I spoke with pro journo Scott Patterson today about his new book Dark Pools.
Dark Pools answers the question “How did we get here?” and you’re going to be surprised how little you really know about what goes on in the world of trading today.Continue Reading...
When you think of trading the steepening or flattening of the yield curve, you have Richard Sandor to thank. He was at the forefront of designing GNMA futures in the early ’70s. He is considered the father of financial futures.
I’ve known Richard for several years now and I often see him speak at conferences such as the Milken Institute’s Global Conference, among others.
His new book Good Derivatives is a memoir that I think you’ll find very interesting. It’s filled with his great anecdotal stories as well as a depth of history that only someone with 40 years of experience like he has.Continue Reading...
Like many of you and other traders of my generation, I can trace any of my success as a teacher, trader, and author to the inspiration I found in the first Market Wizards book. I hope you enjoy this video interview with Jack Schwager in which we discuss his new book Hedge Fund Market Wizards.
Here is the full transcript:
Michael Martin: Hi, everybody. It’s Mike Martin from MartinKronicle and author of The Inner Voice of Trading. Today, I’m with a guy who’s very, very distinguished in our space and he’s a guy I attribute a lot of my success to, the very recognizable Jack Schwager. Jack, thanks for taking time today.
Jack Schwager: Happy to do it, Mike.
Michael: I wanted to get this out of the way very, very early because it’s very meaningful for me. Outside of my own father, Jack, I can’t think of a guy on the planet who’s had a bigger impact on my life than you, primarily starting with one of the loves of my life, your very first Market Wizards book.
I can trace any success that I’ve had as an author, a trader, a blogger and a teacher back to those chapters in that first book and I am deeply indebted to you. Just from the bottom of my heart, I want to say thank you for having the idea and being your inimitable self and putting that book down on paper.
I know I’m not the only person to tell you that, but I am really grateful for you. Thank you so much.
Jack: I appreciate that. Thanks.
Michael: How has writing that book and all the interview books, as we call them, affected your life?
Jack: I guess in a lot of ways. I guess it gave me notoriety or made me famous in a small circle. I’ve always been in the financial world. Now, if I go to meet managers, my role has been easier at times as an allocator or whatever and I have to meet managers. Just by virtue of having written those books, everyone always knows who I am. It has a little bit of an advantage that way. It’s kind of nice also fulfilling a certain goal. When I wrote the first Market Wizards book, I thought it was a good idea. I just thought it would be a fun idea to do.
Michael: You think? [laughter]
Jack: When I wrote that first book, my goal was at that time and the book is still out, it’s still a very famous book Reminiscences of a Stock Operator. That was kind of the book which, when I was writing “Market Wizards,” was about 60 years old. I read that and I thought it was a great book. It was a really great book on trading. Most of your listeners probably are familiar with it but, for those who aren’t, it’s a book that is about Jesse Livermore written from the perspective of Jessie Livermore. The fellow who wrote it, Edwin Lefevre, was actually a real person.
A lot of people for awhile I remember back when I read it some people thought that it was a pseudonym but there really was an Edwin Lefevre. He was a journalist. He wrote this book among others and he wrote a number on the financial community. The thing that impressed me was here I am reading this book 60 years later and it’s still very, very pertinent. There were lines in there that I could just pull out. In fact, I think I have myself quote lines from that book.
When I was writing this I was going to do the whole book in a similar style, but my goal was hey I’m reading this book 60 years later my goal was I wanted to do a book that 60 years later traders would still be reading. Here we are, almost 25 years later, and it’s still very widely read.
I guess in that way having achieved a goal, that’s satisfying. Like I said, any time when you achieve something that’s lasting and it feels good, it’s had a positive impact. It’s given me notoriety. It’s been beneficial to my own trading, just talking to these people. Even though trading is not the only thing I’ve done.
Hardly ever is it a full time avocation and even when I did it was in a computerized way. In so far as I’ve done trading from time to time, when I’ve got time, it’s more like a hobby. It’s not an avocation. When I trade, it would have to be classified as a hobby when I get inspired or have the time.
In so far as I’ve done that, I would have been a terrible trader had I not done these books. By virtue of doing these books, I don’t see myself as a good trader but at least I’m a profitable trader.
Michael: I can see that, spiritually, it’s affected you. I wanted to ask you these questions up front, because I know your new book is a classic. It will be a classic. Even Ed Seykota wrote in the forward of your new book, which we’ll get to, that all of your books show up with what he deems as classics. I will share with you that what I like about “Market Wizards,” your first one, which is the one that I carried around with me forever. I didn’t care for Jessie Livermore as a guy. He got under my skin real quick, whereas the characters and the folks that you interviewed in your book, I liked them.
Jessie Livermore – I wouldn’t take two minutes of this guy’s behavior before I’d want to punch him in the face. I understand there’s a lot of wisdom to be had and virtually everybody in this book quotes Livermore but, just in terms of the character, he’s a guy that grew on me very quickly. I don’t think I could really have a relationship with him, where I kind of fell in love with a lot of the guys here [in the first Market Wizards book].
Speaking of folks in the first book, it must have been very gratifying for you to see someone like Bruce Kovner, who you may have met back in Commodities Corporation through the launch of Caxton circa ’83 and then through his retirement at the end of last year. You have what’s probably the best interview with Bruce Kovner.
Jack: The only interview with Bruce Kovner.
Michael: Right. This one, given how secretive he is, I’m sure he’s still taking Xanax or whatever for all the panic attacks that he’s had. That, in and of itself, must feel really good.
Jack: I knew Bruce, so I definitely had an advantage, but he told me quite up front in the beginning. He said, “You may wonder why I’m doing this interview.” He basically said, “I’m getting too big now and stories are being written about me. I figured, if there’s going to be stuff written about me, there may as well be one accurate story about me.”
He trusted me to do an honest portrayal. That’s why he agreed to do it. It was really only that. He figured he was going to get publicity one way or the other. None of it sanctioned, none of which he participated in.
Jack: He knew, if he participated with me, that it would be a fair representation so that’s why he agreed. As far as I know maybe he’s done another interview I don’t know, but as far as I know that is the only interview I know of that he’s done.
Michael: Yeah, I’ve seen some things that were written about him that maybe they picked up a quote where he’s spoken, but any time you’ve really seen him mentioned in the last 10 years it’s for his eleemosynary or charitable things that he’s done for Lincoln Center or for Juliard or something.
Jack: There’s a sort of people who are completely shy of any publicity or notoriety or anything who just disappear, like Monroe Trout or whatever. I don’t know if he ever gave another interview. There are a number of people along the line that I did these interviews with and I don’t know if they’ve ever done anything else.
Michael: One of the things that I think a reader can take away – and I’m saying this for the two people who might not have known or they’re just getting into trading and they’re going to start picking up your books, which would be a great investment on their time – having read all your books, there seems to be some timeless wisdom that you can delineate or trace from one book to the next. The message is somewhat the same but because of the uniqueness or the idiosyncratic manner of the particular trader, it always comes out in his or, in Linda’s case, her unique vernacular. In all of your books, you seem to be able to trace this wisdom from one generation to the next.
Your new book is right here, Hedge Fund Market Wizards, out on Wiley. What similarities did you see between traders between the first two “Market Wizards” books to this one, which has come out more than a decade later? Did you notice anything similar between the traders?
Jack: There are common denominators across all the books, because the common denominator is in terms of success. Those are similarities, but process wise traders tend to be very different now and then. Also, the traders in this book, which are all introduced at the same time, are all very different from each other. Some things are very different. Personalities are very different, whether people are aggressive or they are more passive people or super brains, double PhDs or they didn’t even finish high school. You get a real range of trades in that respect, but there are certain aspects of trading where there are commonalities.
That’s true across almost any book. Something like discipline, which people hear about and get bored because they hear about it so much, but it’s true. Virtually every trader that I’ve ever spoken to who has been successful has been disciplined. Another one which is very good as an illustration of commonalities is flexibility.
The reason ordinary traders and investors go wrong so often always boils down to a lack of flexibility. Positions going bad, they can’t change their position. They can’t change their mind. They can’t take a loss. All these errors always relate to a lack of flexibility. Of course, in all the books you get this flexibility among really good traders.
The classic example of all time I don’t think anybody will ever beat this was Stan Druckenmiller in 1987, the Friday before the crash. The Friday before the crash, Druckenmiller was managing multiple funds at the time and he had been actually short. People forget that the ’87 crash didn’t just materialize out of thin air.
The market had been going down for a few months before the crash and the week before the crash the market went down a lot. I think some people, when they remember the crash, forget that. Here’s Druckenmiller and the market’s going down a lot.
He thinks, “All right, it’s gone down enough, for now.” What does he do on Friday before the crash? He covers his entire short position, but if that’s not bad enough he goes long. That’s the worst error you could ever make. I can’t make up a worse trading error than switching from short to long on Friday, October 16, 1987.
You can’t make it up. You come in the next morning and the market’s down 10 percent, but here’s the thing. You go back and look at his record and he’s down a few percent for October ’87. How is that possible, right?
Michael: Right, right.
Jack: Well, he made money for the first half of the month because he was on the right side, but here’s the thing. This is the amazing thing. He decided over the weekend he was wrong. Why? People can read the book. It’s tangential, but he decided he was wrong. He had made a mistake. He came in Monday morning knowing he had made a mistake. Unfortunately, the market didn’t let him cover easily. It opened up about 10 percent lower on the gavel. What does he do? This new long position he put on, he got rid of all of it, but that’s not all. He went back short again and that’s flexibility. Right?
No loyalty to position. Just…doing what he knows is right. I know we were chatting about this before, but in this book, I’ve got another trader where…nothing as dramatic as that.
But the same kind of a situation. I use a line describing what he did and other traders like him in the book, that good traders cover their positions when they’re wrong. Great traders reverse their positions when they’re wrong.
Michael: Exactly. That’s at the end of the Jamie Mai chapter, which we’re going to get to. Yeah, being flexible, it seems to me and I wrote this at Amazon that these traders are very emotionally demonstrative. They are very self aware people. They have strong inner voices, where they’re able to they’re not so up themselves in terms of their own postulates. In fact, there’s one of them and I have the note here where in fact, it is Jamie Mai, where he used a quote or you did of trying to drill 50 dry wells.
Then, he spends the most amount of time trying to disprove his own ethos. Where on Wall Street, people get a theme and then they look for the ideas to support it. These guys find ideas and then they look to be their own worst enemy, their own judge and jury, and defend their thesis. They try to poke holes in that.
Jack: Yeah. That’s an excellent point. That really is. That’s a fine point that you picked up. In Jamie Mai’s case, they spend an enormous amount of time trying to disprove their own thesis. That particular trader, talking about flexibility, that’s exactly what happened. He came up with this very plausible idea a couple of years ago that, well, China is growing. China’s growing like crazy. They’re starting to use a lot more coal. At one point, they were producing enough coal to export. They finally reached a point where not only weren’t they exporting coal, they were now trying to import coal and the trend was good, but like this.
He thinks he has a bright idea. “Well, China’s going to be buying all this coal. It’s probably a good idea to be getting long, good dry boat shippers, because this could be a lot more demand for space.”
That was his idea, but the more research he did, he eventually figured out or his group eventually figured out that, because of the commodity boom a couple of years earlier, there had been this massive expansion of shipbuilding. There was actually a glut on the market.
Jack: He realized that his original idea not only wasn’t a good idea, it was exactly the opposite of what he should be doing. He went short. When he goes short, he doesn’t go short literally. He bought Puts. That’s another thing, because his right’s through trades. Leaving that aside for a moment, the idea is he took a short biased position, which is exactly opposite, and that was his single best trade of the year. Interestingly, the guy’s best trade is the exact opposite of what his original idea was, and it was only because they spent months researching everything and figured out they had it wrong.
Michael: One of the traders that you mention in the book, Colm O’Shea, who’s in the macro section the first third of the book, he talks about expressing some ideas, and he talks about being long, debit positions in the options market. I found that interesting, because, I think, back in the first book Jim Rogers said something about 90 percent of the options expiring worthless. He didn’t know why anyone would buy them, which I know is in a certain context, but almost every one of the guys here in this book and they’re all men in this one – talked about not just being flexible in their thoughts but being flexible in how they participated in a trade, whether it was an intra-commodity spread or whether it was a long/short equity position with a net exposure long or short to the market.
A lot of them expressed these ideas, these postulates, being long option premium. Can you reconcile that for us?
Jack: Yeah, I certainly can. You actually touched on two important points. The one about the option premiums, let’s address that one first. But, there’s another one I want you to remind me about, because it’s very, very important. It has to do with the importance of how you implement a trade…
Jack: …which we can talk about the story with Colm O’Shea in a minute.
Jack: But let’s talk about the options first. This is really an important point. I think anybody watching this that, if you get this and you didn’t realize it before, it’s going to more than make up for the time you spend watching this. This is like a massive misconception that people have. Now, you hear this all the time. Unlike Rogers said, OK, some variation of options. Buying options is a mugs game, right? Because if you buy options, they’re usually overpriced and you’re going to lose money.
You have a negative edge. It’s sort of like playing the casino. On one level, it’s true, which is why people get fooled by it. Let’s talk about how it’s true, and then let me then explain why it’s dead wrong.
Why it’s true is the same reason why insurance companies don’t go broke. The public buys home insurance, so on balance, people who have home insurance will lose money by doing that. They will collect less premium.
Jack: They’ll collect less in insurance on houses that burn down than they will pay out in premium. If that weren’t true, insurance companies would go broke. Same analogy applies to options. Options have to be priced so the sellers of options will make some money over time, because otherwise why should they take the risk of selling options? It’s logical that options should be priced at a level where, on average, the sellers of options will make money. You could do empirical studies and I think it’s like 75 percent of the time options will expire worthless , so I guess it’s little odd for percentages.
But let’s leave it this way. Let’s say a good majority of the time, options expire worthless and option sellers over time make money. That’s why this impression exists because, on that level, it’s true, but here is the key thing that people overlook.
Jack: The beauty of options, and I’m talking about buying options, is that you don’t have to buy an option all the time. You can choose when to buy the option. Now, if you’re always buying options, then yeah, it’s probably a losing proposition. However, if you wait for when you have reason to believe, judgmental or technical, that there’s a potential big move in the market and then you buy the option, then options not only provide you with this asymmetric return to risk, but they also have an edge. Because if you have some skill in picking your points, then the odds are in your favor.
I’ll give you a personal example of a trade I did. I don’t normally do this. I haven’t been trading for many years and it was just because I was doing a lot of other things. In the 2008 crash, as the market was coming down, I was looking at certain things like the Chinese stock index.
Jack: Looking at how far they were coming down, and I just thought, “Well, this looks like an extreme panic. The market is oversold . I don’t know where the bottom is, but let me buy five LEAPS anyhow, and if it goes down a few points, who cares? If I’m right, then it will go up a lot.” That’s the situation. I would argue that, after the crash had been going for a while, coming in and buying LEAPS in an index that is down like China, where there is some story of why there should be a recovery and the index is down 70 percent, if that’s when you buy the option, I’m going to argue you have an edge. Because the options are always priced on a probability that is an equal probability of going up or down.
My attitude was when they were down that much in a panic market with a fundamental reason of why it should go higher. At that point, the odds of it going down another 50 percent, I thought, were much less than the odds of it going up 50 percent. Of course, it went up several hundred percent. I wasn’t smart enough to stay with it for that, but that’s an aside.
The important point is, putting on the option at that juncture, I don’t think was an equal bet. I don’t think the probability reflected what really was the situation. If you can pick your points, then options don’t have a negative edge. They can have an immense positive edge.
The other big plus is, when you’re buying options, you can only lose a certain amount. Your risk is built in. Your potential is open ended.
Jack: The other really good thing I would say here, and it comes up in the Jamie Mai interview as well, my personal bias is…he’s reflecting my own philosophy. It’s that you want to be a buyer of long term options because you pay a lot less premium per month to have that position, particularly if you’re looking for a big move. You combine those things, buying long term options, picking your point. Options can be one of the best trades around, the best ways to express an idea.
Then, I told you there was another point I want to come back to, which is how you put on a trade. The thing I want to get to is most people think that it’s all about getting the trade right, having the right trade.
One of the things I love about some of these interviews and some of the things that came out is when you get people saying things that are so either counter intuitive or things you never would have thought about or realized.
One of Colm O’Shea’s points was that how you put on the trade, how you execute your trade idea, is actually more important than the trade idea itself. There’s a great example that comes up there in the discussion of bubbles and so forth.
He had decided, when the stock market or the NASDAQ finally topped out in March 2000, that the bubble was over and all of that. The natural trade, you might think, is go short NASDAQ.
Now, that’s not what he did. Had you gone short NASDAQ, there’s an excellent chance you would have been stopped out at trade because, again here’s something that people don’t tend to realize or remember is that the NASDAQ didn’t just go down slowly.
You might have a natural image of thinking the market peaked in 2000, the tech market just went down. It did go down, but that initial 2000, in the summer 2000, you had a point where the market rebounded over 40 percent. That’s quite a rebound. Not too many people I know that can survive a 40 percent rebound.
If you’d gone short NASDAQ, you probably would have been stopped out and you might have well lost money, even though the trade was totally right. What did O’Shea do? He didn’t go short NASDAQ.
He said, “Well, if this bubble is topped, that means that the economy is going to get weaker. That means that interest rates, which are now moderately high, are going to go down.” What was the play? He bought bonds. The bond move…interest rates were said to be much smoother. The interest rates came down smoothly. The bonds went up smoothly.
He used that concept to do a trade which was totally correlated with his concept, but was a safe way to play it. That’s a good example of how you do the trade can be more important than the trade idea. Because somebody who just went short NASDAQ and had the right idea could have easily lost money.
Michael: Yeah, and that’s something that, even with…I have over two decades experience, I come back and look at. In fact, I was at the Milken Institute’s Global conference, and I had a chance to interview Boone Pickens. We were talking, of course, about the energy market. I talked to him about the spread between West Texas Intermediate and Brent crude, and then also his take on natural gas.
He said, in terms of the natural gas, his play was, he actually bought this strip out in 2015 to play the trade. Because I had asked him at the time, I think the Oct/Dec spread was trading 65 cents to December, was that the trade where you could make money in what seemed like a directionless market?
It just struck me, like, “Here’s a guy who’s 80-something years old, and he’s trading calendar strips in natural gas to express an idea. That’s really brilliant.” I think that’s what the wisdom is that readers and viewers of this interview can take away, that there’s a lot of ways that you can express an idea in the marketplace.
When you get down to trying to get these asymmetric trade offs, you have to find the one that has it, but it’s also compatible with your personality. Ed Seykota said that back in the first book, is that “the goal is for a trader to develop a system with which he or she is compatible.” That is also echoed throughout this book. Say a little bit about that.
Jack: Yeah, I mean, I’ll say this about it. When I give talks about what’s important in trading, the first point I make when I tell people is, “If you get nothing else out of this whole talk, this is what you should know, is that to succeed in trading, you have to have an approach that matches your personality.” You see it time and time again. People evolve completely different approaches, but the successful traders always find a methodology that kind of works with who they are and what they believe in. That’s why you get completely diverse approaches.
You get people like Rogers, who are pure fundamentalists and have complete disdain for technicians. His line about technicians is, “The only technicians who make money are the ones who sell their services.” You have that type of mentality about technicality. Then, you have people who are like Seykota, who’s purely technical, or Marty Schwartz, who talks about how he lost money nearly in fundamentals and got rich as a technician.
You get these diametrically different approaches because they each evolved to what they believed in. How it is possible for one guy to make money purely on fundamentals when he disdains technical, and have somebody else do the exact opposite, is because Rogers really believes in the fundamentals. That works for him.
Then, Schwartz, as an example, completely believes in the technicals and that works for him. That’s just simplistically, fundamental and technical, but it goes down to how long the trades are, or what kind of trades.
Someone like Jamie Mai, every trade I think he ever does is always asymmetric. He structures it so his potential is open ended, his risk is limited. That’s his mentality. That’s what he’s comfortable doing. He couldn’t trade any other way.
Michael: The one thing that I teach about options is that there are several themes that are tied in here which, again, is why I think your books are so rich in content, basically, when you buy a debit, whether it’s a vertical spread or whether it’s a directional outright trade, is that you have a built in stop. Like you were saying, you know what the loss is, but if you have trouble putting your arms around that ahead of time, you can think of it as having a built in stop order, which takes a certain amount of discipline.
Now, I was going to get to this a little bit later, but one of the guys that you interviewed very late in the book, Joe Vidich said that, “Stop orders are for fools.” I know where he’s coming from. Again, you have to take it in the context that he means it. I disagree, generally, with that, especially for newer traders. I also believe in timed stops. Explain that for us. What’s your take?
Jack: Joe Vidich, let’s put this in perspective. Yeah, he says that, and he believes that. He means that the way most people use stops, they’ll tend to…here’s what he really means. He means that people tend to put stops in obvious places, and they’ll get taken out. The floor is always taking advantage. What used to be the floor, now professional traders, are taking advantage of that. That’s what he’s talking about. The other half of that story is that…and, in fact, I titled that chapter, if I’m not mistaken “Harvesting Losses,” I believe.
His philosophy is you’re always, as a trader, faced with this dilemma. Something’s going against you. Well, what do you do? On one hand, you’re afraid of losing too much. But then, on the other hand, you’re afraid of the cognitive market will turn around.
When he faces that type of situation, because he’s not using stops if you used stops of course you don’t have to make that decision what he does, he’ll take half, some portion. He’ll take a quarter and then he does what Steve Clark does also.
He’ll take some more. If it bounces back, he can stay with it but he’s always kind of just taking his losses, taking money off the table. He’s a guy who has discipline and control.
He’s also a guy who has, since he started managing money back in late 1999, I assume he hasn’t had a drawdown greater than single digits. I think his worse draw down is like about 8% or something like that. That’s through these markets. That’s through some pretty wild bear markets. He has a lot of control over his losses but he trusts himself to do it. His approach is not to use stops but to, as he calls it, harvesting losses.
One shouldn’t take the wrong conclusion from that. It’s not that he’s against stops. He’s against putting in stops in obvious places. He thinks he can do better. Well, he can do better. If it’s him is just to take losses gradually as he sees fit.
The time stop issue, that comes up in a number of traders. It’s simply the concept, the idea that, “If I’m right, the market hasn’t gone after some time, then I wasn’t right. Something’s wrong with the original concept. I don’t have to wait for it to get to my stop. I might as well get out now and do something else.” That’s something that a number of traders use that makes sense.
Michael: I will say that I use that probably more times than I care to admit. If you talk about putting on trades and being wrong more than half the time. In a simplistic view, there’s only three things that can happen when you put on a trade: It goes your way, it goes sideways and you don’t make or lose or it goes down. But, to me, in two of those three, you still lose because you have the opportunity cost. I’m always of the mindset that I’m trying to steal second base without taking my foot off first.
Two of the three, to me, is you’re a loser. What I like about, going back to the other point, is the flexibility of scaling in and scaling out and being flexible of saying sometimes, if you’re expecting very, very bullish news to come out and it does come out and it hits the tape but yet the security that you’re long doesn’t move, that in and of itself is telling you something. I know I’m probably echoing somebody from one of your earlier books but…
Jack: This book, as well.
Michael: Yeah. There’s a lot of people who are still reading the tape, literally and figuratively, despite the advent of high frequency trading, which didn’t exist when you wrote wrote the other book or any of your books for that matter. What was your take on that to hear people talk about reading the tape and watching the crowd reaction or the sentiment? You talked about the sentiment, bullish and bearish.
Jack: That came up in a number of different places in this hedge fund market in the book. This idea that how markets respond is really important and the emotional sentiment. One example, a trader was looking for the yield curve to go out, actually. It was only about 30 basis points and he was looking for it to go out.
All this news kept on coming out which was negative for trading. It looked like it should flatten the curve more and the market, nothing was happening. Just each time before the news came out, nothing happened. After a couple of those, he said, “Wow, this is telling me something.” He quadrupled his position…
Michael: Right, it’s a great story.
Jack: That was his biggest trade. It was his biggest trade that year.
Michael: The story that Jack is telling us, folks, is about a trader who expressed an idea in a yield curve spread, not unlike the ones that Bruce Kovner said that he had fallen in love with early in his career. This negative news came out that should have either flattened out the yield curve or kept it flat and nothing happened. He was watching all of this thinking that he was going to get killed, but at the end of the day those fundamentals and the crowd reaction or lack of reaction to that news was a signal unto itself. He basically, like Jack said, came in and quadrupled his position size. I think that’s brilliant.
Jack: I’ll throw out one other point that I think is potentially important. It’s about to use the fundamentals. There’s one level when the metrics can be important here if you use fundamentals for ideas, basically long term trades and that type of thing. But for timing purposes, this is my quote, I’m putting out trades. My own feeling on this is that the only true way the fundamentals are useful and timely is a contrarian way.
If the markets don’t respond to fundamentals the way that you think they should, that’s telling you something. In other words, what it’s telling you is if it’s opposite of what you do things. If it’s a bullish fundamental and the markets aren’t responding, maybe it’s bearish.
As far as a timing tool, fundamentals are only useful in contrarian fashion. One of the big mistakes people make is to use fundamentals for timing in a same direction. “Oh, this is bullish news so I’ll buy.” Well, bullish news comes out, they go up. They go down. But what’s really useful is when bullish news comes out and it’s goes down. That counts. If bullish news comes out and it goes up, it may continue to go up and that’s unusual but it doesn’t tell you anything.
Michael: What you’re really saying there is that, when news comes out, when it hits the tape or you find it on Twitter, what you’re looking for, folks, is a divergence in the behavior of the security. What’s the price telling you versus what is the news supposed to do? If there’s either a convergence or a divergence, that, in and of itself, tells you a lot of information about how everyone’s positioned in the marketplace.
Larry Benedict is a guy that you’ve interviewed for the new book. He’s a tape reader. Did you find that you found that someone like him, who relies so much on tape reading, given the advent of high frequency trading and what that’s done to the concept of tape reading going back to, like, an Ace Greenberg style of tape reading?
Jack: He admits that it’s made it more difficult. He’s adapting. He’s dealing with it. He’s changing some things. The advent of high frequency traders has made it more difficult for him, but he’s still doing fine. Maybe his return purse has gone down. The last couple of years went down, but he’s absorbing it. Last year was his worst year. It was his only losing year in 20 plus years, but he lost a fraction of one percent.
Michael: Put your analyst hat on for a second…what do you think about Relative Strength (RSI) in stock investing?
Jack: Disclaimer here, this is my personal bias. I personally don’t find RSI a useful tool. In fact, I will say this. I know this was true when I looked at it 15, 20 years ago, I haven’t looked at it again since then, but I’d take an even money bet that it’s still true, that if you were going to buy every time the RSI got overbought, and sell every time it oversold, it’s exactly the opposite of what the theory is, you’d make money.
Or, if you didn’t make money, because you’re going to pay transaction costs both ways. You’ll get slippage both ways. But, either you’d make money, which means you’d have to lose money doing the opposite. Or, you’d lose less money than you’d lose by selling when it gets overbought. It’s this confusion of, “Gee, every time the market tops or bottoms, the RSI is extreme territory.”
Yeah, but you also have these immense segments of time where the RSI is overbought or oversold, and the market keeps on going.
I personally think it’s a poor tool, unless it’s used…I’m not saying you can’t figure out a way to use it. You could come out with maybe divergences and certain rules, maybe you could come up with some combination of three or four things, one of which is the RSI.
But yeah, maybe there is a way to use it, if you count the patterns with the RSI as an input, and it might could be of some use. But the typical textbook way that you see these things, which is using RSI to tell you when it should be…if it’s too high, you want to be selling. If it’s too low, you want to be buying. That, I would argue, is worse than random.
Michael: It seemed to me that Larry Benedict was almost boasting about his temper. Do you think that his temper is part of his system?
Jack: …he was being…it was interesting because if you meet him, he was kind of like, “Hey, I come in…” The guy’s wearing…First of all, look at the way he’s dressed. He’s wearing shorts and a T shirt. It’s Florida, but his office is like 65 degrees. He’s like joking around and easy going, relaxed, just nice guy. You wouldn’t know, I wouldn’t have known he had that side at all. But yeah, he only went out of his way to point it out. He had an assistant come in and asked them, and they said…
The assistant tells me they keep having inventory, phones, keyboards, because he’s constantly smashing them against the wall. He didn’t have to tell me that, you know?
Now, I know he was just being part of honest, but he did. He was kind of celebrating, bragging about how back in the days, particularly when he was dealing with brokers on the floor, that when he got kind of taken advantage of on an order, he would yell so loud that they would know and the floor below would hear.
Yeah. I’m not sure what his motivation was, but it was a side of his personality that I wouldn’t have seen in an interview, but which he openly shared.
Michael: Tell us what we need to know about Ray Dalio and Bridgewater.
Jack: They are the largest…largest hedge fund in the world. 120 billion. 1,400 employees. The hedge fund that has made more money for their investors than any other hedge fund in history. They pulled about $50 million out of the market when I interviewed them, it might be more by now.
Michael: His [Bridgewater's] results pretty much smash the daylights out of the Efficient Market Hypothesis.
Jack: Right. That’s the thing itself in a whole different tangent if you want to go there. I’d be happy to go there.
Yeah. I go through all sorts of reasons, what’s wrong with this claim of academics that markets are efficient. There are some tremendous truck sized gaps in that argument.
Michael: Now, Ray Dalio has given investors back $50 billion dollars of efficient market hypothesis. Now, the way he runs meetings, he tells a story about getting a feedback mechanism within his firm, where the management structure he’s a mentor now but the management structure, in terms of communicating, is about as flat as this sheet of paper that my notes are on.
There’s no ego well, there may be ego but all of that is basically suppressed. You tell a story about one of his institutional salespeople coming to him and giving him some feedback on a meeting. What was his grade at that meeting?
Jack: Basically, he was at the exact meeting with some investors. Large investors, and other people from others’ employees. They were doing the presentation, and he kind of interrupted and said, “Hey, stop.” He was pointing. He was like, about 10 rungs down the…
Michael: The mailroom guy.
Jack: They criticized him for doing a narrow presentation which bombed . He said, “I guess you’re right.” He sort of accepted it. The interesting thing of value is, on one hand, he’s very opinionated. He has strong ideas. Obviously, to build a firm of that size and to do what he has done, you’d have to have that type of driving personality.
Michael: The salesperson basically said, as quoted in Jack’s book here, that they gave him a grade of a letter F. They said “that he droned on and on with his talking, and that he represented the firm poorly during the meeting.” That’s some feedback. I want to put you on the spot. Can you imagine, Jack, if you took that same scenario and placed that at 717 5th Avenue [the physical address of MF Global - Jon Corzine's office.]
If you put that inside the offices of MF Global on 5th Avenue, when Jon Corzine came out of nowhere and decided he was going to take a beautiful FCM and basically tried to bull his way with a multibillion dollar position in a concentrated position.
Could you imagine what would have happened if MF Global had that type of feedback mechanism been available inside the firm up at the C suite?
Jack: Well, obviously the leadership styles were quite different.
Jack: It was also, then, I think, a total violation of so many principles. I wouldn’t know where to start. We talked about flexibility before. It’s the epitome of the absence of flexibility.
Michael: Yeah. I mean, Ed [Seykota] calls it “the moron strategy.” When you have a position on and it goes against you, you put “more on.”
Jack: [laughs] That sounds like Ed.
Michael: Yeah. I liken it to being Spring Lake and the Jersey Shore. You’re shoveling sand against the tide. If you have margin calls, the first thing you want to do is stop that bleeding and get out of the position than to create more leverage by borrowing for the money to put onto a losing position. David Bowie sang about putting out the fire with gasoline.
Well, Jack, it’s been great catching up with you on this stuff. I certainly don’t want to wear out my welcome. We’ve been on for over an hour.
Again, I’m indebted to you and I can only share with you that I’m paying it forward by giving back to the community.
Folks, the new book is called “Hedge Fund Market Wizards” by Jack Schwager. It’s available now on hard copy and on Kindle.
Jack, Godspeed and thank you for your time, buddy.
Jack: I enjoyed doing it. Take care. Bye.Continue Reading...
News hit the tape that MSFT will invest $300 MM into BKS to support the NOOK. While we are 1 hour from the 9:30 am ET open, BKS is up 92% on the news, which has obviously caught everyone off guard.
The short sellers are getting murdered as they are buying frantically along with the new longs and existing longs who want to add to their positions. Short selling involves borrowing BKS shares, selling them, and purchasing them back at a lower price. In that instance the trader keeps the difference and returns the shares to the lender.
That’s when things work out. When stocks rise against the short seller, s/he loses money. And since their is no upper boundary to the shares’ price, the risk is said to be unlimited.
To hedge against this risk while short, a trader can purchase call options above the market price to capture any violent reactions to the upside, such as the one we see this morning. This is the best option, literally and figuratively, to offset the risk to the upside.
Selling put options against a short sale is technically considered a “covered” position, but the trader only gets to keep the option premium. If the stock drops far enough, the put option will be exercised and the short seller will be forced to repurchase the stock thereby covering the short position. The option seller keeps the premium also.
But that typically amounts to a few dollars which the put seller will get to keep. However, against a $13 rise, keeping $3 in option premium is the proverbial set of steak knives.
Most traders are taught rightfully to place protected buy stops above the market to purchase the shares and offset the short sales. In instances such as today, there is oftentimes no liquidity since the whole world seemingly wants to buy the stock. Stop orders become market orders once the shares trade “at or through” the stop price that the trader delineates on the order ticket.
If I’m short at $15 and I’ve placed my protective Buy Stop at $18, once BKS trades at $18 or higher, I will get filled at the market. That could be significantly higher. The first trade might not go off until $22. That is “at or through” $18, so there will be significant “skid” or slippage as it’s called on my order. Slippage and skid is an expense to the trader.
A trader could have purchased a call with a $15 Strike Price so that all of today’s news would have been captured in the option premium, thereby benefiting and hedging the short seller for any damage above $15.
The only way to capture that $4 slippage is by owning call options to hedge your short position (especially over weekends). Owning options is a pure hedge. Selling options is a partial hedge strategy and is typically used as a strategy to generate more income.Continue Reading...