Extreme Performance Numbers

Like Dunn Capital’s philosophy this chart (Figure 2.1) assumes an in-your-face attitude and that is not negative. That performance data compares returns if you had hypothetically invested $1,000 with Dunn and $1,000 with the S&P. It demands a choice—either put your money with Dunn, learn to trend follow yourself, or pretend trend following does not exist.

Next, consider two charts that reflect different periods of Dunn Capital’s trading history but tell the same story about their approach. The first one (Figure 2.2) is a Japanese yen trade from December 1994 to June 1996, where Dunn made a monumental killing.

Nineteen ninety-five was obviously a great year for Dunn Capital. And in 2003 Bill Dunn walked through his trend following homerun with an audience that came away with an invaluable lesson:

This is 18 months of the Japanese yen and as you can see, it went up and down and there was some significant trends so we should have had an opportunity to make some money and it turns out we did. Because the WMA is a reversal system, it’s always in the market, it’s either long or short, trying to follow and identify the major trends. So while this is the first signal that’s shown on the chart and is long, we obviously must have been short coming in to this big rise. The rise was enough to tell us we should quit being short and start being long and it seemed like a pretty smart thing do and after we saw that big rise up.¹³

Dunn Capital is riding the trend up that first big hill of the yen in March 1995. They are making decisions within the context of their mechanical system. Bill Dunn continues: “Then we have significant retracement, which caused a short signal for the WMA program; our model has always incorporated near-term volatility and this volatility as we went long was far less than the volatility that was going on when we went short.”¹⁴

Bill Dunn summarizes the trade: “Now also because the volatility was very high here, this rise was not enough to give us a long signal and as a result, we rode this short position for nearly a year all the way down—where we got a long signal that was wrong and we reversed and went down to short. Now that was a very, very good market for our program, but some markets are not so good.”¹⁵

The confidence in Bill Dunn’s tone and delivery cannot be replicated in print. I feel fortunate to have the original tape.

Be Nimble

The beginning is the most important part of the work.

Plato

Bill Dunn, with a straight face after riding a trend to great profit, once noted: “The recent volatility in the energy complex has been quite exciting and potentially rewarding for the nimble.”¹⁶

What does Dunn mean by nimble? They mean they are ready to make decisions based on market movement. When an opportunity to get on a potential trend appears, they are prepared. They take the leap. They are nimble when relying on their system; they react to the Japanese yen move with precise rules because they trust their trading plan and risk management.

The second chart is the British pound (Figure 2.3) where, unlike the Japanese yen, the market proved unfavorable for Dunn Capital. It was a whipsaw market, which is always difficult for trend followers. You can see how they entered and were stopped out; then entered and were stopped out again. Remember, trend following doesn’t predict market direction or duration, it reacts—so small losses are always part of the game. Dunn managed the small losses because the British pound was only a portion of their portfolio. Their yen trade more than made up for losses on the British pound trade, because no matter how uncomfortable others are with that approach, for Dunn, big winners offset small losers in the long run.

If you told Bill Dunn his approach made you uncomfortable, he would be blunt:

“We don’t make market predictions. We just ride the bucking bronco.”¹⁷

Dunn’s failed British pound trades demonstrate exactly what he means when he says, “We just ride the bucking bronco.” In hindsight you might ask yourself why was Dunn Capital trading the British pound if they were losing. The simple answer is they nor anyone else could have predicted whether or not the British pound would be the next great home run. The real question is, “Do you stay out of the game because you can’t predict how the game is going to unfold?”

Early Years

Bill Dunn grew up in Kansas City and Southern California. After graduating from high school, he served three years with the U.S. Marine Corps. In the ensuing years he received a bachelor degree in engineering physics from the University of Kansas in 1960 and a doctorate in theoretical physics from Northwestern University. For the next two years he held research and faculty positions at the University of California and Pomona College. He then worked for organizations near Washington, D.C., developing and testing logistical and operational systems for the Department of Defense. He enjoyed the R&D side of things, but wanted to go beyond theoretical. The markets became his real world.

Around the age of 35 Dunn got it. He was working out of his home in suburban Fairfax, Virginia when he came across a newsletter touting a commodity trading system “which almost sounded too good to be true.” Upon testing, it turned out to be the case and he set about developing his new system. Using daily data, Dunn’s original system looked for big trends as defined by a percentage of a price move from a recent low or high. It traded each market three to five times a year, automatically reversing if the trend moved in the other direction. Dunn determined position size by risking 2 percent to 6 percent of equity under management on each trade.¹⁸

It’s not uncommon for long-term trend followers to have trades in place for well over a year, hence the term long. If you want day-trading insanity or the feeling of exhilaration in Las Vegas, Dunn Capital is not the firm you should choose as the trading role model. Following their computerized trading system, Dunn holds long-term positions in major trends, typically trading only two to five times per year in each market. Their original system was a reversal system, whereby it is always in the market either long or short. Dunn notes proudly they have held winning positions for as long as a year and a half.¹⁹

Early on Bill Dunn needed more capital to execute his particular plan of attack on trading. He found it in the person of Ralph Klopenstein. Ralph helped launch Dunn by giving him a $200,000 house account to manage. Dunn, still a Defense Department systems analyst, realized his trading hobby would require a whole lot of other people’s money to properly use his promising system.²⁰

Gas Station Proprietor: “Look, I need to know what I stand to win.”

Anton Chigurh: “Everything.”

Gas Station Proprietor: “How’s that?”

Anton Chigurh: “You stand to win everything. Call it.”

Gas Station Proprietor: “Alright. Heads then.”

[Chigurh removes his hand, revealing the coin is indeed heads]

Anton Chigurh: “Well done.”²¹

That’s a great lesson: When you stop trying to please others and concentrate on pleasing yourself you become aware of what you are passionate about in life. And when that happens, all sorts of supporters come out of the woodwork to help you achieve your goals. Bill Dunn is serendipity proof positive.

Life inside Dunn Capital

Years back Marty Bergin (podcast episode #525) arranged for me to visit Stuart, Florida and spend a day at Dunn Capital. In one of those classic small-world stories Bergin had been my baseball coach when I was 16 in Northern Virginia outside Washington D.C. Today, he is the president and owner of Dunn Capital while Bill Dunn remains chairman emeritus.

Amazingly, their long time office is on a quiet street located off a waterway in the heart of Stuart, a quiet retirement community 30 miles from West Palm Beach. There is no grand entrance at Dunn Capital, so after you enter, your only recourse is to see if anyone is in. It feels more like an accountant’s office than a high-powered trading firm. In fact, the atmosphere is no atmosphere. Dunn is a shining example of why location, pretentious offices, and intense activity have little to do with long-term trading success.

There are not hundreds of employees at Dunn Capital because it doesn’t take armies to run the fund. Plus, not all employees are traders. One issue to deal with when running a fund is not necessarily trading, but accounting and regulatory concerns. No one at Dunn is tied to screens discretionarily trading. Trades are systematically entered only after an alarm goes off indicating a buy or sell signal.

Another reason Dunn Capital has less infrastructure is because they have a few relatively well-chosen clients. In fact, Bill Dunn was fond of saying, “If people want to invest with me, they know where to find me.” Dunn’s investors benefit from the fact there is no disconnect between their bottom line as a fund manager and the investor’s bottom line—to wit, trading profits.

Dunn Capital is different than many because they compound absolute returns. They leave their own money on the table by reinvesting in the fund. As a result, Dunn’s assets are not only made up of clients, but owners and employees too, all systematically reinvesting profits over a very long time.

Confidence comes from success, to be sure, but it can also come from recognizing that a lot of carefully examined failures are themselves one path to success.

Denise Shekerjian²²

By focusing on profits and incentive fees Dunn Capital makes money only when the fund (read: clients) makes money. They don’t charge a management fee. With no management fee, there is no incentive to constantly raise capital. The only incentive is to make money. If Dunn makes money, the firm gets a portion of the profits. Compounding, or reinvesting your profits, makes sense if you’re serious about making money, and Dunn is serious.

In the time I spent with Bill Dunn, Marty Bergin and other staff I was impressed with their matter-of-fact, no-BS attitude. In fact, the very first time I met Bill Dunn he was wearing khakis and a Hawaiian shirt, and made it clear while he looked out over the waterways of Florida, it was his reasoned way or the highway.

No Profit Targets

Dunn Capital doesn’t say, “We want 15 percent a year.” The market can’t be ordered to give a trader a steady 15 percent rate of return, but even if it could, is a steady 15 percent the right way in the first place? If you started with $1,000, what rate of return would you rather have over a period of three years: +15 percent, +15 percent, and +15 percent or the unpredictable –5 percent, +50 percent, and +20 percent? At the end of three years the first hypothetical investment opportunity would be worth $1,520 but the second investment would be worth $1,710. The second one would be a stream of returns representative of a Dunn type trading style.

You can’t dial in a return for a given year. There are no profit targets that work. Bill Dunn explained:

We only have two systems. The first system is the one I started with in 1974. The other system, we developed and launched in 1989. The major strategic elements of these two models—how and when to trade, how much to buy and sell—have never changed in almost 30 years. We expect change. None of the things that have happened in the development of new markets over the past 30 years strike us as making the marketplace different in any essential way. The markets are just the markets. I know that is unusual. I know in the past five years a lot of competitors have purposefully lowered the risk on their models i.e., they are deleveraging them or trying to mix them with other things to reduce the volatility. Of course, they have also reduced their returns.²³

He is addressing a critical issue: reducing risk to reduce volatility for nervous clients. The result is always lower absolute returns. If you remain fixated on volatility as an enemy, instead of seeing volatility as the source of profit, you will never get this.

Money management is the true survival key.

Bill Dunn²⁴

Dunn Capital by definition is very good at using risk management—more commonly called money management, or as Van Tharp calls it, position sizing—to their advantage. In June 2002 Dunn returned 24.26 percent, then followed that with 14.84 percent for July. By that time he was up 37 percent for the same year in which buy-and-holders of the NASDAQ for this period were crushed. Dunn Capital finished 2002 up more than 50 percent. Their 2008 performance was huge again—a big up year when most of the world was collapsing.

How does Dunn do it:

• Cuts losses.
• Never changes core strategy: Dunn Capital’s performance is not a result of human judgment. Their trend following is quantitative and systematic with no discretionary overrides of system-generated trade signals. This is foreign to those who watch CNBC for stock tips. Dunn’s trading style doesn’t drift.
• Long-term holding: For holding periods of approximately 3.75 years and beyond, all returns are positive for Dunn Capital. Lesson? Stay with a system for the long haul and do well.
• Compounding: Dunn Capital compounds relentlessly. The firm plows profits back into their trading system and builds upon fresh gains.
• Recovery: Dunn Capital had losing years of 27.1 percent in 1976 and 32.0 percent in 1981, followed by multi-year gains of 500 percent and 300 percent, respectively. You must be able to accept drawdowns and understand that recovery is around the corner.
• Going short: Dunn Capital goes short as often as he goes long. Buy-and-holders generally never consider the short side. If you are not biased to trend direction, you can win either way.

Dunn Capital has had its share of drawdowns, but their approach remains clear and calm: “Some experience losses and then wait for gains, which they hope will come soon . . . But sometimes they don’t come soon and sometimes they don’t come at all. And the traders perish.”²⁵

Nevertheless, don’t think for a second you are not going to suffer drawdowns, either by trading like Dunn Capital or letting them manage your money. And drawdowns—a.k.a. your account going down—will make you feel like you need an extra dose of Prilosec.

There are great lessons to be learned from Dunn Capital’s performance data, but I found insight in their writings as well²⁶:

1. As global monetary, fiscal, and political conditions grow increasingly unsustainable, the trend following strategy that Dunn Capital steadfastly employs may possibly be one of the few beneficiaries.
2. The only thing that can be said with certainty about the current state of the world economy is that there are many large, unsustainable imbalances and structural problems that must be corrected. Perhaps the equity markets are correctly predicting a rapid return to more stable and prosperous times. Perhaps not. Regardless, there seems to be more than ample fodder for the creation of substantial trends in the coming months.
3. On the truly bright side, it is comforting to know that the opinions expressed in this letter will have absolutely no bearing on the time-tested methods that Dunn Capital uses to generate trading profits and manage risk.

Change is not merely necessary to life—it is life.

Alvin Toffler

I love that even though Bill Dunn, Marty Bergin and the firm have strong political opinions, they know opinions mean zilch when it comes to proper trading. Their political and economic opinions do not form the basis of when to buy and sell. These problems prevent clients from seeing Dunn Capital’s perspective:

• Clients usually do not understand trend following’s nature. They often panic and pull out just before the big move makes a lot of money.
• Clients may start asking for the trader to change their approach. Although they may not have articulated this directly to the fund manager, they really wanted the trend following strategy customized for them before investing their money in the first place. The manager is then faced with a difficult decision: Take the client’s money and make money through management fees (which can be lucrative) or trade the capital as originally designed. Trading a trend following system as originally designed is the optimal path in the long run.

There must be a match between trader and client as Bill Dunn noted: “A person must be an optimist to be in this business, but I also believe it’s a cyclical phenomenon for several other reasons. In our 18 years [40+ now] of experience, we’ve had to endure a number of long and nasty periods during which we’ve asked ourselves this same question. In late 1981, our accounts had lost about 42 percent over the previous 12 months, and we and our clients were starting to wonder if we would ever see good markets again. We continued to trade our thoroughly researched system, but our largest client got cold feet and withdrew about 70 percent of our total equity under management. You guessed it. Our next month was up 18 percent, and in the 36 months following, their withdrawal of our accounts made 430 percent!”²⁷

Check Your Ego

Dunn Capital once posted a want ad that caught my eye. Part of it read: “Candidates . . . must NOT be constrained by any active non-compete agreement and will be required to enter into a confidentiality and non-compete agreement. Only long-term, team players need apply (no prima donnas). Salary: competitive base salary, commensurate with experience, with bonus potential and attractive benefits, beginning at $65,000.”²⁸

Notice that Dunn Capital says, “No prima donnas.” Readers of this ad can choose either to work for Dunn or attempt to be Dunn on their own, but they cannot have both. Trend following demands taking personal responsibility for one’s actions, and Dunn Capital makes it clear they are responsible.

An interesting trait seen in many trend followers is their honesty. If you listen closely to their words and review their performance, they tell you exactly what they are doing and why. Dunn Capital is a great example in action.

Men’s expectations manifest in trends.

John W. Henry²⁹

There is no Holy Grail. There is no perfect way to capture that move from $100/ounce to $800/ounce in gold.

John W. Henry³⁰

Prediction Is Futile

Henry was always blunt about prediction fantasies:

I don’t believe that I am the only person who cannot predict future prices. No one consistently can predict anything, especially investors. Prices, not investors, predict the future. Despite this, investors hope or believe that they can predict the future, or someone else can. A lot of them look to you to predict what the next macroeconomic cycle will be. We rely on the fact that other investors are convinced that they can predict the future, and I believe that’s where our profits come from. I believe it’s that simple.

Because trend following is primarily based on a single piece of data—the price—it is difficult to paint the true story of what that means. Henry was always able to articulate clearly and consistently how he traded, year after year, to those willing to listen carefully. To generate his profits, 
he relied on the fact other traders thought they could predict where the market will go and often ended up as losers. Henry would tell you that he routinely won the losses of the market losers in the zero-sum trading game.

On the Farm

How are we able to make money by following trends year in and year out? Trends develop because there’s an accumulating consensus on future prices, consequently there’s an evolution to the believed true price value over time. Because investors are human and they make mistakes, they’re never 100 percent sure of their vision and whether or not their view is correct. So price adjustments take time as they fluctuate and a new consensus is formed in the face of changing market conditions and new facts. For some changes, this consensus is easy to reach, but there are other events that take time to formulate a market view. It’s those events that take time that form the basis of our profits.

John W. Henry

John W. Henry was born in Quincy, Illinois, to a successful farming family. For a Midwestern farm boy in the 1950s, there was nothing in the world like baseball, and from the time nine-year-old Henry went to his first major league game, he was hooked. In the summer he would listen to the great St. Louis Cardinals broadcaster Harry Caray night after night. Henry described himself as having average intelligence, but a knack for numbers. And like many young baseball fans, he crunched batting averages in his head.

Henry attended community colleges and took numerous night courses, but never received his college degree. It wasn’t for lack of interest, however. When he was attending a class taught by Harvey Brody at UCLA, they collaborated on and published a strategy for beating blackjack odds. When his father died, Henry took over the family farms, teaching himself hedging techniques on the side. He began speculating in corn, wheat, and soybeans. And it wasn’t long before he was trading for clients. In 1981, he founded John W. Henry and Company, Inc. in Newport Beach, California.³¹

Henry’s first managed account was staked with $16,000 and he now owns the Boston Red Sox. Don’t you think the best question to ask is, “How?” A former president at his trading firm speaks to their success:

There has been surprisingly little change. Models we developed 20 years ago are still in place today. Obviously, we trade a different mix of markets. We’ve also added new programs over the last 20 years, but relative to many of our peers, we have not made significant adjustments in our trading models. We believe that markets are always changing and adjusting, and the information that’s important to investors will also change. In the 1980s, everyone was interested in the money supply figures . . . everyone would wait by their phones until that number came out. In the 1990s, the information du jour was unemployment numbers. But people’s reactions to the markets are fairly stable. Uncertainty creates trends and that’s what we’re trying to exploit. Even if you have better and faster dissemination of information, the one thing we haven’t really improved is people’s ability to process information. We’re trying to exploit people’s reaction, which is embedded in prices and leads to trends. These reactions are fairly stable and may not require major adjustments of models.³²

He reiterates an important philosophical tenet of trend following: In looking at the long-term, change is constant. And because change is constant, uncertainty is constant. And from uncertainty, trends emerge. It is the exploitation of these trends that forms the basis of trend following profit. All of your cutting-edge technology or news reading is not going to help you trade trends.

When I spoke with Henry’s president, he sounded like classic traders from 100 years earlier:

• “We stick to our knitting.”
• “Most people don’t have the discipline to do what they need to do.”
• “We like to keep it sophisticatedly simple.”
• “Our best trading days are when we don’t trade.”
• “We make more money the less we trade.”
• “Some of our best trades are when we are sitting on our hands doing nothing.”
• “We don’t want to be the smartest person in the market. Trying to be the smart person in the market is a losing game.”

He was not being flippant. His tone was matter of fact. He wanted people to understand why his firm succeeded. A few years ago he gave a great analogy about the emotional ups and downs: “Looking at the year as a mountain ride . . . Anyone who has ridden the trains in mountainous Switzerland will remember the feeling of anxiety and expectations as you ascend and descend the rugged terrain. During the decline, there is anxiety because you often do not know how far you will fall. Expectations are heightened as you rise out of the valley because you cannot always see the top of the mountain.”³³

We have made our business managing risk. We are comfortable with risk and we get our reward from risk.

John W. Henry³⁴

Life is a school of probability.

Walter Bagehot³⁵

Worldview Philosophy

Trend followers like Henry could not have developed his trading systems without first deciding how he was going to view the world. Through experience, education, and research, he came to an understanding of how markets work before he determined how to trade them. What he found was market trends are more pervasive than people think, and trends could have been traded in the same way 200 years ago as they are today.

Henry spent years studying historical price data from the eighteenth and nineteenth centuries in order to prove his research. When he explained his philosophy he was crystal clear about what it was and what it was not:

• Long-term trend identification: Trading systems ignore short-term volatility in the attempt to capture superior returns during major trending markets. Trends can last as long as a few months or years.
• Highly disciplined investment process: Methodology is designed to keep discretionary decision making to a minimum.
• Risk management: Traders adhere to a strict formulaic risk management system that includes market exposure weightings, stop-loss provisions, and capital commitment guidelines that attempt to preserve capital during trendless or volatile periods.
• Global diversification: By participating in more than 70 markets and not focusing on one country or region, they have access to opportunities that less diversified firms may miss.

The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor.

Jesse Livermore

The uninformed dismiss trend following as predictive technical analysis. Henry was not a predictive indicator guru: “Some people call what we do technical analysis, but we just identify and follow trends. It’s like, if you are in the fashion world, you have to follow trends, or you’re yesterday’s news. But as with technical analysis, trend followers believe that markets are smarter than any of their individual participants. In fact, they make it their business not to try to figure out why markets are going up or down or where they’re going to stop.”³⁶

Henry’s use of fashion as a metaphor goes beyond obvious comparison between trends in clothing and in markets. To be fashionable you have no choice but to follow trends. Likewise, trend followers have no choice but to react and follow trends, and like those who follow fashion early, successful trend followers exploit trends long before the public is clued in.

Trend followers would agree with H. L. Mencken when he said, “We are here and it is now. Further than that, all human knowledge is moonshine.” They understand attending to what is taking place in the market from moment to moment isn’t a technique; it is what is and that is all. The moment, the here and now, is the only place that is truly measurable.

Henry illustrated the point in a coffee trade: “All fundamentals were bearish: The International Coffee Organization was unable to agree on a package to support prices, there was an oversupply of coffee, and the freeze season was over in Brazil . . . his system signaled an unusually large long position in coffee. He bought, placing 2 percent of the portfolio on the trade. The system was right. Coffee rallied to $2.75 per lb. from $1.32 in the last quarter of the year, and he made a 70 percent return. ‘The best trades are the ones I dislike the most. The market knows more than I do.’”³⁷

What You Think You Know Gets You in Trouble

Henry knew the complicated, difficult elements of trend following were not about what you must master, but what you must eliminate from your market view.

On why long-term approaches work best:

“There is an overwhelming desire to act in the face of adverse market moves. Usually it is termed ‘avoiding volatility’ with the assumption that volatility is bad. However, I found avoiding volatility really inhibits the ability to stay with the long-term trend. The desire to have close stops to preserve open trade equity has tremendous costs over decades. Long-term systems do not avoid volatility; they patiently sit through it. This reduces the occurrence of being forced out of a position that is in the middle of a long-term major move.”³⁸

We don’t predict the future, but we do know that the next five years will not look like the last five years. That just doesn’t happen. Markets change. And our results over the next three years will not replicate the last three. They never do.

John W. Henry³⁹

On stocks: “The current thinking is that stocks have outperformed everything else for 200 years. They may have a little relevance for the next 25 years. But there is no one in the year 2000 that you can convince to jettison the belief that 200 years of performance will not cause stocks to grow to the sky. Right now people believe in data that supports the inevitable growth in prices of stocks within a new landscape or new economy. What will be new to them is an inevitable bear market.”⁴⁰

For all his talk about avoiding predictions, Henry is making one here. He is predicting stocks can’t go up forever because eventually trends reverse themselves. He is also pointing out that as a trend follower he was prepared to take action and profit (which he did during the market crash of October 2008).

Starting with Research

Henry has influenced many traders. One of his former associates presented these observations in his new firm’s marketing materials:

• The time frame of the trading system is long-term in nature, with the majority of profitable trades lasting longer than six weeks and some lasting for several months.
• The system is neutral in markets until a signal to take a position is generated.
• It is not uncommon for markets to stay neutral for months at a time, waiting for prices to reach a level that warrants a long or short position.
• The system incorporates predefined levels of initial trade risk. If a new trade turns quickly unprofitable, the risk control parameters in place for every trade will force a liquidation when the preset stop-loss level is reached. In such situations, a trade can last for as little as one day.

This same employee participated in a conference seminar while at Henry’s firm. The conference was sparsely attended and, as happens when someone speaks to a small audience, the conversation became more informal and more revealing:

There are only a limited number of Fed meetings a year; however, this is supposed to help us infer the direction of interest rates and help us manage risk on a daily basis. How do you manage risk in markets that move 24 hours a day, when the fundamental inputs do not come frequently? In the grain markets, crop reports are fairly limited, and demand information comes with significant lags, if at all. Under these types of conditions, simple approaches, such as following prices, may be better.

Mark S. Rzepczynski⁴¹

We are very well aware of the trends that have taken place in the last 20 years and we are just curious to see are we in a period in this century that trend following seems to work? Have we lucked out that we happen to be in this industry during trends for the last decade or two? We went back to the 1800s and looked at interest rates, currency fluctuations, and grain prices to see if there was as much volatility in an era that most people don’t know much about as there has been this decade. Much to our relief and maybe also surprise, we found out that there were just as many trends, currencies, interest rates, and grain prices back in the 1800s as there has been exhibited this last decade. Once again, we saw the trends were relatively random, unpredictable, and just further supported our philosophy of being fully diversified, and don’t alter your system to work in any specific time period.

He added:

Hours and hours were spent in the depths of the university library archives. They gave us Xerox burns on our hands, I think, photo-copying 
grain prices, and interest rate data—not only in the U.S., but also around the world. We looked at overseas interest rates back to that time period. A lot of it is a little bit sketchy, but it was enough to give us the fact that things really jumped around back then as they do now.⁴²

It reminded me of the scene in the Wizard of Oz when Toto pulls back the curtain to reveal how the wizard works his magic. It was clear there were no secret formulas or hidden strategies. There were no short cuts. This was slow, painstaking trench warfare in the bowels of a research library, armed only with a photocopier to memorialize price histories.

Years later I was inspired to do my own price research. My objective in the moment was not to use price data in a trading system, but to see also how little markets had changed. One of the best places to research historical market data in newspapers and magazines from over 100 years ago is the U.S. National Agricultural Library. Don’t be misled by the word Agricultural. You can review the stacks at this library and spend hours poring over magazines from the 1800s. Like Henry’s firm, I discovered through weeks of research that markets were indeed the same then as now.

We can’t always take advantage of a particular period. But in an uncertain world, perhaps the investment philosophy that makes the most sense, if you study the implications carefully, is trend following. Trend following consists of buying high and selling low. But trends are an integral, underlying reality in life. How can someone buy high and sell low and be successful for two decades unless the underlying nature of markets is to trend? On the other hand, I’ve seen year-after-year, brilliant men buying low and selling high for a while successfully and then going broke because they thought they understood why a certain investment instrument had to perform in accordance with their personal logic.

John W. Henry⁴³

On the Record

I had the chance to hear Henry speak in person at a FIA Research Division Dinner in New York City years back. This was only months after the Barings Bank debacle. During the Q&A Henry revealed the qualities shared by all successful trend followers. He refused to waste time discussing fundamentals and offered a genuine appreciation of the nature of change:

Change Is Overrated

Henry was publicly forthright for years. For instance, his presentation in Geneva, Switzerland, could have been a semester course in trend following for those open to the message: “We began trading our first program, in 1981 and this was after quite a bit of research into the practical aspects of a basic philosophy of what drives markets. The world was frighteningly different in those days than it is today when I was designing what turned out to be a trend following system. That approach—a mechanical and mathematical system—has not really changed at all. Yet the system continues to be successful today, even though there has been virtually no change to it over the last 18 years.”⁴⁵

I always know what’s happening on the court. I see a situation occur, and I respond.

Larry Bird

I can’t help but notice the “we haven’t changed our system” chorus is not only sung by Dunn, but by Henry and many other trend followers. Consider an example of a winning trend for Henry (see Figure 2.4): “We took a position around March or April 1998 in the South African rand, short (which would be this particular chart; this is the dollar going up against the rand). You can see it takes time for these things and if you’re patient, you can have huge profits, especially if you don’t set a profit objective.”⁴⁶

Moreover, Henry did well in the historical Japanese yen trade shown in Figure 2.5. Henry concluded: “You can see that in this enormous move, when the dollar/yen went from 100 to 80 in that particular month we were up 11% just in the Japanese yen that quarter.”⁴⁷

Fade the Fed

Overreaction to Federal Reserve announcements is part of Wall Street life. Some so-called pros take the Federal Reserve’s words and act on them even if there is no way to know what any of it means. And does it make logical sense to worry about what the Fed is going to do if there is no way to decipher it? The Fed to the best of my knowledge has never offered any statement you could rely on that says, “Buy 10,000 shares of GOOG now and sell here.”

Henry’s trend following system was never predicated on the Fed’s statements: “I know that when the Fed first raises interest rates after months of lowering them, you do not see them the next day lowering interest rates. And they don’t raise rates and then a few days later or a few weeks later lower them. They raise, raise, raise, raise . . . [pause] . . . raise, raise, raise. And then once they lower, they don’t raise, lower, raise, lower, raise, lower. Rather they lower, lower, lower, lower. There are trends that tend to exist, whether they are capital flows or interest rates . . . if you have enough discipline, or if you only trade a few markets, you don’t need a computer to trade this way.”⁴⁸

Henry knows the human mind creates anxiety by conjuring up terrifying future market scenarios. He kept focused in the present on what he could control—his system. That attitude for dealing with the Fed never changes, no matter who is playing the game.

The chief obstacle is that we are quick to be satisfied with ourselves. If we find someone to call us good men, cautious and principled, we acknowledge him. We are not content with a moderate eulogy, but accept as our due whatever flattery has shamelessly heaped upon us. We agree with those who call us best and wisest, although we know they often utter many falsehoods: we indulge ourselves so greatly that we want to be praised for a virtue which is the opposite of our behavior. A man hears himself called ‘most merciful’ while he is inflicting torture... So it follows that we don’t want to change because we believe we are already excellent.

Seneca

Trading Retirement

John W. Henry shut his trend following firm down in 2012, but most of his assets under management were pulled in 2007 before the financial crisis in October 2008. That meant billions in Merrill Lynch assets left Henry’s firm and went to other trend following firms (e.g., firms in London). And by the time 2008 unfolded, his money under management had decreased so much that even his great 2008 performance was not enough.

Many will tell you John W. Henry was simply too volatile for modern tastes (whatever modern means exactly), and when taking a look at his programs’ track records, there were big numbers on both sides. Take his Financials & Metals 36 percent annualized volatility for example, or the multiple years with above 40 percent gains or more than 17 percent losses, and you can see that Henry’s model was one of high risk for high return.⁴⁹

Not surprisingly, his exit from trend following has left some confused. This 2016 note in my inbox illustrates: “I recently purchased your Trend Following book (2009 edition) and have been eagerly reading it for the past several days. After reading about the success of John W. Henry, 
I decided to look him up and discovered he had to close his firm a few years ago after experiencing unsustainable losses. In your book, you frequently discuss how time and time again critics argue that trend following is dead, yet they are consistently proven wrong. My question is, if trend following is such a reliable strategy, how could one of the most successful trend followers collapse? In general, I agree with all of the points you make in your book, but I worry that if someone who is exceedingly versed in the methods of trend following can lose huge sums of money, then someone like me, with absolutely no experience using trend following techniques, is also bound to fail.”

Great question. An insider with Henry at the time provided insights instructive for the confused or skeptical:

• “It is a fallacy to say John W. Henry collapsed.” His clients moved on to other trend following firms. Firm assets went from over $2 billion to $150 million in around 1.5 years.
• The firm did not close because of “unsustainable” losses but more from a re-deployment of his talents and investment capital.
• Big funds are all about “distribution.” That means keeping brokers happy, as they live and die with commissions. Henry’s peers weathered the storm.
• Competition replaced older firms who did not respond to vagaries of the brokerage industry. Trend following assets under management exploded inside several London-based firms (e.g., Winton, Aspect, Cantab, etc.).
• Henry essentially moved into venture capital. Red Sox Baseball was not a hobby—it was a business transaction. He also bought Fenway Park, the broadcasting, the Boston Globe, and Liverpool Football Club (U.K.). People don’t think of Henry as a venture capitalist, but he became one.
• Henry still trades his own money as a trend follower with “two” of his original “guys” there.

As an investor you have to dig deep past headline reading. You have to understand all issues associated with any investment—trend following included. And if you think trend following died because John W. Henry or any other one person stopped running a trend fund, you may want to ponder a more complete view, not the incomplete one. Go do the autopsy. Find out why. And hypothetically, even if John W. Henry was the only trend follower to have ever walked the planet, his public 30-year track record requires an objective post mortem.

Win or lose, everybody gets what they want out of the market. Some people seem to like to lose, so they win by losing money.

Ed Seykota⁵⁰

Performance

Seykota earned, after fees, nearly 60 percent on average each year from 1990 to 2000 managing proprietary money in his managed futures program.⁵³

But he is different than Harding, Henry, and Dunn. He literaly has been a one-man shop his entire career. There is no fancy office or other employees. He does not hold himself out as a fund manager and he is extremely selective of clients. He doesn’t care whether people have money or that they want him to trade or not. Seykota takes big risks and he gets big rewards—that takes a strong stomach.

Pyramiding instructions appear on dollar bills. Add smaller and smaller amounts on the way up. Keep your eye open at the top.

Ed Seykota⁵⁴

Seykota was born in 1946. He earned his Bachelor of Science from MIT in 1969 and by 1972 had embarked on the trading career he pursues to this day—investing for his own account and the accounts of a few select others. He was self-taught, but influenced in his career by Amos Hostetter and Richard Donchian.

Originally, he took a job with a major broker. He then conceived and developed the first commercial computerized trading system for client money in the futures markets. And according to Market Wizards, he increased one client’s account from $5,000 to $15,000,000 in 12 years.

His trading is largely confined to the few minutes it takes to run his internally written computer program, which generates trading signals for the next day. He also mentors traders through his website and his Trading Tribe, a widespread community of like-minded traders. He has served as a teacher and mentor to some great traders, including Michael Marcus and David Druz.

The Secret

Seykota debunks market ignorance with terse, Zen-like statements that force the listener to look inward: “The biggest secret about success is that there isn’t any big secret about it, or if there is, then it’s a secret from me, too. The idea of searching for some secret for trading success misses the point.”⁵⁵

That self-deprecating response emphasizes process over outcome, but don’t be misled by his modesty, for he gets impatient with hypocrisy and mindlessness. He is a fearless trader and does not suffer fools gladly. Yet when he remembers his first trade, I saw the passion: “The first trade I remember, I was about five years old in Portland, Oregon. My father gave me a gold-colored medallion, a sales promotion trinket. I traded it to a neighbor kid for five magnifying lenses. I felt as though I had participated in a rite of passage. Later, when I was 13, my father showed me how to buy stocks. He explained that I should buy when the price broke out of the top of a box and to sell when it broke out of the bottom. And that’s how I got started.”⁵⁶

Later on he was more directly inspired: “I saw a letter published by Richard Donchian, which implied that a purely mechanical trend following system could beat the markets. This too seemed impossible to me. So I wrote computer programs (on punch cards in those days) to test the theories. Amazingly, his [Donchian] theories tested true. To this day, I’m not sure I understand why or whether I really need to. Anyhow, studying the markets, and backing up my opinions with money, was so fascinating compared to my other career opportunities at the time, that I began trading full time for a living.”⁵⁷

The guy with discretion has what, a crystal ball?

Leda Braga

Trading was now in his blood, and at age 23 he went out on his own with about a half-dozen accounts in the $10,000–25,000 range.⁵⁸ He found an alternative to the Wall Street career built only on commissions. From the beginning he worked for incentive fees alone. If he made money for his clients, he got paid. If he did not make money, he did not get paid. Most brokers, index fund managers, and hedge funds don’t work like that.

Never Mind the Cheese

As a new trader, Seykota passed through Commodities Corporation, a trader training ground in Princeton, New Jersey. One of his mentors was Amos Hostetter. Hostetter made phenomenal amounts of money trading. When a market’s supply-and-demand prospects looked promising, Hostetter would put up one-third of his ultimate position. If he lost 25 percent he’d get out. “Never mind the cheese,” he’d crack, “let me out of the trap.” But when the market swung his way he’d add another third, taking a final position when prices climbed half as high as he thought they’d go. Hostetter’s strategies were so successful they were computerized so other traders could learn to duplicate his success.⁵⁹

His get-out-of-the-trap strategies influenced many top traders of the last 30 years. Who else passed through Commodities Corp.? Traders with names like Paul Tudor Jones, Bruce Kovner, Louis Bacon, and Michael Marcus paid their dues there. Interestingly, in the mid-1990s, long after the majority of well-known trend followers had left, I visited Commodities Corporation’s offices.

Midway through the tour, I bumped into a stressed-out energy trader. After a few minutes of conversation, we began to chat about his trading style, which was based on fundamentals. Throughout the entire conversation, he was glued to the monitor. When I brought up trend following, he assured me it did not work. I was surprised that a trader working for a famous firm, known for training brilliant trend followers, was completely blinded to even the possibility that trend following worked. I realized then even those closest to trend following’s roots had no appreciation for it.

I believe babies are born as innovative personalities, but our social processes work to stamp out exploration and questioning.

Jay Forrester

System Dynamics

Along with Hostetter, MIT’s Jay Forrester was a strong influence on the then young Seykota: “One of my mentors, Jay Forrester, was a stickler for clear writing, a sign of clear thinking.”⁶⁰

Forrester taught Seykota about system dynamics, which is a method for studying the world around us. Unlike other scientists, who study the world by breaking it up into smaller and smaller pieces, system dynamicists look at things as a whole. The central concept to system dynamics is understanding how all the objects in a system interact with one another. A system can be anything from a steam engine, to a bank account, to a basketball team. The objects and people in a system interact through feedback loops, where a change in one variable affects other variables over time, which in turn affects the original variable, and so on. An example of this is money in a bank account. Money in the bank earns interest, which increases the size of the account. Now the account is larger, it earns even more interest, which adds more money to the account. This goes on and on. What system dynamics attempts to do is understand the basic structure of a system, and thus understand the behavior it can produce. Many of these systems and problems that are analyzed can be built as models on a computer. System dynamics takes advantage of the fact a computer model can be of much greater complexity and carry out more simultaneous calculations than can the mental model of the human mind.⁶¹

If a gambler places bets on the input symbol to a communication channel and bets his money in the same proportion each time a particular symbol is received, his capital will grow (or shrink) exponentially. If the odds are consistent with the probabilities of occurrence of the transmitted symbols (i.e., equal to their reciprocals), the maximum value of this exponential rate of growth will be equal to the rate of transmission of information. If the odds are not fair, i.e., not consistent with the transmitted symbol probabilities but consistent with some other set of probabilities, the maximum exponential rate of growth will be larger than it would have been with no channel by an amount equal to the rate of transmission of information.

J. L. Kelly, Jr⁶²

This type of thought process and computer modeling is not only a foundation of his success, but also can be seen across the entire trend following success landscape.

FAQs

Examples of Seykota’s clear wisdom⁶³:

For a system trader, it’s way more important to have your trading size down than it is to fine tune your entry and exit points.

David Druz⁶⁴

To avoid whipsaw losses, stop trading.

Lesson: You will have losses. Accept them.

Here’s the essence of risk management: Risk no more than you can afford to lose, and also risk enough so that a win is meaningful. If there is no such amount, don’t play.

Lesson: Position sizing or money management is crucial.

Trend following is an exercise in observing and responding to the ever-present moment of now. Traders who predict the future dwell upon a nonexistent place, and to the extent they also park their ability to act out there, they can miss opportunities to act in the now.

Lesson: All you have is now. It is much better to react to the fact of market movements in present time than a future time that doesn’t exist.

Markets are fundamentally volatile. No way around it. Your problem is not in the math. There is no math to get you out of having to experience uncertainty.

Lesson: You can crunch all the numbers you like, but your “gut” still has to handle the ups and downs. You have to live with and feel the uncertainty.

I recall, in the old days, people showing a lot of concern that markets are different and trend following methods no longer work.

Lesson: Today or yesterday, skeptics abound. They sound like broken records in their desires to see trend following debunked.

It can be very expensive to try to convince the markets you are right.

Lesson: Go with the flow. Leave your personal or fundamental opinions at the door. Do you want to be right or make money? Losers try to convince everyone they are right.

When magazine covers get pretty emotional, get out of the position. There’s nothing else in the magazine that works very well, but the covers are pretty good. This is not an indictment of the magazine people, it’s just that at the end of a big move there is a communal psychological abreaction that shows up on the covers of magazines.⁶⁵

Lesson: Crowd psychology is real and the price reflects all.

Students

Campbell versus Benchmarks

While I am no proponent of benchmarking, the following chart (Table 2.3) shows drawdown comparisons across asset classes:

Many skeptics like to think trend followers are the only ones with drawdowns. The chart, however, shows the truth of drawdowns across several indexes and fund types. The key is to accept drawdowns and be able to manage them when they occur. Otherwise, you are left watching the NASDAQ drop 77 percent peak to trough over 2000–2002 with no plan on what to do next.

Still, Campbell’s strategies were often doubted by Wall Street, especially the old-guard efficient market types that griped about the riskiness of trend following. Campbell counters: “A common perception is that futures markets are extremely volatile, and that investing in futures is therefore very risky, much riskier than equity investments. The reality is that, while not for everyone, generally futures prices are less volatile than common stock prices. It is the amount of leverage available in futures, which creates the perception of high risk, not market volatility. The actual risk involved in futures trading depends, among other things, upon how much leverage is used.”⁷²

Campbell & Company analyzes only technical market data, not any economic factors external to market prices.⁷³

Managing leverage is crucial component for risk management regardless of strategy. It is a key part that allows traders to keep coming back day after day and year after year to trade and win.

Correlation and Consistency

Most trend followers earn their returns at different times than common benchmark measures, such as the S&P stock index. Campbell (see Table 2.4) is lowly correlated with major stock market indexes.

Our trend following methods do not pretend to determine the value of what we are trading, nor do they determine what that value ought to be, but they do produce absolute returns fairly consistently.

Campbell & Company⁷⁴

Even more remarkable than the low correlation to the S&P, Campbell’s performance (see Table 2.5) is consistent over total months, total years, and five rolling time windows:

Qualitatively you are not terribly more knowledgeable about Campbell & Company now. But quantitatively their performance numbers demonstrate something way more than an anomaly or luck.

Skeptics

Parker gave a rare speech at the height of the Dot-com bubble. His address covered a full range of trend following philosophies. However skeptical Parker’s audience, it did not prevent him from offering simple, direct, and solid advice about trading to those willing to accept it.

• Dangers of a buy and hold mentality: “The strategy of buy and hold is bad. Hold for what? A key to successful traders is their ability to leverage investments . . . many [traders] are too conservative in their willingness to leverage.”⁷⁶
• Folly of predicting where markets may be headed: “I don’t know nor do I care. The system that we use at Chesapeake is about the market knowing where it’s going.”⁷⁷
• His trend following trading system: “This flies in the face of what clients want: fancy schools, huge research, an intuitive approach that knows what’s going to happen before it happens, e.g., be overweight in the stock market before the rate cut. But obviously you can’t know what’s going to happen before it happens, and maybe the rate cut is the start of a major trend, and maybe it’s okay to get in after. That’s our approach. No bias short or long.”⁷⁸
• Counter-trend or day trading: “The reason for it is a lot of traders as well as clients don’t like trend following. It’s not intuitive, not natural, too long-term, not exciting enough.”⁷⁹
• The wishful thinking of market disaster victims: “They said ‘the market’s wrong, it’ll come back.’ The market is never wrong.”⁸⁰

Ask yourself if you want to be right or do you want to win. They are different questions.

Intelligence

Trend following success is much more predicated on discipline than pure academic achievement. Parker is candid about intelligence: “We have a system in which we do not have to rely on our intellectual capabilities. One of the main reasons why what we do works in the markets is that no one can figure out what is happening.”⁸¹

I participated in the Richard Dennis “Turtle Program.” The methods we were taught and the trading experience received were all a technical approach to trading the commodity markets. The most important experience that led me to utilize a technical approach was the amount of success that I experienced trading Rich’s system.

Jerry Parker⁸²

The great trend followers admit pure IQ is no savior. They also know the latest news of the day does not figure into decisions about when to buy, when to sell, or how much to buy or sell. Parker adds, “Our pride and opinions should not interfere with sound trading approaches.”⁸³

TurtleTraders

Eventually, Dennis would achieve fantastic wealth with profits in the hundreds of millions of dollars. However, his real fame would come from his experiment in teaching trading to new traders.

In 1983 he made a bet with his partner William Eckhardt. Dennis believed trading could be taught. Eckhardt belonged to the “you’re born with it or you’re not” camp. They decided to experiment by seeing whether they could teach novices successful trading. Twenty-plus students were accepted into two separate training programs. Legend has it Dennis named his students “Turtles” after visiting a turtle-breeding farm in Singapore.

How did it start? Dennis ran classified ads saying Trader Wanted and was immediately overwhelmed by some 1,000 queries from would-be traders. He picked 20+ novices, trained them for two weeks, and then gave them money to trade for his firm. His Turtles included two professional gamblers, a fantasy-game designer, an accountant, and a juggler. Jerry Parker, the former accountant who now manages more than $1 billion, was one of several who went on to become top money managers.⁹²

I agree with the metaphysics of technical analysis that the fundamentals are discounted. You don’t get any profits from fundamental analysis; you get profit from buying and selling. So why stick with the appearance when you can go right to the reality of price and analyze it better?

Richard Dennis⁹³

There’s nothing quite as good or bad as trading. They give you a number every day. That’s what’s good about it, and that’s what’s bad about it. That’s what makes it hard. That’s what makes it worth doing.

Richard Dennis⁹⁴

Although Dennis appears to own the mantle of trend following teaching professor, there are many other trend followers, including Seykota, Dunn, and Henry, who have served as teachers to successful traders. Also keep in mind not all the Turtles turned out winners. After they left Dennis’s tutelage several Turtles failed (i.e., Curtis Faith, who later served jail time). Perhaps, too, after some Turtles went out on their own they could not cope without the safety net. Jerry Parker is a monster exception to that theory—he is absolutely the most successful of the Turtles.

This is not a criticism of the system Dennis taught his students. It is rather an acknowledgment that some could not stick with his trading system. In stark contrast, Bill Dunn was completely unknown to the general public when the Turtles burst onto the scene in the 1980s. Since that time Dunn has slowly overtaken all Turtles in terms of absolute performance. I wonder if something about the initial one-man shop of Dunn set in motion habits enabling his firm to roar past the Turtles, who had the head start. For years, many Turtles also refused to acknowledge they were trend followers, while Dunn was candid. Maybe the hype and mystery set forward in the Market Wizards books did not help in the long run.

Nevertheless, the story of the Turtles is so amazing still in 2017 that the criteria Dennis used to select his students is insightful.

Selection Process

Dale Dellutri, a former executive at Dennis’s firm, managed the Turtle group. He said they were looking for “smarts and for people who had odd ideas.” Ultimately, they selected several blackjack players, an actor, a security guard, and a designer of the fantasy game Dungeons & Dragons. One of the ways they screened candidates was by having them answer true-or-false questions.

The following true-or-false questions were sent to the Turtles and were used to decide who was picked and who went home:

All a company report and balance sheet can tell you is the past and the present. They cannot tell future.

Nicolas Darvas

1. One should favor being long or being short, whichever one is comfortable with.
2. On initiation, one should know precisely at what price to liquidate if a profit occurs.
3. One should trade the same number of contracts in all markets.
4. If one has $100,000 to risk, one ought to risk $25,000 on every trade.
5. On initiation, one should know precisely where to liquidate if a loss occurs.
6. You can never go broke taking profits.
7. It helps to have the fundamentals in your favor before you initiate.
8. A gap up is a good place to initiate if an uptrend has started.
9. If you anticipate buy stops in the market, wait until they are finished and buy a little higher than that.
10. Of three types of orders (market, stop, and resting), market orders cost the least skid.
11. The more bullish news you hear and the more people are going long, the less likely the uptrend is to continue after a substantial uptrend.
12. The majority of traders are always wrong.
13. Trading bigger is an overall handicap to one’s trading performance.
14. Larger traders can “muscle” markets to their advantage.
15. Vacations are important for traders to keep the proper perspective.
16. Under trading is almost never a problem.
17. Ideally, average profits should be about three or four times average losses.
18. A trader should be willing to let profits turn into losses.
19. A very high percentage of trades should be profits.
20. A trader should like to take losses.
21. It is especially relevant when the market is higher than it’s been in 4 and 
13 weeks.
22. Needing and wanting money are good motivators to good trading.
23. One’s natural inclinations are good guides to decision making in trading.
24. Luck is an ingredient in successful trading over the long run.
25. When you’re long, “limit up” is a good place to take a profit.
26. It takes money to make money.
27. It’s good to follow hunches in trading.
28. There are players in each market one should not trade against.
29. All speculators die broke.
30. The market can be understood better through social psychology than through economics.
31. Taking a loss should be a difficult decision for traders.
32. After a big profit, the next trend following trade is more likely to be a loss.
33. Trends are not likely to persist.
34. Almost all information about a commodity is at least a little useful in helping make decisions.
35. It’s better to be an expert in one to two markets rather than try to trade 10 or more markets.
36. In a winning streak, total risk should rise dramatically.
37. Trading stocks is similar to trading commodities.
38. It’s a good idea to know how much you are ahead or behind during a trading session.
39. A losing month is an indication of doing something wrong.
40. A losing week is an indication of doing something wrong.
41. The big money in trading is made when one can get long at lows after a big downtrend.
42. It’s good to average down when buying.
43. After a long trend, the market requires more consolidation before another trend starts.
44. It’s important to know what to do if trading in commodities doesn’t succeed.
45. It is not helpful to watch every quote in the markets one trades.
46. It is a good idea to put on or take off a position all at once.
47. Diversification in commodities is better than always being in one or two markets.
48. If a day’s profit or loss makes a significant difference to your net worth, you’re overtrading.
49. A trader learns more from his losses than his profits.
50. Except for commission and brokerage fees, execution “costs” for entering orders are minimal over the course of a year.
51. It’s easier to trade well than to trade poorly.
52. It’s important to know what success in trading will do for you later in life.
53. Uptrends end when everyone gets bearish.
54. The more bullish news you hear, the less likely a market is to break out on the upside.
55. For an off-floor trader, a long-term trade ought to last three or four weeks or less.
56. Others’ opinions of the market are good to follow.
57. Volume and open interest are as important as price action.
58. Daily strength and weakness is a good guide for liquidating long-term positions with big profits.
59. Off-floor traders should spread different markets of different market groups.
60. The more people are going long, the less likely an uptrend is to continue in the beginning of a trend.
61. Off-floor traders should not spread different delivery months of the same commodity.
62. Buying dips and selling rallies is a good strategy.
63. It’s important to take a profit most of the time.

Always say ‘yes’ to the present moment. Surrender to what is. Say ‘yes’ to life and see how life starts suddenly to start working for you rather than against you.

Eckhart Tolle

Chance is commonly viewed as a self-correcting process in which a deviation in one direction induces a deviation in the opposite direction to restore the equilibrium. In fact, deviations are not corrected as a chance process unfolds, they are merely diluted.

Amos Tversky

Not all were true or false. Dennis also asked essay questions:

1. What were your standard test results on college entrance exams?
2. Name a book or movie you like and why.
3. Name a historical figure you like and why.
4. Why would you like to succeed at this job?
5. Name a risky thing you have done and why.
6. Explain a decision you have made under pressure and why that was your decision.
7. Hope, fear, and greed are said to be enemies of good traders. Explain a decision you may have made under one of these influences and how you view that decision now.
8. What are some good qualities you have that might help in trading?
9. What are some bad qualities you have that might hurt in trading?
10. In trading would you rather be good or lucky? Why?
11. Is there anything else you’d like to add?

No trader can control volatility completely, but you can improve your odds.

Student of Richard Dennis

Those questions might seem simplistic, but Dennis did not care: “I suppose I didn’t like the idea that everyone thought I was crazy or going to fail, but it didn’t make any substantial difference because I had an idea what I wanted to do and how I wanted to do it.”⁹⁵

Dennis placed passion to achieve at the top. You have to wake up with inner drive and desire to make it happen. You have to go for it. He also outlined the trend following problem with profit targets—a key lesson taught to the Turtles: “When you have a position, you put it on for a reason, and you’ve got to keep it until the reason no longer exists. Don’t take profits just for the sake of taking profits.”⁹⁶ Dennis made it clear if you didn’t know when a trend would end, but you did know it could go significantly higher, then don’t get off.

Whatever you use should be applied in some quantitative, rigorous fashion. You should use science to determine what works and quantify it. I’m still surprised today at how I can expect so strongly that a trading methodology will be profitable but, after running it though a simulation, I discover it’s a loser.

Paul Rabar⁹⁷

I don’t think trading strategies are as vulnerable to not working if people know about them, as most traders believe. If what you are doing is right, it will work even if people have a general idea about it. I always say that you could publish trading rules in the newspaper and no one would follow them. A key is consistency and discipline.

Richard Dennis⁹⁸

Yet even though some of his Turtle students had successful money management careers, Dennis did not do well when trading for clients. His most recent stab at managing money for others resulted in a compounded annual return of 26.9 percent (after fees). That included two years when performance was over 100 percent.

But he stopped trading for clients after a drawdown in 2000. His clients pulled their money right before his trading would have rebounded. Doubt me? Use Dunn Capital or any other trend follower as a proxy and you will see what happened in the fall of 2000. If those impatient clients had stayed with Dennis they would have been richly rewarded.

I became a computer applicant of Dick’s [Donchian] ideas. He was one of the only people at the time who was doing simulation of any kind. He was generous with his ideas, making a point to share what he knew; it delighted him to get others to try systems. He inspired a great many people and spawned a whole generation of traders, providing courage and a road map.

Ed Seykota⁹⁹

One of the most crucial lessons a trader can learn is trading for your own account and for clients are different. John W. Henry was blunt with me saying it was never easy losing money for clients. On the other hand, traders who concentrate on expanding their own capital have a great advantage. Fund managers must always deal with the pressure and expectations of clients.

Personification of Persistence

Richard Donchian was not an overnight sensation. After 42 years, Donchian was still managing only $200,000. Then, in his mid-60s, everything came together, and a decade later, he was managing $27 million at Shearson American Express, making $1 million a year in fees and commissions and another million in trading profits on his own money.¹⁰⁴

I remember in 1979 or 1980, at one of the early MAR conferences, being impressed by the fact that I counted 19 CTAs who were managing public funds, and I could directly identify 16 of the 19 with Dick Donchian. They had either worked for him or had had monies invested with him. To me, that’s the best evidence of his impact in the early days. Dick has always been very proud of the fact that his people have prospered. He also was proud that after too many years in which his was the lone voice in the wilderness, his thinking eventually came to be the dominant thinking of the industry.

Brett Elam¹⁰⁵

Donchian of course didn’t predict price movements; he followed them. His explanation for his success was simple and as old as the Dow Theory itself: “Trends persist.” He added: “A lot of people say things like: Gold has got to come down. It went up too fast. That’s why 85 percent of commodities investors lose money. The fundamentals are supposed to be bullish in copper. But I’m on the short side now because the trend is down.”¹⁰⁶

These classic Donchian trading rules were first published over 
75 years ago:

General Guides

1. Beware of acting immediately on a widespread public opinion. Even if correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume increases.
3. Limit losses and ride profits, irrespective of all other rules.
4. Light commitments are advisable when market position is not certain. Clearly defined moves are signaled frequently enough to make life interesting and concentration on these moves will prevent unprofitable whip-sawing.
5. Seldom take a position in the direction of an immediately preceding three-day move. Wait for a one-day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, to limit losses, and from certain formations such as triangular foci to take positions. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
7. In a market in which upswings are likely to equal or exceed downswings, heavier position should be taken for the upswings for percentage reasons—a decline from 50 to 25 will net only 50 percent profit, whereas an advance from 25 to 50 will net 100 percent profit.
8. In taking a position, price orders are allowable. In closing a position, use market orders.
9. Buy strong-acting, strong-background commodities and sell weak ones, subject to all other rules.
10. Moves in which rails lead or participate strongly are usually more worth following than moves in which rails lag.
11. A study of the capitalization of a company, the degree of activity of an issue, and whether an issue is a lethargic truck horse or a spirited race horse is fully as important as a study of statistical reports.

Losing an illusion makes you wiser than finding a truth.

Ludwig Borne

Donchian Technical Guidelines

1. A move followed by a sideways range often precedes another move of almost equal extent in the same direction as the original move. Generally, when the second move from the sideways range has run its course, a counter move approaching the sideways range may be expected.
2. Reversal or resistance to a move is likely to be encountered:
   1. On reaching levels at which in the past, the commodity has fluctuated for a considerable length of time within a narrow range
   2. On approaching highs or lows
3. Watch for good buying or selling opportunities when trend lines are approached, especially on medium or dull volume. Be sure such a line has not been hugged or hit too frequently.
4. Watch for “crawling along” or repeated bumping of minor or major trend lines and prepare to see such trend lines broken.
5. Breaking of minor trend lines counter to the major trend gives most other important position taking signals. Positions can be taken or reversed on stop at such places.
6. Triangles of ether slope may mean either accumulation or distribution depending on other considerations, although triangles are usually broken on the flat side.
7. Watch for volume climax, especially after a long move.
8. Don’t count on gaps being closed unless you can distinguish between breakaway gaps, normal gaps, and exhaustion gaps.
9. During a move, take or increase positions in the direction of the move at the market the morning following any one-day reversal, however slight the reversal may be, especially if volume declines on the reversal.

Students

Barbara Dixon was one of the more successful female trend traders in the business. She graduated from Vassar College in 1969, but because she was a woman and a history major, no one would hire her as a stockbroker. Undaunted, she finally took a job at Shearson as a secretary for Donchian. Dixon received three years of invaluable tutelage in trend following under Donchian. When Donchian moved to Connecticut she stayed behind to strike out on her own in 1973. Before long she had some 40 accounts ranging from $20,000 to well over $1 million.

Can one know absolutely when price will trend? No. Does one have to know absolutely in order to have a profitable business? No. In fact, a great number of businesses are based on the probability that a time-based series will trend. In fact, if you look at insurance, gambling, and other related businesses, you will come to the conclusion that even a small positive edge can mean great profits.

Forum Post

Dixon saw uncomplicated genius in Donchian’s trading: “I’m not a mathematician. I believe that the simple solution is the most elegant and the best. Nobody has ever been able to demonstrate to me that a complex mathematical equation can answer the question, ‘Is the market moving in an uptrend, downtrend, or sideways?’ Any better than looking at a price chart and having simple rules to define those three sets of circumstances. These are the same rules I used back in the late 70s.”¹⁰⁷

Donchian was once again ahead of his time when he taught the importance of fast and simple decision making. Dixon was fond of pointing out a good system is one that keeps you alive and your equity intact when trends evaporate. She explained that the reason for any system is to get you into the market when a trend establishes. Her message: “Don’t give up the system even after a string of losses . . . that is important because that’s just when the profits are due.”¹⁰⁸

She also doesn’t attempt to predict price moves, nor expect to be right every time. She knows she can’t forecast the top or bottom of a price move. The hope is it continues indefinitely because you expect to make money over the long run, but on individual trades you admit when you’re wrong and move on.¹⁰⁹

Today most market players still fixate on the new and fresh fast-money idea of the day, yet I still find almost every word Donchian (or Dixon) wrote newer, fresher and more honest than anything currently broadcast on CNBC. My favorite Donchian wisdom tackles an issue that people are still struggling with in 2017: “It doesn’t matter if you’re trading stocks or soybeans. Trading is trading, and the name of the game is increasing your wealth. A trader’s job description is stunningly simple: Don’t lose money. This is of utmost importance to new traders, who are often told ‘do your research.’ This is good advice, but should be considered carefully. Research alone won’t ensure a profit, and at the end of the day, your main goal should be to make money, not to get an A in How to Read a Balance Sheet.”

Richard Donchian’s blunt and a-touch-too-honest talk may explain why the Ivy League’s finance curriculums do not include his exploits.