Aggregation of FAQ comments on Trading

by George Coyle  January 22, 2018

Ed Seykota is a market legend. He was originally profiled in Jack Schwager’s classic Market Wizards. But, beyond being a legend, he is also one of the most often mentioned people responsible for training or otherwise influencing various traders. Given how many times his name popped up in my market reading, I decided to do a deeper dive into his teachings.  

As it turned out, Ed has been managing a website since 2003 in which he responds to questions posed by readers in a section he calls FAQ. You too can send Ed questions on his website (http://www.seykota.com/TT/FAQ_Index/default.html).  

Wanting to learn what lessons Ed might be willing/able to teach, I decided to start reading the FAQ archives from the beginning. In doing so, I found many consistencies and much repetition. In short, a treasure of market wisdom from one of the legends. However, the wisdom is peppered throughout the FAQ section and thus is not easy to distill. So, I took on the task of aggregating what I found. My motivation was mainly to have the lessons for personal use. The cost of the education was months of reading and copy/pasting.

This paper is an amalgam of everything I read on Ed Seykota’s website. I first aggregated things as I read and then categorized/condensed the wisdom. In the end, I decided to structure this work as Q & A since I felt it had a better flow and made for easier reading. In the text that follows, I created the questions largely in response to my aggregation and categorization of Ed’s answers. The answers come directly from what Ed wrote on the blog. However, they were not responses to my specific questions but instead an accumulation of his responses to whoever wrote in to his blog over the past 15+ years. My questions were designed around the answers.

Over the years Ed’s responses to similar reader questions haven’t changed which implied his message regarding markets and trend following wasn’t changing. He even says as much on the website and in this paper.  

What follows is, in my opinion, market wisdom gold as told directly from the keyboard of the man himself. Very few edits have been made to his commentary. To the extent I changed anything, it was typically to add a clarification (which I put in [brackets]) or grammatical changes which became necessary in converting some website materials.  

I hope you enjoy what follows and it helps you in your pursuit of market profits.  

Before we begin, what do I need to know? Any prerequisites to receive your wisdom?


  • A grasp of basic trading math is essential to trading.

  • You can find a wealth of information about trading, all for free at www.turtletrader.com

  • If you want to trade consistently, without the swings in confidence, then you have to learn to accept, even celebrate, the feeling of uncertainty. This is the work of the Trading Tribe.


What is the Trading Tribe?


  • The Trading Tribe is an association of people who commit to excellence, personal growth and supporting and receiving support from each other.

  • The Trading Tribe starts out as a group of traders who meet periodically to explore how to handle emotions so they don't interfere with trading. Over the years, through experimentation and re-invention, it expands to include Tribes all over the world and people in many professions. We use and help to develop a common set of practices we call TTP, the Trading Tribe Process.


I understand you wrote a book about this and the Trading Tribe Process (TTP)?



Ok, sounds interesting. But, for now, I’d like to focus on you and trading. Please tell me about your big picture philosophy. What will give readers an overall sense of how you think?


  • About the only sure thing is that there aren't any sure things.

  • The only thing that stays the same is that things do not stay the same ... at least, not for very long, unless they do.

  • Your beliefs and attitudes frame your world, the way you trade.  Beliefs tend to come true…

  • Intentions = results.

  • Ups and downs seem to be part of trading, part of life.

  • Letting go leads to freedom.

  • There is no way to eliminate risk from trading, or from life for that matter - there are, however, some ways to manage it.

  • Success seems to me to be a result of clear intention, plus a lot of luck.  


How about your philosophy regarding trading and markets specifically?


  • Until you master the basic literature and spend some time with successful traders, you might consider confining your trading to the super market.

  • In the markets, just about everything works sometimes, and hardly anything works all the time.

  • I consider the markets to be unknowable. I study myself and my systems and how to clarify and focus my own intentions.

  • Many traders who would be successful seem to come to trend-following sooner or later.

  • You might think twice before you base your investment decisions on predictions (and promises) of profit. No one can see the (non-existing) future or guarantee profits.

  • I don't pre-dict the non-existing future.

  • ...good traders find a method, based on core principles that they deeply embrace, and that feels good, and they follow it systematically.

  • Many successful traders have (1) a trading system that works, and (2) the ability to follow it.

  • Trading a small account and living off of it at the same time is like eating your own fish bait.

  • You can find lots of bold traders and lots of old traders.  You can't find many old bold traders.

  • You might have some feelings about wanting to control things. This tendency can be plenty expensive in the markets.

  • The best indicator I know is Trend. The other good ones are Trend and Trend.


Ok that’s helpful background. Now let’s get more specific, what are the basics of successful trading?


  • Trade with trend

  • Ride winners

  • Cut losers

  • Manage risk


That seems pretty simple, anything to add?


  • My four "tips" (trade w trend, ride winners, cut losers, manage risk) are hardly original.  They likely date to the days of trading dinosaur bellies on the JFME (Jungle Fruit and Meat Exchange).


I hear markets have changed and what used to work doesn’t anymore, thoughts?


  • These days people are showing a lot of concern that markets are different and trend following methods no longer work.  I recall, in the old days, people showing a lot of concern that markets are different and trend following methods no longer work.

  • The claim that trend following doesn't work seems to pop up now and again ... sometimes just before major trends commence ... sometimes as an excuse for not following trends.

  • The same rules still seem to apply. Ride winners; cut losers; manage risk

  • In the markets, just about everything works sometimes, and hardly anything works all the time.


Ok, of the basics you cite above, what is most important in trading?


  • I do not hold any one element, such as position sizing, to be the most important element in trading.  Nor do I hold any one body organ to be the most important in maintaining life. I tend to see things in the context of their surrounding system, not as disparate elements.


Fair enough. You say above that the trend is the best indicator, what is the trend?


  • There is no such thing as "The Trend."  Trend is a definition that you bring to a chart.  Short-term, medium-term and long-term trends may all be different.


Ok, rephrasing, what is a trend?


  • A trend is a general direction in which something moves. To define a trend, pick a historical price, and subtract it from the current price. The difference tells you the direction and magnitude of the trend.

  • To generalize, use smoothing, such as: moving average; trend line; support & resistance.

  • Your definition of trend is the smoothing method you use.


Let’s talk more about trend. First, what makes trend/trend following work?


  • Trend Following acknowledges the principle of Momentum; as long as momentum exists, there is a place for trend following.


How do you measure trend?


  • In Trend Trading we have two indicators: up trend and down trend.

  • You can determine the trend in various ways and you mostly get the same result, depending on your preference for computing short-term or long-term trends.

  • You can take a chart with one-day bars, stick it on the wall, step back a few feet, determine the trend and enter orders accordingly.

  • In general, a long term trend is what you see when you put a chart on your screen and look at it from across the room.  A short term trend is what you see when you look at it up close.

  • To compute a trend, you have to compare average prices now with average prices then.  Trend measurement requires averaging so you cannot define a trend until after the fact.

  • To define a trend, pick a historical price, and subtract it from the current price. The difference tells you the direction and magnitude of the trend.

  • Also, I prefer looking at graphs, and can get a better feel for the terrain, than I can by just looking at reams of tabular numerical output.


What else can you tell me about trend following?


  • Trend Trading is fairly easy to explain, and fairly difficult to execute.

  • Trend-following systems use historical data to trigger buying and selling in the moment of now. None of this requires prediction.

  • Warning: too much math-turbation can lead to trend blindness.

  • There are very few differences between trend following systems, other than the time constant (how frequently it trades). There are huge differences between the abilities of traders to follow simple systems.

  • Trend Followers are content to submit to the flow of events.

  • Playing for comfort and searching for meanings are both counterproductive to Trend Following.

  • In a Trend Following world, reasons are optional.

  • If you continue to work your trading according to Trend Following principles, you tend to make more money in vigorously trending markets.

  • The trend is your friend except at the end when it bends.


Have your views changed on trend following?


  • My views on trend following stay about the same.


What kind of returns can I expect with a trend following strategy?


  • ...substantial drawdowns and occasional winning streaks.

  • Trend Traders, such as myself, cannot agree to deliver profit to a specific target, particularly on a consistent, annual basis.

  • If you intend to get above-average returns, you might do well to expect above-average volatility, and considerable uncertainty.

  • Rule of thumb for passive trend following systems - allow about 50% of your expected annual profit for drawdowns - so if you want 1,500% per year, you might allow for 750% drawdowns.

  • Following a system does not guarantee profits any more than not following a system. Profits over any time span depend on how well the system fits the market behavior - and on how well the trader executes the system.

  • Ultimately, you cannot guarantee an outcome, so you cannot guarantee performance or take total responsibility [for results].


You mention short and long-term trends, do you have a preference?


  • Price action tends to be fractal; the same patterns show up at all degrees of zooming in and out on the charts.  Transaction costs, however stay the same. So shorter term strategies suffer a higher ratio of transaction costs to gross returns.

  • The shorter the term, the smaller the move. So profit potential decreases with trading frequency. Meanwhile, transaction costs stay the same.  To compensate for profit roll-off, short-term traders have to be very good guessers. To improve guessing skills, you can practice dealing cards from a standard deck, one at a time. When you become very good at it you might be able to make money with short term trading.

  • I have not seen any simulation studies showing profitable regions of operation for High Frequency Trend Trading since the transaction costs and slippage become prohibitive.

  • Scalping, trading against large orders, to provide liquidity, requires skill and experience and close proximity to the action, such as a seat on the floor.

  • Long-term trading has an advantage, in that the transaction costs are small relative to the average move.

  • While it's good to use your head to enter and exit trades, you make the big money using your other end ... sitting tight on winning positions

  • If you want big profits, you want big trends, and to trade long-term.


Any thoughts on specific indicators?


  • Given the benefit of hindsight, you can get almost any indicator to work remarkably well.

  • Advanced technology for analyzing the markets is interesting, entertaining, distracting, and even counter-productive to coming to terms with emotional reactions to uncertainty and volatility.

  • The best indicator I know is Trend. The other good ones are Trend and Trend.

  • I prefer simple indicators.


Simple indicators?


  • A trend is a general direction in which something moves. To define a trend, pick a historical price, and subtract it from the current price. The difference tells you the direction and magnitude of the trend.

  • To generalize, use smoothing, such as: moving average; trend line; support & resistance.

  • Your definition of trend is the smoothing method you use.


Any reason you prefer simple indicators?


  • Warning: too much math-turbation can lead to trend blindness.


What about specific parameters such as moving average lengths, etc.?


  • I do not publish the exact parameters as I do not wish to purvey rather arbitrary values as some kind of "magic formula."


So what’s the secret?


  • I can tell you a couple "secrets" about purveyors of secrets: 1. There are no secrets. 2. They don't want you to know that.

 

Can you help me pick the best system?

 

  • There is no "best system" for everyone, just as there is no best car or best wife.

  • I do not know what's right for you.


Your response is a little frustrating, I just want to make money in markets. If there are no secrets and there is no best system, what can you tell me?

 

  • Discovering your system properties through back-testing - and then discovering your own risk and reward tolerances - can help you determine if your system fits you.

  • The positive intention of the feeling of frustration is to let you know when something is impeding your progress.

  • You might consider taking your feelings of frustration...to your Tribe as entry points.


Anything else?


  • I suggest you forego trying to find a best, or even "reasonable" system until you come to terms with how you like to trade. Start your system design by looking within yourself:

    • define what kind of trading performance you want.

    • determine how much time and energy you are willing to invest.

    • realize that psychological tendencies may interfere with executing signals.

    • spend some time looking over lots of charts to see the kinds of things to expect.

    • look at the daily performance graph of the system to see if you can stand the ride

  • Trading is not an exact science.


So, recapping, I need to define trend myself using a “smoothing” method (or no smoothing method). And I can do this by determining my personal preferences through introspection and simulations/back testing. Once I have defined everything given the method I choose, I will be able to determine the trend and trade accordingly. I have some questions on backtesting but will hold off for now and continue with the basics.


Next on your list was riding winners, please tell me about that.


  • The idea is to control initial entry risk ... profits take care of themselves.


Ok, fairly self explanatory, but how do you know when the trend has changed and the profit is no longer taking care of itself?


  • The trend is your friend except at the end when it bends.

  • Your definition of trend is the smoothing method you use.

  • The methods you use to define trend are entirely up to you, so you get to define trend any way you wish; everyone may have a different idea of "the" trend.

 

Please tell me about cutting losses.


  • Cutting losses refers to the general notion of protecting yourself from further damage.

  • Stop losses provide an automatic way to cut losses.

  • Three important activities are: placing stops, placing stops and placing stops.

  • Risk control has to do with your willingness to allow your stop to do its job.


So I take it your systems use stop losses to cut losses and manage risk?


  • All use stops and all stops trail the price.

 

Stops are difficult because I might sell my long at the dead low only to see a big rebound and know I bailed out at the worst moment. Any thoughts?


  • Getting stopped out is part of trend trading.  Experiencing the feelings of getting stopped out and converting them from adversaries to allies is part of TTP [Trading Tribe Process].


Please tell me more about risk and risk management.


  • Risk is the uncertain possibility of loss.  If you could quantify risk exactly, it would no longer be risk.

  • Risk is a function of the frequency (probability) of an event and the degree of seriousness of the event. There is no way to predict the outcome of a particular event. Over a great many events, you can get a sense for an "average" event and, so long as you do not require any particular event to behave, you can implement aggregate risk control.

  • The point of risk management is to contain risk, by position sizing and stop placement, before you enter a trade. Once you enter a trade, risk control is already a done deal.

  • During trend markets, while trends continue smoothly, most trend systems tend to register profits.  Risk management is for the rest of the time.

  • One of the principles of risk management is to start off with a small position - and make sure you have the resources to take a big "hit."

  • If it is essential for you to keep risk on one particular event to an absolute minimum (zero) then the method is to not take the trade

  • We register risk in our bodies as a feeling of fear.

  • ...one positive intention of fear is to maintain risk control.

  • Trend Trading uses position sizing and trailing stops to control risk in inherently dynamic markets.

 

We’ve generically covered stops above, tell me about position sizing, how much should I risk?

 

  • A: Risk enough to make a difference if you win. B: Risk not enough to hurt you if you lose. If these two amounts don't overlap, don't trade.

 

Hmmm not quite what I was hoping for, beyond taking my feelings of frustration to Tribe as an entry point, what else can you tell me?

 

  • I do not have a logically "correct" answer for you about how much to risk any more than I have a one for you about what car to buy or whom to marry. In all these cases, you might do well to identify your own preferences before you commit.

  • ...you can back-test various entry, sizing and risk-control strategies.

  • Part of back-testing is to determine position sizing and risk management strategies that fit within your drawdown tolerance envelope

 

So, recapping, I want to trade with the trend. But there is no one single right definition of the trend. My definition of the trend will depend on my personal preferences (much like I might not want a sports car if I have 4 kids or a station wagon if I’m single). I can determine the trend for me based on the results of simulations/back testing. I also need to manage risk. I do this via stop losses which trail behind my positions and position sizing. I think I’m starting to get it but still have a lot of questions.  

 

Let’s talk about trade entry, how do trend traders enter trades?


  • Trend followers trade at new highs and at new lows [if going short].

  • You might try:

  • Buying new highs

  • Selling new lows [if going short]

  • Getting back in after being stopped out

  • Entering orders despite multiple whipsaws

  • You might consider using stop orders to enter markets as they are consistent with trend trading.  With limit orders, you risk missing the move.


Where can I learn more?


  • Many basic texts on technical analysis have a section on breakouts [buying high/selling low].


What if the trend is already under way?  


  • If the trend is already in progress, one way to get on board is to enter a stop order just outside the recent trading range.  If a trend is not currently in process, you can enter a stop order outside the long-term trading range.


I’ve read some traders like to buy the dip within the larger trend. So if the trend is up, they wait for a pullback against the trend to get long. Per above, it sounds like you’re not a fan of this?


  • Those who buy the dip may wind up having to sell the subsequent collapse.


How about specifics on stops? I understand I need to use them and they should trail behind my position but how far away should the stops be? 5% away, 10%, etc?  


  • Part of back-testing is to determine position sizing and risk management strategies that fit within your drawdown tolerance envelope.


I’m sensing a theme here, can you give me something to go on...anything?


  • Shooting yourself in the foot: Close stops and close toes are both pretty much easy targets for execution.

  • You might consider determining which stop placement policies are best for you through back-testing.


Unusual way to put it but I think I get it, if the stops are too close they get executed. Determining how far they should be depends on how I design my system based on my simulations and backtests. Thank you. Anything else?


  • Many professionals might risk up to 1/2 of one percent on a trade - and that is versus a pretty wide stop.

  • You might also consider testing some systems with risk-per-trade in the 0.5% area.

  • In actual trading, even with stops, you cannot predict your exact risk.

  • Merely saying you are committing to risking less than 10% does not keep you from risking more in practice.

 

Ok, can you give me more specifics on sizing positions?

 

  • Heat, as I use it, is the measure of equity-normal trade risk. For example, if you trade a $1,000,000 account with 1% heat, your risk budget for your next trade is $10,000. If each contract has a risk-to-stop of $2000, you enter five contracts.

 

Interesting, so heat is the percentage of the portfolio you want to risk on any given trade.  And that translates to a dollar amount ($10k above). That dollar amount can then be compared to the distance to my stop in the given market I am trading. My stop distance is determined by my simulations. If that stop is $2k away from my entry for a single contract, and I want to risk $10k total (per heat) then I would buy 10/2 = 5 contracts.  

 

Any rules of thumb regarding “heat” percentage?

 

  • ...many seasoned professionals consider risking 1/2% [aka heat] to be lively, 1% to be aggressive and 5% to be maniacal.


The “heat” concept seems to imply I need a pretty big account. How much do I need to trade?

 

  • Rules of Thumb: Speculate with less than 10% of your liquid net worth.  Risk less than 1 % [heat] of your spec account on a trade.

  • These days, one futures contract can move several thousand dollars per day - so with diversification into, say a dozen instruments, you might normally experience daily fluctuations of 5-10 k, sometimes much more. If you want to keep your risk per trade at about 1/2 percent, then, setting 1/2 % to $5000, you get 100% = $1,000,000.

  • If you trade a $100,000 account, you might have to experience 5% entry risk.

  • ...many seasoned professionals consider risking...5% to be maniacal


I don’t have that kind of money, what can I do?


  • You can establish a trading account for less than that - although you might have to count on luck, skill, and substantial volatility.

  • You might consider investing in a fund and/or pooling with others.

  • Some start-up traders who have a good system, and no clients, offer to teach trend following basics to investors.  If the trader really know his cookies, the investors sense it and ask him to manage some money for them.

 

Well, that’s somewhat discouraging...I read you turned $5,000 into millions in the 1970s and 1980s. How does that reconcile with the message above?

 

  • I can tell you now (as I recall telling people in 1972) to prepare yourself for substantial drawdowns and to anticipate profits at your own peril.


I’d like to do it like you did, make millions from a small initial capital base. What can you tell me?


  • You cannot do it like me; you must do it like you.

  • Get rich quick generally works better in theory than in practice.


Ok, can you do that for me?


  • ...if you can get some money to me in 1972, I can get you a pretty good compound rate since then to the present.

  • You might also consider that, with trading as with any profession, mastery takes commitment and hard work - beware of people who promise fast and easy riches.

  • In comedy, as in trading, timing counts for a lot.


What else can you tell me about the famous account?


  • My original system, circa 1970, has high heat and by design expects 50% draw downs – and experiences them. It also generates average gains in excess of 200% annually for years on end, which I mostly attribute to my arriving in the business with the right approach at the right time.


Right approach and right time sounds like some luck was involved?


  • Success seems to me to be a result of clear intention, plus a lot of luck.  


What about hard work as the path to success?


  • Working hard to succeed doesn’t always work or succeed.

  • Ultimately, you cannot guarantee an outcome, so you cannot guarantee performance or take total responsibility [for results].


Let’s shift gears a bit. Based on everything I know so far, you clearly don’t try to predict what is going to happen in the future or in markets. But, what are your thoughts on market fundamentals?


  • Fundamental Analysis is basically trying to guess right.

  • Markets typically move before the "obvious" reasons appear.  A need to know everything before you act can interfere with trading.

  • You might notice that news often appears to justify a price move after a large part of the move is already on the chart.

  • Reliance on fundamentals indicates lack of faith in trend following.

  • Analysis and figuring it all out are optional, often counterproductive.

  • One of the functions of fundamental analysis is to justify and medicate fear of trend trading.

  • One good cure for the tendency to believe fundamental predictions: save the prediction and re-play it in about 10 years.


Interesting. George Soros apparently says, “Invest first, investigate later” and is an admitted trend follower (TF). Yet he uses fundamentals. It seems he adheres to TF principles despite being a fundamental trader.


  • The best source of information about George [Soros] is, well, George [Soros].


Is there any information you look for from say a financial website?


  • Open, High, Low and Close.


Let’s talk about trading systems, tell me more.


  • Historical simulation gives you an idea of the ride you might expect at various bet size levels. Ultimately your gut sets the amount of volatility you can stomach.

  • A mechanical system can help increase your consistency, the number of items you can track, and your adherence to the principles.

  • Good trading systems are like bikinis they are fairly simple and they eliminate the guesswork.

  • Following a system is likely to bring up feelings about wanting to abandon the system.


What other big picture things can you tell me?


  • All mechanical systems have some discretion and all discretionary accounts are subject to the mechanical nature of the trader.

  • I do not know of any systems that are 0% discretionary.

  • An ambiguous set of guides can justify whatever you feel like doing.

  • There is no math to get you out of having to experience uncertainty.

  • A Trend Trading system guides a process. It does not predict profit or generate assurances.

  • Traders tend to personalize the relationships they have with their systems. Some might see an authority figure, all full of arbitrary rules, or one who punishes and invalidates. Others might see a caring, protective parent. Some might see a puzzle, that needs continual re-solving and tinkering.  Others might see an enabler, justifying their whims. Some might see a prankster that keeps tricking them into whipsaws. Others might see a cornucopia.

  • I suggest you find out what metaphor you hold for your system, and then make sure it in alignment with stable and lasting adherence to sound trading principles.


So if mechanical trading has some discretion, what are the differences between fundamental trading and systematic trading?


  • In Emotional [fundamental] Trading, you try to figure it all out, and then take a position to find out if you are right (or wrong).  In Mechanical [systematic] Trading, you come up with a method and then mechanically apply the method to many situations. A Mechanical Trader simply (or not so simply) follows his system, without concern about individual trades having to be right or wrong.

  • System traders implement [trading] principles through mechanical systems while discretionary traders implement them as an art form.

  • The borderline between system trading and discretionary trading may be delicate, illusory, and basically incomprehensible.


What are your thoughts on buying a system someone else built?


  • Typically, sets of trading rules, such as you find in books and on internet sites are ambiguous, even internally conflicting.

  • The chances of finding a system, off the shelf, that works for you are slim to none.


How come?


  • The best car for you might not be the best car for me.  I have kids and live in snowy mountains so I like a station wagon with all-wheel drive.  If you can define a Bliss Function that includes all the things you like about a system then you can find the best system, for you.


Right, right...what is a bliss function?



What can you tell me about trend trading systems specifically?


  • There are very few differences between trend following systems, other than the time constant (how frequently it trades). There are huge differences between the abilities of traders to follow simple systems.


Do you have an example of an actual system?



Please tell me about backtesting/simulations.


  • Back testing does not change the markets, does not predict the future does not remove risk from trading and does not endow you with super powers. It can, however, help you get a feel for how various trend definition and risk management methods effect your system profitability and volatility. Your long-term success depends on your ability to stick with your system.  Back testing can help you develop a system you can live with.

  • You can learn many things about the markets by running your tests.

  • I prefer software that imitates real life.

  • Be sure to check your simulation results with your stomach, to see if it can tolerate your system.


What else?


  • If you start with an ambiguous design and try to translate it into computer code, you can easily get lost in math that just doesn't seem to work. Solution: dump it all out and start over.

  • In your models, be sure to give definite names and precise meanings to all your parameters

  • If you back-test a portfolio that you select before the test, you effectively carry your selection decision back to the start of the simulation. A more rigorous approach is to define only your selection criteria and then have your program select the portfolio, real-time, as it proceeds with the simulation.

  • The complexity of a trading system has little to do with the markets and little to do with the math; it has mostly to do with your emotions.

  • Simulations can reveal the characteristic performance of a system over time, and can help the trader to design risk management strategies so as to place the volatility within the range of his own psychological stamina.

  • Part of back-testing is to determine position sizing and risk management strategies that fit within your drawdown tolerance envelope.

  • Your real trading system includes your math and your own willingness to experience your feelings about following your math.

  • Willingness to experience your feelings about your system without acting on them is essential to system trading.

  • You can determine answers to back testing questions by back testing.

  • Ultimately, your system reflects the way you like to do things. If you find yourself fighting your system, or struggling to follow it, you might check your feelings about authority.


Any thoughts on combining a lot of systems?


  • If you have several sub-systems and a systematic way to combine them, then you have one overall system; you can even simulate it to find optimal risk management parameters.

  • My own researches show some improvement in Bliss by splitting the account into sub accounts and then diversifying the sub accounts by fanning out the the moving average averaging times, exponential average time constants, Support / Resistance line lengths, etc.


I’ve heard I want a “robust” system but I’m not sure what that means, what can you tell me?


  • A system is robust if changing a small fraction of the data set does not change the performance.

  • You might consider back-testing many combinations of parameter values over various portfolios of many instruments and look for profitable combinations that show relative insensitivity to nominal variations.


Optimization is the process of making something the best it can possibly be. In this case, that would be making the trading system its best. Any thoughts on the right way to do it?


  • Optimization algorithms follow subjective Bliss Functions, rather than from "the right way" to do it. There is no correct optimization method any more than there is a correct car or a correct mate.

  • Optimization studies on trend following systems indicate a trading frequency of a few times per year and less.

  • Widely different results on different portfolios may indicate instrument-specific optimizations and / or other curve-fitting complications.


Do you periodically enhance your systems?


  • Trade with the trend; cut losses and ride winners; manage risk. I do not know any enhancements.


Hmm not quite the response I was looking for...what I am asking is: is there a point where you decide the old rules are not effective, time for changes?


  • Sometimes markets trend smoothly.  Other times they chop. A long-term trend following system provides direction for all types of markets. Having "rules to modify your rules" sounds like you are just building a playground for Fred.


Who is Fred?


  • http://www.seykota.com/tribe/tt_process/index.htm


So, when do you change a system?


  • ...if it ain't broke, it don't need mending.  If it is broke, get a tinker.

  • Sticking to some system is generally more profitable than tinkering with your system and risking missing opportunities.

  • Playing with your system might provide some insight and inspiration about how it works. If you do it a lot, it might indicate a pattern of postponing commitment.


How should I tinker?


  • I wonder what is standing between you and back-testing your system in order to answer your own questions.


Do you have a preference for being long or short any given market?


  • In general, long-term simulations on Trend Following systems tend to show better results on the long side. This correlates with the observation that volatility is proportional to price, so when you play from the long side you are starting with lower volatility and therefore a better reward / risk possibility.

  • The big, major-mover, long-term multi-fold trends tend to occur on the long side - although riding them can have complications.

  • Riding Bulls (and bull markets) is pretty easy, in theory and in retrospect. In actual practice, and in the now, bulls and bull markets might bring up feelings you are unwilling to experience.


How about counter trend? I hear some trend followers try to marry trend systems with counter trend to offset the bad times.


  • Everything works sometimes. Regression seems to work best when trend-following doesn't. Knowing which method to use seems obvious ... after the fact.

  • Counter-trend systems seem to break down in the area of risk-management.


How much time will it take me to run a trend system (as in actual time from me)? Will I need to be available intraday?


  • Trend systems stop you in and out automatically, so you don't have to watch the markets.

  • You might consider using stop orders to enter markets as they are consistent with trend trading.

  • Optimization studies on trend following systems indicate a trading frequency of a few times per year and less.

  • The systems on the TSP page do not day-trade. Indeed, they rarely trade at all.


What are your thoughts on day trading?


  • Before you give up your day gig, you might want to talk to some other people who support themselves by day-trading.

  • If you know a consistently profitable day trader you might encourage him to share his audited track record and method.  As far as I know, none such exists.

  • The problem with Day-Trading is in the execution.

  • I have an open challenge to see a 1-year back-test of a day-trading system that matches actual brokerage statements.


Back to trend trading, can I avoid whipsaws [entering a position and getting stopped out when a trend doesn’t materialize]?


  • To avoid whipsaw losses, stop trading.


What if I get whipsawed a bunch of times in a row?


  • You might try:

    • Getting back in after being stopped out

    • Entering orders despite multiple whipsaws


Is there any way to avoid the losing inherent in trend following?  


  • You seem to be asking for a way to get on the big trends without having to suffer through the drawdowns. Nice fantasy.

  • You might consider the theory that you make most of your money holding on to major trends and lose money by trying to outguess the wiggles. From that, you can go on to compute the net cost of trying to be right.


Since we’re talking about loss, let’s talk a little about prolonged losing periods (drawdowns).  What can you tell me?


  • Arguing about how to estimate drawdowns is no substitute for knowing how to live through them.

 

Any way to avoid drawdowns?

 

  • You seem to be asking for a way to get on the big trends without having to suffer through the drawdowns. Nice fantasy.

 

What do you do when the drawdown gets really big?

 

  • ...stay on task and keep pulling the trigger


Do you ever take a break or not follow the system?


  • Occasionally, I may take a volatility vacation, during which I may reduce some positions and train my focus on interests other than the market. This refreshing practice is, perhaps, an essential element in my maintaining a commitment to trading trends since 1969 and still remaining occasionally sane.


Now let’s talk about a few other system specifics. Pyramiding is the process of adding to positions as they go in your favor. What more can you tell me about it?


  • Aggressive pyramiding, and other forms of accumulating monster positions are good ways to lose big money, even in a bull market.

  • Too much pyramiding can result in large drawdowns.

  • Pyramiding, as with most trading methods, works better when you observe risk-control principles.

  • If you have a normal risk fraction of say 1/2% of your account, then for a $1,000,000.00 account, you risk about $5,000 per trade. You might, then, consider pyramiding up to your risk, say, in increments of $2,500, $1,500 and finally $1,000, for a total of $5,000. This way, if the market turns around on you after you get your first tranche in place, you only lose on half your normal position. You might consider doing this for all positions, building a number of small pyramids.

  • If you use pyramiding on top of your normal position, then you risk overtrading and inducing excess volatility into your account.

  • If you use pyramiding to the max, say to keep ploughing all your profits back into your position, then you have a very small chance of large gains and a very large chance of wipeout.


How about modeling the difference between where I want to get filled and where I do get filled (slippage) in simulations?


  • You can try simulating various estimations for slippage per some fraction of the distance from the non-slip price to the worst price of the day.  

  • A conservative method to estimate slippage: take the average of the stop price and the worst possible price of the day.  Very few short-term models can survive that assumption.

  • You might then track your actual fills over all your trades, compare against your benchmark and make some adjustments.


If I estimate that much slippage, my system doesn’t work. Thoughts?


  • If your results are sensitive to your slippage, you might consider reducing your trading frequency.

  • Optimization studies on trend following systems indicate a trading frequency of a few times per year and less.


I read on your site that you were considering certifying trading systems.


  • Certification involves demonstration of two critical factors: (1) a winning system and (2) the ability to follow it.


Ok, let’s shift gears a bit again, how did you first get involved in trend following?


  • I find trend following in the 60's and 70's, before the debut of chaos theory.  Nicholas Darvas' book tells how he, as a dancer on tour, is able to place trades, and stop-loss orders, with a simple technical system and run 10K into 2M.  Richard Donchian's weekly newsletter from Hayden Stone shows a trend-following account in action.


I’ve read about your name in association with Richard Donchian, what can you tell me about him?


  • In the early 1980's I collaborate with Donchian and code his 5-20 day moving average system. I conclude it seems to make money for the client and also trades often enough to make a good living for the broker. I then attempt to code his trading guides.  I find (1) insufficient guides to define a full system and (2) internal conflicts between some of the guides, so there is really no system to test.

 

So is his stuff useful if it isn’t specific enough for a full system?

 

  • The Donchian system provides a generic example of the kinds of performance profile you might expect with a long-term trend-following system.  


Got it, so it is a good starting point to learn the discipline. A template if you will. How did Donchian do with his system?


  • Donchian, like a lot of system traders, has a record of taking some trades and not others.


Here's a quote that I stumbled upon:"Ed Seykota once told me he taught a college course in trading that lasted 10 weeks. He spent the first week of the class teaching basic information about trading. He then spent another week teaching the class Donchian's 5 & 20 trading system. However, he needed the remaining 8 weeks of the class to convince people to use the system he had taught - to get them to work on themselves enough to accept the losses that it would generate." This is interesting, what can you tell me about this?


  • I recall teaching the course in using a weekly-rule system at an adult education class at a high school.  I do not recall trying to convince anyone to do anything. I do recall the class starting with about seven students and, by word of mouth, ending with about fifty. If you want to see how the 5/20 system works, you can simulate it on a computer.


Any other traders you think I should study?


  • You might like what Old Turkey has to say in Reminiscences of a Stock Operator.


Who was Old Turkey?


  • Old Turkey is the long term trend follower in Edwin LeFevre's classic, Reminiscences of a Stock Operator. Old Turkey seems willing to feel all the feelings that arise during a long term move, even enjoy them. When you allow your feelings to be, they tend to not interfere with your trading.

 

How about books, what books should I read?


  • Reminiscences of a Stock Operator, by Edwin LeFevre, Reminiscences of a Stock Operator, by Edwin LeFevre, Reminiscences of a Stock Operator, by Edwin LeFevre...read it so many times you lose track of how many, underline your favorite passages until you tear holes in the pages and be able to quote Old Turkey by heart.  


How about you, are there any specific people who have been inspirational to you or who have taught you lessons?


    • Through Reading Books: Nick Darvas, Bernard Baruch, Jesse Livermore, Arthur Cutten, Sergei Rachmaninoff, Milton Friedman

    • Through Radio and Television: Buffalo Bob Smith, George Reeves, Don Herbert, Ernie Kovacs

    • Through Personal Contact:Jay Forrester, Ken Olson, Harold Edgerton, Dick Donchian

    • I don't recall learning specific lessons as much as assimilating attitudes.


Any final suggestions before we move on?


  • I suggest

    • Commit to a specific system

    • Follow your system

    • Work on your feelings


You’ve mentioned feelings and emotions a lot thus far. Clearly this is a big part of your trading. What can you tell me about it?


  • There is no math to get you out of having to experience uncertainty.

  • If you want to trade consistently, without the swings in confidence, then you have to learn to accept, even celebrate, the feeling of uncertainty. This is the work of the Trading Tribe.


You mentioned the Trading Tribe (TT) and the Trading Tribe Process (TTP) earlier, what more can you tell me?


  • The Trading Tribe holds that we set up dramas in order to experience feelings, and that when we are willing to experience feelings directly, we do not have to set up dramatic excuses to do so.

  • Being at ease and letting go of what does not work are trend-following principles  and the basic work of the Trading Tribe.

  • When you work through your unresolved dramas, what's left is to simply ride along with the trends of life.

  • TTP can help you reframe monsters into resources.

  • TTP tends to reduce "amygdala hijacking."


So it is kind of like therapy/analysis?


  • Analyzing feelings, even giving them names, is an intellectual, logical process, and may be yet another way to avoid the real work of feeling them and communicating them.

  • Trying to figure things out interrupts TTP.

  • The Trading Tribe goes with the flow, not against it; trade with the trend.


And this relates to Trend Following?


  • Trend Trading is conceptually simple and operationally difficult only in proportion to unresolved emotional issues. It's a yellow brick road to both self actualization and profit.

  • Your real trading system includes your math and your own willingness to experience your feelings about following your math.

  • The impediments to sticking with a Trend Trading system seem to dissolve with consistent application of TTP.


So is it just about trading?


  • TTP deals with you as a whole person, and trading issues resolve as part of the whole. The best way to become a better trader is to become a better person.

  • People who practice TTP tend to stop day trading, stop top and bottom picking, and stop trying to figure out the markets. They tend to develop an affinity for trend following, profit riding and loss cutting.

 

How about an example, let’s say I get angry because I lose. Does TTP help me to get rid of the anger?


  • Getting rid of anger is not the intention of TTP; accepting it, experiencing it (different from acting it out) and appreciating its positive intention is the intention.

  • In TTP, we do not try to "let go" of feelings in order to feel better. We frame our feelings as having positive intentions and aim to bring them to the surface so we can learn what they have to teach us. Once they have their say, they generally disappear until the next time they have something to share with us.


How about another example, say my trading position isn’t working yet and I’m impatient.  How could TTP help?


  • One way to dissolve impatience is to allow, enjoy and celebrate the feelings of impatience.  This converts the feeling from an drama engine to a drama avoider.


Sounds interesting, where can I learn more?



Thanks. Given your understanding of and experience in trading, I have a few final questions:


As a trader, do you still, after all of these years trading, find your emotions going up and down with your account performance?


  • Yes


Do you find that you really have to "work" to keep pulling the trigger on new signals?


  • Yes

 

OTHER (Doesn’t fit the Q&A narrative):


The following comment showed up in my reading:


  • I conduct back-testing on my own proprietary software - and generally have someone run the same tests on another package as a counter check.


Ed has several systems on his website on the TSP page. He also asks readers to send him an email verifying their results of confirming his system. Given those facts, and the comment above, it is hard not to infer if you really want to know what Ed is trading, look at his online TSP systems.