Market Wizards Study Notes by Zhipeng Yan

Market Wizards

Interviews with Top Traders

Jack D. Schwager

Market Wizards Study Notes by Zhipeng Yan

Part I FUTURES AND CURRENCIES

Michael Marcus: Blighting Never Strikes Twice

Start as a commodity research analyst, then a floor trader, then work forCommodities Corporation. He attributes his success to Ed Seykota, who taughthim how to cut losses, as well as the importance of riding winners. Ed is a trendfollower, who utilized classic trading principles. Ed said, “The trend is down, andI’m going to stay short until the trend changes.” He learned patience from him inthe way he followed the trend.2.

Plywood price case: it was theoretically frozen at $110 per 1000 square feet. Oneday, the futures price was trading 20 cents over the legal ceiling. So I startedcalling around to see what was going to happen, but nobody seemed to know. Iused the following reasoning: if they let it trade over $110 today, they might let ittrade anywhere. So I bought one contract. Ultimately, plywood went to $200. Thefutures market functioned as a supply of last resort to users who couldn’t getsupplies elsewhere. Basically, it created a two-tiered market, a sort of legal black market.3.

Things leaned from the floor: you develop an almost subconscious sense of themarket on the floor. You learn to gauge price movement by the intensity of thevoices in the ring. I learned the importance of intraday chart points, such as earlierdaily highs. At key intraday chart points, I could take much larger positions than Icould afford to hold, and if it doesn’t work immediately, I would get out quickly.My trading in those days was a bit like being a surfer. I later used that surfingtechnique as a desk trader. Although that approach worked real well then, I don’tthink it would work as well in today’s markets.4.

The best trades are the ones in which you have all three things going for you:fundamentals, technicals, and market tone. First, the fundamentals should suggestthat there is an imbalance of supply and demand, which could result in a majormove. Second, the chart must show that the market is moving in the direction thatthe fundamental suggest. Third, when news comes out, the market should act in away that reflects the right psychological tone. For example, a bull market shouldshrug off bearish news and respond vigorously to bullish news. If you can restrictyour activity to only those types of trades, you have to make money, in anymarket, under any circumstances. All my profits come from the trades that metthe criteria. The other trades broke even and kept me amused. The thing thatsaved me was that when a trade met all my criteria, I would enter five to six timesthe position size I was doing on the other trades.5.

I believe that the era of trend following is over until and unless there is aparticular imbalance in a market that overrides everything else. Another exceptionwould be if we were to enter a major inflationary or deflationary environment.One reason we don’t have many good trends anymore is that the central banks arepreventing currency moves from getting out of hand by taking the other side thetrend.6.

I try to avoid the currencies, because I feel it is a totally political situation; youhave to determine what the central banks are going to do. During late 1978, thedollar was getting battered, falling to new lows every day. One day, we noticed2

Market Wizards Study Notes by Zhipeng Yanthat the dollar got mysteriously strong. There was an intense price movement thatcouldn’t be explained by any known information. We just bailed out of our longcurrency positions like crazy. That weekend, President Carter announced a dollarsupport program. That situation illustrates one of the principles we believed in –namely, that the big players, including the governments, would always tip theirhand. If we saw a surprise price move against us that we didn’t understand, weoften got out and looked for the reason later. I believe the European central banksare notified about major changes we are going to make, and they often act aheadof US policy announcements. Consequently, the price move shows up in Europefirst, even if it is because of something we initiate.7.

One of my rules was to get out when the volatility and the momentum becameabsolutely insane. One way I had of measuring that was with limit days. In thosedays, we used to have a lot of situations when a market would go limit-up for anumber of consecutive days. On the third straight limit-up day, I would begin tobe very, very cautious. I would almost always get out on the fourth limit-up day.And if I had somehow survived with any part of my position that long, I had amandatory rule to get out on the fifth limit-up day. I just forced myself out of themarket on that kind of volatility.8.

I think to be in the upper echelon of successful traders requires an innate skill, agift. But to be a competent trader and make money is a skill you can learn.9.

Advice for beginners: always bet less than 5% of your money on any one idea. If you take a long position in two different related grain markets, that is still oneidea. Always use stops. If you become unsure about a position, and you don’tknow what to do, just get out. While you are in, you can’t think. When you getout, then you can think clearly again. Perhaps the most important rule is to holdon to your winners and cut your losers.10.

E.g., when we were in a very inflationary period and all the commodity marketswere trading in lockstep fashion. On one particularly powerful day, almost all themarkets went limit-up. On that day, cotton opened limit-up, fell back, and finishedonly marginally higher for the day. You absolutely want to put down a bet when amarket acts terribly relative to everything else. When the news is wonderful and amarket can’t go up, then you want to be sure to be short.11.

Gut feel is very important. Being a successful trader also takes courage; thecourage to try, the courage to fail, the courage to succeed, and the courage to keepon going when the going gets tough.12.

If trading is your life, it is a tortuous kind of excitement. But if you are keepingyour life in balance, then it is fun. All the successful traders have a balanced life;they have fun outside of trading.13.

On success: I am very open-minded. I am willing to take in information that isdifficult to accept emotionally, but which I still recognize to be true. I look forconfirmation from the chart, the fundamentals, and the market action. I don’ttrade the Dow Stocks. I prefer the little ones, because they are not dominated bythe big professional traders who are like sharks eating each other. Commitment toan exit point on every trade.3