Interview With a Trading Legend, Part I

8:34 am - March 16, 2011 Peter Brandt, author of Diary of a Professional Commodity Trader, may be the greatest trader youve never heard of. We consider him a legend thanks to his stunning performance a thirtyyear track record (audited) of 41.6% compound returns. Just as impressive is the manner in which those returns were achieved. Over a multi-decade span, Peters best year topped 600 percent and yet his worst losing year (of which there were only four) was a single-digit decline of less than 6 percent! (How did he do it? Thats one of the questions hell answer.)

Peters history is intertwined with the futures markets. He was one of the early hedgers for major commercial operations an early adopter of Schabacker, Edwards and Magee in commodity trading and even a trader for the legendary Commodities Corp., the birthplace of Market Wizards like Marcus, Kovner, Seykota and Jones. In addition to the above, Peter is relaxed, down to earth, and an all-around great guy. Mike McD and I had the privilege of hanging out with him over a snowy weekend in Reno/Tahoe, and conducting the following interview.

In part I of this multi-part Mercenary Vault series, youll find out all about how Peter got started in trading how he handled his early going bust experiences and the first big move (in the Swiss Franc) that really put him in business as a trader. JACK SPARROW: So, just to get things started, this is the Mercenary Trader interview with Peter Brandt, author of Diary of a Professional Commodity Trader. Why dont you start off by telling us a little bit about how you got interested in trading, and just how your journey in markets began. PETER BRANDT: Sure. I lived in Chicago we moved to Chicago in 1972, right out of college. I went to work for a big advertising agency, living in a suburb just north of Chicago Evanston, Illinois. I had a young son who played hockey. And so it ended up that a father of another hockey player living just down the street from us was a soybean trader. And I really liked the man, he was a good guy. Hed invite me down to lunch, Come on down to the Board of Trade and have lunch with me. And so I would visit him, and then there was a Board of Trade members dining room, which overlooked the trading floor. At the time it overlooked the Wheat pit and he took me on the floor and I was captivated. These guys are yelling and screaming, shouting matches, pushing people I thought This is crazy. But I was really entrepreneurial. I had earned my own way in life since I was quite young. I had parents who split up, and I was raised by my mom and we were a welfare family so from the time I was young I was figuring out ways to make money. And the Chicago Board of Trade was captivating. These floor trader guys had freedom, they didnt report to anybody, they made their own way in life they knew how they did at the end of every day that to me was ideal, and it was a question of just How do you break into that business? JACK SPARROW: So how did you actually break into the business? PETER BRANDT: I just went literally door to door at the Board of Trade asking people How do I get into this business? And it ended up that Continental Grain, owned by a European family, which at the time was the second largest grain exporter in the world next to Cargill, were starting to look to do commercial business with individual farmers and grain users: food companies, smaller exporters, and so on. And so they wanted to do more on the floor than just their own trading, and they were looking for customers men. You know, people who could learn the grain business and bring in other customers who could also do the grain business. They had all the memberships so they figured they might as well take the commission, and work the commission side of the business. So I went to work for Conti, the futures market division of Continental Grain, and at the time I think I was making $28,000 a year in advertising. And so I went to the president of the advertising agency and said Look, Im doing this. Im going down to the Board of Trade, and Im going to try it out. If I blow it if I screw up can I come back in a year and get my job back at a fifty percent raise. And he said yes! And so I had the license to fly. I went to the Board of Trade, started learning the business, learned the grain business primarily a little bit of livestock and my big client in advertising was the Campbell Soup Company (although I also worked on the McDonalds account).

I knew the president of Campbells really well. He was kind of a rebel guy, had been president of Campbells Canada and now was heading Campbells USA, John Morris, and so I went to him and said: Why dont you send a purchasing guy out to Chicago and work with me to determine whether Campbells ought to be using futures? Which they did. A guy came out for a few months. And the premise was we would go back to the top management team and tell them the truth either theres nothing here for you (in respect to futures) or there is something here. And it was just a layup. Campbells use of futures was just a no-brainer. JACK SPARROW: What made it a layup? Why was it such a no-brainer? PETER BRANDT: Oh, because they used cocoa, they used soybean oil, they used sugar although sugar is funny, the sugar #11 contract is all the sugar nobody has bought under a longterm agreement. Its the non-wanted sugar in the world, and thats why its so crazy. Most sugar in the world trades under long-term agreements. Its called contract sugar. And then you have the #12 Sugar contract in the US which is domestically protected sugar. The #11 sugar is basically the sugar thats not spoken for. Thats why it vacillates so much, because it only represents about 10 percent of the worlds sugar production. But that portion of the worlds production can disappear quickly. Or it can glut quickly. So Campbell Soup used sugar, they used beef, they grew 150 million chickens a year from scratch they contracted with corn growers and bought soybean meal for their grow-outs and we ended up really working out some fascinating hedges for them. For example we worked out hedges on the feed ratio, the cost to produce cattle, chicken or pork per pound. Wed look at the price of the live pig or cattle on the hoof compared to the different cuts they were using, and so they might buy forward on some of their needs, or they might sell short against their inventory depending on what the spreads were. Or they might sell their chicken production to the Board as iced broilers if it made economic sense to go out in the free market and buy their chickens. So we really got creative in how Campbell Soup used the futures. And they became a big commission client of Continental Grain. JACK SPARROW: When did the focus shift to your own personal trading? PETER BRANDT: I knew then that I wanted to start trading for myself. So I started dabbling a little bit, accumulating a little bit of money, starting in 78, doing some trades and I didnt really know what I was doing. One of the first trades I did came from my friend in Evanston who was the bean trader. I was just learning the business, and he had told me he was really bullish on soybeans: Peter, Im REALLY bullish on these beans. And so I watched them for a few days I think they were around $5.50 or so and Id saved up a few thousand dollars to speculate. And they crept up like ten cents, and so I bought a contract, and they went up like five more cents and then they went down twenty cents. And so I got out with my loss, and eventually saw John again and said: John, so what about those beans? And he said Yeah, was that a magnificent move or what? JACK SPARROW (laughing): Oh no PETER BRANDT: Yeah, and I said What are you talking about? And so it ends up that John is a scalper. He never takes a position home at night. He trades the beans for half a cent to a

penny, and he had such a conviction on beans that he had a position he was willing to carry for three or four days. Well I find this out after the fact. He takes ten cents out of the bean market, which for him is a gigantic move, and I wasnt even thinking that way! And that was a good lesson. Traders at the Board of Trade would constantly say they were bullish or bearish, and it was a good lesson that the words bullish or bearish did not mean anything. I would have to ask, Whats your timeframe? How long do you hold trades? How much money are you looking for in a trade? Where are you wrong what will tell you that youre wrong? Why are you bullish or bearish, what do you know? And so I learned really early on that bullish or bearish didnt mean squat. JACK SPARROW: So was that your going bust experience? Or did you have a going bust experience early on, as so many professional traders do? PETER BRANDT: Sort of, but I went bust in little bits. You know, break open the cookie jar, take two or three thousand bucks out, and trade until I was forced to just trade oats! JACK SPARROW (laughing): So you kept getting bumped down the ladder on contract margin. PETER BRANDT: I did. But then Id build up a little bit, you know, put some money away from Campbell Soup I also had some money from other customers that came in. One of the things that helped was that I had the nerve to approach Homestake Mining in South Dakota. I knew nothing about gold, and they didnt do any hedging. But I went and pitched them and they ended up hedging some gold with me. And so they became a gold client. And again, I know nothing about gold. But I was the guy that went and pitched their business. JACK SPARROW: This was before hedging was a common practice. PETER BRANDT: Right, nobody hedged. Except for grain merchandizers, companies didnt hedge. The tax implications of corporate hedging hadnt been clarified most commodityconnected companies just didnt do any hedging. But I picked up a few valuable clients. I ended up getting another customer that just traded tons of copper a giant copper user. They made paint for the Navy. You know the gray paint? The paint used on Navy ships had a very large copper content. And thats what kept the metal from rusting. All that paint that they put on ships contains something like 15 percent copper. So the company was a huge copper user. And so I had those three clients and that was mainly it. And I would save a couple thousand and I would trade it. I didnt know what I was doing. I was listening to different people with different ideas, and one guy even had this plastic thing he used to identify cycles. I tried many approaches such as cycles and seasonals point and figure charts fundamentals I didnt know what I was doing, and I kept losing money. To answer your original question, yes, I went broke, but I went broke many times in little amounts. I would save up five grand, save up ten grand, blow it. And I just constantly was losing, not knowing what to do next. MIKE McDERMOTT: A lot of people would have given up at that point. What made you convinced that you could learn this?

PETER BRANDT: I was in the business and I knew I was going to be there. The commission side of the business was covering my expenses, and I was not risking huge amounts in the trading account. A year had passed and I had stayed I had come to the point where I was making a lot more than I was making in advertising so I was making a fairly good living. This was 1978, and I was making sixty or sixty-five thousand dollars a year, which was a lot of money back then. JACK SPARROW: So you could basically fund your trading experiments. PETER BRANDT: I could fund the losses, but I still had expenses. I had bought a home, I had a family to support, and I even bought a BMW the worst car Ive ever owned, Ill never own German again. MIKE McDERMOTT (laughing): Ouch, dont say that. JACK SPARROW: What led to the breakthrough? PETER BRANDT: Well I met this guy who said, I trade these patterns. I buy these chart books each week and I draw these lines and look for geometric patterns. You ought to go down to the Board of Trade bookstore and buy this book by Robert Edwards and John Magee. Buy the book and read it. Which I did the book had a yellow and blue cover. And so I started reading this book, and I felt like Okay, Im at home now. I understand this. I can do this. It just made sense to me. It was clear, it wasnt mechanical because at the time people were starting to play with mechanical approaches JACK SPARROW: And again this was around 1978? PETER BRANDT: Yeah, 78 or 79 and so I consumed this book, gathered some more money, and figured I really liked this approach, and I could trade the approach without going bust again. But I wanted to trade the approach with the proper amount of capital. So I accumulated a pretty good amount to start with compared to previous attempts when I would fund an account with only a few thousand dollars and then lose the money. I decided I would put a better chunk of change together so that I could actually hold a position and not get knocked out, and I was going to try and trade it the right way. So I cant remember the exact amount, $20,000 I think it was. And I started to make a little money. Lose a little, make a little and I started to make enough that I felt comfortable. Then it was I just have to make a decision to do this. I cant be a customers guy and a trader. And so I left Continental Grain and went off on my own. I still kept a relationship with Campbell Soup to cover expenses, but started trading. And it went well. I made money the first year, made a lot of money the second year and so my account was growing, but I didnt feel like Ive arrived, that I had enough where I could say Im REALLY a trader. Im still kind of hanging on by my fingernails. But my account was growing. And then something happened in the currency markets in 1982 that changed the game for me. Foreign currencies were trading at the International Monetary Market divison of the Chicago Mercantile Exchange. And the European currencies set up in a way that just sang a song for me based on the charts. And I felt so strongly, that this is itthe time to bet the farm.

And it was Wednesday, the day before Thanksgiving Thursday was Thanksgiving, Friday the markets were closed in the U.S., Saturday and Sunday the markets were closed. And on Wednesday the Swiss Franc broke out. MIKE McDERMOTT: The day before Thanksgiving. PETER BRANDT: Yes, the day before Thanksgiving. And I bought ten contracts, which for me was a lot. That was equal to $1,250,000 Swiss francs, which for me at the time was a huge position. I bought late in the day when the market was already up about 50 points the market ended up closing something like 70 points higher. And I called London on Thursday, and the currency traders there just didnt care what had happened on Wednesday in Chicago. It was Who cares what the IMM did. The value of the Swiss Franc did creep higher in London on Thursday, but was still way below where the IMM had finished on Wednesday. I talked a banker into selling me ten contracts of deutschemarks on that Thanksgiving Thursday. So now Im long ten Swiss, Im long ten deutschemarks, its Friday London was still not a believer of Wednesdays strength at the IMM and the Swiss Franc opened lower in Chicago. But despite Europes hesitation, the U.S. took the lead on Friday to strongly rally the European currencies. By the end of the trading day at the IMM on Friday I had a significant profit in both the D-Mark and the Swiss Franc. I had a feeling that on Monday London would again not be a believer of Fridays rally in the U.S. Yet, I slept well over the weekend. I just felt like Londons wrong. The U.S. is right. By Monday morning the tone in Europe had changed to be in line with the strength in Chicago. The European currencies opened higher at the IMM and didnt look back. The Swiss Franc and D-Mark just went straight up for the next five weeks. With that trade, all of a sudden I had a serious amount of money in an account. And from that point on I could seriously consider myself to be a trader. JACK SPARROW: You reached that critical mass. PETER BRANDT: I reached that critical mass. I was like the other guys I knew at the Board of Trade who really were traders. All of a sudden I had the capital to be a trader. I could hold onto positions, I could build big positions, and I could trade enough to where I didnt have to triple my money every year to provide living expenses.

Interview With a Trading Legend, Part II: Mental Milestones

10:14 am - March 22, 2011 In Part I of this Mercenary Vault series, we introduced you to Peter Brandt a 30-year veteran trader with 41.6% annual compound returns.

Part I covered Peters entry into the Chicago futures markets in the 1970s his experiences as a customers man and early commodity hedger going bust in little bits and finding his feet as a chartist and the currency trade that really put him in business as a trader. In Part II we cover (among other things) mental milestones teaching opportunities win/loss ratios and drawdown realizations position size and leverage considerations and Peters ideal trading conditions as a chartist. This interview series is part of the Mercenary Vault, an archive of exclusive high quality materials available to Mercenary Dispatch subscribers. The Dispatch is our means of direct communication (via email) with Mercenary community members and its free! Sign up here and dont miss out on future exclusives. JACK SPARROW: So around the time of your breakout trade in the currency markets, what steps were you taking to become a trader? What were some mental milestones on your journey? PETER BRANDT: Trading based on charts made sense to me, but just saying this does not start to explain the amount of work that was ahead of me. I just started systematically figuring out the charts by this I do not mean the simple recognition of patterns, but rather the practical challenges of trading in real time. Its fine to be a chartist, but what does it mean to be a chart trader. Analyzing charts and trading the charts are two entirely different challenges. Do I trade one-week patterns? Two-week patterns? Reversal patterns or continuation patterns? Where do I place protective stops? How do I enter a trade? Working through the process just took time. In fact, this process continues to this day. You just keep working through the mechanics of how you conduct the process of trading. Whats your game plan? How do you get in, how do you get out? Then obviously you go through periods when the market spanks you and youre wrong four or five times in a row. And you start questioning whether you need to change something. So you go through that process enough that you begin to figure things out over time. Then, just about the time you think you have it figured out, your adopted approach gets challenged by the markets. But that challenging by the markets is good. Enough challenges force you to say I dont care, its just part of the process. The continual challenges brought forth by trading also forces a trader to refine, refine and refine his or her approach. JACK SPARROW: Were there any particular realizations that stood out in the very early years? PETER BRANDT: For me, one of the biggest things was realizing I was not going to be right 80% of the time, or even 50% of the time. I would be right about 35% of the time but that was over an extended period of time. And this figure became real predictable throughout the 80s. If someone had told me, This year, youre going to be right 35% of the time, I could have guessed within plus or minus 10 or 15 percent what my return was likely to be. If someone had told me, This year youre going to be right 40% of the time, I had a pretty good feel of what that meant. That figure of 35% was and still is true over an extended number of trades, where N as the number of trading events was a large figure. Percentages tend to work out over an extended number of Ns. But over a shorter-term number of Ns it can really change. I began realizing that over 10 or 20 or even 30 trading events, the win/loss ratio deviated considerably from the norm with a win/loss ratio that could go as low as 10 or 15%. At that time I went to the statistics department at Northwestern University, just down the street from our home in Evanston, sat down with a professor and said: Figure out for me what the odds could be of being wiped out betting different amounts of my capital on every trade. If Im right

35% of the time over a large number of Ns, whats the chance that Im going to be wrong, just in terms of random distribution, 8 times in a row, 10 times in a row, 15 times out of 20, and so on. JACK SPARROW: Trying to find the extreme statistical outlier for losses. PETER BRANDT: Right. I knew the answer would resemble a bell curve, but I wanted to know what things looked like to the far right and left of the hump. And the professor created a model based on probablities involved in rolling a single dice. And he said, A dice role of the numbers one or four are your winners, the other numbers are your losers. Now lets just go through a very long series of dice rolls and see what happens. The professor ran a computer program and produced a distribution table and bell curves that gave me a considerable amount of insight into the random distribution of winners and losers given various win/loss ratios. I began to realize that risking 4 or 5 percent of capital in a program that was right on 35% over an extended number of trades, but with a high probability of being wrong 80% or 90% of the time over shorter numbers of trades, was a recipe for ruin. And thats how I came to the conclusion that I should generally not risk any more than 1 percent of capital because I realized, based on the mathematical probabilities, that it was inevitable if I risked even 3 percent of my capital per trade each time, I could seriously harm my capital base to the point I would then have to change the way I traded the markets. And thats exactly what I didnt want to happen. That starting point on risk led me through the whole process of learning leverage, and how leverage is built. I think back on a lot of the stuff I had to learn and its often because I took a hit on a trade and realized I hadnt thought about that, or That was not a part of the equation I thought was right. And so I was continually forced to go back and rethink an aspect of the trading process all over again. Of the new people who start trading today so many have no clue of the learning curve. I mean this is a steep mountain. And youve got to be willing to really, really go through a lot of learning and you learn by mistakes. You learn by getting sliced up by the markets. You dont come in, have a hot three months, and say, Man, Ive got it figured out. You learn when when you realize, Oh, Ive been wrong 8 trades in a row, and now Im getting another signal, or, Ive just lost 20 or 30 cents in a 10 cent trading range, and so on. And I just went through these situations again and again, and these were the challenges of the game for me. JACK SPARROW: So how long was that period between when you first discovered Edwards and Magee and realized, This is the approach I like, to the Swiss Franc breakout trade that established you as a trader. How long was that interim? PETER BRANDT: Maybe two-and-a-half years. But then even after that, I had a lot to learn. Any approach you take is complicated. So it was 1982, and there was the big move in the currencies that launched me but then it was just a process of learning more about the markets, myself and my approach, making even more mistakes, feeling better about it, going through drawdowns. You go through a big drawdown, and your first temptation is Ive got to change something. And actually I think the best response is not that something has to be changed, although that may also be the case, but something has to be learned. JACK SPARROW: A teaching opportunity.

PETER BRANDT: Right. Trading is an ongoing education. But like all other forms of education, a tuition has to be paid. When you make money, thats great. When you start losing money, thats the tuition you pay to learn. And the market gets to determine the tuition, you dont get to determine it. Let me add something very important about trading and drawdowns. There is very little material printed or online for the beginning trader on the subject of drawdowns. This is very unfortunate, because drawdowns are a harsh reality of trading. As a result, beginning traders have false expectations of the trading environment. Drawdowns are a fact of trading, and how a trader deals with drawdowns will determine the end game. It is like the word drawdown is a subject that is off limits and seldom discussed. Given that every trader deals with drawdowns and asset volatility, it is sad these subjects are not discussed with more transparency. JACK SPARROW: Speaking of drawdowns, how many significant ones have you had over the past thirty years? PETER BRANDT: Its funny you should ask. I was just studying my drawdown history the other day. Ive had 15 drawdowns that exceeded 10 percent peak to trough to new highs. Many more drawdowns in the 5 to 10 percent range. Some people measure drawdowns peak to trough and thats fine. But what good is peak to trough if you never make a new peak? Youve got to measure the whole round trip. MIKE McDERMOTT: You dont know that the whole drawdown is complete until youve got a new high. PETER BRANDT: Exactly. You dont. And that is why youve got to go through the full cycle. And at first youre tempted and you probably do tweak things, even making major changes, and you find out after the fact that the biggest mistake you can make is changing your trading style based on your previous trade or series of trades. Attempting to optimize a trading approach based on a recent series of trades is just idiotic to do. Youve got to think not in terms of results of a trade, but principles. Not just did I make a mistake but, for example, Do I need to be more conscious of trend. If so how do I determine and measure trend. Do I determine it with a moving average or with some other means? A trader is just constantly playing with these things. But then eventually you go through a drawdown and you dont change a thing, trusting that losing streaks come and go. But what I did find early on is that you do have to change the size of the bets you put on the table. That is because I came to the conclusion early on, with the help from the Northwestern University statistics department, that Id risk about 1 percent of my capital on a trade. And in a drawdown you even start playing with that. For me I reduce my risk even further when I start to lose. If I get hit a few times, well, then its going to be three quarters of a percent, or half a percent, down to maybe a quarter of a percent on a trade. Then you start winning again and you build up the size of the bet. MIKE McDERMOTT: So your position size is based on the amount of risk that youre willing to take. PETER BRANDT: My formula is really easy. I look at a chart for example corn is a market Im involved in right now. Im a breakout trader, and Ill tell you, over time I have had to learn over and over again to resist the temptation: This thing is going to go up, I need to get in before it breaks

out of this pattern. Ive lost so much money in trading ranges. So much money trying to jump ahead of a trend. JACK SPARROW: Because you didnt wait for it to fully confirm. PETER BRANDT: Exactly, I didnt wait for the breakout. So that has been a hard lesson for me to learn. Intellectually I realize that the correct approach for me is to just stick an order in for a breakout and have a computer-based alert system so that I can know when I get filled instead of having to watch the prices all the time. So I get in and I have a rule for where I set my stop. I want to set my stop based on the chart, not based on a dollar amount. I want the stop to make technical sense. So I know my entry, I know where my exit is if I am wrong, I can figure out the dollar risk per contract, so only then can I calculate out my leverage. So in corn it may be that Im risking 12 cents. Or maybe I can get away with risking 4 cents. I dont want to force that number. I want the market to tell me, based on how it breaks out, where my stop is going to be. And that goes into determining my leverage. MIKE McDERMOTT: And by leverage you mean number of contracts PETER BRANDT: Yes, number of contracts. I refer to this as my size. And for me, I always think in units and layers, layers per $100,000. One contract is a layer. Two contracts, two layers. Three contracts, three layers. Per $100,000 unit of capital. And depending on how bold I am, how I feel about the market, I might risk up to 1.5% on the trade. There are times where I have risked 3%. But its rare that I do that. I am amazed when I talk to novices who tell me they risk as much as 10% of their capital on a trade! Well I did that too. Back in the late seventies I did that, and I can tell you it doesnt work! Risking 10% of capital on a trade is a well traveled road to ruin. MIKE McDERMOTT (laughing): You dont usually talk to them three years later. PETER BRANDT: No! Theyre not around. They dont last very long. JACK SPARROW: As a chartist, how would you describe your ideal trading conditions? PETER BRANDT: For me its Who cares what the label is on the chart what market it is. Ive always thought my perfect world would be this: I would be blacked out from ever knowing anything never watching TV never having to drive through a cornfield in the summer never knowing any news and some assistant would bring in charts in the morning, and the price scales would be modified and the name of the commodity would never be on it. It would just be lines and graphs, and I would have to mark it up and say, Buy here, sell there, and the person would have to execute in accordance with the leverage rules. And so they do the execution, and I never have to know about it. Additionally, I would only be able to look at the charts for ten minutes each day and would not be able to see what happened until the next ten minute period in preparation for the next trading session. JACK SPARROW: So with your track record of 41.6% over 30 years, do you think you would have done even better if you had shown the discipline to trade that way? PETER BRANDT: I think I would have. I cant believe how much money I think Ive left on the table because I get influenced by the name of the commodity traded, the price level itself, the

emotional pull of the news of the day or other factors beyond the charts themselves and still do so to this day. In a sense, my perfect trading environment is the antithesis of the environment the Mercenary Trader attempts to create. I would love trading solitude between me and the charts with no other influence. You guys seek to make sense of a tremendous amount of stimuli. I mean you guys have traded enough to understand what it is like when you read something, you hear something, and all of a sudden light bulbs go off. In your approach to market speculation, its not a new thing you discover, but somebody shining a flashlight on something from a brand new angle and all of a sudden its not a two dimensional item but a three dimensional item, or even a four dimensional item. And then you say to yourselves, A-ha! I see what this thing is. Now I understand what is driving price change. I love reading MercenaryTrader.com, but not for your unique macro-economic analysis or specific trading maneuvers. Rather, you guys will hit upon some aspect of human factor or risk control, some other seemingly arcane subject, that really sets off the light bulb in my mind. As an example, you recently introduced the concept of leakage. I had never thought about leakage in that way that Im leaking money, and Ive always been leaking money, and how do I stop the leakage. Because I can stop it! I can identify it and I can stop it. But I had not thought about that concept the way you introduced it. I had thought about it as just, This is the process of trading and you take all of these decisions, and all of these maneuvers, and at the end of the year youve got to live with the bad and live with the good. But now you can break it down and say there is such a thing as leakage that exists. You can isolate it, and you can study it, and you can find ways to address it. That for me was just a gigantic revelation, this leakage concept. I loved it. So Im working on leakage, because I think it could be costing me between 1 and 1.5% of my assets a month. And thats 15% a year! That is a huge amount of money. JACK SPARROW: And then compounded its even more PETER BRANDT: Well as a professional trader you dont look at it like that, because youre taking money out of your account to live on. But in a way it does compound, what remains in the account. MIKE McDERMOTT: But if youre managing capital PETER BRANDT: If youre managing capital, your leakage could be the difference between being an all-star and an also ran. You could be doing 10% a year and not recognized, or 25% a year consistently and become a top tier manager. So leakage really becomes important. MIKE McDERMOTT: So where would you most easily be able to cut the leakage? Or where could most people look at it?

Interview With a Trading Legend, Part III: Staying In The Game

11:14 am - March 29, 2011

In Part II of this Mercenary Vault series, we talked with Peter about mental milestones, win-loss ratios, and ideal trading environments. In Part III we further discuss the topic of leakage the path of least regret the key to having triple-digit up years while cutting off down years and the vital importance of staying in the game. This interview series is part of the Mercenary Vault, an archive of exclusive high quality materials available to Mercenary Dispatch subscribers. The Dispatch is our means of direct communication (via email) with Mercenary community members and its free! Sign up here and dont miss out on future exclusives. MIKE McDERMOTT (continued from Part II): So where would you most easily be able to cut the leakage? Or where could most people look at it? PETER BRANDT: I think it depends upon the trader and trading plan, because every case will be different. We know that every trading approach, whether it is systematic or discretionary, can be in or out of sync with the markets to varying degrees. It is also possible for a discretionary trader to be out of sync with the trading plan. If a discretionary trader thoroughly understands his or her trading plan, then it is possible to identify leakage. I define leakage as areas where a discretionary trader fudges on the plan. In my case, the grand total of all my fudges have resulted in a net loss over the years. That is how I would identify leakage in my case. I think its different for everybody. JACK SPARROW: Can you give a more specific example of what that leakage would look like for you? PETER BRANDT: One example, a big one, would be trading decisions I might make during active market hours. A good rule for me is: Do not trade intraday. From the time I submit my orders, that should represent the sum total of my decision making. I should not change the orders, I should not second guess them. You know the concept of MIT orders, Market if touched. In my trading Ive had CIC orders, Cancel if close. So I put in an order and it becomes a CIC order. As the market gets there, I start to wonder, Do I really want to sell this rally? And I go through that, and it is all about fighting these human emotions. I also know instinctively that worrying about the money, looking at my trading balance is the worst thing I can do. It is important for a trader to trade the markets, not his or her capital balance. I mean you have to have capital to trade, but a focus on account balance and not the markets is a trap. I know it is a trap for me at times. Sometimes it comes down to the course of least regret. Asking, Will I regret it more if I pull the order and it turns out to be a perfect retest, giving me a double unit to ride back to the target or will I regret it more if I put the position on with a nice tight stop, and risk losing a little bit more, but not much, in the big scheme of things, 30 basis points to make 400 basis points. That should be the basis of my decision. JACK SPARROW: Always referring to the present opportunity and the present moment in time. PETER BRANDT: Yes, always attempting to determine the action that will represent my least regret. And Ive got to take that course of action. To do that as an individual you have to think forward, in terms of your human psyche, how youre going to react to different situations. Whats going to be your human emotion, how are you going to live with different courses of decisions and market outcomes.

Richard Dennis used to call it the upstream swim against human nature. Youre battling your fear, your greed, your hope all those human emotions are your challenge, especially as a discretionary trader. Not that systematic traders dont go through emotional turmoil too. They do in some ways I think maybe they go through it more. So for a discretionary trader it comes down to one of two courses of action. In the first, a trader second guesses too many trading decisions, fearing the risk of a drawdown, and ends up with no real trading plan at all. In the second, a trader knows they will go through drawdowns, they live through drawdowns and keep following their rules, and it takes them through. Earlier in my career when I was encountering a drawdown I would frequently override trades, and not take trading signals, and then I realized, You know if I just hang with it and keep following my signals, the drawdown will resolve itself. It is important for an aspiring trader to stick with a plan throughout a drawdown and go through a full cycle. JACK SPARROW: Let me ask about the signals in your trading approach. Have your signals or trading decisions changed much over the years? PETER BRANDT: For me my signaling hasnt changed much, although Im moving toward the point where Im wanting longer term signals almost to where I can throw my daily charts away and just deal with weekly charts. In my head Im sometimes thinking, If Im going to trade another 15 years, maybe I ought to throw the daily charts away and trade just on weekly charts. JACK SPARROW: And to clarify, youre still talking in the neighborhood of a dozen trades a month based on your history. PETER BRANDT: Yes, though maybe if I would go to just weekly charts the number of signals would come down to 8 trades per month. And that would include patterns that are at first a fake out and require one additional attempt at re-entry. My rule on big patterns is that they fool me once and thats fine then Ill let them fool me a second time and after that I dont care what a market does. Im not going to try the third time. Its fooled me twice, thats my rule, let somebody else have the money who has more guts to pile in than me but Im not going to re-enter a pattern that has already fooled me twice. So, anyway, Im thinking longer term chart patterns, move away from shorter term chart patterns. Although when you get a good strong trend, sometimes those two week flags can really be profitable. I mean they can really, really add money to your account when you see them and they work. And I would be giving up these shorter-term pyramid signals if I go exclusively to weekly charts. But thats fine I know that the more detached I become from the markets, the more I remove myself in emotional proximity from markets on a day to day basis, the more Im going to add to the bottom line at the end. JACK SPARROW: Are you pretty confident you can do even better than 41% over the next 10 or 15 years? PETER BRANDT: I think it depends. Proprietary money, I dont think that would be a problem if I am extremely disciplined. But naturally Im going to be more conservative if Im trading customer money. With the money of others I would not take as much leverage. JACK SPARROW: Hypothetically, lets just phrase the question in terms of your own funds.

PETER BRANDT: If its proprietary money, then I dont see that there would be any problem. Because when I consider my 41 percent, that includes 4 or 5 years when I was pretty much shut down and hardly trading. And those years are added into the performance calculation. During these years the performance was something like up 2 percent, up 3 percent, down 1 percent I think it was 4 years in the 1990s where I really didnt do much. JACK SPARROW: So what does the distribution look like? Does that mean you had years where you were up 150 percent, 200 percent, more? PETER BRANDT: Well I had 600 percent at the top side a 600 percent year in 1987. JACK SPARROW: And what contributed to that? PETER BRANDT: I really clocked the S&Ps on the long side, early in the year. After the 1987 crash I was really out of sync with the stock market for something like two years. I dont think I made money in the stock market for a couple years after that. The crash really faked me out. MIKE McDERMOTT (laughing): Obviously it didnt hurt you too bad. PETER BRANDT: But then I also had a lot of 50 percent years and I also have had 4 losing years JACK SPARROW: And your worst losing year was only minus PETER BRANDT: Minus 5.8 percent I think it was. JACK SPARROW: Lets talk about that for a minute. Because for anybody reading this interview, a trading methodology where your best year can be plus 600 percent, and your worst trading year can be less than minus 6 percent thats beautiful. I mean its incredible. How would you explain to readers your ability to have such incredible upside while still, your worst year would be something most money managers would be ecstatic to have as their worst year. PETER BRANDT: I think its really an easy explanation. Jack Sparrow, I think its actually a layup explanation. Minimizing losses during the bad years happens when you attend to taking care of your risk. And then you allow good things to happen. All kinds of good things can happen if you control your game. JACK SPARROW: You cut off the left side of your distribution. PETER BRANDT: You cut off the left side of the distribution, you try to eliminate it. And then all kinds of interesting things can happen. And you just do not let the game get away from you. How many sporting events do you watch where youre in the third quarter of the game, or the fourth quarter, and the announcer says, Such and such a team has just taken it to these other guys, but the other guys are still in the game. And how many of those games just turned in the last five minutes? JACK SPARROW: Right. PETER BRANDT: Because the dominating team outplayed the other team for most of the game, but they couldnt put them away. They couldnt take them out. The team that was getting beat a touchdown down, a field goal down they never got out of the game.

I think in trading, the concept of not getting too far behind in the score is so significant. Its a matter of risk control. Aggressive risk control protocols. If you attend to your losses, pay attention to your losses, thats it. For example, I have a trading rule that I wont take a loser home on a Friday. I dont care how I feel about the market, if on a Friday its a losing trade, Im gone. And I may get back in next week or I may not. I used to have a rule that I dont hold as tightly to now, but I sometimes wonder if I should go back to and thats not taking a losing trade home at all. Or not taking home a trade thats losing more than lets say, in you guys terms, 30 or 35 basis points. JACK SPARROW: Its basically got to work during the first 48 hours or youre done with it. PETER BRANDT: Taking a trade off at a target is an easy no-brainer. Although if the market keeps running you question yourself, but basically for me its pretty easy. I take the profit, I close the book, and I try to make it a habit not to look at that market again for another week or so. Its also easy to take a trade off at the loss point, where you set the risk. For me the hardest part is what to do with a trade that has a profit and is still open. And I think most of the experimentation and tweaking and pondering and second guessing I do takes place with a trade thats somewhere between where I put it in and where I think it can go.

Interview With a Trading Legend, Part IV: Maintaining the Center

11:17 am - April 5, 2011 In Part III of this Series, we learned about the path of least regret the value of long-term chart patterns the key to triple-digit up years (and single-digit down years) and the vital importance of staying in the game. In Part IV we hear more about protecting trade profits staying centered the characteristics of a big trade the truth about a traders biggest opponent in markets and the importance of removing the emotional velcro from money and trading. This interview series is part of the Mercenary Vault, an archive of exclusive high quality materials available to Mercenary Dispatch subscribers. The Dispatch is our means of direct communication (via email) with Mercenary community members and its free! Sign up here and dont miss out on future exclusives. JACK SPARROW: Do you ever use trailing stops or anything of that nature? PETER BRANDT: I just categorically do not like trailing stops. I think what ends up happening with trailing stops, if trading from the long side for example, is that you end up selling where you should have been buying. And that doesnt make sense to me. JACK SPARROW: What about the concept of moving your stop closer based on logical chart points?

PETER BRANDT: Yes, I will do that. Im not going to give all of the profits in a trade back. I refer to trades when all of the profits are given back as popcorn trades in my recent book you watch the popcorn kernel go up to the top of the kettle and then it goes right back down. I dont want to get caught in popcorn trades. It just doesnt make sense to increase risk like that. So Ive got some methods that Ive built into my trading over time for taking trades off, and I use these methods. I keep an excel spread sheet that constantly shows me how the three or four trade management approaches I could use would have done on each trade. One of these approaches I monitor is the possibility of riding the trade all the way back to the starting gate a popcorn trade. No matter which trade management method I end up using, I have a tracking of how all the optional approaches are doing. Having this information keep me centered. JACK SPARROW: And you also stay centered by communicating with other traders. PETER BRANDT: Ive corresponded with a group of traders since 1980. I started with a onepage typed out sheet with graphs, and every Friday I would do it. The guys at Continental would want a copy, so Id make ten and put them on the front desk. Then Id end up making thirty copies as other traders from the Board of Trade came around, and of course it eventually went to email. I have continued to do this over the years. I weekly send out a PDF document that comments on the trades I have done as well as the trades I am looking at for the future. As part of this communications process, every year in early January, I do what I call the ten best dressed list. I look back over the previous year, trying not to be biased on what I traded, and its usually not ten charts but around that number. Sometimes eight, sometimes fifteen. But the idea is just: Oh, that was a really good chart. That was really a classical example of what charting is all about. It was a pattern, it was clear, it was big it was on the weekly chart, it was on the daily chart, it broke out clean and ran the distance, never challenging the entry. My intent for this annual best-dressed list is to identify the best examples of classical charting from the previous year. Doing this every year also brings me back to the center. It says this is what I need to do as a trader. Because without a clear reference point Im likely to drift. I dont want to drift. I want to bring myself back to what I really need to be doing. And that is looking for those patterns that are going to be on that list, because that is where my money is going to be made. JACK SPARROW: So the best dressed list is like a north star for your profitability. PETER BRANDT: Yes, I would say that over the years about 50% or more of my net profits have been from chart patterns that ended up on a best dressed list. It also goes back to controlling risk, and getting to where my head is in the game. When my thinking is ahead of the game, then I can see something on the charts and say, Okay, this market just cant be set up any better. I know this chart is going to be on the best dressed list. Intuitively I just know it. Of course, there are times when my intuitive thinking proves to be wrong. So because I focus on finding big chart patterns, I am in a position to identify situations like that, and the chart breaks out a certain way, and the way it breaks out technically provides an opportunity for very small risk (chart risk), and a number of other factors line up. Thats when I say, Back up the truck. I even have a recording on my computer, the beep beep noise of the truck backing up. I sometimes send it to another trader I work with when I see something really good, I send him the link to the beeping truck. So I get the trade set up, and the truck is beeping, and I say Im not going to risk 50 basis points Im not going to risk 100 basis points Im going to risk 200 basis points. Not only that,

but because of the chart risk I can have four or five contracts per unit of capital, where typically I may only be trading one contract per unit of capital JACK SPARROW: Because youve got such a narrow band. PETER BRANDT: Yes. Then we get a good strong day its a good strong bar that breaks out and holds the breakout the market may slightly back off for two or three days and volume just dries up to nothing then you get what Wyckoff called a hinge day, super-small range day a close in the middle of the trading range where you find out there was no volume at all then I put some more on. It is getting two or three trading situations like this that can give a trader a 100 percent or better year. And it has been market setups like this that have given me my best years. For me, I have not had great trading years because I was right fifty or sixty percent of the time. I have had the really great years when I was able to exploit two or three trades where I was really able to lean into the trade with my shoulder and push. Its those gems that really pay the dividend. I know that if Im going to finish with better than a fifty percent return in a given year, it means I caught some really nice trades. So, I always anticipate that around the next corner theres going to be another great trade. I also anticipate that each and every year will offer me at least 10 charts that can wear the title of being on the best dressed list. And most years this happens, but not all years. I have to admit that there have been some years when either the really great trades did not happen, or they did happen and I missed them. I have been in a drought in recent months for really good trades. JACK SPARROW: Back to this idea of being centered what are some of the dangers that take you away from the center? PETER BRANDT: Bad spells come and go naturally in markets. What I dont want to do is add to bad markets. In my way of trading I tend to look at markets a certain way, analyze markets in a certain way, and have certain ways I get in and get out. So its possible that the way I trade is out of sync with the markets. But it is also possible that I am out of sync with the way that Im supposed to trade. That is the quicksand I have to stay away from. I have to make sure I execute my game plan in the right way, which is just a matter of being disciplined, always questioning, Is this a trade I ought to be doing, not reading anything into the chart that is not there. As Reminiscences of a Stock Operator talks about, just reading the tape. There are some trades that fall into a gray area. If you are a discretionary trader, which I am, you are going to have a certain number of trades that dont fit neatly into a box. What do you do with those? You have to pay attention to the trades you have on. The real opponent of a trader is himself. Not the markets, not other traders down the street, not some commercial house my opponent in the market is Peter Brandt. Am I doing what I know I need to do to put myself in a position where I know I can either be down six percent or up a hundred. MIKE McDERMOTT: Going back to something earlier you talked about having the license to fly when you left the advertising agency, and following that, the point of critical mass where you felt you had truly become a trader. During that build-up phase, you had Campbell Soup as a customer helping to cover your bills. How did the financial stability of having that income affect the trading decision-making process?

PETER BRANDT: It was huge. The Campbell Soup income is what helped me become a consistent performer. By consistent performer, I dont mean someone who is hitting their number every year. To me, a consistent performer is someone who can stay in that acceptable minus-five to plus-100 range and do what they need to do. Consistent performance isnt necessarily based on the dollars you make, but on the things you need to do to perform repeating and repeating what you think are your best practices. The goal is to be a consistent performer and then let the money take care of itself. This is a roundabout way to answer your question. But where the financial stability becomes important is that, if I feel like I need to make $4,000 this month for living expenses, or $8,000 this month or what have you that my tax bill is due or that I need to put a new furnace in my home or that my wife wants a new Subaru Outback all of a sudden Ive taken my trading capital and put dollar signs on it related to things that need to be bought. Ive attached emotion to my capital. In my mind it is so important not to have any emotional propping up of trading capital. Trading capital needs to be just numbers, a way to keep score. The subject of money has emotion. Money has as much emotion for a lot of people as do their wife and their kids and their parents. If you want to get people emotional, bring up the subject of money. So if youre not just cold-hearted and Im not cold-hearted then I have to find ways to move myself away from all the emotional stuff that sticks to money. Money just seems to have emotion-attracting velcro on it. I have to find ways to cut the velcro off. I have to view my capital as just part of the game. The degree to which I am emotional about my capital can be the degree to which I start trading defensively. And defensive trading usually goes in the wrong direction. I also even need to detach myself from what Im trading. Im not trading corn, Im trading price. It is also important for me to detach myself from price itself. It shouldnt matter if I am buying beans at fifteen bucks or six bucks. All that matters is, are beans going to go up? If so, who cares where the price level is. Some of my worst trades have been talking myself into buying something that was cheap. I do not want my trading capital to be assigned in such a way that: This chunk has to go for rent, this chunk has to go for a car, this chunk has to go for education. I want to get rid of all that, which is why it was so important to have the Campbell Soup revenue at that stage in my career, or to have had that back-up game plan of returning to advertising, because then I dont have to worry about needing to use trading profits for living expenses.

Interview With a Trading Legend, Part V: The Toughest Trade

12:11 pm - April 12, 2011 In Part IV of this series, we learned about protecting profits, staying centered, the characteristics of a big trade, and who a traders biggest opponent is in markets. In Part V we hear about Peters experiences as a light aircraft pilot his most interesting trade his toughest (most emotional) trade and key principles to avoid compound errors (making it back from the wilderness). This interview series is part of the Mercenary Vault, an archive of exclusive high quality materials available to Mercenary Dispatch subscribers. The Dispatch is our means of direct

communication (via email) with Mercenary community members and its free! Sign up here and dont miss out on future exclusives. JACK SPARROW: Speaking of license to fly, youve mentioned that you are a pilot. PETER BRANDT: Ive owned three aircraft in my life. I started with a 1951 Piper Tri-Pacer, which was the first Piper that had tricycle gear. It was a fabric aircraft, and had a sink rate of a lead weight, and a high speed for touchdown. It was a lightweight plane, a four-seater, and the thing was just fast. It had a speed of about 135 knots. I bought the Piper with my wifes cousin, who was an Air Force pilot. We both lived in Chicago and he was based out of Michigan, so he needed a plane to fly over to his base. So he said, Want to learn how to fly? You can buy half of the plane. So I learned how to fly that way. Then I bought a Cessna 172, and then a Cessna 182. I wound up selling the Cessna 182 but I should have kept it. Used aircraft just keep going up in value every year. Flying was expensive, but it was great for me because I wrote most of it off. When I moved my family to northern Minnesota I would fly down to Chicago, and I could land at Miggs Field right in downtown Chicago. I could literally walk to the Board of Trade from Miggs Field. It was a tenblock walk. In Minnesota we lived on a lake, and I had a neighbor with a snowplow. He would plow an airstrip for me on the lake. In the winter time I would take an ice auger and auger down my straps, so I could strap it down and keep the plane right on the ice. I didnt have floats on it, but I had floats on the 172. MIKE McDERMOTT: Can you put floats on it? PETER BRANDT: Oh yes. I wound up selling it in Alaska. It had what is called a STOL kit, which stands for Slow Take-Off and Landing. It gave you an extra curvature off the back of the wing. If it was perfectly still and there was no wind, winter-time, early morning or late evening, no thermals, I would see how slow I could be going at the point of touchdown. I used to do that just for fun. I could get it down to 38 or 39 knots. We would take it out and see if we could land it with just the trim tabs. JACK SPARROW: So did you find any parallels between flying and trading? PETER BRANDT: No, I forgot about trading when I was flying. JACK SPARROW: Just a beautiful escape. PETER BRANDT: A marvelous escape. I clocked a lot of hours, flying just about every day. We lived up in Nisswa, Minnesota, and I had the option of landing on the lake in winter time which really scared the ice fishermen, because when you landed on the lake the ice would crack. Its thick enough that it was not going to break, but it does crack. And these ice fisherman would get so mad at me. Then we had a grass strip which was five miles away, and a really nice airport with an 8,200 foot main runway that was 25 miles away. I kept the plane in a hangar there. JACK SPARROW: Tell us about the most interesting trade youve ever had.

PETER BRANDT: It was 9/11, when the first tower was hit. The futures were operating in one of the buildings within the World Trade complex. After the first tower was hit, the trading was halted and then it briefly reopened, and I traded gold. I have a time-stamped order after the first tower was hit. Just the idea of trading gold, considering what was happening, seems to me a fascinating thing. When gold re-opened six days later I think it was $10 or more higher which was a big move at the time and I took my profit and walked away from the trade. I considered myself lucky, and the reason I walked away from the trade is because I didnt like the idea of making money on a lot of peoples suffering. I decided I wouldnt sit and exploit the market any further, and I cant even remember what the market did after that. But I remember taking my profit thinking, Ive just made money on the lives of a lot of people. Ill take my profits and Ill thank the market and walk away. So that was probably my most interesting trade ever. JACK SPARROW: What was your toughest trade ever? PETER BRANDT: The toughest trade ever was crude oil. It was the first Iraq war, January 16, 1991 when the bombing started. I was long crude when the bombing started the evening of January 16 and I was thinking, Man, this is going to be sweet. Crude oil was trading a few bucks higher in the after market, but by the time the pit trading started the next day, the trade opened something like 700 points against me. Prices closed on January 16 somewhere in the area of $30 per barrel. Then the war started, and prices opened in the pit on Feb. 17 about 700 points lower. I remember thinking the night the bombing started, This is going to be payday. Prices were trading that evening on the curb $3 or $4 higher right after the bombing. But by the time U.S. markets opened, crude had in effect declined ten bucks off the previous evenings curb price. JACK SPARROW: Was that your most emotional trade? PETER BRANDT: That was just the hardest trade my biggest, quickest single loss. I dont think the size was very big, it was just a trade I thought Id be making four or five thousand dollars per contract on, and I ended up limping out with a six or seven thousand dollar per contract loss. Oftentimes the emotional hit from a trade is tied to an earlier expectation for the trade. JACK SPARROW: As you said earlier, you know there will be ten great patterns each year and the year after that. Does that help put those kind of setbacks in perspective, or the times when you feel out in the wilderness? PETER BRANDT: There are things that stand out as principles I really need to hold to. One of them is that I need to forgive myself very quickly when I do something stupid. I can sit and hold previous mistakes over my head, and mistakes will compound if I do that. You have to be able to clear your conscience of the mistake you just made. If you beat yourself up and hold onto something, youre going to make another error. It is inevitable that one error will lead to another error in this business. So you have to flatten yourself out emotionally. And until you do, you just have to go back to small positions until you can build leverage back up. Ive been there before, and Ill be there again. In fact, I am there right now as we are speaking.

But youve got to have confidence in yourself, and in what youve done, in order to come out of that wilderness. Otherwise youll change the way you trade and then you wont have a clue where you are. Because what if you change the way you trade, and it works for a month or two, but then the new way of trading goes into the wilderness too. What do you do then? The only way for a novice trader to make it as a trader is to make a lot of mistakes, many mistakes more than once, until they figure it out and say, Okay, this is the way Im going to trade. And it may not be the way other traders do it. In fact, it really cannot be exactly how another trader trades, although it is certainly possible to admire how other traders do it. I can look at how another trader trades and say, Thats a thing of beauty. That is gorgeous how that guy does it. But its not the way I do it. You live and die with your own way. That is what every professional trader does. Thats what you Mercenary guys do. JACK SPARROW: Right its about synthesizing knowledge and great ideas, and then letting your own style emerge. PETER BRANDT: You know, I would love to be your age and know as much as you guys know. The opportunities are going to come your way. Youll just stumble upon them. Like the Commodities Corp opportunity that came to me I wasnt looking for that when it came. Homestake Mining, I wasnt expecting that things will just come your way, and I think youll recognize them. MIKE MCDERMOTT: Weve got our eyes open PETER BRANDT: I was 35 years old when my Swiss Franc trade happened. It all really started for me when I was 35. I think you guys will have an opportunity to manage a billion dollars, if you want to. Or if you want to, keep it at $200 million and have fun and keep it small, without the headache of having to hire an H.R. director. MIKE MCDERMOTT: That will be a fun decision to make! PETER BRANDT: I think it will happen. Youll be able to manage a large sum of money, if thats what you choose to do. You do it smart, youre astute, you have a good approach and good risk management keep doing those things and youre going to get noticed by people who can write out large checks. To be continued