In my senior year of college, I hit the jackpot.

No, I didn’t win the lottery.

I did even better– I got the job I wanted in the markets.

Let me repeat: *the* job.

Note: the lesson is that if I can do it, then anyone can!

Ever since I was 14, I knew that I wanted to be a trader. One day, I was in my dad’s office and pulled a book off his bookshelf about famous investors—and discovered a world that I barely knew existed. The stories of making great fortunes through one’s intellect drew me in and I was hooked. Ever since then, I knew that I wanted to be a trader.

In college, I naturally looked for trading jobs. The single most coveted one amongst my classmates was one at Citibank. Forget investment banking at Goldman Sachs, working 100 hours per week—this was the best opportunity. Each year, Citi hired one person in the world directly on to the Foreign Exchange and Fixed Income prop trading desk. That was a very simple deal—you could trade whatever instrument you wanted, however you wanted, using Citibank’s own capital, while sitting next to the best traders in the bank. It was an peerless opportunity to learn. And if you were good, the job was a potential gold mine.

For me, the attraction was clear. I ditched school for a semester to prep for the interviews. I read ten years of back issues of Euromoney magazine. I learned the names and biographies of everyone I could find from Citibank’s FX desk. I traded the FX and fixed income markets in my account to familiarize myself.  My big winners included the South African rand and government bonds in Iceland. After three months of non-stop work, I was ready.

After two grueling rounds of interviews in New York and one in London, I got the long-awaited phone call. “You’re hired. Our best trader just moved from New York to London, would you like to go sit next to him?”.

Jackpot.

I said “Yes” in about a nanosecond. A few months later, I was sitting next to this trader. We’ll nickname this trader Peerless- because he was. As soon as I began work, I heard all of the legends about him. Highest grosser on his desk — at the age of 21. Biggest moneymaker in the entire department. Best trader at Citibank. “All-around genius”.

Peerless was more than a great trader. He was an oracle, a veritable fount of trading wisdom. I am eternally grateful for the many crumbs from his wisdom table. I’ll try to distill some of his most important tenets.

#1: It’s OK not to have a position

You are a trader, so you’re supposed to have a position, right?

Short answer: no. Not necessarily.

This is one of the most difficult things to learn. Oftentimes, traders are biased toward action and want to be doing something—anything. Psychologically, it feels strange to have no position. It can feel like we aren’t working or that we don’t have a view on the markets.

Peerless was incredible at not having a position.  If he didn’t have a strong view on any market, then he just sat there. When there was nothing to do, he did nothing. He would say “It’s better to have no position than a dumb one”. By allowing himself to skip dumb or marginal trades that were driven by boredom, he avoided trades that were likely to lose him money  Thus, he could wait comfortably until the really profitable trades appeared and swing for the fences.

While such an approach seemingly demands the patience of a saint, it is actually easier to sustain long-term. Once you have a methodology and are comfortable with it, then you should hopefully be convinced of its merits—and want to stick to it! You keep doing your homework and following the markets, thinking of potential positions. But if a trade doesn’t meet your criteria, then you should not put it on. Thus, the ability not to have a position is a reflection of you doing something else right—having a methodology and a rigorous, disciplined adherence to it.

Ultimately, this comes back to the nature of trading. To be successful, you need to make a series of good risk/reward decisions. If there aren’t any good risk/reward decisions out there, then you don’t have a position. Rejecting bad risk/reward situations is actually a very good decision. If that’s the right decision to make, then have confidence in it.

#2. After a correction, you’ll look back and think, “What was the big deal?”

When you have a position on, watching the price movements can become quite emotional. The process of making money on a position can be exhilarating, especially if you have caught a multi-month move. Losing money can be agony, even if it’s only in the midst of a correction to that trend.  

This is one of the key lessons that Peerless taught me. When you open a position, you have in certain reasons for getting in to the trade. If the position is making money and the reasons are still valid, then sit on it and let it make you money. In the midst of that, there can be some seemingly painful short-term periods. Keep your eye on the big picture.

Too often, we have a winning position on and if it begins to correct, we can feel like it’s the end of the world. Watching it go against us, just for a day, can leave us panicked. We feel like our profits are melllllting away. We get anxious and close it out just to stop the pain. OK, we stopped the pain. But was that a good trade? Did closing that position make sense? Under the panicked circumstances—doubtful.

And then later on we look at the charts. We see a nice trend, then a reaction against the trend for two or three days—small, barely noticeable. And then the trend resumes and goes much further. Only at that point do we realize that we closed out the position during the small correction—and missed the whole broader move.

Peerless was great at catching the whole move. He would calmly sit through corrections, even multi-week corrections, if he was confident that everything still made sense. He could always recount the reasons that he had gotten into a trade and was still in it. Tellingly, those reasons would never vary. When we reviewed historical charts and the huge trends that he had caught, he would highlight the small corrections against him, asking the question, “See, what was the big deal?”.

The way Peerless did this was unique. Every day, he would ask himself why he was in a position. He would go through his investment thesis and check to see that every part of it still made sense. He would then ask pertinent questions like, “What could go wrong?” and “What does this event mean for the market?”, to anticipate whether or not his investment thesis would change. If it still made sense and nothing had changed, then he would hold on to the position, even if there was short-term volatility.

Ultimately, as traders, we earn our profits by making good risk/reward decisions. A process like this one, where we are focusing only on why we get in and out of positions and can think through various scenarios, helps us to make better decisions. It also blunts the emotional impact of any adverse short-term price action, leaving us better prepared to tackle the markets.

When looking back on a winning trend, we can rest assured that not every single tick went our way all the time. While losing money for a couple of days may have felt excruciating at that very time, it was not actually that much pain. Missing out on the big trend that we had nailed early on? That’s far more painful.

#3 “Have the courage to be a pig”

He didn’t mean rolling around in the mud. Rather, he meant the willingness to carry a very, very large position when you have a high degree of conviction and the risk/reward makes sense.

This is actually the flip side of Peerless’s last pearl of wisdom- when there’s nothing to do, do nothing. But when there’s something worth doing, then do it in size.

Geroge Soros frequently talks about this, because it’s a common trait of all great traders. In order to be a big winner, you have to be very, very large in the positions that have the best risk/reward. Considering that most traders make their year on two or three big trades, then you have to pile in when you see an opportunity.

The key question is: how do you judge when to be a pig?

The answer: you have to rank your positions in terms of overall attractiveness/conviction and then size them accordingly. Once a trade meets all of the minimum criteria for you to put it on, then you go further and rank it on a scale of 1-5 of overall attractiveness.

For instance, imagine you are trading a system similar to William J O’Neill CANSLIM system. To simplify, you have the following criteria:

–          Strong earnings momentum—EPS growth of 25% or more

–          Strong chart—breaking out of a base of at least six weeks’ duration on 2x average daily volume

–          Institutional ownership and buying, as evidenced by increasing volume on up days

–          An overall stock market that’s trending higher

A stock could just barely meet your criteria, with 25% earnings growth, breaking out of a 8 week base. In this case, you would rate it a 1 out of 5 (the lowest). On the other hand, you could have something like Cisco Systems in the 1990s, which displayed 50%+ earnings growth and which would break out of multi-month bases on huge massive volumes—and already had significant institutional support.  This would merit a 5 out of 5.

How would your position size vary depending on the rankings? For a “5”, you would want a position size that’s several times larger than for a “1”. That means you could put a “1” at 1-2% of NAV, which you would feel comfortable putting on a “5” at 6-10%. After all, you would feel most comfortable betting more on a position where things couldn’t be better, rather than in something that’s barely meeting your entry criteria.

That’s how the best trader at Citigroup did it. Whenever he found a trade where all of the stars were aligned and he felt that the risk/reward was skewed in his favor, he would put on a gigantic position. And while it wouldn’t always work, the gains on his winners would far, far outweigh his losers, leaving him a substantial winner.  Being a pig and going for the big scores is what leads to huge winners.

Conclusion:

Peerless’s methodology was quite simple. He would perform intensive research of the macro markets, looking for trades that fit his methodology. When he had no ideas, he would do nothing; when he had a smattering of decent ideas, he would take some risk; and when he had a fabulous idea, he would put on a large position.

It sounds simple enough, but executing it is properly is another matter. As a matter of fact, despite his fabulous example and education, I was a net loser. Why? When push came to shove, I didn’t have a well-defined methodology for how to approach trades.  Ultimately, no amount of advice will help you when you don’t really have a clear game plan.

As Brett Steenbarger says, the biggest barrier to trading success is usually a methodology problem. Hopefully, my example will show you importance of getting the very basics right.

After that, I hope that the best trader at Citigroup’s advice will help you to transform your trading to the level of the greats.

Disclosure: No relevant positions

By Bruce Bower | E-mail: Bruce [at] howoftrading.com

Blog: www.howoftrading.com | Twitter: @HowOfTrading