I hear that “well” and I say, “Let’s amplify that well. How much is in the well?”
“I probably could make more.”
“How much more?” I asked
“I don’t want to say,” he replied.
“Come on, say it.”
“I don’t want to say it, or else you’ll make me do it.”
“I’m not going to make you do it. But how much do you think you could make?”
“I think I can make a hundred,” he whispered.
“Well, then say it.”
“Okay, I’m going to make a hundred.”
I tell him, “We’re going to get the guys who work with you in here.
We call them in and he says, “I was just talking to Ari and we’re going to make one hundred million this year.”
Three weeks ago he came in and told me that he had reached a hundred million for the year. The key was getting him to recognize his own hesitation when he said that fifty million was his target. If the conversation had ended there, he would not have made a hundred million. There had to be an exchange for me to sense where he was really at. One hundred million wasn’t my number; it was my number for him. If there’s anything unique in what I do, it’s hearing that bit of uncertainty that reflects where a trader is holding back.
You’ve written an entire book about the psychology of trading. What if I asked you for your advice on how to win at trading, but required you to say it in twenty-five words or less.
Define a target, a strategy consistent with the target, a set of disciplines to follow, and risk management guidelines. Then trade, track, and evaluate your performance.
* * *
Dr. Kiev’s advice regarding goal achievement in general and trading success in particular can be summarized as follows:
Believing makes it possible.
To achieve a goal, you not only have to believe it is possible, but you also have to commit to achieving it.
A commitment that promises the goal to others is more powerful than a commitment made to oneself.
Extraordinary performers—Olympic gold medal winners, super-traders—continually redefine their goals so they are a stretch. Maintaining exceptional performance requires leaving the comfort zone.
After setting a goal, the trader or athlete needs to define a strategy that is consistent with the target.
Traders, athletes, and other goal-oriented individuals need to monitor their performance to make sure they are on track with their target and to diagnose what is holding them back if they are not.
* * *
Update on Ari Kiev, MD
Since the original interview Dr. Kiev has continued his focus on working with traders and has written two more books on the subject: Trading in the Zone and Psychology of Risk.
What changes have you seen in the traders you work with during the massive bear market that has emerged and prevailed since our last interview?
Confidence levels are much lower. I’ve been dealing more and more with traders who call me because they feel burned out and don’t have the stomach for the markets anymore, or they perceive their market analysis and methodology are no longer working. They want to know what they should do.
What do you tell them?
I advise them to take time off to replenish their energy, and then start back up small. I’ve worked with them to lower their expectations so that they could regain some sense of mastery. If expectations remain too high, there is likely to be too much frustration. I also caution them against the temptation to make large bets to try to get it all back.
Can you give me a specific example of a trader you work with who has been having significant difficulty in the current market environment?
I recently met with a trader with a long side bias who is running $35 million and is down over $3 million for the year. He had greatly reduced his position size, trying to scratch his way back to respectability. He was in great distress. As he has done poorly, he has become reluctant to come out of his office and interact with other people in the group. He has some of the classic signs of mild depression. He is caught in a self-perpetuating cycle where his poor performance has caused him to lose confidence and withdraw, which in turn impedes his performance.
What advice did you give him?
The problem is that he was defining himself in terms of his results. I told him to become more engaged by contributing ideas and interacting with other people in the firm.
How has your work with traders changed during the bear market?
I have not changed my basic strategy. I still focus on encouraging traders to go for the gold, committing to targets that are a stretch, and then developing strategies consistent with these targets: cutting losses quickly, and sizing positions upward when they have high conviction, an edge, and a sufficient profit cushion.
This approach has continued to work well for a broad spectrum of markets and strategies: foreign exchange traders, macro traders, convertible bond arbitrageurs, and even quant traders using black box systems. Among equity traders, it has worked for those traders with an ability to go short and the conviction to ride out short squeezes because of their understanding of the fundamental vulnerability of their short positions. Some equity traders, however, have had difficulty adapting to the powerful bear market of recent years. For these traders, it’s been less a matter of going for the gold, and more a matter of staying in the game. Although I prefer to emphasize performance enhancement—that is, helping traders make more money on the assumption they could make more—for some traders, it has been more appropriate to focus on preservation of capital and risk management.
Specifically, how have you worked with the traders who have had difficulty?
It has often been a matter of getting these traders to face their tendency toward denial and rationalization. For example, for some traders this has meant learning to cut their losses, even if the fundamentals were sound. For others it has meant helping them overcome their visceral discomfort in going short. I have also advised traders to take larger risks only after they have built up a profit cushion. This works both ways, though. For some more cautious souls who were reluctant to use all the capital allocated to them, I’ve encouraged them to trade larger when they had a profit cushion and their Sharpe ratios warranted it.
Any other changes in emphasis?
I find myself dealing a lot more with management issues such as maintaining firm morale, team building, and communication skills with support staff. For example, a hedge fund manager recently told me, “I instructed my trader to go short 100,000 shares, but he only sold 40,000.” I asked him why he simply didn’t tell the trader to sell another 60,000. “Well,” he said, “I didn’t want to undermine his confidence.” The bull market allowed managers to run their teams in a much more easygoing manner, and a lot of them never learned the skill of getting their staff to understand when they say X, they mean X, not Y. In this market, you can’t afford to make those types of mistakes.
Presumably, some of the managers you work with did well in the bull market, not because of innate skill, but because the market was a one-way street. How do you differentiate between a trader
who may be having temporary trouble and one who may never have had any special talent to begin with?
As a starting point, you look at performance. If the manager is consistently losing money, then maybe he should be doing something else. Also, you have to look at the degree of work and sophistication of the approach, or the lack of it. I recently had lunch with a manager who had been successful in raising a large sum of money to start a new hedge fund. I was amazed by how elementary his approach was. He wanted his analysts to give him a list of stocks near the low end of their range so he could buy them and stocks near the high end of their range so he could sell them. He didn’t have more of a subtle distinction than that. I was shocked. I advised him to bring in some first-rate analysts to strengthen the investment process.
In our original interview, you stressed the
importance of traders committing to higher targets. Surely, in this bear market, many traders must be falling far short of their targets or even losing money. What do you tell them to do?
A trader may have said that $10 million was his target, and he is only up $2 million, and the year is more than half over. In that instance, maybe $5 million is a better target. There is no shame in reducing the target. It’s better to reach a lower target than feel frustrated in trying to reach a higher target.
So, now you find yourself often counseling traders to revise their target down, whereas previously you were advising them to revise their target up.
Exactly.
What about the trader who is not just falling short of his target, but is actually losing a significant amount of money? Say his target was $10 million, the year is more than half over, and he is down $3 million.
The problem is that the guy who is down $3 million is thinking too much about the $3 million. You shouldn’t think about making the loss back—that’s too burdensome. You have to start where you are. OK, you’re down, but what can you do this week, this month, and for the rest of the year? You have to try to regain a sense of control.
* * *
WIZARD LESSONS
1. There Is No Single True Path
There is no single true path for succeeding in the markets. The methods employed by great traders are extraordinarily diverse. Some are pure fundamentalists; others use only technical analysis; and still others combine the two methodologies. Some traders consider two days to be long term, while others consider two months to be short term. Some are highly quantitative, while other rely primarily on qualitative market decisions.
2. The Universal Trait
Although the traders interviewed differed dramatically in terms of their methods, backgrounds, and personalities, there were numerous traits common to many of them. One trait that was shared by all the traders is discipline.
Successful trading is essentially a two-stage process:
1. Develop an effective trading strategy and an accompanying trading plan that addresses all contingencies.
2. Follow the plan without exception. (By definition, any valid reason for an exception—for example, correcting an oversight—would become part of the plan.) No matter how sound the trading strategy, its success will depend on this execution phase, which requires absolute discipline.
3. You Have to Trade Your Personality
Cohen emphasizes that it is critical to trade a style that matches your personality. There is no single right way to trade the markets; you have to know who you are. For example, don’t try to be both an investor and a day trader. Choose an approach that is comfortable for you. Minervini offers similar advice: “Concentrate on mastering one style that suits your personality, which is a lifetime process.”
Successful traders invariably gravitate to an approach that fits their personality. For example, Cook is happy to take a small profit on a trade, but hates to take even a small loss. Given this predisposition, the methodologies he has developed, which accept a low return/risk ratio on each trade in exchange for a high probability of winning, are right for him. These same methods, however, could be a mismatch for others. Trading is not a one-size-fits-all proposition; each trader must tailor an individual approach.
4. Failure and Perseverance
Although some of the traders in this book were successful from the start, the early market experiences of others were marked by complete failure. Mark Cook not only lost his entire trading stake several times, but on one of these occasions ended up several hundred thousand dollars in debt and a hair away from personal bankruptcy. Stuart Walton wiped out once with money borrowed from his father and several years later came close to losing not only all his trading capital, but also the money he borrowed on a home equity loan. Mark Minervini lost not only all his own money in the markets, but some borrowed money as well.
Despite their horrendous beginnings, these traders ultimately went on to spectacular success. How were they able to achieve such a complete metamorphosis? Of course, part of the answer is that they had the inner strength to not be defeated by defeat. But tenacity without flexibility is no virtue. Had they continued to do what they had been doing before, they would have experienced the same results. The key is that they completely changed what they were doing.
5. Great Traders Are Marked by Their Flexibility
Even great traders sometimes have completely wrongheaded ideas when they start. They ultimately succeed, however, because they have the flexibility to change their approach. La Rochefoucauld said, “One of the greatest tragedies of life is the murder of a beautiful theory by a gang of brutal facts.” Great traders are able to face such “tragedies” and choose reality over their preconceptions.
Walton, for example, started out by selling powerhouse stocks and buying bargain stocks. When his empirical observations of what actually worked in the market contradicted this original inclination, he was flexible enough to completely reverse his approach. As another example, as a novice trader, Minervini favored buying low-priced stocks that were making new lows, an approach that was almost precisely the opposite of the methodology he ended up using.
Markets are dynamic. Approaches that work in one period may cease to work in another. Success in the markets requires the ability to adapt to changing conditions and altered realities. Some examples:
Walton adjusts his strategy to fit his perception of the prevailing market environment. As a result, he might be a buyer of momentum stocks in one year and a buyer of value stocks in another. “My philosophy,” he says, “is to float like a jellyfish, and let the market push me where it wants to go.”
Even though Lescarbeau has developed systems whose performance almost defy belief, he continues his research to develop their replacements so that he is prepared when market conditions change.
Fletcher’s primary current strategy evolved in several stages from a much simpler earlier strategy. As competitors increase in the current approaches he is utilizing, Fletcher is busy developing new strategies.
Cohen says, “I’m always learning, which keeps it exciting and new. I’m not doing the same thing that I was doing ten years ago. I have evolved, and will continue to evolve.”
6. It Requires Time to Become a Successful Trader
Experience is a minimum requirement for success in trading, just as it is in any other profession, and experience can be acquired only in real time. As Cook says, “You can’t expect to become a doctor or an attorney overnight, and trading is no different.”
7. Keep a Record of Your Market Observations
Although the process of gaining experience can’t be rushed, it can be made much more efficient by writing down market observations instead of depending on memory. Keeping a daily diary in which he recorded the recurrent patterns he noticed in the market was instrumental to Cook’s transition from failure to great success. All of the many trading strategies he uses grew out of these notes. Masters jots down observations on the backs of his business cards. A compilation of these notes provided the basis for his trading model.
8. Develop a Trading Philosophy
Develop a specific trading philosophy—an integration of market concepts and trading methods—that is based on your market experience and is consistent with your personality (item 3). Developing a trading philosophy is a dynamic process—as you gather more experience and knowledge, the existing philosophy should be revised accordingly.
9. What Is Your Edge?
Unless you can answer this question clearly and decisively, you are not ready to trade. Every trader in this book has a specific edge. To offer a few examples:
Masters has developed a catalyst-based model that identifies high probability trades.
Cook has identified price patterns that correctly predict the short-term direction of the market approximately 85 percent of the time.
Cohen combines the information flow provided by the select group of traders and analysts he has assembl
ed with his innate timing skills as a trader.
A tremendous investment in research and very low transaction costs have made it possible for Shaw’s firm to identify and profit from small market inefficiencies.
By combining carefully structured financing deals with hedging techniques, Fletcher implements transactions that have a high probability of being profitable in virtually any scenario.
Watson’s extensive communication-based research allows him to identify overlooked stocks that are likely to advance sharply well before those opportunities become well recognized on Wall Street.
10. The Confidence Chicken-and-Egg Question
One of the most strikingly evident traits among all the market wizards is their high level of confidence. This leads to the question: Are they confident because they have done so well, or is their success a consequence of their confidence? Of course, it would hardly be surprising that anyone who has done as extraordinarily well as the traders in this book would be confident. But the more interviews I do with market wizard types, the more convinced I become that confidence is an inherent trait shared by these traders, as much a contributing factor to their success as a consequence of it. To cite only a few of the many possible examples:
When Watson was asked what gave him the confidence to pursue a career in money management when he had no prior success picking stocks, he replied, “Once I decide I am going to do something, I become determined to succeed, regardless of the obstacles. If I didn’t have that attitude, I never would have made it.”
Masters, who launched his fund when he was an unemployed stockbroker with virtually no track record, responded to a similar question, “I realized that if somebody could make money trading, so could I. Also, the fact that I had competed successfully at the highest levels of swimming gave me confidence that I could excel in this business as well.”
Lescarbeau’s confidence seemed to border on the irrational. When asked why he didn’t delay a split with his partner, who was the money manager of the team, until he had developed his own approach, Lescarbeau replied, “I knew I would come up with something. There was absolutely no doubt in my mind. I had never failed to succeed at anything that I put my mind to, and this was no different.”
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