>Do not repeat the tactics which have gained you one victory, but let your methods be regulated by the infinite variety of circumstances. **He who can modify his tactics in relation to his opponent and thereby succeed in winning may be called a heaven-born captain.** >-Sun Tzu Understanding the different market participants, their roles, motivations, and constraints is a prerequisite for a successful investor or trader. The financial markets are arguably the most competitive domain in the world today, maybe with the exception of geopolitics. Professional athletes spend most of their time [[Preparation|preparing]] by studying their opponents and it should not be any different in the markets. In the Art of War, Sun Tzu makes the point that we shouldn't strive to find tactics that lead to victory, instead we should be able to adapt to our competition to succeed in winning. This is why I stress [preparation over prediction](https://cedarshillgroup.substack.com/p/chg-issue-57-preparation-not-prediction). The table below is a starting point for this discipline. Risk Flow is the impact each type of investor can have on the supply/demand balance of risk in the market. Understanding that real money investors like banks and insurance companies warehouse risk means that they take risk out of the market for extended periods of time. Understanding that hedge funds can be the marginal supply or demand for risk at any time means they can go with or against real money flows but they have a shorter horizon than real money. The markets are a complex system and understanding the different ways these diverse participants can interact in that system provides a good framework for understanding what the markets are doing. | Type | # of players | Investing Horizon | Risk Flow | Motivation | Constraints | Turnover | | ---- | ------------ | ----------------- | --------- | ---------- | ----------- | -------- | | Pension/Insurance | Low | Long Term/Buy and Hold | Warehouse | Liabilities | Long Only | Low | | Hedge Fund | High | Short to Intermediate | Marginal | Absolute Return | Leverage | High | | Liquidity Providers (Citadel, SIG, Jane Street, etc.) | Low | Short Term | Neutral| Arbitrage | Leverage | High | | Banks | Medium | Short to Intermediate | Warehouse | NIM | Long Only | Low | | Money Managers | Medium | Intermediate to Long | Marginal | Relative Performance | Long Only | Medium | | CTA | High | Short Term | Marginal | Absolute Return | Leverage | High | | Private Funds | Low | Intermediate to Long Term | Warehouse | Absolute Return | Liquidity | Low | | Proprietary Traders | High | Short | Marginal | P&L | Leverage | High | | Broker Dealers | Medium | Short | Marginal | Liquidity | Liquidity | High | | Retail Traders | High | Short | Marginal | P&L | Capital | High | | Retail Investors | High | Intermediate to Long | Warehouse | Absolute Returns | Capital | High | - **Pension and Insurance** investors are the longest timeframe and are immunizing liabilities (Sovereign Wealth Funds are also included in this group). They are performing fundamental analysis to find securities and other investments that will return more than the cost of their liabilities. Their liabilities are long-term so these investors can warehouse large risk over the long-term which is an important function for the economy. Despite their longer timeframe these investors are still vulnerable to getting too focused on short-term performance. - **Banks and Broker Dealers** work the same way but have shorter term liabilities and are therefore riskier but also are more highly regulated given their systemic importance to the economy. Most of the large broker dealers are owned by large banks today and the smaller broker dealers tend to be privately capitalized. Brokers dealers act as market makers but in today's regulatory environment most of their activity is acting as an agent for there customers, matching bids and offers instead of warehousing risk. - **Money Managers** are traditional institutional investors who tend to be long-only but can operate flexibly and opportunistically across timeframes. They have large pools of capital and can move markets when there is a trend to exploit. Included in this category are ETF's which have grown significantly over the past few years. Money managers can be grouped based on their strategy as either: - Active - Passive: systematic, rules-based investors - **Short-Term Traders** can include broker dealers, market makers, CTAs, hedge funds, and retail traders among other categories not included above. These traders can further be categorized as either momentum/trend following or mean reversion traders. CTAs tend to be mostly the momentum and trend followers while retail traders tend to be mean reversion traders i.e.. "buy dips" and "sell rips". - **Retail Investors** either invest in their own or have a financial advisor. They are heavily focused on income generation strategies and minimizing portfolio risk. They are heavy users of ETFs. ## The Wisdom of the Crowd The argument that the market is an efficient voting machine because of the potential financial rewards is flawed because it presupposes the future is knowable. The argument goes that if the market could be beaten then smarter people with more resources would figure it out and arbitrage the opportunity away. While that is true it does not mean all the resources and knowledge we have accumulated as society lead to [[truth]] or that the truth or the future are knowable. The crowd has just as much wisdom as it does folly. Markets are made by humans, and humans are fallible. Perfect knowledge of the truth cannot be achieved by the addition of more fallible opinions, no matter how sophisticated the opinions. There are elements of the future that are knowable and those will be arbitraged away by competition, but what we are left with is the unknown future which is what we humans have been battling with since the Garden of Eden. >Therefore do not worry about tomorrow, for tomorrow will worry about itself. Each day has enough trouble of its own. >[Matthew 6:34 NIV](https://my.bible.com/bible/111/MAT.6.34.NIV) Explore Further: [[The Capital Formation Process]] | [[Auction Process]] | [The Metagame](https://fs.blog/the-metagame/) | [[Efficient Markets Hypothesis]] | [Moontower's Evergreen Beliefs](https://abdelmessih.notion.site/4ed6f1326af04d3386c5d37040cd2b7c?v=3469cdb9541f42b5b939b4f48338c7b9&p=08ad6cd3da9e456898ac5fa2e9140f02&pm=s) Tags: #Disciplines #classification #evergreen Your support for Cedars Hill Group is greatly appreciated <form action="https://www.paypal.com/donate" method="post" target="_top"> <input type="hidden" name="hosted_button_id" value="74PGN8ZXHQVHS" /> <input type="image" src="https://www.paypalobjects.com/en_US/i/btn/btn_donate_LG.gif" border="0" name="submit" title="PayPal - The safer, easier way to pay online!" alt="Donate with PayPal button" /> <img alt="" border="0" src="https://www.paypal.com/en_US/i/scr/pixel.gif" width="1" height="1" /> </form>