Hedge Fund Market Wizards Jack Schwager Interview

Michael Martin interviews legendary author Jack Schwager about his newest book Hedge Fund Market Wizards. Here are some of the most salient insights from this interview.

On Options

Jim Rogers once said that 90% of options expire worthless. But many of the traders in Schwager’s book buy options. So how do we reconcile this?

Schwager says that it’s true most options expire worthless, but you don’t have to buy options all the time. The traders in the book buy options at the right time, when they are more likely to expire in the money. When utilized this way, options limit risk and maximize reward and hence are great trading instruments.

Another highly beneficial feature of options is that they automatically enforce stop loss discipline. If the trade goes against you, your loss is strictly limited to the premium that you paid.

Be Flexible Like Gumby

A key feature of great traders is flexibility. They don’t get locked into being long or short. The example Schwager gave is Stanley Druckenmiller.

The Friday before the massive stock market crash of 1987, Druckenmiller was short the market, but then since he had made a fair amount of money he switched to long. Over the weekend he realized he was wrong, and decided to switch back to being short.

But the market opens down big on Monday. Despite the losses, he switches short and makes back a lot of what he lost in that single, horrible day.

Stops are for Losers

One of the traders in his book mentioned that stops are for losers.

But Schwager says that this trader’s statement is more nuanced than that.

Stops placed at obvious levels are for losers, because professionals know where they are and will try to run them.

Cutting losses is very important.

Lateral Thinking

Everyone knows about the crash of 2000. In hindsight, you might think that shorting the NASDAQ Composite was the obvious trade. But you are wrong.

After dropping the NAZ gave a massive whipsaw correction and rallied almost 40% blowing out a lot of stops.

You might have been right about the correction, but your stop was blown out and you couldn’t profit.

Another trader who made a a lot of money without getting stopped out, did so by thinking outside of the box.

Instead of shorting the NAZ, he bought treasuries. They did extremely well in the market collapse and didn’t exhibit the kind of volatility that would have stopped him out of the trade prematurely.

The Single Most Important Lesson

To succeed in trading you must use a strategy that fits your personality.

Jim Rogers is a 100% fundamental trader and he made enough to retire and travel the world before he turned 40.

Ed Seykota is a 100% technical trader and many believe he has generated some of the highest returns of all time.

How is this possible?

They both used strategies that fit their personality.