- Ed Seykota, a legendary trader profiled in Jack Schwager‘s classic “Market Wizards” series, built a systematic trading program after an initial silver trade went awry.
- In the early 1970s, Seykota’s computerized trading methodology was the first of its kind.
- At its core, his strategy encompasses trend following, pattern identification, and risk management.
- He shared the five trading rules that helped him grow a customer account from $5,000 to over $15 million in a 16-year time span.
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“In the late 1960s, I decided that silver had to rise when the US Treasury stopped selling it,” he told Schwager. “Much to my amazement and financial detriment, the price started falling!”
He added: “Soon my stop got hit.”
But the initial shock and awe that arrived hand in hand with Seykota’s loss didn’t go unavenged. His less-than-stellar first go-round kickstarted a quest to carve out a systematic process he could entrust.
“About that time, I saw a letter published by Richard Donchian, which implied that a purely mechanical trend-following system could beat the markets,” he said. “Amazingly, his theories tested true.”
From that point on, Seykota would spend his days hacking away at his keyboard, testing the performance and validity of any array of different trend-following systems — a market approach that leverages momentum and moving averages to discern buy and sell points.
Periodic tweaks were made where Seykota deemed appropriate, and soon his suspicions were confirmed.
“Anyway, I got my results,” he said. “They confirmed there was a possibility of making money from trend-following systems.”
Seykota’s usage of computing power to trade markets was the first of its kind. At the time, a formalized, systematic, and computerized trading system didn’t exist. Remember, this is the early ’70s.
Though he was skeptical when his trading algorithms started to show promise, Seykota’s remarks seem to underplay the effectiveness of his newly found strategy.
Over time, his approach would produce mountains of cash for himself and those lucky enough to get involved.
“I do not publicize my track record other than my ‘model account,’ which is an actual customer account that started with $5,000 in 1972 and has made over $15 million,” he said in reference to a 16-year time frame that stretched from 1972 to the time of his interview with Schwager.
At its core, Seykota’s trading methodology encompasses a mixture of trend following, pattern identification, and risk management. To a large extent, he attributes the latter to his prolonged success, saying, “There are old traders and there are bold traders, but there are very few old, bold traders.”
Here’s an inside look at the five criteria he lives by.
1. Ruthlessly cut losses
“The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses,” he said.
2. Let your winners ride
Though Seykota has little tolerance for losing trades, he’s not in a rush to get out of a winning position.
Generally speaking, he’ll move his stop loss up to lock in his profits as the trend continues to work in his favor.
3. Don’t bet too big
As a rule of thumb, the most Seykota is willing to risk on any particular trade is about 5%. Remember, he credits his success and longevity as a trader with his adherence to stringent risk-management practices.
4. Stringently adhere to your systems
“Mostly I follow the rules,” he said. “I still go through periods of thinking I can outperform my own system, but such excursions are often self-correcting through the process of losing money.”
5. Know when to divert from your process
Though Seykota’s last two rules are contradictory, he’s unwavering in his support for both.
“As I keep studying the markets, I sometimes find a new rule which breaks and then replaces a previous rule,” he said. “This seems to be part of the process of evolution and growth of a trader.”