INTERVIEW
“The greatest invention since I started trading is the eminis.”
At Last It Can Be Revealed
Jay Kaeppel On Trading Futures And Options And Gold And Sectors
Independent trader and author Jay Kaeppel is a trading strategist with Optionetics, Inc., and writes a weekly column titled “Kaeppel’s Corner” for Optionetics.com, conducts online seminars, and contributes material to new trading courses. He was Head Trader at a commodities trading advisor for nine years as well as a trading system and trading software developer for 15. A prolific writer, Kaeppel has penned numerous articles for Stocks & Commodities over the years, including a series of articles on his Provest option trading method in 2008. An avid systems developer, in 2007 he collaborated with Optionetics to create the Optionetics Futures & Commodities Home Study Course, and in 2008 he collaborated with Rick Pendergraft of the Pendergraft Research Organization and Tom Gentile, cofounder of Optionetics, to create the Velocity Strategy system.
Kaeppel is the author of a number of outstanding books including his current one, Seasonal Stock Market Trends (Wiley 2009), as well as The Four Biggest Mistakes In Option Trading, The Four Biggest Mistakes In Futures Trading, and The Option Trader’s Guide To Probability, Volatility And Timing.
Stocks & Commodities Editor Jayanthi Gopalakrishnan (JG) and Staff Writer Bruce Faber (BF) interviewed Jay Kaeppel via telephone on September 9, 2009.
Jay, how did you get interested in technical analysis?
I started out interested in numbers. I was always a sports numbers guy. I knew everybody’s batting average and all that. When I got to college, though, I realized this wasn’t going to do me much good. Then I happened upon the business page of the newspaper one day and I noticed the stock prices, and it was like, “Wow! There sure are a lot of numbers here. I wonder what this is all about.” It started from there and progressed.
After I got out of college I was in accounting for a while, still fixated on numbers, but then I started following the stock market. I began reading everything I could. I was looking at fundamentals and technicals, and I fell into the technical end of things. I could read all about the fundamentals and analyze them, but the analysis I was doing there wasn’t doing me any good.
JG: Why do you think that was?
I would read about earnings forecasts and things like that, and it drove me crazy that you could get a company that comes out with record earnings, but the earnings would be three cents off of what the analysts expected and the stock would be down 15% for the day. That still happens today and that still drives people crazy. When you get the call right but you still lose money, that is tough.
JG: It is! Please continue on your journey into technical analysis.
The company I was with got bought out, so I got laid off. In the mid-1980s I started writing a newsletter on mutual funds and trading on my own. In the late 1980s I joined Essex Trading, which at the time was a software firm, and we put out programs like Futures Pro and Option Pro. They were quite popular for a while. Then in 1995 we became commodity trading advisors (Ctas). I was the head trader for that. I developed all the trading methodologies we used, and risk management techniques. I did that for nine years, and we made money in eight years out of those nine. The other year we lost 2%.
At the end we went from a maximum drawdown of 8% to a maximum drawdown of about 13% and some of our biggest customers felt that was a warning sign, so they pulled their money out, and at that point the business wasn’t there any more. So I left Essex and joined up with Optionetics in 2004. I’ve been consulting with them for about five years. I write a weekly column for them on Optionetics.com called “Kaeppel’s Corner.” I can basically write about any topic I’d like. I also work on projects for them.
A couple of years ago I did the Optionetics Futures and Commodities Home Study Course. It was about three days of taping for six hours of video and by the end I really did not want it to end. During the last hour we were just bantering about markets and trading, and it was a lot of fun. I also do a lot of writing, as you know. I write articles, and I have written four books.
JG: Having been in the market myself for 20 years, I thought it was interesting that you mentioned before we started that you felt that trading revolved around two principles. Can you explain what they are?
I always tell this to people who are starting out, and they go, “Oh, that’s interesting.” But the people who really appreciate it are the people who have been doing it for a while but have lost focus. Basically, the two key principles to trading are:
- To develop or adopt a method that has some realistic probability of making money in the long run. You can be trading off of one-minute bar charts, or you can be trading once a month, but you have to have some reason to believe that it is going to work over time.
- To have the financial and emotional wherewithal to follow and stick with your method. What I tell people is that whatever you are doing in terms of trading, every once in a while you have to stop and ask yourself, “Where does this fit into these two principles? Am I helping myself develop a better method in the long run? Am I making sure I am controlling risk, and will I be able to come back tomorrow? Am I overextending myself?”
JG: As far as the first principle goes, how do we go about determining whether a system or method is realistic?
First of all, it depends on what you are looking at. If you start with a simple idea such as channel breakouts, volatility, trend-following with moving averages and so on, it is helpful to do some back- and out-of-sample testing. This gives you an idea of what it could look like when you actually start to trade it. People are very fortunate today because there is a lot of computer technology that wasn’t available when I started. Back then, I had to go to the library and write down Value Line stock index futures prices off of the microfilm. Nowadays, you can load up 30 years of data in about a nanosecond, and you are ready to go.
The other thing that is useful sometimes — and I think it was Alexander Elder who wrote about it in one of his books — is that you develop your strategy, whatever it may be, and then walk through your backtest one day at a time, on paper. I found this to be especially true for option trading. You try to get a handle on what it is going to be like when you are doing it for real.
I am, however, of two minds when it comes to paper trading. On the one hand, it is very useful to paper trade just to get the mechanics down and to get a feel for what you are doing. But the problem a lot of people run into is that they are really good paper traders. When they actually have money on the line, though, it becomes a different game. There is that feeling you get in the pit of your stomach when things start going the wrong way, which you don’t get from paper trading.