You can’t stop the waves, but you can learn to surf. —JON KABAT-ZINN
“Cut short your losses, and let your profits run on.” That’s The Rule. That’s Larry.
I also want my grandchildren and their generation to see that many more things are possible if you make the right bets—not only in your money life but in your love life too. Bets are just choices we make.
I was born to a lower middle-class family, had a major learning disability, did poorly in school, and was nearly blind (completely blind in one eye and half-blind in the other). I was not handsome. I was not athletic. Today, I am a self-made multimillionaire. How did I do it? I made a bet on myself and won. You can absolutely do this too.
The real question is, “Who did I write this book for?” It’s for the overweight girl who did not get invited to the high school prom. It’s for the last guy never chosen for a baseball game. You know, that hurts a lot when you are a kid. It’s for the star athlete too—because somewhere he, too, had hard things to overcome. In short, my lessons are for everyone who did not know how to win in grade school or high school or at any time in life—which means it’s for all of us.
Cut your losses and stay with your winners. That is my credo for building wealth and achieving goals of all kinds. It’s my rule.
But what if I told you that I get up in the morning, look at some numbers, and ask myself what is the simplest way for me to get what I want? Then I spend 20 minutes making trades and I am free to go about my day.
you don’t bet your shirt. I will remind you again and again to never risk more than you can afford to lose.
(1) Get in the game, (2) don’t lose all your chips, because then you can’t bet, (3) know the odds, and (4) cut your losers and run with your winners. First,
This includes the story of how my partners and I founded Mint, which became the largest hedge fund company in the world and the first to trade a billion dollars. The
When I deliver talks to university students, I often discuss the seven questions they should ask themselves: 1. Who are you? 2. What is your goal? 3. What game do you want to play? 4. Where are you playing the game? 5. What is your time and opportunity horizon? 6. What’s the worst possible thing that can happen? 7. What will happen if you get what you want? This
I was an unremarkable kid, with no obvious abilities to distinguish me. In fact, I had profound disabilities. I did poorly at everything I tried and felt like a failure for most of my childhood. I tried my best to be mediocre because for me that was equivalent to winning the World Series (boy, that sounds pathetic as I write it). My two major problems that made me not “normal”? The first was terrible eyesight. I was born blind in one eye, and the other eye had very poor vision. My sight was so bad that when they conducted screenings at school, I could not see the E
I was extremely depressed for most of my childhood. At times I thought of suicide.
Why am I bragging about my failures? Because failure became my advantage and made me a great trader, and it can do the same for you. Let me repeat that: Failure was my advantage.
You don’t give up on love because you’ve had a few bad dates. We must fail at love before we find success. Love is not a game of perfection—it’s one of odds.
This led me to define a good bet as when you can make multiples of what you’re risking, and a bad bet when you are losing more than what you can possibly make.
There were times when I was a kid that I thought about suicide. I had no one who knew what I was going through. You think you’re a dummy. But you’re not a dummy. But what you are going through is a lot like hell. People tend to give up on you. In my case it was very hard to read books because I couldn’t see well and I had dyslexia. But what I had was imagination . . . You don’t need to see if you have imagination. It’s just you on the inside. I had to think for myself, because otherwise they were going to throw me in the garbage can. I knew that if I was going to survive, I had to take chances that weren’t going to kill me. I knew I had to think, but I couldn’t do it with a pen and paper, so I taught myself to train my mind. You can train your mind. You’ve got to have a goal, because goals make life simple. And making life simple is the key to winning. Part
Investing offered a path to wealth, and remember, my goal was to be rich. But also, investing is challenging, you meet interesting people, and the markets don’t care where you came from, whether you have a learning disability or bad eyesight, whether you are black, white, Jewish, thin, fat, gay, or straight. The market doesn’t judge you. Said a little more like we might have said on the Brooklyn street corner? The market doesn’t give a damn about you. But in return, and this is a golden truth, you can get rich and owe the market nothing. I love investing because it is about the truth and I found a place where I could be myself. And it’s turned out OK. I wanted to be rich and I became rich. But I also have had a good life and a lot of fun along the way. If you train your mind, you can too. Maybe with my logic you make a billion dollars (not great odds there) or make only a million dollars (much better odds there), but my insights, my hard-earned lessons, are where we all start.
what if you minimized your risk by making 20 small bets instead of placing everything on one or two? What were the chances of all 20 bets going down at once? Pretty small. And
When it didn’t go in the right direction, he got out. He did not call himself a trend follower, but he did practice the cardinal rule of trend followers: Cut your losers and let your winners run.
I looked for a simpler model to investigate. Eventually I found Edward O. Thorp’s famous 1962 book, Beat the Dealer. Thorp (a mathematics professor turned trader) tested thousands of blackjack scenarios and devised a system of card counting in which anyone could use the basics of probability and increase their odds of winning. Thorp spent a year running these scenarios using a massive room-sized computer at MIT. I
For example, you walk across the street looking intently at your cell phone ignoring everything. That’s a bad bet. You could get drilled by an old guy who can’t see over the wheel. But guess what? You’re lucky and you don’t get flattened. In fact, you are not lucky, because this is how you become desensitized to risk. What happens next? You brazenly continue your mindless walking practice until you get hit by a bus. If you keep placing bad bets, over time the law of averages will work against you. This is essentially the probability you never learned in school condensed into a useful heuristic you can use now.
realized I had bet far more than I could afford to lose. I had placed my bet considering the upside (as so many people do), rather than the worst-case scenario. I vowed never to do that again. Don’t forget, lesson number one is to get in the game. You can’t win the lottery if you don’t buy a ticket. But lesson number two is equally important: If you lose all your chips, you cannot
so I needed to find someone who could check my ideas. In fact, throughout my career I always needed quantitative people and computer experts who could execute my ideas. Because
I met Steve, a young quant who’d just graduated from Tufts. He and I copublished an article, “Game Theory Applications,” in the Commodity Journal.
We would look at a set of observable facts, or a single fact, which is followed by an event. Then we count the total number of times that those observable facts occurred, and divide by the number of times that these facts were followed by the event. That’s how probabilities are done. In
words, if you think the market will act a certain way under certain factual conditions, test it a thousand times to find out the odds.
Game theory
So by now, I hope I’ve made it clear that making room for losing and respecting risk are cardinal rules.
Remember, if you’re always winning but winning only small amounts, then you aren’t really winning anything.
To make big money, you have to always bet on something that has a potentially large payoff. If you do this regularly, then eventually the odds will work in your favor and you will win big over time.
A good bet is defined as having a high probability of making more money than you are risking, A bad bet is when you risk a lot for small or limited gains. As a speculator you should be in the good bet business.
If you play in a big game in an intelligent way, you can make a lot. If you are in a game where you can make a lot of money, you have to accept it. I
I decided to apply my investment strategy to my dating. And just as with investing, you can’t win if you’re not in the game. The problem for me was that in dating, the first bet people take is usually based on looks. I was not good looking—that was a simple fact—and therefore a social scene of a party or bar was not a great place for me to succeed with gorgeous women. So I came up with an idea to play the game differently in a way that increased my advantage of at least getting to the first bet. First step? I went to shopping malls because that’s where women strongly outnumber men. Then I kept my eye out for an attractive woman who was by herself looking a bit bored or perhaps on a lunch break. I’d go up and ask if she’d like to have a coffee. Since it was in a public place, it was safe, so this was not a ludicrous suggestion. About one in four women said yes. Then we’d have coffee. I was sure to show an interest in them and not talk about myself—also putting odds in my favor. If we got on well, I’d take the next step and ask them out to dinner. Only one in three would say yes to dinner. If that went well, we’d start dating. Using this method, I drank a lot of coffee and dated a lot of fabulous women. If someone is having trouble dating the right people or even dating at all, putting the odds in your favor like I did will always work.
Mr. Ricardo amassed his immense fortune by a scrupulous attention to what he called his three golden rules, the observance of which he used to press on his private friends. These were, “(1) Never refuse an option when you can get it
But the fourth is the most important. It is Ricardo’s Rule, for which I have named this book: Cut your losses, and let your winnings run. Put simply: When something is not going well, stop doing it. When something is going well, continue. This rule is at the core of my trend following approach to trading. I quote it nearly every day. If you prefer country music, you can quote the legendary song “The Gambler”: “You’ve got to know when to hold’em, know when to fold’em, . .
So for example, if the price of a commodity or stock is higher than it has been for 40 or 50 days, more people believe it is higher, so you can buy and ride this trend. When to get out? I simply ask myself how much can I afford to lose? If the answer is 2 percent, for example, then as soon as the price comes down by 2 percent, it is gone from my portfolio. That’s how much I’m willing to risk. In other words, cut your losses quickly and stay with your winners. This is what makes you money.
Richard Donchian, for example, is sometimes called the father of modern trend following. He was a trader who graduated from Yale and MIT and noticed that commodity prices often moved in trends, meaning that if something went up or down, it would likely continue in that direction for at least a little while. In the 1960s, he started writing a weekly newsletter called Commodity Trend Time, publicizing his “four-week rule,” strategy. He bought when prices reached a new four-week high and sold when they reached a new four-week low. So
To repeat myself, I’ve always built an assumption of wrongness into my trading, and this should be a mandatory practice in your own financial life too. Keep asking, “What is the worst thing that can happen in this scenario?” Then the worst-case scenario is my baseline. We always want to know what we are risking, and how much we can lose.
As my friend Michael Covel discusses in his book Trend Following:
What I am describing is quite different from Wall Street’s conventional advice, which tells investors to buy and hold with a passive approach to their portfolios. In this school of thought, you should do nothing when prices drop. The
Never, ever forget that no one can predict the future.
Let’s look at my basic method again, and I’ll show you what I mean.
Get in the game.
Set clear goals.
Minimize your risk.
Cut your losses quickly,
Where would you place your bets in each of these scenarios?
I recommend you practice losing money. In the long run, that will help you win big.
By 1990, less than 10 years after we started, we were the biggest hedge fund in the world with a record-breaking $1 billion under management.
One of the biggest engines behind our success was a risk management concept I called asymmetrical leverage (AL). AL is how I got rich and how you can too.
put it in zero-coupon, five-year US Treasury bonds where it would not only be perfectly safe but would also double in about five years’ time?
One of the earliest recommendations of this book is to know who you are. I have realized that I am happiest when I am independent and free to come up with new creative ideas to make money.
Cardinal rule number one, the name of this book: How much are you willing to lose?
Use the worst-case scenario as your baseline.
Only risk a very small percent of equity on any single trade.
At Mint, we never risked more than 1 percent of our total equity on any single trade. Repeat: not more than 1 percent on any single trade.
Spread your bets. Diversify and diversify again.
Stick with the plan. Like
We prioritized not losing a lot when we lost, but winning big when we won.
Also, tracking your volatility is a must. Volatile markets and recessions are contagions that can fool any expert. When a market is really volatile, we would stop trading and simply get out.
A 200-day moving average will be slower to reflect a trend, but stronger.
I may buy stock on a rising 200-day moving average and let it run, until it starts to decline by whatever amount I’ve preset that I’m willing to lose, then I get out. I’m not going to sit around for a loss. I’m not there to lose money.
I like to set a “trailing stop,” because these adjust to trailing value, and adjustment is very important. If you buy something for $100 and you have a 2 percent stop-loss—that’s $2 you’re willing to lose. Once the asset goes down to $98, you’re out of there. But what if the value first goes up to up to $110? With a trailing stop, you will automate your sell-off at 2 percent of $110, not $100. You stopped the loss but retained more value of what you won.
Stock options are a wonderful example of asymmetrical leverage. They do not cost much, but the potential upside can be very large.
I say, get smart and just enjoy it. Here’s a kid who was dyslexic, blind, a poor athlete, a poor student, and now a man living in an 11,000-square-foot house. The world could turn out to be a lot better than you think.
There’s a bad thing about being Jewish or Catholic, I’ve noticed: Being raised in these faiths tends to give you a sense of guilt. When things are going too well, you don’t believe you are entitled. In my early years, I was not prepared to be successful.
Choose your clients as carefully as you choose your investments.
Michael Covel has confirmed similar findings in his landmark book
IDENTIFY THE WORST THING THAT CAN HAPPEN IN ANY SCENARIO
a strategy with a 10 percent return over time should be expected to suffer at least double the annual return in a 20 percent drawdown
I am willing to lose a percentage, maybe 2 percent on a trade.
I get on and off trends, based on price averaging in various time intervals, 10 days, 100 days, 200 days—whatever the rule I decide. If a price goes above that average, you become a buyer. If a price dips below that average, you become a seller. The
Are they making a new high? That tells you the trend is up. Or if you hit a six-month low or one-month low, that is your stop.
So if one girl turns me down, I say thank you very much, and I go to the next girl and ask her for a dance. We dance a bit and have a good time, maybe we go to dinner, and then we have a big trend.
When the price makes a new high and you are there and can participate. When the market does something that shows me which direction it is going. If it jumps up over the six-month average, that is an indicator. That shows me which way the market is going. That’s the time. If you buy nothing but new highs in whatever market, then you must have a stop. The important thing is the stop. The stop keeps you alive. That’s it. Do you know who David Ricardo was?
LARRY: David Ricardo was one of the major, major financiers in the 1700s. He became one of the richest men in England. As a hobby he and a couple of guys happen to have invented market economics. But he loved the markets for trading, too. He used to say, when you go in and buy a stock, and it is winning, let your profits run. People get rich when they let their profits run. You just don’t know how far the run will go, so don’t get out early. You are looking for those huge profits, and you want to get as much as you can without making the risk more than 8 percent of your capital.
LARRY: The great thing about my style of investing is it’s been done before, and you can use your coding ability to look back in time and test trading rules against older data. You can see when a strategy works or doesn’t work. You see, the great thing about investing is you don’t have to invest. KOLADE:
LARRY: If you build simulations, you’re seeing mathematical evidence, probabilities, odds, risks. There is no wishy-washy in there. I like numbers because they’re not open to interpretation. They’re facts.
LARRY: The biggest fundamental in the markets are people. That’s it. People. People have not changed in thousands of years.
game. I keep my losses small and when I win, I win on a large scale so I am never in danger of having a negative mean.
Losing was normal, and I was intimately acquainted with it. I had lost so much that I had nothing to lose, so losing couldn’t crush me. I just kept getting up and trying again. That’s the real secret of winning.
your dreams can overcome your limitations.
But being a trader was possible because of my natural abilities, persistence, and how much I loved it.
My trading is based on speculation. But my life itself is also a speculator’s game.
My life is proof that a loser can win.
Comentarios
Publicar un comentario