Correlations, trading philosophy, and etc.

Was talking to a friend of mine last night who had traded currencies professionally for eleven years and now trades exclusively for a few of his old clients. This guy is a machine, trading in size and regularly pulling in over 3% per month. He doesn’t sleep like the rest of us. He catches cat naps here and there — two hours in the afternoon, a few hours at night, and then sleeps like a log on holidays and weekends. He takes the summers off and recharges. He doesn’t head out to some exotic locale. He putters around his house outside of Asheville, NC, running his dogs and riding horses and hanging out at the BBQ pit with his family. He trades FX spot (majors and their crosses), ES, YM, ZB (T Bonds) and a few interest rate contracts, CL and WTI. I asked him once why he trades the little S&P over the big one — he said he prefers the E-mini S&P because it is traded electronically and he gets better fills. I know most of the people reading this will laugh about his returns – I have read rediculous statements about trading not being worth it if one isn’t making more than 100% per year. Most people reading this don’t make the money this guy does…in fact, it’s safe to say that NOBODY reading this blog makes the money this guy does. And I doubt the knuckleheads who made those statements — on EliteTrader.com, I think — are profitable traders. He isn’t a supermegaultimate trader, but he does make a very comfortable living for his family and probably contributes significantly to his clients’ standard of living.

Anyway, we were talking about correlations last night. I was on one of my usual rants about how correlations are not so important when trading on lower time frames. I have seen quite a few people commenting on blogs about the dangers of taking correlated trades. I have observed that most of the bloggers taking these trades are operating on very short time frames. I don’t see a problem on 5min, 3min, 1min and tick charts, as long as one’s method has been tested and the execution is consistent. He agreed, saying that people get confused about how to manage correlations. He trades highly correlated pairs all the time on intraday charts. He doesn’t try to enter the trades at the same time. He enters only when signals print. Often one will win and the other will lose. And he nets a gain. For example, he would take a short in EURUSD and a long in USDCHF (inversely correlated currency pairs), exiting one for a loss and one for a gain. Occasionally he loses on both. He also wins on both, with one often making an outsized gain. An outsized gain for him would be anything above 2R. (Another peeve of his is when traders harp on the 3:1 rule. His experience has been that if he is too insistent on making 3R, he gives back more profit than if he were to simple take 2R.) “Correlations,” he says, “are important for longer term strategies and portfolio managers. I am not a portfolio manager.” I recall having a similar conversation with him about the Sharpe ratio. He thinks it is useless for most traders.

I was on the East Coast for training a few years ago and had a chance to drive out to his house to see his operation. Very humble. Four screens, two computers, and a laptop in a small office. A cheap but comfortable chair, a foot riser, and a treadmill with a side table (for the laptop). He inspired my own setup, minus the treadmill — I have an elliptical machine in the garage, also with a side table for a laptop. (Have to use that elliptical machine more often! It was pricey!) I asked him why the blinds were closed when he had such a nice view. “Focus,” was his answer. I was there during the summer and he wasn’t trading but he still had charts and data up on the screens. We get along well because we are both critical of dogmatic people — whether they are religious zealots, scientists…or traders! When I ask a question, he always asks what I think. This strategy worked, because I don’t ask questions anymore. We end up discussing ideas, instead of one person imparting knowledge to another. Makes for a much more interesting conversation. We have two completely different styles of trading, but he enjoys talking about markets as much as I do and doesn’t seem to mind the vast difference between us in terms of our success as traders. He is genuinely interested in what people think about the markets, no matter who they are. (Another one of his peeves is when traders say they have no opinion about where the markets will go. “What the hell are they trading for, then? Don’t they have a method? Well that is a f@#%ing opinion! What are they doing? Don’t they know why the method is giving them a signal? Don’t they understand why they are long or short or out?”) He’s not a finance geek — he speaks in big blue arrow terms and in plain English. But he is extremely critical of people who don’t understand the simple math behind what they do and the myriad ways to interpret it. “Even if you use an MA or a stochastic, you gotta understand why you use it, what the damn squigglies are and aren’t telling you and whether any of that even makes sense in the moment according to your view of the market. And if you tell me MAs don’t work, I will tell you that you are a presumptuous, one-dimensional knuckle-dragger and you don’t know what you’re talking about.”

In case you’re wondering, he really did say “presumptuous, one-dimensional knuckle-dragger.” After talking to him, I write down the thoughts that stick. He ridiculed me once for this, but after he got his two or three shots in he muttered, ”I should do that.”

He asks: “Why don’t you trade bonds, Jay? Why don’t you trade crude?”

My reply: “I don’t have the capital or the time.”

His reply: “Well I guess you better get things right then, sonny-boy!”

Dontcha love this guy?