August 17, 2011

Ed Seykota - Trading System

Beginning
Ed Seykota runs his closed fund from an office in his house near Lake Tahoe in the American state Nevada. The famous investor Warren Buffett used to live in the same area in the 1980s, but moved away. Maybe Warren Buffett felt he had to move when he realized what kind of returns Ed Seykota achieved?

Lake Tahoe. Source: Wikipedia

Ed Seykota holds a degree in Electrical Engineering from MIT. He became interested in the combination of electrical engineering and finance while in school. But the first experience from the stock market happened when he was thirteen and his father showed him how to buy stocks. His first experience from trading took place in the late 1960s. Ed Seykota decided that silver had to rise, so he opened an account and waited for the large profits. But silver began to fall. "I became more and more fascinated with how markets work," he said.
    At the same time as Ed Seykota had begun trading, he read a report by Richard Donchian, who has given his name to Donchian Channels - an indicator used in market trading. The paper told how a mechanical trend-following system could beat the markets. Ed Seykota wrote a computer program to test if these theories were true, and it turned out they were.
    In the early 1970s, Ed Seykota got his first job as an analyst on Wall Street. He wanted to use computers to improve his analysis, but he was only allowed to use the company's accounting computer during the weekends. Computers were not as common in the 1970s as they are today. Despite the limited time, Ed Seykota simulated about a hundred variations of four simple systems for about ten years on ten commodities. The results said that it was possible to make money by trading with a trend-following system.
    The management of the company became interested in the system Ed Seykota developed. The first commercial computerized trading system was developed, but there was only one problem. The management didn't like the system since it didn't generate enough commission income. So the management of the company wanted to change the system to make it generate more buy and sell signals to improve the commission income. This was one of the reasons to why the now 23 years old Ed Seykota decided to leave the company and create his own fund.

On his own
Ed Seykota work and lives in the same house. He doesn't have a quote machine. The only time he watches the market is when the trading software generates signals for the next day. This happens once a day – after the close of the markets - and it takes only a few minutes.
    One of the problems with Ed Seykota is that he's not publicizing his track record. But he has publicized a model account. That account is an actual customer account that started with $5,000 in 1972 and it has made over $15 million as of mid 1988. Theoretically, the total return would have been many multiples larger if no withdrawals had been made.
    With results like that, Ed Seykota receive requests, but he rarely accepts new accounts. If he accepts a new account, he demands that his customer has to be committed to Ed Seykota managing the money, and not withdraw them if a small loss occurs.

Strategy
What's the secret? "The biggest secret about success is that there isn't any big secret about it, or if there is, then it´s a secret for me too," he said. "The idea of searching for some secret for trading success misses the point."
    Two of his largest inspirational sources were the book Reminiscences of a Stock Operator and Richard Donchian's five- and twenty-day moving average crossover system and his weekly rule system. Ed Seykota's first system was a variation of Richard Donchian's moving average system, but he used an exponential averaging method because it was easier to calculate and computational errors tended to disappear over time. "My style is basically trend following, with some special pattern recognition and money management algorithms," he said. To help us more, Ed Seykota has written "The Whipsaw Song."


The essentials of the song are:
  • Ride your winners. Before one can ride a winner, one has to buy the winner. Ed Seykota believes the long-term trend and the current chart pattern are important to look at before initializing a trade – and then picking a good spot to buy or sell short. He wants to identify a point at which he expect the market momentum to be strong in the direction of the trade. But don't try to pick a bottom or a top. One should stay in the market until a stop point is hit. "Being bullish and not being long is illogical," he said.
  • Cut your losses. Ed Seykota doesn't like to remember past situations. He cut bad trades as soon as possible, forgets everything about them, and then move on the new opportunities. The elements of good trading are:
    • Cutting losses
    • Cutting losses
    • Cutting losses
  • Manage your risk. The key to long-term survival and prosperity has a lot to do with the money management techniques incorporated into the technical system you have. Always bet as much you can handle and no more.
  • Use stops. One should set protective stops at the same time as a trade is initiated. These stops are normally moved to lock in a profit as the trend continues.
  • Stick to the system. Ed Seykota believes it's important to follow the rules without any question. But he also says it's important to know when to break the rules. On example on breaking the rules is when Ed Seykota sometimes take a profit when a market gets "wild" – before his system tells him it's time to sell. The trading system should also keep evolving as the trader keeps learning. The profitability of trading systems seems to move in cycles – you shouldn't give up the trading system if it becomes unprofitable for a while. "Longevity is the key to success," he said.
  • File the news. Ed Seykota believes that the fundamentals you read about are typically useless, and he nicknamed them "funny-mentals." The market has probably already discounted the fundamentals in the price. But fundamentals might work if one is lucky enough to discover them early before everyone else.

Not everyone can be a good trader. Ed Seykota's success originates from his love of the markets. He has a passion for trading – it is his life. But sometimes he exits all positions and take a vacation until he is motivated enough to follow his trading rules again.
    According to Ed Seykota, there are different types of traders in the markets:
  • Winners – winning traders have usually been winning at whatever field they have acted in.
  • Winners - they win because they are lucky.
  • Losers – some people don't want to improve their trading. They get a lot of excitement from winning at first – and then they lose it all because they haven't learned anything. This process of winning and losing is often repeated. Ed Seykota believes this is because this type of people don't want to win, and argues how "Everyone gets what they want out of the market."

Conclusions:
  • One can trade profitably in the financial markets and at the same time live far away from Wall Street.
  • The biggest secret about success in the financial markets is that there isn't any big secret. No one can possibly know what's going to happen in the future. One can only guess.
  • One can trade profitably in the financial markets without staring at a computer screen all day.
  • Stay in the market as long as you are bullish. Being bullish and not being in the market is illogical.

Update! There's a new interview with Ed Seykota available here: Ed Seykota Interview with Michael Covel on Trend Following Radio.

Sources:

2 comments:

  1. Sekoyta...all he did was 1-2-3 tops and bottoms on daily and possibly weekly charts. There is no magic to this. Pattern recognition is all there is...the holy grail so to speak. But Sekoyta had to make it seem magical....so he came up with a lot of other stuff and a computer program.

    But all he really did was 123's and ride it up.

    ReplyDelete
    Replies
    1. Yes, this is what I have heard... it sounds perfect, actually, just like something Ed would do...

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