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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?
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?
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?
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?
What
about specific parameters such as moving average lengths, etc.?
So
what’s the secret?
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.
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?
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?
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.
We’ve generically
covered stops above, tell me about position sizing, how much should I
risk?
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?
Buying new
highs
Selling new
lows [if going short]
Getting back
in after being stopped out
Entering
orders despite multiple whipsaws
Where
can I learn more?
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?
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?
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?
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’d
like to do it like you did, make millions from a small initial
capital base. What can you tell me?
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?
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.
Is
there any information you look for from say a financial website?
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?
Right,
right...what is a bliss function?
What
can you tell me about trend trading systems specifically?
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?
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?
Who
is Fred?
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?
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]?
What
if I get whipsawed a bunch of times in a row?
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?
Any way to avoid
drawdowns?
What do you do when
the drawdown gets really big?
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.
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?
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?
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?
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?
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?
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?
Do
you find that you really have to "work" to keep pulling the
trigger on new signals?
OTHER
(Doesn’t fit the Q&A narrative):
The
following comment showed up in my reading:
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.
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