StrategyTrading1

In May of 1982 the NYSE began trading stock index futures on its index. That year futures began trading on the Value Line Index and the S&P 500.

At the time I had never traded futures. Back then everyone referred to them as “commodities”, with  corn and hogs and soybeans and gold coming to mind.

I was still trading stocks through Charles Schwab, and unlike today commission costs were a large percentage of the total trade cost. There were a few discount brokers offering $29 to $39 commissions, but Schwab was higher. it wasn’t easy to make money trading actively with costs like that.

In my previous post I talked about The Schwab Mob, a group of mostly retired men who spent many hours every day in the Schwab waiting area, watching the tape and talking about stocks. I was the junior member.

It was there that I met Porter. He was in his 60’s, at least, was retired from the Air Force, seemed to always have a smile on his face and something interesting to say, and of course loved trading stocks, and seemed to like me a lot. And I liked him a lot. He was more interested in trading than the others, who were more inclined to buy and hold for some unspecified longer term period.

Porter and I were only interested in holding on as long as we were making money. We were both trying to figure out ways to time the shorter waves that lasted from several days to several weeks in length.

My background was in statistics, computers, and forecasting, and Porter figured out that we would make great trading partners.

He had a wealth of practical stock trading experience and I gained knowledge from our association.

One evening I went over to his house and discovered he was a paper packrat like me. He had piles and piles of papers, all about stocks and the market, piled up, it seemed like,  from one end of the house to the other. I have met other traders like Porter, and all with the same fascination with paper. Today, we are moving into a paperless world, where articles can be bookmarked from the Internet, but then, there was no Internet, so every scrap of paper, every article, every newsletter, every magazine, every copy of  Barron’s or the Wall Street Journal contained some tiny bits of wisdom that just might make us rich someday, so throwing anything away was just not a good idea. And making money would only take that one great idea.

One day Porter came up with one of those ideas - we could trade these new stock index futures for others and take a small percentage of the gains. Essentially, we could become mini-hedge fund managers.

When Porter mentioned this to me he had already approached some of the Schwab Mob members with his idea, and they were interested in diversifying. At the time the market was in a very bad mood, and traders were looking for something new.

So, Porter convinced several Mob members to open futures accounts with Lind Waldock, and we signed on as the traders of those accounts. Each account was opened with $10,000.

Well, we had been working out some profitable trading strategies over several months, getting the NYSE data from the newspaper, Schwab, and the nightly TV business reports.

We began to subscribe to the NYSE bulletin, and of course we had copies of Barron’s and the Wall Street Journal. We were able to put together a complete data history of the NYSE contracts.

However, once we actually began trading the contracts, we ran into drawdown. Of course, we were in uncharted territory.

I know now that every system, from buy and hold, to discretionary trading, to seat-of-your-pants trading, to mathematical system trading, runs into periods of drawdown. I now know that one must have some idea of how large that drawdown might be, and make sure that this number is acceptable relative to the size of the trading account.

I have found that I can take a 20% drawdown without feeling uncomfortable. So, whenever I trade anything I adjust my position size so that, if I get the worst drawdown I can find historically, it will only take my position down 20%.

When Porter and I traded the NYSE futures contracts we only had three months of data to work with, so we really didn’t know what sort of drawdown to expect. We were primarily focused on the potential gains.

All of our systems were worked out by hand. We gathered the data and I plotted it on hand drawn charts. Again, this was before the IBM PC. I used a hand-held calculator to compute gains and losses.

Our systems were profitable on paper, but when we started trading in the real market in real time, we ran into unexpected turbulence.

Well, things weren’t all that bad. Most of the accounts were going up and down around the 10k mark. After many weeks, Porter and I had a meeting at my house, and after hours and hours of work on the systems, we just looked at each other and I said, “Nothing Works”! And the realization of this was really funny at the time, and we both broke out into uncontrollable laughter, and we never forgot the moment.

Well, we were actually trading real money for other people, so this wasn’t so funny. I’m sure that this sort of thing goes on all over the world every day as people who are supposed to be making money for their clients actually come to realize that trading the markets is a lot more difficult than it appears on the surface.

Not long after that I noticed that a few of the accounts took a big “hit” - an equity drop of several thousand dollars. I called Porter and asked what might have happened. Up to that point all of our trades had been agreed upon in advance, and he called them in. He told me that he had made an “off system” trade, and that things hadn’t gone well.

That was it for me. I decided that since “nothing works” and Porter couldn’t control the urge to trade, we would have to shut down the operation and give control of the accounts back to their owners.

It was another series of lessons learned. I learned that when one is looking at a stock chart, or working out a trading strategy,  it seems fairly simple and straightforward to make money trading. However, the reality is that it’s very difficult to do this in real time, in the real market, with real money - and especially with other people’s money.

I found out that it’s also very difficult to stay “on system” and not pick up the phone and call in an “off system” trade on a hunch, or feeling. I have found myself picking up the phone and making trades, as if my brain and hand were disconnected - my hand belonging to another person living inside me, who just wanted to do something bold.

Some people just have to trade. Perhaps, they are like gamblers who just have to gamble. Perhaps they like the action. Perhaps they can’t control themselves. Perhaps the greed or fear takes them over and they lose rational control.

I found out that the only way I can make money in the market is with a carefully conceived and tested trading strategy, an automated trading platform, and strict money management.

I have found that I don’t so much mind losing my own money, but I hate losing other peoples money. I especially hate losing money for friends and family.

After Porter’s “off system” adventure, we broke up our partnership, and I lost contact with him. I also stopped going down to the Schwab office, and began to intensify my system research.

As you may or may not recall, it was in August of 1982, the 13th to be exact, that the market began a huge bull run. I will talk about that in a later post.