I previously wrote a post about Market Wizards: Interviews With Top Traders. This post is the third in a series of curated interview questions and responses from the notes that I took while reading the book.
Who is Richard Dennis?
Richard Dennis is another trader with an excellent reputation but surprisingly little is known about his personal life and background. It seems that he prefers to keep a low profile, similar to Bruce Kovner who I wrote about here. Nevertheless, Jack D. Schwager felt that he was an “essential name” to include when drawing up a list of interview candidates for his book and other traders interviewed in his book remarked “I’m not in his league,” when they learned about Richard Dennis’ involvement.
Richard Dennis is best known for conducting an experiment with fellow trader William Eckhardt to answer the question of whether trading could be taught. Richard Dennis believed that trading was a skill that could be defined by a set of rules while William Eckhardt believed otherwise, claiming that elite traders possessed an innate gift or instinct for trading. To settle this debate, Richard Dennis recruited 23 traders from a pool of over 1,000 applications. Richard Dennis taught them a basic trend following trading strategy along with probability and money management and allowed them to manage $100,000 of his own money. Richard Dennis’s experiment proved that his hypothesis was true — he claims that his recruits averaged 100 percent profit per year.
On the right psychological mindset:
For a lot of traders, it doesn’t matter so much whether their first big trade is successful or not, but whether their first big profit is on the long or short side. Those people tend to be perennial bulls or bears, and that is very bad. Both sides have to be equally OK. There can’t be anything psychologically more satisfying about one than the other. If there is, your trading is going to go askew.
On taking losses:
Since then, I have learned that when you have a destabilizing loss, get out, go home, take a nap, do something, but put a little time between that and your next decision. When you are getting beat to death, get your head out of the mixer. Looking back, I realized that if I had had a trading rule about losses, I wouldn’t have had that traumatic experience.
You mentioned that before you developed a mechanical trading system, you paid close attention to the trading process. Did you keep a log of what you did right and wrong, or was it a matter of memory?
Yes, I would write down observations and think about them. I thought about everything I was doing.
Is that something you would advise other traders to do to improve – that is, keep track of what they are doing right and what they are doing wrong?
Sure. The trading experience is so intense that there is a natural tendency to want to avoid thinking about it once the day is over. I am that way when things are working. But, when they are not, it spurs me to want to think about what I’m doing and how I might do better. When things go bad, traders shouldn’t stick their heads in the sand and just hope it gets better.
What you are saying is that the times when it is most tempting to avoid thinking about the markets at all are the times when you should be thinking about them the most.
Right. I don’t have any problem with that because I am obsessive about the markets.
What about entering a new trade counter to a prevailing trend?
I’ve certainly done it – that is, made countertrend initiations. However, as a rule of thumb, I don’t think you should do it.
Do those type of trades do more poorly than other trades?
Generally, yes, although every now and then they may give you a great story like going short sugar at 60 cents, which I did. I’ve got ten stories like that. But I have to tell you, in all honesty, I don’t think the broad class of trades I have done like that have been profitable.
On keeping an open mind and expecting the unexpected:
There is another point that I think is as important: You should expect the unexpected in this business; expect the extreme. Don’t think in terms of boundaries that limit what the market might do. If there is any lesson I have learned in the nearly twenty years that I’ve been in this business, it is that the unexpected and the impossible happen every now and then.
Why do you handle other people’s money? You are doing very well on your own.
Well, there is one big advantage: managed money offers potential return with no risk. For ten years, people have been asking me if I’m getting tired of all the risk. Do I think I’m going to burn out? Do I think I’m going to stop? For the longest time I didn’t understand what they were talking about. But I have to admit, at this point, I understand the value of cutting down your own risk. I could have traded smaller and had a smaller profit and smaller risk. But if customer money comes in, I could use that to supplement the profitability and still keep my risk lower. It just gives you a better deal.
When you talk about the experience of managing well over $100 million and losing roughly 50 percent, not to mention your personal large losses, you discuss it with great emotional detachment. Do you really take it that calmly? Isn’t there an emotional side to it?
I try for there not to be. It is totally counterproductive to get wrapped up in the results. Trading decisions should be made as unemotionally as possible.
Yes, but how do you do that?
You have to maintain your perspective. There is more to life than trading. Also, to me, being emotionally deflated would mean lacking confidence in what I am doing. I avoid that because I have always felt that it is misleading to focus on short-term results.
Is there any advice you can give to other traders on how to stay emotionally calm during periods of trading losses?
It is a little bit like playing golf: You can throw your clubs around after making a bad shot, but while you are making the next shot you should keep your head down and your eye on the ball.
On missing a profitable opportunity:
The worst thing you can do is miss a profit opportunity (assuming you are already disciplined enough to cut your losses short). And if you think about it, rigid long-term views are the kind of thing most likely to lead you to that mistake. For example, if I believe the dollar is going to weaken, and because of this I ignore a sell signal in the foreign currencies, I might risk missing a large profit. What is my reward if my view was right? Avoiding a small loss. Therefore, the risk/reward is all wrong for my type of trading.
What is the most important advice you could give the novice trader?
Trade small because that’s when you are as bad as you are ever going to be. Learn from your mistakes. Don’t be misled by the day-to-day fluctuations in your equity. Focus on whether what you are doing is right, not on the random nature of any single trade’s outcome.
Interview questions and responses are from Market Wizards: Interviews With Top Traders by Jack D. Schwager. If you enjoyed this post, follow Curated Alpha via Email, RSS, or Twitter . You can also purchase Market Wizards at Amazon.