Determining the amount of capital actually demanded by a trading portfolio is not exact. There are proponents who speak about optimal f, but I really believe not just that this is an overlooked issue but that it is a very difficult issue. Failing to plan and allocate enough capital is a disaster waiting to happen. To some degree diversifying your portfolio can reduce the possibility of ruin. As much as markets are correlated, some markets are not correlated or only correlated to a lesser extent. Trading noncorrelated markets will enable us to benefit due to the differences in time when and if markets trend. There are times markets and sectors get quiet. When markets are quiet, trends are absent. Without movement either up or down, generating profits is very difficult.
I was lucky that one of my mentors learned under Ed Seykota. Years ago I invested with David Druz from Tactical who also learned under Ed Seykota. I learned a lot of ways to think from both my mentor and David Druz. There is no magical system or indicator; it is all in how you think. Ed has been a mentor to many via his Trading Tribe. The Trading Tribe is a group of trend followers who are committed to personal growth and receive support from other traders all over the world.
These trend followers know there is no holy grail.
CHAPTER 4
How Successful Trend Followers Trade
It is imperative to remember that the returns of professional trend followers are not representative of those of all trend followers. More so, do not expect your results to be on par with theirs as you begin your journey.
I am not recommending these managers, rather using their history to show what trend following can generate when one trades with a well-thought-out plan and risk management in place. I am giving a short historical background of each of the managers as well. I present here a hypothetical compounding if you had invested with these various managers.
■ The Trend Followers
Before we start, remember: Past performance is not indicative of future performance. The risk of loss in trading commodity futures, options, and foreign exchange (forex) is substantial.
Salem Abraham
Abraham Trading Company
Began January 1988
CAROR 19.18 percent
Salem Abraham does not trade from Wall Street, rather from Canadian, Texas.
The population of Canadian is is approximately 2,000. However, Abraham Trading has been called “The Best Little Hedge Fund in Texas” by Absolute Return and Alpha magazine. In 2003 the New York Times wrote about Salem. The article was called “A Homespun Hedge Fund, Tucked Away in Texas.” I was surprised that Salem made it mainstream and was featured in the business section of the New York Times. Salem had been in the trading arena since 1988 and had built an impressive real-time audited hedge fund. He started with money his grandfather gave him. I believe the sum was $800,000, which in 1988 was a large sum of money. The deal was that if he lost the money, he would throw his data provider out the window and work in the family business of cattle and real estate. Salem did not lose his initial stake and has been compounding money over the decades ever since. Salem has a strong awareness of risk as per his statement, “You want your seatbelt to work in a wreck, not when you're not in a wreck.” He was quoted in a Pensions and Investments article.
His office is not what you would expect for a successful hedge fund. His initial office was 1,000 square feet above a steakhouse. Salem is proof that one does not need to be in Chicago or on Wall Street to succeed in the financial world. He attended the University of Notre Dame starting in August 1984. As I have stated many times, one does not need to go to Harvard or Yale to be successful over time trend following. No one at the company has an Ivy League degree. The members of Salem's Abraham Trading team do not have the financial background you would expect. Salem's coworkers were originally employed at the area's feedlots or natural gas drilling and pipeline companies. ‘‘This beats shoveling manure at 6 in the morning,'' said Geoff Dockray, who was hired as a clerk for Mr. Abraham after working at a feedlot near Canadian. ‘‘The financial markets are complicated, but they're not as relentless as dealing with livestock all the time.''
None of this has impeded the success of Abraham Trading. Salem has a burning passion to succeed. He did extensive research in the technical and methodological aspects of futures trading, as have most successful trend followers. It is imperative to truly believe in your methodology. He combined information he gathered with ideas that he developed during his research, and he back-tested the profitability and drawdowns of numerous robust trading theories. Salem graduated cum laude with a B.B.A. in finance in December 1987 and moved back to Canadian, where in January 1988, he began to manage customer accounts using his systematic approach. He became registered as a Commodity Trading Advisor in October 1988 and organized Abraham Trading in 1990 to act as a CTA for all customer accounts. The website of Abraham Trading states that 21 years of trading and research make Abraham Trading one of the most experienced traders in the business.
FIGURE 4.1 Hypothetically, if you invested $100,000 in January 1988, today it would be worth $6,743,434.54.
Source: Chart with permission from Iasg.com.
Elizabeth Chavel
EMC Capital Management
Began January 1985
CAROR 21.81 percent
Elizabeth Cheval is the chairman and founder of EMC Capital Management, Inc. It is well known in the trading community that women make better traders. This is not because women are smarter, but because of how women control their emotions in trading. Elizabeth has a B.S. in mathematics from Lawrence University. Not to put down Lawrence University, but it is not an Ivy League school, yet the notion of needing a proper university education such as Wharton is not a prerequisite for trading success. Elizabeth started her trading career at the Chicago Board of Trade. Luckily she landed a job with Richard Dennis. Before working with Mr. Dennis, Ms. Cheval worked with A. G. Becker, a Chicago-based brokerage firm, on the floor of the Chicago Board of Trade. Ms. Cheval has invested in futures since 1983, when she began investing in financial futures for her own account. In 1984, she was lucky enough to be chosen for the investment management training program offered by C&D Commodities. This was the famed Turtle Trader experiment. Richard Dennis and his partner, William Eckhardt, made a bet that traders could be taught how to trade. Some traders did much better than others. Elizabeth did fantastic, however, with volatility. For three years in a row, 1986, 1987, and 1988, Elizabeth returned 134 percent, 178 percent, and 124 percent. In 1990, probably due to the volatilities in the markets, she returned an astonishing 187 percent. However, there is never any free lunch, and there was a period when she experienced a drawdown of 45 percent. She has had periods of one year and longer in which she has had drawdowns exceeding 25 percent up to that dreaded 45 percent. The results of the Turtle Traders varied tremendously even though they all went through the same two-week course. After the Turtle program was disbanded in 1988, Elizabeth formed EMC. EMC, which stands for her initials, was incorporated in May 1988. The EMC trading models invest in over 80 futures markets including stock indexes, currencies, financial instruments, metals, agricultural, meats, energies, and soft commodities. The concept of being diversified is evident in EMC. Elizabeth is available to trade any of the opportunities that become present in these markets. Her proprietary systems include ideas of using multi time frames and multi systems. She uses strong risk management. Her proprietary risk algorithms are based on account equity (core equity), open trade equity, trailing return, and drawdown. Additionally, EMC utilizes proprietary trade-specific risk controls that are independent of the overall portfolio leverage. Market weight factors, system weight factors, and market volatility factors are applied individually to each signal taken at the time of buy or sell. The goal of most managers is to try to mitigate some of the volatilities of returns. After her big drawdown of 45 percent she added filters and enhancement to their Classic Program in July 1996. The goal of these enhancements was to maintain returns consistent with long-term averag
e returns while at the same time trying to reduce the expected drawdown levels and volatility by approximately one half. This is what smart traders do. After a negative run successful CTAs evaluate what happen and try to add filters to mitigate some of these drawdown issues. Her worst drawdown after 1996 was approximately 25 percent. This was a substantial improvement. As per the website of IASG.com, EMC has $110 million under assets. EMC's minimum managed account size is $5,000,000.
FIGURE 4.2 Hypothetically, if you invested $100,000 in January 1995, today it would be worth $20,579,720.22.
Source: Chart with permission from Iasg.com.
Tom Shanks
Hawksbill Capital Management
Began November 1988
CAROR 22.70 percent
Tom was a professional blackjack player in the 1970s. Through playing blackjack he met Blair Hull. Blair Hull is personally credited with buffering the crash of Black Monday in 1987 when he bought the bottom of the market and restored liquidity and confidence to the panicked financial markets. Trader Monthly recognized him for having executed one of “The 40 Greatest Trades of All Time,” and Worth magazine named him one of “Wall Street's 25 Smartest Players.” Tom and Blair were a great team. Tom started as a research programmer for Hull Trading and later became operations manager for research of options. He left Hull Trading in 1985 to work with Richard Dennis and Bill Eckhardt. Tom Shanks was an original Turtle Trader like Elizabeth Chavel. He started his Hawksbill program once the Turtle mentor program was disbanded in 1988. Tom, like others, had a better pedigree than a Harvard education. He surrounded himself with legendary traders and honed his skills with them. This is a common occurrence with traders. They all had their mentors. I have invested with what I call a third-generation Turtle Trader, Alex Spies. His knowledge of the markets was not learned out of textbooks or college. He learned over the years by trading and surrounding himself with great traders.
Hawksbill's methodology involves active, aggressive trading. The trading approach emphasizes risk control through proprietary money management rules and diversification of systems and markets within each portfolio. What is unique about Hawksbill is that as much as he is a trend follower he allows for some discretion. Hawksbill is different from most trend followers who are systematic by his use of discretion.
Underpinning the reality of aggressive trading, Hawksbill has returned some outstanding numbers. Hawksbill's returns have historically shown low to no correlation to bond and stock markets, thus offering the potential to diversify a traditional investment portfolio, as well as a portfolio of alternative investments. In 1990 Hawksbill returned 252 percent; in 1993 114 percent; and for those that think the markets changed and outstanding results are not possible, in 2008 he returned 96 percent. However, as I always say, there is no free lunch with trading, and I would only suggest buying drawdowns of traders like Hawksbill. He has had some extremely deep drawdowns. Hawksbill's worst drawdown was after his huge run up in 1990 when he was down 60 percent. In 1994–1996 he was down 50 percent for almost 24 months. In 2004–2007 he was down 31 percent for 37 months. No one ever promised you trend following is easy. However, putting the whole picture into context, he has been able to compound money at a great rate.
Clearly, money managers and investors diversify across the entire universe of ideas from low volatility to high volatility. It could be considered prudent depending on one's risk tolerance to place a small portion of one's portfolio with an aggressive trader such as Hawksbill. There are also individuals and institutional investors who seek high returns and are willing to accept the risk entailed in achieving them.
FIGURE 4.3 Hypothetically, if you invested $100,000 in November 1988, today it would be worth $13,560,306.49.
Source: Chart with permission from Iasg.com.
William Eckhardt
Eckhardt Trading Company
Began October 1991
CAROR 21.25 percent
Bill Eckhardt is considered by many in the industry to be the Trend Following Wizard. He was behind the Turtle Traders experiment with his high school friend, Richard Dennis. The two were trading partners in C&D. They had a bet to see if trading could be taught. The two disagreed whether the skills of a successful trader could be systematized into a group of rules. The Turtle program was overwhelmingly successful with novice traders ending up making $100 million. Eckhardt believed trading could not be taught and lost his bet with Dennis. After the closure of the Turtle program, Bill Eckhardt founded ETC in 1991. ETC manages over $700 million in managed accounts and both onshore and offshore funds. Eckhardt's managed account minimum is $10,000,000. Bill has been featured in various magazine articles as well as most prominently in New Market Wizards by Jack Schwager. He is the chief architect of ETC's system development and ongoing research. There was a recent article in Futures magazine with the title, “William Eckhardt: The man who launched 1,000 systems.” He has traded futures professionally for over 31 years. Before he started trading he spent four years doing doctoral research at the University of Chicago in mathematical logic. He never lost his passion for mathematics and has even published in academic journals. Even with all of his experience, Eckhardt still had drawdowns and extended periods of elusive profits. His worst drawdown, which lasted for five months in late 1991, was 27 percent. He went through a 20-month drawdown in 2008 till 2010 of 15 percent. The point is that drawdowns and durations happen to every trader and cannot be avoided.
FIGURE 4.4 Hypothetically, if you invested $100,000 in October 1991, today it would be worth $5,718,955.18.
Source: Chart with permission from Iasg.com.
Howard Seidler
Saxon
Began November 1993
CAROR 21.65 percent
During the last Alphametrix trading conference in Miami Beach, I was fortunate to sit and chat with Howard Seidler. I have been watching his program, Saxon, for years. I was extremely impressed by Howard's returns in 2005–2006 when most commodity trading advisors suffered big drawdowns, but he did not. From September 2007 till the present Howard has not experienced any large drawdowns. I only invest when a manager who understands risk encounters a deep drawdown. I feel this lowers my risks to some degree when I invest with a commodity trading advisor. I discussed this with him at the Alphhmetrix convention, and he told me that he included a volatility filter to reduce trades. In prior years Howard would have some big swings in capital. In 1994 he made 142 percent. However, there were periods in which he had drawdowns of 65 percent in 1995–1996.
Howard graduated from Massachusetts Institute of Technology in 1980 with a B.S. in chemical engineering and management science. From June 1980 to July 1983 he was employed first by Putman, Hayes & Bartlett, and then by Industrial Economics as an associate. At about this same time in 1983 he began a full-time intensive study of the futures markets. In December 1983 he was hired and became one of the Turtles in the experiment of Richard Dennis and Bill Eckhardt. Upon the closure of the Turtle program in 1988 Howard opened his trading company, Saxon, in order to manage other accounts for multiple clients as a registered commodity trading advisor. He has a fund that is marketed by Gale Investments and his managed account size minimum is $2,000,000. He is managing approximately $170 million.
Howard is solely responsible for the trading decisions and strategies of Saxon and for directing its ongoing research and development of trading and money management principles. While a large portion of Saxon's trading program is based upon a mechanical application of Saxon's multiple systems, Howard exercises discretion and judgment over certain trades. Depending on market conditions, certain nonsystem trades may be taken and, conversely, certain system trades may not be taken.
FIGURE 4.5 Hypothetically, if you invested $100,000 in November 1993, today it would be worth $4,141,237.63.
Source: Chart with permission from Iasg.com.
David Druz
Tactical Investment Management
Began April 1993
CAROR 19.85 percent
David Druz started out as an emergency room doctor. He told me he became interested in the futures markets when a friend of his, another medical student, ran $2,000 into $500,000 in the soybean markets in the 1970s. For the next 20 years Dave worked in medicine while researching ideas for trading. Dave learned under Ed Seykota. He actually stayed in Ed's house and studied with him for an extended period of time, which was an intense learning process. This learning process was more self-introspection to learn trading indicators or systems. In 1981, he set up his first futures fund, Tactical, while practicing as an emergency doctor in Fairbanks, Alaska. He later gave up medicine and moved from Alaska to the Hawaiian island of Oahu. Tactical Investment Management manages one of the longest running commodity futures trading programs in the world. Since 1981 they have systematically traded futures and currencies for a small number of institutional and individual clients. One can consider Tactical a boutique commodity trading advisor. Dave runs the trading and has an assistant, Colleen Ann Haviland, who runs the back office. Both are a pleasure and I feel honored to be one of their clients.
Dave maintains a robust trading methodology. There is no second-guessing or optimization. More so the parameters are not changed or altered. All markets are traded under the same variables. This is the basis of a robust system. It works over many types of market conditions and over many time frames. The key to success is money management and risk controls. These, however, do not negate drawdowns.
The Trend Following Bible Page 9