From Stock Tips To Systematic Trading

• November 11, 2005
• Eddie Kwong

Welcome to the Big Saturday Interview.
Joining me this week is Dr. Bob Colwell Ph.D. Bob is mechanical engineer who
trades on a part-time basis. We asked Bob to join us because he is a great
example of someone who has succeeded in improving his trading results through
the use of systematic trading.

Eddie: Hi Bob, I’m really glad that you
could join us today out of your busy schedule.

Bob: Well, thank you…I appreciate your asking me to
be involved in this. I hope that there are other traders who might benefit from
me sharing some of my experiences.

Eddie: Yes, I agree. First of all, Bob
can you tell us a bit about your background?

Bob: I am a mechanical engineer. In my mind I have been
an engineer since I was a small child. My father was a builder of all things so
it was a natural direction for me. I entered college as an mechanical
engineering major, and eventually earned a Ph.D. in the same area. I was
essentially required to earn a Ph.D. because I wanted to teach mechanical
engineering subjects in a university and be considered for advancement on a
timely schedule.

Eddie: So did you wind up working for
private industry?

Bob: Well actually, my professional background is a mix
of teaching, research and consulting work related to analytically difficult
problems in the nuclear engineering field. So, in all, a mix of really cool
stuff.

Eddie: That’s interesting. As you might know, there
are many engineers who have migrated over to the trading profession. In your
case, was there anything in your professional background that helped you on the
path toward becoming a successful trader?

Bob: Well, it has been my consulting work that most
directly prepared me to discover that I might succeed as a short term investor 
and trader. Problems I was given as a consultant required creative solutions
that were not immediately obvious. These problems came from areas of engineering
and science in which I had no background.

Eddie: Without getting too esoteric,
might you be able to share an example of an engineering problem you faced that
might shed some light on your problem solving ability as a trader?

Bob: One quick example among hundreds of equally
fascinating pieces of work I discovered or was handed was this. How fast is
hydrogen is generated in an unvented tank of nitric acid and plutonium? This
comes about from alpha particle bombardment of the water in nitric acid. If this
doesn’t sound like typical mechanical engineering work to you, you are correct.

Eddie: Uh…no it doesn’t.

Bob: It is not even close. However, I managed to
develop a set of equations that allowed the determination of hydrogen and oxygen
concentration in the headspace of any size tank with any concentration and mass
of acid solution at any time. What is even better is that when tank headspace
samples were taken, the hydrogen concentration agreed with calculations! This
was a very important previously unreviewed safety question that opened a long
period of work in the hydrogen remediation processes across the facility.

Eddie: Let’s take this into
trading now. What’s the connection you see?

Bob: There are many analogies between my life as an engineer and my
fairly recent embarkation into the world of trading. Both require tremendous
focus, discipline and stamina. Both have many outside influences that must be
ignored. Both require long periods of study that no one can help you with. In
fact, outside assistance only confuses important issues most of the time.

Eddie: That’s fascinating. Many traders
have indeed found that isolation helps.

Bob: Yes. Both require long periods of deep
concentration before the light of a solution or even a bright idea comes on.
Both have interventions that can bring on emotions like panic or fear. Yet, to
be successful we must be able to coexist and learn to thrive in this
environment.

Eddie: Those are powerful connections, especially
in terms of the emotions. So tell me then, what led you to get interested in the
financial markets?

Bob: It was an evolutionary process that
started with a stock tip from my dad in about 1971. I bought Pan Am and lost
some money. My lesson: don’t just enter a trade on a tip, even from your father.
Do some homework. I think he got in that trade on a tip from someone else.

Eddie: I imagine from that point, that
you wanted to find a better approach.

Bob: Yes. Next, about 20 years later I procured the
services a very well known and apparently successful financial manager to manage
my money.

Eddie: Please, don’t mention any names.

Bob: Don’t worry. I don’t really want to. In about two
years, I was convinced he was going nowhere but slowly down, so I transferred
all that money to another management group that allowed me to make my own
portfolio selection. That was in early 1999. I made a small fortune by buying
all the well-known dot.com “rager” stocks. My screening technique was to look
for smooth uptrending charts with relatively small volatility.

Eddie: Did you use some kind of
quantified volatility level?

Bob: I didn’t know what volatility was then; I just
looked for stocks with nice personalities. I even had an equity graph posted on
the side of my desktop computer that predicted the day that I would become a
millionaire. Trouble is the date was sometime in July, 2000. My final event with
that brokerage occurred on the afternoon of Mar 25, 2000. I was using the IBD
newspaper to help me evaluate the health of the market and I had already sold
QCOM near its climactic peak at the end of 1999, so I was a little bit worried
about the rest of my stocks. Anyway, I politely asked the firm management to
liquidate my holdings and they adamantly insisted that I was making a big
mistake. They told me that they were “not market timers”. At that point I became
a little emotional and insisted they close out my account and send me a check.

Eddie: When they sent you the check and
the market continued to plunge, you must felt like a genius.

Bob: Another big plank in the floor of my trading
education had been put in place. During the summer of 2000, I had decided that I
must be a really good trader, but there wasn’t much window of opportunity and
most of the time my small tests of the stock markets failed.

Eddie: So with a bear market in place did you try
any shorting?

Bob: No, since the markets were then very bearish I
decided to open a futures account so that I could trade both ways in issues that
aren’t much related to the stock market dynamics. To shorten this, I learned two
more very important lessons on the way to being a real trader. I thought futures
trading looked pretty much like stock trading, so I was risking too much and not
seeing much success. The futures firm I was with then offered me a really great
opportunity to be a part of an automated e-mini S&P trading system. It did well,
so I upped the ante to 3 or 4 contracts. When that automatic money making
machine decided to be cranky, I lost money very quickly. I had become much more
conservative in my own trading, but one day I was out of money. It was only a
paltry (ahem) $80K! From irrational exuberance to utter defeat in about 2 years.
So, I took some time off, did some serious studying and healed up for a while. I
was very busy doing engineering work in that period anyway.

Eddie: Looking back, that experience
must have had a great impact on you and I’m sure it’s no different from what
many traders experience.

Bob: True. I think, in one way or another, almost all
serious traders must experience the lessons described above before a stable
unemotional systematic approach to trading the markets can emerge. I am still a
serious student of the markets; it is an endless research arena and perfect for
my personal makeup.

Eddie: So let’s fast forward to the
present day. One of the reasons I wanted to interview you is that you have
arrived to a point where you are beginning to see some success. Can you please
tell me what works for you?

Bob: I now swing trade stocks and index futures using a
variety of entry techniques, including the TradingMarkets Swing Trading College
systems, but also a few of my own strategies. I never adopt a strategy that has
not been subjected to serious testing that has been made totally transparent to
the trader. Most sellers of trading methodology have no proof their methods
work, therefore they are, a priori, unacceptable to me. TradingMarkets never
sells an untested or unproven method, so we quite well agree on that issue. The
technique of optimizing the settings on indicators used in trading strategies so
they demonstrate gains over a period (usually short) in a group of issues
(usually very small) I assert does not apply to the TM methods because their
testing is always over very long periods of time and applied to a huge
population of traded issues. Extensive back testing is necessary to develop the
best profit factors, highest probability of success along with acceptable
drawdown, which is of course still optimization but in a much more global sense.

Eddie: Given that, the main challenge
of trading a mechanical system is following it’s entry and exit signals without
deviation.

Bob: You’re quite right. I believe that the emotional
swings of an unseasoned trader, that lead to premature trade exits, are the most
common cause of trading account decline. Discipline in any endeavor is very
difficult when fear is present. That is the essence of why the systematic
trading of an extensively tested method can, over time, bring accelerate the
maturation of a trader that is still searching for trading equilibrium. I don’t
believe I have quite arrived, but I have seen much improvement since I started
using the TM methods I have acquired. My accounts and equity performance curves
certainly attest to that.

Eddie: I’m glad to to hear that. The
important thing is not that you’re executing perfectly. I don’t know anyone that
does that. Rather, it’s important that you’re on the right path, you’re seeing
your results improve and you’re making consistent progress.

Bob: I guess it is in me to always be a student of the
trading game, so I am constantly reading, studying, backtesting and causing my
devoted wife to question my sanity. One area in which I have recently become
interested in is the use of professional traders influences on price and volume
to help me better time entries. We don’t have time or space to discuss this
intrigue here, but you can rest assured that professional trading is what causes
90%…my opinion, not back tested…of the price movement in all markets. Small
traders would do much better if they could buy on weakness and sell on strength,
like the trading syndicates do. That is certainly what the methods espoused by
TradingMarkets try to do. I am on a quest to improve what I do by paying closer
attention to repeated price/volume footprints in the sand of charts.

Eddie: Nice. Can we now take a look at
some recent trades of yours?

Bob: Yes. Let me dig out a few.

Eddie: And let’s follow our cardinal
rule: Don’t cherry pick. Let’s look at both winning and losing trades and try
and learn from them.

Bob: Okay, here’s three trades. Let me comment on them.

 

 

 

Eddie: Well, Bob…I know you have to get going
now. Can you tell me what life is like for you right now outside of trading?

Bob: Overall, things are working well. And
I don’t have a boss/manager type looking over my work. Tomorrow, my wife and I
and some friends, are going to see the Rolling Stones in San Francisco. And I
don’t have any deadlines except to update some stops for Monday. Pretty good
retirement if you ask me.

Eddie:  What are your
long term plans in trading and what are your goals for yourself?

Bob:
Well, I had an indicator on the wall when I first started trading showing when I
would reach the $1 million mark.  Of course I don’t have that up anymore, but I
do have the idea in the back of m mind.  I just keep thinking that I am getting
closer all the time. 

Eddie: Just keep things
going the way you are and you may surprise yourself.

Bob: Thanks, Eddie.

Editor’s note: I had a
great time interviewing Dr. Colwell and I look forward to your comments and
suggestions. Please feel free to email me at
eddiek@tradingmarkets.com.

Eddie Kwong

Editor-in-Chief

TradingMarkets.com