most of those things never came back.”

      The Black Monday incident helped Lo realize that she’d been wise to learn how to trade by working as a broker inside a firm. The mind-sets of a professional trader and an amateur trader are often totally different. Pit a professional against an amateur, and the professional will likely win every time. In one of a collection of essays you’ll find on her Web site, she writes:

       A professional trader probably began studying the market and its psychology at a relatively young age and gained employment in the stock brokerage business in order to make contacts and to develop the skills required to consistently make trading profits ... A retail trader is typically a person with a real job, someone who saved up to take a punt on hope that Lady Luck might parlay the spare cash into a tidy sum.

       The difference between the future professional trader and the punter

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