The New Market Wizards: Conversations with America's Top Traders (13 page)

Was it during that period down in Jamaica that you suffered the most anxiety you ever had in the markets?

No. It was the most I ever lost, but it wasn’t the most anxiety.

Which trade caused the most anxiety?

The British pound trade in November 1978 that we talked about earlier, because it was my first big loss.

Any other memorable trades?

In 1982, I began to notice on the evening news that the Dow was up almost every day. I started getting very strong bullish feelings about the stock market. This was the first time I had ever had any market feel based on something other than watching futures. I was reluctant to start picking stocks, because that was someone else’s game.

I opened an account with a friend of mine who was a stockbroker, instructing him to buy a cross section of stocks because I felt the market in general was going higher. At the time, I didn’t know that his method of picking stocks was exactly opposite to my approach in the futures market. His theory was to buy the weakest stocks on the premise that they could go up the most. Well, that certainly wasn’t my theory. He ended up buying me only three stocks, his favorites, which he had been in love with for the past ten years.

After watching the Dow go up for about three months while my account went down at the same time, I asked him to send me charts on the stocks I owned. I discovered that he was steering me into stocks that were near their lows, while my natural inclination was to buy stocks that were moving higher. I decided the arrangement wasn’t working out, and I closed the account.

I pulled out the phone book and found that there was a Merrill Lynch office nearby at the corner of Michigan and Wacker [in Chicago]. One summer afternoon after the market had closed, I walked over to the bank and withdrew a cashier’s check for $1 million. I then went to the Merrill Lynch office, walked through the door and asked, “Who’s in charge here?” The branch manager came over, and I told him, “I want to talk to your
least
experienced broker.” That’s the honest truth. I wanted somebody without any opinions.

He turned me over to a broker who was about twenty-three years old. I put the check down in front of him and said, “I want to open an account, and here’s what I want you to do. I want you to start out by investing three-quarters of this money in a wide variety of stocks, all of which are at or near all-time highs. After that, each week, I want you to send me a list of stocks broken down by market sector, ranking the stocks in each sector by how close they are to their all-time highs.

He followed my instructions exactly, and I did very well in that account. However, that same year, the Chicago Mercantile Exchange began trading the S&P 500 futures contract, which solved my problems on how to trade the general stock market. I thanked my broker for his efforts, closed the account, and switched into buying S&P futures. I felt bad about closing the account because he had done exactly what I had wanted him to do. He broke the market down into different sectors and bought the strongest stock in each sector.

Don’t feel bad; you probably taught him a lot about the markets. How did you fare once you switched to stock index futures?

Very well. I was fortunate to catch most of the move in the S&P from 120 to 300.

Could you tell me more about what made you so bullish on the stock market?

Part of it was just seeing the market up almost every day without any particular supporting news. In fact, the news was actually quite negative: inflation, interest rates, and unemployment were all still very high. Another important factor was that the stock market was virtually unchanged from its level twenty years earlier, while inflation had skyrocketed in the interim. Therefore, in real dollar terms, stock prices were extremely low. Also, I liked the fact that most of the experts weren’t particularly bullish. One popular analyst at the time whose comments I found particularly amusing was Joe Granville. Each time the market made a new high, he got more bearish than ever—and he was supposed to be a technician!

Are there any specific trading mistakes you made that provided valuable lessons?

In my first significant loss, I was short the Deutsche mark when the market went limit-up. I could still have gotten out limit-up, but I didn’t. The next day, the market went limit-up again. I ended up not only doubling my loss, but it also took me two months to recover to my account size before that trade. I basically learned that you must get out of your losses immediately. It’s not merely a matter of how much you can afford to risk on a given trade, but you also have to consider how many potential future winners you might miss because of the effect of the larger loss on your mental attitude and trading size.

How has the tremendous increase in professional trading that we discussed earlier changed market behavior during the past decade?

The big picture is probably the same, but the nature of the short-term price action is almost diametrically opposite to what it used to be. In order to get a rally, you need people on the sidelines who want to buy. When most market participants were unsophisticated, traders tended to wait until the market was in the headlines and making new highs before they started to buy. In contrast, professional traders, who dominate the markets today, will only be on the sidelines when there’s a large move in the opposite direction. As a result, the price moves that precede major trends today are very different from what they used to be because the behavior of professional traders is very different from that of naive traders.

How have these considerations changed the way you trade?

I used to like buying or selling on breakouts [price moves outside of a previous range—a development frequently interpreted by technicians as signaling an impending price extension in the same direction]. However, nowadays the breakouts that work look similar to the breakouts that are sucker plays. In fact, the false breakouts probably outnumber the valid signals. Consequently, trading on breakouts is a strategy that I no longer employ. I find that major trends are now frequently preceded by a sharp price change in the opposite direction. I still make my judgments as to probable price trends based on overall market action, as I always did. However, with a few exceptions, I now buy on breaks and sell on rallies.

If you’re always waiting for a reaction before entering the market, don’t you take a chance of missing major moves?

Certainly, but so what? I’ve got thirty-eight markets on my screen. If I miss moves in ten of them, there will be ten others that have a price move. The worst thing that can happen to you in the markets is being right and still losing money. That’s the danger in buying on rallies and selling on breaks these days.

You make it sound like a chess game. When your opponent is a farmer or a dentist, you play one way, and when your opponent is a professional, you play another.

No doubt about it. That’s exactly right. You have to keep adapting to changes.

What was your motivation for coming off the floor?

I stopped trading on the floor when my first child was born, because I wanted to be home with her. I was determined not to be one of those fathers that spends an hour with his kids before bedtime and that’s it. I was going to use the advantage of being self-employed to not only get wealthy but also to better enjoy my life.

How did you find the transition from trading on the floor to trading at home?

At first I found it very tough. During the first twelve or thirteen years I traded, the only time I made less money than the previous year was the year I started trading at home. In the pit, you can make quick hits by taking advantage of prices being out of line. In trading off the floor, however, you have to be willing to trade longer term, because you have an execution disadvantage. I think part of my problem that first year off the floor was that I just assumed I would keep on making more money year after year and didn’t have to worry about it. Once I had a mediocre year, I realized I had to put much more energy and focus into my trading. The next year I came back with a lot more determination, and I had my first million-dollar year.

You said earlier that you were a winning trader right from the start. Is there anything specific you did that helps explain that early success?

One of the things I did that worked in those early years was analyzing every single trade I made. Every day, I made copies of my cards and reviewed them at home. Every trader is going to have tons of winners and losers. You need to determine why the winners are winners and the losers are losers. Once you can figure that out, you can become more selective in your trading and avoid those trades that are more likely to be losers.

What other advice would you have for traders?

The most important advice is to never let a loser get out of hand. You want to be sure that you can be wrong twenty or thirty times in a row and still have money in your account. When I trade, I’ll risk perhaps 5 to 10 percent of the money in my account. If I lose on that trade, no matter how strongly I feel, on my next trade I’ll risk no more than about 4 percent of my account. If I lose again, I’ll drop the trading size down to about 2 percent. I’ll keep on reducing my trading size as long as I’m losing. I’ve gone from trading as many as three thousand contracts per trade to as few as ten when I was cold, and then back again.

Is this drastic variation in your trading size a key element to your success?

Absolutely, because every trader will go through cold spells.

In essence, then, you treat McKay as a trend as well.

Definitely, and there’s a logical reason for that. When you’re trading well, you have a better mental attitude. When you’re trading poorly, you start wishing and hoping. Instead of getting into trades you think will work, you end up getting into trades you hope will work.

In other words, you want to wait until you get back into the proper frame of mind, but the only way you can do that is by winning, and you don’t want to bet large in the meantime.

That’s right.

You’ve seen lots of traders in your day both on and off the floor. Do the winners and losers separate into any distinct profiles?

One very interesting thing I’ve found is that virtually every successful trader I know ultimately ended up with a trading style suited to his personality. For example, my brother is a very hardworking, meticulous type of person. When April 15 comes around, he loves to sit down, sharpen his pencils, and do his income tax. In fact, he probably gets all his pencils sharpened in March.

He must be a population of one.

Right. Anyway, he became a spreader, which suited his personality perfectly. [A spreader seeks to take advantage of discrepancies between related contracts by simultaneously implementing both long and short offsetting positions, as opposed to being net long or short the market.] And he was great at it. You could go into the pit and ask him for a quote on any spread combination, and he would be able to give you the price in an instant. He would never step out and take a risk like I would, but he traded the way he wanted to trade. On the other hand, my friends who are speculators are the type of people who will fly off to Las Vegas at a moment’s notice or climb a mountain in Africa. The bottom line is that the trading styles of successful traders tend to match their personalities.

How about your own personality—how does that match your trading style?

It matches it very well, I think. I grew up being very conservative. I was raised as a Catholic, and I was actually in a seminary for four years because I wanted to be a priest. As we discussed earlier, I deliberately allowed myself to get drafted. I was a straight-down-the-line kid. In adulthood, once I got the freedom that came with making money, I became much more of a risk taker. I went to Africa fifteen years ago, before it became a popular thing to do. I’ve taken lots of personal chances as an adult, because I believe life is short and you should live and enjoy it while it’s here.

My trading style blends both of these opposing personality traits. I take the risk-oriented part of my personality and put it where it belongs: trading. And, I take the conservative part of my personality and put it where it belongs: money management. My money management techniques are extremely conservative. I never risk anything approaching the total amount of money in my account, let alone my total funds.

You’re implying that it doesn’t make any difference what one’s personality is, as long as there’s no conflict between personality and trading style.