August 17, 2011

Salem Abraham - Trend Following


Beginning
The town Canadian is located in the American state Texas. Canadian has a population of around 2,000 and the highest building has three floors. The bottom floor of that building is a restaurant and the top floor is the home to 60 computers, eight traders, all controlled by Salem Abraham.
   Salem Abraham grew up in a family of Christian Lebanese immigrants who settled in the town Canadian in 1913. Abraham attended the University of Notre Dame and wanted to found a mail-order business. But everything changed when he attended a family wedding in 1987. At the wedding, he met the trader Jerry Parker, who introduced Salem Abraham to the concept of managed futures - buying commodity futures contracts based on the recommendations of trend-following models. Salem Abraham, who had already decided he wanted to make a living in the town where he grew up said to himself that he could trade futures from Canadian. He immediately shifted his goals in life to pursue trading.
    At the time, Abraham knew nothing about trading. He had no experience, but he began to read everything he could about Richard Dennis and other trend followers. "If you want to be successful at something, well, you want to identify who's been successful and what are they doing," he said.
    He went to his grandfather with a portfolio of twenty-one markets. "Of all the ways to lose money, why in hell did you have to pick the very fastest way?" his grandfather asked. Salem Abraham ignored his grandfather and launched his trading career while finishing his finance degree. He began trading twenty-one markets in the morning and attended classes in the afternoon.
    Abraham had initially $50,000, which he turned into $66,000 the Friday before October 19, 1987 – Black Monday - when the stock market fell 22 percent in one day. His $66,000 dropped to $33,000. But by the end of the day, he had learned a valuable lesson. "The one lesson I was clear on: always know the thing that they say can never happen, can happen," he said.
    In 1988, Salem Abraham wanted to trade full time. He had $45,000 and managed to increase the original investment to $70,000 with the help of his family. He wanted his grandfather to invest $30,000, but his grandfather was still negative to trading. "I'll put up $30,000," his grandfather said. "But if we get down to $50,000, we throw that quote machine out of the window and we stop all this trading nonsense."

On his own
Abraham founded Abraham Trading Company (ATC) in 1988. It was a basic commodities firm and they phoned orders to Chicago.
    In the mid-1990's, Salem Abraham convinced investors like the Commodities Corporation - a futures and commodities investment firm acquired by Goldman Sachs in 1997 - to invest in his fund, so the assets grew to more than $130 million. Before the investment, they asked Salem Abraham what kind of returns he wanted to achieve? He replied how he aimed for 100 percent a year. Salem Abraham was told that 30 percent a year is enough, and that he needed to decrease the leverage.
    Returns decreased in the mid-1990s as the environment for trend-following became more challenging. Salem Abraham made modifications to the strategy which boosted returns, but he remained concerned about the relatively high volatility of the strategy.
    In 2005, he decided to improve his basic approach with the addition of mean reversion, momentum and short-term trading strategies. The addition of these models transformed the risk/return profile of the program. "Our aim is to deliver a steady pay-off to investors," he said. "Having different strategies in the program gives us a better chance of doing that."
    Salem Abraham was frustrated with the performance of the program in 2009, but he is unlikely to change his approach. "We are always looking for ways to improve the program but I still believe our core approach is a good one over the long term," he said. The performance in 2010 was 10.73 percent, -5.10 percent in 2011, and -5.6 percent in 2012. The returns each year since the beginning is available on their homepage: abrahamtrading.com/performance

Strategy
Abraham Trading Company's trading methodology is a systematic approach that combines long-term trend following, short-term trend following, short-term momentum, and mean reversion strategies in an effort to reduce volatility while maintaining a return target of 20-25 percent. Each strategy is further divided into sub-systems to facilitate smoother entries and exits. There's also several implemented filtering techniques in some strategies to avoid trades with adverse risk/reward characteristics.
    The company buys and sells futures contracts in 60 markets around the world. Salem Abraham doesn't need to be in Chicago or New York. On some days, the company's unit that specializes in electronic trading of stock index futures accounts for 1 percent or more of the trading volume on the Chicago Mercantile Exchange. All of the trading is conducted through a system of 60 computers connected to the rest of the world through a dozen high-capacity telephone lines.
    Salem Abraham uses computerized mathematical models to track trends in the market. The model is 99 percent systematic, since even the best systems need some human-based help. He trades only listed futures contracts for products like cattle, corn, and crude oil - no stocks. Trends can last a few hours or days. On some trades, a trend can last a few months. The average holding period for the contracts is three months. "If you are going to trade physical commodities, you need to get in and stay," he said. "We do, on average, one trade per market per year." ATC makes as many as 50 trades a day. Three times a day, its computers print out 100-page reports that describes the firm's positions and what new actions it should take.
    One advantage Salem Abraham has over his competitors is that he is willing and able to take physical delivery of commodities he buys if he can't sell them at a good price. ATC had once 3,000 tons of ethanol delivered to railroad cars in various locations, but they found buyers and sold the ethanol for a profit.
    In 2000, Salem Abraham founded a second company: SAA Ventures. The trading strategies of the two companies are vastly different. The average holding period for the contracts in SAA Ventures is two-tenths of a second. The typical transaction brings in just a few dollars. But about 80 percent of the trades are profitable, ten percent break even, and 10 percent lose money.
    Most of Salem Abraham's employees have backgrounds from farming or natural gas-drilling companies. Their training in the complexities of trading and arbitrage is provided on the job by Salem Abraham himself.
    T. Boone Pickens and Abraham's ranches are next to each other in Texas. In November 2008, T. Boone Pickens said of Salem Abraham: "He's the only money manager who's made me any money this year – and that includes myself."

Conclusions
  • You don't have to be close to Wall Street to be profitable in the financial markets.
  • If you want to be successful at something, you have to identify who's been successful and what they are doing. What you have been doing before trading doesn't matter. You don't need to have the best education.
  • Always know the thing that they say can never happen, can happen. For example, tech stocks crashed and burned after the dot.com-bubble exploded. And the stock market can fall with 22 percent in one day like it did in 1987.
  • One can use different strategies at the same time to deliver a steady pay-off.
  • Abraham's trading model is 99 percent systematic, even the best systems need some human-based help.

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