Some time ago I was reading a bit of a random post from BankersOnWheel‘s weekly link-fest: the author described which practical lessons you can take from famous finance movies like Wall Street or Boiler Room. A line hit me: when he got to Trading Places, he casually mentioned that he did not understand the finale. He even linked a YouTube video with the explanation.
Really?!?
I have a particular relationship with this movie. I do not remember when I first saw it but must have been when I was around 10 or 11; by the time I was 19, an Italian TV channel started to broadcast it on Christmas eve, every year…and it is still doing it (according to Wikipedia, only in 2005 they did not do it). I guess it became a Christmas movie for the same reason Die Hard is. I probably watched it 30 times. When I was living in Luxembourg, one of my best friends (Italian) decided to organise a Trading Places night every December; yeah, I guess if you thought Luxembourg was boring, this piece of info would only cement that idea, righty so.
The fact that I learned when I was 30-ish that the original title was “Trading Places” (the Italian title is uber lame) only added to its charm. I wish I was that creative when I birthed this blog. That movie has so many layers.
It is also racist AF. If Americans leaned a bit too much on the cancel culture lately (Louis CK RIP)…boy, Italians really gloat when the Dukes go hard on the N-word. They suck it in like a spaghetti al dente. Movies that talk about abortion are cut like Winnie the Pooh in China but Trading Places goes unscathed, prime time, in Italy. I understand it is a product of another era but…I’ll show my kids American History X and wait for the reboot of this one, let’s put it this way.
When I was in my 20s, I read the story about the Turtle Traders (I think in the book Market Wizards) and the resemblance with what I saw in the movie so many times made me laugh. I thought the movie took inspiration from reality while it seems the reverse happened: two prominent commodities traders of the era, Richard Dennis and William Eckhardt, decided to re-enact the Dukes’ experiment after having watched the movie. Dennis posted an ad in the newspaper, selected people with a certain affinity for numbers and probability, but with no formal education in commodities, and trained them to trade. The experiment panned out: most of the participants not only generated extraordinary profits for Dennis and themselves, but eventually left for successful Wall Street careers.
I will explain the finale assuming you watched the movie. If you did not and you are still reading…what is wrong with you?!? It is a really good movie, stop whatever you are doing and go watch it, some degen probably uploaded it on YouTube ages ago so you do not have any excuse.
The finale starts with Dan and Eddie walking towards the COMEX (which is the COMmodity EXchange, uh uh) situated in the World Trading Centre. It is a bit weird to say I have good memories about the Twin Towers, considering the tragedy, but my parents brought me there as a teenager on my first trip outside Europe and it will always hold a special place in my heart; I have a shitty memory and yet I remember everything about that trip. Probably it makes this scene even more special for me.
"Think big, think positive. Never show any sign of weakness. Always go for the throat. Buy low, sell high. Fear, that's the other guy's problem. Nothing can prepare you for the unbridled carnage you are about to witness. The Super Bowl, the World Series. Pressure? Here it's kill or be killed. Make no friends and take no prisoners. One minute you're up half a million, the next, boom. Your kids don't go to college and you've lost your Bentley"
This speech is great, it explains really well the essence of trading. Now imagine how anti-climatic it would have been if Dan and Eddie would end…just sitting in front of a laptop and trading from a silent room like is done today. The inner emotions are the same but the screaming floor setting in the movie definitely gives, especially to outsiders, a great understanding of the commotion that is happening.
They are about to trade future contracts linked to the price of Orange Juice. The price of commodities is driven by supply and demand and in the case of OJ, the demand side is pretty stable, so the key element is the supply. If you like to drink OJ for your breakfast, you are probably not going to stop if the price doubles (yes ok, if you live in a developed country where your salary is way bigger than the cost of an OJ); and you are definitely not going to drink double if the price of OJ is cut in half. On the other side, you need to grow oranges if you want an orange juice. If you want a juice now but the only thing you have is an orange tree seed…good luck. The output of a tree can vary a lot from year to year for many reasons, and given that to grow a tree it takes at least seven years, the only thing that can balance supply and demand in this trade is the price of an orange. The lower the supply, the higher the price and vice versa.
Now, if you happen to know what would be the supply number linked to the current crop before everyone else, you can determine what would be the future price of an orange. The price of the “last” orange drives the price of all of them: when demand is inelastic to price (OJ drinkers would pay any price to drink their OJ), if you have 1 more orange than demand, the price of all oranges would go down to the production costs (and even lower, because for a producer is better to sell at any price than to not sell at all); if you have one orange less, OJ drinkers will bid oranges to the moon, because none of them wants to skip their breakfast. Obviously, this is an ‘extreme’ model but it is not far from reality.
This is the Dukes’ plan. Bribe a government agent, get the orange harvest report before everyone else (the supply number) and trade accordingly. Well, I wrote “bribe” but is probably not the right term to use because, believe it or not, at the time it was legal to trade based non-public government information. It became illegal only in 2010, in the wake of the Great Financial Crisis, and it was called…”the Eddie Murphy Rule” (today, before sensitive figures like NFP and CPI are released to the public, a group of journalists from the biggest publications are closed in a room, stripped of their phones and given the figure in advance so they can write their piece and publish it just after the release to the public).
The Dukes are brokers, they buy and sell on behalf of clients and charge a commission, but in this case they act as speculators. They want to trade for themselves. This is also something that became illegal (or at least heavily discouraged, I tried once to understand what constitutes “insider trading” and it is not as restrictive as you would think, so go figure) only quite recently. If you do not see the issue, ask FTX clients.
SPOILER ALERT!!1!
Eddie and Dan give the Dukes a fake report that says that the orange harvest was really poor, the opposite content of the real report that would be revealed later. The Dukes therefore decide to corner the market, to buy all the contracts they can (one of the brother says to his trader “and if the price goes up, just keep buying“…did Nick Maggiulli take it from here?). This way, they would be able to sell oranges, at a later date, at whatever price they want because they would own all (or almost all) the supply. Yes, cornering the market is also illegal.
“they know something”: the floor, the other traders, realise that the Dukes are onto something. The Dukes are considered the Smart Money and are probably worth following if they act. This movie is great because the same characters can be geniuses or fools at a time…which is also what happens when someone judges an investor based on their results instead of their process. Trading on insider information was legit, so paying attention to what people that had access were doing made sense.
In today’s world, with e-trading, is more difficult to directly see what other market participants are doing but the principle is still valid, follow Smart Money. Some people for example look at hedge funds disclosures, but they are published only every three months, the lag is too big to obtain a clear signal. The Bloomberg Chat became a key tool for short-term traders: there, brokers and “friendly” contacts spread rumours on what other big players are doing, how they are positioning themselves on a specific market. It is almost real time information but it works mainly for OTC markets like FX and volatility. For stock trades, some brokers created so called Dark Pools, venues where buy and sell orders can be matched away from public exchanges. No one can see your activity but you also do not know how good of a price you can get…they are quite loved by High-Frequency Traders 😉
Dan and Eddie own the real report, they are the ones who “know something”. But this is only half of the process. In order to make money, they also have to execute their strategy the right way. They first have to wait for the Dukes and their followers to push the market up; if they start to sell too early they would not maximise their profit, or worse, they might even stifle the market reaction after the report release.
They sell with the idea they would be able to buy at a lower price at a future date: in “buy low, sell high” the order does not matter 😉 Crucially, by managing to buy and sell on the same day, they do not have to post any margin and they can maximise their profit with leverage.
The movie simplifies an aspect of trading that in real life is not as straightforward: even if you have the data point in advance, it is difficult to say how the market will react because its reaction depends not on the data itself but on what is already priced in. This is where the “buy the rumour, sell the news” maxim comes from. In many cases, if the market expects a positive number, the price starts to increase way before the number is released…and then drops when the number confirms the market expectation. If you wait for the release to buy, you are screwed. A crucial part of Dan and Eddie strategy is to first make the floor believe the report would be bad and embed that forecast into the price. This way, they also create a demand for their supply.
Then the news breaks: the orange harvest was normal. Everyone that was long, basically everyone on the pit except Dan and Eddie, realises that is in a horrible position: there will be plenty of oranges for sale in April. These guys are all speculators, they bought today with the hope to sell at a profit in the future. Now that the hope is gone, they can only do one thing: sell and cut their losses as fast as they can.
It is so funny how the eruption of screams in the movie stayed so vividly in my mind. It is a perfect scene. Every time I look at my Bloomberg screen when the Non-Farm-Payrolls (or, more recently, the CPI) are released and I see the market dashing up or down, in my mind those screams play over and over again. Some minutes before the release, there is this weird stillness that you can feel, bid and ask disappear for a moment and then…BOOM! Flashing numbers and colours in frenetic succession. Then I glance for a second outside the window and realise that for the rest of the world is just another Friday; it is such a weird job.
With no buyers, the price of OJ collapses. As they did earlier, Dan and Eddie have to wait until the price is low enough, cover their short at a profit when the time is right and, like every good TikTok trader, go to enjoy their quick gains on a beach.
How to trade “news” in real life
There are plenty of great movies that give the spectator the immediate urge to go and repeat what they just observed. Watch Project X and you would want to organise a party. Watch White Men Cannot Jump and you would want to play basketball. Watch Scarface and you would want to start a drug cartel.
Needless to say, the reality is more complicated than what you just saw.
First of all, everything you saw in the movie is illegal. Here is a recap of Matt Levine’s rules about insider trading:
- Don’t do it.
- Don’t do it by buying short-dated out-of-the-money call options on merger targets.
- Don’t text or email about it.
- Don’t do it in your mother’s account.
- Don’t do it by planting bombs at a company and shorting its stock.
- Don’t do it while employed at the Securities and Exchange Commission.
- Don’t Google “how to insider trade without getting caught” before doing it.
- If you didn’t insider trade, don’t forget and accidentally confess to insider trading.
- If you are going to insider trade, do it in a company that is far away from a Securities and Exchange Commission office. Like, physically.
- If you are already under a federal ethics investigation about your ownership or promotion of a stock, don’t insider trade that stock.
- If you are making plans to share your life, and finances, with a certain special someone, and you overhear her working on a nonpublic merger deal, before you go out and buy short-dated out-of-the-money call options on the merger target, maybe tell her first?
- If you insider trade by buying short-dated out-of-the-money call options on a merger target, and the Securities and Exchange Commission freezes your profits, don’t show up in a U.S. court to ask for them back
In the same fashion, I would say: Do not trade. But if you do, do not trade “news”.
If you want to trade news without insider info, consider that we live in an intricate world. Think about NFPs: employment influences economic growth, which influences the FED, which influences the cost of money, which influences corporate profits, which influences stock prices. Considering that the FED acts (or should act) in a counter-cyclical way, what is “good news”?
This is why, even if you had the data beforehand, it’s doubtful you would be able to trade it profitably. Not sure how many of you readers had the luxury like yours truly to be stuck in front of a screen at almost every NFP release of the last 17 years, but a curious phenomenon happens quite often, i.e. randomly enough: the first market reaction is a fake movement. If the market shoots up immediately after the data release, it then ends the day way down. The same information can push the market up 1% and then down 2%; the way headlines change during the day is hilarious. Good luck to detect when you have to fade a move and when you shouldn’t.
In all this mess, you still have the issue to understand what is the current number expected by the market. Thankfully, now we have Kalshi:
Kalshi is the first CFTC regulated exchange dedicated to trading on a new asset class: event contracts. These contracts are structured as questions about whether a future event will happen and can be answered by a simple Yes or No.
Covering a wide range of topics from weather to international affairs to media and more, Kalshi’s event contracts allow you to capitalize on your opinion and hedge everyday risks.
Combining all the simple yes/no events’ probabilities (which are implied in their prices), Kalshi can produce forecasts as below:
Kalshi forecasts are better than traditional forecasts because, being a betting market, they “are backed by the participants’ money”. In other words, participants have no incentive to lie.
Based on the above example, if you are taking a position thinking that the next inflation number will be hot, like the Dukes on the price of oranges, you will then “get paid” only if inflation is 0.4% or higher. 0.3% is basically already priced in, so if that’s the result, it is less likely the market will overreact…but, as I said, this is a very rough explanation of something that is complex.
As with any other betting market, to provide an accurate prediction Kalshi needs to be used by “a group of people with a sufficiently broad range of opinions”. This might not be true at times, for example because the majority of market participants might be influenced by the same bias.
Knowing that Kalshi exist is better than being ignorant; this does not mean that it provides an actionable trading hedge.
Trading single stock news might feel easier because of the reduced ramifications (good profit -> stock up) but it most likely exposes you to being on the other side from someone that has insider information. As always, ask yourself: what is my edge?
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