Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine. © 2004 Technical Analysis Inc., (800) 832-4642, http://www.traders.

com

TRADER’S NOTEBOOK WORKING-MONEY.COM

Trading And “Moneyball”

What do baseball and trading have
in common? More than you would
have thought.

by John A. Sarkett

C an an individual retail trader ven-

ture into the marketplace, take on
elite, highly paid hedge fund managers,
mutual fund managers, market makers,
and other assorted professionals, and come
out ahead? A new book that is all the buzz
in Chicago trading circles would say “yes.”
Moneyball: The Art Of Winning An Un-
fair Game, by Michael Lewis (his other
books include Liar’s Poker), tells the un-
likely story of one Billy Beane, a
supertalented professional baseball player
who never achieved his potential in the
major leagues, who changed course and
then, in a most unlikely turnabout, became
the most successful general manager in
baseball. He did it by forming a funda-
mentally different and iconoclastic view
of the game, one that is built on a statistical
foundation of what actually works.
You must read this book to absorb the
full weight of the evidence, but to whet
your appetite, here are the salient points
that you can apply directly to your finan-
cial market operations.

WHAT’S THE STORY?

ANDREW VANDERKARR

Once upon a time, Billy Beane was the top

prospect in major league baseball. Regarded
as more gifted than 95% of professional
players playing at the time, he signed at 16.
In baseball parlance, he had the “hose” (arm),
“wheels” (speed), body to do it all, and the “Good Face” — that After bouncing around the majors and the minors, he quit
is, the look of a baseball god. He was, as one scout remarked, “a at 27 to become a scout — a move that was unheard of. Unlike
player you could dream on.” most baseball front office types, Beane’s mentor, Oakland As
In accordance with the adage, “Life is what happens when general manager Sandy Alderson, was not a baseball player
you are making other plans,” it was all downhill from there. in his past life, but had been instead an attorney and Marine
Much later, Beane came to realize he didn’t really enjoy officer, who believed in systems and science. And soon
playing baseball, was never comfortable with the pressure, enough, so did Beane.
and had signed on and played for the money only. Beane would become a general manager himself at 35. He
84 • November 2004 • Technical Analysis of STOCKS & COMMODITIES
 Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine. © 2004 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

was aided indirectly by several notable statisticians, indi- ally. So instead, ask yourself: What is your system? What is
viduals like Bill James, who published the Baseball Abstract your edge? Who are you earning your dollars in the market
series, annual volumes of hitherto-overlooked statistics, facts, from and why? If you can’t state your system in one sentence
and analysis on baseball, and directly by Paul DePodesta, or two, you don’t have one. Beane’s offensive system: get on
who was then Beane’s assistant in the As organization. There base, score runs. Defense: get batters out. Sounds simple,
were even some consulting companies retained along the doesn’t it? But most baseball managers are more fixated on
way, one specializing in arcane baseball analysis, the Society effect versus cause: 100 mile-per-hour “heat,” being aggres-
for American Baseball Research (SABR). sive at the plate, speed on the base paths. Beane looked past
This was all most unorthodox. To most powers that be in these ancient yardsticks to actual results.
baseball, the sport was art, indefinable. To Billy Beane and So what works? Does your system work? Can you prove
his various bean counters, it was science. Collectively, they it? Probabilities: put them to work for you. In your trading,
became the equivalent of card counters, the “Einsteins of stack the odds in your favor: fundamentals, technicals, then
baseball,” armed with new evidence and able to see the options analysis.
national pastime in new and startling ways. Here are just a Here’s an example. You want to be long a stock. Instead of
few tenets of their “new” way of analyzing the sport: choosing an overvalued candidate, one that’s already run up
and garnered its share of attention in the media, look for an
1 The single most important thing in the game is to
overlooked candidate. Here’s an example. At this writing,
not make an out.
Liberty Media (L) sells for just under $9 a share. Analysts put
2 As such, bunts, and “hit and run” plays were highly the break-up value of the company (which holds stakes in
overrated, as were “manufacturing runs.” News Corp., Time Warner, shopping network QVC, and
3 Patience mattered: patience to walk, for example. others) some 20% to 30% higher. So the fundamentals are
On-base percentage is more important than bat- there. It has traded recently in a band of $10 to $12. Next, use
ting average. technical analysis (stochastics, relative strength index [RSI],
4 “Taking” the first pitch puts the odds of a success- and so forth) to spot oversold buy points. Finally, use options
ful at-bat in the hands of the batter. to generate leverage and/or risk management.
5 Batters can create walks by deciding which pitches With those simple actions, you just put the odds in your
to swing at. favor three ways: fundamentals, technicals, and options.
Doing so doesn’t guarantee you the win, but it’s a world of
6 Pitchers who know how to strike out batters can
difference from taking uncalculated risks.
often be more valuable than 100 mile-per-hour
hurlers. The market, however, values the latter
more highly. Beane traded these individuals when-
TRADING THE BILLY BEANE WAY
Still not convinced? Take another look, comparing baseball
ever it was to his advantage.
played the Billy Beane way and trading:
Backtest. Go back in time. How would the strategy you are
All of the above were proven statistically, and only statis-
proposing have worked across time? To trade your system,
tically. The naked eye could not discern these facts, Beane
you must have confidence. What was the win/loss percent-
and his counters realized. Did it work?
age, drawdowns, and all the rest? Make this process part of
Beane’s amazing win-loss record as general manager of
your routine.
the Oakland As went like this:
See the same things everybody else does but in a differ-
■ 1998: 74 wins, 88 losses ent way. Most managers pine after big, strong 100 mph
■ 1999: 87 wins, 76 losses hurlers. But when Billy Beane would get one, as often as not,
■ 2000: 91 wins, 70 losses he would trade the pitcher. He looked for real-results players,
■ 2001: 102 wins, 60 losses sometimes chubby, out-of-shape players whom other teams
■ 2002: 103 wins, 59 losses spurned. What does this tell you? Be a hedge fund yourself;
■ 2003: 99 wins, 66 losses “sell” the overpriced securities, buy the obscure and over-
looked. Too many traders only look for the long side of a
Did the As have the stars? No, just the opposite. The market. Rewards on the short side can be faster and more
Yankees paid their players between $50 million and $100 dramatic. Think two ways.
million more than the As each year. Maintain a positive psychology. When Beane was a
It wasn’t the money, it was management. The system was
the star. What is your system? What is your
Great. What’s this got to do with trading?
edge? If you can’t state your
THE SYSTEM IS THE STAR system in one sentence or two,
Many traders flit from idea to idea, tip to tip, hot market to hot you don’t have one.
market. When it doesn’t work, they take the blame person-
November 2004 • Technical Analysis of STOCKS & COMMODITIES • 85
 Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine. © 2004 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

TRADER’S NOTEBOOK WORKING-MONEY.COM

player, he was a mental mess. Bullpen pitchers would come As Bill James wrote in his 1988 Baseball Abstract: “It is a
down to the dugout for one of his at-bats just to see what wonderful thing to know you are right and the world is wrong.”
destruction he would wreak when he struck out. As a foil, in With probabilities, system, and method working for you,
Moneyball, Lewis profiled Beane’s teammate Len Dykstra as you can have a chance to know this feeling, directly, for
“. . . able to instantly forget any failure and draw strength from yourself in your trading.
every success. He had no concept of failure.” One time,
Beane and Dykstra were watching Baseball Hall of Famer John A. Sarkett, developer of Option Wizard Scan and Scan
Steve Carlton warm up. Dykstra didn’t recognize the pitching Wizard software (http://option-wizard.com), may be reached
legend and asked who he was. When Beane told him, Dykstra at jas@option-wizard.com.
replied that he could get a hit off him. “I’ll stick him,” he said.
Then he went out and did it. SUGGESTED READING
Beane did have one good mental trait: he never allowed James, Bill [2003]. The 2004 Bill James Handbook, ACTA
himself to become sentimental about a game, a player, or his Publications.
own experiences. Translating that trait to the markets would _____ [1988]. 1988 Baseball Abstract, Ballantine Books.
be: “Ours is not to reason why, ours is just to sell and buy.” Lewis, Michael [2004]. Moneyball: The Art Of Winning An
Enter your stops or buy your puts, and if it goes, it goes. Unfair Game, WW Norton & Co.
Don’t do it (just) for the money. After Beane became the _____ [1990]. Liar’s Poker: Rising Through The Wreckage
most successful general manager in baseball, he worked a On Wall Street, Penguin Books.
notable trade: himself, to the Boston Red Sox organization, Surowiecki, James [2002]. “The Buffett Of Baseball,” The
for $12.5 million over five years. The deed done, he couldn’t New Yorker: September 23.
go through with it. After his misshapen baseball career as a http://option-wizard.com
player, he had vowed to never do anything just for the money ‡Option-Wizard
again. He was loyal to the As, to his job, to his life in Oakland.
†See Traders’ Glossary for definition
He still had the dream of winning the World Series, and all
‡See Editorial Resource Index
that would mean to the validation of his ideas. So he stuck
with the As.
This article — and articles like it — can be
Similarly, there are other rewards for trading, some psychic: found online at www.working-money.com. S&C

TRADING SYSTEMS
A mechanical, statistically based trading system — like Scan Wizard (shown), which was devised
by the author — can help take the emotion out of trading and allow you to focus on what actually works
over time. Consider purchasing or creating an optimizable system that provides buy/sell signals
(both long and short), exit points, and trailing stops. The program should also keep a track record.

86 • November 2004 • Technical Analysis of STOCKS & COMMODITIES