Edward Arthur Seykota (see Chapter 2) pioneered systems trading using early punch-card computers to test ideas. In his influential best seller, Market Wizards: Interviews with Top Traders, author Jack Schwager devotes a chapter to Seykota and writes that his “achievements must certainly rank him as one of the best traders of our time.”1
The stock market is never obvious. It is designed to fool most of the people, most of the time.
I know you look at trend following from not only a trading perspective, but a life perspective.
I think if you’re going to really be a trend follower you’re going to have a lot of trouble limiting it to one area. Because let’s say you have a trend following system. You say, “I’m going to have a diversified portfolio, a trend following portfolio. I’m going to free myself up from emotions.
Emotions have always been a big problem here, so I’m going to have a diversified trend following portfolio or I’m going to invest in somebody else’s portfolio and that’s going to fix this emotional problem.”
Then what happens? Their investment or their portfolio goes up and down and they get emotional problems with that. You don’t really fix your emotions by having a system. What you do is you just move them up stream. You have constituents within the portfolio that used to bother you, and they went up or down, and then now you have a portfolio that goes up and down so you just move the problem upstream. Ultimately you have to say, “What is it that I’m feeling and what do I do when I feel these things and can I come up with better and more useful or productive ways of responding when the thing goes up and down?” Eventually, you’ve got to come to terms with that.
The best trend followers are the ones that have made peace with themselves, “This is what I do in the case of things going up or down, with the value increasing and decreasing. This is how I behave and this is how I act,” and of course as you know, there are all kinds of things you can do when things go up. Some people, when something goes up, they sell. Some people when things go up, they buy and when they keep going up some people sell more and some people buy more. And if you go to extremes in either of those cases you’re counterproductive, self-destructive. You’ve got to know how to do that and you’ve got to do it consistently. You’ve got to do it in your personal life.
I’m an optimist in the sense that I believe humans are noble and honorable, and some of them are really smart I have a somewhat more pessimistic view of people in groups.
If you do these things in your personal life as well it supports trend following. Because if you’re not in alignment between your overall philosophy, how you behave as a person, and you try to do trend following, there’s going to be conflicts. And so we in Trading Tribe hardly ever talk about actual trading or what the markets are doing. What we’re working with is the emotional reaction to volatility or emotional reaction to loss or to structure or authority or all these other issues.
If people straighten these things out, their relationships with their significant others or their children get better. They report more satisfaction in all areas of life. And oh, incidentally, their trading is getting better. They don’t quite know how that happened, but they’ve turned into a person that now can cope with uncertainty and can cope with volatility, and they couldn’t do it before. You can’t take a system and use that to medicate your feelings. Some people say, “I’m just going to suppress my feelings.” Stiff upper lip approach, grin and bear it or clench your teeth and hope for the best.
I tend to go the other way, “What’s the positive intention to these feelings?” Celebrate them. Find out the positive intention and as soon as you do that the feeling disappears and you go onto the next feeling. I’m more of the go with the flow on the feelings as well. There’s a lot of different approaches.
By now, after we’ve been doing this a couple decades, we’re developing a body of knowledge on how to do this and to what extent can we actually reprogram response patterns, and we’re getting pretty good at this. You can follow what we’re doing. I’ve put it all on my blog at www.seykota.com. All of this is free if people want to go on there. And we’re documenting the growth of all kinds of people that are using this technology and it seems to be, to the extent they use it, working pretty well for them.
It always seems to me the place that one is trying to find is just some peace and contentment. To be able to sit in a room and not have this anxiety, worrying constantly, and if one has that, to work on that. I see parallels to your work in meditation when I read Zen scholars like Alan Watts. It seems like there’s commonalities with some of your work and the Eastern thought process. Do you see that?
EMT says everything I stand for and everything I have done my entire life is a complete waste of time.
I believe every feeling has a positive intention. For instance, if you’re in the house and you smell smoke, you hear crackling sounds, and notice the temperature going up in the room and you conclude that maybe the house is on fire. That would be a really good time to feel anxiety, take some action and respond to it.
I’m not so sure you want to medicate your mind, anesthetize yourself and put yourself into a meditative state where you don’t respond. That’s not really what I’m saying. You want to notice the feeling you’re having in the moment and act appropriately and you want to learn the difference between medicating a feeling and responding to it proactively.
I’m not suggesting you always aim towards peacefulness; sometimes you want to get busy. You might want to get busy and put a trade on or you might want to get busy and take some corrective action, some risk control. Or you might want to take some action and get into some opportunity. Whatever it is, you can learn to come into harmony with your feelings and to some extent it’s nice to just be able to be peaceful and watch your feelings and watch your mind, and rest. It’s important to rest particularly when you feel tired.
I don’t recommend using either Trading Tribe technology, which I call TTP, the Trading Tribe Process, or anything else for medicinal purposes like a drug or alcohol or a sedative. There’s a difference between using any of these technologies as a sedative and I don’t think any of the Zen masters really recommend blissing out and staying there permanently. I think they want to be a little bit
responsive and proactive to whatever feeling arises in the moment.
Time series momentum represents one of the most direct tests of the random walk hypothesis and a number of prominent behavioral and rational asset pricing theories. Our findings present new evidence and challenges for those theories and for future research.2
I love constant learning. What’s the better way to handle expressing oneself? There’s always a better way to do it.
I think so. I try. We’re here in the moment. I’m learning something from you and I’m trying to be responsive. I’ll think about this later and say, “Oh man, I really could have said that better.” But that’s how life is. I do the best I can in the moment and then I go back and maybe do it differently next time. I try to learn and study my responses and say, “Can I change the response?” And that’s what we do in the Trading Tribe. We try to look at what our responses are to our feelings and then we practice identifying, “What is it we are doing? How are we getting the result we’re getting and can we change our response patterns and get different results next time around?”
The only way you can learn is to extend yourself in front of somebody who has more experience, and once you extend yourself there’s the chance that you might be forced to learn something that makes you feel like, “Wow, why didn’t I just say it that way? I could have said it the way he just told me.” But you wouldn’t get to the point of knowing the better way until you’ve extended yourself the wrong way.
You set up an environment in which the goal is for people to help each other improve. This is true in the Trading Tribe and some companies have this down pretty well. Some other organizations too, where personal growth becomes important, people [may] correct you or offer advice and you say, “Thank you for helping me learn something.”
In a lot of situations somebody will correct you or give you advice and then you get upset about it. You may say something to protect yourself, put them down, swear at them, tell them to keep their distance or whatever.
Knowing when to explore and knowing when to quit both have value.
When you have an expansive economy and a company that’s growing, everybody’s trying to do better than the culture in that company. When you have growth, when you have a free competition society and free competition, you have a competitive startup firm. And somebody says to somebody else there’s a better way to do this, and they say, “Thank you for telling me.” And they start doing it that way. When you get a survival company, one that’s overly restrictive and political and there’s regulations, you better mind your own business and don’t go talking to somebody else about what they should be doing.
The environment in one case is pro personal growth and pro learning, and the other one is not. It’s very territorial and very defensive. You can walk into companies and you can sense this right away. Some are open to grow and then they get mature. And if they start getting to the Govopoly model and they start going the other way . . .
One of the things that you do in your Govopoly book is talk about the strategy of trend following. And you offer trend following as a means to cope as we move towards this Govopoly system that you see as inevitable. But I would love for you to go back in time a little bit, if you will, because you’ve had an interesting career.
You’ve had some interesting mentors, interesting students, but there’s a couple of traders in your early years that had a really strong influence on you. I would love for you to share wisdom or memories about two gentlemen in particular and that’d be Amos Hostetter and Richard Donchian.
Amos Hostetter, he was at Commodities Corporation and Richard Donchian at Hayden Stone. Two very accomplished early pioneers in the field of trend following.
I’d be glad to share what I know. I knew Donchian a lot better than Hostetter. Donchian had noticed this system, the two-week rule in copper. Two-week rule: you buy something when it makes highs for two weeks and you sell it when it makes lows for two weeks. I asked him once, “How did you come up with the two-week rule?” And he said, “I don’t exactly know and you’re the first person that’s ever asked.” He said that he just kind of came up with it and I think that was the start of automated trend following [coming up to the two-week rule].
Fear is only as deep as the mind allows.
Before that, you can look at some of Livermore’s writings and he had another system of pivot points and so forth. Donchian basically started the two-week rule. Now that won’t work today. Back then you had different characteristics in the markets. And the two-week rule used to work in copper and then we found that you had to lengthen those and maybe made the weeks longer, six weeks or sometimes 30 or 40, 50 weeks or much more than that.
Donchian had this system and a couple of followers in his office. He didn’t always follow it himself, but he had this system and he had people that were religiously following the system and they seemed to do pretty well. I came along and I studied his rule set. I had Donchian’s rules and guidelines. And at about that time computers were starting to become within reach for people to use them, although they didn’t have personal computers. They did have mainframes at some companies. And if you can believe this, I got to go into the major brokerage house at the time on the weekend. And I had access to their mainframe computers that they used to run the company.
There was a security guard and there was me. And I had access to the complete computer base of the whole company. I was just using it to do computer testing.
Were you pinching yourself at that time?
No, I thought it was just normal. I said, “I want to do this research” and they said okay. In those days nobody ever thought about anybody trying to go in there and do anything nefarious. I was just in there doing research. In those days you wouldn’t even think about something like that. But these days you couldn’t get anywhere close to the inner workings of a brokerage house.
There is the plain fool, who does the wrong thing at all times everywhere, but there is the Wall Street fool, who thinks he must trade all the time.
[I used] all their discs, their history and everything. They were just sitting around in this big room. It was a huge room with all these mainframe computers and the tape drives and so forth. You probably have more computation power in your cellphone now. In those days that was quite the thing so I would run back tests that you could do now in probably a second or two. It would take a half hour, 45 minutes to do one set of tests and I was using punch cards. It was a different era back then.
During the early days there weren’t a huge number of peers that you could bounce ideas off. You knew Donchian but unlike today where there’s a much wider network and people are connected on the Internet [you didn’t have that then].
Investing should be like watching paint dry or watching grass grow. If you want excitement . . . go to Las Vegas.
I took Donchian’s work; he had a letter that he would publish. Every week he would publish a letter which would have his rules on it, and it would also have a kind of a model account and you could follow along. And the idea was you would follow along and place your orders with him. I guess that was the way that was supposed to work. I tested his rules and came back and said, “The rules internally are not consistent. You can’t program all these rules at the same time because they conflict with each other.”
I started taking rule sets that were non-conflicting. I tried to tune it up and say, “Here’s what we can do,” and I would try different experiments with the rules. Then I would check it with some brokers and traders in the office and I’d say, “I’m going to change this. I’m going to make the system less responsive so the market has to go up more before you start to buy it, make the time constants longer,” and people would say, “That’s going to make it more risky because your stops are going to be further away.” Then we would test it and we would get the exact opposite results.
All these things were very counterintuitive. I did some of the first testing and you’re right, there wasn’t any standard. Now I’ve got this on my website and if you want to replicate some of these tests and learn how to do it, you can. There’s a template and you can do it on your Excel spreadsheet or whatever. Enough people have done it that they all get the same result to the penny. So I’m pretty confident I’ve got the right answer up there.
In those days there wasn’t anybody else. I was just curious, and I said, “How does this work?” and Donchian had set it up as a system. I said, “Okay I’m going to simulate it. I’ll go back in the computer and see if I get the same results that Donchian’s getting. I’ll try to set up a diversified portfolio” and we did that. The company I was with marketed it for a while. We had a diversified portfolio and it was all run on computer by a service bureau. We would enter the data every day, then get the result and then we would put the orders in.
The company I was with couldn’t stick to it and they also couldn’t resist the temptation of trying to get the customers to trade more often than the system wanted them to trade. The problem with this system was it worked and it made money for the clients, but the problem was it made far less money for the
brokerage house. Because they were used to day traders, they were used to people coming in and lasting a few months, losing their money, moving on and doing something else. That’s the way the brokerage house was set up. People would come in, try to trade, lose their money, and leave.
The three-to-five million dollar figure is not a random picked number. That amount is about what we are able to recoup on the movies if we don’t get a wide release. In a worst case scenario, we break even and maybe lose a little money but not very much, and everyone gets paid scale . . . That budget is reverse-engineered to thinking that if the movie isn’t in wide release, at least we get our money back and can keep our doors open.
They said, “The commissions are like a tenth of what they used to be. They’re just staying with positions and this is going to wreck our business model.” And so there were all kinds of pressures to get people to trade more often . . . like you pointed out in some of your letters to me. Well, they’ve got fancy names for it now like disposition effect. But in those days, people just didn’t want to hold on to something. It would go up a little a bit and they would want to take their profit. Went down a little bit, they wanted to add more and hope it’ll go back up.
You had lots of pressures against following systems in those days and so I invented something that no one really wanted. Then I left and I went out on my own. Found clients and I found that some of the most important things was developing a relationship with the clients. So that they knew what to expect and they knew what was going on. If the client was not aligned to it and if you didn’t have emotional rapport and understand the system is more than the mathematics [there was trouble]. The system is the mathematics plus the willingness to follow the system. And when you increase your world view to include the investor himself and his emotional responses to what’s going on is when you finally get the system to include everything—you can design a system that works.
But just going into a computer and tuning up their software and saying “Here’s the right set of parameters,” Well, great, you’ve got something that theoretically will work for some theoretical robot that’ll follow it, but there aren’t a whole lot of robots that have got money these days. Maybe someday, but right now you’ve got human beings with human feelings and unless you include that into your system design, the wheels are going to come off the cart around the corner.
You sum up so much of your ethos in those last few sentences for those paying attention. Correct me if I’m wrong, but it seems like you’ve been highly motivated by the puzzle aspect of figuring things out.
Yes, I like puzzles. I’ve got a huge collection of what you might call bar room puzzles—these metal detanglement puzzles where you have metal pieces that fit together and you’ve got to figure out how to get them apart or together. I’ve got a huge collection of those and in the morning I do chess puzzles. I just like figuring things out. That’s always been something that I’ve enjoyed doing. I don’t know exactly where that comes from. I’ve been able to incorporate that in my life in such a way that it’s useful.
I think the puzzle aspect of what I did in the markets, or what I did with my Govopoly book, is what’s driven me. I want to understand how it works. Then if it works and makes money, that’s great. It’s nice to make money, but I wouldn’t have done it in the first place. I’d maybe figure out some other way of making money. But the puzzle was what got me. I said, “I’ve got to figure this out.”
“This guy Donchian, he’s got this thing that’s mechanical, it’s making money, how can that be? How can you get something that’s mechanical that can make money for nothing without doing any work? How can that be?” And so I kind of got attracted to looking at it.
I don’t think I would have gone into it for just the money, it was the puzzle. It was, “How does this work? How does this actually work? Can I build a model? Can I understand this?” And then when you understand it, then it becomes interesting to explain it to people for a while—whether you put it on the website or you write a book. Then you go on, and look for a new puzzle.
In short, we suffer from an “illusion of control” that fools us into thinking the future is more predictable and less uncertain than it really is. Or worse, we believe we can influence chance events through our own actions.
Go back in time: you’re in those mainframe rooms, and you’re by yourself and you’re struggling. There’s got to be a struggle to try and figure this all out. Was it just pure excitement at the time? This internal excitement that was driving you to keep going and going till you got the puzzle solved?
Well, that’s a good question. That’s one of the best questions I’ve ever heard. What motivates somebody who’s a researcher? What motivates them to go? Is it that pleasure or the puzzle, or is it the discomfort of not knowing? It’s deeper than that. It’s just that’s what I do. That’s what I do. I do that and I play banjo and I get lost in it. That’s my meditation, I have to do it. If I can’t play music something dies.
And the same with solving puzzles. That’s who I am and that’s what I do. And I don’t think of it as there’s something that pushes me to do it. That’s just who I am and that’s what I have to do.
I sometimes feel like my career’s the same way. I don’t necessarily know why, I’m just driven to do what I do and I’m not necessarily sure what I even do, but I just do it.
I like that, and you’re good at it. And that’s one of the places we succeed at in the Trading Tribe when we get people to this place you’re at—where you find out who you are and what you do and you just do it. You express yourself and create a value by expressing exactly who you are and not pretending to be somebody else. That’s a very high state. Congratulations for being there. It’d be a different world if everybody could get there, and I would hope people would follow in your footsteps. I’ve watched your career over many years and I’ve seen you keep expanding and getting closer to who you are, and now you’re really blooming and you’re really making a big contribution. So good job.
I’m not going to tell the exact story, but you influenced me greatly when I met you for the first time in 2001, and I can still remember some of the things that you said to me. And for some people they might have felt threatened. I don’t think I felt threatened. I was like, “Okay, what has he just said to me? Why is he saying it? What’s the deeper meaning?”
In many ways, as you talk about your love of puzzles, I felt like you were giving me a puzzle.
“Michael, you might want to consider this ” And so then of course I just considered that and you
didn’t give specific instructions, you gave some big-picture insights. That’s probably how you like to be. You want to see if there’s more puzzle finders out there.
We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.
Yes, and you’re open—you wanted to do something. You wanted to go somewhere. You were on a growth path. And then you viewed ideas from me and other people. And you’ve surrounded yourself with an amazing group of people who have amazing amounts of ability, knowledge, wisdom, and resources.
You’ve surrounded yourself with one of the most advanced group of mentors possible. You just like to do that. I think you had an attraction. You attracted people like that and then you enjoyed hearing what they had to say. The people on your podcasts, and people in your life, all are people with strong opinions, all people that make you think and make you grow. You just have some kind of an affinity for people like that, and that’s part of what makes you good at what you do.
If they keep talking to me, I should keep talking to them. That seems like a good rule. If really smart people will agree to talk to me, I should probably talk to them because then I wouldn’t be that smart. [Laughter]
[Laughter] It seems to be working.
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