Where is the Open? ft. Toby Crabel

[00:00:00] Toby

Markets are nonlinear creatures. We deal with imprecision and probabilities only. And there’s one thing that, you know, the market psychologists generally say, that you’ve got to expect that anything can happen, anything can happen in the market.

Today’s a great example, for God’s sake. And it’s a humbling thing. It really is. It’s humbling for a systematic trader, it’s humbling for a discretionary trader, or anybody that’s watching what’s going on.

[00:00:44] Intro

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

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

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

[00:01:40] Niels

Hey everyone, and welcome to another edition of Top Traders Unplugged, where today Alan Dunne and I are delighted to be joined, by no other than, Toby Crabel, the founder of Crabel Capital Management, as part of our series focusing on CTA and managed futures strategies and the legends that make up this wonderful industry.

Toby, it’s a real pleasure to have you on the podcast. You’ve had a front row seat to how markets have evolved over several decades and how edges that once worked incredibly well eventually get competed away. And I think understanding this process is more important today than ever.

So, Al and I have really been looking forward to this conversation, and a warm welcome to the podcast.

How are you doing? How are things in California?

[00:02:24] Toby

Good, thank you, good. The weather is 90 degrees, in the spring. I think global warming is destroying everything, but that’s all good.

[00:02:31] Niels

That’s all good. Okay.

[00:02:32] Toby

It’s good weather.

[00:02:33] Niels

Good weather, okay, cool. Now, before we dive into all the topics that we have planned to discuss today, as we normally do, we do want to set the stage a little bit for our conversation so that the audience knows a little bit about your background.

So perhaps we could start with perhaps the transition from professional tennis player to futures trader, as that in itself is quite unique and how, and perhaps why did that happen?

[00:03:01] Toby

Well, in my later teens, my father was trading his own account in the stock market. And he took me into the brokerage firm, and between tennis workouts in the morning, and in the afternoon we’d watch the market on the ticker, which, Trans-Lux, I believe it was, would scroll across, from left to right, and make you dizzy if you watch it long enough. But it was fascinating.

That’s where I sort of got the bug. And from there I looked at and studied markets through college and gravitated towards technical analysis. And while I was playing tennis, I mean it was the era of the gold market making its move up to US$800 an ounce. And so, that was interesting. And I would watch that over time, and actually trade a bit – generally options on gold stocks.

And then when I was 25, having had played tennis through college and made a decent… an okay living at it, and I was playing professional tennis in Europe, I had a friend that I had given tennis lessons to in Chicago, during the summer sometime. And he was on the exchange floor, and he invited me to come down and take a look at it. And eventually I ended up starting as a runner, at 25 years old, on the Mercantile Exchange, working for him.

Two months after I started there, I was continually doing technical work and he wanted me to be his chartist and give him ideas in the cattle market and other markets. And then we started trading an account together, and that was at RBH Commodities. He was one of the principals there. Tim Brennan is his name. And that’s how it started.

From there I was generally a trend follower early on. He had no commissions in his account because he was an owner of a brokerage firm. So, I then started gradually going towards shorter-term trading. And around the exchanges most of the traders were day traders. They didn’t generally hold positions for very long. So, that mentality sort of overwhelmed me and had a big influence on what I was developing then for clients later on. That’s kind of the beginning.

There’s a little twist in there. In the mid-‘80s I started hearing about this idea of opening range breakout. Some people had already talked about it; John Hill, Larry Williams. There’s a fellow named Mark Fisher, in New York, that wrote a great book, The Logical Trader, and his group were keying in on the open. And the floor traders in Chicago had a concept, in the bond market in particular, if the market moved eight ticks above or below the open, they would actually fade that. And if it went beyond that, they would start to go with it. They would think that would be a breakout.

Just that concept, in itself, was sort of a foundational principle that I started to work on and then wrote a book about in the late ‘80s.

[00:06:42] Niels

A famous book that became very difficult to buy for most people, I think.

[00:06:47] Toby

Well, we didn’t publish much. It was through Ed Dobson at Traders Press. He published 3,000 copies. And then there was a paperback later on through Dan Rehfelft, who’s not in business anymore. And I don’t know how Ed’s doing, but I see some of his books now and again.

But look, I was surprised and it really helped me. I met some wonderful, very successful people in the business. It was a great calling card for me, including, you know, the introduction to Victor Niederhoffer, in 1991, and ending up going to work for him, which I would consider to be a really foundational moment for me in my career.

[00:07:45] Niels

I wanted to maybe stay a little bit with your book Open Range Breakout, from 1989. Maybe you can take us back, those 40ish years, and describe the edge that you found and maybe also how that edge evolved over time.

[00:08:04] Toby

Well, it’s an interesting story. In fact, it’s going to be a subject that I’m going to take up here in the next several years. I’ll start with you guys. You know, this is…

[00:08:17] Niels

We’re honored, thank you, Toby.

[00:08:18] Toby

Well, I’m writing a little bit about it, but look, the subject is fascinating to me. What ORB is, is a momentum strategy, of course. And, when I went to Victor’s, I was steeped in the idea of trading with momentum. But then I saw him trading against momentum. In fact, our trades were probably opposite each other, which was interesting.

So, I came to appreciate the other side of the equation. But Opening Range Breakout is a great measure of momentum in markets, which is a huge factor. And you can see it even now, in the markets, how powerful momentum can be. And so, you have to really be aware of the moments that you’re going to run into – trend days, generally. They’re not as frequent, it doesn’t look like, as they used to be.

There seems to be a lot of liquidity against momentum that’s used strategically, and again, that sort of moves you towards the mean reversion side. But over the years it had done… In fact, when I published the book, the next 10 years was one of the best periods in history for opening range breakout. And, in effect, that was a good part of the strategies that we had in the firm, in my trading, and it was sort of a launching point for the track record.

There has been an incredible amount of new and different ways of trading that we’ve developed at our firm. But there still is a momentum feature. Other than 1960-1962, which was one of the worst periods for what we would have done, what we do, the last two or three years have been equally as bad. Which suggests the basic concept of opening range breakout. And, in a nutshell, I think the reason why that’s deteriorating like it is, is because where is the open? For God’s sake. I mean, there’s so much volume in the 24-hour sessions it’s impossible to determine what the open is.

So, the wonderful thing about open range breakout is, back in the day, when there were just primary session, domestic session trading, it was the most vital piece of information, reference point, that you could have. And I started to see deterioration even in the ‘80s when they started the night session in the US treasury markets at the Board of Trade. You could see a dissipation of follow-through from close of the prior day to the open of the next day. And you would also see some dissipation of the sort of vitality of momentum off of the open.

So, that was sort of a warning. And the one thing that I did in the ‘90s, also, with my portfolio, after working with Victor, was to add mean reversion to sort of offset what I thought may… When I went to Victor’s there was a wonderful trader that worked for Victor named Monroe Trout, who, you know, is legendary in the business, and I had met him before I went to work for Victor. And when I got to Victor’s shop, they would just disparage poor Monroe, who is one of the best Sharpe traders in history, and talk about opening range breakout just falling apart and, you know, going to find its demise sometime soon. But at the same time I was developing the strategies to trade it, and it worked, and it worked for another 8 to 10 years.

These changes are glacial. You know, it has changed, yes. But, you know, Monroe made a fine living with it, and so did my firm develop around it, but there are adjustments that have to be made.

I’m going to just throw one thing out. So, the real problem is where is the reference point?

Where the open was a great reference point, but now what other reference points are there in the markets? One is the close of the previous day and the movement off of that, that will then cover.

When you come into the day session of the US, for instance, you’ve got all the overnight information that’s been acquired in the movement, and does that have an effect on the upcoming price behavior? What we have found is it does. It’s not as strong as the old opening range breakout was in the ‘80s, but it’s a factor. It’s one of the factors that you can look at.

Highs and lows of the session, in the 24-hour session, highs and lows of the previous day, you know, what’s the market doing when it makes a new low? Like, for instance, today we happen to have made a new low overnight and rallied significantly. Now that’s something that we see a lot more of right now.

It probably won’t impress someone who’s been in the markets for 5 or 10 years. It impresses somebody who has been in the markets for 50 years, and that’s me. And I think that what’s going on is there are many more reversals instead of follow-through days, now, than there have been in quite a while.

[00:14:21] Niels

Maybe just to follow up on two things mentioned. One is more like a fun fact, I think, and I don’t know this for sure but over the years, when I heard the name Monroe Trout being mentioned, it was always associated with him only hiring like professional college basketball players, super tall guys. So, you can probably confirm that.

[00:14:47] Toby

It was a tall firm, that’s for sure. Not all, but his brother was about the same height as he was. I mean with Monroe it affected his trading. You know, he was, apparently, the highest percentage scoring basketball player in Harvard’s history, like 73%.

[00:15:13] Niels

Okay.

[00:15:14] Toby

Which tells you a little bit about his personality. Apparently, he only shot layups, as a center, at Harvard, I guess, and the trades that he did were only layups, I think too.

[00:15:29] Niels

Yeah, that makes sense. But I wanted to just touch on, before we move on, this thing about where is the open? I don’t follow trading that closely. That’s obviously done by other people in the firm I work for. But is it true that, actually, liquidity has also changed? So, the liquidity was, in the old days, around the open, for the most part. But, nowadays, it’s actually around the close.

[00:15:54] Toby

Yeah, which may suggest if you look at the stock indexes, I believe that the closing volume is higher, especially like the S&P. There’s a lot of action right around the close. So, that marks it as a reference point of significance.

You know, to really get an idea of how this has panned out, there are markets that do trade primary sessions like the old ‘80s, I think, I don’t know… palm oil or, well, the Brazilian markets to some extent. So, when that is happening, those markets have much better results for the opening range breakout concept. And so that tells you something.

Whereas in the stock indexes, actually the markets have been pretty dynamic there and that’s probably a place where momentum works very well. But the open is obscured enough so that there’s a lot of crossover around the open, intraday. It doesn’t mean that the market is not going to move directionally from the open, but there’s a wider path, let’s put it that way.

[00:17:10] Niels

I wanted to shift gears a little bit, Toby, just because, I mean, we could continue talking about just that little area for a while, but we’re trying to cover quite a few topics. Staying with this, in some ways, anyways, is that when you see markets as closely as you have done, for so long, do you feel that the markets themselves (other than the fact that they don’t open, so to speak, at a specific time), do you think that they are different today than they were back then, or is it more about the participants in the markets, do you think?

[00:17:53] Toby

Well, I think that we have to assume the markets are evolving. We look at our past portfolios in the firm and if we’re not making progress and making changes, and making good assumptions there, which we have been able to do pretty well… Those old portfolios just don’t work nearly as well as the present day. And that’s because of the changes we make. I mean, I think there’s probably a 10% or more shift in our portfolios every year because of the amount of work we’re doing on it.

Are the participants different? I think, in a way, you can say that markets are really the same and they are much different. The patterns do exist, I think. But look, the thing about markets, it’s a probabilistic game, and if you don’t look at it that way, there’s nothing certain about what’s going on. And the uncertainty, I think, is greater, maybe especially in the last few years.

So, that means that sort of outlier movements can catch you, I think, a little bit easier than they used to, and be a little bit more damaging to the portfolio. But the basic concepts, I think, are still valid. Certainly, there’s room for new concepts.

The players themselves, I mean, if you think about the market makers now, they’re all, you know, algorithmic and they’re huge, and most of them are very profitable. We work against them; we work against larger interest above and below previous day’s highs and lows.

If you imagine yourself as one of the largest traders in the world, and you’d ask the question, where would you get in and out of a market? You want to get out when there’s tremendous amounts of activity. Today is a great example. I mean, I don’t know if you’re going to date this.

[00:20:18] Niels

We can date it now. We are recording on March 23rd and we’re recording in the afternoon, European time, almost dinner time. So, people will notice that markets have reversed direction quite sharply a few hours ago, given the news coming out of Iran.

[00:20:34] Toby

I mean, you know, maybe I haven’t watched markets enough, but to see a move like silver and gold like they had today; going through the Asian session, having a bounce in the Asian session, going all the way into an hour or so of the European session, and then having another significant rally. I mean, the percentage changes are just something I haven’t… I don’t recall percentage… Maybe I’m just, you know, mentally recording the percentage changes. But damn it, they seem much larger than they’ve ever been. And I think we could probably verify that. And what does that do? I think the question is who bought it today, gold, silver on the lows, at plenty of time and higher volume than they’ve had?

I mean, five, ten times more volume than typically, at the lows, over a half hour period or hour period – tremendous liquidity and a tremendous move in the opposite direction. Somebody’s buying it, and why not? I mean, because that’s what’s happening a lot in the markets. But a big trader must welcome the kind of liquidation that took place there today.

And also, you know, there’s also suspicions about people entering before announcements today. There was quite a few number of contracts traded 10 minutes before the announcements of the Iran talks, which I haven’t heard any sort of confirmation that they actually exist. But, so be it. But somebody came in with tremendous volume 10 minutes before that announcement.

I’ve got the number right here, which we’re talking about. Let’s see, on the five minute basis it was five to ten times greater than normal. So, okay, big traders need liquidity, they need to get fed, so to speak. And the markets, by trading through highs and lows, provide that liquidity. And, unfortunately, the fodder of that liquidity is the poor scared, fearful trader who’s liquidating their longs. And silver and gold have been just great up markets.

By the way, just a point here, the market actually holds here in silver and gold, and started, let’s say this is a pullback. Which, by the way, there’s some precedent to suggest that it’s just a pullback in a bull market, then I hate to see what the next three to six months are to the upside, anyway.

[00:23:20] Niels

Interesting. Well, you’ll have to come back in six months and tell us.

[00:23:24] Toby

Lovely, yeah, I know I can’t hold a position that long, personally.

[00:23:29] Niels

Oh yeah, yeah, that is true.

Alan, you’ve been waiting patiently, so, dig a little bit deeper here.

[00:23:37] Alan

Yeah, I mean, you touched on how you were attracted to technical analysis straight away. I mean, as your talking, you know, it’s all about price, volume, volatility. So, these are still the key variables. And, you know, technical analysis is much maligned. A lot of the time people can be quite dismissive but, at the same time, you know, a lot of technicals are around observing the patterns, because of the behavior of insiders like you’re talking about today. So, do you think it’s as valid today, technical analysis, as it was, and what’s the attraction for you? Why does it have such merit?

[00:24:14] Toby

Well, I don’t like momentum much, personally, but it makes money. It’s very hard to do it on a discretionary basis because the market moves much slower in that process, I think. But I think that there are huge interests that are taking advantage of liquidity pockets. Wherever that volume comes in, that’s, you know… Their eyes open wide. It’s a great opportunity. I think that’s… When you see volume, that’s opportunity, you know, especially when you’re outside of ranges.

I think it’s much more important than I recall ever seeing. Now I may be wrong. I mean there are times when, years and years ago, I mean, it’s hard to get data to really nail it down. But you can look at a graphic display of data and you can get some feel for it. There’s a great study that Wycoff did, back on the New York Times index, in the ‘30s, ‘20s-‘30s, 1931. And it does reflect a lot of the stuff that’s going on now. It was an incredibly volatile time in a bear market.

I think that there’s a concentration of really big players out there that are able to come in, and hold the market, and reverse much more effectively. I say ‘much more’. It doesn’t take much. I mean, let’s say that it used to be, you know, 63% of the time the market would follow through after it took out a high or low. Well now it’s only 58% of the time.

But if that were climate change, we would be melting the Arctic, the polar caps, and we would probably be flooded here in Beverly Hills. So, if you can think of markets sort of as an environmental or ecological analogy, just a few percentage points can change us so much in the way the markets behave. And you can see that in the charts.

The charts aren’t really… Look, it’s not like there’s a premise that we have to hold to all the time. The charts are there just to tell us what’s going on in the market. And if you’re constantly watching this, you can get a sense, you can get a feel for it.

Now the next step, for us, is to always quantify that. And we have done some very, very good work on detecting some of the changes that have taken place. And, by the way, if we didn’t do that, our 5 or 10-year ago portfolio would have put us out of business, probably.

[00:27:10] Alan

But just talking about some of the changes. So, if you think about it, obviously, I mean you mentioned changes in exchange, trading hours, etc. But beyond that, obviously we’ve got new products, new participants, you’ve got maybe increased retail participation, you’ve got pod shops, you’ve got new options activities, zero DTEs, you’ve got a lot of structured products. So, the whole landscape has changed over the course of three, four decades.

So, when you’re looking at all of that, can you say, this is the most significant bit, and this is causing this reaction, or how do you think about all of those changes coming together?

[00:27:49] Toby

The wonderful thing about visual displays of data is that you can grasp a good deal about a subject, a market, very quickly and easily. You know, you can see what’s happening and if you use some decent tools, I think it augments that analysis.

I don’t know, I mean you could let the computer run all day. I really… You know, I enjoy the move towards AI and neural network, genetic algorithm, but it’s so hard to capture, I think, even still what’s going on. Seeing what’s going on I think is invaluable.

I couldn’t imagine being in a market without a graphic display in front of me. And there are good reasons for that. I think the human mind can gather information from that picture still, I think, much better than a computer. We’re still in the phase of having to tell the computer what to do, unfortunately.

[00:29:05] Alan

For short term traders, one feedback, you’d sometimes hear, from my own perspective, speaking with investors, and talking about managed futures strategies, particularly when managed futures went into a drawdown in the last decade, there was a common view that we’ve had this growth of high frequency and those guys are making a lot of money. So, basically, that’s a lot of alpha they’re taking out of the market which, maybe previously, was owned by short-term traders. Is that valid or would you push back on that?

[00:29:34] Toby

Well, when you think of the high frequency groups, you know, they really are the liquidity backbone of the markets. There are some nuances there that are a little frustrating but they’re like the floor traders of old, I think. And they’re going to make money.

The one thing I remember about being around the exchanges is that the same guys were there all the time, and they were on top of the pits. And the guys that were trading in the pits, there wasn’t a lot of turnover. There were some people that came in, and they were new, but generally speaking there was a very solid crowd. They were profitable and they did well.

They didn’t do very well when things went more electronic, but I think that these high frequency groups ended up picking that up, obviously, when it went electronic. And I don’t begrudge them their money. They have to spend a lot to get that edge. You know, just millions, and millions of dollars, just to get a damn few microseconds. Which, I’d rather have edge that’s not so expensive. At least with our firm, we get better at execution.

One of the things that’s going on, if you look at the book, I remember days when the S&P had 500 up, you know, on the bid/ask. Well, you’re lucky to get 20 now showing in the book. But there’s still much, much more volume being traded, which is interesting. They’re much more cagey in the methods of execution, and you have to do that in a firm that’s relatively short-term, I think. That’s part of what we concentrate a lot on.

I think that’s okay. It’s just not that much different than even 30, 40 years ago. We still have to compete with other traders.

[00:31:57] Niels

Just staying on the models, we’ve had only really a few short-term managers on this series because there aren’t that many of them. You are one, and, as I mentioned in the beginning, you’re one of the firms have been around the longest in this space. But one question we get, but also actually we get for a trend following strategy, but I would imagine that it’s even more pronounced in your space, and here I’m thinking more of the purely systematic part of your business, Toby. My understanding is that you probably see more model decay in short-term models relative to longer-term trend models. How do you deal with that? How do you evolve models? But also, maybe the hardest question and that is how do you know when to retire a model?

[00:32:44] Toby

Well, I think there’s an allocation process that needs to take place and it’s recognizing individual strategy deterioration and it’s also looking at the environments that exist, that we’re dealing with. And, you know, there has been a move in our firm, fortunately we have a good, really solid research group led by the CEO who, I think, you’ve interviewed, Mike Pomada.

[00:33:18] Niels

Mike, yeah.

[00:33:19] Toby

And what they have done, and there’s conversation around this, is that we notice these incremental changes in, sort of, the structure of the market. One is that, let’s say, there’s been a deterioration in the basic momentum strategies of 4% or 5%. They’re still successful above 50%, or something like that, but they’ve dropped. So, what does that mean? That’s the question that has to kind of be looked at is, what does that mean?

Well, that means that there are more people that are quashing the volatility. They’re compressing the market. That could be option traders, that could be the large pod – groups that have all these traders that are trading a particular way, that maybe work against us. And we can adjust to that. There are ways to do that, and that’s right.

There has been a shift in our portfolios to try to accommodate and adjust to sort of the newer environments that are taking place. We try to front load that. And that’s, I think, important. You know, we have different sections of the portfolio, and we look at those sections, and we see how they’re doing and, we look at it from different market’s standpoints; how is it doing in particular markets? Which then we ask, what’s the environment that’s doing that, changing the way that is trading? And then we can make adjustments around that.

But you have to be… It’s a vigilant process. You really have to be on top of it. And especially lately. Today’s a great example, and I think that the markets are news prone, jumpy, maybe shorter-term in their movements.

Our portfolio has gone from probably an average of a 36 hour hold to something less than that, I think, over time – our basic core portfolio at Crabel, and that reflects our observations about what’s going on.

[00:36:04] Niels

We talked a lot about kind of edge, and I was just thinking whether there is a difference between edges that try to be very precise and maybe those that try to be more robust, if I can put it that way. How do you think about that?

[00:36:23] Toby

Well, you know, I would lean towards generalization of strategies. In the ‘90s, you know, the markets were a little easier and you could have more optimized strategies and still do pretty well. But in the late ‘90s, I decided to generalize the strategies into a portfolio of six primary mean reversion strategies and six primary momentum strategies, and tried to get an even balance of the two strategies because they’re totally uncorrelated with each other, and tried to get each one of the six, also uncorrelated, say, with the momentum batch. And so, they weren’t all executing at the same time.

Surprisingly… And we still had the other optimized strategies in there. Surprisingly, four of the top five strategies, that year, were all the generalized strategies. You know, the results on paper weren’t better. The optimized were always looking better. But, you know, there’s a fallacy in that you’re fooling yourself; if you optimize too much, you’re fooling yourself in this systematic area. And we’ve kind of leaned in that direction since the late ‘90s and try to find exactly what I think you’re talking about; is there very robust strategies that will stand?

You know, I always thought 50 years would be, you know, something. If something could last for 50 years, I’d be very happy about it. And we still have strategies that I developed back in the ‘90s that are in the portfolio that were very general. So happy about that.

But look, these markets are as tough as they’ve been in, I don’t know how long, like maybe 40 or 50 years. And you would think… I think they’re going to get better. I think we’re kind of in a ‘70s environment, maybe. But there’s something else in there, and I haven’t quite put my finger on it, that’s causing some challenges.

[00:38:37] Niels

Yeah, so, maybe before I hand it back to Alan. So maybe I missed this, or maybe we haven’t kind of fully explored it. I’d love to, if we could. Again, going back to this word edge. Where’s your edge?

And it sounds to me like, actually (and I could be completely wrong here, Toby), it sounds to me that a lot of the edge might be found in the way you execute, in a sense. I mean, that execution is really, it’s not just a little bit of friction here and there, it’s really, if you get that right that’s how you unleash the edge, let’s put it that way.

[00:39:17] Toby

And you keep it for sure.

[00:39:19] Niels

Yeah.

[00:39:20] Toby

You have to get better at execution. Find ways of doing something that don’t cost you. And I would say that the execution, in our firm, has improved by multiples compared to where we were 20 or 25 years ago, for sure. In fact, we’ve been getting… Mike sends out a report on slippage, and it’s at the best levels that we’ve ever had in the history of the firm right now, which is gratifying.

And by the way, we need that, it would appear. You’re right. You’re absolutely right. We need to execute as effectively as possible. There are strategies, there’s patience, there’s speed, there are all kinds of things that go into that.

[00:40:11] Niels

Alan, where do you want to go next?

[00:40:13] Alan

Well, I mean, obviously AI is a hot topic at the moment and you’re talking about selecting strategies, selecting speeds, execution, and these are the kind of areas that a lot of people talk about AI as being very useful in. What’s your experience? What do you expect going forward? How important is it going to be for you as a firm and for the industry in general?

[00:40:40] Toby

Right now, I mean, we’ve gone through a bit of a transition and pretty much everybody in the firm is coding. But now coding is different than it’s ever been, and that is that with these languages, Codex and others, you can build and program verbally, basically. And this is a huge development that’s taking place. So, Mike is all about this. He’s pushing this mandate. Pretty soon I’ll be programming, which I was hired for that, but now, basically, all I have to do is tell it what to do, more or less.

But he’s even got… We’ve even got the back office, you know, the people that are talking to clients, and doing statements, and things like that, and accounting, that are using these AI innovations to simplify processes and do things less expensively. It’s an amazing time. I think it is the next major change.

I think that’s a great advancement for our firm and any firm who’s going to use that, which they will, they’ll have to. But what about the markets and what’s that going to do to trading? Does that mean that, you know, a 20 year old can ask a question about the markets and what direction it’s going in the next five minutes and get a good answer? Probably not. Markets are nonlinear creatures. We deal with imprecision and probabilities only.

And there’s one thing that the market psychologists generally say, you’ve got to expect that anything can happen, anything can happen in the market. Today’s a great example. So, for God’s sake. And it’s a humbling thing. It really is. It’s humbling for a systematic trader, it’s humbling for a discretionary trader or anybody that’s watching what’s going on.

Now, I don’t know if I were one of the people that was buying 10 minutes before various announcements were made today, maybe I wouldn’t be humble, I don’t know. But that’s not my approach. My approach is to see, is there extraordinary volume here?

Now, watch out for that. Watch out for extraordinary volume at any point of the day. How about at the beginning of a daily session, something like that? How about at the beginning of a region because everybody’s awake? If you’re trying to get the US stock market to rally, you’d probably do it sometime closer to the open.

[00:43:53] Niels

You know, in the trend following space, in the last few years, there’s been a lot of talk and some great success by people doing it in terms of replicating these strategies. Now, I have my own observations and views about that. But if someone tried to replicate what you do, what do you think they’re going to get completely wrong about that when it’s a short-term strategy?

[00:44:19] Toby

That’s really, really difficult. First of all, it would be very complimentary if someone really did want to replicate our strategy. (I can’t even say it.) So, thank you but no, it’s not possible and they may not want to, but this is what we do, and this is what we know, and this is what we’re developing. And we have a time frame that hearkens back to the days of zero commission trading at the Chicago Mercantile Exchange.

And now we do have other products that hold for longer periods. We have a couple, including a trend following product. And we have done a good job of not only replicating but lately we’ve done a little bit better and our clients are happy with that in our trend following area.

But the short-term stuff… I don’t fear that, and there’s enough nuance and interesting elements about it that it’s going to be hard to replicate. That’s why it’s a higher cost product. It’s more difficult to develop and also to execute. The amount of capital that we’ve put into execution development has been substantial.

[00:45:47] Niels

Speaking of that, speaking of execution, the importance of that, etc., etc., how do you actually think about capacity in our industry? Because that’s obviously something that comes up from time to time. How do you think about capacity, and is it harder to estimate, in your space, compared to say the trend following space? How do you view that?

[00:46:09] Toby

Well, we look at our dollars per contract net and we look at what it’s costing us to actually execute. And if there’s not a fair margin there, then you know, we certainly have stressors and problems. It’s much more of a factor than, say, you know, five to ten-day holds versus what we’re doing in the really short-term strategies and trend following. That said, we still are very conscious of it in every product, in every time frame we’re trading.

But it’s been absolutely necessary to take a look and keep eye on that and research the ways to get more out of our actual execution of these strategies. That helps us a great deal when things aren’t working very well and helps us a lot when things are working well too. So, it’s a huge component.

[00:47:10] Alan

Just going back to AI. And I mean you talked about everybody using coding and the ease of developing new strategies. I mean the simple observation is AI is all about pattern recognition. It’s like LLMs, that’s what they do. I mean, can AI being used to identify the recurring patterns in the market and then, if everybody is using it for that, how does that impact the patterns themselves as it becomes a bit circular?

[00:47:38] Toby

Yeah, I think…

[00:47:39] Alan

What are your thoughts?

[00:47:40] Toby

It may make them better. Who the hell knows if they can actually reproduce, you know, and get it right? Well, let’s assume this. For whatever reason, markets have become more competitive, and the short-term arena has become incredibly competitive too. We can just assume that people are using things that… Well, I know we are.

So, we’re using every tool we possibly can to get an edge. So, I don’t know why anybody else wouldn’t be doing it too. If it’s AI, if it’s genetic algorithms, whatever the key word is to describe the process, speed and ability to quantify data is really, what it’s all about. The assumption right now is that’s accelerating that process and it’s going to be a more and more competitive landscape.

[00:48:43] Alan

And in terms of new ideas, are you looking at different sources of material for new strategies or is this still primarily price, volume, volatility, etc.? Or do you look beyond those kind of, I suppose, traditional metrics?

[00:49:03] Toby

You know, the feeling I get when I look at it is that it’s an endless process with the databases being so deep. I mean, I just feel like we’ve just scratched the surface, that there’s so much more to take out of the analysis. I just wish, even with all of the tools that we’ve been talking about here, I just feel like it’s so slow, the development, and it’s not because our firm isn’t working hard and they’re not smart people doing a good job.

You know that if there’s one question that’s being answered, and some development around that, there’s going to be another 50 to be asked right after that. Just on that note alone, it just doesn’t end. The quantification of the prices… It’s such a complex problem. It’s daunting in a way. I think I’m impatient, but I think this is what everybody is running into.

One for one, just as an example, I mean, volume itself, and the relationships of volume to price, is a subject that I think a lot of people have overlooked. And I think it’s a very deep subject and there’s a lot of ways to look at it. A lot of people have just stuck with price action alone, just price, which I think that misses the nuances, I think, to some extent.

So, you know, look, I wish AI could do something very quickly into sort of keeping my mind active for the next 150 years because I think maybe I’d be able to solve the volume problem.

[00:50:55] Niels

You know, when we spoke last week, briefly, you mentioned something, and I don’t know if we’ve covered that today. We haven’t used the same words at least. So, I just want to make sure that we do touch on it. It seemed like something important to you. I think you spoke about something called effort versus result in price movement. What’s so interesting about that?

[00:51:18] Toby

Well, it was a hundred years ago this fellow talked about markets, volume, and price, and price range, and ease of movement, and labored movement, and churning. And you know, these are all things that he saw. Apparently volume, it was the ticker. You could, actually, at that time, take the tape and the length of the tape would tell you how much activity there was. There just wasn’t that much being transacted.

I remember sitting in the brokerage firm, in 1970s, and it was 15 million shares traded a day on the New York Stock Exchange. That was a huge day. I mean, now look at it.

So, tracking volume in individual markets is not an easy thing. But here’s the thing. You know, effort versus result is a concept that was developed a hundred years ago. Is it still valid today? Yeah, I think it probably is. Think about large traders coming in on a rally and just stopping it dead in its tracks, but with a lot of volume taking place. Is that a place where you want to buy? I don’t like that area, and I don’t like it on a low. Like, by the way, today when the market goes down and it kind of dead-stops and the range is narrow and volume is high, what’s that telling me? Well, someone’s standing in front of that move. And I think that’s a key point.

And that’s one of the concepts that’s derived from the idea of effort versus result. Effort is volume and the result is the position of the price range, the size of the price range.

One thing here, and this is an offshoot. It’ll take 10 seconds to tell you about it. I don’t think there’s been a complete philosophical justification for technical analysis done anywhere. I see people talk about how charts are nice, we should use charts, they’re easy, they tell you everything about the market, all of that. But really there’s something cognitive… There’s a cognitive element here that has to be considered. It seems to me to be really one of the best ways to pick up this information. And these vertical bars, or candles, or whatever, have profound elements of information in them.

[00:53:48] Niels

Is that going to be part of your next book, Toby?

[00:53:50] Toby

Yeah, that’s chapter one, Foundations and Philosophical Premises, yeah, somebody has got to do it. An armchair philosopher, like myself, should probably give it a shot.

[00:54:07] Niels

Alan, as we begin to kind of wind down, what else do you think we need to extract from Toby now that we have him here?

[00:54:19] Alan

Yeah, I think we’ve covered a lot of the big topics, but you know, when we talked about when things stop working, which is a big topic, I mean, you’ve also touched on maybe the 1970s. You made that reference. And I’m also curious. I mean, you’ve been in the markets a long time, but it’s still been broadly a favorable period for financial assets, unlike the ‘70s, which was a tough period. I mean, how much does that kind of inform your thinking, these kind of big picture macro regimes? Is that something to think about or is that too big picture for a short-term trader?

[00:54:56] Toby

Well, I’m not keen on selling my house right now, and I like gold coins and silver coins. I actually bought some, believe it or not. Do you know how much 5,000 ounces of silver weighs? It’s like 350 pounds. And if you want to store it somewhere, it’s going to sink the floor in.

But anyway, there’s many, many ways to transact financially, now. It’s not necessarily all gold and silver. But these markets, you know, one of the examples is, I have a trust and I put a life insurance policy in there for, I don’t know, say it’s a hundred dollars. It’s lost 95% of its value against gold for my kids. And so, what’s happening? Well, it’s that same old story.

What that’s doing is creating these tremendous price movements that we never maybe could have imagined, including stocks going up for so long. And if we can hold the gains today, we’re probably going to get a rally to new all-time highs, something like that. I mean, why not? What else to do under the circumstances? Is there any really significant change taking place?

I mean this is a lot like the ‘70s. Now, of course, it’s different. It’s so much bigger, it seems like, and it permeates globally. I think it’s a tremendously dynamic time. I’m actually surprised at profitability in markets. I mean our trend following product has done very well, and trend following, I think, is up. And I think that what it’s doing is, these large moves are giving some real opportunities in investments. The short-term is a little interesting though. I have to say, it’s not quite as spectacular. But the movements are so abrupt. Are they with trend? Yeah, generally speaking they are. So, the 200 day moving averages become much more important than ever, I guess.

We’re in really dynamic times. I mean, let’s face it, we can’t complain about the volume and volatility, can we? I don’t think so.

[00:57:25] Niels

No, no, no, it does, as you said, at some point it does feel a little bit like the ‘70s, for sure. So, let’s hope it continues for a little while longer, at least from a trend following perspective.

I’ve got two things I wanted to bring up before we wrap up, Toby. We started out kind of on a personal level with you, a bit about your backstory. I’d like to throw in one more question about that, and that is, you seem to be very comfortable doing things kind of your own way. And I mentioned to you, last time we spoke, that one of my own personal experiences, not that I knew you at the time, was attending a conference with you where everybody was wearing black suits and you came in a white suit.

So being different seems to be… And maybe also choosing the short-term space rather than what most of us do in terms of trend following, it seems to be something that, you know, is part of your personality. But where does that come from actually wanting to maybe do things your own way or a different way?

[00:58:41] Toby

It’s a good question. Well, I do know that diversification is something that’s really sought after in the business. And since I was hanging around exchanges in the ‘80s and early ‘90s, and then went to a short-term trading shop, one of the only ones that I knew. I remember Monroe was trading relatively short-term in futures, but Victor was his teacher in a way, at least a mentor. I just thought there was a better risk adjusted return there, and it saved me…

Trend following I did in the early ‘80s and it was a great time to do it. The markets were still really trending significantly well. But as I went along… I also had a seat, and early on I was an IOM for the S&P when it first started, and I would be on the floor watching the movements. As I watched it in the pit, I said, you know, I can get this on a chart. And, essentially, I found a strategy for two months that quadrupled my account, you know, trading five minute bars.

Essentially, the market, at the beginning, would go straight up and straight down for five, six, even ten bars in a row without taking out a low or taking out a high, if it was going down. That worked for a couple months until the institutions came into the S&P. Then it was an example of market compressing, quashing, and there was much more variability. Whereas, before it would be straight up, straight down, straight up, it would do that ten times a day. And it was a tremendously easy thing to capture.

But anyway, when I saw that, and without having a commission to speak of on my training, it’s just that was what I did. Trend following wasn’t an offshoot of that. Although, you know, we have it in the firm now and saw a need for it. But this is just my area. I’m a day trader primarily for my own account. I think we’re primarily day trading in our short-term program too. It suits me.

I used to be a rather aggressive tennis player. Maybe there’s an aggressive feature in my personality, also. The French didn’t really like the fact that I was at the net all the time, and especially on faster courts. On clay courts it was a different story. So, yeah, it could be a personality thing. It could be just the development that I had in my particular environment. It could also be a level of insanity that you just don’t want to add, but there it is.

[01:01:44] Niels

You never know. Well, speaking of, you never know, obviously when Alan and I do these conversations, we never know if we bring up all the topics that you would like to bring for us to bring up.

So, before I close our conversation, I certainly wanted to give you the opportunity to bring up anything that you think we may have missed or that’s important to you, that you think we should just make sure gets recorded as part of this conversation because you don’t do many of these podcasts, so when we have you, we should definitely make the most of it.

[01:02:17] Toby

Well, look, I’d be happy to do this going forward anytime you want. I really enjoy it. I think you’ve asked some great questions and you’re cordial fellows, and I enjoy it.

But look, at this stage, in my early 70s, I’m ready to talk about markets. That’s what I’d like to do for the next 10, or 15, 20, like I said, maybe 150 years if we get lucky, and write, and study, and research. It’s a fascinating subject.

You know, sometimes I have to tell you, I ask myself, Jesus, this is almost not fair. I mean, I haven’t found a cure for cancer or something like that, but, you know, I’m here, and I’m stuck in my profession, and I want to help cancer anyway. I’m pretty good at this and I think I have something to talk about, I don’t know. I mean, so, I’m giving it a try and I’m available to you guys anytime you want.

[01:03:19] Niels

That’s very kind. We appreciate that. And I know you started a Substack, so for people who are listening, definitely go and check out Toby’s new Substack, and subscribe to it, and start following Toby much closer because now there is definitely some thoughts and wisdom being shared.

Toby, this was really wonderful. It’s an excellent point to kind of finish off our conversation today. We’re really grateful for you being on the podcast and sharing your thoughts and insights with us, and I’m sure we’re going to take you up on the offer to come back at a later stage.

And for all of you listening today, I hope you were also able to take something away from today’s conversation to your own investment journey. And if you did, please share these episodes with your friends and your colleagues. From Alan, Toby, and myself, thanks so much for listening. We look forward to being back with you as we continue this series where we dive into the CTA industry. And in the meantime, go check out the show notes for this episode and all the other resources you can find on the website.

And not least, as always, take care of yourself and take care of each other.

And thank you so much, Toby.

[01:04:29] Ending

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