**April 25, 2022** #writing [[Decision Making]] #emotions I was involved in closing a small oil & gas deal last week and it got me thinking about the difference between trading and deal making. When I transitioned away from trading a few years back and got into the family office space I heard a few people speak of trading as low-return, blue collar activity and deal making as the more refined and higher return option. Obviously being a trader by background I didn't like this and disagreed with it, but it was something I have given thought to from time to time over the past few years. We have seen rapid growth in the private markets during this cycle. I think it is fair to say that the private equity (PE) market is now just as important if not more important than the public markets. I believe we are witnessing a sea change in how businesses use the capital markets for capital formation where companies increasingly go to the private market for funding and institutions use the public markets for asset aggregation (think of ETFs and SPACs) or exits (traditional IPOs) that end up getting bought by the asset aggregation vehicles. I remember hearing that the number of new company listings on public exchanges has dropped dramatically, while the number of new ETFs is going parabolic. The capital formation process continues to work, just more so through the private market, or to put a nefarious spin on it: in the shadow banking market. There are tons of implications from this that we aren't going to get into today. The point I want to explore is that I believe that trading and deal making are far more similar than people realize. In the end of the day a deal is a transaction, and a trade is a transaction, so by the Transitive Property deals are equivalent to trades. I believe the major difference between deals and trades is the settlement window. Back in 2017, the SEC moved from T+3 to T+2 settlement for broker-dealer security transactions. Most people don't appreciate the vast financial plumbing of the public markets and some private markets that allows for a T+2 settlement window. If you ever go through a private transaction with a T+30 settlement or longer you quickly learn to appreciate things like the NYSE, OCC, DTC, etc. that enable the dizzying number of transactions that take place daily in our financial markets. Years ago, Alan Greenspan marveled at the implicit trust in the markets where many trades are executed over the phone simply by word of mouth and most settle on time without disagreement. This implicit trust is not given much daily consideration by traders as it is self-regulated by the market because if you say "done" and don't stand up to your commitment then no one will trade with you ever again. The most important part of any transaction is the parties to the transaction and the competition vying to complete the transaction. I believe that investment bankers and other deal makers have a much better appreciation for this than traders, but for both your counterparties and competition are the most important consideration. However, in my limited experience I have seen a much higher rate of deal makers not standing up to their commitments and very little self-regulation by the market. This is an area where the private markets are far less efficient than the public markets and presents a very real but difficult to quantify risk in private market transactions. The value-added part is the art of the deal (not a Trump reference) which includes things like negotiation, self-understanding, and understanding your competition. Anyone who wants to can learn to analyze a company's balance sheet and do due diligence. Traders tend to think the most important thing are things like moving averages, oscillators, valuations, momentum, or whatever style or strategy you fancy. They are wrong. It is better to think like an investment banker, focusing on your competition when trading. It is better to understand the emotions you may go through throughout the course of a trade or deal and how that will impact your decisions and understand how your competition will experience the same emotions. The common thread between trading and deals are the people doing them and their emotions. The good thing about emotions is they follow a predictable pattern which is best characterized by the [diffusion model](https://en.wikipedia.org/wiki/Diffusion_of_innovations). I wasn't an investment banker so I can't speak to their on-the-job training, but as a trader often we were told to control our emotions but also have high conviction. Denise Shull has made the point that this contrast is inaccurate because we [cannot make decisions or have conviction without utilizing our emotions](https://therethinkgroup.net/wp-content/uploads/2020/05/Shull-June17-Modern-Trader.pdf). She quotes John Netto who calls emotions our greatest ally. Awareness of your own emotions and biases as well as awareness of your competition's emotions and biases can help you predict what your counterparties and competition will do. Last week provided a great example of this in the markets. Coming into the week the market had been selling off for two straight weeks. The Fed has begun tightening and increasing the hawkish rhetoric which has bond yields rising to levels we haven't seen since 2019. This has been weighing on stocks and the rally off the February low seemed to have run its course. Using the diffusion model, what we saw on Monday was laggard sellers. The market rallied a few times on Monday to the 50d moving average and every time traders were there selling. If your only reason to sell is the 50d moving average, then you are not the most informed trader out there. I don't know where it is from, but I love the saying about if you can't spot the sucker at the poker table then you are the sucker. If you were able to take a step back and understand the mindset of the sellers on Monday it could have been clear that the market was getting too short to go any lower and the odds of a short covering rally were increasing. On Tuesday, that is exactly what we got. After finding acceptance above the 50d early on Tuesday the shorts panicked, and the market ripped higher as those weak hands were either forced to cover or panicked out of their positions. Going back to the diffusion model as the market rallied on Tuesday the early adopters and early majority started to hop on the train and late Tuesday, we saw a further rally into the close. Short-term traders and momentum-based investors tend to follow price, and this is what was going on late Tuesday and into Wednesday when the market gaped higher. However, once the market gaped higher it lost all momentum and just rotated, but that didn't deter the price-based traders who bought every dip on Wednesday. NFLX had a disaster quarter and stocks were still up. Then we got TSLA's earnings, and the market was heading higher again after the close. The rally ON on Wednesday and the gap higher on Thursday had low conviction. It was clear at that moment the buying we were seeing was from the laggards in the diffusion model once again. We had gone full cycle from Monday thinking stocks could only go down, to crossing the 200d early Thursday and dreams of April's positive seasonality taking us back to the highs. This same process is constantly taking place in life and the markets. Last year everyone was doing a SPAC and this year most of them have been cut in half. There is a craze in the family office space for direct deals and private equity co-invests. There have been stories of sophisticated investors forgoing regular due diligence to win a deal because the competition is so intense. I'm stretching a bit here, but Softbank, whom Grant's calls the "epitome of this cycle", is a perfect example of a laggard buyer. Just because they are laggards doesn't mean they will be wrong or that the market is going to turn on a dime but understanding the psychology and emotions around these things helps you understand where we are in the cycle. If you have ever worked in any sort of financial transaction work, including retail, you have witnessed the point where emotions take over and people do whatever it takes to get the deal done (think Black Friday). Bill Ackman very publicly lost about a half-billion last week when he exited his NFLX position. I really don't know much about the guy, but I respect what he did last week. His process seems to be devoid of emotion. He takes a view, makes his bet, and it either works or it doesn't. That is a really difficult thing to do, and most people cannot do it. I'm not suggesting it is the best strategy, but it at least recognizes the role of emotions and clearly only thinks of decisions as bets and puts the emphasis on the decision-making process. What is interesting about Ackman, is he wasn't always this way. I am referring to his battle with Icahn over Herbalife. That was a case where he let his emotions take control. He seems to have learned something from that experience and changed his strategy as a result. It is fascinating to watch people in the public eye make big adjustments like this in real time. I believe that if you have a deep understanding of how emotions impact you and others then you can trade any financial instrument or commodity. The basics of supply and demand and product knowledge can be learned by anyone or any computer, but the emotional aspect is where you find your edge. I've now transacted an oil field and earlier in my career I traded bankruptcy claims. I can't think of two more different things, but I applied the same decision-making process to both those transactions. It's all the same as long as you are trading with people, and despite all the algorithms these days there are still people behind those algorithms and the majority of trade takes place between sentient beings. Americans are risk takers and gamblers. It was crazy to leave the comfort of Europe to seek riches in the new world, but that is what our ancestors did. They were crazy, and we are crazy as a result, and that is a big reason why we have the deepest and most liquid capital markets in the world. We will always have things like meme stocks, SPACs, and so on because it is in our DNA and the markets, whether private or public, will therefore be driven primarily by emotions.