Thursday, August 11, 2016

Maximize Your Gains, Not Wins: William Eckhardt Interview

Maximize your trading gains, not the number of winning trades you might have. This is the advice of famed Chicago futures trader, William Eckhardt.

William Eckhardt Trading Success Rate Quote Traders Wins Losses
William Eckhardt image via azquotes.com

Now, if you're not familiar with Bill Eckhardt by name, perhaps you know him by reputation. With his friend and partner, Richard Dennis, the pair concocted the famous "Turtle Traders" experiment, in which an eclectic group of novices were taught to trade futures with a rules-based trend following system.

An excerpt from Dennis' Wikipedia page on the origins of the Turtle Trading program:

"Dennis believed that successful trading could be taught. To settle a debate on that point with William Eckhardt, a friend and fellow trader, Dennis recruited and trained 21 men and two women, in two groups, one from December 1983, and the other from December 1984. Dennis trained this group, known as Turtles, for only two weeks about a simple trend-following system, trading a range of commodities, currencies, and bond markets, buying when prices increased above their recent range, and selling when they fell below their recent range. 

They were taught to cut position size during losing periods and to pyramid aggressively—up to a third or a half of total exposure, although only 24% of total capital would be exposed at any one time. This type of trading system will generate losses in periods when the market is rangebound, often for months at a time, and profits during large market moves...
...When his experiment ended five years later, his Turtles reportedly had earned an aggregate profit of $175 million..."

Several of the original Turtle Traders went on to successful careers in professional trading and money management. Their success even inspired mentor Eckhardt to join his upstart students in the field of professional investing! 

After a long and lucrative career as an individual trader on and off the floor of the Chicago futures exchanges, he founded his own investment management firm, Eckhardt Trading Company, in 1991. 

According to Altegris managed futures research, Eckhardt's firm has returned nearly 6,000% since inception, with an annualized return of 18%. This far outpaces the total returns of the S&P 500 and the "Altegris 40" benchmark. See the performance graph below.

Eckhardt Trading Company performance managed futures William Eckhardt
Eckhardt Trading Company performance comparison, via Altegris.


William Eckhardt on the importance of winning trades vs. overall performance:

"The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance."

Wait, a high win rate may be inversely related to performance? How's that work?

Well, did you ever meet someone who boasted of using a system with 80% - 90% winning trades? What you may not have heard is that many of these systems sacrifice profit potential in favor of high winning percentages. Some of these systems, and the traders who follow them, may even lose money over time. 

Take for instance, the trader who frequently captures small profits while taking oversized losses. In no time, the large losses from the infrequent losing trades swallow up the meager gains from the more frequent winning trades. High win rates do not necessarily equal profits and performance.

Focusing on capturing frequent wins may be comforting for the human mind and ego, but that psychological comfort comes at a steep price. Eckhardt spoke about our natural tendency to maximize wins over gains in his Market Wizards interview with Jack Schwager. Here is the full passage on the folly of favoring wins and small profits:

"One common adage on this subject that is completely wrongheaded is: You can't go broke taking profits.
That's precisely how many traders do go broke. While amateurs go broke by taking large losses, professionals go broke by taking small profits. 

The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of a gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. 

The success rate of trades is the least important performance statistic and may even be inversely related to performance."

Eckhardt's partner Richard Dennis compared the trader's focus on money and "wins" (the hoped for results of trading) to a baseball player's lack of focus at the plate (quote from The Complete Turtle Trader): 

“Trading is a little bit like hitting a ball. If you’re thinking what your batting average should be, you’re not concentrating on the right thing when you bat the ball. Dollars are the batting average of the trader.”

Which brings me back to this recent post on Babe Ruth and persistence. The Babe wasn't too focused on strikes or his batting average. He focused on swinging the bat well and connecting with the ball when he was at the plate.

Ruth's system, as it were, capitalized on his herculean feats of slugging. Rather than avoid strikes, he knew that each strike would bring him "closer to the next home run". With a career batting average of .342 (10th highest on the all-time leaders list), Ruth hit safely in "only" 34 percent of his appearances at the plate. However, that's all he needed in order to score a huge amount of runs and help his storied Yankees win numerous championships.  

What are your trading or investing goals? Do you find yourself harvesting small gains and accepting bigger losses? Or do you strive to boost your performance by keeping a tight reign on losing trades and letting your winners run?    

One thing I've learned: If you focus on improving your swing (process) and give yourself room to maximize your gains, you may just end up hitting the ball out of the park!

Related posts:

1. Marty Schwartz: Market Wizards Interview Insights

2. Vic Sperandeo, Market Wizard: Exclusive Interview on Trading

3. William Eckhardt Interview with Futures Magazine

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