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The lesson of cost basis - From the trading desk of JJ @vwaptrader1
The one thing you never hear in retail trading setup is cost basis. This is because retail traders trade very small sizes compared to people who are in the business.
Now that business is huge and there are many participants. The one participant called the size investor/speculator is the one I learned the lesson of cost basis from. This was my first client who taught me the most important rules of the business. This was the Penguin
When I started at my job advertising public companies to get retail interested in buying them. Before the internet there was direct mail. Public companies, or rather people who had funded public companies were always trying to create a market in the stock so they could unload millions of shares.
I had figured out that coming into the office at 6am Vancouver time was the way to success. Everyone else came in at 9 to 10 am. New Yorkers and market people were calling at 6am. All I had to do was answer the phone, talk to the client, take the order and make the commission on the sale.
Everyone else came in at 9-10, hung over and really didn’t do anything until after lunch. The lunch was always booze filled with “prospective clients” They never closed a single one of them
I on the other hand did my work from 6am to 1pm then off to the gym I went or out drinking with my buddies who were either brokers or jr promoters.
On one such morning the phone rang. “ Hey you muthers never answer the freaking phone! Finally!” The voice with a thick east indian accent yelled out.
“Well sorry sir but this is my first week here and I get in every day at 6 so how can I help you?” I came back with that so fast he was taken aback, expecting an argument. Immediately he started to grill me with questions of buying retention, and what kind of response he would get, HE needed to sell stock damnit!!!!
I told him it was direct mail and that someone would have to work and close the leads. The stock doesn’t buy itself. Someone has to sell it to the prospect.
Now I learned he was not running a public company, he was an investor. But as I would soon find out, he was not a typical investor.
The penguin started to grill me about my background. Once he found out my mom was from Bangalore and I was brown it was game over.
“I’m coming to Vancouver on Wed, meet me at the Wedgewood at 2pm” And that was how I met the Penguin.
Wednesday comes and I walk into the Wedgewood hotel. The hotel is owned by my friend’s mother in law and her husband Nelson Skalbania, a real character.But that is another story
I look around, Joanie the bartender comes over and gives me a hug, Checks out my suit and laughs. She knows me from my days as a bouncer. Big time! Who ya meeting? She laughs.
This east indian dude, supposedly an investor. I say.
Oh yes RJ he’s over there. And points to a little chubby indian guy wearing a leather members only jacket and bad shoes. He’s flirting with this female broker.
He looks up and waves me over “HEY MAN!!” This greeting would be my life for the next few years. In all sorts of forms, laughing, angry, and everything in between.
There is a small group of people around him. It’s like he is holding court. When he speaks everyone gets quiet and I feel like I’m in that old brokerage TV commercial. “When Dean Witter speaks, everyone listens”
I recognize some of these people as having public companies and others as the rounder type stock promoters we have running around the city like mosquitos.
He waves them all away and starts focusing on me. So what is your story? I want to be a trader eventually, I reply.
Well he starts probing me with questions about my background, Tons of questions both personal, then business ones.
You see all these people around me? They want money. They all go through money quickly, live beyond their means, try to show off. They will follow me around all day.
I had no idea of the worth of this man. Vancouver was very showy and it was true everyone was faking it till they made it.
You see that guy, he wants 300g, That lady over there 500g. I will give them this money. They will give me stock at a DISCOUNT to where the market is trading.
WHy? Because they have millions of shares and the stock is worthless. They have to make a market and they need money to promote it. I will fund their promotions and also their drilling and prospecting. But I will always need to stock to be promoted before they put a single penny into the ground.
This way I know there is a healthy market in the stock so I can get LIQUID MAN!!!
That afternoon I learned the secret to stocks. While every sucker is paying the quoted price. Insiders who fund these deals and the over extravagant lives of CEOS get their stock at a HEFTY discount.
This ensures they are locked into profit.
The larger and scarier the investor the more stock the company will give them if the price goes lower when they sell it.
This was the lesson of cost basis. In any market there are those with large quantities of a product and their business is to mark it up and sell it.
Learning where the cost basis is located is an essential part of trading. As markets liquidate especially ones like ours with limited supply they will usually come right back to the last time frame cost basis.
Practical use of this story
The lesson is cost basis, we must now build a setup around it
A setup is a business practice that can be repeated over and over again.
A setup also factors risk into the execution. Before we even take a trade we know where the exit is for profit and also the exit if the trade starts to fail.
Understanding cost basis is a wonderful way to use the trade setup based on LACK OF SUPPLY. The
You see when markets liquidate, they usually liquidate because traders are competing to sell to a smaller group of buyers. They start to reduce the price they are willing to sell. This is what causes price to go down.
An example of this is a market moves up and then goes sideways. After an amount of time people who bought after the move up get trapped long and when they see no movement of price higher they start to sell.
The large wholesale traders who have the LOWER COST BASIS see this and immediately lower prices to CAPTURE the buyers at this level. This causes price competition. This is an ESSENTIAL factor for those who want to short. In order for a short sale to work, price competition must be taking place.
Here is what I am talking about using a simple 5 minute candle chart
The Take away from this is to recognize the cost basis and build it into our setup. So if we are shorting that 5290 area in the above example a likely place for the market to fall back to is 5250 as this is the last area of cost basis.
Now we can also use this to help us cover our short. Say for example the market gets back over 5290. Then we have a look below and fail situation where we can then take the long and look for rotation back up to the top of the distribution balance zone.
The point is that we can manage our expectations and traders who are late to the short can still get in. But realize if the market accepts back over 5290 the sellers have seen decent buying and are raising prices.
This is a great way to keep our heads clear when trying to pick direction. If a market cannot sell off back to its last cost basis then the size sellers have seen enough buyers coming in so they don’t HAVE to lower the price and compete with each other.
We teach our traders how to put together trade setups and manage risk based on the reality of the business. This helps us trade and manage risk and get better entries.
Come see us at Microefutures Trading where I (JJ vwaptrader1) teaches and trades live daily - we look forward to helping you on your trading journey
JJ vwaptrader1
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