Does a stock market trader need to be lucky? Or is there a skill that can be learned to get stock market trading success?
Jack Schwager, author of the Market Wizard series, examines the difference between having “luck” in stock market trading and having a well-informed system or algorithm to choose trades. Unfortunately, some investors think intuition is all they need to make great stock choices. Intuition and luck shouldn’t be the basis of trading decisions.
How do you know if you just got lucky or if you discovered a winning algorithm?
Jack emphasizes that vigilance and good research are the most important criteria for success with an investment portfolio. Being well-educated about the current market is really the best course for any investor.
Is the P/E ratio a reliable measure of a good stock?
Many investors depend on the P/E (price earnings ratio) of a stock as an indicator of whether it is a “good buy.”
Doug explains how the P/E ratio is calculated, discusses whether it really is a reliable measure of a quality stock. Is a stock’s P/E a reliable indication as to how it might perform?
Learn more about Jack Schwager by reading his Market Wizard series and his most recent book, A Complete Guide to the Futures Market: Technical Analysis, Trading Systems, Fundamental Analysis, Options, Spreads, and Trading Principles. Or learn more about his trading philosophy at FundSeeder.an analytical platform for traders that creates real time track records.
If you’re not already receiving updates on new episodes, sign up now, and as a special bonus, receive Doug’s free ebook The Retirement Planning Book.
Interview with Jack Schwager
Jack Schwager, who is regarded as a market wizard, lists two common denominators that all successful traders have. Find out what these are, and also if there is a secret formula for trading.
Douglas Goldstein: I’m very excited to have on, The Goldstein on Gelt Show, Jack Schwager, who is an expert in futures and hedge funds. He talks a lot about trading, and he’s written a series of books called Market Wizards.
In fact, his most recent book is a complete guide to the futures markets.
Jack, I have to be very honest with you because in this show, I often discourage people from trading. I’ve seen so many people blow themselves up from it.
I know that’s not your experience. Who is the right person to trade?
Who Should Be Trading, and Who Shouldn’t Be?
Jack Schwager: I think you divide the world into two categories when it comes to trading and investing: those who have superior knowledge and skill, and those who don’t know anything extra.
The latter group shouldn’t be trading because trading is basically a zero sum game. You can go long or short. If you don’t know what you are doing, you are just as likely to lose as win.
Over the long run, everybody pays commissions, so people will lose money if they don’t have an edge.
The only people who should be trading are those who’ve studied the markets and have some skill.
Douglas Goldstein: I like the term “superior knowledge.” Do you mean that they have some sort of inside information? Can someone who does his research well develop these skills?
Jack Schwager: I’m not talking about insider knowledge or anything like that at all. You could be a PhD mathematician who comes up with a formula that works to extract some inefficiency in the market.
In fact, some of the most successful traders of all time, who have literally made tens of billions of dollars in the market, have come via that route.
You could be somebody with great intuitive sense on the markets. I’ve interviewed people of that type as well.
Douglas Goldstein: Let’s talk about the intuitive sense thing because a lot of times people get a sense of something that’s going to happen or they’ll even do a good trade.
They sell out and then go, “Oh, because I knew the market was going to crash in 2008. I felt it was so high and so I sold.” Then you are thinking, “You were just lucky.”
Retrospectively, you think that you knew something. You reimagined history. How do you differentiate from someone who actually has the skill to be a trader and someone who was just lucky?
Luck Versus Skill in the Market
Jack Schwager: That actually hit two different points there: the question about intuition and the question about luck versus skill. The second one, lack versus skill, comes out in the wash over the long run.
Anybody can be lucky over the short run, but over the long run, true talent or lack of talent will blow one out.
The intuition part is also misunderstood. Intuition isn’t black magic or something odd. What it really is for people who are very experienced is they’ve been watching markets for years.
They have a lot of subconscious knowledge. They don’t even know everything that they know or all the patterns they’ve seen.
When they get an intuition, it’s subconscious experience coming through as intuition.
Douglas Goldstein: What about the intuition stories people like to tell for simple things. They say, “You know I have an iPhone or an Apple watch, or an iPad. I feel that Apple is a really good company.” They translate their enjoyment of the product into the company itself. Is that a type of intuition that people should be using to make investments?
Jack Schwager: No. That’s a great way to lose money. Because then you are taking a sample of one. Statisticians would tear their hair out on that type of an approach.
Douglas Goldstein: What about someone who is interested in trading and develops a system. Is that something that could be completely automated or do you still have to have a human who has a feel for the markets?
Automation and Trading
Jack Schwager: No, you can go totally computerized. You can develop algorithms that make decisions for every circumstance and even enter the orders automatically.
In fact, there are many traders who’ve done that. You can go anywhere from totally human to totally computerized.
Douglas Goldstein: Jack, you said that if you have an idea for how to trade, it’s something you could program into a computer and have it do everything for you, not only the analysis but also the trading. Is there some common formula that all traders have?
Is There a Secret Formula for Trading?
Jack Schwager: No, of course not. One of the most important lessons I bring out in my books, maybe the most important one, is that there is no such thing as a secret formula.
Everybody’s got to find their own approach. To quote myself in one of my books, I said something along the line of, “There are a million ways to make money in the markets. Unfortunately, they are all extremely difficult to find.”
Douglas Goldstein: Is it true that once somebody finds a model, it goes away after a while? Presumably, someone is doing well in the market because there is some inefficiency that he’s found, but after time you’ve traded enough time and that inefficiency disappears.
Jack Schwager: Yeah, that’s true for a lot of things, and strictly for quant models that’s true. For more discretional approaches and general trading principles, those things stay the same.
Things along the line of a proper risk management, and how to handle losing trades, and how to enter trades, and exit trades.
A lot of those things do stay the same, but particular inefficiencies certainly can exist and then go completely away.
Douglas Goldstein: Let’s take the scenario of a 30-year-old who has a day job and wants to begin to prepare for his retirement.
Is trading the way to handle a portfolio, or is it better to put it into index funds and let it go?
Jack Schwager: Trading is only appropriate if it’s a real passion and hobby. If you want to trade because you think you can make a lot of money better, I don’t know if that’s the best idea.
Trading, is more like life chess, but infinitely more complex. You have so many more dimensions and so many more complexities, and things are always changing. The patterns always don’t stay the same.
For people who like that type of puzzle, trying to beat the markets and are willing to devote time and read, research, experiment, watch, and have the time to do all that, then yes, trading is appropriate for them.
If they can develop a methodology, and get to a point where they think they have some edge and skill, then it will work for them.
For everybody else, if it’s not done right, it’s better not done at all.
Douglas Goldstein: I like that description. Sometimes people hear stuff from a webinar or see stuff on a website such as.
“Why don’t I spend my money into a property? I’ll buy it, flip it and I’ll make money. I can borrow money from the bank and then I’ll be using other people’s money.”
They hear this and they think it sounds good. They think, “Oh yeah. No problem.” Little do they realize that the people who are successful in the real estate business are people who are actually working.
That’s their job. They spend six, seven, eight, nine, ten, twelve hours a day dealing with it. The way you’re describing it is that people need to also spend time managing their trading portfolio.
Effective Trading Takes Time to Learn
Jack Schwager: That’s right. When I give talks, I sometimes use the analogy of, no sane person would ever go into a bookstore, assuming you can find a bookstore these days, go to a medical book section and take out a book on brain surgery, read it over the weekend, and think they can do brain surgery on Monday morning.
Lots of people go to a financial section, pull out a book How I Made One Million Dollars Last Year In the Markets, read it over the weekend, and think they can be the professionals.
There’s really no difference between those two, but people think completely differently about those two types of vocations.
Douglas Goldstein: Two things you said that I have to differ with. One is that people don’t do surgery. When I had my stitches that I had to take out, because I had a cut, I said to my daughter, who at the time was about 18, “Let’s watch a YouTube because I don’t feel like going to the doctor to have him take it out.” She did. She did a great job taking out the stitches. There you go.
Jack Schwager: But she didn’t do brain surgery.
Douglas Goldstein: Okay. What is it that makes someone a good trader? What is a personality trait that someone has to have to become, sort of, a wizard?
Two Common Denominators That All Successful Traders Have
Jack Schwager: Personalities are all over the place. In my books, I’ve interviewed people who are anything from very aggressive to very meek, friendly, you name it. There is no personality that goes with it.
I think the people who are good have great self-discipline; that’s a common denominator. They almost all respect risk. The importance of managing money and controlling risk to them is a far more important feature of success than the actual methodology.
They respect that and understand it. That’s a common denominator.
Secondly, they are very flexible and can change their mind. Somebody who is very dogmatic would be a horrible trader.
As a trader said, “If you are going to be successful, you have to be able to say the market is going up, the market is coming up, the market is going down.” Just change in an instance, if you have a reason to change your mind.
Douglas Goldstein: Those sound like great and important traits to have. I would say to anyone interested in learning more about this, make sure that you fit the model and that you are flexible.
Make sure that you are open to learning and to changing your mind if it turns out you were wrong.
Jack, unfortunately, we are just a bit out of time, but tell me in the last few seconds, how can people follow you and follow your work?
Jack Schwager: Just by looking up my name on Amazon, you can get to the books.
For most lay people, the Market Wizards books would be the easiest to read. A more analytical book would be something like my recent Complete Guide to the Futures Market.
I also have a financial startup called fundseeder.com that traders could check out, which is an analytical and graphic platform for traders that creates verified track records in real time.
Douglas Goldstein: Okay. Jack Schwager, thanks so much for taking the time.
Jack Schwager: Thank you.