Category: Trading strategy
Reviewed: Jun 2010
This book is written by Bruce Babcock, a popular writer within the commodities industry since back in the 70s. It teaches the four basic rules to successful trading, which are: (1) trade with the trend (2) cut losses short (3) let winners run and (4) and money management. I don't agree that you have to trade with the trend in order to be successful, but it's not necessarily bad advice for beginners. The book is done in interview style and talks to 20 or so commodities traders, many of whom were popular within the commodities industry back in the 80s and 90s (Jake Bernstein, Larry Williams, Glen Ring, Jack Schwager). Here are a few topics covered:
- how to find how to define the trend (higher highs, lower lows)
- it is best to trade on multiple timeframes and use longer-term timeframes as filters for shorter-term timeframes
- trend traders will have large drawdowns. Trend-trading systems should have an annual return of at least twice the maximum drawdown (i.e. 20% annual return with 10% maximum drawdown), and a 3-to-1 ratio is better.
- indicators (which ones to use, how to use them, and how to mix them together).
- the different types of stops.
The book's style is a little annoying because the questions are so close-ended that the answers are usually one word answers. Hence, the wisdom is really in the question instead of the answers. When the questions are open-ended, some of the answers are usually way too general. This book, which is pretty thin and basic, is moderately useful at best and doesn't have much unknown information. I would have given it a lower rating, but if these four rules are all that a reader learns then then they've learned a lot. There were a few interesting stories, including Jake Bernstein's forgotten gold trade, as well as many valuable quotes. Here are a few:
- Glen Ring: "If people want to find the foundation for putting all this [trading success] together, they'll see it every morning when they look in the mirror. It comes back to a person being able to follow his rules."
- Mark Douglas: "Most people like to think of themselves as risk takers, but what they really want is a guaranteed outcome with some momentary suspense to make them feel as if the outcome had been in doubt."
- Walter Bressert: "I view the markets as energy."
- "It's better to be out of the market and wishing you were in than in the market and wishing you were out."
- "Never ask someone else for an opinion. If you must ask, ask about their position."
- Michael Chisholm: "Breakeven stops don't serve any real function other than psychological comfort."
- Babcock: "Trading can be just as risky as you want to make it."
- "That is one of the real stumbling blocks to success [in trading]. The market does not always penalize you when you trade incorrectly. It does not always reward you when you trade correctly. That makes it considerably harder to learn what is correct in what is incorrect."
- Use tighter stops for windfall profits.
- A discussion about the different types of stops.
- Look at using a different exit method for profitable vs losing trades.
- Kelly Angle: "What your system does to you when the markets aren't moving is more important than how your system performs during strong price trends. If you as a trader want to assess your system's ability to hold down losses, you might try this experiment. Examine your historical results and take out the double-digit up months. Then add the remaining single-digit up months and the down months. If the total is at least zero, or ideally, above zero, your system is giving you a risk-free environment in between major price moves."
- A broad diversification strategy actually increases risk because the more markets you trade, the more marginal trades you have to settle for.
- Jake Bernstein: "There are too many traders trying to look at the markets from too stringent an analytical viewpoint. Most of what happens in the market is meaningless. Why try to interpret every little movement, every little reversal, every little tick? In trying to do too much, they're actually paying too much attention to the market. They're laboring under the Judeo-Christian work ethic that says, "if you're a good boy and you work hard and pay a lot of attention, going to make a lot of money." I don't think that's true when you apply it to trading. There is a point of diminishing returns. You have to keep a certain distance from the market."
- Glen Ring: "Planning is so important. The vast majority of people have no idea how they're going to let profits run. When they do get into a big trade, they're just like a dog chasing a car. When they catch it, they don't know what to do with it."
- Peter Brandt: "As the market approaches my profit target, I have a smaller and smaller additional potential profit, but a larger and larger loss if the market retraces to my stop point. This has been a source of consternation over the years."
- "The unfortunate truth is that the odds are overwhelming that the trading style that matches your personality will be a loser. How else could you explain that upwards of 95% of people fail at commodity trading? The way to succeed is not to find a trading style that matches your personality, but rather to find a trading style that works. The two are almost always mutually exclusive. The methods that work are not those that make sense, feel comfortable, and are easy to implement. If they were, a lot more people would be successful."