In this small world, one of the more unlikely people to have asked me, “How do you go about unearthing details?” was Mikhail Gorbachev. The former president had been told in Russian that my career involved profiling traders who make the big money. When an introduction was made he asked me in Russian through a translator, “What is it like to write about these traders?” Realizing his time was limited, my response was short: “Very interesting” I said. He waited for the translation and asked back: “It must be difficult to get behind the scenes; how do you do it?” With a smile, “Oh, I am very good at digging” He laughed. No translation was needed. He understood my English perfectly. Many ask Gorbachev’s question:
“How did you figure this all out?”
“How do I know I can do this?”
And followed by:
“How do I know you can help me to do this?”
Great questions, and what follows is an explanation from many different angles and vantages, along with many resources. Let me start with a personal story. My education comes directly from some of the great trend traders of the last five decades. No hyperbole there, just a fact. However, it did not start that way. It started while finishing graduate school in London circa 1994. A book by motivational speaker Anthony Robbins convinced me that getting close to great traders was a path to pursue. Sounded easy, but how was I going to do it? One part of Robbins’s book really struck me. “Unlimited Power” featured a story about a famous film director:
“Consider Steven Spielberg. At the age of thirty-six, he had become the most successful filmmaker in history. He’s already responsible for four of the ten top-grossing films of all time, including E.T., The Extra-Terrestrial, the highest-grossing film ever. How did he reach that point at such a young age? It’s a remarkable story. From the age of twelve or thirteen, Spielberg knew he wanted to be a movie director. His life changed when he took a tour of Universal Studios one afternoon when he was seventeen years old. The tour didn’t quite make it to the sound stages, where all the action was, so Spielberg, knowing his outcome, took action. He snuck off by himself to watch the filming of a real movie. He ended up meeting the head of Universal’s editorial department, who talked with him for an hour and expressed an interest in Spielberg’s films. For most people that’s where the story would have ended. But Spielberg wasn’t like most people. He had personal power. He knew what he wanted. He learned from his first visit, so he changed his approach. The next day, he put on a suit, brought along his father’s briefcase, loaded with only a sandwich and two candy bars, and returned to the lot as if he belonged there. He strode purposefully past the gate guard that day. He found an abandoned trailer and, using some plastic letters, put Steven Spielberg, Director, on the door. Then he went on to spend his summer meeting directors, writers, and editors, lingering at the edges of the world he craved, learning from every conversation, observing and developing more and more sensory acuity about what worked in moviemaking. Finally, at age twenty, after becoming a regular on the lot, Steven showed Universal a modest film he had put together, and he was offered a seven-year contract to direct a TV series. He’d made his dream come true. Did Spielberg follow the Ultimate Success Formula? He sure did. He had the specialized knowledge to know what he wanted. He took action. He had the sensory acuity to know what results he was getting, whether his actions were moving him closer to or farther from his goal. And he had the flexibility to change his behavior to get what he wanted. Virtually every successful person I know of does the same thing. Those who succeed are committed to changing and being flexible until they do create the life that they desire.”
Spielberg’s story was all the motivation needed. Example: I once flew to Berlin, Germany, spending thousands of dollars not in my bank account, just for the chance to possibly meet and learn from a few traders at a conference–a conference where no one knew me. My credentials were a nametag and moxy, but that calculated gamble worked out enough to find myself spending quality time with a former chairman of the Chicago Mercantile Exchange. Those conferences allowed face-to-face access to legendary traders–enough personal contact that helped me realize the mortality of the markets biggest players.
Once my trend following educational business started, a barrage of interesting people began to appear. Two who heavily influenced our business in early 2001 were Ed Seykota and Charles Faulkner. While we had successfully taught many for years, while Robbins’ influence was always front and center, Seykota and Faulkner brought ‘Neuro-Linguistic Programming’ even more forcefully into my teaching methods:
“Many commentators refer to the field of Neuro-Linguistic Programming as the Science of Success. The reason for this epithet is that people engaged in Neuro-Linguistic Programming concern themselves with modeling what it is about the ‘leaders’ in every field of human endeavor that sets those leaders apart from everyone else. Why is it that one actor can walk on a stage, stand absolutely still, and yet have an audience transfixed, when another actor can jump around and barely command our attention? What is it about some sports competitors that makes it so impossible for an adversary to beat them? How is it that in a war some people appear to have a sixth sense that enables them to avoid danger? How is it that some detectives can intuit when someone is telling lies? How is it that children respect one teacher and yet misbehave for another? Now, via a range of NLP techniques, everyone has access to a simple set of methodologies by which to derive the answers they need to improve performance in any area of life–both personal and professional.”
However, once you realize you can learn, the right attitude must follow.
The Right Attitude
Recently the TV hit me with an ad playing in the background. All I heard was:
“If you are like most your retirement dreams have seen better days.”
If I had a gun at the moment, I would have shot the screen. Not because I am worried about retirement, but because of the overly pampered culture that is being cultivated by the media. However, I guess that is not surprising when you consider this excerpt from The New York Times:
“…today’s children do grow up with soccer leagues and spelling bees where everyone gets a prize. On some playgrounds dodge ball is deemed too traumatic to the dodging-impaired. Some parents consider musical chairs dangerously exclusionary. Children are constantly feted for accomplishments that used to be routine. They may not all be honored at a fourth-grade graduation ceremony – the event in the movie that inspires Mr. Incredible’s complaint about mediocrity – but they all hear the mantra recited by Dash’s sister in response to his ambitions. “Everyone’s special, Dash,” she says. “Which is another way of saying no one is,” he replies. The villain, Syndrome, makes the same point when he envisions empowering the masses with his inventions. “Everybody will be super, which means no one will be,” he says, gleeful that he will finally have revenge on Mr. Incredible for snubbing him during his childhood.”
Everyone wants it easy, but as Allan Sloan of Newsweek once penned, it doesn’t work that way:
“The message here: unpleasant as it is, let’s admit that there’s no such thing as a free lunch. It’s an up-and-down world; be prepared to take the occasional lump. In the markets, as in life, there’s no such thing as return without risk.”
Banning dodge ball and singing Kumbaya is not a path to success. Group hugs will not generate excellence. The path to greatness starts by calling it like it is.
Unfortunately, the average investor to his or her detriment is stubbornly fixated on the security of a “know nothing” existence allowing others (mostly media and brokers) to define financial success as: “Take what the average is and be happy you poor sap!” Finding out how great traders actually do it is ignored.
No doubt for average investors great trend traders have been shrouded in secrecy. This mystery has been propagated because typical portrayals label super earners as genetic freaks, magicians, charlatans or pedigreed investment bankers. The truth? They are almost all self-starter entrepreneurs who through concentration, drive, and fierce independent streaks, have cultivated their knowledge of how to mint money and achieve tremendous success.
That should be good news. For today, more so than ever, with so much uncertainty, people are scared. They don’t know what steps to take with their money. Many just want to hide it under a mattress. The world appears more dangerous than it’s ever been and paralysis seems like a good, or only option to most. And while it might appear harder than ever to make money investing and trading, that’s not the case. The world is actually the same as it always has been, unpredictable — which could be good or bad depending on your vantage.
Sadly, millions still vicariously follow Warren Buffett for ideas on when to enter and exit the market, or for what stocks to buy. Others follow CNBC for stock tips and breaking news looking for ideas. Some treat market gurus as prophets, or read nonstop columns and blogs trying to devise a plan for their money. When the TV people say its time to buy Exxon or dump Apple, many follow that random advice blindly.
This doesn’t work if you want the chance to make money. If you’re worried about an uncertain future (something every investor should be) the ‘secret’ is not to focus on which stocks to buy or sell, but instead to focus on ‘risk.’ Learning how to manage, control and use risk is the most important technique any trader can know.
However, it is hard. People are bombarded daily with noise. For example, I pose the questions: Why do people listen to Jim Cramer on a regular basis? Why should anyone pay attention to him? Are they thinking, ‘Maybe Cramer will help me win the millions in the stock market?’ Or, ‘Maybe he’s right in recommending Google and I can make a killing?’ Or, are people just too sheep-like and gullible to see through the gurus?
The Cramer audience doesn’t understand that following his advice won’t make them a winner. In fact, the odds of winning and losing in the long run by following any talking head’s advice are astronomically bad. Think of it this way: Cramer comes on and says buy ‘XYZ’. Isn’t he saying that to the whole world? Not much of an exclusive. Worse yet, if you allow yourself to buy on Cramer’s tips, does he call you when its time to sell? Or are you just assuming when Cramer says ‘buy’ that the stock will go up forever and you’ll never ‘sell’? And even if you could answer these questions Cramer leaves the most important aspect of making money out. He never tells you how to use, manage, and control risk to your advantage.
‘Risk’ is behind the greatest hedge fund fortunes, the biggest mansions in Palm Beach, Fla. and Greenwich, Conn. Those who use risk management to make millions (and in many cases billions) didn’t get that way writing down television guru’s stock picks every night. They made their money by asking questions like: ‘What can I win?’ ‘What can I lose?’ ‘What are the probabilities of each outcome?’ They don’t waste time with ‘tips’ or the supposed ‘right time to buy’.
Have no clear understanding of risk or knowledge of risk management? You will lose over the long run. Why? We all have limited money. If we don’t know how to manage our losses, we won’t have any money to play the game to make more. Consider wisdom from a famed trader about ‘risk’:
“Risk is the possibility of loss. That is, if we own some stock, and there is a possibility of a price decline, we are at risk. The stock is not the risk, nor is the loss the risk. The possibility of loss is the risk. As long as we own the stock, we are at risk. The only way to control the risk is to buy or sell stock. In the matter of owning stocks, and aiming for profit, risk is fundamentally unavoidable and the best we can do is to manage the risk. To manage is to direct and control. Risk management is to direct and control the possibility of loss. The activities of a risk manager are to measure risk and to increase and decrease risk by buying and selling stock.”
Maybe you assume you get ‘risk’ already, but my 14+ years of experience researching and writing about top traders, says most people don’t have a clue. Consider how important risk management is to some of the top market wizards, and the top traders who make millions (if not billions):
“Throughout my financial career, I have continually witnessed examples of other people that I have known being ruined by a failure to respect risk. If you don’t take a hard look at risk, it will take you.” –Larry Hite
“Frankly, I don’t see markets; I see risks, rewards, and money.” –Larry Hite
“If I have positions going against me, I get right out; if they are going for me, I keep them… Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in.” –Paul Tudor Jones
“Don’t focus on making money; focus on protecting what you have.” –Paul Tudor Jones
“If you have an approach that makes money, then money management can make the difference between success and failure…I try to be conservative in my risk management. I want to make sure I’ll be around to play tomorrow. Risk control is essential.” –Monroe Trout
I have sat down with many great traders. In their offices, in their homes, over dinner, on multiple continents — like a broken record they all lead with risk as their topic number one when it comes to making money.
Risk management can go by different names: asset allocation, position sizing, portfolio heat, portfolio sizing, size management, money management and bet size selection. ‘Bet’ is probably not a word most people associate with managing risk, but every ‘bet’ (read: trade or investment) we take involves the decision to risk something of value for an uncertain prospect of gain in the future. Placing winning bets over the long run requires innumerable decisions in the face of innumerable trade-offs — but it can be done.
The great traders have learned how to win in volatile, uncertain, complex and ambiguous environments (the environments the market is in most of the time) because they understand betting (read: risk management). Play poker in Vegas and you have a fighting chance. Play roulette and over time you will continually lose. Wall Street’s top earners trade like poker players by always knowing the odds and their ‘edge’ (a simple example of managing risk). They bet the ranch when the odds are in their favor and they walk away when the odds are bad.
Bottom line, no one gave me permission to educate students on these subjects. I seized the education mantle. There was a vacuum, and seizing it gave credibility. It opened doors. Why does a London based hedge fund with billions under management make my first book mandatory reading, but refuse all on the record interviews with me? Why did a hedge fund not mentioned in my first book buy 3000 copies? Why did another not mentioned buy 1000 copies? Why did so many top traders speak with me to begin with? They know I do the work. They know I write the truth. However, finding the truth, digging it up and putting into digestible form takes time, energy and many Aha! moments — or said another way a jolt of electricity to the brain.
One of those awakenings for me occurred upon learning about the existence of a documentary from the late 1980s. It profiled the now legendary trader, Paul Tudor Jones. Jones is now worth $3.3 billion–so evidence of his early trading days was welcomed. My intuition said that this out-of-circulation documentary would deliver the unexpected, but it was extremely tough to locate. Amazon, eBay, and most other obvious venues were dead ends. When I finally found it through ‘channels’, my gut was dead on. The March 1987 documentary Trader was made when Jones was 32 years old with just 22 employees in his firm. Today, his firm has 300 employees and more than $10 billion under management. The documentary was all raw passion. Jones and Peter Borish, his second in command at the time, were in the middle of a game with one simple goal: Get very rich. Borish knew there were no shortcuts: “I am graded instantly through the harshest teacher in the world–the market. There is no curve. I can’t say, ‘Boy, I was out late last night and everybody else in the class was at a pep rally for the football game and I only got a 70, but that was the highest in the class, so I still got an A.’ It doesn’t work that way in the market.” Jones was living that nonexistent grade curve. In one scene at his Chesapeake Bay home, you could hear it in his voice as he described playing at the highest level: “Whether you are making 100% rate of return on $10,000 or $100,000,000, it doesn’t make any difference. Right? If you complete 78 percent of your passes, it would be nice to be in the NFL. [But] if you are in college, high school, or elementary school, I am sure the thrill [of winning] is just as great.” Later in the film, Jones reflects about his first boss, a famed cotton speculator named Eli Tullis: “The first year I did nothing but get his coffee. I was learning by osmosis. I was a glorified secretary, which is fine because I was soaking in everything, every move that he made and every step that he took.” Jones was especially fond of one memorable experience with Tullis: “He sat there right in the middle of getting absolutely decimated across the board in these commodities with the most beautiful smile, the most incredibly elegant poise and stylish composure and just had a wonderful little chat with me for 45 minutes to an hour. I was just overwhelmed that anyone could be that strong.” Tullis’s poise under pressure changed Jones’s perspective. It both inspired and taught him a priceless lesson. If you want to end up with a non-average net worth, a ‘learn from someone else’ attitude is paramount. Putting your ego aside and admitting that you don’t know it all isn’t easy, but it is the mindset of true winners.
One final reminder, about trend following and risk management, comes from David Harding (in my film). Harding has been one of the top trend followers for decades and he puts it succinctly:
“We trade everything using trend-following systems, and it works.”
Agreed. Trend Trading for a living.
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