The New Market Wizards: Conversations with America's Top Traders (33 page)

Perhaps Blake’s most important message lies in his amazingly consistent track record, which provides compelling empirical evidence that the markets are indeed nonrandom. Of course, this nonrandomness is hardly blatant. If it were, we would all be millionaires. However, Blake’s ability to win in an astounding twenty-five months for every month he loses, allows us to say “Yes, Virginia, the markets can be beat.”

How can the markets be beat? Certainly not by buying the answer. Even if the answer were for sale, the odds are that it wouldn’t fit your personality and that you wouldn’t have the confidence to follow it. Essentially, there are no shortcuts. Each trader must find his or her own solution to the market puzzle. Of course, most such research efforts will end in failure. If, however, you are able to uncover nonrandom market patterns and can convincingly demonstrate their validity, only two steps remain to achieve trading success: Devise your trading rules and then
follow
your trading rules.

MARKETS GROW OLD TOO

V
ictor Sperandeo started his career on Wall Street straight out of high school. It was certainly an unglamorous beginning, working first as a minimum-wage quote boy and then switching to a slightly higher paying job as a statistical clerk for Standard & Poor’s. Sperandeo found this work, which basically involved copying and transferring columns of numbers, “stupifyingly boring.” He had a difficult time keeping his mind on his work. To his relief, he was eventually fired for making too many errors.

After a stint at another nontrading job in a Wall Street accounting department, Sperandeo talked his way into an option trading position. Over the next two years, he was a dealer in the over-the-counter (OTC) options market, matching up buyers and sellers and “making the middle.”

In the midst of the 1969 bear market, Sperandeo switched firms in a search for greater autonomy in his trading decisions. At this new firm, he was offered a percentage of the spread he earned on each option transaction, as opposed to the flat fee compensation structure at his former company. The new firm, however, would not commit to a salary because of a cautious posture fostered by the ongoing bear market. Sperandeo gladly accepted the offer, confident that he could substantially increase his income by sharing in a percentage of his transaction earnings.

After six months on the job, Sperandeo had earned $50,000 in commissions. His boss, who earned an annual salary of $50,000, called him in for a talk. “Victor,” he said, “you’re doing such a good job, we decided to put you on a salary.” Somehow, the offer of a $20,000 salary and an ambiguous commitment to some sort of bonus in lieu of his existing compensation arrangement just didn’t sound like good news. Three weeks later Sperandeo switched jobs. Unfortunately, he found that his new firm played the same song only in a different key—when he received his monthly profit/loss statements, he discovered that his profits were being eaten away by enormous expense allocations.

After about six months, Sperandeo finally decided that if he were going to get a fair deal, he would have to make it himself. After finding a partner to finance the operation, Sperandeo launched his own firm, Ragnar Options, in 1971. Sperandeo claims that Ragnar was the first option dealer to offer guaranteed quotes on options without charging exceptionally high premiums. If they couldn’t find an existing option contract in the market to meet a buyer’s request (which they could purchase and resell at a premium), they wrote the option themselves. (At the time, options were tailor-made to the customer’s specifications, as opposed to being traded as uniform instruments on an exchange.) As a result of this policy of offering reasonable firm quotes, according to Sperandeo, within six months Ragnar was the largest OTC option dealer in the world.

Ragnar was eventually merged with another Wall Street firm. Sperandeo stayed on for a while but then joined Interstate Securities in 1978. At Interstate, Sperandeo was given a company account and a few private accounts to manage at a 50/50 split (expenses as well as profits). Sperandeo had finally landed the perfect job: complete independence to trade any markets in any way he desired, capital backing, and a meaningful split of profits (and losses). This ideal arrangement finally came to an end in 1986 when Interstate went public and decided to dissolve its trading group. Sperandeo traded his personal account for a little over a year before deciding to start his own money management firm—Rand Management Corporation.

Throughout his entire career, Sperandeo has placed a greater emphasis on loss avoidance than on scoring large gains. He was largely successful at this objective, stringing together eighteen consecutive winning years before registering his first loss in 1990. Over this period, his average annual gain was 72 percent, with results ranging from a single loss of 35 percent in 1990 to five years of triple-digit gains.

Although Sperandeo never bothered to finish the credits for his nighttime college degree, over the years he has done an enormous amount of reading. In addition to books about the market, Sperandeo has read widely in the somewhat related fields of economics, psychology, and philosophy. Overall, he estimates that he has read approximately twenty-five hundred books on these subjects.

The interview was conducted at Sperandeo’s “office,” which is located in the basement of his house, the main section of which he has converted to a lounge, complete with a fifteen-foot bar, seating for seventy-five, and an elaborate sound system. You almost expect Bill Murray to pop up and do his “Saturday Night Live” lounge singer act. I couldn’t help but smile at the image of a starchy pension fund trustee doing an on-site inspection of Sperandeo’s operations in considering him as a prospective manager for its funds. I found Sperandeo very relaxed and friendly—the type of person who is instantaneously likable.

After nearly two decades as an independent or quasi-independent trader, why did you finally decide to start a money management firm?

In 1987 I did enormously well catching the huge break in the stock market. My success in this market led to unsolicited offers to manage some large sums of money. I realized that if I had been managing money, as opposed to simply trading my own account, my profit potential would have been enormously greater.

How have you done in your trading since you started your own management company?

I did well in 1989, which was the first year of the firm’s existence, but I lost money in 1990. Actually, I found it somewhat ironic that my first losing year in the markets occurred after having gained more knowledge than ever.

How do you explain that?

That’s what you call being a human being. [He laughs loudly and long.]

How did you become a trader?

I think my first related interest was an enthusiasm for poker. As a teenager, I literally earned a living by playing poker. When I first started playing, I read every book I could find on the game and quickly learned that winning was a matter of managing the odds. In other words, if you played only the hands in which the odds were in your favor and folded when they were not, you would end up winning more times than you lost. I memorized the odds of every important card combination, and I was very successful at the game.

Although I did quite well, I realized that being a professional card player was not what I wanted to do with my life. When I was twenty years old, I made a complete survey of the
New York Times
employment section and discovered that three professions offered more than $25,000 per year as a starting salary: physicist, biologist, and OTC trader. Now, I didn’t even know exactly what an OTC trader did, but, since I obviously didn’t have the educational background for being a physicist or biologist and OTC trading sounded a little bit like playing cards—they both involved odds—I decided to try for a career on Wall Street. I landed a job as a quote boy for Pershing & Company.

How did you learn about trading and markets? Did you have a mentor?

No. At the time, Milton Leeds, who was a legendary tape reader and trader of his day, worked at Pershing. I found observing him inspirational, but I didn’t work directly for him. Basically, I learned about the markets by reading everything on the subject that I could get my hands on.

When did you actually first become a trader?

After working on Wall Street for almost three years, first at Pershing and then some other short-lived jobs, I decided that I wanted to try trading. I considered the different areas of trading that I could go into. There was stocks—kind of boring. There was bonds—really boring. Then there was options—very sophisticated. in the late 1960s, probably only about 1 percent of all stockbrokers even understood options. I thought that if I undertook the most esoteric form of trading and mastered it, then I would have to make a lot of money. So I applied for a job as an options trader.

What did you know about options trading at the time?

Nothing, but I knew that was what I wanted to do. I tried to make an impression on the senior partner who interviewed me by telling him that I was a genius.

He said, “What do you mean?”

I told him that I had a photographic memory—which, incidentally, I don’t.

He said, “Prove it.”

I told him that I had memorized all the stock symbols—which I had. I had taken a memory course years before. This fellow had been on Wall Street for thirty-five years and didn’t know all the symbols. He tested me, and I knew them all. He offered me the job.

You said earlier that you were drawn to a trading career because of the analogy to playing cards. Do you then see trading as a form of gambling?

I’d say that
gambling
is the wrong term. Gambling involves taking a risk when the odds are against you. For example, betting on a lottery or playing a slot machine are forms of gambling. I think successful trading, or poker playing for that matter, involves speculating rather than gambling. Successful speculation implies taking risks when the odds are in your favor. Just like in poker, where you have to know which hands to bet on, in trading you have to know when the odds are in your favor.

How do you define “the odds” in trading?

In 1974 I missed the huge October-November rally in the stock market. That error served as a catalyst for an intensive two-year study. I wanted to know the answer to questions like: How long do bull and bear markets last? What are the normal percentage price moves a market makes before it forms a top or a bottom?

As a result of that research project, I found that market price movements are like people—they have statistically significant life-expectancy profiles that can be used to measure risk exposure. For example, the median extent for an intermediate swing in the Dow during a bull market is 20 percent. This doesn’t mean that when the market is up 20 percent, it’s going to top; sometimes it will top earlier, sometimes later. However, what it does mean is that when the market is up more than 20 percent, the odds for further appreciation begin to decline significantly. Thus, if the market has been up more than 20 percent and you begin to see other evidence of a possible top, it’s important to pay close attention to that information.

As an analogy, consider life insurance, which deals with the life expectancy of people instead of price moves. If you’re writing life insurance policies, it’s going to make a great deal of difference whether the applicant is twenty years old or eighty years old. If you’re approached by an out-of-condition twenty-year-old, you might judge that the odds of his survival are pretty good. However, you’d be a lot less anxious to write a policy on an eighty-year-old. If the eighty-year-old is the Jack LaLanne of eighty-year-olds—he can do two hundred push-ups; he can swim the English Channel—then fine, you can write him a policy. But let’s say the same eighty-year-old smokes three packs of Camels a day, drinks a quart of scotch a day, and has pneumonia—then you probably wouldn’t want to write him a policy. The older the individual, the more significant the symptoms become.

Similarly, in a market that is in a stage of old age, it is particularly important to be attuned to symptoms of a potential end to the current trend. To use the life insurance analogy, most people who become involved in the stock market don’t know the difference between a twenty-year-old and an eighty-year-old.

In my opinion, one reason why many types of technical analysis don’t work too well is because such methods are often applied indiscriminately. For example, if you see a head-and-shoulders pattern form in what is the market equivalent of a twenty-year-old, the odds are that the market is not likely to die so quickly. However, if you see the same chart formation in the market equivalent of an eighty-year-old, there’s a much better chance of that pattern being an accurate indicator of a price top. Trading the market without knowing what stage it is in is like selling life insurance to twenty-year-olds and eighty-year-olds at the same premium.

When you say that the historical median length of a bull move has been 20 percent, how are you defining a bull move?

I’m talking about intermediate upmoves in a long-term bull market. With very rare exceptions, I define “intermediate” as a price move lasting a minimum of three weeks to a maximum of six months. Of course, there are analogous figures for all other types of market movements categorized by type of market (bull or bear), length of move (short term, intermediate term, or long term), and location within market cycle (first swing, second swing, and so on).

Incidentally, there’s remarkable consistency in the 20 percent median upmove figure, which I based on a study of all years since 1896. When I looked only at markets up through 1945, I found that the corresponding figure was virtually identical at 19 percent. I think there are two reasons that help explain the stability of this approximate 20 percent figure. The first factor is related to value. Roger Ibbotson did a study spanning sixty years of data in which he compared the returns of different forms of investment. He found that, over the survey period, the stock market returned an average of 9.2 percent annually, including dividends. Therefore, if the market rises 20 percent in, say, 107 days—which happens to be the median time duration of an intermediate upmove—then you’ve squeezed out a lot of value in a very short amount of time. The market as a whole has become much less of a value.