The New Market Wizards: Conversations with America's Top Traders (2 page)

Trying to make the best of a bad situation, I related my recent trading experiences to Ed. I explained how I started trading again despite my reluctance to do so and the incredible string of errors I committed on the one British pound trade—errors that I thought I had vanquished years ago. I told him that, ironically, at one point before I put on the British pound trade, when I was still up about $20,000, I was in the market for a new car that cost exactly that amount. Since my house had virtually drained me of assets, I was tempted to cash in the account and use the proceeds to buy the car. It was a very appealing thought since the car would have provided an immediate tangible reward for a few months of good trading without even having risked any of my own funds.

“So why didn’t you close the account?” Ed asked.

“Well,” I said, “how could I?” Although I managed to turn a few thousand dollars into $100,000 on a couple of occasions, I had always stalled out. I had never been able to really break through and extend it into some serious money. If I had decided to cash in my chips to make a purchase, I would always have wondered whether this would have been the time that I would have realized my trading goals. Of course, with the benefit of hindsight, I would have been much better off taking my profits, but at the time I couldn’t see giving up the opportunity. I rationally explained all this to Ed.

“In other words, the only way you could stop trading was by losing. Is that right?” Ed didn’t have to say anything more. I recalled that in my interview of him for
Market Wizards,
his most striking comment was: “Everybody gets what they want out of the market.” I had wanted not to be trading, and sure enough that’s what I got.

The moral here is: You don’t always have to be in the market. Don’t trade if you don’t feel like it or if trading just doesn’t feel right for whatever reason. To win at the markets you need confidence as well as the desire to trade. I believe the exceptional traders have these two traits most of the time; for the rest of us, they may come together only on an occasional basis. In my own case, I had started out with the confidence but without the desire to trade, and I ended up with neither. The next time I start trading, I plan to have both.

I
n many ways, the elements of good and bad decision making in trading are very similar to those that apply to decision making in general. The start of my work on this book coincided with the events immediately preceding the Persian Gulf War. I couldn’t help but be struck by the similarity between Saddam Hussein’s actions (or, more accurately, the lack thereof) and the typical responses of a foundering novice trader.

Hussein’s trade was the invasion of Kuwait. Initially, he had solid, fundamental reasons for the trade. (The fundamentalist reasons came later, of course, as Hussein found it convenient to discover religion.) By invading Kuwait, Hussein could drive up oil prices to Iraq’s benefit by eliminating one of the countries that consistently exceeded its OPEC quota and by creating turmoil in the world oil markets. He also stood a perceived good chance of permanently annexing part or all of Kuwait’s oil fields, as well as gaining direct access to the Persian Gulf. And, last but certainly not least, the invasion provided a wonderful opportunity for Hussein to feed his megalomaniacal ambitions.

In exchange for all this upside potential, the initial risk on the trade seemed limited. Although forgotten by many because of the eventual decisive stance taken by the United States, the State Department’s initial response to Iraq’s invasion-threatening pronouncements and actions could essentially be paraphrased as “It’s not our problem.” In dealing with Hussein, such an ambivalent policy was almost tantamount to offering to lay out a red carpet for Iraq’s tanks.

So initially, from Hussein’s perspective, the invasion of Kuwait was a good trade—large potential and limited risk. However, as so often happens, the market changed. President Bush committed the United States to the defense of Saudi Arabia by sending in troops and spearheaded the passage of UN resolutions aimed at convincing Hussein to leave Kuwait. At this point, Hussein could probably have negotiated a deal in which he would have withdrawn from Kuwait in exchange for some disputed territorial gains and port rights—a quick profit. However, although the trade had started to deteriorate, Hussein decided to stand pat.

Next, Bush sent a stronger signal by doubling U.S. forces to four hundred thousand—an action indicating not only that the United States was ready to defend Saudi Arabia but that it was also establishing the capability for retaking Kuwait by force. Clearly the market had changed. Hussein ignored the market signal and stood back.

President Bush then set a January 15 deadline for Iraq’s withdrawal from Kuwait in compliance with the UN resolution—the market moved further against the trade. At this point, the profit potential was probably gone, but Hussein could still have approximated a breakeven trade by offering to withdraw from Kuwait. Once again, he decided to hold the position.

Once the January 15 deadline had passed and the United States and its allies in the Gulf War embarked on the massive bombing of Iraq, the original trade was clearly in losing territory. Moreover, the market was moving down sharply every day, as each day’s procrastination resulted in more destruction in Iraq. But how could Hussein give in now when so much had been lost? Much like a bewildered trader caught in a steadily deteriorating position, he pinned his hopes on the long shot: If only he held on long enough, perhaps fear of casualties would prompt the United States to back down.

The trend continued to go against the trade as the United States issued another deadline ultimatum—this time linked to the initiation of a ground war against Iraq. At this juncture, Hussein was readily consenting to conditions contained in the Soviet peace proposal, and agreement that probably would have been perfectly sufficient earlier but was now inadequate. Hussein’s behavior was very much like that of a trader holding a long position in a steadily declining market who says, “I’ll get out when I’m even,” and then, as the situation grows more desperate, “I’ll get out at the last relative high,” with the relative high moving steadily down with the passage of time.

Ultimately, with the ground war well under way and his army largely decimated, Hussein finally capitulated. He was like a trader who has held on to a losing position until his account has been virtually destroyed, and then, in complete desperation, finally exclaims to his broker, “Get me out of the market. I don’t care at what price, just get me out!”

THE SULTAN OF CURRENCIES

Q
uick, what is the world’s largest financial market? Stocks? No, not even if you aggregate all the world’s equity markets. Of course, it must be bonds. Just think of the huge government debt that has been generated worldwide. Good guess, but wrong again, even if you combine all the world’s fixed-income markets. The correct answer is currencies. In the scope of all financial trading, stocks and bonds are peanuts compared with currencies.

It is estimated that, on average, $1 trillion is traded
each day
in the world currency markets. The vast majority of this currency trading does not take place on any organized exchange but rather is transacted in the interbank currency market. The interbank currency market is a twenty-four-hour market, which literally follows the sun around the world, moving from banking centers of the United States, to Australia, to the Far East, to Europe, and finally back to the United States. The market exists to fill the needs of companies seeking to hedge exchange risk in a world of rapidly fluctuating currency values, but speculators also participate in the interbank currency market in an effort to profit from their expectations regarding shifts in exchange rates.

In this huge market, there has been only a handful of high-stakes players. Ironically, although these traders sometimes take positions measured in billions of dollars—yes, billions—they are virtually unknown to most of the financial community, let alone the public. Bill Lipschutz is one of these traders.

The interviews I held with Lipschutz were conducted in two marathon sessions at his apartment. Lipschutz has market monitor screens everywhere. Of course, there is the large TV monitor in the living room, receiving a feed of currency quotes. There are also quote screens in his office, the kitchen, and near the side of his bed, so that he can roll over in his sleep and check the quotes—as indeed he does regularly (since some of the most active periods in the market occur during the U.S. nighttime hours). In fact, you can’t even take a leak without literally running into a quote screen (there is one conveniently located, somewhat tongue in cheek, at standing height in the bathroom). This fellow obviously takes his trading very seriously.

I had first contacted Bill Lipschutz through a public relations agent, Tom Walek. Yes, a public relations agent for a trader sounds rather odd. In fact, this is particularly true for Lipschutz, who had managed quite deliberately to maintain virtually total public anonymity for his entire career despite his huge trades. However, after having spent eight years as Salomon Brothers’ largest and most successful currency trader, Lipschutz had just left the firm to start his own management company to trade currencies (initially as a subsidiary of Merrill Lynch; later, the company evolved into a completely independent venture, Rowayton Capital Management). It was this project that required the public relations support. Anyway, after Walek discussed my interview proposal with Lipschutz, he called to tell me that Bill first wanted an informal meeting so that he could see if it “felt right.”

We met at a Soho bar, and after downing several French beers (no joke, the French actually produce some excellent beers) Lipschutz said, “I think you’ll find the story of how, in less than a decade, Salomon Brothers grew from a zero presence in currencies to becoming perhaps the world’s largest player in the currency market an interesting tale.” Besides feeling a sense of relief, since that comment obviously reflected a consent to the interview, his statement certainly whetted my appetite.

In our first meeting at his apartment, with my tape recorders whirring, I said, “OK, tell me the story of Salomon’s spectacular growth as a major trading entity in the world currency markets.” I sat back, anticipating a lengthy response full of wonderful anecdotes and insights.

Lipschutz answered, “The currency options market, Salomon’s currency options department, and I all started at the same time and grew and prospered simultaneously.”

“And…,” I said, prompting him to continue. He rephrased the same response he had just given.

“Yes,” I said, “that’s a very interesting coincidence, but could you fill in the details? How about some specific stories?” He responded again with generalizations. My hopes for the interview went into a rapid nosedive.

I’ve done interviews that I knew were dead in the water after the first hour and have ended up ditching the results afterwards. However, this interview was different. Although I felt that I was getting very little useful material during the first one or two hours of our conversation, I sensed there was something there. This was not a dry well; I just had to dig deeper.

After the first few hours, we started to connect better and Lipschutz began relating specific stories regarding his trading experiences. These make up the core of the following interview.

As mentioned earlier, the large TV screen in Lipschutz’s living room is normally tuned to a currency quote display, with a Reuters news feed running across the bottom. Although Lipschutz seemed to be paying full attention to our conversation, on some level he was obviously watching the screen. At one point, the Australian dollar was in the midst of a precipitous decline following some disastrously negative comments made by the Australian finance minister. Although the market was in a virtual free-fall, Lipschutz felt the sell-off was overdone and interrupted our interview to call in some orders. “Nothing big,” he said. “I’m just trying to buy twenty [$20 million Australian, that is].” Immediately afterward, the Australian dollar started to trade higher and continued to move up throughout the rest of the evening. Lipschutz didn’t get a fill, however, because he had entered his order at a limit price just a hair below where the market was trading, and the market never traded lower. “Missing an opportunity is as bad as being on the wrong side of a trade,” he said.

During our second interview, Lipschutz wanted to short the Deutsche mark and was waiting for a small bounce to sell. When noticing that the mark had started to move lower instead, he said, “It looks like I’m going to miss the trade.”

“That sounds just like last week when you missed getting long the Australian dollar by using a limit order,” I said. “If you feel that strongly,” I asked, “why don’t you just sell the Deutsche mark at the market?”

“What! And pay the bid/ask spread?” Bill exclaimed. I wasn’t sure whether he was serious or joking—or perhaps some combination of the two. (Incidentally, the Deutsche mark kept going lower.)

Our interviews were conducted after U.S. market hours, but, since the currency markets never close, Lipschutz, apparently, never stops trading. However, despite his admitted obsession with the markets and trading, Lipschutz appeared very relaxed. I wouldn’t even have known that he was watching the markets had he not occasionally made references to price movements and placed orders over the phone.

What happened to architecture?

What happened to
architecture?

Well, I had heard that you have a degree in architecture. How is it that you ended up as a trader?

While I was enrolled in the architectural program at Cornell, my grandmother died and left me a portfolio of a hundred different stocks with a total value of $12,000, which I liquidated at great cost because all the positions were odd lots. The proceeds provided me with risk capital. I found myself using more and more of my time playing around with the stock market. It wasn’t that I got less interested in architecture, I just became a lot more interested in trading.

Also, architecture is very much an Old World profession. There is a long apprenticeship—three years in this country—before you can take your licensing exam. Then you spend many more years as a draftsman. It takes a long time before you get to the point where you have control over the design process.

Did you get your degree eventually?

Yes, of course. Actually, I got two degrees. The full-time architectural program took five years. It was not unusual for architectural students to also enroll in other courses and take longer to finish their degree. I ended up taking a lot of business courses and also earned an M.B.A.

What happened after you graduated Cornell? Did you get a job related to architecture?

No, I never practiced as an architect because of the long apprenticeship process I just explained. I went directly to work for Salomon.

How did you get that job?

It’s typical for students in the M.B.A. program to get business-related summer jobs. In the summer of 1981 I got a job at Salomon Brothers. By that time, I was trading stock options very actively for my own account.

Was this the account you started with the $12,000 your grandmother left you?

Yes, and by this time I had built it up a bit.

What did you know about stock options when you started trading?

I didn’t know a whole lot.

Then on what basis did you make your trading decisions?

I tried to read everything I could on the subject. I spent a lot of time in the library reading annual company reports. I became an avid reader of the various financial periodicals such as
The Economist, Barron’s,
and
Value Line.

I also began to watch the stock tape on cable. Because Ithaca, New York, is surrounded by mountains, it has particularly poor television reception. As a result, it was one of the first places in the country to get cable TV in the early 1970s. One of the channels had a fifteen-minute delayed stock tape. I spent many hours watching the tape and, over time, I seemed to develop a feel for the price action.

Was that when you decided to become a trader?

I can’t remember making any conscious decision, “I want to be a trader; I don’t want to be an architect.” It was a gradual process. Trading literally took over my life.

Was the Salomon summer job related to trading?

My wife and I met while I was attending Cornell. She’s very aggressive and has a very strong economics background. The previous summer she had managed to get a job working for Dr. Henry Kaufman [a world-renowned economist] in the bond research department. I subsequently met her immediate superior, who also happened to be a Cornell alumnus. He arranged for me to interview with Henry Kaufman for the same position my wife had held (by this time, she had graduated and had a full-time job).

Ironically, around the same time, Salomon Brothers sent a representative to Cornell to do recruiting. I was invited to come to New York to interview for their summer sales and trading intern program. I was interviewed by Sidney Gold, the head of Salomon’s proprietary equity options desk. Sidney is a very high-strung guy who speaks very, very fast.

He took me into an office that had a glass wall facing out onto a large trading room, with a view of an electronic tape running across the wall. I sat with my back to the tape, and the whole time he was interviewing me, he was also watching the tape. He started firing questions at me, one after the other. Here I am, a college kid, wearing a suit and tie for the first time in my first formal interview, and I had no idea what to make of all of this. I answered each of his questions slowly and deliberately.

After about ten minutes of this question-and-answer process, he stops abruptly, looks me straight in the eye, and says, “OK, forget all this bullshit. So you want to be a trader. Every fucking guy comes here and tells me he wants to be a trader. You said you’re trading your own account. What stocks are you trading?”

“I’ve been pretty involved in Exxon recently,” I reply.

He snaps back, “I don’t know that stock. Give me another one.”

“I’ve also been pretty involved in 3M,” I answer.

“I don’t know that one either,” he shoots back. “Give me another one.”

I answer, “U.S. Steel.”

“U.S. Steel. I know Steel. Where is it trading?”

“It closed last night at 30 1/2.”

“It just went across the board at 5/8,” he says. “Where did it break out from?” he asks.

“Twenty-eight,” I answer.

He fires right back, “And where did it break out from before that?”

“Well, that must have been over three years ago!” I exclaim, somewhat startled at the question. “I believe it broke out from about the 18 level.”

At that point, he slows down, stops looking at the tape, and says, “I want you to work for me.” That was the end of the interview.

A few weeks later, I received a call from the fellow who ran Salomon’s recruiting program. He said, “We have a bit of a problem. Sidney Gold wants to hire you, but Kaufman also wants you to work for him. So we worked out an arrangement where you’ll split your time between the two.” I ended up working the first half of the summer doing research for Dr. Kaufman and the second half working on the options trading desk.

At the end of the summer, Sidney offered me a job. Since I still had one semester left in business school and also had to finish my thesis for my architectural degree, I arranged to work for Sidney during the fall semester, with the understanding that I would return to school in the spring.