Manuel Ochoa: Part II
TradingMarkets.com co-founder and hedge fund star Manuel Ochoa continues his conversation with Marc Dupee. In Part I of this March interview, Ochoa describes his macro style of discretionary and systems trading.
Marc Dupee: What would you say now about the bonds? The bonds have been breaking out to new highs for the year–highs both in the 10-years and 30-years–this week, despite bearish undertones (for February 2000). The bond markets rallied in front of the FOMC meeting. Is this a case where bonds haven’t been discounted enough or what has been your analysis of this?
Manuel Ochoa: Basically, the most important thing is that the bond market right now is betting that Fed is going to be able to slow down growth rate. That the brakes have already been put on. That the car is going to start slowing down even though it hasn’t started slowing down yet. The rate hikes have already taken place. Around the next corner, the economy is going to start slowing. That’s why the bonds are going up. You can’t see the effects now but you will be able to see them sooner rather than later. So the guys who are following this are starting to buy bonds. They’re not going to wait until it’s obvious that the economy is slowing down and then buy bonds because by that time all the guys that took the risk by betting before that, know the price will already be up a lot higher. So they’re buying now because they’re anticipating that the economy is going to slow down. There’s a contra-anticipatory process going on here. They’re not going to wait for the first report to come out showing that the economy is starting to slow down. They’re not going to wait for that. I mean they will, some people will wait for it but the guys that really get good prices, the bond managers, are the ones that are buying now. They have been buying.
Dupee: With the four-day rally in the bonds, you’re still short.
Ochoa: Yeah, I’m still short because I just think that before the Fed meets, we’re going to get a pre-Fed selloff and there will be some doubt. A lot of times rumors go around, oh you know, that the Fed is going to hike 50 basis points. So the fact that we already broke out to new highs today, which is bullish on an intermediate-term basis, I’ve seen this pattern a lot that before the Fed meets, you could get a selloff. But it’s just a short-term selloff. I’m not looking to make a fortune on this trade. So that’s basically the strategy there–along with just being overbought. On a short-term basis, bonds are overbought. There’s a lot of complacency out there. And also, you know, I think the S&Ps will pull back a little bit. I think that sooner or later we are going to see signs that the economy is slowing down when the Fed rate hikes start taking effect. That’s the main reason, basically. Also, on a technical basis, you can’t argue with the price action. Bonds are in an up trend. That doesn’t mean that you can’t go short in periods of intermediate-term up trend. There’s a lot of great opportunities to trade both sides.
Dupee: Getting back to your stops, do you ever use a percentage loss of your portfolio as a stop-loss level. Is that ever one of your rules?
Ochoa: Down a certain amount? Yes, if I ever lost more than 10% in one month, I would probably shut down for a month. That’s never happened to me.
Dupee: That would probably be over several trades, but do you have a percentage loss rule for any one trade?
Ochoa: Yes, I usually don’t like to risk more than 2% on any one trade.
Dupee: What about on the upside, do you ever average up when things are going your way?
Ochoa: Not usually, no. I usually don’t, because that creates a lot of volatility. Because usually if you’re going to be out, you’re not in a market that’s usually moving strongly in your favor and usually when you get markets like that nowadays, you have these violent corrections in between so if you’re averaging up, I have found that during the last five or ten years, that strategy is not nearly as good as it used to be. There are too many speculators in the market.
Dupee: So what happens?
Ochoa: If you’re averaging up, you get these strong corrections, if you’re averaging up before a correction, you don’t know exactly when it is going to occur, you end up taking major heat. You have a temporary loss on your portfolio You might get out of there, because it keeps going up the day after but you take more of a loss than you’d like to. I’ve got clients that follow their equity on a daily basis. Next thing you know, they’re on the phone, asking me why I lost 3% in one day. I know people that do it, but that’s not my style. I don’t like to trade like that because you’re trading based on having a one-way move and usually it’s not that easy. You always get profit-taking in the interim and even on these strong rallies, you get these strong corrections in the Nasdaq.
Dupee: Then you get hammered.
Ochoa: Yeah, then you get hammered and puke everything during the correction. Then, the next day, it starts going back up again after it got you out.
Dupee: A lot of the stuff you describe is reading the market in terms of gauging the sentiment of the market. Do you have any favorite sentiment indicators that you use?
Ochoa: Not really. I used to look at the put-to-call ratio, but that’s been distorted. You’ve got a lot of hedging going on there. You’ve got a lot of synthetic strategies going on. It’s not a clean measure any more. I wouldn’t use it any more.
Dupee: In one of your articles on the TradingMarkets.com Website, you talk about the shotgun approach and the rifle approach. Can you expand on that a little bit? Which one are you currently trading and why?
Ochoa: The shotgun approach would be the macro approach. The rifle approach would be the micro. The stock pickers are using the rifle, and the macro is for guys like me, that don’t know, don’t have the ability to pick out which companies. I don’t want to know. All I want to know is whether the whole market is going to go up or down and I’d buy a little bit of volatility just to catch the train. You know. It would be great if I could do both, but there’s just not enough time to be able to do both of those well.
Dupee: Can you give us a feel of what you do, in general?
Ochoa: Most of my clients are institutional clients that are looking for diversification in their already existing bond and stock portfolios. They’re looking for guys who are going to be able to make some money if the market starts going down or sideways. They’re looking for an alternative investment, which is what guys like me fall under. It’s not for somebody who doesn’t have a regular portfolio already. Our clients usually have regular portfolios and they’re looking for something different to kind of round it out more. It’s not usually a good idea to put all your money in something like this first. I mean you could, but those are the kinds of clients I want, you know, large investors, banks or institutions.
Dupee: How did you fall into having banks giving you a million dollars? You’re young, aren’t you?
Ochoa: Thirty one.
Dupee: How long have you been trading this account size? How did you get your start?
Ochoa: I got my start while I was in college in the late 80s. I was a business major at the University of Southern California and I had professors who were were finance professors and they got me interested in how markets work, why they do what they do, and I started from there. Then I started trading and I lost all of my money. The first time I opened up an account with like ten grand and lost all of it. I kind of started learning from there. (Laughs).
Dupee: So what would you do differently today if put back in that same position?
Ochoa: I would have waited a lot longer before risking real money in the market. I just started trading. You’re eager to start. It takes a while before you can have a chance at making money. I would have studied more. I would have paper-traded more, simulated trading. I would have done that a lot more. I was just too eager. Most people start trading with too small of a bank roll. In other words they don’t have enough capital to start trading.
Dupee: What size account do you think somebody should start with?
Ochoa: They shouldn’t start trading unless they have at least like fifty grand. Otherwise, you know, you’re not diversified enough.
Dupee: What would you tell someone new to trading?
Ochoa: To trade a couple different markets for diversification. To have starting capital of at least $25,000. That’s trading like mini contracts.
Dupee: After you lost all of your money, how did you end up getting a bank or institution to give you a million dollars?
Ochoa: I managed to get some more capital and I traded that for like five years. I decided that’s really what I should be doing. Then I just shopped my performance around for a few years after doing it for myself on a small scale. And I got a couple of investors. The more investors you get, the easier it is to get the next one. Nobody wants to talk to you when you’re small.
Dupee: So it was difficult to get your first break?
Ochoa: Yeah, very difficult.
Dupee: Yours sounds like a discretionary trading style. It doesn’t sound like you trade systems in the commodity markets or you don’t follow the fundamental bases. You have a good knowledge of the global macro investing style. Is there any way you can say how you arrived at what is currently the foundation of your trading strategy?
Ochoa: Observation. Testing.
Dupee: Are your systems something you don’t discuss or is there something you can tell us, without giving anything away?
Ochoa: Basically, they’re trend based. Trend-following systems. You’re not trying to guess or make any type of judgment on the market. You’re just kind of following it to jump off the train. Following the economy. There’s nothing special about that. A lot of people use it. The only reason I do that is it helps round out my risk reward portfolio. It helps lower my volatility. I make some money trend trading, but some days when I’m really wrong on my discretionary trading, I’ll make money off my trend trading. I’ve found that they kind of tend to balance each other off pretty well. There’s nothing special about it though. There’s a million guys that do that. I don’t try to sell myself based on that, at all. Anybody can do that. It’s easy.
Dupee: What type of easy trend-following systems are you describing?
Ochoa: Oh, they’re like pre-packaged, man. Just buy Tradestation. They have like 30 pre-packaged ones in there, ready to go: breakouts, RSI, etc., etc.
Dupee: Are there any you think are better than others?
Ochoa: Nah, they’re all based on the same principle. Trend following. They’re just different variations. They’re all trying to do the same thing. Some years one does better than the other, then vice versa the next year. There’s nothing special about it. It’s real easy. The only comment I have about that is that most people don’t have the discipline to follow them. That’s the only thing of interest to say about that. People just don’t follow it. They don’t have the discipline to do it.
Dupee: What is your time frame? Or do you have varying time frames?
Ochoa: Timeframe varies. Shorter-term, longer-term…I kind of just pick a little bit of each one. That’s the best way to do it, instead of being strictly long-term, or short-term only. The problem with that is that you get erratic performance. And if you’re a money manager like me, after a year of not making money, you start losing clients. If that happens, clients start getting impatient and they start leaving. You’re better off making a little bit every year and keeping them.
Dupee: You’re better off varying your time-frame strategy? You get better results. Talking of results . . .
Ochoa: My average annual return is around 20%.
Dupee: What happened differently in 1998 from your much better-performing years when you were up 47%, 27%? What did you learn from that?
Ochoa: In 1998, the problem was I was too…first of all, I started trading tech stocks and the problem was instead of scaling into it, I made the mistake of just piling into it at once and unfortunately just after I started trading them, I went into an immediate draw down. That was the problem. So the moral of the story is that whenever you are going to start trading a new style, instead of just piling in one day, you’re better off taking it piece by piece, in little pieces. In other words, if you find a new system, like for example you trade bonds, and you decide that you’re going to trade 10 contracts per signal, you’re better off kind of easing into it over the course of like six months, you start trading more and more contracts per signal. So at the first buy signal that you get, you might take two or three contracts, and then maybe a month later, you add some more contracts or start trading six lots, instead of starting to trade 10 right off the bat. What happens is that everything is cyclical. You go through up trends in equity and draw downs. I had the very unfortunate luck of immediately going into a draw down. It hurt my performance. That was a learning lesson.
Dupee: Are commissions and slippage a big factor in your trading?
Ochoa: Yes, definitely.
Dupee: Which markets do you find the most difficult for getting good fills?
Ochoa: You know, the thinner markets, some of the smaller commodity markets. And Nasdaq futures. The slippage there is, wow, $500 slippage. It’s real big. And that’s per side. A thousand dollars.
Dupee: Then do you enter with market orders in the Nasdaq futures?
Ochoa: Sometimes, yeah.
Dupee: Why don’t you use limit orders?
Ochoa: Because the contract is so big $1000 doesn’t even mean anything. It is just like the juice you’ve got to pay for the right to play. The contract is a $400,000 contract. One of the worst things you can do is be right and not make any money.
Dupee: Do you trade a lot of these contracts?
Ochoa: No, not really. I’m going to start trading them more. I’ve just been waiting for some more liquidity in this market, but I don’t think it’s going to get more liquid.