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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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But the point is that I still ended up with a large profit on the trade==== Are there any trades that you would consider particularly memorable? ==== One that comes to mind occurred on the day the Falklands war broke out. People off the floor have the idea that the traders on the floor are the first to know whats going on. Nothing could be further from the truth. The market erupts long before we ever get the news. Were the last to hear whats driving the market. On that day, I had taken a large position in soybean meal at what looked like s great price. By the rime I got out of the position, in what was probably only one minute, I had lost $100,000. ==== Any other memorable trades? ==== Ive always lost money faster than Ive made it. One particularly striking instance concerned the roaring gold market during the period from 1979 to early 1980. Gold was sitting at around $400 when Iran took the hostages. I thought that the heightened tensions aroused by this situation would push gold prices much higher. But the market responded sluggishly, so I hesitated. The market eventually did go higher; it went to almost $500 over the next month. This was a classic example of not doing what you know should be done. ==== In other words, you failed to act decisively, a trait you cited earlier as one of the key ingredients to being a successful trader. ==== Exactly. I eventually ended up buying gold at just under $500 an ounce. And as you might guess, it went down the limit the day I bought it. Locked limit-down, in fact. ==== Did you think of getting out? ==== No. The hostage situation was still completely unresolved. Also, around the same time, the Soviet Union had invaded Afghanistan. I still felt the market would eventually continue to go higher. So I stuck with it. Of course, as you know, the market did go sharply higher. ==== Did you have a plan for getting out? ==== Yes, my plan was to get out whenever the market dropped 10 percent from its high. ==== Basically, your plan was to let the market run until there was some sign of meaningful weakness. ==== Right. Unfortunately, when the market dropped, it lost 25 percent of its value in one day. Needless to say, that was a particularly painful loss. But the point is that I still ended up with a large profit on the trade. In fact, this trade raises the whole question of how you view drawdowns. Most people dont distinguish between drawdowns in open equity and drawdowns in closed equity. [The distinction is that open equity refers to unrealized profits on an existing position. In effect, what Ritchie is implying is that he views a given loss differently if it is a partial surrender erf profits on a winning trade as opposed to if it is a drawdown in alosing trade.] If I protected open equity [i.e., open profits] with the same care I protected closed equity, I would never be able to participate for a long-term move. Any sensible overall risk control measure could not withstand the normal volatility in such a move. ==== In other words, in order to score the really large gains, you have to be willing to see those gains erode significantly before getting out of the market. ==== I cant see any other way. If you get too careful about not risking your gains, youre not going to be able to extract a large profit ==== How much do you risk on any single tradeor idea (measured from trade initiation, not peakequity)?==== About one-half of 1 percent. I think its generally a good idea that when you put on a trade, it should be so small that it seems almost a waste of your time. Always trade at a level that seems too small. ==== You spent approximately the first ten years of your trading career on the floor and then made a transition to trading from an office. Since you were very successful as a floor trader, Id like to understand your motivation for making the switch. First, tell me, would I be safe in assuming that while you were a floor trader, virtually every month was profitable? Lets take it one step further. What percentage of your weeks would you estimate were profitable during that period? ==== Ninety percent. ==== Most people would say, **My God, 90 percent of the weeks this guy makes a profit! Why would you ever leave that type of an edge? ==== First Ill give you my short answer: old age. Also, the soybean market had lost much of its volatility, which reduced trading opportunities. It seemed like the right time to try trading off the floor. ==== Did you have a plan on how you would approach trading from upstairs? ==== I had no idea. I checked out lots of things. I tried a number of advisory services but found that they were often not worth the time it took to listen to the phone tape. I eventually gravitated toward trying to develop my own systems. One of the things that amazed me was the unreliability of information by the so-called pros of the industry. For example, when I started working on testing and developing systems, I purchased price data from a company that marketed what they called a perpetual contract. [The perpetual price is derived by interpolating between the nearest two actual futures contracts to obtain a hypothetical price series that is always a constant amount of time forward from the current date (e.g., ninety days). The resulting price is a theoretical concept that will be a hybrid of two different contracts and cannot be replicated by any real-world trading instruments).] I used this data for over six months before I realized that it was not a reflection of the real market. For example, the perpetual series could show a large price move that implied a profit that you could not have realized in the real market. When I discovered mis, I almost fell off my chair. I couldnt understand how anyone who had ever traded anything could have constructed this type of series. I asked myself, How can all these professionals who obviously know what theyre doing be following data thats fundamentally foolish? The question was easy enough to answer. After all, I had used it myself for six months. I had to go back to square one and start over. I never again trusted anyone elses work. ==== Did you buy any commercial trading systems at the time? ==== Yes, I did buy a couple. One of them-1 dont want to mention the name-was essentially a simulation package. I had assumed that if I could get a tool that would allow me to develop optimized trading systems, it would be a thousand times more effective than trying to approach the market by using charts. [Optimization refers to the process of testing a particular system, using many different values for the key inputs, and then choosing the single combination of values that worked best for past history. Although this procedure can yield wonderful performance for the past, it usually wildly overinflates the implied performance for the future.] Instead, I found the software was worthless. There again, I was amazed at the magnitude of ignorance of the people who had developed this system. ==== In what way was it worthless? ==== The software was a system that allowed you to optimize the market to death. In fact, this organization even recommended reoptimizing the system every week. In other words, curve-fit the program to last week so the trades this week will match what should have been done the previous week. I just got the overwhelming impression that whoever had developed the ideas for this system had never traded himself. ==== Did you ever find out if that was true? ==== [A long sigh] I asked that question, but they just dodged it. In fact, I remember the company salesman showing me how to enter the data manually. Personally, I prefer to get the data by computer, because manual entry just seems like too much work. Anyway, this fellow, who was himself a trader, said, I dont even pay for the price of the Wall Street Journal I have a friend photocopy the price page for me. I thought to myself, Heres a guy whos marketing a program thats being represented as the premiere trading system software on the market, and he doesnt even have enough money to buy the Wall Street Journal. ==== Did you actually try trading the system? ==== Yes, but the results were just spasmodic. Moreover, I was extremely uncomfortable with the idea of trading a black box [trading system computer software that generates buy and sell signals without revealing the rules of how the signals are generated]. I swore to myself that I would never purchase a black box system again. ==== Is your advice to people then: Forget what`s out there and do your own work? ==== My advice to people has always been: Stay out of the business; stay completely away from the market. For novices to come in and try to generate profit in this incredibly complex industry is like me trying to do brain surgery on the weekends to pick up a little extra cash. I have a friend who knows three doctors who got together to invest in a stud race horse. When they took delivery of the horse, they found that it was a gelding. My friend was teasing them about this and asked if they had ever thought of inspecting the horse. You wont believe this, but it turns out that they had thought of it, but they didnt go any further. So he said, Well, you guys are all doctors; did you ever bend over and take a look under there to make sure he had the necessary tools? If you asked those three doctors today what their mistake was, Im sure they would tell you that they should have inspected the horses valuables. They still wouldnt have learned the lesson: DONT INVEST WHERE YOU DONT KNOW WHAT YOURE DOING. If they invest in another horse, they wont get a gelding, but theyll make some other mistake just as laughable. ==== Do you mean to imply that people should just put their money in T-bills? ==== I think they can go with some of the managed funds or trading advisors that have proven track records. But I would take very seriously the standard disclaimer that says, Past performance is no guarantee of future results. Also, I dont think you can make money unless youre willing to lose it. Unless you have money that you can afford to lose and still sleep at night, you dont belong in the market. My willingness to lose is fundamental to my ability to make money in the markets. ==== And thats not true of most people? ==== Thats right. Most people come into this business without a willingness to lose money. They also enter the market with unrealistic expectations. Even if theyre lucky enough to pick a successful trading advisor, theyll likely to pull their money out the first quarter he has a drawdown. So they end up losing even though they may have been in a winning situation. |
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