The Way Of The Dollar Part 4

If you had to choose just one piece of market lore that has survived the ages it might be the adage acut your losses and let your profits runa. Like all such adages, it is not a panacea for beginners. It only works once you understand it deep down, from experience. And experience canat be taught.

This adage comprises two concepts. One is that we must have a system for distinguis.h.i.+ng good trades from bad ones. It may be rough and ready, but concluding that trades that show you a loss are bad trades and those that show you a profit are good ones has the benefit of simplicity and common sense. The other concept is that we must get full value out of our good trades. We cannot afford to fritter them away.

There is an overwhelming weight of evidence in the handed-down wisdom of the markets that the big money successful operators have ended up taking out of the markets over time has almost all been made in trades that were held over the long haul. The long haul means different things to different people. But no matter what our time frames may be, the long haul is those trades we held through the corrections.

You only know this is true when you have done it a few times. Itas a matter of understanding what is driving the price; understanding that a move is in its early stages and why; and understanding that the time frame of those who are responsible for the correction is shorter than the duration of the move, and that your time frame is longer than theirs. You know you mustnat lose your position.

Losing your position is the occupational hazard of active traders. Listen to old Mr Partridge, a hero of the legendary trader Jesse Livermore*, in the story told in Reminiscences of a Stock Operator. Old Partridge was being hectored by a young tyro to sell a stock they both held on the grounds it was due for a reaction. The old hand said he was much obliged, but he couldnat possibly do that. Why on earth not? Because this was abull marketa aif I sold the stock now, Ia d lose my position a , he added, in some distress a"explaining that he had gained this insight through many years of experience. aI paid a high price for it and I donat feel like throwing away a second tuition feea Itas a bull market you know.a And with that he strutted off, no doubt leaving the youngster none the wiser.

Old Partridge knew that if he was fortunate enough to be holding a good stock in a bull market, he was in a good trade. He might or might not be lucky enough to call a reaction. But even if he were lucky, he would have to be lucky a second time to get back in at a good price. From bitter experience he knew that his odds were much better holding on to his position. That left him with only one decision a" which was to get out of the stock when it was no longer a bull market.

Catching Watersheds

The starting point for the big swing must, by definition, be the point at which the previous big swing ended. At that point, you invariably have a big consensus which has finally aligned itself in the direction of the previous swing; and almost equally invariably you will be part of this consensus. You really know you have a consensus out there if youare part of it.

Think back to late-1987/ early-1988, when the dollar was bottoming out after its huge decline from 1985 a" if you were following currency markets then. And think back to mid-1989 when the dollaras 18-month rally came to an end and its downtrend resumed again.

These were the critical moments in the currency markets of the past. They were moments with recognisable characteristics. There was something wrong with the trend. The consensus was too obvious and too stale. It was suspect. We saw a consensus that was no longer being confirmed by the price-trend. Currency Bulletin has often suggested it helps to look at what we call the conversion flow* . This is the flow of conversion among currency partic.i.p.ants from bullish to bearish sentiment and back again a"which runs over many months and maybe years, underlying the big price swings. Early 1988 and mid-1989 were watershed moments in the conversion process.

They called for another look at the evidence, to see whether somewhere a"away out of the sunlight where everyone was lookinga" a new rationale was in the making which might reverse the trend. The new rationales were in fact staring us in the face in the form of a favourable(to the dollar) s.h.i.+ft in interest rate structures in early 1988 and an unfavourable one in rnid-1989.

Catching such watersheds is what making big money in the currency markets is about. Catching them and clinging steadfastly, through the first doubt-sowing correction; and emerging from that trial with your confidence strengthened to hang on through subsequent corrections until you see the symptoms of the end of the big conversion swing and the beginning of the next big counter-swing.

To hold through a correction, you have to believe it is a correction in an ongoing trend. Thatas not so easy because an adverse price movement obviously casts doubt on the validity of the trend. This is where CBas sentiment gauges can help, by giving advance warning of a temporary change in price-trend. Forewarned is forearmed. If we are expecting a correction, our judgement as to whether the main swing, and its rationale, are intact is less likely to be jeopardised by intermediate price action.

If we diagnose a correction according to blueprint, we are faced with choices which depend on our individual, preferred time-frames. Can we live happily with a correction whose depth we cannot gauge in advance, secure in the belief that the main swing will resume? Do we prefer to cut back our exposures to core* positions or long-dated options? Or do we relish the challenge of trying to scalp profits out of corrections? To know the answers, we have to know ourselves. In particular, we have to know what risk we can handle emotionally.

CHAPTER EIGHT.

aI have two basic rules about winning in trading as well as in life. (1) If you donat bet, you canat win. (2) If you lose all your chips, you canat bet. a LARRY HITE.

As if it should come as a surprise, the currencies trade much like other markets. In stock markets and commodity markets, a wealth of wisdom has acc.u.mulated over the ages. We canat recognise wisdom except from our own experience. But this body of market lore is as valuable to the currency trader as to traders in any other market.

Of my 30 years trading financial markets, two thirds was spent trading the securities markets mainly. The last 10 years have been spent trading the currency markets. As far as the practice of trading goes a"as opposed to a.n.a.lysis or forecasting a"a striking difference between currencies and securities is the difference between trading cash instruments that you pay for and forward* or future* instruments that are settled at a later date. The lack of settlement procedures and certificates; the low transaction costs; the sheer ease of entering, exiting and re-entering positions; all these things seemed to call for a different more active approach. At least thatas the way it seemed to me, and to many people.

But perhaps thatas wrong. (For purposes of simplicity, the word afuturea a"or afuturesa a"may be used to cover both forward and futures transactions in currencies ). Why should the fact that you only have to put up a relatively tiny margin to trade instruments that have to be settled at a future date a"as opposed to cash a"make any difference to the way one trades? Well thereas a potential trap here. The use of leverage encourages excessive positions a"aovertradinga*: and the ease of trading encourages a more jumpy and emotional approach. Yet itas interesting that the accounts of great traders donat seem to distinguish between the two.

Well why should they? The main issue is risk, and itas entirely up to us how much risk we take on board in our trading. Letas recap on the checklist suggested in the last chapter. Know your reason. Thatas been dealt with in chapters one to six. We have to know the reason for taking a trade so as to close it once the reason is no longer valid. Chapter 7 dealt with the time- frame. It tried to show how important this was too. What about know yourself? Well, as we shall see in Chapter Eleven, this may be the crucial part of the checklist for many readers. But until then, letas take another look at risk.

The neatest thing ever said about risk was the dictum of Larry Hite, a founder of the giant Mint group, which is quoted at the start of this chapter. Most of us are conditioned into thinking of risk as a bad thing: something to be avoided. The word itself has pejorative connotations. This conditioning does us no favour in financial markets. It leads us to seek situations which offer no risk, and to run away from those where the risk is most evident to us. But there are no situations which offer no risk and at the same time offer the chance of reward. And the situations where risk seems most evident are often those where it is in fact lowest.

In financial markets, risk is the possibility of financial loss or even afinancial disablementa as the euphemism goes. The risk in being short is obviously at its lowest (did we but know it) when prices have risen to a peak. Yet that is when the risk of being short seems to be highest. Likewise the risk of holding is lowest when prices have fallen to a trough a" which is when our perception of the risk of holding is most acute.

So before we can even hope to deal with risk in actual trading we need to reverse our conditioning and start again. Of course we donat know when prices have reached a trough, or a peak. The solution cannot be to try and seconda" guess the real risk. It has to be to recognise that every position involves a risk; to recognise that our perception of risk is unreliable; and to acknowledge that the way to quantify the risk is to define it beforehand. It is as simple as that. The simplest way to define the risk is to determine a stop-limit (see page 75) and many traders like to do this with a market order. But as a first step , all of us, if we are to quantify our risk, have to determine it beforehand in actual money a"dollars, pounds, DM or whatever.

Making friends with RISK

I say itas simple a" but it does involve a new mind-set for most of us, and that may need practice. The new mind-set runs as follows. As a partic.i.p.ant in the currency markets, I am a risk-taker. I have to take risks in order to achieve reward, which is what I am trading for. So I welcome risk, as I welcome reward. The rea.s.suring thing about risk is that I can quantify it, and this I must do. Over time, I cannot make profits without also making losses. Taking losses is relatively easy because they have been quantified beforehand. Taking profits is the hard part. Somehow I have to allow the moment for profit-taking to quantify itself. aHold ona, you may say. aRisk isnat that simple in real life. The position isnat black and white. You have the same risk on a winning positions as on a losing one. For example, if you have a 50% profit on a position, you risk losing it. Also, when you donat have a clearly defined trend, you risk losing 5% here and 5% there, until pretty soon youare talking about real money. You can take on a position with confidence, and then it goes against you and you are prey to doubt and at risk again from your emotions.a Absolutely right. As soon we take on the business of trading markets for profit, we are in the risk business up to our necks. Itas the opposite side of the reward-coin. You canat contemplate reward without coming to terms with risk.

Russian roulette is not a game one would recommend unreservedly, but it can ill.u.s.trate a point. In a haunting film called aThe Deerhuntera, the hero, played by Robert de Niro, goes back to Vietnam to track down and rescue a buddy who is in the business of playing Russian roulette for money or his life. It becomes clear that the buddyas mind has been derailed by his horrendous experiences in the killing fields, where as a Viet prisoner he has been obliged to play Russian roulette for the amus.e.m.e.nt of his captors. After the war, he is still playing a" for the delectation of leisure-business entrepreneurs.

Russian roulette is not quite as dangerous as it might seem. You make a bet, and you win, or lose, by placing a revolver loaded with a single bullet against your temples, and pulling the trigger a" having first spun the revolving chamber. The whole point about the game is that whatever you stand to win is, on the conventional view, oddly incommensurate with what you stand to lose. The reason it is not quite as dangerous as it might seem is that the weight of the bullet tends to swing the revolving chamber of the gun so that the bullet is down-most, and hence away from the detonating pin. But of course it doesnat always work that way. It didnat, in the end, in the case of Robert de Niroas buddy. It never does a" in the end. NO reward can compensate risking all.

In point of fact, trading speculative markets has a lot in common with Russian roulette. In particular, if you regularly stake all you have, you will be wiped out, as night follows day. The point about the Russian roulette a.n.a.logy is to remind us that whatever we stand to gain cannot be worth the risk of wipeout: the chance of having more money can never be worth the chance of having none. So, obviously we must never stake all we have.

The trouble with any sort of gambling is that you can also be wiped out if you consistently make bets with bad odds. In financial markets, this can happen only too easily, as we shall see. In Russian roulette, the odds on any random pull of the trigger are in your favour; itas just that the penalty for losing is drastic. In regular roulette, the odds are more evenly balanced, but are weighted against you. For practical purposes, there is no way of getting the odds neutral, let alone in your favour; so roulette is a mugas game as Iam sure all readers already know.

In financial markets, you have odds against you a" in the form of transaction costs*. Fortunately these are quite small in the currency markets a" a matter of 0.03 to 0.2 per cent, as opposed to nearly 3 per cent in roulette. But the odds are distorted in financial markets by the fact that the players can change the odds when they bet, and make it more difficult to win. This is the way financial markets work. They work in such a way as to make it more difficult for those who do not know what they are doing to win, and to make it easier to win for those who do know what they are doing.

If you have read the preceding chapters of this book and taken them on board, there is no doubt in my mind that you have a better understanding of the currency markets than 95% of currency traders. But you will not necessarily win. To win, you will need to have the winneras mentality. Letas listen to some winners.

Here I must repeat the particular debt we all owe to Jack Schwager for his masterpiece Market Wizards a" a series of interviews with a bunch of heroes among traders alive today, traders who have been able to deal in the era of floating currencies. I think this is the most useful book on the practice of trading to have appeared since the war, or maybe ever. First, here are some key conclusions from the reminiscences of many big winners.

1) If you are seriously committed to winning, you can make a zillion dollars/ multiply your money 100-fold a" over time.

2) When you cannot trade with confidence, do not ever trade, ever.

3) You will be able to win when you realise itas OK to lose, and take your losses promptly as a matter of course.

4) You will lose over time unless you fit every trade into a risk-management context which fixes each stake and defines the maximum loss.

How do these conclusions fit in with the rules set out in Chapter 7: know your reason, your timeframe, your risk, and yourself? Well thereas a lot of overlap. Youall have a problem with 2) and 3) unless you know your reason and your timeframe. Knowing your risk overlaps with 4). Knowing yourself relates to 1),2) and 3): itas so important that the last chapter of this book is entirely devoted to it.

You CAN win big

Winning a fortune is to do with winning more than you lose month after month, year after year. You will multiply your money by 100 times if you average a 30% per annum compound increase for 18 years a" in fact you will multiply it 112 times. Such is the miracle of compound interest, and this is the kind of target we can set ourselves. We shouldnat be dismayed if we fail to achieve it in the early years. It can be done. We can all do it IF we are committed to do it and IF we are free of the hang-ups which prevent us from doing it. As we shall see in Chapter 11, that can be a serious problem.

Some wizards have done it a" and they probably couldnat have done it unless they believed from the start that they could. We are looking with hindsight, and we are probably looking at traders who enjoyed conditions which were particularly favourable to their own peculiar approaches. Thatas no problem. Iam sure we enjoy such conditions now in the currency markets, as explained in earlier chapters. If you sincerely want to win, you will be interested in cutting through all the illusions and delusions that have dogged you and other traders.

aWinners know that they are responsible for their trades; losers think they are not.a Dr. Van K. Tharp.

aDonat be a hero. Donat have an ego.a Paul Tudor Jones*.

aI became a winning trader when I was able to say: aTo h.e.l.l with my ego, making money is more important.a Marty Schwartz.

aPicking tops and bottoms is an ego trip: the name of the game is to make money.a George Angell.

The winning trader will be astrong, independent and contrary in the extreme.a Bruce Kovner*.

In the course of interviewing several market wizard, Jack Schwager encountered some astounding performances. There was Michael Marcus who acc.u.mulated $80m from $30,000. There was Ed Seykota*, whose model account was up 3,000 fold in 16 years. At one point Jack Schwager was astonished to hear the following from Mark Weinstein* on his experience in 1980 to 1988. aI havenat had any losing weeks during that time, but I have had some losing days.a Normally one would have a serious problem with that kind of claim a"though Mark Weinstein is on the record as having entered an option trading compet.i.tion in which he turned a $100,000 account into $900,000 in 3 months without a losing trade. Anyway, Mark Weinstein talks so lucidly about what it takes to be a big winner in financial markets that itas well worth listening: it helps to know that early in his trading career he had lost $600,000 on a single trade a" which was two fifths of all the money he had made in his first four years of trading. Such traumatic occurrences are typical of practically all the most successful traders. You canat learn about risk except by personal experience. Hereas a paraphrase of Mark Weinsteinas 7 rules for successful trading.

1) Always do your homework.

2) Donat be arrogant. When you get arrogant, you forsake risk control.

3) Understand your limitations. (Trade within your capacity).

4) Be your own person. Think against the herd, as they must lose in time.

5) Donat trade until the opportunity presents itself. Knowing when to stay out is as important as knowing when to be in.

6) Be ready to change your strategy with the environment. (The environment, not your strategy, is the data).

7) Donat get complacent once youave made profits. The danger is you may question what you really want from trading and trigger a self-destruct process in which you wind up losing.

Does he have any final advice? aYou have to learn how to lose.a Note that when asked to explain how he had such a big percentage of winning trades, MW replied aBecause I have a real fear of marketsa which has forced me to hone my timing with great precisiona I also donat lose much on my trades, because I wait for the exact moment.a

Trust your trade, or donat trade

I think this is the most important rule of all, partly because itas so difficult to observe.

In the final a.n.a.lysis, confidence is the key characteristic of winners a"and itas probably the key characteristic of those situations where each of us made big individual wins, if you think back. All wizard traders seem to agree that all their money was made in the relatively few trades where they followed their own rules 100%. When all the pieces fitted. On all the rest of their trades taken together a"all those trades they couldnat resist playing even though they were not 100 per centers a" they more or less broke even. If wizard traders just break even on their second-line trades, you can see that the rest of us will lose again and again.

Confidence comes to us out of situations where we recognise winning combinations in the data that come to our attention. There is no reason why this data should not come from publications like Currency Bulletin. But what matters is that we should identify with the data, wherever it comes from. And the cases where we have come badly unstuck were usually occasions where we did not identify with the thinking. It didnat become our own thinking: we just borrowed it.

Imagine that an acquaintance comes up with a trading system that has produced extraordinary results in the past. You trade it. How do you feel if it comes to show you losses? You will give up pretty soon. Your tolerance level for bad experiences will be very low; whereas if you are following a tested approach in which you have confidence from your own experience, you will tolerate losses, and even persistent losing sequences, without despairing.

Confidence, in short, means knowing youare going to win. It isnat a magic quality which once possessed can never be lost. To be sure, regular winners will have an inner conviction that they must win over time, if they play to the rules. This is partly an inherent state of mind and partly the result of long experience of seeing the rules working. But no-one but a fool is convinced they can win just by playing. You win by doing your homework better, following the rules more closely, and acting more consistently than the other players. Winning gives you confidence and confidence helps you win.

That may sound like one of those trite virtuous circles: itas nice work if you can get ita and if you can get it itas nice work. But we come back to the rule: aif you canat trade with confidence, donat tradea. The closer you get to only trading when youare confident youall win, the higher your win rate and your confidence will be.

This is the positional advantage of investors and speculators, and they must not throw it away. In commodities, as Larry Hite* (in Market Wizards) points out, athe tradea (commercials*) have the advantage of product knowledge; and athe floor*a ( the dealers and locals on the floor of the exchange) has the advantage of speed: you can never be faster than the floor. The speculator doesnat have the product knowledge or the speed but ahe does have the advantage of not having to play. The speculator can choose to only bet when the odds are in his favour. That is an important positional advantage.a If you take only one thing away with from this chapter, let it be this rule.

Confidence means knowing youall win, if you obey the rules Listen to Mark Weinstein, again, explaining his astonis.h.i.+ng success rate. aMost people will not wait for the environment to tip itself off. They walk into the forest when it is still dark, while I wait until it gets light. Although the cheetah is the fastest animal in the world and can catch any animal on the plains, it will wait until it is absolutely sure it can catch its prey. It may hide in the bush for a week, waiting for just the right moment. It will wait for a baby antelope, and not just any baby antelope, but preferably one that is also sick or lame. Only then, when there is no chance it can lose its prey, does it attack. That to me is the epitome of professional trading.a We all know the kind of situation. We diagnose a proposition that fits all our criteria except price and say aif it gets to such and such a price, Iall buy. But how often do we wait till it gets there, and only trade if it does? Thereas a parallel with the greatest of all gambling games, poker. The founder of the Hunt fortune was a renowned poker player. Old father Hunt was able to claim he was the richest man in the world: by all accounts, he got there by backing what he saw as the best bets to the hilt. Gary Bielfeldt, a giant player in the US bond markets who started trading with just $1,000, attributes much of his success to applying the poker mentality he learned from his father to the T-bond futures market. aYou donat just play every handa you play the good hands and drop out of the poor hands, forfeiting the ante. When you feel the percentages are skewed in your favour a" you raise and play that hand to the hilt.a And listen to James Rogers: Jack Schwager*: aVery few investors have been as successful as you have been over time. Whatas the difference?a James Rogers*: aI donat play. I just donat playa It happens all the time. I donat do anything until all the pieces fita (my italics).

To summarise, trading with confidence is to do with having a method which you have proved yourself, and which you know will win over time if you follow it consistently. That means being able to recognise the conditions which allow you to trade, and only trading when they are all present. This is comparatively easy with hindsight: when weare actually there, we can see when all the pieces fit. But beforehand, we donat know that all the pieces are going to fit: so we trade because weare impatient and fear that this maybe the best weall get. Well, somehow we just have to get to be patient. Letas face it, it calls for great discipline* .

Itas OK to lose

Peter Steidlmayer*, the well-known trader and market a.n.a.lyst, has made a nice a.n.a.logy between futures trading and golf. Golf players a"and spectators a"are familiar with the phenomenon of the golfer who is unbeatable from tee to green, but falls to pieces when it comes to putting. What happens is that on the green, the subject is a.s.sailed by fear of failure. Steidlmayer contrasts the great Jack Nicklaus whom he holds up as a model for traders. First, Nicklaus was selective about the number of tournaments he played in. Second, ahe prepares himself for each one so that heas not mentally worn out. Next ahe doesnat shoot 64, then 78. Heas consistent. He shoots 70, 69, 71a heas playing within his capabilities. He doesnat try to kill each shot because he knows consistency is what counts.a Finally, aunlike most traders, he doesnat try to predict where his shot is going to land. He doesnat care where it lands, because wherever it goes, heas going to handle it. He doesnat worry about ita Heas got confidence that he can handle the situation, no matter what happensa. The same thing could be said for some of the greatest tennis players a"or poker players, come to that. aItas the same thing in tradinga, continues Steidlmayer, having made it clear that in golf heas a tyro and a hopeless worrier. aWhen Iam trading well I donat care if I have a monetary loss on because Iam going to handle ita. (The Big Hitters*).

Itas OK to lose. Itas the other side of the coin of winninga" you winsome and you lose some. You just have to ensure that your losses are to scale.

Ed Seykota* has to be one of the most successful traders ever (one of his accounts rose from $5,000 to $15m in 16 years, after significant withdrawals). He is also a sage and guru, positively venerated by his friends and co-tradersa" aa geniusa, Michael Marcus has called him. When asked by Jack Schwager what were the elements of good trading he replied aThe elements of good trading are: (1) cutting losses, (2) cutting losses and (3) cutting losses. If you can follow those three rules, you may have a chance.a He was saying aListen. The old lore about cutting losses and letting profits run really does go to the heart of the matter .a Jesse Livermore* had already thrown some light on the subject. aThe successful trader ahas to reverse his natural impulsesa He must fear that his loss may develop into a bigger loss, and hope that his profit may become a big profita (Reminiscences of a Stock Operator).

It needs a change of mind-set to be comfortable taking losses The anatural impulsea is deeply engrained in us by our culture. Losing is bad, winning is good. Losing money is bad, making money is good. So what happens when we show a paper loss on a trade? We are conditioned into hating to realise that loss, so we rationalise with all sorts of reasons for not doing so: and the awful result is that we hold onto an increasing loss until we are forced out when it becomes unbearable. And what happens when we see a paper profit is that we are conditioned into wanting to realise the profit. This is the way we are: it needs a change of mind-set to be different, which is why there are so few successful traders. How can the right thing to do have anya" thing to do with whether our position shows a profit or a loss? Price knows nothing about our position.

Actually, thatas a good question. We can answer it with another. Isnat it in fact more likely that if a position shows a profit, itas a agooda position, which should therefore be held; and if it shows a loss, itas a abad a position which should therefore be abandoned? Either way, itas OK to take a loss. Every great trader agrees.

aLosing money is the least of my troubles. A loss never bothers me after I take it. I forget it overnight. But being wrong a" not taking the loss a"that is what does the damage to the pocketbook and to the soul.a a" Jesse Livermore. aHe [Michael Marcus] also taught me one other thing that is absolutely critical: You have to be willing to make mistakes regularly; there is nothing wrong with it.a a" Bruce Kovner*.

aIf you have a loss on a trade after a week or two, you are clearly wrong.a a" Richard Dennis*.

aI really donat care about the mistake I made three seconds ago in the marketa If you have a losing position that is making you uncomfortable, the solution is very simple: get out, because you can always get back in. There is nothing better than a fresh start.a a" Paul Tudor Jones*.

aYou have to learn how to lose; it is more important than learning how to win.a a" Mark Weinstein*.

One could go on, and on.

Get the Measure of RISK

I donat know how many of us have had a truly traumatic experience in trading financial markets. Jessie Livermore had not one but many, that would have turned most peopleas hair white. Perhaps it was inevitable therefore that he never really learned about risk. Few of us do.

Ed Seykota, who admits Livermoreas beneficial influence on him, delivered this terrible judgement on the great plungeras experience a"though not as terrible as the terminal judgement delivered by the revolver: aI feel it was a function of his psychologya To emulate his experiencea you would probably need to over trade and have wipeouts, while you simultaneously fired up your emotions with the burning desire to awin it right backa. Acting out this drama could be exciting. However it also seems terribly expensive. One alternative is to keep bets small and then to keep reducing bets during equity drawdowns. That way you approach your safe money asymptotically and have a gentle financial letdown.a All great traders seem to have suffered at least one really traumatic experience in the early days: one was usually enough. Market risk is something, it seems, which simply cannot be understood except through vivid first-hand experience. Perhaps nothing important can.

There are two ways of looking at risk. Thereas the objective way, which you can put into numbers. For instance if you take on an exposure of 50% of your funds in a position which can move 10% against you a"your risk in that position is 5%: if your exposure is 300%, your risk is 30%. Well, 5% is one thing and 30% is another. Interestingly, 5% is about the most that any very successful trader seems to be prepared to commit to a single position. The maximum figure for a cautious and very diversified fund such as Mint is 1 %. Says Michael Marcus: a Always bet less than 5% of your money on anyone idea; that way you can be wrong 20 times; it will take you a long time to lose your money.a (Market Wizards).

The other way of looking at risk is the subjective way: itas the risk you feel, as opposed to the risk you run. There is a risk that each one of us can handle and there is a risk we cannot handle. Understanding risk on this level is knowing where the dividing line comes between what we can handle and what we cannot handle. And all the great traders seem to agree that their own learning process has been all one way. The longer they trade, the more they have found that their results improve with reducing their bets.

Give us a couple of winning trades and we soon convince ourselves that we are heroes and can handle bigger bets. But not so. As soon as we increase the size of our bets, we lose our nerve. We grab small profits, and get rattled by random adverse fluctuations. We forget the reason why we made the trade, and rationalise new ones. We buy high and sell low .In short, we fall to pieces like the golfer with putting nerves. aWhen you up your volume, you will losea says Peter Steidlmayer bluntly.

The stories of the hyper-successful traders are all the same in one respect. They spent their first few years finding out what risk they could handle a"and the rest of their careers trading broadly within their capacities. Some traders never find their capacities. Markets that offer gearing (leverage) like the currency markets and futures markets bring out the agamblera in people. This is the character inside us that is forever areaching for the card that is so high and wild heall never need to draw anothera , as the Leonard Cohen song puts it: or indeed areaching for the sky just to surrendera a"for surrender is what all gamblers have to do in the end, in financial markets. Successful traders (and successful poker players) are not gamblers: theyare probability players. If this sounds trite, I probably havenat expressed it is well as some traders have.

Bruce Kovner: aFirst, I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade* is my second piece of advice. Whatever you think your position ought to be, cut it at least in half. My experience with novice traders is that they trade 3 to 5 times too big. They are taking 5 to 10 percent risks on a trade when they should be taking 1 to 2 per cent risks.

Paul Tudor Jones: aThe most important rule of trading is to play great defence.a Larry Hite: aSo the very first rule we live by at Mint is: Never risk more than 1 percent of total equity on any trade Risk is a no-fooling around game If you do not manage risk, eventually they will carry you out.a What has been covered in these last two chapters are some of the practical rules of the trading game, as described by some great players. aDiscipline*a is often said to be the key to successful trading. So it is a" but what does it mean? It means, simply, abiding by the rules, as outlined above, no matter what.