day orwhether his position was down thousands of dollars.
It was obvious from his inaugural experience that there was somethingvery different about this individual. On his ﬁrst day, the trading pit’s biggesttormentor raced up to Plantery with a closed ﬁst, appearing ready to swinga punch and yelling profanities. Without ﬂinching, Plantery stared the bullydown and with a cold, hard look proclaimed, “Take your best shot . . . thenI get my turn!” A long, uncomfortable silence followed. But the point hadbeen made. It was enough to stop the aggression and, more important,established Plantery as someone not to be messed with in the pit. But itwasn’t only the fearlessness that made the man; it was also the discipline ofdoing the proper homework and preparation before every trading session.Every day I watched Mark study price charts and headlines as if he werewatching game ﬁlms of opponents’ offenses.
In contrast, Hughes was pure speed and determination. A Harvard alum-nus, Hughes took the natural feel he had developed for hockey and used thespeed he showed on the ice to become one of the top local traders in theS&P 500 futures. He would be in and out of trades so quickly that he wasn’table to write up one side of the trade before immediately jumping on a bidor an offer to cover the position.
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You might think it would be the same for any athlete—say, a baseballplayer, a football player, or a basketball player—but not so. Anecdotally,the only advantage larger athletes have on the ﬂoor is a function of theirsheer size, which makes them more visible to the order ﬁllers in the pitor if they, themselves, are ﬁlling customer orders. But for whatever rea-son, hockey players and tennis players have consistently been able to takethat intensity and draw through the emotion of the moment of the trade,thus becoming great locals. Both great hockey players and great tennisplayers think and act much like great chess players in that they are al-ways thinking two or three steps ahead of the game. Tennis players aretaught to automatically envision two or three shots in advance of the onethey’re playing. The same is true for hockey players, who are trained toplay both offense and defense up and down the ice, regardless of theirgiven position.
But athletes aren’t the only ones who seem to make natural traders. Thesuccess stories encompass everyone from construction workers to electri-cians to computer salespeople. A seemingly endless list of occupations,both white and blue collar, have been abandoned for the thrill of victory inthe futures markets. The pit is one of the few places in the world where anMBA stands next to a former truck driver, who’s standing next to a formerprofessional athlete, and they all have roughly the same opportunity to suc-ceed. It’s not that former athletes are any more intelligent than the rest ofthe crowd—they just seem to ﬁnd the relentless daily physical and mentalpressures a lot easier to handle than those from ﬁelds that do not routinelyrequire that kind of daily psychological and bodily abuse.
AVERAGING DOWN
The thing that new traders don’t understand and what the general publicdoesn’t realize is that not only is the personality of these traders uniquebut it really becomes part of the methodology used to trade. For example,former athletes usually become scalpers, which requires a very high level ofintensity and stamina. Remember, scalpers don’t hold a trade for more thanseconds. In fact, it’s been said that any scalper who holds a trade for morethan a minute or two is probably stuck on that trade and will inherit a defacto opinion without qualiﬁcation or research. One of the biggest mistakesmade by new scalpers is that they add on to losing positions, looking tomaintain an average price as the market goes against them. More often thannot, the traders keep adding to the loser, hoping to break even on the tradeby creating an average price that will allow them to scratch the position ortrade out of the contracts with a small proﬁt. This is called averaging down.
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When I ﬁrst came down to the ﬂoor, I met a wise old man named Sam,who took a liking to me. I tried to make Sam laugh by telling a joke everytime I saw him. Knowing I was a new member, he would walk by my deskevery morning asking about the day’s data or economic releases. hopingthat I would start looking at the correct indicators. As I began to trade, Inoticed that Sam would watch me from his spot in a quiet section of the pit.After my ﬁrst full week of trading, during which Sam, my new guru,watched everything I was doing, he took me aside and said, “Jack, you’reArmenian, right?” I said, “Yes sir, what about it?” He continued, “Well, myboy, don’t ever forget that averaging down killed more Armenian tradersthan the Turks.” He said it with the affection of a loving grandfather, andthen quietly walked away. I didn’t know what to make of the comment. Itshocked me at the time because I had been averaging down my positionfrom the moment I started trading.
He had watched me buy one and then buy another one and then buyanother one. I added on to the position four times, all of which were losers,before ﬁnally covering the trade and establishing a loss. The logic was thatif I kept my average price lower and lower as the market went down, itwould be easier to break even on the position. Think of how idiotic trad-ing in that manner really is. Average up . . . to catch up! Even though I wasa new trader, I had been around the ﬂoor for years prior to becoming amember, so the revelation that I was making what was considered a be-ginner’s mistake was crushing to my fragile trader’s ego. But Sam’s com-ment taught me an important lesson about risk and reward. It made nosense to add to losing positions just to even up my exposure. The risk-to-reward ratio was way out of whack! This was not the way to trade themarket.
BORN TRADERS
Some of the greatest scalpers I’ve seen are people who must have been bornas pure traders. The best example of the quintessential scalper is DonaldSliter. Growing up in Rogers Park, my old working-class neighborhood onthe far north end of Chicago, Sliter was known as one of the local toughguys. But something always stood out about Don that separated him fromthe crowd. He was always a bit smarter than the rest. When his friendsstarted ﬁghts, Sliter tried to break them up. When they drank in bars, hewas always the bouncer. And when his friends gambled on sports, Donﬁgured out how to middle the point spread. What Sliter lacked in the wayof a formal education, he made up for with a natural gift—an instinctual gutfeeling.
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If you were to ask Sliter what makes him a good trader, he would have ahard time explaining the qualities that give him an edge. Sliter’s philosophyinvolves the frequency of trades. To watch Don trade is to watch a master;he plays the pit and the order ﬂow as if it were a violin, making sweet musicwith every proﬁtable scalp. He’s been known to say that the rest of themarket trades against support and resistance but they fail to realize thatthere are hundreds of proﬁtable trades hidden between those levels. Thisis the type of comment that would be expected from a scalper. A positiontrader can’t think like that.
The one quality that every scalper in any market must possess is a totaldisregard for money. As the proﬁt and loss for the day are calculated, veryseldom do you hear scalpers talk in terms of dollars and cents; rather, theydescribe the equity swings as “ticks” made or lost. Maybe they’re entwined;maybe it’s ironic, but necessary that anyone trading the huge notional size ofa local would completely lack respect for capital. Bing Sung, my old mentor,would say to me that when you’re scalping the market you have to leaveyour brains at home. If you think too much about it, it becomes possible tothink yourself out of every trade made as a local.
As a scalper, it is imperative not to think about the notional valueof the position or the amount of risk acquired. For the very best, in-cluding Sliter, the amount of activity is dictated by the frequency of cus-tomer order ﬂow and daily intraday liquidity of a market. All scalpers willtell you that what makes them proﬁtable is the geographical edge asso-ciated with making markets in the pit when it’s the center of price dis-covery. It’s logical that the only reason a scalper will take down a largetrade is because there is a perceived edge in the trade. Many markets,especially in the stock index and ﬁxed-income futures, have experiencedthe proliferation of electronic trading, which has dwarfed the pit in no-tional value and rendered useless the geographical edge once associatedwith the pit.
So what happened to traders who had a geographical edge and watchedit slowly evolve into a technological edge on the screen? For many veterans,it became a matter of survival, and they began to reinvent themselves aselectronic traders. They morphed scalping into a different art form. Manyformer ﬂoor members left the trading pits and were able to take advantageof the spread between the e-mini contracts of the S&Ps against the largecontract, which has had a supplementary effect of creating an amazingamount of liquidity on the screen.
But more important, these traders picked up larger intraday patternsthat enabled them to use the same scalping techniques they used in theopen outcry pit on a grander scale and with many different marketsat their disposal. Their frequency of trade isn’t nearly as great in anygiven market as it was when they were on the ﬂoor, but they’re trading
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many different types of markets and it allows them the diversiﬁcationthat enables them to ﬁnd the higher-percentage trades that were formerlyhidden from them.
SPREADING
The world of spreading is completely different from those of other tradingmethodologies. A spreader is a trader or investor who takes out whateverdifferential might exist between two different markets and capitalizes onthat disparity. Some people trade an intermarket spread, which is one mar-ket’s calendar month against another calendar month, and others spreadintramarket, which is one contract against a completely different market.An example of an intramarket spreader is a trader who makes a market inpork bellies versus live cattle or S&P versus Nasdaq. An example of an in-termarket spread is trading the August live cattle versus October or tradingthe S&P December contract against the S&P March contract.
Trading the intermarket spread enables you to take advantage of theseasonal adjustments of the contract as opposed to the differential and pricedisparity between the two completely different markets. Spreading reallydeveloped into an art form in the 1960s as trading of the livestock productsbecame more and more popular. One of the pioneers in spreading, Joe Segal,came from the agricultural pits in Chicago. Joe was a good market makerwho discovered he could take advantage of a differential in prices betweenthe months of any given market as the seasonal adjustments came in thatwould create aberrations in pricing. Prior to Segal’s legitimization of thisart, the act of spreading the markets was never looked upon as a viabletrading methodology; in fact, many of the traders from that time frownedon the practice, as one of the byproducts of the strategy was that it madetheir markets more efﬁcient.
The most important ancillary effect of the emergence of spreading wasthe creation of instant liquidity. It’s a difﬁcult academic exercise to gaugeand understand where these markets would be without the spreaders, whomake huge markets for the commercial houses and other end users of theproducts. Spreading became more widely accepted as foreign currency con-tracts emerged, which quickly became a part of mainstream futures trading.As ﬁnancial futures proliferated throughout the 1970s, currency trading be-came more and more popular. Most educated players who trade the currencycontracts even today overlook the fact that every currency transaction isessentially a spread.
The differentials between the currencies—Swiss franc/Deutschmark,Deutschmark/yen, yen/British pound, the U.S. dollar/everything—becamewonderful ways to spread the Forex market with very little effort. Spreading
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is an art that has worked its way into many different strategies foundthroughout the trading community; it has helped generate a huge pool ofliquidity in every market and has been an intricate part of legitimizing theuse of futures among institutional users. One of the secrets of the tradingﬂoor is that the act of spreading and the personality of the spreader areunique. Spreaders are very risk-averse individuals.
SPREADERS AND OPTIONS
Spreaders will often tell you that they are not in the market to take risk.This seems like a strange comment coming from people who trade as aprofession, but the reality is that most spreaders don’t take much risk at all;instead, they are searching for proﬁt, which they lock in immediately. Mostoptions traders are naturally spreaders. Very few market makers will standin the OEX or SPX pits at the Chicago Board Options Exchange (CBOE)and speculate on puts and calls; if anything, they look for the same type ofaction that excites futures spreaders. They look for value or for aberrationsthat will create opportunity and lay off the risk using another market oranother strike price.
Perhaps the most important thing about the personality type of spread-ers is that they think quickly. Speed in the thought process is the mostimportant quality that an options trader can have. Some of my clients weretraders who worked for Cooper Neff (CN), a derivatives company basedoutside of Philadelphia. With a great pool of intellectual capital and alwayson the cutting edge of technology, CN turned into one of the best optionstrading houses on the Street. They had a wonderful way of evaluating po-tential new employees by administering a grueling exam composed of mathand logic. The average person would take approximately an hour to com-plete the test; Cooper Neff would give the person between 5 and 10 minutes.The function of the test was to discover the personality of potential tradersand gauge how well they were able to estimate . . . or guesstimate. The aimof the exam wasn’t to test the knowledge of the candidates but to see howfast their minds worked and, even better, how that quick thinking could bemigrated to the markets.
It’s very important to keep in mind that the type of personality theCooper Neff brass was searching for incorporates quickness and ﬂexibility.The worst possible thing any spreader can do is to have formed an opinionabout market direction. The best spreaders in the world have the worst gutfeelings when it comes to picking the direction of the market. Vince andDennis, my old friends and clients, who have had probably the most suc-cessful index arb careers of any traders on Wall Street, used to be fond of
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telling me that when they walked in every morning, they placed their man-hood, ﬁguratively speaking, in a sealed jar in the coat room. (I’m assumingthey would reverse the process when they left for the evening!) As silly asit sounded, it was their way of telling me that they were not in the businessof taking uncalculated risk.
Another great options trading ﬁrm is a group called KC-CO, which had itshumble beginnings in the early 1980s. KC-CO is a quantitative shop that spe-cializes in exchange-listed options products. Based in Chicago and foundedby Kent Hager, a pioneer of the OEX options pit at the CBOE, the ﬁrm grewto include roughly 80 traders before being bought by the British institutionS.G. Warburg. The purchase came at a time when global players had arrivedat the conclusion that in order to survive they needed the ﬁnest systems forrisk analysis that were available. During the period from 1987 to 1992, smallregional trading house systems evolved into a global institutional method-ology. S.G. Warburg merged with Swiss Bancorp, which created regulatoryproblems and allowed KC-CO to buy itself back from the newly mergedinstitution.
The buyback enabled the original partners to reestablish the cutting-edge technology and regroup the brilliant human capital that once tradedaround the globe, combining these two factors to become a formidablenew player. The quantitatively driven methodology that is used by KC-CO,Cooper Neff, or any other successful derivatives trading group on the ex-change ﬂoors is exactly the type of technique that is employed to this dayby every major money-center bank and ﬁnancial institution.
The term used on the ﬂoor to describe both options traders and manyspreaders is quant jocks. This term implies that most of the trading de-cisions are made by taking a formulaic approach rather than from a gutfeeling. Some futures traders regard that as an insult; others seem to usethe term out of jealousy. I happen to be in the latter category. I lookat quant jocks with a certain amount of envy. I love the fact that thereare people out there who can look at numbers and ﬁgure risk and valueinstantaneously. Many of us wish our minds would work as fast as acomputer!
Writing that the personality of a position trader is unique is an under-statement. Position traders are usually investors in addition to the day-trading activity you might see in their trading accounts. Many good traderstrade around the core position, thus giving them a better price on the posi-tion. For example, a good position trader has a long position as a core butmight be in and out of that position many times during the course of thesession, always trying to maintain the core long.
Scalpers, spreaders, and arbitrageurs must be temperamentally suitedto handle the nuances inherent in their respective type of trading. The high-energy, short-attention-span scalpers possess traits that are best suited for
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their particular style of trading, but these would be an obstacle to spreadersor arbitrageurs trying to stay focused and methodically searching for math-ematical anomalies. Understanding how different these traits truly are andanalyzing the personality of a typical position trader are perhaps the mostdifﬁcult things to do as a student of the markets.
Every person who trades the markets—even someone trading in thesame style—is distinct in the way he or she approaches the difﬁcult task ofmaking a decision. It’s been said that great local market makers have pureenergy ﬂowing through their bodies; if that is the case, then “real” positiontraders have ice water running through their veins. If I were to gauge whothe greatest traders in the business are, I would have to say that positiontraders are the best. One of the wealthiest men I ever met best explainedit to me. When asked how he amassed a fortune well over $300 million, heanswered that it was important to ﬁnd the right horse . . . and keep ridinghim till he drops! I didn’t get it at ﬁrst, and then it hit me. He was tellingme that to ﬁnd real wealth an investor needed a long-term vision and thecourage to put capital at risk to make the vision a reality. If it’s the rightvision, stick with it and success will follow. Putting on any type of positionis a very difﬁcult thing to do.
POSITION TRADERS
The energy level for position traders is almost nonexistent. You put onpassive positions, and then you sit and you watch them. Position tradershave simple rules that every novice quickly becomes familiar with: Don’tadd to losers. Only add to winners. Cut your losses short. Let your winnersride! It might sound easy, but every wannabe futures trader has memorizedthese four rules of the game; however, only a handful of the millions whotrade around the globe have the ability to be real players. Many positiontraders will tell you that it’s much more difﬁcult to deal with a winningposition than a losing position. It’s easy to know where to get out of a losingposition by limiting your risk to a certain level, but dealing with a winningtrade becomes, at times, harder for the trader to handle because of theelement of the unknown.
The best of the position traders will tell you that they will not get intoa trade unless they know exactly what they want out of the trade. In otherwords, they have a target in mind before they even pull the trigger. Disci-plined investors understand that placing stops on losses is an importantpart of smart money management, but when they’re winning on a tradeand, more important, adding to the position, they’re letting it run, whichimmediately creates new disciplinary guidelines. It’s a very difﬁcult thingto digest as a new trader because it’s a very easy way to trade—putting on
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a position and just holding it. But to do it successfully time and time againand consistently come up with high-percentage trades that are proﬁtable isa very, very difﬁcult thing to do.
One of the best position traders to come out of the Chicago markets isa gentleman named Steve Helms. A product of Burlington, North Carolina,and Davidson University, Helms came to Chicago in the hope of learningthe world of commodity trading, to which he had been introduced backin North Carolina. He came to Chicago with modest means, but he intu-itively picked up on the markets and became one of the ﬁnest positiontraders in the agricultural markets at the CME. Helms moved on to theS&P 500 futures pit, but he always has positions on in many different mar-kets simultaneously. What made Helms a great trader on the ﬂoor and whatmakes him a great trader to this day is his ability to detach emotionallyfrom the trade.
I spent hours talking with Helms, and his eyes never made contact withmine, as he stared constantly at the quote boards or the Quotron headlinescreen, looking for his next trade. Helms’s strength as a trader, aside frombeing one of the most intelligent market observers known, is that he hasthe patience of Gandhi coupled with the guts of a riverboat gambler. Once aposition is established, traders can no longer be neutral; they have opinions,they have researched those opinions, and, most important, they have puttheir money at risk based on those opinions.
What makes Helms and other successful position traders different fromthe rest is their ability to do the homework and put on high-percentage tradesbut remain as objective to the market condition as humanly possible. Thisis not only a question of forming a methodology based on a combinationof fundamentals and technicals; it’s also a matter of having an intuitive feelfor the marketplace. Many position traders look at their technical work andform an opinion that the fundamentals might justify, but the gut feeling tellsthem it’s the wrong trade. Most of the time traders faced with a conﬂictinggut feeling will not make the trade even if their homework tells them it’s theright trade to make. All successful traders will tell you that they’re betteroff not making the trade that feels wrong because it would be hazardous tofuture trading decisions.
As Bing used to say to me, when you’re scalping sometimes you haveto leave your brains at home. I think that, as a position trader, the op-posite is true. Your brains are working all the time when you have thesetrades on, and if you fall asleep at the wheel, you could crash. In fact,the most successful position traders tell me that they go home and mon-itor the markets at all times. They watch business television into thewee hours of the morning and play around with positions in overseasmarkets while the rest of us are sleeping. What they are looking for issomething that might change—a news event, a corporate event, anything
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that gives them an informational edge and might drive the market oneway or the other.
A good example is the speech given in the mid-1990s by former Fed-eral Reserve chairman Alan Greenspan in which he referred to “irra-tional exuberance.” At the time he gave the speech, there was a roar-ing bull market and monetary policy seemed to be well maintained. Inshort, the market was not ready for it. Chairman Greenspan might havebeen right about the state of the market in the long run, but he wasway too early in his assessment of the situation. We saw the market re-act immediately to the downside, but it was a very short-term break. Im-mediately the market turned around and we saw a rally of biblical pro-portions, which lasted throughout the next four years and took both theS&P 500 and the Nasdaq indexes to record highs. The position traderwho monitored the “irrational exuberance” event realized there was some-thing signiﬁcant that could be read from the action. The fact is that themarket did not want to go down. It was a clear warning signal for any-one looking to try the short side of the market that this was no ordi-nary bull. The best traders got the message loud and clear—when thechairman of the Federal Reserve tells you equities are a little too highand yet the market rallies, all bears must hide! There were many sharptraders who made a fortune being long over the course of the next fewyears because they realized that, as a result of the Y2K phenomenon,we were entering a period of prolonged earnings growth that would beunparalleled.
OPTIONS TRADERS
Unlike position traders, options traders, aside from being spreaders, cansometimes be very robotic in the way they approach the markets. Watchingthe options pit trade on a daily basis would reveal countless market makersall staring down at a stack of papers that show value in any given strikeprice. All the traders are looking at spreadsheets showing how much acertain option is worth with the underlying market trading at various levels.In other words, the spreadsheets price the options as the market moves upand down. In this type of trade, the market direction takes a backseat to amathematical edge.
What most people don’t know is that all of these options trading groupsstation people in every options pit or electronic market in order to be fullyinformed about like-traded products. For instance, any ﬁrm serious abouttrading listed equity options will have a presence in the S&P options pitat the CME, the S&P 500 futures, the OEX and SPX options at the CBOE,
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and also any exchange-traded fund (ETF) that might have an incestuousrelationship with the other markets. Options traders and the ﬁrms theywork with have always been the segment of the industry that has pushedthe technological envelope as far as the exchanges will allow. A tradinggroup such as the one I described earlier would most likely have everythingelectronically synchronized to give every trader ﬁrmwide instantaneouschanges in positions as they occur.
As the positions are readjusted, the handheld proprietary screens cre-ated by the various groups show changes in the ﬁrm’s market exposure andany concentration of a particular strike. In many cases, these groups con-duct morning meetings that allow both managers and traders the ability toconceptualize what they want to do as a group. These meetings are vitalto the information dissemination within a group, and more important, theyprovide the traders with a collective brainstorming session, ensuring thatthe risk is laid off for any large, major standard deviation move to the upsideor the downside. It’s important to remember that options traders are roboticin their approach, and every position is quantiﬁed. They are looking to lockin proﬁt with a minimum of exposure but, more important, always positionthe ﬁrm to capitalize on any major move.
Options traders are the ﬁnancial engineers of the present day. Most oftoday’s globally available creative ﬁnancing and structured products tracetheir roots to the world of options. In fact, many of the options traders goto the large international institutions and come up with some of these com-plex over-the-counter products that are huge in notional value and tradeprivately between two qualiﬁed institutions. These products have becomeso large that they are now an intricate part of the ﬁnancial services land-scape. One of the interesting things about options is that any options traderor market maker will tell you that they make their proﬁts from others’hedges. What I mean by that is that when a customer wants to put on anoption position or an institution is looking to incorporate options into itsportfolio, usually it’s in the form of a hedge position. It is that hedge—thephysical act of executing the order—that options market makers feed on.It is their lifeblood.
Without the world of those seeking to hedge exposure, the world of op-tions market making would be a very unproﬁtable one. Very few of the largeinstitutional orders that come into these markets are speculative positions.In many cases—especially in the CME’s Eurodollar (ED) options market,which encompasses the short end of the yield curve—options are beingused for caps and collars, which give mortgage and ﬁnance companies theability to extend variable-rate loans with ceilings on interest rates embed-ded in every contract. A student of the market would have to agree that theuse of the ED options by these institutions is the intended purpose of the
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product. It’s why all futures contracts were created—to give end users whatthey really need: risk management!
THE NATURE OF THE TRADER
The one thing that all of these different types of traders have in common,whether they are scalpers, position traders, spreaders, or options traders, isthat those who succeed understand the nature of the trader and the person-ality required to survive in this realm. Scalpers who trade in an open outcryarena drive the market one way or another through the cooperative effortof the community as a whole. This is still evident in many of the New Yorkmarkets that have clung to the Luddite mentality and resisted electronicmarkets and the technology that brings the world into their markets.
If the pit gets too long or short, you could see the market react accord-ingly. A position trader, however, takes advantage of the aberration createdby the concentration of loc