'Hedge Fund Market Wizards - How Winning Traders Win' - Interview with Jack Schwager author of the Market Wizard's books.

Interview by Steven Goldstein

This week sees the publication of ‘Hedge Fund Market Wizards - How Winning Traders Win’, the long-awaited addition to the brilliant and hugely influential 'Market Wizards' series of books written by Jack Schwager.

There are few traders around today who have not read or are not familiar with the 'Market Wizards' series in which Schwager carries out in-depth interviews with some of the world's top traders.  

The original 'Market Wizards' was first published in 1989 and took the financial markets by storm. ‘The New Market Wizards’ published in 1992, and the ‘Stock Market Wizards’ in 2001 followed, adding depth to Schwager's original book. The interviews provided a fascinating mixture of insights, thoughts, anecdotes and perspectives about the trading careers of a number the world top traders from various fields within trading and money management. It captured the mood of the time; the late 1980s was the time of the ‘Liar’s Poker’, the Stock Market Crash and Tom Wolfe’s 'Bonfire of the Vanities'. The traders of the day were regarded as aloof untouchable ‘Masters of the Universe’ who seemed to have the midas touch, they were people who seemed different and distant from the rest of us. The beauty of Schwager’s work was his ability to present these traders as real people, like the rest of us, with the same insecurities and fears, prone to the same errors and foibles, and facing the same adversities and common enemies as the rest of us - ourselves.

Today, I have the opportunity to turn the tables on Jack Schwager. Jack has very kindly agreed to play the part of interviewee for the ‘Trader, Trading & Risk Psychology Blog’.  

SG - Jack a lot of water has flowed under the bridge in the 20+ or so years since ‘The Market Wizards’ and ‘The New Market Wizards’. What significant changes in attitudes or philosophies around trading have you noticed? And if so what do you think has been the most startling difference between working on the original interviews and the latest set of interviews?

JS- The original Market Wizards was written nearly 25 years ago. Certainly, the markets have undergone many changes since then. However, the process and experience of working on Hedge Fund Market Wizards was really quite similar to that of the original Market Wizards. Of course, there are differences, but these differences are primarily a consequence interviewing a different set of traders rather than changes in the markets. Some of the lessons that come out of Hedge Fund Market Wizards are similar to those in the original Market Wizard books, but others provide new insights. The so-called “new” lessons are not new in the sense of emanating from changes in the markets, but are simply a consequence of additional perspectives provided by a different group of traders.

SG - In terms of the interviews, attitudes and perspectives expressed in the new book versus the original books, has there been anything which has remained pretty constant and in particular which has surprised you?

JS - There has definitely been a constancy in many of the underlying common denominators in trading success. I could easily name 20 or more of these. I will just offer one as an illustration: Flexibility. In Hedge Fund Market Wizards, as well as the original Market Wizard books, there are clear examples of how flexibility—the ability of a trader to completely reverse a market view—was instrumental to success and sometimes turned potential disaster into profits. I was hardly surprised that these traits remained constant. In fact, I would have been quite surprised if they had changed.

SG - How would you say the current breed of Traders and Money Managers compare to the original Market Wizards? 

JS - The traders in Hedge Fund Market Wizards are quite different from the traders in Market Wizards and New Market Wizards. The traders in the new book, however, are also strikingly different from each other. What I am saying is that the differences are not due to changes over time, but rather are a reflection of a different group of people being interviewed. One of the traders interviewed in the new book, Ed Thorp, actually began trading before many of the traders in the original Market Wizards, and he could just as easily have been included in the original book.

SG - How difficult was it to write a fourth copy of the book, considering the successes of the previous versions? Was there any pressure to come up with something slightly different, and were you careful not to deviate too far from a successful formula? 

JS - I could see why at first glance it might seem difficult to do a fourth book focused on trader interviews without an element of replication. It turns out, however, that this is not a problem because each of the traders is a very different personality, has a different story, and uses a completely different trading approach. If you like classical music and have a collection of symphonies from a number of different composers, you would probably still be interested in listening to symphonies of other composers and not find it at all repetitive. As for the format, I very definitely stayed exactly with the original format, which I have found works very well—namely, a narrative introduction, a conversation core, and a concluding section highlighting what I personally thought were the essential lessons and insights provided by the trader.

SG - Almost every trader I know at one stage or another has read at least one of your earlier books: As a performance coach working with traders in banks, hedge funds and proprietary trading firms, I find that many of my clients regularly quote or refer to some aspect of one of your books. What is it about your books which you think so captured the interest and attention of traders and money managers and continues to this day to stand the test of time? 

JS - The truth. Markets are always changing, but certain essential concepts and principles remain the same. This element of stability probably emanates from the fact that markets reflect human nature and human nature doesn't change. The comments of the traders I interviewed nearly 25 years ago remain entirely relevant today, despite the market changes in the interim, because the elements that made them successful as traders are still applicable today. The fact that traders today still find the older interviews insightful is a testament to a certain constancy in basic principles that delineate successful and unsuccessful traders.

SG - I notice that the foreword to the books is by Ed Seykota. There is one comment of Ed’s from the original book which stands out in my mind and I believe the minds of many others; ‘Win or lose, everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money’. This quote has been debated many times over, would you be able to shed some light on what you think Ed meant by this. 

JS -Yes, I love that quote. I too was quite surprised when Ed said it, and I remember asking him, “Do you literally mean that people who lose, want to lose?” And, Ed answered by repeating the quote, “Everyone gets what they want out of market.” And, indeed he meant that, at some level, losing traders were fulfilling some other need. I will give you a personal example that while not about trading is nonetheless a perfect illustration of Ed's basic premise. My daughter was a very good ice hockey goalie—good enough to be the starting goalie at the collegiate level in her freshman year. However, while she loved playing hockey, the intense pressure of being a goalie at the collegiate level and the all-consuming nature of playing college sports began to drain some of the enjoyment out of the sport for her and also interfered with the pursuit of other interests. In her sophomore year, she wasn't as good as in her freshman year, even though logically her capabilities were probably even better. I remember thinking about Ed's comment when watching my daughter play that year—even though she wanted to excel and tried her best, I believe that, at some level, she didn't want to continue playing college hockey, and that is what she got.

SG - I am sure there are many fine interviews and quotes and comments in this new book, would you be able to provide any teasers for us or interesting insights from some of your interviewees?

JS - There are many such quotes. One quote I particularly like that has an Ed Seykota-like ring to it is the advice that Steve Clark gives to the traders in his organization: “Do more of what works and less of what doesn't.” Although this may sound like obvious advice, Steve's point is that he has seen many traders go wrong precisely because they stray from this common sense guideline. It is quite common for traders to be good at one type of trade and then do other types of trades because they get bored waiting for their opportunity. I'll give you one more example of a quote I particularly like. This quote, which was a comment made by Colm O’Shea, offered an insightful perspective of how some traders go wrong in applying money management: “Traders often make the mistake of choosing stops as pain thresholds rather than price levels that disprove the trade.” Of course, I could go on and on.

SG - My own take from the original books were that they were more about the philosophy, psychology and attitude of trading and risk than about trading advice and recommendations. Many of the questions you asked seemed to open up the minds of the people being interviewed and enabled the readers to learn from those who have ‘walked the walked’. How easy or difficult did you find this process considering you were probably interviewing some of the most secretive, discrete and guarded players in the financial markets? 


 JS - Judging by reader reviews and direct feedback, the vast majority of readers find the advice in the Market Wizard books very helpful. In fact, I can't tell you how many professional managers have told me that these books were instrumental in their careers. There are, however, a minority of readers who are disappointed that the advice in the books is not more specific. It is as if they were expecting the book to provide some precise formula that would signal trades that they could follow, which would lead to financial success. Besides being unrealistic, such expectations reflect a naïveté about markets and trading success.

Although most of the advice could be termed “general,” it can nonetheless be very helpful in specific trading situations. I will give you one personal example. Last summer, I had been scaling into the short side of equity indexes in the belief that the market was overextended and vulnerable to a slide. Then an unemployment report was released that was unquestioningly bearish. It was so negative that commentators couldn't even pick out one element of it that was a mitigating factor, as they usually do. As expected, the equity market sold off. I thought I was perfectly positioned. But then, as the day progressed, the market started rebounding, and by the close, which was also the close for the week, prices had recovered within striking distance of their highs. I thought this was terrible price action for my position. Over the weekend, I decided that given this action, I would have to cover most of my short position. On Sunday evening, however, prices were actually weaker. I very clearly recalled Marty Schwartz's advice that if you are very worried about a position, particularly over the weekend, and then the market lets you off the hook easily, don't get out. Because of this advice, I stayed with the position, except for covering a token amount after the market sold off a bit, and prices subsequently broke sharply. Now you can certainly call Schwartz's advice “general,” but this didn't keep it from being very useful to me in a specific trading situation.

Getting highly successful traders who are naturally secretive about what they are doing to share information that could be useful to other traders is certainly one of my big challenges. I don't foolishly ask for obviously proprietary information, but I do press to get practical advice as close as I can get to the proprietary threshold. Even though, for obvious reasons, the traders I interview don't share the proprietary elements of their strategy, they still provide important insights. For example, Ray Dalio, the founder of Bridgewater, the world's largest hedge fund, is obviously not going to share the details of his firm’s fundamentally based system. However, Dalio did share specific insights about how he believes the markets work. One example was the concept that fundamental variables behave very differently in different market environments. The same fundamental statistic may have very different implications in a deleveraging bear market than in a recessionary bear market. This observation implies that you cannot build a one-size-fit-all fundamental model that will work across different types of markets. If you are a fundamentally oriented trader, this insight is important information.

As another example, Jamie Mai, the portfolio manager for Cornwall Capital, provides many specific examples of situations in which in his view options are mispriced. He was initially reluctant to allow me to use a number of these examples. I ultimately convinced him to allow this information to be included in the chapter based on the following line of reasoning. I said, “Jamie, arbitrageurs are always going to keep option prices approximately in line with their theoretical levels. Do you really believe that your talking about these trading opportunities is going to change the way options are priced?” He agreed with the logic that talking about these trading opportunities was not going to prevent these opportunities from recurring in the future. Even though this chapter does not contain specific trade recommendations, which would quickly become obsolete anyway, it does contain specific information that can be used by traders to look for trading opportunities.

Ironically, the interviews sometimes contain very specific information, but in this case, the point of this information is to illustrate general principles, not to offer a trade recommendation. For example, in one of the interviews in Hedge Fund Market Wizards, Martin Taylor, the manager of the Nevsky fund, makes an extraordinarily compelling case for both being long Apple and being short Research in Motion. By the time the book was released, the price of Apple had nearly doubled and the price of Research in Motion had fallen by about 75%. Does this mean that the discussion regarding these stocks was obsolete? Of course not! The point of this discussion was never about the stocks as specific recommendations, but rather as illustrations of the type of analysis that led Taylor to reach his conclusions about these stocks.

SG - What new aspects of trading do you believe that you have learned from interviewing and putting together the Hedge Fund Wizards, and how does this add to the fantastic compendium of knowledge, thoughts, wisdoms and perspectives that are inherent in the previous three volumes of the Market Wizards? 

JS - Each set of new traders provides new insights. The specific insights that are important will vary from reader to reader. As an example of an insight that I believe affected my own trading, I will use my interview with Jimmy Balodimas, a proprietary trader. Balodimas is a highly unconventional trader who breaks virtually all the trading rules. As I caution in my conclusion to his chapter, it would be inadvisable and dangerous for most people to adopt a similar trading style. Yet there are aspects of what Balodimas does that have more general applicability. One irony is that Balodimas is often profitable even when he is wrong on the position. How can this be? The answer is that he aggressively trades around his positions, taking partial profits when the market moves in his direction and reinstating the liquidated portion of positions when the market retraces. Conducting my interviews with Balodimas helped me better appreciate the advantages and power of trading around positions. Although I did already utilize this approach before interviewing Balodimas, I believe he influenced me to increase this type of activity to positive effect.

SG - If I hear one particular recurring theme in the market these days from participants, friends and clients, it is their concern over the rise of ‘the Algos’ and how they are taking over the market and making the human task of trading so much more difficult. To what extent was this theme in the book, are these concerns about ‘the Algos’ valid in your opinion?

JS - The role of the Algos did not appear as a significant theme in Hedge Fund Market Wizards. As I recall, the only case where it did was for Larry Benedict who was the only very short-term trader I interviewed. He felt that high-frequency trading was distorting some of the relationships in the markets and made trading more difficult. But he was simply adapting to the new situation. I believe that whatever effect the Algos have is primarily a consequence for short-term traders. Moreover, like any other strategy, as market inefficiencies draw an increasing number of players seeking to profit from those inefficiencies, the edge in the approach will gradually diminish—it will be arbitraged away. Bottom line: I don't believe this factor is important in determining either the potential or methods for achieving trading success. 

SG -I want to thank you for taking the time to sit on the other side of the fence for once and be the interviewee. – I wish you all the best of luck with this book.

Steven Goldstein is a Trader Performance Coach and Trader Development Consultant. - To find out more about his work helping traders to improve performance through developing greater self-belief and confidence and overcoming self-defeating hurdles, visit Steven's business website at www.bgtedge.com.  - To find out more about his courses, seminars and trader development programmes check out 'Trader, Development and Learning' at www.traderld-edu.org.

Great quote by Marty Schwartz which sums up where so many people go wrong in trading.

I have selected a quote from Marty Schwartz taken from his 1999 book 'Pit Bull: Lessons from Wall Street's Champion Day Trader' as this week's 'quote for the week'.

"Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself". – Marty Schwartz.

The full quote is was from the following paragraph from Schwartz'z book - ‘The Pit Bull’s Guide To Successful Trading'. Schwartz himself was one of the original interviewees in the original 'Market Wizards' book.

- I’ve said it before, and I’m going to say it again, because it cannot be overemphasized: the most important change in my trading career occurred when I learned to divorce my ego from the trade. Trading is a psychological game. Most people think that they’re playing against the market, but the market doesn’t care. You’re really playing against yourself. You have to stop trying to will things to happen in order to prove that you’re right. Listen only to what the market is telling you now. Forget what you thought it was telling you five minutes ago. The sole objective of trading is not to prove you’re right, but to hear the cash register ring.

This paragraph is in my mind one of the most influential in all the trading literature, encompassing so many lessons about trading that its almost hard to know where to start, some of the themes covered in the seven lines of this paragraph include:

• Ego getting in the way of good practice.  
• Adaptability.
• Trading as a psychological game.
• Overcoming yourself rather than the market.
• Trying to prove you are right.
• Relying on hope.
• Objective assessment of signs and signals from the market. 
• Maintaining an open mind. 
• The objectives of trading is to win not to be right.

Traders would do well to keep a copy of this paragraph visible as a reminder to try and ward off the inevitable occasions when they succumb to their trading demons.

Past quotes:  

·         “The four most dangerous words in investing are 'This time it's different' - Sir John Templeton.

·         “You will exit a losing trade when the pain of losing one more dollar is more intense than the pain of saying you were wrong in taking the trade.” - Benoit Mandelbrot.

·         “Without continual growth and progress, such words as improvement, achievement, and success have no meaning.” - Benjamin Franklin.

·         “Never let the fear of striking out keep you from playing the game!” - Babe Ruth.

·         “Predicting rain does n't count, building arks does” - Warren Buffett.

·         “Everybody gets what they want out of the market” - Ed Seykota.

·         “In Trading there are no rules, but you have to know them all” – Unknown.

·         “It is not the mountain we conquer but ourselves.” - Sir Edmund Hillary.

Anchoring Bias in Trading. (And you thought you had ‘Free Will’)

Anchoring describes a tendency in our thinking process which leads to us becoming stuck on particular but largely irrelevant reference points which subsequently influences our judgements and decisions. 

Anchoring was highlighted in a famous experiment by Nobel Prize winning behavioural psychologists Daniel Kahneman and Amos Tversky. In the study they asked participants to estimate the percentage of African countries in the United Nations. However before asking the question researchers exposed the respondents to an anchor. They were either asked :

"Is the percentage of African nations that are members of the United Nations more or less than 10%?" 

Or 

"Is the percentage of African nations that are members of the United Nations more or less than 65%?" 

The two numbers 10 and 65 are irrelevant to the question. However those that responded following the 10% anchor guessed on average 25%, and those who had been exposed to the 65% anchor guess on average 45%. The results suggested that the respondents anchored their answer to completely arbitrary numbers presented by the researchers.

How does this affect you as a trader? – One of the effects is to become hooked on your entry level as a reference point, for example let’s say that I enter the market to buy EURUSD FX because I want to go long, I would buy at now at 1.2566, this would now become my reference point, I am likely to be influenced by this number. – This could affect my judgement as I follow the market, obviously it would not be the only factor, however it could sway me towards acting sub-optimally to this trade. –Suppose I place a stop a few points below yesterday’s low at a level of 1.2540, and decide to place a take profit 100 points higher than my entry level. Now assume the EURUSD rallies this over the next couple of hours to 1.2610, then starts to stabilise around 1.2600, I may be tempted to move my stop up to my entry point, thus protecting my profits and avoiding a loss. – This is by all measures a pretty sound strategy, but is it optimal in terms of trading? – My original stop was placed somewhere a bit more relevant, below yesterday’s low point, now it is placed at a level which purely exists because that is where I entered the market where my anchor lies. – Lets also look at some other aspect of the trade, I placed take profit 100 points above my entry at 1.2766, this is another arbitrary number, it relies on the original anchor. It fails to take into account other factors, such as levels of natural support or resistance, pivot levels, trend lines of key moving averages. – It is also possible that sub-consciously this 1.2666 could continue to play an anchoring role throughout the day, influencing my trading judgment sub-consciously. 

Anchoring can affect us and our perceptions of value in all sorts of way in trading, investment and analysis which is not always to our benefit. When key data (E.g. US payroll data) is released on every first Friday of the month the entire market uses the estimates from economists as the anchor for whether the data is good or bad, rather than objectively assessing what this really means for the economy and markets. Too often the original reaction is irrelevant a couple of days later because a more objective assessment of the data has occurred, those traders still holding on to the original anchor can often be trampled over at this stage.

I am sure that we are also vulnerable to being anchored in beliefs which can be heavily influenced by exposure to information, a certain view point, or past experiences, and which can lead to a sub-optimal evaluation of trading prospects. How might this occur, well lets assume you are rather agnostic to rate views in a particular market, however someone hands you a report that suggests rates are likely to rise significantly in the next year, due to factors X, Y and Z. You read it and think you remain agnostic, that you are not bound into any beleif, however now it is quite possible that an anchor has been set in your mind, and future views, beliefs and trades in that market, will be affected by that anchor, rather than a pure objective assessment.  

I will use my own experiences from back in my much younger days to highlight an example: In 1994 I was trading German rate and Bund futures at a large investment bank, through 1994 the bond markets went in meltdown, everything pointed to much higher rates and inflation, it was to prove a very profitable year for me, I was on the right side of much of a very large move. - However the next couple of years proved tortuous, I think that in my mind I had become anchored to the fact that making money came from being short rate futures/long yields. Over the following 2 years the 1994 move was fully reversed, however I was regularly on the wrong side and missed some great trading opportunities.

If anchoring can affect people on an individual level, is it possible that anchoring can also affect the behaviour of the crowd, i.e. many individuals.  It is common for traders to anchor their trading to key high and low points in the market, or previous levels of support or resistance - in my example earlier I place my theoretical stop just below yesterday’s low. These levels can tend to exert an almost gravitational pull on the market, and traders will often place ‘take profits’, ‘stop losses’, exits and entries in relation to these key levels, hence we tend to see volume peak at these key price points (users of ‘Market Profile’ will of course be familiar with this). - It is very common for traders to feel that the market is seeking stops, and many trades become paranoid that the big market-makers and players are teasing with the market, however in terms of anchoring, we can see how much of this is almost a natural phenomenon. 

I come back to the original statement in the title of this post, -‘You thought you had ‘free will’ ’. – ‘Free will’ would imply that you have complete objectivity in your decision making and perception, and complete freedom to make your own choices. – I am afraid to say that sadly that may not be the case. However, familiarity with this behavioural biases, such as anchoring, may start to improve your trading, if you understand the way this affects markets and yourself, perhaps you can start to make small adjustments in your behaviour which can improve your trading performance. 


Image(s): FreeDigitalPhotos.net

Attribution Bias - Distorting you truth.

“Those who do not learn from history are doomed to repeat it” – George Santayana.

Attribution or self-serving bias occurs when one takes the credit for their successful outcomes, but distances themselves from their unsuccessful outcomes. In other words if a person has a positive result they may think it was because they were brilliant, but if they had a negative result they may  see this as the result of events outside of their control.

One sees this bias commonly at work amongst traders and investors, traders may be full of pride and  boasting about their brilliance after a very successful trade, but when they lose money they will look to blame it on other factors, perhaps the unpredictable nature of the markets, a slow internet connection, the broker, the  exchange, the algos or possibly even the source of a recommendation.

The danger of this bias is clear, blaming losses on events outside of one's control, rather than on miscalculations, poor decisions or just the fact that 'some you win, some you lose' can lead to a trader or investor repeating sub-optimal decision making. The past is airbrushed away, and any errors, mistakes or misjudgments are quickly forgotten or excused.

An overlooked aspect of 'attribution bias' is claiming credit for what may merely be 'good luck’. - This is the pitfall of many new traders; they may get an initial trade correct, or possibly an initial few trades correct. This can lead to them brimming with over-confidence, whilst all the time they have probably been on the right side of luck. This thinking does not just befall beginning traders; it can also affect seasoned pros since ‘our minds can often fool us’. – It is when a combination of biases come together that real problems can start, over-confidence bias and attribution bias can create a nasty brew, leading to a trail of losses and sharply eroded capital.  

As I have mentioned previously, these biases often sit just below the level of human consciousness, we are not aware that we have them, and as such they create trading blind-spots which can lead us into all sorts of traps. – I do not know a trader or investor yet that does not fall victim at some time or other to these cognitive errors and distortions. However there are steps people can take to lessen their likelihood of occurrence. If you are reading this now you are on the way to taking one of the steps; increasing your awareness of these biases/blind-spots. - However this will likely only be a fleeting memory soon, as this leaves your short-term and working memory, and most likely does not leave any lasting impression in your long-term memory.  

Regular re-reading or some sort of reminder can help keep this awareness of biases a little more alive, greater awareness is definitely a first step to fighting these blind-spots. – However, I believe keeping a trading journal is one of the best ways to combat these issues over time. I do not feel that everyone has to keep a trading journal, for some it is not absolutely necessary, however, if you are like the 99%+ of traders who often struggle and are tormented by markets and dissatisfied at times with your personal performance, then keeping a journal will prove very useful. I know from personal history and from working with my coaching clients, that many men feel uncomfortable about keeping a diary/journal, it is not generally thought of as a very masculine thing to do. Yet many great traders have kept journals;

• Richard Dennis, arguably one of the greatest ever traders, specified that he would keep a Log of what he did right and wrong. - And I believe he encouraged all the turtles (in the famous experiments to do likewise).
• David Ryan, also in Market Wizards speaks about keeping a trading diary, and contributes it to a major part of his success.
• George Soros keeps a diary of all his thoughts when he's trading and about trading.

However, this is one hurdle many have to overcome. One highly experienced trader with a very successful track record, who I coached earlier last year, was very hesitant to go down the journal route; however once he started keeping a journal he was amazed at how powerful it was. .

I do not suggest keeping it religiously, some people like to update almost every thought and action, I feel intermittent updates when required are however best otherwise it can become a chore and eventually will not be maintained, but no more than weekly otherwise again it will like be forgotten in time. In these updates keep a note of your thinking, including your emotions, e.g. anger, joy, fear, etc.

I would then suggest periodically looking back over your diary, this can really help you deepen your understanding of yourself as a trader, and how you trade. It is here that you may start to find that you have certain patterns at work in your trading and thinking, some of which may hold clues to the biases you are keeping.

I also like to use the journals as memory/reminder boards, I suggest keep a section at the front or back with important information, short articles, inspirations, maybe even list of biases or rules/guidelines. Check these out regularly, since by doing so will eventually keep these more prevalent in your mind.

Bubble Burst!! - Apple inc v Nasdaq comparison update.

Last week I posted a comparison of the chart of the Nasdaq around the time of the 1999 bubble and the subsequent years, with a comparison below of Apple inc's share price over recent years.

I have reproduced these charts below, plus an additional chart with an update below that of the Apple inc chart since then.   

Further to this, there was another interesting post on this theme from Apr 18th, which you may want to check out here.

'No one is bigger than the market' - A lesson it appears the 'The Whale' may have forgotten.

We hear this morning that a man by the name of Boaz Weinstein was the driving force behind hastening the demise of the 'London Whale'. Weinstein runs Saba Capital Management a hedge fund based in New York. Weinstein is a renowned index arbitrageur, he was the apparently the main (though probably not the only person taking on Iksil) in the CDS markets.- Effectively, Iksil was taking on the arbitrageurs, a plight tried by many people, but rarely (if ever) won, I will explain why.

Arbitrage is a word commonly understood as being the ability to take advantage of minor price differences across markets or products. -  I.e. At its most simple to buy Asset A at one price in one market and sell Asset A simultaneously at a higher price somewhere else. - This is the holy grail sought by many banks and large hedge funds who have the ability (capital, resources and infrastructure) to be able to do this. - As one would expect the differences are usually very small and usually exist very briefly, one has to be able to do it in huge size and very rapidly to make it worthwhile, and indeed in the highly liquid markets arbitrage rarely exists, if it does occur, it is very quickly 'arbed' away.

Pure arbitrage, of the form described above, is really a thing of the past, though times of extreme market disorientation can still throw up the odd opportunity. However arbitrage still exists in less liquid and more opaque markets. - Most Investment banks (and many hedge-funds) have teams of 'relative value' traders, looking for and trying to take advantage of arbitrage opportunities or near arbitrage opportunities, between products of a similar nature where a fairly consistent relationship exists. 

In my early days in the markets I worked in the emerging field of derivative arbitrage, trying to takes advantage of the relationship between yields and the forward fx markets. I had two memorable occasions where I came up against traders inside large banks who thought they could take on the arbitrageurs and win, much to their cost:

- The first occasion was in 1989, I was working at a small Norwegian bank in London at the time, where I was active in the markets looking for arbitrage opportunities. This was the time of the collapse of the Berlin wall and German re-unification, the fears at the time were that this would lead to much higher German yields. One particular trader at a large US bank in Frankfurt stood firmly against this move to higher yields, he was on the offer on the German yield market in all maturities up to 2 to 3 years, however the much larger and more liquid forward Foreign Exchange market were producing bids on yields on German instruments greater than his offer levels. - I did not have a view on German yields or Foreign Exchange rates, but it was almost rude not to pass up the opportunity for near risk-free profits by lifting his offers and executing the arb. Fellow arbitrageurs at other banks, including notably one large Dutch bank and another large US Bank, were in on the same trade. - Still the banker at the US bank in Frankfurt sat on the offer refusing to budge, ironically offering even more profit as the synthetic bid from the forward fx market was now even greater, this not only encouraged us arbitrageurs further, it brought in other participants to the trade. - Effectively the Frankfurt banker was overcome and had to pull his offers, the market's had 'boiled-over' him, and eventually this banker was beaten - a spent force. - The irony was that the Frankfurt banker was ultimately proved right, but so big was his position, and so firm was he trying to fight the market, that he was forced to cover, which actually forced the market further against himself at that time of covering his positions. - If memory serves me correctly, yields have never been up there since.     


- The second occasion was a few years later, I had progressed in my career and was now working for a large Swiss bank in London. One of the markets I was actively arbitraging was the ECU (European Currency Unit, the forerunner to the EURO)

At the time I was noticing that the same bank (another large Swiss bank) was opposite me on every trade. - Which meant one of us was wrong. - I happened to know that the other bank was doing the ECU basket trade, buying or selling the ECU basket and doing the opposite in the currencies which were the component of the basket. It was one arbitrage meets the other. - Having done this for around 8 years on the same formula I knew my method was correct, which meant basically that my counterparty to all these trades was basically miscalculating the basket. - Sure enough a few months later some rather large discrepancies started showing up in that large Swiss bank's trading accounts (A bank by the way that has not been immune from similar though much larger problems in recent times).

I relate this back to the unfortunate 'London Whale' because this sounds all too familiar. The instruments may have changed, they are certainly far more esoteric, but in the early days of derivatives, perhaps the instruments I traded, which would be considered part of Trading101 now, may have been considered esoteric by many. - In this instant the very bright and astute Boaz Weinstein spotted the opportunity to buy CDS instruments at a very good discount to the basket of the instruments they were suppose to be hedging, this stopped Iksil from being able to bully the market his way. I suggest that this may have irked Mr Iksil enormously, who despite being a low profile and very private person, would possibly have felt his pride and ego hurt that he was unable to force his will upon the market, and so engaged in even more trades, all of which further lined the pockets of Mr Weinstein and fellow arbitrageurs. This whole situations sounds akin to the example of the Deutschmark trader above, though in far larger size and with a far more devastating outcome.

My years on this planet are littered with failed attempts of one kind or another to take on the markets and win. Amongst some of the more well known ones are the Hunt Brothers and Silver, Hamanaka and copper, Nick Leeson, LTCM, Porsche and VW shares, Armarajo and cocoa, to name but a few. I am sure there are many mini and micro attempts going-on in markets constantly, I believe these contribute to the price action and volatility in the markets. - The moral of the story however is; it does not matter how big you are and how much power you have, you can not fight the market and hope to win, no one can bully the markets, and no one can bend them to their will.

Note : Image "Trader" by Vlado, courtesy of FreeDigitalPhotos.net.

New Quote for the week + A word for the week 'Egregrious'

Quote for the Week – 14^th May – 20^th May:

“You will exit a losing trade when the pain of losing one more dollar is more intense than the pain of saying you were wrong in taking the trade.” - Benoit Mandelbrot

Past Quotes for the week.

·         “Without continual growth and progress, such words as improvement, achievement, and success have no meaning.” - Benjamin Franklin

·         “Never let the fear of striking out keep you from playing the game!” - Babe Ruth.

·         "Predicting rain does n't count, building arks does" - Warren Buffett.

·         “Everybody gets what they want out of the market" - Ed Seykota.

·         “In Trading there are no rules, but you have to know them all” - Unknown

·         “It is not the mountain we conquer but ourselves.” - Sir Edmund Hillary. 

We also have a word for the week this week. - 'Egregious' courtesy of Jamie Dimon.

For those of you not familiar with this word's true definition:
  

Bundebank - Major policy shift on inflation ?!?! - And some illusions.

I awoke this morning to the headline – ‘Bundesbank “accepts” higher inflation‘.

If this is the case, and there already seems to be some backtracking on this, the repercussions could be enormous. If this is really true we are looking at the possibility of significantly lower EURUSD going forward, as the ECB prepares to ease the monetary reigns. Thoughts on Bund yields going forward would have to be revised heavily, and almost certainly this would have a knock on affect throughout European financial markets, perhaps some positive some negative.

I have mostly traded Deutschemark and Euro products since the mid-1980s, this has meant following almost every word, letter and utterance spoken by the Bundesbank, German Finance ministry and ECB for many years: – It has long been held that inflation is the sacred holy cow which Germany will never sacrifice: In my many years in the markets I know how much keeping inflation under control means to the Germans, the spectre of the hyperinflation of the early 1920s and the traumatic events around and following this is etched on the German memory and Psyche, I doubt that any German finance or Bundesbank official would ever be allowed to state that the ‘Bundesbank “accepts” higher inflation‘, unless they were accepting that not doing so could have severely dire consequences. – I don’t think this discussion is as cut and dried as it seems, it may be genuine, or it may be a statement out of context, or it may reflect a short-term modification to a long-held belief (Panic).

If it is actually a genuine shift in policy on inflation by the Bundesbank, we would have to accept that this could be the catalyst for some major long-term changes in certain market relationships. In the meantime – here a few alternative headlines which I think would compare to this one in terms of major paradigm shifts.

‘Pope accepts contraception is not a bad idea’.

‘Fidel Castro to allow Mcdonalds CEO to run Cuba’s economy’

‘Richard Dawkins – I was wrong – The world was created by God’.
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Finally as a follow-up to last week’s post titled ‘What you see is often what you 'think' you see, not what you really see!!! ‘ here are some more very interesting illusions form the world of architecture and art.

This first one is from the 'Might Optical Illusions' website. Apparently the building pictured in this article stands perfectly upright, and has the same width of it’s footer, as of it’s last floor.

The following image contains flat drawings by a 17 year old chilean artist/prodigy called Fredo - Follow this link to see more of his incredible 3D drawing.

Have a good weekend - Steve.

AUSUSD WEAKNESS and RISK OFF GROWS.

With last week's move continuing this week, the call of the past few weeks for further upside is definitely looking wrong.

Some charts which highlight the turn towards the Risk-Off and some key points. - Followed by interesting price action on the SP500 and VIX.

First however last week's Aussie PMI was very nasty, the chart below shows this and the AUDUSD, and with risk-off gathering pace, including gold breaking a serious trendline(See below) the prospects for the AUDUSD look decidedly gloomy. 

Also interesting action on the Daily SP500: - A 'Head & Shoulders Top' pattern on the SP500 daily, with an inverted Head & Shoulders on the VIX highlighting the risk of a sharp move growing.

Name Those Charts?

Time for this weeks game of - Name those (similar) charts?

Yeh I know not too difficult for some of you.

Scroll down a little for answers ---

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I'm not going to add much to this, other than the visual similarity is quite striking in my humble opinion. -  FWIW - If the similarity were to continue ('If' and 'were' being the operative words here), it suggests to me we may be at the early 2000 volatile consolidation before the one final hurrah to a top, though it is also possible we are at the top already (See below). - Highly speculative I know, but if we are not yet at the top. that would suggest a possibility of more highs, possibly above 800 still to come.  

P.S. - Away from markets - I have been playing catch up on the TV series 'Homeland' - totally brilliant.  Best American TV series for years.

Quote for the Week – 7^th May – 13^th May:

“Without continual growth and progress, such words as improvement, achievement, and success have no meaning.” - Benjamin Franklin

Past Quotes for the week. 

• “Never let the fear of striking out keep you from playing the game!” - Babe Ruth.
• "Predicting rain does n't count, building arks does" - Warren Buffett.
•  “Everybody gets what they want out of the market" - Ed Seykota.
•   “In Trading there are no rules, but you have to know them all”
•  “It is not the mountain we conquer but ourselves.” - Sir Edmund Hillary.

What you see is often what you 'think' you see, not what you really see!!!

As a trader coach and someone involved in trading psychology education, I often come across simple but well meaning advice given to traders. Whilst I appreciate the good intentions in imparting these nuggets of wisdom, I often find that these nuggets are in reality somewhat banal and meaningless (In fact I often wonder whether many of these people have really traded for a living or run risk - and in many cases it turns out they haven't). 

As an example: One very common piece of advice is : 'Trade What You See, Not What You Think'.

It sound like good sensible advice, and on the face of it, who would argue with it. - But the problem is we don't actually see what we see, rather we see what we 'think' we see. - If you are confused at this stage I don't blame you, but try and stay with me just a little longer. 

I am going to provide a little example of what I mean here; together with a little explanation from the world of Neuroscience.

Take a look at this shape, I am sure you are familiar with this particular illusion or one of its many variants. Much as you look at it, and contemplate it, your intellect tells you that this is impossible, you could not physically build it, but your brain is still telling you that you are basically seeing a cuboid shape.
This happens because we see with our brain and not our eyes. Neuroscience research has found that there are 10 times more neurons (The basic building blocks of your nervous system) going to the eye from the brain, than there are going the other way from your eye to the brain. Your brain receives light from the eye, but its the brain that makes it up into something coherent. Interestingly, the eye actually throws away much of the information it gets, leaving it to the brain to fill in additional information in its own ways. And here is the crux, the brain zooms in on templates from past experience, and is doing this on auto-pilot, you are not even aware of it. - Hence in this example, much as you know that is impossible, your brain still sees a cuboid.  

Just to add to this, our cortex, the outer layer and newest part of the brain, which in humans is vast and gives us the ability to abstract and rationalise; is scanning for similarities between the immediate situation we observe, and our stored experiences. Hence when you read a sentence such as this one: 

Aoccdrnig to a rescherear at Cmabrigde Uinervtisy, it deosn’t mttaer in waht oredr the ltteers in a wrod are, the olny iprmoatnt tihng is taht the frist and lsat ltteer be at the rghit pclae.

You will almost certainly read it correctly as:

According to a researcher at Cambridge University, it doesn’t matter in what order the letters in a word appear. The only important thing is that the first and last letter be at the right place. 

The reason you were most probably able to read the jumbled sentence, is we use context to activate the area of our brain that signals what we expect next. - It is the same with hearing, if we hear a sound that leads us to believe another sound will follow, the brain acts as if we’re already hearing the second sound. - Our brains draw the same conclusions with words and letters. It is possible that you did not get every single word correct when reading a jumbled sentence or passage but will believe they did because the brain will subconsciously go back and fill in any gaps in your knowledge based on the subsequent context. One final little example for you:

 Read out loud the text inside the triangle below:

Almost certainly you said 'A Bird in the Bush' ?

Try it again -  Still 'A Bird in Bush'? --


This time put your finger over the word 'The' and read it again?

I am sure you have it now - The word 'The' appear twice, but almost certainly most of you have missed seeing 'the' twice. - This merely emphasizes what I have written above.


- Is it any wonder that trading sometimes is such a difficult task?

I will leave it at that for now, however for those of you trading on the Non-Farms this afternoon, best of luck, and 'be careful what you see, or what you think you see'.


If you would be interested to know more about my work a as a 'Trader Psychology Coach' and  'Trader Performance Coach', and how we can help you or your colleagues to become a more effective in your job, please feel free to contact me at sgoldstein@bgtedge.com or visit our our website at www.bgtedge.com. 

FX Updates. - Let the pictures talk!

Some interesting price action on the forex markets. - I am not going to add to much comment here, but will instead present some mostly 'Big Picture' charts of EURUSD, EURGBP, EURAUD and USDCAD, with a few observations added. - The chart which looks the most interesting is the EURAUD in the wake of the surprisingly strong move by the RBA. 

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