The discussion today is about how you can survive all the different market cycles if you ground your process in thinking about risk management. There’s a lot of nuances to that thinking which I cover in the episode.
[00:00:00] Everybody wants to talk about risk management. So this is about that, but in maybe a different way. So I think a lot of people have heard of this Ray Dalio All Weather Portfolio. If you haven't, you can look it up. It's a portfolio construction tool. And what they try to do is own a lot of different uncorrelated assets.
[00:00:22] So if one goes down in one environment, one goes up in that same environment, vice versa, you end up balancing it out. You might make a little less money or apparently he says you can make the same amount of money with drastically less risk, which means you could apply leverage to end up making more money than just owning S&P 500 with less risk. And a lot of people don't like that. I could care less about if that's the best thing to do now.
[00:00:46] My point of saying that though is, his point is that when the risk is lower, you can trade bigger. You can use leverage. I don't think a lot of people want to use leverage, but that's the point.
[00:00:58] So going to your individual trading, you can look at it the same way. And I think this is one of the big things that has helped me a lot the last couple of years in using the daily options more.
[00:01:08] And sometimes when I have a, I also trade stocks, like a stock portfolio. And some of my trades last a few weeks, some of them last a few months. And some of my losers are just a few days. It depends on how it's working and all that stuff.
[00:01:21] But sometimes I use options in there if it makes sense, if the holding period is longer. But during the day, a lot of times if I have a move or an idea, it's very volatile. I've talked about this before.
[00:01:33] And I can try the same trade three or four times and keep losing and then have a big loss and then watch it actually work out. It's infuriating, right? We've all been there.
[00:01:42] So what I do now is I'm using these options a lot more. And when I'm really right, I end up making maybe a little less money than if I was outright.
[00:01:52] But not always actually, because I can trade bigger. Because I've locked in my risk. I can say I'm going to risk X. Whatever it is, $200, $2,000, $20,000, doesn't matter.
[00:02:02] Whatever you're doing, you can lock it in and say, I think this is the amount that's worth it on this idea. And it takes all that stress out of it. You can still trade around it.
[00:02:11] And there's a bad version of me, like an unconscious version of me that can sometimes get unleashed and just blow up during the day.
[00:02:18] Like you lose a bunch of money in one day. Everyone has that. This takes a lot of that out of the process.
[00:02:23] And I know that the more structured your trading gets, if you have rules and systems, you can eliminate some of that.
[00:02:28] But we're humans, right? That's a good thing. And a bad thing depends on there's a lot of things that come together that a human can do that the machines can't do very well.
[00:02:35] Like looking at different variables, the dollar is doing this, but the bonds aren't following.
[00:02:39] And everyone's stuck selling the Israel headline, yada, yada, yada.
[00:02:42] You know, there's stuff like that where the human still has a good advantage on certain days.
[00:02:46] But for me, what I lost when all this stuff started happening, when the market started moving a little more whippy and fast,
[00:02:55] I lost the ability to kind of feel the market on the outrights, but the ideas were still working.
[00:03:01] So now it's the options that saved me because I can just lock that risk in.
[00:03:06] So there'll be lots of paper cuts and then some big winners.
[00:03:08] And sometimes it goes dry for a while where it's like a month or two and you just don't see anything.
[00:03:11] You're taking little losers all the time.
[00:03:13] And then all of a sudden there's a good run where you see a bunch of stuff in a couple weeks.
[00:03:17] And it's like that.
[00:03:17] And I think it's, they call it the Pareto principle or whatever.
[00:03:20] And I think it's true.
[00:03:22] It just works out that way.
[00:03:25] And a lot of times after I have a good winner, it's like, can I sit still and do nothing for a while?
[00:03:28] Because I'm always the most vulnerable for a losing streak or a bad decision after a winner.
[00:03:33] Because you feel like you can trade every price.
[00:03:36] Like if I'm pretty good, I can move it into something else now.
[00:03:38] And I can trade, you almost feel like you're playing with house money.
[00:03:41] And then you end up giving a lot of it back.
[00:03:43] So being super aware of that too is just a maturity or a knowing of yourself that you develop.
[00:03:48] And everyone's different.
[00:03:49] But that's pretty common amongst a lot of people.
[00:03:53] It's definitely something I struggle with.
[00:03:55] But the bigger point is can you figure out a way in your trading to make maybe it's 70% or 80% as much money.
[00:04:02] Maybe it's 50% as much money.
[00:04:04] But with way less risk.
[00:04:06] If you can do that, you start trading bigger.
[00:04:09] Or you start trusting yourself because you're like, I figured out a way that this is not going to kill me when I'm wrong.
[00:04:14] So if you're losing money or if you're not doing well and you're just kind of going sideways to losing small, that's phenomenal.
[00:04:20] And I've been able to do that more by doing these things and just thinking about that all the time.
[00:04:25] Another thing, and this again, like I said, every podcast is essentially the same.
[00:04:29] This is a different topic than the last one.
[00:04:31] But these are things that I've talked about again and again and we'll always talk about in the future because this is the stuff.
[00:04:37] The other thing is you have a bunch of winners on your books.
[00:04:40] Maybe they're more correlated than you think if you're trading stocks or if you're trading futures.
[00:04:45] It doesn't really matter.
[00:04:46] Maybe it's one position.
[00:04:47] But you have to think about like, oh, I thought it was going to go to my target.
[00:04:50] It's 70% of the way there.
[00:04:53] Stuff starts slowing down.
[00:04:54] You start getting a little nervous.
[00:04:56] And then it comes down.
[00:04:57] You're like, I'll just buy a few more because it's going to go to my target.
[00:04:59] All of a sudden it comes all the way back and you're losing money on the trade and you feel terrible.
[00:05:03] That can throw you off for weeks.
[00:05:06] So that's where also there's options.
[00:05:10] There's sell a little bit of calls on some of the position.
[00:05:12] It's called a collar to buy some puts on the whole position so you can't lose.
[00:05:16] You can lock in half.
[00:05:18] There's that.
[00:05:19] There's just getting out of half and then putting a stop on the other half.
[00:05:25] Just really simple things.
[00:05:26] One guy that I was a great trader that I used to trade with, his rule was never let anything substantial come back 50%.
[00:05:32] He would just cut it arbitrarily.
[00:05:33] I think we can do even better than that.
[00:05:34] But I mean, these are things that they do.
[00:05:37] They're really annoying during the day.
[00:05:39] But at the end of the month, you don't remember end of the year.
[00:05:41] You don't remember those days.
[00:05:42] You just remember what you did or what your progress was or your P&L was.
[00:05:46] So you should always be trying to think like this.
[00:05:51] Always be trying to think, how can I keep that risk lower as a general practice every day?
[00:05:57] And it doesn't mean you don't swing hard.
[00:05:58] You might say, this is a great idea.
[00:06:00] I'm swinging three times harder today.
[00:06:01] Okay.
[00:06:02] Then you swing three times harder, but you lock it in.
[00:06:04] You know what you're doing.
[00:06:06] And sometimes it makes more sense to trade the outright.
[00:06:08] It just does because the risk is low and the upside is huge.
[00:06:11] That's fine.
[00:06:11] But it's just thinking about, is there a better way to express the same thing?
[00:06:17] Consider my risk.
[00:06:18] I remember in Hedge Fund Market Wizards, which is a great book if you haven't read it.
[00:06:22] There's year 2000 and the market was about to tip over.
[00:06:26] And I think one of the guys, I forget who it was.
[00:06:29] He could really feel it.
[00:06:31] Maybe it was Drunken Miller.
[00:06:32] I don't know if he was in there.
[00:06:34] Anyways.
[00:06:34] And he said that, yeah, the stock market was like down five, up four, down six, up five the whole time.
[00:06:41] Like just a shit show.
[00:06:42] Super volatile.
[00:06:43] Very hard to hold.
[00:06:45] But the 210 curve, the yield curve was very smooth and it expressed the same type of thing.
[00:06:51] And that trade was the one that he put on.
[00:06:53] It was just a phenomenal winner with almost no volatility.
[00:06:56] So thinking about the best way to express something sometimes is another good way to do this.
[00:07:02] So that's kind of the stuff that, excuse me, that's the stuff I think about as much as I can now during the day.
[00:07:10] Because I've been in so many moments in my life, in my career, where I've had all that stuff come back on me.
[00:07:17] And I've, you know, it's come 70% of my target.
[00:07:19] I don't take anything off.
[00:07:21] I buy more on the way down and it just doesn't work.
[00:07:23] And it really messes your head up.
[00:07:25] So going forward, it's like if I keep repeating a risk-adjusted process, it's easy to develop.
[00:07:32] I can come back the next day and I can stay feeling good.
[00:07:34] Because it's like, well, ultimately, all that matters is your state of being.
[00:07:38] That's why small ball works.
[00:07:40] Like small to medium-sized trading works a lot better for people.
[00:07:44] Because everything stays light and playful.
[00:07:46] Quick to take a loser because you don't care.
[00:07:48] You hold the winner longer because you don't care.
[00:07:51] And then it's a game.
[00:07:52] And you make way more money.
[00:07:53] And then your small size becomes big size in a few years.
[00:07:56] And that's why it's not fun to do for some reason.
[00:08:01] People want to trade bigger.
[00:08:02] But that path works better.
[00:08:04] And it's because you're lighter and quicker on your feet.
[00:08:08] Think about like making a big decision that's really hard to move.
[00:08:10] It's like you have all that sunk cost, junk in your brain.
[00:08:13] And it's hard to move.
[00:08:14] But when you make little light moves, it's easy to move.
[00:08:18] So that's why adding the winner is trying something smaller.
[00:08:21] Like those things have worked well for me.
[00:08:23] And it's not always the case.
[00:08:25] Like some people want to buy a huge position on a pullback or a new high.
[00:08:28] That's fine.
[00:08:28] There's always – there is no best thing always.
[00:08:31] Like there never is.
[00:08:32] But generally, I think these are good practices to play with.
[00:08:37] Another one too is I know some people, and I've done this,
[00:08:40] they're attracted to like really beat up stuff for turnarounds.
[00:08:44] And they work sometimes.
[00:08:46] And the one time it works, you remember it, so you keep trying it.
[00:08:48] But the fact is most things don't work that way.
[00:08:51] And most – like there's a study I read of all the biggest winners of all time.
[00:08:56] And very few of them are turnarounds.
[00:08:58] And there's a few.
[00:08:58] Like Abercrombie just had one, right?
[00:09:00] There's a couple big ones.
[00:09:03] But usually things are strong, and they get way stronger.
[00:09:06] That's how it works.
[00:09:07] It doesn't work like they're shit, and they become really strong.
[00:09:10] And it's the same thing when you're doing – no one wants to pay a high price.
[00:09:15] They want to get a cheap price.
[00:09:16] But a high price is usually higher and higher later.
[00:09:18] And it's learning to rewire your head to think that way.
[00:09:21] Strength is more strength.
[00:09:22] Weakness is more weakness.
[00:09:23] Super simple stuff.
[00:09:25] Easy to get in your own way because you want to get a deal during the day
[00:09:27] and stuff like that.
[00:09:28] You want to get a deal and feel like you don't pay the highest price.
[00:09:31] And again, there's no universal on this,
[00:09:33] but just things that have helped me change my thinking.
[00:09:36] Anyways, that's it for today.