The Old School Book Review

The Professional Commodity Trader by Stanley Kroll (1974)

The Professional Commodity Trader, By Stanley Kroll (1974) details the play-by-play action of the many "trading campaigns" of 1970's Commodity Fund Legend Stanley Kroll (1). Without question this book is at or near the top of my list of best trading/investing books. The reason why is simple --no fluff, plenty of practical advice with real world documented applications, and detailed notes & discussions that describe the mental processes involved in his decisionmaking. I have always preferred documentary / non-fiction type books, and this book is as real as it gets. In the Professional Commodity Trader, Stanley Kroll (SK) provides an intimate and candid look at the day to day management of his fund. The book is full of specifics of his personal notes on analysis of positions and quotes from the various discussions he has with his associates, floor brokers (remember-back then you had to call someone to place orders, then wait for confirmations on order fills), and industry contacts.

History must be studied in the context of the time in which it occurred. It’s therefore important to understand the time period this book is dealing with (1971-1973). In August 1971 US President Richard Nixon ended the Bretton Woods Monetary System when he cancelled the direct international convertibility of the United States dollar to gold. This was referred to as the “Nixon Shock.” (2) Markets were quite volatile during this time, and at the time (1971) the biggest fear was inflation, and the 1970s would wind up producing plenty of that!

In the introduction, SK describes this book as “an expose book -- of sorts” and describes the rush of having on a large position: “if sex and excitement will sell a book, this may very well be a best seller. Have you ever been long 100,000 bushels of soybeans, or twenty silver contracts, with the market moving up sharply—and maybe hitting a few consecutive limit moves, too? Sexy and exciting? Well, everything is relative…”

After the intro, SK gets into discussing the seven-month period from late 1971-spring 1972. In that time span he doubled the firm's trading capital. Their most successful “trading campaign” during this phase was in the silver market. In this context, a "trading campaign" is basically a concentrated “attack” on a single commodity market that, in his view, was poised to make a big move. SK had the ability to recognize when a major trend was in its early phase, and it was at that point he would put on his initial position. The campaign then requires managing the position size (either increasing or decreasing the number of futures contracts) as minor trend reactions occur against the major (dominant) trend, providing opportunities to increase (decrease) position size depending on his interpretation of price action (which he details throughout the book).

Other trading campaigns he undertook during this time were in Cocoa, Copper, and Soybeans. In each case, the common denominator of success was: 1) an ability to quickly position on the side of the newly developed dominant intermediate-to-major upward trends, 2) using minor reactions against these major trends to enter positions, and 3) “we absolutely resisted all temptations to trade with the prevailing mass sentiment; that is, to buy on rallies and to sell on declines.”

Chapter 4 is titled "The Most Important Chapter in the Book" and it's obvious why - on pages 27-28 SK crystallizes his entire strategy with respect to timing entry/exit in a few paragraphs, quoted in full below: "

On Initiating a Position:

Trade in the direction of the major dominant trend, against the minor trend. For example, if the major trend is clearly up, trade the market from the long side, or not at all, buying when:

A: The minor trend has turned down, and

B: Prices are "digging" into support, and

C: The market has made a 35-50 percent retracement of the previous up leg.

If the major trend is clearly down trade the market from the short side, or not at all, selling when:

A: The minor trend has turned up, and

B: prices have advanced into overhead resistance, and

C: The market has made a 35-50 percent retracement of the previous down leg

On Closing Out a Position:

A: At a profit. Liquidate one-third of the position at a logical (chart) price objective into overhead resistance (for a long position) or into underlying support (for a short position). *Following this first liquidation, be alert to reinstate the position, or even 1.5 times the liquidated position on a subsequent technical correction, as outlined in the above discussion, "On initiating a position."

B: At a loss. There are, basically, three approaches: 1: Enter an arbitrary "money" stop-loss; e.g., 40-50 percent of the margin deposit. 2: Enter a chart point stop-loss; i.e., to close out the position when the major trend reverses against your position -not when the minor trend reverses (that's just the point where you should be initiating the position, not closing it out). 3: Maintain the position until you are convinced that you are wrong (the major trend has reversed against you) and then close out the first technical correction (obviously, this can be dangerous unless you know what you are doing)."

The rest of the book is essentially an accounting of the practical application of the above strategic framework. For each position, SK lays out his "strategic conclusions, planned tactics (buy/sell decisions) and then a "forensic analysis" of what actually happened. He explains to us the reasons why he does what he does, and why it works or doesn't work. SK consistently excelled at what is probably the most vital determinant of success: the ability to optimize the establishment of positions relative to the trends and price action—but the means to achieving this objective sprout from his core strategy, cited above

Although SK was a “master trader” with the ability to anticipate trends he had his share of losses and failures, and he gives us an honest accounting of why they occurred. What is vital is that he made sure to keep all losses relatively small. No doubt this disciplined approach to trade in alignment with the major dominant trend, and limiting losses on adverse positions was a key to his success. On page 25 SK tells us: “Since 1960, I’ve spoken to hundreds of speculators about their commodity trading. Most of them were consistent losers, many in a substantial way. My final query was always specific: “If you had limited all losses to 45% of each position’s margin, what would your final results have been? The results of my unofficial poll were hardly surprising. In all cases the profitably would have been vastly improved, and in many situations the final result would have been an overall profit.”

Reading the book, I got the sense that SK’s biggest regrets came from missed opportunities. In chapter nine SK tells us “Once again I fell into the trap of selling out a winning bull market position in order to try to rebuy cheaper…” This reminds me of the quotes from none other than the great Jesse Lauriston Livermore (3) who said: “Money is made by sitting, not trading” and “It was never my thinking that made the big money for me, it always was sitting.” SK was no stranger to the ideas of Livermore. In fact, chapter six is titled “And Here’s to You, Jesse Livermore,” and in chapter seven SK tells us the following: “I got up a little early every morning and read portions from Reminiscences of a Stock Operator, by Edwin LeFevre…It’s the most important and valuable book I’ve come across and it has influenced me significantly… (the book) parallels the career of one of the greatest of the Wall St. speculators and financial operators in both stocks and commodities: Jesse Livermore.”

One gets the impression he focused mainly on the technical aspects (price action), but he had a keen sense of the qualitative factors driving that price action. As you learn from reading the many discussions in the book, he utilized both fundamental and technical analysis—but it was his interpretation of the price action that always ruled the day.

Throughout the book SK details his strategic conclusions with respect to the trends. What struck me most was how well he managed such heavily concentrated positions. In chapter five, titled "The Copper Caper" SK tells us: “there are books about how someone lost a fortune or did some other dumb thing like that. I’ve often wondered why someone doesn’t write about how he’s going to make the million, before he does it…” that is exactly what he did with his copper campaign in 1972-1973, and remember—this is back when $1million was considered to be a lot of money (it still is to me, but with so many Billionaires around it’s kind of lost its significance!). He describes his intuition – “I could feel a big move for copper in every bone in my body…The fundamental market situation, too, supported this bullish view….” And he goes on to detail the micro & macro fundamentals as to why he expects a major bull market for copper in his usual written analysis, which includes his expectations for the price action and how he will manage the campaign with respect to entry & exit.

The picture below from page 47 of the book details his entry and exit points -- the copper market moved just as he predicted in his written analysis prior to beginning the campaign. In addition to the specifics of planned entry / exit points and his script of how he sees the future price action in copper unfolding, SK reminds us of the all-important qualitative factors that make or break a successful campaign: “a speculator’s worst enemy is himself…what should be so difficult about doing nothing (holding the position) …all I had to do was ignore the pit gossip, the market letters and commentators, and even the news. Why ignore the news? Because to a great extent the price makes the news, and not vice versa…. My biggest problem was to restrain myself from buying on the up moves and selling on the reactions.”

Again, we see what made Kroll great – his informal fundamental research on trends in supply & demand (via conversations with associates and industry contacts that he trusted) combined with his ability to interpret price action gave him an edge. But it was his trust of his own intuition and ability to optimize the aggressiveness of position size that made for effective strategy, and the discipline to stick to that strategy created hugely profitable trading campaigns.

SK’s relentless focus on price action, and of course, his ability to interpret it, was impressive. On page 113 SK tell us "…it's fine to watch news developments and it's fine to study the fundamentals, but basically your trade timing should be predicated on technical factors. And when the technical situation clearly shows something at variance with the p revalent psychology of the market, you're better off getting out and standing aside, or else going along with the technical indicators. The news will come out later to support what's happen to prices-it always does.”

On the surface, to those who don’t take the time to understand his decisionmaking, SK would appear as mainly a technical trader who happens to focus on price action. Yet, in chapter 16, titled “Tiptoe into my office and be a fly on the wall”, SK shares with us his daily notes from his trading “diary” from two months in late 1973. This includes details from several phone calls to the trading floors and brokers as he struggles to understand the reasons why prices are moving. We get detailed accounts of phone calls he has with his contacts (including Swiss Bankers) to find out who is buying and selling and why they are doing it!

SK was always interpreting price action (his main focus) through the information he received from his investigations of supply and demand, and who was behind it. He had a very informed mental framework through which he interpreted all that price action that he was so focused on. Out of that arose his intuition, which served him well. Furthermore, SK's unique ability and intelligence in interpreting micro (individual market) price trends in light of the big picture and his investigations of supply & demand (as we learn about in the many conversations he has with his peers) enabled him to manage such highly concentrated positions.

In my view, SK’s success was due to his ability to create a competitive advantage for himself, which he did by leveraging his individual talents, with a well thought out strategy that was optimal for the market conditions of that time (high inflation). More specifically, his understanding of price action in light of the research he did on what was driving supply & demand informed his intuition and created an ability to recognize reversals in major trends and optimize the aggressiveness of his positioning and money management. When you boil it down to its essence, in the context of fund management, competitive advantage, or the lack of it, translates into alpha -- aka excess return relative to some benchmark. If you are doing what everyone else is doing, you will get the same result as everyone else. Traders and investors are able to generate alpha to the extent they are able to create and implement a competitive advantage.

Because of the potential rewards, some of the most intelligent people in the world gravitate to the investment industry. Many of them fail, not because of the lack of intelligence, but because they fail to find a way to leverage it into a competitive advantage over the competition. The business of trading & investment is perhaps one of the most competitive that exists -- literally anyone can enter this market by opening an account (no barriers to entry or exit) as long as they have the funds to do it. How does one go about creating a competitive advantage in such a ruthlessly cutthroat environment?

Currently, the individual investor is no longer just competing against (mostly) other individuals like they were back in the early 1970s. Now, the vast majority of trading volume is created by algorithms that are designed by the geniuses that gravitate to the financial industry because of such large potential rewards. SK found a way to utilize what he brought to the table and then created a strategy around it, and his strategy was aligned to an exploitable opportunity. As an individual, SK had his own competitive advantage with his intelligence, personality, intuition, and his ability to be disciplined and stick to his game plan when it mattered most. When he applied those unique skills and traits to exploiting the opportunity he saw in the commodity markets, the result was alpha, and plenty of it! It would not be hard to create an algorithm modeled after the SK strategy—one would simply have to codify his strategy (presented here as quoted from the book), and many have like done that in the time since the book was published. What is lacking, however, is that vital ingredient – intuition. Intuition about which questions to ask when investigating supply & demand, and intuition on when to adjust positions and by how much. I am not a programmer, but knowing when to break the rules while staying disciplined is not easy to codify, but I would think, given the success of firms like Renaissance Technologies it is certainly being done (4).

The reason why this book gets an "A" grade from me is because 1) there is no fluff whatsoever-this book does not waste your time in any way -- SK gets right into the practical application of his strategic framework and goes so far as to provide the actual discussions he has with his associates, as well as the day to day entries in his journal detailing the reasons why makes the decisions he does, and why these decisions succeed or fail. There is a nice balance of practical application and the theoretical/strategic in this book. The strategic framework is succinctly explained, and when it is applied you get a real-time accounting as to why it works or doesn’t work. SK earns his wealth – in the end it is his intuition that guides his buy & sell decisions. That intuition works because it is guided by his strategic framework and his ability to interpret price action in light of his relentless investigations into the truth about the fundamental supply & demand that is moving prices. It is not the news of the day that he trusts, but his analysis and interpretation of price action.

Maybe it was because of when I ran across this book that I enjoyed it so much (the late 1980s when I was in my late teens), but when I recently reread it before writing this review, I enjoyed it just as much now as I remember in the first reading of it back then, close to thirty years ago. This is not just because of the entertainment value created by his including the history of his conversations, personal notes, and the reasons why he does what he does, but because it is, as he suggests, an expose´ that discloses the truth about his fund management and the important lessons to be learned from it. In addition to the blow-by-blow details of SK's positions and a detailed look at the 1970's commodity bull market you get a detailed explanation of some of the best lessons an investor needs to learn-without any fluff! There are plenty of used copies of this book available (see used.addall.com), and I recommend the purchase so that you can get the details, as a book review can’t do justice to the specifics of the content.

1 Kroll, Stanley, The Professional Commodity Trader (initial publication: 1974; Reprint July 1985 by Traders Press - ISBN# 0-934380-09-0

2 https://en.wikipedia.org/wiki/Nixon_shock

3 “Livermore was famed for making and losing several multimillion-dollar fortunes and short selling during the stock market crashes in 1907 and 1929.” ~ https://en.wikipedia.org/wiki/Jesse_Lauriston_Livermore

4 http://fortune.com/2017/05/16/hedge-fund-james-simons-renaissance-technologies/

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