The Problem with Fundamentals
Like many top hedge-fund players today, Parker gives back to his community. He donated $500,000 to the University of Virginia for the “Chesapeake Capital Trading Room.” It was designed as “a real-world, highly sophisticated trading atmosphere.” Bob Webb, who is the Director of The Mclntire Center for Financial Innovation at UVA, graciously gave a tour of the facility. With numerous trading desks and large quote screens on the walls, you appreciate where every dollar of Parker’s donation went.
Webb, who is a finance professor at UVA, sees the Chesapeake Capital Trading Room as “the ideal environment to illustrate real-time events in financial markets. Students are able to examine the financial markets’ reaction to news events. Working there allows them to look at recent changes and explore what factors promoted the changes.” Webb says that “students get their feet wet right away. They’re able to make predictions, based on real events, from the first day of class. They can then look at factors that later cause prices to change, and that helps them to make better decisions.”15
One business student unaware of Parker and the original Turtle training environment, that office with cube dividers and no TVs, excitedly described the new Chesapeake Capital trading room: “It’s fantastic to be able to use the software to look up information about any company. You can get balance sheets, income statements, ratios, growth patterns — just about anything.”16 The irony, of course, is that Parker would never use “just about anything” to make his trading decisions.
Bob Spear runs a systems-testing software firm with a program called “Mechanica.” He has arguably the most powerful software programs for testing trading systems available to the public.
Two Turtles became his clients over the years: Jerry Parker and Erle Keefer. It was one of Spear’s software ads that caught Parker’s attention. The ad blared: “Trading Recipes pinpoints winning systems, then supercharges their performance!” The 1994 ad spoke of “money management” (what William Eckhardt called risk management), a rarity then.
Parker didn’t know at the time that there was software available to test the Turtle trading systems and money management (see chapters 4 and 5). When Parker first called about Spear’s software, Spear knew immediately who he was. He said, “He didn’t have to explain to me Chesapeake Capital.”
The contradictions between Parker and these statements by a UVA professor and student are not intentional. Webb, an accomplished professor simply teaches a philosophy that sharply contrasts with Parker’s. For example, consider Webb’s view that individuals at the Federal Reserve beyond the chairman can impact financial market prices through their comments. He said, “One consequence is that traders must monitor the comments of a number of individuals at the Federal Reserve System.” Webb’s advice is plausible to many on Wall Street and Main Street who follow fundamental analysis, but his observations do not line up with the trading approach of the Chesapeake Capital Trading Room’s benefactor.
Like his mentor Richard Dennis, Parker wouldn’t consider monitoring multiple voices at the Fed to make a trading decision for a nanosecond. Consider, for example, Parker’s standard disclosure, “Chesapeake believes that future price movements in all markets may be more accurately anticipated by historical price movements within a quantitative or technical analysis than by fundamental economic analysis.”17 With that kind of clear statement of intent, how did students enjoying the Chesapeake Room at UVA miss understanding Parker’s trading style?
Over his career, Parker has repeatedly gone out of his way to educate everyone that technical traders need no particular expertise in the markets they trade, saying, “They do not need to be an authority on meteorological phenomena, geopolitical occurrences or the economic impact of specific worldwide events on a particular market.”18 Parker often borders on exasperation as he fights to get that message across: “If the alternative is massive diversification stocks only, buy and hold, or listen to some analyst with a fundamental point of view. Well, you see what that’s got us.”19 That logic can be hard for people to accept. Investors want big money potential along with a sophisticated story that makes sense fundamentally.
And even if investors understand Parker’s Turtle style enough to invest, they don’t want to watch their account equity going up and down. Even Parker’s clients focus constantly on monthly rates of return. They hold him to a high standard, with admonitions like “Don’t give back my monthly profit,” “I am concerned with all of this monthly data,” and “You’re behind this month versus last month.” Parker said flatly, “It is crazy.”
He added, “I think that risk from initial capital, losing 10%, that’s a serious thing. If I’m up 50%, now I’m up 40%, that’s a whole different thing. But not to clients! Not to the ratios. So we’re screwing around with our profitability when we’re playing with the market’s money, and trying to fine tune the performance table so we don’t have what looks like a risky investment, even though it’s risky. But a much different risk than the risk on initial capital. So I think it’s ridiculous.”20
Dressing up his performance to make it more palatable to nervous clients is not something Parker likes:
No matter how well we do, I’m always being met with people who are telling me, “doesn’t matter how much money you make or how well you do, I just don’t like your style. I don’t like the style that relies upon price only. I don’t like commodities. And it’s hocus-pocus.” When we’re down 20%, my gracious, [they think] we’re on our way out of business. I’ve actually had people calling me on the telephone, [when] maybe we’re down -12% and they’d say, “You’re never going to come back. You’re never going to make money. Forget it.” But if NASDAQ’s down -40%, that’s a pretty good buying opportunity.21
The odd truth about fundamental traders is that behind closed doors, they often trade very similarly to Parker. In public they might talk about the NASDAQ down 40 percent as a good buying opportunity, a value play, but for their actual trading they look for trends.
Parker saw this contradiction firsthand when he was purchasing quantitative information from Ned Davis (a well-known analyst on Wall Street). Parker was getting faxes every day, and he would compare Davis’s analysis to his own positions. Parker, the trained skeptic, said to the staff at Davis’s office, “It looks like a lot of times, almost all the time, my positions are same as yours.” They told Parker, “That’s true because even with all of our good analysis, if we don’t put a trend following component in it, it doesn’t do very well.”22
That said, the most successful Turtle doesn’t sugar-coat his style of trading. He addresses the drawbacks head on. When he compares his philosophy to a form of government, he sounds like a down-to-earth Sunday school preacher:
Trend following is like a democracy. Sometimes it doesn’t look so good, but it’s better than anything else out there. Are we going to rely on buy and hold? Buy and hope, that’s what I call it. Are we going to double up when we lose money? The world is too big to analyze. The fundamentals are too large. We need to aggressively, unrepentantly sell trend following and describe it as it is: a system of risk controls that gets in the right markets at the right times and limits the disaster scenarios.23
Hedge Fund Blowups
In Jerry Parker’s world, the unexpected eventually happens. If you think the world is tidy, get ready for the hurricane to blow you away. For example, if there’s a good side to the 2006 implosion of the Amaranth hedge fund (to the tune of $6 billion), it’s the embarrassment suffered by the state and city pension funds that invested in it. And in Amaranth’s case, its name (a mythical flower that never fades) may have held a hidden meaning. The secondary meaning: a pigweed.24
And “pigweed” all started with “mean reversion.” This term, with its academic overtone, may make some people cringe, but understanding its ramifications lies at the heart of why hedge funds Amaranth and Long Term Capital Management went belly-up.
What is mean reversion? Over the long haul
, market prices have a tendency to “revert to the mean.” That is, studies have conclusively shown that when stock prices (or any price, for that matter) get overextended to the upside (or to the downside), they eventually fall back in line with averages. However, stock prices do not exactly snap back into place overnight. They can remain overvalued or undervalued for extended periods of time.25
That extended period of time is the sandbar that sinks ships. People who bet on markets’ behaving in an orderly fashion (arbitrage) are panning for fool’s gold. Parker and the other Turtles learned a long time ago from Dennis that the hard thing to do is the right thing to do:
Mean reversion works almost all of the time. Then it stops and you’re kind of out of business. The market is always reverting to the mean except when it doesn’t. Who wants a system like we have, “40% winners, losing money almost all the time, always in a draw down, making money on about 10% of your trades, the rest of them are sort of break even to losers, infrequent profits”? I much prefer the mean reversion where I have 55% winners, 1% or 2% returns per month. “I’m always right!” I’m always getting positive feedback. Then, maybe in 8 years, you’re kind of out of business, because when it doesn’t revert to the mean, your philosophy loses.26
Hearing Parker’s Southern cadence as he preaches about mean reversion hits home. Consider an example that makes his point: Let’s say an investor gives a trader money because his two-year track record shows he made 2 percent every month with no down months. Six years later, that same fund blows up and that investor’s retirement is gone because the strategy was predicated on mean reversion. It is human nature to believe in mean reversion, but as Parker says, “it just is a fatal strategy of trading the markets.”27
“Fatal” is the kind of word that grabs you by the throat. “Most of the time” is not a good enough bet. The bottom line: Those hundred-year floods that give mean-reversion traders solace really occur every two or three years—and they can and do wipe out fortunes.
James River Capital
Back in the summer of 1994, the sign outside Parker’s offices in Manakin-Sabot, Virginia, listed two firm names: Chesapeake Capital and James River Capital. Since James River Capital smacked of State of Virginia geography, it could have been anything. It turns out that it was actually the new name for the firm that had risen from the ashes of Kidder Peabody’s managed futures division.
Jonathan Craven saw how critical James River Capital was to Chesapeake Capital’s start. He said, “I met Jerry through somebody I knew at James River Capital. Those guys introduced me to Jerry and I got hired in March of 1990. We were renting space from James River for a long time.” Investor Bradley Rotter added, “Jerry Parker did a very wise thing early on in his career. He associated himself with Paul Saunders and Kevin Brandt.” What Parker did was wise for good reason. Brokerage firms were the perfect partners to sell the Turtles to the public as something sexy.
On the other hand, Erle Keefer thought Parker’s success had an element of rolling the dice: “You would have never picked who, when they left the Turtle program, would be phenomenal or not phenomenal I think it was a crapshoot.”
“Crapshoot” is not quite accurate, but Keefer saw an element of randomness in Parker’s stratospheric rise: “What if it was another time in history that was for the so-to-speak ‘gambler,’ then it would be Tom Shanks who would be trading a billion dollars and Jerry Parker would be trading $250 million. I know a couple of other Turtles who didn’t want to trade public money. They wanted to drive a race car rather than an aircraft carrier.” Keefer saw other Turtles who could have had Parker’s level of success. He said, “If Paul Rabar would have got with those guys at Kidder Peabody rather than Jerry, Paul Rabar would be the one that you’re writing about as trading a billion or two billion dollars.”
However, Keefer was not slighting Parker: “Jerry was at the right place at the right time and what he did is he did not impede himself. I say that in the most positive of ways. Too many of us are presented with an opportunity in life and we hesitate.” Exactly. At the end of the day, Parker had to swing and hit the ball hard to win the game. He had to make it happen. Parker whipped the bat through the strike zone with ferocity.
However, don’t expect to see Parker on CNBC explaining how to make money on unpredictable disasters. Don’t expect to see him on Fox News debating politics with Hannity and Colmes. You have a much better chance of meeting Parker at the local Richmond, Virginia, area Starbucks. The lesson: Be alert when buying your next morning coffee. You just might meet a good trader to handle your retirement money or the needed benefactor for your political run.
12
Failure Is a Choice
“I ran out of gas. I had a flat tire. I didn’t have enough money for cab fare. My tux didn’t come back from the cleaners. An old friend came in from out of town. Someone stole my car. There was an earthquake! A terrible flood! Locusts! It wasn’t my fault, I swear to god!”
Jake Blues,
The Blues Brothers Movie
Understanding why some Turtles were swallowed up in the pressure cooker of ego and expectations while others went on to great success reveals what is necessary to achieve long-term success. Liz Cheval was blunt: “The most interesting thing about the Turtle program was observing who succeeded and who did not.”1 Cheval never expanded publicly about which Turtles fell into which category, but the evidence about which Turtles she was referring to was becoming clear.
Dennis himself acknowledged in a 2005 interview, “You could make the case on reflection that it didn’t make much difference who we picked. The people who could sustain trading after the Turtle program did so pretty much according to their abilities. While they were sort of under our control, it didn’t make much difference how intrinsically smart they were.”2
In fact, when referring to intrinsic intelligence, Dennis makes the point that executing a well-designed trading system does not require, intellect as a key factor: “Good traders apply every ounce of intelligence they have into the creation of their systems, but then they’re dumbbells in following them. You’ve got to have a schizoid approach. Work like hell to make it good, and then ignore it like you’re a brick wall. President Bush would be a great trader if he had a system.”3
Others offered a far different view. David Cheval, a peripheral player in the Turtle story, and Curtis Faith didn’t buy the “anyone can do it” premise from the man who actually proved it.4 Faith said: “You can certainly teach trading and trading concepts. You can teach someone to be a successful trader. There were marked differences in the performance of the group. So some people couldn’t apply or learn trading. Some took several years to catch on. I do believe that legends are born not made. Decent traders can be made however. So I’m in the nature and the nurture camp.”5
The Turtle story does not straddle the debate. Dennis proved conclusively that nurture trumped nature. However once the Turtles were out of his program and out into the real world, many tried to capitalize on their fame in an assortment of different ways. Their behavior provided fascinating insights about what not to do if making big money making is your goal.
It turns out that Russell Sands was not the only Turtle to dispense Dennis’s rules. Curtis Faith, referring to himself as an “original Turtle,” started a website in April 2003 that at first promised to give the Turtles’ rules away free, provided those who found them useful sent a donation to charity “in honor of Richard Dennis, Bill Eckhardt and the original Turtles.”
Faith, without naming him directly, criticized Sands for profiting off the Turtle system: “… it always bothered me that some were making money off the work of Richard Dennis and Bill Eckhardt without their consent.”6
That said there is no evidence that Dennis had anything to do with giving away his rules for charity. When asked about the rules being offered free online, he sounded resigned: “Once I was walking down Michigan Avenue and I heard somebody talking about it. It was pretty clear that they were looking at the
stuff and that they thought it somehow had my blessing. What can I do?”7
But Faith’s charity soon turned capitalistic. In 2006, the website he created switched gears, no longer asking for a charitable donation. The website now charged $29.95 for Dennis’s rules. Faith and his firm were doing what he had criticized Sands for. Additionally, while he had criticized Sands for not trading profitably, there was absolutely no evidence Faith was trading successfully either.
When explaining his career ups and downs, Faith referred back to the money he made sixteen years before as a Turtle: “You’re probably thinking, ‘What happened to those millions?’ More than half went to taxes, about a quarter went to charity and helping my father out, and the rest went to start various businesses.” He said the biggest chunk, $2 million, was invested into a software company.8
Faith explained in online chat rooms how this software firm (which later became the focus of an SEC investigation) went bankrupt. He blamed the firm’s implosion on a newly hired CEO. At the time there were personal issues at play, too: “I went through a divorce and gave pretty much all of the non-risk assets to my ex. I still loved her, and we parted on good terms so I gave her the house, porshe [sic], etc. Long and short of it is that I don’t have as much as I once did. I’m not complaining as I’m still better off than most.”9
But different characterizations regarding Faith’s purported 2003 stock-trading losses, a disgruntled employee, and his personal solvency were making the rounds in cyberspace. Faith commented on rumors of his money woes in 2004: “I am not broke. I have had several periods in the last several years where I was very, very low on cash, but that’s not the same thing as being broke. Even if I had been broke, I’m not sure it matters as I’m selling software, not advice on how not to ever go broke.”10
The Complete TurtleTrader Page 18
