Introduction

About the book

'Unknown Market Wizards' is a book by Jack D. Schwager (author) that reminds all traders that each trader has to find an approach that suits his personality and that works within their set of risk parameters. After this approach is discovered, they can exploit this edge over and over again. 

The book is a curation of several stories of traders around the world that are unknown to the investment world. Despite their anonymity, these traders have achieved fabulous performance records than rivals, if not surpass, the best professional managers. 

About the author 

Jack Schwager is a well-known industry expert in futures and hedge funds. He is the author of many widely praised financial books. He is known for his best-selling series of interviews in the last three decades: Market Wizards, The New Market Wizards, Stock Market Wizards, Hedge Fund Market Wizards, and The Little Book of Market Wizards. 

He is the co-founder of FundSeeder. This firm seeks to find undiscovered trading talent across the world via its trader platform.

Jack Schwager is also a seminar speaker and has lectured on a variety of analytical topics like characteristics of great traders, investment misbeliefs, hedge fund portfolios, technical analysis, and evaluation of trading. 

Buy the book

This book provides you with great insights into what it takes to become successful in the markets. We highly recommend you to read the entire book. (affiliate link)

Buy from Amazon

Peter Brandt: Strong Opinions, Weakly Held

Most people think that the method of entering a trade is the most important part of being a successful trader. However, for Peter Brandt, it is one of the least important factors. He feels that classical chart analysis has virtually lost its entire edge. What’s important is risk management.  

Chart analysis is just a tool to identify points that are susceptible to Brandt’s risk management approach. His methodology comprises identifying asymmetric trade opportunities—trades where the anticipated upside potential significantly exceeds the basic risk.

It is confusing that Peter Brandt used a protective stop strategy that reduced his overall returns instead of using an approach to maximize returns. The reason is that an approach that increases return but also increases risk by a greater amount is insignificant. 

Peter’s primary mentor relied on fundamental analysis however, he himself developed a trading approach strictly based on technical analysis. It involved taking trades of much shorter duration. Brandt learnt the importance of money management from his mentor but developed a trading procedure strictly on his own.

Brandt has been very disciplined about trading his method all through his career with one major exception. In 2013, after months of net losses when his approach seemed to be out of sync, Brandt got influenced by general talks of technical traders. In a moment of weakness, he renounced the approach that had helped him well for so many years and started experimenting with techniques that were not his own. Such involvements simply extended his losses. As a result, he ended up with his only losing year since he started trading again in late 2006. He turned a 5% drawdown into a 17% one.

Human emotions and instincts will often lead traders to do the wrong thing. Brandt admits that he is an impulsive person and that if he watched the screen and followed his instincts to enter trades, he would self-destruct. He believes that he is successful only because he uses a precise process in placing trades and it excludes his emotional responses.

Brandt selects trades that meet specific criteria, and the timing of those trades is well-defined to the entry day. Once he is in a trade, he has a predetermined exit point if he starts losing money and a plan to book profits if the trade is correct.

Many traders, particularly novice, fail to understand the critical difference between bad trades and losing trades. Brandt says that the determinant of a good trade is whether you followed your method, not whether the trade made money. The reality is that no matter how good the approach is, some percentage of trades will lose money and there is no prior way to know which will be the winning trades.

Many traders have a comfort level regarding the trading size. They may do well with smaller sizes but they see a substantial deterioration in their performance at larger sizes, irrespective of the markets being liquid. He suggests that the increase in position size should be gradual.

Some traders may be comfortable trading their own money and may do well but their performance falls apart when trading other people’s money. This phenomenon can occur because, for some traders, a sense of guilt in losing other people’s money may distort their normal trading decision process. It is not a coincidence that when Brandt managed other people’s money it was his worst decline. 

Interestingly, the month when Brandt returned all investors’ money was the low point of his decline and was followed by 20 winning consecutive months. Success in trading one’s own account does not necessarily mean being successful in managing money.

Brandt improved his performance by eliminating “popcorn trades”— trades that have a significant profit but are then held until the entire profit is surrendered or turned into a net loss. This negative experience prompted Brandt to establish rules to avoid such outcomes:

• If he has a net profit equal to 1% of his total equity, he will take partial profits.
• Once a trade reaches 30% of his profit target, he will assign a much closer stop.

Another trading rule is: If an open trade shows a net loss on a Friday close, simply get out. The reason here is that carrying a position over the weekend involves more risk than holding the position overnight on a weekday. Liquidating the position in this scenario is sensible risk management. 

According to Brandt, winning streaks lead to contentment, and contentment leads to sloppy trading. In the strongly winning periods, it is least likely for the trader to consider what might go wrong. 

One thing Brandt regrets is that he did not keep a log. Discretionary traders should categorize their trades and monitor outcomes, so they will have the hard data to know what works and what doesn’t.

Patience is a common trait among successful traders but not necessarily an inherent one. In Brandt’s case, he was impatient but had the self-discipline to enforce patience. He avoids the temptation of taking every trade and waits for the one where the upside prospect is three to four times greater than the required risk. 

According to Brandt, Trading for a living may look appealing but it is far more difficult to achieve. Most aspiring traders are undercapitalized. They underestimate the time it takes to develop a profitable methodology. According to Brandt, it takes three to five years for the same.

Brandt’s motto is: Strong opinions, weakly held. A trader must have a strong reason for taking a trade, but once he is in a trade, he should be quick to exit if the trade doesn’t behave as per expectation. There is nothing wrong with being wrong if you exit the trade with only a small loss. don’t worry about looking foolish because of changing your opinion. Reversing an opinion on a market reflects flexibility which is not a weakness but the trait of a trader.

One of the main characteristics of successful traders is that they love to trade. Be sure you want to trade. They should not get confused between wanting to be rich and wanting to trade. Unless the endeavour is loved, success is unlikely.

Jason Shapiro: The Contrarian

Jason Shapiro’s trading dates back to 2001. His returns were dependent on the fluctuating target volatility defined by the allocator.

At a 20% target volatility, his average annual compounded return is 34.0% and his maximum decline is less than half of his average annual return at 16.1%. 

Shapiro’s volatility is inflated by numerous large monthly gains hence his volatility level overstates the implied risk.

His return/risk numbers are extremely powerful, with a Sortino ratio of 2.83 and a monthly Gain to Pain ratio of 2.45. One remarkable aspect of Shapiro’s record is that his returns are negatively correlated to stock and hedge funds.

Given the developments of the past few decades like algorithmic and high-frequency trading, artificial intelligence, the expansion of hedge funds, it was still possible for Jason Shapiro to beat the market as an individual trader.

At its core, Jason’s trading success is rooted in exploiting the shortcomings in the emotion-based trading decisions of other market participants. He prefers to go short when bullish euphoria over-rules and to go long when bearish sentiment is prevailing. 

While the market structure, the nature of the participants and the available trading tools have all changed dramatically over time, the one thing that has not changed is human emotion. And it is the perpetuity of human emotions that assures that trading opportunities will continue to exist.

To trade like Shapiro, one will have to go against his innate human instincts. 

For a contrarian trading approach to work, entry into markets is critical. There are two vital elements to Shapiro’s approach:

• Taking positions to contradict the extremes of market positioning
• Timing those entries based on market action.

Shapiro depends mostly on the weekly Commitment of Traders (COT) report to determine extremes in market sentiment. He prefers to be on the opposite side of extremes in speculator positioning, or equivalently, on the same side as commercial positioning. As a supplemental input, he also uses financial TV shows which can be useful in trading as a contrarian indicator!

To time his contrarian positions, Shapiro looks for reversals that occur despite a prevalence of news on the contrary trend. 

Markets bottom out on bearish news and top out on bullish news. The general reason would be that fundamentals are only bearish or bullish relative to price. At some price, the news is fully discounted.

However, Jason has a better explanation for this- participation. Markets bottom because speculators are already fully positioned short—a condition that naturally occurs in a situation of relevant bearish news. A similar explanation would apply to market tops.

If there is one absolute in Shapiro’s trading process, it is having a stop-loss on every position. This rule prevents significant losses when the implications of the COT report are wrong. He selects a stop point that negates his assumption that the market has bottomed or topped.

Risk management is not just important for individual trades but at the portfolio level as well. Precisely, traders need to be aware of those times when markets become highly correlated. In such situations, the risk of any portfolio may be much bigger than normal because the probability of simultaneous adverse price moves is higher. Shapiro manages this high correlation risk by reducing his overall position and by adding inversely correlated trades to the portfolio.

Like most other market wizards, he too tells traders not to listen to other people. If they can identify who is reliable & who is wrong, then their opinions can be used on the contrary.

Richard Bargh: The Importance Of Mindset

A repeated lesson that comes up in all the interviews is one should find a method that fits his/her personality. In his early trading years, Richard Bargh tried to work through technicals even though he was naturally more inclined to fundamentals. He found that virtually all of his profits were coming from his fundamental trades. 

Finally, he switched his focus to his preferred method of fundamental analysis and his trading improved dramatically. Later, he also found a way to integrate technical analysis as an addition to fundamental analysis.

 
Richard believes that a calm and peaceful mindset is vital to successful trading. When he doesn’t have the right mindset, he stops trading and takes a break because such losses will generate losses of even higher magnitude.

In his earlier trading years, Richard took uncomfortably large positions to trade. That suspicion of taking trades caused him to miss many excellent trading opportunities. If his position size was more in line with his comfort zone, he would have profited from many of these trades. The lesson is don’t trade so large that fear overpowers your trading.

When uncomfortable about trading, one should try to identify that source of discomfort and then make amendments to eliminate it. Bargh’s discomfort in giving back large open profits on trend trades spurred him to change his exit methods.

Instead of using trailing stops to exit, he adopted a more price-sensitive approach. This modification improved his overall performance.

Impulsive trades are quite often triggered by impatience and Bargh strongly instructs to guard against such temptations. The market rewards patience and trades borne of impatience are usually destructive.

Market opportunities are irregular because of which the goal of consistent earning may not be realistic. If you try to force consistent profitability, you will be prone to take suboptimal trades, which will often end up reducing your overall profitability.

If a trade has not turned out as expected, cut losses immediately. Using stops on every trade is one way to control losses. But if a trade isn’t showing a profit in a reasonable period, as specified by the method, one should not wait for the stop to be hit. 

A trader does not have to exit a profitable trade all at once. Even if a trade reaches the target, a small portion of the position may be kept to get some additional profit if the market keeps moving in the same direction. Richard Bargh routinely maintains 5%–10% of a position that he liquidates because it has met his target. He knows that maintaining such small positions increases his overall profits without significantly increasing risk.

An important lesson he shares is that the damage from a bad trade often extends beyond the loss on the trade itself. Such trades shake up a trader’s confidence and lead to miss out on winning trades. This missed profit can often exceed the loss on the original trade.

Traders need to differentiate between trade outcomes and trade decisions.

Sometimes, a good decision may have a poor outcome, and a poor decision may have a positive outcome. 

Many traders mistakenly analyze their trading based entirely on outcomes, whereas meaningful evaluation should be based on whether trading decisions were consistent. Winning trades can be bad trades if they violate trading and risk control rules. Similarly, losing trades can be good trades if it follows the efficient process in generating profits with logical risk.

Amrit Sall: The Unicorn Sniper

Amrit Sall has one of the best track records of 337% average annual compounded return over a 13-year career. His return/risk numbers are simply astounding: an adjusted Sortino ratio of 17.6, a monthly Gain to Pain ratio of 21.1, and a daily Gain to Pain ratio of 3.6. These numbers are ten times that of excellent performance.

 The Sharpe ratio’s primary hook is that its risk component (the standard deviation) penalizes large gains equivalently to large losses. For a trader like Sall, who has many spectacularly large gains, this penalty is severe.

Sall’s incredible success combines three essential components:

1. Trade Research and Planning— Successful trading is a matter of hard work. Sall prepares diligently for every trade. He has compiled notes in thousands of pages, recounting all his past trades. For each of these trades, he recorded his trading plan, the details of the relevant event and market response, and what he got right and wrong. These trade notes, which are categorized, allow Sall to identify and study historical illustrations to prospective trades. Using this personally assembled research library, Sall prepares a highly detailed write-up for each trade. It is a plan that incorporates a wide range of scenarios as to how the trade might unfold in real-time. Sall also carefully watches the newswire all day for any unexpected events that might offer trading opportunities.

2. Trade Execution— The “unicorn” types of trades, as termed by Sall, require instantaneous voluntary decisions. It accounts for the vast majority of his profits, there is no time for reasoning and analysis. Even using a minute or two to think over the trade would result in missing the opportunity. In addition, Sall engages in picturization and mental rehearsal as to how he will respond in different circumstances. He also gets into meditation and breathwork.

3. Emotional Calm— Sall considers maintaining an appropriate emotional state of being calm, centered and focused. These traits are absolutely essential to being a successful trader. He is meticulous in avoiding a negative mindset or allowing a loss/mistake to impact a subsequent trade opportunity.

He believes that generating profitable trades is challenging, but doing nothing between the genuine trade opportunities is even more difficult. Being patient to avoid such temptations is important for two reasons. First, these trades will be net losers. Second, the negative impact of these trades may result in missing the really big trade opportunities. The lesson is to only take trades that fit your rules and avoid the insignificant trades.

Sall explains that the markets don’t provide opportunities regularly. As a result, a goal of making profits every month will tempt traders to take trades that are based more on hope than methodology. This in turn will make traders act in the opposite diametric of patience. The two essential characteristics of the trades that Sall has the patience to wait for:

1. These trades have a high probability of moving in the anticipated direction.
2. They are asymmetric trades where the potential gain is far more than the risk taken.

Sall takes large positions on these high-conviction trades. The wide variation in his position sizing is an essential factor for generating outsized gains.

Sall always places a stop loss when practical because placing stops at the entry will have a high risk of getting stopped. This is because he trades large quantities based on extremely volatile events. Instead, Sall waits for the market to move enough in his direction so that his stop will only be triggered if the trade idea fails. In case the market moves against him before placing a stop, he quickly liquidates his position.

Winning propagates pride. When traders perform well, they tend to become negligent with their trade entry and money management. After one such winning period, Sall too fell into this trap when he placed positions in three highly correlated markets on a marginal trade.

The risk manager’s intervention helped him to avert a significant loss. Still, the experience helped Sall learn a valuable lesson to stay cautious after an extensive winning period.

Confidence is an inherent trait and Sall provides a good example of this. Even after having a negative account balance in his first trading year, he was still confident of succeeding. Resilience is another trait required for becoming a profitable trader apart from having skills and confidence. One should never give up.

Daljit Dhaliwal: Know Your Edge

Daljit Dhaliwal’s initial passion was tennis instead of trading. Yet, his track record speaks volumes. In his nine-plus years of trading in 2020, he has achieved a remarkable average annual compounded return of 298%. When he has a high degree of confidence, he trades aggressively by taking large positions. His average annualized volatility is immensely high at 84%.

Dhaliwal’s return/risk statistics are impeccable: an adjusted Sortino ratio of 10.3 and a monthly Gain to Pain ratio of 8.5. These numbers are five times the levels of excellent performance.

According to Daljit, a trader must know his edge. If he is not clear about it, he won’t know which trades to focus on or which trades earn a larger position size. One of the crucial improvements Dhaliwal made to his trading was identifying the types of trades that were responsible for nearly all his gains. By doing so, he was able to focus on identifying, executing, and managing those trades that really mattered. As an additional benefit, he was able to greatly reduce taking insignificant trades which had a net negative impact on his portfolio. Those marginal trades also dragged his focus and energy. Once a trader is able to identify his edge, he should stick to those trades that fall in his sphere.

It is amazing how many traders are highly competent in applying a specific methodology, yet fall prey to taking other types of trades, which usually end up with net losses. 

Dhaliwal was also able to identify the trades according to his edge because he kept a detailed daily journal of all his trading. He recorded not only his market analysis and reasons for each trade but also his feelings. This detailed journal made it possible for him to categorize trades and define the common factors in the trades that provided his big wins. 

The trading journal also helps to record lessons like correct decisions and actions and also the mistakes that were made. Reviewing such journals periodically is an effective way for a trader to improve. 

A trader has to be adaptable to become a successful trader. Daljit started out just using technical analysis, but he quickly shifted to focus on fundamentals when he realized that the smaller number of fundamental trades were the source of almost all his profits. 

His original method looked to capture the initial price movements on important headline events. However, once algorithmic traders started stimulating the predicted prices more quickly than he could manage to enter the orders, he shifted to a strategy of fading these price moves. This strategy was trading exactly from the opposite direction after the preliminary price move. 

As Dhaliwal supervised a lot of research with his full-time assistant, macroeconomic analysis became the primary driver of his trades. Change has been the only constant in Dhaliwal’s trading process. 

Daljit always makes sure to have stop loss protection on large positions. Another critical element is a specific process for cutting his position if a downside exceeds certain limits. He will cut size in half if a drawdown exceeds 5%, and cut it by half again if it exceeds 8%. If his decline reaches 15%, he will stop trading until he feels ready to resume. 

Another crucial point that is often overlooked is that the reward/risk ratio of a trade is dynamic and changes as the trade is held. For example, a trade is implemented, seeking a 300-point gain and risking a 100-point loss. If the market moves 200 points in favour of the trade, the reward/risk ratio then is completely different from the ratio at the time of implementation. Daljit Dhaliwal manages this dynamic nature by taking partial profits. According to him, holding the entire position is an attempt to be 100% right with a risk of being 100% wrong. 

Taking partial profits is another form of risk management tool. If the market suddenly moves against the trade, the action of partial profit booking will reduce the profit or loss.

There must be a contingency plan for every trade before execution. Formulating a trade management plan before getting into a trade is much more preferable because there is an advantage of making decisions with full objectivity. Once the position is executed, this advantage is also lost. Dhaliwal also plans out his trades to be sure of his response in each possible scenario.

Generally, traders develop their own opinions about how markets should respond to an event and then trade accordingly. Dhaliwal used the opposite approach of having no predetermined beliefs but instead looking at market price movement and then identifying the reason behind it. In this way, he allowed the markets to teach him the cause of specific price moves rather than trade on his debatable assumptions. 

Although Dhaliwal trades mainly based on his fundamental analysis, he does use technical analysis as a supplementary tool. One technical event that has important price indications is a breakout from a long-term trading range. If it sustains then these breakouts lead to an extended price movement in the same direction. 

The point is that the fascination to be intellectually correct leads many traders adrift. The only thing that matters is whether you are profitable or not. 

One of Dhaliwal’s rules is to seek clarity over certainty. The markets are not about certainty but about probabilities. Waiting for trades that are certain, will lead to inaction and missing many trades that offer good prospective bets. 

One common trait among many traders who achieve spectacular success is a love of effort. They often compare trading with a game. Dhaliwal refers to trading as a chess game. Whether you trade because you love the game of trading or because it is a possible means to make a lot of money? The odds are much better in the preceding case.

John Netto: Monday Is My Favourite Day

In the 10-plus years since he started his official track record, John Netto achieved an average annual compounded return of 42% based on his notional account levels. Using notional account levels instead of the actual account levels dilutes both return and risk levels and represents a performance picture of the planned risk exposure. The maximum decline during this period was 15%. Netto’s return/risk estimates have been excellent, with an adjusted Sortino ratio of 4.7 and a monthly GPR of 4.8.

Many Market wizards have recommended eliminating emotions from trading. However, John Netto takes the provocative view that emotions are one of the most useful tools for a trader. Although it may appear as contradictory advice, there is actually no disagreement.

Netto also believes that emotions will usually have a damaging impact on trading decisions. In fact, the tendency of emotions to lead to bad trading decisions is exactly what Netto seeks to tap into as a source of the signal. 

He tries to be mindful of his own emotional extremes, which will be as deleterious to trading outcomes as anyone else’s, as warning signals calling for immediate corrective action. For example, if Netto is in a trade that moves strongly in his favour, and he further wishes to load up on this position then instead of adding on to it, he will liquidate it immediately.

Although most traders incline to either fundamental analysis or technical analysis, some of the best traders combine both. Netto provides a good example of how fundamentals and technicals can be used collectively.

Netto evaluates the dominant market picture to determine whether he will take a long position or a short one. Once this fundamental bias is ascertained, he will then overlay his technical analysis to select trade entry points. Typically, these will be reactions to support or resistance levels within the market’s prevailing directional bias.

Event trading is another essential aspect of Netto’s methodology. He trades both scheduled events, such as Federal Reserve statements and Government reports, as well as unforeseen events. Netto emphasizes that to successfully trade events, you need to have a good sense of whether any given outcome is a surprise. He will only trade event outcomes that he considers to be a surprise relative to market expectations.

Execution speed is obviously critical in such trades since the market will typically respond quickly and dynamically to surprises. Netto has solved this problem by developing his own software that can read the text related to an event, determine the trade implications and place the appropriate trade, all in a split second. 

For this program to work, Netto defines the trade implications of possible scenarios before each scheduled event. The rapid execution from this process means that if his analysis is correct, Netto will capture a considerable portion of the market move, even when the event triggers a near-immediate market response.

After losing money, it is common for traders to feel a compulsion to quickly make money back in the same market. This temptation must be resisted. In his early trading days, Netto suffered a large loss in a short S&P 500 position. However, This trade was not a mistake because it was consistent with his methods. He was just wrong on the direction call.

He was determined to get his money back from the same market and ended up being stopped four times the same day. None of these four trades complied with his methods. It was just the emotional spiral that he got stuck in. He had lost almost a year’s profit.

One more concept is that counter-to-expected market response to a news development can provide a valuable timing signal. President Bush’s ultimatum to Saddam Hussein, which whistled the close start of the Second Gulf War, was viewed as a bearish development. The equities were still near the lows of a two-year-long bear market. The market opened lower on the news as assumed but then reversed, closing sharply higher. This unexpected price action indicated the beginning of a long-term bull market.

Another example of the same principle was during the election in 2016. It was quite assumed that Donald Trump would lose the election and that it was unlikely for him to win, so the market would sell off sharply. When it was clear that Trump would be victorious, equities began to tank exactly as anticipated. However, then prices rebounded from their initial losses and moved vehemently higher throughout the night. This unexpected market response to the news marked the start of an uninterrupted fourteen-month run-up in stock prices.

Netto explains that successful traders follow a process and strive for continuous improvement. They are aware of the fact that they can lose even when they are right in everything they do. Making money is not everything. Not losing is equally important as winning in some situations. When the risk is taken according to a process, it leads to success. However, when risk is taken on impulse, it leads to regret.

Jeffrey Neumann: Penny-Wise, Dollar Wise

A common theme that underlies Jeffrey Neumann’s spectacular trading career is that he is early. When NASDAQ transitioned the price quotes from fractions to decimals, he took advantage of the temporary trading opportunity created as different brokers authorized orders with different decimals.

In the adopted trading style, he enters his trades at the breakouts from long downtrend lines which is the earliest possible technical signal of a trend shift. This type of entry point often results in buying multiple false breakouts but Neumann gets out immediately if the breakout doesn’t follow through.

Neumann always looks to get in at the early stages of new product sectors, such as 3D printing. Many of these developing industries go through a cycle of a preliminary upward price wave because of hype over a new product. This generates excessive buying which is not justified by the fundamentals and then experiences a complete price drop once reality sets in. Sometimes these companies recover and sometimes they do not. Either way, Neumann seeks to catch the upward price movement phase.

Neumann’s trade entries are near the absolute low following a long decline and right before a massive, near-vertical rally. The trade entries look unnatural as if he had an advance copy of the following month’s prices. The key to such incredible effectiveness is that the trendline breakout is only one component of his overall strategy. Individually, buying trendline breakouts is a loser’s game. However, knowing which breakouts to buy is what makes his approach so powerful.

Neumann’s core trades share many of the following characteristics:

• The stock has largely declined or is extending sideways movement near lows.
• The company has a service or product that indicates significant potential on the upside.
• There is a catalyst to indicate the chance for a near price rally. 
• The stock is part of a sector that Neumann has defined as being primed for a substantial upward price move.
• He is familiar with the product and has tried it himself.
• The stock is showing some signs of life—either a sudden up move after a long period of decline or sideways price movement, or a sudden spike in volume after a prolonged period of relative inactivity or both.

When most of these elements are in place, Neumann is prepared to look for his breakout. Although it looks like a simple trade of buying a downtrend line breakout, it is a far more complex trade that considers a range of factors appropriately lined up.

Successful trading is a matter of skilful money management and not prediction. Neumann steps in only when he has a high conviction on a trade. His trading style requires a strong note of caution and would be dangerous for most traders to attempt. 

Extreme position concentration has helped Neumann because of three elements. 

First, he has a high success rate on his high-conviction trades. 

Second, he scales into his positions so that by the time he has as much as one- third of his account in a single stock or single sector play, his average entry price is much lower, providing him with a substantial cushion if the stock starts falling. 

Third and most importantly, he is very quick in liquidating his position if the stock starts moving down or against anticipation. Unless a trader has similar skills, taking such concentrated positions would be highly risky and would expose them to an account-ending loss.

Chris Camillo: Neither

The market analysis methodologies could be divided into either fundamental or technical or a combination of both. To succeed, a trader must find his own market approach. Chris Camillo’s approach is neither fundamental nor technical. He has effectively created a completely new class of market analysis and trading termed “social arbitrage.” 

Camillo observed social trends and cultural shifts in everyday life to develop his trading method. To expand his scope of spotting these trends, Camillo founded TickerTags. It is a company whose software allows monitoring and computing word combinations (he termed as “tags”) on social media that are important to specific stocks.

He was incredibly successful in this approach for about a decade before TickerTags came into existence. The key lesson was that being observant and highly tuned to new behavioural trends, both in your everyday life and in social media, could be a source for uncovering trading opportunities. 

He suggests not to get confused between a losing trade and a bad trade. They necessarily are not the same thing. Another piece of advice is not to listen to anybody when in a position. One must stick to his own approach and avoid being influenced by conflicting opinions. 

Camillo’s most regretful trade was one in which he got swayed by contradictory market opinions into liquidating two-thirds of his call position at a loss. Later, he found that his original trade assumption was fully validated. 

Patience to wait for the right opportunity is a valuable trait. It is also one of the most challenging qualities to acquire. Camillo believes that he would have done far better if he confined his activity to his high-conviction trades. 

Camillo’s problem is that the high-conviction trades he favours may come along only once every couple of months or even less frequently. He finds it difficult to spend four hours a day searching for trades and then waiting for months to place a trade. Nonetheless, Camillo is mindful of the importance of being more patient and believes his improvement in this regard over the years has enhanced his trading success. Not all trades are the same. As in Camillo’s case, many traders may have trades that differ in their anticipated probability of success. There is a middle ground between taking all prospective trades generated by a trader’s specific methodology and taking only perceived high-probability trades. Alternatively, a trader can vary the position size, taking larger positions on higher-probability trades and smaller positions on lower-probability trades. 

Confidence is one of the best barometers of future trading success. The Market Wizards tend to be highly confident in their ability to continue to win in the markets, and Camillo certainly fits this description. He exhibits confidence in his method and firmly believes that it will provide him with a clear edge. As well as he has done so far, he expects to do even better in the future. One way traders can discover their chance of success is to measure their confidence level. 

Camillo made his first trade at the age of 14. It is found that many of the highly successful traders developed their interest in trading at an early age. Traders who fit this profile probably have a better chance of success. Successful traders love what they do. Camillo succeeded because he found an approach that related well with his natural interests and passions

Marsten Parker: Don’t Quit Your Day Job

Ed Seykota mentioned two trading rules in Market Wizards. They were:

1. Follow the rules without question.
2. Know when to break the rules. 

Marsten Parker's trading story is a proof to the truth in Seykota’s reply.

Parker’s average annual compounded return during the past 20 years was 20.0%, more than triple the return of the S&P 500 index at 5.7% during the same period. His return/risk numbers were concrete with Sortino ratio of 1.05 and a monthly Gain to Pain ratio of 1.24, again almost triple the corresponding S&P index levels. 

The most crucial factor in Parker’s long-term success is that he was willing to seriously change or even abandon systems when they may seem to have lost their potency. He made such major shifts many times in his career. It is striking that some of the systems that were profitable for so many years, stopped working and never recovered. 

Parker could survive only because he was flexible enough to alter his trading approach. A continuous recommendation given to systematic traders is to follow the rules of the system firmly. A system which has a definitive edge and can control risk effectively. In such cases, second-guessing will often have a harmful effect. It is in this context that Ed Seykota’s first rule is to be applied. Parker followed this rule in designing a trading process that was 100% mechanical.

However, the problem is that systems work for a time. This uncomfortable reality implies that the ability to radically change systems is an important factor to longer-term success as a systematic trader. Here Seykota’s second assertion—know when to break the rules —is meant to deal with. Parker again stuck to this principle by changing his systems and it proved significant to his longer-term success.

The trading strategies that Parker had revised were all substantive. For example, switching from entering orders on the close to entering intraday and changing from momentum to mean-reversion systems. These kinds of structural changes are very different from alterations like changing parameter values.

Parker often changed the parameter values in his systems to eliminate the downside. However, he realised that those changes did not bring much difference in future profitability. 

Traders who develop trading systems should be aware of the hooks inherent in optimization. Optimisation may not lead to worse results but it will give high expectations to the traders regarding the effectiveness of the systems. Another problem with over-optimization is that it can lead to designing systems that are too fitted to the past to work well in the future.

Initially, Parker was unaware of these pitfalls. With experience, he became wary of the shortcomings of over-optimization. This does not mean that optimisation has no value. It can be useful to define the suboptimal extreme ranges that should be eliminated from the selection of parameter values. Moreover, for some systems, optimization may provide some advantage in parameter selection, even after suboptimal extreme ranges are excluded. 

Risk management is an important part of success for both systematic and discretionary traders. Parker accepted numerous risk control rules as part of his process. These rules are:

• Trading Stop— Initially Parker stopped trading if his equity declined by 20%. In 2016, after he resumed trading, he reduced this stop point to 10%. When the account is ahead by 5%, this stop is also increased to 15%. 
• System Stop— Parker stops system trading if its equity curve falls below its 200-day moving average and waits to resume till it again rises above that level. The main concept is to apply technical analysis to the equity curve for controlling risk. This risk control strategy applies to systems as well as on the portfolio level. 
• Position Sizing Adjustments—Trading size should be calculated using a consistent formula and should be based on daily net account value. Otherwise, the risk will get magnified. 

Trading for a living is hard. A continuous rise in cumulative profits is not enough. It has to climb more than the total taxes and total living expenses. Parker’s experience with this difficulty steers him to advise others to keep their day job as long as feasible.

Michael Kean: Complementary Strategies

When Michael Kean was a university student in New Zealand, he started investing in stocks as a hobby. Ten years down the line, he started his own management company, he achieved a 29% average annual compounded return (almost triple the S&P 500 return which was 11%). However, he kept his maximum drawdown under 20%. His monthly Gain to Pain ratio was also nearly triple the corresponding S&P figure: 2.86 versus 0.96.

Ironically, trades that appear highly risky are a core component of Kean’s risk mitigation strategy—e.g., short biotech stock positions held into clinical trial announcements, and shorts executed after overnight price gaps triggered by corporate announcements. 

Proper risk management comprises two tiers: the individual trade level (limiting the loss on a single trade) and the portfolio level.

At the portfolio level, there are furthermore two components. First, similar to individual trades, there are rules to limit the loss of the portfolio as a whole. Such rules include a defined process for reducing exposure as a loss drawdown worsens or a specified percentage loss at which trading is stopped. 

The second factor of risk management at the portfolio level applies to the portfolio composition. Positions that are highly correlated would be limited to a feasible extent. Ideally, the portfolio would include positions that are not correlated and, even better, inversely correlated with each other. The idea of building such a portfolio is the essence of Kean’s trading philosophy. Any long-only equity portfolio has a problem that most of the positions will be highly correlated. 

The majority of Kean’s portfolio consists of a long equity component (approximately 60% on average, although this range depends on Kean’s estimation of the prevailing return/risk of the market). 

Kean solves this problem of a portfolio by combining the highly correlated portion with long equities that are inversely correlated to that portion. The trading portion of the portfolio consists mostly of very short-term trades and a lesser extent of longer-term short positions in the biotech sector. The inverse correlation stems from the fact that almost three-fourths of the short-term trades, and also the longer-term biotech positions, are short positions.

Even the long positions of the trading portion and investment holdings are uncorrelated because they are day trades linked to company-specific events. By combining two inversely correlated components, Kean can extract the long-term appreciation in equities without the typical downside exposure of long equity portfolios in bear markets. 

Kean’s unique method of hedging his long equity exposure is not applicable or advisable for most traders. It is not the specific method that Kean uses to reduce portfolio risk that is appropriate for readers. Instead, it is the concept of seeking uncorrelated and, preferably, inversely correlated positions that is important. Traders need to focus not only on their trades but also on how these individual positions correlate with each other.

Michael Kean also applies risk management at the individual trade level with unlimited risk. He learnt the importance of limiting risk on individual trades early in his career when he shorted a stock in a parabolic up move without a contingency plan. The stock price nearly doubled, resulting in a 10% hit to his portfolio—his worst loss ever. He never repeated this mistake. 

Kean typically limits the risk to 1% on his biotech trades, his area of expertise, and to only 30 basis points (bps) on non-biotech trades. He generally enters a large-cap holding only after a sizable retracement, limiting further downside in these positions. 

In late 2014, Kean let his discipline lapse. He was 35% up for the year. Thus, he felt he could take more risk, given his profit cushion. He bought a group of energy stocks because the sector was down sharply. It had nothing to do with his standard methodology. Within two weeks, he had sacrificed 7% of his profits for the year.

It is very common for traders to become careless when they are performing well. 

A trader should be aware of letting such strong performances get to their heads. Persistence is the key to develop a decent edge in this long journey. One has to identify that edge and develop a trading process accordingly. Mistakes teach us a lot when analyzed. Lastly, trading should be done out of love so that one can survive through tough times.

Pavel Krejčí: The Bellhop Who Beat The Pros

In this interview, the most important message is that it can be done. Given the enormous growth in the quantification of trading in the past two decades, many individual traders and investors wonder whether it is still possible for them to succeed. Undoubtedly, it is practical to ask how a sole trader can compete against a plethora of management firms with scores of PhDs & MBAs. It is true that neither the majority of individuals nor the professional managers will succeed, in the sense of outperforming the relevant benchmark.

However, Krejčí demonstrates that success and superior performance are still possible for the individual trader. Krejčí had no education after high school, no coaches and minimal funds. Yet, he developed a methodology that has achieved performance characteristics that far surpass those of well over 99% of long-only equity managers and hedge funds. He supported himself for 14 years with his trading profits. Krejčí chose trading as a career path because he sought an endeavour in which he would be responsible for his success or failure. The operative word here is responsibility. Winning traders understand their responsibility for their outcomes. If they lose money, they will give a few explanations. Either they followed their methodology, and the losing trade was within the percentage of losing trades that is inevitable, or they made a mistake—a fault they will completely own. On the other hand, losing traders will always have some excuse for their loss- they followed someone’s bad advice; the market was wrong, and so on. 

Krejčí cites an example of a trader who succeeded because he found a method that fits his personality. He was uncomfortable holding overnight positions. By trading stocks only, the day after earnings reports, Krejčí was able to develop a strategy that could generate significant returns, at acceptable risk. This means that to succeed in the markets, one has to find a methodology that he is comfortable trading. If there is anything in the approach that is uncomfortable, he needs to figure it out and change the same. 

One characteristic that has been common in so many traders is that they are strongly committed to their work. To develop his method, Krejčí had to put in 16-hours daily apart from his day job and market research. Even though his method resulted in no trading opportunities in five months of the year, he would still devote full-time to the markets in those months, using that time to continue his market research. 

Krejčí attributes his long-term success to how he reacts to losing moments. Whenever he loses, he focuses extremely on research for improving his methodology. 

One significant factor that has enabled Krejčí to achieve his remarkable return/risk performance is his trade restrictions. Krejčí only takes what he understands to be high-percentage trades. 

Many traders can improve their performance by passing on the marginal trades and waiting for high-probability opportunities. Krejčí’s edge comes from his trade selection and the entry-exit timing, but his risk management is the reason for his continuous profits. 

There are two ingredients in Krejčí’s risk management. First, he avoids the risk of holding positions overnight. Second, he places a stop loss on every trade to limit losses. 

Krejčí explains that without stop loss, his percentage of winning trades would be higher, and his returns would be almost the same, but his drawdowns would be deeper. Since larger declines could easily have forced Krejčí to discontinue trading, risk management has been instrumental to his long-term success.

Conclusion

The interviews from the eleven traders impart meaningful lessons for all traders. It reflects the basic market truth irrespective of a methodology or a time period. To summarize, the key lessons are:

• There is no single true path.
• Know your edge and find a trading process that suits your personality.
• Keep a trading journal, categorize your trades & learn from your past mistakes.
• Set meaningful stops because risk management is important.
• Stick to your methods and don’t speculate with loss.
• Take large positions on high conviction trades but don’t make it so large that fear dominates you.
• There is no place for hope in trades.
• Human emotions are dangerous in trading.
• Don’t exit the entire position at the target profit.
• Beware of sloppy trading after a big win.
• Flexibility is a trait and not a flaw.
• Being profitable v/s being right.
• Commitment, patience, and responsibility for your trades is a must.
• Trading for a living is hard.