Revisiting my rules of trading

The end of the year is always a good time to review one's process

We are near the end of the trading year. Oh, what a year it has been!

Ironically, for as strong as the market has been for the past two years, which has benefitted 401(k)s and many entrepreneurs, many of those involved in the markets have not seen the same benefits as you would expect with stocks at all-time highs.

I think I have mentioned before, but investment banks have been noticeably light in their hiring on campus. Historically, one could always count on the number of students they would hire. The last two years, in the face of a strong bull market, this number is about 60% of normal. While not negative (and people are not getting fired or delayed like 2022), this still leaves a lot of congestion among students as there are more qualified candidates looking at the other jobs. Many have pointed out 2025 will be better, but I think this post on LinkedIn from the CEO of Lincoln International (a big supporter of my university), laid it out very nicely:

It hasn’t just been the investment banks that have not been hiring. Many of the trading firms have not only not been hiring but have been letting people go. This is probably some combination of trading losses, lack of volume, and the AI revolution leading to an internal re-prioritization. However, stories like this are not what you usually see with markets at all-time highs:

Regardless of whether things look great, or things look a little tough, I think it is important for anyone in the financial markets to go back through their results for the year to see how well the process worked. This is not with an eye of radically changing a process, but determining where there may be more data needed, where biases may have crept in, where one might be more consistently out of touch with the market than they may think. I did that for the trade ideas I put out for the CME Group this week. In some places I was quite happy with the results. In others, it is clear I have some work to do in order to improve. Either way, while it can be a long exercise, I think it is worth doing:

Excell with Options for CME - A Year in Review

While I go through this process at the end of a year, I have found there are some tenets to my process and philosophy that always stand the test of time. These have become my “Rules of Trading” that I make sure I always stick to. When I veer from these rules, bad things always happen (which is not to say good things always happen when I stick to them). I have reviewed these in the blog in the past. Here they are:

Rule #1: Stay humble

Rule #2: Learn from your losses

Rule #3: Keep your powder dry

Rule #4: Maintain intellectual curiosity

Rule #5: Stay unbiased

Rule #6: Understand both sides of the argument

Rule #7: Value being out of consensus

Rule #8: Help others

For this blog, I want to go through each rule and how I saw it play out this year. Enjoy!

Rule #1: Stay humble

Early in September this year, my process was leading me to be pretty bearish. We had come out of the August de-risking event and recovered into the Labor Day holiday. Then, as traders got back from their summer holidays, we had another risk flare. Many of my signals were bad. I made sure to let everyone know:

In reality, that was a horrible decision. My post came out on Sunday after a very poor week. The market then rallied every single day the next week and never looked back:

Yet another example of the humbling that the market can give you. As I tell my students, if you are going into a career in trading or investing, get ready to be wrong, a lot. Even if you are wrong a lot, you can still be successful. Think of the .300 hitter in baseball in the Hall of Fame, or the best 3-point shooters hitting 44% of their shots. That said, when you make a big call and it is wrong, it hurts more than when you make a small call and are wrong. Thankfully, I have enough experience to know that the market is larger and smarter than any individual. Confidence is key, but arrogance leads to costly mistakes.

Rule #2: Learn from your losses

At the start of 2023, I was bearish. I was definitely bearish on the economy as I thought we would have a recession during the year. As such, I was also downbeat on stocks. For that reason, I did not participate in as much of the equity rally as I would have liked. Fortunately, I did decide to buy crypto instead of AI as a lot of my bearishness was about persistent inflation and higher for longer. Also fortunately, my process is fundamental, technical and catalyst so even as the fundamentals stayed bearish, the bullish technicals got me in. However, I was too bearish, and this led to losses on put premium and opportunity costs. I learned from that though.

Early this year, I wrote a piece called Dazed and Confused. There was much discussion about the type of landing we would have and whether or not we would see as many rate cuts as were priced in. With all of the confusion and no clear signals, I chose to be much more tactical than strategic. I avoided the big calls like early 2023 and made tactical bets on things like too many rate cuts priced in until June, whether Bitcoin and Ether ETFs would be bullish, and what we might learn from different earnings periods. Because I was tactical, even though I was not simply long all year and riding it up, I was still able to deliver returns like that but doing so in a way that meant I also wasn’t led to any de-risking decisions in August. This nimbleness certainly was a positive in 2024, and I think it will be again in 2025.

Rule #3: Keep your powder dry

I am contrarian by nature. Whatever everyone else wants, I don’t want it out of principle. This could be my preference for an Android instead of an iPhone (I was actually maybe the only person in the US with a Microsoft phone when it came out). It is definitely why I didn’t want a Callaway driver when everyone I knew was getting one. In markets, this can be beneficial. After all, no less than Warren Buffet says be greedy when others are fearful, and fearful when others are greedy. Thus, with the US stocks massively outperforming the rest of the world, and with large cap stocks massively outperforming small cap stocks, my interest is in global ETFs and SMID ETFs.

However, as I wrote in Ruh-roh in April, it is important to look at the action beneath the surface. When one asset is lagging another correlated asset, you need to find out why. Is it simply investor preference, or is something else at work? In fact, all of this year and last, the massive outperformance of large cap US names has been driven by fundamentals, namely far superior earnings performance. Identifying this in the blog helped me keep my powder dry and have a risk budget that I could use at another time, for instance, now. I do think the outlook for small caps may be changing materially with rate cuts, reductions in regulations and the potential for tax cuts. We see this in the survey data. However, if I would have gone long small caps in April, or the previous year etc., I wouldn’t have the appetite for the idea right now. That isn’t to say it will work, but the set-up for small caps vis a vis large caps certainly has some fundamental support now.

Rule #4: Maintain intellectual curiosity

Never stop learning. Always stay curious. Not only do I tell my students this with the hope it will help their careers, I tell my friends who are retiring this with the hopes that it will forestall cognitive decline and help them find their raison d'etre in their later years. This intellectual curiosity has certainly aided me in my career and continues to even now. It is one reason why I enjoy the podcasts I do for the CFA Society Chicago. I am able to learn so many new things from the top people in the industry. Have a look at the material produced this year:

CFA Society Chicago podcasts

I try to do the same thing on Substack with many of the fellow writers. I added a new one this year when I interviewed Amrita Roy at The Pragmatic Optimist:

Not only was this a chance to get an incredibly informed and interesting opinion on an important topic, it was also a chance to meet and dig into the process of a very talented individual. This was not the only podcast I did on Stay Vigilant. In fact, I just did one this week with Michael Kantrowitz from Piper Sandler, the founder of H.O.P.E. Have a listen:

Kantro podcast

I know they aren’t the most popular if I look at the statistics, perhaps because they take too long to listen to, but I know I find that they really inform me and keep me curious, so I am trying to pass that along. If you find you are fulfilling your intellectual curiosity elsewhere, great. If not, have a listen to some of these podcasts. You just might like them.

Rule #5: Stay unbiased

It is incredibly important to stay unbiased when approaching trading and investing. It is also incredibly easy to become biased as a trader or investor. Perhaps there is a company where the management team has let you down before and you can’t trust them, so you never want to buy the stock. Maybe there are others that you just can’t fathom not being long. Perhaps you have a strong bias toward growth or tech stocks or selling options. Whatever it is, it has probably made you money. However, there is no guarantee it will always work, in fact, it is very likely it is both going to stop working at some point, and maybe not working as well right now as you think.

The asset class that I see the most bias in is crypto. People either love it and will never sell it, the HODLers, or they think it is a complete scam and would never consider buying it. Both groups are too biased. There is money to be made (and lost) in an asset class that is now $3.75 trillion. Bitcoin itself is $2.1 trillion, which puts it in the Mag7. Yet no one flinches in thinking those can continue to dominate. Regardless of whether you are on one side of the fence or the other, or you just don’t know much, it is worth understanding what is driving it because attracting capital from institutional investors and maybe soon the federal government. That is exactly what I tried to do in January with the cryptocurrency outlook. This podcast helped me set the tone for the year, and it was an incredibly fruitful year for me in crypto. I am not a HODLer by any stretch. However, if there is money to be made in a liquid asset, I am going to try to understand it.

Rule #6: Understand both sides of the argument

Too many investors I have worked with in my career suffer from cognitive dissonance or the discomfort of holding conflicting beliefs or ideas. This leads to confirmation bias where they only look for information that confirms their views and discount information that challenges their views.

I am a big believer in the Socratic debate process. I believe we should all debate our views, in a respectful and tactful manner that is. If we win that debate, we should feel more confident, and this may even lead to increasing our positions. If we lose the debate, we probably need to go back and do more work. This may even save us from losses we couldn’t anticipate. This is along the same lines of the radical transparency Ray Dalio talks about at Bridgewater. In Lingering questions this year, I tried to explore both sides of the arguments. In fact, I do that each and every week and post where I find a preponderance of the evidence. I challenge my own views every week and try to show you that process in my writing. My goal is to show you this in order to either help you improve your own process, or to get you to challenge me if you don’t agree with my views. I am happy either way. I love the comments. Please keep them coming, even if, especially if, they challenge my own views. Socrates would be proud, and we will both be better off as a result.

Rule #7: Value being out of consensus

The biggest returns are made when you are out of consensus, and correct. It isn’t enough to simply be out of consensus all of the time. Consensus isn’t always wrong. However, if you are positioned in line with the consensus view, it will be harder to make money, and if there is any catalyst to get people to change their minds, it can get ugly. I have learned this in trading through the European exchange rate meltdown, the Asian Financial Crisis, LTCM, Tech Bubble, Great Financial Crisis and Covid.

It was in the spirit of looking at historical analogies that I wrote Fool me once, shame on you. History doesn’t repeat, but it rhymes, as Mark Twain or someone else said. Markets have repeatable patterns because of human nature. This leads to greed and panic. Understanding when we have seen these patterns in the past, can help one navigate current times. This doesn’t mean that one immediately says ‘this is like the tech bubble, you should short the market’. In fact, in may be more like the Nifty Fifty which means there is a lot more in it. Surely, though, we can count on panic and euphoria from investors and unintended consequences from government actions. Thus, there is a time to be out of consensus, you just need to always know where consensus is, and to look for catalysts to be out of consensus.

Rule #8: Help others

I am going to leave it here. Substack is always telling me to turn on subscriptions. This is probably more to help Substack in its IPO process than it is to help me, but either way, it is outside of the reason for why I started this Substack. I have been blessed to have had an exciting career living all over the globe and investing in every asset class. I hope to pass some of that along to help you. After all, helping others is not just in the spirit of the season, it is the true path to happiness.

I had a student ask me the other day about how important it was to take a job that paid more than another. This led to a much longer answer than she probably wanted, but ultimately, if you seek to find your happiness in money, power, pleasure or fame, you will definitely find yourself never happy. True happiness comes from helping others. That isn’t just me saying that. It is a truth from time immemorial.

While I don’t look for subscriptions, if you do value any of this writing, I ask you to consider donating to the Evans Scholars Foundation. The Evans Scholars are the largest privately funded scholarship in the US. It gives full tuition scholarships to 1200 students at 24 different universities with three things in common: they are smart, they are in financial need, and they were caddies in golf. I benefitted from the Evans Scholarship when I was in university, and my life was permanently changed. This is a link to donate if you are so inclined:

Evans Scholars donation

I would just ask that you reference Stay Vigilant by Rich Excell in the message. This helps me when I follow up with the organization (Western Golf Association).

I have one more blog next week before Christmas and then will take some time off around the holidays. I hope you have had a great year. Do yourself a favor and go back and thoroughly vet it. It will only help you.

Until next week … Stay Vigilant