A couple of Tom Basso’s podcasts showed up on my YouTube feed, and they were quite insightful. In case you didn’t know, Tom Basso is a veteran who’s also been profiled in Jack Schwager’s books.
I picked a few interesting snippets from the 2 conversations I heard. I highly recommend listening to the full podcast. The links are in the end.
Interviewer: When you look back at your trading career so far, what do you think has been one of the key factors, or the key factor, in your longevity? How have you survived so long when probably millions of people have come and gone in trading and in the markets?
Tom Basso: I would say it’s sort of two things. One is, after reading Larry Hite’s chapter in Market Wizards, I really started thinking a lot about, as he calls it, bet size, or what I call the risk exposure of each position and the risk exposure of the portfolio. That would be the first thing that comes to mind that has allowed me longevity. As I wrote in the book, successful traders size their positions carefully. With very simple math that you learned in junior high school, you can set your exposure to risk by changing your position size up or down until it’s exactly where you feel comfortable over the long run.
If you set your risk too high—like if you start risking 2% in a position and you have 50 positions, and all those positions hit their stop-loss points—you’d wipe yourself out. You wouldn’t even get that far because you’d get margin calls before that, and your broker would liquidate your positions.
So there’s some kind of reasonable maximum that you can logically take. On one end, there’s zero risk, which would get you zero return, and on the other end, there’s a happy medium in between that each trader must decide for themselves. It needs to be comfortable, not lead to blowing up your account, and allow you to size positions appropriately so that all positions are contributing to the potential profit or loss as a portfolio.
For example, if you’re sizing your positions in such a way that you have one very large position that has appreciated significantly—let’s say it’s now 20% of your portfolio—while all the other positions combined make up only 10%, and you have a lot of cash sitting around, then you don’t really have a balanced portfolio. You have Nvidia and some other stuff.
And I think that’s what I see a lot of people do—they lock onto a certain size of position, let their positions run as a good trend follower should, but they don’t ever modify that position. What that leads to is an imbalance in the portfolio.
The second part of longevity is once you’ve got your position sizing and risk management correct, the next thing you need as a trader is awareness and discipline. You need the awareness to recognize when you go off your plan, and you need the discipline to put yourself back on track. If you don’t have those two things—and you should work on both of them—start with awareness so you can tell whether you’re being greedy, wanting to cut a trade short a little too quickly, and not letting it run as you should, or if you’re upset because the last trade was a loser and you’re determined to make the money back quickly by doubling the position size just to “teach the market a lesson” or something. Those are classic problems over the long run if you have that kind of mentality.
I’ve been very even-keeled for a long, long time in markets and trading, and to me, putting on one more trade is about as easy as breathing at this point. I think that’s been the second part of my longevity—just sticking to the plan.
There are days when I’m on my fifth day in a row of losing money, and I usually maintain it pretty well, but there are some days when it catches my attention, and I think, “Wow, that’s getting a little bit impactful here.” But I try to balance myself out. When I’m in a drawdown, I think of when I’m making new highs. When I’m making new highs—which I did yesterday afternoon when I made my run—I was at new highs on the equity curve. I remind myself that a drawdown is right around the corner, and here I am today at the start of another drawdown. So, you know, I try to balance myself, and I think that’s the key to success too. If you’re all over the map, you’ll never be able to stay with the plan.
When you’re starting out, a new trader might have, let’s say, around $10,000 to $20,000 to work with. Fortunately, in today’s financial markets, there are options like fractional shares available at some brokers, which allow for very small position sizes in equities. Then, on the futures side, there are micro contracts, mostly offered by the CME, that enable traders to engage in very small sizes of commodities like crude oil and others. This accessibility allows even those with limited capital to diversify across more positions.
Now, the reason I emphasize that this is important is because it’s somewhat of a freebie. If you could magically manage 50 or 100 positions, and keep track of them all—either using computers or some existing software—it changes the game. What happens then is that no single position in your portfolio will drastically sway your entire financial picture on any given day. This is crucial because it prevents major shocks; you don’t want to wake up, check your computer, and find your entire portfolio has swung 10% overnight. That’s not a good way to start the day.
In practice, you’re aiming to calibrate each position so it makes reasonable contributions to the overall health of your portfolio. In my own experience, managing a reasonably sized portfolio, I spread my investments across about 50 to 55 different positions on any given day, sometimes even as many as 60. This includes trading in about 30 different futures markets, various ETFs, and engaging in options like credit spreads. I’m also implementing around 10 different trading strategies concurrently.
For someone just starting out with a smaller sum of money, my advice would be to not concentrate all your capital into one or just a few stocks. Aim to own at least 10 to 20 different stocks as you begin to grow your portfolio. This not only helps in managing risk but also aids in gaining exposure to different market dynamics. If you can diversify your holdings to include both stocks and futures, you’re even better off. Stocks tend to move in unison, especially those within the same sector or index, so by adding futures into the mix, which might react differently to market conditions, you enhance your portfolio’s resilience. This kind of diversification helps ensure that some parts of your portfolio can perform well under conditions where others might not, smoothing out the overall returns and reducing the likelihood of significant drawdowns.
I’ve never had a strategy that was 100% reliable. My average over my lifetime is probably 33 to 35% reliable, meaning that 2/3 of my trades are losers. Every time I go into a trade, 66 or 67% of the time, I am going to lose on that trade. I do it anyway because I know that about 33 to 35% of the time, I’m going to have a winner, and some of those winners are going to be like the orange juice, Cocoa, or Nvidia trades—outliers that are going to make me a ton of money. That’s where I make my profits over the long run: those outliers.
To put it in perspective, there was one year, way back at TrendStat days, when we had a pretty boring year. It was positive—we didn’t lose money—but it wasn’t anything to write home about. We had about a 6% positive return. I had the guys in the computer department take our actual trading database of real trades and line them all up from the most profitable to the worst trade in the book. When we figured out that all of the bottom trades all the way up to many of the profitable trades completely washed each other out, it was revealing. One trade in Japanese Yen, which we held for about 15 months, was the difference between that 6% gain and making nothing.
So, you’ve got to find those outliers, you’ve got to be in on them, you cannot avoid them, and you can’t screen them out. You’ve got to find that outlier that pays the freight. It was very enlightening to me and got me thinking about making sure that I do the next 1,000 trades and get everyone into the portfolio because I never know which will be the next Japanese Yen.``
Interviewer: I want to reference something in your book where you emphasize a lot on staying calm during market volatility. I’m really curious about how traders can condition their mind to remain composed when their capital is on the line, because obviously the panic is an emotional response and then you know that fixes your state of being and then you start to behave a certain way. So, what’s your take on that?
Tom Basso: My take would be that most traders, especially those starting out and especially those without enough capital, will tend to have their position sizing too high. This leads to larger swings in their percent returns and losses. So, when you get into the volatile periods, their positions are too large, the volatility hits the larger positions, and they start thinking, ‘Wow, I’m down 20%.’ That’s going to pierce your consciousness and your well-neutralized mental state, and all of a sudden you start thinking, ‘Wow, 20% of my account is gone.’
The human mind wants to take the slope of the line of the equity curves going down and extrapolate that line all the way to zero, and ask, ‘How much time do I have left before I have nothing?’ So, you start to get a fear thing going, you get a panic thing going, and then you make dumb decisions because you’re making them out of panic; you’re not staying to the plan.
And really, sometimes it’s just as simple as just backing off your position sizing. That’s why I wrote the book, ‘Successful Traders Size Their Positions.’ I put the math in there that we’ve used at TrendStat for over the last 45 years. It’s math you learned in junior high school. It’s not differential equations or calculus or anything—it’s just add, subtract, multiply, divide. I’ve used it in a simple way to keep my positions always sized properly. I’m never too overleveraged, and I’m never too underleveraged.
If you see a position going over and you don’t buy the appropriate amount, it’s not going to have the effect it needs to have on your portfolio. And if you buy too much of it, it’s going to have too much of an effect on your portfolio. Your job as a trader is to get all your positions to be a part of the portfolio, have everyone be contributing its own possibility for gain or loss, then you have a real diversified stable situation.
The other side of that same coin, which I also put in the book, is what happens when you get something like a Nvidia, or an outlier like cocoa earlier in the year, or orange juice last year, where you get a move that just goes so straight up like a fighter jet taking off. If you don’t manage the portfolio and say, ‘Okay, well this one position here is now no longer just an equal partner in the portfolio; it is now dominating the portfolio, and I’m just trading Nvidia and a few other things that don’t matter anymore.’ When you look at your daily returns, it’s all driven by what that one position does.
In my mind, to keep your mind stable, I just keep adjusting those position sizes and make them so that everything’s in the same ballpark. For example, say you started out with 10 contracts of orange juice last year, the market goes nuts, well maybe you peel off two of them, now you’re down to eight, and that’s enough to keep it balanced. But it goes up some more, so maybe you peel it back to seven. By the time you get done to the end of the run, maybe you’re back to five, but in all of the days that you were in that, you’re not getting totally driven by orange juice because you’ve got a whole bunch of other things doing their thing, and you’ve sized the orange juice appropriately so that it’s part of your portfolio. If you don’t do that, you become ‘orange juice and a few other things,’ and that, to me, is not a portfolio.
Here’s the ctranscript from the exchange between the interviewer and Tom Basso discussing ego, admitting wrongs, and maintaining an objective perspective in trading:
Interviewer: I speak about this a lot in what I do, you know, sometimes if the ego is there, there’s also a part of us that won’t admit we’re wrong. You know, we do our thesis, we take information, we make a call, and there’s that internal struggle. I’m sure you would agree with some traders out there that they don’t want to admit that they’re wrong. In fact, that’s probably the biggest weakness, is like, you got to the moment you know you’re wrong, you just have to say, “I’m out. I admit it.” It’s not personalizing it, you know. It’s like taking that personal versus becoming, as we say, the observer—there’s sort of a disconnect between whatever you thought it might be versus what it is right now, and now it’s time to be able to switch that and shift back away from it, you know, would you agree?
Tom Basso: Yeah, I would agree. It’s very hard to admit you’re wrong. It’s easy to get overly excited when you’re right, on the other side of the mental spectrum, and both are dangerous. Thinking that you’re full of it and that you’ve solved the magic puzzle to wealth down the road is dangerous because you can get a little bit overleveraged. You can say, “Well, you know, I’ve just done five trades in a row correctly; I’m going to really load up on the sixth one,” and then it hammers you. That’s a good way to put yourself in harm’s way.
So just position sizing yourself appropriately on every trade, just as if that trade’s just a standard single trade, a single data point out of your next 1,000 trades. It’s just one more trade, one more data point, just keep going, crank the process. Boring is good. I don’t like my trading, although I’ve had some good returns over the years, to think of it as exciting. It’s a relatively boring process, and I try to make it as boring as I can. I like to automate as much as I can just to free my time up so I can be outside.
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