Looking Back At My 20 Years in Trading, Success All Boils Down To This One Thing
Preservation of Capital
“All of life is the management of risk, not its elimination.” – Walter Wriston, former CEO of Citicorp
Trading wouldn’t be trading if it were not for risk. Someone always has to step up to the plate, sell when nobody else will, or buy when there are only sellers. That person, in my estimation, is a trader. A trader in the truest sense of the word. Keep in mind that being a trader doesn’t mean you stick your neck out so far that you can’t come back and play tomorrow. People that do that are referred to as former traders. My responsibility as a trader is to make a fair and orderly market and to make money for my firm. Your responsibility is to make money. Period. You don’t carry my baggage of SEC and exchange-mandated responsibilities. You are just supposed to trade when the odds favor your long or short position and then to take profits or cut losses.
I’ve been there in the pits, during the crash of ’87, through the mini-crash of ’89 and for the past 12 months when the world suddenly became allergic to the US stock market. I can tell you first hand how chilling it is to hear twenty brokers shouting in unison various call offers and put bids. Keep in mind that these same brokers have been slamming us with enough stock to choke Warren Buffett, but they expect us to still keep on bidding for calls and offering puts. It’s pretty much like hitting yourself in the head with a hammer. It feels so good when it stops!
The reason we have to keep on buying on the way down and selling on the way up is because the SEC compels us to do so. For being there to facilitate entry to or exit from the market, we don’t have to put up margin. None, nada, zip. All we have to put up is enough money to cover the risk of our overnight positions. So, while a customer can buy 1000 shares of IBM on margin and put up 50% of the $96,000 it would cost to fully pay for that amount of Big Blue, professional pit traders like me have to put up just $250! Not $48,000. Just $250. That kind of leverage can swing both ways, so you can imagine the cowboys have pretty much been wiped out of our business.Those are the former traders I referred to earlier in this section.
There are countless books and seminars that purport tell you how to make money without taking risk. They are all full of crap. Even an arbitrageur takes risk. They reduce their exposure to risk by timing their entry and exit, but even the best arb firms on Wall Street take risk in the establishment of the first leg of their trade. What if the stock is halted before they can buy or sell the second leg? What if the company extends the deadline for proxies? What if another bidder comes along? Each could negatively impact what would have otherwise been a riskless trade.
Most successful traders will tell you one of the most difficult and important lessons to learn about trading is discipline. Without discipline, the best system, most accurate technical studies and fastest access to the market is all wasted. Without the discipline to take your profits and cut your losses, you will never know whether it was your system, trading methodology or bad luck that was to blame for your loss.
On the floor we have an expression that perhaps you’ve heard; you can’t eat like a bird and defecate like an elephant. (Ok, in the pits we don’t say defecate, but you get the idea!) Put quite simply, you can’t take $.50 profits and let your losses run against you by $2. All too often, I see investors and occasionally professional traders let their losses run, which is the quickest way to ruin. Lack of discipline is the most commonly blamed culprit, but I would place improper planning at a strong second. A plan for your investing means you set entry and exit points before you commit capital.
When I said that at the www.TradingMarkets.com conference in Las Vegas last October, you’d think I had three heads. I just think you can’t establish a short position without knowing where you expect the stock or index to go. You have to set a mental stop, or cover with a call option (against a short position), to keep your position from trading you. Proper risk management means you have to cut your losses at the same percent you would take your profits.
Unfortunately, the prolonged selloff has taken many formerly disciplined investors and turned them into gamblers. Instead of selling half their position when they get a margin call, they meet the call with cash, thinking the bottom must be just ticks away. This has kept some of the fallen angels from their true bottoms, but that action has only prolonged the pain, rather than the capitulatory panic that creates a true bottom. Some of these people will ride CMGI, MSTR and the like down to zero. Being a successful trader doesn’t mean buying bottoms, or selling tops. Being a successful trader means you have the discipline to come back to the tables tomorrow.