Transcript: Charting Masterclasses from a Trading Legend – Episode 2 – Risk

Management

Featuring: Peter Brandt

Published date: 17th of May 2017

Length: 00:41:11

Synopsis: Charting Masterclasses from a Trading Legend continues with Episode 2 as

Peter Brandt outlines the backbone of his trading philosophy and what keeps him in the
game – Risk Management. In this episode, Peter spells out the ratios and rules he has lived
by throughout a 40-plus year career trading commodity futures markets and the principles
that guide him as a classical chartist.

Topics: Psychology, Technical Analysis, Trading

Tags: Factor, Trader, Classical, Charting, TA

Video Link:
https://www.realvision.com/channel/realvision/videos/5f6c94dff4e84746b752f6f363
0e9fc0

The content and use of this transcription is intended for the use of registered users only. The transcription
represents the contributor’s personal views and is for general information only. It is not intended to amount
 Charting Masterclasses 2: RISK MANAGEMENT

to specific investment advice on which you should rely. We will not be liable to any user for any loss or
damage arising under or in connection with the use or reliance of the transcription.

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Peter Brandt: I have been a professional foreign exchange and futures trader dating
back to 1975 at the Chicago Board of Trade. I am a classical chartist. I've used price
charts to earn my living during all of these years and in the process have learned a lot of
lessons, some the hard way. And it's really those lessons and that perspective of all of these
years training that I'd like to bring to you. I'm Peter Brandt. I am a classical chartist.

I would like to relate to you very sad and very true stories. Story number one. In February,
I was hosting a webinar for members of the Factor Research Service. And the question
came up from a member, what would I do if I were short the stock index markets from a
level where the Dow Jones was 10,000?

I was flabbergasted. I was almost breathless after that question was asked as I pondered
the idea that the per contract loss and the contract of the Dow Jones futures would have
been over $50,000. That somebody would be short the Dow Jones for more than half of
its rise since the 1930s Depression low, I wasn't exactly sure how to answer. But I did
answer because the answer was rather simple.

Over the years as a trader, I have focused on risk management. And I have developed a
number of different little techniques and tools and guidelines that helped me from taking
the big loss. Because it's big losses such as this, which occur all too frequently, that really
end the career of traders and the aspirations of novice traders who are looking forward to
a career in trading.

And a couple of examples of that would be the fact that I always have a stop in the market.
I don't come into a market, put a position on, and ignore it and then hope for the best and
then get stubborn and then get so far underwater in a trade that I have no choice but to
hang on and have it get bigger.

I use stops. I get stopped out of positions. A second technique that I use is to always get
out of a loss on a Friday. And so I am geared up as a trader avoid just such a story.

Story number two. I started in the world, the crazy world of Twitter, back in early 2011 at
the encouragement of my publisher John Wiley & Sons, who had just published a book that

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I did on my own trading. And it was a crazy world at that. I had no idea that the world of
Twitter even existed.

I was very lucky in April of that year to call within 24 hours the absolute high of the silver
market at $50.00. And I did so boldly, and looking back, almost with arrogance. And I
received the full wrath of the Twitter world and silver bulls who lived in it. There was one
particular other member of the Twitter world who bet me $1,000 that the price of silver
would never again go below $25.00 an ounce. And I eagerly took that bet. I won the bet.
He lost the bet.

He never paid, and he disappeared from the world of social media. I later heard that he
had his entire fortune wrapped up in the price of silver at an average of $38.00. And he
lost his complete family fortune on the crash of the silver market. What was the lesson there?
I mean for me, the lesson is that he was betting on everything he understood to be the
global macro story of silver, the cost of production, the limited supply, all of these other
factors.

He got caught up in what the title of the market was, the name of the market in the upper
left hand corner of the chart. That's what he thought he was trading, where I was trading
price and price alone. I looked at the y-axis on the right hand side of the chart. He was
caught up in the excitement of the name of the chart itself. And that was a lesson there.

I look back and realize how fortunate I was early in my career to have had another member
of the Chicago Board of Trade take me under his wing, an individual who was probably
the best risk manager, money manager, I'd ever encountered as a trader. And he really
mentored me. He poured a lot of his life into me.

And at the time, I guess I was a novice enough that I actually believed the things he was
telling me. But I look back now and just realize the wisdom that he shared with me was just
priceless. It's prevented me from falling into a situation just like the two stories I've related.

We're on the subject of risk management, but risk management is really-- it's an umbrella
phrase. It's a catch-all phrase that has a lot of different implications to it. I'd like to show
you a diagram that really kind of puts it all together for you as to what I think about when
I'm thinking about risk management.

Risk management's the broad spectrum, but under risk management we really have-- the
way I trade, there is capital or money management on one side and there's trade
management on the other. So the umbrella is risk management. Capital or money

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management really deals with questions such as what positions-- or should I have any
positions at all into Brexit or the US election?

That deals with questions applying to my capital, to the amount of money in my account.
It's, should I have a limit on how much I lose in an individual day before exiting a trade?
How should I position myself before an important fed announcement? What should be the
composite risk on highly correlated trades? How much should I risk per trade? Those are
all capital management questions and decisions for me.

And then there's trade managements, the other side. And trade management really applies
to individual trades that I'm in. How do I get into a trade? What's my strategy for doing
that? How do I set my stop? How do I size an individual trade? How do I take profits? And
so that gives you kind of a feel for when I think of risk management, what all things are we
are involved.

There's another diagram that I would like to show that will give you a whole different context
for how I think about risk in trade management in my own market speculation. I have
noticed that novice traders especially want to run right to tactics. So when I see dialogue
taking place on social media, the questions that get asked of me on Twitter or email, really
all deal with tacticals. They're tactical questions.

Why did you select that market? Why did you get in where you got in? Why did you get
out here? Why did you use that stop? Those are all tactical questions. And a trader who
just focuses on tactics really loses a sense for the broader concept and construct of the
whole business market speculation.

So as I show by this pyramid-- I consider this pyramid really to be my pyramid for decision
making. And decision making has to start with larger concepts-- for me-- with really the
philosophy of market speculation. What's market speculation all about? What's the
philosophy that's going to drive my participation in the marketplace?

And from that philosophy, I can really move to principles and guidelines. And from
principles and guidelines, then you get tactics. And tactics can't just stand out there on their
own. A tactic is like something you put on a Christmas tree. Without the Christmas tree,
what you put on a Christmas tree can't hang.

And so tactics need to hang from a broader construct. And that's what this triangle shows,
is that whatever tactic I have to come up with, that tactic needs to resonate and be consistent
with guidelines, which need to be consistent with really the philosophy of my trading.

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I'd like to show a couple of examples about how tactics flow out of guidelines, flow out of
philosophies just to put some meat on the bone in terms of this triangle and explaining how
tactics flow out of bigger considerations. This was a trade that I put on in December, early
in December.

It was a trade in the euro currency. I shorted the euro currency on December 15th as I saw
the market breaking out. Because I'm a chartist, I trade break out patterns. There was a
break out of the euro currency against the US dollar on December 15. The principle, the
philosophy here behind the tactics that I'll show, is that capital preservation is the first
priority of successful market speculation.

That in itself is not a tactic. A tactic has to flow out of that. And so capital preservation has
to be the first priority. The principle that comes out of that philosophy is to cut losses short,
is that if capital preservation is the philosophy, cutting losses short is really the definition of
how that is done. And in this case, then, the tactic flows out of that.

The tactic that I use and that came into effect in this trade is to never take a loss home on
a Friday. And so that tactic is great in and of itself, but it flows out of bigger things. It flows
out of capital preservation, it flows out of cutting losses short, and then you have to have
an action point to those things. My action point is that I will not take a loser home on a
weekend.

And so in this case, I was short the euro currency. And on December 30, I exited it because
it was going into a weekend. I had a loss in the trade, therefore I exit the trade.

The final two examples really fit into the triangle in the sense that the philosophy of market
speculation is that net profitability will really come from very few large trades. It's the whole
concept of letting winners run, cutting losses short. And it's those winners that a trader
allows to run. Those are the trades that really will put in the net bottom line over a period
of time.

And so the philosophy is one of allowing profitable trades to get larger. The guideline
portion of the triangle is really to have some mechanism by which stops on a trade to
protect the stop is allowed to trail the stop. Because again, I don't want a winning trade to
come against me and go all the way back to where it started from. But I do want to allow
it to run. And so my guideline is really to use trailing stops.

And my tactics is a little mechanism which I call the three day trailing stop rule. I wont
describe it, but its a little tool that I use that says, OK. This is as far as I going to let it run.

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If certain things happen I will get out. But I'll allow it to run to at least 70% of what my
initial target was when I established the trade to begin with. I always have a target in mind.
And that is where I am anticipating the market will go.

And so there are two examples here of that taking place.

I'll show you those two examples. One was in the case of the Eurodollar market, where I
established a short position in early November. And in the Eurodollar, the market went in
my direction. It went in my direction right away. And as it went, I just continued to lower
my stops, lower my stops, lower my stops. And finally, I was taken out of the trade on
December 29 when it reverses.

And so as a general rule, when the market is run, I'll let it run. When it reverses back to me
after reaching 70% of its target, there is a little technique that I use called the three day
trailing stopper rule that will then take me out of a trade.

The other example is that of Soybean Meal, where there was a head and shoulders bottom,
a classical pattern, a textbook classical head and shoulders bottom that completed in
Soybean Meal on April 11. Again, it was as most really good trades are, they go
immediately. I have found that the best trades are those trades that I put on and they're
profit by the end of day one and they never look back.

And those are really the trades that, for me, put in my net bottom line at the end of each
year. In this case, Soybean Meal. It broke out, and it ran. And I bought the Meal on
November the 11th. I bought some more on the way up. And finally, it actually exceeded
my target price. But then on May 31, it triggered what I call the three day trailing stop rule
and stopped me out of the entire trade.

So there are examples of trades where the principle of the trade is that very few trades will
really be the best trades. The trades will put in the net profit over a period of time. To let
those trades run, to use trailing stops to manage those trades. And when they reach a
certain point, to start tightening stops up extremely tight to capture the maximum amount of
profit that the move might offer you.

I could talk about trading tactics all day long. In fact, I would say that 90% of the questions
I get from people on Twitter and by email deal with trading tactics, the what markets to
buy, when, and how. And tactics, as I have explained, really need to be subject to larger
issues.

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And so what I'd like to talk about now is the major philosophical principles and guidelines
that over time sometimes through trial and error, sometimes through losses, but at least I
have come to understand as those things which really need to guide my trading.

The very first guideline, principle, that I go by is the fact that my judgment on markets is
unreliable. I cannot trust it. I may think I know where market's going to go. I may be
absolutely convinced that I know what the market is up to. But in the final analysis at the
end of the day, markets are going to do what they're going to do. So I cannot trust and
become dependent upon my judgment on where a market's going to go.

There is a tactic that flows out there. And that tactic is that I need to use stops. I need to cut
losses short. Because I could be absolutely 180% wrong on a market's direction.

The second major principle that guides my trading is the belief that there are two dimensions
to a trade. I've heard so many people tell me, boy I knew what crude oil was going to do.
I knew it was going to go down. But the reality is that the two dimensions of a trade are
not just direction but also timing. And if timing is not right in a trade, it doesn't matter that
one has direction right. One has to have both timing and direction right in the trade. To
end up with a successful trade, both dimensions must work.

The third principle that guides my trade in is the fact that traders trade price and price
alone. Now, somebody like Warren Buffett buys entire companies. And he buys them to
hold on to them. And he is an owner of that company because of what that company does.

I may think I am trading Apple computer, and in my mind, I have the vision of the Apple
Store and my iPad and my iPhone and all of those things. I may think that I'm trading
soybeans, and I have a mental vision of a farm and a tractor. I may think that I'm trading
a variety of things. And what I may be fixing on is the name on that chart that's up in the
upper left hand corner. But the reality is I trade price and price alone.

Unless you're Warren Buffett, unless-- if you are trading as I do for a price change, then we
trade price. And so I need to keep in mind that there is a differential between what I'm
trading and the fact that I am really just a price trader. I'm trading price change, and that
is how I make my living.

The fourth major guideline or principle that I use to guide my trading is the idea that trade
identification is really one of the least important components of successful market
speculation. This idea of signaling, it's picking out the right trade, what I call trade
identification or signaling.

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That's where 90% of novice traders spend 90% of their time, money, and energy trying to
figure out. They think that's where the magic is. And trade identification is not one of the
key things that really will produce the outcome of a long term profitable trading.

The fifth major principle or guideline that I follow is the idea of longevity. Trading is not a
sprint, it's a marathon. And the advice that I give young traders is set up your trading
approach so that it may last an entire generation. Think long term.

Don't think about how much you're going to make today or this week or this month or even
this year. But think in terms of how can you trade in a way that will keep your capital
together and provide you over a long term period of time? A compounded rate of return
that keeps you in the game and allows you to catch major moves.

And one component to that is that no position is a position. It just seems like there is this
compelling urge on the part of traders to always have a position on. If they can't have a
position on, they somehow feel naked. And the reality is that having no position is one of
the positions that frankly will best be suitable toward a longevity approach to trading.

The sixth major principle or guideline that really dictates my trading is the idea that I really
have only one job to do. My primary job is to manage losses. This was taught to me early
on by the guy that was my mentor early on. When I would ask him, what do you do? How
do you define your job? His answer was, I define my job as being a loss taker. I take losses.
I let profits take care of themselves. And so I need to be the manager of losses. The focus
my attention needs to be on my losses. Let my profits take care of themselves.

And I have a couple of different rules that kind of apply to tactical implication of that. One
is that I limit my risk on any given trade to 1, a maximum of 2% of my total trading capital
on a given trade. And I've talked to people who would say, well, I don't do that. I risk 5%
of my capital on a trade. I risk 10% of my capital on trade.

I think that's fine for people like George Soros. But for an active trader who comes in with
the idea that they're going to trade markets, I can't go into the statistics and how they work
now, but I can say without a doubt that the person risking 5% or 10% of their capital on
each trade is just bound for doom. And that's the reality of how the math works.

The seventh major principle in guiding my trading is the idea that I have a pile of chips. It's
like I'm a poker player in Las Vegas. And once that pile of chips is gone, I'm out of the
game. And I'm forced to leave the table. And it's really related to the idea of managing

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my losses. But I need to protect my pile of chips. I need to be judicious in watching my

capital and keeping it together.

I've always told people, and I really believe that applies to myself, although I hope in the
end it doesn't, and that is that my worst drawdown is the one that's yet to happen. And
when I mention that to people, they go, oh my gosh, I hope that's not true. But I think a
trader needs to trade that way. I need to always be thinking of the fact that if I don't guard
myself very carefully, my worst drawdown may be the one that's yet to happen.

And what that does is it gives me respect for sizing. I know that when I size a trade, I have
to size a trade with that in mind. There's another aspect to that, or a dimension to that. And
I look back over the history of my trading, and my win rate is just slightly more than 40%.
Actually, it's around 41, 42% of my trades over a long, long, long period of time have
been profitable trades.

What that means for me is my default way of thinking is that the next trade that I put on is
going to be a loss. Now, I never put on a trade thinking, well this is going to be a loss. But
the reality is that it is most likely to be a loss. And if I trade in such manner where I know
that my default trading outcome is a loss, it gives me respect. And it leads me to this whole
idea of protecting my pile of chips.

The eighth guiding principle of my trading is the idea that I want to focus on my sequential
closed trade NAV. This is going to take a little bit of explanation because it's a very
unconventional way of kind of tracking my performance as a trader. Most traders look at
the value of their account, which includes their open trade profits.

And frankly I think that a compulsion about what the value of an account is based on open
equity is a very destructive way to trade. Because the reality is my open profits are not
mine. They don't belong to me. They're out there. They're play money. What matters is
what's in the bank. What's in the bank after trades close?

And so I keep a graph. And what that graph shows is my net asset value, which changes
based on the rate of return of the next trade, the next straight after that, the next trade after
that. And that's what I chart. And I refer to that as my sequential closed trade equity NAV
line. It ignores open profits.

Let me give you an example of how a focus on open trade equity can really screw up the
head of a trader. And I know this just happened to me early on in trading. And I believe

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I've kind of moved past that by looking at sequential close trade profits. Let's say I have a
3,000 or fourth-- let's say I have a $3,000 profit in a contract of Soybeans.

And I come in some day, and there's a government report. The market reacts violently. I
exit the trade. And the value of that trade goes down during that day by $1,000 for each
contract. And so what was a $3,000 open trade equity for a contract with Soybeans all of
a sudden becomes a $2000 open trade equity for that contract to beans. And then I close
it out. Well here's my question. Did I just make $2000 or did I lose $1,000?

And I've heard traders talk about the fact that they've had such a bad day. And when I ask
them did they contribute to their close trade bottom line, they tell me yes. And I have a hard
time figuring out how taking money off the table and putting it into the bank can represent
a bad day.

But it's just the perspective of a way to look. It's that close trade net asset value line that I
want to go to protect. I think there's several steps that I use as a way to really focus in on
continuing to move that close trade net asset value line higher and keeping it from having
big dips or drawdowns.

The first is that when I enter a market, I try to enter a market at that precise point on a price
chart that should lead to an immediate increase in the value of a long position or a decrease
in the value of a short position. And so I have no desire to be involved in a market when it
is in a big broad trading range where it goes up and it goes down. I have an interest in
getting involved in a market where it can have an immediate thrust in the direction that I
anticipate. So I want to enter trades at breakouts where I can possibly put money into the
trade right away.

The next thing that I do in managing that net asset value line is really to advance stops on
trades to break even just as quickly as I can. Sometimes that can be the same day.
Sometimes it's the next day or two days later. But when I risk a certain amount in the trade,
my goal is to try to move my protective stop.

And I use protective stop on all trades to move it into a place where the trade that I have
on. If it's stops me out, it's at least stopping me out at break even, perhaps even a small
loss.

Kind of the next thing that I do in trying to manage that net asset value is to allow profits to
run. I mean, it's the old saying, right? You cut losers short. You allow profits to run. And
that's easier said than done. The reality is that there's a great temptation on the part of a

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trader who perhaps has taken a loss on the last five trades he did. All of a sudden, you're
in a trade that's making money. And there is a great temptation to grab money just as
quickly as you can. But that's actually the wrong thing to do.

I want to take the attitude that if I have money in the trade, if and trade is in working in my
favor, I want to give that trade the ability to stall, do some backing and filling, and to really
allow that profit to run as long as it's not going to come back to where I got in.

And the fourth thing that I attempt to do in the way of managing that net asset value line to
make sure that line just continues to progress is to protect trades that I call popcorn trades.
And we've all been involved in those, where we get into a trade. It works the first day, it
works the first week, there's a nice trade going. And all of a sudden, the market rolls over
and goes all the way back to where we get in.

I have various statistical methods that I use to manage that type of trade, but the idea is
that I want to employ tactics that prevent a trade from having a profit and then move you
all the way back down to where I get in.

The ninth major principle or guideline that I attempt to guide my trading decisions are the
fact that money management has to take priority over my market opinions. What I what I
think about the market or what position I'm in or my view of a chart, let's say, is irrelevant
if a market starts going against me and I have a trade that has a loss. Who cares what the
charts says to me if I look at a position and it's going into a losing position?

So I try to make money management take priority over my opinion of a market. What that
means, though, is that I may be stopped out of a trade, and I haven't changed my opinion
on a market. And there's a saying that I use that people kind of quote me to saying, and
that is "strong opinions weakly held."

I can have a strong opinion on a market, but the minute I have a position that turns the
wrong way, I want that opinion to be weakly held.

And the 10th and final principle that guides my trading deals with trading metrics. Two
things that people ask me right away, and it seems to be the two questions that most people
want to know about trading. And that's, what is your annualized rate of return is the first
one. And then what is your Sharpe ratio is the second one.

And the reality is, those two metrics are basically junk. They need to be placed on the junk
pile. They're not good measures of a trader. Rate of return everybody wants to know about.

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Everybody wants to know about Sharpe ratio. And frankly, Sharpe ratio in my opinion is
worthless.

They don't really represent good measures of the skill of a trader. There are, however, three
metrics that I believe in. And I believe that anybody that takes their trading seriously, that
wants to think of themselves as being in the business of trading, these are metrics that they
need to keep track of.

The first one is what I call the gain-to-pain ratio. And these ratios are available. A person
can Google them. They're in a book that was written by a friend of mine, Jack Schwager.
But it's the gain-to-pain ratio. And to calculate gain-to-pain ratio, what that person does is
they work out an equation and they calculate what the sum of all their monthly rates of
return is.

And so you have a monthly rate of return 1%, and then the next month you have a rate of
return of 2%. Now all of a sudden you're at 3, then you have a minus 1, now you're back
to 2. And so you take a mathematical sum of all your monthly rates of return and you divide
that by the sum of the absolute value of the negative monthly rates of return.

And what you end up with is a ratio. A gain-to-pain ratio of 1 is considered to be quite
good. A gain-to-pain ratio of 2 is excellent for a trader. A gain-to-pain ratio three or above
is really world class. So I want to focus on that. It's a risk-adjusted return that's very different
than Sharpe, much more active, I think, much more lively.

The second ratio that I focus in on is what's called the profit ratio. Whereas the gain to
pain ratio dealt with monthly rates of return, both negative and positive, the profit ratio
deals with individual trades. And so to calculate the profit ratio, one adds up the cumulative
rate of return of each individual trade. And so you calculate what the rate of return of each
trade is against total trading trapped capital.

You add up all of the positive rates of return, the cumulative of all of those trades that were
positive, and you divide that by the absolute value of the cumulative rate of return of all the
negative trades. And so it's all the positive trades above the line, all the negative trades
below the line. And that produces a ratio. That again is a metric that I really want to pay
attention to. Those are metrics to me that matter much more than what my rate of return is,
much more than what my Sharpe ratio is.

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And the final metric that I pay attention to is what's called the Calmar ratio. And this is
calculated on a three-year basis or it's calculated on a five-year basis. The textbook
calculation of Calmar ratio is five years.

And to calculate the Calmar ratio, you take your average annual rate of return over some
period of time, three years, five years, you could even do 10 years, and you divide that by
what your worst drawdown was during that same equivalent period of time. And so a five
year Calmar is your five-year annual rate of return divided by your worst drawdown during
that five-year period. And you end up with a ratio there.

In the case of Calmar, it's very similar to gain-to-pain, a ratio of one is good, two is very,
very good, outstanding. Three is world class. So the big question one might have in their
mind is so these 10 principles, what has been the effect for them?

These are the things that have guided my trading and how they worked for me. And let me
first just add a disclaimer that past performance is not indicative of future results. But I I'm
just thrilled with how risk management and attention to these principles have worked for
me during my trading career.

In 2010, I had my trading records going back to 1981 reviewed by an auditing firm, and
they attested to my performance. They compared my brokerage statements with my bank
statements, and more importantly, with what I paid the Internal Revenue Service in the
United States. And they calculated that my average rate of return during that period was
about 41.6%.

And I don't attribute that to my genius or my smarts or my talents as a trader. What I do

attribute it to is the attention that I have paid to risk management and the principles that
we've talked about in that video. I'm much more satisfied with some of these other metrics
that I've accomplished during this period of time. A profit ratio of over 3, 3.5, a strong
gain-to-pain ratio, a strong Calmar ratio, and even an MAR ratio, which is above 1.

And it's those metrics that matter to me. And I believe that traders who pay attention to the
metrics that are really important and really attempt to achieve those metrics will be very,
very pleased with how their trading performance progresses over a period of time.

And I think that's really the message that I'm trying to communicate in this video, is the fact
that we need to trade based on principles, based on guidelines, and based on great
attention to the way that we manage our money and the way that we treat risk management.

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I would like to end this video with a word of encouragement to traders out there who
sometimes feel frustrated with the progress you're making trading. And I am older than 70
years old, and I sometimes feel like I'm never making progress. I mean, that's kind of the
reality of what we do.

But I would like to give you an encouraging word. I know when I first started trading, I just
kind of thought, well this was the problem I was facing. And really successful trading is just
a process of solving problems one after another. And I think, OK I'm going to get over this
hurdle and it's going to be clear running. And you worked hard to try to solve some aspect
of your trading. And you get over that hurdle, and you think you're clear sailing and you
run right into another hurdle.

And it's one after another. And trading is a long term process of solving problems one after
another. And I think sometimes you get the feeling that it's two steps forward and one step
back. You make some progress and then you get a little bit of discouragement. And you
make some progress and it's a little bit of discouragement.

And the reality of trading, and I could get into the statistics and the probability theory-- a
little more complicated than the scope of this video-- the reality is that trading progresses
two steps forward, one step back. That is the reality.

I want to show you a graph of Factor Trading, which is my firm, my proprietary trading
account going all the way back to 1981. And this is what's called an underwater curve.
And this shows you really what is happening most of the time. The reality for a trader is
either they are in a drawdown or are recovering from a drawdown the vast majority of
times.

And I know that feels very counter-intuitive. But if you're a trader and you're in the trenches,
I think you'll understand that it's not new high equity each day, each week, each month,
each year. It's two steps forward, one step back. And there are statistical reasons for that.

And if you look at the factor underwater curve, the reality is that even though I have had a
great degree of profitability in trading for me and my own proprietary account, I've
accepted the fact that I'm either in a drawdown or recovering from a drawdown the vast
majority of time. And it's just not in Futures and Forex that that takes place. I want to show
you another graph here in a minute to illustrate this point.

But we all know that since the early 1980s, the US stock market has been one massive bull
market. And you think, well, if you'd only bought the stock market in 1982 or 83 or 84

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 Charting Masterclasses 2: RISK MANAGEMENT

whatever the case may be, that it's nothing but a gravy train from there on forward. And
this is the underwater chart of the S&P since 1986, which it has been a massive advance
since that point.

And as you can see on this chart, the S&P is-- if you're just simply trading the S&Ps through
an ETF or a balanced portfolio, from an underwater standpoint, the S&Ps have either been
in a drawdown or are recovering from a drawdown the vast majority of time since 1986.

And again, there are very statistical probability theory reasons why that happens. And it's
counter-intuitive, but I think if you're a trader, you understand this concept. And I think what
that means given that fact is just the focus on risk management. You realize that it is two
steps forward, one step back.

That's the reality of how markets go. That's the reality of a trader's life. And so the focus
during that period has to be on risk management to prevent the drawdowns from getting
too deep so that the recovery periods can be more rapid from a more shallow point.

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