After a couple week break we’re bringing back the Market Wizards Remembered series to close out 2016. If you are not familiar with the series please check out this summary post from a couple weeks ago. If you’re unfamiliar, The Market Wizards series is a collection of books written by Jack Schwager that captures the philosophies, traits, experiences, and advice of great traders, seeking to draw out lessons that could help all traders from novices to professionals.
The following is an excerpt from Jack about Al Weiss:
THE ROLE OF RESEARCH AND TECHNICAL ANALYSIS IN TRADING
In New Market Wizards, the second book of the series, Schwager interviewed Al Weiss, a CTA who began trading in 1982. Weiss is best known for averaging a return of 52% annually, and during his worst year had a drawdown averaged a bit under 5% while having an average annual return exceeding 29%! The following excerpt from New Market Wizards focuses on the role of research and technical analysis in trading.
How did you end up becoming a trader?
It was not an overnight process. I spent four years of solid research before doing any serious trading. After literally thousands of hours of poring over charts, going back as far in history as I could, I began to recognize certain patterns that became the basis of my trading approach.
You spent four years doing research before you even started trading? Yes. I’m a risk-averse person. I wanted to have confidence in my approach before I started.
Precisely how far back did you go in your chart studies?
It varied with the individual market and the available charts. In the case of the grain markets, I was able to go back as far as the 1840s.
Was it really necessary to go back that far?
Absolutely. one of the keys in long-term chart analysis is realizing that markets behave differently in different economic cycles. recognizing these repeating and shifting long-term patterns requires lots of history. Identifying where you are in an economic cycle say, an inflationary phase versus a deflationary phase is critical to interpreting the chart patterns evolving at that time.
How did you support yourself during the four years you devoted to researching the markets?
In my early twenties, I had pioneered the development of the urethane skateboard wheel, which was a great financial success. I invested the money I made on this venture into the real estate market, which also proved to be very profitable. As a result, I had all the money I needed and was able to devote my full time to research.
I understand that you’re basically a technical systems trader. Why do you believe your track record is so much better than those of other commodity trading advisors using similar methods? In particular, I’m interested in how you have managed to avoid the large drawdowns that seem to be almost intrinsic to this approach.
Although I employ technical analysis to make my trading decisions, there are a few important differences between my method and the approaches of most other traders in this group. First, I think very few other technical traders have gone back more than thirty years in their chart studies, let alone more than a hundred years. second, I don’t always interpret the same pattern in the same way. I also factor in where I believe we are at in terms of long-term economic cycles. This factor alone can lead to very substantial differences between the conclusions I might draw from the charts versus those reached by traders not incorporating such a perspective. Finally, I don’t simply look at the classical chart patterns (head and shoulders, triangle, and so on) as independent formations. rather, I tend to look for certain combinations of patterns or, in other words, patterns within patterns within patterns. These more complex, multiple-pattern combinations can signal much higher probability trades.
What popular chart patterns are accurate only 50 percent of the time?
Most of them. but that’s not a drawback. A pattern that works 50 percent of the time can be quite profitable if you employ it with a good risk control plan.
Is technical analysis an art or a science?
It’s both an art and a science. It’s an art in the sense that if you asked ten different traders to define a head-and-shoulders pattern, you’d come up with ten different answers. however, for any individual trader, the definition can be made mathematically precise. In other words, chart traders are artists until they mathematically define their patterns—say, as part of a system structure—at which time they become scientists.
Why have you chosen a purely technical approach in favor of one that also employs fundamentals?
Many economists have tried to trade the commodity markets funda- mentally and have usually ended up losing. The problem is that the markets operate more on psychology than on fundamentals. For example, you may determine that silver should be priced at, say, $8, and that may well be an accurate evaluation. however, under certain conditions—for example, a major inflationary environment— the price could temporarily go much higher. In the commodity inflation boom that peaked in 1980, silver reached a high of $50—a price level that was out of all proportion to any true fundamental value. of course, eventually the market returned to its base value— in fact, in the history of markets, I can’t think of a single commodity that didn’t eventually move back to its base value—but in the interim, anyone trading purely on the fundamentals would have been wiped out.
Do any particularly memorable trades come to mind?
Whenever I’m on vacation, I continue to chart the markets. In the summer of 1990, while on vacation in the bahamas, I was updating my charts on a picnic table beneath the palm trees. I noticed patterns that indicated buy signals in all the energy markets. These signals seemed particularly odd because it’s very unusual to get a buy signal in heating oil during the summer. however, I didn’t question the trade and simply phoned in the orders. Three days later, Iraq invaded kuwait and oil prices exploded.
Do you follow your system absolutely, or do you sometimes override the trading signals?
I follow the system well over 90 percent of the time, but occasionally I try to do better than the system. since I employ such deviations from the pure system very selectively, they have improved performance overall.
Give me an example of a situation in which you overrode the system.
In October 1987 when the stock market was in the midst of its crash, I started receiving anxious calls from my clients who wanted to know if they had suffered a large loss. I calmly explained that we were still up 37 percent for the year and that the total risk on all our open positions was only 4 percent. I had a feeling that people would be very insecure in the markets and that there would be a resulting flight to T-bills. I decided to take off my entire short position in T-bills, even though my system had not yet provided any reversal signal. That proved to be the right action, as the T-Bill market took off on the upside almost immediately afterwards.
It’s obvious from your earlier comments that you consider cycles important. Could you please elaborate?
There are cycles in everything—the weather, ocean waves, and the markets. one of the most important long-term cycles is the cycle from inflation to deflation. About every two generations—roughly every forty-seven to sixty years—there’s a deflationary market. For example, in respect to the commodity markets, we’re currently in a deflationary phase that began in 1980. over the past two hundred years, these deflationary phases have typically lasted between eight and twelve years. since we’re currently in the twelfth year of commodity price deflation, I think we’re very close to a major bottom in commodity prices.
Another important consideration in regard to cycles is that their lengths vary greatly from market to market. For example, in the grain markets, which are heavily weather dependent, you may get major bull markets about five times every twenty years. In the gold market, however, a major bull cycle may occur only three to five times in a century. This consideration could make a market such as gold very frustrating for traders trying to play for the next bullish wave.
What is the single most important statement you could make about the markets?
The essential element is that the markets are ultimately based on human psychology, and by charting the markets you’re merely converting human psychology into graphic representations. I believe that the human mind is more powerful than any computer in analyzing the implications of these price graphs.
Are You the Next Market Wizard?
As the Chief Research officer of FundSeeder, Schwager plans to select traders discovered via FundSeeder as interview subjects for his next Market Wizards book, tentatively titled Undiscovered Market Wizards. If you would like an opportunity to be featured in this book or to be selected to manage investor capital, or if would just like to enjoy a great trading analytics platform free of charge, click on the link below to sign up for FundSeeder today.
