The Market Wizards

Book Review

Book Title: The Market Wizards : Conversations With America’s Top Traders

Author: Jack D. Schwager

Date Published (Slightly updated edition): 2012

Rating: 8/10

Author background

Some key facts about the author Jack Schwager follow:

Born: June 27, 1948
Birthplace: Antwerp, Belgium (naturalized U.S. citizen)
Education: earned a BA in Economics from Brooklyn College (1970) and an MA in Economics from Brown University (1971)
Occupation: investor, businessman, author
Now: currently the co-portfolio manager for the ADM Investor Services Diversified Strategies Fund, a portfolio of futures and FX managed accounts.

Additional information on the author

Jack Schwager is a recognized industry expert on futures and hedge funds and the author of several widely acclaimed financial books. He is currently the co-portfolio manager for the ADM Investor Services Diversified Strategies Fund, a portfolio of futures and FX managed accounts.

Market Wizards – Book Theme

How do the world’s best traders do their thing? Is it pure luck or a combination of luck and trading mastery? Do they have a set of unique skills and mental aptitude or is this ability to succeed as a trader transferable to the layperson? Author Jack D. Schwager wanted to dig deep and uncover the truths. What made these folk the best of the best? What can we learn from them and apply to our own trading methodologies?

Jack interviewed many of the top traders across most financial markets. Their trading success generally can be boiled down to the same essential formula:

proven methodology (trading plan / rules and solid risk management) + proper mental attitude (positive mindset) = trading success.

In the words of Martin W. Zweig (Editor, The Zweig Forecast), “Market Wizards is one of the most fascinating books ever written about Wall Street”.

As Robert R. Prechter Jr., Editor, The Elliott Wave Theorist, explains, “these guys have it all: a method, the conviction, and the discipline to act decisively time after time, regardless of distractions and pressures. They are heroes of Wall Street, and Jack Schwager’s book brings their characters vividly to life.”

Market Wizards – Pros and Cons

Pros

An interesting insight into the minds and exploits of some of history’s most successful traders
A rare revealing of some tips, trading advice and rules that are still truly relevant in current times
Reinforces the importance of risk mitigation, having a trading plan/methodology which is adjusted over time and the undeniable relevance of the mental mindset.

Cons

One can argue that as the interviews took place in the 1980’s or thereabouts, perhaps the book is now showing its age however I still think a lot of the discussion has great relevance in today’s markets
Perhaps an under focus on stocks and general share trading
Unsurprisingly, there are no in-depth strategies revealed. However, the advice revealed is very valuable.

Market Wizards – Brief snapshot from the interviews and key takeaways

(Note: the content below is mostly taken direct from the book and simplified further in some instances)

Part 1 – Futures and Currencies

Michael Marcus – Blighting Never Strikes Twice

Michael Marcus was a commodities trader who learned from Ed Seykota and reputedly turned $30,000 into $80 million over a 10-year period.

Marcus’s advice for traders:

The best trades should have three qualities:

- Fundamentals (which suggest an imbalance in supply or demand, which could result in a major move)
- Technicals (the chart must show that the market is moving in the direction that the fundamentals suggest)
- Market tone (when the news comes out, the market should act in a way that reflects the right psychological tone)

Stay with the winners. Taking advantage of potential winning trades and letting them ride is critical to successful trading; it will also pay for the losers. Cut losers.
If you are a beginning trader, never bet more than five percent on a single trade idea.
Use protective stops and commit to an exit point on every trade
Trust your gut and being a successful trader also takes courage: the courage to try, the courage to fail, the courage to succeed, and the courage to keep on going when the going gets tough
To be an elite trader requires an innate skill, a gift. To be a competent trader and make money is a skill you can learn
For stocks, look for confirmation from the chart, the fundamentals, and the market action and a high EPS with a low P/E.

Bruce Kovner – The World Trader

Bruce Kovner is an American investor, hedge fund manager, and philanthropist. He is Chairman of CAM Capital, which he established in January 2012 to manage his investment, trading and business activities. From 1983 through 2011, Kovner was Founder and Chairman of Caxton Associates, LP, a diversified trading company. In 2008, he was inducted into Institutional Investors Alpha’s Hedge Fund Manager Hall of Fame.

Kovner’s tips for traders:

You must be willing to make mistakes regularly, a lesson he learned from Michael Marcus
Stay rational and disciplined under pressure
Trade on a market view, in combination with technical information – a combination of fundamental and technical analysis is important
The more a price pattern is observed by speculators, the more prone you are to have false signals. The more a market is the product of non-speculative activity, the greater the significance of technical breakouts
Risk management is the most important thing to be well understood; always decide on an exit point before you make the trade. Also, evaluate risk on a portfolio basis rather than viewing the trade independently. Undertrade – whatever you think your position ought to be, cut it at least in half
Place stops at a point that will indicate that the trade is wrong, not at the maximum dollar amount you are willing to lose per contract
Whenever you enter a position, have a predetermined stop. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. Always place the stop beyond some technical barrier
Do not view the market as a personal nemesis; it will obscure your vision of the market and take your attention away from the diagnostic process.

Richard Dennis – A Legend Retires

Richard J. Dennis, a commodities speculator once known as the “Prince of the Pit,” was born in Chicago, in January 1949. In the early 1970s, he borrowed $1,600 and reportedly made $200 million in about ten years. When a futures trading fund under his management incurred significant losses in the stock market crash of 1987 he retired from trading for several years.

Dennis’s tips for traders:

If you are a novice trader, trade small
Do not be misled by the day-to-day fluctuations in your equity; focus on whether what you are doing is right
Do not miss a major profit opportunity; Dennis estimates that 95% of his profits have come from only 5% of his trades
Do not hold a rigid opinion of the market; be on the lookout for major trends
The times that you least want to think about trading (during the losing periods) are precisely the times you need to focus most on trading
You should expect the unexpected in this business; expect the extreme. Do not think in terms of boundaries that limit what the market might do. If there is any lesson that I have learned in the nearly twenty years that I’ve been in this business, it is that the unexpected and the impossible happen every now and then
The market being in a trend is the main thing that eventually gets us in a trade. Whatever method you use to enter trades, the most critical thing is that if there is a major trend, your approach should assure that you get in that trend
One of the worst mistakes a trader can make is to miss a major profit opportunity. According to his own estimate, 95 percent of his profits have come from only 5 percent of his trades.

Paul Tudor Jones – The Art of Aggressive Trading

Paul Tudor Jones II (born September 28, 1954) is an American billionaire hedge fund manager, conservationist, and philanthropist. In 1980, he founded his hedge fund, Tudor Investment Corporation, an asset management firm headquartered in Stamford, Connecticut. Eight years later he founded the Robin Hood Foundation, which focuses on poverty reduction.

Jones’s global macro trading style is based primarily on technical analysis, as opposed to value investing, with an emphasis momentum factors driving markets. One of Jones’ earliest successes was predicting the 1987 market crash, Black Monday. In 2008, he was inducted into the Investors Alpha’s Hedge Fund Manager Hall of Fame.

Jones’s tips for traders:

Risk control is imperative for success and is the most important thing when trading. Rather than focusing on what you might make on a given trade, focus on what you might lose
It is easier to get back in rather than to get out. Closely monitor the performance of your entire portfolio in real time; for Jones, if his total equity drops 1 to 2 percent during a single trading session, he might liquidate all of his positions simultaneously to cut his risk
If you start trading poorly, reduce the position size till you get back on track, so that when you are trading your worst, you are also trading your smallest. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in
After big winning streaks, be cautious about getting overconfident
Avoid any emotional attachment to a market
Consider using both a price stop and a time stop
Don’t focus on making money; focus on protecting what you have
The most important rule is to play great defense, not great offense.

Gary Bielfeldt – Yes, They Do Trade T-Bonds in Peoria

Gary Bielfeldt was the epitome of the small-town model American citizen: honest, hardworking, and devoted to family and community. After a modest start (purchasing a single corn contract for $1000), Bielfeldt eventually built his account up to staggering proportions. He focused much of his career on the soybean complex, dabbling less extensively in related grain markets. However, when Bielfeldt’s trading size had grown to the point that the government developed speculative position limits in the soybean and grain markets, Bielfeldt shifted his focus to the T-bond futures market.

Bielfeldt tips for traders:

Be disciplined – If you are a novice trader, it is important to not get too far behind because it is difficult to fight back. Use fundamental analysis supplemented by technical analysis to make trades, and don’t overtrade
Learn discipline by using a trend-following system, even temporarily, it will increase your odds of being successful as a trader
Be patient – Wait for the right trade and when you have a good trade on, you have to be able to stay with it. Just as you wait for the percentage hand in poker, when you wait for the right trade there is less risk when you are aggressive.
Have courage to go into the market; adequate capitalization also helps increase courage
You must have a willingness to lose, which is also related to adequate capitalization. If a trade doesn’t look right, get out and take a small loss, just as you would with a poor hand in poker
The most important thing is to have a method for staying with your winners and getting rid of your losers
You need a strong desire to win. Just as in poker, the goal of trading is to win.

Ed Seykota – Everybody Gets What They Want

Edward Arthur Seykota (born 7 August, 1946) is a commodities trader, who earned S.B. degrees in Electrical Engineering from MIT and Management from the MIT Sloan School of Management, both in 1969. In 1970 he pioneered Systems trading by using early punched card computers to test ideas on trading the markets. Trading as a trend follower, Ed Seykota turned $5,000 into $15,000,000 over a 12 year time period.

Seykota’s tips for traders:

In order of importance are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell
Set protective stops at the same time you enter a trade. Move these stops to lock in a profit as the trend continues
Risk below 5 percent on a trade
Cut losses
Ride winners
Keep bets small
Follow rules without question
Know when to break the rules.

Larry Hite – Respecting Risk

Lawrence D. Hite is a hedge fund manager who, along with Ed Seykota, is one of the forefathers of system trading. Larry was the founding principal and Managing Director of Mint Investment Management Company. During his 13-year tenure at Mint, the composite of funds achieved a compounded annual rate of return greater than 30% before fees during that period. Hite pioneered the use of the “guaranteed fund” concept, which helped Mint be the first to raise over $1 billion.

Hite’s tips for traders:

Avoid personal bias; use a statistical approach
If you don’t bet, you can’t win
If you lose all your chips, you can’t bet
Control your risk by applying four basic principles:
- Never trade counter to the market trend
- The maximum risk should be limited to 1 percent of total equity
- Diversify in the systems you use to decide on a trade, as well as in the markets you trade in
- Track volatility so that you can liquidate or temporarily suspend trading in those markets where the risk/reward ratio exceeds well-defined limits
When a market makes a historic high, it is telling you something.

Part 2 – Mostly Stocks

Michael Steinhardt – The Concept of Variant Perception

Michael H. Steinhardt (born December 7, 1940) is an American investor, hedge fund manager, and philanthropist. In 1967, he founded a hedge fund, Steinhardt Partners, that averaged an annualized return for its clients of 24.5% from 1967 to 1978. His fund lost 1/3 of its value in the 1994 bond market crisis. In 2004 Michael headed up WisdomTree Investments, a fund with nearly US$43 billion in assets under management.

In a January 2014 article by Bloomberg, he was referred to as “Wall Street’s greatest trader”.

Steinhardt’s tips for traders:

Buying and selling stocks is an extremely competitive business; when you decide to buy or sell a stock, remember you are competing with people who have devoted a good portion of their lives to the same endeavour
Good trading is a balance between the conviction to follow your ideas and the flexibility to recognize when you have made a mistake. You should have a balance of confidence and humility along with respect for the person on the other side of the trade.
The more things you bring to the table – shorting, hedging, participation in bond markets, futures market trading, and so on – the better off you are.
There is no absolute formula or fixed patterns; the markets are always changing, and the successful trader needs to adapt to these changes.

William O’Neil – The Art of Stock Selection

William J. O’Neil (born 25 March, 1933) is an American entrepreneur, stockbroker and writer, who founded the stock brokerage firm William O’Neil & Co. Inc in 1963 and the business newspaper Investor’s Business Daily in 1983. He is the author of the books How to Make Money in Stocks, 24 Essential Lessons for Investment Success and The Successful Investor.

O’Neil’s tips for traders:

Buy stocks that are coming out of broad bases and beginning to make new highs relative to the preceding price base. You are trying to find the beginning of a major move so that you don’t waste six or nine months sitting in a stock that is going nowhere
He developed the acronym CANSLIM for picking winning stocks:
“C” is current earnings per share (quarterly earnings per share should be up by at least 20 to 50 percent year to year)
“A” is annual earns share (each year’s earnings per share should show an increase over the prior year’s earnings)
“N” is something new (it could be a new product or service, a change in the industry, or new management)
“S” is shares outstanding (investors should not limit themselves to only larger capitalization companies)
“L” is leader or laggard (pick the leading stocks – the ones with the high relative strength values – and avoid the laggard stocks)
“I” is institutional sponsorship (leading stocks usually have institutional backing, but while some institutional sponsorship is desired, excessive sponsorship can result in the poor performance of a stock
“M” is market (three out of four stocks will go in the same directions as a significant move in the market averages; when you learn to interpret price and volume on a daily basis, you will know when the market has topped).
The idea is to buy when there is the least probability of a loss. If you buy within the base, the stock will frequently fluctuate 10 or 15 percent in normal trading action, and it is very easy to get shaken out of the position. But if you buy at exactly the right time, the stock is usually not going to go down to my maximum 7 percent stop-loss point.
The secret for winning in the stock market does not include being right all the time. In fact, you should be able to win even if you are right only half the time. The key is to lose the least amount of money possible when you are wrong. I make it a rule never to lose more than a maximum of 7 percent on any stock I buy. If a stock drops 7 percent below my purchase price, I will automatically sell it at the market—no second-guessing, no hesitation.
Letting losses run is the most serious mistake made by most investors.
You should hold a stock as long as it is performing properly. it is ridiculous to kick yourself when a stock goes higher after you sell. The goal is to make substantial profits on your stocks and not be upset if the price continues to advance after you get out.
A common mistake a lot of investors make is to buy a stock solely because the P/E ratio looks cheap
Diversification is a hedge for ignorance. I think you are much better off owning a few stocks and knowing a great deal about them. By being very selective, you increase your chances of picking superior performers. For an investor with $5,000, hold one or two; $10,000, three or four; $25,000, four or five; $50,000, five or six; and $100,000 or more, six or seven.
Just as a doctor would be foolish not to use X-rays and EKGs, investors would be foolish not to use charts. Charts provide valuable information about what is going on that cannot be obtained easily any other way. They allow you to follow a huge number of different stocks in an organized manner
Mutual funds are an absolutely outstanding way to invest. The key to success in mutual funds is to sit and not to think. When you buy a fund, you want to be in it for 15 years or more. That is how you will make the really big money. In a mutual fund, you should sit through the bear markets. When a good, diversified growth fund is down sharply, you should buy more
Trading success requires three basic components: an effective trade selection process, risk control, and discipline to adhere to the first two items.

David Ryan – Stock Investment as a Treasure Hunt

After graduating college, Ryan began working for his idol, William O’Neil, and within four years became the youngest vice-president of the company, with responsibilities as a portfolio manager and as O’Neil’s direct assistant in stock selection for institutional clients. He also twice won the U.S. Investing Championship with triple-digit returns.

Ryan’s tips for traders:

Essential reading on top of the list is O’Neil’s book, How to Make Money in Stocks (McGraw-Hill, New York, NY 1988). Another book that is must reading is How I Made Two Million Dollars in the Stock Market by Nicholas Darvas (Lyle Stuart, Inc., Secaucus, NJ, 1986). Another book I would recommend is Reminiscences of a Stock Operator by Edwin Lefevre. A good one on what to look for in individual stocks is Super Performance Stocks by Richard Love (Prentice Hall, Englewood Cliffs, NJ, 1977). The book has a great study on some of the greatest winners of all time. Another good one on picking stocks is Profile of a Growth Stock by Kermit Zieg and Susannah H. Zieg (Investor’s Intelligence, Larchmont, NY, 1972)
Buy high and sell higher; avoid stocks under $10
Never buy an overextended stock (a stock that is trading far above its most recent price base)
As high as possible EPS-at least above 80, and preferably above 90
The relative strength is very important (The relative strength ranks a stock’s price change relative to all other stocks surveyed) – At least above 80, and preferably above 90 – For example, Microsoft had a relative strength of 97 when it was at $50 a share. It eventually moved to $161. However, once the relative strength starts falling off, I usually get out of the stock
The maximum loss I allow is 7 percent, and usually I am out of a losing stock a lot quicker. A rigid stop-loss rule is an essential ingredient to the trading approach of many successful traders
I usually hold my big winners for about six to twelve months, stocks that aren’t that strong about three months, and my losers less than two week
Maintain a trader’s diary; every time you buy or sell, record it with the reasoning for your decision so that you remember the characteristics of winning stocks and avoid repeating trading mistakes
The best trades are winners from the start. Having a profit on the first day is one of the best indicators that you are going to make money on the trade
Learn from your mistakes. That is the only way to become a successful trader.

Marty Schwartz – Champion Trader

Martin S. Schwartz (Buzzy, born 23 March, 1945) is a Wall Street trader who made his fortune successfully trading stocks, futures and options. He received national attention when he won the U.S. Investing Championship in 1984. Schwartz is the author of Pit Bull: Lessons from Wall Street’s Champion Day Trader.

Schwartz’s tips for traders:

Try not to go against the moving averages; it is self-destructive
After a successful period, take a day off (Schwartz believes it is difficult to sustain excellent trading for more than two weeks at a time).
After a strong run of profits, play smaller rather than larger (Schwartz biggest losses have always followed his largest profits).
Bottom fishing is one of the most expensive forms of gambling.
Before taking a position, always know the amount you are willing to lose (Schwartz refers to it as you “uncle point”).
Work, work, and more work
The most important thing is money management
Learn to take losses. The most important thing in making money is not letting your losses get out of hand
Don’t increase your position size until you have doubled or tripled your capital. Most people make the mistake of increasing their bets as soon as they start making money. That is a quick way to get wiped out.

Part III-A Little Bit of Everything Mostly Stocks

James B. Rogers, Jr. – Buying Value and Selling Hysteria

James Beeland Rogers Jr. (born 19 October , 1942) is an American investor and financial commentator based in Singapore. Rogers is the Chairman of Beeland Interests, Inc. He was the co-founder of the Quantum Fund and Soros Fund Management. He was also the creator of the Rogers International Commodities Index (RICI).

Rogers’s tips for traders:

Whenever I buy or sell something, I always try to make sure I’m not going to lose any money first. If there is very good value, then I’m probably not going to lose much money even if I’m wrong
Never follow conventional wisdom; learn to go counter to the markets
The trend is not your friend; following what everyone else is doing rarely gets you rich over the long term
Be willing to buy or sell anything; be flexible and alert to investing in anything
Be selective; wait for the right trade to come along
Be flexible. Biases against certain markets or types of trades limit your field of opportunity
Sell hysteria – Wait for hysteria; examine to see whether the market is wrong; go against the hysteria if fundamentally validated; be sure you are right, and then hold on tight
Good investing is really just common sense.

Mark Weinstein – High Percentage Trader

After a brief period spent as a real estate broker, Weinstein became a full-time trader, profiting well through trading in a wide variety of markets, including stocks, stock options, stock index futures, currencies, and commodities.

Weinstein’s tips for traders:

Always do your homework
A market that is fundamentally and technically poised to move higher is not going to reverse direction because of a news item—even a dramatic one
Don’t be arrogant, because when you’re arrogant, you forsake risk control. The best traders are the most humble
Understand your limitations
Be your own person and think against the herd
Don’t trade until an opportunity presents itself. Knowing when to stay out of the markets is just as important as knowing when to be in them
Your strategy has to be flexible enough to change when the environment changes
Don’t get too complacent once you have made profits
You have to learn how to lose; it is more important than learning how to win
Limit losses quickly. Traders should fear a larger loss and hope for a larger profit. Most traders hold on to their losses too long because they hope the loss will not get larger.

Part IV-The View from the Floor

Brian Gelber-Broker Turned Trader

Brian commenced his career as a broker, managing a major brokerage firm’s financial futures operation on the floor of the Chicago Board of Trade. He soon began trading for his own account before directly managing customer accounts in addition to supervising a group of traders in both cash and futures in government securities and other markets. He also became the president of Gelber Group, Gelber Management, and Gelber Securities, companies involved in clearing, brokerage, and money management.

Gelber’s tips / advice for traders:

Recommended books include: Technical Analysis of Stock Trends by Robert D. Edwards and John Magee (John Magee, Inc., 109 State Street, Boston, MA) and Reminiscences of a Stock Operator (Reprinted in 1985 from the original 1923 edition by Trader Press, Inc., Greenville, SC.)
Listen to other traders that you know.
Lose the ego. Most traders who fail can’t admit they are wrong.
Know yourself and trust your gut.
If you are on a losing streak, wipe the slate clean and start fresh
Never add to a loser.

Tom Baldwin – The Fearless Pit Trader

Lucian Thomas Baldwin III is a bond trader investor and founder of the Baldwin Group of companies. He was described by the Wall Street Journal as a trader who can singlehandedly move the Treasury bond market. He often trades the 30-year bond in the pits of the Chicago Board of Trade. Baldwin got his start in trading when he left his job as a product manager for a meat-packing firm and leased a seat on the Chicago Board of Trade. Even with no prior trading experience, he turned a profit from the beginning, becoming a millionaire before his first year was up. His aggressive risk-taking is one the keys to his success.

Baldwin’s tips for traders:

Avoid excessive trading; patience is an important aspect of trading
The best traders have no ego. To be a great trader, you have to have a big enough ego only in the sense that you have confidence in yourself
Think of trading in terms of gains and losses rather than monetary implications
Don’t get out of a losing trade too hastily because by bearing the pain just a little longer, you may be able to find a more favorable circumstance for liquidating.

Tony Saliba – “One-Lot” Triumphs

Anthony “Tony” J. Saliba is a trader, author, and entrepreneur based out of Chicago, Illinois. He currently serves as CEO of Matrix Holding Group, Mercury Digital Assets, Option Technology Solutions, and Fortify Technologies.

Saliba’s tips for traders:

Elements of good trading – Clear thinking, ability to stay focused, and extreme discipline. Discipline is number one: Take a theory and stick with it
Always respect the marketplace. Never take anything for granted. Do your homework. Recap the day. Figure out what you did right and what you did wrong
Trade small (“one-lot” at a time) until your capital has grown sufficiently to allow you to increase your position size
Exceptional traders owe their success to doing their “homework” every night, not allowing leisure or other business from interfering with their daily regimen of market analysis
Anticipate “what-ifs”, examine many different scenarios, and be prepared for all contingencies.

Part V-The Psychology of Trading

Dr. Van K. Tharp – The Psychology of Trading

Dr Van Tharp is a research psychologist who received his Ph.D. from the University of Oklahoma. He has spent his career studying how stress affects human performance. He developed the Investment Psychology Inventory, a test that measures winning and losing traits. He has also written five books on successful investing which provide the core of his investment course. Additionally, he is a contributing editor for Technical Analysis of Stocks and Commodities and is a frequent guest on financial television and radio programs. He mainly devotes himself full-time to counseling traders from his office in Glendale, California and continues his research on trading success.

Attributes of a successful trader:

Has a well-rounded personal life
Has a positive attitude
Has the motivation to make money
Lacks conflict
Feels a responsibility for results
Has a solid knowledge of technical factors in the market
Has an aptitude for making sound decisions without common biases
Has an ability to think independently
Has risk management
Has an ability to be patient
Has intuition.

Attributes of the unsuccessful trader:

Is highly stressed
Has a negative outlook on life and expects the worst
Has a lot of conflict in his/her personality
Blames others when things go wrong
Does not have rules to guide behavior
Is a crowd follower
Is disorganized
Is impatient.

Final Word (Jack Schwager) – Common Denominators amongst the Market Wizards

The following is a list of commonalities that Jack uncovered following his interviews:

All had a driving desire to become successful traders, overcoming significant obstacles to reach their goal
All reflected confidence that they could continue to win over the long run
Each trader found a methodology that worked, and they remained true to that approach
Top traders take their trading very seriously, devoting a substantial amount of their waking hours to market analysis and trading strategy
Rigid risk control is one of the key elements in the trading strategy of virtually all those interviewed
There was a high level of importance in having patience to wait for the right trading opportunity to present itself
Acting independent of the crowd was a frequently emphasized point
Top traders understand that losing is part of the game
They all loved what they were doing.

Read, learn, enjoy, be persistent and most importantly, take action!