How Expert Traders Outperform Novices in the Stock Market Game
View(s):I saw some interesting numbers—highest, lowest, shares traded and closing—for the first time in my life in a daily newspaper that Mr. Bandara was reading one day in the year 2003 at HT Peiris & Co, a firm of Chartered Accountants. I cannot quite remember his forename because it was a long time ago, but he was the one who introduced me to the stock market, where I learned how money is lost and earned. I would like to share my experience in this article, with some insights on how this game is factually played.
Most theorists (e.g., Fama) have defined the ‘stock market’ entirely from a theoretical perspective, subject to some contextual assumptions, but their fallacy lies in the fact that it all depends on how the cards are played. Whereas, some have factored behavioural biases into the definition of the stock market and put it forward as so-called ‘Behavioural Finance’. Still, none of these perspectives have been successful in explaining the true underlying mechanism of the stock market game and how some amateur traders, even without any knowledge about the finance or valuation, earn fame and fortune in the gallery of the Stock Exchange.
If you ask someone new to the stock market the question ‘how to succeed in the stock market’, the obvious answer would be ‘make informed decisions’, in which the most frequent ‘fine’ line would be ‘pick the undervalued stocks and dispose overvalued stocks’. ‘Don’t put all your eggs in one basket’ is another phrase in the stock market vocabulary of novices and sometimes with traders who have been in the stock market for some times. For expert traders, these are unorthodox or somewhat very basics. Little of these are useful for earning superior returns against all odds in the stock market game.
What is stock market intelligence and awareness?
Who are expert traders? Expert traders are those who possess market intelligence and awareness. They earn an above-market-average profit from trading using their skills and expertise built upon market intelligence and awareness. Market intelligence, in relation to the stock market, can be defined as the ability of a trader to gather information from a wide variety of sources, analyze and interpret it (all in the head), and arrive at accurate probability estimates about future prices. Expert traders are not necessarily high-net-worth individuals, but they have a higher chance of accessing various private information, including stock trade secrets, firm-specific details, and macro-level economic information through investment advisors at their stockbroker firms and connections with top-level executives or friends in listed companies and related organizations. This access to diverse sources of information contributes to their expertise and ability to make informed trading decisions. Novice traders find it more challenging to access such privileged information due to their relatively smaller trading positions and volumes.
Stock market awareness refers to the current and up-to-date status of market intelligence. While possessing comprehensive market intelligence is crucial, it becomes ineffective for decision-making if the information is not current and relevant to the present market conditions.
Who have ‘privileged information’?
Experienced investment advisors, especially those working for large brokerage firms for years and catering to high-net-worth clients, often have access to various private information and data through their research and analysis capabilities, as well as their connections with clients, corporate and industry executives.
The executives of stock exchange can witness various tactics of trading, the patterns that emerge in the placement of orders, and the actions of diverse market participants. This firsthand exposure gives them with a comprehensive understanding of market trends, prevailing attitudes, and potential price fluctuations, a level of insight that ordinary traders do not have. However, it is a widely held presumption that these executives, by virtue of their contract of employment, would refrain from exploiting this privileged information for personal financial gain.
Senior executives of stockbroker firms and margin trading companies have a good understanding of the market dynamics, trading strategies, and the behaviour of institutional traders, funds, and other major traders. Also, they may have access to research, analysis, and trading data that can inform their trading decisions.
How do expert traders capitalise
on stock market intelligence
and awareness?
Expert traders leverage superior market intelligence and awareness to outperform novices. They gather information from diverse sources, including private channels, to accurately estimate future stock prices (mostly their best guesses). Their connections give them privileged insights into companies. Expert traders closely monitor market dynamics, trading tactics of other players, and who is buying/selling which stocks and volumes. They are first-movers, executing trades before new information reflects prices to capitalize on arbitrage opportunities. In contrast, novice traders lack this private information and deep insights, relying mostly on publicly available information/data which may not provide a timely advantage. The salient trading characteristics that define an expert stock trader can be categorized into three distinct domains:
Stock market intelligence
and awareness
n Expert traders have the ability to gather information from diverse sources (financial statements, economic indicators, news, market sentiment, private information) and process it intuitively in their heads rather than relying upon valuation and forecasting techniques to arrive at accurate probability estimates of future stock prices.
n Expert traders have access to private information through connections with investment advisors, executives of listed companies, etc., giving them an advantage over novice traders.
n They are constantly aware of the latest market dynamics, trading tactics of other players, and who is buying/selling which stocks and in what volumes.
Mindset and decision-making
n Expert traders approach trading with a calculated, disciplined mindset focused on expected value (i.e. average profit) rather than unrealistic optimism about maximum profits.
n They are not emotionally attached to stocks and can make objective decisions. For example, unlike experts, some traders dream of becoming the top 20 shareholder of the company even before their profits are realised whereas some build houses and even spend their fortunes with beautiful but ‘prospective wives’ in their mind while stocks are in hand (i.e. stocks with unrealised profits). Some dream of becoming a member of the board directors by shareholding as they fall in love with stocks while the prices appreciate. At the end of the day, most of these traders sell their stocks at a loss because their attachment is so severe that they are reluctant to exit even in a declining market.
n Expert traders have the ability to exercise self-control, avoid reckless decisions, and accept the inherent role of chance/randomness in trading results. They humbly accept their mistakes and are exceptionally good at reviewing past and learning from mistakes.
Timing and execution
n Expert traders are the first-movers, able to capitalise on arbitrage opportunities by picking up or disposing of stocks before new information is reflected in prices. They are incredibly good at forecasting future price movements patiently and are not desperate in trading like the rest of us. Expert traders believe that there will always be another chance.
n Even when information is public, they can react and execute trades faster than novices.
Self-diagnostics
Have you lost every penny in the stock market or a substantial part of your wealth? Or have you even earned just a marginal return compared to other foregone investment opportunities, despite following principles from finance books?
There is no scientific theory that suggests someone who has experienced a streak of bad luck or losses in any game will eventually recover more than he/she lost. But, possessing market intelligence and awareness, the right mindset, and timing could relieve you from all worries one day and, if not, your loss will likely be the experts’ profits as long as you remain in this game.
(The views, opinions, experiences and analyses expressed here are the author’s own and do not necessarily reflect those of author’s past or present affiliations)
Reference:
Senarathne, C.W. (2021). How do expert traders outperform novices in the Colombo Stock Exchange? A phenomenological approach [Unpublished working paper]. Colombo Institute of Research and Psychology.
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