91 Keeping it Simple in Trend Following with Andreas Clenow of ACIES Asset Management

Niels

Hey everyone, and welcome to another episode of Top Traders Unplugged. Thank you so very, very much for tuning in today. For those of you who are regular listeners, you know that my goal with the podcast is to share the stories of some of the great traders in the world and to ask those questions they don’t usually get asked. To help you get more clarity, confidence and courage to take your own trading or investment career a step further.

Today you are listening to episode 91. If this is your first episode that you’ve heard, you might want to go back and listen to all the earlier conversations. Before we find out who’s on today’s show, I just want to mention that today’s episode is brought to you by Eurex. Given all the current market volatility relating to U.S. rate hikes and the slowdown in China, you’ll find some very useful ways of hedging your portfolio risk if you visit the Eurex website.

Andreas

This is Andreas Clenow, Chief Investment Officer at ACIES Asset Management in Zurich and you’re listening to Top Traders Unplugged.

Niels

By the way, if you want to read the full transcript of today’s episode just visit the TOPTRADERSUNPLUGGED.COM website and sign up to receive access to all of them. Now let’s get started with part 1 of my conversation. I hope you will enjoy it.

Andreas, thank you so much for being with us today. I really appreciate your time.

Andreas

Thank you Niels, happy to be here.

Niels

Good, now Andreas, today we’re going to make full use of the many talents that you have. On one hand you are running your own systematic investment strategies, which requires a lot of the various disciplines that I often discuss with guests on the podcast, but also you allocate to external managers, which is a rare combination. So perhaps we can touch on this skillset as well.

Of course many people know you as the author of two books. The first one, Following the Trend, which caters to an audience that is interested in the classical way of using trend following strategies on a basket of futures contracts. Your latest book, Stocks on the Move, which goes into why and how you need to trade stocks when applying a rules based approach. Is that a fair summary would you say?

Andreas

Pretty much, yes.

Niels

Good, now for full disclosure, Andreas, I read your first book a few years ago, so I may not remember all of the details, and I have read most of your latest book, leading up to our conversation today. I’m sure you will guide me to the juicier bits of both books during our talk. Before we jump in I just have this simple question that I try to ask all of my guests in order to appreciate the different answers there is to the question. Basically, it’s how you respond when a person you haven’t met before asks what you do. How do you explain what you do, Andreas?

Andreas

Well I have this running joke back in Sweden when someone asks me this, not knowing the business what-so-ever, I just shrug and say that I make rich people richer. That might not be the most accurate description, but it’s fun enough.

What do I do? I am Chief Investment Officer of a little bit different shop here in Zurich. Here we are a type of family office. That means that much of the capital that we manage belongs to us, the partners, me and my partner. That gives us a large degree of flexibility. We can do what we think makes sense with this pool of money. We can create our own strategies. We can take in investor money since we are also a licensed asset manager here in Europe. We can invest in other people’s products. We can do private equity deals. We can do all kinds of deals and investments that make sense.

Obviously if you manage a reasonably large pool of money, it doesn’t make sense to put it all in one strategy. Not even if it’s your own really great strategy. Therefore, we do a lot of different things that usually surprises people that we’re in so many areas. As I say, I’m mostly known for the systematic side, primarily because of the two books that I wrote about the subject, but that’s one out of many things that we do, really.

Niels

Sure, absolutely. I’m going to stay with your story, at least for a little bit longer because I’m curious to know how you got to where you are today and I wanted to put some extra color in that. So tell me a little bit about what you were like as a kid or young man growing up, and where that all took place.

Andreas

Let me see, I’m actually from a very small town up in rural Sweden. Pretty much the Midwest, the cow center of Sweden if you like. It’s the kind of place where you look around and you see a flat horizon in all directions. It’s a town that… really, I’m not making this up. I couldn’t make this up. It’s a town that uses the slogan “most cow dense city of Sweden,” or “town” to be fair. There’s more cows per square meter than anywhere else in the country. That is the tourist slogan of where I’m from. So you see where we start in the story.

Niels

Absolutely.

Andreas

I never saw a cow in my life growing up, but that doesn’t let me escape the reputation of the town itself. I went to school in Gothenburg, and while I was there I got increasingly interested in trading on two topics actually: in trading and computers. The computer interest I had for many years before. But I guess I developed the skills a little bit better during those years. I studied finance in Gothenburg School of Economics and these two things started melding together more and more. I started a computer consultancy company. Back in those days this was, of course, the mid and early nineties. Well, who didn’t have a computer company back then, right?

Niels

Right.

Andreas

It was almost too easy. If you know computers back then, the way that most people, well pretty much everyone knows computers today, if you had a decent base skill, well, you were in demand back then.

Niels

Sure.

Andreas

So I and a lot of my buddies, back then, were running similar types of companies. We were doing training, programming, servers, networks, computer security, these kinds of things. During this time, as well, I got more and more into the whole trading thing. I read a lot of trading books. I got into all the deep rabbit holes of all the technical analysis and all these things. That, by the way, I think we might return to that later if I know you right, but that’s probably something that makes me a little bit different from most people in my situation. I find it unusual that people – hedge fund managers and the like, come from a normal background, so to speak, or normal retail trading background to begin with are reading TA books and all of these things. That’s on the unusual side, I think – that’s both good and bad for me.

I had a company back then then and I figured sometime in the late 90s that it was time to grow up and do something real for a living. I left the whole entrepreneurial thing and joined a company that was, back then, called Reuters, and is now called Thompson Reuters. I was head of their financial consultancy up in Nordic for a while. This was interesting I would have to say. It was an interesting learning experience to be on the corporate side for a while. I learned a lot about corporate law and most of all I learned about how I don’t really belong there. I realized far enough, I think a lot of people realize the same thing: the better you get at something, in that kind of environment, the less you get to do it.

Niels

Right.

Andreas

That’s one learning experience. The other one was that if you want to get something done in a corporate environment you have to break the rules. Then you have to be lucky and get away with it. I’m not talking about regulations or laws or these kinds or rules, but rather the rules that tell you that here is your box and here is what you’re allowed to do in the company, and here’s what you’re allowed to have opinions about.

So what I figured out quite quickly, and I guess that’s where I’m heading with this story, why I changed everything in the end; what I figured out is that to get something done, to get ahead in a corporate environment, I had to just go ahead and do what I was sure needed to get done, whether or not I was authorized to do this or not. Instead of the usual committees, approvals, teleconference, and project managers, and discussions, and so on, I just got it done, mostly by myself on evenings and weekends. What usually happened, lucky me, a lot of people wanted to get me fired, a lot of people wanted to promote me and lucky me they picked the one who wanted to promote me. I got away with that a few times, and a few years later I was head of Reuters Quantitative Development Team in Geneva for equities and commodities and I was slowly starting to get increasingly cynical about that other point that I was learning: that the better you get at getting things done the less they let you do it.

I found myself in the end, at the age of… before 30 I guess, I don’t want to think back on how old I am. Somewhere around that age I figured out that, here I am in teleconference all day talking to people who talk on teleconferences all day discussing headcounts back and forth, discussing projects and budgets for things we all know has no real meaning anyway, right? Things that don’t really matter. We’re just fighting over whether, “should Geneva do it, or should Paris do it, or should London do it,” and spend half a year and I don’t know how many millions discussing this.

I was increasingly feeling that it’s nice. I have a nice title, they pay me nice money, but I can’t keep doing this. For my own sanity I can’t be here in 20 years. Nothing bad about Reuters. It’s a nice company to be with. I think this is a phenomenon you find in all large organizations. This happens after a while. Well, how did I move from there?

Niels

Exactly. That’s sort of the corporate world and then at some point you, I guess, decide enough is enough.

Andreas

Yeah, basically.

I did what I tend to do and what I’ve done a few times in the past when I felt that I was either in trouble or I needed to change something. You basically raise a flag and hope that a friend sees it. Make yourself visible and someone will find you. I did that. I got a bit lucky back then. This was 10 years plus ago.

I happened to, by an absolute coincidence, run into people who had large sums of money they needed to have managed. They had some basic idea on how it should be done, but not really the details and they don’t want to do it themselves. I understand completely how improbable this whole thing seems and that’s what it seemed like to me at that time as well, but, that got me into the whole hedge fund space. I started up a hedge fund back then.

Back in those days it was a straight forward to start a hedge fund, at least over here. Regulations, well, let’s just say that it wasn’t too important for the regulators at that time. The regulators allowed all kinds of things that today would be impossible. You set up off-shore hedge funds in the Cayman’s. It was quick, cheap and easy and compliance and all of these things were minimal. Now it’s a whole different world. Today it wouldn’t be possible to do what we did back then – not legally and how I’m sure people do it. But back then we could, within the current framework at the time, do these kinds of things which we couldn’t have done now.

I kind of got locked in. What’s the expression? I stepped on a banana peel and slipped into the business. I had some background to begin with. I had, hopefully, a decent preparation for what I jumped into. Things developed quite well. I had a couple of more times where things happened in the right direction. In the end, my general philosophy is you have to, for these seemingly improbable things to happen, you have to create the circumstances for it.

Niels

Sure. If I can just stop you there. I’m just curious… You say you meet some people who have money to be managed and you start a hedge fund, but at what stage had you already started managing your own money? Did you have a strategy? Where does that fit in? Because usually, even rich people don’t give money to people who don’t have some level of experience in what they want them to do. So where did that start?

Andreas

OK, I had been trading my own money for a long time. At the time my money was, in the context of things, fairly insignificant. Reuters paid me well, but not that well. I started off, like most people I guess who want to get into the business, I started out building trading systems back already back in the mid-90s. A simple Metastock or Tradestation – what it was called back then. The usual suspects of technical analysis programs. Of course now, looking back, I realized just how amateurish those things were, but we all have to start somewhere. I remember I was building a point and figure plotter in excel that automatically reads real time from Reuters and makes a point and figure chart in Excel. I don’t know what that’s good for but I did those kinds of things.

I guess, my trading, if you want to step back to that. In the beginning I liked trading back to the 90s and I thought I was really good at it. I made very good money, but you know where I’m going with this, don’t you?

Niels

Sure.

Andreas

Who didn’t make good money at that time.

Niels

Exactly. Long technology stocks.

Andreas

Oh yeah, I was really smart. You know my strategy? I bought Nokia, that’s the strategy. This is the 90s and most people trading back then traded the long side of the equity markets and it didn’t matter what you threw the dart at, it’s going to hit something profitable. So I guess I got lucky. If I started trading in 1999, 2000, something like that, I would have taken some losses and I would have done something real for a living instead.

Niels

So what do you think that the people that you met, what did they want you to do specifically, initially when you started off?

Andreas

They wanted me to develop… They had some basic trading ideas that they were unable to develop, to test, and to implement. They needed someone to do this fulltime as well, which they were not prepared to do at that time.

I guess we spent a few months discussing the whole thing. I built some prototypes for them and this is also something that I always keep stressing in my books and website – things like programming skills are absolutely vital in this business. It doesn’t matter if you plan to be the cool hedge fund manager with a staff of 20 programmers, you have to learn at least basic programming – simple programming that is. I developed things. We launched with, let me see – what was it back then? It wasn’t big but it wasn’t insignificant, 30, 40 million, something like that I guess. It was a decent enough starting base back then.

Niels

Absolutely, still is I think.

Andreas

Yeah, it’s enough to start with, for sure. We did well for a few years and it was fun for a while. It’s not the fund or the company that I’m with now. I left that some years ago. I can’t remember the timeframe at the moment, but about six, seven years ago, something like that. I moved to my present position at ACIES. ACIES is not (it’ a question I always get), it’s not some sort of abbreviation based on my name. The company has been around since 1995. Back then I was trading Nokia, so I was not around to be a part of ACIES back then.

Niels

Sure, absolutely. Obviously we’re going to talk much more about what you do today inside ACIES, of course, but just before we jump to that – writing books and running your investment strategies is a big part of your life today, but what do you do when you’re not working? What do you like spending your time doing outside the office?

Andreas

That’s an unusual question. I haven’t gotten asked that in an interview before. Well, should I say long walks on the beach, and reading a good book, I don’t know. What do I do? I like photography actually. That is a little bit more normal thing that I do. Then of course between that and family and a small son, how much time is really over?

Niels

Sure, sure, excellent! Now you’ve written a couple of books about systematic trading strategies which usually involves a lot of math and equations, but you’ve actually managed to write them with very little math being used or shown, and I think what you’re trying to promote is the importance of trading broad concepts, not complex super systems. Explain to me why this is so important in your view.

Andreas

If you trade what most of us see as normal types of systematic models… I’m excluding here the high frequency stuff because that’s a whole different ballgame, but normal systematic strategies, usually they’re about trading broad concepts. I always see an over-focus on details – usually details that don’t really matter. So if you discuss with… If I discuss with retail traders that contact me because of the book, a common theme I always see is this focus on the tiniest details – the things that I wouldn’t even bother with. Therefore, I try to emphasize the larger things. For instance, you can talk about when you measure a trend and when you use exponential moving average or a simple one or a weighted moving average, my only answer is, “I don’t really care.” What’s the difference in the end?

Niels

Sure, sure.

Andreas

There’s going to be a rounding error.

Niels

So people strive for perfection but essentially perfection is not needed in this particular instance?

Andreas

I think it’s a misconception. This focus on the details, I believe this comes from very much from the TA School – the Technical Analysis School where people have read all those books about a hundred different indicators and the five different settings on each and how you can treat the perimeters and optimize things. It doesn’t work like that. You won’t really find hedge fund managers sitting there optimizing his ten indicators and combining to get to the perfect buying signals. No one really works like that on the institutional side. This is a bit of a retail illusion. You find what kind of phenomena you want to exploit – what kind of strategy. It’s never about the best possible strategy. There is no best possible strategy. You find a style and try to find a good way to trade that style.

Niels

Sure, sure. Just as a quick follow-up, and I know it’s very related to what we just talked about, you also refer to the value of simplicity and how very simple rules can perform remarkably well. Tell me more about those findings, and also how you got to that conclusion. Was it just through testing, or was there something else that made that very clear to you that actually simplicity is… It does really work?

Andreas

You’re absolutely right. The simpler systems are usually the better ones.

Niels

What do you mean by better, by the way? That’s something that I often get asked and how do we define better in this work?

Andreas

You’re right, better is actually a bad word, what’s a better word here?

Niels

Are you thinking risk adjusted returns? Are you thinking when you…?

Andreas

Exactly. Why add complexity if you don’t get paid for it? You have to get paid a lot to add complexity, otherwise the complexity is not worth having there. If you put the complexity in, you will have a much more difficult time executing it. It’s much less likely to work because it’s probably just over-optimized, if you use your 10 indicators that has to be working together to give you the signals, while also it just happens to work because you over-optimized it. It fitted perfectly to the recent past.

When I wrote my first book I thought I made a very simple trading model. The whole point with the model that I show in the first book Following the Trend is that the whole point is it is supposed to be a very simple model to describe generally, what the trend following user does.

Niels

Right.

Andreas

My biggest regret with that book is that I didn’t make it even simpler.

Niels

How could you have done that?

Andreas

Quite easily, actually, and I have to say I have to give credit where credit is due, the suggestion came to me after I wrote the book by, I think you know him already, Nigol Koulajian over in New York at Quest, a very good asset manager.

Niels

Absolutely, definitely.

Andreas

So his suggestion was, well, did you try just looking at just a 12 month return and nothing else? At first when he suggested that I thought, well, like everyone else he’s got to be kidding. He wasn’t. I did the math on it. I got back to him and said yeah, you’re right, I should have done this. For two reasons I should have done this, both because it’s simpler and therefore nicer, and it would have also prevented the unfortunate side-effect I see sometimes in my book where people mistake my demo system that I made to explain the phenomena, explain the… It’s like a teaching tool, and once in a while people contact me and they seem to think that I meant that this model is like a perfect trading model recommending that people should take these rules and start trading them. Over 10 years it will probably give you an OK return, but this model, these rules are not meant as advice and not to trade. They were meant as a description of what the business is, on average.

Niels

So what did Nigol mean by an annual system, if I heard you right before?

Andreas

Sure, this type of system is often called a 12-month momentum rule – 12 month return rule. What you do is you look at two data points. So what was the price yesterday, what was the price a year ago, is it higher yesterday or lower yesterday as it was a year ago? If yesterday’s price is higher than it was a year ago, then we go long, if not we go short. That’s pretty much it.

Niels

You do that on a diversified basket of futures. So this is something that would give similar performance as what you would demonstrate in the book using a different set, maybe a more classical way of doing trend following?

Andreas

It would, actually, embarrassingly enough, it would be better results than the model that I presented in my book. Of course this is, the big disclaimer here, this is of course based on a couple of assumptions. First, you have to trade a broad universe, as we say. Applying this in one single market, well, maybe it works maybe it doesn’t. You apply it on 50 to 100 different futures markets, so far it works fine. Of course you have to have some sort of risk allocation method or position sizing if you will. What I use there is a classic vol. or parity model, which is quite normal. Then of course the big downside of this type of model, in reality, is that you are in all markets at all times, which means you’re eating a very high level of margin to equity.

Niels

Sure. What about… So the interesting thing is that you’re not trading that model, as far as I understand. Nigol is not trading that model. What makes that model interesting on one hand and yet I’ve not come across anyone who trades that kind of strategy?

Andreas

I wouldn’t say go out and trade exactly like this, but as a learning tool it’s amazing. It’s a benchmark tool as well. Obviously you’ve developed your own rules, the way it makes sense to your type of strategy – what you want to accomplish, but benchmark against this. If you can’t beat this model, well then you might have a problem.

Niels

Sure. Now, not that I intended to go down that model, because obviously I didn’t know you were going to bring it up, but now I’m curious. Does this model, because we’re going to talk about this latter on, does this model, does it require the full diversification? Meaning that’s what trend following often benefits from; i.e. either diversification between different markets or could you, in theory (not that I want to jump too much into what we’re going to talk about) but could you also apply the same methodology to 50 different stocks, or 100 different stocks?

Andreas

Well you could, but the results would be different. You have to do things a little bit different on the stocks. I would assume that you want to wait and not let me jump ahead, but to answer your questions briefly in a way, you do need a broad set of things, otherwise, if you apply this just to one or even to five markets, well anything could happen really. You can get some very weird results from that.

Niels

Let’s dig into the books a little bit. We’ll probably discuss ideas from both books a bit randomly as we are already doing now. My apologies for that, but I wanted to start out with some general observations that I have made looking at your work and some of the ongoing publications that you produce and that you appear in.

The first one is about trend following where you often refer to trend following as being an easy simple strategy where, and I’m quoting, “where anyone can find basic rules on the internet, and the fact that there’s not that many ways that it can be done.” My question is, why do you like describing trend following in this way?

Andreas

Did I say easy?

Niels

I don’t know but that’s the feeling I get when I read some of these things. I don’t mean to be taking the other side, but there could be a reason why you are describing it this way.

Andreas

Sure, I was just surprised about “easy”, but then again I write a lot of things and I can’t keep track of it myself. Easy yes, on one point, on one side you can say easy. The rules themselves are often easy. You look at the rules, the trend following rules are usually not complex. That’s not where the complexity is. Is it easy to implement this? Is it easy to run this relatively? Not always. Then there’s the matter if you run a fund or a larger mandate you probably don’t just run one trading model. So how do you combine this? How do you do risk management? There are a lot of variables that come in, in reality. But in theory, if you wanted to design a trend following model in a simulation platform, well, that’s not terribly difficult.

Niels

Sure. If I can just add my two cents. I agree with you that the concept of trend following is simple, but I think as soon as you get beyond that, it really isn’t that easy to find rules that one, can stand the test of time, and also can produce a relative return to the drawdowns that comes with it that most people can stomach. What I find really interesting at the moment is that the return dispersion between managers that all have maybe 10, 20, 30 years of experience, that dispersion seems to be on the rise. To me that means that a lot of people with a lot of actual experience are having to find slightly new ways of doing trend following in order to stay competitive. So I agree with you. There are some simple things or sides to trend following, but I think it’s becoming a little bit more complex.

Andreas

Sure and there’s one thing that… There’s another reason why you see what you are seeing – the difference between men and managers. Obviously some differences are due to their different speed of the trend following, some is due to their different focal, different asset classes and so on, but this is old news. We all knew this before, at least those of you who read my book and you all did, I hope. But the recently new thing, is that the number of pure trend followers is now quite small.

Most shops in the CTA industry, they’re primarily trend followers, not a lot of them, but most of them are primarily trend followers. That doesn’t mean that trend following is the only strategy or even dominant strategy. There has been a trend for some years now to un-bias strategies, to reduce volatility, to find ways to cover the drawdowns. You introduce carry strategies, calendar spreads. You introduce counter trend models. There are all kinds of separate satellite strategies (I call them) to introduce as overlays. This has, sometimes, worked out fine. For others it backfired, but this is, in my view, the main course in this – the increasing divergence in performance.

Niels

Sure, I think that’s a very valid point.  Also, I just want to mention that I really like your analogy about trend following where you compare it to watching a scary movie, where you say that the happy ending is never in doubt but it takes a lot of nerve to sit through the whole film. Just like we have the emotional roller coaster that trend following gives us and indeed any other investment strategy, once it is live and it is real money and you’re having a real drawdown, it’s a different thing than just looking at…

Andreas

There’s another important thing as well when I mention that topic, is that you can’t just blindly follow the rules. Even if you have great rules that worked great for you for 30 years, there might be a situation coming up that just didn’t occur for 30 years. Take a year ago, for instance, with what happened in the Swiss, when the floor was let go. For some CTA firms it caused extreme moves up or down. For most it didn’t do that much, but I would say it shouldn’t be a big event for a trend follower.

The models may think so. You run your simulation and you might get some really extreme stuff there. If you actually took those rules, if you actually followed them completely, then you have to stop and question, why did no one do any critical thinking here? For instance, there were three main positions that would be concerned. You have the Euro Future, the Swiss Future, and the Euroswiss Future. So why would you trade both the Swiss Future and the Euro Future for instance? I committed to start trading the Euro Future, but the Swiss Future would have given you the exact same position on a very high correlated basis.

Of course if you have that position, if you were short the Swiss on the way down, then you took a massive hit that day. If you were in the RF Future, the Euroswiss, then you would really have to wonder here, because that’s where things can get really dangerous. You had an artificial law of volatility, which means standard models, which would use some sort of vol or parity position slicing, they would tell you to take an absolutely insane position size. Those who followed that, well, those are the ones who saw the 25%, 30% up or down that month, depending on what side they happened to be on.

Niels

Sure. That’s a very good point and one thing I recall from having last year interviewing a few managers around that time of the move, my good friend Jerry Parker, actually in the interview I did with him, which is just a short review, he said, “well, you know, you always have to put in a minimum level of volatility regardless of what the actual volatility is.” I think a lot of people, if they didn’t do it before, they would certainly do it now because it’s not going to be the last time we see this artificial volatility. Even in December was a good example when we had the ECB decision which obviously caused some of the short term European bond markets to move quite extensively. Again, if you don’t have a minimum level of volatility for individual markets you’re going to run into trouble.

Andreas

Exactly, and you have a similar situation in… Actually, right now, you’ve had for quite some time in primarily European STIR markets, that is the short term interest rate markets. There you have a very clear asymmetrical risk which your trading models would be completely unaware of. So you’re trading over 100, which means the settlement that would apply to what the banks are willing to lend to each other on an unsecured basis and pay for the privilege. Now, we might stay there for a while during this extreme situation. We might even move up a little bit, but either we move a tiny bit up or we can make a huge move down. So there is a very asymmetrical risk and these things you have to take into account. You can’t just run a trend following model and close your eyes.

Niels

Absolutely. That is true. I think a lot of people who look at the stock markets, and as we as human beings, we have a tendency to only focus on the recent history, and since we’ve had a bull market now for six or seven years, it would be natural to conclude that doing trend following on stocks would be very straight forward and very profitable. But there’s a problem with that logic when I read your book. Explain to me what the issues are in doing that.

Andreas

There are a couple of issues. Let me start with, in the book I made a clear distinction between trend following and momentum. I understand, a lot of people have asked me about this. Obviously I’ve made the semantic distinction there to make a point. In my view it is very different. The alternative would be to say that trend following on stocks works differently than trend following on futures. That’s also correct, but it’s easier to make the point if you use a different terminology and therefore I was very deliberately using the momentum term instead of the trend following term in the book to make sure that people understand what I’m talking about.

The difference is, as you know, when you’re running a trend following model on futures, it works because you’re trading so many different things. Maybe for the next two years the commodity futures will fail completely. Maybe there’s no trends there. Maybe you keep losing there. Maybe you make all of your money in the currency futures, or in the bond futures. That’s, in the end, the entire rational for the trend following type models that most markets fail most of the time, but there will always be something that will produce enough profits to make up for it.

How you trade stocks, well, the good thing is you have a lot of different instruments to choose from. You have thousands and thousands instead of just a 100 or so for futures. On the other hand, you are dealing with a lot of instruments that are very high in total correlation. You’re going to gain at the same time. You’re going to lose at the same time. Most importantly you’re going to lose at the same time. Things might look reasonably uncorrelated on the up side, but then, like this week, the market goes down and guess what, all the stocks, even the great ones will take a big beating at the same time. Your risk models go out the window.

The other problem is, of course, which stocks do you trade in? If you trade futures, you have the luxury of trading all of them all of the time. What’s the problem? You have a hundred or so to choose from, right? Anything that trends you can take, and the signal you get? You just get it.

Now in a Bull Market you’ll get a buy signal on every single stock out there, or most of them anyway. You can’t take them all. You need some sort of ranking method; otherwise how do you determine which stock to buy? To say you do normal trend following that would mean you stay in it until it stops going up, right? But the problem with that is, in a Bull Market everything goes up. It doesn’t mean that it’s the best stock to have. The stock might go sideways, or slightly up and you’re sitting on this for a long time, wasting your capital on it while other stocks are skyrocketing. You have to trade differently. That’s why I present, in the book, a model to rank the stocks – pick stocks in a systematic way to decide which stocks to be in, to decide when you pull some out, when another stock is performing better. I would say the single most important thing is don’t buy stocks in a Bear Market. You have to have some sort of filter for what is the overall stock market doing. You can’t just expect stocks to move up to the same extend in a Bear Market. If the general index is falling you can’t expect to find a lot of great buying opportunities out there. So your rules should be aware of what’s going on in the overall markets.

Niels

So those are the two main differences you would flag. There’s another one I’m sure you’re going to come to that anyway and that is, of course, in your momentum trading strategy for stocks you don’t go short. In fact, you go as far as saying that shorting stocks is a fool’s errand. Tell me more about the reason behind this.

Andreas

Most people lose money on shorting stocks. Shorting stocks is very, very difficult. Can it be done? Are there people doing this for a living and making great money? Yes, of course there is, but that doesn’t mean it’s easy, it doesn’t mean that most people should do it or should even try. Stocks that are in a Bear Market are very, very difficult to trade. They have a tendency to behave very violently, so you have small moves, moves down that keeps ticking down day after day, week after week, and suddenly you get this one day moves and events coming up, some banks, some government coming in, whatever else happens and you get a massive move against you and you lose all your money in a day. This happens all the time with stocks. A share goes down a lot because of the horrible conditions. You are short for months and everything is great and then of course some other company realizes they are a great take-over candidate and they buy it and you lose all your money.

Shorting, in general, for everything is much more difficult than buying, especially if you have a longer time horizon. Stocks are even worse of course.

Niels

Obviously people should go and buy your book and read about how the details are in terms of how to trade stocks the way you suggest, but I just have a… I’m just curious about something. If we take your suggestion about buying stocks that move up. Essentially that’s what you are saying, and you should buy the ones that have the most momentum, and you shouldn’t short them, and you should have some kind of filter for the environment, which, by the way, I’d like to talk a little bit more about that in a bit. Could you add, if you don’t want to short individual stocks, would it make sense at all to short say the index? Obviously we know that there are some good moves on the down side in equities once in a while. We haven’t seen them for a while, but they do occur. Have you ever thought about that as a possibility?

Andreas

Sure. There’s a lot of things that make sense that I, at times, would recommend against, especially in the books, because frankly most people reading the books are retail traders and I try, therefore, to err on the responsible side, if you understand my point. Do I short stocks? Do I short indices? Yes, of course I do; not to a huge extent. It’s never a main strategy, but yes, of course. You can look at, for instance, if you want to look at the neutral strategies and these kinds of things, you can try to short out the index completely, that’s fine if you really know what you’re doing and you’re really to have the models to monitor it and you understand the potential risk for it. For most people it’s not a good idea, but if you know what you are doing and you understand what the risks are then why not?

Niels

Sure. Now, again, I’m just sort of jumping around a bit on different topics. Feel free to go down other ideas that you want to talk about. A lot of people in the money management business, they’re usually very focused when explaining what they do and how good they are at doing it in order to convince investors to let them manage their money, but you do it slightly differently. You spend a lot of time giving away specific rules as to how investors could do it themselves instead of giving you the money. Why is that? I’m sure you’ve had this question before.

Andreas

Yes, or variations of it. Why write the book? Well, I had fun doing it. I wanted to write a book, I wrote a book. I had time. Most people don’t have time. Most people aren’t allowed to. Most people are employed in the capacity where either all their time is gone, or they’re not allowed to do anything like that. I have my freedom. I do what I like. I wanted to write a book.

Why do I give away these secrets? Frankly, all the wrong people, I think that I wrote in one of them, that all the wrong people know this anyways, so who am I really hiding it from? What I write in the books is hopefully there are some ideas here and there, even for the professionals, but no one is going to read the book thinking, “This is great. I’m going to go put a billion bucks in the market and explore this idea.” The people who manager large amounts of money, the people who run hedge funds, management shops, they have quants employed, either they already know what I write in there, or they can figure it out. It’s not something really revolutionary. I try to explain it in a way that hopefully the way that I explain it is new. Hopefully I can contribute a little bit with this, but there’s nothing really secret in there.

To be completely frank, I think the strategy of getting a little bit well known by the books has paid off. There have been a lot of investments, a lot of businesses coming in because of this; people who have read the books contact me on the websites. They come with a couple of questions and maybe something comes of it maybe something doesn’t, but it never hurts.

Niels

It never hurts. I do have a follow-up question. It’s not specific to your books, but clearly there are a lot of choices today where investors can either read a book, or buy a system and they might get this false idea or hope that by following whatever they buy they will become a great trader. Something clearly, as you described before, certain things you have to probably leave to the professionals. My question is, do you have any advice to people who either read your books or other books or buy some of these things that we all know are available out there on the internet, as to how they can determine if they are equipped to do it themselves, or whether they’re better off letting their investments be managed by other people? How can people figure that out?

Andreas

You have to, of course, look at your situation. See what kind of knowledge you have to begin with, look at the material you’ve been reading, see if it doesn’t make sense. I think the most important thing to look at when you read different material is see what it promises or implies about your probable eminent success.

If someone writes a book or offers coaching, or something else and if they make crazy promises – if someone says they train millionaires for a living and they make normal people into millionaires in a year or so or they promise triple digit returns – no, it doesn’t work like that. It doesn’t exist. If you’re even considering something like that, well, then you’re probably (at least not yet) equipped to manage your own money, because then you’re believing in things that are very impossible.

Staying in the realm of sanity, well, the first thing is taking very low risk. I would say the main mistake that retail traders do is that they take on risks that would get people fired or worse in the hedge fund world. People say that we take a lot of risks in the business, but when I see what retail traders do, well that goes on the crazy side.

You have to have realistic expectations. Of course that’s usually where it fails because with realistic expectations it’s no longer interesting for many retail traders. When you start to understand that a compound return of say 15% or so maybe per year, even 10% per year over time is considered to be quite good. Then a lot of people lose interest. Of course if you aim for 50% or 100% you will most likely, you will lose most of your money before you learn the mistakes. You’ll have a couple of good years, a couple of bad years, and wild swings and hopefully you get out before you lose everything. No one in history has sustained such a high return.

Niels

Sure. I guess on this topic I noticed a blog post you wrote and I don’t remember exactly when that was written, but it was titled something along the lines of, “Why Managing Your Own Money is a Bad Trade.” Tell me a little bit about that one.

Andreas

Yeah, obviously my headlines are usually written in a way to get people to click on them. As I like to say, if you’re going to click-pay people you have to at least deliver afterword. I try to make sure that there’s some actual content to back up my sometimes…

Niels

Cheeky titles…

Andreas

Cheeky titles, yes, exactly, but I always try to deliver. It’s a bad trade. What I tried to point out there is that many people have this dream of trading for themselves, and I understand that, but I would suggest modifying that dream a little bit. More people are saying that their biggest dream is to be able to sit at home, or have their own office and just trade your own money all day and have a great return and be a professional trader. My point would be, if you’re going to do that anyway, why don’t you throw in other people’s money in the bucket too. Why, well because you get a base fee on that and you get a performance fee. You can manage your own money at the same time. That’s not the issue, but just your own money, well that’s risky.

Maybe you have that bad year, and you make no money and how are you going to pay for that office and the computer you have in front of you? On the other hand, if you have client money in there as well, you can do the exact same thing. You can still be a professional trader, you can still trade your own money for a living, but other people’s money as well. Now you can see more long term, because now you don’t have this constant stress that you have to make money before the end of the month otherwise you can’t pay the bills, you can’t pay your food, you can’t pay the car payments and your wife’s going to leave you, right?

So what you do instead, you have this base fee coming in. That means you can relax. You can do things more calmly. You can think long term. You don’t have to take big risks just to make ends meet by the end of the month. You probably manage your own money better. You probably manage your client’s money better that way, and everyone is happy.

Niels

Sure. I know that at the end of that blog post you do have some reasons why people shouldn’t take outside money to manage. Some of them you refer to as excuses, some of them you refer to as valid. What are the valid, or are there any valid reasons why not to do it?

Andreas

Well, one valid reason would be that you simply don’t like people: You don’t want to deal with people. You don’t want to deal with clients. You don’t want to have the hassle of getting investors, reporting to investors, possible compliance issues, and so on. That’s fine. If you really don’t want to deal with that, that’s fine, but then you made an economic decision based on your preferences which economically might not be the best, but fine, it’s a valid reason.

Other things or course, here in Europe these days if you know what I’m talking about there. Regulations are getting borderline ridiculous, and Mr. regulator, if you’re listening to this, I have absolutely no problem with what you’re doing in the business, it’s getting very, very strict and very, very expensive to comply with increasing regulatory requirements. The hurdles of entry are going up fast. I mentioned before that I got lucky. I got into the business at a time when it was easier and cheaper to start something in the business.

These days, someone comes to you with a million bucks and asks you to manage it, if you’re based in Europe, well that doesn’t make any sense. There’s no way you can make any money from that. If someone comes to you with ten million, well, you’re not going to make enough to have a proper salary, but at least you can start something. That’s a very valid reason as well. My understanding is, though I have no knowledge myself, but my understanding is that this is still much easier in the U.S.

Niels

OK, yeah, well, it may well be. There’s no doubt that regulation is on the up and it’s probably not going to end here, so that is definitely something to consider if you’re thinking about doing it on your own.

Andreas

Let me just mention this, there’s one more valid reason (there’s probably more of them, but I just remember one). You may have a trading strategy which you cannot scale. If you’re doing quick in and out, back and forth. You take a couple of lots here, a couple of lots there, well, if someone puts another ten million in the bucket, maybe you can’t do it anymore. That’s, of course, absolutely valid.

Niels

Sure. Just for people to realize this, because I’m sure a lot of people will go and look up your blog and your website, etc. etc. Again, just to stress the point that we talked about before and that is that a lot of the things that you might write about or use a title to, when people see it I think it’s a good idea just to read the article before they make their conclusion because often you actually end up arguing the opposite that the title might say, or something different at least, so just be aware of that.

Andreas

The thing you learn very quickly when you run a website is that if you have a title about How to Use Momentum Analytics to Beat the S&P Benchmark in the Long Run, no one is going to read that – no one. Even if you write the best possible article, no one is going to read that.

Niels

Sure, No, that’s true. Now staying on that theme and staying about blog posts in general and the fact that you like to have these sort of juicy articles from time to time. You did take a stab and you even did it early on in our conversation today, you’ve taken a stab at technical analysis some time ago, saying that the visual nature of technical analysis lends itself to get-rich-quick stories. So how do people tell the difference between technical analysis and say, momentum or trend following trading? How do they do that?

Andreas

Well, common sense I guess. The problem with technical analysis is there’s no definition of it. Everything is technical analysis. You’re dealing with a price, well it’s TA, right? I wouldn’t say that all technical analysis is nonsense. I spent a lot of time with technical analysis, especially when I was younger. I read all the books. I’ve gone through all the phases like most people. I’m sure you can come up with some sort of seven stages of technical analysis model that people go through before they finally accept it and move on?

There are a lot of weird things in there, and as I pointed out before, some of the technical analysis organizations are really guilty in promoting it. They give it some sort of legitimate… They legitimize it by including it in their courses. There are some particular pet peeves of mine like Elliott Wave Theory for instance, about how the universe moves in magical waves and you can predict and so on. These are fluffy things that can neither be proven or disproven. If I say that I come up with a new idea that there’s actually seven magical waves I’m sure I can write a book about it and I can make a lot of money from it, but no one can prove me wrong, right? They can make eight waves, what do I know?

You have funny things like a Fibonacci numbers where you have all these decimals that looks like there’s something magic with this, what is it, 0618… I don’t know. If someone tells me that this 06 whatever the ratio actually is, is somehow better than saying approximate to two-thirds, well, I want to see some math on that, but no one is producing that. That’s a lot of nonsense there. But ignoring the new age nonsense, which every reasonable adult should be able to ignore anyway, then you are still left with a lot of things that just cloud the picture.

All these indicators for instance. Many of the indicators might have a value, but once you start using an indicator for everything… There’s an old expression, “if all you have is a hammer, you start seeing nails everywhere.” That’s the problem with technical analysis too. You have all of these indicators. You throw a whole bunch of it at the wall and see what happens and hope that you are right. It doesn’t mean that you have anything of value.

Niels

Let’s move back to your books in some way and discuss some of the topics. In the context of perhaps more than the usual questions that I ask my guests which relates maybe a little bit more to your own trading, but before we go there, there’s just a couple of topics I wanted to bring up that I thought were interesting as well. I think again, a lot of people know you for trend following or momentum strategies, but actually you also highlighted to me that counter trend models – paradoxically can be beneficial in a portfolio, so let’s explore that for a little bit more. That’s not something I think a lot of people usually would associate with you.

Andreas

There are a couple of types of counter trend models to begin with. There’s one I prefer more than the other. What most people think about it is the models that just go against a strong trend, those can be dangerous. I don’t always trade those as well, but they’re not as interesting in my view. That would be, for instance, you have a very strong Bull Market, or let’s say the oil situation at the moment, it comes crashing down, crashing down, crashing down, and all of a sudden you decide, well, here’s where it stops and you buy. That’s one type of counter trend trade. I don’t like that so much. Not that it’s impossible to work that way, but I don’t like it so much.

What I prefer instead is the type of counter trend models that trade in the direction of the dominant trend, but enters after a certain type of pullback in that trend. That type of model came from… This is certainly not a new idea. I see a lot of other people doing similar things in the past, but the idea here came from the realization that many of you out there probably have, that trend following models tend to stop out too early – especially medium term trend following models.

Niels

Right. That’s interesting.

Andreas

So, what if they measure where these stops are normally taken and we take the opposite side? So when the long positions stop out, we enter. The easy way to do this, and I think I published a code list of this a while ago – must have been a year or two ago I published this as an indicator (half-jokingly as an indicator) because I usually criticize indicators. I made an indicator which measures the number of ATR units you are from the recent extreme of the trend.

Now if you read my first book, which you claim to have done, that model stops out after three ATR units from the recent trend extreme. So I just made a model that is simply biased exactly that. First it checks, are we in an uptrend or down trend? Based on that it checks how many ATR units are we away from the most recent extreme. Then when it hits three, you buy, or short, of course depending on the up or down trend. As an entry model it’s not that bad. It works quite OK. Of course entry logic in itself is not enough to have a complete trading model, but it’s a start. That’s the type of model I’m talking about.

Niels

Sure. I just wanted to mention to people who may not be familiar with the term ATR, that Andreas is using, but that is referring to Average True Range in this case. I think it’s interesting what you say, having said that also I would say that since a lot of people, and I would certainly agree with that, that a lot of trend following strategies that probably, in a broad spectrum have similar entries and similar exits. You know a three average to range from the last extreme is probably not a bad estimation of that. Could it be argued that it’s a little bit dangerous to go against those forces if you’re trying to actually buy when they sell and sell when they buy, or does that not really matter when you test something like that?

Andreas

I don’t find that to be a high risk situation. Of course you need to have some sort of exit model in the whole thing, but I don’t find it to be any higher risk. Then of course, if you like, you could argue that my plan here all along was to write first a book to make everyone exit their trend models at three ATR units and I make a model to take the opposite side. I’m not going to comment on that.

Niels

I’m sure there’s some cynical people out there thinking that is exactly why you did it, but let’s not go there. Before we go to talk about your own business, that’s how I call it, but it’s more about your experiences running your own business, you actually wrote something about starting a trading business, what it takes, what’s realistic, what people are missing, how would you sum up that kind of theme? I think a lot of people who listen to us today, there are more emerging managers than established managers for sure, so clearly that’s something that people would be interested in because you’ve been around for a while, you’ve started a couple of businesses, what you think it takes. We talked about the regulations. I accept that.

Andreas

That cannot be overstressed. If you ignore regulations, and I know a lot of people do that, they can go under the radar for a while, manage their money, no harm done, everyone is in agreement, the clients are happy with it, they’re happy with it, let’s just go with it, right? I would still recommend against that.

The problem is, even if everyone is happy, you’re managing your uncle’s money and he doesn’t care and so on, well, if something happens. If you have a loss and someone gets unhappy, someone hears about these who doesn’t like you, whatever could happen here and regulators found out about this and you are done in the business. You will not be able to go into the business again, and take this very seriously.

This is not the same business as ten, fifteen years ago where things were easier on that front. Now it’s very, very strict to follow these rules. Having said that, starting a business, well, the cost side is the first thing that people miss. It’s very easy to think, well, I’m going to make X amount of dollars per year so you look at what amount of trading you need for that. But the revenue side is not the only thing that you need to look at in your business is it?

You may or may not need an office. So you need a Bloomy or Reuters, well that’s another 2K a month. Maybe you can get away with something cheaper, I don’t know, but you will have a lot of overhead costs to begin with. You will have to make sure that you can cover this with base fees – never budget with performance fees. Performance fees may or may not cover the end of the year, but if your depending on performance fees to survive in the business than the business is not sustainable. It’s not going to work. Then it’s depending on luck. You have to be able to cover your base fees with your base income. That’s of course your management fee.

The difficulties of starting a business: ignoring regulations, disregarding regulations is still, depending on where you live, how much money you need at the end of the month left over, and how much money your professional staff will need well it varies dramatically from place to place.

Incidentally you might not want to start your business in Switzerland for that reason. It is not a low salary place. It’s tough to get people for decent money here compared to decent money in many other places, many other countries.

The need for a large base of revenue is the primary thing and for that you need a large asset base. Obviously, if you can take between 1% and 2%, hopefully, in base fee, just doing the math on that, just paying your own salary takes quite a lot of asset under management, paying all the systems, all the other costs, paying the brokers, paying the administrator, the custodian. There’s a lot of people to get paid before you see anything. The initial asset base – that is the key trick. How do you get that?

Niels

Sure. No, that’s fine. Let’s talk more about the usual topics that I would discuss with the managers. It somewhat relates to how you then build a strong organization. Let’s assume that you overcome some of these financial challenges that you just mentioned. In your case, I wanted to ask you something more focused on research because that’s something that you’ve done a lot of.

Investors, they will put a lot of emphasis on the research capability of the manager when making their selections. Clearly research is, to a large extent, the heart of a systematic manager. But you also have an allocator or investor hat to put on. So if we put that on for a little bit now, what kind of research and capability do you look for when you are looking to allocate money away?

Andreas

OK, limiting to systematic managers, because we allocate to a lot of different things. Something I shouldn’t say on a public podcast because that means the amount of calls and emails I’m getting is going to increase from…

Niels

Oh, most definitely, Andreas.

Andreas

Yes, don’t worry I have an assistant to forward them to. What I look for? Well first of all I very, very rarely invest…

Ending

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