Ed Seykota, The true trend-following trader
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Thread: Ed Seykota, The true trend-following trader

  1. #1

    Ed Seykota, The true trend-following trader

    Part 1. Biography

    Edward Arthur Seykota was born August 7, 1946. he’s a commodities trader, who earned S.B. degrees in Electrical Engineering from MIT and Management from the MIT Sloan School of Management, both in 1969. Ed Seykota resided in Incline Village, Nevada, on the north shore of Lake Tahoe, but recently moved to Texas. he is a American-born Dutch commodity trader. in studying to get knowledge and trading methods, Ed Seykota is a self-taught person who learns from experience. it emerged that back in the 1970’s, he conceived and developed the first commercial computerized trading system for managing clients’ money in the futures markets.

    as a teacher and trading mentor, his students have now become powerful and well-known traders, including Michael Marcus, David Druz and Jason Russell from Salida Capital. Seykota's most impressive achievement was being able to develop client funds from $5,000 to $15,000,000, or around 300,000% within 12 years. although he's known as the greatest commodity trader of all time, Ed Seykota has always kept a low profile and a humble person in his life.

    Part 2. Career

    he began his trading career in the 1970's when he was hired by a major brokerage firm. it was there that Ed developed one of the first commercialized trading systems for managing money in the Futures market. after a few disagreements regarding the way management was interfering with his system, Ed Seykota decided to go out on his own. in the middle of 1988's, he was able to make one of his client accounts which was started with $5,000 in 1972 increased around 300,000% on a cash-on-cash basis. if we normalize for withdrawals with today's current values exchange, the account would have been up for several million percent. Ed Seykota is a commodity trader who in 1970 pioneered a computerized trading system, which now it’s known as Trading System for the futures market for the brokerage house where he and Michael Marcus were working for. however, Ed Seykota is reluctant to take on new clients. he once said:

    much of Ed Seykota's success was attributed to his development and utilization of computerized trading systems to which he first tested on a mainframe IBM computer.

    later on, the brokerage house he had been working for adopted his system for their trades. his interest in creating a computerized system was spawned after he read a letter by Richard Donchian on utilizing mechanical trend following systems for trading and also Donchian's 5 and 20 day moving average system. he was also inspired by the book Reminiscences of a Stock Operator by Edwin Lefèvre.

    his first trading system was developed based on exponential moving averages. Ed Seykota improved this system over time, adapting the system to fit his trading style and preferences. with the initial version of the system being rigid, he later introduced more rules into the system in addition to pattern triggers and money management algorithms. another aspect of his success was his genuine love for trading and his optimistic demeanor. this factor sustained his efforts to continuously improve on his system although he never changed the response indicators of the system and instead fine tuned market stimuli. an example of Ed Seykota's exponential moving average can be seen from chart below:

  2. #2
    Part 3. Trading rules

    those are truly staggering results. keep in mind that those figures spanned more than a decade of trading, so this wasn't a fluke or some lucky win streak. what follows is a rather detailed explanation of Seykota’s 5 most cherished trading rules. it includes some of my own explanations as well as the quotes from the man himself.

    Rule number 1: Cut Losses
    i’m sure you've heard the old advice about cutting losses and letting market moves to leave us. it’s been explained countless times over the years. but do you know the reason why? of course it’s true that every traders must have the responsibility to keep their account safe so they can produce more profits later from correct trades. another reason why Ed Seykota’s first trading rule is to cut losses is because of protecting our own capital is our primary job as a forex trader. making money comes second.

    i'll add one thing to Ed’s trading rule. instead of simply saying it's to cut losses our trades, we can also change or modify it to cut losses early. think about it, without money, you can’t trade. so if you fail to cut losses early you’ll eventually blow your account and make us do nothing with market since there's no more margin left to trade. once we do this, well, it’s game over. here’s some advice from Ed Seykota on losing:

    "Embrace trading losses."

    simple yet so true. to get ahead in this business, you've got to learn to lose like a winner. that means accepting a loss the moment the market invalidates your trade idea. if you make the mistake of hoping for the market to turn around in your favor, you’ve already lost. the best way to embrace trading losses is to have a plan. combine that with small bets and you’ll be lightyears ahead of other Forex traders. if you can’t take a small loss, sooner or later you will take the mother of all losses.

    anyone who has traded for more than a month can relate to the quote above. we all have at least one story that involves taking a significant loss. and if you have been trading for years, you likely have several stories to tell. i certainly do. the takeaway from Ed Seykota’s advice is straightforward. either learn to handle small losses or risk blowing your entire account. if you can’t do the former, the latter is inevitable. losing a position is aggravating, whereas losing your nerve is devastating. this quote goes hand-in-hand with the last one. what Ed is saying is that it’s okay to take a loss. although they’re never pleasant, losses are part of the business. what is never okay is losing your nerve. the best way to ensure you never lose your nerve is to cut losses early. it’s one of the simplest ways to maintain your discipline and avoid emotional decision-making.

    Rule number 2: Ride Winners

    cut losses and ride winners. that’s according to Ed Seykota and just about every profitable trader i have ever talked to or studied. there’s a reason why i recommend a favorable risk to reward ratio. it’s because your winners have to pay for your losers. you see, trading isn’t about having a win rate of 70% or 80%. it comes down to how much you make when you’re right and how much you lose when you’re wrong. that’s the only thing that matters. everything else is trivial. allow me to expand on this idea for a moment. each one of the names listed below is a multi-millionaire (or billionaire) trader or investor:

    Bill Lipschutz
    Paul Tudor Jones
    Ray Dalio
    Warren Buffet
    Carl Icahn

    i’m sure you have heard these names at least once in your lifetime. most likely they have come up over and over again in your search for consistent profits. no two market players above are the same. they each have a unique style and differing opinions about the markets, technicals vs. fundamentals, and even risk management. however, they all share one incredibly important rule. can you guess what it is? they all require an asymmetrical risk to reward ratio. that’s a fancy way of saying that the rewards must vastly outweigh the risks. the only way to achieve asymmetrical returns is to ride your winners. it’s great to know that you have to ride your winning trades. but how exactly can you do that? knowing you should do something is one thing. knowing how and having the discipline to see it through is another matter entirely.

    Rule number 3: Keep Bets Small

    one of the best ways to keep emotions at bay while trading is to keep bets small. if you risk too much on any one trade, fear and greed will surely find you. here is how Ed Seykota manages to keep his bets small:

    "Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth."

    notice that his risk per trade is less than 1% of his account balance. this allows you to endure losing streaks without losing your account or your nerves. however, he also defines a percentage of his liquid net worth. this includes cash and other assets that can be readily turned into cash. as his rule states, he’s only allowed to speculate (using his trading account) with less than 10% of his liquid net worth. why is this important? because it drives home the importance of trading with disposable income. in other words, risking money you don’t need for rent, utilities, groceries or other necessities.

    i wrote about this concept, which is often referred to as trading with risky money. when you combine all of Seykota’s rules, you will see that there is no room for trading with risky money or risking too much of your account balance. that’s a winning combination if you ask me. he also coaches us to, risk no more than you can afford to lose, and also risk enough so that a win is meaningful. i have also written about the idea that a win must be meaningful. what’s interesting is that i didn’t see Ed Seykota’s comment in Jack Schwager’s book until after i’d already written a lesson on the topic. if you want to get ahead as a forex trader, you have to strike a balance between risking too much and not enough. risk too much and fear will take over. what’s worse is that you stand a good chance of losing your nerve and ultimately blowing your trading account.

    but here’s the thing, if you don’t risk enough, that setup that you waited two weeks for won’t produce a meaningful profit. when that happens, it’s easy to begin overtrading because you feel that the reward isn’t worth the wait. the solution is to risk just enough that a profitable outcome is meaningful but not so much that a loss forces you to lose your nerve.

    Rule number 4: Follow the Rules Without Question

    trading rules are vital and Ed Seykota knows it. whether it’s a rule that defines how much you’re allowed to risk or what you’re supposed to do during a losing streak, trading rules are critical to your success. i won’t get into the specifics of Ed’s rules because the truth is he and i are very different. he uses a trend trading system whereas i trade price action. more to the point, most of his rules are proprietary and are therefore not publicly available.

    however, we don’t need to know his rules to know that they’re an important part of any trading style. as traders we live in a world without many boundaries. you can put on and take off trades whenever you like and risk as much or as little as you like. you can trade the EURUSD, GBPUSD, AUDUSD or any other currency pair your broker offers. now, compare that to the rest of your life. when you get in your car to drive somewhere, you can’t just do whatever pleases you. there are rules of the road that serve as boundaries to what you can and cannot do. the same applies to your job. chances are you can’t show up and leave whenever you want. your boss also expects certain work to be done within a specific period of time.

    these boundaries are everywhere in life. except for trading. When you sit down to place a trade, nobody tells you how much to risk or whether to buy or sell. it’s all up to you. this is why trading rules are so important. they help keep you disciplined in a world without many boundaries.

    Rule number 5: Know When to Break the Rules

    this may sound counterintuitive to what we just covered. after all, we just discussed how important it is to follow the rules. now you’re supposed to break them? yes and no. Ed Seykota does an excellent job explaining why a balance between following rules and breaking them is so important. here is what he has to say about breaking rules:

    Sometimes I trade entirely off the mechanical part, sometimes I override the signals based on strong feelings, and sometimes I just quit altogether. If I didn’t allow myself the freedom to discharge my creative side, it might build up to some kind of blowout. Striking a workable ecology seems to promote trading longevity, which is one key to success.

    in other words, gut feel is often just as important as your trading rules. i will admit that gut feel and intuition are learned. nobody is born with the ability to predict a market’s likely path forward by intuition alone. it’s something that comes with thousands of hours of screen time. one thing that struck me the first time i read the passage above is the part about quitting altogether. what is Ed Seykota referring to here? he’s saying that if something doesn’t feel right, he stays on the sideline regardless of what his rules are telling him to do. this is a key observation. as i remind this many times before that your first job as a trader is to protect your capital and that’s precisely how Ed uses his intuition.

    here's the 3 favorite quotes that i like most from Ed Seykota:

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