Chapter Five

THE QUEST

How Do The Pros Make Money?

          If I was going to learn how to make money trading I was going to have to find out how others had done it.  I went and read the books and articles about, and interviews with, successful market professionals.  I studied the best investors and traders from Wall Street and La Salle Street:  Peter Lynch, Bernard Baruch, Jim Rogers, Paul Tudor Jones, Richard Dennis and many more.  After all, when you're sick you want to consult the best doctors, and when you're in trouble you want the advice of the best lawyers.  So, I consulted what the successful pros had to say about making money in the markets.  If I could figure out how they did it, I could still pull off getting rich again.  And this time I would keep the money.

          Below is some of the advice the pros offered for making money.  Appendix A has brief dossier on these pros for those of you not familiar with their names.

Advice and Dissent

          "I haven't met a rich technician." --Jim Rogers

          "I always laugh at people who say, 'I've never met a rich technician.'  I love that!  It is such an arrogant, nonsensical response.  I used fundamentals for nine years and then got rich as a technician." --Marty Schwartz

          Not very encouraging!  Okay, so maybe the key to success wasn't whether you were a fundamentalist or a technician.  I mean, I had made a lot of money using both of these methods. While I found technical analysis indispensable, there was nothing like a good fundamental situation to really make a market move.  Maybe another topic would begin to reveal the pro's secret.

          "Diversify your investments." --John Templeton

          All right!  Now I was getting somewhere.  This was striking a familiar chord.  Maybe I had placed too much emphasis on the soybean oil spreads.  I had too large a percentage of my capital committed to that market and that trade.  Even afterwards, I was trading only one market at a time.  This looked like my first lesson from the masters: diversify.  Or it looked that way until I read the following:

          "Diversification is a hedge for ignorance." --William O'Neil

          "Concentrate your investments.  If you have a harem of 40 women you never get to know any of them very well." --Warren Buffet

          Buffett has made over $1 billion in the market.  Who was I to disagree with him?  But Templeton is also one of the greatest investors alive and he said something totally opposite of Buffett.

          Okay, so maybe diversification wasn't the answer either.  Maybe you could put all of your eggs in one basket and still get rich by watching the basket very closely.  Perhaps the topics I had selected so far were too broad in their implications.  Certainly the pros would agree on the more specific and practical applications of investment and trading mechanics.

Averaging a Loss

          "You have to understand the business of a company you have invested in, or you will not know whether to buy more if it goes down." --Peter Lynch

          "Averaging down is an amateur strategy that can produce serious losses." --William O'Neil

Top and Bottom Picking

          "Don't bottom fish." --Peter Lynch

          "Don't try to buy at the bottom or sell at the top." --Bernard Baruch

          "Maybe the trend is your friend for a few minutes in Chicago, but for the most part it is rarely a way to get rich." --Jim Rogers

          "I believe the very best money is made at the market turns.  Everyone says you get killed trying to pick tops and bottoms and you make all the money by catching the trends in the middle.  Well, for twelve years I have often been missing the meat in the middle, but I have caught a lot of bottoms and tops." --Paul Tudor Jones

Spreading Up

          "When you're not sure what is going to happen in the market it is wise to protect yourself by going short in something you think is overvalued." --Roy Neuberger

          "Whether I am bullish or bearish, I always try to have both long and short positions -- just in case I'm wrong." --Jim Rogers

          "I have tried being long a stock and short a stock in the same industry but generally found it to be unsuccessful." --Michael Steinhardt

          "Many traders have the idea that when they are in a commodity (or stock), and it starts to decline, they can hedge and protect themselves, that is, short some other commodity (or stock) and make up the loss.  There is no greater mistake than this." --W.D. Gann

          I had expected there might be some subtle differences among the pros.  After all, some were stock market moguls, while others traded options or futures contracts.  But didn't these guys agree on anything?  Based on the examples above, they sounded more like members of a debate team trying to score points against each other. 

          I had to find out how the pros made money in the markets. I had to learn the secret that all of them must know.  But if the pros couldn't agree on how to make money, how was I going to learn their secret?  And then it began to occur to me: there was no secret.  They didn't all do the same thing to make money.  What one guy said not to do, another guy said you should do.  Why didn't they agree?  I mean, here was a group of individuals who had collectively taken billions of dollars out of the markets and kept it.  Weren't they all doing at least a few things the same when they made their money?  Think about it this way; if one guy did what another said not to do, how come the first guy didn't lose his money?  And if the first guy hadn't lost, why didn't the second guy?

          If imitating the pros was supposed to make you rich and not imitating them was supposed to make you poor, then each one of these guys should have lost all his money because none of them imitated each other.  They all should be flat broke because they very often did things opposite of each other.  It finally occurred to me that maybe studying losses was more important than searching for some Holy Grail to making money.  So I started reading through all the material on the pros again and noted what they had to say about losses. 

Losses

          "My basic advice is don't lose money." --Jim Rogers

          "I'm more concerned about controlling the downside.  Learn to take the losses.  The most important thing in making money is not letting your losses get out of hand." --Marty Schwartz

          "I'm always thinking about losing money as opposed to making money.  Don't focus on making money; focus on protecting what you have."(18) --Paul Tudor Jones

          One investor's two rules of investing:

"1. Never lose money. 

2. Never, forget rule #1." --Warren Buffett

          "The majority of unskilled investors stubbornly hold onto their losses when the losses are small and reasonable.  They could get out cheaply, but being emotionally involved and human, they keep waiting and hoping until their loss gets much bigger and costs them dearly." --William O'Neil

          "Learn how to take losses quickly and cleanly.  Don't expect to be right all the time.  If you have a mistake, cut your loss as quickly as possible." --Bernard Baruch

          Now I was getting somewhere.  Why was I trying to learn the secret to making money when it could be done in so many different ways?  I knew something about how to make money; I had made a million dollars in the market.  But I didn't know anything about how not to lose.

          The pros could all make money in contradictory ways because they all knew how to control their losses.  While one person's method was making money, another person with an opposite approach would be losing -- if the second person was in the market.  And that's just it; the second person wouldn't be in the market.  He'd be on the sidelines with a nominal loss.  The pros consider it their primary responsibility not to lose money.

          The moral, of course, is that just as there is more than one way to deal blackjack, there is more than one way to make money in the markets.  Obviously, there is no secret way to make money because the pros have done it using very different, and often contradictory, approaches.  Learning how not to lose money is more important than learning how to make money.  Unfortunately, the pros didn't explain how to go about acquiring this skill.  So I decided to study loss in general, and my losses in particular, to see if I could determine the root causes of losing money in the markets.  As I said at the beginning of the book, I may not be wise, but I am now very smart.  I eventually did learn from my mistakes.