Author: Michael Arold
Covestor model: Technical Swing
“A mouse can go where an elephant can’t” is a well-known quote from Edwards & Magee’s investment classic Technical Analysis of Stock Trends. The metaphor applies very well to the nature of an individual investor’s edge in the markets.
The most important question for anybody participating in the stock market is “What is my edge?” How could a retail investor have a chance to outperform large institutions, which most likely have better research, better management access and certainly employ more analysts?
It is key to understand the strengths and weaknesses of the large funds. One area of strength is certainly fundamental research on publicly available information. The chances of the individual investor or even small financial advisor to know more about a company than the armies of professional analysts are virtually zero, unless perhaps one were to apply a Peter Lynch-type research approach and invest only in companies one can follow actively. The Peter Lynch strategy could theoretically result in earlier knowledge of information and therefore create an edge.
A major weakness of large institutions is their size, and I believe that this size effect can be exploited by individual investors in the role of the “mouse.” The funds represent the “elephant.” Individuals can get in and out of positions very fast, while institutions cannot.
Let’s take an example: Wells Fargo & Company (WFC) is currently one of the largest positions in Warren Buffett’s portfolio. Mr. Buffett, via Berkshire Hathaway, owned 361 million shares of WFC as of September 30, 2011. Wells Fargo’s average daily trading volume is about 39 million shares. As a rule of thumb, a large scale investor can buy or sell 20 percent of the daily trading volume without moving stock prices too much. In that case, it would take Mr. Buffett roughly 46 days to build up the position. In reality, the period would be much longer because he has to be careful buying on strong days, so it could have taken him at least three to four months to accumulate his current position.
If the stock market crashes tomorrow, I will be out or even go short the stock. Warren Buffet’s hands would be tied (he would probably buy, which would make sense for the long term).
The size effect is one of the reasons why I trade on short time frames. I’m using one of the strengths I enjoy over large institutions. Even if Mr. Buffett would want to apply a short-term trading style, he simply couldn’t. I, on the other hand, have no problem being the mouse.
