The Trader Who Never Spoke...Until Now ft. David Druz

[00:00:00] Dave

Futures trading is a zero-sum game that has got to be understood by anyone who is trying to be successful in the markets. If you’re going to win, there has to be somebody that’s going to lose. And if you don’t have a good concept of who is losing money for you to make it, I think you’re a bit at a disadvantage in these markets.

[00:00:40] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged. The place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we’ll have about investment performance is about the past. And past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions.

Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:35] Niels

Welcome to another episode in the Open Interest series on Top Traders Unplugged, hosted by Moritz Seibert. In life as well as in trading, maintaining a spirit of curiosity and open mindedness is key. And this is precisely what the Open Interest series is all about.

Join Moritz as he engages in candid conversations with seasoned professionals from around the globe to uncover their insights, successes and failures, offering you a unique perspective on the investment landscape. So, with no further ado, please enjoy the conversation.

[00:02:11] Moritz

Hey everybody, it’s great to be back. This is Moritz Seibert. This is the Open Interest series on Top Traders Unplugged. And let me tell you that today I have an awesome guest, someone that’s has never been on a podcast before, a trader who many of you will surely recognize. His name is Dave Druz, the founder of Tactical Investment Management. And let me just say that it’s been a fantastic conversation.

Dave is a great storyteller. It’s a natural conversation and what ended up happening is that, you know, we have material for more than two hours. We had a pre-call where Dave talked about his time with Ed Seykota. Dave was Ed Seykota’s first apprentice. We’ll split this into two parts. Part two is going to be the bonus parts about his time with Ed Seykota.

And in this part one, we’ll share the actual conversation about trading and position sizing, managing his firm, clients, all these type of things, which is also super interesting. So here we go. This is part one. I hope you’ll enjoy it. I thought it was really, really great. And we’ll be out with the bonus part two in a couple of days, so look out for that. Here we go, part one.

[00:03:27] Dave

I actually, went back and forth between Alaska and Hawaii after a period of time.

[00:03:29] Moritz

Okay, okay, and Alaska was out of interest because you liked the landscape and…

[00:03:39] Dave

No, no, no. I was an emergency physician as well as a commodity trader, and that’s where I had my medical practice.

[00:03:48] Moritz

In Alaska.

[00:03:49] Dave

In Alaska, correct, correct.

[00:03:52] Moritz

Is this where you went to med school?

[00:03:55] Dave

No, I went to med school at Johns Hopkins, in Baltimore, and then did my residency at University of Michigan State, and then I went to Alaska to practice when I was in private practice.

[00:04:10] Moritz

Got it. Got it. I don’t think I’ve ever asked, but how did you get interested in trading? Were there other people in med school trading and you followed them, or was it your own interest?

[00:04:20] Dave

No, that might be a story you might want to ask me during the podcast.

[00:04:25] Moritz

Well, I already pressed record. I can stitch these things together.

[00:04:29] Dave

You’re going to stitch? You did not tell me. Oh, I didn’t know we were recording. Ah, okay.

[00:04:41] Moritz

Well, you’re very good as you are.

[00:04:44] Dave

Okay. No, the way I got into trading was I had an unusual major in college, engineering, electrical engineering and pre-med. I knew I wanted to go into medicine, but I also wanted to learn electrical engineering just because I was fascinated. So, I was doing both.

And I was in a fraternity in Urbana, Illinois, which is about two and a half hours sort of south of Chicago. I had a fraternity brother who was two years older than I was, who made an enormous, enormous amount of money in the ‘70s in, you know, there were those huge moves. I’m sure you’ve looked back on the charts. There were all these amazing moves in the ‘70s. This guy’s name was Charlie, and Charlie had graduated already, but he would come back to school on weekends because he had a girlfriend that was in college.

Now, Charlie, he started with a very modest sum of money and pyramided the whole thing, just like in the books, you know, like, ‘don’t do this at home’. But he did it. And he made so much money that after a year, he bought a seat on the board of trade, and he was a floor trader for his own account. He would come down to visit his girlfriend, and when he came down, he had wads of $100 bills in his pocket, okay. And he took all the guys at the fraternity out to the bars.

Now, I never drank. I wasn’t a drinker. But whenever Charlie came down, everyone said, hey, Charlie. Hey, let’s go to the bars. I said, Charlie, I want to know how you did this. I want to know how did you make this kind of money, and what are you doing at the board of trade, and what is that like? And so, Charlie took me under his wing a little bit and explained to me my first things about trading.

He also got me a job, in the summer, working in a brokerage firm in Chicago in the research department. And that’s how I first got exposed and interested in commodities and trading. And I just fell in love with it. And I knew this was my passion. And I was still on a medical track, but I just had this passion for trading.

Now, in the research department, this was a company called Stotler and Company. They long since have gone out of business, but at the time they were a very prominent brokerage firm and FCM and also, they were a big grain elevator merchant. So, they had it covered on both sides, the commercials and the speculators. So, they did extremely well.

Anyway, I was the first programmer that Stotler and Company ever had. Computers were real new. They were the big giant IBM 360s that sat in a room and needed to be air conditioned and blah, blah, blah, all this stuff.

Anyway, I was their first computer programmer because in college in my engineering, I had learned to program computers. And so, at the time there weren’t a lot of people that could program. Anyway, in the research department, I did a lot of amazing things for them.

We time rented data over with telephone lines, back then, with a company in California who provided us price data. Stotler didn’t have their own database, and in those days, databases were really premium. So, we were running programs there, in Chicago, and moving data back and forth across the phone lines. Imagine how slow that was.

Nonetheless, I did some interesting programming things for them which so much so impressed the partners that they offered me a very lucrative job to just quit school, start to work for those guys in the research department, and forget this medicine idea. It was a bit tempting, I have to say, but one of the partners (this was a closely owned firm of partners), one of the partners was also a fraternity brother from several years older, who was no longer in a fraternity, but he also was a friend of Charlie’s (Charlie had gotten me the job there). this Guy’s name was Robert Stotler, Robert Stotler Jr.

And what the traders used to do back in those days is, after they traded all day on the floor along with the people that worked in the office, they would hit the bars at the Board of Trade after hours, and they’d hang out there and talk story, and so on. And I would go down and hang out with them and try to find out what are these guys doing, how are they trading?

I never drank, but I was always interested. So, I hung out in the bars with them. And now they had offered me this really high paying job. And so, I’m thinking about it. And one day Robert (Robert Stotler was one of the partners) got really drunk after work, and he’s the only guy left with me sitting in the bar there. And he’s telling me about what it’s like to be a floor trader and all this.

And he says, Dave, he says, don’t take the job. And he’s a partner trying to get me to take the job, but now he’s plastered. And so now he’s telling me what he really thinks. During the day he said, “Oh yeah, Dave, take this job.” But now he’s drunk, “Don’t take the job.”

And I said, “Robert, why not?”

“Dave,” he says, “You got the makings of a good trader,” he says, “And if you take this job, you’re going to trade with your own money, I know it. And it’s going to be scared money. It’s not going to be enough money for you to work and trade like you want to.” He says, “You go on, you get your medical degree and that will be your nest egg, that will be your source of money. And then when you trade, you won’t be playing with scared money and you’ll do it right.”

So, it made total sense to me, you know, have an independent source of income which is enough to provide for my needs, and then I can take any excess money that I don’t need and use it to trade. And it won’t be scared money, it will be money that I could trade properly and afford to lose.

So thanks to Robert Stotler, and that conversation, I did not drop out of school or drop out of medicine and did exactly that. I then started to actually trade with some of my own money and then decided, “You know, to do this right, you really need a lot of money to diversify properly, so why not start a fund?” And then that’s how the whole thing got going.

[00:12:19] Moritz

For how long did you practice medicine, for how many years?

[00:12:22] Dave

For nine years I was both. I was trading our funds, running Tactical Investment Management and practicing medicine for nine years after residency. And we actually started our first fund while I was a resident, and I essentially did not sleep, you know.

But the great thing about being an ER doctor, and if you look back, there have been a number of ER doctors who were quite successful in managing money for people. The great thing about an ER career in medicine is you shift work.

It’s one of the most unusual fields. You can do that in radiology, you can do that in ER, you can do it in clinical pathology. But most other doctors, you know, they’re on call, at least part of the time, even in a group. And you would have a hard time doing the best job for your patients and trying to be a trader in most careers in medicine. But in ER, it’s not hard. I mean you work your shift in medicine, you’re then off during your off-time, do what you want.

That’s when I downloaded my data, did the data analysis, wrote my program, so on, and so forth. So, I had two concurrent careers, both full time, for nine years. And like I said, I hardly ever slept.

[00:13:51] Moritz

Tell me a bit about the Commodities Corp piece. I forgot. You told me about your apprenticeship with Ed Seykota when we spoke during our pre-call. But was the Commodities Corp stuff, was that after the Ed Seykota period or before? It must have been before.

[00:14:06] Dave

No, actually it was after.

[00:14:09] Moritz

It was after.

[00:14:10] Dave

Yeah, I traded for Commodities Corp in the ‘90s, mid-‘90s to the late ‘90s, and just about until the time they got bought out by Goldman Sachs. And, at that point, there was a huge reshuffling of traders and personnel, and Goldman Sachs had a completely different way to view things, and lots and lots of traders got let go at that time. But no, my time at Commodities Corp Was in the mid’ 90s and it was a wonderful experience.

They had some wonderful people there. Sandra Ditalia, I remember, Francois-Henri, they were the two people that I dealt with primarily. And also Elaine Crocker was around at that time, but then she sort of, I don’t know what she did. Maybe she left or she got some other position of responsibility in the firm and Sandra took over her position. This position was finding traders, and it would be like if you were a spy, they were your runner. I mean they found a trader, and then they helped counsel them during the drawdowns and tried to keep their spirits up, if they weren’t doing well for a while, because they recognized some value in a person and they wanted them to succeed.

So, they were like sort of, not exactly a coach because the traders knew what they were doing, but they were a psychological support in addition to the person that found you and recruited you into the firm. So, Sandra was that person for me and she was great. It was a wonderful experience. I don’t know what else I can say. Commodities Corp was top notch in every way. They really understood the business. They had a fabulous stable of traders, and it was a wonderful time for me to be associated with them.

[00:16:29] Moritz

You were in their Princeton office, sitting with all these people in the house there?

[00:16:33] Dave

No, that’s not how it worked. There were some traders like that. There were some in-house traders, but at the time I was there, I don’t know if it was most, but it was certainly, I think it was most of their traders were not there. They had, wherever they were in the world, they were affiliated with CC, and they traded from their offices wherever they were.

[00:17:04] Moritz

And that was also true for you. So, you were somewhere else in the world?

[00:17:09] Dave

Correct. That’s correct. Wherever you wanted to be.

CC also had an affiliation, at that time, with a Japanese firm named ORIX. ORIX is a huge Japanese firm with interests in many, many different areas. And they were, I think they own a baseball team, and financial institutions, and who knows what else. But at that time, ORIX and CC had teamed up in some type of a joint venture and ORIX was trying to train their own traders to learn to trade. And so, CC flew me over to Japan a number of times to work with the ORIX traders. And I really enjoyed that too. That was a wonderful thing. I met some great guys there, and at least one of them turned into a really pretty good trader.

And then, it’s so interesting, in Japanese firms, at the time, they felt that people were interchangeable. You know, it really didn’t matter what your experience was. We’re just going to move you over here and put someone else there because they’ll learn to do the job too. It really doesn’t work like that in trading. And so, this guy who turned into an excellent trader, they eventually just moved him somewhere else. It was mind boggling.

So, when you were affiliated with CC, there were other things that you could get involved in. And they tapped me to do some trader training in Japan, which was a wonderful thing also.

[00:18:54] Moritz

Right, but when you did this at Commodities Corp you were no longer practicing as a doctor. This was now your full-time job, right? Or was it, again, a dual career?

[00:19:04] Dave

No, at this time I had retired from practicing medicine and was just full-time commodities. That’s correct. I couldn’t have done it otherwise.

[00:19:14] Moritz

When you were there, were you already trading in a trend following trading style?

I’m asking that question because when you did speak to me about Ed Seykota, I think you mentioned he’s the greatest trader the world has ever seen.

[00:19:28] Dave

In my opinion.

[00:19:29] Moritz

In your opinion.

[00:19:30] Dave

That’s my opinion.

[00:19:32] Moritz

Right. And then you also said that there is a big misunderstanding or misconception about Ed Seykota, which is that most people think that he’s a computerized systematic trader. And you said he’s absolutely not that. He’s more a technical, pattern based, setup-based trader.

So, you learned from him, you were his first apprentice. Then when you moved to Commodities Corp. How did you find out about trend following? Did you trade trend following systems? How did you find out about that method?

[00:20:00] Dave

Well, first of all, I’m not a trend trader. Everybody thinks I’m a trend trader.

[00:20:04] Moritz

Oh, there we go.

[00:20:07] Dave

See. It’s just how everyone thinks Ed is a computer… everyone who has read that Market Wizards book from the ‘80s, by Jack Schwager. I can’t say everybody, but probably most people that have read that book come away with the impression that Ed is an algorithmic, computerized, systematic trend trader. He’s not. He’s just what you described. He is a computer assisted, technical, discretionary trader.

I don’t know what he’s doing now, but this was back then, and I think it’s probably the way he’s always been. He knows everything about systems and has backtested, you know, out the wazoo. So, he knows what systems are doing. He knows their strengths and weaknesses. But his style is pattern based, discretionary trading. And the computer is an assist to display data, to gather data, to clean data, to present data in different formats that may be of use to him.

And when Jack Schwager was there, no doubt, he saw these computers (which at that time were still relatively new, you have to remember), and just made the assumption, because that had charts up or whatever, that this is the kind of trader he is. And Ed has, of course, certain very well-defined rules in his mind for trading.

And so, when he’s talking to Jack about always trade by your rules, and then, know when to break your rules, you know, if you read his things that he says to do. Jack probably assumed that he’s talking about computerized rules that generate all your trades. Well, that’s not the way Ed traded, no.

And we, at Tactical, I never considered ourselves a trend trader though we’ve always been lumped into that group because we correlate so highly with trend traders. And when I went to apprentice with Ed, I was already trading for over 10 years, for our investors, with our computerized systematic trading method.

I didn’t go to learn how to do that from Ed. After I was there, I realized I’m not going to learn it. When I went there, my original hope was maybe I can learn to do it better. But he wasn’t that kind of trader, so, that’s not what I learned from him. I continued, the whole time I was with Ed, trading for Tactical with our computer programs, which I had written. But I didn’t learn how to do any of that from him.

In fact, I would have to say there’s almost nothing I learned from Ed that we incorporated into our trading for investors. But what I learned from him is that you’re doing everything pretty much exactly right if you’re going to trade the way you’re trading. And it gave me great confidence.

Now, as I mentioned to you in our pre call, he always encouraged me to try to trade in a style more similar to his because he felt it was more profitable over the long run – a technical discretionary trader as opposed to an algorithmic computerized systematic trader. But we never did that for our investors.

[00:23:47] Moritz

Right, so, Tactical was already up and running when you were with Ed.

[00:23:51] Dave

Oh, for over 10 years.

[00:23:53] Moritz

Got it, got it.

[00:23:54] Dave

We started in 1981.

[00:23:58] Moritz

So, I would have put you into the trend following trading box, but I know I never asked. So, you said you’re not really a trend following trader. You correlate highly with these folks. So, what is it that you do or what is it that you did? Like, how would you categorize yourself and Tactical?

[00:24:16] Dave

Tactical always looked at our trading as the edge. Where is your edge? Okay, you’ve got to have an edge in the markets, right? And trend traders edge is identifying trends and writing trends, in one way or another, however you want to define these terms and be more specific about certain details. But their edge is to try to capture trends.

We always felt that our edge was capturing risk premia from hedgers and we designed our system specifically to do that. And it turns out, however, when you make most of your money, when you are in fact capturing risk premia from hedgers, it’s during the time that markets are trending and therefore you correlate very highly with people who are following trends. But you have a completely different way to look at the markets.

[00:25:23] Moritz

So, this, now, makes much more sense. This is one of the reasons why you didn’t trade the equity markets. You removed them from your portfolio. They were never in your portfolio. You were focused on the commodities, I think, the fixed income markets and currencies.

And I guess this is where you reckon that you would see these commercial hedging flows appear and therefore you could trade against them or fade them. But it’s something that you couldn’t be doing in the equity markets.

[00:25:51] Dave

That’s correct.

[00:25:53] Moritz

And how would you… So, help me out a little bit. How would you identify when to get in a position because of hedging flows? Because you need to have anticipation there and say, like, now these guys are coming, now they’re going to be hedging their crude oil position.

You know, for trend following traders, it’s something like, what, 100 day high, or 200 day high, or you’re breaking across a moving average, or something like that. But what type of signals did you use?

[00:26:22] Dave

All right, good question. Can I back up here a little bit and make sure. So, I’m not exactly positive who your target audience is. If they’re all just very sophisticated fund managers, that’s one thing. But if there might be some people who are newer to trading, trying to learn by listening in, these comments would be for them, these next comments, before I tell you how we determined how to time our entries.

Futures trading is a zero-sum game that has got to be understood by anyone who is trying to be successful in the markets. If you’re going to win, there has to be somebody that’s going to lose. Now you would think this is so obvious, but it’s not that obvious.

When I’ve talked to a lot of people who are trying to get into trading or even who might have been into trading for a while, they don’t think about where is my profit coming from? Oh, it’s coming from riding the trend. No, no, no. It’s coming from somebody else who took the opposite side.

And maybe some guy took the opposite side right at the beginning, and then he got out and gave it to somebody else, who gave it to somebody else. But there’s somebody who is on the opposite side losing money if you’re making money. And if you don’t have a good concept of who is losing money for you to make it, I think you’re at a bit of a disadvantage in these markets.

So, with that in mind, let’s look at who wins and loses in the markets. There have been many, many studies done by universities, and most of these, I think, initially, were done quite a long time ago, decades ago. I don’t even know if they waste their time doing it anymore.

But the Journal of Finance and all these old periodicals used to publish studies, done by universities, breaking down the three major groups of traders. You’ve got the big speculators, the small speculators, and the commercial hedgers. and who makes money over time and who loses money over time.

And in that group, only the big speculators, over time, take money out of the markets. The commercial hedgers lose money in the futures markets and the small speculators lose money in the futures markets. Only the big professional traders make money in the futures markets.

Okay. Therefore, if you’re going to do this as a professional trader, you’re going to have to take your money from either a hedger or a small speculator because the big traders, they’re all taking money out of the market as a block. You know, individual ones, of course, may lose, may blow up. So why not just try to figure out what the other guys are doing and do the opposite?

And then you would say also, well, if I want to eventually trade in any size, small speculators are going to become irrelevant because the size that they trade is tiny compared to the size you might want to trade, especially if you’re running funds or larger amounts of money. So, where does your money come from? It’s going to come from commercial hedgers. It’s got to, as you’re playing a zero-sum game.

You’re a trend trader, you’re taking money from commercial hedgers, whether you know it or not. So, you are identifying trends, blah, blah, blah. But behind all that, what you may not realize is that those hedgers have traded opposite you at some point. The price got high enough for them to hedge and so they sold into the market.

If it keeps going, well, they’re going to lose money in the futures market and you’re going to make money as the trend continues, it’s money that they lost. But their products.,,, Take a corn farmer, the price gets high enough, he hedges his corn into the market. He sells his corn into the market.

Well, he has locked in a profit for his business by doing that, and now he transfers the risk into the futures market because he’s happy. He says, oh my gosh, price went high enough, I can pay my overhead, I can make a profit for the year, I can pay for my seed, I can pay for my new equipment and so on, and so forth. I’m happy, I’ve got a good price.

Well, the futures market keeps going up. Well, he loses money on his futures position from then on out, but he makes money on his corn that he’s holding. But at that point he locked in a profit and he transferred the risk to you. And so, in my mind I said, whoa, let’s just figure out what the hedgers are doing and try to figure out a way to stay opposite the hedgers. Because it’s a zero-sum game and they’re the only big guys that are losing in this business.

Okay, so this is my rationale. back in the late ‘70s, early ‘80s, just thinking about how markets work. Well, here’s how we determined our algorithms for positioning ourselves opposite hedgers. And you cannot do this today. People have tried, but they can’t. And I’ll tell you why.

Back in the day, back at that time, the futures markets were really the only vehicles that big commercial hedgers had that were liquid enough for them to hedge their positions. Nowadays you’ve got all kinds of off market things and options and bazillions of different ways that hedgers can lay off their risk. But back then you had the futures markets, If you’re a corn trader, hey, you had court at the Board of Trade. That was all you had.

You may know, from the time that you lived in the States, that the Commodity Futures Trading Commission, at least at the time, I don’t know if they still do it, published something called the Commitment of Traders Report. And the Commitment of Traders report would come out with a two week lag, there was a two week lag. And traders who were of a certain size were required to report to the CFTC their position. You know, okay, I’m big enough, I have to report to the CFTC that I am long corn or I am short soybeans. And hedgers had to do this. Big speculators had to do this.

Small speculators of course didn’t have to do it, but you could figure out the small speculators position, the residual, so the CFTC could figure it out. And so, they would publish these reports that showed the big spec position, the hedger position and the small traders. And this would come out every week. And this was really the only place that hedgers had to hedge in those days. So, you knew what the hedgers were doing.

Now, you’re two weeks late, so, that’s a little bit late to take a trade, you know, especially in a fast-moving market. But you had the data, and you could compare it to the charts and the price action previously, and you could see where the big specs and the hedgers shifted from net long to net short and vice versa.

And then you could correlate that, then, with the chart patterns and see what kind of chart patterns indicate to you that you’re going to have a shift. And hedgers are now going to be, oh, they’re now going to be net short, or now they’re going to be net long. And so, I went back and looked at as much data as I could on this to try to get some rules of thumb for when these toggles would happen in the market.

And this is just in the big macro picture that this is when the toggles happen. And so, this is how we devised our algorithms to determine our timing for entering the market. We want to enter the market when we feel the pattern is such that the hedgers are likely to have shifted around this point.

Now, do I know that they actually did? No, I have no idea. But it’s a better basis for determining timing than just trying to guess that a trend is starting, from my perspective. So that’s just how I looked at it. And we used the same algorithms, the same timing algorithms, that I wrote a basic program for in 1984, all the way to the end.

[00:35:57] Moritz

So, all the way to the end, I think for Tactical is 2022 or 2023?

[00:36:04] Dave

2023. June 30, 2023.

[00:36:07] Moritz

So, you were still using the CFTC, Commitment of Traders data?

Because I remember you said you cannot do this anymore because there are too many off-taking risk routes.

[00:36:18] Dave

No, no we weren’t. We abandoned the data way back in the ‘80s. All right? We developed our algorithms based on the patterns from the Commitment of Traders reports. Once we had the algorithms, we don’t need the Commitment Of Traders reports anymore. And those algorithms are what we used for 40 years.

[00:36:43] Moritz

Right. And they were purely based on price.

[00:36:46] Dave

Correct.

[00:36:47] Moritz

Okay, and unlike Ed, you were following the rules, 100% systematized, no discretion, you were just putting in the trades which the algorithms wanted to have. There was no overriding or anything like that.

[00:37:02] Dave

No overriding. But you have to remember too, Moritz, that systematic trading is also a hundred percent discretionary because you have to decide what system and what rules you have. And once you decide them now, you don’t screw around with it. You know, that’s the difference Whereas the discretionary trader is making this decision more frequently, maybe all the time. But yeah, systematic trading is also discretionary. But discretion, it goes in at the front.

[00:37:36] Moritz

That’s right.

Now with regard to the commercial hedging properties, it’s easy to understand that for corn, and soybeans, and oil. You also traded the fixed income in the currency markets.

So, with say, currency markets, who’s hedging there? This is different than like a physical, like, products such as corn. Like a farmer planting that, harvesting it, and then offloading the risk into the futures markets. If you have a euro… (back then it didn’t have euro), let’s say a British pound or US dollar position, how would you determine hedging flows there?

[00:38:14] Dave

Well, of course, we, when we designed our algorithms, they didn’t even have currency futures. But if you think about the makeup of the currency markets, they’re laying off risk all the time. You’ve got financial institutions, you have big international corporations, they are always using those markets to lay off risk. It’s absolutely a valid model in those markets.

And the same thing in the interest rate futures, though, as you get shorter and shorter on the yield curve, I think that breaks down a little bit more because it’s somewhat more arbitrage to the fixed rates that the central bank set. But it still is a valid hedging model in our opinion. And so, when the currency markets became viable futures markets, we said, oh my gosh, absolutely. They’re all laying off risk. They want someone to take the other side. And, we just moved right in there.

[00:39:24] Moritz

And you don’t think that exists in the equity markets where, say, you have a big institution sitting on a long position in the equities? Which, in aggregate, people are long equities. They must be long equities. Right?

Don’t they have a hedging propensity there as well, where they say, oh, I want to be selling some futures against the equity position because it’s been riding high enough for me. I’m happy with that.

[00:39:47] Dave

You have some of that, of course, but it’s not the same mix. You think about it. The equity futures are not “free markets” in the sense that you have price discovery. In the futures market, the equity futures are tied to an arbitrage to the underlying indexes.

So, in your classic futures market with hedgers, the futures markets serve as a mechanism for price discovery based on the needs of the participants to move their risk around. And so, I don’t consider the type of hedging that goes on in the equity markets to fall into the same type of category.

And this is just my assessment. It doesn’t mean that someone else might view it differently and say, oh, I think that the tactical model applies to equity markets. Well, I just never felt comfortable with it. And so, we didn’t use our method in the equity markets.

[00:41:04] Moritz

When you have a position or your model, your algorithm tells you to go long or short, it sounds to me, when we did our pre-call, that you were essentially sizing this position like a CTA would today where you’d be risking a fraction of your close trade equity or whatever you use as your capital base. You would then have that trade appropriately sized. You may have to roll it over time to stay in the position. But other than that, you will just look for a trend to establish itself and just ride it for as long as you can with an exit at some point, which is also algorithmically determined.

[00:41:41] Dave

I need to just sort of correct you a little because you said something about a trend there. Okay, all right. So, now you’re getting into… You’re asking a question about money management.

[00:41:56] Moritz

Sizing, yes.

[00:41:57] Dave

Okay. So, remember, in a system of trading, there are three main aspects: there’s timing, there’s money management, and there’s portfolio selection. And all of those have to go into the pie that you’re making. So, what we were discussing previously with the hedgers, this has to do with timing. It does not have anything at all to do with money management. That’s a separate issue which you have to incorporate in the overall system.

And so, the entry, the way we traded, the entry was based on trying to stay opposite the hedgers, and the exit was based on money management rules. We were not an ‘always in the market’ trader. Now, you could trade that way and be opposite hedgers and say, I just want to only stay in the market 100% of the time. But from a money management perspective, to me, that wasn’t the most optimal way to do it.

And so right from the beginning, I always felt money management was distinct from the timing. They had to be incorporated as a whole, but it wasn’t, oh, I’m always going to be in the market. You’re always going to be, how big do I trade? Where do I put a stop loss point? Do I use a stop loss point? You know, all these type of questions which all traders ask.

[00:43:40] Moritz

I agree with that. We also differentiate these pieces like, you know, you have entry signals and then a second question is, how do you size a position and when do you get out of it? So, it sounds like when you had the position, your exit at some point was based on a trailing stop or something like that, but not necessarily something that had to do with price development.

[00:44:02] Dave

Well, there are different ways to do it. And we did use trailing stop. That’s no secret. I mean, I’m not trading anymore. It’s not like I have like a lot of great secrets I don’t want anybody to know. But we used a trailing stop. We sized our positions based on the likelihood that that position would get stopped-out with just a random movement of price versus some real significant movement of price. And so, the way you would talk about that probably is saying, the position was sized based on the volatility of the market at the time the position was put on.

[00:44:47] Moritz

Yes, ATR based, or volatility based.

[00:44:51] Dave

Whatever. Some type of means to give the market enough room but not too much.

And actually, the best kind of trade, if you had a system that could do it, would be to buy or sell at a point the market will never come back to and have virtually no risk in an infinitely large position. But of course, no, we didn’t do that.

[00:45:16] Moritz

At what type of… I mean, you were trading at a higher level of volatility, if I recall your track record correctly, how did you cope with that? Like, how difficult did you find it, also personally, maybe emotionally too, you know, to live with the markets, go through these drawdowns. You had some big up months, big down months. You’ve made a lot of money. It’s a great track record. But you also had like a rough patch in between.

[00:45:45] Dave

Well, so there’s, there’s two aspects to that question. One is how do you emotionally and psychologically deal with it? And let me get to that in a second. But first let me make clear that, in my mind, I always realized this was going to have to be part of the process because if you’re taking risk from the hedgers to make money over the long run, you’re going to have a risky or a volatile equity stream. You can try to minimize this by diversifying, by doing some other things with your portfolio, by trying to have the best money management strategies you can. But I felt that this style of trading was inherently going to have a swingy type of equity stream because I’m taking what the hedgers don’t want, that’s what they don’t want. And they’re going to pay me to take it, so I have to be able to take it.

And it’s like somebody is hitting you and knocking you down, and every time you have to stand up again, and then they hit you again and they knock you down, and you have to stand up, and they hit you again. Okay. And then you stand up enough times, and they go, okay, now we’re going to pay you a lot of money.

So, that’s how we felt this type of strategy was going to be. It’s like you’re being an insurance company as a trader of this type, but you are not getting the beautiful income stream of an insurance company where they have lots, and lots, and lots, of little profits from their premiums and they have an occasional catastrophic payout. It’s the opposite.

You’re losing almost every time because the hedgers, they’re smart. They know when the price is too high or too low, and that’s where they’re going to trade. And so, you’re taking these positions and most of the time you’re going to lose. And only when they’re wrong, and something surprises people, that’s when you make your money. And so, now the question becomes, psychologically, how do you deal with that?

And the first part of the answer is you have to understand that this is expected in this type of trading. So, that initially gives you a little bit of an advantage or an ability to realize that drawdowns are absolutely part of this technique. It’s not like it’s coming out of nowhere. Oh, my. I never expected to have a drawdown. It’s like, yeah, I expect to be in a drawdown most of the time. Until you have these DOUCH, big moves that pull you up and make you give you new highs. They may go on for a while. If you’re lucky, they’ll go on for many months, maybe a year or two.

But then you can be expected to have long periods where you’re not necessarily making any money. So, coming into it with that mindset, now you just have to deal with how do you stand up every time you get hit? And that is understanding your own psychology, and how much heat you can take, and just being able to never quit.

You know, that’s the thing. You make a decision at the beginning: I have faith in this method. I’m not going to abandon the method, and I will stand up each time. And this is where it’s very helpful to have that computer that is saying, okay, here’s your buy, here’s your sell point. This is the size.

Because if you’ve been knocked down 10 times in a row, and you’re in a big drawdown, and you haven’t had equity highs for three years, you know, you’re not going to want to take every single trade that comes along, especially when it looks absolutely horrible on the chart. So, being a systematic trader really helps in this regard.

But I don’t want any newer listeners to think that systematic trading takes away the psychological pain you feel when you’re in a drawdown. It’s absolutely still there.

[00:50:23] Moritz

Yes, it is there. That also ties into what you said, that it’s so important to take these trades when you are in a drawdown and not have them dialed back because you want to be in a position to get out of the drawdown. Again, it’s part of the system.

You’ve mentioned heat, which is a term that I know from my readings of, of Ed Seykota portfolio, heat and how much heat can you take? When you look at your portfolio, I’m not sure how many markets you traded, 30, 40, 50, something like that probably. But imagine you had a position in many markets at the same time and you were sitting on big open trade profits and you just had a great run. But in aggregate, over the entire portfolio, you may now have a lot of heat if all these positions, in your case, move to their trailing stop. You’d give back a lot of these open trade profits. Would you ever kind of like have a maximum portfolio heat and say, up to here and then no further? And would then not take any new trades or reduce open positions so that you would mitigate that potential drawdown or would you just, you know, stick with them and ride every single one for as long as it takes?

[00:51:35] Dave

We did not have such a rule in the system. If the portfolio had a large open equity, it was not a trigger for bailing on the portfolio or cutting the portfolio back.

This is where we fall into a money management type of category. And here’s the other thing. Even though I told you that we used the same timing algorithm from 1984, that just shows that it was robust. I tested absolutely every single thing under the sun. I had computers going 24/7 for years, testing every possible system, every idea I could think of.

Because I think, well, you know, there may be other ways to do this. You’ve got this one way. It makes sense to you. You’re trading it for investors, but maybe you can improve, maybe you can find something that’s better, or maybe you can find something that complements it that would be somewhat distinct, that would smooth the equity a little bit. So, I never stopped testing systems, and we had a huge database.

In fact, even though we’re no longer trading, we still keep the database up because in my mind it’s immensely valuable. And who knows, maybe someday we might use it again for something. But I tested absolutely everything, and I programmed it all myself. So, I could ask any kind of question. The question didn’t have to be, is the program that I’ve purchased able to answer this kind of question?

And so, I could answer very complex, interrelated, money management, portfolio level questions, which sometimes are a little more difficult for certain sort of off-the-shelf programs to address, though they’ve gotten much better over the years in this regard. And so no, the answer to your question, we did not have such a rule.

[00:53:49] Moritz

What programming language did you use? Did you continue with BASIC all the way until 2023?

[00:53:54] Dave

The first program language I learned was Fortran. Basic was very similar to that. Then I switched to C and C++, and that’s what I used subsequently. And most of those programs, the C, C++ programs were used for research.

The trading, believe it or not, we still use the BASIC program as the core algorithm and then layered on top of that with the more advanced type of programming languages for certain types of money management portfolio things. But that algorithm amazingly worked that entire time.

Again, this is for people who might be a little newer. This is probably not information that seasoned money managers know or need to know. But they may not put it in context of the bigger picture with the correct or, let’s say, the most optimal waiting.

There are three aspects to a system we’ve talked about: the timing, the money management, and notice you didn’t ask me a single question about portfolio. And this is typical (I’m not saying you, you’re very sophisticated money manager, so I know you have thought about it). But, you didn’t bring up the question about the portfolio. How do you construct your portfolio?

In my mind, of the three things: timing, money management, portfolio, the portfolio is an order of magnitude at least 10 times more important than either of the other two. Ed used to say, “Put your affection on portfolio selection.” And I’ll give you just a real easy thought experiment on this.

Let’s suppose your system just traded one market. Now, that would be sort of a crazy kind of system to have, but let’s suppose that’s what it did. In 2024, there are two guys, they both have the same timing, the same money management. But one guy says, my portfolio consists of cocoa. The other guy says, my portfolio consists of crude oil. At the end of the year, they’ve both traded exactly the same timing and money management.

And the guy who traded cocoa, as his portfolio, absolutely did fabulously well. And the guy that traded crude oil probably got chewed up and may have had a loss for the year. The portfolio is more important, in my mind, than anything else. And I think it’s very important, especially for new traders, to really think about how their portfolio is constructed, whether or not there is any algorithm that adjusts the portfolio.

People usually, when they design a system, they spend a lot of time on timing and money management, and then they say, well, I think I’m going to trade this basket. And then that basket doesn’t change. Or if it changes, it’s a discretionary change. And why did you do that? Why did you take this market out, put that market in? And should every market in the portfolio have the same weighting?

You know, these are really important questions and very often traders don’t ask them. And I think if Tactical had an edge, in any way, that was our own, it was how much attention we gave to the portfolio, the weighting, the weighting of individual markets, any algorithms that were designed around the weighting of the portfolio. So anyway, I just wanted to mention that before we get off of trading.

[00:58:03] Moritz

No, we don’t get off of trading now because now you brought it up, and I’m very happy about this. That is something that I’d like to take a deeper dive in now.

Before we do that, and maybe this is just (we’ll speak about the portfolio in a second)…

Systems, did you combine different time frames, different methods, different things in a portfolio, irrespective of the markets? Like trading the same basket of markets (we’ll get to that in a second) but did you also diversify across system timeframes and system types?

[00:58:38] Dave

Not at first. At first, I simply used, okay, where do I see the commitment of traders? Give us the big toggle from the big universe of hedgers and big specs. And then, as I learned more over the years, I recognized that markets are fractal over a wide range. If you get too short or you get too long, the fractal nature of markets breaks down. And of course, fractal is self-similar at different scales.

And so, I said, whoa, I know there’s hedging going on at all. different time frames, maybe I can just apply this pattern at different time frames. Hm, it makes sense to me. Let’s try it. And so, we tested it. Of course, we backtested it first, and son of a gun, it worked. And so, we did trade different time frames with the same pattern recognition that we devised for the big macro switches. So that answers that question for you.

[00:59:50] Moritz

Now, markets, there’s one interesting aspect you just mentioned with it, which is it’s kind of sounded like a dynamic composition of the portfolio or a dynamic weighting algorithm where you would, at some point maybe, put more risk into the 10-year note or less risk into corn or vice versa. Or maybe you would change the composition of the portfolio and not trade the 10-year note at all but put more risk into cotton.

Was something like that going on or did you have a static basket of markets?

[01:00:22] Dave

It wasn’t static in the way that most people think about a systematic trading system where you do have a static basket and nothing changes. But the changing that happened was, I wouldn’t say it was as slow moving as a glacier, but it was definitely built into the method.

I can give you another example of why it has to be there somehow. But I’m going to take you back to the ‘70s to do this. And if people have done their research and looked back, you always want to look back as far as you can if you’re doing systematic trading. We got data back as far as the Board of Trade, all these wonderful friends of mine, Tom Carpenter was a floor trader. He went to the Board of Trade bowels library and we xeroxed every single chart from way back and I typed in all the data by hand.

So, you want to look back as far as you can. So, if you’ve looked back far enough, you’ll know that in the ‘70s, one of the biggest movers up and down, with amazing trends, was the potato futures. All right, let’s suppose the potato futures were in your portfolio. Well, where are potato futures today? They don’t exist. They stopped trading. So, at some point you had to stop trading potato futures.

Now, do you stop trading potato futures when the exchange says we’re delisting them, or do you stop trading potato futures when the volume and open interest get so thin you can’t trade them? You have to have some rule to tell you when to stop trading a certain market. It has to be there.

Most people don’t think about it, they just think it’s obvious they’ll know what to do. But it might not be so obvious. Similarly, we were trading before crude oil futures started to trade. So, when crude oil starts to trade as a futures, heating oil was first, then the petroleum complex. But the question is, oh my gosh, do we trade this, or do I wait 10 years till I have 10 years to backtest and make sure my system “works on it”? So, you have to have some method to incorporate in your portfolio new markets or markets that are no longer viable.

Similarly, in my mind, you want to have something in your portfolio that looks at what your portfolio is trying to achieve for you and makes sure that you have some feedback on it. Now, what is a portfolio trying to achieve for most people? Most people are trying to diversify, with their portfolio, as much as they possibly can, to smooth out their equity growth. And that’s fine if that’s what you consider the portfolio is giving you, it’s giving you smoothness of equity growth.

And if that’s the case, then as you construct your portfolio, you have to construct it with this goal in mind. And you have to say, I want orthogonal markets, meaning markets that are like at right angles to each other and have nothing to do with each other. The more my markets can be completely independent, the better chance I have to get what I’m trying to attain, which is my goal in my portfolio, diversification, and smoothness of equity growth.

If your markets are all correlated with each other, you’re not going to smooth your equity growth at all. You could have 25 markets in your portfolio, and if they’re all interest rate futures, you’re getting virtually no benefit for smoothing your equity growth.

So, when the portfolio is being constructed, and this is a discretionary decision for most traders, they need to look at how orthogonal are my markets if my goal of that portfolio is smoothness of equity growth? You don’t just arbitrarily pull markets and say, well, I want to have 50 markets and what’s out there? You might end up with a predominance of interest rate futures. Or if you trade equities, you’ll have a number of equity futures, and it might be too weighted.

You have to think about these types of questions. And in this regard, in my mind, you have to be very careful the slice of the portfolio pie that you give each individual market. But not only that, you have to be very careful how much of the portfolio pie you give a market sector.

For example, we’ve been talking about interest rates lumping in together. That’s a sector which is highly correlated with itself. Even across different countries, there’s still a relatively high correlation in interest rate futures. And so, what we would do is we would start at the big picture and look at all the sectors that are out there. And before we started to do anything else, we’d say, what sectors can we break down the universe of available markets into? And then what of those sectors are orthogonal to each other or how orthogonal are they?

And in this way, we would be able to start to say, well, we’re going to give so much weighting to this, and so much weighting to that sector. And trying to, at first, determine how do we smooth things out at a sector level?

And now, within the sectors, let’s look at what markets are available within the sectors, how separate, how similar are these, and therefore, what’s the weighting within each of the sectors with respect to the individual submarket groups? For example, in the commodity sector, you have agricultural markets, it’s a sub sector, and you have a sub, sub sector of that. You have grains and you have oil seeds. Well, these are all correlated with each other in certain ways.

And so, in each case we would break it down and try to find the most optimal diversification that we could obtain based on our assessment of orthogonality of markets. And that’s how we would start. And then we had algorithms that would keep track of this type of thing and ever so slowly make adjustments over time if markets no longer were behaving in the way that we had initially assessed them. Are these markets now acting similarly, whereas, before they didn’t? And this is something you have to be very careful about and look over a very big period of time.

But I still think it’s important that traders at least think about these questions and answer them appropriately for their system.

[01:08:05] Moritz

I couldn’t agree more. And that’s what we’re spending a lot of time on is like, what type of markets do we add to the portfolio and how independent and idiosyncratic are they?

So, in what you’ve just described, when I take the example of what you’ve called the petroleum complex: heating oil, back then it was unleaded gas, now it’s RBOB gasoline, you have WTI, you have Brent, you have all these gas and oil in Europe, you have these markets. Would you say, okay, if I’m getting a signal to take a position in WTI crude oil, and at the same time you’re getting a signal to take a position in the same direction in heating oil, would you size them each fully or would you, because of your sector weightings that you’ve calculated previously, have said no I’m only going to be taking half a position in crude oil, I’m going to taking another half risk position in heating oil because these folks are correlated.

[01:09:00] Dave

This is something I think needs to be defined in the system. So, in advance, of course, you know what you’re going to do. There are different ways to think about this. One way is, okay, they’re very correlated, so, each market’s only going to have a half a weight. That’s one way to do it.

The other way to do it is, oh, whichever signal I get first, that’s probably the market that’s going to have the most umph behind it, whether long or short. I’m going to put all the weight in that and not in any of the others.

See, these are the kind of questions that people have to ask and determine for themselves. And, of course, the way I would do this is ask the question, and then look back as far as I could over time, write a program, analyze the results, and then break it up in little segments of yearly intervals (rolling intervals, 5 years blocks, 10 year blocks), and see how is that question answered over different periods of time. And is there a robust answer to the question or is there not?

If there is, maybe it’s something you want to incorporate. If so, well, you can test it, that same idea, not just on the petroleums, but on other groups that have similar markets. And you may find that you’ve come up with some rules which benefit the overall portfolio composition, which is dynamic. It’s a dynamic type of a portfolio in some regards.

So, anyway, everyone has to decide these types of things before they start trading so they’re not too weighted or underweighted. And remember I said this is assuming that your portfolio goal is smoothness of equity growth. There’s a whole other way to look at it. Or there may be many ways to look at it, but the other way to look at it, that is most common in my mind other than smoothness of equity growth, is I want a portfolio that has the markets in it that have the best potential to make money in the near term. And so, then you have to have some type of an algorithm that gives a relative strength weight to each of the markets.

And then you have to have some way to change the portfolio as that relative strength changes over time. And this would be like the example of some guy, he looks at all the markets, but he’s only going to trade five markets at a time. And so, this is the kind of guy that last year would have wanted to identify cocoa as one of those five markets and get that in there somehow.

So, there’s more ways to look at a portfolio than just the money manager way of smoothing the portfolio growth. There’s also at least the way of let’s try to have a portfolio of just the best stuff all the time.

[01:12:13] Moritz

And make the most amount of money. How did Tactical do it? Did Tactical look for smoothness of equity or did you go for the big bang?

[01:12:21] Dave

No, we looked for smoothness of equity because we were trying to responsibly invest for our investors who expected us to try to do as much as we could to minimize the volatility which we knew was inherent in our system.

[01:12:43] Moritz

So, this is probably now a good segue into what I wanted to do, which is speak a little bit about Tactical and how the firm developed irrespective of the trading. Like, you know, the people there, the clients, AUM growth, and all these types of things. Because, you know, you manage a business. Trading is one thing. Running Tactical, as a firm, and speaking to investors is another thing. They correlate, but they’re not the same.

I think you mentioned to me that you’ve never invested, I don’t want to say that you said anything, maybe not much into marketing because you said marketing is a cost in and by itself, which at some point the investors need to bear. They will have to pay for that. So, you stayed away from this. I think it kind of like goes the way, you know, Tactical, with a 40 year plus track record, you’ve never scaled your firm into the billions. You stayed around, I’m not sure, 100 million, maybe more than a hundred million, something like that, but not into the billions. So, you did have a different spirit in the way you ran the business.

[01:13:49] Dave

That’s true.

[01:13:49] Moritz

Like you could have… This is also a matter of choices. You know, there are some firms that set themselves up and they say, look, you know, I want to become a multibillion-dollar hedge fund and be on the cover of the Bloomberg News magazine. That’d be really important. And be speaking with all these sovereign wealth funds, and become incredibly wealthy as a money manager that way, because I’m earning management fees on a very large pile of assets.

There’s certainly that group of traders and hedge funds that exists out there. And I think that is probably not too long for today’s conversation. I personally think there’s a lot of things wrong with that which are overlooked by investors that allocate these big tickets to these firms. There’s not necessarily an alignment between investors and what it is that the money manager is doing.

There’s another group of funds that stay smaller. They seem to have a different philosophy and spirit and the way that they trade and the way they work with their clients. And so, you clearly chose to be in that second box.

[01:14:55] Dave

We did. Remember, we started back in the early ‘80s at the same time as a lot of these guys who have become the billionaires with their firms. And in order to do that, you need to have an active marketing aspect of your business. You have to be willing to pay for that marketing aspect of your business and that money that you pay for that, it comes out one way or another from the investor. You can say, well, you know, as the trader, I’m going to take less, and we’ll give some to our marketer. And that’s one way to do it.

And the few times we did market, the marketing money came primarily from less income to us. But the people who got really big, they spent a significant amount of money on marketing and the investors paid for it one way or another.

In the old days, this usually happened through larger commissions and so it was hidden from the investor. In the, let’s say the ‘80s, ‘90s, a lot of large brokerage firms would offer funds and promote funds. And the fees to the advisors might look reasonable. But the commissions were ridiculously high compared to what you could get if you were just trying to get the best deal for your investor. And those commissions paid for the marketing.

And I remember, there were many times in the early ‘80s, in mid-80s, that we were approached by large firms. I mean, we had what, a 5 year track record or something at that time, and it was volatile as heck, but still it did pretty well for our investors. And they wanted us to trade for them. And I said, well, we can bring you so much money in, but we’re going to need to charge $75 round turn. And I said, no, I’m not going to do that to our investors.

So, our philosophy was, investors first and foremost, and do the very best you can for them in every way. And so, we never went in for paying for marketing because eventually we thought the investors were going to have to foot that bill.

And I have no regrets whatsoever. I’m so happy we did it that way. I don’t need to own a baseball team or be on the cover of some magazine.

[01:17:55] Moritz

It’s music to my ears. I’ve said to our investors, we’re never going to be hiring a salesperson. And, we don’t. If there is any sales and marketing, it is something that we do personally. We speak with every investor. I think it’s a different way of running a business. I think it is, at least to me, it’s subjective. You know, not everybody has the same interpretation of ‘better’, but it’s a better fit for us.

And it sounded like it was also a better fit for Tactical, to run the business in that way, which means you can operate with a fewer amount of people, which means there’s less organizational complexities in your organization. It probably improves the quality of your life.

At least in my case that is true. You can be independent, kind of like work from anywhere with the technology that we have available. And it also means that you have a different investor base at the end of that. Because of that your investors are not going to be the big institutions.

[01:18:53] Dave

Right.

[01:18:54] Moritz

You will have more like, you know, private investors, family offices maybe. And we just enjoy that much more because it gives us an opportunity to also explain in more detail what it is that we do, how we trade, why the volatility exists and that they need to be there for a period of time. They can’t day trade us in the same way they couldn’t day trade you, or month trade you, or something silly like that. It’s just a different model.

And the other thing that I find is important, like I don’t want to speak about fees, but it’s about the markets which, you’ve mentioned, is kind of like the most important input aspect when you design these systems. If you are smaller, you can operate in some of these smaller markets. And some of these smaller markets are the really diversifying ones. It’s not the ten-year note. We can be a billion-dollar fund and we can trade 10-year note futures all day long. But you cannot be a $10 billion fund and trade lumber futures all day long (which is one of these markets that is absolutely orthogonal. which is a term that you’ve used), or orange juice futures, or cotton, or cocoa, or sugar, these type of things.

And that is also a responsibility, I think, at least we view it this way to our investors, to create that portfolio that has these different risk inputs that are uncorrelated to each other over time. That allows us to extract the small edge that we have.

In our case it’s a trend following trading edge, with more precision, over time, and less noise, relative to somebody that has an over proportionately large amount of risk into the interest rate or equity markets where all of a sudden you’re subject to, oh, it’s risk on, it’s risk off, and it’s kind of like all the same thing.

And then they have to dial their positions down, and they have to respond to these investors, and smooth the returns, and vol control stuff, and avoid getting into a drawdown otherwise they get fired. And still they get a management fee. That is where the alignment breaks.

And I think the way that you’ve run your business, and we’re, in a way, looking up to that, and others who’ve run the business the same way, is actually more, I’m not sure if honest is the right word, but it’s just a better fit for us.

[01:21:14] Dave

Yeah. Yeah. Well, my philosophy and your philosophy, in that regard, align very closely. And I admire that you are doing it this way. I just think it’s wonderful. It’s a question of, are you in the business primarily for the investor or primarily for yourself?

[01:21:36] Moritz

That’s right.

[01:21:37] Dave

All right. And that’s what it comes down to. It’s like when I was practicing medicine, the patient came first no matter what. It doesn’t matter how I felt or I don’t want to go see this guy again, or I don’t want to go in today. I’ll call in sick. No, it doesn’t happen. The patient comes first. The investor comes first. And that’s how we always ran our business. It sounds like you’re running yours that way, and to put the investor first.

Yeah, you want to trade some of these markets that you can’t trade if you have a billion dollars. So, I completely concur with your philosophy in that regard. And I also concur with your observation that you will attract a much different clientele with that philosophy than with someone who has a big marketing arm and is a large firm. And so, I also have that observation as well.

[01:22:38] Moritz

Yeah, yeah. And these might be “the better investors” who understand it better, who kind of like have a journey with you and stay for the longer run. And then that allows them to also get the benefit of our way of trading, as opposed to the fast money.

We’ve even put language in our legal offering documents that will limit the size of the fund so that we’re kind of like capping ourselves. We cannot and won’t go larger than a certain amount of money, because if we did, we wouldn’t be able to trade lumber anymore, and we wouldn’t be able to trade oats anymore and canola. But these are markets that we do want to trade because they’re awesome to trade.

That doesn’t mean that every trade is going to be making money in these markets. Quite the opposite. 70% of the time we’re losing in these markets. But in aggregate, on a portfolio level, the addition of canola to the 10-year note is awesome. And the addition of the 5-year note to the 10-year note is not awesome. It does have a small benefit, a tiny benefit. It’s not zero, but it’s not as large as canola and sugar.

[01:23:38] Dave

Correct.

[01:23:38] Moritz

And that is just something that… There are other markets that are popping up. You’ve said it’s glacial speed. There are markets disappearing, there are markets surfacing, new markets coming up that have really good portfolio qualities.

Some of these markets we can find in China, where they have markets that are very liquid, very large, markets that are difficult to access for, say, US persons and institutions. But there’s good ways to get to these markets.

And you know, they just have stuff that you don’t find on the CME, chemical contracts and things like that. So, this is great. And to me, personally, also, one thing that I don’t want again in my life is these big organizational complexities where all of a sudden you have a team of 30 people. I mean, there’s a cost associated, not just financially but also in the management of that type of organization. But if you are a large fund, with a big marketing department, as you’ve just mentioned, you will, at some point, have that type of size.

If you have US$1 billion, US$2 billion, US$3 billion of assets under management, the investors demand you to have that. They want to read the due diligence question, and they want to see how many PhDs do you have, and you need to have at least like 30 or 40 people.

This is a completely different business that is so now apart from trading, which removes your focus from trading because it’s requires you to focus on the business and that is where the alignment breaks. Because that, I think, that is what you said. Are you doing it for the investors or are you doing it for yourself?

And I think if you are in this very, very large category, you’re much more likely to be running something that’s good for yourself because you’re kind of forced to, in these big organizations, to operate that way. And that is a function that is absolutely different, and has nothing to do with the quality of your trading.

[01:25:32] Dave

Right. You’re right. I agree with you. And if I could just mention a couple things. There were a couple times that we did have marketers out there telling people about us. These were folks that came to us and said, can I market for Tactical? And I said, well, you’re not going to like it because you’re not going to make a lot of money. And I may turn down investors you bring to us because I don’t feel they’re a good, fit. Wonderful people, Tom Carpenter was with me for a while, and Rob Lingle, both really great guys, and they were willing to take a small amount of our income to do some marketing.

But it became very frustrating for them because, you know, they weren’t making the kind of money that they could make marketing for someone else. And also, a lot of times they would spend a great deal of effort to try to bring a client to us. And then I would have the personal interview, like you mentioned that you do. And I would say, guy’s, they’re not a fit, sorry. And it’s like, I just worked six months on this guy, Druz, how come you’re not going to take him? And I felt bad about the times that happened. But I think it’s appropriate for you to always trade and run your business in a method, in a manner that suits your personality, your outlook, and what you’re trying to achieve.

[01:27:12] Moritz

It has to suit your life and what you want. Where do you see yourself in, like, 10, 20, 30 years? And. And so, that is how we run. And I agree with you, we do turn people down. It’s not like we have the most rigid interview process and you need to pass a test, and we’re not trying to scare people away, but we want to be very upfront about the risks that we’re taking and the ups and downs, and the swings, and how painful it can be.

And if we feel that it wouldn’t be a good fit for them, they shouldn’t invest, because the likelihood is then very high that they’re going to be an unhappy investor. And if they are an unhappy investor, and if they’re in a drawdown, they have a tendency to redeem at the low point. It’s not good for them, it’s not good for us. And then nobody’s being helped. And maybe you end up not liking each other. So, we just try to filter that a little bit so that we get the right type of investors that understand what it is that we want to do for them.

[01:28:12] Dave

Yeah, I agree completely. It sounds exactly like our philosophy. It’s an alignment of expectations. If the expectations aren’t aligned of the investor and you, and you and the investor, it’s not going to work right. And they won’t stick around or something will come up and there’ll be a tense situation somehow, somewhere.

Could I just mention one other thing? I think it’s important that your audience knows why Tactical is not in business anymore. You know, most commodity traders stop trading because they blow up. I’d say that’s the number one cause for a firm that’s been around a while to no longer be there, or else the people get too old and they may pass away. But in our case, I would love to still be trading.

But our organization, as you mentioned, was small because of the way we had it structured. And I had two key employees that were with me for about 40 years. Colleen Haviland and Paul Brinkworth, wonderful, fabulous people. And we had this amazing team. Colleen was back office. Paul was trade execution. He would execute the orders the computer put in. They were each like an entire little, three, four person group.

And both of them, simultaneously, at the same time, in early 2023, told me that they were concerned about their health and felt they needed to retire that year. And I couldn’t possibly replace either of them quickly. And both at the same time was absolutely impossible.

And so, the best thing we could do for our investors was simply to close everything down. But if it weren’t for that, we would still be going. I always told people, look how old Warren Buffett is. He’s still going. He’s doing great. I plan to do this until I die. But I didn’t anticipate that Colleen and Paul would have this type of health problem.

But they’re doing all right. It’s not like they got a cancer, or died, or anything, but it was time for them to move on and have some time to do some other things in their lives. So, that’s why Tactical is not here anymore.

[01:30:48] Moritz

Yeah, you told me that when we had our phone call when I was on vacation. So, I knew this. But I have a final, final, final, final question related to that, because I’m of the same view, I’d like to do this until I drop dead. I don’t think there’s a retirement age if you’re still enjoying it. If you’re having a good time with that, if it’s a good fit for your life, why not continue to do it? So, in your case, these two key employees retired and that kind of stopped Tactical.

My question is, were any of the investors, that they had at the time, upset about that? So, background to this question is, sometimes when like these larger firms, they speak with you, they have a due diligence questionnaire, 30 people in the firm, backup plans, yada, yada, yada, yada, yada.

And they ask this because, well, we want you to do this, and that, and the other thing, and charge a management fee because we want you to be around and have longevity and not be forced to close on the business. And I sometimes think, well, you know, if we had to close our business, maybe because of the same reason as Tactical, the stuff that we’re trading is liquid.

We can liquidate the portfolio. It’s not going to be… Well, by the way, we need three years to get out of an interest rate, credit derivative swap contract or something like that, which we’re tied into. And so, what’s the big deal? We have monthly liquidity. You will get your money back within 30 days, essentially, or 35 days, depending on payout cycles. It’s pretty much going to be a coin toss if we’re going to be at an equity high or in a drawdown, but we’ll be where we are.

Hopefully, if you’ve been with us for a long enough period of time, you would have had a great experience investing your money with us. You would have compounded it. So, what’s the big deal? You get your money back. So why would they be upset? I failed to see this.

And so, the question is, were any of the investors upset when you told them, look where we’re giving you your money back?

[01:32:47] Dave

Not in the way that you, say, in an antagonistic upset. It was like, oh, no, come on, Druz, keep trading.

No, no, they were wonderful. We sent out a memo to everyone, explained the situation. It was really hard for me to write that we were closing down, you know, and they were fabulous. And I want to give a shout out to one particular investor, it actually a larger firm than usually invests with us. They had added a significant amount of money to their investment the month before we found out we had to close, and we lost money that month. So, there’s no chance to make it back. And they were great about the whole thing. I never heard a harsh word from them. The investors, they understood what happened.

And I think if this ever happens to you, you’re trading, and perhaps your key employee or yourself has some type of an accident that prevents you from continuing. Your investors, if you’ve selected them according to the criteria you’ve mentioned, they will understand.

In fact, they’ll do everything they can to try to keep you trading somehow. It’s like, Moritz, I know you’re in a hospital bed and traction, but I’m going to wheel your computer in. I want you to keep trading for me. You know, don’t stop. You know, it’s like you’re the best trader I’ve ever had. I want you to keep going. Come on. Hey, come on. Let’s give him life support here. I want you to keep on trading.

[01:34:31] Moritz

Yes.

[01:34:32] Dave

That’s what they’ll do.

[01:34:34] Moritz

Well, great. Dave, thanks very much for doing this, for agreeing to come onto a podcast for the very first time in your life. It’s been a blast chatting with you, and I think the listeners will find it not only entertaining, but also helpful; valuable to learn from your experiences, how you’ve traded.

We’ve got some things corrected, such as you’re not a trend trader. Probably people didn’t know that. I didn’t know that. You’re in a different box Ed Seykota is not a purely systematic trader. So, some news was shared. And thanks for all of this.

[01:35:13] Dave

You’re welcome. And I just want to say, if I weren’t impressed with your integrity, I would never have agreed to do this. Other people have asked us to be in their podcasts and books, but you, you’re a class act, Moritz, and I just am behind the way you’re approaching this business a hundred percent.

[01:35:38] Moritz

Well, thank you for these kind words. Okay, this is a wrap. This is the end of part one of my conversation with Dave Druz.

As I’ve mentioned in the intro, there will be a bonus part, our second part, which will release in a couple of days. So, I hope you’ve enjoyed this conversation with Dave. Please look out for the next part that will be released in a couple of days. Thank you.

[01:36:01] Ending

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