Like almost every interview in Market Wizards, Larry Hite spent most of the conversation discussing risk and his careful respect of it. I found his witty responses to be both clever and enlightening. Three aspects of this interview that particularly stood out to me were Hite’s discussion of the four types of trades, his rules to live by, and his illustration of his three light system. Once again, this is not the first time I have heard any of this, however there is something to be said about getting the information directly from the source that everyone else I have read is quoting.
Four Types of Trades
“There are really four kinds of trades or bets: good bets, bad bets, winning bets, and losing bets.” – Larry Hite
This is one of those key points that has been ground into my thinking over the past few years. Hite basically says that good and bad trades are independent of winning and losing trades. Therefore, a winning trade wasn’t necessarily a good trade, and a losing trade wasn’t necessarily a bad trade. There are trades that are good when taken that end up losing and trades that are a bad idea from the start that make money.
Digesting this line of thought over time has given me the luxury of allowing myself to not get to excited over winning trades or beat myself up over losing trades. I am developing the ability to logically assess whether my reasons for taking a trade were sound without letting the outcome affect my opinion. This has been particularly interesting in analyzing my current losing streak. Even though they have all been losers, some were good trades. Some weren’t.
Rules to Trade By
Hite’s four rules to trade by are: Never risk more than 1 percent of total equity on a trade, always follow the trend, diversify, and track volatility. I do half of these well. I always trade with the general market trend, and I have recently committed to never risking more that 1 percent of my equity. It’s the other two that I need to work on.
I guess diversification is up for debate. Hite trades multiple systems across something like 60 different markets. O’Neil discusses trading 5 different stocks being enough diversification. Seeing as I am trading a very small account both in terms of the average trader and my personal income, I am not overly worried about this right now, but expect it to be a concern in the future as I grow my account.
Volatility is another aspect that I have not yet analyzed in great detail. Once again, this is something that I expect to understand better as I get more experience.
Three Light System
I thought it was interesting how similar Hite’s description of his three light system was to Investor’s Business Daily’s system. Hite’s green light is just like IBD’s “Confirmed Uptrend” where the investor is free to purchase as he sees fit. The yellow light is comparable to “Market Under Pressure” where the investor is warned to be more careful. When Hite’s system goes to a red light, he liquidates his positions. IBD does not advise this when their system goes to “Market in Correction,” but systems advise against establishing new positions at this point.