Sun Tzu the Trader

From The Art of War by Sun Tzu:

“What the ancients called a clever fighter is one who not only wins, but excels in winning with ease. Hence, his victories bring neither reputation for wisdom nor credit for courage. He wins his battles by making no mistakes. Making no mistakes is what establishes the certainty of victory, for it means conquering an enemy already defeated. Hence the skillful fighter puts himself into a position which makes defeat impossible, and does not miss the moment for defeating the enemy. Thus it is that in war the victorious strategist only seeks battle after the victory has been won, whereas he who is destined for defeat first fights and afterwards looks for victory.”

This passage rings true for trading and it can be rewritten so:

“What the ancients called a clever trader is one who not only wins, but excels in winning with ease. Hence, his successful trades bring neither reputation for skill nor courage for taking bold risks. He wins his trades by making no mistakes. Making no mistakes is what increases the chances of success, for it means trading when things are in his favor. Hence the skillful trader puts himself in a position that makes any losses minimal, and does not miss the chance to put on high-probability trades. Thus it is in trading the successful trader only seeks to trade after the edge is confirmed, whereas he who is destined for losses first trades and afterwards tries to secure a profit.”

You can already envision such a trader. That he makes no mistakes means that he follows his process to the letter, and doesn’t miss a step. He positions himself for minimal losses by executing his trades well—looks for good entries with tight stops, and uses the appropriate position size. He doesn’t miss a chance to put on high-EV trades but is patient enough to wait for them, and only then places the trades. He waits until he has an edge.

The chapter where that passage is from begins like this:

“The good fighters of old put themselves beyond the possibility of defeat, and then waited for an opportunity of defeating the enemy. To secure ourselves against defeat lies in our own hands, but the opportunity of defeating the enemy is provided by the enemy himself. Thus the good fighter is able to secure himself against defeat, but cannot make certain of defeating the enemy. Hence the saying, one may know how to conquer without being able to do it.”

That last line is a reminder not to beat yourself up if you do things right but your trades still don’t succeed. It happens even to the very best. However, only when you’ve done your due diligence can you know if your losses are your own fault or not.

There’s another passage I like:

“Let your rapidity be that of the wind, your compactness that of the forest. In raiding and plundering be like fire, in immovability be like a mountain.”

The phrase “…rapidity be that of the wind” means that you have to be decisive. Also, when you’ve planned your trade, execute without hesitation. Don’t dilly dally and watch how the candles lay out. When it’s time to cut the trade, cut it. “…compactness of the forest…” means that your process, system and strategies have to be integrated so that everything works together cohesively. “…in raiding be like fire…” means that when edge presents itself, trade with conviction. Size big, add to pullbacks and let your winners run. Your profitable trades should compound and grow like an inferno. And finally, “…in immovability be like a mountain…” means when there is no clear edge, do absolutely nothing. No forced trades, no boredom trades. The mountain doesn’t chase the clouds—it waits for them to come to it.

Sun Tzu also said: “Whether to concentrate or to divide your troops, must be decided by circumstances”, and I think it applies to decisions about whether to split a trade across different assets or not. I also like: “The control of a large force is the same principle as the control of a few men: it is merely a question of dividing up their numbers.” , which is similar to the idea that trading is the same no matter the size. It’s important to remember because as you vary your trading size, you tend to act differently.

He also said: “So in war, the way is to avoid what is strong and to strike at what is weak” and “That the impact of your army may be like a grindstone dashed against an egg—this is effected by the science of weak points and strong.” It is similar to how in trading you really want to avoid trading when there are conflicting signals—when the market is ‘stronger than you’, and wait for things to align for you so you have an edge. It’s the same as in baseball when you bat the ones that are in your sweet spot and you KNOW you can hit, while letting the difficult pitches pass.

Something similar to the need to use house money to compound profits: “Hence a wise general makes a point of foraging on the enemy. One cartload of the enemy's provisions is equivalent to twenty of one's own, and likewise a single picul of his provender is equivalent to twenty from one's own store.”

Sun Tzu said: “In war, then, let your great object be victory, not lengthy campaigns” and I find this wisdom to hold true when it comes to sizing ones trades. A factor I don’t see talked about enough is the relationship between frequency of trades and position sizing. The fewer trades you are taking, the bigger they need to be and vice versa. In general, smaller position sizes will mean you take longer to make a lot of money, and in the process, all the emotions and psychological trials of trading can wear you down. But if you are trading very frequently, bigger sizes would cripple you. What you want is to figure out the right size for your strategy, and that’s not an easy thing.

This one is a classic and it applies to trading too: “According as circumstances are favorable, one should modify one's plans”. It’s about being nimble.

Then, “While heading the profit of my counsel avail yourself also of any helpful circumstances over and beyond the ordinary rules”. That’s the greatest strategist to have lived saying that if you find something out there that is helpful, use it.

There is more useful wisdom in the Art of War. Here is the full text.