TTU145: Jerry Parker, Founder of Chesapeake Capital

[00:00:00] Jerry

2020, 2021, 2022 I think were just the beginning of getting back to a normal situation where all this diversification and these trend following strategies will be superior. That’s one of our main goals in life is to see trend following elevated to its proper position where it should be. We’re just continually reminded of other managers, famous hedge funds that have these really bad horrible periods and trend following just keeps cooking and going right along. So I think I agree with you that people underestimate how dangerous the world is and how crazy things can happen and how trend following is one of the best solutions.

[00:00:47] 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 will 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.

[00:01:43] Niels

Hey everyone, and welcome to another edition of Top Traders Unplugged, where today, Alan Dunne and I are joined by Jerry Parker, who is the Founder and the Chairman of Chesapeake Capital as part of our mini-series focusing on the one investment strategy that beat everything else in 2022, namely, trend following and managed futures more broadly.

First off, Jerry, it is great to have you back on the podcast, even if it’s only been a week or so ago since we last spoke. Thanks so much for joining us today. Alan and I have very much been looking forward to our conversation. Are you still hanging out in Florida? Where are you today?

[00:02:15] Jerry

I am in Florida today. Thanks for having me. Yes, I’m still in Tampa headed to New York City tonight and going to the Beyonce concert. Oh, I shouldn’t have admitted that. I have a reputation. But yeah, wife wants to go see Beyonce. I went to see Barbie last night, so I’m very diversified, Niels, in my entertainment choices.

[00:02:38] Niels

Exactly. You know, of course, our neighbors here in Scandinavia, the Swedes, they realized that actually Beyonce, because she was having three concerts in Stockholm, pushed up the inflation rate of the whole country. So anyways, there we are. The Fed has enough to do as it is, and now Beyonce is pushing it even further in the US. There we are.

Now, before we dive into all the different topics we’re going to discuss today, I would like to set the stage for our conversation a little bit so that the audience knows a bit more about the evolution of Chesapeake Capital as a firm, because I think 99% of our listeners probably know your background as being part of the Richard Dennis Turtle Program. But I would like for you maybe to talk a little bit about the broad evolution of Chesapeake.

For example, I noticed on the website that the executive team today is made up by you, Mike Ivie and Anil Ladde, both of whom I obviously worked with back in the ’90s when I was part of your organization. But I’m curious to know a little bit more about who else you associate yourself with in the firm today, and also maybe not necessarily diving into the detail just yet, but maybe you could share a big-picture overview of some of the different research avenues you’ve tried over the years.

Because for example, I seem to remember back in the ’90s, you were sort of doing something in the single stock futures markets, but now of course it’s single stocks and I don’t know if there was a period in between where you didn’t do it. So I’m kind of curious about bringing people up to speed on the evolution of Chesapeake as a firm, so you can jump off anywhere you want, Jerry, and talk about it.

[00:04:28] Jerry

Great, great. That’s not a question I get that often, but it’s a long story. In 1988, Chesapeake was formed after the Turtle Program kind of ends after four years. We all scattered and went back to where we wanted to be and started our own fund. Chesapeake got a good start. We had a good track record. It was so key coming out of that program. People believed the track record. They thought it was legit. They’d heard a Richard Dennis.

I’ve told the story of going to Wall Street walking around trying to get meetings and I called up the guy who headed up Merrill Lynch managed futures. His person answering the phone said, “Well, he’s not interested in talking to you,” and I said, “Oh, well, tell him I’m one of the Turtles.” She comes back on the phone, she’s kind of laughing, and she goes, “Yeah, come on up. Come on up. We’ll talk to you.” So all due to Richard Dennis and starting out and getting my start with Paul Saunders at Kidder Peabody giving me money to manage and it was just a wonderful beginning.

As you said, I soon met Mike Ivie and Anil Ladde. I think they’ve been at Chesapeake for over 30 years, 35 years. So we’ve worked together for a long time, just great people. Mike is a great researcher, computers and math guy and Anil has been the head trader and President at compliance and all that sort of stuff. So it was a great group of people. They were just fantastic and still are fantastic to work with. Chesapeake was one of the first, I would say, managed futures dedicated firms.

At some point time in the ’90s, John Henry and Chesapeake were getting a lot of the public fund money from Merrill, Smith Barney, Morgan Stanley, Dean Witter, Prudential, but it was not a great situation in that a lot of this money was very expensive with 10% loads, 12% loads. So that was kind of a challenge. Thankfully, we had a big, big, huge commitment like a lot of CTAs from Abu Dhabi who pretty much carried the managed futures industry for, I don’t know, 20 years maybe. That was a great, great client.

So yeah, it was a great start and a great beginning for us. We had many, many years of managing billions of dollars and then it all kind of came crashing down when mutual funds came around, CTA mutual funds, and then the public funds went away and we were not very prepared for replenishing that asset base.

[00:07:03] Niels

Now, I mentioned in the introduction also that of course, you are known for your very strict adherence and belief in trend following of course, and a specific way which we’re going to talk about of applying trend following. But I’m just curious a little bit if you can share maybe some of the experiences along the way to getting to where we are today in terms of maybe I wouldn’t call them detours, but there might be other things that you tried and where you’ve kind of realized that maybe that’s not for me or maybe that’s not the best way of doing things.

You were very fortunate, as one of very few people I imagine, who were given a set of keys to the golden rules very early on in your career. Most people have to go and dig for years and try and fail and try again, and so on and so forth, in order to find something that they believe in and something that works. So I’m sure that must have had an impact in terms of how much you want to deviate away maybe from what you were taught. I don’t know. I’m curious.

[00:08:19] Jerry

Oh, no, you’re 100% right. I took it more seriously than anyone else by far, I think, and I still take it very seriously, the philosophy, the 10 commandments, maybe there’s 20, I don’t know, Richard Dennis, what he said to me and when he said to all of us. It was quite an experience, because it was just not here are the rules, here’s how we trade. It’s the philosophy, the math, the statistics.

From day one, it was all about follow these broad rules and broad ideas and you’ll stay alive forever. This is to help you stay alive forever. Things are going to change, the markets will change, you’ll have to change with them. But it was really a situation where we were told of these eternal truths, I would say, and I took them very seriously, and I still do. I felt like I came to this realization recently that for Rich and for I think most of the Turtles, it was never really about trend following per se, or necessarily trend following. It was systematic trading.

So once the Turtles got away from Chicago in 1988, it became kind of okay, there was maybe a little bit of trend left or a lot of trend left, but it became more do whatever you want to do as long as it’s systematic and researched and backtested. I think Rich and Bill, especially Bill, are sort of famous for saying and telling people straight up, I don’t do anything that we taught the Turtles, as kind of like a negative, like, oh God, if I did anything like I taught them, how dumb would that be? So I’m just like I don’t care what they say. I’m a trend follower.

So I left there thinking we’re all like trend followers, but I think I was the person who was dedicated to the trend following, and of course, systematic trend following, but everyone else I think felt more freedom to expand and change than I did. Because I believe what they said probably more than they believe it now. They probably listen to what I say on some of these podcasts and go, oh, I don’t think that anymore or you have it all wrong, you took it to some extreme.

I think that’s just my personality is that I really wanted to dig deep into these rules and philosophies and have that carry me. But I didn’t always follow the rules. I did have periods where I went off the track. I can talk about that if you like.

[00:10:51] Niels

Sure. By all means. Yeah.

[00:10:53] Jerry

So I think there were periods, when we started out, one of my contingents about this classic trend following is that it has all kinds of problems with drawdown and losing trades and volatility and it’s just really difficult, as you’ve talked about many times. There’s many good ways that other CTAs try to mitigate and create more smoothness in the returns. So after about 10 years, we had like 10 years of winning years in a row.

I think that that was our conclusion was that these type of systems with all their problems, they were very consistent on an annual basis or trailing 12-month return. That’s what the market was saying. If you’re willing to suffer through these drawdowns and this really low Sharpe ratio, then you will have more consistency, and we certainly experienced that. But we just couldn’t resist the temptation to make it better.

So at some point in time around ’06, ’07, we started experimenting with things that I talk bad about now, profit objectives, smoothing, dynamic position sizing. We did all of that, we did all this fancy backtest and correlation management, volatility management, you name it, we were doing it, because we were hearing everyone else was doing it. We needed to graduate. We needed to get bigger and better and smarter.

So then of course after just a few months of trading this way, we just noticed performance that we had never seen in the backtest before. The classic mistake. So we just apologized to ourselves and said we would never do it again and reversed course and went right back to more of the classic one entry, one exit, and a stop loss type trading.

[00:12:43] Niels

Okay, good stuff. Alan. Sorry, I kind of dived into some of the things but I’m sure you will pick it up as you always do by diving into the first major topic we want to talk to Jerry about.

[00:12:56] Alan

Well, the first major topic is on this theme and topic of philosophy. I’m curious to get Jerry’s sense on what that philosophy is exactly, in the sense that some people are trend followers but they have a belief, maybe they’ve seen the statistical evidence of serial correlation in markets, whereas others have more of a sense, well, this is the way I’ve observed markets trading from their time as a discretionary trader. We’ve seen that with other people.

With Jerry, obviously, on the one hand, he said he was given a philosophy in a sense, but then you’ve embraced it more you say than the people who gave it to you. So what is your belief in markets that prompts you to be a trend follower, or your belief about markets or the behavior of markets?

[00:13:50] Jerry

Well, I would say that I’m afraid to do something other than trend following. I liked everything about the built-in risk management without sacrificing the ability to make profit. From early on, it was trading should be hard, trading is difficult, choose the tougher path. If there’s something out there, that’s going to make it smoother, be very skeptical. Some of the cliches were do the hard thing, do the right thing, follow the rules.

I’ve said many times that the answer to every trading question is the same. It’s something about sample size. I talk about that a lot. No one seems to care except me. Trade sample size was a big deal. They just talked about that all the time and so we were very impressionable and they were very smart people, the smartest people I’d ever met so I was keen to take in all of this stuff, and they gave us the money. If we lost money, they gave us more money.

We had this very pretend situation where you had the perfect mentors, the perfect client. Genius-type people had already started with backtesting. Bill Eckhart is a really genius math guy. It makes me very nervous to be in the same room with those guys honestly because they were just so overwhelmingly smart. We got there and we thought we were really, really smart people. They hand-picked 20 people, and then you sit in there and have a talk with them. You’re just shaking your head like, oh, God, this is just too much.

But I think yeah, this love, the trend following, I never could break it down and say, okay- every part of it, taking the small losses sounds right, letting profits run sounds right. Massive diversification was a big key with them. One entry, one exit and a stop loss, I think that was big. Volatility is not risk. This was drilled into us. I never could prove any of these things wrong.

I remember Rich came to visit us once when I had Chesapeake, probably 2000s. I asked him, I said, “Hey, we did this backtest on stop losses and these Turtle stop losses do not look very good in the backtest. They’re too short-term. Two ATRs.” His response was “Oh, yeah, that’s true. That’s just a personal preference of mine.” I was like, “Oh, crap, I thought we were looking at the backtests and doing the perfect systematic trading.” So when we did our own backtests, we went that direction and we had no personal biases.

There is a truth that I think there were just different types of people coming off the floor, living in Chicago, growing up in that type of trading, being on the floor, then getting off the floor, and incorporating the math and the science and the backtesting, the computers. They had a little bit of both in them that we didn’t have at all. So everybody evolves and changes a bit over the years, I suppose.

[00:17:02] Alan

In terms of that evolution, you touched on how you made some changes and you changed back and then you kind of forgave yourselves for trying it in the first place. How do you balance that idea of evolution with too much tinkering, it’s the classic dilemma, and being adaptive versus having style drift? How do you think about that? What’s your framework for saying, okay, here’s a potential area for enhancement, but we’ve got to be careful that we don’t deviate too far from the philosophy?

[00:17:40] Jerry

Yeah. I don’t know how we would deviate but we did. We would have ideas. We had smart people and fast computers. We just couldn’t resist changing things up. But I think my goal at the firm, or my job at the firm was always working with this research team and keeping them on the straight and narrow and saying, no, we can’t go down this route because it violates some of the ideas and principles that I was taught and just trying to restrain us and pull us back in.

Obviously, the biggest change we made over the years was going from a short-term lookback, 20-day lookback, to hundreds of days now and becoming very, very long-term. We’ve been accused of buy and hold. I hear a lot of managed futures, CTA is talking about longer-term lookbacks, six months, 12 months. But also, people will say, well, if you’re going out that far, it’s kind of like buy and hold.

I do feel bad sometimes that I haven’t evolved as much. I hear people talk about how they’ve evolved and I’m like, yeah, I guess I haven’t really evolved very much except this longer-term lookback. But we’re on the forefront of expanding into equities, single stocks, trading as many commodities as we can, currencies, oh, man, so many currencies and cross currencies, interest rates, futures and all the different markets.

There’s a new interest rate I heard about the other day, it may have been on your podcast, but the three-year futures. There’s a three-year US futures note market. I had never heard of this before. So we just added it like today. So we’re fiends on adding these things. I’ve ventured over the past few years into ETFs, mortgage backs, TIPS, corporate bonds, muni bonds, junk bonds.

So we’re always looking for anything. The securities markets, the stock markets, they give you a lot of opportunity to go out and find interesting companies and interesting things to add.

[00:19:52] Alan

In relation to that, obviously, that sounds like a big change going from 20-day breakout to 100 days or beyond. What prompted that and how did you get comfortable that that was the right thing to do? Could you shift back at some point? What would prompt you to change it again?

[00:20:08] Jerry

Well, we had poor performance and so we were thinking like performance is not very good, and this was the late ’90s. Then I just started putting up weekly charts instead of daily charts, and I would just go through all the markets that we traded, and I was saying, wow, look at those big trends. If you put up a weekly chart, you see some 1, 2, 3-year moves that are just amazing. I told the research team, I’m like, let’s research this.

I made it my project to go through all of the big trades in all of history of the markets that we trade. Just with my chart, I just CQG machine with a channel breakout, I just noticed that would look to me like some decent parameters. So I told them, I’m like, okay, I’m going to tell you what I think the parameters are going to be and let me know if that’s what the backtest says as well. They said, yeah, that’s exactly what the backtest says.

So I was just able to, from a really unscientific point of view, look at these charts and say, oh, man, it really looks like one-year holding periods might be optimal. Then we would compare that to the ’70s, and ’80s, and ’90s and it was like, man, these long-term systems, they did well back when we were trading 20-day breakouts. So it wasn’t like they were just getting well.

The markets were sort of changing and now was the time to change. No, this longer-term approach was always better, depending obviously upon how you define better, not from a Sharpe ratio point of view, but more from a risk $1 to make $3 point of view. That’s how we kind of look at it. You risk $1 to make $3. What is that small loss, what is it going to cost you, and then what are the winners going to cost you? How much are they going to make for you? That’s how we do it. We ignore volatility and drawdown on open trades and things like that.

[00:20:58] Alan

Okay. One of the things that we normally ask about is trend following versus diversified trend following, trend following versus other systems. I know you’re very much a strong advocate of trend following plus nothing, so we won’t go into that. When you’re running a trend system, there’s a number of key decisions that you’ve got to make that helps define the program versus competitors as simple as what level of volatility you’re going to run at. But then obviously, number of markets, risky allocations, speed, stops or not. Some of these have a more meaningful impact on the overall performance. What’s the biggest most important decision you think you have to make?

[00:22:58] Jerry

Well, I’ve made so many big mistakes over 39 years, and they usually revolve around two things, which Rich told us in 1983. These will be your two mistakes. One is trading too large. I think that’s the most important thing. You want to stay in the game and staying in the game will be difficult if you trade too large. I’ve done that many times. Of course, the second one is follow your rules. Be disciplined.

Whatever system you have, even if it’s an average system, if it’s followed 100% of the time, it might have better performance than a better system where the people don’t really follow it as much as they should. Then of course, if you trade too large, that starts impinging on your ability to follow the system. You’re losing this money. You have to come in with some sort of money management override or capital preservation rule.

You really don’t want to have to do that very often because nothing is going to have better performance than your set of rules. So I think those are pretty important. I think you can trade fewer markets, you’re not going to die, you are going to stay in the game. But it’s really hard to beat trading small and trading a pretty decent system.

[00:24:14] Alan

Yeah. What is too large? Because most people think in terms of a target vol, but obviously, that has to then translate into contract size, etc. Obviously, it’s personal. I guess some people have different risk tolerances. Somebody might be happy to run a 30 or 40-vol program. Is it just a personal matter? Obviously, for a program to be valuable to investors, it has to be run at a meaningful level of volatility. How do you think about it?

[00:24:49] Jerry

I think it’s difficult for people to under-trade. I don’t think there’s much danger in that honestly. It has never been a problem for me. I’m always maybe a little too aggressive. I was laughing because as soon as you said that, I thought of Mulvaney. It’s his personality. Niels and I have debated this subject. Whatever your preference is, that’s a good reason to do it.

I understand that you have to have a system that you can trade, but you have to hold yourself to a high standard and do hard things, do things that you don’t like, accept drawdowns, take small losses, go with the trend, have a winning percentage less than 50%, watch big trades turn into losses. So these are painful things, and I think trying to get rid of them because you don’t like it, I wouldn’t want to go down that path.

I want to continue to hold myself to a higher standard and pursue excellence and pursue the best trading system I can. It’s probably going to be something that my personality really doesn’t enjoy and doesn’t like. I think these choices, they do make a difference. But I do think the one thing that your personal preference should definitely have an impact on is your trading size.

So for Paul Mulvaney, obviously, he has a different personality than me. I want to make 15% a year or 15% to 20% in a good year and he wants to make 15% a month. So that I won’t complain about. You’ve just got to figure out a way to stay in business and not lose your clients and lose your capital. It’s a personal decision, as you said.

The other things I think that should not be personal decisions in the sense that, stay away from ease, comfort and pleasure. Trading should be hard, it should be painful, it should be very annoying. If your systems are creating things that human beings don’t typically like to experience, you’re probably on the right track.

[00:26:48] Niels

I want to jump to something new, but I also want to stay a little bit longer on this because Alan covered quite a few things that I was about to bring up, so I just want to add a few things to it. You talked about the parameter selections, because I think this is actually quite an interesting area in terms of what we do as managers. You talked about how by looking at charts, you were compelled to become more long-term.

It’s not my impression, and correct me if I’m wrong, it’s not my impression that you change these parameters very often. But it is my impression when speaking to managers that most, including the firm I work for, actually have some kind of process of ongoing analysis and parameter selection, recalibration, whatever we call it. So I’m kind of curious, you mentioned in just your own words just now that you want to pursue excellence becoming the best trend follower you can be.

I’m thinking, well, we don’t know what the best parameters will be in the future. They’re most likely not the same as they were five years ago. So have you ever considered using some kind of process, ongoing process for parameter selection? If not, why not?

[00:28:10] Jerry

Well, just to be clear, I just was guessing, and I was going to go with the backtest. Just because my eyeballs said hundreds of days breakouts, 100 to 200 or 300-day breakouts are better than what we were doing, and I guessed correctly. So we were definitely doing what the backtest said. But really, the way we approached it was what’s the shortest term we can trade and have a healthy average trade and have a healthy win percentage, have a healthy average win versus average loss, these trade stats that we wanted to look at.

We were very keen on trade stats versus taking too much away from the equity stats. We just never thought that that was a good idea. We were interested in our batting average and how many home runs we were going to hit and how many doubles and triples, but we didn’t think the game was going to play out in the future like it had in the past. So our big question was how short-term we should trade and how long-term should we trade.

So once we established those goalposts, we don’t want to get too shorter term than this and no reason to go really longer term than x, then we just said well, okay, let’s do those two and we’ll trade a bunch of things in between just in increments of 50 or 25. So it was like we were just wanting some diversification in our systems. Then we found out that there is a sweet spot in this one entry, one exit, one stop loss breakout method where everything you choose, all the parameters, historically, they make the same amount of money.

So it didn’t really matter over the entire test period which ones we chose. We just chose as many as we could trade. Another thing too I wanted to say is that another thing that is one of the 10 commandments is use all the data. So there you have it. How much can you even change? Once you have 20 years and you’re in the business for another 10, now you have 30 years of data. Now I’m up to 40, 50, 60 years’ worth of data. So we use all the data. We don’t use the most recent data only. We don’t overweight the most recent data.

The chances that when you run a backtest, that it’s going to even change the parameters and all of a sudden, system four of eight is going to have performance that’s no good using all the data and maybe you want to get rid of system four, the chances of that is very low. I do think that as markets proceed over time, and maybe things will get more choppy, worse trending markets, that maybe our system one will have to go away because maybe it’s a bit too short-term.

So I could see that over time on the edges, maybe system eight is too long-term, system one is too short-term, so we have to get rid of them or adjust the parameters a bit. But I’ll be pretty shocked and pretty disappointed to start seeing a major fall off in all of our systems. Then I’ll just hang it up, I guess. At some point in time, maybe trend following, even long-term trend following, may not be able to stay in the trades the whole time and give back too much money. That’s really for me what it’s all about.

I think that’s the goal of the research. I want to stay in the trade and not get bounced out too quickly, whatever that means. There’s a major trend going on here, I need to be in it, I need to stay in it. I can’t be getting whipsawed and looking back and saying, wow, look how far these markets have gone, I really didn’t make any money. That’s pretty easy. But then the hard part is, well, if you’re going to use that parameter, how much of the big profit are you going to give back?

So you want to walk that fine line of staying in. But since we’re only going to use that same parameter and not change it at all with a vol or correlation exit, then we’re really sitting there with I hope this really long-term exit doesn’t give back all of our profit. Sometimes, it does.

[00:32:18] Niels

Now, the next section that I normally bring up, I was really struggling about how should I ask you this question because I normally talk about if CTAs have become too concerned about the Sharpe ratio because there was a paper by Cliff Asness that he co-authored back in 2022. I think he wrote it because he felt that some managers had started to include more non-trend components in their strategy. So I thought, well, you know, what’s the question that they’re really asking in this paper? That was, I think, whose Sharpe ratio should we be concerned about?

But I also felt that I already knew what you were going to answer, and that is, well, we shouldn’t be concerned about any Sharpe ratio. So I need, I think, to phrase my question differently. So I came up with this, and that is, why should we not be concerned about the relationship between the returns we generate and the volatility it comes with? Why should we not be concerned about this?

[00:33:24] Jerry

Well, you didn’t give me a heads-up.

[00:33:27] Niels

I’m sorry about that.

[00:33:30] Jerry

Nor should you, nor should you.

[00:33:32] Niels

Then my follow-up question is kind of, and I know you touched upon it a little bit but this was obviously before I knew what you were going to say, and that is, you want to stay true to trend following. But you also have, and I know you’re a very competitive person, so I think you have an ambition and I think you alluded to it to improve the strategy. So again, and it relates a little bit back to the Sharpe even though we may not think it’s super useful in some ways, but it does provide some level of information though.

So I’m just thinking, what would an improvement even look like? How would you measure an improvement if it doesn’t involve some level of better relationship between say return and volatility? I know it could be return in drawdown of course. I’m aware of that. I accept what you say because I’m not a great believer of Sharpe in our world because a lot of the volatility is from the upside. So I’m aware of that.

But I’m trying to dig a little bit deeper here and say, well, what would an improvement look like for you and why, because if I was an investor, and certainly, most of the investors I speak to, they would rather have a 10% return with a lower vol than a higher vol. So it certainly has some importance to them as investors. Anyways, hopefully you’ve had enough time to just think about the topic.

[00:35:17] Jerry

Well, what I was going to see is that listening to the CTAs, you asked them this question and I think almost every one of them said it’s not a great idea for Sharpe, it doesn’t fit with this non-normal distribution with the outliers, with the positive skew, it’s not really for us. But then they would kind of go on later and talk about using Sharpe, so I was a little confused by a lot of that. My recollection is only one, Bruno at Quantica, he totally embraced Sharpe.

So I think the problem with it is it just penalizes unfairly and inaccurately. It’s just an inaccurate measurement of risk and it penalizes and prevents one of the cornerstones of trend following, which is letting your profits run. Trend following separates the profits from the loss, so it’s totally natural to have a systematic approach that does that as well. What we’re trying to protect is that capital in our account. We’re not protecting at all the open trade profits, we’re letting them run. This is how we’re going to make more money.

So I think it doesn’t flow to the bottom line, which is the volatility doesn’t flow to real risk. I think some managers who have a certain money management scheme of using current equity every day as their trade level to size their new trades, I think that that causes problems and probably for them, it probably necessary for them to use other methods than a trailing stop or a stop loss. But for me, I use my capital and account to close trade equity. Then that gives me the freedom to follow the trades or follow the trends and not override the position until the trend reverses.

I think to answer your last question, it’s what I said before. I think that people do want all kinds of things. I think it’s up to me, personally, to tell them really, you don’t want that. Let me give you what you need versus what you want. I think what we can substitute with control of volatility is consistency. I think that is what Chesapeake did for the first 10 or 12 years to make money every year.

Of course, a lot of that is just due to the calendar. But a more consistent 12-month trailing rate of return is what you’ll get from these plain old classic trend following systems that open up the possibility for giving back open profit, but they really are consistent in the long run and over a year period. So I think that is what we should strive for. Staying in the game, being consistent, and not succumbing to what people want, what clients want.

When the Turtles left, the Turtles were taught when they left Chicago, boy, we had a really big chip on our shoulder about clients because clients were going to steer you wrong, they’re going to tell you things that you should not do, they’re going to pressure you to take those profits too quickly. I think it’s just born out to be so true.

If you go to your clients and you say, hey, I know you don’t like drawdowns, I know you like smoothness, I could give you that without any sacrifice, of course, they’re going to take it, and I think that people don’t like to eat their broccoli. Jerry’s just always saying eat that broccoli. Buck up, do the hard thing, do the right thing, and that’s why I have very few clients.

[00:39:05] Niels

Well, I can’t disagree. Obviously, I don’t know. You could be right about this. Because I actually think that clients also want consistency. Maybe they want high Sharpe and consistency, but I think consistency is actually very important. I think that’s a very important point you bring up. But I have no stats. I have no insights as to one or the other creates that. But I do think and it kind of brings us into this inevitable point we always talk about, Jerry, and so why not also today, which is a little bit about this role of volatility in the approach, in the process.

I’m sorry, Alan to go a little bit long here, but it’s just I think it fits in here. Because of course, your contention is that if you do any kind of volatility management or dynamic position sizing, you kind of give up the outliers. That may be true. It’s likely to be true that you’re going to make a little bit less on those 5% of the trades that are the real outliers. I don’t dispute that. I have no stats, but I don’t dispute that.

On the other hand, let’s just say for argument’s sake that there’s going to be, I don’t know, 40 or 50% losing trades, so we don’t need to worry about them. But I’m pretty sure then if you do apply some level of volatility, I don’t want to use the volatility management because that’s not what it is, but dynamic position sizing, I do think it’s true that you will make more money on that 45% or whatever that number is that is left on those trades.

Overall, that could actually be beneficial for the total performance. I’ve heard people say, many different people, not just CTAs, but many people of markets, and I’d love to hear your thoughts on this, that actually, markets tend to become more volatile around turning points. I started out as a trader and so I followed markets for a long time as well, and I think there’s some truth to that. It doesn’t mean that they can’t go back into the trend of course.

But I do think that it is true that volatility tends to pick up around turning points, and obviously, there is a chance that these turning points become reversals. So I’m just curious to hear your thoughts about whether you think that could be true, because it’s not that you don’t think volatility is important because you size your positions based on volatility, but you only think it’s important on day one of the trade not necessarily all the other days.

Of course, most managers I guess today will take a different view on that. So I am curious why you think volatility is only important on that day and whether or not there might be some truth in the fact that volatility picks up when trends are likely to change direction.

[00:42:09] Jerry

Well, I use volatility on the day of entry to size the trade and normalize the risk across all the markets. I don’t really use it after that. I try to use the trend following methods breakouts to determine if the trend has changed. I do think that there is evidence, I’m sure that there is evidence that and I’ve personally experienced it. So anecdotally, I totally agree that there is a lot of volatility around turning points.

I think one of the problems with that, and I listened to Florin Court, Doug, recently and he talked about it, and that’s one of his main themes, I think. I think one of the problems with that, which I think Rich told us in 1983 on this particular subject, a lot of things happened around a turning point. Unfortunately, it happened five times before the turning point. I think that’s one of the little problems.

But once again, I can deviate and I always get in trouble when I get too far off the ultimate answer for this, and that is basically the sample size. We don’t have a lot of trades to look at. Our philosophy is of the thousands of trades that I have in the backtest, we include the outliers as well. That’s a little controversial these days. We’re getting good information about how to trade with outliers by the sample size.

Some people now are saying that you should not include the outliers in your sample size. So I think the more you drill down into these trends as to what’s going on inside of these trends, especially the large trends, the big trends in the turning points, now you’re down to a sample size, it’s so small that you start to see that there’s issues with that. I haven’t really seen in the backtesting a big benefit to increase these parameters and these rules over just sucking it up and letting it happen and staying in these markets.

Because a lot of times, we’ve seen especially recently what looked like turning points, what looked like exhaustion and massive volatility, and it was a painful drawdown let’s say. But the markets have a tendency to return right back to the highs and keep going sometimes. So it’s pros and cons of both. If the backtest did not give us a good result with one entry, one exit and a stop loss, we certainly wouldn’t do it, obviously.

[00:44:42] Niels

Yeah. Great. Alan, back to you.

[00:44:44] Alan

Yeah, I guess I just wanted to pick up on what you’re talking about here. What Jerry is saying is very interesting because a big theme that we got from a lot of the CTAs we spoke to was this idea of offering solutions to clients and that it’s not about saying this is the way to do trend following. It was saying, well, we can offer you pure trend, we can offer you alternative markets, we can offer your trend plus diversifying strategies. They can reasonably argue that they want to be in the investment management industry and offer solutions to investors.

So is there inherent conflict between keeping these rules and satisfying investor’s preferences granted you don’t want to do things that are fundamentally wrong? I guess I’m saying will there not always be that tension between following a philosophy that people maybe would not do. I think the irony is that kind of solutions approach and adding on trend and stuff like that was generally driven by a desire for more consistency.

So I think the prevailing view about most people that we spoke to was that if you were a bit more diversified, you would be more consistent and that pure trend wouldn’t be delivering returns year in, year out. So I just wanted to get your thoughts on that, the difference between running money as an individual and then getting people to come with you, and running money as a large investment management firm. Are they maybe fundamentally different?

[00:46:20] Jerry

I think there is just always this conflict. Yeah, for sure. There is a big conflict. Buffett, at some point in time, whatever Buffett says is gold and people are going to do it. I don’t know of any CTAs, certainly not me, we’re quite at that level where if Jerry says it, people are going to do it and they just know that it’s right. Their feelings are definitely going to come into play.

I think one of the other podcasts that you guys did that I thoroughly enjoyed was, I think it was CFM. I don’t really remember the guy’s name, but he was from CFM. He had this famous quote that I posted on Twitter as my pinned tweet for a while when he said basically in his analysis, and I think they’re one of the top research firms a CTA is going was that CTAs offer nothing really other than trend following. There’s nothing really going on there. 90%, 95% of the returns are totally due to trend following. I kind of agree with that.

I never really wanted to have any sort of negative skew things in my system. Rich told us many times, he would say, trade systems that don’t make money, trade systems that lose money or don’t make very much money because you’ll find systems that fit in really well with your trend following. We would research that and we just couldn’t get over the fact that we were just going to make less money. We just really did not want to do that.

So trend following plus nothing, trend following alone, we try to come up with all these cliches, go out and find people who are crazy like we are, who just love trend following. I learned about it when I was in my 20s, I loved it, I fell in love with it. I thought it was the greatest thing ever. I’ve fallen in love every day since then even more. I didn’t need any education. I got a lot of education on how to do it correctly and experience, but I didn’t need to be persuaded.

I think there’s 5% or 10% outliers and 5% or 10% of the people when you get up in front of me to talk to them about trend following, they instantly get it, they instantly love it. There’s nothing else they can do with the rest of their life. If you challenge them to live with these drawdowns, live with this volatility, it just makes them stronger. It’s just kind of a weird group of people that I’m a part of that just can’t get enough of feeling superior by doing things that are hard and sitting through difficult things.

Not enough volatility and losses to be fatal and not keep you in the game, but enough to be uncomfortable. If it’s uncomfortable, we must be doing the right thing.

[00:48:54] Alan

Interesting. Just picking up on this whole philosophy, obviously, trend following plus nothing is the name of the ETF and that’s your philosophy too. You tend to be dismissive, I would say, maybe of the idea of trend following plus long equities or trend following as 10% of a role in a multi-asset portfolio, and the idea that trend is that kind of diversifier. I’m conscious most people would find that a strange approach.

I went to a course a couple of years ago, a group of international investment people, I’d say 50% of people never heard of trend following or managed futures, and you’re saying to them, you should be 100% in this. I’m conscious, if everybody was a trend follower, would it still work?

[00:49:46] Jerry

Oh, that’s good. I read a paper yesterday. I tweeted it. You should read this paper. It was basically trying to prove that letting profits running taking small losses doesn’t work in stocks, and you should let losses run, I think was one of their comebacks on that. One of their conclusions was thank God that too many people don’t do this because it would just cause havoc in the markets. I think that’s true.

I think proper trend following or classic trend following the way we do it is probably not a great business. it’s not going to grab a lot of people’s attention, and people not going to be able to continue to do it. So it’s kind of a self-preservation mechanism. But it’s going to be for you and your friends and maybe a small ETF, and it’s probably not going to grow too much. So it kind of is going to be around, but probably not something that’s going to raise you tons of AUM.

[00:50:43] Alan

So the fact that it’ll never be universally adopted means there’s an opportunity there for the people who do embrace it. That’s kind of the idea.

[00:50:52] Jerry

Right. I think I wanted to mention on the stocks, I am dismissive of a lot of things. I have this personality that comes across as dismissive. But our idea is we embrace stocks like crazy. We love stocks. Half the portfolio, 150 stocks, but we’re trend following the stocks. So my idea is let’s trend follow these stocks with a stop loss, with a trailing stop. We’re following price.
If we’re following price and we have a decent portfolio that’s really diversified in stocks, then we’re going to have some shorts on. So possibly, the small allocation to CTAs managed futures in a traditional portfolio is great, but maybe trend following your equities, sell your equities, put it into our fund, and then you maybe will have fewer crises and so there’ll be less need for a crisis alpha in this allocation to traditional stocks and bonds.

We saw what happened with bonds last year in particular, and stocks. This is one of the reasons I’ve just never ever bought into this idea that we should pay any attention that stocks go up over time, 60/40 works, bonds go up over time. I just have never paid attention to that and I’ve been a diehard trend follower. Anything I see and touch and look at, I’m going to try to trend follow it because everything at some point in time needs a trailing stop and a stop loss, this 8% annual return with a 50% drawdown or more, 90% in the NASDAQ let’s say.

A trend follower can never be that bad. If you wrap trend following around it and you look at all the data, not just data at the peak of a bull market, you’re going to see that the trend following approach is going to at least make about the same amount of money if not more and have a much better drawdown and profile. It’s the first question you asked me, why do you do this? I’m like, I’m afraid. I’m afraid.

I don’t care what’s happened in the past. But you tell me I can get a decent return and wrap around my trading and all these markets I trade, this massive diversification, stop losses and trailing stops, and it’s not going to negatively impact my ability to make money, then I’m going to be an extremist on that. I’m an accountant and I’m very conservative and I don’t like to lose. Maybe I’ll put 10% or 20% long stocks and 80% diversified trend following, but certainly what’s the data say? Go back and look at the data. You talked about what the data says.

[00:53:35] Alan

I think most people would say that data says combine the two.

[00:53:40] Jerry

But trend following, diversified trend following would get the bulk of that.

[00:53:44] Alan

It depends on what level of vol we’re running at. Probably pretty equal I would guess at an equal value basis. I’d have to check the numbers for that. I guess it’d be about equal. But again, even intuitively, we say the 2000s were very good for trend following, tough for equities. 2010s, very good for equities, tough for trend following. 1970s, very good for trend following, tough for equities in real terms.

So intuitively, you can see why it would make sense. Just conscious of time, you mentioned stops. I know you enjoyed when we had Harold, from Transtrend, were on earlier this year. Harold told the story about when they started off, they decided not to use stops and this was a big negative and people were I guess dismissive of Transtrend because of the lack of use of stops. But they still see themselves as being good risk managers.

When you hear that, do you think that’s possible, plausible to be a good risk manager in managed futures and trend following without using stops?

[00:55:01] Jerry

I think that it is. I’ve stopped saying… Well, I’ve said it many times on here, but I usually don’t say take small losses or use stop losses. I usually just say keep losses small or optimal and I think that’s a more accurate statement. When we did our backtest and we optimized the stop loss level, we realized the average loss was the same as no stops at all.

So there was no problem with using a stop loss. It was you could use it or you don’t have to use it and we were like, okay, then we’ll use it. If it’s not going to hurt performance, then we’ll just go ahead and use it. I think another thing that’s very confusing is when people talk about their backtests and the way they trade, their dynamic position sizing, one of the things I picked up on your series with CTAs was how complicated. It’s way more than what I thought it was.

It’s a very complicated way of trading and managing money and relative strength and correlation, and all these different things that people have put into their programs with trend, I suppose. So it’s really difficult to criticize or make comments on how other people are doing things when all I do is this discrete one entry, one exit and a stop loss. So I can only comment on those really. I really don’t have any opinions on other people’s systems because I’m afraid that I don’t know anything about them.

If people looked at my systems, they would say, “Well, wait a second. I don’t like what you’re doing here. It doesn’t look very good.” And I’d say, “Oh, did you notice this thing over here?” And they’re like, “Oh, okay, yeah, then you’re fine. I didn’t really notice this thing over here.” So there’s much complexity and personalization in people’s trading that I don’t feel comfortable making broad statements other than the ones I made. I don’t think my strategy with correlation and volatility management and dynamic position sizing, it doesn’t add any benefits to it.

[00:57:09] Niels

Yeah. Obviously, we are sort of nearing the end but maybe we can squeeze in one more little controversial topic that you and I have talked in the past. Actually, I think it is a little bit of a new modern view that I hear today, that you say that because that’s how I felt. Over the years when we’ve spoken, when I hear you talk to your tribe, you are of course very black and white. You say, yeah, what we do is best, no discussion, and you’re not shy of talking about how other people do it.

I’m thinking, well, actually, it’s probably quite complicated what to do so we have to be careful about saying one is better than the other. Again, I was trying to come up with a different way of asking you a question just because I’m curious about your thought process here. No doubt that your approach works. You’ve proved that for 40 years. That’s not the question here. But here’s my thought experiment. If we have a very simple portfolio just consisting of two investments, stocks and bonds, and let’s just say that for argument’s sake, today, the signal shows that you should be long both stocks and bonds.

But then at some point, the signal changes in say the bond sectors, and suddenly you’re long stocks but you’re short bonds. Now, to you, the risk is the same, right? Because you size your position at entry. But for those who use correlations in their ongoing dynamic positioning, they would probably say, well, hang on, the risk is not the same because now you’re short one and long the other. That is not the same risk as being long both because of the way correlations have been over a certain period of time.

So because you say that correlations are not important, so to speak, I’m kind of curious why you think all those other firms may be wrong, or maybe you’re not saying they’re wrong anymore. Maybe there’s a slightly different view on it, or maybe not view but I think you know what I mean, Jerry. I’m curious about that kind of difference. Because we already talked about volatility, I thought I better bring up the correlation point as well.

[00:59:34] Jerry

Well, one of the things I get frustrated about is I don’t ever really hear too much about the pros and cons of some of these ideas. So it’s up to me to bring up some of the pros and cons. So I’m always talking about it, it’s pretty obvious what my pros and cons are. Oh, yeah, it’s great, you made money, but you have these big drawdowns and you give back profits. You’re consistent on an annual basis, but everybody made money in a certain market or sector except you in a certain month because you gave all the profit back.

Yeah, I’m not very consistent on the trade-by-trade, but by not micromanaging those trades on a daily, weekly monthly basis, miraculously, we become very consistent on an annual basis, because we’re following a simple system with fewer parameters. So more parameters, more moving, more rules, these things make me nervous. It gets back to the sample size again.

Given two choices, I’ll take the simpler, the fewer parameters, the larger sample size, the fewer rules. These rules are here for one reason and one reason only. They work, they’re in the backtest, so you’ve got the rules. But once you have them, they’re only good for one thing, and that is forcing you to treat every situation in the same way. So that’s why I use the rules. That’s why I’m going to disregard your example that two markets are now long, both are long, or one is long and one is short. That’s two different situations.

My goal is to take these simple rules and to do the trade the same way each time. I’m going to have higher risk sometimes and lower risk other times, but I’m also measuring my risk from my capital and taking that small loss and not using my current AUM to size these trades, sort of the typical CTA money management which is using current AUM, let’s say. So the need to unwind that pretty quickly, because now this open trade profit that these new trades were put on with, now the open trade profit is going away.

So this whole other way of the money management and using the close trade equity is so different and so profound that I can see how it would force people. They’re doing the wrong thing by using current AUM. My opinion, I’m kind of tongue-in-cheek. So yeah, you better do something wrong to get yourself out of this trouble. I am keeping my trade level at a million dollars for the whole year, if not longer and I’m looking at my risk as a small percent of that $1 million bankroll.

At some point in time, I’ll incorporate the profits in a very slow, methodical way, and then go another year or to using that new trade level. So if you’re going to do it that way, you’re never in trouble. One of the things that the research shows is that the drawdown in your closed trade equity is always less than your open trade equity. So at any day in history, I could have liquidated the portfolio and never had a capital drawdown. So things like this really turn me on. I love that I’ve never had any positive feedback from anyone else.

But I do think that, like a good trend follower, you are separating, you are protecting that capital with those small losses. You’re not doing anything to protect that open trade profit. So you cannot incorporate any of that open trade profit into sizing your positions. Everyone does that except me. So I think that is an integral part of this whole… We’re really deep in the weeds now. We’ve lost people. But I do think that the pure trend following does include that sort of money management scheme that obviously I did not come up with.

Yeah, I don’t think Sharpe and vol and correlation, done the way that we trade, has any relevance at all to risk of capital. Risk of open trade profit, of course. I’m already flouting, thumbing my nose at the risk of open trade profit by having a trailing stop that’s so far away. Why do I do that? Because the computer says if you do that, you’ll make more money.

[01:03:54] Niels

Well, at least I did my best to kind of bring a little bit of discussion on topics that we’ve discussed for many years hopefully in a new light. As I’ve said many times, what I really love about what we do as an industry is that we can kind of interpret things a little bit differently and we can actually all make it work because when I look at all these great firms that we’ve had in the series, they’ve all done a pretty good job over a long period of time, which not many strategies can say, or have even been around for that long.

Of course, you yourself is coming up for 40 years, which is an amazing achievement. Now, we normally end up with a couple of questions that we’ve asked everyone so you may already be very well prepared for these. There’s no surprise here. But one is, I’m kind of curious to hear what you say, that is, what is the one thing you hear about trend following you disagree with the most?

[01:04:57] Jerry

Oh, well, everything we’ve talked about, volatility matters, Sharpe matters. Oh, I think the one thing that Alan was hitting on it a bit, I’m not going to be moved. I don’t think there’s any reason any logic, I’ve never seen anything that anybody could say to me that would say 100% trend following is not a superior portfolio. I do think that if I could throw in some Renaissance and some Medallion fund and have some insights on what’s going to happen in some of these markets where people have some knowledge I don’t have, sure.

But in the world that we live in, we occupy, the sort of normal guys trading and taking positions, I don’t think there’s much evidence that 100% trend, especially with a diversified portfolio like we have. I’m very jealous of Florin Court’s 500, adding 50 markets per year. I love that. I think it’s fantastic. I don’t really agree with him necessarily that these are superior markets. He was really hammering on managed futures and CTAs of your inferior markets as compared to his. I don’t really agree with that.

But I definitely think that when you boil it all down, if you have a good allocation to equity single stocks, not trading, he trashed, trading stocks, trading indices and I don’t really agree with that either obviously, but I do think if you have a great portfolio of lots of different markets, as many as you can trade, a healthy dose of equities, you certainly don’t need anything else. It’s too risky to put things in your portfolio that don’t have a trailing stop and a stop loss.

[01:06:48] Niels

Another question that we also ask at the very end, and I have to preface this by saying besides your own new launch of your ETF, what are the things that excites you the most about our industry looking into the future even though we normally don’t predict anything as CTAs of course? But is there anything very exciting you have besides the ETF?

[01:07:17] Jerry

Well, I would say that I agree with a subject you bring up a lot, and you’re the first person I heard talk about it recently, and that is, people don’t understand how crazy things can be and how wild things may happen in the future. When you and I got started in the business, the marketing material would show trend following programs making more money than equities and with less drawdown. I think we’re going to get back to that period.

I’m excited that 2020, 2021, 2022 I think were just the beginning of getting back to a normal situation where all this diversification and these trend following strategies will be superior. That’s one of my main goals in life is to see trend following elevated to this proper position where it should be. We’re just continually reminded of other managers, famous hedge funds that have these really, really bad horrible periods and trend following just keeps cooking and going right along.

So I think I agree with you that people underestimate how dangerous the world is and how crazy things can happen and how trend following is one of the best solutions.

[01:08:27] Niels

I love that Jerry, and wonderful to end on a note where we wholeheartedly agree. We’re going to wrap up our fascinating conversation with you, Jerry. Thank you so much for being on the podcast, sharing your thoughts and insights with us. Of course, we will do this again sometime in the future.

To all of you listening today, I hope you’re able to take something away from today’s conversation on to your own investment journey. If you did, please share these episodes with your friends and colleagues.

From Alan and me, thanks so much for listening. We look forward to being back with you on the next episode of Top Traders Unplugged as we continue our deep dive into the CTA industry.

In the meantime, go check out the show notes for this episode and all the other resources that you can find on the website. Of course, not least, take care of yourself and take care of each other.

[01:09:17] Ending

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