The Way of the Dollar

welcome reward. The reassuring thing about risk is that I can quantify it, and this I must do. Over time, I cannot make profits without also making losses. Taking losses is relatively easy because they have been quantified beforehand. Taking profits is the hard part. Somehow I have to allow the moment for profit-taking to quantify itself. “Hold on”, you may say. “Risk isn’t that simple in real life. The position

isn’t black and white. You have the same risk on a winning positions as on a losing one. For example, if you have a 50% profit on a position, you risk losing it. Also, when you don’t have a clearly defined trend, you risk losing 5% here and 5% there, until pretty soon you’re talking about real money. You can take on a position with confidence, and then it goes against you and you are prey to doubt and at risk again from your emotions.”

Absolutely right. As soon we take on the business of trading markets for profit, we are in the risk business up to our necks. It’s the opposite side of the reward-coin. You can’t contemplate reward without coming to terms with risk.

Russian roulette is not a game one would recommend unreservedly, but it can illustrate a point. In a haunting film called “The Deerhunter”, the hero, played by Robert de Niro, goes back to Vietnam to track down and rescue a buddy who is in the business of playing Russian roulette for money or his life. It becomes clear that the buddy’s mind has been derailed by his horrendous experiences in the killing fields, where as a Viet prisoner he has been obliged to play Russian roulette for the amusement of his captors. After the war, he is still playing – for the delectation of leisure-business entrepreneurs.

Russian roulette is not quite as dangerous as it might seem. You make a bet, and you win, or lose, by placing a revolver loaded with a single bullet against your temples, and pulling the trigger – having first spun the revolving chamber. The whole point about the game is that whatever you stand to win is, on the conventional view, oddly incommensurate with what you stand to lose. The reason it is not quite as dangerous as it might seem is that the weight of the bullet tends to swing the revolving chamber of the gun so that the bullet is down-most, and hence away from the detonating pin. But of course it doesn’t always work that way. It didn’t, in the end, in the case of Robert de Niro’s buddy. It never does – in the end. NO reward can compensate risking all.

In point of fact, trading speculative markets has a lot in common with Russian roulette. In particular, if you regularly stake all you have, you will be wiped out, as night follows day. The point about the Russian roulette analogy is to remind us that whatever we stand to gain cannot be worth the risk of wipeout: the chance of having more money can never be worth the chance of having none. So, obviously we must never stake all we have.

The trouble with any sort of gambling is that you can also be wiped out if you consistently make bets with bad odds. In financial markets, this can happen only too easily, as we shall see. In Russian roulette, the odds on any random pull of the trigger are in your favour; it’s just that the penalty

for losing is drastic. In regular roulette, the odds are more evenly balanced, but are weighted against you. For practical purposes, there is no way of getting the odds neutral, let alone in your favour; so roulette is a mug’s game as I’m sure all readers already know.

In financial markets, you have odds against you – in the form of transaction costs*. Fortunately these are quite small in the currency markets – a matter of 0.03 to 0.2 per cent, as opposed to nearly 3 per cent in roulette. But the odds are distorted in financial markets by the fact that the players can change the odds when they bet, and make it more difficult to win. This is the way financial markets work. They work in such a way as to make it more difficult for those who do not know what they are doing to win, and to make it easier to win for those who do know what they are doing.

If you have read the preceding chapters of this book and taken them on board, there is no doubt in my mind that you have a better understanding of the currency markets than 95% of currency traders. But you will not necessarily win. To win, you will need to have the winner’s mentality. Let’s listen to some winners.

Here I must repeat the particular debt we all owe to Jack Schwager for his masterpiece Market Wizards – a series of interviews with a bunch of heroes among traders alive today, traders who have been able to deal in the era of floating currencies. I think this is the most useful book on the practice of trading to have appeared since the war, or maybe ever. First, here are some key conclusions from the reminiscences of many big winners.

1) If you are seriously committed to winning, you can make a zillion dollars/ multiply your money 100-fold – over time.

2) When you cannot trade with confidence, do not ever trade, ever.

3) You will be able to win when you realise it’s OK to lose, and take your losses promptly as a matter of course.

4) You will lose over time unless you fit every trade into a risk-management context which fixes each stake and defines the maximum loss.

How do these conclusions fit in with the rules set out in Chapter 7: know your reason, your timeframe, your risk, and yourself? Well there’s a lot of overlap. You’ll have a problem with 2) and 3) unless you know your reason and your timeframe. Knowing your risk overlaps with 4). Knowing yourself relates to 1),2) and 3): it’s so important that the last chapter of this book is entirely devoted to it.

You CAN win big

Winning a fortune is to do with winning more than you lose month after month, year after year. You will multiply your money by 100 times if you

average a 30% per annum compound increase for 18 years – in fact you will multiply it 112 times. Such is the miracle of compound interest, and this is the kind of target we can set ourselves. We shouldn‘t be dismayed if we fail to achieve it in the early years. It can be done. We can all do it IF we are committed to do it and IF we are free of the hang-ups which prevent us from doing it. As we shall see in Chapter 11, that can be a serious problem.

Some wizards have done it – and they probably couldn’t have done it unless they believed from the start that they could. We are looking with hindsight, and we are probably looking at traders who enjoyed conditions which were particularly favourable to their own peculiar approaches. That’s no problem. I’m sure we enjoy such conditions now in the currency markets, as explained in earlier chapters. If you sincerely want to win, you will be interested in cutting through all the illusions and delusions that have dogged you and other traders.

“Winners know that they are responsible for their trades; losers think they are not.” Dr. Van K. Tharp.

“Don’t be a hero. Don’t have an ego.” Paul Tudor Jones*.

‘I became a winning trader when I was able to say: “To hell with my ego, making money is more important.” Marty Schwartz.

“Picking tops and bottoms is an ego trip: the name of the game is to make money.” George Angell.

The winning trader will be “strong, independent and contrary in the extreme.” Bruce Kovner*.

In the course of interviewing several market wizard, Jack Schwager encountered some astounding performances. There was Michael Marcus who accumulated $80m from $30,000. There was Ed Seykota*, whose model account was up 3,000 fold in 16 years. At one point Jack Schwager was astonished to hear the following from Mark Weinstein* on his experience in 1980 to 1988. “I haven’t had any losing weeks during that time, but I have had some losing days.”

Normally one would have a serious problem with that kind of claim –though Mark Weinstein is on the record as having entered an option trading competition in which he turned a $100,000 account into $900,000 in 3 months without a losing trade. Anyway, Mark Weinstein talks so lucidly about what it takes to be a big winner in financial markets that it’s well worth listening: it helps to know that early in his trading career he had lost $600,000 on a single trade – which was two fifths of all the money he had made in his first four years of trading. Such traumatic occurrences are typical of practically all the most successful traders. You can’t learn about risk except

by personal experience. Here’s a paraphrase of Mark Weinstein’s 7 rules for successful trading.

1) Always do your homework.