MARKET

WIZARDS

Interviews with Top Traders

JackD. Schwager

HarperBusiness A Division of HarperCoWinsPubltshers learn to You've to learn how to fall,beforeyou fly. got Contents \342\200\224PaulSimon

One man's ceiling is another man's floor. \342\200\224PaulSimon Preface, ix If I wanted to become a tramp, I would seek information and advice from the mostsuccessful I could find. If I wanted tramp Acknowledgments, xi to becomea failure,I would seek advice from men who had neversucceeded.If I wanted to succeed in all things, I would Prologue, xiii lookaround me for those who are succeeding and doas they have done. Marshall Own xv \342\200\224Joseph Wade My Story, Wall Street Wisdom (as quoted in a Treasuryof edited by Harry D.Schultzand SamsonCoslow)

PART I FUTURES AND CURRENCIES

Out 3 TakingtheMystery of Futures, The Interbank Currency Market Defined,7

Michael Marcus: Blighting Never Strikes Twice,9

Bruce Kovner:The World Trader, 51

Richard Dennis: A Legend Retires, 85 Contents vii vi Contents

PART III A LITTLE BIT OF EVERYTHING Paul Tudor Jones: The Art of Aggressive Trading, 117

Yes, They Do Trade T-Bonds Gary Bielfeldt: James B. Rogers, Jr.: Buying Value and Selling in 141 Peoria, Hysteria, 283

Ed GetsWhat Want, 151 Seykota:Everybody They Mark Weinstein: High-PercentageTrader,321

Larry Hite: Respecting Risk,175 PARTIV THE VIEW FROM THE FLOOR

PARTII MOSTLY STOCKS Brian Gelber: BrokerTurned Trader, 345

Tom Baldwin: The Fearless Pit Trader,367 Michael Steinhardt: The Concept of Variant

Perception, 193

TonySaliba:\"One-Lot\" Triumphs, 387

William O'Neil: The AH of StockSelection,219

PART V THE PSYCHOLOGY OF TRADING DavidRyan:Stock Investment as a Treasure Hunt, 23?

Dr. Van K. The 257 Tharp: Psychology of Trading, 411 Marty Schwartz: Champion Trader, The Trade: A Personal Experience, 431

Postscript: Dreams and Trading,437

Final Word,439 Preface

and Appendix1:Program Trading Portfolio Insurance, 441 There are some amazing stories here:

the 443 Appendix 2: Options\342\200\224Understanding Basics, \342\200\242A trader who, after wiping out several times early in his career, turned a $30,000 accountinto $80 million Glossary, 447 \342\200\242A fund who achieved what manager many thought impossible\342\200\224fiveconsecutive years of triple-digit percentage returns \342\200\242A trader from small-town America who started out on a shoestring and has become one of the world's largestbond traders \342\200\242A former securities analyst who, during the past seven years, has realized an average monthly return of 25 percent (over 1,400percentannualized), primarily trading stock index futures \342\200\242An electrical engineering graduate from MTTwhose largely computerized approach to trading has earnedhis accounts an astounding 250,000 percent return over a sixteen-year period

These are but a sampling of the interviews contained in this book.

In his own way, each of the traders interviewed has achieved incredible success. What sets these traders apart?Mostpeoplethink that winning in the markets has something to do with finding the secret formula. The

truth is that any common denominator among the traders I interviewed had more to do with attitude than approach. Some of the tradersuse fundamental analysis exclusively, others employ only technical analysis, and still others combinethe two. Some traders operate on a time horizon measured in hours or even minutes, while others typically implement X Preface

that intend to hold for months positions they or evenyears.Although the trading methodologies varied widely, the forthcoming interviews reveal certainimportant commonalities in trading attitudes and principles. one of the last Trading provides great frontiers of opportunity in our economy. It is one of the very few ways in which an individual can start with a small bankroll and relatively actually become a Acknowledgments multimillionaire. Of course, only a handful of individuals (such as those interviewed here) succeed in this but at turning feat, least the opportunity exists. While I hardly expect all readersof this book to transform First and I would like to thank who foremost, Stephen Chronowitz, pored themselves into super-traders\342\200\224the world just doesn't work that over in this book and a multitude of way\342\200\224I everychapter provided helpful believe that these thought-provoking interviews will most serious and I am indebtedto Steve for both the help suggestions editing changes. and readers their I open-minded improve personal trading performance. quantity (hours) and quality of his input. truly believe that whatever the It may even a select few help becomesuper-traders. merits of this work, it has benefited significantly from his contributions.

I am grateful to my wife, Jo Ann, not only for enduring nine months \"book but valuable board\342\200\224arole JackD. Schwager as a widow,\" also for being a sounding Goldens Bridge, NY she performed with brutal honesty. Sample:\"This is the worst thing you May 1989 ever wrote!\"(Needlessto say, that item was excised from the book.) Jo Ann possesses commonsensein abundance, and I usually followed her

adviceunquestioningly.

Of course, I would like to expressmy thanks to all the traders who agreed to be interviewed, without whom there would be no book. By and

large,thesetraders neither need nor seek publicity, as they trade only for wish to. their own accounts or are already managing all the money they In many cases, their motives for participating were altruistic. For example, as one trader expressed it, \"When I was starting out, I found

biographies and interviews of successful tradersparticularly helpful, and I would like to play a similar role in helping new traders.\" I wish to express my sincere appreciation to ElaineCrockerfor her friendly persuasion, which made someof the chapters in this book possible. For advice, leads, and other assorted favors,I would like to thank Courtney Smith, Norm Zadeh, Susan Abbott, Bruce Babcock, Martin Presler, Chuck Carlson, Leigh Stevens, Brian Gelber,MichaelMarcus, and William Rafter. Finally, I would like to thank three traders who were to me which were not gracious enough grant lengthy interviews, and Martin incorporated into this book: Irv Kessler, DougRedmond, Presler

(the former two because, in retrospect, I considered my line of question- *\" Acknowledgments ing too esoteric and technical; the latter because publication deadlines did not time for permit needed follow-up interviews and editing).

Prologue

The name of the book was The BigBoard. . . . It was about an Earth-

ling man and woman who were kidnapped by extraterrestrials. They were put on display in a zoo on a planet called Zircon-212. These fictitious people in the zoo had a big board supposedly showing stock market quotations and commodity prices along one wall of their habitat, and a news ticker, and a telephone that was supposedly connected to a brokerage on Earth. The creatures on Zircon-212 told their captives that they had invested a million dollars for them back on Earth, and that it was up to the captives to manage it so that they would be fabulously wealthy when they were returned to Earth.

The telephone and the big board and the ticker wereallfakes,of course. They were simply stimulants to make the Earthlings perform vividly for the crowds at the zoo\342\200\224tomake them jump up and down and cheer, or gloat, or sulk, or tear their hair, to be scared shitless or to feel as contented as babies in their mothers' arms.

The Earthlings did very well on paper. That was part of the rigging, of course. And religion got mixed up in it, too. Thenews ticker reminded them that the President of the United States had declared National Prayer Week,

and that everybody should pray. The Earthlings had had a bad week on the

market before that. They had lost a small fortune in olive oil futures. So they gave praying a whirl. It worked. Oliveoilwent up.

\342\200\224KurtVonnegut Jr. Slaughterhouse Five

If the random walk theorists are correct, then Earthbound traders are suffering from the same delusions as the zoo inhabitants of Kilgore Trout's

novel. (Kilgore Trout is the ubiquitous science fiction writer in Kurt Vonnegut's novels.) Whereas the prisoners on Zircon-212 thought their

decisions were being based on actual price quotes\342\200\224they were not\342\200\224real- life traders believe they can beat the market by their acumen or skill. If xiv Prologue markets are truly efficient and random in every time span, then these traders are attributing their success or failure to their own skills or shortcomings, when in reality it is all a matter of luck.

After interviewing the traders for this book, it is hard to believe this view of the world. One comes with a belief that it is away strong highlyunlikely that some traders can win with such consistency over vast numbers of trades and Own many years. Of course, given enough traders, My Story some will come out after a ahead even long period of time, simply as a consequence of the laws of probability. I leave it for the mathematicians to of determine the odds traders winning by the magnitude and duration that out of I as a research those interviewed here have. Incidentally, the traders themselves Right graduate school, landeda job commodity have not a of I was to find that economic and glimmer doubt that, over the long run, the question of who analyst. pleasantly surprised my wins and who statistical a number of loses is determined by skill, not luck. I, too, share this analysis correctly predicted major commodity price conviction. moves. It was not long thereafter that the thought of trading came to mind. The was that did not only problem my department generally permit analysts to trade. I discussed my frustration over this situation with Michael Marcus (first interview), with whom I became friends while interviewing for the research position he wasvacating. Michael said, \"You know, I had the same problemwhen I worked there. You should do what

I did\342\200\224open an account at another firm.\" He introduced me to a broker

at his new firm, who was willing to open the account. At the time, I was earning less than the department secretary, so I didn't exactlyhave much risk capital. I had my brother open a $2,000 account for which I acted as an advisor.Sincethe account had to be kept

secret,I could not call in any orders from my desk. Every time I wanted to initiate or liquidate a position, I had to take the elevator to the building's basement to use the publicphone.(Marcus'solution to the same problem is discussed in his interview.) The worst part of the situation was not merely the delays in order entry, which were often nerve-

wracking, but the fact that I had to be very circumspect about the number

of times I left my desk. Sometimes, I would decide to delayan order until

the following morning in order to avoid creating any suspicion.

I don't remember any specifics about my first few trades. All I recall is that, on balance,I did only a little better than break even after paying commissions. Then came the first trade that made a lasting impression. I had done a very detailed analysis of the cotton market throughout the entire post-World War II period. I discovered that because of a variety of government support programs,only two seasons xvi My Own Story xvtt My Own Story

since 1953 could truly be termed markets in free [markets which prices to notice be of any value. Working closely with Steve, however, I were began determined by supply and demand rather than the prevailing his market calls were often I became convinced I that right. Eventually, government program]. correctlyconcludedthat only these two seasons that my initial assessment of technical analysis was wrong. I realized could be in used forecasting prices. Unfortunately, I failed to reachthe that, at least for fundamental analysis alone was insufficient for more myself, significant conclusion that data were insufficient existing to I also needed to for the successful trading; incorporate technicalanalysis permit a market meaningful analysis. Based on a comparison with these two timing of trades. I inferred that cotton seasons, prices, which were then trading at 25 cents The secondkey element that finally put me into the winner's per pound, would move higher, but peak around 32-33 cents. column was the realization that risk control was absolutelyessentialto The initial part of the forecast proved correct as cotton pricesedged successful trading. I decided that I would never again allow myself to higher over a period of months. Then the advance accelerated and lose everything on a trade\342\200\224no matter how convinced I was of my cotton from single jumped 28 to 31 centsin a single week. This latest was rally market view. attributed to some news I considered rather unimportant. \"Close enough the trade that I consider and one of to Ironically, my turning point my my projected top,\" I thought, and I decided to short. the go Thereafter, best trades everwas a loss. At the time, the Deutschemark had market actually moved slightly higher and then quickly broke back to the 29-cent carved out a lengthy trading following an extended decline.Based level. This seemed range perfectly natural to me, as I expected markets to on my market analysis, I believed that the Deutsche mark was forming conform to my analysis. My profits and elation were short-lived, however, an base. I went within the consolidation, as important price long cotton prices soon reboundedto new and then moved highs the recent simultaneously placing a good-till-cancelled stop order just below unrelentinglyhigher: 32 cents, 33 cents, 34cents,35 cents. with Finally, my low. I reasoned that if I was right, the market should not fall to new lows. account equity wiped out, I was forcedto the liquidate position. Not having out of Severaldays later, the market started falling and I was stopped my much in money those days may have been one of my luckiest breaks, at a small loss.The was that after I was out, since cotton position great thing stopped eventually soared to an incredible level of 99 cents\342\200\224more the market plummeted like a stone.In the past, this type of trade would than double the century's previous high price! have me out; instead, I suffered only a minor loss. That wiped trade knocked me out of the box for a while. Over the next Not long thereafter, I becamebullish on the Japanese yen, which few I years, again tried my hand at trading a couple oftimes.Ineach had formed a technically bullish consolidation, providing a meaningful instance, I started with not much than and more $2,000 eventually I wiped close point to place a protective stop. While normally implemented out because of a single large loss. My only consolation was that the only a one-contractposition, the fact that I felt reasonably ableto define amounts I lost were small. relatively I that my risk at only 15ticks per contract\342\200\224today, find it hard to believe Two things finally broke this of failure. I pattern First, met Steve with me to I was able to get away that close a stop\342\200\224allowed put on a Chronowitz. At the time, I was the commodity research director at three-contractposition.The market never looked back. Although I ended Hornblower & Weeks,and I hired Steve to fill a slot as the department's up getting out of that position far too early,I held one of the contracts precious metals analyst. Steve and I shared the same and office, we long enough to triple my small accountsize.That was the start of my became quickly good friends.In contrast to myself, a pure fundamental success at trading. Over the next few years, the synthesis of technical analyst, Steve' s approach to the markets was technical. strictly (The and fundamental analysis combined with risk control allowed me to build fundamental uses analyst economic data to forecast prices, while the my small stake into well over$100,000. technical analyst employs internal market data\342\200\224such as price, volume, and Then the streak ended. I found myself trading more impulsively, sentiment\342\200\224to project prices.) believe I had failing to follow the rules I had learned.Inretrospect,I just Until that time, I had viewedtechnical with analysis great I remember a trade in become too cocky.In particular, losing soybeans. skepticism. I tended to doubt that anything as simple as chart reading could Instead of taking my loss when the market moved against me, I wasso xviii My Own Story convinced that the decline was a reaction in a bull market that I substantiallyincreased my position. The mistake was compounded by taking this action in front of an important government crop report. The report came out bearish, and my equity took a dramatic decline. In a matter of Parti

days, I had surrendered over one-quarter of my cumulative profits. After in to a house and later a cashing my chips buy taking Futures and Currencies yearlong sabbatical to write a book,* my savings were sufficiently depleted to defer into for five When I my reentry trading nearly years. began trading again, typical to my usual custom, I started with a small amount: $8,000. Most of this money was lost over the courseof a year. I added another $8,000 to the account and, after some further moderate setbacks, eventually scored a few big winning trades. Within about two years, I had once again built my trading account up to over $100,000.I subsequently stalled out, and during the past year, my account equity has fluctuated below this peak. Although, objectively, my trading has beensuccessful,on an emotional level, I often view it with a sense of failure. Basically,I feelthat given my market knowledge and experience, I should have done better. I ask \"have I been able to a sub-$ \"Why,\" myself, multiply 10,000 account more than tenfold on two occasions, yet unable to expand the equitymuch beyond that level, let aloneby any multiples?\" A desire to find the answers was one of motivations for my writingthis book. I wanted to ask thosetraders who had already succeeded: What are the key elements to your success? What approach do you use

in the markets? What trading rules do you adhere to? What were your

own early trading experiences? What advice would you give to other traders?

While, on one level, my search for answers was a personalquest to help surpass my own barriers, in a broader sense, I saw myselfas

Everyman, asking the questions I thought others would ask if given the

opportunity.

* JackD. Schwager,A CompleteGuide to the Futures Markets(John Wiley & Sons, New York, NY, 1984). Taking the Mystery Out of Futures

Of all the markets discussed in this book, the futures market is probably the one least understood by most investors.It is also one of the fastest growing. Trading volume in futures has expanded more than twentyfold during the past twenty years. In 1988, the dollar value of all futures contracts traded in the U.S. exceeded$10trillion!* Obviously,there is a lot more than pork belly trading involved here. Today'sfutures markets encompass all of the world's majormarket groups: interest rates (e.g., T-bonds), stockindexes(e.g.,the S&P 500), currencies (e.g., Japanese yen),preciousmetals (e.g., gold), energy (e.g., crude and commodities the oil), agricultural (e.g., corn). Although futures markets had their origins in agricultural commodities, this sector now accounts for only about one-fifth of total futures trading. During the the introduction and of new past decade, spectacular growth many contracts has resulted in the financial-type markets (currencies, interest rate instruments, and stock indexes)accounting for approximately 60 percent

\342\231\246Thisis a rough but conservative estimate based on 246 million contracts traded and assuming an average contract value well over $40,000. (Excluding short-term interest rate futures, such as Eurodollars, single contract values ranged from about $11,000 for sugar at 100/lb. to $150,000 for the S&P 500 at an index value of 300.) 4 Introduction Introduction 5

of all futures trading. (Energy and metal markets accountfor nearly half futures 4. Leverage\342\200\224The markets offer tremendous leverage. Roughly of the remaining 40 percent.)Thus, while the term commodities is often speaking, initial margin requirements are usually equal to 5 to 10 used to refer to the futures it has become a markets, increasingly of the of the futures percent contract value. (The use term margin in the misnomer. Many of the most actively tradedfutures markets, such as those market is unfortunate because it leads to tremendous confusion with in the financial instruments, are not truly commodities, while many the of in stocks. In do concept margins the futures markets, margins futures markets. commodity markets have no corresponding not sinceno actual transaction imply partial payments, physical The essence of a futures market is in its name: Trading involves a occurs until the expiration date; rather, margins are basically good-faith standardized contract for a commodity, such as gold,or a financial the attributes deposits.) Although high leverage is one of of futures instrument, such as T-bonds, for a future delivery date, as opposed to the markets for traders, it should be emphasized that leverage is a two- present time. For example, if an automobile manufacturer needs copper sword. The use of is the most edged undisciplined leverage single for current it will buy its materials directly from a operations, producer. reason in important why most traders lose money the futures markets. If, however, the same manufacturer was concernedthat copper prices In general, futures prices are no more volatile than the underlying would be much higher in six months, it could approximately lock in its cash prices or, for that matter, many stocks. The high-risk reputation costs at that time by buying copper futures now. (This offset of future of futures is largely a consequenceof the leverage factor. price risk is called a hedge.)If copper prices climbed during the interim, 5. Low transaction costs\342\200\224Futures markets provide very low the on the futures hedge would offset the profit approximately higher transactioncosts. For example, it is far less expensivefor a stock portfolio cost ofcopperat the time of actual purchase. Ofcourse,if copper prices manager to reduce market exposure by selling the dollar declined instead, the futures hedge would result in a loss, but the equivalent amount of stock index futures contracts than individual than it by selling manufacturer would end up buying its copper at lower levels was stocks. willing to lock in. futures While such as the above automobilemanufacturer, 6. Ease of offset\342\200\224A position can be offset at any time during hedgers, market are not locked at or limit- participate in futures markets to reduce the risk of an adverse price move, hours, providing prices limit-up down. futures markets maximum traders participate in an effort to profit from anticipatedpricechanges. (Some specify daily price changes. traders will the futures markets over their cash In casesin which free market forces would normally seek an In fact, many prefer equilibrium price outside the of boundariesimplied limits, counterparts as trading vehicles for a variety of reasons: range by price the market will simply move to the limit and virtually cease to trade.) 7. Guaranteed futures trader does not have to be by exchange\342\200\224The 1. Standardized contracts\342\200\224Futures contracts are standardized (in terms concerned about the financial stability of the person on the other side of and not have to find a the trade. All of quantity quality); thus, the trader does futures transactions are guaranteedby the clearinghouse specific buyer or sellerin order to initiate or liquidate a position. of the exchange. 2. \342\200\224Allof the futures markets excellent Liquidity major provide Since by their very structure, futures are tiedto their liquidity. closely underlyingmarkets (the activity of arbitrageurs assures that deviations are 3. Ease of going short\342\200\224The futures markets allow equal ease of going relatively minor and short lived), price moves in futures will very closely short as well as long. For example,the short seller in the stock market parallel those in the corresponding cash markets. Keeping in mind that (who is actually borrowing stock to sell) must wait for an uptick the majority of futures trading activity is concentrated in financial before a no such restriction exists in the futures , initiating position; instruments, futures traders in traders in and markets. many are, reality, stocks, bonds, currencies.In this context, the comments of futures traders interviewed Introduction \342\202\254

even to investors who in the following chapters have direct relevance and bonds. have never ventured beyond stocks

The Interbank Currency Market Defined

The interbank currency market is a twenty-four-hour market which literally follows the sun around the world, moving from banking centers

in the U.S. to Australia, to the Far East, to Europe, and finally back to the U.S. The market exists to fill the need of to companies hedge risk in a world of values. For exchange rapidly fluctuating currency example, if a Japanese electronics manufacturer negotiates an exportsale of stereo equipment to the U.S. with payment in dollars to be received

six months hence, that manufacturer is vulnerable to a depreciation of the dollar versus the yen during the interim. If the manufacturer wants to assure a fixedpricein the local currency (yen) in order to lock in a profit, he can hedge himself by selling the equivalent amount of U.S. dollars in the interbank market for the anticipated date of payment. The banks will quote the manufacturer an exchange rate for the precise amount required, for the specific future date. Speculators trade in the interbank currency market in an effort to profit from their expectations regarding shifts in exchange rates. For example, a speculator who anticipated a declinein the British pound against the dollar would simply sell forward British pounds. (All transactions in the interbank market are denominated in U.S. dollars.) A speculator who expectedthe British pound to decline versus the Japanese yen would buy Introduction o0

and sell an equivalent dollar a specific dollar amount of Japaneseyen amount of British pounds.

Michael Marcus

BlightingNeverStrikesTwice

Michael Marcus began his career as a commodity research analyst for a major brokeragehouse.His near-compulsive attraction to trading led him to abandon his salaried position to pursue full-time trading. After a brief, almost comical,stint as a floor trader, he went to work for Commodities Corporation, a firm that hired professionaltraders to trade the company's own funds. Marcus became one of their most successful traders. In a number of years, his profits exceeded the combinedtotal

profit of all the other traders. Overa ten-year period, he multiplied his company accountby an incredible 2,500-fold! I first met Marcusthe day I joined Reynolds Securities asa futures research analyst. Marcus had accepted a similar job at a competing firm, and I was assuming the position he had just vacated. In those early years in both our careers, we met regularly. Although I usually found my own analysis more persuasivewhen we disagreed, Marcus ultimately proved right about the direction of the market. Eventually, Marcus accepted a jobasa trader, became very successful, and moved out to the West Coast. When I first conceived the idea for this book, Marcus was high on my list of interview candidates. Marcus' initial response to my request was agreeable, but not firm. Several weeks later, hedeclined,as his desire to maintain anonymity dominated his natural inclination to participate in an endeavor he found appealing. (Marcusknew and respected many of the other traders I was interviewing.) Iwasvery disappointed because 10 Michael Marcus Marcus Michael 11

Marcusis one of the finest traders I have been privileged to know. That's all you paid him? Weren't there any profit incentives\342\200\224extra some additional a mutual friend if Fortunately, persuasion by helped change potato chips he did well? his mind. When I met Marcus for this interview, it had been seven yearssince No. we had last seen each other. The interview was conducted in Marcus'

two-house set on a cliff a beach in much home, a complex overlooking private How money did you allot for trading? Southern California. You enter the complex through a massive gate as described an assistant who me with (\"amazing gate\" by provided About $1,000 that I had saved up. of driving directions) that would probably have a good chance holding up through a panzerdivision attack. Then what happened? On first greeting, Marcus seemedaloof, almost withdrawn. This

side ofMarcus'personality makes his description of his short-lived My first trip to a house quiet brokerage was very, very exciting. I got dressed to be He became on attempt a floor trader particularly striking. animated, up, putting my only suit, and we went to the Reynolds Securities however, assoonashebegantalking about his trading experiences. Our office in Baltimore. It was a big,poshoffice, suggesting a lot of old money. conversationfocusedon his \"roller coaster\" which he There was all early years, mahogany over the place and a hushed, reverential tone considered to be the most of his career. the office. It interesting permeated was all very impressive. The focal point was a big commodity board at the front of the office, the kind that clicked the old-fashioned way. It was really exciting futures? to hear the click. How did you first get interestedin trading click, click, They had a gallery from which the traders could watch the but it board, was so far away that we had to use I was of a scholar. In I from Johns binoculars to see the prices. That was something 1969, graduated also very exciting, becauseit was Phi Beta the of class. I had a Ph.D. just like a horse Hopkins, Kappa, near top my watching race. in at Clark and to live the life My first realization that fellowship psychology University, fully expected things might become a little scary was of a a mutual I met this fellow named John, when a voice came over the professor.Through friend, loudspeaker recommending the purchase of looked who claimed he coulddoublemy money every two weeks, like soybeanmeal.I at John, to see an expecting expressionof clockwork. That sounded I think I even asked confidence and assurance on his very appealing [helaughs]. don't face. Instead,he lookedat me and asked, an attractive idea that I didn't want \"Do you think we should it?\" John how he coulddo it.It wassuch do [he laughs]. It quickly dawned on me that John didn't to spoil things by finding out too many facts. I was afraid I would get know anything at all. I remember cold feet. soybean meal was trading quietly: 78.30,78.40,78.30, 78.40.We put the order in, and as soon aswe got the confirmation back, Weren't Didn't he soundtoo much like a used car almost the started you skeptical? mystically, prices clicking down. As soon as it knew that I salesman? was in, the market took that as a to start I signal descending. I guess had good instincts even then, because I immediately said to John, \"We're I had never invested in and I was very naive. I hired John, not too out!\" No, anything, doing well,let's get We lost about $100 on that trade. who was a junior at my school, to be my commodity trading advisor at The $30 a week.Occasionally, I threw in free and soda. He had next trade was in corn, and the potato chips same thing happened. John that could subsist on that diet. asked me whether we should a theory you do the trade. I said,\"Well all let's corn.\" right, try The outcomewas the same. 22 Michael Marcus Marcus Michael 13

Did know at all about what were Hadyou the you anything you doing? deliverable against February contract. The logic of the trade was read anything about commodities or trading? flawed in the first place.

No, nothing. Had John ever traded before?

Did you even know the contract sizes? No.

No, we didn't. Sowhere did he come up with this story about doubling your money every two weeks? Did you know how much it was costing you per tick? I don't know, but after that I trade, was wiped out. So I told John that, in of what Yes. light happened, I thought I knew as much as he did\342\200\224which was that I was nothing\342\200\224and going to fire him. No more potato chips; knew. that was about the only thing you no more diet soda. I'll never Apparently, forget his response. He told me, \"You are the mistake making greatest of your life!\" I asked him what he was going Our next trade, in wheat, didn't work either. After that, we went to do. He \"I am Right. said, going to Bermuda to wash dishes to make a back to corn and that trade worked out better, it took us three days to lose stake. Then I am to trading going become a millionaire and retire.\" The thing our We were measuring success by the number of days it took that amused me was that he money. didn't say,\"I'mgoing to Bermuda and take us to lose. a to make a stake.\" He job trading was very specific; he was going to wash dishes to get his trading stake.

Were you always getting out after about a $100loss? What eventually happened to John? Yes, although one trade lost almost $200.1wasdown to about $500 when with an idea that was to save the We would this I John cameup \"going day.\" To day, have no idea. For all I know, he oe in might living bellies and bellies because the Bermuda as buy August pork sell February pork spread a millionaire because he washeddishes. in waswiderthan the carrying charges [the total cost of taking delivery After that, I to managed rustle up another $500 and placed a few storing, and redelivering in February]. He said we couldn't lose silver trades.I out that August, wiped stake as well. My first eight trades, five on that trade. with John and three on my own, were all losers. I vaguely understood the idea and agreed to the trade. That was the first time we decided to out to lunch. All the other times we had been Did the ever enter go thought your mind that maybe trading was not too busy scrutinizing the board, but we thought this was a \"can't lose\" for you? trade, so it was safe to leave. By the time we came back, I wasjust about out. I remember this feeling of shock, dismay, and incredulity. No. I had done well at wiped always school, so I figured it was just a question I never the of John\342\200\224he was a guy of the knack of will forget image very portly getting it. My father, who died when I was fifteen, had to and left in with thick, glasses\342\200\224going up the quote board, pounding $3,000 life insurance, which I decided to cash opaque in, despite my want to make a shaking his fist at it, and shouting, \"Doesn't anyone mother's objections. I that bellies were not guaranteed profit!\" Later on, learned August pork i 14 Michael Marcus MichaelMarcus 15

But I knew I before that I really needed to learnsomething trading again. did, I rather pompously told them was a speculator. It had a nice I read ChesterKeltner'sbooks on wheat and and I also to it. soybeans, ring subscribed to his market which made recommendations. I In the of the started letter, trading spring 1971, grains getting interesting again. and it worked. followed the first recommendation, which was to buy wheat, There was a theory around that the blight had wintered over\342\200\224that is, it I think I made 4 cents bushel on that trade. It was first win the winter and was to I per [$200] my had survived going attack the corn crop again. and very exciting. decided I would be really positionedfor the blight this time. Then betweenletters, the market fell back to my original buying

it on own. I felt I price, so I bought again and made another profit my Was this Keltner's theory, orjust a marketrumor? Even in the I was beginning to develop a sense for trading. beginning, own. What next was Keltner liked the feeling of doing things on my happened I think believed it too. I borrowed$20,000from my mother, sheerluck.I three contracts of December corn in the it to and bet on the I the just bought added my $30,000, everything blight. bought That was the summer summer of 1970, based on a Keltnerrecommendation. maximum number of corn and wheat contractspossiblefor $50,000 in that blight devastated the corn crop. margin. Initially, the markets held steady because there was enough fear the to of blight keep prices up. I wasn't making money, but I wasn't Was that first win? it either. Then one your big losing day\342\200\224Iwill never forget this\342\200\224there was an article in the Wall Street Journal with the headline: \"More Blight on the with and Yes, that trade combined buying some more corn, wheat, Floor of the Chicago Board of Trade Than in Midwest Cornfields\" [he on recommendations in the and on own The corn market soybeans, partly letter, partly my laughs]. opened sharply lower and fairly quickly went intuition. When that glorious summer was over, I had accumulated limit-down.

sum to come from a middle class futures $30,000,a princely me, having [In many markets, the maximum daily price change is I it was the best in the world. restricted a limit. to family. thought thing by specified Limit-down refers a decline of this magnitude, while limit-up refers to an equivalent gain. If, as in this case, the decide when to take How did you profits? equilibrium price that would result from the interaction of free market forces lies below the limit-down price, then the market will lock limit- I took some on the and some when the markets started coming way up down\342\200\224i.e., trading will virtually cease. Reason: there will be an down. I cashedin well. abundance of Overall, very sellers, but virtually no willing buyers at the restricted limit-down price.] even then? So instinctively, you were doing the right thing Were you watching the market collapse? Yes. Then that fall I attended graduate school in Worcester, Massachusetts, but I found that I didn't want to think about my thesis. Yes, I was in the brokerage office,watching the board as prices fell. Instead of going to class, I would often sneakdown to the Paine Webber in Worcester to trade. Did think of office you getting out on the way down before the market was

I was having a great time. I made a little money, not a lot. I was lockedlimit-down? to find classes since I had been a shocked myself cutting frequently, I dedicated scholar at Johns I realizedthat the was on felt that I but I Hopkins. handwriting should get out, just watched. I was totally paralyzed. I out of school and moved to was the wall, and in December 19701 dropped hoping the market would turn around. I watchedand watched and at the Y for When asked me what I then it New York. I stayed a while. people after locked limit-down, I couldn't get out. I had all night to think MichaelMarcus 26 Michael Marcus 17

about but I had I didn't have more and sun was while if \"the it, really no choice. any money said, \"the out,\" that meant onething, I said, weather I the had to get out. The next morning, liquidated my entire position on is cloudy,\" it meant something else. opening. While I was trying to write my market reports, I kept peeringout

through the glass partition to see the prices on the big trading board in Was the market lower on the When I sharply again opening? the main office. was winning, I tried to hide my elation, and when I was losing, I had to make sure not to let it show on my face. I don't not about 2 cents. ever No, sharply, just think anyone caught on, but I was in a manic-depressive state

throughout that time. I felt tortured because I wanted to be free to trade much did lose time How you on the trade by the you liquidated? without going through this elaborate charade.

I lost own of the $20,000 mother had lent my $30,000, plus $12,000 my Were you making or losing money during this time? me. That was my lesson in betting my whole wad.

It was I lost. the same old cycle of borrowing money and consistently What did do then? you losing it.

I was I decided I had to to work. Sincethere was a really upset. go Did you know what you were doing wrong then? I recessionat the time, I thought probably couldn't get a reallygoodjob and should to settle for a lesser I found that even I I try position. though Goodquestion. Basically, had no real graspof trading principles; I was interviewed for positions for which I wasunusually well qualified, I couldn't Then in October while at broker's doing everything wrong. 1971, my seem to I realized that I couldn't these I met one the attribute get any job. finally get jobs office, of people to whom I my success. because I didn't really want them. One of the best job openings I found was a commodity research Who was that? that it analyst slot at Reynolds Securities. I discovered was easier to get this better because could tell I wanted it. I learned Ed Heis a and a trader who position they really Seykota. genius great hasbeen what much better chance that if you shoot for you want, you stand a of phenomenallysuccessful. When I first met Edhe had recently graduated from MIT it because care much and had the first getting you more. developed one of computer programs for testing and was office Anyway, there a glass partition betweenmy and the main trading technical systems. I still don't know how Ed amassed so much office where the brokers sat. I still had the trading bug and it was very knowledge about trading at such an earlyage. to watch them trading and whooping it up. Ed told me, \"I think to work here. We are a painful you ought starting research and group you can trade your own account.\" It sounded great; While you were just doing the research? the only problem was that the firm's researchdirector refused to hire me.

Right, because the analysts were strictly forbidden to trade. But I decided Why? I wouldn't let that stop me. I borrowed from my mother again, my and an account at another firm. I I brother, and my girlfriend opened couldn't imagine why since I wrote well and had experience.When I workedout an intricate code system with my broker to keep people in pressed him for a reason,he told me, \"I can't hire because you you if I my office from knowing that I was violating the rules. Forexample, already know too much and I want to train somebody.\" I said, \"Look,I Michael Marcus Marcus 18 Michael 19

I will do anything you want.\" Eventually, convinced him to hire me. Were you making recommendations for the firm at the time? It was really great, because I had Ed to learn from, and he was a successful trader. a trend who already very He was basically follower, Yes. utilized classic trading principles. He taught me how to cut my losses, as well as the importance of riding winners. And how did the recommendations work out? Ed provided an excellent role model. For example, one time, he was the market were better I I short silver and just kept eking down, a halfpenny a day, They because was morepatient. Anyway, was totally out a penny a day. Everyone else seemedto be bullish, talking about why of money, and out of people who would lend me money. But I still had but stubborn confidence I silver had to go up because it was so cheap, Ed just stayed short. Ed a kind of that could somehow getbackon the right said, \"The trend is down, and I'm going to stay short until the trend track again. I was only making $12,500 a year, but I managed to save learned in he that wasn't even changes.\" I patience from him the way followed the trend. $700.Since enough to open an account,I opened a joint

account with a friend who also put up $700. Did Ed's exampleturn you around as a trader? Were you totally directing the trading in this joint account? Not initially. I continued to lose, even with Ed there. friend Yes,my didn't know anything about the markets. Thiswasin July Do you remember what you were still doing wrong at that time? 1972 and, at the time, wewereunder price controls. The futures market was supposedlyalsounder price controls. I think I wasn't patient enough to wait for a clearlydefined situation. This was Nixon's price freeze? Did you think of just tailcoating Ed, because he was so successful? Yes. As I recall, the plywood pricewas theoretically frozen at $110 per couldn't to do that. No,I bring myself 1,000 squarefeet. Plywood was one of the markets I analyzed for the firm. The price had edged up close to $110, and I put out a bearish Did ever think of on even you just giving up trading? newsletter saying though supplies were tight, since prices couldn't go beyond $110,there was nothing to lose by going short at $110. I would sometimes think that maybe I ought to stop trading because it to In the is How was very painful keep losing. \"Fiddler on Roof,\" there a scene did the government keep pricesat the set limits? What wherethe lead looks up and talks to God. I would look up and say, \"Am prevented supply and demandfrom dictating a higher price? I really that stupid?\" And I seemed to hear a clear answer saying, \"No, You it.\" So I did. It was you are not stupid. just have to keep at against the law for prices to go higher.

At the time, I was befriended by a very kind, knowledgeable, and successful semiretired broker at Shearson named Amos Hostetter. He You mean producers couldn't charge more for it? likedmy writing, and we used to talk. Amos reinforced a lot of the things the two What was was that the Ed taught me. I was getting same principles from people. Right. happening though price was beingkept Michael Marcus 22 20 Michael Marcus didn't sell futures and deliver the Why producers just against low, and there is that an artificially an^onojrricprinciple artificiaUyJ[ow_ contract as opposed to selling in the cash market at the price control but price will create a shortage.Soshortages^eveTope^nplywood, sup- level? pose^Iptn^utu^^SKeTwas also under this guideline. However, no one was sure; it was sort of a gray area. One day, while I was looking at The smarter ones were learning that, but it was the infancy of futures the quote board, the price hit $110. Then it hit $110.10; then $110.20. In trading in plywood and most producersweren't that sophisticated. Some other the futures price was 20 cents over the legal words, trading weren't surethat it was to do that. Even if producers probably legal they around to see but ceiling. So I started calling what was going to happen, thought it was, their lawyers might have told them, \"Maybe people can nobody seemed to know. buy plywood at any price in the futures market, but we better not sell and deliverabove the legal ceiling.\" There were a lot of questions. market its freeze Was plywoodthe only exceeding price level?

Did the government ever try to interfere with the futures markets? the market closed somewhere Yes.Anyway, nothing happened. I think over $110 that day. The next day it opened at about $110.80.1 used the Well not exactly, but I will get back to that. In just a few months, $700 following reasoning: If they let it trade over $110 today, they might let had grown into $12,000 trading plywood. it trade anywhere. So I bought one contract. Well, ultimately, plywood went to $200. After I that first contract, and rose, it was bought prices Was this the only trade you had on? just a matter of pyramiding and riding the position.

Yes. ThenI got the bright idea that the same shortage situation was going Was that first really trade after you had been out in your big wiped to occur in lumber. I bet everything on one trade just as I had on the the corn market? corn/wheat trade, that lumber would also the expecting go through ceiling price. Yes. What was lumber doing at this time? Did the cashplywood market stay at $110?

It did It nothing. just watched plywoodgo from $110 to $200. Since they The futures market functioned as a supply of last resort to users who were both wood products, and lumber was also in short supply, I couldn't get supplies elsewhere. reasoned that lumber could go way up\342\200\224andit should have. However, after I bought lumber at around $130, the government finally woke up it of black Basically, created a two-tiered market, a sort legal what to had happened in plywood, and they were determined not to let market? the same thing happen in lumber. after I The day went long, some government official came out with frozen out because didn't have Yes. Those who were they any an that announcement they were going to crack down on speculatorsin with their at a longstanding relationships producers could get plywood higher lumber run who were trying to up the market like they had plywood. The in the futures market. The were fuming at the thought price producers lumber market crashed just on that statement. I was down to the that they had to sell at the legal price ceiling. 22 Michael Marcus MichaelMarcus 23 point where I wascloseto being wiped out again. There wasa two-week Was it insight or courage that gave you the willpower to hold on? period during which they kept issuing these statements. The market stabilized a there at level just above whereI would have been wiped out. I had Desperation,mainly, although was a support point on the charts market held on. At just enough money left to hang on to my position. that the couldn't seem to take out. So, I the end of that year, the $700, which I had ran up to over $ 12,000 and back to under The market was at $130 when you bought it. Where was it at this $4,000,was now worth $24,000. After that scary experience,I never time? really overtraded again. the the The next year, 1973, government began lifting price About$117. controls. Because the price controls had created numerous artificial shortages,when they were lifted, there was a tremendous run-up in many So the of this much smaller than even though magnitude decline was commodities. Just about everything went up. Prices doubled in many the rise lost almost price in plywood, you as much money because markets, and I was able to take advantage of the tremendous leverage had a much in lumber than in you larger position you had plywood. offered by low futures margins. The lessonsI had learned from Seykota

about staying in markets with major trends really paid off.In 1973,my two I Right. During those weeks, was constantly on the verge of being account grew from $24,000 to $64,000. out. It was the worst two weeks in whole went to wiped my life. I the office each about to day just ready give up. At that time, we were seeing something completelynew.I rememberthose markets. Even after prices had goneup only 10 percent of to that Giving up just stop the pain, or so you would at least have their eventual advance,historically,it seemed like a very large price something left? move. What made you realize that prices couldgosomuch further?

Both. I was so upset that I couldn't hands from At the I was and that fit with an stop my shaking. time, politically right wing being inflation-alarmist. The that the evil was theory government constantly Howclosedid you come to out being wiped again? debasing the currency provided the perfect perspectivefor trading the inflationary markets of the mid-1970s. Well, my $12,000 had shrunk to under $4,000. It was the right theory for the right time. Did you say to yourself, \"I can't believe I have done this again\"?

Right. The markets were so fertile for trading then that I could make and I never did it That was the last time I bet on Yes, again. everything plenty of mistakes and still do well. one trade. the Tradingstrictly on long side? What eventually happened?

Yes. Everything was going up. Although I was doing very well, I did I managed to hold on, and the market finally turned around. There was make one terriblemistake.During the great soybean bull market, the one and took a shortage, the government didn't seem to have the will to stop the that went from $3.25 to nearly $12,1 impulsively my profits and futures market. got out of everything. I was trying to be fancy instead of staying with the 24 Michael Marcus Michael Marcus 25

I out trend. Ed Seykota never would get out of anything unless the trend down and was stopped quickly. Ed, however, because he was a I in had in and ended in a limit- changed. So Ed was in, while was out, and I watched agony as major trend follower, no stop up being locked soybeans went limit-up for twelve consecutivedays.I was real down market for several days in succession. competitive,and I would come into the office he was in and every day knowing Each day, Seykota was lockedin a losing position while I was out I was out. I dreaded to work, because I knew would be going soybeans of the market. That was the exact opposite situation of the soybean trade, bid limit and I couldn't in. I again get when he was in a winning trade and I was out. I couldn't help it, but felt a sense ofjoy.I asked myself, \"What kind of a placeis this that one's Was this market as experience of not being in a runaway is to found when else is screwed?\" That greatest joy be somebody getting aggravatingas actually losing I was money? was the point realized that what I was doing too competitive, and I decided to becomea floor trader at the New York Cotton Exchange Yes, moreso.It was so aggravating that one day I felt I couldn't take it anymore and I tried tranquilizers to dull the mental anguish. When that It soundslikethe floor would have been even more competitive. didn't work, somebody said, \"Why don't you take something stronger, calledthorazine?\"

Well, but it wasn't. I remember taking this thorazine at home and then getting on the maybe, to to work. The doors started to close as I was subway go subway on and I started to fall down. At I didn't connect it with the getting first, Did you have any concern about being a floor trader\342\200\224the fact that thorazine. I wandered home and fell the field of Anyway, back just through you were now reducing your opportunity down to one doorway\342\200\224itwas that strong. It knocked me out and I missed work that day. market?

That was the low point in my trading career.

I was a little concerned about it. As it turned out, I should have beenvery You never threw in the towel and just went back into at soybeans in the worried. However, the thought of trading ring was very exciting somepoint? to me. The truth of the matter was that while I was very good at picking trades,I was a total bust at the execution part. I was very shy, and I was No, I was afraid of losing. too timid to yell loud enough to make myselfheard on the floor. I ended

up slipping my orders to a floor trader friend of mine, who handled them Despitethat mistake, you mentioned before that you built your for months until I me. That went on for a few realized what I wasdoing. account up to $64,000 by year-end. What happened next?

Were still the even Around that time, I would haveto over to the Cotton you approaching markets as a positiontrader occasionally go I would have an rush when I though you were on the floor? Exchange. adrenalin heard the traders yelling yy and screaming. It seemed like the most exciting place in the world. But I learned that I needed to show$100,000net worth to get in. Since I had but it was out of Yes, just timidity.] virtually no assets outside of my commodity account, I couldn't qualify. I continued to make money in the markets, and after several So, I assume that many days you weren't even trading. months, I had surpassed the $100,000 mark. Around that same time, Ed Seykotarecommended that I go long coffee. So I did, but I put a close stop in under the market just in case it went down. The market turned Right. 26 Michael Marcus Michael Marcus 27

because the markets have become Was there any advantage to being on the floor? Is that choppier?

hi those days, if the market reached an intraday chart point, it No, not for me. But I did learn a lot from the experience, and I would Right, Now it mat point, take off, and never look back. often recommendit to anybody who wants to become a better trader. I used might penetrate comes back. what I learnedthere for years.

So what is the answer? What type of things did you learn?

make. The I mink the secret is cutting down the number of trades you You of develop an almost subconscioussense the market on the floor. for best trades are the ones in which you have all three things going you: to You learn gauge movement by the intensity of the voices in the price fundamentals, technicals, and market tone. First, the fundamentals For when the market is and ring. example, active moving, and then gets and which should suggest mat mere is an imbalance of supply demand, quiet, that is often a sign that it is not to much further. Also, going go could result in a major move. Second, the chart must show mat the market sometimes when the is ring moderately loud and suddenly very loud, gets is moving in the direction mat the fundamentals suggest. Third, when instead of a that the being sign market is ready to blast off, as you might news comes out, the market should act in a way mat reflects the right think, it actually indicates that the market is into a amount running greater tone. For example, a bull market should shrug off bearish of orders. psychological opposing and to bullish news. If can restrict news respond vigorously you your have to make in activity to only those types of trades, you money, any But how do use that of information once are off the you type you market, under any circumstances. floor? You on said that the things you learned the floor helped you later on. Is that more restrictive trading style the approach you eventually adopted? learned the I importance of intraday chart points, such as earlier daily At chart I I the much. I knew mat I should highs. key intraday points, could take much largerpositions No, becausebasically enjoyed game too man I was a release and for could afford to hold, and if it didn't work immediately, I would only be in those optimum trades, but trading hobby out For at a critical I lot of other in life. I the fun of the get quickly. example, intraday point, would take a me. It replaceda things my placed instead of the three to five could action ahead of own criteria. the that saved me was that twenty-contract position, contractsI my However, thing afford to would enter five to times the hold, using an extremely closestop.Themarket either took off when a trade met all my criteria, I six and or I out. Sometimes I ran, was would make 300,400 points or more, position size I was doing on the other trades. with a only 10-point risk. That wasbecause,by being on the floor, I had familiar with how the Were all from the trades that met the criteria? become market responded to thoseintraday points. your profits coming My trading in those days wasa little bit like being a surfer. I was hit trying to the crest of the wavejust at the right moment. But if it didn't Yes. I work, just got out. I wasgetting a shot at making several hundred points and I Were other trades even? hardly risking anything. later used mat surfing technique as a desk the breaking trader. Although mat approach worked real well men, I don't tiiink it The trades even and amused. would work as well in today's markets. other broke kept me 28 Michael Marcus MichaelMarcus 29

Did track of which were which the moment the market breaks a chart you keep so you knew what was going go back in. Nowadays, key point, on? it is perceived by a whole universeof traders.

Just mentally. My goal on the other trades wasjust to break even. I knew So the lagged follow-up trades are nolongerthere? that the big money was going to be made on the trades that met my criteria. There will be trades that the elevator has bet. The dentists don't always meet those requirements,but Right, grain operator already there be their of is infinitesimal. may fewer of them, so you have to be much more patient. count because level trading participation

Is that because now have their money invested with fund Why are there fewersuchtrades?Hasthe marketplace gotten more they sophisticated? managers instead of trading by themselves?

still are Right, and even if the dentists are there, they trading one-lots, Yes. Thereare many more professional traders than in my In early days. a which is a when the fund managers are trading those had an meaningless position years,I edge just by knowing the angles that Ed Seykota thousand at a Now almost have to be contrary. You have to ask, and Amos Hostetter me. Now clip. you taught everybody knows those principles. it true that all fellow tradersare already in, so who You have \"Isn't my professional trading rooms filled with bright people and computers. is left to You didn't have to worry about that before, because there In those watched the buy?\" days, you board, and you would buy com the was left to buy\342\200\224thepeople who were getting when it moved above chart always somebody a key point. An hour later the grain elevator information or reacting slower. Now, isjust asdecisive,just as would a from his broker everybody operator get call and he might buy. The next the fast. day, brokerage house would recommend the trade, pushing the market up some more. On the third day, we would get short covering Are the markets more to false breakouts now? from the that were and then prone people wrong, some fresh buying from the dentists the of world, who finally got the word that it was the right time Yes, much more. to buy. At that time, I was one of the first ones to buy because I wasone of the few professional traders playing the game. I would wind up then doomed to Are trend-following mediocrity? out to systems selling the dentists several days later.

I believeso. I believe that the era of trend following is over until and You'retalking about short-term trades. Weren't for the you trading unless there is a imbalance in a market that overrides major moves? particular else. 1988 in the belt, which everything [The drought grain developed of the of shortlyafter this interview, provides aperfect example type exception I traded some major moves, but times I would make in many my profits Marcus is describing.]Another exception would be if we were to enter two or three days in just that kind of trade. a major inflationary or deflationary environment.

When did back in the you get market? In other words,unless there is some very powerful force that can overwhelm everything else. the dentists Well, weren't going to keep their positions, since they were buying at the wrong time. So when the market would fall back, I would Yes. 30 Michael Marcus Michael Marcus 31

Have the markets changed during the past five to ten years because have to determine what the central banks are political situation; you professional money managers now account for a much greater going to do. proportion of speculative trading activity, as opposed to the small speculatorswho tend to make all the mistakes? When you were trading the currencies actively,wereyou getting up

through the night because you were worried about getting caught The markets have The is that changed. proof Richard Dennis, who has on the wrong side of a major movebeforethemarketsopenedinthe done well for many years, lost over 50 percent on the funds he was U.S.? in 1988. The managing trend-following systems approach doesn't work The that once anymore. problem is you have defined a trend and taken Yes. a position, everyone elsehas taken a position as well. Since there is no one left to buy, the market around in the times swings other direction and gets Did you always trade that way, or did you get caught enough out. you so that you started tradingaround the clock? One reason we don't have many good trends anymore is that the central banks are preventing currency moves from getting out of hand It happened enough times to make me leery. by taking the other side of the trend. Therewould be a big gap move that you could have avoided by Haven't that? they alwaysdone trading overseas?

I don't think so. If you look at a chart of remember one late the treasury debt held by foreign That is right. For example,I time, during 1978, central banks, you will see that it has risen to new lows was astronomically during the last dollar was getting battered, falling every day. This few years. The banksseemto be over a when I and as a with foreign taking from private foreign during period was cooperating trading colleague investors in our we noticed financing trade debts. Bruce Kovner. We used to talk hours every day. One day, that the There was an intense dollar got mysteriously strong. price What do you think that means in terms of trading, and has your own movement that couldn't be explained by any known information. We just trading becauseof it? That style changed bailed out of our long currency positions like crazy. weekend, President Carter announced a dollar support program. If we had waited until At one time, I traded in currencies. For in heavily example, the years the next U.S. trading session, we would have been annihilated. after Reagan was first elected and the dollar in\342\200\224 was very strong, I would That situation illustrates one of the principles we believed take positions as large as 600 million Deutsche the would marks betweenmy own namely, that the big players, including governments, always account and the company account.At the time, that was about $300 their hand. If we saw a move us that we didn't tip surpriseprice against million worth. That was a pretty good line. I was one of the we often out and looked for the reasonlater. probably understand, got bigger traders in currency the world, including the banks. It was because it very exhausting was a twenty-four-hour market. I rememberthat market well. The currency futures markets were When I went to I would have to wake limit-down for several in a after that sleep, up almost every two hours locked days row to check the markets. I would tune in near the that every major center as it opened: announcement. You must have gotten out right top of Australia, Hong Kong, Zurich, and London. It killed my marriage. market. I to avoid the Nowadays, try currencies, because I feel it is a totally We made a great exit on that trade. Anyway, my point is that I believe, 32 Michael Marcus Michael Marcus 33

the asa courtesy, European central banks are notified about and taxed the traders 30 a year major in an expansionary phase, they percent changeswe are going to make, and they often act ahead of U.S. for their policy to pay expenses. announcements. the Consequently, price move shows up in Europe first, even if it is because of initiate. If had account level. something we it's an action initiated So you to make 30 percent a year to keepyour the the return the by Europeans, price moveis certainly going to occur there first. You must have had someincredible years, given growth I think the best hours to trade often in under that are Europe. If I had a period in of your account\342\200\224particularly handicap. which I was going to devote my life to trading, I would want to live in for and Europe. I was making at least 100 percent a year years years.

Let's fill in some gobackand of your trading history. Where did you What was your best year? go after you decided to give up on beinga floor trader? It was an incredible I My best year must have been 1979. year. caught I a call from Amos to over got Hostetter, who had befriended me at Shearson. gold when it went up $800. At the time, he wasalso some for trading money Commodities Corporation.Amos told me that I would bewelladvised to the whole move? consider joining You caught Commodities Corporation as a trader. At the their but chunks of it\342\200\224$100 time, theory was that they were going to hire all these I was in and out, I remember catching big per great econometriciansto be traders. They had people like Paul Samuel- ounce at a time. It was a wild time. In those days,I would buy gold in son on the board. the would it $10 it would They brought up idea of hiring me at a meeting. Australia, Hong Kong push up higher, go up The in and York I was able first question was, \"What articles has he written; in what journals another $10 London, by the time New opened, has he been published?\" I had a B. A. in liberal arts and that was it. The to sell out at a $30 profit. line \"He trades.\" punch was, just Everybody thought that was very funny. It sounds like there was an enormous advantage to buying gold in the overseas markets rather than in the United States. But weren't they in business to make money trading? In those days, I had an advantage by being in California, because I was didn't think it was to in when New York were I They possible really make money unless you had up trading Hong Kong my colleagues asleep. a Ph.D. the invasion on the But Amos convincedthem to give me a chance. I believeI was remember when I heard about of Afghanistan the first non-Ph.D. to see if knew about trader they had ever hired. They started me out with television news. I called Hong Kong anybody it, in to $30,000 August 1974. After about ten years, I had turned that account and nobody seemed to; the price wasn't changing. I was able buy into knew what was $80 million. Thoseweresomevery good years. 200,000 ounces of gold before anybody happening.

Did the into Did have with you multiply original $30,000 $80 million, or did they That's 2,000contracts! you any liquidity problems add money along the way? their taking on that size position in HongKong?

After the first few me another years, they gave $100,000 to trade. After No, they gave me the stuff, but of course, they got fried by doing it. I that time, were out. In those I they always taking money years, they were was told on my last visit to Hong Kong that shouldn't visit the 34 MichaelMarcus Michael Marcus 35

floor. Some still gold of the people remember that episode. Your transition from being a losing trader to being very successful

coincided with the big bull phase in the commodity markets during They knew who was on the other side of the trade? the early to mid-1970s. How much of your early success was due to skills as how much was the your a trader and just markets? Yes, they knew.

Honestly,I think the markets were so good, that by buying and holding Did they think that you knew lot of other success stories. Fortunes something? you just couldn't lose. There were a werebeingmade. I No,they probably thought was just crazy, comingin and buying all that gold. Then, when the news broke about five to ten minutes later, But a lot of those people didn't keep their fortunes. started I everybody scrambling. had an immediate $10perounce profit on 200,000 ounces. That's true. I fortunate. the time the markets But, was very By got difficult again, I was a good trader.By then, I had really learned my craft. It's hard to believe you could trade off the television I news. Also, by that time, had the advantage of having become very knowledgeable in one market: cocoa. For almost two years, I traded Iknow. I had never done it before. That was the first, last, and only time, almost nothing but cocoa, because of the information and help I got from but I did do it. Helmut Weymar [the founder of Commodities Corporation].Helmut was an incredible expert on cocoa. He wrote a book that was so deepI That market ended in a near-vertical particular gold rise and fall. couldn't understand the cover. Also, he had all kinds of friends in the Did get out in time? you business. With the knowledge and information I got from Helmut and his friends, I felt that I knew the universe of cocoa in a way that I had Yes, I got out around $750 on the way I felt when I saw up. sick, gold never known any market before. go up to nearly $900. But later when it was back down to $400,1 felt much better about it. That phase of almost exclusivecocoatrading obviously came to an end. What happened? All in all, you got out very well. What tipped you off that we were neara top? Helmut retired from cocoa trading.

At that time, we had wild markets. One of rules many my was to get I assume Helmut was not nearly as successfula traderasyou were. out when the volatility and the momentum became absolutely insane. One I had of that was with limit In way measuring days. those days,we Let's just say that I traded much better on Helmut's information than he to have a lot of situations when a market used would go limit-up for a did. number of consecutive days.On the third straight limit-up day, I would to be cautious. I would almost out on the that begin very, very always get Excluding the early losingyears,werethere any trades stand fourth if I had with limit-up day. And, somehow survived any part of my out as being particularly traumatic? position that long, I had a mandatory rule to get out on the fifth limit-up I forced out of the market on that kind of in day. just myself volatility. Well, I would never let myself get caught up potentially intimidating 36 MichaelMarcus MichaelMarcus 37 disasters. The worst situation occurred during my heavy currency It soundslikeas wise as you were as a trader, you were naive as an tradingperiod. I was doing well and couldafford to hold large positions. One investor. time, I had a really large position in Deutsche marks when the Bundesbank came in and decided to punish the speculators. I called in just I was naive. Out of a number of real estate around the time that all this was happening and found out that I was out Yes, incredibly fairly large transactions\342\200\224many in California\342\200\224I lost money on all but one of them. $2'h million in about five minutes. So I got out, rather than see the $2k I am the alive that can claim that dubious million loss go to $10 million. ThenI had to endure the disturbing probably only person distinction. experience of watching the market recover its entire fall.

Why do you think you did so poorly on your investments? How long after you got out?

I would do everything emotionally. I didn't analyze anything. About half an hour. In a sense, you were repeating the mistake of your early trading Did back in? you go experience: getting involved in something you knew nothing about and then losing money. Didn't any bells go off ? It almost sounds like had No, they had taken the starch out of me by that point. you a self-destructive instinct in losing your moneyelsewhere.

I lost more than half the I made. In retrospect, do you feel you did the right thing by getting out of Yes, absolutely. probably money that trade? During this period when you were doing all these unwise things, didn't anybody try to grab you by the shoulders and say, \"Do you Yes,but it still hurt to realize that if I had sat it out and done nothing, I realize what you're doing?\" would have beenOK instead of losing $2k million.

Yes,but any time someone on my staff did, I would fire them. At one Did you invest any of the money you were making in your trading, time, I was employing sixty or seventy people. In addition to all my or did you keep plowing it back into your own account? money-losing businesses, I had a huge nut to make to just support the payroll. Frankly, a lot of the money I made just went down the drain. I made a number of bad investments and losta fairly large chunk of the made money I had trading. When I was trading big, I wanted to have a Did these losses have any of the emotional impact of lossesin the reason to keep doing it, so I just spent money wildly. At one time, I market? The reason I ask is that you seem to talk about these owned about ten housesand ended on all of them. Some up losing money investment losses I in them. I charter very dispassionately. sold before I had evenspentasinglenight had a plane service and lost a lot of money on that. At one point, I figured out that Yes, it hurt to realize what a fool I had been, but I have learned not to for every dollar I madetrading, 30 percent was going to the government, be as attached to material things. I accepted it as a lifelesson.I learned 30percent was going to support my planes, and 20 percent was going to I don't have to own a house in every beautiful place in the world; I can support my real estate.SoI finally decided to sell everything. stay at a hotel and walk on the beach or climb a trail there. Or, if I real- Michael Marcus 38 Michael Marcus 39

can charter a I don't to own ly feel like spoiling myself,I plane; have I would imagine in your case you can't actually put a stop in because one. orders are too your large.

but broker can hold it. Right, that certainly makes sense,but what I am getting at is that I Yes, my suspectthat if you had lost the same amount of money trading, it When an order to get into a is it would have been a much more traumatic experience. Is that because you place position, accompanied by an order to get out? your egowasn't attached to these other ventures?

Another is that if as That's right. thing a positiondoesn'tfeelright soon that's true. I felt that, at least, I was smart at one Yes, I'm sure always it don't be as you put on, embarrassed to changeyour mind and get right I feel is the I am at. If not for thing. like trading only thing really good out. that, I probably would have wound up shining shoes. So, if you put the trade on and five minutes later it doesn't feel right, innate skill? think to \"If I Do you think being a great trader is an don't yourself, get out this quickly,my broker will think that I'm an idiot.\"

I think to be in the upper echelon of successful tradersrequiresan innate violinist. But to be Yes,exactly. If you become unsure about a and don't know skill, a gift. It's just like beinga great a competent position, you what to do, out. You can come back in. When in trader and make money is a skill you can learn. just get always doubt, get out and get a goodnight's sleep.I'vedone that lots of times and the next day everything was clear. Having been through the whole trading experiencefrom failure to extreme success, what basic advice could you give a beginningtrader Do you sometimes go backinright after you get out? or a losing trader?

Yes, often the next day. While you are in, you can't think. When less you get The first thing I would say is always bet than 5 percent of your money out, then you can think clearly again. than it on any one idea. That way you can be wrong more twenty times; I that the will take you a long time to lose your money. would emphasize What other advice would you give the novice trader? take a in two different 5 percent applies to one idea.If you long position related grain markets, that is still one idea. Perhaps the most important rule is to hold on to your winners and cut mean The next thing I would advise is to always use I stops. your losers. Both are If with equally important. you don't stay your out that commits at a certain actually put them in, because you to get point. winners, you are not going to be able to pay for the losers. You also have to follow your own light. Because I have so many where will out Do you alwayspicka point you get before you getin? friends who I are talentedtraders, often have to remind myselfthat if I to trade their or on am try way, their ideas, I going to lose. Every trader have done that. You have to. has and Yes,I always strengths weaknesses. Some are good holdersof winners, but 40 Michael Marcus MichaelMarcus 41

little Others their winners a is the may hold their losers a too long. may cut reading on the sentiment indexes? little short, but are quick to take their losses. As long as you stick to your the and bad in own When Can you think of own style, you get good your approach. you any good examples ofmarket tone tipping you off often wind with the on a trade? try to incorporate someone else's style, you up worst of both styles.I've done that a lot. The most illustration I can classic think of is one of the soybean bull the same of confidence in Is it a problem because you don't have type markets the late 1970s. At the time, soybeans were in extreme in a trade that isn't One of the the yours? shortage. things pushing market up was the weekly government reports indicating strong export commitments and sales. I

In the final need to have the courage to hold the washolding a in and Exactly. analysis, you heavy long position soybeans someone from take the If it comes down to \"I'm in this trade because Commodities called me with the position and risk. Corporation latest export figures. He said, not to have the to stick with \"I have have Bruce is in it,\" then you are going courage good news and I bad news.\" I said, \"OK, what is the good it. So as well not be in it in the first news?\" \"The news is that the commitment you might place. good export figure was fantastic. The bad news is that don't have a limit you position [the Do still talk to other traders about markets? maximum you permissible speculative position size].\" They were expecting the market to be limit-up for the next three days. Not too much. Over the it has cost me When I wound years, mostly money. Actually, I up being a little depressed that I didn't have a talk to other I to conscious of the idea that I have The next traders, try keep very larger position. morning, I entered an order to buy some more to take their information without contracts in to listen to myself. I try getting overly on the opening, just case I got lucky and the market traded their before influenced by opinion. locking limit-up. I satbackto watch the fun. The market opened as limit-up expected. Shortly after the opening, I noticed a lot of ticks talented I assume that we are about very traders, and it still as if the market was the talking being recorded, trading at limit-up. Then prices doesn't make a difference.If it is not your own idea, it messes up eased off as broker called limit-up just my to reportmy fills. The market started down. I said to your trading? trading myself, \"Soybeansweresupposedto be for three and can't limit-up days, they even hold limit-up the first You need to be aware that the world is very and morning.\"I called broker and Right. sophisticated immediately my frantically told him to sell, sell, left to act on this always ask yourself: \"How many people are particular sell! idea?\" You haveto consider whether the market has alreadydiscounted your idea. Didyou get out of your whole position?

How can you possibly evaluatethat? Not only that, but I was so excitedthat I lost count of how much I was selling.I accidentally wound up being short a substantial amount of the classic momentum-type indicators and market which I back 40 By using observing soybeans, bought to 50 cents lower.That was the only market been down in a row? What tone. How many days has the or up time I madea lot of money on an error. Michael Marcus Marcus 42 Michael 43

I remember a situation just likethat.It was the cotton bull market Any other misconceptions? To this I I was when prices almost reached$1a pound. day, recall came out a half The foolishbelief that there is long cotton and the week's export figure showing conspiracy in the markets. I have known to China. It was the most bullish cotton many of the tradersin the and I that million bales of exports great world, can say 99 percent of I had But instead of opening limit-up the next the time, the market is than sooner export figure ever seen. bigger anybody and, or later, it goes about 150 and then where it wants to Thereare but day, the market opened only points higher go. exceptions, they don't last too long. started trading off. That proved to be the exact high. You haveattributed a lot of success to your Ed and Amos who taught you the principles of Have in Another I remember, occurred when we were in a trading. you, turn, taught other interesting example, traders? and all the markets were in very inflationary period commodity trading almost all the lockstep fashion. On one particularly powerful day, Yes. best in fell My result, terms of his the best trader I ever markets went limit-up. On that day, cotton opened limit-up, back, becoming worked as well as for the That was the market with, being a closefriend, is Bruce Kovner. and finished only marginally higher day. but cotton never saw the peak. Everything else stayed lockedlimit-up, How much do ofhis success you attribute to your training, and how light of day again. much of it was just his own talent?

Is the implied rule that if you find a common behavior between When I first met he wasa writer and a Bruce, professor; in his time, want to sell the one that is lagging as soon as it starts spare markets,you he was some I doing trading. was staggered by the breadth of heading down? trading knowledge he had accumulatedin such a short time. I rememberthe first I met Bruce I tried to day impress him with complicated concepts. Here You want to down a bet when a market acts terribly absolutely put I was, a trader in professional who, those days, spent fifteen hours a day relative to else. When the news is wonderful and a market can't everything trading and the and I analyzing markets, couldn'tcomeup with anything want to be sure to be short. go up, then you that he couldn't I understand. recognizedhis talent immediately.

into What kinds of misconceptions about the markets get people That relates to his intellect, but wasthere something about him that trouble? told you that he was going to be a good trader?

of financial disablement is the belief that Well, I think the leading cause Yes, his A trader can't objectivity. good be rigid. If you can find if know the can on the to helpyou. It might, you right somebody who is to you rely experts really open seeing anything, then you have found the raw to be Paul Tudor Jones' and expert. For example, if you happen barber, ingredient of a trader\342\200\224and I saw that in good Bruce right away. I knew it not be a bad idea to listen. he is talking about the market, might from the moment I first met him that he was going to be a great trader. Your however, these so-called \"experts\" are not traders. average What I tried to do Typically, was convey to Bruce the principles that Ed and couldn't be a trader in a million More money is lost Amos had broker years. taught me, along with some of skills. my acquired My best other an intense listening to brokers than any way. Trading requires trading occurred when Bruce and I were collaborating; we did some and what personal involvement. You have to do your own homework, that is There were phenomenal trading. years when I was up 300 percent and I advise to do. he was 1,000 He a people up percent. had very great gift. MichaelMarcus 44 Michael Marcus 45

Is the fun still there if are it thirteen Do you feel you get grounddown as a trader? aspect you doing hours a day?

No. If is it is a torturous kind of in I felt that I trading your life, excitement. But if Absolutely. Around 1983,1 began to taper off my trading. you are life in keepingyour balance, then it is fun. All the successful traders needed to recharge my batteries. I'veseenthat lasted in the business later sooner or got to that point. They havea balanced life; they have fun outside of You can't sustain in trading. How important is gut feel trading? it if you don't have some other focus. wind Eventually, you up or overtrading getting excessively disturbed about failures. trader temporary Gut feel is very important. I don't know of any great professional that doesn't have it. a successfultrader also takes courage: the Being When you do hit a losing streak, how do you handle it? to the to succeed, and the courage to try, the courage fail, courage courage when the to keep on going going gets tough. In the I've sometimes tried to past, fight back by trading even heavier after I start but that losing, usually doesn't work. Then I start cutting Do have aside from trading at this point? down fast to the you any goals very point of stopping completelyif it gets bad enough. But usually it never gets that bad. but I I have taken karate for many years. I am already at a high level, I made a of Do you sometimes to would like to get the blackbelt.Also, have study spiritual manage fight your way out of it? traditions and there is a bit more work I would like to do with that. Sometimes, but most of the time I would have been better off if I had had want to be just stopped. I've trouble to do that, because I am a You sound very vague about it.Doyou vague? bringing myself natural The fighter. typical pattern is: Lose, fight like hell, lose again, then cut back, or sometimes until I I it. Albert stop, get on a winning track. It is very hard to talk about this. Let me seehow can put is whether the Einstein said that the single most important question How long have you stopped for? universe is friendly. I think it is important for everybody to come to a that the universe is point where they feel inside friendly. Usually three, four weeks.

Are you there now? When are in it you a losingstreak,is because you are out of sync with the markets, or is there a better way to describe it? I'm a lot closer.

I think that, in the end, losing When start it But that's not where started off ? begetslosing. you losing, you touches off negativeelements in your psychology; it leads to pessimism.

No. I started off with the feeling that it was an unfriendly place. There few traders who are very have been as successfulasyou. What do you think makes you different? Do you see yourself trading ten or twenty years from now?

I am very open-minded. I am to take in information that is want to make a lot willing Yes,it's too much fun to give up. I don't more money. difficult to accept but which I still to be it in real estate emotionally, recognize true. Forex- I would probably just end up losing again. Marcus Michael Marcus 46 Michael 47

faster than I have to the letters have it ample, I have seen others make money much only Judging by you mentioned, I take that you trade when started stocks as well.How have been wind up giving everything back, because they losing, they long you trading stocks? able to couldn't stop. When I have had a bad losingstreak,I have been When a market moves For about the last two say to myself, \"You just can't trade anymore.\" years. to \"I had counter to my expectations, I have always been able say, but it isn't so Do trade stocks than trade hoped to make a lot of money in this position, working, you differently you futures?

I'm getting out.\" I'm more patient.

on a basis? Do Do you keep track of your equity day-to-day you Is the selection process different? actually plot it?

look for No, I confirmation from the chart, the fundamentals, and the I have done that a lot in the past. market think action. I you can trade anything in the world that way.

for traders to their Is that helpful? Do you think it's a goodidea plot Do you focuson any particular types of stock? equity?

I trade the don't Dow stocks. I prefer the little ones, because they are that is a to cut back I think so. If the trend in your equity is down, sign not dominated the by big professional traders who are like sharks eating a faster than Or if see that are money lot other. and reevaluate. you you losing each The basic principle is that it is better to trade the Australian made it, that would be a warning. dollar than the you Deutsche mark, and the small OTC stock than the big Dow stock.

Are there any advisors you pay attention to? What are the fundamentals you look for in a stock? in of and My favorite market letter terms readability, imagination, I like to use I found Stock Letter something in Investor's the earnings per knowledge of the subject is the California Technology Daily: share is 155 Suite 1401,San (EPS). [The EPS ranking based on comparing the earnings (CTSL Publishing Partners, Montgomery Street, per share of a stock market letters out growth relative to all other stocks. For more details on Francisco, CA 94104). I also like the put by Marty the see the William O'Neil and The P.O.Box EPS, David Ryan interviews.] I Zweig (TheZweigLetter, Zweig Forecast, 360,Bellmore, combine the EPS with own sense of market share If DowTheory my potential. a NY 11710) and Richard Russell (DowTheoryLetters, company has already saturated their little niche in the world, a EPS is not that Letters Inc., P.O. Box 1759, LaJolla, CA 92038). high important. But, in those issues where the EPS is growing, and there is still plenty of pie out there, the situation is much more attractive. Of the traders I have interviewed, Zweig is probably the one most I alsoliketo look at the (P/E) ratio in mentioned. price/earnings conjunction with the EPS. In other to see a words, while I like company with a strong earnings growth pattern, I also want to know how much the market is out of He is solid. for that You always get something of value Marty Zweig. very paying earnings growth pattern. MichaelMarcus MichaelMarcus 48 49

How much EPS with a low P/E. common behavior is there between different markets? So like seeing a high you For can example, you trade bondsinthesameway you trade corn?

I am sure thereisa way of combining Yes.That's the best combination. and with a very good system. I that if the two on a computer coming up really feel you can trade one market, you can trade them all. The principlesare the same. Trading is emotion. It is mass psychology, greed, relative measure ofa stock'sprice and It all in Howabout the strength [a fear. is the same every situation. which isanother indicatorin performance relative to all other stocks], key Investor'sDaily! For most great traders, early failure is more the rule than the exception. tells you what a stock don't think that helps that much. Relativestrength an I Despite incredible long-term performancerecord,Michael Marcus the time a high relative strength has already done. Frequently, by you get his career with an began trading unbroken string of trading losses. the stock has exhausted itself. figure, Moreover, he wiped out not just once, but several times. The moral is: Early trading failure is a sign that you are doing something wrong; it is in a stock? Is there else you look for not anything necessarily a good predictorof ultimate potential failure or success. I found it particularly interesting that, despite a number of painful now 1988], I the basic For example, right [May I look at industry. trading losses, Marcus' most devastating experience was a actually the business. to be bullish on tanker rates and, therefore, shipping trade in which he out happen profitable got prematurely. Taking advantage of potential major winning trades is not only important to the mental health of the For what reasons? trader, but is also critical to winning. In the interview, Marcus stressedthat letting winners ride is every bit as important as cutting rates are like they demand. Tanker commodity prices; losses own Supply and short.Inhis words, \"If you don't stay with makes a your winners, you Prices high and everyone follow a classic cyclical pattern. get are not going to be able to pay for the losers.\" a lot of and down. so they build ships pricesgo Marcuslearned about the lot of money, dangers of overtrading the hard way. In We have had the are and prices go backup again. one instance trade in Eventually ships scrapped (the grain the nonexistent corn blight year), an a lot of tankers low rates for many years and have scrapped account he had built from small very up a very stake to $30,000 was wipedout where backup So we are that part of the cycle pricesgo all his annually. entering by betting money on a singletrade.Hemade the same mistake a second time in again. the lumber market, coming to the brink of disaster before narrowly escaping. Theseexperienceshad a dramatic impact on Marcus' of the account gets Does become more difficult as the size trading trading philosophy. It is no accident that the first rule he cites when asked to advice to the bigger? give average trader is: Never commit more than 5 percent of your money to a singletrade idea. markets that are forced to in fewer and fewer Yes, becauseyou compete are being traded by other big professionals. 50 Michael Marcus

In addition to not overtrading, Marcus stressesthe importance of trade. He feels that committing to an exit point on every protective stops this commitment on the trader. He are very important because they force when also recommendsliquidating positions to achieve mental clarity one is losing money and is confused regarding market decisions. own mind Marcus also emphasizesthe necessity of following your Bruce Kovner even when as a trader.He suggests that following the advice of others, as it the worst they are traders, often leads to problems combines good The World Trader elements of both traders. Marcus Finally, despite being an aggressive trader, strongly for believes in being restrictive in selecting trades. He adviseswaiting those trades in which all the key elements line up in one direction. By the of success on each trade. doing so you greatly enhance probability to be Making lots of trades when the conditions appear only marginally in favor of the tradeideahas more to do with entertainment than trading Bruce Kovner well the world's trader in success. Today, may be largest the interbank currency and futures markets. In 1987 alone,he scoredprofits in excess of $300 million for himself and the fortunate investors in his

funds. During the past ten years, Kovner has realized a remarkable 87 percent averaged annual compounded return. Two thousand dollars invested with Kovner in early 1978 would have been worth over $1,000,000 ten years later. Despitehis incredibletrack record and huge trading size, Kovner

has managed to a low Hehas keep surprisingly profile. assiduously pursued his privacy by steadfastly refusing all interview requests. \"You

might be wondering why I consented to this interview,\" he said. As a matter of fact, I was, but I did not want to raise the question.I had assumed that his agreement reflected a voteof confidence and trust. Seven years earlier,our paths had crossed briefly when we both worked at Commodities Corporation\342\200\224he as one of the firm's principaltraders, I as an analyst. \"It Kovner continued, seems like I can't avoid somepublicity, and

the stories are usually distorted and fanciful. I thought that this interview would help establishat least one accurate record.\"

Kovner hardly fits the intuitive image of a trader who typically holds positions with a total face value measured in billions of dollars.

With his incisive intellectand easygoing manner, he reminds one more BruceKovner 53 52 Bruce Kovner

ber, and December). Given the prevailing phase of the business cycle, of a professor than a giant-scale trader in the highly leveraged currency interest rate theory predicted that the nearby contract (for and futures markets. Indeed,Kovner started out as an academic. example, March) should trade at a higher price (loweryield)than the next contract After graduating from Harvard, Kovner taught political science (for example, June).Although the nearest two contracts did indeed tend courses at Harvard and the University of Pennsylvania. Although he to this Kovner found that the difference \"I reflect relationship, price liked teaching, he was not enthused with the academic life. didn't between more forward contracts often started trading at near-zero levels. enjoy the process of alwaysconfronting a blank page in the morning and His first trade involved buying a forward interest rate contract and thinking of brilliant to write.\" something selling a more forward contract, in the expectation that, as the purchased In the early 1970s, Kovner manageda number of political contractbecamethe nearby contract with the passage of time, the price campaigns, with the idea of eventually running for office himself. He spread between the two contracts would widen. abandonedpolitics because he didn't have the financial resources, or the That first trade worked just according to textbook theory and desire to work his way up the political ladder from committee jobs. Kovner was hooked as a trader. His second trade also involved an intra- During this time he also worked as a consultant for various state and market spread [the of one contract the sale of another federal agencies. purchase against contract in the same market]. In this case, he bought the nearby copper Still searching for a careerdirection, Kovner shifted his attention contractand sold a more forward contract, in the that to the financial markets in the mid-1970s. He believedthat his economics expectation supply tightness would cause the nearby copper contractto gain relative to and political science educationprovided the right background, and he the forward position. Although his idea right, he was found the idea of the world to make eventually proved analyzing trading judgments too early and lost money on that trade. At the end of these two trades, tremendously appealing. For about a year, Kovner immersed himself in Kovner was still ahead, with his original $3,000 stake having grown to studying markets and the related economictheory. He read everything about $4,000. he could gethis hands on. One \"I subject he studied intensively was interest rate theory. fell in with love Haeyield curve.\"[Theyield curve is the relationship between third trade is in an the on securities and their time to For My what really put me the business. In early 1977, yield government maturity. if each apparent shortage was developing in the soybean market. It was a example, successively longer-term maturity provided a higher yield a demand driven market. Every week the crush was higher than expected than shorter-term maturity\342\200\224for example, five-year T-notes at a higher than and nobody believed the figures. [The crush is the amount of soybeans yield one-year T-bills\342\200\224the yield curve would reflect a continually for use as meal and I was the rising slope on a graph.] processed soybean soybean oil.] watching between the old Kovner's of the interest rate markets coincidedwith the July/November spread [the price difference crop July study contract and the new November Sinceit looked like we initial years of trading in interest rate futures. At that time, the interest rate crop contract]. were to run out of I that the old futures market was relatively unsophisticated and price distortions, going soybeans, thought crop July which would contract would expand its to the new Novembercontract. This be quickly eradicated by arbitrageurs today, persisted over premium crop As spread had been trading in a narrow consolidation near 60-cents time. Kovner explains it, \"The market hadn't becomeimportant premium I I could out below the enough for CitiBank or Solomon Brothers,but it was important enough July. figured easilystopmyself just for me.\" consolidationat around a 45-cents premium. At the time, I didn't realize how the could be. I on one One of the primary anomalies Kovner discovered was related to volatile spread put spread [that is, bought July and sold near 60 cents the price spread (difference) betweendifferent futures contracts. Futures soybeans simultaneously Novembersoybeans] and it widened to 70 cents. Then I on another I on are traded for specific months (for example, March, June, Septem- put spread. kept pyramiding. 54 Bruce Kovner Bruce Kovner 55

How big of a position did you build up? Were you just adding to your position as the market went up, or did you have someplan? I eventually built up to aposition of about fifteen contracts,but not before

I had to switch brokerage firms. When I started out, I was trading at a I had a plan. I would wait until the market moved up to a certain level small brokeragehouse.The head of the company, who was an old floor and then retraced by a specified amount before adding another unit. My trader, went over the trades everyday and spotted what I was doing.By pyramiding did not turn out to be the problem. that time, I had built my position up to about ten or fifteen contracts. The The market had entered a string of limit-up moves. On April 13, on a contract was while the the market hit a new record The commotionwas tremendous. margin singleoutright $2,000, spread high. My margin was only $400. broker called me at home and said,\"Soybeans are going to the moon. It He told \"The have on trades like an lookslike is and November is sure to follow. You me, spreadpositionyou July going limit-up, I am to raise from to are a fool to short the November contracts. Let me lift outright long position. going your margins $400 $2,000 stay your contract.\" are lower than Novembershorts for and when the market for the next few per [Spread margins outright margins, you, goes limit-up the that a net or short will be will make more I and wecovered reflecting assumption long position considerably days, you money.\" agreed, my more volatile than a Reason: In a the Novembershort spread position. spread, long position. contract of the sition is to at least offset portion po likely partially price in movement the short contract position. In a shortage situation, however, an AH of it?! intercrop spread, such as long July soybeans/short November soybeans can to be as volatile as a net or short prove nearly long position.] All of it [he laughs loudly].

He was obviously quite concerned with the risk in your position. Was this a spur of the moment decision?

was that Yes.He concerned I had only put up $400 margin per spread, It was a moment of insanity. Fifteen minutes later, my broker callsme on a spreadwhich behaved like a net long position. back,and he sounds frantic. \"I don't know how to tell you this, but the market is limit-downl I don't know if I can out.\" I went into Actually, he wasn't that far off. get you shock. Iyelledat him to get me out. The market moved off of limit-down by a little bit and I got out. He was right, but I was furious. So I moved my account to another brokerage firm, which shall remain nameless, for reasons that will soon become clear. Did you end up getting out at limit-down?

You were furious becauseyou felt he was being unfair, or\342\200\224 I got out between limit-down and slightly above limit-down. I can tell

you the dimensions of the loss. At the moment I covered my short I was Well, am not sure I thought he being unfair, but I certainly knew November position leaving myself net long July, I was up about $45,000. he was an obstacleto my objective. I moved my account to a major By the end of the day, I had $22,000 in my account. I went into brokeragehouse,and got a broker who was not very competent. The emotional shock. I could not believe how stupid I had been\342\200\224how badly market kept moving up and I kept adding to my position. I had put on I had failed to understand the market, in spite of having studied the I my first spread on February 25; by April 12, my account was up to markets for years. I wassickto my stomach, and I didn't eat for days. $35,000. thought that I had blown my career as a trader. 56 Bruce Kovner Bruce Kovner 57

What to the But you still had $22,000comparedto your original stake of only eventually happened spread? $3,000. Keeping things in perspective, you were still in pretty good shape. Thespreadcollapsed.Eventually, it went below the level that I had first

begun buying it at.

Absolutely. I was in good shape, but\342\200\224 Since you liquidated your position on the day the marketand the Was it the stupidity of the mistake or was it the money that you had spread topped, you would have given back a portion of the profits given back that caused such emotional pain? even if it wasn't for the disastrousdecisionthat forced you out of the market.

No, it wasn't the money at all. I think it was the realization that there really was \"fire\" there. Until then, I had ridden $3,000 to $45,000without That may be true, but for me, that was my \"going bust\" trade. It was the a moment of pain. closest I ever cameto going bust and, psychologically, it felt as if I had.

Was trade? On the way up, did you think, \"This is easy\"? that your most painful

It was easy. Yes. Far and away.

Did you give thought to the possibility that the market streak any Even though you actually ended up making a substantialamount of could the other eventually go way? money on the trade?

No, but clearly, my decision to lift the short side of my spread position I multiplied my money by nearly sixfold on that trade. I was, of course, in the middle of a showeda for risk. I think panic complete disregard I insanely leveraged, and didn't understand how risky my position was. what bothered me so much was the realization that I had lost a process of rationality that I thought I had. At that moment, I realized that the Was getting out of entire immediately after your as your position markets were truly capable of taking money away every bit as fast broker called to tell you the market was limit-down a matter of it to That madea on me. they gave you. very strong impression panic, or do you think you had some instinctive commonsenseabout with Actually, I was very lucky to get out $22,000. controlling risk?

that averted a I assume that your quick action day probably I'm not sure. At that moment, I was confronted with the realization that complete disaster. I had blown a great deal of what I thought I knew about discipline. To this day, when to disturb emotional Absolutely. After that day, the market went straight down as fast as it something happens my equilibrium and my sense of what the world is like, I close out all related had gone up. Perhaps, if I hadn't made my stupid mistake, I might have positions to that event. made the mistake of riding the market down. 58 Bruce Kovrter BruceKovner 59

Do you have a recentexample? That is a great lead-in. What is the punch line?

me that could make a million dollars. He showed me that October 19,1987\342\200\224the week of the stock market crash.I closedout all He taught you could It is to on October and 20 I if yourself, great things happen. very easy my positions 19 because felt there was something you applied showed me that if in that miss the that can do it. He you take happening the world I didn't understand. The first rule of point you really are a and use discipline, you can actually make it. trading\342\200\224there probably many first rules\342\200\224isdon't get caught in a position situation in which you can lose a great deal of money for reasons you don't understand. It sounds like he gave you confidence.

Let's back to me one other that is critical: You get the period after your soybean trade. When did you Right. He also taught thing absolutely start trading again? have to be willing to make mistakes regularly; there is nothing wrong

with it. Michael taught me about making your best judgment, being next best making your third About a month later. After a fewmonths I had my account back to about wrong, making your judgment, being wrong, best and then $40,000.Around that time, I answered an ad for a assistant judgment, doubling your money. trading position at Commodities Corporation. I was interviewed by Michael in world. There are Marcus in his usual idiosyncratic manner. He had me return to Commodities You are one of the most successfultraders the a small number of traders of caliber. What makes Corporation severalweekslater. \"Well,\" he said, \"I have some good only your you news and some badnews.The bad news is that we are not hiring you as different from the averageguy? a trading assistant; the good news is that we are hiring you as a trader.\" while others I'm not sure one can reallydefine why some traders make it, How much did think of two elements. I have money Commodities Corporation give you to trade? do not. For myself, I can important First, the world different from the ability to imagine configurations of today it I that can Thirty-five thousand dollars. and really believe can happen. can imagine soybean prices and double or that the dollar can fall to 100 yen.Second,I stay rational Were disciplined under pressure. you trading your own money,as well, at the same time?

skills be Yes, and that is I am Can trading taught? something very glad about.Commodities Corporation had a that policy allowed you to trade your personal account, as train well as the and to a limited extent. Over the years, I have tried to perhaps companyaccount, Michael and I were very aggressive Only turned out to be traders. thirty people, and only four or five of those have good traders. Were you influenced by Michael? What happened to the other twenty-five? much. Michael Oh, yes,very taught me one thing that was incredibly important [pause]. Theyare out of the business\342\200\224and it had nothing to do with intelligence. 60 Bruce Kovner Bruce Kovner 61

When you compare the traineesthat made it to the majority that did days earlier, as the negotiations were finishing up. At that inSant, I felt do find traits? comfortable that one of the ir the not, you any distinguishing completely saying major pieces valuation of the Canadian dollar had just changed, and the marlet had They are strong, independent, and contrary in the extreme. Theyareable already voted. to take positions others are unwilling to take. They are disciplined Prior to the agreement, I felt the Canadian dollar was at the top of to take the size A trader blows a hill, and I wasn't sure whether it was or enough right positions. greedy always going to roll backwads I know some traders who never to the forwards. When the market I was to with tlat out. really inspired managed keep moved, prepared go money they made. One trader at Commodities Corporation\342\200\224I don't movement because we had a conjunction of two important element!: a major struck me as brilliant trader. The in fundamentals know in want to mention his name\342\200\224always a change (although, I wasn't smart enough tc with were often which it ideas he came up were wonderful; the markets hepicked direction would impact the market), and a techncal price the right markets. Intellectually, he knew markets much better than I did, breakout on the upside. yet I waskeepingmoney, and he was not. What do you mean you weren't smart enough to know in which So where washegoingwrong? direction the trade pact announcement would move the market? Since U.S./Canadian trade is so much a larger component of Position size. He traded much too big. For every one contract I traded, Canadian trade than it is of U.S. trade, wouldn't it hive been he traded ten. He would double his money on two different occasions logical to assume that the trade pact would be bullish for the each year, but still end up flat. Canadian dollar?

Do you always use fundamental analysis in forming your trading It didn't have to happen that way. I couldjust as easilyhave aigued that decisions? the trade pact was negative for the Canadian dollar because he elimination of the would allow to trade barriers imports from the U.J. almost trade on a market I trade on Canadian interests. There are still some tdhere to I always view; don't simply submerge analysts who technicalinformation. I use technical analysis a greatdealand it is terrific, but that argument. My point is that there are well-informed tralers who hold a I understand the market should than I I can't position unless why move. know much more do. I simply put things together. Tley knew which to voted Canadian way go, and they in the marketplace by buying that take has a Is to say that virtually every position you dollars. fundamentalreason behind it? Is the generalization of that example that when an importart I think that is a fair statement. But I would add that technical analysis fundamental development occurs, the initial direction of the marlet move can often clarify the fundamental picture. I will give you an example. is often a good tip-off of the longer-term trend? for the During the past six months, I had good arguments Canadian for the Canadian dollar market know dollar going down, and good arguments going Exactly. The usually leads because there are people Wio up. It was unclearto me which interpretation was correct. If you had more than you do. Forexample,the Soviet Union is a very gocdtrader. put a gun to my head and forcedme to choose a market direction, I probably would havesaid \"down.\" Goodtraderin which markets? Then the U.S ./Canadian trade pact was announced, which changed the entire picture. In fact, the market had broken out on the upsidea few In currencies, and grains to some degree. 62 Bruce Kovner Bruce Kovner 63

How does one know what the Soviets are doing? intelligence to draw conclusions about what the past activity of some traders may say about the future activity of other traders. Because the Soviets act commercial banks and and through dealers, you For me, technical analysis is like a thermometer. Fundamentalists hear about it. attention to who say they are not going to pay any the charts are like a of doctor who says he's not going to take a patient's temperature. But, It to me seems rather contradictory that a country that is sopoorin in course, that would be sheerfolly. If you are a responsible participant running its own economy should be a trader. good the market, you always want to know where the market is\342\200\224whether it is hot and excitable, orcoldand stagnant. You want to know everything Yes, but if you ask people in the business, you will find out that they are. you can about the market to give you an edge. Technical reflects the vote of the entire marketplace and, or how? analysis Why, behavior. that therefore, doespickup unusual By definition, anything It is creates a new chart pattern is something unusual. very important for It is a but do read of our mail. The Soviets joke, perhaps they some (and if I can observe me to study the details of price action to see something other have advance information. governments) occasionally Why the charts is about how everybody is voting. Studying absolutely crucial shouldn't they? They have the bestdevelopedintelligence service in the and alerts me to existing disequilibria and potential changes. world. It is a well known fact in the intelligence community that the are of Soviets (and others) capable eavesdropping on commercial look at a chart Do you sometimes put on a trade because you and communication. That is firms why the large commodity trading sometimes of a say, \"I'veseenthis pattern before, and it is often a forerunner use scramblers when are they making very sensitive calls. market advance.\" That even not have is, though you may any My point is that there are thousands of difficult-to-understand fundamental reasons? mechanisms that lead the market, which come into play before the news trader reachessomepoor sitting at his desk. But the one thing that does Yes, I will do that sometimes. I would only add that, as a trader who has hit the market is a huge sale or purchase. seen deal and been in a lot of markets, there is nothing a great to me about a move out of a that disconcerting price trading range nobody Isn't that the basic rationalization for technical analysis? understands.

Technical analysis, I think, has a great deal that is and a deal right great Does that imply you usually go with breakouts? that is mumbo jumbo.

Sure. That's an interesting statement.What's right and what's black magic? But the markets are often prone to false breakouts. There has to be more to it than that. deal of There is a great hype attached to technical analysis by some technicians who claim that it predicts the future. Technical analysis Tight congestionsin which a breakout occurs for reasons that nobody tracks the it does not the future. You have to use own past; predict your understands are usually good risk/reward trades. 64 Bruce Kovner Bruce Kovner 65

How about breakouts that occur becausethereisa story in the Wall Let's do a market on an breakoutfrom a say you buy upside Street that Journal day? consolidation phase, and the price starts to move against you\342\200\224that is,

back into the range. Howdo you know when to get out? Howdo you That would be much in tell the difference bad trade? less relevant. The Heisenbergprinciple physics between a small pullbackand a provides an analogy for the markets. If something is closely observed, the odds are it is going to be altered in the process. If corn is in a tight Whenever I enter a position, I have a predetermined stop. That is the then breaks out the I can I know where I'm out before I in. The consolidation and the day Wall Street Journal only way sleep. getting get carries a the size on a is the and the is story about a potential shortage ofcorn, odds of the price move position trade determined by stop, stop being sustained are much smaller. If everybody believes there is no determined on a technical basis. For example,if the market is in the midst within reason for corn to break out, and it suddenly does, the chances that there of a trading range, it makes no sense to put your stop that range, an are to some is important underlying cause are much greater. sinceyou likely be taken out. I always placemy stop beyond technical barrier.

It sounds likeyou are saying that the less explanation thereis for a Don't run into the that a lot of other be price move occurring, the better it looks. you problem people may using the samestoppoint, and the market may be drawn to that stop level? I think that. The Well, do more a price pattern is observed by speculators, the more prone you are to have false signals.The more a market is the I never think about that, because the point about a technical barrier\342\200\224and product of nonspeculative activity, the greater the significance of time\342\200\224is I've studied the technical of the market for a that technical breakouts. aspects long I to avoid a that the market shouldn't go there if you are right. try point floor can at I at an traders get easily. Sometimes may place my stop Has the greatly increased use of computerized trend-following obvious point, if I believe that it is too far away or too difficult to reach systems increased the of false technical frequency signals? easily. To take an actual example, on a recentFriday afternoon, the bonds I think so. The fact that there are billionsof dollars out there trading on witnessed a high-velocitybreakdown out of an extended trading range. that use technical systems moving averages or other pattern simple As far as I couldtell, this price move came as a complete surprise. I felt recognition approaches helps produce many more false I have signals. very comfortable sellingthe bonds on the premise that if I was right about developed similar systems myself, so that I can tell when the other the trade, the market should not make it back through a certainamount systems are is going to kick in. If it clear that prices are moving because of a previous overhead consolidation. That was my stop. I slept easily these into the billions are kicking market, it is a lot less interesting than in that position, because I knew that I would be out of the trade if that if a breakout occurs becausethe Russians are buying. happened. 66 Bruce Kovner Bruce Kovner 67

Talking about stops,I assume because of the size that you trade, your Do you feel it is possible to ever develop a systemthat would do as stopsare always mental stops, or is that not necessarily true? well as a goodtrader?

Let's put it this way: I've organized my life so that the stops get taken I think it is unlikely because the learning features of such a system would care of. They are never on the floor,but they are not mental. have to be very highly developed. Computers are good at \"learning\" only when there are clearhierarchies of information and precedent. For What eventually tells you that you are wrong on a major position example,expertsystemsfor medical diagnostics are very good because trade?Your stop point will limit your initial loss, but if you still the rules are very clear. The problemwith developing expert systems in the fundamental believe analysis underlying the trade, I assume for trading is that the \"rules\" of the trading and investment gamekeep that will it If are about the have some time with you try again. you wrong general changing.I spent working expert system direction of the of At market, won't you take a series losses? what point developers, and we concludedthat trading was a poor candidate for this in towel on the trade do you throw the idea? approach, because trading decisions encompass too many types of and the rules for the information knowledge, interpreting keep First of all, a lossof money itself slows me down, so I reducemy changing. positions. in the situation the in the Secondly, you described, change technicalpicture will give me second thoughts. For example, if I am bearish Does the fact that you are trading somuch greater size than you did the dollar in it on and a major intermediate high has been penetrated, I would your early years make more difficult? have to reevaluatemy view. There are far fewer markets with sufficient liquidity for the optimum size Earlier mentioned that had own of trades. you you developedyour my trend-followingsystems to provide an indicator ofwhere the largeamount of money managed under such systems couldbe expectedto hit the How much money are you currently managing? market. Do you use your own trend-followingsystemsto tradeany portion of the money you manage? Over $650 million.

Yes, about 5 percent. I assumemorethan half of that is due to capital appreciation.

Is that the level of confidence? I it is not 5 Yes, last alone were about million. your guess negative year's profits $300 percent, so it could be worse. What are some markets that you really havetrouble trading because make but have of insufficient Overall, my systems money, they volatility liquidity? characteristics,and problems related to risk control that I don't like. But, since market I like a but in which they offer diversification from my other trading, I use them to a small An example of a great deal, the liquidity is degree. often poor,is copper.In copper, I am now the elephant. 68 Bruce Kovtter Bruce Kovner 69

What kind of size can be moved comfortably in a market like but are limits, they very high. I plan to very carefully manage the future copper beforeit becomes a problem? growth in the size of funds I am managing.

I would say, in a day, you can comfortably move500 to 800 contracts; When you put in orders in markets that are not among the most uncomfortably, somewhat more than that. But the daily volume of liquid\342\200\224inother not T-bonds or the currencies\342\200\224do words, major you is 7,000 to 10,000 contractsand a lot of that is local copper currently only find your orders actually moving the market? trading or spreads. In contrast, in the T-bond market, you can move5,000 contracts without a problem. You can also move very large size, in the They can, but I never bully a market. interbank currency market.

which have about that, one often hears stories about Can you trade a market like coffee, doesn't deep Talking very large traders to the markets or that work? liquidity, but sometimes can develop enormous trends? trying push up down.Does

did trade coffee few million dollars in it. I It can Yes,I last year and made a don't think so. be done for the short term, but eventually it will am in $2 million in Now, if I managing $600 million, and I kick profits lead to serious mistakes.It usually results in arrogance and a lossof touch on coffee it doesn't matter that much. In fact, it could even with the market both trades, really underlying structure, fundamentally and The traders that I be counterproductive, since the time and energyI spend concentrating technically. know who thought too highly of their ability and on the which I trade tried to coffee diminishes my focus on currency markets, bully the market, ultimately made the mistake of overtrading and far more heavily. went under.

It would that you have reached a size levelthat impedes your Without appear mentioning any names, can you provide an example? trading performance. Since you havesubstantialpersonalfunds, did ever consider own money and avoiding all the you just trading your There is of a a recent example British trading organization getting into related headaches in managing money? serious trouble after they tried to corner the crude oil market. At first but then they succeeded, they lost control and crude oilpricesfell by $4. I Yes, but there are severalreasonswhy don't. Although I invest a great deal of own in funds, the portion of my funds that is my money my What was the end result? a to an that has managed money represents call. [Analogy option risk limited unlimited profit potential in the event of a pricerise,but to its They lost about $40 million and the organization is in trouble. cost in the event of a decline.] I don't say this to be flippant, since my to reputation among my investors is extremely important me, but a call You are more than is a much better position than a symmetrical win/loseposition. probably managing money any other futures trader in the world.How do you handle the emotional strain when hit a Is thereapracticallimit to the amount of money you can manage? you losing period?

Inmost futures there is. in Theemotional burden of is on commodity markets, certainly However, trading substantial; any given day, I could interest and a few such crude there are millions of dollars. If currencies, rates, commodities as oil, lose you personalize these losses,you can't trade. Bruce 70 Bruce Kovner Kovner 71

Was confidenceshakenat all that Did Do the lossesbother you at all anymore? your year? you go back to the drawing board?

Every so The only thing that disturbs me is poor money management. had a lot of I went back and lot of risk often, I take a lossthat is significantly too large. But I never designeda management systems. I paid strict as as losses were the attention to the correlations of all difficulty with the process of losingmoney, long my positions. From that point on, I the side of the measured total risk in the outcome of sound trading techniques. Lifting short my market everyday. that scared me. I learned July/November soybeanspreadwasan example as When you trade do use the a lot about risk control from that experience. But a day-in, day-out currencies, you interbank marketor the futures market? losses does not bother me. process,taking

I only use the interbank market, unless I am an Did you have any losing years? doing arbitrage trade against the IMM. [The International Monetary Market (IMM)is a subsidiary of the Mercantile and the foremost Yes, in 19811 lost about 16 percent. Chicago Exchange world's futures The is currency exchange.] liquidity enormously better, the the markets? transaction costs are much it is Was that due to errors you made, or the nature of lower, and a twenty-four-hour market, which is to us because we trade important literally twenty-four hours a day. that it was the It was a combination of the two. My main problem was and What portion of is in first major bear market in commodities I had experienced, bear your trading currencies? markets have different characteristics than bull markets. On about 50 to 60 our average, percent of profits come from currency markets trading. Was it a matter ofbecomingcomplacent about always being in an uptrend? I assume are you also trading currenciesbeyond the five that are currently tradedonthe IMM. of a market is actively No, the problem was that the principal characteristic bear retracements. I would very sharp down movements followedby quick We trade any currency that is highly liquid. Virtually all the European sell too late and then get stopped out in what subsequently proved always currencies those of the (including Scandinavian countries), all the major In a bear market, to be part of a wide-swinging congestion pattern. you Asian currencies and the Mideast currencies. Crosses are probably the have to use countertrend rallies to enter sharp positions. most important trading vehicle that we use that you can't trade on the IMM. are a trade two [Crosses involving foreign countries. For example, What other mistakes did you make that year? buying British pounds and selling an equal dollar amount of Deutsche marks is a You can't cross.] trade crosses on the IMM because they have I had correlated trades. My money management was poor. too many fixed contractsizes. Kovner 72 Bruce Bruce Kovner 73

the IMM the ratio of the Is there a the futures But you could do a crosson by adjusting reasonwhy market hasn't been able to capture to the a numberof contracts between the two currencies equalize larger percentage of world currency trading? dollar value of each position. The futures market is not currency efficient in several of the most direct to use the interbank market. For important First, dollar But it is much more exact and respects. hedging usually has a specific and date and Deutsche For if I example, Deutsche mark/British pound mark/Japanese requirement. example, need to hedge$3.6million for April 12, the traded and active. bank takes it. The futures yen crosses are highly very just market, however, trades only for specific dates and fixed the contractsizes,so hedger is not precisely covered. it in I assume that when you do a mark/yen cross, you price dollars, not in terms of one of the two currencies. So there is actually no way the futures market can compete,because the interbank market can tailor a hedge for any customer. worth of marks and That's right. You simply say: Buy $100 [million] dollar is sell $100 [million] worth of yen. In the interbank market, the That's In right. addition, the activity takes place within normal the world. the unit of exchange all over commercial banking relations. That is, very often, the hedger wants to show his interest banking that he has a locked-inprofit so he can borrow or the release of an against In situations where a surprise newsdevelopment it. economicstatistic out of line with expectations causes a sharpprice interbank market react less responsein currencies, does the Can you talk about your fundamental analysis How the the two methodology? violently than the futures market, or do arbitrageurs keep do you determine what the right price for a market shouldbe? markets tightly linked?

assume the I that price for a market on any given is the correct The two markets are well arbitraged, but those are the moments when day price, then I to out The markets do a try figure what are occurring that will alter that a swift arbitrageur will make some money. get changes very price. little bit out of line, but not a lot. Oneof the of a jobs good trader is to imagine alternative scenarios. I to to such events be less try form many different mental pictures of what the world should be Will the interbank marketpriceresponse like and wait for one of them to You extreme? be confirmed. keep trying them on one at a time. Inevitably, most of these pictures will turn out to be is wrong\342\200\224that is, only a few elements of the Yes, because what happens on the futures market that the locals back picture may prove correct. But all of The the markets backis then, a sudden, you will find that in one out of away and let the stops run. only thing that pulls picture, nine ten the other side. elements click. That scenario then becomes of the world the arbitrageurs who have the bank on your image reality.

commercial Let me give you an The after the October 19 What percentage of bank markettrading represents example. Friday stock market crash, I had trouble which is unusual for activity, or hedging, vis-a-vis speculative trades? sleeping, very me. But I am sureI wasn't the trader to only lie awakethat night. All week long, I the on but struggled with how the events of that week were The Fedhas donea study on that. I don't have figures hand, going to impact the dollar.I was on different it is Thebanksare the trying visions of the world. One of these basically a hedging market. principal speculators, pictures was total panic\342\200\224the world to an as well as a few players like myself. coming end, financially. BruceKovner 74 Bruce Kovner 75

the safest haven, and In this scenario, the dollar becomes political How often do you get calls in the middle of the night? in dollar. In as a result, there could be a tremendous rise the fact, on

that the dollar did rise dramatically as many people I Tuesday of week, have an assistanttrader, and the joke is that he is allowed to wake me the withdrew their from other During next three days, at home twice a But money places. up year. it really isn't necessary very often. had there was tremendous confusion. the end of the week,the dollar Whenever the markets are By busy, I know what is going on all the time. started to home is give ground again. My fully equipped with trading monitors and direct lines.Also, It became It was then that it all coalesced in my mind. absolutely my assistant's is to be and job up get the calls. He probably getscalled that of need for stimulative action, three or clear to me given the combination a four times a night. dictated by the tremendous worldwide financial panic,the reluctance of the Bank of and German Bundesbank to potentially Are that Japan adopt you saying you delegate the nighttime decision making? trade deficits, the inflationary measures, and the continuing wide U.S. only Baker to let the dollar Someone We create a solution was for TreasurySecretary go. scenario for everycurrency at least once a week. We define and that someone would be the United the we had to play the stimulative role, ranges expect for each currency and what we will do if it breaks States. out of these ranges. would and it would not be in the As a result, the dollar drop was convinced So assistant interestof the other central banks to defendit. I absolutely your knows that if currency X gets to 135\342\200\224 that was the only thing that Baker could do. He should buy it or sell it. Thosedecisionshave been made beforehand. in You realized this late Was it too late to take action the But are under all Friday. they instruction to call me if the Prime Minister resigns, markets? or if there isa major unexpected currency revaluation, or something else happens to invalidate the recent scenario. Yes, and it was a very tense weekend becauseI realized that the dollar lower. I waited for the Far East markets to Are there times end might open sharply open you up trading at night? Sunday night. Yes,a lot. Do you do a lot of your trading outsideof U.S. hours? You can't trade obviously round the clock. How do you structure monitors I home, in time to balance Yes. First, I have everywhere go\342\200\224inmy my country your your work versusyour personal life? home. Second,I have a staff on duty twenty-four hours a day. I to generally try keep my trading confined between8 A.M. and 6 or 7 in case Is staff instructed to alert you immediately something P.M. The Far East is and if the your very important, currency markets are very I will trade the big happens? active, Far East, which opens at 8 P.M. The A.M. session in Tokyo trades until 12 P.M. If the markets are in a period of First of we have call levels in If a tremendous I will Absolutely. all, every currency. movement, go to bed for a of hours and to catch couple get up breaks out of a that we have previously identified, my staff the next market It is currency range opening. tremendously interesting and exciting. is under instructions to call. 76 Bruce Kovner Bruce Kovner 77

To seethe wave roll from country to country? Do you use your guru report as a measureof contrary opinion?

out When are involved, the screen almost reaches I not to be too Absolutely. you really try much ofa wiseguy because during major price moves, The the are made They wider; will and grabs you. way quotes changes: get they be right for a portion of it. What I am really looking for is a all over the world in each of these markets they get wilder. I have contacts consensusthat the market is not confirming. I liketo know that there are There and I know what is going on. It is a tremendously exciting game. a lot of peoplewho are going to be wrong. for a one of the are opportunities all the time. Forgetting trading minute, I this business is that I find the of worldwide reasons am in analysis So if you see that most of the members on your guru list are bullish politicaland economic events extraordinarily fascinating. time when the market at a is not moving up, and you have some fundamental reason to be bearish, you will feel stronger about the whole sound like a The way you describe it, you make the process trade? look at it that constant game, rather than work. Do you really way?

Yes, much stronger. it feels like work It doesn't feel like work, except when you lose\342\200\224then [he laughs].For me, market analysis is like a tremendous Do intellectual. For you think people cantrade profitably by the multidimensionalchess board. The pleasure of it is purely just following gurus? out the the finance minister of New example, it is trying to figure problems A lot of will Zealand faces and how he may try to solve them. people but is Probably, my impression that to make money, you have to hold a isn't exotic think that sounds exotic. But to me, it at all. with conviction. ridiculously position That is very difficult when you are following this and he hasa real set of problems. Here is a guy running tiny country someone else.There are some good gurus, however. Forexample,in the how to with the U.S., and the labor He has to figure cope Australia, stock market, I like Marty Zweig. He uses excellent risk control. Unlike him unions that him is to do the with other he doesn't are driving crazy. My job puzzle some gurus, believe he is predicting the future; he is what he to and what the of and figure out is going decide, consequences simply observing what is happening and making rational bets. his actions will be that he or the market doesn't anticipate. That to me,

in itself, is tremendous fun. You talk about both the importance of risk control and the of the read a necessity having conviction to hold a position.How much risk do In following all these varied world markets, I know you you typically take on a trade? tremendousamount of economic literature. Do you also pay any attention to the various market advisory letters? First of I hard all, try very not to risk more than 1 percent of my portfolio on trade. any single Second, I study the correlation of my trades to reduce I get a \"guru report\" every day. my exposure. We do a daily computer analysis to see how correlated our

positionsare.Through bitter I have learned that a mistake in Who is on that list? experience, position correlation is the root of some of the most seriousproblemsin If like Prech- trading. you have eight highly correlated positions, then you are All the newsletter writers who have a large following. People reallytrading one position that is eight times as ter, Zweig, Davis,Eliades,and so on. large. Kovner 78 Bruce Bruce Kovner 79

mark and Does that mean if are bullish in both the Deutsche Do you believe that the cross rates better you provide trading one like better and opportunities in currencies Swiss franc, then you decidewhich you place your than net short or long positions against the entire long position in that currency? dollar?

that is true. But even more is the idea of Yes, definitely important becausethere are a lot Yes, fewer people paying attention to the cross short in a related market. For trading a long in one market against a example, rates. The general rule is: The less observed, the better the trade. short the I am the and short right now, although I am net dollar, long yen the Deutsche mark. In all my trading, if I am long something, I like to Your trading style involves a synthesis of fundamental and be short something else. technical if analysis. But I were to say to you, Bruce, we are going to put you in a room and you can have either all the fundamental Do the cross rates likethe Deutsche mark/Japanese yen move slower informationyou want, or all the charts and technical than the individual currencies themselves? input you want, but only one, which would you choose? cross rate was Not necessarily. For example, recently the sterling/mark in a between 2.96 and 3.00. It That is like a doctor whether he would yearlong congestion approximately asking prefer treating a patient month The it broke out, it the with finallybroke out about a ago. day challenged diagnostics or with a chart monitoring his condition. You need both. about times. The Bank of kept on if the fundamentals top of the range twenty England But, anything, are more important now. In the 1970s, the Bank of in. As soon as the cross it was a lot defending it. Finally England gave easier to make money using technical analysis alone. There the 3.01 there were no trades. In there were no were far false breakouts. rate pierced level, fact, fewer Nowadays, everybody is a chartist, and it hit So it moved a full 1 without there are a technical trades until 3.0350. virtually percent huge number of trading systems. I think that change trading. has made it much harder for the technical trader.

market? Do think Is that unusual for the interbank you that the trend-following system approach will eventuallyself-destruct under the weight of its own sizeand the fact that was the 3.00 level. Once most of Very unusual. It meant everybody watching these systemsare using similar approaches? not one everyone realized the Bank of England was stepping in, no I think that is true. The wanted to be a seller. only thing that will save those technical systems is of aperiod high inflation, when simple trend-following methodologies that of breakout\342\200\224a violent and one\342\200\224much more will work Is type quick again. However, there is no questionin my mind that if we reliable than a breakout? have moderate rates of typical stable, inflation, the technical trading systems will kill each other off. Yes, it is much more reliable. Let's shift our conversation to the stock market. Do you believe that fills are worse? the stock market Even though your behaves differently from other markets, and if so, how?

Terrible fills. The worse the fills are, the betteryour trade. In that case,

for and 3.02, the rate went The stock after trading a couple of hours between 3.04 market has far more short-term countertrends. After the market to 3.11. has it wants to straight up goneup, always come down. The commodity markets aw 80 Bruce Kovner Bruce Kovner 81

and demand for if there is a true Are we about insurance driven by supply physical goods; talking portfolio as opposedto arbitrage- type insurance shortage, prices will tend to keep trending higher. program trading! [Portfolio involves systematically sellingstockindexfutures as stock prices decline (and coveringthose there shortswhen prices rise) in order to reduce portfolio risk.Program So if the stock index market is much choppier, are any trading normally refers to buying and sellingstockindexfutures technicalapproaches that can work? against an opposite position in a basket of stocks when the prices of the two are out of line.] that Perhaps, but they keep changing. I have found very long-term will catch the bigger stock market advances, decision-making systems Right. The only way in which arbitrage could besaidto have contributed to but you need use very wide stops. to the rather than that if problem, helped it, is it weren 't for program trading arbitrage, portfolio insurance may never have beendeveloped. filter out the noise. Soyou have to be very long term to Sothe are to be for the market arbitrageurs only blamed decline insofar as they made portfolio insurance possible? Much longer than most traders can handle because that strategy involves riding out large retracements.As an alternative approach, one of the If read to Yes. you the Brady report, you will see that the insurers traders I know does very well in the stock index markets by trying portfolio cameinto the market with billions ofdollarsworth of sales in a few hours. figure out how the stock market can hurt the most traders. It seems to The market was unable to insurance work for him. absorb it. Portfolio was a terrible idea; it was insurance in name only. In fact, it was nothing more than a massivestop-lossorder.If it were not for portfolio insuranceselling,the he that? How can quantify market would still have gone down sharply, but nothing like the 500- point declinewewitnessed. He looks at market sentiment numbers, but basically it is a matter of gut feel. Do you feel great traders have a specialtalent?

Some critics attributed the October1987crashto there have program Ina sense.By definition, can only be a relatively small group of What are own trading. your feelings? superior traders, sincetrading is a zero-sum game.

I think two different elements were involved. First, overly high prices What is the balance of trading success between talent and hard left the stock market vulnerable to a decline, which was triggered by work? rising interest rates and other fundamental causes. Second, that decline from funds who were involved If don't work it is was accentuatedby heavy selling pension you very hard, extremely unlikely that you will be a in so-called portfolio insurance. goodtrader. 82 Bruce Kovner Bruce Kovner 83

who can innate Are there sometraders just coast by on skills? the need for evaluating risk on a portfolio basis rather than viewing the risk of each trade independently. This is absolutely critical when one You can do that for a while.There are a lot of wondersin holds that are since the overall one-year positions highly correlated, portfolio risk find who has a that to be than the trading. It is quite common to somebody strong feeling is likely much greater trader realizes. is to 40 or that the are to widen One statement which made a sugar going cents, copper spreads going by Kovner, particularly strong For I dramatically, and that one idea turns out right. example, recently impression on me, concerned his approach in placing stops: \"I place my trader who made million this at a that or too heard about a $27 trading copper spreads stop point is too far away difficult to reach easily.\"In this past year, and then lost virtually all of it. manner, Kovner maximizes the chances that he will not be stopped out of a trade that proves correct, while at the same time maintaining rigid What advice would you give the novice trader? money management discipline. The philosophybehind this approach is that it is better to allocate the predetermined maximum dollar risk in a the most to First, I would say that risk management is important thing trade to a smallernumber of contracts, while using a widerstop.This is undertrade is second the be well understood.Undertrade, undertrade, my exact reverse of the typical trader, who will try to limit the loss per Whatever think to be, cut it at piece of advice. you your position ought contract, but trade as many contracts as possible\342\200\224an approach which in is that trade three in least half. My experience with novice traders they usually results many good trades being stopped out before the market to five times too are 5 to 10 risksona trade moves in the direction. The big. They taking percent anticipated moral is: Place your stops at a| 1 2 when they should be taking to percent risks. point that, if reached, will reasonably indicate that the trade is wrong, not at a point determined primarily by the maximum dollar amount you Besides what other mistakes do novice traders are to lose contract. If the overtrading, willing per meaningful stop point implies an typically make? loss trade a smaller uncomfortably large per contract, number of contracts. the market. A common mistake is to think of the market They personalize Kovner's worst trading mistake\342\200\224his \"going bust trade,\" as he The of is it as a personalnemesis. market, course, totally impersonal; terms it\342\200\224resulted from a spur of the moment decision. My own personal whether make a trader doesn't care you money or not. Whenever says, experienceunderscoresthat there is probably no class of trades with a \"I \"I he is in a destructive of wish,\" or hope,\" engaging way thinking higher failure rate than impulsive (not to be confused with intuitive) because it takes attention from the the away diagnostic process. trades. Regardless of approach used, once a strategy is selected, the trader should stick to his or her game plan and avoid impulsive trading decisions (for example, putting on an unplanned trade because a friend

with I was struck the immense has recommendedit; a before the In my conversation Kovner, by just liquidating position predetermined still can't out how he find is of an complexity and scope of his analysis. I figure can stop point reached because adverse price movement). the time to follow and the economies of so Kovner views a trader as and analyze intricately many Finally, good \"strong, independent, different countries, let alone integrate these various analysesinto a single contrary in the extreme,\" and points to disciplineand a willingness to of picture. Clearly, Kovner's unique synthesis worldwide fundamental make (and accept)mistakesas significant traits of the winning trader. and is translatable to the trader. technical analysis hardly average Nevertheless, there are key elements in Kovner's trading approach that have directrelevance to the more mundane trader. he Kovnerlistsriskmanagement as the key to successful trading; on a He always decides on an exit point beforehe puts trade. also stresses Richard Dennis

A Legend Retires

Richard Dennis became intrigued by commodity trading during the late 1960s, while earning the minimum wage as a runner on the exchange floor. In the summer of 1970, he decided to take a crackat trading on his own, and with $1,600 borrowed from his family, he purchaseda seat on the Mid America Exchange. The Mid as it is kind of minor Am, called, is a league exchange because it trades pint-sized versions of the contracts traded on the major exchanges. The Mid Am tends to attract the business of small hedgers and speculatorsfor whom a single regular-sized contract representstoo large a position. As a fledgling trader with little risk capital, the Mid Am was well suited to Dennis\342\200\224it was also the only exchange on which he could afford a seat. him TheseatcostDennis$1,200,leaving a scant $400 for trading.

Incredible as it may seem, he eventually transformed that tiny stake into a fortune, which has been estimatedby someto approach $200 million. As his father is reported to have said, in what must be one of the grand understatements of all time, \"Let'sjust say Richie ran that four hundred

bucks up pretty good.\"

Although Dennis has been exceptionally successful over the long haul, he has withstood a few dramatic setbacks.Hewas in the midst of one such downturn at the time of our interview. Severalof the public

funds managed by Dennis lost enough during the late 1987-early1988 86 Richard Dennis Richard Dennis 87

to the 50 loss cutoff for the cessation of I arrived about five minutes before the time and was period trigger percent point appointed similar fate. As into a office. trading. Dennis' personal account witnessed a he expressed ushered large but decidedly unpretentious Dennis arrived in a letter to investors, \"Theseresults parallelimmense losses in my own precisely on the hour, shook hands politely, and sat down at his desk. He in advance in the course of the interview, he personal trading.\" apologized if, at the that he could his mind Perhaps one of Dennis' most impressivetraits as a trader is his occasionallyglanced quote screen, explaining keep the me to weather such hard times with little emotional on interview at the same time, and would signal if he had to put ability impact. losses in any orders. the experience of myself (albeit on an in- Apparently, he has learned to accept suchsporadiclarge as part of Having trading smaller scale), I that I understood. the game. His confidence during such periodsremains unshaken, as he finitesimally explained As the interview there was an element ofuneaseon both our believes he will eventually rebound if he stays true to his basic trading began, In I had a sense of a clock with not time strategy. Had I not known, judging by the mood and confidence of the parts. my case, ticking enough to the task at hand. In the case of I believe it was a man I interviewed, I would sooner have guessed that he had just made a accomplish Dennis, matter in terms of a small fortune rather than lost one. of a genuinely shy personality, at least first meeting. After five to ten minutes, the tension was gone, the became Whatever the of a centimillionaire atmosphere stereotype image may be, relaxed,and the conversation flowed smoothly. Dennisdoes not fit it. His low-spendinglifestyle is legendary. In fact, his minutes into the interview, I to think that things real are his sizable and charitable Forty-five began only extravagances political were going so wellthat Dennis would continue our conversation beyond contributions. His political views also do not mesh with the popular image of the allotted hour. At exactly ten minutes before the end of the hour, my the very rich. Dennis is the founder of the Roosevelt Center for illusion was shattered. \"I'veonly about ten more minutes,\" he said, American a liberal think and he the got Policy Studies, tank, supports \"so if there's still stuff that's important you may want to get to it.\" I concept of higher tax rates for wealthy Americans. In recent years, he has shuffled through my index cards and quickly tried to identify some of taken an increasingly active role in the political sphere, supporting a the key questions I had not yet covered. Precisely at the end of the hour, variety of liberal candidates. Unlike trading, his win-loss ratio in politics Dennis said, \"That's about all the time I thank you.\" In the have, has been disappointing. the 1988 presidential race, Denniswas One segment of questions I did not get to dealt with the political national cochairman for the Babbitt campaign. side of Dennis' experiences. These topics included the Senate hearings In drawing up a list of candidatesto be interviewed for this project, on alleged manipulation of the soybean market by Dennis, the Roosevelt Denniswasan essential name. He is one of the foremost trading legends Institute, and the various political figures Dennishad known. Although of our time\342\200\224atrader that a number of others interviewed in this book these subjects were certainly areas of interest and color, they were not cited with the phrase, \"I'm not in his league.\" to the focus of this book. I chose pertinent primary Consequently, In the I dealt with one of Dennis' assistants. setting up interview, questions related to trading before attempting to turn to anything politically After told me he talk explaining the project to him, he would to Dennis oriented. to me. About one week I receiveda call and get back later, informing At the end final card \"I of the interview, I played my by saying, me that Dennis could see me on a date about one month forward for didn't even to any questions related to the side.\"\"They're get political one that I was to the exactly hour. I explained coming Chicago for primary not interested in that anyway,\" Dennis replied as he politely said that one hour purpose of interviewing Dennis and was hardly enough goodbyeand left the office. time to coverall the essential areas. The was:that response essentially About six weeks I and obtaineda later, requested follow-up was all the time allotted; the implicit message: Take it or leave it. I interview with Dennis. The portion of the interview dealing with the budget time if the hoping that I would get some more interview was agreed, deficit problemand Dennis' large losses in his public fund trading at that well. going time came from this second meeting. 88 Richard Dennis Richard Dennis 89

A month after our last conversation, Dennisannounced that he was Do you consider that period worthwhile, nonetheless, because of the lessons learned? retiring from trading to concentrate on his political interests full-time. Will Dennis never trade again? Maybe, but don't bet on it. Yes, in retrospect, I would say this to new traders\342\200\224although it may not be a reassuringthought\342\200\224when you start, you ought to be asbada trader as you are ever going to be. How did you first get involved in commodity trading?

Because it is less expensive at that time? After graduating high school, I got a summer job as a runner on the floor and I dabbled in a little bit. With I trading my minimum-wage salary, Right. You shouldn't be too surprised if you really screw up. was making $40 a week, and losing $40 an hour trading. I didn't know what I was The was that at least I to do it with for whom doing. advantage got Do you know traders early success proved to be their to the what I small amounts of money. I like say tuition was small for undoing? learned.

I have noticed variations of that. There are a lot of who people get like ducks. You can teach them that a is their mother if I heard the story that before you turned twenty-one, you had your imprinted warship them For a lot of it doesn't matter so father standin the ring, while you stood on the sidelines signaling you get young enough. traders, tradesto him. much whether their first big trade is successful or not, but whether their first is on the or short side. Those tend to be big profit long people perennial bulls or bears, and that is very bad. Both sides have to be equally That was in 1968 and 1969. My father had the membership but he didn't OK. There can't be anything psychologically more satisfying about one know much about trading. He was just going along with it because I was than the other. If there is, your trading is going to go askew. underage and wanted to do it. When I turned twenty-one, it was one of I think that's what happened to a lot ofpeoplein the 1973 runaway the happiest days in his life because he said,\"I really hate this. I have bull market in soybeans. Even if they didn't make money themselves, no idea what I'm doing. It's yours!\" but were just present to witness the market mania and see a few people

make a lot of money, they were imprinted with it. Were you at a disadvantage trading onestepremoved,with your father filling the orders? You're talking about a subsequent bias to the bullishsidebecause of that experience?

Sure.We consistently lost. Yes.

But you couldn't havelost very much because you were trading very What gave you confidencewhen you first started trading on the Mid small. America Exchange with such a small stake? After all, one mistake and you were out of the game.

I probably lost a couple of thousand dollars during that period. Well, no, the advantage of the Mid America Exchange was that 90 Richard Dennis Richard Dennis 91

traded had a few in I wascuriousabout to school your they minicontracts. I mistakes me, and I mademost, your going graduate despite but not all of them. I don'tknow that I had any confidence. I just had initial trading success. what a lot when of people have they get in this business: a need to try to were I for school before the summer of 1970, which was succeed. I mean, if you betting on this sort of thing before the signed up graduate when I in for the first time. I had to trade fact, you should have bet that it wouldn't work. There is no doubt about traded the pit just planned over the but the three months and in made a that. summer, $3,000 profits big in impression on me. I went to Tulane New Orleans and lasted for about Most traders are not successful in the first year. What were you one week. I used my laundromat quarters phoning trades into Chicago. the and had but I had doing differently? Once I used up all quarters nothing dirty clothes, no choice but to come back to Chicago. I was doing enough things right that I didn't capsize evenwith that small I was to into Since then you have been a full-time commoditytrader? capitalization. lucky enough stagger having the right on positions before the big corn blight in 1970. Yes. Was that luck or foresight? What comes to mind as your mostdramatic or most emotional think it I was more foresight. I had very pale ideas, rules, and attitudes trading experience? about the market then. But a few that I learned were right, like go with the trend. There was one in the first year. I had just quit graduate school to trade.

One the One I made a bad trade and lost about $300. SinceI Friday, grain markets all closed at their highs for the year. day, particularly had about that was a loss and it was I believed\342\200\224and I still believe\342\200\224that you go with the trend, and the only $3,000, very big destabilizing. I then the error my original position and losing stronger the trend, the better. I remember getting in on the close andjust compounded by reversing I then reversed back to buying a couple of minicontracts in corn, wheat, and beans. The next again. To top things off, my original position all the limit and lost a third time. the end of the day, I had lost $1,000, or one- Monday morning they opened up because of the corn blight By news. third of my entire capitalization. I have learned that when have a Sure that didn't have to happen,and if it didn't, it would have set Since then, you destabilizing loss, take a do but a little time between me back. It might have taken a lot longer to get to about $2,000,which get out, go home, nap, something, put that and next decision. When are beat to death, your compared to $400 was a realgrubstake.But, it wasn't like I threw a dart your you getting get head out of the mixer. realized that if I had had a and decided what to do. I did something that should work in the long Lookingback,I that run\342\200\224Iwent with the trend. trading rule about losses, I wouldn't have had traumatic experience.

Is this In would that was one of your best trades particular pattern\342\200\224a very strong close on a Friday\342\200\224a retrospect, you say because were so with that that didn't market characteristic that you find useful as an indicatorof the you imprinted experience you following week's price action? make a mistakeof that magnitude, percentagewise, again?

at a I learned to avoid trying to catch up or double up to recoup Yes, minimum, it is important not to have a short position with a loss Absolutely. I also learned that a certain amount of loss will affect on Friday if the market closes at a high, or a long position if it closes at losses. your alow. 92 Richard Dennis Richard Dennis 93

that judgment, so you have to put some time between that loss and the next Giving you a high probability the next day you would be ahead? trade.

You have to remember some of thesemarkets went up the limit ten days

I of that in a row. Most that even four or five consecutivelimit- guess a corollary would be: When things aren't going right, people thought don't push, don't press. up days was impossible.

In situations where a market limit-up, limit-up, limit-up, at Yes. After all goes is said and done, you have to minimize your losses and some point, the market may open limit-down. How do you try to preserve capital for those few instanceswhen you can make a lot recognizeor sense when not to buy at limit bid? in a very short period of time. What you can't afford to do is throw away your capital on suboptimal trades. If you do, you will be too debilitated in It's just an odds play. There is a lot of volatility the outcome, but you to trade when the right position comesalong. Even if you put the trade know the odds are in your favor when at limit bid. it will be you go long on, relatively small because your capital will have been depleted by the other trades. In all the years you have traded, have there been any really bad years? Was there a particular market or two that you were dead Was the 1973 soybean market your first really big market? wrong about and that caused it to be a bad year?

I in that made enough market to to the Chicago Board of Trade not market money go When we have had bad trading periods, it is really one that the next I didn't make I year. my money by just going long soybeans. does it. In those situations, almost all the markets are going sideways and was a trader, who traded in and out a lot. The markets were basically pit making lots of false breakouts. If one of the markets is decent,that is very good, because there was excellent order flow. It was a time great usually enough to avoid a bad situation. to be in the pit. Is there any year that stands out? So it wasn't so much catching the trend. It was more a matter of the market was not a for I losses scalping successfully. 1978 good year trading. compounded the transition unnecessarilybecause I was in the process of making from floor trader to off-the-floor trader and had no idea how different were. Also, so many people would make incredibly bad tradesjust to take a they profit. They would get out even though the market was locked limit-up Was 1978 the that started from an office? and almost sure to go up the next day. Theycouldn't stand the profits year you trading in their burning a hole pocket. I would try to get in when they were In and 1978 I had the full- getting out. 1977,1 was mostly a floor trader, by made time transition. It sounds like easy pickings. Did that switch cause you to become more of a long-term position trader? There was some amount of risk, but if you were disposed to going with a trend, it was a deal. were an to do it. term strong They giving you edge Ultimately, what I learned from 1978 is that you have to be longer 94 Richard Dennis RichardDennis 95

as a desktrader. In the if it looked like were to break Let's pit, soybeans going ly, I said, \"Here is a way we can definitely resolve this argument. 3 I would sell, and if it didn't I would out. cents, break, get You don't hire and train some people and see what happens.\" He agreed. have that off the because lose the when luxury floor, you edge putting It was an intellectual experiment. We trained them as well as we in the orders. Also, the make at the tried judgments you looking prices on could.That was the way to do the experiment right, I thought. I to screen aren't as as those made in the what is on. We a good pit watching going codify all the things I knew about the markets. taught them little In the there are indicators that leam like \"these pit, you subconsciously, bit about probability, money management, and trading. It turned out I three guys are never at market turns,\" and if all do the same the but even I right they was right. I don't say that to pat myself on back, am a It thing at the same time, light clicks on. took me a time to how well it worked. how well it worked. long surprised It's frightening realize that those tools weren't going to be availableanymore. Is your basic contention that you can take almost any reasonably Why did you make the change? You were doing really well on the intelligent individual and turn him into a successfultrader? floor. Why switch to a desk?

No. We screened for people we thought would be right. We received When I started in 1970, there were no futures markets in currencies, applications and narrowed it down to forty people whom we these 1,000 interest rates, or gold. By 1978, markets had been listed on the interviewed. Then we picked ten. board long enough to be viable. The currencies started in 1974, but it took several years to get enough volume. for? What qualities wereyou looking

So,it was the desire to trade moremarketsthan you physically could that because if I told one of the we in a single locationthat motivated your move? I don't like to discuss you things it we be lookedfor was chess players, and we everdo again, would inundated resumes from chess And the opportunity didn't exist five years earlier. by players.

I understand that you initiated a trader-trainee program. What Was intelligenceone of the key items? year was that?

It was one of the traits, but it wasn't the essential item. To find the things at We hired a group the beginning of 1984 and another at the group that we were looking for, we couldchoosefrom intelligent or of beginning 1985. with extreme extremelyintelligent people. We picked the ones intelligence just

because they were available. What was the motivation for this program?

Didn't you have any reluctance about giving away trade secrets? I who has have a partner been a friend since high school. We have had about philosophical disagreements everything you could One vulnerable to imagine. Sure, but I don't think trading strategies are as not was ofthesearguments whether the skills of a successfultrader could be traders believe. If workingif people know about them, as most what you are reduced to a set of rules\342\200\224that was my point of view\342\200\224orwhether there idea about it. I doing is right, it will work even if people have a general was something ineffable, mystical, or intuitive that made in and subjective, always say that you could publish trading rules the newspaper no someone a trader. This had been on for a good argument going long time, one would follow them. The key is consistencyand discipline. Almost and I I was a little frustrated with idle Final- guess getting speculation. anybody can make up a list of rules that are 80 percent as goodas what 96 Richard Dennis Richard Dennis 97

we taught our What couldn't dois them the people. they give confidence I've heard this group of traders referred to as the \"turtles.\"I found to stick to those rules even when are things going bad. that term somewhat amusing. What is the origin of the name?

How long was the training process? When I decided to do the trader-trainee program, I had just returned from a trip to the Far East. In telling someone about the program I said, \"We Shockingly short. In the first year, it took two weeks. Then we had them are going to grow tradersjust likethey grow turtles in Singapore.\" I had trade for a month and a made their keep log indicating why they trades. visited a farm there and seen a huge vat with thousands of squirming We wanted to see if they were consistentin doing what had been they turtles; that became my image of growing traders. We it in the taught. really got good at second year\342\200\224the course took just one week. How much of a role doesluck play in trading?

How many trainees were there? In the long run, zero. Absolutely zero. I don't think anybody winds up making money in this business because they started out lucky. Twenty-three in total. But on individual trades, obviously,it makes a difference? What were the results?

That is where the confusion lies. On any individual trade it is almost all We dropped three people who didn't do well.The other twenty, however, luck. It is just a matter of statistics. If you take something that has a 53 have averaged about 100percent profit per year. percent chance of working each time, over the long run there is a 100

percent chance of it working. If I review the results of two different When you train people, you tell them your basic approach to the traders, looking at anything less than one year doesn't make any sense. markets. Isn't therea risk of creating twenty clones of Richard It might be a couple of years before you can determine if one is better Dennis? Wouldn't their results be correlated with trading highly than the other. what you are doing?

You are one of the few people who is both a discretionarytraderand There was a huge spread. One of the things that we told the repeatedly a systems trader. How would you compare the two approaches? class was: \"We are what going to teach you we think works, but you are to add own expected your personal flair, feeling, or judgment.\" Professional traders may do somevery intelligent things, but they have a tendencynot to think systematically about what they are doing. For How large are the stakes these tradersare using? example, most traders who do a trade that works will not think: Why did it work? What did I do here that I might be able to do in another It has increased over the years as they have made I would on money. say market, at another time? Thereis not a lot of reflection on the process average about $2 million each. of trading. In contrast, I think I always have been analytical about trading, even before I ever researched a mechanical system. What did they start out with? On the have the academic who opposite extreme, you types research before they have ever traded. They lack the seat-of-the-pants One hundred thousand dollars each. I knowledge necessary to develop goodtrading systems. Mercifully, did 98 RichardDennis Richard Dennis 99 the trading first. Therefore, the research wedois more applicable to the What do you do in a situation where your feelingsas a tradertell real world. you to do one thing and your systems point in the other direction?

me an of real world Can you give example of how the lack experience If they are absolutely opposed, you do nothing until you can resolve that would hurt the researcher? conflict.

Are in nature? As an example, assumeI develop a mechanical system that often signals most of your systems trend oriented placementof stops at points where I know there will tend to be a lot of stops. In the real world, it is not too wise to have your stop where Yes. everyone else has their stop. Also, that system is going to have above- skids. If don't understand that and the results So, definition, they will never be in the right direction at market average you adjust by but turns. Yet as sense when a market accordingly, you are going to get a systemthat looks great on paper, is you, an experiencedtrader,may for a In going to do consistently poorerin the real world. may be prone turn. a situation like that, would you be willing to buy because of what you see as a trader even though your

You mentioned that before you developed a mechanical trading system is short? system, you paid closeattention to the trading process. Did you keep a of what did and or was it a matter of I would want to be flat, since I tend to the log you right wrong, memory? probably weigh psychological,opinion-oriented segment of trading about equal with the technical Yes,I would write down observations and think about them. I thought and trend-following element. I about everything was doing. So you want to see the market displaysomesigns of turning around

Is that something you would adviseother traders to do to improve\342\200\224 before you'll commit?

that is, keep track of what they are doing right and what they are doing wrong? What is more likely is that I will be positioned in the right direction of a trend and decide to liquidate faster than a trend-following system would Sure. The is so intense that there is a natural because of the intuitive factor. trading experience am tendencyto want to avoid thinking about it once the day is over. I that way What to a trend? when things are working. But, when they are not, it spurs me to want to about entering a new trade counter prevailing think about what I'm doing and how I might do better. When things go done it\342\200\224that made bad, traders shouldn't stick their heads in the sand and just hope it gets I've certainly is, countertrend initiations. However, better. as a rule of thumb, I don't think you should do it.

What you are saying is that the times when it is most tempting to Do those type of trades do more poorly than other trades? avoid thinking about the markets at all are the times when you should be thinking about them the most. Generally, yes, although every now and then they may give you a great I story like going short sugar at 60 cents,which did. [Sugar plummeted of 66 cents in November 1974 to a relative low under 12 Right. I don't have any problem with that because I am obsessive about from a high

the markets. centsonly seven months later. Each 1-cent movein sugar is worth $ 1,120 100 Richard Dennis Richard Dennis 101

trade per contract. A large trader like Dennis will often positions Otherwise, there wouldn't be that much risk in the trade. measured in thousands of contracts.] I've got ten stories like that. But I have to tell you, in all honesty, I don't think the broad class of trades I Right. The idea that one side of the market is much more likely to work have done like that have been profitable. in the absence of anything else is an illusion. The market just wouldn't

be there if that was true. There were plenty of guys who went short the The short trade is a because market had at in at 4 sugar greatexample soybeans $4 1973, because just like sugar cents couldn't go any witnessed an and it took a lot of beans incredibly explosiveupmove courage lower, at $4 couldn't go any higher. Well, not only did they go to in at But take the side when is step as a seller 60 cents. flip sugar higher, they went to a high of $12.97 in a matter of four or five months. in a real bear market and is down to 5 cents; every trend-following There is another that I think is point as important: Xgujhould^Xi- in the world is to be short. if conditions are such system going Yet, pect the_unexpected in this business; expect_th^ejctreme.Don'tthink in that the fundamentals are in transition and the market is only price terms^fJbojjoJafies^aUunit^'hat the market might do. Iftnerels any would make an a little over the cost of the bagit's packedin, you lesson I have learned in the nearly twenty years that I've been in this it is that the exception? business, unexpected and the impossible happenevery now and then.

in the Actually, I've lost more money situations like that because all So don't be too tied to history? market has to do is go down one more cent and you are out of there. I but I lost made a lot of money going short sugar at 60 cents, much more Right. going long sugar at 6 cents.

And yet, all your rules are basedon history. Is there a contradiction When you do a trade like that, that is, buying a market because the there? \" \" downside is so-called limited, do you just ride it out, or do you in the towel? a eventually throw No,because good trend-following system will keep you in the market

until there is evidence that the trend has changed. If you had been doing your historical researchon soybeans in 1972, you would have concluded You throw it in. Because how do you know? Maybe it is going to 2 cents; that any time soybeans advanceby 50 cents,you might as well get out, maybe it is going to 1 cent. because the market had never movedup or down by significantly more than that. Obviously, that was the wrong conclusion because it went up the I guessa main concern is that you are constantly giving up another $8. A good trend-following system, however,would have kept premium in the forward months. [Ina bearmarket,the more you in for most of the move. forward contracts tend to trade at a premium.Forexample,May sugar be at 6 at and October at 7. Even if cash So don't want to draw boundaries from over market might cents, July 6\\ prices you history remained stable, a holder of October futures would lose 1 cent behavior? between May and October.] Right. The correct approach is to say: Thisstructure means up, and this

structure means up no more, but never that this structure means up this in at it Sure, you are forced out at 3 and back 5. Then falls to 3 again. get much and no more. Richard Dennis 102 Richard Dennis 103

Could that have been a a with the version of the system subliminal reason for your When you trade system,do you go developing command training program\342\200\224to to the that tested out best for the past, or doother factors try diversify decision-making process? consideration? we Actually, hadn't thought of it that way, but it did work to our how to is whether advantage. In we are to to One of the toughest problems in deciding trade you fact, going try market some of the traders we for the data or whether start from have trained for trading customer just go with what is optimal base, you money. trade other than some other premise. You might deliberately something Is of the with the best past slippage a problem in your trading? is the difference the optimal parameter set [version system [Slippage future is to unlike the in betweenthe theoretical execution assumed a performance] because you think the going be past price by computer other set to have a program and the actual fill price.] a specific way. By definition, any parameter is going than the set. But if the difference in poorerpast performance optimal No. We 10 it well be worth that 10 percent try to make a hard-nosed estimate when the cost of performance is only percent, might building as data, trading into a system. Also, we reduceour costs difference if you believe the suboptimal set, measuredby past significantly by having our own brokers. will fit the future better.

trader trader, When you hold a major at what do know You have gonefrom being a very small to a very large position, point you you are Do find wrong? What tells to out of the especially now that you are managing outsidemoney. you you get position? more that order sizegetsin the way? Does it become substantially If you have a loss on a trade after a are difficult to be successful when you are trading size? weekor two, you clearly wrong. Even when you are around breakeven, but a significant amount of time

think we have reached that has you are there too. At some level it would. I don't point yet, passed, probably wrong far from it. I think about three although we may not be tremendously away define now would be about it. We Do you your maximum risk when into a trade? times the amount we are handling just point you get in customer funds. currently have about $120 million You should always have a worst case point. The only choice should be to out In other words, you haven't hit the wall yet? get quicker.

Are a or did other No. you largely self-taught trader, traders teach you lessons that were worthwhile?

are different and, Is that because you using many approaches in at one I would I am self-taught. What is is how little therefore, don't have all your orders going point? say really amazing literature published there is on trading. had one Yes. You have to think about diversification. If you method, Is there all the decisions, couldn't handle amounts anything you can recommend to who are interested or one person, making you people in use different and have a diversity in trading? that large. But if you strategies without decision makers, you canhandle severalhundred million dollars I think Edwin Lefevre's Reminiscences of a Stock a any major problem. Operator[reputedly 304 Richard Dennis Richard Dennis 105

of JesseLivermore, the stock Would the semifictionalized biography legendary you say stock market is an exception?That is, does the and the feel of well, but that stock trader] is interesting captures trading pretty market also behave like other markets, or does the stock book was written sixty-five years ago. market have its own behavior pattern?

I think it is Are there some key trading strategies that you can talk about probably separate. without revealing any secrets? Why would you say that is true?

us in The market being in a trend is the main thing that eventually gets Well, research on and sure my individual stocks showsthat price fluctuations are a trade. That is a pretty simple idea. Being consistent making closer to random than are in do that all time is more than the they commodities. Demonstrably, you the probably important particular commodities method use to are trending and, arguably, stocks are random. characteristics you use to define the trend. Whatever you enter trades, the most critical thing is that if there is a major trend, your Do you have an that in that trend. explanation for phenomenon? approach should assure that you get

I believe that there is not enough fundamental information stock to defined a Is there per A trend could easilybe using simple system. createsufficient trends to move them from their random character. There define a trend? something special that you look for to aren't as many commodities as there are stocks.

No. If I see a trend developing, I know eventually I'll have to get in. In other words,thereis not the same flow of information as in the is whether I in earlier or later, and that depend The question get might commodity markets? on how I see the market reacting to news. If a market goes up when it earlier. If it down when it should should go up, I might buy goes go up, There is not not enough information, enough fundamentals. Just nothing wait until the trend is better defined. I'll going on.

How much common behavior is there between markets? Are the In the commodity markets, technical information is basically of or do markets patterns of beans similar to the patterns bonds, confined to price, volume, and open interest. Sincethereissomuch more have their own personalities? technical information available for stock indexes\342\200\224advance/decline various sentiment ratios, indicators, relationships between different I could without the name of the market. of etc.\342\200\224do trade knowing groups stocks, ordinary trend-following systems start off at a big disadvantage becausethey don't use enough information? So, what you are saying is that patterns in different markets are very similar. I'm not sure that is the disadvantage. I think the disadvantage is that stock indexpricesare too close to random to develop enough clear-cut and beans, trends because the Yes.Inour research, if a system doesn't work for both bonds inputs\342\200\224the individual stocks\342\200\224are mostly random. we don't care about it. 106 Richard Dennis Richard Dennis 107 What are on the your thoughts recent attacks against program Howabout fallacies trading? regardingtechnicalanalysis?

The belief that technical factors are not The that are as important as the people complaining ought to be ashamed of themselves. fundamentals.

Do mean in the Are you people financial community? there any analysts whose work you respect?

Yes. They should have There are a lot of enough sophistication to understand the inanity them/Zweig)for is of example, good. what they are complaining about. Would you consider the work of outside analysts as an trade? input in a Do you see program as a convenient trading scapegoat for a declining market? No. When we taught our people to trade, I had a hypothetical question: Suppose Sure. It is a excuse for a everything you know about the markets good doing lousy job for yourself and your indicates a Then you call the floor \"buy.\" clients. The claim is that traders are and they tell that I'm program taking money out of the you selling. Do you: (a) buy, (b) go short, do pockets of the people who are in the stock (c) nothing? If didn't investing market. Nothing they eventually understand that (a) was could be further from the truth. correct because have to Program trading may move the stock they make their own market decisions,then market around a bit, but not in If they didn't fit into the any systematic way. program trading program. caused to prices go too high or too low, that should provide better Why do you handle opportunities for the value other investor. Of course,it's bad for those who people'smoney? You are people on your own. doing very well pretend they are value investors, but are reallytraders.

Well, there is one big Howdo you handle a losing streak? advantage: managedmoney offers potential return with no risk. For ten years, people have been asking me if I'm tired of all the getting risk. Do I think I'm to Cut back. If it is going burn out? Do I think really bad, stop and get out. to I'm going stop? For the time I longest didn't understand what were talking about. But I they have to admit, at this I Do sometimes point, understand the value you need to get away from the markets for a few of down days? cutting your own risk. I could have traded smallerand smaller had a profit and smaller risk. But if customer comes I it takes a use money in, could Generally, just day or two, but you do need to for a that to the stop period supplement profitability and still keep my risk lower. It of time. It is almost like a not just pitcher balking. Before he throws the ball, gives you a better deal. he has to at least for that second. stop That is what I try to do\342\200\224atleast have a It pause. could be forjust one day. In a later interview, Dennis his changed mind on this subject, What is influenced possibly the biggest fallacy about market behavior? by the public aggravation related to lossesin his Dennis large public funds. decided to extricatehimself gradually from the management money business, saying: \"I found it That that was more markets are supposedto make sense. trouble than it was 108 Richard Dennis Richard Dennis 109

were The If the market is that much out of worth. The costs were not financial; they psychological.\" line, do you still get out of your material that follows is from that second interview. position right away?

Sure. If have doubt you any about getting out as fast as possible in a to situation like that, then you are in trouble. I know this is not going to be your favorite subject, but I've got really big ask you about it. Some of the public funds you managed ceased Do you think the losses reached the automatic 50 sharp you suffered were dueto any change trading in April 1988. Is that because they in the markets? percent loss cutoff point?

That's hard to The factor I can say. only objectively identify is the were down under 49 percent when we stopped Actually, they just tendency toward more false breakouts. than the automatic termination we trading. Rather trigger point, the investors to allow a lower cutoff liquidated all positions and resolicited Do you feel the recent prevalence of false breakouts is relatedtothe point. tremendousincreasein computerized trend-following trading the five to ten Are during past years? there just too many people in the future because of this Would you do anything differently the same doing thing, getting in each other's way? particular experience?

there is no doubt Yes, about it. In a perverse sort of way, it represents but the would be the I would cut back a little faster than I did, trades still the ultimate of technical over triumph trading fundamental trading. I say same. Someone said to me, \"You claim the markets were bad. Well, becauseit is a that perverse victory devalues technical trading. and made a lot of since you could have done the exact opposite money, I told him that the last thing I would have Do think we weren't they really good?\" you may seethe day when trend-following systems no the wanted to do was to be on the opposite side of those trades. In long longer work? run, that is a way to lose an infinite amount of money. There will come a day when easily discoveredand lightly conceived rate markets in October 1987 resulted no The shortsideof the interest trend-following systems longer work. It is going to be harder to in one of your worstlosses.What went wrong there? develop goodsystems.

Given can the to the fact that the market that, approaches you were using beforestillwork with A large part of that loss was due gapped way the same short For on October efficacy? past our point for covering our position. example, Eurodollar 20, we would normally have been out of our short position Actually, I believethat if view the can about 40 to 50 points higher, but the market opened 240 points higher you problem correctly,you make the fact that there are trend in a skid that was many other followers in the market work to that day. We blew 190 points absolutely unavoidable. your advantage. I can't get too specificabout the solution, because if we 110 RichardDennis Richard Dennis 111

are is valuable information. To be successful right, that pretty you Yes, but how do you do that? of else. always have to be one step ahead everyone You have to maintain your perspective. Thereis more to life than Also, to me, deflatedwould mean It sounds like you started working on this problemwell before your trading. being emotionally lacking confidence in what I am I avoidthat because I have felt that performance problems began in late 1987. doing. always it is misleading to focus on short-term results.

a virtual That's right. During the past ten years, there has been So you are able to avoid the emotional trap? We bandwagon-effect of people using trend-following approaches. the work in have been thinking about this problem for a long time. Half Yes, but the flip side is that I also avoidthe emotional elation when things it. It took us solving a problem is finding the right way to conceptualize are going well. There is no way to play just one side of that street. If out the years before we figured right questions to ask. you feel too good when things are going well, then inevitably you will feel too bad when they are going poorly. I wouldn't claimthat I realized When did arrive at what considered a you finally you satisfactory but it for that after three years of trading, after you've done twenty years, solution? it either drives you crazy, or you learn to put it into perspective.

Ironically, right around the time we closeddown the public funds. Does it become easier after twenty years?

Not to but I know you can't bespecific,but does your solution to false breakouts necessarily [he laughs]. It getseasier put it into perspective, has shock that deteriorate over involve being far more short-term oriented, so that you can respond everyone absorbers time. Being a trader more quickly to those situations? is like being a boxer: Every now and then, the market gives you a good wallop. After twenty years you get a bit punch-drunk.

The secret is as short term or as term as can stand, being long you Is there any advice you can give to other traders on how to stay on It is the intermediate term that picks up depending your trading style. emotionally calm during periods of trading losses? the vast majority of trend followers. The best strategy is to avoid the middle like the plague. It is a little bit like playing golf: You can throw your clubs around after making a bad shot, but while you are making the next shot you should When talk about the of managing well over $100 you experience head down and the ball. keep your your eye on million and losing roughly 50 percent, not to mention your personal large losses, you discuss it with great emotional detachment. Do you Do you use long-term scenarios about economicgrowth, inflation, take it that calmly? Isn't there an emotional sideto it? really and the dollar in making your trading decisions?

I for there not to be. It is to I have mental but I not to use them when I'm try totally counterproductive get wrapped pictures, try trading. made as as to me is like on roles of the dice that up in the results. Trading decisions should be unemotionally Trading betting independent you a little bit in know some possible. think are loaded your favor, because you 112 RichardDennis Richard Dennis 113

about the market. to be statistical things Long-term scenarios canprove Are you implying that the deficit problem isjust a time bomb, which but even if on I'm not right or wrong, they are right, balance, convinced will eventually shatter the economy? that they make much difference over the term of any individual trade.

Sure. We tend to think that since it is not a problem now, that means it think the dollar is to that doesn't affect Even if you going collapse, won't be. We in our but the and expectcontinuity lives, economy, your basic trading pattern? certainly the markets, are more discontinuous than continuous.

I would like to say it doesn't, and I don't think it should, but it And are that the deficit after you saying peoplelookat year year and probablyhas in the past. The worst thing you can do is miss a profit think, it can't be so the is and one \"Well, losses bad, economy strong,\" day opportunity (assuming you are already disciplined enough to cut your everybody wakes up\342\200\224 short). And if you think about it, rigid long-term views are the kind of thing most likely to lead you to that mistake. For example, if I believe It is like termites in the foundation of house. You not the dollar is going to weaken, and because of this I ignore a sell signal having your may a notice them until one day they gnaw away big chunk and the house in the foreign currencies, I might risk missing a large profit. What is my collapses. I don't think anybody should take a large amount of comfort reward if my view was right? Avoiding a small loss. Therefore, the in the fact that things appear to be holding together. risk/reward is all wrong for my type of trading.

Acknowledging that caveat, as a long-time market observer, what Hypothetically, if you were President and couldinfluence change, major trends do you see shaping up over the comingyears? would the deficit be the first thing you would change?

I bet we will be at record levelsof inflation by the end of 1990.[This think it is Sure. I especially important for Democrats, since they were interview was conducted in mid-1988.] the first ones to pick up the banner of Keynesianism [the advocacy of that while government programs to increase employment], to admit it What is to be the force behind that inflation? going driving may be a great theory, it doesn't work in the real world.

It is to be driven to avoid a recession. The going by trying deep I don'tthink Keynes ever proposed using deficit spending in strong recession is going to be caused by the federal budget deficit as investors economic times. require higher and higher levels of real interest rates to buy the debt. The the recession government will try to avoid by stimulating the economy, that's true. He that were to be a tactic which essentially doesn't work. No, proposedsurpluses supposed to in countercyclical deficits. Surpluses in good times; deficits bad times. The In other words, fear of a recession will cause tremendous monetary trouble is that we have only one side of that equation because of the lack which in turn will will to create when times are what easing, lead to inflation? of political the surpluses good. So we really ought to do is admit that Keynesian economics is just an It is, unfortunately, a very Republican idea, but I think it is right. excuse for easy money, overspending, and overconsuming. We ought to in that the and the Whether you like it or not, the financial markets are conservative just admit government is a debt junkie whole concept of will not is in hands. Peoplewho lend money to the government and business deficitspending flawed practice. buy monetary easing as a solution to a recession. 114 Richard Dennis Richard Dennis 115

You mean Keynesianism as it is being applied, not Keynesian Individuals who invested in your funds during your final year as a fared have done if economics as he himself purported it? money manager poorly. How would an investor he started on your first day as a money manager and kept his money

fully invested until your last day in that role? The theory is fine, it just doesn't work in the real world. Therefore, we shouldn't use it. Besides, Keynesian economics was a solution to the Each $1,000 invested would have been worth $3,833 when the accounts problem of oversaving and underconsumption, which was a fair enough were closed. [This works out to approximately a 25 annual to us out of the Great The now percent attempt pull Depression. problem compounded return. The figure would have been more than double that at is the exact opposite: undersaving and overconsumption. Even if the equity peak about one year earlier.] Keynesianism were politically tenable,you still need a different solution because you have the exact opposite problem. You are rumored to have lost a very substantial portion of your own net worth during your final year of trading. Are these stories true Is therean economictheory that you feel fits the times and makes sense? or exaggerated?

I lost about 10 percent of the money I had made in the markets. Of course, We have to rid of deficit We need to retire the deficit in get spending. a of net the is much measuredas percentage my worth, figure higher some orderly way, and the federal government should have to balance because of my charitable and political contributions over the years. its budget just as the states do. At that point, Milton Friedman's proposal for a constant money supply adjusted by a growth factor would Did your poor trading resultsduring the past year speed your career be a idea. probably good transitions?

What isthe most advice could the novice trader? important you give It made no difference.

Trade small because that's when you are asbadas you are ever going to Have you really gonecoldturkey, or are you still trading lightly? be. Learn from mistakes. Don't be misled the your by day-to-day fluctuations in Focus on whether what are is your equity. you doing right, I am not trading at all. not on the random nature of any single trade's outcome.

Richard Dennisis one of the legendary commodity traders of our time. After Dennis announced his retirement from trading to pursue his He is the of trader visualize type you might implementing large long politicalinterests full time, I called with some I to follow-up questions. spoke positions near market bottoms and largeshort positions near market tops. an aide who took down the Several later, he called back questions. days It is thus surprising that Dennis downplays the value of trying to pick and answers with Dennis' These follow. In that such trades have replies. questions major turning points. fact, he claims done little,

if anything, to contribute to his trading success. 116 Richard Dennis

Dennis believesthat one of the worst mistakes a trader canmake to is miss a major profit opportunity. According to his own estimate, 95 percent of his profits have come from only 5 percent of his trades. a few such could have a dramatic Missingonly profit opportunities negative on impact performance. As a corollary, you need to guard against holding too rigid an opinion on a market, since such an opinion could easily lead to missing a major trend. Paul Tudor Jones One particularly useful piece of advice offered by Dennisis that the times when least want to think about Art you trading\342\200\224the losing The of Aggressive Trading the times when need to focus most on periods\342\200\224are precisely you trading.

October 1987 wasa devastating month for most investors as the world stockmarkets witnessed a collapse that rivaled 1929.That same month, the Tudor Futures Fund, managed by Paul Tudor Jones,registeredan incredible 62 percent return. Jones has always beena maverick trader. His

trading style is unique and his performance is uncorrelated with other

money managers. Perhaps most important, he has done what many

thought impossible: combine five consecutive, triple-digit return years in with very low equity retracements. (I am fudging slightly; 1986,

Paul's fund realized only a 99.2 percent gain!) Jones has succeededin every major venture he has tried. He started out in the business as abrokerand in his second year grossed over $1 million in commissions. In fall 1980, Jones went to the New York Cotton as an floor trader. he was Exchange independent Again millions the next few His spectacularly successful, making during years. really impressive achievement though was not the magnitude of his his winnings, but the consistency of his performance: During three and

a half years as a floor trader, he witnessed only one losing month.

In 1984, partially out of boredom, and partially out of fear of

eventually losing his voice\342\200\224an occupational hazard for a pit trader\342\200\224 Jones again abandoned his successful careerfor a new venture: money management. He launched the Tudor Futures Fund in September 1984 with $1.5 million under management. At the end of October 1988, each 118 Paul Tudor Jones Paul Tudor Jones 119

in Are we in? to shifted $1,000 invested this fund was worth $17,482, while the total amount (\"Buy 300 at even! Go, go, go! Speak me!\")Yet, he of money he managed had grown to $330 million. In fact, the amount easily between trading and our conversation. under would have been but Jones Jones with admiration about his first tutor in the business, management higher, stopped speaks new investment funds in October 1987 and has made cash the cotton Eli Tullis.Perhaps the one trait of Tullis that accepting also legendary trader, disbursements since that time. made the greatest impression on Jones washis steel-hard emotional conversation If one believesin cycles\342\200\224as Jones does\342\200\224itappears that he is due control. He recalls how Tullis could carry on a polite,relaxed for another career change. It is hard to imagine what he can do for an with visitors, without blinking an eye, at the same time his positions were encore. getting decimated in the market. Jonesis a of contrasts. In Jones' casualnessin visitors, to his staff, and compendium private conversation he is seeing talking but as a trader shouts his in this at time he was a S&P relaxed, he orders with the ferocity of a drill participating interview the same trading heavy of in stock index futures in the sergeant. His public image is one a swaggering, egotistical trader, but position reflected the same trait. A rally one-on-one he that million loss in Jones' is easygoing and unassuming. The media usually closing minutes of trading day caused over a $1 dramatizes the that I didn't realize the market had flamboyant elements of his lifestyle\342\200\224Chesapeake Bay position. Yet, he was so composed Mansion, private 3,000-acre wildlife preserve, beautiful women, fine moved against him until I checked the closing prices later that day. restaurants\342\200\224but he the interview at our first has also made helping the poor a second avocation. There was insufficient time to complete Jones has emulated New York businessman I returned about two weeks later. Two were notable Eugene Lang by meeting. things a the whereas he had been bearish setting up fund to finance college education of eighty-five elementary about this second meeting. First, strongly in market at the first school graduates Brooklyn's economically depressed Bedford- and heavily short the stock time of our conversation, section. the stock market had shifted to bullish in Stuyvesant This is not merely a matter of donating money; Jones Jones' short-term opinion on the stock market to follow on the has becomepersonally involved by meeting with his adopted students the interim. The failure of through weekly. More recently, he started the Robin Hood Foundation, whose downside at the price and time he had anticipated convinced him that the the short term. endowment has grown to $5 million. This organization, true to its name, market was headed higher for from the he at our second raises money rich and distributes it to private groups and \"This market is sold out,\" emphasized meeting. individuals working to aid the poor. This 180-degree shift in opinion within a short time span exemplified success. He not Joneshad arranged our interview for 3:15 P.M.,a time by which all the extreme flexibility that underlies Jones' trading only the futures markets are closed, except for the stock indexes. Even with quickly abandoned his original position,but was willing to join the other only one market trading, I was a little concerned about the practicality side once the evidence indicatedhis initial projection was wrong. (Yes, of starting the interview at that time, since I knew that the S&P stock his change of heart proved well timed.) index futures contract was one of Jones' Jones had a cautious tone primary trading vehicles. In fact, Second, suddenly adopted very when I the stock market arrived he was in the midst of trading the S&P. regardingprojections p \"rtaining to and the economy. Hewas I until that a second wave in the stock market\342\200\224the waited he finished shouting orders over the speakerphone concerned major selling that I did not first October 1987\342\200\224could lead to a of financial Mc- and explained want to interrupt his trading. \"Maybe we being type the there is historical for such should delay interview until the market closes,\"I suggested.\"No Carthyism. Indeed, precedence concern: in the committee members problem,\" he answered, \"let's go.\" During the Senate hearings held 1930s, were As it turned Jones was not the that so to find villains for the 1929 stock crash that they out, merely trading S&P desperate responsible he was a in New York Stock officials who had held afternoon, building up major position anticipation of a huge break dragged up Exchange long the in the stock market. There is an intensity in Jones' placement of an order positions during price collapse. that is reminiscent of a tennis player aggressivelyreturning a volley. 121 120 Paul Tudor Jones Paul Tudor Jones

went to work for Eli instead of uncle? Jones feared that, as a prominent speculator and forecaster of Howcomeyou your make economic trends, he might a convenient target for any future Because uncle was involved in the cash side of the governmental witch-hunts. Jones had been particularly rattled by a call my primarily cotton. I was interested in becoming a trader from a prominent government official regarding his trading. \"You business, merchandising wouldn't believe how high-placedthis person was,\" he explained to me straightaway. in voice a tinged with incredulity, taking particular care not to divulge did work on the floor of the What was your anything specific. How long you exchange? there? Jones remained the directness of the first job Although friendly, was interview replaced by an almost prerecordedquality in his replies. For I was a floor clerk; that is how everybody begins.But I also did a lot of example, a questionabout trading strategy was met with a response about to out what made it analytical work, watching the market to try figure front-nmmng^-an illegal practicein which a broker places his own order tick. I clerked in New York for about six months and then returned to in frontofalarge customer order. This reply virtually bordered on the New Orleans to work for Eli. absurd since Jones handles no customer orders. It made as much sense as a football fan, who bets in his office pool, denying that he took a bribe Did learn a lot about trading from Eli? throw you to the game. It sounded as if Joneswas using the interview as a

forum for making an officialstatement, perhaps to be used as evidence Eli a fabulous Hewould trade Absolutely. Working with was experience. in some hypothetical future I that Jones congressional hearing. thought entire market interest position sizes of 3,000 contractswhen the open was cautious\342\200\224if not then the being overly paranoid\342\200\224but again, cotton was 30,000. He would trade more volume than any trader only expectation that a true economic crisis would lead to \"killing the messengers off the floor. He was a true sight to behold. of bad news\" does not really seem that far-fetched.

Was he trading futures against cashorjust speculating?

was that since he used He was a pure speculator. The amazing thing When did you first get interested in trading? knew what his his own broker on the floor, everyone always exactly to Eli's attitude \"The hell with position was. Hewas very easy tag. was, When I was in I read an article on Richard which made college Dennis, it, I'm going to take them head on.\" a big impression on me. I thought that Dennis had the greatest job in the world. I had an for because already appreciation trading my uncle, Billy So everyone knew his hand? Dunavant, was a very successful cotton trader.In 1976,after I finished college, I went to my uncle and asked him if he could me started help get Definitely. as a trader. He sent me to Eli Tullis, a famous cotton trader, who lived in New Orleans. \"Eli is the best trader I know,\" he told me.I went down hurt him? But, apparently, it didn't to see Eli and he offeredme a job on the floor of the New York Cotton Exchange. No. 122 Paul Tudor Jones Paul Tudor Jones 123

that an hide about out of the entire at the Is exception? Do you try to your positions? that I won't have to worry getting position where the are hit. I will half point stops being always liquidate my position the half that I try. But, realistically, the guys in the pit who have been there for five below new highs or lows and remaining beyond point. ten know it when I trade. The or years is me. Everyoneknows one thing I learned from Eli the market is to it is that, ultimately, going go where Any other lessons you can attribute to Tullis? is going to go. I markets look their best By watching Eli, learned that even though very So you don't think it is important to hide your positions? when they are setting new highs, that is often the best time to sell. He instilled in me the idea that, to some extent, to be a goodtrader, you have think it is to For orders I important make an effort. instance,my used to to be a contrarian. in be particularly easy to read because I traded multiples of 300 contracts.

Now I breakmy orders up; I might give one brokeran order for 116 and You have donetensof thousands of trades. Is there any singletrade another broker an orderfor 184.1 have at least four brokers in every pit. that stands out?

What else did you learn from Tullis? Yes, the 1979cotton market. Onelearns the most from mistakes, not He was the son of a bitch I ever knew. He me that successes. I was a broker back then. We had lots of accounts toughest taught speculative is have to be able contracts of cotton. The trading very competitive and you to handle getting your and I was long about 400 July market hadbeen butt kicked. No cut it. there are in and I was it matter how you enormous emotional ups trading a range between 82 and 86 cents, buying every and downs involved. time it came down to the low end of that range. One day, the market broketo new lows, took out the stops, and That sounds like a What about the reason the general character-building lesson. immediately rebounded about 30 or 40 points. I thought the specifics regarding trading? market had been acting so poorly was because of price vulnerability that the implied by the proximity of those well-known stops. Now stops me When are Tullis taught about moving volume. you trading size, you had been touched off, I thought the market was ready to rally. out when the not when want to an act of have to get market lets you out, you get I was standing outside the ring at the time. In bravado, I out. He me that if want to move a which at taught you large position, you don't told my floor brokerto bid 82.90 for 100 July, the time was a wait until the market in new or low because and I remember is high ground very little very big order. He bid 90 for 100, the Refco broker it is a most of volume may trade there if turning point. came running across the pit screaming, \"Sold!\" Refco owned I trader was that for One thing learned as a floor if, for example, the the certificated stock at that time [the type of cotton available delivery old was at to be high 56.80, there are probably going a lot of buy stops against the contract]. In an instant I realized that they intended to deliver at 56.85. If the market is the whole at a 4-cent trading 70 aid, 75 offered, trading against the July contract, which then was trading about ring has a vested interest in buying thJ market, touching off thosestops, premium to the October contract. It also dawned on me that the whole and into is a liquidating the stops\342\200\224that very common ring practice. As congestion pattern that had formed between 82 and 86 centswas going from 82 an upstairs trader, I put that together with what Eli taught me. If I want to be a market measurement for the next move down [the break to cover a positionin that type of situation, I will liquidate half at 75, so cents was going to equal the width of the prior 4-cent trading range]. 125 124 Paul Tudor Jones Paul Tudor Jones

So you knew you were wrong immediately? 70 percent of their equity in that single trade.

that the that trade whole in terms I saw immediately market was going straight down to 78 cents, Did particular change your trading style and that it was my blood that was going to carry it there. I had come in of risk?

long 400 contracts, entered another 100 as a day trade, and a final 100 I \"I am not cut out for this on that macho-type bid that I should never havemade. Absolutely. I was totally demoralized. said, business; I don't think I can hack it much longer.\" I was so depressed Soyou realized instantly that you wanted to beout. that I nearly quit.

been in at time? No, I realized instantly that I wanted to be short. How many years had you the business that

fast did How you react? Only about three and a half years.

been successful that Almost immediately. When the Refco broker shouted, \"Sold,\" everyone Had you up to point? in turned the ring around and looked at me, because they knew what I was to do. The of clients had made and I was an important trying guy standing next to me said, \"If you want to go Relatively.Most my money, to the bathroom, do it right here.\"HesaidI looked three shades of white. producer for my company. I rememberturning around, walking out, getting a drink of water, and who had at the of then telling my broker to sell as much as he could. The market waslimit- How about someone given you $10,000 beginning down in sixty seconds, and I was only able to sell 220 contracts. the three-year period?

threefold. When did you get out of the rest of your position? They were probably up about

of the The next the market 100 lower and I started So everyone who was with you for a long time was stillahead morning opened points selling from the opening bell. I sold only about 150 contracts before the game? market locked limit-down time again. By the it was all over, I endedup intensedrawdowns the interim. That selling some contracts as much as 4 cents below the point I first knew Yes, but I had to suffer some during for me. It was at that that the position was no good. cotton trade was almost the deal-breaker point not make I said, \"Mr. Stupid, why risk everything on one trade?Why life a of rather than Even though you reacted fairly quickly, you still took a bighit. In your pursuit happiness pain?\" when I I had to learn and retrospect,what should you have done? That was first decided discipline money in that I management. It was a cathartic experience for me, the sense as a and decided that First of never macho man with the never went to the my very ability trader, all, play market. Second, edge, questioned I was determined to come back and I overtrade. My major problem was not the number of points I lost on the I was not going to quit. fight. and businesslike but that I was far too decided that I was to become very disciplined trade, trading many contracts relative to the going in equity the accounts that I handled. My accounts lost something like 60 to about my trading. 126 Paul Tudor Jones Paul TudorJones 127

Did your trading style change from that to and radically point on? Oneaspectof your trading style is a contrarian attempt buy for a sell turning points. Let's say you are looking top and go short Yes.Now I with a close when the market reaches a new You then get spend my day trying to make myselfas happy and relaxed stop high. as I can be. If I have out. On a trade how many times will you try to positions going against me, I get right out; if they stopped single idea, are going for me,I keep them. pick a turning point before you give up?

Until I mind, Otherwise, I will keep cutting I not started change my fundamentally. guess you only trading smaller, but also quicker? size down asI have trades. When I am my position losing trading I size. That I will be poorly, keep reducing my position way, trading my Quickerand more defensive. I am about always thinking losing money smallestposition size when my trading is worst. as opposed to making money. Back then, in that cotton trade, I had a vision of to 89 centsand I about all the July going thought money I was What are the trading rules you live by? going to make on 400 contracts. I didn't think about what I could lose.

Don'tever average losers. Decrease your trading volume when you are Do increase volume when are well. Never you always know where you are getting out before you put a trade trading poorly; your you trading on? trade in situations where you don't have control.For example, I don't in that is risk significant amounts of money front of key reports,since gambling, not trading. have a I mental If it hits that number, I am what. stop. out no matter that is the If you have a losing position making you uncomfortable, solution is very simple: Get out, because you can always get back in. How There is start. much do you risk on any single trade? nothing better than a fresh Don't be too concerned about where you got into a position. The are bullish or on the only relevant question is whether you bearish I don't break it down trade trade. All the trades I by have on are as last I can position that day. Always think of your entry point night's close. interrelated. I look at it in terms of what my equity is each or morning. My goal always tell a rookie trader because he will ask me, \"Are you short is to finish each day with more than I started. Tomorrow I will morning long?\" Whether I am long or short should have no bearing on his market not walk in and say, \"I am short the S&P from 264 and it closed at 257 opinion.Next he will ask (assuming I have told him I am long), \"Where I can stand a I think of yesterday; therefore, rally.\" always it in terms of am from. are you long from?\" Who cares where I long That has no being short from the previous night's close. relevance to whether the market environment is bullish or bearish right control most .Bjsk isjhe importanUhmg_jn_trading. For example, now, or to the risk/reward balance of a long position at that moment. right now I am down about 6k for the not percent monmTTHave a 3\\ percent The most important rule of trading is to play great defense, great on for the rest of the stop my equity month. I want to make sure that I offense. Every day I assume every positionI have is wrong. I know never have a double-digit loss in any month. 128 Paul Tudor Jones Paul Tudor Jones 129 where risk are to be. do that so I can define my stop points going I my Is it a matter of doing a seriesof probes until you finally hit it? maximum possible drawdown. Hopefully, I spendthe rest of the day that are in direction. If are enjoying positions going my they going against Exactly.I consider myself a premier market opportunist. That means I then I have a for out. me, game plan getting develop an idea on the market and pursue it from a very-low-risk Don't be a hero. Don't have an and ego.Always question yourself standpoint until I have repeatedly been provenwrong, or until I change Don't ever feel that The your ability. you are very good. second you do, my viewpoint. you are dead. Jesse Livermore, one of the greatest speculators of all time, In other it makesa better to \"Paul the words, story say, Jones buys said reportedly that, in the long run, you can't ever win trading markets. That T-bond market 2 ticksfrom the low,\" rather than, \"On his fifth try, wasa for someone like into the from its devastating quote me, just getting Paul Jones buys the T-bond market 2 ticks low.\" business. The idea that you can't beat the markets is a frightening prospect. That is is defense. If make why my guiding philosophy playing great you I think that is certainly part of it. The other part is that I have always a don't think it is have some goodtrade, because you uncanny foresight. been a swing trader, meaning that I believe the very best money is to be maintain sense of but it in check. Always your confidence, keep made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in But havebeen successful for Aren't more the middle. Well, for twelve I have often been the meat you very years. you years, missing a confident now than you were before? in the middle, but I have caught lot of bottoms and tops.

If you are a trend follower trying to catch the profits in the middle of a have to use not comfortable I am more scared now than I was at since I move, you very wide stops.I'm doing any point began trading, that. Also, markets trend about 15 of the time; the rest of because I recognize how ephemeral success canbein this business. I know only percent the time move that to be I have to be hits have they sideways. successful, frightened. My biggest always come after I have had a greatperiod and I started to think that I What isthe most fallacy in the public's about knew something. prominent perception markets?

My impression is that you often implement positions near market That markets can be manipulated. That there is some group on Wall turns. Sometimes your precisionhasbeenuncanny. What is it about Street that controls price action in the markets. I can go into any market your decision-making process that allows you to get in so close to the and create a stir for a day or two, maybe evenaweek.If I go into a market turns? at just the right moment, by giving it a little gas on the upside, I can create the illusion of a bull market. But, unless the market is really sound, the have the I very strong views of long-run direction of all markets. I also second I stop buying, the price is going to come right down. You can have a very short-term horizon for pain. As a result, frequently, I may open the most beautiful Saks Fifth Avenue in Anchorage, Alaska, with trades from the of weeks in try repeated long side overa period a market a wonderful summer menswear department, but unless somebody wants which continues to move lower. to buy the clothes, you will go broke. 130 Paul Tudor Jones Paul Tudor Jones 131

What have about the markets? other misconceptions do people Any advisor you consider underrated?

The idea that people affiliated with Wall Street know something. My I think Ned Davis does the best researchon the stock market that I have mother is a classic Shewatches \"Wall Street Week\" and she seen. he is well I don't think he has received the example. Although known, would takeseverything they say with almost a religiousfervor. I bet that recognition he deserves. you could probably fade \"Wall Street Week.\" Any analysts you consider overrated? I know you talk to traders in virtually every major market on an almost daily basis. Are you uncomfortable about being on the Judge not, least you be judged. oppositeside of the fence from these people?

Very few traders have reached your level of achievement. What Yes. Who wants to fade a winner? I want to be with them because I make makes you different? a point of talking to the people who have the best track records.

I I think one of my is that view that has up How do you keep all theseother opinions from confusing your own strengths anything happened are of the to the present point in time as history. I really don't care about the vision? Let's say you bearish on a market and 75 percent mistake I made three seconds in the market. What I care about is what I people you talk to about that market are bullish.What do you do? ago am going to do from the next moment on. I try to avoid any emotional attachment to a market. I avoid be influenced I wait. I will give you a perfectexample.Until last Wednesday, I had letting my trading opinions comments I have on the record about a been bearishon crude oil, while it was in the midst of a $2 advance.The by may made market. best crude oil trader I know was bullish during that period. Becausehe to in was bullish, I never went short. Then the market started to stall and one No loyalty positions is obviously an important element your

day he said, \"I think I am going to go flat here.\" I knew that instant\342\200\224 trading. particularly, given the fact that bullish news was coming out of OPEC at that time\342\200\224that crude oil was a low-risk short.I sold the hell out right It is important because it gives you a wideopen intellectual horizon to of it, and it turned out to be a great trade. out what is It allows to come in with a figure really happening. you completely clean slate in choosing the correct forecast for that particular Are there any market advisors that you pay attention to? market.

and Ned Davis are Prechter is the Marty Zweig great;Bob champion. Has the tremendousgrowth of the money you are managing made Prechter is the best because he is the ultimate market opportunist. it more difficult to trade at the samelevel of profitability?

What do you mean by opportunist? It has made it tremendously more difficult.

The reason he has been so successful that the Elliott Wave think could make is theory Do you you a substantially higher percentage allows one to create incredibly favorable risk/reward opportunities.That return if you were trading smaller amounts of money? is the same reason I attribute a lot of my own success to the Elliott Wave

approach. Without question. Paul Tudor 132 Jones Paul Tudor Jones 133

of size on Do you ever question whether the detrimental impact your We had been expecting a major stock market collapse since mid-1986 performance outweighs profit incentive fees you earn from and had contingency plans drawn up because of the possibility we managingmoney? foresaw for a financial meltdown. When we came in on Monday, October 19, we knew that the market was going to crash that day. to I think about that question every day. It is going to be interesting see what the time book is happens by your published. What made you so sure?

Have you stopped accepting new investment funds? Becausethe previous Friday was a record volume day on the downside. The exact same thing happened in 1929, two days before the crash.Our Yes,a long time ago. analog model to 1929 had the collapse perfectly nailed. [Paul Jones'

analogmodel,developedby his research director, Peter Borish, and a How do You have been both a broker money manager. you superimposed the 1980s market over the 1920s market. The two markets of two compare the relative advantages and disadvantages these demonstrateda remarkable degree of correlation. This model wasa key jobs? tool in Jones' stock index trading during 1987.] Treasury Secretary Baker's statement that the weekend U.S. would no longer support the I out of the business becauseI felt there was a gross got brokerage dollar because of its with West the kiss disagreements Germany was of conflict of interest: If are a clientcommissionsand he loses you charging death for the market. money, you aren't penalized. I went into the money management business because if I lost I wanted to be able to that I had not money, say When did you cover your short position? me gotten compensated for it. In fact, it would probably cost a bundle becauseI have an overhead that would knock out the Bronx Zoo. I never We actually covered our shorts and went somewhat long on the close of win. to anybody, because I don't get paid unlessI apologize the day of the crash itself [October19].

Do in own funds? you keep your money your Were most of your profits in October due to your short stock index position? I would say that 85 percent of my net worth is invested in my own funds, that is the safest in the world for it. I primarily because I believe place we No, also had an extremely profitablebondposition.The day of the believethat I am going to be so defensive and conservative that I really crash we put on the biggest bond position we ever had. The bond market will get my money back. terrible all had been acting day long on October 19. During the day, I was very concerned about the financial safety of our clients' and our own You did extraordinarily wellduring October1987,a month which assets.We had our assets with various commission houseson the street, fill in some was a disaster for many other traders. Could you of the and I thought those funds could be in jeopardy. It was an intolerable details? situation for me.

I on What is the kept thinking: Fed reaction going to be?I thought week of the crash was one of the most of my life. The excitingperiods that thev would amounts of have to add massive liquidity to create a very Tudor 134 Paul Tudor Jones Paul Jones 135

since bonds had been Do see in which we rosy environment, instantaneously. However, you any way can solve our current problems to the on a long beforewe go into a even acting poorly all day, I couldn't bring myself pull trigger deep recession, or depression? the last half hour of bonds suddenly bond position. During trading, to and it clicked in mind that the Fed was going That is what scares me so much. I don't see out of started to turn up, my any blueprint our As current take actions that would create a tremendous upsurge in bond prices. dilemma. Maybe there are macroeconomic forces at work that are for a I went wild. of a that soon as I saw the bond market act right moment, part larger super cycle we don't have any control over. Perhaps we are simply responding to the same type of cyclesthat most advanced an warning signal of it Do you believe that October 1987 was early civilizations fell prey to, whether was the Romans, sixteenth-century

more negative times ahead? Spain, eighteenth-century France,or nineteenth-century Britain. I think that we in are going to be for a period of pain. We are going to relearn dealt a life- I think the financial community, particularly Wall Street,was what financial discipline is all about. in and don't realize threatening blow on October 19,but they are shock and was Do use it. I remember the time I got run over by a boat, my backside you trading systems at all? first was, \"Dammit, I ruined chewedup by the propeller. My thought just to stitched Because I was We have tested under the sun my Sunday afternoon because I have get up.\" every system and, amazingly, we have the found one I even realize how cut up I was until I saw that actually works well. It is a but for in shock, didn't badly very good system, obvious I can't tell much faces of my friends. reasons, you more about it. a times fasterthan it is built Everything gets destroyed hundred up. that have taken ten What of realm doesit fall into: contrarian? trend It takes one day to tear down something might years type following? kind of that is in to build. If the economy starts to go with the leverage will I hate to believe Trendfollowing. The basic of the it, it will deteriorate so fast that people's heads spin. premise system is that markets move is what I is to sharply when they move. If there is a sudden in a it, but in my gut that think going happen. range expansion market all that has been human nature is I know from studying history that credit eventually kills great trading narrowly, to try to fade that price card and move. When a the societies.We have essentially taken out our American Express you get range expansion, market is sending you a made sure that the very loud, clear that the market is in said we are going to have a great time. Reagan signal getting ready to move the his term in office our direction of that economy would be great during by borrowing way expansion. and soon we will have into prosperity. We borrowed against the future, Are you trading a portion of funds on that at the to pay. your system present time?

Are you blaming the current situation on Reaganomics? We just started trading the system about six months ago, and so far it is a that is wonderful\342\200\224 doing well. I think Reagan madeus feel good as country\342\200\224and very disaster that ever struck. but, in terms of economics, he was the biggest to cut the and Do you feel a good system can with a trader? I think he basically hoodwinked us by promising deficit, compete good in the of this I then went on the biggest spending binge history country. with because A good system may be able to trade more markets than a don't think a Democrat could have gotten away it, everyone effectively good a billion deficit. trader because it has the advantage of unlimited After would have been very vigilant about $150-180 computing power. 136 Paul Tudor Jones Paul Tudor Jones 137

is the of some out 120-month car loans.Think about all, every trade decision product problem-solving that! Who owns a carfor ten years? or otherwise. However, because of the complexity in the of process\342\200\224human Twenty years ago, average length a car loan was twenty-four market a will it is defining interacting and changing patterns, good trader months; today fifty-five months. I think the final bottom line will be the but the usually be able to outperform a goodsystem. same, ease of credit will delay the process relative to the 1920s, when we had a cash economy. But a goodsystem can help diversify? Someof your preliminary comments before the start of our interview A will catch ten times as much of the price today make it sound like are of Unequivocally. good system you paranoidbecause your in a success. move as I will, during the 15 percent of the time a market is major trending phase. If the in this misery country gets deep enough, the perception is going to that we did be well as a trading firm, while other were people hurt, because we had some It is that we The following sectionof the interview was conducted two weeks later. knowledge. not had any unfair knowledge bias on the stock that other didn't it is that we During the interim, Jones had reversed his trading people have, just did our homework. People don't want to believe that market from bearish to bullish. just anyone can break away from the crowd

and rise abovemediocrity.

I understand similar to of weeks were bearish. What made your that, a number other traders I have Two ago you very you change interviewed, have trained a mind? you group of apprenticetraders.What was your motivation?

You mean besides the Wall Street Journal article that publicized to the

that I was short S&P contracts?The market didn't down. When I was a world 2,000 go twenty-one years old, guy took me under his wing and it I ear to the I believe was the that ever The first thing do is put my railroad tracks. always greatest thing happened to me. I felt an obligation to that prices move first and fundamentals come second. do the same thing for other people.

Do you mean that if you were right, prices should have gone down How did you find the people you trained? and;they didn't? Countlessinterviews. We have been deluged by applicants. One of the things that Tullis taught me wasthe importance of time. When a time If I think a I I don'tjust use a stop, I also use stop. trade, price How many traders have you hired? market should break, and it doesn't, I will often get out even if I am not the market losing any money. According to the 1929 analogmodel, About thirty-five. should have gone down\342\200\224itdidn't. This was the first time during the past think the of the three years that we had a serious divergence. I strength Have they been successful? economy is going to delaythe stock market break.

I believe onereasonwhy we are diverging from the 1929 modelis is Somehave done very well, but overall we have had mixed becauseof the much easier availability of credittoday. Volvo giving success. 138 Paul TudorJones Paul TudorJones 139

it takes talent to be a trader? What is the most advice Doyou believe that is because good important you could give the average trader?

to believe that now. One of I never thought that before, but I am starting to be too my weaknesses is that I always tend optimistic, particularly about the ability of other people to succeed. Do you still see yourselftrading ten or fifteen years down the road? have to Was your I Have a Dream Program, in which you pledged from a sticken area, I wouldn't have it other sponsorthe education of a group of kids poverty any way. inspired by the \"60 Minutes\" show about Eugene Lang?

him the week after the show, and within three Paul Jones was a trader Right. I went to talk to winning from his start in the business, but, in the beena believer months we had set up our own program. I have always big early years, his performancewasvolatile. It took a traumatic trading me on about the was to in leverage. The thing that really turned program experience permanently forge the importance of risk control into his can the for its onekid,you mind. Since that cotton potential multiplicative impact. By helping gut-wrenching trade in 1979, Jones has managed on his and other kids. to maintain excellent net while have an impact family profitability, bringing his risk way down. Hood We also set a new called the Robin risk control is the essence of have recently up program Today, Jones' trading style and to seek out and fund who are on the success. He never thinks what Foundation. We are trying people about he might make on a given trade,but in food and shelter to the poor. We are seeking out on what he could frontlines providing only lose.Hementally marks each of his positions to who are to with no at all, rather the market. No matter how he the people used working virtually budget large a profit may have in a position, in the effective- Jones' mind than the bureaucracies, which often do not deploy money his entry price was the previous night's close. Since this approach assures that there is never a cushion in his trades, Jones never about gets complacent any of his positions. He not only watches the risk of life? but Has this become a major part your of each position, he closely monitors the performance of his entire in real-time. If his total 1 to 2 portfolio equity drops percent during a I feel I I would so. The markets have been so good to me that should he well say single trading session, might liquidate all of his positions in return. I can't that I have been successful give back something say instantaneously to cut his risk. \"It is always easier to back in than to get get else. the of I was in the because I am better than anybody By grace God, out,\" he says. the so I feel a tremendous obligation to share. If starts right place at right time, Jones'trading going poorly, he will continually reduce his size until he is on track position again. That way, when he is trading his of Is the intensity of winning as strong as the pain losing? he is his positive worst, also trading smallest. In any month with net trading Jones will losses, automatically reduce his risk exposure to make sure low that it is There is worse than a bad trading day. You feel so he never a in nothing registers double-digit loss a single month. After big difficult to hold head But, if I knew that I could also have a he is your up. winning streaks, particularly cautious about getting overconfident. in the exhilaration of I would take the In similar experience winning, short, Jones maintains risk control in a dozen different As ways. that much combination of and any time because you feel he \"The most in winning losing days puts it, important rule trading is: Play great defense, not an intense of what life more alive. Trading gives you incredibly feeling great offense.\" live on the is all about. Emotionally, you extremes. Gary Bielfeldt

Yes, TheyDoTradeT-Bondsin Peoria

For years, I have heard the name BLH mentioned as one of the major players in the futures markets, particularly T-bonds, the world's largest futures market. I assumed BLH was a huge trading corporation, but in seeking out the country's best traders, I discoveredthat BLH was basically a single individual: Gary Bielfeldt. Who is Gary Bielfeldt? Where did he get the capital to rival the primary Wall Street institutions as a major force in the T-bond futures market? Bielfeldt beganhis trading career twenty-five years ago, with a mere $1,000 investment. At first, his capital was so limited he confined himself to trading a single corn contract\342\200\224one of the smallest futures in contracts at a time of relative stagnation agricultural prices. From this modest Bielfeldt built his account to extremely start, eventually up staggering proportions. How did he do it? Bielfeldtdoesnot believe in diversification. His trading philosophy is that you pick one area and become expert at it. For much of his trading career, the soybean complexand, to a more minor extent, the relatedgrain markets provided that focal point of attention. Although Bielfeldt had the desire to becomea full-time trader from the beginning, his tiny capital base restricted his trading to a part-time a endeavor. In those early years, he earned his living running small brokerage office. The problem he faced was how he, a trader with- 142 Gary Bielfeldt GaryBielfeldt 143

could a sufficient base to tures trader in the same as the most institutional market out any independent funds, develop capital league prominent desire to make in become a professional trader. Bielfeldt's strong this leap participants. if not risk. not be further removed the his capital base prompted him to take a large, imprudent, Bielfeldtcould from popular image of his initial a trader in the futures By 1965, Bielfeldthad painstakingly built up $1,000 large-scale highly leveraged sphere of trading. One stake to $10,000. Based on his fundamental evaluation of the soybean would hardly expect to find one of the world's largest bond traders in Peoria. Bielfeldt's market, as well as the concurring opinion by his former agricultural attachment to his home town is so strong that he believed to consider a the of economics professor, Thomas Hieronymus, Bielfeldt strongly refused becoming trader on floor the Chicago Board he of Trade because it would that prices would go higher.In an all-or-nothing play, bought twenty have meant giving up his cherished lifestyle. his He is the of the small town soybean contracts, an extremely high-leverage position given epitome model American citizen:honest, would have hard devoted to and of $10,000 account size. A mere 10-cent price decline working, family community. One Bielfeldt's while a smaller decline major has been to backa portion of his wealth completely wiped out his account, considerably goals plow trading-derived would have been sufficient to generate a forced-liquidation margin call. into projects benefiting his home town. close to I interviewed Bielfeldtin his furnished Initially, prices did move lower, and Bielfeldt came perilously large, comfortably office. that damaging margin call. But he held on, and prices eventually reversed The huge, wraparound desk configuration was flanked by ten quote to the upside. By the time he liquidated the position, he had more than screens. Despitethis vast array of electronics, Bielfeldt was low keyed. his on that trade. That trade launched Bielfeldt He rarely glanced at the screens the afternoon I in his doubled equity single during spent a full-time and it is to him toward his much sought after goal of becoming trader. office, hard visualize trading frantically at any time, the Bielfeldt built his account with unerring consistency. By the early vast array of quote machines notwithstanding. that Bielfeldt a man of few 1980s, Bielfeldt's trading size had grown to the point government- is soft-spoken words. He is also a very in the and markets modest man who hesitated about his established speculativeposition limits soybean grain consistently talking achievements, lest it sound nature were becoming an impediment. This factor, aided by a particularly bad like bragging. His very conservative led him to avoid in the market in Bielfeldtto shift his focus even innocuous For at one in trade soybean 1983, prompted seemingly subjects. example, point limit. the to the T-bond futures market, which at the time had no position discussing reasons for his net trading losses in a given year, he asked in the T-bond to turn off (Although a position limit was eventually implemented me my tape recorder. I couldhardly imagine what he might market, the 10,000 contract limit dwarfed the 600-contract limit in say that necessitated this precautionary measure. The off-the-record comments far from It turned that his soybeans.) proved shocking. out trading lossesin The 1983 loss have been the best thing that ever that were influenced by an overextension into other soybean may year with an commitments, his on the Board of Trade Board happened to Bielfeldt. His shift to T-bonds coincided evolving major including membership Chicago bullish and built a of a which travel to bottom in that market. He became very up huge long Directors, position required frequent Chicago. he reluctant did T-bond positionat the right time. When the T-bond market exploded Apparently, was to be quotedbecausehe not want to make was it seem that he was his other he deemed during the mid-1984 to early 1986 period, Bielfeldt perfectly blaming responsibilities\342\200\224which for of his natural his losses. positioned to garner huge profits. His ability to stay with a major position part obligations\342\200\224for trading well-timedtrade to a much The combination of Bielfeldt'slaconicnature, and a long-term move allowed him to leverage his modesty, conservatism made this a difficult interview. In this was the greater degree than would have been achieved by most professional very fact, only was interview I conducted in which the of the was traders with the same initial position. This long T-bond position average length questions than the of the the Bielfeldt's best trade ever and catapultedhim into a new echelon. That, longer average length responses. I considereddeleting interview from the book\342\200\224a choice since I had an in short, is the story of how a one-lot corn trader became a T-bond fu- tempting excess 144 Gary Bielfeldt Gary Bielfeldt 145 of material. However, I found Bielfeldt's story so compelling and his What is your opinion of trend-following systems? the character so strong that I was reluctant to take easy way out. As a this to the narrative side and limited the The best can out is to trend compromise,I weighted chapter thing anyone do when starting learn how a interview section to a few excerpts. system works. Trading a trend system for a while will teach a new trader the principle of letting profits run and cutting losses short. If you can just learn a discipline by using trend-following system, even temporarily, it will increase odds of as a trader. What is your basic approach in analyzing and trading the markets? your beingsuccessful

Do fundamental since you have an opinionabout systemssoldto the I always try to lean primarily on analysis. However, public? I found it was very difficult to know all the fundamentals\342\200\224usually you looked at some of few if of the it I these systems a years ago and found that they are doing pretty well you have 80 percent pieces\342\200\224I thought made too trades. If a trades too the to have to fall back on in case generally many system frequently, was important something my transaction costs will be too high, a factor that will significantly reduce fundamentalanalysis was wrong. the of the I think to be a probability system working. viable, has to be medium to term. The more sensitive I assume you are referringto technical analysis as a supplement. trend-followingsystem longer systems just generate too much commission.

Right. I developed my own trend-following system. Besides providing a training vehicle for learning good trading this in consistent habits, do you feel that trend-following systems can provide an Do you trade system any way? effective trading approach?

I use the system primarily as a backup to tell me when to get out of a I would advise who a to combine it with their position. anyone develops system own judgment. In other words, they should trade half the money on a and the in think of an system other half using their own judgment, just case the Can you example? system isn't working.

At the start of 1988,1 was long the bond market primarily because I was Is seemed to be on until that the way you trade? expectinga weakereconomy.Everything target started early March when the bond market edging down. At some point, to more attention than I In this me with I used pay to systems do now. Basically, I just you have to say you are wrong. case, my system provided focus on own the rationale for getting out of my losing position. my judgment.

Is that because your own judgment is more reliable, or because What went wrong with that trade? systems haven't been working as well as they used to?

Basically, the economy was a lot stronger than I had anticipated. I that there would be a fear factor left over from the haven't worked aswellas used to because there are too thought bigger They they many October 1987 stock market crash than actually materialized. people using them. Whenever too many people are doing the same thing, 146 Gary Bielfeldt Gary Bielfeldt 147

will a the market go through period of adjustment. Do you remember when you finally got positioned at a point where

you didn't have to get out? What are the key factors you focus on in fundamentally evaluating the T-bond market? I turned really bullish in May 1984, when they auctioned off five-year notes at a 13.93yield.I had been involved in banking since 1974,and at The economyis definitely the single most important factor. Four other the trade the time, we couldn't find any qualified borrowers for three-year loans important elements are inflation expectations, the dollar, at 13 percent. Yet here were government five-year notes selling at and the deficit. balance, budget nearlya full percentage point above that level. Moreover, this was at a time

when we were at the height of a recession in Peoria: was You have been trading for over twenty-five years\342\200\224a much longer Unemployment approaching 20 percent and the farm crisis was I felt that time period than most other traders.Isthereany single trade that worsening. interest rates had From that on stands out as the most dramatic? probably gone high enough. point through April 1986,1 traded T-bonds heavily from the long side. There is no that that was trend ever. the one question my best trade and longest There are quite a few trades that would qualify as dramatic, but the bottom of that stands out most prominently was my attempt to pick the bond market in 1983 and 1984. What are the elements of goodtrading?

When did you start trying to buy the bonds? The most important thing is to have a method for staying with your the in the 63- winners and getting rid of your losers. I started trying to pick a bottom when bonds were trading 66 area.

What do you do to makesure that you stay with a winning position How much risk dia you allow when putting on a trade? to exploit the longer-term trend? Howdo you avoid the temptation of taking profits prematurely? Vk in futures Generally anywhere from \\ to points. [One point T-bond is equal to 32 ticks. A 1-point move is equal to $1,000 per contract.] Thebest way I know to learn discipline and patienceis to think through a trade thoroughly before putting it on. You need to develop a of So if you tried to pick a spot that looked good and it didn't work, plan your strategies for various contingencies. That way, you won't get you would bail out and try again at another spot? swayed by every newsitem that hits the market and causes pricesto move up or down. Also, it helps greatly to have a long-term objectivethat you Right. have derived by really doing your homework. You combine that long- term objective with a protective stop that you move as the position goes Since bonds eventually declined into the 50s, I guessyou must have your way. Alternatively, you could use a trend-following system to before went in the had a few strikes you you finally long right against signal when should out of the trade. out you get By having thought your place. objective and having a strategy for getting out in case the market trend

changes, you greatly increase the potential for staying in your winning there were several losses over a of time. Yes, period positions. GaryBielfeldt 149 148 GaryBielfeldt

how do success'. Why do most traderslose? Speaking personally, you judge

I judge successby what I do with the money I accumulate. One of the They overtrade, which means that they have to be right a lotjust to cover that wife and I have doneis to establish a foundation so that commissions. things my we could share some of our successwith the community by supporting various What are the traits of a successfultrader? programs.

Is this foundation one that or do you have a hands-on The most you just fund, important is discipline\342\200\224I am sure everyone tells you that. relationship in running it? Second, you have to have patience;if you have a good trade on, you have to be able to stay with it. Third, you need courageto go into the market, My family and I are directly involved in evaluating different projects and and courage comesfrom adequate capitalization. Fourth, you must have deciding which ones to fund. a willingness to lose; that is also relatedto adequate capitalization. Fifth, you need a strong desire to win. When did you set up this foundation?

Those elements seem fairly straightforward, except for the In about the the 1970s. 1985. But I had idea as far back as willingnessto lose. Can you expound on that? thought early I had always planned that if I were to become successful,I would set up a foundation to help the community. You should have the attitude that if a trade loses, you can handle it without any problem and come back to do the next trade. You can't let Do think this wasan motivation a trade you long-term goal important losing get to you emotionally. leading to your success as a trader?

Can you talk more about what you mean by courage? Yes,I think it helped.

If a 260-pound fullback is running through the line and a 175-pound What advice do you have for the beginning trader? linebackerhas to stop him, he has to have the courage to go into him.

You need that kind of courage to be ableto participate in the markets. If When you are starting out, it is very important not to get too far behind everyoneis bullish the dollar, and the yen is sharply lower, it takes because it is very difficult to fight back. Most traders have a tendency courage to fade that major consensus and buy the yen. to take risks that are too large at the beginning. They tend not to be selective enough about when they take risks. How do you judge success?

Most people will judge success by how well they do in their field. A At this Bielfeldt asked me to turn off the recorder. He talked teacher would judge success by how well the students do and how they point, tape about the relevance and of to His go through life. A trader would probably judge successby whether he application poker strategy trading. the comments off-the-record want wins or loses in the market. reason for keeping was that he didn't 150 GaryBielfeldt to contribute to the image of trading as a form of gambling. I found his analogy particularly apropos and finally persuaded him to put it on the record.

Could you explain your analogy between trading and poker?

I learnedhow to at a father me Ed play poker very young age. My taught Seykota the concept of playing the percentage hands.You don't just play every hand and card, because if do, will have a Gets What Want stay through every you you Everybody They much higher probability of losing. You should play the good hands, and drop out of the poor hands, forfeiting the ante. When more of the cards are on the table and you have a very strong hand\342\200\224inother words, when you feel the percentages are skewed in your favor\342\200\224you raise and play that hand to the hilt.

If the same of to it you apply principles poker strategy trading, increases your odds of winning significantly. I have always tried to keep the but to most of the Although completely unknown, not only to public, the concept of patience in mind by waiting for the right trade, just like financial community as well, Ed achievements must you wait for the hand in poker. If a trade doesn't look right, Seykota's percentage rank him as one of the best traders of our time. In the early 1970s, you get out and take a small loss; it's precisely equivalent to forfeiting certainly was hired a firm. He conceived and the ante by dropping out of a poor hand in poker. On the other hand, Seykota by major brokerage when in the first commercial computerized trading system for the percentages seem to be strongly your favor, you should be developed clients' in the futures markets. His system proved aggressiveand really try to leverage the trade similar to the way you raise managing money but interference and on the good hands in poker. quite profitable, second-guessing by management This the significantly impeded its performance. experience provided on catalyst for Seykota going out his own. In the ensuing years, Seykota applied his systematized approach Bielfeldt's story provides an inspiring example of what is attainable that to trading a handful of accounts and his own money.During period, given patience on the one hand and an aggressive trading style on the the accounts managedhave witnessed an absolutely astounding other. Here is an individual who, starting with a minuscule amount of Seykota rate of return. For as of mid-1988, one of his customer and without benefit of staff example, money, working independently, or elaborate accounts, which started with $5,000 in 1972, was up over 250,000 percent technology, becameone of the world's most successful traders. on a cash-on-cashbasis. (Normalized for withdrawals, the account Moreover,becauseof his long-term goals and actions, his ultimate million I know of no other trader theoretically was up several percent.) success positively impacted an entire community. who has matched this track record over the same length of time. Theportion of Gary Bielfeldt's interview that I found most of when I first on this I had never heard Seykota began working insightfulwas his analogy between poker and trading. It is also interesting to book. name had come up several times during my interview Bielfeldt's in this to the similar advice Seykota's compare key point analogy of MichaelMarcus as the who was most influential in offered James the to the trade to person by Rogers: Have patience wait for right him into a successful trader. After our interview, Marcus said reflec- come along. transforming Ed 153 152 EdSeykota Seykota

from a three-dimensional on the tively, \"You know, you really should interview Ed Seykota. He is not engineering MIT), bringing up diagram one the he had only a great trader; he is a mind.\" computer screen, generated by of many programs in another when the conversation turned to the Marcus provided an introduction over the phone, and I briefly designed. Yet, moment, outlined he would reveal sensitivity and insight into the concept of my book to Seykota. SinceI was already out West, psychology of trading, great it was most convenientfor me to interview Seykota on the same trip by human behavior. in recent has become involved in the rerouting my return to New York via Reno. Seykotawasagreeableto Indeed, years, Seykota very its but seemed of field of It appeared to me that psychology, and participating, skeptical my ability to complete the inter- psychology. solve their had become a more view in the space of two hours (the time available in order for me to make application in helping people problems, element in his life than market and trading. I my flight connections). I assured him that, although it was tight, I had important analysis suspect find this contrast somewhat artificial, in donea few other interviews in that space of time. \"It is feasible as long that Seykota would probably and are one and the same thing. as our conversationremains very focused,\" I explained. that to him, trading psychology arrival at Our conversation was not as focused as I had intended it to be. In I cut my the airport extremely close,having forgotten to that had scratched the revise ticket to reflect the in fact, it went off in so directions we barely my change itinerary. After a vociferous many surface the time the two hours had I continued on, argument with a ticket agent who insisted I didn't have enough time to by elapsed. that I would catch a later flight. As it turned out, the flight catch my flight\342\200\224acontention she nearly made self-fulfilling\342\200\224I raced assuming merely that I had missed was the last direct one from Reno to New York. through the airport, reaching the gate with only seconds to spare. By the I later told me that he knew in our first conversation time arrived in Reno, the tension from my near-missed flight had just Seykota phone that Heis about about dissipated. The drive to Seykota's house was too far for a cab,so I would end up spending the day. extremely perceptive rented a car. at one in our conversation, asked I It was very early morning, and the highway winding up people. For example, point Seykota minutes do set watch?\" I found this into the mountains offered spectacular vistas below. The classicalmusic me, \"How many fast you your in that in our brief time he had station I found on the radio was playing Mozart's Clarinet Concerto.The question particularly striking together, one traits. The combination was glorious. been able to pick up on of my basic character question near-missed earlier that Seykota works from an office in his house, which borders Lake was also particularly timely, given my flight

Tahoe. Before beginning the interview, we took a brief walk out onto morning. his He me the beach behind his house. It was a cold, clear morning, and the view Seykota'ssuccessgoeswell beyond trading. impressed was who had found in his life, and was living exactly idyllic. The contrast between his workplaceand my own\342\200\224anoffice as someone meaning in the with a the life he wanted to be Wall Street area, prominent view of an ugly building\342\200\224could living. have been hardly more striking. I plead guilty to jealousy. In contrast to virtually all the other traders I had interviewed, not in Seykota'sdeskis flanked by an array of quote screens, or, for that How did you first get involved trading? matter, even a single screen. His trading is largely confined to the few minutes it takes to run his computer program which generates signalsfor In the late 1960s,I decidedthat silver had to rise when the U.S. Treasury the account to take full next day. stopped selling it. I openeda commodity margin In with broker convinced me my conversation Seykota, I was struck by the intensity of advantage of my insight. While I was waiting, my both out and lost some and his intelligence and sensitivity\342\200\224an odd combination I thought. He to short some copper. I soon got stopped money of at So I to for the start of the big, has a way looking things from a unique vantage point. At one my trading virginity. went back waiting in I Much moment, he could be talking about analytical techniques and would inevitable bull market silver. Finally, the day arrived. bought. appear as the consummate scientist (he holds a degree in electrical to my amazement and financial detriment, the price started falling! 155 154 Ed Seykota Ed Seykota

a There was a lot lessmanagement, so I took At first it seemed impossible to me that silver could fall on such a through reorganization. the bullish deal. Yet the and of the lack of supervision by using accounting computer price was falling that was a fact. Soonmy stop advantage the weekends. had an IBM 360 hit. This was a education about the markets to test trading systems during They got very stunning way which took a air conditioned room. Over the course of about a discount news. I became more and more fascinatedwith how markets work. up large hundred variations of four About that I a half I was able to test about a simple time, saw letter published by Richard Donchian, year, for about ten of data on ten commodities. Today, the same which implied that a purely mechanical trend-following systemcould systems years I results. beat the markets. This too takes about one day on a PC. Anyway, got my They seemed impossible to me. SoI wrote job confirmed there was a of making money from trend-following computer programs (on punch cards in those days) to test the theories. possibility his theories tested true. To this I'm not systems. Amazingly, day, sure I understand or why whether I really needto. Anyhow, studying the markets, of and I take it that computer testing of systems was not part your job, backing up my opinions with money, was so fascinating compared it on weekends. What were hired to do? to other career at the since you did you actually my opportunities time, that I began trading full time for a living. During the week, my normal ClarkKent type job was to load new rolls when the turned I was of paper onto the Reuters machine margin pink. What was first trading-related your job? in and them alsoresponsiblefor tearing off the news strips hanging up on the wall behind the machine. The trick was to tear between line-feeds I landed first on Wall Street in the was that my job early 1970s as an analyst with so as to get a smooth edge. The funny thing hardly anyone a to have lean over the machine to major brokerage house. I was assigned cover the egg and broiler would read the newssincethey'd to way markets. are chickens to 2\\ the news and it [Broilers young up pounds dressed weight. see the pages. SoI started reading personally delivering The futures markets for to observe a lot of both broilers and eggs have sincedisappeared to the brokers. One bonus of this job was that I got as waning trading activity prompted their delisting by the parent brokers' trading styles. exchanges.] I found it that an level like me was interesting entry guy in of sounds like a office did immediately placed charge dispensing trading advice. I once wrote Your officialposition glorified boy. Why you an article recommendingthat traders stay away from the market for a accept such a menialjob? while. Management censoredthat comment from the market letter\342\200\224 in and I what I likely because it didn't promise to motivate much trading. BecauseI knew I wanted to be the business, didn't care I start wanted to applying computers to the business of analysis. did, or what I got paid. in those Remember, days computers were still typically punch card devices The didn't at At least there you used for accounting. guy who was running the computer Why you stay your original position? department seemed to see me as a threat to his job security, and he were an analyst. chasedmeoff his turf. After month at that repeatedly about a job, I announced that I was it was a environment. I of management going to quit. The head of the department calledme Because stultifying disapproved in to find when I there were no trading out why. It was the first time he had ever been interested in pressures to recommend trades thought that allowed access to the talking to me. opportunities. Also, I saw being company went to work for (my real desire) was a deadissue. I for another brokerage house, which was going computers testing trading systems 156 Ed Seykota Ed Seykota 157

Did you know that you could have accessto the computerat your As the market kept moving higher without any meaningful retracements, new and 100 job? they changed the rule to 50 points eventually points. Finally, with sugar prices around 9 cents,they finally decided that it was a bull but since the before went much No, company had just gone through a major shake-up and market, and that they had better buy prices higher. most of the had been I the accounts at that As management fired, figured there wouldn't be very They put managed long point. you might guess, much of a with the bureaucracy to interfere my use of the computer. the sugar market peaked shortly thereafter. They compounded error the sell well\342\200\224a which also would have by ignoring signal as signal been What became of work your on computerizedtrading systems? very profitable. The bottom line was that because of this interference, the most

interested in for trade of the As a Eventually, management got using my research results profitable year ended up losing money. result, instead I the first theoretical return of 60 the a few accounts managing money. developed large-scale commercial ofa percent for year, quite was one of computerized trading system. actually lost money. This type of meddling the main reasons

why I eventually quit. What do you mean by large scale? What were the other reasons? The program was marketed by several hundred agents of the firm, and the under several the so equity management was million dollars\342\200\224a large Management wanted me to change system that it would trade more amount of in the 1970s. more to money early actively,thereby generating commission income. I explained but so them that it would be very easy to make such a change, doing How did to that seem you get management support you to extent? would seriously impede performance.They didn't to care.

were familiar with Richard do They Donchian, who was a pioneer in What did you after you quit? developing trend-following trading systems, although, at the time, he

was doing everything by hand. Because of that were I the research but I on as a broker exposure, they just quit department, stayed managing already favorably disposed to the concept of using trading systems to accounts. After about two years, I gave up brokerage to become a money manage Also, at the time, were so new that That shift allowed me to from from money. computers manager. get away earning my living was a \"computer system\" great buzzword. commissions, which I think can be a counterproductiveincentive to switched to a incentive fee making money for clients. I pure profit Howdid your do? trading program arrangement.

The did was that program fine; the problem management couldn't keep Did you continue trading the system after you left? from second-guessingthe signals. For example, I remember one time the for program generated a buy signal sugar when it was trading around Yes, although I substantially revised the system over the years. 5 the cents. Management thought that market was already overbought and decided not to take the signal. When the market kept on going What is the performance track record? higher, they came up with the rule that they would buy on the first 20- 1 When no such do not track record other than \"model account,\" which point pullback [100 points equal cent]. pullback I publicize my my in developed, they modified the rule to buying on the first 30-point reaction. is an actual customer accountthat started with $5,000 1972 and has 158 Ed 159 Seykota Ed Seykota

made over $15 million. the total return would have the Theoretically, been new at the time that it was being passed around by word of mouth as many multiples larger had there been no withdrawals. \"expedential system.\"

With like performance that, how come you haven't been deluged Your reference to a first systemimpliesthat you eventually changed with word-of-mouth requests to manage money? to be systems. How did you know when your system needed changed? I do receive but I requests, very rarely accept new accounts. If I do, it is

only after considerable interviewing and screening to determine the trick is for a trader to a Systems don't need to be changed. The develop motivations and attitudes of the client. I have found that the people I with which he is associate with have system compatible. subtle, yet very important, effects on my performance. for are If, example, they able to support me and my methods over the with then Were you incompatible your original system? long term, they tend to help me. If, however,they get too concerned with the short-term ups and downs of their account, they can be a with hard-and-fast rules that didn't hindrance. My original system was very simple with the while allow for any deviations. I found it difficult to stay system own I on and off\342\200\224often at Howmany accounts did you originally start out with? disregarding my feelings. kept jumping just the At the I the wrong time. I thought I knew better than system. time, would There is About a half dozen back in the early 1970s. didn't really trust that trend-following systems work. of it seemed a waste of plenty literature \"proving\" they don't. Also, my How many ofthoseaccountsare still with you? intellect and MIT education to just sit there and not try to figure out the markets. Eventually, as I became more confident of trading with the with Four. One client made about $15 million and decided to withdraw his trend, and more ableto ignore the news, I became morecomfortable trader money and manage it himself; another made over $10 million and the approach. Also, as I continued to incorporate more \"expert decided to buy a houseon the beach and retire. rules,\" my system became more compatible with my trading style.

What source learn from did you before designing your first system? What is your trading style?

I was and influenced the book Reminiscences inspired by of a Stock is trend with some My style basically following, special pattern and also Operator by Richard Donchian's five-and twenty-day moving recognition and money management algorithms. average crossover system and his weekly rule system. I consider Donchian to be one of the guiding lights of technical trading. Without divulging trade secrets, how have you been able to so spectacularly outperform standard trend-following systems? What was your first trading system?

The key to long-term survival and prosperity has a lot to do with the first My system was a variation of Donchian'smoving average system. money management techniques incorporated into the technical system. I used an exponential averaging method becauseit was easier to There are old traders and there are bold traders, but there are very few calculateand errors tended to overtime. It computational disappear was so old, boldtraders. 160 161 EdSeykota Ed Seykota

Witty and true, but the albeit in translated form: and future for questionremains, What are the present prospects trend-following There are many trend-following systems with money management systems? Do you think the growing prevalence of their use will doom rules; why have you done so much better? them to eventual failure?

to have think it All is on sort of whether or not it is Iseem a gift. I is related to my overall philosophy,which No. trading done some system, trends. Life has a lot to do with loving the markets and an conscious. Many of the systems arebasedonfollowing maintaining optimistic good attitude. as I start south for the winter and on Also, keep trading and learning, my system (that is the itself is based on trends. Birds keep mechanical track trends and alter their computer version of what I do) keeps evolving. I would add going. Companies products accordingly. that I consider in trends chemical and luminescence myself and how I do things as a kind of system which, by Tiny protozoa move along definition, I follow. SometimesI trade off the always entirely gradients. mechanical I in part, sometimes override the signals based on strong feelings, and The profitability of trading systems seems to move cycles. successful will sometimes I just quit altogether. The immediate trading result of this Periods during which trend-following systems arehighly around is their increased As the number of users jumping probably breakeven to somewhat negative.However, lead to popularity. system if I to directionless didn't allow myself the freedom to discharge my creative side, it increases, and the markets shift from trending price action, build to kind of and and might up some blowout. Striking a workable ecology these systems becomeunprofitable, undercapitalized to to traders will shaken out. is the to success. seems promote trading longevity, which is onekey success. inexperienced get Longevity key

How What are about using fundamental analysis as an would you compare the relative advantages and disadvantages your thoughts of systems trading versus discretionarytrading? input in trading?

useless as the market Fundamentals that you read about are typically has Systems trading is ultimately discretionary. The manager still has to discounted the and I call them However, decide how much risk to accept, which markets to play, and how already price, \"funny-mentals.\" have if catch on before others believe, then you might aggressively to increase and decrease the trading base as a function of you early, equity valuable \"surprise-a-mentals.\" change. These decisions are quite important\342\200\224often more important than trade timing. it that use Your answer is a bit facetious. Does imply you only What of technical analysis? percentage your trading is systems based? Has this percentage changed over time? I am primarily a trend trader with touches of hunches based on about of In order of to me are: (1) the Over time, I have become more mechanical, since (1)1 have become twenty years experience. importance and of trend long-term trend, (2) the current chart pattern, (3) picking a goodspot more trusting trading, and (2) my mechanical programs have the three of in more and more the I to buy or sell. Those are primary components my trading. factored \"tricks of trade.\" still go through periods down in distant fourth place are my fundamental ideas and, of thinking I can outperform my own system, but such excursionsare Way very me often quite likely, on balance, they have cost money. self-correcting through the process of losingmoney. 162 Ed Seykota Ed Seykota 163

the to do mean a How about someactual\"war stories\"? By picking right spot buy, you determining reaction point at which you will buy? If so, how do you avoid sometimes missing major price moves? I prefer not to dwell on past situations. I tend to cut bad tradesas soon aspossible,forget them, and then move on to new opportunities. After I a dead trade,I don'tlike to dig the details again\342\200\224atleast not Oh no. If I werebuying, my point would be above the market. I try to bury up after off the a at the in someevening, dinner, sitting around a fire, identify point which I expect market momentum to be strong in print. Maybe the to record, in the Tahoe winter... direction of the trade, so as reduce my probable risk. I don't try deep to pick a bottom or top. Can you describe specific trading mistakes that you learned from?

that if Does imply that you are bullish, you will always wait for short- had a for silver for One of first losses was in silver, or I \"thing\" years. my term strength beforeenteringa position, will you sometimes buy as were of worst losses. It seemed to into blood and on a reaction? many my get my hypnotize me. It inveigled me to pull my protective stopssoas to avoid bear-raided. it would hold and then getting Naturally, momentarily If I am bullish, I neither buy on a reaction, nor wait for strength; I am times silver that I started collapse some more. I got killed so many by spikes turn bullish at already in. I the instant my buy stop is hit, and stay I was some kind of werewolf. I worked on with thinking myself bullish until sell is hit. bullish and not is my stop Being being long hypnosis and positive imagery. I also avoidedwalks in the full moon. So illogical. far it seems to be working.

Do you ever use contrary opinion asan aid to your trading? How do you pick your trades?

at Sometimes. For a recent conference, virtually all I will an example, goldbug Mostly by my trading system, although occasionally, get the speakers were bearish. I saidto \"Gold is near a flash and override I don't take myself, probably impulsive my system. Fortunately, usually bottom.\" market did [The indeed rally after that conference.] on a big enough positionto do any lasting damage to my portfolio.

What are the elements of Would you buy because of that type of input? good trading?

The elements of good trading are: (1) cutting losses, (2) cutting losses, Oh the still down. no, trend was But it might get me to lighten up my and (3) cutting losses. If you can follow thesethree rules, you may have short position. a chance.

most dramatic or What was your emotional trading experience? Howdo you handle a losing streak?

I handle streaks down I wait it out. Dramatic and emotional trading experiences tend to be negative. Pride losing by trimming my activity. just to trade a streak is is a great banana peel, as are hope,fear, and greed. My biggest slip-ups Trying during losing emotionally devastating. Trying I to \"catch is lethal. occurredshortly after got emotionally involved with positions. play up\" 164 Ed Seykota Ed Seykota 165

a Since you are a trader, wouldn't following primarily systems What was your single worst \"thin market\" loss? system imply no changes of trading activity during losing periods?

All markets are too thin when I want to get out of a bad position in a I have into such as incorporatedsomelogic my computer programs, hurry. Most markets have, on occasion,moved rapidly against me due the on market behavior.Still, modulating trading activity depending to surprise news. As soon as the news is digested,the market thickens decisions need to be made outsidethe mechanical system at important up again a new level. During the big sugar bull market when prices boundaries such as maintain diversification for a account when , how to growing moved from 10 cents to 40 cents,I was carrying thousands of contracts some are at limit or when markets are too thin. several cents positions position and I gaveup getting out of my position. [Each cent in sugar on I tend to alter activity depending is to Psychologically, my equivalent $1,120 per contract.] and performance. I tend to be more aggressiveafter I have been winning, less so after losses. These tendencies seem OK. In contrast, a costly few traders have have. Very enjoyed the spectacularsuccessyou is to even with an tendency to get emotional over a loss and then try get What makes you different? overlylarge position.

I feel my success comes from my love of the markets. I am not a casual trader teach trader. It is a Are you a self-taught trader, or did another you my life. I have passion for trading. It is not merely a hobby worthwhile lessons? or even a careerchoicefor me. There is no question that this is what I am supposedto do with my life. both and I am a self-taught trader who is continually studying myself other traders. What are the trading rules you live by?

in ona a. Cut losses. Do you decide where you are getting out before you get trade? b. Ride winners. c. Keepbetssmall. I set protective stops at the same time I enter a trade. I normally move I d. Follow the rules without question. thesestopsin to lock in a profit as the trend continues. Sometimes, take e. Know when to break the rules. doesn 't me out profits when a market gets wild. This usually get any better than waiting for to close in, but it does cut down on the my stops rules Your last two are cute because they are contradictory. of which calm nerves. a volatility the portfolio, helps my Losing which do know when Seriously now, you believe: Followthe rules,or to position is nerve is aggravating, whereas losing your devastating. break the rules?

What is the maximum of equity you will risk on any percentage both. I As I Ibelieve Mostly follow the rules. keep studying the markets, individual trade? I sometimes find a new rule which breaks and then replaces a previous rule. Sometimes I get to a personal breakpoint. When that happens, I I intend to risk below5 on a trade, allowing for poor executions. percent just get out of the markets altogether and take a vacation until I feel that I have taken losses above that amount when major news Occasionally I am ready to follow the rules again. Perhaps some day, I will have a caused a thin market to through my stops. jump more explicit rule for breaking rules. 166 Ed Seykota Ed Seykota 167

What is the most advice can the trader? I don't think traders can follow rules for very long unless they important you give average a is reflect their own trading style. Eventually, breaking point reached find a find a new set of rules he can That he should superior trader to do his trading for him, and then and the trader has to quit or change, or of a find something he loves to do. follow. This seems to be part of the process of evolution and growth go really trader. Do you believe chart reading can be used for successful trading? the size of the bet? How important to trading successis varying trend I consider following to be a subset of charting. Charting is a little

a on the reason for so. Consider, like surfing. You don't have to know a lot about the of tides, It might be good idea depending doing physics for resonance, and fluid in order to catch a if had a successful modification policy,say \"M\" dynamics good wave. You just though, you then be better off \"M.\" have to be able to sense when it's happening and then have the drive to changingsystem \"S,\" you might just trading act at the right time.

How important is gut feel? What was your personalexperiencein October 1987? in Gut feel is important. If ignored, it may come out subtle ways by I made money on the day of the October 1987 crash.I also made money It can be dealt with meditation and coloring your logic. through for the month as a whole, and for the as well. I lost on the after then it year, day reflectionto determine what's behind it. If it persists, might be a the crash, however, since I was short the interest rate markets. Most trend it valuable subconscious analysis of some subtle information. Otherwise, traders were out or likely either short stocks and stock indexes during be a sublimation of an inner desire for excitement andl might dangerous the crash. not reflect market conditions. Be sensitive to the subtle differences between \"intuition\" and \"into wishing.\" Are the markets different now than they were five to ten yearsago becauseof the much greater current participation by professional What was your worst year? What went wrong? managers?

of worst was1980.The bull markets had ended, but I keplt No.The markets are the same now as were five to ten One my years they years ago back in at lower The markets keplt because like trying to hold on and buy prices. just they keep changing\342\200\224just they did then. on breaking. I had neverseena major bear market before, so I wasall educational Does difficult as size setup for an important experience. trading becomemore your increases?

irn It becomes more difficult because it is harder to move What happened to the money management rules in your system large positions without the market. It becomes easier have more 1980? Did you override them? moving becauseyou access to competent peopleto support you.

out of tlue I continued to trade even though my system was largely What type of support do you mean? markets due to the enormous volatility. I tried to pick tops and bottomis oversold markets. Thie in what I considered grossly overbought and A team of with attitudes. I the experienced brokers professional Experienced' markets just kept on going and I losta lot. Eventually, saw futility traders can be there for and and for a while. very supportive by just being sharing joys of my approach quit 168 Ed Seykota Ed Seykota 169

seem to the sorrows. Also, the old-timers be able to smell beginnings usually no one around to take the other side of a trade. and endings of major moves.I also receive important support from my Does friends, associates,and family. the stock market behave differently from other markets?

Do you use any outside advisory services? The stock market behaves differently from all other markets and it also behaves differently from the stock market. If this is hard to understand, the business I keep track of a lot of outside advisers,mostly by reading it is because trying to understand the markets is a bit futile. I don't think

from brokers. The services usually break even, it makes more sense to understand the press or hearing my any trying stockmarket than trying then are headed for trouble. to A except when they start to gloat, they likely understand music. lot of people would rather understand the market than make money. Howabout market letters? What do you mean, \"The stock market behaves differently from the Market letters tend to lag behind the market since they generally respond stock market\" ? to demand for news about recent activity. Although there are certainly

letter is often a beginning job in the The stockmarket behaves from itself in that important exceptions, writing differently easily be handled traders or non- identifiable seldom industry, and as such may by inexperienced patterns exactly repeat. traders. Good traders trade. Goodletter writers write letters. What is your long-term outlook for inflation, the dollar, and gold? Do you use the opinionsof other traders in making trading decisions, solo? Inflation or do completely is of the way societies the old order. All you operate part sweep away currencies debased\342\200\224like it or not. one eventually get Compute penny I advice from other the ones who invested at the time of at usually ignore traders, especially Christ, compounded 3 percent per year. Then \"sure The who talk about believe they are on to a thing.\" old-timers, considerwhy nobody has anywhere near that amount these days. and are often and Gold \"maybe there is a chanceof so so,\" right early. tends to be dug up, refined, and then buried again. The geographical entropy of all gold on the planet seems to decrease over At the confidence that could on A lot what point did you get you keep time. has been collected in vaults. I project the trend as one toward a winning as a trader? central world gold stash.

I vacillate between(a)\"I can keep on winning,\" and (b) \"I have just been Dogreattradershave a special talent for trading? most confident of before a lucky.\" I sometimesget my ability just major traders have a losing streak. Good special talent for trading just as good musicians and good athleteshave talents for their fields. Great traders areoneswho are markets? How similar are the pricepatternsin different absorbed by the talent. They don't have the talent\342\200\224the talent has them.

individual market For Common patterns transcend behavior. example, What is the balancebetween talent versus work in trading success? in common with the cockroaches crawl bond prices have a lot way up and down a wall. Unfortunately for cockroach followers, there is I don'tknow where one starts and the other stops. 170 EdSeykota Ed Seykota 171

in success? would be How much of a role does luck play trading winnings necessary to emulate his experience, not to avoid it. Furthermore, you would probably also need to overtrade and have in success. Some were while Luck plays an enormous role trading people wipeouts, you simultaneously fired up your emotions with the to be bom smart, while otherswere even smarter and got burning desire to \"win it back.\" out this lucky enough right Acting drama could be However, it also seems bom lucky. exciting. terribly expensive. One alternative is to keep bets small and then to systematically keep reducingrisk during Howabout a seriousanswer? equity drawdowns. That safe way you approach your money asymptoticallyand have a gentle financial and emotional touchdown. attitudinal \"Luck\" or \"smarts\" or \"gift\" are words indicating an proclivity at one's I I notice for mastery. One tends to do well calling. think most good thereisno quote machine on your desk. are traders have a little extra spark about trading. Some people natural think it is a musicians or or salesmen or I difficult to Having quote machineis like a slot desk\342\200\224 painters analysts. having machine on your talent for if it is there, it can be you end up it all I acquire trading. However, already feeding day long. get my price data after the close discovered and developed. eachday.

do so What effect has trading had on your personallife? Why many traders fail in the marketplace?

life is with life. For the same reasonthat most turtles fail to My personal integrated my trading baby reach maturity: Many are called and few are chosen. Societyworks by the attraction of the of as intense as the of As are Is the joy winning pain losing? many. they culled out, the good ones are left, and the others are releasedto go try something else until they find their calling. The same there with the is true for other The joy of winning and the pain of losing areright up pain fields of pursuit. are the and of winning and the joy of losing. Also to consider joy pain

not The relative of these feelings tend to What can of participating. strengths a losing trader do to transform himself into a winning increase with the distance of the trader from his commitment to being a trader?

trader.

A losing trader can do little to transform himself into a winning trader. When made first few million, did you lock some of it away you your A trader is not losing going to want to transform himself. That's the kind to avoid the JesseLivermore experience? [Livermore was a famous of thing winning traders do. speculator of the early twentieth century who made and lostseveral fortunes.] How would you rate the relative importance between psychology and marketanalysis to successful trading? I feel the Livermore experience was a function of his psychology and In I remember had little to do with the location ofhis assets. fact, motivates the of that Jesse Livermore used to lock some of his winnings away and Psychology quality analysis and puts it to use. reading is the Psychology driver and analysis is the road then find a key when he neededto get at them. Therefore, locking up map. Ed Seykota 173 172 EdSeykota

doctor told her a shot was available which would cure her. She You have focused a lot on the field of psychology. Can you tell by found excuses to avoid the shot a constantly appearing for and eventually avoided talking to a personwhether that person would probably be it her entirely. Perhaps political position was more important than her winning or losing trader? life. People' s trading performance probably reflects their priorities more than they would like to admit. at whatever field Yes, the winning traders have usually been winning think that some I of the most flamboyant and interesting traders are are in for years. they for more than playing profits alone; they are probably also playing for excitement. Oneof the best to is to do trader ways increase profits goal setting What traits do you look for to identify the winning and visualizations in order to align the conscious and subconscious with personality? making profits. I have worked with a number of traders in order to examine their priorities and align their goals. I use a combination of 1. He/she loves to trade; and hypnosis, breathing, pacing, visualization, gestalt, massage, and so forth. 2. He/sheloves to win. The traders usually either (1) get much more successful, or (2) realize

they didn't really want to be traders in the first place. Don't all traders want to win?

Surely, some peoplelosebecausethey lack the skill, even though they Win or lose, everybody gets what they want out of the market. Some really want to win. to like so win peopleseem to lose, they by losing money. I know one trader who seems to in near the start of every get It is a happy circumstance that when nature us true burning desires, of gives substantial bull move and works his $10 thousand up to about a quarter she also gives us the means to satisfy them. Those who want to win and a million in a couple of months. Then he changes his personality and lack skill can get someone with skill to help them. Once I loses it all back again. This process repeatslike clockwork. traded with him, but out when his personality changed. I doubled got I sometimes have dreams related to the impending direction of a while he wiped out as usual. I told him what I was doing, my money, market. Although these dreams tend to be very infrequent, himself. I and even him a management fee. He just couldn't help paid uncannilythey often prove right. Have you had any similar experiences? to. He a don't think he can do it any differently. He wouldn't want gets his he to be a he sympathy from lot of excitement, gets martyr, gets I know who claim to several people have market insights during dreams. and he to be the center of attention. Also, possibly, he may friends, gets I think one of the functions of dreams is to reconcile information and their financial be more comfortable relating to people if he is on plane. feelings which the conscious mind finds intractable. For instance, I once On some level, I think he is really getting what he wants. told a lot of my friends that I expected silver to keep on going up. When into their I think that if people look deeplyenough trading patterns, it went down instead, 1ignored the signs and tried to tell myself it was find that, on balance, including all their goals, they are really they just a temporary corrertion. I stoodto lose face and I couldn't money. not it or want to what they want, even though they may understand getting afford to be wrong. Around that time, I had dreams of being in a big, admit it. shiny, silver aircraft that stalled out and started going down toward an A doctor friend of mine tells a story about a cancer patient who inevitable crash. I eventually dumped my silver position, even went to used her condition to demand attention and, in general, dominate short, and the dreams stopped. with her the others around her. As an experiment prearranged family, 174 EdSeykota

How do you judge success?

I don'tjudgesuccess.I celebrate it. I think success has to do with financial finding and following one's calling regardless of gain.

Don't be fooled by the humor in Seykota's comments; there is a great deal of serious wisdom in his pithy replies. For me personally,the most Hite Larry of striking comment was: \"Everybody gets what they want out the market.\" When first made this I he was Seykota remark, thought RespectingRisk merelybeing cute. But I soon realizedhe was deadly serious. My reflexive response to this premise was disbelief: It implies that all losers want to winners who fall short of their are lose and all goals (like myself) fulfillingsome inner need for a constrained threshold of success\342\200\224a difficult to swallow. mind would proposition Although my rigidly logical normally dismiss the idea, my respect for Seykota's knowledge about markets and forces me to the truth of the people consider potential market\342\200\224a Hite's interest in statement that everybody gets what they want out of the most Larry the financial markets was sparkedby a college provocative concept. course,but his path to Wall Street was as circuitous as Moses' to the Land of Israel.His early adult years did not offer any clue that this was a man headed for eventual his academic young majorsuccess.First, performance was inauspicious. Then he went through a string of odd jobs,

never managing to hold any for very long. Eventually, he drifted into a dual career of actorand screenwriter. While not recording any major successes, he managed to support himself, and enjoyedhiswork.Oneof his movie scripts, which never found its way into production, was optioned so often that he began to view it as a source of steady income.

One day, Hite heard H. L. Hunt on the radio describing how he

madehis fortune buying up lots of cheap oil right options, which gave him the opportunity for occasional windfall profits with minimal risk. That same Hite met Brian the of the night, briefly Epstein, manager Beatles,at a party. The two ideas fused in his mind, leadingto another career change. He thought to himself, \"Here is something [a rock promoter] that has the for a lot of with a minimal potential making money investment.\" Although he landed a few record contractsfor some of his groups, none ever reached true stardom. Once again, although his success he was limited, managed to earn a satisfactoryliving in a self- employed position. 176 Larry Hite Larry Hite 177

Meanwhile, Hite's real interest remained in the financial markets. Our interview was conducted over lunch at Windows of the World

on on a with \"You often hear about people working Wall Street to become atop New York's World Trade Center, day it was blanketed in the screenwriters.I may be the only person who ever workedas an actor and clouds. We took the hint when we were the last ones left restaurant a scriptwriter to pay formy Wall Street career,\" he says jokingly. In 1968, and finished the interview in Hite's office.

Hitefinally decided to pursue his primary interest. While fascinated with the futures markets, he didn't have the slightest idea how to break into that field, so he began as a stockbroker. Several years later, he became How did you first get interestedin markets? a full-time commodities broker.

More than a decade before that he had passed Hite, convinced When I was in college, I took a businesscourse with a professor who learned the ingredients necessary for successfullong-term trading had a trenchant sense of humor. To an he also worked give you example, took the initial that led to the ultimate formation of Mint performance, steps asa bank examiner. One day, before leaving the bank following an audit, Investment He realized that his ideas Management Company. trading he turned to the bank president and, as a joke, said,\"Got you!\" The man needed to be to scientific With an offer subjected rigorous testing. of had a heart attack on the spot. After that, they did another audit and found but no immediate he enlistedPeter who partnership, pay, Matthews, that the bank president had embezzled$75,000.Anyway, in class one held a in statistics. One Ph.D. year later, he hired MichaelDelman, a day, this professor is reviewing all the financial instruments: stocks, of firm. designer computer systems for a defenseelectronics Matthews bonds, and so on. Then he says, \"Now we come to the craziest market and Delman their own ideas to the but even more brought table, perhaps of all\342\200\224commodities. Thesepeople trade on only 5 percentmargin\342\200\224and significantly, their work provided the mathematical proof that Hite's most of them borrow that.\" The whole class laughed, except me. For were indeed sound. Hite is made trading concepts statistically emphatic somereason,the idea of trading on 5 percentmargin perfect sense that Mint's success would not have beenpossiblewithout Matthews and tome. Delman.

never to make return. Mint's objective was the largest percentage When did you first get involved in the financial markets?

Rather, Hite's philosophy was to aim for the best growth rate consistent with risk control.It is in this Not until a rock at and on extremely rigorous perspective (return many years later. I was promoter the time, one relative to risk) that Mint really shines. From the inception of trading in April weekend,there were three separate shootings in clubs at which the 1981 Mint an annual were I it was an through mid-1988, registered average compounded groups I managed working. decided opportune time to return of over 30 But it is their that is most careersand true interest\342\200\224the financial markets. percent. consistency change pursue my impressive:their annual returns have from a worst of to I idea how ranged plus 13percent Although was really interested in futures, I didn't have any to a best Their loss six-month of plus 60 percent. largest in any period was look for a job in that field. So I decided I would start out as a stockbroker. only 15percentand under 1 percent in any twelve-month period (not just My first interview was with a very old-line Wall Street firm, with calendar years). offices that made you feel like you should speak in hushed tones. The Not Mint's stellar has resulted in a man who interviewed me was the kind of a surprisingly, performance guy [he adopts pompously spectacular growth of equity under management. In April 1981, they began refined voice] who talks with his teeth together and livesin Connecticut. with $2 million; over $800 million. He tells \"We blue for our clients.\" trading today, they manage me, only buy chips there is no evidence that the of under Not a financial I was unfamiliar with the term Significantly, surge money having background, managementhas had any deleterious effect on performance.Hitebelievesthat \"blue chip,\" but it sounded odd to me in the context of a staid investment Mint billion\342\200\224an that the can ultimately manage $2 unprecedentedly large sum firm. So after the interview, I lookedup its derivation. I found for a futures fund. 178 Larry Hite Larry Hite 179

of the term could be to the origin traced color of the most expensivechip stockcalledTexasInstruments trading at $207. It eventually dropped to in Monte Carlo. I said to myself, \"Aha, now I know what this game is a decline of 77 If think we have more $49, percent. you gotten all I about\342\200\224gambling.\" threw away my copy of Graham and Dodd sophisticatedin the 1980s, all you have to do is look at silver prices, which in considered the [Principlesof Security Analysis, by many to be \"bible\" 1980 reached a peak of $50 and subsequently fell to $5, a 90 percent of stock market analysis] and bought a book called Beat the Dealer. I decline. came away with the idea that successful investment was a matter The is that because are the if use really point people same, you of and if could the could can test and odds, you compute odds, you find and test sufficientlyrigorous methods to avoid hindsight, you a system see methods that could beat the idea that market. how it would have done in the past and get a fairly good of how

system will perform in the future. That is our edge. believe What made you that you could develop methods to put the odds in your favor? Isn't it possible that the markets can change and the future will be very different from the past? I don'tknow that I understood it all then, but over the years I came to that the markets realize are inefficient. I have a friend who is an The markets may change, but people won't. When we were still in the economist. He would to if try explain to me, as talking to a child, why testing stage, before we actually started managing any money, my what I was to do because \"the with the of trying was futile, markets are efficient.\" I partner Michael Delman came up concept using holding have noticedthat who has ever told me that the markets are as a measure of everyone periods system performance.Evaluating systems solely efficient is He that if I want to know poor. argued could develop a winning system on a on a calendar year basisisvery arbitrary. What you really so could and we would computer, others, all cancel each other out. are the odds for profitableperformance in a holding period of any length. In our simulations, Peter determinedthat 90 percent of all the six- month What is wrong with that argument? 97 of the twelve-month and 100 holding periods, percent periods, percent of the eighteen-month periods would be profitable. After over seven Becausepeopledevelop systems and will make mistakes. Some of actual the numbers turned out to be 90 99 people years trading, percent, will alter their or from to system jump system system as each one has a percent, and 100 percent. Others will be unable to resist the losing period. second-guessing I will tell you how confident I am of the future validity of our Whenever I to conference trading signals. go a money management and sit evaluation process. There is a fellow who works for us who used to be down with a to have some drinks at I the group night, always hear same a colonel in the British army. His service specialty was dismantling story. \"My system worked great,but I just didn't take the gold trade, and bombs all over the world. I asked him, \"How did you do it?\" \"It wasn't that would have been winner.\" my biggest that difficult,\" he says. \"Thereare different styles of bombs; a bomb in There is a here: That very important message People don't change. Malaysia is different from a bomb in the Middle East. You go there and is this whole In in why game works. 1637, tulips Holland traded for 5,500 see what kind of bomb it is and take it apart.\" I said, \"Let me ask you a florins and then crashed to a 99 loss. that, 50, percent Well, you might say, question. What happens when you come across a bomb you don't \"Trading was relatively new then; these were in \"You record people primitive; know?\" He looks me the eye and says, your first was still in its capitalism infancy. Today we are much more impressionand it is not last.\" hope your sophisticated.\" So to 1929 and find a stock like Air Reduction which found this same you go I came into the office one day and steel-nerved traded at a of and after fell to a high $233 the crash $31, decline of 87 individual virtually on the brink of tears.I asked him what was wrong. It percent.OK, you might say, \"The '20s were crazy times, but turned out that the Fed had made a which Roaring major policychange, now are surely different.\" Move ahead to 1961 and find a which things you dramaticallyreversed many major market trends. Overnight, our fund, Hite 181 180 Larry Hite Larry

There are who use from a value had fallen back many money managers trend-following had gone starting of $10 to nearly $15, to systems\342\200\224andquite a few of those don't second-guesstheir own under $12, just after he had opened a major Swiss bank as an account. systems. What makes Mint different? How have you been able to I told him, \"Get them on the phone.\" \"What?\" he asked somewhat achieve return/risk ratios far above the industry average? confused. I repeated[speakingmore slowly and emphatically], \"G-e-t t-h-e-m o-n t-h-e p-h-o-n-e.\" Because we know that we don't know. No matter what information you When I was a broker,my boss taught me that if you don't call your what I have, no matter you are doing, you can be wrong. have a friend client when he is losing money, someoneelsewill. And, to be honest, fortune who has amassed a in excess of $100 million. He taught me two when I was a broker, I did the same thing. When I called prospectsand basic lessons. First, if you never bet your lifestyle, from a trading they complained about their broker, I would say, \"Oh, how could he put standpoint, nothing bad will ever happen to you. Second,if you know you in that trade?\" what the worst possible outcomeis, it gives you tremendous freedom. So I get the account on the phone and explain that our simulations truth is The that, while you can't quantify reward, you can quantify risk. show that this type of event will occur once every few years and that I I will give you an example how important this advice is. One of the am confident that in nine months the fund will be back to a new high. world's largest coffee traders invited me to his house in London. When \"In fact,\" I said, \"I have just borrowed some money to add to my own I walked into his library, I noticed he hadjust about every bookever investment in the fund.\" \"You did that?\" he asked in a really surprised written on power. He took me to one of the finest restaurants I have ever tone.I assured him that I did. beenat. At dinner, he asked me, \"Larry, how can you know more about Well, the account doubled up on their investment, and the fund coffee than me? I am the largest trader in the world. I know where the that account is immediately shot straight up. Today one of our biggest boats are; I know the ministers.\" \"You are right,\" I answered, \"I don't clients.How could I be so sure? I knew what those were about. systems know drink anything about coffee. In fact,Idon'teven it.\" \"How do you What makes this business so fabulous is that, while you may not know \" trade it then?\" he asked. I told him, I just look at the risk.\" Well this what will happen tomorrow, you can have a very good idea what will great meal lasted for severalhours. Five times he asked me what I did, happen over the long run. and five times I told him that I managed the risk. The insurance business providesa perfect analogy. Take one sixty- Three months later I heard that he had blown $100 million in the and what the odds are year-old guy you have absolutely no idea that he coffee market. He obviously didn't get the message. And you want to will be alive one year later. However,if you take 100,000 sixty-year- know something? He doesknow more about coffee than I do. But the olds, you can get an excellent estimate of how many of them will be alive point is, he didn't look at the risk. we numbers one year later. We do the same thing; let the law of large So the very first rule we live by at Mint is: Neverriskmore than 1 work for us. In a sense, we are trading actuaries. percent of total equity on any trade. By only risking 1 percent, 1 am went understand I have a friend who broke trading futures. He can't indifferent to risk any individual trade. Keeping your small and constant how I can trade by following a computerized system religiously. We is critical.For one I know had a absolutely example, manager large were playing tennis one day and he askedme,\"Larry, how can you trade account that withdrew half the money he was trading. Instead of cutting the way you do; isn't it boring?\" I told him, \"I don't trade for excitement; his position size in half, this manager kept trading the same number of I trade to win.\" It may be very dull, but it is also very lucrative. When I contracts. Eventually, that half of the original money becamelOpercent get together with other traders and they start exchanging war stories of the money. Risk is a no-fooling-around game;it does not allow for about different trades, I have nothing to say. Tome, all our trades are the same. 182 183 Larry Hite Larry Hite mistakes. If do not the and other you manage risk, eventually they will carry you So one of the key differencesbetweenyou trend-following out. managers is that you have developeda way of defining when not to The second we do at that we thing Mint is always follow the trends play? and we never deviate from our In methods. fact, we have a written agreement that none of us can ever countermand our system. The trades are In any situation or game, you can define a positional advantage for any all the same. That is the reason we have the weakest one. In can define three why never had a bad trade at player\342\200\224even trading, you categories Mint. There are four kinds the The trade has the best really of trades or bets: goodbets,bad bets, of players:the trade, the floor, and speculator. bets, and bets.Most think that a and the best of out of For winning losing people losing trade was product knowledge ways getting positions. a badbet.That is You if in a bad in futures absolutely wrong. can losemoney even on a good example, they are caught position the markets, they bet. If the odds on a bet are 50/50 and the payoff is $2 versus a $1 risk, can offset their risk in the cash market. The floor has the advantage of that is a bet even if lose. The While the good you important point is that if you do speed. You can never be faster than the floor. speculator of thosetrades or bets, have to out the or the he doeshave the enough eventually you come ahead. doesn't have product knowledge speed, The third we do to reduce risk is of can choose to thing diversify. We diversify in advantage not having to play. The speculator only bet two we trade more markets when is ways. First, probably worldwide than any the odds are in his favor. That an important positional advantage. other money manager. Second, we don't just usea single best system. To as a provide balance,weuselots of different systems ranging from short You mentioned before that you used increasedvolatility signal term to term. How of data use to long Some ofthesesystemsmay not be that to trading a market. many days past do you good by stop but we themselves, really don't care; that is not what they are there for. determine your volatility filter? The fourth Mint does to thing manage risk is track volatility. When the of a volatility market becomesso great that it adversely skews the Anywhere from ten to 100 days. expected return/risk ratio, we will stop trading that market. our has three in When ten to 100, are you trying to be deliberately ambiguous Essentially, approach lights determining the you say acceptance of When the or mean use different time frames within that range? trading signals. light is green, we take all signals. do you you When the is we will light yellow, liquidate an existing position on a signal, but we will not on a new We look at different time windows in that put position. Finally, when the light is red, range. we liquidate existing positions automatically, and we do not take any new positions. I fully understand the logic of your 1 percent stop-lossrule. For in one is: Once are out of a example, 1986, when coffee went from $1.30to $2.80 and However, my question you stopped back to out of our position without the an what gets you $1.00, we got long positions on the way up at $1.70 system providing oppositesignal,* and didn't trade the market for the the back into the trade if the market reversesto its direction? rest of price climb and subsequent original while have lost some Isn't it possible that you could out on a moderate price collapse. Now, we may additional profits, being get stopped out of then miss a move? markets like that is one of the ways we are able to achieve such reaction and subsequent major rigid risk control. If the market makes a new high, we get back in.

*For example, if a long position is stopped out on a money management rule without in a and no a sell signal actually being generated, the system will still be long mode buy a sell were signal will be generated, no matter how high prices go. (If, however, signal generated, the system would begin monitoring for a buy signal.) 184 185 Larry Hite Larry Hite

But that the market into a When I was a kid and first motorcycle, I had an older friend suppose goes widetrading range,might got my when you not get would into He told me, \"Larry, you are on continuously whipped between beingstopped out and who always get fights. a You will lose.\" The same lesson reentering the position at new highs? a motorcycle,never argue with car. If with the will lose. applies to trading: you argue market, you once That The Hunt brothers are a example. Somebody asked happens, but not enough to be a problem. perfect Let's me, \"How could the Hunts lose? They were worth billions.\" say and $20 billion worth of silver\342\200\224Iam You have an you have a billion dollars, you buy incredibly strong respect for risk.Were there any the are in these numbers up for the sake of example\342\200\224you personal events in making your trading career that ingrained you with that with who owns $20,000 the $1,000 attitude? exactly the same risk position as guy worth of silver. his I have a goodfriend who started from very humble beginnings; When I first became in involved commodities, I noticed that if and he you father was a sanitation man. Anyway, he is a very bright guy got bought pork bellies in and sold them before September July, you almost at it and made a fortune. I into option arbitrage. He was extremely good made a So I formed fund with always profit. a a group of friends, and I in remembervisiting him at a palatial estate he bought England. put on this trade. It worked. I the I doubled money. felt like a but he turned out to be genius. Well, he may have beena great arbitrageur, At the time, I had a friend who followedthe corn market. I that made One didn't a bad trader. He developeda trading system money. day know about anything corn; I knew about talked me in it doesn't look only pork bellies.He he saidto me, \"I am not taking the sell signal gold; into buying the new crop com and the old Since this was of the are selling crop. right to me. Besides,almost 50 percent signals wrong anyway.\" to supposed be a relatively safe trade, in that I was wound offsetting my long Not only didn't he take the sell signal, he actually up going long. in position one contract month with a short in another I \"Get out!\" but he position month, I Sure enough, the market went down. told him, loaded really up. Shortly thereafter, the government released a will come back.\" insisted, \"The market estimate. In surprisingcrop response, the month I was went limit-down the mansion and else. long Well, he didn't get out, and he lost everything and the month I was short went limit-up. Now he livesin a rented box on a streetwith a hundred other ticky-tacky I in was such that I this I still remember the name of his estate: \"Beverly.\" despair remember walking out to the stairway houses. To day, and literally down on knees his loss of that house had an getting my and saying out loud, \"Dear God, He is still one of my best friends, and huge I don't care how much I but on me. He had it and lost it all! And all lose, please don't let the account go into a enormous emotionalimpact debit.\" At the I was for a is that if he had followed his he time, working sophisticated international firm, because of one trade. The irony system, and as I just was making my providential plea, a Swiss banker came would have made a fortune on that trade. walking down the staircase. To this I who turned $5,000 into day, still wonder what he must have I will tell you another story. I have a cousin \"How did do thought. $100,000 in the option market. One day I askedhim, you if it I it?\" He answered, \"It is very easy. I buy an option and goes up, stay Were there other out until I am at least even.\"I told him, any personal traumatic experiences caused by a in, but if it goes down, I don't get failure to that is not heed market risk? \"Look, I trade for a living, and I can tell you strategy just going it doesn't have to work in the long run.\" He said, \"Larry, don't worry, till I make a million. I know what I am Not for but financial to work in the long run, just doing. myself, throughout my career, I have continually take a loss.\" I \"OK...\" witnessed examples of other that I have I just never said, people known being ruined by a worth of Merrill failure to In his next trade he buys $90,000 Lynch options, respect risk.If you don't take a hard look at risk, it will take and and down. I talk to him about you. only this time, it goes down, down, Hite 187 186 Larry Hite Larry

of [Bonds up when interest rates decline.] one month later, and he tells me he is in debt for $10,000.1 said, \"Wait every eight years. go to him than the a minute. Obviously,the name \"bonds\" means a lot more reality. You had $100,000 and you bought $90,000 in options. That

should still leave you with $10,000, even after they expired worthless. wide of markets. Do trade them all the How have a \"I You trade a very variety you could you deficit of $10,000?\"Hesaid, originally bought same way? the options at $4k. When the price went down to $1,1 figured out that if I bought another 20,000, all it had to do was go back to $2^ for me to We don't trade markets, we trade money. Mickey Quenington, who is break even. SoI went to the bank and borrowed $10,000.\" director, once introduced me to a former chiefexecutive for risk is not it our marketing Respect just a matter of trading; applies to any type of this firm F. the firm to which Hite 50 of business once worked for a firm the [E. Man, gave percent decision.I where company in in for financial a ownership his management company exchange backing]. president, very nice guy, hired an option trader who was brilliant, but not This was a old Irishman and he askedme,\"How do you stable. One the trader the firm guy tough, day option disappeared, leaving stuck with differentiate between and cocoa in trading?\" I answered, \"They a The was not a and he gold your losing position. president trader, sought my are the He are both a 1 percent bet; they same to me.\"He was outraged. advice. \"Larry, what do you think I should do?\" I told him, \"Just get out of shouted back at me, \"You mean to tell me that you don't see the to practically position.\" Instead,he decided hold on to the trade. Thelossgot a any difference between gold and cocoa?\" I think if it wasn't for the fact little worse, but then the market came back, and he liquidated the much, he would have thrown me out of his that he liked so position at a small Mickey profit. office. After this incident, I told a friend who worked at the same firm, woman who is concerned I married a very proper English always \"Bob, we are going to have to find another job.\" \"Why?\" he asked. I a that her family considers me a bit crass. I was once interviewed by answered,\"We work for a man who has just found himself in the from the London who asked me what I thought about the middle of a mine what reporter Times, field, and he did was close his eyes and walk through I future direction of the London cocoa market. I told him, \"Frankly, don't it. He now thinks that whenever you are in the middle of a mine field, see markets; I see risks,rewards, and money.\" I was the last person the propertechnique is to close your eyes and go forward. Less than one in that article. He finished it \"Mr. Hite doesn't care this same quoted by saying, year later, man had to liquidate a huge delta neutral spread wife read the in about the cocoa market, all he cares about is money.\" My position options [a balancedposition whose value will change very \"Great. Now I'll never be able to home; this will just little for small in either article and said, go price moves direction]. Instead of just getting that were all he prove to my family they right about you along.\" out, decided to get out of the position one leg at a time. By the time he finished that liquidating position, he had gone through all of the firm's if trade all marketsthe same, don't capital. I assume that you you probably of believe in optimization. [Optimization refers to the process testing many variations of a system for the past and then selecting the best- Besideserrors in riskcontrol,why do people lose money trading? with this fine- performing version for actual trading. The problem tuned approach is that the link betweenpastand future performance Sometimes,becausetheir trades are based on a personalbias,instead of is often a very rough one.] a statistical approach. For example,there is a regular panelist on \"Wall Street Week\" who is about sixty-five or seventy years old. On the show \"It is incredible how rich can Absolutely. We have a saying here: you one day, he said that the lesson his father taught him was, \"Bonds are not We are not looking for the optimum method; the cornerstoneof your portfolio.\" Think about that! Since this man first get by being perfect.\" we are looking for the hardiest method. Anyone can sit down and devise got into the business, he has seen interest ratesgo down only once out a perfect system for the past. 188 189 Larry Hite Larry Hite

Are there any technical indicators that have Jack had been out recommendations for his firm for you found to be putting trading overrated? many years. I found that if you followed all of his recommendations,you how did would have made money in every year. Finally, I asked Jack he Overbought/oversold indicators. None of them seemto out it. You have to that Jack was six foot-four. He said, \"Larry, if prove in picture market is all have to do is this.\" testing. you want to know where a going, you He threw his charts on the floor and jumped up on his desk. He said, Any of indicators types you consider particularly valuable? \"Look at it, it will tell you!\"

Although I don't trade off of there really them, are two that come to mind. I assume by that, he meant get a perspectiveof the big picture. First, if a market doesn't to respond important news in the way that it it is should, telling you something very important. For when example, Right, because I don'tknow of too many people who get rich by taking the news of the war first came out Iran/Iraq over the newswire, was forme. From gold small profits. Working with Boyd was extremelyimportant only able to move to \"A up $1.1 said myself, Middle East war has the to do it. just the time I met him, I knew that his approach was right way broken out and the best the gold market can do is $1; it has to go up be In other words, I knew that if you traded across the board, controlled a great sale.\" The market broke sharply after that. The second item is had to work. I couldseeit your risk, and went with the trend, it just something that Ed Seykota taught me. When a market makes a historic absolutely clearly. high, it is No matter how telling you something. many people tell you the market shouldn't be that why high, or why nothing has changed, the Any final words? mere fact that the is at a new price high tells you something has changed.

about in as wellas in life: If other that I have two basic rules winning trading (1) Any lessons you learned from Ed Seykota? win. If lose all can't you don't bet, you can't (2) you your chips, you Ed bet. Seykotaactually explained his philosophy one day: \"You can risk 1 percent of your capital, can risk 5 or can risk you percent, you 10 but percent, you better realize that the more you risk, the more volatile the two to Hite's First, results are going to be.\"And he was There are basic elements trading philosophy. absolutely right. is convinced that the contrary to the opinion of many academics, Hite firmly a method that Besides who I know were in markets are inefficient.This means that if can your partners, integral developing your you develop were there other the odds in favor (and it doesn't have to be by very much), trading systems, any traders who taught you places your valuable is a but not lessons? you can win. Second, an effective method necessary, also sufficient, condition to win. In order to survive and thrive at trading, you it will Jack who hired have to market risk. If you don't, sooner or later, get you. Absolutely. Boyd, me as a broker/analyst. Having read respect that risk four basic Handy and Harman had said in their annual report that silver stocks Hite controls rigorously by applying principles: totaled either three billion or seven billion ounces,I wrote a report on the silver market in which I His never trades counter to the market trend. There are no said, \"According to Handy and Harman, 1. system there is either twice as and he follows the much silver as some people think or less than exceptions, always system. half.\" That went over with limited to 1 of total report very big Jack and helped me land the 2. The maximum risk on each trade is percent job. equity. 190 Larry Hite

3. Mint carries diversification to an extreme. First, their system is really

a combination of many different systems, selected not only for their II individual performance, but also for their degree of lack of Part correlationwith other selected systems. Second, Mint trades in an wide of in extraordinarily spectrum markets (nearly sixty all), encompassing Stocks Mostly exchanges in the U.S. and five foreign countriesand diverse market groups including stock indexes, interest rates, currencies, raw industrial goods, and agricultural commodities.

4. Volatility is continually tracked in each market in order to generate or in signals to liquidate temporarily suspend trading those markets where the risk/reward ratio exceeds well-defined limits.

One final observation: After merely earning a modest living at some colorful careers (such as, scriptwriter, actor, rock promoter), Larry

Hite succeededspectacularly in the single endeavor for which he had the enthusiasm\342\200\224fund I found this to be a greatest manager. striking example of Ed Seykota's comment: \"It is a happy circumstance that when nature true it also us the means to gives us burning desires, gives satisfythem.\" Michael Steinhardt

The Concept of Variant Perception

Michael Steinhardt'sinterest in the stock market dates backto his bar mitzvah, when his father gave him 200 sharesof stock as a present. He in a recalls hanging out the local brokerage officeas teenager, watching the ticker tape along with the old men, while his friends were out playingstickball. A very bright student, Steinhardt completed his education at an accelerated pace, graduating from the Wharton School of the University of Pennsylvania in 1960 at the age of nineteen. Steinhardt headed for Wall his first as a research straight Street, landing job assistant. In subsequent years, he held positionsas a financial journalist and a research analyst. In 1967, having established a reputation as a talented firm analyst, Steinhardt and two other partners founded the investment of Steinhardt, Fine and Berkowitz\342\200\224the predecessor to Steinhardt Partners. (Fine and Berkowitz left the firm in the late 1970s.) In the twenty-one years since its inception, Steinhardt'sfirm has achieved a truly remarkable track record. During that time, Steinhardt Partners has realized a annual rate of over 30 compounded growth percent (just under 25 percent after subtracting a 20 percent profit incentive an 8.9 fee).In comparison, the S&P 500 index registered only percent compounded annual growth rate (dividends included) during the same period. One thousand dollars invested with the firm at its start in 1967 would have grown to over $93,000 by Spring 1988(after deducting profit incentive fees). To put that in perspective, the same $1,000 investedin 194 Michael Steinhardt Michael Steinhardt 195

a basket ofS&Pstocks would have only grown to $6,400. Gain is only of part the story; Steinhardt's track recordalsodemonstrates admirable consistency. Steinhardt Partners has witnessed two only losing years. In What are the major elements of your trading philosophy? both cases, the net loss was under 2 percentbefore profit incentive fee adjustments. I The word \"trading\" is not the way I think of things. may be a trader in Steinhardt's performance has been achieved superior by using a the sense that my frequency of transactions is relatively high, but the myriad of approaches. He is both a investor long-term and a short-term word \"investing\" would apply just as much, if not more.In my mind, he is as comfortable stocks trader; shorting as buying them; he will shift an of a sale at the time of For trading implies anticipation purchase. chunks of the firm's major capital into other investment if futures vehicles,such example, I go long stock index tonight because I expect as treasury securities, if he feels that is the best investment choice. tomorrow's trade number will be bullish for the market, and I plan to sell To be Steinhardt Partners' sure, track record is not a solo tomorrow\342\200\224that is The bulk of what I do is for a my position trading. performance. addition In to his over the the firm cofounding partners, years, much longer duration and for more complexreasons.Forexample, when has employednumerous tradersand there analysts. However, was never I went long the debt markets in 1981,1 held that position for two and a doubt that Steinhardt was in any clearly charge. He reviews the firm's half years. portfolio severaltimes each day. Although he gives the firm's traders latitude to make their own judgments, Steinhardt will require a trader to Well, for purposes of this book, I would still call what you are doing rigorously his if he justify position has qualms about that position. If he feels Steinhardt will trading. strongly enough, override the trader and liquidate the position. Steinhardt's extreme and How then do you define the difference between trading and investing? scrutiny control of the firm's portfolio has him a given reputation of beinga very demanding man to work for\342\200\224 too for the obviously, demanding many of traders who have left the firm I make two key distinctions. First, a trader will go short as readily over the in mind that years. Keeping Steinhardt's wraparound desk has as long. In contrast,the investor\342\200\224for example, the portfolio been constructed in the shape of a bow, it is not that of a mutual fund\342\200\224will be If he is ship's surprising manager typical always long. one journalist doing a him with the profile tagged sobriquet, Captain uncertain about the market, he may be only 70 percent invested, but Ahab. However, Steinhardt'stough side is The that a trader is very much related to his job he is always long. second distinction I make is role\342\200\224much as in football coaching, toughness is probablya virtue in primarily concerned about the direction of the market. Is the managing a group of traders. or market, orstock,goingup down? The investor is more concerned I never saw Steinhardt's tough side. The man I interviewed was about picking the best stocks to invest in.Thereisnovalue judgment relaxed, soft and spoken, patient, good humored. (Of course,our involved in my distinction between traders and investors, it is interviews were always conducted outside of market Steinhardt a matter of a certain thematic focus for this book. In hours.) merely maintaining possesses a keen sense of humor. He has been known to call friends any case,on both counts, I would certainly qualify you as a trader. impersonating an IRS mumble agent, deliberately fictitious orders to To get backto my original question: How would you define your brokers before the market right close, and double-talk in a Dr. Irwin philosophy of trading? manner when he wishesto the Corey-like pull leg of an analyst or reporter who calls him. His conversationis alsoliberally sprinkled with Yid- My particular style is a bit different from that of most people.Concept dishisms\342\200\224\"proprietary dreck,\" for is how he to number one is variant I to that I example, refers perception. try develop perceptions newfangled fund products. 196 Michael Steinhardt Michael Steinhardt 197 believe are at variance with the general market view. I will play those that to make money in the markets, you have to be willing to get in the variant perceptions until I feel they are no longer so. way of danger. I have always tended to short stocks that were favorites

and backed by a great deal of institutional enthusiasm. Generally me an of in the current Couldyou give example variant perception speaking,I have tended to short too early and, therefore, have usually started marketplace? off with losses in my short positions. If I short a stock and it goes up a lot, it may skew my exposure a bit, but as long as my variant perception We have been short Genentech for a year and a half. Therewasa period is unchanged, I'll stay short. If I'm wrong, I'm wrong. of months and months when we losta lot of money in that position. But I stayed short because I continued to have a variant perception about the Are you saying that as long as you think the fundamentals, as you future of their drug, TPA. [TPA can be injectedintravenously to dissolve perceive them, are unchanged,you will hang tough no matter how blood clots.] It is our perceptionthat, in a year or two, TPA will be a much the positiongoesagainst you? minor drug that will be supplanted by more effective drugs that also cost substantially less. The thrust of the entire company has been based on Right. Of course, if it is triple horrible, I might trade around the position this one drug. If our perception is correct,this company will be earning to take the pressure down a little bit. I would say, \"OK,this looks awful; 20 or 30cents share and selling for under $10. Thestockis per I see but don't I the and see if I can nothing buyers. Why join buyers at $27 down from a of $65. late currently [June 1988], high [By November, In make some money.\" a matter of speaking, I dichotomize myself. I Genentechhad fallen below $15 and Steinhardt was still short.] But I have a fundamental view, which I believe in my heart, but I try to separate think the general perception is still that Genentech is a first class that from the short-term fervor and intensity I see in the market. So may biotechnology company that will produce many products that are going to even though I am short in that type of situation, I might periodically be revolutionize the industry. As long as my view is a variant perception, I a buyer. will stay short.

Might you actually go net long during those periods, or does your That is a clearexample,but it raises a question. Let's say you go position just fluctuate between fully short and flat? short a stock because of your variant perception, and the position goesagainst you.If the fundamentals don't change, the more it goes It wouldn't even remotely approachflat, because that type of buying is against you, the more attractive the short sidewould appear. Yet based on very short-lived perceptions.I might take 20,30, or 40 percent from a money management standpoint,at somepoint, the position of the position and trade with it. would have to be covered.It seemslikethere be two basic might trading principles in conflict here. If you are very negative and short in a particular stock, but are not necessarily bearish on the industry, might you sometimes hedge There are certain shibboleths that exist in the world of trading, which yourself by buying another stock in that group against your short may or may not be accurate, but I have not followedthem. For example, position? there is a view that shouldn't short a until it has general you stock already peaked and started down\342\200\224that you shouldn't go short until the I have tried that at times, but have generally found it to be unsuccessful. stock is already reflecting problemsthat are evident for all to see. In some What it tends to do is give me two problemsinstead of one. Usually, your sense,I can understand that. Maybe that is a superficiallysafer way to knowledge about the second stock on the other side will tend to be short stocks and can more that you sleep comfortably using approach. it to relatively skimpy because you are just grasping at use as a hedge. If I have never done it that attitude has However, way. My always been that need not your problem is so great you to hedge it, why address the 198 MichaelSteinhardt Michael Steinhardt 199

on a A common problem directly rather than taking totally separate position? Let's example might be: BeforeI get into a position, I know and the stocks are so where I am out. It doesn't say you are short a paper stock paper roaring, you exactly getting necessarily have to be a short stock will risk control it could be\342\200\224 buy another paper stock against it. Maybe your go up rule, more; maybe the other stock will go up more. Who knows? If you have with the don't it. No, I don't have rules about made a mistake, deal mistake; compound any stops or objectives. I simply don't think in those terms. Besides the variant perceptionconcept,what are some of the other elements of your trading philosophy? At this there is a on the point, call speakerphone. The caller is giving Steinhardt some news in Nothing that is so distinctive. I don'tuse stop-lossordersorsuch.I don't late-breaking regarding a decision a lawsuit on or I at against the tobacco \"The verdict is back. use any rules about buying weakness strength. don't look industry. Everyone wascleared the charts. except Liggett who had to a fine and no breakouts or breakdowns. I don't use group pay $400,000 punitive damages.\" Steinhardt replies, \"So it was basically a decision slightlyin favor of the defendants.\" You don't use charts at all?

Charts just leave me blank. [He adoptsa JackieMason-likespeech went short I the like tobacco stocks about a month ago. was pattern.] I look at the stock. It has a fantastic chart. The chart hasa base My reasoning that if the won the the a it is a real plaintiffs case, stocks would down a lot, but if this, and then if it goes up little bit more, boy breakout, blah, go the plaintiffs lost, the stocks wouldn't go up too much, since the blah, blah, blah. They all seem the same to me. tobacco had companies never lost a case and winning another one wouldn't be That is really news. an example of a variant perception. It will be But from an informational standpoint, don't you use charts as just to interesting see how much I will lose, because was has traded over the my original theory a quick and easy way to see where a stock years? that it wouldn't be much. Hereit is [reading story headline from screen],

\"Liggett Group Found Liable for Contributing to Smoker's Death.\" You stocks as as I do,I some sense of price levels, By watching closely get know what, I won't lose A anyway. phrase like that will scare somebody. uptrends, ranges, and all that. Goingbackto our discussion, let's say you are short a stockbecause Let's know that a stockhas from $10 to wouldn't of say you gone $40, your fundamental analysis and the stock isgoingagainstyou.How it matter to how it went from $10 to $40? would you you know when is because have your analysis wrong you overlooked some unknown important element? It makesno difference to me. That situation happens fairly often. You buy or sell a stock and it doesn't act the think it should. I Do you have any trading rulesthat you could define? way you go through my portfolio six times a day.There are many stocks in the portfolio that I am not directly responsiblefor. For example, someone else is short Time, Inc. are short Give me an exampleof a trading rule. They 200 MichaelSteinhardt Michael Steinhardt 201

this or that. But the stock is that answers the too because the magazine business is lousy, and OK, question simply. Assume you wanted to be is 10 from where we shorted it. I will short the tobacco stocks as a and the acting really strong and up percent longer-term position market for the Time Life and ask off today's news and closed tomorrow. Would go over to the person responsible position shrugged higher you that is cover then? severalkeyquestions:When are we going to get something going to that will ease to surprise the world? When is something going happen It on reasons. If I wanted to short the feeling that this company is ripe for a takeover? depends my be the tobacco companies the If there is a because I felt tobacco to In a sense,I am a negative monitor of portfolio. consumption wasgoing decline much more than I it That makes presently perceived, it wouldn't matter that much. If the market rallied problemwith a position will go through very regularly. I talk to when things tomorrow, I would have to take of it and sell some mea very difficult person here, because only people advantage more. like should. are lousy or when their stocks are not acting they So you wouldn't care if the market didn't react to the news the way its would it should as as felt for If a stock is not actinglikeit should based on fundamentals, have, long you the main reason being short that would was still valid. that be the type of market action change your thinking?

on the other side of a trade knows as least as Yes, but if the news was terrible and the stocks were I would to I try to assume that the guy up, try it down understand Sometimes the market has more the much asI do.Let'ssay I buy Texaco at $52 and suddenly goes why. information and variant action is to $50. Whoever soldTexacoat $52 had a perception that was really telling you something. from mine. It is incumbent on me to find out what his dramaticallydifferent But haven't there was. been instanceswhereyour analysis was perception completelywrong?

What if can't it? you explain Sure.

but can The explanation might be superficial or serious, you usually get And you realized it somewhere down the road? something.

Yes, and not necessarilysoquickly. the Let's take the situation of the tobacco companies. On balance, the tobacco news that came out after the close sounded bearish.If At down tomorrow and then come right back, this point, Steinhardt a phone call in which his side of the stocks go only modestly gets conversation is filled with non and deliberate would you cover your position? sequiturs mumbling. He then explains to me his occasional habit of playing practical jokes on callers. on the news. I would cover it anyway. I would cover the position

For I a call from a broker who I haven't to for is example, get spoken a So oncethe newsis out, the game over for you. time. I around and long swooshsome papers then say, \"Buy 30,000 shares of ZCU [mumbles another sentence].\"Didyou understand what I was short. Right. That was the only reason I said? 202 MichaelSteinhardt Michael Steinhardt 203

and is the No [I laugh]. manager, that really key element. That flexibility could include ableto short stocks as being well as buy stocks, use options, futures, and but it didn't it? he calls so on. That is what a fund is in That is exactly right, sounded legitimate Anyway, hedge general terms, but the variations in the bathroom. He calls on the theme wide me back, and I have my secretary tell him I'm covera very continuum. the and I am back again,frantic because it is five minutes before close, What to the of still unavailable. Then at 3:58,1 call him back and say, \"Haven't you happened original concept a hedge fund? do Of done that order yet? What's the problem? Just the damn thing!\" the stock.\" So I tell him The flexibility of the fund structure attracted course, he says, \"I didn't catch the name of [he hedge numerous young, and before he can else. aggressive entrepreneurs in the 1960s because it allowed them an mumbles another sentence] hang up say anything to start their opportunity own business at an early age in a way that wasn't otherwise possible.Those were times of stocks with Your fund is often labeledasahedgefund because it trades very great wonderful stories. Therewere a elaborate on the quite number of stocks showing terrific differently than a typical mutual fund. Could you growth. The people that came into the fund business were not meaning of a hedgefund. hedge theoretical practitioners of the idea of hedging, but were moreinterested in the idea of their own bosses, and the to be credit for the first being having flexibility long The A.W. Jones Group has been given being hedge a lot of stock.Although they also had the of to which flexibility being short, they fund. Originally, the term referred a precise concept, didn't use it in any serious The word has a in the world of do not way. hedge very specific essentiallysaid the following: We money management meaning in the English language. In most of these could in which are hedgefunds, you have the ability to forecast trends the stock market, seriously ask, \"Where is the hedge?\" functions of a host of variables that are largely beyond the consistent ability to what we as can do, of individuals anticipate. But, money managers So they were hedge funds in name only? careful is to make accurate as to which through analysis, judgments that are not. if one balanced companies are doing well versus those So, long Correct.They wouldn't even call themselves to with short hedge funds; they were positionsin stocks that were perceived be relatively strong embarrassed by the name. The term had a connotation of and market risk would be being short, positions in stocks expected to act poorly, the the short trading side had an anti-American ring to it. It was as if eliminated. For example, if you loved Ford and hated General you totally were for rooting disaster. So they started the term a tone were short a dollar of General using [he adopts Motors,and for every dollar long Ford you of mock pomposity] private but if was partnership. Motors,you might lose on your shorts, your judgment good, come out ahead. the of a fund you would So, original concept hedge Ironically, today, with the disintegration of the relatively smooth totally emphasized the ability to pick stocks. seculartrends of the 1950s and 1960s, the concept of a true hedge fund make more sensethan it did in may its early days. Why aren't Doesanyone still trade that way? there any practitioners of the hedge fund concept in its pure form?

the term fund is somewhat of a misnomer. The term Becauseit is a No, today, hedge very restricting approach. Thepremiseof being a dollar in which the is now refers to a limited partnership general partner long and a dollarshort in some related a lot of entity requires using on a basis, as to more traditional money dollars How different typically paid performance opposed ineffectively. are Ford and GeneralMotors going to of a who are on assets the manager be? are both affected the managers paid managed. Typically, They by same macroeconomic factors.If you fund has a deal more than a traditional money have to hedge great flexibility put up some dollars for the long and some dollarsfor the short, 204 Michael Steinhardt Michael Steinhardt 205

be to difference over a of a How do you determine your outlook for the market you may lucky realize a 10percent period general direction, since that is a criticalelementof your year\342\200\224that is, assuming you are right. obviously very approach? There is a group we areassociatedwith on the West Coast that in stocks. has been mentioned It is really beyond definition, except to say that there are a host of specializes exclusively shorting The thought with neutralize variables, some sometimes more important than others, and that maybe they should their market exposure by being long they change the time. dollars in the stock indexes as are short in all Having done it as long as I have gives me the an equal number of they opportunity to be 51 percent right rather than 50 individual stocks, because what they bring to the party is the special ability percent right. the closest I have heard to pick shorts. That is thing to this concept Does that but do it. imply that your main profitability comesfrom stock recently, they don't selection as opposed to net exposure adjustments for anticipated in the broad market How does your own fund fit into the hedge fund concept? changes direction?

No, I was a bit facetious. It is more than a 1 but it is It fits in the sense that shorting is used actively. We always have some being percent edge, not a like 80 of the or shorts.I also spend a good deal of my time thinking about net market big advantage being right percent time, anything In approaching that. exposureand risk, and planning and adjusting for it. the twenty-one years that I have been doing this, our overall exposure here has averaged about 40 percent. Relatively speaking, how important is the bias of the right market direction versus stockselectionasa factor to contributing your overall You mean 40 percent net long? superior performance?

As I look back on the there is no set of Yes. In contrast, I would doubt that the most conservativeof typical past twenty-one years, pattern successful In some we did well on the mutual funds has had an average exposureof less than 80 percent during activity. years, particularly of a few well-chosen stocks. In other we did the last twenty years. strength years, well exceptionally because we were on the right side of the market. For example, in have been about 40 net What 1973-1974, when the market went down we were up On average, you percent long. range enormously, because we other does that encompass? substantially, largely were net short. There were periods when the bulk of our money was made in bonds. I think there is a in the fact that there is no real who thinks he can I rememberbeing15or20percent net short at one point, and, at another message pattern: Anyone formulate success in this racket is because it time, being over 100 percent net long. deluding himself, changes too quickly. As soon as a formula is right for any length of time, its own the of its So you have the flexibility of being net short as wellasnetlong? successcarries weight inevitable failure.

What made confident of net Yes. One of the things I would emphasizeabout our approach is its you sufficiently lowerstockpricestogo to make short in 1973-1974? flexibility to shift market exposure so as it an exceptionally too in our meaningful\342\200\224sometimes perhaps meaningful\342\200\224tool The of a recession. investmentmanagement arsenal. anticipation 206 Michael Steinhardt Michael Steinhardt 207

Based on what? against the crowd must always be right. Well, life doesn't work that way. There were plenty of contrarians who bought bonds when interest rates I felt that the higher inflation rates of that period would lead to higher went to 8 percent for the first time, and 9 percent, and 10percent.There in would slow down the interest rates, which, rum, economy. was a great deal of money lostby people buying bonds at what were then all-time high yields. Were on the stock market in the the you negative period preceding There is a very important difference between being a theoretical 1982bottom as well? major contrarian and dealing with it in practical terms. In orderto win as a contrarian, you need the right timing and you have to put on a position in Not as But in 1981 and made an enormous amount of strongly. 1982,1 the appropriate size.If you do it too small, it's not meaningful; if you do a in notes. one it too money by having leveraged position treasury Although big, you can get wiped out if your timing is slightly off. The process couldn't the end of the rise of interest rates it was predict timing-wise, requires courage, commitment, and an understanding of your own clear that unless interest rates camedown, other areas had to be psychology. in relativelyunattractive. When you could get 14 percent long-term treasury in order to had to much lower securities, be competitive, stocks sell so I that assume you probably had the market run against you for quite than were at that it wasn't even worth on which they selling focusing a while in that trade. stocks to buy\342\200\224although you might focus on the short side. What was unique in that period was the inevitability of a turn in interest rates in Right, it did. It was a very painful period, becauseas far as most of my order for anything else to be worthwhile; it was simply a matter of timing investors were concerned,I was an equity investor. What did I know that turn. In contrast to most other this period had a clear periods, about bonds? Who was I to contradictHenry Kaufman who was telling fixed income unidirectional message: U.S. Treasury securities were by the world that interest rates were going to the moon? Not only was I far the quintessential value of the time. doing something that was different than in the past, which always raises Anyone with sense of contrarian mentality had to look at any the those antennas of investors\342\200\224particularly with an institutional a interest rates in the early 1980s as presenting potentially great mentality\342\200\224butI was doing it in an enormous size. would started opportunity. You knew the Fed have to ease as soon asbusiness to run into trouble. In addition, we had alreadyseenan important Were more than 100 on you leveraged percent your position? topping in the rate of inflation.

Yes, at one I had three to four times the firm's in So, some of the pieces ofthe puzzlewerealready in place? point capital five-year how maturities. In stocks, you have a policeman who tells you much you can it is called But in treasuries, can Yes, and that is as much as you can hope for, because when they are all speculate: margin requirements. you finance as much as 98 of on in place, it is too late. percent your purchases, depending maturity, so thereis no real constraint.

You mention a contrarian mentality, but that type of thinking could have justified trying to pick a top at much lower rates. How long was the period between when you started buying treasuries and the market bottom [interest rate peak]? Absolutely. People think that being a contrarian implies victory. After what is a contrarian but someone that the crowd. It is all, goes against I started buying in the spring ofl981,andI think treasuries bottomed on the is the who stands almost a cliche that crowd always wrong\342\200\224so guy September 30,1981. 208 Michael Steinhardt Michael Steinhardt 209

How much did rates moveagainst you in that first half year? So you backed off during that period?

I don'trecall,but rates went up enough to be painful, especially given At times we did, because we werelosinga lot of money. the size of my position. Did that prove to be the right move, because stocks eventually went Up until this time, you had primarily beena stock trader. Here on to much higher multiples, or would you have been better off if you your first major foray in treasuries, you started out by incurring had held on? substantial losses.Didn't you have periods of self-doubt? In hindsight, in almost all cases, I would have been better off sticking it All the time. The summer of 1981was the worst experience of my out. business life. A number of thoughtful, intelligent investors were really very with what I was I wasn't so sure You mentioned that October 1987was one of the worst market unhappy doing\342\200\224and myself. experiences in your career. Obviously, you had lots of company. But I Did ever come close to I am and find it such a contrarian. I wouldn't have you saying, \"Maybe wrong,\" surprising, you being to be in a liquidating, or at least decreasing, your position? expected you heavily long year with such bullish euphoria. What happened? No, never. in of Actually, the spring 1987,1 wrote a letter to my investors stating One of your basic principles seemsto be that as long as you believe the reasons why I was cautiousand substantially reducing my exposure with a in I you are fundamentally right, you will stay position. Have the market. Having done that, kept thinking about why the market markets in there been any exceptions\342\200\224that is, which you didn't was trading at a level that was too high by historic standards I came to fundamental but the the change your view, loss just got too big? conclusion that the quintessential issue wasa unique combination of phenomena occurring in the American equity markets\342\200\224a substantial There have been some situations when I was short and simply didn't continuous reduction in the amount of equitiesoutstanding, coinciding to in with the full-boat of the That with attitude toward As have enough courage hang position. a more liberal debt. long as banks were in the was particularly true 1972, at height of the \"Nifty-Fifty\" comfortablelending money, the junk bond market was good, and corporate With the of that was the their phenomenon. exception October1987, probably managers saw repurchasing shares as the right thing to do, I felt in investment life. At the there was that would worst period my time, a theory there be an unusual upward bias to equity prices. That to me was as long as a company continued to sustain substantially above-average the single most important reason in the seeming overvaluation of stocks secular growth, it didn't matter how much you paid for it. Many growth that existed through most of 1987. at that were We went short Polaroid stocks traded multiples just crazy. Therefore,the important question was: What was going to change when it was at times which we was this situation? The And whenever selling sixty earnings, thought answer was a recession. that recession absurd; it then went to seventy times earnings.The market seemed to lose would come, its impact would be horrendous because the government track of reality, and we found ourselves asking, \"What is the difference didn't have the flexibility to fight it since they had deviated from a times and a the between forty earnings eighty times earnings?\"By putting countercyclical fiscalpolicyduring expansion phase. But during the the secular rate could different number on growth estimate, you justify fall of 1987, not only was the economy not weakening, it was in almost any multiple That is how people were thinking those days. strengthening\342\200\224so much so that the Fed tightened. 210 Michael Steinhardt Michael Steinhardt 211

What I didn't anticipate was that less-than-dramatic events could Why? Were you still bullish? have as an on the market as did. What was the real large impact they the Fed have in importance of tightening? Ordinarily, that might created a My increasing exposurewas strictly a contrarian trade the sense that 100-or 200-point decline in the stockmarket, but not a 500-point decline. when the markets have an enormous move, most of the time, it is right In the light of history, what was the significanceof Treasury Secretary to take the view that there is a lot of emotionalism and extremism in that Baker's criticism of Germany?It was merely a disagreement as to the move. If you can maintain a bit of distancefrom the emotionalism, you I proper valuation of currencies\342\200\224hardly a unique event. In retrospect, tend to do well.Somy buying that day is what would have done on any what happened to the real world after October 19?Almost nothing. So, 300-, 400-, or 500-point down day. in some sense, you have to conclude that this problem was internal to the it wasn't that the market was an imminent Did with market; forecasting you stay your long position? financialdebacle or great recession. No,I reduced it throughout the next two months. The magnitude of the decline and the in confidence that it How then do you explain the extreme nature of the October19price extraordinary change engendered break? affected me as well.I thought it was better to sit back and rethink the situation with a lot of cashrather than try to hang in.

The problem that led to the October 19 collapse was the combination of Did think that basic for wasno of you your premise being long longer relatively modest real world changes and an inability the markets' valid? mechanism to deal with the institutional changes that occurred mostly

during the 1980s. The elements of stability\342\200\224the individual investor and I thought that I had underestimated the impact of the forces that had the specialist system\342\200\224had been greatly reduced in importance. diminished market stability.

Do you believe portfolio insurance exacerbated the decline? What was your percentage loss during October 1987? [Portfolio insurance is the systematic sale of stock index futures to reducethe risk exposure in a stock portfolio as pricesdecline.See I was down over 20 percent for the month. Appendix 1 for more detail.]

As you look back on the October1987experience,are there mistakes That wasone of the new elements. On one hand, you had a reduction in that you believe you learned from? the elements of stability. On the other hand, you had the creations of the insurance, and asset 1980s\342\200\224portfolio program trading, global who There is a very good investor I speak to frequently said, \"All I bring allocation\342\200\224whichtended to exert a unidirectional impact. By that, I mean that to the party is twenty-eight years of mistakes.\" I really believe heis right. participants in these strategies tend to be buyers and sellers at the same When you make a mistake, there is somesubconsciousphenomenon that time. The stock market was not prepared to handle it. makes it less likely for you to make that same mistake again.Oneof the a advantages of trading the way I do\342\200\224being long-term investor, short- Where were you, positionwise, coming in on October 19? term trader, individual stock selector, market timer, sector analyst\342\200\224is

that I have made so many decisions and mistakes that it has made me I came in very much long exposed\342\200\22480 to 90 percent\342\200\224and I increased wise beyond my years as an investor. my exposure during the day. 212 Michael Steinhardt Michael Steinhardt 213

The typical mutual fund adheres to a buy-and-hold approach. Do How did you get started asa fund trader? you think that concept is basically a flawed strategy? When I first into this business in the late I had an got 1960s, only analyticalbackground. I was an agricultural equipment and cyclical goods Yes, although flawed isn't quite the word I would use. I would say it is with two other a analyst at Loeb Rhoades. My business was started too limiting strategy. The objective of participating in the long-term fellows who were also analysts. As our businessgrew, trading became more growth of American equities, willing to suffer through those periods I became the trader for the firm, having had very little when equities decline, is fine, but it leaves so much on the table in terms important. of potential professional management. It is an incomplete strategy. trading background.

If you had very little experience, why did you become the trader? Yet, the vast majority of all funds fall into that category.

I probably wasn't as good an analyst as the other two. I but less than before. More and more are guessso, people paying attention to market timing, not that they are necessarily to do it qualified Even in those early years, you did very wellasa trader.How do you terribly well, but because they have cometo recognize what a buy-and-hold think you managed that without benefit of experience? When I was it common approach means. a kid, was advice to buy a stock, put it in a vault, and forget about it. You don't hear that sort of concept My father has been a gambler all his life. Although I can't remotely anymore. We have lost confidence in the long term. justify it, I feel there is an element of gambling in this business. Maybe I got that talent from my father. Do you think the mutual fund industry is going to change? You have traded the stockmarket for over twenty years. Have you time? The mutual fund industry is certainly sensitive enough to the whims of noticed any significantchangesduring that the investing public to find products that will meet contemporary needs. The amount of intellectual poweron the trading desks twenty years ago was minimal to The institutional traders were Howdoyou handle a losing period? compared today. typicallykids from Brooklyn, who could hardly speak the language, made a minimum amount of and had little discretion. So when I As is true for so many other questions in this business, there is no pat money, very first started it was like from a answer or formula. There is nothing that can be articulated precisely trading, taking candy baby. I remember trader needed to sell shares of Perm enough to lead othersin a certain direction. once a 700,000 Central. At the time, the stock was already in Chapter 11. The last trade was at 7, and the seller didn't bother to check the board. I bought 700,000 In other words, onelosingperiodmay be sufficiently different from shares at 6\\. The seller was relieved to sell that amount of stock at less another so that, even for yourself, there may be no generalwisdom than a dollar under the last trade. I turned around and sold that applies. Meanwhile, the 700,000 shares at 6\\. I could have sold three times that amount at that price. I madea half million dollars on that trade, and it took me all Correct. of twelve seconds. 214 Michael Steinhardt MichaelSteinhardt 215

How long did that environment last? What laws are you referring to?

Until the consolidated tape in 1975. Now there is a lot more The Justice Department's reinterpretation of takeover laws; the competition;the people on the trading desks are much brighter. Another change definitionof what is and is not monopolistic. is that retail buyers and sellers have diminished greatly in importance. The market hasbecomeinstitutionalized. Individuals stock buy through What would be the most important advice you could give to the mutual funds. firms don't sell customers much as Brokerage stocksso layman? they sell those horrible mutual funds and other awful things they call \"financial products.\" One of the of this business is that sometimes the allures greatest Perhaps the most important change is that the world has become ignoramus can do very well. That is unfortunate because it creates the much more short term oriented. All sorts of people who used to be to impression that you don't necessarily need any professionalism do well, investors are now traders. The institutions now define themselves as and that is a great trap. So the major advice I would give anybody is: whose to achieve the when enterprises goalis highest rate of return, they when Recognize that this is a very competitive business, and that you used to define themselvesas long-term investors. People's confidence decide to buy or sell a stock,you are competing with people who have in their to secular trends has diminished. In ability predict greatly 1967, devoted a of their lives to this same endeavor. In good portion many it would be typical to see a report by a brokerage firm estimating instances, these professionals are on the opposite side of your trades and, McDonalds' per share earnings up to the year 2000. Those people on balance,they are going to beat you. thought they could estimate long-term earnings because companieswere a in growing in stable and predictable way. Theybelieved America and Is the implicit message that, most of the time, the novice trader would steady growth. Today, stocksdon'tlend themselves to the same type of be better off having his money professionally managed? secularanalysis. The implication of secular growth trend analysis not having worked The term professionally managed implies a credit I am not sure I would in the 1970s and 1980s relates to the question of trading. In the 1950s is give the average professional in this business. My point that you should and 1960s,the heroes were the long-term investors; today, the heroes are have a goodreasonto assume that you are going to achieve a the wise guys. There arepeoplelike Goldsmith, who lauds the virtues of in stocks. If significantlysuperior return for investing you can get 9 percentor 10 capitalism.Hetalks about \"what I did for Goodyear.\" What did he do by investing in T-bonds and 7 or 8 percent by investing for Hewas in there for seven made zillion percent percent Goodyear? months, eight in T-bills, what should you in stocks to offset the incrementalrisk? dollars for get himself, and left the management after taking greenmail. He talks that Probably something much higher. You have to decidewhat number about what he did for Goodyear, because heis uncomfortable and has to should be, and whether you have a realistic chance of achieving it. somehow associate himself with the capitalist process. He and these other peoplehave to bitch and moan about management, but they don't Don't underestimate the difficulty of the game. know their ass from their elbow about running companies. With the breakdown of certain laws, peopleare allowed to do things they weren't allowed to do before. Right, and forget the shibboleth that stocks are going to give you 216 Michael Steinhardt Michael Steinhardt 217

the ease at which he short or as well a higher rate of return because they are more risky. That is not true. They demonstrated by equal goes long, markets other than stocks when warranted are more risky; therefore, you have to be convincedthat you are going as his willingness to trade by to his the fundamentals. \"The more to the get a higher rate of return in order to play the game. Don't assumethat perception of things you bring in mutual in bond futures market by investing some fund, you are going to get a higher rate of table\342\200\224shorting, hedging, participation markets, return. trading, and so on\342\200\224thebetter off you are,\" he says. Onetrait I have noticed among a number of the great traders is their

Isn't that hasn't the stock market and to take on a particularly large position when they true, though? Historically, willingness ability significantly beat interest rate returns? perceive a major trading opportunity. The nerve and skill required to step

on the accelerator at the right time is certainly one of the elements that

but there is a lot of mumbo traders from traders.Steinhardt's True, statistical jumbo involved. Average separates good exceptional heavy return on position in of this calculations dependheavily the starting date. If you start in treasury notes during 1981 and 1982is a perfect example 1968 or 1972, for example,the numbers look a lot less appealing. characteristic. for but it is Conviction is probably an important quality any trader, the contrarian trader. Steinhardt has demonstrated What are the elements of good trading? essential to repeatedly difficult as amazing resolve in maintaining large positions during times, long as he was convinced he was still right. Witness his convictionin Goodtrading is a peculiar balance between the conviction to follow your the six-month climax in staying with his treasury note positionduring ideas and the flexibility to recognize when you have made a mistake. in immune not to the market move You need interest rates 1981, remaining only to believe in something, but at the same time, you are going him, but also to the of complaining to be a considerable number of times. The balance between against psychological pressures wrong investors who his sudden transition into treasuries after a career confidence and questioned humility is best learned through extensive experience and asa stocktrader. Throughout it all, Steinhardt held on, and evenbuilt his mistakes. There should be a respectfor the person on the other side of because he remained convincedthat he was Without his the trade. position, right. Always ask yourself: Why does he want to sell? What does he heard strong sense of conviction, the world probably would never have know that I don't? Finally, you have to be intellectually honest with of Michael Steinhardt. yourself and others. In my judgment, all great traders are seekersof truth. Steinhardt also stressesthat there are no absolute formulae or fixed and patterns. The markets are always changing, the successful trader needs to adapt to thesechanges.In Steinhardt's view, traders who try to Steinhardt's variant perception is basically a contrarian approach. But find fixed approaches will be doomed to failure sooner or later. can't be a successfulcontrarian sentiment you by just using survey numbers or other measures of bullish consensus. The markets don't pay off that easily. Although sentiment is always very bullish at tops and very bearish at bottoms, unfortunately, extreme bullish and bearish readings are also characteristic of extended trends. The trick is not being a contrarian, but being a contrarian at the right time. Such judgments cannot bemadeon the basis of simple formulae. The successfulcontrarian needs to be able to filter out the true opportunities. Steinhardt's filters are a combination of a keen sense of fundamentals and market timing.

Flexibility is another essential key to Steinhardt's extremely favorable return/risk performance characteristics. This flexibility is William O'Neil

The Art of StockSelection

William O'Neil is an unreserved optimist and ebullient fan of the American economic and its O'Neil \"Great system possibilities. says, opportunities occur every year in America. Get yourselfpreparedand go for it. You will find that little acorns can grow into giant oaks. Anything is possible with persistence and hard work. It can be done, and your own determination to succeed is the most important element.\" O'Neil is living proof of his own words: a classic American success story. Born in Oklahoma during the lean Great Depression years and raised in Texas, he went on to build dual fortunes as both an immensely profitable investor and a highly successful businessman. O'Neil began his financial career as a stockbrokerfor Hayden, Stone and Company in 1958. It was there that he first began the research that led to the formulation of the key elements of his investment strategy. O'Neil's trading concepts proved remarkably effectivefrom the start.

During 1962-63, by pyramiding the profits in three exceptional back-to- back trades\342\200\224short Korvette, long Chrysler, and long Syntex\342\200\224he managed to parlay an initial $5,000 investment into $200,000. In 1964, O'Neilusedhis investment winnings to buy a seat on the New York Stock Exchange and to form William O'Neil and Co., an institutional research brokerage firm. His firm was a leader in offering 220 William O'Neil William O'Neil 221

comprehensive computerized stock market information and today is one of the most highly respected securities research firms in the country. William O'Neil and Co. servicesmore than 500 institutional describe stockinvestment approach major I think it would be fair to your accounts and individual their first 28,000 subscribers to Daily Graphs charting as individualistic and original. Where did you develop your service. data base The firm's contains 120 different statistics on eachof trading ideas? 7,500securities.

In what was in most do. I subscribed to a certainly his boldest endeavor, 1983, O'Neil I went through the same process that people in found that launched Investor's Daily direct competition with the Wall Street few investment letters and most of them didn't do too well. I financed the low Journal. He newspaper with his own funds, knowing that theories like buying low-priced stocksorstockswith price/earnings it would be before he could even. many years hope to break Skeptics (P/E) ratios were not very sound. abounded when the paper began with a press run under 30,000 in 1984, compared to over two million for the Wall Street Journal. Bymid-1988, When did you first find an approach that worked? Investor's Daily's subscribership had expanded to over 110,000,and the in well in growth circulation was accelerating.The estimated breakeven point Back in 1959,1 did a study of the people that were doing very of subscribersno far-fetched. O'Neil fund was a small fund, 200,000 longer seems believes the market. At that time, the Dreyfus very Investor's can to readers. His who the fund, was Daily eventually grow 800,000 unflagging managingonly about $15 million. Jack Dreyfus, managed in of their confidence the paper stems from the fact that Investor's the results of all of his So I got copies Daily's doubling competitors. financialtables contain statistical information else\342\200\224 and on charts where unavailable anywhere prospectus and quarterly reports plotted precisely share and volume their stocks. There were over 100 of these earnings per (EPS) rank, relative strength, percent they had purchased each of are I made first real change. (These measures discussed in the interview.) securitiesand when I laid them out on a table, my In combined his to but stock had been when 1988, O'Neil concepts in the book How Make discovery: Not some, not most, every single bought in McGraw-Hill. Money Stocks, published by The book combines clarity it went to a new high price. and with to brevity excellent and very specific trading advice. It was the So the first thing I learned about how get superior performance investment stocks that are best-selling book of the year. is not to buy stocks that are near their lows, but to buy O'Neil's various businessventures have not his out bases and to make new highs relative to impeded coming of broad beginning performance as a virtuoso You to find the of a stock investor. During the past ten years, O'Neil has the preceding price base. are trying beginning major over months in a stock that is averaged a 40 percent profit annually on his stock investments. move so that you don't waste six or nine sitting of his Some biggest winners were the Canadian oils during the 1970s going nowhere. and Pic'n'Save and Price Co. the late 1970s and 1980s. I studied the stocks that were winners in past years and tried to during early big Perhaps O'Neil's most famous market calls weretwo full-page Wall Street find the characteristics they had in common before they became major Journal imminent to notions like ads heralding major bull markets. The timing of these successes.I didn't just limit myself preconceived P/E to model on how ads could hardly have been better: March 1978 and February 1982. ratios; I examined a lot of variables develop a based William O'Neil and Company isa no-frills operation. Rarely have the real world worked. I seen a more crowded office environment. O'Neil, however, does not himself out for In what must be a stocks? single any special privileges. surely Can you describe this model for picking winning rarity among chief executiveofficers, he shares his office with two other

O'Neil me articulate, CANSLIM. Each letter of this name employees. impressed as being confident, I use the easy-to-rememberacronym and bullish on America. of the all-time win- opinionated, very represents one of the seven chiefcharacteristics great 222 William O'Neil William O'Neil 223

stocks their made ning during early developing stages, just before they million. Many institutional investors handicap themselves by restricting advances. huge their purchases to only large-capitalization companies. By doing so,they The \"C\" stands for current share.The best eliminate some of the best earnings per automatically growth companies. performingstocks showed a 70 percent increasein earnings for the average The \"L\" in our formula stands for leader orlaggard.The 500 best- current over the same in the quarter quarter prior year before they began an performing stocks during the 1953-1985 period had average relative their advance. I am amazed how individual major continually by many of 87 before their increase [The strength major price actually began. and even fund investors, pension managers, buy common stocks with the relative strength measures a stock' spriceperformance during past twelve or unchanged lower current quarter earnings. There is absolutely no months compared to all otherstocks.For example, a relative strength of reasonfor a stock to go up if the current earnings are If, as our poor. 80 would mean that the given stock outperformed 80percentof all other research the demonstrated, best stocks had large profit increases before stocks during the past year.]So,another basic rule in stock selection is in they advanced rapidly price, why should anybody settle for mediocre to pick the leading stocks\342\200\224the ones with the high relative strength So, our first basic rule in stock selection is that earnings? quarterly avoid the I to to values\342\200\224and laggard stocks. tend restrictpurchases share should earnings per be up by at least 20 to 50 percentyear to year. companies with relative strength ranks above 80. The \"A\" in our formula stands for annual earnings per share. In our The \"I\" in the formula stands for institutional sponsorship. The studies, the prior five-yearaverage annual compounded earnings growth institutional buyers are by far the largest source of demand for stocks. rate of outstanding performing stocks at their early emerging was stage have institutional Leadingstocksusually backing. However, although 24 percent.Ideally,each year'searnings per share should show an some is is not, institutional sponsorship desired, excessivesponsorship increase over the prior year's earnings. because it would be a sourceof large selling if anything went wrong with It is a combination of both current and unique strong earnings high most the company or the market in general. This is why the widely owned average earnings growth that creates a superb stock.The EPS rank, institutional stocks can be poor performers. By the time a company's which is published inlnvestor'sDaily, combines a stock's percent that almost all institutions own a it is performance is so obvious stock, earnings increase during the past two quarters with the past five-year average too late to and probably buy. percent earnings compares that figure to every other stockwecover. The \"M\" in our formula stands for market. Threeout of four stocks An EPS rank of 95 means that a company's current and five-year in will in the same direction as a significant move the market averages. historical earnings have outperformed 95 percent of all other companies. go That is need to learn how to interpret price and volume on a The \"N\" in our formula stands for something new. The \"new\" can why you the market has daily basis for signs that topped. be a new product or service,a change in the industry, or new of the stocks in the In At any time, less than 2 entire management. our research we found that 95 percent of the greatest winners given percent market will fit the CANSLIM formula. The formula is deliberately had something new that fell within these categories. The \"new\" also restrictive because want to the very best. If you were refers to a new high price for the stock. In our seminars we find that 98 you pick only an entire of to recruiting players for a baseball team, would you pick lineup percent investors are unwilling buy a stock at a new high. Yet, it is to hitters as one of of the of .200hitters, or would you try get as many .300 possible? the great paradoxes stock market that what seems too high usually goes higher and what seems too low usually goes lower. The \"S\" in Since use such a restrictive selection doyou have a the formula stands for shares outstanding. Ninety-five you process, high trades? percent of the stocks that performed best in our studies had less than percentage of winning million twenty-five shares of capitalization during the period when they had their best The of all of these two-thirds of stock were performance. average capitalization I guess over the years, about my purchases stocks was 11.8 million shares, while the median was 4.6 have found that one or two figure only actually closed at a profit. However, I only 224 William O'Neil William O'Neil 225 stocks of ten I have have turned out to be is volume for several but there is every bought truly rally vulnerable. Second, surges days, market outstanding. very little, if any, upside price progress as measuredby closes. In this latter case, there may not be a pickupin volume when the market

Wouldn't most of the indicators in your CANSLIM formula, such initially tops, since the distribution has taken place on the way up. a Another the market is as EPS, pick up stock before it goes to new highs? Why not just way to determine the direction of general to buy the stock when it is still forming a base instead of waiting for it focus on how the leading stocks are performing. If the stocks that have to go to a new high? been leading the bull market start breaking down, that is a major sign the Federal market has topped. Another important factor to watch is the You don't want from a the Fed two or three to anticipate a breakout base because a stock may Reserve discount rate. Usually, after raises the rate never break out. You can buy too soon as well as toolate. The idea is to times, the market runs into trouble. when useful indicator to buy there is the least probability of a loss. If you buy within the The daily advance!decline line is sometimes a base, the stock will fluctuate 10 or 15 in normal watch for of a market [The advance/decline line illustrates the frequently percent signs top. trading action, and it is very easy to get shaken out of the position. But if I difference between the total number of New York Stock Exchangestocks at the the stock is not to each versus the number the buy exactly right time, usually going go down advancing day declining.] Frequently, the market and fail to my maximum 7 percent stop-loss point. advance/decline line will lag behind averages to penetrate prior peaks after the averages reach new highs. This indicates You have stated that the stocks have relative superior high strength that fewer stocks are participating in the market advance. figures\342\200\22480 or higher. Although high relative strength is good,is as theresucha thing it being too high? In other words,might a When that the market has entered a bearish you believe general relative strength of 99 indicate that the stock is overextendedand would advise short rather than phase, you going merely liquidating vulnerable to a sharp correction? longs?

You have to lookat a chart to make that determination. The key point is not how the relative is, but rather how far the stock is I don't advise to sell short unless are high strength normally people they professional extended its most You short is made beyond recent price base. buy stocks that have a traders.Selling quite tricky. I myself have only significant high relative strength if they are just beginning to emerge from a sound profits on the short side of two of the last nine bear markets. I A short because its base-building period.However, would generally not buy a stock with stock should never be sold price looks too high. a high relative strength that is already more than 10 percent beyond its The idea is not to sell short at the top, but at the right time. Short selling prior price base. of individual stocks should only be considered after the general market shows signs of a top. The best chart pattern to short is one in which a The \"M\" in the CANSLIM formula makes sense sincefew stocks stock breaks out on the upside of its third or fourth base and then fails. can buck a general bear market.However, that rule sounds easier The stock should be breaking down toward the low end of its previous in theory than in practice. After all, how do you tell the difference base pattern on increased volume. After the first serious price break between a normal bull market market top and a correction? belowthe base, there will usually be severalpullback attempts. The prior

base will now provide an area of overheadsupply, as all investors who in the market in in number of them will be Top formations averages occur only one of two ways. bought that zone will be losing money, and a First, the average moves up to a new high, but does so on low volume. eager to get out near breakeven. Therefore, pullbacks to failedprice bases that the demand is at that the Thistellsyou for stocks poor point and that also provide good timing for short sales. 226 William O'Neil William O'Neil 227

in Does the element of unlimited risk presentany special problem turkeys have wandered into the box. However,oncehe shuts the door, short selling? he can't open it again without going back to the box, which would scare

away any turkeys lurking on the outside.

No,becauseI never take unlimited risk. If a short position goes against One day, he had a dozen turkeys in his box. Then one walkedout, me, I will be out after the first 6 or 7 percent loss. Beforeyou sell any leaving eleven. \"I should have pulled the string when there were twelve that short stock short, you should decide the price at which you will cover inside,\" he thought, \"but maybe if I wait, he will walk back in.\" While if position a loss occurs. he was waiting for his twelfth turkey to return, two more turkeys walked out. \"I should have been satisfiedwith the eleven,\" he thought. \"If just Besidesthe CANSLIM formula, which is critical to stock one of them walks will the While he your back,I pull string.\" was waiting, selection risk control role in three he process, obviously plays an important your more turkeys walked out. Eventually, was left empty-handed. a that element of overall strategy. Can you talk little bit more about His problemwas that he couldn't give up the idea that some of the trading? original turkeys would return. This is the attitude of the typical investor himself to sell the who can't bring at a loss. Hekeepsexpecting stock to is that all stocks are bad. There are no stocks recover. The moral To reduce stock market My philosophy good is: your risk, stop counting unless they go up in price. If they go down instead, you have to cut your turkeys.

losses fast. The secret for winning in the stock market does not include all should win even if being right the time. In fact, you be able to you OK, you use your CANSLIM methodology for selecting stocks, and

are right only half the time. The key is to lose the least amount of money your 7 percent rule for getting out if you are wrong. Howdo you a possiblewhen you are wrong. I make it a rule never to lose more than decide when to liquidate a winning stock position? maximum I of 7 percent on any stock buy. If a stock drops7 percent below my purchase price, I will automatically sell it at the market\342\200\224no First, you should hold a stockas long as it is performing properly. Jesse Livermore \"It the second-guessing, no hesitation. said, is never your thinking that makes big money, it's Some people say, \"I can't sell that stock because I'd be taking a sitting.\" Second, you have to realize that you will never sell the exact loss.\" If the stock is belowthe price you paid for it, selling doesn't give top. Therefore, it is ridiculous to kick yourselfwhen a stock goes higher you the loss; you already have it. Letting losses run is the most serious after you sell. The goal is to make substantial profits on your stocks and understand not be to advance after mistake made by most investors. The public doesn't really upset if the price continues you get out. the of losses If don't have a rule like philosophy cutting quickly. you disdain for a that cutting a loss at 7 percent, then in bear markets like 1973-74, you can lose Your writings express number of factors many 70 or 80 on I have seen in that people consider P/E dividends, percent your holdings. people go bankrupt important, including ratios, and indicators. Could type of situation. If you aren't willing to cut your losses short, then you diversification, overbought/oversold you explain think is with probably should not buy stocks. Would you drive your car without what you wrong the conventional wisdom regarding brakes? thesesubjects.Let'sstart with P/E ratios. In the author my book, I repeata story told by Fred C. Kelly, of Why You Win or Lose, that provides the best exampleI know of how the To say that a stock is undervalued because it is selling at a low P/E ratio In our we low correlation typical investor procrastinates when it comes to making a selling is nonsense. research, found there was a very A between the and the stocks. Some decision. man has rigged up a turkey trap with a trail of corn leading P/E ratio best-performing of these into a big box with a hinged door. The man holdsa long piece of twine, stockshad P/E ratios of 10 when they started their major advance; others had the in connected to the door, that he can use to pull the door shut once enough P/E ratios of 50. During thirty-three years our survey period 228 William O'Neil William O'Neil 229

195 the average P/E ratio for the best-performing stocks at their The final item on list of [ 3-1985], my your most prominent conventional for early emerging stagewas20,comparedto an average P/E ratio of 15 wisdom targets is diversification. the same time. At the end of their the Dow Jones Average during these stocks had an ratio of 45. expansionphase, average P/E approximately Diversification is ahedgefor ignorance. I think you are much better off stocks with This means that if, in the you were not willing to buy a few stocks and a deal past, owning knowing great about them. By beingvery above-average P/Es, you automatically eliminated most of the selective, increase chances of you your picking superior performers. You securities. best-performing can also watch those stocks much more carefully, which is important in A common mistake a lot of investors make is to buy a stock controlling risk. There is a solelybecause the P/E ratio looks cheap. usually very good reason a ratio is low. when I was first to issues would why P/E Many years ago, beginning How many you advise a typical investor to hold at any study the market, I bought Northrop at four times earnings and watched one time? in disbelief as the stock eventually declined to two times earnings. Another common mistake is stocks with high P/E ratios. I selling For an investor with $5,000, one or two; $10,000,three or four; $25,000, still remember in 1962 when an investor into my friend's barged four or five; $50,000,five or six; and $100,000 or more,sixor seven. brokerage office, declaring in a loud voice that Xerox was drastically it was at times He went short overpricedbecause selling fifty earnings. Aside from the we subjects havejustdiscussed,isthereanything else at $88. Xerox went to $1,300, adjusting for stock splits. eventually you consider a major public misconception?

Your thoughts on dividends? Most investors think that charts are about 5 to 10 hocus-pocus.Only and In percent of investors understand charts. Even a lot of There is no correlation betweendividends a stock's performance. professionals are about charts. Just doctor fact, the more a company pays in dividends, the weaker their posture totallyignorant as a would be foolish not to use interest rates funds and EKGs, investors would be foolish not to use charts. becausethey may have to pay high to replace paid X-rays Charts valuableinformation about what that out in dividends. It is naive to hold stocks that are going down because provide is going on cannot be If a 4 and the stock obtained easily other allow to follow a they pay dividends. you are getting percent dividend any way. They you huge number of different stocks in an manner. goes down 25 percent, your net yield is a 21 percentloss. organized

How about overbought/oversold indicators? Earlier, you talked about using volume as a clue that the market

averages were topping. Do you also use volume as an indicator in attention to indicators. I oncehired I rarely pay any overbought/oversold trading individual stocks? a well-known professional who specialized in such technical indicators. At the the 1969 market breakwhen I was trying to very point during The volume in a stock isa measure of supply and demand. When a stock to he was convince portfolio managers to stocks and move cash, is to move into new liquidate beginning high ground, volume should increase by them it was too late to sell becausehis indicators said the market at least 50 the telling percent over average daily volume in recent months. High was oversold. Oncehis indicators were oversold, the market break is very volume at a key point an extraordinarily valuable tip-off that a stock really accelerated. is ready to move. 230 William O'Neil William O'Neil 231

is I remember Volume can also be used in a reverse manner. When prices entera going. selling a $100 stock one time and it eventually went to didn't idea it volume should dry very $1.1 have any was down that far, but what would consolidation after an advance, up going should be little selling coming into the have happenedif I had held on to it? One mistake like that and can't substantially.In other words, there very you volume is come back. market. During a consolidation, declining generally In in a mutual constructive. contrast, fund, you should sit through the bear markets. Since most funds will be diversified in 100 or more stocks across the American How do you handle a losingstreak? economy, when stocks recoverafter a bear market, these funds will recover as well\342\200\224they almost have to. Unfortunately, in a it is not because what are doing is bear market, most scaredand decide to their If you hit a losing streak, and you people get switch, ruining be bad. If have when a wrong, that tells you the whole market may going you long-term holding plan. Actually, good, diversified growth fund back to see if it is time to start is down should more. five orsixstraight losses, you want to pull sharply, you buy

moving into cash. Would it be fair to say that the general public tends to treat funds

the of like they should individual The \"M\" in your CANSLIM formula emphasizes importance stocks and stocks like they should funds? market\342\200\224at least on the side\342\200\224during major By that I they tend to hold on to in being out of the long mean, their losers individual mutual their structure, stocks, but their mutual funds when bear phases. Since most funds, by very liquidate they are down in both bull and bear sharply. remain heavily invested stocks throughout mutual funds are a markets,doesthis imply that you believe poor Yes, that is investment? exactly right. Because of the emotional element, most of what people do in the market is wrong. funds are an This is going to surprise you.I think mutual absolutely I that should own their own Along that line, what are the mistakes outstanding way to invest. believe every person biggest investors generally stock account or own make? home, own real estate, and have an individual can make substantial mutual funds. Those are the only ways you any mutual funds are an excellent In my book I have a on common mistakes. income above your salary. Although I think chapter eighteen know how to handle investment, the problem is that most peopledon't sit and not to think. When them. The key to successin mutual funds is to is want to be in it for 15 or more. That how The list of commonmistakes from you buy a fund, you years following isexcerpted O'Neil's book But in order to do that, need the How to Make in you will make the really big money. you Money Stocks, published by McGraw-Hill in 1988. or five bear markets.The courage to sit through three, four, typical 75 to 100 in a bull market, 1. Most investors never the diversified growth stock fund will go up percent get past starting gate because they do not use 20 to 30 in a bear market. good selectioncriteria.Theydo not know what to look for to find a but it will decline by only percent successful stock. Therefore, they buy fourth-rate \"nothing-to-write-home-about\" stocks that are not acting well in the and are not real from an individual stock particularly marketplace So treat a fund very differently market you leaders. account?

2. A to good way ensure miserableresults is to buy on the way down in individual stock, have to a stock seems a real Very, very differently. With an you absolutely price; declining bargain becauseit's cheaper than it was a few months because never know how far down the stock earlier. For example, an acquaintance of mine Interna- have a stop-losspoint, you bought 232 William O'Neil William O'Neil 233

it was down in 7. Investors tional Harvester at $19 in March 1981 because price sharply buy second-rate stocks because of dividends or low This was his first investment, and he made the ratios. Dividends not as and seemed a great bargain. price/earnings are important as earnings per share; in mistake. He a stock near its low for the As it turned fact, the more a in the classictyro's bought year. company pays dividends, weaker the company may be the was in serious trouble and was headed, at the time, for because it may have to interest rates to out, company pay high replenish internally needed funds that were possible bankruptcy. paid out in the form of dividends. An investor can lose the amount of a dividend in one or two days' fluctuation in the price of the stock. in than A low P/E, of is low 3. An even worse habit is to average down your buying, rather course, probably because the company's past record is inferior. and then more at and out up. If you buy a stock at $40 buy $30 average your and cost at $35, you are following up your losers mistakes by putting good This amateur can serious losses and weigh 8. People names are familiar money after bad. strategy produce buy company they with, names they know. Just because you down with a few big losers. you used to work for General Motors doesn't make General Motors a necessarily good stock to buy. Many of the best investments will be at low share. names you won't know well but could and should 4. Thepublic loves to buy cheap stocks selling prices per very know if you would do feel it's more shares of stock in round lots of a little studying and research. They incorrectly wiser to buy 100 or 1,000shares,and this makes them feel better, perhaps more important. or of sounder 9. Most investors are not able to find information You would be better off buying 30 50shares higher-priced, good and advice. if had in terms of the number of dollars are Many, they sound advice,would not or follow it. The companies. You must think you investing, recognize average friend, stockbroker, or service could be a not the number of shares you can buy. Buy the best merchandise available, advisory source of losing advice. It is or stock seems irresistible. But always the small of not the poorest. The appeal of a $2, $5, $10 exceedingly minority your friends, brokers, or advisory services that are successful in the most stocks selling for $10 or lower are there because the companies have enough market themselves that merit your them consideration. stockbrokersor services either been inferior in the past or have had something wrong with Outstanding advisory are no more than are else. You the best at the frequent outstanding doctors, lawyers, or baseball recently.Stocks are like anything can't buy quality cheapest players. Only one outlJ of nine baseball that price! players sign professional contracts ever make it to the big And, of course, the It usually costs more in commissions and markups to buy low-priced leagues. majority of ballplayers that graduate from since stocks can 15to 20 college are not even good to a stocks, and your risk is greater, cheap drop percent enough sign professional contract. will not faster than most higher-priced stocks. Professionals and institutions the and so have a much 10. Over98percent of the masses are afraid to normally buy $5 $10 stocks, you poorer grade buy a stock that is As to into and for these securities. discussed earlier, beginning go new high It too following support low-quality ground, pricewise. just seems high to them. stock Personal and institutional sponsorship is one of the ingredients needed to help propel a feelings opinions are far less accurate man markets. higher in price. 11. The of unskilled majority investors stubbornly hold onto their First-time want to make a in the market. want losses when the losses are small and reasonable. 5. speculators killing They They could get out cheaply, but too too without the and preparation or being involved and much, fast, doing necessary study emotionally human, they keep waiting and hoping are for an to until their loss much and acquiring the essential methods and skills. They looking easy way gets bigger costs them dearly. effort what make a quick buck without spending any time or really learning are 12. In a similar investors cash in they doing. vein, small, easy-to-take profits and hold their losers. This tactic is exactly the opposite of correctinvestment in on rumors, stories, and procedure. Investors will sell a with a 6. Mainstream Americadelights buying tips, stock profit before they will sell one with advisory service recommendations.In odier words, they are willing to risk a loss. rather than on their hard-earned money on what someone else says, knowing what are themselves. Mostrumors are false, and even if a 13. for sure they doing Individual investors worry too much about taxes and commissions. down in is correct, the stock ironically will, in many cases, go price. Your should be to first tip key objective make a net profit. Excessive worrying 234 William O'Neil William O'Neil 235

investments in the of achieving a about taxes usually leads to unsound hope tax shelter. At other times in the past, investors lost a good profit by holding even to a gain. Some investors, on too trying get long-term capital As someone who lifetime long, has spent a researching stocks and the convince themselves they can't sellbecauseof taxes\342\200\224strong ego, erroneously, American do have economy, you any opinions about the quality of weak judgment. research a provided by Wall Street firms? Commission costs of buying or selling stocks, especially through to more important discount broker, are a relatively minor factor, compared decisions in the first and taking action An article in Financial World found that aspects such as making the nght place top-rated analysts generally un- of stock over real estateis the S&P when needed. One of the great advantages owning derperformed average. One major problemis that 80 percent of and lower commission and instant marketability liquidity. firm research is the substantially brokerage written on the wrong companies. Each or to quickly at a low cost to take advantage This enablesyou protect yourself industry analyst has to turn out his or her of even evolve. quota reports, though of highly profitable new trends as they continually a few only industry groups are leaders in each cycle. Thereis insufficient to determine which screening reports should actually be written. in too much because they think it 14. The multitude speculates options Another major problem with Wall Street research is that it seldom When they incorrectly concentrate is a way to get rich quick. they buy options, that involve provides sell recommendations. entirely in shorter-term, lower-priced options greater volatility time works and risk rather than in longer-term options. The limited period would holders. also write what I assume, given the consistency of successasa stock against short-term option Many options speculators your are but a risk investor for over are referred to as \"naked options,\" which nothing taking great twenty-five years, that you don't think very much of a relatively unsound investment the random walk for a potentially small reward and, therefore, theory. procedure. The stock market is neither efficient nor random. It is not efficient limits on their orders. like to 15. Noviceinvestors put price buy-and-sell because there are too many poorly conceived opinions;it is not random market orders. This is because the investor rarely place procedure poor They because strong investor emotions can create of a rather than the trends. is quibbling for eighths and quarters point, emphasizing overall movement. Limit orders eventually result more important and larger not out of stocks that should in your completely missing the market and getting losses. In the most be soldto avoid substantial general sense, trading success requires three basic an effective trade components: selection process, risk control, and discipline to or sell. In other 16. Someinvestors have trouble making decisions buy to adhere to the first two items. William O'Neil providesa perfect their are unsure because minds. words, they vacillate and can't make up They illustration of the successful trader. He hasdeviseda specific strategy for are do not have a a set of they really don't know what they doing. They plan, selecting stocks (CANSLIM),hehasa rigorous risk control and are uncertain of what they rule, he principles,or rules to guide them and, therefore, has the discipline not to deviate from his selection and risk should be doing. control In addition to the strategies. specific stock selection methodology in this are detailed chapter, traders and investors should find the 17.Most investors cannot look at stocks objectively.They always advice and on their hopes and personal regarding common mistakes, listednear the end of the hoping and having favorites, they rely interview, which to the of the useful. opinions rather than paying attention opinion marketplace, particularly is more frequently right.

that are not crucial, 18. Investors are usually influenced by things really news announcements, and brokerage such as stock splits, increased dividends, firm or advisory recommendations. David Ryan

Stock Investment asa TreasureHunt

David Ryan does not believe in buying low-priced stocks. But that was not the case. Heremembers the Wall Street always flipping through Journal when he was thirteen years old and finding a $1 stock. He ran with the paper in hand to his father and asked, \"If I go up to my room and get a dollar, can I buy this stock?\"His father told him that it didn't quite work that way. \"You have to do someresearchabout a company before you invest in the stock,\" he explained.

A few days later, leafing through the Wall Street Journal again,

Ryan found an article on Ward Foods, which made Bit-O-Honey and Chunky candy bars. It seemed like a perfect investment, sincehe ate a lot of candy. His father set up an account for him, and he bought ten shares of the stock. He recalls getting all his friends to buy the candy bars so the company would make more money and his stockwould go up. That was the official start of Ryan's career asa stockinvestor. Ryan's interest in the stock market increased as he grew older. By the time he was sixteen years old, hewas subscribingto a weekly chart service and attending investment seminars by William O'Neil and other market analysts. In college, he read everybookon the stock market he could find.

William O'Neil was Ryan's idol. After graduating college in 1982, he decidedto to a at O'Neil's He told the try get job company. receptionist of his interest in O'Neil's work and his willingness to accept any David 238 Ryan David Ryan 239

in the door. He was even What job, no matter how menial, just to get his foot kind of things were you studying? to work for free. was and within four his willing Ryan hired, years, investment success led to his appointment as the youngest vice-president I would go over our charts. I studied the company's past of the company, with responsibilities as a portfolio manager and as recommendations.I studied historical models of stocks to in O'Neil's direct assistant in stock selection for institutional clients. great winning ingrain my mind what a stock looked like before it made a major move. I tried Ryan achieved a degree of fame in his own regard when he won to get to the point where I was at the exact same O'Neil the 1985 stock division of the U.S. Investing Championship, a contest looking things did. He was my role model. run by former Stanford University Professor Norm Zadeh. His return that year was a phenomenal 161percent.As if to demonstrate that his the contest in performance wasno one-year fluke, Ryan reentered 1986, Were you trading at this time? with a 160 virtually duplicating his previous year's performance percent return second-place finish. In 1987, he won the contest once again with Yes,I opened a $20,000 account after I started for the another For the three as a his shortly working triple-digit return year. years whole, return company [1982]. compounded was a remarkable 1,379 percent.

Although most of the traders I interviewed have a love for trading,

the none have unbridled enthusiasm demonstrated by Ryan. To Ryan, How did you do? treasure the whole process of stock selectionis like a terrific game\342\200\224a

hunt as he describes it\342\200\224andhe still can't believe he is getting paid to do I ran the account to about it. Initially, up $52,000 by June 1983. Then I gave it all back, including some of my starting capital. mid-1984, The officesof the traders I interviewed ranged from the unadorned By my account was down to $16,000. the staked to the elaborate, but Ryan clearly had the low end of spectrum I find out. Instead of an office, plain or otherwise, was surprised to Do know what did Ryan's workplace to be a cubicle within a noisy, floor-sized room. Ryan you you wrong? didn't seem to care about the lack of amenities. I suspect that as long as he was with his charts and runs, he would probably supplied computer Yes. I sat down and studied every mistake that I had made from June be content to work in a hall closet. 1983 the through middle of 1984. Probably my biggest mistake was that even though we were in a moderate bear market\342\200\224the Dow came down from to continued to 1,296 1,078\342\200\224I play as aggressively asI had during O'Neil & the Did your original job at William Co. involve any market bull market from August 1982 through June 1983.1 also made the analysis? mistake of buying stocks that were overextended. By that I mean I was buying stocks that had already moved 15to 20 percent above their price but once I and You should No, was in, I just started studying studying. bases. only buy stocks that are within a few percent of their

base; otherwise, the risk is too great. On own I your time, I takeit turned it around by learning from all the mistakes that I had made. In late of real estate I 1984,1 solda piece owned and put all the money Yes. I on would take stuff home everynight and weekends. in a stock account. David 240 Ryan David Ryan 241

mid- others? Were you confident, despite your poor performance during Any that had out what 1983 to mid-1984,becauseyou felt you figured A good one on what to look for in individual stocks is Super you were doing wrong? Performance Stocks by Richard Love (Prentice Hall, Englewood Cliffs, NJ, The book has a on some of the 1977). great study greatest studied hard and was determinedto be Yes, because I had very winners of all time. Another one on stocks is good picking Profile of a Soin 19851 entered the I thought I was going to do very well. Growth Stock Kermit and Susannah H. disciplined, by Zieg Zieg (Investor's U.S. I won the stock division that year with a Investing Championship. Intelligence, Larchmont, NY, 1972). I would also recommendMarty Zweig's 161 return. I reenteredthe contest in subsequent years and percent book, Winning on Wall Street (Warner Books, Inc., New York, NY, exceeded 100 returns in 1986 and 1987 as well. I was and Stan substantially percent 1986) Weinstein's Secrets for Profiting in Bull and Bear I the exact same over and over again. was buying stocks doing thing Markets (Dow, Jones-Irwin, New York, NY, 1988), which has some when had all the characteristics I liked. they good sections on short selling. Finally, on Elliott Wave analysis, which I think has some there validity, is Elliott Wave Principle by Frost and Prechter(New Classic Library, Inc., Gainesville, GA, and a book How are you doing this year [May 1988]? 1978) called Super Timing by an English fellow named Beckman(Milestone Publishers,London). far this I am down. We are in a different type of market: Stocks So year, All those books are good, but you leam the most from the market have in the last three I am aren't as as they years. itself. time I a I the moving quickly Every buy stock, write down reasons why I bought this because I think the with a much smaller amount year, potential it out a playing [he pulls binder containing annotated charts]. Doing this helps is more limited. for a lot of money much cementin mind the making my characteristics of a winning stock. Maybe even it more important, helps me learn from my mistakes. book You mentioned earlier that for a while you read virtually every What kind of did trader's would things you learn by keepingyour diary? on the markets you couldfind. What reading list you give to out who is serious about becoming a successful someone starting Not overextended O'Neil's criteria for stock buying stocks,using stock trader? selection, and being as disciplined as possible.The more disciplined you can the better in get, you are going to do the market. The more you listen to and the more Essential reading on top of the list is O'Neil's book, How to Make tips rumors, money you're likely to lose. New NY 1988). Another book Money in Stocks (McGraw-Hill, York, Has keepingthis diary been an important of success? that is must reading is HowI Made Two Million Dollars in the Stock part your A Market by NicholasDarvas (Lyle Stuart, Inc., Secaucus, NJ, 1986). Absolutely. but it is fun and learn a ton. lot of people laugh at that title, reading you book I would recommend isReminiscencesofa StockOperator Another Can you describe your procedure for selectingstocks? about Jesse Livermore].Livermore by Edwin Lefevre [reputedly thin How to Trade in Stocks (Institute for himself wrote a very good volume, I start out by going through the stock charts and writing down the stocks Economic & Financial Research,Albuquerque, NM, 1986). with strong technical action. In other words,I write down all the stocks 242 DavidRyan David Ryan 243

I want to take a closer lookat. bined in our earnings per share (EPS) rank. [See the O'Neil chapter for a detailedexplanation of the EPS.] at Your company follows 7,000 stocks; you can't possiblylook 7,000 charts on a regular basis. What are you looking for in an EPS figure?

As as but in about high possible\342\200\224at least above 80, and above90. I don't look through 7,000, a week I probably go through preferably a lot of have in mind there Actually, stocks I buy an EPS rank of 99. 4,000 charts. So, I seea majority of the data base. Keep are probably about 1,500to 2,000stocksthat trade under $ 10, and I don't In markets my experience, usually anticipate. One thing that like to look at those anyway. me surprises about the EPS is that I would think that the price of the stock would run up well before the earnings growth starts to be Is that a rule:Avoid stocks under $10? good extremelypositive.

because are down there for a reason. Yes, they usually That is what a lot think. ofpeople They say, \"It's too late to buy the stock; the earnings are alreadyon the table.\" However, in analyzing hundreds Doesn't that knock out a lot of the OTC stocks? of the biggest winners, we found that, in many cases, the earnings had been on the table for a while.

Yes, a lot of the smaller OTCstocks.

What would to cause a stock just sit despite very good earnings? But aren't those sometimes the best buys\342\200\224the stocks that no one is

attention to? The broad stock paying any market may be weak and holding back the stock, but once the of the market comes these weight off, stocks just go right But of those stocks down there for and Sometimes. many stay years through the roof. to years. I would rather wait until they prove themselvesby moving up the $15 to $20range. How about if the stock market is OK? What would keep the stock from taking off in that type of situation? After you have reviewed the charts and written down the stocks that interest you, what do you look at next to screen your selection? Perceptions\342\200\224people might not believe that the earnings are going to continue as as had in the and the two strongly they past. I look at the five-year earnings growth record last quarters of earnings relative to the previous year's levels.The quarterly What else are besides the show if there is deceleration in the you using EPS and the earnings comparisons you any earnings growth breakdown to screen stock rate over the last your selections? rate. For example, a 30 percentgrowth five yearsmay look very impressive, but if in the last two quarters earnings were only it warns that the relative is up 10 percent and 15percent, you strong growth period The strength very important. [The relative strength ranks a those two factors\342\200\224the stock's may be over. Of course, five-year earnings price change relative to all other stockssurveyed. See the O'Neil growth record and the earnings during the past two quarters\342\200\224are corn- chapter for a detailed definition.] 244 David Ryan David Ryan 245

in relative Do What are you looking for strength? you also use the relative strength of the industry as a filter in your stock selection?

At least above 80, and preferably above 90. Yes. Investor's ranks between 0 and 200.1 Daily industry groups want the to be in the 50. Intuitively, I would almost think that\342\200\224 usually industry group top

To continue the after the screening process, checking stock's \"It has already gone too far. It can't get any stronger.\" relative strength, the EPS, and the industry relative strength, what is your next step? Well, not necessarily that it can't get any stronger, but it seems to me that, by definition, every stock has to have a high relative I checkthe number of shares outstanding. I am looking for stockswith strength when it tops. How do you avoid sometimesbuying the highs, less than thirty million shares and preferably only five to ten million if you are restricting yourself to high relative strength stocks? shares.Stockswith more than thirty million shares aremore mature; they have a few times.It is a caseof and demand: already split supply I am able to avoid mat because in first of the usually my step screening Because you have more supply, it takes a lot more money to move those charts, I generally rule out stocks mat are overextended from their base. stocks. Very often the stocks with the highest relative strength continue to the market Microsoft had outperform for months and months. Forexample, What else do you look at? a relative strength of 97 when it was at $50 a share.It eventually moved

to You want $161. some institutional ownership, because they really power a stock higher, but you don't want too much sponsorship.I would the 1 to 20 mutual fund Are you implying that the higher the relative strength better? say percent percent sponsorship is the ideal range.

Are there other into the stock rather of any important elements that go Yes, I would go with a relative strength 99 than 95. However, selection process? oncethe relative strength starts falling off, I usually get out of the stock.

Yes. There should be something new that attracts people to that stock. So you are not only paying attention to the relative strength value For example, Reebok had shoes that were hot. Compaq had a fantastic itself, but also the trend ofthe relative strength. portablecomputer. Microsoft was a leader in the software field.

Right. If the relative strength starts breaking an uptrend, then I would be Doesn'tthat rule out most companies that have been around for a very cautious, even if it is still well above 80. while?

Am I going in the right order, EPS to relative strength, in terms of Yes. You don't want to be playing General Electric because there is how you filter down your initial stock list? usually nothing really hot or brand new going on. Occasionally, there are exceptions.For example,General Motors has gone virtually I would relative strength first, then EPS. Many times the probably place sideways for the last five years, and it looks like they are trying to turn relative strength takes off before that big earnings report comes out. their situation around. 246 247 DavidRyan David Ryan

With General \"new\" be the hold a stock? Motors, might the recent shift to high How long do you typically styling?

months, stocks that I usually hold my big winners for about six to twelve Yes, but in most are to find the new in cases, you going emerging than two weeks. aren't that strong about three months, and my losers less entrepreneurial growth companies.

Do an on the stocks you buy? I would imagine if you go through 7,000stocks,there must be quite you pick objective

a large number that meet your criteria.

runs then No. I usually wait until the stock up, builds another base, and On average, there are probably only about seventy stocks that meet the breaks down. That is when I liquidate.

criteria, because it is tough to meet all the conditions. ThenI cut those seventy down to about seven. Do you think people should only use market orders?

How do you cut down from seventy to seven? in a In a dull market that is just trading back and forth, you could put to I those stocks that have all the limit order. But if you really think the stock is going make a big pick characteristics plus a great-looking that be the reason are the stock to base pattern. I also look at how the stock has done in the past. For move\342\200\224and should only you buying an of a has the stock doubled before? A lot of the stocks I have begin with\342\200\224then there is no reason to haggle over eighth point. example, buy think doubled the stock. The same thing to the downside; if you already and tripled before I buy them. Just buy applies the stock is going to drop, just sellit.

You to a stock that has learned the market orders in 1982 when I was actually prefer buy already doubled as I lesson about trying to a stock in a it opposed that is long base? to buy Textone, which was trading at $15, for $14%. The next day to the stock at jumped Vh points, and I couldn't bring myself buy $16k that shows me That Yes, because there is something very unusual going on, when I could have bought it at $15 a day earlier. stockeventually and if the situation is that good, a doubling may just be the beginning. It went to $45. is probably going to double again.To sum it up, I am looking for the stocks in the in terms of strongest market, both earnings and the when it makes a One element of your trading style is buying a stock technicalpicture. new high. Wouldn't the fundamental screening conditions you use have been in place well before that point? Since use an you extremelyrigorousselectionprocess,doyou have a high percentage of winners in your stock picks? to a stock when In somecases,they might have been. But I am trying buy have the most chance When a stock is off about I cut the you of making money. coming No, only 50/50, because losers very quickly. The the low end of a base back to the high end, there will be a lot of people maximum loss I allow is 7 percent,and usually I am out of a losingstocka who it near the and sat with a loss for months. Some of lot quicker. I make my money on the few stocks a year that double and bought highs to out at and that creates a in in those people are going to be happy get even, triple price. The profits those trades easily make up for all the small losers. lot of overhead resistance. 249 248 David Ryan David Ryan

a stock which much more of If it reenters its base at all? Do mean even if it is below the So, isat newhighshas an open running you just some minimum field? top end of the base, or do you require penetration?

it out and No, if it just reenters the base. In some cases, will break come Right, because no one ahead of you is at a loss and wants to get out at to the of the but not reenter. That's fine, and I will stay the first back top base, opportunity. Everybody has a profit; everybody is happy. it with the stock. But if the top of the base was $20 and breaks back to $193a,I want to sell at least half of the position because the stock didn't But the downside of that is if to new you wait for a breakout highs, when a stock back into its base, it keep on moving. Frequently, drops a lot of times the market will back into pull the trading How the of the In the range. goes all the way back down to lower end base. example, do you avoid getting whipsawed in those situations? if it goes from $21 down to $l93/i, it will often go all the way back down

to $16. Therefore,you want to cut your losses quickly. You can tell a lot by the volume. If the volume doubles one day and the stock moves to a it is is the back into the base a new high, telling you a lot ofpeopleare interested From a technicalperspective, price going in the stock and buying it. bearishindicator?

Yes. Stocks should be at a the first them. In fact, So volume profit day you buy becomes very important as a filtering process to avoid a on the first is one of the best indicators that you are getting whipsawed. having profit day going to make money on the trade.

Yes. If the stock moves to new but the volume is with the high ground, only up Do you use the table in Investor's Daily that lists the stocks 10 I would be in the percent, wary. greatest percentage increase volume relative to past fifty-day average volume levels? Do you buy it the first day the stock breaks out to new highs, or do that are to take off. you wait for it to consolidate for a few days? Yes, I use it to help spot stocks just about ready

Are you using it to verify stocks you have alreadypickedout? I want to buy it as soon as it goes to new highs.

to the stocks I am Yes. After I have done my weekly screen select for the to hit that column as a If a stock at it interested in I sometimes wait stock you buy new highs and then pulls back into the range, buying, at what point do you decide it was a false breakout? For example, timing signal. assumea stockthat has been trading between $16 and $20 goesto Can elaborate on volume as a tool? $21and you buy it. What do you do if two days later the stock isback you using trading to $19? want to When a stock that has been moving up starts consolidating, you see volume dry up. You should see a downtrend in volume. Then when If it its I reenters base, have a rule to cut at least 50 percent of the it means the stock is to volume starts picking up again, usually ready position. blast off. David 251 250 David Ryan Ryan

Do therefore avoid P/E ratio stocks? So, in the consolidation phase, decreasingvolume is good. If you you high continue to see very high volume, do you start thinking potential top? Yes, in many cases I do. The most profitablesituation is when you find in that a stock with a trend that is trading at a P/E ratio line Yes, because shows that a lot of peopleare getting out of the stock. strong earnings with the broad market ratio. You want an increase in volume when the stock breaks out, but you want a decrease in volume as the stock consolidates. If you avoid high P/E ratio stocks, wouldn't that have prevented you from the whole biomedical move? Any other volume signals you look for? catching group

That was a little different because of the fact that the whole was When the market, or a stock, is bottoming, you want to see increased group at P/E ratios. volume combinedwith an absence of further price progress on the trading high downside. For example, if the Dow declines from 2,200 to 2,100, trades there for a new down to 2,085 the next day, and then closes higher on increased volume, Does that imply that should be an exceptionmade it demonstrates support. It suggests that there are a lot of buyers coming industry? in.

with these rules. Yes, you don't want to be absolutely rigid have in The screensyou described selecting stocks are essentially

O'Neil'sCANSLIMmethodology. [See the O'Neil for chapter Has the basic market behavior stayed the same in the 1980s versus definition.] Did add of own elements to his you any your approach? the 1970sand the 1960s?

Yes, I learned that most of our greatest winning recommendations started Yes, the same types of stockswork time after time. It hasn't changedat off with prices under thirty times earnings. O'Neil says the P/E all. We can take one of the greatest winning stocks from 1960 and line ratio is not think it [price/earnings] important. I is, in that your success it with one of the best stocks in 1980 and are to have up they going ratio is a lot higher on lower P/E ratio stocks. exactly the same characteristics.

But I guess not too low P/E ratios? Do you have any thoughts on the subject of short selling?

When I'm talking about lower P/E ratio stocks,I mean stocks that have it ratio I need more time to and more experience. However, to pick a a P/E that is between even and up to two times the S&P 500 P/E study I all these characteristics we ratio. So if at fifteen times short, think you need to flip were talking the S&P 500 is earnings, you should try to about. Instead of a should look for a five- buy stocks with P/E ratios between 15and 30. Once you start going much good growth record, you poor that the year growth record and quarterly earnings are decelerating. The beyonddouble S&P 500 P/E ratio level, your timing has to be more and stockshould be losing relative uptrends, starting exact.You are bound to make a few moremistakeson higher P/E ratio strength, breaking stocks. to hit new lows. 252 253 David Ryan David Ryan

Do think that short be a critical was on low volume? you selling may element for Because the rally superior performance if we go into a long bear market?

Yes, and the fact that there were very few stocks that participated in the I think it Bill Yes, would help. But, O'Neil will tell you that is the line did not move as as it did on the shorting rally; advance/decline high about three times hard as as buying stocks. Bill says he has made previous in late the discount rate was raised for the first rally. Also, August, substantial in two of the bear money only past nine markets. He thinks the time in three years. I think that really stabbed the market. best thing you can do in a bear market is just sit it out. You haven't beenin the business that long. Do you have the How do a market before you recognize bear it's too late? confidence that you will be able to trade successfullyalmost every year for a long time? how individual stocks are By well my doing. If, during the bull phase, the leaders start it indicates that a market is that will losing, bear developing. If I Yes,becauseI have established a very defined set ofprinciples have five or sixstocks in a row that a caution for I get stoppedout, flag goes provide the foundation for successful trading years to come. Also, up. plan to never stop learning.

What else do you look for to a bear market? signal Do you feel you are getting better as a trader?

Divergence between the Dow and the advance/decline trade that are daily line [a graph Yes.If you try to learn from everysingle you make, you of the cumulative net difference between the number of York Stock time on. New only going to get better and better as goes Exchange stocks advancing each day versusthe number declining]. The tends to out a few than the advance/decline top months before the Dow does. Why are you so much more successful typical stock investor? Did that happen in 1987? Because I am doing something that I love to do and find fascinating. After or nine hours at work, I home and spend more time on the The advance/decline topped out during the first quarter of 1987, well eight go markets. I the charts to me on and I through before the stock market peak in August. have delivered Saturdays, go are them for three or four hours on Sunday. I think if you love what you doing, you are going to be a lot more successful. Were you looking for a top because of that?

A lot of people who invest use their spare time to study the market Not at that because a lot the point, of individual stocks were still doing and still have only mediocre, or even losing,results. well. that the market very Thebig clue was really topping was after the Dow came off its at there high 2,746, was a very feeble, low-volume That is probably because they have not found a disciplined system for rally, and then the market got hit for another 90-point loss. At that stocks. read an article and \"That sounds like a good picking They say, juncture, I decided it was time to move out of the market. their broker recommends stock, I'll buy it.\" Or they buy a stockbecause it. 254 David Ryan David Ryan 255

What advice would novice you give the trader? The made a most recent pricebase]. 1983-1984 experience lasting that mistake. impression on Ryan, and he has not repeated The single most important advice I can give anybody is: Learn from your a trader's is an essential element of Maintaining diary Ryan's mistakes. That is the only way to become a successfultrader. annotates the chart with his approach. Every time he buys a stock, Ryan the stock. Whenever he or adds to an reasons for buying liquidates Any final comments? a new chart is includedwith comments. This existing position, updated in his mind the characteristics of approach has helped Ryan reinforce key The about the market is that it is greatest thing always fun to be his has looking winning stocks. Perhaps, more important, reviewing past entries for that next to find all big winner\342\200\224trying the stock with the mistakes. helped him avoid repeating similar trading characteristicsthat are to make it have a move. going big The isn't any is feeling Ryan's basic approach, like William O'Neil's approach, to buy different now than when I was only trading 500 shares. There is still the value and strength. He also believesin focusing on the very best stocks same satisfaction of knowing you found a stock before it made its big as to his One important observation Ryan move. opposed diversifying portfolio. is his made, which many other traders may find helpful, that best trades little reservation are usually winners right from the start. Thus, he has You make it sound like a game. about getting out of a losing trade quickly. The maximum he will risk on trade is a 7 decline.A rigid stop-loss rule is an It any percentprice is. To me it is like a treasure hunt. Somewhere giant in here [he traders. pats essential ingredient to the trading approach of many successful the chart there is to weekly book] going be abig winner, and I am trying to find it.

The conventional wisdom about how to make money in stocks is summarized by the semi-facetious advice: Buy low and sellhigh. David Ryan would His can be summarized disagree. philosophy as: Buy high and sell higher. In Ryan will not consider fact, usually buying any stock selling for less than $10.

success is to Ryan's basically due using aprecise methodology and to applying great discipline follow it. As Ryan has clearly demonstrated, a trading methodology doesn't have to be to be original extremely successful. Ryan readily acknowledges that most of his approachhas been learned directly from the writings and teachings of William O'Neil.With the of hard work and help in-depth study, he has been able to apply O'Neil's trading philosophy with great effectiveness. When traders deviatefrom their own rules, they invariably tend to lose. Ryan is no exception. During mid-1983 to mid-1984,hewitnessed a period of extremely poor performance. He let his previoustrading success go to his head by repeatedly breaking one of his own cardinal rules: Never an buy overextended stock [a stock that is trading far above its Schwartz Marty

ChampionTrader

I interviewed Marty Schwartz at his office after trading hours. I found him to be very opinionated and intense about the subject of trading. This intensity occasionally spills over into anger when a raw nerve is hit (such as program trading). In fact, Schwartzreadily admits that he finds anger a useful trait in trading. None of this \"going with the market flow\" philosophy for Schwartz. In his view, the marketplace is an arena and other traders are the adversaries.

I was also struck by Schwartz's dedication to his daily work routine. He was doing his market analysis when I arrived and continued to run through his calculations during our interview. When I left that evening, his analysis was still unfinished. Although he appeared very tired, I had no doubt that he would that Schwartz has finish his work evening. followed his daily work routine religiously during the past nine years.

Schwartz spent a decadelosing money on his trading before he found his stride as a remarkably successfulprofessional trader. During his earlier years, he was a well-paidsecurities analyst, who, as he describes it, was always broke because of market losses. Eventually, he his in the of changed trading methodology, process transforming himself from a repeated loser to an amazingly consistent winner. Not only has Schwartz scored enormouspercentage gains in every year since he turned full-time trader in 1979, but he has done so without ever losing more than 3 percentof his equity on a month-end to month-end basis. 258 Marty Schwartz Marty Schwartz 259

Schwartz trades from an office at home. I was to Amherst which was one of the independently Heisproud accepted College, great of the fact that he has no traders of this no of life. When I went to freshman orientation said, employees. Solitary type, experiences my they matter how are unknown left and that half of are to be successful, usually to the public. Schwartz, \"Lookto your right and realize you going attained a are to in the bottom however, has degree of fame through repeated entries in the in the top half of the class and half of you going be U.S. run Norm half.\" Most of those who matriculated there, were in Trading Championships, by Zadeh, a Stanford including myself, His the their school class. that I wasn't Universityprofessor. performance in these contests has been nothing short top 5 percent of high Perceiving going of astounding. In nine of the ten four-month trading championships he to be at the top of everything was a difficult first realization. even had to a entered (typically with a starting stake of $400,000),he made more It was the first time in my life I had to struggle. I get than all tutor for calculus because I wasn't the But when I money the other contestants combined.His average return in just getting concept. at a these nine contests was210 the one finally got it, when the light bulb clicked on, it was like looking percent\342\200\224nonannualized! (In I the of and remainingfour-month contest he witnessed a near breakeven result.) In his magnificent painting. really experienced joy learning working in a hard there. a means to an I found single entry one-year contest, he scored a 781 percent return. Before, studying was only end; now, Schwartz's that itself was a Amherst had a influence on entry into these contestsis his way of telling the world that learning realjoy. profound he is the best trader around. In terms of risk/reward ratios, he may well me. be. After graduating in 1967,1 was accepted to the Columbia Business School. At the time, the government had just ended graduate school in military deferments. Since I was unhappy at Columbia and combat Vietnam didn't appeal to me, Ijoineda U.S.Marine Corps reserve unit Pleasestart by telling me about your early days. that was recruiting officers. You have to be somewhat crazy to be in the Marines; it is a very far back do want the then rebuild in How you me to go? unusual organization. Theypush you to edge and you their own mold. However,I have developed a great respect for that because the Marine been From whenever you think is appropriate. bureaucracy, throughout Corpshistory, they've consistent in their training procedure. As a second lieutenant you have

forty-six lives under your control, so you must be wellskilled.They put Well it is very relevant to go backto my childhood, quite frankly. Should you under a lot of pressure.If you couldn't cut the mustard, you didn't down on the in I lay couch? I grew up New Haven in a family of modest get the bars. We had an attrition rate that I believe approached 50 was hard seven or means.I very working. When I was eight I would go percent. out with a snow shovel and come back with $10 after a snowstorm. I was the only reservist in Officers Candidate School in Quantico Even now, I stillput in about twelve hours a I feel day. at that time. There were 199 regularswho went to Vietnam, but I came uncomfortablenot doing the work; that's why I am it now as are doing you sitting home; that was the deal I made when I was recruited. I was alsothe only here. I calculate a lot of mathematical ratios and oscillators, and I too post Jewish person there, and they weren't favorably disposed toward my own charts. My attitude is that I always want to be better prepared Jews. One time, the platoon sergeant drew the Star of David on my than someone I'm The I is competing against. way prepare myself by forehead with a magic marker. I wanted to knock the crap out of him, work each doing my night. but I figured he didn't really know the historic significance of what it I As grew up, I realizedthat education was ticket, meant. I knew he was to find kind of point that my probably just trying any pressure it because was strongly emphasized in my family. I studied hard and was would make me break. The hardest thing I had to do wasscrubthe magic an honor student in school. high marker off my forehead. That's abitch [helaughs].Anyway, Ipersevered 260 Marty Schwartz Marty Schwartz 261 and made it through successfully. I consider that a really fine At the time, did you know what had happened? achievement.The feeling improves as time passes,and you forget the real pain of the experience. No, I didn't, but I assumed that everything would be all right if I told the The me rigorous Marine training gave the confidence to believe truth, which I did. I was totally exonerated; the exchange realized I had that I could at perform levels beyond my previous expectations. Just as beensetup.The drug analyst eventually confessed because an exchange Amherst had mind, the Marines strengthened official found out what it all It was a strengthened my my body. happened by piecing together. two convinced me that I almost if I The experiences coulddo anything rotten, bitter experience for me, and I was very sour. I shut the door of my worked hard enough and the groundwork for successful office and I lost the the the desire to provided my stopped working. spark, drive, trading. That's not to say it worked right away, because it didn't. succeed. After getting out of the Marines, I returned to Columbia and held some boring part-time jobs while I completed my M.B.A. My first full- What were you doing at that time? time job was as a securitiesanalyst at Kuhn Loeb. I specialized in the health and retail field, and I stayed there for two years. I found that, on I was still doing reports, but I didn't have my heart in it. Besides that Wall Street, the best way to receive a pay increasewas to change jobs. whole negative experience, it was early 1973, and I felt the market was The work for never wants to as much as a out. I had become interested in technical At the company you pay you topping very analysis. to recruit the line had formed a months company trying you. time, advance/decline major top many I left for XYZ in 1972.1 want to leave out the firm's name and other earlier. I felt that the market and the stocks I was covering were going to go particulars for reasons that will soon become obvious. This provedto be down.Still,peoplewanted to know how many widgets a company was one of the most difficult periods in my life and career. XYZ had thirty sellingand at what price. I lost the spirit to write bullish reports, because divided into three often. Because the research if stock are down, who cares how are analysts, subgroups prices going many widgets being directordidn't want to work, he had one of the senior analysts of each group sold.I was covering growth stocks, which in those days sold at forty or reviewthe work of the analysts. The policywasthat our research reports fifty times earnings. It was all so ridiculous! would be circulatedand critiqued by the other analysts within the Were from what subgroups prior to being sent out. you discouraged writing bearish reports? Also, I had written a bearish report on hospital management stocks, ever happened to the bearish report that was leaked? saying that the industry would eventually go to a utility rate of return. wrote on Wall Street at that time. I allowed As part of the normal routine, the draft was circulated among the other Nobody bearish reports was one of whom drunk one on a home from to the bearish on the hospital but analysts, got night flight complete report management industry, believe ever intended it. Of it was Californiaand told a client about my report. He even sent him a copy of the I don't they to publish course, after rush it to the their report in progress. What right did he have to send out my work? The leaked, they were forced to printer to save scalps. stocks began plummeting prior to the report's release, becausethe client started spreading rumors that a negative report was about to be issued. What eventually happened?

It was a bitter experience. I had to testify for six hours before the I in the bear and out of work for four New York Stock Exchange. My company's counseltold me, \"We will lost my job market was months. but should our interests at we will That wasa very interesting because I believe you learn the most represent you, diverge any point, period, inform you.\" Schwartz 262 Marty Schwartz Marty 263

which in those I resented what I the through adversity. I had about $20,000, days was a lot of called \"tap dances,\" which made you feel like I found a real lunatic who had a of meat. You meet with money, and was going to trade. I developed piece portfolio managers to give them your commodities. At the he had to rent views on the stocks follow, so that will computerprograms for trading time, you they give commission on business to firm. On a time on a monster machine to run programs that today you could do your typical trip, you might have five appointments I in Houston, to San Antonio for any PC. He was using different moving averages, that sort of thing. put fly dinner, and then fly to Dallas later with that to be for the some of my money in with him, and I lost most of it\342\200\224along my night ready breakfast next morning. I got sick of it. I wanted to have a I dreams of glory. family, but felt that I wasn't able to handle it I had to back to work. I financially. I had resisted married because I Having dissipated my capital, decided I go getting was afraid of being out. in for a shock. I had been honest and I tapped But, at that point, I wondered whether it had been a was Although totally forthright, seem was tainted. \"Oh, aren't you the guy who wrote that report?\" It didn't self-fulfilling prophecy. People to know how to handle failure because can it matter that I had been totally ethical and exonerated.Peopledon'twant they produce themselves. It almost becomes a negativecauseand it effect know to get involved with any controversy, even if wasn't of your own cycle, whereby they produce it, they how to handle it, and making. they wallow in it. had A friend of mine helped me get ajob at Edwards & Hanly, which, By mid-1978,1 been a security analyst for eight years and it had it was a retail-oriented had a of who become intolerable. I knew I had to do different. I although firm, group analysts something always knew I wanted to work for became real stars. It was there that Imet Bob Zoellner, the managing partner myself, have no clients,and answer to no one. almost That, to me, was the ultimate I had been of the firm. He was a great, great trader.He single-handedly kept goal. brooding for years,\"Why wasn't I well when I was the firm afloat in 1974 by shorting stocks and making money in the firm's doing groomed to be successful?\"I decided it the side. He was now time to be successful. capital account, while they were losing money on operating When a fund in 1976 and went on to becomean brokerage firm wants to hire started his own hedge you, they'll give you anything. Once you are there, are far less when I extraordinary success. they responsive. So, was romanced I asked I always had a goodnoseas a securities analyst, and it has stood being by Hutton, for a quotemachine in my office. I who was the securities that had machine. me in good stead. When I noticed that the head of research, never only analyst a quote During my last at I out to lunch I started year Hutton, started closing the door to office so that I could went out to lunch, began going regularly, my when the firm in fall watch the market. I talked to friend Bob times a interviewing for another job. So, went bankrupt 1975, my Zoellner several day, and he taught me how to market action. when I had another job linedup at Loeb Rhoades. analyze For example, the on me. market newsand it means the market In 1976,1 met my wife-to-be and she had a profound effect gets good goes down, is very weak; it when it bad news and it means She made me realize that my life was not a dress rehearsal; was the gets goes up, the market is healthy. that I real and I had been it up. I had steadily earned During year, started taking trial subscriptions to a lot of thing screwing Although different I was still almost broke because I lost newsletters. consider a I didn't goodsalaries,I consistently money myself synthesizer; create a in the market. necessarily new methodology, but I took a number of different and molded them into We got married in March 1978. By that time, I was methodologies my own approach. I found a on business harder guy, Terry who lived in Nantucket and had an workingat E. F. Hutton. Being married made going trips Laundry, unorthodox called the When are friends from in approach Magic T Forecast.Hewas an MIT and harder. you twenty-five, seeing college when in engineering graduate with a math and that to different cities around the country is very exciting, but you get background, appealed me. had to me out the His basic theory was that the market the same amount of time your thirties, it gets real stale. My wife literally push spent going as down. the door when I had to go on thesetrips. up going Only amplitude was different. 264 Marty Schwartz Marty Schwartz 265

down Did In my experience, markets come a lot quicker than they go up. you make a complete transition from fundamental to technical Doesn't that contradict the theory? analysis?

Themarket movement before it goes down may bea distributive process. Absolutely. I always laugh at people who say, \"I'venever met a rich use the time element is technician.\" I that! I call them M-tops. Thepoint you to measure not love It is such an arrogant, nonsensical response. I the price high, but an oscillator high, which precedes the price high. That, used fundamentals for nine years and got rich as a technician. in fact, is a major cornerstone of his work. The theory had different me. But were still properties that I learned, and it has been extremelyhelpful to you doing fundamental analysisasan analyst?

to earn For the record, what is the name of Laundry's book? Yes, a salary. But my wife said to me, \"Go out on your own. You're and thirty-four you've always wanted to work for yourself. The There is no book. He extolledhis his various worst that can is that '11 back to what were just theory through happen you go doing you doing After before.\" newsletters. He also had some pamphlets. Actually, it was kind of funny. I in a Barron's he for his I mentioned him article, got a lot of inquiries always picturedmyself as being brave, courageous, and strong, pamphlets. He is a little eccentric. His response was, \"I don't have any but when it came time to take the chance, I was scaredout of my mind. I copies available.\"He should have printed them and made somemoney. had $140,000, of which about $30,000 was tied up in tax deals and I developed and synthesized a number of indicators that I used to $92,500 was used to pay for a seat on the American Stock Exchange. with determinewhen the market was at a lower-riskentry point. I focused on That left me about $20,000 when I went on the floor as a market there are maker. I borrowed determining mathematicalprobabilities. Although occasionally $50,000 from my in-laws, which gave me $70,000 of situations where the market goes three standard deviations instead of working capital. based on the likelihood that 98 of the moves will at I started off in first two in the business. I two, percent stop losing my days got two standard deviations, I'll take that bet any day of the week. And, if I involved in Mesa Petroleum options because Zoellner,whom I I risk control and out X dollars am wrong, am going to use stop myself profoundlyrespected, thought they were significantly undervalued. I called him the most critical element. the second from I away. That is day the floor, \"Are you sure you are right?\" must have I to all these a had a total of ten down Anyway, subscribed letters, developed grand options. I was $1,800 and dying. I was hadrun to in methodology,and traded like crazy. By mid-1979,1 $5,000 up $140,000 petrifiedbecause, my mind, I was down almost 10percent,sinceI didn't consider in just two years. my in-laws' money part of my own working capital. The third Mesa day, options started going up and I never looked back. When did you turn from a loser to a winner? After the first four months, I wasahead by $100,000. The next year I earned$600,000.After 1981,1 never earned less than seven figures. I When I was able to separate my ego needs from making money. When remember talking to a good friend of mine in 1979 and saying, \"I don't was think I was able to accept being wrong. Before, admitting I was wrong anybody can make $40,000a month trading options.\" Now I can more than the I used to to will to do that in a without a upsetting losing money. try things day problem. I it therefore it can't be When I becamea happen. figured out, wrong. the You were did winner, I said, \"I figured it out, but if I'm wrong, I'm getting hell out, doing very well on the floor. Why you leave? because I want to save my money and go on to the next trade.\" By living so It the philosophy that my winners are always in front of me, it is not was very slow during lunchtime in those years. I used to go to an painful to take a loss. If I make a mistake, so what! upstairs office to eatmy lunch. While I was at my desk eating a sandwich, Schwartz 266 Marty Marty Schwartz 267

I would do charts and look for different ideas. I came to realize that book is the most my extraordinary advantage one could everaskfor. In I could see much more at the desk, at a machine, than normal the sitting looking markets, specialists can always define their risk. If they have a being at a post, trading an option. On the floor, the specialists chose the bid for 20,000down %, can the they buy stock, knowing they can always symbols they wanted to on the quote machines, because out'/\302\253lower. So, are keep they paid get they protected. I always tell my friends to have the rent on them. So had to run around to find what their you always you daughters marry the son of a specialist. wanted to see. I felt much more comfortable Ican't standmost established upstairs. institutions. Ihaveame-against-them About a and a half later, after I started a lot of which I believe year earning money, mentality, helps me be a better, more aggressive trader. the floor wasn't There was a much arena to in. It as as I maintain an big enough. bigger play helps long intellectual bias in my work and the fact in in the Another reason for my move was that, 1981, a change discipline in money management. tax laws made it more lucrative to trade futures than stocks and options. In my futures trading, I didn't try to make two one year, four the What was your experienceduring the week of the October 19 stock the earn more in futures next, eight next, etc. I didn't significantly my crash? in in in trading 1987 than I did 1982, because I used my profits to invest

real estate and other things to enhance the quality of my life. came in I long. I have about it, and I would do the I wasbrokein the 1970s, and I never wanted to bebrokeagain. My thought same thing again. Why? Because on October 16, the market fell 108 philosophy was that if you make money every month, nothing bad is points, which, at the was the won't never time, biggest one-day point decline in the of going to happen to you.So,you be the richest person. You'll history the stock exchange.It looked climactic to me, and I that was a be the richest person anyway. What difference does it make? I'm proud thought buying opportunity. The only problem was that it was a a of my futures trading, because I took $40,000and ran it up to about $20 Friday. Usually down Friday is followed by a down million with never more than a 3 percent drawdown. Monday. I don't think would have Monday been nearly as bad as it was, if James Bakerhad not started Did you continue trading stocks during this period? Treasury Secretary verbally bludgeoning the Germans about interest rates over the weekend.He was so belligerent. Once I heard Baker, I knew I was dead. Yes, but with a different mentality. I tradedstocksfrom a little longer time horizon. I don'tfeelthe same pressure when I own 100,000 shares of stock as when I own 100 S&Ps. So, you knew that you were in trouble over the weekend?

Will trade the short side as the you stocks as readily from long side? Yes. Also, Marty Zweig, who is a friend of mine, was on \"Wall Street Week\" on Friday evening, talking about a possible depression. I called No, I find it harder to trade stocks from the short side. Marty the next and he saidhe there day, thought was another 500 points in the risk market. Of course, he didn't know it Because of the uptick rule? was going to happen in one day.

No, it is just easier to short the S&P, because you get so much more bang hate the What made him so bearish for the buck. Also,I specialist system; they are always trying to at thetime?

con you to death. I'll give you my view on specialists: Never in my life have I met a lesstalented of who make a I think his indicators were group people monetary terribly negative. Remember, the their skills. bonds were disproportionatelylarge amount of money relative to Having the specialist sinking rapidly at the time. Schwartz 268 Marty Schwartz Marty 269

had known what was What happened that Monday? When did you get out? they going on. The banks weren't meeting any of the calls at the brokerage firms. On Tuesday morning, we were within hours of the whole in the S&P on was269.1liquidated my position thing totally collapsing. So my caution was well The high Monday long 267'a. I was real of that because it is hard to pull the advised. at proud very a loser. I I think I was 40 contracts I think my fear of a is related to father trigger on just dumped everything. long depression my graduating in 1929. If talk to who out of at that coming into that day, and I lost$315,000. college you people got college time, One of the most suicidal can do in is to it is as though a ten-year is from their lives. There was tilings you trading keep period missing I could have lost million that substantial on in this That stuck with adding to a losing position. Had I donethat, $5 just nothing going country. always and but I honored risk and because I feared it so much. I think that is one of the I day. It was painful, I was bleeding, my points me, reasons why don't bit the bullet. try to increase my earnings geometrically. On the day of the crash, Marine came into when I looked at son in his I I don't want him That's another example wheremy training play. my crib, thought, ever to when are under attack. One of the ask \"Dad, didn't do could have done?\" They teach you never to freeze you me, why you everything you manual is either or tactics in the Marine Corps officer's go forward out of Even When did you start trading backward. Don't just sit there if you are getting the hell beat you. again? are still It is the retreating is offensive,becauseyou doing something. is to of that week. It was because I started out same thing in the market. The most important thing keep enough Wednesday funny trading only comeback. I did real well after October19.Infact, one or two S&P contractsat a time. The S&P was in powder to make your trading full point increments to $500 contract, to for a 1987 was my most profitable year. [equivalent per compared $25 minimum tick], and I didn't know how to handicap what was going on. From Did I knew we were in some sort of You liquidated your long position very wellon October19. you past experiences, opportunity period, but were the rule attitude think about actually going short? they rewriting book. My is: Never risk your didn't need family's security. I to make any more money at that point. \"Now is not the time to On the market to an area it should I thought about it, but I said to myself, worry Wednesday, got up whereI thought what be short twelve about making money; it is the time to worry about keeping you shorted. I ended Wednesday S&P contracts, which for me have made.\" Whenever there is a really rough period, I try to play was a miniscule position. defense, defense,defense.I believe in protecting what you have. That night, Bob Prechter [editor of the Elliott Wave Theorist, a out of most of and followed out a The day of the crash, 1got my positions protected widely advisory letter]put negative hotline message. The went to next the market Then at 1:30 P.M.,with the Dow down 275 I morning, was under tremendous partially my family. points, pressure, out. Half hour I went to because of that but because one my safe deposit box and took my gold an later, recommendation, mainly of the biggest fund in another bank and started checks to cash out. I started managers the country was trying to liquidate a monster writing get my long bills and for the worst. I had never seen position. It has been stated that he lost $800 million that buying Treasury preparing during period. I called the S&P before the that anything like what was going on. pit just opening morning, and my clerk said,\"Decembersare offered at 230, offered at 220, offeredat 210,

the under? at 200 even.\"I \"Cover!\" I made million You were seriouslyworriedabout banks going trading yelled, a quarter of a dollars on twelve of the contracts! It was one most memorable trades of my

I heard, from on the life. Why not? The stories subsequently, people the of the if operations side of the business would have stopped hearts public 270 Marty Schwartz Marty Schwartz 271

an element What are your thoughts about program trading? [See Appendix 1 Your example introduces of frontrunning, which for definition.] obscures the basic question.What I am trying to get at is: What is immoral about buying stock and selling futures (or the reverse in I hate it. There used to be a natural ebb and flow in the market, but trade) because prices the two markets are out of line? killed it. Those firms wield program trading doing program trading to move the and the locals have BecauseI've seen situations in which a firm has information about a extraordinary power market, simply to it a ahead of time. For when the state of become accomplices. I'm not just paranoid, becauseI've adjusted and debt/equity swap day example, New billion worth of it been successful. But I hate it. Jersey sold $2 stock and moved into the bonds, this firm it the knew about day before. Since they knew they were going to be $2 billion worth of stock the next from 4:00 to Some people say that all this criticism of program trading isa bunch selling day, 4:15, sold thousands of futures contracts to set the of nonsense. they up trade. That stinks.

The you is a case of on inside example just gave (a) trading Well, they are idiots. information,(b) frontrunning, and (c) an outright trade. It is not a program trade. Let me give you an example.Let'ssay a trading firm has a No,someof them are very intelligent people. computer programthat signals when stocks are overpriced or un- relative derpriced to futures, and they are not doing any customer are one of them that are idiots. No, they idiots. I can prove to any they business\342\200\224

How do you prove it? Let me give you an example first. If these brokerage firms need an 80- cent discount to take off a customerprogram, they will take off their own position at a 50-cent discount. They have the edge and can run in front There is something I would like the regulators to investigate. The market their of their clients because transaction costs are lower\342\200\224they're not than used closesnear the high or low of the day much more frequently it paying commissions to themselves. within 2 of to. During the last two years, the market has closed percent

the or low of the day about 20 percent of the time. high to I keep trying separate these things out. Let's take an chance. example Mathematically,that type of distribution is impossibleby where there is no or customer frontrunning business\342\200\224just their own somebody trading money, trying to take out an arbitrage profit. if it is immoral. is You talk about trading as What If that is their it worse program methodology, why is any than your futures? unethicalabout trading stocks against methodology?

the to Because it Becausethe program traders also have the other side of equation is a dumb game. Anybody who puts on a basket of stocksto do. You have the so-called Chinese wall in investment banking, where earn 80 basis points above the T-bill yield is an idiot! Theyare the same bankers the same idiots I from when I they don't want the arbitrageurs and investment on tried to get away left security analysis. Who the hell talk I would like the SEC needs to over floor for fear they might to each other. Well, earn 80basispoints Treasury bills? The brokerage firms to explain to me how they can allow agency program traders sitting sell them this bill of goodsbecauseit is a way of creating moreorder the firm's own which on alongside principal traders for account. flow, Wall Street today has becomethe ultimate power. 272 Marty Schwartz Marty Schwartz 273

is even for that sold more Are you sayingprogramtrading wrong, some entity like an imbecile,I with the S&P locked at the 500-pointlimit me and than an hour is not trading customer money? against less left in the trading session. My wife, who was working with me at the time, was out that day. a and The next she cameinto work, and ten minutes she would I grew up being security analyst, analyzing things buying day every say, index futures, in and \"Get smaller.\" I something for value. Trading stocks against stock out, smaller, get kept taking losses, just getting out of the serves no useful purpose. position. Whenever you get hit, you are very upset emotionally. Mosttraders and and and What's to make it Theyare buying selling, you are buying selling. try back immediately; they try to play bigger. Whenever you the difference? try to get all your losses backat once, you are most often doomed to fail. That is true in everything\342\200\224investments, trading, gambling. I learned to earn when I trade. the table at I am trying infinity from crap Las Vegas to keeponly X dollars in my pocket and

never to have any credit, because the worst thing you can do is to send What makes that more than the which is trying after bad. style any right style good money If you can physically removeyourself from the to the market? which the same in arbitrage premises, is thing futures trading as getting flat, you in a can see things whole different perspective. it is their constitutional and are able to do it, but there After a I guess right they devastating loss, I always play very small and try to get as a I scream at the kids who ink. are some incredible abuses consequence. black ink, black It's not how much money I make, but just getting firms: \"You SOBs have no no ethics! work for these brokerage integrity, my rhythm and confidence back.I shrink my size totally\342\200\224to a fifth or what You are to kill the Now You know will happen? going game.\" they a tenth of the position that I trade normally. And it works. I think I ended are at me. When they stopped doing program in November a swearing proprietary up losing only $57,000 1982, after taking $600,000 hit wish!\" I it is not trading they said, \"Are you happy? You got your said, \"No, on November 4. the which comes when quite finished yet.\" I didn't tell them conclusion, are no or more a and find out mistake they longer earning $300,000 year, they Isthereany trading that you could isolateasresponsiblefor what they are really worth; when they are hitting the bricks and can't get that Election Day, 1982, loss? a job for $50,000. Then it will have come full circle. to shorts futures Adding when the market is already locked-limit against of we seem to be moving in one on this and the cash it is 200 Speaking circles, subject. you market looks like points higher is pretty stupid. on. What stands out as most dramatic Let's go your trading experience? When you look back, do you say, \"Why did I do it?\"

time in November 1982. I had a much The most gut-wrenching was I think because I had huge gains the month before. I've always had my worth and a in one smaller net then, I took $600,000loss day. biggest setbacksafter my biggest victories. I was careless.

> What happened? Do you still make trading mistakes? By that, I mean deviations from trading principles you consider valid\342\200\224not losing trades. It was Election Day,and the Republicans did much better than expected in the races. The market ran 43 which at that congressional up points, You always make trading mistakes. I made one just recently\342\200\224a terrible in I and time was one of the largest point advances history. was short, mistake. I was short the S&P and short the bonds, and I got nervous be- 277 276 Marty Schwartz Marty Schwartz

off with a clean slate? Why the difficulty in this area? You start every year

I think it all relates to event. I'm my fears of some cataclysmic That's my philosophy: January 1, I'm poor. like W. C. Fields:I have several bank accounts and a few safedeposit boxeswith and cash. I'm well diversified. gold extremely My thought Do you trade smaller in January? process is that if I screw up in one place, I'll always have a life preserversomeplace else. Not necessarily. It is just that my attention is greater.

Any other rules you can think of? Do you take your losses more quickly in January?

Yes. If you're ever very nervous about a position overnight, and the to No, I always take my losses quickly. That is probably key my especially over a weekend, and you're able to get out at a much betterprice success. You can always the trade back on, but if you flat, you see than you thought possible when the market trades, you're usually better put go with the short things differently. off staying position. For example, the other day I was the

S&P and got nervous becausethe bond market was very strong on the session. The next the stock market was Greater clarity? night morning, virtually I I a unchanged. was so relieved that could get out without loss, I covered Much because the feel when are in a my position. That was a mistake. A little later that day, the S&P greater clarity pressure you you When worst fears aren't should that is not working puts you in a catatonic state. collapsed. your realized,you probably position increase your position. Getting back to managed money, I wonder, after years of making of what motive could What has been your worst drawdown percentagewise? plenty money trading on your own, possible you have for bothering with managing other people's money? were deal. My records just evaluated for a money management Over my felt that I was a little and this a wholenew entire career as a full-time trader, based on month-end data, my biggest I getting stale, presents after October realized that downside risk can't be drawdown was 3 percent. I had my worst two months around the birth challenge. Also, 1987,1 measured.The to more is with an of my two children, because I was worriedabout whether I was going to adequately way get personal leverage the ball in in outside of get tennis the right place Lamaze class. pool money. My philosophy has always beento try to be profitable every single How much money are you going to be managing? month. I even try to be profitableevery single day. And I've had some extraordinary runs\342\200\224over 90 percent of my months have beenprofitable. I don'twant to be specific about the amount, but I'm only taking on one I'm particularly proud of the fact that, in virtually every year, I didn't or two of money. I don't want to deal with multiple havealosingmonth before April. I probably don't makeas much money large pools investors, even I'm certain I couldraisea great deal more money if I as I could because of that, but I'm more concerned about controlling the though downside. went with a public underwriting. 278 Schwartz Marty Marty Schwartz 279

The more have the people you involved, morepotential headaches. the year and in New York the other half. I have a wonderful lifestyle. For when I met a fund he asked example, large manager, me how many My kids think all fathers work at home. employees I had.I told him, \"None.\" He told me he had seventy. When he wants to it will be more difficult because he'll quit, have their lives What is the best advice you can give to the ordinary guy trying to in his hands. I don't want that kind of pressure. become a better trader?

to losses. in You seem rather isolatedhere.Do you like working alone? Leam take The most important thing making money is not

letting your losses get out of hand. Also, don't increase your position

It took me to size until have doubledor tripled your capital. Most people make several years to be able accept working alone. I used to go you to a the mistake of their bets as soonas they start making money. downtown office because a lot of my friends were there. But, as time increasing That is a to out. passed and fewer of those people were still there, the attraction quickway get wiped diminished significantly. Now, I have half a dozenpeopleI talk to on

the phone daily. I've taught my methodologies to a number of them, and initial they have methodologies of their own. Marty Schwartz's story should encourage those whose attempts at trading have met with failure. Here is a trader who was unsuccessful over a to lose to himself Have you ever tried training people to be traders working for you? ten-year period, managing enough money keep near broke, despite consistently earning good salaries.Yet, Schwartz was eventually able to rum things around and become one of the world's best I hired four people, but nobody lasted. They all became intimidated. I traders. tried to and it didn't clone myself work. I taught them all my How did he do it? There were two essential elements. First, he but the methodologies, learning intellectual side is only part of it. You found a methodology that worked for him. Throughout his losing years, can't teachthem your stomach. Schwartz used fundamental analysis to determine his trades.It was not until he immersed himself in technical analysis that he became Why do most traders losemoney? successful.The point here is not that technical analysis is better than fundamentalanalysis, but rather that technical analysis was the methodology that Because they would rather lose money than admit they're What wrong. was right for him. Some of the other traders interviewed in this book, is the ultimate rationalization of a trader in a losing position? \"I'll get such as James Rogers,have been very successful using fundamental out when I'm even.\" Why is getting out even so important? Because it analysis to the complete exclusion of technical analysis. The key lesson protects the ego. I became a winning trader when I was able to \"To say, is that each trader must find his or her own best approach. hell with is more my ego, making money important.\" The second element behind Schwartz'stransition to success was a

change in attitude. As he describes it, he became successful when his What do you tell who seek your advice? people desire to win took precedence over his desire to be right. Risk control is an essential elementof Schwartz's trading style, as

I always try to encourage people that are thinking of into this attested to his low drawdowns. He achievesthis risk going by incredibly business for themselves. I tell them, \"Think that become more control his \"uncle on trade. No doubt, his you might by always knowing point\" any successfulthan ever because that's what as well as you dreamt, happened to me.\" approach of sharply reducing position size after large losses, I have the freedom I wanted, both and I extended contributes to his success. The always financially structurally. winning streaks, heavily can go on vacation at any moment. I live in Westhampton Beach half of rationalefor reducing position size after a destabilizingloss is apparent. 280 Marty Schwartz

However, the reason for taking the same action after a winning streak deserves further elaboration. As Schwartz explains it, he has always his this is experienced biggest losses after his biggest gains.I suspect true Part III for the majority of traders. Winning streaks lead to complacency, and leads to complacency sloppy trading. A Little Bit Most traders cite similar rules (suchas disciplineand hard work) of Everything as the reasons for their success. Therefore, it is always a treat when a top trader provides a rule that is unique and rings true. I was fascinated with Schwartz's observation about a that are maintaining position you worried about, when the market action doesn't fears. The justify your implicit concept is that if the market is letting you off the hook easily on a position for which there was a basis for fear (such as a fundamental adverse to the or a technical breakout in the development position opposite direction), there must be strong underlying forces in favor of the direction of the original position. James B. Rogers, Jr.

Value and Buying Selling Hysteria

Jim Rogersbegan trading the stock market with a paltry $600 in 1968. In 1973, he formed the Quantum Fund with partner George Soros.The Quantum Fund proved to be oneof the best-performing hedge funds, and in 1980, having amassed a small fortune, Rogers retired. \"Retired\" is the word Rogers uses to describe the management of his personal portfolio, an endeavor that requires considerable ongoing research. Hisretirement also includes teaching investment courses at the Columbia University Graduate School of Business.

I waseagerto interview Rogers because of his stellar reputation as one of the shrewdest investorsof our time and because his comments on television financial interview shows and in the print media always seemed to strike a note of common sense with rare clarity. Since I did not know Rogers, I sent him a letter requesting an interview, explaining I a of that was working on book on great traders. I includeda copy my previous book on the futures markets, which I inscribed with a quotation from Voltaire that I deemed particularly appropriate: \"Commonsenseis not so common.\"

called a few later to thank me for the book and to Rogers days indicate his willingness to participate. \"However,\" he cautioned, \"I am probably not the person you want to interview. I often hold positions for many years. Furthermore, I'mprobably one of the world's worst traders. the I I never get in at the right time.\" He was referring to distinction had 284 B. 28S JamesB.Rogers, Jr. James Rogers, Jr.

at that time? made in my letter, indicating that I was interested in great traders rather What made you so bullish on Germany than great investors. As I in 1982. More use the term, a \"trader\" would be primarily concerned with Thebull market had started here August important, which direction the bull market since the all-time stock market washeading, while an \"investor\" would Germany had not had any kind of previous concentrate on with the best in earlier. The German market had selectingstocks chance of outperforming high 1961, twenty-one years then. In the the market overall. In other words, the investor was always long, while crumbled in 1962 and had essentially gonesidewayssince the trader be or had boomed. So there was basic value might long short. I explainedmy use of these terms to meantime, the German economy and stressedthat he was indeed the of I wished to there. Rogers type person to make sure I'm interview. Whenever I buy or sell something, I always try I If there then I'm arrived at Rogers' home, a baronial, eclectically furnished not going to lose any money first. is very good value, even if I'm townhouse, on a fall-likespring afternoon. The atmosphere seemed more probably not going to lose much money wrong. reminiscentof a comfortable English manor than a home in New York have that market ten earlier on the same City. In fact,if my only exposure to New York City was that afternoon's But you could bought years with in conversation Rogers his antique-filled sitting room, with its theory. pleasant views of the Hudson, I would conclude that New York City was to You could have it in 1971 for an eminentiy peaceful place live. After greeting me, Rogers That's absolutely right. bought exactly \"I still and watched German stocks sit for ten while wehad immediately stated, think you have the wrong man.\" Once again, he thosereasons years, You was referring to the fact that he did not consider himself to be a trader. a major bull market in the U.S. But this time there wasa catalyst. This is which At the time, the the note on the following interview begins. always need a catalyst to make big things happen. catalyst the Socialists were was the upcoming German elections. I figured going to be thrown out, and I knew that the opposition party, the Christian investment. I in our Democrats, had a platform designed to encourage As told you phone conversation, I don't considermyself a trader. basic assessment was that if the conservative Christian I remember when I went to buy German stocks in 1982,1 said to the My Democrats won the election after been out of power for so many broker, \"I want you to buy me X, Y, and Z stocks.\"The broker, who having also knew that they were going to make major I many didn't know me, asked,\"What do I do next?\" I said,\"You buy the stocks years, changes. German were holding back from investing in capital and send me the confirmations.\" He asked, \"Do you want me to send companies equipment and in 1982 in anticipation of a conservative victory. you some research?\"I said, \"Please don't do that.\" He asked, \"Do you expansion if the conservatives did win, there would be a real explosion want me to send you opinions?\" I said, \"No, no, don't.\" He asked, \"Do Therefore, want me of capital investment. you to call you with prices?\" I said, \"No, don't even give me pent-up prices, becauseif you do, once I see that these stocks have doubled and Was the election a toss-upat the time? tripled, I might be tempted to sell them. I plan to own German stocks for at least three think years, because I you are about to have the biggest bull Not in my mind. market you've had in two or three generations.\" Needless to say, the broker was dumbfounded; he thought I was a madman. I in terms of the Now I don't considerthat trading; it was determining that there was mean polls. about in to be a major change a market and taking a position. By the way, I got that one right. I bought the German stocksat the end of 1982 and I guessso,because when the conservatives did win, the market exploded sold them out in late 1985 and early 1986. tot same day. 286 James B. 287 Rogers, Jr. JamesB.Rogers, Jr.

What if had lost? they Are all your trades fundamentally oriented?

I think I ResearchBureau charts still didn't would have lost any meaningful money for the Yes. Occasionally, however, the Commodity reasons I mentioned before. I will the chart for a market will show an had every anticipation that there was going provide a catalyst. Sometimes in the charts. to be a major change, and that the bull market would last for two, three, incredible spike either up or down. You will see hysteria four like to take to if I shouldn't be or years. When I see hysteria, I usually a look see going the other way. It sounds like you have a greatdealof conviction when you put on a trade. Can you think of any examples?

I went short after had straight I Yes. Two yearsago, soybeans they gone Yes, usually do; otherwise, I don't bother doing it. One of the best rules to $9.60. The reason I remember it so vividly is because that same can learn about is to up anybody investing do nothing, absolutely nothing, I went to dinner with a of traders, one of whom was unless there is evening, group something to do. Mostpeople\342\200\224not that I'm better than about all the reasons he had I said, \"I really have talking why bought soybeans. most people\342\200\224always to be playing; they always have to be doing that can't tell all the bullish are wrong; all I know is make a I you why arguments something.They big play and say, \"Boy, am smart, Ijust tripled I'm rush shorting hysteria.\" my money.\"Thenthey out and have to do something else with that money. They can'tjust sit there and wait for something new to develop. How do you pick the time to go against the hysteria?

Do you wait for a situation to line in favor? Don't always up your I wait until the market starts moving in gaps. you ever say, \"I think this market is probably goingto go up,soI'll it a shot\"? give In the midst of it all, or do you wait for some sign of an end to the

move, for example, a reversal day?

What you just described is a very fast way to the poorhouse. I just wait until there is in the No,I don'tknow about reversal days. money lying corner, and all I have to do is go over there and it in the pick up. I do nothing meantime. Even people who lose That to mind a classic example of hysteria. In late 1979-early money in the market \"I lost now I have to do brings say, just my money, advance. to the gold market witnessed an incredible accelerated something make it back.\" No, you don't. You should sit there until you find 1980, Did short that market? something. you go

Yes,I sold gold at $675. Trade as little as possible.

That was almost $200 too early! That is I don't think of as a I think of as why myself trader. myself too but it was someonewho waits for something to come along.I wait for a situation that is I told you I'm not a good trader. I'm nearly always early, in like the proverbial\"shooting fish a barrel.\" only about four days before the top. 288 B. 289 James Rogers,Jr. JamesB.Rogers, Jr.

I didn't were off but say you way timewise, pricewise it must have The reason I askedis that I have always felt that the relationship been ride. When a pretty scary you do a tradelikethat, isn't there between gold and oil was a coincidentalcorrelation.

a point where you have secondthoughts?

Yes, that was all it was. For one very short period of time, gold and oil Yes, when it to goes $676 [helaughs]. moved together.

But with the trade? you stayed Does that mean you will sometimes do a trade based on a relationshipyou know doesn't really make any sense, simply becauseyou in that Yes, case, because it was chaos. It was something that couldn't think that the rest of the world believesit? last. It was the gold market's dying gasp.

what I the the truth. Rarely. I usually like to look at think is fact, The Was that a matter of recognizing the fingerprint of a market in its main item then was that I thought Volcker meant it when he said he was final blowoff, or was it a matter of gold being overpriced? inflation. The oil to going to break the back of fact that was ready go down anyway was just the kicker. Both.Gold was but was\342\200\224I overpriced, basically it like your of terminology\342\200\224the\"fingerprint\" hysteria. Just about every time you go against Actually, the decisive step came in October 1979, when the Fed panic, you will be right if you can stick it out. changed its policy from controlling interest rates to controlling moneysupplygrowth. Yet the gold market apparently didn't believe So when you see panic, do you automatically go against it? it, becauseit went up for several months after that point. In situations like are the markets toowound in their hysteria to the that, up pay The panic, hysteria, in and of itself is only a catalyst to make me look attention to changing fundamentals? to see what is It doesn't mean I'm going on. going to do anything. In the case of the early 1980 gold market, I had a view of the world that was will Absolutely. It is amazing how sometimessomething important bearish for gold. Volcker had just become the Federal Reserve that. I am happen, and the market will keep going despite Now, experienced Chairmana few months earlier and said that we were going to beat inflation. I mean that I enough to know that just because see something doesn't believed he meant it. I also happened to be bearish on oil at the time, everyone sees it. A lot of peopleare going to keep buying or sellingjust and I knew that if oil went down, gold would go down as well. becausethat has been the thing to do. Was that because you thought gold and oil should move together, or the market doesn't to some becauseyou thought the rest of the world believedthat? So,justbecause respond important news, such as the October 1979 change in Fed policy, doesn't mean that it At that time, everybody in the world believed that. isn't important.

But, did you believe that the was true? market the it shouldn't relationship All the better. If the keeps going way go, then know an will especially if it is a hysterical blowoff, you opportunity I knew that it was not true. present itself. 291 290 James B.Rogers,Jr. James B. Rogers, Jr.

were a financial Can you think of a more recent example? Why you expecting collapse?

October 1987. It was the was the world. stock Yes, October 19 is my birthday, by the way. At the end atmosphere. Money flooding Every market in the world was at an all-time You had all these stories of of 1986 and the beginning of 1987,1 had predicted that we would have high. three out of half a million dollars a one more big move up in the stock market and then witness the worst young guys, years school,making That is not Whenever see that in a are near bear market since 1937. But I didn't know it was going to happen on my year. reality. you market, you a went into the summer for a birthday. It was the best birthday present I ever had. top. So, I positioned collapse.

Were short stocks or Did you have any idea that the break could be aslargeas it was? you long puts?

When John Train interviewed me in I was short stocks and short calls. I don'tbuy options. Buying options is January 1987,1 told him, another fast to the Someone did a for the SEC and \"Somewherealong the way, the market is going to go down 300 points in one way poorhouse. study discovered that 90 of all aslosses.Well, I day.\" He looked at me as though I were a madman. I envisionedthat the percent options expire figured Dow around out that if 90 of all lose that meant would be 3,000, and 300 points would only be 10 percent. percent long option positions money, that 90 short make If I want to use In 1929, the market went down 12 percent in one day. Ten percent in percent of all option positions money. one to be I sellcalls. day was not such a big move, given the kind of markets we were options bearish, then. The market had seena number of and 5 having already 3, 4, percent So When did you cover days. I said, \"Why can't the market go down 300 points in a your positions? day?\" Little did I know it would be 508 points. During the week of October 19. If you remember, by that time, that the financial structure of America was over. Why did you pick 1937 as a comparisonin your prediction for a everybody thought stock market collapse? Did you cover then because wehad hysteria goingthe other way? Becausein 1937, the Dow went down 49 percentin six months. What I to That is exactly That week wasa textbook case of hysteria. Under was trying say was that we were going to have a major, fast, deep, right. those kind of conditions, if are still solvent, have to in there horrible collapse, as opposedto say 1973-1974, when the market went you you step and it. that was to be the one time it was the end down 50 percent, but it took two years. go against Maybe going of the world, and I would have beenwipedout too. But 95 percent of the time when that kind of are to make Why did you use 1937asan analogy as opposed to 1929-1930? you go against hysteria, you going money. and didn't have shorts. Because 1929-1930went on to be a major depression.I knew we were BetweenOctober1987 January 1988,1 any That was one the few times in whole life that I didn't have going to have a bear market caused by a major financial collapse. I was of my any shorts. Whether I am bullish or bearish, I to have both not convinced we were going to have a depression.I was differentiating always try long and short in case I'm Even in the best of times, between a financial and economic collapse. positions\342\200\224just wrong. 292 JamesB.Rogers, Jr. James B. Rogers,Jr. 293 there is and even in the worst of was in I always somebody fouling up, times, I a panic\342\200\224and was already short! I calledSingaporethat there is somebody doing well. Sunday night to add to my shorts. [Singaporeopensearlier than we do.] all who came So those guys in on Monday to sell had very, very good reasons to and there no no Are you implying that after the collapse, you couldn't find any stocks sell, were buyers around. Therewere buyers, because there no to you wanted to be short? was reason for people buy. Even the buyers were scaredand bearish that Monday. the I thought that if I were right and world wasn't coming to an end right stocks that I Are you saying the crash was causedby Greenspan and Baker? away, everything was going to go up\342\200\224including those knew, fundamentally, were coming apart at the seams. In January [ 1988], I am There were a lot of causes:Greenspan, Baker, the fact that money was I started putting a couple of shorts back on, and eventhough losing the I tight, steady worsening of the balance of trade, and you had a market money on one of those shorts, 1 am happy to do it because feel more to that had spiked up 2,700 six weeks earlier. If you check, you will see comfortable having the protection of some short positions. that, during 1987, while the S&P and the Dow were going up, the rest

of the market was quietly eroding away. In December 1986,1 shorted A lot of blame the October1987breakon trading. people program the financial stocks, and throughout 1987,1 didn't loseany money, even Do you consider that scapegoatism? though the Dow and the S&P were going through the roof.

it on understand the Were there Absolutely. The people who blame that do not any times you faded hysteria and lost? look market. Politicians and people who lose money always for and one of in scapegoats. In 1929, they blamed the crash on short sellers margin Yes, my greatest lessons happened my early days and taught

There were lots of reasons the stock market went me about bear markets. In January 1970, a time when I still requirements. good why bought I took had\342\200\224which down. What they should focus on is why there were sellers on October options, all the money I wasn't very much\342\200\224and bought In the market caved and the the 19,but no buyers. puts. May 1970, in, day market hit I the weekend I sold I I \"I'm I remember why became even more bearish on bottom, my puts. had tripled my money. was a genius! going to I before October 19. The weekbefore, [Federal Reserve Chairman] Alan be the next Bernard Baruch,\" said to myself. much better then was to wait for the market to this time Greenspan announced that the balance of trade was getting My plan rally and to sell short so I and things were under control. Two days later, the balance of trade instead of buying puts that would make money faster.Sure in the of the market and I I had and figures came out, and they were the worst history the world. enough rallied, took everything went short. doesn't have Needless two months I out because Right away I said, \"This guy is either a fool or a liar. He to say, later, was completely wiped I didn't what I was any idea what is going on.\" Then on the weekend before October19,you know doing. One the stocks I Memorex had [Treasury Secretary] Baker telling the world we were going to stick of had shorted was Memorex. I sold at the the Germans weren't 48. In have the it to the Germans by letting dollar go, because those days, I didn't staying power\342\200\224psychologically, had It looked I loosening monetary and fiscal policyas Baker demanded. emotionally, and, most important, financially. ended up covering my

like the trade wars of the 1930sall over again. shorts at 72. Memorexeventually went to about 96 and then went straight down to 2. B. 295 294 James B. Rogers, Jr. James Rogers,Jr.

So even if falls below short that the stock market the October low, you can still I was dead right, absolutely, flat-out, perfectly right to see the economy doing well? stock at 48.1 just ended up getting completely wiped out. The market didn't care that I was dead right. That is one of the reasons that I now Unless the foul it know about hysteria. Absolutely. politicians up.

what? What did you learn from that particular experience? By doing

of I than Raising taxes, tariffs, protectionism. There are lots things the That the market is going to go higher than think it can and lower politicians can do to foul it up, and I'm sure will\342\200\224they always have. I think it will. I had a tendency to think that if I knew something, they I know we will have a financial crisis. if the it knew it. in the I didn't And, politicians get wrong, everybody I would just read things paper; have we that may get an economic as well. any inside information. What I now know is they don't know what collapse I know. Mostpeopledon't have the foresight to look six months, one What is going to trigger the financial collapse? year, or two years out. The Memorex experience taught me that anything can happen in the stock market, because there are a lot of people in the The trade will start worse and this will market who don't understand what is going on. figures getting again, eventually precipitate another dollar crisis.

Are you looking for a very pronounced bear market beyondwhat What do you see as the main cause of the trade deficit? we have already seen?

The and causes the You are not the budget deficit, by large, trade deficit. Yes, eventually I expect the market to break October 1987 low. going to get rid of the trade deficit until you get rid of the budget deficit.

Do you expect a very deep recession as well? Given the magnitude of the deficit problem, is there anything that can be done at this still point? Right now [April 1988], I'm looking mainly for a financial collapse. the foul it and turn it into an economic However, politicians may up The basic problem in the world today is that America is consuming more collapse. than it is saving. You need to do everything you can to encourage saving and investment: Eliminate taxation of the tax, and Can we get a financial collapsewithout actually having a very serious savings, capital gains recession? dual taxation of dividends; bring back the more attractive incentives for and At to IRAs, Keoghs, 401Ks. the same time, you need do everything can to tax structure to utilize It has lots of times. That is I used 1937 as an you discourage consumption. Change our Sure. happened why a value tax, which taxes than and before. I don't the to because as the added consumption rather saving example expect economy collapse Cut investing. government spending dramatically\342\200\224and there are lots of dollar keeps getting weaker\342\200\224which is what I expect\342\200\224many parts of the ways of doing it without hurting the economy too We would have American economy will do well\342\200\224steel, agriculture, textiles, mining. badly. 296 James B.Rogers,Jr. James B.Rogers,Jr. 297

but the would not be asbadas when are not to do what has to be done. are to be more problems, problems nearly they going They going concerned forced on us. If we don't bite the bullet, then we are going to have a about keeping their votes and winning the next election. That is 1930s-typecollapse. going to continue until we are forced into solving our problems.Then it is going to be a disaster. Your answer implies that there are relatively painlessways to cut Could some government spending \"dramatically.\" you provide If the politicians don't act, do we eventually face a choicebetween specific examples? very high inflation or a deep recession?

I'll two I could a dozen. The U.S. give you examples; give you It is to an extreme. What I will I going be suspect happen\342\200\224and am just government billion the domestic of so spends $5 a year to support price sugar to speculating, I don't have make this decision yet\342\200\224isthat somewhere that Americans can pay 22 cents a pound wholesale, when it is selling along the line a recessionwill develop. Initially, the politicians will say, We for 8 centsa pound in the world market. Five billion dollars! would \"We've got to bite the bullet and suffer through this. This is goodfor us; be better off if the told \"We'll government every sugar grower, give you it will out our help clean system.\" People are going to buy that for a $100,000 a year for the rest of your life, a condominium, and a Porsche while. Then it is going to start to hurt. Then it is really going to start to if just out of the sugar business.\" We would savebillionsof you get hurt. At that the politicians are to and are point, going give up, they going would better would dollars a year, and the whole country be off because we to start to inflate their way out of it. But the only way to inflate your way all be less for paying sugar. that is out at point to really print money! If to do know what our you really want save abig number, you annual balance of trade deficit is? Onehundred and billion dollars. Do fifty In that scenario, we start off with a recession and end up with very know to you what it costs us each year keep American troops stationed high inflation. in Europe? One hundred and fifty billion dollars. American troops were sent there as an army of occupation forty-three years ago!Mostpeople Right, but we could have wild inflation first and then deflation. Another in this country weren't even born when the decision was made to send real is that we will have but very possibility eventually exchange controls. our troops to Europe. They are doing nothing there sitting around, Fortunately, I don't have to make my investment decisions for two or The GAO has said drinking beer, getting fat, and chasing girls. that we three yearsforward right now. don't have enough bullets to fight even a thirty-day war in Europe. Yet it costs us $150 billion a year to keep those guys there. I would submit What kind of exchangecontrols? to you that if we stop spendingthat $150 billion a year and bring those troops home, the Europeans would defend themselves. And the kicker controls I mean limitations on flows. If want to is:Do you know who they would buy their guns from? They would buy By exchange capital you to can't take more than their guns from us, because they don't have a very good defenseindustry go Europe, you $1,000. You can't ship money establishment. out of the country without the government's approval.

What to the relative values of currencies in a situation like But those are very unlikely actions. No politicians are even talking happens about those solutions. that?

in it is not The dollar What would on controls is the I understand that. With the present cast ofjerks Washington, disappears. bring exchange are to are dollar getting weaker and weaker. The would then to going to happen. The politicians going foul things up. They politicians try bring 298 JamesB.Rogers, Jr. JamesB.Rogers, Jr. 299 in Draconian exchange controls, which would just make the situation But, sooner or later, the bond market collapses. worse.

Absolutely. Sooner or later, we repeat the English experience of not about When you say disappear, are you talking the dollar becoming having a long-term bond market. But I don't know when sooner or later like the Argentine peso? is. It could be three years; it could be ten.

the Civil War Why not? Why couldn't it happen? Remember expression, How far did Britishbonds fall in the situation are to? \"I don't give a damn about a greenbackdollar.\" you referring

You talk about the collapse of the dollaras if it's an inevitability. About 70 percent.

In 1983, we were the largest creditor nation in the world. In 1985,we What kind of things do you look at in deciding which scenario will becamea debtor nation for the first time since1914.By the end of 1987, happen first: deflation or inflation? our were than all of the debts of foreign debts greater foreign every nation south of the Rio Grande Brazil, Mexico, Peru, put together: supply, government deficits, trade inflation the Argentina,and all the rest. Money deficits, figures, financial markets, and government policy.I look at all those things for the U.S. and the key foreign countries as well. It is one Can I paraphrase chain of events you imply as follows:Nothing big, The three-dimensionalpuzzle. However, if had a three-dimensional meaningful will be done to change the budgetdeficit situation. you puzzle, you could it will that the trade deficit eventually put together. But this puzzle is not one in which you continued budget deficit guarantee can out in spread the pieces on a table and put them all situation stays bad or even gets worse. That, turn, guarantees that great big together. The is some taken sooner or later, the dollarwill come under extreme pressure. picture always changing. Every day pieces get away and others get thrown in.

Absolutely. That's why I'm not long the dollar.

While we are the of on topic scenarios, do you have a long-term Howdoesthe bond market fit into this scenario? outlook for gold?

At some are to into this point, foreigners going stop putting money In 1934, they set the price of gold at $35 an ounce and gold production because of the dollar. That means the American country weakening declined between 1935 every year and 1980. Productionkept going public will have to finance the debt. We have only a 3 to 4 percent savings down because there was no incentive to lookfor gold. During that whole rate. To getthe American public to finance that debt, interest rates would forty-five-year period, the consumption of gold kept up, If to avoid rates going have to be very high. the Federal Reserve tries high by especially during the 1960s and 1970s, when we had the electronic more then the dollar and the Fed loses printing money, just disappears revolution.Demand got bigger and while at the same time, the and 25 bigger, supply control completely. That is the case where you get hyperinflation was going down. You would have had a great bull market in gold in the Either to rates. to 30 percent interest rates. way, we are going have high 1970s, no matter what. Even if inflation was at zero percent, you still You might start out with lower rates first if the politicians decide to bite would have had a big bull market in gold during the 1970s, because of the bullet by having a recession. But then, they will eventually give up supply and demand. and start printing money. 300 James B. Rogers, Jr. JamesB.Rogers, Jr. 301

The situation has in the 1980s. Thereis changed entirely nothing In a situation like that, I would think the price of gold would go up like from to into the taking the price of gold $35 $875 to make peoplego of the in mine sharply,because panic related to disruptions gold business. Gold production has goneup every year since 1980. Just production. based on known projections for mine openings and expansions,gold is scheduled to until at least 1995. At the production go up every year While the revolution is going on, the price will go up, but after that, it same there have been advances in the time, major technological recovery will go down. Themove down will completely confuse everybody. They for available than gold. In short, there is much more there will is processes gold ask, \"Why the price of goldmoving down?\" But you will want to used to and that trend will continue at least into the mid-1990s. be, buy after that move down, because the euphoria of the revolution will I own an insurance but I think is some gold as policy, don't gold also bring chaos. going to be the great inflation hedge of the 1990s that it was in the 1970s, because and demand is so different. I don't know what the We have views supply talked about your long-term for the stock market, inflation of the 1990s will be but I have to decide hedge yet, fortunately, don't bonds,currencies,and gold. Any thoughts about oil? today.

when the I Yes, recession hits\342\200\224and guarantee it will some day\342\200\224the The you are painting for gold is of supply/demand picture obviously price oil is going to go way down. You can put that in writing; I don't But if you put that with a situation in which, negative. together using mind saying that. It certainly is going to go under $12. Whether that is own \"the dollar wouldn't such an event your words, disappears,\" $11 or $7 or $3,1don'tknow. [The price of oil was approximately $16 swamp the internal supply/demandbalanceof gold? at the time of this interview.]

its It it Certainly, gold may keep purchasing power. may do better, may Given the general scenario you are talking about\342\200\224the stock market not to be the market. do worse, but it's going best going down, the dollar goingdown, etc.\342\200\224isthere anything that the average guy can do to protect himself? In other words, gold was yesterday's inflation hedge.

Buy European and Far Eastern currencies; buy Treasury bills; buy farm Generals always fight the last war. Portfolio managers always invest in land. the last bull market. The idea that gold has always been the great store of is have been times in when has value absurd. There many history gold Howdid you first get interested in trading? for lost purchasing power\342\200\224sometimes decades.

I should add else about Remember that three- stumbled onto something gold. Investing. I Wall Street. In 1964,1 had just finished dimensional I was where there are and was puzzle talking about, always pieces college going on to graduate school. I got a summer job through a removed and added. Don't South in that Gold being forget Africa puzzle. guy I met, who happened to work for a Wall Street firm. I didn't know is more becauseof the South African situation. I fully about Wall Street at the time. I didn't know the difference complicated anything South Africa to blow becauseI think that the between stocks I know expect eventually up, and bonds. didn't even that there was a difference governmenthas painted itself too far into a corner. If there were a revolution betweenstocksand bonds. All I knew about Wall Streetwas that it was the South whites tomorrow and the blacks took over, African would somewhere in New York and something unpleasant had happenedthere down dump all their gold. So the price would actually go a lot. in 1929. 302 James B.Rogers,Jr. James B. Rogers,Jr. 303

After that summer, I went to Oxford during 1964-1966. Whereas Were you investing in the stocks you were covering? all the Americans I knew at Oxford were interested in politics, I was more interested in reading the Financial Times. I invested in anything.

Were you trading while you were at Oxford? Successfully?

I was an The I in still had Very lightly. odd lotter. money was investing the market I came into the market on August 1,1968, right at the top. But I was would my scholarship money at Oxford.I get my scholarship money some money left, and in January 1970,1 figured out it was going to be a at the of beginning the year and invest as long as I could. bear market. I don't know how I figured it out. As I mentioned earlier, I

took all the money I had and bought puts. By May, I had tripled my Not I and I exactlydeeppockets. money. In July, started shorting stocks, by September, waswiped out. Those first two years were great: I went from being a genius to a If I had in either of [Helaughs] lost much money those two years\342\200\224 fool.

So started off the bat? What you actually making moneyright Soyou were back to ground zero in September 1970. happened then? I bull Yes, was making money. That was the market of 1964-1965. By the time I left Oxford in the summer of the bear market had I into 1966, started, I saved everything had and put it back the market. I didn't care but I had off had already paid my bills. I waslucky.If I gone to Oxford about a TV or a sofa. The wife got rid of me. I was the entrepreneurial would have out. who build during 1965-1967,1 probably gotten wiped spirit personified. Just like those guys up great retail chains, back into and plow everything their stores, I was plowing everything What happened after Oxford? back into the market.

I was in the for a of and since I didn't army couple years, have any money, Were you trading just stocks at this time? I couldn't follow the market. In 1968, the day I got out of the army, I went to work on Wall Street. I invested I first wife everything could. My Bonds,stocks,currencies, commodities. used to say, \"We need a TV.\" I said, \"What do we need a TV for?Let's put the money in the market, and wecouldhave ten TVs.\" She said, \"We When did you get involved in these different markets? need a I \"We could sofa.\" said, have ten sofas if we just put the money in the market for a little while.\" I traded all of them almost from the very beginning. Bonds and stocks I at I from day one. Currencies fairly early too. When was Oxford, kept What kind of on Wall were to job did you get Street? as much money in dollars as I could, because I knew they going did\342\200\224a devalue sterling any day. I knew it was coming, and it year after Junior I I little Even I had a analyst. left. Once again, was a early. then, strong awarenessof currencies. what stocks? Covering In the late 1960s, I also got involved in commodities by buying in remember for a gold. In my early years the business, I interviewing Machine tools and then advertising agencies. job. The fellowaskedme,\"What do you read in the Wall Street Jour- 304 James B. Rogers, Jr. James B.Rogers,Jr. 305

nalT I \"One of the said, first things I read the is commodity page.\" The Did you and George make independent trading decisions? was stunned, because he did guy too. This wasbackbefore commodities were commodities. He offered me ajob, and when I turned him down, broke down the division of he was the trader and I was he almost This No.If you labor, strangled me. job interview was in 1970, and I was the already trading commodities. analyst.

Going from zero in with the the ground September 1970, where did you start Did you come up idea, for example, shorting dollar,and pickingup tradingwiseto build up to your ultimate trading success? did he decide the timing of when to doit?

losses My early taught me a lot.Sincethen\342\200\224Idon't like to say this kind sort of. of Yes, thing\342\200\224Ihave made very few mistakes. I learnedquickly not to do anything unless you know what you are doing. I learned that it is better to do and What if on a market? nothing wait until you a you disagreed get conceptso right, and a price so nght, that even if you are it is not wrong, going to hurt you. if Usually we disagreed, we just did nothing. Did have a after you losingyear that point?

So, you both had to agree on a trade to doit? No.

There were no rules. Sometimes we would disagreeand do the trade How did the Quantum Fund get started? anyway, because one of us felt more strongly. But that type of scenario rarely came up, sincewewere usually in agreement, and once weworked George Soros was the senior partner, and I was the junior partner. We the or things through, it was pretty clear that trade was either right wrong. started off with one senior partner, one junior partner, and one hate to secretary. When we thought something through, a consensus was formed.I

use that word, because consensusinvesting is a disaster, but we almost How did you know George Soros? always seemedto come together.

In went to 1970,1 work for him at Arnhold and S. Bleichroeder. We left such as and in 1973 because new firm When you were trading leveragedproducts commodities brokerage regulations did not allow you to get a of the We currencies, how did you determine what your allocation was? percentage trading profits. could have stayed, but we couldn't have managed So we had to money. leave\342\200\224fortunately. We left and started our own firm. to the When Until we ran out of money, wewere always leveraged hilt. would look at the we bought something and ran out of money, we What kind of trading did you do for the attractive item Quantum Fund? As I portfolio and push out whatever appeared to be the least understand that it, fund was ran of managed differently from the typical fund. at that point. For example,if you wanted to buy corn and out or money, you either had to stopbuying corn sell something else. It was We in invested stocks, bonds, out this currencies, commodities, everything\342\200\224 an amoebic process. You know how amoebas grow\342\200\224they grow and long short\342\200\224all over the world. out the It way, then they run into pressure so they grow other way. was

a very amoebic portfolio. 306 James B.Rogers,Jr. James B. Rogers, Jr. 307

You never evaluated the risk of on an individual your positions commodity, bond, and stock books so many times, for so many years. basis? if lost in one market had to So, you money and reduce your As an example, I knew about the great bull market in cotton in 1861, portfolio, you might just as easily cut back in another market? when cotton went from \\ cent to $1.05.

We would what Right. always cut back on we thought were the least How do you find out about a marketlikethat? attractive positions in the portfolio.

I start by finding the anomalous years in a long-term historical chart. Even that sounds like a unconventional fund. Back today, very then, When I seea picture like the 1861 cotton market, I ask myself, \"What I imagine it was probably in terms of its investment unique strategy. caused that? Why did that happen?\" Then I try to figure it out. From that,

you learn an enormous amount. It was I still don't know who trades all the certainly unique. anybody In fact, one of the courses I teach at Columbia, which the kids call markets. all the I mean all the By markets, currencies, commodities, \"Bulls and Bears,\" requires each student to find a major historical market bonds, and and short\342\200\224alloverthe world. I am retired stocks\342\200\224long now, move. It doesn't matter which market, or whether the move was up or and I still do all these markets. to \"You're retired? We People say me, down. My instructions are for them to tell me what one couldhave known have a full staff and can't even with all these markets. What do keep up at the time to see the big move coming. When rubber was at 2 cents you mean you are retired?You are short stocks all over the world!\" everyone said, \"How can rubber ever go up?\" Yet it went up twelvefold. seen Somebodysawit. I always ask them, \"What could you have at the I must admit, I find it amusing when you say you are retired. time?\" I always nail them. They will say, \"I knew the market would go up becausethere was going to be a war.\" But I will make them tell me in Now my retirement, I'm more activethan anybody, and people say, how they could have known at the time that there was a war coming.The \"How do you follow all these things?\" course gives them historical perspective across a broad spectrum of markets and teaches them how to analyze. I have the same question. I have lived through or studied hundreds, possibly eventhousands, of bull and bear markets. In everybull market, whether it is IBM oroats, I don'tseehow you can invest in American steel without understanding the bulls always seem to come up with reasons why it must go on, and what is going on in Malaysian palm oil. As I explainedbefore, it is all on, and on. I remember hearing hundreds of times, \"We are going to run part of a big, three-dimensionalpuzzle that is always changing. out of supply.\" \"This time is going to be different.\" \"Oil has to sell at $100 a barrel.\" \"Oil is not a commodity [he laughs].\" \"Gold is different How do you find enough time to on all thosemarkets?Just spend it has not from every other commodity.\" Well, damn, for 5,000 years the reading itself seems to be a monumental chore. been different from every other commodity. There have been some periodswhen gold has been very bullish, and other periods when it has I do not do it nearly as actively as I usedto. Over the years, I have spent gone down for many years. Thereis nothing mystical about it. Sure, it a great deal of time pouring a lot of stuff into my head. I have developed has been a store of value, but so has wheat, corn, copper\342\200\224everything. a great deal of perspective on many markets. When I teach, students are All these things have been around for thousands of years. Some are more always astonished by the range of historical markets that I am familiar valuable than others, but they are all commodities. They always have with. I know about these markets because I have pored over many been, and they always will be. 308 B. 309 James B. Rogers,Jr. James Rogers, Jr.

I guessthe 1987 stock market is a prime recentexampleof the \"this time is to be different\" going complacency. Is there a lot of similarity between different cases of market There Right. was going to be a of stocks shortage again. In 1968, one of hysteria? the major Wall Street houses publisheda great learned thesis on there was a of stocks why shortage developing, and why the bull market had It's always the same cycle. When a market is very low, there comesa to going for keep up years\342\200\224right at the top. In started 1987, you time when some it because it has become it all peope buy undervalued. The hearing over again: \"There is a of stocks, because shortage everybody market it is is starts to go up and more buy because a buying in all this stock.\" At the people bottom of the bear market [he begins sound to do or becausethe charts look In the next a that builds fundamentally thing good. stage, laugh steadily] there is to be a of going shortage money\342\200\224 mother calls me I assure people buy because it has been the thing to do. My up you\342\200\224with a gigantic surplus of stocks. \"Because the and says, \"Buy me XYZ stock.\" I ask her, \"Why?\" stock

has tripled,\" she answers. Finally, there comes the magical stage: People because the market is are hysterical to buy, they know that going to go While editing this I chapter, came across the item in a following Time up forever, and prices exceed any kind of rational, logical economic about the magazinestory incredible bull market on the Tokyo Stock value. Exchange (August 8, 1988, p. 29). One could ask for a hardly better The whole then repeats itself on the downside. Themarket current process example of \"this time is going to be different.\" The subject of the gets tremendously overpriced and it starts to go down. More peoplesell Japanese stockmarket actually comes up later in this slightly interview. becausethe fundamentals are turning poor. As the economics deteriorate, The more and more peoplesell.Next, people sell just because it has been the explosive growth worries some Western financial experts, who fear that the to do. knows it is to to nothing, so they sell. boom could go bust. If that thing Everybody going go happened, investors with heavy losses in could be to Then the market reaches the and underpriced. Tokyo forced pull money out of other hysteria stage gets very crash. markets, triggering another Japanese stocksare at That's when can buy it for a But for a long-term investment, already trading astronomical prices in you pop. comparison with the the profits of companies that issued have to wait a few and let the market base. the shares, at least by you usually years American standards. On the New York Stock such Exchange, price-earnings ratios run about to 15 1, while in the are Tokyo multiples often four timesas Talking about extreme bull markets, I recently read that Australia high. & Nippon Telegraph Telephone trades at 158 times its earnings. sold a 1\\ acre plot in Tokyo for $450 million that they bought for \"Japanese authorities have allowed a speculative bubble to grow,\" warns $250,000 twenty-five years ago. Is Japan the tulipmania of our day? George Soros,manager of the New York City-based Quantum Fund, \"At no time in the a frenzy in tulips swept Holland, past has a bubble of this magnitude been [During 1634-1636, speculative deflated in an orderly manner.\" causing suchan enormousriseand collapse in tulip bulb prices that Such worries are groundless, the event is still famous argue analysts in Tokyo. The Japanese today.] attribute the high ratios in to price-earnings part accounting rules that allow companies to understate earnings to their taxes I that the stock market is to have a keep lower. Another factor guarantee Japanese going major propping up is prices so-called of stock. Because of our cross-holding many Japanese collapse\342\200\224possibly within the next year or two. Many stocks are companieshold large blocks of other companies' stock, which out of to down 80to 90 in the bear market. A lot more of theirs traditionare seldom going go percent traded, fewer sharesareavailable for purchase so their rise. prices are going to go down 80 to 90 percent. 310 JamesB.Rogers, Jr. James B.Rogers,Jr. 311 Is there any way the average U.S. trader can take of that? advantage Wouldn't you be protected if you were short a Japanesemarket that traded on an American exchangelikethe CBOE? Short Japanese stocks, short short Japanese indexes, Japanese calls, buy Japanese A lot of puts. Japanesestockstrade here and you can just short Suppose they create two levels of currencies and the guy on the other them. You can short the trade Japanese index, which trades in Singapore and side of the can't meet his obligation. Osaka. Most American brokerscan do it for you. There are at least five major Japanese which have corporations options traded on the Chicago The clearinghouseisresponsible. Board Options Exchange. I think a Although collapse is coming, you have to be very careful about going short Japan, because they might OK, fine, I'm happy to hear it. That's the best news I've had in a long change the rules on at you any time. the time. Still, whatever I do,I'm going to be careful. If Japanese stock I if don't know you remember the Kuwaiti stock market of 1980- market goes from 30,000to 24,000 or 20,000 that's fine. But you better 1981. In that market, could stocks with a you buy postdated check. You the bit think about getting out of it before last if it goes to 12,000. If you could $ 10 million buy worth of stockswith a postdated check; could you wait that long, you may get your profits out, but it is going to be very $100 million buy worth of stock that way. It didn't matter. Everybody painful. was doing it. In the there a end, was passportclerkwho owned $10 billion worth of stocks! All of it on postdated checks. Why did you leave the Quantum Fund? that market was a Although very clear exampleof hysteria, I didn't short it. I about it that thought long [he snapsfingers].The reason I didn't I didn't want to do the same thing for the rest of my life. I always wanted go short was because I knew when the market caved in, they would create to have more than one career. When I came to New York in 1968,1 was rules so that I would never get my money out. Of course,the market from Alabama. had made than I knew If a poor boy By 1979,1 moremoney eventually collapsed. I had gone short they would have blamed it on existed in the world. Also, we were getting very big. We had started with me and said I causedthe damn thing by shorting. People wereeven three and we had fifteen They wanted to know me for the people, by 1979, people. blaming October crash last year, because I said it was to going could on wasn't interested in Some when they go vacation, get raises,etc.I any happen. claim I people caused oil pricesto collapse, because I said the of of that; I was interested in investing. I didn't want to get bigger. price oil was going to go down. I wish I were that influential or In decidedit would be my last But then, powerful. September 1979,1 year. in October, there was a in the stock market, which we sailed To get back to I have a few bigcollapse Japan, Japanese shorts,and I'm going It was so much fun that I decided to stay on one more year. to have more. But right through. whatever I do in Japan, I know when the crisis comes, I left in 1980. I don't want to be around near the bottom, because the Japanese are going to And protectthemselves. whatever they do to it protect themselves, Was 1980 the start of \"retirement\"? ain't to your going be good for Jim Rogers. I guarantee that.

Yes, in 1980,1 cashed in my and retired. You not just chips may be ableto getyour money out?

Is that the point you became an independent trader? Yes, could the they freeze currency. They could have three different tiers of God knows what will currency. they do. The term I really prefer is \"unemployed.\" 312 313 James B. Rogers, Jr. JamesB.Rogers, Jr.

Well, you teach at Columbia. Any negative dramatic experiences?

That's I did it as a in unemployed. part-time thing starting 1983 so that We were and short August 1971 was a exciting time. long Japan I could very play squash. announced that he was America, and one Sunday night, Nixon taking America off the standard. I didn't evenknow it had happened. I had I gold thought it was the love of teaching. been off somewhere on my motorcycle, and I camein Monday morning market without having read the papers. That week the Japanese stock It has developed into much more. But when I started out, I didn't even went down 20 percent, and the U.S. stock market went up. We were want to teach. I just wanted to learn how to play squash. both sides. losingheavily on

You're not facetious? You being actually started teaching so you off the bat? could play squash? Did you have to liquidate your positions right

I'm dead serious.Columbia is right here and the Dean me sell to in kept pestering You can't liquidate at a time like that. Who can you Japan? to teach a course.I told him, \"I don't think should to business covered people go Who could you buy from in the U.S.? If you your shorts, you school.\" I thought that, for many people, business school was a waste of have to out whether made things worse. In a situation like that, you figure time. I think still so. But one thing I wanted to learn in retirement to be fundamental my you are right or wrong. If there was going a major was how to made play squash. So I a deal with the Dean to teach one the best loss. But if change forever, the first loss is fundamentally you course semester for in per free, return for lifetime access to the do but sit there and let the market are basicallycorrect, then you nothing Columbia He gym. agreed. I thought I got a deal, but he was smarter than great hysteria wash around you. I was\342\200\224I'm still teaching.

I Did you stay with your positions? take it, at this point, you really enjoy it.

Oh, it's goodfun, yes. And Columbia is terrific. Yes.

What courses are you teaching? So, you really had to ride out a rather treacherous paper loss.

Security analysis,investment analysis, and the \"Bulls and Bears\"course A loss is a real loss. we talked about before. Thereis no such thing as a paper loss. paper very

Of the multitude of to with your trading experiences, do any stand out as What was the analysis that gave you the confidence stay your particularly dramatic? positions?

Lots. My October 19 that I talked about birthday present earlier was the had Our analysis was that this was not the end of world. America the best. 1982 is another. I a probably August put gigantic part of my net to solve our simply taken a short-term step, and it was not going country's worth into bonds throughout 1981 and 1982, and in August 1982, they long-termproblems. skyrocketed. 314 B. 315 James B. Rogers, Jr. James Rogers, Jr.

involves with a Did that position actually turn out to be OK? $ But actually, your whole style of trading staying trend for years. So isn't what you are sayingcontradictory?

It turned out fine. The Nixon announcement was just another in the step different. dissolution That kind of trend\342\200\224atrend that is economically justified\342\200\224is of the Bretton Woods Agreement [a 1944 international pact and You have to see the supply/demand balance change early, buy early, that, among otherthings, established guidelines for foreign exchangerate and only buy markets that are going to go on for years. By \"trend following,\" stabilization] the decline of America.America was rallying in its I a market because it up and selling it just own bear market. meant buying just goes because it goes down. saw So, you it as a cosmetic move that wasn't going to change the What trading rules do you live by? trend, and you stayed with your position.

the but don't Look for hysteria to see if you shouldn't go opposite way, Right. examined the situation. Also, go the opposite way until you have fully remember that the world is always changing. Be awareof change. Buy Is that a When general principle: government measures are You be to or sell anything. So many people change. should willing buy implemented to counteract a should sell the after the \"I never utilities,\" trend, you rally say, \"I could never buy that kind of stock,\" could buy government action? to \"I could never play commodities.\"You should be flexible and alert investing in anything. Absolutely. It should be written down as an axiomthat you always invest against the central banks. When the central banks If were the investor, what would you tell try to prop up a you counseling average currency, go the other way. him?

the until know what you are doing. If you make 50 What is biggest public fallacy regarding market behavior? Don't do anything you then lose 50 in the third percent two years in a row and percent year, you off than if in a That the market is would actually be worse you just put your money money always right. The market is nearly always wrong. I that know is market fund. Wait for to come along you right. canassureyou of that. something in the market and wait Then take your profit, put it back money fund, just You will come out ahead of else. What else? again. way everybody of Are you ever wrong on a major position play? That is, are one follow Never, ever, conventional wisdom in the market. You have to or are so that your almost sure shotseverwrong, they well selected leam to go counter to the markets. You have to learn how to think for they just invariably go? yourself; to be able to see that the emperor has no clothes.Mostpeople do it. Most can't people want to follow a trend. \"The trend is friend.\" lose your I don't want to make it sound like I don'tknow how to that is valid Maybe for a few minutes in Chicago, but for the most most there has part, money\342\200\224becauseI know how to lose money betterthan people\342\200\224but following what everyone else is doing is rarely a to rich. You have to remember that way get not been a major mistake in a long time. But you may make money that way for a while, but it is hard. a keeping very I don't trade that often. It is not as though I'm making three decisions 316 James B. Rogers, Jr. James B.Rogers,Jr. 317

month. I make three for one for may decisions a year, or five decisions a year, and What happens when you have one scenario currencies, with them. I'll stay the stock market, one for the bond market, and not everything meshes? How often do you make a trade?

Then I won't do anything. It happens all the time. I don't do anything Well, there is a difference between a trade and to making deciding buy until all the pieces fit. bonds in 1981. I've owned bondssince1981,but I sell around the position. I make trades, but basically I own them. I went short the dollar at What is your opinion about chart reading? the end of 1984.Now, I have made a fair amount of tradesin currencies since the end of 1984,but it is basically one trade with a lot of trades haven't met a technician. of technicians who around it. I rich Excluding, course, sell their technical services and make a lot of money.

Very few investors or tradersareassuccessful as you have been over Do use charts time. What makes you different? you yourself?

for to see what I don't play.I just don't play. Yes,I look at them every week. I use them knowledge, what is on in the is going on. I learn a lot about going world by looking I can understand that. But still,very few people can analyze the same at charts. fundamentals you are at and looking soconsistentlybecorrectin assessing all the variables. and \"I've this of But you don't ever lookat charts say, seen type pattern before and it usually means the market is topping.\" Just don't do until know anything you you've got it right. As an example, until see you American agriculture hit a low, then no matter what I look at charts to see what has happened. happens in the world\342\200\224unless the world is going to stop eating\342\200\224you can't American is now so go wrong. agriculture competitive, and so many Not what will happen? marginal farmers have been washed out, that it has to go up. You just watch American agriculture deteriorate, deteriorate, deteriorate, and then you know never What has happened. If you don't what has happened, you'll buy. You or late. In a little may buy early my case, usually bit early. But, is know what is going to happen. The charts say to me that there a so what? The worst that happens is you bought it too Who cares? early. but that's it. I don't runaway bull market. They give me facts, say\342\200\224what is that term you used earlier,reversal?\342\200\224there is a reversal here. I don't Isthereanything else besides the fact that you are very selectivethat even know what a reversal is. sets you apart?

A reversal simply is\342\200\224 I have no boundaries.I am flexible. I am totally open to everything, and I pursue everything. I have no more compunction about speculating in mess know about those dollars or Don't tell me. It might up my mind. I don't things, Singapore shorting Malaysian palm oil than I do about buying General Motors. and I don't want to know. 318 James B.Rogers,Jr. James B. Rogers,Jr. 319

Dothe markets behave any differently now because so much money is being managed by trend-oriented systems?

Jim Rogers' unique approach may be difficult to emulate in its entirety, not but are No.They may always have been on a computer, but there always many of his trading principles of great relevance to all traders. have basic been systems.I guarantee that you can go back 100years in the His concepts are: market and not find a single decade where there hasn't beensomekind of some much even if system, kind of new formula developed to play the markets. 1. Buy value. If you buy value, you will not lose your timing is wrong.

So the markets today are basicallythe sameas the markets in the 1970s, 1960s, and 1950s. 2. Wait for a catalyst. Bottoming markets cango nowhere for very long periods of time. To avoid tying up your money in a dead market, wait until there is a to the market direction. The same as the in the catalyst change markets nineteenth century. The same things make markets and have not go up down. They changed the rules of supply and demand. 3. Sell hysteria. This principleis sound, but its application is far from can as Wait for easy. Rogers'methodology be paraphrased follows: hysteria, examine to see whether the market is wrong, go against the Do you have any goalsat this point? be and then hold hysteria if fundamentally validated, sure you are right, last on tight. The tricky parts are the two steps. Very few traders have I'mlooking for adventure. I'd like to be able to wean more and the maze myself Rogers' analytical skills and intuitive insights to wade through more from the markets. There two are problems. First, investing is such of facts and statistics in the \"three-dimensional puzzle\" of world markets a wonderful pastime that it is hard to I haven't from with give up. changed and arrive at the correct long-term projections uncanny high when I was twenty-two years old. I wanted to read and know the to always accuracy. Without this type of accuracy, ability sit tight could be a everything that was on and out the future. The second going figure lethal virtue. And, even if you can predict long-term economic trends is what do I do with funds if I If turn it over to problem my just stop? I with a sufficient degree of accuracy, there still remains the problem of broker at XYZ, I would be broke in five and then my friendly years, I being able to sit tight, particularly when the financial steamroller of would have to backto work. go market hysteria is running counter to your position. For example, I doubt many traders would have been able to sell at short while it to $875 in four and Any last words? gold $675, stay surged only days, then hold the position through the subsequent long-term collapse, at a Even if have the steel nerves eventually liquidating large profit. you Good investing is really just common sense. But it is how lack astonishing necessaryto duplicate this feat, you probably the financial resources to few have common sense\342\200\224how people many people can look at the exact this of market or the same of in outstay type high degree accuracy same the exact same scenario, facts and not see what is going to happen. shots. this should comewith a pickingyour Perhaps particular concept of them will focus on the same but the Ninety percent thing, good caution label attached: Warning! Any attempts by the unskilled practitioner investor\342\200\224or to use term\342\200\224will see else. The to trader, your something ability to apply the method described herein can lead to financial ruin. get away from conventional wisdomis not very common. 320 James B. Rogers, Jr.

4. Bevery selective. Wait for the right trade to come along. Never trade Have the fortrading'ssake. patience to sit on your money until the high

probability trade sets up exactly right. Mark Weinstein 5. Be flexible. Biases against certain markets ortypes of trades limit your field of A trader who \"I will never opportunity. says, go short,\" has a High-PercentageTrader distinct disadvantage compared to the trader who is willing to go short as well as long. The trader who is open to examining a broad range of markets has a distinct advantage over someonewho is willing to par-

ticiggjB4H-\302\253nly-\302\251Hejiiarket.

^^. Never follow conventional wisdom,.Veepthis principle in mind and yoiTwillJxJess likely to buy stockj^after the Dow has already moved After a brief as a real estate broker, Mark Weinstein became a from 1,000 to 2,600 and everyone is convincedthat there is a shortage period of stocks. full-time trader. His start in trading was so naive that he virtually threw his money away.After that early failure, Weinstein withdrew to the markets and earn another stake. With the Know when to hold when to seriouslystudy trading exception 7. and liquidate a losing position. If you disastrous Weinstein was a successfultrader believe the of one trading experience, market is going against you because your original analysis from that point on. He has intensively traded a wide variety of markets, was flawed (such as when you realize overlooked an you important including stocks, stock options, stock indexfutures, currencies, and fundamental factor), then as states: \"The first loss is the Rogers best loss.\" commodities. Although he is reluctant to divulge specific details,it is clear However, if the market is going against you, but you are convinced your that he has profited handsomelyin all these trading arenas. original analysis was right, then sit out the hysteria. As a cautionary Mark Weinstein a mutual he was this latter I met through friend. Although word, condition should be appliedonly by traders who fully the his desire for made him understand the risks involved. very intrigued by project, anonymity reluctant to tell his story. He would call me and say, \"OK, I will do it, let's schedule the interview.\" Then the next day he would call and say, \"I changed my mind. I don't want the publicity.\" This pattern was repeated several with each decision times, accompanied by lengthy phone conversations regarding the merits and drawbacks of doing the interview. in I we could have done three Finally, exasperation, said, \"Mark, interviews in the time we have about it.\" That was our last spent talking conversation regarding the matter until about two months later when, impressed by the caliber of traders who had agreed to participatein this book, Weinstein decided to do the interview. Weinstein met me at my office one summer evening. Because the 322 Mark Weinstein Mark Weinstein 323

turns off the forced Did broker friend advise to follow the building air-conditioning after 5:00 P.M.,we were your you analyst's out recommendation? into a corner lobby, which, although warm, was at least less stifling. The interview was conducted over a dinner of deli sandwiches and soda. and he What I didn't realize then that the Through our phone conversations, I knew Weinstein had a strong Yes, also followed it. was for some time when tendency to go off in many directions in any conversation\342\200\224that's how market had been rising and was alreadyoverbought It wasn't a in on the move his mind works, one topic leadshim to think of five others and their I went long. even bad reaction. I just got too various interrelations. Dreading a mammoth editing task, I stressedto late.I didn't have enough margin to keep the position going. Also, my turned on and want to more Weinstein the need for remaining focused on the specific questions. I guts me, I didn't put up any money. could tell that Weinstein was making an extra effort to heedthis advice. me like friend that was This fact notwithstanding, the interview lasted five hours and yielded a It sounds to your let you put on a position out of line with 200-pagetranscript. clearly any money management principles.

It was one of those get-rich-quick schemes.

How did you first get involved in trading? Did you know anything about the markets at the time?

Back in 1972, when I was a real estate broker, I had a friend who was a a Absolutely nothing. If I flipped through chart book, it looked like a and commodity broker. He I had gone to school together. collection of TV test patterns to me.

Didyour friend get you interested in the markets? Did you have any idea of the risk involved?

It didn't take much to me interested because father's was get my hobby I knew that the chances of my winning were very slim because I didn't at to gambling. He was very good percentages, and I used watch him at know what I was doing. the crap tables.In a sense,I think being a trader is in my genes. Also, fascinated me because of mathematics and science Didn't it occur to that should learn before trading my you you something you background in college and because I had a commodity broker friend who was started? into computer strategies. because I was for a I didn't like a real No, desperate change; being Do you remember your first trade? estate broker.

Was the money that you invested a substantial part of your savings I remember it I a account with exactly. opened up commodity $8,400, at the time? and I went long corn based on a recommendationmade by the firm's grain analyst. Three days later, I was out $7,800. It was all the money I had. 324 Mark Weinstein Mark Weinstein 325

When did you get enough money to come back into the markets? Did you have a method for controlling risk? \302\253

It took me six or sevenmonths. I worked seven a I approximately days No, and still don't. I dependedonmy nervous system and gut reaction. weekand rented as as I could my hands on. I also many apartments get I coveredpositionswhen I did not feel right about them. Sometimes it sold a few that I had about $24,000.1 took out co-ops. By time, savedup would be after two days; sometimes after two hours. $4,000 to live on, and used the remaining $20,000 to open an account.

Were you spending all day trading? Did you make any effort to learn anything about the markets in the interim? All day and all night. I was losingfriends left and right. I sat in a studio

apartment with charts plastered on every wall. I probably looked like a Yes.I studied the gold market, learned how to chart, and became familiar madman to the friends I had left. that if I with the concept of overbought and oversold markets.I figured a oversold market and left myself enough money for bought severely Sothis was really a full-time endeavor. two margin calls, I couldn't lose unless something drastic happened in the That was my method. economy. an Not only endeavor\342\200\224it was an obsession! I slept with it; I dreamt about

it. Sometimes I would stay up all night thinking about what I would do But if you use that approach in a trending market, you are goingto the next day. If I didn't need sleep,I would have done it twenty-four get killed. hours a day. At that point, it wasn't the money that was motivating me. on the I washooked game: on the challenge of trying to figure out the It worked in that market. I was bliss. guess ignorance market.

What were your trading results the secondtime around? Did you sometimes wake up with a feeling that you knew the gold market was or like that? I did well for several after that and to build a small goinghigher anything years managed fortune. But a lot of that was due to luck.

No, it had nothing to do with the direction of the market. It was just an It couldn't have all beenluck.What were you doing right when you extension of what I was doing during the day. I would take so much of were making money? it to sleep that I ended up exploring unconsciously what I had been doing consciously that day.

In relation to what I know now, there was very little that I was doing those commodities seemed right. I think I just had good markets.In days, Did you have any goals when you set out?

to follow chart patterns a lot better than they do now. Very few people

knew about technical then, so the markets were much anything analysis Well, the great American dream is to make a million dollars, and that as much more orderly. I got a break by learning as I could about in was particularly true those days. I never really had a materialistic technicalanalysis at a time when it was working pretty well. dream until I started vacationing and traveling in Europe. Mark Weinstein 326 Mark Weinstein 327

What When was this? How many years after you started trading? happened?

about or four On next I on a in It was in the mid-1970s. I had been trading for three years. my trade, put large long position soybeans. The market closed the first and I had up day, about a 25 percent profit on my money. I was to out the Had the million dollar mark by that point? planning get of position at the end of the week. The you passed mistake I biggest made was having a specific target of what I wanted out of to be able to relax, start the trade. Yes,and I had made enough money to At that I was vacationing,and think about things I wanted buy. point, feeling confident to know that I could replace the money I spent with The enough target being determined not by market analysis,but rather by I the next step was to start the my trading profits. figured logical $350,000 you wanted to make on the trade. Did you trade that I the I was I sawa castlein the south of France because appreciating money making. differently you were trying to make money for a specific that the castle had a moat around wanted. I was particularly impressed purpose? to me. It was on the market for it, and the idea of living there appealed it would take about $50,000 a to keep only $350,000, and I figured year Yes, I didn't consider the risk and took on too largea position.I was not it up. using any type of rational judgment. I was being guided by my material desires.The market went up again the next day, but That doesn't sound likea lot of money for a castle. collapsed suddenly late in the session, locking limit-down.

When I came back to the U.S., I Today it is probably worth $5 million. That Did stuckwith at wanted to make the money to pay for the castle almost immediately. you get your position limit-down? wasa tremendous mistake.

Yes, I couldn't out. The next at get day I showedup the brokerage the to the I don't understand. You already had money buy castle; office and the market opened offered limit-down. I waited all day to see if have to make it. you didn't it would come off of locked limit-down, but it didn't.

I still looked at it in terms of how much Even though I had the money, I take it that have million in their you would have liquidated if could it cost. I know people in this business who $17 your position you a new car. have. trading account and won't buy

the account to the castle. So didn't take your money out of buy If the had you market traded, I would have sold out at any price.

be No, I camebackand decided that making the money was going to my Do you remember your emotionsat the time? goal.

I was in a next $350,000 in was goingto go for the state of shockand had no left In other words,your profits decision-making capability whatsoever. I couldn't fall castle. asleep, and found myself almost praying the market would somehow trade the next day. On the third day, I called the office about a half an hour before the and told me it Exactly. opening, they didn't 328 Mark Weinstein Mark Weinstein 329

bother in because I to their grains I was for to hold look like there was any hope. I didn't even going spoke analyst. looking someone my hand. He told would be the in the office. I was certain that they were me I OK, because the fundamentals were still couldn't face people strong and situation. there would be a tremendous demand for if the market went getting a big thrill out of my soybeans down another day. Of course, on the fourth day, the market locked limit- down Why is that? again.

traders in the office who werenever There werea few other professional How much were you eachday? When this situation losing able to make the kind of money I had been making. almost relieved. It seemed to justify all those years developed, they were were heartless. The About $ 125 thousand a at a time of their not taking positions like I did. They really day. This was when the average annual was was broker, and, frankly, that was salary was $15,000.1 was not born rich, and I couldn't of only person who really upset my stop thinking loss in those terms. probably becausehe was afraid of losing the account. my

Did the other traders kid you about it? Could you put that loss in perspective relative to your account size? it behind back. They overconsoled me and then laughed about my They That is I coming Before that I had million wanted to see me come in and fall apart. why stopped trade, nearly $1.5 in my trading account. So I was 10 to the office. losing nearly percent of my equity level prior to the trade each day. it made them Do think relished your predicament because I devastated. I felt you they was like I was wounded in a trench and less deficient as traders? to seem watchingmyself bleed death. The market went limit-down five days in a row, and I lost On the fifth over$600,000. day, I remember sitting in a in this business who It went that. I think there are a lot of people hands with a I beyond park holding girl had picked up, literally crying on her others lose money. I was in a just enjoy watching lap. practically psychotic state. I thought about getting out of the business altogether. I started to think that what everybody was what did do the Once into the office, you during me was it you stopped going telling true\342\200\224maybe was just luck that I had made money all those I worried that if I continued day? years. trading, I couldwind up losing it all, and being forcedto go back to some job I didn't like. to I checked with other brokerage houses, trying get price quotes.

Which was more the own broker? devastating, large monetary loss,or your Why didn't you just call your feelings about going from success to failure?

I was too embarrassed,and I didn't want to take the derision.

It was the money and the limit situation, and the fact that I couldn't act. Your own broker was kidding you? were: Here My exact thoughts I am, a person who thought it was un- American to go short, and what I found out was really un-American was him. I to and I didn't know what to think of was starting get paranoid not being able to get out of a position. to a firm and hostile because nothing could be done.I went competing 330 Mark Weinstein Mark Weinstein 331

How long did the emotional of this So you felt cheated by not being able to get out? impact experience last?

Months. I didn't want to trade commodities think there is anymore. I every chart I definitely felt cheated. To this day, I something wrong ripped off walls. my I tore up everything in my house that had to do with limit price moves. anything with commodities.

Are that price limits that were supposedly created to you implying When did you begin trading work them people again? protect the public actually against by preventing from getting out of their losingpositions? After a few months, I started AMEX trading stocks, but I found it slow. I missed amazingly the leverage of the commodity markets. I didn't free of restraints. Yes. I think the market should be totally think I could successfully support myself trading stocks. Around that time, I ran into a friend who is a great trader. of options limits on stock markets as a way told There is talk about putting I him about and he that I my experiences suggested join him. In my that be from the frying pan reducingvolatility. Would actually jumping first week at his office he told me to buy Teledyne calls right before into the fire? because he was sure expiration they were going up. I followed his advice, and the calls completely collapsed. that if he wants to out, Absolutely. Now, the average investor knows get this calls his broker he can at least get out at some price. Imagine if guy How much did you lose? and finds out that he can't even get out of the market. About $40,000.1 felt extremely hostile,but I didn't want to show it because he are who are the never me results. I was so that In other words, you saying that those expounding promised any upset I walked out for the small of the office and didn't come two idea of limits are really going to make matters worse back for days. He tried reaching me that I investor. during time, but didn't return his calls. Finally, he got a message to me through a mutual friend. of It is absolute lunacy.It is a law that is being proposedfor the benefit Was he upsetthat he had given you bad advice? sophisticated institutional investors.

When I came back to the office, he told me that he had done the exact Your earlier comment implied that, prior to the soybean trade, you oppositetrade in another account, and that the trade was mine. So I didn't always traded the long side of the markets. Is that right? really lose any money.

the Yes. I never went short. I felt it was un-American. After soybean i That sounds like an awfully odd type of practical joke. trade, I realized that the business I was in was the height of capitalism, were on. it made no difference what side of the market you It wasn't a He and really practical joke. was trying to teach me not to place blind short made All I could think about was that the who were money trust in anyone\342\200\224even him. It was his of people way teaching me the importance and I lost money. of self-reliance in being a good trader. Mark Weinstein 332 Mark Weinstein 333 I know once entered an How did you do after that point? you optionstrading contest. Can you tell me about it?

knew friend was a trader.He I did pretty well. My phenomenal options I learneda tremendous amount from about the market and It was originally organized two traders on the CBOE everything by floor. They got 47 traders him. together, each of whom put up $5,000 in a winner-take-all contest.Each trader opened a $100,000 account with the same clearing he you? firm. Did you trade options basedonthe methodologies taught

technical Yes, combined with my own analysis. How long was the contest for?

Your friend didn't usetechnicalanalysis? Three months.

didn't believe in it. He was a tape reader. No, he What were your results? successfulasa 100 Hasthe fact that you have been extraordinarily I turned the $100,000 into over his mind about technicalanalysis? $900,000 without any pyramiding percenttechnical trader changed [using profits to increase leverage]. a crutch for me, and the Not at all. He thinks technical analysisisjust There was a at which we real reason I make money is experience. point That'sa ratherphenomenal performance. He came to my office one day and watched separated for a few years. \"You made it.\" me trade.Heembraced me like a father and said, finally Yes, but the markets were very good at that time. of but I had learned I told him that not only had I gained a lot experience, there was about technical analysis, including just about everything What did you trade when went out in He \"You never give up, do you? you on your own 1980? certain things I had created myself. said, technical You are trading that way It has to do with analysis. nothing I traded I because of experience.\" everything. continued to trade stockoptions.When stock index futures in the trading began early 1980s, that became a primary market friend eventually separate? for me. I also traded the markets. In Why did you and your option trading commodity fact, during the last two years, my trading has shifted to nearly 90 percentcommodities. trader who was There was a conflict in our trading styles. He was a great because he knew he would more to take an occasionallarge loss, willing Do you remember your first soybean trade after the debaclein the and come out ahead in the long than make up for it with large gains way 1970s? that I trading run. However, I was uncomfortable trading way. preferred to to eradicate trades. I wasn't willing for small profits and trying losing For a I avoided was purely technical, long time, soybeans. But, as I began to find myself take the same type of risk. Also, my approach to the a reader. in 1980,1 decided trading commodity markets effortlessly, I knew deep down that I would whereas he was basically tape Anyway, later. eventually get back the money I lost in soybeans. I never about it. go off on my own. We got together again years forgot 334 Mark Weinstein Mark Weinstein 335

It sounds like were for revenge. it. Either you were off when did the or didn't have you looking you trade, you the experience. There is always a mistake involved. Yes, exactly. Every time I lookedat a commodity chart book, my eyes the would over to the chart, then I would quickly flip page. You that one edge soybean mentioned earlier of the reasons you split with your When watched the market for beforedoing anything. former I peripherally years trading partner was that your own trading style was geared down to knew were near a low, but I didn't soybeans went $4.75,1 they to extremely low risk. Since1980,what was the worst percentage them until I was sure I couldn'tloseon the trade. I was like want to buy drawdown you have experienced? for a Sicilianwhose wife had been murdered ten years earlier,waiting When technical convinced the perfect moment for revenge. my analysis that I I losesoinfrequently don't really keep track of that type of in on the for I side. me that the market had bottomed real, jumped long number.

Where did you buy the beans? Well, let's put it this way: What was your worst single trading month? the 1988 caused Around $6.18. [Thiswas shortly before drought prices

to skyrocket.] I haven't had any losing months. Where did you get out? You have made money in every single month since 1980! rest at $9.92. of the move I got out of some at $7.25, and the [The high was $10.46.] Yes. Of course, I could have made a lot more money if I wasn't so

cautious, but that is the way I trade.

How much did you make on that trade? Do you remember your worst losingweek?

Let's just say I made my money back in spades. haven't had I any losing weeks during that time, but I have had some losing it sounds like that trade was a relief days. The way you talk about it, great

for you. That is an incredible statement. How can you be sure that you are not about a few simply forgetting weeks when you lost money I had it was a total catharsis. I realized that there was a reasonwhy Yes, trading? lost the money in the first place. J The reason I am sure is that I remember all my losses. For example,I What was the reason? have had three losing days in the last two years. Out of the thousands of trades I made that I had 17 but nine of during time, losers, them were I don't believe ever out because BecauseI was inexperienced. anyone getswiped my quote machine was down, and when that happens I just get out for in the market because of badluck;there is always some other reason of my position. 336 Mark Weinstein Mark Weinstein 337

traders on 50 of their trades, quently for market Most would be happy winning percent adjusts changing conditions. Hecombinesthis win 75 yet are intensivereal-time with chart and a ratio of percent would be spectacular, you analysis comprehensive analysis incorporating in the of 99 a that win ratio is somewhere vicinity variety of including Fibonacci implying your methodologies, cycles, retracements, is hard believe. and Elliott Wave this percent\342\200\224that really to analysis. Finally, add to one last essential ingredient: an sense of market when uncanny timing. Only nearly I told him about hundreds of trades lines You cancheckwith Leigh. my during everything up right and he feels the timing is virtually perfect does he the few Stevens isa mutual friend who introduced me put on a trade. He trades past years. [Leigh passes up many that he believes have a high of to Weinstein.] probability working, but for which he lacks the same degree of near absolute confidence. Because of the combination of a lifetime devotion to studying the markets, intensive real-time analysis, innate market sense but I've had and trade OKreader,I know what you are saying: '\"No losing weeks, incredibly rigorous selection,virtually all of Weinstein's trades I admit Weinstein's are at least at some within some losing days.' Givemeabreak.\"Frankly, marginally profitable point twenty minutes of not his claims That is all Weinstein needs to assure a better statements sound preposterous. I could verify by examining entry. breakeven or result. are in the It to understand that Weinstein account statements becausehis partners vigorous maintaining helps usually plays for quick profits of the as it is a and covershis trades within hours or even minutes. Even on confidentiality partnership's trading activity private position the In a number of his were trades,Weinstein will usually take some to assure a net trading firm, not open to public. fact, partners profits quickly this interview and were successful in profitable outcome.Healso trades markets in adamantly opposed to nearly rotation, quickly shifting The account statement his profits from market to market, the dissuading Weinstein from participating. only always seeking profit potential with the lowest risk. Weinstein the Weinstein was willing, or able, to show me washis independent entry perceived Finally, enjoys support of which did indeed confirm that he a floor network that often him on the side of the bid-asked in the option trading contest, puts right a account ninefold in three months with 100 spread. multiplied $ 100,000 percent Weinstein's comments sound like written winning trades. may boasting on the Still unsatisfied, I spoke to Leigh, who has known Weinstein for page, but that belies their tone\342\200\224naivete would be a much closer him trade. I have known description.When Weinstein talks about his are years and hasspentmany days watching Leigh trades, comments peppered with describe him as such \"It's the market is for three years and can confidently honest, low-keyed, phrases as, obvious going lower,\" \"This market is so It is clear he has no how and levelheaded.Leigh confirmed that of about 100 of Weinstein's easy.\" conception of difficult trading is for hundred more Weinstein the rest of us. tradeshe had personally witnessed and several after he them he could told him about on the phone (right put on), Even if because mean rememberonly one that was a loser. of faulty memory (I actual this not as a for dishonesty), Weinstein's How do you your ability to win such a of the literally, euphemism explain high percentage than he I still believe percentage winning rate is somewhat lower implies, time? his win/lossratio is incredibly high. it? Weinstein's own to this follows, Because have a real the How can hedo response query I fear of markets. I have found that the greatest it I some further elaboration would be traders are the ones who are but to put in perspective, thought most afraid of the markets. My fear of the his own state-of-the-art markets has forced me to helpful. Weinstein employs custom-designed hone my timing with great precision. When I to monitor technical indicators to am it is computersystems constantly designed trading properly, like apoolplayer running racks. If my gut feel than use the standard measure in market momentum. Rather of market conditions is not I don't trade. is a changes right, My timing Weinstein uses his own values, which he fre- combinationof and values for these indicators, experience my nervous system. If my nervous system tells 338 Mark Weinstein Mark Weinstein 339

it is the action me to get out of the position, because market triggers problem is that no single technical approach works all the time. You have that I have seen before. when to something in my knowledge and experience to know use each method. I also don't losemuch on my trades, because I wait for the exact will not wait for the environment to itself right moment. Mostpeople tip How do you do that? still I until off. They will walk into the forest when it is dark, while wait it the cheetah is the fastest animal in the world and gets light. Although It is and feel. I use all forms of technical but experience gut analysis, it will wait until it is sure can catch any animal on the plains, absolutely interpret them through gut feel. I do not believe in mathematical systems It hide in the bush for a waiting for just it can catch its prey. may week, that always approach markets in the same way. Using myselfas the It will wait for a and not just any the moment. baby right baby antelope, \"system,\" I to constantly change the input achieve the same output\342\200\224profit! one then, when antelope, but preferably that is also sick or lame. Only there is no chance it can lose its prey, does it attack. That, to me, is the Is there anything you can single out as the most important element epitome of professional trading. in deciding to put on a trade? When I trade at home, I often watch the sparrows in my garden. When I feed them bread, they take just a little piece at a time and fly I am for a market that is then and small bits of bread. always looking losing momentum, and go away. They keep on flying back forth, taking the other hundred stabs at a of bread to what way. They may have to make a piece get is You will a pigeon gets at one time, but that is why a pigeon a pigeon. traded both the stock and is the I Having commodity markets, would you never be able to shoot a sparrow, it is just too fast. That way day say behave when I am sure that they differently? trade. For example,there are times during the day the and am out the S&P is going up, but I don't try to pick bottom, I is Absolutely. In contrast to the commodity markets, the stock market very before it tops. I just take the mid-range where the momentum greatest. the rarely gives you opportunity to enjoy a meaningful trend. That, to me,is trading like a sparrow eats.

Why is that? The cheetah is for Am I paraphrasingyou correctly? your analogy and the is analogy for day trading. positiontrading sparrow your when Because institutions and specialists sell out, they don't sell out at The common denominator is that both animals wait for can't-Iose one price level, they scale out as the market goes up. Similarly, when circumstances. in as the they buy, they scale market goes down. This leads to choppier action the price and is reason why many good commodity tradersthat I know Exactly. lose every time they go into the stock market.

How do your trades? you pick But you win consistently in the stock market, as well.What are you doing differently? Elliott Wave and I use many different types of technical input: charts,

numbers, sentiment, I Gann analysis, Fibonacci cycles, moving averages, don't try to figure out where the market is going before the action; I let is unreliable and various oscillators.Peoplethink that technical analysis the market tell me where it is Also, there is such a of going. variety tend to the one are comfortable with. The technical in the becausethey pick thing they input stock market (divergence,advance/decline, sentiment, Mark Weinstein 341 340 Mark Weinstein

profits. The media owesit to the public to report that the market goes ratios, and soon),that you will almost always get a signalbefore put/call not down only on profit taking, but on a lot of loss taking as well. the market is about to do something.

What are the trading rules you live by? in the stock Is your method of technical analysis therefore different market than in the markets? commodity 1. Always do your homework. 2. Don't be arrogant. When you get arrogant, you forsake risk control. I look at the individual stocks; they all have uieir own personalities. For Thebesttraders are the most humble. and General Motors will before a example,IBM usually rally major 3. Understand your limitations. Everyone has limitations\342\200\224even the best As another market bottom and fail to rally before a major market top. traders.

I have never seena real good rally without the utilities leading example, 4. Be your own person. Think against the herd, as they must lose in time. come me market. The utilities go up when interest rates are expectedto 5. Don't trade until an opportunity presents itself. Knowing when to stay down, and when interest rates comedown, portfolio managers jump into the markets out of is as important as knowing when to be in them. stocks. I have done extremely well trading the indexes, because before 6. Your strategy has to be flexible enough to changewhen the I ever traded index futures, I had become a very experienced trader of environment The mistake changes. most people make is they keep the same stocksand options. strategy all the time. They say, \"Damn, the market didn't behave the I way thought it would.\" Why should it? Life and the markets just What do think is the about the you public's biggest misconception don't work that markets? way. 7. Don't get too complacentonce you have made profits. The toughest in the world on to thing is holding profits. That is becauseonceyou That who trade the markets Iknow floor traders that have have attained people gamble. a goal, you then set a second goal that is usually the that made for twenty straight years. You can't call gambling. same as the first one: to money make more money.Consequently, for many Another is that people always expect the attainment that second is major misconception people, of goal not as rewarding. Theymay market to reactto news. For when John F. Kennedy was to example, begin question what they really want from trading and trigger a the market broke but then assassinated, initially very sharply, quickly self-destructprocessin which they wind up losing. rebounded to new highs. Thispriceaction baffled many people. the Investorswho sold on the news only to watch the market reverse blamed Any final advice you have for the beginningtrader? institutions for pushing the market higher.What they failed to realize is

that a market that is fundamentally and technically poised to move higher You have to leam how to lose; it is more important than learning how to item\342\200\224even a dramatic isnot going to reverse direction because ofanews think win. If you you are always going to be a winner, when you lose, one. will of and end the market you develop feelings hostility up blaming Another item I would place under the category of misconceptions instead of trying to leam why you lost. for me market down. isthe way the media reports me reasons being They Limit losses quickly. To paraphrase from Reminiscences of a Stock that the market is down because of I think arealways saying profit taking. most traders hold their Operator, on to losses too long because they hope the it would be wonderful if everybody was always taking profits. But, the loss will not get larger.They take profits too soon, because they fear and the reason markets down is truth is, most peoplelosemoney, go the will diminish. traders should feara loss and profit Instead, larger hope the news because take meir losses. I know educated people who watch they for a largerprofit. when else and wonder why the hell they lost money everyone is taking 342 Mark Weinstein

Weinstein's most traumatic trading experience occurred when he let a Part W material goal interfere with his trading. This is a common theme that has surfaced in other interviews. It seems to be a mistake to invariably The View the Floor translatethe potential profit or loss of a trade into material terms. from The cornerstone ofWeinstein's trading approach is to wait for those

trades in which everything appears to be lined up exactly right, and the

odds of winning seem overwhelming. Even though most ofus can never expect to remotely approach Weinstein's confidence in the trades he the of for those trades onefeels most selects, concept waiting only confident about is sound advice that is echoed by a number of traders in this book. Although viewing markets as nonrandom over the long run, I have

long believed that very short-term market fluctuations (i.e., intraday price movements) were largely random. Weinsteinhas shaken this belief. Brian Gelber

Broker Turned Trader

Brian Gelber began his careerasa broker, managing a major brokerage firm's financial futures operations on the floor of the Chicago Board of

Trade. After successfully advising institutional clients, he begantrading for his own account. In the early days of T-bond futures trading, Gelber enjoyed the dual distinction of being one of the most (if not the most) prominent brokers on the floor and one of the largest local traders.

In January 1986, Gelberexpandedhis trading to include the direct of customer accounts. In addition to his own management trading, Gelber supervises a group of traders in both cash and futures in government securities and othermarkets. He is the presidentof a group of companies: Gelber Gelber and Gelber Securities. These Group, Management, are companies involved in clearing, brokerage, and money management. Gelber's relaxed personality seemedalmost out of place with his profession. Insteadof the high level of intensity expected of someone who trades and supervisestrading in multimillion dollar bond positions daily, I found a man who talks about his work as if he weredescribing a pleasant vacation.

Although our meeting took place during trading hours, Gelber did not seem to be overly concerned with the bond market. In fact, heseemed quite relaxed, despite leaving the trading desk for his private office to conduct our interview. \"I'll probably do better by staying here,\" he 346 Brian Gelber Brian Gelber 347

remarked,obviously what he What kind of reflecting perceived to be a jobs? low-opportunitymarket at the time.

In railroad cars. Thenone day I walked into a Thomson McKin- response to a query regarding other tradersI was interviewing, I Unloading non office and said, I have a broker's license.\"The fellow there mentioned that one, TonySaliba,had made the cover of the current issue \"Hey, a amount of of Success me said he would pay me $800 a month. That was large money magazine. Gelberasked if I had a copy. I pulled out the me at the time. All I had to do was in and cold call; accounts magazine from my attache case and handedit to him. He smiled as he for go any read the bold headline I would be mine. describing Saliba's experienceduring the week opened of the October stockmarket crash: 19,1987, \"Victory! He Made $4 at all that time. Million in But you knew virtually nothing about markets at Seventy-Two Hours.\" Jokingly, Gelber asked, \"I made $4 in million twenty minutes on that day; how come I'm not on a magazine and I knew about cover?\" It was not I had read a ofbooks, something charts\342\200\224having meant to be boastful.It did,however, very couple first fellow I worked them for the for. specificallysummarize a basic truth about traders: if kept great Many, not most, maintain low relatively profiles and are thereforevirtually unknown to the read? There weren't too around at that public. What books did you many time.

The book I learned the most from was Technical Analysis of StockTrends How did started in this you get industry? by Robert D. Edwards and John Magee (John Magee,Inc.,109State Street, Boston, MA).

After from graduating college in 1976,1 backpacked around the country. What other books would you recommend to people? In Salt Lake City, I answered an ad for a commodity broker position.I didn't have any idea what it was, but I figured it was like a something The first book we have our traders read is Edwin Lefevre's account of stockbroker. I license while got my working for a guy who was in 1985 Jesse Livermore, Reminiscencesofa StockOperator [Reprinted basicallyrunning a boiler room operation. from the original 1923 edition by Trader Press,Inc.,Greenville, SC] I've read it at least a dozentimes. around the time that I started at Thomson McKinnon, the You really started out on the wrong side of the business. Anyway, Ginnie Mae market was just coming into its own. Thomson McKinnon run I told them I had just hired a trading group to a Ginnie Mae desk. When I walked there was seated market. in, a guy at the back end of a penny was interested in learning more about the Ginnie Mae stock office. He his the spent days on phone trying to convince people to him or to that market? give $5,000 $10,000 to speculate onhis charting system. It was Why were you attracted a real fly-by-night operation.

It was a new market and seemed more than the I was keeping his charts for him, while I manageable getting registered. kept more if I to \"This conventionalcommodities. I figured my business would grow steadily saying myself, guy is pretty much of a crook.\" I got my license number of trades in Ginnie and Then I focused on that market. Also, I had made a quit. bummed around for another few months, just working first trade was a winner, but the ones werealllosers. temporary jobs to pay the rent. Maes. The following 348 Brian Gelber Brian Gelber 349

It was magnetic; I felt I could make money there, but I kept losing, and Who were those trades for? that made me want to learn more about it. who didn't Just accounts I had opened by cold calling\342\200\224people really that could and when lost, were always It soundslikeyou had a minor compulsion to pursue it. understand they lose, they they upset.

Yes,becauseI had failed. Anyway, the traders at the Ginnie Maedesk them me a few and I went Were you giving trading suggestions? taught things, out and opened almostevery mortgage banker account in Salt Lake. Pretty much.

Did you understand the Ginnie Mae market at that time? Using chart analysis?

When I first started accounts,I didn't understand about opening anything Believe it or not, more off the research of Thomson McKinnon analysts, it. Newer brokers tend to on and secondarily off my charts. definitely rely their firm's research. How then did you sell people on yourself? Did your customers losebecausetheresearchwas wrong? I snowballedthem at first, but I listened and I learned from the questions asked me. their time horizon was to while they Initially, I was confused by what they were doing, and No. They lost because mostly day day, they were equally confused by what I was trying to sell them. the research was longer term.

So there wasa mismatch? At least you understood futures as an instrument.

most brokers and their Exactly. I think that is a basic problembetween And with that bumbled Right. limited knowledge,I through my first few to market information to customers. It is almost impossible get your meetings. ThenI really got pretty at it. good customer quickly enough for the customer to acton it.

Were beat the these hedgingaccounts? What you are saying is that even if a brokercan actually market trading short term, he can't translate that to the customer. all Yes, pure hedging accounts. By May 1977,1 was making $2,000 a month in have two who have to the commissions. That was a tremendousamount of money for me. Insurmountable odds, becauseyou people pull trigger, and the information changes so quickly.

Was this all in the Ginnie Mae market? So, one of the points of advice you would give to speculatorsis to trade with a longer-term perspective? At that point, yes. Previously, I had donesomebrokeragein other commodity markets such as wheat, hogs, and pork bellies. Yes, you have to. 350 Brian Gelber Brian Gelber 351

Let's talk about floor at trading.I know, one point, you were both a But you were. floor broker and trader in the T-bond futures market.Thequestion I think a lot of would ask is: If people you receive a largecustomer It was a wild time. I was the biggest trader and the biggest brokerin the sellorderat the same time out exhausted when you're thinking of closing your own same market. I worked very long hours and was totally how do handle it? long position, you I went home. ThenI would just get up the next day and do it again. This went on for three years, and while it was a great experience, I really I never scalped, so the idea of and a trader. I being long having large customer shouldn't have done it. You can't be a greatbrokerand a great order movethe market me 2 or 3 never made life. against ticks any difference. did a good job, but it probably took years off my I had so customers Besides, many that they were often going opposite ways. Are most of the significantsizetraderson the floor just traders, or do somealsohandle customers? that'san one. But what if some OK, easy important newswas breaking,and all your customer orders were to goingone way against your They all are either brokersor traders now. That is the only way go; own Did in position? you ever endup trapped a position because you there is no doubt about it. had to execute all the customer orders first? Is that true of most floors,orjust the T-bond floor? that to me Yes, happened about half a dozen times, and it probably cost me a total of a half million grand dollars over a number of years. But Primarily, the T-bond floor.In the S&P and in the New York markets, measured the amount of against money I was making, it didn't kill me. someof the big brokers are also big traders.

That was the costof doing business? are who violate the Given today's increased scrutiny, people confidence of dual trading [handling customer orders andtradingone's Right. own account] likely to get caught?

It must be a situation gut-wrenching though, knowing you want to It is still very difficult to create a flawlessaudit trail in an open outcry but not able to get out, being act because ofa conflict with customer market. orders.

hit some Say bonds are trading at 95.00and the marketgets with Usually, you are too as a broker and I amount of orders for busy acting thinking, \"OK, have bearish news. The broker executesa large to sell how can I do from 95.00 1,000lots; it best?\" Then, when you are done with customers and his own account, and the market goesstraight the order, you might say to yourself, \"Oh damn, I'm still long; I have to to 94.00. His Alls are 94.31, 94.30, 94.29 and all his customersget out of this in How does he get thing.\" fills at 94.27 or lower. [Bond prices trade 32nds.] explain his way out of that one? Is built-in there a disadvantage for a floor trader who also handles customerorders? to another broker. Or He could give his order or his customers' orders number on own he could fill both orders and put another broker's his Absolutely. As I tell the I \"If are a The smart people hire, you broker, you are not order. There are always ways to get around extra scrutiny. a if are a are trader; you trader, you not a broker.\" crooks will always be difficult to catch. 352 Brian Gelber Brian Gelber 353

Is the temptation in dual too trading great? It's odd you say that, because you have been far more successful than most traders. No. After been having through it, I would say that dual trading is good for in the efficiency marketplace, but it is too a burden for the is that as a brokerI was at an even echelon. I heavy I guess my point higher individual. it was really good at it, and suited my personality.

Should the rules be to disallowdual changed trading? So, why did you get into trading?

That is a difficult What is more the the know question. important, efficiency of I started trading because some of my customers said, \"You the market or the of the individual? There is no doubt in mind at but integrity my market so well, why don't you just trade?\" I resisted first, after six that dual trading adds tremendous to the and that it evolved. liquidity system, is months of holding out, I started trading. From there just probably more important than the fact that a small percentage of dual traders cheat. if were may Besides, even dual trading banned, the stealers Do you remember your first trades? would still find a way to steal. That is their perception of how to make in this business. money My first trade was a long position,and I made some money. Then I put on a long bond/short Ginnie Mae spread,which was almost like being When did first involvedin the T-bond you get market? long. The market went down, and I lost all the money I had made, plus $50,000 more.SinceI was making about $50,000 per month as a broker, In moved to and September 1977,1 Chicago became a broker on the T- my attitude was that I basically broke even that month. But I didn't like bond floor. I was and I I went to a just twenty-five got lucky. New York the feeling at all. So, I cut my position size down and started trading in November 1977 and met with eight big-name companies, seven of little more actively. This happenedduring the bear market of 1979. The whom opened accounts. I was at the at the the right place right time. problemwas that I was bullish all way down.

When did you start trading for your own account on the floor? Why were you bullish? In 1979. that rates couldn't My customers kept telling me go much higher.* For example,I was handling the orders for CitiBank and Citicorpand they Were you tempted to give floor sothat could that up your brokerage you were buying all the way down. These were renowned peoplesaying concentrate on trading? they had an opinion and backing it up with deeds.

Actually, it was just the opposite. I had started out as a customer's man, and from 1979 through 1981,1 built a massive customerbase.We were a force in the market This a that is sometimes powerful at that time. Probably the saddest thing I *Bondprices fall when interest rates rise. is basic concept ever did a to the novice.Thereason that bond prices decline if rates increase canbeexplained was to became trader too. I was a great brokerin my twenties, confusing as If rates itmeans that all arelessattractive and if I had that follows: rise, existinglower-yieldinginstruments parlayed for ten years, I probably would have ended up to investors. To induce an investor to purchase these lower-couponbonds, their prices must where I am now without enduring all the pains of trading. I consider fall sufficiently so that the return is equivalent to the return on the higher-coupon bond to be an trading unrewarding, unglamorous game. purchased at face value. 354 Brian Gelber Brian Gelber 355

What would you do today in the same situation? customers as I had done in 1979,1 would have thrown away money all over again. Now, I know the characteristics of various institutions. Let's take Citi- I Bank. Back then, was buying because they were buying. Now, if Citi- What told you not to listen to your customersthen? I Bank wasbuying, might conclude that they were just reallocating their the of have of based on someone else's assets or changing duration their portfolio. Today,I little The 1979experience losing money that was regard for the views of portfolio managers, because their outlook tends opinion\342\200\224a sound opinion by intelligent people just absolutely to cover a much longer time perspective than mine. I didn'tunderstand wrong. that back then.

Where were your successes coming from? So, you don't pay much attention to those types of opinions anymore? I learned how to read the tape and developed good instincts. We were and such big players in bonds back then\342\200\224we, meaning my customers listen to the market. I them in passing. I don't read the Barron's interviews of myself\342\200\224that the spots we picked to trade could virtually stop of and resistance It portfolio managers anymore.It never did much for me, and I don'tthink We were actually creating some the support points. think there it does much for any trader. didn't take that much to do it back then. I was a streak of

months when I hardly had any losing days. In other words, the problem wasn'tthe fact that you were listening that it without the accounts? to other people,but you were listening to the wrong people. Could you have done commercial

didn't know which were would that I it without them; that it wasn't a self- I how to decide the right or wrong people. I was I hope could have done But if know. a naive kid saying, \"Here is a major accountthat is buying a lot of stuff; fulfilling prophecy. it was, fine. I don't the market should go up.\" When did that streak end? You had no no no You were really strategy, plan, system. just until shootingfrom the hip. From a trading standpoint, I never had a losingyear 1986, although the bull market in bonds. I did struggle in 1985 during the mid-stages of Then over That's right. time, I started to get a grip on how to make money. As opposed to saying, \"I have an opinion and I want to express Was your trading successa matter of being able to read the tape? it in the market,\" I started asking, \"How do I make money out of all this?\" Yes. I was attentive and had good instincts. What had you learned by that point?

It soundslikeyou are saying that either you are born to be a good I had learned that an opinion isn't worth that much. It is more important traderoryou are not. to listen to the market. I became a reactive trader as opposed to an opinionated trader. don't Well, to a certain extent,that may be true. My feeling is that you In 1980,one of my customers was Solomon Brothers.At the time, have to be, but it helps. they were bearish on bonds from 65 to 80. If I had listened to my big Brian Getber 356 Brian Gelber 357

Is it a matter of having a sixth senseabout the market? Beingonthe floor sounds like a very intense thing to be doing day in, day out. Doesit physically grind you down? Yes. Your gut often tells you what to do.

Absolutely. You canseethat in the older fellows. When you are in your Are people who don't have the natural instincts for trading wasting twenties and thirties, you can rebound pretty well from the physicaland their time? Or can almost anybody be successful if he or she works mental stress. As you get older, you don't rebound as well, and you have at it hard enough? to push harder to maintain your performance.

Working hard has nothing to do with it. About two weeks ago, a very It sounds like professional sports.You get to a certain age and no \"This is bright fellow who works forme said, a very frustrating business. matter how good you were\342\200\224 It doesn't matter how hard I work; it has no bearing on whether I make not.\" You have that to money or to know yourself and put knowledge That's right. It's exactly like that. work in the market.

Out of every 100 people who goto the floor to become traders, how That sounds like a cliche.What do you mean by \"know yourself\"? many will make at least a million dollars within five years?

I'll an example. I think I'm a good trader, but there is a guy give you Maybe five or less. working for me who is better. I could go out there and beat my head the desk and to outdo can be Let him try him, or I just myself. will against Howmany end up losing everything they came in with? make whateverhe can, and I'll make whatever I can. view of a in the life of a trader:Four out of twelve This is my year At least half. You are so at months you are hot. excited that you can't sleep night. You can't wait to get to work the next day; you're rolling. Two months just You have been more successfulthan most traders. What do you out of the are cold. You are so cold, are miserable.You year, you you attribute your success to? can't sleep at night. You can't figure out where the next trade is going to from. The other six months out of the make and lose, come year, you The reason I have been so consistent is that I'm a great listener. I You can't to make and lose. sleep, because you are trying figure out how probably talk to about twenty-five traders eachday.Mosttraders don't listen are going to make money. you to your opinion; they only want to tell you their opinion. I am different result is The net that you never sleep,becauseyou are constantly because I honestly and truly listen to what they say and how they say it. too much about trading. It is an all-consuming thing. That is thinking For example, if one of the major locals calls me up three days in a row need to know yourself\342\200\224to moderate emotions. If you why you your when the market has rallied, and he is asking me what I think, I know then after a success, are as a kite. You are not don't, big you high prepared that he has been selling and is not sure of his position. the the to when just around corner, market suddenly brings you back in the situation, when are earth. Or, opposite you consistently losing, you What does that tell you? out of a window. did I leave the floor? might end up jumping Why Again, I know I need to interact with and that doesn't because myself. people If it is in line with what the other traders I talk to are doing, it tells me there. happen the market will probably go higher. 358 Brian Getber Brian Gelber 359

of are nervous too So if you talk to twenty-five people,and twenty them By \"trying hard,\" do you mean pressing when there is no trade? are about the market going higher becauseimplicitly they short, the side? is of the in does that tell you that you should be trading on long Pressing one reasons I'm sitting here with you for so long during trading hours. The markets haven't tradedwell in weeks, and we number in the and that is a are of for not Yes. I know a large of people industry big proud ourselves having thrown a lot of money away. plus. I listen to them. I go with the people who are hot. Sure, I can form the I do in the Sowhen the aren't my own opinion, but that is not what makes me do things opportunities there, you just lay fairly low? is and I'll with it. market. Sometimes,Iknow my opinion right, go I know else is and I'll with their I'm Don't misunderstand me. I'm not that at but I have Sometimes, somebody hot, go opinion. good that, gotten if better as I've older. that not picky about how I make my money. It doesn't matter my opinion gotten I've learned lesson over the last couple of whether I make After Richard Dennis left the \"The is right or wrong. All that matters is money. years. floor, he said: first year I left the floor was the most painful experience for me, and I have paid the it and tuition I ever have.\" It was the Doesn't get confusing when you talk to twenty-five people largest same with me. fifteen are bullish and ten are bearish? What was the motivation for coming off the floor,sinceyou were so been able successful there? Sometimes,but I've been doing this since 1976.I've always even thinks I listen. For to read people very well, though no one example, now. All I have to do is I felt that the had the I have one trader here who is cold as ice right industry developed to point where my brokerage listen to him. Last night, he told me he wanted to be short. I knew that I skills wereno longer needed. All anyone wanted to know was: \"Where's was to be the next tick?\" \"How can I move size?\" The to be for going long. price paid my particular skills was too low.

As long as he is cold? You are talking in terms of customer business? fine. When the is he cold. Right, and the one time he getshot, guy cold, is Customerbusinessand The You can't say to a trader, \"You're cold, you can't trade.\" You have to trading. market had gotten so voluminous that let them run their course. my style of swing trading was worthless. It got to the point where I was just trying to read the next tick instead of the next 8 ticks. Is reading other traders a key componentof your personal trading couldn't right now? Why you play the same game?

The understand how to read them. volume was too was too I couldn't Yes,I'm pliable. I know these people, so I big; capitalization big. read the market from the floor. I don't want to hear what Jack Schwager says,becauseI don't know him. I only want to talk to people I know very well. Because there were too many players?

What other things are important to your trading success? In the Exactly. early days of T-bondfutures trading, the depth was low and when and you could read when were The realization that when you don't care, you do well, you try people overextendedlong or short. You couldn't do that anymore. too hard, you don't do well. Brian Gelber Brian Gelber 361 360

see the Is that still true? Did your performance start decreasing;did you handwritingon the wall? I countertrend real No, it has changed. I've gotten better. can still trade and I dollars for the first time well, but I found can also make a lot of trend following. In 1985,1 made under a million trading you money I had been a very consistent trader, knew something was wrong. always that each I lookedat my results and found my Do use making more money year. you trading systems? 3 and 4 ticks, and my losses were greater. profits were smaller, meaning I found a much more active pit trader. first reaction was to become No,we are \"discretionary traders.\" We only use technicalindicators and My was on tremendous and the risk/reward we that I was taking positions systems as trading tools. One particularly interesting system have that I had to make a I convinced change. that insane. That was when became developed is based on quirks related to volatility. Our belief is volatility offers clues to trend direction. Although we've found through hit hard during that that didn't get really we not Were you just lucky you backtesting that this system gives you good signals, do blindly trade? period on any particular follow the trades.

of but I had some good I did hit pretty hard a couple times, Actually, get For an automated, computerized system, what would you consider and I found that The is that as I worked harder harder, winners too. point resultsin terms of average annual return? to work hard at good was running in place. I don't like all I was doing exhausting myself. and here I was just mentally and physically trading, About 40 to 50 percent, with maximum equity drawdowns under 10 have percent. well as in years, would you If you had been doing as previous stayed in the pit? But systems will always have larger maximum drawdowns than that. have environment. Off the floor, you Yes. The pit is a very stimulating That was a difficult we haven't traded on them. to be motivated each day. very That is why directly money to force yourself

transition. a Do you think any system can compete with good trader? Is it harder to trade offthe floor?

I haven't seenone there be one somewhere. in 1987 and 1988 has been pretty yet, although may Not in the long run. My profitability

good. Therearesometraderswho have the skills, but who don't succeed. difficult. the floor was very What is it You mentioned that your first year off that keeps them from becomingsuccessful? still to trade the market Was the main problem that you were trying

did on the floor? and can't admit as you Most traders who fail have large egos that they are wrong. Even thosewho are willing to admit that they are wrong early in reason was that the the number one reason. The second Yes, that was their career can't admit it later on. Also, some traders fail becausethey bound the 1986 runaway bull market. I was transition occurred during are too worried about losing. not based on following trends. to lose because my style was 362 Brian Gelber Brian Gelber 363

matter of to avoid It sounds like of In other words, successful trading isa trying part your money-management philosophy is based each losses,but not being afraid of them. on treating year independently.

it. When start Right. Anyway, I sold a little bit more at the and that That is a good way to put I'm not afraid to lose. you being up highs, from point on, I was only concerned with I waited afraid to lose, you're finished. covering. patiently, and the market started coming backdown.I ended up losing only $400,000 for the day, not all that bad whereI was earlier. But that Is the ability to accept lossesa characteristicof a winning trader? considering trade had a emotional onme.I was big impact flabbergasted by the market action. I had that markets run like the forgotten could away that. I couldn't Yes. Tom Baldwin is a good example.He only trades market; he believehow wrong I had been. doesn't trade sizeor equity. By that I mean, he doesn't say to himself, \"I am long 2,000 contracts.Oh my God, that is too many, I have to sell What mean did you earlier when you said the Japanesecorneredthe some.\"He never looks at it that way. He will sell either when he thinks market? thinks that his is the market has gone up too far, or when he position wrong. When the want to Japanese buy something, their big thing is market share. This the first was time the U.S. got a good feelof how the Japanese In your trading experience,isthereone particular trade that stands buy securities\342\200\224they buy them all. out as the most dramatic?

Was this the move that drove us to the highs in the bond market? the there In 1986,when the long bond was being corneredby Japanese, on I the was a big, emotional rally a Monday morning. had thought That's right. it market was too high at 90.00, and here was trading over 91.00. So I sold contracts above that level. The market backed down So, the 1,100 scale-up apparently, Japanese weren't as fazed by the yield being so at 91.00. Just as I was that I had this the and was offered 1,000lots thinking low for all risk implied in a long bond position. trade nailed, in less than five minutes the market reversed and soared to 92.00. I don't think look at it in terms they of yield. Rather, they view things as I was down $1 million, and the market was only a few ticks away whether are and if prices going up, they are, they buy. Every time they from limit bid. I had never lost somuch money, so fast, and it was would would and buy, prices go up, they would buy some more. because I did things differently than I normally do. The bond market hascollapsedagainsincethen; did they get out of What specifically? their positionin time?

don't trade that in the I like to make Sure. Do know who the I usually big early year. money you bought most at the highs? TheU.S.dealers at first and then with the money I have made. who needed to cover had gradually play desperately becausethey sold on the way up. Brian Gelber 364 Brian Gelber 365

Why didn't you the before the since Are the Japanese smarttradersthen? buy spread vacation, you had the idea?

have a are cannonball traders. They go one way, No, they just style. They I was for the waiting spread to break out above its trading range. I wanted A friend of mine at one of the Japanese shops and they all go together. to it buy above $26,000. At a $30,000 spread, I just the about bond couldn'tpull told me about a trader who bought just every long Japanese trigger. and asked, on the screen. About fifteen minutes later he called back T-bondsand T-bond is the basis [the spreadbetweencash What is the \"Why price key trading rule you live by? had noticed that cash futures] going out?\" Naively, the Japanese trader while futures didn't much. My friend prices had gone way up, go up very Never add to a loser. bond available. Of course, the told him, \"Well, you just bought every out.\" didn't understand the impact of basis is going to go They really What does the average trader do wrong? their trading. market in did much the same in the U.S. equity The Japanese thing Heovertrades and begs for tips. took control of it, 1987 as they did in bonds in 1986. They practically

buying because priceskept going higher. How do you handle a losing streak? and bonds in F11 never forgive myself for not buying stocks selling That was to be number one trade in 1987. I 1987. going my instinctively trade smaller and sometimes Ijust take abreak.Itisagood habit to wipe the slate clean and start fresh. run Was the reasoning that the bond market had already way up, the two markets were out When are but still while stocks hadn't? Did you just believe you going bad, have somegoodpositions on, do of line valuewise? you liquidate them as well?

Absolutely. They are bound to turn against you too. were buying the high- That's right. Also, we knew the Japanese learned their in capitalization U.S. stocks. Having already buying style the bond market, the trade was even more obvious. I found the of dual and subjects trading the Japanese impact on the U.S. T-bond market among the most of conversation do it? interesting portions my Then why didn't you with Brian Gelber. These subjects, however, did not provide any insights into the art of On trading. a more practical note, one of the primary and the T-bond contract was trading caveats Gelber concerned the The spread between the S&P providedby misuse of brokerageresearch. value basis. I went Henoted a for between $19,000 and $25,000 on a one-to-one contract tendency the broker and clientto use longer-term research few in the for short-term This on a four-day vacation, and in just a days, Japanese buying trading. misapplication of information often leads to to even when the stock market had pushed the spread $30,000. trading losses, research is right. Brian Gelber 366

and of are elements of Clearly, flexibility suppression ego key with their Gelber's success. Referring to hot traders, he notes,\"I'llgo I'm All that matters is whether I opinion.... It doesn't matter if right. make money.\" is onecited a Finally, Gelber's reaction to losingstreaks by the slate clean and starting fresh. Tom numberof traders. He advises wiping Baldwin allows the trader to achieve clarity. Getting out of everything greater if still attractive, can be Liquidated positions, they appear always TheFearlessPit Trader reentered once the trader has regained his confidence.

The trading pit of an active futures market is an imposing place. Scores

of traders push over each other, while shouting buy and sell orders at the of their To the it seems miraculous that top lungs. uninitiated, this institutionalized bedlam functions a for actually efficiently as process executing orders. In the frenzied world of futures pits, the T-bond ring, with over 500 out as the traders, stands unchallenged giant. The pit is so large that one side of the ring often does not know what is happening on the other side. By most accounts,Tom Baldwin is the single largest individual in trader the T-bond pit. His trading size puts him in the same leagueas

the primary institutional players. Single trades as large as 2,000 contracts

($200 million face value T-bonds) are not unusual for him. Ona typical

day, he may trade over 20,000contracts (the equivalent of $2 billion in face value T-bonds). Baldwin is in his early thirties, having begun trading T-bonds a scant six years ago.

Baldwin'sentry into the world of floor trading sounds more like a recipe for failure than success. In 1982, with no prior trading experience,

Baldwin left his job as a product manager for a meat-packing firm to on the lease a seat Chicago Board of Trade. Hisstakewas only $25,000. Out of this skimpy capitalbase,he had to pay over $2,000 per month to lease the seat, and at least another $1,000 per month for living expenses. this were As if not enough, his wife was pregnant at the time. 368 TomBaldwin Tom Baldwin 369

it safe. His risk- late. The was over. had to Obviously, Baldwin is not one to play aggressive game Baldwin said he get going and excused is the elements of his success. He turned a himself. taking posture one of key millionaire before his first was profit from the beginning. He wasa year and has never looked back. he declines to discuss the up Although to be a conservative estimate. extent of his winnings, $30 million appears Howdid you first get interested in trading?

The true figure could be significantly higher. I an interview with Baldwin essential to this project, considered I had taken some classesin commodities in graduate school. I wanted to the most successful floor trader in the because of his as but I didn't have prominence trade, the money to buy a seat. In 1982,1 found out I futures market. Baldwin, however,was not eager to be world's largest could lease a seat,and that's when I began. in the he had interviewed. Although he had done some interviews past, reluctant to do more. Without Brian Gelber's obviously grown any Did want to as you always trade a local as opposedto any other type two are friends and admire eachother's generous intervention\342\200\224the of trading? interview would never have taken trading abilities\342\200\224this place. me could be either abrasive or Gelberhad warned that Baldwin Yes. former. As an Gelber saidthat gracious, but to be prepared for the example, of how first involved Baldwin would probably answer the question he got Howdid learn to trade? \"I to the and you in trading with the curt response: went down floor began this was close to the of his answer. trading.\" As it turned out, very spirit the end of the One lot at a time. I had an All I arrived at Baldwin's office several minutes after always opinion. day long I stood there and I Baldwin arrived a few minutes later. Sincehe had just developed an opinion.As came to see that my was I was day's trading. opinion right, the reinforced, even if I didn't the trade. moved to new offices and the furniture had not yet been delivered, make Then when I traded, I knew from there six hours a that most of interview was conducted sitting on a window sill. standing day, every day, the time I aloof was I would see the same over Baldwin's attitude was neither abrasive nor gracious; might right. scenariosdevelop and over again. distinct that the minute be the best way to describe it. I had the impression would It was Are about market I hesitatedin asking the next question, Baldwin be gone. you talking patterns or traders doing certain intensified each time St. Patrick's Day, and this impression was things? at a local someoneleft the office saying that he or she would meet Baldwin to could sense that Tom was anxious to them. I decided Both. Market bar. I join patterns would occur over and over again, or market off a new conduct the interview shooting question would do the over and completely impromptu, players same thing over again, and you just trade the second he finished answering the prior one. Often his responseswere it.

I felt like a stalking a rare bird; one false quite short. photographer step would off. and the bird fly What were your first few months like? Were you profitable I knew at some I would not be able to think of an that, point, initially? minutes into the immediate follow-up question. This happened about forty I down at my index cards, searchingfor a interview. quickly glanced I think the I ever most was down was 19 ticks, so I pretty much started focused on a I had already touched lead. Unfortunately, my eyes question out profitably. I tried to ask it from a different it was too upon, and though perspective, Tom Baldwin 370 TomBaldwin 371

to the with no background, what was it that gave you what Coming pits Right now, percentage of your trades are position versus scalp? enough of an edgeto be right on the market? A small percentage, well below 10percent. I workedhard.I stood there six hours a day, all day, every day. are still Basicallythen, you using the same basic trading style yon But you didn't have any experience to fall backon. started out with.

education at all to do it. You don't need it. You don't need any The Right. it smarter you are, the dumber you are. The more you know, the worse

is for you. Do you use any technical input?

on a For your type of trading\342\200\224that is, scalping\342\200\224when you put Yes. I use charts. trade, what are you looking for? Do you use intraday charts, since you are trading shortterm? full or 1 To get as much as I can get out of it. I've taken points just tick the out of a trade. You just never know. You have to watch market, get No.Bar charts covering the past six months. a feel for it, and if you are in the right position, just go with it. If look at the you charts and say, \"I'mbasically bullish,\" do you will net out at a few ticks? On average, though, your trades primarily scalp from the long side?

4-tick on Not I start with an Yes. I probably average profits big positions. necessarily. would opinion, but if I saw something to change my mind, I would adjust.

I assumeyour holding time is probably very, very short. Is the fact that you started off with a chart-influenced trading bias

a key elementbehindyour winning? I try to make it short.

Yes. Are we talking about minutes?

Were there periods when you were unsuccessful,or did you remain or that is less risk. The is Yes, seconds. Just because object always: consistent? Minimize your risk. Consistent. Have you always been a scalp-typetrader?

Didn't you have any losing months? of and Well, I evolved from a pure scalper to a combination scalper speculator. Yes, I had one or two. Tom Baldwin 373 372 Tom Baldwin

Is that a of But not two together? characteristic winning traders: They have less fear than the losers?

No, never. Yes.

floor still What percentage of those who come to trade on the are their stake and out? around after five years, versuslosing dropping Can you size up a new trader onthe floor and tell if he is goingto makeit or not? Less than 20 percent. That is really the rule of thumb, and it's probably less than that. Yes.

What percentage are successful to the point of making and keeping What kind ofthings would tip you off that he is a loser? at least a coupleof million?

Mostimportant, losers don't work hard enough. Mostpeoplewalk in and One percent. think there is a 50/50chance on any trade. They don't think there is anything more to it than that. They don't concentrate. They don't watch the In other words, a very small fraction of traders. factors that affect the market. You canseeit in their eyes; it is almost as if there is a wall in front of their face. How to Right. It is like any other industry. many people get be president

of General Motors? By factors, do you mean fundamentals? Do you have an opinionabout what separates the 1 percent from the other 99 percent? No. Paying attention to what other markets are doing,suchas the Dow Jones or the gold. Watching traders in the pit.

Yes. It is a lot of hard work, for one.It's perseverance. You have to love to do it. Also, in our business, you have to have a total disregard for Patterns? money. You can't trade for money. Yes. with Do you mean as long as you like the position, you stay it? That you can't think, \"I'm losing $1 million on this trade, and In other words, they are not paying enough attention. They are with million I a house.\"You can't $1 could have bought great standing there trying to pick a tradehereand there, but they are not translate it into real terms. absorbing everything that is goingon. Exactly. Mostpeopledo. their Right. Also, expenses are usually way too high. They can't stand there and hack it to it Because it is if it is long enough pick up. like any job, I guess another way of saying you have to have almost no fear. you stand there long enough, you have to pick it up. It is just a matter of can how long you afford to stand there beforeyou do. Right. 374 Tom Baldwin Tom Baldwin 375

Do you really believethat? Waiting for the right spot?

million-dollar but if he Well, the average guy might not be a trader, stands Right, I bet most people are probably aheadafter their first five trades. he would have to it It is just like a You there for five years, pick up. job. \"This They think, is great, like free money.\" But then they forget that don't start and feel comfortable in the first six months. any job the reason their they made money on early trades was because they waited a long time. They said,\"I bet this is a good spotto buy it because You did. I've seen the market act this way a lot of times.\" And they made money. But all of a sudden,they are doing a trade every day. Yes, but I did start as a one-lottrader. And I wasn't really comfortable, The next thing that happens is they lose on a few trades, and had to becauseI had to make money. I only $25,000 my name. invariably don't know how to take a loss.They made money to start, and know before they it, they are even. Now they hesitate. \"Where do I get confident that were to be At what point were you you going out?\" The minute the they hesitate, market just keeps going. Now they successfulat it? are losing money and they say, \"If I sell it here, I'm going to lose $1,000.\"

They don't like to lose $1,000, when they're getting $500 a week. in paid That is an interesting question. You are never really confident this all Now, of a sudden, they are thinking about the money. business, because you can always bewipedout pretty quickly. The way the die the sword. There is the I trade is:Live by sword, by always with a in a fluke move with Once you think about the money, you are dead? potentialthat I could get caught big position the the other there doubt market going the limit against me. On hand, is no I could walk into market in the world and make in my mind that any Yes.That is what usually happens to the public. money. What is your own way of losses? of handling What percentage your days are losers?

Get out. One day out often.

over time? Has that percentage changed Quickly?

That is over a long period of time. If I can. My point is that I have a lot of patience and I wait. If I know it

is a losing trade, I wait for what I think is the optimum time to bail out. From your perspective, what does the average trader\342\200\224that is, Then I try and reverse. public trader\342\200\224do wrong?

So, if you realize don't likethe trade anymore, you'll get out, their you They trade too much. Theydon'tpick spots selectively enough. but you'll pick your time? the market want to be in on the action. When they see moving, they So, the trade rather than Patience is they end up forcing waiting patiently. don't have. Right, but I will get out. an important trait many people 376 Tom Baldwin Tom Baldwin 377

Your size has since Let's say you are doing that on a day when the marketisa one-way trading obviously grown quite dramatically you first into that made it street. At what point do you just have to cough it up? got the business.Has harder to trade?

have to Yes, you adapt. You need to changeyour method of buying and It depends how far it has gone against you.If it's against you a long way, selling, becausethe market is continually changing in subtle ways. at some point you just throw it in. Those days happen maybe three or four times a year. You just start bailing out. What changes have you seen in the bond market since you got in?

But usually have a feel for when that is the thing to do? can trade can you Well, you bigger size. Now you usually trade a couple of hundred at each tick. It doesn't move the market as much.

Yes, because it has happened before. How about a thousand lots?

But normally, if you are just a bit behind in a trade, you are better It depends on the liquidity at the time. Lots of times you can get out. It off if you let the market movea little in your direction and try to sell is amazing how much liquidity there is when you want to get out. on strength, or buy on weakness, instead of just trying to dump it in a hurry? On average, if you had to dump a thousand, how much would that move the market?

Right.

Dependingon the time of day and the liquidity, maybe 1 or 2 ticks.

Is that a key element to your trading style? Not much at all?

Yes. Never on a trade. traders who are in a losing trade give up Many No, not much. will just get out because they were taught that you have to have But if discipline. Great. Those traders will always be around. they just had Has size been an impediment at all if the liquidity is that good? some patienceand said, \"Yes, it is going to be a losingtrade, but instead of out here at 7, if I wait and just sweat it out for another getting maybe Yes,it is harder. Generally, when you get into a big position, the rest of I at 10.\" minute, cansell the floor knows about it stood there because they and watched you. At least they think they know. Theyall put their hands down and wait when

And if they think are It is natural for a trader to be Is it a matter ofjust wanting to get out to stop the pain? they you wrong. skeptical. were willing to stand the pain a little longer, they would be better would it? I almost think that because you have a record of off.Is that a fair way of putting long-term success, they would more often coattail you.

Yes. too In most cases,if you don't give up, you They give up quickly. Lots of times that is true, and that also makes it harder to get in and out. be able to turn a five-yard loss into a loss. might two-yard When you go to offer them, they are all offering too. 378 Tom Baldwin Tom Baldwin 379

How do you handle those situations? Do you use fundamentals?

Whenever fundamental numbers come out, I use them. You have to pick your spot. You have to wait for the big paper order to any important come in and then go for it. Do you use the fundamentals indirectly, that is, by seeing how the to the it like market new information? Does become a chess game, where you sometimes want the pit responds thinking that you are selling when you are really buying? Yes, but also by being the first one to trade off the new fundamental information. I know what I am to do if a number comes out one way Yes,sometimes. But generally, you can't trade big size when you are going or the and I have the to be first. doing that. other, usually opportunity

You want to there before the crowddoes.Are you normally right So, frequently, if you are long and want to liquidate, you just wait get for the bid to come in? on that type of trade? Yes. Right.

You've done tens of thousands of trades. Does trade stand What kinds of things do you look for in a chart? any single out as particularly emotional?

Key points such as the high and low for the week, the halfway backpoint, and consolidation areas. The first 100-lot I did. It was a milestone.

What kind of jump was that for you? Do you use charts for short-term or long-term perspective?

You tend to go from one lot to five lots to ten lots to twenty lots to fifty Short term. lots.

Short term in your case meaning? So, you probably went from 50to 100?Do you remember that trade?

I as short as You in a make as fast as guess possible. get trade, money Yes, it was a much bigger risk. The market was trading at 64.25 and a possible, and minimize your risk. a brokerbid 25 for 100 lots. But he didn't put size on it, he just bid 25. and \"I'll the SoI said, \"Sold.\" He thought I was being funny said, buy I've noticed that a lot of will take out one- times, bonds and two- 100,\" knowing I had never traded that big before. So I said, \"Well, I'll week or lows by a few ticks and then back. The sell 100.\" The market went to 24 offered highs pull price you instantly. action almost seems like a trap for the breakout players. Is that a pattern in the bond market? It almost sounds like you did your first 100-lot as a dare?

almost. But I wasn't a trader then. I Yes. It always has been. Well, very good immediately 380 Tom Baldwin Tom Baldwin 381

then ten more. I was to bid at and the market went Are in or are there when have lost bought ten, trying 23, you always control, days you 22 I to offered. By the time I got out, had ten different people in the trade, control? because I didn't know how to cover 100 lots. There were days when I've lost control. But the trade worked out for you?

Any that stand out? Oh yes. Well, actually, the word got out that this small trader had done a 100-lot.SoIhad to go up to the office to talk to the clearing firm after A couple. You have to say that about any day you lose a coupleof the close. million dollars.

How long had you been trading at that time? Were those days one-way street markets? Six months.

Yes, one-way streets. Because I'm a market maker, I take the other side That was assume of the trend. So, if the market one for 50 ticks, I can pretty early on.I your capitalization was really goes way guarantee I'm at some inadequate to handle 100 lots? you going the wrong way, and point, it is going to be a loss.

I in Right. had probably made $100,000 by then. Maybenot even that. What was your position at the October 1987low bonds?

Even at that wouldn't cover for much of a move. $100,000, you I was long.

Yes, only 1 point. [In bonds, 1 point equals32 ticks (the smallest price When did you start getting long? movement).] I told them, \"Look,Ijust thought it was a great trade at the time, and I'll probably never do it again.\" Five points higher.

How long was it before you traded 100 lots again? Five full points! You mean 81?

Two days. contracts. Other Yes. The day it broke below 77,1 was long thousands of

You just never thought about the risk side of it? traders were also heavily long.

if a think That the we lower. Who was No, guy bids 25 for 100, and I that it is a great trade, Ijust say was day gapped sharply selling? \"Sold.\" The commercials just kept selling.

Is thereany element in your mindset as a trader that says: I had second better be careful that I'm always in the game? Didyou have thoughts?

That camelater. Yes. 382 Tom Baldwin Tom Baldwin 383

Did you think if the market went down to 76, it could to maybe go You have to pay your dues to get the luck. 70? Right. No.At that point, you had to say it was all over and done.

Are there peopleon the floor who are not good traders, but are way Why? ahead because they just happened to do a coupleof big trades on the right side of the market? Can anybody really get by just on luck? Technical analysis and experience.

No, not for long. The rule of thumb is if you have lasted a year, you will Was that an example of your in picking to being patient your spot make it, but it is hard. get out, even when the initial trade was wrong?

Are there traders that you are influenced by because you respect Right. what they are doing?

Do you ever use any trading systems for anything? Oh, yes. They are indicators.

No. They wouldn't be there if they weren't wrong. So, that is actually part of your trading approach. For example, if trader X isa goodtrader,and he is on a roll, and you are thinking Do you think trading systems are a losing game? of selling\342\200\224

Sure.Why do they exist? And he does, then you know you're right. You tell me. But if he is buying?

confident in their own Becausepeoplearen't ability. If you had a really Then hesitate. don't into the trade. good trading system, you could make millions. Why would you sell it you Maybe you get for $29.95? Are there traders who can't succeedbecausetheir ego is too big to Doesluck have anything to do with trading? ever be influenced?

other Trading is like any job. You work hard, put in the time and effort, Yes. and make your own luck. I was lucky that the first 100-lot I sold wasa winner. But was I BecauseI stood there all for over six why lucky? day Is part of the success a willingnessto not always do your own thing? months, developing and honing market feeling. When the opportunity occurred, I didn't hesitate. success. If Right. You have to adapt to your you make a lot of money, 384 Tom Baldwin Tom Baldwin 385

all of start to a suddenyou think you are infallible.You forget the reason could a floor trader, whose time horizon is measured in minutes and were was because of all those little factors that you right you followed. seconds, say that was relevant to traders who hold positions for weeks As soon \"I'm the as you think, guy who is going to lead the way,\" you or months? get slammed. To the interview some relevant my surprise, yielded insights. on not Perhaps the most important point made by Baldwin washisemphasis So, it doesn't make a difference whether it is idea or really your viewing trading in terms of money.To him, money is only a means of somebody else's. Winning or losing is all that counts. Where the idea most traders tend to think of and keepingscore.By contrast, gains came from isn't losses frame of mind important? in terms of their monetary implications\342\200\224a that only

gets in the way of making trading decisions. Right. to For example, assume you originally planned to risk up $5,000 this on a trade, and quickly find yourself down by $2,000. If, at point, Do you have to be somewhat of an to be a egomaniac good trader? you start to think of the trade in terms of money (for example,\"the extra

$3,000 can pay for my vacation\,")you might well liquidate the position, the best traders have Actually, no ego. To bea great trader, you have to even still believed in the trade. It is one to out though you thing get have a in the that have bigenough ego only sense you confidence in because no like the but it is another matter to you longer position, quite yourself. You cannot in let ego get the way of a trade that is a loser; have into you liquidate on impulse simply because you have translated the risk to swallowyour pride and out. get tangible terms. Another interesting point made by Baldwin is an unconventional After is you get way ahead, there a temptation to say, the extra wait and one: Don't get out of a losing trade too hastily; instead, choose doesn't mean money anything anymore, maybe I shouldcashinthe advice. your time. This advice seems to fly in the face of most trading chips? After isn't one of the basic tenets of success to cut all, trading your lossesquickly? However, I don't think Baldwin's statement contradicts the never that when I I I thought way. Obviously, started, needed to make out rule. I believe he is saying that often the worst time to bail of a money to support my family, but I never had a to make a million is that goal position is during a violent price move against you. Baldwin's point dollars. I this is make said, \"Hey, great, maybe I can $100,000.\" be find a more by bearing the pain just a little longer, you may able to

favorable circumstance for liquidating. Of course, this philosophy should You that a time Do have passed very long ago. you any other goals? with the to maintain be appliedonly by disciplined traders: those ability a risk control No. strategy.

You just do what you do because you enjoy it?

Yes. And I hope it lasts.

Baldwin's incredible trading achievements madehim an ideal interview candidate for this book. However, I did not really expect his comments to be pertinent to myself or other off-the-floor traders. After all, what Saliba Tony

\"One-Lot\"Triumphs*

Tony Saliba came to the floor of the Chicago Board Options Exchange m 1978.After a half-year of clerking, Saliba was ready to try it on his own. He found another trader to back him for $50,000, and after a favorable start, nearly self-destructed. He pulled back from the brink of disaster by altering his trading techniques, and has beensuccessfulever since.

Saliba's trading style can be describedas trying to do a little better than water in, while to take treading day day out, being positioned advantage of the rare spectacular trading opportunity. His fortune has been built largely by exploiting only a handful of such events. Two of these situations\342\200\224the Teledyne price explosion and the October 1987 stock market collapse\342\200\224are discussed in the interview. The impressiveaspectof Saliba's trading achievements is not the few spectacular gains he has registeredin his career. Rather, it is that these gains have been achieved by using a trading approach exemplified by incrediblerisk control. In fact, at one point, Saliba managedto string together seventy consecutive months of profits exceeding$100,000. Quite a few traders have become multimillionaires by scoring several big hits. A much smaller number have managed to hold on to their gains. Only the rare trader can boast both occasional dramatic gains and consistent trading profits.

\342\231\246Readersunfamiliar with options may wish to first read Appendix 2 in order to understand the trading-related references in this chapter. 388 Saliba Tony Tony Saliba 389

the homework for Saliba's successful is Although required trading was, \"Thank God I'm the one facing the screen.\" extensive, he has nonetheless managedto diversify into a wide range of other ventures, including real estate investments, a software company, and a restaurant chain. Overall,his extracurricular business endeavors What led you to become a trader? have but have his proven only modestly profitable, they indulged appetite for variety. I was a for some traders when I was in school. In caddy grain high During the time theseinterviews were being conducted, Saliba was college, a friend of mine asked me if I would like to be abroker.I thought in the involved most important business venture of his life: negotiating I that he meant doing the same thing as the guys had caddied for. So, I with a French bank to back him with several hundred million dollars to said,\"Yes. Great! Where?\" \"Indianapolis,\" he answered. I said,\"What form a major trading company. His goal is to discover and train a exchange is in Indianapolis?\" \"None,\" he said, \"you do it on the phone.\" generationof successful traders. I had this impression of: \"Hello New York, buy; Chicago, sell.\" When I Saliba is a likablepersonwho makes you feel like you're one of got there, I found out I was a salesman. his best friends within five minutes of meeting.He is a person who After a few months, I asked the guys in the office, \"Who makes all genuinely likes people\342\200\224and it shows. the money in this business?\" They saidyou have to be on the floor. Right On the evening beforeour scheduled meeting, Saliba had a minor there I decided to go to the ChicagoBoard Options Exchange. On the accident, slipping on the marble floor at the health club in the Chicago floor, I met one of the traders I had caddied for years ago, and he BoardOptions Exchange building. As I showed up at the scheduled time, grubstaked me with $50,000. his aide told me that in that the Tony would not be morning due to accident. I left a message. Saliba calledlater that day, and to spare me the Isn't that unusual, giving $50,000 to a kid who used to caddyfor inconvenience of missing my that or making another trip flight evening, you? to Chicago, he arrangedto meet me several hours later. We talked at the LaSalle Club bar, which was sufficiently empty It was, except that he was very wealthy and needed to get off the floor to not cause a distraction. I was too focused on major Initially, intensely because of his high blood pressure. He owned a seat that he had bought directing the interview to pay any attention at all to the largemovie screen for and needed the to trade in a customer only $10,000, just ability at the front of the bar. Later as I I at the on, however, relaxed, glanced account. I was going to help him do that. screen as Saliba was one of I answering my questions. instantly recognized the train scene from the movie Business in which the What made him think could make it as a trader? Risky you sensuous Rebecca DeMornay seduces Tom Cruise. have a bad habit of Hehad heard some rumors around the floor that I was a hotshot clerk, I severely overschedulingmy appointments, and as third to feel and he basically took a chance on me. Saliba was my interview of the day, I was beginning the strain. My first thought was, \"Keep your eyes off the screen, you are What happened? having a hard enough time keeping your mind focusedas it is.\" My second thought was, \"It would be incredibly rude not to pay full I in the went from $50,000 to about $75,000 first two weeks. I had put attention to Tony, especially after he literally hobbled over to spare me the on all these volatility spreads [an option position that will gain if the inconvenienceof having to reschedule our interview.\" My third thought market becomesmore volatile] and they were getting pumped up. 390 Tony Saliba Tony Saliba 391

Did feel better Did you think, \"Boy, this is easy\"? you because you had a cushion?

Yes. I \"This \"This But what I was said, is great, I've still got fifteen grand in account.\" I thought, is it!\" I mean, Iwasagenius. really doing my was the side of the other brokers were taking opposite positions You had so left a stopon your life to speak? liquidating, letting them out of the market with their profits, while I was

holding the bag. This was spring 1979 and implied volatilities were very had a went Exactly, exactly.I stop on my career. So, I decidedto back and high because 1978 was a very volatile year. Well, the market go give it one more shot. nowhere, and the volatility and option premiums collapsed.Within six

weeks I had lost almosteverything. The original $50,000 was down to Did the fellow who know remember the staked you how much you had lost? Didhe only about $15,000.1 was feeling suicidal. Do you big eversay anything? DC 10 crash at O'Hare in May 1979, when all those people died? That was when I hit bottom. Oh, Jack. He good question, calledmeevery night. I' ve grubstaked many since then, and three or four of them guys have lost more than fifty grand Was that a metaphor for your mood? each. This man wasa multimillionaire, and he acted as if this was the end of the world. Yes. I would have exchangedplaceswith one of those people in that plane on that day. I felt that bad. I thought, \"This is it; I've ruined my Did he ever ask you for the rest of the money back? life.\"

No, he just moaned and He had become groaned. wealthy through because Did you feel guilty you had lost someone else's money? inheritance and he in money made another business. He really didn't know much about He the option trading. had bought seat to have something to and I felt like a failure. do with his life. He told \"If Yes, me, you lose $5,000 more, we'll pull the So, I the next plug.\" spent few weekswinding down my positions. that I Had you started out confident? During time, sought advice from the more experienced brokers on the floor. \"You They said, have to be disciplinedand you have to do your homework. If do those two because I on you things, you can make Initially, I was very confident before started trading my money down here.You might not get rich, but can make $300 a own, I had clerked for a broker for four months and picked his brain you day, at the and end of the that's You have to look at it that clean. year $75,000. way.\" It was like a light bulb went on. I realized that this chipping away approach was what I should be not at doing, putting myself a big risk, trying now the was over? And you thought game to collect a ton of dough. At the time I was in Teledyne options, which was a very volatile I went to the market. So, I switched to which was a Yes. In June 1979,1decidedthat better find another job. I Boeing, very tight, narrow range built for of market. I became Levy brothers, who owned a chain of restaurants that my dad type a spreadscalper trying to make a quarter or an time want a can run one of our eighth of a point on a trade. them. They said, \"Any you job, you that line. I to it one more I stuck to restaurants.\" So, I said, \"Hold am going give strictly my goal of trying to average $300 a day and it was This month,\" working. period taught me to be regimented and disciplined. 392 Tony Saliba Tony Saliba 393

Were To this day, I live by the credoof hard work, homework, and discipline. you the only one-lot trader in Teledyne? I teach my guys that. of For the most Anyway, at this same time, I still had the remnants a big spread part, yes. in the of It was a position in Teledyne that I was process liquidating. in a market. One after I had been Did you take a lot of position that would lose rising day ribbing? started I trading Boeing for about five weeks, Teledyne moving up sharply. rushed into the to take Oh, did I! They called me \"one-lot\" for the time. individual was not going to let it get me again.I Teledyne pit longest The in with orders, and all who gave me the hardest time was the best trader in the crowd. He had my position off. I was hearing floor brokerscome the same made millions and was a in his of a suddenI found myself responding to them. I was adapting virtually legend own time. He started on I had learned in to instead of leaning me and ribbing me right from the He made life technique Boeing Teledyne, except beginning. my I was for halves and dollars. miserable. scalpingfor an eighth or a quarter, scalping

Did these What size were you trading at the time? your ego get dentedby really successful traders railing you?

I was one lot at a time. The guys didn't like me because I was doing orders. Oh, And, it went on for almost a out. getting in their way. They wanted to do ten-or twenty-lot yes. year, day in, day

In other words, you were just a nuisance. W\302\253reyou tempted to pick up your trading a little bit?

I did, but not for that reason. who had me such a hard Exactly. My backer, given time when I wasdown, was the prod. Although he didn't know that much about he did of How did you get someone to take onelot? trading, giveme one piece very useful advice. Once I started it around, he told me to size. He turning increasemy said, \"Tony, a banker first loan first served. If have 100 to makeshis and he is careful, but as he more On the options floor, it's first come, you sell very gets have to do his comfortable, hemakeshisloans You need to increase size.\" and someone bids first for just one, you one before you bigger. your if he do 99 with the number two guy. The broker could ignore you wants, How the harassment did you were taking on the floor finally end? but if he does,he's breaking the rules.

When they introduced puts in June 1980, the lead trader, who had given Were you ignored? the hardest me time, hated them. He said they were bad for the business

and hedidn't want to trade them. I that seized opportunity to really study Thebrokersnever did, but the market makers on the floor did. what puts would mean to us, and I wasone of the first market makers to start trading puts. By brokers, you mean order fillers?

Actually, it opens up a wholerange of new strategies. Yes. The floor brokers are the order fillers, and the market makers are On the exchange, the two Oh, unbelievable. These other were set in the locals who trade for themselves. options guys their ways, even though had been there a are separate. they only couple ofyears.Soonerthan you might think, 394 Tony Saltba Tony Saliba 395

this number one trader befriended me and that we work do suggested By buying butterflies, you mean you were long the middle or long We started on advanced real the the together. working strategies, getting wings [that is, higher and lower strike price options]? creative and abstract.

the Your risk Long wings. is limited, and if the market does not move Were these out on a computer? time works in you working widely, decay your favor. [Barring a favorable pricemove or an increase in volatility, the value of an option erodes steadily over we did hand. out all these \"what-ifs.\" time. In a flat No, everything by Writing relatively market, the premium erosion in options with a strike near the market in price price\342\200\224\"middle\" butterfly spread\342\200\224will Didn't still have to be on and be you guessingright price volatility greater than that of optionsfurther removed from the strike price\342\200\224 direction? in Of tried \"wings\" spread.] course, I to buy the butterflies as cheapas I could.If I chained of them enough together, my profit zone would be You would have to right on volatility. However, we didn't have wide. Then I would guess fairly do an explosionposition in a more distant that to peg market direction, because we were setting up spreads had a month. be overvalued big edge.Forexample,one option might highly because firms. What do it was popular among the member you mean by the term \"explosionposition\"? I of the while this trader Eventually, felt I was doing more work, top to muscle the market. He in the pit was counting on his ability would That's basically my own term. An is an explosion position option from the we had worked out and even started position that has limited risk and also stray strategies doing open-ended potential, which will profit from to to hurt me. I would say, \"What are you doing?\" He would a move or an increase in things try large price volatility. For example,a position just answer,\"I changed my mind.\" consisting of long out-of-the-money calls and long out-of-the-money I'm own.\" I started would be Finally, I just said, \"Forget it, working on my puts an explosion position. taking on more size.When interest rates went through the roof in 1981 well and I started a It soundslikethe feature and early 1982, my strategies workedreally making basicunifying of the explosion position is lot of Then in the bull market in 1982,1 had when I was that as the market the delta money. days moves, [theexpectedpricechange in the $200,000 a The guys in couldn't believe option position given a one-unit change in the of making day. my clearinghouse price the the was tons underlyingmarket] increases in sheets; there just of paper. your favor. So, you are really betting on volatility.

What kind of trades were you doing? Exactly. I was I consider a matrix trader. I trade doing everything. myself In this is the it interrelates to else. basic effect, opposite of what do with the everything on the screen as everything My strategy, you butterfly. however, was buying butterflies [a long or short position at one strike Yes. I on the in an in and lower strike put butterfly the front month, where time is for price balancedby opposite position higher working me, and the in the mid- or options\342\200\224for one IBM 135 short two IBM 140 calls, explosion position back-month. Then I example, long call, complement that with scalping to for the time in the and long oneIBM145call]and offsetting that with an explosion help pay decay explosion position. position. 396 Saliba Tony Tony Saliba 397

bet in case of In other words, the explosionpositionis your money a What happened after that? big move, while your scalping is paying the bills, that is, the time decay cost of the explosion position. One of in life was millionaire my goals to becomea before I was thirty and retire. Well, I was a millionaire before I was twenty-five. I had Exactly. decided to retire when I was thirty. On May 5, 1985, my thirtieth I walked off the floor birthday, and said good-bye to everybody and that Were one with another? In other you always offsetting position was it. I was never going to comeback to the floor. words, were you always delta neutraP. [An option position in which total equity will remain roughly unchanged for smallpricechanges How far were you up then? in either direction.]

About $8-9 million. net Usually, but once in a while I would take a significant position. Did you know what you were going to do? What was your first really big trade? I know. I didn't really thought I'd stay in the business somehow, but and I was Teledyne in 1984. The stock had dropped sharply building up work off the floor. a position in the out-of-the-money Octobercalls.Well, the stock started where inching back up, but these guys from the Pacific CoastExchange, How long did your retirement last? also list were on they Teledyne, leaning my longs. They just kept Instead of I batteringthem on the close every night. shying away, steppedup About four months. Vu and would buy them. \"You want to sell them at Vk, I'm bid for fifty.\"

This went on for over ten trading days. Were you bored?

Yes. I missed the markets. I missed the Why were these Pacific Coast tradersleaningonthe calls? excitement.

in the So, beginning, money was the goal, but once you got there it The stock had gone down from 160to 138, and then inched its way back became\342\200\224 think to On up to 150.1 guess they didn't it was going go up anymore. May 9 at 9:20 they stopped trading in Teledyne because of news it Yes, became if I had a wife and Announces a Stock secondary. Maybe kids, or someone pending. The news comes across the tape: \"Teledyne specialin my life, I might not have gone back. But was life. Repurchase Program at $200 per Share.\" trading my It made me feellike it something; gave me a reason for being.

Buying back their own stock? I understand one of your best trading periods was the weekof the October 1987 stock crash. Tell me about it. Yes. The stock was at $155, and I owned the $180 calls. Overnight, I

made millions. The stock went to $300. The next four to eventually up was a but I I expecting big move, didn't know if it would be up or down. five months were great. I the So, started building same type position that I had in Teledyne. Saliba 398 Tony Saliba Tony 399 back to about I The butterfly spread combined with the explosion position. unchanged. actually bought out-of-the-money calls that Friday for protection. Yes. But you said you thought the market was going down?

What was the explosion position in this case? Yes,but I just wanted to have some insurance. A trader once told me, \"Saliba,in second, never take hand off first In this case, it was formed by buying out-of-the-money puts and out-of- stealing you your until your other hand is on second.\"That's the I I the-money calls in the back months. To counterbalance this position, I way am; always have insurance. time had butterfly spreads in the front month, which would profit from Still, you must have been confident that the market decay. awfully was going sharply lower on Monday morning.According to the cover story in Success it sounds like What told you the market was going to have a big move? magazine [April 1988], you knew the market would collapse.It saysyou even deliberately chose to go to the office instead of the floor to You could feel it in the wild that were late avoid beinginfluenced out of gyrations occurring by your by all the confusion on that September. position the floor. Isn't highly unusual for you to go to the officeinsteadof the floor on a trading day?

Did you expect the move to be on the downsideby that time? Yes,if I'm trading, I'm on the floor. But that article is completely At misleading. They wrote it that to sell it sound Actually, I thought it was going to be on the upside. first, I thought way magazines. They make like I and to the floor we were going to attack the old highs again. planned plotted avoid that day. That's not the story. I was concerned about the positionsheld by my clearing firm. One guy When did you change your mind? in particular had a huge position, which he wasn't closing, and I had to spenda great deal of time on the phone. Now, that's not as dramatic as market fell the way the wrote it but that's what On Wednesday of the week before the crash, the apart. magazine up, really happened. Thursday, it didn't bounce back, but kind of churned.Now, if it had rallied on then I would have But instead, the market Didn't also sell seat that Friday, been confused. you your day? You must have beenreally cracked on Friday. At that point, I was sure we weregoingdown. confident the market was going down to sella seat.

Becauseit was the end of the week? I hit that seat before the market opened.I figured if I didn't hit the bid for the someone else I seat, would.Anyway had seven seats; I just sold Yes,and there is a high correlation betweenthe action on a Friday and one. least the follow-through on the next Moniday\342\200\224at on the opening.

Was this the first time you traded a seat?I mean seats aren't of the move on the Did you have any inkling sSze of the impending exactlya liquid market. following Monday?

it was the first time it like I Yes, I did that: trading the seat round turn in Do know what I really thought was going to happen Monday? you one But day. I have traded seatsbefore.I trade them depending on thought the market would open lower, go down sharply, and then bounce my Saliba 400 Tony Tony Saliba 401

I want to be mood in the market. Onbalancethough, long seats. Ibelieve But everybody wanted volatility. in our industry.

when the That's register really started ringing. It was the that the sun But in that circumstance, it did seem like a good trade? day was so close to the earth that everybody needed zinc ointment, and I was the that had some left. in seats\342\200\224afew million dollars only guy I figured, \"Hey, I have a lot of exposure worth\342\200\224Ibetter take some protection.\" I sold that seat for $452,000 in the and it back the next afternoon for morning bought $275,000. Let's take the other side of the fence: What did the traders who got buried in October do wrong? How much did you make that Monday?

took for that would be a normal started That has causedmea lot of headaches. I would rather not say. They granted Monday day.They out long, thinking the market was just correcting and was due for a bounce.Then on the Obviously, your big moneywasmadein the out-of-the-money puts. they bought way down; they bought every dip. What percentage of that position did you keep as ofMonday'sclose? Did sometradersjust freeze? About 95 percent.

But it Sure, some did. I have one friend, who is a million-dollar annual earner. You kept most of it! the profits were so huge. Wasn't On I walk in and what do think? temptingto just take it? Tuesday morning, say, \"Hey, Jack, you to Are you going get them today?\" But he just stood there. Hedidn'tsay a word to me. He lookedshellshocked. over his The reasonI didn't cover was because I felt my long puts hadn't gone Hejust kept going sheets, for to but not what to do. So up enough. They all went to parity. The puts that were thirty points in- looking something do, knowing he missed at In other the all the opportunity. the-money weretrading $30. words, option premiums consisted almost entirely of intrinsic value; the market wasn't giving them market I any time value premium. Given the enormous volatility, thought Why was the way you responded to the marketsodifferent from the that was crazy. way your friend responded?

So,you figured you would wait till the next day. wasn't sure what his He position risk was.I always define my risk, and and do know what I did to I more I don't have to about it. I walk into the with a clean Yes, you hedge myself? bought worry pit every day so that I can take what is insurance at the close on Monday. I covered hundreds of my short calls. slate, advantage of going on.

You were basicallybuying more volatility. A clean slate soundslikeyou come in with a flat position every day, but you obviously hold positions overnight. didn't It was the best thing I could have done. The next day they know what they wanted more of:Half the world wanted puts, and half the world wanted calls. I mean that I'm always hedged, and I'm always prepared. Saliba 402 Tony Tony Saliba 403

Do always know the maximum risk in a position that you hold? you Howdo you handle a losing period? Do you always know what your worst case is? How do lose It is you money? either bad day trading or a losing position. Yes. Now, what could happen? The market sits, it explodes, or If it's a bad position that is the then should out of problem, you just get But no what I know worst case. something in between. matter happens, my it.

My loss is always limited. Is that what you do? do so traders who come to the floor endup losing Why many everything? Yes.I either liquidate it or neutralize it, because then you are back afloat. When you are in a boat that springs a leak, you don't drill another hole I think the biggest problem with some traders that come on the floor is to let the water out. that they think they are bigger than the market. They don't fear the and lose of their discipline and the hard work marketplace, they sight What if your trading lossesare due to your making bad decisions? are the traders who blown out. But most on the ethic. Those get guys What do you do then? floor really work hard. off. I Take a day If get myself all wound up, I like to lay out in the sun What is the biggest misconception the public has about the and while and bake for a let all the strenuous stuff go out of my head. marketplace? What are the elements of good trading? them to The idea that the market has to go up for make money. You can With make money in any kind of market if you use the right strategies. Clear to thinking, ability stay focused, and extreme discipline.Discipline there futures, and the underlying markets, are enough tools is number one: options, Take a theory and stick with it. But you also have to be availableto set up a game plan for any situation. open-minded enough to switch tracks if you feel that your theory has beenproven wrong. You have to be ableto say, \"My method worked for In other the much of a bullish bias? words, public hastoo this of not in that type market, but we are type of market anymore.\"

it is the American The market has to The Yes, way: go up. government Trading rules you live by. we never said anything about program trading when were in a three-year bull market. Once the market started down, all of a sudden, going I scalein and scale out of my positions, so that I can spread out my risk. set commissions program trading became a major concern, and they up to do all of I don'tlike a large orderright up front. galore. For the average person, like my mom or dad and their relatives, the What else? biggest misconception is that they think when the market goesup, you make money, and when it goes down, you lose. People needto approach the Always respect marketplace. Never take anything for granted. Do little it from a more neutral standpoint and say, \"I'm going to be a long the your homework. Recap day. Figure out what you did right and what short in this but limit short-side risk in this category and category, my did That is one of the the you wrong. part homework; other part is because it is infinite.\" projective.What do I want to What happen tomorrow? happens if the opposite Tony Saliba 405 404 Tony Saliba

but I success, don't feel like I'm a success.I really don't. I feel like I've the \"what- occurs? What happens if nothing happens? Think through all madea lot of money, and I've been successfulat this one area in my life. ifs.\" Anticipate and plan, rather than react. I the help needy, but I don't have that family fulfillment. How do you judge success?Idon'tknow. All I know is that all the money in the world When made first few did sock some of it you your million, you away isn't the answer. to limit your worst casepossibility?

You thought it was at one time. No. My trading strategies were growing and I needed new capital. Then after I made some more, I started putting money into other investments: YesI did. And to be honest, is because it is influential. real estate,stores,exchangeseats, and things like that. Then when the money important See that over know him from market crashed\342\200\224I hate to that term\342\200\224on October guy standing there? I don't Adam. But say use Monday, 19,1 he came over to talk to us. If he madea bad first on realized that I didn't have a big chunk of cash anywhere, so I took a couple really impression me, I might not have much for him. But if then told me that of million dollars out of the flow and bought T-bills. Then, a few weeks respect you guy is worth $50 million, and he made it on his own, that would later,I used the money to buy an annuity. completely change my opinion of him. That may not be fair, but that's the it is. I guess because your trading styleissofocused on limiting losses, the way first time you felt the need for a safety net was when the market that a could occur and have How does affect your life? seemedtobe saying catastrophe trading personal nothing to do with you.

it I'm able to handle well from a business standpoint, but from a social What if million in but Yes. happens you have $10 your trading account, standpoint it clobbers me. It doesn't allow me to give the time to women shut down the they game? and friends that they require. People like to just sit and talk sometimes. Unlessit is about business, like this with you, I'm out of here.

Howdo you set goals?

Are you always that conscious of time? Until recently, I setgoalson a monetary level. First, I wanted to become a millionaire before I was I did it before I was twenty-five. Then thirty. Most aren't. Yes. people They say, \"Well, don't you ever just sit home I decidedI wanted to make so much a and I did that. year, Originally, and watch TV?\" the goals were all numbers, but the numbers aren't so important anymore. but will also Now, I want to do somethings that are not only profitable, Do be fun. For I'm on a you? example, currently working setting up trading company and a software company. I also want to do the family-type thing. have the but Well, I might TV on, my head is always on trading. Last I came back from a dinner date at I wastired and wanted How do you judge success? night midnight. to to bed, but I was until 2:00 A.M. out trades. It's an go up figuring addiction. I used to be much worse. I got lots of grief from former I used to judge success as being the best in your field, like Bruce girlfriends because I would take my work with me on dates. I don't do Springsteenin rock music. In my industry, it would have to be dollar- that any more, but I'm still about think I'm a always thinking trading. wise.Now, I think it is more quality of life. A lot of people 406 Saliba Tony Tony Saliba 407

What makes different? you of market daily regimen analysis. When they stray from that discipline, it ends them usually up costing money.InSaliba'sown words, referring I think I can do anything, and I'm not afraid of hard work. Right now, to a recently missedtrade due to his failure to have his ordersin while for I'm on a deal with a French bank to example, working put together on a business \"It cost me ten and trip, grand, all those little ten grands a I can't wait until this venture starts so that I can trading company. up, can add up.\" start working with these kids, training them to be traders.I don'tknow exactly how much the bank is going to giveme,but I could have hundreds of millions to work with. I love that type of challenge.

It is important to realize that many of the great traders interviewed in this book were not successful. Saliba's initial immediately trading experience was so disastrous that it brought him to a nearsuicidalstate of mind. However, what these traders shareis a senseof self-confidence and persistence. In the case of early failure, these traits are enough to lead to eventual success.Besidesallowing him to make a comeback from his early poor start, Saliba's persistencealso came into play at other points in his trading career. For example, many others faced with the type of constant ridiculethat Saliba was subjected to in the Teledyne pit might have abandonedtheir strategy. This same Teledyne example also illustrates another important characteristic of the trader: the maintenance of risk superior rigid control, even in difficult circumstances. It must have been very tempting for

Saliba to trade a larger position size in the Teledyne pit when he was being derided as \"one-lot.\" Instead, he maintained his discipline and continued to trade small until his capital had grown sufficiently to allow him to increase his positionsize.

Working hard and examining many different scenarios so that he is preparedfor all contingencies is a critical elementof Saliba's success. By anticipating all the \"what-ifs,\" he can take advantage of situations such as the October 19stockslide,instead of being immobilized by such an events. For many people, the concept of a great trader conjuresup image of someone using a shoot-from-the-hip approach, moving in and out of markets with great agility and a near sixth sense. The reality is far less glamorous.In the majority of cases, exceptional traders owe their success to hard work and preparation. In fact, similar to Tony Saliba, many of the very successful traders will do their \"homework\" every night, not allowing leisure or other business from interfering with their PartV

TkgPsyc^ogy of Trading Dr. Van K. Tharp

The Psychology of Trading

Dr. Van K. Tharp is a research psychologistwho received his Ph.D. from the University of Oklahoma, Health Sciences Center,in 1975. He has how spent his career studying stress affects human performance. His interest is in the of as strongest psychology winning\342\200\224especially winning applies to the markets. In 1982,Dr.Tharp developed his Investment and Psychology Inventory, a test that measures winning losing traits.

Thousands of investors and speculators\342\200\224myself included\342\200\224have taken this test, which includes a written evaluation and a ten-minute phone consultation. Dr. Tharp has written Five books onsuccessfulinvesting which provide the core of his investment course. He is a contributing editor for Technical Analysis of Stocksand Commodities and has also written numerous articlesfor other financial publications. Dr. Tharp isa frequent guest on Financial television and radio programs,and has spoken at many investment conferences.

Dr.Tharp currently devotes himself full time to counseling traders from his officein Glendale, California, and continuing his research on trading success. A recent focus of this research has been interviewing and studying top traders so that he couldcreate a model for success. His basic theory is that by teaching the winning traits of the top traders (not he can the specifictrading methodologies), dramatically improve performance of less successful traders and investors. In his most recent project,he is attempting to turn his most successful clientsinto \"super- 422 413 Dr. Van K. Tharp Dr. Van K. Tharp traders\" that the losses had to do with me. by extending his normal program of two two-day sessions into market, I had to conclude something in a class in at an ongoing semiannual process. During that same time period,I enrolled prosperity of the in After I interviewed Dr. Tharp, he askedwhether he could do a video the local Church of Religious Science. One principles taught interview of me as of that what to reflects mindset. I had read a tape part his ongoingresearch.SinceI thought such that class is happens you your an interview be in of and while I considered most of that might helpful improving my own trading performance, lot on the psychology trading, I The interview lasted for information to be I wanted to test it out. I decided to do soby eagerly agreed. over four hours. Dr. Tharp has \"folklore,\" a a test to measure particularly probing questioning style. After an initial response to a developing my Investment Psychology Inventory, would as a creative for that class. question,he ask, \"What else?\" and repeat this process several investment strengths and weaknesses, project times. When so I it to R. E. the editor I could no longer think of any additional responses, he No one in the class would take it, sent McMaster, would have me shift the direction of to which I was McMaster took it and then my gaze (he later explainedthis of a newsletter subscribing. instruction was intended to I received close to a thousand facilitate accessing different parts of my brain), offered it to his subscribers. Overall, and sure I would think of that roused interest in this area as a career. enough another point I had somehow responses and really my overlooked. I felt that this interview yielded some important personal of the to test? Were insights. (One these self-realizations is briefly discussed in the next What did you learn in analyzing responses your chapter.) there any major surprises? I would have liked to provide my personal impression of Dr. basic of success built into the test, so I couldrank the Tharp's course, which includes five books and four tapes. I had severalmeasures However, I reviewedthe material to \"successlevel.\"The investment literature although briefly as background for this responses according the combination of ten different areas that be important. As a result, I designed chapter, simultaneously working at a full-time job suggested might and this book did not with to measure each of those areas.I did a number of statistical writing leave me enough time (or energy) to questions the course the serious attention it calls for\342\200\224a the data and found a correlation betweeneach give personal project I plan analyses of significant for later. I attest and success. In addition, I found that those ten areas can, however, to the fact that one of the traders area investment I label the interviewed in this book served as a in Dr. could be into three major clusters, which subject Tharp's project on grouped success and and factor, and the modeling was duly impressed with his intellect and into psychologicalfactor, the management discipline insight successful since refined the test, I still use the same trading. decisionmaking factor. Although I've and three major clusters. In addition, I still keep the ten original areas, I've addedan extra one\342\200\224intuition.

How did you first get interested in the connection between What are the eleven areas you measure? psychologyand trading?

the factor has five areas. These include a well- research Well, psychological My primary interest after graduate schoolwas how various the motivation to make rounded personal life, a positive attitude, money, drugs affect human After Ph.D. in performance. receiving my results. Motivation to make lackof conflict, and responsibility for money I psychology, spent about standard eight years doing fairly psychological with but I it in the test is not significantly correlated success, keep research. For I example, helped standardize the current Field Sobriety Test is because lack of such motivation plus high conflict very significant. that Battery police throughout the country are still using. While I was include There are three factors in the decision-making area. These I also learned to doing that, how lose money trading options. In fact, I an for a solid knowledge of technical factors in the market, aptitude lost fast and so money so consistently that when I finally got out of the the to think making sound decisions without common biases, and ability 414 Dr. Van K. 415 Tharp Dr. Van K. Tharp

independently. Incidentally, knowledge of technical factors has little Have your ideas and concepts changedfrom what they were early relationship to success basedon the test scores. research? Also, there are three in your management-disciplinefactors. One needs risk control and the to be ability patient. In addition, I also include intuition the to who could win and who couldn't. Now, I in this I designed test predict category. Although I have not found any relationship between if do so. believethat anyone can win they are committed to Primarily, intuition and I trading success, keep the factor in the test because it is it's just a matter of learning how. interesting to me. stuck the beliefs hold, Too many people get by they yet they in are continue to cling to those old beliefs.My beliefs, contrast, constantly Given those what are the areas, characteristics of the them to their losing trader? evolving, and I think it's becauseI value according utility. are For Thus, I'm willing to admit most of my beliefs probably wrong. The of composite profile a trader would be who in losing someone is example,there may be people who could not be successful trading stressed and highly has little from has But useful protection stress, a negative outlook even if they were committed to doing so. right now, it's most on life and expects the worst, has a lot of conflict in that I am much his/her personality, for me to believethat anyone can win. When I hold belief, and blames when others things go Such a would wrong. person not have more effectiveat helping people become winners. a set of rules to guide their behavior and would be more likely to be a crowd follower. In addition, traders tend to be case of who losing disorganized and Could you provide somespecific examples people want action now. impatient. They Most losing traders are not as bad as succeeded or failed in consultation? the composite profile would suggest. They just have part of the losing profile. One trader who cameto me hadn't been able to trade for over a year.He did full consultation. As a wanted me to get him trading before he the You now consult with for about minutes. I many traders. How did you get started in that? result, I had him drop by one morning forty-five that he had a gatheredsome information and made an educated guess then went an exercise that took about ten After I started the test conflict problem. He through using regularly, people to askme what to began the results of that do about minutes. It took him two weeks to mentally integrate their particular investment problems. Since psychology is a but after that he was trading again. He'd spent a lot of money rather unique area of I found exercise, study, I didn't know how to respond to lot of to correct the and none of it had worked. many of their As a and donea things problem questions. result, I decidedto write a pamphlet on it ten-minute exercise and two weeks of integrating the each of the ten areas\342\200\224both to learn Yet, only took a about the areas myselfand to provide investors with a results to solve his problem. source ofhelp.The first pamphlet turned into a book.I tried that with another who was unable to afford my decided at that point to cover the matter I person subject in five workbooks which for whom a exerciseof that nature didn't work. His would constitute a course in the of consulting fee, simple psychology investing/trading. After I had to do with his Although he was in his finished the second I started problem nothing investing. workbook, training in Neuro-Linguistic wasstill a little in that he couldn't adult NLP is a late forties, he boy accept Programming (NLP). really science of how to duplicate He with his his whole success, and I was able to responsibilities. still lived mother, and lifestyle supported incorporate a number of those techniques into my to a child. The only reason he wanted to trade was to be able course. The development of the course being naturally led to a private continue that I doubt that I couldhave him without a consultingservice. lifestyle. helped major commitment on his part to change his lifestyle,which he was unwilling to give. 416 Dr. Van K. Tharp Dr. Van K. Tharp 417

Another client made minor adjustments after two of that need a to trade days leaving the markets, but a few decide they system consulting.He was reluctant to do the follow-up because he thought it would more effectively.Thosepeoplewho do adopt a systems approach probably be superfluous. But he decided to do it. eventually I spent usually just end up transferring their problems from dealing with the market another two to him talk and then days listening we did a simpleexercise to dealingwith their system of trading. together. At the end of that he was a exercise, totally changed person One of the basic problems that most traders face is dealing with it (although probably took him a week to the effects of that two rules successful integrate risk. For example, primary to speculative trading He called me two exercise). months later and said he had made over are: Cut your losses short and let your profits run. Most people cannot $650,000 in the markets. trading deal with those two rules. For example, if making money is important to investment will you\342\200\224asit is to most people who play games\342\200\224then you In the case ofa who uses a trader nonquantifiable small losses. As a small lossesturn approach (for probably have trouble taking result, example, \"I buy or sell whenever I a about get feeling the market's into moderate losses, which are evenharder to take. Finally, the moderate direction impending from the chart how do take\342\200\224allbecause it patterns\,") you distinguish losses turn into big losses, which you are forced to whether trading are related to of skill problems lack or to was so hard to take a small loss. Similarly, when people have a profit, psychological impediments to success? this now they want to take it right away. They think, \"I'd better take the harder it is to before it gets away.\" The bigger the profit becomes, BeforeI take someone on as a I needto know that client, they have some resist the temptation to take it now. The simple truth is that most people sort of methodology that they think works. I what evidence determine are risk-aversivein the realm of profits\342\200\224they prefer a sure, smaller gain have that. they of Can they, for example, convince me?Have tested in the they to a wise gamble for a larger gain\342\200\224and risk-seeking realm that their methodology? Does testing amount to a hindsight evaluation, As a most of losses\342\200\224they prefer an unwise gamble to a sureloss. result, or is it based on actual that trading signals one can follow. I alsoam the of what is for cut people tend to do opposite required success.They convinced that it is difficult to make or in a short money day trading trading their profits short and let their losses run. time frame, so I am about who skeptical anyone wants me to help them If think of as a and that a mistake is not you trading game trade day successfully. it becomes followingthe rules of the game, then much easier to follow these At the same time, I think that lack of skill in a is, itself, two rules. You should review rules at the of the and your beginning day psychological to impediment trading. People don't a systematic approach If develop review your trading at the end of the day. you followed your rules, or don't their test approach because of lack of poor judgment, goals, even if you lost money, pat yourselfon the back. If you didn't follow internal conflict, etc. the area So, perhaps they need in is what did help overcoming your rules, then mentally rehearse you and give yourself more internal resistance to developing a systematic approach to the market. If appropriate choices in the future. came to me and said that was the somebody problem wanted with they help The secondmajorproblem people have is dealing stress. Stress I would with, have no problem at all accepting that as a client. person really takes two forms: worry and the biological fight/flight response. Our brains have a limited capacity for processing information. If your What are the primary psychological impediments that most keep mind is preoccupied with worry, that worry takes up most of the decision from people being winning traders? How can they deal with each of space, and you don't have enoughcapacity left to perform effectively. those problems? One aspect of the fight/flight response is that it causes people to narrow their focus. They revert to earlier well-practicedresponse What when is that typically happens people approach the markets, they patterns. For example, a common decision that people make under stress is their with them. bring personal problems The markets are a natural place not to decide. They do what they did when they were a beginner.They to act out those but not to problems, solve them. Most end up people do what their broker advises. In short, they do anything simple. Simple 418 Dr. Van K. 419 Dr. Van K. Tharp Tharp

solutions are When that each is satisfied. If rarely correct. people are stressed, they also tend to negotiation between the parts so part possible, be crowd followers. The behavior of also want to the so that others providesa simpleexample you integrate parts they join together. to follow. Crowd followers don't have to make decisions,but crowd is a sure to following way lose money in the markets. I find the concept of people having different parts in conflict with A second effect of important the fight/flight response is that it each other a little difficult to conceptualize. Could you provide an causes to people expend moreenergy.When faced with stressful events, example? people give more effort to the few alternatives they do consider. They keep on doing what they were do it doing\342\200\224only they harder. Putting I worked with a floor trader whose father was fairly successful. His father more into energy trading decisions doesnot make As help you more money. was not a good model for him, however, in that he was an alcoholic. Instead you will tend to make quick, irrational choices, which use up a result, he developed a part to protecthimself from being like his father. some of that excess energy. You more into a if more probably put energy losing He couldmake about $75,000 per year trading, but he made any positionby actively resisting closing it out. The result is a he would biggerloss. than that, this part kicked in to make sure that not become too In summary, the will fight/flight response decrease your performance by successful.He was the one who made $650,000 in about two months to causing you narrow your choices and concentrate more on energy the after we had completedthe parts negotiation. remaining alternatives.

The solution for with stress is to work on the that some to on a dealing causes and to Are you implying people actually want lose stressprotectors. I would recommend develop that people with this subconscious level because it fulfills some other positive intention? How problem go into a stress management program. Also, it is important to common is that? understand that stressful events are such because many of the way you perceive them. those and Change perceptions you will change the event Halfthe traders I work with have problems of this nature. I think it's very itself.For example,winners typically differ from losers in their attitude common. about losses. Most peoplebecomeanxious about losses, yet successful speculators have learned that an essential to is to So cited risk and conflict as ingredient winning far, you've poor attitudes, stress, make it OK to lose. Sincemost in our people culture are taught that only impediments to trading success. Are there any other major problems winning is most must acceptable, investors change their beliefs about peoplehave with the markets? losses to becomesuccessful. The third major problem that have is with fourth is that allow their emotions to people dealing conflict. A major problem many people have People different parts of each of which has control their In most to involve themselves, a positive trading. fact, trading problems appear intention. For someone ten of example, might have a part to make money, a emotional control in some manner. I know of at least methods helping to him part protect from failure, a to make him feel their mental states. An method that can part good about people control easy people adopt himself, a part which looks after the welfare of the and muscle tension. family, etc. Now, once right away is simply to controlposture,breathing, establish these you parts, you usually allow them to If those will find that operate you change factors, you probably you change your What is subconsciously. happens the parts continually adopt new behaviors to emotional state. carry out their intentions. those decisions. there Sometimes, new behaviors canproduce Finally, the last major problemis making Although major conflicts. This model of conflict is one of my most useful beliefs. are many facets to decision-makingproblems,what most people do is I'm not saying that people have but it is to the markets. actually parts, very useful in bring their normal method of making decisions trading helping people solve their for in order to trading problems me to believe that. You For example, think about what you go through buy a new car. have to make them of just aware their parts and then conduct a formal You have to think about the model, make, deal, service, cost, accessories, 420 Dr. Van K. Tharp Dr. Van K. Tharp 421 etc. And it probably takes you a weekor more to evaluate those factors can their results. As a most martial Most you duplicate nontrading example, and make a decision. people bring that same method of making arts experts believe that it takes years of practice to break a board with decisions to trading and it just doesn't work. It takes too much time. So, bare hand. I was to observe someone for about fifteen minutes the your able solution is to adopt a trading system that gives you signals to act.But and then break two k-inch boards with hand. I even showed most pine my my people with a trading system continue to apply their normal method son (who was ten at the time) how to do it. That's the power behind of making decisions to the signals given to them by their trading system. modeling. And, of course, that doesn't work. The best method that I've found of What happens with most experts is that they are unconsciously dealing with long, ineffective decision-making problems is to short They do things well, which means they do them circuit them a called That is a little too competent. through process anchoring. process For most are at involved to explainhere. automatically. example, people unconsciouslycompetent driving a car. You don't eventhink about it when you do it. When someone who is unconsciously competent tries to explainwhat he or she is doing to Do you believe that most people can be successful traders if they someone much of what is is left out. focus is learn to eliminate negativeemotions? else, important Thus, my to discover the missing pieces and help people install those pieces.

Well, that assumes that negative emotions are the cause of trading Let's talk about the first factor: beliefs.How are beliefs important problems. I think they are just a symptom of the basic problem. In most to trading success? cases, I don't believe it's even necessary to solve specificproblemsto have to teach to do in an produce success\342\200\224you simply people things Letme an from another The Army effective manner. The give you example modeling project. teaching process, however, involves working with modeled the rifle skills of the two best sharpshooters in the U.S. They how people think, and most trainers do not emphasize that. were then able to develop a training class for Army recruits in which Right now, I consider myself to be an expert modeler. By that, I reduced the time from four to two while mean that if they training days, increasing someone can do something well, then I can figure out how to were able the qualification rate from 80 100 percent. In addition, they they do it and teach those skillsto anyone else. I'm concentrating on to use the same to the shooters their skills. and knowledge help top improve modeling trading investment excellence. So naturally, I believe that The information they gathered about shooting beliefs was particularly I can teach anyone who is committed to being a successfultrader to be one of the best. revealing. The two top shooters, for example,believed:

Are superior traders better because of keener or analytical skills, \342\200\242 Shooting well is important for my survival. because they have better emotional control? \342\200\242 Hunting is fun.

\342\200\242Mental rehearsal is to successful Better emotional but I think that both of factors are important performance. control, those \342\200\242If I it has to with overemphasized. miss a shot, something do my performance.

One of the two when were in So what does it take to duplicate successfultrading? top shooters, they competition together, won. And could tell the difference between the two in always you accordance with their beliefs. For example, the best shooter believed that it There are three primary factors involved in duplicating success\342\200\224beliefs, was important to rehearse an entire 1,000-round match the prior evening, mental states, and mental strategies. If you duplicate the way the best whereas the second best shooter only believed that mental rehearsal was tradersuse those three factors for every aspect of the trading task, then important. In addition, the best shooter believed that it was important to Dr. Van K. Tharp 423 422 Dr. Van K. Tharp

that winners know the bull's You mentioned they've won the gamebefore they hit the center of eye on each shot (even though you didn't get start. Although I can easily seehow suchconfidence would be extra points for that), whereas the second best shooter believed that it beneficial for the established the of this was hit the winning trader, might impact only important to bull's eye. Can you understand why one trait bereversedfor the novice trader? For in was better than the other just from their beliefs? actually example, your first week on skis, confidence about your ability to go down the Now, contrast the beliefs of top shooters with the beliefs of new expert slope might not be such a quality. How does the less recruitscoming into the Army. The latter might believe: great expert trader distinguish between justified and misplacedconfidence? \342\200\242Guns are evil; they kill people. The traders that I've worked with their careers with an \342\200\242If shoot this top began they weapon too many times, they might go deaf. extensivestudy of the markets. and refined models of how to \342\200\242 They developed If they miss the target, it means the gun is misaligned. trade. Theymentally rehearsed what they wanted to do extensivelyuntil they had the belief that they would win. At this point, they had both the I think, just on beliefs alone, you can begin to understand why the top confidence and the commitment necessary to producesuccess.In shooters were so much better than the raw recruits. addition, they also had the entire constellation ofbeliefsI just described. As Now, let me explain some of my findings in working with top a result, I believethat there are three major differences betweenjustified traders. You might find some of these beliefs confirmedin other confidence and confidence. First of misplaced all, justified confidence interviews in your book. Generally, I find that top traders believe: comesfrom a constellation of beliefs, such as the one I just described.

If a trader has confidence and else, he is probably in a lot of \342\200\242 nothing Money is NOT important. trouble. Second, justified confidence comes from extensive testing of \342\200\242It is OK to lose in the markets. some sort of model of trading. If you don't have a modelthat you have \342\200\242 is Trading a game. properly tested, then your confidence is probably misplaced. Third, \342\200\242 confidence comes with an extensive commitment to Mental rehearsal is important for success. justified being \342\200\242 successful as a trader. Most people who want to be traders are not They've won the game before they start. think committed\342\200\224theyjust they are. There is a poemby W. N. Murray, of the Scottish that \"That the moment that one Although there are a lot morethan five critical beliefs, I think these five Himalayan expedition, says: commits most definitely oneself, then Providence moves too.\" are among the important. Most people approach trading to make a If are not are certain that that is one of you really committed, then only you you lot of money, and the primary reasons they lose. Because have are doing the right thing, but somehow events just seemto occur to help money issoimportant, they trouble taking losses and letting profits you. If you are really committed to being a trader, then you probably run. In contrast, when you think of trading as a game and play by certain have an understanding at some level of what I'm talking about. You rules, then it becomes much easier to follow thosetwo golden rules. probably even understand that those events that you might be big In addition, because of mental rehearsal and extensive planning, help losses. If are not on the other then are in mind you committed, hand, you top traders have alreadygonethrough all the trial and error their probably saying, \"I don't understand what Tharp is saying. I'm committed, before they begin. As a result, they know they are going to win in the but events have not been me.\" long run, and that makes the little setbacks much easier to deal with. certainly helping 424 Dr. Van K. Tharp Dr. Van K. Tharp 425

notice how other walk. a dozen or so walks for Earlier, you mentioned \"mental states\" as the second critical factor people Duplicate yourself and notice how mental with each in modelingsuccess.Could you explain what you mean by that? your state changes one. I'm not that mental state is the saying controlling your magic are solution to success. It's of the answer. when admit If you ask people to list their trading or investment problems, they trading just part But you of two don't own and mental state control that the answer is within come a The types\342\200\224problems they yourself, you've long way. Problems don't own consist of the realizationthat are for the results is the to problems. they blaming markets, you responsible you get key successful Winners know for their blaming floor traders or locals,blaming insider trading, blaming their investing. they are responsible results; losers We have a natural think are not. broker, or blaming their system for what goes wrong. they other than for what tendency to blame something ourselves happens. Society promotes it. For example,the recent media coverage of program Can you give a practicalexampleof how someone can control their who lost in trading virtually implies that investors money the stock mental state? market did so because of this activity, rather than because of any fault of their own. when blame other than you Yet, you something yourself, Well, mental state manipulation is what most people call discipline. I can continue to the mistake because it was the result of something repeat teachpeoplea very simple procedure that they can use right away. For control. are at beyond your example, suppose you your desk and you become aware that you The best an investor cando,when things go wrong, is to in a mental would thing are state that you like to change. Get up out of the determine how he or she those Now, I don't mean that you produced results. chair. Walk away about four feet and then look at how you looked in that should blame for mistakes either. I mean that at some point yourself your chair. Noticeyour posture, your breathing, your facial expressions.Then that those in time, for any situation, made a choice produced results. you imagine how you would look if you had the sort of mental state you Determine what that choice was and other options to point give yourself would like. When you can see that clearly, sit down in the chair again the take when encounter a similar choice point in the future. you Change and assume the position that you just imagined. That exercise works for will the decision at similar choice points in the future and you change almost situation as it involves several any important can results And so now, you make it easy you get. by imagining doing principles\342\200\224changingyour body posture, seeing yourself from a more objective viewpoint, to select alternatives in the future. those and imagining a more resourceful state. When people own their own problems, they discover that their results stem from somesort of mental state. Common examples usually Please elaborate on mental strategies\342\200\224the third element cited are: you earlier as critical to success. Could duplicating you provide some examples? \342\200\242I'm too impatient with the markets. \342\200\242I at the get angry markets. To understand strategies, you have to understand how people think. \342\200\242 think in the same their five in I'm afraid at the wrong time. People modalities as senses, that is, terms

\342\200\242 of visual and for some tastes and I'm too optimistic about what will happen. images, sounds, feelings, people, smells. Thosefive modalities are to mental strategies as the alphabet is to musical of mental Once a great novel, oras notes are to a symphony. It's not the These are just a few examples state problems. you great can do it because this elements, but the way in which the elements are A mental identify a mental state problem, you something about put together. is the in which think. sort of problem is within your control. I've already mentioned how one strategy really sequence you one's Rather than a in which I think is can use body posture, breathing, and muscle controlto manipulate explain complex topic detail, into a mall and beyond the scope of this interview, let me give you two First, mental state. To try this out for yourself, go shopping examples. Van K. 426 Dr. Tharp Dr. Van K. Tharp 427

have a that imagine that you trading system gives you specific signals. very aware of their purpose in life and as a trader. They believe they are most are visual, such as a chart pattern or of and with the Since signals particular part a \"bigger picture\" they just go flow. that visual certain signals on your computer, imagine your system gives you The mechanical trader is very logical. He constructs his models Now, try on the following strategy: in his Heis in his and signals. visually imagination. very precise language His models tend to focus on his of how to trade thinking. concept \342\200\242See the signal. successfullyand of how the economy works.Hedoes not believe that his models \342\200\242 are adequate until they can be converted into algorithms for the Recognize that it is familiar. computer that match his own mental As a result of this belief, he \342\200\242 if processes. Tell yourself what might go wrong you take it. has computerizedhismodels,modifying both his constructed image and \342\200\242Feel bad about it. his computer output, until both models match\342\200\224in his words, \"until they both look right.\" This is a very slow and laboriousprocess.I think it even take Could you trade effectively using that strategy? Would you hinders his decision making on everyday events, and he tends to agree the not! What if used the strategy? signal? Probably you following with me, but it helps him in the long run. When his mental image and

the computer model match, he virtually takes himself out of the trading \342\200\242See the signal. picture. The computer does everything, so at that point, decision making \342\200\242 is for him. Recognize that it is familiar. easy

\342\200\242 The intuitive trader, in contrast, has a modelof how he Feel good about it. developed thinks markets operate, rather than a model of how to trade successfully. He also believes that the markets are and even the two constantly evolving Could you trade from that signal? Probably. So though it that is more important to up with changes in the market than to lead different results in terms of keep strategies are quite similar, they to very test his models an to them. He like the by developing algorithm computerize trading. If you are trading a system, you need a simplestrategy trades from his expectations of what the markets will do, which are last one in order to use it effectively. visualizations. But I think that he tends to convert his visualizations into

feelings. Feelings actually are a mode of thinking, but they are difficult Two of the top traders that you used in your research in modeling to communicate to others or to computerize.As a result, he believes that success have completely different trading styles. One is very exercises such as computerizing a trading system are a waste of time. mechanical, while the other uses a much more intuitive approach. Rememberthat his main emphasis is to explainhow markets work (rather Could you contrast their differencesandcomparetheir similarities? than how to trade), and hebelievesthat the markets are constantly As a evolving. result, he has difficulty explaining how he trades to anyone their because are extensive. In First, let me talk about similarities, they it intuitive. else. Hejust calls At the same time, he makes day-to-day when find extensive similarities between two excellenttraders fact, you decisions distinct contrast to the mechanical trader who is easily\342\200\224a who seem so different, then you can begin to assume that those uncomfortable until he has proven his work by computerizing it. similarities are essential to successful trading. Both traders, for example,

for how the markets work and did extensive research developed models What are the most difficult problems to solve? think the to test those models. Although their ideas are very different, I of and some sort of model is very process developing testing probably I think there are only two difficult problems. One is lack of commitment In both traders share all the same beliefs that I important. addition, to trading. People are not going to do what I tell them to do unless they mentioned earlier as common to successful traders.Third, both traders are are committed to becominga goodtrader, so I don't see many noncom- 428 Dr. Van K. Tharp Dr. Van K. Tharp 429

reduced-rate with him. In a I that we had mitted traders. It's only occasionally, when I do a free or working sense, felt only started working with this sort of The man who together. The more I about it, the more the consultation, that I see traders problem. thought question kept as into mind: \"What if we this to wanted to remain a little boy, and was trying to use trading a means popping my pushed the limits? What is he mistake of So the idea of the of accomplishing that, was a classic example. I don't make the capable accomplishing?\" super-trader program was born from I called him of seeing noncommitted traders too often. thosethoughts. up and suggested the idea to him. The second most difficult situation is the trader who does not own Naturally, he was all for it.

About four of clients have now the his problems. Thispersoncan continue to repeat his problems because my graduated to super-trader don't see these It means that I continue to with he never gets at the source. Once again, I usually people. program. simply work these people on their own a basis When people come to me, they realize that they produce regular (usually semiannually). The idea is to stretch their performance to the limits. problems, although, to some extent, everyonehas problemsthat they Many people aren't ready for that, but I have clients who are. in don't own\342\200\224even my clients. enoughamong my Who knows, three or four years, I have about Among the people who cometo see me, I think the most difficult might just fifty top traders that I work with on a continual crave the basis! I find that best clients now type is the compulsive gambler. Sincethesepeopletypically Incidentally, my make excellentmodels to use to action of the markets, they are not likely to want my help until they are study top traders. them to Gamblers or heavily into debt. At that point, I refer Anonymous I have had one trader I sometimeshave dreams which involve market to somelocalsourceforhelp.However, compulsive impending direction. these I've Although are rather they prove a among my clients. He's now in my super-trader program. simply infrequent, right high percentage ofthe time.Is this unusual? channeled his compulsiveness from the markets into working on himself. I is imagine that it's quite common because tell me that all the I'm not sure that correcting trading problems always the answer people time, on would top traders. For both the mechanical and though. For example, one approach to teaching a class trading especially example, intuitive that we talked about earlier that be to give everyonethe fundamentals in the first session and a simple super-traders expressed they had dreams in the second. You could then the about the market that were amazingly accurate. But most traders that trading system spend remaining say That such dreamsare so that could not sessions dealing with their problems trading that system. would infrequent enough they trade on them On other could conduct This phenomenon even occur more than one probably be a very effective class. the hand, you regularly. may frequently form. the same class them the fundamentals. Then you might give might imagine\342\200\224in symbolic But most do not bother to by giving people their them the beliefs, mental states, and mental strategies necessary to trade interpret dreams, so they miss the symbolic predictions. However, I them to must admit that it interests I this the system. Finally, you might give the system. I'm willing bet although me, have not investigated area that the second method would be more effective than the first. At least very extensively. I know of of that is the direction I'm heading. lots people of genius level who claim that some of their creativity comes from their dreams. Michael Jackson claims he doesn'twrite his Talk about the origins,concepts,and direction of your super-trader songs\342\200\224they just come to him. Paul McCartneysaid that he heard the in a program. song \"Yesterday\" dream. Einstein essentially dreamedthe theory of relativity. I think there are probably a lot of famous that one trader called and of this sort. It all what It all beganon Christmas Eve one year, when examples boils down to intuition really is, but told me that he had made $650,000 in the two months since I had finished don't ask me to explainit. I don'tunderstand it\342\200\224YET! 430 Dr. Van K. Tharp

I assume that the reason you have not tried trading again is that you perceive that it would interfere with your objectivity in dealing with your clients. Yet, given all that you have learned about successful trading during the past five years, I imagine there must be some handle this conflict? temptation to try it again. How do you What do you envisionasthelong-termresolution? The Trade

There are two reasons I don't trade.The first is the reason you mentioned A Personal trade Experience about objectivity with clients. If I'm helping someone and I have conflicting positions,then I may not be very objective about what they are An is that I am doing. equally important reason, however, fully committed to doing what I am doing. I love helping other people, writing, that. It is giving talks, and soon.I'm very happy doing also a sixty-hour start then I would have to per week job right now. If I wanted to trading, devote almost as much time to doing that, at least at the beginning. Why

I do that and what I know I love In the course of the this should give up already doing? Player conducting interviews for book, I came to in of are not that effective at realize that one of coaches, the history most sports, usually my primary motives for the entire project was a quest for I have either coachingor playing. self-discovery.Although been a net profitable trader over the years that I to and asa Your question also assumes am committed trade, (substantially multiplying a small initial stake on two separate result there is a conflict. I find that as I more and more into occasions), I had a definite sense of failure about Actually, get my trading. Given the have less and less interest in extent of helping others become successful,I trading my knowledge and experience about markets and trading, as well I'm in and in business now. I as the fact that on numerous had myself. investing myself my right occasions I correctly anticipated major work at skills and and that is I felt that constantly improving my knowledge, paying price moves, my winnings were small potatoes comparedto off should I dilute that effort? sometime in the what I should have made. forme. Why Perhaps I I can or I'll In of future, will decide that I have done everything do, perhaps one my trips for this book, on one evening, I was interviewed want to I'm or I'll want a break. For at about Dr. Van change what doing, perhaps just length my trading by Tharp, and the very next evening, three to four now I be with I had a conversation example, years from might just working fifty probing about my trading with the very perceptive or traders. If that then I'll also trade. Ed This back-to-back more top quality happens, maybe Seykota. experience caused me to focus intensely on the flaws But for the near future, it doesn't seem very likely. that had prevented me from reaching what I perceived to be my true potential as a trader. As a result of this self-examination, I came to realize that one of errors had my great been failing to exploit major price moves that I had correctly anticipated. Invariably, my initial position would be far too small, given the potential I perceived in such trades. This mistake was then a compounded by highly premature liquidation of the position. Typically, I would take profits on the first leg of the price move,with the of the intention reentering position on a correction. The problemwas 432 The Trade The Trade 433

corrections fell short of reentry points and, tion of intended trade since realization about it the that subsequent usually my my my previous the I ended the rest of the Even on that the refusing to chase market, up watching price morning. morning's opening, trade could have been that the next moveunfold while I was on the sidelines. I vowed to myself implemented at much more favorable price levels.As I was trying to decide effort to time such a situation would arise, I would make a concentrated what to do, the silver/Swiss franc ratio continued to move higher and the of I decided come closer to realizing true potential the trade. higher. that I had to act to prevent the possibility of missing I did not have to wait very long. Twoweekslater, while on a plane this trade altogether. I immediately called in an order establishing the about of to Chicago to conductsomefurther interviews, I was thinking my minimum position long three silver contracts and short one Swiss that I had come franc contract. No review of the price charts the previous evening. Irecalled sooner had I placed the order than the price ratio distinct that metal were ready seemed to reachits and The ratio away with the impression precious prices peak began retreating. pulledback to move even the markets appeared further during the next two As it turned out, I had to higher, though foreign currency days. managed should implement the vulnerable to further price erosion. Suddenly, the trade I have made trade at the exact worst possible moment in time since the of became clear. Given combination of a trade inception of my idea. However, the silver/Swiss franc ratio crystal my expectations, price be and a was long precious metals and short foreign currencies would particularly quicklyrecovered, few days later I well ahead. in the the At this I about attractive. (Since these markets normally move same direction, point, thought my recent realization regarding my continued combined less risk than an outright long position in failure to profit from major moves. I decided positionimplied adequately price this trade to maintain precious metals.) I made a mental noteto generate some charts on my position and, moreover, selecteda reaction point for

the The correction later and I at my first opportunity. doubling up position. came about a week followed The next morning, I found a quote machine capable of generating my game plan. My timing proved good, as the trade once again First, I rebounded in favor\342\200\224this time pricecharts and sat down to evaluate various pricerelationships. my with double the initial position. Given and and looked at the interrelationships between silver, gold, platinum my account size (approximately $70,000 at the time), the long six the metals. Then I two Swiss franc decided that silver was my preferred buy among silver/short position was about twice aslargeas the one I reviewed the interrelationships between the various foreigncurrencies normally would have held. My efforts to correct my aforementioned the weakest flaw seemed to and decided that the Swiss franc appeared to be currency. trading be paying off, as the trade raced in my favor two I then reviewed charts of the the two weeks. a month of Having made these determinations, during following Within putting on the trade, from ten over silver/Swiss franc ratio for various time spectrums,ranging years my account was up 30 percent. I now faced dilemma: On the to one month. a one hand, my new-found at the brink of realization This analysis led me to the conclusion that we were suggested that I hang on to the trade for the long run. On the other other a advance of silver relative to the Swiss franc. hand, one of my rules is that if you are ever to possible multiyear lucky enough I because me realize a on a trade take will Although had intended not to trade my traveling prevented very large profit very quickly, it, because you the of the trade seemed an to reenter the trade from paying attention to the markets, potential usually get opportunity at considerably more on at least To be done favorable levels. The second rule came to mind when the so dynamic that I had to put a base position. silver/Swiss dollar in franc ratio properly, a ratio trade requires approximately equal positions price began falling. that it A examination the charts each market. I quickly calculated at the prevailing price levels, cursory of price suggested it might be to balance one to take at least I should would require approximately three long silver contracts prudent partial profits. have done more analysis short Swiss franc contract. to reach a decision. However, the combination of having undertaken a the franc ratio. new while at the same time this left me with I lookedat a short-term chart of silver/Swiss price job, writing book, very in the direc- little time and to focus on other included. Instead of To my dismay, the price ratio had already movedsharply energy areas\342\200\224trading doing the necessary work, I made a snap judgment to stay with the trade. The Trade 434 The Trade 435

The trade now moved swiftly against me, and within a week, I had given the total hours I ing the sales of my book, royalties per copy sold, and back a significant portion of my earlier gains. He on a had spent writing the book. then scribbled various calculations Although a week earlier,I had rationalized that my substantial hour. he yellow pad. He arrived at a final figure of $18.50 per \"Here,\" profits would give me enough of a comfort cushion in the event of a book.\" The tone of his voice said, \"this is what you are making on your reaction, now that such a reaction had occurred,I found that I had in seriously implied that I was crazy to jeopardize tens of thousands of dollars my comfort level. I was that I misjudged my Suddenly, concerned might for such a sum. the $18.50 estimate is trading paltry (Actually, even ride give back all my profits, and possibly the trade into a loss.I this was a probably wildly overinflated, but remember dream.) not decide whether to blow out of the trade or with it as could stay that this occurred the after It was no coincidence dream night initially planned. Schwartz interview with his editing the section of the Marty dealing That I was to a night had a dream.I talking friend of mine, who is the markets. I realized that diligence in doing his daily homework on a developer of software for the of futures and options markets, analysis there are no shortcuts.If you want to be a good trader, you have to do not a trader. In We but my dream, he had begun trading. were talking If there is not your work on the markets every day. enough time, you about and current dilemma the silver/Swiss franc trading my regarding have to make time. The costs for straying from this daily discipline, in position. terms of lost as well as losses, can be very profit opportunities friend commented on my predicament, \"Everybody gets what was: If My substantial.The message my subconscious seemed to be crying out you they want out of the markets.\" I \"You sound just like Ed replied, are going to be seriousabout trading, you have to reestablish your time Seykota.\"This soundeda bit odd to me, since as far as I knew, he did priorities. not even know To he \"I have been Seykota. my surprise, answered, talking to Ed Seykota for a while and I have been winning in my trading ever since.\"

Hehad a sheet in front of him, with one of the columns indicating his month-to-month ending equity. I glanced at the sheet and was astounded to see that the last figure exceeded $18 million. I exclaimed,

\"Bert, you have made $18 million in the market! I hope you plan to take a few million out for safekeeping.\" \"No, I need all the money for trading,\" he replied. \"But that is crazy,\" I said. \"Take $3 or $4 million out, and that way you will be sure then that no matter what happens, you will out \"I am come way ahead.\" know what I doing, and as long as I do my homework on the markets every day, I am not concerned,\" he replied. His answerhad implied, quite correctly, that I did not diligently do my homework on the markets every day. His point, although unstated, was quite clear: If I did my work on the markets every day, I wouldn't have any trouble understanding why he did not need to pull out several million dollars in profits from his accountto feel confident that he would not lose back all his profits in trading.

\"You say you don't have enough time each day to do your work on the markets. You are too busy with your new job and writing your book. Here, letme show you something.\" He started citing assumptions regard- Postscript

Dreams and Trading

The relationship between dreams and trading is a fascinating subject.

Readers may look up Seykota's and Tharp's commentson this matter. There was another interview in which this was topic prominently discussed. In that instance, the trader decided to rescindhis approval for use of our conversation in the book. I was somewhat puzzled by his decision, sincethe was \"What could chapter basically complimentary. you have found so offensive as to back out I asked. possibly completely?\" \"Absolutely nothing,\" he replied. \"In fact, you made me sound almost human.\" It turned out that he wasupset about his inclusion in a recentlypublished book and that he was adamantly opposed to his appearance in any book. Even the offer of anonymity failed to change his decision. I did,however, manage to get his permission to use the dream-related portion of the interview. (Thename references in the following conversationhave been changed.)

I In 1980, the year when corn set its record high, was long the position limit. One night I had the following dream. I'm talking to myself and I \"To say, \"Hey Jerry, where is corn going to?\" $4.15.\" \"Where is corn now?\" \"$4.07.\" \"You mean you are taking all that risk for an extra eight cents?Are you crazy?\" I woke up in a flash. I knew I had to get out of my entire corn position as soonas the market opened the next day. 438 Postscript

The next the morning, market opened up a little higher, and I started The market moved a little selling. higher, and I sold more heavily. The market moved up some more.For a minute, I thought the floor broker

had executedmy order backwards. He hadn't. a few minutes Anyway, later, I'm completelyout of my position and the It's friend phone rings. my Carl, another good trader, who had also been long corn. He is that all the says,\"Jerry, you doing selling?\" I Final Word tell him, I out of \"Yes, just got my entire position.\" \"What are you he doing?\" shouts. I say,\"Carl, where is corn going to?\" \"About $4.15- 4.20,\" he replies. \"Where is corn now?\" I ask him. I hear an immediate click over the He didn't even time phone. waste any saying good-bye.

And was that the top of the corn market?

It have another but might gone up day, that was just about the high. Once it started I could never falling, have unloaded a position of my size.

The There is no holy grail to trading success. methodologies employed the \"market wizards\" cover the entire from by spectrum purely I found this trader's narration of his dream particularly since fascinating, technicalto fundamental\342\200\224and in between. The of I have purely everything length occasionally had similar experiences. Usually, I have found that time they typically hold a trade ranges from minutes to years. Although when feel about you strongly enough a trade (either getting in or getting the styles of the traders arevery different, many common denominators out) to dream about it, the should be message heeded. Of course,like were evident: this does the anything else, not work all time, but I believe it places the odds more in your favor. 1. All those interviewed had a driving desire to become successful As I interpret it, the dream is the means by which our subconscious traders\342\200\224in many cases, overcoming significant obstacles to reach the barriers we penetrates sometimes erect in accepting the true analysis their goal. of a market. For if I am bullish and example, not in a market, I might 2. All reflected confidence that could continue to win over the long they rationalize that it is prudent to wait for a reaction before the entering as run. Almost invariably, they considered their own trading the best trade\342\200\224even if a realistic assessment would suggest that such a and safest investment for their money. developmentis This is because the unlikely. entering market at a higher price is 3. Each trader had found a methodology that worked for him and a confirmation that, to some I have failed extent, already (that is, by not was remained true to that approach. It is significant that discipline the buying sooner)\342\200\224a distasteful acknowledgment. In such a case,a dream word most mentioned. that the market was to run on frequently going away the upside might be the subconscious' of 4. The traders take their seriously; most devote a way breaking through mental impediments. top trading very substantial amount of their waking hours to market analysis and trading

strategy.

5. Rigid risk control is one of the key elements in the trading strategy of virtually all those interviewed. 440 Final Word

6. In a of of the variety ways, many traders stressed the importance of having the to wait for the patience right trading opportunity to present itself. 7. The importance of acting of the independent crowd was a frequently emphasized point.

8. All the top traders understand that losing is part of the game. 9. all love what are 1 They they doing. Appendix

ProgramTradingandPortfolioInsurance

One subject that has received widespreadpublicity in recent years is of program trading. Perhaps never in the history financial markets has there been more criticism about a trading approach that was less understood. I would venture a guess that less than one out of ten people opposed to program trading even know the definition of the term. One

sourceof confusion is that program trading is used interchangeably to both the and as a more term describe original activity general encompassing various computer-supported trading strategies (for example,

portfolio insurance).

Program trading represents a classicarbitrage activity in which one

market is bought against an equal short sale in a closely related market

in order to realize small, near risk-freeprofits, resulting from short-lived distortions in the price relationship between such markets. Program

tradersbuy or sell an actual basket ofstocksagainst an equal dollar value

position in stock index futures when they perceive the actual stocks to be underpricedor overpriced relative to futures. In effect, program trading tends to keep actual stock and stockindex futures prices in line. Insofar as sale of actual stocks is offset a every program-related by purchase at another time and most program tradesare first initiated as long futures of the in stock/short positions (because uptick requirement shortingactual stocks), arguments that program trading is responsible for stock market declinesare highly tenuous. Moreover, since the bulk of 442 Appendix 1

economic evidence indicates that arbitrage between related markets tends to reduce the volatility, relationship between increased volatility and program trading is questionable at best. Portfolio insurancerefers to the systematic sale of stockindex futures as the value of a stock portfolio declines in order to reduce risk Once the exposure. reduced, net long exposure is increasedbacktoward a 2 full position as the representative stock index price increases. Thetheory Appendix underlying portfolio insurance presumes that market prices move smoothly. When witnessan the Basics* prices abrupt, huge move, the results of the Options\342\200\224Understanding strategy may differ from the substantially theory. This occurred on October 19, when 1987, prices gapped beyondthreshold portfolio insurance sell levels, triggering an avalanche of sell orders which were executed far below the theoretical levels. Although portfolio insurance may have accelerated the decline on it October19, could reasonably be argued that the underlying forces would have resultedin a similar price decline over a of in greater span days the absence of portfolio insurance. This is a The of a that can never be There are two basic types of options: calls and puts. purchase question answered. (It is doubtful that program the not the call with the right\342\200\224but obligation\342\200\224 trading, as defined above, played much of a role in the crash of the week of option provides buyer called the strike or October sincethe to purchase the underlying item at a specifiedprice, 19, severely delayed openings of individual stocks, time to and the date. tremendous confusion related to exercise price, at any up including expiration Aput prevailing price levels,and exchange the with the not the obligation\342\200\224to sell restrictions the the option buyer right\342\200\224but regarding use of automated order entry systems provides the item at the strike price at any time prior to expiration. severely impededthis activity.) underlying while a (Note,therefore, that buying a put is a bearishtrade, selling put a As an is a bullish trade.) The price of an option is called premium. 130 call the the example of an option, an IBM April gives purchaser right the life to buy 100 shares of IBMat $130 per share at any time during of the option. from an rise The buyer of a call seeks to profit anticipated price by

in a The call maximum locking specified purchase price. buyer's possible loss will be equal to the dollar amount of the premium paid for the maximum loss would occur on an held until option. This option For expirationif the strike price was above the prevailing market price. when the 130 the example, if IBM was trading at $125 option expired, the of the option would expire worthless. If at expiration, price underly-

Guide to the Market *Adapted from Jack D. Schwager, A Complete Futures (John

Wiley & Sons, New Yoik,NY, 1984). 444 2 445 Appendix! Appendix

above the small of a loss in ing market was strike price, the option would have somevalue whereas the option seller acceptsa probability large and would hence be of a small In an efficient market, exercised. However,if the difference between the exchange for a large probability gain. market and the strike nor the consistent seller should price price was less than the premium paid for the neither the consistent option buyer option option, the net result of the still be a over the run. trade would loss. In order for a call have any significant advantage long buyer to realize a net the of two intrinsic value profit, difference between the market price and The option premium consists components: the strike would the value of a call is the amount price have to exceed premium paid when the call plus time value. The intrinsic option by was for is above the strike (The intrinsic purchased (after adjusting commission cost). The higher the which the current market price price. market the the which the current market is price, greater resulting profit. value of a put option is the amount by price The of a seeks the intrinsic value is that of the buyer put to profit from an anticipated pricedecline below the strike price.) In effect, part the locking in a sales Like the call if the were exercised at by price. buyer, his maximum possible premium that could be realized option loss is limited to the dollar amount of the The intrinsic value servesas a floor price for an premium paid for the option. current market price. In the case of a held until the lessthan the intrinsic value, a put expiration, trade would show a net profit option. Why? Because if the premium were if the strike exceeded the market exercise the and offset the price price by an amount greater than trader could buy and option immediately the premium of the at a net (assuming that the put purchase (after adjusting for commission cost). resulting market position, thereby realizing gain Whereas the buyer of a call or put has limited risk and unlimited trader covers at leasttransaction costs). the true for calls with strike below potential gain, reverse is the seller. The option seller (often Options that have intrinsic value (i.e., prices calledthe receives the above the market are writer) dollar value of the premium in return for the market price and puts with strike prices price) the to that have no intrinsic value are called undertaking obligation assume an opposite positionat the strike said to be in-the-money. Options price if an is exercised. For if a call with a strike closest to the option example, is exercised, the out-of-the-money options. Options price seller must assume a short position in the underlying market at the strike market price are called at-the-moneyoptions. the the which definition has an intrinsic price (since by exercising call, buyer assumes a long positionat An out-of-the-money option, by that of the price). value equal to zero,will still have some value because possibility The seller of strike to the a callseeksto profit from an anticipated sideways to that the market price will move beyond the price prior the market. In such a date. An will have a value greater than modestly declining situation, the premium earnedby expiration in-the-money option a the in to a selling call provides most attractive trading opportunity. However, intrinsic value because a position the option will be preferred if the trader a Because both the and the expected large price decline,he would usually be better position in the underlying market. Why? option off short the market or a will in the event ofa favorable price going underlying buying put\342\200\224trades with open- market position gain equally ended In a similar loss is limited. The portion of the profit potential. fashion, the seller of a put seeks to movement, but the option's maximum from an the intrinsic value is called the time value. profit anticipated sidewaysto modestly rising market. premium that exceeds Some novices factors that influence an time have trouble understanding why a trader would not The three most important option's the side of always prefer buy the option (call orput, depending on market value are: out- opinion), since sucha trade has unlimited potential and limited risk.Such (1) Relationship between the strike and market price\342\200\224Deeply confusion reflects the failure to take will have little time value since it is unlikely that probability into account. Although of-the-money options the seller's will move to the strike to option theoreticalriskisunlimited, the price levels that have the market price price\342\200\224orbeyond\342\200\224prior the greatest of have little time value, because probability occurrence (i.e., prices in the vicinity of the expiration. Deeply in-the-money options market when the similarto the market\342\200\224both price option trade occurs) would result in a net gain to these options offerpositionsvery underlying the option seller. the will and lose amounts for all but an extremely adverse Roughly speaking, option buyer accepts a large gain equivalent the fact probability of a small loss in return for a small of move. In other words, for a in-the-money option, probability a large gain, price deeply 446 Appendix 2 that risk is limited is not worth very much, because the strike priceisso far from the prevailing market price.

(2) Time remaining until expiration\342\200\224The more time remaining until expiration, the greater the value of the option. This is true because a life increases the of the intrinsic value longer span probability increasingby any specified amount prior to expiration.

(3) Volatility\342\200\224Time value will vary directly with the estimated volatility [a measure of the degree of price variability] of the underlying market for the remaining life span of the option. This relationship is a result of the fact that raises the of the greater volatility probability intrinsicvalue increasing by any specified amount prior to expiration. In other words,the greater the volatility, the greater the probable price range of the market. is an factor in the Although volatility extremely important determination of option premium values, it should be stressed that the future volatility of a market is neverpreciselyknown until after the fact. (In contrast,the time remaining until expiration and the relationship between the current market price and the strike price can be exactly specifiedat any juncture.) Thus, volatility must always be estimatedon the basis of historical volatility data. The future volatility estimate implied by market prices (i.e., option premiums), which may be higher or lower than the historical volatility, is called the implied volatility.