The following is an excerpt from Barton Bigg’s book, Hedgehogging, where he relates a conversation with “Tim”, a successful macro investor (emphasis mine).
Tim works out of a quiet, spacious office filled with antique furniture, exquisite oriental rugs, and porcelain in a leafy suburb of London with only a secretary. My guess is he runs more than $1 billion, probably half of which is his. On his beautiful Chippendale desk sits a small plaque, which says totis porcis—the whole hog. There is also a small porcelain pig, which reads, “It takes Courage to be a Pig.” I think Stan Druckenmiller, who coined the phrase, gave him the pig.
To get really big long-term returns, you have to be a pig and ride your winners… When he lacks conviction, he reduces his leverage and takes off his bets. He describes this as “staying close to shore… When I asked him how he got his investment ideas, at first he was at a loss. Then, after thinking about it, he said that the trick was to accumulate over time a knowledge base. Then, out of the blue, some event or new piece of information triggers a thought process, and suddenly you have discovered an investment opportunity. You can’t force it. You have to be patient and wait for the light to go on. If it doesn’t go on, “Stay close to shore.”
What separates the great traders from those who are just good?
The answer is knowing when to size up and eat the whole hog.
Let me explain.
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During three separate interviews this week I was asked if I was seeing any signs of complacency among investors, markets, or clients.
If anything, the people I talk to are more concerned with the high probability of lower market returns in the future but my view is surely clouded by the clientele and readers I deal with on a regular basis.Whether my sample size is representative or not, measuring market sentiment is getting harder and harder these days. Everyone now has a megaphone to voice their opinions — social media, blogs, 24-hour financial television, podcasts, conferences, magazines, financial news websites, etc.I don’t see how you can reliably track sentiment when it comes at you every day like a wave that changes form and shape depending on people’s mood that day. There’s just not much signal in all of the noise anymore.Of course, investors have been given plenty of excuses to be complacent. It feels as though volatility and bear markets have been outlawed in 2017 and stocks in the U.S. haven’t seen a down year since 2008.Since I don’t see any reliable way to track the potential complacency of investors as a whole, I tend to look at different ways investors can be complacent depending on which type of market environment we’re in.For example, last month I read the Schroders Global Investors Study which surveyed over twenty thousand investors from around the globe to get their expected portfolio returns over the coming 5 years. The results show this group was a tad ambitious: Investors expect an annual return of 10.2% on their investments over the next five years, according to a major new study.The Schroders Global Investor Study (GIS) 2017, which surveyed 22,100 people from around the globe who invest, found millennials even more optimistic. Those born between 1982 and 1999 expected their money to make average returns of 11.7% a year between now and 2022.Older generations were more realistic. The Baby Boomer generation – born in the two decades after the Second World War – anticipated 8.6% a year.Millennials (born 1982-1999, aged 18-35): 11.7% Generation X (born 1965-1981, aged 36-52): 9.8% Baby Boomers (born 1945-1964, aged 53-72): 8.6% Silent Generation (born 1923-1944, aged 73+): 8.1%Double-digit annual returns over the next 5 years from current valuation and interest rate levels seems like a stretch to me. I could be wrong but investors with such lofty expectations after we just went through a period of above-average returns (at least in the U.S.) seems to be somewhat complacent to me.Here’s another example (although this is more delusional than complacent):
A profitable stock trader’s success is not based on picking the right stock at the right time. There are dynamics that determine success other than entries and picks. Millionaires aren’t created because they have a magic system for trading through all market environments. There are a couple of things that influence profitable trading, and they could surprise you.
#1. Having the right mindset to win; psychology.
#2. Managing your risk exposure on each trade; risk management.
No system will work if you can’t trade it consistently. You must stick to your method when you are losing. Whether it’s to keep taking entries, to go to the sidelines and wait for volatility, or to settle down and wait for a trend to emerge.
You must stay in the game and be ready to take your entry signals. The primary reason that traders lose money is that they give up when things get tough because they don’t have faith in their system. A trader must persevere, never quit learning, never quit working, and always be ready to trade.
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The reward to risk ratio (RRR, or reward:risk ratio) is maybe the most important metric in trading and a trader who understands the RRR can improve his chances of becoming profitable.
A trader who uses the RRR incorrectly will never become profitable on the other hand. In this article, I will show you what you need to know about the RRR.
Busting myths around the reward:risk ratio
Let’s first tackle some of the common misconceptions about the RRR to help you understand what most people get wrong before then diving into the specifics of the RRR.
Myth 1: The reward:risk ratio is useless
You often read that traders say the reward-risk ratio is useless which couldn’t be further from the truth. When you use the RRR in combination with other trading metrics (such as winrate), it quickly becomes one of the most powerful trading tools.
Without knowing the reward:risk ratio of a single trade, it is literally impossible to trade profitably and you’ll soon learn why.
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I will start this piece by saying that I am not bullish or bearish, I don’t make market calls, or predictions and I don’t have opinions about the markets that I trade. I just follow my process, which is based on risk management, money management, price and moving averages. I lead off with this statement so that readers do not think that I am making some type of a market call by talking about risk management and downside protection while we are at all-time highs. I follow core concepts:
Respect price, respect risk and always be prepared for any outcome.
With Global markets at or near all-time highs, and the money flowing in for many, now seemed to be an opportune time to remind ourselves that every day is a good day to focus on risk management. All of the greatest traders, Soros, Druckenmiller, Tudor Jones and Kovner, to name just a few, have a laser-like focus on capital preservation and risk management. They have all publicly stated that risk management and their ability to cut losses short is the cornerstone of their success. Paul Tudor Jones, a Billionaire Trader, is frequently the most quoted and has said:
“…at the end of the day, the most important thing is how good are you at risk control. Ninety-percent of any great trader is going to be the risk control.”
“Don’t focus on making money; focus on protecting what you have.”
“I am always thinking about losing money as opposed to making money.”
Bruce Kovner, another Billionaire Trader, said in Market Wizards: “First, I would say that risk management is the most important thing to be well understood”.
With that being said, here are 10 key concepts regarding risk management that I focus on:
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If you have a winning system with the right risk management you can still fail to be profitable if you do not have the right trading psychology to trade it with discipline.
If you have a winning system with the right trading psychology you can still fail to be profitable by blowing up during a losing streak without the right position sizing and risk management.
If you have the right risk management and trading psychology you can still fail to be profitable because you are trading with no edge because you don’t have a winning trading system.
Profitable trading requires three dynamics: a winning price action trading system with an edge, proper position sizing with risk management, along with the right trading psychology to allow you to trade your process with discipline.
The original post is authored by Steve Burns of newtraderu.com and is available here.
Good traders are known to be masters of risk management. Risk management includes following a detailed trading plan, setting stop and limit orders and managing traders without succumbing to emotions.
Good traders also tend to follow a robust trading plan that focuses more on ensuring that the traders do not lose their capital, while the profits are seen as only secondary. As part of this pursuit in achieving trading excellence, professional and seasoned traders follow the concept of setting limits on their losses, on a daily, weekly and even monthly basis.
Trading with limits ensures that the traders do not end up sabotaging themselves in the heat of the moment as emotions can often override logic when a trade turns into a loss.
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When it comes to evaluating market risk, your time horizon is a key factor to consider. As a general rule, shorter time horizons require more caution than do longer ones. I would also argue, however, that this concept applies to many areas of investing—and beyond.
Long-term investing
Let’s start with why longer-term results can be more predictable than shorter-term ones. The answer is, simply, averaging. One data point might be noisy, but as you accumulate more and average them, the outliers tend to offset each other. As a result, the signal starts to dominate the noise. The more data points you have, the closer you get to the expected result. Investors with 40 years, for example, can look at longer-term return goals with a reasonable expectation of actually getting them. But for shorter time frames, the noise can dominate. Hence, the extra caution needed as you get closer to retirement.
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This article is for those traders (new or experienced) who have trouble booking profits. Do you often see large profits evaporate as the market reverses against you, leaving you feeling powerless and confused? If so, you know how frustrating it can be and you know exactly what I’m talking about.
Poor target placement, lack of experience, greed, arrogance and stubbornness are all issues that can cause traders to not take profits off the table.
I appreciate this article may conflict with some of my core beliefs and teachings on taking profits since typically I encourage people to aim for a 2 to 1 risk reward or greater and to set and forget stops and targets. In theory, this makes sense, but in the real world, as you likely already know, there are still a great number of trades that almost hit your profit target or where a trade has moved quickly in the right direction and you’re staring at a giant profit… and then the next day or week, the market goes the other way and your once giant profit has become a much smaller profit or even a loss.
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Why it’s valuable to calculate how your investment price can go to zero
“Any time you manage other people’s money, risk management should be defined as preventing the permanent impairment of capital. Nothing can be riskier to an equity investor than losing all your money. Anybody who loses sight of this is – quite frankly – both a terrible fiduciary steward and value investor.” – Duncan Farquhar
In a recent article, Science of Hitting discussed the difficulty in adding to your position after Mr. Market plays havoc on the stock’s price and valuation. Making the decision to double down is tough for several reasons.
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