technique that was being incor-porated became a self-fulﬁlling prophecy for a market that was alreadyin a weakened state.
Unfortunately, the strategy added incredible amounts of selling pres-sure, which helped to break the market. There are many reasons why thathappened, most of which have been ﬁxed through a strong cooperativeagreement among the exchanges in Chicago and the equity exchanges inNew York, with the Federal Reserve acting as ultimate vanguard. But themost important lesson learned from this experience is that at times hedgingsimply doesn’t work. It took a stock market crash for institutions that werenew to futures to learn what farmers and ranchers have known forever—that hedging is an art form like no other!
KNOW THE MARKET YOU TRADE
One of the biggest problems that I’ve seen over the course of the years is thatpeople get caught in bad trades in markets they simply don’t understand.Nothing is more painful than seeing good S&P futures traders stuck in a
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horrible hog position, having no logical explanation for why and how theygot into the position. It is very important to pay close attention to the marketthat you’re trading, so you pick up on the nuances of the trade. It’s clearthat knowing the players, knowing the participants, and knowing when thisﬂow is coming in and when they’re getting out of trades are what separatesgood traders from great traders.
You learn these things over the course of time, but even more important,you learn them through observation and by doing your homework. One ofmy ﬁrst employers was a great trader named Bing Sung. Bing was a boygenius, having graduated from the prestigious Phillips Academy in Andover,Massachusetts, at the age of 16, and from Harvard at the age of 18. By theage of 21, he was an associate professor teaching analytic decision makingat Harvard.
I considered Bing a mentor. He had both brain power and a great gam-bler’s instinct, a combination that made him one of the best market thinkersI have ever met. Bing went from being an academic at Harvard to helpingrun the Harvard Endowment Fund. After he had left the fund, I becamehis assistant on the ﬂoor of the CME, trading futures and options for himthroughout the course of the day and engaging in a daily Socratic dialoguethat taught me more than any university curriculum ever could.
“I ONLY KNOW HALF THE SCORE!”
Many of the lessons that I learned in trading the markets were learned fromBing during those ﬁrst formative years. In fact, many of the sayings that I useto this day originated as “Bingisms.” I ﬁnd myself, at times, unconsciouslyusing his colorful language to describe events when I do my daily TV shotson Bloomberg or CNBC, and I’m reminded of my early teacher as I hearmyself talk.
Spending hours on the phone with Bing gave me plenty of informationto process while attempting to execute my clerking duties without an error.Whenever the market began a signiﬁcant move up or down, Bing wouldask for my opinion. As I described to him the technical levels and the ﬂowmoving the market, he would invariably say to me, “Jack, my boy, that’s onlyhalf of the score. It’s as if you’re telling me that the baseball score is Cubs3, White Sox . . . silence?” I remember being confused by the comment theﬁrst time he said it. I asked myself if it was Bing’s attempt at being difﬁcult,but I eventually learned that he was trying to teach me that there was a largeorder moving the market—we just didn’t see it!
I would explain to him that I would see order ﬂow doing one thing oranother, that I would look at the board or check through our network and
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realize there was an asset allocation, but he would always follow it up witha compliment and then say, “That’s still only half of the score.” I wouldrespond, “I guess I need to do more homework?” He would usually laughand in his own colorful way say to me, “Don’t worry, sweetie pie, you’lleventually get it!”
Bing was a storehouse of information, showing me how institutionaltraders think and act and what strategies were driving daily volatility. Oneof the Bingisms I remember is: “There are over 2,000 rules in the book oftrading [an imaginary book he thought up] and over the course of my career,I’ve only learned 20!” Now that was over 20 years ago. I hope that Bing, asbrilliant as he is, would have been able to pick up on at least a thousandof those lessons by now, but I know that if I were to ask him that questiontoday he would say the number is probably no higher than 50. Still, learningthose lessons is worthless unless the trader incorporates what has beenexperienced into the daily routine.
DO YOUR HOMEWORK
Learning a hard-earned lesson in the markets and not using it to become abetter trader is a waste of energy and, even worse, a waste of money. Buthow do you try to ﬁnd the full score? How do you do your homework in anenvironment where the market information might not be transparent?
These are questions that all new traders should be asking if they areto regard trading as a serious business rather than a passing hobby. Newtraders are sometimes so enamored of charts and technical indicators thatthey neglect to study the real foundation of the price movements. This iswhere access to a proper information network is vital, and it’s likewisevital to keep your eyes and ears open at all times. In fact, I think the besttraders are those who hear and see everything around them, then reﬁne andsynthesize it into a trade.
In mid-October of 1987, I was on the phone with Bing, and we watchedthe market start to break hard. For those of us on the ﬂoor at that time, it wasan experience we’d never forget. Prior to this, Bing and I had participatedin markets that went down, and we were successful in making money, butthis was a trade that became scary. In fact, when I heard the fear in Bing’svoice, I started to become afraid myself. The conversation was no longercentered on whether to buy or sell the market, but rather on how muchdamage the system could endure. Would the economy seize up? It got tothe point where Bing started to be concerned about the entire bankingsystem, which worried me even more. Up until then, as a 26-year-old novicetrader, I had thought only about making the right trade.
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It had never dawned on me that we might be looking at the potentialcollapse of the entire ﬁnancial system as a result of a stock market crash.Fortunately, as we all know, the system didn’t collapse. In fact, years later,studies were released proving that futures helped save the system on theway down by being the only place where portfolio managers could limittheir risk—they acted as a buffer for a falling market. But what it taught meat the time, and what Bing’s concerns taught me, was to never lose respectfor the market. It can carry us all through!
That experience also taught me the importance of doing my homework.For months prior to the break, the long end of the interest rate curve wasyielding 10 percent, which created a serious competitive risk for the dollarsthat were being invested in equities. Bing had pointed that out to me time andtime again by recognizing an asset allocation order or by noticing volatilityin options premiums long before a volatility index (VIX) was created, but itwasn’t until we actually witnessed the market reacting to this phenomenonthat I began to feel the market as a trader.
THE PETER LYNCH METHOD
Knowing and understanding what you’re trading are not new concepts—and this does not just apply to futures. Peter Lynch, who managed FidelityMagellan, the best-known mutual fund in the 1980s and 1990s, talked aboutthat with regard to stocks. In fact, Lynch’s approach to investing is prob-ably the most practical methodology that the average investor could everadopt. His advice was simple: Don’t buy anything that you don’t know orunderstand! I learned from experience that taking a walk through a shop-ping mall could be just as effective as looking at a company balance sheet,and in many cases, it means much more.
Browsing a mall or a shopping center to see what people are buying willgive you an idea of what the trends are, and even more important, it will giveyou an idea of where future earnings might be. Practical information col-lected through observation, coupled with due diligence on company man-agement and governance, enables you to form an educated opinion abouta stock, its sector, and the economy in general. Better yet, it creates whatevery trader wants—a high-percentage trade!
I love telling the story about my daughter Emily coming to me with astock pick—Claire’s, a retailer that girls in her age group were frequent-ing. Emily was 13 years old at the time, and she and her friends spentquite a bit of money at Claire’s. Knowing I was a professional trader,she asked questions about what I was doing; as she began to understandthe basics of what drives stocks, she quickly developed an opinion. She
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urged me to buy stock in Claire’s because she thought it was a greatstore.
Although her purchases looked like junk jewelry to me, I realized overthe course of a couple months that it really wasn’t junk at all—the girls werespending a lot of money on it! In a last-ditch effort to be the Warren Buffettof the seventh grade, Emily pleaded, “Dad, please, I think you should buyClaire’s stock because we see a lot of people there and all our friends arespending all their money in the store.” I thought to myself, “Okay, Sweetie,what do you know?” I patted her on the head and assured her that I wouldtake her advice and buy the stock. The next day Claire’s announced earn-ings signiﬁcantly higher than expectations and the stock was up 10 percentwithin the ﬁrst 10 minutes of trading.
Having two teenage children is a retail stock picker’s dream becauseof the nature of the spending habits in their demographic. I ﬁnd myselfconstantly asking both my son and my daughter what they’re buying andwhat their friends and classmates are talking about. This gives me not onlythe parental control necessary to successfully raise teenagers today, butalso a knowledge base for a simple investment strategy.
WHAT ARE THE FUNDAMENTALS?
Another of the best-kept secrets on the Street is that many people tradingin the markets don’t really understand what the underlying contract they’retrading is all about. They don’t understand the composition of the indexesor the size of a cattle futures contract, but that doesn’t keep professionalsfrom placing huge positions in markets that might be a mystery. Case inpoint: Many of the professional liquidity providers trading the S&P futurescontract, both in the pit and electronically, don’t understand the basicsbehind the contract; they don’t understand how it is composed or rebalancedand what types of strategies are being engaged in the marketplace. The besttraders understand the fundamentals that drive a market on a daily basis,regardless of what they might be trading. When I raised this issue of marketknowledge with some of the greatest locals Chicago’s trading pits haveproduced, I got a deﬁnitive analogy in response: “I watch television, but Idon’t necessarily know how the machine really works.”
Most average investors and most traders assume that everyone on theﬂoor and in the pit is an expert on the capital market structure. Nothing couldbe further from the truth. I often tell people that their educated opinion isin many cases better and more informed than those of a majority of theprofessionals on the trading ﬂoors. Trading in a pit environment is much
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more physical than sitting and staring at a screen for a good portion of thesession. It’s very difﬁcult for traders on the ﬂoor to get accurate, timelyinformation because their attention is divided between the action takingplace in the pit in front of them and the large information wallboard wherethey might ﬁnd a headline that would change the pricing of the market atany given time.
THE LEMMING MENTALITY
Back when I was doing institutional brokering, I encountered two of theﬁnest traders that the index arbitrage world ever produced: Vince McLaugh-lin and Dennis DeCore. The two met at Merrill Lynch as the concept of stockindex futures was being introduced into the capital markets. Index arbitragetakes advantage of the disparity in price between the futures market and theunderlying cash market, creating the arbitrage. Pioneers in this game, Vinceand Dennis, over time, took the strategy to a new level. Later chapters inthis book will explore this strategy in more depth, along with the ancillaryeffects that are being created as a result of the sheer size of the arb positionsin the present-day market.
I consider the years that I spent on the phone with Vince and Dennisto be my version of graduate school. The two gave me a good feel for whatwas going on in the outside world, what was hitting the futures market, andthe aberration in pricing that occurred through various corporate eventsthat drove the index one way or the other. Vince and Dennis opened myeyes to a world that I had never been exposed to before. To that point, Ihad spent my career in the world of futures, and I had never been around orthoroughly understood the equity markets. The two worlds are so differentin terms of both culture and regulatory oversight, and these differenceshave been institutionalized since the creation of the Commodity FuturesTrading Commission.
As I now look back on the days I spent with Vince and Dennis, I ﬁndit strange how much of their vocabulary and personality worked their wayinto my market options and attitudes. Dennis, in particular, had a funnyway of describing what he saw as a foolish trade. A contrarian by nature,he loved to watch as traders moved the market, creating a stampede ofemotions that extended the moves and brought on aberrations in price. Hecalled this movement the “jumping of the lemmings.” Whenever the marketstarted running one way or another, Dennis would invariably say to me,“Jack, the lemmings are at it again.”
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Let me explain: The lemming is a rodent that has been mythologized asbeing suicidal—it’s possible to witness lemmings jumping off cliffs in Nor-way en masse into the sea. Thus, the lemming has always been associatedwith a herd mentality, regardless of whether the ﬁnal outcome is destruc-tive. Dennis hoped for that herd mentality to drive prices into the inefﬁcientcondition that allowed his trading desk to generate proﬁts. He often com-mented on the silliness of traders putting on positions and having enormousamounts of capital at risk because the trader next to them in the pit wasdoing the same—yet that’s exactly what would happen in the market at anygiven time of the open outcry trading session.
The best example of the lemming mentality is the Nasdaq bubble expe-rienced in the late 1990s. I had never seen a period in the market when moreprofessionals were bafﬂed by what was happening daily in Nasdaq stocks.I saw the most experienced traders in the world ﬁght the tape consistentlyfor the three or four years of the balloon and get to the point physically,emotionally, and ﬁnancially where an economic disaster was the only thingthat would make them break even, let alone make a proﬁt. These were notnovice traders and investors; they were seasoned pros who had been in thegame for 20 or more years and thought they had a full grasp of what droveprice action.
Many of the big bear funds and their bearish market strategists hadtheir day in the sun a few years later, when we watched valuations onsome of these tech stocks break down 90 percent from where they hadbeen during the late 1990s. But it was the lemming mentality that drovethe market to unforeseen heights and unattainable valuations, and it wasa good trader who could recognize and capitalize on the condition thatwas created. Perhaps the most difﬁcult thing to do as a trader is to bea contrarian and ﬁght the crowd by fading the collective bullish or bear-ish mood. When day traders see others putting on trades, they feel as ifthey’re missing the boat if they don’t have anything on—it’s only natural.Every trader who has had any success in the pits has adopted what I call atrader’s ego, which will not allow trading proﬁts to be the exclusive domainof the next trader.
One of the most important lessons the lemming mentality actuallytaught me is to make my own mistakes without following the herd. Whyshould I get an opinion from someone sitting in an ofﬁce a thousand milesaway from the action instead of using the tools I have at my disposalthrough observation and analysis? There are many wonderful techniciansand market strategists who have educated opinions on market direction orgeopolitical factors, but my opinion, based on their work, is the only onethat matters. It’s my own opinion that will either garner me a proﬁt or turnmy analysis into a losing trade.
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MAKE YOUR OWN MISTAKES
Every now and then I’ll get a call from somebody soliciting a certain stockor a certain strategy over the phone and I’ll ask the person why he or sheis making that recommendation. After going through an entire sales pitch,the person admits that the only reason this stock or strategy is being toutedis because it was on the recommended list of the person’s ﬁrm. I usuallyrespond to that type of solicitation by saying, “Thank you, but I can makemy own mistakes. I don’t need your ﬁrm or you to make them for me.” Italways surprises me that people will take their hard-earned money and putit at risk with information that is so often inept and incomplete.
What’s really ironic is that these are the same educated, Internet-savvypeople who will do months of research before buying a car or go to greatlengths to ﬁnd the right doctor, but they will make a trading decision basedon a whim or a gut feeling. Granted, a trader should not trade without agood gut feeling, but it’s an educated gut feeling that’s needed. A gut feelingthat is not supported by the proper homework or analysis is nothing morethan a gambler’s hunch.
A client of mine in the mid-1990s was an individual with one of thehighest net worths to ever trade futures for his own account. A natural-borngambler, he would refer to me as his “walking casino.” He was worth wellover nine ﬁgures and understood the concepts of risk and reward betterthan anyone else I had ever met, but he preferred a winning trade basedsolely on his feeling to one requiring days of painstaking analysis. Therewas nothing he liked more than making money in the market, but it wasn’tthe proﬁt of the actual trade that excited him as much as being right aboutthe market.
I realized that somebody who had made that kind of money and hadbeen that successful in life didn’t really care about the few hundred thou-sand dollars shifting from a proﬁt to a loss on a daily basis; rather, it wasthe trader’s ego that was involved with every decision he made. It was thepure satisfaction of knowing when he was right and the disappointmentwhen he realized he was in a bad trade and had to cover the position.Such emotions are incomparable! This man made and lost millions of dol-lars trading through me, but the one thing he would tell you to this veryday is that he enjoyed every minute of it because he made every decisionhimself.
For those who are successful in other businesses, the lure of the futuresmarkets is magnetic. More important, the ability to make an analogy be-tween their chosen profession or business and futures trading is absolutelynecessary in order for them to feel the action. One of the best descriptionsof the pit that I’ve ever heard came from this same wealthy gentleman, who
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came and watched the markets trade right next to me on the ﬂoor of theexchange. He saw the order ﬂow come in and out and watched the pit reactto every order. After silently observing the trading for 15 minutes, he turnedto me and said, “Oh, well, this is just like the auto parts business.” I told himI didn’t understand. “Well, Jack” he said, “I would give hub caps away forfree until somebody asked me how much hub caps were—then the pricewent up to $10 apiece.”
He had made the analogy between the auto parts business he had builtfrom scratch and the futures market—and it was perfect! He was sayingthat as demand for hub caps increased with the seasons, the price would goup. As demand dwindled and the way hub caps were used changed, priceswould go down. It was no different in the pit. His insight was a revelationof the obvious! But it showed me what had been drowned out by the noiseof the pit, offering me a crystal-clear lesson.
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C H A P T E R 2
Many Are Called,Few Are Chosen
P it etiquette is a custom created by the open outcry environment,
which essentially self-polices the trading activity in a given pit. Itwas common for traders to become “invisible” to the order-ﬁllingbrokers when they committed an act that was determined to be disrespect-ful of pit etiquette. One major violation of the practice was when a pit trader,watching another pit trader trying to buy or sell an order, jumped to grabthe trade and, even worse, made a market for the stuck trader at a proﬁt.
One of my earliest recollections of being on the trading ﬂoor was as arunner being shufﬂed between the Chicago Board of Trade (CBOT) and theChicago Mercantile Exchange (CME) in my ﬁrst weeks of employment. I sawtwo older veteran grain traders staring each other down. In the middle of analtercation, they were tossing obscenities obliviously, as if they were every-day adjectives. It became apparent that the short, rotund gentleman in his50s was accusing the other gentleman of stealing a trade. The smaller of thetwo took a swing and hit the larger trader so hard that it sent him to the ﬂoor,with papers, pens, and trading cards ﬂying out of his pocket. It shouldn’thave shocked me—I came from what I thought to be a somewhat roughneighborhood on the far north end of Chicago—but I nevertheless felt un-comfortable watching these two grown men, who were older than my fatherat that time, ﬁghting like schoolboys. The much larger and heavier traderwent down like a heavyweight ﬁghter catching a perfect punch on the jaw.As the exchange’s security guard arrived on the scene, I found my-self eavesdropping on the conversation and it quickly became apparentfrom the security guard’s tone that the aggressor of the incident wouldhave to pay a monetary ﬁne, which, in this instance, depending on the
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disciplinary committee’s ruling, could be in the neighborhood of $500.These days an incident involving physical aggression can cost a traderas much as $30,000 and a suspension that could last for months. For thevery worst offenders, it might mean expulsion from the ﬂoor. But thelate 1970s were a different day and age for the ﬂoor, and a country-clubmentality ruled.
As the dialogue turned to the prone body of the unfortunate recipient ofthe punch, the trader who had hit him pulled out a handful of hundred-dollarbills and threw them at the poor soul. The security guard, seeing that thepile of money far exceeded any ﬁne that would be assessed, asked with apuzzled look, “Why have you thrown down twice the normal amount?” Theaggressor responded, “Pick up every bill. When the son of a bitch gets upI’m going to hit him again.”
This was my ﬁrst revelation. At the time, I remember thinking to my-self, “Do I have the personality for this business?” In fact, I rememberscratching my head, observing the anger coming from this one gentle-man, and asking myself, “Is it possible for me to get that angry . . . at any-thing?” I realized that it takes a certain type of personality to be in themarkets daily and make a successful career out of the organized chaosthat I was observing. It was an eye-opener at the time, but I remember dis-covering that money intensiﬁes emotions more than any factor other thanreligious fanaticism.
WHAT ARE THE QUALITIES OFA GOOD TRADER?
The markets bring out the best and worst in a trader’s personality be-cause the act of trading the markets and putting capital at risk taps intoan incredible array of raw emotions. A trader’s true personality surfaceswhen he or she is faced with the difﬁcult decision of covering a losingtrade or is ﬁnally convinced to establish a position. Traders are a strangebreed. Superstitious by nature, some ﬂoor traders have been known towear the same shoes or tie for years because they consider these itemsgood luck charms. Even I ﬁnd myself falling into this pattern by walk-ing through the same turnstile every day and having a cup of coffee inthe same location. My day wouldn’t be complete if these little rituals werenot followed.
As a creature of habit, before every TV shot—and I do roughly 15 liveshots a week—I walk over to the same spot on the ﬂoor where I have con-ducted my business for 15 years. Standing next to John Scarnavac, AdrianByrne, and the rest of my former ﬂoor colleagues, I observe the market from
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my comfort zone and absorb the day’s events. I feel as if I can get a bettersense of the market’s pulse and, better yet, give TV viewers a solid reportby talking to the traders and brokers who are responsible for making theaction happen.
SCALPERS
To understand the personae of traders, it’s important to understand that thepersonalities of different types of traders are diverse. The personality of alocal who scalps the market during the day is much different from that ofa spreader who is taking less risk and trying to lock in proﬁts through thephysical act of laying off the risk in one market, or one sector of the market,against another. The personality of a scalper or spreader is much differentfrom that of a true position trader. Each of these distinct types of trader hasa certain type of personality that enables the person to do what is necessaryday after day. For many in the pits, it’s a question of endurance and mentaltoughness that separates success from failure on the ﬂoor, qualities muchlike those of professional athletes.
One of the interesting phenomena that I’ve noticed over the course ofthe last few years, and something that not many people would know, is thatathletes seem to make wonderful traders. It only makes sense—an athleteis trained, both mentally and physically, to endure the hardships of trainingand the pressures involved with the actual game. Athletes recognize thatthey are considered only as good as the last good season or, in some rarecases, the last play. The world of sports, much like that of trading the capitalmarkets, is not very forgiving.
SPORTS AND TRADING
Thus it should come as no surprise that many former college and profes-sional athletes look to the ﬂoor as a way of transferring the energy from theirchosen sport into a trading methodology and discipline that they can quicklylearn and understand. More speciﬁcally, of all athletes, tennis players andhockey players seem to make the best traders. One reason for this is thatboth tennis players and hockey players are taught from an early age to playboth offense and defense simultaneously. They are thinking defensively asthey’re playing offense; they are thinking offensively as they’re playing de-fense. This becomes an integral part of their approach to the game, and withmany traders it becomes a natural part of their approach to the markets.
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There are some great examples of tennis pros and semi pros who havebecome successful traders, many of whom are still on the ﬂoor of the ex-change today. Likewise, there are hockey players who have demonstratedtheir ability to succeed in the trading pits just as they did on the ice. Some ofthe best locals that the S&P pit ever produced can trace their roots to pro-fessional sports. The Hughes family—George, Jack, and Jim; Troy Murray;Jack O’Callaghan of Olympic gold medal fame; and Mark Plantery are only afew of the former hockey players who have become successful local traders.Mark Plantery and George Hughes, in particular, stepped into the pit withfearless attitudes and total disregard for the bullying tactics that seemedto dominate the crowd in their era. They came in with a mind-set acquiredduring their playing days, which is exactly what is needed to supply thecourage to trade.
Plantery started trading after playing professional hockey for six yearsin the National Hockey League and one year in Italy. He played with Winnipegand became a good defenseman specializing in penalty killing. I sat in aweas he and other former professional hockey players told stories of going upagainst the best players of the day, including the great Wayne Gretzky. Butwhat separated Plantery from the rest of the crowd, in my mind, was hisability to remain emotionally detached regardless of the market condition.Mark wasn’t the biggest trader in the pit, but what he lacked in market sizehe made up for with pure hard work and determination. That’s what madehim the deﬁnitive athlete turned trader, in my opinion. Looking into hiseyes, you wouldn’t be able to tell whether he was having a proﬁtable