The Trend Following Bible

by Andrew Abraham

  Tactical has three different products and in total approximately $100 million under management. The returns range both on the upside as well as on the downside. Dave defines exactly what his system does: “My trading system captures the capital that hedgers use to defend positions.” He has back-tested and quantified it, and so he knows and expects that his system will generate 30 percent drawdowns. But over time, he has achieved excellent results because he is focused, he understands his markets, he has good money management rules, and he has a realistic time horizon within which he plans his trading. In one particular fund, his Tactical Institutional Commodity Program, he has returned a CAR of 18.87 percent since 1993. I recently bought into his current drawdown, which is his worst. He is down as of this writing –32.94 percent. This drawdown started in May 2011 and is still continuing as of February 2012. I entered in February 2012. I have money with Dave in another of his products and used this point as an additional entry. I have no idea if the drawdown will worsen. I strongly doubt that I am buying in at the bottom. The only investors that do that are ones that have numerous drinks in them whom I have met at trading conferences. I am not recommending Tactical, rather demonstrating how I allocate to trend followers in my personal trading. Every trend follower is going to have drawdowns and ugly periods. These are the times to enter. Unfortunately, many feel much more comfortable buying when times are good. It is easier emotionally; however, I believe it enhances the inherent risks when allocating to trend followers. I am not recommending Dave and would suggest you conduct your own due diligence.

  FIGURE 4.6 Hypothetically, if you invested $100,000 in April 1993, today it would be worth $3,119,771.09.

  Source: Chart with permission from Iasg.com.

  Jerry Parker

  Chesapeake Capital

  Began February 1988

  CAROR 12.73 percent

  Jerry Parker has been considered by some as the most successful of the Turtles. Jerry is a Turtle who trained under Dennis and founded Chesapeake Capital Management in 1988 after almost five years of trading his own proprietary capital. Jerry's approach is not as aggressive in seeking returns as some of his Turtle colleagues. This approach has made his trading more palatable for institutional investors as well as high net worth investors. At his peak Chesapeake in 2008 had a little under $2 billion of assets under management. Chesapeake encountered a rough patch in the markets in 2011 and so far in 2012. Assets plummeted to $766 million. Again, the institutional investors have done the wrong thing. After one has done due diligence, now could be considered a great time to invest with Chesapeake. I am not recommending; however, Jerry has been around with Chesapeake since 1988 and has returned a CAR of 12.62 percent. Considering how the stock market has done and at what volatilities, it is an interesting comparison. Chesapeake's investment portfolios are not biased toward long or short positions and, therefore, can profit in both rising and falling market environments. Chesapeake actively monitors, and has the potential to invest in, over 90 markets worldwide. Jerry, like most trend followers, patiently seeks trend breakouts. His Chesapeake system is a technical, trend following system. The system on average generates 200 trades per year, of which some six will pay for losses and generate returns, Jerry has stated. Quoting him, “One would not want to invest too much negative emotion in the 194 losers; you likely won't be around for the six big winners.” This exemplifies what trend following really is. In a later section in my diary of trades, Jerry's statement is proven in my actual trades in my proprietary account.

  Michael Covel is considered by many as well as myself as one of the best writers on trend following. He has a very select group of trend followers whom he considers his influencers and his mentors. Jerry Parker from Chesapeake is on the short list. This is a strong statement of support. It is ironic to me that some investors left Jerry after such a long and illustrious trading run. Probably a big mistake.

  FIGURE 4.7 Hypothetically, if you invested $100,000 in February 1988, today it would be worth $1,642,892.48.

  Source: Chart with permission from Iasg.com.

  Michael Clarke

  Clarke Capital Management Worldwide

  Began January 1996

  CAROR 14.14 percent

  Michael Clarke, the principal of Clarke Capital, has been trading futures for client accounts since 1993. Michael was successful in his trading in the beginning, focusing on arbitraging equity options before he started trend following. His strategy was to be a disciplined buyer of volatility-sensitive options when they were extremely cheap and hedge them with overvalued options or stock. In the late 1980s the nature of the equity options business changed and it became less attractive to Michael. Starting in 1989, Michael started researching and verifying whether he could write computer algorithms that would be based on his knowledge and previous trading experiences in the markets. He questioned if he could actually make a living trading futures. Michael started developing a new career as a futures trader and eventually a CTA. He became a position trader using computer systematic algorithms to develop the entry and exit points. His earliest systems were profitable, yet they overtraded the markets and required too much risk to achieve their results. This would not have been attractive to clients. He developed techniques and various strategies over the period of 1989 to 1993. Michael spent a considerable amount of energy on the development of the software tools. Michael's testing was beyond extensive. He wanted to confirm the robustness of the systems. The systems had to be robust and were tested in over 100 markets with some containing data that dated back to 1945. Michael uses multiple trading systems. The systems had a synergistic and complementary effect by the fact that they were not all getting into or out of the same positions at the same time or at the same exit price. Additionally, when using multiple systems there were significant reductions in the length of drawdown periods as well as a smoothing of the equity curve. Remember our goal of building an equity curve. This is the way we compound money over time.

  In order to diversify Michael has seven different programs: Worldwide with a minimum investment of $250,000, Orion with a minimum investment of $200,000, Millennium with a minimum investment of $1,000,000, Jupiter with a minimum investment of $3,000,000, Global Basic with a minimum investment of $50,000, Global Magnum with a minimum investment of $100,000, and FX Basic with a minimum investment of $1,000,000.

  It was very smart on Michael's part to make all of these types of programs for investors. In this fashion he has made himself available to both institutional investors and smaller futures brokerage clients. Michael's programs are not immune to the inevitable drawdowns that trend followers face. His worst drawdown was in the Millennium program at 60.87 percent drawdown. He is currently in the drawdown from December 2008 till the month of this writing, February 2012.

  Over the years Michael's hard work and efforts paid off. Michael has been awarded many accolades including:

  ■ 1993 Futures magazine “Top Trader.”

  ■ 2000 Futures magazine “Top Trader.”

  ■ 2007 Futures magazine “Top Trader.”

  FIGURE 4.8 Hypothetically, if you invested $100,000 in February 1988, today it would be worth $829,862.02.

  Source: Chart with permission from Iasg.com.

  Paul Mulvaney

  Mulvaney Capital Management

  Began May 1999

  CAROR 15.19 percent

  Paul Mulvaney is the principle of Mulvaney Capital Management and is responsible for the Global Diversified Program. The Global Diversified Program is a long-term, systematic trend following program, covering all the major financial and commodity futures markets worldwide. Usually programs that are diversified provide returns that have historically exhibited low correlation to traditional stock and bond markets. The trading program is systematic and trend-based. Mulvaney Capital is operated out of London in conjunction with GNI Fund Management. GNI Fund Management seeded Mulvaney with a $5 million managed account in May 1999. Mulvaney's program is continually on the lookout for a
market price breakout from a trading-range channel.

  Mulvaney says his approach is totally systematic; he states, “The essence of trading comes down to psychological factors. What's really difficult is keeping emotions out of the equation. A completely systematic approach does that automatically.” Mulvaney completely believes in mechanical trading systems that can be designed to exploit trends and produce acceptable risk-weighted returns. A fully computerized mechanical system can trade in many more markets than a discretionary trader could handle. He is a very big believer of reducing the risks inherent in the markets to remove the human element in trading process.

  Mulvaney's program exploits price changes that occur over long periods. This is both a positive and a detriment. It has enabled large outsized returns as in 2008 when Mulvaney generated returns in excess of 100 percent. Yet there were periods of time such as in 2006 through 2007 when Mulvaney encountered 40 percent drawdowns plus. Mulvaney, like Dunn Capital, swings for the fences. He is looking to maximize his returns over time. Depending on the markets, it is not unrealistic to believe Mulvaney will achieve more 100 percent years in the future. However, with those types of returns, would I anticipate some steep drawdowns on the horizon?

  Mulvaney is diversified across approximately 50 futures markets, many of which have no or low correlation with one another. Mulvaney's program attempts to capture long-term trends in all the major sectors of the global financial and commodity markets, and it invests 51 percent in financials and 49 percent in commodities. The rules of Mulvaney's trading strategy are simple: buy on strength and sell on weakness; run profits and cut losses short. “If you take our initial position and it starts to generate positive returns, then we'll increase it. If it starts to hurt the portfolio, then we'll reduce it and ultimately exit.”

  Mulvaney's initial commitment to any market is very small, on average 0.5 percent or less of account equity. His trading strategy is based on a piecemeal basis; if the trade seems to be working, he will scale in to a greater extent.

  The program holds positions for 180 days on average, which is much longer than most. Mulvaney believes the way to beat the market and to garnish outsized returns is to have a longer time frame because psychologically participants seem to be too focused on the short term. Different from other commodity trading programs, it doesn't have to rush to market. Rather, the program can wait for a bigger breakout from a wider channel before taking a position. This is different from many other programs and the benefit is avoiding being caught by false breakouts. More so, the program, unlike many others, does not use a profit target. Mulvaney will hold a position until a trend reverses. There is never a free lunch when trading. There are always trade-offs.

  FIGURE 4.9 Hypothetically, if you invested $100,000 in May 1999, today it would be worth $628,625.68.

  Source: Chart with permission from Iasg.com.

  Bernard Drury

  Drury Capital

  Began May 1997

  Bernard Drury is the principle of Drury Capital. Drury Capital was founded in Illinois in 1992 as initially a fundamentally oriented grain trading program. Bernard focused on the grain markets from 1978 before shifting his focus to mechanical and algorithmic system development. While earning his M.B.A. from the University of Chicago, Bernard became interested in quantitative, systematic approaches to the futures markets. He was fascinated with the benefits that systematic trading could offer. This was a huge difference coming from a discretionary trading background. A computerized system offered consistency as well as diversification of different synergized models. This was the beginning for him to develop and refine his own trend following system. Bernard gained further trading experience at Louis Dreyfus Corporation, Commodities Corporation, and Goldman Sachs Princeton. His extensive research and development, along with his grain trading skills, served as a foundation for his trading career. In 1994, he joined Commodities Corporation in Princeton, New Jersey, where he further developed his systematic trend following trading system, operating as an independent entity within the firm. Through system testing Bernard became a firm believer that a systemic, rule-based approach to trading could give greater potential than discretionary trading in a single sector.

  His systematic approach was thoroughly tested, researched, and applied robustly to a broadly diversified portfolio. He began trading client funds in the Drury Diversified Trend-Following Program in May 1997. Bernard's Diversified Trend-Following Program's trading methodology approach is built on elements of trend following and diversification.

  The thoroughness of research and precision in execution was paramount to his models. The trading system has evolved over time to include additional systems and markets. Initially it only traded 30 markets and was only one system. By May 2008 he had increased the number of markets to 70 and included three other systems, making a total of four distinct systems. These enhancements on the methodology have reduced expected volatility from 25 percent to 18 percent. As far as risk per trade, there are a large number of small trades; the risk allocation to any given trade is very small. This is a common theme among successful trend followers.

  The model is broadly diversified across six sectors, which are equally weighted, approximately. He maintains an exposure to 50 percent commodities and 50 percent financials. The portfolio emphasizes diversification by trading metals, agricultural products, foreign exchange, stock index futures, energy products, financial instruments, and softs such as cocoa and coffee. The speed of trading is slower than that of longer-term trend followers. As in most successful trend followers, the risk management system emphasizes the protection of equity. His unique methods of risk and money management result in different entry and exit points from other trend followers. His average hold period is four months and when trades are working, this can be up to eight months. Like most other trend followers, he exits losing trades quickly. Over a five-year time period, even with all of the inherent drawdowns, he has been profitable. His models do suffer as would most trend followers when there is a long period of broad nondirectional, high-volatility price behavior. Drury's minimum for managed accounts is $10,000,000. In addition to the managed accounts he maintains a fund in which an investor can gain access with a minimum of $100,000. He is currently managing approximately $400 million. He went through his worst drawdown in 2004 through 2006. He declined from his peak –32.52 percent. His second worst drawdown was in 2011 from February to October, –26.45 percent.

  FIGURE 4.10 Hypothetically, if you invested $100,000 in May 1997, today it would be worth $553,991.42.

  Source: Chart with permission from Iasg.com.

  Jeff Austin and Andy Silowitz

  Blackwater Capital Management

  Began July 2005

  Blackwater Capital Management is managed by Jeff Austin and Andy Silowitz. Jeff started his career working on the floor of the Chicago Mercantile Exchange in 1994 taking care of the CTA business for Dean Witter. Andy traded spot forex and forex options. Jeff left the floor and gained further experience at Rotella Capital, a large commodity trading advisor. After that he started working at Eagle Trading Systems in Princeton, NJ, another large and successful commodity trading advisor. His focus of work at Eagle was research and system development. While at Eagle he met Andy. The two worked on system development at Eagle. The two partners got their pedigree while at Eagle and honed their skills. They decided to go out on their own and co-founded Blackwater Capital Management. The learning curve was passed from mentor to student. Eagle Trading's principal is Menachem Sternberg. Sternberg was the head trader for the Bruce Kovner fund, Caxton. Bruce Kovner was featured in the Market Wizards book by Jack Schwager. This is a common thread with successful traders.

  The system that is run by Blackwater is a medium- to long-term pattern recognition program that trades 45 markets with strict profit targets. The model uses price and volatility patterns as well as some breakout elements. As do many other commodity trading advisors, they use multiple models. After launching the program in 20
05 they added a second model that is longer term. Quoting Jeff, “It is two models and two signals. The second model is based on the same structure; the patterns that we are looking for are a bit bigger. … Once we hit these profit objectives we are switching to a proprietary momentum indicator that tells us when we view the markets as stalling. If the markets are screaming we will stay with the trade until we see any kind of weakness.” What is ironic to me is that they do not use trailing stops. They have profit targets and utilize wide stops.

  The worst drawdown so far that Blackwater has experienced was in 2005–2006 of approximately 15 percent. I would believe that over time they will experience a much greater drawdown as your biggest drawdown is always ahead of you, not behind.

  Blackwater Capital Management is currently managing approximately $500 million. Their minimum managed account size is $5,000,000.

  FIGURE 4.11 Hypothetically, if you invested $100,000 in July 2005, today it would be worth $258,318.06.

  Source: Chart with permission from Iasg.com.

  Justin Vandergrift

  Chadwick Investment Group

  Began July 2007

  CAROR 21.37 percent

  Chadwick Investment Group Inc. was formed by Justin Vandergrift in 2003. Justin's CTA is still small, approximately $11 million, however, with his firm grasp of trend following it would be easy to believe he could be an upcoming player in the commodity trading advisor world. He has the proverbial characteristics of a successful trend follower, passionate, hungry, and driven. Justin has contributed to the books Trend Following, 3rd edition, and The Complete TurtleTrader, 4th edition, written on the trend following method by Michael Covel. As well he was featured in Michael Covel's latest book, The Little Book of Trading.