The Little Book of Market Wizards Page 2
Despite his dismal start, Gibson ultimately went on to become one of the best pitchers in baseball history. He is widely considered among the top 20 pitchers of all time. Gibson played 17 seasons in the majors, winning 251 games, with 3,117 strikeouts and a 2.91 earned run average (ERA). In 1968, he posted an unbelievably low 1.12 ERA—the lowest such figure since 1914. He won two Cy Young awards, twice was named as the World Series most valuable player (MVP), played on nine All-Star teams, and was elected to the Baseball Hall of Fame in his first year of eligibility.
If at First You Fail
One of the surprises I found in doing the Market Wizards books was how many of these spectacularly successful traders started with failure. Stories of wipeouts, or even multiple wipeouts, were not uncommon. Michael Marcus provided a classic example.
Michael Marcus was enticed into trading futures when he was a junior in college. There he met John, a friend of a friend, who dangled the prospect of being able to double his money in two weeks by trading commodities. Marcus fell for the pitch, hired John as a trading adviser for $30 a week, and opened a futures account with the money he had scraped together in savings.
Standing in the customer gallery of the brokerage firm, watching the clicking prices on the wall-size commodity board (this was back in the 1960s), Marcus quickly realized that his “adviser,” John, was clueless about trading. Marcus lost money on every trade. Then John came up with the idea that was “going to save the day.” The trade was buying August pork bellies and selling February pork bellies of the following year because the price spread between the two contracts was greater than the carrying charges (the total cost of taking delivery in the nearby contract, storing the commodity, and redelivering it in the forward contract). It seemed like a can’t-lose trade. After placing the trade, Marcus and John went to lunch. When they returned, Marcus was shocked to find that his account had been almost completely wiped out. (Marcus would later discover that August pork bellies were not deliverable against the February contract.) At that point, Marcus told John that he thought he knew as much as he did—which was nothing—and fired his adviser.
Marcus then managed to rustle up another $500, which he lost as well. Unwilling to give up and accept failure, Marcus decided to cash in $3,000 from the life insurance left to him by his father, who had died when he was 15. He then started reading up on grains and making some winning trades. In 1970, he bought corn based on a recommendation in a newsletter he subscribed to. By sheer luck, 1970 was the year of the corn blight. By the end of that summer, Marcus had turned the $3,000 into $30,000.
In the fall, Marcus started graduate school, but found himself so preoccupied by trading that he dropped out. He moved to New York, and when asked what he did for a living, he told people rather pompously that he was a “speculator.”
In the spring of 1971, there was a theory around that the blight had wintered over and would infect the corn crop again. Marcus believed this theory as well, and he intended to capitalize on it. He borrowed $20,000 from his mother, adding it to his $30,000 account. He then used the entire $50,000 to buy the maximum number of corn and wheat contracts he could on margin. For a while, the market held steady because of the blight fears, but it didn’t go higher. Then one morning, there was a financial headline that read, “More Blight on the Floor of the Chicago Board of Trade Than in Midwest Cornfields.” The corn market opened sharply lower and fairly quickly moved to and locked limit down.2 Marcus stood by paralyzed, hoping the market would rebound, and watching it stay locked limit down. Given that his position had been heavily margined, he had no choice but to liquidate everything the next morning. By the time he was out, he had lost his entire $30,000 plus $12,000 of the $20,000 his mother had lent him.
I would look up and say, “Am I really that stupid?” And I seemed to hear a clear answer saying, “No, you are not stupid. You just have to keep at it.” So I did.
Michael Marcus
I asked Marcus whether with all these failures he ever thought of just giving up. Marcus replied, “I would sometimes think that maybe I ought to stop trading because it was very painful to keep losing. In Fiddler on the Roof, there is a scene where the lead looks up and talks to God. I would look up and say, ‘Am I really that stupid?’ And I seemed to hear a clear answer saying, ‘No, you are not stupid. You just have to keep at it.’ So I did.”
He did, indeed. Eventually, it all clicked for Marcus. He had an amazing innate talent as a trader. Once he combined this inner skill with experience and risk management, he was astoundingly successful. He took a trading job at Commodities Corporation. The firm initially funded his account with $30,000, and several years later added another $100,000. In about 10 years’ time, Marcus turned those modest allocations into $80,000,000! And that was with the firm withdrawing as much as 30 percent of his profits in many years to pay the company’s burgeoning expenses.
“One-Lot” Persists
Although many of the Market Wizards started off with some degree of failure, perhaps none reached the depth of despondency over their losses as did Tony Saliba. At the start of his career when he was a clerk on the floor, one of the traders staked him with $50,000. Saliba went long volatility spreads (option positions that gain if the market volatility increases). In the first two weeks, Saliba ran the account up to $75,000. He thought he was a genius. What he didn’t realize was that he was buying these options at very high premiums because his purchases followed a highly volatile period. The market then went sideways and the market volatility and option premiums collapsed. In six weeks Saliba had run the account down to only $15,000.
Recounting this episode, Saliba said, “I was feeling suicidal. Do you remember the big DC-10 crash at O’Hare in May 1979, when all those people died? That was when I hit bottom.”
“Was that a metaphor for your mood?” I asked.
“Yes,” answered Saliba. “I would have exchanged places with one of those people in that plane on that day. I felt that bad. I thought, ‘This is it; I’ve ruined my life.’ . . . I felt like a failure.”
Notwithstanding this dismal start, Saliba had one important thing going for him: persistence. After his disastrous beginning, he came close to quitting the world of trading, but ultimately decided to keep trying. He sought the advice of more experienced brokers. They taught Saliba the importance of discipline, doing homework, and a goal of consistent, moderate profitability, rather than trying to get rich quick. Saliba took these lessons to heart and switched from trading options in Teledyne, which was extremely volatile, to trading options in Boeing, which was a narrow-range market. When he did go back to trading Teledyne, his standard conservative order size led to ridicule by the other brokers and the sobriquet “One-Lot.” Once again, Saliba persisted, this time putting up with all the ribbing and not being goaded into departing from his cautious approach. Ultimately, the persistence and attention to risk control paid off. At one point, Saliba put together a streak of 70 consecutive months with profits in excess of $100,000.
Two Key Lessons
There are two key lessons that can be drawn from this chapter.
First, failure is not predictive. Even great traders often encounter failure—and even repeated failures—early in their careers. Failure at the start is the norm, even for those who ultimately become Market Wizards. As a related comment, the fact that most people who attempt trading fail at the beginning suggests that all novice traders should start with small amounts of cash because they might as well pay less for their market education.
Second, persistence is instrumental to success. Most people faced with the types of failures encountered by the traders detailed in this chapter would have given up and tried some other endeavor. It would have been easy for the traders in this chapter to have done the same. Were it not for their relentless persistence, many of the Market Wizards would never have discovered their ultimate potential.
Notes
1. www.baseball-almanac.com/feats/feats23.shtml.
2. In many f
utures markets, the maximum daily price change is restricted by a specified limit. Limit down refers to a decline of this magnitude, while limit up refers to the equivalent gain. If, as in this case, the equilibrium price that would result from the interaction of free market forces lies below the limit-down price, then the market will lock limit down—that is, trading will virtually cease. Reason: There will be an abundance of sellers, but virtually no willing buyers at the constrained limit-down price.
Chapter Two
What Is Not Important
Before considering what is important to trading success, let’s start with what’s not important, because what many novice traders believe is essential to trading success is actually a diversion. Many would-be traders believe that trading success is all about finding some secret formula or system that explains and predicts price moves, and that if only they could uncover this solution to market price behavior, success would be assured. The idea that trading success is tied to finding some specific ideal approach is misguided. There is no single correct methodology.
Let me illustrate this point by comparing the trading philosophies and trading approaches of two of the traders I interviewed: Jim Rogers and Marty Schwartz.
Jim Rogers
Jim Rogers is a phenomenally successful trader, although he would insist on calling himself an investor, as opposed to trader, because of the long-term nature of his market positions. In 1973, he partnered with George Soros to start the Quantum Fund, one of the most successful hedge funds of all time. Rogers left Quantum in 1980 because the firm’s success had led to expansion and with it unwanted management responsibilities. Rogers just wanted to focus on market research and investment, so he “retired” to manage his own money.
Rogers is particularly skilled in seeing the big picture and anticipating major long-term trends. When I interviewed him in 1988, gold had been declining for eight years, but Rogers seemed certain the bear market would carry on for another decade.
“Generals always fight the last war,” he said. “Portfolio managers always invest in the last bull market. The idea that gold has always been a great store of value is absurd. There have been times in history when gold has lost purchasing power—sometimes for decades.”
Rogers was absolutely right, as gold continued to slide for another 11 years. Another market he was particularly opinionated about was the Japanese stock market. At the time, Japanese equities were in the midst of an explosive bull market. Yet Rogers was convinced there would be a tremendous move in the opposite direction.
“I guarantee that the Japanese stock market is going to have a major collapse—possibly within the next year or two . . . [Japanese stocks] are going to go down 80 to 90 percent.”
This forecast seemed preposterous, yet it was absolutely correct. A little over a year after our conversation, the Japanese stock market peaked, beginning a slide that would see the Nikkei index lose about 80 percent of its value over the next 14 years.
Clearly, Jim Rogers is a man whose opinion is worth paying attention to. Rogers is a fundamental analyst. I asked Rogers what he thought of chart reading. His response left little question about his derisive attitude toward technical analysis.
“I haven’t met a rich technician,” Rogers said, “excluding, of course, technicians who sell their technical services and make a lot of money.”
I then asked Rogers if he ever used charts.
“I use them,” he said, “to see what is going on . . . I don’t say—what is that term you used earlier, reversal?—‘There is a reversal here.’ I don’t even know what a reversal is.”
When I tried to explain the term, he cut me off.
“Don’t tell me. It might mess up my mind. I don’t know about those things, and I don’t want to know.”
I doubt that it would be possible to get any more cynical about a particular trading methodology than Jim Rogers’s attitude toward technical analysis.
Marty Schwartz
Now let’s consider another incredibly successful trader, Marty Schwartz, who is at the other end of the spectrum in terms of analytical approach. When I interviewed Schwartz, he had run a $40,000 account into over $20 million while never realizing a drawdown of more than 3 percent (based on month-end data) in the process. Schwartz took pains to point out that his two worst months—losses of 3 percent and 2 percent—were the months his children were born and he was unavoidably distracted. During this period, he had entered 10 public trading contests. Nine of these were four-month contests in which he averaged a 210 percent return nonannualized! In his single one-year contest, he scored a 781 percent return.
Clearly, Schwartz is another trader whose opinion should be taken very seriously. What does he have to say on the topic of the efficacy of fundamental analysis versus technical analysis? He had been a securities analyst for nearly a decade before he became a full-time trader using technical analysis. When I asked Schwartz whether he had made a full transition from fundamental analysis to technical analysis, ironically, his reply seemed to be a direct retort to Rogers’s comment on technical analysis—a statement I hadn’t mentioned to him.
Schwartz answered, “Absolutely. I always laugh at people who say, ‘I’ve never met a rich technician.’ I love that! It is such an arrogant, nonsensical response. I used fundamentals for nine years and got rich as a technician.”
It would be difficult to find two more divergent or strongly held viewpoints on what works and what doesn’t work in trading the markets. Rogers has based his trading decisions solely on fundamental analysis and considers technical analysis to be on the same plane as snake oil, while Schwartz consistently lost money using fundamental analysis, but has achieved incredible performance using technical analysis. Both men have succeeded spectacularly, and both view each other’s methods with complete disdain and even cynicism.
Reconciling the Divergent Views
What does the dichotomy between Rogers and Schwartz tell you? It should tell you that there is no single true path in the markets. There is no single market secret to discover, no single correct way to trade the markets. Those seeking the one true answer to the markets haven’t even gotten as far as asking the right question, let alone getting the right answer.
There is no single market secret to discover, no single correct way to trade the markets. Those seeking the one true answer to the markets haven’t even gotten as far as asking the right question, let alone getting the right answer.
There are a million ways to make money in the markets. Unfortunately, they are all very difficult to find. But there are many, many ways to succeed. Some traders, such as Rogers, succeed using only fundamental analysis; others, such as Schwartz, succeed using only technical analysis; and still others use a combination of the two. Some traders succeed holding positions for months, or even years, while others succeed on a time scale measured in minutes. Market success is a matter of finding the methodology that is right for you—and it will be different for everyone—not a matter of finding the one true methodology.
Chapter Three
Trading Your Own Personality
In the previous chapter, we established that there is no one path that will lead to success as a trader. This insight points to an essential element of trading success. If you get nothing else out of reading this book than the one following principle, it will still have been a very worthwhile endeavor:
Successful traders find a methodology that fits their personality.
So, while there is no single correct way to trade the markets, in order to be successful, you need to find the one way that is right for you—a methodology that suits your personality. It is the one thing that all the successful traders I have ever interviewed had in common: They all developed a trading style that was consistent with their personality and beliefs. This observation seems very logical to the point of even sounding obvious. You might wonder, “Doesn’t everyone trade in line with their personality?”
Well, actually, no, they don’t. Schwartz spent nearly a d
ecade trying to adapt fundamental analysis to trading markets, an approach that was very poorly attuned to his personality. It led to tying his ego to his fundamentally derived market opinions. Speaking of this early period, Schwartz said, “Although I steadily earned good salaries, I was still almost broke because I consistently lost money in the market.”
It was not until Schwartz immersed himself in technical analysis that he became successful. Technical analysis gave Schwartz a methodology that allowed him to get out of trades quickly when he was wrong. If he got out of a losing trade, there were always lots of other trades in front of him. As Schwartz explained, “By living the philosophy that my winners are always in front of me, it was not so painful to take a loss. If I make a mistake, so what?” He had found a methodology that was a much better personal fit. The point here is not that technical analysis is better than fundamental analysis, but rather that technical analysis was the better methodology for Schwartz. For other traders, such as Jim Rogers, the reverse would be true.
You would be surprised by the number of people who waste time and money trying to fit their personality into a trading method that is not suited for them. There are traders who have innate skills in creating computerized trading systems that do well in the markets, but then feel a compulsion to intervene with discretionary trades—often sabotaging their own systems. There are traders who are naturally attuned to ascertaining long-term market trends, but who get bored staying with a position for a long time and then make short-term trades that lose money. People stray from methodologies that best suit their personality and skills all the time.