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How a trader knows when to strike

Most traders won't admit this, but here's a dirty, little secret of Wall Street: The best ideas usually aren't your own.

I traded for 15 years and for several hedge funds. The trades that I — or we (the fund) — profited from the most came from a myriad of places. In and out of the office, I waited until I sniffed something that forewarned me that there was a trade — money to be made. You probably never realized it, but wherever you were — at Happy Hour, walking by the trading desk or speaking freely riding up the elevator on a summer Friday — I was taking notes, analyzing every word and reading your body language like a soon-to-be ex-girlfriend.

Then, I would wait … until it was time to pounce.


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When their breath stinks with fear

Sometimes, you can smell it immediately.

I worked with an analyst whose threshold for pain was my buy signal. She'd come running to my desk telling me we had to sell some of our position because the stock kept trading down. As soon as she'd leave my desk, I'd buy more. I knew when she couldn't take it anymore — it meant it was time for the stock to rally. BUY MORE.


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There was another analyst I worked with who was very talented. He had great calls and was very often right, but when he'd timidly approach my desk to buy some stock, he'd tell me to buy 25k or 50k shares. For a billion-dollar fund, that wouldn't move the needle. I knew he was usually right, so as soon as he'd walk away, I'd buy 100k shares. BUY MORE.

Then there was the most valuable guy in the office. He was one of our analysts and he was ALWAYS wrong. It was gold. No matter what he said, you should do the opposite. He says, "buy more?" SELL MORE.

The only useless or dangerous person in the office to a trader is the person who's correct fifty percent of the time. They're toxic. STAY AWAY.


Slow day? That's when they let their guard down

Sometimes, it's not about smelling fear — it's about sensing the comfort.

Typically summer Fridays are considered unproductive and not very actionable. The office is quiet and people feel a little more at ease. And a beautiful thing happens: Analysts and portfolio manager have candid conversations with traders. They might be talking about an individual stock or the market in general, but it's free of fear.

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They're not paralyzed by the flashing red and green on their screens. When you ask them what they think about stock XYZ, they don't have to check the price action before responding. It's these unfiltered ideas and thoughts that provide great trading ideas.

On a slow day, an analyst might say, "Man, if AAPL ever trades back down to $550 I'd back up the truck and buy every share I can because of these three reasons." But something funny happens a few weeks later when the action comes to fruition. When you walk into the analyst's office and AAPL is trading at $550 they no longer want to buy it. So, I'd ask, "Has anything changed?" Are your reasons to back up the truck still intact? Even when they'd respond, "yes," they still didn't want to pull the trigger. Fear had taken over.

So then I'd have to resort to Jedi mind tricks to get them to buy the stock. I'd either say, "Fine, we'll just buy 200k and see how it trades." After they accidentally choked on their pen cap, I could get them to agree to buy 100k and they'd feel like they won the battle. Or I'd just tell them I was buying it on my own and they wouldn't get credit for the trade. The fear of missing out usually persuaded them to get on board with it.


Knowing when to strike

It's not always an instant kill.

It was late in the summer of 2007, and scrolling across the tape was an announcement that (DCX) Daimler Chrysler deal was falling apart because of financing. I stood up and screamed, "It's time… It's time!" My portfolio manager had no idea what I was talking about.

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Months earlier, my PM had made an off-the-cuff remark. We were in the midst of a flurry of M&A activity in equities. It seemed like every morning we came into the office, there had been four different takeovers overnight. I'd never seen anything like it. I knew my PM wanted to be short the market, but he just didn't know when. So one afternoon he casually said, "You know, the next time one of these deals falls apart because of financing, it's time to short the whole market." As soon as he said it I ran back to my desk and wrote it down in my notebook next to all of the other smart things people said when they were free of fear.

When I reminded him of his prediction, he wanted to dismiss it because the market was too strong. He no longer wanted to get short the whole market. But we at least started the process of getting rid of lukewarm longs and finding some new shorts. Was it the greatest analysis of predicting the market was about to crash? No, but it was an inflection point we had identified several months in advance.


Look for the patterns

You hear scientists talk about how there are patterns in nature. But there are also patterns in human behavior.

People make mistakes all the time. Unfortunately for them, it's often the same mistakes.

When I'd look around the office and keep seeing repeated mistakes over and over again, I recognized how consistent they were. I realized their consistency could help me navigate the stock market.

Everyone on Wall Street uses their eyes and ears, but sometimes it's easier to smell it.

Commentary by Turney Duff, a former trader at the hedge fund Galleon Group. Duff chronicled the spectacular rise and fall of his career on Wall Street in the book, "The Buy Side." Follow him on Twitter @turneyduff.

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