Only the Zeros Are Different: How Great Traders Go Bad
By John A. Sarkett, Developer, Option Wizard*
Like a pilot, a police officer or a trapeze artist, a professional trader knows he or she must follow the rules just to stay alive. Usually, this bracing thought is enough to focus the mind. Usually, this awareness suffices.
But, occasionally, the realization is lost.
Mistakes follow.
Losses mount.
An otherwise great trader succumbs.
A great trader goes bad.
How to avoid that tragic circumstance was the subject of a Futures Industry Association presentation in Chicago by Ray Kelly, professional trader and trading coach.
"Large traders trade more zeros than small traders, but the process is the same," Kelly says. "Both on the upside and the downside."
The catalyst for destruction, Kelly says, is most often ego.
Ego is the Ebola virus to the active trader.
There is an antidote, however â balance, humility and the ability to accept being wrong.
Can you or I become infected? Of course we can!
What can be done to protect against ego and its devastating effects?
Kelly says pay close, introspective attention to the following four areas: Self-knowledge, market knowledge, trading strategy and risk management. Answer the hard questions for yourself, before the market does. Like meditation, or exercise, attention must be paid each day for maximum effectiveness.
Self-Knowledge
First, when you come into your trading room, leave your ego entirely outside the door. Kelly defines ego as the sense of who we believe we are: A trader, a religious person, a father, a spouse, etc.
When the over-inflated ego gains the throne, rules go out the door. Egotism consumes natural and healthy caution, replacing it with an illusion of invincibility. An overdeveloped ego fells even the most successful, sometimes especially the most successful trader.
Expecting occasional failure, the trapeze artist practices with a net. He or she knows that the body is not more durable than the concrete below. The trapeze artist knows that he or she can only exist in the high-flying environment by following the rules.
Trouble is, ego is not software that can be easily re-installed in the trader psyche. It is hardware. You and I are hard-wired with ego. Ego is self-identity. Ego never wants to be ignored, left out, left behind. But, sometimes it gets out of control and becomes self-absorbed and unrealistic. Sometimes, you have to decide not to run with the crowd. But, to do so, you have to go against your wiring.
There is something in the human that wants to believe in the hero, the guru, the champion, and, for many, that belief is coupled with a desire to become that person. If you can't become the hero, it is almost as good to run with him or her â a dream come true!
Usually, you can't. You may only watch the hero from the stands or the balcony. But, in the financial markets, you have the opportunity to participate directly or partner with the prospective hero. His or her glory becomes your glory. This prospect is so appealing, so motivating, it will cause some of us to leave sense, common or otherwise, far, far behind.
Watch out!
In the 1980s, I participated in a risk arbitrage managed account program at a major brokerage firm, supposedly run by supertraders. Ascending to the hero's podium, my account executive disclosed that returns were expected to be 60 to 100 percent, but, if only mediocre returns were generated, the return might be as low as 30 percent or so.
Hundreds of trades (and commissions) later, I went through the laborious task of reconstructing the trading history and actual return of my account. It was 12 percent, exactly the money market rate of the day.
Contrast the swashbuckling image of the wanna-be trading hero with the wry and self-deprecating words of $1.5 billion Chesapeake Capital CEO and former Turtle Trader Jerry Parker (another FIA speaker), who says, "We know we don't know what we're doing."
Far from true, (he meant that we can't predict rate cuts, market movements, the future), but this kind of modesty contrasts sharply with what is said by those promising spectacular returns and is undoubtedly a better and safer way to sail the market oceans. His trading methodology is to take trend-following positions across many markets, expecting a few large gains to outweigh numerous losses.
Defining Success
While the psyche is often looking for others to admire and emulate, it is not taking the time and effort to define success for itself. This is usually too much hard work. Easier and more fun to soak up the vibes from the hero or try to be one yourself.
What is success? For speaker, Ray Kelly, it has been earning 200K to 300K each year, 40 percent returns, no drawdowns and the opportunity to spend time with his wife and children, he says.
To define your own success, you must answer these questions.
Who am I?
Why do I trade?
How do I prepare?
What are my beliefs about myself? About trading?
Am I ready to handle the pressures of trading?
Sound too easy? Have you ever actually done it? Kelly says, "Great truths unfold at the level of the student. As a student learns more, these questions become deeper and more profound."
Ray Kelly's own introspection involved working through a family background that included an alcoholic father and a very religious Catholic background. The religious background left him believing that it was evil to be rich. The instability in his home made him feel that, somehow, all the tension and insecurity was because of him. Therefore, he was not worthy of success.
These powerful subconscious beliefs limited his success, that is, until he worked through them. When he resolved his own conflicts, he was able to progress to a higher level of trading success.
Do these subconscious messages really sabotage your trading? Kelly relates the story of a trading associate. His son died in a tragic accident. Blaming himself, he started losing significant sums the very next week.
Kelly further cites a university study that indicates a high degree of unresolved guilt among prisoners. The study concludes that prisoners committed crimes so that external activity would match internal guilt, not the other way around.
Other enemies of trading success: Divorce, employment change, trauma, illness or anything that creates emotional distractions or pain.
"If you owned a Testarossa, you wouldn't think anything of having it checked and tuned on a regular basis," Kelly says. "Many trader egos are too big for a regular tuneup, however."
What to do? Often you do not realize that you are laboring under the weight of conflict. It shows up as poor performance or an inability to follow your rules. Losses are the inevitable by-product.
What to do? It depends on the person and the severity of the problem. The best course to take is to do introspective exercises constantly. Know the resources you need before you need them.
If you are already in the fire? Walk away. Take time off. Get counseling. Don't trade in the financial markets until your conflicts are resolved. Do not make the expensive mistake of thinking that, whatever "it" is, it will go away if you ignore it.
Other questions to ask yourself about your state of mind, according to Kelly, are:
Do others comment on my personality traits negatively?
Do I suffer extremes in emotion?
Is my body sending me a message?
Am I uncomfortable with this subject?
Do I take responsibility for my actions?
"Society teaches us to places blame, to externalize our failures," Kelly says. "Bad system. Bad broker. Bad quotes. Introspection is just too painful for most."
But to be a successful trader, you must go against the grain and do the heavy lifting of introspection.
Approach the Markets with Equanimity
Kelly says to incorporate a "bottlecap" mentality into your trading. "Like Laverne & Shirley on the TV sitcom at the Schott's Brewery, you put one bottlecap on after another, and then you go home and plan your excitement after work," he says. "Don't seek excitement from the markets, or, unhappily, you may find it."
Similarly, R. Jerry Parker says trading is a brick-upon-brick enterprise, but that Commodity Trading Advisor (CTA) clients prefer a "rock star" approach. "They want magic," he says.
Trading in some 70 of the most liquid 150 futures markets, patiently seeking break-outs, the Chesapeake system is a technical, trend-following system. The system will generate 200 trades per year, of which some six will pay for losses and generate returns, he says. Obviously, if you invest too much negative emotion in the 194 losers, you likely won't be around for the six big winners.
Market Knowledge
Market knowledge is the second major pillar you must depend on to avoid a market catastrophe.
You must ask yourself, continuously:
What affects markets?
How? How might things be changing?
When do you know you are wrong?
What are you trying to extract from the markets?
