Last week I travelled to Seattle and had the great honor of meeting Ed Seykota and watching him give a presentation to the Puget Sound chapter of the Market Technicians Association.
Ed is without doubt one of the most renowned trend followers in market history, and came to prominence for many through arguably the most engaging and quoted of all Jack Schwager’s ‘Market Wizard’ interviews in 1989.
He was in good form, returning to the city where he was born, and with banjo in hand, kicked off the evening with a rendition of ‘The Whipsaw Song’ coercing the audience to sing along and learn his trend following rules.
Before going into his main presentation, he spoke about his work with The Trading Tribe, a group he established for traders to deal with the psychological issues that affect their trading, but which has now extended to a much wider audience. This is something clearly important to him and he talked about it at length in the Q&A afterwards too.
He then turned to the main topic of the evening, and the subject of his most recent book, Govopoly in the 39th Day. For anyone who wasn’t already aware of the subject matter this may not have been what they were expecting, as it’s a heavy subject and he was attempting to do it justice in an hour or so. I was already aware of its outline having listened to his podcast with Michael Covel in 2013, and as luck would have it, had just read the entire book a few hours earlier on the flight over!
Govopoly is monopoly by government sanction, and Ed believes in an assimilation model where the govopoly system grows inside the economy by assimilating the assets of the free-competition sector until both are destroyed, similar to the way a parasite consumes its host. He uses the example of duckweed in a pond that grows exponentially, doubling every day or so until it covers the entire surface in just 40 days. By the time the problem is recognized the pond is half covered, it’s the 39th day and already too late to act. The duckweed in this case is debt. Ed states that no fiat currency system has ever lasted more than a few hundred years and he sees an eventual collapse as a certainty, it’s just a question of when, and it may still be many years from now. He does however offer some advice on navigating such a scenario, which I’ll leave you to explore further in the book.
He seemed wary of being associated with the extreme elements in social and political arenas that share such views, lamenting the lack of credible material available on the subject, and it’s likely this was a motivation in writing his book. I would also note the stark contrast here between having an opinion but not trading it. He still trades his trend following models the same as he ever has, but is aware of the need to adapt system risk parameters should a rapidly changing economic environment materialize in the way he foresees.
After the presentation he had a Q&A session which after a couple of Govopoly questions moved more into Trading Tribe psychological questions and general trading questions. I wasn’t able to capture every question and answer, so in some places I may narrate or paraphrase what was said, but otherwise anything in quotes and italics is all him.
He was asked about how he weights different markets, ie futures and commodities, compared to stocks, and unless I’ve misunderstood, his answer surprised me here, because at first I thought he was talking about survivorship bias and answering it as if the questioner had meant how he weights his portfolio at any given time, rather than how he weights his universe of markets he covers, but I believe he is actually saying you should have a part of your system that selects the universe of markets on an ongoing basis rather than having a fixed universe to take the signals from. I can understand that approach in stocks as there are so many and it’s a problem I’ve wrestled with myself, but unless I’m misunderstanding him I haven’t heard this in futures before. I have always assumed most Trend Following CTA’s have a fixed universe from which they take whatever signals are triggered.
“That depends on which ones are moving, I’m weighted toward the stuff that’s moving. I don’t have a fixed portfolio, I have a varied portfolio. Part of what the system does it has predicated in that it selects the markets. In a lot of backtesting you start with a certain portfolio, and you say I’m gonna test these 25 things, and you optimize it. OK. Cool. Except for one thing. You selected those 25 things today and then you started the test back 20 years ago so you brought information back to the future, from now to the start of your run. So if you really want to do a system, you’ve got to have a system that has an algorithm in it for picking a portfolio as well as trading it. You can’t pick the portfolio now, transport it back to the past and say ‘Hey that worked really good’, and you get some numbers. So now, I’m gonna start trading today but I’m gonna start trading today based on a portfolio of stuff that I find out how it does 20 years from now. That’s what you’re saying. You’re gonna test and start trading something based on the theory that your portfolio today is gonna be based on the results you’re gonna do 20 years in the future from now.”
“So the question you’re asking me about how do you weight it, I say go back and make sure your system has a method in it for selecting markets, because you’ve got to have that thing run cold turkey with no information, it’s got to pick the markets too. If you have a fixed portfolio you’ve already fudged and you’re curve-fitting. Take markets that aren’t even there any more, years ago you would’ve had onions, potatoes, pork bellies in your portfolio, but you probably aren’t going to backtest with those things in there now, unless your system has a way of putting those things in. Try even getting data on that stuff. You’re not gonna find a database with them in it but they were big markets, but your data now is not gonna have them in there so how are you gonna do a backtest and decide what markets? I don’t have all the answers for you, but I can try to raise some questions for you to think about.”
Ed was asked about his use of magazine covers which he has been known to use in some of his discretionary systems, and if it would cause him to lighten up on a position.
“Some systems I don’t, some systems have some discretionary things. If I see a magazine cover it has to have certain characteristics about it. It has to have a certain emotional content, it has to have certainty that something’s going to happen. It’s not every magazine cover, but every so often…”
He was pressed if his recent website posting of a magazine cover on the Euro was an example of that, but stated he simply posts whatever people send questions on, and wouldn’t be drawn on an opinion.
“I don’t give market opinions, but I’m curious about things and I’ll post it up and say ‘well take a look at this’… I just put it up there as a curiosity… when oil was $150, every magazine had oil on the cover in the same week… that was the top of the market”
He was asked for his thoughts on why people medicate, what is its main function? - medicating in this sense is a reference to an action or pattern of behavior that one uses to suppress feelings, and is one of the areas Trading Tribe members work on when they meet.
“People learn to medicate, usually from their parents, the word medication to me means when somebody does something to make a feeling go away, rather than dealing with the underlying situation. So if someone is overweight, they have feelings about it, they don’t like it, they can take a proactive approach, eat less and exercise more, or they can go to the refrigerator and torpedo their feelings by eating a lot of cookies. A lot of times medication will interfere with being proactive, alcohol is pernicious that way, because alcohol destroys a lot of things, and you can’t even work with people who have alcohol addictions, alcohol is very pernicious.”
“The thing we work most with in the tribe is medicinal patterns of response, which is someone will shut down or pout, or walk away… the most proactive thing in most situations is tell the other people in the situation how you feel, and that seems to be hard for people to do, that unwinds most of the problems someone has, tell the person how you feel and ask them how they’re feeling and get that information to flow with rapport and without judgment. That solves 90% of everything.”
“Most people can’t do it, they say ‘well it won’t work in this case, ’cause I just can’t talk to that person’ but that’s the solution to most problems and most medication. It has to do with shutting down the ability to tell what you’re feeling, and when you stop telling yourself how you feel and you start to medicate… you start doing things with your trading to medicate your feelings, because it’s hard, it’s counter cultural to buy things at the high, it’s counter-cultural to buy something everyone else is saying to sell it, it’s hard to do.”
“Medication is some behavior pattern that operates directly on your feelings and makes you feel better, it’s when you select that path rather than dealing with the underlying situation that requires hard work and requires that you deal with those feelings.”
“We find most people will shut down because they had some pattern or person in their life that they saw shut down, or be abusive. If you have an abusive father and a mother that puts up with it and she says look this is the way to get along in this family you just shut up let him beat you for a while and he’ll go away, the pattern gets expressed that way. After a while anytime something gets tough that person is just gonna shut down and go to sleep. They have a bad trade, the thing goes against them and they’re supposed to put their stop in there and they didn’t do it because they just didn’t like getting beat up by that market. Pretty soon it gets in their trading.”
“So we try to unwind it, when you have an abusive parent we set up a role play and you just confront the abusive parent and say ‘what are you feeling, what are you feeling right now, I want to tell you how I feel, I feel scared, and I feel angry what you’re doing to me, and I want to know how you’re feeling.’ You maintain the rapport, and you get the feelings to pass and when that happens in most cases the abusive person loses any desire and will apologize for what they’re doing… but people don’t believe it will work, so we set up role-playing for them to practice a few times. and they say, ‘Gee it worked in this role-playing, I believe it’, and then they’ll risk it. Advice will never work because they will never be able to muster the response in real life against a lifetime of someone shutting them down so we use role-playing.”
Ed was asked about the early part of his career and the mental fortitude required to ride major trends, if he felt any mental distress or pressure holding onto large gains, how did some of those big trades feel?
His response “Sad, I felt very sad” was clearly unexpected. The questioner replied ‘that surprises me’ to which Ed responded “It surprised me too, but that’s what it was. It felt very sad.”
He continued “You just don’t know, but I worked on that… that’s what happened… everyone has a different way of doing it, everyone has a different set of feelings. You asked me what I felt and I gave you the answer… I don’t recommend that, but some people get angry, or they get very proud and arrogant, so I think maybe sad wasn’t a bad alternative to feeling arrogant, because those guys just know everything and there’s no talking to them.”
Asked if he still felt sad now he joked “No, I don’t feel much of anything, like a machine. My favorite guy is Data from Star Trek.” He added “I don’t think it matters what you feel as long as you don’t respond to it in a medicinal way. If you have a feeling and you respond to it proactively you’re going to have more success, but if you have some feeling whether it’s sad or happy or jealous and you let that interfere with your trading then you’re going to get a different result. You always have a choice, are you gonna medicate the feeling or are you gonna have a proactive response? What the feeling is, I don’t think it even matters. I wouldn’t try to change it, just figure out a healthy response to it.”
He then responded to a further question on working through feelings:-
“Well that’s what we do in tribe, we’re always looking at our feelings, and how we respond to them. We don’t judge them. Someone has a feeling we say ‘Well, that’s your feeling, good. Do that more.’ We encourage them to explore and find where it’s coming from and specifically what kind of action do they take in response to the feeling. We’ve been talking about families but this applies to what you do in trading or your relationships. We’re always looking at feelings, we don’t judge them as being right or wrong. We can’t change our feelings, what we can do is change how we respond to them.”
Have you noticed any notable difference in returns between your systematic and discretionary systems?
“I would say basically I’m always experimenting with stuff within different portfolios, in general the automatic trading stuff is a lot better than my attempts to come up with discretionary things. I’m not very good. But at least I know. I want to try it, I want to experiment with it but I limit the risk, I don’t consider I’m good at it.
As he has a lot of self-awareness and yet his systems are very scientific, he was asked if over the years he has been able to incorporate some of the psychological things he’s discovered into his systems.
“I don’t try to suppress the feelings, that won’t work. I try to express the feelings and find out what they’re trying to do and do what they want to do, and then I have the trading going on too. You can think of the system as a silicon-based logic system, and you can think of feelings as carbon-based. Silicon-carbide. Look for that. You want to combine the two. Carborundum. Almost as hard as a diamond. Carbon and silicon working together.”
Do the people in your trading tribe mostly trade systems too, or are some discretionary?
“Everybody’s got a different way. A lot of them have systems, some of them aren’t even traders. There’s no right way, there’s just a right way for you. I’m not here to teach you a way of trading, because I don’t think it would work. If you traded like me it would drive you crazy. Trading Tribe started out as what can we do with our feelings, because we’re always screwing up our trading with our feelings, and we got that down and we kept going because people said ‘well, I’m getting results in my life, with my family, my relationship with my children is getting better,’ so the Trading Tribe became more of a support group for anything. It started out as a trading-specific group but it’s not just for traders… people stop medicating other areas, lead happier lives and become more focused on their work.”
Ed was asked about adding to a trade, his thoughts on pyramiding, and if he had a preferred method.
“If you backtest a pyramiding system and it works, follow it. Most pyramiding that works, you pyramid up to your base position, a quarter of it, a half, you pyramid up to your base position, but if you keep adding on it’s a different trade. So you might want to look at whether pyramiding is part of your system, or is that just additional drama to medicate something else because you want excitement in your life. Pyramiding is exciting, but you might want to backtest it. If you can get it in your system then that’s fine, but if you have a system and then you say ‘now I’m going to pyramid’ well that’s something else, that’s drama on top of a system.”
Ed was asked if his Trading Tribe ‘Essentials’ card depicting his trend following rules is still available.
It is. He told us he used to have an offer where if you sent him a dollar he’d send you the card plus two dollars, but he didn’t have any takers! Then when he charged $10 everyone wanted one! He now gives you a choice. You can buy it here for $1, or you can pay $10 here! I don’t know if he still sends $2 back on the first offer.
“They’re not secrets! There are no secrets. The only secret is there’s no secret, and the guys that sell secrets don’t want you to know that secret.”
How did you come to live in Puerto Rico and how long have you lived there?
“I went down there in June of last year on a business trip for three days and on the third day I decided to not go back. I asked a friend of mine to pick my car up from the airport because I’m not coming back for a while. It’s been a wonderful adventure, I’m living my life in Spanish now…”
Ed had already stated he still trades one of his first systems which has hardly changed since 1970, and mentioned the influence of Richard Donchian. He was asked how many systems he is trading now.
“Well I have relationships with people that have systems. So I have a number of relationships in which I have a part of the system. I won’t identify those, but I have participations in those. Those are mostly purely systems, some are partially discretionary. I have a bunch of them. I have a diversified portfolio of systems myself first hand, and some of them have more discretion than others… Each person has developed a system, I’ve helped them develop it and tune it up to fit them… and they do the trading… I also had a relationship with a broker and said here’s the deal, you follow the system for me and you can have my account, as long as you follow the system. If you miss one signal I’m gonna move my account somewhere else. So he had no stake in jumping it. He has to follow the system in order to maintain the account. So that’s another way of doing it.”
In relation to his Govopoly book Ed was asked if in a rapidly changing environment, there are market events that would cause him to intervene in his systems, or would he let his system take care of it.
“If you have an override to your system that’s part of your system which is outside the math, so you might want to consider looking in advance at what that is that you would do and make that part of your system. Otherwise you’ve got drama. You’ve either got a system or you don’t. Sometimes the system loses money, sometimes it doesn’t. If you have a system and then you think ‘Well I have to have an override to the system’ then what is the nature of the override, what are you doing? Can you define what it is you’re doing as your override and can you make that part of your system and backtest that override as part of your system?”
Ed was asked about knowing what the ‘right risk’ is, and if he could talk about position sizing.
“If it’s too much you’re going to have more volatility, and if it’s too little you don’t make any money. There’s an optimal amount based on what I call your ‘bliss function’. You optimize your system with regard to both things. You want to reward the system for long term rate of return and you want to penalize it for volatility, so you use Sharpe ratio or MAR or some other bliss function and you optimize your system around that. You optimize it with your stomach and make sure you can take it. When I started out, the way I built it when I first started, I said I want to build a system, I can handle a 50% drawdown. How much money can I make on a 50% drawdown? That was my parameter and that was a good time to do that because it was a very aggressive system. I had 50% drawdowns several times and I always came out of them. I would come out in a couple of weeks. Those days that was the right system. These days that’s pretty draconian, you won’t have many customers if you try to do that. But in those days it was really good. So it depends on what kind of drawdown can you really handle.”
Ed was asked for his shortlist of favorite trading books.
“I think Reminiscences of a Stock Operator has pretty much the last word on it. Extraordinary Popular Delusions and the Madness of Crowds. Those are a hundred years old, nothing much better written on it, and then the operators manual for Excel to get some testing going.”
How might you differentiate the role of skill versus luck?
He pondered this a while before answering: “I think skill versus luck is some subjective decision you make retrospectively on a situation. You either involve a system or you don’t, you do what you do, and then you sort it out and parse it and say ‘well, that was skill and that was luck’, but I don’t think that leads anywhere. I think you work hard and you do the best you can. Sometimes you get a break, sometimes you don’t. Sometimes the market moves in your direction, sometimes it moves against, and you can say ‘well that was lucky and that was skill’ or whatever, I don’t see how that changes anything. It’s an interesting way to parse things, are we living in a deterministic society or is there free will? You can argue that one, but I don’t think it makes a difference. You just do the best you can, mostly learn not to shut down under stress, learn to stay awake and express your feelings to other people, do your backtesting, commit to following the system, notice when you’re jumping your system, what feelings you had that made you do it, try to learn something about yourself. I think that’s about the best you can do.”
I’ve been very fortunate to have met some extremely talented traders and money managers over the years, including a couple of legendary trend followers, and one of the things I’m struck by is their mindset, their way of thinking, isn’t just markedly different to most people, but even to most traders. When you ask them a question, if you’ve really done your homework, deep down you already know what they’re going to say, it’s just it’s not the answer you want to hear! If you just asked the question stood in front of the mirror you’d have your answer. Listening to some of the questions to Ed I was thinking ‘I know this one!’, because to be honest the answer to most questions asked of trading legends all have a similar theme – you’ve got to do it yourself. They can help guide you, but they can’t give you the answer, only you can. You’ve got to do it yourself, and there’s just the moment of now.