Thinking of investing in the trendiest name on a gap up day? Do you really think it is going up again tomorrow or are you just trying to fool yourself into thinking that you can buy the gain that already happened?

Smaller capitalization (i.e. <$1 billion) companies are more volatile and less efficient than their larger peers, and this is both an opportunity and threat to the individual investor. Individuals actually have a bit of a competitive advantage in small caps as it is difficult for institutional investors to build meaningful position sizes. But be careful. Manipulation and pump & dump schemes do exist. Even legit, big buyers and sellers can come out of nowhere, move the market and then leave just as fast. The short term price action, in many cases, will not be an indication of you either being super smart or missing something in the small cap space.

The scientist Stuart Kauffman coined the suggestive name, “the adjacent possible”, for all those first-order prospects. The saying is intended to capture both the limits and the potential of innovation. In his 2010 Wall Street Journal article, ‘The Genius of the Tinkerer’, author Steven Johnson described Kauffman’s adjacent possible as “a kind of shadow future, hovering on the edges of the present state of things, a map of all the ways in which the present can reinvent itself”. Most advancement comes from small scholarly improvements based on experience and trial & error (i.e. the adjacent possible); not abrupt, sweeping, unexpected, revolutionary changes. The big and unexpected often come more by random chance. Penicillin and Sildenafil come to mind.

Every time you buy a stock someone is selling it to you, and vice versa. You may be surprised to learn that your counterparty is probably not unemployed, uneducated, or living in their parents’ basement. Most investors are professionals with a college degree and high disposable income. Many have graduate degrees. Said differently, your counterparty is likely wearing a suit, not high tops.

Marc Andreessen, co-founder of Netscape and general partner of venture capital firm, Andreessen Horowitz, summarizes this notion very well in the following quote from a WSJ article: 

“One of the things I always tell our entrepreneurs is, don’t just hire people out of successful companies, because the people out of successful companies didn’t learn anything. Maybe they were just along for the ride. Whereas, the people who have been through tough times tend to be much more resilient and they tend to be much more determined and they’re not daunted by things being hard.”

Sometimes it can be tempting to sell into an usually large short term rally or buy after a big drop, but, on the margin, your intuition may be fooling you. Gap ups and gap downs are often a leading indicator of the (near) future trend after a material development is announced.

The textbook definition of arbitrage reads something like, “the simultaneous purchase and sale of the same security in different markets to profit from unequal prices”, or ‘riskless profit’. Genuinely ‘riskless profits’ do not exist in my experience, but clean-cut market inefficiencies occur occasionally. This is ordinarily when the chance for profit at ‘measurably low’ risk presents itself. Continue reading “Arbitrage” →

Grey market trading in private company shares can be pretty funky – producing unique opportunities and challenges. Many stemming from limited regulatory or liquidity-driven oversight. Investors can commonly accumulate or dispose of private company positions without drawing too much regulatory and/or volume attention. The same is awkwardly true for companies and their insiders themselves. For instance, with less restrictive disclosure requirements, a private oil company could feasibly accumulate substantially more land in a highly prospective area than a public company with material purchase disclosure requirements may be able to. 

There is one opportunity special to private company grey markets that I have pursued on more than one occasion – bidding aggressively for new companies with celebrity management teams three to six months after their initial financing round. Continue reading “Grey Markets in Private Companies” →