Investing Discipline is Total Bulls-t

Boris Schlossberg

As an investor, how do you know if you are disciplined or stubborn?
If you go broke you are stubborn.
But if you survive and make money you are disciplined.
That’s laughably stupid if you think about it for longer than a minute.

Yet every single day you are bombarded with the conventional pablum that all you need to do is be “disciplined”, buy an index fund and keep buying more on a regular basis and 30 years later you will be rich. The underlying assumption is that the upward drift in stocks will continue infinitely. But the future is almost never just a slightly different version of the past.

Today, America is quickly losing economic power to China. It is destroying the only competitive advantage it has by banning immigrant labor which is responsible for almost all the intellectual contribution to the country’s economy. And it’s getting old. Everywhere you look the United States is a country of fat, old people in wheelchairs sucking up all the available tax dollars of Social Security and Medicare benefits, while the young struggle to live two to a room as they attempt to pay off their student loan obligations from which they can only escape through death.

So yes -- there is every possibility that the American Empire is following the path of Rome and that the wonderful 200 year plus run of progress and innovation that translated into a ever rising upward drift of equity prices could come to an end. And of course now that we find ourselves at the apex of equity valuation, not one person is thinking about the end of Pax Americana, just like the Romans submerged in their orgy of sex and violence of the Colosseum couldn’t possibly imagine that their way of life would be smashed to smithereens by hordes of primitive barbarians.

But I am getting too dark and frankly a bit off point. I have no idea when the US growth party will end, but it sure feels like it could be soon. More importantly, if it does end there will be literally nothing you can do to help yourself if you follow the conventional investing wisdom of the day. Discipline will lead to ruin as you just keep buying an ever falling asset.

The laughably false distinction between discipline and stubbornness (there is no way to judge which is which until you get the final result) was made very vivid this week by the tragic travails of David Einhorn -- a one time a hedge fund God, a Master of the Universe, the King of Value and the present day owner of Greenlight Capital who is suffering the humiliation of seeing his fund lose 20% this year. Again. Einhorn, who for the past ten years has been busy losing all the money that he made in the ten years prior, wrote a letter to his investors noting that, “Right now the market is telling us we are wrong, wrong, wrong about nearly everything….And yet, looking forward from today we think this portfolio makes a lot of sense… We have been accused of being stubborn, but one person’s stubbornness is another person’s discipline.”

To which the inimitable Matt Levine of Bloomberg, the best writer in finance today, responded, ”Yes! Correct! Let me make that a bit more explicit: If you have a plan, and you do the plan, and it makes money, people are like “good job being disciplined in sticking to your brilliant plan.” If you have a plan, and you do the plan, and it loses money, people are like “bad job being stubborn in sticking to your dumb plan.”

I mean! This is wrong! In fact, people regularly distinguish stubbornness from discipline, and evaluate the quality of your plan, without reference to current results; they care about the process by which the plan was arrived at and the quality of your reasoning and the convincingness of your explanation of how the plan will make money in the future. It is not incoherent to say “my strategy is good, and I am right to stick with it, even though so far it has lost money.” It is just kind of funny. And of course, in the long run, how would you distinguish stubbornness from discipline other than by results?”

Exactly.

But it doesn’t have to be that way. You don’t have wait until you lose 75% of your money -- whether you are a buy and hold Mom and Pop investor or hedge fund titan to find out if you are “disciplined” or “stubborn”. If you day trade and if you do it right (not correct, but right, meaning that you slice risk into teeny, tiny pieces by making lots of small trades, you will never put yourself into such a no-win situation. You will have near instant feedback on whether you are correct or not and more importantly you will have much greater control over your drawdown. My pal Robbie Booker showed me an account today where he made 12% return while drawing down just 3%. The best part is that he did it by trading 1000 unit size on a 10,000 dollar account.

That’s right he traded 1/10th leverage and STILL beat the S&P! But that’s not unusual. I have seen many traders in my chat room achieve 20% returns with 3% drawdowns all because they traded small and controlled risk on every trade.

That’s the beauty of day trading. The discipline is in the size and in the stop. You don’t need to come up with excuses. You don’t need to wait years to be proven right or wrong. Your results are there every day and you have much better control of your financial destiny.

Trading Discipline? Waste of Time

Boris Schlossberg

The greatest economist that ever lived was John Maynard Keynes. (All the Austrian School economists, indulge me for a minute). But besides saving capitalism and setting the foundation for our modern world, Keynes was a damn good trader.

Here is how Keynes performed during the depth of the Great Depression managing the endowment of King College, which he managed to increase tenfold over a period of twenty years.

Keynes

As you can see, for a pointy headed academic, Keynes was a very skilled trader. One of Keynes great quotes is, “I would rather be vaguely right than precisely wrong.” That’s pretty good advice for life overall, but it’s probably the greatest trading advice ever given.

I was thinking about Keynes’s words when I was live trading in the BK Chat room during last night’s UK Retail Sales. As I was furiously moving in and out of the pound, the yen and the various pound crosses I suddenly realized that there are three very distinct states of trading. There is the ideal trading model that you develop after thousand of hours of observation and back testing. There is the live market price action that rarely corresponds to the exact parameters of the model and lastly there is the actual trading that you will do under real market conditions that will only approximate the rules of your model.

Don’t get me wrong. It’s extremely important to have all three components in order to trade successfully. You can’t trade a strategy unless the intellectual foundation is technically valid. But it is naive beyond belief, to think that having a great trading strategy is all you need to make money in the markets. The markets are designed first and foremost to wreak havoc with your strategies and force you out of your trades, usually at the worst possible time. Speculative markets are essentially nothing more than massive poker bluffing machines whose primary function is to transfer the wealth from the weak hands to the strong hands.

The easiest way to become weak is of course to over leverage your trades. But beyond that I think the other way to let the market wear you down and destroy you is by being too disciplined, by faithfully following your model on every single trade, every single day. Doing that will inevitably create two problems. After some period of time your model will begin to lose -- and no matter what you tell yourself -- just like a spouse who cheats on you -- will grow to resent your model and then doubt it and then eventually abandon it, even though in the long run it may prove to be very profitable.

So it’s actually okay to be sloppy, to be imprecise, to make mistakes. In my BK chat room I laid out my run to the 00’s model using crisp, clean instructions that looked wonderfully efficient on the chart. But of course in the mayhem that followed news trading, my execution was off, my first exit was flawed and my second exit was driven more by psychological compunction rather than proper risk control.

And yet it was perfect trading day.

We made money because I got the big thing right -- direction. And most importantly I did not fret about botched executions, or missed opportunities or unfavorable spreads. I focused on the only thing that really mattered -- where was the trade going?

And as John Maynard Keynes made perfectly clear -- in trading and in life that’s the only thing that matters.

Discipline is Bulls-t.

Boris Schlossberg

Do you think George Soros made all his money because he was right?

Wrong.

Over his long and illustrious career Soros made a multitude of investment errors. We simply don’t hear about them because while frequent in scope they were miniscule in size. In fact, Soros was notorious for “testing” the markets by sending out small orders in the opposite direction of his view just to see how they performed. If the trade turned profitable he would rethink his whole investment thesis.

Soros is famous for saying that “it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

I was thinking about this quote this past Wednesday after a few frenetic hours of day trading the FOMC decision in our chat room. K and I live-traded like we always do and I used my personal account to execute the trades. For the first few hours I stuck to our Boomer strategies and slowly and surely put up 36 pips in about 90 minutes hitting all our trades to spec. Then we closed up the “official” tally and I started to screw around. The markets were still very volatile and there were plenty of trades to tempt me. None of them however, were the proper Boomer setups. So basically I just gut traded for an hour and managed to give back all the gains, plus set myself back another 40 pips.

I was trading reasonable size all throughout the day, so the damage was not terminal, but it was nevertheless there and most importantly it was utterly unnecessary. I could have gone on a massive internal rant telling myself how stupid I was for losing my discipline. How I should have known better to not get distracted by the bright shiny objects of the post FOMC price action. But before I even started down that path I knew its was total bulls-t.

The fact of the matter is that I will never be disciplined. And neither will you. And neither will anyone else with a pulse. We are human. We respond to stimuli. To deny that is basically to deny the very essence of our nature.

But thinking about Soros I realized that there is a way to stay consistent and successful while at the same indulging your baser urges. Basically I adapted his
“bet-small-when-you-are-fooling-around-bet-big-when-you-have-the-edge” approach to my own day trading style. I call it the 10 to 1 approach. Let’s say my regular trade size is 10,000 units. I trade that size for any legitimate set up that I have. But anything out of the ordinary. Anything that is not part of my trading plan I trade at 1/10th my regular size. This way I get to participate in the market, but if I get stopped out ( as I inevitably do ) my loss on the “punt” trade is literally half of my one winning trade. Given the fact that I aim to make 10 legitimate trades per day and lose only once, any losses from “punts” are miniscule and do not damage my psyche or my equity.

I even went a step further and created templates 1/10 the size of my real trade templates, so that I would only trigger the “tiny” trades when I wanted to fool around.
Here is how that experiment went today

10v1

As you can see I did a lot of random trades, but none of them hurt me because they were “tiny”.

I can’t tell you how important this trick is. All of us who engage with the market every day, who are tempted by risk at least 3 times every hour, need a proper mechanism to cope with the temptation. And just saying NO is not a real answer. Discipline is bullsh-t. It’s what trading gurus who never have real money on the line like to teach you. For real traders who trade every day, the 10 to 1 rule is a much better solution.