Mark Boucher: The Midas Touch

The trading industry is full of great stories. Fortunes made, fortunes lost, big money and big egos make for a colorful business filled with a long list of legends and tall tales.

Trader Mark Boucher’s story is no exception–and it’s true. His Midas Trust hedge fund, which he’s been managing since 1992, was recently ranked number one by “Nelson’s World’s Best Money Managers” for its five-year average annual return of 26.6%. But Boucher’s success as a hedge fund manager is only one part of long trading career that started with a bang when he was still in high school.

After a $100,000 trust that had been set aside in a “nifty fifty” fund for his future had dwindled to $10,000 as the stock market crawled to its 1972-1982 bear market lows, Boucher, age 16, decided he needed to learn something about the markets. (He compares the star-crossed nifty fifty funds of the day to today’s NASDAQ 100, by the way.)

“That’s how I got interested in investing,” he says. “I figured out I had to make that $10,000 go an awfully long way if I wanted to go to college.”

So he hit the books, trying to learn everything he could about the markets while saving money from odd jobs. When he felt he was ready, he took the plunge–with some remarkable results. He inaugurated his trading career by putting his nest egg almost entirely into call options on gold stocks at the beginning of the gold bull market in the late 1970s, turning $3000 into around $50,000 in six months or so.

It was pretty heady stuff for a teen-ager, but it didn’t last for long. Emboldened by his initial success, Boucher turned to increasingly risky trades in commodities, quickly giving back half his profits before realizing he’d been “fairly lucky” the first time around.

He had some amazing moments, though. The day gold hit its peak around $850, Mark Boucher, at age 18, was a millionaire on paper, but the market immediately went limit down, and by the time he was able to extricate himself from the trade, he was left with a $20,000 profit. Such wild successes and equally eye-popping failures were typical of his early career, but it was not the way to build a future, Boucher knew.

“I realized this wasn’t the way to do it,” he says of his early, volatile forays into the markets. “Basically, I learned what differentiates great traders from good traders or mediocre ones is their ability to make money consistently with relatively low risk. My focus was to figure out what these traders had in common and how I could use it, because I had to have enough money to pay for school, and the wild fluctuations were driving me nuts.”

He majored in economics at the University of California at Berkeley, from which he graduated with honors, and had learned his first lessons well enough to essentially pay his way through school by trading. After graduating, he had enough money to trade his own account full time, and did so successfully, day trading for about a year until it turned into a bit of a “grind,” as he says. Even though he was making a good living, he wanted to try a different approach.

In the mid-1980s, public speaking engagements brought him into contact with other traders who were interested in his work. He embarked on a nearly three-year research project (while continuing to trade) with Stanford Ph.D. and Professor Tom Johnson and others. Using the university’s top-flight research resources (including ample graduate students), they performed a comprehensive study of trading and investing strategies.

The goal: to find out what worked consistently on a risk-reward basis in the markets. They looked at everything–fundamentals, technicals, liquidity cycles. They researched anything that was quantitative enough to be subjected to mechanical testing, using a vast array of markets and time frames to ensure rigorous results

It was not just academic research they were engaged in, though. When they realized the strength of some of the trading ideas they developed, Boucher and some partners decided to put to them to work in the markets, starting a fund in 1989 that they traded until 1991. In 1992, Boucher started his current funds, Midas Trust and Midas High Yield Trust. He describes them as “global asset allocation hedge funds” that cover a vast number of array of asset types.

Mark began by describing the kinds of trading approaches he developed through his research and what drove them. His basic principles are straightforward, emphasizing market selection to find the best trading opportunities and risk control to make the most of them.

What were the practical results of your research in terms of the kind of trading approaches you developed?

We came up with many different models–for equities, commodities, currencies, bonds. Even though all the models weren’t necessarily technical, they almost all had a technical aspect–a price or quantitative base-as a screen. One thing we found by analyzing a lot of good fundamentalists, it seemed that their performance was held back by the fact that they had large positions in things that just weren’t moving for long periods of time. Applying a technical screen can really help improve that type of approach.

What were the basic principles these models were founded on?

One of the things we found about traders who did well consistently, was that there were many people–like a Peter Lynch or a Warren Buffet–who would have extremely good performance when their asset class was doing well, but they would do very poorly when their asset class wasn’t doing well. People don’t realize that Warren Buffet had 50 percent declines in his portfolio in the 1970s.

That wasn’t the type of performance we were looking for. The people who were more consistent regardless of the environment were looking at a much broader of asset classes than just one or two. That’s why I look at such a wide variety of markets for trading opportunities.

It’s a multi-layered approach. I use a number of different models–ones that determine which asset class to emphasize, others to determine how to profitably invest in those assets, and then different types of timing models.

What would you say is the defining characteristic of your trading approach?

I try to ‘cherry pick’ the easy part of a price move. You know, you can have the first 30 percent of a move and the last 30 percent of the move, all I want is the safe 40 percent in the middle.

I trade when technicals are very strong, when liquidity analysis points in the direction of the trade, when there’s good valuation and good relative strength–in other words, when a number of things are suggesting a particular trend will continue. And as soon any of these start to melt away, I reduce my position. That doesn’t mean the move is over, it’s just that my goal is to find the safe part of the move.

What kind of time frame do you like to trade in?

I operate on multiple time frames, but most of my positions are at least multi-month. But my models can also help me zero in on markets to trade on a short-term basis, as well. I do some day trading, for example, although it’s not my primary focus.

What do you think is the most important aspect of successful trading?

The most important thing is to think about risk in addition to reward. It’s a problem most investors are going to have to come to grips with in the next couple of years. Right now, the average investor is focused on return and not even thinking about risk. But over the long term, risk is more important than the type of return you’re trying to get. You can have a 50 percent return one year, but if you have a 30 percent decline the next year, you’re not going anywhere.

Most investors right now are using the buy-and-hold philosophy, thinking the market is going to go up forever. I’m much more comfortable using some kind of timing model to help potentially take away the risk of negative periods in the market. By doing that, you can create long-term performance with the same sort of return as a buy-and-hold approach, but with much lower drawdowns-lower risk.

As far as I’m concerned, that’s the way the typical stock market investor should be approaching the market. They need to be more cautious about avoiding negative periods, especially in the market environment I think will evolve over the next five years.

The bottom line is, using a timing model can help investors sidestep some of the negative market periods. Sometimes that means you’re not participating in an up move, but what you’re really looking for in investing is the best return you can get with the risk you can handle.

What do you think qualifies as a good risk reward ratio?

For a good manager with a ten-year track record, an average annual return the same size as the maximum drawdown over that period is very good performance. A fantastic manager might have a return of three times drawdown.

We’d lose a large percentage of our client base if we had a 20-percent drawdown. Our largest drawdown was around 8 percent, and our average annual return is in the 30s. Basically, we’re trying to keep drawdown below 15 percent and have average returns that are at least that high.

Besides risk control, are there any other basic, effective concepts you think most traders tend to overlook?

The other things investors could do is look at the short side as well as the long side, and think in terms of “paired” hedging opportunities, where every time you’re going long one market, you’re going short another-long Dell and Gateway, instead of just long Dell, for example.

Also, most investors are not very prudent about stock selection. I have many criteria for selecting stocks on both the long side and short side of the market.

So, what attracts you to a particular trade or market?

In equities, I’m looking for stocks with good relative strength and good earnings momentum, and I also apply some value criteria-ideally, stocks selling at 70 percent or less of their expected growth rate or past growth rate, and stocks with still-accelerating earnings. They should also be leading technically-breaking out of trading ranges, for example, where I can go in and establish a relatively low-risk trade, placing a protective stop below the low of the trading range.

In the futures markets, I do a lot of sentiment work, including Fibonacci timing and volume accumulation–I like to have a lot of different tools pointing to the trend I see developing.

Would you describe yourself as a mechanical trader?

I have many mechanical systems, and I trade some of my money with them, and I also try to put a lot of them together to smooth out performance, but I also try to look at the bigger picture and improve performance by using my brain. Even deciding how to blend and apply mechanical systems can be a discretionary process.

There are times, for example, in the commodities markets, when you can see the economic environment is shifting in a particular direction globally. Right now the commodity market trends are still down, and the leading economic indicators of every country except the United States are basically turning down–so there’s still a likelihood that you’ve got a trend in force, and you can probably say that you’re either going to trend down or experience a fairly sharp shift into an uptrend. So, you could conclude that trend-following models in the commodity markets should be working fairly well, and you’d use a mix of those.

You’ve mentioned that much of your trading is longer term. Can you shed some light on your shorter-term ideas?

The things I’ve got on TradingMarkets.com are more short-term. First, there’s the Top Relative Strength and Earnings New Highs list, which contains stocks with strong relative strength and good earning per share, among other things, that are making new highs. It shows which stocks are “running away” and would be good candidates for long trades.

We can look at these everyday so we don’t miss a breakout in a stock with strong potential. It also allows us to pick stocks where can go to an intraday type pattern and get in on a breakout move with much lower risk.

I’ve also got a corresponding list called the Bottom Relative Strength and Earnings New Lows list, which shows stocks with low relative strength and a low earnings per share rankings that are making new lows. So, if we start to get worried about the market environment, we’ve got a list of stocks with negative criteria making new lows. It’s useful to constantly have a list of stocks like these to hedge our portfolio on the downside, or go net short.

Many times you can compare the New Highs and New Lows lists and find stocks in similar industries and identify short-term trading opportunities on the long side in one stock and on the short side in the other stock–the kind of paired hedge opportunity I talked about before.

You’ve based you trading on your own unique research and testing. How do you feel about most standard technical indicators?

I think the majority of technical indicators that many investors look at are not valid. Most investors are so focused on finding some holy grail trading indicator that they ignore basic approaches that work, as well as basic money management.

With most indicators you read about in books and magazines, some guy explains how to use them and shows a few examples–and usually in the examples you can find instances for which the indicator didn’t work. When you actually make these things mechanical and test them, you find that most of them don’t even make money. Unfortunately, investors are spending most of their time looking at things that don’t work.

The most important things are really pretty simple. Risk control and market selection–those are the things traders should be paying attention to.

Mark Boucher’s Top Relative Strength and Earnings New Highs list and Bottom Relative Strength and Earnings New Lows list are available in Hedge Fund Managers Corner.