Saturday, September 08, 2012

I see a lot of traders get emotional about market movements, either into euphoria or emotion, treating it like a game of excitemet. Well, Larry Hite, the billion dollar fund manager, as described by Stanley Kroll in his book Dragons and Bulls can shed some light on this 'emotional' approach to the markets: In reality, the majority of traders get suckered into the gambling approach to the bursamalaysia derivatives futures market

This is what Hite had to say about his development as a fundmanager:

‘I began to devote my resources to developing an unemotional, risk averse quantitative approach to the markets. Price data was subjected to rigorous computer testing to determine if they were recurrent statistical events. If so, then the events were subjected to further testing using strict risk parameters to determine if such a disciplined methodology could be consistently profitable. I discovered that, yes, I could risk a very small part of the farm, and make above-average returns with reasonable consistency. Yes, I could totally avoid any interpretations of chart patterns or underlying supply and demand factors that impact a particular market, and my returns would not suffer. And yes, I could diversify into many markets, remain extremely disciplined, and still show an appealing return on investment.

I considered my strategy to be a real accomplishment because it has a trading plan that suited my personality and my wallet; disciplined, quantitative and profitable. In short, with the assistance of a statistician and a programmer, I have developed a set of mathematically proven rules that have worked for me.’

Here is what Hite had to say about the ‘good bets business’:

‘I consider myself to be in the good bets business. That is, through the use of a computer, we search for good bets and try to play only good bets. If the bet does not meet our standards, we throw it out, even if it is something that someone else might jump at. This is analogous to actuarial work. Essentially, what I did was to take a highly charged, exhilarating profession and turn it into an actuarial process - something that would appeal to anyone who finds accounting too exciting. I de-emotionalized markets and trading and reduced them to a probability study.’

On trading being ‘Zen-like’:

‘For me, this is a very Zen-like business, and your most valuable tool is yourself. There is a Japanese book about sword fighting whose premise is this: when you get into a sword fight, immediately assume that you’re dead so you won't have to worry about being killed. Then, all you have to worry about is
making the appropriate moves. Once you figure out the right action, assemble the means to implement it correctly and then proceed. That is what a good trader does. He or she sets out a programme either through the use of a computer or through some other method to achieve a designated objective. In my case, I thought that de-emotionalizing the markets was the right way to approach the idea of consistent returns. If that is not exciting enough for some people in the business, then so be it. I don't trade for
excitement; I trade for profits.’

And on limiting risk:

‘It boils down to a de-emotionalized, risk management game for both the big trader and the small speculator. Although we are sometimes involved in as many as 50 markets at any given time, we have a set risk parameter, or stop level, in every one of these 50 markets. Beyond that, we use a maximum percentage
draw-down, which relates risk on each position to total equity. That is, we limit the risk on each position in our portfolio to one percent of the accounts total equity, based on closing prices. Any time that the loss on any position, as of the close, equals one percent (or more) of total equity, we liquidate that position the followitrrg norning.’

In our conversation, I discussed with Larry Hite his strategy for implementing a maximum risk of one percent of the account's equity on each position. I pointed out that, while it was easy to limit losses to within one percent when dealing with accounts in the multi-million dollar category, it would be more difficult for the smaller investor for whom the one percent limitation would obviously be too close. For
instance, a one percent limit on an account with US$30,000 would only be US$300, and this would be so close as to stop the trader out recurtently just on the ‘noise’ from the floor traders’ scalping activities. Hite acknowledged that the one percent limitation would be too restrictive for smaller accounts. Nevertheless, he felt that the general strategy of this approach to risk control was valid. He would, on a smaller account, bump up the risk limitation to approximately two percent of capital. This would still adhere to the general strategy of risk control, but would allow the smaller trader additional leeway. Obviously though, risking more than the recommended one percent limit does make the overall operation more risky, and behoves each trader to exercise even more vigilance to avoid overtrading and other inappropriate tactics.


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"There is the plain fool who does the wrong thing at all times anywhere, but there is the Wall Street fool who thinks he must trade all the time."J Livermore Manchester City FCl Crude Palm Oil


From Dragons and Bulls by Stanley Kroll
Intro and Foreword
The Importance of an Investment Strategy
5 The Art of War, by Sun Tau (circa 506 BC) and The Art of Trading Success (circa AD 1994)
That's the way you want to bet/a>
Long-term v Short term trading
Technicals v Fundamentals
Perception v Reality
Part 1: Winners and Losers
Part 2: Winners and Losers
Sun Tzu: The Art of War
Those who tell don't know, those who know don't tell
Why there is no such thing as a "bad market"
The Secret to Trading Success
The Experts, do they know better?
Risk control and money management
Good advice
The 'good bets' business by Larry Hite
Don't lose your shirt
Ed Sykota's secret trend trading system