I previously wrote a post about Market Wizards: Interviews With Top Traders. This post is the fifth in a series of curated interview questions and responses from the notes that I took while reading the book.
Who is Ed Seykota?
Ed Seykota is one of the pioneers of computerized trading systems and has been extraordinarily successful with a combination of technical analysis and trend following techniques. Jack D. Schwager writes that Seykota is “one of the best traders of our time”. Seykota claims that one account that he managed in 1972 started with $5,000 and over the course of 16 years has achieved a return of over 250,000 percent on a cash-on-cash basis and several million percent after adjusting for withdrawals. His interview is worth the read for traders interested in implementing a systematic trading system.
Without divulging trade secrets, how have you been able to so spectacularly outperform standard trend-following systems?
The key to long-term survival and prosperity has a lot to do with the money management techniques incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
Witty and true, but the question remains, albeit in translated form: There are many trend-following systems with money management rules; why have you done so much better?
I seem to have a gift. I think it is related to my overall philosophy, which has a lot to do with loving the market sand maintaining and optimistic attitude. Also, as I keep trading and learning, my system (that is the mechanical computer version of what I do) keeps evolving. I would add that I consider myself and how I do things as a kind of system which, by definition, I always follow. Sometimes I trade entirely off the mechanical part, sometimes I override the signals based on strong feelings, and sometimes I just quit altogether. The immediate trading result of this jumping around is probably breakeven to somewhat negative. However, if I didn’t allow myself the freedom to discharge my creative side, it might build up to some kind of blowout. Striking a workable ecology seems to promote trading longevity, which is one key to success.
What are the present and future prospects for trend-following systems? Do you think the growing prevalence of their use will doom them to eventual failure?
No. All trading is done on some sort of system, whether or not it is conscious. Many of the good systems are based on following trends. Life itself is based on trends. Birds start south for the winter and keep on going. Companies track trends and alter their products accordingly. Tiny protozoa move in trends along chemical and luminescence gradients.
The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and undercapitalized and inexperienced traders will get shaken out. Longevity is the key to success.
What are your thoughts about using fundamental analysis as an input in trading?
Fundamentals that you read about are typically useless as the market has already discounted the price, and I call them “funny-mentals.” However, if you catch on early, before others believe, then you might have valuable “surprise-a-mentals.”
Your answer is a bit facetious. Does it imply that oyu only use technical analysis?
I am primarily a trend trader with touches of hunches base don about twenty years of experience. In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading. Way down in very distant fourth place are my fundamental ideas and, quite likely, on balance, they have cost me money.
By picking the right spot to buy, do you mean determining a reaction point at which you will buy? If so, how do you avoid sometimes missing major price moves?
Oh no. If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk. I don’t try to pick a bottom or top.
What are the elements of good trading?
The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.
How do you handle a losing streak?
I handle losing streaks by trimming down my activity. I just wait it out. Trying to trade during a losing stream is emotionally devastating. Trying to play “catch up” is lethal.
Do you decide where you are getting out before you get in on a trade?
I set protective stops at the same time I enter a trade. I normally move these stops int o lock in a profit as the trend continues. Sometimes, I take profits when a market gets wild. This usually doesn’t get me out any better than waiting for my stops to close in, but it does cut down on the volatility of the portfolio, which calm my nerves. Losing apposition is aggravating, whereas losing your nerve is devastating.
What is the maximum percentage of equity you will risk on any individual trade?
I intend to risk below 5 percent on a trade, allowing for poor executions. Occasionally I have taken losses above that amount when major news caused a thin market to jump through my stops.
Very few traders have enjoyed the spectacular success you have. What makes you different?
I feel my success comes from my love of the markets. I am not a casual trader. It is my life. I have a passion for trading. It is not merely a hobby or even a career choice for me. There is no question that this is what I am supposed to do with my life.
What are the trading rules you live by?
a. Cut losses.
b. Ride winners.
c. Keep bets small.
d. Follow the rules without question.
e. Know when to break the rules.
Your last two rules are cute because they are contradictory. Seriously now, which do you believe: Follow the rules, or know when to break the rules?
I believe both. Mostly I follow the rules. As I keep studying the markets, I sometimes find a new rule which breaks and then replaces a previous rule. Sometimes I get to a personal breakpoint. When that happens, I just get out of the markets altogether and take a vacation until I feel that I am ready to follow the rules again. Perhaps some day, I will have a more explicit rule for breaking rules.
I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
What is the most important advice you can give the average trader?
That he should find a superior trader to do his trading for him, and then go find something he really loves to do.
At what point did you get the confidence that you could keep on winning as a trader?
I vacillate between (a) “I can keep on winning,” and (b) “I have just been lucky.” I sometimes get the most confident of my ability just before a major losing streak.
Why do so many traders fail in the marketplace?
For the same reason that most baby turtles fail to reach maturity: Many are called and few are chosen. Society works by the attraction of the many. As they are culled out, the good ones are left, and the others are released to go try something else until they find their calling. The same is true for other fields of pursuit.
What can a losing trader do to transform himself into a winning trader?
A losing trader can do little to transform himself into a winning trader. A losing trader is not going to want to transform himself. That’s the kind of thing winning traders do.
What traits do you look for to identify the winning trader personality?
He/she loves to trade; and
He/she loves to win.
Interview questions and responses are from Market Wizards: Interviews With Top Traders by Jack D. Schwager. If you enjoyed this post, follow Curated Alpha via Email,RSS, or Twitter . You can also purchase Market Wizards at Amazon.