Finance blog


The Fritz Rules of Trading

December 21, 2021

For many years, I enjoyed reading the daily Dennis Gartman newsletter. It was a fantastic amalgamation of trading insights and news. It was usually around 10-12 pages jam-packed with facts and information from around the world. Keep in mind that I used to catch the 6:25 A.M. train, and it was always ready before I headed to the station. I have no clue how they did it by then every day. Mr. Gartman was a commodity trader and was very focused on daily opportunities. I would say that his advice was more for a "mid-term" trading style. Not necessarily a one-day in-and-out style, but not a long-term investor, either. I loved it because it gave me insights into why the market was moving at any given time--great insights into the Fed actions, U.S. markets, and the rest of the world. One of my favorite pieces every year was his "Gartman's Rules of Trading". When it came out, I always printed it out and stuck it somewhere on my desk.

Dennis retired after the 2019 season, and this year I want to re-create his "rules of investing" list but with a longer-term vision more appropriate to the purpose of this blog. I hope he won't mind if I borrow some of his maxims and insights. I plan on quoting some of his rules verbatim, and when I do, I will mark them with a "DG" designation. He deserves most of the credit for this list, but I will modify and add a few nuggets.

Enjoy! I always did and I think there are some cool insights to be had.

1. (DG) Never, ever, ever add to a losing position: Ever! There is a reason this is Rule #1. It is the most important rule of them all, for adding to losing positions will eventually lead to ruin. All great market humiliations are precipitated by someone doing so, such as the Nobel Laureates of Long-Term Capital Management in 1998.

2. Remember TMI (Time + Money + Interest Rate Scenarios). Most investing statistics do not include time as a component. Yield, duration, average life, and many others ignore that we -as investors- invest over time. This is one of the most important aspects of investing - especially for fixed income portfolio managers. Our horizon is greater than one day. To be truly great, we need to measure all our investment decisions over time. We need to count projected money over time and across interest rate scenarios. It must be done.

3. (DG) Mental capital trumps real capital. Capital comes in two types: mental and real. Holding losing positions diminishes finite and measurable real capital AND one's infinite and measurable mental capital always and everywhere. (KF) Long held and venerable belief systems can handicap our decision-making process. Just because something has been done in a certain way does not mean it is always and forever correct. If I had a dollar for every time I have heard someone say, "we've always done it that way," I would be a very rich man. The "just because" approach costs our industry untold amounts of money.

4. "Expensive" does not = bad. Sometimes you must pay for quality. In the world of fixed income, people often buy based on "cheap" or "wide" spreads. This should mean nothing to us. There are times when we should be looking for cheaper or less structured products, and there are times that we should be willing to pay for more structure or quality. If you really think about it - do you always want the "cheapest" pair of shoes? Remember #2 above. We need to quantify over time and make the best decisions given the facts at the time.

5. Don't Sell Cheap Options! If you have read my posts throughout the last couple of years, you will be familiar with this phrase. As bankers and fixed income portfolio managers know, we are constantly selling options - whether they be hard calls or prepayment options. The challenge, and my charge, is that you can't sell them too cheaply. Selling options is a way to help boost income, but it often will hurt us OVER TIME. Buying cheap options may cost us near-term income but it can help protect us from outsized market moves. Don't sell cheap options.

6. (DG) "Markets can remain illogical far longer than you or I can remain solvent." Keynes said this decades ago and Dr. A. Gary Shilling made it clear to us. They were and still are right, for illogic does often reign, despite what the academics would have us believe about efficient markets!

7. (DG) Buy that which shows the greatest strength; sell that which shows the greatest weakness. Metaphorically, the wettest paper sack breaks the most easily and the strongest winds carry the ships the farthest and fastest.

8. Wish for the wind. Nassim Taleb discusses this idea in his book "Antifragile" when he talks about the ability to grow stronger through adversity. The examples he uses are a single candle and a roaring fire. The candle fears the wind and the roaring fire wishes for it. If we behave like a candle - stand alone and don't take chances nor adapt - we can be easily extinguished. On the other hand, if we behave like the roaring fire - collaborating, sharing ideas, and taking chances - the wind will only make us stronger.

9. (DG) Trading runs in cycles. In the "Good Times," even one's errors are profitable; in the inevitable "Bad Times," even the most well-researched trades shall go awry. That's just how it is! (KF) This has always reminded me of credit cycles. In the "good" times - it seems like every decision works out…in the bad times, nothing seems to work.

10. (DG) Keep all trading systems simple. Complication breeds confusion; simplicity breeds profitability. (KF) This is why we believe Shape Management® is so awesome. Since none of us know the future, we need to focus on projected outcomes in different scenarios. If we rely on computer algorithms, we will ultimately rely on machines that do not know our situation, nor our business. As Einstein said: Keep things as simple as possible, but not simpler.

11. (DG) There is never just one cockroach. The lesson of bad news is that more almost always follows and with an ever-worsening impact.

12. (DG) Do more of that which is working and less of that which is not. This works in life as well as in trading. If there is a "secret" to trading…and to life generally…this is it!

13. (DG) Clean up after yourself. Need I say more? Errors only get, and losses become larger. (KF) I learned this lesson early at the Chicago Mercantile Exchange. Cover your mistakes. All of us - and I mean every single one of us - will make mistakes. Cover them quickly. Tell others what has happened and how you screwed up. Sometimes it will be embarrassing and painful, but it's the right thing to do and others will appreciate it over time. No one is perfect.

14. (DG) There is always a bigger junkyard dog. No matter how much "work" we do on a trade, someone knows more; is more prepared; and has more capital! Accept that fact and move on. (KF) We can run vectors on prepayments and make assumptions all the live-long day. We still can never have perfect insights into prepayments and the behaviors of individuals. We will never have perfect information - and that is O.K. Make the best decisions you can, given the information sets available, and move on.

15. (DG) When the facts change, change!! Lord Keynes…again…once said that "When the facts change, I change; what do you do, Sir?" When the technicals or the fundamentals of a position change, at least reduce your exposure and consider exiting entirely.

16. (DG) All rules are meant to be broken. But they are to be broken only rarely, and true genius comes with knowing when, where, and why!

I hope you enjoyed the "rules of investing". I don't expect you to stick these on the refrigerator with your favorite holiday cards, but if a few of you print this out and tuck it in your drawer I will feel I have accomplished something!

This will be my last post of 2021 and I am planning on starting 2022 with some predictions for the new year. Hopefully, I will be better than the 60% correct I posted in 2021…I truly hope you all have a wonderful Christmas and Happy New Year!

Final, final thought: Is it possible that eggnog is actually good for you? I mean - it does bring a smile to your face!

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The information, analysis, guidance and opinions expressed herein are for general and educational purposes only and are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Information obtained from third party resources are believed to be reliable but not guaranteed. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.