The New Market Wizards: Conversations with America's Top Traders (32 page)

Are there any clients that you’ve dropped completely?

One of my clients was someone I didn’t know personally. He opened an account with me in response to another client’s recommendation. The money he invested represented an inheritance his wife had received, and he was very nervous about the account. I couldn’t have started in a worse situation. It was the fall of 1985, and I had two disastrous trades in healthcare. I entered the first trade on the day the industrialized nations announced a plan to weaken the dollar. The dollar cracked and drug stocks took off. The next day, everyone was saying the plan wouldn’t work; the dollar rebounded, drug stocks got clobbered, and I was out with a big loss. Only about a week later, I went back into healthcare. The following day, Hospital Corporation of America reported surprisingly bad earnings, and the sector got hit extremely hard again.

How big a hit were these trades?

About 2 or 3 percent each. Anyway, this particular client was extremely nervous about his investment. The account had gone from $70,000 down to about $67,000. I told him, “Don’t worry, I’ll cover 100 percent of your losses.” I went down to the bank and sent him a cashier’s check for $3,000. I told him, “If in two weeks we’re down $3,000, then I’ll send you another check. Just hold onto the check; it’s as good as cash.”

Normally, you wouldn’t make up the difference until the end of the year—is that right?

That’s right, but this guy was so nervous that I always wanted him to have the $70,000. About a month later, the account was back over $70,000. I have to admit that I did inquire whether he cashed the check, and it turned out that he had. A year or two later, when I was reducing my clients, he was the first to go, because his actions were indicative of a lack of trust.

Why do you believe Fidelity went from a policy of virtually encouraging switching in its sector funds to imposing onerous restrictions that made active switching all but impossible?

I suppose they thought that the profits being made by some market timers were coming out of shareholders’ pockets. I would submit, however, that the profits were coming mostly from unsuccessful market timers.

An example of Fidelity’s attitude toward market timing was their response to a
Wall Street Journal
article in early 1989 that mentioned my track record and that I traded the Fidelity sector funds. Two days after the article appeared, I called to place an order and was told, “I’m sorry, Mr. Blake, but the hourly investment limit in energy service has been lowered to $100,000.” (The previous limit had been 1 percent of the fund’s assets, or about $500,000.) I suspect they checked and found that energy service was a sector that I traded exclusively for a half-dozen clients and that I had been doing very well.

Why had you used this fund more actively?

Because energy service contained the most reliable pattern that I had ever found. A year or so after Fidelity introduced hourly pricing of sector funds in 1986, I discovered that energy service had an extraordinarily strong tendency to trade near its daily low at the beginning of the day. When I first analyzed the hourly data, I found there was a 90 to 95 percent probability of realizing a gain by simply buying this fund at ten, eleven, and twelve o’clock, for different clients and then selling at the close. Remarkably, this extremely high probability continued to hold up in the year or two that I traded this fund.

It’s amazing that such a simple pattern could exist with such consistency. Does this pattern still exist today?

It might, but it’s of little value. In November 1989, Fidelity began charging a fee of 0.75 percent on trades held less than thirty days.

I assume that the management of your funds takes only a small part of your day.

A tiny part. I spend most of my day researching new methods.

Do you find new strategies that are better than the ones you’re using and shift your approach accordingly?

All the time.

Presumably, since you can’t use everything at the same time, you must have a lot of viable methods on the shelf that you’re not even using.

I do.

Do you follow your trading signals absolutely? Or do you ever stray from a straight mechanical approach?

For me, it’s important to be loyal to my system. When I’m not, which happens occasionally, then, win or lose, I’ve made a mistake. I usually remember these for years.

It’s not disloyal, however, to question a trade. Sometimes, based on prior experience, a trade just doesn’t look right. If I can complete the necessary research before the close and the results so dictate, then I make a permanent amendment to the rules.

How important is the performance of the funds you’re using to your overall performance?

It’s not nearly as important as you would think. The difference between trading a fund that rises 20 percent in a year versus a fund that loses 20 percent in a year is surprisingly small. For example, if a fund has an average daily volatility of 1 percent, an annual return of 20 percent would imply that approximately 54 percent of the days were up and 46 percent were down, and vice versa for a fund that loses 20 percent. [Assuming 250 trading days per year and an average 1 percent price change per day, a net 20 percent return would imply 135 up days and 115 down days, and 135 is 54 percent of 250.] For my strategies, the difference between trading a fund that’s up 54 percent of the time and one that’s up 46 percent of the time is not that significant.

Any trades that are particularly memorable?

When I was just starting out, there was one day when I didn’t get the closing price over the phone. I knew it had been a pretty good day, but I didn’t know to what extent. I woke up in the middle of the night and remembered that I hadn’t checked the closing price. I called and found that it had been a huge up day—twice what I had expected. I think I made a few thousand dollars. You have to remember this was back when I had just started. I was so excited that I couldn’t sleep. I was like a kid at Christmas. I’ll always remember that feeling.

Are there any other trades that stand out for one reason or another?

On July 7, 1986, the stock market fell 62 points (a record then, I think). I knew that morning that I would be out of my positions at the close. However, since this was before hourly switching was available, there was nothing I could do in the interim. That afternoon I had a windsurfing lesson. I thought that I would be able to get back well before four o’clock to place a call to liquidate my positions. Unfortunately, I hadn’t mastered the sport well enough and got blown to the other side of the lake. I knew time was running out, and I paddled back as hard as I could to try to beat the close. I didn’t make it, and it cost me.

Any other trades come to mind?

In August 1987 I took a position in the gold sector fund. The day after I entered the trade, the fund dropped, giving me a red light, but I stayed in.

Why did you stay in?

I honestly don’t remember. Anyway, the next day, the gold stocks were down big, while a bright green light in technology was staring me in the face. I remember that I found it extremely difficult to exit all my clients from the gold sector at a big loss—a loss that I knew I shouldn’t have taken in the first place—and immediately place them at risk again in the technology fund, which was already up sharply. I think the thing that made it so difficult was that I had violated my rule. As it turned out, the subsequent gain in technology more than made up for the loss in gold.

So in the end you did follow your system.

Yes, but I almost didn’t. The lesson for me was that if you break a discipline once, the next transgression becomes much easier. Breaking a diet provides an appropriate analogy—once you do it, it becomes much easier to make further exceptions.

Have the markets changed in the past decade?

In a micro sense—yes; in a macro sense—no. Opportunities change, strategies change, but people and psychology do not change. If trend-following systems don’t work as well, something else will. There’s always money being lost, so someone out there has to win.

What do you believe are the major myths about markets?

A prevailing myth on Wall Street is that no one can consistently beat the market year in, year out, with steady returns of 20 or 30 percent a year. On the other hand, the sales side would have you believe that it can be done by anyone. Neither is really the truth.

Why do traders lose?

First of all, most traders don’t have a winning strategy. Second, even among those traders who do, many don’t follow their strategy. Trading puts pressure on weaker human traits and seems to seek out each individual’s Achilles’ heel.

What makes a good trader?

A critical ingredient is a maverick mind. It’s also important to have a blend between an artistic side and a scientific side. You need the artistic side to imagine, discover, and create trading strategies. You need the scientific side to translate those ideas into firm trading rules and to execute those rules.

Can people be successful using a purchased system?

I believe that systems tend to be more useful or successful for the originator than for someone else. It’s important that an approach be personalized; otherwise, you won’t have the confidence to follow it. It’s unlikely that someone else’s approach will be consistent with your own personality. It’s also possible that individuals who become successful traders are not the type to use someone else’s approach and that successful traders don’t sell their systems.

How would you respond to Burton Malkiel [the author of
A Random Walk Down Wall Street
]?

Well, I’m more in agreement than in disagreement with him. The markets
are
mostly random, and most people
can’t
beat or “time” the market. One hundred money managers each believe that they can consistently outperform the market. My feeling is that the number is a lot closer to zero than one hundred. Trading is probably more of an art than most people want to believe. I guess I’d also be tempted to show him my numbers.

What advice would you give to a novice trader?

There are five basic steps to becoming a successful trader. First, focus on trading vehicles, strategies, and time horizons that suit your personality. Second, identify nonrandom price behavior, while recognizing that markets are random most of the time. Third, absolutely convince yourself that what you have found is statistically valid. Fourth, set up trading rules. Fifth, follow the rules. In a nutshell, it all comes down to: Do your own thing (independence); and do the right thing (discipline).

At the core, the quality of open-mindedness is responsible for Blake’s success and, for that matter, his entire career. For many years, Blake sincerely believed that the markets were random. When confronted with contradictory evidence, he didn’t dig in his heels and argue his position—the reflexive response most people would have in such a situation. Instead, he researched the question, and when the evidence suggested that his prior views had been wrong, he changed his mind. The ability to change one’s mind is probably a key characteristic of the successful trader. Dogmatic and rigid personalities rarely, if ever, succeed in the markets.

Another attribute that has allowed Blake to excel is his adaptability. The markets are a dynamic process, and sustained trading success requires the ability to modify and even change strategies as markets evolve. Blake began by trading municipal bond funds. However, when the reliability and profitability of his approach in that sector started to diminish, he didn’t just blindly keep repeating the same strategy that had worked for him in the past. Instead, he used the changing market conditions as a spur to start an intensive research project, which eventually yielded an entirely new and even more effective approach. When hourly switching became available in the Fidelity sector funds, he altered his methods accordingly. Then, when Fidelity made it virtually impossible to use its funds for switching strategies (by imposing prohibitively high fees), Blake switched to different fund families and different strategies. Blake’s ability to adapt has allowed him to maintain a remarkable consistency of performance, despite profound changes in his trading environment.