281: Marsten Parker - The Purely Systematic Wizard Trader

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And I experienced how addictive it could be to get you know, I just like keep keep wanting to put on a trade and and see what happens. It's just like a slot machine, really. You know, you get a dopamine hit from the winds and then it makes you want to just put on another one right away. And risk. Yes, that's right. This is Chat with Traders episode 281. Hey traders, this is Tessa. What's going on?

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Before we introduce our guest today, please allow me to take a few minutes to do a quick shout out to our Chat Witch Traders community members. For those who don't already know, recently we made the difficult decision to close the online chat with traders community. When we launched this space back in November 2022, we wanted to create something truly special and different.

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Now, I am excited to introduce a special guest. Today, In speaks with Marston Parker. Starting in classical violin and computer programming, Marston's path took a transformative turn when he ventured into trading. Despite a rocky start, his disciplined, algorithmic driven approach led to consistent returns earning him recognition in Jack Schwager's unknown market wizards.

We get to learn about his transition from discretionary trading to systematic trading and emphasizing the importance of statistical analysis over emotional decision making. Marston used his programming skills to create fully automated trading systems to take advantage of breakouts, mean reversion, and IPO opportunities and other strategies.

Also please note this recording was made before the sad news of Jim Simon's passing. Ladies and gentlemen, we are so pleased to present Marston Parker from Massachusetts. Well Marston, welcome to Chat With Traders. Thank you. Where are you calling from? I'm in Reading, Massachusetts, which is about twelve miles north of Boston. Yeah, it's great to be here. I actually um had been in touch with Aaron Fifield about ten years ago during the first

days of the show and uh almost came on then, but I didn't have any kind of online presence. So I thought, no, I don't think I'll do that. So better late than never. Yeah, well, um, you you happen to be fortunate enough to be the only purely systematic trader whose performance over the decades was sufficiently superior to make it into the book Unknown Market Wizards by Jack Schwager. How how did you get known to him? Yeah, I mean,

I I have a feeling there are probably a lot of systematic traders with better performance but who just uh w weren't known to him or weren't interested in being in a book. But uh I I was lucky enough to be recommended. I didn't know he was making a new market wizards book at all or or seek to be in the book. I've had been uh I'm still a member of a community online called Stock Bee.

which I joined in twenty thirteen, I think. And the the fellow who runs that community, Kradeep Bond, somehow was in touch with Jack and was let known that Jack was looking for people for his new book and recommended a couple of different people, uh including me. Uh the the others who he recommended declined to be in the book, but I agreed. Uh so that's how that happened.

Uh, and then of course, as as usual in Market Wizards I had to send Jack all kinds of documentation about my track record. Luck luckily I had um, you know, all my old brokerage statements going back twenty years. So uh So that was fine. Uh and and as he wrote, uh my stats were really just barely qualified me, but Somehow he decided to put me in. So here I am.

Oh, great. Great. Thanks. Yeah. Let's dive into your background. Um, kind of where did you grow up and uh what were your early interests in life? Yeah, well I grew up uh here in the Boston area. As a teenager, I had two main interests, uh classical music and specifically violin, and computer programming. Uh and they they sort of competed for my attention throughout high school. And I ended up

deciding to to try to pursue a career in music. And I went to a conservatory in New York City and and studied classical violin. But this was the early eighties when the personal computers were just being introduced in uh Uh and I got one. And so I ended up spending more and more of my time while while in school coding and less time practicing violin. So by by I graduated, but it was clear that

I wanted to go in the computer direction by the time I finished. Uh so I moved back to Boston, took a job at a computer store and then uh eventually uh found employment at a at a software startup uh in nineteen eighty four and um Uh yeah, worked for that worked for that company and two other companies. The third one was called Segway Software, S E G U E. And uh they they ended up going public in

nineteen ninety six on Nasdaq, symbol S E G U. And I was one of the earliest employees, so I owned about four percent of the company. So I had some stock and that that's what got me interested in trading. What kind of um uh job did you have at the at the software company that you I was a s I was a software developer, software engineer at at uh th that was my profession from nineteen eighty four through nineteen ninety seven.

Oh wow. Thirteen thirteen years. Uh yeah. And what kind of software did you uh did you write? It was it uh it's I started out working on a uh VAX um mini computers and then s transitioned to personal computers. Um software and it's basically it was tools for other developers. The first thing I built w was was a an editor for a particular programming language that the company offered. Um For a a lot of the latter part of the career I was involved in building tools to support testing of software.

So so our customers would be QA engineers at other software companies. Yeah. Segway's main product was something called Silk Test, which I think was the leading thing in that category for a while. Uh-huh. And uh did you get a lot of satisfaction from uh being a programmer? Um and I did, yeah. Uh yeah, I've always enjoyed building software and having people use the software that I build and uh so that that was satisfying.

Yeah. So the famous Jim Simmons, uh, he was involved in the in the buyout of the company you worked at. Yeah, I think he pronounces it Simons. He um was the third company Segway Software. Uh he was the chairman of the board and the largest investor in that company. He um

At that time in the early nineties, he he hadn't had you know, he had some success in his hedge fund business, but not quite not, you know, nearly as much as he did later. And he was um, or maybe just on the side, he he he had a venture capital fund that So he he was investing in I don't know how many in total, probably five or ten software companies typically, and and we happen to be one of them.

When the buyout occurred, were you itching to retire at that point or were you imagining yourself uh just getting another software job or No, I mean it wasn't so much a buyout, it was a it was an actual initial public offering. So so so I mean the the company did eventually get bought, but that was years after I had left. Um uh so n no, I wasn't really itching to

to to uh to get bothered to do anything. I mean it kind of was surprising when it became a possibility that we could go public. Uh we were a very small company, uh th these days it could not have gone gone public. So but yeah, at some point

The we we went public in the spring of ninety-six and then several months later, uh there was a fairly major correction in the Nasdaq. The tech companies were um were struggling, and um I um kind of g uh got got tired of of uh working there really and uh to to and and I I I just got more and more obsessed with watching our stock and and then started buying books about trading and walk getting involved in other stocks and dabbling with trading strategies and

Just kind of thought, okay, I'm gonna leave for a while and try this as an experiment. You know, I could always go back to that company or get a job at a different software company if I wanted to. But then I I did fairly well fairly soon. Uh, and the experiment went on for for quite a while to the point where it was kind of too late to go back and get employed again.

Any uh books come to mind uh that uh influenced you in in the early stages? One of the earlier books I bought was called Trading for a Living. What's the name of that author? I Is that elder? El yeah, Alexander Elder, right, right. And that I I think just the very title was influential. It just it didn't occur to me that anybody traded for a living until I saw that book. And then I thought, Oh, okay. So that was one uh but also that was just the the time when

Some online resources were first coming available. Uh, like there was a site called thestreet.com that I would read and and there were starting to be some, you know, early versions of kind of like online user groups. I think Yahoo. had a whole bunch of user groups. So I would I would participate in some of those. Oh yeah, there is a site called Silicon Investor, I think that's sort of like I might have participated in.

So I don't know. I was getting inputs from all over the place and getting interested in And trading, so. Yeah. Uh so tell us a little bit about your early trades, your early big winners and and losers, and how how did it go early on?

Well early on, you know, I did some I I I opened a brokerage account and, you know, had my restricted shares converted to regular shares so I could start to sell them and and have some trading capital and and just started dabbling in some there was some I don't remember where I it must have been some other earlier book that I read that uh it was more of a fundamental angle of of like

you know, kind of rotational investing based on things like PE to growth ratio or stuff like that. You know, I s found a way to do some scans for things like that uh online maybe or or with some I think I had a piece of d software on my desktop computer called window on Wall Street or something like that.

So I you know, I d I would just put on a trade because I thought it met some criteria that that I had heard recommended. Oh, and I've I was also watching I think CNBC was a was just kind of getting started at that time. And so I would watch that. I remember my f my first big loser this was in ninety seven when I was still employed in trading on the side. I I heard On TNBC, uh what is it? Herman Miller Company had beat their earnings expectations. So I immediately bought the stock.

Like w like way larger position. It's like, oh I they said it was good on C N V C so I better take a really large position. And and it was one of those sell the news situations apparently. So I remember having a couple of sleep sleepless nights on that one. So yeah, that first year of trading in ninety seven, I I think I ended up losing about fifty grand. And then at the end of that year on that basis, I said, okay, I'll quit my job and trade for a living.

I had no idea what I was doing. Well, I I was starting to get an idea that I could maybe make take a more systematic approach and I was kind of I I somehow got included into the the fact that some people had trading systems and followed them. rather than just trying to, you know, make discretionary decisions and b be right about things.

Which clearly wasn't working for me. I started corresponding with one person who was sharing some aspects of of his trading strategy in a series of articles on thestreet.com, a guy named Gary B. Smith. And we just kept corresponding and became friends and eventually trading partners. You know, so I I I followed his his systematic it was m mostly systematic. There was some discretion in the selection of which stocks to buy or short, but then the exits were a hundred percent mechanical.

Since you were doing this for a living, uh, did you have any expectations as to a targeted annual income or total return goal? I had a general concept of a and and I remember um corresponding with with Gary about this and kind of get doing a sanity check with him of, you know, do do you think I could consistently make twenty percent a year?

And and he said, Yeah, that should be easy to do. I had uh about a million of trading capital. So I thought if I could consistently make twenty percent a year, you know, even a after taxes and be able to have more income than I had from my fr former job and um And maybe even, you know, grow the the account a little bit. So I I I kind of had a goal of being able to grow my account five or ten percent a year after taxes and living expenses.

You know, now I understand you you can't really have a have a income type goal from trading. It doesn't make any sense whatsoever. Uh, you know, it's you're gonna have big swings up and down and so on. But you know, uh compared to many, I think I was I was in a pretty stable situation because I had plenty of trading capital and um, you know, and I also I I had paid off all of my debts, like my mortgage and so on when the company went public. So I had no debt.

Plenty of capital. So and a career I could go back to. So it it wasn't a huge risk at the time. It I I just kind of viewed it as an experiment that I was that I was doing and uh

That book that you mentioned, uh Trading for a Living, um, uh when I looked into that book, it appears to be a book about discretionary trading. Did you kind of set aside those early books that you got into uh and then focus? m more and more on systematizing your approach. Yes, I pretty much yeah, you know, I've gone through a lot of different books and looking for

really clues about how to proceed. And and you know, and I found thing clues here and there, but but like you said, most of them are about discretionary. There there weren't any books there that that said, you know, here here are all the exact rules of a trading system that that's highly likely to work. I mean, I don't even think I don't know when some of the first books about trend following came out. I don't think that there were many yet back then. There may have been.

I I pretty much set that aside and and adopted the method that Gary Smith was was using and then sp gradually tried to systematize that method. Uh in our pre-call, you mentioned that you hate trading. Uh why is that?

Yeah, I mean I may have overstated that some, but I I I don't really have the the person the typical personality of a trader who uh, you know, who who who is kind of enjoys placing bets on things or, you know, likes the challenge of tr of trying to make correct calls about the direction of things of price going or

or anything like that. I mean, I di I do enjoy it and particularly did early on in terms of the as a kind of puzzle of, you know, how can you come up with a strategy that that made money in the past and more importantly will continue to make money in the future. So I en I enjoy the the kind of research and the of that aspect of it, you know, of testing different strategies, trying to come up with ideas and so on. But the actual process of trading, of you know, placing trades and

I mean I kind of I went down that rabbit hole a little bit early on. I I even spent about a month doing very active discretionary day trading in Nasdaq stocks in nineteen ninety seven during that losing period. And I experienced how addictive it could be to get, you know, I just like keep keep wanting to put on a trade and and see what happens.

It's just like a slot machine, really. You know, you get a dopamine hit from the winds and then it makes you want to just put on another one right away and So you know, fortunately I was self aware enough to to s to observe myself in that process and realize that this was gonna be dangerous.

uh slippery slope for me if I continued in that direction. So I I said, No, at heart I'm very conservative. You know, I'm not interested in in losing a lot of money and I'm not I'm not the kind of person who will who will will ever make a big bet on anything. Do you think i if you had beginners luck uh from the beginning, say in nineteen ninety seven, and had good gains early on, would you have still started the process of moving to a systematic Approach.

Um is that just kind of in your nature? Yeah. I think it's in my nature. Yeah. I mean it uh you know, as I mentioned that when I started trading with Gary, we our method was had a discretionary element in that, you know, we'd run a scan. Well not r s not so much run, but get get the investors business daily newspaper and look at the table of stocks that had unusual volume the prior day.

So we would go through the charts of those and he would make mostly him would make some kind of subjective judgment of how the chart looked. and kind of rank them on that basis for for what are the best entries to to take. And and I tried to grasp that what he was doing there and I always found it sort of arbitrary.

I so right away I wanted to um I wanted to be able to test it. And I also wanted to be able to test the exits we were using and see if we could come up with better ones for the given the set of entries we had actually taken. what different exits would have worked better. So yeah, no, e even if I had succeeded initially with the with some of the discretionary type approaches I was doing, I probably would have written code to test it fairly soon.

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As a musician, do you see a link between musical reading and playing skills and systematic trading? But the things I learned from from trying to be a violinist, you know, concentration, ab ability to to stay focused at a task, uh which didn't come that easily to me, but um I worked at it. Th just the discipline of practicing every day. There's there's some there's some overlap there. Yeah, there's a lot of of uh

structure or you might even say system behind behind music, uh, you know, some of which I learned about in school and so on. So you know, there probably make some some connections there. I don't know if it's super specific.

Yeah. So let's dive into your early uh algo trading. Can you share with us a little bit about some of your early algo strategies? Well, you first started off as systematic, right? Were you uh manually entering in uh your orders or how soon did you actually go to an algo approach? So basically from

So I started trading with this Gary Smith in nineteen ninety eight, February nineteen ninety eight. And we were trading one pair of strategies, basic long and short, kind of a symmetrical, uh not exactly symmetrical, but Uh is basically buying breakouts uh with unusual volume or shorting breakdowns and then setting a bracket like a target and a stop and whichever one gets hit first.

Uh and then the the only thing that was a little unusual about that strategy as opposed to classical trend following is that the the stop is larger than the target. You know, and and it's so it hi had a fairly high win rate, like a seventy percent win rate. I think we were using like a five percent

uh target and a 7% stop initially. You know, later I I discovered other ways to measure those things like uh ATRs, but um that's what we were doing initially. And I basically traded th that that exact system, those two s that one pair of long and short strategies, just with minor variations all the way until

2015. I would I wasn't doing I wasn't really doing anything else. You know, I kept over optimizing them and tweaking the parameters. But the basic concept was the same. So I I I don't think all the optimizing and parameter changing I did really made very much difference.

I could have chosen different parameters and hit maybe r at random I would have had better results or worse results or or whatever. But the the basic concept was the same. You're buying breakouts on unusual volume and and setting a target at a stop and Uh I think there was also a time stop. So there's basically three three components to the exit. So to answer your question, uh when we first started this in ninety eight, we were we would actually

phone in our orders to a broker. Yeah, there wasn't even an online platform where like Interactive Brokers is now where you could actually Do that. Uh Schwab maybe started to have an and yeah, TDM eritrade. That came a year or two later. When we first started, there really wasn't much. Uh so we were yeah, we were using this online broker. I mean it it was kind of an agency, a small broker in New Jersey.

So we would call in the orders. Then, you know, since we were doing this every day, we asked if we could email them the orders. So we s we started emailing them the orders instead. And then I ended up, you know, writing code to generate those emails. So that that was my first automation was actually um code that

that generated and sent emails to a human broker who would then d do the order entry. I actually stayed with that broker until twenty thirteen. They were called Trade Managed Capital. And earlier than that they had been called Yamner. I think we were probably their only retail clients and all their other clients were hedge funds. Um, but we were sort of behaving like hedge funds. So they took us on and so they gave us this software and um and I changed my code to use that.

But and then in uh the twenty thirteen I switched to interactive brokers d just'cause I was paying too much commissions basically with the other people and the and and the slippages were getting worse. They they had been giving us I think very good fills. Um early on, but uh the the slippages were getting worse and cited changed from interactive brokers. Um and then it you know, coincidentally I went kind of went through a rough patch for the next several years.

But I don't think it was'cause I changed brokers. I think it was because the strategies were were winding down and not working as well anymore.

Uh so to be clear, for for what, since 1999, 2000 era till 2014 or so? I mean, a good long stretch that you were doing two basic strategies, correct? Yeah, or really two sides of one strategy, you might say. Two sides of one strategy. So let's dive into that uh a little bit more. What um so you're on one side, you're buying breakouts on heavy volume. Like

Yeah, you basically I mean w in the early days when we would do the scanning well, you know, every day after the market closed, after data was available. So you're basically scanning the you know all all common US common stock.

that meet a like like a liquidity criteria or price and liquidity filters. Uh For um, yeah, kind of three things that, you know, unusual volume, like at least two times average or three times average volume, a significant move, you know, not like up five cents on two times average volume, but you know, up several percent. uh in one day. And

then the prop pre prior to that, it should not have already been overbought. So right, you know, ideally it's it's like a flat congestion area and then a breakout from there. Yeah. So that's the basic setup. I mean it's probably the most well known breakout setup in the universe. Um there's there's nothing original about it. I think Gary got it. He started by reading the works of William O'Neill.

uh how to make money in stocks and basically took the can slim method, discarded all the fundamentals and changed the the profit target from twenty percent to five percent and that was about it. So that's essentially what we were running. And then he he added the short side, which O'Neal wasn't doing any shorting and hadn't even published any his book about shorting yet back then. So those were I think the most innovative thing was was that Gary had added the short side, which

where where he was looking for kind of a an even more big breakdown. He used to describe it as like it should look like you just broke your arm and it was dangling. So the the the criteria for entering shorts was more stringent and required a a greater gap down on heavier.

Basically he was looking for for um for a really a visible gap and the way he used to say it is that the stock should look broken. Most of these entries would be after a negative earnings surprise or a negative earnings pre announcement. I mean that was typically in those days, you know, that that was the news that would lead to that pattern. Yeah. And how long did you uh typically hold these uh positions, both long and short? Did you have targets?

Yes. Yes. We w it's the moment we play yeah, uh initially we would we would basically place an order to buy or short at the open at market with an attached bracket of a target and a stop order, you know, whichever comes first. So, you know, a one cancels the other kind of situation. Um and those would be calculated in advance as as um you know five percent Favorable or seven percent adverse.

So in the case of a long it would be five percent up and seven percent down, vice versa for in the shorts. And that was it. And then you just leave them alone until they hit one or the other, uh which would typically be in those days uh anywhere from from that same day to a week or two later. But most mostly it was within a few days. I mean, it doesn't it doesn't take that long for a

a stock that just had an unusual move on unusual volume to move another five percent one way or the other. Um so so yeah, it's it it was really uh a few days was the average holding period, maybe three, four days.

What were your thoughts about uh holding it for a relatively short amount of time? Um, you know, given the old adage, the trend is your friend, and uh did you have a kind of a reasoning for um, no, let's get out early, earlier than than normal. Yeah, I mean our reasoning was

That we want to be in what is moving right now. And that that keeps changing every day or every few days. You know, whereas y if you buy a breakout and then just hold it until some longer term stop is hit, you know, you might be tying up your money in that one stock for a long time, uh some of which it's not really going anywhere. Gary's philosophy that I adopted is is that your capital is sort of like inventory and you want to just keep turning it over and putting it in where the action is.

You know, within reason, uh I mean, in those days that kind of time frame was about as small as you could get w you know, without trading costs totally overtaking. Because remember back then, um, stocks were still priced in fractions and the tick size was one eighth. of a dollar, uh, which is pretty large spread. And then and the commissions were were like, I mean, if we were trading one or two thousand share lots, the commission would be, you know, fifty or sixty dollars.

Per round trip trade. So That's great. So you know, it's so there there is kind of a sweet spot where um five hundred to a thousand round trip trades per year. You know, it was was workable. Gary was less conservative than me. So that that year, nineteen ninety-eight, our first year of trading together, he made eighty percent and I made fifty percent. It was a good Good year for us.

Uh, you mentioned in in a previous interview that you like to have large numbers of trades to be statistically significant. Do you tweak your system so that it will generate a likely minimum number of trades per year? Um, you mentioned I think five hundred or a thousand trades per year. Is that kind of the sweet spot to be statistic? Yeah, I mean I if I look at a back test I want to see, you know, thousands of trades to to believe that

that there's there's an edge to it. I mean, if if if you see a back test that only produces fifty trades, you know, and there's one or two outliers in there, it doesn't really tell you anything about the rules that that led to those trades. So that's what I I was typically looking for, yeah. Yeah, i again there's kind of well, it depends on on what data you have. I mean, I've I've generally always worked with daily bars, that kind of five hundred to a thousand round trips a year.

uh holding for a few days is kind of as as low as you can go with daily bars. I mean, obviously you can't really model intraday trading on daily on daily bars or even um even a A day trading. There's one day trading strategy you can where where you enter with a limit order and exit with MOC. Other than that, How how time consuming is coding everything yourself? Is it I imagine it's a big upfront investment, but uh later on, how much time do you spend both in the early stages and later on?

I don't know how I've I've probably spent many, many thousands of hours on on the coding, but it's not like I'm starting from scratch every time I have a a a trading idea. I mean I fr from the beginning I built a general purpose uh back testing program and then later it general purpose automation program. Uh most of that time it was in a in Excel, but um but now I have a standalone program. So so now I mean w given the software that I have, if I want to test a new idea, it it

I can do it in a m a few minutes. And and if I want to start trading a new strategy, I can do it with very little additional coding. 'Cause I have the infrastructure. But ear yeah, early on, I mean it it just kind of evolved. It there wasn't some big task I had to complete before I could trade systematically. You know, I it it gradually evolved from mostly manual to to semi systematic to I think I

started being fully automated from my Excel VBA code uh at the beginning of two thousand. I don't think I've placed a manual trade order since since nineteen ninety nine.

Let's go back to the kind of the timeline of you used um your first system until how long did you use your very first system without maj making major modifications to it? I was always tweaking it. So it's ev everything just kind of, you know, gradually evolved. I I mean in in so n so we had that very good year in ninety eight. Ninety nine I was I I was really getting much more sist systematized. I was I had become disillusioned with the

chart judgment process with our eyes and and you know, wanted to make rules for for what the data should look like. So I kept changing those rules and um Yeah, we ended up having a fairly mediocre year in nineteen ninety nine, which is unusual because most traders had a fabulous year in that year, uh, except for ones who are exclusively short.

I I went back and looked at all the times I had changed the rules and realized I would have done better off leaving them how they were at the start of the year. So I made this resolution of okay, going into two thousand, I'm going to trade one set of rules all year and not change it all year. And I and I actually did that. And as it happened, I had had my best year yet. So that worked well. Um

After that, if I had many periods where I where I would frequently tweak things. You you fall into a I think everybody's susceptible to this. Where when you're in a drawdown, you say, Well, how could I have avoided this drawdown or made it less severe? And you find some rules that would have made it less severe and you put them in place. I mean, I was totally naive. I didn't know anything about overfitting or whatever. I just did that. And um sometimes

it it helped and sometimes it didn't. My usual process would be, okay, I'm in a drawdown, let's retest and let's see if I can come up with a new idea that would have made the drawdown better or would have made recent performance better and put that in. And then there were a couple of times when I couldn't find any parameters that would have done better.

And then I thought, oh shoot, look the whole approach is broken now. So what do I do? One of those was he was actually, yeah, I said I had this great year in two thousand and of so of course I kept running the same rules going into two thousand and one.

And I immediately had a twenty percent drawdown within the first month. And I'd never had a drawdown that large before. So that That caused me to, you know, to stop for a little while and reevaluate and I ended up putting something in place that was fairly similar, but I I think I changed to um that I would get a real-time data service and enter my um do my entries to

before the close rather than at the next open.'Cause'cause in backtesting I had figured out that would have done a lot better uh recently. Uh so I made that change. And then I I I did an analogous thing when things stopped working again in the in 2005 of of um switching to uh to get getting in even earlier. So I would I would look

starting about five minutes after the open for the stocks that seem to be making big moves on unusual volume and and buy them then. So I ran it that way. And that that did did well in oh oh oh six and oh seven. were my neck my other two best years besides two thousand and um And even NO eight was okay. O nine ten was quite good. Yeah, eleven twelve. 2012, basically the the short side when we got into that to that decade, especially after starting 2013, the short side. completely failed. And

Um prior to that, more than half of my total profit was from the short side. You know, if if I had b just been trading my long side all that time, I wouldn't have even beat the market at all. My, you know, I I would have been better off buying and holding. uh long and then just shorting against it. But I I didn't know that. Maybe not in O eight, but other than that, yeah.

I see. Why do you think the the short side was hurt in uh twenty twelve? What what was it about the markets that uh made that year different? Oh I th I think uh M more and more other traders started uh adopting the, you know, buy the dip uh approach. B basically mean you know, short-term meaner version became a very popular strategy. So uh so the kind of sharp breakdown pattern that was my short entry signal became a long entry signal for many traders. Um Oh wow. So so yeah, they they would

So that's what I kept seeing. You know, I would I would be end up shorting it near the low and uh and then having it go against me, uh, you know, more and more often. You know, it wasn't like I suddenly got all these huge losses. It just um you know, the stats eroded. The the the win rate got lower and the average loss got got larger than you know than the average win and so on. Uh that that's what typically happens. This uh by the uh BTFD uh by the dip phenomenon. Um did this phenomenon exist?

It is the technical term, BTFD. Yeah. Uh did this phenomenon exist in other roaring uh bull markets of the past, or was it an additional nuance of that particular market? Oh I think it I think it became it was a fairly new thing that started in in that around uh twenty twelve, twenty thirteen. Um I don't remember. I mean, of course prior to that there were, you know, value investors who who were, you know, would

uh know what what stocks they wanted to own and wait for them to to be cheap in order to buy them. So so in a in a longer time uh trading time frame you might say uh Sure, dip dip buying has always been part of, you know, buy low, sell high. That's that's always been part of the uh the investment landscape. But I think it became a popular short term trading strategy mostly after um

I it m maybe even in oh eight. I mean w I I ended up uh you know adding meaner version to t to what I do in twenty fourteen. And when I did the back testing I found that E even the long side would have done great in in a way the the long b dip buying. So I think it was going on for a while, but it probably reached some critical mass where where my

my particular um shorting setup didn't s just stop working. But I don't know really. You know, you you never can know exactly why you don't you don't know who else is doing what in the market. So you you best you can do is guess why something doesn't work.

Are there any objective or subtle indicators that start to appear when a strategy has stopped working? No, it's a it's very hard to um pin that down. It's really more of a more of a judgment call. Yeah, I that's where where I'm I'm discretionary is in strategy level decisions. I I still have uh in in the back testing software that I sell, I I include um at one of my many example scripts is the the long essentially the long and short strategy that I traded from the

late nineties through the mid two thousand, uh like till after twenty twelve. And um yeah, it and it you can see when you run that back test all the way back to the nineties that how it did very well. Uh and then went flat for a long time. Yeah, and then it mysteriously did really well in twenty twenty two when most other short-term stock trading strategies did poorly.

So you just you never know when something is is gonna start working or st or stop working really. It's it's it's a it's a judgment call. So my understanding is that you uh added a mean reversion strategy uh to your repertoire of uh Yeah, I became aware of that concept uh in that stock beforeum that I was a member of uh in twenty thirteen, twenty fourteen. Um and and Did a lot of research and backtesting of it. I think I also was aware of uh or became aware of the writing of Larry Connors, who

who's pro probably Connors and Cesar Alvarez are the people who have done the most publishing on the on the topic of short term mean reversion. Yeah, I f I found some strategies I liked and and uh So in twenty fourteen I divided my capital in two and kept running my old strategies in half and uh the my new mean reversion strategies in the other half.

the uh the old strategies were flat and the mean reversion half had a very good year. So then in twenty fifteen I just decided to abandon the old ones and put everything in in this long and short meter version strategy pair that I had built. And I had a great start to that year and then a really nasty drawdown.

What what what was the cause of the uh the of the drawdown and what was the catalyst? So was it the mean reversion part of your strategy that Well, I was only by so from the start of twenty fifteen I was just running long long and short meter version with all with my whole account. So and e so each position was ten percent of my account. No, i I take it back. I was still trading fixed shares, not fixed percentage then. But but it was it was on average around that size.

10 to 15. It really, I mean, all it takes for the the in a typical mean reversion strategy, you're buying. You're catching a falling knife, you know, you're buying a stock that's dropping or shorting a stock that's ripping higher. But you know, you've based on some calculations that that it's already overbought or already oversold, vice versa.

And i if you try to put uh stops in those strategies, it they don't work at all. You you basically have to rely on on on the stats of You know, if you if you take a thousand trades and that are overbought in this way, you know, an on average you'll make money. Uh but it but every now and then you'll you'll take a larger loss. And they and you you m just manage that by keeping your position sizes small enough so that so that even if

You know, you t you a stock went down like fifty percent more from where you bought it, you know, you might only have a two or three percent drawdown on your account. And that would be that would only happen once or twice a year. So so the drawdowns in those strategies happen when

There's some typically there's some kind of market event going on where you get, you know, serial correlation of those bad trades. So you you you get enough several significant losers in a row. And and that's what happened uh in the Second half of twenty fifteen, especially in August. I mean it you you the the market was was very bad in uh in August twenty fifteen. And that's when you had your big drawdown?

Yeah, it it had started I think it might have started in June or July. A lot of it is random. I mean I I think I had one chunk of the drawdown in um June. Th there was one where I was shorting Chinese stocks that were ripping. There was one where I was buying biotech stocks that were plunging after um, oh, I think like Hillary Clinton was running for president and made some announcement that she was going to crack down on the pharmaceutical industry and the whole biotech sector fell apart.

And but I kept buying the dip'cause that's what my rules said to do. So basically when you when you have some something like that where there's a a news based catalyst or or a f you know, a um feeding frenzy like the like the meme stock craze that happened later. Uh you just end up having too many large losers.

next to each other. Uh, you know, whereas when you back to that kind of strategy, the the large you you see some large outlier losses, but they're spread out most typically. And so the stats still look really good. But then in real life when they happen one after the other, you you you and and then when you have several periods like that interspersed with flat periods.

Yeah, it all adds up to a to a significant drawdown. So my I mean, starting my drawdown had started in mid twenty twelve when my that was my equity high, uh, the summer of twenty twelve. all the way uh and it, you know, I had some recovery periods and then some further losses and then some recovery periods. So it basically my equity was in a downtrend from mid 2012 all the way until 2015 and added up to about 45% total drawdown.

Wow. Yeah, curious how much does does a strategy have to erode in performance over time before you look to tweak the system or just dump it entirely? I I pretty much always set a twenty percent drawdown as my kind of system stop or my off switch where where I'll at least

pause, if not stop for a while and reevaluate and you know, then it's I mean, then that happens several times during that period. And then at some point you you either say, uh, okay, well I I think I've got a new idea that'll do better. So I'm gonna restart. Good morning. But of course you're not back you you can't wait till you get back to an equity high before restarting by definition because you have to be trading to get back to an equity high. So um Yeah.

So so at some point you just have to keep, you know, y at any given point you either believe you have something that's gonna work and go back in or or you throw in the towel and say I'm done forever. Um which I I thought I had done that in twenty sixteen and I I I stopped for a three months actually in but then yeah, I've I've got all this software, all these tools, all this experience, you know, just see what I can do.

Put a put a more conservative strategies with fewer parameters in place and uh So that's how you got out of the uh forty five percent drawdown is to is to uh simplify your system.

Uh right, simplify, make make it more uh take take smaller positions and diversify more. You know, I had just been trading the two meaner burden systems, but then I went back and added You know, they my old breakout systems were still no good, but but I found a new long breakout system by narrowing the universe to recent IPOs, which ended up being my best performing strategy for the next several years.

Um and then um and added a sh a new I I did go back to something like my old shorting strategy, but with some with some differences. Uh In particular, I rather than just buy uh shorting on the breakdown, I sh I I shorted on a little r rebound after the breakdown um to get a big a bit of a better price advantage. So so those four together kind of like my core four strategies that I'm that I'm still running and that they did mo you know, mostly wealth since then.

Do you program any of your systems to avoid either highly shorted stocks or any of the meme stocks? And how do you screen uh these out of your system if you do want to avoid them? I do have some I yeah, I have a well I have a upper volatility filter. Actually use it on both sides. Uh Which I mean there's a couple of ways to approach that. I mean, one way is to to uh restrict your trading to a to a narrow a narrower universe like the you know, the constituents of a major index, for example.

So some people do that. Um I've always found I can get better stats by by having my universe be all publicly traded US common stocks and then applying a liquidity filter. But the main difference between this universe and say the Russell three thousand is that that the the broader universe will include a lot of ADRs. So it's actually you're actually getting a lot of uh foreign stocks, uh, you know, hence my issue with Chinese names uh that I had mentioned earlier.

So oh shoot, I've sort of lost my thread of thought now. What what did you ask me? Yeah, yeah. So the meme so a few years ago we had the the meme stock. Oh meme stocks right. I mean I did I did take a bit of a hit when that first started. I remember luckily I I avoided GameStop, but I think BBBY, uh and maybe AMC. I you know, I had some

some significant losing trades in a couple of those. Um at the same time my my IPO strategy was was on fire. So it kind of canceled out. Like I didn't notice those big losses quite as much as I would have. They didn't cause an an overall account drawdown, but but that strategy was definitely doing poorly. Uh and and I was a you know aware of what was going on and with the meme stock craze'cause everybody was uh it's but by that point, you know, I I had

been marketing my backtesting software for a while. We had a fairly active forum. So there's a lot of conversation about it as well. And um Yeah, we started just a little bit. The first thing we did was to just build a an an exclude list and a text file of, you know, we're just not going to trade these symbols because they're the ones that these these idiots are buying. And um so um

So so I did that. The the other thing you can do that I that I also do sometimes is look at the brokers like margin requirements or short borrow rates and and just avoid the especially, you know, the I figure if If I B says you need a hundred percent margin or more, I mean, I've seen stocks where they want four hundred percent margin to short it. Wow. That's great. Right. I mean that tells you that their risk management people have said

This is this is dangerous. So why why would I want to do that? So so yeah, you can that that's another thing you can do is let the broker give you some clues about what's too risky to be be shorting. Right, right. So tell us about your IPO strategy. How how does that differ from your other strategies?

It's it's it's so simple that it's stupid. I mean really I i the idea was to just Well define an IPO as as a a stock that only has a limited number of of uh days in its trading history and then uh buy it when it closes at a new all-time high. you know, and then sell it if it has a like a one or two day low, you know, fairly, fairly tight. I I've I don't use stop. I've never used stop orders in any of my trading strategies, but I use stop rules.

But, you know, on a closing basis. Basically I just don't want to be taken out by intraday noise. Yeah, and also s uh stop orders have uh more slippage than any other type of orders. So so yeah, I'll I'll get out of the close. Um You you sell out, you're saying um so how long would you when you buy the the IPO, it's hitting a new high. Uh then how long would you typically hold it if it's a if it's running, you know, day after day going higher and higher?

Well, they really I mean, they they typically are. I I I I have a profit target in that strategy as well. So I'll fold it till it hits the target. And and then you know, it might have a down day and then make another new high and then I might buy it again. No, th that strategy worked very well. Um it started it in twenty seventeen and it worked, you know, well enough through

twenty seventeen, eighteen, nineteen. Uh, and then it really hit it out of the park in the middle of twenty twenty through the middle of twenty twenty one, uh, when everything was kind of on fire. I mean, practically any strategy worked during that time period, so it's not really saying anything. But since uh

Since the uh end of twenty twenty one, it it's just been flat. But you know, I mean, a good thing about that approach is when the when the market's correcting, there there are fewer IPOs because companies just cancel their IPOs. So it kind of has a built-in regime filter of its own.

Uh there a lot of people focus on on trading IPOs. I'm not sure. I mean part of the the success in the twenty twenty and twenty-one were all the SPACs, which is kind of no longer a thing. I think there's there's one I just saw the other day. three letter symbol starting with I where it got cancelled and it dropped like eighty percent in one day uh after a run up. Anyway, yeah, it I think it's gonna be a while before

That strategy works. I mean, I'm still running it, but it's just been flat for about two years now. It's not doing anything.

So uh going back to your mean reversion strategy, uh, does your system differentiate between an earnings release gap down on massive volume versus a steady multi-day drop on above average volume, not tied to earnings? Uh, would your mean reversion strategy play a big gap down influenced by volume?

It w it would only if the if the stock had already been falling for for several days and then had a big gap down, it would be then then I might buy it there. Um that would be like a capitulation type thing. But I mean the the choose anything that was like at a new high and then suddenly had a big gap down, which w which is my old short setup. And th those did work well in um like twenty thirteen and and around there, but but the uh I think

I don't know. They they might work well now. I I'm not I have no awareness of whether it's earnings or not. I don't pull I don't pull in any news, fundamentals, uh earning states, whatever. I mean I'm I'm really I'm literally just taking price history and And and when price does the thing I'm looking for it to do, then that's my signal. So Yeah. Yeah, I I clearly uh you know. All of my trading strategies are basically looking for unusual volatility.

Um like I said earlier, you know, from from the beginning, we we wanted to be in what was moving at any given time. Um and and so clearly I'll get more more trades during earnings season than not during earning season. But there there's some amount of earning season every quarter. I mean, b you know, the the big ones are are are the the usual, you know, m March, uh June and so on. But uh I mean April, July.

But some many companies are on a offset fiscal year, so you you get a certain clump of earnings every month. Mm-hmm.

Um I'd like you mentioned earlier about curve fitting and optimization. What what are the primary kind of dangers one should look out for so that they don't get sucked in by this attractive uh shiny object? Well, the the number one is don't even try to build a strategy for one symbol. I mean that there there's no way you can build a strategy for a single symbol without over overfitting it.

in my opinion. And unless you're talking about very short term intraday, you know, I mean if if you have tick data and or or one minute bars and can go back several years, you know, maybe uh you can find something that works consistently. But um and and I had that instinct from the very beginning, was to I basically I I want my system to be modeling a process where I'm scanning the whole market every day for for For that day's trade.

So that it's always a different set of stocks that I'm trading every day. I mean, if I if I look at, you know, do a like a buy symbol back test of my of my systems, I mean, there there'll be fairly few trades in any one symbol in the course of a year. There'll be hundreds of different

symbols in total. So that's one that's the easiest way to avoid overfitting is to do portfolio based approach, not a single, single stock approach. You know, what I see a lot of people do is is, you know, or like, I want to find a strategy that would have caught the most possible gains out of Tesla in the last three years. Yeah. Or or right now you see people doing that with Bitcoin, which is pretty dumb'cause it's not gonna keep repeating.

Uh, you know, that like that was a thing that happened and it's gonna be a different a different stock or or thing next time. So avoid that. I mean and then other than that, you know, it's just keeping your uh total number of parameters or degrees of freedom as the quants would say, um, small. I don't do optimization for the most part. I I I'll use the optimizer to to uh

go over a fairly small set of parameters or just kind of study how a parameter impacts the results. But I I don't do the classic thing of run the optimization over every possible combination and find the best stats and choose that one. That's the thing I want to run. So basically you avoid curve fitting by not curve fitting. Right, right, right. So uh I I I've read that um Back testing, the issue problems with back testing. Uh often we back test a system that will yield much higher returns.

and smaller drawdowns than typically experienced with live trading. Well what is it about that process? Um why why does that happen? Are we not looking at enough long enough timeframe um for this? And Is that inherent? It it happens because when you back test you keep trying different things and discarding the ones that work less well and keeping the ones that work better and it

After do it doesn't take too many iterations of that before you come up with something that works better than is likely to happen in the future. That's kind of inevitable. I mean I I just over the over the years have learned to assume that my results going forward are not gonna match what the back test indicates. In fact I my rule of thumb is is half the return and twice the drawdown.

Um, so it so unless I I'm content with that, I I I typically won't run something. I mean that rule of thumb probably s shows that I'm overfitting as well. But Uh-huh. I th I think there's no way to avoid it. I mean as soon as you run your second test, you're you begun the overfitting process. Right. Excuse the last interruption here. This is Tessa. We hope you're enjoying this episode so far. If you love the podcast,

Please give Chatwith Traders the best review you can on whatever platform you're listening from. This will help us to keep the episodes coming. Also, if you haven't subscribed to our email list, please hop on to chatwithraders.com and click on subscribe. so we can keep you posted of information that may be of importance. Thank you. Now back to the chat with our guests.

Right, right. It um is there a way to measure different types of bull and bear markets with subtle granularity so we can have an earlier detection of the conditions that could cause drawdowns in our strategy so that We get, you know, different we don't just simply say, well, this was during a bull market or this is went during a bear market. Well, what type of bull market? What type of bear market? How did this bull market and bear market different was different from past bull and bear markets?

Is there a way to kind of get that uh unique granularity of that particular market so that we can understand greater what's going on? There may be. I know that uh some people have done work in that area. I think Van Tharp had a whole whole way of classifying different market regimes like that.

Uh you know, I mean the simple as it's just a a binary market regime that, you know, bull or bear, like is it above or below the two hundred day moving average? But but yeah, you can go from there. You can do I think there's like a four-way thing of

bull with high volatility, bull with low volatility, bear with high volatility, bear with low volatility. Uh and there's probably other dimensions you could add. And then and then you have to back test that against the, you know, you have to pick a strategy and try it. in each of those regimes and see how it did and is that indicative of what will happen in the future? Maybe. You kind of if if you wanna use regime filtering in in the in these kind of systems, you have to kind of decide

from the beginning that that's what you're going to do. Start with a regime filter in place and then put your rules on top of it. Because if you optimize some trading rules and then try to apply a regime filter, it'll always almost always make it look worse. 'Cause you've already uh kind of uh accounted for that in the trading rules themselves.

Since you were interviewed in the uh unknown market wizards, um, say twenty twenty three and so far in twenty twenty four, uh how how have you been how have you been doing? Well, basically, uh you know, my my last equity peak was was the middle of twenty twenty one. Um, you know, I've I had a bit of a drawdown in the or end of twenty twenty one and then had a flat year in twenty twenty two. And I had a another drawdown at the start of twenty three and it and then flat

Since then I'm up slightly this year. So basically I'm no longer achieving market wizard results. in in the last few years. But, you know, then again, there were m several years in the in the past, uh, the period that's documented in the book when uh my results weren't that great either. I mean it's i he's looking for overall stats.

uh uh over a long term. So, but you know, I the one way to look at it is I had an extreme outlier period of from mid-2020 through mid-2021 where where I had the best 12 month results I've ever had. And then and now my equity's mean reverted since then back to its uh usual trend uh kind of kind of twenty percent average. Mm-hmm.

Uh, so why do you think uh more traders don't go systematic? Uh are the barriers to entry or learning curve uh are they high? Uh not quite as exciting as for the adrenaline junkies. All of those things. Yeah, I mean it you know, it's the the old cliche of finding an approach to trading that fits your personality. I mean the the ones more likely to go systematic or are the ones who don't care so much about the the gambling feeling of

putting on a trade and and don't care about, you know, wanting to be right, you know, like your typical global macro kind of trader who who who who likes to do all this analysis about what's happening in the world and make the correct call about what stocks, bonds and golds are gonna do and uh, you know. gets pleasure. It it sort of comes down to what w what gives you pleasure, what makes your dopamine fire, probably. So um, you know, from for me, the the actual trading process of

put you know, putting on one trade. Like I don't even care what my individual trades are. I I know I have some positions open right now, but I couldn't tell you what the symbols are. I can't remember. I d I didn't even look. I d I just I literally don't care about an individual trait. I care about the stats. Yeah, so so what gives me pleasure is is um finding a strategy that

feels robust to me and has had good stats in the past and then you know having putting it on and having it keep working um over time. Uh but more than that, uh working on this the back testing software and um you know improving the software itself. actually gives me more pleasure than anything related to trading. So I've I've kind so part of why my results are flat is I've really been neglecting my own trading system research recently.

I'm putting all my focus and working on my software because I have over 700 users now who who l like to use it and I I just really like uh you know supporting them and it's kind of like I'm back in the software business, but I'm still trading too because I have money to invest and I don't know of another way to do it, so I do it that way.

And so your trading software uh does what helps users do back testing? It's a back testing yeah, a back testing tool. And then I d I also have a uh an automation tool that uh you know integrates with interactive brokers and places the orders that the software generates for the for the strategies. have been modeled. Yeah. It makes it fairly easy to to build a system that combines multiple strategies and um and see what the results would have been in the past and trade it going forward.

Yeah. So so that's kind of your your passion currently is the uh working, tweaking your software and and uh communicating with your fellow members on their strategies and so forth? Yes, for sure. Yeah. Well, great. Well, thank you, Marcin, for coming on uh Chat with Traders. My pleasure. Thank you for having me. Yeah. How how can our listeners uh get in touch with you?

The my website is mhptrading.com. Uh and so that's where you can you can find out about my software and actually there's links to my all the other podcasts I've been on and this one will soon be on there as well. Um great. I'm on Twitter, also known as X as Mars10 P. That's M-A-R-S-10 P. Those are the best ways to find me. Okay, fantastic. Thanks, Marson. Thank you. You've reached the end of this Insight and if you leave a rating.