Jack D. Schwager is probably one of the best author on trading books that have ever been written. His first book, Market Wizards, published in 1989 has attained a cult status among market participants and helped them develop an edge and strategy that are important in money management business. In his latest book released this year, he interviewed 11 traders (6 futures and 5 stocks) and share the insights he gathered from the conversation. Below are the points made in the book, which do not do justice compared to reading the book itself, but serves as a personal reminder for me in the years ahead.

Every decade has its characteristic folly, but the basic cause is the same: people persist in believing that what has happened in the recent past will go on happening into the indefinite future, even while the ground is shifting under their feet. —George J. Church

While he was buying into weakness, he wouldn’t just put on a full position and hold it. He would probe the market for a low. He would get out of any trade that had a loss at the end of the week and then try again the next time he thought the timing was right. He kept probing, probing, probing.

“There are two parts to a trade: direction and timing. And, if you’re wrong about either one, you’re wrong on the trade.”

Yes, I saw that he took much smaller positions than he could. The lesson I learned from Dan was that if you could protect your capital, you would always have another shot. But you had to protect your pile of chips.

So it wouldn’t bother you going long at $1.50 after getting stopped out twice at $1.20? No, that has never bothered me. I think that type of thinking is a trap that people fall into. I trade price change; I don’t trade price level.

it is easy to believe in a trade that conforms to conventional wisdom. It used to bother me to be wrong on a trade. I would take it personally. Whereas now, I take pride in the fact that I can be wrong 10 times in a row. I understand that my edge comes from the fact that I have become so good at taking losses.

Nor does it make any sense to me that some people use their open profits on the trade to add more contracts. That, to me, is the most asinine trading idea I ever heard. If you do that, you can be right on the trade and still lose money. In my own trading, my positions only get smaller. My biggest position is the day I put a trade on.

Charts are wonderful in finding specific spots for asymmetric risk/reward trades. That’s it. I am focused on the probability of being able to get out of the trade at breakeven or better rather than on the probability of getting an anticipated price move.

I think there are things that the winners have in common. They respect risk. They limit their risk on a trade. They don’t automatically assume they will be right on a trade. If anything, they assume they will be wrong. They don’t get too excited about a winning trade or too bummed out about a losing trade.

They risk way too much. They don’t have a methodology. They chase markets. They have a fear of missing out. They can’t keep their emotions in check; they have wild swings between excitement and depression.

The essence of Brandt’s strategy is to risk very little on any given trade and to restrict trades to those he believes offer a reasonable potential for an objective that is three to four times the magnitude of his risk. He essentially uses charts to identify points at which it is possible to define a close protective stop that is also meaningful—points at which a relatively small price move would be sufficient to trigger a meaningful signal that the trade is wrong.

mathematically, by increasing position size, a method with higher return-to-risk can always be made to yield a higher return at the same risk level than a lower return-to-risk method (even if its return is higher).

Success in trading one’s own account will not necessarily translate to success in managing money. Some traders may be comfortable and do well trading their own money but may see their performance fall apart when trading other people’s money. This phenomenon can occur because, for some traders, a sense of guilt in losing other people’s money may impair their normal trading decision process.

If your portfolio is sailing to new highs almost daily and virtually all your trades are working, watch out! These are the times to guard against complacency and to be extra vigilant.

Brandt’s motto is: Strong opinions, weakly held. Have a strong reason for taking a trade, but once you are in a trade, be quick to exit if it doesn’t behave as expected.

It was like Jesse Livermore used to say, “You make your money in the sitting.”

We used to have a saying in Hong Kong, “Should’ve been up, but it’s down, so short it; should’ve been down, but it’s up, so long it.” That trading philosophy became the basis of what I wanted to do: When the tape is telling you something, don’t fight it; go with it.

The low of the reversal day will be my stop. I’m not going to argue with it. If I go long, and the market goes back to the low of that day, I’m out. I’m so disciplined with this stuff. It’s not just that I have a stop on every trade, which I do, but that I have a stop that is based on some meaningful market move. The news came out, the market gapped down, and then it closed up. OK, that low is going to be my stop forever. If that low is hit, I’m out.

By definition, everyone can’t make outsize returns. So if everyone is doing something, the only way to make outsize returns is by being on the other side. The great thing about the markets is that I can wait until there is a confirmation before taking the opposite position.

People fail, and they quit; they get scared. For some reason, I have a risk instinct. I hate failing, but I don’t mind taking the risk and then failing.

Markets bottom on bearish news and top on bullish news.

I learned that keeping losses as small as possible is critical to capital preservation. The most crucial thing in trading is mental capital. You need to be in the right headspace for the next trade. I find that when I go into a deep drawdown, my mindset is not right. I might start forcing trades to try to make money back. I might get gun-shy about taking the next trade.

When Brandt gets into a trade, he expects it to work straightaway if he is right. The best trades just go. If there is any sign that the market isn’t doing that, he tightens his stop for getting out. That approach fits the way I trade the fundamentals.

sometimes, when I did get out, the trade would then go to the target. When that happens, it teaches you to do the wrong thing, which is to hold on. The problem is that you only remember the times you got out, and the trade then went to the target; you don’t remember all the times when you got out, and it saved you money.

If there is an explosive upmove, I will tend to take profits because any meaningful stop would risk giving back too much of the open profits. If, however, the market has a steady trend, I will move my stop up gradually.

To be a good trader, you have to have a high degree of self-awareness. You have to be able to see your flaws and strengths and deal effectively with both—leveraging your strengths and guarding against your weaknesses. It doesn’t matter if I miss a trade because there will always be another opportunity. Mental capital is the most critical aspect of trading. What matters most is how you respond when you make a mistake, miss a trade, or take a significant loss. If you respond poorly, you will just make more mistakes. If you take a trade that results in a loss, but you didn’t make a mistake, you have to be able to say, “I would take that trade again.” Opportunities are dispersed. You might have an opportunity today and then have to wait three months for the next opportunity. That reality is hard to accept because you want to make a steady income from trading, but it doesn’t work that way. In 2017, nearly all my profits came from two weeks in June and one day in December. That’s it. The rest of the year amounted to nothing. Have a long-term focus and try to increase your capital gradually rather than all at once. You have to forgive yourself for making a mistake. For a long time, I would beat myself up anytime I made a mistake, which only made things worse. You have to accept that you’re human and will make mistakes. It took me four or five years to understand that. I don’t know why it took me so long. Staring at these screens all day long is like a casino inviting you to click. You have to guard against the temptation of taking impulsive trades. If a bad or missed trade destabilizes me, I have rules for bouncing back: Take some time off, exercise, go out in nature, have fun.

I realized that I was in a position, hoping for it to work. The second I realized that I was hoping and not trading anymore, I immediately liquidated everything.

the big trades are pretty simple. You don’t have to go looking for them, but you do have to wait for them. Trading opportunities in the market ebb and flow. There will be periods in the markets where opportunities dry up, and there will be nothing to do. In those nothing periods, if you are looking for something to do, that is when you can create real damage to your account.

A lot of losing traders I have known thought they had to make money consistently. They had a paycheck mentality; they felt they had to make a certain amount every month. The reality is that you may go through long periods when you don’t make anything, or even have a drawdown, and then have a substantial gain. Entrepreneurs understand that. They will invest in a company for a long time, and the payoff comes in one hit after many years of hard work. If you are looking for outsize profits, you can’t approach that goal with a mindset of consistency.

Successful traders take care of the downside and know that the upside will take care of itself.

The trades that Sall has the patience to wait for have two essential characteristics: They are trades he perceives have a high probability of moving in the anticipated direction. They are asymmetric trades: the potential gain far exceeds the risk taken.

If you ever find yourself in a trade based on hope, get out. You need conviction, not hope, to stay in a trade.

“I don’t have to be right all the time; I just need to be right in a big way a few times a year.”

I realized an unexpected event that ran counter to the news flow was present in every one of my big winning trades. Another characteristic of these trades was that my reason for entering was very clear; I didn’t confuse my short-term and long-term views. I also noticed that these trades were never down by much and usually tended to be profitable almost immediately, whereas the trades that didn’t work tended to go offside quickly and stay offside.

Always make sure your stops are set at a point that disproves your market hypothesis; never use a monetary stop—a stop point selected because it is the amount of money you’re willing to risk. If you are tempted to use a monetary stop, it is a sure sign that your position size is too large.

placing large bets when you had the right set up, and keeping bets small when you didn’t. My winning percentage on trades is way less than 50%, but I still do well because I can recognize the one or two times a year when all the pieces of the puzzle are in place, and I need to bet big on a trade.

How would you define your trading methodology? I look at trading like a puzzle; I have to get the four corners in first. What are the four corners? The first corner is technical analysis; you have to have the right chart pattern. The second corner is a clean share structure. What do you mean by that? The stock has few or no options or warrants, and preferably, there are fewer than 200 million shares. What are the other two corners? Being in the right sector and having a catalyst or story that will make the stock or sector move up. Once the four corners are in place, you can then fill in the pieces.

When you see a big movement in a stock price, there is a reason why that price change happened. In many cases, the price moved because there is some inflection point in demand for that company’s services or products. Was there a way to identify that change early? I knew those opportunities existed, but I couldn’t figure out how to capture more of them. The opportunities I was catching were very random and based on my physicality—where I was, and what I saw at that moment in time.

Don’t ever listen to anybody when you are in a position. Stick to your own approach and avoid being influenced by contradictory opinions.

One of the toughest dilemmas that face systematic traders is deciding whether an ongoing losing period for a system represents a temporary phase that will be followed by a recovery to new equity highs, or whether the system no longer works. There is no simple prescription for how to decide between these two opposite interpretations. However, the lesson systematic traders should draw from this chapter is that sometimes abandoning a system is the right decision. It is one of those rare instances where discipline in trading—in this case, following the system absolutely—may not be a good thing.

Any system—repeat, any system—can be made to be very profitable through optimization (that is in regards to past performance). If you ever find a system that can’t be optimized to show good profits in the past, congratulations, you have just discovered a money machine (by doing the opposite, unless transaction costs are excessive). Therefore, incredible past performance for a system that has been optimized may be nice to look at, but it doesn’t mean very much. Optimization will always, repeat always, overstate the potential future performance of a system—usually by a wide margin (say, three trailer trucks’ worth). Therefore, optimized results should never, repeat never, be used to evaluate a system’s merit. For many, if not most systems, optimization will improve future performance only marginally, if at all. If optimization has any value, it is usually in defining the broad boundaries for the ranges from which parameter values in the system should be chosen. Fine-tuning optimization is, at best, a waste of time and, at worst, self-delusion. Given the above considerations, sophisticated and complex optimization procedures are a waste of time. The simplest optimization procedure will provide as much meaningful information (assuming that there is any useful information to be derived).

“Michael is unique because he combines two very different approaches: long equities on one side and a unique short strategy on the other. His ability to do both shows how adaptable he is as a person, and adaptability is critical in the game of speculation.”

In a recession, the market will typically go down 20%–30%. Assuming my 60% long portfolio does no better than the market, it will lose approximately 12%–18%. I would expect my short-term trading and short positions to cover that loss.

Appropriate risk management encompasses two tiers: the individual trade level—limiting the loss on any single trade—and the portfolio level. At the portfolio level, there are again two components. First, analogous to individual trades, there are rules to limit the loss for the portfolio as a whole. Such rules might include a defined process for reducing exposure as a loss drawdown deepens, or a specified percentage loss at which trading is halted. The second element of risk management at the portfolio level pertains to the portfolio composition. Positions that are highly correlated would be limited to the extent feasible. Ideally, the portfolio would include positions that are uncorrelated and, even better, inversely correlated with each other.

It is commonplace for traders to get sloppy when they are doing particularly well. Beware of letting a period of strong performance go to your head.

I knew I wanted to find something where the success or failure would depend only on me, not my colleagues, my boss, or anybody else. If I make money, that’s great; if I lose money, it’s my mistake. Trading is great in this way. You can’t find many other activities where success or failure depends only on you.

Dhaliwal makes the critical point that protective stops should be placed at a level that disproves your trade hypothesis. Don’t determine the stop by what you are willing to lose. If a meaningful stop point implies too much risk, it means that your position is too large. Reduce the position size so that you can place the stop at a price the market shouldn’t go to if your trade idea is correct, while still restricting the implied loss at that stop point to an amount within your risk tolerance on the trade.