Imagine you found an advertisement in the newspaper offering a position with a one sentence application process.

Would you take it?

What if it was for a position where you would learn a proprietary trading system in which you would trade solely for owner of the firm?

What if that man was Richard Dennis?

Our next guest took that position in 1983 and it changed his life forever, for the better. He found himself with what was to become a famous title, a Turtle. He was given the opportunity to manage a million dollar account with specific rules to follow. Rules that he would learn to love and perfect.

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In This Episode, You’ll Learn:

• About the Turtles and how the unique experiment grew into the Managed Futures/CTA Industry
• How Wall Street Leaks inspired Jerry into understanding the industry
• How Jerry encountered trend following for the first time
• The One Sentence culture in Richard J. Dennis’s office
• How to excel at unprecedented tests from leading traders
• What it was like moving to Chicago to train as a Turtle
• What the Turtle training was like and the mindset provided in the training
• The most challenging thing about Trend Following when Jerry started with Richard Dennis
• About the transition from Turtle Trading to starting his own organization, Chesapeake Capital in 1998
• The evolution of Chesapeake’s strategy from day one after leaving Richard Dennis’s program
• The early focus on diversification and adding new markets
• Issues with trying to improve the original Richard Dennis
• The shift in investor expectations with the growth of institutional investment organizations while operating on of the largest CTA firms in the industry
• Why it’s best to take an optimal loss rather than a small loss
• On the meaningfulness of track records and what else investors should be encouraged to explore when choosing an investment management decision

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The advertisement Jerry responded to in 1983:

Richard J. Dennis and CD commodities is accepting applications for the position of Commodity Future Trader to expand his established group of traders. Mr. Dennis and his associate will train a small group of applicants in his proprietary trading concepts. Successful candidates will then trade solely for Mr. Dennis. They will not be allowed to trade futures for themselves or others. Traders will be paid a percentage of their trading profits and will be allowed a small draw. Prior experience will be considered, but is not necessary. Applicants should send a brief resume with one sentence giving their reason for applying.

Resources & Links Mentioned in this Episode:

• The Barefoot Trader (Article about Richard Dennis in Wall Street Journal)
• Learn more about Richard J. Dennis the founder of the Turtle program

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

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Learn more about the Trend Barometer here.

Send your questions to info@toptradersunplugged.com

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Niels

Jerry, thank you so much for being with us today. I really appreciate your time.

Jerry

Oh, thanks for having me. I'm looking forward to it.

Niels

Good. Now, Jerry, the turtle story is well known today, but for many years it was one of the best kept secrets in our industry, at least that's how I remember it. But when I think about how the story has become known over the last 10 years or so, not least due to the big efforts of Michael Covel, who has written some great books on the subject, I'm not aware that any of the Turtles have ever talked about their experience in detail directly to a wider audience. There's been pieces of information made public, directly, from one or two of the Turtles, but not a lot. So I think today will be quite special because you are able to set the record straight, so-to-speak, and tell us about this unique experiment that turned out to be such an important part of what we know today as the managed futures/CTA industry, and in particular the trend following world, which is perhaps a better name for what you represent. Now before we dive into the story itself, perhaps you could start by telling us about your journey leading into the day where you came across the advertisement in the Wall Street Journal. What were you doing in your life at this time?

Jerry

Niels

So, discretionary trading was not really part of what you were doing at the time?

Jerry

No, I think it's kind of amazing that, from the very beginning when I first heard about a systematic approach and trend following, it just made perfect sense to me and was something I wanted to do. I would watch Wall Street Week here, in the states, and it's a popular TV show, and on the show there were some people who talked about trends and things like that: price trends, and risk control, taking small losses, diversification, and that was about all that I needed to encourage me to continue down that road.

Niels

Jerry

Oh wow, that takes me back. Well, as fate would have it, I had heard of Richard Dennis, and so I'm living in Richmond Virginia, and that would be unlikely that I would even hear about him, but I had received something, or seen an article - a business week article, I believe about Richard Dennis, and it was entitled, I believe, "The Barefoot Trader", so I guess Rich would sit in his office and do his trades, and not wear shoes. OK so that's the title of the article, so, immediately, like you implied, you need to have some confidence that this is a legitimate ad. So it was in the Wall Street Journal, and I never would really even read the Wall Street Journal ads, who even reads them? But I happened to stumble across it and I immediately thought it was legitimate, and I was very excited and hopeful and I sent my resume in.

Niels

Do you remember what reason? I mean he asked for one sentence in terms of a reason, do you remember what reason you gave? Because clearly, you got to the next stage, so you must have said something that appealed to him.

Jerry

I don't. I don't remember. I think everyone probably got a response, and the response from them was: here is a test of 100 true/false questions that you had to answer and send back. It's kind of funny, because the whole idea of one sentence was exactly what they always wanted, regardless. When I got the job, they would ask us, a few time a year to respond to a question, but every response had to be one sentence. So, it was kind of funny.

Niels

Yeah, so, date the time when you saw this ad, what are we talking about in terms of time?

Jerry

Niels

OK, tell me about the interview experience. What did they want to know about you and also, did you have any questions for them? And I know we mentioned Richard Dennis all the time as the name, but of course in reality we're talking about two individuals here: Richard Dennis and Bill Eckhardt.

Jerry

Yeah, but it was mostly Rich's project, and you certainly knew that Rich was running the show, and that Bill was his incredibly trusted friend. So I tried to study, how silly is that, to study to better impress them with all my knowledge of trading. But a couple of things stand out about the interview. And to go back to an earlier comment that you made, to set the record straight, my memory is not that great, and then everyone just has different opinions of the facts and of what happened, and it has, over the years of talking about the experience in the Turtle Program, everybody remembers it slightly different. So there is no setting the record straight, it's just what I remember and how I remember it.

Niels

Exactly.

Jerry

A couple of things, one was they asked me, "how do you think you did on the test?" And I said, "I think I did pretty well." I had just taken this test around with me and kept it as long as I could, and agonized over it, and I finally sent it in and they said you had the highest score out of 1,000 people. So, that was sort of my claim to fame. I think they wanted to hire people who had done really well on the test, and they wanted to hire people who had done poorly on the test and had other things going for them. So there were people there with better personalities and histories and maybe more things going on in their life than me, and they were hired, and I was sort of hired because of the test. And there was one famous funny question that Rich asked me, and I think a hand full of other people at least, was, "how much do you think you already know about trading, on a scale from 0% to 100%, how much do you already know?" And I said, well, I would say about 90%. Of course that's sort of laughable, or should have been laughable at the time, but I said it never the less, and I think other people, maybe even went higher than that, but, if I remember correctly, I think Liz Cheval said close to 0 (laugh). So, the first year there were 11 guys hired and Liz Cheval. The only woman that was hired was the only one with the proper amount of humbleness. In reality, the rest of us, or at least a couple of us were way over confident.

Niels

Why did you think that you did well in the test? Was that because the questions came natural to you, because you already were, sort of a little bit familiar with trend following, you mentioned, or I heard that some people had read up on articles on Richard Dennis and actually could pretty much get the answers from those articles, why do you think you did so well?.

Jerry

I just remember looking at the test, one day, and saying well, here goes, I hope that these guys are trend followers. And I guess I didn't really remember, or get that from that business week article. And, another thing too is, that I had probably some experience in what you would call a contrarian thinking - In not going for the obvious answer, so maybe that helped also.

Niels

How long did it take for them, after the interview, to inform you that you had been selected?

Jerry

I don't remember, but another funny story is that, I was at an audit, and I got a phone call, and I got a message saying call this number in Chicago, and so I sort of ignored it for a few days or a week, and then I got another phone call saying, please call us, and I was like, oh, wait a second, this could be Richard Dennis, I think I should call (laugh).

Niels

Jerry

December of '83 I moved to Chicago, and yeah, I had two suitcases and I sold my car, I sold my microwave, I talked to a friend of Rich's, a real estate agent, and the first apartment she showed me was just wonderful, beautiful, 16th floor, overlooking the beach, for $600 a month, and I didn't know a lot about Chicago, or that process, but I knew enough that that was a good deal, and so I had a great place, and it was just perfect from day one, and I just loved living in Chicago, and the people were amazing, and I loved everything about it.

Niels

Sure. You mentioned that there were 11 of you in the first class. Tell me about your first day. What impression did you have of the other Turtles when you first came to the office, I guess?

Jerry

The first interaction was in the Turtle class. I think there were 2 or 3 weeks that we spent 8 hours a day at the Union League Club, in Chicago, being taught trading, trading psychologies, and some statistics in math, concepts - it was important to them. And so, I kind of got to know some of the Turtles there, and I was impressed. There were a lot of very smart people, but also people that had worked for Rich or friends of Rich, and just an amazing group of the smartest people I had ever met: Rich and Bill and Dale - and some of the nicest people I had ever met also. I was really amazed. I didn't understand why every 30 minutes or every hour we would take a break and everybody would run for the phones to check up on the quotes and stuff, not realizing that in a month or two I would be doing the same thing, so there was no cell phones, or mobile ways of checking the markets, but everybody was very interested in that.

Niels

Sure. And just out of curiosity, how many were in the second class actually, so how many were you in total?

Jerry

I think there were 8 in the second year, and so one year later they just did this same process over. So I think it was around 20 people, and we were all trading from this same office in the insurance exchange building, in an office, in a building separate from Rich's office. I think the second group was a very good group, maybe better traders, more intelligent people. I know I'll get in trouble for saying that, but I was in the first group, so I guess it's OK, but a great group. Both groups were great, but the second group was particularly good. They have more people still trading: Paul Rabar, Tom Shanks, Jim DiMaria - some lifelong friends. Another thing that was kind of interesting, which comes to mind, and I don't know if anyone has ever mentioned this to you, but one of the most fun things that the group ever did was, like once a year, everybody would have an opportunity to go up and trade with Rich for a day, so if you get the impression that we didn't see Rich very much, other than that, it's kind of right. We maybe saw him a few times a year. They would come over and talk to us and give us some ideas and some constructive criticism, or some new research ideas, but it was pretty much sink-or-swim, you had the rules, you should follow the rules, but it was really fun to go up to Rich's office, once a year, and talk about trading, and talk about politics, of course, and then go to lunch, and so that was a highlight. I talked about trading for the first hour and then it was mostly politics the rest of the day (laugh).

Niels

Sure. Now, just in the first period, during the classes that you took with Richard, what were you actually taught? What did they tell you, because it was quite a short period of time compared to the length of the experiment?

Jerry

You mean the training class was short?

Niels

Yes, my understanding is that you were only spending two or three weeks actually being taught the rules and so-on-and-so-forth, so what were you actually being taught initially before you were let lose so to speak?

Jerry

Well we were taught the philosophy of the trading systems, the philosophy of trend following, and specific entry and exit signals. But it was much more than that, it was a mindset, it was a philosophy. How should you approach the markets, how should you think about the markets? The markets are going to change over time, so these specific set of parameters may have to be adjusted over time. So we were well equipped with training and the mindset that you need to evolve over time and understand how the markets work. Another thing that is totally under reported is the impact that you can have learning from such great people, and people who are very smart and know how to approach things in the right way. You just can't duplicate that. If we lost money, we were only evaluated in terms of, did you follow the systems, not your performance necessarily. And just the encouragement in that atmosphere, which is a pretend atmosphere, that you're not going to have clients with that sort of understanding, our client Richard Dennis, created the systems, and so he believed in them as much as we did, and more than we did. That sort of mentoring and foundation that we had far exceeds just me telling you, or someone telling me, here's how you should trade, here are the systems, and here are the parameters. So when you have to deal with the markets and clients and drawdowns, there's a lot more to draw on than just the specifics of the systems, for instance.

Niels

Sure, sure, and the concepts, if not the rules - when you were taught them, did they make sense to you straight away as they do now, or were you initially simply just following what you were being told to do?

Jerry: They definitely made sense to me, they make more sense to me now, and I was OK following them. I think at that point in time, in that Turtle room, it was more like I really want to make sure Rich is happy, and I want to make sure that I don't blow this opportunity. I think that part of their desire for the Turtles was to get something out of the Turtles - to learn what we know and what we've taught you, but from your experience in trading; to tell us what you think might be some good ideas and some ways of looking at the markets. But I don't think it worked out that way. I think people were competitive and too interested in making sure they followed the rules exactly, and their creativity was limited. The down side was too large. If you strayed from the systems, at least in my doubts, I felt that if I strayed too much, that there wasn't much of an upside to that. It was only when the program ended and I started Chesapeake, that I really had the freedom, and I had to, I had to be my own person, more so, and I had to think about it more, and it was up to me what I wanted to do there was no more having to please Rich, or to have him tell me what I could and couldn't do, and you're on your own, and now my creativity reached an all-time high. I was forced into it.

Niels

So after the teaching ended, after the first two or three weeks, what happened next? Did you all get information about what account size to trade, and how does that work?

Jerry

Yeah. I think in the very beginning, you know we started trading January 2nd, and I believe that everyone had a million dollars to manage, and we were using our strict rules: the rules of the entries and the exits, and the trading size. Then, about after a week of trading, Rich called us all on the telephone and asked us how we were doing and what we thought. And so, I had a really slow start, I was a little timid, and I just remember him being very understanding, and he said, "Well, how do you think you've done in your first week?" And I said, "Well, I think I did OK but I probably should have taken more trades." And he said, "Yeah, yeah you should have done more trades, don't worry about it, just start trading and doing the trades that you should do." So, of course, one of the biggest rules of trend following, or systematic trading, is you must take all the trades, and so here's this guy, kind of afraid and kind of shy, and typical Rich, he was just very understanding, and he just knew how to deal with people and to motivate them, and just a really kind person. So, eventually I got the hang of it, and I started doing a lot better.

Niels

Sure, and in the beginning, what was the most difficult thing? Was it working out the signals, or the risk, or was it really just pulling the trigger that you found difficult?

Jerry

I think pulling the trigger, for sure. I'm not sure why, now, after so many years, but at least then it was...yeah, pulling the trigger, doing those trades, buying those breakouts and going with the trend, just the fear of losing money: putting a trade on and having to lose money. At some point in time I'm sure the second problem was getting out of trades too quickly in trying to preserve a profit. That's kind of a no, no. You just need to do the trades that the system says to do and sometimes the system is going to...you hang in there longer than you feel comfortable doing. That seems like such a long time ago now.

Niels

(laugh) I know that Richard Dennis taught you to love your system. Tell me about this statement, and during the Turtle Program, how long do you think it took you to get to the point where you loved your system 100%?

Jerry

Wow, I don't know how long it took me, but, I would definitely say that the problem with loving your system is you have to love the characteristics of it. That's really the problem, and the characteristics are, you have less that 50% winning trades, take lots of small losses, you have big profits turned into small profits, profits turn into loses, you have drawdowns, you have really bad days, and so embracing all of the characteristics is very difficult, but I guess their point was, you've done your back test, you have your system, this is your best idea on how to trade and be profitable, so you should love everything about this.

If part of the characteristics of this system is losing trades, of course you love your losing trades; if part of it is drawdowns then of course you love the drawdowns. One of the true/false questions, on the Turtle test was (that) a trader should love to take loses. It's true, because taking loses is part of your system and you love your system. Now, I think what happened, after the Turtle Program, is the problem with loving your system, and the elements and the characteristics of that system is that maybe you love it, but your clients don't. So that has a big negative impact on your daily enjoyment of life, and once again, that's why the Turtle Program was so amazing, because our client understood trading, unlike most clients, and actually created those systems and created the Turtles.

Niels

Sure. Absolutely. Now you mentioned that, maybe the experiment didn't foster the result in terms of the Turtles going out and developing their own additions to a large extent, and in your case, that all came later. But was there any kind of evolvement of your own trading, your own system, during those 4 years?

Jerry

Not really, like I said, Rich would come in every now and then and discuss new research and, I pretty much took his recommendations on this research, and how I should alter my trading based upon their research, so we didn't have the capability to create our own research, or at least I didn't, and it was only afterwards where I felt more freedom to use my own ideas.

Niels

Yeah, now about a year after you started, the next Turtle class joined. Did that change anything, in terms of dynamics, of the group, and were there any of them that, just generally during the time in Chicago, that you became closer to?

Jerry

Oh sure, I'm still friends with Jim DiMaria, and Paul Rabar, Tom Shanks, Mike Carr...but I don't think it really changed the atmosphere too much. We had more fun, maybe. I remember one of the big conversations that we would have with people, in the Turtle class, would be typical politics and sports and stuff, and I just felt the need to remind everybody every now and then, that this is the greatest job ever...we're having more fun than we are ever going to have in our entire life, and we are incredibly fortunate to be here, and life is never going to be any better. We were so happy trading a couple of million dollars. For me that was probably my peak with Richard Dennis, and had no idea that the CTA business would turn into billions of dollars under management, and big businesses, and so it was not even thought of, and at the time we didn't feel it was necessary. The quality of life was so high when we were there. It was just a magical time intellectually, personally, and it couldn't be better.

Niels

Sure, sure, and how long did it last and when did the program finish, and did it finish for everyone at the same time?

Jerry

Niels

Sure. I want to move on to the beginning of Chesapeake, but before I do so, you mentioned how important Rich was as a mentor for you during those years. After the Turtle program, did you stay in touch, or even close with him after that?

Jerry

Well, I've seen him a few times over the years, and had some nice conversations. Then about 5 or 6 years ago, Rich hosted a Turtle reunion in Chicago, and so that was fun, and we got a chance to see each other and talk about the prior years. Like I said, I see some of the Turtles every now and then, and I communicate with some via email and such.

Niels

Jerry

No, no, no, like I said, I had no idea that I should move on, or that I would make more money. I just didn't have that concept, and Richard sort of decided to move on. The program was initially supposed to last 5 years, so it ended up lasting 4, and I don't think that anybody was looking forward to going out and trading without Rich. It was just too much fun, and we were all making good money, and we didn't know what we didn't know at the time, which was that the industry was going to grow, so I wasn't ever faced with that temptation to want to leave.

Niels

So when you did finish how did you...because it would seem to me, at least, that it was a rather swift transition from leaving to actually starting Chesapeake, how did that come about so quickly?

Jerry

I met Paul Saunders, of Kidder Peabody, and he had a track record, which was very important, of course, and the track record was good, and he gave me my first client. I had a managed account, $2,000,000, so right out of the box I kind of knew that I should trade smaller. I think back in the days the Turtles were making about 150 to 200% a year (laugh). My worst drawdown was in, like the spring of '86, I think I lost 60% in one day.

Niels

Wow, yeah, that's a lot.

Jerry

I was up 200%, and this was on the back of...probably most of the markets were really trending, and especially crude, and crude was on its way from $40 to $10, so we were short a lot of crude, and it was just one of those days, probably one of the first counter trend days that we experienced, and it was a massive counter trend day, and started the day plus 200 and ended the day plus 140. But in that environment, this is what we knew. This is what our mentor had told us to expect, and we were following the rules, and so what. So when I started Chesapeake, I kind of said, well, maybe I should shoot for 20%, and I remember doing those first trades with a lot less leverage and risk, but kind of feeling a little guilty. I knew Rich was not watching me but I still felt guilty changing my approach here, my risk approach, but right out of the box I lost like 20%, and then I lost my client, so a quick introduction. So by then I had two clients: I had a $2,000,000 client and a $300,000 client, so I was left with only the $300,000 client, but we had some good trends that summer, and probably by the middle of summer I was making pretty good money and I had some clients coming back.

Niels

Sure, because you actually end up the year...I know you were down 20% the first three months, but you end the year by being up nearly 50%, so clearly the trends came back.

Jerry

Yes, and I was just...I should have been more fearful about losing clients at that time, but I...even today, I still try to err on the side of I'm just going to make myself happy, do what I think is right, and you just have to be true to yourself and your system, and not be too concerned about your clients.

Niels

Jerry

I would say that's about right, I just don't remember how I evolved. The most important thing about my evolution has been, whether it was by instinct, or having computer research, it's always been to become a little bit more longer term. I think that has proven to be necessary, over the years, given the choppiness of the trends, and the amount of trend followers and computers. Trend following can be good, and will be good, but it's going to be a little bit more choppy with the bigger drawdowns. We need to have longer term exits in order to stay in the trends and not keep getting whip sawed in and out.

Niels

Jerry

Niels

Sure. Well we might talk about that a little bit later, but in the early stages of your research, do you remember what you were focusing on? Was it mainly time frame differences, or was it market diversification, do you remember what you were focusing on early on?

Jerry

I've always been very focused on diversification, and adding markets, and being as quick as possible to adopt the non-US markets, and I've done the single stock futures, so I've always been sort of preoccupied with trading as many markets as possible and dividing up my risk budget amongst as many markets. Even if they're correlated, they're not going to be 100% correlated. I just like trading them all.

Niels

Yeah, because I was actually thinking back because I, of course, had the pleasure of working for you in the mid '90s and I seem to remember, but correct me if I'm wrong here, that even in the mid '90s you were looking at, or maybe had already implemented some of the single stock futures as well the traditional futures markets, is that right? Or did that come later, actually?

Jerry

That's right. We may not have traded the single stock futures, but I know we started out trading cash stocks, contracts for difference, maybe some options, synthetic futures in the options markets, so we did other things, but once the single stock futures, and once Chicago started, for a long time, we were pretty much the only CTA utilizing those markets. You asked me another question, like what kind of other research I was doing, and I would just say that I don't really remember, but I know what I was not doing - I was not interested in adding anything to the trend following. I was not interested in anything counter trend, lean reversion...I just bought this stuff hook-line-and-sinker, almost like no one else. And I would say that I classify myself as someone who is very flexible, and I would say that I am open minded, but I probably trade the original system philosophy as much as humanly possible. I don't know what the other Turtles...how they trade, necessarily, but the most important thing that we did was expand our holding period.

Honestly, I have been in this business for 30 years, I have talked to a lot of people, I have read a lot of material, I would change in a heartbeat, in an instance, if I could improve, but I just haven't seen anything better than what we were taught. Especially given the fact that I'm always going to err on the side of robust systems, and being conservative, and not trying to do things to my systems that would weaken their reliability. Like you said, we never had as good a period as we did in the first years, where we made money almost every year. I think that's good enough. Part of with trend following, you're going to have the volatility, you're going to be tempted to reduce those drawdowns, capture profits more frequently, and you're going to be tempted to do that in ways that I don't think, in the long run, is going to be helpful. I think resisting that, and creating systems that have a tendency to make money almost every year, clients will respond to that and, I believe, that that is a trade off if you are willing to sit through some drawdowns and follow the rules and not have your systems having too many parameters and too many rules, then that will increase the reliability of the systems and your ability to make money almost every year.

Niels

Jerry

That's a good question. I think that we were riding high and on top, and since we had proven we could make money very frequently, what's next? Only thing next is to get rid of all those bad drawdowns, so I think by trying to minimize the drawdowns, and the bad parts, the

parts people don't like about trend following, we ended up getting rid of some of the good parts also. So, essentially, the way I would describe it is, everyone is tempted, most people do it and that is putting things in your systems that essentially cause you to cut your profits short. So whether it's taking profits, or preventing what you think might happen if you wait for your trend following exit, you could get back too much profit, resizing your positions based upon the new volatility, profit objectives, that's one of the problems of trend following, is that the Turtle trend following: Richard Dennis trend following was the severe limitations on the "research" and supposedly improvements on your system, is that they do improve the back test, but they don't improve the future.

Niels

Sure, sure. Now, before we jump to the next point, I wanted to just stay a little bit with what you said, namely that people don't like the down side of trend following, but I've heard you say, before, and I hope you know what I mean when I say this, and that is that you actually have a very strong belief that trend following is the least risky investment strategy, which to many people is not exactly how they see it. Can you explain a little bit about why you know this to be the case?

Jerry

Ah, well...

Niels

And I guess it goes to the philosophy of cutting losses, letting winners run, etc. etc.

Jerry

That's right. I just think when you break down the trend following that I've been doing, and the way I was taught, there was not any component of it that you would not want to embrace. These markets are very dangerous, and competitive, and so the first element of my systems is diversification. I don't want to become less diversified - that doesn't sound right, I want to be more diversified. I want to have shorts and participate in many different trends and many different markets as possible.

Number two would be the systematic characteristic that it has, I want to back test my rules, I want to make sure that they work, I want to sample size to be thousands of trades, and I want to follow those rules. I don't think it's appropriate to get rid of the systematic approach and trade without the rules or without following those rules. I think the third part would be the long term nature. I think you should only be as long term as you need to be. Everybody desires to trade shorter term, the drawdowns would be less, the pain would be less, but you just need to find that sweet spot to where you can continue to make money. We can't bill ourselves as trend followers and then see a 2 or 3 year trend in gold, for instance, and we don't make much money because we kept getting in and out. So I think all of the elements of trend following, taking small losses, letting your profits run, using a trailing stock, paying attention only to the market prices, these are all things that are ultimately necessary to have a good risk control approach to these markets.

Now, I think that CTAs, and Chesapeake in particular let's say, has taken this amazingly great approach and philosophy and mishandled it in different ways, at different times, and one of those would probably be too much leverage, trading too large. So, if you trade too large, and you have 30% or 40% drawdowns, then the poor client cannot see all of these benefits, and experience those benefits because the leverage was just too much for them to take. I think, as an industry, sometimes the fees have been too high, the commissions have been too high, the leverages too high, etc. etc., so all the great characteristics have been overwhelmed by some of our poor business decisions.

Niels

Jerry

Well, only in the sense that, in hind sight, I think it was a low leveraged program - one that's intended to make about 10% a year, would have been a better idea from a business point of view. So I think...and I do think that we resisted the idea of portfolio management, and managing the volatility.

Niels

In what way Jerry?

Jerry

I talked to other CTAs and they would say well, if the volatilities in a trade increase, we will decrease our position of volatility. If the portfolio gets above a certain level we'll do non-system trades that are more portfolio management type trades. And I think we resisted that, and I think that we were right in resisting that, because too much of that destroys the core system and the robustness of the trading in general. But in a period, like the last 4 or 5 years, where there are not that many big trends, and cutting your profits short, it tended to work, so I don't think it's something you should be doing, but bad ideas can work for a long period of time. That's one of the things that Rich told us, is that, if you lose 50% of your money, you are going to be fired. But he said, you know what, I'm going to look at all this based upon how well you are following the rules, and so if you are making money, but not following the rules, you also may be fired. But if you are losing money and you are following the rules, then (that might be OK). So I think that's sort of the problem with evaluating traders on a small sample size, is that bad ideas can seem to work. I think that any idea that cuts your profit short in the trend following space, overall, eventually that's going to not work very well.

Niels

Jerry

Niels

I've seen that a few times as well for sure. Yeah. Now the last 4 years you've mentioned a couple of times, and we all know that they have certainly been challenging. Is there anything in the way that you look at it that makes you think that something's changed? I know we can talk about, which I don't think we need to, that there's been a lot of external manipulation, and-so-on-and-so-forth, but I also recently heard that Larry Hite at ISAM, that they are going back all the way, I think, 800 years or so, and looking at those numbers, that they concluded that this is kind of a normal phase within a bigger picture. Do you share that view, and is it because we, maybe only look back 20 or 25 years when we talk about CTA performance, that we think that the last 4 years is unusual?

Jerry

I definitely think it's unusual. I think that (maybe we can talk about this latter) but I think that it's worth exploring the differences between trend following and managed futures. So I think that trend following is fantastic when the markets are trending. So our stock fund made 65% last year, awesome. And I'm sure I'm going to be happy with the way it handles the inevitable reversal, in some of these stocks and in stock markets in general, so as compared to other ways of liquidating those trades. But I think the problem with the managed futures industry, or Chesapeake in particular, is that 40% to 50% of our risk exposure, or risk budget, was in the commodities, and they have just been flat lining for 4 or 5 years. So it looks like we don't know what we're doing any more. It looks like trend following is broken. But maybe what's broken is a part of our decision making process of making commodities 50% of our risk exposure. The same systems that had poor performance, or no performance apply to more normal type trending markets, get much different answers.

I think trend following is broken if you trade too short term. It stopped working in the late '90s - the shorter term approach. But the longer term approach continues to do very well, but nothing is going to work well (when the markets don't trend). It's working the way it should when the markets don't trend, and it's more of a business decision - a portfolio construction decision on the CTAs than it is on the systems themselves. The CTAs that are really large, that cannot trade more than 10% or 20% commodities, have done much better.

Niels

That's true, that's true.

Jerry

This was a big disadvantage not to have all this great diversification that you can get with commodities became a big advantage because the portfolios of the larger CTAs concentrated mostly on stocks and interest rates.

Niels

Before we leave the subject on losses, I know that you were quoted by Michael Covel as saying something like, "I used to say we take a small loss, but I think it's better to take an optimal loss". Can you tell me a little bit about what that really means and why it's so important to look at it that way?

Jerry

Oh, I think that, very quickly, the computer can tell you what is an optimal stop loss placement, and how to calculate the optimal stop loss. So it's kind of unspecific to say I take small losses, well what does that mean, because a loss that is too small, you'll continue to be whip sawed, and your percentage of winning trades will be too low. The size of the stop loss and the trailing stop will have a direct impact on your winning percentage. Just because you are willing to trade a system that is 40% when it trades, or less than 50%, doesn't mean you want to be in the 30s or the 20s. So you want a stop loss that is sort of optimal in a sense that winning percentage is in the low 40s, you don't continue to get in and out a lot, which you have trading costs, slippage costs, and commissions, but you don't want your stop loss to be too large, so I think it's just better to look at these things in more specific terms rather than in something so general.

Niels

Sure, sure. Now, this is not specific to your trading, but more specific to your experience, and that is when people look at performance and they need to decide who to invest with, they obviously look at historic numbers. Do you think that historical track records are really that meaningful for investors to look at when they do their research and, if not, what would you look at, what would you encourage investors to look at when they do their research to decide?

Jerry

I definitely think you should look at the track records, there's no doubt and the most important thing about a track record is the longevity and obviously the performance. I think the problem with looking at track records is that you can come to a conclusion that you know who the top five traders are, and so the best idea is to hire 20 traders that all look pretty decent and good and have been able to stay in business, and withstand many different environments, but don't for a minute think you can pinpoint who the top five are going to be in the future. The fact of the matter is that most of these CTAs and trend following systems, they make the same amount of money. That's our experience, and that's been our research is sort of sharing that every different set of parameters will have better and worse performance over time. After a 20 year period, or 10 year period, it's going to be pretty much the same performance. I think people just don't want to hear that. They want to be able to segregate the different traders or people into the good, and the bad, and so they're totally shocked when the best manager has a poor year, or a bad period as if they can defy the laws that all the rest of us live under.

Niels

Jerry

I think the biggest complaint that people have now...

Ending

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