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Webinar: Jack Schwager of Market Wizards
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Webinar: Jack Schwager of Market Wizards

  #121 (permalink)
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Chapter 1: Colm O'Shea

The primary theme I got from this chapter is that risk management is essential. O'Shea's trading strategies themselves are designed to minimize risk. For example, instead of being too heavily long in a bull bubble market which can deflate rather quickly, he uses long call options to minimize downside risk, while giving the option of the upside potential. His primary tenet seem to be: reduce downside risk, maximize upside potential. His impressive risk-adjusted multi-year track record bears this out, with a -3.7% worst month, and a -10.2% max drawdown in seven years of records publicly available. Regarding risk, O'Shea comments that "you have to embrace uncertainty and risk."

One of the primary strengths O'Shea seems to have is that he has no problem cutting a loss. His approach is very simple: his exit point (stop) is determined based on where he will be wrong, not based on his pain threshold. Determine the exit point, then determine the position size depending on the risk desired on the trade. If the stop is not determined this way, the temptation is too great to set the loss to a pain threshold, and once hit, immediately re-enter because one thinks he is still not wrong. This can lead to many losses. He lauds George Soros' ability to cut a loss. "[Soros] has no emotional attachment to an idea. When a trade is wrong, he will just cut it, move on, and do something else."

O'Shea says to "wait for and recognize the right time" to implement an idea, and as an example of this advocates "selling the market on the way down, not on the way up." "Having a beautiful idea doesn't get you vary far if you don't do it the right way." This emphasizes the importance of implementation of the idea. He comments on his need to improve his ability to participate when fundamentals don't back up the price action. I can certainly relate to this. O'Shea says, "If it trades like a bull market, it's a bull market," regardless of what the fundamentals are. He does not attempt to top or bottom pick; "great trades don't require predictions," says O'Shea, citing Soros' famous GBP short as an example.

"[Trading] can't be taught, but it can be learned," says O'Shea. Good traits and habits can be picked up from observing good traders, but one trader's style will likely not be suited for someone he would try to teach. If one is willing to put forth the effort, then one can learn what his style should be.

O'Shea's feelings about rules coincide perfectly with my own. "I use risk guidelines, but I don't believe in rules in that way" (in response to the question "Are there trading rules you adhere to?"). A trader may stick to rules and be failing because the rules used to work, but no longer work. Why? "The world has moved on without them."

O'Shea comments on traits of successful traders. Perseverance and emotional resilience are mentioned first, because we take beatings in trading. "You can't trade because you think it is a way to make a lot of money. That won't cut it." Just like the great golfer Jack Nicklaus continues to play golf now because he loves it (and not for the money), great traders keep going after the money is comfortable. "Trading is simply what they do."

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  #122 (permalink)
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josh View Post
I just finished the first chapter. The presentation is great, with the flow being very conversational, not just like one person interviewing another. As Jack is market-savvy, it's an actual conversation between two traders. As the Olympics opening ceremony is at the Parade of Nations and they are only up to Fiji, I thought I would take a break and post a brief synopsis of what I underlined and am trying to internalize from the first chapter. What better way to learn than by summarizing and presenting the material?

With Mike's and Jack's blessing, I would like to do this for all chapters as I finish them, and will post them in this thread (may be a bit challenging during the week but will catch up on weekends if I get behind).

The summaries are not intended to be extensive, and Jack actually presents a much better summary at the end of the interview for each chapter, but this is meant to be a bullet-point, Cliff's notes version. Even after just reading the first chapter, I would highly recommend that everyone go and buy this book. The highlights here are what stood out to me personally, and what I underlined is what I need; you might pick out many different nuggets, thus the need to read it for yourself to find out what YOU need!

@josh, You stole my idea! Just kidding. I started reading "Markets In Profile" this week and thought about creating a thread to discuss the context with those who have already read it and those who maybe interested in reading it now. Sort of like a book club, but acutely read and discuss the book, not like my ex-wife's book club where no one read the book and it was just a reason to get together once a month and drink and discuss their lives.

I am in chapter 3 and the book can be quite intense, so it would be nice to get others perspective. Maybe I will start the thread to see if it creates any interest and if not so what.

Cheers,
Ryan


BTW, I have the book in pdf format for anyone who does not have it and wanting to read it.

Edit: I reference the wrong book, I meant "Mind Over Markets"


Last edited by itrade2win; July 28th, 2012 at 10:51 AM. Reason: See edit: No coffee yet this morning
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  #123 (permalink)
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Chapter 2: Ray Dalio


I had mixed emotions as I read this chapter. Obviously Mr. Dalio is a very successful trader but a strange vibe comes across as I read his conversation with Jack. Perhaps it's his self-assumed title of "Mentor" of his fund, Bridgewater. Or perhaps it's his, in his own words, "problem communicating my way of seeing to others." Or, maybe it's the description of the culture at Bridgewater, where all employees must read Dalio's 111-page philosophical work titled Principles and where openness is so encouraged that all meetings are taped and made public to employees. It's hard to tell from just reading a short interview, but it seems like a trip to Anal Retentive Central. At the end of the interview, he tells Jack as the time expires "Okay, we're done." Sounds like a real nice guy. With that being said, I know that I also rub some people the wrong way so I'm more than willing to forgive and accept those who have a bit of a Brillo pad side to them at times.

The openness can be viewed as quite positive, and at least there are principles laid out of what's expected. And Dalio is obviously very good at what he does. In fact, he manages $50 billion. He trades in over a hundred markets at a time, his turnaround time to flip a position is usually 12 to 18 months, he is solely fundamentally based, and he is 99% systematic (1% discretionary). He uses not only historical analysis, but he uses fundamental situations from the early 1900s and earlier. Yes, post-WWII data is not sufficient, as his long term cycle for an economy is over 120 years long. That's right. So, in most every way he takes exactly the opposite approach that I do (as a less than $50 billion , single market, single day, technically based, 99% discretionary, screw the historical garbage type). So, what can I learn from someone like Dalio?

Dalio says that "the markets teach you that you have to be an independent thinker," and that given this, "there is a reasonable chance you are going to be wrong." He takes an interesting view on correlation: he sees the correlation as the result, and not the driver. Trading markets that are uncorrelated is bound to fail, according to Dalio, because one is only trading the result, not the driving cause of the correlation (or lack of it). This makes a lot of sense. So, his risk control is based on the premise that he trades so many uncorrelated markets that he can never lose too much.

Dalio "learned not to fight the Fed," and says that learning experiences manifest themselves as visceral feelings, as opposed to light bulb moments; "being in the market and actually experiencing it" is the key, he says. I agree with this. Reading about a market crash, for example, and actually being in the market during it are quite different experiences.

Perhaps the foremost lesson to be learned is that of learning from mistakes. Dalio places a lot of emphasis on this, and says that the only bad mistake is one that is not used to learn and grow.

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  #124 (permalink)
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@josh, I'd like to hear more on your thoughts on trading correlated/uncorrelated markets. Here are a few threads that might be more appropriate:

https://futures.io/psychology-money-management/3411-multiple-non-correlating-strategies-portfolio.html

https://futures.io/traders-hideout/9174-trading-correlated-markets.html

https://futures.io/index-futures-trading/13830-correlation-between-index-futures.html

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  #125 (permalink)
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josh, I'd like to hear more on your thoughts on trading correlated/uncorrelated markets. Here are a few threads that might be more appropriate:

Mike, I think that it makes sense for the way that someone like Ray Dalio invests. He can't just get out of a position; it takes him 12 to 18 months on average if he wants to flip from long to short, for example. So, he must be diversified in his positions. It just takes too long to get out of a potential catastrophic situation, so he must limit risk by investing in a diversified way; I'll call it investing, because it's more what I consider to be investing than trading, though either term applies I suppose.

The key for him is that he is fundamentally based, and fundamentals simply do not change quite so fast. You can't day trade the same way that he trades. In other words, I can't be bullish S&P in the morning because of fundamentals, and then bearish in the afternoon. It just doesn't change like that. So, the way that he trades uncorrelated markets, based not on divergences or convergences in price, but on the underlying drivers of the markets, is only suited for a much longer term horizon than what someone like me (and probably 95% of others on this site) uses.

So, for a day trader to trade based on the correlation of markets, it essentially has to be technically based, most likely using the relationship of the price differential between markets. This being the case, given that this changes from day to day (one day the nasdaq is a laggard because of bad AAPL earnings, the next day it's a leader because of something else), it's much simpler for me to risk a certain amount on a single instrument (or a combination of instruments though I don't do that), and trade each separately.

So given the small time horizons on my trades, it does not make any sense to increase leverage being used by opening more than one position to hedge risk; it makes much more sense to simply open a smaller number of positions (usually one for me). If I am long equities and I want to reduce risk, I can either go short bonds, or I can simply have a smaller ES position. The latter is quite unsophisticated and boring, but for a day trader like me I think it's the best solution. For someone who has several days or weeks in a trade, the former is probably more suited.

Though the point was that Dalio invests in uncorrelated markets to reduce his risk exposure, some of the substance in the above threads you referenced was different, and that was using one market to "predict" another market. So if I see NQ begin to move up, and then ES moves up, NQ is "leading." To me, I still see no point in this. If I see NQ turning up and that makes me bullish, then why don't I just buy NQ? Who cares that ES turned up later? Who's to say that ES won't turn a little, and then keep going down, making NQ the true laggard while ES is the real 'leader' still going down? This is too much in the realm of arbitrage for me, and I don't play that game. Some people are obviously effective (or they say that are) with this type of thing; but even then I question whether it's any superior to simply tuning in to a product and trading that one.

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  #126 (permalink)
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Chapter 3: Larry Benedict

After the last post on correlation of markets, and after Chapter 2, it's safe to say that the timing of the information in Chapter 3 concerning Larry Benedict is quite appropriate.

Larry Benedict trades primarily S&P futures, but also trades other markets such as the HSI and Nikkei, Euro, oil, t-notes, and others. He is taking 100 to 200 trades a day, and manages about $1 billion (as he was down on the day of the interview about 1 percent, which he stated was $10 million). He is discretionary in his trades, and uses various correlations between markets to formulate his trade ideas. He also has a huge temper, and has been known to kill countless phones in his career!

Perhaps the most outstanding thing about Larry is that he began trading with no prior exposure to it at all, was fired from multiple trading jobs, lost tens of thousands of dollars time and time again, yet he kept persisting. "I never gave up," says "Benny," as he is known by some. "All the mistakes I was making ... were providing experience, which was critical. The lessons I learned from those early failures helped me become successful."

He trades on feel alone, and he says that "I could never teach my kids or friends what I do because it is so innate. I am constantly trading. It's not like there is one type of trade or even a few specific trades ... I don't constantly trade the same way ... I am constantly adapting." He does not use charts, and only reads the tape. He gave several examples of the types of trade sequences he will go through, like buying S&P futures, and then perhaps buying bonds; I won't go into all the examples here but the point is simply that trades correlations between markets. "I try to look at anything the market thinks is important at the moment," admitting that he's not very good at a long term market view, which could be as short as a week to a month. "I let the market dictate to me how I should be trading, not my macro views of what I think the market will do."

Benedict's risk aversion is evident in his maximum drawdown since 2004 of less than 5%, with an annualized net compounded return of 11.5%, and he has been profitable every year since 1990 except for a less than 1% loss in 2011. His "Gain to Pain" (similar to profit factor) ratio is an amazing 3.4 -- in short it means that he has made 3.4X the money he has lost. One way he is able to do so well is that when he experiences a 2.5% drawdown, he cuts size in half until he is profitable by some margin again. Someone says of Benedict, "the biggest principle Larry pushes is that you are not a trader; you are a risk manager." Larry's advice on risk: "Never stay in a losing trade because you think it will come back. Minimize the loss. Accept the loss and walk away from it."

Benedict says that "one big mistake is averaging losing trades. Trading is very hard, but it is also easy if you maintain discipline. People blow up because they lose their discipline." Regarding losing traders, Benedict says that one trait they all shared is that "they had a gambler's mentality ... they were always looking for that one trade that would make it all back. I learned early on that you can't do that."

A couple of Benedict's mistakes can be learned from as well. First, he made money shorting 9/11, but soon thereafter felt guilty about it, and "patriotically" was long thereafter. He lost money in the process, and this is a great case for demonstrating how one's psychological issues (guilt) can cause one to engage in knowingly self-destructive behavior. Second, he lost money in 2011 because he was pushing for a particular profit target for the year. He forced and tried to profit in places the market was not willing to give profit, and thus lost money from trying to project his own personal profit desires onto the market.

All in all, I thoroughly enjoyed this chapter. It's a great story of an obviously nice guy (though he is clearly animated and has a tempter problem) who overcame numerous obstacles when it would have been easier simply to quit. He touts the title of "Risk Manager" and I made this my own futures.io (formerly BMT) custom user title a while back, and I'm happy that someone who trades in a similar fashion as I do (short term, discretionary) is as focused on managing risk as I am trying to be. It also shed some light on trading correlations. I am not there yet in terms of being able to do this, nor am I particularly interested in doing so, but it was a very apropos read after the last post I made on correlated markets.

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  #127 (permalink)
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Regarding the post above on Ray Dalio, attached is the referenced "Principles" document that he uses at Bridgewater. I have not read it yet but I thought it might be good to have it attached here for the record.

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Webinar: Jack Schwager of Market Wizards-bridgewater-associates-ray-dalio-principles.pdf  
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  #128 (permalink)
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Chapter 4: Scott Ramsey

I thought about Mike when I read the opening paragraph of this most enjoyable chapter, because Scott Ramsey does business from St. Croix. Imagine that, a multi-billion dollar trader in an inconspicuous shopping center accessed through the outside from a hardware store front!

Ramsey trades futures and forex, and in eleven years has never had a losing year, with a 17.2% average annual compounded net return and max drawdown of 11%.

As with all the traders interviewed so far, he blew an account or two, making good money on some trades but then blowing it all at once. Losing money got him hooked on trading, and he insisted that he was to be one of the ten-percenters who made it successfully. In fact, he had a GPA of 3.9 and was only a few credits shy of completing college when he quit and left to pursue trading full time.

He was a broker for a period of time, as well as a trader in the pits. Being a broker allowed him to see certain things that retail traders do that are mistakes, like taking small profits and letting losses run, and basing trading on emotional decisions. For his time in the pit, he says that "it was a big disadvantage," compared with the ability to be in front of screens and see other markets and the bigger picture, rather than just some guys coming in to buy and sell.

Ramsey began as a technical-only trader. Then, he became interested in the fundamentals and the psychology of the market. He does not seem to care about fundamentals in the sense an investor would; rather, he tries to imagine the mindset and position of traders who are currently short or long, and he lets this be his fundamental premise for a trade, and then he looks for a technical pattern to confirm his idea. Technically, Ramsey uses the RSI for divergences, and the 200 day SMA and Fibonacci retracements.

He has a very logical but surprisingly uncommon view of correlated markets. If one market has been leading (over the course of days or weeks, for example) a strong move up, and another market which is normally correlated is not moving up, some people will respond by buying the "lagging" market. Ramsey generally views this, however, as a sign that the laggard is in fact not lagging at all, but is simply weak. He will look to short this market, while others are buying it. He gave the example of gold and platinum. Gold had surged to new highs, while platinum had only retested its highs. Shortly after they both fell hard. Gold then rebounded strongly, but platinum only recovered by about half as much. This was the idea; but, he still waited for platinum to fall below a key technical level, and he shorted there, and then added as it fell. This seems to be the type of trade he looks to take. He will buy the strongest market in a sector, and sell the weakest.

Interesting is that Ramsey was an engineering student, which is often a very black and white world, yet he developed a discretionary approach, where many shades of gray exist. Asked why, he said that "[discretionary trading] just fit my personality. I enjoyed the observation part of it. I am the guy who sits in front of the screen every trading day of the year ... the wheels of your subconscious are spinning ... your mind is working out these patterns for you. Trading gets so ingrained in your psyche that it becomes second nature like driving a car." Also, Ramsey times his travel around market holidays, and follows the markets while on vacation. He even gets up several times during the night to check the markets. Besides this last part, I can totally relate--I also am often glued to the market. I feel like I do not get the whole picture by looking at a chart after it happened; when I'm in it, I have a much better feel for what's going on.

Ramsey is a rigorous risk manager. He risks only 10 basis points per trade, and will usually exit by the end of the day if it does not start working for him. He will get in and out 9 times if it means getting it right the 10th time. Still, when he does have a drawdown, he reduces his size, and he always has a stop in the market. Sometimes still, his intuition tells him to exit a trade and he winds up taking a full loss because he did not listen to his intuition. "My misplaced hope and my desire to still be right sometimes cause my losses to be greater than they need to be. Hope is the worst four-letter word for a trader." Regarding intuition, he says that it is a "subconscious skill you develop over time."

Perhaps the most important benefit of proper risk management is what Ramsey beautifully sums up this way: "Rigorous risk control is not only important in keeping losses small, but it also impacts profit potential. You have to put yourself in the position to be able to take advantage of opportunities. The only way you can do that is with a clear mind. If you have trades that are not working, and your mental energy is going toward damage control, you can't think clearly about opportunities in the market." In other words, while you're trying to make your short trade work out and you are underwater, you could have gotten flat, gotten a clear head, realized the market really wants to go up, and just bought, and you'd be not only not underwater, but actually well into profit.

As far as mistakes to learn from, one that Ramsey made was that he pulled money out of his account and never increased his size, and stayed a 1 to 2 lot trader for too long. He also says that looking to outside sources for guidance is the biggest mistake people make. Ramsey says that "it's not about being right; it's about making money." Taking losses is part of the process, and one needs to make sure that losses are smaller than wins. "Every trading decision you make is subject to some randomness. It doesn't matter whether you win or lose on any individual trade, as long as you get the process correct."

"Discipline" was the answer to the question of what personal characteristics were instrumental to his becoming successful. Also, he says "you need incredible dedication ... treat trading like a business. Keep a journal."

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The Ray Dalio "Principles" are not an easy read. I think he is a very deep thinker. Much truth in there.
Thank you very much.

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