The Real Secret to Wealth is Not What You’ve Been Taught

Boris Schlossberg

Today we are faced with two opposite myths both of them wildly dangerous to your long-term financial health.

The “crypto/Lambo” myth is certainly much easier to understand and mock. This is the get-rich-quick myth that permeates all of trading. It comes in every flavor imaginable but the basic premise is the same. All you have to do is learn a few simple strategies and in a matter of months, you’ll be independently wealthy. It doesn’t matter what you trade -- stocks, options, forex -- the message is always the same. I. CAN. MAKE. YOU. RICH. Crypto is simply the latest incarnation of this age-old con, but equities work just as well. My personal favorite these days is a guy named Jason Bond (what brilliant scam name) whose Youtube ads are ubiquitous even on my five-year-olds Barbie channel (business rule 101 -- the faster someone talks, the more they are lying)

Of course, you can’t turn $1000 into $1 Million in a matter of years. Of course, you can’t make $10,000 per day every day in just a few hours of market trading. And no, of course, you can’t trade for a living with just $10,000 worth of capital.

But while the get-rich-day-trading scheme is easy to spot, the flip side can be just as deadly. This is of course is the you-don’t-have-to-do-anything to retire myth of index investing. The financial media constantly tells you all you have to do is drop 10% of your yearly income into an index fund and NOT DO ANYTHING. It will just magically compound to $1 Million! $2 Million! $5 Million! money pot and you will to retire to Boca and play golf with the sunshine boys for the rest of your carefree days.

Like all good myths, this one originated with a kernel of truth. Over the past 30 years the virtuous cycle of easy monetary policy (yes Virginia -- this is actually the MAIN reason stocks always go up -- check the 30-year bond for the past 30 years), massive technological advances and financial deregulation have created the perfect environment for the index investor. The financial press is full of gleeful stories of Mom and Pop savers eviscerating the Masters of the Universe on a daily, monthly, and multi-year basis. The “F-k me, I am a hedge fund manager” T-shirt, so popular in the early aughts seems as quaint now as the Lambo/crypto dream of 2017.

The message of the index myth is -- you don’t need to know anything, you don’t need to do anything, just buy the f-ing dip and money will grow like a magic tree.

I am not going to bore you with all the empirical data that I’ve already shared before how there are many, many periods in American history where that wasn’t true. I will, however, share just one interesting tidbit that I came across this week. Did you know that since 1962 (that’s 56 years) the return on Japanese equities is 2.72% per annum, for German equities it’s 3.46% and for Italian equities its … wait for it -0.38% per year! Now you can believe in American exceptionalism all you like but you would be beyond irresponsible to risk your financial wealth on that assumption.

In any case, there is something incredibly primitive about the index myth. What after all, is the difference between the indigenous people of the Amazon who perform the rain dance without understanding a thing about meteorological patterns and the index investors who perform the “saving dance” without understanding a thing about financial markets? Eventually, the drought comes. Eventually, there will be a time when 30 years worth of savings will evaporate in 30 days of the market meltdown and … the money will never come back. Don’t believe me? Just ask Mr. and Mrs. Watanabe who’ve never seen the Nikkei at its 1988 highs in their life.

So instead of falling for the get rich quick myth or the do-nothing-and-money-will-come-to-you myth, the reality is that we all need to become trader/investors. We all need to learn how to manage risk both in terms of size and stops. We all need to learn about algo trading. We all need to learn how to trade both sides of the market (not that there is anything with that). We. All. Need. To. Become. Active. Not. Passive.

It’s not glamorous to make 10 pips per day. It’s not easy either, but therein lies the true secret to long-term wealth. Because 10 pips per day will accrue to millions of dollars over years of trading. 10 pips per day is 25% per year -- which is huge if you understand the compound tables and even half that -- 5 pips per day -- is a pathway to financial security.

More importantly, it’s eminently doable. It’s doable not only from an absolute return point of view but from a volatility point of view. I can assure you that if you learn how to make 5 pips per day you will never put yourself in a position of losing 90% of your retirement savings in a matter of weeks. If you learn to trade actively, you will obtain the ultimate wealth building skill -- control.

How Yogi Berra Taught Me to Win 95% of the Time

Boris Schlossberg

In my day trading room we try to hit 95% of our trades. We do this because I am firm believer in the insurance model of day trading (lots of small wins with a few large losses) rather than the lottery model of day trading (a few large wins and many small losses). Lotteries are for suckers while insurance companies are some of the best businesses in the world. I have discussed this subject many times in prior columns, but today I can across another reason why my model is working our chat room.

I was reading a summary of Brett Steenbarger book on Trading Psychology on Ivanhoff’s Capital webpage when I came across this tidbit

“A small win is a small mirror. It reflects a winning image to us. Accumulate enough small wins and that winning image starts to become familiar. We internalize that which we experience repeatedly. That’s one of the reasons positive emotional experience is important….People I’ve known who are particularly adaptive have made small wins a habit pattern. They undertake many new challenges and regularly define meaningful, doable goals. They set themselves up for success. Positivity becomes a habit, a lifestyle, making the whole issue of discipline moot.”

Without really appreciating its power, I hadn’t realized just how valuable the idea of frequent wins is to overall success of the trader. I have seen with my own eyes as more and more traders in my room start to put together profitable runs of days, weeks and even months. In the world of retail trading this an exceedingly rare occurrence and I don’t think it’s due only to efficacy of my strategy but rather to the fact that positive experience creates good habits that leads to better performance.

Which brings me to Yogi Berra. He died this week and it is true testament to the kind of man he was that his death managed to stand toe to toe in headlines with Pope Francis’s visit President Xi’s White House arrival. Berra was not just a great athlete but a great philosopher. His sometimes unintended witticisms are far more quotable than anything uttered by Jean Paul Sartre (and I would argue more insightful as well).

Berra is famous for saying, “You can observe a lot just by watching.” Which is a lesson that I live by every day. Whenever people ask me why I don’t back test my strategies I always think about that Yogi Berra quote and laugh. Markets like any man made social constructs are fluid and ever changing. Back testing data is like trying to figure out social habits of Millennials by studying the Victorians. It’s why every perfectly backtested system, whether it be done on your MT4 package or by Andrew Lo of MIT, always fails. Its why if want to succeed in day trading you watch what is happening now. As Mr. Berra used to say, “In theory there is no difference between theory and practice. In practice there is.”

Upon his death many analysts have re-examined Berra astounding athletic achievements. And as fivethirtyeight has pointed out what’s absolutely remarkable about Berra is that no one with his slugging percentage has struck out less. Berra only struck out 5% of the time and he was notorious for being a bad ball hitter. That means that instead of waiting for a perfect pitch he took what the pitchers threw and tried to make contact. And any time you make contact in baseball you have a chance to score.

This is perhaps Berra greatest legacy and his most valuable lesson to us as traders. Instead of looking for the perfect set up or the absolute best execution, we should try to figure out how to turn every trade into whatever win, scratch or small loss that we can. Berra collected 10 World Series titles by never trying to be perfect but by winning by any means necessary.

“FOMO=FUP” or How Warren Buffett Taught Me to Take Money From The Market

Boris Schlossberg

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Allow me to explain.

Let’s go back to insurance. The insurance business is the only business model based on the idea of taking your money first while making a murky promise of delivering a payout sometime later. In fact, in a perfect scenario the insurance company would love to collect money from you in perpetuity and never pay you out a dime.

I am always amused at the fact that people find interactions with the insurance companies to be so confrontational. Of course they don’t want to pay you! In all other businesses they need to deliver the goods before they get your money. That’s why they are so nice to you. In insurance, they already have your money, so everything else that follows is pure annoyance and cost for them.

But setting the ethics of the business aside, the financial rewards of running an insurance company can be enormous IF you price the risk correctly. And this is where Warren Buffett comes in. If you read anything about Mr. Buffett’s insurance operations he is the farthest thing from being a low cost provider. In short, Mr. Buffett never cuts his premiums to attract more business. Indeed if you follow all his recent market deals be they insurance or not -- the primary principle by which he operates is get paid first, worry about making money on the investment later. Preferred stock anyone?

But back to the insurance business. There are basically two components to making it wildly profitable -- take the money in and make sure you give as little of it back as possible. (Buffett’s Rule #1 of investing -- Don’t lose money. Rule #2 -- see Rule #1) By assiduously focusing on both sides of the equation Buffett has learned how to take money from the market rather than just make it.

What does that mean for us as traders? It means that under no circumstance ever, do you chase business. You let the business come to you, on your terms or no terms at all. Over the past week or so I have been extraordinarily selective in picking out VT levels for us to trade. The net result is that of course we made far fewer trades, but those trades were all winners and we wound up the week up about 1% with no drawdown whatsoever.

Its not glamorous. It’s not sexy. It’s hard to sit on your hands and deny yourself the lower quality trades even as you watch them go to profit. But it undeniably works. We have a saying in the room -- “FOMO=F*up” ( i.e. Fear of Missing Out will kill you in the end).

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I think Mr. Buffett will agree with the spirit if not the tone of that message as his lesson of taking money from the market rather than making money from the market reverberates with all us in the BK trading room.