We: Can you talk a little more about the connection you see between music and trading?
CJ: Music is full of symmetry, art is full of symmetry, nature is full of symmetry. Reading the natural world is really what pattern recognition is all about. I studied jazz — I majored in the trumpet — and had been learning improvisational playing since I was a kid. We’d play and study chord structures that had “resolutional” feelings attached to them as they climbed, climaxed, and descended. Market patterns are basically the same, but you need a method that allows you to analyze them, manage the risk, and then extract a profit from them. I look for symmetry in several areas to determine the [musical] “key,” if you will, the market is currently playing. It’s like there’s a current world view being established by the patterns, and as a manager, I am taking opportunity flow from those patterns. Once I have the current market “key,” I apply the notes — the trades — and hopefully make some music. I have to be flexible in my approach because although patterns repeat, the outcomes are random. Art is flexible, music is flexible, nature is flexible. Everything is moving, flowing, ebbing, and running, and I am following that flow.
WE: But you use a systematic approach to trade. How did you develop that part of your trading?
CJ: Going through all the hard knocks it takes to become a trader, I started to learn about the discipline and psychology of trading, and I decided I wanted to learn about system development. I already had a pretty extensive computer background and I started building systems for futures. I felt I needed cash data to design the systems because there were problems building systems using futures data, where the data had to be seamed at the end of every month (to construct a continuous price series out of individual contract months). You can’t build systems unless you have clean data. I don’t care who’s generating the data; if it has to be seamed in a specific fashion, that will lend itself to problems later in system construction. I was somewhat homegrown as far as doing this. I’m sure there are people who know how to get around that [problem], but I didn’t, so I set futures aside for a while and started doing a lot of research with cash markets. I found the models I was developing really lent themselves well to currencies, so I naturally gravitated toward them because there was lots of liquidity and plenty of cash data available. I started to do all my research in modeling currencies.
WE: Did the data situation push you toward forex, or were there other things that attracted you to it?
CJ: The availability of the data, but also the liquidity. I wanted to trade 24-hour markets because I thought it would give me more opportunity for profit. I wanted something that had some sort of pattern recognition feature, and the currencies are so huge and the liquidity is so deep, it just seemed like there was less interference with some of the patterns.
WE: In terms of the hard knocks you took, what lessons did you try to address in developing your systems?
CJ: I learned a lot about the psychological aspects of trading. Trying to trade from a discretionary base lends itself to a lot of emotional decision making. You can have a good run for a while, but eventually, if you’re making decisions from an emotional place, you can get yourself in trouble. And I found that for me, day trading was not the way to go. Making decisions from a long-term perspective was fine. I could be something of a long-term, macro trader — using a buy-and-hold view.
Taking risk wasn’t a problem — I could always take risk, and effectively manage it. The problem was day trading didn’t fit me, so I started developing models that would handle the execution for me. Creating ideas and putting them together in a mathematical algorithm that would express itself in the market was a fun challenge. But I found out that using just one system would work fine for a while, but inevitably the market would fall out of sync with that system. That was frustrating. On the one hand, discretionary trading was problematic emotionally. On the other hand, although I had learned that systematic trading was fine if you could construct it in a way that always fit the market, it didn’t always it the market. I ended up falling right in the middle — one approach being left brain and one being right brain. I would have a systematic method that I could control [discreetly]. In other words, I’d use the flexible left-brain energy to read the market from a macroeconomic perspective and look at how a system is performing, and I would use the systems in a very rigid, mechanical way to execute the trades themselves. That’s what the FX multi-strategy has become — a hybrid strategy that is fully systematic, with my discretion applied over the systems.
WE: How, then, does discretion come into play?
CJ: I have six different programs that I run across five different markets. I try to keep these engines running so they fit the markets in the proper perspective, relative to the currencies I’m trading. The systems running together create a portfolio matrix with its own characteristics. I think this is the neatest aspect of the program. Understanding the individual pieces and the relationship to the whole makes this method more of an art. It’s like a painter who understands the relationships of color, value, shape, and textures. Everything comes together to make a fine [piece of] art. In one currency I might trade one strategy for a period of six weeks. On another currency I might trade another strategy for a period of three weeks. As the market evolves and the liquidity shifts between currencies, I’m able to detect change in that liquidity flow, from my macro-fundamental approach to the market — which is all behavioral finance by the way, and one of the elements I use. The other element is pattern recognition — not necessarily pattern recognition of the market itself, but pattern recognition of the systems I’m trading. In other words, how a system is trading with a particular market.
WE: Are you talking about managing a system’s equity curve, to a certain extent — adjusting your trading depending on whether a system is going through a relatively good or bad phase?
CJ: Exactly. Basically I’m looking at the equity curves, excursion analysis, and a couple of other things that are proprietary, but I’m looking at the behavior of how the system is trading in a particular market to give me an indication of what’s next.
WE: So you’re looking for signs that particular system may be getting out of sync with a market?
CJ: Yes. And if you were just trading two markets you might not have enough information to go on. I’m trading five markets that are all interrelated.
WE: Which ones do you trade?
CJ: I trade the four major pairs and the Euro-yen. I basically have five confirmations of how a system is performing. I have the systems trading live and trading a “dummy” in the background on all the markets to give me the indications as to how to set the rotation [among the systems]. The systems themselves represent different ideas trading on different time frames. What’s unique is how I mix the systems in a portfolio context.
WE: What’s the range of holding periods?
CJ: I’m out the losers pretty quick — usually in one day. Winners will last as long as a week sometimes. The average trade frequency is 2.8 days.
WE: How many trades will you have on at a given time?
CJ: I’ll have five trades on all the time. I typically use four to one leverage — five-to-one, max.
WE: You’re never out of the market?
CJ: We’re always in, long or short, in all five pairs.
WE: What are your most important trading principles?
CJ: Years ago I talked to a lot of professionals — a lot of fund managers. I wanted to see what they were doing, because at the time I didn’t know if I was going to let them manage my wealth or do it myself. The story I got back then, and the one I got a couple of years ago, is that the most important thing is what you can say you have right now in terms of profits. They look at consistency and monthly profits. In other words, just stay profitable every month. So for me, I would say that’s become the most important thing, along with keeping drawdowns manageable. In June 2004 I de-leveraged the program by half to cut the drawdowns to a manageable level. That’s the only major change I’ve made. I look for consistent profits every month because that’s where I think investors are going to be. They want “alpha,” but they also want to know they’re not losing money. Since we retooled in June 2004 my biggest drawdown has been 5.75 percent.
WE: Do you ever use currency futures?
CJ: No. We look at some data in the futures, but we trade spot only. A lot of people have an issue about whether a trading program is better suited to futures and whether execution is better in futures. As an experienced trader, I’ll say futures aren’t liquid enough in the Globex session, which is when we are trading, for what we’re doing. Futures used to be much more tight than the spot market, but in the last few years the depth and tightness of the spot market has made it much more competitive that I think the futures are less attractive for what we do. For other people it may be different. If they want to be in the regulated exchanges for certain risk-related reasons, that’s fine, but I think the spot market is far better for trading, and I think most banks and fund managers would agree.
WE: Do you think that’s true for smaller traders, also?
CJ: On the retail level it may be a toss-up. When the spreads get wide in the spot forex market, it might make sense for a small trader to use futures.
WE: As far as market characteristics go, do you think trading currencies is any different than trading anything else?
CJ: I think a tradable market is a tradable market, as long as it’s liquid. I think our strategy in a couple years might lend itself to other markets. I don’t know for sure, yet — I’ll have to see. I have my hands full right now trading currencies. I might always be in currencies — that’s what I specialize in. For now, I plan on remaining a specialist.
WE: If 2005 turns out to be a down year for currency managers, it will be the first since 1994. Why do you think it’s been so challenging?
CJ: I can’t speak for other traders, but it appears that most of the [currency managers] are trend followers. The currencies have had some good trends, but those trends have occurred inside a very wide volatility envelope. They haven’t been able to capture those trends in their normal modeling.
Rather than pursuing a trend, I’m pursuing liquidity. That’s my main objective — to pursue money flows, not necessarily to use the trends as an indication of that. I do use some volume in my studies.
This year [many currency managers] are out of sync. There are some quality traders out there, for whom I have a lot of admiration, that are having losing years. For them, I think it’s reversion to the mean for their programs. And I have a deep respect for reversion to the mean because I had some of that myself in my program last year — and I didn’t like it. I wanted to pull the volatility out and keep the focus on staying profitable now — that’s what counts. [I’m only concerned with] making alpha this month. My next challenge is to set and maintain a target volatility for the program.
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