Ep. 1414: Systematic Trading Redux with Michael Covel on Trend Following Radio

Please enjoy my monologue Systematic Trading Redux with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive. --- I'm MICHAEL COVEL, the host of TREND FOLLOWING RADIO, and I'm proud to have delivered 10+ million podcast listens since 2012. Investments, economics, psychology, politics, decision-making, human behavior, entrepreneurship and trend following are all passionately explored and debated on my show. To start? I'd like to give you a great piece of advice you can use in your life and trading journey… cut your losses! You will find much more about that philosophy here: https://www.trendfollowing.com/trend/ You can watch a free video here: https://www.trendfollowing.com/video/ Can't get enough of this episode? You can choose from my thousand plus episodes here: https://www.trendfollowing.com/podcast My social media platforms: Twitter: @covel https://twitter.com/covel Facebook: @trendfollowing https://www.facebook.com/trendfollowing/ LinkedIn: @covel https://linkedin.com/in/covel/ Instagram: @mikecovel https://www.instagram.com/mikecovel/ Hope you enjoy my never-ending podcast conversation!

• 0:00Speaker 00

  What a wild world. Chinese equities imploding, Indonesian equities imploding, America feels on edge, Brazil is on edge. Supposedly AI is going to take over the world. You believe that bullshit? Well, guess what? There's only one way to play all of this, and that is with systematic trading, otherwise known as trend following. My guest today, reaching back into the archives, goes there. I hope you enjoy.

• 0:47Speaker 00

  My guest today is an independent trader, investor and writer. Spent over a decade working in the city of London before retiring from the industry, so to speak. He was once a portfolio manager for AHL, the famed trend following CTA hedge fund. My guest today is Robert Carver. He has been on this podcast twice before, and today, we talk about a lot of trading stuff and perspectives. I get to pick his mind. He corrects me where he sees fit. And we do dive into some detail from his new book, Advanced Futures Trading Strategies. Without any further delay, let's jump right into my conversation today with Robert Carver.

• 1:42Speaker 00

  Let's just get that out of the gate, because it is true. Your work, what you do, is for serious traders who really want to understand systematic trading, no BS. I mean, Joe Friday, just the facts. That's how your books read. And so, from that standpoint, if people are really interested in systematic trading, well, that's important. I try to get behind the covers and give some of the nitty gritty details too, but I think you go an extra mile in your books. I think people need to understand that right out of the gate. I just mentioned that we had spoken 2016 and 2017, and I think it would be great for people, as we weave ourselves into the idea of systematic strategies, it'd be great

• 2:27Speaker 00

  for people to understand that while you, I think by any definition, could be considered an expert in this space, you've got enough experience to where you're going back, some of the folks in their twenties and thirties today are going to say, what's that? Pit trading? And even though they say that about trading places, what you quote in the beginning of your book, some young people might go, what's that? But I think your initial trade, so to speak, in the pit as a young guy, is so interesting, because that's how I think most people approach trading. But you've gone full circle in your life to where the way you would have approached it in the pit all those years ago, that's not your life today.

• 3:08Speaker 01

  Yeah, I just want to be very clear. I've never actually traded in a pit. I wish I had. It would have been an amazing experience.

• 3:14Speaker 00

  You placed one trade?

• 3:15Speaker 01

  Actually, I'm old enough that when I started trading professionally, I was literally picking up a phone and speaking to people. No, I've never actually traded in a pit. I started on an investment bank trading floor, which I suppose-

• 3:27Speaker 00

  A pit feel?

• 3:28Speaker 01

  A pit feel, but everyone's sitting down most of the time, although not always. I think especially, we're talking over 20 years ago now. This sounds bad, but the locker room feel, I suppose, of a trading pit where the majority of people, especially 20, 30 years ago, were probably male, probably from a similar background, that aggressive place.

• 3:49Speaker 00

  It was like a sport.

• 3:51Speaker 01

  Yeah, exactly. And my understanding is a lot of pit traders were, say, in Chicago, guys who played college sports, maybe had an injury or something. To actually trade in the pit, you needed to be physical, standing shoulder to shoulder, crammed in. The best description I can give is, if you imagine riding on the subway or the underground in London at rush hour, so you're crammed into a shoe carriage, and you're also trying to have a conversation with somebody 20 feet away from you, that conversation could be responsible for millions of dollars in gains or losses. That's what I would imagine trading in the pit was like back in the day.

• 4:24Speaker 00

  Before Richard Dennis went from the pit to the upstairs, before he taught the turtles, I don't think this is speaking out of turn. I'm pretty sure this is the facts, is that he was a man of about six foot two in size and close to 300 pounds. So he had a physical presence in the pit, which probably helped him at that point in his career in terms of pit trading, beyond his acumen. I'm sure the physical size helped.

• 4:49Speaker 01

  Obviously, a lot of pit traders transitioned upstairs. This was a big thing in London, because I think every trading floor in London is now closed. The last one closed during COVID and believe hasn't reopened. Where I used to work at AHL hedge fund, we employed quite a few ex-floor traders, execution traders. There's always this question as to whether their skills would be able to transition from the trading pit to the upstairs environment, where, putting aside the physical side of things, you're no longer looking people in the eye, can't read body language. It's not like sitting around a poker table anymore. It's more like playing poker on a website. You can only see what people are doing from the evidence of the patterns of trading and the bids and the offers that they're placing. You can no longer see, I know when that guy twitches his eyebrow, it means that he's actually trying to spoof me, and he's really got another big order coming in on the other

• 5:33Speaker 01

  side, and he's just trying to lift the market a little bit higher before he comes in and gets rid of it. The ex-floor traders we employed were still able to pick up that information just by looking at the order book, which is an incredible skill. Not all of them made it. Quite a few ex-pit traders couldn't make the transition upstairs and so retired.

• 5:50Speaker 00

  Before we get into some more detail about strategies, types of tactics, whatnot, at its basic level, if you were in the pit, I mean, it's a little arbitrage type thing, very short term perhaps, especially for solo speculators. Whereas upstairs, to go at that faster speed is going to require more technology. It's going to require more coding. It's not going to be the person that can sit in front of the screen and trade one-minute bars, so to speak.

• 6:20Speaker 01

  I guess the types of pit traders who probably made the transition were those whose trading style was more smaller risk, but holding positions for longer, potentially even overnight. The reason why the independent traders didn't prefer to scalp and not hold positions overnight, because obviously the margin requirements were lower, and that enabled them to hold bigger positions on smaller capital. Once everything moved upstairs, those guys were competing against HFTs, against computers, co-located PCs and whatnot. And as a human being, there's no way you can compete against those. It's just pointless. The guys had a longer timeframe, were probably better off than transitioning to more of an upstairs environment where you need to hold overnight risk. You don't want to be competing against computers anymore. You want to be competing against mostly other human beings. Certainly, that's my background and experience. It's definitely in trading

• 7:06Speaker 01

  at longer timeframes. We did actually dabble with HFT, and we obviously dabbled with execution algorithms as well. I've got my own execution algo that I run myself at the moment, but in terms of a pure scalping or short-term trading strategy, that's definitely not the world that I'm familiar with at all.

• 7:23Speaker 00

  I know you believe that there are some short-term strategies that can work, and I think you would say probably down to the hour bar. And just for a moment, I would love to pick your mind at that short term. People send me emails all the time, and they talk about that they want to trade five-minute bars or 15s. I've had people say one minute. As you, a very experienced guy, how do you bring somebody off that ledge? Somebody comes up to you, perhaps they have a lot of money, perhaps they have a little money, but they want to trade five-minute bars. You know all that you know. You've gone down the path, you've researched it, you know what they're facing, and you know that they don't know what they're facing. The Don Rumsfeld thing, what you don't know about what you don't

• 8:05Speaker 00

  know. How do you bring them off that ledge? How do you bring them down easily? Or can you bring them down easily? Because I know you want to see people do the right thing, and if someone is going down the path of chasing the idea of trading five-minute bars, that's a tough road to hoe.

• 8:20Speaker 01

  Definitely. The way I normally try and explain this is by starting with the idea of trading costs and saying, well, okay, if you're going to trade, let's say with a horizon of, say, 30 minutes. So that means during the day, you're chopping or changing your position by maybe 15, 16 times. And then say, well, what are your trading costs on each of those trades? And obviously, costs are commission plus spread. As a small retail trader, actually, generally speaking, there's roughly a 50/50 split between those. So normally, in most futures contracts, about half your costs are commission, about half the spreads, very roughly. I say, okay, well, that means just to break even, then you're going to need to make this much money every day if you're going to be paying 15, 16 lots of

• 9:02Speaker 01

  commissions every day. Now, the immediate reaction to that is, well, that's fine, because everyone has the idea that they're an above-average person, and they assume that they'll be able to make above-average returns. But I say, well, hang on a second. If you actually look at the distribution to the trading profits, you're going to need to be not just above-average, but actually in the 0.01 percentile of all traders, just to break even, trading at this frequency. And that normally works.

• 9:28Speaker 01

  That normally brings them up short. Now, in my book where I say, well, to trade on a slightly longer timeframe, but still relatively short, because most of my systems and most of the systems I trade myself and in the book as well, are systems where the average holding period is weeks to months. That means generally speaking, that you're not going to be running into issues with trading costs. You can potentially go shorter, but only if you change the way you actually execute trades, so that you're only ever paying the commission, not paying the spread. And that's by using limit orders effectively. And that also means that the style of trading that you can do is only where you've got a mean reversion towards some equilibrium value. And mentally think about a chart, it's in a range bound pattern. You want to be buying at the bottom of that range and selling near the top of that range.

• 10:10Speaker 01

  If you can identify what the range is, you can place a limit order above and below average value. Essentially, the market's ticking up to you and ticking down to you. And you're never actually having to cross the spread and pay that part of the trading costs. And if you do that, you can reduce your trading costs to the point where it is actually profitable to trade a strategy with a shorter holding period. Certainly not 30 minutes trading on a one minute bar or something like that. For a retail trader paying retail trading commissions, that's just not going to happen. You're just not going to be profitable enough unless, as I already said, you're really in that top, top, top percentile of traders, which by definition, most people aren't going to be.

• 10:47Speaker 00

  I can think of some other practical costs at trying to trade five minute bars during the course of a day. Food, the toilet and getting tired, just all those basic issues. This came up in a conversation with trader Tom Bosso on my podcast recently. Tom was making the case, very similar to you, which is like, look, you can do this, but here are the pros and cons. Like you, he's like, well, that's not really what I do for my own stuff. I said, well, hold on, Tom. If you are not really doing it, in this case, Rob is not really doing it. And at least in my study of systematic price based traders over time, most of them have got a longer time horizon. I would tell the audience, maybe when these smart people say what they do, that's perhaps

• 11:32Speaker 00

  the most important lesson, at least from my perspective.

• 11:36Speaker 01

  That's definitely true. I'm a fully automated trader. That means in theory, at least, I could actually trade these much shorter timeframes and I wouldn't have to worry about food or the toilet or whatnot. But yeah, the advantage of trading at a slower timeframe, my trading actually happens on a daily frequency. So I could in principle actually do that manually. It would obviously take time, which I'd rather not spend sitting in front of a computer clicking. So I still prefer to do things in an automated way. People say to me, well, what's so great about being an automated trader? Well, to me, it's the fact that I'm fundamentally lazy and I can think of a million things I'd rather be doing than manually entering orders. But of course, you don't have to be automated to trade these daily systems. You can actually trade them manually. And with relatively rudimentary tools like spreadsheets and standard web interface, you

• 12:21Speaker 01

  can probably get the whole thing done in 20, 30 minutes every day, which means that you can actually do this part time, because a lot of people have the dream of becoming full time traders. But actually, the best way to start off is not to actually just remortgage your house and put all your capital into your trading accounts. By far, the optimal strategy is to start with a small amount of capital, keep your job, trade part time and learn essentially. I definitely recommend that.

• 12:45Speaker 00

  I remember back in the day, I was standing on a sidewalk, I guess, in Lower Manhattan, and John W. Henry had just given a speech. And I was outside on the sidewalk and I was watching his limo go up north towards Manhattan. I remember his license plate was JWH1. I ended up talking to a guy on the street there, watching him drive away as well, and it was his CPA. I was still trying to gather information. I remember having a conversation with him when he was just talking about how vanilla they were. And I started asking some basic questions off the record about technology. And he's like, man, Excel, Lotus 123. I mean, come on, that was such an eye opener for me. Here you are, bookending the same thing, telling all the people who are listening in

• 13:27Speaker 00

  2023, hey, okay, you might go down some fancy software path, you might have great coding skills, but you can still do it in a spreadsheet.

• 13:36Speaker 01

  Yeah, so my book, there's 30 trading strategies and I'd say probably 26 or 27 you could run off a spreadsheet. The intra day ones, the ones we've been discussing, for those, I'd say you probably should be automated. You don't have to be, you could still do it off a spreadsheet, but I think in a from practical sense, you probably ought to be automated. And then there's one strategy that's particularly advanced that definitely you need code for. But yeah, the vast majority of stuff that works is stuff you can just run off a simple spreadsheet. There are probably people listening to this who not only haven't seen trading places, but don't know what you mean by Lotus 123. So I guess they're going to have to go and Google that now.

• 14:11Speaker 00

  Exactly. At some point in time in the not too distant future, I suspect it will be built into all the iTunes podcast apps, some AI that will finally transcribe all the audio, so I don't have to do it and probably give cues to people, hey, that's what this is, or links out or whatever. Let me take you to something that I think is really basic level. Maybe it drives you crazy to hear a question like this, maybe not. What percentage of people do you think get the idea that all of the fundamental data can be embedded in the price data and that you can make decisions of when to buy and sell and size your position off this price data? Where do you think we are?

• 14:55Speaker 00

  Do you think that the percentage of the population understands that basic idea that you know so well? Do you think that's held steady over the decades or do you think it's improved? Where do you think we are?

• 15:05Speaker 01

  You're going to probably hate me for saying this, but I don't actually agree with that statement myself. I do actually believe that there is value in using fundamental data alongside price data personally. In the past, I've built trading systems that do use fundamental data. And the reason why I don't use fundamental data now is purely a matter of workload. Let's take, for example, you're trading single name equities. So your fundamental data would be accounting ratios like price earnings, price dividend yield and so on and so forth. So all of a sudden, the universe of factors you've got to pull into your system and understand and test and analyze has gone from one thing, which is price, to a dozen things or maybe more. And that's just a huge amount of additional work, which as someone running their own trading system with their own capital, it's just not worth me doing, basically.

• 15:50Speaker 00

  But you disagreed and then you came right back to price.

• 15:53Speaker 01

  But I'm saying that you made a statement, sorry to be pedantic. I'm a nerdy guy and I like to use very precise language. But you said that all fundamental data is in the price, which to me implies you don't need the fundamental data.

• 16:04Speaker 00

  I was saying that was from the standpoint of a systematic price based trader. A systematic price based trader, when they're doing their systems, would be thinking, okay, all the fundamental data is embedded in the price and I will use price to make my decisions, not using the other data, which you confirmed is what you do.

• 16:25Speaker 01

  My more nuanced reframing of that statement to more precisely reflect what I think is, if I run a system with just price data, I can capture 80 to 85% of the potential value of trading a particular market with maybe 5% of the work. If I was to add in fundamental data, I'll get a small boost to my performance of maybe another 10, 15% on top. But with multiplying my workload by 20 fold, that work versus return equation makes absolutely no sense for me as an individual trader.

• 16:58Speaker 00

  I see the way you're parsing it, but let me take it back to the big picture, even though, okay, now you've officially parsed and you've laid out the subtle nuance, but to the point of where people think, again, taking into account your nuance, but the percentage of the population that would think they could use price as a cue, as a decision making cue for their buys and sells and position sizing, where do you think we are in terms of people understanding that that's a viable strategy? And do you think it's changed over the decades?

• 17:29Speaker 01

  I actually think it has increased. I'm going to reframe your question if you don't mind. I'd say something like, what percentage of people think that you can use price only as a pretty good trading system? The opposite of that was some of the things, there's no point using price because what information is it telling me about, say, Tesla's earnings? If I want to know what Tesla's earnings are going to be, which will affect future prices, I need to go and look at annual reports and so on and so forth. There's trading system, which probably is relatively simple and using relatively simple rules. How can that just look at one factor and make a valid decision? That seems crazy. So the percentage of people that believe that, I think, has been going down over time, but not necessarily for good reasons. I think the proliferation of YouTube content and Instagram content of people pretending

• 18:14Speaker 01

  to be expert traders who are mostly just flogging stuff has absolutely exploded and a lot of that's come on the back of crypto. 90 to 95% of those people only use price in their systems. So there's an awful lot of people out there who now think that the good thing, which is that just using price as a valid input to a trading system. Unfortunately, they've learned it from the wrong people in the wrong context.

• 18:39Speaker 00

  That's a great point. Let me add something to that really quick. I had noticed these videos on YouTube too. And generally, I felt like I tried to define this with my first edition of trend following, which is why I would say there's two forms of technical analysis and maybe you would call this something different, but there's a reactive and a predictive and reactive would be more in your headspace when you're using a price based model. Whereas some of the YouTube guys that I see, they're using the price and they've got a chart up on the screen, all kinds of lines and candlesticks and this and that. And they're saying, when this cross is here and this line grows to here, this is going to happen. I think that makes your point. That is the wrong thing to learn.

• 19:15Speaker 01

  For me, the distinction is even clearer and more stark, and that's between systematic and discretionary use of price data.

• 19:22Speaker 00

  Fair enough.

• 19:23Speaker 01

  If you can't write down your rules and test them and then use them systematically, if you're ever having to use discretion and say, well, yeah, this looks like a rising cloud, or this is clearly a red candle pinned to the bottom of the mountain.

• 19:34Speaker 00

  Are you telling the audience, Robbie, you don't trade rising clouds?

• 19:38Speaker 01

  I don't even know what a rising cloud is.

• 19:40Speaker 00

  I don't either.

• 19:41Speaker 01

  I think that, to me, is the clearest distinction. The reactive versus predictive, I see what you're saying, but again, being pedantic, in a sense, all trading systems are predictive because anytime you put a trade on, you're essentially making a prediction about what you think the price is going to be in the future. I don't personally like that reactive predictive distinction, although I see where you're coming from, but I think we agree that we think the whole cloud candlestick stuff is just nonsense, whereas relatively simple rules that filter the price in relatively simple ways, most importantly, in a purely systematic way, that's actually a valid way to do things.

• 20:12Speaker 00

  When I asked you that question about the audience that you brought it back how you did, when I asked you the question about the audience, I was thinking more in terms of a systematic price-based approach. But on the other side of my brain, I've been in enough bookstores, especially here in Asia, where I do see this proliferation of these discretionary technical analysis-type books. They're everywhere. I don't pay attention to them, but I guess it does make your point about how things have gone in the wrong direction. So that brings me back to my point, even though we keep going off on side tangents here. What percentage of people do you think have a systematic price-based understanding? It's probably hard for you to say, but to me, it feels small. I guess that's where I'm going with this.

• 20:57Speaker 00

  To me, it feels relatively small. Put aside the people that are learning the wrong way and really not doing what you're talking about in your work, it still feels small to me.

• 21:08Speaker 01

  It does. Unfortunately, I don't think that's been growing, despite all the shouting from the rooftops that you do and I do and various other people do. I think it is because the more discretionary technical-based analysis, it feels more like a skill that can be learned. It feels like, yes, if I read this book and watch these YouTube videos and stuff, there's this skill I can learn and I can learn how to do this thing that only a small number of people can do. Because I believe I'm above average, because everyone does, I'll be able to learn the special secrets and these special skills and apply these quite loose rules in a specific way and be profitable. That sounds like a good story. That sounds like a reasonable thing to say that, yes, trading is hard, but there are some people who can do it. It's a skill. It can be taught.

• 21:51Speaker 01

  It makes it sound a lot more like sports, in a sense. Whereas to say to somebody, yeah, trading is difficult to do exceptionally well, but actually you can do pretty well.

• 22:02Speaker 00

  You're the Picasso of trading. You're just an artist.

• 22:04Speaker 01

  Exactly. Everyone wants to be an artist. People think that you're a trader. Wow, that sounds cool and interesting, and you must be so clever and you must have learned all these special skills that no one else has and whatnot. If I said to people, yeah, I'm a trader, within about three minutes, they wander off board because it's not a compelling story to say, yeah, well, there's these simple rules I follow and that makes me probably better than 90 to 95% of retail traders out there. And yeah, there's some people who probably do have some exceptional skill and can do better than me, but there aren't many of them. That is not a compelling story.

• 22:38Speaker 00

  I think one of my skills is to take the world that you were in and traders like you and bring it to a conversational level where people don't doze off, they get them engaged, because I always think it's possible. Also, to take it to another point on the discretionary, quote, price strategies or technical analysis, I always find it interesting because when I first saw the systematic side of the price strategies, I thought it was so interesting that there were these CTA track records out there, like the firm that you used to work for, AHL. And that was so interesting. There's all this interesting data of results. People that came before us, I had a conversation with Paul Mulvaney recently, and he said the same thing. He's like, yeah, I mean, hey, I wasn't reinventing the wheel.

• 23:22Speaker 00

  There was people before us. What's really interesting about the discretionary folks that want to use price, no one seems motivated by that. There's no motivation to find that. It's so sexy. It's so cool. We're all going to be Picassos with bells and whistles all over our screen. The proof part seems to have gotten lost somewhere.

• 23:46Speaker 01

  Well, it's fundamentally an unprovable thing, isn't it? You can't backtest these people. There are probably certainly guys out there running funds who use discretionary prices and have been doing so for a long time and have been very successful, and you can go and look at their track records. You don't really need to do that to actually tell the story. I think that's the difference. I think because the systematic trading system story is so dull, I agree with you, Mike, you can try to make it interesting and do try and make my books as interesting as possible to read. And I'd like to think I've improved, actually. I think my current book is probably more interesting to read than my first book. Maybe people will disagree. Because it is such a dull story, you do need to add evidence to that. You need to say, well, yeah, okay, it doesn't sound like a compelling story, but here's the evidence. Here's all these funds that have been around for decades that have got these track records, and that's pure out-of-sample performance.

• 24:32Speaker 01

  That's not just a backtest that obviously you can fiddle with and look amazing. So people need that additional evidence to believe the story, whereas people don't seem to need any evidence, bar the fact that the guy on the YouTube video has borrowed a Lamborghini for the day and rented a nice house and has got a whole bunch of monitors. That seems to them to be enough evidence that this person is a success.

• 24:52Speaker 00

  There's a blond-haired guy who I like his economics a little until he pulls up the screen and starts going down the discretionary price stuff. He's got this blonde hair that goes straight up, all waxed together, and there's always fire on the screen.

• 25:05Speaker 00

  You just said something that I think is interesting, and I want to dive a little bit deeper. You use the term dull. Describing the strategies, maybe people could say, well, maybe Rob thinks of himself as a little dull too. But I don't think that's true at all because you would not have the consistency, the duration, the passion to be doing this for decades if you thought anything you were doing was remotely dull. You're giving it that bad pejorative over there, but you really don't believe it's dull.

• 25:34Speaker 01

  Of course I don't.

• 25:36Speaker 00

  I'm not going to let you call it dull, and I don't believe it's dull either. I'm like you, I'm crazy too.

• 25:40Speaker 01

  I know, but I think the difference is that maybe the percentage of people in the population who find this thing we're talking about interesting is probably smaller than the percentage of people who can look at a YouTube video with a nice car and the dinosaur part of their brain starts firing off saying, oh, yeah, this looks good, this looks good. Whereas with us, it's appreciating the analysis and the more complex part of your brain being used. If I was to actually sit in front of my screen all day and trade, as I've already said, actually trade the simple rule-based systems, that would be dull for me. I think that would be true for most people. That's one of the reasons why automating as much as possible, at least for me personally, means I can then focus on the stuff that I find really interesting, which is actually the research and implementation of these ideas.

• 26:23Speaker 01

  The actual physical act of looking at a line on the screen, deciding whether it's going up or down, then clicking a button, I think most people would find that pretty dull, especially if they were doing it all day.

• 26:33Speaker 00

  I think when you bring people into the idea, though, that you're expending 5% of your time to get perhaps, as you say, 80% of the result, that's eye-catching, that's ear-catching. I mean, that's interesting. We both know what we're up against. There's an entire Wall Street machine. It's on CNBC, Bloomberg, 24 and 7, and that keeps people's attention. It's amazingly the same players, year after year, decade after decade, no matter what happens, they're still there. I really don't even know if the people on CNBC are actually alive anymore. I have no proof that they're alive or they are just animation. I have no idea. I bet the same people will be there 100 years from now, because with AI, how will you not know they're there?

• 27:17Speaker 01

  ChatGPT at the moment is firing up to run a whole bunch of CNBC anchors all the time. I just want to say one thing quickly as well. I'm not sure that trading shouldn't be dull because people say to me, oh, why do you do this? It's so boring. I'm like, well, okay, the primary reason why I trade is to make profits, not to have fun. If I want to have fun and I want to encourage my gambling instinct in doing that, then I'll go to a casino or I'll go to the races or I'll play some online poker or something like that. But I'll do so with a very limited amount of money, knowing that I'm probably going to lose that all, and that's going to be the cost of that particular form of entertainment. People who treat trading like that shouldn't be systematic trading. Fine, yeah, set up a small retail account, put a couple of thousand dollars in if you

• 28:02Speaker 01

  can afford to lose it, and then just buy and sell random stocks all day. Enjoy yourself. If that's your idea of fun and you enjoy that, I'm not going to tell you that you shouldn't be spending your money on that. But if you actually want to trade and make money, then you need to completely pull the idea out of saying, well, I want to do the form of trading that makes me the most excited, that makes me the most entertaining for me. And so, well, I want to make profits and I want to do that in the most efficient way. And for me personally, that's automated. And as I say, you don't have to be automated if your timeframe is nice and long, but it's also simple rules that on the face of it seem pretty boring.

• 28:35Speaker 00

  Your book, we're looking at 30 strategies, multiple styles, multiple timeframes, but primarily using price as a decision-making cue. You might hate me for generalizing this question, but work with me. How can you explain the why? What do you think, you're on the elevator and you're a smart doctor, a smart attorney, whatnot, why do these strategies work? Assuming good portfolio, assuming good risk management, position sizing, all that type of thing, but what's the why?

• 29:09Speaker 01

  I have a fairly reductionist view, actually, of trading profit. Going back to this idea, you can get 80 to 85% of the value of trading through just using price-based systems. And actually, just to add as well, all the strategies in this book do use price. So although I believe in fundamental data, I believe it works, I don't personally use it. I don't write about it either because I don't consider myself an expert in the subject.

• 29:32Speaker 00

  By the way, that's the most interesting hedge.

• 29:36Speaker 00

  Mike, I can't agree with you. The fundamentals, they can work, but Mike, by the way, I don't use them myself.

• 29:40Speaker 01

  I don't, yeah. But as I said, that's primarily for workplace. Anyway, let's move on.

• 29:46Speaker 01

  I've also believed that eighty to eighty-five percent of profits you can make while trading are from basically being exposed to what an economist would call a risk factor. But then there's an additional ten to fifteen percent which can come from, people call it alpha, secret sauce, whatever you want to call it, it's something that you know that no one else does, whereas these risk factors are very well known. I basically focus on the risk factor stuff, doing that well, not making mistakes. And that means I believe I can catch eighty to eighty-five percent of the value that's out there. And again, it comes back to time. I can do that with a minimum amount of time to actually discover the secret sauce and the alpha requires a lot of intensive research. I'm just one person who's fundamentally lazy, so I'm not going to do that. The risk factor stuff then, because that's what I'm talking about, that's where I believe most of the value comes from.

• 30:31Speaker 01

  And the good thing is, as the saying goes, it's nickels on the sidewalk, you can just go and pick them up. You don't need any special skill or research, all the information's out there. We know about the things like, for example, being long equities. Equities are risky, therefore you can make money from equities. But there are lots of other factors out there that take you beyond that. So obviously, being long bonds gives you some risk, some return as well, because essentially you're acting like a bank. Most of the time, if the yield curve is upward sloping, you borrowed a low interest rate and you can deposit that for a high interest rate, longer duration. Obviously, that hasn't worked too well for some banks in the US, but we won't talk about that.

• 31:07Speaker 00

  You should probably offer a quick textbook on the use of the word factor, because some people might not be understanding how you're using the word factor.

• 31:16Speaker 01

  Probably an easy way of thinking about it is like this, there are a whole bunch of people out there in the market, and they've all got different preferences of risk. Let's take a really silly example. Some people may not like stocks that begin with the letter T. They don't like Tesla, they didn't like Twitter, they don't like Toyota. If you don't share that bias, then you can make money by buying stocks that start with a T. Because there's a bunch of people out there that don't like them, that means those stocks will be fundamentally and systematically underpriced, so you can make money by buying stocks with a T. There may be some other people out there who absolutely love stocks whose name starts with an A. They like Apple, they like Amazon, they like Alphabet. Actually, there is a group of people like that, and they're called VC investors, but anyway.

• 31:59Speaker 01

  So you could, that means that those stocks will be fundamentally overpriced. Interestingly, Apple, Amazon, Alphabet, a couple of years ago, I believe, were fundamentally overpriced, but that's another story. You can make money by shorting those stocks because they're fundamentally overpriced. Okay, you've now got yourself a classic equity long-short portfolio that's not got no overall exposure to the market because you've got an equal balance of longs and shorts, but where you're systematically making money from the fact that there are a bunch of people out there who don't like stocks that start with T, and a bunch of other people out there who really like stocks that start with A, and you're able to sit in the middle and just collect that money. A very silly example, but that's an example of a risk factor. A more serious one would be something like the fact that there are certain assets that

• 32:42Speaker 01

  have really horrible downside risk, really horrible negative skew. An example of that would be a short option strategy, which you can replicate in futures by shorting the VIX future. In simple terms, you're basically betting that the volatility of US stocks is going to fall systematically. And the reason that makes profit is that there are an awful lot of people out there who have a bias towards buying volatility to hedge themselves against market crashes. So there's a whole bunch of people essentially who overprice the likelihood of a market crash, and that means that volatility is systematically overpriced, which means you can systematically make money by selling volatility. So that's a more serious example of a simple risk factor. And there are a whole bunch of these things, and they're all very well known, and you can

• 33:26Speaker 01

  see them in the backtest, and you're looking for things that persist over decades, if not longer. The one, of course, that you'd like me to talk about, Michael, which I talk about in my book a lot.

• 33:36Speaker 00

  Oh, I didn't say anything, you're reading my mind.

• 33:38Speaker 01

  I know, I'm really good at that. But that's trend or momentum. People do not like holding trend or momentum portfolios. People do not like holding assets, being long assets that have recently gone up a bit because they want to sell them and make a quick profit. They'll prefer assets that have gone down recently because they think they'll go back up, and they don't want to crystallize their regret by closing those positions. We can talk about prospect theory, and I know you've had.

• 34:02Speaker 00

  Daniel Kahneman.

• 34:03Speaker 01

  Daniel Kahneman, the Nobel Prize winner. And we've got prospect theory, that's a possible explanation for that.

• 34:08Speaker 00

  I was letting you hang on purpose.

• 34:10Speaker 01

  I know. So momentum is an example to me of a risk factor in that it works, I believe, mainly because most of the markets don't like holding momentum-like portfolios. And that means if you don't care about that, if you're happy to take the other side of that trade, you can make money from that. Most of my trading strategies, if not all, effectively what I'm doing is saying, well, who's the person out there who doesn't like this risk? I'm going to take that risk off them and collect a risk premium for that. And because I've got a diversified set of these risk premia, so for example, if you were just shorting volatility, downside of that particular strategy is, in a market crash, you will lose a lot of money very quickly. So you don't want that to be the only thing you're doing, you want to have that alongside

• 34:52Speaker 01

  a whole bunch of other things that are hopefully uncorrelated and diversifying.

• 34:56Speaker 00

  You do a great job in this book, you're talking about diversification across markets, strategies, timescales. Let me keep it at markets for a second and maybe get you to go back in time and just share some color and maybe some of your early experiences. One of those lightbulb moments for you, perhaps, I'm just going fishing here, I don't know what I'm going to find, but when you first wrapped your arms around the idea of systematic strategies, using price as a cue, and applied over so many different markets, allowing markets to be treated in a similar fashion, even if their volatilities are different, you can account for that. But can you recall when you first had that moment, you're like, oh, wow, that's interesting? You must have had some revelation at a moment in your life, where you just born this way, you just got it from day one?

• 35:40Speaker 01

  It's interesting, because my first trading, as I said, was an investment bank, as a sell-side trader on the floor, so, and there, you're generally speaking, dealing with a very limited number of markets. Any discretionary trader has to deal with a limited number of markets, because you can't possibly look at and understand and interpret charts for a hundred and fifty or two hundred futures markets, which is what I trade, it's just impossible. And in fact, even as a systematic but non-automated trader, you're going to struggle with that many markets. You can still do better than the discretionary person. I went for an environment investment bank where I was looking at maybe five or six markets, pretty much sterling, euro and dollar swaptions, and then the underlying swaps and futures we were hedging them with, at an absolute maximum of ten markets.

• 36:22Speaker 01

  But then when I started in systematic hedge fund world, and it was right, okay, you need to pull the trading strategy, and it's got to cover, and the first strategy I built covered, I don't know, twenty global equity markets, trading futures. Immediately, there was no question of starting off and saying, well, you're just going to do a strategy with one market. It was always, right, you're automatically going to build something with twenty markets. But something I only gradually realized when I left and started doing my own research, it only really came to me in stark way when I actually ran the numbers. And then I ran the numbers, and I'm like, okay, if I just trend follow a single market, if I take the median performance of all the markets in my data set, basically what I'm saying is, if I pick a market at random, it could be really good or really bad, but a lot of that's just luck.

• 37:06Speaker 01

  If I take the median, then that's a very robust way of saying, what's an average market chosen at random likely to have done in terms of trend following in the last fifty years, which is how long my backtest run for? Then the sharp ratio of that market comes out at, I think from memory, something like zero point two. Sharp ratio is a risk-adjusted return. Keep things simple, let's translate it into an annual return, that means you'd be making on average, say, at a twenty percent risk target, you'd be making four percent a year just trading one market. Four percent a year, it's okay, it's not great, you get some interest on top of that from your unused margin, but four percent's not great. Now, if you then increase the number of markets in that portfolio, so now instead of trading just one market, you're trading five, six, ten, fifty, a hundred markets, you see that

• 37:51Speaker 01

  expected sharp ratio increase and increase and increase. When you get to a hundred markets, that's increased by a factor of nearly five. So you've gone from four percent to twenty percent. Now, there is almost nothing out there in the world that will give you a factor of five improvement in your performance, except maybe a massive degree of overfitting of a system. That, to me, is just extraordinary. So what I did was go, well, okay, maybe this is just a fluke, just a property of markets, because everyone knows that if you want to invest in stocks, you want to invest in more stocks, and you get more diversification. What happens if I just trade those one hundred futures markets, but I don't trend follow them, I'm just going to trade them on a long-term basis?

• 38:31Speaker 01

  Now, the good news is you still get an improvement in performance without the trend following components. So going from one market to a hundred market, you go from maybe two or three percent, you double your performance, you go up to maybe four, five, six percent. So you're still doing okay. You're doubling your performance. It's pretty good. But that massive fourfold, fivefold increase, that seems to be fairly unique to trend following type of strategies. You see, do see an improvement with other strategies, but in trend following in particular, it seems to be that huge increase. So my theory about this is that generally speaking, when we look at diversification, we try and summarize it using a simple linear measure of co-movement, which is correlation. But when you're trend following, what you're really capturing is

• 39:12Speaker 01

  the non-normality and the outliers. So you just see more diversification than if you're just holding on to a hundred positions in a static way. It's been gradual in the sense that I started off looking at a lot of markets, didn't really think anything of it. But going back to what you're saying about Bloomberg, I think the downside of having a Bloomberg terminal on your desk and having a Bloomberg television above your desk, which is what I used to do, and having the market news constantly coming, it's actually really hard to take a step back and think clearly and come up with these insights. That's the one thing I found quite helpful about locking myself away and never looking at CNBC, frankly.

• 39:46Speaker 00

  Well, there's an opportunity cost to that, too. Like you just said, if you are digesting all of this video and whatever other content, then you can't use your mind to do something else. It's like the basic multitasking counter. Well, there's a certain point in our life where people were talking about multitasking like it was something useful. And I don't think there's much evidence that that really works.

• 40:09Speaker 01

  Not for me personally. For me, if I try multitask, I end up doing lots of things badly. Most things, you want to be focusing on one thing for several hours minimum to get back to them. But anyway, yeah, to answer your original question, it's only really slapped me in the face when I was writing this book and I actually did the statistics. Wow, actually, that is a huge increase in performance from diversification. It's just massive.

• 40:30Speaker 00

  You mentioned the non-normal trades, the outliers coming from diversification, or at least potentially coming from diversification. And Larry Hyde's been on this podcast a lot, and Larry loves to talk about asymmetric returns. I love the part of your book, though, where you break down and get people to understand the symmetric versus asymmetric. I'd love for you to share your perspective there.

• 40:47Speaker 01

  Most people think about risk in an asymmetric way. So they're only worried about losing money. Okay, which is fair. If you make a lot of money, most people will be saying, oh, great, good job, well done. But to me, if I make an unexpectedly large profit on one day, my first thought is, okay, well, actually, there's probably only a 51% chance on any given day that I'll make profits. I may have just got lucky this time. It's quite likely that the coin came around on the other side. I would actually have lost, say, 10% in one day, which for me would be a big loss, rather than making 10% in one day, which for me would be an unexpected and welcome gain. I think it's really unhelpful to think about risk in these asymmetric ways. So there's a lot of advantages to using a symmetric measure of risk, like, say, the

• 41:29Speaker 01

  standard deviation. And people beat up on it and say, well, you're only concerned yourself with downside risk. Upside risk isn't risk. But to me, if you're exposed to potentially large gain, then unless you're trading options, maybe, and you're long options, and therefore you have got a limited downside, the chances are you're equally exposed to a very large potential gain. And there are other more nerdy reasons as well. If you just focus on losses, then you're effectively throwing away half of your distribution. You get a less robust estimate of your risk. The last point is also, it may make sense to focus only on the downside if you're just trading long only. But as a futures trading, I'm trading long and short. Should I use a different measure of risk when I've got a long stop position versus a short stop position? Maybe there is actually a little bit of a difference in the distribution

• 42:13Speaker 01

  of returns, but it sure as hell would make life extremely complicated to do that. So it is much simpler to use a symmetric measure, definitely.

• 42:20Speaker 00

  I am just barely scratching the surface of the detail that you call dull. Not dull.

• 42:29Speaker 00

  I implore people to check out your book, Advanced Futures Trading Strategies, 30 Fully Tested Strategies for Multiple Trading Styles and Timeframes. Robert, you're very detailed. I love it. I have all kinds of conversations with people, and I've not listened to our old episodes for a long time. I remember, Robert, exactly. I love that. I love that you give another version of a Joe Friday, just the facts, here it is, let's be very precise, let's get down to the nitty gritty. That's life for people that want to get ahead. Some people can look at the TV or something and they can think, well, there's some riverboat gambler, he won the lottery. What a great life. I'm going to emulate that. That's not really how life works. I love that you break it down and you say, hey, look, if you want to try, if you want to give it a swing, here's things that you should know based on my decades

• 43:14Speaker 00

  of experience. You do a good job of that.

• 43:16Speaker 01

  Thank you. That's very kind. I guess I'm like the anti-Youtuber. So I'm not exciting and interesting. I haven't bought a Lamborghini or lots of monitors.

• 43:25Speaker 00

  I gotta send you the video of this guy with the blonde hair and the flames and stuff. You could get a wig.

• 43:31Speaker 01

  Yeah, that's the other thing. I'm extremely bald. I'm definitely the anti-Youtuber in that respect as well.

• 43:36Speaker 00

  I wouldn't knock the bald thing. I think we're all headed there at some stage of the game before a guy. And I think there's very few that survive with the full head of hair. So it's just a matter of timing. Hey, Robert, the book available, all those fun places people can buy books and all that fun stuff. Is there a website you might want to direct people to?

• 43:53Speaker 01

  Yeah, so my personal website is systematicmoney.org.

• 43:58Speaker 00

  Systematicmoney.org?

• 44:00Speaker 01

  Yeah, dot I O G. So from there, you can buy all my books, click through to my blog and all my social media and all that kind of stuff.

• 44:07Speaker 00

  There's something that's off the hook, exciting, crazy and wild when they go to the social media.

• 44:14Speaker 01

  Is there?

• 44:14Speaker 00

  I don't know. I'm asking, I haven't been to your social media yet. I don't know what's going on there. Is it bikini women everywhere?

• 44:20Speaker 01

  I'm like, what have I put on there that I've forgotten about?

• 44:24Speaker 00

  I've not been there. You may have got to go to check right after this podcast.

• 44:27Speaker 01

  Yeah, there's a lot of bad jokes on Twitter, but apart from that, I think it's pretty clean, to be honest. And dull, like I said.

• 44:34Speaker 00

  Hey, isn't that the truth, though, these days? Even if one of us has a controversial opinion, maybe somebody could say Advanced Futures Trading Strategies, book by Robert Carver, is controversial. But I think you can live with that. There's not going to be a big problem if somebody considers that controversial. But the other aspects of all of our lives, eh, we just got to be quiet. So that's the way it is these days.

• 44:52Speaker 01

  Yeah, I think one of the main differences between me and Elon is I sometimes type tweets and then delete them before sending them, whereas he clearly never does that.

• 45:00Speaker 00

  I saw part of his interview with BBC the other day. The BBC guy looked a little less than sure, dealing with the guy worth, I don't know how many billions Elon's worth these days, but it was an interesting clip that I saw.

• 45:10Speaker 01

  Yeah, I watched the full interview last night. He's an interesting guy. I'm just going to leave it there. I'm not going to say anything controversial.

• 45:18Speaker 00

  Exactly.

• 45:18Speaker 01

  Second richest guy on earth.

• 45:20Speaker 00

  Yeah, seriously. Robert, great stuff. I appreciate you coming on. Hopefully, we'll do it again.

• 45:24Speaker 01

  Cheers, Michael. Thank you very much.

• 45:31Speaker 00

  I see a time when those awake will understand how to make money in up, down, and surprise markets. Whether new trader or experienced, college student or financial advisor, protecting against a crash, or just trying to make a lot of money, trend following offers everyone an answer in uncertain times. To get started immediately, send me an email, [email protected]. I will send you the right trend following steps to take, along with my free video. But if you want to buy and hold, trust the government and trust Wall Street, this is absolutely not for you.