Ep 563: The Goal Is Not to Make Money; the Goal Is to Manage Risk

Sometimes the most valuable truths about trading are those we don’t want to hear … or accept. In Episode 563 of The Traders Podcast, your hosts Rob Booker and the producer Jason Pyles talk about the importance of focusing on how to reduce your risk, not making money. If you manage your risk, the money will accrue over time. This is not very sexy news for those who want to “get rich quick” and become overnight successes, but those are the realities of trading.

Also in this episode, we receive a question from Dave in Columbus, Ohio, who asks about hedge funds and why so many have closed this year after being so profitable for so long. Dave wants to know why they aren’t profitable anymore. Join us, and we’ll discuss it!

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Links for this episode:

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Trader Interviews.com

Be sure to catch up with Scott Welsh at his Website
and at Twitter

Jason’s movie podcasts:
http://moviepodcast.network/ – A group of eight movie-related podcasts covering new movie releases and many genres: sci-fi, horror, western, etc.

Full Episode Transcript:

Jason Pyles: Hey, Rob. One of my favorite things on The Traders Podcast and something I really missed was getting questions from the listeners because I find that these episodes where we’re discussing the listener’s thoughts and concerns are some of the most insightful, for me at least.
Rob Booker: I love it, and I love the episodes where we get comments inside of the show notes, so wait a minute, are you saying you have a question?
Jason Pyles: Yeah. Well, there’s a question here that comes from Dave from Columbus.
Rob Booker: Dave from Columbus.
Jason Pyles: Yeah, and Dave says, “Home of the greatest trader in history, Scott Welsh.”
Rob Booker: Not anymore. Scott lives in Florida now.
Jason Pyles: That’s funny. He says, “Hey, Rob. I thought that this story might interest you. Apparently several hedge funds have closed this year due to poor performance. I’m curious to hear why you think all these guys who have been elite for so long can’t seem to turn a profit in the markets anymore.”
Rob Booker: Well, fascinating. Yeah. There have been, especially in a year where the S&P 500 is way up, the stock market’s way up, it is interesting that hedge funds are down. Like a lot of hedge funds are down. Now not all of them are down, but it is interesting. Jason, it is a quandary wrapped in a paradox.
Jason Pyles: Okay. A conundrum within a donut. Yes.
Rob Booker: It’s a shroud of uncertainty wrapped in creamy filling.
Jason Pyles: Yes. Right.
Rob Booker: The answer is most of these hedge funds are driven by performance, meaning they are constantly striving for gains, and most of these hedge funds were started, I hate to be so crass, but the reason they started was because someone wanted to make a lot of money. If you just think about it for five seconds, if you build a set of relationships in the world of finance, and then you have the potential to go out on your own and raise 100 million dollars, you’re going to do it. It’s just going to happen. Finance and arrogance go hand in hand. If you have had one good year, you suddenly think that you’re going to have 30 good years. This business is terribly difficult.
The other part about it is that hedge funds, they are restricted by what they can do. Once you put together an offering document and you say that this is what you’re going to do. You’re going to trade Norwegian bonds against Afghani currency or whatever, and you’ve specialized in a method for doing that, then you’re kind of stuck. That’s the method you’re going to do. That’s the crazy thing is that once you’re stuck in that method, if that method stops working or goes through a difficult period of time, then you’re screwed. I mean, that’s it. A lot of these funds are hampered by the fact that they promise that that’s what they were going to be doing.
You kind of get the feeling that these people shouldn’t be managing money, but it’s not about getting a return. It’s about getting more money to manage. When you manage money as a hedge fund, automatically you earn every year a percentage of the assets under management, generally 1 to 2% automatically. If you raise 100 million dollars, you get 2 million dollars every year just for having the 100 million, whether or not you make any money for any of those people. To me, also the incentive to make any money, then it goes down. I don’t know. I just think it’s a cycle that spirals out of control. You start because you want to make money, and then you’re stuck with a strategy that might not be working, and then you panic, and then investors want quarterly performance. You’re chasing after performance instead of chasing after actual processes.
Instead of focusing on what works, you’re trying to quickly make a bunch of money. It’s such a vicious cycle. I don’t know how anybody makes money managing money professionally. I don’t know how anybody does it. The largest hedge fund in the world is Bridgewater Associates, run by Ray Dalio, which we’ve talked about him a lot. Ray is the most successful hedge fund in history, and it’s the largest hedge fund in history. The whole thing is basically fully automated. The whole thing is automated because it’s so hard to make money, but they find strategies that work, and then they program them, and then they run them automatically. I think a lot of hedge funds are run by people who want to be the one that pushes the buttons. They’re constrained by the strategies they use. If they’ve had a somewhat okay year, they want to make it better so they don’t lose their investors. It’s a cycle that just spirals out of control
Jason Pyles: Wow. It sounds difficult. If we were to analyze that, though Rob, the reason that happens is because, I don’t want to say inner principles, but the priorities of how they’re going about making money, that shifts, and they’re not focusing on the true principles that they know. They’re just focusing on desperation and emotion.
Rob Booker: Yeah, right.
Jason Pyles: Interesting.
Rob Booker: Yeah. Agreed. I mean, if you want to turn this into lessons for us as traders, you’d say be flexible enough to achieve your goals. Don’t constrain yourself by one strategy, although you might have one strategy that you’re best at, one pattern that you recognize that you do over and over. You want to remain flexible. The goal is not necessarily even to make money. The goal is to manage risk. The goal is to reduce risk. The goal is to never get yourself into huge amounts of trouble, and then let the money take care of itself, as opposed to being a hedge fund who believes that the goal is making as much money as possible, all risk be damned.
Jason Pyles: Right, so-
Rob Booker: Yeah, go ahead.
Jason Pyles: You said this before. Really what I’m starting to take away now in trading is that being a successful trader isn’t about making money, it’s about not losing money, right?
Rob Booker: Yes.
Jason Pyles: I love that. [crosstalk 00:06:59]
Rob Booker: Yes. There’s only one rule of trading. Never let a small loss become an unmanageable monster loss. That is the only rule. If you abide by that only rule and you don’t lose money, you will survive, and if you survive, you will eventually come across a trade, a strategy, or a method, or a situation where you have the opportunity to make money. There’s a balancing act. There’s this tension that exists between how badly do I want to try to make a lot of money versus how badly do I want to stay in the game for a long time. This is the same tension that exists in all areas of our lives. I want an exciting relationship, but I don’t want to blow my relationship. I want to drive fast in my car, but I don’t want to die. I want to have as many really fun technology gadgets in my life without going broke. What most of our world is centered on is the risk taking part of that.
We idolize and put up on a pedestal all of the people that have taken huge risks and then succeeded. We read news stories about them. We live in a world that sensationalizes and makes it seem easier than it is to accomplish and have extraordinary success having taken huge risk when day-to-day grinding it out and reducing risk is boring and unenjoyable, but it’s the way that you get from here to there. It’s the way that spectacular successes really are made. You put yourself in a position to have spectacular success when you have lasted through all of the difficult experiences in the world of trading without losing all of your money. That’s how you get to the point where you can take that big trade.
So many people, they just want the big trade. They just want it now. They don’t want to put the work in, and they don’t want to go through seven years. If I tell somebody, “Okay, it takes seven years to become truly successful at trading,” they’ll just go on to the next podcast. They’ll just go on to the next teacher. They’ll just go listen to the next interview with somebody. They’ll just think, where’s the shortcut? The Tim Ferriss 4-Hour Workweek spawned an entire industry of how do I get the same result that I don’t have to do the work? What they forget is you can trick your body into growing muscle quickly. You can shortcut it. The trade-off is you’re going to take risks with your health, and you’re never going to grow the mental stamina along with the physical growth. That’s what everybody seems to be interested in these days is how do I get the result, how do I pump whatever it is up by taking shortcuts, and then you don’t mature as an individual during that process at all, and you lose all of it.
I’m not trying to be old school. I’m just trying to be real school. There isn’t a shortcut. There are no shortcuts without consequences. The shortcuts exist, and I don’t hate Tim Ferriss. I just think that a lot of this advice is really, really problematic because it sells well. How do I get from here to there more quickly, how do I take a pill, how do I take a little bit … I mean, there’s a whole industry. Do you know this Jason? There’s a whole industry, like a little cottage industry of selling small doses of LSD in Silicon Valley to programmers.
Jason Pyles: Whoa. No. I didn’t know about this.
Rob Booker: You don’t know about microdosing?
Jason Pyles: No, no. I’m out of touch with the cool kids and what they’re doing.
Rob Booker: I hate my job. I’m not happy at work, so I microdose, and it puts me in a state of mind so that I can get my work done. People microdose. It is like an erection for the happiness portion of your brain. I’m just going to take a pill and that’s going to happen.
Jason Pyles: I do that too, but I do it with Snicker bars in the afternoon.
Rob Booker: Exactly. Yeah. Exactly. All right, fine. Now, how far do people take it? This is exactly the thing is that maturing as an individual says, I’m going to face the reality that this situation isn’t working, and I’m going to work through the root causes of the problem. Whereas the new shortcut industry is how do I ignore the root cause of the problem and treat the symptoms?
Jason Pyles: Mm-hmm (affirmative). Yeah.
Rob Booker: In the world of trading, that’s really dangerous. How do I shortcut everything, learn a pattern? Can I make a million dollars tomorrow? No. However, the journey is enjoyable. That’s the best whole thing.
Jason Pyles: Yeah. Yeah. No. Wow, that’s so interesting. It reminds me of The Karate Kid in a way. Do you remember that movie from 1984? It’s one of my favorites. Daniel just wanted those beliefs to stop. He just wanted a fast solution. Mr. Miyagi started out with having him stay on the floor. You know what I mean?
Rob Booker: Yeah.
Jason Pyles: It was a long progression to get him where he ultimately wanted to be.
Rob Booker: Yeah. Favorite line from that movie, Jason?
Jason Pyles: The one where he talks about being on the right side of the road as [crosstalk 00:12:09]
Rob Booker: “Squish like grape.”
Jason Pyles: Yeah. “The middle of squish like grape.”
Rob Booker: Yeah. That’s my favorite too. I also never forget the, “Put him in a body bag.”
Jason Pyles: Yeah, that’s hilarious, and “Sweep the leg.” Yeah.
Rob Booker: “Sweep the leg.” Oh my gosh. All right. Well, to our dear listeners, we have a special announcement here at the end of the show. We ran a contest on the comments section of the podcast. Two things have happened. We have a winner, which we will announce in the next episode, and we also fixed the blog so that all of your content, all of your comments, are now visible on the blog. You can talk to each other and comment to each other, and all the comments are now visible on each episode. Go to traderspodcast.com, leave a comment on your favorite episode, and, Jason, we’ll do it again. We’re going to announce a winner next time, but we’ll start running the contest again for the next few episodes, and we’ll give an Amazon gift certificate to the comment or question that comes in that we like the most.
Jason Pyles: Yeah. I like that. That’s fun.
Rob Booker: Love you all, everybody. Thanks for listening. I’m Rob Booker and on behalf on our esteemed producer, Jason Pyles, you’re listening to The Traders Podcast.

One comment on “Ep 563: The Goal Is Not to Make Money; the Goal Is to Manage Risk

  1. David G Kelly says:

    I agree with the whole “trading maturity” thing. With this coming January 29th I will be trading or studying trading for 5 years. I thought that I was being very slow to learn but I think I had to chase around those shiny objects being dangled in front of me and burned by them until I finally settled down and got methodical. Just by being actively in the market over time you learn much in this process that helps you to understand what your trading style is. Once you know your basic strategy you must, as Rob the wise says, “OBSESS” on it. I got a journal that gave me the parameters I wanted to focus on and started populating it with very small live positions. After hundreds of trades and 10 months I began to analyze the trades. This helped me to fine tune my positions and I am just to the point to start SLOWLY let out the clutch and start adding to my positions…Quite the process!

    And guys…come on…the most memorable line of the movie?

    ” WAX ON – WAX OFF”!!! Lol

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