FX Lessons from Larry Hite

Larry Hite was one of the most successful derivatives traders of his day and during his time with Mint Investment Management Company in the 1980- 90s, he helped to the fund the biggest in the world and made it the very first business in derivatives, to have of in excess $1 billion in assets under management.

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Market Wizards

The famous interviews with traders conducted by Jack D. Schwager in Market Wizards included Hite, who discusses how he got started in commodities trading and his trading strategy.

Hite believes that successful trading is simply based on calculating and trading the odds and bases his strategy not on getting the highest return – but on getting the best return, in terms of keeping downside volatility to a minimum.

Trading Strategy

Hite, compares trading to playing poker. Profitable investing is really based on betting the odds, and if you can estimate the odds of a specific trade or investment, then you can establish if the price is to high or to low.

Similar to poker, favorable odds do not guarantee any individual trade will be successful but as any good poker player knows, if you keep playing the odds with tight money management, you can make a lot of profit.

Larry Hite famously said:

“We approach markets backwards. The first thing we ask is not what can we make, but how much can we lose. We play a defensive game.”

His goal was to achieve the best returns while employing tight risk control, Hite stresses three key trading rules.

First, he advocates never risking more than one percent of total capital on one single trade, no matter how good the trade looks.

His second rule is to always follow trends and never deviate from your methods or systems and it’s true, if you can’t trade a system with discipline, you don’t have a system This view is based on trading the odds and how the great poker players make money.

Losing money in the short doesn’t matter, because if you continue to play the odds correctly, you will win but you must stay on course.

You need to have the conviction and courage to cut losses and hold big trends, in the face of open equity dips and at the end of the day – it’s the long-term profit that counts and what happens in the short term is irrelevant.

Hite’s last rule is to diversify across several different areas and he traded in multiple markets across the world, diversifying his portfolio into several different asset classes which were not correlated.

The Mint Fund

“There are two basic rules about winning in trading and life. One, if you don’t bet you can’t win. Two, if you lose all of your chips you can’t bet.”

The Mint Guaranteed Fund – a Series A fund – proved to become one of the best publicly traded commodity funds, in terms of performance to draw down.

Hite used diversification as a key tool for cutting risk and never overexposed the fund in any one area.

The fund achieved an annual return of over 30% before fees over a 13-year period under his guidance and in term of the low downside volatility, this is a truly outstanding performance.

In terms of the Mint Fund Larry made the point that the saying that they lived by was:

“It is incredible how rich you can get by not being perfect.”

He makes the point that in trading the Mint Fund, the object was not to find the optimum method but the hardiest system which goes with the overall view of Mint that risk control is the key to making long term gains.

Summary

In 1994, Larry Hite retired as the hands-on fund manager at Mint. Since his retirement, he has held the position of managing director of Hite Capital LLC and in has performance in terms of profits to downside volatility compares with any other trader, making him one of the most important and influential traders of recent times.

Forex Lessons from Bill Lipschutz

Bill Lipschutz was the biggest currency trader in the world during the 1980s and in his eight-year career with Salomon Brothers, he generated more than half a billion dollars in profits trading currencies.

Lipschutz helped create the Salomon Brothers Forex department which was the most important player in the market when he was there. With an ability to manage risk and call FX markets correctly, he once had 16 positive months in a row.

At this time, he turned over half of the currency-option volume on the Philadelphia Stock Exchange and was on many occasions, responsible for up to 80% of the open interest on the market.

Forex Trading Strategy

Bill Lipschutz has had his fair share of losses and like the all the great traders, he’s learned from them. One of them involved his personal account, in which he lost $250,000, which he had taken five years to build, in a matter of days, the effect was to tighten up risk control.

Risk Control

Also, he began to adopt better risk control strategies. Which would include not placing the entire trading capital into one single trade, or even into trades which are highly correlated. Also, analyze the risk / reward ratio at the current point in time and NOT at the point when the trade was first taken.

All the great traders know how to manage risk and many of the greatest traders have been taught by the pain of taking a big loss. If you want to win at Forex trading, strong money management is the foundation any successful strategy is based on.

The Importance of the Fundamentals

“I don’t trade on dreams or rumors. I’m a fundamental trader. I try to assemble facts and decide what kind of scenario I think will unfold.”

Its the fundamentals which drive the big trends and Bill had the discipline to follow his basic strategy of placing trades only when the fundamentals are favorable and he will study all the facts to determine a justification for a trade before placing it in the market.

This may sound simple but most traders don’t have the ability to study the facts and work out there impact on prices.

The Importance of Trend Following

Big trends last a long time and you can see big trends in any currency pair which last for many weeks, months or even years and Lipshutz commented:

“It is well acknowledged that the most profitable market environment for FX [foreign exchange] trading is a trend – in particular a trend that unfolds over a medium-to long-term time horizon,”

Lipschutz identifies big trends and then tries to ride them to their conclusion but of course all traders want to do this but there is a major problem which all currency traders face when trend following and that’s deciding exactly when a trend may end and also, staying with it during counter reactions – is the counter reaction a trend change or just a reaction within the trend?

If you want to win at FX trading you need to know…

Holding Positive Carry

Another simple idea he uses is the carry trade…

“A key to profiting from a trend is the ability to stay in the trade and not be shaken out during periods of price consolidation or correction.”

So what’s Lipschutz’s solution to this problem we all face?

His solution is to “hold positive carry” so what is it and why does it make trend following easier?

When you make any currency trade, you obviously exchange one currency relative to another and it’s more than likely, the two currencies will have different interest rates.

To “hold positive carry,” all you have to remember is to exchange a currency with a low interest rate for a currency with a high interest rate and benefit from the interest rate differential.

After Salomon Brothers

Lipschutz left Salomon Brothers in 1990 at the age of just 36 but soon He eventually formed Hathersage Capital Management which during the the 1998 Asian financial crisis, when panic took hold of the Yen market, Lipschutz cleaned up and was up 42 percent for the year year.

Over the past 15 years, Hathersage has made an 18.8 percent average annual return and only one in one month period did losses exceed 5%.