|You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind|
When I first met Tom Basso, I was immediately struck by his incredible ease about trading
Tom Basso: Mr. Serenity
To be frank, Tom Basso was not on my list of interview subjects for this book. Although his track record is solid, it is by no means striking. As a stock account manager, he has averaged 16 percent annually since 1980, approximately 5 percent above the S&P 500 return. Quite respectable, considering that the majority of managers underper-form the index, but still not the stuff of legends. As a futures fund manager, Basso has averaged 20 percent annually since 1987 with only moderate volatility. Here, too, the results are significantly better than the industry average, but hardly extraordinary. And yet, in an important sense, Basso is perhaps the most successful trader I have interviewed. To paraphrase a recent commercial, how do you spell success? If your answer is M-O-S-T B-U-C-K-S, then Basso doesnt make the grade. If, however, your answer is G-OO-D B-U-C-K-S, G-R-E-A-T L-I-F-E, then Basso has few peers.
When I first met Basso, I was immediately struck by his incredible ease about trading. He has learned to accept losses in trading not only in an intellectual sense but on an emotional level as well. Moreover, his feelings of exuberance about trading (or, for that matter, about life) bubble right out of him. Basso has managed to be a profitable trader while apparently maintaining complete peace of mind and experiencing great joy. In this sense, I cant think of a more worthy role model for a trader. I knew within minutes of meeting Basso that he was someone I wanted to include in this book. I also realized that my method of selecting interview subjects strictly on the basis of numbers was a somewhat myopic approach.
Basso started out as an engineer for Monsanto Company. He found that this job didnt fully absorb his energies, and he began dabbling in the investment field. His first foray into the financial markets was a commodity (futures) account, which proved to be an immediate disaster. Although it took many years before Basso was able to trade futures profitably, he persisted until he finally succeeded.
In 1980, he began managing equity accounts as an outgrowth of an involvement in an investment club. In 1984 he expanded his management scope to include futures accounts as well. The small size of most of these futures accounts (many as small as $25,000) resulted in excessive volatility. Basso realized that in order to reduce volatility to a reasonable level while still maintaining adequate diversification, he would have to drastically raise his minimum account size. In 1987, he raised his minimum to $1 million and returned the funds of all clients with smaller accounts. Today, he continues to manage both stock and futures accounts.
Basso and I met at a psychology investment seminar mn by Dr. Van Tharp and Adrienne Toghiaie. The seminar was held in the somewhat unlikely locale of Newark, New Jersey. The interview was conducted over lunch at a local diner.
==== One of the things that immediately struck me about you is that you have this aura of incredible relaxation-almost bliss-about your trading. Its the antithesis of the mental state people typically associate with traders. Have you always had this attitude about trading? ====
Not at all. I still remember my first trade. In 1975,1 opened a commodity account for $2,000. I bought two corn contracts and immediately lost $600. My stomach was turning. I couldnt concentrate on my work. (I was an engineer in those days.) I called my broker every hour.
==== Do you remember your motivation for that trade? ====
I put on the trade because of a rather naive study I did in which I found that a certain very infrequent chart pattern had been followed by a price
advance 100 percent of the time. Several years ago I heard you give a speech in which you talked about the well-chosen example. 1 laughed to myself when I heard you use that phrase because it reminded me of my first trade, which was the epitome of the well-chosen example.
[The well-chosen example Basso is referring to represents one of my pet peeves. The basic contention is that virtually any system ever invented can be made to look great if one simply illustrates the approach by selecting the historical market that proved most favorable for the particular method. I first became aware of this concept in the mid-1980s, when I read an article on a simple, fully disclosed trading system. At that time I was working on a rather complex system of my own. To my shock and dismay, this very simple system seemed to have outperformed the far more complicated system I had spent so much time developing-at least for the one illustration provided.
1 reread the article with greater scmtiny. The proposed system consisted of only two conditions. I and Norman Strahm, my partner in system development at the time who did all our programming, had tested one of the conditions before. We knew it to be a net winning, albeit only moderately performing, trading rule. The other condition was a rule that we considered to have such a poor prospect of success that we never even bothered testing it. However, if the system described in the article were really that good, its superiority had to come from including this second condition-a trading rule we had dismissed out of hand.
Naturally, we tested this second condition. Its performance for the market illustrated in the article was exactly as indicated. However, the time period selected for the example just happened to be the single best year in a ten-year test period for that market. In fact, it was the single best year for any of the twenty-five markets we tested for that ten-year period. No wonder the system had appeared to be that good-we were looking at the single best case out of the 250 possible market and year combinations we tested. What a coincidence! Im sure hindsight had nothing to do with it.
But thats not the end of the story. The system did dismally in the remainder of the test sample. In fact, for the ten-year period tested, seventeen out of twenty-five markets actually lost money once transaction costs were taken into account. Ever since that time, I have had an ingrained sense of skepticism regarding the illustrations used in trading system articles and advertisements.]
==== Do you believe that most of the people who sell trading systems using these well-chosen examples know better? Or are they really fooling themselves-as you admittedly did in your first trade? ====
I think its probably a bit of both. Some people are just selling garbage and they know it, while others are kidding themselves-they believe they have something thats worthwhile, but they really dont. This type of self-delusion occurs frequently, because its psychologically comforting to construct a system that looks very good in its past performance. In their desire to achieve superior past performance, system developers often define system conditions that are unrealisncally restrictive.The problem is that the future never looks exactly like the past. As a result, these well-chosen models fall apart when theyre traded in the future.
After my years of experience in the markets, I now try to keep my models as flexible as I possibly can. I try to imagine scenarios that would almost make good movie plots. As an example, the U.S. government falls, causing the Treasury to default on its T-bill obligations and the U.S. dollar to drop by 50 percent overnight.
==== How can you possibly design systems that can cope with those types of extreme situations? ====
I dont necessarily design systems that will cope with those situations, but I mentally live through what will happen to my positions, given one of these scenarios.
==== How does that help? ====
It helps prepare me for all the different market conditions that can arise. Therefore, I know what Ill do in any given situation.
==== In your description of your first trade, you come across as being filled with tension and anxiety. How did you go from that mind-set to your current extraordinarily relaxed attitude? ====
I realized that every time I had a loss, I needed to learn something from the experience and view the loss as tuition at the College of Trading. As long as you leam something from a loss, its not really a loss.
==== When did yon adopt that mental attitude? ====
Very early; probably right after the corn trade.
==== Did it help? ====
Definitely. By adopting that perspective, I stopped looking at the losses as problems and started viewing them as opportunities to elevate myself to the next plateau. Over the next five years, I gradually improved and lost less each year.
==== After losing money for five consecutive years from your start in trading, didnt you ever think that you might not be cut out for this endeavor? ====
==== What gave you the confidence? You obviously werent getting any reinforcement from the market ====
My reinforcement came when my losses gradually became smaller and smaller. I was getting very close to the breakeven point. I also kept my losses at a manageable level. I always traded a very small account-an amount that I could afford to lose without affecting my life-style.
==== Did you stop trading when you lost whatever amount of money you had set aside to risk in a given year? ====
That never happened. I had developed the concept of never taking a trade that would jeopardize my ability to continue trading. I always limited the risk on any trade to a level that I knew would permit me to come in and play the game again if I were wrong.
==== What lessons stand out most vividly from the period during which you attended your so-called College of Trading? ====
An absolutely pivotal experience occurred in 1979, about four years after I had started trading. My parents, who lived in Syracuse, New York, came in for a week-long visit. I was busy playing tour guide and fell behind in my work. Unbeknownst to me, that same week, silver broke out violently on the upside. The next week, I updated my work and discovered I had missed a buy signal in silver.
==== Were you trading a system at the time? ====
Yes. I was following a specific system and had taken every trade for nine months straight. In other words, theres no question that I would have taken the trade had I updated my work. Over the next few months, silver skyrocketed. The end of the story is that missing that single trade meant an opportunity loss of $30,000 profit per contract.
==== What was your trading account size at the time? ====
It was very small-about $5,000. So that trade would have meant an approximate sixfold increase in the account size. From that point on, no matter what system I was using, I always made certain that I would take all the trading signals.
==== Were any other trades pivotal in shaping your overall trading approach? ====
In 1987 my wife and I had an account that, at the time, had an equity level of about $130,000. We were long several contracts of silver when the market exploded. We watched the account go up by about $500,000 in one month and then surrender 80 percent of that profit in only a week.
That trade taught me a lot about my own stomach lining. When your account has these massive swings up and down, theres a tendency to feel a rush when the market is going your way and devastation when its going against you. These emotions do absolutely nothing to make you a good trader. Its far better to keep the equity swings manageable and strive for a sense of balance each day, no matter what happens. That trade was the catalyst for my adopting a formula that limited both my profits and drawdowns by notching back the number of contracts traded in each market to a tolerable level. The key is that the number of contracts traded fluctuates in accordance with each markets volatility.
==== Getting back to my first question; can you explain how you manage such a composed attitude in trading the markets? ====
When I come to work each day, I know that the risk and volatility in my portfolio is exactly the same as it was yesterday, last week, and last month. So why should I let my emotions go up and down if Im in exactly the same exposure all the time?
==== I assume that being able to have that attitude requires great confidence in your system. ====
Its a matter of both having confidence and being comfortable in the approach youre using. For example, if I gave you my exact system, Im sure that within a month you would be making changes to fit your own ideas. For one reason or another, you probably wouldnt be comfortable with what I gave you. It would be even worse if I gave you the system as a black box [a computer program that generates buy and sell signals based on undisclosed rules]. That would drive you crazy. Since you wouldnt have any idea what went into the program, the first time the system had a losing streak, you would probably abandon it altogether. You would say, Tom may be a nice guy, but how do I know he just didnt develop this system off of some wellchosen examples?
==== That is precisely the reason why I believe people almost invariably fail to make money on trading systems they buy. Even if they are lucky enough to purchase a system that worksy they almost never have the confidence to stay with the system when it hits its first major drawdown period-and every system in the world will have a drawdown. ====
I couldnt agree more.
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