Rob Hartman knows that showing up is half the battle when it comes to work in any industry. But his viewpoint as a solo fund manager give us deep insight into the inner-workings of a firm and how it deals with drawdowns, track record, and investors’ questions. In Part 2 of our conversation with Rob, we dive into his models and programs and how each of them works. We also learn about Rob’s background that helps round out this picture of a successful manager.

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50 YEARS OF TREND FOLLOWING BOOK AND BEHIND-THE-SCENES VIDEO FOR ACCREDITED INVESTORS - CLICK HERE

In This Episode, You’ll Learn:

• Why Hannah Montana has some life lessons to teach.
• Rob’s track record and how to read it.
• What happened when he changed his strategy.
• The details of the programs he runs.
• How Vanguard, his flagship product, works.
• How he manages his momentum trades, or trend following trades.
• Why his thoughts on position sizing have evolved over time.
• How he conducts his research and why he doesn’t do any discretionary trading on his models.
• The risk that he focuses on as a smaller manager and how he manages that risk.
• How he deals with questions about drawdowns from investors.
• How Rob copes emotionally when he experiences a drawdown.
• What his research process is without a research team.
• What is the optimal number of rules for Rob’s models to have.
• What questions investors are missing in their due diligence.
• Books he would recommend for would-be managers.
• The advice he gives to his kids and the lessons he wants to pass on.

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Resources & Links Mentioned in this Episode:

• Van Tharp – Trade Your Way To Financial Freedom
• Rishi Narang – Inside the Black Box: A Simple Guide to Quantitative and High Frequency Trading

Rob also mentions getting inspiration from Kathryn Kaminski, who was our guest on Episode 41 and Episode 42.

Follow Niels on Twitter, LinkedIn, YouTube or via the TTU website.

IT’s TRUE ? – most CIO’s read 50+ books each year – get your FREE copy of the Ultimate Guide to the Best Investment Books ever written here.

And you can get a free copy of my latest book “Ten Reasons to Add Trend Following to Your Portfolio” here.

Learn more about the Trend Barometer here.

Send your questions to info@toptradersunplugged.com

And please share this episode with a like-minded friend and leave an honest Rating & Review on iTunes or Spotify so more people can discover the podcast.

Follow Rob Hartman on Linkedin.

Copyright © 2024 – CMC AG – All Rights Reserved

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PLUS: Whenever you're ready... here are 3 ways I can help you in your investment Journey:

1. eBooks that cover key topics that you need to know about

In my eBooks, I put together some key discoveries and things I have learnt during the more than 3 decades I have worked in the Trend Following industry, which I hope you will find useful. Click Here

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Niels

This is sort of a spur of the moment. Let me try if I can formulate this correctly, so it makes sense. So I have two young kids. I guess in particular my daughter Amalie she had a phase a few years ago where she loved Hannah Montana. So we often had to sit down and watch her movie in which there's a song called "The Climb", and what this song is all about is really that we all strive to get to the top of something or the end of a quest, but that the real joy and satisfaction that we get should not come from reaching that top but it should come from the climb to the top ie the process of reaching our goals in life, is this kind of where you are heading and actually say I take enough joy from the process of putting my trades on every day and let it take as long as it takes, but it's enough for me to be a part of this journey?

Rob

Absolutely and I was hoping that you might burst into song, but it appears you won't.

Niels

(laugh) Not today, Rob.

Rob: Maybe offline I'd like to hear you do that. But I agree that's really it. It's a lot of fun. I've tried to express that earlier. It just sort of appears to be in my DNA that I love the campaign. My twenty years of windsurf racing, it's basically, and I know it's very popular in Europe or at least used to be, now everybody kite surfs, right?

Niels

Sure.

Rob

Back in the old days it was sort of this messy affair where it looked like it was simple but it wasn't easy and then you'd go to just being able to get on it to then get it to move, and then to get right to the chase as you're now basically trying to take this thing as fast as you possibly can through the roughest water that you can find and you're being chased by other really fast racers. Just the idea that you could get to that point it makes me get up early and hit it hard every day.

Niels

Sure, sure. Well, from Hannah Montana, I want to jump to something completely different, and that is your track record. Not specifically, but you've mentioned in the last hour that we've been talking about a number of changes that you've made and the fact that you do research continuously, so how do investors read your track record? How do they make sense of what they're buying if they're buying from you? How do you help them along the way?

Rob

And the rational is many of the same methods... basically it's me using the same methods, the same ways, thinking about trading the same way, just on a higher timeframe, managing risk, getting a little bit of diversification and basically knowing that I'm not creating the Holy Grail. I'm just creating something that offers a unique return stream. And in the case of Vanguard, it's multi-day, to generalize again, US financials program. So, people kind of look at that and they go, "Well okay, your intra-day, and you know there is a story there, and you've had plenty of assets, so, you know.." And I've told them that I've managed simultaneously, a hundred and twenty-five clients while I was trading the intra-day program. You know, a lot of this is just staying organized and being willing to do whatever it takes to make money for the client. And I would add, in interesting ways.

So, you know... you can look at the track record now and you can see that I've been putting in new equity highs for a number of months now. But when I switched over to this new method, it was no easy task. I was in the deepest draw down to date, intra-day. I had a vision of what I wanted to do, and I had to make that leap. And once you make the leap, and you tell somebody that you're sort of changing a fundamental characteristic... you know shifting the marquee value to something else... you know you're going to loose... I lost probably two-thirds of my remaining clients, and I had to basically buckle down and begin to trade up, with the confidence that... you know not a sure thing... but the confidence that in the end this was going to be the best way to go forward.

Niels

Staying with that theme, clearly you've launched a couple of new strategies, and as you say, it's always difficult when you have to tell a client that you're changing the strategy that he or she has invested in. I mean, going forward, given what you've learned so far, is it too difficult to actually do that? I'm not talking about small research changes; we know they take place all the time. But is it actually easier to launch a new strategy, where you don't have the issue of potentially losing two-thirds of your assets? And just say, "I think this is a better approach, so I'm launching this new strategy, but feel free to stay with the old one if you want?" Or, are you planning on continuing to make the changes that you think are right, regardless of what changes in assets that that may lead too.

Rob

Well I think the situation with Vanguard was unique because... you know, I'm not out banging the phones every single day, and raising money like that's the only thing I have to do. I really depend on the databases and some visibility. So, when faced with the choice of basically, you know, erasing my existing track record with Vanguard, and starting fresh with, Vanguard #2 or whatever you want to call it going multi-day... the rational was why would I have Pacific Capital Advisors lights blink out, you know, in the marketplace? So again, I don't think my rational was too far out of line because it's me trading essentially the financials in a similar fashion up timeframe.

My belief now is that I need to have... well let me say that I think that what you're describing and what we're talking about is just such an incredibly difficult part of this job, as a CTA, because you constantly... maybe this isn't... let it be unfair right? But I constantly receive pressure from people about how you shouldn't change, limiting change, what are you doing? But the answer is these markets change. They're changing faster now probably than they ever have, particularly the financials. You have to have a response if you're going to work for people and make money for them. So my philosophy now is that I think people... I would express to my clients that you know; it's really not as strict as they would like it to be. I think the strictness comes in expressing each program as having an operating envelope. So the declaration that with Vanguard that I've got, you know the S&P's and the 10 and the 30... well I can certainly stick to that and it's got a margin to equity sort of risk range; you know again, part of the envelope that it operates in - the general holding period, and so forth. But the details within that - try not to worry so much. We can operate within that range.

Now, there is a point where you need to... you know it becomes a material change and you certainly at least need to declare it to other people so that they can back out, or whatever the case may be. But try to think of it as an operating envelope, giving guys like me, and especially any other beginner who has a specialty product, you've got to give it some room to move. And I think that's what's going... like with Terra, I believe the same thing. You know, it's livestock and it's grains, people would say why aren't you trading beans in there? Well, because it's a big, powerful contract, and it can really change the way it operates. Maybe it'll get added later, don't know, but there's the envelope: risk, markets, and direction that it's going. I hope that answers your question.

Niels

Sure, sure that's fine. And I think there is generally this debate and this conflict between investors not really wanting you to change, yet they want you to innovate. And those two things are very difficult to completely align. But you know, you find a compromise and as you say, the most important thing is to make sure your investors understand the change and usually they will give you the benefit of your expertise, and stick with you... so I appreciate that.

Now let's move on to the heart of the strategy. Namely the programs itself. Now, you have three programs, so we may not be able to cover all three, and maybe there is some commonality between them, but I would love for you to dive into... you know, either one really, but if you want to stick with Vanguard, we'll stick with Vanguard. So... but just tell me in your own words, how you've structured the program from a top-down point of view, and why you've designed it the way you have, and if there's a sort of particular philosophy behind where you are today with the strategy?

Rob

So I've tried to construct, basically three strategies and roll them together for the S&P. One is long only, which you know has... can take a break out or it can buy on limit on a dip. And it does have targets, so it likes to be long and it likes to take bites, not necessarily run with the trend. And then if we sort of move up in the stack, I've got a strategy that is really sort of trend following and momentum based, and it has a lot of determination to stick with trends for as long as it can. And then that was particularly tough because the S&P goes through periods where it just really chops around and so I've tried to get the best compromise so that we can capture what clearly in the last few years has existed. It's just this incredible upside bias. So, try to capture that.

Then the scariest bit of all is how do you figure out how to short this thing, especially in recent years. And so I've got another strategy that is short only that rides on top of those guys. And I would say that it's not promiscuous. It's careful, but you have to have a way to get short your tops on occasion. I should mention that that momentum based one will go long and short. So theoretically, we've got exposure if we get into a long down trend, it can get into a short position, stick with it. However, it will be doing battle with the other strategy, trying to get long and so forth. So this is the challenge that there is no simple answer but you just have to sort of attack it with the best set of strategies you can.

Niels

Sure and do you use the same three strategies for the 10 years and the 30 years in Vanguard? I mean is it really, you know... you develop the same model parameter sets?

Rob

No, no. I'm one of those guys that does individual strategies for individual markets. And so while you know, as I like to say, "They may all be dogs, but those different breeds sure behave differently." So the 10 and the 30, if I was to characterize them, I'd really go for a mean reversion entry on those, because those markets by my observation and testing tend to stretch and then rubber band back, and that gives a bit of an edge for better P&L getting in. And then in some cases, depending on how it plays out, it will get out on a target if it's wobbling around in a range. But, thankfully, if it starts to exhibit the proper characteristics, when it's in a position, it will continue to stick with it for long periods of time. Long periods being, you know... the last year and a half I've had a month, month in a half long trades that have worked out well. So it's almost like it's a mean version strategy with an option to stick with a winning trade. So yeah, that's kind of the two.

Niels

Can you treat the 30 year and the 10 year exactly the same? Or even between those two you have to have slightly different parameters?

Rob

Even those two are different. So I should probably describe what it is I do to develop these and why it's kind of different. And it applies to everything I'm doing now, is you know... back to the old days, get a big portfolio, line up the data, and then begin to essentially add rules. You pick the core rules, some filters, you know, and you sort of work your way through to find out what singular or you know, small subset of strategies that you can run across all of those markets. And that has a particular process I'm very familiar with. And then when you get into the single market stuff, the challenge is getting enough trades to have... to build what you believe is a non-curve fit system that has some statistical... theoretically has some statistical reliability going forward.

So, my challenge is, how do you get enough data? Well, there's a few things that work in our favor here. Ten year, and you know, those financial products go back to having been pit traded back into the 80's or even the 70's. And also with the agricultural products as well, they go way back. So we have a pretty nice long data stream, and the catch here is that if you... you need to work on what I would consider to be a short timeframe, you know, an average trade of, typically being, you know, between let's just say four and eight days. And so when you sort of look at it that way, and you look at many, many years like that to develop on, and even hold, and of course you have to hold some of the data as out of sample for validation. On that short time frame, it gives you an opportunity to really find out what sort of... I call it the thumbprint of the market is.

To go back to your question, there is a difference between the thumbprint of the 10 year versus the 30 year. And the S&P is certainly different than the other stock indices. Most of them don't go back very far, which presents other challenges. So that's what I do, is I... what I find is that, I mean it's really lovely when a trend appears, and you know, you're fortunate enough to have a position on the right side of it, and you hang on, you get these wonderful trades. Really, the dirty work and the hard work is how do you survive those consolidations and the difficult periods, and what sort of details and vagaries are associated with each of these markets. How can you sort of "suss" those things out? And without adding too many rules, hopefully very few... essentially not curve-fitted, but find a way to do better during those tough times while clearly enjoying the majority of the big moves with momentum and so forth. So that's generally it.

Niels

I mean some people would argue and say, well actually the way you survive those periods is by... through diversification. Yet you've chosen to be very specific in your... in the portfolios of each of the programs. I know you've said, you know, people can choose, and they can put it together. But, have you ever been tempted to say, "Let me just put together the best possible program and let it include all the markets that I think is necessary to have." You know, better performance during the times when, maybe when the financials are being a bit tricky?"

Rob

So, having said that, when you look at the liquidity available and the size that can be traded in the ag markets, I think... I don't want to undermine the performance of the Terra program by trading those same markets over in this program I call Spectrum. So, they would be exempt, but pretty much everything else is on the table. And you know... by the way, I don't only have... I think what I should mention is that I have, (what I) call an inventory of strategies. So, even though I'm running essentially a subset of what I have in inventory, that's what I think is the best stuff to run at the time. It's very sticky, and I don't change it out. But I'm constantly generating inventory of other strategies that run on other markets. And it's not just the single market, single strategy. It's... I do have portfolio strategies that I've also developed... and they're, you know... like I have a grain strategy, I have a currency strategy... but they're all portfolio based so they're designed to work together in a portfolio. So I would invoke those as well.

Niels

Sure. And just on the program side, does that... you know, Terra, for example, does that then also mean that each of the markets in here will have its own, not just models, but also parameters? Or do you actually trade some of the markets completely different, not just where there're slightly different parameters, but maybe using different types of models?

Rob

Yeah... Terra, really all of those markets, you know, I enter on a stop. I make the market come and get me; I don't put any limits out there so that I can get filled and have limit up or limit down for three days just for kicks. So, they use very similar entry tactics. There's a lot of commonality with them where they really differ. And I don't want to... I don't use an oscillator that I twist a knob on... you know for a look-back. I have a few stable un-adjustable blocks, and they have very short look-backs. And then I combine that, depending on the market, there's certain you know... I use nerd stuff here, Boolean expressions, so that I can identify patterns for when to get long, short, or out... you know, reverse some of them, well, all of them will actually reverse periodically.

So, you know the answer is, is that entry tactic is the same for all of them. Their overall behavior is very similar, in that there's a trade-off... hopefully you'll enjoy this... A true trend follower might sort of sniff at what I'm doing, because, I don't have a rule that says, "Hey! If this market is getting away from us, then this is last call, you've got to get long or short, you've got to go with the direction, because you can't afford to miss this trade." Well, in my case, I'm not dependent on any... my entire program isn't really dependent on not missing the big move. But, in fact, the trade-off is in each of these markets, with each of these systems, generally I will catch big chunks, and in some occasions all of the big moves. But there's no guarantee that I'll get all of it, and sometimes not even the majority of it. It's just the price that you have to pay; it's a tradeoff.

Niels

So in other words, essentially, you are more selective in your entries. It's not just about it breaking above a thirty day high?... and bang, you're in!

Rob

Right, no, there's particular setups and patterns for... and again, sort of if you think about it in the business logic, sure I'm going to get long at yesterday's high, or short at the prior days low, or some variant of that. But in the business logic, there's other setup elements that are tied to... again, looking back at thirty or forty years of a combination of electronic and pit data... I should mention that as well is that the electronic markets do trade differently and look differently than the old pit markets in the ags and so forth and in other places as well. But, what I do is I try to only trade during the liquid times. So I don't... I can't get in when Globex opens and, you know, trade into a vacuum. I use custom sessions to make it so that I'm executing... or I'm available to execute orders. Really, back aligning with the pit hours still. And that's where the liquidity is, and fortunately when you look at the data, recent data, in the last eight to ten years that's electronic it merges nicely with the pit data and you can divine the thumbprint and execute in liquidity.

Niels

And for your momentum trades or trend following trades, do you have like a favorite indicator you just think is more reliable? And I'm not talking about specifics here, and I'm not asking for you know a thirty day high would be better than whatever, but just generally speaking. Because there's obviously the debate about do you move moving average oscillators or do you use price breakout or whatever it may be? In your research, have you found anything that you think is more robust or better at identifying when trends start?

Rob

I'd like to say that I've found that I can be wrong on all accounts all the time. But there's no particular indicator of sorts. It's really the combination of... do we have the set up, you know, in the business logic, and then can it finish off with enough momentum to get me into a trade? And then... kind of the fun part of it is... and I really enjoy trading Terra in particular because you get into these little tight areas where I just remember being cut up in prior years with other programs. And it'll just sort of ping pong along and actually make a little bit of money, not a lot, but make a little money, loose a little. And generally make some money in that area. Then the best momentum trades are the ones where I get knocked into a position in this consolidated area, say in the middle of it, and then it breaks out and continues to go my direction... but it wasn't part of some twenty day look-back period or something... I just threw that sort of that nettling little logic that I've got there, and I managed to be going the right direction at the right time, and it took off. So that's, hopefully, helpful, but that's kind of the way I think about it.

Niels

And each model is allowed to take a full position every time, or do you scale in, or how does it get you into your full position?

Rob

Yeah, my position sizing thoughts have morphed. I use to do volatility adjusted position sizing over the years with trend following, and with my intra-day stuff. And with my latest round of research I've really tried to strip everything bare and I don't want to involve any sophisticated position sizing whatsoever with what I'm doing. And it doesn't mean I wouldn't move forward with something later on, but right now I just do a one lot, I get in with a one lot, and I exit the one lot. So there's no confusion in terms of... am I really finding a good pattern and doing the right thing at a very purest level with regard to the thumbprint of the market or do I really have kind of a slick position sizing?

Niels

Sure, so it's really the AUM that decides the number of contracts and nothing else?

Rob

That's right, so I'm doing one lot in each of those and... well, we're talking about Terra now, and that's a one lot. And with each of those, like when we go back to... well Agilis is a one lot in the Russell, the DOW, and the Nasdaq, those are one lots; and over on the Vanguard side, you can only be long two, or short two, or flat over on the S&P side. And it's one lots over with the 10 year and the 30 year, so it's just very bare bones.

Niels

But if you had ten times the AUM, you would just do ten lots every time you do one?

Rob

Yeah, I love that!

Niels

In terms of getting out, do you use stop losses when you trade? Or do you have to wait for a signal to change to get out?

Rob

There will always, after we get a position on, there will be a stop loss in the market. So I do use that. But then obviously, there's reversal signals that could get me going the other way. And there's also trailing stops that chase things eventually. And again, those are sort of pattern-based and so forth.

Niels

Besides the research, which obviously involves a lot of subjective decisions. Is there any discretion used in the day to day trading of the three programs?

Rob

No. No, there isn't. But I will say... I will promise you this... that if I think something is going... you know, the technical term I use around here is "kablooey," I will shut things down and extract everyone as fast as I possibly can. So it's really sort of a... I think of it as an emergency failsafe, is really the way I look at it. But I'm not over here, sort of, making willy-nilly adjustments or changes, no.

Niels

Let's shift gear to an important topic, which is sort of the risk management side. And I know there are constraints when you have a limited AUM in one way. But, on the other hand, risk is something we all need to think about, really regardless of the AUM we have under management. In your mind, what is risk? What's the risk you're trying to control? Is it the volatility of the P&L swings, is it the drawdowns? What's the risk that you're focusing on?

Rob

Well, within each of the programs there are two different things to look at. I have to now put a plug out there for one of your other guests... that did the trend following book... was it Kaminski... and so forth. Yeah, wonderful stuff. Because if you consider what's happening over in the financials area is that... more of a convergence strategy is agreeable with those sorts of markets. And that's my sort of tortured existence I have over there is trying to catch the big moves, step out of the way when they happen with your mean reverting programs. So essentially the... what I'm wrestling with over in those markets is, you know it's never really going to be just right. Don't try to make the equity curve too smooth. That means you've probably tightened it up too much... my mumblings to myself, right? And it's going to wiggle up and down, but we're configured such that we're... the equity curve will put in higher highs and higher lows, and there will be some... you know, there will be periods where it's sort of relaxed for people to look at their statements, and there will be periods where it may move up and down over the course of four or five days where, you know, they get a little heartburn from it. But it's the nature of managing that... that disagreement, right, between those two things.

Over on Terra, I mean, I just... it's really kind of fun, because you let it go... you know it's fun... alright here's the trade, we're long, we're short and I wonder if this is one that's really going to take off? The danger, of course, with any of these, is there's true catastrophic danger. You know, after 9/11, there's just... the idea that the markets... that we could lose an exchange for five days. And you're long, or you're short. And by the way, that's why I just do one lots is I just think of what it would be like to be over leveraged with too big of a position on one way or the other, and then you know, planes hit buildings, or who knows what... right? That's really sort of the worst thing that could happen.

But in terms of the P&L while we're trading, the beauty of... well, Vanguard at least has two sort of... you know, it's got interest rates and stocks that definitely gives some diversification because the difference in strategies and the markets. And over in Terra, we've got these wonderfully, oddball... don't you love them? The grains and the meats, and the sugars doing something else. So there's really, generally very nice diversification over there just by virtue of the markets. And then in another level of diversification because I'm not trading the exact same strategy on each one of them. So, there's some diffusion there.

Niels

I mean it's very interesting that you bring up Katy Kaminski, and for those who haven't listened to those episodes, it's episode 41 and 42. I think what you're saying, and I want to try to interpret that, is that the concepts of convergent and divergent strategies is really what you're trying to combine. And what Katy Kaminski really also concludes is that there is no wrong or right. It just happens to be that trend following is a divergent strategy, but at times, as we know, we all need some convergent strategies. So, it's the combination of the two. And I think, from what I'm hearing, in a roundabout way that's actually what you're doing by combining mean reversion type strategies in some markets with more momentum-based strategies in other markets.

Rob

That's precisely it, and I'd like to thank you for doing a wonderful summary of it. So, it is very much a divergent arrangement... in nature, over in Terra. And then there's that challenge that we have over in the financial markets. And just to sort of roll back to the original premise of what's happening over here is that you can mix and match with what you've already got or you can combine what Vanguard, Agilis, and Terra... and you really have a fairly affordable... the 100K minimums... Because I don't have a broad portfolio with a lot of participation in Terra, the margin to equity ratio is quite small. And admittedly I've had some outsized returns in the last few months, but I won't take credit for that. That's just the markets. The markets have handed me some wonderful trades. But the point is that we can do a mix and match, and you get this convergent, divergent combination set and hopefully gives you nice risk-adjusted returns for your portfolio.

Niels

Rob

Well that's the challenge because they demand an answer, and I'd prefer to not give an answer that they'd like. I'd like to... I mean I think that no matter what number you give them, you know for sure that if you're around long enough and the wrong thing happens, it would be exceeded. It's just sort of the you know...

Niels

That's the academic answering the question. That if we're around for a thousand years you’re probably at some point going to lose all of your money. But that's not really the answer we can give, so how do we bridge that?

Rob

No, no! And you know, I'm not an academic, I'm a... you know I'm a feet on the ground, wrench in the hand kind of guy. I like to take what I think is the worst intra-day drawdown that I see all the way back through time... peak to trough and at least double it. And then what I try to tell people is that now that you know that, under allocate to me please, start small, get a feel... because I want you as a client for a long time so I don't want to scare you away but I want to give you a number that will give us a wide birth to stay engaged while the clock runs forward.

Niels

A lot of, probably most managers, strive to reduce the downside volatility while keeping the upside volatility. But very few managers have actually achieved that in my experience. How do you look at that? Is that where your research essentially is going? That if you can reduce the downside... or let me rephrase that... is that sort of one of your goals, is to try and improve the downside of your programs?

Rob

Absolutely, I think really almost all my focus is in trying to understand and control drawdowns. I think that good things sort of just happen for us in this business. As long as we've really been diligent and focusing on risk management and controlling the downside. So I'm very much focused on that. Success... I think that success will be defined by the diligence, the time and diligence you put into ongoing research. And like I say, it's a lot of fun, it's a huge challenge, but a large component of your everyday existence is making sure that you wake up with a little fire in your belly and you're worried. And I'm always concerned with... I knew how to make money yesterday, I feel pretty good about what's happening today, we've got it under control, but I'm always concerned with how it's going to go tomorrow and what can I do today and going forward to limit the downside and essentially move the whole business forward with all these products. So a lot of it is worrying, and it really revolves around the downside.

Niels

Tell me one thing... and when I look at your numbers, you're certainly not one of the managers with the largest drawdown, let me put it like that. But still, there is this emotional impact when we go through drawdowns because, one is we feel it ourselves, but we also feel it on behalf of investors. So how do you cope with that emotionally when you go through a period of drawdowns? Whether it's not so deep necessarily, but it could be long, how do you deal with that?

Rob

Intensified research and lots of exercise. None of which may lead to any changes in the program. But, it is very, very tough. Actually, the reason that I am configured the way I am right now, if we look at the transition, if you can imagine me with my eyeballs on the intra-day trading screen, running the business the way I used to. Then you examine the way it is now where it's more... I can do a lot more research, and it's... I get to have a more executive approach to the business. It's because of that; there are a couple of things: if you have one program and you're in a drawdown, for lack of a better term, it is a real beat down. I mean, it is really hard on you. These people have trusted you to trade their money. You warn them as best as you can, but certainly they're every bit as human as you, and they're looking at the statements, you know, they've engaged with you and it's not that you're failing per say, but when you're making money, it's better than when you're losing money. And that's simply the human condition.

Again, I would have to say that because of the operational simplicity that I've got, I can have more products or programs. And with each program, certainly there's more to support in terms of having my brain engaged in how each of them is performing and worrying about how they're doing. But if one goes into a drawdown, it's very unlikely that all of them would go into a drawdown. So usually you can have some sort of a winning area. It's not that you don't want to look at the stuff that's in a drawdown, but sometimes you've got to have something to hold onto. You're okay, and you're making some money for some people... and most importantly getting some revenue in the door. In so much as you owe your clients profitability, you're not a business if you don't have revenue coming in. So you have to work on all aspects.

Niels

Let's shift gear to another area which we already sort of touched upon which is the research side. Now, many of the guests that I've talked to, they have very large research teams. And what I've tried to gauge from them is really you know, what are the questions being asked when they sit down, and they have their research brainstorming sessions? I mean in your case, it's quite a one-sided conversation! So what questions are you asking yourself when you sit there and think about research?

Rob

Well, first I try to be polite with myself, which is not always easy depending on what's happening. Well, there's the... well, boy... I feel like I'm back in the IT thing here: there's maintenance; there're ongoing operations, you sort of have your check boxes, are we okay? You know, the variety of questions you might ask yourself: is everything okay, do we need to make any adjustments to shore up our existing products and the expectations of how they perform for the clients? That's one whole area which is always present.

But then, the new, fun, what do you want to do next... sort of stuff... what I do... well, there's a couple of things that I've done. I think that I've told you that I'll go off, and I'll take a sector. Basically, I'll look at the markets because it's just all about the markets. And what I can find out about them and it's sort of like... I'm spelunking; I'm going around and finding this stuff. You find interesting things, you bring them up to the surface, and say that we could put these together, and this would be interesting, and so forth. So, I go off and... I think I mentioned I have some things that are portfolio based for sectors: energy, metals, currencies, and things of that nature. And as you can imagine, as all of us do, it's Saturday morning when it's still dark, I'm down here plinking around and basically going through a long list of notes and things that I want to look into, and then logging everything that I discover, or don't discover.

What I'm doing essentially is, as I mentioned before, building up... taking ideas about checking out particular markets or sectors and testing them to see if I can come up with some strategies that work reasonably on them, and then put them into inventory. And periodically I'll go back and look at them and say well, maybe we can piece this together and this together. I'm not particularly, at this point... let's put it this way... with Vanguard, Agilis, and Terra, it's a lot. And I need to stay focused on it, and that's sort of the production set up, right? But as this inventory builds, there will be potential for other products. And as I mentioned there's Spectrum, which I would deploy reasonably soon. That's my approach. I have this ongoing battle with cotton. It's like... this is bothering me, I kind of found it to work this way, but not that way... and what's wrong with this time period? And do I need to combine it into a portfolio? So I sort of have these things that have my attention and won't let go of me. And I continue to hunt them.

Niels

Do you have some objective criteria that the models have to live up to? Meaning... in two instances: one, I'm guessing that it can be very hard to be completely objective when you're not debating the issues with anyone else other than yourself. And we all know that in some ways we can so easily fall in love with our own work. And so it's both in terms of what triggers a final decision to say, yes, this is good enough, or what triggers a decision to say, actually... this model is not working anymore? If I can put it that way?

Rob

Well, the first thing, you know... this model's not working anymore has the implication that I've already put it into production and have somehow given up. The thing that I will run into from time to time, and actually it's frequent, is there're just markets that I just can't figure it out. I don't have a good answer; I don't have a good solution. I look at the data; I give it my best shot, and I can't get something that looks like it's worth putting into a small portfolio, because it appears to not make reasonable money year over year. And these are not... you hear how squishy that description was... I begin to get a feel for... Here's what I do, I really look at every trade; I review everything that I'm doing as if I think I have a strategy that's beginning to work. And I begin to look very carefully at the market itself. I look at each trade and try and see how much it captured or didn't capture. And if I find that the market is sort of wild enough that I'm going to have to apply too many rules relative to its whole number of trades, that's a black mark. I'm trying too hard; it's starting to look a little curve fitted. So you try to work out of that. And if you can, it still doesn't mean that it's okay, because I could have something that I build a system on and I try and validate it in out of sample testing, and you can't believe that you curve fitted it, but then you look at the data and you say, well, this market can do these bizarre things and I still can't trade... it doesn't make sense. So what can I say... like cocoa, I don't know what to do with that... coffee... I kind of took some... worked on it, but I don't have a good answer. So the answer is don't, right?

Niels

You mentioned something which I found interesting. How many are too many rules, say for a model? When does it become an issue that you're putting too many rules together in order for it to work? In other words, what's the optimal number of rules where you say, yeah, if I can get it to work based on these X number of rules, it must be pretty robust?

Rob

Sort of the... if you can get enough data and you trade on a reasonably short time period like I do. If you can get something in the order of eighty and a hundred and twenty trades per, and I don't even really call them rules, it's like... logic bits or widgets... trade widgets - another technical term, so sort of that hundred to one is rule-of-thumb. But that's just for starters, just to say hey, we've got a big enough sample, and we don't have so many rules that this doesn't make sense. But then probably most importantly is that validating on out of sample and seeing what the performance is there on unseen data. So, are there occasions where I might have... where that ratio might be a little skewed to, let's say eighty, eighty to one or something like that, sure. But the reason that I'll go with it anyway is because I've sort of really closely examined what's going on in the market that I was doing development on, and then very carefully, really feel confident about how it worked in out a sample. So there's some wiggle room.

Niels

But actually I think that I was going a slightly different way. I was trying to figure out how many rules actually go into creating what I... because I think this is something that a lot of people struggle with, and this is why we often get the labels of black box and so on and so forth. But in reality, I think when you speak to most successful managers they would say, simplicity is really the key to robustness. So, I'm just curious... so you could say one rule would be, you know, if it goes higher than the forty day high, we buy. I mean that's just one rule. But in your case, I mean... how many rules do you think on average do you have to have in order for a model to be able to get you in and get you out and make a meaningful contribution to the portfolio? Are we talking about twenty different rules? Or is it just a handful of rules?

Rob

It's more than a handful, but not twenty. Typically I find myself eyeballing it and seeing that really I've got it done... really good ones are in the six to seven range. Ones where I'm beginning to question myself get up into that nine and ten range. Hopefully, that's sort of the ballpark you were looking for.

Niels

It makes sense. But I think sometimes people have the impression that these things are massively complicated. But they don't have to be. I wanted to ask you a last question before we jump to the last section and the question I want to ask you is, when you meet with potential investors, and obviously you've been doing this for a long time, so you've had, I'm sure, a few rounds of meetings, phone calls, doing due diligence, etc. etc. But I'm just curious in one thing, and that really is, what are the things that people should be asking you in order to understand you better which they're actually not? What do you think they're missing in the due diligence that you feel is really important but maybe they're not focusing on that?

Rob

Excellent question, and usually when we're going through the process, I make sure that I weave in... first of all, none of them are as good as the session we're having now. Period.

Niels

Thank you.

Rob

You're welcome. But what I try to do is make them understand who I am, how I react when things are difficult, and I try to give them examples. And fortunately, I'm fortunate enough to be around in the business long enough, and been through sort of three phases of it. How I rationalize how to handle what's currently going on, formulate a problem... or I'm sorry, formulate a solution to really difficult, and as we talked about, can be very highly emotional periods. And sort of have the gumption to make the appropriate changes to move forward. So how do you do that? I think that you have to have these conversations where you get to talk about what happened with MF Global. We talk about how after having learned some lessons, how do you make it so the business is more robust in the long run so that... you know, I certainly love to learn lessons as long as the tuition isn't too high. But, if you've learned some lessons, what are the fundamental adjustments that got made? How did you manage that? And then the final question is, how are you going to manage the next serious problem because there's always a next one? So, I try to find a way to get them to find out really who I am, and I would encourage them to dig in and ask questions that allow them to understand sort of the material, the primordial goo that they're dealing with in terms of the trader.

Niels

Now let's just jump to the last section, and this is just sort of what I call general and fun, so there's no real theme here other than maybe just for people to get to know you even better. And I just have a couple of questions. One of the things that I wanted to ask you was... I mean, you're obviously self-taught in many ways. It doesn't sound like you had a mentor that took you under their arms and guided you. And I imagine that you probably gained a lot of your knowledge and inspiration from reading some kind of books relating to trading. Are there any of these books that sort of stand out, where you said, yeah, this was a really, really important book for me to take me to the next step? And maybe also in addition to a trading book, maybe just a book that was important for you as an inspiration through your entrepreneur journey?

Rob

Wow. That last one will be tough because I was working so hard on your question earlier was! Free time, you're implying there's some free time?

Niels

Well! I don't know about that!

Rob

So, I would divide the books into two camps. I would like to really thank, wholeheartedly, all the people who wrote all the books that talked about all the trading solutions and how to code things up. And you know, this high is above that low, and this oscillator does this and that, because early in my career, I grabbed all of those and very quickly coded up everything that they talked about and saw it all just fail miserably. And it was fabulous that I was able to dig those things up and just completely debunk all the stuff that looked like it was going to work and it didn't, so it allowed me to clear my plate; to go find the ones that might work. So I would... I think one of the... Tharp has one. I can't remember, and I have it somewhere in the corner over here! Which I won't leave you to go grab! But the thing that got me about that is it didn't give out a lot of specifics, and those are the best ones, that just kind of gives you guidelines. And it kind of got me down the path of risk units and volatility adjusted position sizes. Back in the early days, I sort of used that to retool the way that I thought about risk in general. It seems primitive now, but I remember as I read it and worked with it, it made quite a difference for me.

The other one I would mention is one called, "Inside the Black Box," by Rishi Narang. And it's just sort of an exposé on how to break down what it is we do. Flow charts and boxes, and you know, various models generating alpha versus cost models and so forth. And that's a wonderful book. So I'll just leave it at those two.

Niels

That's fine. Do me a favor and send me an email afterwards with the exact name of the Van Tharp book and then I'll put it on your show notes, so that people can see what inspired you and maybe they can get some inspiration themselves. Let's do it like that. You have children you mentioned?

Rob

Yes!

Niels

I wanted to ask you, if you could pass on just one of your skills to your children, what would that be? And why?

Rob

Okay, those would be good things I want to pass on! Okay... boy I... the things that I tell them now, they're just both... you have to love your kids, they're just wonderful, smart, brilliant, young people. And what I try to tell them and I try to practice this... and I saw it in the workplace in my prior career, is that you're going to be up in the ninety-fifth percentile if you wake up, get up, show up. And you don't have to know exactly what to do but just start working on things. And you will get amazing things done. You may be brilliant, that's wonderful, but just keep showing up, and if you have the right philosophy and the right belief system and the right values you combine those things. And I believe anybody can do just amazing things. So that's sort of the dinner table thing, and they roll their eyes. "Yeah dad..." But I try.

Niels

What about a fun fact about yourself Rob, is there anything that even people who know you may not know about you?

Rob

Niels

That's fantastic, great stuff. Now, it's not always that you have a conversation where both Hannah Montana and President Nixon is involved. And so... but I want to make sure that we've covered all the ground that we needed to cover today, and make sure that I haven't left anything out. Is there anything you think we need to touch upon before we end our conversation? And anything you feel we've missed today?

Rob

You know, I think we did really well. You guided me down the path, and I tried to get into the corners of all of it when you gave me the opportunity, and I think we did well! Thank you!

Niels

You're welcome, it's my pleasure. Now what's the best place to people to reach out and learn more about Pacific Capital Advisors, Rob?

Rob

Well, the website, which is pacific capital advisors.com. And you know the phone number is on there as well. And I love taking phone calls. And my email address is: rob@pacificcapitaladvisors.com. And I love corresponding and talking and interacting with clients and fellow traders and so forth, so feel free to pick up the phone.

Niels

Well thank you so much Rob, it's been a great conversation. And I appreciate your transparency. We touched upon some topics which aren't necessarily easy, but as you say, if you don't understand... it's certainly my opinion, if you don't understand the story, how can you understand the numbers? So I appreciate that. And of course the listeners can check out the show notes on the TOPTRADERSUNPLUGGED.COM website where there will be lots of links and points from our conversation today. And I hope we can connect at a later time and see how things are panning out! With all of that I just want to wish you a... enjoy the rest of your Sunday and thanks so much for taking the time Rob.

Rob

Well thanks for having me, and I'm honored to be a part of your stable of traders on Top Traders Unplugged, thank you!

Niels

My pleasure. All the best, take care Rob!

Rob

Thank you! Bye.

Niels

Bye.

Ending

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