Trend Following Mentor reveals the Hard Truths about Trading – Interview with Andrew Abraham of Abraham Investment Management

Andrew Abraham

23 Feb Trend Following Mentor reveals the Hard Truths about Trading – Interview with Andrew Abraham of Abraham Investment Management

Andrew Abraham released his book, The Trend Following Bible, at the end of 2012 and he sent me a copy for review. You can read the book summary here. I set up the interview with him in Jan 13 where he talked about several aspects of the trend following technique. He currently trades for himself and his clients, and he also conducts courses. Here is the interview. Enjoy!

How long have you been trading, Andrew?

I started trading in 1994 and I probably made every mistake possible. I managed to learn from the mistakes though.

Who was your mentor?

I had two mentors. One of them was my broker, whom I went to college with. He learned from Ed Seykota and Van Tharp. He taught me there is  no magical system or anything like that. He also shared with me his most successful investor was a dentist who adopted trend following in his trading. This dentist started in 1979 and made a lot of money over the years.

Why trend following?

Trend followers have had a very rough 2011-12, and then you have some very famous money managers and trend followers that are closing like John Henry. It is contrarian play when people are saying that trend following is dead. In 1979, the cover of Business Week stipulated the dip of the stock market and 1982 was the beginning of the greatest bull of market we’ve ever had in stocks. So, as much as people are talking about the death of trend following, I think it’s a screaming buy from every facet of the contrarian standpoint. Looking at the amount of money leaving trend following funds due to the poor performance from the past 2 years, this is a golden opportunity for trend followers. And then, with the idea of the amount of money that was printed throughout the central banks, I can’t help but believe we are going to have some massive inflation. And the only place to hide really is, in a trend following portfolio. Trend following has to work because if Richard Donchian and many others, had traded profitably with this methodology for 50 years. Even with the last two years being very difficult for me, I know that the concept will work over time.

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How long did it take you to become a profitable trader?

I’m not sure if the right word is ‘profitable’ or ‘consistent’. I would say ‘consistency’ is even more important than being profitable, because once you are consistent, it leads to being profitable. Once you develop trading plan. So, in context, it depends of what the markets give us. At times there are trends, and at other times, there are no trends. The most important issue I learned was to build a trading plan.

Really the key is, and it’s probably not what your audience wants to hear, because what the audience really wants to hear about the ‘Secret Sauce’, the indicator, the engineering miracle of alchemy, but the real truth is and it is instilled in me, was how to think. To realize I cannot avoid a loss. To realize that I had to accept risk when I put up a trade. To accept the outcome and then put out the next trade. Not to have fear, or greed. To realize the importance of having a well thought-out plan so I know at every moment what I need to do, what I need to buy or sell, how much to buy or sell and when to exit with a profit or a loss.

What I’m hearing is that the turning point has to do with psychology. It is the point where you start to realize that you need to manage your emotions with regard to handling the losses. It is this understanding that have turned you into a consistent trader. Am I right to say that?

100%. I’ll give you another example. When most people put on a trade, they feel they are entitled for the trade to work or make money. When I put on a trade, I say, how much is this going to cost me to see if it will work. It’s important that people really come to terms with it because you have to realize anything can happen. There are no perfect anything and what we can do is manage risk and manage our expectations and be consistent in order to compound money.

When you say ‘consistency’, are you referring to the way you trade is always the same, or rather, profits are consistent.

Good question. The reality is like this: You want to make it as though it is a business plan. You want to be able to recognize what an opportunity looks like. You want to have the fortitude to take that trade, and then you also want to have risk management on your positions. There are no guarantees that any trade will work out. And being consistent is doing the same thing over and over again as per the trading plan.

There are only 4 possibilities: the Big Loss- which we need to put proper stop orders to protect against; there are the Small Losses- Small Profits, which we should not worry as they will offset each other. And then, to realize that the big profits are rare and few in between. And no one ever tells you when they are going to happen. You have to continue to put on the next trade.

I understand that. I’ve actually done trend following in the past. And like everybody else, I have experienced consecutive losses. I always thought that I had picked the wrong stocks, and the consecutive losses discouraged me from trading. The moment I stopped trading, the market starts to run. This cycle keeps repeating; and that is why I can vouch for what you said in the book – trend following is simple, but it’s not easy.

Yes, but in the book I spoke about a filter where it gives you an advantage over most other trend followers. I rank the markets based on strength or rate of change. What you want to do is you want to buy the strongest markets. First, you need to identify them. Then, you wait for some type of signal which in my case is a break out. I will take the break out if it a low risk trade where I can risk a small percentage of my account size to see what happens. The strongest market may possibly continue to run or maybe not.

What program do you use that can help you do all the screening for you?

I use Tradestation, Mechanica, and Trading Blox.  There’s no magic system. What the magic system really boils down to, is the way to think. Like the way you mentioned you had numerous trades in a row that didn’t work. The key is to understand that yes, they aren’t going to work and that is why you keep the losses small, and that your big winner is ahead of you. That comforted me, or convinced me. The psychological aspect of trading is the most important issue and it is also where I had the hardest time.

On the back of my business card I have these 4 lines written: “Trade with the trend, Cut your losses, Let your profits run and Don’t let the big profits get away“. This is as simple as it is, yet we make it so hard because of the emotions and the fears and the greed.

I understand that you do teach and run courses. Let’s talk about it.

Yes. I feel I’ve been very blessed and it’s a way to give back. I’ve had people helped me. Trading is very difficult. And as you know, most people or let’s say 90% of the people, try to trade and fail.

I made the course initially for my children. They have been trading since they were 12 years old and they are in University now.  What I did was, I made the course into videos and written material and charge US$100 dollars. That’s it, small money. And if someone wants personal mentoring, I charge US$5,000 and we coordinate time like on Skype to develop a trading plan. We go over everything repeatedly as well as the most important thing, trading psychology.

How long does it take for someone to really learn the ropes and trade on their own?

It depends. Some guys have gotten it and I’m really proud, and I had one guy in Australia who didn’t really want to follow it. Another guy, it was like Las Vegas. It was exciting, and gambling and that is the wrong mentality. My mentality is to compound money. I don’t do this for fun, what I do is boring. And boring is good!

As I said, teaching is my way of giving back but my main focus is to grow my money management business based on the principles and values that are in this book.

What do you find more satisfactory: teaching someone and they become successful or helping someone compound their money.

Both. The goal is to help people.

I agree with you that teaching is only effective for a small group of people who can follow trend following diligently and with discipline. But most people are not able to take draw down and losses, and it is very hard for them to change their psychology and way of thinking. I’m glad that you say your focus is on managing money and helping people compound their wealth. I think that is more palatable for most people. You should share more details about your funds.

I have 3 types of programs. They are based on the risk management of what the client is anticipating, or what they are willing to go through. The first program is called Formula 72L, which I attempt to make portfolio volatility low, from 8% to 12% drawdowns. I made this program on the request of an investor in my other program and I built it over a year. I’m trading it with proprietary money first, to confirm that this is what it does. The second is called Formula 72H which is a higher volatility where I anticipate having much higher returns as it did very nicely in 2010 with 34%. Conversely, it’s going to have bigger drawdowns. I’ve been trading this concept pretty much since 1994, with enhancements along the way. And my worst drawdowns were in 2005 and 2006 which were in the mid 30% range. And again, the worst draw down is going to be ahead of me, not behind me. Lastly, I have the Formula 72M, which is a mid-volatility fund. We’re attempting like 15% returns and my worst drawdown was in the mid 20% range.

That’s the other good thing about letting people know to expect a potential draw down so that they can accept. I think most people will just ask, ‘what are your returns?’ Before they decide to put their money with any money manager.

You know what, I’m going to qualify that. Because in 2007-08, trend following was fantastic. It was the only strategy that made a lot of money. In 2009 was very difficult. And then 2010 was okay for some trend followers. And what I want to say is that some years I’m going to do much better than others, and then there might be other years I’m going to under perform. But 2011-12 were really rough, a tough period for trend followers. So when someone asks, ‘How was the last year?’ It’s not the issue. The issue is please tell me how does your strategy work, differentiate to me, explain to me, is it logical, how do you manage risks, and if that makes sense for my account?

There are two things that you are looking for when you invest with others: How the person trades and what are the risk managements in place? Are there any other questions an investor should ask a money manager?

That will basically explain. But let me backtrack a little. I do two things to compound money. First, I trade my own money. Second, I invest with other money managers. I’m humble enough to admit that there are years I will underperform some other managers and there will be other years I will outperform them. By doing these, I have a higher chance to compound money over the long run. In my new book, I spelled out the considerations to choose a money manager. They must minimally compounded at an annual rate of 15% for 10 years. The assets they trade must be liquid. They must be transparent with me about their strategies and I want to understand the risk management. I don’t look at how much I am going to lose. There are other attributes that are in that book and I also discussed about Madoff, and how people should do their due diligence.

What is your routine for a trading day?

My day starts at 5 in the morning. I put in data and run my programs for about half an hour before I send my first order to the trading desk in Chicago. Then I work on my stocks which will take about an hour. The rest of the day is mainly research. I have a programmer who is in California and who is as passionate as me about trading. Sometimes we will talk in the middle of the night breaking down trading ideas to test. When the Asian markets open, I will also see if there is any work to do with Chicago. It is all mechanical without expression or emotion.

There are a lot of orders for futures trades so I detail them in a spreadsheet and I email to the trade desk or whichever broker I use. For stocks, I do that online since there aren’t many. I’m looking at maybe 10 or 15 trade ideas and I don’t trade stocks in and out that often. If the stocks are moving up, I will adjust the stop orders higher to trail the prices. If they are not, I’m looking to see what replaces them.

If we are below a 200-day exponential moving average in the stock market, I’m out. I’m sitting on the sidelines. It is very difficult and whippy at times to go short. Also, when you are long only, you can make much more money over time than trying to go short.

Does it mean you that you would not short stocks?

No, because in the past I did. I said to you, I spend so much time researching and testing to find enhancements that can generate higher and smoother returns with less draw downs. One thing I discovered – on the long side you can make more money with lesser draw down.

What are the charges for your funds?

For Fomula 72L, I charge 1% management fee and a 15% performance fee. I charge a lower performance fee for this fund because I do not want the cost to eat into the clients’ account. The other programs which could have better returns, or also greater draw downs, I charge 2% management fee and 20% performance fee, which is the norm in the industry.

What are the minimum investments for each fund?

US$300,000 for Fomula 72L and US150,000 for Formula 72H and Fomula 72M.

Does the client need to be an accredited investor?

No. They do not have to be accredited or a Qualified Eligible Participant (QEP).

Are there any lock in periods?

No, that’s the beauty. They can liquidate everything easily.

Can we elaborate a little more on your funds. Let’s say someone overseas is interested in investing in one of your funds. How would he go about it?

There’s a company called Straits Financial, they have an office in Chicago and Singapore, They can open a managed account with them.



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