2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.

3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.

4. This is Not a Business of Buying Low and Selling High: It is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.

5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it, however, and fewer still embrace it. 

6. “Markets Can Remain lllogical Far Longer Than You or I Can Remain Solvent.” These are Keynes’ words, and illogic does often reign, despite what the academics would have us believe.

7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break the most easily. When bullish we need to sail the strongest winds, for they carry the farthest.

8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.

9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In “good times,” even errors turn to profits; in “bad times,” the most well-researched trade will go awry. This is the nature of trading; accept it and move on.

10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we’ve known have the simplest methods of trading. There is a correlation here!

11. In Trading / Investing, An Understanding of Mass Psychology is Often More Important Than an Understanding of Economics: Simply put, “When they are cryin’, you should be buyin’!” And “when they are yellin’, you should be sellin’!”

12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.

13. There is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow… usually hard upon and always with detrimental affect upon price, until such time as panic prevails and the weakest hands finally exit their positions.

14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades. The older we get, the more small losses we take each year… and our profits grow accordingly.

15. Do More of That Which is Working and Less of That Which is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a “secret” to trading (and of life), this is it.

16. All Rules Are Meant to be Broken… But only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.

- Dennis Gartman

JS Comment: 

We especially like rule number two… 

- Bill Lipschutz (via New Market Wizards)

JS Comment:

Sometimes there really is a “market taking off” inflection point, depending on a combination of catalysts, technical levels and tipping point news events. But in other instances the Lipschutz approach — building a position incrementally, cashing out incrementally — can be a superior strategy.

Do you ever scale into your positions, e.g. put on small amounts and then add as conviction levels increase? How about on the exits? Have you ever thought about it?

(The specific mechanics of scaling in and out — which go hand in hand with pyramiding technique — are an example of what we’ll cover in great depth in the MT Driver’s Manual.)

The piece, “After a decade of decline, it’s time for the dollar to have its day,” is worth perusing.

Here’s our version of the cliff’s notes:

The dollar fell against a broad basket of currencies for a decade due to:

- expensive military adventures abroad
- aggressive tax cuts at home
- broad fiscal deterioration
- commodities surging as an asset class
- emerging markets drawing investment dollars

Ten years earlier (in the 90s) the $USD situation looked different:

- tax rises + peace dividend from fall of Berlin Wall
- fiscal deficit shrinking / turning to surplus
- positive real interest rates
- global fervor for US equities as an investment destination

Now the picture is reverting to more of the “nineties” than the “noughties:”

- progress on budget and trade deficits
- military withdrawals from Iraq and Afghanistan
- commodities as an asset class cooling
- emerging markets as an asset class cooling
- US recovery strongest in the developed world

And as bonus effects:

- knock-on effects of the US energy boom (natural gas / shale)
– Japan aggressively devaluing its currency in attempts to reflate
– Europe on verge of recession / depression, forced to emulate Japan?

And as catalysts:

- Federal Reserve telegraphing hints of ultimate withdrawal
- US recovery putting 6.5% unemployment recovery target in sight
- US equity / real estate strength drawing foreign investment dollars

Oh and then there’s this: Even as the Fed’s mouthpiece (WSJ reporter Jon Hilsenrath) leaks whispers of tightening, central banks around the world are getting their cut on:

Joining a recent wave of global central bank easing, the Bank of Israel cut its benchmark interest rate Monday in a surprising move aimed at relieving upward pressure on the country’s currency.

A growing number of central banks have been cutting rates. Slowing inflation gives them more leeway to pursue policies aimed at stimulating growth amid a global economic slowdown. Meanwhile, some central banks, including Israel’s, are trying to prevent their currencies from rising and hurting exports.

Central banks in Australia, South Korea, Poland, India and Hungary have pushed their benchmark borrowing rates lower in the past few weeks.

- WSJ, Banks Rush to Ease Supply of Money

As far as central bankers go, mini-doves are breaking out everywhere, even as the once-biggest dove of all (the US Fed) starts morphing into a hawk. How ’bout them apples?

As Larry David might say, “Pretty good. Prettay, prettay good.”

And how about the price action? That’s pretty good too.

Take a look (via UUP):

click to enlarge

Point of amusement: There is a certain class of macro perma-bear for whom the thought of a stronger dollar is impossible… like one of those wacky staircases in an M.C. Escher painting.

This comes from factors like a one-sided focus on the liability side of the U.S. balance sheet (ignoring the asset side)… an inability to see currencies in relative terms (as the USD does not trade in a vacuum, it trades against other currencies)… a Calvinist need to see the sins of debt repaid, and so on.

And for a possibility that could really bake your noodle, consider this: The dollar is likely to strengthen more against a weak recovery than a strong one. 

Why? Because of bonds (US treasuries):

• If the economy strengthens too fast, treasuries get dumped. 
• If treasuries get dumped, the Federal Reserve has to act as buyer of last resort.
• Failing this, plummeting bond prices lead to spiking interest rates…
• Which in turn kill the recovery.
• The Fed cannot allow the recovery to be killed.
• So in this instance, it prints dollars with which to buy bonds…
• And sacrifices the dollar for the sake of safeguarding the strong recovery.

BUT:

• If the recovery remains weak, treasuries are never really jeopardized. 
• With an anemic recovery, there is no “real fight / true exit test” (as referred to in this rant).
• A sluggish, half-dead recovery is one in which treasuries remain a safe haven…
• And long-term rates stay low as a function of chronic and persistent weakness.
• In this scenario, the Federal Reserve can edge towards less accommodation…
• Even as Japan and Europe increase their levels of accommodation…
• And the US wins the “least pathetic recovery” race in relative terms.

And so, irony of ironies, to say “The dollar can’t get stronger because the US recovery is bogus” is an exactly backwards argument.

It is possible for the dollar to get stronger bit by bit, via incremental progress, precisely because the US recovery is bogus (or rather, too weak and anemic to really move the needle on a treasuries exit).

What the dollar bears REALLY need is the threat of a full-on bond market crash, which doesn’t really materialize until / unless the US recovery starts looking so good and so solid there is no question we are out of the woods, forcing the “bond panic + Fed save at expense of USD” scenario — but how does a genuinely strong recovery square up with traditional bearish viewpoints again?

Meanwhile take a look around at what’s happening beyond US borders:

• Canada’s housing market is looking shaky (ready for a bubble burst)?
• Australia’s housing bubble burst is just a matter of time
• China is still slowing and stumbling and fumbling
• (60% of Chinese multi-millionaires want to leave for pete’s sake!)
• Japan is voluntarily turning its currency into confetti
• Europe is staring recession / depression in the face
• All this plays into the “least ugly in a beauty contest” dynamic…

Easy takeaway: Start looking for ways to benefit from a slow-but-steady strengthening dollar trend — like shorting the commodity currencies, Aussie Aussie Oi Oi! — and be wary of asset classes and equity plays for which a weakening USD served as a long-standing tailwind. (And if you want to know what we are doing in light of all this, scope out the Mercenary Live Feed.)

JS (jack@mercenarytrader.com)

• Has the US Dollar Long-Term Bottomed?

• Weezy, You Idiot

• The Law of Diminishing Returns

• Gold Looks Great... Gold Stocks Look Terrible

• Requiem for a Twinkie

• Killing the Wrong Pig

• Hey Bill Gross, Why So Serious?

• The Euro, William Jennings Bryan, and Newly Constructive Thoughts on Metals

• "Stupid Stimulus" Courts Disaster

• Knee-Jerk Fed Reaction Doesn't Add Up

• Gold Looks Terrible Part III: The Mass Capitulation Thesis

• Gold vs Bonds: At What Point Should Gold Believers Lose Faith?

• Attention Frustrated Chartists: It's not HFT - it's the Macro!

• A Dangerous Market Full of Crosscurrents

• Euro Zone Crisis: Back on the Front Burner

• Concerning Gray Swans: Europe, China, Profit Margins and The Fed

• The Return of Ugly Goldilocks

• Gold Looks Terrible Part II: Clarifying Thoughts

• Home Builders (Technically Speaking)

• Downgrades & Mellonists: This is What the Market Fears

• The Bond King Gets Desperate

• S&P 400? The Deflation Shock Scenario

In a nutshell, some very respected macro guys said some very harsh things about Bernanke at the latest Ira Sohn conference (a who’s who gathering for star money managers). Stan Druckenmiller, in particular, said Bernanke was running “the most inappropriate monetary policy in history.”

Other investing titans, like Peter Singer of Elliott Capital Management and Seth Klarman of the Baupost Group, have torn the Fed’s policies to shreds in their quarterly letters.  (Singer is particularly eloquent. You can read an excerpt of his Bernanke policy indictment here.)

In backlash to these hedgies ripping Bernanke a new one — with Druckenmiller at Sohn the seeming catalyst — there has been an outbreak of journalistic smugness (the forementioned “Why do rich hedge fund managers hate Bernanke” meme). Here are some examples:

• Why Old Hedge Fund Managers Hate Bernanke (Business Insider)
• Why are Hedge Fund Managers so Relentlessly Wrong (The Atlantic)
• Rich Hedge Fund Managers Hate Bernanke bc They Don’t Want to Pay Taxes (Slate)

Joe Weisenthal at Business Insider (aka “Weezy” via Josh Brown dubbing) is the worst offender.

Here is his forehead-smackingly obtuse conclusion as to why “old” money managers — as if having experience in macro is a liability! — hate Bernanke:

Hedge funds are doing badly in this rising-tide-lifts-all-boats market, and they feel that they would be outperforming if the Fed just let things collapse, and they could swoop in when prices “clear.”

The inflation and hyperinflation fantasies are another important aspect here. A lot of these guys cut their teeth during the 80s, when inflation was the enemy, and Volcker was a hero for fighting it. Thus being anti-inflation is kind of a nostalgia trip for them. Also in general, the older people are, the more worried they are about inflation. Also the older people are, the more they are inclined to invest in bonds and risk-free assets, so low rates aren’t fun.

Really dude? REALLY? Never mind that putting all hedge fund managers in a monolothic group makes about as much sense as putting all actors, golfers or musicians in a monolothic group. Outliers of talent, consistency and skill credibility make a HUGE difference. (Another reason why assessing “all” hedge fund managers in toto makes about as much sense as assessing “all” musicians in making a pronouncement on the quality of music available. You don’t listen to ‘em all, dummy.)

Even putting that aside, the level of asinine blather in Weisenthal’s conclusion above (and in the rest of the piece) takes the cake…

Normally the mouth-breathing theories of the mainstream financial media can be ignored. But in this case the stupidity is beyond belief. As a cathartic exercise, here is my open letter to Weisenthal (and by extension his like-minded non-trading, non money-managing peanut gallery brethren):

Weezy, you f–g IDIOT. Do you really want to shove your head all the way up Paul Krugman’s rectum just because the stock market is hitting new highs? As for dismissing all these “old” money managers — Druckenmiller, Singer, Klarman in particular — have you considered these guys have made BILLIONS upon BILLIONS for their clients, and have some of the best track records in existence?

Druckenmiller earned 30% compound returns over 30 years for god’s sake. He architected the famous Soros British Pound trade in 1992 that netted a billion plus in one day. He has forgotten more about macro than you will ever know. Singer and Klarman are also superstars in their own right — Klarman hailed by some as better than Buffett — running tens of billions, with excellent risk-adjusted returns, for decades. In other words, these guys are not run-of-the-mill sour grapes snipers with nothing better to do than drum up attention. They are the documented best of the best, and waving that off, as opposed to considering the substance of their arguments, is insane.

Have you further considered that maybe these guys actually care about the danger they see coming as opposed to having personal axes to grind? It would be one thing if, say, Stan Druckenmiller was an out of work pundit trying to drum up some business. But the guy is a multi-billionaire, retired to trade his own billions, AND he is sharp enough to be long the Soros-style “false trend” created by inflated QE hopes. Even as he is hating this artifically induced market, he is probably making a killing on it, because he is a world class trader. Klarman and Singer, billionaires too, are also making money. So have you considered the possibility that maybe they actually understand something you seem to completely dismiss: That no matter how good things look now, they may well end very, VERY badly.

Have you ever traded, Weezy? Could you even trade your way out of a paper bag? Do you have any memory of macro-historical events like, say, the dot com bubble and bust? Have you even considered the possibility that the “Bernanke won” euphoria percolating now is comparable to the Nasdaq 5,000 euphoria circa Spring 2000? Or that Alan Greenspan was feted as “The Maestro” before his reputation went down in flames under the weight of historical aftermath? Or that this kind of shit happens OVER and OVER again, where policies that deliver short term pleasure have extremely painful consequences on a delayed basis, and that maybe these “old”  managers you dismiss like a hand-waving doofus have the foresight to SEE that pain coming… because over the decades that is what they have proven themselves the best in the business at doing?

Phew. That felt good to get off my chest…

Again, we normally ignore the ramblings of blowhard journos who don’t actually trade and would probably have to scramble to get together three hundred bucks for a Scottrade account. But in this case, the blatant Krugman worship — the view that Keynesianism has won, that QE has proven itself, that all is sunshine and rainbows and Bernanke is the man — is just so damn myopic it is mind-blowing. If we are entering a blow-off euphoria stage, then OF COURSE it is going to look like central bankers are heroes, because virtually EVERY major policy induced bubble or instance of false trend mania has generated feelings of euphoria and invincibility leading into the peak stage!

Also for the record: No sour grapes coming from this corner either. We are not short any equities right now, and put on a hefty-sized long small caps position (now nicely profitable) some days back when it became clear that “risk on” was going to dominate. (The only thing we are short at moment is AUDUSD — a position looking mighty sweet as of this writing.) 

And for all those doing Bernanke / Krugman victory laps: Read up on reflexivity theory and the phenomena of false trends.

Here is an excerpt from a 2010 Soros speech to get you started:

I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend.When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance. We are still dancing.” Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.

Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.

Now — and I’m talking to you, smugly history-blind journos — stir the above in your perspective-challenged brain and add the following:

Dismissing cranks and blowhards is one thing. But waving off guys with some of the BEST LONG-TERM TRACK RECORDS IN EXISTENCE is probably not a sound idea.

The appearance of stability, soundness and even invincibility in the strongest stages of a Soros-style false trend (before the decelerating twilight / self doubt period comes) is a normal and even expected occurrence.

Historical evidence shows that “party now, pay later” monetary policy strategies — and trading strategies too for that matter — tend to have a “cartoon whale” graph profile: The curve slopes higher, increasing confidence all the while, until you get to the whale’s forehead. Then there is a near vertical drop.

The guys who have made billions seeing around corners may not just be griping because they are “old” or “cranky.” It may be in fact they see what is coming based on the fact that blatant central planning and market distortion has never had a happy ending, whereas the “oh shit” moment following on the heels of max confidence (such as what is being displayed now) prior to deceleration and harsh denouement has occurred OVER and OVER again.  

 Dismissing straw men is not the same as dismissing real dangers. Krugman and others (but mostly Krugman) deserve shoulder pats for dismissing the cranks over the past few years who constantly claimed that hyperinflation was just around the corner or that the US bond market was about to crash. But again, kicking sand in the face of the 90-pound geek at the beach (who presents plenty of false errors to harp on) isn’t the same as manhandling Arnold Schwarzenegger.  

The real test is how we are going to get the hell out of this — how QE and mass stimulus will be withdrawn, if it is even possible to withdraw, and / or what happens when inflation pressures start to accelerate in synchronized fashion with the realization that the risks are too big, and that central banks can’t truly pull out even if they desire to because the patient would be killed by sudden withdrawal. THE REAL FIGHT IS NOT EVEN HERE YET, DO YOU UNDERSTAND? ANY JACKASS CAN START A MARTINGALE CHAIN, JUST LIKE ANYONE CAN TAKE  OUT A LOAN FROM THE MOB. THE QUESTION IS HOW YOU GET OUT. 

Last but not least, do not doubt the ability of the sharpest players to make money even in environments they “hate.” Stan D. is likely not only long here, he is probably killing it. This again goes back to track record and demonstrated capabilities. World class traders (and to some extent investors) know how to exploit false trends profitably, even if they do not like what they see coming. If you are not a trader yourself, you may not understand this flexibility or even comprehend it. That’s ok. That’s why you are paid like a journalist.  

Rant mode off. Back to happy chill mode…

JS (jack@mercenarytrader.com)

• Has the US Dollar Long-Term Bottomed?

• Weezy, You Idiot

• The Law of Diminishing Returns

• Gold Looks Great... Gold Stocks Look Terrible

• Requiem for a Twinkie

• Killing the Wrong Pig

• Hey Bill Gross, Why So Serious?

• The Euro, William Jennings Bryan, and Newly Constructive Thoughts on Metals

• "Stupid Stimulus" Courts Disaster

• Knee-Jerk Fed Reaction Doesn't Add Up

• Gold Looks Terrible Part III: The Mass Capitulation Thesis

• Gold vs Bonds: At What Point Should Gold Believers Lose Faith?

• Attention Frustrated Chartists: It's not HFT - it's the Macro!

• A Dangerous Market Full of Crosscurrents

• Euro Zone Crisis: Back on the Front Burner

• Concerning Gray Swans: Europe, China, Profit Margins and The Fed

• The Return of Ugly Goldilocks

• Gold Looks Terrible Part II: Clarifying Thoughts

• Home Builders (Technically Speaking)

• Downgrades & Mellonists: This is What the Market Fears

• The Bond King Gets Desperate

• S&P 400? The Deflation Shock Scenario

“Why? Are you some kind of slob who has no willpower? Not necessarily. Backsliding is a universal experience. Every one of us resists significant change, no matter whether it’s for the worse or for the better. Our body, brain and behavior have a built-in tendency to stay the same within rather narrow limits, and to snap back when changed – and it’s a very good thing they do so.

“Just think about it: If your body temperature moved up or down by 10 percent, you’d be in big trouble. The same thing applies to your blood-sugar level and to any other number of functions of your body. This condition of equilibrium, this resistance to change, is called homeostasis. It characterizes all self-regulating systems, from a bacterium to a frog to a human individual to a family to an organization to an entire culture – and it applies to psychological states and behavior as well as physical functioning.

“The simplest example of homeostasis can be found in your home heating system. The thermostat on the wall senses the room temperature; when the temperature on a winter’s day drops below the level you’ve set, the thermostat sends an electrical signal that turns the heater on. The heater completes the loop by sending heat to the room in which the thermostat is located. When the room temperature reaches the level you’ve set, the thermostat sends an electrical signal back to the heater, turning it off, thus maintaining homeostasis.

“Keeping a room at the right temperature takes only one feedback loop. Keeping even the simplest single-celled organism alive and well takes thousands. And maintaining a human being in a state of homeostasis takes billions of interweaving electrochemical signals pulsing in the brain, rushing along nerve fibers, coursing through the bloodstream.

“One example: each of us has about 150,000 tiny thermostats in the form of nerve endings close to the surface of the skin that are sensitive to the loss of heat from our bodies, and another sixteen thousand or so a little deeper in the skin that alert us to the entry of heat from without. An even more sensitive thermostat resides in the hypothalamus at the base of the brain, close to the branches of the main artery that brings blood from the heart to the head. This thermostat can pick up even the tiniest change of temperature in the blood. When you start getting cold, these thermostats signal the sweat glands, pores, and small blood vessels near the surface of the body to close down. Glandular activity and muscle tension cause you to shiver in order to produce more heat, and your senses send a very clear message to your brain, leading you to keep moving, to put on more clothes, to cuddle closer to someone, to seek shelter, or to build a fire.

“Homeostasis in social groups brings additional feedback loops into play. Families stay stable by means of instruction, exhortation, punishment, privileges, gifts, favors, signs of approval and affection, and even by means of extremely subtle body language and facial expressions. Social groups larger than the family add various types of feedback systems. A national culture, for example, is held together by the legislative process, law enforcement, education, the popular arts, sports and games, economic rewards that favor certain types of activity, and by a complex web of mores, prestige markers, celebrity role modeling, and style that relies largely on the media as a national nervous system. Although we might think that our culture is mad for the new, the predominant function of all this – as with the feedback loops in your body – is the survival of things as they are.

“The problem is, homeostasis works to keep things as they are even if they aren’t very good. Let’s say, for instance, that for the last twenty years – ever since high school, in fact – you’ve been almost entirely sedentary. Now most of your friends are working out, and you figure that if you can’t beat the fitness revolution, you’ll join it. Buying the tights and running shoes is fun, and so are the first few steps as you start jogging on the high school track near your house. Then, about a third of the way around the first lap, something terrible happens .Maybe you’re sick to your stomach. Maybe you’re dizzy. Maybe there’s a strange, panicky feeling in your chest. Maybe you’re going to die.

“No, you’re not going to die .What’s more, the particular sensations you’re feeling probably aren’t significant in themselves. What you’re really getting is a homeostatic alarm signal – bells clanging, lights flashing. Warning! Warning! Significant changes in respiration, heart rate, metabolism. Whatever you’re doing, stop it immediately.

“Homeostasis, remember, doesn’t distinguish between what you would call change for the better and change for the worse. It resists all change. After twenty years without exercise, your body regards a sedentary style of life as “normal”; the beginning of a change for the better is interpreted as a threat. So you walk slowly back to your car, figuring you’ll look around for some other revolution to join.

“Take another case, involving a family of five. The father happens to be an alcoholic who goes on a binge every six to eight weeks. During the time he’s drinking, and for several days afterward, the family is in an uproar. It’s nothing new. These periodic uproars have become, in fact, the normal state of things. Then, for one reason or another, the father stops drinking. You’d think that everyone in the family would be happy, and they are – for a while. But homeostasis has strange and sneaky ways of striking back. There’s a pretty good chance that within a very few months some other family member (say, a teenage son) will do something (say, get caught stealing drugs) to create just the type of uproar the father’s binges previously triggered. Without wise professional counsel, the members of this family won’t realize that the son, unknowingly, has simply taken the father’s place to keep the family system in the condition that has become stable and “normal.”

“No need to count here the ways that organizations and cultures resist change and backslide when change does occur. Just let it be said that the resistance here (as in other cases) is proportionate to the size and speed of the change, not to whether the change is a favorable or unfavorable one. If an organizational or cultural reform meets tremendous resistance, it is because it’s either a tremendously bad idea or a tremendously good idea. Trivial change, bureaucratic meddling, is much easier to accept, and that’s one reason why you see so much of it. In the same way, the talkier forms of psychotherapy are acceptable, at least to some degree, perhaps because they sometimes change nothing very much except the patient’s ability to talk about his or her problems. But none of this is meant to condemn homeostasis. We want our minds and bodies and organizations to hold together. We want that paycheck to arrive on schedule. In order to survive, we need stability.

“Still, change does occur. Individuals change. Families change. Organizations and entire cultures change. Homeostats are reset, even though the process might cause a certain amount of anxiety, pain, and upset. The questions are: How do you deal with homeostasis? How do you make change for the better easier? How do you make it last?

“These questions rise to great importance when you embark on the path of mastery. Say that after years of hacking around in your career, you decide to approach it in terms of the principles of mastery. Your whole life obviously will change, and thus you’ll have to deal with homeostasis. But even if you should begin applying mastery to pursuits such as gardening or tennis, which might seem less than central to your existence, the effects of the change might ripple out to touch almost everything you do. Realizing significantly more of your potential in almost anything can change you in many ways. And however much you enjoy and profit from the change, you’ll probably meet with homeostasis sooner or later. You might experience homeostatic alarm signals in the form of physical or psychological symptoms. You might unknowingly sabotage your own best efforts. You might get resistance from family, friends, and co-workers. And you can consider yourself fortunate indeed if you don’t find yourself on that old, familiar slide back to the ways of the Dabbler, or the Obsessive, or the Hacker.

“Ultimately, you’ll have to decide if you really do want to spend the time and effort it takes to get on and stay on the path…”

- George Leonard, Mastery

JS Comment: 

Breaking through to higher levels of performance requires powerful and sustainable change.

In your efforts to transform yourself as a trader — or simply as a human being — what are some subtle (or not-so-subtle) instances of homeostasis you face? Habits, friends or family, limiting beliefs…  what’s holding you back?

Gold melted down as the Keynesians declared uber-victory.

A Reinhart-Rogoff excel sheet error gutted the entire austerity movement.

Evidence is increasing that “Abenomics” might actually work (at least at first)…

Even as the Bundesbank triples down on austerity vigilance…

Meanwhile US equity celebration hits a fever pitch…

Just as seasonals and global economic data turn very very dark…

And the threat of austerity blowback (particularly in Europe) looms large…

As funds that specialize in tail risk find themselves ignored…

And the risk appetite canary in the coal mine (IWM / small caps) shows signs of keeling over dead…

Like we said a couple weeks ago — it’s a recipe for mashed potatoes with black swan gravy. As for the current mood, some old Buffalo Springfield lyrics capture the gist.

There’s something happening here… what it is ain’t exactly clear…

We do have some theories as to what’s “going down.” The following commentary was posted in the April 29th morning briefing of the Mercenary Live Feed:

04/29 Commentary: The Beautiful and Damned

8:30 am – April 29, 2013

Ray Dalio, founder of $120-billion-plus hedge fund Bridgewater, is one of the most successful money managers of all time. In a Barron’s interview from May 2012, Dalio explained his prediction for a “beautiful deleveraging:”

A beautiful deleveraging balances the three options. In other words, there is a certain amount of austerity, there is a certain amount of debt restructuring, and there is a certain amount of printing of money. When done in the right mix, it isn’t dramatic. It doesn’t produce too much deflation or too much depression. There is slow growth, but it is positive slow growth. At the same time, ratios of debt-to-incomes go down. That’s a beautiful deleveraging.

We’re in a phase now in the U.S. which is very much like the 1933-37 period, in which there is positive growth around a slow-growth trend. The Federal Reserve will do another quantitative easing if the economy turns down again, for the purpose of alleviating debt and putting money into the hands of people.

The idea of a beautiful deleveraging is gaining traction, which is why risk assets are grinding higher. To a certain degree the stimulative actions of the Federal Reserve are being offset by government austerity, with low inflation (as evidenced by weak gold and crude oil) giving central banks more elbow room to stimulate further if need be.

Add the growing belief that central banks (other than the US Fed) are buying equities, and the potential for grind-up conditions remains.

Alternatively there is the “damned” scenario, put forth vigorously by John Hussman, Bill Fleckenstein, and others, that says US economic growth is a ruse, corporate profit margins are overextended, and the entire market is due for a massive break — possibly even a crash in a brutal return to secular bear form.

It is possible both these scenarios have merit, with the key question being timing. Stocks could grind higher for another six months, ignoring seasonals, before crashing in earnest. Or the swift and brutal correction could hit as soon as this week or the next. There are too many variables for anyone to have certainty, even the guys with supercomputers.

From a trading perspective, the breakdown (damned) scenario would be more interesting and lucrative — and also be healthier for the markets, as it would allow excess optimism to “clear” and attractive valuations to make a comeback.

And yet, black and gray swans aside, there is no reason to deny the possibility of more grind-up, in which equities drip-drip higher for an extended period of time. The stock market’s rejection of the previous corrective break, and shift back toward grind ‘em up form, makes this an increasing likelihood (though by no means a lock).

If more slow bullishness is what we get, our longside roster will slowly expand with institutionally favored quality names (like TEG and GPS) set to benefit from ongoing capital rotation. If we get the “damned” scenario, however, we’ll be ready to hammer the short side in size at moment’s notice.

As you can see from the above, the Live Feed is much more than just trading ideas. It IS that, of course — a place we detail our trading positions in real time, complete with position sizing, risk points, daily trend assessments, and more… all of this available via morning email, real-time texts (if so desired), and a highly intuitive blog interface.

We say it is “more,” though, because we also include our broader thoughts in the Live Feed… what we are thinking about markets… about the state of our portfolio… about our own emotions and psychology at the present state in time, in juxtaposition to that of the markets… pretty much everything of relevance that seasoned traders focus on,  day in and day out, in our pursuit of excellent risk-adjusted returns.

All we’re saying is, the Live Feed is pretty cool and much more than “just” trading ideas… if you haven’t already, maybe you should check it out…

For those of you who haven’t seen the poker movie Rounders: What the heck is wrong with you? Go and rent this movie immediately — then start doing the Teddy KGB impersonation for all your friends. (Meester sahn of beech — let’s play sahm kards!)

For those who have seen it, you’ll get a kick out of this question from new reader Endre:

Just as a sidenote, as a big Rounders and poker fan, I have a quick question.  Please only answer if you feel like it.  In real life would you pick Mike or Knish to trade for you?  

For the cinematically incomplete: “Mike” is the hero of the movie, played by Matt Damon, who almost goes broke (and almost gets himself killed) taking big risks in order to build his bankroll and bail out a degenerate friend.

“Knish” is Joey Knish, an older, wiser player — based on a real-life rounder named Joey Bagels — who acts as a father figure and counsels extreme caution in all things.The choice boils down to 1) talented gunslinger with shining talent but also some big embedded risk, or 2) a proven low-level performer who never goes for the gusto but, in a cautious and plodding way, generally gets it done.

The answer to “who would you want to trade for you, Mike or Knish” — assuming their poker skills translated — should depend, in part, on what percentage of assets you are talking about and how those assets are designated. If you already have a sensible strategy for your “safe haven” capital — i.e. the core of a substantial asset base — then you would probably be better off giving Mike something like 5 to 15 percent of your capital (not the whole wad) to see what he can do with it. His added aggression might even reduce volatility for your overall portfolio by providing non-correlated returns (and greater chance of doing well in crazy market environments).

If you are a high-flying entrepreneur, on the other hand, or otherwise someone who has plenty of embedded risk and optionality in your day-to-day business life… and if you don’t have a safe haven strategy yet, and just want a place you can put a chunk of “responsible” savings and forget about it, knowing the lights won’t be shot out but capital will be cultivated slowly… then Knish is your guy.

It’s an interesting way to think about diverse hedge fund strategies. There are the “Mike McD’s” of the hedge fund world — like this guy, who will make a killing if he gets it right — and then there are the Knishes, trying to grind it out for, say, seven percent returns with drawdowns measured in handfuls of basis points.

But here is a more interesting question — assuming you’ve seen Rounders, which trader would YOU rather be personally, with the long-run fate so entailed — Mikey or Knish? 

That one’s easy. We’d pick Mike every time… why? Because Joey Knish will never be wealthy… and he will always be too close to the felt for comfort. The take from the movie is more or less correct:

Guys around here’ll tell ya… you play for a living. It’s like any other job. You don’t gamble. You grind it out. Your goal is to win one big bet an hour, that’s it. Get your money in when you have the best of it, and protect it when you don’t. Don’t give anything away. That’s how I’ve paid my way through half of law school. A true grinder. See, I learned how to win a little at a time. But finally, I’ve learned this… If you’re too careful, your whole life can become a f–n’ grind.

Now compare this to an observation from Robert L. Bacon in his 1954 tome, Secrets of Professional Turf Betting:

The player at the races can’t grind or chisel because [that girl] is taken. The racetrack has all grind and chisel privileges! The mutuel take and the breakage add up to a percentage that continually grinds and chisels the betting money…The grind privileges are spoken for and taken, so the professional bettor must speculate. The mutuel grinding only goes one way – against the bettor. But any percentage can be overcome by enough winners at fat enough prices!

Fortune favors the speculator over the grinder because of the plain old arithmetical percentages. The speculator has a percentage chance to win. The grinder has no chance.

To beat the percentage of the mutuels, the player must ALWAYS have an overlay. He must always have an extra percentage in his favor, to counteract the “take” percentage. Forget about this idea of “grinding out a day’s pay.” If you want to make a day’s pay at the races, get a job watering horses, or pitching manure into trucks. But never try to grind it out of the mutuels…

You Must Speculate — You CAN’T GRIND!

Just as in poker, the problem in approaching markets with a “grind” mentality is that the light isn’t worth the candle. The same is true in broader business too: One of the saddest stories we ever heard was of a husband and wife (friends of a relative) who owned a struggling pharmacy.  This couple probably averaged $70K a year out of the pharmacy over many decades — but year in and year out, it was like squeezing blood from a stone. There were always brutally nasty problems, always exhausting hours to be worked… always some perpetual major stress point in their lives. And for what? To pay the bills at a double middle-manager wage?

Life as a poker grinder, or a trading grinder, is similar. Via passing acquaintance, we know both varieties personally. Their lives are no cake walk! Trying to make a living at low ball stakes is no real living — it’s an existence. (Fun stuff in your twenties, but beyond? No.) Almost always undercapitalized… “playing a short stack” (as the saying goes) and afraid to lose the money when the rent is tight… always fearing the lurking drawdown that might kill your shoestring… even if you’re paying the bills, that’s no real way to live.

(Just like passive investing is no real way to invest. Again, why take all that embedded risk just to face the odds of retiring poor because the markets went into a ten year secular downturn — as they sometimes do — at just the wrong time?)

Mike McDermott — the “Rounders” Mike, not Mercenary Mike — made some huge mistakes at a formative point in his poker career — but he also learned from those mistakes, or so we can assume, and became a far more formidable competitor in result. (Come to think of it, Mercenary Mike did that early on too. As did Jack.) Learning from mistakes, including occasional gut-wrenching ones, while still maintaining the passion and drive to become a champion is the best combo in our view. If you’re going to play the game, PLAY THE GAME… and give yourself a chance to build real, meaningful wealth by doing so.

In the real world, the timid Joey Knishes wind up getting man-handled by the bold Mike McDermotts. Why? Because the Mike McD’s are the ones with a real shot at getting rich, via the willingness to press their edge at the right time and make full use of what they’ve learned.

And the “wicked smaht” Mike McD’s have used their wide roster of experience — born of bold experimentation — to fully explore the highly volatile, yet highly profitable avenues of positive expected value, or +EV… and such exploration, along with a capitalization edge, allows them to come along and volatility-stomp the poor Knishes just trying to pay the light bill.

As William Blake once observed, “The road of excess leads to the palace of wisdom.” Sometimes the way to learn the right thing is by having the guts to do to the wrong thing, at a scale you can afford, until experience and determination grant you the advanced skills you seek. 

Some of the greatest traders of all time — with track records encompassing 25 years straight with no losing years — spent their early years doing all kinds of crazy things, blowing up small or even not-so-small trading stakes multiple times… NOT because they were intrinsically reckless, but because pushing the envelope — while  risking money one can afford to lose — is often the best way to learn.

What about those Knish-style hedge funds, some of you ask: They “grind it out” for super-low returns don’t they?  Yeah, and you know who those hedge funds cater to? Rich folks. People who are already wealthy. When your net worth is, say, ten million plus, suddenly the majority of your capital becomes something you are more focused on keeping than growing. I mean, you always want to keep it, but beyond a certain seven-figure threshold your concern about “growing” falls somewhere between “keep up with inflation” and “just don’t take any risk!” This makes you greatly interested in, say, steady-eddie seven percent returns.

Whereas, if you aren’t wealthy yet, how much are seven percent returns really going to help you? Not much… and especially not relative to the risk taken on (as even the “safest” of safe strategies can get black-swanned, without compensating upside possibility).

Oh sure, maybe you can “save” your way to being a millionaire by clipping coupons and not drinking Starbucks and driving a ten-year-old car, the way those awful and depressing “financial advice for the masses” books recommend… and by the time you actually get your million, it will be worth maybe $150K inflation adjusted, and you will look forward to a grind of a retirement along with your grind of a life. Gross!!!

We’d rather go for the gusto — and use excellent risk control to make sure we survive and thrive as we do so, thus paving the way for the next knock-the-cover-off-the-ball home-run trade… and the next, and the next…

Speaking of gusto (and poker), we will be in Las Vegas for much of the World Series… quite possibly at the Bellagio. Apparently the Bellagio has the most consistent-running “big game” still in reach of non-zillionaires, a daily $10-$20 No Limit where average stacks range from $2,000 to $10,000 (though occasionally much bigger).

In our initial scouting of the Vegas poker room landscape, we wrote off the Bellagio years ago. That is because the main floor of the Bellagio room is terrible. The stack limits for most of the normal sized games, even 5-10, are tiny (a move designed to put tourists at ease). Worse still, the tables are packed so tightly together you feel like you’re in a cattle car. It’s almost impossible to order food, or even turn around, without elbowing someone in the head.

Dinky buy-in limits, insultingly crowded room, surly staff… no two ways about it, the Bellagio poker room sucks. If you are looking for modest sized action, the Venetian or Wynn are miles better.

Except — and this is what we learned on our most recent trip — the Bellagio 10-20 No Limit is a different beast, and maybe the biggest “regular” game of its kind (in terms of running all year round). It’s an uncapped game (no max buy-in, which we greatly prefer). It is on a step-up level, in the higher stakes area away from the hoi polloi (where you can actually turn around, stretch out, and eat in peace).

And most importantly, lots of d-whales and marlins gravitate to the game… or so we are informed (and will soon find out)…

If you come to Vegas during the series, or even just before, shoot us an email (jack@ or mike@). One or both of us will be there, laptops in tow, as we keep on top of markets and play…

Finally in respect to poker, we still get regular emails asking “How is Maker doing?” And “are you willing to sell / teach the Maker methodology?” Short answers to both questions:

• Maker is kicking ass beyond all expectations;
• No, we are unlikely to ever sell or teach it.
• (Except, possibly, to a select few proteges down the road.)

If you’re wondering “what the heck is Maker,” this explains it… to give a brief update, the Maker cash game methodology has evolved well beyond trackable version numbers (too many micro-evolutions to count). The focus is almost exclusively cash games now (tournament buy-ins below $5K determined not worth the effort)… and Maker development and deployment has taken on a life of its own, in context of pure organic opportunity.

The reason we can’t share Maker with a broad audience — and we like to share, as you have probably figured out — is because the poker ecosystem is simply too small. There just aren’t enough watering holes to go around, if you will, and only so many “big game” venues to exploit.

And thus, the fewer apex predators there are hunting big games with Maker firepower, the better it is for us…

But fortunately, there are no such pool-size limitations in trading, or at least in the particular manner we trade. We practice an “old school” method of trading and speculating, one that traces its roots back to Livermore, Wyckoff, Cutten, and the great speculators of a century ago, running on through the champion traders of “Market Wizards” fame and the global macro savvy, equity-equipped “go anywhere” greats of today.

That is why we are able to share virtually everything we know about trading — and new skills as we add them to boot — via the MT Driver’s Manual,  our all-encompassing, 360-degree immersion in how to trade the Mercenary way. And by all encompassing we mean everything: Psychology, money management, pattern recognition, trade structures, pyramiding and position sizing, the whole works.

It is going to take literally years to get through everything the Driver’s Manual will have to offer. And by then there will be even higher levels to explore… you can check out the first few installments of the Driver’s Manual — killer stuff that is absolutely free — by signing up here if you haven’t already.

And as always, we love hearing from you guys on any and all topics — questions, thoughts, article suggestions, you name it: jack@ or mike@ mercenarytrader.com!

Similar articles you might like:

• Mike vs Knish (Gearing Up for the Big Game)

• From Cabo to the Wynn

• The Most Important Work We've Ever Done

• From AC to Biloxi

• Putting Maker to the Test

• Vegas Reconnaissance, Plus, Looking for a Few Good Mercenaries

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- Paul Tudor Jones

JS Comment:

What does it mean to be a hero in trading?

In poker, a “hero call” is sometimes appropriate. It refers to the call of a very large river bet with medium strength — or even Ace-high — based on a strong read that your opponent whiffed on a draw and is representing a huge hand to steal the pot.

In markets and trading, there is no official definition, but we can more or less surmise being a “hero” looks like the following:

Putting your foot down and saying “markets will do X, I’m sure of it!”

Pointing to the sky like Babe Ruth — “this is where my profits on this trade are going to go!”

Making large bets (relative to your capital base) with a do-or-die mentality. “Dammit I am right!!!”

Declaring with godlike authority how certain macro events will play out. “The treasury bond market WILL collapse!!!”

And so on…

Off the top of my head I can think of three ‘hurting heroes’ right now: John Paulson (gold and gold stocks), Kyle Bass (Japan) and Bill Ackman (Herbalife, JC Penney). There are probably many more…

There are also many semi-heroes among the journalists and chattering classes, though these guys don’t really count. If the pundits make a huge prediction and it comes true, they get lots of publicity. If it doesn’t come true, no skin in the game so who cares… they just wait a while and make another big prediction. Wash, rinse, repeat.

What does NOT being a hero look like in trading? Some possibilities:

• Not trying to catch the absolute top or bottom
• Not “fighting the tide” because you are “right”
• Being agnostic and opportunistic deep in your bones
• Changing your stance immediately if price action fails to confirm
• Never entering without price confirmation in the first place
• Looking for max risk-adjusted odds of profit, not max glory

Not being a hero means less glory, but ultimate far more profit, because if you have the patience to wait for the (non-heroic) optimal moment — which is almost never the initial turning point, which heroes love to call out — you can more effectively scale up and put leverage to work in your favor.

Not being a hero in respect to adverse price action — dumping positions quickly that aren’t working out as planned — also lets you safely deploy more size in general, which in turn allows for more effective pyramiding and greater profits from the very same move the hero took with less size (because he got chewed up so many times trying to catch the damn turn).

And of course, there are the invaluable merits of pure survival and never going down with the ship (as heroes all too often do)…

Do you have any “hero tendencies” in your trading? Any excessive need to be vocal or first or proven right in the face of opposition, with the “ego” account balance taking precedence over trading P&L? How to jettison these tendencies and become an egoless, agendaless profit-hunting Mercenary instead?

How to Win at Poker: A Handy Tip

Economist April 20th print edition

A POKER face. It is the expressionless gaze that gives nothing away. To win at poker, the face must be mastered, and master it is what the best players try their best to do. But a study just published in Psychological Science by Michael Slepian of Stanford University and his colleagues suggests that even people with the best poker faces give the game away. They do so, however, not with their heads but with their hands.

Mr Slepian made his discovery when he showed 78 undergraduate volunteers video clips of players placing bets at the 2009 World Series of Poker. (Bets in poker are placed by pushing chips into the middle of the table.) The clips were 1.6 seconds long, on average, and featured different parts of the players’ anatomies. Some showed everything visible from the table up: chest, arms and head. Some showed just the face. And some showed only the arms and hands. Each volunteer watched only one of the three types of video, but was shown several examples.

After each viewing, volunteers were asked to rate the quality of the player’s hand on a seven-point scale. Then, when they had finished watching all the clips, they were asked to rate their own experience with poker on a similar scale.

Mr Slepian found that students were poor at judging the quality of a player’s hand when shown just that player’s face. Indeed, he noticed a negative correlation of 0.07. This is not huge (a perfect correlation is 1.0). But it meant there was a statistically significant tendency that the better a volunteer believed the hand to be, the worse it actually was. When a player’s whole posture was considered, this misapprehension went away: if a volunteer could see everything about a player from the table up there was no correlation between his judgments of a hand’s value and its actual value. When a volunteer could see only arms and hands, however, Mr Slepian found a positive correlation, of 0.07, between his guesses and reality.

To confirm his discovery, Mr Slepian re-ran the experiment with a different set of clips. The results were the same. Students, even those who were poker novices, could judge the quality of a professional poker player’s cards from the behaviour of his hands. The next question was, how?

Mr Slepian knew from previous studies by other people that anxiety has a tendency to disrupt smooth body movements, and he suspected this might be the explanation. To find out, he showed 40 new volunteers the clips he had used in the previous experiment. Rather than asking them to judge the quality of a player’s cards, however, he asked them to rate either that player’s confidence or how smoothly the player pushed his chips into the middle of the table.

He found that when students rated players as being confident or having hands that moved smoothly, the cards they held were likely to be good. There was a positive correlation of 0.15 when the students considered confidence and of 0.29 when they looked for smooth movement, so they were actually more capable of determining hand quality from these variables than when asked to estimate it directly. The moral of the story for players, then, is don’t look your opponent squarely in the eye if you want to know how good his cards are. The secret of his hand is in his hands.

God bless academics… entertainment value aside, that study is completely worthless (albeit in an interesting way).

One can question whether a 0.29 correlation has any merit in the first place. But putting the dubious math and questionable control variables aside, findings like this one completely overlook the subtleties and complexities of the game.

For example, re, competitive poker edge, we can demolish the “watch their hands” argument with a simple application of experience and common sense:

If your opponent is weak enough to let hand movements broadcast information, you do not need subtlety to beat him. Bad players are legion at the poker tables. In any given tournament or cash game — even at higher stakes buy-ins — the amount of staggeringly bad play is eye-opening. Given this empirically observable reality, how do you handle terrible opponents? The answer: Very simply and straightforwardly. Subtleties are wasted on them. Not only that, applying subtlety in attempting to “read” a bad opponent can actually be counterproductive, because if he is bad enough, your opponent will misread his own hand values (and generate a fool’s confidence in doing so). Based on board texture and betting sequence, top pair / top kicker could be all but worthless, yet your awful opponent may treat it as the stone cold nuts in his mind — telegraphing the strength of a set, a straight or a flush (via confident hand movements) because he is too green (or dumb) to situationally distinguish between a strong hand and a weak one.

If your opponent has any kind of experience or skill, on the other hand, buttery smooth bluff movements will be second nature (thus invalidating the entire premise). Subtlety does have value when facing skilled opponents. But skilled opponents present a different kind of problem: They are well aware of telegraphed signals and have lots of practice concealing them. Worse still, a truly skilled player can run a large bluff with absolute calmness and confidence (not a tremor to be found) because, if he understands the game with sufficient depth, he will literally not care about the outcome of that single confrontation. Bluff spots are assessed probabilistically: If you know that X bluff in X situation has a certain favorable expectation, regardless of this result, you can make that bluff in the same way you would accept a 60/40 coin flip with the 60 in your favor… and do so with nonchalance bordering on boredom.

On a personal note, I remember the first time (circa eight years ago) I made a big bluff at a cash game pot. It was actually a little nothing amount — something like 75 dollars — but it felt absolutely massive at the time. I remember an adrenaline rush so strong it felt like my heart might pound right out of my chest.

Now, these many years later, I have made — and called down — countless bluffs in the +$1,500 range, or even larger, without so much as a half-degree rise in temperature. Firing, say, $600 into a cash game pot on a casual bluff or semi-bluff with a net positive expectation produces no more internal drama than, say, tossing in a $5 chip.

That’s a long way from sweating bullets over 75 bucks…

And it is the same for other experienced opponents, thus making the smoothness of hand movements completely worthless as a tell. If the opponent is a tourist, subtleties are a waste or even counterproductive. If the opponent has been around the block enough times, he will possess a smooth bluff confidence that originates from a place wholly other than the value of his cards.

(The situation gets even more complex, by the way, when an opponent is smart enough to understand that a gigantic value bet is more likely to be called if it is made to appear as a bluff. On the river, your opponent fires $1,200 into a $700 pot — a bet way too large to make logical sense, unless he is trying to scare you off with sheer force. Meanwhile, he looks away when you make eye contact with him. When you say “time” and take another thirty seconds, he spreads out the twelve benjamins he has laid out in an intimidating peacock fan. Very briefly, he tugs at his collar in just the way Joe Navarro says indicates discomfort. These are nervous tells that practically scream “I am bluffing!” Which is exactly the point. He knows the tells just as you do, and is attempting to induce a hero call.)

Ah yes, complexity… the stuff that only seasoning and experience can overcome.

Are there ways to win at poker, and win consistently, by walking a higher skill path than one’s opponents? Oh indeed. We could give a sixteen-hour lecture series, sans notes, on the finer details of poker theory (and even most “good” players are not nearly as good as they think they are). But silly stuff like “watch their  hands” would not be a part of any theory curriculum. (Except maybe a section titled “dumb stuff not to rely on.”)

Articles like the one in The Economist cited above, and the research studies that generate supposed “insight” into poker and trading, highlight a key point:

In respect to highly competitive, skill-based human endeavors with zero sum or minus sum outcomes (like poker and trading), tentative hypotheses generated by non-practitioner research are generally worthless. 

This is because far too many nuances, subtleties, and empirically critical factors (hidden edges discovered and verified through ample experience — things one wouldn’t even know to consider without experience) are completely overlooked by those outside the game.

This train of thought also explains why academics who condemn trading as impossible, or say trading outperformance is impossible based on various “studies” or “models” or Wall Street test cases blah blah blah, are almost invariably nitwits with an agenda.

(My favorite class of folly in academic research, as it relates to trading, involves the studies that purport to investigate whether chart patterns “work” by, say, looking at 7,000 separate instances of data-mined head and shoulders setups in U.S. equities of a certain market cap over the years 1981 to 1995, assuming equal fixed fractions of risk capital — no situational adjustments, position sizing, trend management, nothing — uniformly applied in all 7,000 cases. As far as useful conclusions go, the implied shortfalls here are so glaring, they might as well be doing flight tests on jumbo jets made of cream cheese, or something of comparable idiocy.)

Bottom line: There is no substitute for getting in the thick of things, accumulating insights and a-ha moments born of real world experience, and stress-testing your research with hard-nosed verification of what does and doesn’t work. Rick Bookstaber has a useful take:

[In respect to how markets work,] a better analogy than physics or biology is a military one. The point is that there is a strategy of intelligent reaction to any action, an arms race to leapfrog one another in information gathering and technology, to know what others are doing, and to react in a way that they will not anticipate. This is the point where I could pull out quotes from The Art War about seeing into the mind of the enemy, attacking when your opponent believes you will retreat, and the like. That is not physics.

Nor is it hubristic academic findings with gaping holes big enough to drive a mack-truck through… so remember that next time a non-practitioner tries to lecture you on what can or can’t be done.

JS (jack@mercenarytrader.com)

p.s. Like this article? For more, visit our Knowledge Center!

p.p.s. If you haven't already, check out the Mercenary Live Feed!

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You may have noticed the “Trading Food for Thought” section in the right sidebar of the site, where a random quote populates when the page refreshes.

Over the past few years we have collected 2,000 such quotes and counting — some funny, some serious, some thought provoking etcetera.

Among these are sprinkled a few dozen “Sparrowisms” — nuggets of whatever worth (perhaps not much!) from yours truly.

Just for fun, here they all are in one place. (Drink up me hearties, yo ho…)

Sparrowisms (circa April 2013)

“‘Know your own strength’ can be taken as a pessimistic warning or a lofty aspiration. It all depends on how you look at it. But then that’s pretty much true of everything.”

“Great traders can afford to be humble. In the face of ever present uncertainty, their huge profits give them comfort.”

“This is an excellent time to be a flexible, fleet-footed, go-both-ways trader who knows how to scale up low-risk positions. Conversely, for hidebound, stubborn, “set in their ways” long only investors, it is almost the worst environment imaginable.”

“Typical “contrarianism:” Pointing to one’s pathetically conventional target of choice and saying “LOL u guyz r dum so I’m goin 2 do the opposite LMFAO”…”

“You develop some ideas, go forth into the market and try some things. Over time, you build up experience this way. (Profitable or unprofitable, it’s still experience.) Then, having accumulated that experience, you step back to examine and theorize. You analyze what happened and why. You think about the strengths and weaknesses of what you just tried. You start to develop a new round of ideas. You get a sense of where the holes are in your capability, where the most profitable areas of exploration might be.”

“Progressing forward as a trader is a matter of filling in knowledge gaps and connecting abstract concepts with vivid memories of real world application. The absolute beginner is so void of experience he has no idea where his gaps even are. At the point of starting out, all trading knowledge is a swirl of hypotheticals. The trick of advancement, then, is to go back and forth between theory and experience, theory and experience, in a regular intertwined dance.”

“As a general rule of thumb, simplicity beats complexity because simplicity travels light.”

“The crowd is NOT ‘always wrong’… it is only wrong at turning points.”

“Becoming a great trader is an evolutionary process. It’s a series of trial and error transformations, mental map adjustments, and incrementally acquired skill sets, all blended together. And there is no substitute for hypothesizing, testing, and experimenting, with the requirement of organizing one’s thoughts logically and empirical verification serving as the great crystallizer.”

“Financial commentators who don’t actually invest or trade are like sex therapists who don’t have sex.”

“…the one big problem of over-aggressive players is this: They don’t know how to use it sparingly. The beauty of aggression is how powerful it can be when judiciously applied. Selective use of aggression, at supremely appropriate moments, is what makes the value stand out.”

“For traders, work nights are really “school nights:” Rest up and do your homework, or the market will school your ass good.”

“There are few activities so enlightening as to read old books with new eyes.”

“Trading is a curious mix of mostly going with the flow, yet knowing when to selectively fade the flow.”

“Being contrarian at the wrong time is akin to arguing with a herd of cattle.”  

“…the practice of rigorous risk management is more than just preachy self-discipline or boring bean counter talk. Managing risk is a key source of trading longevity, a means of positioning for future profits, and a hallmark of competitive excellence. Smart risk management not only helps preserve capital, it puts money in your pocket by ensuring you have the mental and financial capacity to swing with conviction when the time is right.”

“Today’s mistake is tomorrow’s insight.”

“The greater the number of conditional probabilities — small edges — you have in your favor, the better, and trades are like poker hands in this regard: The “setup,” especially when as thin as a single bar, should be validated or invalidated (taken or passed) based on surrounding factors (much as certain poker hands are either played or not played depending on multiple elements of situational context).”

“Trading is easy, same as poker is easy — just hit your nut flush draws and open-ended straight draws on the turn.”

“Rather than daydreaming of a huge windfall in markets, perhaps traders should proactively seek out windfalls of experience, seasoning and knowledge…”

“The universe is a perfect machine. It cannot put a foot wrong.”

“Knowing when to “get a hunch and bet a bunch” is not so much a matter of luck. It is more a matter of hard work, intuition and experience, coupled with a dedicated focus on being in touch with the ebb and flow of markets from day to day. In other words, the hard work of being deeply in tune with markets — and justifying your convictions through constant interaction and hypothesis testing at lower risk levels — is precisely what fuels the winning combination of careful and conservative 90% of the time plus balls-out aggressive 10% of the time. You earn the right to swing, and just as importantly the insight as to when to swing, through consistency, diligence, and dedication.”

“Rare is the blessing that bears no resemblance to curse.”

“In secular bear markets, fighting general conditions is an expensive habit. Wall Street is addicted to this habit by design.”

“Markets have a distinct game theory component in that, the fewer the total number of survivors after a “wash and rinse” period, the greater the future opportunity that comes available (with comparatively few left to exploit it). To put it another way: If the money always came flying in through the window, too many profit seekers would crowd the window. Pain facilitates gain by blocking the pathways of the insufficiently persistent, motivated and seasoned.”

“Theory without practice only survives in the suspended animation chambers of academia and government, where political survival skill, ideological purity, and self-perpetuating mediocrity (plodders promoting plodders) outweigh actual usefulness or merit.”

“Life is a race. Death is the finish line. The objective is to go out with the highest score possible — not in terms of dollars earned or battles won, but a life most fully lived.”

“Wall Street is populated by conventional thinkers, serving compromised ends, in the confines of a broken system.”

“The beating heart of creativity is a passionate commitment to exploring, testing and discarding new ideas.”

“As the saying goes, “If you’re going to bet the farm, have two farms.” This is taken as a warning not to risk too much. But you can also look at it like this: After building a cushion of profits over an excellent trading period, you can take a goodly portion of that profit and treat it as your “second farm,” making a large bet with a limited risk options position (assuming the conviction-based opportunity is there). If you are wrong, you wind up having a good year instead of a great year. But if you are right, you go from a great year to an absolutely fantastic year – without ever placing your original farm at risk. Knowing how to do this, and how to do it properly without unduly increasing mortality risk or initial capital risk, is one of the hidden factors rarely talked about that puts some traders head and shoulders above the rest, in respect to their ability to deliver superior risk-adjusted returns.”

“The best “plungers” will not be those inclined to plunge by dint of gambling nature, but rather those with a calculated risk taker’s soul and a deep and passionate desire to win – even a ferocious desire to win — with the understanding that excellent opportunities do not grow on trees and should be played to the hilt (while limiting risk) when such comes available.”

“Perpetual pessimists are fools, as are perpetual optimists. There are times for both in proper measure… an inflexibility of perspective is a sign of ideological distortion and / or mental weakness.”

“Fear is an impediment to clarity. So is greed.”

“It is wise to avoid predictions when possible, and to recognize that the scope of accurate prediction making is very limited. Successful macro trading is much less about “knowing” what is going to happen in future, and much more about having a handle on odds, probabilities and scenarios, without growing attached to any single one, and then acting fluidly in the moment as the picture crystallizes in actionable ways.”

“The best traders and mentors are humble on a profound level, because they understand what an awesome force of nature the market is. Thinking you can “conquer” the market, or that you are somehow bigger than the market, is like a mountain climber thinking he is bigger than Mt. Everest. True practitioners laugh at such notions – which are actually not funny, in a way, because they get a lot of folks killed.”

“Government is to efficiency as Britney Spears is to gravitas.”

“Follow your own path, seek out what has worth to you, and who gives a shit about what’s said from the side of the road.”

“Truly excellent traders are open to the fact they have flaws. Truly excellent traders are realistic about the fact that all methodologies have strengths and weaknesses, and that a constant incremental process of improvement and evolution must be applied over time. Truly excellent traders reflect on mistakes they have made in the past, and recognize that, as much as they hate it, they will make mistakes in future. Truly excellent traders are proud of their skills, and yet deeply humble, because they know the market is bigger than any one man and that new challenges are constantly arising.”

“Cloaking one’s statements in mysterious impenetrable gibberish, instead of speaking clearly and plainly, is a classic device of oracles, shamans, gnostic seers, and other such shepherds in search of gullible sheep. The trick is in getting your acolyte to misinterpret complexity and opacity as hallmarks of a secret knowledge. Then, once hooked, said acolyte can be exploited, perhaps indefinitely, as he strains and struggles to understand the secrets for himself. The more gibberish that the shepherd speaks, the more entranced the sheep becomes.”

“You don’t have to be a genius in this business, but you can’t be a moron.”

“If you can preserve your financial and mental capital when others have depleted or squandered theirs, the long-term rewards will be great.”

“Every path chosen precludes an infinite number of alternative paths.”

“Tuition that can be measured in a handful of basis points is wonderful stuff indeed.”

“In their worship of logic and rationality, economists are amusingly short-sighted and irrational.”

“When everyone 95% agrees on something — home prices will never decline, China can’t be stopped, commodities can’t go down, etc. — there is real risk of ‘everyone’ taking a frying pan to the face.”

“There’s practice, and then there is deep practice. All too often, the first is a waste of time.”

“Patience is required most when one desires to apply it least.”

[On a message board:]“Every time we clash I get the impression we’re on different floors of a building. You’re first level, I’m fourth level, and I keep urging you to use the stairs.”

“The truly skilled poker player — and all the more so the truly skilled trader — is not just a fighter. He is also an artist, a statistician, and a student of human nature, all rolled into one.”

“Winners evolve.”

“Academic assertions that outperformance is impossible pose a useful sort of litmus test. If one is cowed enough by the dogma to accept mediocrity as inevitable, then one most likely lacks the drive, the talent or the intellect (or some combination of the three) to achieve excellence in the first place.”

“Some assert that currency issuing governments are “not operationally constrained.” This is pedantically true in the sense that a man standing at the edge of a cliff is not operationally constrained. He can throw himself off, but that doesn’t mean he can fly.”

JS (jack@mercenarytrader.com)

• Sparrowisms

• What Sushi and Trading Have in Common

• A Trader's True Allies: Making Millions the Livermore Way

• Where the Wild Profits Are

• Parsons' Rules

• Lessons from the King of Blackjack

• Jeremy Lin, Role Model for Traders

• Trader Vic's Principles of Trading

• Wisdom from Kovner

• "Think Only Of Cutting"

• Insight From "The Philosopher"

• Wisdom From Bloomberg

• The Wyckoff Spark

]]> http://www.mercenarytrader.com/2013/04/sparrowisms/feed/ 3 http://www.mercenarytrader.com/2013/04/never-forget-what-you-are/ http://www.mercenarytrader.com/2013/04/never-forget-what-you-are/#comments Mon, 22 Apr 2013 19:34:05 +0000 Jack Sparrow http://www.mercenarytrader.com/?p=30718 “Never forget what you are, for surely the world will not. Make it your strength. Then it can never be your weakness. Armour yourself in it, and it will never be used to hurt you.”

- Tyrion Lannister (Game of Thrones)

JS Comment:

Tyrion Lannister is a fictional character, but Julius Caesar lost his life to the above lesson.

Caesar was ultimately a dictator who took Rome by force. But in his mind, Caesar did not see himself as a dictator. He wanted to be benevolent and beloved… which is why he spared Marcus Brutus, who in turn had Caesar killed for the good of Rome.

If Caesar had embraced who he and what he was — a dictator, for better or worse — he would have smelled the Brutus threat first, and dealt with it ruthlessly. (Love of the people could have come later.)

How does this apply to trading and investing? “Never forget what you are” means knowing your core strengths and weaknesses — and not diluting those strengths or pretending to be what you’re not.

If you excel at cutting losses but are terrible at letting profits run, don’t pretend to be an investor. If you have the patience and conviction to hold for long periods but hate taking quick losses, don’t pretend to be a trader. Don’t dilute your natural style because of undue influence from someone else.

Know your core strengths and build a game plan around them. Work on mitigating weaknesses, but never forget what you are (and find out soon if you aren’t sure).

“Are these outcomes rare? A recent study of Florida lottery winners suggests no.

“Economists at the University of Kentucky, University of Pittsburgh and Vanderbilt University wanted to answer a public policy question: What happens when individuals in financial trouble are given large lump sums? So they collected data from nearly 35,000 winners of up to $150,000 in Florida’s Fantasy 5 lottery from 1993 to 2002, and cross-referenced this information with state bankruptcy records.

“Their findings, published last fall in The Review of Economics and Statistics, show that a big lottery score does little to reduce the likelihood of bankruptcy.

“More than 1,900 winners went bankrupt within five years. That number implies that 1% of Florida lottery players (winners and losers) go bankrupt in any given year, about double the rate for the broader population during the study period.

“Big lottery winners, defined by the researchers as those awarded between $50,000 and $150,000, were half as likely as small lottery winners to go bankrupt within two years of their score but just as likely to go bankrupt three to five years after. “The results show that giving $50,000 to $150,000 to people only postpones bankruptcy,” the authors concluded…”

- Smart Money, “Why Lottery Winners Go Bankrupt”

JS Comment:

As a version of the old saying goes, “It’s easy to make money trading. Just try keeping it.”

The sad precedent of lottery winners blowing their windfalls — be it $50,000, $5 million, or even more — is analogous to those who make a “big score” in markets through dumb luck or fortunate circumstance, but never develop the capital preservation skills to hold on to it.

This is also the source of the saying, “Never confuse brains with a bull market,” in reference to those who make money hand over fist for a temporary window of time via reckless exposure, pollyanna optimism, and gross lack of risk control. The combination produces the most profits in the “silly season” part of the trend, but also the most debilitating losses when the worm turns (as it always does).

Rather than daydreaming of a huge windfall in markets, perhaps traders should proactively seek out windfalls of experience, seasoning and knowledge…  

p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

- Michael Marcus

JS Comment: 

Michael Marcus, one of the original Market Wizards, is noted for turning $30,000 into $80 million. If even he started out taking enough lumps to generate serious self-doubt, how can traders learning in today’s environment expect less of a persistence breakthrough challenge?

Visit the Trading Wisdom Archives! 

p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

“It’s the latest it’s the greatest, come on baby, it’s so easy to do. Oh, mashed potatoes, mashed potatoes, you can do it too. Mashed potatoes, mashed potatoes, yeah, yeah, yeah…” 

It was 3:59. Hayes Noel and I were up on the balls of our feet, twisting our crepe-soled shoes in opposite directions, dancing around the floor of the American Stock Exchange singing Dee Dee Sharp’s 1962 hit. As my young son would later say, “It had been a big busy day.” Discarded buy-sell slips covered the floor and we were getting some good sliding action. We were hot. I was up ten grand on paper for the day with only a minute to go. I’d only been trading on the floor for a couple of months, and I was so happy that I was doing so well and that my positions were all marked up in my favor that I didn’t realize that I should have converted the ten grand into real money. 

The market opened way down the next day, and because I’d been dancing instead of closing out my positions, I was locked in and lost the whole $10,000 in paper profits. From then on, I always fought back the temptation to start dancing before I’d heard the cash register ring. When you feel like doing the mashed potatoes, it’s a visceral clue that you’ve lost your objectivity, you’ve gotten too emotional, and you’re about to go into the shitter. 

The other thing that’s stupid is that you actually think you’re dancing well. And, of course, you’re not. 

Until last Friday’s gigantic bust of a non-farm payrolls report, investors had been doing the mashed potatoes over the prospect of a housing-led US economic recovery. While equity markets recovered from the shock of a +100K jobs whiff, a fair amount of technical and sentiment damage was done. Long-term treasuries took off like a bottle rocket as investors dog-piled into safe havens, and small caps were beat by the ugly stick.

It is an ironic fact of markets that the crowd is always wrong at turning points. The crowd is not wrong all the time, of course. There are great long stretches where the crowd successfully rides a trend.

By definition, though, a turning point will catch the crowd by surprise… because if the crowd had anticipated it and acted earlier, the turning point itself would simply have arrived earlier.

Crowds are also known for unimaginative extrapolation in straight lines. The trend, once sufficiently reinforced in the collective institutional psyche, is de facto assumed to persist indefinitely.

That makes the following especially juicy (via Reuters):

LONDON (Reuters) – Hedge funds set up to profit from huge market slides are falling out of favor, signaling that investors are increasingly confident leading central banks can avert the kind of meltdown that followed the Lehman Brothers’ collapse.

Investors are pulling out of such “tail risk” funds although economic and geopolitical bolts continue to strike from the blue, be they the messy bailout of Cyprus which has shown how the euro zone crisis can flare up when markets least expect it, or the U.S. stand-off with North Korea.

Despite such crises, shares have ploughed on to multi-year highs while volatility, as measured by the VIX or “Fear” Index, fell in mid-March to its lowest level since before the financial crisis when the U.S. investment bank went under in 2008.

Last year’s promise by European Central Bank chief Mario Draghi to do whatever it takes to safeguard the euro, along with bold measures by policymakers to stimulate economies from the United States to Japan, have undermined tail risk funds.

“If the world’s central banks have decided they are going to do whatever to support the economy then you are not going to have crazy volatility. You need a catalyst,” Nicolas Rousselet, Head of Hedge Funds at Swiss investor Unigestion, told Reuters.

- Investors turn their backs on “black swan” hedge funds

In the aftermath of a hurricane, investors rush to take out insurance on their beachfront condos — just when premiums are the most inflated. Then, after a long season of sunshine and mild winds, their memories fade and they let the policy lapse… just as danger looms large again.

Here are the following reasons to extrapolate blue skies ahead (with no black swans in sight) — see if you can spot what’s amusing:

• The US housing market is healthy. 
• Housing + Energy = economic recovery. 
• Crisis in Europe is contained. 
• Asia is on a solid, stable footing. 

The irony is that all four of those factors were plausible reasons for bullish optimism as recently as a few weeks ago… and now they are all in doubt.

The housing market is indeed recovering. But how much of it is solid fundamentally, and how much is driven by falsehoods? John Hussman makes an intriguing argument that the whole thing is a classic misallocation:

While some observers will reflexively point to the housing market as a sign of economic recovery, it is important to recognize that the millions of homeowners with underwater mortgages (home values below the amount of mortgage debt still owed) have no ability to sell their homes even if they wish to do so, unless they can come up with the difference out of pocket. As a result, the natural flow of demand from new household formation must be satisfied from an inventory of homes for sale that is much smaller than the actual “shadow inventory” that would be available if losses did not have to be taken in order to sell those homes. So the demand for homes resulting from household formation is satisfied from limited inventory plus new home building, even though there is an ocean of distressed and unsold homes already in existence. From this perspective, it should be clear that the bounce we’ve seen in housing is not a sign of economic recovery, but is instead a sign of misallocation of capital due to what economists would generally call a “market failure.”

- John Hussman, Taking Distortion at Face Value

We can also see, via Friday’s jobs report, that whatever is going on in housing, it isn’t helping the real economy in key ways — and millions of Americans are dropping off the radar:

Put out an all-points bulletin: Millions of Americans have gone missing from the workforce.

Every month that those would-be workers are gone raises the odds that they might never come back, dimming the prospects for future economic growth.

The vanishing trend is more than a decade old, but it accelerated during the Great Recession. Throughout 2012, economists held out hope that it had stopped. But then came Friday’s jobs report, and hopes were dashed.

The Labor Department reported that the U.S. labor force — everyone who has a job or is looking for one — shrank by 500,000 people in March. That brought the civilian labor force participation rate to 63.3 percent in March, its lowest level since May 1979. And it left the workforce several million members smaller than the Congressional Budget Office estimates that it should be, given the nation’s demographics.

Perplexingly, the driving force behind the decline does not appear to be baby boomers beginning to retire, an event economists have long predicted would shrink the size of the workforce. It’s people in the prime of their working years, ages 25 to 54, who began tumbling out of the job market in the early 2000s and have continued to disappear during the recovery.

That’s obviously bad for those people, who aren’t earning money in any way that would legally require them to pay taxes. It’s also bad for the economy for a simple reason: The fewer workers, the less growth produced…

- Washington Post, Vanishing Workforce Weighs on Growth

Alongside housing, there is a belief that a new energy boom will power a US-led recovery. But this rationale is out of whack for two reasons: The timing cycle is all wrong, and cheap energy has not slowed the automation uptick and offshoring exodus that has made manufacturing jobs disappear. We may well have cheaper oil and gas in five to seven years. But that is no counter to persistent weakness here and now.

And what about the argument that crisis has been contained in Europe? Pardon me for a moment — HA HA HA HA HA — ok and we’re back.

Prior to Cyprus, it was possible to argue, albeit unconvincingly, that Mario Draghi had “saved” Europe and everything would be fine. Now, though, it is becoming clear that Cyprus was not some bolt out of the blue, but the thin end of a very large wedge.

What happened in Cyprus is representative of Europe’s unsolvable problems on the whole — problems that are already festering in Italy, Portugal, Spain, Greece, and even France. Europe is no closer to a solution now than it was in the throes of Greek crisis… and the odds of another “black swan” out of Europe are now so high (timing notwithstanding) the swan should rightfully be labeled gray.

Cyprus is also important as a form of throw-in-the-towel turning point for Europe. Up until Cyprus, there was still a large contingent of euro-optimists who thought the kinks would work out and the euro would survive as a viable currency. After the utterly ridiculous fiasco that ensued (and is still ongoing), many one-time “believers” switched over to the no-hope side.

And as for Asia: Just in case North Korea’s threat of nuclear war and Japan’s embrace of nuclear monetary policy were not enough, there is this:

China’s unprecedented run of better- than-forecast export growth has spurred deeper skepticism of the data at banks including Goldman Sachs Group Inc., casting doubt on the strength of the recovery.

Gains in overseas shipments exceeded forecasts by at least 7.5 percentage points in December, January and February, the first time that’s happened in three straight months in the eight years Bloomberg has compiled analyst estimates for the data…

Overstated exports would mean China is failing to get the boost from global demand that the data suggest as the new government under Premier Li Keqiang seeks to sustain an economic rebound. Theories include companies inflating the value of shipments to bring money into China, according to Nomura Holdings Inc., and exporting the same goods twice as local governments seek to boost data, Goldman Sachs says.

“The recovery in exports is there, but the magnitude probably is much weaker than the official data has been indicating,” said Zhu Haibin, chief China economist at JPMorgan Chase & Co. in Hong Kong…

- Bloomberg, China Export-Data Skepticism Deepens From Goldman to Nomura

The traditional view of North Korea’s leadership has been: “They aren’t actually insane, it just pays geopolitically to pretend they’re insane.”

Vis a vis China – to the degree that North Korea actually starts acting nuts, then, it suggests some internal pressures could be forcing the regime’s hand.  How does this story end? Barring the (small) possibility of an actual nuclear exchange, we have the further possibility — economically terrifying to China — of an imploding North Korean state sending millions of starving refugees flooding over China’s borders.

And if the whole North Korea thing dies down, there is the risk that China’s white-hot housing bubble is in the midst of popping anyway… and then of course you have Japan implementing perhaps the craziest monetary experiment in history (a QE plan that is effectively three times bigger than the United States)…

And as a piece de resistance, as observers like Hussman and Jeremy Grantham have observed, corporate profit margins are some 70% above historical norms — and as Grantham has said, if margins do not revert at some point it means capitalism is broken.

Basically, if investors had any sense they would be purchasing black swan insurance by the metric ton right about now (instead of shunning it).

JS jack@mercenarytrader.com

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• The Law of Diminishing Returns

• Gold Looks Great... Gold Stocks Look Terrible

• Requiem for a Twinkie

• Killing the Wrong Pig

• Hey Bill Gross, Why So Serious?

• The Euro, William Jennings Bryan, and Newly Constructive Thoughts on Metals

• "Stupid Stimulus" Courts Disaster

• Knee-Jerk Fed Reaction Doesn't Add Up

• Gold Looks Terrible Part III: The Mass Capitulation Thesis

• Gold vs Bonds: At What Point Should Gold Believers Lose Faith?

• Attention Frustrated Chartists: It's not HFT - it's the Macro!

• A Dangerous Market Full of Crosscurrents

• Euro Zone Crisis: Back on the Front Burner

• Concerning Gray Swans: Europe, China, Profit Margins and The Fed

• The Return of Ugly Goldilocks

• Gold Looks Terrible Part II: Clarifying Thoughts

• Home Builders (Technically Speaking)

• Downgrades & Mellonists: This is What the Market Fears

• The Bond King Gets Desperate

• S&P 400? The Deflation Shock Scenario

The Dabbler

“The Dabbler approaches each new sport, career opportunity, or relationship with enormous enthusiasm. He or she loves the rituals involved in getting started, the spiffy equipment, the lingo, the shine of newness.

‘When he makes his first spurt of progress in a new sport, for example, the Dabbler is overjoyed. He demonstrates his form to family, friends, and people he meets on the street. He can’t wait for the next lesson. The falloff from his first peak comes as a shock. The plateau that follows is unacceptable if not incomprehensible. His enthusiasm quickly wanes. He starts missing lessons.

“This really isn’t the right sport for him. It’s too competitive, noncompetitive, aggressive, nonaggressive, boring, dangerous, whatever. He tells everyone that it just doesn’t fulfill his unique needs. Starting another sport gives the Dabbler a chance to replay the scenario of starting up. Maybe he’ll make it to the second plateau this time, maybe not. Then it’s on to something else.

“The same thing applies to a career. The Dabbler loves new jobs, new offices, new colleagues. He sees opportunities at every turn. He salivates over projected earnings. He delights in signs of progress, each of which he reports to his family and friends. Uh oh, there’s that plateau again. Maybe this job isn’t right for him after all. It’s time to start looking around. The Dabbler has a long resume…

The Obsessive 

“The Obsessive is a bottom line type of person, not one to settle for second best. He or she knows results are what count, and it doesn’t matter how you get them, just so you get them fast. In fact, he wants to get the stroke just right during the very first lesson. He stays after class talking to the instructor. He asks what books and tapes he can buy to help him make progress faster. (He leans toward the listener when he talks. His energy is up front when he walks.)

“The Obsessive starts out by making robust progress. His first spurt is just what he expected. But when he inevitably regresses and finds himself on a plateau, he simply won’t accept it. He redoubles his effort. He pushes himself mercilessly. He refuses to accept his boss’s and colleagues’ counsel of moderation. He works all night at the office, he’s tempted to take shortcuts for the sake of quick results.

“American corporate managers have by and large joined the cult of the bottom line; their profile is often that of the Obsessive. They strive mightily to keep the profit curve angled upward, even if that means sacrificing research and development, long-term planning, patient product development, and plant investment…

“Somehow, in whatever he is doing, the Obsessive manages for a while to keep making brief spurts of upward progress, followed by sharp declines — a jagged ride toward a sure fall. When the fall occurs, the Obsessive is likely to get hurt…

The Hacker

“The Hacker has a different attitude. After sort of getting the hang of a thing, he or she is willing to stay on the plateau indefinitely. He doesn’t mind skipping stages essential to the development of mastery if he can just go out and hack around with fellow hackers. He’s the physician or teacher who doesn’t bother going to professional meetings, the tennis player who develops a solid forehand and figures he can make do with a ragged backhand. At work, he only does enough to get by, leaves on time or early, takes every break, talks instead of doing his job, and wonders why he doesn’t get promoted…

“The Hacker looks at marriage or living together not as an opportunity for learning and development, but as a comfortable refuge from the uncertainties of the outside world. He or she is willing to settle for static monogamy, an arrangement in which both partners have clearly defined and unchanging roles, and in which marriage is primarily an economic and domestic institution.

“This traditional arrangement sometimes works well enough, but in today’s world two partners are rarely willing to live indefinitely on an unchanging plateau. When your tennis partner starts improving his or her game and you don’t, the game eventually breaks up. The same thing applies to relationships.

“The categories are obviously not quite this neat. You can be a Dabbler in love and a master in art. You can be on the path of mastery on your job and a Hacker on the golf course — or vice versa. Even in the same field, you can sometimes be on the path of mastery, sometimes an Obsessive, and so on. But the basic patterns tend to prevail, both reflecting and shaping your performance, your character, your destiny.”

- George Leonard, Mastery

JS Comment: 

Do you detect any of the above traits — Dabbler, Obsessive, Hacker — in your personal trading profile? If so, how to root them out?

Visit the Trading Wisdom Archives! 

p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

- Richard Driehaus

JS Comment: How does one confirm an effective core philosophy? Here is one simple test. Imagine a wealthy businessman — a friend of the family perhaps — will give you $5 million to manage upon reasonable convincing, over the course of a light lunch, that you have a viable strategy for profiting in markets.

Without notes or power point, could you sell this person on your methodology, explaining in plain English what it is and why it works?  Could you confidently defend against devil’s advocate criticisms?

If the honest answer is “no,” work hard on making it “yes” and your core philosophy will emerge…

Visit the Trading Wisdom Archives! 

p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

You would be justified picking the Great White Shark. All those teeth. The Jaws movies. The National Geographic footage of a seal getting devoured.

But the Great White is not the baddest of them all. That would be the killer whale, aka Orca. We just don’t think of the Orca that way because it has such a friendly appearance. Shamu at Sea World wouldn’t hurt anyone, right?

The Great White knows the score. Scuba divers in shark-infested waters (off the coast of South Africa for example) are known to carry black-and-white paddles that resemble killer whale markings at a distance. If a shark starts swimming too close, the diver will flash the paddle — and the shark will instinctively turn tail and book it (for fear of becoming lunch).

This is analagous to what can happen  in poker and trading, as the following tale will attest…

An Epic Cash Game 

Two weekends ago, yours truly (JS) played in one of the most epic $5-$10 No Limit cash game sessions in history. (To be accurate, this game only played like a $5-$10 forty percent of the time. The other sixty percent of the time, it was more like $25-$50 / $100 to go.)

There were multiple sharks at the table, one or two grinders, and two full-on whales. We’ll call them Whale One and Whale Two. By the time the smoke cleared in the wee hours of the morning, Whale One had taken a solid $15,000 from the various sharks… but then turned around and given $40,000 to Whale Two.

The action was non-stop, with $4,000 pots every 20 minutes or so…. routine button straddles of $100 preflop… and multiple pots in the 10 to 20K range. The biggest pot of the night — $35,000 by the river — went like this:

• Whale One has J-3
• Whale Two has J-9
• Doomed shark has 9-9 (pocket nines)
• Flop comes J-9-3
• The turn is a J, for J-9-3-J (river is a blank)
• Three full houses, raising and reraising galore…
• Whale Two takes down 35k with jacks full of nines.
• Whale One, felted and steaming, reloads for $20,000…

Whale Classification

In the Mercenary poker lexicon, there is a type of player known as a Degen Whale, or “D-Whale” for short.

D-Whales have three general characteristics:

• They are successful businessmen.
• The money (and the swings) mean very little to them.
• They play for fun rather than profit.

In the case of this particular cash game, Whale Two owned a software company. Whale One led a real estate investment group. Both these men are the epitome of caution, rigor, and strategic management in their respective businesses. They are very good (and very professional) at what they do.

The game of poker for these guys — as it is for most D-Whales — is an opportunity to get crazy, blow off steam, and have a great time taking ballsy risks for the hell of it. A D-Whale might get hot and win $20,000 in a high stakes poker outing, or he might run cold (or just neutral) and lose $20,000. Either way, it’s not going to impact his lifestyle much, or even his mood come Monday.

The “sharks” in question — typically younger players on a financial shoestring, trying to beat the game with skill — are almost uniformly 1) far smaller-stacked than the D-whales, and 2) rightfully afraid of them, just as real sharks fear Orcas.

In the poker ocean, the natural food source for the shark is squid, seal, and various fish of small to medium size. (Sharks also vary in size and stature themselves.) D-Whales are a much more dangerous prospect.

Tonic Immobility

You might wonder why D-whales, e.g. wealthy businessmen with no heavy skill investment in poker, would want to sit down and play with sharks at all, even for entertainment. It is because the D-whale knows something powerful: If he can get the shark flipped over on his back, that shark is toast.

In the ocean, Orcas have developed sophisticated means of hunting Great Whites. The Orca’s goal is to make a meal of the Great White without getting hurt in a confrontation. (Larger predators have to guard against life-complicating wounds inflicted by a prey animal fighting for its life. This is why bears don’t mess with badgers.)

By a quirk of biology, if a shark is flipped on its back, i.e. rotated upside down, it goes into a trance-like state and cannot move or defend itself. This is known as “tonic immobility.” The shark can literally drown in this state, for lack of oxygenated water passing through its gills. (If a shark stops swimming forward, it dies. Hence Woody Allen’s charecterization of a stalled relationship as a “dead shark.”)

Marine biologists don’t fully understand the tonic immobility phenomenon (why upside-down sharks trance out). But Orcas intuitively know how to exploit it. The Orca’s tactics include forcing the Great White up toward the surface of the water, then using its tail like a giant spatula to flip or roll the shark onto its back. Once that happens — dinner time!

In similar fashion, at the poker table, a D-Whale can “roll” a shark through deception and pure volatility dominance.

For example, if a medium-sized shark bets $300 preflop with AK and the D-whale calls with 6-7, and the flop comes K-7-7, guess who’s going to get rolled? Or maybe the D-whale called with a hand that whiffed… but the shark has to fear the possibility of trips on a K-7-7 board, knowing 6-7 is within the D-Whale’s range… and so when the $1,500 flop bet comes, the shark has to fold or brave the risk of getting eaten.

In poker, D-whale vs shark engagement is a function of stack size, brute force aggression, and willingness / capability to endure swings. The D-Whale can take huge downswings (created by actions like calling big raises preflop with 6-7), yet compensatingly eat his lesser-capitalized opponents in one or two bites. That means the shark can win six confrontations out of seven, lose the seventh, and give up all his chips.

The D-whale eventually loses money in the end — you can only make so many bad calls before EV (expected value) calls you out — but he has a great time doing so, which is the point, and makes a meal of many a shark along the way. 

Neither Shark Nor Whale…

So where does the Mercenary fit in the poker ocean? As in trading, labels are hard to apply. The versatile practitioner does not fit neatly into a box. The answer is not “shark,” because the typical shark is under-capitalized relative to the stakes they play… and much of the time sharks are not all that smart. (Or at least, not nearly as smart as they think they are…)

But nor is the answer “whale,” in the D-Whale sense, because the Mercenary 1) keeps a handle on volatility through skillful risk management, and 2) plays for profit rather than entertainment (though winning is quite entertaining at the end of the day).

Apex Predators

In the actual ocean, killer whales are known as “apex predators” because they fear no other animal. The Wikipedia description of “apex predator” is interesting:

Apex predators (also known as alpha, super, top or top-level predators) are predators with no predators of their own, residing at the top of their food chain. Zoologists define predation as the killing and consumption of another organism (which generally excludes parasites and most bacteria). In this context, “apex predator” is usually defined in terms of trophic dynamics. Apex predator species occupy the highest trophic level(s) and have a crucial role in maintaining the health of their ecosystems. One study of marine food webs defined apex predators as greater than trophic level four. The apex predator concept is commonly applied in wildlife management, conservation, and ecotourism.

Food chains are often far shorter on land, with the top of the food chain limited to the third trophic level, as where such predators as the big cats, crocodilians, hyenas, wolves, or giant constrictor snakes who prey upon large herbivores. Apex predators do not need to be hypercarnivores. For example, grizzly bears and humans are each apex predators and are omnivores.

In a high stakes cash game, the apex predator would be a player who combines the deep capitalization of a D-Whale with the skill and nuance of an alpha-shark.

Essentially, capitalization matters and absolute skill level matters at separate ends of the spectrum. An abundance of one can compensate for a shortage of the other — but only up to a point. If you have superior levels of capitalization and skill — the ultimate apex predator combo — your opponents are basically fish food.

There will always be guys with more money in play, of course. If you are worth $10 million, and you play high enough, you will run into some guy worth $100 million, and so on. But there are no solo factors, only combined factors. We can thus further define “apex predator” not as the player with the biggest capitalization or the greatest skill (because skill can be hobbled when short stacked), but rather as the player with the most potent combination of capitalization and skill, for max compounding effect.

In a 5-10 no limit cash game, then, the player to fear most is not the hyperactive D-Whale with the $20,000 stack (though he must be handled carefully)… or the “seasoned internet pro” short-stacked at $1,500… but rather the guy with the formidable stack (5k+) who has zero fear, inexhaustible patience, and a strong reservoir of talent.

Trading Takeaway: Capitalization Matters

How can we take this back to trading? One primary lesson from observations of the poker ecosystem is that capitalization matters.

Capitalization means mental fortitude alongside fiscal fortitude. As such, capitalization extends beyond what you have on the table (or in the market). It encompasses your free cash flow, and what you have in the bank (or in the mattress), relative to coolness of mental state.

Skill aside, capitalization enables four types of edge (or lack thereof):

• ability to wield volatility
• ability to absorb volatility
• ability to wait out lumpy profit distributions
• ability to generate absolute dollar returns

Capitalization (ample funds in reserve) allows you to put pressure on opponents…  withstand pressure put upon you… go for extended stretches without a payday… and make enough profit overall, in absolute dollar terms, to justify the opportunity cost of time and energy investment.

These ideas matter in trading too. In this arena short-term traders can learn from medium-term traders and longer-term investors.

A successful investor will not be put out of business by a quarterly drawdown, or even the relatively infrequent annual drawdown (if such is within reason). He (or she) is not living so hand-to-mouth as to demand a weekly or even monthly paycheck from markets, instead understanding that the distrbution of lump sum payouts will be more erratic.

As with certain business models, the ability to handle uneven profit cycles is a form of robustness. (This concept applies in poker too. While a strong cash game player can expect to have winning sessions 60 to 70% of the time, the ability to do the occasional make-up stretch in drawdown purgatory — after, say, taking a tag from a D-whale — is critical.)

Would-be traders, for some reason — perhaps because it’s easier — often tend to overlook hard capitalization realities. They approach markets in the hopes of getting a weekly or monthly paycheck — not realizing this level of dependence on steady payouts is a form of time fragility, and thus a significant weakness. In addition, they ramp up their expected return-on-investment demands too quickly relative to a skimpy capital base — trying to make a too-small stake do the work of what should be a larger one, even as their psyche is made vulnerable.

Building a Trading Stake From Scratch…

- Peter Lynch

JS Comment: Take it from the great mutual fund manager Peter Lynch (whose success had nothing to do with the 1980s): The thing to do is just be 100% long at all times. Risk control is overrated versus making sure you never miss an uptick. Oh, and you should get all your ideas from going to the mall. If your wife really likes the pair of shoes she bought, invest in shoes, stuff like that. And don’t waste any effort on dumb junk like price action, sentiment, or macro drivers. Watch CNBC instead.

p.s. April Fools!!!

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- The Big Rich: The Rise and Fall of the Greatest Texas Oil Fortunes

JS Comment: 

Hugh Roy Cullen, one of the original Texas Oilmen, died in the 1950s with a fortune estimated at $200 to $300 million — enough to make him a billionaire in today’s terms.

Cullen’s mantra, “drill deeper,” was used to find oil in places others had abandoned or overlooked. The “drill deeper” mindset can be good advice for struggling traders who feel unsatisfied with their results. Flitting from one approach to another is the equivalent of “drilling shallow” — leaving dry wells strewn across the landscape, none of them deep enough to hit paydirt.

“Drill deeper” also applies in seeking to attain mastery of a craft. The effort required to master simple competitive endeavors, let alone more complex ones such as trading, is usually far greater — and the well far deeper — than the average person anticipates. (Or, as Jack Kerouc put it: “You drive and drive and you’re still in Texas tomorrow night!”)

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p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

It’s a nice example of our thought process in grind-’em-up enviroments…

In addition to featuring our trading setups in real time (typically broadcast an hour before the market opens) — along with real-time executions available via text and twitter —  the Live Feed serves as a sharing point for all our thoughts on strategy, market tone, macro factors, and more (as you can see below).

You can find out more about the Live Feed here, or go here for a no obligation 14-day trial!

8:16 am – March 19, 2013

French composer Claude Debussy once said, “Music is the space between the notes.”

This is a very useful idea. At certain times one could say “profit is the space between the trades,” or “profit is the space between inflection points.” Selective periods of low activity contribute as much to long-run P&L as periods of high activity.

This is a hard lesson to learn. It is probably one of the reasons Warren Buffett plays bridge twelve hours a week. It is an even harder lesson to absorb from a trading perspective, where the dynamic profile of being small, nimble and unconstrained creates the ever present possibility of making large profits very quickly. You make those profits via, bold decisive action. So what is happening when there is no action (or very little action)?

It is counter-intuitive to think that a lack of activity produces profit. How do you get ahead of the crowd by expending less energy?

Of course, it is key to act at the right time. If you wait and wait to ramp up activity, and then continue to wait when the inflection point arrives, and do not jump on it with gusto, then all the previous waiting was a waste of time. So it’s really not just a lack of action that makes money, but a lack of action combined identifying the right moment and stepping up when it comes.

The markets overall offer up a handful of “inflection points” per year — periods where an exceptional degree of opportunity warrants ramping up exposure and activity within a narrow window of time. If you miss one of those inflection points, it can be like missing a bus or a train — there is a broad sweep of movement that unfolds by and large without you, requiring patience until the next bus or train (inflection point) comes along.

The last major actionable, exploitable inflection point the market presented was smack in the middle of the “fiscal cliff” drama — the major bullish engulfing day registered by the major indices on the last trading day of the year in 2012, followed by an opening-year gap higher. We did not press that inflection point aggressively to the long side as we should have, out of worry over political uncertainty and potential violent reversal.

It can be unnerving buying in size when the words of dumb politicians can body slam the market in a heartbeat. But we should have better respected the loud and clear “Go!” green light signal from the price action at that point, and not been held back by the surrounding fog of the fiscal cliff.

This is water under the bridge, but the point is nicely illustrative. Price action is the ultimate arbiter of inflection point opportunity, and there will always be fog on the fundamental side. It was a good lesson learned in terms of outlier coupling of an extremely clear signal (the movement in the major indices) juxtaposed against extremely loud uncertainty (the fiscal cliff BS). We have much more clarity as to which way the chips should fall next time when a juxtaposition like that comes along. Managing the downside is what risk control is for… risk control is no excuse for inaction when the moment for action is telegraphed.

For now we continue to hunt and observe with a “small ball” mindset, finding attractive pockets of weakness here and there, via individual names, even as broader markets creep further out on a limb and the majors resolve toward a correction that is taking its sweet time. The macro picture continues to be bullish drivers for the US economy — with analysts increasingly table-pounding in their optimism — even as Europe coughs up a new giant hairball every few weeks (first Italian elections, now Cyprus, next…?). When the time comes to act boldly and in size again, we’ll be ready.

• The Space Between the Notes

• Adding Efficiency To Your Trading Process

• The Trouble With Inverse ETFs (And Other Structured Securities)

• Trend Trades vs Mean Reversion Trades

• Swing Trading in Two Sentences

• Proportion and Perspective (Give That Chart Some Room)

• On the Importance of Themes (and Getting Around)

• Why Trades Are Like College Interns

• How to Avoid 'Sitcom Syndrome'

• The Viking Remedy: Concentration as Salvation

- Chinn Ho

JS Comment: 

Chinn Ho, known as “the Chinese Rockefeller,” was the first Asian American to make a fortune in Hawaii real estate development.

His offhand success formula — “wait long, then move fast” — is all too often the opposite of what investors do: They “can’t wait” to chase trains that have left the station, and then move slowly (rather than fast) to seize opportunities and cut losses.

The concept applies in trading in respect to waiting for a clear and present inflection point before making a sizable bet.

But it also applies in daily life, in respect to simple activities like purchasing a used car or buying a house. The more in a hurry you are, the less likely you are to come across an exceptional opportunity. (And of course, you want the checkbook in your pocket when you find it.)

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p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

While many of the other Cabo resorts are huge and seemingly overrun, with a significant trek to restaurants and amenities, at Pacifica it truly feels like a private, quiet getaway… and your bungalow door is a thirty second walk from everything, including the ocean.

It’s a working vacation – thanks to high speed internet, all a Mercenary needs is a laptop and comfortable chair to follow markets and stay on top of positions anywhere in the world. Phone text alerts for price triggers make this even easier too.

Places like Cabo are thus an ideal mesh for the independent swing trader’s life: Two to three hours of focus in the morning (on a “work-lite” schedule),,, coupled with relaxing or sight-seeing in the afternoons… and then another hour or two of research slipped in here and there, quite possibly via shaded umbrella by the infinity pool. (Daiquiri anyone?)

The trader’s life can seem ridiculously idyllic. Travel where you want, when you want… enjoying the best of everything… focused on work that is constantly interesting and engaging, with no boss and unlimited financial upside to boot. Believe it ,we sometimes pinch ourselves and ask, “How good can life get?”

But there is a real cost to all this — the cost of self-discipline and self-directed focus. It’s like working from a home office. Most people love the sound of a home office – no supervisor, no corporate policies, no punch clock and so on. But when the topic of working from home comes up, a common confession is: “I would never have the self discipline to pull that off.”

Most people wouldn’t…

And trading takes the self discipline requirement to a whole other level. In addition to a  tough-as-nails work ethic, you have to execute your trading plan, and do your “homework” (research duties and trade setups) with no stumbles and no slacking, rain or shine, day in and day out without fail.

Nor does the above even touch on the need to honor your risk points… the need to never self-sabotage or do something foolish because of a discipline lapse… to always stay patient and cool as a cucumber in the face of adversity or “boring stretches” of low market activity…

We routinely hear discipline lapses  presented as if they were acceptable, and it always makes us laugh. There is a strange sort of casual acceptance in the online trading community:

Forgot to place your stop? Pulled your risk point at the last second? Took a ‘flyer’ on a dumb position in too large a size because you were mad at the market? Blew off your daily routine because you were in a bad mood? Ha ha, that’s “just part of trading…”

Sorry, but that stuff is NOT part of professional level trading. It’s strictly amateur hour — screwing around and not being serious about the craft. The game is hard enough without tolerating an enemy in your own camp!

Imagine you were managing a large sum of capital for a very serious and demanding client. In our view, you should treat your own capital with the same amount of respect as you would that client’s. Any lapses in discipline that would get you fired from running someone else’s OPM, should also be out of bounds with your own money. Because seriously, aren’t you your own best client? Does it really matter that your personal trading account hasn’t reached $100MM yet? It shouldn’t…

Perfect trading discipline is no holy grail of course — it’s more like “table stakes.” As in,

To win the game, you have to have a seat at the table. If you can’t come up with “table stakes” — the minimum buy-in required to play the game — you don’t get that seat. (You may think you’re at the table, but you aren’t.) Certain requirements, like executing your methodology with 100 percent consistency, and constantly looking for areas of incremental improvement, should be considered “table stakes” in trading. Such does not guarantee you will be consistently profitable. But without such efforts, you’re damn near guaranteed not to be.

People underestimate the level of self discipline and personal emotional control it takes to become a competent trader. Why? Probably because “discipline” is a dirty word… and topics like, say, checking on markets from the deck of your bungalow in Cabo are a lot more fun and sexy. But the hard work is the backbone of the payoff. You don’t get the fun and sexy before working out the nitty gritty.

Much of this (working out the nitty gritty) is a function of trading psychology — getting your head and heart and mental perspectives right. Most would-be traders spend about as much time thinking about trading psychology as they do thinking about money management (that is to say, almost zero).

That’s a shame because trading psychology is critically important. It is the foundation upon which everything else rests. In such a competitive environment as trading, if you can’t operate with clockwork discipline and always bring your ‘A’ game, what chance do you have?

That is why we are kicking off our MT Drivers Manual – long in the works, finally being rolled out now — with the Trading Psychology Field Guide.

Part I of the Field Guide details the ultimate source of profits in trading… why the many lose to the benefit of the few… and why it is so critically important to undergo a transformation in outlook, so as to become one of the few.

Part II then digs into the actual nitty gritty — the hard transformative work required to change the structure of the mind… and in so doing laying the foundational groundwork for lasting trading success.

Part III — on packing and preparing for the trading “journey” — is now underway…

It’s a risky approach, quite frankly. We are going far afield from traditional trading topics with some of this stuff… sharing ideas and processes people have never come across before… straying well off the beaten path of more conventional “how to trade” materials.

The idea is, by sharing unexplored truths — and creative approaches developed over the course of a decade or more — we feel we can succeed in shaping traders from ordinary clay where other efforts failed.

We expect the Driver’s Manual to serve those not cut out for trading as well… by doing them a service in opening their eyes. The DM lays out in bold clear terms what is genuinely required, so that the challenge is clarified with no misconceptions. (If trading is not for you, in other words, the DM will give you a firmer grasp as to why — and possibly save a lot of effort and time.)

Because it isn’t just sufficient trading capital… or a workable method… or strong enough motivation and a logical plan… it is something bigger, deeper and more comprehensive than all those things. It can’t be encapsulated in a paragraph or two, any more than a white collar career discipline can be picked up in a weekend.

The DM is a wildly ambitious project all told. Over time (as the materials will be ongoing) we will lay out everything, and that means everything, required to build successful traders from the ground up — starting with only the building blocks of strong motivation and deep desire.

Through this process we will be forced to hone and sharpen and clarify our own procedures and thought processes  like never before. (Nothing invites razor sharp clarity like sharing with the world, part of the reason we’re doing this).

If you haven’t yet signed up for the Driver’s Manual, there’s no cost or obligation to check it out. And the Trading Psychology Field Guide — as we have said previously, some of the most important  work we’ve ever done — comes with the DM and is absolutely free…

Follow this link to get the Field Guide (and additional Driver’s Manual materials) sent to you via email.

Speaking of “the life of the independent trader”… in April we will continue living the life — because it’s profitable, and because we can — by hitting the Wynn poker room in ever alluring Las Vegas.

From April 3rd to 11th we will be staying and playing at the Wynn, crushing the $2-$5 and $5-$10 NL tables while getting our trading work done during the day (and at the tables, courtesy of high speed internet and chargers at every seat),

If you will be in or around Vegas at that time, or can make plans to drop by the Wynn for drinks, shoot us an email — jack@ or mike@ mercenarytrader.com!

Similar articles you might like:

• Mike vs Knish (Gearing Up for the Big Game)

• From Cabo to the Wynn

• The Most Important Work We've Ever Done

• From AC to Biloxi

• Putting Maker to the Test

• Vegas Reconnaissance, Plus, Looking for a Few Good Mercenaries

• Of Poker and Balance Sheets

• Revving Up The Driver's Manual This Fall!

• Dedication, Passion and Purpose

• Kicking Back at Lake Tahoe

“Being prepared, on a few occasions in a lifetime, to act promptly in scale in doing some simple and logical thing will often dramatically improve the financial results of that lifetime. A few major opportunities, clearly recognizable as such, will usually come to one who continuously searches and waits, with a curious mind, loving diagnosis involving multiple variables. And then all that is required is a willingness to bet heavily when the odds are extremely favorable, using resources available as a result of prudence and patience in the past.”

- Charlie Munger

JS Comment:

How many traders and investors are prepared to “act promptly in scale,” i.e. exploit opportunities in size when they come? How many diligently scan the horizon for such moments?

How many more bow their heads in submission to the “you are doomed to mediocrity” message of passive investing advocates, random walkers et al… those who say exceptional performance is unattainable and further admonish you in firm tones — without even knowing who you are — to not even try?

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“The most liquid period is the opening. Liquidity starts falling off pretty quickly after the opening. The second most liquid time of day is the close. Trading volume typically forms a U-shaped curve throughout the day. There’s a lot of liquidity right at the opening, it then falls off, reaching a nadir at midday, and then it starts to climb back up, reaching a secondary peak on the close. Generally speaking, this pattern holds in almost every market. It’s actually pretty amazing. ”

- Monroe Trout, New Market Wizards

JS Comment:

It’s interesting to think about the U-shaped liquidity profile in the context of an old belief: Dumb money trades at the open, while smart money trades at the close.

If the open and the close are the most liquid parts of the day — the open being dominant — it’s probably more accurate to say the bulk of money trades at the open, period.

As for why trades at the close look smarter, there is a simple explanation: Time position. More information is available at the end of the day than the beginning. The opening trades on an FOMC day come before the 2:15 announcement; the closing trades come after it.

There is also a way to interpret EOD (end of day) trades as “smarter” regardless of what happens:

• If the market reverses into the close, EOD trades can be painted contrarian / dodging a bullet.
• If the market stays directional into the close, EOD trades can be painted as confirming the trend.

With that said, there are logical reasons for avoiding the opening in respect to new trade executions… the frequency with which opening prints reverse, for example, is also explainable through the U-shaped liquidity lens. (If most of the buying gets done in the first three minutes, there are greater than normal odds an exhaustion reverse will follow, etc…)

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- William Eckhardt, New Market Wizards

JS Comment:

Warren Buffett has said something similar in regard to investing (paraphrase, “average IQ is enough”).

Markets are curious in their ability to attract both the exceptionally intelligent and the exceptionally unintelligent: Smart people tend to think “I’m top notch doing X, so why wouldn’t I be good at this,” whereas dumb people think “Ooh! Free money!”

While a lack of intelligence (being dumb) is a disadvantage for obvious reasons, being exceptionally intelligent has potential disadvantages too (less obviously so) in respect to the impact on ego.

If one is used to getting things right, or even arrogantly confident in one’s ability to do so, it can be maddening when the markets says “wrong!” for the fourth time in a row, in turn exacerbating risks of emotional meltdown.

Another reason average intelligence may be better, on balance, is because the trading learning curve can be so extended, and so brutal, that a personal ego investment in mental superiority — a need to preserve the vanity core that says “I am smarter than this” — becomes a training liability.

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p.p.s. follow us on Stocktwits & Twitter! @MercenaryJack and @MercenaryMike

“What good can come from comfort? It’s not going to be art. I think there’s a false ideal out there, to some people — maybe younger people — they might think “I could be an artist and I don’t have to work.”

“But I think calling yourself an artist, you have to work three times as hard as someone with a punch-clock job. Because if you punch in, you have a responsibility at your job, but you can also do what you’re told, and work the machine, whatever you’re doing, do whatever is already there for you… do what’s expected of you of that job.

“But if you are an artist and you have to create something from nothing — there is nothing on this canvas, nothing on this tape, we have to create something that didn’t exist before — that’s ultra-responsibility, super-responsibility isn’t it.”

- Jack White (via Conan O’ Brien)

JS Comment:

Traders and investors bear a “creative responsibility” in respect to creating something from nothing… starting with a blank canvas (portfolio) and producing profitable and worthwhile results over time.

This notion reflects the craftsmanship embedded in the investment process… trade selection… methodology and process design…

As an active market participant, do you see yourself as an artist too? How do you embrace the creative responsibility that comes with such?

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