BUSINESS, MARKETING, and MONEY

After being in the field since 1994 and working with many investors and traders it has become very clear to me what is the HOLY GRAIL in the Commodity Markets & Forex Markets. The whole basis of trading with CNBC, Bloomberg and others is based on trying to have an edge of information or finding some magic system or trading signals. A well folk, the Holy Grail does not exist that way (in this context). No one knows more than you. Even with all their analysis there is no magic system, no magic guru. The only way is to achieve long term success is to diversify your allocations, managers and methodologies. Since I want to compound my way to long term wealth, what I do is allocate between 2-3% per idea/manager, no more than 5% ever. Even though I am co manager of a commodity pool and I think we are pretty clever after seeing every mistake possible (plus some of the ones we made), I still only allocate up to 5% of my net worth in any of our trading programs. In conjunction to achieve my goals, I allocate to other commodity trading advisers who think the way I think (mostly about risk). I realize anything can happen and 6th sigma events are out there. My goal is to compound my way to wealth. I have seen personally the power of compounding and the difference it has made in my own net worth.

In my opinion what differentiates a successful trader and one that wants to be is how the trader utilizes risk…understands risk…and implements risk. Many in the field remember Julian Robertson’s bet with the Yen carry trade or Long term capital. These guys were PhDs and had tons of money under management who had no concept of risk. They blew up! There is also the story of Amaranth the energy trading company that blew up…or in years past Metalgeschaff. Now compare the last mentioned to commodity trading advisers that have been around for decades like Jerry Parker from Chesapeake… or David Druz…as well as a handful of others, all they think about is risk.

With the experience I have earned over the years, this is the Holy Grail. If you truly want to be successful in this business you need a methodology & plan, with every contingency planned out. Why you enter… why you exit with a loss…or why you exit with a profit…as well as how many shares or contracts you put on. There are countless books on the issue… however too many are focused on this great indicator or complicated system. I can tell you first hand from being a trader for almost 15 years, only simple ideas can work over the long run. The problem is most people try to avoid risk. In their quest to avoid risk they take on more risk. The prime example is all the Madoff investors. There is no way to avoid risk…everything has risk. In order to be successful embrace the risk. Realize that any trade is 50/50. It is perfectly fine that a trade does not work. It is like breathing in and out. Realize there are only four possible outcomes… big losses. In which you need to prevent with immediate stops that don’t change… small losses… small profits… and rare… big profits…when something trends and you catch it. This starts to put things in context. One starts to realize this becomes a numbers game. Profits are made over long periods. One must take every trade as we never know which trades will ever work. This is the psychology of trading…but much more important than what any commentator has to say on CNBC.

There is much more. Since we know all the above… (That we don’t know the future…any trade is 50/50…etc) how to stay in the game? Here is our Holy Grail…and yes… it is really the Holy Grail. As a trader or investor… you have to decide how much of a draw down you can with stand. Meaning the greater the potential returns…the greater the potential drawdowns. No pain …no gain… but to what extent. As we want our investors to stay with us…as well as we know anything can happen. We prefer the compound your way to wealth model. Our goal over the long run is 15-20% returns with approx that much in anticipated draw downs. This is the key now… WE BREAK UP OUR RISK MODEL INTO SEVERAL ASPECTS IN ORDER TO ATTEMPT TO ACHIEVE OUR GOALS… First we decide risk per trade… meaning how much of our account are we going to risk on any trade. In our case we strive to risk less than one percent. Believe me that is enough. Some traders think that is way too small…but they realize after their first draw down. Secondly we look at correlations as too many a time. We had a concentrated position in the bonds or currencies…and wake up to see they are moving jointly in the opposite direction. So our maximum allocation per sector is no greater than 5%. The next most important issue is maximum open trade equity. Again, same lovely story… profits are flowing nicely and then we wake up in the morning to see they are going in the opposite direction. So we cap our only trade equity depending on volatility to a low of 20%. As you glean we are accepting the risk…and looking to manage the risk.
We have a working methodology based on the above but as I stated earlier it is not the Holy Grail. What happens in reality, for instance this year…? Nothing happens in the commodity markets… It is quit. This is what separates those who achieve success and those you can’t. There are times in the markets, nothing happens. It is these times in which a trader needs to be patient and disciplined. Truthfully nothing has to happen and when you expect the least the greatest profits come like last year. This is a marathon or I like to compare it to a football game. Too many investors want nice consistent monthly returns. They jumped on asset backed lending ideas… Madoff ideas only to lose a large chunk of their money. In the commodity arena the best analogy is I want to win the football game. Does it really matter if I score in every quarter…or if I score several touch downs in the last quarter when many in the stands have walked out in disgust.