Wednesday, April 28, 2010

Emini trading may be a better alternative than stock trading, part 1

If your stock trading is not going well, and you are falling short of your expectations, emini trading may be a good alternative choice. This article discusses one reason why emini trading may be better for you.

Why is trading the emini better than trading stocks? There are many reasons, in my opinion, but I will discuss one of them here, and other reasons in future articles. I prefer eminis to stocks because they avoid certain types of exogenous shocks. In economics the term exogenous is used to refer to an event that occurs “from outside” the system, model, or idea you are considering. It usually is an unexpected event that creates a shock to the system. For some traders, exogenous shocks can result in a windfall of profits, but for most traders, exogenous shocks result in losses in their brokerage accounts—which leaves them shocked.

There are many types of exogenous shocks, however, to keep things simple I will look at two specific kinds of exogenous shocks. I like to call these verbal exogenous shocks. They usually occur from the mouths of hotshots, and they also have the tendency to occur right after you have bought the stock. The first type of verbal exogenous shock occurs when some hotshot analyst downgrades the stock, sector, or industry you are invested in. The second type of verbal exogenous shock occurs when some hotshot CEO or CFO tells the investing community, “we will be making one penny less than you expected.” WHAM! and OUCH!

Just like earthquakes, verbal exogenous shocks lead to verbal exogenous aftershocks. One type of aftershock occurs to the other stocks in your portfolio that are in the same industry. Another type of aftershock occurs from what is called herding. Herding refers to analysts having a tendency to hold similar views. What usually occurs after one analyst is brave enough to create a verbal exogenous shock, is that the others quickly follow—this leads to additional verbal exogenous aftershocks to your stock or portfolio.

Verbal exogenous shocks do not occur in the market as a whole. The market does not give a damn what some analyst thinks about a company, or what a CEO said, or stated about their upcoming earnings report. This is one of the major reasons why trading the market, on the whole, is better than trading its components. One may argue that the market also experiences exogenous shocks. Of course it does. As traders we already face so many risks each day. I, for one, do not care to add on verbal exogenous risks.

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