Wednesday, March 4, 2009

Larry Hite: Market Wizard

(Each week I've been discussing a new interview from Jack Schwager's canonical trading book Market Wizards. This week I discuss the interview with Larry Hite.)

I had very low expectations for this interview. The subtitle was "Respecting Risk," and I thought, "How dull, another dude here to tell me to cut my losses short while trading in the stock market." But I was pleasantly surprised by Larry Hite and what he offered.

First of all, from a completely non-trading perspective, Hite told great anecdotes while making his points about trading. I get the feeling that in some of the Market Wizard interviews, the interviewees were like, "Who is this Jack Schwager guy, and why is he asking me all these questions..." and so they offer lots of terse responses.

Hite wasn't like that. He offered page-long responses to many of Schwager's questions with nice little stories about death and success peppered here and there. And hey, they conducted this interview from Windows of the World, the restaurant that used to sit atop the World Trade Center... perhaps that made me a little nostalgic.

Anyway, so lets get right into one of the long meaty answers that Hite offers. Schwager asks him about trading systems, but I think Hite's response speaks more to human psychology, and why the market will always be here. It also hints at why we'll eventually bottom.

People don't change. That is why this whole game works. In 1637, tulips in Holland traded for 5,500 florins and then crashed to 50, a 99 percent loss. Well, you might say, "Trading was relatively new then; these people were primitive; capitalism was still in its infancy. Today we are much more sophisticated." So you go to 1929 and find a stock like Air Reduction which traded at a high of $233 and after the crash fell to $31, a decline of 87 percent. OK, you might say, "The Roaring '20s were crazy times, but now things are surely different...
Hite offers more examples, but you get the point. However, if you really need more, check this table put up by Barry over at The Big Picture, (a blog that refuses to link me) in his discussion of Zombie Banks.

At a few separate times during the course of the interview, Hite says that trading is boring. He's not into exchanging war stories. As he puts it, "I don't trade for excitement; I trade to win." That makes a lot of sense to me.

I mean, if you read this blog, you know about the RO and how on any given day some dude normally makes $20 grand, and some dude normally loses $8 grand. There's a lot of excitement in those numbers and often traders will vacillate between winning and losing all day. My goal is to always be in the top 10 and just stay there throughout the day. It's a little boring, but it'll extend my life a few years, I know it.

Now we get to the portion of the interview where I decided that I really liked Hite. Schwager asks him how he has been able to achieve returns far above the industry average. Hite answers that they manage risk. "The truth is that, while you can't quantify reward, you can quantify risk."

In a nutshell, this is how I used to trade back in my sun filled early years. I'd sit at my desk and hold 30 or 40 positions knowing that I could get out if they went a quarter point against me. I entered, knowing where I would get out and let them run if they worked. Sure, I got stopped out of many, but a large percentage also ran. Often, out of those 30 or 40 positions, I'd only have 1 or 2 big winners and then the rest of them would cancel out.

The hybrid market really changed this equation. With all the 100 and 200 share static moving stocks 40 or 50 cents on no volume, managing my risk became a much more difficult task. This is the story of the last two years for me, figuring out how to manage my risk once again.

Also, I liked Hite because he didn't claim to really "know" anything about the markets he was trading. "Fuck yeah!" I thought. I mean, aren't 95% of analysts always wrong? You can only manage your personal risk, you can't know a market. Schwager asks Hite about how he can trade so many different markets successfully and Hite replies, "We don't trade markets, we trade money." When asked how he differentiates a trade in gold versus a trade in cocoa, Hite answered, "They are both a 1 percent bet; they are the same to me." Indeed.

This helped me come to terms with the apparent fog I've been in for the last decade. People who know I trade are always asking me about the stock market. I always respond, "I don't know anything about what the stock market is going to do." I think that often, people walk away thinking I'm some sort of crackpot. But it's the truth and it always has been, I simply don't know. Further, I don't know what credit derivatives are, I don't care about the relation between bonds and stocks, and fundamental analysis is and always will be silly.

To a trader, these things, these specifics are rather unimportant. You just care about managing the money you have, finding good entries, and managing your risk. Hite really drove that point home and I walked away from the chapter more confident than ever in my utter ignorance and disregard for the minutia of the markets.

Next week we will venture into Part II of Market Wizards where the focus shifts away from commodity traders to stock traders.

8 comments:

anarco said...

Very interesting article DT!
I was also thinking about the concept of "trading to win and not trading for the excitement."
The real challenge (and with real I mean the challenge that we have to face when we have money on the line) is that both loosing and winning evoke, in most humans, a sort of excitement (fear, greed, agitation, frustration, etc). So although the focus should be on winning, in fact a lot of the background psychological work one needs to do is controlling emotions.
(I find myself coming back to your blog, so I am here from mine).
Cheers,
Anarco

anarco said...

Last sentence does not make sense in the above post. I meant to say that I am linking to your blog from mine.
Cheers

Dinosaur Trader said...

Cool, thanks.

Yes, you're right. Controlling the emotions is key. Whether or not you are winning or losing you should try and keep an even keel. Important to notice that when you're winning you shouldn't get too excited, just as when you lose you shouldn't get too depressed.

Thanks for reading.

-DT

Yogi & Boo Boo said...

DT - Good post. Maybe it's time I go back and re-read Market Wizards. Nothing ever changes in the markets. I like your comment about "figuring out how to manage my risk once again".

For me, that's been the most difficult skill to master. Markets always change, that's a given. We as traders are also always changing. That's also a given, but I think it far more difficult to master.

MikeH said...

I don't think I'd dismiss "knowing" about the markets so easily. It is true that on average, human emotions and the resulting actions have not changed over time. But the situational circumstances change, usually accompanied by "this time it's different!". We know the results are the same, but the game has changed and if you continue to play the "old" way, you die out. Like a dinosaur.

Let's say that before the hybrid changes, every trade you did paid out 6:5 odds. You just keep doing them, and it does take on that feeling of "boring". But now some factors change, such as hybrid exchange and the growth of algorithmic execution engines. Say this changes your odds to 5:6. And while it's still trading and your basics are still correct, you are, in your own words, in a fog as to why it is not working.

I've got a idea for a post rolling around in my head about the cycle of street smarts vs. book smarts. One side is always putting it to the other, but that side switches over time. You'll be naturally inclined to operate on one side or the other, but ignoring everything else will get you blindsided to some degree. You need to be "aware" of as much as you can, and how it applies to your "go to" skills.

J to the B said...

how could anyone refuse to link to the Dino Trader???

Sheeeeeeettt

TRB

Dinosaur Trader said...

Mike H,

You raise some good points. True, human behavior is far more constant than market behavior, but humans create these markets with their neverending war pitting fear versus greed. So even if a market feels "different this time" it will end up acting the same, whether it be a bubble in tulips or in housing.

Thanks for the thoughtful comment.

And "J to the B," you're currently running my favorite blog out there. Keep up the great work and thanks for linking me. When your blog gets huge, I look forward to the bump in traffic!

-DT

Charlie G. said...

Thanks for doing the work on summarizing these - this in my list to read but getting the digestible nuggets with the discussion is helpful.