Wall Street Applied to Technology Entrepreneurship
Posted on August 28, 2008
Filed Under BS-Free Advice |
Just what does Drama 2.0 do? One of activities I’m most heavily involved with is the trading of financial instruments (primarily option contracts).
Trading is a wonderful exercise not only because there’s a lot of money to be made (and lost, of course) but because the most powerful human emotions - fear and greed - are grappled with an on almost daily basis.
There are a lot of life lessons to be learned and many of the “rules” of trading can be applied to the world of technology entrepreneurship, especially in a day and age where startups are built to be “flipped” and entrepreneurial employees jump from one startup to another in search of the “big hit.”
Here are several trading “rules” that can be useful for technology entrepreneurs.
The Trend is Your Friend
In the startup world, spotting market trends in technology isn’t as easy as looking at a trendline on a price chart but it’s not too difficult either.
Most savvy and experienced entrepreneurs have a good sense of trends. They know which markets are meeting needs and seeing the creation of potentially valuable businesses, they know which markets are seeing increasing inflows of investment capital and they know which markets have a healthy level of M&A interest or activity.
While most entrepreneurs want to get into hot markets before they’re hot because there is the perception of greater profit potential, it’s worth noting that in the financial markets, the average investor only makes money in the middle of a trend. This is often called the “meat of the move.”
As such, entrepreneurs should consider that they don’t necessarily have to try to predict new trends and can instead place their bets when a trend has been established.
Example: Friendster popularized the modern day version of the “social network.” It launched in March 2002 and it didn’t take long for Friendster to take off. Social networking was officially “hot.”
Yet a number of startups that launched after the social networking “trend” had been established have done far better for themselves.
MySpace, which launched in August 2003, sold to News Corp. for $580m in July 2005. Facebook, which launched in February 2004, has reportedly entertained 10-figure buyout offers. And Bebo, which launched in January 2005, recently sold to AOL for $850mn in the largest social network acquisition to date.
The lesson? You don’t always need to be “first.”
The Trend is Your Friend Until the End
Some trends last longer than others but all eventually come to an end, hence the saying “The trend is your friend until the end.”
Entrepreneurs should recognize that no matter how much they believe in the trend they’ve invested themselves in, the trend is only working in their favor while it’s intact.
In the world of startups, once a trend ends, if you don’t already have a viable, self-sustaining business and a revenue model that can realistically withstand a bit of a shakeout, any advantages that inured to you when you were going “in the direction of the trend” are eliminated.
Example: online video startups have raised lots of money and much of this money flowed into the market after Google’s $1.65 billion acquisition of YouTube in October 2006. And yet while online video has a bright future, the trend that supported online video startups looks to be waning.
The fire sale of heavily-funded startups like and is likely just the first part of a shakeout I predicted earlier this year and online video entrepreneurs relying solely on the “online video is hot” trend are not likely to fare well.
Don’t Try to Call Tops and Bottoms
One of the biggest mistakes a trader can make is to call market “tops” and “bottoms.” In fact, this mistake probably accounts for the majority of the losses amateur traders make.
Professional traders understand that they have no control over the markets. They are successful because they keep their emotions in check, think objectively, play probabilities and understand the importance of money management.
Amateur traders think success is dependent upon predicting what the market is going to do. They will rush head-first into trades because they think they can call market highs and lows.
When it comes to startups, entrepreneurs should recognize that they don’t know when the hot new markets they’re in will lose their luster. Thus, getting greedy and trying to predict when it will “peak” so as to “get out” at the very top is foolish. See “Pigs Get Slaughtered” below.
Conversely, trying to predict when a market will rebound is equally foolish and the saying “never try to catch a falling knife” serves as a reminder to those who think they can call bottoms.
Example: with it becoming clear that many Web 2.0 startups aren’t going to make it, Om Malik suggested that it might be time to start a vulture fund that buys up distressed Web 2.0 “assets” at a bargain basement price. But just what is a bargain basement price? A startup that once raised $10 million but is being sold off for $1 million may still be overvalued and the worst could still be yet to come.
As , “successful vultures don’t reap financial windfalls by buying everything that declines significantly in value.” The bottom line is that most of the time, trying to predict when an asset has hit its lowest point in value usually leaves one holding an asset that continues to fall in value.
Pigs Get Slaughtered
Greed is the second most powerful emotion in financial markets (behind fear). Traders who are unable to control their greed and leave everything on the table inevitably become “pigs” and “pigs get slaughtered.”
While some “pigs” don’t think at all, many “pigs” believe that they will be able to predict the “top” of the market, as discussed above, giving them an ability to maximize profits. Few are successful and those that are typically mistake luck for skill.
The same goes for entrepreneurs. Knowing that trends don’t last forever and accepting that they have no knowledge of or control over when they’ll end, smart entrepreneurs recognize that there’s a time to take money off the table.
In today’s Internet startup world, taking money off the table typically means selling your company. How do entrepreneurs know that they’re selling too early? They don’t.
Example: Facebook. The company led by wunderkind Mark Zuckerberg reportedly turned down 10-figure offers and instead choose to raise money at a ridiculous valuation, maintaining that he felt the company is better off remaining public and eventually going public sometime after 2008.
Yet Facebook’s valuation raised eyebrows - and skepticism. The company’s revolutionary advertising play (Beacon) flopped and the company’s shortcomings (especially around monetization) are now . The public markets don’t look like they’ll be conducive to an IPO anytime soon given the company’s financials, leaving shareholders illiquid. Hence it’s no surprise that some Facebook shareholders are attempting not to be pigs - to sell their shares privately.
Respect Support and Resistance
In the financial markets, support and resistance are key points at which supply and demand are in alignment. Support is the point at which demand keeps price from falling further and resistance is the point at which supply keeps price from rising further. Support and resistance are often found in the form of previous highs and lows, moving averages, floor trader pivots, etc.
While “buying into support” and “selling into resistance” are not hard and fast rules (support and resistance do break all the time), not recognizing support and resistance levels is a huge mistake.
In the startup world, a similar dynamic of supply and demand exists.
Every “hot” new market gets hot because there is some demand. This leads, of course, to the creation of startups to meet it. Yet at some point, the supply exceeds the demand and the market is left with a field of companies that have essentially failed.
Entrepreneurs must be realistic and should observe the supply and demand dynamics in their markets.
Example: social networks. It’s unlikely that MySpace and Facebook are going away anytime soon because there is demand for them (support), yet the rise of the social networking market led to literally hundreds of social networking startups (more than a few of them funded). Clearly, the supply of social networks now exceeds the demand (resistance). Thus, launching a social networking startup today would be akin to “buying into resistance” and unless an entrepreneur has a valid rationale for that, it’s probably not a wise move.
Patience is a Virtue
In the fast-paced world of financial markets, it’s really easy to lose patience. When you miss a great trade, the desire to “chase profits” creeps in. When you’re looking too hard for trading signals that just aren’t there, “overtrading” can occur.
The same problems are present for entrepreneurs who often find themselves scrambling to enter hot new markets when they feel they’re missing the boat or who feel the need to explore every opportunity that they think exists even when these opportunities are objectively dismissed.
Patience is a virtue for both traders and entrepreneurs.
For traders, patience often means sitting on the sidelines when there is no opportunity that gives you a discernable edge. It also sometimes means sticking with a trade (i.e. letting your stops take you out of a long trade despite your emotional desire to get out sooner).
For entrepreneurs, patience also often means waiting for the right opportunity.
And while it’s far too easy to get emotionally attached to a company and not “cut your losses” when you should, patience can mean sticking with good opportunities even when they don’t get realized overnight.
Example: one need go no further than the conference and party circuit in Silicon Valley to meet entrepreneurs chasing opportunity and jumping from ship to ship in search of it. Most will not be rewarded by chasing success in this fashion.
And one need look no further than a company like Shutterfly to find entrepreneurs who were patient and “stuck with it.” Shutterfly struggled to make it through Bubble 1.0 and its future still has a lot of uncertainty but it was able to go public in 2006.
Conclusions
Obviously, there are a lot of similarities between “traders” and “entrepreneurs.” But there are a lot of differences too.
While a considerable amount of wisdom gleamed from the financial markets can be applied to the entrepreneurial experience, I personally don’t recommend that entrepreneurs treat their business decisions like pure trading decisions.
Unlike with trading, some emotion is good for entrepreneurs - starting a new business (or going to work for a startup) shouldn’t be a detached process that is driven solely by profit. After all, the best entrepreneurs truly believe that their companies are doing something important and that they have what it takes - the best traders believe in no such thing.
Yet exercising the objectivity and discipline traders strive for and which the rules above demand can help entrepreneurs make better, more logical decisions. And that’s a good thing, especially at a time when so many entrepreneurs (and wannabe entrepreneurs) have discarded logic for hype.
Addendum
My predictions on Schlumberger and Google proved to be quite profitable.
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Drama 2.0 spikes the Web 2.0 kool aid by providing critical analyses of Web 2.0, its people, its startups and its impact on the world of media. Other topics are explored when Drama 2.0 has been drinking too much 1975 Dom Perignon. Read more about the Internet's version of Keyser Söze here.
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So, this idea of buying ‘distressed’ Web 2.0 assets–does that mean, like, slightly used Aeron chairs and widescreen monitors?
Jared: sort of, except the Aeron chairs and widescreen monitors not only have some real value, they’re actually quite useful as well.
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