Read The New Market Wizards: Conversations with America's Top Traders Online
Authors: Jack D. Schwager
Who interviewed you?
Richard Dennis and a couple of his associates.
Can you recall any of your responses during the interview that might have helped you get the job?
Nothing in particular. I think, however, despite my having had no background in the business, I was able to ask intelligent questions and respond appropriately. However, there was one exception. [
He laughs at the recollection.
] I was probably one of the only candidates who knew virtually nothing about Richard Dennis. Although I didn’t know it, Richard Dennis was famous for being one of the world’s great technical traders. During the interview I asked, “Do you trade the markets fundamentally or technically?”
That got a good chuckle. He answered, “We trade technically.”
I responded by asking, “Is fundamental analysis dead?”
Dennis answered, with a smile, “We certainly hope not.”
Obviously your lack of experience didn’t hurt you.
As it turned out, of the thirteen people selected, one-third had no experience, one-third had significant experience, and the remaining one-third had a little bit of experience.
I know you can’t divulge any of the specifics about the training course. However, are there any general lessons that came out of those sessions that you could talk about?
One nugget of advice that I believe is valuable to anyone trading the markets is: Don’t worry about what the markets are going to do, worry about what you are going to do in response to the markets.
Any other advice regarding psychology or attitude?
In my opinion, a large segment of the population should never trade the markets. Although I hesitate to use gambling as an example, I believe it provides a close analogy. Those people who are wise and prudent gamblers would probably also be wise and prudent investors, because they have a somewhat detached view of the value of money. On the other hand, those people who get caught up in the excitement of the amount of the wager, whether it’s gambling or investment, are likely to be destabilized by losses.
Why do you trade?
Part of it, of course, is to make a living. However, trading has many of the elements of a game. For someone like me who has always been interested in games, I don’t think there could be a better job.
HOWARD SEIDLER
Howard Seidler was certainly the most ebullient of the Turtles I interviewed. He exuded a general sense of enjoyment in trading, in emotion as well as in word. During our interview, his attitude toward trading was so upbeat that I naturally assumed he must have been enjoying a profitable streak in the markets. To my surprise, I later discovered that the half-year period preceding our interview was actually his second worst six-month performance ever (he was down 16 percent). Seidler certainly wins my award for the most happy Turtle. As to performance, he has averaged 34 percent (on an annual compounded basis) since he began trading in 1984.
When did you first become involved in the markets?
My first exposure was actually as a child, since my father dabbled in the markets. When I was in high school, I became aware of the futures markets. Futures fascinated me because of the symmetry of being able to go short as well as long. I was also attracted by the potential for leverage. As I began to read about the futures markets, the general description seemed to be: “Here’s this game, and by the way, hardly anyone ever succeeds at it.” To me, that was like throwing down the gauntlet.
When did you first actually begin to trade the markets?
In high school. Of course, I was too young to open my own account, so I opened an account under my father’s name.
How large was the account?
One thousand dollars. I had saved up that money by doing chores, such as shoveling snow and mowing lawns. It took me a little over a year before I lost it all.
That’s actually a pretty long ride considering the minuscule size of the account and the fact that you were a complete novice.
Of course, I wasn’t too thrilled about it at the time. However, as I got older, I realized that I had really done pretty well considering the circumstances. I certainly did get my money’s worth in terms of experience.
Do any traders from that time stand out as a learning experience?
One trade that I think was quite fortunate was actually a missed profit opportunity. Based on some trading ideas I had developed, I thought that the potato market was going to break sharply. I went short one contract, and the market started going in my direction. Once I had a small profit, I decided to double my position. Now, my account was so tiny that even a one-contract position was pushing it. I really had no business adding to this position.
Shortly after I had sold the second contract, the market started to go up. I became concerned about losing my equity, and I liquidated the contract that I had added, taking the loss on the trade. However, because of that loss, I also ended up getting out of my original contract way before the market reached my objective. Two days after I liquidated my position, the market began a steep collapse, just as I had originally anticipated.
I don’t understand why you termed that trade “fortunate.”
If I had stayed with the entire position and ended up making several hundred percent on the trade, I would have thought that I knew it all. There are certain lessons that you absolutely have to learn to be a successful trader. One of those lessons is that you can’t win if you’re trading at a leverage size that makes you fearful of the market. If I hadn’t learned that concept then, I would have at some later point when I was trading more money, and the lesson would have been far more expensive.
Did you eventually return to trading before you became a Turtle?
Shortly before I saw Richard Dennis’s ad in the
Wall Street Journal,
I had left my job as an economic consultant to become a full-time trader.
Only about one out of a hundred respondents to the ad were ultimately chosen for the training program. Do you have any idea why you made the final selection cut?
Although they weren’t looking for people with trading experience, by the same token, being a trader didn’t rule you out either. I think that insofar as I did have the trading background, the fact that my philosophy about the markets was similar to Dennis’s probably helped out. Also, and I’m just speculating, I think that Dennis might have been curious to see how somebody with my academic background—an MIT engineering degree—would work out.
What advice would you give someone in regards to being successful in the markets?
I think the single most important element is having a plan. First, a plan forces discipline, which is an essential ingredient to successful trading. Second, a plan gives you a benchmark against which you can measure your performance.
Doesn’t your bottom line equity give you that information?
Over the long run, sure. However, you can be following your rules exactly and still lose money. In that situation, you certainly haven’t performed poorly as a trader. The basic idea is that if you follow your rules over the long run, the probabilities will be in your favor, and you’ll come out ahead. In the short run, however, conformance to a trading plan is more significant than short-term equity fluctuations.
What else is important to succeed as a trader?
You need to have the persistence to stay with your ideas day after day, month after month, year after year, which is hard work.
Why would that be difficult? Why would you want to stray from a winning approach?
Because human beings are human beings. If you get enough negative feedback over the short run, you’re going to be tempted to respond to it.
Any other trading advice?
It’s important to distinguish between respect for the market and fear of the market. While it’s essential to respect the market to assure preservation of capital, you can’t win if you’re fearful of losing. Fear will keep you from making correct decisions.
I realize that this chapter has not provided any definitive answers as to what made the Turtles such a successful trading group. Nevertheless, it does offer an incredibly important message to those interested in trading: It is possible to develop a system that can significantly beat the market. Moreover, if you can discover such a system and exercise the discipline to follow it, you can succeed in the markets without being a born trader.
I
first met Monroe Trout several years ago, when a broker in my firm, who was trying to land Trout’s account, brought him by as part of the company tour. I knew that Trout was a commodity trading advisor (CTA) new to the business, but I didn’t know much else. Subsequently, I often heard Trout’s name mentioned as one of the younger CTAs who was doing very well. I didn’t realize how well until I started to work on this book.
In consulting the quarterly issue of
Managed Accounts Reports
while doing research for this book, I found that in terms of return/risk measurements, Trout’s performance was the best of the more than one hundred managers covered. There were a few who exhibited a larger average annual return, and fewer still with smaller drawdowns (although these CTAs had dramatically lower returns), but no one came close to matching his combination of return to risk. Over the five-year period surveyed, his average return was 67 percent but, astoundingly, his largest drawdown during that entire period was just over 8 percent. As another demonstration of his consistency, he had been profitable in 87 percent of all months. I was particularly surprised to discover that for the period in which Trout has been trading (he became a public money manager in 1986), even such legendary and extraordinary traders as Paul Tudor Jones did not approach his return/risk performance figures.
One of the things I like about Trout is that he does not trumpet his successes. For example, he was already doing quite well as a trader when I first met him several years ago, but, as I recall, he made no mention of his performance.
Trout sees himself as a businessman whose job it is to make money for his customers. As he expresses it, “Some people make shoes. Some people make houses. We make money, and people are willing to pay us a lot to make money for them.”
When did you first get interested in the markets?
When I was seventeen years old, I got a job for a futures trader named Vilar Kelly who lived in my hometown of New Canaan, Connecticut. He had an Apple computer, and at the time (1978), you couldn’t buy data on diskette—or at least he didn’t know where to buy it if it was available. He had reams of price data that he had collected from newspapers and wanted typed into his computer. He hired me and paid me a couple of bucks an hour to type in this data.
That sounds like real grunt work.
Yes, it was. But he also taught me a few things about the futures markets and computer programming. The computer experience was particularly valuable because, at the time, PCs were sort of novel.
That summer job sparked my interest in the markets. By my sophomore year at Harvard, I knew that I wanted to be a trader. I took whatever courses they had on the markets. I did my senior thesis on the stock index futures market.
What was the conclusion of your thesis?
The most important conclusion was that the probability of very large price changes, while still small, was much greater than might be assumed based on standard statistical assumptions. Therefore, a risk control methodology must be prepared to deal with situations that statistically might seem nearly impossible, because they’re not.
I assume the stock market on the high-volatility days in October 1987 and October 1989 is a perfect example.
Absolutely. If you assume that price changes are normally distributed, the probability of daily price moves of that magnitude would be virtually zero, which, of course, it was not.
I assume that theoretical realization made you trade smaller than you might have been inclined to otherwise.
Yes. I don’t use that much leverage.
Did your thesis reach any other significant conclusions?
I found that prices were not independent. That is, there were some statistically significant patterns.
Did you go on to graduate school?
No.
You graduated with honors from Harvard. I assume that you probably could have had your pick of any graduate school in the country. Didn’t you hesitate giving up that opportunity?
Not at all. I knew what I wanted to do—trade. Graduate school would only have delayed that goal. I never considered it.
How did you break into the business?
The athletic director at Harvard, Jack Reardon, knew Victor Niederhoffer, who headed NCZ Commodities, a New York trading firm. Victor had graduated from Harvard in 1964 and was a great squash player. (In fact, at one time he was the world’s best.) Jack knew I was interested in trading and suggested that I talk to Victor. We hit it off, and he offered me a job. It was a great job because I got a lot of responsibility very quickly.
Doing what?
Within two weeks I was trading on the floor of the New York Futures Exchange [trading the stock index]. Victor owned seats all over the place and needed people to trade on the floor for him.
Executing his orders?
A little. But mostly I just scalped for myself. I had a profit-sharing type of deal. [Scalping refers to floor brokers trading the market for very quick, small profits. There are two principal methods: (1) capturing the bid/ask spread by taking the opposite side of customer orders; (2) taking advantage of temporary, small price discrepancies between related positions (e.g., the March stock index contract being out of line with the June contract).]
You were fresh out of school. How did you learn to become a scalper overnight?
You ask a lot of questions. You stand in the pit and talk to the people around you. It’s actually a great place to learn quickly. At some point, you hit a plateau. But when you first get into the business, it’s a great place to start, because there are hundreds of traders. If you find the ones who know something about the markets and are willing to talk to you about it, you can learn quickly.
Do you remember what you learned in those early days?
I learned how quickly you can lose money if you don’t know what you’re doing.
Did you see that happen to some people?
Sure. One day somebody will be standing next to you in the pit, the next day they’re gone. It happens all the time. I also learned a lot about transaction costs. I’m able to estimate transaction costs fairly accurately on various types of trades. This information is essential in evaluating the potential performance of any trading model I might develop.
Give me a practical example.
Let’s take bonds. The average person off the floor might assume that the transaction costs beyond commissions is at least equal to the bid/ask spread, which in the bond market is one tick [$31.25]. In reality, if you have a good broker, it’s only about half a tick, because if he’s patient, most of the time he can get filled at the bid. If you have a bad broker, maybe it’s one tick. So the transaction cost in that case isn’t as high as you might think. Therefore, a T-bond trading system that you might discard because it has a small expected gain might actually be viable—assuming, of course, that you have good execution capabilities, as we do. The S&P market, on the other hand, is just the opposite. You might assume a bid/ask spread of 1 tick [5 points = $25], but very often it’s higher, because when you try to buy at the offer, it disappears.
What else did you learn on the floor?
I learned about where people like to put stops.
Where do they like to put stops?
Right above the high and below the low of the previous day.
One tick above the high and one tick below the low?
Sometimes it might be a couple of ticks, but in that general area.
Basically, is it fair to say that markets often get drawn to these points? Is a concentration of stops at a certain area like waving a red flag in front of the floor brokers?
Right. That’s the way a lot of locals make their money. They try to figure out where the stops are, which is perfectly fine as long as they don’t do it in an illegal way.
Given that experience, now that you trade off the floor, do you avoid using stops?
I don’t place very many actual stops. However, I use mental stops. We set beepers so that when we start losing money, a warning will go off, alerting us to begin liquidating the position.
What lesson should the average trader draw from knowing that locals will tend to move markets toward stop areas?
Traders should avoid putting stops in the obvious places. For example, rather than placing a stop 1 tick above yesterday’s high, put it either 10 ticks below the high so you’re out before all that action happens, or 10 ticks above the high because maybe the stops won’t bring the market up that far. If you’re going to use stops, it’s probably best not to put them at the typical spots. Nothing is going to be 100 percent foolproof, but that’s a generally wise concept.
Do you believe your floor experience helps explain your superior performance?
I believe so. For example, I have a pretty good eye for picking out where stops are going to be, even from off the floor. I try to get in the market a bit before that point is reached, sometimes even trying to set the stops off myself—and then the market will be off to the races.
The example of a common stop point you mentioned earlier—the area right beyond a prior high or low—is kind of obvious. Are there any other less obvious examples of popular stop points?
Round numbers. For instance, when the Dow Jones starts creeping up toward 3,000, I’ll start buying some in anticipation of it going through 3,000. The 3,000 level acts like a magnet.
So the markets are drawn to round numbers. Do markets usually reach the round number, or do they often stop just short of it?
I believe markets almost always get to the round number. Therefore, the best place to get in is before that number is reached and play what I call the “magnet effect.” For example, I might buy the stock index markets when the Dow is at 2,950, looking for it to go to 3,000. When the market gets close to 3,000, things get more difficult. When that happens, I like to have everybody in the trading room get on the phone with a different broker and listen to the noise level on the floor. How excited does it sound down there? What size trades are hitting the market? If it doesn’t sound that loud and order sizes are small, then I’ll start dumping our position because the market is probably going to fall off. On the other hand, if it sounds crazy and there are large orders being transacted, I’ll tend to hold the position.
Give me a recent example of the noise level on the floor being a good indicator.
When crude oil reached $20 [during the Persian Gulf crisis], there was a lot of noise on the floor and the market continued to move higher.
What else did you learn from your floor trading experience?
I learned what are the most liquid time periods of the day. When you’re trading one contract, that’s not important. But when you’re trading thousands of contracts, it can be critical.
What are the most liquid times of the day?
The most liquid period is the opening. Liquidity starts falling off pretty quickly after the opening. The second most liquid time of day is the close. Trading volume typically forms a U-shaped curve throughout the day. There’s a lot of liquidity right at the opening, it then falls off, reaching a nadir at midday, and then it starts to climb back up, reaching a secondary peak on the close. Generally speaking, this pattern holds in almost every market. It’s actually pretty amazing.
It’s also important to know when the illiquid periods occur, because that’s a good time to support your position. For example, if I’m long one thousand S&P contracts and it’s 11:30 Chicago time, I’m probably going to want to put in some sort of scale-down buy orders, like buying ten lots every tick down, to hold the market in my direction. It doesn’t cost me that many contracts at that time of day to support the market, because there are not a lot of contracts trading. The longer you can keep the market up, the better off you’re going to be.
Isn’t supporting the market a futile effort? In other words, isn’t the market ultimately going to go where it wants to go, whether you support it or not?