Almost Trading for a Living
Welcome to the Big Saturday Interview. This week,
I’m delighted to have with me, Steven Gabriel, MD. Steven is a self-taught
trader who primarily swing trades for his own account from home. He has been
trading for 8 years and is primarily a non-discretionary systematic trader.
Steve trades stocks, single stock futures, options, and e-mini’s for both risk
control and leverage. Recently, Steve started
blogging at TradingMarkets and his
commentaries and the markets and insights on trading psychology have been among
the most popular in the blogs section. Steven is also a board-certified physician in
Emergency Medicine and still practices medicine in southern CA.
Eddie: Steve, I’d like to
start out by asking you a little about your background. Can you share with us
about your career as an emergency medical physician and how you also became a
serious trader?
Steven: I grew up
in Huntington Beach, CA. I have one older brother who has been an incredibly
positive influence on me through all stages of my life (but who is not a
trader). I went to medical school in New York at SUNY Brooklyn-which was a
fantastic experience because of the intensity of living in “the city†for the
first time especially after spending my growing up years in suburbia,
California. In your last year of medical school, everyone generally chooses
what specialty they want to do. At the time, I wanted to do internal medicine.
My older brother, Anthony, is an internist, who is a mentor to me– told me not
to do internal medicine and that he felt that the Emergency Department fit my
personality and interests better. So that month, I signed up for a rotation in
the Emergency Department, and I loved it. Right away I switched career paths
from Internal Medicine to Emergency Medicine. Emergency Medicine is a 4-year
residency, but the first year of internship is not done in the Emergency
Department. You really have some flexibility on where and what you do your
internship in so I did my internship through the University of Hawaii.
Then, I went to UCLA
Medical Center for the next 3-years to do my residency in Emergency Medicine.
Shortly after residency, I got married to my wife, Zena, who was a medical
student at UCSD. I moved to San Diego and took a job at a busy Emergency
Department in Oceanside, CA. I love working there. Meanwhile my wife started a
Dermatology residence at USC–so I kept my job in Oceanside, and we moved to
Orange County, which is right between San Diego and LA. She commutes 50 miles
to Los Angeles, and I commute 50 miles to Oceanside for work. It’s painful, but
it works.
“…This
transaction cost more than my entire net annual residency salary…”
Eddie: When did you first
get interested in the financial markets?
Steven: I guess I
was always interested in the concept of investing, but didn’t have the money or
access to buy stocks. When I was just 10 years old, I began collecting comic
books. I really wasn’t as interested in the comic book stories as I was in the
investing potential. When I was in the 5th grade, I had a neighbor that sold me
his entire comic collection of about 30 comic books for about $20.00. I don’t
even remember how I got that $20.00 to buy those comics. I am sure I convinced
my mother that it was a good thing to do. I sold about 1/2 of those comics
later that year for the same $20.00. I still have the rest of those comics that
are probably worth about $100.00 (thanks Ruben). I guess this was my first
lesson in money management. I continued to buy comic books all through high
school that I still have.
Eddie: Did you have any
relatives who traded? Or were there any acquaintances that you modeled yourself
after?
Steven: I have
always eyed the stock market as I was growing up because my godfather, Nick
Edwards, and my Uncle, Anthony Belli were avid stock market participants. I
gravitated towards conversations about stocks with them even when I was
younger. I remember my godfather having a chart subscription service. He would
have binders of stocks in his office. When I visited him, I would look at the
charts in the binders. I still can’t even tell you what either of their trading
styles are–I really just think that they are more buy and hold participants.
This piqued my interest, and I always waited to get enough money to get an
account myself. When I was on my summer break after my 1st year of medical
school, I worked in my father’s law practice in Long Beach, and I went over to
the Charles Schwab office up the road and opened my first account with about
$8000.00. I really didn’t know much about trading so I picked some stocks. I
think I bought American Electric Power (power seemed logical, right?), Apple
(because I’ve always been a Apple fanatic), Cisco (I loved the idea of
networking computers), and Merck (I always had remembered my godfather talking
about this company). I really just held these stocks for the most part, until
about four years later when I moved to Hawaii to start my internship. The tech
boom had just started, and I had about a $20,000 stake. I started trading tech
stocks through a broker at Dean Witter in Hawaii-I thought if I were going to
start trading I would get some help.
Eddie: If you think back
to your early days as a trader, is there anything that you’d do differently?
Steven: Well at
the beginning, I was doing my internship and I was in the hospital all of the
time. I was watching CNBC at night in the call room while trading to study up
on medicine. At first, I watched new IPO’s at the time come out and saw 10+
point moves in 1 day (this is before it really got crazy). I thought, I need to
jump on this bandwagon. Fundamentally, I was so excited that the world was
embracing the internet because I was using a modem when was about 10 years
old–I knew that connecting computers was.. â€The way.†So, I just started
buying anything that had to do with the Internet and went up–fast. I loved the
volatility. I remember thinking that Yahoo, Amazon, and eBay were changing the
world–that they would never stop going up…it was endless. This was really my
first lesson as a trader–that there can be a complete disconnect between
fundamentals and stock prices. Because I really had just started “trading†in
this period of stock price insanity, I didn’t understand the concept that the
stocks really are priced based on the STOCK MARKET fair value, not necessarily
their real worth. (I understood this well a couple of years later when I got
destroyed). Because I was making so much money, I felt great. I felt that I
bought tech stocks earlier than everybody else and that made me naive. You have
to remember that my peer group was a bunch of medical residents and interns who
had very little money–so I really felt that I was “good†at “stocks.â€
Although, in actuality, I wasn’t taking any time to learn anything substantial
about trading, the markets, or risk control; I really just bought stocks based
on what was going up the fastest. This became my trading methodology. I always
knew what to buy the next day… whatever went up the previous day. I remember
that there was a day that I was in the Emergency Department at Olive View
Medical Center (a UCLA hospital). I had just finished a night shift and I had
about 500 shares of AMCC in my account. I saw that the stock was up about 10
points in the morning. I looked right at one of my co-residents, and I said I
need to buy more right now. I bought 500 more shares right in the ED (I think
that it was trading around 70 at the time). This transaction cost more than my
entire net annual residency salary. I think that my co-resident bought about 10
shares that morning. The stock closed up about 25 points that day.
Looking back at that time, I was really just lucky. I didn’t know anything
more about the markets than anyone else. What I should have done differently
with my time was study
other great traders, and learn during that period instead of just trading with
such little knowledge.
Eddie: What were your
early experiences when you first started trading. What did you learn?
Steven: Really my
whole strategy was based on momentum, but I really couldn’t even define my
strategy at the time I was trading it. In hindsight, I looked for the most
volatile stocks, and after the stock had a volatility contraction-I would wait
for volatility to explode again, and when the stock started moving-I would buy.
I would exit when the stock started consolidating again. This worked great in
the late 90’s. But this strategy was really flawed in several ways. First, and
most importantly, I did not manage risk. As a matter of fact, I didn’t even
think about risk-let alone manage it. I bought as much as I could, not thinking
of the consequences if things didn’t go my way. Secondly, stocks don’t trend as
well as they did during that time in the late 90’s–so that strategy worked
because it worked for that market which really was an anomaly. But, honestly,
if you don’t control your risk, I don’t believe that any strategy will work even
if the strategy is extremely robust. Who knows maybe if I quantified the
strategy that I used back then and applied the money management principles I use
now. It may work well.
Eddie: What strategies
were you trying to apply when you first started trading? Looking back on it,
do you think those strategies were flawed? If so, in what way?
Steven: I have
really evolved through multiple trading strategies, and although I don’t
currently trade any of the strategies that I’ve used before, my experience with
each strategy is incorporated into the way I analyze the markets now.
Eddie: Over the years, what
other types of trading strategies have you used, but then discarded because they
either didn’t work, or didn’t fit your personality?
Steven:
Now, in all fairness, my trading success really started when I began focusing on
money management and risk control. So, I’m not really sure if the prior
strategies that I traded were the problem or the way that I managed my account
at the time.
Anyway,
after losing a huge amount of money with my momentum strategy. I began studying
all of William O’Neil’s books and I subscribed to Investor’s Business Daily. I
liked the concept, but I was finding trades 2-3 times per week. I was voracious
about looking at charts and numbers in the paper. Well, I just couldn’t resist
taking every trade that I found, and I felt that I would be safe taking all of
these trades because O’Neill teaches money management and the use of stops. I
felt that by just using stops, I really couldn’t lose too much money. I quickly
found out what happens to your account when you compound 8% losses. You lose
your capital very quickly. But, I was beginning to learn the importance of
money management and the importance of capital preservation. Overall though,
his style just didn’t fit my personality. It was too subjective, if you look
closely enough you can find a lot stocks that fit his criteria–so then I was
left with the subjective questions of what stocks to buy and I didn’t like that
subjectivity. Also, although he writes about the appropriate time to exit,
ultimately it is somewhat subjective–which just didn’t work well for me.
I later
turned my attention to just pure technical trading, and I was following the
recommendations of Gary Smith on Real Money. This was really another poor
strategy–following someone else. You never know what is in that person’s
head. You don’t understand their exit strategy, their uncle point, or their
exact time frame. I really believe that just blindly following someone without
a passionate understanding of their methodology to the point that is your own,
doesn’t work. So, I started reading several books on the technical trading to
make technical analysis “my own†strategy. For whatever reason, I found that I
seemed to be good at the entries, but I could not be consistently successful
with my exits. As technical as technical trading is–it also seemed too
subjective. I could draw trendlines and patterns to fit the same chart in
multiple different ways. We have a similar concept to this in medicine–you can
use physiology to explain anything. What this means is that using a basic
understanding of physiology, I could explain the same disease process in
multiple different ways-even though there really is only one right way. This is
how I think about advanced technical analysis-I could draw lots of different
patterns on the chart to explain to you what I want you to see. Don’t get me
wrong, I do think that there is value to technical analysis, but it is much
harder than it appears when you first start learning it.
I eventually dropped
these methodologies and went for a more, what I call, a statistical approach to
the markets.
“…During those three years of residency, I turned my small roughly $10,000
account into $500,000…”
Eddie: Did you ever get to
a point where you thought seriously about giving up trading? If so, what made
you determined to stick it out?
Steven: For some
reason, I never felt that I would quit trading. The primary reason was that I
kept reading about people who were successful at trading. And, if it was
possible for someone else, I knew that it was possible for me. My parents have
always taught me to never give up. So despite my early failures, I did what I
always do, I continued to study as much as I could about trading and the
markets.
Eddie: What do you think
was the turning point in your development as a trader? What was that defining
moment that enable you to get to where you are now confident that you can trade
for a living at some point in the future?
Steven: I can’t
say that there was one day that made me feel confident as a trader. I think that
if you have one day that makes you feel that you finally got it (trading). You’re
probably not there. I think I really am still building my confidence as a
trader. I feel that being too confident is always a recipe for failure
especially in this game. But, I’ve built my confidence by looking at my account
on a monthly basis and seeing a large volume of overall trades with a high
percentage (75+%) of them being successful with relatively small losses from the
losers. But, even more importantly, my performance measures have stayed fairly
consistent even in different market environments. To make a baseball analogy,
hitting a lot of singles in a lot of different games against a lot of different
pitchers.
Eddie: Something I’ve seen
before is where traders go through painful cycle of blowing out their account,
saving up some funds, trading again and then blowing it out again. And this
repeats itself over and over gain until either you “figure it out” and achieve
some level of success? Or you discover that trading is simply not for you and
you give it up. Did this ever happen to you?
Steven: Heck yeah,
I think that you have to go to rock bottom at least one time to really
understand risk–and know what it can do to you. During those three years of
residency, I turned my small roughly $10,000 account into $500,000. It then
took me about a year and a half to take my account from $500,000 down to
$15,000. And, as I tried different strategies, I would continue to overexpose
myself (from a risk standpoint) even though I didn’t have any consistency in my
trading. I would then lose more money, and then fund my account again, and
again, and again. All the while, I would just keep reading anything I could get
my hands on, I began keeping a trading journal-and I would look at what I was
doing wrong. I was always interested in statistics so I would analyze my
account-sometimes it was a nightmare.
Eddie: Everybody knows
there is probably a disproportionate percentage of doctors and surgeons who
trade. Do you happen to know a few? If so, can you share with us what you know
about their trading styles and relative levels of success? Also, what kinds of
common themes do you see among your doctor friends in their trading experiences?
Steven: I know
several doctors who trade stocks. As a matter of fact, one of the attendings
(senior physician) at my residency program was an avid trader. He strictly used
a covered call strategy. He actually did extremely well as far as I know. He
never used margin and always bought more stock with the proceeds from the sale
of his calls. He was really just building a huge portfolio. His trading style
didn’t exactly fit me, but it worked well for him. I am also very close friends
with two other doctors who trade, and I know several other doctors not as well
who trade also. The biggest theme that I see with doctors is that they are
reckless. They take on huge risks with little knowledge and try to hit it out
of the park with one big winner. On a few occasions I’ve explained that you
really just want a lot of small winners, and other doctors have looked at me
like I was crazy with responses like, “you’ve got to buy 5000 shares so that it
makes a difference.†I’m sure that it eventually makes a difference for most of
them because most of them end up not talking about trading anymore, and begin to
say things like, “I’m not into that (trading) anymore, I just have a broker take
care of that for me now.†Overall, my experience has been that doctors as a
group are not good traders.
“…The
lesson is that when you are afraid to tell people what you are doing in the
markets – you’re doing the wrong thing…”
Eddie: Do you see anything
about the similar about the process of being successful at what you do as a
physician and what you do as a trader? Has being a doctor and having the mindset
of a doctor helped you in your trading? Or has it hindered you in some way?
Steven:
Absolutely, one of the main skills about being an emergency physician is
filtering out noise (lots of patients, long waits, lots of people demanding your
attention) and knowing who the few sick patients are in the emergency department
amongst an entire department full of people. In trading, there is also a high
stress environment with a lot going on and you must see the few trades that have
an edge amongst a whole sea of data bombardment. Both jobs really get much
simpler when you realize that there are really only a couple of issues that are
critically important despite their being a lot of other stimuli.
Additionally, medical training helped me with trading because it built my
confidence in terms of what I could do and learn. After going through medical
school, I figured out that one has the ability to learn incredible amounts of
information in a short time. So, when it came to trading, I figured that I
should put as much time into studying the markets, trading ideology, and
traders, as I did into learning medicine.
Eddie: How do you juggle
trading while at the same time being a full time physician?
Steven: This
really is a tough one, and it’s very difficult sometimes. The real answer here
is passion. I’m passionate about medicine and about trading so I make it work.
For the most part, I work at night and often on the weekends. When I get home
from a night shift, I usually watch the market open-and make sure that trades
that I may have put on the night before go through as planned. I then usually
go to sleep and set my alarm for 12:15 PT-to see if there are any trades that I
want to exit or enter. When I’m done placing trades near the close, I usually
go back to bed for a few hours and get ready for work. So the answer is…
generally market hours are when I’m off work (which is during the middle of the
night (sleep time) in terms of my schedule).
Eddie: Without naming an
names, do you have any interesting or funny stories about you or anybody else
you know who is a doctor, but who also trades?
Steven: Of
course… I have two very close friends Amit and Christopher that I went to
medical school with that became traders who unfortunately aren’t trading anymore
because they needed the money for other projects. But, we use to have a rule
between the three of us, that if you do something in your account that you are
afraid to tell either of the other two friends about–you should get out of the
position. In other words, it usually means that you are doing something
irrational if you are afraid to tell your friends about it. Well, for some
reason, two of us would always know if the third trader was hiding something
just by the way they were talking. Well, one time Christopher was really
talking up Krispy Cream Doughnuts in 2001. He clearly was too into these
doughnuts. So Amit and I would keep asking him, “what did you do with KKD?â€
And, he kept telling us that he had a small position, but we knew better, so we
kept asking and he kept his mouth shut. Well, that month as expiration month
came to a close, he shared with us his little secret, which he basically filled
his account with out of the money KKD calls and it pretty much wiped out most of
his account. The lesson is that when you are afraid to tell people what you are
doing in the markets–you’re doing the wrong thing. It’s a good litmus test.
Eddie: When you are at
work, do you think about trading?
Steven: When I am
at work, I think about patients. I’ve now designed my trading strategy so that
I place trades at the end of the trading day when I’m not working. So I really
don’t think about trading while at work. I really like it better that way. I
want to be good at what I’m doing so I need to have my attention there.
Eddie: What is your
schedule like? Can you give us a snapshot of what the day is like for you for
you. I.E. What’s your regular work schedule? When do you have time to do your
nightly research? When do you place your orders? How do you have time for a
regular family life?
Steven: I work in
the evening or overnight. If I work in the evening, I do my trades at the close
of the market between 12:30pm and 1:00pm. I then eat lunch and leave for work
at around 2:00pm to get to work at 3:30pm. I stay at work until around 1:30am
and get home at approximately 2:30am. At that time I will look at charts until
around 3:30am-4:00am. I generally don’t do screens because I like to look at
each chart individually; it gives me a better feel for the market. I look at
about 100-150 charts. I then enter orders. Often, I get up at 6:30am to make
sure that there are no problems with my executions. I then go back to bed at
around 7:30am, and then wake up at 12:30pm and do the same thing all over again.
If I work from midnight and get off in the morning, I essentially just come
home and begin looking at the markets.
Because I
have an erratic schedule–I also have a lot of weekdays off, and some
flexibility in the number of days that I work in a month. So, when I’m
off–this is all moot.
In terms of a regular
family life, my wife is still doing her residency and I primarily work nights.
Therefore, we only see each other about 3 times per week. We don’t want it this
way, but for right now it works.
Eddie: How do you stay in
touch with the markets while you’re out in the field? Do you ever call for
quotes or do you have a handheld device that tracks your position or something
like that?
Steven: Actually,
this has been one of my biggest frustrations for me until recently. I really
don’t need a device like this when I’m at work. But when I leave work in the
morning, I often want to check my orders. Or sometimes, I have administrative
meetings at the hospital in the day time, and I want to place orders at the end
of the day. I recently bought a Verizon EV-DO card for my laptop. It works
great. I now get high speed Internet whenever I need it. Sometimes, I even
pull over in my car if it’s around 12:30pm PT because I couldn’t get home in
time for the market close.
Eddie: What kind of
technology do you use? Can you give us a description of your platform?
Steven:
I really don’t have anything too complicated. I use an 15†Apple Powerbook G4
without and external monitor. That’s it. I’m sort of a simpleton. I believe
that it’s not the equipment that makes you good–it’s you. But, I will say that
an external monitor would probably make a huge difference. I’m constantly
switching between my trading platform, and my charting program on the screen.
In terms of trading, I
trade through Interactive Brokers–they are incredible. In terms of charting, I
use Prophet.net. I also use Virtual PC for to access TC NET, but I really use
it only once per week for one particular strategy that I trade. Unfortunately,
I’m going to have to upgrade soon because I want to start doing some more
complex analysis–I’ve sort of prided myself on trading with such a simple set
up.
Eddie: What’s the biggest
mistake you ever made in your trading?
Steven:
Where should we start? Well, I have two kinds of mistakes. One is that I just
enter the wrong thing because sometimes I’m just tired…a stop instead of a
limit, or the wrong price. I just did one of those yesterday. But, those are
mere accidents. I’d like to get rid of them, but it’s just part of it.
In terms of consciously
making a mistake, the entire time I traded without aggressive position size
management for risk control. Period. I believe that risk control affects
performance dramatically.
Eddie: What’s the biggest
success or winning trade that you ever had?
Steven: I can give
you a story that impressed me at the time in terms of dollars, but in terms of
trading skills is irrelevant. During the 2000 run up, I had 1000 shares of
Qualcomm the day it went up 100 points. I believe that was my biggest trade
gain, but who cares? It just sounds exciting. My personal biggest success is
that I trade one strategy that originated from TradingMarkets, but that I have
modified, that I have never had a loser with. I believe that I’ve been trading
it for over a year. I don’t know how much money I’ve made doing it–but those
are the kinds of things that impress me now. Everything is scalable, so I care
more about performance statistics of a strategy… not whether someone made $1
or $1,000,000 with their particular strategy.
“…If I
could generate enough money from trading, I would like to spend a lot of time with my wife practicing medicine in developing countries…”
Eddie: Now let’s talk
about your current trading strategies.
Steven: OK
Eddie: Who are you heroes
and/or mentors?
Steven:
From a personal development standpoint, my family. My brother, Anthony really
taught me how to look at numbers; he is really a phenomenally intelligent
person. He is also very self-less and giving. So, in terms of heroes, he is
really the one I think of. I could really go on and on about him. Of course my
parents instilled in me an incredible sense of confidence. And, my wife, Zena.
She is amazing. She is so supportive of my interests and education because she
knows that I really enjoy all of this. I’m constantly educating myself and
interrupting the little home life we have with my continued work on improving
myself as a trader.
In terms of
traders, there are really two traders who have influenced me. First is Larry
Connors. Whenever I read about trading, I would always save the data that was
in his articles. I was constantly frustrated with traders who would write
advice and not back it up with statistical data. How often does it work?
What’s the draw down? Average win? Average Loss? As soon as I read any of
Larry’s work, I knew that he was looking for a quantitative approach to the
markets, which is exactly where I felt market literature should be going. I
believe that, “How Markets Really Work†is the best stock book ever written.
This leads me to another
trading inspiration for me, Ed Seykota who is also a systematic trader, but
seems to have a spiritual angle to trading. He really is ground breaking in
terms of applying mathematical systems to the markets.
Eddie: If you were to
someone just starting out as a trader came to your for advice, what would you
tell him?
Steven: Get a
mentor, someone who can help you. One of my biggest mistakes was trying to
re-invent the wheel. I read and I studied, but you can’t get inside someone’s
head easily from reading their articles. I think that you need someone to talk
to who has already done what you are trying to do.
Eddie: Let’s now talk
about systems and strategies. What type of systems and strategies work best for
you? Where have you seen the greatest success?
Steven: I
basically trade reversion-to-the-mean strategies. All of my strategies look for
short term market inefficiencies to correct themselves. Whenever an individual
stock, moves counter to its trend by more than a couple of standard
deviations–it is usually an aberration and the market generally fixes that. I
look for those situations and buy into those inefficiencies, and get out when
the market “rights†itself. I believe that the market is long-term efficient
and short-term inefficient. I use a similar approach to the indexes as well as
individual stocks. I see the most success on stocks that are already trending
well, using the same strategy. This is my trading methodology.
I also use a position
strategy, which I believe has an equal effect on account performance as the
entries and exits themselves. It is how you put the whole portfolio together.
Generally, I use in-the-money front money options for my positions, options
reduce risk, and they give me leverage. I use a position strategy that is based
on my account size and the volatility of the individual position that I’m
taking. I risk between 1-2% of my account value per position. That does not
mean that the position size is 1-2% of my account value. I evaluate the
volatility and swing moves of the position that I’m taking, and based on the
swing moves–I determine roughly what my risk will be in a 7-10 day period
(barring any freakish news). I then buy the number of contracts that if the
stock moved in its full swing move (meaning high to low over about a 7-10 day
period) against me–that the point loss multiplied by the number of contracts
would be about 1% of my account value. This basically means that my position
size is determined not by how much the position costs, but by how volatile the
position is relative to my total account value. I really want to stress how
important this aspect of my trading is, and I think should be for everyone who
is serious about the markets.
Eddie: Can you give us
your definition of what systematic trading is?
Steven: Systematic
trading essentially answers the questions that a trader has before any decision
that he or she makes. It mechanizes your approach to the markets. The system
should tell you what markets you can trade with the system, when to get in, when
to exit, and your position sizing. Ironically though, I do believe that even
despite using a system, that systems trading is still ultimately discretionary.
The trader still decides how much risk to take on, and the allocation of risk
towards different systems and individual components within systems. This
allocation of risk that is discretionary has tremendous impact on your
performance. For instance, I know a trader who is essentially trading the same
systems that I am, and has less than 1/2 of my annual performance. I am not
saying that I am better than him; in another year, he may have double my annual
performance. I’m just trying to point out that even if you trade the same
systems as another trader that you can have different outcomes.
Eddie: With all the
advertising you see with people making claims about system performance, what
criteria do you use to determine whether a system is good or not?
Steven: This is
very difficult, but what I usually look for is the volatility of the performance
of the system over a period of time. What you want to see is for a system to
perform relatively well, and somewhat similarly each year (taking into account
overall market performance) over let’s say 10 years or more. In other words, if
you see a system that averages 40% per year, does it make about 40% every year
or does it have a few great years and a bunch of weak years?†I also look at
the average performance of the system relative to the markets performance.
Meaning if there is still variability between years in terms of absolute
percentage gains can you explain this variability by the markets annual
performance. If the system is performing at 20% better than the market each
year–that is also consistency. Next, I really look at drawdowns. How long and by
how much did the system drawdown before it came back to break even? This really
effects how much risk you can allocate towards the system. Because even though a
system may have an average of 100% a year gains, if the system has had a 75%
drawdown. I would never allocate more than let’s say 10-15% of my account value
towards that system. It becomes harder to incorporate and possibly not worth it.
These are really the main things that I look at. I will say though that if a
system looks too good to be true–take a look, maybe it really is that good, or
maybe you can extract some information from that system that may be
helpful for another methodology that you are trading.
Eddie: How do
you protect yourself from acquiring a system that has been over-optimized? Are
there any rules of thumb you can use to avoid curve-fitted systems?
Steven: Two things
that I look for are 1) if there are too many rules that are about what positions
qualify (not about position sizing or add-ons), I think that is a bad sign. I
think over about 6, I would start to get worried. It only makes sense. Imagine
if you made a system and it worked most of the time. Then you start adding
rules until the performance data looks great–that is how systems become over
optimized. 2) If there are any strange rules in there, such as, “never take
trades in October‖that is something that the creator just put in to make
his/her numbers look better. Be aware of these two things.
Eddie: Do you ever get
tempted to second guess your system and overrule a decision that has been made
by the rules?
Steven: At times I
do get tempted to over-ride the system, but very, very rarely. Once in a while,
if you understand the essence of the system, you can see that a position just
barely didn’t make a cutoff requirement–in rare instances I will still execute
the trade especially if I know that I may not be able to conveniently be at my
computer on the next trading day.
Eddie: Can you imagine
having to overrule your system if there is every a major world event that has
major repercussions in the marketplace?
Steven: This is
something that I have really thought of. What would happen in this scenario is
that I wouldn’t be over-riding my system; the market would intrinsically be
over-riding my system of position sizing. Let me explain. I choose my position
size based on the recent volatility of the equity. If suddenly there was a
massive explosion in the volatility of the positions, I would essentially have a
bunch of positions that were way too big. So, the answer is that if there
was a sudden swing in volatility that was so large that most of my positions
became 1.5-2.0 times too big, I would right my account, adjust exposure to the
appropriate size and continue trading my systems. But, I do want to point out
that I don’t think that one’s daily trading strategy should be based on
protecting yourself from these once-a-decade market moves. I think that you
should be aware of what you will do, but you can’t paralyze your daily trading
activity waiting for a disaster (a few people have asked me about this).
Eddie: Do you think it’s
possible that the systems you use will ever lose their edge? If so, what
safeguards do you take to minimize the damage that a string of consecutive
losses might cause?
Steven: Yes, I am
concerned that any system I trade will lose its edge. The question is, how do
you know when that happens? Is it after 1 year, 2 years, or is after a
percentage loss 30%, 40%? I’ve decided that once a system performs at a level 2
standard deviations below its mean performance, it is very suspect. That should
only happen by random chance 2.5% of the time. So, if it performs 2 standard
deviations below the mean for 1 year, I will allocate 1/2 of my account risk
that I was giving that system the prior year (so reduce exposure to that
system). If the system performs in that range again, I
would abandon the system. I will move on.
Eddie: What sort of money
management strategy do you follow? You trade so many different types of
vehicles. How do you determine what the maximum position size is and what the
maximum portfolio risk is?
Steven: The way I
try to control for this is in my account (because it will happen) is by trading
multiple different systems each with only a certain amount of risk allocated to
each system. So when one system starts to fail, hopefully the others will
continue to perform well. Another criteria, I look for in a system, is how it
performs relative to other systems I trade. Meaning, I want the systems to be
out of phase with each other. When one is doing poorly, they all shouldn’t be
doing poorly, at least historically.
Eddie: How do you relieve
stress? What kinds of outside activities, if any, do you enjoy outside your work
and trading?
Steven: During my
free time, I like to spend time with my family. I also love to surf, run,
swim and travel. All of these things really relax me.
“…Giving yourself to people and making an impact in someone’s life is the
ultimate rush…”
Eddie: What’s your
long-term plan as a trader? I heard that you want to trade full-time
and help Third World countries.
Steven: I love
medicine and I love the markets. I would like to separate medicine from money
as much as I can. If I could generate enough money from trading, I would like
to spend a lot of time with my wife practicing medicine in developing
countries. There is something wonderful about the idea of practicing medicine
with less importance on billing/legal issues. Right now these issues are
important to me because I support myself with my profession. But I’d like to
move in a direction where I could support myself more from my trading and do
medicine just to help others. My wife feels the same.
Eddie: How will you know
when the time is right to quit your job so that you can trade full-time?
Steven: I don’t
ever see myself giving up medicine – the glory of life for me is not just making
money…yes, I love the markets – I love the mathematical puzzles of the markets
and the daily challenges it brings, and if it makes me rich, great! But the real
glory for me is when I make a real connection with another human being – and
being an emergency physician gives me a unique opportunity to help people in
their most vulnerable states and I love helping people in these moments. Giving
yourself to people and making an impact in someone’s life is the ultimate rush.
The market is, in a way, just the little boy in me who is really very passionate
about mastering “The Great Game.”
Eddie: Steve, we could probably go for another five hours, but I know
you have to get some sleep. I want to thank you for joining us today!
Steve: Thanks Eddie,
it’s been my pleasure.
Editor’s note: Do you have any questions or comments about my interview with Steve? Or, are you
interested in appearing in the Big Saturday Interview? If so, please feel free
to email me at
eddiek@tradingmarkets.com.