Hedge Fund Market Wizards

After so many years, Market Wizard series are still one of my favorites. The latest “Hedge Fund Market Wizards” was on my shelf since it was published and available in Malaysia market. Finally, I got time to sat down and enjoy this book. What a marvelous and excellent write up. Before I move on, allow me to rate this book at 10/10! Zero flaws and simply perfect!!!

This book reminds me on a lot of concepts and techniques that I personally experienced for the past 15 years. In fact, it is not only about good stuff. Those bad experiences and failure stories sound familiar too. End of the day, no matter which type of trader and which method you apply, the flow of the stories do not differentiate too much. It is the same old stories… stories with joy and pain along the way.

Final conclusion with 40 pieces of wisdoms is fantastic. Furthermore, it was nice to end with Zachary Schwanger (son of the author)’s thought on Market Wizard series. This is how the son rates his father: “My dad is one of the kindest, humblest, and most generous people I have ever come across. I would much rather be as great a person as he is than to be as successful as he is.” What a nice quote to end this book!  End of the day, life itself is not only about money, trading and successes. We have family, friends and lessons to support us in leading a meaningful life. I very much appreciate series of market wizard. It certainly helps in shaping what I am today. Thumbs up and well done once again to Jack D. Schwager!

Fantastic quotes from fellow traders:

Colm O’Shea:

Until I started my hedge fund, I believed in myself more than I believed in Warren Buffet.

I constantly getting in and out because I was scared of losing money. The rational trade hypothesis was beautiful. The implementation was entirely emotional and stupid. I realized that you have to embrace uncertainty and risk.

It took me a while to realize that those trading books are counterproductive because the rules are generic and not specific. Most trading books are designed for people who have the error of excess optimism and are in emotional denial of their losses. Trading books are designed to protect traders who are gamblers.

All the traders you write about have a method that is personal and fits them. You learn from everyone around you, but you have to do what make sense for you, even if it’s opposite of what makes sense for other people.

In those early days, I wasn’t setting stops at levels that made sense based on the underlying hypothesis for the trade; I was setting stops based on my pain threshold, and the market doesn’t care about your pain.

Trading skill can’t be taught, but it can be learned.

Perseverance and the emotional resilience to keep coming back are critical because as a trader you get beaten up horribly. Frankly, if you don’t love it, there are much better things to do with your life. You can’t trade if you think it is a way to make a lot of money.  

I think trading books that provide specific rules can be quite dangerous. They can lead to the illusion that you are in control and being disciplined. And it is true that you are restricting yourself from a single catastrophic loss, but it doesn’t prevent repeated losses on the same idea.

Ray Dalio:

In trading, you have to be defensive and aggressive at the same time. If you are not aggressive, you are not going to make money, and if you are not defensive, you are not going to keep money. I believe anyone who has made money in trading has had to experience horrendous pain at some point.

Diversification is the holy grail of investing.

We test our criteria to make sure that they are timeless and universal. Timeless means that we look at strategy during all different times, and universal means that we look at how a strategy worked in all different countries. There is no reason why a strategy’s effectiveness should change in different time periods or when you go from country to country.

Larry Benedict:

The growing influence of high frequency trading has changed the behavior of the market and has made it more difficult for someone like me who is a pure tape reader looking for clues in the market action.

One of the hard things about managing client money is that although I am very patient, the clients aren’t very patient.

Scott Ramsey:

The reality is that I am not being paid to be right. I am being paid to make money. Whenever I talk to my investors, I make it clear to them that whatever I say today about the markets may or may not reflect the positions I have tomorrow or the next day. I recently reviewed a presentation I gave about six months ago, and I realized that everything I had predicted didn’t happen- and yet, I made money in almost every month since then.

Jaffray Woodriff:

I started out using market-specific models. I ended up realizing that these models were far more vulnerable to breaking down in actual trading because they were more prone to being over fitted to the past data. In 1993, I started to figure out that the more data I used to train the models, the better the performance. I found that using the same models across multiple markets provided a far more robust approach. So the big chance that occurred during this period was moving from separate models for each market to common models applied across all markets.

Systems that work well across many markets are more likely to continue to work in actual trading than systems that do well in specific markets. The lesson is: Design systems that work broadly rather than market specific systems.

Edward Thorp:

If you have a really strong conviction about your edge, then the best thing to do is sit there and take your lumps. If however, you believe there is a reasonable chance that you might not have an edge, then you better have a safety mechanism that constrains your losses on drawdowns. My view on trend following was that I could never be sure that I had an edge, so I wanted a safety mechanism.

Jamie Mai:

We are comfortable losing 100 percent of our premium four times in a row, as long as we believe that a 25 times payout is likely to occur if we make the same bet 10 times consecutively.

Michael Platt:

If the market is going up today, your forecast is going to be that it will continue going up because it is how you feel at the moment that is the most important thing. Today becomes how you felt in the past because you misremember. So, everything is about today. In this sense, financial markets become self-referential.

That’s the type I want ~ someone who understands an edge. Analysts, on the other hand, don’t think about anything else other than how smart they are.

The problem always comes down to ego. You find that analysts and economists have big egos, which just gets in the way of making money because they can never admit they are wrong.

I hate losing money more than anything. It’s the fact that it messes up your psychology. You lose the bullets in your gun. You feel like an idiot, and you are not in the mood to put on anything else. Then the elephant walks past you while your gun’s not loaded. It’s amazing how annoyingly often that happens. In this game, you want to be there when the great trade comes along. It’s the 80/20 rule of life. In trading, 80 percent of your profits come from 20 percent of your ideas.

In this game, you have an option to keep 20% of your P&L this year, but you also want to own the serial option of being able to do that every year. You can’t be blowing up.

When queried about systematic trend following, Platt mentioned two key factors. First, their system will liquidate positions when trends get overextended without waiting for trend reversal signals. Second, there is continuous ongoing research and implementation of changes to improve the system. System trading is a dynamic rather than static process. In Platt’s words, system trading is a research war.

Steve Clark:

Charts are simply the record of how things have traded in the past. That’s it. I am not a big believer in chart analysis. It is extremely appealing to think that you can take a data set from the past and predict what will happen in the future…To say that you can predict the future from past data is patently untrue. You can talk about percentage probabilities of what might happen next, but you can’t go any further than that.

Let me tell you the trouble with trading. There is no career in trading. You are only as good as your last trade, and that is it. You build nothing; you just trade. The day you stop trading, it’s gone. So, what you have spent doing for X hours every working day of your life has ended, and there is nothing left to show for it, except for money.

Being a trader was fun, and you could walk away. But, when you have business, you can’t walk away. So, it becomes prison in some ways, whereas being a trader was very free.

I found it was critical to find things to involve yourself in. It is a very good thing to be busy when you are a prop trader because you don’t want to have much time to stare at the screen… Once you have positions on and are waiting for the market to do what it needs to do, what are you going to do in the interim? Staring at the price is not going to tell you very much. You will start to overprocess and overtrade.

Some traders will change while their one trick is still working and destroy it. You need to be a bit obsessive to do the same thing 10 hours a day. People who are obsessive can become very good traders.

The market is not about facts. It’s all about people’s opinion and positions. Consequently, anything can be at any price, any time. Once you understand that, you realize you need to have protective stops.

Martin Taylor:

If someone comes to you and says they only invest in risky assets, but guarantee you limited downside volatility, they are either extraordinary geniuses – and they are probably only two of them on the planet – or they are liars.

I am trying to get away from that tyranny in hedge funds: monthly performance… You end up in this situation where you are obsessed with monthly returns, which can influence poor long-term investment decisions…I am trying to stop caring about what my clients think. I want to continue to invest money the same way but have the freedom to take a longer view.

We have never had and would never use any form of quantitative risk control because all quantitative risk control models use historical volatility. It is like driving by looking in the rearview mirror. If you use volatility as a guideline, and volatility suddenly increases, you will – Doh!

RSI doesn’t work as an overbought indicator because stocks can remain overbought for a very longtime. But, a stock being extremely oversold is usually an acute phenomenon that lasts for only a few weeks.

You need to understand what you invested. If you don’t understand why you are in trade, you won’t understand when it is the right time to sell, which means you will only sell when the price action scares you. Most of the time, when the price action scares you, it is a buying opportunity, not a selling indicator.

I consider my pattern of taking quick profits in 2009 a dreadful error that I think came about because I had lost a degree of confidence due to experiencing my first down year in 2008, even though the loss was consistent with the expected loss given the magnitude of the market decline.

Tom Claugus:

The responsibility of having other people’s money really weighs on me. If you have a 10 year time horizon, you can make good decisions and make a lot of money. If you have three year time horizon, you could probably still do well. But if you have only a three month horizon, anything can happen.

Just because you made money doesn’t mean you are right, and just because you lost money doesn’t mean you are wrong. It is all a matter of probabilities.

There are many reasons why airlines are widely considered to be poor investments. They are capital intensive, they are people intensive; they are difficult to manage; they have to rely on inefficient government air traffic control system; and if, despite all of that, they ever manage to make money, the unions start asking for more wages, so they don’t make money then, either.

Trading is a matter of probabilities. Any trading strategy, no matter how effective, will be wrong a certain percentage of time… A good trade can lose money, and a bad trade can make money. A good trade follows a process that will be profitable if repeated multiple times, although it can lose money on any individual trade. A bad trade follows a process that will lose money if repeated multiple times, although it can lose money on any individual trade.

Joe Vidich:

Most people are afraid of making money than losing money.

The next time you are undecided between liquidating a losing position and gritting your teeth and riding it out, remember that there is third alternative: partial liquidation.

If you are going to control your losses, there will be times when you will get out just before the market turns around. Get used to it. This frustrating experience is an unavoidable consequence of effective risk management.

Kevin Daly:

I have seen managers who did so well while trading smaller asset levels, but then experienced significant performance deterioration when they allowed their assets to grow beyond the optimal level for their methodology. For managers, the discipline to turn down additional investor assets when they believe it would impede their performance is an important element in longer-term success.

Jimmy Balodimas:

The beliefs have always kept me making money and not playing the short term moves that I don’t really trust. The markets are such a greater fool’s game. I don’t want to be the greater fool.

All I think about is making money, not being right.

Joel Greenblatt:

If I wrote a book about a strategy that worked every month, or even every year, everyone would start using it, and it would stop working. The market doesn’t always agree with you… over the short term, which sometimes can be as long as two to three years, there are periods when it doesn’t work.

People don’t fully appreciate the importance of not losing money. Negative compounding is very difficult to overcome.