Pit Bull

by Martin Schwartz

  “What was your plan?” I asked.

  “My plan? I was going to hold it until it got back to fifty dollars. What else?”

  That’s the problem with amateurs, they only have half a plan, the easy half. They know how much of a profit they’re willing to take, but they don’t have the foggiest idea how much they’re willing to lose. They’re like deer in the headlights, they just freeze and wait to get run over. Their plan for a position that goes south is, “Please God, let me out of this and I’ll never do it again,” but that’s bullshit, because if by chance the position turns around, they’ll soon forget about God. They’ll go back to thinking that they’re geniuses, and they’ll always do it again, which means that they’re sure to get caught, and get caught bad. What most people fail to understand is that while you’re losing your money, you’re also losing your objectivity. It’s like being at the craps table in Vegas, and the fat bleached blonde in the sequined dress is rolling the dice, and you’re losing, and you’re determined that you’re not going to let her beat you. What you’ve forgotten is that she doesn’t care about you, she’s just rolling the dice. Whenever you have jealousy as an emotion, or greed, or envy, it distorts your judgment. The market’s like the bleached blonde in Vegas, it doesn’t care about you. That’s why you have to put aside your ego and get out. If you have trouble doing that, as most people do, be like Odysseus: tie yourself to the mast with an automatic stop and take your emotions out of play.

  Stops come in two forms: an actual order to sell at a certain price that you place with your broker, or a contract you make with yourself that you’re going to sell at a certain price, no matter what. Either way, a stop is an investment in self-preservation because if you’re wrong, it saves you those extra dollars that you’d lose by hanging on to a losing position. It keeps you from digging the hole deeper and it makes it easier for you to climb back out. A stop automatically takes your brain out of reverse and puts it into neutral. Your money’s not back to neutral, but your mind’s back to the point where you can regroup and try to think up a fresh idea without the pressure of a losing position hanging over your head.

  The more you lose in a trade, the less objective you become. EXITING A LOSING TRADE QUICKLY CLEARS YOUR HEAD AND RESTORES YOUR OBJECTIVITY. After a breather, you might put the same trade back on if you can intellectually justify it, but you have to constantly remind yourself that there’s a myriad of opportunities in the marketplace. By preserving your capital through the use of a stop, you make it possible to wait patiently for a high-probability trade with a low-risk entry point.

  9

  Little Brown Bags

  “So, Mr. Schwartz, if we were to approve your application, how do you propose to pay for the monthly maintenance?” the president of the Park Avenue Co-op Board said.

  Monthly maintenance? What the hell was this man talking about? We’d just committed to plunking down $3 million in cash for a twelve-room apartment on the seventh floor, and now he wanted to know if we could pay the monthly maintenance?

  “You’re in the commodities business,” the man continued. “That’s like gambling, and we want to make sure that all of our owners are financially stable. What happens if something goes wrong? We’d hate to have to ask you to leave.”

  I looked over at Audrey. She was getting that worried look, the one she got just before I went ballistic. I took a deep breath and said, “I’ve had a seven-figure income for the past five years and, as you can see from our application, our net worth is nine million dollars. I don’t anticipate anything going wrong.”

  “Still, things happen. The markets are very unpredictable.” God, I hated negative thinkers, they were such losers. “Well,” I said, “if something happens, I guess you’ll just have to ask us to leave. You know, you have to do what you have to do.”

  It was November 1984, and we were sitting in the president’s living room along with two other senior members of the co-op board. These three old-timers were the screening committee of the board of directors for prospective new buyers and they had to approve us before we could move into the building. They squinted through their thick glasses, taking our measure, like old tailors seeing if we were a good fit. If accepted, Audrey and I would be the youngest people in the building by far.

  I knew our money looked good and I figured that this interview was just another case of having to kiss somebody’s ass before they’d let you into the club. I was sure that they were just showing us who was boss, putting us in our place, letting us know that not just anybody could walk into their Park Avenue co-op. I hoped that was the case, because we really wanted this apartment.

  “Yes,” the president said, “if you couldn’t make your monthly payment, then I’m afraid we would have to ask you to leave.” The other two members nodded in agreement. “And with that understanding, let us be the first to welcome you to Park Ave.”

  Audrey was three months pregnant with our second child, which is why we decided that it was time to move, but for us to put $3 million, or one-third of our total net worth, into an apartment was another dumb financial decision. That was money I was taking out of play, money that I could have parlayed into a much bigger grubstake, but we’d made the same decision before. Over the last two years there had been many times when I’d said to myself, gee whiz, why did I dump one-third of my net worth into that beach house? If I’d put that money into mutual funds, it’d be worth well over a million now and that would have made my entire family more secure.

  That was the trap that a lot of traders fell into. Most big-time traders didn’t taste the fruits of their labors until they’d climbed to the very top of the tree, and in some cases, they never tasted them at all. To them, making money was the fruit, because to them, money was power, and power was the only way they could feed their giant egos. I wasn’t interested in power. I wanted to taste my fruits all the way up the tree, which meant that I didn’t mind spending money, lots of money. I figured, so what? I’d found a money machine in the S&P 500 futures, and I could always make more. If Audrey and I wanted a beach house, we’d buy a beach house. If we wanted a twelve-room apartment on Park Avenue, we’d buy that, too. There came a time when you had to spend the money you’d been making so you could understand why you’d been killing yourself. And, to be honest, I didn’t mind letting other people see that I’d made it.

  On Thursday morning, April 4, 1985, we were scheduled to close on our new twelve-room apartment. We’d planned to move in that afternoon, but as usual, there was a glitch. I’d scheduled the move for Thursday because the next day was Good Friday and the markets would be closed. I thought that I could get my office set up and be trading by Monday, but at the closing, the people we’d bought the apartment from said their movers hadn’t come and could they have an extra day?

  I’m a guy who signs a contract and says, “This is what it says and this is what it means,” but that doesn’t seem to apply to the rest of the world. Our movers were sitting out on Park Avenue with our stuff, but what could we do? I was screwed. We couldn’t get in until they got out, and I knew that I’d never get my office set up by Monday. I had to call and reschedule the telephone people who were going to put in my extra phone lines and the computer people who were going to set up my screens. I’d be lucky if I could get to work by the end of next week.

  Fortunately I wasn’t planning on trading much, anyway. What I eventually learned was, don’t trade too heavily the month before and two months after your wife gives birth. While her hormones are changing, yours are just trying to keep up. If you’re a good husband, you’re not staying home at night working on your charts and figuring out your ratios. For the month before the birth, you’re going to Lamaze class working on how to breathe, how to rub your wife’s back. For the two months after the birth, the baby takes center stage and your whole routine is thrown out of whack. You’re not getting any dinner, you’re not getting any sleep, you’re not getting any anything. You’re up two, three, four times a night. You’re trying
to figure out if you have the disposable diaper right side up or upside down. You’re always tired, you lose your concentration. Our daughter was born on June 7, 1983, and the worst stretch of trading I’d had since “Never Short a Republican” was May, June, and July of 1983 when I lost $150,000.

  Now, in addition to the birth of our second child, we’d thrown in the move to Park Avenue, and it had gotten all messed up, so our lives were really turned upside down. We finally moved in late Friday afternoon, the fifth, and Audrey, who was eight months pregnant, hit the beach like a marine. All day Saturday and Sunday she was unpacking cartons, moving furniture, barking orders, trying to get our nest settled before our chickee arrived. As I wandered around the apartment listening to Audrey’s plans to move walls, put in a new kitchen, redo the bathrooms, and install new window treatments, I began to get a feel for how much this place was really going to cost me. My nut was going to be huge, and the more Audrey kept talking, the more the old garment man’s promise to throw us out if we couldn’t make our monthly maintenance fee kept ringing in my ears. I was really going to have to make some big money to keep this place going, but I wasn’t worried. Once I was up and running again, I was sure I could whack the S&Ps for all the new kitchens, new bathrooms, new window treatments, and monthly maintenance fees we’d ever need.

  I’d come a long way since my first S&P trade just three years earlier and I’d made a lot of money playing the S&Ps, but it hadn’t been easy. Trading in Chicago was nothing like trading in New York. There’s an old joke that says “I went to a fight the other day and ended up trading futures in Chicago.” Chicago was still the wild, wild West. It was where Richard Daley had been sheriff and the tombstones voted. It was where Mike Royko, the legendary columnist for the Chicago Daily News, often suggested that the city’s official motto, “Urbs in Horto” (“City in a Garden”), should be changed to “Ubi est Mea” (“Where’s Mine?”). The rules of the Merc weren’t written by the Marquis of Queensberry, and the pits were no place for a gentleman. Being tough and knowing the right people was a lot more important than being honest and having gone to the right schools.

  And the Merc was no place for outsiders. If you weren’t part of the family, you paid the price, usually up front. In New York, if you were a principal, you were trading for yourself, and if you were an agent, you were trading for a client and getting a commission. That’s how the game was supposed to be played, but not in Chicago, because the Merc allowed something called “dual trading.” That meant that a broker could act as both a principal and agent at the same time. Being able to trade for his own account while he was executing orders for his clients presented a huge conflict of interest and strongly encouraged a tactic known as “front running.”

  A front runner was a broker who’d sneak his own trades in front of a client’s, or use his brother-in-law standing next to him as the bagman, knowing that the client’s order would be right behind his, backing him up or protecting a no-loss situation. A simple example is the broker who gets an order to buy ten S&P contracts at 80. Simultaneously, the brother-in-law also bids 80 for ten contracts, knowing that if he buys his first he can always turn around and sell them back to the broker, at worst breaking even or scratching the trade. If he buys the ten contracts and the price ticks up, he’s in a riskless trade, while the client receives the famous report of “ND,” or “nothing done.” After seven ticks on the screen at his price, the veins begin to explode at the top of his forehead.

  After this happens all day long to you and thousands of dollars have been bucketed out of your pockets, you change brokers.

  The way to tell if you have a semihonest broker is to get a partial fill of your order, meaning you’ve bought four contracts out of ten when it ticked seven times at your price. At least that indicates that he’s trying for you. You’d think that brokers would want to fill your orders because they earn their living from commissions on executed orders, but the bagger’s “executed orders” provide thousands of dollars versus tens of dollars for commissions. In New York, front running was the exception; in Chicago, it was an art form.

  During the first three years that it traded, the S&P contract didn’t move as fast as it does today and I liked to play an “accordion.” When I thought the market was near a buy point, I’d place a scale of, say, fifty lots, where I’d try to buy five lots every 10 cents down (or two ticks) on the S&Ps, hoping that by the time it bottomed and turned up, I had bought most of the scale, but not all. After the market turned in my favor, I’d pick a reasonable price objective on the upside and scale the contracts out, hoping for the eventual price move to just exceed my last offer on the up side. I might even reverse the process and scale into a short position, then I’d cover my position, and start the game all over again. If my indicators were correct, I’d be scalping the market all the way up and all the way back down the scale. In a slow-moving market, scale trading was a great way to make money, and if my core position was right, there was very little risk.

  I used to have a broker named Tony D., and Tony D. had a brother-in-law named Sonny J. Sonny J. would stand right next to Tony D. and after a while, I began to suspect that when I put my order in to scale up or scale down, Sonny J. would jump in ahead of me. I’d be looking at my screen and I’d see trades of .10, .10, .10, but Tony D. wouldn’t call and say that my five lot had been filled until they had traded through my price.

  And so it would go, all the way up and down the scale. I began to wonder how come I was always getting filled on the last tick. I wasn’t naive, I’d been on the floor of the Amex, but trading on the Amex was like playing bingo at the Knights of Columbus compared to trading in Chicago. There was no specialist like Chickie or Frannie making the market at the Merc, so there was no way of putting your order in line. Trading in the pits was a free-for-all, and when I’d call and complain, I’d always get the same answer: “Sorry, Marty, somebody jumped in front of you, but hey, what are you complaining about? You’re making money.” Big money, but I was still pissed.

  Front running was only one of the hurdles you had to jump if you wanted to make money on the Merc. Trades were made by the “open outcry” system. That’s where traders in the pit would shout and use hand signals to make their trades. This method of trading led to a lot of disputes, especially in a fast-moving market. “Lennie, we had a trade!” “No, I wasn’t looking at you. I was looking at the guy right behind you.” “Bullshit, the guy behind me’s your kid brother.” Members were always getting fined for fighting, unruly behavior, and other forms of misconduct, but that was just a cost of doing business, and if you weren’t there to defend yourself, they really beat you up.

  The Merc even had its own Back to the Future machine, the “pit committee.” The committee was generally made up of big players in the pits who got to police themselves. Unfortunately, this was the equivalent of giving the inmates the keys to the asylum. The more they made, the more their seats were worth. The pit committee had the power to repeal time. They could go back in time and “whistle out” trades. They actually had a whistle that they’d blow to make trades disappear. One day, I thought the market was about to peak so I called my clerk and told him to sell, “ten offered at fifty.” I saw .55, .55 flash on my screen, which meant that there had been two trades at .55, but still I couldn’t get a confirmation that my ten lot had been sold at .50. Then, just as my indicators had predicted, the market started to fall, .40, .30, .20, .10, .00. What the hell had happened to my ten lot? Getting the last tick is one thing. Getting no tick and no fill and then having the market run away from you is something else.

  For ten minutes, which is a lifetime when you’re trading, nobody could tell me whether or not my order had been filled, or even if I still had the ten lot. I was yelling and screaming at my clerk on the phone, going crazy because the market was moving and I didn’t know what my position was. Finally, my clerk told me that the two trades at .55 had been “whistled out” and that my trade hadn’t been filled at .50. I still was
long the ten lot, only now my winner was a loser.

  I called the Merc’s legal department. I told them I was sick of getting screwed and I was going on the record. They said that they’d look into it, but, of course, since I wasn’t a member of the club, nothing ever happened.

  They have a machine that records the time and price of every trade. When they whistle a trade out, they merely take out the printed record as though it never happened—it was just a mistake. It’s been going on forever.

  Over the three years I’d been trading, I’d learned that the Merc was a world unto itself, and I’d come to accept the fact that in addition to making money for my own family, I was supporting a lot of different “families” in Chicago. Unless I moved to Chicago and climbed into the pit to fight for myself, there was nothing I could do about it; there was always going to be some slippage. Slippage was the price you paid for doing business in Chicago. As Leo Melamed, chairman emeritus of the Merc, acknowledged in Escape to the Futures when he described his first days on the Merc, “I knew how a market was supposed to work, keyed to supply and demand; they knew how to work the markets, keyed to their advantage.” Ubi est mea?

  To trade on the Merc, I had to have a member firm to clear my trades. Finding a good clearinghouse was a constant problem. With futures, all trades were “marked to market.” That meant that at the end of each day, the clearing firms submitted all the trades that took place that day to the central clearinghouse at the exchange, and all accounts were settled on a cash basis. If you lost money, your account was debited and if you made money, it was credited. Unlike stocks, it didn’t make any difference whether or not you still held the position. Every day everybody settled up in cash, and the next day, they all started with a clean slate. It was this ability to have a cash settlement for the S&P futures contract that made trading the S&Ps possible since it would be impossible to deliver a certificate that was properly weighted to represent each of the five hundred stocks in the index.