Jack Schwager of Market Wizards Talks About Systems Trading

Volume Two, No. Four
Jul/Aug 1995

The Wizards Cast A Spell

By Tom Girard

Not everyone can make Jack Schwager's Market Wizards honor roll, but several bona fide wizards gathered together to share a few tricks about the magic of trading.

So many tough market decisions. So few wizards. Three dozen in all - wizards that is. At least that's how many were knighted by Jack Schwager in his pair of "Market Wizards" books.

Schwager's incisive interviews have become must-reads for many investment pros and amateurs alike - each eager to learn if these few had deciphered a portion of the Grail.

Even technical analysts, the generally austere diagnosticians who rely on bar charts, oscillators and other graphic indicators, find it alluring to gauge the wizards' wisdom.

The prospect of getting a few of Schwager's chosen together sparked the imagination of the Market Technicians Association which counts 1,000 member. So, the nation's premier technical group heralded "Market Wizards" as the theme of is 20th annual seminar in Las Vegas this Spring.

Although they gathered in the casino capital, the technicians eschewed the local action - nestling off the Strip at the Alexis Park Resort, where there's no gaming and the feel is more Sarasota or Scottsdale.

A casual but serious atmosphere prevailed at poolside breakfasts and sessions in the hotel's Zeus Room. Nearly 200 would-be wizards came to hear Jim Rogers, Vic Sperandeo, Linda Bradford Rashcke, Howard Seidler and Charles Faulkner, and five others.

Who better to keynote the even and share wizard anecdotes than Schwager himself, who's out to prove that he, too, qualifies as such a luminary. (See "Is this Man a Wizard Too?," p. 23)

The common element among those I interviewed was that they all love what they do." Schwager conveys comparable affection for his adventures on the trail of market wizardry. "If there was one surprise, it was the immense spread in the types of approaches people use. A method is critical. They all have very specific methods they describe very precisely."

Drawing upon material mostly familiar to his readers, Schwager recounts the "one momentary lapse of discipline" that cost wizard Randy McKay $7 million on a currency position. Another became a winner when he "learned it was okay to lose." One supertrader bluntly predicted that most market players do worse than random "by following their own opinions."

Ah, the value of opinions - the very heart of the matter on this occasion. "You cannot get ahead listening to other people's opinions, even if the people you're listening to are world-class traders…it's just an opinion," Schwager warns.

Okay, fair enough. But shouldn't a portfolio manager or pit scalper or upstairs trader adopt some of the wizards' ways? Says Schwager, "You've got to find your own way. There's not a specific answer. You've got to trade your own personality."

Enter five distinctive personalities, whose opinions address the worldwide context, technical configurations and psychological challenges of trading.

The Globe Trotter
His personality is a whole lot bigger than his bow tie. His public demeanor also features an unmistakable Alabama-country-boy-goes-to-Wall-Street-and-then-all-over-the-world-on-a-motorcycle charm. Using maps and photos from his investment biker travels, Jim Rogers presents global views in a manner one CNBC colleague has dubbed "geo-nomics."

Central Europe: "It's going to be an economic, political, military and social disaster area. What you see in Yugoslavia is the beginning to happen in Central Europe. Don't put your money in Central Europe."

The Former Soviet Union: "You're going to have that empire break up into 50 or 100 states. You'll see hyperinflation. It's like feudalism again. Everybody's trying to get what he can."

China: "The 21st Century is going to be the century of China. In the year 2020 China is going to have the largest economy in the world. Capitalism is running amok in China right now. They work very hard, they save and invest, and they educate their children. (But) you're about to see a period of political and economic turmoil."

Japan: I don't have any investments in Japan - long or short. They have serious problems. They're going to have to start running a deficit."

Australia and New Zealand: "They are gigantic natural resource-based economies. They know their future is in Asia, which desperately needs their resources. New Zealand has one of the four or five most soundly managed economies in the world."

With his usual self-denigrating humor, Rogers labels this verbal globe-trotting "the ramblings of a demented mind." He also calls himself "a simple trader," a phrase reminiscent of the late senator Sam Ervin jocularly claiming to be "just a country lawyer."

Now, back aboard the bike…

Africa: "The economies are much freer than just about any economies in the world right now. Africa also has vast natural resources."

Latin America: "The 500 million people South of the Rio Grande are mostly the same religion and speak the same language. Chile is the best managed economy in the Western Hemisphere. Teach your children and grandchildren Chinese and Spanish."

Other Emerging Markets: "There are going to be some more shocks."

Back Home: "I'm net long U.S. stocks and bonds but I don't think I'm going to be much longer. The bubble is coming to an end. In my view it's going to end sometime (by) August. All the signs of excess are there. There's a mutual fund mania in the land the like of which I've never seen.

"It's the official policy of most U.S. Democrats and Republicans to devalue the currency. They think that will help us be more competitive, and win their next election. Sell your dollars. It's going to get a whole lot worse as far as the currency is concerned.

"Natural resources are making a base and setting out for the next bull market and paper assets are making a top. I'm not bullish on gold. It's not going to be the great inflation hedge of the future. This inflation is real and it's coming back big."

New Market Realities
Wizard Vic Sperandeo's style couldn't be more different than Rogers', but his message is similar.

New York bred and Street wise, Trader Vic is crisply tailored in double breast and French cuff, and presides at the rostrum like a captain on the bridge.

These days Sperandeo is in transition - from stocks to futures, and from New Jersey to a home base of Dallas. He's adjusting to the world around him and chooses a chameleon metaphor to begin his presentation. If Schwager were to do his book again, Sperandeo muses, "I'd say make me a lizard" rather than a wizard.

Like Rogers, Sperandeo believes the stock market is about to burst. The collapse lies just ahead, he forecasts, because the nation's huge debt cycle is ending as the Federal government tries to reduce deficits.

"Corporate America has benefited from debt. Any time you created more money, those dollars wind up in corporate hands." The efforts to balance the U.S. budget will create "flat to declining earnings" and thus lower equity values.

Concentrating these days on trading 42 futures markets through his commodity trading advisor firm, Hugo Securities, Sperandeo urges his audience to hedge five to 10 percent of their via managed futures. "Inflation is going to come back. I'm setting myself up to participate in an inflationary environment. I expect to see the greatest move in commodities in the last 100 years." Besides employing futures for inflation plays, Trader Vic promotes them as an antidote to the marginal tax rate of 39.6 percent on stocks versus 32.6 percent on futures contracts.

As for his own trading techniques, Sperandeo tells the MTA: "Think risk control 100 percent of the time. I usually take a lot of small losses but not usually big hits in one trade. Technical analysis is less important to me than sentiment and cash flows."

Sperandeo downplays indicators since he believes they do not generally help determine "When you add to and when you get out of" positions.

Getting Technical
This wizard packed her charts for the trip from New Jersey, but Linda Bradford Raschke, "a devoted student of technical analysis," also touts a trading system that originated back in the pad and pencil days.

Now managing $30 million as a CTA, this former floor trader of equities and equity options presents her models for gauging price behavior.

"I would say still 90 percent of my trading and my systems tend to be based on some type of momentum principle. The reason is that momentum to me is one of the very leading indicators," says Raschke, to gauge the rate at which price movement is changing. "Momentum is the best tool I've found that serves me."

Interpreting the "Squiggly lines" on her big-screen computerized charts, Raschke shows how momentum comprises the essence of the "Critical Day Index" and "Impulse Meter" she's developed with Oregon-based research guru Steve Moore. Their LBRMoore Trading Co. cranks out a daily fax service based on these approaches, which measure volatility through contractions in momentum indicators. The idea is to define setups that presage market breakouts.

"Volatility is so much more cyclical than price," Raschke believes. "You can use volatility to get an edge on price direction. So many times trends begin out of equilibrium levels. They don't begin out of overbought or oversold types of markets. They begin from a very neutral point. And that's why trends tend to sneak upon people. A lot of the work we've done shows that 80 percent of a trend occurs in 20 percent of the days."

The home-based trader also reviews some of her other attempts to convert the past into prologue, specifically via artificial intelligence. "Neural nets absolutely are a valid tool as pattern classifiers. But they are not necessarily great for predicting a directional outcome or to use as a primary trading tool. It's also difficult to incorporate money management algorithms into them."

Notwithstanding sophisticated forays into crunching historical data, she is most devoted to the Swing Trading technique that was detailed in a book by George Douglass Taylor. "I still consider it my Bible," Raschke says.

She describes the three-day swing rhythms from highs to lows: "You have your buy day, your sell day and your sell short day. Activity around the previous day's high or low tells you 10 times more about the market than any little technical indicator."

Ultimately, Raschke believes a trader's approach may be dictated by how many markets must be tracked. Dozens to thousands require mechanical thresholds while following a few allows time for the "art" of chart reading.

Be A Seeker of Truth
A rather philosophical seminar topic is chosen by Howard Seidler, the former Turtle turned CTA. Based in the Ft. Lauderdale area, he characterized himself as "one of the often maligned trend followers." Seidler managed $14 million but is down from several ties that amount following his solo startup in 1988. Perhaps trading setbacks since the lofty inclusion in Schwager's work have given this technical trader his reflective orientation.

On the nature of knowledge: "Make it a habit to think critically and clearly. Start with an open mind. Challenge the conventional wisdom; Challenge all assumptions."

On contrarian thinking: "Always question things. Realize there's a possibility that things are different than people assume. Be an independent thinker. Make your own decisions and rely on yourself."

On thought experiments: "Create practical tests. Think through the things you can analyze that allow you to be more systematic, that allow for tests to see how things worked in the past, and to make educated guesses about how to bet in the future."

On a scientific approach: "make an honest attempt to disprove ideas because a lot of knowledge can be gained in disproving ideas. It might be difficult to do but you might find a break there. You might create a wonderful system. It looks great. Then you go back and say, ‘now I'm going to make an honest effort to disprove it. I'm going to try to find a way to shoot holes in it.' And you might not. And that's great because now maybe you have something to work with. Yet you might find something you missed before and that's going to keep you out of a lot of trouble."

Did he say this? "Remember that this all made up. Whether it's a structured view in analyzing the fundamentals or your technical model, it's all made up. And I would argue it is far more important to do quality work than to pick one magical approach over another."

Where does this leave us? "What you want is something simple that actually captures some really good insights. And it may have started with a complex idea but if you're going to use it you better boil it down to something fairly simple so you can grasp it and you can operate with it."

And, finally: "Ultimately, persistence is really crucial. Make a game of it. Follow a process. Play for the big moves. Try to tap your own curiosity about the markets because that's what will drive you on."

The Inner World
Jack Schwager may interview the supertraders but Charles Faulkner climbs inside their heads. He's a trading coach, who uses a process called Neuro-Linguistic Programming.

Faulkner has traded for his own account, so he's been on the line. He will soon trade again through a mechanical system rooted in chaos theories.

Precise in his use of the language, Faulkner speaks with a mastery developed through hundreds of seminars on how traders can gain a "mental edge." And he certainly knows his subject, having worked with 200 traders directly since 1987.

"I model human excellence." Faulkner asks MTA-ers to join in an exercise to see whether their self-perceptions match those of the very best.

"What do you do?" he asks them to ask themselves. If they reply: "I'm a trader" or "I trade - that's who I am" they're in sync with the winners. "How do you trade?" He quotes wizard Ed Seykota as saying: "I've made phenomenal amounts of money for very simple decisions but I was willing to make them. Somebody had to." Others, Faulkner adds, "are looking for highly complex ways of interacting with the markets, when most of the time it's only the simple ones that are going to work."

"What's personally compelling?" Referring to Rogers and Sperandeo, he says they "want to fathom the world as it really is" and they "like knowing the way the world works."

Faulkner sees the wizards exercising "relentless effort" and he quotes top bond futures trader Tom Baldwin as saying: "Everyone wants the money but who's going to do the work?"

NLP's techniques involve moving out negative mental beliefs and replacing them with positive ones. "Think of an unpleasant trade," Faulkner advises. "As you do that, what happens if you take a breath and go ‘aaah,' push it out and the trade with it? Much better. People go through fifths of scotch trying to get that feeling. When you get agitated, go ‘whooh' and just step out of it that way and you'll find that it's less. Do it again and you'll be at zero real fast."

Faulkner's ultimate objective is to get traders to believe that, "I am competent to be confident. I know what's going on in these markets. If I don't know, I get out."

And he concludes this most psychological of presentations with this: "I think we're all an experiment that hasn't ended yet."

Copyright (c) 1995, Financial Trader



All International Welcome Messages: 1, 2, 3, 4, 5, 6, 7 & 8