May

20

One of the best things that I've done in my own speculative career is to realize that I am a loser in various niches and to exit those forever.

I retired relatively gracefully from squash after losing for only a year or two. I did the same with fixed income, and after a loss with foreign currencies. Vis-à-vis the latter, I concluded that whichever way I traded the market would go the other way — It wasn't so much a matter of running my stops and taking advantage of my fixed decision making, it was more a matter of the banks making say 300 billion a year from the markets. How in the world is there going to be enough money left over for me to make?

I shudder at how active and how good one has to be at something just to try to stay above water. I would urge all who trade the markets to periodically stop and think whether they have an edge. They should decide if they've made money, taking into consideration all their bad luck and the rule of ever-changing cycles.

The market loves to let you make money on small capital (like they did with the trend followers and so many hedge funds) just so you invest humongous amounts on 'the system that can't fail', only to take you for billions later on.

But of course the rate of return is still positive, and the manager still has 50% of the fund that he owns, since he takes out the fees monthly — the customer takes the losses on the big capital.

If only managers and customers were more humble, more willing to admit that they are guaranteed to lose in certain niches, the public would lose so much less than they have to. Moreover, the world of markets would be a much healthier place, and we would have fewer poseurs and flimflam artists in our midst.

Mark Goulston comments:

This post makes a great point. Here are a couple reasons why people don't cut their losses.

If as right as you thought you were is as wrong as you turned out to be, the fear is that you could be wrong about lots of things.

People confuse making a mistake with being a loser. If, however, you see every loss as a mistake and learn the lesson it teaches, you never have to view losses as a failures, just as lessons.

A friend of mine, Jason Calacanis, who has made and lost lots of money in Internet ventures, told me that if you make a decision that turns out to be dead wrong, recognize it when it is obvious, change direction, and never make the same mistake again. Then you'll be better off than 90% of people.

Steve Leslie adds: 

One of the great lessons in poker is that it is a game of imperfect information. Therefore you have only so much to go on. And you have a very limited time to make decisions, never more than a minute or two at the very most. Now in no limit hold-em this can be a decision that can end your tournament hopes or advance you to the championship.

Once you make your decision there is no going back. You can call, raise, or fold. That is it. And all decisions are binding. Just like trading.

After playing serious poker for a decade, I have made many incorrect decisions. I have also made plenty of correct decisions. But I think I have made more correct ones that wrong ones.

My goal every time I sit at a table is to try and play each individual hand as correctly as I can. Once I decide to play a hand I try to conjure up energy in my mind to focus exclusively on this event, to attack with laser like focus, eliminate as many distractions as possible, and to play within myself. That is all anyone can expect in the game of poker. The rest is a result of mathematics, statistics, and luck or variance. Sometimes you win; sometimes you lose. But unlike baseball you never get rained out. And you accept the outcome.

Finally, after these many years, I believe that my first impression of the correct play is the best one. After observing, calculating odds and my bet, I go with my initial decision. I do not try to talk myself into something else. It may not be the one, but it is the clearest one, the one that has the best vision, at least in my view. And this is the one that counts.

There are plenty of coulda, woulda, shoulda's, but after all it is all part of the game. If it were easy, then everybody would do it and they would be good at it and there would be no value left, or exploitation, or need to try to get better.

Just like trading.

From Dylan Distasio: 

I firmly believe that there is a meal for a lifetime in this post. Even with an edge, beating any particular market average over the long term is an incredibly difficult proposition. Without an edge, it becomes impossible.

Besides gauging the dynamics of a particular market, and examining your edge through experience, knowledge, or other empirical means, I think it's also critical to examine whether a particular style or timeframe of trading agrees with your personality and psychology.

As an example, some people are able to thrive in an intra-day environment, whereas others due to psychological makeup alone may not be suited for this pace of trading despite having the informational tools available to make a go at it.

There are a myriad of timeframes, markets, and methods of trading out there. Finding one that suits you from both an empirical edge and a psychological edge is your best chance at finding long-term success.

The psychological edge, I believe, becomes extremely important during the inevitable draw downs, mistakes, and bad luck that accompany all trading.

Alan Millhone writes:

Would there be any fund managers who would honestly admit in public that they are not making money? The Chair makes a well-founded point for a person to leave alone areas where they are not familiar. I try to stay with areas where I have some knowledge and familiarity. In construction we have two major hospital additions going up as I type. This type of commercial work is out of my realm. I don't have the crew, equipment, or bonding capability to ever consider undertaking such projects.

As Clint Eastwood says, "Man's got to know his limitations." This holds true in the market and with about any other undertaking we can envision in life. Years back I did a lot of work for a local oil and gas business. It was interesting to watch them pour over a map of an area and decide where to drill and then go out and find investors. I think I could have pinned the map to a wall and thrown darts at it and been just as accurate. The owner once told me the definition of an oil well. He said it was a hole in the ground with a bunch of liars standing around the hole looking down into it! 


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2 Comments so far

  1. manuel ochoa on May 21, 2007 10:24 pm

    According to my experience, most managers that trade diversified portfolios of different markets usually make most of their returns from just a few of the markets over lengths of time greater than 5 years. I believe this implies that in the majority of markets they trade at a loss or breakeven. As markets become more efficient, it’s my view that this observation will further magnify itself. The take away; define your edge, increase the leverage on it, and discard the rest {Eddie Lampert method}.

  2. Midweek Stock Market Observations | Diario BV on March 25, 2009 5:03 am

    […] * Know Your Limits - Victor Niederhoffer makes a case for periodic, difficult self assessments. […]

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