Building A New Playbook

Thoughts on how to find edge

"thoroughly conscious ignorance is a prelude to every real advance in science" James Maxwell.

One of the biggest obstacles faced by a trader, new and developed alike, is how to find edge in the markets. There is so much randomness, uncertainty and just plain dumb luck which is all completely out of our control. Our human mind is programmed to try to make sense of the world but the reality is there’s an enormous amount we simply do not know. I have experimented with trading in every possible way you could imagine, across different products and timeframes, so it has taken a while for this simple message to sink in. I have ripped through every indicator you could think of and I have even gone deep on counting waves, all to no avail. Sound familiar?

I believe the starting point is knowing the limits of our knowledge and accepting what we do not know. If we can fully heed this, then it becomes easier to let things pass us by without committing wasted capital. Our ultimate goal is to make good decisions over and over again to put the odds in our favour. These decisions come from following a sound process that is backed up by sound rules, experience and probabilities stacked in our favour. Key point there is to actually have a process. That all comes from building a system or a “playbook”.

So what is the right way to do this?

The common mistakes:

A common pattern I see from short term traders is to pull up a host of tickers that have some form of news that day, put them in a watchlist, and then proceed to trade them all through the day. Some will trade the match because of flashing new buy orders; some will breakout trade it through a made up resistance level or the high of the day; some will buy into vwap; some will stop out below vwap; some will use a 8 day exponential moving average etc etc. Have any of these rules even been tested or are we just doing what everyone else is doing? The more experienced trader will have more advanced tape reading skills and use this to their advantage BUT often still lack deeper variables as to why they are even actually trading this stock. Are we trading a news event the market even cares about? If so, has the market priced this incorrectly hence the reason to trade? To be clear, I am not saying that these methods cannot work and each trader has to find a style that suits them. If you think I am immune from trading like this, think again as check out this dummy who fomo’d into WTC short on Friday cos “news”:

WTC 24/11/23:

2.5k donation to the market. What did I do wrong here? I didnt follow my system. I made stuff up on the fly.

The "Broken Slot Machine”:

Back to my previous questions- what is the right way to do this? To me wrapping the layers and variables increases the probabilities for better decision making in a world of uncertainty. What is truly needed is to build out rules via a playbook. This can be through observation of countless reps. This could be through clear backtested data. Nonetheless, you needs rules to create a rigid system. They need to be SPECIFIC. This is where most fall short. When you hear "man I covered too early" or "I didn’t size enough" it is because there was NOT a clear system in place to do so. Why would you expect anything different. Real time it is hard to execute without these guide posts. It is why I write trade reviews to create those pathways for next time.

The concept that I like to follow is what Lance Breitstein coins “the Broken slot machine”. Essentially this means observing what trades are working in the market or what other successful traders are doing. Then you reverse engineer the crap out of these trades to see what identifiable variables and factors were present. Get data, re watch tape, repeat repeat repeat. There may be an element of hindsight bias to these trades and thus key will be whether they can truly be replicated over and over again. Following someone more experienced can massively cut that learning pathway. Once you have edge that you can truly define and is working real time, then do it better! Get better through technology, get better through size, do whatever you need to just get that edge better.

One of the reasons I love short term trading so much is that I get so many more hits and reps. There are many factors inside of my control vs holding positions longer term which expose me to overnight market moves, fresh news and etf moves which are all outside of my control.

Just last week on the ASX you might have noticed Iron ore stocks dumping on breaking news; AGL breaking down on a new proposed government energy policy; TNE selling post a big block; TWE and HLS under pressure post big dilutive capital raises; WC8 rallying post its capital raise; ORG getting hit ahead of its scheme meeting. These trades may have suited a multitude of skills and personalities. How many of you have taken the time to truly study these, watch them, and define them as strategies or playbooks? Have you written them up? If you are a developing trader and you haven’t done this work by now then I do not know what you are doing with your time (I am btch).

FMG 23/11/23:

A snapshot of my playbooks:

I have built extensive playbooks across strategies in an attempt to find edge. Some of these have been tested via quant data. Others are discretionary through observation. What they all have in common are firm rules and the guidelines are:

-know what I want see

-where I want to see it

-when I want to see it

This blogpost does not have the capacity to expand so please just go and read Mike Bellafiore’s “the Playbook”. This was the game changer for my career. It led me on this path. Here is a snapshot of my Evernote and a outline of my different playbooks. Some of these strategies I run to this day whilst some of these have been abandoned because they do not work anymore. However what they all have in common is a template of rules.

Expanding into a new playbook: Event Driven in ORG

I am always looking to see if there are new strategies that I can grow into. One area that I have very much avoided is M&A and event driven trades. This is a competitive landscape with full time hedge funds deploying vast capital for small returns. These guys pour over the offer documents and do their homework. They own it. I always felt like I just couldn’t compete here and it just wasn’t worth my energy particularly given how rare they are. However, no doubt this was a self limiting belief. Seeing recent events play out in AZS, LTR and now ORG has forced me to address my previous bias (spoiler alert no borrow in LTR). Perhaps I could devise my own special situation playbook for these rare events? Thus this trade write up is all about my attempt to do so: https://www.evernote.com/shard/s500/sh/99679eed-fb7e-9795-8402-94298bee3712/sHyBPYnwdWewV8pekrxTFxTU_3VMcfLKTQHCJ0gaCztoYUkbIGXsm3q6GA.

No doubt there was much I could have done better. It wasn’t a big trade given the size of the move. BUT that’s all to be expected as I grow into this new area. You can also read below vs the Evernote link.

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-Trade name: ORG

• Event driven short

-Catalyst:

• Scheme scheduled for today for approx $9.48 bid but unlikely to get up given Au Super block and proxies: ORG on Aus Super block 2/11/23

• Brookfield/EIG have asked for a variation of the scheme. Scheme vote meeting was scheduled for 2pm on 23rd November but original deal was not going to get across the line given the Proxy votes coming in. New vote adjourned until the 4th December and no reason to suggest the outcome will be any different.

• Plan B revised proposal is a slice and dice. This is non binding and indicative. Under the revised proposal ORG shareholders may receive up to $9.08 per share, comprising sale proceeds of Origin's Energy Markets and cash (seek a normal resolution to sell Energy Markets for $12.3bn, and then an off-market bid for APLNG). Conditional on 50.1% acceptances needed. This approach incurs a tax payment of ~$603m, which allows for additional franking, thus making the offers equivalent.

• KEY is that the Board do not endorse at this stage. This is a total change of rhetoric from previous scheme: "The Board has significant reservations as to the complexity, conditionality and differing value, and potential adverse tax outcomes to Origin and shareholders". Significant ETF flow on the register that votes with proxies/board.

• More complexity that Federal government said that it intends to expand its Capacity Investment Scheme from the pilot stage to a scheme that is targeted to deliver 9 GW of dispatchable capacity and 23 GW of variable capacity nationally. This announcement previous night seemed to have tempered Brookfield's bid.

-Variables:

• Negatives: are non binding indicative; funding not lined up; regulatory risk from FIRB and NOPTA; board doesn't endorse for now; new government energy news adds complexity. Au Super probably still not going to be happy with this as it doesn't address the fundamental issues raised

• Positives are it becomes easier to pass 50% vote (but lower price for shareholders). However, they cant go hostile if no board support for asset sale.

• In conclusion, upside capped but downside increased given those negatives and increased govt back generation capacity. This needs to be priced at a fair discount to $9.08 given these significant negatives and time value of money.

• Was matching 8.80 at one stage so only 3% discount. Came in to 8.70 which was only 4% discount. This seemed like very good risk/reward odds to short.

• Prior to this, Macq wrote: "A failure of the scheme we see has downside risk to the $8.00-8.22ps level, however a likely restructure of Origin to unlock the individual asset values is unlikely to see that weakness last.

• 1hr halt from 12pm release to re-open. Is this enough time for the market to process and deploy? Reality is alot of ARBs have already sold into this who were significant on the register. However, remaining shareholders may be forced to act as clear scheme dead in the water and revised plan is act of unlikely salvage.

• What I did really well here is engage with new M&A broker to get the colour and talk through all the variables. This helped me process everything and frame the risk reward context. KEY for him was the change in board sentiment. "This is very messy, I dont think this trades up too much if at all. " Again expanding my team and using other peoples experience

-What did I do:

• Open Volume: Matches 871 on 650k or $5.9m. This was a gap up of 3.2% from last and only 4% discount to the new terms

• Order book: Book offered over on the open with plenty of protection. 100k at 872; 140k at 874; 400k at 875. Thus, can really be putting on size here with 4-5c stop. Even then, IF this is a thesis trade, why stop out into 875s? Have to respect risk especially as a new play but food for thought.

• Entry: Open. Can hit open or can hit confirmation on a break through open. I did latter once I saw 871 bids getting hit and dropped out. Skinny below until 865. KEY was seeing that refresh seller early at 870. I shorted 50k or $435k. Reality is I could have been double the size with the liquidity of name and this is how I must approach M&A going forth if I have done the work. However, wanted to grow into the playbook

• Risk: 5c on 50k is $2.5k. Doesnt make sense for a playbook that is rate. $20k+ if once a quarter event. $20k would be 200k shares on a 10c stop. 4x my size (but wider stop).

• MAE (max adverse excursion): 0. Never breaks open. BEST TRADES GO FROM THE START.

• Adds: the only clear add for my system was on the break through 850 consolidation on the breaking news headline: 3.01pm *AUSTRALIANSUPER SAYS WILL REJECT REVISED ORIGIN ENERGY OFFER

• Exit: my first cover into low 860s was pure order book trading vs following a plan. Well bid and supported into this zone so I defaulted to taking the scalp. However, no turn, no changed price action e.g. a  bid drop and recovery, and thus no exit signal at all. This is where having a clear plan ahead of time is important. What discount to terms do I think is appropriate given the negatives outlined? 860 is only a 5% discount so this is still not enough.

• Exit 2: Idealised exit for 1/2 the position was into low 850s as stock holds in price and time. Well supported here and volume completely drops out = efficient. However, now at approx 6% discount which still doesn't mean the trade has played out if the deal is truly dead. Needs patience in these longer term plays and thesis ideas.

• See it moment: Dropped straight from the open on volume. See it moment 2 was breaking news headline and decent volume into the 850 zone e.g. 200k at 852 or 2% of the day; follow through with 850 bid getting hit on light volume and then again down at 840s. Just no buying at all of note late in afternoon. Most the stock could bounce was 2-3c. No turn bar

• Notes: I adapted ok to the unfolding price action, using the backdrop as context. Reduced size given a new playbook. Key for next leg down was breaking news headline. I missed the 850 bid as was processing the news, and then joined the clear breakdown through 840 for trend to close play.

-Better next time:

• Sizing: 100k+ early on open. Borrow is cheap. Liquidity is plentiful with 250k protection at 875 or 5c risk. Risk/reward compelling. As well sell off in price and time, clearly R/R diminishes

• Management of trade: exit management important here and needs new rules. This is a thesis trade thus needs time to play out. I defaulted to order book scalping before any true capitulation event or decent discount to the terms = reason to exit. Better would be to frame a sensible % discount to the deal e.g. 7.5% to 8.40s or vwap into the close. Build a gameplan and use price action as the confirmation. My short was NEVER in any risk and no key levels were recaptured e.g. back above 860.

• Tech solutions: none needed