NEW YORK (TheStreet) -- It's not often you get to interview a wizard. But Jack Schwager is an industry expert in futures and hedge funds and the author of a number of widely acclaimed financial books, including the Little Book of Market Wizards.
He is a currently a founding partner of Fundseeder.com, an online platform for connecting seed investors with undiscovered trading talent." Previously, he was a partner in the Fortune Group, a London-based hedge fund advisory firm that specialized in creating customized hedge fund portfolios for institutional clients.
I love "The Little Book of..." series because the books are fun and easy to read, packed with tons of trading wisdom thanks to his interviews with some of the most successful traders of all time.
Here's an edited version of my interview.
Rachel: Even though persistence and fearlessness after failure are key characteristics of traders, you say risk management and knowing when to say "uncle" are just as important. What are the best ways traders can practice risk management?
Jack: Let me give you two simple risk management rules recommended by multiple Market Wizards, each of which can be stated in a short sentence: "Decide where you will get out before you get in" and "Never risk more than some small percentage of your assets (e.g., 1%) on any single trade idea.
Rachel: You talk about one of the most important things a trader/investor can do is find a methodology that fits their personality. What methodology fits your personality and why?
Jack: Excluding trades that have an investment component (e.g., buying an exchange-traded fund or calls in an ETF in a sector or region that seems overdone on the downside), the typical trade I am likely to do can be described as follows: Select an entry point based on chart considerations (for example, entering a GTC buy order in a market at a point near anticipated support), along with a pre-determined stop point.
This approach gets around my natural tendency towards impatience -- a highly undesirable trait for a trader -- as I am making pre-planned trading decisions rather than actively watching the market and being tempted to make impulsive trades. By pre-selecting the exit as well, I take most of the emotionalism out of the trade. This is a good thing as I believe my emotions are a detrimental influence.
Rachel: What single trade or investment in your career taught you the most valuable lesson?
Jack: My best and most influential trade was a losing one. When I started trading futures, I made decisions based on fundamentals. Although fundamental analysis can be used effectively for trading, it inherently fights money management because the more a market moves against you, the more attractive the trade appears. If corn seems like a good buy at $6, it appears to be an even better buy at $5.
So the more the market moves against you, the less appealing liquidation appears. When I discovered technical analysis, I found that it had the great advantage of built-in risk management -- that is, for most technical approaches, the market moving against your position will signal an exit.
Rachel: Regarding successful traders you write, "They all had a specific methodology ... Successful traders are confident that their methodology provides an edge." Can you give two examples of methodology of real people you interviewed so I'm sure of what you mean by methodology and how specific it should be?
Jack: First, there is a specific way of picking trades. This approach could be fundamental or technical or a combination of the two. It could involve discretionary decision-making or it could be strictly systematic. The key point is that it is not a shoot-from-the-hip trade entry approach.
Second is the risk management plan. The risk control strategy would dictate a specific exit point or exit rule for any trade and it would also deal with controlling total portfolio risk relative to assets in the account. Any successful trading approach must contain both components: a specific entry strategy that has an edge and a specific risk management strategy.
Rachel: You quote George Soros as saying, "It's not whether you're right or wrong...but it's how much money you make when you're right and how much money you lose when you are wrong." That statement means that stock selection is less important to the success of a trader, and that your skill as to when you enter and exit a trade is more important to the success of a trader. Is that a correct assessment?
Jack: I think the main intent of Soros' comment to Stanley Druckenmiller, who was my interview subject, was that it was important to "step on the accelerator" when you are highly confident on a trade. The idea of betting more on high-probability trades was an essential component of the trading methodologies of not only Soros and Druckenmiller, but also many of the other traders I interviewed.
Rachel: You state, "Don't publicize your market calls." You explain the most successful traders do not publicize their trades. I always tell people to trade their own stock picks and have their own entry and exit points. Why do so many people follow the exact trades of other traders if it is not a pattern for success?
Jack: Because they lack confidence in their own abilities as a trader. Confidence is another essential trait of the Market Wizards. Are successful traders successful because they are confident or are they confident because they are successful? That may be a difficult question to answer. But one thing you can say is that seeking out the advice and opinions of others instead of making independent trading decisions is a sure sign that a trader lacks confidence.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.