Market Wizard Lessons
Jack Schwager
The 4 Types of Trades
Implementation is as Important as Idea
How Colm O’Shea played 2000 peak in Nasdaq
STOPS: PAIN VERSUS PROOF
O’Shea on misguided stop selection
Adjust Exposure to Changing
Volatility
Manger to O’Shea in 2008: “I cut risk in half”
“That’s quite a lot”
“Yes I cut leverage from 4 to 2”
“Do you realize volatility has increased fivefold?”
Money Management Can be Counterproductive if
Inconsistent with Trade Hypothesis
Martin Taylor’s biggest position (20%) and responsible fro drawdown was
AAPL
Gave back 75% AUM so didn’t have to manage to monthly returns
Mistakes Provide Path to Improvement
Ray Dalio: Mistakes provide trading lessons and opportunity to improve.
 Trader’s notebook
Mindset—Respect for mistakes will mean you will know you can be wrong and plan for being wrong
Education system—geared to not making mistakes (regurgitating facts) instead of learning from mistakes
The Losing Trade Dilemma
•Worried about getting out right before turn, but don’t want to risk open-ended loss
•Steve Cohen: Cut in half and cut in half again—pretty soon you don’t have to worry about position
•Vidich—harvesting losses
Caution Against Trading to Meet Profit
Goal
Benedict in trying to get to 10% target for year ending up with suboptimal trade and further from goal
Buy Strongest; Sell Weakest
BUY
SELL
•Scott Ramsey looking for upside reversal in $ at end of QE2 chose Turkish Lira because it couldn’t rally even when dollar weak
•My experience in inadvertent long FXI/short XRT
Failure to Respond to Correlated Market
Move
Ramsey: September 2011 equity prices rallied, but commodity prices (e.g., HG) weakened. Bear signal for commodities
Effective Money Management Can be Simple:
The Bluecrest Model
Midteen returns; Maximum drawdown < 5%
Down 3%
Down 3%
Systems that Work on Many Markets are Stronger
•Jaffray Woodriff: Systems that work across many markets are more likely to continue working
Betting More on High Probability Hands Can
Even Transform Negative Edge
Don’t Trade Beyond Comfort Level or Fear
Will Dominate Your Decisions
Option Prices Assume Equal Probability of
Prices Going Up or Down. Identifying when
this is Wrong Leads to Opportunities
Jamie Mai Korean stocks selling below net cash balances
Volatility Does Not Equal Risk
Low volatility can be high risk—e.g., short out-of-the-money options
High volatility can be low risk: Jamie Mai shorting subprime CDOs
Underappreciated Reason for Avoiding Large
Losses: Mentally Impede Trader and Result
in Missed Winning Opportunities
Michael Platt: You take big loss and then you’re standing there with your rifle unloaded when the elephant walks by
If Market News Is Adverse to Position and
You Don’t Lose Much—Add, Don’t Liquidate
Michael Platt: Expected 2/10 curve to widen. Repeated news favorable for flattening did not impact market. He thought, “Yield curve
can’t get flatter.,” and quadrupled position—spread went from 25 to 210; best trade of the year
Traders Go Wrong by Diversifying Away
from their Expertise
Steve Clark’s dictum
Do More of What Works and Less of What
Doesn’t
Steve Clark's advice to traders; traders go wrong by diversifying from their expertise
You Can’t Turn a Losing Streak Around by
Trying Harder
Position Size Can Be More Important than
Entry Price
Entry
Price
Position
Size
•The larger the position, the greater danger of exiting on meaningless price move
•Also important trading larger than normal when everything lines up
The Mindset of a Good Trader
 One Minute Later
“It’s definitely going up”
Steve Clark observation. His own experience with Euro Disney
“It’s definitely going down”
Music Is the Space between the Notes
Successful Trading Is the Space
between Trades
Kevin Daly up 800% for 12-year period S&P flat despite being primarily long only (shorts less than 10%)
The Advantage of Trading around a
Position
•Balodimas can be flat or even up by trading around positions
•Treats trades as dynamic rather than static.
•Taking profits before objective can add return
•Will increase staying power on pullbacks
•Only downside: gives up some windfall profits in straight line moves.
Greenblatt’s Three Rules of Value
Investing
Magic Formula Deciles:
1 > 2 > 3> 4> 5> 6> 7> 8> 9> 10
Why not buy 1 and sell 10 instead?
1. Value investing works
2. Value investing doesn’t work all the time
3. #2 is why #1 is true.
•Gotham fund 50% average return in 10-year period. Worst year +28%
You Don’t Have to Trade.
“There Are No Called Strikes in Trading”*
*Greenblatt quoting Warren Buffet
Flexibility
1. Mai and dry bulk shippers
2. O’Shea bearish Spring 2009 changed hypothesis (Asia led recovery)
The Trader and the Guillotine