Huffington Post blogger and commodities trader Michael Martin's new book, The Inner Voice of Trading: Eliminate the Noise and Profit From the Strategies That Are Right for You, takes a candid look at the psychology of successful trading, with an emphasis on the "softer" side of the art of the deal. His theory? The industry's most successful traders find and then consistently use a trading methodology that's "in harmony" with their personalities.
In the following Q&A, Michael answered some of our questions about The Inner Voice of Trading.
Every year, there are 500 new "How To Trade..." books. If they were so good, we wouldn't need 500 of them each year. The goal for a trader or investor is to develop a methodology for managing risk that is congruent with their personality, so they have harmony in their lives. From Warren Buffett to George Soros, these managers are very self-aware. You're not going to find this wisdom in Graham and Dodd, but you will get a glimpse of it at Yogis Anonymous or the Lake Shrine, and that's what my book is trying to get across ever-so-delicately, without coming across as as full-on granola bar.
Is The Inner Voice of Trading a self-help book for "regular" investors or a how-to for aspiring traders?
In my experience as a contributor at HuffPost, the readers are astute, albeit politically biased. That said, I think the general reader would be interested to read about what actually goes on inside the minds of the world's most successful managers -- it's not what they'd expect. For the aspiring trader, I think it will surprise them equally, because trading is not about the "how to" part, it's about the emotional game that goes on inside your head.
Wall Street hired really intellectually smart people. Such people are not used to being wrong, as they've been straight-A students their wholes lives. That means they've demonstrated a high-level of accuracy in their studies.
Put those same brainiacs in a situation such as trader or portfolio manager and their accuracy rate drops to somewhere between 30 and 40 percent, so it becomes a game of mathematical expectation, not accuracy. That can mess with someone's head.
In Inner Voice you write:
... once they achieve a harmony between technical rules and self awareness, they discover an inner calm and sense of confidence. When this occurs, they hold conversations with what I call their inner voice. This is the one voice that the "market wizards" developed and listen to exclusively.
You sound more like a guru than a trading expert. Have you reached that "harmony" in your own trading practice? Can you describe the moment when you got there? Do you feel an inner calm and sense of confidence?
Trading is upwards of 70 percent emotional and psychological, so it's not the first time someone has said that. In my own trading, I realized that the bigger losses that I didn't like had been "baby" losses days or weeks earlier. The key was to cut them at the knees before they become "tweens" or teenagers. I think most parent readers can identify with that...
But that's a lot harder than it sounds. You don't know how low it will go, so there is a great deal of uncertainty. On top of that, smart people don't like being wrong. They've spent their whole lives studying and being graded on how accurate they are. Trying to replicate that in trading and investing is lethal at the get-go.
This is a macho, testosterone-fueled business. Is anyone buying the "inner calm" bit?
I think the film industry has painted a picture of Bud Fox, etc., but those aren't the traders or investors who make it to 60 to 80 years of age with a great track record. George Soros or Bruce Kovner didn't exactly take steroids or HGH to increase their returns. In fact, great traders and investors can talk about a 30-year track record only by keeping losses small. That means they have to focus on playing superior defense, and that speaks to early surrender when they're wrong.
What is the difference between gambling and trading? Aren't these investment "pros" really gamblers by nature?
It's a fair question. Although the math used can be similar, there is a striking difference between a gambler and an investment pro. Gamblers seem to like the "action" and they play for entertainment and pleasure, or what economists call "economic utility." More than the money they can win, they are playing for the emotional payoff, almost exclusively. You can know the approximate odds in poker or blackjack, however, so they are excluded. Most gamblers have no idea what the odds of winning are, nor the payouts if they win. Hence the term "gamble."
Traders and investors, on the other hand, focus on a process that they know makes money over hundreds of attempts (trades). They've tested their theories with computers and rely on the same math the casino relies on: that although they may lose very small amounts of capital 60 to 70 percent of the time, they make many more times their losses the other 30 to 40 percent of the time. Therefore, unlike the gambler who loves to pull the one-armed bandit or throw the dice because of how each throw feels, the professional investor loves the emotional payoff of following his/her overall process. They are not married to any particular outcome.
Do the rogue traders that rip off their firms and make headlines (the latest being the alleged $2 billion bilking of UBS by Kweku Adoboli) have any traits in common?
I wrote about rogue traders such as Hunter, Leeson and Kerviel. They all seemed to have gigantic egos and were not capable of suffering any humility... even privately. Each must have had some type of hero complex to trade the way they did. Each could have avoided their fate had they taken small losses, but instead of doing that, they actually added to their losing trades, making them even larger positions. When the trades continued to lose money, the rogues added more on, hoping that even a small recovery would bring them back to even. That is referred to as the "Moron Strategy." When things go against you, you put "more on."
What about the most successful traders? What traits do they share?
The world's most successful traders seem to sleep with one foot on the floor every night. When they smell smoke, they assume it's going to become a five-alarm fire very quickly and hence they cut losses. You can think more clearly when you are in cash, and out of the losing position. At the end of the year, when they look back on all their winning and losing trades, their large winners only look large to the extent that they kept their losses small. A couple of big losers, and they all net out.
They also have the propensity to be fantastically flexible in thought. They are not married to their theories. The world changes very fast. Another trait is that for all their wisdom and far-reaching understanding of the political economy, they are voracious readers. Victor Sperandeo has read over 2,000 books ... I've seen them. Paul Tudor Jones, George Soros and the soon-to-be-retired Bruce Kovner ... devour books. Bill Dunn, Michael Marcus, Ed Seykota and Linda Raschke -- traders whom I've interviewed for the book -- have very eclectic reading interests.
Discipline beyond what most people can fathom or endure. It's much easier to lack discipline in life. To perform consistently over several decades is superhuman.
I also think they have a deep appreciation for being trusted with client money and for being even-keeled. You don't get to build a 30-year track record by being a jerk.
What are the lessons here for non-professional traders, for ordinary investors? Particularly now, with all this market volatility?
For one, volatility does NOT equal opportunity. When the volatility of gold, for example, doubles and displays price changes that range between $80 and $100 per day, professionals head for the sidelines, whereas tangentially interested parties flock to gold, trying to get in on the action. The pros visualize what they can lose and how painful that will be, whereas the amateur sees only the opportunity and the joys of winning.