Survival of the Fittest

By: Laurence A. Connors and Blake E. Hayward

The following is an excerpt from Connors & Hayward's Investment Secrets of a Hedge Fund Manager

Trading is one tough game. In the futures markets, 97 percent of all traders lose. Those who win, win big. Individuals such as George Soros, Monroe Trout, and Bruce Kovner make millions year in and year out. Those millions do not appear from the sky. They are taken from the pockets of the 97 percent who lose. 

What do the 3 percent have that the other 97 percent don’t have? A trading methodology combined with proper money management and a proper psychology that works.

We believe that in order to survive and prosper at the trading game one must develop a “survival of the fittest” mindset. We believe that the four most important components of that mindset are commitment, a daily approach that is different from the herd, an unshakable belief system, and guts.

COMMITMENT

If you think succeeding at trading is easy, you are out of your mind. Unless you are fully committed to this game, you will lose. Commitment doesn’t mean studying the markets when you feel up to it or when you find the time. It means studying them seven days a week.

Success in trading is no different than success in anything else. Dan Gable worked out twice a day, seven days a week, for six years in his quest to win an Olympic gold medal in wrestling. During the football season, Vince Lombardi worked 18 hours a day and slept in his office most nights. Hedge fund manager Mark Stome, whose fund appreciated over 130 percent in 1993, reported works 14 hours a day, seven days a week. Marty Schwartz said in Market Wizards that he worked 15 hours a day. Imagine attempting to wrestle Dan Gable or coach against Vince Lombardi by working a few hours a week. It would be insane, yet that is what the majority of people do when they attempt to enter the trading arena and compete against the likes of Stome and Schwartz.

Unless you are willing to commit yourself to this game with drive, determination, desire, and persistence, you will always be part of the 97 percent of the traders who lose.

A DAILY APPROACH THAT IS DIFFERENT FROM THE HERD

The average trader/investor doesn’t have a daily plan of attack. Instead, he is a clay pigeon waiting to get shot by an onslaught of outside forces. Instead of having a proven trading methodology that is void of outside interference, he is swayed by anything and everything. His trading plan consists of listening to the last analyst interviewed by CNBC, trading on the advice of the latest guru quoted by The Wall Street Journal, investing in his broker’s pick of the day, or plunging on the recommendation of a newsletter he subscribes to. Instead of waiting for the correct moment to trade a historically proven strategy, he will jump into the fracas and let the chips fall where they may.

Successful traders have a daily plan that works consistently over a period of time. Their trading methodologies work in the bull markets, bear markets, and sideways markets. Their trading methodologies exploit periods of high volatility as well as low volatility. If their methods don’t make money in certain markets, they avoid those markets.

Successful traders are not swayed by analysts on television, analysts in newspapers, brokers with stories, or gurus who sell newsletters. Successful traders have the war won before ever fighting a battle. Losing traders do not!

AN UNSHAKABLE BELIEF SYSTEM

We said above that most successful traders have won the war before the first battle is fought. This is a critical concept in trading. There is enormous peace of mind in knowing you have a trading methodology that consistently makes money in the markets. Unfortunately, few people ever achieve this peace of mind.

To truly achieve success at trading, you much have an unshakable belief in your trading plan. You must know that the odds are in your favor. The only way to achieve this belief is by actually trading your system in the real markets and experiencing the ups and downs that accompany all plans. Your plan of attack doesn’t have to be identical to ours. There are plenty of other strategies that work. The main thing is for you to be totally comfortable with your approach and to understand that there will be times when losses occur. 

The confidence we have in our plan comes from us knowing three things: 1) the results achieved from back-testing our strategies, 2) the results achieved from actual trading, and 3) the knowledge that we can always make our strategies better. Again, our methodology is not the only methodology that works, but it does work for us. We have an enormous amount of faith in our plan. We honestly believe we can make money every month of the year with out strategies. Of course there will be periods of drawdowns, but overall our belief in the plan allows us to withstand this. Finally, and most importantly, our belief allows us to ignore the constant bombardment of outside investment advice, much of which has never been properly tested or quantified.

GUTS

It takes guts to be different from the crowd. We are all essentially social creatures who find solace in being part of the crowd. Unfortunately, successful trading means going against the herd.

News reversals are one of our most profitable strategies, yet psychologically they are the toughest for most investors to trade. Take for example, the day after the November 1994 elections. While everyone is screaming “buy, buy, buy,” you have to be the one on the sidelines waiting patiently for the market to reverse. Not only are you not participating in all the initial excitement, but should the market reverse, as it did that day, you will be profiting at the expense of others. For many traders, this is an extremely difficult situation, yet this is why this strategy is so successful.

Your money-management strategy should be different from most other traders. While others are waiting for the fundamentals to play themselves out (a nice way of saying the position is moving against them), you are a vigilante with your stops. While others are looking for 100 percent moves, you are a realist and looking for 2-4 percent moves. While other plunge recklessly, you patiently wait until the odds are in your favor. All combined, this mindset requires an enormous amount of self-discipline. This discipline, though, can and will be rewarded when harnessed properly. Remember, if it was easy, everyone would be doing it.