Trader Vic Returns (Part II)

In Part One of our interview with Victor Sperandeo, we talked about his S&P Diversified Trends Indicator, the cyclicality of commodities and the pursuit of consistent superior returns (“alpha consistency”) as opposed to the sort of outsized returns typical of commodities trading. In this second half of our conversation with “Trader Vic” we listen to his advice about the value of trading systems, how to choose which futures to trade, and what it takes today to successfully day-trade the S&P futures market.

If you missed the earlier conversation with Victor Sperandeo, click here for Part One.

Penn: For somebody who is interested in that “pure skill” trading you talked about earlier, someone looking to trade individual futures, who was just starting out – where would you direct this person? How does someone start trading futures?

Sperandeo: Well, I mean the first thing we do is get some books that will help educate you. And if you’re saying how do you start, meaning getting some money to go ahead and do it, there’s not a great deal required to trade futures and you can certainly start with a small amount of money, relatively speaking. Various firms have various minimums…

But if you were a young person and you really wanted to gain the best experience, you’d go down to the Loop in Chicago and you’d go to the floor of the Exchange and you’d apply for a job! You’d get a job on the floor and basically learn from that.

The greatest experience is definitely working on the floor. But, yes, you can open up a small account, read some books, and you can try the paper trading first. And then if you’re successful on paper, then you could try real trading, which is a little bit of a different dimension.

“Systems value because the problem, when it comes to money, whether it be in stocks or it be in commodities or anything, is that people are emotional.”

Penn: Should new futures traders rely on systems or try discretionary methods and set-ups?

Sperandeo: Let me tell you why systems have a value. They have a value because the problem, when it comes to money, whether it be in stocks or it be in commodities or anything, is that people are emotional. And this is also the case when it comes to food. That’s why people have such a hard time losing weight. And for the most part, it also has to do with sex. We just do the wrong thing sometimes.

Generally, when you’re dealing with human beings, you have emotion that runs counter to logic. And one of the good things with systems is that they keep you grounded to discipline.

You know, intelligent people are losers (as traders) because they tend to be seldom wrong. So they tend to overstay their welcome if something is going against them because they’ve been right so many times in the past.

And like everybody else, they ride with the wind. If they,re making money, they,re happy, they sound like “oh, it’s good that it went up!” And if it goes down, it’s bad. Well, that is the most novice mentality you can have in any kind of money management business.

Making money and losing money is really the same thing in this game. The key is that when you win, you should win more than when you lose. Losing is not bad. Losing big is bad.

Penn: And this is where having a system comes in?

Sperandeo: If it’s designed properly, it’s what keeps you out of losing lots of money. That’s what hurts you in this business, losing peak money. You know the firms that blow up. There’s really only one major reason: that’s leverage. That’s the primary reason. But in order to lose with leverage, you’ve got to be wrong. So they should never lose a lot. If you’re using leverage, then you’ve got to take smaller losses, right?

But in general, systems are good because they can perform to execute disciplines. And that’s kind of the bottom line of why systems work well in the commodity business, because people are tempted to take profits. You know the markets are up. I mean you hear this all over the place. Gold is high. Well, maybe it’s high. It could be halfway to its goal.

By the way, there’s a high correlation between gold and oil. Just for the record, if anybody wants to run the correlations, its about 85 to 90, which is almost like T-notes and T-bonds. A bit higher, but it’s a very high correlation. So in order for gold to be like oil, gold would have to trade at about $1,600.

Penn: Good grief!

Sperandeo: So in some respects, it’s not high at all. It’s still got 50 percent to go. But most people will look at it and say, “gee, it’s turning at 990, or 980, and it used to be $250 in the 1990s and now it’s up here, so it’s high.” So now, what does the system do? It tells you, well, if the trend is up you’re still long, depending on the trend-following process.

The S&P DTI has been a goal for quite some time. And it tells you not to worry about the price. You know, not making a decision of taking a profit because you think the price is high. So you see, that’s where a methodology that is systematized is very helpful to most human beings because they get their emotions involved.

They want to take a profit. You know, it’s kind of like: let me out! I made some money, now give it to me! So they let their emotions act subjectively within the context of the financial world.

“You need volatility because the more volatility, the more ability you have to capture middles.”

Penn: How does a futures trader decide which instruments to trade?

Sperandeo: You basically need two things. We’re talking trading. Not talking long-term investing. You need volatility because the more volatility, the more ability you have to capture middles. And then you need liquidity.

You’ve got to get in and out at a reasonable price when you want to buy and when you want to sell. So those are two things you start out with. You start out with liquidity and volatility. One or the other comes first. It doesn’t matter, but you need both.

For example, palladium is volatile, but it has no liquidity. That’s a bad thing to trade because it has very little liquidity.

Now gold is a very good thing to trade because it has a very respectable liquidity, and it has a degree of volatility. Silver is even better because silver is extremely volatile and it has the liquidity. Platinum is worse than gold. It’s a little better than palladium because, again, is has a lot of volatility but very little liquidity. So that’s how you determine the things to trade.

Penn: Once upon a time you spent many hours day-trading the S&P futures. Are the techniques you used then still valid now, in your opinion?

Sperandeo: Sure. Virtually everything is the same. It’s actually easier to trade today than it was in the mid-1980s because programs became a dominant feature of trading in the mid-1980s and that made day trading very hard. It changed the world.

In the 1980s and 1990s, day trading became difficult because the programs would dominate and you never knew where one was coming from. And you could be bullish for the right reasons and, all of a sudden, somebody would do a sell program and you would lose money. You could still do that today. It’s just less prevalent than it was.

Penn: What were some of the techniques or strategies that you used when trading the S&P futures?

Sperandeo: Well, that would be a long drawn-out answer perhaps. I’d have to give some thought to that… I believe in my second book, in one of the last chapters, I really outline all the things I used to do, and I would only refer to that because there are so many different things that one has to see and do.

Penn: Maybe from a broader perspective?

Sperandeo: The most important is news of the day, because news affects short term price action a great deal. So these numbers that come out, any economic number that comes out affects the markets in the short run. Most of it is all noise and doesn’t have any meaning to the intermediate trends or the long-term trends.

But the short-term trends are important. So someone would have to know what’s going on in the news, and know what the expectations are. For example, if the CPI (Consumer Price Index) core rate is expected to come out at .02 of a percent, and it comes out as .04, somebody has to realize that that’s a bad number, and it might indicate higher interest rates under normal conditions. And, therefore, tightening by the Fed, therefore the market sells off. And so, to be a short-term trader, you have to act very quickly and sell either short or your longs, as you will lose money.

“Texas Hold ‘Em teaches you to fold a great deal of the time, and lose quickly, and lose small. And that’s why it’s a great teacher because, really, trading futures is like that as well.”

Penn: You talk a lot about losing. The importance of losing and the ability to understand the implications of losing as a trader. You’ve compared it in the past to the lessons people can learn from playing games like Texas Hold ‘Em…

Sperandeo: Well, the lives of the “trader” – as opposed to an investor – involve making many, many decisions. And naturally, the more decisions you make, you’re going to be wrong a great deal of the time. That’s because they’re rather quick decisions and not analyzed as ably as, let’s say, more important decisions you might make on bigger investments. So most people just don’t like losing. And so it’s hard for them to take a loss.

And in poker, Texas Hold ‘Em in this example, teaches you to fold a great deal of the time, and lose quickly, and lose small. And that’s why it’s a great teacher because, really, trading futures is like that as well. You have to lose quickly, and small, many times.

If you are trading objects unto themselves, like the S&P futures, or you want to trade gold, or silver, or grains, you’re focused on that group, if you will, or that object. And you know you’re going to be right and you’re going to be wrong. And the quicker you realize, to get out of a bad position, the more professional you are and, also, the longer you’ll be in business.

Penn: Certainly. And that’s the game, on balance, that you have left behind in your pursuit and development of the S&P Diversified Trend Indicator.

Sperandeo: With the DTI, it’s just the nature that the base of the concept is very valid. It makes very conservative returns over time, and it completely throws out of the water the idea that commodities are a no-win game, a zero sum game, a volatile game, a game you can lose all your money in. I mean it completely throws that out because it’s just a different way of using futures, if you will, and commodities, and getting in sort of an investment portfolio, rather than an aggressive trading picture.

Penn: Undoubtedly. Mr. Sperandeo, thank you very much for giving us some of your time this afternoon. It has been a pleasure speaking with you and learning about what you have been up to with the DTI and commodities over the years.

Sperandeo: Thank you. I appreciate your time as well.