Devising and implementing a strategy is the key to successful trading, according to Jay Kaeppel, director of market research for Essex Trading Co., Ltd. Stocks & Commodities Editor Thom Hartle spoke with Kaeppel via phone on February 18, 1997, to inquire about his favorite techniques for investing in the stock market, trading futures and options.
"You need two things to trade. First, you need an approach with a realistic chance of making money in the long run, and it doesn't have to be fancy. Having the plan is part 1. Part 2 is having the discipline to follow the plan.
-- Jay Kaeppel
Let's start with a little history.
"Okay. My first job, after I finished college, was with an oil company as an accountant. At the same time, I actively followed the markets on the side.
What year was that?
That was 1981. In 1984, the company was bought and I was laid off, so I started my own company. For about five years, I published a newsletter -- The Mutual Fund Switch Service. Then in 1989, I came here to Essex Trading as director of market research. We develop software for futures and options traders. In 1995, we started managing money as a commodities trading advisor (CTA). I've continued to do system development, research and writing. Just recently, we published the Pro-Vest Option Trading Method, which is a rule-based approach for trading options.
You mentioned rules. Did you start off as a rule-based trader?
Not even close! Back in 1982, my first stock purchase was a company called Shopwell, Inc. I had been following it for a while, and I sat there and watched it go from $6 to $7, and then from $7 to $8, and finally, I paid $8-1/4 for it, which at the time was the all-time high! I bought it at the close on a Friday, and then I spent the weekend kicking myself. I had paid more than anybody else in history for the stock. I couldn't believe it, and I kept asking myself what in the world I had been thinking about. What I didn't realize at the time was that buying stocks that are making new highs is actually a pretty good strategy.
So what happened?
Two weeks later, the stock went to $10-1/2. So I got my calculator out and calculated my annualized rate of return and decided that I couldn't pass it up. So I sold it at $10-1/2, for a nice little profit in two weeks.
You were an investing genius!
Sure! Except about six months later, the stock was trading at $35-1/2!
I realized that I didn't really know why I had bought it, and I really didn't know why I had sold it. I really had no idea of what I was doing.
Most people don't trade or invest with a plan.
No, they don't. One of the opportunities we have here at Essex is that we talk to a lot of people. Some are really good at what they do, while some don't have any idea of what they're doing. We hear about the same mistakes over and over again. The main problem is that people are just making it up as they go along. Ultimately, that costs a lot of money.
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What makes a good system for trading futures?
I love simple ideas. If you have to put 47 columns into a spreadsheet to get one oscillator number, then that makes me nervous. If I were to do that, by the time I got to the 47th column, I would forget what I was trying to do.
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How about an example?
One simple method is a moving average crossover system. For example, use the crossover of a nine-day simple moving average and a 50-day simple moving average for your buy and sell signals. This system will get you into every important trend. But you can suffer a lot of losses during sideways trends, so I added a refinement: Use an 80-day simple moving average as a confirmation signal. This has tested out reasonably well over the last 20 years (see sidebar "A simple futures trading system").
A SIMPLE FUTURES TRADING SYSTEM
Trading systems can be complex or they can be based on simple trading concepts. Here's a simple system. First, calculate a trend-following indicator:
1. Start with a simple moving average crossover (nine-day and 50-day)
2. Refinement 1: Add a third moving average
(80-day) as a filter.
Apply the indicator using the following rules:
1. Go long when 9d > 50d and close > 80d
2. Go flat when 9d < 50d and close > 80d
3. Go short when 9d < 50d and close < 80d
4. Go flat when 9d > 50d and close < 80d
5. Refinement 2: Trade a diversified group of futures markets.
Sidebar Figure 3 shows a table of profits and losses using this simple moving average crossover system on a diversified portfolio of futures. Sidebar Figure 4 shows the results of applying the system to individual markets over similar test periods. For the coffee market, a simple moving average crossover nine and 20 days was used instead of nine and 50 days.
-- Editor
