Buy the Fear and Sell the Greed
Christopher Aiello
Centurion Global Capital, Hong Kong
November 27, 2007

For the last 3 years I have been making a living from trading statistical arbitrage, relative value, and event driven strategies both for my own account and for an institutional client portfolio.

I keep an extensive trading journal and after reviewing 4 volumes of my trading journals, I have been able to distil my overall philosophy to a core view of how markets operate and how to exploit opportunities for profits while actively managing risk to minimize the loss of capital.

First, I have a core set of principles that I base all of my trading and risk management decisions upon. These core principles are the foundation of all of my decisions related to research, trade selection, position construction and risk management. The core principles in order of precedent are:

1. Protect Capital-Preserve Principle Money as the primary focus;
2. Minimize Drawdowns and avoid large draw downs
3. Only Enter a position when I have identified a low-risk entry point
4. Create Consistent Profits first and think about generating large wins second.
5. Create a steadily compounding, upward growing equity curve.

Next, my trading style is based on my own philosophy of how markets operate based on the view that markets are driven primarily by human behaviour and since a market is nothing more than a collection of individual decision makers allocating capital to investment and trading ideas, by understanding how humans operate primarily from emotions, then a savvy and professional Trader can find market inefficiencies and anomalies consistently and pull money out of the markets from weaker hands.

My trading style and decisions are then based on the following beliefs
I have about markets:

1. All success in trading comes down to a very simple process of either Buy Low and Sell High or Sell Short High and Buy Low, regardless of the type of strategy being employed, i.e. momentum-directional, relative value arbitrage etc. Even when a Trader is trading an arbitrage/spread based strategy, he is making an assumption that the "spread is cheap" or the spread is "at a premium". So the maxims of Buy Low/Sell High or Sell Short High and Buy Low still apply even when trading relative value or statistical based arbitrage strategies.
2. As a professional Trader then my thinking and decision making in regards to exploiting market opportunities boils down to:
   1. Buying at a Discount/Sell Short Premium
   2. Buying an Undervalued Asset/Selling Short an Overvalued asset
   3. Buying low expectation assets/Selling Short high expectation growth assets
   4. Buying Fear and Selling Short Greed

I have employed this philosophy successfully and profitably whether trading statistical arbitrage, a relative value basket of stocks or options/warrants.

3. Regardless of the trading strategy or asset I am allocating capital to, the Paramount determining factor of success in trading any financial market is the disciplined, consistent and ruthless focus on risk management and protection of capital and the minimization of losses and drawdowns. To my mind and experience it is essential to take every single stop, in order to maintain a disciplined inner state and mental control over my trading decisions. The markets are too big for any one trader, and the markets can stay irrational much longer than I can stay solvent, so the way to succeed over the long-term as a professional trader is to take stops and protect capital.
4. For me, all investment and or trading decisions must be based on first a fundamental notion of the economic value of the asset, whether it is an equity, a bond or a derivative. While I do use a lot of technical analysis and statistical analysis, I always start from a fundamental idea and then add on technical, statistical and sentiment analysis on tope of that, and I will always trade in the direction of the fundamentals and never against the fundamentals.
5. Once I have an idea of the economic value and fundamental bias, enhanced with technical analysis, statistical analysis etc, then I will structure a trading position around the investment/trading idea with a methodical discipline of:

   1. Define my bias, Long or Short
   2. Have a defined set-up and entry decision process to create a Low Risk Entry
   3. Have a pre-defined capital protection stop-loss point before I open the position
   4. Have a profit maximization plan i.e. the maxim applies, Cut your Losses Short and Let your Profits Run

6. The Human Factor of Emotions: Finally, I never forget the Maxim that "Markets can stay irrational much longer than I can stay solvent". This also is coupled with my belief that markets are driven primarily by human emotions of fear and greed. Market action is the result of a multitude of psychological and emotional decisions (i.e. sentiment).

Therefore market values will hardly ever be aligned with what the true Intrinsic Value/Economic value of the asset is. Market Sentiment (fear and greed) will almost always drive prices to levels of overvaluation (premium and greed) and undervaluation (discount and fear).

Based on this, the astute and disciplined Trader will always have the opportunity to succeed, profit and thrive in any capital market by enacting the principle of generating profits by Buying discount and Selling short Premium.

Important Disclaimer:

The views and issues expressed in this article are those of the author's and not that of Risk Latte Company Limited ("the Company") or any of its employees and members. The Company is not responsible for any factual or conceptual errors contained in the body of the content of this article and shall not be responsible and liable for any losses, direct or otherwise, incurred by anyone, individual or partnerships or body corporate, by making direct or indirect use of any of strategies, ideas and points mentioned in this article. The Company is not a stockbroker or investment advisor and is not registered with the SFC in Hong Kong or with any other regulatory body anywhere in the world. Buying and selling stocks, securities and other financial assets could be extremely risky and investors should consult their brokers, investment advisors and banks before making any investments.

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