The following was originally published on Trading Technologies Trade Talk blog. * * * * * Wizards of Today’s Markets: Jack Schwager, Part 1 We recently ran our third “Wizards of Today’s Markets” Q&A, rounding off our trio of Chicago trading legends with TransMarket Group’s Ray Cahnman. To close out the series, we thought it would be fitting to talk with the originator of the “Market Wizards” moniker himself, Jack Schwager. Jack authored “Market Wizards” — a series of interviews with some of the most successful traders in a variety of different markets — in 1989 after publishing the more technical “A Complete Guide to the Futures Markets” in 1984 (a revised version of which is coming out this year). Since then, he has followed up with more additions to the Market Wizards series, including “The New Market Wizards” (1992), “Stock Market Wizards” (2001) and “Hedge Fund Market Wizards”(2012). Therefore, we think it’s safe to say that Jack has interviewed more successful traders in depth than any other person. Jack is based in Colorado, so we conducted this interview via phone. His newest venture is FundSeeder, a risk management and performance analytics platform for traders which also provides access to an emerging manager support structure. FundSeeder’s sister company, FundSeeder Investments, is a regulated entity and provides properly regulated traders with an opportunity to seek out possible employment opportunities as well as seed capital allocations. As a reminder, this series is presented as transcripts of the conversations, which have been lightly edited for readability. I hope you enjoy this interview and have enjoyed this series as a whole. Thank you to Don Wilson, Blair Hull, Ray Cahnman and now Jack Schwager for making themselves available and sharing important trading and career insights with our Trade Talk readers. While they didn’t say it outright, it’s clear that prudent risk management coupled with lifelong learning and the relentless pursuit to discover the next big trade are hallmarks of their success. Rick Lane, CEO Rick: So, Jack, for the small minority of people reading this blog who haven’t read at least one of the books in the “Market Wizards” series, could you give us a little bit of background on your ties to the industry? Maybe a little bit of the impetus for writing the initial book and a bit of your own background? Jack: Sure, well, I started out with an economics degree looking for an analytical job. I fell into a research analyst position for commodity futures — back then the job was called commodity analyst. I think a more accurate term would be futures analyst. So that was the first position I took, which was back in ’71 out of grad school. And the position I took, it’s worth mentioning, was a position being vacated by Michael Marcus, who was chapter one of the first “Market Wizards” book. He was leaving to become a trader, and he ultimately became a spectacular trader. So that’s actually an important thread in how the first book came about, because he was a critical interview. Anyway, I was falling into this world of futures, which I really knew nothing about. Particularly when I went to college and graduate school, which was in the late 60s and the beginning of the 70s, economics departments taught almost nothing about financial markets, not even about equities and market analysis. Forget anything about futures. Even nowadays, I don’t think there’s a tremendous number of courses on that. I quickly learned about futures. I liked it because of the fact that it was, to me, like a game. Here’s a market, you’ve got to try to figure out where it’s going. You’ve got all these facts and it’s up to you to try to put them together, whether statistically or some other way. I always knew I wanted to do a job that was non-repetitive. And by definition, futures seemed to be an area that was certainly non-repetitive — things are always changing. And I liked the writing aspect — being an analyst, I have to write on the markets. So now being in that position, it doesn’t take very long to say, “Hey, I would like to put money on what I’m projecting.” That’s how I got involved in trading my own account. And trading my own account was always a sideline. But that was my interest in trading. I started out, like most people, a terrible trader. Rick: And part of the impetus initially — of the first book, at least — was your pursuit of some advice. Jack: Yeah, part of it was exactly that. Part of it was like, “Here’s a great excuse to pick the minds of the best traders in the country.” And it’s a fun project. That was really the idea. I thought people would probably like reading about that. I actually had the idea for quite a few years before I actually did it. I believed that there wasn’t a decent analytical book on the futures markets. And, right or wrong, I thought that I could do something that was better than anything else that was out there. So I wrote my first book, “A Complete Guide to the Futures Markets,” which incidentally now is getting revised and updated and will come out later this year. But anyway, that was the first book. And that book was well received, but it was not as readable as the “Market Wizards” books. Hopefully it’s as readable as any serious analytical book can be. But it was certainly a heavier go. However, the publisher approached me — the book had done well for that type of book — and they wanted me to do a whole bunch of books for them. They asked me to be a contributing editor for a series of analytical books, one on each market. And I said, “Hey, I’ve been there, I’ve done that. Anything I do now I want to do more for a mass audience. And I have this idea…” — it was at that lunch that I dropped the idea of “Market Wizards.” They said, “Hey, that’s great.” So that was the catalyst that actually got me to do the book. It was a combination of wanting to interview these people to figure out what they are doing, glean insights they could share, use what I learned to become a better trader, and then communicate all of that to the rest of the world. It seemed like it would be a fun project. Rick: That’s all very interesting. You wrote the original, and I don’t know how much time there was in between that and “The New Market Wizards.” Jack: There wasn’t much. The first book came out in ’89 — it was a surprise hit. One of the things that’s still a sore point for me is The Wall Street Journal did a story on the book, and the book really shot up in terms of sales and sold out the inventory pretty quickly. My publisher, who shall remain nameless, was just borderline incompetent in terms of getting it replenished. So you have all this demand for the book and it took about a month or two before new copies became available. I think that kind of hurt, but the book still did remarkably well despite that. In any case, because it had done so well, and because I knew other traders that I had not interviewed for the first book and who were of the quality that would be good content for another “Market Wizards” book, I decided to do a second one. For the first one, I had relied on a friend who was an author to review my contract, and he wasn’t a lawyer and he wasn’t an agent. And, with the best of intentions, he said it looked fine. I made it clear to the publisher at the time that I was writing a book for a general audience — a “trade” book as it is called in the vernacular. In the publishing world, if you do a book, a sort of more mass-market, general audience book, the typical contract says 15% of the list price is the royalty. But if you get into technical books — “professional” books, they’re called — like my first analytical book, then the deal is in net terms. And the difference between the two is literally a factor of about two to one. I had naively agreed to a net deal for a book that was really more of a mass-audience book and should have been a straight gross deal. My income on that book was about half of what it should have been. And I don’t think I’ve gotten into this in other interviews, but since this is a different topic for me to talk about — I was a bit pissed off. I went back to the publisher and said, “Clearly I know this misunderstanding is, contract-wise, on your side and all that. So can we negotiate something? I’m going to do another book. Can we do something here?” And they basically came back with, “Well, if you got past X number of hardcover books, then we’ll go from 15% to 20%.” Somebody else I knew from networking gave me his agent that he used, and I spoke to him. He was really very nice, took the time and listened to all the details, and he said, “Well you know, what they’re offering you is kind of like giving ice to the Eskimos.” His point was that by the time I got to the break point they were offering me, the hardcover sales would be just about done. And he was spot on. The hardcover sales ended, and it went to paperback. So what they offered me was really worth nothing. Anyway, after that book, that’s when I got an agent. And so I had success with the book and I wanted to actually do a deal where I got paid properly for it, and that was probably also motivation for doing a second book more quickly. Rick: So it sounds like you learned some hard lessons with that first book. Jack: That was the most expensive three letters I’ve ever seen — n-e-t. Each one of those letters was worth $50 to $100 thousand. At the time, I was a research director. I wasn’t doing poorly, but that word cost me a couple of years’ worth of salary. It left an impression. I decided I would never again negotiate a book without an agent. I went to the agent who was gracious enough to talk to me and advise me, even though I wasn’t his client. And he became my agent. To this day, he’s still my agent. Rick: So it sounds like you learned a tough lesson there. Did the pursuit pay off for its original intended purpose? Did you learn any lessons that you were able to apply to your own trading and become a better trader via these interviews? Jack: Through the book or through the — Rick: Through the canvassing of the world’s best traders. I’m just curious if you ever really got back in the saddle and tried to apply some lessons you learned. Jack: Yeah, certainly. I would say the reason I’m a net profitable trader is because I did those books. I was probably singularly untalented in terms of having any trading skill. Although I would say probably the majority of people are. I don’t think the majority of people are natural musicians or natural athletes or natural anything. That includes trading. I had no particular skills. And being a good analyst, I would say, does not have much to do — maybe anything to do — with being a good trader. If you’ve got the skills to be a good trader, being a good analyst might be helpful because you have the trading skills that, in combination with some insights you might get from the analytical side, could be helpful. But being an analyst or having that type of skill doesn’t in any way make you a good trader. In my own case, I have traits — which I know through doing the books — that are negative for being a good trader. One that I cite often, because it’s such an obvious one, is patience. One of the things that good traders have is patience. And patience translates into trading in two critical ways. First, waiting for a trade, not just jumping the gun because you want to do something, or you just lost some money and want to make it right back, or you’re making money too slowly, or you’re bored, etc. Being a good trader means having the patience not to do that. Just to wait and do nothing. Second, it also means even if you’re making good money but the trade still looks like it could go a lot further, and you’re worried about giving profits back, you need the patience to just be able to stay with the trade. There’s the famous quote from “Reminiscences of a Stock Operator,” which says that, “It was never my thinking that made the big money for me. It was my sitting. Got that? My sitting.” And so patience is a really important thing. And it’s not merely a trait I don’t have — it’s a trait I have in reverse. I am an impatient person. I am the type of person that, before the advent of iPhones, would not walk around without a “Time Magazine” in my hand because God forbid I would have to wait in a line for two minutes and not be able to do something. I have natural characteristics that would make me a poor trader. And if I am net profitable as a trader, it is simply because of things that I have learned from people who are successful. I know, for example, that patience is important. I know I don’t have it. I’m cognizant of that weakness. So any time I get tempted to do a trade that’s really not well-founded on any type of approach I use, I kind of think, “Wait a minute here. There’s really not a trade here.” Being aware of that is important. And that self-awareness, I guess, is important in different respects for different people, depending on what flaws people have in terms of trading. You have to know where your weaknesses are so you don’t fall prey to those mistakes you’re most likely to make. Rick: In addition to having those incumbent strengths and weaknesses that define whether someone’s going to be a good trader or not, there seems to be a theme, certainly in the interviews we’ve been doing in this series, and, I think, in your own personal trading history. The theme is that some of the most memorable trades for top, very successful traders are really bad trades. Fortunately, really bad trades tend to happen early in their careers and have a scope and a scale that isn’t enough to completely wipe them out of the market. Nevertheless, a bad trade tends to teach more lessons than a good trade. First, I’m curious if you would agree with that and, second, if you’ve ever come across someone who was consistently successful in their trading career who didn’t have one of those horror story early career bad trades which helped them later in life. Jack: You’re absolutely right that a bad trade, especially a really bad trade, is much more meaningful as a learning experience leading to improvement — if you use it correctly — than any type of good trade. And one theme I try to emphasize is that although failure unfortunately has this real negativity attached to it — particularly in America — a majority of the most successful people have had failures. If they were afraid to fail, they would never have gotten to the points where they were successful. The famous quote by Thomas Edison is, “I have not failed. I’ve just found 10,000 ways that won’t work.” That’s the mindset of people who are successful, whether in general or in trading. A great example among the people I’ve interviewed would be [Bridgewater Associates founder] Ray Dalio. The centerpiece of his philosophy is the importance of failure in improving and learning from mistakes. Something he tries to instill in everybody in the Bridgewater organization is that the single most important thing to his success was his ability to learn from failures and mistakes, both his own and those of his employees, to make the approach better. That’s absolutely a critical element. And you’re right that most of the traders that I interviewed had some anecdote about some really bad mistakes they made. I, as an interviewer, was always looking for those because they were the best stories, but they also have lessons in them. Most traders had those stories. There were very few exceptions — one I can think of right off the bat is Michael Platt from Blue Crest, who started out successful from the beginning and, at the point I interviewed him, had never had a significant drawdown. He had never really had a catastrophic trade. Rick: Yeah, it sounds like he’s definitely the exception. So, probably a tough question for you to answer, but you’ve interviewed some of the best traders of our time. I’m curious if you have your own Mt. Rushmore, so to speak. The top three or four whom you think are the best of the best. Jack: I get asked that question in various forms pretty commonly. It’s a reasonable question to ask. There are lots of people that come to mind — take, for example, Stanley Druckenmiller. He has a 40-year career, compounding at nearly 30%, and ran the Quantum funds for many years while [George] Soros was off in Eastern Europe. Then you have somebody like Bruce Kovner, with the spectacular success of Caxton Associates in his career. When I spoke to him, he had a 10-year record of 88% compounding a year. Then there is Paul Tudor Jones, who built a very successful organization managing tens of billions of dollars, and incredibly at the time I interviewed him had put together five consecutive years of triple-digit returns. And Ray Dalio probably made more dollars for investors than any other fund. Michael Marcus turned $30 thousand into $80 million. I’m just giving you names off the top of my head, and I have already given you a lot more than three traders. I could keep on going — and I haven’t even mentioned the one person that I have to say, impressed me the most out of everybody. It’s not that when I give that name I’m saying he’s the best. I’m just saying when you get to that level, it’s like… If I did a book on great sports figures where I interviewed the best baseball players, football players, basketball players in the world, and I did that for a dozen sports, and then you ask me which athlete do I think is the best, I really couldn’t answer that — they’re all great in different ways. There are at least a dozen plus people that I interviewed who would be appropriate as an answer to your question, and it would be hard to say who should be the top. I will say the person that I think was the most impressive of them all, just in terms of achievement and sheer raw intellect, was Ed Thorpe. But again, that doesn’t take away from anybody else. Rick: Yeah, of course. Ed Thorpe. To give you some background on myself, I came into this industry at the very beginning of 2006 — so relatively still a newbie. My “Market Wizards” book is about ten and a half years old, because when I thought I was going to come into capital markets, that was a recommendation very early on someone told me to read. The guy who ended up hiring me, actually. It’s still one of my favorites. I entered the futures industry at one of those inflection points where the market volumes were dramatically migrating to the screen and to electronic trading. This was right around the advent of the arms race for ultra-low latency execution. So I really learned most about the good old days of floor trading and how the markets used to be from history books, and not from personal experience. Even my view — and I’ve been in this industry ten, eleven years now — is, I think, very skewed compared to the way the world worked when you wrote this first book. If you wrote your book today, if you were a trader trying to make ends meet and looking for some tips from the people who are today doing it best, I suspect a lot of the stories would be very different and have a much larger technology component to them. If you were to write “Market Wizards” today, how do you think it would be different? How do you think it might be the same? Jack: I don’t have to speculate about that because the last standard format “Market Wizards” book I did, “Hedge Fund Market Wizards,” came out in 2012. And the world in 2012 looked a lot like the world today. And I would say that even though “Hedge Fund Market Wizards” was written nearly 25 years after the first “Market Wizards” book, the themes and lessons were not all that different. But there are some detail differences. For example, today there wouldn’t be any floor-related stories. For example, in my Paul Tudor Jones interview in the first “Market Wizards” book, he had a great story about his worst trade ever — the trade that almost knocked him out of the business. This trade changed his whole way of managing risk and by far influenced him more than any other trade in his career. And this particular trade occurred on the floor. I’ll tell you the story here because you couldn’t get that story now, unfortunately, because in today’s purely electronic markets, you lose a bit of the color that you might have in a floor-type situation. This trade involved July cotton, which is the last old crop month and can be particularly tricky to trade in its final weeks before expiration due to technicalities related to the certificated stock (i.e., the deliverable supply). So July cotton was making a new low. Paul Tudor Jones, who is on the floor, sees July cotton make a new low and then pop back into the range. And Paul looks at that and says, “classical bear trap.” That’s one of the things that I think is really important to understand — when markets have a market action that would normally be interpreted as a signal, and then violate that signal, that becomes a better signal than the original one. I call it a “failed signal.” Bear traps and bull traps are examples of failed signals. A bear trap is what happens when the market goes to a new low, taking out the people who have put their stops right at new lows or right below new lows, and then rallies back into the range. That can be a really good buy signal. So Paul Tudor Jones is looking at this and saying, “Okay, it’s a bear trap,” and he’s going to really put on a big trade. He then bids for what is a very large position relative to the amount of money he’s managing. And then, flying across the pit, arms outstretched, yelling, “Sold!” at the top of his lungs is the broker for the merchant that controls virtually the entire certificated cotton stock. In other words, he’s the one guy who really knows what’s going to happen with the July contract — whether there’s going to be enough cotton to deliver or not. That instant, Paul realizes that he’s dead in the water. And so does everybody else in the pit. And very quickly the market goes limit down. It’s not until a couple of days later, and a couple of limit-down mores that he is finally able to get out. He basically wiped out about 60% of his capital on that one trade. That type of story, it’s so visceral and colorful, you can really picture it. Unfortunately, I’ll never get a story like that based on screen trading. So you do lose that. But there are the same types of lessons. You could do the same type of thing trading from your screen, make some critical mistake, and have the market suddenly turn. If you look at “Hedge Fund Market Wizards” and compare it to the first two “Market Wizards” books, I would argue that there’s probably not that much difference. There’s also a lot of similarity in lessons that come out of the books. There are different individuals in each one, so you get different takes and lessons to some extent. But people in “Hedge Fund Market Wizards” could easily have been in the earlier books — in fact, somebody like Ed Thorpe arguably should have been in one of the first two “Market Wizards” books. I just never got around to including him. The fact that he ended up being in the book I did in 2012 was simply because I was doing a book then. I was looking around for people who should be in the book and he clearly fit that description. But there’s no real distinction to the fact that he’s in that book versus the earlier books. And the same would hold true today. A lot of people that I might interview if I was going to do a book today wouldn’t look all that different. Except that there wouldn’t be floors. Rick: But, you have to admit, the floor aspect definitely makes for better stories. When you have someone literally running, screaming, waving their arms, shouting at the top of their lungs, you miss some of that — Jack: Sure, you lose a bit of that color. But in terms of lessons and content, I don’t really see a lot of difference between something like “Hedge Fund Market Wizards” and the first two “Market Wizards” books. I think there’s certainly a lot more overlap in the general feel of those books and the general lessons than there is contrast. Rick: And what’s interesting — I think you could even extend that one degree of separation further, and when you talk about pure technology and lessons learned. For instance, if you look at the Knight Tradings of the world. Those were not mistakes from making the wrong trading decision, from interpreting fundamentals incorrectly, or from simply bad timing of a trade — but those were mistakes purely from a technology failure. And there are many lessons to be learned for people who are participating in automated trading and algorithmic trading where I think the lesson learned is still the same, which is that you need to be more thoughtful about the systems you’re building and how you build them. You need to understand that technology can often disobey what you expect it to do. You have to take my word for it that when you see an algo doing something that it’s not supposed to be doing, and doing it far faster than you can catch up to it, because it’s a computer, those — much like I think a bad trade tends to be more visceral and everlasting than a good one — those technology failures certainly stick with you far more than the technology successes you have when you’re in that space. So it’s all cut from the same cloth. I think the same lessons could be learned when you look at this purely from a technology point of view as well. Jack: To some extent, depending on the particular mistakes, a lot of those cases could fall into the basket of having overlooked something. You think you told the computer to do what you want it to do, but then some situation arises where you as an individual wouldn’t want to do a trade, but the rules you programmed signal a trade. Or you could have the reverse situation where you intended and expected a trade signal but your exact rules fail to signal a trade. It’s simply a matter of failing to take into account everything that could happen under the rules you programmed and the result is an unintended consequence — either getting a signal where you didn’t intend one or not getting a signal where you did. Rick: Right. Or you didn’t account for the long tail, the edge cases, and that’s exactly what happened. So, like you said, the program didn’t have the right logic to account for those situations. Last question along the “Market Wizards” line and on the pure trading side of things. For people who are getting ready to start, or are considering starting a career in trading professional capital markets, what advice would you have, given that today’s trader probably looks different and has a very different skill set than they did 25 years ago? Aside from reading your book, what advice would you give? Jack: Well, are we talking professional trading or somebody just looking to trade real money? Rick: Professional trading. Jack: With professional trading we’re talking about somebody who’s actually going to earn a living trading. I’ve actually never done that. I never thought I was good enough to be a professional trader. I wouldn’t want to have to make a mortgage payment, for example, based on my continued success as a trader. I wouldn’t feel competent doing that myself. And I think that most people wouldn’t be either. So, if you are contemplating being a professional trader, you really need to have the confidence that you have that edge and skill. The people that I interviewed did have the confidence and that edge. But you need to be realistic. If you’re going to earn your living literally by being more right than wrong in the markets, you really need to be better than the vast majority of people in the markets, and you need to know exactly what your edge is. I think that some people who contemplate being professional traders really couldn’t check off all those boxes. There’s some hope involved in there, and I think if there’s hope involved, then maybe professional trading isn’t the best way to go. You really need that sense of — I forget which trader in which book said it — but the line was something like, “You could put me down in any market anywhere in the world and I know that, watching the pit, I can become successful. I just know I can do it.” So, that is the type of mindset that you need, not misplaced confidence. If you aspire to actually be a so-called “professional trader,” you better be pretty sure that you’ve got that skill and that you’re confident about it. Part 2 of this interview with Jack Schwager will be published on Wednesday, November 19.