The following is an exclusive excerpt from The Inner Voice of Trading: Eliminate the Noise, and Profit from the Strategies That Are Right for You
One of the most expensive errors I’ve ever made, but also one of the funniest, occurred in the early 1990s. An extreme heat wave was just sitting on top of the Great Plains, home of the majority of states growing wheat deliverable against the Chicago Board of Trade (CBOT) contract. Wheat as a crop is a total wimp, but soybeans can take more extreme conditions. Too much moisture for too long, and you end up with a rust fungus. Too much heat, and the arid conditions or drought kills off the crop.
Two weeks before the July 4th weekend, the heat was brutal. I was long on wheat in modest amounts in all my commodity accounts and was making all the money I could dream of as the fear of damaged crops drifted and crept along the floor of the CBOT. As we came in to the last trading day before the holiday weekend, I was sure the contract was going to sell off. Most of the traders on the floor would take their gains and go home with no open positions. Everyone in the market was long on wheat, and all they needed was one sprinkle or break in the heat over the holiday weekend, and the contract would have traded down its allowable limit (the maximum it can trade in one day).
The contract had moved about 80¢ ($4,000 per contract) over that two-week period of time, and I had already taken decent gains out of the long trade. Now I was going to test my knowledge of how the floor acts. Obviously, I thought I could take on the traders in Chicago looking at one another on the floor from my desk in Manhattan. I decided that going short would be the play, as a deluge of selling would surely hit the tape in the last 30 minutes of trading; we’d be good for at least 5¢ to 10¢ of downward pressure. My reasoning was that anyone who was long would have already been long. No one would be initiating new long positions before a holiday weekend; there was too much uncertainty. If one floor trader started selling, I figured they’d all pile on and sell.
My risk on the short sale was 2¢ above my short entry, and I was figuring on as much as 5¢ to 10¢ of profit if the contract sold off like I thought it would. So I called my floor trader and sold 50,000 bushels of the July contract with about 30 minutes left in the trading day. But nothing happened, and the selling didn’t show up.
The wheat market, like all commodity markets, is a living and breathing mechanism. The sum total of all commodities trading in wheat will give you its pulse and vital signs, not just for one month, but for all the expiration months. I was about to learn this. What I didn’t notice was that the floor was selling a deferred month’s contract short—in this case, the December contract—to establish a hedge against the long July contracts. That’s why the July contracts were not depreciating. The floor traders were selling heavily, but not the contract I thought they would sell, and it was all happening under my nose.
In the end, they had created a spread position by being simultaneously long the July and short the December contracts. (In a short sale, you can make money when the instrument declines in price. In this scenario, the professional traders had two contracts in their portfolios of the same commodity over the weekend: They kept their July contracts long but sold the December contract short, in the event that something negative happened. The losses would be offset by the short December contracts. With this strategy, traders wouldn’t get hammered for large losses by being long only the July contracts.)
I was so emotionally invested in making a quick 10¢ that I had neglected to look at what was happening in the entire wheat market, not just the front month. (The front month, also known as the near month, is the first contract for expiration that you can trade in the current calendar.
Contrasts with deferred month, or deferred contracts, may be many months away from the front month.) With six minutes left in the trading day, my strategy did not play out.
We weren’t losing anything, but the beer at the South Street Seaport had sharper selling than wheat did in Chicago that afternoon. I called the client and said, “Nothing’s doing. Let’s get out and come back next week.” The client said, “You’re right. Let’s just sell it.” Time was of the essence, as we had five minutes to the close of the market. With my wheat trader on the phone in my other ear, I said, “Sell 50 July Market.” “Sold,” he screamed back into my ear. Then came a moment that can only be expressed as the cartoon scene when Wile E. Coyote is trying to blow up the Roadrunner, and he’s got the live grenade in one hand, but he’s got the pin stuck on his finger of his other hand. He says, “Stunning! Isn’t it?”
realising that the grenade was about to go off—which it eventually did—I saw that I had not “covered” or offset my 50,000 bushels with a buy order. I had actually doubled-down and was now short 100,000 July wheat contracts with about five minutes until closing.
We weren’t allowed to call the floor in a panic and undo error trades, which would have been the smartest and least painful thing to do. No, we had to go to the operations desk and get someone with Commissar Authoritarian Wisdom to electronically journal the trade to the firm’s error account and then offset it there, all while the market was still moving, but nearing the close. This gave me great motivation to run as fast as possible to the operations desk. In a moment of hilarity, I ran like heck from my desk and turned the corner, blowing past the men’s room and the front door to the office, a blind spot where a gentleman was walking through the front door. I took him out with an open-field tackle reminiscent of the late Oakland Raiders defensive back Jack “The Assassin” Tatum, and kept going. I had no time to stop to see his strewn papers still floating in the air like that bird feather at the beginning of the movie Forrest Gump.
I got to the operations desk, and the person who had to help me was smoking and talking on the phone, with her back to the window. I pounded on the bulletproof glass to get someone’s attention, and she slid the window open and said, true as God, “My daughter just broke up with her boyfriend. I’ll be with you in a minute.” I went from being a confident grains trader to an actor cast in a David Lynch movie. My life had been reduced to a scene from Twin Peaks in less than five minutes. We did all the journaling, and in the end, it cost me about $1,200.
Some of it was to pay for the error on the trade: We had to make the client whole and give him the buy price at the time of the error trade to cover his short position, and I had to offset the loss to the firm in the error account.
This $1,200 error was my tuition for an important lesson. If I was going ahead with the late short sale, I should have written down the order, repeated it to the client, checked it against the existing position on the books, and finally called it in to my trader. I had become cocky because I’d had a great two weeks of trading.
Being cocky is an emotional problem, not a technical one. In the overall scheme of things, I should have gone to cash at the open and taken half a day. I could have read a good book on the train to Spring Lake.