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Two Amazing Trading Lessons from “the Cal Ripken of Hedge Funds”

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Comparing a trader to a baseball legend may seem odd at first. You might be more likely to look for an athlete known for flash, like Michael Jordan, or aggressiveness, like Mike Tyson. However, the aide who described hedge fund manager Monroe Trout in The New York Times as “the Cal Ripken of Hedge Funds” couldn’t have been more right.

Much like The Iron Man set the record for consecutive games played, Trout never missed a day in his 15+ years at the helm of Trout Trading. But showing up is a just small part of Trout’s story. These stats tell the rest:

  • In one five-year period, Trout was profitable in 87% of months.
  • His average annual return during that period was 67%, while his largest drawdown was just 8%.
  • In all months, Trout Trading never had a losing year and posted an average annual return of 21.5%.

Trout’s return/risk measurements are extraordinary, but his methods for achieving them can be followed by any trader. Let’s take a look at a few tactics you may be able to emulate.

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This week our series of insights from Jack Schwager comes from his second book New Market Wizards. This article focuses on Monroe Trout, an expert in quantitative analysis. After working for Victor Niederhoffer at NCZ Commodities, Trout open his own firm and managed the $3 billion Trout Trading Fund. He retired at the age of 40 with a net worth reportedly in excess of $900 million. (Check out our last post “Repeated Failures Made This Trader a Success.”)

Find an Edge

Trout says one of the biggest mistakes traders make is to trade based off other's information — like a broker telling you that the market is bullish. This may bring some short-term success, but it’s probably won’t turn into consistently profitable months. For that, Trout says traders need to know what their personal edge is.

Trout lists a number of ways he has an advantage, including good research and a rational approach. But his greatest advantage may be his ability to time his entry and exit. For example, Trout has developed what he calls “the magnet effect.” He believes the market moves towards round numbers. While some would look at a big handle approaching and think they should sell ahead of expected resistance, Trout said he typically buys when he sees a product nearing a round number. Momentum is a powerful thing. 

The takeaway: Finding an edge is the most important step to becoming a successful trader. Trout says one way you can get an edge is to find a successful system, so put some effort into developing an approach before you start trading. 

Discipline and Self Control

Once you have an edge, Trout recommends setting strict risk management rules. For him, this means a:

  • 1.5% loss limit on a single trade;
  • 4% daily loss limit for his entire portfolio;
  • 10% monthly loss limit; and 
  • Maximum position size that he sets each month.

Perhaps the most interesting part of Trout’s risk management is what happens when he hits his loss limit. If he’s down 4% on a single day, not only does he close all of his positions, but he walks away from the market for the day. He also says if he was ever actually down 10% for the month, he’d close out and wait for the next month before he’d trade again.

One reason Trout puts so much emphasis on risk control is because he discovered large price changes happen more often than typically assumed. His risk management plan protects his portfolio from enormous swings that seem nearly impossible. 

The takeaway: Risk management is essential. Set strict loss limits to make sure you can always trade another day.

What risk management do you set for yourself? 

Posted by TopstepTrader on March 13, 2018
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