The New Market Wizards: Conversations with America's Top Traders

by Jack D. Schwager

Is there anything you consider unique about your money management approach? Yes, I analyze risk by measuring the extent and duration of price swings. For example, if the market has risen 20 percent in roughly 107 days, even if I’m still extremely bullish I’ll have a maximum position size of 50 percent, because statistically we’ve reached the median historical magnitude and duration of an upmove. In other words, you vary the size of the bet relative to your perception of the market risk. Do you do anything differently in terms of cutting loses? Losses are always predetermined so that I can measure my risk. By “predetermined” you mean that you decide where you’re getting out before you get in? Exactly. Let me give you an example to illustrate why this principle is so important. Take the typical trader who gets a call from his broker. “Listen,” his broker says, “I have some information from a reliable source that stock XYZ is going to be a takeover play. It’s only trading at $20; it could go up to $60!” The trader buys the stock, and two weeks later it’s trading at $18. The action just doesn’t seem right, so he promises himself to get out when he’s even. The next week the stock is down to $17. Now he’s beginning to feel a little bit concerned. “I’ll get out on the first rally,” he vows to himself. One week later the stock is down to $15, and the trader, who has bought the stock on margin, suddenly realizes he’s lost half his money. Two days later the stock is at $14...