11 Questions with Market Wizard Tom Basso
The keys behind building an adaptive trend-following system.
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We take a deeper look into the process and mental make-up of Tom Basso, a market wizard featured in Jack Schwager’s “The New Market Wizards” who has automated his process to a point that emotions are removed from the equation:
Tom Basso is an Engineer by profession and was president and founder of Trendstat Capital Management. Along with authoring several books, he currently runs Enjoytheride.world, a website dedicated to trader education.
What does your Daily routine look like?
Up at around 6:30am. Some days decaf in bed, checking the overnight prices, messages, emails, etc. Breakfast with Varney and Company at about 7:30am. About 8:00am (an hour and a half after stocks open) I wander down to the office and fire up the screens and browser. Check out any overnight trades to make sure my positions match the broker's positions on my accounts. That takes maybe 5 minutes, unless there's an issue.
Next, clear out overnight emails, answer questions, clear out social media DM's and responses to my posts. Now at around 8:30am, I finish at least two Spanish lessons on Duolingo. I'm up to 700 days straight of Spanish lessons. Living in Arizona with an open border to Mexico down south, it's come in handy a few times already. About 10am or so I have an open slot in the day where I either work on projects at the desk like my new book coming out in the 1st quarter next year or I head to the gym and work out or I work on projects around the house. About 12PM is lunch for maybe 30-40 minutes.
At about 1am Arizona time (close of the stock market) I'm back at the desk running my "afternoon exam." I run 8 strategies daily and a ninth intraday, if I'm sitting at the desk. It currently takes me about 1 hour and 15 minutes on a typical day. I can be an hour on a good day and 1.5 hours on a tough day with lots of trades or order changes. With the help of a developing trading platform that I have been consulting on, I hope to get that down to 15 minutes.
The rest of the afternoon, I leave intentionally open for interviews, projects, working out if I haven't worked out earlier or golf. Dinner later, relax and asleep by 10:30pm.
How do you go beyond being interested in a name to actually buying it - What specifically do you look for with regard to price and volume before buying a stock?
I don't currently even look at individual names in stocks. When we did back in my Trendstat days, we screened on things like average volume, capitalization, institutional ownership and positive net income.
Individual corporate risk in any single issue has gotten completely out of control with + or - 20% moves on gap openings. Hard to control the risk or position sizing with that going on, so I use 30 sector ETFs for my equity exposure and bury that risk across a portfolio within the ETF. Much less time for me to manage that in retirement.
How much of your total equity do you risk per trade and what is your average position size?
On the futures side of things, I use a 0.5% risk/equity limit on initial positions and 1.0% risk/equity on ongoing positions. I also limit initial positions to 0.2% volatility (21 day ATR) / equity and limit ongoing positions to no more than 0.3% volatility/equity. I cap total portfolio risk to 17% risk/equity currently with the current mix that I have.
I caution readers to set their own levels realizing that higher ratios lead to larger positions and more dangerous movement in the portfolio and lower ratios lead to smaller positions and less dangerous movements.
On ETF trading, I look for 0.5% risk and 0.3% volatility to equity ratios for new positions and 3.0% risk and 0.7% volatility to equity ratios for ongoing positions. I cap ongoing total portfolio risk to 15%. Start low and work your way upward until you reach your own personal comfort zone. Details on the formulas in my book “Successful Traders Size Their Positions - Why and How?” - available many places.
I definitely do not commit the same capital to each sector. First I set the buy and the sell stops, I then calculate the risk per one unit of that instrument, then calculate the position size. This is not what most traders do. I find most traders set their position size, then set their stop based on the risk they can tolerate. That would be backwards in my opinion and will lead to far more erratic performance
What do you do when you have a series of losses - what adjustments do you make to your trading to recoup yourself and fight the urge to overtrade?
With my position sizing method, that takes care of itself. No matter whether my equity is up or down, the positions are always sized for that amount of equity. No more or no less. I don't love drawdowns any more than the next trader, but they are part of the process of trading and you have to keep on making your next 1000 trades to capture your edge. During the drawdowns, my positions are automatically sized smaller. When making new equity highs, they are sized larger for the increased equity.
How do you manage successful trades - what constitutes a sell signal for you and makes you decide between selling into strength vs letting your winners run?
I'm basically comfortable with trend following and have been for about 50 years now. So, I don't sell into strength with respect to my indicators. I move the stop losses behind the move and eventually am stopped out good till cancelled. I do measure ongoing risk and volatility and if the stops have not moved as much as the market has moved and the % risk/equity or % volatility/equity gets above my set points mentioned earlier, I "peel off" enough of that position to bring the position back into my tolerance levels. Other than that, I simply let my positions run as far as they have the ability to do so and move the stop orders when I can.
How do you know when your strategy may be broken versus just being out of favour with the current market?
Broken strategies are found when they do something that you didn't design it to do. Your design should look at up, down, and sideways markets. For example if you are buy and hold long stocks and the stock market goes down 50%, and you lose 45%-60% of your equity, that would be expected and the strategy is not broken. Nothing to fix there. If you are timing using a 20/100 day moving average and the stock market goes through a sideways period of 1 year and ends up unchanged for the year and you are down 10-15%, that's also to be expected with the whipsaws. It's not broken, so don't try fixing it.
One time, I had a strategy that had very favorable conditions and I made some 40%, when I would have expected about 20% in that year. I knew something was off, investigated and dialed back the position sizing to bring it back to where I wanted it to be.
It comes down to your objectives for each strategy in terms of risk, volatility, sensitivity and time periods. If it is doing what you expected during the conditions that have existed, then it is not broken, so don't be fixing it.
What were your hardest obstacles to overcome to become a successful trader?
Yourself. The markets will definitely try to find your weaknesses and cause you to screw up whatever your plan is. Taking self-responsibility to examine your own mental psyche is the first thing I would think about. Self-awareness would be next. With self-awareness, you can be more disciplined, because when you are aware of you deviating from your well thought-out plan, you can put yourself back on the plan.
Keeping a balanced mental state is next. Throughout trades from start to finish, you need to be aware of days when your mental status is not perfect for trading. You don't want to be too excited, angry, depressed, greedy, self-absorbed or anything else.
You don't want to be biased up or down on the markets. You don't want to be obsessed with predicting what will happen next. YOU DO WANT TO BE NEUTRAL and be prepared to deal with whatever the market throws your way.
What was the "aha" moment in your trading career?
Several moments. The first was that what indicator you use to get on board a trend doesn't matter that much and that's what most new traders spend their most time researching, just like I did back in the day. Most trend indicators of similar time periods will signal direction changes at about the same point, so don't obsess over that.
Next, I realized, through testing, that good position sizing method has more of an effect on return to risk ratios than the indicators that get you into and out of the trade. Making sure every position in the portfolio is properly sized and contributing to the profits and losses smooths performance and keeps drawdowns more in check. That improves your return to risk ratios and helps to keep your trading psyche more balanced.
Third one was realizing that you don't need to trade just one strategy. By diversifying into various markets, various time periods, various instruments and various indicators, you stabilize the overall portfolio, improve the return to risk ratios, and help to stabilize your trading psyche.
Were there ever times that you deviated from your discipline? What caused you to lose focus? How did you get back on track?
The last time I deviated was when my parents were visiting some 45 years ago. I let my daily process slide and caught up with it after they left. I realized that I had missed a trade that would have been my largest profit of the year. I then decided that that was never going to happen intentionally again and I've keep that promise to myself. I simply never deviate, no matter what the news or price movement.
What are your top 5 trading rules?
Have a logical way to screen your universe in question down to a workable number, then have a way to rank those if you end up with too many trading candidates.
Pick a Buy/Sell engine that is over the time period you want to exploit. Don't obsess over it, but make sure you understand the math it uses and understand its strength and weakness.
Have a sensible way of sizing your positions. Keep managing the position size throughout the life of each trade.
Have a way of sensing you mental state, and work on the ability to change it to a more balanced mental state.
Have contingency plans for when things are normal. What happens when the internet goes down, the phones go down, your child is sick at school and needs to be picked up, or when you get a phone call with some other emergency situation.
What advice would you give to new traders?
Save as much as you can to increase the size of your portfolio as much as possible. Larger accounts have so much more of an advantage in diversification, position sizing and cost structures.
Start small and get experience with real time trading before making mistakes with larger portfolios.
Don't predict what will happen. Let the market does what the market does and go along for the ride.
Systematize as much as possible of the repetitive, routine work and save your human brain for the creative things in trading, like decisions on new trading strategies, deciding how large and exposure to any one market you wish to take, or how you are going to get through the process each day.
Check Tom Basso out on:
His personal website - which provides books, seminars, computer tools and videos to help traders develop their own successful trading strategy.
Panic-Proof Investing: Lessons in Profitable Investing from a Market Wizard
The frustrated investor
Books regarding Tom Basso:
Huge thanks to @basso_tom for this opportunity! A truly generous individual who was very willing to help out.