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Hi Ric.
In the movie "A River Runs Thru It" the lead
character, as a child, was required by his father to write an essay each day as
part of his home schooling. He explained that since his father was a
Presbyterian minister and Scottish to boot, frugality of words was
mandatory. Each time he would turn in the essay his father would edit it
and require him to rewrite it again half as long.
This would go on several times for each essay until
he had gotten it down to a few dozen words expressing the core idea. His
father would then approve it and he could go of fishing.
You need to try this. Therefore you're not
excused until you rewrite this again, half as long.
Good luck and good trading,
Ray Raffurty
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----- Original Message -----
<DIV
style="BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: black">From:
ric
ingram
To: <A title=realtraders@xxxxxxxxxxxxxxx
href="mailto:realtraders@xxxxxxxxxxxxxxx";>realtraders@xxxxxxxxxxxxxxx
Sent: Friday, February 08, 2002 1:39
PM
Subject: [RT] Masters of the Difficult or
Students of the Easy
Hi,This is a long email.
For those who like to 'read' pictures I suggest the delete key.As a
trader are you trying to be a master of the difficult or are your hoping to
become a student of the easy?As your still with me, this email
gives: - a
possible explanation of why most (it is said 95%) traders lose
money, - a
practical example of one of three trading styles that seem to account for
the
majority of the successful traders.The approach taken is to suggest it
is perhaps easier to make money as a not too effective trader, trading an
inherently highly profitable approach, than to try to learn to be a highly
tuned money-making-machine using a hard to win at style of trading.I
repeat, as a trader are you trying to be a master of the difficult or are your
hoping to become a student of the easy?Traders who regularly make
money trading with the trend are rightly applauded.For it is a
difficult task to master, and that is why such traders are so are few in
number and rarely make more than 50% per annum every year. Even
a consistent 20% plus a year is impressive for such trading, and an investment
manager that can make a regular 20% plus a year with limited draw-downs and is
willing and able (psychologically) to manage other peoples money will have
many ready takers. And deservedly so, for such
managers are masters of the difficult and deserve every penny they
make.Some manage a trend following trading style without much stress
and good luck to them. There are techniques that can catapult them
to lower stress, more regular and higher profits - for example risk of ruin
considerations and position sizing and service concepts.The fact that
most trading material that is written assumes that trading with the trend is
the only way to trade is to be expected
as: - it
is
simple, - it
meets instant gratification
needs, - it
is what the majority of new traders want to
hear, - it
is assumed to be the only way to
go, - many
of 'fundamental' based players are natural trend
followers, - a
majority of 'technical' based techniques are trend followers
tools, - most
like to be a member of the
crowd, - most
spend their lives seeking rather than offering service.So most new
traders try to trade this way, hoping to emulate the masters of the difficult,
but then most traders lose and drop out. But still the
'penny does not drop' - and for some, because of human nature, perhaps never
will, at least in this life.Most successful traders, and certainly an
overwhelming majority of those that regularly make 50% or more per annum seem
to mostly use one of three trading techniques or variants or combinations of
: - spread
trading
strategies, - volatility
breakout
techniques, - market
making techniques.This is because these trading styles/techniques tend
to have lower stress and are inherently more profitable - so a mere student of
the easy can often exceed the success of the masters of the
difficult.We will look at the spread trading concept - as it is simple
to describe and to give some examples.Some of the biggest
traders by capital employed are spreaders. Arbitrage of index
futures against the underlying cash instruments is a example of
spreading. Let us look first at these traders.Let us
assume the fair premium of the S & P 500 future (based on interest rates,
margin requirements, dividend distributions, time to expiry) is 4 points for 2
months to go to expiry.Imagine that the index future stands at 6
points above the cash stocks. An index arbitrageur will buy the
cash stock (probably via an ongoing arrangement with a pension fund) and sell
the futures to an equivalent value.He/she will then pick up the two
points discrepancy to fair value by holding the cash and futures to expiry of
the futures and sell the cash stock back to the original owner at the going
rate.He/she will pick up a net, near risk-less, 2 points in 2 months
less annual fees to the stock lender for his trouble.Only 2 points you
say, in 2 months - not a good return. But often the profit
is on money borrowed for the purpose, and that 2 points in say 1,000 is worth
having - on say, $500,000,000 of stock, as it amounts to a million
bucks.Yes, this is not an untypical trade size for arbitrageur of this
kind.Also, in practice the premium often varies from 2 points above
fair value to 2 points below fair value and back again many times in two
months. Often the swings available are much higher than those in
the example.So our hero/heroine takes his/her four points (or more)
often many times in the 2 month period.So now you know why the big
guys get bigger - they take nearly risk-less profits over and over again on
their own and/or other peoples money.They get paid well because they
provide a range of
services: - they
are low risk borrowers for the banks and pay interest on big
chunks
of money to the
lenders, - they
help keep the futures premium within reasonable bounds so more
near
a fair premium is paid by future
traders, - they
provide a large supply of future contracts when everyone is bidding
up
the price of the future compared to the cash index - that is when the
premium
is
high, - they
provide a large demand for future contracts when everyone is
selling
the future compared to the cash index - that is when the
premium
is
low, - they
help keep the market makers books more balanced and requiring
less
cash for their
activities, - they
permit big buy and hold institutions such as insurance companies
and
pension funds to earn extra stock lending fees to add to
dividends, - ...But
let us look at a more practical spread available to those only with pennies a
point (not $50,000 a point) to risk and available more than once most
weeks.Imagine you have an account with an internet trader that allows
you to trade in 1 cent units on the S & P 500 and the DOW.
Real time prices, updated every 20 seconds or better is provided free - so
your costs are limited to your internet charges. This is all a reality
now.You have analysed the relationship between the movements on the
DOW and the movements on the S & P 500. You believe they move
in a ratio of 7 to 1, 8 to 1 ... 12 to 1 - each traders perception is
different. Whatever works for you.This morning they move
out of line (according to your ratio) by 25 (or 50 or 100 or other parameter)
DOW points. You buy the cheap one, you sell the expensive
one.Your studies tell you that such a discrepancy unwinds within the
hour/day/week/month 30%, 40%, ... 90% of the time - every traders time
horizon and perception is different.When it unwinds or reverses
(another alternative view) you take your profit. If the
divergence gets bigger you take your loss or increase your position - another
alternative.You find perhaps you can take the equivalent of 2 full S
& P 500 points every day out of the market net of losses.An
example based, for simplicity on 25 points discrepancy and assuming a 10 to 1
ratio will perhaps help.I am sure your research will verify that 10 to
1 is not appropriate, but it makes the arithmetic easier.The S & P
500 today is say at 1000.0 at open and the DOW is at 10,000 at open.By
10:03 a.m. the DOW has risen to 10050 and the S & P 500 has risen to
1001.5.They have not moved in line and you feel the discrepancy is
sufficient, based on your research, to try and exploit.You buy 10
cents a point of the S & P 500 at 1002.0 (including all dealing costs),
and you sell 1 cent a point of the DOW at 10046 (including all dealing
costs).Your spread is much lower risk than just buying 10 cents a
point on the S & P 500 or just selling 1 cent a point of the DOW as you
have a spread and they tend to move together.The margin for this trade
will be less than $10 (that is right ten dollars).Your margin is
higher - you pay margin on both sides - helping to stop you
overtrading.Your research is good and most of the time (your
percentage from your research) the two markets come back in line by the end of
the hour/day ... and you unwind at 1019.5 and 10198 including all costs
with the
results: profit
$0.10 x (1019.5 -1002.0) =
$1.75 loss
$0.01 x (10198 - 10046) = $1.52Net profit $0.23. Not bad
on a low risk trade in a hour or so and on a standard margin of say $10
excluding running profits or losses.Assume you have an account of
$1,000 and so you are only trading (in terms of the $10 margin) about 1% of
your account size.Sometimes, based on your research - you take a
loss. Let us assume that $0.03 average allowance for losses
must be made for each profitable event.You have made $0.20 profit,
(net of allowance for losses) on $1,000.Assume this is available just
once each and every day and you trade 200 days a year.Your yearly net
profit is $40 or 4% per annum.Let us assume that you can continue this
profit profile over several months, building confidence slowly to be able to
trade 20 cents against 2 cents (assuming the mythical 10 to 1
ratio).You are now making 8% per annum. You take the
time to back-test by hand (by hand for optimum confidence) using the free data
supplied by your internet dealer over 30 years of data to include a very big
up day and a very big down day. Your confidence grows. You
go, small step by small step to trading $1 on the S & P against 10 cents
on the DOW (assuming you still feel 10 to 1 is the appropriate ratio) - 10
times your original risk level - your daily standard margin (excluding running
losses or profits) is now about $100 - well within the original $1,000 account
- leaving lots of room for any sudden dramatic doubling or trebling or even
quadrupling of margin. You are not going to be in the class of
losers that get closed at a loss out because you run out of margin.You
are now making a net $2 a day - $400 a year and 40% per annum profit ignoring
compounding. And low risk and stress-free too. You are
a student of the easy, not a master of the difficult.As often as your
research tells you, you count your profit and assess against five
criteria: - profit
percentage per unit time after allowing for occasional
losses, - net
reward per unit
risk, - net
reward per unit
margin, - the
stress
level, - actual
market behaviour against theoretical behaviour.You find the first is
good, the second outstanding, the third poor, the fourth lower than you have
ever known, the fifth to build your confidence, give you early warning of
changes in spread relationships, and data to refine your risk of ruin
calculations.Why predict and invoke your ego?Why emote away
and suffer for it?Why not provide service in this
case: - by
buying that index most
oversold, - by
selling that index most overbought,so you do not self-sabotage as you
know you have provided service and profit is your due
reward. You get to keep your profit.Good thinking
leads to stress-free enjoyable and profitable trading.And a life
outside of trading - and the money and stress-free existence to enjoy it to
the full.Effortless and simple. Much better to be a
student of the easy than to try to be a master of the
difficult.Unconditional regards, Ric.<A
href="http://www.traderscalm.com/"; eudora="autourl">www.traderscalm.com
P.S.There are many pairs of markets to spread, each with their
own opportunities and risk profiles.Sometimes you can spread the same
pair of markets for a profit several times in the same day.The
possibilities are as large as your imagination. To
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