How to Beat the Odds in the Markets
The Trading Rules of Larry Hite
Larry Hite is one of the forefathers of system trading. From failing desperately in pretty much anything early on in life to co-founding the largest commodity trading advisor, Hite is living proof that anyone can become a great trader with enough patience, consistency, and the ability to learn from failure.
In his book: The Rule: How I Beat the Odds in the Markets and in Life, he put forward the rules that allowed him to become one of the most successful trend followers of all time.
This article will outline the 4 main ideas of this incredible trend follower.
1. Get in the Game
“You never know what you are going to get just by showing up”
There is this story of this poor young man who was having a terrible financial year and seemed to be spiraling further and further into credit card debt. To escape this unfortunate place, he turned to his last resort: God. He prayed for hours every day begging God to make him win the lottery. But six months passed, and no signs of improvement. Angry and desperate, our boy gave up and shouted out to the sky:
“You, God, don’t seem to listen to me. I prayed for hours every day to win the lottery and I didn’t get a single sign that you were here.”
And out of nowhere, a loud voice coming from the sky replied:
“You, fool, I heard every single one of your prayers. But how can I make you win the Jackpot if you don’t even bother to buy a single lottery ticket?”
The moral of the story is simple: if you don’t bet, you can’t win. In other words, if you never take action on your trade ideas, you have a 100% chance of failing. Hence, the first lesson is to have skin in the game.
2. Don’t lose all your chips
“I won because I always expected to lose”
If you lose all your capital, you can’t bet. And if you can’t bet, you can’t win. Proper risk management is one of the most important aspects of trading. Prior to taking any bets, you first need to know how much of your equity you are willing to lose on any single idea.
No one can win all the time and failure is part of the journey. In fact, I would argue that when you trade, you will fail way more often than you will win. The only difference lies in the fact that when you win, you win big. But when you lose, you lose small. So get comfortable losing, and respect your money management at all costs.
3. Know the Odds:
“It is incredible how rich you can get by not being perfect.”
According to Larry Hite, there are four kinds of bets:
- Good bets: These are asymmetrical positions when you can make multiples of what you are risking.
- Bad bets: It is the opposite of good bets. Here, you can lose multiples of what you can win.
- Winning bets: When the outcome of your bet is positive.
- Losing bets: When the outcome of your bet is negative.
Winning and losing bets are beyond your control. You cannot have an impact on the outcome of your bets, you can only control the choices you make. So rather than focusing on winning versus losing, you should focus on taking good bets repeatedly. Over time, if you keep placing those good bets with proper risk management, the law of large numbers will reward you.
4. Cut your losers and ride the winners
“When something is not going well, stop doing it. When something is going well, continue.”
This philosophy is at the core of any trend-following strategy. You need to understand that only a small percentage of your trade will make your entire trading performance. As a Trend follower, you are not trying to predict the future. Instead, you are in the business of adapting to what the market tells you in the here and now. A bit like a surfer who uses the feedback of the wave to adjust his stance.
To master this, you need to have a plan that will allow you to ride your position for as long as the trend last while knowing how to properly get out of a trade that doesn’t go in your favor.
While those rules sound so boring that they could be considered “cliché”, they are at the core of any good trend-following strategy. Over time, simple rules well executed will always beat fancy complicated methods.
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