Bill Lipschutz [PDF]

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The Trader’s Tao Organization

Bill Lipschutz – The Sultan of Currencies In a training course with Forex in its name, it would be inappropriate to ignore the advice and experience of Bill Lipschutz – The Sultan of Currencies. Bill was featured in both Market Wizards and The New Market Wizards books. He was in his early 30s when he earned that recognition from author, Jack Schwager, and is still going strong. In this largest of all financial markets, there has been only a handful of high-stakes players. Most are unknown to most of the financial community, let alone the public, although they sometimes take positions measured in billions of dollars. Bill Lipschutz is one of these traders. Prior to the books by Schwager, Bill had managed quite deliberately to maintain virtually total public anonymity for his entire career despite his huge trades. Lipschutz gained his reputation at Salomon Brothers when the currency options market, Salomon’s currency options department, and he all started at the same time and prospered simultaneously. It may be helpful for your perspective, though, to know this: Bill traded his personal account that was funded by a $12,000 inheritance when he first started at Salomon. He steadily grew it into a small fortune of $250,000 in about four years. Then he lost it all in just a few days as a result of a series of bad trades. He never traded a personal account again. It has been estimated, however, that Bill Lipschutz is personally responsible for creating more than ½ billion dollars in FX profits for Salomon Brothers over eight years.

There was a particularly telling moment in Schwager’s interview when he asked the following question: I’ve always been puzzled by the multitude of banks in the United States and worldwide that have large rooms filled with traders. How can all these trading operations make money? Trading is just not that easy. I’ve been involved in the markets for nearly twenty years and know that the vast majority of traders lose money. How are the banks able to find all these young trainees who make money as traders? Bill’s answer: There have been a lot of studies done on [the] question [of whether the banks’ profitability is due to the advantage of earning the bid/ask spread on customer transactions or primarily due to successful directional trading]. [One] study concluded that if Citibank (the largest and probably the most profitable currency trading bank in the world at that time) traded only for the bid/ask spread and never took any position trades, they probably would make $600 million a year (at the time they usually made about $300 million to $400 million a year in their trading operations). “Assume you’re a trader for a bank and you’re expected to make $2.5 million a year in revenues. If you break that down into approximately 250 trading days, that means you have to make an average of $10,000 a day. Let’s say an unsophisticated customer who trades once a year and doesn’t have a screen comes in to do a hedge. You do the trade at a wide spread, and right off the bat you’re up http://www.traderstao.com/

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The Trader’s Tao Organization $110,000. You know what you do? You spec your buns off for the rest of the day. That’s what almost every currency trader in New York does, and it’s virtually impossible to change that mentality. Because if you’re lucky, you’ll make $300,000 that day, and you’ll be a fucking hero at the bar that night. And if you give it all back – ‘Ah, the market screwed me today.’ Is that trading? Even at Salomon Brothers, where there’s a perception that everyone is a trader, it came down to only about a half-dozen people who took real risk. The rest were essentially just making markets. That nuance is lost on most people.” Schwager’s follow-up question: If it weren’t for the bid/ask spread, would the banks make money on their trading operations? Lipschutz: Probably not in conventional position trading in the way you think of it. However, there is another aspect of directional trading that’s very profitable. Take Joe Trader. Day in, day out, he quotes bid/ask spreads and makes a small average profit per transaction. One day a customer comes in and has to sell $2 billion. The trader sells $2.1 billion, and the market breaks 1 percent. He’s just made $1 million on that one trade. In a lot of markets that’s illegal. It’s called frontrunning. Bill pointed out that it’s not illegal in the interbank market, because the broker is not putting his order in front of the customer’s. He’s basically riding his coattails. Between these two factors – “frontrunning” and having to make up the spread – you can see that the small trader is already at a disadvantage. Piled on top of that, the inability of the average trader to analyze volume makes it a David and Goliath contest. Bill explains the volume dilemma this way: “Foreign exchange is all about relationships. . . . your ability to be plugged into the information flow – it all depends on relationships. You need to be plugged into the news and to know what the market is looking at. Foreign exchange is a very psychological market. If you move the market 4 percent, for example, you’re probably going to change the market psychology for the next few days. [Size is] a huge advantage in foreign exchange.” Unfortunately, as retail platform traders, we don’t have the ability to identify size transactions that move the market significantly. We don’t know if the movement is being caused by one massive order or many small ones. That is a disadvantage that must be understood and overcome.

So, there you have it – yet another discourse about seemingly insurmountable odds against you. You might think I’m trying to discourage you from trading in the FX markets. Such is not the case.

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The Trader’s Tao Organization Every financial market that serves as a deep well of profitable opportunities for the institutions that depend on them for their enormous wealth have their own methods for going after your money. Stock markets have their specialists that “maintain a ‘fair and orderly market’ in the stocks they trade by stepping in with their own capital to help reduce market volatility when there are not sufficient buyers or sellers.” Really!? Do you think they might be afforded some lucrative opportunities by seeing both sides of every trade? I’m just sayin’. I have personally sold substantial sums of “secondary stock offerings” from the premier financial advisory in America to people just like you. These offerings contained exorbitant, almost criminal bid/ask spreads that produced monstrous profits for my employer. And they immediately tanked after being transferred from the underwriter to the portfolios of my clients. The pits of the futures exchanges could just as well be called “traps.” It’s a good ole boy’s world, folks. They are on the inside, and you are on the outside. If you are ever going to be a consistent winner in any of these markets, you must know your adversary and his tactics. You can ignore all this reality or choose not to accept it, but you do so at your own peril.

Aside from this negative stuff, the interview focused on Bill’s trading philosophy and tactics, all worth adding to your library of knowledge that will make you more successful. Bear in mind that Bill Lipschutz is a fundamental trader. Does he believe that stops have a tendency to get picked off in exchange-traded markets? Yes, he does. Risk Control: Always know exactly where you stand. Don’t concentrate too much of your money on one big trade or group of highly correlated trades. Always understand the risk/reward of the trade as it now stands, not as it existed when you put the position on. Losing Streaks: When you’re in a losing streak, your ability to properly assimilate and analyze information starts to become distorted because of the impairment of the confidence factor, which is a by-product of a losing streak. You have to work very hard to restore that confidence, and cutting back trading size helps achieve that goal. Entry and Exit: Bill is a scale trader – scaling in on entries and out on exits. Winning Percentages: You have to be able to let your profits run. I don’t think you can consistently be a winning trader if you’re banking on being right more than 50 percent of the time. You have to figure out how to make money being right only 20 to 30 percent of the time.

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The Trader’s Tao Organization Decision-making: You don’t want to hold a position when you don’t understand what’s going on. Many people think that trading can be reduced to a few rules. Always do this or always do that. To me, trading isn’t about always at all; it is about each situation. On Being a Trader: The best traders I know are really quite brilliant, and they all work very hard – much harder than anyone else. . . . when I talk about working hard, I mean commitment and focus; it has nothing to do with how many hours you spend in the office. It’s not enough to simply have the insight to see something apart from the rest of the crowd; you also need to have the courage to act on it and to stay with it. It’s very difficult to be different from the rest of the crowd the majority of the time, which by definition is what you’re doing if you’re a successful trader.

Takeaways: 1. Recognize the adversarial forces that are competing with you and the odds that are against you. Know your enemy. 2. Understand how the institutional side (the other side of the trade) of this market works. 3. Determine whether you want to be a fundamental trader (and what that takes) or a technical trader, and why. 4. Fold the wisdom of one of the most successful Forex traders of all time into your trading plan.

I wish you the best in all your trading

Raleigh Lee The Trader’s Tao Organization www.traderstao.com

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