WHAT PAUL TUDOR JONES LEARNED FROM HIS WORST TRADE EVER
The Market Wizards series is a collection of books written by Jack Schwager that captures the philosophies, traits, experiences, and advice of great traders, seeking to draw out lessons that could help all traders from novices to professionals. The following is an excerpt from Jack about Paul Tudor Jones. A new never before seen video recalling this interview will be hosted to FundSeeder later this week.
In Market Wizards, the first book of the series, Schwager interviewed Paul Tudor Jones, who starting out his career as a broker. After successfully trading his own account, Jones launched his own fund in 1984. By the time he was interviewed for Market Wizards four years later, his fund had realized a more than 17-fold return since its inception. Jones continued on to become one of the most successful hedge fund managers of all time. The following excerpt from Market Wizards focuses on Paul Tudor Jones’s worst trade and what he learned from that experience.
You have done tens of thousands of trades. Is there any single trade that stands out?
Yes, the 1979 cotton market. One learns the most from mistakes, not successes. I was a broker back then. We had lots of speculative accounts and I was long about 400 contracts of July cotton. The market had been trading in a range between 82 and 86 cents, and I was buying it every time it came down to the low end of that range.
One day, the market broke to new lows, took out the stops, and immediately rebounded about 30 or 40 points. I thought the reason the market had been acting so poorly was because of the price vulnerability implied by the proximity of those well-known stops. Now that the stops had been touched off, I thought the market was ready to rally.
I was standing outside the ring at the time. In an act of bravado, I told my floor broker to bid 82.90 for 100 July, which at the time was a very big order. He bid 90 for 100, and I remember the Refco broker came running across the pit screaming, “Sold!” Refco owned most of the certificated stock at that time [the type of cotton available for delivery against the contract]. In an instant I realized that they intended to deliver against the July contract, which then was trading at about a 4-cent premium to the October contract. It also dawned on me that the whole congestion pattern that had formed between 82 and 86 cents was going to be a market measurement for the next move down [the break from 82 cents was going to equal the width of the prior 4-cent trading range].
So you knew you were wrong immediately?
I saw immediately that the market was going straight down to 78 cents, and that it was my blood that was going to carry it there. I had come in long 400 contracts, entered another 100 as a day trade, and a final 100 on that macho-type bid that I should never have made.
So you realized instantly that you wanted to be out.
No, I realized instantly that I wanted to be short.
How fast did you react?
Almost immediately. When the Refco broker shouted, “Sold,” everyone in the ring turned around and looked at me, because they knew what I was trying to do. The guy standing next to me said, “If you want to go to the bathroom, do it right here.” He said I looked three shades of white. I remember turning around, walking out, getting a drink of water, and then telling my broker to sell as much as he could. The market was limit-down in sixty seconds, and I was only able to sell 220 contracts.
When did you get out of the rest of your position?
The next morning the market opened 100 points lower and I started selling from the opening bell. I sold only about 150 contracts before the market locked limit-down again. By the time it was all over, I ended up selling some contracts as much as 4 cents below the point I first knew the position was no good.
Even though you reacted fairly quickly, you still took a big hit. In retrospect, what should you have done?
First of all, never play macho man with the market. Second, never overtrade. My major problem was not the number of points I lost on the trade, but that I was trading far too many contracts relative to the equity in the accounts that I handled. My accounts lost something like 60 to 70 percent of their equity in that single trade.
Did that particular trade change your whole trading style in terms of risk?
Absolutely. I was totally demoralized. I said, “I am not cut out for this business; I don’t think I can hack it much longer.” I was so depressed that I nearly quit.
How many years had you been in the business at that time?
Only about three and a half years.
Had you been successful up to that point?
Relatively. Most of my clients had made money, and I was an important producer for my company.
How about someone who had given you $10,000 at the beginning of the three-year period?
They were probably up about threefold.
So everyone who was with you for a long time was still ahead of the game?
Yes, but I had to suffer some intense drawdowns during the interim. That cotton trade was almost the deal-breaker for me. It was at that point that I said, “Mr. Stupid, why risk everything on one trade? Why not make your life a pursuit of happiness rather than pain?”
That was when I first decided I had to learn discipline and money management. It was a cathartic experience for me, in the sense that I went to the edge, questioned my very ability as a trader, and decided that I was not going to quit. I was determined to come back and fight. I decided that I was going to become very disciplined and businesslike about my trading.
Did your trading style change radically from that point on?
Yes. Now I spend my day trying to make myself as happy and relaxed as I can be. If I have positions going against me, I get right out; if they are going for me, I keep them.
I guess you not only started trading smaller, but also quicker?
Quicker and more defensive. I am always thinking about losing money as opposed to making money. Back then, in that cotton trade, I had a vision of July going to 89 cents and I thought about all the money I was going to make on 400 contracts. I didn’t think about what I could lose.
Do you always know where you are getting out before you put a trade on?
I have a mental stop. If it hits that number, I am out no matter what.
How much do you risk on any single trade?
I don’t break it down trade by trade. All the trades I have on are interrelated. I look at it in terms of what my equity is each morning. My goal is to finish each day with more than I started. Tomorrow morning I will not walk in and say, “I am short the S&P from 264 and it closed at 257 yesterday; therefore, I can stand a rally.” I always think of it in terms of being short from the previous night’s close.
Risk control is the most important thing in trading. For example, right now I am down about 6 1/2 percent for the month. I have a 3 1/2 percent stop on my equity for the rest of the month. I want to make sure that I never have a double-digit loss in any month.
One aspect of your trading style is a contrarian attempt to buy and sell turning points. Let’s say you are looking for a top and go short with a close stop when the market reaches a new high. You then get stopped out. On a single trade idea, how many times will you try to pick a turning point before you give up?
Until I change my mind, fundamentally. Otherwise, I will keep cutting my position size down as I have losing trades. When I am trading poorly, I keep reducing my position size. That way, I will be trading my smallest position size when my trading is worst.
What are the trading rules you live by?
Don’t ever average losers. Decrease your trading volume when you are trading poorly; increase your volume when you are trading well. Never trade in situations where you don’t have control. For example, I don’t risk significant amounts of money in front of key reports, since that is gambling, not trading.
If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in. There is nothing better than a fresh start.
Don’t be too concerned about where you got into a position. The only relevant question is whether you are bullish or bearish on the position that day. Always think of your entry point as last night’s close. I can always tell a rookie trader because he will ask me, “Are you short or long?” Whether I am long or short should have no bearing on his market opinion. Next he will ask (assuming I have told him I am long), “Where are you long from?” Who cares where I am long from. That has no relevance to whether the market environment is bullish or bearish right now, or to the risk/reward balance of a long position at that moment.
The most important rule of trading is to play great defense, not great offense. Every day I assume every position I have is wrong. I know where my stop risk points are going to be. I do that so I can define my maximum possible drawdown. Hopefully, I spend the rest of the day enjoying positions that are going in my direction. If they are going against me, then I have a game plan for getting out.
Don’t be a hero. Don’t have an ego. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead.
Jesse Livermore, one of the greatest speculators of all time, reportedly said that, in the long run, you can’t ever win trading markets. That was a devastating quote for someone like me, just getting into the business. The idea that you can’t beat the markets is a frightening prospect. That is why my guiding philosophy is playing great defense. If you make a good trade, don’t think it is because you have some uncanny foresight. Always maintain your sense of confidence, but keep it in check.
But you have been very successful for years. Aren’t you more confident now than you were before?
I am more scared now than I was at any point since I began trading, because I recognize how ephemeral success can be in this business. I know that to be successful, I have to be frightened. My biggest hits have always come after I have had a great period and I started to think that I knew something.
The Undiscovered Market Wizards Search
Jack Schwager is one of the cofounders of FundSeeder (fundseeder.com) a new online technology company that provides traders with a free graphic and analytics platform, as well as offering traders worldwide the opportunity to get discovered. FundSeeder’s technology allows traders to verify their track records, benefit from performance analytics and risk management tools, access an emerging manager support structure, find potential trader employment opportunities and, if regulated, connect with investors.
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