Protect unrealized gains to maximize returns

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• 0:01Speaker 00

  Hey everybody, good to see you again. You look great. Have you lost weight? Today I want to talk about a comment that came in on a previous video and it asked effectively, "How much of the unrealized gains should you risk, right? In order to stay in that same trade?" And you know, as you can imagine, that's a highly personal choice. I don't think there is a single rule that says this is how you should do it. I go back to again, like, what are your goals? It's hard to make a lot of money if you're cutting your risk very, very quickly. So I think for like scalping, if you're not, if you're like risk on, risk off,

• 0:43Speaker 00

  you have to do a lot of trades to make bigger money. Where scalpers do make bigger money is they stagger their setups. Meaning, they have an A setup that might take up half to almost all of their daily max loss that they would lose across all trades and they tend to put a good chunk of that, maybe three quarters, whatever it is, it could vary by person, by firm. So let's say that you were risking 500 bucks a day and once you lose 500 across any or all trades, you stop trading for that particular day. So maybe though you find like your A setup and you know this, you can nail this and you

• 1:26Speaker 00

  can see that there's five to one payoff and you know that the thing can run, you might put 375 bucks up, right? Of the, you know, what 75%, yeah, that'd be about 375 of your 500 on that type of trade. So now you're kind of scaling it up in a mathematical way that makes sense because you have evidence that the setup works. And then, you know, you're kind of hunting for bear at that point. You have your biggest position on, they don't happen every day, they might happen once a month to once a quarter. And then you go back to what your goal is. Is the goal to make a bunch of money quickly and then get to cash as fast as possible?

• 2:10Speaker 00

  Or is it to put on an optimal position and let it ride? Or do you tend to put on, well, I'm going to risk 375, but I'm not going to risk that all at once. I might risk part of that or say half of that to get in, maybe 250 of it. Then I'm going to add another piece and then the risk on that second piece, which would be smaller as a pyramid, that might all add up. I might 250 on one piece, not 125 on the next piece. So there collectively is my 375, which would be 75% of my daily max loss. So then it's like, okay, well, how does it play out after that, right?

• 2:53Speaker 00

  If you, if your thing scales up, are you selling, is it LIFO accounting? Are you going to sell your last smaller piece and then keep your original piece? I never really did it that way. I was always trying to be a pig, in a manner of speaking. And I made the money when I could and I also paid the price when I didn't. But it was always my intention to make sure that I was biggest when the moves were in my favor. So I added to winners three, four, five, six times, right? I teach, as a case study, I have, I have, like I talked about having some of these confirmations from a long time ago.

• 3:35Speaker 00

  I had this 401k rollover from when I kind of got, it was more of a man acquisition than it was a buyout. And I had a small CTA with like, I don't know, 27, 28 million in client assets plus my own. They needed somebody who had experience with options and futures, so they brought me over, joined the company. It was supposed to be a five-year deal. They ended up breaching the contract, so I split after about two, two and a half years. And, but from that period of time, I had been contributing to 401k and then investing

• 4:18Speaker 00

  that money very aggressively inside the 401k. So I rolled out about 50k into this thing. And then nine months later, because sugar, gold and copper were ripping, I think China was buying everything in that period of time. This was 05 and 06, maybe part of 07. Those markets were ripping, margins were low and I would have 60 to 80% of my account tied up in margin in very concentrated positions. That nine months later, that count was just under 300k. And I teach to what I was thinking, why did I scale up? Why did I take the losses?

• 5:01Speaker 00

  As, as, and I'm telling you with 50k, I can promise you, forget the wins, I can show you confirmations where I was having four, five, $8,000 debits. So it's not to gloat. I can show you the losses are where you learn, like you take an $8,000 loss as you're growing that account. But I also had the payoffs, you know? I pulled 140,000 out of sugar alone in two different kind of trades from like nine to about 14 and a half. Then it ripped from about 14 or 15 to like 19 and I had, I was twice as large at that period of time.

• 5:44Speaker 00

  So I practice a lot of what I preach, but I also have to face the music when I'm wrong. You know, when you take a 10% hit on your account, you know, you sit up straight and that's the way it works. Like I knew what the numbers were, I was comfortable with it. And, and so I had it to give, is the expression. So I lost 8k, but it wasn't from initial corpus. You know, my account was probably 100 or whatever it was, 120k maybe at the time. So I was taking larger risks, but again, my normal accuracy was 30, 40%. Now the accuracy in these types of trades were 60 and the payoff was upwards of like six and seven to one.

• 6:26Speaker 00

  So when you have that type of an environment in three different markets and you go back and look at gold, copper and sugar in that period of time, they all basically went parabolic and I was smart enough to have enough risk on. So I don't want to say that it was luck, because I knew what I was doing. I had 15 plus years of experience. I had spent over two something years in, in like I said, the trading tribe. I had, I had, I had all, everything that I needed to succeed right then and there and I was in the right time at the right place and I had the clarity of thought to put the trades on. So what are you risking?

• 7:08Speaker 00

  When you put the trade on and you're up, say, one or two percent on your account, does that fit with your overall goals? Is that enough? Because if you want to try to 3x your account, you typically don't take the risk off at one or two percent to the up, meaning your account is up one or two percent. You can, but then you have to do the math and say, okay, if I want to make 200% of my, I have 100k, I want to make 200k, so I have 300k. So I make $2,000, but I want to make $200,000. Now I need 99 more of these trades? How am I going to find them? So what you might find, depending on your trading style, is that there are only so many opportunities.

• 7:53Speaker 00

  If you have one of those types of A setups per month, you're going to fall way short of your goal because there just aren't 99 opportunities, right? That's Jay-Z's song. So you have to be a complete hog when it's time to be a hog. Obviously you need to know and how to manage the risk. For me, I always look at myself and people laugh in my face, but this is just my style. Again, I got these buck slips. I used to call in the orders and then all day I'd carry these in my pocket with pens and I would just wait for stops to get hit. I had buy stops to buy aggressively if the market took off and I always had protective

• 8:33Speaker 00

  sell stops below the market to knock me out of trades if they, if they went sideways. I would also use a combination of support and resistance. You can do a lot of great things with just support and resistance. Honestly, if you're having trouble based on yesterday's discussion and you need to simplify, take all the shit off your charts and just think of support and resistance. Because yes, I would use ATR. You have to find a way to normalize the risk, right? And so that, that helps you figure out what your position size is. And I had a, I have a good sense of timing. So I was largely a breakout trader, very rarely would I buy on pullbacks.

• 9:14Speaker 00

  Then what would happen is the thing would stall. It would break out, the market has to kind of get used to it being at this price range and then it would create like a Stan Weinstein kind of base in what you would know as a stage two breakout. Now these are commodities, but the language still fits. So you'd have to sit and wait and I'd be like, okay, we're at a multi-year high, it's kind of basing, I'm making a little bit of money. I have 40% of my account tied up in margin and that's not really a risk management tool, but it is a metric to be aware of. It's definitely at that point, very aggressive and I'm like, I'm just getting started. Why? Because just like if you trade 4x during the day, right?

• 9:57Speaker 00

  Or maybe 10x if you're at some of these other types of places and they're broker dealers and they can extend to you as general securities firms, you know, 10 to one leverage, right? That's not take-home overnight leverage. That's like, I need that much money to acquire these $1,200 share stocks, but I'm only risking five bucks a share, right? So there's a difference between capital committed, margin, which is, you know, futures margin is set up by the exchanges where the commodities trades. Then the firms, the member firms, the FCMs, future, what is called futures commission merchant, it's like a broker dealer for futures.

• 10:40Speaker 00

  They can either say, okay, we're going to take the exchange minimum for initial margin or we're going to make it more stringent because we kind of want to discourage people trading those instruments here. But all the while, I'm just moving, I'm babysitting a book of stop orders. I know where I'm adding risk and I know where I'm removing risk. Here's the funny thing about that period of time, I was using end of day data. I was clearing through a company that doesn't exist anymore. It was called EDNF Man. And they had a website, it was like manfinancial.com, something like this.

• 11:17Speaker 00

  And I would look at the chart and say, okay, I wonder what people are gonna do here. If it goes here, I wanna add. If it goes here, it's gonna hurt me. And I would calculate the stops. I'd write them out on these buck slips. And then at five o'clock in the morning, Pacific time, I'd call the floor and say, here are the orders for the day. Give me the ticket number. And then I would literally just wait for the phone to ring. I very, I had maybe Bloomberg on or whatever, but I didn't pay for realtime quotes. I was using end of day data. And that's a true story. So if you're, if you're jacking up and spending a lot of money on these resources, you might wanna think twice. But the goal here is to help you understand how much of your unrealized gains do you wanna give back in order to kinda stay in the trade?

• 12:02Speaker 00

  I think I developed an uncanny ability to kinda understand when the near-term move was over and the getting out part. You know, you gotta get out when the getting's good. You've probably heard an expression like that in life, maybe not related to trading. But basically where I would, I would say, okay, if it goes here, the move in the near-term is definitely gone. And sometimes it's difficult, cuz like in sugar, there wasn't really any structure to place your stop. So you had to use a percentage-based stop. If it kinda consolidated and made a base and broke out to the next piece, I would look at where the low of that range was and then position size for my next piece accordingly, right, based on the, the size of the range.

• 12:46Speaker 00

  And not terribly sophisticated by today's standards, but 20 years ago, like I said, support and resistance meant a lot. And I would see like, okay, if this base failed, what was likely to happen, given the greater structure here, knowing that we're at five to 10-year highs in sugar? I don't remember. It was probably 10-year highs. That eventually increased to almost 20-year highs, and there was no news of it in the newspaper. So I'm like, this is a perfect trade for me. Nobody's talking about it. We're, we're at multi-decade highs. And the chart is still moving at like a 45-degree angle. It doesn't show any sign of stopping, so perfect trade for me.

• 13:26Speaker 00

  Go back to your goals and say like, what is it that you want your money to do for you? Right? Because if you're gonna make it and take it, that to me satisfies a, a strong emotional need to be right.

• 13:38Speaker 00

  Nothing wrong with it. I like that, too. And if you're in a, coming out of a losing streak, that can be a ray of encouragement, that win. You need that emotional win. Been there a million times. Million times. There's nothing that you're going through that I haven't mastered. Right? I used to joke, there was a window of time where I was having a particularly difficult time. And I used to say, hey, you need tax loss carryforwards? I'm your guy. It's like, I'm a, I'm a natural. I don't even have to try. I create losses for you like nobody's business. Promise you. Guarantee it. We can't use guarantee in this business, but I guarantee it. And I just laugh it off. It's like, okay, I'm gonna figure this out. I'm gonna keep, I don't like to use the word grind,

• 14:19Speaker 00

  but I'm gonna be persistent and determined, as only I can be. And I'm gonna stick with it. And it's a personal choice to figure, like, when you think about what your goal is, if your goal's to double your money, you kinda need to keep either trade bigger at the onset or you have to find a way to maybe cash out your first piece, but then leave a runner for an extended period of time. Like, I'm talking weeks to months. Otherwise, it's very difficult to grow your money. Why? Cuz I don't think the A setups that you're looking for are that prevalent. They're very rare. I was talking, like I said, I stopped in to see my friends at SMB, spent some time with Steve Spencer, I've known for over 20 years.

• 15:02Speaker 00

  Exceptional guy. Unfortunately, we didn't have a lot of time to hang. And I spoke with Jeff, who's also a great guy. I vouch. You know, and we're talking about, you know, risk management, which is at the heart of what we do. We're effectively risk managers, and we're trying to use these tools to help us know, when is the, when is the light green? When is it yellow? When is it solid red? When is it flashing red? Right? So, so, so you have to look at the markets and see. And we're talking about, there's a lot of volatility, but the A setups might only be around once a quarter.

• 15:41Speaker 00

  And so at that moment in time, that's when you can scale up and get the best of it, right? As Dave, the late, now, he just recently passed away. He's a great book, if you wanna learn about odds and bet-making on poker, written by a guy named David Sklansky. I think he wrote, him and, what's the other, Mason Malm, Malmut? I hope I'm saying his name right, wrote, I think, the best books on poker. David Sklansky, rest his soul. Book is called Getting the Best of It. Great book. I'm sure, like, money of the books. I've got two copies.

• 16:15Speaker 00

  So understanding that, like, what kinda table are you sitting at? Right now, the table is like full of like B, C, and D's. And in that case, the D trades are kinda like, why bother? And I have to admit, I don't even really have a C setup. The, it's As or Bs, which means I'm not active all the time. I don't wanna force trades if I can't see the numbers.

• 16:40Speaker 00

  So if my goal is to double my account, I'm not gonna sell a piece of equity when I'm up $2,000 on a $100,000 account. It is 2%, but if my goal is to double my money, you know, yes, you have to trade the tape. But again, if the move is just starting and you wanna double your account, it's hard to grow your account by that magnitude with so few choices if you are cutting risk. Cuz reward goes with the risk. Probably goes without saying. So I would stay invested for as long as possible, adjusting your stop. I tend to not, I scale in, but when the party's over,

• 17:25Speaker 00

  everyone has to go at the same time. Jared Dillian makes a lot of fun of me, cuz of the way, it's like, okay, you can get there half an hour early, like your good friends would, to help you set up the party. You can have the folks who don't wanna look bad by showing up late, so they show up at 7 on time for the dinner party. Then you've got the folks who come in fashionably late because they think they're too cool for school, and they want you to make a seat for them when there's no more chairs left. I'll be like, I'll get to that in a couple of minutes. But then when the party's over, everyone's gotta go at the same time. Right? Cuz I have to get up at 5. You know, we're 4:30, so I don't need you to come in for a cup of coffee or one for the road. It's not safe, anyway.

• 18:08Speaker 00

  So you can look at that in life, like, what did we not see between 7 and 10 that we're now gonna try to see between 10 and 10:30? Remember, kids, nothing good happens after 10 o'clock at night. If you haven't seen it by 10, it's probably not gonna happen. So go home.

• 18:27Speaker 00

  So what I think a lot of traders do is they look to get the mastery of the setup. They get their process down. And then, as far as goals, they don't really have a goal other than following their process, and they're gonna take whatever the market can kinda give them. I always start the other way and say, okay, what do I want the end result to be? Not just, if I did this process every day, what will the market give me? 30%, 10%, you know? Whatever it might be. You gotta take it for sure. But start with the intention of saying, I wanna make, I wanna make,

• 19:05Speaker 00

  I'm gonna say his name wrong. I think it's Lance Brightstein. Hopefully, I'm saying it right. I'm not throwing shade, showing the guy some props. I wanna make, the, the Swedish guy. Actually, it's a Finnish name, but he's from Sweden, I think. Christian Qualamagi. I hope I'm saying his name, too. I wanna make that kinda money. Well, I haven't met these people personally, but I don't think you can make those outsized gains by cutting risk. Now, it could be that you're a swing trader or a scalper, and you see that setup, and you're like, oh, my God! And you smash, you know, a, a, a position that could be five times its normal size, and you make it and take it off.

• 19:50Speaker 00

  But you're gonna still need to see those setups very, very frequently and then have the intuition to put on those types of sizes, perhaps. There are times when markets are really, really ripe. And I just explained one where I was involved heavily, fully loaded, full boat, almost all my money, all my buying power committed

• 20:13Speaker 00

  in sugar, gold, and copper in '05 and '06. And they all ripped. I haven't seen that since, to give you context. So, yes, there was the move before Nvidia split. Everyone knew 505, it was gonna, it coiled, and it was gonna rip. Right? So there's one.

• 20:40Speaker 00

  But there's, it's hard, and then the semi's kind of ripped, but it's very difficult to, to isolate those instances. So what I would do is, I would go back and set up a goal for yourself and say, because that'll give you the clarity. If you're happy trying to outperform buy and hold, you might be, feel good with making 20 to 25% taxable. Maybe 50%. I don't know what kind of setups you're looking at. But I feel like if you want the outsized, the outsized gains, right, then you're gonna need to carry more risk. Because the setups that you're looking for that have the really big asymmetric payoffs, they don't come around

• 21:25Speaker 00

  that much. And if you're gonna reduce risk, even in the face of those great setups, it's hard to maximize returns, right? So then it begs the question, why do you do what you do? Why are you selling winners? I've said this before on the show, if you're selling because you want to feel good, it's probably not a good trade. Right? From the chapter that says, financial, you know, financial decisions, good ones, they don't necessarily feel good. You have to, you have to get used to that so that they, they become, they become a good feeling for you. Right? Adding to winners, paying higher prices. When I was

• 22:10Speaker 00

  getting into sugar, my first buys were at nine. In that first piece, I was paying up to almost 12 by the time I was done buying. There's a 33% increase in the price and I wasn't done buying. So, but I knew what my goal was. This money was all growing tax-free, don't forget. So, I was like, this is time to really ramp the living crap out of this stuff. And I can manage the risk. I know I can make the money. And if I lose it, it's okay, because these moves are so pronounced. There may be about a volatility that I can't

• 22:51Speaker 00

  anticipate, but that's what protective stops are for. I know guys like Scott Kaminsky, who, you know, and Steve Strazza, who would, you know, Scott was a futures, is a futures trader. And when he had a position on, and it would go up 1 ATR, he'd sell half the position, move the protective stop to break even and let it run. And as a levered position in futures, that would, that would pay off handsomely. He had a beautifully smooth equity curve. I have another friend, he's Steve Strazza. And he's trading, and his consulting

• 23:34Speaker 00

  business is around options. He does something similar with Breakout Multiplier, where he'll put a risk unit on, when the option price goes from one to two, or two to four, or doubles, he'll sell half, take out his original investment, and let the remaining piece run. If it goes to zero, he's flat. If it, if it continues to run, he'll make money. My style was different, in that I would put on a decent size at the beginning, but I would look to scale with the anticipation that this was the beginning of a big move. Whether it was gonna happen or not, I have no power over that. I can't wave my wand or like Yoda,

• 24:19Speaker 00

  take the X-Wing Fighter out of the Swamp Sadegah and make a move happen. But my, my intention was that this is gonna be a big move, given where we are in, in the history of prices. And I want to get to the biggest point at this, I want to be as big as I can be at this key inflection point. So then when it rips beyond that, I'm fully loaded, and I have unrealized gains as a cushion. I didn't take them. They weren't realized gains, they were unrealized gains as my cushion. Why? Because, say I bought, like in the sugar, I was buying, I was buying, at the time, five contracts, which was probably up to

• 25:02Speaker 00

  almost 10% of my equity in terms of margin to equity requirement. And I was buying like five lots of five, the next piece, when the price had already gone up from, say, nine to 15, and then stalled, and I got knocked out, literally on the last day of the year, at 1450. Had to protect the capital, there was no structure. Then the next, and if you look at the March SBH of 2006, you see there was, on 1231, this jag had moved down, I had to protect, so I threw out my, stopped on everything. Then the first week or two of January in 06, it kind of consolidated and the bars were getting smaller. I'm like,

• 25:43Speaker 00

  hmm, March is the, is the first month, it's the front month in the calendar. And no one's selling this thing, everyone's looking at the same market. I'm like, there's more strength under this market than is being revealed. I was using CQG at the time, for that particular chart. And, so, at the end of the day, I was like, if this thing starts to move higher, I am not gonna get caught with my, my pants down, so to speak. So I basically came in twice as large, and let the thing run, using some of the buffer, right, of the realized

• 26:26Speaker 00

  gains. Then as the, the market basically went parabolic, and in like the next week or so, it basically went from 15 to 18, including two hundred point days. But I always knew where my stop was, so that if it came sharply back against me, I knew where I was gonna get out. Then here's the, there, here's the rub, and I'll finish with this. I would, I wouldn't meditate the way you, you would think of classical meditation. But in my mind, and look, I've got notebooks every here. I have one, two notebooks, I just picked up these three small ones I can carry with me from Moleskine in Columbus Circle. I would

• 27:08Speaker 00

  write down like, what would happen if it moved here, and what I would make, but then how would I feel? Would that be okay? So I had all of that reconciled long before the trade ever evolved. I worked it all out ahead of time. Said, okay, I don't want it to come here, I want to stay long. If it knocks me out, I'll be aggravated, but I also have to protect my cash. So I would look and see, okay, where's the structure, where's the moving average, where's the ATR, where's the percentage based, where's, where can I get the best exit for the risk that I'm willing to take here? And I think that's the best you can do when you're thinking about, you're in a trade that's winning, and you have to move your, adjust your protective stops, knowing that some of that, those unrealized

• 27:51Speaker 00

  gains could be at risk. Think about where you'll get out, when you're acting in concert with what your long-term goal is, perhaps you want to double your account, but then, what's gonna give you the best exit? Is it price-based? Is it position, is it percentage-based? Or is it structural? All right? Thanks very much for being here, folks. I'll see you tomorrow.