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THE OPTIMIZED TRADER


The Godfather Rules Of Trading

08/08/07 02:05:48 PM PST
by David Penn

Everybody wants to give you trading advice. How about some advice you can't refuse?

There's a lot you can learn from watching mob movies. Want to know how to make red sauce good enough for 18 hungry gangsters holed up in a cold-water flat across town? Or how to remove roadkill from the grill of your car using nothing more than a butcher knife from your mom's kitchen? The mob movies will tell you. Want to know how to con a salesman into thinking you actually know something about top of the line diamonds and jewelry? Or convince some bigshot's lady friend she'd look better on your arm than on his? Forget asking Dr. Phil. The mob movies will tell you.

Who knows exactly why mob movies so effectively capture the imagination of audiences across the spectrum -- rich or poor, black, brown or white. But when you look at classic mob movies, the ones that have stood the test of time, it is easy to see why -- as films if not as paeans to the gangster life -- films like The Godfather, Goodfellas, Donnie Brasco, and Scarface continue to mesmerize and even, in their own crooked way, actually inspire. Classic films -- like classic art -- are classics in part because the moral struggles they reveal often mirror in some way the moral and ethical struggles that challenge regular people in everyday life. And while not everyone is trying to manage a multimillion-dollar criminal enterprise -- or even just the gang of low-life knuckleheads stealing change out of parking meters -- everyone at one point or another finds themselves caught between independence and commitment, between fear and greed, between loyalty -- to family, friends, goals, ideals -- and betrayal.

And in this, traders are no different from anybody else. It could be argued that fewer regular Joes and Janes experience the drama of fear and greed, the emotions of loyalty and betrayal more frequently than the average man or woman who sets out to trade the financial markets. Whether you are managing millions or just trying to keep your own low, five-digit trading account above water, as a trader you regularly experience the same kind of issues and dramas that drive anyone making money off of what essentially amounts to a bet, a gamble that if you turn the cards enough times -- and know when to leave the table -- life can come out aces.

So with that in mind, I provide my fellow traders and market technicians with what I call the "Godfather Rules of Trading." See if you don't find more than a few parallels between the sage advice of cotton-mouthed mafiosos and the trading shibboleths we would do well to never forget.

OFFERS YOU CAN'T REFUSE
Scene and context: The classic Godfather line is first uttered by Marlon Brando as Don Vito Corleone looking to do a favor for Johnny Fontane, the Sinatraesque crooner desperate to convince a jealous movie producer to give him the lead role in the "new World War II pic." Rising star Michael Corleone (played by Al Pacino) uses the same phrase when looking to do some persuading of his own during his bid to move the Corleone family business from the Big Apple to Las Vegas.

Moral for mobsters: When the Don asks for a favor, it is best to take the first offer.

Trading truth: There are a number of trader translations of this idea. The first one, to quote David Nassar from his presentation Foundational Analysis, is that there are times when markets can be traded and times when markets must be traded. The former should often be avoided. But the latter represents a sort of "offer you can't refuse" from the market. When a market makes a breakout on overwhelming volume, when a market makes a low and then fails to follow through to the downside and instead closes above recent highs ... these all represent "offers" that you, as a trader, cannot refuse, cannot ignore, and hope to become successful with.

Trader Oliver Velez Jr. once put it this way: "Your job as a trader is to buy every dip. Not a few of them. Not some of them. All of them. The only question is when." The idea is the same. The market is the provider and arbiter of all opportunity. The market, in this sense, is the Don. And when the Don makes an offer, if you're in the "muscle" end of the business, then it is often a matter of self-preservation as a trader not to refuse.

INSIST ON HEARING BAD NEWS IMMEDIATELY
Scene and context: Tom Hagen, Don Corleone's counselor or consiglieri (played by Robert Duvall), has failed to convince famous movie producer Jack Woltz to give the lead role in the new "war pic" to the Don's godson, Johnny Fontane, a singer and actor who Woltz accuses of having stolen away his best young talent (read: young starlet prefers suave crooner to over-the-hill movie mogul). Hagen abruptly ends his dinner when the director emphatically turns down the Don's final offer. "Perhaps you could arrange for a car to take me back to the airport," Hagen announces. "My employer insists on hearing bad news immediately."

Moral for mobsters: The sooner you know the bad news, the sooner you can take action to either correct it or keep it from becoming worse news. Being surrounded by those who fail to tell you what you need to hear -- and promptly -- instead of what you want to hear is a sure road to getting not just inaccurate information, but the wrong information.

Trading truth: Trade what your technicals tell you, not what you want your technicals to be saying, or what you think they might be saying if such-and-such were happening instead of what is really happening. If your technicals tell you it is time to take a position, then take that position. If your technicals tell you there is trouble ahead, heed that warning and lower your exposure.

The idea of "hearing bad news immediately" is related to the idea of cutting your losses short. Losses are the only bad news that count in trading, and being able to recognize them as such and to react to them swiftly and appropriately is the signature of a trader or investor who is in control of his business, rather than being led around the nose by it.

NEVER TELL ANYONE OUTSIDE THE FAMILY WHAT YOU ARE THINKING
Scene and context: Michael Corleone's brothers, Sonny (played by James Caan) and Fredo (played by John Cazale), are at different times admonished for speaking out of turn, a major faux pas of mob morality. Sonny does so during a meeting with Don Corleone and his rivals, and Fredo, unfortunately, takes his misbehavior to new heights by admonishing newly appointed Don (and younger brother) Michael for Michael's tough stance taken toward Fredo's most recent benefactor, casino tycoon Mo Green. Don Corleone warns Sonny never to tell anyone outside the family what you are thinking. Michael ends up warning Fredo never to take sides with anyone against the family again.

Moral for mobsters: Family comes first (and second, and third, and fourth ...). There is nothing more important than loyalty.

Trading truth: For the trader, the family also consists of real, flesh-and-blood loved ones from whom no trading secret should be kept. But traders also have another "family" that includes their trading methods, trading tools, and even trading partners if they are working and trading collaboratively. But more important than the trader's family is what the trader's family is not. The trader's family is not the guy on the airplane sitting next to you. The trader's family is not the smart-aleck brother-in-law who you'd love to take down a peg by regaling him and anyone else in the vicinity of your trading prowess, acumen, and/or accomplishments. The trader's family is not the coworker in the next cubicle whom you constantly hear cursing himself for buying or selling the wrong stock at the wrong time.

"Tips," as Jim Cramer, former hedge fund manager, trader, founder of TheStreet.com, and host of CNBC's Mad Money television program often says, "are for waiters." In the long run, there is little to be gained by aspiring to be the fount of free trading information. While it is tempting to impress others with your knowledge of what remains a relatively esoteric field of endeavor to most people, sharing your wisdom not only does nothing for your own trading but can expose you to hard feelings when you are wrong as well as uncomfortably fond feelings when you are right.

If you've got a great idea, then write a book. Start a blog or an investment newsletter service. By all means, let your significant other know what you are doing with what is often the family's money. But your disclosure requirements as a trader end there. Let everybody else read about your great works in the next edition of Market Wizards or when you make the cover of Forbes.

A WARTIME CONSIGLIERI
Scene and context: Michael is taking over the family business in the wake of the assassination attempt on his father, Don Corleone, and the Don's impending convalescence. Part of Michael's reorganization includes removing Tom Hagen as family consiglieri. "You're not a wartime consiglieri," Michael tells Hagen frankly, as he reassigns him to other responsibilities. Hagen has heard hints of this before, when he was rebuffed by Michael's older brother Sonny (who first took over after the Don was hospitalized following the assassination attempt). "Maybe there's something I could do to help," Hagen offers vainly. "Sorry, Tom," replies Michael Corleone. "You're out."

Moral for mobsters: When you've got dirty business to do, you need guys with dirty hands.

Trading truth: Although this was perhaps not the most memorable scene in The Godfather, it does hold a few important points that make sense for traders and for trading in general. Foremost, trading is a tough business, a painful business, and an often-mortifying business. While it is too much to say that trading is like combat, there is something to be said for making sure that as a trader, you have the stomach for the attention and focus that success will require. There is no right to be a trader -- and no responsibility to be one, either. That means if you are more comfortable as a quarter-to-quarter investor, or even a buy & holder of blue-chip, dividend-paying corporations, then be happy with that and get good at it. It probably means you are not ready for the trench fighting that comes with shorter-term trading, the kind of conditions that make a "wartime" -- as opposed to everyday -- consiglieri necessary.

"AFTER ALL, WE ARE NOT COMMUNISTS"
Scene and context: A meeting of the Five Families is held in the wake of Don Corleone's survival of an assassination attempt and the ensuing intramob violence. Don Barzini chairs the meeting, which is largely an attempt to get Don Corleone to allow other dons access to Corleone's political connections. "Don Corleone must let us drink the water from the well. Of course he can present a bill for such services. After all, we are not communists."

Moral for mobsters: More frequently expressed by the mob movie axiom, "It's not personal, it's business," this line is intended to encourage gangsters to keep the dollar signs at the top of the priority list, and not to let feuds and personal rivalries get in the way of making a crooked buck.

Trading truth: If you'll forgive another Cramerism, you might appreciate his point about trading and investing in what might be considered unsavory or even unethical businesses such as oil corporations or tobacco companies. "Take all the money you make investing in Haliburton," Jim Cramer quipped, "and send it to Greenpeace, for all I care." Cramer's point was that investing and trading is about making business decisions, not personal ones. While there are a number of "socially responsible" mutual funds and money managers, Cramer's point is twofold: first, spending too much time ferreting out politically correct companies means missing great trading and investing opportunities in not so politically correct companies, and second, the bank doesn't care which stock you made your money in, and once you've made your money, it's yours to spend -- or give away -- as you choose.

So don't handicap yourself by trying to be a holier-than-thou investor. Buy good-looking stocks that are going up, and sell bad-looking stocks that are going down. If you accomplish that much as a trader or investor, you've got the rest of your time to be as humanitarian as you want to be.

Another worthwhile interpretation of this notion is that trading and investing is a business. It is not a reflection on the trader as a father or mother, as a brother or sister or member of the community or citizen of the republic. It's just business, a business of making decisions to be sure, but those decisions should not be fraught with the sort of existential peril that too many traders attach to them. You are looking to take money out of the market and then go home to the rest of your life. Sometimes it works. Sometimes it doesn't. However much your wins and losses inevitably define you as a trader, they bear no reflection on you as a human being. Big win? It's nothing personal. Big loss? Nothing personal. It's just business.

FIN
Just about every trader worth his or her salt talks about the business of trading, or how traders need to learn how to treat trading as a business. Different traders mean different things when they provide this advice. Some emphasize record-keeping, encouraging traders to keep their accounting straight, while others expand that idea of financial accounting to include mental or psychological accounting. These traders advise keeping trading journals and diaries, the sort of "board of directors" memoranda that can help keep a trader on track when the markets are moving and the rationales for taking and exiting positions grow faint and increasingly difficult to recall. Still others look at the business of trading even more creatively, imploring traders to think of their trading capital not so much as cash but inventory, or the stocks they buy as employees that must turn over (in the former case) or perform well (in the latter case).

But what underlies all of these different conceptions of trading as a business is the most basic notion that traders must take their craft seriously, even if no one else does. I would not begin to suggest that the lives of mobsters -- and fictionalized ones at that -- provide the ideal template for traders looking to bring a business attitude to their efforts. Nevertheless, again, there is something in those dramatized conflicts, those do-or-die situations, that make us say to ourselves as we watch: "That's why you've got to be loyal, that's why you've got to stick to your guns," or "Wow, that was a tough decision. But it ain't personal. Gotta move on."

While it is true that many of the lines and scenes from great movies like The Godfather can contain nuggets of wisdom applicable beyond the world of the film and its characters, I found it interesting to hear about what it took to put those "nuggets of wisdom" together.

The Godfather was a very unappreciated movie when we were making it. They were very unhappy with it. They didn't like the cast. They didn't like the way I was shooting it. I was always on the verge of getting fired. So it was an extremely nightmarish experience. I had two little kids, and the third one was born during that. We lived in a little apartment, and I was basically frightened that they didn't like it. They had as much as said that, so when it was all over I wasn't at all confident that it was going to be successful, and that I'd ever get another job.

In these reflections from Francis Ford Coppola, director of The Godfather and other highly acclaimed films, there is if not wisdom for traders, then perhaps the same sort of doubt, dedication, and longing that all traders -- at some point during their trading career -- feel down to the marrow of their bones. And maybe, the same aspiration toward accomplishment, success, and even redemption.

SUGGESTED READING
Coppola, Francis Ford [1995]. "Francis Ford Coppola Interview," Academy of Achievement, June 17.
The Godfather [1972]. Dir. Francis Ford Coppola. Paramount Pictures.



David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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