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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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As might be expected of a man who has built one of the worlds most successful trading operations, Joe Ritchie is dynamic, energetic, and brilliantJoe Ritchie: The Intuitive Theoretician Joe Ritchie is the founder and driving force behind CRT. It is his ideas, concepts, and theories that serve as the blueprint for the complex strategies that guide the firm. Although he has never taken an advanced math course, Joe Ritchie is considered by many to be a math genius-a natural. He would have to be, given the intricate mathematical nature of the trading models employed by CRT. Joe describes math as something he almost feels or mtuitively understands. Ritchie would be the first to emphasize that the success of CRT is hardly a solo act. There are many individuals that are integral to me companys achievements. In our interviews, Joe insisted that I also talk to some other CRT personnel. Here is how one key employee described Ritchies philosophy: Joe believes in empowering people. He trusts people. I sincerely believe that one of the reasons we can make so much money is that Joe makes us feel absolutely comfortable to risk his money. Ritchie makes a lot of business decisions based on his gut feeling about the people involved. If he feels any discomfort with the people, he has no reservation about walking away from even the most lucrative venture. On the other hand, he has been known to initiate major operations on not much more than a handshake. A recent case in point is his venture in launching a computer company in the former Soviet Union. The company is involved in every phase of the production and marketing chain, including developing software, importing hardware, establishing service and trading centers, and implementing a distribution system. This whole elaborate operation sprang to life because Ritchie was impressed by an entrepreneurially inclined Russian whom he met. His trust and confidence in this man was all it took to convince Ritchie to make the investment commitment. As one CRT employee explained, While every other U.S. company involved in a joint venture in this region is trying to write three-hundred-page legal documents to protect themselves, which dont hold water there anyway, Joe asked the Russian to write a contract that he thought was fair, and Joe signed it on his next trip to Moscow. As might be expected of a man who has built one of the worlds most successful trading operations, Joe Ritchie is dynamic, energetic, and brilliant. Work is truly fun for him because it is an endless challenge and an ever-changing puzzle. But there is another key aspect that delights Joe Ritchie about his work: the people. I love to come to work, he booms. And he means it. Its not just that he loves what he does, but he considers CRT an extended family. He appears to exude a genuine affection for his employees. ==== When you first started doing silver arbitrage, you had hardly invented the wheel. Other people were already doing the same thing. Did you do anything differently in order to succeed? ==== We tried to do a better job of understanding the interrelationships between markets and assessing the probabilities involved. We also traded more aggressively and for a narrower margin than the other brokers. We did the same thing years later in options, when by using more accurate pricing models we were able to quote such narrow bid/asked spreads that our main competitors assumed we were making markets that were too tight to be profitable. If you really have the mechanics or theoretical value nailed, you can do a lot more volume at a smaller margin. ==== How did the other floor brokers respond to your competing for the same type of business? ==== They resented us because we were so aggressive and were eating into their volume. ==== But I imagine that back then you had very low capitalization. How could you have been much of a threat to their business? ==== Thats true. We probably had one of the smallest capitalizations on the floor. Some of the other key players might do a five-hundred-lot arbitrage order, whereas if we did fifty, we would be up to our limit. However, we traded it back and forth much more aggressively, so we ended up with a much larger proportion of the volume than might be expected relative to our typical order size. ==== Was that a matter of your willingness to take a smaller edge than the other brokers? ==== That was certainly part of it. But there were a hundred other small things. For example, getting better phone clerks, or coming up with faster ways to communicate between the Chicago and New York silver floors. ==== I dont understand. Doesnt everyone use the telephone? How much faster can yon get? ==== Youre going to find this hard to believe. When I first came to Chicago, we found that a lot of the people who were doing silver arbitrage didnt even have a phone clerk because they didnt want to pay for one. Instead, they had a telephone with a little light above it, and when the market changed in New York, the New York floor clerk would pick up his phone, which would cause the phone light to flash in Chicago. When the Chicago broker saw the light, he would run over to the phone, get the quote, hang up the phone, and run back to the pit to do the trade. The transmission time that was involved was so slow that we thought we could easily beat it by getting good phone clerks. ==== Were most people doing it that way? ==== About half of them were. But even the ones who were using phone clerks still had a transmission time of about three to ten seconds. We found that if we got the best phone clerks, motivated them, and did everything else right, we could cut that time down to about two seconds. ==== Essentially, you were doing the trades faster and taking the trades before the spreads widened to the point where other brokers would do them. I assume that approach didnt make you very popular. ==== It made us very unpopular, hi fact, they tried to throw us off the floor. ==== On what grounds? ==== For rule violations, such as the phone clerk verbally calling orders into the pit. Technically, the orders are supposed to be written down and carried to the pit by a runner. However, it was standard operating procedure for orders to be called into the pit. The exchange realized that they needed the arbitrage activity to provide liquidity, so the rule was not enforced. However, that didnt stop them from pulling us in front of the committee for violating this rule. In the end, they had to drop the issue when they realized that trying to enforce the rule against one party and letting everyone else violate it was not going to work. ==== You make it sound like a real insiders club. ==== It was. ==== Is that true of most exchanges? ==== [Long sigh] It varies a great deal from exchange to exchange, but its a lot less prevalent than it used to be. The competition has just forced changes. ==== The silver arbitrage operation eventually came to an end. What happened? ==== The silver arbitrage was very profitable during 1973-74 because the market was so volatile. However, when the volatility died down in 1975, the silver arbitrage became a very slow business. I tried to convince the fellow who owned the company I worked for to try something else. I thought that the soybean cmsh was the business of choice at the time. [Soybeans are crushed into two constituent products: meal and oil. If soybean prices are low relative to the product prices, then crushing plants can lock in very attractive profits by buying soybeans and selling an equivalent amount of products. This activity will cause soybean prices to gain relative to product prices. Conversely, if soybeans are highly priced relative to products, causing the profit margins to be low or negative, crushing activity will be reduced. In effect, this development will reduce soybean demand, which will decrease soybean prices and reduce product supply, which will increase product prices. Essentially, these economic forces will cause soybean and soybean product (meal and oil) prices to maintain a broadly defined relationship. The soybean crush trader tries to buy soybeans and sell products when soybeans are priced relatively low versus products and do the reverse trade when soybeans are priced relatively high.] ==== What did you do differently to give you an advantage over other brokers who were doing the crush? ==== Very simple things. Many of the same things we did in silver. We would keep the best clerks by paying a good wage and providing them with the opportunity for growth. We also constructed our own crude slide rules that would show the implied price for soybeans given different price combinations for soybean oil and soybean meal. This tool allowed us to instantaneously calculate the value of the market, which helped us take advantage of the order flow more quickly. I cant tell you why the other brokers werent doing the same thing, but they werent. ==== Were you still associated with your original company at the time? ==== Yes. I reached an agreement to switch from silver arbitrage to doing the soybean crush, wherein I would be responsible for all losses but would split any profits with the company 50/50. ==== It sounds like heads you win fifty, tails you lose one hundred-not a very good deal. Why did you stay with the company under that arrangement? Did you need the use of their seat? ==== No. It was probably a combination of inertia and loyalty to the company for having given me my start in the business. But eventually I went off on my own. ==== Was that the start of CRT? ==== Yes, although the name and the partnership arrangement came later. The move into the soybean complex was also characteristic of what was to become one of our principles all along-namely, not being tied to any one business but rather moving to the markets where something interesting was going on. When we first formed a partnership, the company name was Chicago Board Crushers. Then some time later we changed the name to Chicago Research and Trading. [Mark Ritchie, who has been sitting in for the interview, interjects.] One of the reasons we changed the name from Chicago Board Crushers was that our secretary got tired of explaining to people who called in why we couldnt crush their boards. ==== Youre joking. ==== No, seriously. ==== You just mentioned the idea of being flexible enough to switch to the markets that had the best trading opportunities. As I recall, you became involved with silver again during the wild 1979-80 market. Were you just trading the arbitrage, or did you do some directional trades? ==== Almost exclusively arbitrage. When the volatility expands dramatically, the opportunities for profit in arbitrage are greatly enhanced. There was one trade, however, that you could term directional. This is one of those stories that proves that its better to be dumb and make a profit than be smart and take a loss. In early 1979, some mystery buyer came in and bought twenty thousand contracts of silver. Nobody knew who it was. I did some digging around and found that the person who was managing this trade was a Pakistani. I happened to know a Pakistani who was from the upper cmst, and the upper crust of that country is relatively small. So I asked her if there were any Pakistanis who could have that kind of money. She said, No, but there are two Pakistanis that manage money for the Saudis. She gave me the two names. Sure enough, with a little secret investigating, we found that one of these guys was connected to the buying. We thought we had a nice bit of information. At the time, silver options were traded only in London. The out-of-the-money silver calls were trading at very low prices. Even though the market was not that liquid, I bought a huge amount of calls. I took a ridiculously large position relative to our equity base, knowing that our downside was limited. [Essentially, an out-of-the-money call gives a buyer the right to buy a contract (silver in this instance) at a specified price above the current price. If the market fails to rise to that price, the option will expire worthless, and the entire premium paid for the option will be lost. On the other hand, if prices exceed the specified price (called the strike price), then the right to buy offered by the call position can result in profits. If the strike price is significantly exceeded, the profit potential can be huge.] We had lots of theories about who might be buying all this silver. But there was one theory that we had never considered. It turns out that some guy had passed off a $20 million bum check to a brokerage office in Dallas. ==== What did that have to do with the Saudis? ==== Absolutely nothing. Apparently, he wasnt related to the Saudis. He was just someone who passed a bad check. So while we thought we were being very clever, all our analysis actually proved to be inaccurate. The brokerage company finally caught this guy, sold out his position, and silver prices slid down to under $6.1 couldnt even get out of my position because the market was so illiquid and I held so many options that I would have gotten virtually nothing for the contracts if I had tried to sell. Essentially, I ended up being married to the position. At that time, I went away for a vacation, which was fortunate, because the Hunt buying started to push silver prices sharply higher. Im sure that if I were around, I would have gotten out at the first opportunity of breaking even. By the time I came back, the silver calls were in the money [i.e., the market price had risen above the strike price], Although I thought the market was going to continue to go up, I couldnt stand the volatility. One day, I decided to go into the silver pit just to get a feel for what was going on. I promised myself that I would keep my hands in my pocket. At the time, silver was trading at $7.25.1 decided to sell twenty-five contracts against my calls just to lock in some profits. Before I knew it, I had liquidated my entire position. By the time the calls expired, silver prices had gone up to about $8.50. |
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