Book Review by Peter Obermeyer: Market Wizards

Editor’s Note: This is the 12th book review we are publishing as part of our Get Paid to Read contest. Last week, I wrote a review of a book I immensely enjoyed listening to as an audiobook, “Richer, Wiser, Happier“.

You can explore the rest of the reviews we’ve published in the Reading List section here.

This week, Peter Obermeyer reviews Market Wizards by Jack D. Schwager.  Peter is a portfolio manager for a family office based in Montana and a graduate of the University of Oregon. Go ducks!

Market Wizards: Interviews with Top Traders by Jack D. Schwager sat unopened on my bookshelf from the time I started working in investment management.  I am grateful to Asif and InsideArbitrage for the nudge to finally pick it up.

Peruse most lists of classic books about the industry and one is likely to find this title.  Given the current abundance of blogs and podcasts, many of which feature today’s top investors, it is easy to overlook the unique and valuable contribution Schwager made by sitting down with people possessing exceptional investment track records and attempting to extract the disciplines that enabled their high performance.  It was a welcome change to read interviews that did not pertain to the current market environment, as it is easy to become distracted by today’s events and miss the timeless principles of money management explored in these conversations.

Format

The book contains five sections, four of which are composed of interviews with traders organized by the markets in which they are involved: currencies and futures, mostly stocks, a little bit of everything, and pit trading.  The final section in the edition I read (2012) pertains to the psychology of trading based on an interview with Dr. Van K. Tharp.

The interviews vary widely in length, and Schwager provides a several page summary of his key takeaways at the end of each chapter.  Each conversation was valuable in its own way, but I found the interviews with Bruce Kovner, Paul Tudor Jones, Ed Seykota, Michael Steinhardt, and William O’Neil particularly rich.

Key Themes

While there was a great deal of variation among the traders’ strategies, several themes came up repeatedly that I believe are worth flagging.

• The primacy of risk control: all of the interviewees (save Michael Steinhardt) strongly emphasized having and adhering to a plan to keep losses small. Given most of the book pertains to trading instruments with inherent leverage (such as futures), this discipline is critical to avoid the blowups experienced by a high percentage of the market wizards early in their career.  A range of technical approaches to risk control were discussed (stops, position sizing, locking in profits), but nearly as much attention was given to the psychological risks of overconfidence and timidity that can lead to deviation from a profitable strategy.
• The importance of trends: a profitable record consists of small losses and big wins created by correctly identifying and sticking with trends. The majority of interviewees were trend followers and would prefer to buy breakouts than attempt to identify reversals. Paul Tudor Jones is the notable exception, but he also emphasized the need to let winners run to make up for numerous and inevitable small losses.
• The virtues of flexibility and conviction: resolving the intuitive tension between these two traits was a commonality of the market wizards. Flexibility allows one to “imagine different configurations of the world,” in Kovner’s words, and more accurately assess the potential risk and reward of a position as it evolves.  An underappreciated aspect of flexibility mentioned by several interviewees was the ability to do nothing—as constantly needing to trade is a form of mental rigidity that often results in losing money.  While addressed more subtly than other topics, betting big (within one’s risk control framework) at the right time was a key element of the market wizards’ success.  For example, Michael Marcus described placing small trades for entertainment when he didn’t have strong conviction, but sizing up when all of the elements he tracks lined up for a trade.
• Passion and individuality: as many of you reading this will know, success in markets requires a great deal of effort and focus, and hard work flows naturally from passion—a point often raised in conversations and exemplified by the routines of the market wizards. At times, interviewees would describe diametrically opposed disciplines as key to their success, which emphasizes the importance of developing a set of practices that fit with one’s personality and interests.

Criticisms

In my opinion, the book’s strength lies in the diverse and engaging presentation of the key themes above.  Learning these lessons through the tales of great traders was enjoyable, and will hopefully discount the tuition one pays to the market in the form of unforced errors.

With that said, there are two points of criticism that I feel are worth raising, particularly for the InsideArbitrage audience.  The first is the emphasis on relatively short-term trading of high-leverage instruments.  While an excellent opportunity to discuss risk control, the relevance of commodity trend-following strategies or the machinations of a trading pit is likely less relevant to longer-term investors focusing primarily on equities.  Second, the market structure has changed significantly since the interviews were conducted in 1989.  The rise of ETFs, passive investing, sophisticated algorithmic trading, growth in the options market, and multi-strategy hedge funds (to name just a few factors!), belie an increasing financialization of society that likely makes uniquely profitable strategies shorter-lived and harder to come by.

A Parting Thought

In the interview with Ed Seykota, he remarks that, “Win or lose, everybody gets what they want out of the market.”

While very few people would say they consciously want to lose money, I think it is worth pondering what one subconsciously wants out of their trading—perhaps it is to play out a fear of being unsuccessful or to take losses in order to feel a sense of camaraderie with others involved in a position.  In investing, we are often our own worst enemy.  It follows that clear-seeing of oneself is foundational to becoming a market wizard.