Maverick Trading: PROVEN STRATEGIES FOR GENERATING GREATER PROFITS FROM THE AWARD-WINNING TEAM AT MAVERICK TRADING (GENERAL FINANCE & INVESTING) - Hardcover

FISCHER

Hardcover

ISBN 10: 0071784314 ISBN 13: 9780071784313

Publisher: McGraw Hill, 2011

Synopsis

Don’t conform to Wall Street’s rules. Be your own trader―Maverick style.

PROVEN STRATEGIES FOR GENERATING GREATER PRO FITS FROM THE AWARD-WINNING TEAM AT MAVERICK TRADING

Wall Street’s dirty secret is out―you don’t need a professional to manage your money, and you can beat the market on a consistent basis. All that’s required are three things: personal dedication, a sound risk management strategy, and the trading system outlined in this book. Yes, it’s that simple.

As active traders at the private proprietary trading firm Maverick Trading, the authors have taught hundreds of budding traders how to end their relationship with the so-called professionals and trade on their own, using the same system the firm used to generate gains of more than 100% in 2008, 50% in 2009, and 50% in 2010. It’s not a get-rich-quick scheme.

It’s a long-term methodology designed to create steady wealth you can live on, retire on, and pass down to the next generation. Maverick Trading teaches you how to:

• Design a portfolio using long and short options
• Read OHLC and Candlestick charts
• Hedge your investments with options
• Create a risk-assessment tool kit
• Mentally prepare yourself for the life of a trader

It’s not complicated. In the authors’ own words, “The system in this book relies on pattern recognition, impeccable risk management, understanding yourself, and fifth-grade math.”

The hard part is up to you. You have to make the decision to go all in. Full-time. No turning back. Once you do it, you’ll wonder what took you so long. Let Maverick Trading put you on the path to the life you were supposed to lead.

About this title

About the Author

Darren Fischer has evaluated and consulted more than 200 funds spanning asset classes such as hedge funds, private equity, venture capital, and real estate. He is a trader at Maverick Trading.
Jon Frohlich joined Maverick Trading in 2002. He travels across North America introducing nascent traders to the powerful tools he has learned.
Robb Reinhold has decades of experience as a trader. A passionate educator, he travels the world teaching and recruiting new traders for Maverick Trading when he’s not trading in the currencies market.

Excerpt. © Reprinted by permission. All rights reserved.

MAVERICK TRADING

PROFESSIONAL TECHNIQUES TO CREATE GENERATIONAL WEALTH

By DARREN FISCHER, JON FROHLICH, ROBB REINHOLD

The McGraw-Hill Companies, Inc.

Copyright © 2012 The McGraw-Hill Companies, Inc.
All rights reserved.

ISBN: 978-0-07-178431-3

Contents

INTRODUCTION
CHAPTER 1 Don't Put It All on Black: Risk Management
CHAPTER 2 Playground Economics: Determining Market Direction
CHAPTER 3 Reading the Tea Leaves: An Introduction to Chart Reading
CHAPTER 4 Options and Trading Techniques: The Secret Sauce
CHAPTER 5 What Are These Things in My Toolbox?
CHAPTER 6 Getting into the Game: Technology and Broker Selection
CHAPTER 7 Batting Practice: Paper Trading
CHAPTER 8 The Big Time: Live Trading
CHAPTER 9 You Versus You
CHAPTER 10 You Versus the World
CHAPTER 11 The End of the Beginning
INDEX

Excerpt

CHAPTER 1

Don't Put It All on Black: Risk Management

We don't care if you ignore every other chapter in this book and get yourtrading ideas by sacrificing a goat under the light of a full moon. If you don'tmake a commitment, right here and right now, to developing and following acomprehensive and methodical risk management strategy, please put this bookdown, walk over a few aisles, pick up Roulette for Idiots, and plan yournext trip to Las Vegas. There are a multitude of casinos that would like todevelop a lifelong relationship with you.

Trading without a risk management system is gambling. Gambling relies on hope.When you gamble, in the long run, the house always wins. The balance of thisbook will lay out in minute detail a proven system for making money in themarkets, but if you don't master risk management from the beginning, weguarantee that you will lose money, regardless of the trading or investingsystem you decide on in the end.

INEFFECTIVE RISK CONTROL

Ineffective risk control is, if anything, more dangerous than a lack of riskcontrols. At least with a lack of risk controls, your emotions will let you knowwhen the pain becomes too great, and you will liquidate your position. Adherentsof ineffective risk controls spout watchwords like an oracle and will oftenfollow their creed straight to a 55-gallon drum of Kool-Aid and an implodedportfolio.

This book is not a rehash of Warren Buffett's investment philosophy. Buffett'sstrategy, while successful, does not fit with our investment style.Additionally, a multitude of authors have covered and tried to emulate Buffett.

However, Buffett does have two rules that we follow:

Rule 1: Don't lose money.

Rule 2: Never forget rule 1.

Keeping this bit of wisdom in mind, we've found that we need to convince peoplewho are new to Maverick's system to break some bad (money-losing) habits.

Dollar Cost Averaging

This is also known as DCA. Should someone suggest with a straight face that thisconcept is either an investment strategy or a method of risk control, run, donot walk, out of his office. Such people should not be entrusted with a piggybank, much less with substantial amounts of capital.

In this misguided concept, you establish a position and then continue to add tothat position if it begins to decline in value, thereby lowering the averageunit cost of the position. The basic tenet of DCA is that you get to buy more ofsomething with less money. We would rather buy more of something with moremoney.

DCA makes a very large and dangerous assumption: what goes down, mustcome up. Wrong, no, nyet, nein, non. Just take a look at LehmanBrothers (bankrupt), old General Motors (bankrupt), Citibank (down 90 percentfrom its all-time high), and any of a myriad of stocks that either have gone theway of the dodo bird or have failed to exceed their previous highs of severalyears ago.

From an objective viewpoint, every dollar that your portfolio declines in valuetoday is one less dollar that you can use to trade tomorrow. Most amateurtraders don't understand the mathematics of dollar cost averaging on losingpositions. Imagine a trader who sells his winning trades after a $500 profit butlets a losing trade go against him, doubling and tripling down as the stockmoves lower. When he finally has to sell the position, he will take a loss ofseveral thousand dollars, erasing 5 to 10 of his positive trades. The negativemathematics of doubling down on losing positions ensures that the trader willhave an abysmal reward/risk ratio in the end. At Maverick, we teach pyramidingin winning trades to get the mathematics working in our favor, adding to atrader's reward/risk ratio.

The arguments made by financial advisors who advocate DCA as a method of riskcontrol have several implications that we disagree with philosophically. (1)These advisors tell you that you can't time the market, so don't worry aboutshort-term swings. (2) These same advisors illustrate the supposed benefits ofthis strategy by showing examples where the stock or mutual fund is higher thanyour entry price when you exit the position, with the implication that youcan time the market when you get out. If this isn't an example oftalking out of both sides of your mouth, we don't know what is.

Darren: In a previous firm, I consulted with alternative asset fundsseeking to raise capital from institutional investors. In 2008, I was speakingwith a long-only fund manager to determine if it would be worthwhile for hisfirm and mine to enter into a relationship. As any fund manager would be, he wasextremely excited at the prospect of gaining access to institutional capital. Hegave an elaborate presentation focusing on the fact that he was a stock pickerpar excellence and went over his entire methodology regarding how his bottom-upapproach was certain to pick winners "over the long run." For his cornerstoneexample, he highlighted an office supply company that was already in anestablished downtrend.

After listening to his presentation, I said, "Well, this looks interesting, butwhat do you do if you're wrong?"

His reply: "What do you mean?" A little red LED in my brain started blinking atthe rapid rate.

"When would you exit the position? What would you do if this stock dropped 50percent?"

"I'd buy more." Not with my money, I thought. I ended the call shortly afterwardand politely declined interest in working with his fund in the future. Thatstock did, in fact, go on to fall 50 percent from where it was when the managerrecommended it and has yet to recover.

Even professional managers who control millions and even billions in pensionfunds, endowments, and trusts can fall victim to the dangers of dollar costaveraging.

Efficient Market Theory

Proponents of the efficient market theory (EMT) hold that you can't time themarket, that the price action reflects all that is known about the stock at thetime, and that trying to time the market is ultimately detrimental to aportfolio. These people believe that the best investment philosophy is tosystematically invest in a broad-market index fund.

Ah, the world of academia. Viewed strictly at a single point in time, from astrictly economic point of view, this idea has a certain appeal, especiallyimmediately after significant events (such as earnings surprises, naturaldisasters, or management changes).

However, viewed over time and with some simple psychology, we have found thatyou can time the market, with remarkable accuracy. EMT fails to adequately takeinto account fear and greed among the market drivers (institutional investors).

Systematic Investing

Whoever first came up with the term systematic investing should beapplauded for her marketing genius (notice that we don't say her investingacumen). This concept conditions people to think that it's acceptable to losemoney. The implication is that the money manager to whom you are writing thecheck every month is smarter than you are. What crap.

This doesn't mean that you shouldn't put aside some income every month toincrease your trading capital. It just means that we don't feel it is prudent toblindly send a check to a mutual fund every month, regardless of itsperformance.

Systematic investing is an offshoot of dollar cost averaging. Think of it as DCAon a much broader scale with a marketing spin. In plain language, the mutualfund people are saying, "Send us a portion of your money on a regular basis,regardless of our performance, because we know better. Investing is dangerousfor you, but easy for us, and you'll just screw it up if you try to go it alone.Don't pay any attention to the man behind the curtain. Short-term losses are tobe expected; don't ask about underperformance, outright losses, window dressing,our modest management fee, the marketing fees we charge to let you and othersknow how great we are, or any of the other fees we use to bleed you dry and thentell you that losses aren't our fault."

The cold reality is that 75 to 80 percent (depending on the year) of so-calledprofessional mutual fund managers underperform their benchmark indices.To add insult to injury, the fund managers get to pick which index theybenchmark to.

"But what about peer rankings?" you say. That's like putting a bunch ofunderperformers in the room and ranking them by how little they underperformed.

Mutual fund charters often stipulate that the fund will be fully invested (lessthan 5 percent in cash) at all times. That's like saying, "You will stayon that ship at all times, even if it is sinking."

Blind Diversification

This theory holds that if you pick individual stocks, you should have someexposure to a variety of sectors (for example, having five technology companiesin your portfolio is not diversification, but having one company each from thetechnology, consumer staples, financial, energy, and industrial sectors isdiversification) because various sectors come into and out of favor in themarket, and as a few stocks lose value, the others will gain value. Thispractice offers some protection in a bull market, but what happens in a massivebear market where everything loses value?

You will see shortly that we trade our portfolio using a basket of positions.That is not the same as diversification. We are actively picking strong sectorsand weak sectors and taking positions accordingly.

Hope

Hope is the first form of risk control for many new retail investors. The hopemethod involves blindly buying a stock, often taking too large a position, andthen hoping the value increases. The hope method usually results in a newinvestor watching a position decline in value day after day. Occasional up daysare met with maniacal glee; the down days are met with increasing gloom andstress.

When the position moves substantially against them, such as a 10 percentcorrection or, even worse, a significant gap down, adherents of the hope methodsay, "OK, I can weather this. I'll just wait until it gets back to the price Ibought it at and then get out with a breakeven. I can live with that."

Unfortunately, these investors have just become part of the herd. All the otherinvestors, including institutions, who bought at an unsustainable high arethinking the same thing and acting the same way.

Often a stock will approach its previous high, probably where the investorsbought it, and then fail to break through to a new high. Then the mantra amongthe hope investors becomes, "Just one more day."

"Just one more day" turns into a week with further losses. The week becomes amonth. The trade becomes an "investment for the long term." Dollar costaveraging starts to look like a good option. The losing position becomes asubstantial portion of the portfolio. The pain mounts, and these investors arechecking the position every 30 minutes. Finally, the pain becomes unbearable,and they capitulate and wind up selling at the bottom.

All of these are ineffective risk controls. They do nothing to actually controlrisk and actually contribute to and reinforce losses.

WHAT CAN YOU CONTROL?

To clarify a few things:

1. You are a retail investor/trader. Your purchase or sale of a few hundred or afew thousand shares of a stock will not appreciably move the market, eitherigniting a bull run or precipitating a catastrophic sell-off.

2. Institutional investors (pension funds, market makers, endowments, long-onlyfunds, mutual funds, and hedge funds) are not actively out to make you losemoney. Their primary concern is making money for their funds and their clients.Quite simply, they don't care if you come along for the ride or get run over bythe bus.

3. You cannot anticipate every piece of information that will affect themarkets, so don't try. You don't control what goes on in another country, what acompany's earnings announcement will be, what an analyst will say about saidearnings, or how the institutional investors will react to any piece of news.

4. The only things that you can control are which positions you take and howmuch capital you are willing to risk on each position. That's it.

Of the two things that you can control, position selection and the amount ofcapital you are willing to risk, the amount of capital you are willing to riskis more important. You will never be correct in 100 percent of your trades orinvestments. When you are starting out, you will be doing well if 50 percent ofyour trades are profitable. As you gain more experience, a good year will be 60percent correct trades. Any year you bat over .700 will be a year to remember.The sooner you accept these statistics and move on, the sooner you will beprofitable.

To make trading a long-term, profitable career, you need to adopt the mantra, "Iwould rather be profitable than right."

NOT ALL LOSSES ARE CREATED EQUAL

A loss is a loss is a loss, isn't it? No. There are many factors that can causea loss. Price, timing, direction, momentum, volatility, and external factors canall cause losses. In the following chapters, we will be discussing strategiesprimarily involving options. You will find situations where you may ultimatelybe correct on direction, but you are off on timing, and the decay in time valuemakes the position lose value. Likewise, volatility in a position may makecertain strategies and tactics prohibitively expensive, so that the reward/riskratio doesn't make sense. In other instances, you may find an outperformingstock with an excellent setup, but a broad-market move may move the positionagainst you.

As mentioned previously, an experienced trader, using established guidelines andentry points, should expect 60 percent correct trades. Put another way, evenwhen you do everything correctly, four out of every ten trades will lose money.The losing percentage is even higher for a trader who trades by the seat of hispants and bases his decisions on emotion rather than rules.

A trade that moves against you and is exited at a predetermined loss after beingproperly selected with a high-probability setup and with the appropriatestrategy is an acceptable loss. Letting a trade move against you when you haveno predefined loss limit is not an acceptable loss.

TRADING AS A BASKET

No trader enters a trade expecting to lose money. Ask a trader right before orright after she enters a trade what she expects to happen, and you willuniversally hear that the trade will be spectacularly profitable. Unfortunately,for a significant percentage of trades, this is not the case.

Trading as a long-term career is a game of statistics. Some trades will beprofitable, and some trades will generate losses. The common cliché is to letyour winners run and to limit your losses. This is easier said than done,especially for traders who have never been taught risk control.

A common and career-shortening practice of new and/or undisciplined traders isto devote all their available capital to a single trade at a time. Additionally,maintenance margin requirements typically allow traders to increase theirposition after an overnight holding period.

Increasing a position in this manner can produce spectacular gains, but moreoften it produces spectacular losses, unnecessary stress, and interference witha trader's objectivity.

For example, using some system (which one is immaterial at this point), a traderidentifies what looks like a good trade in XYZ Corporation. Let's say he has$10,000 in a margin account, the overnight margin requirement is 50 percent, andthe maintenance margin requirement is 25 percent.

Absolutely convinced that this trade will produce a profit, the trader buys$20,000 of XYZ (half of which is his $10,000 and half is the broker's money).The next day, the stock hasn't moved appreciably. As he looks at his tradingpower, the brokerage says he has another $10,000 in buying power at his disposal[his $10,000 account less $5,000 (25 percent maintenance margin on $20,000 inXYZ stock) divided by 50 percent (the overnight margin requirement)]. He buysanother $10,000 of XYZ.

On Day 3, he finds that he has another $5,000 in buying power, so he adds to hisposition again, ending up with $35,000 in XYZ.

After the bell on Day 3, an event occurs—let's say an earningsannouncement—and XYZ gaps down 5 percent. The value of his XYZ position isnow $33,250, a loss of $1,750. A 5 percent drop in XYZ decimated his account by17.5 percent. Additionally, because of the volatility, the brokerage mayincrease the maintenance margin requirements on XYZ, and the trader may face amargin call or forced liquidation. This series of actions is summarized inTable 1-1.

Additionally, the trader now needs to make trades equal to a 21 percent gainjust to get back to his starting position.

Typically, one of three things will happen: the trader will make more all-or-nothingbets (often incurring even greater losses), he will throw in the toweland not trade anymore, or he will learn risk controls and methodically work hisway back to profitability.

It can't be stressed enough that at least 40 percent of your trades willgenerate losses. It may be the first 40 percent, the last 40 percent, orinterspersed throughout the trading activity of a year. Despite all thepreparation that you will do prior to a trade, you never know whether the tradewill be a winner or a loser until it is done.

The key is to not incur a loss in any single trade that is so catastrophic thatit knocks you out of your trading career.

Rather than devoting all your preparation and effort to finding a single tradeat a time and then committing all your capital to that trade, the better, safer,and less stressful method is to find and make multiple trades at the same time,ending up with a basket of positions.

At Maverick Trading, we will typically look at three to six setups per week, ofwhich one to four will trigger (we will discuss trade triggers at a later time),and we will commonly have between four and ten open positions at any one time.Over the course of a year, we will make between 150 and 200 trades.

This practice forces traders to continually refresh their portfolios,eliminating languishing and unprofitable positions to free up capital for new,potentially profitable setups.

Figure 1-1 is a fairly common statistical distribution of trades for atrader who does everything correctly.

(Continues...)

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Excerpted from MAVERICK TRADING by DARREN FISCHER. Copyright © 2012 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

Edition details

• Publisher: McGraw Hill
• Publication date: 2011
• ISBN 10: 0071784314
• ISBN 13: 9780071784313
• Binding: Hardcover
• Language: English
• Number of pages: 304