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You have to design what you do to suit your own financial puzzle and your own biases.
As the great late Dr.
Tharp used to say, you trade your beliefs, not the market.
Sit down and write down your objectives, your financial puzzle.
What are you trying to really accomplish with your trading?
And design what you do to fit your lifestyle, fit your expertise levels, fit your portfolio size, then execute the darn thing flawlessly, and life would be good.
You'd be a lot more Mr.
Serenity's out there floating around the trading world than there are these days.
Markets, speculation, and risk.
This is the Chat with Traders podcast.
This is episode 271 on Chat with Traders.
I'm Tessa, your co -host, and today we have the pleasure of speaking with a special guest.
Experiencing the brutal market of 1973, 74, impressed upon our guests the necessity to find ways to hedge risk.
This began a multi -year long quest to find the right combination of uncorrelated assets, technical indicators, and adjust the weightings as needed to provide enough protection to fill in the potholes of equity drawdowns while retaining the bulk of upside potential.
Having a sweet balance between risk and reward, both in the financial markets and in his personal life has enabled him to maintain a serene disposition.
Who is this? His name is Tom Basso, who was on the show back in 2015 on episode 30 with Erin Fifield.
If you haven't listened to that episode or want to listen to it again, you are more than welcome because we know how beneficial it is to keep these episodes up because of course there's still so much value to be gained from them.
Fast forward eight years later, our host Ian Cox has the pleasure of speaking with Tom.
There's still so much insight that we were able to extract from this very amazing veteran trader of the markets.
Why? Because even though he's been there and done that and have been a big influence on the trading careers of many, he didn't stop learning, growing, and improving as a trader and investor.
He kept going as you'll learn.
Tom is a retired money manager and futures currency trader, golfer, winemaker, author of the All Weather Trader and believer in behavior economics and more.
Ladies and gentlemen, we are so pleased to present and welcome back the calm, cool and collected and one of the market wizards, Mr.
Tom Basso from the cooler part of Arizona.
Well Tom, welcome back to chat with traders.
It's been a while. Yes, it has.
Eight years since you were on here last time, back in episode 30.
What have you been up to in the last eight days?
Tessa in the introduction left out the fact that I'm an amateur chef and I love to prune my gardens.
It's a very Zen like thing that I do.
I do it all by hand.
I don't use gas engines or anything loud.
So I might have some peaceful music in my ear or just let nature talk to me.
Then I hand prune everything and now I'm remodeling a house.
So that's my real estate expert wife decided that real estate prices about two years ago were insane in Scottsdale.
And she said, you know, this beautiful condo we decked out with a private elevator and everything with a gorgeous view, which I loved.
She said, we'll never get the price out of it as we will right now.
And she was right. We ended up with two bids over asking, sold it out and then moved to our mountain home which is why I have a fleece on today because my office is downstairs which works great in the summertime because it's nice and cool down here but it's also nice and cool now in November.
So it's, it feels a little more comfortable to have a long sleeve fleece on.
Because it's a little less warm down here in the basement in the wintertime and it's getting chilly outside.
So we go down and the remodel is down in Scottsdale and it's been keeping me hopping for about the next two months I guess and then we'll move in in January.
Hopefully life will settle back into a little bit of normalcy.
So what part of Arizona are you in now?
Your - I'm in basin Arizona, which would be Northeast of Scottsdale approximately an hour and 40 minutes door to door.
And I'm up at 5 ,000 feet.
So we get about 10 to 12 degrees cooler than whatever's happening down in the valley, Valley of the Sun, Phoenix and Scottsdale.
So it's great in the summertime cause it takes the edge off that 115 degrees that you get in June and July and all that but not so good in November.
Number one is starting to get a little chilly at night down into the 30s, sometimes low 40s.
And as a Arizona guy for the last almost 30 years my blood's pretty thinned out at this point and I like the warm.
Yeah, well in eight years, have you seen anything that has piqued your interest or caught your eye that's happened in the last eight years?
It's kind of impacted the way you trade.
Yeah, the biggest thing that I think has changed for me over the last eight years probably has been the whole concept of what a good friend of mine Lawrence Benzdorp says, filling the potholes.
I've always been sort of an all weather trader and it's probably why Eric Crittenton and I got together with Standpoint to try to get that off the ground because he's an all weather trader as well.
And I like the concept of trying to create an equity curve that's fairly smooth.
I think it helps the mental psyche of trading and that's so important.
I think a lot of traders that I see comments on Twitter or Facebook, they're all over the map emotionally and stressed out and of course, Jack called me Mr.
Serenity because I am a little bit more even keeled and part of why I'm so even keeled is that I've tried to blend in different types of things to my trading so that in any one time I've got green and I've got red and you just add them up and if it's totally green, it's a great day.
But mainly you just follow the strategies and let each one strategy that is designed to do certain things have its day in the sun or its day in the dog house.
When you add them all together, you're just trying to make the total portfolio go the right way.
I liken it's a pistons and a gas engine.
You never see the cutaways they have of the engine cut in half and they show the pistons going up and down in a gas engine and they're all going up and down at different times but they're all pulling the car in one direction.
That's kind of the way I look at the multi strategy portfolios.
So I've spent a lot of time in the last eight years thinking through where are my most vulnerable points with say a long -term trend following strategy which I'm probably best known as a long -term trend follower.
And well, they would be coming off of an equity high, markets pulling back to their stops.
That'd be the first part of a drawdown.
Second part of a drawdown would be a choppy sideways period.
So what can I add that would do well in a sideways period or that would help reduce the amount of drawdown I get off of an equity high.
And so that's been probably the biggest focus of the last eight years of what's helped me.
And it's really stabilized my returns nicely.
And I think I'm up something like 29 % this year or something according to IB who I trade through.
They're saying my time later return on my all weather strategy is something up just close to 30 now.
And it's been fairly steady is the more important part of it.
I haven't had a lot of ups and downs and all over the places.
So it just allows me to be more even keeled which just helps your thinking and your emotional state and puts trading in its proper perspective and doesn't get you bent out of shape all over the place which I think a lot of traders tend to fight.
Yeah. Well, this is a good segue because I'd love to dive in to hear more about what you think about regarding hedging for our listeners who may not know what hedging is.
Tell us what is the goal of hedging?
The goal of hedging is to quickly with a hedge, a single instrument, hopefully you could do it with a couple per husband.
For me, it's just a single S and P futures contract.
You could use a short sell against a stock portfolio, lots of things but what you're trying to do is to set up two parts of your portfolio.
One that would be exposed to the long side and therefore would tend to make money when the market goes up and lose money when the market goes down.
And then there's the hedge.
The hedge might be for simple terms like a short sale and a S and P futures index which is what I use.
So my portfolio tends to be pretty broad when it is all on is I'm trading 30 different sector ETFs.
That's gonna cover most of the market.
So it's gonna look like the S and P 500, therefore if I use an S and P futures hedge, so if you look at my hands, here's my stock portfolio and you make money to the palm of my hands when the market goes up and you lose money when it goes down.
If I put in place an S and P futures hedge, then that's notice that my hands the opposite way.
It's gonna make money as the market drops.
It's gonna tend to lose it when it goes up.
If I put these two things in balance, I'm halfway decently, you're not gonna make or lose anything.
So it's just like you sort of sold out your entire stock portfolio, which in some people's cases especially if you're in illiquid instruments, it's really a lot of work, it's a taxable consequence.
There's lots of negatives to selling out an entire portfolio from the standpoint of work and taxes.
If you put a hedge in place that is just an index of some sort, then you're not really selling those instruments that you have in the long side of your portfolio, but you're basically taking away a lot of the potential for a catastrophic loss due to a say 50 % down bear market which Lord only knows we
could be on the verge of any moment with the market doing so well and so overbought.
If a thing went the other way and panic set in or a war broke out or any number of different things, you could be off to the races to the downside and it could happen very quickly because down markets happen quicker than up markets.
And by being able to put one instrument on and knock down the market risk so dramatically, to me as a retired guy, it just gives me the peace of mind knowing that I've got a protection mechanism ready to go and I don't have to worry about all those longs.
They'll eventually sell themselves off, but it might take a week or two.
And meanwhile I'm exposed to a lot of market risk, but with the hedge on, I'm not exposed to almost any market risk.
If we could go back in time a little bit back when you graduated as a chemical engineer in 1974, what was the catalyst for you to first get interested and investigate hedging?
It was the concept of, I had lived through 7374 as I was coming out of school at Clarkson University as a cheme and I was getting my first chemical engineering job and that 7374 bear market for those that are probably too young to have lived through it was 50 cents on a dollar.
And when you get those types of dramatic moves, it starts affecting capitalization of businesses and everything, you got boom and bust, surges in the economy and recessions coming through in the 70s, about every four years it seemed.
And until Reaganomics came around and launched almost a multi -decade surge in the US economy, you ended up with these boom and busts that chemical engineers would be hired like crazy when the boom was going on and then we'd be laid off.
And I was thinking to myself, I need to protect myself against these down markets but I also knew that just from looking at charts and all that, that if I went long stocks and I had one of these recessions come along and the stock market got cut in half, I hope my savings, which I would have to live
off if I've got laid off from my chemical engineering job would be decimated.
So I had to figure out a way to mitigate risk and some of the stocks I owned were fairly illiquid, small, low price, less liquid types of positions that I would build up for a fairly long run, hoping to get to a longterm gain eventually.
And by having the hedging, it just seemed like that would mitigate a lot of that risk.
What were some of your earliest strategies for hedging?
How did you dive into this?
What I started with was because I didn't have a futures capability.
When I wasn't at interactive brokers back then, I had multiple brokerage accounts which creates a little bit of an interesting logistical problem with your cash because if you've got say a futures hedge that you want to do or you want to do a short sale on an SPY, which would be the Standard Force 500
ETF, that very famous and well traded, you have the logistics of making sure you have enough cash to handle the SPY short sale or the futures trade, which sometimes in some stockbrokers case can't be done at the stockbroker, you gotta go find a futures broker.
And then you're moving cash, wiring cash back and forth to cover your margins and it gets awkward a lot easier these days where I do it all at one place.
But back then the S &P 500 ETF was what I used and I'd short sell it.
And until one day I was at a brokerage firm that I thought looked attractive and I went to borrow the SPY shares to short them.
And they said, you can't borrow them, we don't have any to borrow.
I thought, wow, this most liquid traded vehicle in the New York Stock Exchange it seems, what the heck, you can't borrow it, you gotta be kidding me.
So needless to say, I wasn't at that brokerage firm very long after that, moved to a place where I wanted to see the depth of the SPY so I could use them for hedging and eventually moved on to futures and got it even more streamlined so it'd make it easier for myself.
So how did your... What was your first bear market where you put on hedges and how was kind of the result of that?
Ken, what was your strategy in the first time?
Well, in that particular case I had in the eighties, I finally moved to futures as my hedging vehicle and still was operating with two different accounts at that point and probably the most famous one would be the 87 crash.
87 crash, the hedges ended up making about, I don't know, 24 % overnight and the stock portfolios we were running for clients were down about 23.
So we picked up like a percent on the portfolios and boy, I was patting myself on the back for protecting the client assets in that case and I thought I was gonna be a hero but very famously we had one pension plan out in California that had a bunch of PhD physicists on the pension panel and they wanted
me to shut down the stock portfolio because we lost their 23 % and just trade futures because we made 24 and I told them, now you can't do that.
The reason this works is they're both together and we protected the assets and that's what we're supposed to be doing here.
We couldn't see eye to eye and I ended up firing them and it was a multimillion dollar account which hurt me a great deal business -wise at the time but it was the right thing to do.
I couldn't see just trading futures for them in their pension plan.
It's a good example to me in an early age at that point of how completely brilliant people sometimes are so common sense stupid when it comes to investing and how being a money manager doesn't just mean being a good trader.
There are two different things.
Money managers have to understand the psychology of not only themselves because there's, Lord knows, huge amounts of pressures from the markets and everything that's going on, the news coming in every day but you also have that added pressure from your clients expecting you to work miracles sometimes
and very unrealistic about what it is that you do and what you have to go through.
If they knew what you knew, they would be trading themselves probably.
So they hire you to do it but they still have that ultimate power to pull the cash and that pressure is always there as a money manager and when I retired about 20 years ago, I put a smile on my face.
It's been there ever since.
I don't have any clients anymore.
I don't have any registrations.
I don't have the SEC coming in and auditing my books and all that stuff that you have to do as a money manager then life's good.
So what got you into the hedge just prior to the 87 crash?
Kind of what kind of indicators were you looking at to get you to put on the hedge because you felt that something, a big crash might happen.
Well, a crash might happen someday.
I had no idea the crash was going to happen but approximately two weeks before that, at that point, I was using moving average, a fairly long -term, like 20 -day moving averages and it clicked over to the downside.
So I put the hedge on, on the mutual fund timing that we were doing for clients back in those days where they used to allow mutual fund timing, we went to cash.
So we were in total cash in those programs as the crash happened and those folks were quite happy.
So we batten down the hatches.
We had no clue that it was going to be the crash of 87.
It just intended to follow through, panic set in.
At one point, the Quotron machines in our office were running two hours late on updating the prices.
That's how we talked to the floor.
They told us where the market was.
We looked at the screen.
He said, oh, that was two hours ago.
They were so backlogged on getting the throughput through the wires and out that we were running two hours late on the screens.
It was insane. And an interesting time to live through, especially since we were protected.
But you never know, to me, the market at any point in time, and particularly in a time like we are in right now, where you have everybody getting kind of excited about how far the market's moved up.
And the more things move up and the more people get excited, the more nervous I get, just as an experienced trader.
And thinking, when I'm making new equity highs, and I've had a good streak, I'm sitting there remembering those times when I'm at new equity lows to balance myself out and keep myself very even -keeled.
And likewise, when I'm in the middle of a drawdown, I'm thinking about those times when I was making new equity highs.
And you just never know when something triggers it.
And then it's like a match to gasoline that's spilled all over the floor.
You just have this complete fire going in every direction.
And then the news is all turns into negative and people panic and the selling just gets out of hand.
And with computers, back in 87, a lot of the stuff was done by hand, you remember.
I mean, PCs, personal computers only came in.
I got my first PC in 1980.
So in 87, computers were coming into the industry, money management industry and the trading industry, but it wasn't as pervasive as it is today.
And it certainly wasn't the speed and the huge disk drives and the capability to mass handle just huge amounts of information by artificial intelligence was maybe a dream of somebody.
It just wasn't there.
So you look at how things have changed and you think about panic setting in and everybody has the ability to move a lot more money a lot quicker than they used to when they had to call up a broker and it had to get wired down to the floor and a runner had to take it out on the floor and things were slow.
So that in itself slowed down the panic, but now you can just hit a button and sell.
And I really worry that circuit breakers notwithstanding, I still think things could get really ugly really quickly and people always have to keep that in the back of their mind and have a plan.
It's not that you have to run scared.
I'm a fan of trying to say that you have to look at the risks out there and attack them.
You can't try to hide from them.
You have to realize they're there and ask yourself, what are you gonna do about it when it hits and be prepared, have a plan.
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Do you ever do any personal hedging, like hedging outside the markets, given that you're rather cautious nature toward things are going?
I remember reading a quote that you said that governments are in a race to the bottom.
And so I just wondered if you, any other types of hedging.
I have a pantry that I could live off of here and that's next door to me.
It's probably got enough food in there for three to four months for the two of us, Brenda and myself.
I've got water, fresh water, if I need it.
I have ways of filtering water.
I have ways of hunting up here and we have a plentiful elk supply.
So that would be some food.
I own some gold bullion.
The typical stuff that you might do to try to hedge.
Based on what happened during COVID, I have plenty of toilet paper.
That seemed to be in.
And zero supply around the world here and the United States at least.
Those types of things I would say would be what I try to do.
I also try to stay in good physical shape.
I'm 71 years old, but I still work out and try to keep my weight down, try to, watch what I'm doing so I have the physical capability to get out there and do stuff if I have to on my own.
There may not be people to hire to do things.
So you have to be able to be a jack of all trades a little bit.
So in my personal life, there's a little bit of that, but I don't obsess over it.
I try to operate in both worlds and not really dwell on either one.
I'm not Pollyanna -ish to think that the world is always gonna be wonderful.
And I'm also not obsessed with that.
It's gonna all fall apart either.
How about the other bear markets with the strategy that you're doing regarding hedging the bear markets of 2001, 2008, and then 2020 because they have different types of bear markets.
Yeah, 2000 was more of a tech bubble.
The timing on all of our tech mutual funds and anything I was doing back then with respect to mutual funds, all went to cash.
So that was easy. The hedging, we weren't trading stocks, individual stocks at that point.
So I didn't have to worry about anything like that.
Futures nailed it. So that was a good period for futures.
When you have indexes going down 80%, and you can go short those indexes, you can make a lot of money.
And some of the currencies, some of the bonds, type movements lend themselves to big profits.
The 2008 was definitely, God, you can make a lot of money on the debt instruments there because you had interest rates making some move.
You had the stock market falling like crazy, about 50%.
So that short sales and the indexes there were wonderful.
And so we buffered there really well.
At that point, I had been started retired and I was now trading ETFs instead of mutual funds because mutual funds tend to be end of day pricing.
And I found it more convenient to use an ETF and then I can put stops in.
And if a panic sell off occurred, I could sell my ETFs off during the day as opposed to waiting to the end of the day.
So that seemed to me to be a good way to go.
It fit my lifestyle and retirement better and nailed that one.
It was great. I guess the most recent year, last year, there was a little bit of downside and about 30 something percent down.
I got that one with the hedges as well.
I put my hedge strategy exactly what I do right on my website.
So people can go back and look at the charts and where my most recent three or four signals have been and see the most recent one was WIPSA for instance.
So I actually came up behind on that particular hedge trade but the current up move is looking like I've already locked in a break even almost.
So that looks like a good trade, taking the hedge off and letting my 24 out of 30 now sector ETFs go along and they're clicking along nicely.
I would have not predicted this.
I think the economy is a little bit shaky in the US but hey, the stock market's moving up, I'm long.
I don't question it.
I don't use my own judgment even in my trading.
I just look at the indicators and go with it.
Right, on your site you mentioned that you have a 50 day to initiate a hedge, is that correct?
And then 21 days to take off the hedge.
Is that accurate? I do the same thing the other way with my long ETFs.
So if anybody cares, when I'm trading my 30 sector ETFs which range across almost all the sectors in the markets, the reason I do that is using 21 for the upside and 50 for the downside puts a slant towards the upside which to me, the stock market has experienced that since the depression of the early
1900s. I view that as probably the Fed and Treasury and government in the US leaning towards slight inflation.
So there's an upside bias to equity prices because if you think of it, a dollar of earnings and a stock sells for a PE of 10, then it would be at $10.
But if the value of the dollar is diminished and now the company makes $2 of earnings but the $2 is equal in purchasing price to the $1 that it used to make, then nothing's really changed from a real earnings standpoint.
But at the same PE, the stock would sell for 20.
So the downward bias in the purchasing power of the dollar seems to me to always put an upward bias to the price of stocks.
And so I lean my indicators that way to suit my bias that way.
And this is what I talk about a lot with traders.
You have to design what you do to suit your own financial puzzle and your own biases.
As the great late Dr.
Tharp used to say, you trade your beliefs not the market.
And my belief is that there's this upward bias to equity.
So therefore, I upward bias my indicators in a fashion that you pointed out.
So if inflation were to pick up strongly with all the money printing due to servicing the debt, would you ever consider adjusting your indicators to be more bullishly biased?
I think it's a trade -off between what you just said on the inflation side and the increased volatility that would tend to occur in an environment like that.
And I think that having the 21 days to the upside and then giving it the room of a 50 to the downside might be more than enough, especially with the indicators I'm using that measure volatility in the equation, which would be Donchez, Keltner's and Bollinger's.
They all have a component of volatility.
So in a world of volatile inflation, I would think the indicators would automatically separate the noise bands out and probably give me enough room.
So I have a tendency to say, I probably shouldn't have to change anything there.
The indicators should adjust themselves, but you know, hey, it's my portfolios and my indicators.
I can do what I want as a human being any day I want here.
And so yeah, everything I do is subject to change if I think of a better way to do it, sure.
I'd like to dive in now to correlations and diversification.
What do you look for in diversifying your portfolio?
What I look for is I try to use my own common sense.
I'm not really hung up on running 60 million correlation coefficients of everything under the sun against each other and then picking the 10 most non -correlated.
But what I'm looking for is investment A and investment B not really being tied to each other a whole lot.
And it's one of the reasons why I'm so happy that I was able to explain in the all weather trader book that I just came out with last April, how I took over the years a large equity exposure and I moved into extreme diversification in the things like futures markets.
Because if you think just as a human being, you know, you got the stock market and you got corn.
Does corn care what the stock market did today?
Does the stock market care what corn did today?
Those two investments, if you're trading both of those are going, they both could go up in a certain day, they both could go down or one could go up, the other one could go down.
They have nothing to do with each other.
And likewise, if you took say corn and you put it against, I don't know, euro currency or Japanese yen, why would they have anything to do with each other?
So just common sense starts telling you that there's certain markets that could be very non correlated.
And it turns out if you run a lot of correlation coefficients, you'll see that your common sense is probably not too off the mark there.
So what I try to do is look at markets and say to myself, is this likely to trade exactly like that?
And I try to cobble together a list of tickers that has a lot of diversity to it.
And then I try to time all of those.
And when you do that, you're gonna always, if I look at a screen any one day, I've got 50 positions, 60 positions depending on the time you're talking.
And I'm looking at it and half of them are up and the other half might be losing and hopefully the ones that are losing are losing a little bit and the ones that are up are making more.
And the important number of course is the total at the top of the screen, you hope that's green.
It isn't always. I run about 50 % days up and 50 % days down, but my reliability and my strategies is down in the 30s.
So when you add them all together, it gives you that smoother track record.
I'd love to make the number instead of 50 % of the days, I'd like to make it 100 % of the days.
And that's the financial puzzle I continue to try to solve.
Is there such a thing as an ideal correlation range to look for?
Yeah, you want to, a perfect correlation would be 1 .0 or 100, depending on how you wanna do the math.
A negative perfect correlation where one thing goes up and the other thing always goes down, which would be the case in a hedge for instance, would be minus one or minus 100.
So you'd have this range from minus one to plus one.
Zero is what you seek.
If you can get zero out of it, that means that one investment doesn't have anything to do with another.
If you can realistically find something between say, minus 0 .2 to plus 0 .2, you don't have a whole lot of correlation there.
That's probably a real safe spot to try to search for if you're looking for correlation coefficients and using your spreadsheets and putting the prices of one thing against the prices of another and using the C -O -R -R -E -L function in Excel or something to run a coefficient.
It's easy to do. It comes with Excel.
You could easily set that up and get the data and run it.
Just to verify your own common sense that corn has nothing to do with the S &P 500, let's say.
Yeah, how many different types of assets do you trade and are you looking for a particular percentage weighting between commodities and stocks?
Okay, I approach the problem that I have this way.
I start out with my base load of sector ETFs.
That gives me my equity exposure and I trade that the 21 and 50.
It's a fairly long -term type of strategy.
I don't do a lot of trades there.
Try to get to long -term gains if you can.
It's more advantage from the tax standpoint and that's kind of the way I handle that long exposure.
When I'm not in those ETFs, I go to money market fund and make interest, which is not bad these days either with interest rates being up.
I then ask myself, well, where's the vulnerability or risk there and how can I attack it?
So the thinking would be the vulnerability of an ETF timing is gonna end up happening in two pieces.
It's gonna be the stocks make new highs.
The ETF timing makes new highs.
It starts settling down and the bear market starts and I'm getting back to my stock losses to time out into cash.
So that little bit of downswing is gonna start my drawdown.
So there is where I like to have a hedge capability to come in a little quicker, hedge some of that long exposure out and protect some of that downswing due to just coming off equity highs.
The next part of the drawdown that I'm gonna experience in those types of strategies is gonna be a market like we've had kind of this year, really, where you aren't really going anywhere but you're going sideways, but you're going sideways with enough swings that it catches a few of those ETFs to the upside
and then stops them out for a whipsaw.
And in those types of markets, you wanna just try to come up with other strategies that might make money during those periods.
So one of the things I do is I sell option credits on indexes.
So when I have an excessively overbought situation, I'm selling call spreads and making money as the market goes sideways, I just do that once a week and just keep bringing in more and more cash from the credits because the markets don't carry through anymore, they're going sideways by definition, let's
say. And those credit spreads do really well there where they get hurt is when you have major trends.
Well, if you have major trends, I'm making money over in the other one, so I don't care.
I'm losing on the option spreads and I'm making it over in the ETF.
So by blending things together like that, what I'm doing is designing various strategies to take care of certain conditions in the market and be the hero.
And they take turns being the hero.
And then I then say to myself, well, what if we have an extended bear market and it's pretty much downward, but it's downward in a trend that is not so sideways.
So the credit spreads aren't gonna handle it.
Where could I make money in an extended bear market?
Let's say it's a year or two years or three years or God forbid the depression was more like what, 10 or 12 years or something like that back in the early 1900s.
How do you deal with stuff like that?
Well, you got to look for other opportunities.
So trading things like my 26 different futures markets that I'm involved in gives me the potential to try to make money in like lately orange juice, making new highs today.
I've been long for a long time.
It's been a great market to the upside.
It keeps clocking in some nice money every day for the last, I don't know, month and a half or so.
So that type of thing, no matter what's happening over in the stock market is completely separate and unrelated return stream because orange juice doesn't care what the stock market's doing.
Cotton doesn't care.
Coffee doesn't care.
Cocoa doesn't care.
And by trading all these things, you get return streams that are unrelated to each other.
Cocoa doesn't really care what corn's doing in the United States, right?
So you get different return streams at any one point in time.
You've got one losing, you got another one gaining.
It blends it all together into a much more steady return stream.
And you can set up indicators, and if I had to do everything I'm doing by hand, it would take me about an hour.
I've got it down to about 35 minutes now, and I'm hoping, maybe this afternoon actually, to automate two more of the indicators or strategies that I do, and I have it down to less than 15 minutes.
So if you think about it and use some spreadsheets or do a little programming or hire somebody to do some programming, you can speed yourself up and run a strategy with pretty little time, and yet gain those return streams that are unrelated and smooth out the track record.
And then you just don't have to sit there in front of a computer all day, which I've done all too many times over my lifetime, and I enjoy getting away from the computer.
Yeah, if I'm not being interviewed, I like to go out outside and either hit golf balls or go trim some bushes or do something.
In recent years, I read that you've added Bitcoin futures to your ensemble of assets to trade.
Were you just excited that there was one more thing that you could add to the list or was there anything about Bitcoin which attracted you?
I wouldn't call it excited.
I was dipping my toes in the water when I started.
The Bitcoin and Ethereum praise that was in the early going, I just didn't want anything to do with it.
It seemed insane to me.
When they started adding futures, I started thinking to myself, all these potential bankrupt companies trading cryptocurrencies, I have a hard time doing due diligence on them.
The FTXs of the world, it'd be hard for me to waste the time going in and trying to figure out what they're doing and whether I trusted it or not.
So to protect myself, I've been a futures trader for what?
45 years probably now.
I understand futures.
I understand the exchanges backing the contracts, all the futures brokers that back up the exchange, backing up the exchange.
So there's lots of different layers of protection for the position.
So that if I make money in a crypto positions, I have a good chance that somebody, the exchange is going to pay me off.
I don't have to worry about the guy.
If I bought cryptos and he shorted it and he wiped himself out, I don't have to worry about him making good on that trade.
Like you might, if you got into a weird situation where a firm was about ready to go bankrupt, you might make money and they can't pay you your money.
So futures was a logical kind of stick my toe in the water type thing.
I could see that the prices move dramatically and all the studies I've ever done as a trader show that the faster and farther a market moves, the more likely there is for profit.
It makes sense. We all have to buy low sell high or sell high buy low.
And the farther the buy low sell high is, the more money you can make.
So markets moving is always a good thing for traders.
And here's Bitcoin going all over the map.
And I'm thinking, well, I'm going to give it a try with the futures.
So I set my risk and volatility control schemes on my position sizing in there and dialed it in with the equity and away we went.
And it's been highly profitable.
I have to say it's been good.
And I have the protection mechanism of the markets behind me.
So I feel very comfortable with it.
I'm on a profitable trade to the upside right now.
When I look at asset classes like Bitcoin and compare them to the S &P, for example, I find periods of high positive correlation for say a number of months and then highly negative correlation for other months.
How should we treat rapidly shifting correlations between asset classes?
And how often do you look and what timeframes do you look at them?
I try to look at the strategies and say over time, should these things be correlated or non -correlated?
When I do that, I realized that as long as I dial in each of these strategies for an appropriate amount of the equity in the portfolio, the total portfolio, I allow each to contribute to the positive when they're making money and each contribute to the losses potentially.
And I try to balance them using the volatility of the strategies.
If I know that the volatility of my general ETF timing is a certain amount and then I've got my futures program dialed in with the right amount of exposure to the equity per position and I look at those as a total portfolio movement against total portfolio movement of the strategy, the subsection of the total
portfolio. If I can match those roughly, then I know that there's times where they're both correlating and I'm just slaying it, there's times where the strategies are, maybe this one's struggling, that one's going my way and so I'm making less or I may be offsetting each other and I'm just breaking
even but I'm trying to dial each one of those in so they can contribute to the profits of the total.
And so in something like cryptos going from positive correlation to negative correlation which just recently is done, lately it's been negatively correlated, we're really strange, you know, whatever.
I still run, still make a lot of money over in the crypto and I've been making a lot of money over in the ETFs but I've been doing it for the most part in two different directions until just very recently where the stock market seems to be doing all right and the crypto seems to be faltering here, maybe
it's gonna go to negative correlation in the future here, I don't know.
But I just keep running the indicators and putting the positions on and don't worry about it too much.
I see, so you're making frequent adjustments to the weighting in your portfolio depending how the correlations change over days, weeks, months?
No, I'm using roughly one year concepts of how fast each of the strategies move and I tried, they move in up and down directions so they have positive periods, negative periods.
I roll all that together into just the absolute volatility of all of those and I try to roughly balance them so that I'm maybe trading 50 % of my equity over in sector timing, I think I've got right now but I'm using a half of 1 % risk and 0 .3 % of equity volatility on my futures trading on 100 % of the equity
because I only use a very small amount of the equity for my futures trading and then I have similar types of exposures for my crypto.
Each one has its own exposure levels of the total equity, which changes daily to try to know what my position sizes are gonna be for each one of those strategies and that's how I kind of balance it to the best of my abilities.
It's never perfect but if I can get it into the ballpark, that's enough.
In a previous interview, you mentioned that correlations between world stock markets have gone up over the decades.
Why do you think this has happened?
Happened through computers.
Back in the day for me in the 1970s to trade a Japanese stock would have been you'd have to be a billion dollar manager with a staff of who knows how many and some of them might need to speak Japanese.
In today's world, everything's computerized, place like IB or wherever you could go in and just sign up for some of the data feeds from the Singapore exchange or wherever and off you go and you can just put it into the computer.
You don't have to speak Japanese or German or anything else back in the day.
It was very complicated to do international trades but now it's just easy and so what happens now you tend to have New York, let's say has a dramatic 500 point down day on the Dow.
Well, no surprise I guess, Tokyo opens up down 3 % or 2 % or something and Singapore opens up down 1 .5 % and Hong Kong and then you get over into Europe and they're all down and then you get back to New York and start the whole thing all over again and it's just kind of everybody's going in the same direction.
It's just a matter of how much so the correlations keep creeping higher and higher and there's plenty of people out there that would try to do some time arbitrage and if one's down a lot and the other one's not down so much maybe they're trying to sell one by the other and driving them all together
into even more correlations.
So there's lots of different strategies and games out there that are being played and with the thanks to computers and the fact that the Electron going through the internet doesn't really care whether it's a Japanese trade or a German trade or a UK trade or a New York trade it's all the same and the computers
can do it. So it's gotten to be a very highly correlated world out there in the stock market.
Yeah and one of the interviews you showed a chart where surprisingly the Japanese stock market was one of the least correlated of all the world markets.
Do you frequently get into the Japanese stock market long or short as any interest?
I use some of the foreign ETFs and I do trade the Japanese yen as a currency as one of my futures position so I get exposure to Japan.
I find in retirement if I were to trade stocks and I don't have yet the automation level that I would like to see on stocks to get me thinking about it again.
I just find ETFs so much less time consuming because if I wanna buy tech stocks for instance I could try to go in and buy the seven top guys that everybody knows about.
I could just as easily do XLK as a spider and get exposure to all of those plus a whole bunch of other ones and I can do one trade in a highly liquid vehicle and I can just track that, automate it, no problem.
To get involved with an individual stock and deal with earning surprises and all the different things as a retirement program I would have to bury that corporate risk within a lot of positions, keep track of a lot of things, deal with a lot of data and it would just take me longer each day to do my
work and I'm not sure I might have the potential of making more money but making more money to me is not my main motivator for doing what I do.
Mine is protecting my retirement portfolio, keeping my return to risk high, not return, return to risk and that's very important distinction.
There's a lot of traders out there wanna make as much as they can and that's fine.
If that's their puzzle they're trying to solve then go at it, that's not mine.
So I design everything I do to suit me and I just don't find individual stocks.
So when you get into Japanese stocks that's another whole layer of slight difficulty.
I could do it, I know how I would go about doing it if I wanted to attack that problem but I think it would just take more time than I wanna waste sitting in front of the computer.
Right, so you design your strategy and portfolio to be a little bit more simple that can fit within your lifestyle.
Exactly right. I think every trader should do that.
If you wanna sit there all day and day trade and your lifestyle lends itself to it and that's what you wanna do, go for it.
I don't ever say that anybody day trading or anybody doing any particular type of trading is a bad idea.
I just see a lot of people, for instance, a lot of people wanna try to copy tongue and I look at what I'm doing and I ask them a few questions.
How big's your portfolio?
Well, that's $30 ,000.
Okay, I'm trading millions and you're trading 30 ,000.
What in the world would make you think that you can simulate what I'm doing in a $30 ,000 portfolio?
Why don't we design, I try to help people but I try to get them to think realistically about what are you trying to solve here?
You can't do what I do with $30 ,000 but there are things you can do with $30 ,000.
So why don't you design something that fits your situation and your expertise?
I mean, I know things that other people don't know.
I'm an engineer by background.
I've got a math background.
I've got a computer background.
I'm retired. I have a good size portfolio, portfolios actually.
And there's not another person in the world that is exactly the same as Tom Basso.
And likewise, if somebody was trading a $30 ,000 portfolio and turned it into a $60 ,000 portfolio because they're so brilliant and they had a great strategy, I'm not likely to copy them because it doesn't fit what I do.
I don't wanna spend that amount of time or I don't want to, I'm not shooting for those big returns and the volatility that goes with it sometimes.
So I'm a big fan of saying sit down and write down your objectives, your financial puzzle.
What are you trying to really accomplish with your trading and design what you do to fit your lifestyle, fit your expertise levels, fit your portfolio's size.
Once you do that, then execute the darn thing flawlessly and life would be good.
You'd be a lot more Mr.
Serenity's out there floating around the trading world than there are these days.
Your study that you did at Transtat some number of years ago, you noticed that just two trades made the difference from a breakeven year to a significantly profitable year.
So the question I have is how do you find these two trades and what keeps you in the trade instead of reducing or eliminating the size due to your 20 day volatility screening process?
Okay, that's a fair question and pretty good one.
It's got a couple of parts to it.
The first thing is you don't know that that trade is going to be one of those top one or two trades that you do all year.
You end up thinking in terms of statistical sampling.
So I fond of saying your job as a trader is to do your next 1000 trades.
And there's a couple aspects to that.
First, it helps you think in terms of finding those two out of the 1000 maybe, or out of the 500 or out of the 200 or whatever number it takes to get to those two or three or whatever trades are gonna pay for your profits this year.
By doing a large sample and doing a larger sample, larger sample you can get to, you increase the odds of finding those one or two or three that are gonna be the big winners.
The other thing it does is it de -emphasizes in your brain and your emotions the importance of any one trade.
By putting out a Japanese yen and I don't know that the Japanese yen is gonna go 75 to 150 against the dollar like it did back in, I think it were, was it 150 down to 75?
I forget, it's been so long, but back in 1997, I think it was, there was a major move.
I mean, the face value of the yen went in half, I think, or something.
When you have a situation like that and you're trading currencies as I was then at FX, you're gonna have the potential to make massive sums of money because of the leverage and everything.
You don't know that that's gonna happen when you put the position on.
So you just are following, you're getting that next data point in the next 1000 trades and off it goes.
But the other thing that it does for you, once the yen does start moving your way and the position starts becoming very profitable, the second part of your question was a good one because how do you manage that?
And that's why I wrote the book, Successful Traders Size Their Positions, Why and How, because I took the exact algorithms we used at Trendstat and I still use today to not only size my position appropriately out of the gate on the trade, so when I put the first position on, I've got it properly sized
according to what I believe works for me at least.
And then there's the ongoing position size and I track that every day and I limit that to a certain risk of equity and a certain volatility of equity.
So as markets get insane, as the risk gets higher, I'm peeling off part of that position to maintain a proper exposure in the portfolio.
So I don't let, say, if you think about somebody that bought Amazon in their stock portfolio way back when when it was, I don't know, $20 or something, and they just held onto it and they didn't change their position size or do anything.
Well, right now, if they had a stock portfolio, they'd have an Amazon position and everything else and their portfolio would be dominated by Amazon.
So if you don't do anything different, what you end up with is not a portfolio anymore.
You have one big position and a whole bunch of other non -important stuff.
That's not the way to run, to me, a logical, diversified, protected portfolio.
You have to continue on the job managing your position sizes and trying to maintain exposure in some kind of a sensible way across a portfolio.
And you can choose to do what I talk about in the book or you can come up with your own.
There's lots of different ways of measuring equity.
I like market to market equity.
Some people like what's called core equity, which is after all your stops are hit, your basic amount of cash that's gonna be left.
There's lots of people that just use realized.
So there's lots of different ways to slice it.
But I think in the end, to not have any way of managing your ongoing equity is a problem because like that Japanese yen trade we were talking about, it would become a portfolio of Japanese yen and 20 other things that don't make any difference anymore.
So by keeping them balanced, you can stay balanced.
Excuse the last interruption here.
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I'd like to transition to psychology.
I noticed that you're a follower of behavioral economics.
Yeah. There's lots of different schools, subtleties in economics and most economists, I think, generally speaking have a hard time predicting anything, particularly the stock market.
So I'd be very careful using economics and trying to decide whether you should go long or short.
A good example right now, I feel like this economy in the US right now, as we speak in this interview, is looking like it could get really shaky really quickly, but here the stock market's making new highs.
And so thank goodness I've separated my economic brain from my trader brain, and with trading, I just do what I'm supposed to do and I don't worry about it.
So I've had a nice run here to the upside, but I would have thought going a month or two ago, just seeing what was laying out in the world, the war's breaking out, everything, I figured, boy, this would be a tough period economic -wise.
But what I do with the economy, to try to get a little bit more of my personal planning of what I'm trying to do with my own personal life and be prepared for what might come up, is I look at behavior of any economic decision that the government fed anybody else that would try to make, what would be
the likely behavioral reaction of your average citizen, or if they're, let's say, taxing the rich, what would be the logical reaction from the rich?
Whatever happens out there, behavior in the end will drive that economy.
So if you can try to pay attention to any kind of economic decision or policy or debate that's going on in Congress and ask yourself, what would be the logical behavior reaction of the population in general, you'll probably be able to tell what will happen.
The reason, say, the Laffer curve, which people badmouth sometimes, I mean, it was the, I think the standpoint or the critical underpinning to Reaganomics where you cut taxes, well, what would be the logical reaction?
Going into the cutting of those taxes, we had the very excessively high tax rates and people were doing tax shelters, stupid investments just to save tax money.
And the investment would be driven by the amount of savings they can make on their taxes, and of course the IRS would go after the shelters, some of them would fall apart, there'd be penalties.
There was a lot of wasted, nonproductive to the economy effort just to try to get away from taxes.
So enter Reagan, cut the taxes, take interest rates up to knock down inflation, inflation gets reasonable, taxes are a lot lower, well, there's no motivation to go find a tax shelter now.
So might as well like buy the stock market or put up some money in a new offering because it looks promising, they've got a new drug or they got a new invention, let's take a chance there, people are starting to make money, people are starting to trade those stocks, taxable consequence.
So with a lower tax rate, revenues to the government actually went up, not what you would expect when you cut tax rates, why?
Because people behavior created an environment where because it's a lower tax rate, I'm more likely to do a taxable consequence transaction because it's not gonna hurt me so bad.
And so that's the kind of concept of thinking through how people react to the reality of the world out there.
And as you change economic policy, what effects that gonna have on the human psyche and what they're gonna try to react to because people are always gonna try to maximize their own economic utility.
If taxes are lower than, hey, maybe you trade, you day trade, you don't have to worry about anything.
I mean, if taxes were zero, you could just do taxable consequence transactions anytime you wanted.
If they're minimal, you're not gonna make that a dominant part of your psyche, but if it's 90 % tax rate, if you start taxing the wealthy at 90%, they're gonna go out of their way to move money out of the country.
They're gonna go out of their way to not do taxable consequences and it will actually hurt government revenues.
It will not help. They'll do respect to the Keynesians out there and some of the idiots, economic minds over at the Wall Street Journal or the New York Times especially.
I just shake my head at some of the things that come out of their mouths.
Mm -hmm, so you've talked about in the past viewing your life as a movie and you had a sticky note on your computer reminding you about awareness.
How has this viewpoint and greater awareness helped you in your life?
It's helped me because it allows me to choose to be as emotional or non -emotional as I wish to be in any moment.
If I wanna get mad, I can get mad.
If I wanna be excited and celebrate, I can do that too.
But if I wanna also realize that when I'm trading and I've got winners and losers on the screen, I don't wanna obsess either way.
I wanna be more even -keeled because I wanna be logical.
I wanna run my strategies.
I don't want to have my emotions high and low all the time.
It's exhausting. So by being aware any way you can do it, for me it was putting the sticky note there and having an alarm go off.
And then I would ask myself, was I aware just now?
And if I wasn't, I would sort of do an assessment of what was going on in my head that moment.
And what was I thinking of?
Was I totally consumed with doing something and not thinking of how I felt or how nervous I was or was I nervous or was I a little too enthusiastic?
Was I a little too depressed or anxious or any other type of emotional state?
By getting myself back into the awareness mode, what ends up happening is you start calming yourself down into a steady state a little bit more when you're doing something like trading.
And that's a great way to be because then you see some setup and you want to go along, but then at the same time your neutral brain says, okay, well let's assess the risk.
Let's see what the reward is.
Let's make a logical decision.
You don't get yourself excited or depressed or anything.
You keep yourself even healed.
And if you ever notice yourself not being that way, you get yourself back to that mental state.
And so I encourage people to increase their awareness.
I think it'll help in your interpersonal relationships with other people, try to be sensitive to what they're going on with their lives and helps you react to them better.
And I think life just gets better.
So in a way, it's like cultivating this awareness in ourselves helps us to fill in the emotional potholes that come up in our life, right?
A little bit, yeah, because a lot of those are caused by just, I don't know, you just took a loss and wiped out 25 % of your portfolio and you're crushed.
You're so crushed that there's another trade set up that just set itself up and you miss it because you're still being crushed and you don't know what to do.
You're frozen. And now all of a sudden you just missed the best trade of the year because you weren't neutral and just saying, okay, let's take the next trade and keep going, don't worry about it.
So yeah, the emotional swings you get in life can be dramatic.
I mean, it can cause things ranging from depression, suicide to bipolar behavior, that manic depressive, go swing to the enthusiasm side, to the negative side and all over the place.
And I don't think that's a great way to live your life.
Yes, indeed. Well, to wrap things up, I really enjoyed the quote that you shared last August to celebrate your 71st birthday.
Sit tall in the saddle, hold your head high, keep your eyes fixed where the trail meets the sky and live like you ain't afraid to die.
Don't be scared, just enjoy the ride.
Tom, thanks for coming on chat with traders.
My pleasure. How can our listeners get in contact with you and where can they find your new book?
Well, a new book is in all the different popular bookstores, the Amazons, the iBooks, all those things.
The website is enjoytheride .worldnot .com and has a lot of free information for traders on all sorts of things.
A copies of various interviews I've done over the years are on there, you can listen for free.
I got book recommendations.
I have my explanation of my hedging strategy if you want to be more curious about what I do with hedging.
Just a lot of information there, go and take some time and wander around and enjoy the read instead of the ride.
Probably the most people find me on social media on Twitter, I got like almost 52 ,000 followers on Twitter at at basso underscore Tom, be careful, social media.
The guy like me, that's got a lot of exposure, gets tons of impostors.
Do not ever buy anything.
I don't sell anything by direct message.
I don't want your crypto business.
I don't want you to invest in a charity that I'm sponsoring or something.
I'll do that elsewhere if I do it anywhere.
Just be careful, I've had friends scammed by thinking they were talking to me and they weren't.
So I try to do what I can to get rid of the impostors but I appreciate anybody out there pointing out some of my impostors so that I can report them to the authorities.
I'm also on Facebook and LinkedIn pretty heavily and that seems to be an increasing part of the people following me, but that's pretty much it.
I also have a sub -stack.
I kind of write some articles when the mood strikes me as I have something I want to say, I'll put it on sub -stack and send it out to the sub -stack list so you can subscribe to my sub -stack publications and you'll get it into your email if you want it.
So there's lots of ways.
Great, thanks, Tom.
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