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A Tale of Two Traders
(April, 2001) Most of us struggle every day with good, bad and sometimes ugly trades. Occasionally, we enjoy great trades. At the end of almost every day, we could begin a diary of that session with: "It was the best of times; it was the worst of times .... "
What is the difference between a good trade(r) and a bad trade(r) ... other than the obvious record of gain or loss? What separates the winners from the losers? Can a loser become a winner? Why do the majority of traders end up quitting, as losers? Is there such a thing as "safe" trading? Who makes a great trader, and why? Who makes a bad trader, and how?
We operate in an industry which, like most, punctuates the road to success with obvious question marks.
I have been involved in financial markets for over 35 years. After Yale, and a brief career as a journalist and foreign correspondent, I became the financial editor of an international news magazine in 1967. I wrote hundreds of column inches every week covering important financial events. I did not really understand what I was talking about, but I fudged it with great clarity and insight.
I come by my financial curiosity honestly. My grandfather was a financial journalist early in his life, too. A banker, he became the Cleveland governor of the Federal Reserve under Roosevelt. My father was a successful bond trader and stockbroker. Both these men tried to beat some financial sense into me when I was a callous youth. Some of it helped. Much of it passed through my gray matter without leaving any residue whatsoever. Youth.
I have become a successful trader. Which is a bit like being a recovering alcoholic or reformed compulsive gambler ... you are always just one binge away from total failure. Still, I believe I have learned some answers to the dilemma of trading. That's what this article is about.
Good versus Bad Traders
Obviously, the market does not care who you are, where you've been, what you know, whether you are good or bad, where you were educated, your religion, creed, race, IQ or native language. The market, like money itself, has no feelings.
It does, however, have opinions.
It has intentions.
Millions of them.
All synergized, minute by minute, second by second, into the fluctuating price of an index, a share, a commodity.
But ... the market has no feelings. It will not applaud your victories. Nor will it forgive your mistakes. It has an underlying, "no return" policy. You break it, you take it.
One thing that separates good traders from bad traders ... is the shape and form of the ego they use to confront this "uncaring" market.
Random house defines ego as: "the part of the psychic apparatus that experiences and reacts to the outside world and thus mediates between the primitive drives of the id and the demands of the social and physical environment." The id represents instinctive, unconscious reaction ... uncontrolled impulse ... psychic energy unmodified by ego.
Ego is not a bad thing, although it is often used in a derogatory sense to indicate misguided conceit.
The shape of a successful trader's ego creates a desire to be right, but no need. Such traders quickly admit they are wrong, and just as quickly look for an avenue to being right. In my opinion, they are psychological Skinnerians (admirers of B.F. Skinner)... they understand that the environment controls their success, but that their success does not control the environment. This is not the fatalism of a compulsive gambler, but rather the pragmatic result of a useful, good trading ego. No conceit. Plenty of curiosity, and a desire to win.
Successful traders discover and use the momentary "truth" of the market, even if it goes against what they personally believe "should" happen. They do not bury their heads in the sand or hope for better times. They react to the market's "anti" messages by either moving to the sidelines, or by taking a position which actually opposes their personal "feelings". The latter is probably a great trader. The former makes a good living.
Put simply, a pragmatic ego makes money. Conceit loses, and sometimes hides, often beyond redemption.
Winners versus losers
Winning traders are like winning golfers, or tennis players, or boxers, or track stars. They understand the rules of their game. The physics of their game. The mathematics of it.
Great athletes probably do this inherently. The rest of us need to work on it, train for the game, get ready to win. But whether great, or just good, there is another step successful players must take to win.
I was a good golfer when I was a kid. Now, at 58, I am a much better golfer, although I rarely play. I can shoot in the low 80's with no practice, playing once every two months or so. This drives the golfers I occasionally play with nuts. They are out there, every day, pounding balls on the range, playing three to four rounds a week, and they often have a tough time busting 90.
I do not think I am any smarter than they are, or more coordinated, or in better physical shape. My bride of 28 years will attest to this.
But ... I understand the mechanics of golf, the physical rules of golf, and I can apply those rules when I get over that stupid little white ball. I have read Ben Hogan's Fundamentals of Golf, and I understand what he wrote. I did not at first. But I do now. I had to read, and reread, the book many times. I skim over it on those rare opportunities when I am going to play. Most important, I can apply Ben Hogan's rules to what I do on a golf course. It is the only golf book I pay attention to. There are many others out there. Fine ones. Useful ones. But Ben Hogan's book is the one I have learned to apply.
The same holds true in trading. It has taken me a long time to realize the obvious. It is not the rules which create success, it is the successful application of those rules. Put Ben Hogan's Fundamentals of Golf in the hands of someone who refuses to try to understand what that great golfer was writing ... and it will not help their game by a single stroke.
How do pros become pros?
Many people on the Internet dismiss any trader who does not give away their "system" for free. Often, a trader is dismissed even if they do give it away for free (as I do at my free site).
Of course, the Internet has a long-standing love affair with "free" ... one which I enjoy myself, immensely. But I have also been in business long enough to understand that "free" is often worth exactly what one pays for it ... or less.
One thing truly amazes me, however. That is the thought that any advice offered by a successful trader should not be listened to ... that one must develop one's own set of tools, and not pay any attention to anyone else.
This resembles the deification of reinventing the wheel. That's dumb religion. And it's a pretty strong indication that the trader may be confronting the market with the wrong sort of ego.
There are many folks out there who are a lot smarter than I am, who have developed useful tools for trading ... and you better believe I will use them. Stochastics and Bollinger bands are two of my favorite signals (even if I use them a little differently than their brilliant originators intended).
I figure, if the best pro golfers in the world (people like Tiger Woods) can take lessons from other golf pros (like Butch Harmon), then there's nothing wrong with me listening and paying attention to other traders who have systems with a proven track record. And if I find something I can incorporate in my own trading, I will do it.
Can mathematical slavery help?
In trading, I have always had a problem with the "religion" of mathematics. It has led to some spectacular failures. Let me digress for a second.
I appreciate and respect great artists ... painters, writers, poets and sculptors. Especially painters. Their craft has always fascinated me.
I believe that great paintings are almost always mathematical masterpieces. Their balance, their perception, their deception ... all meld perfectly along mathematical lines to produce something that confronts the eyes and sparks the brain. It's a marvelous event, when it happens.
And yet, great artists do not paint by the numbers. They understand structure and depth and color and bring it together in a burst of creativity. Turner's sunsets match the best the Lord has to offer. The twisted horror of Francis Drake makes Stephen King look like a child's bedtime storyteller.
Yet, all great artists are slaves to the mathematics of the universe ... physics, if you will. These are laws from which there is no escape.
So it is with traders. And yet ...
How come LTCM had to be bailed out?
In March, 1994, a bunch of very smart folks established Long-term Capital Management. Nobel laureates in economics (Robert Merton and Myron Scholes) joined experienced trading stars (like John Meriwether from Salomon Brothers) to form a surefire winner for fat cat investors.
These folks understood the mathematics of Wall Street. They started out as a specialists in arbitrage trades (bonds and bond derivatives) and quickly became a macro fund willing to speculate in other markets.
LTCM enjoyed extraordinary success. By 1997, it had nearly tripled investors' money. Annual rates of return pushed 40%. Assets grew from $7.3 billion to $120 billion.
To increase returns, these mathematical geniuses (I am not being derogatory ... they were mathematical geniuses) decided to jack up returns even further, by leveraging their bets from a 16 to 1 ratio up to a 25 to 1 ratio. More leverage. More profit.
And, of course, more risk.
So when Russian devaluation slapped a moratorium on debt repayments, the ripples of deteriorating creditworthiness turned arbitrage spreads between emerging-market bonds and Western Government instruments into an ever-widening chasm.
LTCM had bet on narrowing spreads.
The two-edged sword of their increased leverage drew blood.
In September, 1998, the Fed decided to rescue LTCM from the brink of failure. Greenspan actually must have feared a collapse of America's financial system. Many people, then and now, felt that the company and its investors should have been fed to the wolves instead.
Whether the rescue was warranted or not will be discussed for a long time. My question is far simpler.
How come these math geniuses screwed up?
The religion of mathematics ... false idols in waiting
Empirical evidence tells me that many mathematicians make very dangerous traders. Why? Because they treat their craft as a religion, and not as the useful tool it represents.
Always, in human endeavor, a razor-thin line separates confidence from arrogance. "Belief" (religion) pushes people across that line, into the arms of arrogance. And, despite its status as a cliché, arrogance does come before the fall.
So it was, I believe, with Long-term Capital Management.
And so it is, I believe, with EWave, Fibonacci numbers, Gartleys, and any one of a number of mathematically-derived "systems" used, successfully by some, to "beat the market".
As long as these systems are used as tools, they can work. When they become religion ... when they assume the veneer of "belief" ... they become dangerous routes to failure. This, more than anything else, explains why I treat EWave as a filter for my trading, and not as a (more powerful) signal.
In the end, "safe trading" is understanding the limitations of a system, and of yourself. Strengths take care of themselves. But weaknesses kill.
Entries and exits ... know thyself.
I consider myself an expert at entering trades. It is a strength. I think I am well below average at exits, however. Over time, my exits will improve. It is something I can always work on.
But I long ago learned the old sailor's saying: "You never have to recover from a good start." So I focus much more on my entries than I do on my exits.
I am often asked why I only trade one contract. Why not build positions? Or start with three contracts and close the winners out at pre-determined profit points?
To some extent, I trade a single contract because the responsibilites of the site make me want to keep things as simple as possible. But, even more significant, I figure that if my work can't profit on the basis of a single contract at a time, then no amount of mathematical bells and whistles will turn it into a winner.
This is my approach, of course. I have many members who trade better than I do, and differently. Some use my roadmaps better than I do (but, please, never take them as gospel). Many members are much better at exits than I am. Obviously.
And every day, I am two traders.
A good trader.
A bad trader.
It is the best of times. It is the worst of times.
I try to minimize the bad trader, and give the good trader a chance at becoming ... a better trader.
Trade safe.
Temple |
